#278 | Principal Completes its Strategic Review

small judge gavel placed on table near folders

Yesterday morning, Principal announced the conclusions of the strategic review that had been brought on by activist investor Elliott Investment Management’s increased stake in the company earlier this year and their demands that Principal take a hard look at its business operations. My phone and email immediately lit up with messages saying some variant of “another one bites the dust.” Based on the press release, it’s hard not to draw that conclusion when the headline of a section reads “Discontinue sales of US retail fixed annuities and consumer life insurance products.” But read a little deeper and the story gets quite a bit more interesting.

Before I get there, I want to reference back to the article I wrote when Principal announced that it would be doing the strategic review. My point in that article was more or less that I thought the Principal strategic review would come to different conclusions than what we’ve seen at other companies for one simple reason – Principal isn’t saddled with a toxic Variable Annuity block and isn’t conducting the strategic review out of necessity. Instead, the review was initiated by a third party looking to get blood from a stone and, fortunately for them, there were a couple of very obvious ways to do it.

I argued that, by far, the most likely outcome would be a reinsurance deal for their in-force fixed annuity block. That was a slam dunk. It would immediately release a few hundred million dollars in capital and ceding commissions. Beyond that, if they could line up a buyer, they’d also want to dump the in-force Guaranteed UL block in a similar trade to what Voya just managed to pull off with Resolution Life. Finally, I argued that Principal’s new business life and annuity offerings were interwoven to the core Principal story of working with businesses and, therefore, unlikely to be eliminated whole cloth.

I ended that article by saying that my observations were pure speculation. That’s true. I had no inside track at Principal and no one I know at the company was involved in conducting the strategic review. The folks I know at Principal were awaiting the results as eagerly as you and I were, albeit with much more skin in the game. My observations about what was most likely to happen were simply logical conclusions about what I knew about Principal’s block and new business operations. Anyone could have come to the same logical conclusions that I did.

And, in this case, logic prevailed. Principal did what I thought they’d do almost to the letter. The hallmark of the strategic review is, as expected, the pursuit of “strategic alternatives, including divestiture” of the in-force fixed annuity and Guaranteed UL blocks. According to the press release, those two blocks tally up to $25 billion in reserves, making the combination a pretty attractive target by virtue of its sheer size. In my view, the deck is stacked for Elliott’s own Prosperity Life reinsurer to take those two blocks, but we’ll have to see what happens when the actual trade is announced.

On the new business side, Principal is refocusing its life and annuity efforts towards one market – businesses. For annuities, that means eliminating its traditional deferred annuities, payout annuities and indexed annuities. This sounds more dramatic than it actually is. Principal has never been a major player in those lines of business and their offerings aren’t particularly competitive. Principal had to do something with them to justify their existence and, given that they clearly weren’t making investments to keep up with their competitors, cutting the products probably made more sense than trying to grow their presence. However, not all is lost for annuities at Principal. They are retaining their variable annuity that “plays an important role within [Principal’s] complete suite of retirement solutions.”

The picture for life insurance is quite a bit more nuanced. The press release says that “Principal will fully exit the retail consumer market – discontinuing new sales for term life and universal life products to retail customers” and then later says that “the company will continue to support business owners and key executives, allowing for an even sharper focus on the business market and products with limited interest rate exposure.” In another communication to its distribution partners, Principal says that “in US life insurance, our product portfolio remains largely the same…what’s different is we’ll focus exclusively on the business market” and that “the company will discontinue sales of its products to retail customers by the end of the third quarter 2021.”

Allow me to translate for you – Principal isn’t going to write a life insurance policy on your high net worth client unless your high net worth client happens to be a business owner. Besides that, it appears, nothing is really going to change. Principal is still very much going to be writing life insurance because, as other documents point out, 60% of its business already involves businesses and business owners and that’s where the company has long focused its efforts.

If drawing the line at business ownership seems like a wonky technical distinction, that’s because it is and it raises a lot of questions. What qualifies your client as business owner? Will a sole proprietor LLC do the trick? What about a small minority share in a non-controlled company? How about a business owner who buys a policy in their personal estate? What about a business owner who buys a policy in a trust for estate tax purposes? Is Principal really not going to take a case just because the client doesn’t happen to own a business but if they set up a little LLC with an ostensible business purpose then they can have a Principal policy? It makes no sense.

After being a part of one of these strategic review projects during my time at MetLife, I have a suspicion about how this decision happened. This was a strategic review demanded by a third party. Principal couldn’t just say that they were actually already running a lean shop in their life insurance area and had already begun to transition away from interest-sensitive products like Guaranteed UL. They had to do something. Preferably something, you know, strategic. You know what sounds strategic? Saying that your core mission is serving businesses and so, therefore, that means you should stop selling life insurance to anyone who isn’t a business-owner. Elliott wanted blood and Principal gave it to them – albeit, with this one, it’s costume blood.

In my view, the announcement about the Life business was designed for the sole purpose of making an initial splash. That’s it. Someone wanted a dramatic headline and they got it. But over time, my hunch is that the business-only sales restriction will turn into very much a gray area where the company makes a lot of exceptions for its key distributors – who, by the way, it seems will still very much have access to Principal products – and eventually does away with the restriction altogether because it just doesn’t make sense. Principal can focus on the business market and “look to further invest and build even more differentiating capabilities to serve this customer segment” without, in any way, being impacted by selling policies to individuals. How do we know that? Because Principal has been doing it already for decades and my hunch is they’re going to keep doing it because it was working.

Mark Twain once famously said that “the reports of my death are greatly exaggerated” and Principal could say the same thing for its Life operation. Don’t write the headstone yet. Better yet, don’t write it at all. From what it looks like so far, precious little is changing for life insurance at Principal and that’s a welcome change from the deluge of life insurers getting out of this business. In fact, by the time Principal actually gets around to “phasing out” its sales to retail customers later this year and Elliott has already made its triumphal exit holding aloft its prized reinsurance deal for Prosperity Life, there’s a chance that the restrictions might not even be enacted at all and in the end, nothing will actually change.

Except, of course, for the folks who own Guaranteed UL products written by Principal. That’s where things get thorny. Principal was a heavy user of captives and a smaller writing entity (Principal National Life) that allowed it to stay in – and even competitively in – the Guaranteed UL market for far longer than some of its peers. An acquiring company will undoubtedly take the capital structure of the Guaranteed UL block. On its own two feet and without the umbrella of a strong parent life Principal, the Guaranteed UL block is very likely on the same shaky ground as all other Guaranteed UL blocks with the same sort of capital structure – and an acquirer will undoubtedly thin the capital structure even more to make the economics work.

None of this is good news for Guaranteed UL policyholders who thought they’d bought a Guaranteed UL from a conservative, highly-rated midwestern company. The name on their policy is going to change and there is no chance that it’s going to be a welcome change. Long gone are the days when a firm like Hartford can sell its business to a bigger, stronger and even more highly rated carrier like Prudential. Now, the game is reversed – major players pawning off their business to small firms specializing in wind-downs. Block divestitures flow downhill, eventually all pooling at the bottom in a tar-black concentration of specialty run-off firms, captives and off-shore reinsurers.

That’s the state of the world we’re in. So while we can take as welcome news the fact that Principal is still going to be a player in writing new life insurance, that’s cold comfort for the folks who sold Principal Guaranteed UL – and there are a lot of them. And they are not going to be thrilled about their policies being pawned off. Not one bit. And they’re going to remember it the next time they’re tempted to write a Principal policy and, for that, Principal needs a response.