A Transformative Time for Principal
In 10 years, D.M. insurer has become a major asset manager with global presence.
When Principal Financial Group became a publicly traded company 10 years ago today, few could have foreseen how bumpy the decade would be, or how far the company would travel—literally around the world—in that time.
The next 10 years could be filled with other risks and opportunities: Retiring baby boomers, higher health care costs and growing wealth in the Middle East and elsewhere.
The Des Moines insurer was the first major U.S. company to do an initial public offering after the terrorist attacks of Sept. 11, 2001. Its IPO price of $18.50 a share shot up $2.50 on the first day of trading, and would more than triple in value to nearly $70 in late 2007 before plunging to near $6 in early 2009. It later rebounded to more than $30 before sliding into its current trading range of $22 to $26 a share after the market crash in August.
The wide swings were more a reflection of market conditions than changes in strategy or execution by Principal, analysts said.
In fact, with a couple of exceptions—selling its residential mortgage business in 2005 and exiting health care insurance last year—Principal’s overall strategy remained remarkably consistent throughout the decade.
But make no mistake: Principal is a much different company than it was 10 years ago.
Its global footprint today includes operations in Latin America, China and India, while it barely had a toehold on world markets in 2001.
Plus, while Principal still sells insurance and is regulated as an insurance company, its chief job today is accumulating and managing assets, mostly for corporate and individual retirement plans in the United States and increasingly overseas. In the past 10 years, assets under management have nearly tripled to $336 billion.
“We now use the term ‘investment management leader,’ ” said Chief Executive Larry Zimpleman. “We were recognized in 2010 by (the market research firm) Harris as the best investment brand, ahead of Fidelity, Vanguard and T. Rowe Price.
“For us to be the best investment brand says a lot about what we’ve done over the last 10 years,” Zimpleman said. “That’s going to be the flag we carry going forward.”
Need for capital, fairness prompted public offering
Ten years later, it’s easier to see why executives decided in 2001 to change Principal Financial Group’s corporate structure from a mutual company that was essentially owned by policyholders to a business whose stock is publicly traded on the New York Stock Exchange.
At the time, there was debate about whether the conversion was a good idea. Some questioned whether pressure from shareholders would cause executives to focus on short-term gains at the expense of long-term growth and stability. There was also the issue of how to divide the $6 billion windfall that would result from converting 700,000 policyholders to stockholders.
Looking back now, the change seems almost inevitable, said Tom Root, who teaches insurance at Drake University.
In large part, he said, it was prompted by the Financial Modernization Act of 1999, which pulled down long-standing walls between banks and insurance companies, allowing each industry onto the other’s previously exclusive playground.
The 1999 law “spawned a huge wave” of mutual insurance firms becoming publicly traded companies, Root said, including Principal, MetLife and Prudential.
“In 1991, eight of the 12 largest U.S. insurance companies were mutuals, but by 2004 there were only three,” said Ty Leverty, who teaches insurance at the University of Iowa.
“It had to do with economic pressures and capital requirements,” Leverty said.
The big insurers were selling annuities, a form of investment contract that guarantees specific payments over a period of time, which can be a set number of years or the life of the buyer.
But as annuities gained in popularity, insurance companies ran into a production problem. Regulators would allow them to sell the contracts only if they had certain levels of capital to cover the possibility of unforeseen losses.
The problem was that many insurers raised capital by selling bonds. At times, it was difficult to attract the huge sums of capital the insurers needed as quickly as they needed it and at affordable prices by selling bonds.
Another solution was to sell equity. Mutual insurance companies could not do that without changing their corporate structure, but once they did, their new publicly traded stock companies could go to the equity markets anytime they needed more capital to fuel growth.
Plus, selling stock was a more attractive strategy for this type of growth because there was no debt repayment.
Principal was already a leader in collecting and investing retirement money for U.S. workers and companies, and analysts believed it could grow even faster by selling equity, in addition to debt.
Principal CEO Zimpleman admits the conversion made it easier to tap capital markets, but he said that was not the driving reason for switching to a public company.
It was, he said, a matter of fairness. Top executives believed Principal had outgrown the mutual structure.
As a mutual company, “the ownership was in the hands of … 700,000 individuals who owned Principal Financial Group insurance policies. But the faster growth was happening in areas outside the individual life (insurance) part of the company,” and customers in those areas did not participate in ownership the same way insurance policyholders did.
“It was no longer appropriate for those policyholders to have the benefit of the growth that was going on across the company, which they didn’t do anything to create or support,” he said.
After IPO, fewer workers produce larger profits
Numbers reflect the impressive growth at Principal during the past decade. Its customer base is 23 percent larger today, assets have grown 68 percent, profits are roughly double what they were in 2001 and assets under management have nearly tripled.
One number that’s lower is employees. Current employment is 13,445, which is roughly 3,700 fewer workers than the company had in 2001.
The University of Iowa’s Leverty has done research that shows “one of the biggest advantages of moving to a stock organizational form is increased efficiency.” That’s partly because there is more external monitoring of stock companies, he said.
Stock companies “always have these analysts who are on your back telling you that you don’t need that many employees, which creates a lot of external pressure for the company to get leaner. So businesses re-evaluate and say: ‘Maybe we don’t need three people to do that job. Maybe we can do it with two,’ ” Leverty said.
Also, he said, “the way managers are compensated depends upon the stock price,” which creates performance pressures that do not exist in a mutual company.
Leverty said his research showed that “when you put a mutual company into a stock form, 99 percent of the time the company will become more efficient.”
Zimpleman cites two additional reasons for increased efficiency.
“We have the most strategically aligned set of businesses that we have ever had,” he said. Plus, “we invest about $250 million a year in technology.”
The business alignment is important because Principal today is not a collection of unrelated financial services businesses, which was true at times in the past.
In fact, Principal jettisoned its residential mortgage business, which had 800 employees, in 2005 and its health insurance business, which had 1,500 employees, last year. Neither fit well with the company’s strategy of being a leading provider of asset management, retirement and insurance services to individuals and small- to medium-sized companies in the United States and in other parts of the world where Principal can gain a competitive advantage.
Global strategy was to find new niches
Zimpleman is an actuary who spent much of his early career studying demographics to help identify profitable niches for Principal’s insurance and retirement/investment products.
“I didn’t have a passport until I was 45,” Zimpleman said.
He got it when he was asked in the late 1990s by then-CEO David Drury and then-President Barry Griswell to explore options for growth, including the possibility of expanding overseas.
“It’s smart for Principal to go into countries that don’t have the same demographic trends as the United States,” Leverty said.
Said Zimpleman: “We quickly discovered that Europe was not really an opportunity for us because it’s a slower-growth, mature market with a lot of competitors,” not unlike the U.S.
“We saw that in Latin America and Asia there was opportunity,” because there was “a growing middle-income class and they were typically a little younger.
“There was less competition, and there was going to be this emerging middle class that was going to allow us to grow these businesses,” Zimpleman said.
“We were a little bit early in some of these markets,” he said, because they’d discuss defined contribution pension plans—similar to 401(k)s and individual retirement accounts—“and people would say: ‘We don’t know what that is.’ ”
The company’s early efforts were largely a trial-and-error process. But before long, it began making inroads working with existing businesses and explaining to governments the options they could use to help secure the financial future of workers in their countries.
“China now has defined contribution plans. Hong Kong has had a mandatory system since 2000. Latin America has mandatory systems,” starting with Chile in 1981 and Mexico in 1999, Zimpleman said.
Boomer withdrawals are the next big risk
One of the biggest challenges Principal faces is “withdrawal risk,” Raymond James analyst Steven Schwartz wrote recently.
“While Principal has benefited greatly from the aging of the baby boom generation and its need to save for retirement, the company—more than any other, we believe—is at risk of losing baby boomers’ assets upon eventual retirement,” he wrote.
Schwartz added that Principal has taken “appropriate steps by building non-pension investment capabilities to provide rollover opportunities for current clients.” But it is too early to know how successful they will be, he said.
Zimpleman said he’s confident Principal can win the battle to capture post-retirement investments.
Not only does Principal have annuities and mutual funds for retiring workers to roll their 401(k) and other pension funds into, but it also has its own bank, which most other insurers do not have.
Principal Bank was created in 1998 as one of the nation’s first online-only banks. Its original focus was student loans, but it soon became a midsized player in the residential mortgage market, before Principal decided to leave that business in 2005.
It would be easy to argue that the bank, which posted a loss of $14.3 million in 2010, is now an anachronism, and that like Principal’s mortgage and health insurance units, it does not fit the company’s strategic alignment.
But Zimpleman said the bank, which earned a profit of $10.4 million during the first half of this year, will play a key role in fending off “withdrawal risk.”
When people move from job to job or from job to retirement, they need someplace to store their retirement accounts while they decide on the proper mix of investments going forward, he said. The bank is an excellent solution and keeps the assets in the Principal family, Zimpleman said.
Two new segments could hold the future
Ten years ago, Principal’s international operations amounted to 1 percent of the company’s earnings. Today, it’s 16 percent, and in 10 more years, Zimpleman expects the international segment to account for 25 percent of overall profits.
A fair question is what the next engine of growth will be for Principal. What business segment that isn’t even on most people’s radars now will be making money for the company down the road?
Zimpleman offers two examples.
“The wellness business has a tremendous amount of potential in the U.S.,” he said. “If we are ever going to get a handle on health care costs, it is going to be based on engaging employees where they work in wellness programs that result in each of us taking more responsibility for our own behavior.”
Principal, he explained, has a long-standing network of counselors who advise workers and businesses about retirement planning. It is now adding wellness experts who can deal directly with workers at midsized businesses and provide online and other remote advice to smaller operations.
Another example is Islamic asset management, which is in its infancy but has huge potential, given the huge wealth in Islamic Middle Eastern and Asian countries.
Islamic asset management is based on the Koran and has profit-sharing principles that are different from Western investment principles. Investors avoid certain segments, such as tobacco, alcohol and gambling.
Principal recently established a joint venture with CIMB of Malaysia, a recognized leader in Islamic banking.
The goal, Zimpleman said, “is to do something today that is going to be very meaningful to somebody who is sitting here 15, 20 or 25 years from now, because it was the decisions made 10, 15 and 20 years ago that got us into the markets that are driving this company today.”