Principal Financial Group Inc

NASDAQ:PFG

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, and welcome to the Principal Financial Group Fourth Quarter 2018 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.

[John Egan, Vice President, Investor Relations]

Thank you and good morning. Welcome to Principal Financial Group's fourth quarter and full year conference call. As always, materials related to today's call are available on our website at principal.com/investor. I'll start by mentioning two changes in our fourth quarter financial supplement. In PGI AUM by boutique table on the top page 16. Effective October 1st, 2018 Morley Financial Services joined Principal Global Fixed Income to better align capabilities and resources. As a result, approximately $17 billion of AUM moved from the Morley Financial Services boutique to the Principal Global Fixed Income boutique.

Additionally, during the fourth quarter we announced our exit from the actively managed currency market and closed the macro currency group boutique. With the closure PGI no longer manages $1.8 billion of assets related to the boutique. We've included two additional slides in the earnings call presentation this quarter. Slide 5 provides details of the fourth quarter significant variances and other macroeconomic impacts. Slide 14 provides some details of our high quality investment portfolio.

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; Tim Dunbar, Global Asset Management, Luis Valdés, Principal International; 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 the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K filed by the company with the U.S. Securities and Exchange Commission.

Additionally, some of the comments made during this conference call may refer to the non-GAAP 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.

As highlighted on 2019 outlook call, starting in 2019, we changed how we allocate certain expenses and net investment income among the business units. These changes were evaluated in conjunction with an enterprise wide global financial process improvement project. We plan to have a recast historical financial data including the fourth quarter financial supplement available on March 2019. Dan?

[Dan Houston, Chairman, President and Chief Executive Officer]

Thanks John. And welcome to everyone on the call. This morning I characterize our performance for the year and share key accomplishments that position us for long-term growth. Then Deanna will provide additional detail on fourth quarter and full year financial results and an update on our capital deployment.

Despite a challenging fourth quarter, we delivered record full year 2018 non-GAAP operating earnings of $1.6 billion and 8% increase over 2017. 2018 was year of strong execution of Principal overall. A year in which we continue to help customers achieve their financial goals. We continue to expand our distribution network and array of retirement, investment and protection solutions. We advanced our digital business strategies creating value for customers and helping us address fee pressures and our global asset management and US retirement businesses.

We built additional momentum in key emerging markets with particular progress in Asia where we delivered record full year pretax operating earnings and reported net cash flow. We benefited from purpose full diversification by customer type and geography and by revenue source with our risk businesses providing stability and strong growth. We added 1.3 million net new customers in 2018 with our ISP and Principal International, each adding more than a 0.5 million for the year. And we continue to be good stewards of capital deploy $1.4 billion in 2018 while continuing to invest heavily in organic growth.

I'll spend a few more minutes expanding on our success. I'll also address where we felt short and what we are doing about it. But first some context on the headwinds that dampened the fourth quarter and 2018 results. Clearly, the macroeconomic environment impacts our customers and our business. 2018 was certainly volatile.

Starting with equity markets. The S&P 500 index was a negative territory in eight separate months in 2018. In addition to declining 14% in the fourth quarter. For the first time since 2008, it generated a negative total return the year. Additionally, December was the worst month of outflows in the history for the mutual fund industry. 2018 results are also reflects unfavorable foreign currency exchange, as well as lower than expected encaje performance and inflation in Latin America. Despite these headwinds, non-GAAP operating earnings were again $1.6 billion in 2018, up 8% from 2017. And comparing 2018 to 2017, and to our long-term growth target, it's important to understand the headwinds associated with unfavorable macroeconomic conditions.

Over the course of 2018, AUM declined $42 billion, primarily due to unfavorable market performance and foreign currency exchange. Total company net cash flow was positive through nine months. Outflows in the fourth quarter drove results to a negative $2 billion for the full year. IRS and Principal International, however, delivered more than $11 billion of positive net cash flow for the year combined. IRS generated $6 billion of positive net cash flow. This reflects strong sales in our pension risk transfer and fixed annuity businesses in RIS-Spread and strong sales retention and reoccurring deposit at RIS-Fee.

Principal International generated $5 billion of positive net cash flow. PI gain meaningful traction in Asia with reported net cash flow nearly tripling from 2017 to $3 billion. China also improved substantially with net inflows increasing 80% to $33 billion or 26% of beginning of year AUM. Additionally, at year end, our joint venture with China Construction Bank was the third largest mutual fund company in China. As reminder, China is not included and reported net cash flow.

With net outflows of $5 billion in the fourth quarter PGI source net cash flow was a negative $15 billion for the full year. Recent headlines regarding the asset management industry have highlighted significant acceleration of active outflows in the fourth quarter. The industry and PGI continuously pressured from a number of factors including increasing demand for lower cost options, higher interest rates which have created headwinds for many yield oriented products and volatility in the capital markets, which is caused some institutional retail clients to invest in cash.

While these pressures are considerable, we have a deep and broad expertise across asset classes and an asset allocation. We continue to adjust our products and approach to better meet client needs and are taking meaningful actions. We are continuing to expand our solutions set and make those solutions more accessible. In 2018, we launched more than 50 new investment options across our US and international investment platforms. This effort includes an intensified focus on expanding our suite of lower cost investment vehicles, refreshing and repricing a number of existing products, better meeting the needs of self directed investors through digital capabilities. And using data analytics and technology to advance our investment process and improve our alpha generating capabilities.

We are also continuing to get our investment option added to third party distribution platforms, recommended list and model portfolios. And in 2018, we earned more than 120 total placements with over 50 different offerings on nearly 40 different platforms. We are continuing to add resources to better position PGI with our targeted channels and client segments. And we are focused on working closer with Principal International and its joint venture partners to achieve greater reach and capture additional market share.

Before moving on, I want to address the decline of our investment performance from September the 30th. The driver can essentially be isolated to our international equity strategies which also impact our target date series. These strategies are invested in high quality earnings growth stocks where the fundamentals remain strong. However, they substantially underperformed in the fourth quarter. As we've experienced during similar period in the past, we've already seen a rebound in performance of the stock so far this year.

Over the short term, this can create volatility in our performance. That said, five year performance remains strong and we continue to believe exposure to actively manage international equities is in the best long-term interest of our investors. Two other relevant points, for our Morningstar rated funds, 73% of the fund level AUM had a four or five star rating at year end. Clearly, positive engaging our ability to attract retain assets going forward. Additionally, our asset management franchise continues to receive important third party recognition.

In 2018, Principal funds were ranked eight on Barron's list of Best Fund Families. Throughout the year we also received dozens of best fund awards in Asia, Europe, Latin America and the US. For more organization including Bloomberg, Morningstar, Thomson Reuters, Lipper.

For the seventh consecutive year, we were recognized as one of pension investment best place to work in money management. Principal tied for the 14th fastest growing firm within the top 50 in the Willis Towers Watson research on the world's largest asset managers, which was released in the fourth quarter. Rankings were best on the compounded annual AUM growth from 2012 through 2017. With an 11% compounded annual growth rate over that period, we also moved up five spots to number 38.

2018 was also a year of continued strong performance in our US Insurance Solutions business. In particular, special benefits continued its pattern of strong growth and margins. As additional highlights for 2018, we continue to become easier to do business and continue to help customers improve with their financial well being through comprehensive education and innovative engagement tools. We intensified our focus on digital solutions in 2018 and made no worthy progress in the areas of customer experience, digital sales and advice and our global investment research platform in addition to driving business efficiency.

As communicated on November Investor Day, we anticipate an IRR of at least 20% from our accelerated digital investments. With revenue and expense gains beginning to emerge in 2019 in line with our original expectations. We'll also continue to advance the cause of retirement readiness as advocates for best practice plan design. We remained engaged in and are pleased with the direction of pension reform discussions in Brazil, Chile, Malaysia, India, Hong Kong and China. Promoting fully funded systems that leverage the voluntary savings to address longevity risk.

In 2018, we continue to deliver our core values with recognition from Ethisphere, as one of the world's most ethical companies. And recognition from Forbes the number six on their ranking of America's best employers for diversity and number one on their ranking of America's best employers for women. Despite revenue pressures, we remain committed to investing in our businesses. Rest assured, we also remain committed to aligning expense growth with revenue growth. We've identified opportunities to improve our cost structure in 2019, and we will continue to take appropriate expense actions throughout the year.

Challenges remain but we operate from a position of strength. We are competitive in our markets. We've a diverse business mix. Our investment portfolio is high quality. Our capital position is strong. And we continue to capitalize on markets and demographics that present substantial growth potential for decades to come. Deanna?

[Deanna Strable]

Thanks Dan. Good morning to everyone on the call. This morning, I'll discuss the key contributors to our financial performance for the quarter and full year. Capital deployments and our capital position at year end. And some details on our investment portfolio. Staring off, it's important to quantify the impacts of the volatile macroeconomic environment on our fourth quarter results. The S&P 500 index declined 14% during the quarter, the largest quarterly point to point decline since the third quarter of 2011. On a daily average basis, a better indicator of fee generation, the S&P declined 5% from third quarter 2018.

Despite the fourth quarter decline, the S&P 500 daily average was favorable for the full year and increased 12% compared to 2017. This negative equity market performance during the fourth quarter, along with macroeconomic drives in Latin America pressures non-GAAP operating earnings in the fourth quarter by a total $68 million pretax or nearly $50 million after tax.

As shown on Slide 5, more than half of the macroeconomic impact is included in this quarter significant variances. The remainder reflects the net impact from lower AUM and account value, resulting in lower revenue and pretax operating earnings in RIS -fee and PGI. Despite the unfavorable macroeconomic conditions in the fourth quarter, an ongoing industry pressure, I am pleased with full year results.

Net income attributable to Principal was $237 million for the fourth quarter 2018 and $1.5 billion for the full year. Quarterly net realized capital losses of $80 million were driven by derivative losses and DAC amortization with minimal credit losses.

Reported non-GAAP operating earnings were $316 million for fourth quarter, or $1.11 per diluted share. Excluding significant variances, fourth quarter non-GAAP operating earnings were $354 million, or $1.24 per diluted share. Reported full year 2018 non-GAAP operating earnings were a record $1.6 billion, an increase of 8% over 2017.

Excluding the impacts of the annual actuarial assumption review, full year earnings increased 6% and earnings per diluted share increased 8% over 2017. This growth reflects strong execution, a diversified business mix, benefit from US tax reform and specific to EPS, an increased level of share repurchases. 2018 non-GAAP operating ROE, excluding AOCI other than foreign currency translation was 13.8% at year-end, excluding the impacts of the annual assumption review.

The full-year non-GAAP operating earnings effective tax rate was 18.3%, within our guided range of 18% to 21%. At 16.6%, the fourth quarter effective tax rate was below our guided range due to lower total company pretax operating earnings overall, including the segments with higher tax rates, Principal International and PGI. As communicated on our 2019 outlook call, we expect our 2019 effective tax rate to be between 16% to 20%.

Turning to slide 5, we had four significant variances that negatively impact fourth quarter non-GAAP operating earnings by $54 million pretax or $38 million after tax. These were primarily macroeconomic related and impacts on a pretax basis include $15 million of higher DAC amortization and RIS-Fee due to the decline in the equity markets.

As a reminder, DAC amortization is impacted by the point-to-point market change not the daily average. We expect DAC amortization to return to our normal range of $20 million to $25 million per quarter in 2019, assuming market returns are in line with our expectations. $17 million of lower than expected encaje performance in Principal International, $8 million impact from lower than expected inflation in Brazil, also in Principal International, a portion of this could reverse in first quarter 2019.

And we also had $14 million of additional expenses, primarily severance related, with $9 million in PGI, $3 million in RIS-Fee and $2 million in Principal International. While not considered a significant variance, the bottom of slide 5 shows the net revenue and expense impact, the lower equity markets and resulting AUM and account values had on our quarterly pretax operating earnings in RIS-Fee and Principal Global Investors.

In the fourth quarter, mortality was unfavorable in Individual Life, seasonally negative in RIS-Spread, but favorable for Specialty Benefits. On an annual basis, mortality and morbidity were in line with or better than our expectations across all our impacted businesses.

Total company compensation and other expenses reflect higher seasonal expenses in the fourth quarter compared to the first three quarters of the year excluding significant variances. The increase that we experienced this quarter was in line with our expectations.

Our accelerated digital investments remain on track and in line with the impact communicated at our recent Investor Day and the 2019 outlook call. While we remain committed to managing growth and expenses with revenue, it's critical that we also continue to execute on our digital investments to position us for long-term growth.

Moving to business unit results. As shown on slide 7, RIS-Fee's pretax operating earnings were $110 million in the fourth quarter, excluding significant variances. Account values declined 10% from third quarter 2018 due to unfavorable equity markets. This negatively impacted quarterly pretax operating earnings by $13 million.

Excluding the impacts of the annual assumption review, full year 2018 net revenue growth was flat and below our guided range of 2% to 5%. Pretax return on net revenue of 31% was within our guided range of 30% to 34%. In 2018, RIS-Fee continued to demonstrate strong underlying growth. Compared to full-year 2017, recurring deposits increased 9%, 401(k) participants with account value increased 7%, and we added nearly 1,300 net new plans.

Turning to slide 8. RIS-Spread's fourth quarter pretax operating earnings were $79 million, an increase of 6%. Growth in the business was partially offset by higher non-deferrable sales-related expenses in the current quarter. Excluding the impacts of the annual assumption review, full-year net revenue growth of 2% was below our guided range of 5% to 10%, due to the timing of sales throughout the year and pricing discipline in our opportunistic investment-only business.

Pretax return on net revenue of 64% was at the high end of the guided range. In 2018, account values grew 12% on strong sales of $7.4 billion. This includes $3.8 billion of fixed annuity sales, a 62% increase over 2017 and $2.7 billion of pension risk transfer sales.

Moving to slide 9. Excluding significant variances, PGI pretax operating earnings were $110 million in fourth quarter. AUM declined 6% from third quarter 2018, primarily due to market performance. This resulted in a net negative $15 million impact to pretax operating earnings, as lower fees were partially offset by lower variable compensation expenses. Excluding the impact from the accelerated performance fee in third quarter, operating revenue less pass-through commissions, increased 3%, slightly below our 2018 guided range. And PGI's margin ended the year at 35%, within our guided range.

Turning to slide 10. Excluding significant variances, Principal International's fourth quarter pretax operating earnings were $80 million. As a reminder, beginning in fourth quarter, Brazil's DAC amortization expense is $5 million higher than prior quarters as a result of the 2018 annual assumption review. Compared to the prior year quarter, foreign currency negatively impacted pretax operating earnings by $9 million.

We believe that fourth quarter's pretax operating earnings, excluding significant variances, is a good starting point to use to estimate PI's earnings in 2019. Relative to 2017, PI's full-year pretax operating earnings were negatively impacted by $112 million as a result of the annual assumption review, lower than expected encaje performance and inflation, as well as foreign currency headwinds. As a result, PI's full-year net revenue growth and margins were lower than our 2018 guided ranges.

As shown on slide 11, Specialty Benefits' pretax operating earnings were $75 million in fourth quarter, an increase of 19%. This strong increase was driven by continued favorable claims experience and growth in the business. 2018 was another very strong year for Specialty Benefits. Excluding the impacts of the annual assumption review, pretax operating earnings were a record $283 million, an increase of 17% over 2017. Full-year premium and fees increased more than 7% within our 2018 guided range on strong retention sales and in-group growth. Excluding the impact of the annual assumption review, pretax return on premium and fees was 13%, an improvement of 100 basis points from last year.

In 2018, Specialty Benefits had record sales of $387 million, up 12% over 2017. And we deepened relationships with our group benefits customers. Products per customer increased a strong 5% from 2017. Over the past five years, Specialty Benefits premium and fees have increased nearly 8% on a compounded annual basis. And the pretax margin increased 250 basis points over this time period. These results reflect our strong business fundamentals and our focus on our customers.

Moving to slide 12. Individual Life's fourth quarter pretax operating earnings were $33 million, below our expectations, primarily due to unfavorable claims experience, which were volatile throughout the year. In 2018, Individual Life premium and fee growth of 2% was slightly lower than our guided range, primarily due to sales mix. Total Individual Life sales were strong for the year. Business market sales of $146 million increased 30% over 2017, and represented 63% of 2018 total sales. Excluding the impacts of the annual assumption review, Life's 2018 pretax margin was 16%, in the middle of our 2018 guided range.

Corporate fourth quarter pretax operating losses of $55 million were in line with our expectations. For the full year, corporate losses were slightly below 2018 guidance, as expenses associated with our digital advice platform were more than offset by positive interest and penalty abatements related to prior year tax settlements.

Looking ahead to 2019, I want to remind you that the first quarter is typically our lowest quarter for earnings due to seasonality of dental and vision claims in Specialty Benefits and elevated payroll taxes in PGI.

Turning to capital. As shown on slide 13, fourth quarter capital deployment included $210 million of share repurchases $152 million of common stock dividends and $10 million of acquisitions. In 2018, we exceeded our guided range for capital deployment with $1.4 billion of deployments during the year, or 90% of net income.

Our long-term objective is to deploy between 65% to 70% of net income per year, with variability in any given year. Full-year 2018 capital deployments included $650 million of share repurchases, a majority of which was opportunistic and reflective of our share price, $599 million of common stock dividends, and $140 million through strategic acquisitions, including expansion in Asia and a digital advice platform. As of the end of 2018, we had $425 million remaining on our current share repurchase authorizations.

As always, we will continue to take a balanced and disciplined approach to capital deployment. The full-year common stock dividend was $2.10 per share, a 12% increase over 2017. Last night, we announced a $0.54 dividend payable in first quarter 2019 and in line with our targeted 40% dividend payout ratio. As shown by this quarter's volatility, pretax operating earnings in the fee businesses can fluctuate.

We have deliberately balanced our operating leverage with other considerations through a conservative liability profile, a high-quality investment portfolio and strong levels of liquidity and capital. As John noted in his comments, we've added slide 14 to provide some color on our investment portfolio. We have a high-quality and diversified investment portfolio that is well matched with our liabilities.

Over the past 10 years, we significantly upgraded the quality of both the fixed maturity and commercial mortgage loan portfolios. In addition, we are comfortable with the components of our alternative investment portfolio. Our capital and liquidity position remains very strong. We ended 2018 with over $1.1 billion of available capital at the holding company, an estimated risk-based capital ratio within our target range of 415% to 425%, post tax reform changes, a very strong result given the negative 45 percentage point impact from the tax reform change through the NAIC formula, and over $400 million of available cash in our subsidiaries.

In addition, the $750 million of contingent funding arrangements that we added in 2018, along with a low leverage ratio and no debt maturities until 2022, provides us significant financial flexibility. While fourth quarter results were dampened by unfavorable markets, I'm pleased with our results for the full year, a better indicator of our performance and the fundamentals of the business. 2019 won't be without its challenges, but we are excited about the prospect a New Year brings.

[Operator]

[Operator Instructions]

The first question will come from Jimmy Bhullar with J.P. Morgan.

[JimmyBhullar]

Hi, good morning. I just had a question first on the asset management business and the driver of your weak flows. To what extent, do you think it's an industry phenomena that's hurting you as well versus maybe just company specific issues? And you mentioned fund performance improving in 1Q. Have you seen flows recovered in January as well?

[DanHouston]

Yes. Jim, this is Dan. Appreciate the question this morning, and we're fortunate to have Tim here to respond directly. I just would make this sort of macro observation. I couldn't be more enthusiastic about Tim Dunbar and Pat Halter's leadership within Principal Global Investors. There are a lot of good things going on. They're making a number of, what I would call tactical changes, shift tacking, if you will, to better align our resources to best meet the needs of the marketplace. But your observation about, do we think we are an outlier relative the industry? I'd say not. I think we're very much in lockstep with a lot of the industry challenges and frankly, I'm very confident in the team. So with that, Tim?

[TimDunbar]

Sure. And I agree with Dan completely. I think this is more of an industry phenomenon. So if you look at our sourced flows, we had about $4.9 billion in outflows and of that only about $800 million or so were related to institutional flows. The remainder $4.1 billion or so was related to our funds business. And again, there has been a lot written about what happened in the fourth quarter. Predominantly in December, we did see a lot of outflows out of our mutual funds. I think those was driven by a number of factors, largely investors sort of flee the market in any sort of risk-related assets and so really moved into more cash holding.

Two, we did see a little additional movement from active to more passive investments. Obviously, we're more focused on the active side of the equation and so that would have hurt us a bit. And then the other thing that we did see is that a lot of our retail investors were moving out to really realize some tax losses in order to pay for some capital gains that they previously received. So, we do think that that's an industry phenomenon. And I would say, so far in 2019, we're optimistic that a lot of what happened in that fourth quarter, particularly in December has abated.

One month does not a quarter make, but we do see some positive actions taking place. I would say retail investors are still a little cautious as they come back into the market. But we said in the past and I would reiterate that, as Dan said, we have a lot of confidence in some of the changes that we've made on the distribution side. We still have a really high-quality asset management franchise. Nothing is broken on the investment performance side of the equation. And we would see those flows turning around in the latter half of 2019.

[JimmyBhullar]

And then just to follow up on RIS-Fee. Can you talk about what you're seeing in terms of competitor behavior and just competition overall in the DC market, and whether you're confident in being able to achieve your 1% to 3% flow target for the year?

[DanHouston]

Yes. So -- and Nora, certainly in a position to respond to that. I would tell you, I'm actually pleased with the last year's results because we did come in within that 1% to 3%. I don't think that the competitive environment has changed dramatically. We've been dealing with this for the better part of half a decade. And again, scale and capabilities and things like TRS are the differentiators that put us in a favorable position. But Nora, you want to take that one head-on?

[NoraEverett]

Sure. Yes. To Dan's point, Jimmy, I'm really pleased with full-year net cash flow at almost $3 billion and that's built through strong transfer deposits. So if you look at that transfer deposit line of 26% quarter-over-quarter and then the strong reoccurring deposits that both Dan and Deanna have mentioned, looking just 4Q over 4Q, up 11%. So, a very, very powerful franchise with regard to that growth.

We talk about net new plans, but as important is this participant growth and participants with account value. So when we look at participants, we measure those that were gaining with regard to bringing on an account value. And when we see that up almost 7%, trailing 12 months, all of those things are fundamentals that give our lead indicators with regard to 2019, in particular, strong retention.

Oftentimes, when we talk about our model, we talk in terms of, one, the platform, the record-keeping service and our reputation in the market with regard to record-keeping and service. But two, equally important is our distribution footprint. And that still remains a significant competitive advantage whether we're working with the TPAs in the local market, whether we're working with an advisor in the large wirehouse firms, those relationships matter and really help us drive those transfer deposits and those sales.

So, lots of confidence going into 2019 around the fundamentals and certainly would expect to remain a top-tier player in highly competitive, including looking at consolidation opportunities. We're in a nice position to take advantage of those folks that are subscale today, that are probably over the next 12 to 24 months going to move out of the business. So looking forward to 2019, for sure.

[Operator]

The next question will come from Erik Bass with Autonomous Research.

[ErikBass]

Hi. Thank you. Dan, I was hoping you could expand on your comments on expenses. I mean, clearly, the revenue backdrop has become more challenging since you gave your outlook but markets can change quickly. So just wondering do you have any plans changed that reduce or delay any of your planned investments and make broader expense cuts at this point? Or will you wait and see how the environment develops?

[DanHouston]

Yes. I think, clearly, Erik, every leader out there competing in this marketplace today is happy to always be mindful and looking closely at expenses. And we're no exception. We'll be looking very closely at expenses. But I do want to may be correct one item before throwing it over to Deanna. And that is our planned investments around digital remain very much intact. We look at those as very much investments. We really like the optics of the internal rate of return that we hope to achieve by those and we are very much on track. So we will be disciplined about how we take out expenses, but understand that the need is there and we'll be very surgical about doing it. Deanna?

[DeannaStrable]

Yes, I think -- Erik, thank you for the question. I think if you look back over the past decade, we have a very proven ability to make expense adjustments, to mitigate any significant market adjustments. Most notably, we did that back in 2009. We did it again in 2016. And I think when you consider our severance actions both in the third quarter and the fourth quarter of this year; it clearly shows that we've already started the process to ensure our expenses are better aligned with the lower revenue base.

Obviously, we did have a market decline in the fourth quarter. But in some of our businesses, we were seeing revenue pressure even before that, which really points to those actions that we have taken. We're going to continue, as Dan mentioned, to evaluate and manage all of our expenses as we proceed in 2018. We'll be prudent in doing that, but we ultimately do have the aim of aligning our expenses with our revenue without jeopardizing our ability to compete over the long term.

And regarding severance, probably, we have some of that in every quarter. We'll only identify if it adds up to a significant driver for the quarter, obviously. So, I think, bottom line, we are focused on expenses. We are focused on investing for the long term, and we'll be prudent as we proceed through 2019.

[ErikBass]

Thank you. I appreciate the color. And I guess, at this point then, there's no reason to expect that you couldn't fall within your range for margins that you guided to across the different businesses, maybe a little bit at the lower end because of less favorable markets. But you think those ranges are still achievable at this point?

[DeannaStrable]

Yes. I think relative to margin ranges, we feel pretty good. Obviously, our outlook ranges did reflect market decline to, I think, the end of November. We've seen -- even if you take the positives that we've seen in January, we're down from there. And so I think it is important that you update your expectations for what we deliver here in fourth quarter. But I think I have much more confidence about our margin ranges. We have the ability to adjust expenses to align with that.

When I think specifically about the revenue growth and specifically, those two businesses that have the most market sensitivity, RIS-Fee and PGI, for us to get to the daily average assumption, in our outlook call, it would take a 5.5% quarterly market appreciation from where we sit today to the end of the year, that's quite a bit above what our normal 1.5% market appreciation assumption. So the revenue ranges, obviously, too early in the year to adjust any of those. But more pressure on those than I would say on the margin ranges.

[Operator]

The next question will come from Ryan Krueger with KBW.

[RyanKrueger]

Hi, thank. Good morning. I had a follow-up on expenses. Just when you give the 4% to 6% sensitivity to earnings from a 10% move in the equity market, I was just curious. Does that already incorporate any expense actions or would potential expense actions reduce the impact relative to that 4% to 6%?

[DanHouston]

Expense actions would be over and above what that range of 4% to 6% would be. And again, just for those others on the call, a 10% reduction on the first day of the year in the S&P 500 that endured and then started getting back on track for 2% per quarter, would negatively impact our earnings 4% to 6% of operating earnings on a full-year basis. Works both ways, right? But we do not embed within that range any sort of expense actions that we would take and clearly, we would be taking those actions.

[RyanKrueger]

Yes. On PGI, I guess, the management -- the rate has been pretty stable over the last few years. So I was just hoping if you can update on your thoughts going forward. I think you talked at Investor Day about maybe taking some modest fee reductions on certain products. But just curious about an update on how you're thinking about the fee rate.

[DanHouston]

Yes. Good question. Tim, please?

[TimDunbar]

Sure. Yes. We are looking at that always, Ryan, just to make sure that we are in line with market expectations. And I would say that we do continue to see some fee pressure. We are looking at that closely, and we'll take appropriate action as we need to. You might have seen that the basis points dropped a little bit this quarter. I would say that's really more related to the flows coming out of the mutual funds. Mutual funds tend to be at a higher fee rate than the institutional business.

So we haven't seen a phenomenal move in terms of new mandates, one, and lower fee levels. But there certainly is some fee pressure out there. I don't want to mislead you.

[Operator]

The next question will come from John Nadel with UBS.

[JohnNadel]

Good morning, Dan. Question for you on slide 6, the investment performance slide. The bars are shown on an equal weighted basis. So I was wondering if you recast that on an asset weighted basis, what the performance would look like for the one, three and five. And how much it would have changed over the last three months from the September to December period?

[DanHouston]

Yes, good morning, John. Appreciate the question. Frankly, we have not done that calculation. I think if you look to the right on slide 6, you would see some math we did relative to the asset weighted, using again a very common standard in the industry, which is Morningstar to see what that looks like. But frankly, it's a good question. We'll go back and make that calculation but unfortunately, we're not sitting on that here today.

[JohnNadel]

Okay. I think that will be helpful. It sounds from your -- maybe I just want to make sure I got your commentary right in your prepared remarks that it's really more a function of international equity that drove the performance decline.

[DanHouston]

Yes. That's right. It's roughly four funds. But let me have Tim add some additional color.

[TimDunbar]

Yes. That's right. The international equity, we saw some disruption in the investment performance for fourth quarter. And as Dan had said, that's really in line with our investment process. So they're really focused on companies that have high-quality earnings growth. And as you know in fourth quarter with a risk-off environment, those stocks tend to under perform. And they did.

What you usually see in a period after that when the market comes down a little bit is that those stocks will tend to rebound. We are seeing those stocks rebound as well so far in this quarter. So, behaving exactly as we would have anticipated. But Dan mentioned, as well as those funds are part of our ETF, part of our lifetime franchise, our life cycle franchise. And so those had an impact on our life cycle performance during the quarter. We would expect to see that start to rebound as well and have seen again that that rebound in similar periods. And so, I think we're sitting in a pretty good spot as we go forward from here.

[JohnNadel]

Okay. Appreciate that color. And then I did have one follow-up or a separate question on RIS-Fee. And -- we've seen that there's clearly a differential in the rate of growth of fee revenues relative to account value. So there's your gap that indicates fee rate pressure. I'm just wondering if you see any reason on the horizon that we should expect that that gap between the two should do anything other than continue to widen as we look over the next couple of years.

[DanHouston]

Yes. John, I think it's a really good question and believe me; we're highly sensitive to it. And that delta has existed forever. And it's obviously been slightly intensified the last few years. I think you really have to dissect it, though to understand what are the biggest contributors to it. Because again, we'd have the same number of participants, the asset size is still the same. But it may turn out that the biggest impact it has on revenue is the fact that the plan sponsor and the advisor shifted 30%, 40%, maybe 50% of the asset to a passive model, which obviously has a dramatic impact on the revenue. So those active strategies generate higher revenue. So with that, let me throw it over to Nora to add some additional details.

[NoraEverett]

Yes, John. To Dan's point, we've historically seen this five to eight roughly, give or take, a quarter. We would expect that to continue. The one caveat we talked about it, I talked about it on the last call is we do have this phenomenon of this roughly 2% drag for a period of time going forward. And it's counter revenue. It's not going to impact the bottom line. But as we talked about last time, it's a meaningful number, as more and more firms shift their business model from a commission model to a plan expense fee model.

So, we expect to see -- to be at the higher end historically, because you've got that, up to roughly 1.5% to 2% drag on revenue growth. But remember, as we talked about, it will actually -- you will actually see the reduction on the commission expense line. So again, no impact to OE, but certainly, it's pressuring that historical range towards the upper end and a little over depending on the blocks that move from that commission chassis to a fee chassis.

[DanHouston]

John, hopefully that helps.

[Operator]

The next question will come from Humphrey Lee with Dowling & Partners.

[HumphreyLee]

Good morning and thank you for taking my questions. Just a follow-up question to Tim. Regarding his comment about the flows turning better towards the second half of 2019, I was wondering if he can elaborate some of the actions being taken by PGI account maybe. You elaborate a little bit in terms of distribution changes and also maybe on the product side what are you doing to help to drive that account flow towards positive, towards the second half?

[DanHouston]

Yes. It's a great question, Humphrey, and we appreciate that. No, one thing I'm reminded about is the demand for income-generating vehicles and retirement, the demand for growth, that hasn't waned one single bit. There's just huge demand for these kinds of products. Getting the right product at the right price through the right distribution is key, which is probably what gives us the most optimism about our franchise and our capabilities. But, Tim, you want to provide some additional details?

[TimDunbar]

Sure. And I think we've mentioned a lot of it from the past, Humphrey. But just some of the leadership changes that we've made, we think are very focused on really connecting with our clients and making sure we understand what their investment needs are and helping them provide solutions. Again we have a very diversified suite of investment products, that hasn't changed. And we have some good investment performance as it relates to that. So, Dan mentioned getting on a number of new platforms, I think that's helpful. I do think some of the investments, or some of the macro environment has changed a little bit. Again, yield assets are a bit more in favor then they were as we talked in third quarter.

You've seen some of the interest rates pulled back a little bit, and there has been some muted commentary coming out of our Fed Chairman and others related to interest rate movements. So, as always, yield-oriented products are going to ebb and flow just a little bit with the macro environment that comes into play.

I'd say as well, we're looking ahead and we're thinking about what are some other asset allocation types of products that we can offer like interval funds and some other innovative and creative ideas. And then, our suite of real assets and real returns have really performed well over this -- over really a long cycle and continue to be in favor as we look forward. And we are seeing a lot of client demand for those strategies.

[HumphreyLee]

This is helpful. And then maybe shifting gear to a question for Deanna. So obviously, buyback was very strong in the fourth quarter. Looking ahead like how should we think about your capital deployment given the weakness in the stock price? And then, additionally, is there any other kind of off-balance sheet investments that you could potentially monetize to take advantage of the current stock price?

[DanHouston]

Just real quick and a very high level, Humphrey. This focus on capital management is a very high priority. Our single and highest priority is always around organic growth. We want to make selective investments where we can build on scale and capabilities. We have achieved this net -- 40% of net income dividend ratio, which again is something we've been talking investors about for a long time and we feel very good about that.

And we have roughly $425 million remaining on our stock repurchase. This is a frequent conversation with our Board. At every Board Meeting, it's a high priority. And Deanna can certainly provide you with some additional insights and color on the stock buyback.

[DeannaStrable]

Yes. Thanks, Humphrey. You're correct, obviously, our fourth quarter activity and our full-year buyback activity was at a very high level. In total, for the year, $650 million, which was triple what we did in 2017? But what I would say is it's very consistent with our strategy. So we've always said that buyback was primarily opportunistic, and it was really based on evaluation of our stock, our capital position and other deployment opportunities.

So if you think of 2018, one, we came into the year with a very strong amount of excess capital. We also throughout the year had valuation, which was very, very attractive. And our M&A was, frankly, at a little bit lower pace than we had seen in prior years. And so, all three of those factors really then led to us doing that elevated amount. And so what I would say is going forward, we're going to follow that same strategy and the amount that we do will be based on all three of those factors.

We do still have $425 million of authorization as we came into the quarter. But ultimately, we'll be disciplined and focused on making sure we're doing what's right for our shareholders. Relative to the off-balance sheet, there's nothing right now that we're considering that would free up capital to give us more. And ultimately, even though we'll continue to look for that, that's not really in our strategy for 2019.

[Operator]

The next question will come from John Barnidge with Sandler O'Neill.

[JohnBarnidge]

Thanks a lot. Wanted to ask question about the standout in the quarter, Specialty Benefits. There are clearly concerns about the economy right now, yet sales were strong across that segment. Can you kind of talk about maybe what you're seeing there as a driver and then, pricing and competitive landscape perspective?

[DanHouston]

Thanks, John. And Amy is really ready respond to your question. Dying to, it looks like

[AmyFriedrich]

Yes. Thanks, John. Thanks for the question. Yes, I think there is some concern. I guess what I would begin to isolate though is that's kind of hitting consumer sentiments first. So when we look back over the last, probably five years of small employer sentiment, even though it has declined a little bit the last few months, we're still at near-record highs. So when we look at larger employers, they still have a huge need for talent and they would say their top issue going on is they can't find the right talent.

And so when they're looking at their employee benefits package, they're doing more talking about ancillary benefits than they've ever done before. So when I look at the correlation between a tight labor market and high ancillary, kind of Specialty Benefits sales rep, I see a direct correlation there.

Now, some of that may continue to soften, as we look forward into the future in terms of, if sentiment changes a little bit. And I will tell you even though we're seeing all-time highs in terms of employment growth, in 2018, what we've modeled for 2019 pulls off of that just a little bit.

[JohnBarnidge]

Okay. And then what I would say is your commission rate as a percent of premiums did go up in 2018. Are you expecting that to maybe level off a little bit similar to what you were doing in 2016 and 2017 going forward? Or is that something that we should consider as a run rate?

[AmyFriedrich]

First point I would make is that we look at total expenses. So whenever you look at particular line, they can kind of move up and down, either over the full year or by quarter. I'm very comfortable with our total expenses. I do feel like commissions as a percent is one that because we're in the small market, that can look a little bit more elevated. But again, when I put it together with a combined ratio of the loss ratio that we have against those expenses, I'm very comfortable with those levels.

[Operator]

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

[AlexScott]

Hey. Thanks. First question I had was on the RIS-Spread business. I guess when I think about the margins there, I guess, you've got 64% in last 12 months, but I think there's some favorable NII in there, I think sort of fully normalized your significant variances that was closer to maybe 61%, 62%. And I'm just wondering how much of that is abnormal drag from expenses or maybe other items that have been weighing on that this year as opposed to just the re-segmentation? This should get you up to that 65% to 70% range. I'm just trying to think about bridging the gap and what the real earnings power should be for this business.

[DanHouston]

Yes, thanks, Alex, for that question. I'll have Nora respond. The one thing I'm reminded, when you framed it this way, whether it's 60% or 70%, those are really strong margins and a great way for us to deploy capital. Nora?

[NoraEverett]

Yes. So, Alex, maybe go at it -- I'll go at it a couple of different ways to try to be responsive. First of all in 4Q what you're seeing is seasonally higher expenses in 4Q that we've talked about. Also seasonally higher reserve negative. So we talked about seasonality with regard to our reserves in mortality first half versus second half. So certainly from a quarterly perspective and Deanna also mentioned the higher non-deferrable sales expenses so certainly from a quarterly perspective there were some pressure on margin.

But if you look at that trailing 12-month margin and you look at the 64% what we're talking about there is a very diversified set of spread businesses. So think about product mix. So we are going to be highly disciplined around our IO business for example. So our IO sales were significantly down this year because of that discipline. On the flip side PRT as you know relative soft first quarter but very significant sale second half of the year and the pipeline that we're looking at coming into 2019 really robust.

So you're going to see margin differences as product mix shift as well. But certainly when we said on that outlook call and talked about the margins that we're looking forward to in 2019 and to Deanna's point we have confidence role in those markets but it's not going to be a level quarter over quarter over quarter. It's a very diversified mix of business. That mix of business impacts margins as well. But if we take a 12-month look either back or forward it's a very, very healthy business and we're really pleased with both top line and with bottom line.

[DeannaStrable]

And just one more comment on that. The bridge to the 2019 higher margins in 2019 was more to do with the benefit that spread got from the recast and net investment income and expenses than it was a fundamental change in the margin producing of that business. So I think that will be evidence when we come out with our revised supplement in March but wanted to mention that as well.

[AlexScott]

Okay that's all very helpful. Second question I had is just a follow-up on the expense conversation. I guess could you give me a feel for some of the actions you took this quarter that resulted in the higher severance cost. Is there a step-down inside in sort of core rate of expenses going forward as a result of those actions? And can you help me quantify that may be and just may be 4Q seasonal expenses down to 1Q which I think still has some seasonal expense in it. When I think about these different pieces how would you expect expenses to kind of trend quarter-over-quarter and can help us some of those bigger moving pieces?

[DanHouston]

Yes. So I think Alex not trying to avoid and give a specific number but I think the best way to look at this is we clearly can see what the revenue run rates are looking like. We know the pressures on the business. An expense is something that we analyze constantly. And so when we step back and look at our 2019 expenses we know there have to be reductions and we have to be surgical about taking those out.

We're not in a position today to state a dollar amount that we are targeting in 2019 except to say there will be ongoing consistent efforts on our part to become more efficient without mortgaging our future relative to our ability to attract and retain business. This is not the end of cost associated with reductions in force. There is going to be future cost associated with that. And as we continue to develop those plans we'll provide you as an investor with more additional colors and insight. Deanna you anything you'd like to add to that?

[DeannaStrable]

No I think that's good. And obviously the IR team can help you to I probably go back and really focus on that ratio of expenses to revenue and how that is easily throughout the year that might be another way to back into it as well.

[Operator]

The final question will come from Suneet Kamath with Citi.

[SuneetKamath]

Thanks, good morning. Let me just start with the RIS-Fee business and the target date on the performance. Should we be expecting a shift in to the allocation of those funds because of the underperformance as we move through 2019?

[DanHouston]

I say at a very high level we have had such good investment performance for the one, three and the five and for the 10-year numbers on our target dates series whether it's a CAT or a registered product. That we have one sort of bad quarter here that was dramatic. I would remind you that in some of these instances the difference between the 25th and the 75th percentile is like 150 basis points.

So I frankly personally don't see this as having a significant impact. But recognize there is pressure in the marketplace to look for other strategies around target date. And passive strategies around target dates are probably the bigger challenge than is the performance in the quarter, but let me look to Tim to provide some additional color.

[TimDunbar]

Sure. And one thing I'd point is the long-term investment which remains very strong. And these life cycle funds, I know you know this but they're really designed for someone to be in for 40 years or more. I mean it moves in conjunction with their lives as they move closer to retirement. So really aim to be in those in and out of cycles.

And I think that actually that we work really well. A couple of other things I just mentioned in terms of the LifeTime Funds are that they really outperformed over long-term basis. So average rankings across all-time frames had really been on the top quartile for one, three and five years and we've been above median in all-time frames for about 80% of the time so these are consistent performing funds. And we do have some going forward as we said are confident that you will see some rebound in investment performance from here.

[DanHouston]

Suneet did you have a follow-up?

[SuneetKamath]

Yes I did just briefly on the underwriting results. I think you'd mentioned Individual Life RIS-Spread and Specialty Benefits with the first two segments I think being bad guys. Can just help us sort of quantify what the unfavorability and favorability in Specialty Benefits for the quarter?

[DanHouston]

Deanna you want to.

[DeannaStrable]

I think the underperformance in Individual Life is about $7 million in pretax earnings. I think the underwriting loss in RIS-Spread was a couple million for the quarter. I'd say in total Specialty Benefits mortality and morbidity was pretty in line with what we would expect in our first quarter. The life mortality may have been a little bit positive but I think I'd point you more to the total Specialty Benefits loss ratio which we feel was pretty in line.

End of Q&A

[Operator]

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

[DanHouston]

When I reflect on this past year despite significant macroeconomic headwinds in 2018, frankly, it was record year for Principal in both earnings and the number of customers that have been attracted to the Principal. The underlying and the fundamentals of business are very much intact. We feel good about it. There are challenges in the industry, but there is no doubt my mind we have the management team in place to deal with these challenges to best serve the needs of both customers as well as our shareholders.

In closing, I would like to recognize Nora Everett she's retiring at the end of March after 27 years. She has been very instrumental with our evolution as a company. She played a very important part 18 years ago as we IPO the organization. She played a very important part of the development and the creation of our mutual fund company and played an active role in acquiring WaMu which really launched us so that we're very thankful.

And most recently your leader in retirement and income solution. So just want to say thank you Nora for everything you've done for the organization. I also want to welcome Renee Schaaf to step in her role as Divisional President. We're excited. It was very much a planned succession and look forward to introducing Renee to many of you out there in the investor community here in the course of the next quarter or two. So thank you and have a great day.

[Operator]

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 P.M. Eastern Time until end of the day February 5 2019. 5384726 is end of the day February 5, 2019. 5384726 is the access code for the replay. The number to dial for the replay is 855-859-2056 U.S. and Canadian callers or 404 537-3406 international callers. Ladies and gentlemen, thank you for participating. You may now disconnect.