美國信安金融集團 (PFG) 2005 Q2 法說會逐字稿

Good morning, and welcome to The Principal Financial Group Second Quarter 2005 Conference Call. [Operator Instructions]

I would now like to turn the conference over to Tom Graf, Senior Vice President of Investor Relations. Please go ahead sir.

Thank you. Good morning, and welcome to the Principal Financial Group's second quarter conference call. If you don't already have a copy of our earnings release and financial supplement can be found on our web site at www.principal.com/investors. Following a reading of the Safe Harbor provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks. Then we will open up for questions. Others available for the Q&A are our three division presidents, John Aschenbrenner, responsible for the Life and Health Insurance segment, Jim McCaughan, responsible for Global Asset Management, and Larry Zimpleman, responsible for US 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 Company's annual report on Form 10-K for the year ended December 31, 2004, and the company's quarterly report on Form 10-Q for the 3 months ended March 31, 2005, filed by the company with the Securities and Exchange Commission. Barry?

Thanks Tom, and welcome to everyone on the call. The second quarter reinforced strong first quarter performance, positioning us in 2005 to exceed our long-term EPS growth target of 11% to 13%. For the three months, we delivered record operating earnings, record earnings per share, and exceptional growth in assets under management. These results were particularly strong in light of continued equity market weakness in the second quarter.

As always, Mike will provide a detailed overview of our second quarter financials, I will briefly offer some performance highlights, then I will focus the remainder of my remarks on continued progress in three key areas. Accelerating growth in our US and International Retirement businesses, creating a successful global asset manager, and profitable growth in our life and health insurance businesses.

The second quarter was again, marked by excellent results for The Principal. There were also some unusual items during the quarter benefiting our results, which Mike will discuss. But these don't eclipse strong underlying growth across the majority of our businesses. During the second quarter, we delivered record assets under management of $188 billion, up 36 billion or 23% over the prior-year quarter. Record operating earnings per diluted share of $0.76, a 41% improvement, and record operating earnings of $221 million, up 27%, including record earnings for the life and health segment, record earnings for Principal International, and double-digit earnings growth for Pension full service accumulation, mutual funds, and individual annuities.

I would add that for the six months ended June 30, 2005 we delivered double-digit earnings growth for each of our operating segments, driving 20% improvement in total company earnings compared to the same period a year ago. We also achieved very solid sales performance for the three key retirement and investment products, as well as in each of the life and health divisions.

As we have communicated, in 2005 we remain highly focused on several key areas. Let me start with our efforts for accelerating growth in our US and international retirement businesses. Pension full service accumulation delivered another solid earnings quarter, up 10% from a year ago and was the key contributor to US asset management and accumulations growth during the quarter. Compared to a year ago, full service accumulation account values were up 20%. Excluding the ABN Amro acquisition in the fourth quarter of 2004, the increase was 14%.

Given that full service accumulation earnings growth is so closely tied to account value growth, let me provide a little more color on a couple of important drivers including our outlook for sales and net cash flow. Through 6 months, full service accumulation sales are $2.5 billion, up 2% compared to the same period a year ago. Second quarter 2005 sales were very solid at $1.2 billion, down 2% from the year-ago quarter. While we are below target growth through the mid-year, we are highly confident about achieving our 10% to 12% organic growth target for the full-year 2005.

Our confidence reflects a strong mid-year outlook. Commitments with second half effective dates are more than $500 million higher than they were a year ago, which we believe will enable us to achieve the 5.7 to 5.8 billion sales target for 2005.

Before moving to net cash flow, I would like to make a couple more comments on full service accumulation sales. Alliance sales, a key driver of longer-term sales growth, continued to increase strongly. They were up nearly 250 million, or 40% in the second quarter, exceeding $860 million through six months and reflecting our increased success with existing partners.

In the second quarter, we continued to focus on opportunities for plan count growth in the small case market. Security builder sales improved 35% from a year ago and are up 22% through mid-year, as we continue to target 1500 new security builder plans for 2005. We also continued to capitalize on the shift and demand to our total retirement solutions. Our total retirement suite continues to drive strong sales success, making up roughly 30% of our sales through mid-year.

In terms of full service accumulation net cash flow, through mid-year 2005 we are down about $700 million compared to the first six months of 2004. Withdrawals are coming in about as expected. At 8.6% of the beginning year account values through mid-year, withdrawals are very comparable to the 18% annual rate averaged between 2002 and 2004. Deposits are up about $930 million, or 15% from mid-year, a very good result but not sufficient to cover the growth in withdrawals which has primarily been driven by a 23% increase in beginning of year account values. I would also add that due to the flat sales year-to-date and some late sales effective dates in the second quarter, transfer assets are a smaller component of total deposits than in the past.

With that background, I will make a few comments on our outlook and expectations for full service accumulation account values, net cash flow, and operating earnings growth. For the last few years, our expectation has been for full service accumulation account values to grow at a long-term normalized rate of 14%, driven by investment performance of 8% per year and net cash flow of 6% per year. Adding operational efficiency gains of 1%, arrives at our longer- term normalized growth rate for full service accumulation operating earnings of 15%.

With the growth and maturation of our full service accumulation block and industry dynamics changing with a clear trend towards consolidation, we believe that components of growth will be somewhat different than they have been in the past. As an industry leader, we expect to continue to benefit from consolidation as we already have with KeyCorp and ABN Amro. Over the longer term, we believe consolidation will contribute an average of about 1% per year to account value growth. We anticipate that this will be uneven. Some years it will be 0% and other years it may be as high as 4% to 5%.

On the other hand, because some of these consolidations involve acquisitions of closed blocks of business, with deposit flow only from existing clients and because of the overall increase in the size and maturity of our full service accumulation block, we now believe that the longer-term annual net cash flow component will be 5% of beginning of year account values.

The important take away here is that we are not reducing our growth expectations for the full service accumulation business. Our longer-term growth expectations remained at 14% and 15% respectively for account values and operating earnings. We do expect consolidation to drive approximately 1% per year of that growth, which will offset the change in our longer-term net cash flow assumptions.

Our confidence in our outlook for second half full service accumulation sales that I mentioned previously, should allow us to achieve higher percentages of net cash flow for that business. We are expecting full service accumulation net cash flow in the second half of the year to be approximately 3% of beginning of year account values, which will bring full year net cash flow to approximately 5%, including ABN Amro. While we remain very pleased with the performance and retention of the ABN Amro block to date, I would caution that they have still some uncertainty as to the net cash flow of that business for another several quarters. As always though, we will continue to focus on sales growth as well as improving contract level retention, participation, and deferral rates. With our outstanding member level asset retention capabilities, we also expect to continue driving stronger growth and net cash flow and earnings in our retail businesses.

Moving to our International Retirement businesses, we continue to make significant progress in driving growth. Principal International achieved record net cash flow of $500 million. Assets under management are up 42% from a year ago to a record $11.8 billion at quarter end with our Latin America operations surpassing the $9 billion milestone. Revenue growth also remains strong, reflecting increased premium collections and higher investment yields in Chile during the second quarter, as well as significant growth in assets under management overall.

We also continue to make outstanding progress in creating a successful Global Asset Manager. More than 75% of Principal branded retirement plan separate accounts were in the top two Morningstar performance quartiles for the six months and one and three-year periods, ending June 30, 2005. For the 5-year period, nearly two-thirds of these accounts are now in the top-two quartiles, and all 6 of our lifetime separate accounts rank in the top 20% of their categories for both the 1 and 3-year periods. As a result of improved investment performance and an expanded portfolio of value-added products, we are becoming increasingly successful competing for new institutional mandates.

Compared to a year ago, Principal Global Investors' third party assets under management are up $18 billion, or 65%. Through mid-year 2005, we have won and funded 27% more mandates, representing more than twice the assets won and funded in the first 6 months of 2004. In addition to the notable second quarter wins announced in May, we have also added $1 billion high-yield plus mandate for a major global financial institution. This outstanding growth in assets under management is translating into outstanding earnings growth. For the first six months, Principal Global Investors' earnings are up 35%, compared to the same period a year ago.

In terms of profitably growing our life and health businesses, I would point to several key areas of progress with our growth initiatives. First-year recurring premium individual life sales continue to be strong, up 17% from a year ago and the division lapse rates remain in line with expectations. Sales of variable universal life funding non-qualified retirement plans made up one-third of these sales and more than doubled compared to second quarter of 2004.

In the health division, sales in our target states increased by 78% from a year ago. Total group medical covered members are up 3% from year-end. This is our second consecutive quarter of growth in the block, driven by 7% growth in our target states, which have now achieved a four consecutive quarters of growth. Finally, this was another strong quarter for their Specialty Benefits division. Sales continue to increase with the second quarter up 23% from a year ago, contributing to record operating revenues for the division and the segment. We continue to see solid growth patterns in terms of the division's in force measures, notably in force premiums and fees surpassed $1 billion in May, an important milestone for the division.

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 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 to utilize excess capital. In the second quarter, we completed the Board's $250 million March 2005 authorization. Mike will provide a brief update on the preferred stock offering and accelerated share repurchase program announced in June.

Let me also briefly discuss our outlook for the remainder of the year. As indicated in yesterday's earnings release, while it is not our policy to update full-year guidance on a quarterly basis, given our very strong first half, we determined it was appropriate to revisit guidance at this time. The company now expects 2005 operating earnings to range from $2.80 to $2.86 per diluted share. I would remind you that our outlook for operating earnings in the second half of the year contemplates equity market appreciation of roughly 2% per quarter for the remainder of the year.

In closing, we will continue working hard to extend our leadership with small to medium businesses and their employees. We are confident that with further economic recovery and modest equity market growth we will continue to achieve our EPS growth targets, continued to deliver ROE expansion, generally 50 basis points per year, and continue 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're very pleased with our record operating performance in the second quarter. As Barry indicated, we delivered strong total company operating earnings growth, an improvement of 27% from second quarter 2004, driving 41% improvement in operating earnings per share. We continue to be very pleased with our strong growth in assets under management, particularly in light of continued difficult equity markets.

Moving to the segments, I will start with highlights for the US asset management and accumulation segment. Segment assets under management increased $34 billion, or 26% from a year ago, driving total company assets under management to a record $188 billion at quarter end. Compared to a year ago, operating earnings for the segment increased 7% in the second quarter to $131 million. Through 6 months, segment earnings are up 12%.

Pension full service accumulation was the largest contributor to the second quarter increase improving $5.5 million, or 10% from the prior year quarter, to $62 million. Through mid-year, full service accumulation earnings are up 14% to $123 million, driving pension earnings to $200 million for the six-month period. The individual annuity and mutual fund businesses continue to contribute to segment earnings growth as well, improving 18% and 10% respectively. Reflecting very solid sales and good retention of at risk or retirement plan participant assets, both businesses have achieved 20%-plus account value growth compared to second quarter of 2004.

At $16 million, Principal Global Investors' second quarter 2005 earnings were strong, though down from $18 million in the second quarter of 2004. The prior-year quarter benefited from unusually strong commercial mortgage backed securitization results. As Barry mentioned, through 6 months Principal Global Investors' earnings are up 35%, or nearly $10 million, reflecting continued strong organic growth and strong commercial mortgage-backed securitization activity. Its run rate of earnings is now $65 million to $70 million on an annualized basis.

Earnings growth in the second quarter for the US asset management and accumulation segment compared to a year-ago was also partially offset by lower full service pay-out earnings. The $2 million decline primarily reflects lower mortality gains in the second quarter of 2005 compared to the prior-year quarter. The low interest-rate environment continues to depress single premium group annuity market and our sales.

Within our international asset management and accumulation segment, Principal International's second quarter 2005 earnings grew to $19 million from $9 million in the year-ago quarter. Approximately $3 million of the increase in earnings compared to the second quarter 2004 relates to higher fee revenues due to continued strong growth in assets under management. The other primary contributors to the increased earnings were higher inflation linked investment yields in Chile, foreign currency strengthening, and a tax benefit related to our second quarter repatriation of funds through the American Jobs Creation Act.

On this last point, as we mentioned last quarter, in the light of Principal International's strong growth and increasing profitability, we repatriated $46 million from Mexico in June. The strong second quarter earnings results, along with lower deployed capital, increased segment return on equity of 180 basis points from a year ago to 6.1%. The segment remains on track to achieve 7% return on equity by 2007 and 10% by 2010. Principal International's normalized run rate of earnings is currently $44 million to $48 million on an annualized basis. However some volatility and seasonality can occur within quarters.

Moving to the Life and Health Insurance segment, we continue to see very solid results overall, driven by strong sales and improving retention. Second quarter 2005 earnings were a record $76 million, reflecting a solid result from individual life, good progress for the health division, and strong underlying growth in the specialty benefits division. Individual life earnings were $31 million for the second quarter 2005, up $5 million from a year ago, but basically flat on a comparable basis. Compared to second quarter 2004, the division benefited by approximately $7 million of unusual items, primarily as a result of methodology improvements relating to reinsurance values.

Earnings for the specialty benefits division were a record $21 million, compared to $13 million in second quarter 2004. The increase reflects continued strong growth in the business overall, as well as highly favorable but unsustainable claims experience in the group life and long-term disability lines. Compared to the year-ago quarter, all lines have delivered double-digit growth in premiums and fees reflecting strong sales and favorable retention.

Health division earnings were $24 million in the second quarter, compared to $18 million in the year-ago quarter. The increase between periods reflect the return to more normal claims experience in second quarter 2005, as well as premium refund accrual that reduced second quarter 2004 earnings by $3.5 million.

In addition to the progress Barry discussed in each of the life and health businesses, I will provide a bit more color on the progress of our health division initiatives. Growth in members is driving good growth in premium and fees, which are up 6% for group medical overall and 12% in our target states, compared to second quarter 2004. Continued success with our new high-deductible health plan, which accounted for 7% of new sale covered members through six months, and very strong growth in our wellness business which has increased 11.5% from year-end to over 74,000 lives.

Before taking questions, I would like to comment on net income in the second quarter, briefly revisit certain factors impacting growth expectations, and provide an update on our preferred stock issuance and accelerated repurchase program.

Net income in the second quarter benefited by approximately $34 million due to a recovery of previously impaired Enron fixed maturity securities, received as a result of a litigation settlement. We have adjusted our expectations for full-year realized, unrealized capital losses to reflect the positive impact of the recovery. As provided in yesterday's earnings release, we've decreased expectations for full-year realized and unrealized capital losses to $20 million for 2005.

In terms of growth expectations for the second half of the year, we believe it is important to keep several items in mind. In any given comparison period, there are a number of factors that can cause results to fluctuate, including equity market performance, expenses, and interest credited, 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 growth target of 11% to13% for operating earnings per share assumes equity market returns of roughly 2% per quarter. Through mid-year, the S&P was down 1.7%, though it rebounded nicely in the month of July, equity markets clearly remained volatile and challenging.

I will close with a brief update on our preferred stock issuance and accelerated repurchase program. As you know, concurrent with the preferred stock issuance, we entered into an accelerated share repurchase program. The transaction resulted in the purchase of 13.7 million shares, or $542 million, an average price of $39.47 a share. The transaction is subject to a market price adjustment provision based on the volume weighted average market trading price over the execution period.

In the second quarter, we did not declare any preferred stock dividends. I''d remind you that starting in the third quarter preferred dividends declared will reduce corporate segment and total company operating earnings. This will substantially offset the positive impact of lower weighted average shares outstanding on earnings per share in the second half of the year. Because of preferred stock dividends beginning in the third quarter, we would expect the corporate segment to have total operating losses of between 25 and $30 million for the second half of the year.

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 Saul Martinez with Bear Stearns.

Good morning, a couple of questions here. Can you comment on competition in the small and mid-case 401(k) market? Anecdotally, we have been hearing that Fidelity and maybe some others have become more aggressive in pricing. Are you also seen this or is this assessment off in your opinion?

And then, I guess, secondly, I actually have a question on individual life. My understanding has always been that the closed blocked weighed down the segment's ROE, but the proportion of in force and reserves coming from UL and VUL has really increased over the last couple of years. I'm curious why we haven't seen a pickup in the segment's return on equity if that is the case?

Good morning, Saul. We'll be happy to cover those. Let me ask Larry to cover the one in competitions, small and medium case market and then John will take the earnings out of the closed block.

Good morning Saul, this is Larry. I think in terms of your question around competition in the small-case market, as we have commented in the past, it has always been competitive there and it remains competitive. I will tell you that in the smaller end of the market, price does drive a lot of the activity. When I talk small-end here Saul, I am talking primarily in the under $25 million marketplace. There it really has driven more by price. And again, while we think we have a very competitive price, we also do have a fully bundled service offering which we believe is unique and it has generated a lot of sales success for us in the past.

Above 25 million it is a little bit more of a combination of both features and price, so it is price competitive but is also a question of what features you bring to the table. So, I would not say that there is dramatic change in the marketplace. It has been competitive. It remains competitive. We feel in our scale and with our local service and sales presence we feel comfortable we can compete.

So if I'm hearing I correctly, it is always been competitive but there is no change that you're witnessing in terms of the competitive dynamics there?

Nothing dramatic, other than there are too many players in the market today and that does tend to accelerate price competition. You are going to scale, again we have got about 70 billion in full service account values and that's a big advantage for us when it comes to the economics of the business. So, I think, if you look, generally speaking our margins have held up and we expect that to continue.

I would say Saul, that to the extent that the dynamics drive the increased competition, if you can imagine that we are holding out pretty well, we are the market leader, I think what it does to smaller players who do not have the scale. And I think those same dynamics will ultimately drive industry consolidation, and it puts a lot of pressure on those who are marginally in the business. And then I would argue over time, it will be those kinds of price competition effects that will drive others to decide to get out of the business. John, you want to comment on the earnings from individual life and the effect of the closed block?

Sure, yes. Saul, you are correct that we are seeing a shift with the non-closed block growing faster and the closed block beginning to shrink a little bit. The reason you're not seeing as bigger jump in the ROE as you might expect would be twofold. One, it takes a little bit of time for the new sales to really kick in and start generating the earnings that you would expect. And second, as we talked about before a little bit, the universal life secondary guarantees has not turned out to be as profitable for us as we would have liked it to be. We have made a number of changes during the year to improve that profitability and we'll continue to make changes. So, it is profitable, but it is not to the level that we would like it to be to start driving up the overall individual life ROE.

Okay. So If I hear that correctly, I mean, I think in the past you said you priced it. You try to price your life policies to a marginal ROE of 12% to 15%. If I hear you correctly, is it fair to say that some of the stuff that you have written over the last couple of years will likely not meet that hurdle rate?

Exactly.

Thank you.

Your next question comes from Jimmy Bhullar with JP Morgan.

I just have a couple of questions. First, Barry, on the pipeline you have mentioned for the last two or three quarters that the pipeline is strong. At the end of the first quarter you'd mentioned that it was up 13% over the same period last year. But we have not really seen the benefit of that flow through sales. What gives you confidence that the10% to 12% sales growth goal is achievable? That is my first question.

And second, on the share buybacks, I know you had the 13.7 million program through UBS, but should we expect something more in terms of what the company is going to do on its own? And if so, how much in the second half of the year? That is it.

Good to hear from you. I think there are things that are different about the way we view this next quarter or next two quarters. And it really has to do with our seeing more committed cases earlier in the process. And so, in the past, we have had a very strong pipeline, but we have not had necessarily the indication as to when they will come out. I think now we're seeing more of an indication that some of these cases have already committed to be second quarter-- third quarter and fourth quarter cases. So my confidence comes greatly from, I think, very strong evidence that many of these cases have committed or are we have gotten very close to being committed. I want to say this time it is for real. It has always been for real, but I think this time we have evidence that they're starting to come out what is, somewhat of a bulging pipeline at this point.

The second part of your question, I would say that we really are pretty much at our expected capitalization rate and I would not expect any additional share repurchase, even though it's the Board decision I would say we don't really have the capability for the balance of the year. We are pretty well where we thought we would be with our capital position. Of course, that will change going into 2006, but I wouldn't expect any additional share repurchase for the balance of the year.

Okay. Thank you.

Your next question comes from Jason Zucker with Fox-Pitt Kelton.

Hi, good morning. Couple of questions as well. Going back to sales and targets again, could you just go back maybe and talk a bit about why we were below target in the first half? And perhaps also, maybe compare that to the competition, where we have seen some competitors do pretty well over the last couple of quarters. And then related to that, in part is your confidence with 10% to 12% derived from the fact that you see perhaps, a few very large cases that either have committed to you or about to commit in the next couple of quarters?

Good morning Jason, I will take a first stab at it and then ask Larry to provide little more details. I think there is a couple of things to keep in mind. Unfortunately, sales have become somewhat lumpy, and one way to look at the first six months is to say that they have been flat or they have been disappointing. The fact of the matter is that we are still clicking it over $1 billion a quarter. If you look at the second quarter at 1.2 billion, I think that was our highest or second highest ever second quarter results.

Second quarters tend to be the more depressed quarters that we have. The fact is that we had a very strong second quarter in 2004, and so when you add all this together we feel like a $2.5 billion through the first half of the year given the seasonality is actually a pretty good result. We will admit that we had a little bit of a disappointment in the first quarter that typically is a little stronger than we have shown, but still the second quarter was a very strong quarter. We remain, as I said in my prepared remarks, we remain highly confident that we're going to achieve the 10% or 12%, which translates to 5.7 to 5.8.

And as I just said to it Jamie, in response to his question that confidence comes from a variety of sources. The fact that we had a lot more activity, we have a very strong close rates, we have a strong pipeline, and indeed, you are right that we do believe that there are several large cases that will hit in the third and fourth quarters, which will kind of, ensure that we will hit those targets. I would say that activity is strong across the board. It is not just large cases.

But I will say the one area that we are having our most success, and this has been true for the last several quarters and I think will be so in the future, is with this total retirement solutions, where you get into a larger organization that has a DB, a DC, and a qualified, an ESOP, or really any combination of two of those, there is a strong likelihood that the competitive field which they can go to get the kind of quality service they expect is a more limited field and therefore, gives us a very strong competitive advantage since we do all four of those on a fully integrated basis. Having answered the question, I will see if Larry wants to add anything.

That was a very complete answer. I would say Jason again, just summarizing as Barry said, at the start of the year we were optimistic because it was pipeline. We have seen our close rate continue to stay steady before it has been, while that pipeline is now turning into commitment, in which as we move forward in 2005 will turn into sold business and eventually deposits. So, I think all the dynamics are there, for all the reasons as Barry said, our alliance success is solid, TRS is solid, solid security builder cases are solid, so all in all, I think if you look forward through the year, we will see all this translate into the kind of momentum that we know we are certainly looking for as a management team.

Thanks everybody.

Your next question comes from Colin Devine with Smith Barney.

Good morning, Barry. A couple of questions for you first, starting with Mike, can we just drill in a little bit more...

We lost connection here, could you start again?

Okay, first good morning. I am just wondering a couple of questions. First, on the net flows this quarter, putting Mike on the spot, are you really just saying that was a timing issue? We talked before that sales, isn't the best way to measure a companies such as yours, it's an asset manager more and net flows are the key, and certainly at 500 million I think that is clearly a disappointment.

Secondly, on the UL no lapse product, I am wondering if we, perhaps Mike can talk a little bit more as to why that product is not turning out to be as profitable as you thought? What went wrong on the assumptions? Thirdly, Barry if you could talk about how interest rates impact or don't impact Principal's earnings right now, with obviously the tenure being so much lower than most people thought. And then lastly, any comments on M&A or to the excess capital. I appreciate that there's no more left to do with the stock buybacks, but what else are you looking at?

Okay, thanks Colin, let me ask Larry to start on the net flows, and then John can talk about UL. I am actually going to have Mike to take the interest rate and I'll come back with the M&A. So Larry?

Okay thanks. Colin good morning. On your net flow question, I think Barry had a few comments on that earlier and let me just expand on that a little bit. In the second quarter, one of the unique dynamics that was in there was that there were some business some fairly substantial amount of sold business, that had a late effective date in the second quarter. Normally, Colin what we see is that in any given quarter of a total sales volume of say $1 billion or 1.2 billion, about 65% of that normally turns into cash during that particular quarter, the other 35% comes in the subsequent quarters.

Because of the lateness of that particular effective date in the second quarter, only about 40% of our second quarter sales came in as actual cash during the second quarter. So we know we're sitting out there with about $300 million of cash that will come in early third quarter, really attributable to second quarter sales. So in our view, when we are analyzing deposits and net fund flows, those are the kind of timing implications that as we look at it and over time aren't going to have dramatic implications, but when you stop on June 30, those flows can look a little bit anemic in which you need to understand what is going on. So that was the essence of Barry's comments.

Just touch us the follow-up on that. Then, when we see third quarter, whatever sales projection I have for you, I should expect to see about an extra $300 million and that should just be the catch up from the second quarter. That is what you're saying?

That is assuming we don't have-- we may have a similar situation where some of the large cases happen to be toward the end of the quarter, so it is not absolute. You should see pretty robust deposits in the third quarter.

Okay. But we should just keep that in the context of it's more of a timing issue?

Right. John?

On the UL with secondary guarantees, what happened to cause our earnings to be less than we would have expected. Really three things. One, the reinsurance market has changed very dramatically from when we first put the product out. Second, reserving has changed and so we are holding higher reserves than we would have originally anticipated. And third, we got a different mix of business. So the product has many different cells that all have different profitability, and we've got a different mix than we would have expected starting out. We've made a lot of changes throughout the last year to correct a lot of that.

Stopping issues above 870, some changes on single premium, some compensation changes, and so we made a lot of changes that are bringing the profitability back. Another positive that is going on is the second quarter there was a significant shift where much more of our growth now has coming from the non-qualified deferred compensation, which are products that are more at our target earnings level. We're seeing a shift from the secondary guarantees towards the more non-qualified deferred compensation. The other thing that happened is it appears as though the reserving requirements have now pretty well shaken out and we have a pretty good feel where we expect those to end up. So, now we've had at a point where we can move to those new reserving standards and make sure that the product is competitive at the new reserving standards.

To follow up on that then, just two questions. On the mix, is the one, that's just sort of, caught my attention here in terms of whether you're getting older aged people and that is why the changes in the low 70 or not over 70 on the issue? And then, the second thing is how much have you had to raise prices on the product to compensate for these issues? Just a rough idea?

Sure by the way, Colin this will be your sixth question.

Well, it's just follow-ups. I'm sorry. I am just trying out --

We are okay, we have all the information.

Thank you.

One of the cells was the over ages, and that was one spot where the reinsurance had the biggest change for us and that was an area where we were writing more business than we would have like to write. And so, that was why we made the change to cut off sales over age 70. As far as pricing changes, to date, we have not changed the price. We have not really changed the product pricing. We have made changes in compensation and changes in features on the product. Now that we have the reserving figured out, we are in that position where we can go back and change prices to fit the new reserving standards.

And I guess what I am trying to get out is what is going to be the impact of the new reserve standards on price?

The price will go up, Colin.

Well we're trying to get a bit more color than that, Barry. Is that 5%, 10%, is that 25% under priced under the new reserving standards? What ever you are looking at?

I don't think you can turn it into a simple percentage like that. It is going to going to very, very much by cell, and it is going to vary considerably as to how different companies are going to react to it. You'll have to wait and see.

Okay.

It is more than 5 and less than 25, we can tell you that.

Thanks, Barry.

Interest rates, interest rates.

Colin, the question in a way it's a little bit difficult to answer because it depends on level of rates, it depends on the shape of the yield curve, it depends on the spreads of corporate over treasuries, It depends on the spreads between credit quality and it also depends on what level of rates for how long. Now to talk about the Principal. If you look at our mix of business, a big chunk of our business is duration managed. And by duration managed, means we price for a spread.

And as long as we can price for the spread between the rate that we are having to put the gics (ph) out and medium-term notes out and what we can go back and invest and, as long as we can make that spread our profitability holds, and our profitability has held up very, very well in this low interest-rate environment. In terms of movement of rates, again, if rates move up or down, as long as we make that spread we are pretty much immune to interest rate movements. Our profitability on that particular segment of business is a very stable profit picture.

So the impact, obviously but with rates today not being they were you had projected they would be when you establish guidance, has really had a de minimus impact on the earnings?

That is correct. We would have expected a slight rise of interest rates throughout 2005. The fact that we really have not seen that also, immaterial impact on our earnings.

Thank you.

On the M& A, Colin not a lot new there are our three priorities continue to be supporting organic growth, to do strategic acquisitions, and of course share repurchase and increased dividends. We have been very faithful to that. We do have, I suppose and will have changing debt capacity, so I kind of gave Jimmy the answer that we don't have capacity. We don't have the capacity in our current debt structure, but there is of the top possibility and raising debt particularly if we had an acquisition that we really wanted to do. But going forward, if you look at the amount of excess capital we generate, we have plenty of excess capital to support our organic growth.

We're not typically looking for very large transactions, so I would anticipate that we will have large capital do the kind of, midsize strategic acquisition that we normally do, and to some extent if we have excess capital or want to change our capital structure, as we just did we will have the ability to do some share repurchase going forward. We feel very good about where we are and our ability, but we really don't see any major consolidation trends that would cause us to want to move out and do a very large transaction. We just don't think we need that.

Thank you.

Your next question comes from Andrew Kligerman with UBS Securities.

Hi good morning. Just a little more clarity on the capital position that you are in, RBC, what is your debt capacity? How much free cash flow do you think you'll throw off over the next 12 months that might be available to redeploy for buybacks or acquisitions? Then I have a follow-up question.

Sure Andrew, If you want that kind of clarity, I will turn it to Mike.

I will try to give you as much as I can, because, obviously, we work off of projections just like you. But if you look out and if where we are today, we have between 50 million and $100 million of excess capital. That is a position that we are very comfortable with. As Barry said, we want to keep a little bit of dry powder just because you never know what sort of smallish acquisition prospects you may have going out into the future. We do have some debt capacity. If you look at our debt to capital ratio at the end of the second quarter, I believe it shows something just shy of 20%. That number actually was a little bit less than what we were expecting.

We sold some medium-term notes towards the end of second quarter and had a little bit more cash in the organization and therefore could cut back on some of our short-term borrowing. So, I think if you look at what we would expect on a normalized basis, it would be more like the low 20% range. Again, we'd like to keep a little bit of dry powder as far as debt capacity as well. So if you think about where we are, I think it matches Barry's answer, we are just about where we think we want to be.

If you look at risk-based capital, our goal is to manage to both an IC risk based capital level of 350 to 375, on an S&P basis it would be a little bit over 165. We are about there. We've got a little bit of cushion. But I'd say we are right in the range of where we want to be. I think the wild card is that we are obviously continuing to look at capital and continuing to look at how we use debt. We are certainly studying ways that we might be able to take some of our operational financing, put that into a separate subsidiary perhaps, but all of that is kind of speculative right now. So, if we can free up some additional debt capacity, we may have a little bit more flexibility in terms of share repurchase. Again, that is a study going on into the future.

What should we look at as just sort of the build-up of excess earnings less dividend--?

Well, if you typically think about it, Andrew, it is about 50% of our earnings going to support organic growth, about roughly in the 20 to 25% range, at least that is what we have been paying out in the past, would be for sort of dividends, pay-out ratio has been roughly in that range that we would leave 25% of earnings that would be basically free.

Got it. And then, just lastly just a housekeeping item in the international asset management accumulation business. The higher inflation linked investment yields in Chile and the foreign currency strengthening, is that sustainable? Or is it-- you listed it as a non-recurring item, but it would strike me that those might be sustainable. Could you give a little clarity around that?

Hi Andrew, this is Larry. Just to quickly comment on that, I would, I think, concur. It is not necessarily one time in the sense that it would never be repeated, but it does fall into the category of being not certain as to whether it is sustaining. It is in the kind of experience factor. The reason for that has to do with the actual pay out annuities in Chile being adjusted to the inflation rate and consequently the asset portfolio also being adjusted to the inflation rate. So, when inflation picks up, investment income picks up if you will, the pay-out amount picks up or vice versa the other way.

And there's a drag on that.

There's a slight delay on that. To the extent however that inflation remained at the current level, then you would see some increase in earnings come through as a result of that, or if inflation goes back down, you will see some diminishment in our earnings as a result of that. So, it is an experience factor another example to beyond currency that's the kind of experience factor that is not some of the international business, it is not so much of our US business.

But then if the currency rate changes shouldn't you assume the same rate going forward, hence a little bit of a likely pickup? When I model, I often assume a permanent change in the foreign-currency even though it is not, because I have no idea in terms of projecting. Shouldn't that stay in place and should not the...?

The only point I'm trying to make Andrew is that currency here ,currency fluctuations are one component and the inflation component is a second component that together they can act offset each other or they can both go negative, so it is another reason example of moving part, if you will, that is in some of our international business that again is not a part of our US business. It's just that you need to take into account of that as you're doing your modeling. That's really my only point.

In this case, what happened was basically on hinging usually you would expect FX and inflation to offset, and in this case they didn't.

Okay. All right, thank you. I will follow up later.

Your next question comes from Tom Gallagher with Credit Suisse First Boston.

I just wanted to start off Barry, just going back to the cash flow expectations. Is it fair to say that you think $500 million in net flows is likely to be the bottom? I guess the reason I ask is that I appreciate what you said about the pickup due to timing related issues as well as the strong pipeline, but you also seemed a bit cautious related to the ABN transaction and what that might do to near-term redemptions?

Certainly if you project out for the balance of the year, I certainly think 500 million is the bottom. One of the things that's going on here, and just take a second to give you my spin, we have had two or three years of unbelievable growth in asset account values, and that has come in part because of ramping up our sales organization. It has also come in large part because of acquisitions, KeyCorp and others that have been in the mix. I think there is a cooling off period that goes on. When you have this huge ramp-up in account values, and your sales organization, can't necessarily, even though it is performing well, it cannot keep up the withdrawals that come from that larger account base, but then what happens is you go through period, we have more acquisitions and more consolidations.

I think one of the things you are going to see out of the account values is they are going to be a little more lumpy. And I tried to take some pain, some effort to highlight that it is probably a 5% net cash flow over a long period of time, it's going to be the right, but there are going to be periods when it drops down like it has in the first half of this year to something considerably less and there going to be times as there have been in the last couple of years when it is significantly more.

I think the key here is to think about this over a longer period of time and not get fixated on a quarter or even two quarters, but to think about the trend lines. When you do that, we are very confident that you are going to see the kind of 15% increase overtime that we have been talking about, which will translate into a 15% operating earnings growth rate because of this extra percent that comes from consolidation.

Got it. Okay, thanks. The next question is, I know Principal Global in aggregate had a very big increase in deposits, and I think you made reference to that. But can you give us a bit more color in terms of big increase in deposits, and I think he made some reference to that. Can you give a bit more color in terms of what drove that? Was that institutional mandates? And also, you just looking at the numbers, there were $14 billion of deposits that was versus $8 billion last quarter. Can you just give a little color on what is driving that? Is that low-margin business? Is there a mix of margins in there and how we should see that trend in the next year or so?

Yes I'll ask Jim to pick up here, but it is a little bit of both. We did have a, as I recall, a $4.9 billion structured transaction that would be certainly lower margin than you would think about that traditional institutional asset management mandates, but yes we also picked up a $1 million mandate that was the more typical -- $1 billion, the more typical mandates. So, it was a mix but it came from outsource it came from some acquisitions that had been done, it came from foreign exchange, it came from the institutional mandates I mentioned, it came from good cash flows from our own affiliated assets. It was a mix. Jim, do you want add a little bit?

I think you mentioned in your overnight when you refer to single-digit basis point revenue on some business. That comment would be as to the 4.9 billion structured transaction being concerned, that will be on the lower fee basis than our typical client, than our typical client mandates. However, the rest of the business, and Barry has mentioned, there were actually two in the quarter, $1 billion plus mandates for non-affiliate clients. Those were well into double-digit basis points.

Those were on typical institutional fees. I have to say looking at the development of the business, outside of the structured products which plainly are on lower fees, I have been very pleased with two things. One is that we have kept the fee on our non-affiliated business of very much in the market range and typically in the 30 basis point to 40 basis point range for most of that non-affiliated business.

Secondly, I've been very pleased to see that not only are we developing the real estate business where we have been established for quite along time as a premier manager, but we are also getting significant client business in fixed income, including the specialty fixed income areas such as high yield and preferred and private placement bonds. Also increasingly over the last two quarters or so we are getting equity business. They are unusual among the growing and successful asset managers in attracting business across those three asset classes of fixed income and real-estate.

Jim, just as a follow up, is the pipeline fairly strong there? When you say equities, is that international equities?

The equity is international and domestic. It's kind of hard to say whether the pipeline is strong or not. The best evidence is that year to date, we have acquired 74 new institutional mandates for $5.3 billion. That is going to go onto the strongest results in the industry. The second half, I can't really make promises, but we feel the momentum is very strong and we feel very confident for the second half, particularly given the performance numbers that Barry mentioned in his prepared text, which are really a very strong underpinning for that business development.

Ok thanks.

Our last question comes from the line of Tamara Kravec, Banc of America Securities.

Good morning. A couple of questions, given that most of my it answered, but if you could focus in on the benefits ratio in the specialty division, I guess for the last three quarters it has been in your view unsustainable, yet you have seen that continue. Can you get into what is causing that and whether you really think it is unsustainable? My second question relates to the security build up products. If you could quickly explain what that is and how you expect that to trend going forward?

Sure, good questions. John, you want to take the first one?

Sure. Talking about the loss ratio on Group Life and group disability and very strong performance, this quarter, on the group disability. Very strong performance obviously this quarter. On the group disability. it is really pretty broad spread. It is improvements in the incidence of disability and it is primarily in the under 500 life market, so the bulk of our business. We think there is probably a combination of a positive trend. We have had, for example, some large case lapses that were high loss ratio cases, which really help us, and we will continue price to try and maintain an acceptable loss ratio. But also, some of it has to be variability that is in the normal range. We expect a return to more normal loss ratios and it may be in the quarter or longer than that, to get back to more normal loss ratios.

Security builder, Larry?

On security builder it's a fully bundled, both as to service and price. It is a fully bundled pension product that is geared at the start up market up to about $2 million in assets, and it is a product we brought out two years ago and is distributed by a subgroup, a sub segment, of our normal sales group, so we have some specific reps dedicated to this. This is a part of the market that we have a historically dominated and we think our security builder efforts are going to allow us to continue to dominate that. So far year to date, our sales I think are up 22% case count for security builder. I think there were up 35% in the second quarter. We're very pleased with that. This is the market that has historically been a strong point for us, they're a security builder that continues to give us the success we've had historically.

Is there anybody else out there with this type of product?

Well, there are a lot of players. We do believe that the fully bundled service and sales of it is a little bit unique. There are models out there, but they typically involve more local third-party administrators doing some element of the servicing. The fact we bundle it all together is still a little bit unique.

And you have a dedicated group so that helps too?

That is correct.

Thank you.

At this time-I'm sorry, go ahead sir.

I think that was our last question. Let me just thank you all very much for joining us on the call. Let me just close with what I hope you sensed through my remarks as well as the call and that is our very strong confidence in the organization and our ability to deliver. We have made some comments here that would lead you to believe that we're going to have a strong half of the year in terms of growth, and that certainly what we believe will be the case. We look forward to delivering on those commitments. I look forward to being with out with many of you in the coming weeks and months, and hope you have a great remaining summer, and we look forward to seeing you also.

Thank you for participating in today's conference call.