principal financial group inc. · specialty benefits' premium and fees increased 9% over third...

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CONTENTS

CALL PARTICIPANTS 2

PRESENTATION 3

QUESTION AND ANSWER 9

Principal Financial Group Inc. NYSE:PFG

FQ3 2014 Earnings Call TranscriptsFriday, October 24, 2014 2:00 PM GMT..............................................................................................................................................................................................................................................................

S&P Capital IQ Estimates -FQ3 2014- -FQ4 2014- -FY 2014- -FY 2015-

CONSENSUS ACTUAL SURPRISE CONSENSUS CONSENSUS CONSENSUS

EPS Normalized 1.06 1.19 12.26 1.05 4.39 4.46

Revenue (mm) 2547.89 2552.70 0.19 2622.82 10225.07 10662.02

Currency: USDConsensus as of Oct-24-2014 12:27 PM GMT

- EPS NORMALIZED -

CONSENSUS ACTUAL SURPRISE

FQ3 2013 0.87 0.90 3.45 %

FQ4 2013 0.93 0.96 3.23 %

FQ1 2014 0.92 1.06 15.22 %

FQ2 2014 1.01 1.08 6.93 %

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COPYRIGHT © 2014, S&P CAPITAL IQ, A PART OF MCGRAW HILL FINANCIAL.

Call Participants.............................................................................................................................................................................................................................................................. EXECUTIVES Daniel J. Houston

President of Retirement, Insurance & Financial Services James P. McCaughan

Chief Executive Officer of Principal Global Investors and President of Global Asset Management John Egan

Vice President of Investor Relations Larry D. Zimpleman

Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Luis E. Valdés

Senior Vice President, President of International Asset Management & Accumulation, President of Latin America Operations, Chairman of Principal International Inc., Chief Executive Officer of Principal International Inc and President of Principal International Inc Terrance J. Lillis

Chief Financial Officer, Chief Accounting Officer and Executive Vice President ANALYSTS Erik James Bass

Citigroup Inc, Research Division Jamminder S. Bhullar

JP Morgan Chase & Co, Research Division

Sean Dargan

Macquarie Research Seth Weiss

BofA Merrill Lynch, Research Division Steven D. Schwartz

Raymond James & Associates, Inc., Research Division Suneet L. Kamath

UBS Investment Bank, Research Division Thomas G. Gallagher

Crédit Suisse AG, Research Division



Presentation

.............................................................................................................................................................................................................................................................. Operator Good morning, and welcome to the Principal Financial Group Third Quarter 2014 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference call over to John Egan, Vice President of Investor Relations. 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 a reading of the safe harbor provision, CEO, Larry Zimpleman; and CFO, Terry Lillis, will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A are Dan Houston, Retirement and Investor Services and U.S. Insurance Solutions; Jim McCaughan, Principal Global Investors; Luis Valdés, Principal International; and Dennis Menken, Vice President of our investment team. Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise them or update them to reflect new information, subsequent events or changes in strategy. 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 and quarterly report on Form 10-Q filed by the company with the Securities and Exchange Commission. Before we get to the prepared remarks, I'd like to announce some upcoming investor events. First, on the afternoon of November 21, we will host an event in New York City to provide an update on Principal Global Investors, our asset management business. Details are available on our website. We're also planning an update in the spring on Principal International's Latin American businesses. That event will be held in Santiago, Chile on March 11. We hope that many of you are able to attend these events. Finally, our 2015 outlook call will be held on the morning of December 8. We'll provide call-in information closer to that date. Now I'd like to turn the call over to Larry. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas: First, I'll discuss third quarter and year-to-date results; second, I'll provide an update on the continued successful execution and long-term benefits of our strategy; and I'll close with some comments on capital management. As John mentioned, slides related to today's call are on our website. As you can see on Slide 4, total company quarterly operating earnings of $354 million made this our third straight quarter of record earnings. As Terry will discuss, the results included a $39 million benefit from our annual review of actuarial assumptions and methodology. However, even adjusting for this, we consider third quarter to be another strong quarter. Third quarter results, combined with a strong first half, resulted in year-to-date 2014 operating earnings of $994 million. This is a 28% improvement over year-to-date 2013 results on a reported basis and a 23% improvement when adjusting for the actuarial assumption review. This is an outstanding result despite continued macroeconomic volatility and reflects the strength of our diversified business model and the ongoing momentum in our businesses.



Assets under management were $514 billion at quarter end, down 1% from midyear. The strengthening of the U.S. dollar reduced assets under management by $9 billion for the quarter. Solid sales and retention contributed to $3.7 billion of total company net cash flows for the quarter and $18 billion over the trailing 12 months. This demonstrates the competitiveness of our businesses, the outstanding investment performance we are generating and the strength of our distribution partnerships across the organization. Following are additional key growth metrics from the quarter. Full Service Accumulation quarterly sales were $1.8 billion. We continue to strike the right balance between growth and profitability. Third quarter recurring deposits increased 9% over the prior year period, reflecting the recovering economy and improving deferral rates as our retirement readiness initiative start to take hold. Principal Funds had strong sales of $5.2 billion for the quarter. Net cash flows were $1.4 billion. This is Principal Funds' 19th straight quarter of positive net cash flows. At 8% of account value, Principal Funds' net cash flows were almost 3x the industry. Principal Global Investors had $500 million of unaffiliated net cash flows, which contributed to unaffiliated assets under management of $114 billion at the end of the third quarter. Total assets under management in Principal Global Investors were $307 billion. Principal International's assets under management increased 13% over the prior year quarter to $116 billion despite the strengthening of the dollar. Coming off record net cash flows in the second quarter, Principal International delivered strong third quarter net cash flows of $2.5 billion, driven by continued strength in Brazil. Specialty Benefits' premium and fees increased 9% over third quarter 2013 as a result of record third quarter sales and strong persistency. In-plan growth over the past 12 months was 1.5%, the highest level since 2006, signaling more sustainable job growth. We continue to deliver products and solutions that are in demand with a focus on providing financial security to business owners, individuals and investors around the globe. We remain confident about our competitive positioning and our ability to continue to grow our businesses into the future. Next, I'll provide a few updates on the continued execution of our strategy. Many of you had the opportunity to attend our investor event in September with members of our U.S. Retirement leadership team. As they discussed, The Principal remains competitive and is a retirement leader with key differentiators like Principal Total Retirement Suite and Retire Secure. These innovative approaches build stronger relationships with advisers, plan sponsors and participants, driving better persistency. We're also focused on addressing retirement income gaps through our retirement readiness program called Principal PlanWorks. PlanWorks encourages plan-level features, such as auto enrollment and auto escalation, to drive improved participation and deferral rates. Additionally, we recently rolled out a new participant website designed to provide participants a quick view of their retirement savings and drive them to take action to improve their retirement readiness. As Slide 5 shows, investment performance continues to be very strong and is a leading indicator of growth for our retirement and investment management businesses. At least 85% of Principal Funds' investment options were in the top half of Morningstar rankings on a 1-, 3- and 5-year basis at quarter end. Principal Funds continues to perform very well. Funds had record operating earnings in the third quarter, demonstrating our ability to turn the strong growth in recent years into bottom line results. Principal Funds continues to have great success executing on a strategy focused on asset allocation multi-manager funds that address risk and income needs. 65% of Principal Funds' assets under management are in Morningstar-ranked 4- and 5-star funds. We continued to expand on our outcome-based funds lineup and enhance our investment platform. Through the third quarter, we've launched 4 new fund products this year and anticipate launching 3 more in December and up to 5 more in 2015. Principal Global Investors made 2 strategic announcements in the third quarter that enhanced our successful multi-boutique strategy. First, we announced that Principal Real Estate Investors, the dedicated real estate group of Principal Global Investors, partnered with Macquarie Group to create a nationwide commercial lending platform known as Principal Commercial Capital.



Principal Real Estate Investors will provide its underwriting and loan origination expertise but will not take on the balance sheet risk. In addition, we announced that Principal Global Investors has increased its ownership stake in Columbus Circle Investors from 70% to 95% with plans to acquire the remaining 5% over the next 2 years. Columbus Circle has performed exceptionally well since we first acquired a majority ownership in 2005 with assets under management quadrupling over that time. Investment performance is strong, and we've retained all of the key investment staff. This boutique remains an important part of our overall investment management strategy as it invests on behalf of all of our platforms. Principal International had another quarter of record operating earnings despite continued macroeconomic headwinds. On a local currency basis, operating earnings once again grew at a double-digit rate compared to the prior year quarter. The combination of our investment management expertise, our ability to effectively manage the business at a local level and our relationships with marquee distribution partners positions Principal International for continued long-term growth and success. An example of our strong distribution partnerships is the success of our joint venture in Brazil, BrazilPrev. On a trailing 12-month basis, BrazilPrev garnered 58% of net deposits in the Brazilian open pension market, moving them into the #2 spot for pension providers based on assets under management. This underscores the strength of Banco Brasil's distribution reach and demonstrates the powerful long-term opportunities for BrazilPrev. Additionally, we continue to focus on maximizing the voluntary savings opportunity in Chile. Cuprum voluntary sales increased 29%, and net cash flows for voluntary products were 5x higher than the year ago quarter's results. I also want to mention the continued strong performance from our Specialty Benefits division. Our team continues to do an excellent job of maintaining above-market growth with sound pricing discipline, resulting in better-than-expected loss ratios. Providing leading employee benefit solutions to small and medium-size businesses continues to be an important part of our strategy in the United States. Next, I'll comment on capital management. Our fee-based business model allows us to generate free cash flow and strategically deploy it to create long-term value for shareholders. We remain well positioned to deploy capital through a variety of options in addition to supporting organic growth. Last night, we announced a $0.34 per share common stock dividend payable in the fourth quarter. This brings the annual 2014 common stock dividend to $1.28, up 31% over full year 2013. The merger and acquisition pipeline remains active with opportunities to further enhance our global investment management platform. In closing, I want to point out 2 third-party recognitions we received. I'm especially pleased because both of these recognize our commitment across the entire company on corporate responsibility and sustainability. First, Principal Real Estate Investors recently received the Green Star designation for 3 funds from the 2014 Global Real Estate Sustainability Benchmark survey, including achieving the #1 ranking out of 64 opportunistic investment strategy funds. Green Star is the highest ranking this organization provides. In addition, The Principal was recently recognized as a leader among S&P 500 companies by the environmental nonprofit organization CDP for its actions to reduce carbon emissions and mitigate the business risks of climate change. We take being a socially responsible company very seriously and are proud of our recent recognitions of our efforts. Before I turn it over to Terry, I just want to take a minute to note that yesterday was the 13th anniversary of our initial public offering. At that time, we had approximately $100 billion in assets under management and a solid position in the U.S. insurance and retirement markets. Our aspiration was to become recognized as a global leader in the mutual funds and asset management areas. Since going public, we've generated nearly $150 billion in net cash flows, and assets under management have grown to over $500 billion. That's a compounded annual growth rate of over 12%, which is 2.5x the growth of the S&P 500. But as pleased as we are about our results to date, we are even more excited for the growth opportunities that lie ahead of us. Terry? Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President Thanks, Larry. This morning, I'll focus my comments on operating earnings for the quarter, net income including performance on



the investment portfolio and an update on capital deployment. Third quarter continued to build on our strong first half of 2014. Total company operating earnings of $354 million were up 31% over the prior year quarter. On a reported basis, operating earnings per share were a record $1.19, a 32% increase over third quarter 2013 results. Total company operating earnings for 2013 were a record $1.1 billion. Year-to-date 2014 operating earnings of $994 million are already 94% of that amount. We continue to successfully execute on our strategy, and momentum continues to build across all our businesses. With our continued shift towards a fee-based business model, we're increasingly well positioned for long-term growth. During the quarter, we completed our annual actuarial assumption and model review. The impact from the review was predominantly recognized in the Individual Life division. Individual Life had a net operating earnings benefit of $39 million or $0.13 per share. In third quarter 2012, we made a significant change in our long-term interest rate assumption and glide path. Thus, the current year impact from the continued low interest rate environment was minimal. The benefit this quarter in Individual Life was driven by several updated assumptions and model enhancements, including refined coverage periods and policy-specific premiums. On Slide 6, we normalized third quarter 2014 earnings for 2 additional items. First, the encaje return in Principal International was $12 million or $0.04 per share better than expected. The higher-than-expected encaje returns are reflected in Street earnings expectations for the quarter and are consistent with the encaje return information available on the websites we've provided in the past. Next, Individual Life claims adversely impacted earnings by $10 million or $0.03 on a per share basis. Analysis of claims points to random volatility, which is inherent in risk-based businesses. Given what we've seen in the last few quarters, we continue to analyze the results and will communicate any changes to our expectations if deemed necessary. On a normalized basis, earnings per share were $1.05, up 13% over a normalized prior year quarter. At quarter end, return on equity, excluding AOCI, was 14.1%. This is a 220 basis point improvement from 1 year ago. Organic growth contributed 145 basis points of the increase as operating earnings improved 26% while mean equity increased only 6%. Operating earnings during this time period benefited from favorable equity markets and high variable investment income, which were partially offset by the strengthening of the U.S. dollar and higher-than-expected mortality. We're still targeting 50 to 80 basis points of annual return on equity expansion as the strength of our diversified business model continues to provide many growth opportunities, both domestically and internationally. Now I'll discuss business unit results. Retirement and Investor Services delivered its eighth straight quarter of double-digit operating earnings growth. For the accumulation businesses, operating earnings were $180 million, an increase of 19% over the year ago quarter. Slide 7 shows that the net revenue was up 11% over third quarter 2013 and up 12% on a trailing 12-month basis. Trailing 12-month pretax return on net revenue improved to 34%. Full Service Accumulation operating earnings were $113 million, a 24% increase over the year ago quarter. Net revenue growth of 9%, combined with expense discipline, resulted in an improvement in the trailing 12-month pretax return on net revenue to 35%. This margin has been helped by the strong equity market returns over the past year and some positive onetime items that we've discussed in previous calls. Net cash flow for Full Service Accumulation were slightly negative for the quarter. In light of our shift in focus on asset sales to new business revenue, we've become more selective on new sales, particularly at the large end of the market. We're increasingly focused on 2 measures: first on planned retention, which was very strong at 97% year-to-date, up 100 basis points from 1 year ago; and second on capturing more assets to Principal-branded funds, which is up 5 percentage points to 73% year-to-date on new sales, reflecting strong investment performance. Principal Funds' third quarter operating earnings were up 25% from a year ago quarter to a record $28 million. On a trailing 12-month basis, revenue was up 14% and operating margins continued to improve due to the scale-based nature of the business.



For the quarter, Principal Funds' sales were $5.2 billion, contributing to $1.4 billion in net cash flows. Strong investment performance and our focus on outcome-oriented products have led to strong sales across multiple asset types. Individual Annuities' operating earnings were $31 million for the quarter. Increased fee revenue on our variable annuity business due to market appreciation continues to offset spread compression on our fixed deferred block of business. Looking at Slide 8, the guaranteed businesses within Retirement and Investor Services continued to perform as expected. We continue to approach these businesses opportunistically. Turning to Slide 9. Principal Global Investors' quarterly operating earnings were $25 million, a 10% improvement over the year ago quarter. Trailing 12-month pretax margin was 25%, slightly below our expectation of 26% to 28% for the year. Fourth quarter 2013 benefited from large performance fees, which lowered the trailing 12-month pretax margin by approximately 100 basis points. We still anticipate increasing to a 30% pretax margin. We expect 2014 revenue in this business to be similar to 2013 levels. While management fees should grow in line with assets under management, performance fees are less likely to reach 2013 levels. Third quarter net cash flows from our fee-based products were nearly $750 million, which was partially offset by our opportunistic approach to the guaranteed businesses. Net cash flows at Post Advisory Group improved dramatically with only modest outflows during the quarter, reflecting some rebalancing occurring in high yield. Quarterly performance remained in the top quartile. Assets under management for Principal Global Investors increased 9% over the prior year quarter to $307 billion. Unaffiliated assets under management ended the quarter at $114 billion, a 7% increase over the year ago quarter. Slide 10 shows record quarterly operating earnings for Principal International of $74 million, a 46% increase on a reported basis. As pointed out earlier, results in the current quarter were helped by higher-than-expected encaje returns in Chile. While the strengthening of the U.S. dollar dampens growth when comparing prior period results, Principal International continues to perform well on a local currency basis. Operating earnings were up 12% over the prior year quarter after adjusting for normalizing items. On a trailing 12-month basis, combined net revenue was up 20%, above our 16% to 18% expectation due to the strong encaje returns. Combined pretax return on net revenue was 52% on a trailing 12-month basis, at the top end of our range. As shown on Slide 11, Individual Life operating earnings were $52 million for the quarter, impacted by the items previously discussed. Moving to Slide 12. Specialty Benefits' operating earnings of $31 million were roughly flat with the year ago quarter, while quarterly premiums and fees were up 9% over the year ago quarter. The loss ratio for the quarter remained strong at 64.5% relative to our 65% to 71% targeted range. The more favorable claims and strong growth in the current quarter were offset by lower expenses in the prior year quarter. On a trailing 12-month basis, premium and fees were up 6%. This is above our expectation of 3% to 5% growth for the year. Trailing 12-month pretax operating margin of 11% is in line with our expectations. For the quarter, total company net income was $241 million, including realized capital losses of $55 million. Net credit-related losses continue to be in line with expectations. We saw improvement in the commercial mortgage-backed securities asset class with impairments of only $15 million in the quarter. Net income was negatively impacted by $58 million due to the Chilean tax reform bill that was signed into law during the quarter. The tax rate will increase over time, so the impact to operating earnings will be gradual. However, we adjusted our deferred tax liability for the ultimate tax rate in the third quarter. Unrealized gains were $2.8 billion at quarter end. As a reminder, because of our strong asset/liability management, changes in net unrealized gains or losses due to interest rate movements do not result in an economic impact. Our asset/liability management expertise, combined with strong liquidity, allows us to avoid forced asset sales in periods of stress. In addition, our predominantly fee-based business model limits our sensitivity to interest rate movements. As outlined on Slide 13, our approach to capital deployment is balanced and focused on increasing long-term value for



shareholders. We've now announced plans to deploy more than $855 million of capital in 2014, well above our $500 million to $700 million stated range for the year. In addition to the third quarter common stock dividend and increased ownership in Columbus Circle Investors, we repurchased $72 million of common stock during the quarter. We still have $50 million remaining from the previously announced share repurchase program. In closing, there are some macroeconomic factors providing significant headwinds as we start the fourth quarter. However, we feel that our diversified business model positions us well for future growth in various economic environments. This concludes our prepared remarks. Operator, please open the call for questions.



Question and Answer

.............................................................................................................................................................................................................................................................. Operator [Operator Instructions] The first question will come from Tom Gallagher with Crédit Suisse. Thomas G. Gallagher Crédit Suisse AG, Research Division First question is just on can you help us think through -- and I guess it would either be for Jim or Terry. Can you help us think through the valuation on the Columbus Circle buyout? Was that just a contractual obligation? Was that negotiated? Because when I look at the implied valuation of $720 million, it looks pretty high relative to what I would expect that to be earnings with AUM. That's my first question. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Okay, Tom, this is Larry. I'll have Jim take that one for you. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes. Tom, I think you have to see that final payment in the context of the incentive structure at Columbus Circle. And to the take you through the whole story as quickly as I can, for the first 70% in -- at the end of 2004, we paid $60 million of this to the company. It was way smaller then and management has done a fine job growing it. And we've obviously supported that. We paid a further $180 million -- $179 million for the next 25% share. What that means is we've effectively, for $240 million, bought a company that's current value must be around $500 million if you marked it to market. Now as you remark, the price we've paid for the 25% looks to be pretty clearly above market. That was a contractual formula we settled on 5 or 6 years ago very deliberately to incent management to go strongly for growth and to build a very sound business. Management has delivered on that, so that's why they got a good price for the further 25%. And from a Principal point of view, we've ended up with a very valuable asset. We've also, by the way, in the 10 years we owned it, received almost $180 million of dividends from Columbus Circle. So if you add this all up, this has been a really tremendous acquisition. The return on the capital invested so far has been in the high teens, so I think we're poised to make this very successful. Thomas G. Gallagher Crédit Suisse AG, Research Division Okay, that's pretty clear, Jim. The -- just to follow up on the mortality in Individual Life this quarter. Now I know the actuarial review had gains, and I presume those were nonmortality related. Can you just address the issue of what has been, I guess, different quarters of weak mortality over the last 2 or 3 years and whether or not that was factored into the actuarial review? And how would you think about that in the context of the balance sheet? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, Tom, this is Larry. I'll make a few comments and maybe ask Dan or Terry to comment as well. I think if you look back over about the last 3 or 4 years, I think the last sort of 15 quarters we've had a little higher mortality in about 7 of those quarters. So in the current quarter, Tom, the higher mortality really was more a matter of severity than it was of frequency. So we are going to take a further look into that. I think it's something that we do need to pay a little bit of attention to. Having said that, the mortality was not really an issue in the actuarial assumption review. We took our appropriate steps a couple of years ago relative



to interest rates and other economic factors. The adjustments this time were more related to lapse rates and reinsurance costs and what I would call sort of maybe some secondary factors rather than basic mortality or interest rate. So let me see if Dan wants to add anything. Daniel J. Houston President of Retirement, Insurance & Financial Services Yes, maybe just a couple of data points, Larry. The first is which -- on a year-to-date basis, if we look at large claims, it's actually been about 1 less than one would have expected for that period of time. But to the comment that was made in the earlier comments, the severity of those large claims has been more significant. We would have expected maybe 380,000, 400,000 versus 800,000. So this is a severity issue. We are taking a very hard look at this. We've got a group of senior executives drilling down to take a very, very hard look at the business and make adjustments as necessary. But at this point in time, we do not think that we've got a systemic problem. This is all in the course of the volatility associated with a life block like this. Thomas G. Gallagher Crédit Suisse AG, Research Division So Dan, nothing -- because I remember several years ago you all had mentioned the IOLI issue. Is it -- so you're not tracing it back to that per se right now? Daniel J. Houston President of Retirement, Insurance & Financial Services We're not. We can identify 3 or 4 very large claims. Had they not occurred, we wouldn't have had the mortality expense that we have. As you know, our business is bifurcated. Some have more reinsurance than others. And unfortunately, in these instances, they were just almost freakish sort of claims. So again, more validation that we don't think this is a systemic issue. It's more of a situational one. But again, that won't keep us from really digging into the details. Operator The next question will come from Seth Weiss with Bank of America Merrill Lynch. Seth Weiss BofA Merrill Lynch, Research Division If I could just follow up on the actuarial review. And I believe you mentioned that the impact from interest rates was minimal for the quarter. Could you comment on the -- how you reset the glide path of interest rate improvements in the future in your assumptions? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, Seth, this is Larry. I'll have Terry make a few comments. I -- if you go back again, I think to really understand this year, you have to sort of go back and look at what was done in the past. I know some comments have been written as to whether this is to indicate other companies are going to have comparable sort of positive numbers or rather negative numbers. And of course, there's no way to ever really make any conclusion on that unless you have a sense of what each company has done up to this point in time. So sort of the trough at this point, and again it's up till now, the trough really was in 2012 where at that time, the 10-year treasury was sort of, give or take, in the range of 1.75%. Today, it's sort of give or take 2.20%. So from the time we actually took the hit in 2012, which I think was around $90 million, interest rates are now actually up about 45 basis points. At that time, we not only the lowered the long-term interest rate, but we also changed the so-called glide path that you referenced in your question. So we expected that the portfolio rate was going to continue to actually go down from that point for another 3 or 4 years, and that's kind of exactly what's happened. So what I'd say is again, we took the adjustment in 2012. It has sort of trended or followed that path that we expected it to follow in 2012, so there's very little need to do any particular updating. So Terry, you want to add anything? Terrance J. Lillis



Chief Financial Officer, Chief Accounting Officer and Executive Vice President Yes, it's Terry. Just a few additional comments on it. Each quarter, we take a look at any significant items that may have changed. But in the third quarter of each year, we do an annual actuarial review of our models as well as our assumptions. We look at interest rates; we look at mortality; we look at lapses, expenses, premiums, reinsurance, all the different drivers of those long-term actuarial models. And as Dan said, we looked at mortality this quarter, decided that it was more of a few random isolated cases. So we did not adjust for the mortality at this point in time, but we will continue to look at it. As Larry said, though, in 2012, we looked that the low interest rate environment has turned the ultimate rate and lowered our ultimate rate down by 50 basis points at that point in time. But probably equally as important and maybe even more so important is the glide path of -- with which to get there. Each company will have their own opinion as to this, but I think one of ours is probably a little bit more conservative as to how long it takes us to get to that glide path. A year ago, we looked at the rising interest rate environment, the environment at that point in time, and decided we're not seeing a significant change in the glide path that we would warrant a positive unlocking a year ago. And it served us well this year. We did, again, look at the trajectory out to that longer-term rate. We feel very comfortable with our ultimate rates for each of our businesses. We feel very comfortable in terms of the glide path. But as we've mentioned before, these are just a couple of the components that impact the actuarial unlocking. The last point I'd make on this actuarial unlocking for the $39 million that we called out impacting the life area was that was really conservative assumptions that we've had over the last 6 or 7 years. And so in a lot of cases, you'll see an unlocking or bringing in profitability or losses from future years. This is all with respect to the last 6 or 7 years of understating some profitability. So we're very comfortable with the actuarial review this quarter and the unlocking that we called out. Seth Weiss BofA Merrill Lynch, Research Division That's very helpful. And if I could just, I suppose, follow up on that. And I know you haven't given specific quantitative landmarks in terms of where rates need to get to, but I believe that general commentary, at least back in the third quarter of 2012 when you and some others changed the interest rate assumptions, was following the forward curve in the near term, which rates have actually followed pretty closely what the forward curve suggested if you go back 2 years ago. But then I believe that it implied a faster improvement in interest rates if you look forward 3 to 5 years going back to 2012 or coming up upon that. So the question is if we just follow today's forward curve going forward, is that not going to be a fast-enough rate of improvement in order to avoid balance sheet charges in future years? Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President No, Seth. This is Terry again. No, I think what we're looking at right now is an ultimate rate that is probably -- and it varies based upon the product and the duration, obviously. But if you're looking out 30 years -- or 25, 30 years out into the future, the forward rates are probably pretty close to where we would expect them to be at that point in time. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Seth, this is Larry. Maybe I'm just going to add one higher-level comment. The Individual Life business remains very important to us strategically. But I also think it's important that investors not lose sight of the fact of the substantial growth that's happened over the last few years that's going to continue to happen with our fee-based businesses. So what you're talking about there again is roughly, give or take, somewhere between 5% and 8% of our total company earnings attributable to Individual Life. So we could talk about sort of the unlockings and there is going to be some noise from time to time, but I don't want to let that obscure the real trend which is happening, which is really the growth in the fee-based businesses. So just wanted to add that comment as background. Operator The next question will come from Erik Bass with Citigroup. Erik James Bass Citigroup Inc, Research Division



Can you talk about what drove the decline in the pretax margin at PGI this quarter? And it sounds like, from your comments in the script, you still are comfortable getting to the 30%-plus range for pretax margins over the next few years. So if you could just talk about kind of what are the key drivers there. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, you bet. I'll have Jim cover that for you. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes, thanks, Erik. Firstly, there's always a lot of fluctuations quarter-to-quarter so really better to look at the trailing 12 months to move that out to get the trend. First thing to say as a broad context is the industry is suffering and has been suffering in the last 2 years as assets have moved to passive and to liability-driven investing. We are in those businesses, but we're not big players. So in terms of flows, though, the main point is those are very low-fee businesses, and that's put some pressure on industry margins. What that pressure is meaning is that we're going to take longer to get to that 30% we've talked about. If I looked to the current quarter, however, it was a pretty low quarter for both transaction fees on real estate and for performance fees generally. So that actually means that it was, if anything, a pretty low quarter if you look at the fluctuations quarter-to-quarter. Secondly, in conjunction with the general churn in the industry, the net flow consists of some pretty big inflows and outflows. And the inflows, of course, are not cost free. There's costs, including commissions of putting that business on the books. So that's actually one of the factors that brought the margins down a bit for this particular quarter. Now of course, being able to take in assets, in contrast to many in the industry because of our performance and our distribution reach, is long term good for the business, but short term, it does cause a bit of a margin impact. And if you look at the trailing 12 months, which I encourage you to think of as the glide path towards that 30%, firstly, the fourth quarter of 2013 will fall off. That was a low-margin quarter because of the particular set of incentive fees we had in that quarter. We're pretty confident the trailing 12 months will again show some progress and be in -- albeit to the lower level of that 26% to 28% range we previously talked about. But we're on course to continue improving margins. The real reason I'm confident of that is that the business we're putting on the books at the moment is both very well priced and should be quite profitable looking forward. The margin on new business is very profitable. So that's really the root of our confidence that we're headed for 30%. Erik James Bass Citigroup Inc, Research Division That's helpful. Any sense of, I mean at this point, how quickly you would assume that pace of expansion from -- kind of getting from that 26% to 28% to the 30%? James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes, we'll get more formal about that in the guidance call, Erik. But I think it's fair to say the industry background makes it fair that it'll take 1 year or 2 more than we perhaps thought when we first set it. Erik James Bass Citigroup Inc, Research Division Okay. And if I could ask just one other margin question, this time on RIS Accumulation. At Investor Day, you'd talked about continuing to target the 28% to 32% return on net revenue over time and outlined a couple of factors that could pressure margins other than just a market decline. I think you also suggested that margins could remain above that target near term if the markets hold up. So if you could just help us think about how long it would take for margins to decline from the current level to that kind of 28% to 32% range if the market performs in line with your expectations. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief



Executive Officer of The Principal Life Okay, Erik, I'll let Dan cover that. Daniel J. Houston President of Retirement, Insurance & Financial Services This is Dan. Yes, I would say over the course of the next couple of years. Again, we've had really nice tailwinds here in the last 2 years driving equity markets, and it's been really nice, obviously. But again, when we validate those long-term earnings rates, we feel very confident that they -- we can hold up into those ranges. And the fact they're up slightly has a lot more to do with just how positive the markets are right now as opposed to anything else. Operator The next question will come from Sean Dargan with Macquarie. Sean Dargan Macquarie Research Jim, in PGI typically in the fourth quarter of a good year, you'll receive some performance fees that'll flow through the income statement. I'm wondering if you could give us a directional sense of where they may shake out this year. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management That's a terribly hard thing to do given volatile markets. And even a well-managed hedge fund, which is where the big numbers tend to come from, can have individual month drawdowns in the low single digits, and that can affect the amount we make. As of the end of September, we were confident of a decent fourth quarter but not as a big a performance fee as last year. And I think that's probably about the best I can say right now because there is a high degree of uncertainty until you really get into the closing stretch. But the other thing I'd point out, though, is we were a little unfortunate last year in that the big performance fee came through on a set of hedge funds where we have a very long -- a very historical agreement, a very legacy agreement with the team that will pay them a large proportion in incentive comp of the carry on the fund. For the funds we've set up and developed more recently, we have a more market deal, so there won't be the adverse impact on margins if it flows through as expected. Sean Dargan Macquarie Research That's helpful. And then just going back to the change in the tax law in Chile. So your -- the effective rate over time will creep up to 27%, is that correct? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life That's correct. Sean Dargan Macquarie Research And how long will that take? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life 5 years. 4 to 5 years.



Sean Dargan Macquarie Research Okay. And the charge was related to a deferred tax liability, which is why you put it below the line? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life That's right. That's right. I mean, we sort of believe -- this is Larry, Sean. We sort of believe that the operating earnings metric is best suited to sort of help to predict how the businesses themselves are doing, not the -- not some of the other balance sheet impacts. So to put the, at least in our thinking, the way we construct operating earnings, to put a onetime item like a reset of the deferred tax asset into an operating earnings number would make it more difficult for you to try to understand and to get a reasonable estimate of what the run rate earnings of the business are. So that's why to us, it made sense to put in the other after-tax adjustment. Operator The next question will come from Jimmy Bhullar with JPMorgan. Jamminder S. Bhullar JP Morgan Chase & Co, Research Division The first is a question for Dan just on FSA flows and deposits. They seemed a little weak this quarter. I think you were optimistic at the last call that things are going to improve in the second half. So maybe you could talk about how you're balancing margins and flows in that business and how the competitive environment is. And maybe talk about the pipeline as well. And then secondly, for Larry or Terry, you've spent more on buybacks and deals and dividends this year than you'd indicated previously. So should we assume that you're going to be active on buybacks through the remainder of the year as well or not? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Okay, I'll have Dan take the FSA one first, Jimmy. Daniel J. Houston President of Retirement, Insurance & Financial Services Yes, Jimmy. Good, strong margins. Good recurring deposits. Good, strong revenue growth. A little light in sales at $1.8 billion versus prior quarter $2.7 billion. We have one sale just this last -- 1 year ago quarter that was nearly $1 billion. So again, if you wanted to kind of compare the 2, the numbers were closer to being on top of one another than perhaps you realize. The large case market is more lumpy. That's a reality. When we validate the value proposition of TRS, working with our alliance partners, executing our PlanWorks, that's all still very much resonating with our customers. There's been a pickup here recently in terms of the size of the pipeline. I'd say the first half of the year, the pipeline is pretty light. Again, strong investment performance probably contributes to some of that. In terms of value proposition, again, when I look at investment performance, as we mentioned in the earlier comments, we've got very, very strong performance coming from Jim and his team for our Principal-branded funds. We had 88% of our funds at the 5-year level that are in the top 2 quartiles, which makes our existing customers happy and prospective clients pleased. We got record retention during that period of time. And the other item, and I brought this up on previous calls, but when I look at our DCIO business, which again is taking advantage of our investment management capabilities without necessarily buying our recordkeeping, that's up double from where it was in 2011 at $3.3 billion. In terms of the shift in net cash flow, a little bit light. It negative a couple of hundred million dollars. Again, we're still coming in on top of that net cash flow, which would be somewhere in that $1.5 billion on a year-to-date business, which would put us at the low end of our range of 1% to 3% of beginning year account balances. So it's not performing that unlike what we would have expected, and the difference is probably a few larger cases. But again, we're going to stick to our focus on being disciplined, on profitable growth and write businesses that are going to allow us to execute on all of business -- all the values that we bring as an asset manager, in addition to being a provider of services to participants and plan sponsors. So hopefully, that helps, Jimmy.



Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life So on your other question, well maybe -- or just a quick comment, Jimmy, on your first one, which is if you had -- if you as an analyst or you as an investor had a choice between 2 different paths, one path would have higher sales and less retention, the other path would have lower sales and higher retention, 2014 represents that second path. And that second path is actually a better economic outcome, to have somewhat lower sales and better retention, because your most profitable business is the dollars that you have on the books. So actually, of the 2 paths, we like this path better. Now on your question on buybacks, again, I think we have been more consistent on this issue, certainly, than many of our insurance peers but even more, I think, than many other public companies. We have said now for some period of time we are less oriented toward share buyback. We think we are among a very small set of companies that can organically grow our earnings and use that to grow EPS. And so we think about share buyback as simply a tool to offset dilution. And that's essentially what's happened over the last couple of years, is we do share buyback to offset dilution. We've allowed the businesses to grow organically and that provides EPS. I think as I sit here today, Jimmy, and I look forward, I think that's going to continue to sort of be the formula. We have a lot of opportunities. As we said before in the script, we have a lot of opportunities around M&A. I think for those who are long-term shareholders, the best thing we can do is to use our capital to deploy it to grow our businesses and grow shareholder value over the long term. And so that's what we're going to continue to do. We will continue to move the dividend up. I think a 31% increase in our common stock dividend this year should be viewed very positively by investors. But a share buyback, while it is a rheostat, it's not something that we have to go to in order to grow EPS, which is what most companies end up having to do. Jamminder S. Bhullar JP Morgan Chase & Co, Research Division And the deal focus primarily, I'm assuming, is asset management and international? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life That is correct. Operator The next question will come from Suneet Kamath with UBS. Suneet L. Kamath UBS Investment Bank, Research Division Just a couple of quick ones. First, on the asset management business and specifically the buy-ins of -- any future buy-ins of boutiques. Are there any more deals that were sort of structured like the Columbus Circle that we should be thinking about over the next couple of years in terms of put options and the like? James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, I'll have Jim cover that, Suneet. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management



Yes, thanks, Suneet. The only one that's on a similar formulaic pattern is actually the further 5% of Columbus Circle, which there's no guarantees, but we expect to be able to buy that in from management over the next 2 or 3 years. So that would be on the same sort of structure as I described. Since about 6 or 7 years ago, really the rules around put and call options have made it much more advantageous to go with pure market value assessments. And so the exact structure I described in Columbus Circle is not replicated on the other puts and calls. Where management have equity in the boutiques, we generally do have put rights for them, particularly if they want to retire, and call rights for us some years out in the future. But really, the 2 -- the further 5% of Columbus Circle is the only one that's imminent in the next year or 2. Suneet L. Kamath UBS Investment Bank, Research Division Okay, got it. And then I guess for Dan on FSA, just to follow up on Jimmy's question. I guess at the beginning of the year, you'd talked about flat sales. It looks like fourth quarter would have to be a pretty huge quarter for that to happen. So any sense on what a -- what your full year outlook is now for sales? And given some of the market dynamics that you mentioned, now how should we be thinking about 2015 sales growth? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, so this is Larry. I'll just make a couple of high-level comments. We're now a little bit more focused, Suneet, on sort of the revenue generated by the sales rather than the AUM generated by the sales. And so we have a certain target sort of thinking that 2014 was going to represent an FSA sales volume and net revenue new volume that would be comparable to 2013. And I think while we may fall a little bit short on the asset component, we do expect to be pretty close in terms of the revenue generated off of that sales volume being very comparable with 2013. So again, all in all, in an era where there's less money in motion, I think that's actually a pretty good result. And as I said, we are seeing retention at an all-time high, which again adds to the margin and to the profitability of the business. Suneet L. Kamath UBS Investment Bank, Research Division Okay. And then just one last one just on that same topic. So I think, Dan, you had said earlier or somebody had said earlier that about 73% of new FSA sales are going into Principal Fund. How high do you think that number could go? I would imagine at some point you'll hit a ceiling, but I just don't know if you have a sense of how high that number could go. Daniel J. Houston President of Retirement, Insurance & Financial Services Yes, I think the ceiling is 100%, and I don't know whether... Suneet L. Kamath UBS Investment Bank, Research Division You could actually do 100%, you're thinking? Daniel J. Houston President of Retirement, Insurance & Financial Services Well, I like to think we could because investment performance is good. And in all seriousness, the reality is it really differs by the size of the plan. The smaller the plan, the higher probability you're going to have a higher percentage allocated to Principal Funds. And if I look at that emerging market, which is under $5 million, that's north of 80%, 85%. If I look at that dynamic on a $5 million to $50 million, those numbers kind of settle in, in the 70s. It's when you get to the really large cases where you get this volatility. It can go -- if you wanted to, you could write a lot of plans where you didn't manage any of the assets and you did 100% of the recordkeeping. The economics on that are not very good. The reality is that space is going to probably end up settling into that 50% to 60% of Principal managed accounts. The good news is we got a really good value proposition with the service package and investment performance is good, which leads to being more selective, more disciplined. And we just



finished an institutional client conference in September where some of our largest clients had the opportunity to showcase what we're doing, some of the new plan, at some of the new investment options, some of the new services, in particular about helping their future retirees do a better job of planning for retirements called PlanWorks. The feedback could not have been more positive. So again, it reinforces that we feel that our strategy is very much on point. We may say sales, as Larry pointed out, if measured by assets, down, say, 5% or 10% on a full year basis relative to 1 year ago. And at some point, maybe we can have a more extended conversation about the difference in a model that values assets under management versus assets under administration because those are 2 very different models, and I suspect the industry will start bifurcating to some extent along those lines. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes, if I can add to reinforce Dan's points. Dan makes some excellent points, but I would emphasize that his team and mine, in other words the retirement services people and the product people within Principal Global Investors, work very, very closely together designing capabilities that provide outcomes that are attractive to the plan participant. And that's why ultimately, we're doing better in terms of the allocations that are coming both from the plan sponsor level and the plan participant level. It's that as well as having, I would argue, the strongest suite of investment products in the industry that makes us so confident we can keep in on in this direction. Suneet L. Kamath UBS Investment Bank, Research Division And those large cases that you're talking about where maybe you get a smaller-than-average percentage of the asset management mandate, so that -- is that running about 1/3 of your new business? Daniel J. Houston President of Retirement, Insurance & Financial Services Yes, that's probably a good number. I think in years past, it could have been as much as 50%. But if we settled in on 1/3 small, 1/3 medium and 1/3 large, and those large plans are ones that really value the entire suite of services and products and investment lineup, that's probably not a bad place for us to end up. Operator The final question will come from Steven Schwartz with Raymond James. Steven D. Schwartz Raymond James & Associates, Inc., Research Division Mostly asked and answered, but I am interested in any update you might be willing to give on expansion in Asia and, of course, particularly in China. Anything happened in the quarter? Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Okay, okay. This is Larry, Steven. So as you know, we've had a very successful -- I'll talk about China first and make a few comments on Asia and see if Luis wants to add anything. We've had a successful mutual fund company in China since 2006. And again, for those not as familiar with our businesses, our partner there is China Construction Bank, which is a very large state-owned bank, today probably the third or fourth largest bank in the world. And that's been a very successful effort in the mutual fund and asset management space, but the desire is to hopefully someday get into the retirement business in China. That business exists today. It's called enterprise annuity, but it's been limited to local companies. And so we continue to travel over there to visit with regulators, recognizing their need to deal with aging, which in China is one of the most aged populations on the earth because of the one-child policy. So we remain hopeful, although I don't think we'll have anything to announce in the near term on that particular project. But we do remain hopeful that over time, we think if and when they expand that industry, we'll be one of the first ones allowed in. More broadly across Asia, Steven, it's a great question. And what I would say is, and I



mentioned this in the opening comments, there is more activity. And some of that is in Asia, and most of that is coming out of banks, primarily European banks, but some U.S. banks who are in the process, as I think everyone knows, of having to get out of geographic markets that are not meaningful and having to get out of tangential businesses that are not meaningful. So the regulatory pressure on the larger banks continues to be pretty severe, and that gives companies like Principal, I think, a great opportunity. And we've done a number of acquisitions in Asia, although they've been pretty small. You may remember last quarter we announced an acquisition in Thailand. That's kind of small on one hand, but it actually doubled the size of that Thailand business. So again, it's a matter of trying to sort of get to scale within each of the 7 countries in Asia where we operate. So anything you want to add, Luis? Luis E. Valdés Senior Vice President, President of International Asset Management & Accumulation, President of Latin America Operations, Chairman of Principal International Inc., Chief Executive Officer of Principal International Inc and President of Principal International Inc No. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Okay. I hope that helps, Steven. I appreciate questions. Operator We have reached the end of our Q&A. Mr. Zimpleman, your closing comments, please. Larry D. Zimpleman Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer of The Principal Life Yes, I just want to say thanks to all of you for joining us on the call this morning. We're very pleased with our results to date in 2014, and we look forward to a strong finish to the year. And so with that, thanks for joining us. I hope to see many of you on the road in the coming months. Have a great day. Operator Thank you for participating in today's conference. This call will be available for replay beginning at approximately 12:00 p.m. Eastern Time today until end of day, October 31, 2014. 8844037 is the access code for the replay. The number to dial for the replay is (855) 859-2056, U.S. and Canadian callers, or (404) 537-3406, international callers. Ladies and gentlemen, thank you for participating. You may now disconnect.



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