Principal Financial Group, Inc. (PFG) Q2 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Principal Financial Group Second Quarter 2020 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 conference call over to John Egan, Vice President of Investor Relations.

Thank you and good morning. Welcome to Principal Financial Group’s second quarter 2020 conference call. As always, materials related to today’s call are available on our website at principal.com/investor. Similar to last quarter, we posted an additional slide deck on our website with details on our U.S. 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 Renee Schaaf, 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 non-GAAP financial 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. Our 2019 corporate social responsibility report was released a few weeks ago. Learn more about how we are working to build a more inclusive, resilient and sustainable global community by reading the report on principal.com. Dan?

Thanks, John, and welcome to everyone on the call. I hope you’re all well and have found some sense of normalcy during these unprecedented times. This morning, I’ll provide an update on how Principal’s responding to the COVID-19 pandemic and its impact on our global economy, our strong financial position, key performance highlights for the second quarter and how we are well positioned for long-term growth. Deanna will follow with additional details on our capital and liquidity position and our investment portfolio as well as impact from COVID and our second quarter financial results. The safety of our employees and our customers continue to be top of mind as the vast majority of our employees continue to work remotely. Our previous investments in technology and our accelerated digital investments have enabled us to rapidly meet the challenge of a changing operating environment. Our ability to communicate effectively with our employees, distribution partners and customers has allowed us to minimize disruption and service to our 32 million global customers. Consistent with our core values and mission, we continue to help our customers and communities through this pandemic. Since announced in April, The Giving Chain powered by Principal has provided more than 50,000 meals for more than 120 businesses and over 30 communities around the world. And we continue to focus on reducing the financial burdens that our customers may be facing by waiving certain fees for participants taking COVID-related withdrawals and loans from their retirement accounts. We’re also working closely with plan sponsors and group employer customers to maintain their retirement and protection plans. This pandemic has certainly created some challenges for Principal to overcome, but our diversified business model has been resilient. I’m confident that we’re in the right businesses with the right teams in place and we’ll continue to make investments to create long-term shareholder value. We serve our customers across small, medium and large businesses in the U.S. and we know there are some concerns about the health of small- to medium-sized businesses right now. We’re finding that the impact from COVID is less about large versus small businesses and more about what industry business is in. As shown on Slide 7, we have less exposure to the industries that have been the most impacted by COVID, including accommodation and food services, retail trade, and arts and entertainment. And we have more exposure to industries that are less impacted, such as professional services, wholesale trade and finance and insurance. While the impacts of unemployment and the economic recovery are uncertain and vary by industry, the amount of stimulus business owners have received from the U.S. government is unprecedented and has helped stabilize businesses during the quarter. As a result, our U.S. retirement and group benefits businesses have had less of an impact from the current environment during the second quarter than some may have expected due to our intentional diversification by industry and geography. Turning to Slide 8, we remain well capitalized and are in one of the strongest financial positions in our history. At the end of the second quarter, we had over $3 billion in available cash and liquid assets, and over $2.3 billion of excess and available capital. We’ll continue to be diligent stewards of our capital and take a balanced and disciplined approach to capital deployment, carefully weighing opportunities as they arise. Moving to our second quarter results, we delivered non-GAAP operating earnings of $403 million. Excluding significant variances, earnings were down 8% compared to the strong prior year quarter, partially driven by foreign currency headwinds. During the quarter, we continue to make progress to align our expenses with revenues, and our second quarter results reflect benefits from our expense management actions. Compared to the first quarter, total company AUM increased $71 billion to $702 billion at the end of the second quarter. This increase was driven by favorable market performance as well as the positive net cash flow. Market performance contributed $67 billion to AUM the second quarter, helping to offset most of the unfavorable performance in the first quarter. Additionally, we ended the quarter with $142 billion of AUM in our China joint venture and $713 billion of assets under administration in the Institutional Retirement & Trust or IRT businesses. Through the first six months of the year, total company net cash flow was a positive $9 billion, including more than $6 billion in the second quarter. On a trailing 12-month basis, net cash flow of $23 billion improved significantly from $400 million in the year ago period, with $21 billion of the increase from PGI. This achievement highlights the strength of our distribution network, our investment performance and our in demand products and solutions. RIS-Fee generated over $700 million of positive debt cash flow. This was driven by sales of $2.8 billion, low contract lapses and continued but pressured growth in reoccurring deposits. Transfer deposits were down compared to a year ago period due to lower sales, while participant withdrawals were slightly elevated but in line with our expectations during a stressed period. RIS spread net cash flow was flat despite $2.1 billion of sales, including $1.1 billion of opportunistic issuance in investment only. Due to low interest rate environment, we’ve started to see the pension risk transfer pipeline slow down, and we continue to expect lower annuity sales for the remainder of the year. Principal International generated $900 million of net cash flow and marked its 47th consecutive positive quarter driven by positive flows in Mexico, Chile, Hong Kong and Brazil. Our collaboration between Principal International and PGI continues to show results as we won a large institutional mandate in equity funded Mexico. The investments that we’ve made in the digital platform in Chile are also paying off as we’ve continued to onboard and service customers during this pandemic. While not included in the reported net cash flow, China had $4.6 billion of net cash flow in the quarter, as market volatility drove investors to money market funds. PGI sourced net cash flow was a positive $4 billion. This was our highest quarter of both PGI sourced and institutional net cash flow since 2016. And it was aided by the continued strong net cash flow on our mutual fund platform. Institutional sales were across a number of equity and real estate strategies. In the current low interest rate environment, there’s increased demand for yield and proven investment performance. As shown on Slide 14, our investment performance remains strong. At quarter-end, 75% of Principal mutual funds, ETFs, separate accounts and collective investment trust were above median for one-year, 81% above median for three-year and 80% were above median for five years. Additionally, for our Morningstar rated fund, 77% of the fund level AUM had a four or five star rating. This continued strong performance positions as well to attract and retain assets going forward. The strong net cash flow across the company is a testament to the great work our teams have been doing in a challenging environment to create in demand products and leverage our digital investments. A few examples include; in PGI, our Principal Blue Chip Fund was awarded the Best Large Cap Growth Fund over the past five years by Lipper. And Principal Real Estate Investors was named a 2020 Green Lease Leader, achieving Gold Recognition from our commitment to high performing and sustainable property management. Brasilprev, our joint venture with Banco do Brasil in Principal International has had great traction with Brasilprev Fácil, our retail long-term savings product that requires no money to open and only a contribution of about US$20 per month to maintain an account. And under two years, we have sold more than 500,000 plans as we’ve reduced the barriers to entry for long-term savings and helped an underserved market. From a digital perspective, our Principal mobile app is now a top-rated app in the App store in the retirement industry with more rating and actionable feedback than our competitors. We also launched an interactive dashboard for retirement plan sponsors and advisers to understand the behaviors of plan participants. Since its launch in April, we’ve had extremely positive feedback on the dashboard, and it’s a differentiator for Principal in the marketplace. In Individual Life, we’ve seen continued adoption of our term life online self-service tool. Principal Life Online, one of the first fully digital experiences in the industry. Since January, we’ve had 25,000 applicants utilized this tool. By leveraging our digital application tools and investments in the underwriting automation, more than a third of our underwriting approvals are able to be completed with less than 10 minutes of underwriting time. Through the first six months of the year, I’m proud of our 18,000 employees executing our diversified and integrated business model. Our capital position remains strong, and we continue to invest for the future, while aligning our expenses with revenues. Before I turn the call over to Deanna, I want to make a few comments regarding Principal’s dedication to social equality. Principal has a strong history of doing the right thing. And in terms of diversity and inclusion, we have an extensive track record on being recognized for our efforts, including being named by Forbes as one of the best employers for diversity in 2020. Global inclusion is a business imperative for Principal, and we are driven by our purpose of making financial security accessible to all. While we are all proud of the efforts thus far, we continuously push ourselves to do better, both in our communities and our workplace. With that, let me turn the call over to Deanna. Deanna?

Thanks, Dan. Good morning to everyone on the call. I hope you are all staying safe and healthy. This morning, I’ll discuss our current financial position, details of our investment portfolio, impacts from COVID-19 and the key contributors to our financial performance for the quarter. We remain committed to helping and protecting our customers through this pandemic. COVID has certainly impacted where and how we do business, and we’ve included additional details in our conference call presentation to highlight the various impacts many of which have yet to fully materialize. While there is continued uncertainty on how COVID and the related market impacts play out over the next 12 to 18 months, I’m pleased that many of the metrics we’re tracking are trending better than we expected they would a quarter ago. As shown on Slide 8, our capital and liquidity position remains strong. At the end of the second quarter, we had $3 billion of available cash and liquid assets at the total company, and we have $800 million of untapped revolving credit facilities available for liquidity purposes. We had $2.3 billion of excess and available capital at the end of the quarter. This includes nearly $1.6 billion at the holding company, almost $750 million higher than our target of approximately $800 million to cover the next 12 months of obligations, $400 million of available cash in our subsidiaries and $340 million in excess of our targeted 400% risk-based capital ratio at the end of the quarter estimated to be 422%. The RBC ratio is higher than our target due to uncertainty in the timing and impact credit drift and credit losses could have on the rest of 2020 and beyond. Over time, we expect the RBC ratio will trend down to our targeted 400%. Our excess capital at the holding company increased during the quarter and reflects the $500 million opportunistic debt issuance we completed in June at a very attractive coupon rate of 2.125%. While we don’t expect to need the proceeds from this issuance under our baseline scenario, it provides additional financial flexibility and offers protection if the environment deteriorates. We also have access to a contingent capital facility that allows us to borrow up to approximately $1 billion, the current fair value of the treasury assets in that facility. Our non-GAAP debt-to-capital leverage ratio, excluding AOCI, is low at 23.5%. Our next debt maturity of $300 million isn’t until 2022, and we have a well-spaced ladder debt maturity schedule into the future. In the near term, we remain focused on maintaining our capital and liquidity targets at both the life company and the holding company. Despite the pressures of the current environment, we remain in one of the strongest financial positions in our company’s history, and we have the financial flexibility and discipline needed to manage through this time of economic uncertainty. As shown on Slide 9, we deployed $154 million of capital in the second quarter for common stock dividends. As a reminder, we pause share repurchases in early March as the pandemic and the resulting market volatility emerged. We have $850 million remaining on our current share repurchase authorization. To determine when we’ll restart repurchases, we’re looking for enhanced clarity and stability in the macro environment for the range of possible outcomes to narrow and to have a better understanding of timing of the potential impacts. We are well positioned today, but we’re being prudent on capital management given the uncertainty. As discussed last quarter, we continue to expect our full year 2020 external capital deployments will be between $800 million and $1 billion, which is lower than the target that we had at the beginning of the year. While capital is expected to be pressured by credit drift, credit losses and lower operating earnings. Some of the pressure will be offset by a lower level of capital needed to support sales, lower external deployments, expense management actions and our recent debt issuance. Last night, we announced a $0.56 common stock dividend payable in the third quarter, unchanged from the second quarter and our dividend yield is approximately 5%. As shown on Slides, 10 and 11, our investment portfolio remains high-quality, diversified and well-positioned, and importantly, our investment strategy hasn’t changed. Slide 11 provides detail of our U.S. fixed maturities and commercial mortgage loan portfolios which represents nearly 90% of our U.S. investment portfolio. The portfolios remain high quality and we’re better positioned relative to 2008. A few key takeaways, at the total company we are in a $3.5 billion net unrealized gain position. This includes a $5.5 billion pretax net unrealized gain in our U.S. fixed maturities portfolio, which increased $3.8 billion during the second quarter as spreads tightened. The commercial mortgage loan portfolio has an average loan-to-value of 50% and an average debt service coverage ratio of 2.6 times. We have a diverse and manageable exposure to other alternatives in high risk sectors and importantly our liabilities are long-term. We have disciplined asset liability management, and we aren’t forced sellers. We’re continuing to evaluate the potential impacts to our capital and liquidity position under a wide range of economic scenarios. Our capital and liquidity positions remain or above targeted levels under our baseline scenario for 2020 and into 2021. In the first half of the year, we have had approximately $115 million impact from credit drift and credit losses with more than $80 million in the second quarter. For full year 2020, we’re now expecting approximately $300 million to $500 million of credit drift and credit losses lower than the $400 million to $800 million we estimated on the first quarter call. Using the global financial crisis as a guide we’re expecting additional credit drift and credit losses to emerge beyond 2020 due in part to impacts from the U.S. government’s recent large and unprecedented fiscal and monetary stimulus programs. We’re continuing to watch the situation closely, modeling several scenarios, and we’ll continue to evaluate the impacts and communicate estimates as more clarity emerges. Slides 5 and 6 provide details of the COVID related financial impacts we’ve experienced in the second quarter as well as updated thoughts on potential impacts the pandemic could have on our business and our results in the future. In the second quarter, many of our businesses experience direct COVID related impacts. Pretax operating earnings benefited by a net positive $51 million and included a $68 million net benefit in specialty benefits as very favorable dental and vision claims, as well as favorable short-term disability claims were partially offset by COVID claims and group life and premium assistance for our dental customers. A $4 million benefit from favorable mortality and RIS spread. These benefits were partially offset by a negative $15 million impact from unfavorable claims and surrenders in individual life and a negative $6 million in RIS – Fee from waive fees for COVID related participant withdrawals. The net positive benefit from COVID related impacts this quarter, shows one of the benefits of our diversified business model as well as the relative magnitude of our dental business. As we incorporated our experience from the second quarter into our modeling, we have reduced our estimated after tax impact to non-GAAP operating earnings from $20 million to $10 million for every 100,000 U.S.COVID related deaths. This reduction reflects a lower incidence of COVID related deaths in our insured populations. Note that this sensitivity only includes the direct U.S. mortality and morbidity impacts in U.S. Insurance Solutions, RIS spread and Principal International. It does not include the indirect impacts on claims experienced due to office closures or reduction in elective procedures for dental vision or disability and specialty benefits. We’re continuing to monitor several key indicators to gauge the potential magnitude of the financial impact from COVID and the related market volatilities. In the retirement business trends in both plan sponsor and participant behavior were pressured during the second quarter, but are manageable, while still positive growth in recurring deposits slowed during the quarter to 1.5% compared to the prior year quarter. Participants making deferrals were down modestly from pre-COVID levels due to layoffs and furloughs. And so far less than 1% of plan sponsors have reduced or suspended their company match. For those participants still contributing to their plan, the average deferral rate hasn’t changed from pre-COVID levels, signaling active participants haven’t reduced their contributions. Looking at withdrawals, COVID related participant withdrawals have increased, but they are partially offset by lower hardship withdrawals and loans as we expected. In total, participant withdrawals are only slightly elevated. Plan sponsors are continuing to delay the decision to transfer their retirement plans and many sales could be pushed into 2021. This has certainly impacted the level of sales in the second quarter, but was partially offset by strong retention. Specialty benefits had very strong persistency in the second quarter, as there was a heightened focus on protection products by employers, and we provided enhanced service and support to our customers. In group benefits, the number of lives covered under existing plans is a good indicator of employer behavior. In the second quarter covered lives decreased 1.4%, which is significantly better than the change in the unemployment rate. Breaking this down a little further, a majority of the impact in the second quarter was from businesses with 200 or more employees with less of an impact in businesses with fewer than 200 employees. Overall in specialty benefits, we’re expecting the pattern of pretax operating earnings to emerge differently this year. Earnings from dental and vision are expected to be pressured in the second half of the year relative to what we experienced in the first half due to dental premium credits and increased dental utilization. In Individual Life, while sales are down overall, we’ve seen an increased interest in term life insurance. Application volume is up due to increased awareness of mortality and our enhanced digital capabilities and digital distribution. We have a strong history of effectively managing our expenses in line with revenue during times of uncertainty and market volatility. During the second quarter, we continue to make progress, reducing our expenses to align with revenues. Compared to our expectations at the beginning of the year, we reduced expenses by approximately $75 million in the second quarter alone. This has spread across all businesses and contributing to resilient margins despite revenue pressures. Some of the expenses are naturally lower right now, like travel, sales related expenses and bonus accruals. And we’ve intentionally reduced other expenses, including hiring, salary cost, third-Party spend as well as marketing and advertising. These actions will continue to impact earnings and margins the rest of the year. For full year 2020, we’re expecting our actions will reduce expenses by $225 million to $275 million relative to our expectations at the beginning of the year. Not all of the expense reductions are permanent, and they will likely come back at different paces. Hiring and salaries will return at some point, and bonus and incentive accruals will naturally reset in 2021. Some expenses may return at a more gradual pace and at an overall lower level like travel. Our commitment is to align growth and expenses with revenue, but there is always some lag with the amount of volatility we are experiencing. Moving to our second quarter financial results, net income attributable to principal of $398 million. This includes net realized capital losses of $4 million with manageable credit losses of $21 million. Reported non-GAAP operating earnings were $403 million for the second quarter or $1.46 per diluted share. Excluding significant variances, but including foreign currency translation headwinds, non-GAAP operating earnings was down 8% and non-GAAP earnings per diluted share was down 6% compared to second quarter 2019. As shown on Slide 13, we had several significant variances during the second quarter. These had a net benefit to reported non-GAAP operating earnings of $36 million pretax $27 million after tax and $0.10 per diluted share. Pretax impacts included a net positive $51 million benefit from COVID related claims and other impacts in our RISs and USIS businesses as I mentioned earlier. A net positive $29 million benefits in principal international due to higher than expected encaje performance in Latin America, partially offset by lower than expected inflation, primarily in Brazil. An $18 million benefit from lower DAC amortization and RIS-Fee driven by the point-to-point increase in the equity market. And a positive $1 million impact in RIS-Fee as IRT integration costs were more than offset by a final reduction in the earn-out liability as we released the remainder of the liability in the second quarter. Revenue retention remains in line with our original expectations. These positive benefits were partially offset by a negative $44 million impact from lower than expected variable investment income in RIS and USIS. Slightly more than half of the impact was from lower than expected alternative investment returns with the remainder from lower than expected real estate sales and prepayment fees. Additionally, we had a negative $19 million impact in specialty benefits from unfavorable non-COVID related individual disability insurance claims experience driven by higher incidents. Looking back, second quarter 2019 reported non-GAAP operating earnings benefited from significant variances by $27 million pretax and $21 million after tax. Looking at macro economic factors in the second quarter, the S&P 500 index rebounded and increased nearly 20%, while the daily average was down nearly 5% compared to the first quarter of 2020, and only up slightly more than 1% from a year ago quarter. This is pressuring revenue growth in our fee based businesses relative to these two comparison quarters. Moving to foreign exchange rates, I’d like to remind you that revenue expenses and pretax operating earnings are translated using average foreign exchange rates while AUM is translated using the spot rate. Movements in the average rates continue to be unfavorable during the quarter. Impacts to the second quarter pretax operating earnings included a negative $7 million compared to first quarter 2020, a negative $18 million compared to second quarter 2019, and a negative $40 million on a trailing 12 month basis. While interest rates remained relatively unchanged during the quarter, second quarter revenue and earnings for the IRT Trust and Custody business in RIS-Fee impacted by the 145 basis point drop in the interest on excess reserves or IOER rate in March. We estimate the drop in the IOER rate in first quarter will have a negative $30 million pretax impact on full year 2020 revenue and earnings in our RIS-Fee. For the business units, second quarter results excluding significant variances were largely in line with expectations given the current macroeconomic environment and we’ve added additional details in the slides. The legacy business in RIS-Fee continues to perform well, given the current operating environment. Excluding significant variances, the margin for the legacy business was 33% in the second quarter. The migration of the IRT business to principal platforms remains on track and will start later this year. As the IRT business migrates, results will be combined into our existing businesses and we’ll begin to realize some of the synergies, but standalone details of the legacy business won’t be available. In closing COVID and the related market volatility are certainly impacting us, but we’re managing through these unprecedented times. We’re being prudent with both expense management and capital preservation in order to mitigate impact and be prepared as the impacts play out. Our diversified and integrated business model continues to serve us well. And our financial strength and discipline positions us well to navigate the crisis. This concludes our prepared remarks. Operator, please open the call for questions

[Operator Instructions] And the first question will come from Suneet Kamath with Citi. Please go ahead.

Thanks. Good morning. First question on RIS-Fee. Just looking at Slide 15, it looks like your net revenues increased about 19%, but the earnings, whether reported or sort of normalized, were down kind of 8% to 12%. So I’m just trying to understand what the disconnect is between revenue growth and earnings growth.

Yes. Thanks, Suneet, for the question. I’ll just ask Renee to respond to that. Renee?

Yes, absolutely. Suneet, thank you for that question. I think in order to understand the results that we’re seeing here, it’s important to look at both the legacy business as well as the IRT business. And first off, if you look at the legacy business, as Deanna indicated in her remarks, we are seeing the pretax return on net revenue remained very consistent in second quarter of 2020 over second quarter of 2019, about 33%. When we look at the IRT block of business, there’s a couple of things to keep in mind. First off, you will see that the integration expenses will be – will create some noise and some volatility from quarter to quarter. And so it’s important to adjust your model for that. Second, as also pointed out in the comments, we are seeing pressure from the IOER rates. And then last of all, I would remind you that as the IRT block of business transitions from Wells Fargo to Principal, there will be a lag between when we see the expenses begin to decline along with the decline in the business. So we will see necessarily some lag there. And when you take all those things into consideration, that creates the difference. Does that help?

It does. I mean it sounds like – just looking at the income statement, it sounds like the compensation and other line was the one that really increased year-over-year. Is that where most of that impact was?

Yes. So the comp and other line is going to reflect the TSA expenses. And that’s the portion that’s going to have the most noise as we begin to migrate the business over and incur integration expenses.

One of those classic examples of SME, where we’re getting the expenses front-end loaded as we nearly have to double up to get the business successfully transition, let alone all the resources going into programming and application development and the transitioning of the services. Did you have a follow-up, Suneet?

I did. Just sticking with RIS-Fee. On the comment about releasing the earnout liability. Is that because the macro environment changed? Or did that earnout assume like lapses would be lower than what has actually occurred?

Renee, please.

Yes. So Suneet, the earnout was based on a revenue retention target that was actually higher than what we had assumed in our valuation. So what the release of this liability suggests is that the revenue retention did not meet the earnout requirements, but I’m very happy to say that when we look at overall client retention and revenue retention, we are right on track, and we’re very pleased with the results that we’re seeing and it’s consistent with our modeling.

Another way of saying that, Suneet, is I believe that our initial analysis of what we thought the value of the business was we are correct because that additional lump sum payout would have been conditional on something that was above what our modeling would have produced. And so it’s nearly coming in on what we thought the value of the business was. And again, I would give a lot of credit to Renee and her team for successfully working through a very, very large transaction. So thanks for the question, Suneet.

Yes. Thanks, Dan.

The next question will come from Ryan Krueger with KBW. Please go ahead.

Hi. Good morning, everyone.

Hi, Ryan.

Can you help us think a bit more about your dental expectations for the second half of the year? And I guess more specifically, I know you’re not expecting it to be nearly as good as the first half, but I guess, would you expect dental to still be favorable to your normal expectations in the back half of the year? Or would you actually expect it to be somewhat unfavorable because of some of the rebates type of activity?

Yes, Ryan, great question. I’m only laughing because I hadn’t been to the dental office for six months. I went two weeks ago for the first time and I have to go back tomorrow. So one way or another, they’re going to extract their value from Dan at least. So Amy, you want to help us work through the profile of the dental business.

Yes, Ryan. Let me go back to your actual question and gets you kind of a little bit – take you back a little bit what happened, what we saw happen in second quarter. April was very low utilization. Around the nation, the provider offices, many of them were closed and only providing emergency services. We saw that kick back up in May. And then in June, in some geographic areas, some regions, we even saw what I would consider some pent-up demand; more procedures, some higher dollar procedures and even higher kind of utilization than we would see on a normal full month in some regions of the country for June. And so the wildcard here really is with sort of an unknown amount of virus activity, an unknown, I would call it, patient comfort with how and when they seek care, particularly in those areas that are seeing a little bit more activity. I think our assumption is the dental offices will stay open in the second half of the year. Our assumption also is that there will continue to be a little bit of pent-up demand probably play through the rest of the year. And if we’re going to see a quarter where we see some of that pent-up demand, we’ll probably see that during third quarter. So third quarter is probably the one that I would point back to being probably closer to what our seasonal lower points are in a normal year. Does that help, Ryan?

It does. Thank you. And then…

Hey, Ryan, one thing I’d add to that is our premium credits actually have a full impact in the third quarter and only had one month of impact in second quarter and one month of impact in fourth quarter. So that’s going to play into the third quarter result as well.

Can you quantify how the magnitude of the premium credits and the in-network refunds?

Well, I think on the premium credits, it isn’t a 10% reduction, and we do give you a premium on the supplement page. I’ll let Amy talk about the in-network credit.

Yes. And so by magnitude basis, the premium credits are, by far, the larger thing that you’ll see flowing through, and that will go through our premium line. And again, as Deanna noted, that will be a full impact in all three months of third quarter. We saw one month of that influencing the results in second quarter, and we’ll see one month of that in fourth quarter. And again, I’ll let you do the math against the premium numbers that we put out there. The protective equipment that credit we’re giving in terms of PPE for the dentist, that is in order of magnitude, much smaller than the premium credit in terms of how it will impact. But I do want to point out that will be full year. So that will be third quarter as well as fourth quarter, and that will impact the claims line as opposed to the premium line. So much, much smaller impact, but that will be coming through a different line.

Ryan, the one thing I’d say is I think like all medical offices, they’re figuring this out, and so we would anticipate over a period of time here that this gets sort of back to normal. They’ve got the proper PPE, people are taking appropriate precautions. And so this is probably a two or three quarter anomaly. And then we’re right back to what I’d consider our traditional run rates for procedures for the dental offices. So thanks for the questions.

Thank you.

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

Good morning and thank you for taking my questions. Just to follow up on the dental piece. So in the supplement, I think the dental and vision premiums was $240 million in the second quarter. Can you give us the breakdown between dental and vision for your block of business so that we can think about the 10% premium credit?

Yes. This is Amy. Happy to jump in and answer that. The breakdown on that is really probably think of dental as the vast majority of that. So think of it as 90% to 95% of that. Vision is going to be significantly less.

Okay. That’s helpful. And then shifting gear, in terms of PGI, can you talk about your net flow expectation and the impact of the lower transaction fees? I think Tim said in last quarter that the expectation is third quarter will remain challenged. And then hopefully, fourth quarter will be back to normal. Is that still the expectation?

Tim, do you want to please take that?

Sure. When it comes to transaction fees, there, we’re mostly talking about commercial real estate. And so I think what you’ve seen so far this year is first two months were strong. Then as COVID started to hit, transaction started to wane, and they’ve continued to be below expectations for the – our original expectations for the first half of the year. So just to give you some perspective, transaction volume is down about 33% from 2019. What we have started to see is that the markets are starting to evolve a little bit. People are finding ways of getting out and seeing properties. We’re certainly seeing that on the commercial mortgage loan portfolio. And then we’re starting to see more transactions. Now the transactions done right now have typically been worked on prior to COVID. And we’re still seeing a lot of price discovery going on between investors and sellers. So we’d hope that, that starts to pick up as people are able to travel, maybe a little bit more, maybe able to physically inspect some of those properties or find ways to do that virtually. But right now, I think we expect that third quarter will be lighter. And then as we said, hopefully, in fourth quarter, things will get back to a more normal pace.

Do you have a follow-up, Humphrey?

Yes. Is there any way to think about the impact, so you called out, it was $5 million lower relative to last year’s second quarter. But should we kind of expect something in that magnitude for the third quarter and then maybe a little bit better in the fourth quarter?

Yes. So on sort of a normal run rate basis, I would think that we would see a little bit lighter in third quarter. So we’re probably coming in $2 million to $3 million lighter in the third quarter and then hopefully back to normal in fourth.

Got it. Thanks.

Thanks, Humphrey.

The next question will come from Andrew Kligerman with Credit Suisse. Please go ahead.

Hey. Good morning. With regard to your capital deployment, you indicated $800 million to $1 billion for the year. Just assuming the normal run rate of dividends that would leave you, if you were to do $1 billion close to $200 million to deploy, what type of opportunities might be out there other than buybacks for use of that capital? And what do you think the probability of using the capital for buybacks might be? And when might we do so this year?

Just tell me how the COVID is going to go from here, and I can respond to that question. This is a really important question, Andrew, and one that we talk about a lot. It’s one of the reasons why we had the issuance of $500 million that Deanna mentioned at such favorable terms. It’s why we have been so aggressive in managing our expenses. We’ve maintained the dividend payout in spite of the fact it’s above the 40% targeted range to support shareholder support and provide continuity. We do, as Deanna said in her comments, have over $800 million of authorized share buyback still out there. We have frequent conversations with the Board. And we’ll look for the right way to go about deploying that remaining excess portion of the capital, whether it’s organic, whether it’s if a property were to become extremely distressed in the marketplace, M&A may be an option, but still, we look at share buyback as a good tool to provide good value for long-term shareholders. Deanna, I don’t know if you have anything else you’d like to say on that?

Yes. Just a few comments. Obviously, the math you did was correct. At the low end, we basically have no additional external deployments, assuming that we kept the dividend flat at the high end or closer to $200 million. I’d say for the next quarter, we’re going to continue to stay on the sidelines, and we’ll ultimately probably start having more discussions on this as we get towards the back half of the – or the back quarter – last quarter of this year, into 2021. Really what we want to see is more clarity. And even though we have some additional clarity given one quarter of experience behind us, I’d say relative to the path forward, especially around the pandemic, I’m not sure we have any more clarity sitting here today than we did a quarter ago. And so again, like we said, the debt issuance is a help, but we obviously just didn’t do the debt issuance to turn around and buy back shares. It’s there to really help us in case things start to deteriorate more than we are. And we really have to see much more clarity until we start to deploy unless an opportunistic M&A came to us that we really wanted to look at. As we’ve talked about M&A, obviously, the pace of activity is lower. But there could be a small number that had started discussions prior to this crisis that if those came to fruition, that could be another opportunity as we go into fourth quarter into 2021.

Andrew, a follow-up?

Yes, sure. And that makes a lot of sense. So with regard to life insurance, your sensitivity went from, as you said earlier, $20 million per 100,000 lives down to $10 million. What was it about your or what is it about your insured population that differs from what you were thinking three, four months ago, allowing you to change up the sensitivity, geography-wise, age-wise or what have you?

Yes. I’ll take the first stab at is since it does impact a number of our different businesses beyond just USIS and then I’ll see if Amy has anything to add to that. Obviously, when we were sitting here a quarter ago, we had to take a guess with absolutely no experience about how the total population incidence of COVID death would translate into our insured population. And again, we did the best guess based on our analysis as far as – and third-party analysis that had been developed. But again, we had no real experience to look at. Obviously, now three months later, it’s not totally credible experience that we’ve seen. But we do have a lot of claims, about 150 on the insurance side that have come through during the quarter. That we’re better able to just look at the nature of those claims, whether it be age, whether it be face amounts, whether it be size of the annuity products, and we’re just better able to update how that translation happens between the general population experience and the experience of our insured population. And so that did cause us to cut in half our sensitivity. I think the good news of that is probably the estimated number of deaths has probably more than doubled. Our impact of that is less – is cut in half. And so ultimately, feel good about the – how we are able to manage that going forward. I do want to make sure you’re aware that, that does consider all life and disability claims in USIS. It’s also offset by benefits that we see in our annuity businesses, both here in the U.S. and outside of the U.S., but it doesn’t contemplate any indirect claim impacts due to office closures or lower elective procedures on our Specialty Benefit business. So I’ll see if Amy has anything to add, but I also think that rule of thumb held pretty close as we looked at our second quarter experience.

No, Deanna, you’ve covered it really well. I think that you’ve covered that it’s an aggregate number that kind of crosses multiple businesses. And I think the good news there is we’re seeing good protective value. We do certainly – our group life block is a working-age population, faired relatively low, again, given the markets we’re in fairly low face amounts and so you have to have quite a few claims for those to add up significantly. Our Individual Life is holding up well in terms of the protective value of the underwriting we do and the types of business we put on the books. Keep in mind, we have probably a disproportionate amount of working-age populations even in our Individual Life insurance coverage because of our business market focus.

Thanks, Amy. Thanks, Deanna. Thanks, Andrew, for the question. Next?

The next question will come from John Barnidge with Piper Sandler. Please go ahead.

Thank you. I want to go back to dental for a second. Obviously, the first half of the year had low claim activity because people aren’t going or couldn’t go. There could be a catch-up in the third quarter. But I’m more thinking about renewal and pricing as you prepare for open enrollment season to 2021 because obviously, there’s a cohort of people that aren’t going to the dentist at all this year, that probably have pent-up issues that are probably more serious than what Dan has to go back into for a couple of good points. How do you square the lack of activity in 2020 with pricing and renewal and potential pent-up demand for 2021?

Amy, please?

Yes. John, these are good questions you’re asking. And so one of the things we’ve been doing is sort of refreshing our claims studies with respect to dental and looking at them a little bit more closely than we more frequently than we have in the past. So what we know is that keep in mind with this footprint that is primarily for our group benefits business, a lot of smaller cases. Some of that big push towards annual enrollment is not as marked as you’d see in some of the larger case business. So you spread it out amongst 80,000 or 90,000 of those smaller cases. And so what we’re watching and what we are seeing is a little bit more usage on what we would consider kind of higher dollar procedures. If that continues, then we’ll watch and continue to price for what we think could happen in 2021. Now keep in mind, there’s some natural plan provisions that kind of dictate a little bit how many dental coverages you can seek in a given year or procedures you can have in a given year. So you’re going to have some – one preventative care visit in six, two and 12. And those are going to provide some natural protections. But more importantly, there are restarts for the next year as we kind of restart our pricing.

Excellent, thank you. Do you have follow-up, John?

Yes, sure. How do have changes in the health and rate environment kind of change how you’re approaching the upcoming actuarial assumption.

Yes. Deanna, you want to walk us through that.

Yes. So obviously, in a volatile environment like this, we have to think of this over the long term, which rather than adjusting to short-term volatility. And again, we’re trying to predict what 10-year treasuries and spreads are going to be 10 years from now. And obviously, you can’t overreact to kind of pressure that we have. But having said that, obviously, the pressure that we’re in the sustained low interest rate environment is something that we have to contemplate. As we go through our third quarter process, and also, we have to look not just at interest rates, but all of the other policyholder and actuarial behavior assumptions that we have in that, we have not made any decisions at this time. We continue to evaluate it based on our own analysis, also take into account other people’s thoughts on that trajectory as well. But I would tell you, as we sit here and manage capital and think about capital scenarios, we are incorporating impacts if we do make a reduction to that interest rate assumption and how that would flow through our capital position. So again, no decisions have been made, but I think we’re being prudent as we analyze the different capital scenarios to make sure that we feel good about our capital position.

Thanks John for the questions. Excellent.

Thank you.

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

Hi, thank you. I have a couple of questions around the expense savings. First, do you have a new full year target for the corporate loss? And then at the business level, is the goal, I guess, to still be able to achieve the target margins you provided at the beginning of the year despite the revenue pressures?

Yes. So – and I’m going to throw this to Deanna quick. I just want to go on the record with regards to our approach to expenses. And you can go back for as long as I can ever remember, and I’ve been here a long time, we have always looked at the revenue that we’re able to generate and then adjust our expenses accordingly. And there are certain points in a volatile economy where there’s these inflection points where you have to go above and beyond. And you are trying to anticipate. Deanna outlined very carefully for you in her prepared comments, those areas that will likely bounce back and those that will continue to manage in accordance to the business. But one of our objectives has been to stay as closely aligned with the margin expectations that we have framed with you, framed for you previously and not making any adjustments to those. But it’s one of those approaches that we’ve always taken that I would describe as surgical as opposed to across the board, and we have not had any broad-based significant reductions in force which is why we are still able to maintain very strong customer service scores, get the work done, while at the same time, adjust these expenses accordingly. Deanna, do you want to provide some additional insight there?

Yes, I’ll first take your quick question on our corporate results. And what I would say there is there’s always volatility in that line of business. But as I think about the second half of the year, we’re going to continue to benefit from the expense management efforts that we have underway and how that flows through the corporate results. Offsetting that partially, that we’ll see some added debt expense due to our recent issue in debt. What I would say is, if you average the first quarter and the second quarter, I think that’s a good proxy for the second half of the year relative to corporate. Moving on to expenses. I think Dan made some great comments. And obviously, I frame that within the prepared remarks. But let me just try to give you a little bit more color. And I think your comment on margins probably more aligns to how we think about 2021. I think in 2020, obviously, the efforts that we made were really across all of the businesses, pretty indiscriminate of what revenue pressures they’re seeing. And so we didn’t tell Amy because she’s having good dental claims experience that she could spend a lot of money. And on the flip side, we didn’t tell Luis that’s being pressured by FX, we had to take additional cuts. And so when I looked at the $75 million that we talked about for the second quarter alone or the $250 million that we’re talking about for the full year, and I think about each of the businesses, the percent change is pretty similar for all of the businesses. And so again, your models may show one business or another. But when I look at it, I’d say the percent reduction is in a pretty narrow range across all of those businesses. As we think about 2021, I think that’s when the more comments around margins come into play because again, this was tightening our belt given the environment that we’re in and basically looking at all of our expense items, some that naturally came down such as travel, but also being very, very disciplined on hiring and staffing costs and some of that’s going to start to normalize as we go into 2021. For example, our incentive compensation is all reset at the beginning of the year. And so even though that’s helping our expense base this year, those will again kind of come back to a normal level. And then other items, I’d say, will still be lower than what we would have anticipated pre-COVID, but we will see some gradual increase as we move forward. Travel could be an example of that, staffing, salary cost could be an example of that as well. And so I think that’s when you start to see us making sure that our expense levels are leading to our targeted margins by business as we move into 2021. Hopefully, that helps.

Yes, that’s very helpful. Thank you. And then if I could ask one follow-up just on RIS-Fee. I think your guidance implies expecting organic growth at the low end of the 1% to 3% target range. And I assume that’s just for 2020, and that kind of implies breakeven flows for the remainder of the year. So I was just hoping you could talk a bit more about the dynamics there and how you see both sales activity and recurring deposits trending over the next few quarters?

If you’ve captured that well, Renee, do you have quick comments, please.

Yes. Absolutely. So Erik, when we think about net cash flow for 2020, you’re correct that we do believe that we will come in at the low end of the 1% to 3% of beginning of the year average account values. And it’s being driven by several things. First off, when you look at the sales environment that we’re currently in – due to the pandemic, we do see that our sales are pressured. We’re seeing some recovery in the pipeline in June, which is really good news. And we are also seeing a portion of the decrease in sales being offset by an improved level of contract termination. So there’s kind of two sides of the same coin there. From a recurring deposit perspective, I think the thing to note there is that we do have a level of resilience in our block of business because of the nature of industries that our customers are engaged with. And we show that to you in the slides that we’ve provided. We are seeing pressures, but they are manageable. So if you look at recurring deposits, we see about a 1.5% increase in recurring deposits over second quarter 2019. And if you drill down a little bit deeper, what you’ll see is we are seeing a decline in the number of deferring participants. We saw the trough of that decline in May. In June, we saw a little bit of an uptick in the number of participants that we’re making deferrals. The deferral rate throughout this whole time period has remained steady from 2019. So that’s good news. And we also have seen about only 1% of employers have either reduced or eliminated their match. So they’re applying a great deal of discipline in how they’re approaching, their retirement plans and understanding the value that, that brings to their workforce. Turning very quickly to participant withdrawals. In the last earnings call, I framed for you that to put a little bit perspective here, in the 2008, 2009 crisis, we saw participant withdrawals reach about 11%. And while certainly, participant withdrawals have been pressured, we’re not reaching that same level in the second quarter. With that said, though, we did see about 2% of participants take COVID-related withdrawals. But I would remind you that those are going to be low balance, typically low balances. And so if you express that, as of the withdrawals that we see as a percent of beginning of year account values, it’s about 0.3%. So all of those things taken into consideration does lead us to the guidance of 1% to 3% with 1% being – we think we’re going to come in at the lower end of that range. And all of this is contingent upon market performance and what happens with the economy in a pandemic.

Erik, hopefully, that additional detail was helpful. Thank you.

Yes, thank you.

The final question is from Tom Gallagher with Evercore. Please go ahead.

Hi, just a follow-up question on RIS-Fee related to also retention. So your – if I look at the planned breakout by number of lives to 1000 and larger lives plans declined by 16 sequentially, that’s the biggest drop I can remember in quite some time. Is that normal Wells-related attrition that you’ve been expecting? Or would you call out anything else in particular that’s happened in the large end of the – of your – of the market?

Do you want to identify that, Renee?

Absolutely. So Tom, thank you for that question. And I’d remind you that when you’re looking at the number of plans in the supplement, that’s going to exclude the IRT block of business. So – and if you look at the number of plans in total, you’ll see that our plan count is down slightly from second quarter 2019. And the primary driver of that is that sales are down. And so when you – we simply don’t have that sales engine putting new plans on the book at the same pace that it was. When we look at the large plan market in particular, we’re actually very pleased with the performance of our large plan block of business. We’re seeing really good pipeline. We saw really strong sales and you saw that come through in 2019 and the first quarter of this year, and retention remains strong across the block. So it’s really reflecting sales.

But I guess just a follow-up on that. I presume those plans are not going away. Would you have lost 16 plans quarter like versus the end of the first quarter? And is competition somehow intensifying, I would have expected movement among carriers to actually be down. So I was a little surprised to see that many plans.

Yes. In that large piece of market, a lot of that is we’re on the losing end of some merger and acquisition where there was an even larger company bought it. We don’t have that broken out with a lot more detail. But each one of those plans are priced individually. They’re not priced in aggregate. So if there is a lapse and we lost it, there are some instances where we perhaps would have wanted to retain it because of profitability expectations. But more times than not, it would have been a plan that was acquired by a much larger plan and the plan services went to the acquirers’ record keepers as opposed to Principal. I do think in this environment, there has been – it is increasingly challenging to have those sorts of discussions when you’re on the – being on the bought end of that. Renee anything else you want to add?

No, I think that’s very well said. We did see maybe a little bit of volatility in the larger plan market, but our model is working really well, and we see nothing that gives us concern moving forward.

Tom, do you have a quick follow?

I do. Yes, Dan. Just a quick one on individual disability benefit ratio being elevated. And I think you called out a $19 million unfavorable earnings issue. What’s your level of conviction that this won’t recur? And I don’t – and I asked that because in prior economic cycles, when we’ve seen unemployment go up a lot, you have seen some elevated disability claims. So do you believe this is really a nonrecurring issue? Or are you still kind of waiting to see how this plays out?

We think we’ll be nonrecurring. But Amy, you want to provide some additional sights?

Sure. Tom, thanks for the question. So a couple of thoughts go into this. I think, number one, in 2019, we were really seeing some good – really good claims performance for our individual disability block. And so just given the natural claims volatility of the segment, seeing a little bit of a blip in a quarter is not totally unexpected, especially on kind of an incidence basis. So the other thing I would tell you is that typically, if we were seeing something that was going to be a disability, macroeconomic conditions starting to affect disability, we would have seen it emerging in group disability as well. So to see it kind of emerge a little bit differently in individual disability, has given us a little bit of comfort that we’re probably seeing something that’s closer to a volatility issue and not necessarily a precursor to what we might see in the future. Now even having said all that, we’ve talked a lot today on the call about uncertainty, we will continue to watch this block. If we see incidents emerge in areas or patterns that indicate to us, it’s a macro, kind of a leading macro, we’ll certainly let you know that.

Tom, thanks for the questions. Appreciate it.

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

So we’re slightly over the hour here, but – so I’ll be quick. And the first thing I want to say is we feel as much conviction today as ever about the diversified and integrated business model, the fee, the spread and the risk businesses. We like what portfolio we have, and we’ll continue to build upon it. Although Luis didn’t get any questions asked today, these international markets, they are volatile, but they will enjoy long-term growth. It’s where the middle class is coming. And so again, we feel very good about the international. I think you saw firsthand how resilient, small-to-medium size employers are. Hopefully, you had a chance to dig in through some of the detail in the slide deck because, again, it is a good proof point that they are very adapting to the marketplace. Expense management philosophy is to be smart, thoughtful aligning expenses and revenues. We continue to make that a priority. The IRT integration is on track, and we feel good about its ability to provide long-term value. I feel bad for Tim, he didn’t get asked questions about the great investment performance for PGI two back-to-back quarters of plus $7 billion in sales in our mutual fund franchise, which is in this day and age in active strategies, that speaks volumes about the durability. And I’d also be remiss if I didn’t call out the 33-year anniversary for Spectrum Asset Management. And they’ve done a great job in that preferred space, adding a lot of value and Mark Lieb and his team have just done a superb job leading that franchise. So I wish I could say we’d come out and see you in person, but I’m afraid it’s going to be on video conference, but we very much look forward to any follow-ups that are on the call today. Have a great day. Thank you.

Thank you for participating in today’s conference call. This call will be available for replay beginning at approximately 01:00 PM Eastern Time until end of day August 4, 2020, 2169068 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. Thank you for participating, you may all disconnect.