Principal Financial Group Inc Q3 FY2020 Earnings Call

Good morning, and welcome to the Principal Financial Group’s Third Quarter 2020 Financial Results Conference Call. There will be a question-and-answer period after the speakers have completed their prepared remarks. I would now like to turn the call over to John Egan, Vice President of Investor Relations.

Thanks, John, and welcome to everyone on the call. I hope you and your family are staying healthy and well. This morning I'll provide an update on how Principal continues to respond to COVID-19 and its impact on our business. I'll discuss key performance highlights for the third quarter, our continued strong financial position and how we are well-positioned for long-term growth with the right strategies in place. Deanna will follow with our third quarter financial results, including the financial impacts from our annual actuarial assumption review and COVID, details of our capital and liquidity position, and an update on our investment portfolio. Safety of our employees and customers remains a top priority. While most of our employees continue to effectively work remotely, we're gradually welcoming some back into our offices around the world. We're extremely pleased on how effective and flexible our employees have been in this remote work environment while maintaining excellent customer service. Our investments in technology and digital solutions over the last several years continue to pay off and allow for a seamless transition. COVID has had an impact on the retirement and group benefits landscape, with both employers and employees recognizing the need for benefits that protect the health and well-being of individuals and their families. This has magnified the role employer benefits play in attracting and retaining top talent, especially within small to medium-sized business communities. Last quarter, I mentioned that the impact COVID is having on our customers was less about the size of the business and more about the industry they operate in. This continues to be true. We remain well-diversified by geography and industry, and we're less exposed to industries most impacted. The pandemic has certainly created some unique opportunities and challenges for Principal. Our integrated and diversified business model remains resilient. I'm confident that we're in the right businesses with the right teams in place, and we will continue to make investments to create long-term shareholder value. Moving to the third quarter highlights, we’ve reported non-GAAP operating earnings of $235 million. Excluding the impacts of the actuarial assumption review and other significant variances, non-GAAP operating earnings of $417 million increased a strong 10% compared to a year-ago quarter. The increase was driven by higher revenue from increased assets under management (AUM) and disciplined expense management, partially offset by foreign currency headwinds. At the end of the third quarter, we remained well-capitalized with $3.4 billion in available cash and liquid assets and $2.6 billion of excess and available capital. We’re positioned to execute on the right opportunities that will enable Principal to grow and create long-term shareholder value. Compared to the second quarter, total company AUM increased nearly $30 billion or 4% to $731 billion at the end of the third quarter. This increase was driven by both positive net cash flow and favorable market performance. We closed the quarter with a record PGI managed AUM of $468 billion and record PGI sourced AUM of $226 billion. This continues to highlight the strength of our investment performance and our in-demand products and solutions. AUM on our China joint venture, which is not included in our reported AUM, declined 16% during the quarter to $120 billion. This decline was primarily due to the industry trends in China to move investments out of money market funds in light of the low-interest rate environment. Through the first nine months of the year, total company net cash flow was a positive $11 billion, including $2 billion in the third quarter. On a trailing 12-month basis, net cash flow of $18 billion increased from $7 billion in the year-ago period. Principal International generated $1.8 billion of net cash flow and marked its 48th consecutive positive quarter, driven by positive flows in Brazil, Southeast Asia, Chile, and Hong Kong. This is an extraordinary feat given the significant macro headwinds in emerging markets. Our investment performance remains strong. At quarter's end 73% of Principal Funds and ETFs, separate accounts and collective investment trusts were above median for the one year, 77% above median for three years, 76% were above median for five years, and 91% above median for 10 years. Additionally, for Morningstar rated funds, 74% of the funds level AUM had a four or five star rating. This continued strong performance positions us well to attract and retain assets going forward. Combined with positive net cash flow, this is a testament to the great work our teams have been doing to create in-demand products and leverage our digital investments. I'll now share some additional execution and business highlights starting with the integration of the IRT business. Despite working remotely, our teams have successfully started to migrate the core IRT retirement business to our platform. The migration of the retirement plans will continue through the summer of 2021. Importantly, the strategic and cultural fit are confirmed and showing benefits already. The revenue and expense synergies are also confirmed, though delayed, with the expense synergies expected to be 50% higher than originally modeled. These benefits will help mitigate the impact from the reduction in the interest on excess reserve or IOER rate on deposit revenue. These financial benefits will start to emerge after the Transition Services Agreement unwinds in the summer of 2021. Our increased scale and access to the consultant in large market channels have doubled the volumes of created pipeline in the large plan segment. This pipeline is coming from distribution channels we haven't previously had access to. The combined platform we built offers enhanced capabilities for not only our new IRT customers, but also our existing and prospective clients as well. We are extremely excited about the IRT business and the benefits it will provide throughout the organization and all of its segments, small, medium and large plan markets. From a digital perspective, our Principal mobile app remains a top-rated app in the retirement industry with more ratings and actionable feedback than our competitors. We also launched Simply Retirement by Principal, a new all-digital 401(k) solution that helps small business owners and their financial professionals build retirement benefit programs in a matter of just a few hours. Simply Retirement features competitive pricing, our industry-leading digital onboarding experience and tools to make it easy to administer. In individual life, we've seen continued adoption of our term life digital self-service tool, Principal Life Online, one of the first fully digital experiences in the industry. Since January, we've had 47,000 applicants utilize this tool. By leveraging our digital application tools, and investments in underwriting automation, about a third of our underwriting approvals can be completed with less than 10 minutes of underwriting time. In Chile, Cuprum recorded the highest net transfer rate of new customers since our acquisition of Cuprum in 2013. The new customer growth is driven by Cuprum’s easy-to-use digital solutions as well as our investments in direct consumer and cloud capabilities, all of which have helped make our transactions simple for our customers. We've enjoyed some noteworthy third-party recognition during the third quarter as well. In our Global Asset Management franchise, we received recognition for our ESG efforts from the United Nations Principles for Responsible Investing or UNPRI. PGI received an A plus overall approach rating, and Principal Real Estate Investors received an A plus rating for the fourth consecutive year, both the highest rank awarded. Principal was recognized by Financial Advisor IQ Service Awards as a Top Three Record Keeper for an excellent advisor experience. U.S. News & World Report again named Principal to its list of Top Life Insurance Companies, and CNET named Principal the Best Overall Life Insurance Company for 2020. In PI, BrasilPrev was recognized by Isto é Dinheiro Magazine as the Best Insurance Company in Financial Sustainability, Innovation, Quality, and Social Responsibility. They've been performing an annual analysis for the last 16 years. Before I turn the call over to Deanna, I'd be remiss if I didn't recognize the upcoming retirements of Tim Dunbar and Julia Lawler. I'd like to thank Tim and Julia for their unwavering commitment to Principal over the last 35 years. They've been tremendous individuals, leaders, and professionals over the years and our organization would not be the same place today without them. I, along with so many others, will miss them personally and professionally. We wish you both the best in your well-deserved retirement. That said, Pat Halter and Ken McCullum are in place to now carry the torch as we continue our journey as an ever-evolving and growing global financial services organization.

Thanks, Dan. Good morning to everyone on the call. This morning, I'll discuss the key contributors to our financial performance for the quarter, including details of our actuarial assumption review, impacts from COVID, our current financial position, and details of our investment portfolio. COVID continues to impact where and how we do business, and we've included additional details of the impacts in our conference call presentation again this quarter. While uncertainty remains on how the impacts play out over the next year or so, many of the metrics we're tracking continue to trend better than we expected at the onset of the pandemic. Third quarter net income attributable to Principal of $236 million included net realized capital gains of $2 million with manageable credit losses of $17 million. Reported net income reflects a negative $187 million impact from the assumption review and other significant variances. We reported $235 million of non-GAAP operating earnings in the third quarter or $0.85 per diluted share. Excluding the impacts of the assumption review and other significant variances, non-GAAP operating earnings of $417 million or $1.51 per diluted share increased 10% and 12%, respectively, compared to the third quarter of 2019. As shown on our slides, we had several significant variances during the third quarter. These had a net negative impact to reported non-GAAP operating earnings of $233 million pre-tax, $182 million after-tax and $0.66 per diluted share. Pre-tax impacts included a net negative $142 million impact as a result of the assumption review, primarily due to lowering our interest rate assumptions; a net negative $48 million impact from COVID-related claims and other impacts in our Retirement and Income Solutions (RIS) and U.S. Insurance Solutions (USIS) businesses; a negative $17 million impact in RIS-Fee from IRT integration costs; a negative $14 million impact from lower-than-expected variable investment income in Specialty Benefits, Individual Life, and Principal International; and a negative $12 million impact in Principal International from lower-than-expected performance in Latin America and lower-than-expected inflation, primarily in Brazil. Looking back, significant variances negatively impacted third quarter 2019 reported non-GAAP operating earnings by $41 million pre-tax, $34 million after-tax and $0.12 per diluted share. This year's assumption review was primarily impacted by economic and experience assumption changes. The most significant impact was the result of updating our interest rate assumptions. We lowered our long-term 10-year Treasury rate assumption by 75 basis points to 3.25%. In addition, the starting point dropped more than 130 basis points from this time last year. Experience assumption changes primarily included updates in RIS-Fee and Individual Life. Individual Life had an unfavorable impact from updated mortality and premium assumptions. This was partially offset by a favorable impact in RIS-Fee from updated mortality and withdrawal assumptions in our variable annuity business. As a reminder, the SECURE Act changed the required minimum distribution age from 70.5 to 72 years of age, meaning annuitants can take their withdrawals later. We expect these changes will decrease pre-tax operating earnings in Individual Life by $4 million to $5 million per quarter and have an immaterial impact on the other business units. We'll be finalizing statutory results during the fourth quarter, including the impact of these updated assumptions as well as our annual asset adequacy testing. We expect this capital impact to be manageable. Turning to macroeconomic factors in the third quarter, the S&P 500 Index increased more than 8%, and the daily average increased 13% compared to the second quarter and 12% from the year-ago quarter, benefiting revenue, AUM, and account value growth in RIS-Fee and PGI. Moving to foreign exchange rates, average rates improved during the quarter, but we continue to face headwinds compared to a year ago. Impacts to third quarter pre-tax operating earnings included a positive $5 million compared to the second quarter 2020; a negative $16 million compared to third quarter 2019; and a negative $53 million on a trailing 12-month basis. For the business units, third quarter results, excluding significant variances, were largely in line or better than expectations given the current macroeconomic environment. 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 nearly 35% in the third quarter and reflects strong expense management and equity market tailwinds. Slides also provide details of the COVID-related financial impacts we've experienced in the third quarter as well as updated thoughts on potential impacts the pandemic could have on our business and our results in the future. Third quarter pre-tax operating earnings were impacted by a net negative $48 million including a negative $42 million impact in Specialty Benefits, primarily from a 10% premium credit for our dental customers, claims in group life and group disability, as well as unfavorable dental and vision claims from pent-up demand that partially offset some of the positive impact from the first half of the year, a negative $8 million in RIS-Fee from waived fees for participant hardship withdrawals, and a negative $2 million impact from claims in Individual Life. These impacts were partially offset by a $5 million benefit from favorable mortality in RIS-Spread. In total, our third-quarter direct COVID mortality and morbidity impacts in Specialty Benefits, Individual Life, and RIS-Spread netted to a negative $3 million after-tax impact with slightly more than 80,000 COVID deaths reported in the U.S. during the quarter. Our third quarter impact was lower than our COVID sensitivity of a $10 million after-tax impact to earnings for every 100,000 U.S. COVID deaths, primarily due to lower than assumed claims in Individual Life. We believe this was normal volatility and are still comfortable with our sensitivity. We're continuing to monitor several other key indicators to gauge potential future financial impacts from COVID and the related market volatilities. In the Retirement business, the trends we saw in the second quarter for both plan sponsor and participant behavior continued in the third quarter. Participant withdrawals remained elevated during the quarter, partially due to $1 billion of COVID-related withdrawals which we waived fees on through September. We continue to expect full-year total participant withdrawals to be approximately 11% of beginning of year account value, about 1 percentage point higher than we typically see. While we continue to see growth in recurring deposits compared to a year ago, growth is muted as participants making deferrals remain lower due to layoffs and furloughs. In group benefits, as I discussed on last quarter's call, the number of lives covered under our existing plans is a good indicator of employer behavior. While overall covered lives decreased 1.2% during the quarter, we saw growth in September in certain industries and regions, a sign of recovery for some sectors. And we're seeing continued improvement so far in October. In Individual Life, while sales are down overall due to our concentration in the business market, we continue to see an increased interest in term life insurance. Application volume is up nearly 140% compared to a year ago, due to increased awareness on mortality and our enhanced digital capabilities and digital distribution. In Principal International, Chile passed a law in July allowing participants to take COVID hardship withdrawals. This negatively impacted our AUM levels by $1.4 billion. To mitigate some of these pressures, we have a strong history of effectively managing our expenses in line with revenue during times of uncertainty and market volatility. Compared to our expectations at the beginning of the year, we've reduced expenses nearly $200 million year-to-date, including more than $100 million in the third quarter. This is spread across all businesses and contributing to resilient margins despite revenue pressures. For full year 2020, we continue to expect our actions will reduce expenses by approximately $250 million relative to our expectations at the beginning of the year. As a reminder, fourth quarter compensation and other expenses are typically 7% to 10% higher than other quarters due to seasonality of certain expenses like marketing and IT. We expect to be at or below this range in the fourth quarter this year. Turning to capital and liquidity. Our financial position remains strong and improved from last quarter. We ended the quarter with $3.4 billion of total company available cash and liquid assets. And we had $2.6 billion of excess and available capital, including $1.6 billion at the holding company, double our target of $800 million to cover the next 12 months of obligations, $500 million of available cash in our subsidiaries and $480 million in excess of our targeted 400% risk-based capital ratio at the end of the quarter, estimated to be 431%. The RBC ratio remains higher than our target due to uncertainty in the timing and impact of credit drift and credit losses. We continue to expect the RBC ratio will trend down to our targeted 400% over time. Our non-GAAP debt-to-capital leverage ratio, excluding AOCI, is low at 24%. Our next debt maturity of $300 million isn't until 2022 and we have a well-spaced ladder debt maturity schedule into the future. 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 opportunistically deploy capital and manage through this time of economic uncertainty. As shown on our slides, we deployed $154 million of capital in the third quarter for common stock dividends. We plan to restart share repurchases either in the fourth quarter or the first quarter of 2021. While uncertainty remains, we continue to be in a strong financial position. We're starting to have enhanced clarity and stability in the macro environment, and the range of possible outcomes is narrowing. We have $850 million remaining on our current share repurchase authorization. Last night, we announced a $0.56 common stock dividend payable in the fourth quarter, unchanged from the third quarter, and our dividend yield is approximately 5%. Our investment portfolio remains high-quality, diversified, and well-positioned. And importantly, our investment strategy hasn't changed. A few takeaways: At the total company, we are in a $3.7 billion net unrealized gain position. This includes a $6.5 billion pre-tax net unrealized gain in our U.S. fixed maturity portfolio, which increased another $1 billion during the third quarter as spreads continued to tighten. The U.S. commercial mortgage loan portfolio average loan-to-value of 50%, and average debt service coverage ratio of 2.6 times did not change from the second quarter. We have a diverse and manageable exposure to other alternatives and high-risk sectors. And importantly, our liabilities are long-term. We have disciplined asset-liability management, and we aren't forced sellers. Year-to-date, we've experienced $165 million of credit drift and credit losses with $50 million in the third quarter. Our outlook for 2020 continues to improve, and we're now expecting $200 million to $300 million of drift and losses for the full year. This has improved from the $300 million to $500 million range estimated on the second quarter call and $400 million to $800 million that we estimated at the start of the crisis. Using the global financial crisis as a guide, we're expecting additional credit drift and credit losses to emerge beyond 2020. Economic impacts from the pandemic have been delayed due in part to the large and unprecedented global government, fiscal, and monetary stimulus programs. We're currently estimating approximately $400 million of credit drift and credit losses in 2021. We continue to monitor the situation closely, and we'll provide updates on future calls. In closing, COVID and the related market volatility are certainly impacting our business, our employees, and our customers, but we're managing through these unprecedented times. We're being prudent with both expense management and capital preservation in order to mitigate the 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 this crisis.

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

The first question for Deanna. You mentioned that you plan to resume share repurchase either in the fourth quarter of this year or the first quarter of next year. I guess, like, what factors do you need to see before you decide to do this in the fourth quarter, into the first quarter?

Yes. Thanks, Humphrey, for the question. As you mentioned, we did say in the prepared remarks that we continue to be in a very strong capital position. We have, every quarter, gotten increased clarity on the range of potential path forward with reduced expected impacts from drift and impairments. As you said, we mentioned that we'll either restart share buybacks in the fourth quarter or first quarter. I'd say based on what we know today, I think there is definitely a path to additional capital deployment in the fourth quarter. But I also think you can agree that uncertainty exists, whether that be uncertainty around market volatility. Obviously, what we saw yesterday showed some pretty significant pressure, uncertainty around the stimulus package and how that may impact some of our businesses, as well as uncertainty around COVID impacts and how those could play out. And we want to be prudent and not ignore some of that volatility that is out there. But I think, bottom-line, we have a strong capital position and all deployment options are currently on the table.

Humphrey, do you have a follow-up?

For the third quarter, our expenses showed strong efficiency, but some of that may not be sustainable moving forward. Looking into the fourth quarter, it seems there will be fewer benefits compared to the third quarter. Can you discuss what level of expense savings might be maintainable? Additionally, as we move beyond the pandemic, how can we retain the efficiencies that we've discovered, considering that some expenses are currently on hold?

Humphrey, I'll throw this to Deanna quickly, but I just want to be on the record to remind you, we have had a history of aligning our expenses with revenues consistently. I think the fact that we could identify $250 million this year was exemplary and a good indication that the team is really on board doing the right thing. Having said that, we are going to work. And we've made good investments. Our digital transformation is still very much intact. We're transitioning the IRT business over. And so we fully intend to have a similar approach to 2021. But I'll throw it to Deanna to provide some more detail.

Yes, Humphrey, I would like to provide some details regarding the 2020 expense actions and offer insights into the fourth quarter and 2021. We continue to emphasize, as we did last quarter, that we expect approximately $250 million in expenses, and so far we have realized about $200 million of that through the end of the third quarter. This estimate does not take into account adjustments to variable expenses that fluctuate with revenue changes, such as investment management fees and bonus pools. We believe that around half of the reduction comes from staff-related expenses, which include lower incentive compensation, reduced benefits, decreased hiring, and earlier salary actions. The remaining reduction is from non-staff related expenses, such as travel, contracting, consulting, and advertising costs. So far this year, we've seen $200 million against the $250 million target. You are correct that the third quarter may represent the peak of our expense management efforts. However, we still anticipate some of these measures to continue into the fourth quarter and into 2021. It's important to note that there is a seasonal factor that typically raises expenses in the fourth quarter, and while we expect this to be somewhat muted, we still anticipate this seasonal pattern. Looking ahead to 2021 and considering the factors influencing our expense management strategy, some elements will reset, such as incentive compensation and salary levels. Meanwhile, items like staffing and travel will rise, but at a lower level than we would have predicted before the crisis. In estimating 2021 expenses relative to our pre-pandemic expectations, we project a decrease of about $100 million. This indicates that approximately 40% of the $250 million reduction will carry over into 2021, with some items resetting at the start of the year while others will gradually increase throughout the year. This is an initial assessment of our expenses for 2021, and given the significant revenue volatility we've experienced over the past six months, we will keep reassessing and adjusting our approach. Our ultimate goal remains to align our expenses with our revenue and to achieve the targeted margins we've communicated to you and our investors.

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

Sales volume year-over-year in Specialty Benefits actually got worse sequentially. Can you provide any color on that? Is it small business related, social distancing related? And how do you think of it going forward?

Yes, great question. And in the midst of a global pandemic, we've certainly seen sales across our small and medium-sized business get impacted, both RIS as well as SBD. But Amy has got some additional insights and thoughts maybe about the future. Amy?

Sure. It's good to receive your question, John. The key aspect to consider here isn't so much the specifics of our sales process but rather how employers are making decisions about implementing new benefits. From my perspective, while we have noticed a decline in sales volume, there is still significant interest from small, medium, and large employers in protection coverages. However, they have been hesitant to proceed with establishing new plans at this time. The positive news is that we are beginning to see the sales pipeline recover, especially for protection-based coverages like life and disability. There’s emerging interest in our voluntary coverages as well. Additionally, I want to highlight that our persistency numbers, which are already strong, have improved even further. Therefore, when I assess sales trends alongside persistency activity, I feel very optimistic about the overall premium levels for the business.

And Amy, before John addresses a second question, I'd like to share some thoughts. We've noticed that life insurance sales have actually declined, reflecting the overall sentiment in the marketplace. Perhaps we should discuss that briefly before moving on to the next question.

Yes. I think when we think about the life business, term life interest, and Dan, you noted this in your comments, has been incredibly strong. I think there's both in understanding that people need protection, maybe more than they were understanding that before. And also, I think it's a nod to the fact of the investments we've made in our straight-through processing are really paying off. So when we look at our term life business and we look at the experience that you can have on that term life business, that is industry leading. The place where we're seeing a little bit of holding in terms of making sales decisions is probably more aligned with our executive variable UL business, which is really aligned with our NQ business. So we're seeing the same pattern of some employers saying they kind of held off on making some decisions in the second and third quarter, and we're seeing that pipeline begin to pick up as well.

John, do you have a follow-up?

Yes, thanks. The decline in the AUM in RIS, I know there was a low fee legacy client that was exiting. How much of that decline is from that and how much remains?

Yes, it's a great question and one that Renee can address head on. Renee?

Yes. Thank you for the question, John. When you look at the AUM, as you noted, when we acquired the block of business, we understood that there was a large legacy client, a trust and custody client that was slated to leave. And so we have recognized probably 80% of the withdrawals from that client with the rest slated to go out over future quarters. But the other thing to note, we were aware of this at the time of the transaction and the revenue impact of this particular client was small.

Yes. Well, the persistency, John, on the block is about what we expected from the initial pricing, adjusting for this large withdrawal. The other thing noteworthy, although we didn't break it out, we've actually added a fairly large well-known Fortune 50 company where they awarded us business in that same period of time. So we're open for business as it relates to that trust and custody business. So we feel good about it. Thanks for the question.

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

When you originally announced the Wells IRT deal, you talked about a 28% to 32% margin, I think, by the end of 2022. With the additional expense savings you're expecting and then the lower interest rate outlook, I guess, do you still think you can get to that level? And do you have a sense of when you may get there now?

Yes. Great question. And all very relevant as you think about it. I mean we are transitioning a massive block of business over in the midst of a pandemic, and interest rates have moved the wrong way. And I again applaud the team for the synergies they've been able to realize thus far and process the necessary work. Renee, do you want to frame what you think, best thinking right now as it relates to long-term profitability on margin and growth?

Yes, absolutely. So when I step back and we look at this acquisition, we remain very pleased with how the business is performing and how the integration is going. And of course, it starts with that great strategic fit. This reinforces our standing as a top 3 retirement provider. It positions us for future growth and a really strong cultural fit as was noted in the prepared remarks. The other thing that we can see is that expense synergies and the financial fit continues to remain very good. So when we look at the expense synergies, in particular, right after we closed on this block of business, we made a very important strategic decision, and that was to migrate to a single IT platform as quickly as we could. And to combine the best applications from WySTAR with the Principal applications so that we could introduce enhanced capabilities across the board, both to IRT customers as well as to Principal customers. What this meant, though, was that we delayed the transition of the clients over from IRT to Principal. What it allows for, though, is that client retention is right on track. And we know that we can create a very smooth and seamless transition for our clients. And that was demonstrated in the first wave migration that occurred a couple of weeks ago. It was incredibly smooth and very seamless for both plan sponsors and participants alike. But as we go through this migration, and the migration for the retirement side will be completed in June of next year, we can see that the expense synergies that we had originally modeled, we believe we can exceed those by about 50%. We'll begin to see expense synergies emerge in the summer, next summer, and we'll continue to increase throughout the latter portion of next year. And we'll continue to drive towards a mature synergy, expense synergy run rate throughout '22 being realized in '23. So the good news is, the critical decisions that we made early on are paying off. They're delayed, but we can see that the expense synergies will be greater.

So Renee, to address Ryan's question directly about the range of 28 to 32, considering the offset of the IOER along with the improved synergies, it's likely well within that range. We will not be adjusting that range at this time.

No, the range remains intact.

Okay. Ryan, does that help?

It does. And then I just had one quick follow-up. Are you seeing dental utilization, I guess, normalize now? I mean are you expecting it to be more typical in the fourth quarter?

Well, it couldn't get any more untypical than the last 2 quarters. But yes, we think that on a trailing 12-month basis, it's going to come in line. Amy, any closing comments there?

Yes. No, I think we're seeing it begin to normalize. Keep in mind that the fourth quarter, we would have seen people moving through their benefits. So fourth quarter typically had a really low seasonal utilization. I would say we're going to go back to normal, but it might feel more like mid-year normal in terms of normalization. So we're seeing it normalize. Some of the pent-up demand has been exhausted, and we would expect the fourth quarter to be more of a normal pattern of dental utilization.

The next question will come from Suneet Kamath with Citi. Please go ahead.

Deanna, I wanted to start by discussing the assumption review. Last year's review indicated a change in the grade up period from 10 years to 7 years. I understand this quarter you're reverting back to 7 years. I'm interested in the reasoning behind this change. If you hadn't changed it back to 7 years, would the charges or the ongoing impact that you mentioned earlier in the call have been significantly different?

Yes, Suneet, thanks for the question. So yes, you're correct. So last year's review, we would have hit a 4% Treasury in 2029. And at this year's review, we are seeing 3.25% in 2027. So it's a 2-year change in that cycle. What I'd say is that it's not an exact science. There are many inputs that we look at. We talk to our economists. We look at peer perspectives as well as other external perspectives. And I think the fact that we're getting to a lower ending point made us comfortable that getting there in 2027 made sense. To get to your second question, when we look at the total impact from interest rates, which was about $85 million of the $114 million after-tax impact, we think about two-thirds of that is from the reduction in the starting point. So again, when we did last year's review, 10-year treasuries were around 2%. When we struck it for this year's review, it was closer to 65 basis points. And so given that two-thirds was a starting point, I don't think having that be extended beyond 7 years would have had a significant impact on the numbers.

Got it. Okay. And then my second question, I guess, for Dan, just bigger picture. We are starting to see more insurance companies rationalize their business mixes, either selling businesses or taking blocks of business and reinsuring them. There's clearly a lot of capital available to do that. Just curious if that enters into your game plan at some point? I'm thinking specifically about fixed annuities or any spread-based blocks you may have, but also on the Individual Life side?

Yes. Absolutely, Suneet. So I think I'd put it into 2 different buckets. The first bucket is, are we committed to the fee spread and risk business? The answer is yes. Do we like the insurance business, this risk business? The answer is yes. We think it very much serves the needs of small to medium-sized employers. It provides us with a lot of flexibility. And then, frankly, it's a great way for us to serve the needs of our clients. The other half is financial transactions related to the in-force blocks of business. And I would tell you, our capital markets area looks very closely at this, looking at the long-term implications on capital, how it would be redeployed and the financial impact on those blocks of business. So it's very much top of mind for us. It gets a lot of consideration. We've not yet seen the right opportunity that we felt we wanted to move it forward. But certainly, in the categories you've identified, that is part of our consideration. Appreciate the question.

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

Can you talk about your expectations for RIS-Fee flows as we move into 2021? Do you expect to get back to the 1% to 3% organic growth range as withdrawals normalize? Or could there be some ongoing impacts from a slowdown in recurring deposit growth?

Yes. I'll throw out to Renee quickly, but I would just say this. I'm absolutely somewhat shocked by the fact we could be in a global pandemic, and they've held up as well as they have. And there's a lot of variables that go into it. But certainly, these hardships were a big contributor, not only here in the U.S., but also, as you know, in some of the emerging market countries as well. Renee, maybe give us some insights and thoughts and components and where you think this might go in the future?

Yes, absolutely. When we consider net cash flow, there are several key factors influencing it this quarter and that we need to keep in mind as we look ahead to 2021. The first significant factor impacting us this quarter is the COVID-related withdrawals, which have resulted in approximately $1 billion in withdrawals during the third quarter, representing about 3% of our total participants. This trend aligns with what we saw in the second quarter and is consistent with ongoing activity expected in the fourth quarter. To potentially slow down these withdrawals, we must consider a couple of factors. Firstly, it heavily depends on how the pandemic and the underlying economic and employment trends evolve. Another important variable is that the CARES Act eliminated the penalty on hardship withdrawals, but that provision will end this year. If there is a new stimulus bill that extends this waiver, we might continue to see these withdrawals into 2021. Therefore, it's reasonable to expect that COVID-related withdrawals will exert ongoing pressure on net cash flows through the end of this year and into 2021. The next important factor is recurring deposits. We were initially seeing about an 8% increase on a trailing 12-month basis, but that has declined to a 3% increase in recurring deposits for the third quarter of 2020 compared to the third quarter of 2019. This reduction can again be linked to a couple of factors. The number of deferring participants dropped by about 2% in the quarterly comparison, even though the deferral rate has stayed relatively stable and strong. As we look ahead, we expect this trend to remain under pressure, largely depending on how the economy and pandemic play out and what kind of recovery we might see. Lastly, we note pressure in new sales, particularly within the small to medium-sized business segment as many companies have been distracted due to COVID. Conversely, the IRT acquisition has led to significant growth in our large plan pipeline. With a larger presence in that area and an expanding number of consultant relationships, we believe we will see some recovery in new sales for 2021. However, this too is contingent upon economic and pandemic developments. The positive takeaway is that our client retention remains strong. We are focused and continue to effectively support plan sponsors and participants. Considering the overall net cash flow for 2020, we expect it will be flat, as it has been impacted by COVID-related withdrawals and recurring deposits. We will provide a clearer perspective in the upcoming outlook call, but we anticipate some pressures will persist.

Erik, hopefully, that helped.

Yes. And then if I could just ask quickly on PGI margins, which were very strong this quarter, I think about 40%. Do you expect to be able to sustain a higher than target margin in the near term due to expense savings? Or do you expect that to come back down to more of the target range given either higher compensation accruals or other adjustments given the recovery in revenues?

Well, since this is Tim Dunbar's last earnings call, he's passing this over. I'm interested to see how he responds to this question and outlines the future direction. Tim, please.

Thanks, Erik, for the question. I'm going to be nice to Pat and share that we would guide you to our long-term guidance for margins to be between 34% and 38%. While this quarter's margins were quite strong at 41%, we believe that the fourth quarter and beyond will likely align more with the trailing 12-month range, which is currently around 37%.

The next question will come from Tom Gallagher with Evercore. Please go ahead.

I wanted to follow up on the underlying persistency trends in your RIS-Fee business. Are you noticing any indications when you analyze the data that there's pressure, especially in the small business segment regarding company closures? Have you observed any significant changes in trends related to bankruptcies and plans actually disappearing, or do you believe that isn't emerging?

Yes. This has actually been one of the solid outcomes that have come from this situation. While many employees in hospitality and the airline industry have been displaced, and restaurants have faced hardships, many of those affected were not small employers and did not have many plans in place. We have noticed some reduction in the participant base of those plans, but there has not been an increase in lapses. Although new case sales have declined and new plan formation has slowed, it's understandable that those without a plan might be hesitant to start one during a pandemic. Renee, would you like to add any further insights on this topic?

Yes, definitely. When we examine new plan formations, it has indeed slowed down. However, plan terminations due to dissolutions are not presenting a threat this quarter. The actions from the stimulus package we are implementing are beneficial for small and medium-sized employers. We might see some challenges arise in future quarters, but currently, there are none. What's particularly interesting and reaffirms the strength of our diverse business within RIS is that when we assess plan size and its effect on net cash flow, our small to medium-sized business segment has shown remarkable resilience across almost all measures, including in-plan participation and employer match, which continues for this segment. Consequently, the net cash flow for the SMB business is actually performing slightly better than that of the large plan business.

Tom, before you move on to your next question, I want to mention that at Principal, the group benefits for small to medium-sized businesses are looking quite similar, with a decrease in participants in the existing plans around 2% to 3%. However, the rate of plan lapses or terminations is not increasing. So, it seems that small to medium-sized businesses at Principal are doing well. Do you have a follow-up?

It’s great to hear that, Dan, regarding the underlying experience. My follow-up question is about your expectations for credit loss. It seems like it has been pushed out to 2021. The $400 million figure seems higher than I expected based on current trends. Is this due to caution, or are there signs in commercial real estate, such as delinquencies not yet affecting you because of the NAIC moratorium? Could you explain why you still have a relatively high expectation for next year?

Yes. Thanks again for that question. It's a timely one. And your term of abundance of caution is one that we use frequently around here because we want to make sure that we've got adequate capital. And I do think we've sized up the balance of the year nicely and by making that adjustment. But Tim, you want to sort of give your insights and perspective on the $400 million for next year?

Sure, Tom. And I’d just be remiss if I didn't mention that we talked often about the quality of the portfolio going into the pandemic, and I think that's across the board. So it would be, in our fixed income portfolio, certainly on our commercial mortgage loan portfolio, and on our alternatives portfolio. So we think we were coming at this pandemic from a position of strength. And our expectations were set generally by some high-level modeling that we've done based on the great financial crisis. And as we moved through 2020, we saw unprecedented Fed action. We saw government stepping in, and it really delayed a lot of our credit losses and a lot of the drift that we think could have taken place in 2020. And that's been a very positive story. And you've seen prices on bonds rebound. And actually, our commercial mortgage loan portfolio has maintained very high ratings. We've been through that portfolio. And we think it stands pretty strong. So as we look at 2021 and our projections there, yes, we're upping it a little bit. I would say the range for 2021 as we sit here today is quite wide. It depends again a lot on Fed actions, on government support. And what we're seeing there is that we don't really have a lot of specific ideas about drift and credit losses, but we would expect, as COVID rears its head again and weighs on the economy, that there's potential that we could have up to $400 million in losses in drift. Most of that, again, would be coming from the bond portfolio, probably only about a third coming from the commercial mortgage loan portfolio. So that's some of the color and some of the way we're looking at it. And obviously, we'll continue to go through the portfolios and refine these numbers as more information comes out.

Tom, thanks for the question.

The final question is from Josh Shanker with Bank of America. Please go ahead.

So I want to talk a little about the commercial mortgage portfolio, the 14 loans that have gone into forbearance. Can you talk a little bit about the process of the mortgagee in your relationship and how that process is set and whether or not we should expect more loans to go into forbearance over the next 12 months? What's sort of the process by which this occurs?

Tim, please?

Sure. So what really happens is that we get contacted from the borrower. The borrower gives us then some very specific information about the property, their situation, and generally makes a request of what they're asking for. And generally, when we say forbearance, that doesn't mean we're forgiving the loan payments for a period of time. It really means that we're working out an alternative schedule until we think the property can get back on its feet and start paying the mortgage payments again. Sometimes, it's an extension of the loan, but it's very dependent on the specifics of that situation. We have 14, as you suggested, those are all in good states. So they are living up to the loan agreement that we had set with them. And we've worked through the entire list of requests that we've had. Now what happens next depends a lot again on how the pandemic plays out, how the economy plays out. But we're watching and monitoring commercial mortgage loans very closely. But I expect to see some additional modification probably going into 2021 as we see how really the economy looks and what we're thinking is going to happen. But I'd be remiss if I didn't say that I think this portfolio is incredibly high quality. I don't really see a lot of losses coming through. Our loan-to-values, after going through every one of the properties in May, still stands at an average of 50% loan-to-value, and we still have good debt service coverage. So that's kind of how we're looking at the portfolio.

Thanks, Tim. Do you have a last follow-up?

Yes. I'll stick on this topic just to exhaust it. These 14 examples, do they have anything in common geographically or property type or anything we need to think about in relationship to the rest of the portfolio?

Yes. Generally, these loans are primarily from retail. We have limited exposure to shopping malls, but a fair number are sourced from them. Additionally, we hold some hotel properties, which make up less than 1% of our commercial mortgage loan portfolio, and those have been modified. There are also a few properties that don't share much in common. I want to stress that our portfolio is significantly less exposed to retail compared to the NCREIF Index, which we monitor closely. Furthermore, it is heavily concentrated on grocery-anchored retail or single-store box retail, and those projects are performing relatively well.

Thanks, Tim. Yes, I appreciate the question, Josh.

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

I'll be quick. We had a Board strategic retreat. We talk about strategy at every Board meeting. But once a year, we get together and interrogate our strategy. We get some third-party unaffiliated views about the strategy. And I would tell you, we exhausted it in terms of looking closely at the fee, the spread and the risk businesses, the countries that we're in, the portfolio that we have, and we really feel there's good long-term upside for investors in our current strategy adjusting on the margin. The second thing I'd take away from today's call, strong balance sheet, liquidity, significant scale, and capabilities. We have good differentiators and the 5% dividend yield at today's price we still think is very strong to investors. And then I would say from a historical perspective and going into the future, we have a strong reputation for aligning our expenses with our revenues. We've deployed capital in a very thoughtful and balanced approach, and we'll continue to do that, both in the near and the long-term. And we are going to continue making investments in our future. I've seen too many businesses become irrelevant because they fail to make investments in their businesses. And I look at these digital investments. And frankly, whether it's international or domestic, we're seeing those payoff. So thank you for your interest in the company, and I look forward to talking to you on the road. Have a great day.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 PM Eastern Time until end of day, November 3, 2020. 2198859 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 all disconnect.