Letter from the CEO

Despite rocky financial markets in 2018 and persistent revenue pressures, I offer two words:

Stronger.

Better.

Those words perfectly capture how I feel about Principal and our year of progress toward lasting success. We've launched an accelerated digital strategy. We're expanding our global asset management franchise. A volatile business environment didn’t discourage us.

Over 140 years, Principal has endured war, depression, recession, volatility, and disruption. Edward Temple had already rebounded from more than one financial panic when, on June 25, 1879, he established Bankers Life, offering Midwestern bankers the security of life insurance. His company would grow and thrive to become Principal Financial Group.¹

Today, we deliver investment expertise and financial solutions to individuals, small-to-medium-sized businesses, and institutions worldwide. We’re taking bold and deliberate steps forward on strategic projects and investments that will enable us to deliver better results for our customers and power our businesses for decades.

We’re well diversified and committed to our mix of asset management, asset accumulation, and protection businesses. We’re going digital in the right way. And global demographics tilt in our favor.

Still, the essential character of Principal hasn’t changed. We’re grounded in dependable performance. We act on core company values. We prioritize customer service and financial security.

For a deeper dive into how that’s happening and how it benefits you, keep reading.

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2018 markets versus our fundamentals

We closed 2018 with the worst December for U.S. stock markets since the Great Depression and the worst year for stocks in a decade.² Our international operations faced macroeconomic headwinds that dampened our earnings.

Throughout 2018, our assets under management (AUM) declined $42 billion, mostly due to unfavorable market performance and foreign currency exchange.

We weren’t alone in experiencing pressure on AUM. The retail mutual funds industry last year saw a wave of outflows from active U.S. equity funds, as some investors shifted to passive or cash in response to market volatility.

Our total company net cash flow was a negative $2 billion in 2018 despite positive net cash flow from both Retirement and Income Solutions and Principal International.

More broadly, our AUM since 2013 has grown by more than $140 billion, or 30 percent. In the past five years, this fact helped drive a 9 percent compounded annual growth in non-GAAP diluted operating earnings per share.³

Despite 2018’s volatility, we still added 1.4 million net new customers. We also delivered a record $1.6 billion in non-GAAP operating earnings,³ an 8 percent increase in 2017.

Like most companies, we face stiff competition. Like most industries, we feel the pressure on margins. Digital access is transforming financial services at exponential speed. People have long since adapted to online shopping and streaming video. These are our clients, who demand similar convenience and value from us.

It’s up to us to cultivate technology that not only meets but exceeds their expectations.

Digital development is more complicated than merely rushing to keep pace with rapid change or lower fees; in a minute, I’ll share with you why our strategy adds to my optimism about our future.

We’re in the throes of the largest middle-class expansion in history, much of that centered in Asia. Half the world’s population already is, or soon will be, considered middle class.⁴ A rapidly aging globe will hold 1.6 billion people 65 and older by 2050.⁵ We’re long established in regions where these demographic shifts should help us continue to deliver above-market growth.

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5 strategies to power long-term growth

To better prepare for that future, 2018 was a year in which we rededicated ourselves to a set of five clear strategies that capitalize on Principal’s traditional strengths.

1. Remain good stewards of shareholder capital.

We deploy our capital with balance and discipline, last year to the tune of nearly $1.4 billion.

Our priorities are to:

• invest in our existing businesses to drive organic growth,
• acquire new businesses that are a strategic, cultural, and financial fit, and
• return capital to shareholders.

We repurchased $650 million in shares in 2018 for antidilutive purposes and to capitalize on valuation of our stock. We’ve raised our quarterly common stock dividend 11 consecutive times in recent years to target a payout ratio of 40 percent of net income.

At year-end, we had more than $1 billion in available capital at the holding companies and $400 million of available cash in our subsidiaries. The $750 million of contingent funding arrangements that we added in 2018, along with a low leverage ratio and no significant debt maturities until 2022, gives us significant financial flexibility.

We plan to deploy from $1 billion to $1.4 billion of net income externally in 2019.

Last year we completed the purchase of MetLife AFORE (now Principal AFORE) in Mexico. We’re now the fifth-largest mandatory pension provider in Mexico, with 7 percent market share. Through Principal AFORE, we now manage about 3 million individual retirement accounts and $11.3 billion in assets.

We also completed the purchase of INTERNOS Global Investors (now Principal Real Estate Europe), expanding our investment network in European real estate and bringing Principal Real Estate Investors to more than $70 billion in AUM at year-end.

In July, we acquired RobustWealth, bringing us a digital advice platform, goal-based investment tools, and more efficient client enrollment. We’re also building planning features that will allow advisors to configure their own digital experience for clients.

But RobustWealth is just one component of a much broader digital strategy.

2. Accelerate our digital investment.

Investments in digital and technology are nothing new for Principal. Our work with technology, like everything we do, is grounded in improving the customer experience. We don’t chase that one killer app. No tech fad or gimmick can single-handedly deliver lasting success.

So we’ve outlined a comprehensive digital investment plan to sharpen our competitive edge. The underlying goal is simple: Reach more clients who demand convenient and efficient - yet fully secure - digital solutions.

In 2017, we named a chief digital officer to design our next generation of digital capabilities and help chart the best path forward.

We’ve embarked on a multiyear accelerated spend on strategies to transform our customers' experience, provide direct advice and sales, and build our future investment process. We expect an internal rate of return on this investment of at least 20 percent, with revenue and expense gains beginning to emerge in 2019. Rest assured, we remain committed to aligning expense growth with revenue growth. We’ll continue to take appropriate expense actions in 2019 to improve our cost structure.

The acquisition of RobustWealth was one of the more noticeable pieces of this strategy. The platform allows individuals to better manage their financial lives or advisors to offer fine-tuned customization to their clients. The technology harnesses more than 6,000 different asset allocation outcomes to help meet each client’s unique financial goals and risk tolerance. This development complements the ongoing expansion of our distribution through wirehouses, broker dealers, and other traditional channels.

Whatever we offer must be simple, personalized, and secure for our customers. We want to put their financial goals within reach, not complicate their lives. We pursue a variety of digital innovations in four main areas:

Next generation customer experience: Last year we launched an online chat tool for retirement plan sponsors. This year we’re delivering an enhanced Principal mobile app that allows account holders to sign in with a thumbprint or facial recognition. But effective digital customer experience also includes less visible work behind the scenes. A life insurance policy traditionally required nearly a month to buy. Now through the use of Accelerated Underwriting^SM and digital improvements, it takes on average less than half that time. Often we can put a policy in the customer’s hands within a few days.

Direct to consumer: Most people don’t have access to a traditional financial advisor. But we can reach even more clients through digital sales and advice. In the U.S., we offer advice to retirement participants with benefit events, including when they change jobs or transition to retirement. Ciclic, our joint venture with Banco do Brasil’s insurance and pension operation, is one of Brazil’s first digital retirement sales platforms. Claritas, our investment company in Brazil, now sells mutual funds through 13 digital platforms. In 2018, our China joint venture added more than 2 million investors and more than $4 billion in AUM through Alibaba and Tencent. By the end of 2018, we totaled 4.4 million digital customers in China, more than half of them under age 35, which is another indication of how we can benefit from a demographic wave.

Effective investment management: We’re building an “analyst cockpit” to help Principal Global Equities and other teams boost investment performance. This will magnify the impact of our analysts, giving them the capacity to evaluate dozens more companies—more efficiently and in greater detail. The new system predicts earnings surprise by managing a constant stream of data and prioritizing critical information. It zeroes in on long-term expectation gaps that are likelier to bring success to a portfolio.

New efficiencies: In little more than a year of implementing robotics process automation across Principal, we’ve saved more than 77,000 manual hours and more than $2 million.

Robotics process automation is just one example of the array of work housed at our most unique and comprehensive innovation lab in Pune, India. Principal Global Services teams work there across the boundaries of IT, high-end business services, and data analytics. The staff of 1,400 includes not only analysts and actuaries but also medical doctors. The work in Pune enhances the account data used by several countries and serves Principal's global data analytics needs.

Despite this broad digital investment, we never forget that it’s merely a means to an end. We always start by asking a basic question: How will this improve our customers’ financial lives?

3. Expand our global asset management franchise.

Our investment management expertise bolsters our accelerated digital spend.

Today, we think of ourselves as a solutions provider. That means connecting better with clients to understand exactly what they want to achieve.

At year-end, Principal had $627 billion in AUM. We manage assets for institutional clients in more than 80 nations and territories.

Principal Global Investors collaborates effectively with Principal International, Retirement and Income Solutions, and U.S. Insurance Solutions to make sure we’re doing more to tailor our offerings based on investor need, whether that’s for retirement and other long-term strategies, income solutions, or other outcomes such as capital preservation and protection against inflation.

We help millions of workers save for retirement and other long-term needs in the U.S., Latin America, and Asia. And we manage assets to meet ongoing obligations to our insurance and annuity customers.

In short, we operate as one Principal.

Responding to demand for lower-cost options, we’ve built a strong network for systematic investing with Principal Global Equities and are building a similar structure in Principal Global Fixed Income. That positions us well in active, systematic, and passive strategies. In 2018, we launched more than 50 new investment options across our domestic and international platforms. We also earned more than 120 total placements on various third-party distribution platforms—more than 50 different offerings on nearly 40 different platforms.

Principal does business in more than 80 nations and territories.

In the U.S., we're also working with Retirement and Income Solutions to take greater advantage of the opportunities in the IRA rollover and defined contribution investment-only markets.

Through Principal International, we’re becoming more effective at making local investment capabilities available to global portfolios and vice versa. We have a team based in Hong Kong that’s adept at cross-pollinating local and global investments. Our domestic experts in commercial real estate investing have worked closely with their counterparts in Chile, building our franchise there.

4. Capitalize on emerging markets.

A generation ago, Principal International was aspirational. Today, we have 19 million customers across 10 international locations. In 2018, this division generated more than $250 million in pretax operating earnings.

And that excludes our AUM in China, which has grown from $4 billion to nearly $150 billion over this same period.⁶

Including China, that’s nearly tenfold growth overall in AUM, from $33 billion to more than $300 billion.

This is the consistent story of Principal: With foresight and resolve, we plant the seeds for long-term growth. Millions of people around the globe are reaching an income threshold that makes voluntary savings possible—and necessary. Our effective management of both accumulation and de-accumulation helps us serve them.

Citizens around the globe want investments they can understand, which is why much of the world’s population still invests heavily in cash and real assets. As their economies develop and societies support longer lifespans (I’ll elaborate on this later), we can help provide the equities, fixed income, and other solutions they may need for financially secure retirements.

This is why Principal International and Principal Global Investors are working hand in hand.

For instance, we first established an office in Beijing in 1995. In 2005, we launched our joint venture with China Construction Bank, CCB Principal Asset Management Company. In a relatively short time, our joint venture has become China's third-largest retail mutual fund company.

As proof of our traction in 2018 compared to 2017, net cash flow in China increased 80 percent to $33 billion.⁷ We also nearly tripled the net cash flow in Asia (excluding China), to $3 billion.

Principal International has put us at the heart of a massive demographic boom in markets where our investment expertise is well suited to help millions of people achieve financial security.

As we did in 2018, we’ll continue to invest to build scale and capabilities. I already mentioned our purchase of Principal AFORE in Mexico. We also increased our ownership of CIMB-Principal Asset Management Group in Southeast Asia to 60 percent, expanding a partnership begun 12 years ago.

5. Act on our ESG ideals.

Environmental, social, and governance (ESG) have long been top of mind at Principal and are well-integrated into our core values and management. An ESG committee drives these efforts across six categories:

Governance, ethics, and risk: This encompasses everything from the Board of Directors to shareholder rights and data. The board oversees management’s execution and performance of its risk management responsibilities—including oversight of credit, market, liquidity, product, operational, cybersecurity, and general business risks.

Employee engagement and development: We're proud to be routinely cited as a welcome and supportive workplace. Forbes in 2018 ranked us as America's Best Employer for Women and No. 6 among the Best Employers for Diversity.

Responsible investing: We integrate ESG into our investment philosophy and process. We’re a leader in creating and managing real estate funds focused on environmentally efficient projects (“green funds”).

Operational environmental impact: We strive to be responsible stewards of our environment by reducing water usage and taking other steps to minimize our carbon footprint.

Consumer protection: We educate our customers on what they purchase and focus on providing fair marketing of our products.

Community investments: Wherever we do business around the globe, we strive to be a good corporate citizen through ethical business practices, employee volunteerism, and philanthropy. Our Principal Foundation, for instance, has a goal within the next five years to help 50,000 youth in communities worldwide to earn and save more.

These strategies turn the global retirement challenge into opportunity.

With our global expansion, we’ve embraced the responsibility of helping to alleviate the global pension savings gap, because people of every nation are increasingly responsible for their own financial security. The notion that governments can save the day and close this gap is long over. Workers must take control of their own savings and retirement—with guidance from the private sector.

Meanwhile, the fundamental structures of economies and employment are shifting. In the U.S., where 10,000 baby boomers retire every day,⁸ the demographic imperative of global aging is clear. But it’s equally clear in countries like Brazil, Chile, China, India, Indonesia, Malaysia, and Mexico, where the ratio of elderly (those 65 and older) to workers (ages 20 to 64) is projected to double, and in some cases triple, between now and 2050.⁹ And 61 percent of the world is informally employed—the vast majority of those workers (93 percent) in emerging and developing markets.¹⁰

We have much to offer from our experience in the U.S. retirement industry. Consider that U.S. workers have amassed more than $24 trillion in retirement savings, primarily in individual retirement accounts and defined contribution plans. The U.S. by far is the world’s largest retirement market among 22 of the top nations, with 62 percent of assets, followed distantly by Japan (7.7 percent) and the U.K. (7.1 percent).¹¹

Internationally, the pension gap is especially challenging because these emerging markets are getting older before they’ve gotten as wealthy as developed nations.¹²

But this is why we’re in the right business for sustained growth. We’re connecting with people who may never have access to a traditional financial advisor. We’re successful at our job only if workers around the world become more secure retirees.

We press on to promote financial security.

Our successful protection and retirement businesses in the U.S., and our focus on small- and medium-sized businesses (SMBs), continue to show our investment in the growing middle class.

We’re more committed than ever to our relationships with 140,000 SMBs. For instance, the average company that we serve with a retirement plan employs about 140 workers. Our average group benefits customer employs around 40. That epitomizes the economic backbone of Main Street America.

At the end of the 19th century, connected by rail and telegraph, our company spread across the Midwest to enable the financial security of an underserved population far removed from the established commercial capitals.

In the early 21st century, connected digitally around the globe, we’ve spread far beyond the Midwest and the sole business of life insurance. But what was true in the 19th century is even truer in the 21st: We help deliver financial security to more clients than ever.

Twenty-five years ago, we couldn’t foresee exactly how international markets would transform us. But we saw the clear trends and acted on our conviction.

Today, we follow a similar strategy of sustained investment with technology and global asset management.

We have a lot more work to do. But our 2018 milestones define our path ahead.

We will be nimbler for all our customers.

Valuable to our shareholders.

Stronger.

Better.

Sincerely,

Dan Houston

Chairman, president, and chief executive officer