美國信安金融集團 (PFG) 2004 Q2 法說會逐字稿

Good morning and welcome to the The Principal Financial Group, 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 this time, press star and the number 1 on your telephone key pad.

I'd 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 second quarter conference call. If you don't already have a copy, our earnings release and financial supplements can be found on our website at www.principal.com/investor.

Following the 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 and A are our three division presidents, John Aschenbrenner, responsible for the life and health insurance segment, 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 call 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, and in the company's quarterly report on form 10Q for the quarter ended March 31, 2004, filed by the company with the Securities and Exchange Commission. Barry?

Thanks, Tom. Good morning and welcome to everyone on the call. Mike Gersie and I will focus our remarks on three areas. We'll describe our performance for the second quarter, as always, we'll provide segment detail and discuss those items impacting comparability between periods. We'll describe our progress in achieving the longer term objectives and we'll also provide some clarification around our expectations and assumptions going forward in light of the sale of Principal Residential Mortgage.

Let me start by saying that we're pleased with our results for the second quarter and importantly we're very pleased with how our performance is emerging over time. As always, Mike's remarks will include a detail overview of financial results, but I'd like to offer some key highlights for the second quarter. 7% growth in earnings per share, which I'll touch upon again in a moment. Record operating earnings for U.S. asset management and accumulation, a fifth consecutive quarter of records earnings, up 15% compared to the year-ago quarter. Record pension, full service accumulation earnings of nearly 57 million, up 33% from a year ago, which contributed to our second best quarter of earnings for pension ever.

Record earnings for Principal Global investors, continued strong earnings growth for our mutual fund and individual annuity businesses, record assets under management, very strong sales performance for pension full service accumulation, mutual funds and individual annuities, as well as for individual life and each of our specialty benefit lines. Continued strong account value growth for pension full service accumulation, including very solid net cash flows, record net cash flows for Principal International of nearly a half billion dollars. I'll also add that on July 1st we successfully completed the sale of Principal Residential Mortgage, positioning us to go forward with an intensified focus on our best opportunities.

As I mentioned, EPS improved 7% compared to the prior year quarter. Given the gap between our 54 cents and the first call mean estimate, I'd like to discuss the results in more detail. To truly understand the real growth achieved in the second quarter, 2004, compared to the prior year quarter, it is important to look back at what we communicated a year ago. This analysis will also help quantify the growth expectation underlying the first call mean estimate.

In our second quarter 2003 earnings call we discussed several items benefitting that quarter's results. Items that we indicated were not part of our normal operating earnings. In total, these accounted for $12 million after-tax or 4 cents per share. Specifically, we identified a $2 million benefit in U.S. asset management and accumulation from the sale of Principal Banks credit card portfolio. A $2 million benefit inflating Principal International's second quarter, and an $8 million benefit in life and health, favorable loss ratios driving a sustainable level of earnings for that segment. We went on to provide a normalized range of earnings for International asset management and accumulation, and for life and health which we have since updated.

The point here is that in characterizing our EPS growth over last year is very solid, with comparing 54 cents to 47 cents in the prior year quarter, not the 51 cents. This translates into a 15% improvement. On the other hand, to have come in at the first call mean estimate of 59 cents, we would have needed to grow earnings per share by nearly 26% on a comparable basis. As you know, our long-term target is 11 to 13% growth. In communicating our results over time, we've consistently disclosed items that have benefited our cause. Again, we had a number of those items in the second quarter of 2003, but not in the current quarter, a quarter otherwise marked by very strong results in our core asset accumulation and management businesses.

Moving to our progress against growth objectives, I'd like to provide some color on how earnings are emerging over the longer term. Year to date, total company earnings are up 13% driving EPS growth up 17%. For the trailing 12 months, total company operating earnings have grown 20%, which translates into approximately 25% EPS growth. U.S. asset management and accumulation earnings improved 27%, and pension full service accumulation earnings are up 25% compared to the same trailing 12-month period a year ago. I'd add that compared to a year ago, assets under management are up 19% and full service accumulation account values are up 20%. These are key metrics we analyze to gauge our progress and these results give us confidence we're effectively executing our growth strategy in positioning the organization for long-term success.

In terms of our performance going forward, in particular for the remainder of 2004, I'd like to clarify some of our assumptions and expectations. This clarification is in light of discontinued operations treatment related to the sale of mortgage banking and our decision last quarter to stop providing quarterly guidance. Starting with total company, we believe we're on track to deliver full year EPS growth within our long-term range of 11 to 13%. I'd remind you that expectations built into this range incorporate equity market growth of roughly 2% per quarter for the second half of the year. I'd also remind you that with the July 1st close of the sale of Principal Residential Mortgage, corporate overhead previously allocated to mortgage banking will be allocated among the remaining segments.

We believe approximately $7 million or 2 cents per share per quarter is a very good estimate of the cost that will be spread among the segments for the remainder of the year, impacting their results. We are aggressively working to reduce these costs and we expect to eliminate them by year-end 2005. Moving to each of the segments, we expect continued strong quarter-over-quarter improvements in U.S. asset management and accumulation earnings. We're looking for full year 2004 segment earnings to grow by around 13%, which we view as particularly strong result given the flatness of the equity markets in the first half of the year. I'd also add that this segment will take a significant portion of the corporate overhead that I just discussed.

For International asset management and accumulation, we expect normalized earnings of approximately 9 to 11 million per quarter over the near term. The life and health segment continues to be on track to hit previously communicated earnings of approximately 245 million for 2004. Let me remind you that in the life and health segment, the earnings do not emerge uniformly over the year but tend to be front-loaded in the first quarter reflecting seasonality in the health line. Likewise, because of the seasonality, the fourth quarter tends to have the lowest quarterly earnings of the year. In addition to this color, we decided to reset total company guidance for full year 2004.

As communicate in the second quarter earnings release, the company expects full year 2004 operating earnings to range from $2.28 to $2.32 per diluted share. I would add that in spite of the seasonality of claims in the health business, fourth quarter tends to be the strongest earnings quarter per total company. Again, these estimates incorporate domestic equity performance improvement of roughly 2% per quarter. Our range compares to the earnings per diluted share of $2.04 for 2003. I'll discuss expectations around another key measure as well, pension full service accumulation sales.

Second quarter sales were 1.2 billion, our best second quarter ever. And a 29% improvement over the prior year quarter. This demonstrates that our value proposition and competitive position remains very strong. We've carefully built a sales infrastructure that can deliver a normalized sustainable 1.2 to 1.3 billion of sales each quarter without the impact of any large cases which we define as $100 million-plus in assets. For the third quarter we expect sales consistent with this normalized production level and we're optimistic that fourth quarter will exceed that level.

We had record RFP activity during the first half of 2004, but, again, have seen a slow-down in plan sponsored decision making, particularly with the larger cases. While challenging to us from a sales perspective, it is a significant benefit on the retention side. Client lapses are at an all time low and our large case lapse rate is 68% lower than the rate for our total block. To quantify, our lower lapse rates year to date, have the equivalent impact on account values as an additional $600 million in sales, which supports continued strong net cash flow. We're optimistic that the pick up in proposal activity, combined with the delayed decisions to date, will provide us opportunity to write more large asset cases in the fourth quarter than in the third quarter.

While market conditions change and there will always be some uncertainty around whether we secure large case sales quarter to quarter, our longer term outlook remains very positive. As we continue to refine our sales coverage model and add resources, as necessary, we stand by our longer term sales growth goal of 15% per year for pension full service accumulation. Our confidence reflects the growing strength of our value proposition, our ongoing efforts to improve our sales infrastructure and tremendous optimism around the power of the Principal's total retirement suite to help drive future sales. Launched late last month to meet the employer's need for a single retirement platform, our offering provides comprehensive, integrated consulting and administrative services for qualified and non-qualified defined benefit and defined contribution, as well as employee stock ownership plans.

Before handing it over to Mike, I'd like to briefly discuss our on going efforts to expand our leadership with small to medium businesses as well as our use of capital. During the quarter we continued to refine and improve our product and service platform and to build lasting relationships with business owners and their employees. I've already mentioned the Principal's total retirement suite launch. We also introduced the Principal managed account program to offer retirement investors personalized, affordable advice, and we made Principal higher to retire, participant education tools available to define benefit plan clients. We unveiled a new mutual fund platform designed specifically for financing non-qualified deferred compensation plans, and we launched a new high deductible health plan with a health savings account.

I'd add that we're extremely proud to have been named the National Association of Women Business Owners 2004 corporate partner of the year, reflecting our continued commitment to women business owners. In terms of our effective use of capital, during the quarter we continued to utilize capital to achieve organic growth and I've already mentioned some recent product and service launches.

We also continue to buy back shares, repurchasing 6.3 million shares at a cost of approximately $222 million. During the quarter, we completed the May 2003 board authorization and began buying back shares under the June 2004 board authorization. I'd add that in the month of July we repurchased an additional 1.9 million shares from the latest authorization. As previously indicated, we expect to opportunistically repurchase shares going forward as an option for utilizing excess capital.

In closing I'd like to emphasize that 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 market growth we can continue to deliver on our long-term financial goals. Mike.

Thanks, Barry. We have a lot to cover this morning so I'll jump right in. As Barry stated, we are very pleased with our longer term performance trends and view our results in the second quarter is solid. We delivered record operating earnings in the U.S. asset management [inaudible] segments, driven by outstanding results for full service accumulation and Principal global investors. Sales of our key retirement and investment products were again outstanding, including record individual annuity sales and the 29% improvement in pension full service accumulation sales.

As Barry mentioned, we also delivered 7% earnings per share growth, but we had a number of unusual items that benefited second quarter 2003 operating earnings, dampening the comparison to the prior year quarter. Absent these unusual items, earnings per share would have improved by 15%. This improvement is more consistent with our year to date and trailing 12-month performance, and we believe indicative of the underlying strength of our businesses.

Moving to segment detail, let me start with U.S. asset management accumulation. Segment assets under management are up $20 billion or 19% compared to a year ago, driving total company assets under management to a record $152 billion as of quarter end. Compared to a year ago segment earnings increased 15% in the second quarter, to a record $122 million. Our efforts to accelerate growth in our U.S. defined contribution businesses continue to yield outstanding results.

Pension delivered another strong earnings quarter of 12% up from a year ago driven by 33% growth in earnings for pension full service accumulation. Full service accumulation, net cash flow, was up slightly from the year-ago quarter at nearly $1 billion. This net cash flow equates to 1.7% of beginning of the year account value, ahead of our aggressive quarterly target of 1.5% for this business. Second quarter net cash flow reflects strong deposits of $2.9 billion, up slightly from a year ago. Withdrawals were $2 billion which is a percent of beginning of year account values represents an improvement from a year ago.

Our employer level retention remains among the highest in the industry and we continue to do an excellent job in retaining plan participants. Our participant rollover asset retention rate improved to 56.5% for the quarter, our best quarterly result ever as we continue to be an industry leader in retention. We are also very pleased with full service accumulation sales of $1.2 billion for second quarter, all organic. This amount compares to $900 million of organic sales in the year ago quarter. As we discussed, there are sales seasonality in this business and our result represents our best second quarter sales performance ever. As you know, we've expanded our channel developer resources, individuals who work with our alliances to drive sales opportunities to our 100 or so pension sales reps. We've also increased our emerging market focus and early signs continue to be promising. We are on track to sell more than 1,000 security builder cases in 2004, which would represent a 40+% growth from a year ago.

Principal global investors also had an outstanding quarter with record operating earnings of nearly $18 million. The improvement reflects unusually good commercial mortgage-backed securitization results and continued growth in asset based fees, including very good performance from post-advisory groups. We do normalized earnings for this business as 10 to $11 million per quarter for the near term. Principal global investors continues to successfully compete for new third party institutional mandates with 54 new wins year to date, including assets of $2.8 billion. Compared to a year ago, non-affiliated assets under management are up $7 billion or 32%.

In the second quarter Principal global investors continue to deliver solid investment performance. 70% of our retirement plan separate accounts ranked in the top half of those categories on a year to date basis. Our percentage of top half performers improved to 63% from 55% on a 3-year basis and improved to 53 from 42% on a 5-year basis. For the trailing 12 months, a percentage of top half separate accounts was 65%. Only slightly lower than at the end of 2003. Especially note-worthy is our bond and mortgage separate account, our largest separate account is $6.1 billion. At June 30, 2004, it ranked at the top 20% of its peer group year to date and for the trailing 1, 3 and 5-year periods.

In terms of accelerating growth and profitability of our International asset management and accumulations segment, Principal International continues to make good progress. They delivered a very solid earnings quarter, 45% growth in assets under management from a year ago to $8.3 billion and record net customer cash flow of 497 million, up 65% from a year ago. Principal International second quarter earnings were $9.3 million, compared to 11.9 million for the second quarter of 2003. In comparing the two periods, second quarter 2004 earnings, reflected additional costs associated with [Anara] mutual fund in Mexico, the implementation of SOP03-1 in Brazil, and higher amortization of deferred acquisition costs.

As Barry mentioned, second quarter 2003 earnings were approximately $2 million higher than normal, primarily due to a tax benefit in our Mexican [inaudible]. These unusual items offer [inaudible] Principal International's return on equity trends. The operating return on equity figures for first quarter 2004, and fourth quarter 2003, include higher than normal second quarter 2003 earnings. Importantly, we continue to expect segment return on equity to reach 7% by year end 2007.

Moving to life and health insurance, earnings for the quarter were $57 million compared to $63 million a year ago. The life and specialty benefits divisions each achieved earnings growth with individual life experiencing some better than expected mortality during the second quarter. As described in the earnings release, segment earnings were dampened by a premium refund accrual in the health division in the second quarter. Last quarter we indicated you could expect life and health segment earnings to average 60 to $62 million per quarter, with the first quarter being higher than average due to seasonality of medical claims. With $132 million of operating earnings for the segments year to date, we're well positioned to achieve the approximately 245 million we would expect for the full year.

New strategies for the segment that we've described over the past several quarters continue to show promise. In addition to improved earnings in our individual life and specialty benefits divisions, we achieved strong individual life sales growth, with recurring premium individual life sales of 89%, strong sales and in-force growth in each of our specialty benefit lines, improved lapse rates for group dental, vision. We are also seeing very good results in our retention efforts in health division. [inaudible] rates improving for group medical On the other hand, after three consecutive quarters of medical sales growth in our growth states, sales slipped and group medical covered members declined after having stabilized.

That said, we remain optimistic that intensified efforts to drive sales, new product offerings, like high deductible health plans and health savings accounts, and increased retention efforts will result in modest member growth in the second half of 2004, and more pronounced growth in 2005.

I'll now move to mortgage banking. Pursuant to statement of financial accounting standard number 144, accounting for the impairment or disposal of long life assets, all revenue and expenses, excluding corporate overhead allocated to the discontinued segment, are reported below the line as discontinued operations. The operating earnings impact of the corporate allocated overhead was $5.4 million loss in the current quarter compared to a $4.5 million loss in the prior year quarter. As you know, on July 1, 2004, we closed the sale of Principal Residential Mortgage. We are pleased with the outcome of the transaction.

Going forward, we will have greater focus on resources to capitalize in our most compelling opportunities with small to medium sized businesses, their employees and institutional clients. We now estimate net sales proceeds from the sale of approximately $630 million, subject to post-closing adjustments. The decline from our original estimate primarily reflects transaction costs not included in the original proceeds estimate, a lower sales premium due to a decline in the pipeline in mortgage service and rights premium, and the decline in the equity of the business due to second quarter operating performance. We now estimate that after-tax capital gain on sale for Principal Residential Mortgage of approximately $125 million.

Before wrapping up, I'll briefly discuss the net realized, unrealized, capital losses and credit quality of our fixed maturity securities portfolio. After tax net-realized and un-realized, capital losses were $45 million for the quarter, compared to $14 million in the year-ago quarter. The increase in losses can primarily be attributed to mark-to-market on certain seed money investments. Losses from impairments and impaired sales of our fixed maturities were $14 million in the second quarter, down from $23 million in the year-ago quarter. As a percentage of total U.S. fixed maturities, the low investment grade makes up 6.3% of the portfolio, down from 8.7% a year ago.

As a percentage of total invested assets and cash the low investment grade makes up 4.4% of the portfolio. Gross unrealized losses increased during the quarter as expected given the rise in interest rates to $286 million. Importantly, only $3 million relates to securities 20% or more below amortized costs for 6 months or greater. I'd add that we are not concerned with this level of increase due to interest rate changes as we manage our assets and liabilities together.

This concludes our prepared remarks. I would now ask the conference call operator to open the call to questions.

We'll pause for just a moment to compile the Q and A roster. Your first question comes from Jason Zucker of Fox-Pitt, Kelton

Good morning, everybody, I have a couple of questions. The first, Barry, it sounded to me like on 401K sales, at least for this year, that we should expect to be below the 15% more normalized longer-terms sales growth goal. And I just wanted to--you to just reconcile the guidance that I had written down from previous quarters, which for this year for sales was 1.2 to 1.8 billion per quarter. And then the second question I had was, now that we've got written--gotten rid of the mortgage banking business, can you just talk about earnings sensitivity relative to the equity markets, for example, a 10% move in the equity markets is what percent swing in earnings? Thank you.

Thank you, Jason, good morning. Let me take the last one first, and if I get it wrong, Mike can jump in, basically we believe about a 10% change in the equity markets would represent about a 6% change in total company earnings. Of course, depends on the timing, the longer it's depressed, the more chance we have to do some other things to litigate that, but that is the basic rule of thumb that we use.

Okay.

On the sales--full service accumulation, I guess it is a little early to tell exactly how things will play out for the full year. We certainly did give a range of 1.2 to 1.8 billion, and I think one of things we've been trying to say is the underlying sales power of our organization is probably more like 1-2, to 1-3. What we're counting on from time to time with some larger cases which can be lumpier, a little more uncertain as to how they'll come in, and, I think, we've seen some delayed decision making in the larger case markets this year, so we're not giving up on some increase this year but I don't think it is going to be 15% probably, but that is not out of the question, we still got the last two quarters to go. The 15% is really a longer term goal and we feel pretty comfortable with that, Larry, you want to add anything to that discussion?

I think--Jason, this is Larry--I think Barry has said it well. I think again, whether we actually hit 15 this year, which again is a long-term number, is literally going to come down to our position on a handful of very large cases. But the infrastructure is solid and we'll continue to deliver solid results there.

How often do you get these cases that are over $100 million. Are they rare, only two, three, four, five, a year? How do I compare, maybe the last year? How many did you have last year?

Yeah, Jason, this is Larry, I would say that probably in a year we would typically see maybe half a dozen or so, of those kinds of cases, so that could be somewhere around 10% or so of our total sales in the year, 10 to 15% can be tied up in those relatively jumbo cases. But there's a handful of them out there, our pipeline is strong, our pipeline is up about 60% over what it was a year ago. We do compete very well, as Barry and Mike both talked about. We have our total retirement suite launched, which we did here on July 1st, we think that will compete very, very, well. Frankly, we're optimistic, but the RFP process is a little slow, it takes about 7 to 8 months now, whether those come in Q4 or whether they come in Q1 of next year, will somewhat come down to the timing and the buying decision.

This is Barry. I would also remind you of something I said in my prepared remarks, the other side of that is that lapses are way down, considerably down, lowest we've had in a long, long time. And we think we're at about $600 million of equivalent account value to the fact that lapse rates are so low. You do have to consider that. The negative is, that the sales are challenging. Positive is that we're obtaining a lot more of our larger cases.

And you believe those [inaudible] lapse rates are sustainable.

They're correlated to buying decisions. If the buying decisions pick back up and there's a lot more activity, you know, lapse rates will probably inch back up, but you will see much increase in sales activity. So I think they're very much correlated.

Great. Thank you.

Your next question comes from Andrew Kligerman of UBS Securities.

Few questions, let me start with the first one, can you talk about how the low lapse rates correlate with this FSA defined contribution plan. I notice in the fourth quarter, for example, it was 32,139 and it dropped in the second quarter of '04 to 31,717. So, I'm just kind of curious, I want a little color why the plan accounts seem to be declining.

I'm going to have follow up.

The lapse rate we're talking about and the way we measure this is basically an asset lapse rate. We really look at what percentage of the assets are we retaining year over year. You're talking about a case count. We talked about this a little bit in the past. We had a couple of things going on. We had some definitional issues that we cleaned up, some definitions within our system. But, more to the point, we've had a number of very, very small cases that, frankly, have not been profitable and we've been trying to move a number of those cases to other forms of coverage, whether it be an IRA, or just an individual savings account of some sort. It's really been more of a planned effort on our part, from an economic standpoint to focus on cases that are more profitable. We do have some very good new products that are specifically designed for the small end of the case. Market. We mentioned that in our remarks. I think we said we're looking at maybe writing 1,000 new security builder products this year. That is a products specifically for the small end of the market. That will be a 40% increase. We have a number of new resources dedicated there. So, we're not abandoning the small end, but we did have to recalibrate the product offering we had in the small end. I think much more important metrics are plan members which are up, account values which are up and assets which are up quite nicely.

Shifting over to the health and specialty benefits loss ratios, group medicals spiked up to 80% and part of that I know was the premium refund. But also it seemed like morbidity [inaudible] and group disability, with that spiking up north or around 87.6%. Can you talk about what your outlook is for those ratios. Do we have a problem there or is that just a blip?

I don't think we have a problem there, and I'll let Josh Aschenbrenner give you some color on it.

Yeah, Andrew, if we take them separately, on the medical side, two things happened in that blip, part of it was the first quarter was abnormally low because of seasonality, and so that will have reversed and second the premium refund that we talked about. If you take off that premium refund and another small reserve adjustment, the loss ratio for medical would have been 78.2 for the quarter, which we're very comfortable with. We need to be in the 77 to 78% range. So we don't see any problem at all in the medical side. The disability is a significant concern for us that we're looking at. It is primarily a couple of large cases that we're getting some very poor experience on. We are addressing those large cases, and we don't think it will be an on going problem at all.

Great. And then one last question, it looked like in corporate and other, your investment income came down pretty sharply. It was about 1.6 million, down from 13.4 in the quarter. I think some of that is due to real estate partnership income, but why the sharp dropoff, and what can we expect going forward as a run rate?

In terms of--this is Mike Gersie, Jason--.

Andrew.

Andrew, sorry. Couple analysts behind. In terms of some of the change, there is some seasonality in some of our investment income, joint venture performance fell off. There was some--we owned some hotels down in Australia which we have sold, finally and we're happy to be out of the hotel business in Australia. But that had a little bit of seasonality to it. It was stronger first quarter earnings, just because first quarter is a holiday season down in Australia. We also lost a little bit of assets. We redeemed some surplus notes right at the end of first quarter, that was about a $200 million payoff, and so we had 200 million less to invest in the corporate segment. That number is going to be a little bit lumpy. And rather than talk about income, investment income, probably best to focus on, sort of a normalized run rate of operating earnings for that segment. We would expect normalized earnings as we had said in the past, to be somewhere between negative 10 to negative 15 per quarter. I think you could expect that as sort of normalized. We were a little bit better than that for this quarter, but it's going to vary.

I think you're always getting out of something in Australia. Are you fully out of everything there?

Pretty much out of there.

That was McCaughan that answered that. He's the investment guy.

We have relatively small [inaudible] investment office in Australia with 25 people doing some management of currency and fixed income which is part of our global platform and also servicing our actually now growing client based in Australia. It is purely an asset management operation, as part of our global asset management platform.

Thanks a lot.

Next question comes from Ed Spehar of Merrill Lynch.

Good morning, I had a few questions. First, I was wondering if someone could talk about the[inaudible] business. If I look at the performance both in investment only and then the portion that is in the full service segment, the assets are up slightly year over year in both of those businesses, but the earnings are down in the investment-only 14%. If I kind of just rough sort of spread income in the full service, looks like down about 12. I wonder if you could talk about what's going on in sort of those institutional spread businesses and then I got a quick follow-ups.

I'll let Larry jump in and take that.

Ed, good morning. First of all, on the investment-only business, that block of business is growing. The account values are growing, but because of the decline in interest rates, you are seeing some reduction in investment income. In the second quarter we also did a slight repositioning of that portfolio in order to better match up our floating rate assets and our floating rate liabilities, and that, we think, will better position us going forward should interest rates increase. End result of that, I think, is that we are going to continue to see earnings out of investment-only area of somewhere around $25 million a quarter. That's, I think, very much consistent with what we communicated in the past. On the full-service accumulation side, the driver there, Ed, for slightly greater decline in net investment income, is the defined benefit business that's embedded within that full service accumulation block. That defined benefit business is more mature. Actually, the account values are slightly negative for the entire year, so that's why you're seeing the net investment income there go down a little bit faster than you're see ing net investment income in the investment-only segment.

Okay. And then that's helpful. And a couple of other quick ones. I was wondering, if you look at sort of across a number of business lines, your DAK amortization was up relative to pre-tax profits before amortization. We all like to see that, but I'm just wondering, is there anything that was going on in terms of amortization rates in the quarter? And then, just a final question, is ton the large case 401K business. One of the reasons you are less optimistic about those big cases for the balance of the year because of competition for business in that market? Thank you.

Larry, go ahead.

I'll try to take both of those briefly, Ed, on the DAK amortization, I don't think there is anything unusual going on there, I think--what you're seeing in terms of the quarterly amortizations is a reasonable proxy for what you would see going forward, as that block of business has built up, we expect to see those amortizations increase. That is what is happening in both our full service accumulation, as well as, our retail annuity lines of business, and we think the rate of amortization you see is very reasonable. In terms of the large case market, I don't want to leave you with any impression that we're not able to compete in the large case market, in fact, we think we are better able to compete today than we ever have been. And again, both Barry and Mike talked about our total retirement suite, and I will tell you that I'm very optimistic about the ability of our total retirement suite to drive large-case sales. The issue, again, is simply one of how long it takes to go through the more formal RFP process. The plan sponsors all seem to want to follow more today than they have in the past. As a result of that we're seeing the time that it takes a case to work its way through the pipeline as being extended from perhaps 5 or 6 months in the past to something closer to 6 or 7 or maybe some cases 8 months. Just as one final stat, I tell you that over 85% of the pipeline that we had going into the start of 2004, have not yet made buying decisions. So there is still a lot of business out there to compete for and I think we'll win more than our fair share.

Thank you.

Your next question comes from Eric Berg from Lehman Brothers.

Thanks very much. I have a fresh question I also wanted to go over a couple of the responses so far. I think I heard Barry say that the number of planned participants in the small employer, I hope I heard you right, is growing. Could you point me in the direction of those numbers, because when I look on page 31 I see in the small employer marketplace, I see numbers basically flat to down. When you talked about--I'm sorry, never mind, I'm--this is the second panel of data, is the number of plans. Your point was that the number of employees is actually--number of planned participants, Barry, is growing?

That's right in an overall block. 2.5% or something like that.

Okay.

2.7, over 2.6.

Okay, very well. The answer to the last question, regarding the earnings in the investment-only area, are you effectively saying that because of the repositioning of the assets and the associated liabilities, that [inaudible] margins or spreads are narrowing. Is that effectively why the earnings are not going to grow in the face of assets growth. I just need to clarify that.

We repositioned to make sure margins are the same going forward. But, go ahead, Larry.

Actually, again, if you look at this trend area over a period of time, say go back to a year ago, you would find that the margins today are very consistent with what they were a year ago. I don't want to leave you with any impression of diminished spread when we look at it by historical standards. But, from quarter to quarter there can be, as we reposition the portfolio and again, in second quarter we brought in a greater amount of floating rate assets, if you just isolate it on the second quarter, you might see some diminishment in spread for that particular quarter. But, on a go forward basis we actually think that's going to be a better position for the portfolio, because we're more correlated with the same amount of floating rate assets and liabilities. So, we think we've essentially protected, and again, that sort of 25 million a quarter is now a more reasonable estimate going forward than it would have been had we not done the repositioning.

But you would expect, just to clarify, you expect, therefore, given your repositioning of your assets to include more floating rate assets and your moving to protect margins, I would think, therefore, that earnings will not be stable from here, but will be increasing reflecting the growth in assets.

It will increase at approximately the level of the account level growth, Eric, that's correct.

Okay. My final question --.

Other thing to remember, Eric, is that for the [inaudible] to medium term notes we're fairly capped out in terms of our ability to grow that business. So it can only grow about as fast as our general account grows.

Okay. My final question relates to the life and health business in general. Barry, we've seen certainly some improvement in the top line after an extended period of [inaudible] in here, but it is uneven, as I see things, and even mid-single digit would be fair a characterization of the growth. The earnings have been--I hope you think it is fair to say--they have been choppy, you have lots of special items both positive and negative. Are you committed to this business?

We are absolutely committed to it. We think it works very well with our S and B focus. We have long tradition of managing these businesses. Part of the problem is the last couple of years we had an--last year in particular--we had awful lot of positives go our way, and I think it is giving maybe the impression that the underlying earnings are perhaps a little better than they really are. We've been trying to communicate that what you really ought to think about is somewhere around $60 million a quarter, and I would think as you go into '05 we'd be thinking about increasing that to probably 65 million a quarter. We think these are good businesses to be in, they have good strong strategic bids and we're commit to them.

Thank you.

You next question comes from Jimmy Bhullar of J.P. Morgan.

You recently mentioned--your press release mentioned 3.5 million negative impact from health results from litigation approval, on the positive side, Principal's global results were, roughly, I think, 7 million higher than the run rate because of unusually high income from commercial mortgage security tisization. My question is what are you, were there any other unusual items in the quarter or any other items that you would consider unusual in the quarter and what would normalized earnings have been excluding these items.

Jimmy, I don't think there was really anything significant beyond those. To some extent they kind of counter it out. I would say the earnings that we're reporting are pretty reflective of our normalized earnings.

Okay. Second question, just wanted to make sure, I think you mentioned this in your comments, but the mortgage number we saw, mortgage banking was negative 5.4 million, that should go to 0 next quarter, because that will be assigned to other businesses.

That's right. It's a stand alone, is a number that you can see, it'll go to other businesses, that's right.

Okay. Thank you.

Your next question comes from Colin Devine of Smith Barney.

Good morning, gentlemen. First, I'm wondering if we could talk a little bit more about the full service accumulation business. Given, I guess we all expect it would be somewhere in the [inaudible] of proof Cigna, [inaudible] and with their Hancock acquisition. Larry, isn't it really fair to say that sales are a little disappointing from where you would expect them to be given that you've got two major competitors out there who seem to be focussed elsewhere? Secondly, for Mike, if you can give us an idea of what the risk space capital number was in the [inaudible] company at the end of the second quarter? How do you see, when will the money come out of there for the sale of the mortgage business proceeds?

I'll let Larry jump in too, but yeah, I think I would readily admit that we're not happy with where sales are. On the one hand, if you look back where we've been, going from 2 billion, to 3.3 billion, you know, to 5 billion, we're absolutely elated with the last 4 or 5 years in what we've done. But if you look at this year specifically, if you think about the economy, you think about the war in Iraq, you think about all of the things that have gone on, I would have hoped we would have been doing slightly better than we are. We have some disappoints, but in terms of looking forward, our risk-based proposition and our acceptance in the marketplace, and I don't think we've got anything to be, you know, embarrassed about. I think we have probably the best other than Fidelity the best machine out there in terms of new sales. So, yeah, we are disappointed, I think that is a good thing, we would have hoped to have done better. Mike, you want to talk about the capital?

I'll approach your question two different ways, Colin, because I'm not sure exactly, if you're looking for excess capital or looking at risk-based capital. I'll try to hit both of them. If you haven't asked one of the questions, and that will hopefully answer a second question someone else might ask. In terms of risk-based capital we had roughly between a billion and a billion one of excess capital at the end of the second quarter, with expected deployment of capital, expected share repurchase, we've got some debt maturing in the second quarter and we do not plan on refunding that debt or reissuing that debt. By the end of the year we'll probably have that number worked down to somewhere between 200 million and 300 million of excess capital. In terms of what that does to risk-based capital, at the end of 2003, we had risk-based capital on a NAIC basis of about 444. If you take out the impact of PRMI, and the impact of PRMI just because of some of the goofy ways that the formula works, would have reduced that ratio to about 404, and then with moving capital from the life company up to the holding company, and some of that movement has already occurred and some is scheduled to occur in the third quarter, we would anticipate, again, on an NAIC risk-based capital basis to be somewhere around between 350 and 360 at the end of the year. So, hopefully, that gives you reasonably good look at capital movement, available capital and where we'll be on a risk-base capital basis between now and the end of the year.

That's perfect, thank you. One quick follow-up. On the [inaudible] operations, with sales being a little lighter than perhaps we all thought, have you cut back some of your planned technology spending or have you decided justed to just [inaudible]?

Not in any meaningful way, Colin, on either one of those. I think we view that our technology spend as a real investment and we think and we demonstrated that it has produced significant economic value, and really as it relates to all aspects of our operation, we're very focussed on maintaining our efficiency but we don't see ourselves really cutting back on any technology spin, Colin.

Thank you.

Next question comes from Nigel Dally of Morgan Stanley.

Couple of quick questions. Following up on the excess capital, with your excess capital, can we get an update on what you potentially see for equity opportunities going forward, whether there was any change in the marketplace there and whether you're beginning to see any opportunities emerge. Second, just wanted to clarify with regard to pension and net flows. You expect lower [inaudible] to be fully offset by improved consistency so that your net flow expectations haven't changed? I want to make sure that I got that right. Thanks.

Nigel, I'll take the first and let Larry take the second. I don't think there has been any significant change in outlook around what we're going to do with excess capital. Certainly we continue as we say over and over, a good organic growth is our first priority and we do have some areas that we can deploy capital. We continue to have a preference for strategic acquisitions that bring us different capabilities and certainly the spectrum asset management, CN post, CW post, PPI, more recently Malloy, VCI, all have been just very, very strong acquisition for us bringing us capabilities in our adding to our International operations will continue to be a focus, but all of these are small to medium. We're not oblivious to or certainly not going to look at larger acquisitions that come along, that is probably not our focus right now. We continue to focus on the other 3 that I mentioned. Larry, want to get back at to how the offset of sales from improved lapses and how that impacts cash flow?

Nigel, in terms of cash flows, we certainly are very much staying with the expectations that we already communicated, and again, just to reiterate those for you, on the full service [inaudible] business, we expect to see account value growth of at least 1.5% per quarter or 6% over the year. Again, you go back and review--you know, we have been actually far in excess of those, but, again, we're trying to be reasonable in light of the 15% organic sales target that we're trying to hit and unless we have a key-corp type of acquisition or some other event that comes along our way, we think the 1.5 per quarter is a very reasonable expectation and we're staying with that. We're staying committed to that.

That's great. Thanks.

Next question from Jeff Hopson of AG Edwards.

Hi, good morning. Larry, just to maybe a final question on this whole issue. What has changed in your mind in regard to the RFP process that's made it more formalized? Does it have anything to do with the mutual fund scandal? And is this a process where you're going to finals, such that you would have gotten some feedback on some of these larger accounts, in terms of pricing and other issues?

Yeah, interesting questions, Jeff, thank you. I would say, and again this is all anecdotal, but I do try to stay very, very close to our sales team and spend time, as well, involved in some of these situations, and I would say that it would be reasonable to say that larger plan sponsors are feeling a need to go out and entertain RFP bids periodically. Frankly, Jeff, many times, even when they may not be committed to make a change, and that in itself is one of the different trends we're seeing now. In other words, these larger plans may feel a need to go to market every 3 to 5 years. Much has happened on the health side, historically, but has not been as prevalent on the pension side, we're starting to see more of that. The other thing that happens is, I think that, that RFP process tends to be more consultant-driven. When the consultants are involved they will tend to probably go out to more companies and thus it takes longer to aggregate all the data, get all of the information together, go back and forth to the client, and that's what leads to that longer buying decision, that we've referenced in our comments. Again, I think, over time, this thing will begin to smooth itself out, but right now we're in the midst where we're seeing it lengthen out and we're not seeing quite the sale of larger cases we have in the past. I think it will turn around and we'll see those start to come in, again.

Okay. If I could follow up. Barry, it sounds like you are pretty comfortable that the sales in the life health business, in particular on the individual side, are something that you can now count on, maybe not to the same degree, but it seems like that business has in fact seen a real pickup.

Yeah, absolutely, Jeff. We believe that we have turned the corner and we talked about this last year and we said that you should see good signs of growth and individual life area, and we're certainly getting those. We've had some new product introductions that have been helpful, but one of the things that have been particularly helpful, we seen a lot of growth in corporate and life insurance operation -- not so little anymore, operation we have down in North Carolina that really provides excess plans and qualified plans and it has really taken off and that is really true of a lot of our growth. There was a little bit of up demand, I think, from last year when there was some threats to corporate life insurance and those have gone away, but we're very, very pleased in the results in the individual life area.

Thank you.

Next question comes from Suneet Kamath of Sanford Bernstein.

Few questions, please. First on the full service accumulation flows, are you guys indifferent with respect to the return on assets to the margins in terms of the asset growth, whether it comes from higher levels of retention, or new sales? And then, second, on the capital, can you talk about your buy-back expectations that are embedded in your earnings guidance, and perhaps any rating agency or capital ratio threshold that you may kind of come up against as you think about buy-backs for the balance of the year. Thanks.

Very good, Larry, you want to take the first and Mike, you can talk about the share repurchase.

On the--Suneet, good morning, this is Larry. On the net flow issue, I would say that from a purely economic perspective, quite frankly, we are better off hanging on to or retaining a greater share of the dollars than we are going out and securing new dollars. Now, I don't have a--an exact metric around that, but I can tell you that the by and large that's a better overall economic outcome. Of course, at the end of the day we want both. We want to see the sales growth and we want to see the retention. But we've had some very deliberate activities that we have used on the service side, we think have also helped to drive the better retention, including relationship managers for larger accounts and local service platform of about 150 local service reps. So, we think that that retention will be sustainable going forward. At the end of the day we would rather hang on to the assets, than have to go out and secure new ones, I'll turn it to Mike for the other question..

The other question dealt with expectations for share repurchase and capital constraints, perhaps, from rating agencies. As we do our, ran our financials through our projections, embedded in them is fairly aggressive share repurchase activity, so that the $700 million authorization would be, I'll say, substantially completed. Obviously, we'll be a little bit looking at what the market does, and that will impact our share repurchase, but it is really aggressively using up the excess capital that we have to get to the numbers that I talked about when I answered Colin's question. In terms of impact on how the rating agencies view share repurchase, we believe that to some extent they view share repurchase more benign than making acquisitions. So, if you think about it, we don't anticipate bumping up against any rating agency capital barriers to making sure that that level of share repurchase, although obviously we interact with the rating agencies very frequently, and if there is an issue, that would impact the level of repurchase. But right now we don't see any.

I think we're probably at the end and I thought I might just make a couple of quick closing comments. I appreciate all of your support. I know it's been a difficult quarter, there has been a lot of noise, lot of conversations and I appreciate your interest and hanging in there with us. I thought it might be helpful just to make one quick comment about 2005. We are moving away from quarterly guidance, but it might be helpful to remind you, some of the expectations, while we do have 11 to 13% long-term earnings per share goal, we believe that if equity markets perform at the 2% per quarter next year, that we'll be able to achieve more like a 16 to 18% EPS growth into 2005. Again, thank you all very much for your support, we look forward to seeing you on the road, soon.