Principal Financial Group Inc

NASDAQ:PFG

Earnings Call Transcript 2017-Q4

[Operator]

Good morning and welcome to the Principal Financial Group Fourth Quarter 2017 Financial Results Conference Call. There will be a question-and-answer period after the speakers have completed their prepared remarks. [Operator Instructions]

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

[John Egan, VP, IR]

Thank you and good morning. Welcome to the Principal Financial Group's fourth quarter conference call. As always, materials related to today's call are available on our website at principal.com/investor.

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

Additionally on Page 16, our financial supplement, we've updated the assets under management detail for Principal Global Investors. The Principal Global Investors sourced AUM schedule includes all AUM sourced by PGI including the previously denoted institutional AUM and U.S. mutual funds AUM.

In 2015, we've changed our reporting structure to move our mutual fund business into PGI and since then have further integrated the distribution channels and fund platforms. The new PGI sourced AUM schedule provides a better reflection of how we view PGI. The U.S. mutual funds and EPS AUM schedule has been updated as well, and we'll provide the breakdown of the sourced of the AUM PGI sourced and sourced by other entities of PFG.

Following the reading of the Safe Harbor provision, CEO, Dan Houston; and CFO, Deanna Strable will deliver some prepared remarks. Then, we will open up the call for questions. Others available for the Q&A session include Nora Everett, Retirement and Income Solutions; Jim McCaughan, Principal Global Investors; Luis Valdes, Principal International; Amy Friedrich, U.S. Insurance Solutions; and Tim Dunbar, our Chief Investment Officer.

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

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

Now, I’d like to turn the call over to Dan.

[Dan Houston, CEO]

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

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

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

Just after year end, we received some notable recognition, we ranked number sixth in Forbes list of the best employers for diversity, and we made Fortunes list of World's Most Admire Companies. At nearly $1.5 billion, we delivered record non-GAAP operating earnings in 2017, with double-digit growth compared to 2016. We grew assets under management or AUM by $77 billion or 13% to a record $669 billion at year end, providing a solid foundation for growth in 2018.

Throughout the year, our asset management franchise received dozens of best fund awards in Chile, China, Hong Kong, India, Europe, Malaysia, Mexico and the U.S. from organizations including Bloomberg, MorningStar and Thomson Reuters Lipper. For a sixth consecutive year, we are recognized as one of pension investments and best places to work in money management. Most recently Principal Millennials ETF made investment news list of best performing international ETFs, topping the world large stock category with a 41% gain in 2017.

In the fourth quarter, Willis Towers Watson released research on the world's largest asset managers, Principal tied for the tenth fastest growing firms within the top 50 based on compounded annual AUM growth of 12% from 2011 through 2016. We moved up 13 spots over the five year period to number 38. For our MorningStar-rated funds, 68% of fund level AUM had a four or five star rating as of year-end.

Further as shown on Slide 5, our longer-term MorningStar investment performance remains very strong. At year end, 83% of Principal mutual funds, ETFs separate accounts and collective investment trusts were above meeting for five years performance, 69% above median for three years performance and 76% above median for one-year performance.

2017 was our eighth consecutive year of positive total company net cash flows with a $122 billion over this period. This result underscores strong diversification by investor type, asset class and geography, strong integration of our businesses enabling us to meet investor needs as they transition from accumulation into retirement, and the value we can deliver to investors through fundamental active management including equities, fixed income and alternatives including real estate.

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

We are particularly pleased to see net cash flows in Chile turned positive during the fourth quarter. While not included in the reported numbers, net cash flows in our joint venture with China Construction Bank also rebounded strongly in the second half, bringing full year net cash flows in China to more than $18 billion. Again, these assets are primarily short term in nature, but with over $100 billion in positive net cash flows in China joint venture over the past three years, two points were clear, the magnitude of the opportunity in the China and the immeasurable value of having CCB as our partner.

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

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

Importantly, the fundamentals of business remains strong as evidenced by our meaningful growth in planned count, participants and reoccurring deposits that increased 6% to a record $20 billion in 2017. For both RIS-Fee and PGI, we continue to expect larger institutional deposits and withdrawals to occur unevenly overtime, which will create both quarterly and annual volatility in net cash flows.

Nonetheless, we remain confident in our ability to attract retain business. We have now outstanding array of solutions and we positioned ourselves to capitalize on markets with substantial growth potential. Net cash flows remain important, but we continue to focus on revenue growth. This means delivering better client outcomes and differentiating through value added specialties, solutions and alternative investments.

I'll now share a few execution highlights starting with our efforts to expand and enhance our investment platform through a continued focus on outcomes, diversification, asset allocation, downside risk management, and cost effective alternatives to pure passive management.

In 2017, we've launched more than 50 new funds in total across Southeast Asia, China and Latin America responding to increasing local retail and institutional demand through multi-asset and income generating solutions. We had several new launches and are double in platform as well, notably more than doubling sales on this platform from year ago to $5 billion, generating nearly $2.5 billion of positive net cash flow for the year.

On our U.S. platform, we've launched four new ETFs in the fourth quarter and a total seven for the year, bringing us to a dozen ETF strategies in the market as of yearend. Our ETF franchise surpassed both the $1 billion and $2 billion milestones in 2017, moving us up seven spots on ETF lead tables and placing us in the top 30 as of yearend.

We also remain highly focused on digital solutions and made some noteworthy progress. In 2017, we launched a new account aggregation tool. This provides retirement plan participants, a more holistic view of their finances and more accurate estimation of their retirement readiness. We also launched a first of its kind retirement modeling planner, using real-time data, plan sponsors and advisors can assess retirement plan health, see how the plan design features impact participant retirement readiness and estimate cost associated with changes to the plan design.

And we continue to make enhancements to our digital education and enrollment resources within our retirement and group benefits businesses, enabling an increasing number of workers to take important steps towards financial security. In the fourth quarter, we began accelerating our investment and the digital business strategies discussed in our 2018 outlook call, more to come in 2018, as we intensify our focus on, the customer experience, direct consumer offerings and our global investment research platform.

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

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

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

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

[Deanna Strable, CFO]

Thanks, Dan. Good morning to everyone on the call. This morning, I’ll discuss the impacts of the U.S. Tax Cuts and Jobs Act or tax reform on fourth quarter results and on our effective tax rate guidance for 2018.

The key contributors to our financial performance for the quarter and full year, and capital deployment in our capital position at year end. As you know, U.S. tax reform was signed into law late last year. The net financial impact shown on Slide 6 were reflected in other after-tax adjustments and excluded from non-GAAP operating earnings.

The impacts included a $626 million benefit from the re-measurement of our net deferred tax liability and $57 million of higher tax expense, including $43 million from the one-time deemed repatriation tax on foreign earnings. Tax reform did not have a material impact on our 2017 estimated risk based capital formula or statutory surplus, and we remain confident in our ability to deploy our targeted $900 million to $1.3 billion of capital in 2018.

Non-GAAP operating earnings ROE excluding AOCI other than foreign currency translation declined approximately 40 basis points at year-end due to tax reform, as the net benefit increased our equity base. As shown on the bottom of Slide 6, we've updated our 2018 effective tax rate guidance to reflect the total company impacts of tax reform. The total company non-GAAP operating earnings effective tax rate guidance range is now 18% to 21%. This should increase our 2018 non-GAAP operating earnings by approximately 3% over 2017.

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

For the full year 2017, net income was a record $2.3 billion, including a record $1.5 billion of non-GAAP operating earnings, the benefit from tax reform and the gain from the third quarter real estate transaction. At $47 million for the year, credit losses remain below our pricing assumptions. We've reported non-GAAP operating earnings of $351 million for the fourth quarter 2017 or a $1.19 per diluted share. On a full year basis, excluding the impacts of the annual assumption reviews, non-GAAP operating earnings increased 10% from 2016, reflecting continued strong execution and favorable equity markets.

A majority of the quarter's results can be explained by a few items higher operating expenses, timing of taxes and lower performance fees in PGI. As in prior years, we saw an increase in fourth quarter operating expenses compared to the other quarters, primarily in compensation and other expenses. In total, operating expenses were elevated by about $80 million to $90 million from the average quarter in 2017 and can be attributed to three factors, seasonality in timing, one-time items, and increased investments in the business.

Slightly more than half of the total was due to seasonality and timing of expenses including branding, benefit cost, M&A transaction fees, variable sales expenses and back amortization. In regard to the timing of expenses, the first three quarters of the year benefited from lower expenses while fourth quarter was impacted by higher expenses. Approximately 25% was due to one-time or higher than normal expenses including a guarantee fund assessment and incentive and stock-based compensation. These are not expected to continue at the same level into 2018.

The remainder was increased investment in our businesses including the beginning of our accelerated business in digital business strategies. In addition to the higher operating expenses in the quarter the quarter, the timing of taxes particularly between third and fourth quarter negatively impacted the fourth quarter by approximately $15 million. Our full year total company non-GAAP operating earnings effective tax rate was in line with our expectations.

In the fourth quarter, mortality and morbidity were slightly favorable overall, a benefit to Individual Life, Mutual to Specialty benefits but a negative to IRS-Spread primarily our pension risks transfer business. On an annual basis, mortality and morbidity were in line with our expectations for all our impacted businesses. We view the total company items I discussed earlier, expenses and timing of taxes, as normal quarterly fluctuations that level out over longer periods of time.

The only significant variance in the fourth quarter was lower than expected encaje performance of $6 million on a pre-tax basis. In my following comments, on business standard results, I will exclude the significant variances from both periods in my comparison. Taking into account the impacts from mortality, morbidity and the elevated operating expenses in the quarter, fourth quarter pre-tax earnings for RIS-Spread, Individual Life and Specialty Benefits were in line with our expectations.

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

As shown on Slide 7, RIS-Fees pre-tax operating earnings of a $127 million increased 2% compared to the year ago quarter. Now, revenue growth of 3% was driven by a 9% increase in fees in other revenue, partially offset by a lower net investment income. Additionally, the current quarter was impacted by the higher operating expenses described earlier.

Excluding the impacts of the annual assumption reviews, full year 2017 pre-tax operating earnings increased 9% over the prior year, primarily driven by higher account values. Both revenue growth and margin metrics ended the year at the top end or higher than our 2017 guided ranges.

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

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

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

Consistent with our international growth strategy, we've recently announced three planned acquisitions in Principal International. All three are slated to close in the first half of 2018. As announced in October, the planned acquisition of MetLife's Afore business will provide additional scale and distribution strength in the mandatory pension business in Mexico. At the beginning of 2018, we announced that we planned to take full ownership of the Principal Punjab National Bank Asset Management Company in India. We have been in India for nearly 20 years and have been increasing our ownership overtime. This transaction gives us greater economy in executing our strategic business plans in India.

Finally, we also announced the plan to increase our ownership in our asset management joint ventures in Southeast Asia with CIMB. Once complete, our ownership will be 60% positioning us to better leverage our retirement and global asset management capabilities in the region. We are excited about these opportunities and in total we expect these transactions to be accretive to 2018 earnings.

Moving to Corporate, pre-tax operating losses of $61 million were higher than our expected run-rate due to the higher operating expenses discussed earlier. For the full year, corporate losses were in line with our 2017 guidance and the losses can be volatile in any given quarter. Fourth quarter reported non-GAAP operating earnings ROE excluding AOCI other than foreign currency translation adjustment and excluding the impacts from the annual assumption reviews was 14.1%, a 50 basis points decline from a year ago.

This decline primarily reflects the higher equity base due to the impacts of tax reform and the gain on the third quarter real estate transaction. Our estimated risk based capital formula was 445% at year-end. This is above our targeted range of 415% to 425% primarily due to the real estate transaction in third quarter. Our goal remains to bring the RBC ratio back to our targeted range over the next several quarters through strategic capital deployment opportunities.

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

Full year 2017, capital deployments included $540 million in common stock dividends, a $193 million in share repurchases and a $180 million through the planned MetLife Afore and Internos acquisitions and increased ownership of our investment boutiques. The full year common stock dividend was a $1.87 per share, a 16% increase over 2016 as we continue to target a 40% dividend payout ratio.

Last night, we announced the $0.02 increase in our common stock dividend payable in the first quarter, bringing the dividend to $0.51 per share. Despite the fourth quarter results, I am very pleased with our strong financial results for the full year, a better indicator of our performance.

Looking ahead to 2018, I want to remind to you that the first quarter is typically our lowest quarter for earnings due to dental and vision claims in Specialty Benefits and elevated payroll taxes in PGI. As a reminder, the accelerated investment in our digital business strategies will flow through the business unit results and the investment may occur unevenly throughout the year.

While included in our guided ranges, it will likely cost 2018 margins to decline from 2017 levels. We anticipate the tax reform will have a positive impact on an already strong economy and on our target market of small to medium sized businesses whether through wage inflation, employment growth, additional growth in the economy, or by enabling companies to offer new or enhanced benefit packages.

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

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

[Operator]

[Operator instructions] And the first question will come from John Barnidge with Sandler O'Neill.

[John Barnidge, Sandler O'Neill]

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

[Dan Houston, CEO]

Yes, John, thanks for the question this morning. I’ll take maybe the impact as it relates to acquisitions and client behavior and then through it over to Deanna. I would say that the fundamentals of our criteria, for making acquisitions, has to do with building our scalar capabilities whether that’s international or domestic, and I don't see that having a material impact. I think generally we have thought that most of our domestic businesses are at scale, and over the years, we have added to some capabilities. International, you have seen us most recently start making the move on acquiring larger shares and stakes to gain majority control. That’s what you saw in the case of CIMB and certainly more control now with Punjab National Bank.

I think as it relates to the benefits, I just was speaking with an employer earlier this week, yesterday, about tax reform and it seemed to fallen to three buckets. One was what the anticipate was increase in benefits, as you say whether its volunteer or matching contributions, although and working with Nora and her team, we have not yet seen a material change in matching contributions. But his view was that, yes, we would continue to make those sorts of investments. The second was in the business itself. I don't know if it's just us who's having to make an investment in digital. I think it goes across every industry and every sector. And the last one frankly and it’s a public traded company, they talked about flowing back to investors. And so with that, let me turn over to Deanna to hit the RBC ratio itself.

[Deanna Strable, CFO]

Good morning. John. Thanks for the question. A couple of things I’ll mention there and you're right, we did have a, a very minimal impact on our RBC formula from tax reform. Despite the DTA at the total company level that caused the significant gain in the quarter, we did have a DTA in our life companies. But as we re-measure that DTA and took into account the amount of that, that was admitted, it only had about $30 million or 3 percentage point impact on our risk based capital. I think a wildcard going forward is obviously our current risk based capital formula does have a provision for tax rate, and it's likely that the NAC at some point could update that.

And we've talked about it in the past that impacts would impact all the insurance companies and we estimate about 65 percentage point impact just from that. Having said that there is other moving pieces within the formula that NAC is contemplating and the timing of that as well as rating agency reaction is unclear. I think to kind a wrap it up, I feel, we're in a very strong capital position. Our risk based capital is at a very strong level as well as the capital that we have throughout the complex. So, we feel confident that we can withstand any impact of tax reform on our capital position in RBC going forward.

[Operator]

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

[Alex Scott, Goldman Sachs]

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

[Dan Houston, CEO]

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

[Nora Everett, President, Retirement and Income Solutions]

Sure. Good morning, Alex. Yes, on the RIS-Fee side, full service, our full service retirement business. As we've talked about the last couple of calls, net cash flow has been impacted there by just a handful of larger cases. And in fact I spoke to one really large case for our block, and that out has actually been split between the after transfer there between 4Q about $800 million on that case, went on 4Q and actually about $1 billion on that case went out in 1Q '18. We saw it was north of 1.5 a quarter ago with the equity market rise at that about 1.8. So, we're going to continue to see lumpiness in the net cash flow at the large end of the case flow as Dan points out.

But we're extremely pleased with our core SMB segment and the net cash flow there that remains well within that 1% to 3% metric that we used at the beginning of the year account value for the full year. And we're confident going into this year that, we see the momentum in that core SMB net cash flow as well. It doesn't mean that there isn't going to be lumpiness ins and outs at the larger end of our block, but certainly when we look at this revenue growth to Dan’s point and focus on that, it's this core SMB net cash flow that we’re very focused on.

[Dan Houston, CEO]

Jim, you will take a crack at PGI.

[Jim McCaughan, President, Principal Global Investors]

Yes, certainly. Thank you, and thanks for the question, Alex. I could illustrate this I think by talking about two of late in the year client movements, one in outflow, one inflow. The outflow was for a currency mandate where the AUM was $1.2 billion that one-time in December, so it's $1.2 billion. The revenue on that was just over $200,000 a year. In other words, it was a very straight forward rather in a sense commoditize mandate.

The other big one in December, was in inflow, $600 million for a large pension clients into international small cap with the revenue there being $3 million a year. I think that illustrates the fact that, the specialty asset classes that we are running which Dan refer to, have still got quite rich revenues and have a pretty good pipeline. And that’s the underlying reason for my confidence that we can continue with pretty good revenue growth particularly management fee growth. So, I feel pretty confident that the pipeline remains strong, and so you will see quite unpredictable results in particular quarters as regards to lows, but the underlying revenue development for PCI is in much better -- is in really very good shape.

[Dan Houston, CEO]

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

[Luis Valdes, President, Principal International]

Okay, sure Dan. Alex, let me tell you that we’re very pleased about our $2.5 billion of net customer cash flows in the fourth quarter. And if you are looking quarter-over-quarter and you are looking one-year back, we are very pleased because the quality of that $2.5 billion are much, much better than the one that we had one year ago. Pretty much more one year ago, we would rely on just on Brazil. Now, you could see there is a $1.9 billion coming from LATAM, and $0.6 billion is coming from Asia. And that is not counting the other 7 billion that we had in China which is quite of our combined net customer cash flow.

So I would say that we are pretty much more back to normal. I would say that 2 billion to 2.5 billion is a pretty much more our run rate for fourth quarter. Certainly, the first quarter in 2018 every single first quarter is a little bit kind of low because we have summer time in Brazil, summer time in LATAM. So, we have to be a little bit conscious about that, but we are very pleased to see that all our operations and companies and countries are putting positive net customer cash flows.

[Dan Houston, CEO]

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

[Alex Scott, Goldman Sachs]

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

[Dan Houston, CEO]

Yes, it is an important matter for customer. It's something we take out it very seriously and I'll ask Nora to speak it specifically on our full service payout business.

[Nora Everett, President, Retirement and Income Solutions]

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

[Operator]

The next question is from Eric Bass with Autonomous Research.

[Eric Bass, Autonomous Research]

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

[Dan Houston, CEO]

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

[Amy Friedrich, President of U.S. Insurance Solutions]

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

[Dan Houston, CEO]

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

[Eric Bass, Autonomous Research]

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

[Dan Houston, CEO]

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

[Luis Valdes, President, Principal International]

Yes, let me tell you that we're very excited in order to get additional control over our franchise in Southeast Asia. Just to feature you, we’re talking about a footprint that we cover almost 350 million people, with that footprint, in the region which is growing every year around a 4.5%, 5% year-over-year. So, it’s a very vivid kind of a part of the planet. And what we are doing is taking control of than fit, in order to speed up our process and our growth, not just in Malaysia, certainly in Thailand and Indonesia and Singapore jointly with Jim with PGI.

We have had a tremendous corner in the last years with CIMB, but it seems to be that we just finish the first phase which was really to establish that’s a premium in the region, so we have really need more things like operational staff and knowledge about those markets. But going forward, it's pretty much more about asset management expertise, pension expertise, long-term saving products, distribution and digital. So it seem to me that is, if this kind of transaction is open up for many, many future opportunities for us.

[Dan Houston, CEO]

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

[Jim McCaughan, President, Principal Global Investors]

Yes. For the last -- thank you. For the last 20 years, Principal has been very focused on U.S. commercial real estate both private equity and private debt. And that's on the ground, but if you focus you’ll probably be better, will be very, very strong. We got to a point though for our leading position in U.S., commercial real estate, is leading to specific clients, asking us to do things for them around the world. And we have already started doing that, in a modest way, before the Internos acquisition. The Internos acquisition brings us a pan-European group that can be highly integrated into our real estate efforts. Don’t think of it as a typical semiautonomous boutique. I think if it is Principal real estate investors Europe and that will enable us to provide very high quality services across Europe as well as the United States. And that’s in the end I think is going to be a very important step towards globalizing our already leading real estate franchise.

And thus Internos, if you can forgive me for a comment on CIMB, it fits within Principal International, but we are really one company a Principal. We are working very close on the asset management function. And the fact that we have taken a majority stake or are taking majority stake in the CIMB joint venture, there is a lot more control and a lot more leverage about the management to the assets and we will be able to make some in effect parts of our global asset management platform. We believe that a strong local player, with access to best global practices in all our resources, we will do even better than not already successful partnership has been doing so far.

[Dan Houston, CEO]

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

[Operator]

The next question will come from Tom Gallagher with Evercore.

Q - TomGallagher

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

[Dan Houston, CEO]

Yes, Tom. Appreciate the question. I guess the way I would respond to that and I'll throw it to Nora here in a second. That 1% to 3% really works well with that core SMB market. Think about fewer than 1000 employees. But then if you start having plans with 5000, 10,000, 15,000 planned participants and the turnover in those plants will then measured in billions is one introduced that element of volatility. But when I step back and look at that business line in total, they grew their participants by nearly 140,000 plus, they grew the number of plants this past year by over 800. They hit their marks within this SMB market with the 1% to 3%. So this really can be isolated to be the institutional element and by definition, it's going to be a volatile. But I'll have Nora to clean that up for me.

[Nora Everett, President, Retirement and Income Solutions]

Yes. As a reminder Tom, we talked about this before, but the equity markets put pressure on AV base percentage. Those withdrawal amounts are driven and hired by the market growth where our payroll based contributions obviously are not. So the percentage itself gets materially impacted by the lift in the market. But that to Dan's point, when you look at the impacted 1Q this year by the $1 billion the large case that has an outflow. There is already pressure on that metric.

But if you strip that out and take a look at the overall block, you're still going to see that core SMB well within that range, that's our expectation anyway sitting here today. But there could be one or two outflows at the larger end of our block that would take us in total down to the lower end of that range. So we're just going to have to watch those variables. We'll obviously be as transparent as we've been historically, but it is a tough metrics to cover the entire block.

[Dan Houston, CEO]

Tom, do you have a follow up?

[Tom Gallagher, Evercore]

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

[Nora Everett, President, Retirement and Income Solutions]

That's fair assessment based on sitting here today, absolutely.

[Operator]

So, next question will come from Suneet Kamath with Citi.

[Suneet Kamath, Citi]

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

[Dan Houston, CEO]

Sure, Deanna, do you want to take that?

[Deanna Strable, CFO]

Yes I'll take that. You're correct, we've previously have guided to the 21 to 23. Our new total company effective tax rate is 18 to 21. As you might expect, there is a lot of moving pieces underneath that, but let me just highlight I believe the most three significant. First of all, obviously the tax rate is reducing from 35 down to 21. We have BRD that reduced around 60%. So, historically, we'd have had about 8% to 10% benefit on our ETR now in that 3% to 4% range.

And probably, the one that is harder for you to model and get your hands around, is really how the tax rates of our foreign jurisdictions go into our effective tax rate. And so, obviously, all of the jurisdictions that we are in have a tax rate in there. Previously, we had a foreign tax credit, and now we don't have a foreign tax credit, and we take in actually the tax rate for those foreign jurisdictions.

I’d say that probably caused about a 4% to 5% swing where previously it was helping our ETR by 2% to 3%. And now it's reversed to probably about a 2% increase in our ETR. So, I'd say those are the major moving pieces of that, and ultimately what got us to that 18% to 21%, but obviously we’ll continue to look at that going forward. But those would be the major parts of that.

[Dan Houston, CEO]

You have a follow-up.

[Suneet Kamath, Citi]

Yes, that’s helpful. I just wanted to follow-up on the large case RSI-Fee questioning. I had thought previously when you talked about those terminations, a lot of that was driven by M&A, but anything that the tone on this as a little different? Maybe I am wrong, but just wanted to look on that how and just see what’s going on in that larger case market. Is it tight competition? Is it people folding in tax rate declines into their pricing? And what’s driving some of that commentary?

[Dan Houston, CEO]

I don’t know anybody has done that. I would still say, you have got really three buckets when you think about why you might lose a piece of business. M&A is still and far away the biggest one, in the large case market, where we were the -- we our customer was acquired and often times they go to the larger or they acquired company. And that represents about half of it. Just as a side note on that, really small to medium size business, business is a lot of business and we --there is new plant formation. We are certainly benefit there but that’s also another place where we lose it.

The second area is in some way for whatever reason we underperformed from a customer service investment performance that hold gamut of products and services. I would tell you that’s the smallest bucket, we’ve queried ourselves extensively, we hire third parties to evaluate how we are performing for our customers and lot of that, is publicly available information, so we feel like we are doing a really good job in that category.

And then I think, this third area has to do with whether or not there is a perception, that you have the right sort of capabilities around technology or robo, or they in fact one have complete open architecture and in those cases we may not be the most competitive offering out there. But again, a lot of these large case markets exclusively focused on, we were on the losing end of M&A and Nora, you want to add to that.

[Nora Everett, President, Retirement and Income Solutions]

Yes, one just and this is a very practical aspects of our business. You can have a key decision make or change. You can have an advisor or consultant change. So, we see day to day that can have as much impact as whether you are talking about service levels or pricing, so there is just a practical aspects of this business that comes into play.

[Suneet Kamath, Citi]

You mentioned the tone of the call. I have no reason to believe at this point. S so there is somehow our offering isn’t as is competitive, the performance is not as good, but I think it's been normal mix, it just turns out that you have got one or two cases here actually very large in size, mega plans, that is distorted the results not one for the quarter but the year?

[Nora Everett, President, Retirement and Income Solutions]

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

[Operator]

The next question will come from Jimmy Bhullar with JP Morgan.

[Jimmy Bhullar, JP Morgan]

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

[Dan Houston, CEO]

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

[Jim McCaughan, President, Principal Global Investors]

Yes, thank you Jimmy. The incentive fees have been low in 2017 and will remain fairly low in 2018 most likely, not because of performance but because of incidence. Remember the big ones we have mainly on real estate both debt and equity and have assessment periods of 3 or 5 or even more years. And indeed in some cases, the incentive fee income when you have the outflow and sale the assets. So that structure means that the incidence is somewhat predictable, even if the exact amount when it comes is pretty hard to forecast.

We will get up to good levels of performance fees again 2019 and 2020 and that's when we see a bit more incidence. There is some possibility then something to drop forward into 2018 because of clients wanting to take that profits and move on. And that of course is good news as we should accomplish as far as clients concerned. But I wouldn't count on that happening, it is possible. But most likely we'll be back to what I think over the more normal level of these longer term incentive fees in 2019 and 2020.

And lastly there is an annual performance fee piece for others smaller than the multiyear carriers. That would be primarily are hedge fund in a few long only pieces where we have an annual incentive fees. And that was pretty seen in 2017 as well. As you know the hedge fund world has find hard to carry are to decent results. But we're optimistic that that will come back over the next year or two also. But that's more a matter of predicting particular segments of the market rather than the incidence. But really it's the incidence that drives that.

[Dan Houston, CEO]

Excellent, Luis, you were just down in Chile.

[Luis Valdes, President, Principal International]

Yes, Jimmy, let me tell you that we think that we do think certainly that political environment in Chile during the next four years, is going to be much more positive and pro-market in essence. So I do think we're not for sure, but I do think that the next administration that is going to takeover in March 11 is very likely that they're going to repeat and replace the current pension bill which is in the congress. This is my personal take. Last week the current administration they didn't have even quorum in order to approving the small piece of that legislation.

So, it seems to me that they're not going to try to attempt any other apply for that particular pension bill. So and also the other good news is that, we already have some information about how the administration is taking a look at and they have a much, much holistic approach to the pension problem in Chile. So the ASPs are just one pillar out of four. And the main problem that Chile has is with other pillars instead of ASPs, the ASPs that they really need some adjustments particularly, they contribution rates and other things that, we think that this pension reform is going to be much broader and more interesting.

And certainly much more compelling as I said to you, so we are pleased with that, a lot of work has to the end. We are going to be very eager to continue working on about the fees and pressure on fees, honestly. As I said to you many times and our valuable position in Cuprum is the highly differentiated. We’re number one in customer service. We just were rank again in the top 100 most profitable companies in Chile.

In the long-term investment performance, we are number two, four strategies out of five. So I would say that we differentiate ourselves in Chile as a best pension company. Having said that, we’re not competing against head to head, but with MetLife and [Providas], so if we are making any decision going forward is going to be in light of the easiest of our customers and that is what we are looking every time, all the time.

[Operator]

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

[Sean Dargan, Wells Fargo Securities]

Just had one question about I guess the pace of expenses to come. When you look at your product offering, specifically in IRAS, compared to where the competition has gone in terms of digital solutions, that allowed to participants that checking their balances and do things on a daily basis. Are you where you need to be or I mean how much longer is this paid of investment kind of going on until you get to where you need to be?

[Dan Houston, CEO]

I don’t think it ever goes away to be frank, Sean. When I reflect on this, I think about the current expense run rate that we have had, has focused on trying to reduce our expenses and also add to new capabilities and we are leading best-in class today. And I would say that one of our greatest threat is probably come from non-traditional players, because consumers has now had a really good look at how they purchase other things, unrelated to financial services.

And so I think what we are up against is an environment where the any has been raised relative to the customer experience, its simplicity, its convenience, how we access it. So this digital initiative, as we spoke about as back on December the 12 has everything to do with about two-thirds of the portfolio on driving revenue and about a third of it is about taking out additional expenses. It touches the consumer within our group benefits, it's individual life, it's our RIS-Fee businesses.

It has to do with driving technology in Jim’s portfolio management area and again hiring data scientist and people with a lot of skill sets that are new to Principal. And although I don’t think this expense rate every going to come back down. I think it's going to remain elevated. What I think we will see after 12 months and 24 months and 36 months, is those revenue enhancers coming in and that expense being taken out. We don’t want to leave you at the impression, somehow, we are going to finish up 2018 and the expense run rate is reduced, I think in fact it will be where it's at and we’ll build upon that new base, and we can expect revenues and expense reduction in other areas to offset those. So, hopefully that helps.

[Operator]

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

[Dan Houston, CEO]

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

[Operator]

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