美國信安金融集團 (PFG) 2015 Q3 法說會逐字稿

Good morning and welcome to the Principal Financial Group third-quarter 2015 financial results conference call.

(Operator Instructions)

I would now like to turn the conference 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 the reading of the safe harbor provision, CEO, Dan Houston, and CFO, Terry Lillis, will deliver some prepared remarks, then we will open up the call for questions. Others available for the Q&A are Nora Everett, Retirement Investor Services; Jim McCaughan, Principal Global Investors; Luis Valdes, Principal International; Deanna Strable, US Insurance Solutions; and Tim Dunbar, our Chief Investment Officer.

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

Before we discuss the quarterly financial results, I want to remind you of the investor workshop we're holding on November 6 in New York City. Dan Houston, Jim McCaughan, and other members of our leadership team will provide an update on our strategy and discuss the benefits of integrating Principal Funds and Principal Global Investors. Additionally Terry Lillis will provide an overview of the enhancements we're making to our financial supplement. Registration details are on our website. We look forward to seeing you there. Now I'd like to turn the call over to Dan.

Thanks, John, and welcome to everyone on the call. As this is my first earnings call as CEO, I'd like to take a brief moment to thank our Chairman, Larry Zimpleman, for his many contributions throughout his 44 years at The Principal and especially as CEO. He not only led us through the financial crisis but also helped us evolve from a domestic employee benefits Company to a global leader in retirement and investment management.

I'm proud to lead our Company in executing on the strategy firmly established during Larry's tenure and will continue to focus the Company on delivering sustainable, profitable growth. Larry remains Chairman of our Board and we'll continue to benefit from his guidance and tremendous breadth and depth of knowledge.

I'd also like to welcome Nora Everett, President of Retirement Investor Services; and Deanna Strable, President of US insurance Solutions to today's call. They will be available to answer questions at the conclusion of our prepared remarks. I'm incredibly proud of the strength and commitment of our leadership team who are all industry experts in their respective fields.

Now I'll provide some comments about our results. As John mentioned, there are slides related to today's call on our website. The key themes for the quarter are outlined on slide 4. The businesses delivered solid results in third quarter, especially given strong macroeconomic headwinds from market and interest rate volatility and a continued strengthening of the US dollar.

The results generated this quarter demonstrate the revenue and earnings stability it that our diversified business mix provides in a variety of market conditions. Strong fundamentals and focused execution across our businesses resulted in total Company operating earnings of $317 million in the third quarter, driving the year-to-date total to $967 million. Year-to-date net income is strong at nearly $1 billion. Our continued ability to generate growth enables us to increase long-term value for shareholders through capital deployment.

Last night, we announced a fourth-quarter common stock dividend of $0.38 per share and our Board authorized a new share repurchase program. These actions signal our confidence in our ability to grow earnings in 2016 and beyond. Terry will provide additional details on third-quarter financials, including normalizing items that impacted results.

Despite unusual items this quarter, our businesses continued to achieve solid underlying growth. On a trailing 12-month basis total Company net cash flows were $25 billion and we ended third quarter with $516 billion in assets under management.

Strong investment performance continues to be a differentiator and is a foundation for future operating earnings growth. 45 of our rated mutual funds, or 78%, have a four- or five-star Morningstar rating.

Additionally as slide 5 shows, at quarter end 86% of Principal's investment options were in the top two quartiles of Morningstar rankings on a one-year basis and 91% in the top two quartiles on a three- and five-year basis. Finally, 100% of our target date funds were once again on the top two quartiles of Morningstar rankings across all time periods at quarter end, further enabling us to help more customers achieve financial success.

This performance translated into strong flows across our retail, retirement and institutional platforms. Principal Global Investors ended the third quarter with total assets under management of $324 billion, including $120 billion of unaffiliated assets under management.

Third quarter unaffiliated net cash flows of $2 billion were a large portion of Principal Global Investors third quarter net cash flows of $3 billion. Success across multiple asset classes along with our global distribution footprint, have helped us build scale and drive strong growth.

Principal Funds had its 23rd consecutive quarter of positive net cash flows. A combination of strong and diversified distribution channel and a broad mix of investment options aimed at solving for favorable outcomes drove strong sales of $5 billion for the quarter. On a trailing 12-month basis, Principal Fund sales were up 22% and both our equity and fixed income flows were four times the industry average versus the same period a year ago.

Third quarter 2015 marked Principal International's 28th consecutive quarter of positive net cash flows. On a trailing 12-month basis net cash flows were $12 billion. Highlighting the negative impact foreign exchange has had on our results, reported assets under management of $106 billion for Principal International included a $34 billion negative impact from foreign exchange rates over the last 12 months.

More than a decade ago we focused Principal International's strategy to serve the retirement and long-term saving needs of the rapidly growing middle classes in select emerging markets. We knew that emerging markets would have volatile time periods; that's the nature of emerging markets.

However our consistently strong growth metrics in Principal International demonstrate that the long-term growth opportunities outweigh bouts of volatility. Despite the recent volatility in these markets, tremendous growth opportunities remain and we're just as confident as we've always been about our ability to capture market share and continue to grow over the long term.

The success we've achieved in Principal International is driven by two key advantages: our expertise in providing the savings solutions customers seek; and our partnership with marquise distribution networks, which is critical for success in international markets. For example, our long term exclusive distribution partnership with Banco do Brasil, the largest bank in Latin America, provides us access to their large customer base, where to date we've reached just 3% of their customer base.

As a stand-alone bank with a quality reputation, customers in Brazil view Banco do Brasil as a safe haven, particularly during volatile periods. Our tax-advantaged individual retirement products remain in favor, garnering Brasilprev $1.2 billion of net cash flow in the third quarter. This strengthened its position as the number one private retirement provider in terms of net cash flow and assets. In addition during the quarter Brasilprev received multiple awards, including recognition as one of the most innovative companies in the Brazil pension industry.

Additionally our partnership with China Construction Bank, the second largest bank in the world, has generated $26 billion of net cash flows in China on a trailing 12-month basis. The continued growth in China makes us a formidable player in this market. As other pension and other long term savings opportunities materialize in China, we're well positioned to capitalize on those opportunities in this long-term strategic market.

Another key focus is on enhancing expanding distribution. A main driver of growth in Principal International has been our successful implementation of strategic acquisitions, such as Cuprum in Chile and HSBC in Mexico.

We've closed on the acquisition of Axa's pension business in Hong Kong on September 1 and the transition is proceeding smoothly. The acquisition adds $3 billion of assets under management to our current business, making us the fifth largest mandatory pension provider in Hong Kong.

Importantly, the deal includes a 15-year exclusive distribution agreement with Axa's network of some 4,400 agents. This provides additional opportunities to grow our market share as the mandatory and voluntary pension markets grow in Hong Kong.

Turning to Principal Funds, our ongoing advisor development efforts have driven double-digit growth year to date and the number of advisors selling our funds to 52,000. Principal Funds is the 16th largest advisor-sold fund family in the US and we continue to grow our market share.

Our advisor-centric distribution strategy provides us a competitive advantage for our US retirement business as well. Year-to-date, alliance channels accounted for more than 75% of our Full Service Accumulation sales.

Third-quarter sales of $1.5 billion were largely driven by sales in the small- and medium-sized business market. This market has been a long-term focus for Principal as it's historically been underserved. Additionally, we continue to grow the number of plans in the large market as plan sponsors of all sizes seek our retirement benefit solutions for their employees.

In addition to building strong distribution partnerships, we've built our leadership position in the retirement industry by providing solutions from hire-through-retire and we continue to successfully execute on that strategy. The underlying growth metrics in Full Service Accumulation remain strong with third-quarter recurring deposits up 7% for the quarter and year to date.

Plan count and active participants continue to increase as well. This growth reflects our efforts to continue to expand participation and deferral rates through innovative plan design features in addition to improved employment trends.

The US is still the largest retirement market in the world and there's still a lot of work to be done as people are not yet saving enough for a comfortable retirement. As a leader in the industry, we remain actively engaged in working with others to insure the proposed regulations from the Department of Labor protect efforts to help Americans achieve a secure retirement.

Providing protection solutions in addition to retirement and long-term savings options is important to our strategy of helping customers achieve financial success and especially benefits our competitive benefits solutions and strong distribution networks help drive an 8% increase in year-to-date normalized premiums and fees. We continue to see in-plan growth quarter over quarter and the loss ratio remains favorable, at the low end of our targeted range.

Business market sales in Individual Life remain strong and made up nearly 60% of sales in the third quarter. These plans help small- and medium-sized business owners with the business continuity strategies as well as enhance our total retirement suite through robust non-qualified plans.

In closing, I'm excited about the tremendous long-term growth opportunities ahead. I remain optimistic about our future despite continued global macroeconomic volatility.

I'm proud of our dedicated employees who continuously demonstrate their ability to execute on our strategy. It's their commitment to meeting the needs of our customers that will continue to successfully drive the Company forward.

Terry?

Thanks, Dan.

This morning I'll focus my comments on: operating earnings for the quarter; net income, including performance of the investment portfolio; and an update on capital deployment. Third-quarter continued to build on the momentum from the first half of 2015 as the fundamentals of our business remains strong. However, results were masked by ongoing macroeconomic headwinds.

Operating earnings for the quarter were negatively impacted by the combination of the strengthening US dollar, negative equity markets and lower interest rates. The impact was partially offset by our annual actuarial model and assumption review.

In addition on a total Company basis, variable investment income was down compared to the prior-year period due to lower than expected prepayments on US investments. Total Company reported operating earnings were $317 million, or $1.06 per share.

Slide 6 shows the normalizing items for the quarter. As we typically do in the third quarter, we completed our annual review of actuarial models and assumptions. The review resulted in a net benefit to operating earnings of $0.11 per share. Notable impacts of the review include reducing interest rate assumptions, other assumption updates and model refinement.

Other normalizing items for the quarter include a $0.06 negative impact from additional expense recognition in Full Service Accumulation and Individual Annuities due to market declines as well as lower variable investment income in Individual Annuities. And a net $0.03 negative impact to Principal International earnings per share due to lower than expected encaje returns and an impairment resulting from the review of specific intangibles associated with our 2012 purchase of Claritas, our Brazilian mutual fund operation. These were partially offset by higher than expected Latin American inflation and variable investment income in Chile.

On a normalized basis, earnings per share were $1.04, down $0.01 from the normalized third quarter 2014. After adjusting for foreign exchange, third quarter earnings per share grew 6% over the year-ago quarter. Additional detail about the actuarial review and intangible asset impairment is outlined on slide 7.

At the end of the third quarter return on equity, excluding AOCI, was 13.2%. When we adjust the average equity for exchange rate movements, the return on equity was 14.5%.

Now I'll discuss business unit results. The accumulation businesses within Retirement Investor Services reported operating earnings of $143 million. On a normalized basis, operating earnings were $180 million for the third quarter 2015, flat compared to the year-ago quarter.

Slide 8 shows that quarterly net revenue was up 1% compared to third quarter 2014 and up 4% on a trailing 12-month basis. Adjusting for the actuarial assumption review, trailing 12-months pretax return on net revenue was 32%. This margin remains attractive and is within our guided range.

Normalized Full Service Accumulation operating earnings were $110 million, down 3% from the year-ago quarter due to lower revenue and slightly higher expenses. Net cash flows for Full Service Accumulation were slightly negative for the quarter as we continued to balance growth and profitability. Year-to-date flows were a positive $2 billion and we're still on track to end 2015 within our targeted 1% to 3% of beginning year account values.

Principal Funds third-quarter operating earnings were a record $30 million, an increase of 6% over the prior year. The trailing 12-month pretax return on revenue continues to improve as we grow scale. Strong investment performance and flows contributed to account values of $122 billion at quarter end for the total Principal Funds complex.

Individual Annuities normalized operating earnings were $33 million for the quarter, an 8% increase over the prior-year quarter. We continue to believe that the run rate for this business is in the $32 million to $36 million range in normal operating conditions.

Looking at Slide 9, operating earnings for the guaranteed businesses within Retirement Investor Services were $21 million. Full Service pay out had adverse mortality in the quarter that was within our expected range of fluctuations. In the third quarter, we had almost $700 million of Full Service pay out sales, bringing the year-to-date total to $1.5 billion. We continued to approach our guaranteed businesses opportunistically.

Turning to Slide 10, Principal Global Investors quarterly operating earnings were $30 million, a 20% increase over the year-ago quarter. Trailing 12-month pretax margin was 27%, an increase of 190 basis points over the same period a year ago.

Net cash flows of $2.9 billion during the quarter highlight the confidence investors have in our diversified solutions. The net cash flows have been driven by our yield-oriented products and are a direct result of our investment in our global distribution platform.

Assets under management for Principal Global Investors increased 6% over the prior-year quarter to $324 billion. Unaffiliated assets under management ended the quarter at $120 billion, also a 6% increase over the year-ago quarter.

Slide 11 shows normalized quarterly operating earnings for Principal International of $54 million. Third-quarter operating earnings were negatively impacted by $18 million due to foreign exchange on a quarter-over-quarter comparison. On a local currency basis Principal International drove year-over-year growth in the mid teens.

Included in the normalization is the $11 million impairment of intangibles in Claritas, our mutual fund operation in Brazil. The impairment recognizes the loss of some specific assets under management and distribution in force at the time of our 2012 acquisition as investors' sentiment shifted to less volatile fixed income investments.

Claritas has largely maintained it assets under management by continuing to develop market-driven investment solutions, often leveraging The Principal's global asset management capabilities. This global synergy is becoming a strong competitive advantage given recent regulatory changes allowing more Brazilians access to overseas investments. We remain committed to offering a broad line-up of appropriate long-term investments to our customers and Claritas remains a critical piece of our Latin American strategy.

As shown on Slide 12, Individual Life reported $73 million of operating earnings in the third quarter, reflecting a benefit from the actuarial assumption review and model enhancements. The adjustments better reflect actual experience and are predominantly prior-year experience adjustments.

Normalized Individual Life operating earnings were $31 million for the quarter, a 33% increase over a normalized prior-year period helped by favorable claims experience. On a trailing 12-month basis, the normalized operating margin was within our targeted range.

Moving to Slide 13, Specialty Benefits reported operating earnings were $42 million reflecting the benefit of the actuarial model enhancements. Normalized quarterly operating earnings were a record $34 million, an 8% increase over the prior-year quarter.

The normalized loss ratio for the quarter was 64%, well within our expected range. The normalized trailing 12-month pretax operating margin remains strong and within our targeted range.

Corporate operating losses were $37 million. This includes expenses associated with the closing of the acquisition of Axa's pension business in Hong Kong. We still anticipate full-year 2015 corporate operating losses to be in the previously announced range of $130 million to $150 million.

For the quarter, total Company net income was $300 million, a strong result reflecting the benefit of our diversified business model. Net credit-related losses were $6 million for the quarter and continued to be below our long-term expectations. Our capital deployment strategy remains balanced as we leverage multiple options to increase long-term value for shareholders.

Slide 14 shows that year to date, we've deployed $885 million of excess capital. In the third quarter, we closed on the Axa acquisition, paid a $0.38 common stock dividend and opportunistically repurchased 2.2 million of our shares.

Yesterday, we announced a $0.38 common stock dividend payable in the fourth quarter, bringing our full year common stock dividend to $1.50 per share, a 17% increase over the full-year 2014 common stock dividend. With the fourth-quarter dividend, our 2015 capital deployment amount will be nearly $1 billion.

Additionally yesterday we announced that our Board of Directors authorized a $150 million share repurchase program. With the recent completion of our previously $150 million authorization, this new authorization is an acceleration of our 2016 capital deployment plan and allows us to continue to repurchase shares opportunistically.

In closing, this quarter demonstrates 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)

The first question comes from John Nadel from Piper Jaffrey.

Good morning, everybody. Dan, I guess a question to start. With a change in management recognizing that there's likely very little, if any, change in strategy, just a question for you about capital deployment. I realize that the longer-term track record here on the acquisition side remains very sound, but given the recent intangible impairments when you look at Liongate and Claritas, I'm curious whether you might have a different view about the method of deploying free cash flow and capital as we look forward?

John, thank you for the question. Just a couple of comments and I can appreciate your perspective, but our capital strategy will remain the same. It's going to be a very balanced approach. Increasingly we become more driven by our fee businesses which gives us, frankly, more flexibility.

We could demonstrate through a lot of Jim's operations when I think about WM Funds and Morley and Spectrum and Origin and Finisterre and HSBC Mexico, these are really, really strong results. When I look at Luis's Cuprum, Axa, Brasilprev, an exclusive distribution agreement that was added to, we've got actually a very strong track record of executing on successfully integrating companies that we've acquired, supplementing our organic growth strategies.

Having said that in the case of Liongate that you cited, Liongate I think is one-off. It was an asset class that our timing wasn't good. The performance was underwhelming and caused us to lose a lot of the assets. We recognize that. We did our due diligence; we did our look-back and certainly understand perhaps how we could go about acquiring an asset like that in the future.

Frankly, I wouldn't even put Claritas in the same category. That's a different sort of impairment on an intangible. Maybe with that, I'll ask Terry to provide some additional comments. But again I would say, John, we remain quite confident about our ability to successfully execute our capital strategy. Terry?

No, I -- Sorry, Terry, yes.

Yes, this is Terry. Each quarter, we take a look at all of our assumptions. But in the third quarter of each year we do a thorough review of the tangibles, the goodwill as well for each of our businesses. And that's similar to the actuarial model and assumption review that we also do. We look at all of the tangibles as well as intangibles, whether they're finite-lived or infinite-lived.

And in this case in particular with Claritas, we reviewed it this quarter and we looked at the fund, a particular fund at the time of the purchase when we acquired Claritas. The macroeconomic conditions have really changed and become much more challenging for the mutual fund business within Brazil. As a result, associated with this one particular fund that went out of favor, and we had to impair the intangibles that were associated with it.

These were related to the investment management contract that we had, the value of the customers in the fund, the distribution agreements. These all moved away from us and so we had to impair those specific impairments associated with that, and we had to impact it in the current quarter. Now that's about $23 million for the 100% of it, which we had 60% of that impairment.

Now we also looked at, because of the timing of this, we also looked at it in terms of the goodwill associated with Claritas. We did not impair that, which is probably more important to us in terms of the long term.

As Dan noted, it's a significant player in our Latin American strategy, both on the asset management side as well as on Principal International. They've proven themselves, they've actually replaced much of the assets under management by developing some other market-driven investment solutions that have been very strong, by leveraging as I mentioned earlier in the call, leveraging our Principal Global asset management capabilities. So it still has a competitive advantage for our products, so we didn't feel there was an impairment there.

Now that being said, and where the question would go is, are there other impairments out there of goodwill or of an intangible? We do, as we do with an actuarial review and assumptions, we do a thorough scrubbing of the goodwill. And we're seeing a strong cushion on all of the remaining intangible as well as goodwill. Hopefully that helps.

I appreciate that.

John, do you have a follow-up question?

Yes, I wanted to ask a question about Principal International. In particular wanted focus on Latin America. Obviously flows remain positive but net flows slowed down and I don't think that's that surprising.

But I was wondering if we could get an update on conditions locally, particularly in areas such as Brazil, Chile, maybe even Mexico where clearly, the economies are weaker. And in the case of Brazil in particular, there's been a lot of press about the very worried state of the pension market there and what a mess that is economically for the country. I'm wondering what you think it might mean for Principal's opportunities.

Really good question, John so appreciate that and I'll make a couple of over-arching comments and then flip it over to Luis to add some color. It's an important driver for PFG, it represents roughly 25% of our earnings. I would just remind everyone on the call we've got 28 consecutive quarters of positive net cash flow that are being driven by Principal International.

I'd also say that we have tremendous partners. I think about China Construction Bank and Banco do Brasil, who are very much entrenched in these local markets and add enormous fire power to our ability to distribute our products.

When we do our look-back on places like China and India and Brazil and Mexico and Chile, some things haven't changed. There's still a very significant emerging class growing. These are middle income investors and people who will save for retirement.

Aging the demographics are even more severe than they are here in the US, so they need these products, they need these solutions. We know government is not in a position to take over these responsibilities in any of these countries. And we know that to date they've embraced very much private sector approach to solving the problems. But with that, let me throw it over to Luis to add some additional color, John, on those specific countries you cited.

John, very good question indeed. Particularly talking about Mexico, Brazil and Chile and where they are at. Three different countries, three different problems, totally different.

In Brazil essentially what we have, we have a country which is certainly fixable. They have the political crisis is obstructing the economy's recovery and meanwhile we're going to live within this economic political turmoil is going to be very difficult at the fiscal adjustment that is really needed is going to go through.

So probably we're going to have another year, year and a half that we're going to see this political turmoil but certainly the Brazilians are going to be able to fix this. Whatever is going to be that solution is the Minister of Finance, currently Levy, he knows very well what they have to do, but politically speaking he has to be on leash in order to fix the problem. As I'm saying, Brazil is fixable.

What's then said is very important. The fundamentals in Brazil really remains and the truth of that is that strong and big and large middle class is the one that is keeping our net customer cash flows in a very positive environment month after month and quarter after quarter. We continue growing and if you're looking at our results coming from Brazil and particularly you're paying attention, Brasilprev if put in nominal terms and in US terms, is demonstrating a flat result year over year in the nine-months period ended. It means it's us being able to grow a steady percent plus year over year.

The solution for Mexico is a little bit different. Situation is a much more stable economy where it's tied to the US economy. So we have to pay a lot of attention about what is going to happen to the US economy, and then we're going to have some conclusions about Mexico.

Unfortunately they went through a very important reform particularly the energy reform, the most important reform, wrong timing. But we will see what is going to happen, but Mexico we're not -- Mexico is in a total different stage.

Chile, they have to readjust their economy a little bit. They are highly dependent on the commodity cycle. They have to readjust their macroeconomics but Chile is still a AA- country so they have the highest rating among the emerging countries in Latin America.

Our strategy will remain very clear with our strategy, it's a right combination between voluntary money and compulsory money. As we improve that it a very solid and sound and successful strategy. We see that we don't have any reason to start changing our strategy and we remain very confident about the future of our operations in Latin America.

Very good. Thanks, John, for your question.

Really, really appreciate the color. Thank you so much.

Very good.

Your next question is from Ryan Krueger from KBW.

Hi, thanks, good morning. First a separate follow-up on the international business. It looks like China's earnings were up pretty significantly. I was hoping you could do a little bit of an update on what's going on there and if that's sustainable.

Yes, Ryan, thank you, and yes, you're right. This is a quarter that we've called that out. It is increasingly become significant both from a profitability perspective, net cash flow as well as sales, so Luis, you want to go ahead and provide some additional color?

Yes, absolutely, Ryan. Again this is the result of our own strategy. As we have said, we're very much more patient-oriented, long term saving-oriented. So our offering and value proposition, all of those markets is in that sense.

As long as we start having this kind of choppy road in China, and very volatile market, essentially what is happening is customers, they are flying into they -- have put in a flight to quality and they're looking for a safe harbor. That is exactly what we're offering there, so we are perceived in our JV attached to the CCB, which is the second largest bank in China, we are perceived as a safe Harbor.

And we have had this tremendous amount of net customer cash flows that in essence in one year we doubled the size of our Company. So we're running a Company with $41 billion in total AUMs. We think that we're going to continue looking and facing that kind of reality. So all these kinds of things that happen in China, the wealth management products and the shadow banking system, seems to me that money is flying away from that solution and looking for very serious managers and partners like we are in China.

Thank you. Then shifting to FSA, can you talk about the pipeline as well as generally what you're seeing in terms of plan sponsors and proposal activity and retention levels.

Very good, I'll make a couple of over-arching comments and then throw that over to Nora Everett to answer some questions. I was reflecting on this in preparation of the call. Just a couple of weeks ago we hosted roughly 130 of our clients down in Florida. This would have been larger clients. An opportunity to sit down face-to-face with our client counsel.

It also was an opportunity to spend a couple of days getting to know them better and to hear their candid views. I walked away with a few. One was they value what we do significantly. We are making a difference. They increasingly look at us as an out-sourced partner to handle matters related to their benefits and in particular as it relates to retirement plan. I was reminded about how much the relationships matter in this. They are very close to their relationship managers and we have a long-tenured group of professionals out there that work with our clients every day.

Then I also couldn't help but notice during our session regarding investment choice and performance. Jim was there and presented along with other peers, or his contemporaries, to present our platform. As you know, we have very strong investment performance, which is well received by our clients.

And then lastly, it seems like most of the conversation isn't around the funds and fees, it was around what can we help them with as it relates to plan design, to get to better outcomes. With that, I'll throw it over to Nora to help answer specific questions on the pipeline and outlook for FSA.

Sure. Good morning, Ryan. We're actually really pleased with the growth in momentum in our pipeline. As you know, we don't give sales guidance but we're seeing double-digit increase in that pipeline. Remember the life cycle, the sales cycle here can be rather long. So a lot of that we'll see impact in 2016.

But we're particularly happy to see that our core SMB, in the core SMB space, we're seeing that pipeline build. We expect typically over half of new sales AV, account value, to be in that SMB space. Continued success with our alliance firms, continued success with our TPA channel. In particular, this total retirement suite differentiator of ours, we see that on the sales front and continue to see pretty significant build around that TRS suite.

So even though we're not giving sales guidance, I would point you to net cash flow. We expect to meet the guidance we've given, between 1% and 3% beginning of the year account value. I would say that given what we see today, it will likely be the lower end of that range.

And there's always the caveat in our business that one or two plan decisions, whether it's timing or something else, can shift that number a bit. So we're always a little bit careful about trying to predict. But with that said, we're really pleased with the growth in momentum in that sales pipeline.

Ryan, thanks for your question.

Thank you.

Your next question comes from Tom Gallagher from Credit Suisse.

Hi. First question is on the actuarial review and the 50 basis point reduction in interest rates. Can you comment on the long end of the curve, where does that put you from an absolute standpoint? What is the absolute rate assumption that you're now using? That's question number one.

Then relatedly, can you talk about the mechanics that resulted in no net charge, in fact it was favorable overall? What were the other offsets within the assumptions that more than offset the negative impact of interest rates?

Very good. Thanks, Tom, for those questions. I'll have Terry go ahead and respond.

Yes, Tom, this is Terry. On the long end of the interest rate, we look at the 30 years out plus. As you can do with any actuarial reserve, we're trying to make our current best estimate of what's going to happen in the future. None of us have a clear crystal ball. But what we do is we look out, see what the trends are and then make some adjustments.

Back in 2012 we looked at the long-term interest rate and lowered it as well, and also changed the trajectory of it. But now we're seeing that interest rate environment is staying longer and longer out into the future. So we looked out 30 years and we lowered our long-term rate by 50 basis points.

Now, that is meaningful probably most for life insurance business. The other businesses have a shorter duration. So when we look at the trajectory to get to that longer-term rate, we also an impact on that and smoothed out or reduced that short-term rate. The impact that we saw was probably closer in that $25 million to $50 million range.

Offsetting that though, as I mentioned before, we have to look at our current best estimate on all the actuarial balances, reserve, DAC. We have to look at what else is out there in terms other refinements on how we recognize reinsurance premium, mortality improvement. We looked at revenues, et cetera, and margin out into the future, anything that might affect AGP.

There were more than positive offsets that we have reflected through our experience on the business that we have written, in the past, and predominantly in the life area. Most of that has been due to prior-year experiences. The current guidance, current GAAP guidance that we're utilizing, is to come up with our best estimate of where we think that it will be in the future.

As a result we took a reduction in the long-term interest rate, but we backed up these others. It created a huge amount of noise this quarter and it varied by different business units. But in large part the lower interest rate environment was a negative, more than offset by our experience adjustments in terms of mortality and other model enhancements. Hopefully that helps.

That was helpful, Terry. So after making the 50 basis point reduction and I heard you on the life insurance side, that was the most impacted business, what is the actual level you're now at? When you look at the very long duration interest rate assumption, what is the absolute level right now?

Yes, the absolute level, we probably -- we're not going to share that in terms of the absolute level because there's multiple parts to it. There's the risk-free rate, we could use a 10-year Treasury as an example of that. We also look at the spreads that we would price for and what we're getting on our investments, default rates, credit analysis, et cetera. So there's a lot of things that come into it which we're not going to share in terms of what we think the absolute rate would be.

But just to give you a little bit of color, as I mentioned earlier, the longer-term end of the curve probably affects the life business the most. Some of our other businesses have shorter durations, so the shape of the yield curve is very important as well. If you were to say right now, we would say -- and just use as a risk free rate of return for our business just as a proxy, but you have to look all along the yield curve, use the 10-year Treasury where it currently is right now. And the ten year Treasury is around that 2% range.

What we look out into the future is over the next 30 years, it would grade up to probably maybe 25 basis points a year for the next 10 years. Your guess is as good as ours. And then it probably remains flat thereafter. That kind of gives you an idea where we're looking out 10 years. But then on top of that you have to put our pricing assumptions or spreads that we're getting, et cetera. That gives you a little bit of a basis point.

Tom, was that helpful?

Okay, thanks. Then just one follow-up question. On Hong Kong, I saw earnings came down a bit, and I know you have the acquisition going on there. But I believe you mentioned the restructuring or costs associated with integration were flowing to corporate-other. So can you give a little help on the earnings progression that we're going to see from Axa Hong Kong and timing around that, how that's going to earn in from an earnings contribution standpoint?

Yes, very good. Luis can give you some color on that.

Okay, Tom. Essentially meanwhile we're going through the integration of Axa for the next quarter. Axa is going to be neutral, if not a little bit negative for Hong Kong. Next year we're expecting something in the range of $7 million, $7.5 million total impact in our after-tax OE for Hong Kong. That help?

Yes, thank you.

Tom, this is Terry, I'm going to add just a little bit. We mentioned in the corporate segment this quarter we only included the closing costs associated with that. The rest of it in the future will come through Principal International.

Got you, thank you.

Okay, thanks for calling in, Tom.

Your next question is from Sean Dargan from Macquarie.

Thanks and good morning. I have a question about your capital deployment strategy. Last year we saw three different dividend raises over the course of the calendar year. It's been flat at $0.38 over the four quarters this year. You've talked about getting to a 40% pay-out ratio. I'm just wondering if anything has changed in your thinking.

No, not at all, Sean, and again thanks for calling in this morning. Our commitment still remains the same relative to our dividend pay out. If you look at it over a trailing 12-month basis it's up 17%. The targeted pay out still is right at 40%. I think if you did your math it's somewhere around 36% today, so it's right well within the range. And over the course of the next couple of years we would expect to have the dividend securely at that 40%, absent something dramatic happening, Hopefully that helps.

It does, thanks. And coming back to Principal International. The underlying trends have been okay, considering what's been going on in the local markets. But the US GAAP results are obviously being obfuscated by the FX headwinds. Have you given any thought to hedging the income statement impact of FX? Or is it just too expensive now?

Yes, with that maybe I'll let Terry go ahead and tackle that question.

Sean, this is Terry. As we look at this, we see this is more of a translation issue. The revenue that's generated in the international companies also has expense associated with it at the same currency rate, so we're really translating it back to the US.

If we were to try to hedge this, first off it would be very expensive because we're in multiple countries. Second, we wouldn't get hedge accounting treatment so we'd just create some additional volatility. We just see that this is a translation so that's why we provide the information on a local currency basis as well as try to give the impact to what it would be in terms of mid teen growth rate. We're at probably mid to upper teen growth rate in terms of this business on a local currency basis.

Now, that's translation. But when it comes to an economic impact where we are actually moving capital from one jurisdiction to another, we'll make a call and actually hedge that flow so that we do not lose the value at the time that the earnings are generated. We do make a call in terms of hedging money, but as you've seen, we've generated a lot of earnings outside the US.

An example of it is in Latin America as pointed out before. Doing the Axa acquisition in Hong Kong, the money never even got back to the US. We'll make sure that the capital gets appropriately hedged as it goes from jurisdiction to jurisdiction. But in terms of operating earnings, we're just trying to provide a little bit more clarity on a local currency basis and not incur the additional costs for the translation. I hope that helps.

It does, Terry, thank you.

Sean, we do spend a lot of time internally modeling these sorts of potential ideas to either hedge or not to hedge. It's not by accident or lack of a lot of thought that gets us to where we are at with our current policies and strategies. If the dollar should ever weaken, if we should see these foreign currencies gain some strength, there's certainly some upside and some tailwinds. So thanks for the question.

Your next question is from Michael Kovac from Goldman Sachs.

Great thanks for taking the question. I'm just wondering, given the multiples that we've seen come down in asset managers across the board, how does this change any opportunities you might see for future M&A?

Very good and I appreciate that. Let me make a couple of comments then flip it to Jim. We do keep a very active list of those asset classes that we think that could be complementary to our existing platform. We look for potential strategies that would be uncorrelated, that would support our global platform, whether that's for retail or retirement or institutional investors.

Again, I think our track record speaks for itself as it relates to our ability to leverage that into either separate accounts or mutual funds, institutionally managed accounts, separately managed accounts, collective Investment trusts. And so with that, maybe Jim, you could provide some color on valuations of these properties and where you're going.

Yes, Michael, you're right that multiples on many of the transactions over the last few years have been very high. If you'd asked me three years ago about the balance between organic and growth by acquisitions, I would have thought three years ago we'd have done more acquisition. But in fact, with the high multiples we've been extremely focused on organic growth and hopefully that will continue to come through the numbers.

As regards to one or two recent transactions at lower multiples and the talk of lower multiples, yes, that's something we'll be watching. I would say though, that the lower multiples have tended to be on firms that don't really have the kind of growth edge that we're looking for in an acquisition. We're looking, as Dan said, for complimentary capabilities that we can really work with our clients to use. But whichever clients you're talking about, whether it's insurance, full service, the mutual fund company, the international distribution, and we're not seeing that a lot in the companies that are coming through at cheaper multiples.

I don't think it's a step change, but we'll be watching it. I think on balance the next three years could see a bit more acquisition opportunities in asset management in the last three did. But I don't feel that it's necessary for us to grow; I think our organic story is sufficiently strong on its own.

Michael, hopefully you'll be able to join us on our investor workshop on November 6. Jim will probably get into some of those details with more depth and understanding. Some of the obvious questions are how are you able to maintain such positive net cash flow in an environment where so many of the dollars are going to passive? I think it has a lot to do with the strategies that were created within the funds business and with Jim's institutional asset management business to work the edges, as opposed to going right down the middle on some of these large cap strategies that are tending to migrate towards passive. Again, hopefully you can join us for that meeting on the 6th of November.

Great, I'm looking forward to that.

Thank you, Michael, for the call.

Your next question comes from Erik Bass from Citigroup.

Hi, Thank you. I had a couple follow-up questions on Principal International. First on the Axa acquisition, want to make sure I followed on Luis's comment correctly about the earnings expectations for next year. Was that $7 million to $7.5 million after-tax the expectation for the full year or on a quarterly run rate? And thinking that you're putting up about $335 million of capital, that if that's the full year impact, it seems like a relatively low ROE.

Okay thanks, Erik. Luis?

Yes, Erik, that's a good question. In next year, we're not going to be able to enjoy all the synergies that we're going to enjoy, particularly in 2017. This is due to many contracts are tied to the Axa block of business, particularly with Best Serve and other asset managers. So we're going to transition that block of business in the very first six months of 2016. In essence, my answer for you is that we're going to enjoy just 50% of those synergies in the first year and full synergies in 2017, Erik.

Got it, thank you that helps. And Terry, wanted to follow up on your comments around the impairments. Were you speaking specifically about Claritas of no future impairments that you see on the horizon? Or was that about all international acquisitions broadly? And one thing to clarify there, I'm assuming when you do your test it's all based on local currency results and currency is not a factor; is that correct?

Yes, that's correct, Erik. This is Terry. The impairments that we did, we look at all the intangibles and goodwill across all of our entities, not just Claritas. Claritas is the one where we actually found an impairment this quarter, but we've looked at every one of them; we scrub every one of them. We do scrub them on a local currency basis as well, as you pointed out.

But across all of our goodwill, all of our intangibles, we found that we have a significant cushion that we are not looking to impair any of those other entities across anything. That goes back to entities that we acquired many years ago.

Got it, thank you. And a final thing following up on, I think your response to Sean's question. How much of the 65% to 70% of earnings that you talk about is deployable capital? How much of that is contributed from the international business at this point? Thinking about it, how much of the cash flow actually gets to the Holding Company?

Terry?

Yes, if I look at Principal International, it goes to different Holding Companies. We have a UK Holding Company and we also have a US Holding Company. Most of the earnings that are generated out of Principal International come up through that UK Holding Company or entities there. For example, the earnings that are generated in the $250 million or above we'll use some of that for organic growth within those businesses. And we also have a large portion of it available for acquisitions to fund their own acquisitions within Principal International. I'd say that the international business mirrors the total Company's position in terms of available capital, in that two-thirds of the earnings associated with it. The rest is supporting the organic growth that's going on in the different entities, member companies.

Got it.

Hopefully that helps.

It does, thank you very much.

Thanks for calling in.

Your next question is from Suneet Kamath from UBS.

Thanks, good morning, guys. So Terry, I just wanted to get back to your $1.04 normalized number. A couple things jumped out at me as I was trying to think through the baseline for model projection going forward.

It looked like in FSA the tax rate was once again negative, even if I make the adjustments for the actuarial review and then the market-driven expenses. And I thought on the last call you'd guided to more of a 5% to 7% tax rate. As we think about trending this, how should we be thinking about getting back to that 5% to 7% over what period of time?

Yes, thanks, Suneet. First off, I want to say what you need to do in terms of a tax rate, you need to look at the total Company. That's where we really focus our attentions. It's really over a longer period of time than just simply some quarter-by-quarter distortions that may occur.

Now that being said, the total Company effective tax rate is in that 20% to 22% range, as we've talked about before. But if you go down to one of the biggest reasons for that drop is the dividend benefit that we receive. Most of that is concentrated within the Full Service Accumulation line. This quarter there was a significant negative effective tax rate, as you pointed out. However if you look at it over a period of time and you adjust for the unlocking, as you said before, the true-ups in the prior year, you're still at a negative rate on a year-to-date basis, albeit it's much lower than -- it's just barely negative in terms of an effective tax rate for the full year. So look at it over a longer period of time.

Now that being, said one of the reasons it's negative right now is because you've seen some higher growth, or faster growth, in the dividend received benefit that we get in Full Service Accumulation than on a pretax earnings basis. Now there's a lot of adjustments that you can make in order to get the earnings growth on a pretax basis.

In 2014, we saw significant benefit for variable investment income that was a much higher rate than what we're currently seeing this year. Now why is that? Well, in large part you look at what was the sentiment back in 2013 that was a rising interest rate environment. So you saw a lot of prepayment activity going on in 2014 that we're not seeing in 2015. Therefore, the pretax earnings basis isn't growing as fast as the dividend received basis.

Now as you go into the future, you tell me what's going to happen in terms of the economic environment, in terms of the equity market that's down on a total return basis of -- down about 9%. Excuse me -- down 1% where we would have expected to be up 8%. So you got a good point that we've got a negative effective tax rate at this point in time, albeit I think that it can turn around very quickly and get into that 5% to 7%. Again, we take a longer look at it, don't let the current periods distort it and then that 5% to 10% is probably still a pretty good number for FSA.

Thanks, Terry, and thank you, Suneet, for the question.

I had one follow-up, if you have a second?

Oh, please go ahead.

Thanks. Again, on the normalizing numbers. I just want to make sure we're keeping score consistently here. Because if I think about that $0.06 that you're adding back from weak markets, when I go back and look at prior periods where you had favorable markets, I would have thought we would have seen an adjustment going the other way. Based on the way that we track this, I didn't see it.

So is there something unusual in this quarter the reason that you're calling out those two? Or in periods of prior strong equity markets, did you have an expense adjustment going the other way that maybe wasn't called out?

Yes, exactly. Suneet, this is Terry again. You're absolutely right. One of the thing that we try to do in terms of what we call out, is we try to get the end number to what we believe is the appropriate run rate for that business given a more normal environment.

There will be periods where we will have higher variable investment income because of positive markets and there will be higher expenses that offset that. So we try not to get quite as granular as we did this quarter with all of the different noise items. This is probably the most adjustments that I've been associated with in any one particular quarter. But we do try to keep that total run rate where we're trying to net to, to get to an appropriate number.

Now to the point that you made about this quarter being highly unusual, well, we saw the S&P as a proxy for the market being down nearly 7% this quarter. That had an adverse impact on the DAC amortization for both the individual annuity area as well as the Full Service Accumulation area.

The Full Service Accumulation is a little bit more abnormal than what we would have normally seen because we've been having volatility in that business, albeit it's not the magnitude that we saw this quarter. And in large part that is one of the model enhancements that we actually have made, the DAC model on a go forward basis that had an impact, more than normal adverse impact this quarter, in terms of a reversion to more of a mean rate over a longer period of time. There was some unusual higher than expected, but I would not expect to see that kind of volatility on the Full Service Accumulation line in the future.

Now that said, for the individual annuity line with the variable annuity which is still a relatively small block of business. Out of the $516 billion of assets under management, we're talking maybe $9 billion of variable annuity. There is some volatility associated with that, that will continue. But net net we're trying to get you back to a number that we think, whether we can agree to disagree on this, what we think is the appropriate run rate for the business in a particular quarter, given the economic environment that we're seeing and where we would expect future quarters to evolve from.

Suneet, what I would say is in closing here, we're running out of time, is that the 7% negative performance in the quarter for the S&P 500, when we would have anticipated a plus 2%, that's a delta of 9%. We think that's worth calling out. I do think we've tried to bring that out in previous calls, but we'll try to be more consistent for you in doing that where we see out-performance that really does fall out of a significant range. So we'll tighten that up for you in the future so. Again, thank you for the call.

Much appreciated, thanks.

I'd just like to thank everyone for joining us today on the call. Appreciate your good questions and your interest and support. We still remain very optimistic about the growth and the strategy here at Principal, and we remain confident that the strategies we have around retirement and investment management and protection will serve our long term shareholders for many years to come. Hopefully we'll see many of you at the Investor Day event in New York City on November 6. And with that, good day and safe travels.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 PM Eastern Time until end of day October 30, 2015. 44931486 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 for international callers. Thank you. This does conclude today's conference call. You may now disconnect.