It's not every day one encounters a company that's content to be No. 2. But that's exactly the business plan of Principal Retirement & Investor Services. While Principal serves three million investors in 40,000 employer plans, most of those plans are at companies with 1,000 workers or less.

Ever since Principal, a 125-year-old firm, entered the pension and retirement services market 60 years ago, it has concentrated on serving smaller businesses with personalized service, says Larry Zimpleman, president, Principal Retirement, and EVP of Principal Financial Group.

Zimpleman recently spoke with Money Management Executive Editor Lee Barney about how he plans to grow his firm, as well as some of difficult issues facing 401(k)s.

MME: How has becoming a publicly traded company three years ago changed your firm?

Zimpleman: For the quiet firm that we are, being a public company has really raised our visibility. Asset management is just the integral part of our retirement businesses. We have to be good at asset management in order to be good at retirement.

That said, we have continued to focus on our retirement business. We are extremely well-known in the industry as one of the nation's 401(k) leaders, and as a leader in total retirement services, particularly in the small-to-medium-business (SMB) market.

MME: Why pursue the smaller market?

Zimpleman: That's how we define ourselves: Serving employers who have 1,000 employees or under, although we are also finding ourselves in the 1,000-to-2,500-employee market, because of our total retirement solutions capabilities.

This is the market we have pursued for the 60 years that we have been in the retirement market business. We have a very long and deep expertise in that business. We have a local presence in 47 cities around the U.S. We have 100 sales reps. We have 150 service reps. So, we have the national footprint to pursue a very local SMB strategy.

We have also built an impressive array of infrastructure and technology capabilities that gives us a very, very scalable platform so we can use our fully bundled retirement solution without having to add cost. All this works very well in the small/medium business market.

MME: When Principal started in this 60 years ago, at that point, a company with 1,000 employees would have been a giant. As corporate America grew to be larger, did you fall into the next-tier down?

Zimpleman: We definitely want to be in the second tier. I can't emphasize enough that it is a chosen decision on our part. It's not that we couldn't compete.

If you look at the 1,000-or-less market, you'll find that 98% of the businesses in the United States would be classified as small/medium businesses, and there are 5.7 million businesses out of six million that are in this niche. So, we think we have the lion's share of the market.

The other thing is that when you look at the net employment growth and the general year-by-year economics, you see very different trends in the SMB market and the large market. If you take the decade of the 1990's, for instance, the SMB market saw net employment growth in nine of those 10 years. That has not always been the case in the large employer market, which not only is saturated, but tends to go through boom-and-bust cycles.

MME: Is that why Fidelity has been targeting the smaller 401(k) market in the past few years?

Zimpleman: I think that's right. There are no new companies of 5,000 or 10,000 people being formed. Ninety-five percent of those companies already have a 401(k) or defined contribution plan. Anything there involves what we call a transfer or takeover situation.

In the 500-or-less employer market, only about 40% of those employers have any type of defined contribution plan. Overall, that adds up to 11% per annum growth in the large market, and 15% in the SMB market.

MME: What about corporate governance, a hot topic today. Are your clients now making any new requests here, with regards to concerns over the fund scandal and better governance?

Zimpleman: Our clients are experiencing a significant amount of concern and anxiety, as we all pick up the paper every day and read about some new variation of the problems. It continues to be a troublesome and unfortunate series of events for the industry.

They want us, as an organization they rely on, to play a more active role in monitoring and, ultimately, due diligence, around the various investment options and providers they make available.

They expect Principal Financial Group to be a very important partner to them, to make sure that the right monitoring and the right decisions are being done and made, relative to investment choices. This has become a critical part of our sales process. It's become a critical part of our servicing process.

The good news is that going back three years ago, we set about to create a very robust monitoring/due diligence process. We call it the Principal Blueprint Process, which involves a very active dialogue with every one of our investment managers.

Besides Principal Global Investors, we also offer other 401(k) sub-advised options from 12 other investment management firms. If we find that some of these firms do not have the desired level of compliance or safety and security of protecting our investors' retirement funds, then it will be our responsibility to make the right choices to make sure these retirement monies are safe.

MME: Have you eliminated any funds yet?

Zimpleman: We have not, as yet, but we are actively monitoring a number of the names that have been in the press.

MME: One of consumer advocates' concerns has been a potential conflict of interest between fund companies' plan sponsor divisions and investment management divisions, with regards to voicing proxies and corporate governance concerns.

Zimpleman: Like all mutual fund companies, a majority of our board is comprised of independent, outside directors. In fact, I am on the mutual fund board, and I chair the mutual fund board.

In our case, for our mutual fund complex, Principal Global Investors is not the only investment manager that we use in our mutual fund family. Our goal, again, is to do the right thing with regards to all of the investment options we offer. So, whether it's Principal Global Investors or an outside sub-advisor, our board provides significant input to us as to who should be managing the various investment products on our open-architecture mutual fund platform.

MME: Besides targeting the SMB market and having been a mutually owned company, how do you try and distinguish yourself from your competitors?

Zimpleman: There are four answers, really, as to why we are unique. First, as I've said, retirement is our lead business, without minimizing the complementary insurance businesses.

Second, the depth and the breadth of our retirement offerings is significantly beyond what the bulk of our competition could provide. For example, with the market now moving towards total retirement solutions, not just 401(k), we also offer non-qualified and defined benefit solutions, as well as a single statement and a single Web site.

We, thirdly, are pursuing a fully bundled solution that includes all of the employer-level plan design, discrimination testing [i.e. suitability and equivalent tax incentives for all income levels], enrollment, participant-level communication and recordkeeping.

Such exhaustive offerings are very unique in the small-to-medium business landscape. When you go upmarket a bit, to firms on par with Fidelity and Hewitt, you'll see this level of service, but a fully bundled market is very unique on this end.

Fourth, and finally, we offer a very extensive sales and service platform locally, throughout the United States. That density is two-to-three times what our competition provides.

MME: What, to your mind, are one or two of the more interesting trends right now in the defined contribution space?

Zimpleman: The one thing that is happening, very quickly, is this movement toward total retirement solutions. At the same time, employers are under cost pressure. Ten and five years ago, you could compete just on 401(k)s and write a lot of business. But today, in order to really be a partner to that human resources department, you have to be a partner to all of their retirement programs.

This is really going to redefine who is going to compete and win. It's going to be difficult for a lot of the providers to have enough mass, scale and expertise to compete in a total retirement solutions landscape.

MME: You haven't mentioned advice/education in your total retirement solutions package. Where do you stand on this issue?

Zimpleman: The way I think about this is on a continuum, beginning with descriptive material and general financial-planning types of information. Moving from that, you offload some of the asset-allocation responsibilities through balanced funds, lifetime and lifecycle funds, based on time horizons and risk tolerance.

On the other end of the continuum, we can provide true investment advice, but the way we have to do that is through Department of Labor laws that require us to go to a third-party provider. Ours is Financial Engines' online service, which we can integrate into out platform for any employer.

Now, the new form of advice coming down the retirement services pike is the so-called separately managed account, where, because of technology, you can actually go in, for a fairly modest-sized balance, and offer individualized investment selections.

We are looking at offering this in our plan by this summer, at the earliest, or by year-end, at the latest.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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