The Principal Financial Group's Second Quarter 2023 Conference Call began with a reading of the safe harbor provision and remarks from CEO Dan Houston and CFO Deanna Strable. They discussed key aspects of the company's financial results and performance highlights. The conference call also included a question-and-answer session with Chris Littlefield, Pat Halter, and Amy Friedrich. The company warned that some comments may contain forward-looking statements and refer to non-GAAP financial measures.

Deanna reported that the company had $376 million of non-GAAP operating earnings in the second quarter, and that their business had generated strong free capital flow. They invested for growth in their business and returned $255 million of excess capital to shareholders through share repurchases and common stock dividends. In addition, their total company managed AUM was $675 billion, a 2% increase from the first quarter. Net outflows across the industry were a challenge, but the company saw positive net cash flow in the real estate market and greater opportunities to deploy new money into the real estate marketplace.

Global asset management is seeing momentum build across high yield and core fixed income, specialty equity strategies, and local solutions in international markets. The company has a real estate pipeline of $7 billion of committed yet unfunded mandates expected to be invested over the next 12-18 months. Investment performance has improved significantly across Morningstar rated funds and composites. The company is launching new ETFs and a new equity strategy with a joint venture to offer investors additional ways to access popular solutions. With this momentum and recovery in investment performance, the company is optimistic for asset management net cash flow in the second half of the year.

In Principal International, total AUM increased 4% to $174 billion due to market performance and foreign currency translation. The company has established strong relationships with global joint venture partners to gain access to high growth markets. In US Retirement and Benefits and Protection, revenue is benefiting from the strong employment market, particularly in the small to mid-sized business segment. To capitalize on opportunities, the company launched a Hospital Indemnity insurance product. In Retirement, net cash flow was pressured due to an uptick in large plan lapses, but was positive in the SMB segment due to a 16% increase in transfer deposits and a 9% increase in reoccurring deposits.

In the second quarter, the company reported net income of $389 million and excluding income from exited businesses, net income was $325 million with manageable credit losses of $37 million. Credit drift was a positive $5 million in the quarter. The company is expecting to be within their net revenue growth and margin guidance for the full year and is seeing signs of recovery and positive momentum in real estate in the broader investor market. They are confident that their focus on high growth markets, product suite, and distribution partnerships will continue to drive value for customers and shareholders.

The second quarter of 2023 saw a net negative impact on non-GAAP operating earnings of $53 million pretax, $39 million after tax and $0.16 per diluted share due to lower than expected variable investment income in RIS, Principal International and Benefits and Protection, as well as unfavorable inflation and LDTI discount rate impacts. This was partially offset by a 5% increase in the S&P 500 daily average from the first quarter, and a modest tailwind from foreign exchange rates. Nevertheless, expenses have decreased at the enterprise level compared to a year ago, and revenue growth and margins were in line with expectations, aside from PGI revenue growth.

PGI's performance fees and transaction and borrower fees were down compared to the year before, affecting revenue, margin, and pretax operating earnings. Specialty Benefits pretax operating earnings increased due to growth in the business and improved loss ratios. The company remains in a strong financial position with $1.2 billion of excess and available capital. They returned $255 million to shareholders in the second quarter and announced a $0.65 common stock dividend. The investment portfolio is high quality and well-positioned for various economic conditions.

The real estate portfolio is high quality and well-positioned to withstand potential economic stress. The commercial mortgage loan portfolio is healthy, with a low average loan to value and strong debt service coverage ratio. The office exposure is geographically diverse and high quality, with 100% of 2023 maturities paid off and the portfolio revalued each quarter. The loan to value of the office portfolio increased slightly while the debt service coverage ratio improved. The company is confident in the quality of the portfolio and is focused on maximizing growth drivers to deliver long-term shareholder value.

Dan Houston and Chris Littlefield respond to Suneet Kamath's question about the outflows of large cases over the past three quarters. Chris Littlefield explains that there is a wide range of reasons for the lapses, including M&A activity, reluctance to make changes to the plan, and changes in pricing. Despite the large case outflows, there has been resilience in the SMB side with recurring deposits up 9% and transfer deposits up 16%. There is also good momentum heading into the second half of the year, indicating that the volatility of large case activity is beginning to lessen.

Dan Houston and Pat Halter are confident in the outlook for the second half of the year in terms of net cash flow in the wealth management and retail spaces. They believe that the market tone has improved and that there is a lot of money that has gone to the sidelines in terms of money market and bank deposits. They also note that there will be some additional pressure on lapses in the second half, but overall they expect to see strong growth across SMB and large.

The company is seeing an increase in activity in the real estate market, with $7 billion in unfunded committed capital, and is pursuing a large portfolio acquisition. They are also seeing takeovers of existing portfolios from poor performing managers, as well as increased activity from institutional investors. The company has also developed a joint venture in China in the industrial space.

The investment performance from Dan has given the public market more confidence and led to money being deployed into mid-cap strategies and high yield capabilities. There are positive indicators that growth should be seen in the second half of the year, particularly in Southeast Asia and Latin America. The base management fee has been at 29 basis points for many years and has dipped to 28.4 basis points due to the mix of business, but the trailing 12 months have still been strong at 28.9%.

Dan Houston and Pat Halter discussed the real estate flows in the first half of the year, which were muted relative to their historical standards. They expect the flows to increase in the second half of the year, with a goal of reaching $3 billion in net cash flow. Additionally, Dan Houston noted that in the SMB market, there tends to be a lot of M&A activity, which has been a new narrative for Principle as their large plan market has grown.

Pat is expecting more real estate flows to come through, which should lead to higher variable investment income. Deanna Strable added that approximately $600 million of buybacks for the full year is a good range, and that this points to slightly higher buybacks in the back half of the year.

Dan Houston and Deanna Strable both comment on the outlook for variable investment income due to real estate sales in the second half of the year. They expect inflows into real estate before transaction volume, and muted results in variable investment income as a result. Pat Halter adds that there is a pipeline of opportunities for variable investment income, but that it is more likely to be realized in 2024 than in the next two quarters.

Tom Gallagher asked Chris and Dan about the competitive landscape of the 401(k) and large case market and whether they were seeing more aggressive pricing. Dan Houston responded that it is a competitive marketplace and they differentiate themselves with their TRS capabilities. Chris Littlefield added that their focus is on managing profitable growth and maintaining pricing discipline, rather than maximizing flows.

Dan Houston and Chris Littlefield discussed net flow dynamics in the RIS spread business, noting that strong PRT sales were offset by GA flows due to better equity markets. They emphasized the need to remain disciplined in pricing in order to attract new business and noted that the spread based net cash flow was flat in the quarter.

Pat Halter discusses the trends in the investment only business, which can be lumpy, and how this can contribute to flat performance on spread based net cash flow. He then talks about the increasing passive share of the marketplace and the importance of demonstrating active return over indices in order to gain more mind share and wallet share. He also mentions SMA, mutual funds, and CITs as areas that they are looking to grow in.

Dan Houston and Amy Friedrich discussed the sales volume in Specialty Benefits, which has seen a second straight quarter of declines. They attribute this to pent-up demand in the smaller markets that was seen in 2022, as well as the fierce labor fight for talent. Despite the decline, they view the second quarter of 2023 as strong, as it is the second best second quarter sales they have ever recorded. They also discussed the new Hospital Indemnity product and the strong fundamentals of their business, such as staffing, process, technology, and distributor relationships.

Amy Friedrich discusses how Hospital Indemnity can be a supplement to core benefits, helping to fill gaps and rounding out the worksite portfolio. It can help the company compete for additional worksite sales and grow their wallet share across small and midsize business customers. Dan Houston adds that employers consistently cite health care as one of the most important aspects.

Pat Halter clarified that the performance fees in PGI are related to real estate transaction activity, and due to increased activity, the muted performance fees seen in the first half of the year should start to change in the second half. Deanna Strable answered the second question, which was about the holding company's liquidity and leverage ratio, by saying that the company wants to run the liquidity near the target and the leverage ratio should migrate back towards 25%.

Dan Houston states that there are two factors contributing to optimism for improved flows in the second half of the year: better investment performance and positive signs in the first month of the third quarter. Additionally, the target leverage ratio for the company is 20-25%, and the Board Finance Committee looks at capital at risk on a quarterly basis. The cushion held in the company is around $100 million, and may fluctuate depending on market pressures.

Principal International had a strong start in July, with increased retail flows and anticipated pipeline activity. Pat Halter discussed the potential for real estate acquisition portfolios and funding new funds, which could mean strong net cash flow. Asset management fees have dipped slightly, but mortgage origination activity is increasing, suggesting transaction fees may return to more historical levels.

Pat Halter and Dan Houston discussed the intense competition and fee pressure in the asset management business, and how Principal needs to continue to deliver strong alpha performance and build relevant capabilities globally in order to stay competitive. They also noted that with the increasing popularity of passive investing, it is important for Principal to differentiate itself by developing unique capabilities. Finally, they discussed how inflation could affect their expenses, and how it could offset the help they are getting from the recovering market.

Dan Houston and Deanna Strable discussed how inflation affects Principal's revenue growth. When wages increase, so do premiums for life insurance and disability coverage. This benefits Principal as 401(k) salary deferrals also increase. The company is able to manage expenses in order to align with revenue, evidenced by the 3-4% decrease in adjusted comp and other on a trailing 12-month basis.

Dan Houston explains that Principal is not a pure-play asset manager, and as such they have more customer service expenses. He also reminds the listener to take this into account when comparing Principal to other competitors. Amy Friedrich then goes on to say that they feel good about their overall loss ratio and margins when considering the full suite of products.

The speaker believes that utilization and frequency of dental procedures have returned to pre-pandemic levels, but there is still more severity in the results. The speaker believes that this will moderate in the second half of the year, as the product is very responsive to changes in how it is being utilized. In addition, the speaker believes that there are signs of recovery and positive momentum in real estate, such as PGI and mortgage origination activity, which may be driven by real estate fundamentals or technical factors.

Pat Halter believes that the risk return trade-off is becoming reasonable again, and with the Fed pausing, people have more confidence in terms of valuations and capital availability. Halter's firm is taking advantage of this opportunity by investing in asset classes such as industrial, data centers, and residential. He also believes that the credit cycle is providing a slight benefit of capital, and that his firm's full year expectations are taking this into account.

Deanna Strable and Pat Halter discussed the positive capital impacts from drift in the first and second quarters of the year, which was driven by the high quality and diversified portfolio of the balance sheet. Despite the recession, they expect some drift to continue in the rest of the year due to the quality and diversification of the balance sheet. Chris Littlefield reported that the industry sales of PRT are expected to be in the range of $30 billion to $40 billion for the year.

The small to mid-sized marketplace is still vibrant, as employers understand that offering a great benefits and savings package is critical for retaining talent. This is evident through their purchasing behavior and persistence on plans. Dan Houston asked Mike Ward about Specialty Benefits, to which Amy Friedrich responded that employers are still committed to providing benefits to their employees. Additionally, 15% of the premium and 42% of the cases in the PRT business year-to-date have come from existing clients, showing that Mercer's existing client base has provided them with built-in advantages.

Dan Houston concluded the conference call by reflecting on the quarter and the company's performance, noting that the earnings and margins were in line with guidance and that there was a path to a net cash flow of 75-80%. He also noted that the business was making changes in order to improve results, aligning expenses with revenues and investing in growth and innovation, while still focusing on profitable growth for long-term shareholders.

The speaker is thanking the participants for their involvement and letting them know that they can now disconnect their lines.

This summary was generated with AI and may contain some inaccuracies.