美國信安金融集團 (PFG) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Principal Financial Group Fourth Quarter 2017 Financial Results Conference Call. (Operator Instructions)

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

Thank you, and good morning. Welcome to the Principal Financial Group's fourth quarter conference call.

As always, materials related to today's call are available on our website at principal.com/investor.

I'd like to mention a few changes to our fourth quarter materials. To comply with recent SEC guidance on non-GAAP financial measures, we've changed our operating earnings label to non-GAAP operating earnings on both a pretax and after-tax basis at the total company level. The calculation of these measures has not changed.

Additionally, on Page 16, our financial supplement, we've updated the assets under management detail for Principal Global Investors. The Principal Global Investors sourced AUM schedule includes all AUM sourced by PGI included in the previously denoted institutional AUM and U.S. mutual funds AUM. In 2015, we changed our reporting structure to move our mutual fund business into PGI and since then have further integrated the distribution channels and fund platforms. The new PGI sourced AUM schedule provides a better reflection of how we view PGI. The U.S. mutual funds and ETFs AUM schedule has been updated as well, and we'll provide a breakdown of the source of the AUM PGI sourced and sourced by other entities of PFG.

Following a reading of the safe harbor provision, CEO, Dan Houston; and CFO, Deanna Strable, will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A session include Nora Everett, Retirement and Income Solutions; Jim McCaughan, Principal Global Investors; Luis Valdés, Principal International; Amy Friedrich, U.S. 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. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K filed by the company with the U.S. Securities and Exchange Commission.

Additionally, some of the comments made during this conference call may refer to non-GAAP measures. Reconciliations of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may be found on our earnings release, financial supplement and slide presentation.

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

Thanks, John, and welcome to everyone on the call. This morning, I'll share highlights for the year and key accomplishments that position us for continued growth. Then Deanna will provide details on the impacts of U.S. tax reform, our financial results and capital deployment.

2017 was another very good year for Principal despite fourth quarter results. As Deanna will cover in more detail, the fourth quarter non-GAAP operating earnings reflect higher expenses and taxes, low performance fees in PGI and accelerated investments in our digital strategies. I see full year results as a much better indicator of company performance and a source of continued confidence in our ability to deliver on 2018 guidance we provided in our outlook call last month.

In 2017, we substantially expanded our distribution network and array of retirement, investment and protection solutions. We enhanced our digital capabilities, and we made important progress in key markets including Brazil, Chile, China, India and Mexico. It was a year where we continued to produce strong growth, balanced investments in our businesses with expense discipline, be good stewards of shareholder capital and deliver value to our customers, drive improvement in our communities and be a great place to work for our employees.

Just after year-end, we received some notable recognition. We ranked #6 in Forbes' list of the Best Employers for Diversity, and we made Fortune's list of the World's Most Admired Companies.

At nearly $1.5 billion, we delivered record non-GAAP operating earnings in 2017 with double-digit growth compared to 2016. We grew assets under management, or AUM, by $77 billion or 13% to a record $669 billion at year-end, providing a solid foundation for growth in 2018. Throughout the year, our asset management franchise received dozens of best fund awards in Chile, China, Hong Kong, India, Europe, Malaysia, Mexico and the U.S. from organizations including Bloomberg, Morningstar and Thomson Reuters Lipper. For a sixth consecutive year, we are recognized as one of Pensions & Investments' Best Places to Work in Money Management. Most recently, Principal Millennials ETF made InvestmentNews' list of best-performing international ETFs, topping the world's large stock category with a 41% gain in 2017. In the fourth quarter, Willis Towers Watson released research on the world's largest asset managers. Principal tied for the tenth fastest-growing firms within the top 50 based on compounded annual AUM growth of 12% from 2011 through 2016. We moved up 13 spots over the 5-year period to #38.

For our Morningstar-rated funds, 68% of fund-level AUM had a 4- or 5-star rating as of year-end. Further as shown on Slide 5, our longer-term Morningstar investment performance remains very strong. At year-end, 83% of Principal mutual funds, ETFs, separate accounts and collective investment trusts were above median for 5 years performance, 69% above median for 3 years performance and 76% above median for 1 year performance. 2017 was our eighth consecutive year of positive total company net cash flows with $122 billion over this period. This result underscores strong diversification by investor type, asset class and geography; strong integration of our businesses, enabling us to meet investor needs as they transition from accumulation into retirement; and the value we can deliver to investors through fundamental active management, including equities, fixed income and alternatives including real estate.

At $7 billion, our full year net cash flows were down substantially from a year ago. As discussed on prior calls, much of the decline from 2016 reflects softness in the first half of the year with significant improvement in the second half of the year. Principal International's net cash flows were nearly $3 billion higher in the second half of 2017 than the first half of the year with meaningful improvement in Brazil, Chile and Southeast Asia. We are particularly pleased to see net cash flows in Chile turn positive during the fourth quarter.

While not included in the reported numbers, net cash flows in our joint venture with China Construction Bank also rebounded strongly in the second half, bringing full year net cash flows in China to more than $18 billion. Again, these assets are primarily short term in nature. But with over $100 billion in positive net cash flows in China joint venture over the past 3 years, 2 points are clear: the magnitude of the opportunity in China and the immeasurable value of having CCB as our partner.

Principal Global Investors sourced net cash flows, including institutional retail, also rebounded substantially in the second half of the year, improving more than $4.5 billion compared to the first half. That said, PGI net cash flows were negative in the fourth quarter and for the year, primarily reflecting the loss of several large lower-fee mandates. Importantly, though, our focus on revenue has enabled PGI to deliver strong growth in management fees despite ongoing pressure on fees for the industry.

Moving to RIS-Fee and our core small- to medium-sized business market, we continue to deliver net cash flows near the top of the targeted range of 1% to 3% of beginning of year account values. However, higher large case withdrawals drove RIS-Fee full year net cash flows below the 1% to 3% target in total.

Importantly, the fundamentals of the business remains strong, as evidenced by our meaningful growth in plan count, participants and reoccurring deposits that increased 6% to a record $20 billion in 2017. For both RIS-Fee and PGI, we continue to expect larger institutional deposits and withdrawals to occur unevenly over time, which will create both quarterly and annual volatility in net cash flows. Nonetheless, we remain confident in our ability to attract and retain business. We have an outstanding array of solutions, and we've positioned ourselves to capitalize on markets with substantial growth potential.

Net cash flows remain important, but we continue to focus on revenue growth. This means delivering better client outcomes and differentiating through value-added specialties, solutions and alternative investments.

I'll now share a few execution highlights starting with our efforts to expand and enhance our investment platform through a continued focus on outcomes, diversification, asset allocation, downside risk management and cost-effective alternatives to pure passive management. In 2017, we launched more than 50 new funds in total across Southeast Asia, China and Latin America, responding to increasing local retail and institutional demand for multi-asset and income-generating solutions. We had several new launches in our Dublin platform as well, notably more than doubling sales on this platform from a year ago to $5 billion, generating nearly $2.5 billion of positive net cash flow for the year.

On our U.S. platform, we launched 4 new ETFs in the fourth quarter and a total of 7 for the year, bringing us to a dozen ETF strategies in the market as of year-end. Our ETF franchise surpassed both the $1 billion and $2 billion milestones in 2017, moving us up 7 spots on ETF League Tables and placing us in the top 30 as of year-end.

We also remained highly focused on digital solutions and made some noteworthy progress. In 2017, we launched a new account aggregation tool. This provides retirement plan participants a more holistic view of their finances and a more accurate estimation of their retirement readiness. We also launched a first-of-its-kind retirement modeling planner. Using real-time data, plan sponsors [and advisers] can assess retirement plan health, see how the plan design features impact participant retirement readiness and estimate costs associated with changes to the plan design. And we continue to make enhancements to our digital education and enrollment resources within our retirement and group benefits businesses, enabling an increasing number of workers to take important steps towards financial security.

In the fourth quarter, we began accelerating our investment in the digital business strategies discussed in our 2018 outlook call. More to come in 2018 as we intensify our focus on the customer experience, direct-to-consumer offerings and our global investment research platform.

Moving to distribution. We continue to advance our multichannel, multiproduct approach. In 2017, we increased the number of firms producing at least $2 billion in sales from 5 to 6 and achieved a double-digit increase in the number of firms producing at least $0.5 billion in sales. We made tremendous progress in getting our investments on recommended lists and model portfolios. We earned a total of 72 placements in 2017, getting us over 40 different options on more than 2 dozen third-party platforms with success across asset classes.

As highlighted throughout 2017, we've had a number of important distribution developments. As part of the broader efforts to expand our distribution resources, we've opened an office up in Zurich. We also added and expanded upon several key distribution relationships, most notably Alibaba. Our top 10 firms now average more than 5.5 products per platform.

During the fourth quarter, we launched a fully digital pension product platform in Brazil and after regulatory approval will be owned through a joint venture with BB Seguridade. This is just a prelude to a much broader effort by Principal to introduce digital sales and advice platforms that support advisers as they seek asset allocation models to use portfolio construction and support individuals through simple, affordable direct-to-consumer solutions for protection, retirement and other long-term savings needs.

In closing, again, 2017 was a year of strong growth for Principal and a year of meaningful progress. Competitive environmental challenges remain, but we go forward from a position of strength with outstanding fundamentals and the benefit of broad diversification. I look for us to continue to build on the momentum in 2018 and for that momentum to translate into long-term value for our shareholders. Deanna?

Thanks, Dan. Good morning to everyone on the call. This morning, I'll discuss the impacts of the U.S. Tax Cuts and Jobs Act or tax reform on fourth quarter results and on our effective tax rate guidance for 2018, the key contributors to our financial performance for the quarter and full year and capital deployment and our capital position at year-end.

As you know, U.S. tax reform was signed into law late last year. The net financial impact shown on Slide 6 were reflected in other after-tax adjustments and excluded from non-GAAP operating earnings. The impacts included a $626 million benefit from the remeasurement of our net deferred tax liability and $57 million of higher tax expense, including $43 million from the onetime-deemed repatriation tax on foreign earnings. Tax reform did not have a material impact on our 2017 estimated risk-based capital formula or statutory surplus, and we remain confident in our ability to deploy our targeted $900 million to $1.3 billion of capital in 2018.

Non-GAAP operating earnings ROE, excluding AOCI other than foreign currency translation, declined approximately 40 basis points at year-end due to tax reform as the net benefit increased our equity base.

As shown on the bottom of Slide 6, we've updated our 2018 effective tax rate guidance to reflect the total company impacts of tax reform. The total company non-GAAP operating earnings effective tax rate guidance range is now 18% to 21%. This should increase our 2018 non-GAAP operating earnings by approximately 3% over 2017.

Moving to financial results. Net income attributable to Principal was $842 million for fourth quarter 2017 compared to $318 million in the year-ago quarter. The increase was primarily a result of the $568 million net benefit from tax reform. In addition, during the fourth quarter, we made a $70 million pretax contribution to the Principal Foundation, reflecting our strong financial position and our long history of charitable giving.

For full year 2017, net income was a record $2.3 billion, including a record $1.5 billion of non-GAAP operating earnings, the benefit from tax reform and the gain from the third quarter real estate transaction. At $47 million for the year, credit losses remained below our pricing assumptions.

We reported non-GAAP operating earnings of $351 million for the fourth quarter 2017 or $1.19 per diluted share. On a full year basis, excluding the impacts of the annual assumption reviews, non-GAAP operating earnings increased 10% from 2016, reflecting continued strong execution and favorable equity markets.

A majority of the quarter's results can be explained by a few items: higher operating expenses, timing of taxes and lower performance fees in PGI. As in prior years, we saw an increase in fourth quarter operating expenses compared to the other quarters, primarily in compensation and other expenses. In total, operating expenses were elevated by about $80 million to $90 million from the average quarter in 2017 and can be attributed to 3 factors: seasonality and timing, onetime items and increased investments in the business. Slightly more than half of the total was due to seasonality and timing of expenses, including branding, benefit costs, M&A transaction fees, variable sales expenses and DAC amortization. In regard to the timing of expenses, the first 3 quarters of the year benefited from lower expenses while fourth quarter was impacted by higher expenses. Approximately 25% was due to onetime or higher-than-normal expenses, including a guaranty fund assessment and incentive and stock-based compensation. These are not expected to continue at the same level into 2018. The remainder was increased investment in our businesses, including the beginning of our accelerated investment in digital business strategies.

In addition to the higher operating expenses in the quarter, the timing of taxes, particularly between third and fourth quarter, negatively impacted the fourth quarter by approximately $15 million. Our full year total company non-GAAP operating earnings effective tax rate was in line with our expectations.

In the fourth quarter, mortality and morbidity were slightly favorable overall. A benefit to Individual Life, neutral to Specialty Benefits but a negative to RIS-Spread, primarily our pension risk transfer business. On an annual basis, mortality and morbidity were in line with our expectation for all our impacted businesses.

We view the total company items I discussed earlier, expenses and timing of taxes, as normal quarterly fluctuations that level out over longer periods of time. The only significant variance in the fourth quarter was lower-than-expected encaje performance of $6 million on a pretax basis.

In my following comments on business unit results, I will exclude the significant variances from both periods in my comparisons. Taking into account the impacts from mortality, morbidity and the elevated operating expenses in the quarter, fourth quarter pretax earnings for RIS-Spread, Individual Life and Specialty Benefits were in line with our expectations.

For the year, excluding the impacts of the annual assumption reviews, our spread and risk businesses were within or better than their guided revenue and margin ranges. Together, spread and risk accounted for nearly 40% of total company non-GAAP pretax operating earnings, reflecting a combined 10% increase in pretax operating earnings from 2016.

As shown on Slide 7, RIS-Fee's pretax operating earnings of $127 million increased 2% compared to the year ago quarter. Net revenue growth of 3% was driven by a 9% increase in fees and other revenue, partially offset by lower net investment income. Additionally, the current quarter was impacted by the higher operating expenses described earlier. Excluding the impact of the annual assumption reviews, full year 2017 pretax operating earnings increased 9% over the prior year, primarily driven by higher account values. Both revenue growth and margin metrics ended the year at the top end or higher than our 2017 guided ranges.

Slide 9 shows Principal Global Investors' pretax operating earnings of $124 million. Compared to the prior year quarter, 10% growth in management fees was offset by the anticipated lower performance fees. Full year 2017 pretax return on operating revenue less pass-through commissions was 37%, at the high end of our 2017 guided range. Operating revenue less pass-through commissions increased 5% despite the large decline in performance fees.

I'll refer back to Dan's point regarding our focus on revenues. Despite industry pressure on fees, we grew management fees in line with an 8% growth in average AUM in 2017. In the fourth quarter, we announced the planned acquisition of Internos. This will give us a platform to combine and leverage our real estate expertise throughout Europe. We are still on track to close in the first half of 2018.

Turning to Slide 10. Principal International's pretax operating earnings of $84 million increased 9% over the year ago quarter. Earnings from growth in the business was partially offset by the higher operating expenses discussed earlier. Excluding the impact of the annual assumption reviews, variance from expected encaje performance and a onetime expense in Mexico in second quarter, Principal International's 2017 combined pretax return on net revenue was 38% and combined net revenue increased 13%. Both were within the 2017 guided ranges.

Consistent with our international growth strategy, we've recently announced 3 planned acquisitions in Principal International. All 3 are slated to close in the first half of 2018. As announced in October, the planned acquisition of MetLife Afore business will provide additional scale and distribution strength in the mandatory pension business in Mexico. At the beginning of 2018, we announced that we plan to take full ownership of the Principal-Punjab National Bank asset management company in India. We have been in India for nearly 20 years and have been increasing our ownership over time. This transaction gives us greater autonomy in executing our strategic business plans in India. Finally, we also announced a plan to increase our ownership in our asset management joint ventures in Southeast Asia with CIMB. Once complete, our ownership will be 60%, positioning us to better leverage our retirement and global asset management capabilities in the region. We are excited about these opportunities and in total, we expect these transactions to be accretive to 2018 earnings.

Moving to corporate. Pretax operating losses of $61 million were higher than our expected run rate due to higher operating expenses discussed earlier. For the full year, corporate losses were in line with our 2017 guidance, and the losses can be volatile in any given quarter.

Fourth quarter reported non-GAAP operating earnings ROE, excluding AOCI other than foreign currency translation adjustment and excluding the impacts from the annual assumption reviews, was 14.1%, a 50 basis point decline from a year ago. This decline primary reflects the higher equity base due to the impacts of tax reform and the gain on the third quarter real estate transaction.

Our estimated risk-based capital formula was 445% at year-end. This is above our targeted range of 415% to 425%, primarily due to the real estate transaction in third quarter. Our goal remains to bring the RBC ratio back to our targeted range over the next several quarters through strategic capital deployment opportunities.

As outlined on Slide 13, we take a balanced approach to capital deployment. Our goal is to deploy between 65% and 70% of net income per year, with variability in any given quarter. In 2017, we deployed $913 million of capital or 68% of net income, excluding the net income impacts from tax reform and the third quarter real estate transaction.

Full year 2017 capital deployments included $540 million in common stock dividends, $193 million in share repurchases and $180 million through the planned MetLife Afore and the Internos acquisitions and increased ownership of our investment boutiques.

The full year common stock dividend was $1.87 per share, a 16% increase over 2016 as we continue to target a 40% dividend payout ratio. Last night, we announced a $0.02 increase in our common stock dividend payable in the first quarter, bringing the dividend to $0.51 per share.

Despite fourth quarter results, I'm very pleased with our strong financial results for the full year, a better indicator of our performance. Looking ahead to 2018, I want to remind you that the first quarter is typically our lowest quarter for earnings due to dental and vision claims in Specialty Benefits and elevated payroll taxes in PGI.

As a reminder, the accelerated investment in our digital business strategies will flow through the business unit results, and the investment may occur unevenly throughout the year. While included in our guided ranges, it will likely cause 2018 margins to decline from 2017 levels.

We anticipate that tax reform will have a positive impact on an already strong economy and on our target market of small- to medium-sized businesses, whether through wage inflation, employment growth, additional growth in the economy or by enabling companies to offer new or enhanced benefit packages.

2018 won't be without its challenges, but we are excited about the prospects a new year brings and remain confident in our ability to execute on our strategy to continue to deliver above-market growth.

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

(Operator Instructions) And the first question will come from John Barnidge with Sandler O'Neill.

My question, your RBC ratio saw no material impact from charges, and that contrasts to some peers this quarter. One, has this combined with tax reform changed your appetite on M&A and possibly shifted it from being more international in focus to possibly more domestic in focus? And then the second part of the question is, how -- with tax reform in the rearview mirror now, are you seeing a large increase in interest from clients increasing their employee benefits whether it be medical, life or retirement?

John, thanks for the questions this morning. I'll take maybe the impact as it relates to acquisitions and client behavior and then throw it over to Deanna. I would say that the fundamentals of our criteria for making acquisitions has to do with building out scale or capabilities, whether that's international or domestic, and I don't see that having a material impact. I think, generally, we have thought that most of our domestic businesses are at scale and, over the years, we've added to some capabilities. International, you've seen us most recently start making the move on acquiring larger shares and stakes to gain majority control. That's what you saw in the case of CIMB and certainly more control now with Punjab National Bank. I think as it relates to the benefits, I just was speaking with an employer earlier this week -- yesterday about tax reform, and it seemed to fall into 3 buckets. One was what they anticipated was increase in benefits, as you say, whether it's voluntary or matching contributions, although in working with Nora and her team, we've not yet seen a material change in matching contributions. But his view was that yes, we would continue to make those sorts of investments. The second was in the business itself. I don't think it's just us who's happy to make an investment in digital. I think it goes across every industry and every sector. And the last one, frankly, and it's a publicly traded company, they talked about it flowing back to investors. And so with that, let me throw it over to Deanna to hit the RBC ratio itself.

John, thanks for the question. A couple of things I'll mention there, and you're right, we did have a very minimal impact on our RBC formula from tax reform. Despite the DTL at the total company level that caused the significant gain in the quarter, we did have a DTA in our life company. But as we remeasured that DTA and took into account the amount of that, that was admitted, it only had about a $30 million or a 3 percentage point impact on our risk-based capital. I think the wildcard going forward is obviously our current risk-based capital formula does have a provision for tax rates, and it's likely that the NAIC at some point could update that. And we've talked about it in the past, that impact would impact all of the insurance companies, and we estimate about a 65 percentage point impact just from that. Having said that, there's other moving pieces within the formula that the NAIC is contemplating, and the timing of that as well as rating agency reaction is unclear. I think to kind of wrap it up, I feel we're in a very strong capital position. Our risk-based capital is at a very strong level as well as the capital that we have throughout the complex, so feel confident that we can withstand any impact of tax reform on our capital position and RBC going forward.

John, did you have a follow-up?

No, that's good. You answered it.

The next question will come from Alex Scott with Goldman Sachs.

First question on flows. Was just interested in your outlook for flows in the fee business. And any competitive pressure that you're seeing that you'd characterize as incremental? And would you expect to sort of have to pass through tax benefits there? And I guess, considering DRD is going away to some degree, will that kind of result in less of that for the segment?

Yes, so good question, Alex. Appreciate that. And I'd say broadly, and I'm going to ask Nora and Jim and Luis all to weigh in on your question related to net cash flow because it is important. I would give you the overarching response to this, though, and that -- and Deanna mentioned it in her prepared comments, this has far more to do with revenue growth and operating earnings and margins than perhaps it does on net cash flows. These have become quite uneven for a variety of different reasons. And as I reflect on your question related to net cash flow, it's in the large case market where we see the most volatility. It is in the group benefits business for premium. It is in the retirement business. It's institutional asset management and full service payout. So we need to orient ourselves that we're going to see volatility in net cash flow. But with that, let me throw it over to Nora to specifically talk about full service.

Yes, on the RIS-Fee side, full service -- our full service retirement business, as we talked about the last couple of calls, net cash flow has been impacted there by just a handful of larger cases. And in fact, I spoke to one really large case for our block. And that out has actually been split between -- the asset transfer there between 4Q -- about $800 million on that case went out in 4Q and actually about $1 billion on that case went out in 1Q '18. We saw it. It was north of $1.5 billion a quarter ago. With the equity market rise, it's at about $1.8 billion. So we're going to continue to see lumpiness in the net cash at the large end of the case flow, as Dan points out. But we're extremely pleased with our core SMB segment and the net cash flow there. That remains well within that 1% to 3% metric that we use, the "beginning of year" account value for the full year. And we're confident going into this year that we see the momentum in that core SMB net cash flow as well. Doesn't mean there isn't going to be lumpiness in and out at the larger end of our block. But certainly when we look at this revenue growth, to Dan's point, and focus on that, it's this core SMB net cash flow that we're very focused on.

Jim, do you want to take a crack at PGI?

Yes, certainly. Thank you, and thanks for the question, Alex. I could illustrate this, I think, by talking about 2 of the "late in the year" client movements, one in outflow, one in inflow. The outflow was for a currency mandate where the AUM was $1.2 billion. That went out in December. So it's $1.2 billion. The revenue on that was just over $200,000 a year. In other words, it was a very straightforward rather in a sense commoditized mandate. The other big one in December was an inflow, $600 million for a large pension client into international small-cap with the revenue there being $3 million a year. I think that illustrates the fact that the specialty asset classes that we are running, which Dan referred to, have still got quite rich revenues and have a pretty good pipeline. And that's the underlying reason for my confidence that we can continue with pretty good revenue growth, particularly management fee growth. So I feel pretty confident about that. The pipeline remains strong. And so you'll see quite unpredictable results in particular quarters as regard to the flows. But the underlying revenue development for PGI is in much better -- is in really very good shape.

Luis, you had a nice quarter. You want to give some additional color on maybe sort of your outlook and how things are going in Asia and Latin America?

Okay. Sure, Dan. Alex, let me tell you that we are very pleased about our $2.5 billion in net customer cash flows in the fourth quarter. And if you're looking quarter-over-quarter and you're looking 1 year back, we're very pleased because the quality of that $2.5 billion is much, much better than the one that we had 1 year ago. Pretty much more 1 year ago, we'd rely just on Brazil. Now you could see there's a $1.9 billion coming from LatAm and $0.6 billion coming from Asia. And that is not counting the other $7 billion that we had in China, which is part of our combined net customer cash flow. So I will say that we're pretty much more back to normal. I will say that $2 billion, $2.5 billion is pretty much more our run rate for fourth quarter. Certainly, the first quarter in 2018 -- every single first quarter is a little bit kind of low because we have summertime in Brazil, summertime in LatAm, so we have to be a little bit conscious about that. But we're very pleased to see that all our operations and companies and countries are putting positive net customer cash flows.

Alex, I would say to just answer that last part of your question around impact on tax benefits and DRD. Frankly, when you took the reserves, the DAC and the DRD, although the composition might be a little bit differently weighted, it wasn't a material change. And so I don't see that, that has any significant impact on us. As it relates to the foreign tax credit, it would certainly have to go into your valuation models on acquisitions, if we're not going to have as favorable of a tax situation. So that's something we'll have to work through internally. Did you have a follow-up?

Yes. Maybe if I could just sneak one more in on the pension business. We had a competitor announced that they were improving processes around finding annuitants where contact information have been lost and there was an assumption in the reserves, I guess, associated with whether those would end up being paid out. Can you just provide some commentary on what you guys assume in your reserves for the pension business and your process around finding "missing annuitants"?

Yes. And it is an important matter for customers. It's something we take obviously very seriously, and I'll ask Nora to speak to it specifically in our Full Service Payout business.

Sure. So Alex, familiar with the competitor situation. We obviously can't speak to the details. But when we look at our block, both with regard to the pension risk transfer reserves and the DB reserves, we're very confident that we're holding adequate reserves for those 2 businesses. We've had processes and procedures in place, and they are designed to locate missing or unresponsive individuals. And we use both internal and external sources. So our confidence level is high. Certainly, we'll continue to monitor the situation.

The next question is from Erik Bass with Autonomous Research.

I guess first, just one on taxes, in employee benefits specifically. We've heard at least one competitor talk about passing along the benefit from tax reform in terms of lower pricing. Can you just talk about how you're thinking about after-tax margins and pricing in that business?

Yes, that's fine. Amy, you want to take a crack at that?

Sure. Erik, I think when you have a business that is reliant as we do in terms of the small- to medium-sized marketplace on your manual rate, what we do is we do studies on a continual basis that look at the expenses of our business, the claims pattern. And we do those on a quarterly, on an annual basis. And so what happens is you end up picking up things like a tax rate fairly quickly and moving it into your pricing. So I would see, especially for people who are using and reliant on more of a manual kind of that small case rating and they look at their block consistently, they would move that into their pricing fairly consistently. Now you can always hold some things off for profit and make some discrete decisions. But I would say leaving the market kind of to itself, it would be reasonable to assume that some of that, if not all of that, benefit over the period of time, 1 year, 18 months, 2 years, would come back into pricing competitiveness.

I think the reality is there's so many variables that go into the pricing. This is just one component. In the grand scheme of things, it's a relatively small component. Did you have a follow-up, Erik?

Yes, that's helpful. I was hoping you could provide a little bit more color on the recent acquisitions or changes in ownership stakes in Principal International and just thinking about the incremental growth opportunity you see by having more control and maybe a little bit more detail on what the expected earnings contribution is.

I'm glad you asked the question. I'm going to ask both Luis and Jim to speak to CIMB and also Internos because we're excited about those opportunities. As it relates to CIMB, the first thing I'd like to say is they have been a wonderful partner to work with for over 10 years, and we think of them as very capable partners and good distribution partners. By going to more than 50% or taking ownership, a majority stake in CIMB, it's going to allow actually Luis' Principal International team to pull in more Jim's resources with Principal Global Investors as we look at that area in a broader context. So I look at it as a much bigger pie for the organization to go after across a broad range of options across our entire sleeve of asset classes. So again, we're very enthusiastic about that, but let me ask Luis to talk further about those acquisitions.

Yes. Let me tell you that we're very excited in order to get additional control over our franchise in Southeast Asia. Just to picture you, we're talking about a footprint that we cover almost 350 million people with that footprint in a region which is growing every year around 4.5%, 5% year-over-year. So it's a very vivid kind of part of the planet. And what we're doing is taking control, as Dan said, in order to speed up our process and our growth not just in Malaysia, certainly in Thailand and Indonesia and Singapore, jointly with Jim with PGI. We have had a tremendous partner in the last years with CIMB, but it seems to me that we just finished the first phase, which was really to establish that footprint in the region. So we'd really need more things like operational staff and knowledge about those markets. But going forward, it's pretty much more about asset management expertise, pension expertise, long-term saving products, distribution and digital. So it seemed to me that this kind of transaction is opening up for many, many future opportunities for us.

Jim, you want to talk a little bit about your enthusiasm for European commercial real estate and how that complements our business?

Yes. For the last -- thank you. For the last 20 years, Principal has been very focused on U.S. commercial real estate, both private equity and private debt. And that's on the grounds that if you focus, you'll probably be better, will be very, very strong. We got to a point, though, for our leading position in U.S. commercial real estate is leading to specific clients asking us to do things for them around the world. And we had already started doing that in a modest way before the Internos acquisition. The Internos acquisition brings us a pan-European group that can be highly integrated into our real estate efforts. Don't think of it as a typical semiautonomous boutique. Think of it as Principal Real Estate Investors Europe. And that will enable us to provide very high-quality services across Europe as well as the United States. And that in the end, I think, is going to be a very important step towards globalizing our already leading real estate franchise. So that's Internos. If you can forgive me for a comment on CIMB, it sits within Principal International, but we are really one company at Principal. We're working very close on the asset management function. And the fact that we've taken a majority stake or are taking a majority stake in the CIMB joint venture gives us a lot more control and a lot more leverage about the management to the assets. And we will be able to make them in effect part of our global asset management platform. We believe that a strong local player with access to best global practices and all our resources will do even better than that already successful partnership has been doing so far.

To your last question, Erik, around what it means from a financial perspective. I guess, the best way I think about that is you look at our 2018 outlook, it would have anticipated these moves, and I would say that they are baked into what we've already provided you. So appreciate the question.

The next question will come from Tom Gallagher with Evercore.

Just wanted to make sure I understood the way you're thinking about the RIS flows going forward. The 1% to 3% that I know you've targeted historically, is that not a good range to think about considering what's going on in large case more the way we should think about the non-large case business for 2018? Any clarity there would be appreciated.

Yes. Tom, appreciate the question. I guess, the way I would respond to that, and I'll throw it to Nora here in a second, that 1% to 3% really works well with that core SMB market, think about fewer than 1,000 employees. The minute you start having plans with 5,000, 10,000, 15,000 plan participants and the turnover on those plans when they're measured in billions is when you introduce that element of volatility. But when I step back and look at that business line in total, they grew their participants by nearly 140,000-plus. They grew the number of plans this past year by over 800. They hit their marks within the SMB market with the 1% to 3%. So this really can be isolated to be the institutional element. And by definition, it's going to be volatile, but I'll have Nora clean that up for me.

Yes. And as a reminder, Tom, we talked about this before, but the equity markets put pressure on the AV-based percentage. Those withdrawal amounts are driven higher by the market growth, whereas our payroll-based contributions obviously are not. So the percentage itself gets materially impacted by the lift in the market. But back to Dan's point, when you look at being impacted 1Q this year by the $1 billion, the large case that has an outflow, there's already pressure on that metric. But if you strip that out and take a look at the overall block, you're still going to see that core SMB well within that range. That's our expectation, anyway, sitting here today. But there could be 1 or 2 outflows at the larger end of our block that would take us in total down to the lower end of that range. So we're just going to have to watch those variables. We'll obviously be as transparent as we've been historically, but it is a tough metric to cover the entire block.

Tom, do you have a follow-up?

Yes. And so, Nora, just following up on that, so it sounds like based on -- from the pipeline you're seeing today, you would still be overall, including large case, in positive net flows, but toward the lower end of the 1% to 3%, is that a fair assessment based on what you know right now?

That's a fair assessment based on sitting here today. Absolutely.

The next question will come from Suneet Kamath with Citi.

Just wanted to follow up on the tax rate. I don't want to get too technical. But if we think about the 18% to 21% guidance that you've given for 2018, it's a little bit higher than, I think, what we were modeling. So is there any way that you can maybe attribute the decline from the 21% to 23% to the 18% to 21% in terms of just the big moving pieces?

Sure. Deanna, do you want to take that?

Yes, I'll take that. You're correct, we previously had guided you to 21% to 23%. Our new total company effective tax rate is 18% to 21%. As you might expect, there's a lot of moving pieces underneath that, but let me just highlight probably the most 3 significant. First of all, obviously, the tax rate is reducing from 35% down to 21%. You have DRD that's reduced around 60%. So historically, we would have had about an 8% to 10% benefit on our ETR; now in that 3% to 4% range. And probably the one that is harder for you to model and get your hands around is really how the tax rates of our foreign jurisdictions go into our effective tax rate. And so obviously, all of the jurisdictions that we are in have a tax rate in there. Previously, we had a foreign tax credit, and now we don't have a foreign tax credit and we take in actually the tax rates of those foreign jurisdictions. I'd say that probably caused about a 4% to 5% swing where previously it was helping our ETR by 2% to 3%, and now it's reversed to probably about a 2% increase in our ETR. So I'd say those are the major moving pieces of that and ultimately what got us to that 18% to 21%. But obviously, we'll continue to look at that going forward, but those would be the major parts of that.

Was there a follow-up?

Yes, that's helpful. I just wanted to follow up on the large case RIS-Fee questioning. I had thought previously when you talked about those terminations, a lot of that was driven by M&A. But it seems maybe that the tone on this call is a little different, maybe I'm wrong. But just wanted to look under the hood here and just see what's going on in that large case market. Is it price competition? Is it people folding in tax rate declines into their pricing? What's driving some of this commentary?

No. Yes, I don't think anybody has done that. I would still say you've got really 3 buckets when you think about why you might lose a piece of business. M&A is still far and away the biggest one in the large case market, where we were -- our customer was acquired, and oftentimes they go to the larger or the acquired company. And that represents about half of it. Just as a sidenote on that, really small- to medium-sized business, businesses go out of business. And we -- there's new plan formation, we're certainly benefiting there. But that's also another place where we lose it. The second area is in some way, for whatever reason, we underperform from a customer service, investment performance, that whole gamut of products and services. I would tell you that's the smallest bucket. We query ourselves extensively. We hire third parties to evaluate how we're performing for our customers, and a lot of that is publicly available information. So we feel like we're doing a really good job in that category. And then I think this third area has to do with whether or not there is a perception that you have the right sort of capabilities around technology or robo or they, in fact, want to have complete open architecture. And in those cases, we may not be the most competitive offering out there. But again, a lot of this large case market is exclusively focused on we were on the losing end of M&A, and Nora, you want to add to that?

Yes. One, just -- and this is a very practical aspect of our business. You can have a key decision-maker change. You can have an adviser or a consultant change. So we see day-to-day that, that can have as much impact as whether you're talking about service levels or pricing. So there's just a practical aspect of this business that comes into play.

You mentioned the tone of the call. I have no reason to believe at this point, Suneet, that somehow our offering isn't as competitive, the performance isn't as good, but I think it's the normal mix. It just turns out that you've got 1 or 2 cases here, actually very large in size, mega plans, that has distorted the results not only for the quarter, but the year.

Our retention rates remain remarkably high. We have very, very strong retention at the plan sponsor level. So to Dan's point, we're highlighting these larger cases because they're impacting net cash flow, but the retention on the block is extremely strong and industry leading.

The next question will come from Jimmy Bhullar with JPMorgan.

I had a couple of questions. First, on PGI, your performance fees were low in 4Q, and I think that was expected just given how your contracts are now sort of structured. Can you comment on what your expectation is for this in 2018? And then on the international business, maybe if Luis could just talk about the competitive and regulatory environment in Chile? It seems like there were some headwinds that -- MetLife lowering prices and political pressure about the elections going in the right direction and seems like those might be abating, but what you're seeing in the market?

Yes. Two really good questions. And as you know, with the presidential election in Chile, things perhaps are better for business broadly defined. But why don't we take them in the same order. Jim, you want to go and talk about performance fees?

Yes. Thank you, Jimmy. The incentive fees have been low in 2017 and will remain fairly low in 2018 most likely not because of performance, but because of incidents. Remember, the big ones we have are mainly on real estate, both debt and equity and have assessment periods of 3, 5 or even more years. And indeed in some cases, the incentive fee only comes when you have the outflow and sell the assets. So that structure means that the incidence is somewhat predictable even if the exact amount when it comes is pretty hard to forecast. We will get up to good levels of performance fees again, 2019, 2020. That's when we'd see a bit more incidents. There is some possibility that something will be brought forward into 2018 because of clients wanting to take their profits and move on. And that, of course, is good news. It's mission accomplished as far as the client's concerned. But I wouldn't count on that happening. It is possible, but most likely we'll be back to what I think of as a more normal level of these longer-term incentive fees in 2019 and 2020. Lastly, there is an annual performance fee piece, which for us is smaller than the multiyear carries. That would be primarily our hedge fund and a few loan-only pieces where we have an annual incentive fee. And that was pretty thin in 2017 as well. As you know, the hedge fund world has found it hard to earn carry, hard to have decent results. But we're optimistic that, that will come back over the next year or 2 also. But that's more a matter of predicting particular segments of the market rather than the incidents. But really, it's the incident that drives it.

Excellent. Luis, you were just out in Chile.

Yes. Jimmy, let me tell you that we think that -- we do think certainly that the political environment in Chile during the next 4 years is going to be much more positive and pro-market, in essence. So I do think -- we're not for sure, but I do think that the next administration that is going to take over in March 11, it's very likely that they're going to repeal and replace the current pension bill, which is in the Congress. This is my personal take. Last week, the current administration, they didn't have even quorum in order to approve a small piece of that legislation. So it seems to me that they're not going to try to attempt any other try for that particular pension bill. So -- and also the other good news is that we already have some information about how the new administration is taking a look to it, and they have a much, much holistic approach to the pension problem in Chile. So the AFPs are just 1 pillar out of 4, and the main problem that Chile has is with other pillars instead of the AFPs. The AFPs, they really need some adjustments, particularly their contribution rates and other things that -- we think that this pension reform is going to be much broader and more interesting and certainly much more compelling, as I said to you. So we're pleased with that. A lot of work has to be done. We're going to be very eager to continue working on. About fees and pressure on fees, honestly, as I said to you many times, our value proposition in Cuprum is highly differentiated. We're #1 in customer service. We just work -- ranked again in the top 100 most reputable companies in Chile. In the long-term investment performance, we're #2, 4 strategies out of 5. So I will say that we differentiate ourselves in Chile as the best pension company. Having said that, we're not competing against head-to-head with MetLife and Provida. So if we're making any decision going forward, it's going to be in light of the interest of our customers, and that is what we're looking every time, all the time.

The next question will be from Sean Dargan with Wells Fargo Securities.

I just have one question about the, I guess, the pace of expenses to come. When you look at your product offering, specifically in RIS, compared to where the competition has gone in terms of digital solutions that allowed the participants to check on their balances and do things on a daily basis, are you where you need to be? Or I mean, how much longer is this period of investment going to go until you get to where you need to be?

I don't think it ever goes away, to be frank, Sean. When I reflect on this, I think about the current expense run rate that we've had has focused on trying to reduce our expenses and also add to new capabilities, and we are leading, best-in-class today. And I would say that one of our greatest threats probably comes from nontraditional players because consumers have now had a really good look at how they purchase other things, unrelated to financial services. And so I think what we're up against is an environment where the A&E has been raised relative to the customer experience, its simplicity, its convenience, how we access it. So this digital initiative, as we spoke about this back on December 12, has everything to do with about 2/3 of the portfolio on driving revenue and about 1/3 of it is about taking out additional expenses. It touches the consumer within our group benefits. It's Individual Life. It's our RIS-Fee businesses. It has to do with driving technology in Jim's portfolio management area and, again, hiring data scientists and people with a lot of skill sets that are new to Principal. And although I don't think this expense rate is ever going to come back down, I think it's going to remain elevated, what I think we will see after 12 months and 24 months and 36 months is those revenue enhancers coming in and that expense being taken out. So I wouldn't want to leave you with the impression that somehow we kind of finish up 2018 and the expense run rate is reduced. I think, in fact, it will be where it's at, and we'll build upon that new base. And we can expect revenues and expense reductions in other areas to offset those. So hopefully that helps.

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

Yes. I think it's pretty simple because from our perspective, our fundamentals remain very much intact. It's around introducing financial security through retirement solutions, asset management and protections, whether it's life and certainly annuities. The demand couldn't be greater. We know that around the world, they're under-saved and under-protected. They're under-advised. We have a lot of solutions that get after each one of those areas. And what we didn't want to do, of course, is to under-invest in these businesses and find ourselves behind the eight ball or irrelevant as time goes on. So I think as our shareholders and as people that are interested in the success of this company, it has everything to do with making sure our customers are getting what they need for them to be successful in the future. So appreciate your interest, and we look forward to seeing you out on the road. Thank you.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 p.m. Eastern Time until end of day, February 6, 2018. 3269287 is the access code for the replay. The number to dial for the replay is (855) 859-2056, U.S. and Canadian callers; or (404) 537-3406, international callers. Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect.