美國信安金融集團 (PFG) 2005 Q1 法說會逐字稿

Good morning, and welcome to The Principal Financial Group first quarter 2005 conference call. There will be a question and answer period after the speakers have completed their remarks. If you would like to ask a question at that time simply press star and the number one on your telephone 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 first quarter conference call. If you don’t already have a copy, our earnings release and financial supplement can be found on our web site 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 and a are our three Division Presidents, John Aschenbrenner, responsible for the Life & 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 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, 2004, filed by the Company with the Securities & Exchange Commission.

Barry?

Thanks, Tom. And welcome to everybody on the call this morning.

The first quarter was a very good start following an outstanding 2004. For the three months we delivered record operating earnings, record earnings per share, and very good growth in assets under management. These results were particularly strong in light of equity market declines in the first quarter.

As always, Mike will provide a detailed overview of our quarterly financials, including items impacting comparability. I’ll briefly offer some performance highlights for the first quarter. Then I’ll focus the remainder of my remarks on our continued progress in three areas: accelerating growth in U.S. and international retirement businesses, creating a successful global asset manager, and achieving profitable growth in our life and health insurance businesses.

The first quarter was, again, a very good start to the year for The Principal. In addition to some unusually strong performance from Principal Global Investors, which Mike will discuss in detail, we delivered record assets under management of 175b, up 25b or 17% over the prior year quarter; record operating earnings per diluted share of 69 cents, a 19% improvement; record operating earnings of $209m, up 12% including an eighth consecutive quarter of record earnings for U.S. Asset Management and Accumulation; double-digit growth for Principal International; and very solid operating results for all three Life and Health Divisions.

We also delivered very solid sales performance for our three key retirement and investment products, and continued progress with our Life and Health segment growth initiatives, evidenced by record operating revenues and good growth in our key in force measures.

As I mentioned, in 2005 we remained highly focused on several critical areas. Let me start with our efforts to accelerate growth in our U.S. and international retirement businesses.

Pension Full Service Accumulation had another outstanding earnings quarter, up 18% from the first quarter 2004, and was one of two key drivers of U.S. Asset Management and Accumulations’ record earning performance. Compared to a year ago, Full Service Accumulation account values were up 19%, and while poor equity market performance in the quarter offset positive net cash flow we continued to see very strong growth in deposits.

In the first quarter Full Service Accumulation achieved record deposits of 3.9b, an increase of 18% from a year ago. This reflects continued strong organic sales, the power of payroll deduction, and our ongoing success in maximizing participation and deferral rates. At approximately 700m in the first quarter Full Service Accumulation net cash flow was down from a year ago. This reflects an increase in withdrawals due to higher than normal lapses associated with our clients being merged into other entities and some higher lapse rates for small and medium sized plans. Large case retention remained strong.

Given continued growth in assets at risk due to retirements and job changes, it’s increasingly important to keep in mind not only the level of withdrawals but also the significant level of assets in the withdrawal number that remain with The Principal. First quarter 2005 withdrawals included more than 370m of assets we retained into mutual funds, individual annuities, and bank products. These strong results reflects our continued success in simplifying the IRA rollover process and our expanded focus on retaining at risk participant assets into our retail rollover solutions. Adjusting withdrawals to reflect these internally retained assets produces net cash flow of 1.6% of beginning of year account values. We do not view the recent increase in withdrawals as a systemic issue. That said, we’re certainly keeping a very close watch on lapses, and we continue to intensify our efforts to maximize plan and member level retention.

As indicated last quarter, there is clearly some uncertainty around how lapses will emerge from the ABN Amro acquisition, and increasing competition is always a concern. But based on continued strong growth in deposits and our sales picture, which I’ll discuss shortly, we remain committed to our longer term, 6% of net cash flow target and are working very hard to achieve it for the full year 2005.

Moving to Full Service Accumulation sales, organic sales for the first quarter were 1.4b, up 5% from a year ago. Alliance sales, which we view as a key driver of longer term sales growth, increased 50% from a year ago, exceeding 550m for the quarter and reflecting increased success with our existing partners.

In the first quarter we continued to pursue our initiatives around growing case count and capitalizing on the shift in demand toward total retirement solutions. Our increased focus on the small case market continues to pay off. Compared to a year ago sales of security builder plans are up 16%, with more than 400 plans in the first quarter we’re well on track to exceed our target of 1,500 new security builder plans for 2005.

Total Retirement Suite continues to be received with great enthusiasm, as well, and importantly is driving strong sales success. Nearly 30% of our first quarter sales. Further, we believe that as the year progresses we’ll begin to see the American Jobs Creation Act create significant additional TRS activity. Nonqualified plan sponsors are faced with the review and potential redesign of their plans to meet the requirements of the Act, and our nonqualified leadership and expertise position us to capitalize on this substantial opportunity.

To wrap-up the sales discussion, we continue to strengthen our best in class retirement solutions, as well as our powerful sales infrastructure and exceptional distribution reach. We’re particularly encouraged by the growth in the number of cases written and some promising developments on the large case side that we expect to bolster sales in the second half of the year. As such, we remain committed to and confident about achieving our 10 to 12% organic sales target for 2005.

Moving to our International retirement businesses, we continue to make significant progress in driving growth. Principal International’s assets under management reached a record 10.6b at quarter end, an increase of 30% from a year ago, with Brazil and Mexico both crossing the $3b milestone during the first quarter. Revenue growth also remained strong, reflecting record payout annuity sales in Chile during the first quarter, and significant growth in assets under management overall.

We also continued to make very good progress in creating a successful global asset manager. Principal Global Investors’ strong investment performance contributed to recognition The Principal Mutual Fund family received in March, Lipper's best overall fund group and best mixed equity fund group for delivering the strongest three-year risk adjusted performance by a smaller fund firm. I’ll add that in April Principal Global Investors received the 2005 Asian Investor Achievement Award for Asia ex Japan Equity, also based on a three-year risk adjusted performance.

For the three-year period ending March 31st, 2005 80% of Principal branded retirement plan separate accounts were in the top two Morningstar performance quartiles, and all six of our lifetime separate accounts, which keep the asset mix appropriate for investors, as they age ranked in the top quartile of their categories for both the one and three-year periods.

As a result of improved investment performance and an expanded portfolio of value added products, we’ve become increasingly successful competing for new institutional mandates. Compared to a year ago Principal Global Investors’ third party assets under management have increased by $10b or 36%, fueling their number five ranking by Money Management Letter for net asset gained in 2004.

Since the end of the first quarter we’ve already won two important new mandates, a 1.1b fixed income mandate with Iowa Public Employees Retirement System and the management of a newly created 4.9b structured credit transaction. The revenue on these two recent wins is likely to be between 1.5m and 2m per year as fees are lower on structured credit transactions.

In terms of our efforts to profitably grow our Life and Health businesses, I’d point to several key areas of progress during the quarter. Recurring premium individual life sales continued to be strong, up 12% from a year ago, and lapse rates improved from a year ago and sequentially.

In the Health Division sales in our target states increased by 24% from a year ago. Total group medical covered members increased by 0.5% from year end driven by 3.3% growth in our target states, a very solid result and our third consecutive quarter of growth in our targeted states.

Finally, this was another strong quarter for the Specialty Benefits Division. Sales continued to increase with first quarter being up 25% from a year ago, contributing to record operating revenues for the Division and the segment. We also continue to see solid growth patterns in each of the Division’s in force measures. Notably, in force premiums and fees are quickly approaching $1b, a milestone we expect to surpass in 2005.

Before I close, let me briefly cover a couple of other areas. In terms of effective use of capital, funding organic growth and strategic acquisitions remain our top two priorities. We continue to seek opportunities like the ABN Amro Trust acquisition we announced in December. We are optimistic that DC market consolidation will continue, and, again, we intend to be a major player.

As you know, we also continue to use share repurchase in our efforts to effectively utilize excess capital. In the first quarter we bought back 4.2m shares for 164m, this completed the Board’s 700m May 2004 authorization as well as approximately $89m of the Board’s $250m March 2005 authorization.

Let me also briefly discuss guidance. We believe it’s in the best interest of shareholders for us to revisit our annual EPS guidance from time to time to ensure clarity if events or changes in the environment occur during the year. Given our unusually strong first quarter results, equity market declines of 4.5% through April, and continued uncertainty around interest rates, and the economy, we felt this was an appropriate time.

As you know, in November of 2004 we communicated a range of $2.60 to $2.72 for 2005 operating earnings per diluted share, with the midpoint being $2.66. In spite of some short-term pressure on earnings we continue to view that range as being our best estimate for the year. I’d add that this expectation contemplates equity market appreciation of roughly 2% per quarter for the remainder of the year.

In closing, we’ll continue working hard to extend our leadership with small to medium businesses and their employees. We’re confident that with further economic recovery and modest equity growth we’ll continue to achieve our EPS and ROE targets, and to deliver superior long-term results for our shareholders.

Mike.

Thanks, Barry. This morning I’ll spend a few minutes providing additional highlights for the quarter and financial detail for each of our operating segments.

We are very pleased with our record operating performance, particularly in light of first quarter equity market declines. As Barry indicated, we delivered strong total Company earnings growth, an improvement of 12% from first quarter 2004, driving 19% improvement in operating earnings per share. We continue to be very pleased with our ability to drive strong growth in assets under management, given continued difficult equity market conditions.

Moving to the segments, I’ll start with highlights for U.S. Asset Management and Accumulation. Segment assets under management increased $24b or 19% from a year ago, driving total Company assets under management to a record $175b at quarter end. Compared to a year ago operating earnings for the segment increased 16% in the first quarter to a record $139m.

Principal Global Investors was the largest contributor to the increase, improving $11m from prior year quarter to $21m. Principal Global Investors’ first quarter 2005 earnings growth primarily reflects continued strong growth in assets under management, and extraordinary commercial mortgage loan securitization results. Fluctuations in any given quarter can stem from market driven narrowing or widening of commercial mortgage backed security spreads which added $3m to first quarter 2005 earnings, as well as a number and size of securitizations completed.

Principal Global Investors also earns incentive revenues on several of the investment styles it manages, particularly, high yield bonds. These incentive revenues can vary widely from year to year. Principal Global Investors continues to experience strong organic growth and its current run rate of earnings is between $60m and $65m on an annualized basis.

Full service accumulation was the second biggest contributor to segment earnings growth, improving by $9m or 18% from a year go to $61m, and driving a record $101m of earnings for the quarter for pension. The individual annuity and mutual fund businesses continued to contribute to segment earnings growth, as well, improving 8% and 11% respectively. Reflecting very solid sales and good retention of at risk retirement plan participant assets, both businesses delivered 22% growth in account values from first quarter 2004.

Increasing earnings for U.S. Asset Management and Accumulation compared to a year ago were partially offset by lower full service payout earnings. The $6m decline primarily reflects a benefit in first quarter 2004 for a onetime reserve adjustment to better reflect the timing of reported mortality. While the first quarter 2005 results improved sequentially the interest rate environment continued to depress the single premium group annuity market and our sales.

Within our International Asset Management and Accumulation segment Principal International’s first quarter earnings grew to $9.5m, from $8.6m in the year ago quarter, a 10% improvement. The first quarter increase is primarily due to improved results in Mexico, reflecting better [4A] pension sales, lower operating expenses, and higher assets under management. The improvement in first quarter earnings lagged our longer term growth expectations of 15 to 20%. But based on growth and assets under management and continued strong sales, we are confident that we will return to that range as the year progresses.

As I mentioned last quarter, in light of Principal International’s strong growth and increasing profitability we brought back $10m of capital from Brazil in March, and expect to repatriate approximately $45m from Mexico in June. Reducing deployed capital will have a modest positive impact on segment return on equity but will slightly dampen Principal International’s earnings growth in 2005, as well.

Moving to the Life and Health segment, first quarter 2005 earnings were $70m, reflecting solid results from each of the Divisions. Compared to an exceptional first quarter 2004 earnings were down about $5m, but rebounded strongly from fourth quarter results. After adjusting for items impacting comparability between first quarter 2005 and first quarter 2004 earnings would have been essentially flat, approximately $65m for both periods.

Moving to the Divisions Individual Life earnings were $30m for first quarter 2005, down $3m from a year ago, primarily due to a return to more normal mortality. Earnings in both quarters benefited by approximately $4m due to favorable deferred policy acquisition cost adjustments.

Earnings for the Specialty Benefits Division were $14m, compared to $15m in first quarter 2004, reflecting the benefit of a favorable reserve adjustment in the prior year quarter.

Health Division earnings were $26m in the first quarter, compared to $27m in the year ago quarter. The decline reflects a slight increase in loss ratios which remained in an acceptable range. The Division continues to deliver strong return on equity. Over 21% for the trailing 12-month period. I’d remind you the first quarter is generally the strongest earnings quarter for the Health Division, as well as for the Life and Health segment. This is due to seasonality of health claims which tend to be lower in the first quarter and higher in the fourth quarter.

In addition to the progress Barry discussed in each of the Life and Health businesses, I’ll provide a bit more color on the progress of our growth initiatives in the Health Division. Total group medical covered members increased slightly from year end, driven by very solid growth in covered members in our target states, a 3.3% increase from yearend.

We also achieved 9% growth in premium in our target states over first quarter 2004, increasing success in our new high deductible health plan which accounted for 7% of first quarter 2005 insured medical sales, and very strong growth in our wellness business which increased 6% from year end to 70,000 lives.

I want to also quickly comment on recent declines in fee for service covered members in sales. We’re increasing our focus within the administrative service only market on smaller cases in target states where we’re more competitive. We remain confident that our network discounts will positively impact fee for service member growth over time.

Before taking questions, I’d like to briefly revisit some important items to keep in mind in terms of growth expectations for the remainder of the year. In any given comparison period results tend to fluctuate due to factors such as prepayment and deferred acquisition costs unlocking, as well as normal variations in mortality, morbidity, and lapse rates.

As always, our growth target should be applied to normalized historical results. Our long-term earnings per share growth target of 11 to 13% incorporates equity market returns of roughly 2% per quarter. In the first quarter the S&P dropped 2.6%, followed by another 2% decline in April. Clearly, equity markets remain volatile and challenging.

I’ll close with a brief follow-up to last quarter’s capital management discussion. We’ve now completed our capital study which focused on our business and financing needs and our capital structure. We will be discussing the study with the Board of Directors later this month. As always, we’ll keep you informed of any new developments.

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

[OPERATOR INSTRUCTIONS]

Your first question comes from Edward Spehar with Merrill Lynch.

Good morning, everyone.

Good morning, Ed.

I was wondering in terms of the money, the new sales or the new money coming into the small case or into the 401(k) business, could you give us some sense of the allocation between PGI managed funds, Principal branded funds that are sort of a sub-advisory structure? And then if you could compare that to what the total book of business is, and just discuss in whatever detail you can kind of the margin implications of what’s going on? Thanks.

Sure, Ed. We’ll be glad to address that. I’ll ask Larry to jump in and give you those details. I think you want to know about new dollars coming in as well as the entire block. So, Larry?

I guess the margin implications, too.

Yeah, we’ll cover that, too.

Okay.

Sure. First, let me cover, Ed, the kind of current breakdown for the overall portfolio as it exists today. And that breakdown is that about 58% of the account values are in PGI managed assets, about 20% are in what we do refer to as our partners subadvise structure, and about 22% are in either what we call access funds, which would be third-party retail mutual funds or there’s an increasing amount of that, Ed, that is also in employer securities given our TRS and ESOP capability.

In terms of the breakdown by new contributions coming in, that actually varies by whether we’re talking about what we call the emerging markets, you go to 5m, or dynamic or institutional.

And now I think that it’s fair to say that if you look across the block the deposit cuts aren’t significantly different than what I just gave you between the account values, 58 PGI, 20 partners, and 22 access. It may be just slightly below those, slightly fewer proprietary and slightly greater access in the institutional; on the flip side, emerging is going to have far more PGI and partners, and very little access.

In terms of margin implications, which you asked about, I think the best response that we have there continues to be what we’ve said in the past on margin implications, which is that we think the value of our PGI managed alternatives are approximately 10 to 15 basis points on an annual basis.

Well, let me just add, Ed, that the most recent trends would also be affected by takeover and acquisition. So the ABN Amro, for example, that block of business is going to have a much higher concentration of non-PGI to start out, as would some of the other acquisitions that we made. But given the track record of PGI and some of the investment performance I just talked about we believe very strongly that we can migrate much of those dollars back over to PGI invested funds, as long as we maintain good track records.

Okay. Thank you very much.

Your next question comes from Nigel Dally with Morgan Stanley.

Great. Thank you. Good morning.

Good morning, Nigel.

You mentioned that you’re happy to, happy with your ability to retain assets and funnel them into mutual funds, annuities, and Principal Bank. Yet, when you look at the net flows of those Divisions, flat to down from the prior year, hopefully you can discuss why that would be the case?

Yeah, sure. Larry, go ahead.

Good morning, Nigel. First of all, you know, we have had, as we have profiled for you during 2004 we have had very, very strong growth in both new sales, as well as net cash flow for both our annuity and our mutual fund businesses, so I would hope that in kind of comparing where we are in first quarter 2005 to prior periods you really need to take account of that.

As we said, as Barry said in his comments, we conserved approximately 370m of at risk assets in our retail products in the first quarter, and that’s up from approximately 300m to 325m a quarter that we would have done generally through 2004. So, that gives you some idea of the incremental amount of sales that were coming out of that additional activity. So, honestly, we feel pretty good about that. And as Barry also commented, that would put our net cash flow for full service accumulated at about 1.6% for the quarter.

The other thing I’ll comment on is to say that the overall net cash flow for our U.S. asset accumulation businesses has been running -- in the first quarter was about 1% of total account value. And, again, as we have guided you in the past, we think if we can produce 2 to 3% net cash flow over the entire year we would have the capability to hit our operating earnings target. So, while that’s a little closer to the margin than it has been it still remains within, overall it remains within the guidance that we provided in the past.

Okay. And just –- sorry.

Back to the retail fund issue, you know, when we first started retaining assets we retained most of those assets in, actually in the plan, itself. We had an option within the plan. And it’s only been in the last couple of years that we’ve really gotten aggressive with the IRA, mutual funds, annuities, and the other retail products. So, I think you’re going to see that trend continue, where we retain more and more of those assets in IRA rollovers.

Okay. That’s helpful. Just to follow-up on withdrawals, is it possible to split out what percentage of withdrawals are related to the ABN Amro block? And generally how withdrawals in that block have tracked versus your expectations at the time of purchasing [inaudible]?

I think, let me let Larry; he's jumping to answer that one. He must have the facts, right at hand.

Well, yeah, actually again, you know, we’ve been careful because it’s always hard to forecast, Nigel, in a situation like that, it’s always a little hard to forecast what your experience may be. And, again, I don’t want to suggest to you that one quarter makes a trend here, but what I would say is that our experience so far has been extremely positive with that block of business. We’re very, very happy with it.

We’ve been working hard to get the message to not only the clients, but also the intermediaries of the ABN Amro block, and actually that, it was a net positive contributor, about 100m to 150m positive during the first quarter. But, again, we want to be a little bit cautious and conservative about how that may play out during the rest of the year. But we’re very happy so far.

Okay. That’s great. And just one last question, just with regards to your guidance. Do you have a number for stock repurchases which you’ve built into your guidance expectations?

Yeah. I think you could probably think about what we’ve already authorized as being the right number. So, we’re implementing, we’ve already completed a 700m repurchase from last year, and we’re working our way through the 250m that the Board authorized in February. And I think that would be a good response as to what’s built into guidance.

That’s great. Thanks, guys.

Your next question comes from Jeff Hopson with AG Edwards.

Hi, good morning. I think you mentioned some optimism about large case sales later in the year. Can you give some details on that? And then in terms of defined contribution consolidation, any change in the outlook in terms of people staying in or getting out sooner versus later?

Sure, Jeff. I think I mentioned both of those in my script, so I’ll just touch on them very, very briefly. We are optimistic that the defined contribution marketplace will continue to consolidate. But there’s really nothing tangible that I can point to and say, see, it’s going to.

I think the one thing that I would point to that’s in the market, obviously, is the volatility around equity markets. And I think anytime you get those kind of wild swings it puts a lot of pressure on companies that are somewhat marginal in this business. So, you know, my sense is that the pressure at some point will come to a point where you’ll see more activity, but who knows, people have to make those decisions themselves.

You know, on the large case, I think it would be fair to say that as we look at our pipeline, as we look at our activity that we do feel like the second half of the year has the potential to be very, very strong, because of some larger cases that we’re working on. There’s never any assurances that they’re going to come through. Things can always happen. But it does give us a fair amount of optimism, just looking at the pipeline of larger cases that we’re working on right now.

And back to the withdrawal question, something I want to make sure that people heard because it relates to the larger cases, that we did lose in the first quarter several fairly large cases that were lost due to acquisitions. And we had some companies that were bought by larger companies, and unfortunately their plan took over our plan in that instance. And we don’t think that is something that will continue throughout the year. We think that was a bit of an anomaly. But it does happen from time to time, and that explains a fair amount of the net cash flow problem in the first quarter.

Okay. If I could follow-up on the new large cases potentially in the pipeline, anything different about those? Any breakthroughs? Or is this a regular business activity?

Well, not really. I think the trend continues to be total retirement solution, Total Retirement Suite, continues to be for us a significant differentiator in the large case market. Increasingly, those plan sponsors are demanding that they do business with a company that can take care of the DBDC, ESOP, and nonqualified. And I think that is an enormous competitive advantage we have. And as Larry said, I think 30% of our sales, Larry, in the first quarter were from TF, TRS, so I think that is the significant trend that continues to emerge.

Okay. Very good. Thank you.

Your next question comes from Suneet Kamath, Sanford Bernstein.

Good morning. Thanks. Two questions. First, on the 401(k) pipeline, I think you had also mentioned in past quarters that it was up pretty strong. And obviously, we haven’t seen that necessarily come through. I’m just wondering if that pipeline that you’re talking about now is the same as the pipeline that you were talking about in past quarters, or if it’s different?

And then, second, on the capital plan, as I understand it, you probably don’t want to discuss it too much ahead of the Board meeting, but is there any way that you can dimension or qualitatively describe what your findings were? Thanks.

Sure. I’ll ask Larry to jump in on the first, and then Mike can pick-up on the capital plan.

Sure, Suneet. On your pipeline question, again, what we really talk about here is what we would refer to as our late stage pipeline. And as we’ve said, basically, at the end of the first quarter, we see that pipeline is up about 13% over where it was a year ago. So, that’s the quantitative background for Barry’s comment around how things may play out during the year.

I understand, you know, your point around when does that translate into sales? Again, we’re starting to see some of that. The one thing, of course, and again Barry commented on it, that none of us control is the timing decision of those buyers. And as we have commented on in prior periods, the length of time from RFP to ultimate decision, to move the business, does seem to be lengthening.

One thing we’re optimistic about is the Job Creation Act and the need to literally redesign every nonqualified plan by the end of the year, you know, may put a little bit of a timeline out there, and a little bit of a cliff relative to some potential TRF prospects. So, we’ll have to see how all of that plays out. But, again, we remain optimistic and think we have the pipeline to hit our sales goals.

Mike, you want to comment on the capital plan?

Yeah. I’m going to have to be a little bit noncommittal, and tell you a little about the analysis that we went through. And that’s about as far as I can go, Suneet. Because I don’t want to get ahead of the Board on this one. I mean they really need to, along with Management, take a very good look at –- and here’s what we looked at, sort of our current capital position, forecast of where we think our capital position will be over the next year or two.

We’ve been visiting with investment bankers about some of the products that are out in the marketplace and, obviously, investment bankers are very creative in coming up with capital raising alternatives. And then the rating agency reaction to any change in our capital structure. And so those are the things that we kind of stirred into the mix. Those are the things that we’ll be talking to the Board about, and we’ll see where we go from there.

Okay. Thanks.

Your next question comes from Tom Gallagher with CSFB.

Good morning. Let’s see, first question is just in response to a comment you just made, Barry. In terms of the fact that you lost several large cases due to M&A, you gave some I guess generic quantification of it, but would you say that the lost large cases would have accounted for most of the YOY decline in net flows of about $300m in Full Service Accumulation?

I’d say it would be the vast majority of it. It would be pretty close to the whole amount, but it was a significant number.

And as we think about the way that affects net flows, isn’t there a spillover effect, meaning not everybody is going to move the money this quarter? Will we continue to see that drag out, or was there, in fact, a pop? And will we see that improve next quarter?

I believe there was a pop. I’ll look to Larry for the details. The cases that left, Larry, are they pretty well were gone, probably were gone at the end of last year, early part of the first quarter?

Yeah, Tom, I would say in response to your question the activity that we saw in the first quarter was activity from, again, usually M&A activity in 2004. As we look forward, there’s always going to be, you know, a slight, there’s always going to be some volume of that, but it’s not, as Barry has already commented, it’s not anywhere near at the level that it was in first quarter. So, we do think it’s a blip.

Now, on the other hand, you know, consolidation in the business community does seem to be picking up. So, you know, we don’t know what that may mean for the future. But in terms of the remaining amounts it’s certainly less than it was in first quarter.

Okay. So, you’ve already seen that started to trail-off thus far in Q2?

Yes, in fact, because the majority of that was in the banking industry, just to give you some further kind of color and understanding around that.

Okay. Got you. Now, in terms of the commentary that lapses are going up in the small to midsized case market, can you talk about what’s driving that? Is there new competition out there? Is it the usual suspects you’ve been competing against? Has anything changed?

Well, Tom, this is Larry. I’ll make a few comments on that. We have looked at this very intently, obviously, over the last couple of quarters, we’re following it very, very carefully. I would tell you that it tends to be a little bit concentrated in the kind of plan sizes between $3m and $10m, roughly. And I guess I would start by saying that as we commented in 2004, we saw a record retention, record employer retention, or said the other way, we had record low lapse rates at least based on any historical memory that I know going back years and years, and years.

So, what we’re seeing is there is more competition in this 3m to 10m, and we’re seeing that lapse rates maybe have ticked up a little bit in that sector of the market. It is primarily driven by fees. It is primarily employers who very much like our value proposition. There’s no indication of any service issues here. This is strictly a question of whether the client can afford to pay for, what the client can afford to pay for their 401(k) or defined contribution plan.

So, we’re very intensively on those clients. We’re looking at all of our expenses and fees and service models. We think we can compete very well. But it is a section of the market, quite frankly, where everybody competes in 3m to 10m.

Okay. Got you. But have you seen a dramatic pickup in terms of aggressive pricing, or just from a competitive standpoint? And any color you could give us there.

Yes, the way I would describe it, Tom, is there are so many players that compete In that space. Again, insurance companies, banks, and mutual funds. Everybody plays there. And all it takes is one or two irrational competitors. It’s never the same one or two, but there will always be a couple of irrational competitors in that part of the market, because that’s kind of where everybody is going into.

And I would just, again, you know, caution you to kind of look at the across the whole spectrum. As Barry commented, on the lower end with security builder, we’re seeing 16% increase in growth. On the higher end with our total retirement suite we’re seeing that’s now 30% of our sales.

So, one of the real advantages that we have is we play across the spectrum, whereas most of our competitors tend to concentrate in that $3m to $10m range. So, while that’s going to continue to be a very, very competitive part of the market we’re still playing across there, where we can pick and choose, and focus our efforts where our best opportunity is.

Got you. Okay.

We’re committed to the 3m to 10m and we’re going to do what it takes to compete down there. But as Larry said, luckily we compete other places, as well.

Okay. Thanks a lot.

Your next question comes from Jimmy Bhullar with JP Morgan.

Hi. I just have one question. You’ve had very strong UL sales the last few quarters. I wanted to just get an idea of what sort of an ROE you’re pricing the business for, and what is it that you’re getting on the business right now?

Sure, Jimmy. I’d be glad to have John answer that. He’s the person in charge of that business. John?

Yeah. We attempt to price all of our life products in the 12 to 15% return. With the UL, with secondary guarantees right now, with the changes we’ve seen in reinsurance, and the changes we’ve seen in reserving, the current product has not been performing or does not look like it will perform at that level for us. And so we are in the process and have made a number of adjustments to try to bring the product back into the range where it ought to be.

Okay. And, also, I think just if you could give us an idea about whether you’ve made any pricing changes or you’ve held back certain products? I think in the last, the second half of last year you did pull back the 70 plus product, but if you’ve made any other changes besides that?

The other changes that we’ve made is we have cut back on the single premium we will accept on the product. We’ve changed some field compensation, we’ve reduced field compensation in some aspects of the product. And we have modified the term end of the product, as well. So, a number of changes as we’ve gone along.

Okay. And just, actually, just to follow-up on – in the press release you mentioned the commercial mortgage, loan securitization income was very high in the U.S. asset management business. Could you give us an idea of how much of that was extraordinary? Or how much was it higher than normal?

Let me ask Jim McCaughan to jump in, he heads up our Global Asset Management Organization.

Yes, Jimmy. The amount that was really outside of the normal repeatable run of business was the 3.2m arising from spread narrowing. So, that was really the extraordinary piece. Our securitization business, like many of the other things we do, has been growing. And there’s been very good execution there which has helped both the volume and the profitability.

And just to give you an idea, in the first quarter we did 394m of securitization compared with 833m for the whole of 2004. So, it’s been growing like our other businesses with good execution helping the profitability. But really it’s the 3.2m from spread narrowing that was the extraordinary piece of the profits in the quarter.

And you might add to that, Jimmy, a higher amount of securitization, so you might want to, you know, factor in a bit more because we did have a lot more volume in the first quarter. So, 3m on the extra spread and maybe a couple other million because they’re pushing a lot more production in the first quarter.

Okay. So, that may be roughly close to 5m, somewhere around there? Okay. Than you.

Your next question comes from Colin Devine with Smith Barney.

Good morning. Barry, I believe you indicated that for this year one of your key strategies was to try to generate some cross sales between the life business and the pension business. And perhaps you could sort of update us on where that stands? And also you’ve done a lot to restructure Principal in your tender as CEO. As we look at it today, and I guess I’m thinking particularly the health business, is that still a strategic asset for you?

Well, we’ll save the tough one for last. I’ll let Larry jump in on the cross sale, and then I’ll come back and talk about our mix of business. Larry?

Yeah, Collin, good morning. I think the best example, the best real world and point of moment example relative to your question about cross selling opportunities, particularly between life and pension really are Barry’s comments earlier around the nonqualified opportunity. I mean it is easy to establish that life insurance remains the dominant form of funding for nonqualified plans in this country.

And because of our leadership primarily around a subsidiary called executive benefits services, who is one of the premiere design administrative firms in the area, along with our own life capability here in Des Moines, we are extremely well positioned to capitalize on that opportunity around Jobs Creation Act.

Now, what we’re going to need there quite frankly is we’re going to need a little bit more definitive guidance from the Department of Labor, which according to the last information that we received is probably going to be sometime in the, around the late June, maybe early July period. But I think that’ll kind of represent the starting gun to what we hope will be a frenetic need to go in and do a lot of redesign of nonqualified plans, which is also going to kick up a lot of opportunity for our total retirement suite platform. So, that’s just one real world example. It’s probably the one that will be the dominant cross selling opportunity we’ll be working on this year.

Does that mean you’ve backed away from trying to cross sell then your group products? I mean the part that I recall particularly was your group disability customers, group life customers. My understanding is very few of them are 401(k) customers, and that was going to be a major strategic focus. Is that now not the case?

What we said, Colin, is we want to go where there is the most natural cross sell opportunity. You know, that’s where we’re going to focus our efforts. Ands that’s why I used the nonqualified situation in 2005. We haven’t, we by no means have eliminated other possibilities around cross-selling capabilities, but like all things in a sales and marketing environment, you know, you have to go really where the demand is.

The other comment I want to make just real quickly is we are making great strides in our initiative to further penetrate our defined contribution, and frankly also our voluntary benefits for additional retail sales. These are what we call our retire secure and work secure initiatives. And we’ll be in over 20 locations, which is about half of our locations, by the end of the year. And we should begin to see also great opportunity around cross selling of retail products to a combination of our specialty benefits business, as well as our full service accum business. That’s on the retail side, as compared to the employer side which I was speaking to earlier.

Okay, Larry, but just to be certain here. Then what you are saying is the priority or there’s not the demand from your group disability group, life customers, or your 401(k) products. Is that what I’m hearing? Because that is not a likely area of growth? Just to get sort of…

Collin, we’re pushing home all of those things. I mean as I was about to say, I think our largest case last year, the largest case we wrote or one of the top two or three cases, came from an administrative services only client. So, we are always looking for those cross sales. As Larry, you know, was saying, we’re just going to those areas that make the most sense to begin with. But we’re pushing on all of the buttons for cross sale that continues to be an important strategy.

And, in fact, let me use that as a segue to answer the second part of your question, we are very much focused on serving the small to medium business market with a variety of offerings. And certainly the health area is one of the offerings that we think is very important into that market. And interestingly, there are some trends in the health area that look an awful lot like what went on in the retirement area a few years ago, and that’s moving to more of the health savings accounts, the high deductible plans, the health area is starting to look more like the defined contribution did 20 years ago. And we think we’re ideally positioned to take advantage of that with our bank, our mutual funds, our administration, our claims paying.

So, to answer your other question, I believe our portfolio of businesses make a great deal of strategic sense, and we continue to work on profitability. If you look at the health business, itself, it continues to be over 20% return on equity, and it’s very strategic. So, I’m very pleased with our portfolio of businesses, and we will work hard to continue our cross selling efforts.

So, you’re in the health business to stay?

Never say I’m anywhere for anyplace to stay, and I never say never, so we like our businesses.

I hope you’d at least say that about the 401(k) business, but thanks, Barry.

Good point. And I also say it about staying married to my wife, too, but thanks, Collin.

Thanks, Barry.

Your next question comes from [Joan Beet] with Goldman Sachs.

Thank you. Good morning. I was wondering if, Mike, you could talk a little bit about the cash flow? You, in the first quarter there were a lot of buybacks, there was an IRS payment, your debt to capital went up to 21%. You know, what are you thinking about for the rest of the year? What does this mean for your interest expense? Have you done more, you know, long-term debt financing? Are you going to be able to keep up the pace of buybacks in the second quarter? And just generally, you know, how should we be thinking about your cash flow, your ability to make those acquisitions, and buyback important?

Joan, those were about 50 questions, I think. I don’t know if we’ve got time to answer all of those. But I’ll try.

Let me start off, first of all, I know you’ve had some I’ll say questions about the tax payment that we made, so let me talk about that very briefly, first. As you’re aware, all large companies are audited every time they file a tax return. And so us being audited and having some issues with the IRS is an annual occurrence. So, to start off with, we’ve got a couple of issues with the IRS that we reported in the K and the Q, really revolve around structured investment deals where we split some principal and interest to meet an investment need, sold off a piece, and then the tax consequences of that sale is one of the issues.

Another issue which is probably even a bigger issue, is some tax carrybacks that we had from years 2002, 2003, back to the years 1999 and 2000. Most of these issues, Joan, are timing issues, so they really don’t revolve around are we ever going to get a deduction for these transactions? It’s the timing of those.

So, the IRS assessed us with about a 440m roughly in deficiency and interest. Our expectation is that we will have resolution on the carryback issues sometime this year, and so we’ll get a big chunk of that money back sometime this year. In terms of impact on our income statement, really no impact on either GAAP or stat earnings because we’re either fully reserved or we have a receivable.

Now, we get to the cash management issue. Cash management issue is so how did you fund these things? And we typically, we manage our cash needs from a pool concept, so we look at how much cash do we have, splashing around the organization from various operating activities, short-term debt capacity, and then also from time to time going into the term debt market. So, terming it out with longer paper.

Another place we can get assets or get cash is also from asset sales. So, in the short term we were able to and are able to carry that financing what we believe short-term cash need of the payment to the IRS through short-term debt and cash that’s splashing around the organization. Sold a bit of assets, low yielding assets, also, to cover that.

In terms of cash going forward, there we get to available capital. And so you’ve got a little bit of a, you’ve got to consider not only cash, because we can raise a lot of cash, the other constraint is well, how much available capital do we have? And I think we’ve said at the end of first quarter we had about 350m of available capital, somewhere in the 300m to 350m. With share purchases through the end of the first quarter, some net income that was generated, we’re in roughly the 200m range at the end of second quarter.

You look at our capacity to, again, fund growth, to fund acquisitions, you’ve got to look at our net income, and so certainly that gives us available capital. We have some debt capacity, as you point out. We’re running right around 20%. We’ve stated that the maximum that we bump up against is maybe 25 which is a maximum that the rating agencies would hold for a AA rated company. And so we’ve got some capacity both in terms of I’ll say equity capital and also in debt. Does that answer your question?

Yes. That’s fine. So, then I shouldn’t expect to see much impact from either added interest expense from the borrowings? And I shouldn’t expect to see any major slowdown in the buyback program?

No, you shouldn’t see any real impact other than arbitrage between the receivable that we will get from the IRS, because they’ll pay us our tax plus interest when we recover it, and whatever the interest carries on a short-term borrowing.

I mean what’s the risk that you don’t get it back?

I think it’s – we would view it as a very low risk, so we would view it as very low risk.

Okay. My second question, that was only one question. My second question is about the international area. I mean you talked about repatriating the capital, back out. Talking about how it may slow earnings growth a little bit, but improve the return on equity. Can you just explain exactly what type of magnitude of improvement in the return on equity you’re thinking about? And does that change your target for getting the ROE of the International business up higher, faster?

It’s fairly modest, I think about 50m or 60m, whatever we said on top of fairly significant equity base, so it’s fairly modest. And it doesn’t change our target of 7 by 2007, and 10 by 2010.

All right. And, you know, Barry, do you still – I mean I know that you’re talking about a lot of growth there. But the returns of that business just don’t match what returns you get in [Usam] and some of your other asset management business. Are you still comfortable that in the long run that’s an important place for you to be?

We are, Joan. As I’ve often said, I think we’re planning important seeds in important markets that will come back to us in positive ways. It’s good to have an areas where you can get a 15 to 20% earnings growth, but I can assure you we wouldn’t be planning those flags or planting those seeds if we didn’t think the long-term profitability was there.

And we’re not going to be patient forever. You know, we’ve said, we’ve had the two milestones we’ve given you, 7% by 2007 and 10% by the year 2010. And thereafter, we’re going to have to continue to make significant progress toward having that business be additive, not dilutive to our return on equity. So, we’re committed to managing it, and we believe that it’s a good place to be. But we’re going to watch it carefully, as you might imagine.

Great. Thank you.

Your next question comes from Eric Berg with Lehman Brothers.

Good morning. I certainly understand your point that you have been conserving assets by moving, withdrawing funds into say annuities or mutual funds. And I’m presuming that those withdrawals, when they are used to purchase annuities in mutual funds are booked as deposits by those other part of Usam.

But as I look at sort of a time series of data showing your deposits for all of Usam, annuities, mutual funds, and the pension business, and the bank, over time express this%age of assets under management, it looks to me like growth of deposits adjusted for the size of the business is slowing, that your productive capacity is, that you’re sort of falling victim to the size of the company, you know, it might be called the law of large numbers, not in an insurance sense, but that you’re just getting much bigger and that the growth of the deposits relative to the size of the company is, in fact, slowing. Is that not a fair way of looking at it, or?

Well, Eric, good morning. This is Larry. I guess just to make an observation that, I mean obviously you’ll are the analyst, you can, you know, you can form the opinions on that. I would caution you, however, in doing that kind of trend analysis that you’re talking about, I think one of the very significant events that you need to think a little bit about was the key bank sponsored endorsement that we had running through there in 2002 and 2003.

Kind of the way that particular transaction worked, Eric, we didn’t bring that in like we did ABN Amro as for billing of account value, which we did at the end of the year for Amro. Rather, we kept that and then brought that through, when we transitioned that business we brought that through as new sales and new deposits, and most of that came in in late 2002 and early 2003. So, you see a fairly, if I could use the word, extraordinary rise in our ‘deposits’ during that period of time that really was associated more with that onetime sponsored endorsement.

So, if I were going to try to form an opinion about whether because of the growing size of the organization, and we are having a robust asset growth, so we agree with that, but to whether we’re starting to max out, I would argue you need to take that particular component out of there because it really does represent more of a onetime. And I think when you do that you’re going to get more comfortable that we’re continuing to have that same trend line going forward.

That was a very helpful reminder. I had forgotten that. But, thank you for that.

My second question relates to the health business. Again, I’m certainly aware that you have been affecting this transition in favor of a focused strategy and away from a nationwide strategy. Should we expect the ROE which is, I understand admittedly very, very high, but has been going down, should we, and I think it fell again in the March quarter, should we expect that ROE to stabilize and start increasing from here?

This is John, Eric. No, I don’t really think in the long run that the health business is a 20 plus ROE business. So, I would expect that it will be in the high teens and what we’re attempting to do is try to manage it so that as it works its way down to the high teens we’ll be replacing those earnings with growth in the size of the business.

Thank you.

Thanks, Eric.

I think that’s probably the last question, so let me just, at least the last one we can take, you may have other questions and Tom Graf is always here to answer those questions. But we appreciate very much your continued interest in The Principal Financial Group. We will continue to work very hard to create and maintain shareholder value. So, I’ll look forward to being out on the road and visiting with many of you in the near future. So, thank you all very, very much.

Than you for participating in today’s conference call. This call will be available for replay beginning at about 1:00 p.m. EST until end of day May10th, 2005. 4869279 is the access code for the replay. Again, that’s 4869279. The number to dial for the replay is 800-642-1687 or 706-645-9291. Again, thank you for participating in today’s conference call. You may now disconnect.