Principal Financial Group, Inc. (NASDAQ:PFG) Q4 2022 Earnings Call Transcript
Principal Financial Group, Inc. (NASDAQ:PFG) Q4 2022 Earnings Call Transcript January 31, 2023
Operator: Good morning, and welcome to the Principal Financial Group Fourth Quarter 2022 Financial Results Conference Call. There will be a question-and-answer period after the speakers have completed their prepared remarks. I would now like to turn the conference call over to Humphrey Lee, Vice President of Investor Relations.
Humphrey Lee: Thank you, and good morning. Welcome to Principal Financial Group's fourth quarter and full year 2022 conference call. As always, materials related to today's call are available on our website at investors.principal.com. Following a reading of the safe harbor provision, CEO, Dan Houston; and CFO, Deanna Strable, will deliver some prepared remarks. Dan will open the call for questions. Others available for Q&A include Chris Littlefield, Retirement and Income Solutions; Pat Halter, Global Asset Management; and Amy Friedrich, U.S. Insurance Solutions. Some of the comments made during this conference call may contain forward-looking statements within the meaning of 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 financial measures. Reconciliation of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may be found in our earnings release, financial supplement and slide presentation. Our 2023 outlook call is scheduled for Thursday, March 2, where we will share enterprise and business unit 2023 and longer term guidance. On Wednesday, March 1, we plan to release a recast fourth quarter 2022 financial supplement.
It will include the impacts of the targeted improvements for long-duration insurance contract accounting guidance, or LDTI, which goes into effect with our first quarter 2023 reporting. Dan?
Dan Houston: Thanks, Humphrey, and welcome to everyone on the call. This morning, I will discuss the milestones we achieved in 2022 as we executed on our strategy, along with key highlights from our fourth quarter and full year 2022. Deanna will follow with additional details on our fourth quarter and full year 2022 financial results, our current financial and capital position, as well as an update on LDTI. In 2021, we outlined our strategic path forward, one balanced with a focus on a higher growth, more capital efficient portfolio and a commitment to return more capital to shareholders. This guided our successful execution in 2022 despite a challenging macroeconomic environment. We've made meaningful progress towards our goals and continue to invest in our long-term growth drivers of retirement, global asset management and benefits and protection.
In January, we announced an agreement to reinsure our U.S. retail fixed annuity and universal life insurance with secondary guarantee blocks of business. The transaction closed in May and was a key milestone reinforcing our strategic focus on continuing to evolve into a higher growth, higher return, more capital efficient portfolio while improving our overall risk profile. We delivered on our strengthened capital deployment strategy and our commitment to rightsize, return the excess capital that we have built up during the pandemic with $2.3 billion returned to shareholders in 2022 through share repurchases and common stock dividends. We've continued to adapt to the volatile and uncertain macro environment and have taken appropriate actions to manage our expenses with pressured revenue while continuing to serve the needs of our customers, invest for growth and deliver strong total shareholder return.
Starting on Slide 2, we reported $1.7 billion of full year 2022 non-GAAP operating earnings, or $6.66 per diluted share. Excluding significant variances, earnings per share increased 2% over 2021, a strong result given the pressured macroeconomic environment. As shown on Slide 3, we reported $422 million of non-GAAP operating earnings or $1.70 per diluted share in the fourth quarter. We ended 2022 with $635 billion of total company managed AUM. Unfavorable equity and fixed income markets pressured AUM throughout 2022 and $23 billion was transferred out in the second quarter as part of the reinsurance transaction. Turning to investment performance on Slide 5, our long-term performance remained strong, particularly in our specialty fixed income strategies.
The volatile markets impacted our short-term investment performance throughout 2022 as our investment style, which is focused on high-quality growth stocks was out of favor for much of the year. During a volatile and pressured year for asset managers, we generated a positive $3.9 billion of full year total company net cash flow. This was $1 billion higher than our 2021 net cash flow and included $4.4 billion of positive PGI managed net cash flow. This was a very strong result during a period of outflows across the industry. The positive net cash flow in 2022 was driven by strong institutional flows across equities, real estate and specialty fixed income highlighting the value of our diversified distribution through our institutional, retail and retirement channels.
Fourth quarter total company net cash flow was negative $3 billion. Net cash flow is typically negative in the fourth quarter for both PGI and RIS-Fee. Similar to other asset managers, we experienced retail platform outflows during the quarter as customers moved cash to the sidelines. While market volatility can impact the timing of when new mandates fund, we are seeing positive momentum with our institutional clients. Early in 2023, we have meaningful commitments for several of our fixed income and special equity strategies, which are expected to fund in the first quarter. The committed pipeline for our real estate products is healthy, which will likely start funding in the second half of the year. Turning to our growth drivers and some additional highlights for the year.
In Retirement, we continue to solidify our position as a top retirement provider as we completed the integration of the IRT business in early 2022. The acquisition provides us with new capabilities, additional revenue-generating opportunities and expanded distribution relationships. RIS-Fee contract lapses contributed to negative account value net cash flow in the quarter. The fourth quarter is typically the highest quarter for lapses as plans often change providers at the end of the year. Roughly one-third of the lapsed account value was related to a single, low-fee large case with no principal managed assets. Looking ahead to the first quarter, we anticipate positive net cash flow in light of our sales pipeline. The underlying fundamentals of the Retirement business were strong throughout 2022.
Compared to full year 2021, total recurring deposits increased a very strong 26% with a 14% increase on our legacy block. This was driven by employment growth and wage inflation, as well as increases in participant deferrals, company matches and higher incentive compensation. We also saw great opportunities in the future with the passage of SECURE 2.0, a bill for which we advocated. This legislation expands the U.S. retirement market overall, creating greater access to retirement savings plans for businesses and improving long-term savings in financial security for Americans. While it will take time and won't have an immediate impact, we expect that the bill will drive increases in new plant formations employer matches as well as employee participation in deferrals, all of which will help support better retirement readiness and long-term growth in our business.
We're uniquely positioned to benefit from SECURE 2.0, thanks to its focus on small and midsized businesses and its support for more cost-effective start-up plans. We're already leaders in this market and applaud the additional options for workers to save more for retirement. Outside the U.S., we continue to focus on markets with compelling growth opportunities where we can leverage our local and global asset management capabilities and lean into established local partners. During the fourth quarter, we extended and strengthened our asset management partnership with CIMB in Southeast Asia. And at the end of the year, we closed our transaction with China Construction Bank Pension Management Company, acquiring a minority ownership stake in the pension company.
This is expected to be immediately accretive and grow over time. Both opportunities expand our existing partnerships of more than 17 years with these market-leading wealth management, mutual fund and pension distributors. In Global Asset Management, we continue to unify our investment footprint across more than 80 markets we serve, demonstrated by the launch of Principal Asset Management in October and increasing integration with Principal International. We continue to expand our specialty offering in 2022. As an example, our direct lending team doubled its committed capital and increased their foothold in the middle market throughout the year. Principal Asset Management has once again been named the Best Place to Work in Money Management by pensions and investments.
Photo by Damir Kopezhanov on Unsplash
This is the 11th consecutive year we have earned this recognition, and it's a testament to the work of our employees to create a positive culture and deliver results for our customers. In Benefits and Protection, our focus on the small to medium-sized business delivered strong results in 2022. The businesses we serve prioritize providing benefits to attract and retain employees throughout the year. Record sales, strong retention and employment growth is evident in Specialty Benefits results. We deepened our relationships with existing customers, attracted new customers and expanded our market share. In Specialty Benefits, premium and fees increased a robust 11% year-over-year, exceeding the top end of our guidance range, with over half of the growth coming from net new business.
Full year sales increased 19% compared to 2021 with continued strong momentum early in 2023. Our focus on business owner and our diversified set of solutions continues to drive results in Individual Life insurance. Full year business market sales hit record levels up 73% year-over-year. This growth included record non-qualified COLI sales. Approximately 50% of these sales were with our retirement plan customers, highlighting the value of our integrated business model. We're delivering on our go forward strategy, transforming our portfolio businesses, resulting in a higher multiple and increased shareholder value. We have de-risked our portfolio, reduced our balance sheet risk and our less capital intensive. We have sharpened our focus on higher growth markets, investing in our business and leveraging our competitive advantages all while returning more capital to shareholders.
While 2023 presents its own challenges, we have a good line of sight and confidence in achieving our long-term financial targets. Deanna?
Deanna Strable: Thanks, Dan. Good morning to everyone on the call. This morning I'll share the key contributors to our financial performance for the quarter and full year, our current financial and capital position, as well as an update on LDTI. Full year reported net income attributable to principal was $4.8 billion, excluding income from exited businesses net income was $1.5 billion for the full year with manageable credit losses of $48 million. Fourth quarter non-GAAP net income, excluding exited businesses was $504 million with $12 million of credit losses. As a reminder, the income from exited business is non-economic and is driven by the change in the fair value of the funds withheld embedded derivative. Importantly, it doesn't impact our capital or free cash flow and can be extremely volatile quarter-to-quarter.
We also had positive credit drift during the year further demonstrating the quality of our balance sheet. We reported full year non-GAAP operating earnings of $1.7 billion or $6.66 per diluted share including $422 million or $1.70 per diluted share in the fourth quarter. Excluding significant variances full year non-GAAP operating earnings was $1.7 billion or $6.77 per diluted share, this included $420 million in the fourth quarter or $1.69 per diluted share. Compared to full year 2021, we increased earnings per share 2% as the benefit from share repurchases and strong customer growth was partially offset by macroeconomic pressures on earnings. As detailed on Slide 15, we had several significant variances that virtually offset and had a slight net positive impact on non-GAAP operating earnings during the fourth quarter.
On a pre-tax basis, benefits from lower DAC amortization higher than expected Latin American Encaje performance and favorable Brazilian inflation more than offset lower than expected variable investment income. These had a net positive impact to reported non-GAAP operating earnings of approximately $5 million pre-tax, $2 million after tax, and $0.01 per diluted share. While variable investment income was positive for the quarter, we experienced lower than expected alternative investment returns, prepayment fees and real estate sales. Macroeconomic volatility continued in the fourth quarter and pressured earnings in our fee-based businesses. The S&P 500 daily average decreased 3% from the third quarter of 2022, 16% from the fourth quarter of 2021 and 4% on a full year basis.
Relative to our 2022 outlook, the full year 2022 S&P 500 daily average was 17% lower than we expected heading into the year and fixed income returns were approximately 18% lower. This unfavorable market performance negatively impacted AUM, account values, fee revenue margins and earnings in RIS-Fee and PGI throughout the year. Headwinds from foreign exchange rates pressured reported pre-tax operating earnings by a negative $5 million compared to the fourth quarter of 2021 and a negative $21 million for the full year. It was immaterial compared to the third quarter of 2022. Throughout 2022, we took actions across the enterprise to manage expenses as fee revenue was pressured as we have during previous periods of unfavorable macroeconomics. Our efforts have paid off, on a full year basis, compensation and other expenses excluding significant variances were 3% lower than 2021 and fourth quarter expenses were 8% lower than the fourth quarter of 2021, despite approximately $15 million of elevated severance and restructuring expenses across the fee-based businesses in the quarter.
Some expenses naturally adjusted throughout the year like incentive compensation and other variable cost, and we took actions to reduce other expenses while continuing to balance investments for growth. As a result, we didn't see the typical 7% to 10% increase in compensation and other expenses this fourth quarter relative to the average of the first three quarters. Turning to the business units, the following comments on fourth quarter and full year results exclude significant variances. RIS-Fee's margin improved in the fourth quarter, but end of the year below guidance as the benefit from IRT expense synergies was more than offset by unfavorable market performance, which pressured fees and net revenues throughout the year. Through the end of 2022, we've realized more than $80 million of run rate expense synergies and are well on track to realize the full $90 million in 2023.
RIS-Spread net revenue growth and pre-tax margin exceeded our post-transaction guidance for the full year. Favorable investment income, a benefit from rising short-term interest rates and growth in the business helped offset the impacts of the reinsurance transaction. We completed $1.9 billion of pension risk transfer sales in 2022, including more than $750 million in the fourth quarter. The PRT pipeline remains very strong as we head into the first quarter. PGI's pre-tax margin was 39% for the full year and at the low end of our guidance range despite significant macro headwinds throughout the year. The overall management fee rate of approximately 29 basis points remain stable. And Principal International pre-tax operating earnings were pressured throughout 2022 as underlying growth in the business was masked by the regulatory fee reduction in Mexico and foreign exchange headwinds.
On a constant currency basis, full year pre-tax operating earnings increased 5% over 2021 with strong growth in Brazil and Chile. In Specialty Benefits, pre-tax operating earnings and premium fees both increased the strong 11% over full year 2021. This was fueled by record sales as well as strong retention and employment growth while maintaining disciplined expense management and a stable loss ratio. Turning to capital and liquidity, despite the volatile environment, we remain in a strong financial position heading into 2023. We ended 2022 with $1.5 billion of excess and available capital. This is above our targeted levels as we felt it was prudent to be disciplined due to the uncertain and volatile macro environment. This included approximately $1 billion at the holding company, $200 million above our $800 million target, $425 million in our subsidiaries, and $80 million in excess of our targeted 400% risk-based capital ratio estimated to be 406% at the end of the year.
Our leverage ratio is low at 22% and within our 20% to 25% targeted range. We have the financial flexibility, discipline, and experience necessary to manage through this time of macro volatility and uncertainty. As shown on Slide 4, we returned $2.3 billion to shareholders in 2022, including nearly $1.7 billion of share repurchases and more than $640 million of common stock dividends. We also deployed $300 million to debt reduction and approximately $200 million towards M&A bringing our full year capital deployments to $2.8 billion. In the fourth quarter, we returned more than $400 million to shareholders with $250 million of share repurchases and $156 million of common stock dividends. Last night, we announced a $0.64 common stock dividend payable in the first quarter in line with our targeted 40% dividend payout ratio.
We remain focused on maintaining our capital and liquidity targets at both a life company and the holding company and will continue with a balanced and disciplined approach to capital deployment as we head into 2023. Our investment portfolio is high quality and a good fit for our liability profile. The commercial mortgage loan portfolio is very high quality with an average loan to value of 46% and an average debt service coverage ratio of 2.5 times. We have a diverse and manageable exposure to other alternatives and high risk sectors, and importantly, our liabilities are long-term and we have disciplined asset liability management. Additional details of our investment portfolio are available in the appendix of the slides. As a reminder, LDTI goes into effect in the first quarter.
Importantly, this doesn't change our underlying economics, free cash flow generation or our capital position, but it will have an impact on our reported financial results. We plan to release a recast fourth quarter supplement on March 1, the night before our 2023 outlook call. The most notable impact to total company non-GAAP operating earnings is a change to the geography of some variable annuity fees, moving the hedging related fees below the line. This will reduce our operating earnings by approximately $60 million on an annual basis with no corresponding impact to net income, free cash flow generation or our capital position. In addition, there will be impacts to segment earnings that will largely offset at a consolidated level. More details will be shared during our upcoming outlook call.
Moving to equity, the transition impact from the adoption of LDTI will decrease total stockholders' equity by approximately $5.3 billion as of January 1, 2021 with nearly all of the impact in AOCI. Sitting here today, we expect the impact of stockholders' equity from LDTI to be slightly positive as of the fourth quarter of 2022, as interest rates have risen significantly from where they were at the beginning of 2021. 2022 was a transformative year for Principal as we completed the reinsurance transactions mid-year, executed on our go-forward strategy and strengthened our capital management and deployment approach. We're focused on maximizing our growth drivers of retirement, global asset management and benefits and protection, which will drive long-term growth for the enterprise and long-term shareholder value.
This concludes our prepared remarks. Operator, please open the call for questions.
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