美國信安金融集團 (PFG) 2004 Q4 法說會逐字稿

Good morning, and welcome to the The Principal Financial Group fourth quarter 2004 conference call. I would now like to turn the conference over to Tom Graf[ph], Senior Vice President of Investor Relations.

Thank you. Good morning and welcome to the Principal Financial Group's fourth quarter conference call. If you don't already have a copy, our earnings release and financial supplement can be found on our website at www.principal.com/investor.

Following a reading of the Safe Harbor provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks. Then we'll open up for questions. Others available for the Q & A are our 3 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, 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 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 September 30, 2004, filed by the Company with the Securities and Exchange Commission. Barry?

Thanks, Tom, and welcome to everyone on the call. The fourth quarter was an excellent finish to an outstanding year for The Principal. For the three months we delivered strong earnings growth and near record earnings per share. We continue to drive solid growth in assets under management and account values, with both reaching record levels at year end.

As always, Mike will provide a detailed overview of our quarterly financials including items impacting comparability. I'll offer some performance highlights for the full year and for our three-year track record since our IPO. Then I'll focus the remainder of my remarks on the health of certain key businesses and our ongoing efforts to accelerate growth in each.

While we did benefit from some unusual items, which Mike will discuss in detail, 2004 was again a great year for The Principal.

We delivered record assets under management of $169 billion, up 16 percent, record account values for U.S. asset accumulation of $109 billion, up 18 percent, record operating earnings of $765 million, up 15 percent, including record results for all three operating segments, record operating earnings per diluted share of $2.43, a 19 percent improvement, strong sales performance for our three key retirement and investment products, surpassing $10 billion combined for the first time, including record sales of mutual funds and individual annuities, and good progress in the Life and Health segment with recurring individual life sales more than doubling, and solid growth of group medical covered members in our target states, strong improvement for the year in our group medical lapse rate, strong initial interest in our new consumer driven healthcare offering, and significant growth in wellness lives.

And we had record sales and earnings from Specialty Benefits with sales up 26%, and earnings up 29%.

2004 also contributed to very strong longer- term results, particularly strong in light of a very difficult operating environment. For the 3 years since our IPO, our performance includes compound annual growth rate of over 15 percent for earnings per share, driven by a 9.8 percent rate for operating earnings, 12.5 percent for earnings in U.S. asset management and accumulation, 14 percent for account values in our U.S. asset accumulation business, and 17.5 percent for total assets under management excluding BT, the Australian asset management subsidiary we sold in 2002.

We we also had a 340 basis points improvement in ROE since 2001.

Our strong financial performance has translated into outstanding stock price appreciation with our share price nearly doubling from our opening of our IPO through year end 2004.

In 2004 we remained highly focused on several critical areas, including accelerated in our U.S. defined contribution business, driving international growth and profitability, creating a successful asset management organization, and profitable growth in our life and health businesses.

Our outstanding results in each of these reflect a year of continued strong execution.

I've already mentioned some of the progress in the life and health segment. I'll spend the next couple of minutes on the performance and progress of our three key asset accumulation and asset management businesses, starting with pension full service accumulation.

In addition to a record fourth quarter, full service accumulation delivered record earnings for the year, up 25 per cent or $45 million, driven by continued strong account value growth. Excluding approximately $7 million in 2004 of unusual items aiding this growth which Mike will cover, earnings improved by more than 20 percent.

Account values increased $13 billion, or 23 percent for the year, to a record 69 billion, including 4 billion for the fourth quarter ABN Amro trust acquisition. Excluding ABN Amro, account values increased 16 percent.

Credited investment performance contributed $6 billion to this growth. Net cash flow contributed $3.8 billion, or 6.8 percent of beginning year account values.

In spite of some higher withdrawal activity in the fourth quarter, which again Mike will cover in his remarks, this was a very, very good result. $450 million ahead of our long term 6 percent target, reflecting increasing deposits from retirement plan investors, and continued strong retention.

In terms of full service accumulation sales, in 2004 we intensified our focus on both asset and case growth, positioning the organization for strong future performance in both measures. We continue to see meaningful shift in the demand toward total retirement solutions.

Again, from its mid year launch, Total Retirement Suite has received great enthusiasm and achieved strong sales results, making up nearly 25 percent of our 2004 sales.

Our increased focus on small case market is paying off as well. We achieved 37 percent growth in security builder cases in 2004, selling more than 1,000 plans. We expect to increase our base of emerging market reps again in 2005 in light of strong success with our small case offering.

I'll offer a couple of additional thoughts on sales for the year. At $5.2 billion, our organic sales were clearly among the strongest in the industry. Our level of production was particularly strong in light of some difficult market conditions.

During the year, we continued to strengthen our comprehensive portfolio of best-in-class retirement solutions as well as our powerful sales infrastructure and exceptional distribution reach.

Our pipeline at year end was very strong, and we remain highly optimistic about achieving our 10 to 12 percent organic growth target for 2005.

I would also emphasize that asset retention continues to be a major focus, and our results remain among the best in the industry. At 5.7 percent for 2004, employer level lapses were an all-time low, and at 3.1% lapses, large case retention was 45 percent better than the overall retirement block.

We also continued to effectively retain assets when a plan participant changes jobs or retires, with 54 percent rollover asset retention rate for the year, well above industry averages.

To add some perspective, in 2004, we retained nearly $3.6 billion of at-risk assets, an increase of $530 million for 2003.

As part of our ongoing efforts to strengthen the earnings power of our businesses, we continue to refine and enhance our product and service platform. In 2004, we launched several important new offerings. As I mentioned, Total Retirement Suite provides comprehensive consulting and administrative services for qualified and non-qualified DB and DC and employee stock ownership plans, on a single retirement platform.

We also launched Retire Secure to provide employees easy access to personalized guidance, advice, and financial solutions through the worksite.

This and other refinements and enhancements during the year enabled us to expand our role as trusted advisor, transform products into solutions, particularly in the area of retirement income management, and help small and medium businesses and their employees achieve financial security and success.

Moving to Principal Global Investors. 2004 was a breakout year; a record $56 million in operating earnings, a 56 percent improvement. A record $128 billion in assets managed, including a 26 percent increase in third-party assets to $32 billion, and a record 110 new third-party institutional mandates.

Principal Global Investors now manages assets for 8 of the top 25 U.S. pension funds, and came in fifth in Money Management Letters most recent net-assets-gained ranking.

In terms of growth, Global Investors has done a tremendous job. From the time they were acquired, Spectrum and Post have driven nearly $14 billion in assets under its growth, an increase of more than 300 percent.

I would also mention continued strong growth in the real estate side. In 2004, for example, real estate equity assets under management increased more than $2 billion, reflecting strong growth of the Principal U. S. Property account and Reed[ph] Securities, as well as the success of a new private placement real state fund.

Looking forward, we're also very excited about our acquisition of a majority interest in Columbus Circle Investors, a premier asset management firm specializing in growth equities. This makes us more search competitive in equities and supports our ongoing efforts to improve investment performance across all asset classes.

In terms of accelerating international growth and profitability, Principal International continued to make excellent progress as well, with a strong fourth quarter and an outstanding year.

In 2004, Principal International's earnings improved 17 percent to a record $40 million. Operating revenues increased 30 percent from 2003 to a record $518, net customer cash flows reached a record $1.5 billion, up 57 percent from 2003, and assets under management increased strongly, up 36 percent to a record $10.2 billion at year-end.

In 2004, Principal International's growth was primarily organic. So while we'll continue to seek strategic acquisitions for Principal International, our primary focus is on leveraging and expanding our distribution and sales networks, launching new product solutions, and preparing to capitalize on pension reform in Chile, China, and India.

Before I close, let me briefly cover a couple of other areas. In terms of effective use of capital, again we had a number of strategic acquisitions during the year, including the ABN Amro Trust acquisition announced in December, and we're very excited about this acquisition. We believe this opportunity signals continued consolidation of the DC market, and again, we intend to be a major player.

As I mentioned, the acquisition includes $4 billion in account values. It also includes 280 plans, adding further scale to our retirement business. Importantly, the acquisition adds incrementally to our distribution relationships and provides an excellent opportunity to serve a group of clients who can truly benefit from our total solutions platform.

In addition to funding organic growth and strategic acquisitions, our top two priorities, we also bought back 21.7 million shares for $772 million, or an average price per share of $35.56.

As of year-end, we had completed nearly 90 percent of the board's $700 million May 2004 authorization.

As I mentioned, throughout 2004 we continued to receive some very important third party recognition for our leadership in meeting retirement plan sponsor and participant needs, for our innovative use of technology, and as a premier employer. I would add that in January, 2005, we were again named to the Fortune 100 best places to work for a third consecutive year.

These awards are particularly gratifying, and we believe communicate the strength of our commitment to our customers, and to our people.

In 2004, we accomplished a great deal, and today we're at one of the strongest points in our history.

Driven by a strong performance and the benefit of some unusual items, ROE for the trailing 12 months improved strongly from a year ago to 12.3 percent. Excluding the operating earnings from 2004 unusual items, without further adjustments to equity, our ROE would have come in at around 11.7 percent for the year. So there is still a lot for us to do to accomplish our year-end 2005 goal of 12.5 percent in ROE.

Looking ahead, we'll continue working hard to extend our leadership with SMBs[ph] and their employees, to be a great place to work, and to create value for our shareholders. We're confident with further economic recovery and modest equity market growth, we'll continue delivering superior long-term results for our shareholders. Now let me turn it over to Mike.

Thanks, Barry. This morning I'll spend a few minutes providing financial detail for each of our operating segments, and additional highlights for the quarter and the year. I'll close with some brief comments on growth expectations for 2005.

As Barry indicated, we were very pleased with our results, particularly in light of weak equity markets for most of the year. We delivered strong earnings- per-share growth in the fourth quarter, an improvement of 16 percent. We also delivered 19 percent improvement in earnings per share for the year.

Both periods benefited from some unusual items. [technical difficulty] approximately 4 cents in fourth quarter 2004, 2 cents per pension full service accumulation, and 2 cents for the corporate segment, primarily from additional earnings on PRMI sale proceeds, and approximately 13 cents for the full year. I'll cover these unusual items in more detail shortly.

Moving to the segments, I'll start with highlights for U.S. asset management and accumulation. Segment assets under management increased $23 billion, or 19 percent from a year ago, driving total Company assets under management to a record $169 billion at year-end.

Compared to a year ago, segment earnings increased 18 percent in the fourth quarter, to a record $134 million.

Pension full service accumulation was the main contributor to improved earnings, increasing 20% to a record $65 million.

There were a couple of items impacting comparability between the two quarters. Deferred policy acquisition cost amortization in fourth quarter 2004 was $17 million higher than in the prior year period. We steadily increased the normal quarterly expense, which is now about $7 million higher than a year ago.

The difference also reflects approximately $6 million of positive unlocking, which decreased amortization expense in fourth quarter 2003 due to strong equity performance and true-ups[ph] to assumptions.

Adjusting for the unlocking in fourth quarter 2003, growth in pretax earnings would be very consistent with growth in average account values over the period.

The other unusual item for full service accumulation was income taxes. The fourth quarter 2004 decline primarily reflects an abnormally large amount of dividends received in fourth quarter 2004, resulting in a $6.2 million tax benefit for dividends received.

Excluding the additional tax benefit in the fourth quarter 2004, and deferred policy acquisition costs unlocking in fourth quarter 2003, gives a more accurate picture of the earnings power of full service accumulation business in each period. About $58 million and $48 million respectively. And we continue to see growth in operating earnings consistent with account value growth.

As Barry mentioned, full service accumulation net cash flow of $3.8 billion in 2004 was a very good result, exceeding our long-term target.

Some additional color on deposits and withdrawals, including items impacting comparability, reveals very solid results for these two components of net cash flow, as well. 2004 deposits were a record $13.3 billion. They do not include ABN Amro, which were recorded as operations acquired in the account value roll-forward.

This compares to $12.6 billion in 2003, which as you may recall included KeyCorp deposits of approximately $900 million. The 2003 total also includes $359 million of deposits for sales no longer classified under full service accumulation.

Excluding these two items, deposits would have improved 17 percent on a comparable basis.

Withdrawals, as a percent of beginning of the year account values, improved from 18 percent in 2003 to 17 percent in 2004, in spite of some heavy activity at year-end.

Speaking to the absolute dollar increase in withdrawals for the quarter and the year, there are several things to keep in mind. Employer lapses tend to come in unevenly throughout the year, with fourth quarter withdrawals generally to the higher end of the range. The fourth quarter 2004 increase was exacerbated by the strong runup in equity market values at year-end.

Finally, over the course of the year, we expect withdrawal growth to parallel the growth in average account values. Excluding ABN Amro, average account values increased by 22 percent in 2004. By comparison, withdrawals increased 23 percent.

As Barry mentioned, retention remains at an all-time high, both at the employer and employee level. We don't view the fourth quarter increase in withdrawals as an emerging trend. However, in the near term, we do expect some volatility in withdrawals from the ABN Amro acquisition, which could temporary bring net cash flow below goal.

As you know in any such acquisition, withdrawals tend to be higher than the existing block. As such, we build conservative lapse assumptions into pricing. Our first priority is to maintain this block of business and to improve its profitability. We are highly confident our efforts to maximize retention will be successful. We're very excited by the potential of the acquisition.

Over the longer term, as we bring our local consulting and service capabilities to these clients, we expect to move the new block to the profitability level of the existing block. But the acquisition is forecasted to be earnings neutral in 2005 and 2006.

One last point on net cash flow. In comparing 2004 to prior year, I would remind you that 2003 was exceptionally strong at 11 percent of beginning of the year account values, $2 million[ph] higher than our long-term target. It also includes the $1.2 billion I described earlier in my deposits discussion.

For the full year, the earnings for U.S. asset management and accumulation improved 18% to a record $499 million. In addition to pension full service accumulation, three other businesses in the segment achieved significant earnings growth and record or near-record performance.

Principal Global Investors earnings improved sharply, up 116 percent in fourth quarter and 56 percent for the year, reflecting significant margin improvement asset growth in the Post acquisition. Fourth quarter tends to be higher than normal due to the timing of annual incentive fees[ph].

For 2005, we anticipate only moderate additional margin expansion, so earnings growth will come from a higher base of assets managed. As of year-end, 2004, Principal Global Investors total managed assets were up 13 percent from year-end 2003.

Mutual fund earnings improved 21 percent in fourth quarter , and 55 percent for the year. At a record $3 billion, mutual fund sales remained outstanding with double digit growth again in 2004.

Individual annuities earnings improved 27% in the fourth quarter, and 30 percent for the year. Relationships in the bank channel, along with a strong demand for our fixed annuities, drove record individual annuity sales of $2 billion in 2004, an increase of 39 percent.

U.S. Asset Management and Accumulation earnings were dampened in 2004 by spread compression in our full service payout in investment-only businesses. The low interest rate environment also depressed the volume of business in the group single premium guaranteed annuity market, further impacting full service payout results for the year. If this environment persists in 2005, it will continue to be difficult to grow earnings in these businesses.

Within our International Asset Management and Accumulation segment, Principal International's fourth quarter earnings grew to $11.5 million, from $8.2 million in the year ago quarter. For the year, Principal International's earnings grew 17% to a record $40 million.

The fourth quarter increase is primarily due to improved results in Chile, reflecting inflation and stronger currency. It also reflects improved results in Hong Kong due to higher fees in the first quarter of 2004 Dow Hang[ph] acquisition.

Hong Kong and India both crossed the $1 billion milestone for assets under management during the year, and Brazil crossed the $ 2 billion milestone.

In light of Principal International's strong growth and increasing profitability, we are reviewing the optimal amount of capital to deploy in each of our international subsidiaries. Based on our evaluation, we anticipate repatriating some level of funds in 2005. Reducing deployed capital would have a positive impact on segment return on equity, but it would also slightly dampen Principal International's earnings growth in 2005. We expect to provide more details during first quarter 2005 earnings call.

Moving to Life and Health Insurance. While 2004 was a record year for the segment, earnings for the quarter were $53 million, compared to $66 million in the fourth quarter of 2003.

The Specialty Benefits Division achieved strong earnings growth, improving from $9 million a year ago to $18 million in the fourth quarter of 2004. or the quarter and the year, each of the Specialty Benefits lines achieved strong sales growth and favorable retention. Dental performance was particularly strong. Sales improved 58 percent for the year, while loss ratios remained stable and better than pricing.

Earnings growth in the Specialty Benefits Division only partially offset declines in the Individual Life and Health Insurance Divisions. Both Divisions had several unusual items impacting comparability.

At $26 million of operating earnings in the fourth quarter, results for the Individual Life Division were very solid. Unusual items aided earnings in the fourth quarter 2003 by around $13 million, primarily due to our conversion to new financial valuation models. Adjusting for unusual items in the year-ago quarter, the Division would have posted a modest improvement.

Individual life recurring premium sales finished strongly, increasing 124 percent in the fourth quarter, and 110 percent for the year. UL[ph] protector sales were a key contributor. While we're excluding UL protector, sales still increased 23 percent for the year.

The decline in segment earnings from a year ago also reflects a difficult quarter for the Health Division. Operating earnings declined by $11 million, primarily reflecting unfavorable claims experience and seasonality. We expect claims experience to return to more normal levels in 2005. Seasonality of claims in the fourth quarter 2003 was offset by favorable reserve adjustments.

While group medical covered lives declined sightly in the fourth quarter, we did achieve solid growth for covered members in our target states, up 3.5% from fourth quarter 2003.

We delivered 10.9 percent growth in premium in our target states, good initial reaction to our new health savings account combined with high deductible health plan, and very strong growth in wellness lives[ph], which more than doubled to 66,000 in 2004.

Overall, 2004 was a solid year for the segment and for each of the divisions. In 2005, we'll continue working to improve our competitiveness, focusing on our target markets and opportunities to generate sustainable, profitable growth.

As you know, we're no longer providing quarterly guidance or updates to our full year guidance which we communicated in November, 2004. But before taking questions, I would like to revisit some important items to keep in mind in terms of growth expectations for 2005.

In any given comparison period, results tend to fluctuate from normal run rate due to factors such as prepayments, deferred acquisition cost unlocking, as well as mortality, morbidity and lapse rates.

Our long term earnings-per-share growth target of 11 to 13 percent incorporates equity market improvement of roughly 2 percent per quarter. Through January, the Standard &Poor 500 was down more than 2.5 percent, recovering most of the drop in the first week of February. Equity markets remain volatile and challenging. As always, our growth targets should be applied to normalized results.

I would also remind you of the unusual items that aided 2004 operating earnings, including a $25 million we identified in third quarter 2004 earnings call, we had $38 million in total for the year.

By business, we had $9 million for the corporate segment, reflecting favorable tax adjustments and excess earnings on PRMI proceeds, $8 million for speciality benefits due to reserve releases, $7 million for individual life, due to deferred acquisition cost unlocking and higher than normal investment prepayments, $6 million in pension for higher-than-normal investment prepayments, about $1 million for full-service accumulation, $2 million for full-service payout, and $3 million for investment-only. Another $6 million for full-service accumulation due to the impact of dividends received in fourth quarter 2004, and $2 million for Principal International for net favorable tax adjustments.

While unusual items impacted earnings on an quarterly basis in the Health Division, for the year they basically netted each other out.

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

The first question comes from Andrew Kligerman with UBS.

Couple of questions. Just first I would like to get a sense of the spread outlook for investment-only pension business, and to what extent the mismatching of the floating rate liabilities hurt spreads in 4Q'04.

You had a couple Andrew. Do you want us to answer that one first, or do you want to put them both on the table?

Both on the table.

Okay. I'll ask Mike Gersie to jump in and give you a general answer. He may want to defer to Jim or Larry. You really had -- you had two basically, the spread on the investment-only, and then the -- the other one was a --

mis-matching of floating rate liabilities. Did that hurt spreads in 4Q'04, and how much?

Mike?

I'll speak to the spreads. I may defer the floating to Larry, because Larry is a little closer to the investment-only business.

Certainly on spreads, we have seen spreads come in, put a little bit of pressure on earnings, as we've moved through the year. As we're looking at our forecast for 2005, our forecasts are also showing some pretty tight spreads and some thinner margins in the investment-only business, and also in our payout business, as well.

So it is having a slight impact on our -- on the business. We're a little bit--perhaps a little bit conservative as we're doing our projections. Larry keeps telling me that spreads could widen, and that business could bounce back to be a little more profitable, but that's where we are today.

Larry, do you want to talk about the [inaudible] business?

On the -- Hi, this is Larry. On the floating rate issue, we do watch that very carefully in terms of the floating rate assets versus the liabilities.

And in fact we've taken steps over the last couple of months to make sure we've got those aligned so that any future volatility in our interest rates wouldn't really hurt the earnings coming out of those businesses.

I don't think we believe that the alignment of the floating rate assets and liabilities, though, has hurt--to this point, has had any negative impact on the earnings in those businesses, but we do have those well aligned, and we continue to watch that carefully.

Okay, and then just with regard to full service accumulation withdrawals. It did pick up meaningfully.

I think what I'm reading from the presentation earlier is that we shouldn't read anything into it, that net flows are going to be pretty solid going forward? Is that the right read? Or is there something unusual that will continue?

You got the right read, Andrew. We don't really expect any significant change in trend here. But let me have Larry give you just a little bit more color, because I know this is an important one. Mike did cover it in his remarks, but make sure everybody understands that there are a couple of things going on here, and this does not indicate a trend that's coming where you're going to see higher withdrawals going forward.

Thanks. Andrew, just a few comments on that. We do watch this very, very carefully, including close studies of customer satisfaction, and loyalty measures and all of those things.

In the fourth quarter, just because of the relatively unique movements of the equity markets, which bounced up late in the quarter, we think that of that increase in withdrawal, for example, about $400 million of it is attribute just to the particular method within which the equity markets moved late in the quarter.

In addition to that, there is also a little bit of seasonality. I mean, employer withdrawals, for example, will be, give or take, in a quarter--and as you've seen over the first three quarters of 2004, the employer lapses were extraordinarily low. And as Mike commented in his earlier remarks, at 5.66 percent for the full service accum[ph] block, they were actually the lowest at any point that I can ever remember in the history.

So we feel very confident, Andrew, there's no emerging trend there, and the slight drift upward that you saw in the fourth quarter, you'll see that level out in the quarters going forward.

Okay. Great. And then lastly, I just want to know what the impact might be of President Bush's Social Security proposals, and that's it.

Well, gee, Andrew, thanks for ending on a very easy question.

Got to get all those questions in.

Well, I think you got four in.

That's true.

I think it's a little bit premature to really talk much about the President's program for Social Security. I mean, it's a long way from going anywhere.

I think if you just took what he has proposed, and if it got enacted exactly like he proposed it, I think it would have relatively little effect on us. I think the biggest positive effect would be that it would heighten the awareness of Americans to have the need to save, and I think having personal accounts would do that.

Our view is we need to fix the fundamental financials of Social Security before we worry about personal accounts, but, as I say, if he got everything he wanted passed, it would have very little effect on our basic business. It might have a greater impact on capital markets, which I think we're all trying to figure out what that might be.

Thanks a lot.

The next question comes from Jeff Hopson with A.G. Edwards.

Hi. This is actually Greg Mason with a couple of questions on behalf of Jeff. First, if you could give us what the impact of Q4 incentive fees were to the bottom line of Pension Global investors, and then Jeff also wanted to know if there's a particular reason why the number of pension plans picked up so much in Q4 after a decline in Q3.

Sure, Greg. Let me ask Jim McCaughan to answer your first question, and while he's looking for the exact number, I would imagine that the pension count was ABN Amro which added 280 cases. Is that right, Larry?

Yes, Greg it would be a combination of ABN Amro, and it would also reflect, as we've commented before, that we've getting some very good attraction with our focus on the smaller end of the retirement market, with what we call our security-builder product.

We have a dedicated group of retirement sales people that focus on selling that product, and the particular plan counts were up over 1,000. They were up 37 percent in 2004 over 2003, so we're very happy with how retirements sales in that smaller end of the market have been going, and that's also what is driving that case count increase that you're seeing. I'll let Jim comment on the PGI Incentive piece.

As Mike mentioned in his prepared speech, the incentive piece for PGI are loaded into the fourth quarter. The highest incidence is in the fourth quarter. And the incentive fees that actually happened in the fourth quarter of '04 were really focused on high yield and post, and also in our real state business, and the positive impact of those in this fourth quarter of '04 was $10 million after tax.

These are clearly offset by additional incentive comp to the people that generate the higher -- the higher investment performance. And in this particular quarter, the offset for incentive comp for generating high investment performance was around $5 million after tax.

So the net, if you like, that takes this away from a -- whatever a normal quarter is, is about $5 million net.

Thanks, Jim.

And one final question. Are you seeing any change, really, in the nature of your sales pipeline going forward, in terms of plan size? I know you focused on larger plans, but now it seems you are shifting the focus back to the smaller plans. What's your outlook on the plan size and the pipeline going forward?

Sure. Larry, do you want to comment?

Just a couple of comments on that, Greg. I think the better way -- I the way you would want to sort of interpret our comments on this topic over the years has been, we have to be good at all sizes.

It's not a question of of shifting focus from one to the other. The reality is, again we think because of our value proposition in the marketplace, we can compete in small and medium, and even in the upper end of medium with our TRS initiative as Barry commented.

So in terms of our pipeline, it does remain strong. We've commented before. I think the most recent number is up about 25 percent, but again, the whole issue is really the close rate, and the whole issue is around making sure that employers are motivated to make buying decisions, so we'll continue to work at that. But we'll compete at all size ranges in the marketplace.

Thank you.

The next question comes from Saul Martinez with Bear Stearns.

Hi, good morning. I guess I am a little surprised that you didn't up your guidance for 2005. I hear what Mike said, but given the -- that your initial guidance was based on an equity market return of 2% per quarter, and the S&P was up 9 percent in the fourth quarter. I am wondering what else has changed in terms of your assumptions. Is it greater spread compression or are you just being conservative in your EPS guidance for '05?

My second question is -- is on your effective tax rate. Obviously, you have benefited from a tax benefit, but even if I strip that out, it was kind of at 22, 23 percent. I think the guidance previously had been closer to 25 percent. So if I could just get an update on what kind of effective tax rate we should be looking at going forward--if that's changed any?

Yes. Saul, good morning. I'll speak to the tax rate, and then I'll defer to Mike to talk a little bit about our guidance and while --

First of all, we're not -- as you may recall, we said we're not updating guidance, so I'm not sure exactly how much we can give you on that, but let me come back around to the tax rate.

I think it really reflects, as you know, because of the way we're taxed, and the businesses we're in, we do get a dividend-received deduction; and I think that probably is reflective of a greater amount of dividends being paid by companies that we invest in today than has been in the past. That certainly would be true because of the change in the tax law favoring dividends paid.

Obviously we had a large dividend in our calculation this year which would have added to that. So I think those two things, the large dividend that we received and then a general trend to seeing more companies paying larger dividends, is probably what's driving the effective tax rate, keeping it to the lower end of the range. Mike, on the --

So should we expect something low -- I'm sorry, Barry -- but should we expect something lower than 25 percent going forward, marginally lower than that? I don't know if you've given guidance on that.

This is Mike. If you look at -- at the next year or two, we do have a little bit of an impact in some tax-advantaged investments. I think that will put us slightly lower than that 25%. The advantage of investing in those investments will go away in about two years, but for the foreseeable -- looking out two years, think of it more like 23, 24, than 25.

So it coming down, but we would expect it to pop back up to that 25 percent rate longer term.

In terms of, I'll say guidance, I think you certainly answered part of the question. We're a little bit nervous about spreads, we're a little bit nervous about choppy equity markets; and so certainly that always puts a little bit of uncertainty into where we think the year will end, especially being this early in the year.

I think another factor that you need to consider; we set a fairly wide range of guidance going into the year, and, again, I think that all of those things play into the fact that we're really not updating guidance.

Okay. All right. Thank you.

Thanks, Saul.

Sure.

The next question comes from Thomas Gallagher with Credit Suisse First Boston.

Good morning. I guess the first question is, can you just talk about uses of cash flow in '05? Do you see another year of robust share repurchase, or do you think we look at more small deals as the likely opportunities? Can you just, Barry, maybe talk about the trade-offs there, and how you see that playing out in '05?

Yes. Well, certainly you start -- you start with our philosophy, and our philosophy hasn't changed. And the philosophy is that we very much want to use our capital to grow organically, because that's -- we think the best use.

And as Mike and I have said in different forms, we think about half of our net income generally is used for organic growth, just as a rule of thumb.

We've also said we think our next best use is to make strategic acquisitions, acquisitions that really do add value, whether it be strategically, whether it be giving us critical mass, and I certainly would point to the Columbus Circle, I would point to Post, Spectrum, VCI, Malloy, Tapiac[ph].

Those are the kinds of acquisitions that we will really like to do. They really add, not just earnings, but they give us something quite unique in the market, and we'll continue to look for those.

And to the extend we're not able to find those, or to the extent they're not of the nature that would be -- give us enough strategic value, then we'll use the rest of our funds, we'll recommend to the Board that we do share repurchase. Either that or increased dividends or to pay dividends. So if you think about half of our earnings for organic growth; the other half, roughly, can be used for acquisitions and return to shareholders either through dividend or through share repurchase.

I hope that answered your question in terms of priority. We understand that share repurchase is an important lever.

Obviously last year was quite an unusual one with the sale of Principal Residential Mortgage. I think we very wisely decided to redeploy the proceeds from that in share repurchase. Obviously we'll not see anything like that going forward. But we will use share repurchase as a very important tool in managing our structure.

And Barry, just to follow up on that. Are any of these deals that you've announced--are they going to use up any of '05 cash flow, or are those all users of '04 cash flow. So can we think of '05 as being free and clear between potential new deals and buyback?

I think it's certainly the latter. I think most all the capital that I mentioned, they'll not be capital users. There may be a little bit in one of the -- in one or two, but basically it's starting over.

Okay. And then just one follow up. On the -- Mike, you had mentioned the PMRI in corporate other added 2 cents of earnings. Were those -- Is that CMBS securitizations?

No. I think what I was referring to there was the fact that we still had some of the PRMI assets that were embedded in Corporate, waiting to be deployed in share repurchase which then generated some additional investment income in the Corporate segment.

Once we actually repurchase the shares, we lose the investment income.

Okay. And then just a related question. I've noticed some other companies this quarter have been benefiting from an unusually high level of commercial mortgage prepayments, and I know you all have a pretty big portfolio. Was there any of that type of activity this quarter helping that investment income?

Not really. I'm looking Julia Lawler, our CIO, and she's saying, "Basically not this quarter." We have, in prior quarters this year. But this quarter was pretty normal, pretty low.

Okay. Great. Thanks.

The next question comes from Jimmy Bhullar with J.P. Morgan.

Hi. I was wondering if you could just comment on the competitive environment in the pension business. I know Barry has mentioned in the past that you were seeing some competition from the non-public companies. If you could just comment on that.

And then also your outlook for FSA organic growth in 2005. That's it.

Sure, Jimmy, we'll be glad to -- I'll start, and Larry can kind of chime in. I do think it is incredibly competitive right now, particularly the larger case market. And we've talked about some of the reasons.

As we have said, some of the non-public companies I think probably are very, very aggressive. I think some that have been acquired and are making sure that they try to protect their block, so there's a lot of that going on.

I guess I would also say the regulatory environment and governance environment--I think companies are a little less -- they really want to scrutinize before they make a move. So there's a longer pipeline, I think, involved. And so all of those things really do make it more difficult.

But I would also remind people, and we said this last quarter, that the other side of a competitive environment is that we are retaining more of our cases, so as Larry mentioned, we have got an all-time low lapse rate on our block. In our large case market we have a 45% lower than the entire block. So the corollary to slower sales is stronger retention, better retention, and we're certainly experiencing that.

I think, one of the great things that is helping us, particularly in the large case market, to overcome some of that competitive nature is our Total Retirement Suite. We are really -- I think we mentioned 25% of our sales came from Total Retirement Suite in the quarter, so that is giving us an edge. It's not necessarily enabling to us have huge numbers as we would hope, because it is so competitive, but it is enabling us to maintain our very, very strong $1.1 to $1.3 billion quarters that we've having.

What I've basically said -- what we've said about next year is that we said last time we thought it would be touch to beat the $5.4 billion of organic sales, signalling that we would come in just over $5 billion. We came in at $5.2 billion organic sales for the year. And what we said is we would expect a 10 to 12 percent growth in organic sales in '05, and we feel very comfortable with that.

We've got a pretty good pipeline going into the first quarter of the '05, so we feel pretty confident about it. Larry, did I miss anything there?

No, that's pretty complete. I guess I would add just one thing, Jimmy, to all of what Barry said. And that is simply that, again, we do have opportunities, and we are beginning to move in to some new distribution channels that we're also very excited about. I think one advantage that we have is the breadth of our retirement sales platform.

So, for example, we continue to work to do business with third party administrators which has not been a major part of our business, but which is now growing. We have relationships with several payroll firms throughout the country to write plans in the small-employer segment. So all of these things are happening, and they -- and we hope and we're optimistic that they will gain traction.

And you are seeing -- that's part of the reason for the pick up in the case count in the retirement sales area.

Okay. Thank you.

The next question comes from Colin Devine with Smith Barney.

Good morning. I just have a couple of questions guys. First for Larry. If we could talk about sales this quarter. It struck me as obviously well down from last year, and frankly, fairly -- somewhat light in what seasonally I would have thought would have been your big quarter. And perhaps you could just expand a bit more on what's going on there.

And then for Barry. You talked about the stock buy-backs being well down this year, yet you ended the year I think at about 11.9 percent debt to cap. What's the opportunity to start using some increased leverage [inaudible] securitization, a few other things to get ROE up again from where we see it today?

And then if you could also expand a little bit on the status of what you're trying to do to build out third party distribution. Thanks.

Good morning Colin. I'll ask Larry to jump in and talk about the fourth quarter, and then maybe he can also talk a little bit about building out third party. I think he has already mentioned some of that. And then I'll turn it over to Mike actually to talk about the debt to capital and where we're going with that.

Good morning Colin. I would characterize 2004 sales overall as a solid year. Not a great year, but I would characterize it as a very solid year. And again, we've commented, Barry and Mike have commented on this.

Our organic sales were -- if you tried to get it as comparable as you could, we are about flat with last year.

The issues really are around the length of time that it is taking plan sponsor to reach a buying decision, and/or whether they effectively ever decide to move from their current provider to somebody else. As you've -- as we've said, that benefits us, because on the other side of the equation, our lapse rate is at an all-time low.

Another thing -- we think that's worth about -- the functional equivalent of about $400 million in sales just through lower lapse rates in 2004.

Another thing we've worked hard on, Colin, in 2004, is to get better participation in deferrals out of our existing block, and our deferral rates are up about one-half of one percent on average. Our participation rates are up about half of one percent, so that's worth another $400 million to $500 million. So at the end of the day, we remain very confident that we can do the things we have to do to grow the earnings out of our full service accum[ph] business.

In terms of third party distribution, we do work hard at that. What we call our alliance activity is today running about 30 percent of our annual sales volume. In year 2000, that was zero. So that represents a very significant increase in our sales activity.

And as I've said before, we really are just getting started with some of these distribution relationships. They are firms like UBS, Morgan Stanley, Russell Advisors, etc.; and we've deployed a lot of what we call business development resources against that.

We now have about 25 business development resources, 25 individuals, who promote The Principal Financial Group's value proposition against these large third party distribution net works. So we're going to continue to work at that, and I think you'll see that 30 percent move up a little bit in the year ahead.

Colin, let me also -- you'd asked about fourth quarter and the seasonality. I think one of the reasons for the fourth quarter not being as strong as you might have predicted, and as much as we would have liked, is probably large cases. We had one large case, as I recall, in the fourth quarter of this year, and I think we had three in the fourth quarter of last year; and the fourth quarter of last year was just an outstanding year.

As I recall, it was $1.8 billion. I think it was probably one of our very largest quarters, second largest in history, so we were up against a big quarter. We didn't get as many large cases, and I think those would be the two reasons I would say.

I do think the pipeline is strong going into the first quarter, so there probably was a little bit of business. As you recall we had -- we came out of the blocks pretty slow the first quarter of this year, having had such a strong quarter the last quarter of '03.

So Mike, do you want to talk about the debt to cap?

Sure. Colin as you rightly observed, we are at a -- I'll say an abnormally low debt to cap ratio. As we look forward throughout 2005 -- toward the end of 2005, based on some modeling that we've done, we would anticipate a modest increase in that debt ratio. Partly because the rating agencies take a very comprehensive view of debt, and so even short term debt that we would use from an operating standpoint be counted in the way they view debt to cap. And certainly we're very focused on protecting our financial strength ratings. So that's another factor that we look at.

All that said, though, we are taking a very comprehensive look at capital management, capital structure, and I can't really tell you--we're a little early in the process to tell you where that's going to shake out. But certainly we're aware that we do have some capacity, and it's just a matter of how we're going to use it, whether it's going to finance some operating activity, or potentially be used to buy in shares, or for some other purpose.

Okay. Mike, just to come back for a second. I thought I've understood from Barry in the past that his target leverage was about was about 20 to 25 percent. If I look at your AA rated peers, 25 percent seems to be about the norm. Let's say you're at half that. What is so unique about Principal's assets and liabilities that would be causing you pressure from the rating agencies [inaudible] debt to cap that's half that of your peers. Maybe you could help me there.

Colin, I probably misspoke. There is no pressure from that standpoint. So I -- we do have a lot of capacity. It is just a matter of how we're going to use that capacity.

So we're doing some analysis -- again some capital analysis as to how to deploy it, and certainly the other thing we don't want to do is be right up against it. We do want to have a little bit of flexibility, especially as we draw down our excess available capital.

So that's another -- there's an interplay of a couple of different items that we're looking at very hard as we go through 2005.

Okay.

You should assume, Colin, that that number will go up over time.

Oh, yes.

Maybe you could then confirm, is your target still the same, and how much excess capital then do you think you still have?

Yes, our target would still be -- I'll say -- target for debt to cap would be somewhere around, I'll say 20 to 25 percent. I'm not sure we'd want to run right at 25. We'd probably want a little bit of slack in there just to have a little bit of capacity. And then I'd -- and then in terms of available capital, it's probably somewhere in the $300 to $350 million range at the end of 2004.

Okay. Thank you.

Sure. Thanks, Colin.

The next question comes from Suneet Kamath with Sanford Bernstein.

Good morning. A couple of questions. First of all, on the international business. I guess Mike in your comments, you mentioned a review of capital, and perhaps bringing back some capital at some point this year. I was just curious if that was included in your original expectations to hit an 8 percent ROE by 2008, and 10 percent by 2010. Or would this be incremental to that?

And then second for Barry, if you could just give us your thoughts on some of the recent, both M&A[ph] transactions in the life insurance industry as well as -- I guess American Express's spin-off--maybe remind us what the restrictions are related to your de-mutualization[ph], if there are any left, with respect to somebody coming in and acquiring you. Thanks.

Mike?

I'll take the capital question. I believe the potential for repatriating capital was indeed embedded in our 7 percent by 2007, 10 percent by 2010 goal that we set for PI. And I think that the amount of capital that we're talking about repatriating is probably not -- it's -- it would be a significant dollar amount, but I'm not sure it would have that big of an impact over all on PRMI's return on equity. PI, sorry.

And Suneet, on the -- I'll answer the easy one first, and that is our protection. We -- our demutualization provision allowed a 5-year period where no one can purchase more than 5 percent of the shares of the company without the insurance commissioner and the Board's approval, and that expires, I believe, in October of 2006.

The broader question about consolidation and what's going on, I'm not sure that I'm necessarily an expert. I mean, obviously there's a lot going on with the Met Travelers and American Express. There's some little deals going on in our area. You've got St. Paul saying they're going to sell New V[ph]. You've got Lowell Mutual and Ameritas and Union Central merging. So there's no doubt that things have picked up. Whether this is the beginning of a longer trend of mergers and acquisitions, I don't really know.

You know, we feel very, very comfortable with our growth prospects as we are. We certainly, as I have said many times, would not make a large transaction unless it was very strategic and really added great value to our organization, so I don't know that there's any real news for us. It seems like the consolidation will be more in the life insurance arena, maybe less so in the areas that are important to us, asset accumulation, asset management.

Okay. Thanks.

Thanks.

The next question comes from Jeff Schumann with KBW.

Good morning. You indicated that the health insurance loss ratio was somewhat aberrational. But I wondered if you can give us any additional color in terms of product or geography or case size trends that you saw there. Sure Jeff. I'll ask John Aschenbrenner who has been sitting here patiently waiting to answer a question.

Yes. Nothing really spectacular or different to react to. If you remember that about $4 million, and that's somewhere between 1.5 and 2 points on the loss ratio, are seasonality. So we expected that, and talked about that in advance.

The other, say about $5 million, is abnormally high claims; and as we looked at that backwards and forwards, we don't see anything. It's not more in the target markets than the non-target markets or vice versa, just kind of across the board; and we think it's an aberration that will correct itself going into next year.

Yeah, you mentioned before I think that you no longer can sort of reserve for the seasonality. Is that going to affect other quarters in addition to the fourth quarter. I mean, historically, we haven't really seen that much volatility in this business. Are we going to see, kind of, more throughout the year now, do you think?

Yeah, in 2003, we reserved for seasonality, so you didn't see the fluctuations. In 2004, we did not reserve, and roughly it would be about $6 million impact on the first quarter, so that would be a positive impact on the first quarter, and the second and third quarter minimal impact, maybe about $1 million negative each of those quarters, and in the fourth quarter, probably $4 to $5 million negative impact. And we should see that every year now going forward.

Okay. Thank you. And one other area, maybe Barry or Jim can remind us. How complete do you think the sort of the -- the PGI product is at this point? You've done a lot of deals. Is it pretty complete, or do you still have some holes to plug.

I'll give you my view, and and then Jim can -- I think we're pretty complete. I mean we've certainly -- with Spectrum, we got the preferred securities, with Post, we've gotten the high yield. Certainly with Columbus Circle Investors, we take care of a very important part of our portfolio, the growth equities.

And I don't think there's so much of a product or asset class that we're necessarily looking for.

It might be if you had a period of bad performance, or you needed to make sure you had the very best in a class. It might be geography, you know, if you wanted to do more in the international arena, something in Europe, for example.

But by and large, I think what we have is really, really strong, and we might just add incrementally to what we have. I don't see any major holes, but, Jim, you're the expert.

No, I think you're right in that getting the growth equity gap in a sense filled with a very convincing product offering through Columbus Circle was a key strategic move to enhance our product array.

I think that one of the things we have to continually look at is changes in the marketplace, and the investment markets are always very innovative. And we obviously are going to be cautious about being too innovative, because the first mover can often get into problems in equity markets or in investment markets generally.

But some of the things that have developed well for us, for example, in the last two years, have been some of the structured products; and we feel, as Barry said, in international markets, some innovations or asset backs and high yields and things becoming more commonly used in other markets.

And if there are opportunities to use our skills to benefit clients and do profitable business, we'll look in those areas, but I'm extremely pleased with the way we've built out our product array so far.

Okay. Thanks a lot.

Thank you.

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

Well, I thank you all very much for your attention today. We appreciate your support.

Maybe just in closing I will remind you that I think we have just concluded three outstanding years of performance. We have delivered on the promises that we set at the time of the IPO. We look forward to continuing to deliver on those promises, and I'll look forward to seeing you all in the new year as I make my way around to meet with investors and analysts.

So thank you all very, very much.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. Eastern Time until end of day February 15th, 2005. 3002676 is the access code for the replay. The number to dial for the replay is 800-642-1687. U.S. and Canadian callers or 706-645-9291 for international callers.