美國信安金融集團 (PFG) 2004 Q1 法說會逐字稿

Good morning and welcome to the Principal Financial Group 1st quarter, 2004 conference call. There will be a question-and-answer period after the speakers have completed their remarks. If you would like to ask a question at that time, simply press star and the number one on your telephone key pad. I would now like to turn the conference over to Tom Graf, Senior Vice President of Investor Relations.

Thank you. Good morning, and welcome to the Principal Financial Group's first quarter conference call. If you don't already have a copy, our earnings release and financial supplement can be found on our website at www.principal.com/investor. Following a reading of the Safe Harbor provision; CEO, Barry Griswell; and CFO, Mike Gersie will deliver some prepared remarks, then we'll open up for questions.

Others available for the Q & A are our three division presidents, John Aschenbrenner, responsible for the Life and Health Insurance and Mortgage Banking segments; Jim McCaughan, responsible for Global Asset Management; and Larry Zimpleman, responsible for U.S. and International Asset Accumulation. Julia Lawler, Senior Vice President and Chief Investment Officer, will also be available for questions.

Some of the comments made during this conference may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause actual results to differ materially are discussed in the company's annual report on form 10K for the year ended December 31, 2003 filed by the company with the Securities and Exchange Commission. Barry?

Thanks, Tom and good morning. Let me also extend a very personal welcome to everyone on the call. This morning I'll provide a brief overview of our results, focusing most of my comments on key accomplishments and progress in executing our gross strategy during the first quarter. Mike Gersie will follow my comments with a detailed overview of financial results.

We are very pleased with the result for the first quarter. We delivered a 9% increase in earnings per share compared to a year ago, and a record 223 million in operating earnings, which included 25-plus percent growth in three of our four operating segments, U.S. asset management and accumulation was the key driver achieving a fourth consecutive quarter of record earnings, including record pension earnings of 96 million. We're also very pleased with the life and health segment performance as well as solid earnings in the mortgage banking segment. Beyond strong first quarter earnings in our core retirement businesses, we continue to achieve very solid results in such critical performance measures as pension account values, deposits and net cash flow and sales of key retirement and investment products.

I'll spend a few minutes on these measures as well as progress on several of our high level initiatives. Continued growth in U.S. and international asset accumulation and management businesses, profitable growth for the life and health segment, and effectively deploying our capital. Our efforts to accelerate growth in our U.S. defined contribution businesses continue to yield outstanding results, as I mentioned, pension again delivered record earnings up 17% from a year ago, including 23% growth for pension full service accumulation. Once again, account value growth was outstanding with full service accumulation increasing 13.5 billion or 31% from a year ago. Full service accumulation fee revenues increased 19% over the same period consistent with the mean account value growth over the period and up 6.5% compared to the fourth quarter.

On net cash flow for full service accumulation is down from a year ago, there are a couple things to keep in mind. At 3.3 billion we view first quarter 2004 deposits as very strong. As you may recall, first quarter 2003 benefited significantly from key core deposits. I'd also add that as a percentage of beginning of period account values, withdrawals actually improved from a year ago, and remained at the low end of our expected quarterly range. Our employer level retention remains among the highest in the industry, and we continue to do an excellent job retaining planned participants. Our rollover asset retention rate remained outstanding, again, making us an industry leader in retention.

Importantly, full service accumulation net cash flow for first quarter 2004 came in at 1.8% of beginning of year account value. Solidly ahead of the 1.5% target per quarter for this business. As you know, last quarter we began providing a breakdown of full service accumulation sales between organic and acquisition related. First quarter sales were 1.3 billion, all organic, which compares to 1.7 billion of organic sales in the year ago quarter. I'd note that in the year ago quarter we had three very large cases that made up approximately 700 million in sales and that generally, large cases tend to come in unevenly throughout the year.

While a decline, I would characterize the first quarter 2004 as very solid, we delivered our third best organic sales quarter ever, in spite of impact of delay buying decisions on some of the large cases, we continue to build the sales infrastructure to support our aggressive sales growth objectives. Over the past three quarters, we've more than doubled our channel developer resources, these individuals work with our alliances, such as A.G. Edwards and Frank Russell, driving sales opportunities to our 110 pension sales reps, we continue to see them making a meaningful impact on our pipeline as well as on alliance sales, which more than doubled from a year ago to $442 million.

In the first quarter, we also increased our emerging markets focus, adding 20 new sales reps, focusing on plans under $5 million. Early signs here are good, as well with security builder sales up 10% from a year ago. In closing the sales discussion, some additional context may be helpful. In the small and mid sized market, other than perhaps fidelity, there's not a single competitor with a pension sales organization that can rival our sales platform. We reached our $6 billion sales target two years ahead of time. We've delivered more than $1 billion of organic sales in 7 of the last 9 quarters, averaging nearly 1.3 billion per quarter over that period.

This compares to $2 billion in sales for all of 2000, we're proud of what we've accomplished and we will continue our efforts to further build out our full service retirement sales capabilities, we remain committed to the organic sales targets for 2004 that we established at year-end of 1.2 billion to 1.8 billion per quarter. Based on our strong pipeline to date, we expect good growth in second quarter sales compared to a year ago, and for the second half sales toward the top end of the range; importantly, we remain confident that over the coming years as recent enhancements take even greater hold, we will hit our longer term annual sales growth target of 15 to 20%.

Our ability to grow, also reflects continuous refinement and improvement of our product and service platform, during the quarter, we introduced our new registered DB solution, principal advantage defined benefit and we launched our new program to help the independent registered investment advisors deep in their relationships with clients and grow their retirement plan business through customized retirement solutions. Our ability to grow reflects on our success in meeting customer needs as well, and during the quarter we continued to receive some very important third party recognition. From spark research group, ranking us first in employee education and participant statement. From DALBAR including top honors for our DB retirement planned statement and their communication seal for our DB/DC total retirement and variable annuity statements. And from Chatham Partners, including best in class, for being easy to do business with.

In terms of accelerating international growth and profitability. Principal international continues to make excellent progress with a very solid earnings quarter, 67% in growth and assets under management. And a near record 370 million in net customer cash flow. Principal international's customer base now exceeds 5 million. We continued to position principal international for success in Hong Kong's fast growing retirement market with the acquisition of Dal Hain fund management, a pension mutual fund and institutional asset manager. As we've discussed in recent quarters, we continue to implement new strategies in the life and health segment, intensifying our focus on key growth markets, enhancing flexibility and benefit design, refining distribution, and launching new products. Here are some very important signs of progress which Mike will discuss more in detail. But I'll briefly comment on one of them.

Sales in the individual life division. Recurring premium individual life sales were truly outstanding during the quarter improving 85% from a year ago, reflecting growing success with our small and medium business market. Moving to asset management, principal global investors continues to increase its presence in the global asset arena. In February, Principal Global Investors was ranked number 7 by Money Management Letter based on assets gained in 2003. During the first quarter, we continued to successfully compete for new third party institutional investment mandates with 28 new wins, including assets of 1.3 billion. Compared to a year ago, nonaffiliated assets under management are up 10 billion or 56%.

In addition, we're already seeing good performance from Post Advisory Group, where third party assets have increased by approximately 600 million or 17% since our August 2003 acquisition. In terms of principal global investors investment performance, we've had strong performance in the first quarter in all asset classes. Of our separate accounts, all managers and all asset classes, 65% ranked in the top half for the 3-month period up from 41% as of year-end 2003. Longer term results continue to improve as well. Especially the three-year period where 47% were in the top half, as compared to 33% at year-end. At 46% in the top half for the 12-month period, our results were down slightly from December 31 '03.

In terms of effective use of capital. During the quarter we continued to utilize capital to achieve organic growth and for acquisitions. I've already mentions some recent product and service launches as well as acquisition activity at principal international. We did not buy back any shares during the first quarter from the program authorized in May of 2003 as we continued our discussions with the rating agencies on their capital adequacy models. Through the end of April, however, we repurchased approximately 2 million shares, so approximately 25% remains of the $300 million authorization. We'll continue to optimistically repurchase shares going-forward as an option for utilizing excess capital.

As we indicated in yesterday's earnings release, the company has changed its policy on providing future earnings guidance. We will no longer provide any quarterly operating earnings per share guidance or net income per share guidance, in addition the company will no longer provide quarterly updates to full-year earnings per share or net income share expectations as the year progresses. We will continue providing investors with information and insight into strategic initiatives, growth and value drivers, and trend and industry data critical to understanding our business and our operating environment. We believe this change focuses investors on the company's long-term objectives and the strategic initiatives to build our businesses and drive sustainable profitable growth over the long term. The change is also in keeping with the practice of the majority of industry participants.

In closing, I'd like to re-emphasize that the first quarter was a very good start but recognize there was more for us to achieve. We continue to position the organization to take advantage of a Fuller recovery in the economy, and we are confident that with the continued recovery and modest equity growth we can continue to deliver on the long-term financial goals. Mike?

Thanks, Barry. This morning I'll spend a few minutes providing additional highlights for the quarter in financial detail for each of our operating segments. I'll close with some brief comments on the quality of our general account portfolio. As Barry indicated, we are very pleased with our overall results for the first quarter, record total company operating earnings, 9% EPS growth, as compared to first quarter 2003, very solid retirement and investment sales, and outstanding growth in assets under management in account values. There are several things I'd like to highlight at the segment level, starting with U.S. asset management and accumulation.

Segment assets under management are up $28 billion or 29% compared to a year ago, driving total company assets under management to a record $150 billion at quarter-end. Compared to a year ago, segment earnings increased 25% in first quarter to a record $122 million; pension was the main contributor to improved earnings, increasing 17% to a record $96 million, each of our pension businesses delivered double-digit earnings growth in the first quarter, with whole service accumulation earnings increasing nearly $10 million. A 23% improvement. In addition to pension's strong contribution, our mutual fund and individual annuity businesses also delivered significant earnings growth and record sales performance during the quarter. Within our international asset management and accumulation segment, principal international's first quarter earnings were $8.7 million compared to 6.6 million in the year-ago quarter .

The improvement reflects strong growth in our pension business in Mexico aided by our Tepeyac AFORE acquisition and strong growth in assets under management, which are up 67% from a year ago to $8.2 billion. Moving to Life and Health Insurance, earnings for the quarter were $75 million compared to $59 million a year ago. The increase from a year ago primarily reflects reserved refinements in the medical business, deferred policy acquisition costs on locking, and favorable mortality in individual life, and favorable morbidity in dental/vision and individual disability. As Barry mentioned, over the past several quarters, we've implemented new strategies in the segment, in addition to improving earnings and strong individual life sales, we saw a number of other positive signs. That's rates improved for health and each of the specially benefits lines, while total covered members were down slightly for insured medical, we do believe they are stabilizing, the decline from fourth quarter reflects a move of a large group medical case to fee-for-service.

In our insured medical target markets, we've experienced covered member growth in each of the last three quarters. Dental/vision covered members are also trending upward. In fee-for-service covered members grew significantly due to the acquisition of the Malloy Companies. As you may recall, throughout 2003, we guided you to the mid-$50 million range per quarter for the segment. Our progress gets us confidence; our initiatives will drive continued growth. For 2004, we expect normalized segment earnings to average 60 to $62 million per quarter. Generally, first quarter will be the strongest, reflecting seasonality of health claims, they tend to be lower in the first quarter and higher in the fourth quarter, as previously mentioned, first quarter results also affect deferred policy acquisition costs on locking and favorable mortality and morbidity.

I'll now move to mortgage banking and spend a couple of minutes discussing components of first quarter segment earnings. Mortgage Banking had earnings of $29 million in the first quarter, production generated $24 million in earnings, and servicing generated $5 million in earnings; production earnings were down from $110 million in first quarter 2003 as expected reflecting lower mortgage origination volumes and tighter margins. The $5 million of earnings from servicing reflects two items; $35 million in earnings from servicing operations, which included $7 million from the sale of GNMA loans; and a $30 million loss from MSR adjustments, driven by a 45 basis point interest rate declined during the first quarter; importantly, our financial hedges worked well and as expected.

I'll briefly share a couple of additional points on our mortgage banking business. At quarter-end, the weighted average interest rate of our portfolio was 5.88%. At March 31st, nearly $96 billion of our $118 billion servicing portfolio or 81% had an interest rate at or below 6.5% As you may recall from last quarter, we anticipated getting FAS 133 treatment in the first quarter for residential mortgage loans held for sale, and we have. I'd now like to briefly discuss credit quality and our Fixed Maturity Securities portfolio. After tax, net realized capital losses of $23 million for the quarter reflect $15 million in losses from impairment in impaired sales of our fixed maturities, down from $53 million in the year ago quarter. Gross unrealized losses continue to decline from $358 million a year ago to $69 million at March 31, 2004.

And as a percent of total U.S. invested assets in cash, below investment grade makes up 4.6% of the portfolio, down from 6.2% a year ago. Based on our watch list, which now makes up only 8/10 of a percent of our Fixed Maturity portfolio, we are reducing expected net realized credit capital losses after tax for 2004 to $45 million from $65 million and expect $10 million in realized credit capital losses after tax for the second quarter 2004. This concludes our prepared remarks. I would now ask the conference call operator to open the call to questions.

At this time, I would like to remind everyone that to ask a question press star and then the number one on your telephone key pad. We'll pause for just a moment to compile the q-and-a roster. Your first question comes from Ed Spehar of Merrill Lynch.

Good morning, I was just curious, on the guidance issue, you are providing some guidance on segments like in, for example, just now talking about capital losses, which I think most companies would think to be one of the hardest things to predict would be what are gains and losses going to be.

So I'm just curious, maybe you could talk a little bit more about the decision, and then on the full-service accumulation business, in terms of the idea that the sales should pick up in the second half of the year, at least the idea that sales could be toward the top end of the range in the second half, could you just say one more time what it is that's, sort of, giving you confidence that we would see that kind of a ramp in the second half? Thank you.

Sure, Ed. And good morning, I'll take the first and ask -- and maybe Mike will want to join us in, I'll ask Larry to comment on full-service sales.

On the guidance issue, I don't know that there's a lot to add from what I said and what's in the release, you know, we think it is important for investors to focus on the long-term results of our businesses and we get concerned when we look at quarterly results and try to pin them to a penny or two pennies to three pennies, we think think it's much more important to look at the long-term drivers of our business, to look at sales, to look at deposits, to look at lapse rates, and we just think that's an emerging practice, and we think it's one that we feel a lot more comfortable with.

We understand clearly the need for investors and analysts to understand where our business is headed, to understand the environment, and that's why we're going to continue to talk about, you know, what we see coming out of various segments on a normalized kind of basis, we're going to continue to talk about our sales targets and where we see that going, and importantly, we will likely continue to talk about our credit losses and the -- and where we see the trend at least going. I think the difference in the two is, one is a longer term trend normalized and the other is trying to predict with precision where a specific quarter is going to come out and getting out any slight volatility that might happen.

But I can assure you, we're not backing off, trying to give investors and analysts good information so that you can build your models to understand over the longer term where our businesses are going.

So Barry, if I could just follow up on that, in terms of idea of giving out, sort of, longer terms targets in terms of ROE and those types of things, you intend to still stick with that kind of approach, or are you going to not give out specific, sort of, longer term targets as well?

That would absolutely be our intent. I mean, we're still committed to 11 to 13% EPS growth over the longer hall. We're continued to getting our ROE up, you know, 13%, then increasing 30 basis points over time. So, those, kind of, macro goals that we first laid out when we became a public company, we'll continue to talk about and give you the longer term targets that we have. And Larry, you want to talk about the full service for the sales?

Sure, Ed, good morning. This is Larry. In terms of the full service sales, we've communicated in the past that there is a bit of seasonality to those sales, and you've seen that from the breakdown we've provided, so we're a little bit cautious as it relates to second quarter, but getting beyond that, we see that our pipeline is approximately 25% higher at this time than it was a year ago, and the late pipeline or those pieces of business moving more to a decision stage is up about 40%, so we feel good about that.

As Barry commented, we also have a number of, kind of, strategic initiatives around adding developer resources, adding some emerging market sales reps so, all in all, we do expect to see the sales trend upward as we move beyond what is traditionally a little bit of a soft, second quarter.

Just -- any update on, sort of, what you might be seeing in terms of takeover opportunities, you know, change in ownership and situations that might arise as a result?

Yeah. Well, we don't really have any specific comment there, Ed, I mean, we continue to look for those opportunities, we haven't yet been able to come to any conclusion on any of those, but we will continue to look, it's a high priority for us.

Thank you.

Thanks, Ed.

Your next question comes from Jeff Hopson of A.G. Edwards.

Hi, good morning. It appears that you were less aggressive on the GIC and/or funding side, and then on the life annuity sales or life health, particularly on the individual side, are you confident that you've now, kind of, reinvigorated those sales at this point, and should we expect an acceleration of sales in that channel here going forward?

Good morning, Jeff. I'll let Larry take the first, and John can jump in on the second.

Good morning, Jeff. On the investment only sales, it was a bit of a conscious decision on our part to hold back a bit on our Q1 sales and investment only, and there were two issues there, one was the -- our ability to get our desired margin going forward on new business we write, but probably as important for us in the first quarter is, we brought on online a new registered program for our investment only business, taking that product into the retail market.

And we had a number of regulatory hurdles that we had to overcome. And while -- we were always -- we're always a little bit optimistic about when that's going to happen, it turned out to be, sort of, late in the first quarter, so we didn't get as much activity in our retail registered program as we'd like, but we think we're now going to be able to pick that up, and we're now on the street with that. And so, we think you'll see those sales pick up in later quarters.

Let me just patch up, we do have a rating agency limit on that business, but we fully expect to be up to that limit by year-end. So, this is more of a temporary phenomenon.

Okay.

This is John Aschenbrenner, on the individual life sales, we feel that we really have reinvigorated that operation, I'm not going to predict that we'll have a continued 85% growth for the rest of the year, but I think we will have very, very strong growth in individual life sales.

Basically, what happened, I think, as we really built this foundation with distribution and strong solutions and competitive products last year, we had a very strong pipeline, but through the end of the year, we just weren't seeing people making decisions and actually closing the cases.

In the first quarter, we got a lot more activity in closing cases, and we think that will continue. The good news is, is that we came out with a very competitive new product toward the end of the first quarter that really didn't influence first quarter results, and we grow on our individual life wholesalers dramatically in the first quarter, neither of which impacted first quarter results, so they will help us to continue with the momentum going forward.

Okay, John, and anyway to tell if you're actually getting those small business owners?

Yes. The vast bulk of our growth was coming with cases in the small business market heavily, the nonqualified deferred compensation funded with life insurance, and a lot of that growth was coming from the ties that we now have between the individual wholesalers and the group and pension sales force.

Okay, great, thank you.

Thanks, Jeff.

Your next question comes from Nigel Dally of Morgan Stanley.

Great, thank you, and good morning. First with the rating agencies, you mentioned you didn't repurchase any stock because of ongoing discussions you had with the agencies, I think it was in particular, (Moodies). Yet from an external perspective you [with] by capital ratios seems very high. I hope can -- you can help us understand what in particular the rating agencies are concerned about. That's first, second, just a numbers question on prepayment income. If you can just tell us what the influence of prepayment income was in your result this is quarter, thanks.

Thanks, Nigel We'll have Mike Gersie jump in on both of those, I think.

Well, let's start with the rating agencies, in our discussion -- our primary discussions have been with (Standard & Poors), and if you think about the way each rating agency, if you're talking about (Moodies) or if your talking about (Standard & Poors), but then you look at the NAIC risk-based capital formula, each one of those formulas have different components and look at the businesses slightly differently. And so it's a little bit inaccurate to look at the NAIC risk-based capital formula and say that that's the same view that the rating agencies have.

So we have been in fairly extensive discussions with S&P, we believe that they have a very good understanding of the risk profiles of our business, so we think we've got our capital, I'll say, right sized with S&P. Probably the main difference between the rating agencies and the NAIC formula is perhaps a little heavier capital waiting for the mortgage banking business. But I think we're in the position now, getting back to I guess the -- we didn't go into the market and buy-in stock in the first quarter, we think we have our capital based pretty much right sized.

We were back in the market working on the current repurchase program, that the board has authorized -- we would anticipate that we will have some additional free capital during the year to use for either support organic growth or acquisitions or share repurchase going into the future. So we're pretty comfortable with our capital base and comfortable with our ability to generate excess capital. In terms of prepayment, prepayments roughly gave us about a $12 million increment to investment income during the first quarter. That would be roughly what we would anticipate on a normalized basis.

So it really wasn't an excessive amount. We did an average, and it's kind of lumpy, so some quarters we get a lot more, some quarters we get a lot less, but 12 million, if you did a mini-quarter average, would be right around that average.

Great. Just to follow up on the capital questions, going-forward, what is the normalized level of excess capital we should think is being free for other acquisitions or stock repurchases given your expectations for [inaudible] looking forward?

well, it's a difficult because it depends on the level of organic growth, and the type of organic growth, and then how much capital it takes to support that. But we have roughly, I'll say in excess of $400 million of capital at the end of third quarter -- at the end of first quarter, I mean, and if you look at, sort of, going forward into the future, on a normalized basis, capital needed to up -- the over and above what it takes to support organic growth is somewhere about half the earnings we generate. So think about operating income or net income, take about half of that, and that would be roughly or level of free capital per quarter, it varies, but that's a ballpark number.

That's great. Thank you.

Thank you, Nigel.

Your next question comes from Joan Zief of Goldman Sachs.

Good morning, thank you. I just have two questions -- or a couple questions. The first is just to follow up on this mortgage banking and the rating agencies, the Mortgage Banking is owned by the Life Company, so it's stacked underneath the Life Company.

What do you -- what's the value that you're carrying the -- the ownership of the Mortgage Banking business at in the Life Companies? That's my first question. My second question is, you have very good margins, very good profitability in the mutual funds and the annuities and then principal global of investment.

Is there anything that's going on there, is that a new run rate, are you finally have an asset, you know, under management where you're, you know, covering your fixed expenses and you're really seeing the leverage there? And then the last question I had was, you had very strong group sales, group and life sales, you know, group dental sales, can you just describe how -- what you see in the marketplace? Are you seeing a less competitive marketplace? Are you seeing a more competitive marketplace, and just, you know, what is the real driver of those strong sales in the group area?

Thanks, Joan, I'll -- I think I'll spread these around among my team here, let Mike take the rating agency comment and then Larry can come in with the mutual fund annuity and John can talk about the group sales.

Carrying value of mortgage banking business, Joan, in the statutory statement. I don't have the number right in front of me, but it would be roughly in the -- I believe the $600 million range give or take. Which would be roughly equivalent to the -- I'll say the book value of the servicing asset.

Alrighty, on -- Joan, this is Larry, good morning, on the annuity and mutual fund results, first of all, thanks for your comments, we appreciate that. We do believe those results are very sustainable.

You can see that our mutual fund account values are up about 49% from a year ago, and our individual annuities are up, account values are up 28% from a year ago, and in a mutual fund case, a lot of that, again, is driven by participant level asset retention as well as some good retail sales, and the individual annuity business, we're seeing a lot of opportunity for sale of new product in the bank distribution channel.

So we do think that we're on the positive end of gaining critical mass, and we do have every expectation we'll continue to grow the earnings out of those two businesses. I'll ask John to comment on the life sale--

wait -- before you do that -- I'm sorry, before you do that. Let me just make sure, so you -- you believe that the current types of margins, returns on assets that we're seeing in those businesses are sustainable and can actually move up from here if you continue to grow the assets strongly?

Yes, Joan, I do believe that the margins that are currently reflected are sustainable margins for those businesses, yeah.

And you also mentioned PGI, Joan, so maybe we ought to have Jim McCaughan comment on that as well.

Thanks, thank you also for your comments, Joan. In 2003, we spent quite a lot of money on the increased [sales resource] and also on the build-out of the international offices. And as Barry had mentioned with 1.3 billion of nonaffiliate sales in the first quarter and as we mentioned last year, 6.1 billion of sales with 76 new clients last year.

We had very rapid growth in that institutional business over the last 5 or 6 quarters. As that growth is coming through, the margins are improving because the incremental span is a lot less than the build-out that I mentioned earlier, we're also working hard with Larry's team to make sure that our investment offerings into retirement services is very compelling, because one of the distinctive features of principal has been that many clients have bought the proprietary investment offering, and we're certainly, as Larry just said, improving the performance competitiveness of that and working very closely with Larry's people to make sure these offerings are well communicated to our retirement clients.

Thanks, Jim. John, group sales.

Yeah, Joan, this is John. On the group sales, I think one thing we have to remember is that they are lumpy, and the first quarter is always going to be our best sales quarter. And so, if you look at life and disability, for example, they're down slightly from the first quarter of the prior year; in total, our sales are up substantially from the first quarter, and a lot of that is dental.

What I would say the picture -- the competitive picture is, first of all, we have expanded our nonmed sales force, and as you remember, they were a brand new sales force for us in 2001 and they continue to gain maturity. So, I think a lot of the growth we're seeing is coming out of the improved nonmed sales force. The competitive picture would be the large case market we still see as very competitive, so we're not writing a lot in the large case market.

The smaller case, we're doing pretty well, and the other competitive thing that we're noticing, and it's more anecdotal, I think than anything, is that people are slower in making decisions, so that there's maybe less coverage out on the market and less coverage moving from one carrier to another.

Before we move on, John, I think Mike wanted to add one other comment.

Yeah, Joan, I just want to make sure, I may have misspoke, I talked about roughly 600 million of equity value, and then I think I said roughly the book value of the servicing asset, and it's really our equity investment and servicing asset, is what I really meant to say, since we carry the servicing asset with a combination of equity and debt. So, I just wanted to make sure I didn't leave the wrong impression.

Thank you.

Thanks, Joan.

Your next question comes from Coline Devine of Smith Barney.

Good morning, gentlemen. A couple questions, on the rating agency thing, one more time, I guess, perhaps I can flesh out what, sort of, capital charge they're applying to the mortgage business and how that is changing its economics and perhaps how we should be looking at its ROE going forward, since that seems to be the, I guess, the debate here, it certainly lets you stop share repurchase in the first quarter, and if you alluded it's really why you're carrying such a high RBC number.

Secondly, if we could then turn to the group disability line, the loss ratio deteriorated, certainly the weakest we've seen in well over about a year and a half now, and perhaps you could explain what was going on there. And then lastly, with respect to the cap ratio and the MSR, I noticed it was down this quarter. I trust that was just due to what happened in rates. Or was there been some change in your policy to perhaps run it at a somewhat lower level?

Thank you, Colin, good questions. Let me ask Mike to take the first one and John will take the second two.

Colin, you're getting into some murky water here and perhaps some detail, that is a little bit, I'll say, beneath me or I can't really get my hands on right now. But, in a way of thinking about it, Coline, our target, if you think about, sort of, how much additional equity are we carrying over and above what we would choose to carry, it would be somewhere, the between an NAIC risk-based capital ratio of roughly 375 versus the risk-based capital ratio that we have today. And so, think about that as being largely due to mortgage banking, but not entirely due to mortgage manking. I think that at least gives you the size of the additional burden (of that business here) --

Okay, but it you're saying that and you're carrying an extra 19% growth or about, I guess, by my tally then, by cost an extra 75% on your RBC score, what does that say about the real ROE on this business.? If we're looking at the capital, the rating agencies are making you hold, that's really where I want to go with this, what is now the return on this business and has it changed? I presume it has changed because you've been in negotiations with S&P in all of the first quarter, and you stopped (their repurchase), but maybe that's incorrect.

I think where we're still at Coline, and I think you raised a good question, but the way we look at the business is what does it really take to run the business from I'll say, our internal analysis of risk-based capital. And so, I think we've got the capital allocated to the mortgage banking business, I'll say, a right-sized basis, and the additional excess capital, you're right, is sort of orphaned capital at the corporate level, that has an impact on corporate return, I can't dispute that.

Yeah, Coline, this is John Aschenbrenner. I'd ad a little bit to Mike's comments. One is, we did go in at the 12/31 and significantly increase the capital in mortgage banking, so we took a significant amount of that and put it in the mortgage banking, the other place where a lot of the extra capital comes from, from the rating agencies is in the way we fund the mortgage banking business.

So we are in the middle of changing, fairly significantly, the way we fund our mortgage banking business that should drive down that extra capital that we will need for the rating agencies. So, we still believe, even putting all of the rating agency capital on to the mortgage banking, that it is still a high team ROE, in a normalized more stable environment.

Well, you got the floor, John.

Yeah, now that I got the floor, moving on to the question. I think your question was on the loss ratio on group disability as to why it was --

Why it's the weakest we've seen in a while? Yes.

Yes, that was primarily caused by higher claim amounts so it wasn't incident it was larger amounts on the new claims that we had, as far as we can tell, it looks like it's just a normal fluctuation for us, but we will be watching that closely. And then you asked about the MSR cap ratio?

Yep.

That went down purely because interest rates dropped 45 basis points during the quarter. So we made no other changes.

Okay. Then I've got one follow-up, and I've had a chance to crunch the numbers for Mike. If I look at where your total adjusted (cap FAS) capital ended in the year at 4.6 billion, and adjust for the extra that you're carrying in the RBC, am I doing the math right, correctly figuring out then that you're carrying an extra -- the cushion you've got sitting up in corporate to support the mortgage business is roughly $700 million?

I'd have to take a look at your numbers.

I presume we can take the 444 and just divide, you know, look at that's the difference over the 375 and just run it through. But that's -- and I presume then, that if I'm right on that $700 million, that's what I'm not seeing allocated down to the line, but if I want to really try to understand what's the ROE, because the agencies are making all this capital, it's with that $700 million in.

And that's not the correct number?

No.

We'll have to get offline and work through it with you.

Okay, that's what I'd like to understand, because if there's orphaned capital setting up there's nothing allocated down, you may do that for GAAP purposes, by the end of the day as a mortgage business isn't there, it's freed up capital. That's how I'm looking at it, maybe that's wrong.

Let us go offline with you on that one, Coline, and get you the right number.

Thanks, guys.

Thank you.

Our next question comes from Andrew Kligerman of UBS Securities.

Thanks. After the FSA business, could you give a little color on takeover opportunities? It just doesn't seem like you've had a lot out there recently; secondly, with regard to your mortgage banking unit, you talked about in production pressure on margins -- tighter margins, could you give some clarity on what those margins are today, versus say a year ago? And then finally, you said that in individual life, you dramatically increased wholesaler accounts, again, now versus a year ago, what was the change there?

Andrew, hi, this is Larry. Just -- if I could make sure I'm getting to your point on takeover opportunities. Are you talking about (Baltic Overs, Ala Key Corp) or are you talking about just [inaudible] activity in the marketplace?

Key Corp-type deals.

Yeah, they're, again as we've expressed in the past, we continue to be active in looking for those opportunities.

It's my personal belief, Andrew that the more positive equity market of a year ago, particularly during 2003, has to some degree, sort of, you know, propped up or postponed what is, we believe this inevitable consolidation in a defined contribution business, because it did provide at least on a short-term basis a bit of fee revenue through the equity increase that perhaps has some of these entities continuing to think about staying in the business, but we still think over the longer term, the consolidation is inevitable; and again, we believe as new market demands like total retirement solution really take hold, it's going to put even further pressure on that need to invest in the business, and it's going to put further pressure on those who aren't at critical mass.

But, having said that, we'll continue to look for those opportunities. Don't really have anything further to comment on at this time.

And then, are you seeing competition for those type of opportunities? A lot of competition?

I would say the bigger problem, Andrew, is just those companies making a final decision about their need to ultimately rationalize their business model more than others competing and taking it away.

On the mortgage banking business, margins have probably shrunk somewhere in the 50 -- maybe from the peak, even we were getting, maybe, 75 basis points higher margins; on individual life, we were at 15 wholesalers in the middle of '03, we're now at 27. And that occurred primarily late in the year, early this year, and so very little first quarter production came out of the increased wholesalers.

Got you. Thanks a lot.

Thank you, Andrew.

Your next question comes from Mario Mendonca of CIBC World Markets.

Just a quick question on the mortgage banking business and -- Originations of this quarter of 6.8 billion seemed, sort of, light in the context of what was happening in the quarter, particularly when you look at the mortgage composite index. Did that reflect just unattractive margins this quarter, or does it speak to something a little bit more meaningful for principle and principles intentions with the mortgage banking business?

It really, Mario, was the first. It's really a margins issue, we have always had a very strong record, I think, of not going in and buying business when margins are -- you know, aren't unattractive, so it was more us being more selective in our pricing, and it was very purposeful on our part and that's really the only thing that was going on there.

So, going forward, if we continue to see this, sort of, competitive environment for whatever's left over, we could see production decline still further? Is that a reasonable statement?

I think it's reasonable to say that the relative production that we have versus some of the larger players who are very much more interested in market share, yes, the production could be weaker for us, in that kind of an environment. I don't think that translates necessarily into weaker profit, but it does translate into lower originations.

Thank you, very much.

Your next question comes from Tom Gallagher of CSFB.

Good morning. First just a follow-up on your -- for John Aschenbrenner, on your response on (purchase) and mortgage banking. You had commented that your 75 basis points off of peak margins in '03, if I understood you correctly. Where are you now on an absolute basis in terms of production margins?

I don't have those actual absolute margins.

One of the calculations you can do is, you can you go into the supplement and you can divide the origination fees by the originations done and you'll get a number. And, I think, it was like, 90 basis points. And you can go back and do that over last year, and you'll probably get an average for the whole year of 140, 150 basis points.

Okay. Mike -- my question was more, are you still seeing shrinkage from where you were in 1Q on the margin, or do you feel like that's stabilized?

Oh, I'm sorry. No, that has stabilized. I think we probably were at our toughest point in the, early in the first quarter, and I think that has stabilized somewhat.

Yeah, we're sorry we misunderstood your question, I think we're looking at the current margins as being pretty sustainable given the current environment.

Okay, good. The next question is just on commercial mortgages, can you just give an update on experience there, whether you're seeing an increased delinquencies or is that fairly stable?

We have Julia Lawler with us, and she gets a question now. So, Julia.

Good morning, we have not seen, we've actually seen -- and you will see in our Q an increase in our -- what we're watching in our problem, potential problem list, but we have not seen an increase in our delinquencies and we've not seen an increase in our losses.

Okay. And Julia, has there been a -- is that a significant pickup in the watch list?

I wouldn't call it significant, no. Relative to the market, but we are very conservative in our approach to what we put on that list and are watching. So, I'm not concerned about the increase considering the delinquencies haven't increased in our -- again, our forecast [inaudible] are not increasing.

Okay, and then just one last question on the growth in plan numbers in full service retirement was actually pretty good on a sequential quarter basis in all but 1to 99 employees, and this number keeps going down. Do you think this will eventually bottom out, start turning around, and are there any plans to improve retention on the micro cases?

Tom, this is Larry, I'll be happy to provide you a little background on that. There has been the transition going on for a little bit over a year, as you noted. Where in many cases, those plans that may have been low-end 401K or profit sharing plans, quite frankly, may be better fit as simple programs or step programs using a mutual fund chasse, so we have been making those -- we have been making those conversions; Barry mentioned in his comments our activity around our new emerging market sales reps, and frankly, a lot of their activity will be in this 1 to 99 end of the marketplace brought on 20 new sales reps who will focus on that, sort of, 1 to 99 part of the market.

And I would just point out to you, that I think we're getting very good traction very early, and I'll give you one stat around that. Our product called Security Builder is actually the primary product in that 1 to 99 life area, and in the first quarter, we sold 349 Security Builders as compared to 133 in the fourth quarter of last year; so we are seeing real good traction real early from that emerging market sales program, and we think that should more than correct, and you'll start to see some growth in that 1 to 99 life area.

Okay. Thanks.

Thanks, Tom.

Our next question comes from Eric Berg of Lehman Brothers.

Thank you, and good morning. Three questions, first of all, you referenced both today and in the narrative of your news release the reserve requirement -- reserve refinement, pardon me, we were, kind of, struggling last night to understand precisely what that was all about.

Second, while I understand that they were unusual items with respect to the cash flow in the investment area only in the quarter, I think I'm right when I say, correct me if I'm wrong, that the cash flow has been negative for some time, and I'd like to know whether you, you know, whether there was something more endemic, something more, you know, serious going on there than just a quarterly slowdown in sales. And third, finally, when can we expect to see growth in covered lives in your medical area? Thank you. Those were the three questions.

Thanks, Eric. We'll be glad to take those. Reserve refinement, John. You want to take that?

Yeah, I'll take the first and the third. The reserve refinement, I assume you're talking about was in the medical insurance.

Yes.

And we -- our claims are always lower in the first quarter, highest in the fourth quarter, and in the past few years, we have had a reserve to even that out. So, we held a reserve in the first quarter for the higher claims that we had paid later in the year. We have since gotten -- this year we got away from that reserve and so there was about 6 million extra claims in -- or, excuse me, 6 million less claims in the first quarter this year, than in the past would have been put into a reserve. Those will then -- we expect about a million each in the second and third quarter and probably about 4 million in the fourth quarter.

On the covered lives, we continue to have good growth in our target states. The members of both sales and lapses are good in the target states. The members fell off a little bit faster than we expected in the non-target states. I would expect that we will quickly get back into a -- later half of this year, hopefully, get back into a total growth in covered lives, as the target states start to pick up and make up for the falloff in the non-target states.

And then the cash flow in the investment only area, please?

Yeah, Eric, this is Larry, I'll handle that one. Last year in the investment only business, we made a conscious and it turned out a very good decision to concentrate our sales activity in the investment only arena in the first part of the year, and so, for the first two quarters of last year, we had over 750 million of net cash flow, and then that, sort of, evened out the rest of the year in order to, again, stay under the limitations of the rating agencies; so we had 750 of positive flow the first two quarters and about 200 million negative aggregated of the last two quarters; this year as I mentioned, we probably would have followed the same track, except that we were bringing on line the new retail register program.

And because we didn't get that up quite fast enough, we have about 275 million negative net cash flow for the first quarter, we are working hard at that. You will see that be a positive net cash flow in second quarter, it'll turn that around; but overall, we are seeing growth, but it's at the level of the growth in the general account overall. That's what you should expect, Eric.

Thank you.

Eric, if I could add one more comment on covered lives and medical.

Sure.

We had one large case that moved from the insured lives into the fee-for-service. If that case had not moved, we would have had an increase in covered lives this quarter, so we would have had two quarters in a row of slight increases in covered lives for medical.

Very good, I got that early, and I appreciate you repeating it to drive the point home. Thank you.

Thanks, Eric.

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

Well, again, thank you all very much for your continued interest in the Principal and your support. We look forward over the next several weeks and months to be back out on the road visiting with investors and analysts, and hope have you a great year. Thank you, very much.

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 May 11, 2004. 6515635 is the access code for the replay. The number to dial for the replay is 800-642-1687 or 706-645-9291.