美國信安金融集團 (PFG) 2004 Q3 法說會逐字稿

Good morning, and welcome to The Principal Financial Group’s Third Quarter 2004 Conference Call. There will be a question and answer period after the speakers have completed their remarks. If you’d like to ask a question at that time, simply press star and the number one on your telephone keypad.

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 Third Quarter Conference Call. If you don’t already have a copy, our earnings release and financial supplement can be found on the Investor Relations section of our web site 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 10-K for the year ended December 31, 2003, and in the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2004, filed by the Company with the Securities & Exchange Commission.

Barry.

Thanks, Tom. And welcome to everyone on the call.

This morning, Mike Gersie and I will focus our remarks on three areas. We'll describe our performance for the third quarter and focus on our key growth measures. As always, we'll provide segment details and discuss those items impacting comparability between periods. We'll provide an update on our uses of excess capital, and we'll also provide some color around our operating earnings guidance for 2005. In addition, I'll make a few comments on issues related to insurance broker compensation raised by the New York Attorney General.

As always, Mike's remarks will include a detailed overview of financial results, but I'd like to offer some highlights for the third quarter. We had record assets under management of $156b and record full service accumulation account values of $60b. Record operating earnings driving strong improvement in operating EPS compared to the year ago quarter, a sixth consecutive quarter of record earnings for U.S. asset management and accumulation, up 14 percent compared to a year ago in spite of weak equity markets in 2004, record pension full service accumulation earnings up 24 percent from a year ago driven by strong net cash flow, continued strong earnings from growth from our individual annuity business, strong financial performance from each of the Divisions in our Life and Health segment, strong sales performance for full service accumulation, mutual funds and individual annuities, as well as for our individual life and each of our specialty benefit lines, and good progress in the Health Division with solid growth in group medical covered members in our targeted States and strong growth of wellness lives.

We are clearly very pleased with the quarter, but I'd also point out that certain unusual items boosted third quarter operating earnings. Mike will discuss these in more detail in just a moment. As you know, accelerating growth in our U.S. retirement services business is a critical element of our strategy. It's very important to us that investors fully understand how to gauge the earnings power and strength of these businesses. In particular, the pension full service accumulation. So I'll spend the next couple of minutes discussing the health of these businesses, including the keyed indicators of growth, account values, net cash flow, and sales.

Compared to a year ago full service accumulation account values have increased 18 percent or 9b to $60b. Credited investment performance contributed 5.3b to this growth. In spite of declining equity markets over the past three quarters we're still experiencing some lift from strong equity market performance in late 2003. Net cash flow, the second largest component of full service accumulation account value growth, contributed 4.5b. Excluding M&A and the prior year trailing 12 months we've achieved double digit growth in net cash flows and deposits.

Importantly, through only three quarters net cash flow already equates to 5.5 percent of beginning year account value, over 92 percent of our full year target. A big part of this success is plan level retention which remains among the very best in the industry. At 3.5 percent YTD client lapses continue at an all time low, and the large case lapse rate is less than half of that of our overall retirement block.

Because of our extensive local service team and our network of relationship managers that work with our large retirement clients we believe these lower lapse rates will continue into the future. We also continue to effectively retain plan participants with 52.5 percent rollover asset retention rate for the third quarter.

Payroll deductions from retirement plan investors and employer match now make-up more than two-thirds of the deposit number, growing as a result of our strong retention efforts combined with our success in increasing participation and encouraging higher deferrals.

As you would expect, it is significantly more profitable to retain a dollar and account value than it is to bring in a dollar of new business. As a percent of beginning year account value, again, on a trailing 12-month basis, we've reduced withdrawal to 16.7 percent from 19.5 percent, a 14 percent improvement.

At 1.3b organic sales are up 13 percent from the year ago quarter and 11 percent sequentially. At 3.8b YTD organic sales are flat, and we believe it will be very difficult in 2004 to match full year 2003 organic sales due to the especially strong sales in the first and fourth quarters of 2003. We view our sales results through the three quarters as very strong, particularly in light of the current market conditions which includes some aggressive pricing by competitors and some continuing delay in employer decision making.

I point out, again, we've carefully built a sales infrastructure that can deliver normalized sustainable sales in excess of $5b per year. We continue to strategically invest in that infrastructure. With our total retirement suite launch in July we bring to the table a comprehensive set of best in class retirement solutions to meet the needs of small to medium businesses and their employees.

The launch is being received with great enthusiasm and solid initial sales success. It narrows the competitive landscape and also provides a significant opportunity to improve sales by meeting a broader range of needs of our existing clients. We also continue to make great strides in enhancing distribution, including our recent addition of channel developers and emerging market reps.

As you may recall, just three years ago organic full service accumulation sales were $2b a year. Over that period we've constructed an outstanding sales organization and, again, a sustainable base of sales in excess of $5b per year. Given market conditions and from our current strong base we believe a realistic sales growth target in 2005 is 10 to 12 percent which will support our net cash flow and EPS growth targets for the year. Our 2005 sales growth target does not include any growth from continuing consolidation and the defined contribution business in which we expect to be a strong player.

In closing the sales discussion I would, again, emphasize that sales are just one of several elements of our full service accumulation growth strategy in concert with growing deposits from existing customers, and strong employer, and employee level retention we expect to continue exceeding our annual net cash flow target of 6 percent of beginning year account value for this business.

Moving to the uses of excess capital, we continue to utilize share repurchase in the third quarter. 8.2m shares for $284m, at an average price per share of $34.43. As of September 30th, 2004 we had completed just over half of the $700m program authorized by the Board in May of 2004. We will continue to opportunistically utilize share repurchase as one option in our effort to effectively utilize capital to achieve our EPS and ROE targets.

Just after quarter end we announced that Principle Global Investors had agreed to acquire a majority interest in Columbus Circle Investors, a premiere asset management firm specializing in growth equities with more than $3b in assets under management. The acquisition enhances our capabilities and complements an already strong team of equity investment professionals.

As you also know, in late October, the Board of Directors declared an annual dividend of 55 cents per share, payable on December 17th to shareholders as of record on November 12th. We were very pleased to be able to increase the shareholder dividend by 22 percent from a year ago. We believe this increase reflects our continued strong earnings growth as well as our commitment to deploying capital to create long-term value for our shareholders.

Moving to our outlook for 2005, we expect operating earnings per diluted share to range from $2.60 to $2.72. Last quarter, as you may recall, we communicated a preliminary expectation for full year 2005 EPS growth of 16 to 18 percent. This was based on a full year 2004 guidance of $2.28 to $2.32 per share, which translated into a range of $2.64 to $2.74.

Our 2005 EPS range is, therefore, consistent with that guidance. The difference reflects the impact of lower than expected equity market performance since providing preliminary guidance. I would also point out that the percentage growth will be more in line with our long-term 11 to 13 percent growth target as a result of the impact of the unusual items in 2004 we discussed.

I would add that this estimate is based on certain key assumptions, including domestic equity market performance improvement of roughly 2 percent for the fourth quarter 2004 and continuing at roughly 2 percent per quarter throughout 2005. As you know, market appreciation is a significant component of assets under management and accounts value growth. Declining market performance over the first three quarters of 2004 has had a dampening affect on growth, so I want to again emphasize the importance of this assumption on our ability to achieve our full year 2005 EPS target.

Before wrapping up, let me spend a minute or two on an issue that is top of mind for the industry and The Principal, the New York Attorney General's investigation of continued commissions and bid rigging. The Principal has not received any subpoena on this matter, but we're conducting our own thorough internal review to ensure our policies are being adhered to by our employees.

At this point, the Company has not identified any instances of bid rigging. To be clear, though, bid rigging is a fraudulent practice and not tolerated by The Principal in any form. The Principal does pay compensation in some situations based on factors including volume, profitability and persistency. This amounted to approximately 6 percent of total compensation paid for group insurance product sales, including group annuities and our employee benefit businesses in 2003. We will continue to closely monitor the rapidly unfolding legal and regulatory developments around contingent compensation arrangements as well as developments in industry practice.

I'll close with a comment on our operating return on equity. For the trailing 12 months, our ROE has climbed to 11.8 percent, from 10.1 percent a year ago. We're targeting 12.5 percent as our yearend 2005 goal, and generally a 50 basis point improvement per year thereafter to achieve our longer term target of 15 percent.

Now, I'll turn it over to Mike.

Thanks, Barry.

This morning I'll spend a few minutes providing additional highlights for the quarter and financial details for each of our operating segments. I'll close with some additional color regarding our outlook for 2005.

As Barry indicated, we're very pleased with our results for the third quarter. We delivered very solid growth, particularly in light of weakness in the equity markets. As Barry mentioned, there were a number of items that aided third quarter 2004 operating earnings and impacted comparability. These items are important in characterizing results for the third quarter, and also in establishing growth expectations for each segment going forward. In total, the items added approximately $25m to operating earnings or 8 cents to operating earnings per diluted share.

To summarize, the Life and Health segment benefited by $10.6m due to reserve adjustments. The Corporate segment benefited by $5.2m, and International Asset Management in accumulation benefited by $2.7m, both due to favorable tax adjustments. Also included in the $25m total, the $6m of operating earnings due to higher than normal prepayment fee income in the three pension businesses. I'll provide more detail on each of these shortly.

Moving to the segment discussion, I'll start with highlights for U.S. asset management accumulation. Segment assets under management are up $22b or 20 percent compared to a year ago, driving the total Company figure to a record $156b. Segment operating earnings increased 14 percent to a record $124m compared to $108m in the year ago quarter. YTD segment earnings are up $56m or 18 percent.

Pension was the main contributor to improved segment earnings, increasing 13 percent to a record 99m compared to 87m in the year ago quarter. As I mentioned, higher prepayments added $6m to pension operating earnings. $2.9m for investment only. $1.7m for full service payout. And $1.4m for full service accumulation.

Pension full service accumulation earnings improved 24 percent to 57m compared to 46m in the year ago quarter. Full service payout earnings were down $2m from a year ago, and are basically flat for the year, primarily reflecting some normal but unfavorable fluctuations in mortality.

Investment only earnings were up 10 percent in the third quarter, however, excluding higher prepayment fee income investment only earnings would have been down slightly compared to a year ago. The segment increase also reflects continued strong earnings growth for individual annuities, which increased 19 percent in the third quarter and is up 32 percent YTD. Through nine months individual annuities net cash flow is up 91 percent to more than $870m. Sales are also very strong up 53 percent to a record $1.5b, surpassing total sales for 2003.

Mutual fund earnings increased 10 percent compared to a year ago, and are up 75 percent YTD. Mutual fund sales for third quarter were down slightly from a year ago. Through nine months, however, we've achieved double-digit growth in mutual fund sales to a record $2.2b, also surpassing 2003 totals.

Reflecting the Principal's connections strong asset retention efforts, merely $580m of withdrawals YTD from pension full service accumulation were retained into our mutual funds. And $11m Principal Global Investors' third quarter earnings were solid, up 7 percent from a year ago. Importantly, Principal Global Investors continues to successfully compete for institutional investment mandates. Their unaffiliated assets under management are up nearly $9b or 40 percent from a year ago, reflecting continued momentum with third party institutional clients, as well as the acquisition of post-advisory group. YTD their earnings are up 38 percent, reflecting strong growth overall in assets under management.

Within our International Asset Management and Accumulation segment principal internationals earnings improved 40 percent from a year ago to $11m. Pretax operating earnings, however, were only up 5 percent compared to the year ago quarter. The increase in operating earnings basically reflects the impact of $2.7m in tax benefits, primarily a net operating loss tax credit triggered by the sale of mortgage banking. Excluding the tax benefit operating earnings would have increased consistent with the 5 percent increase in pretax earnings.

YTD Principal International's earnings are up 10 percent to $29m. This compares to 21 percent growth in assets under management through nine months. 2004 unusual items have basically offset each other for the nine month period. But as you may recall, second quarter 2003 operating earnings included a $2m favorable onetime tax adjustment in Mexico. Excluding this unusual 2003 item nine month earnings would be up nearly 19 percent compared to the same period a year ago, consistent with our long-term growth expectations we've communicated for the segment.

Pretax earnings have declined over the past two quarters reflecting some planned expansion, including cost to add an investment option in our Mexican [Afore] [ph] in the first quarter 2005. We expect planned expenditures to also dampen earnings in the next two quarters, returning to our targeted operating earnings growth for the segment in the last three quarters of 2005.

Moving to Life and Health, segment operating earnings were $72m, compared to $53m in the year ago quarter. As I mentioned, the third quarter results included some unusual items. The variance includes two favorable reserve adjustments, $7m in the Health Division for refinement to the extended benefit preserve, and into $3.6m incurred but not reported release for group disability in the Specialty Benefits Division.

This quarter was very solid for the segment contributing to a very solid year, even removing the impact of unusual items segment earnings would have been consistent with our normal run rate. Individual life sales were again strong, up 142 percent in third quarter compared to a year ago, and up 105 percent YTD. Sales growth reflects very strong sales in our new universal life product, as well as strong growth for our other individual life products which are up 33 percent YTD.

Sales in the Specialty Benefits Division also improved strongly, up 29 percent for the quarter and 30 percent YTD, driven by outstanding dental sales. In addition, lapse rates YTD have improved for all specialty benefit lines, as well as for individual life and group medical. While group medical covered members are down slightly in total, our focused growth strategy is starting to take hold. Within our group medical target States inforce monthly premium is up 13 percent from the year ago quarter. This increase was driven in part by higher covered members in our target States, which were up 5 percent from the prior year quarter.

We're also very pleased with the early interest in sales success in our new high deductible health plan with health savings account, as well as in our wellness offering. Looking forward, we expect we'll take a couple more quarters before we see growth in total group medical covered members, as growth in target States offset the decline in members in other States.

In ramping up the life and health discussion let me share some additional thoughts. I'd remind you that fourth quarter 2004 segment earnings will be negatively impacted by seasonality of health claims. After tax we expect the impact to be approximately $4m. I'd also remind you of some unusual items in the fourth quarter of 2003. As previously communicated, these items improve segment and total Company operating earnings for the fourth quarter 2003 by $9m, or nearly 3 cents per share.

Before closing, let me briefly provide some additional color around operating earnings guidance for 2005. Our longer term expectations are applicable for 2005, including 11 to 13 percent growth for total Company, 13 to 15 percent growth for full service accumulation, high teens growth for Principal International, and mid single digits growth for Life and Health segment. As always, the growth expectation should be applied to normalized results.

In Life and Health, in addition to the $11m described this morning, full year segment earnings have been bolstered by another $10m YTD. As such, we estimate $240m to $245m as the segments underlying earnings power in 2004. Within the U.S. asset management and accumulation segment we don't expect the unusually high prepayment activity in pension during the third quarter of 2004 to be sustainable.

While unusual items have impacted operating earnings on a quarterly basis within International Asset Management and Accumulation they basically netted out YTD. In the Corporate segment we're refining the run rate from $10m to $15m of losses per quarter for 2004, to $25m to $35m for full year 2005, reflecting lower interest expense due to reduced corporate debt.

Finally, I'd reiterate that equity market performance heavily influences account value growth over time and, therefore, our ability to achieve our operating earnings growth targets. Debt equity markets YTD do not provide the same sturdy springboard for 2005 results that we had going into 2004.

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

[Caller Instructions.]

The first question comes from the line of Jimmy Bhullar with JP Morgan.

Hi, thank you. I just had two questions. First, you spoke a little bit about the competitive environment in the pension business, if you could just elaborate on that? Whether you are seeing some more competition from the nonpublic payers and how that's affecting your sales?

And second, your UL sales have been very strong this year. If you could just talk about pricing in the UL business? I think you've recently pulled back from the 70 plus product, but if you have taken any other pricing actions besides that? And that's it.

Thanks, Jimmy. Good to hear from you. Let me ask Larry Zimpleman to hit the one on - excuse me, Jimmy, let Larry hit the one on competition, and then I'll ask John Aschenbrenner to chime in on the pricing of UL.

Okay.

Good morning, Jimmy. This is Larry. Just the trends that we've commented on in prior calls basically continue, which is that our pipelines remain strong, but it remains a very, very competitive market. It does appear that some companies are willing to recognize that the long-term business is one where they want to price the employer plan a little more aggressively, and then try to focus on asset retention. But overall, we still feel like our prices are competitive, and we're going to win more than you fair share. But the basic trends continue.

Okay. Now, are these non-publics that are causing the most competition? Or being more aggressive?

Well, it's a combination of both. There are some, you know, private or mutual companies, but it's broadly across the industry, Jimmy. It's not, you know, unique to certain types of companies.

Okay.

Our UL sales had been very strong this year, but I think that it's important to understand that even without the UL sales our individual life sales would be up 33 percent this year. And a lot of that growth is coming from variable universal life that's used in nonqualified excess 401(k) plans or nonqualified deferred compensation plans.

Yeah, we did withdraw our product above age 70, and that was a result of I think the reserving and the reinsurance continue to evolve on this product. The above age 70 was not turning out as profitable as we had expected when we began to issue the product, and we were selling more, those older ages than we were comfortable with so we did discontinue the product above age 70. We've not made any other pricing changes on the product.

Okay. Thank you.

Thanks, Jimmy.

Your next question comes from the line of Tom Gallagher with CSFC.

Good morning. The first question is just in terms of your earnings guidance can you comment on what your expectations are for interest rates implicit in your guidance? Are you assuming interest rates will remain low? And can you comment on whether or not you're seeing any pressure on spreads, or you expect to see pressure on spreads in '05? That's my first one.

All right. Well, we'll take that, and let you ask your second one, Tom. I may look over to Mike Gersie and a few others.

You know, we're fairly interest rate neutral when we're making our guidance decisions. You know, I think we and our economic area would have thought interest rates would have ticked up over the year and would have ended up the year, you know, considerably higher than where they started, obviously, that's not turned out to be. They've been more flat. But there's not a real implicit increase in interest rates in our guidance. Again, we do a lot of very good asset liability matching, and we're somewhat neutral in that regard.

The second part of your question was spreads, and here again, that's - it's kind of a difficult question to answer because you have to be a little more specific. We have so many kinds of different businesses. If you look at the annuity and fixed UL, for example, obviously there are some pressure on guaranteed interest rates versus crediting rates, but we're quite a way away from that, and it's really not having any significant impact on earnings.

If you look at some of our other businesses, the medium term note and single premium businesses, obviously there is a bit of pressure on spreads there, but again, we've written a fair amount of business in that area this year. It'll ebb and flow, but I would say none of this is really putting significant pressure on our business that would impact earnings.

Okay. And Barry, it sounds like it's safe to say that you’re guidance would not be at risk if interest rates did not go up? Is that a fair comment? All risk factors being equal?

That's a fair comment. Embedded, as we were doing, looking at guidance for 2004 we had implicitly built into it an assumption of about 50 basis points of interest rate rise. Now, as we're looking at 2005 I think we've got, again, implicitly built in about 50 basis points of interest rate rise. But it doesn't really matter whether we hit that or not, and as you've seen from 2004 results the fact that interest rates have actually declined really hasn't hurt our results any for 2004.

Okay.

Of course, the corollary to that is if interest rates do or don't rise what do the markets do? And those typical, you know, move in some relationship to each other.

Got you.

Not always. And in today's market. Do you have another one, Tom?

Yeah. The next question is just on your buybacks. Can you comment on how much you've bought back in October, and what does that leave you to buyback the last two months of the year? And do you still fully expect to get through the 700m authorization by yearend, or is that not a line in the sand?

Well, it's not a line in the sands in the sense that, you know, we've got an absolute commitment to do it. We continue to try to be somewhat opportunistic, but I will say that I'm still fairly optimistic that we will, barring anything significant happening. I don't have the exact number in front of me, Tom, but I would suggest it's probably $100m that we bought back in October.

We're positioned so that we could buy in the full additional amount by yearend if conditions were right.

Okay, great.

Yeah, thanks, Tom.

Your next question comes from the line of Jeff Hobson with AG Edwards.

Hi, good morning. I have two questions, you've seen very good growth on the individual life insurance side, and I suspect that you're investing some money there, as well. But so my question is when would you think the higher sales will have a more dramatic impact on the bottom line? And then, two, if you could comment a little bit more on Columbus Circle, and how that's going to fit? Is that a recognition that there's a weak spot in terms of large cap growth? At Principal Global? Or just comment more fully on how that fits?

Sure, Jeff. We'll be glad to cover those. Let me ask John to talk a little bit about individual sales and when that'll show up in the bottom line.

Yeah, Jeff, that's a slow process. The closed block is still a very significant piece of the individual life business. That closed block is actually continuing to grow a little bit, and we're not able to change the earnings pattern on that closed block. So it's just going to be a very gradual improvement in the individual life borrowee.

And I'll ask Jim McCaughan who is here to talk about Columbus Circle.

Yes. The question, Jeff, was really how Columbus Circle fits into our equity strategy. And I would say we're very pleased with the improvement in performance that we've achieved in the equity area generally over the last three or four years. And in particular, that, for example, last quarter our weighted average percentile in Morningstar was 36, so those are very good numbers, and the trailing three-year up to 47 on a trailing three-year numbers supporting very well our equity activities.

However, it has to be said that our, the personality if you like, of our expertise in Departments across seems to work better in value and blend, and to have done well in small and international. The large and mid cap growth for Columbus Circle, itself, have really been products we have been less strong in, and it is a fair assumption to say that that piece of our equity activities looking forward will be led by the Columbus Circle Group.

And I guess I would just add, Jeff, that Columbus Circle brings us search competitive in the institutional area, which is something we were not, and that's a big part of our strategy is to continue to grow nonaffiliated assets, and it brings us that right away, which we think is important.

Okay, very good. Thank you.

Thanks, Jeff.

Your next question comes from the line of Jeff Schuman with KBW.

Good morning, Jeff.

There seems to be no response. Your next question comes from the line of Nigel Dally with Morgan Stanley.

Great. Thank you. Good morning. I have two questions. First, just in regards to capital. Looking beyond 2004 to 2005 what should we be expecting for buybacks, excluding potential acquisitions in 2005? And second, just getting back to the competition in 401(k), are you seeing that intensify in any particular area, large case or small case, or is it just consistent across-the-board? Thanks.

Thanks, Nigel. In terms of excess capital I probably will have Mike clean-up here. Let me just make a quick comment. I think we're kind of expecting if all goes well and we continue to do our share repurchase we're probably going to be somewhere around $200m to $250m at the end of this year.

And we've kind of said that you could kind of look at our net income and probably somewhere around half of it could be considered as excess capital. So you can do the math, and we'll be in a pretty strong excess capital position going into 2005.

We certainly leave to the Board the decision around share repurchase and dividends, and you know, I'll just reiterate, our strategy is to use that capital to very much support our organic growth. And there's been some growth in that. We also look, and we very much like strategic acquisitions like Columbus Circle, like Post Advisory, that really are, they don't require a lot of capital but they bring us significant capabilities. And then we continue to use share repurchase recommended to the Board, as the third tool we have in managing our capital.

Mike, you want to add to that?

Hi. Thank you. You've covered it very well, Barry.

Okay, good. 401(k) competition, Larry, any particular area that we're - that you're seeing this happen?

Well, I would say, Nigel, that we, you know, we tend to measure the competitive environment by the larger cases, so I'd say generally that's sort of the 10m and up market, maybe the 25m and up market.

But what I would say to the positive on that is, again, as you know, we're really worrying hard to approach the market on more of a total retirement solutions concept versus just a 401(k) vendor. And I would say that since July when we had our formal launch in this activity we're very, very encouraged by our ability to differentiate ourselves in the marketplace.

So I think you should expect to see that have some traction and have some results going forward, and it really is a way to kind of set ourselves apart from the vast majority of the competition who really isn't able to operate across those kind of four pillars, around DC, DB, nonqualified and AESOP. And so we're very optimistic about that going forward.

Great, thank you.

Thanks, Nigel.

Your next question comes from the line of Randy Simpson with Goldman Sachs.

Hi. It's [Joan Siefe] [ph]. I had a few questions. First, just following up on this whole 401(k) area. Is there any sweet spot then in either size or type of account that you're really focusing on? Should we expect to see your approach to the marketplace looking or certainly increasing maybe the larger case types as opposed to what has been sort of this small case focus? That's my first question.

My second question is could you talk about these new universal lapse, the universal lapse policies with the secondary guarantees? What are the key assumptions? What lapse rates are you looking at? Are, you know, what are you thinking about the reserve requirements, and things like that? And will this continue to be a product you're going to be supporting?

And the last thing is if you could just talk about currency? If there are any benefits that you're seeing this year from currency? You know, are you hedging it going forward, or is it basically not material?

Thanks very much, Joan. We'll let Larry take the first, John the second, and Mike the third. So.

Good morning, Joan. As it relates to your question on sweet spot, I mean I would say as we've communicated in the past, you know, we have a primary target market for us remains the small, medium business market which, again, we define as 1,000 lives and under.

The enhancement or addition to that, Joan, I would say is our activity around total retirement solutions. So to the extent that our fully bundled capability which is critical in the 1,000 life, in the 1,000 and under life market, to the extent that bundled capability, you know, gives us advantage in a TRS setting where we go a little bit above that, we're certainly willing to do that. But I don't want you to think that we're going to ever get away from our SMB target market focus which, again, remains 1,000 and under.

And I guess I would just add that maybe the sweet spot was more like 100 lives, if you're looking on life basis, a few years ago, and it's probably inching up closer to 50 to 500 on new cases, would be my guess.

Right. Our average case size is up about 10 percent, but that's still a relatively modest change, Joan.

Okay.

Bob.

Yeah, Joan, on the universal life secondary guarantee products we have a very elaborate, sophisticated and conservative approach to testing those reserves. We're very comfortable with the adequacy of the reserves. We test them at very low lapse rates at 1 percent of and even lower lapse rates to make sure that they're sufficient.

We' holding reserves that are substantially in excess of what the AXXX formula would require, and in fact, there's a new proposal that an NAIC Committee has released, and it's a proposal from New York. The reserves that we're holding today exceed the reserves that would be required under that proposal.

Over a period of time we would probably have to increase reserves in the future a little bit over what our current formula would give, but we've tested those reserves under the proposal, and they would not hurt our, the profitability of our product at all.

Yeah, Joan, I think we've mentioned in the past, and we haven't really changed our position that we don't hedge our operating activities, we believe that we're - our operations are small enough and scattered through a number of countries.

And so from an economic perspective it just doesn't make sense to hedge because continuous hedging could be pretty costly. We do hedge capital movements, and so if we have an acquisition, for example, we'll hedge the capital from the time we sign the purchase agreement till the time the money is actually paid out. Similarly, if we're bringing capital back through a dividend, if we know that we're going to move some capital and believe that markets might move on us, we'll hedge the reverse capital movement, as well.

I believe the hedging has added a dab to, or the foreign exchange has added a dab to operating earnings for international this year, but I don't think it's added a real significant amount.

Thanks. Thank you

Thanks, Joan.

And our next question comes from the line of Liz Werner with Sandler O'Neill.

Good morning. Most of my questions were asked, but I just have a couple of follow-ups. First, despite the aggressive market you've talked about, on 401(k) side, is it still fair to say that you're very comfortable with margins holding where they are on that business? And is there any potential for margin improvement, and as that business grows?

And then secondly, I know annuities are not a core product for you, but can you talk a little bit about the product and distribution that was driving the strong sales in annuities in the quarter?

Sure, Liz. Good to hear from you. Let me let Larry to answer both of those.

Good morning, Liz. As it relates to margins, I think it is, you know, fair to say that despite the competition we're going to remain very, very disciplined in terms of our sales efforts. And so in our view, our expectations would be for margins to remain very consistent with what they have been historically.

Again, one of the things, though, you do have to remember a little bit in this business is that there is a combination of spread business and fee business in our present block, and as that business over a period of time migrates into more of a fee business, mutual funds separate account form, the ROAs the return on assets in that business will show some slight diminishment, although the return on equity will be enhanced as a result of moving from general account to separate accounts. But basically, the margins are going to remain the same.

As it relates to annuities, we're actually very optimistic. We've done a really fine job of building out our distribution capability for retail annuities. The primary enhancement there has been distribution through banks. We have relationships with several of the top bank distribution groups in the country, and that's really what's driving that significant growth in retail annuities. We do expect that to sustain itself, and in fact, we do plan to continue to expand that business over a period of time going forward.

Let me add to the first part of the, your comment to Liz, and maybe this is for everybody. I was reading yesterday an article, I think published by Defined Contribution News, and all this talk about margins and competition, maybe just to make the point that this survey was looking at all major players in the defined contribution area, and it looked at the last 12 months ending June 30, and the improvement and assets under management, and we were the second leading in terms of growth, I think at 44 percent. The only one that had grown faster than us was Prudential, and that was because of their acquisition of Cigna.

So while we talk a bit about how competitive it is I guess I would just point out that we've probably done as good a job if not the best job in the industry in terms of dealing with the environment.

Okay, great. Thank you.

Thank you, Liz.

Your next question comes from the line of [Esemet Kamoss] [ph] with Sanford Bernstein.

Thank you, and good morning. Maybe two quick questions. First, on the 401(k), and the level of asset retention that you guys are putting up. I guess I'm just curious if you've looked at it this way how much is due to your efforts to actively improve asset retention and how much of it is just a follow-on to that trend that you discussed earlier about you know, delays in moving plans from provider to provider? That's question one.

And then question two is just a follow-up on the universal life. It just seems like you're holding a lot more in terms of reserves than perhaps you need to. And I'm just wondering in this interest rate environment what that means for the products’ ROE, you know, given that some of your competitors are not selling the product because you know, they're not able to meet their profitability targets? Thanks.

Thanks, Esemet. I'll ask Larry to answer your first question. I will say I don't think you asked this, but I'll just take the opportunity to point it out, that if you go back over since we really started aggressively trying to retain participant level assets, we were retaining, I think about 36, 37 percent, and I guess last year we were well up over 50, 55, 56 percent. So there has been a real concerted effort at the participant level to improve asset level retention. And there's several billion dollars that are at risk every year that we're able to retain, you know, very high percentage.

If you look at our net cash flow this year, Larry, I guess the breakdown between plan level and member level, and what's contributing to the good growth there?

Sure. Just a couple of comments. First of all, you know, again, on a YTD basis what we're seeing with the withdrawals in our full services business is YTD so far we're at 11.6 percent total withdrawals for the year. And remember, some of that actually goes to our mutual fund and annuity business. So even not all of that 11.6 actually leaves the complex.

To Barry's point on participant asset retention, many times that's moving to our mutual fund or our annuity products, but that 11.6 percent is about a 170 basis point improvement and a lot of that improvement is coming from the lower employer level lapse rates that was commented on by Barry and Mike in their script.

And again, we really believe that because of this, our value proposition which emphasizes the local service capability, as well as relationship managers on our larger clients, we really think that that’s very sustainable trend going forward. We're very happy with the kind of feedback we're getting from our clients. We have client conferences. We're in regular touch with those clients, and so we're very optimistic that the withdrawal should stay hopefully closer to the level they're at currently versus where they've been historically.

And John, do you want to address the UL reserve issue, again?

Yeah. I'm not sure I really understand the question, because I think you said that we were holding substantially more reserves than we really need, and I would say that we're not, that we really have done, as I said, a very detailed analysis of our reserves. And I feel they are very appropriate, not overly conservative, nor under reserved. And so I'm very comfortable with the reserve level.

And really don't know and can't comment on what's going on in any of the other companies at this point.

Maybe if I could just follow-up, did you just discuss the returns that you're getting on the new products that you're selling?

Sure. When we originally priced the UL product we priced it at approximately a 15 percent return on equity. The, as I mentioned earlier, the reinsurance market and the reserving is continuing to evolve on that. Some of the evolution of that has hurt that return on equity that we originally thought we would get on the product, but the cutting out the above age 70 has also helped to bring that back to a more reasonable level.

So perhaps less than, a little less than the 15 percent we started out, but still we think very good returns.

Okay. Thanks.

Thank you.

Your next question comes from the line of Al Capra with Oppenheimer and Company.

Good morning, everybody. Barry, I recall last quarter during the conference call that you were thinking about changing or increasing the run rate on the life business to 65m per quarter, which implies something like 260m for the year. And I think Mike had mentioned something like 240 to 245 as guidance, so I was just wondering what drove the sort of change in sentiment?

I think we were talking about 60 to 65 per quarter. John, do you want to?

Yeah. I guess first of all, we’re talking about the entire life and health business.

Right.

And I believe our indication for the underlying normalized earnings was more in the 60 to 62 range, and then with some of the one-shot things that was going to drive the total higher. So that 240 to 245 that we’re talking about is really the underlying normalized, and we have somewhere in the neighborhood of 20m so far this year of one-shot earnings that are on top of the normalized.

Okay. And just one additional question. In terms of your tax rate, if I were to add back the benefits you received this quarter, I think your tax rate still was around 23.9 percent which was pretty far below where you were in the first two quarters of the year. And I was just wondering if that was sustainable? And perhaps what you were utilizing in your guidance for 2005?

Better than our guidance for 2005 would be a tax rate in that neighborhood. Just a couple things are impacting, obviously, to get to that lower tax rate you’ve got dividend receive deductions which we’ve talked about, also, a new phenomenon that’s going to ripple through our results for a couple of years, Section 29 investment that we have which is a tax credit deal, and so that will decrease our tax rate a little bit.

But we don’t see any major swings in the tax rate. I think another thing that’s benefited us a little bit this year is release of a couple of minor tax reserves. And so that would also depress the rate. But it would be in the, I’ll say the 23 to 25 percent range would be roughly the rate that we’ve been running at, and that’s about I believe where we’d be in 2005.

Okay. That’s very helpful. Thanks a lot.

Thanks, Al.

Your next question comes from the line of Jason Becker with Fox Pitt.

Great. Thank you, and good morning.

Good morning, Jason.

I actually just have a quick numbers question. In the fourth quarter of ’03 you guys reported $1.6b of pension sales. And I was hoping you can just tell me, of the $1.6b, first, how much of that is organic? And then second, how much of that is large cases over 100m?

Well, we’re looking through some data right here, Jason. Larry, do you have it?

Yeah, I think so, Jason. In the fourth quarter of ’03 in terms of the over 100m, approximately 300 of that was over 100m, and I think as it relates to M&A business, let’s see, I think that was a relatively modest amount, but I’ll look that up and it looks like it was, there was no particular amount of M&A, so the basic one to net out of there would be the 300m of large case, Jason.

Terrific. Thanks.

You’re welcome.

Thank you, Jason.

Your next question comes from the line of Matt Greenberg with [Meridian Asset Management] [ph].

Hi, good morning.

Good morning.

Just two questions. You might have mentioned it, I just want to review, your earnings assumptions for next year, what are you predicating the equity markets performance to get there?

And the second question is you talked about excess capital at the Company, and I thought I heard you say a couple $100m? For some reason I was under the impression it was much greater than that. Could you look at those please?

Sure, sure. The basic equity market improvement that we’re looking for in ’05 continues to be 2 percent per quarter. I think the issue is that we’re starting from a much lower standpoint today than we would have thought we were, because we also had founded in this year 2 percent per quarter, and we’ve not achieved that, so we’re basically starting from where we are today, and we’re assuming a 2 percent for the fourth quarter, and then 2 percent for each of the quarters next year.

In terms of excess capital, I think I was the one who said we would anticipate at the end of the year having roughly 250m. And indeed, if you go back to the last call, we still, we were sitting on the 700m roughly that we got from the sale of PRMI. We had not made the declaration around our dividends, so you really have those two things to pull out. And Mike was probably talking about $1b, $1.2b, and again, the difference being dividend payment, as well as a share repurchase that we were anticipating executing by the end of the year.

I see. Thank you.

I think said another way, end of third quarter we had somewhere in excess of $700m and think about completing the share repurchase program, think about the shareholder dividend, you subtract off those two amounts, and that gets you into the $200m to $300m range.

Yeah, but it’s 700 now, and then you’re continuing to generate across.

John That’s correct.

Yeah, I was projecting forward to the end of the year.

Okay. thank you.

Thank you, now.

Your next question comes from the line of Andrew Kligerman with UBS Financial.

And then, just following on that excess capital, if you were to deploy the capital allocated to the closed block, could you talk about what the number would be? And then I have another question.

Yeah, Andrew, I think we’ve said before, it’s probably in the half a billion dollar range, somewhere in that general area. But, you know, you’ve also got to look at how the rating agencies would look at that if you were to securities it and pull it out. But it’s somewhere in that general 500m, 600m range. Maybe a little more.

Okay. And then, shifting back to the net flows questions, which I think are very interesting. You mentioned that a realistic sales growth target would be 10 to 12 percent. What does that imply for net flows? And I guess sort of a subset of that question would be with regard to the retention that’s substantial improvement going from a 35 plus percent retention to a 50 plus, how high can you get the retention level?

Yeah, on the first question I guess it depends on what you’re looking at, but I think we’re looking at 1.5 percent per quarter, and I think I may have said that in our script. That’s our longer term, which is basically 6 percent of beginning account days. You know, we’re obviously doing a bit better than that. We’re already at 5.5 through 9 months, so we’ll do better than that this year. But on a sustainable basis we think 6 percent of the beginning account days is sustainable for that number.

The other, you know, we’ve kind of thought about getting to 60 to 65 percent as being the next kind of area we want to go to. We’ve been, I think, as high as 57, 58, you know, it bounces around depending on some things in the market, but we really believe we may get slightly in excess of 60 percent in the next couple of years. Beyond that it’s kind of hard to tell, but we think we’ve got a big part of the answer through our principal connection network, through some of the product offerings, and I can assure you this is one we’re really, really focused on.

Is this the number, 60 to 65 percent, that competitors have obtained in the past?

No, I’m not totally sure, Andrew. I think if you look at more insurance company peers it’s more in the 25 to 30 percent. My guess is if you look at some of the best in class mutual fund companies that may be up in the range that we’re in.

Right now, in the 50’s?

Yeah. Larry, do you want to?

Well, Andrew, this is Larry. Just to make a quick comment on that. I think one of the really powerful things that comes with our fully bundled model, and maybe we haven’t done as good a job of laving this out, as perhaps we should have. But I think our fully bundled model where it is all wrapped in a principal financial group wrapping as compared to some of our competitors, does give us a significant advantage when it comes to participant level asset retention. You know, some of our competitors using a model that’s not fully bundled, it’s a little more difficult because a participant never, or perhaps it’s less clear as to who is really underneath their servicing capability.

So as Barry said, that’s really been critical to driving that improvement in asset retention, we’re going to continue to focus on it. And I think as the demographics move more toward retirees, people who have had their 401(k) accounts, The Principal Financial Group for 10, 15, 20, 25 years, and we’re very focused on building those relationships we do hope we can drive that retention up into the 60, 65 percent range.

I mean is bundling something unique that the competitors can’t do?

No, no, but I would say that as it relates to those who use a different model the people in this industry who bundle, I think do, Andrew, have a competitive advantage when it comes to retention over people operating in this market who aren’t using a fully bundled model. That’s the main point, and I just wanted to make it clear that, you know, by virtue of our strong fully bundled offering we do think it advantages us for participant retention.

And of the universe, like what would – what percent of your competitors are fully bundled?

I don’t really have a, you know, a metric around that. What I would say is as you move down to smaller and smaller competitors you get into the, you know, the second 10 in the 401(k) market, and the third 10 and the fourth 10, you’re going to find people using more unbundled models than bundled models, because you really have to have size and mass to execute the fully bundled models. So the people at the top of the industry tend to have a fully bundled model, and as you move down the industry it tends to be an unbundled model.

Got it. Thank you.

Thank you.

We have reached the end of our q and a. Mr. Griswell, your closing comments, please.

Well, I just want to thank everyone for joining us on the call this morning. We appreciate your interest, quite a lot. You have a Senior Management Team here that’s committed to continuing to serve our customers, our employees, and to building shareholder value. So, again, thank you all. And I look forward to seeing many of you as I travel around and make my investor calls. So have a great day.

Thank you for participating in today’s conference call. This call will be available for replay beginning at approximately 1:00 p.m. ET until end of day, November 9th, 2004. 1100874 is the access code for the replay. The number to dial for the replay is 800-642-1687 for U.S. and Canadian callers, or 706-645-9291 for international callers. You may now disconnect.