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Principal Financial Group, Inc. (NASDAQ:PFG)
Q4 2017 Earnings Conference Call
January 30, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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

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

John Egan -- Vice President of Investor Relations

Thank you and good morning. Welcome to the Principal Financial Group's Fourth Quarter Conference Call. As always, materials related to today's call are available on our website at principal.com\investor (sic).

I'd like to mention a few changes to our fourth quarter materials. To comply with recent SEC guidance on non-GAAP financial measures, we've changed our operating earnings label to non-GAAP operating earnings, on both a pre-tax and after-tax basis, at the total company level. The calculation of these measures has not changed. Additionally, on Page 16 of our financial supplement, we've updated the assets under management detail for Principal Global Investors. The Principal Global Investors source AUM schedule includes all AUMs sourced by PGI included in the previously denoted institutional AUM and US mutual funds AUM.

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

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

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. Risk and uncertainties that could cause actual results to differ materially from those that are expressed or implied are discussed in the company's most recent annual report on Form 10-K, filed by the company with the U.S. Securities and Exchange Commission.

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

Now, I would like to turn the call over to Dan.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

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

2017 was another very good year for Principal, despite fourth quarter results. As Deanna will cover in more detail, the fourth quarter non-GAAP operating earnings reflect higher expenses in taxes, low performance fees in PGI, and accelerated investments in our digital strategies.

I see full-year results as a much better indicator of company performance and a source of continued confidence in our ability to deliver on 2018 guidance we provided in our outlook call last month. In 2017, we substantially expanded our distribution network and array of retirement, investment, and protection solutions. We enhanced our digital capabilities and we made important progress in key markets, including Brazil, Chile, China, India, and Mexico.

It was a year where we continued to produce strong growth, balanced investments in our businesses with expense discipline, be good stewards of shareholder capital, and deliver value to our customers, drive improvement in our communities, and be a great place to work for our employees. Just after year end, we received some notable recognition. We ranked number six in Forbes' list of the best employers for diversity, and we made Fortune's list of the world's most admired companies.

At nearly $1.5 billion, we delivered record non-GAAP operating earnings in 2017, with double digit growth compared to 2016. We grew assets under management, or AUM, by $77 billion, or 13%, to a record $669 billion at year end, providing a solid foundation for growth in 2018. Throughout the year, our asset management franchise received dozens of best fund awards in Chile, China, Hong Kong, India, Europe, Malaysia, Mexico, and the U.S. from organizations including Bloomberg, Morningstar, and Thomson Reuters Lipper.

For a sixth consecutive year, we are recognized as one of Pension Investment's best places to work in money management. Most recently, Principal, Millennials ETF, made Investment News' list of best performing international ETFs, topping the world's large stock category with a 41% gain in 2107. In the fourth quarter, Willis Towers Watson released research on the world's largest asset managers. Principal tied for the tenth fastest growing firms within the top 50, based on compounded annual AUM growth of 12% from 2011-2016. We moved up 13 spots over the five-year period to number 38.

For our Morningstar rated funds, 65% of fund level AUM had a four- or five-star rating as of year end. Further, as shown on Slide 5, our longer term Morningstar investment performance remains very strong. At year end, 83% of Principal mutual funds, ATFs, separate accounts, and collective investment trusts were above median for five years' performance, 69% above median for three years' performance, and 76% above median for one-year performance.

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

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

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

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

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

Importantly, the fundamentals of the business remain strong. As evidence by our meaningful growth and plan count, participants, and reoccurring deposits that increased 6% to a record $20 billion in 2017. For both RISB and PGI, we continue to expect larger institutional deposits and withdrawals to occur unevenly over time, which will create both quarterly and annual volatility in net cash flows. Nonetheless, we remain confident in our ability to attract and retain business. We have an outstanding array of solutions, and we've positioned ourselves to capitalize on markets with substantial growth potential.

Net cash flows remain important, but we continue to focus on revenue growth. This means delivering better client outcomes and differentiating through value added specialties, solutions, and alternative investments.

I'll now share a few execution highlights, starting with our efforts to expand and enhance our investment platform through a continued focus on outcomes, diversification, asset allocation, downside to risk management, and cost effective alternatives to pure passive management. In 2017, we launched more than 50 new funds in total across southeast Asia, China, and Latin America, responding to increasing local retail and institutional demand for multi-asset and income generating solutions.

We had several new launches in our Dublin platform as well, notably more than doubling sales on this platform from a year ago to $5 billion, generating nearly $2.5 billion of positive net cash flow for the year. On our U.S. platform, we launched four new ETFs in the fourth quarter, and a total of seven for the year, bringing us to a dozen ETF strategies in the market as of year end. Our ETF franchise surpassed both the $1 billion and $2 billion dollar milestones in 2017, moving us up seven spots on ETF League Tables and placing us in the top 30 as of year end.

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

And, we continue to make enhancements to our digital education and enrollment resources without our retirement and group benefits businesses, enabling an increasing number of workers to take important steps toward financial security. In the fourth quarter, we began accelerating our investment in the digital business strategies discussed in our 2018 outlook call. More to come in 2018 as we intensify our focus on the customer experience, direct consumer offerings, and our global investment research platform.

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

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

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

In closing, again 2017 was a year of strong growth for Principal, and a year of meaningful progress. Competitive environmental challenges remain, but we go forward from a position of strength without outstanding fundamentals and the benefit of broad diversification. I look for us to continue to build on the momentum in 2018 and for that momentum to translate into long-term value for our shareholders. Deanna?

Deanna Strable-Soethout -- Executive Vice President and Chief Financial Officer

Thanks, Dan. Good morning to everyone on the call. This morning, I'll discuss the impacts of the U.S. Tax Cuts and Jobs Act, or tax reform, on fourth quarter results and on our effective tax rate guidance of 2018, the key contributors to our financial performance for the quarter and full year, and capital deployment in our capital position at year end.

As you know, U.S. tax reform was signed into law late last year. The net financial impact shown on Slide 6 were reflected in other after tax adjustments and excluded from non-GAAP operating earnings. The impacts included a $626 million benefit from the remeasurement of our net deferred tax liability and $57 million of higher tax expense, including $43 million from the one-time deemed repatriation tax on foreign earnings.

Tax reform did not have a material impact on our 2017 estimated risk-based capital formula or statutory surplus, and we remain confident in our ability to deploy our targeted $900 million to $1.3 billion of capital in 2018. Non-GAAP operating earnings ROE, excluding AOCI, other than foreign currency translation, declined approximately 40 basis points at year end, due to tax reform, as the net benefit increased our equity base.

As shown on the bottom of Slide 6, we've updated our 2018 effective tax rate guidance to reflect the total company impacts of tax reform. The total company non-GAAP operating earnings effective tax rate guidance range is now 18-21%. This should increase our 2018 non-GAAP operating earnings by approximately 3% over 2017.

Moving to financial results, net income attributable to principle was $842 million for fourth quarter 2017, compared to $318 million in the year ago quarter. The increase was primarily a result of the $568 million net benefit from tax reform. In addition, during the fourth quarter, we made a $70 million pre-tax contribution to the Principal Foundation, reflecting our strong financial position and our long history of charitable giving. For full year 2017, net income was a record $2.3 billion, including a record $1.5 billion of non-GAAP operating earnings, the benefit from tax reform, and the gain from the third quarter real estate transaction.

At $47 million for the year, credit losses remained below our pricing assumptions. We reported non-GAAP operating earnings of $351 million for the fourth quarter 2017, or $1.19 per diluted share. On a full year basis, excluding the impacts of the annual assumption reviews, non-GAAP operating earnings increased 10% from 2016, reflecting continued strong execution and favorable equity markets. A majority of the quarter's results can be explained by a few items -- higher operating expenses, timing of taxes, and lower performance fees in PGI. As in prior years, we saw an increase in fourth quarter operating expenses compared to the other quarters, primarily in compensation and other expenses.

In total, operating expenses were elevated by about $80-90 million from the average quarter in 2017 and can be attributed to three factors -- seasonality and timing, one-time items, and increased investments in the business. Slightly more than half of the total was due to seasonality and timing of expenses, including branding, benefit costs, M&A transaction fees, variable sales expenses, and DAC amortization.

In regard to the timing of expenses, the first three quarters of the year benefited from lower expenses while fourth quarter was impacted by higher expenses. Approximately 25% was due to one-time or higher than normal expenses, including a guaranty fund assessment and incentive and stock based compensation. These are not expected to continue at the same level into 2018. The remainder was increased investment in our businesses, including the beginning of our accelerated investment in digital business strategies.

In addition to the higher operating expenses in the quarter, the timing of taxes, particularly between third and fourth quarter, negatively impacted the fourth quarter by approximately $15 million. Our full year total company non-GAAP operating earnings effective tax rate was in line with our expectations.

In the fourth quarter, mortality and morbidity were slightly favorable overall -- a benefit to individual life, neutral to specialty benefits, but a negative to RIS spread, primarily our pension risk transfer business. On an annual basis, mortality and morbidity were inline with our expectations for all our impacted businesses. We view the total items I discussed earlier -- expenses and timing of taxes -- as normal quarterly fluctuations that level out over longer periods of time. The only significant variance in the fourth quarter was lower than expected Encaje performance of $6 million on a pre-tax basis.

In my following comments on business unit results, I will exclude the significant variances from both periods in my comparisons. Taking into account the impacts from mortality, morbidity, and the elevated operating expenses in the quarter, fourth quarter pre-tax earnings for RIS spread, individual life, and specialty benefits were in line with our expectations.

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

As shown on Slide 7, RIS fees pre-tax operating earnings of $127 million increased 2% compared to the year ago quarter. Net revenue growth of 3% was driven by a 9% increase in fees in other revenue, partially offset by lower net investment income. Additionally, the current quarter was impacted by the higher operating expenses described earlier. Excluding the impact of the annual assumption reviews, full year 2017 pre-tax operating earnings increased 9% over the prior year, primarily driven by higher account values. Both revenue growth and margin metrics ended the year at the top end, or higher than our 2017 guided ranges.

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

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

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

Consistent with our international growth strategy, we've recently announced three planned acquisitions in Principal International. All three are slated to close in the first half of 2018. As announced in October, the planned acquisition of MetLife's Afore business will provide additional scale and distribution strength in the mandatory pension business in Mexico.

At the beginning of 2018, we announced that we planned to take full ownership of the Principal Punjab National Bank Asset Management Company in India. We have been in India for nearly 20 years and have been increasing our ownership over time. This transaction gives us greater autonomy in executing our strategic business plans in India.

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

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

Our estimated risk based capital formula was 445% at year end, this is above our targeted range of 415-425%, primarily due to the real estate transaction in third quarter. Our goal remains to bring the RBC ratio back to our targeted range over the next several quarters through strategic capital deployment opportunities.

As outlined on Slide 13, we take a balanced approach to capital deployment. Our goal is to deploy between 65-70% of net income per year with variability in any given quarter. In 2017, we deployed $913 million of capital, or 68% of net income, excluding the net income impacts from tax reform and the third quarte real estate transaction. Full year 2017 capital deployments included $540 million in common stock dividends, $193 million in share repurchases, and $180 million through the planned MetLife Afore and INTERNOS acquisitions and increased ownership of our investment boutiques.

The full year common stock dividend was $1.87 per share, a 16% increase over 2016, as we continue to target a 40% dividend payout ratio. Last night, we announced a $0.02 increase in our common stock dividend payable in the first quarter, bringing the dividend to $0.51 per share. Despite fourth quarter results, I'm very pleased with our strong financial results for the full year, a better indicator of our performance.

Looking ahead to 2018, I want to remind you that the first quarter is typically our lowest quarter for earnings due to dental and vision claims and specialty benefits and elevated payroll taxes in PGI. As a reminder, the accelerated investment in our digital business strategies will flow through the business unit results and the investment may occur unevenly throughout the year. While included in our guided ranges, it will likely cause 2018 margins to decline from 2017 levels.

We anticipate that tax reform will have a positive impact on an already strong economy, and on our target market of small to medium sized businesses, whether through wage inflation, employment growth, additional growth in the economy, or by enabling companies to offer new or enhanced benefit packages.

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

...

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

Questions and Answers:

Operator

[Operator instructions] The first question will come from John Barnidge with Sandler O'Neill. Please go ahead.

John Barnidge -- Sandler O'Neill & Partners -- Analyst

Thank you very much. Your RBC ratio saw no material impact from charges, and that contrasts with some peers this quarter. Has this, combined with tax reform, changed your appetite on M&A and possibly shifted it from being more international in focus to possibly more domestic in focus? And then, with tax reform in the review mirror now, are you seeing a large increase in interest from clients increasing their employee benefits, whether it be medical, life, or retirement? Thank you.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Thanks for the question. I'll take the impact as it relates to acquisitions and client behavior and then throw it over to Deanna. I would say that the fundamentals of our criteria for making acquisition has to do with building out scale or capabilities, whether that's international or domestic. And, I don't see that having a material impact.

I think, generally, we have thought that most of our domestic businesses are at scale, and over the years we've added to some capabilities. Internationally, you've seen us most recently start making the move on acquiring larger shares and stakes to gain majority control. That's what you saw in the case of CIMB and certainly more control now with Punjab National Bank.

I think, as it relates to the benefits, I was just speaking with an employer yesterday about tax reform. It seemed to fall into three buckets. One was that they anticipated an increase in benefits, whether it's voluntary or matching contributions -- although, in working with Nora and her team, we've not yet seen a material change in matching contributions. But his view was that we would continue to make those sorts of investments. The second was in the business itself. I don't think it's just us who is having to make an investment in digital. I think it goes across every industry and every sector.

And the last one, and it's a publicly traded company, they talked about it flowing back to investors. With that, let me throw it over to Deanna to hit the RBC ratio itself.

Deanna Strable-Soethout -- Executive Vice President and Chief Financial Officer

Good morning, John. Thanks for the question. You're right, we did have a very minimal impact on our RBC formula from tax reform. Despite the DTL at the total company level that caused a significant gain in the quarter, we did have a DTA in our life company. But, as we remeasured that DTA and took into account the amount of that that was admitted, it only had about a $30 million, or 3%, impact on our risk based capital.

I think the wild card going forward is that our current risk based capital formula does have a provision for tax rates, and it's likely that the NAIC, at some point, could update that. We've talked about it in the past, that that impact would impact all of the insurance companies. We estimate about a 65% impact just from that.

Having said that, there are other moving pieces within the formula that the NAIC is contemplating. The timing of that as well as rating agency reaction is unclear. To wrap it up, I feel we're in a very strong capital position. Our risk based capital is at a very strong level as well as the capital we have throughout the complex. So, I feel confident that we can withstand any impact of tax reform on our capital position and RBC going forward.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

John, did you have a follow-up?

John Barnidge -- Sandler O'Neill & Partners -- Analyst

No, that's good. You answered it. Thanks a lot.

Operator

The next question is from Alex Scott with Goldman Sachs.

Alex Scott -- Goldman Sachs -- Analyst

Good morning. First, on flows, I was interested in your outlook for flows in the fee business and any competitive pressure that you're seeing that you'd characterize as incremental. And, would you expect to have to pass through tax benefits there? Considering DRD is going away to some degree, will that result in less of that for this segment?

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Yeah. I'll give you the overarching response to this, that this has far more to do with revenue growth and operating earnings and margins that perhaps it does on net cash flows. These have become quite uneven for a variety of different reasons. As I reflect on your question related to net cash flow, it's in the large case market where we see the most volatility. It is in the group benefits business for premiums. It is in the retirement business. It's institutional asset management in full service payout. So, we need to orient ourselves that we're going to see volatility in net cash flow.

But with that, let me throw it over to Nora to specifically talk about full service.

Nora Everett -- President, Retirement and Income Solutions

Sure. Good morning. On the REFC side, full service retirement business, as we've talked about the last couple of calls, net cash flow has been impacted there by just a handful of larger cases. In fact, I spoke to one really large case for our block, and that out has actually been split between asset transfer there between 4Q -- about $800 million on that case went out in 4Q -- and about $1 billion on that case went out in 1Q '18. We saw it was north of 1.5 a quarter ago. With the equity market rise, it's at about 1.8.

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

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Jim, you want to take a crack at PGI?

James McCaughan -- President, Principal Global Investors

Yes. Thank you. I could illustrate this, I think, by talking about two of the late in the year client movements -- one in outflow and one in inflow. The outflow was for a currency mandate where the AUM was $1.2 billion. That went out in December. The revenue on that was just over $200,000 a year. In other words, it was a very straightforward, rather in a sense commoditized, mandate. The other big one in December was an inflow. $600 million for a large pension client into international small cap with the revenue being $3 million a year.

I think that illustrates the fact that the specialty asset classes that we are running still have quite rich revenues and have a pretty good pipeline. And that's the underlying reason for my confidence that we can continue with pretty good revenue growth, particularly management fee growth. I feel pretty confident about that. The pipeline remains strong and so you'll see quite unpredictable results in particular quarters as regards to flows, but the underlying revenue development for PGI in really very good shape.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

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

Luis Valdés -- President, Principal International Segment

Sure, Dan. Let me tell you that we're very pleased about our $2.5 billion in net customer cash flows in the fourth quarter. If you're looking quarter-on-quarter, and one year back, we're very pleased. The quality of that $2.5 billion is much much better than the one that we had one year ago. Pretty much, one year ago, we rely on Brazil. Now, you can see there's $1.9 billion coming from Lat Am and $0.6 billion coming from Asia. That's not counting the other $7 billion we had in China, which is part of our combined net customer cash flow.

So, I will say that we're pretty much more back to normal. $2-2.5 billion is pretty much more our run rate for a fourth quarter. The first quarter in 2018, every single first quarter is a little bit low because we're summertime in Brazil and Lat Am. So, we have to be a little bit conscious about that. But, we're very pleased to see that all our operations and companies and countries are putting positive net customer cash flows.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

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

Alex Scott -- Goldman Sachs -- Analyst

Yeah. On the pension business, we had a competitor announce that they were improving processes around finding annuitants where contact information had been lost, and there was an assumption in their reserves associated with whether those would end up being paid out. Can you provide some commentary on what you guys assume in your reserves for the pension business and your process around finding "missing" annuitants?

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Yeah, it is an important matter for customers and something we take very seriously. I'll ask Nora to speak to it specifically in our full service payout business.

Nora Everett -- President, Retirement and Income Solutions

Sure. I'm familiar with the competitor situation. We can't speak to the details, but when we look at our block, both with regard to the pension risk transfer reserves and the DB reserves, we're very confident that we're holding adequate reserves for those two businesses. We've had processes and procedures in place, and they're designed to locate missing or unresponsive individuals. We use both internal and external sources, so our confidence level is high. We'll continue to monitor the situation.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Thanks for the question, Alex.

Alex Scott -- Goldman Sachs -- Analyst

Thanks.

Operator

The next question is from Erik Bass with Autonomous Research.

Erik Bass -- Autonomous Research -- Analyst

Hi. Thank you. On taxes and employee benefits, we've heard at least one competitor talk about passing along the benefit from tax reform in terms of lower pricing. Can you talk about how you're thinking about after tax margins and pricing in that business?

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Yeah, That's fine. Amy, you want to take a crack at that?

Amy Friedrich -- President of U.S. Insurance Solutions

Sure. Hi, Erik. When you have a business that is reliant, as we do, in terms of the small to medium sized marketplace on your manual rate, we do studies on a continual basis that look at the expenses of our business, the claims pattern, and we do those on a quarterly and annual basis. So, you end up picking up things like a tax rate fairly quickly and moving it into your pricing.

I would see, especially for people who are using and reliant on more of a manual -- kind of that small case rating -- and they look at their block consistently, they would move that into their pricing fairly consistently. Now, you can always hold some things off for profit and make some discreet decisions. But, I would say leaving the market to itself, it would be reasonable to assume that some of that, if not all of that, benefit -- over a period of time -- a year, 18 months, two years -- would come back into pricing competitiveness.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

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

Erik Bass -- Autonomous Research -- Analyst

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

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

I'm glad you asked the question. As it relates to CIMB, the first thing I'd like to say is they have been a wonderful partner to work with for over ten years, and we think of them as very capable partners and good distribution partners. By going to more than 50%, or taking a majority stake in CIMB, it's going to allow Luis' Principal International Team to pull in more of Jim's resources with Principal Global Investors as we look at that area in a broader context. I look at it as a much bigger pie for the organization to go after across a broad a range of options across our entire sleeve of asset classes.

We're very enthusiastic about that, but let me as Luis to talk further about those acquisitions.

Luis Valdés -- President, Principal International Segment

Yes. Let me tell you that we're very excited in order to get additional control over our franchise in Southeast Asia. Just to picture you, we're talking about a footprint that we cover almost 350 million in a region which is growing every year around 4.5-5% year-over-year. So, it's a very vivid part of the planet. We're taking control in order to speed up our process and growth, not just in Malaysia, but also in Thailand, Indonesia, and Singapore, jointly with Jim with PGI.

We have had a tremendous partner in the last years with CIMB. It seemed to be that we just finished the first phase, which was to establish that footprint in the region, so we really need more things like operational staff and knowledge about those markets. But, going forward, it's pretty much more about asset management expertise, pension expertise, long-term savings products, distribution, and digital. So, this kind of transaction is opening up many many future opportunities for us.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Jim, do you want to talk a little bit about your enthusiasm for European commercial real estate and how that compliments our business?

James McCaughan -- President, Principal Global Investors

Yeah. For the last 20 years, Principal has been very focused on U.S. commercial real estate, both private equity and private debt. That's on the grounds that if you focus you'll probably be better will be very very strong. We got to a point, though, where our leading position in U.S. commercial real estate is leading to specific clients asking us to do things for them around the world. We had already started doing that in a modest way before the INTERNOS acquisition, but the INTERNOS acquisition brings us a pan European group that can be highly integrated into our real estate efforts.

Don't think of it as a typical semiautonomous boutique. Think of it as Principal Real Estate Investors Europe. That will enable us to provide very high quality services across Europe as well as the United States. That, in the end, is going to be a very important step toward globalizing our already leading real estate franchise.

First INTERNOS -- if you can forgive me for a comment on CIMB, it sits within Principal International, but we are really one company at Principal. We're working very close on the asset management function and the fact that we are taking a majority stake in the CIMB joint venture gives us a lot more control and leverage about the management of the assets. We will be able to make them, in effect, part of our global asset management platform. We believe that a strong local player with access to best global practices and all of our resources will do even better than that already successful partnership has been doing so far.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

To your last question, Erik, around what it means from a financial perspective, the best way I think about that is you look at our 2018 outlook. It would've anticipated these moves and I would say that they are baked into what we've already provided you. So, I appreciate the question. Thank you.

Erik Bass -- Autonomous Research -- Analyst

Thank you.

Operator

The next question will come from Tom Gallager with Evercore.

Thomas Gallager -- Evercore ISI -- Analyst

Good morning. I want to make sure I understand the way you're thinking about the RIS flows going forward. The 1-3% that I know you've targeted historically, is that not a good range to think about considering what's going on in large case, more the way we should think about the non-large case business for 2018? Any clarity there would be appreciated.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

I guess the way I would respond to that -- that 1-3% really works well with that core SMB market. Think about fewer than 1,000 employees. The minute you start having plans with 5,000-15,000 plan participants, and the turnover in those plans when they're measured in billions, is when you introduce that element of volatility. But, when I step back and look at that business line in total, they grew their participants by nearly 140,000-plus. They grew the number of plans this past year by over 800. They hit their marks within the SMB market, with the 1-3%. So, this really can be isolated to be the institutional element and, by definition, it's going to be volatile.

But, I'll have Nora clean that up for me.

Nora Everett -- President, Retirement and Income Solutions

Yeah, as a reminder, the equity markets put pressure on the AV based percentage. Those withdrawal amounts are driven higher by the market growth, whereas our payroll based contributions are not. So, the percentage itself gets materially impacted by the lift in the market.

But, back to Dan's point, when you look at being impacted 1Q this year by the one billion, the large case that has an outflow, there's already pressure on that metric. But, if you strip that out and take a look at the overall block, you're still going to see that core SMB well within that range. That's our expectation, anyway, sitting here today. But, there could be one or two outflows at the larger end of our block that would take us in total down to the lower end of that range. So, we're just going to have to watch those variables.

We'll obviously be as transparent as we've been historically, but it is a tough metric to cover the entire block.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Tom, do you have a follow-up?

Thomas Gallager -- Evercore ISI -- Analyst

Yeah. Nora, it sounds like, based on the pipeline you're seeing today, you would still be overall, including large case, in positive net flows. But, toward the lower end of the 1-3%. Is that a fair assessment based on what you know right now?

Nora Everett -- President, Retirement and Income Solutions

That's a fair assessment based on sitting here today. Absolutely.

Thomas Gallager -- Evercore ISI -- Analyst

Okay. Thanks.

Operator

The next question will come from Suneet Kamath with Citi.

Suneet Kamath -- Citigroup, Inc. -- Analyst

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

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Sure. Deanna, do you want to take that?

Deanna Strable-Soethout -- Executive Vice President and Chief Financial Officer

Yeah, I'll take that. You're correct. We previously had guided you to 21-23%. Our new total company effective tax rate is 18-21%. As you might expect, there's a lot of moving pieces underneath that, but let me highlight probably the three most significant. First of all, the tax rate is reducing from 35% to 21%. You have DRD that reduced around 60%, so historically it would've had about an 8-10% benefit on our ETR and now in that 3-4% range. And, probably the one that is harder for you to model and get your hands around is really how the tax rates of our foreign jurisdictions go into our effective tax rate. All of the jurisdictions that we are in have a tax rate in there. Previously, we had a foreign tax credit, and now we don't have a foreign tax credit and we take in actually the tax rates of those foreign jurisdictions.

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

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Was there a follow-up?

Suneet Kamath -- Citigroup, Inc. -- Analyst

Yeah, that's helpful. On the large case RIS fee questioning, I had thought previously when you talked about those terminations, a lot of that was driven by M&A. But, it seems that the tone on this call is a little different. Maybe I'm wrong. I just wanted to look under the hood here and see what's going on in that large case market. Is it price competition? Is it people folding tax rate declines into their pricing? What's driving some of this commentary?

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

No. I don't think anybody's done that. I would still say you've got three buckets when you think about why you might lose a piece of business. M&A is still far and away the biggest one in the large case market, where our customer was acquired, and oftentimes they go to the larger, or the acquired, company. That represents about half of it. Just as a side note, on that really small to medium sized business, businesses go out of business and there is new plan formation. We're certainly benefiting there, but that's also another place where we lose it.

The second area is in some way, for whatever reason, we underperformed from a customer service investment performance -- that whole gambit of products and services. That's the smallest bucket. We query ourselves extensively. We hire third parties to evaluate how we're performing for our customers and a lot of that is publicly available information, so we feel like we're doing a really good job in that category.

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

Nora, do you want to add to that?

Nora Everett -- President, Retirement and Income Solutions

Yeah. This is a very practical aspect of our business. You can have a key decisionmaker change. You can have an advisor or consultant change. So, we see day-to-day that that can have as much of an impact as whether you're talking about service levels or pricing. There is just the practical aspect of this business that comes into play.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

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

Nora Everett -- President, Retirement and Income Solutions

Our retention rates remain remarkably high. We have very, very strong retention at the plan sponsor level. So, we're highlighting these larger cases because they're impacting net cash flow. But, the retention on the block is extremely strong and industry leading.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Appreciate the question. Thank you.

Suneet Kamath -- Citigroup, Inc. -- Analyst

Thanks, Dan.

Operator

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

Jimmy Bhullar -- J.P. Morgan Chase & Co. -- Analyst

Hi. Good morning. First, on PGI, your performance fees were low in 4Q and I think that was expected, just given how your contracts or earnouts were structured. Can you comment on what your expectation is for this in 2018? And, on the international business, maybe if Luis could just talk about the competitive and regulatory environment in Chile? It seemed like there were some headwinds with MetLife lowering pricing and political pressure, but the election's gone in the right direction and it seems like those might be abating. But, what you're seeing in the market.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Yeah, as you know, with the presidential election in Chile, things are perhaps better for business broadly defined. Jim, do you want to go ahead and talk about performance fees?

James McCaughan -- President, Principal Global Investors

Yeah. Thank you, Jimmy. The incentive fees have been low in 2017 and will remain fairly low in 2018 most likely, not because of performance, but because of incidence. Remember, the big ones we have are mainly on real estate, both debt and equity, and have assessment periods of three, five, or even more years. Indeed, in some cases, the incentive fee only comes when you have the outflow and sell the assets.

So, that structure means that the incidence is somewhat predictable, even if the exact amount when it comes, is pretty hard to forecast. We will get up to good levels of performance again 2019-2020. That's when we see a bit more incidence. There is some possibility that something will be brought forward into 2018 because of clients wanting to take their profits and move on. That, of course, is good news. It's mission accomplished as far as the client's concerned. But, I wouldn't count on that happening. It is possible, but mostly likely we'll be back to what I think of as a more normal of these longer term incentive fees in 2019 and 2020.

Lastly, there is an annual performance fee piece, which is rather smaller than the multiyear carries. That would be primarily our hedge fund and a few loan only pieces where we have an annual incentive fee. That was pretty thin in 2017 as well. As you know, the hedge fund world has found it hard to earn carry to decent results. But, we're optimistic that that will come back over the next year or two also. But, that's more a matter of predicting particular segments of the market rather than the incidence. But, really, it's the incidence that drives it.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Excellent. Luis, you were just down in Chile.

Luis Valdés -- President, Principal International Segment

Yeah. Jimmy, we do think that the political environment in Chile during the next four years is going to be much more positive and pro market in essence. So, I do think -- we're not for sure -- that the next administration that is going to take over March 11, it's very likely that they're going to repeal and replace the current pension bill that is in the congress. That's my personal take. Last week, the current administration didn't have a quorum to approve a small piece of that legislation, so it seems to me they're not going to try to attempt any other try for that particular pension bill.

Also, the other good news is that we already have some information about how the new administration is taking a look. They have a much much holistic approach to the pension program in Chile. So, the AFPs are just one pillar out of four and the main problem that Chile has is with other pillars instead of the AFPs. The AFPs really need some adjustments, particularly the rates and other things, but we think that this pension reform is going to be much broader and more interesting and much more compelling.

We're pleased with that. A lot of work has to be done. We're going to be very eager to continue working on -- about fees and pressure fees. As I've said to you many times, our position is highly differentiated. We're number one in customer service. We just ranked again in the top hundred most reputable companies in Chile. In the long-term investment performance, we're number two in four strategies out of five. So, I would say that we differentiate ourselves in Chile as the best pension company.

Having said that, we're not competing head-to-head with MetLife and ProVida. So, if we're making any decision going forward, it's going to be in light of the interests of our customers. And that is what we're looking every time, all the time.

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Jimmy, appreciate your questions.

Jimmy Bhullar -- J.P. Morgan Chase & Co. -- Analyst

Thank you.

Operator

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

Sean Dargan -- Wells Fargo Securities -- Analyst

Hi. I just have one question about the pace of expenses to come. When you look at your product offering, specifically in RIS, compared to where the competition has gone in terms of digital solutions that allow the participants to check on their balances and do things on a daily basis, are you where you need to be? How much longer is this period of investment going to go on until you get to where you need to be?

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

I don't think it every goes away. When I reflect on this, I think about the current expense run rate that we've had, as focus on trying to reduce our expenses, and also add to new capabilities. We are leading best in class today. I would say that one of our greatest threats probably comes from nontraditional players, because consumers have now had a really good look at how they purchase other things unrelated to financial services.

So, I think what we're up against is an environment where the ante has been raised relative to the customer experience, its simplicity, its convenience, and how we access it. So, this digital initiative, as we spoke about this back on December 12, has everything to do with about two-thirds of the portfolio on driving revenue and about one-third of it is about taking out additional expenses. It touches the consumer within our group benefits, it's individual life, it's our RIS fee business, it has to do with driving technology in Jim's portfolio management area and hiring data scientists and people with a lot of skillsets that are new to Principal.

And, although I don't think this expense rate's ever going to come back down -- I think it's going to remain elevated -- we will see, after 12 months, 24 months, and 36 months, those revenue enhancers coming in and that expense being taken out. I wouldn't want to leave you with the impression that somehow you have to finish up 2018 and the expense run rate is reduced. I think, in fact, it'll be where it's at and we'll build upon that new base. We can expect revenues and expense reductions in other areas to offset those. Hopefully, that helps.

Sean Dargan -- Wells Fargo Securities -- Analyst

Yeah, thanks, Dan.

Operator

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

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

I think it's pretty simple. From our perspective, our fundamentals remain very much intact. It's around introducing financial security through retirement solutions, asset management, and protection -- whether it's life and certainly annuities. The demand couldn't be greater. We know that around the world they're underserved and under protected. They're under advised. We have a lot of solutions that get after each one of those areas.

What we didn't want to do, of course, is underinvest in these businesses and find ourselves behind the 8 Ball, or irrelevant, as time goes on. As our shareholders, as people that are interested in the success of this company, it has everything to do with making sure our customers are getting what they need for them to be successful in the future. So, I appreciate your interest and we look forward to seeing you out on the road. Thank you.

...

Operator

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. Eastern time until end of day February 6, 2018. [Operator instructions]. Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect.

Duration: 64 minutes

Call participants:

John Egan -- Vice President of Investor Relations

Daniel J. Houston -- Chairman of the Board, President and Chief Executive Officer

Deanna Strable-Soethout -- Executive Vice President and Chief Financial Officer

Nora Everett -- President, Retirement and Income Solutions

Luis Valdés -- President, Principal International Segment

Amy Friedrich -- President of U.S. Insurance Solutions

James McCaughan -- President, Principal Global Investors

Alex Scott -- Goldman Sachs -- Analyst

Jimmy Bhullar -- J.P. Morgan Chase & Co. -- Analyst

Erik Bass -- Autonomous Research -- Analyst

John Barnidge -- Sandler O'Neill & Partners -- Analyst

Suneet Kamath -- Citigroup, Inc. -- Analyst

Sean Dargan -- Wells Fargo Securities -- Analyst

Thomas Gallager -- Evercore ISI -- Analyst

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