美國信安金融集團 (PFG) 2006 Q1 法說會逐字稿

Good morning and welcome to the Principal Financial Group first quarter 2006 conference call. [OPERATOR INSTRUCTIONS] 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 quarter conference call. If you don't already have a copy, our earnings release and financial supplements can be found on our website at www.principal.com/investor.

Following a reading of the safe harbor provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks. Then we'll open up for questions. Others available for the Q&A are our three division presidents -- John Aschenbrenner, responsible for the life and health insurance segment; Jim McCaughan, responsible for global asset management; and Larry Zimpleman, responsible for U.S. and international asset accumulation. Julia Lawler, 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 most recent annual report on Form 10-K and quarterly report on Form 10-Q filed by the company with the Securities and Exchange Commission.

Barry?

Thanks, Tom, and welcome to everyone on the call. The first quarter was an excellent start following an outstanding 2005. For the three months we delivered record operating earnings, record earnings per share and record assets under management.

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

The first quarter was, again, a very good start to the year for the Principal. Highlights include -- record assets under management of $205 billion, up $32 billion or 19% over the prior year quarter; record account values for U.S. asset accumulation businesses, up $18 billion or 16% to $127 billion; our second-best quarter of net cash flows for our U.S. asset accumulation businesses, up $940 million or 90% from a year ago to $2 billion; record operating earnings of $240 million, up 15%, including record earnings for Principal Global Investors, full-service accumulation, mutual funds and individual annuities and an 85% improvement in earnings for Principal International; and record operating earnings per diluted share of $0.85, an improvement of 23%.

We also delivered exceptional sales performance for our three key retirement and investment products, including a billion dollar win in the full-service accumulation business to provide total retirement plan solutions for a leading academic medical center. And we continue to make real progress with our life and health growth initiatives evidenced by a sixth consecutive quarter of record operating revenues for the segment, record individual life sales to fund non-qualified plans and continued strong renewals offsetting some of the expected decline in the new universal life with secondary guarantee sales, continued good growth in insured medical covered members and continued strong performance in the specialty benefits division, including a 19% growth in premiums and fees, 40% growth in earnings and record sales, up 48% from a year ago, including 90% growth in the sale of voluntary benefits.

As I mentioned, we remain highly focused on several critical areas. I've already described some of our progress in the life and health segment, so I'll spend the next few minutes on three of our key asset accumulation and asset management businesses.

I'll start with the full-service accumulation, which had a truly exceptional quarter, delivering record earnings, record account values, record deposits, record net cash flows and record sales, including a 38% increase in cases sold. With earnings up 21% from the first quarter 2005, full-service accumulation was the key driver of record performance for U.S. asset management and accumulation.

Compared to a year ago, full-service accumulation account values were up 20% to $82 billion. First quarter 2006 results, which included strong credited investment performance and $1.5 billion of net cash flows, drove more than a third of the growth in account values over the 12 month period.

As I mentioned, full-service accumulation also achieved record sales in the first quarter -- $2.9 billion, an increase of 109%. Even excluding the large win during the first quarter, this was one of our very best organic sales quarters to date and sales were up 25% from a year ago quarter, reflecting a continued shift in the demand toward total retirement solutions. Total Retirement Suite again drove strong sales, representing nearly 60% of the first quarter 2006 total.

Clearly, we're extremely pleased with the start to the year. We achieved strong growth in cases and assets sold across all segments of the SMB market, improved close rates and significant advances in sales rep productivity.

Importantly, the strong first quarter gives us great confidence in our ability to reach or exceed our 10% to 12% organic sales growth target for 2006. As previously mentioned, sales do come in unevenly throughout the year for full-service accumulation business and the second quarter is a seasonally low quarter.

Moving to the international asset management and accumulation segment, we continue to make significant progress in driving growth. Principal International's assets under management reached a record $16.1 billion at quarter end, an increase of 35% from a year ago on an organic basis.

During the quarter, assets under management in our Latin America operations reached $11 billion, with Brazil reaching the $5 billion milestone. AUM growth continues to drive very good growth in fee revenues and operating earnings and, in turn, steady growth of segment ROE.

We also continue to make very good progress creating a successful global asset manager. Investment performance continues to be strong across asset classes. Of the retirement plan assets managed by Principal Global Investors at March 31, 2006, 87% ranked in the top two Morningstar quartiles for the one-year period, 78% for the three-year period and 82% for the five-year period -- very high performance which bodes extremely well for sales and asset retention.

Improved investment performance and an expanded portfolio of value-added products has made us increasingly successful competing for new institutional mandates. From a year ago, Principal Global Investors' third-party AUM is up $9 billion or 25%, fueling their number five ranking by “Money Management Letter” for net assets gained in 2005. In the first quarter 2006 funding for new institutional mandates and additional assets on mandates won in 2005 exceeded $3 billion.

Before I close, let me briefly cover a couple of other areas. In terms of effective use of capital, organic growth remains our top priority. This is followed by strategic acquisitions and we continue to seek opportunities to participate in retirement market consolidation, as well as opportunities in asset management.

We also continue to use share repurchase in our efforts to effectively utilize excess capital. In the first quarter we bought back 3.4 million shares for $162 million. As of quarter end we had just under $90 million remaining in the board's $250 million November 2005 authorization.

In closing, I'll remind you of the company's EPS growth objective of 11% to 13%. With our great start to the year, including 23% growth in earnings per share, we're well positioned to continue delivering on this key long-term target. We're clearly pleased with domestic equity markets, as well, which have performed significantly better than our 2% per quarter assumption.

As always, we'll continue working hard to extend our leadership with growing businesses and their employees and we remain confident that with further economic recovery and modest equity market growth we will 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. As Barry indicated, we're very pleased with our record first quarter performance with 15% growth in earnings and strategic use of share repurchases driving 23% improvement in operating earnings per share compared to a year ago.

Moving to the segments, I'll start with highlights for U.S. asset management and accumulation. Assets under management for the segment increased $26 billion or 18% from a year ago, driving total company assets under management to a record $205 billion at quarter end.

Operating earnings for the segment increased 14% in first quarter to a record $158 million. Full-service accumulation was the biggest contributor to segment earnings growth, improving by $13 million or 21% to a record $73 million. The increase was primarily the result of higher fees due to growth in account values.

The increase in operating earnings also reflects nearly $5 million of tax benefits in first quarter 2006 as a result of the final dividends-received-deduction tax calculation for 2005, an increase of $2 million compared to the benefit in first quarter 2005. Earnings growth, excluding the benefit from both periods, was about 18%, tracking pretty closely with growth in average account values, which was about 16%.

Over the trailing 12 months, full-service accumulation net cash flow contributed $4 billion to the increase in account values or 5.8% of beginning of period account values with some fairly large fluctuations between quarters. These fluctuations have become more pronounced with our increasing sales success at the large end of the small-to-medium business market.

At $5.4 billion, full-service accumulation deposits increased 40% or nearly $1.6 billion from a year ago. Full-service accumulation withdrawals increased 26%, primarily reflecting two factors. As you know, withdrawals grow proportionately to account value growth. Compared to a year ago, average account values are up $11 billion or 16%. And, as communicated last quarter, by integrating ABN Amro more quickly we compress expected lapses into a much shorter period.

Contract lapses for the ABN Amro block in the first quarter were about $385 million. By accelerating the integration, we're bringing the block to target profitability more quickly, positively impacting full-service accumulation earnings for the remainder of 2006. Importantly, overall retention of the acquisition has been excellent, significantly better than our initial expectations.

One final point on withdrawals. Lapses in our larger institutional block are often higher in the first quarter as those plans tend to have calendar year ends and tend to change providers on their plan anniversary.

This leads us to full-service accumulation net cash flow. At a record $1.5 billion or nearly 2% of beginning of year account values, first quarter 2006 net cash flow was outstanding and a result that gives us great confidence in our ability to achieve our target 5% for the year.

In terms of achieving this target over the long term, I'd reemphasize our ongoing focus on increasing participation and deferral rates in the overall block. Furthermore, with Total Retirement Suite, we've built a competitive advantage with small-to-medium-size businesses, one that has become particularly noticeable in driving sales success at the larger end of the market, positively impacting deposits and net cash flows and one that we will expect to continue to drive exceptional retention of our institutional clients.

On a related note, I'd like to point to our continued success retaining assets at risk due to retirements and job changes. In the first quarter we retained more than 54% of at-risk assets, including some $360 million directly into mutual funds, individual annuities and bank products. This strong result reflects our continued success building relationships with retirement plan investors and retaining at-risk assets into our retail rollover solutions.

Moving back to the U.S. asset management and accumulation earnings discussion, the individual annuity and mutual fund businesses also contributed to segment growth, improving 33% and 38%, respectively. Reflecting very solid sales and the previously mentioned good retention of at-risk assets, both businesses delivered 20%-plus growth in account values from first quarter 2005.

Principal Global Investors also delivered solid first quarter earnings growth, particularly in light of extraordinary commercial mortgage loan securitization results in the prior year quarter. Combined full-service payout in investment-only earnings were down $2 million compared to first quarter 2005, but essentially flat excluding higher prepayment income for both businesses in the year-ago quarter.

Moving to Principal International, first quarter earnings grew to $18 million from $10 million in the year-ago quarter. Excluding $3 million of benefits in first quarter 2006 related to expense and DAC refinements, segment earnings improved about $5 million or 54%. The first quarter increase is primarily due to improved operating results in Brazil, Chile and Hong Kong and to foreign currency strengthening in Latin America.

Adjusting for items benefiting earnings over the trailing 12 months, segment return on equity is around 6.5%, up roughly 160 basis points from the year-ago quarter. The segment remains on track to achieve sustainable return on equity of 7% by 2007 and 10% by 2010.

In the life and health insurance segment, first quarter 2006 earnings were very solid at $70 million. As you may recall, first quarter 2005 included a $4 million benefit in the individual life division due to favorable deferred policy acquisition cost adjustments. Excluding that benefit, segment earnings were up 7% and individual life division earnings were up 3%.

As Barry mentioned, we're making good progress in the individual life division, meeting the needs of growing businesses with offerings such as executive variable universal life for non-qualified plans. We plan to launch our new UL secondary guaranteed product later this month. This product, focused on the needs of our retail customers, will enable us to better tap into independent distribution and is expected to drive growth in first year recurring premium sales.

Earnings for the specialty benefits division improved 40% to $19 million from $14 million in first quarter 2005. Continued strong sales growth and very good retention drove premiums and fees up 19%.

There was no benefit to division earnings in the first quarter related to the change in reserving on long-term disability claims. We continue to estimate that the new reserving approach will add $10 million to division operating earnings in 2006 and expect those benefits to begin in second quarter.

Health division earnings were $24 million in first quarter compared to $26 million in the year-ago quarter. The decline reflects a slight increase in loss ratios which remained in an acceptable normal range of fluctuations. Importantly, the health division continues to deliver strong return on equity, nearly 18% for the trailing 12 months.

As Barry mentioned, we continue to see meaningful growth in insured medical covered members, our seventh straight quarter of target state member growth and our fifth straight quarter of growth in total. Compared to a year ago, insured medical covered members in target states are up 17% and nearly 10% in total, reflecting strong sales and improving retention.

I want to quickly comment on the decline in fee-for-service covered members, as well. We're continuing to focus our efforts within the administrative services only market on smaller cases in target states where we're more competitive. We've made good progress in first quarter 2006 in terms of new sale covered members, which exceeded our total for all of 2005. While there's more work to be done, we remain confident our network discounts and recent additions of dedicated sales reps will positively impact fee-for-service member growth over time.

I'll close with a brief followup on capital management. As you know, the company continually monitors its capital resources and liquidity. Absent more attractive investment opportunities for the higher asset base currently in the corporate segment and contingent upon several factors, including the outcome of rating agency discussions, regulatory approval and board authorization, we continue to believe we have additional repurchase capacity of several hundred million dollars. We will update investors, as appropriate, after all necessary discussions have taken place and we can better quantify our deployable capital resources.

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

[OPERATOR INSTRUCTIONS] Our first question comes from Ed Spehar with Merrill Lynch.

Good morning. Thank you. I was wondering if you could expand a little bit on the growth in the specialty benefits area. I know that we've heard-- a number of us on this call have probably heard comments from competitors about the competitiveness of the market and what is it-- I know you've expanded distribution substantially, but what is it that gives you confidence that the offerings that you have in the market are not being-- are not being sold because of price or underwriting and it's because of something else? Thanks.

Well, good morning, Ed. I will ask John Aschenbrenner to kind of fill in the details, but I can-- I can assure you your first assumption is correct, that our sales growth is coming because we're expanding distribution. We have-- we've had about a three-year expansion plan in putting more wholesalers out into the market and there is a-- a build-on effect that comes from that as these wholesalers become more productive and it really is about distribution expansion. It really is not about any kind of price pressure or underwriting cuts or anything like that. But, John, do you want to kind of fill in and maybe give a little more detail?

Sure, yes. I think the-- the aggressive pricing you're hearing about and the aggressive pricing we're seeing about is really in the large case market, the over 5000 lives, and that's not really a market where we're very active. We're much more in the small, medium size business market.

But, as Barry said, the growth really is coming from more feet on the street out there. We're growing our reps and getting them more effective.

In 2005 we increased the total number of reps from 60 to 72. More importantly, we increased the number of experienced reps who have been with us over 15 months from 43 up to 56.

If you remember, we really started this specialty benefits field force almost from scratch in 2001. So it really is building off a pretty small base and we're seeing strong growth in the numbers but also strong growth in the effectiveness of those reps as they get used to the Principal and the market.

A couple of things that give me confidence that this is not out buying the business with low prices, first of all, would be loss ratios. If you look at loss ratios, they went from a little over 80 in 2003 to 77 in 2004 to about 70 in 2005 and now starting out in 2006. That came from a couple things. One we've talked in the past about some problems we were having and poor experience on a few large cases and we've effectively corrected that, but it also comes from a significant premium increase on our LTD product in early 2005. So we had about an 8% premium increase on the LTD in 2005, which drove the improvement in loss ratios and also, I think, is key to my comfort that we're not underpricing the market.

The other statistics that give me confidence are the close ratios and the opportunities we have to quote. So our growth right now is coming because we're quoting on a lot more cases than we've quoted on in the past and we're seeing a continuation of the same close ratio. So if we were really out buying the business, we'd see a major spike up in that close ratio. We're not seeing that; we're just having the opportunity to quote a lot more because we've got more effective feet on the street right now.

We're very comfortable with the results we're seeing there.

Thank you very much.

Thanks, Ed.

Your next question comes from Suneet Kamath with Sanford Bernstein.

Hi. Thank you. I just wanted to talk about the full-service accumulation pipeline, I guess, for takeover business. With the equity markets a little bit better and then some of the potential regulatory changes that would be positive to 401(k) providers, is your sense that more people are staying in that business versus, maybe, what you had expected in the past?

Thanks, Suneet. I understood two questions. How is our pipeline looking and the second is relative to consolidation and maybe some companies are getting out. And I think I'll let Larry handle, actually, both of those.

Okay. Good morning, Suneet. On the-- on the pipeline question, again, I think that's an appropriate question every quarter when we do have a big sales quarter is to see whether we're still able to rebuild a pipeline following-- following strong sales.

Again, we feel very good about his. Much like John was discussing with specialty benefits, our activity with some of our new alliance partners is allowing us to quote on a lot more business. It's not just a matter of a big spike in close rates, although we did have-- we did have some increase in close rates in Q1, but our pipeline is up about 20%, our total pipeline, over what it was a year ago. So, again, that reflects the success that we're having in building relationships with some of our key alliance partners.

In terms of retirement market consolidation, I think you heard Barry comment earlier, we continue to try to be active as we do believe retirement market consolidation's going to continue. But, again, that has been, still, at a relatively modest pace. It has not been that significant yet.

It may be-- as you speculate, maybe it's a result of equity markets. I don't know that that's a huge factor. I think it's just something-- it's a trend that will play out over many, many years and, again, we think as we continue to build our market leadership position we're going to be a net winner in that consolidation.

Okay, thank you.

Thanks, Suneet.

Your next question comes from Colin Devine with Smith Barney.

Good morning, gentlemen. I guess I'll put my question to Larry. Larry, I was wondering if you could talk a little bit about how you perceive the impact of current pension reform legislation may mean for the Principal, particularly auto enrollments in 401(k)s, but also, then, the opportunity that's unfolding to start, I guess, more formally going in and providing financial planning advice to pre-retirees?

Good morning, Colin. Good to hear from you. Go ahead, Larry.

Thanks.

Yes, Colin. Well, first of all, as you know, the House and the Senate do have a conference that is debating pension reform, I hope as we speak. I don't know that for a fact, but I hope as we speak, and we are very involved in that. Barry has been involved in that; I've been involved in that. We do have our Washington office involved in that.

We remain generally optimistic that some sort of compromise will be-- will be struck and that we will see pension reform this year, albeit there are still-- as we understand it, there are issues that still need to be compromised. Generally speaking, we see it as being a positive event, both for the defined contribution business and, I will also point out, Colin, for the defined benefits business. And when you look at our sales activity, while it's still relatively small, when you look year-over-year our defined benefit sales are growing substantially, so there is opportunity there.

On the DC side, you are seeing-- you will see improvements in things like auto enroll. You will see more integrated investment advice where we can use our own-- potentially use our own investment advice engines rather than relying on someone outside.

On the defined benefits side, we'd like to see more stable funding rules. We'd like to see cash balance plans legitimized and we're particularly encouraged that a proposal that we and the American Society of Pension Actuaries have been working on that we call [DBK] is in the Senate version and we think that would be a great new solution for small-medium businesses that's a combination of defined benefit and defined contribution plan.

So, again, we feel very good about it. We are hopeful and we're doing everything we can to encourage them to-- to reach an agreement here shortly.

Thank you. Then one quick followup for Barry. Barry, looking where your stock's trading today, buybacks probably aren't quite as appealing as they were a year or two ago, based on the valuation. Is there any change at all in your thinking with respect to M&A, away from the sort of smaller KeyCorp/Fortis deals perhaps, to something substantially more significant to take out another competitor?

I really don't think so, Colin. I mean, our strategy on M&A is not really driven towards excess capital or stock price. It's really driven on strategy and we have a lot of discipline toward executing that strategy and, quite frankly, we have found that it adds much more to the value of our organization to buy smaller properties that really do add value and fit with the strategy and we've tried to resist and we'll continue to resist buying things that take us off the strategy just because we have excess capital. We think that would not be the appropriate way to go. And part of our problem is that we have such a unique strategy. It is more difficult to find properties, larger properties, that really add value.

But back to the discussion about defined contribution consolidation, there will come a day when things that really, really do fit uniquely with our strategy and I think because of our strong capital position we'll be able to take advantage of those.

Thanks, Barry.

Your next question comes from Jimmy Bhullar with JP Morgan.

Hi, thank you. Just on your FSA organic sales growth guidance of 10% to over 10%, I would have thought that there might be room for upside in that, given how strong the first quarter was and also the fact that the pipeline you're mentioning is up 20%. Is that-- the fact that you're reiterating that, is that just conservatism on your part or is there lack of visibility that you might not be able to surpass that? If you could just comment on that?

And second, if you could just give us an idea of what benefit to the tax rate was from the synthetic fuel credit in the first quarter?

The-- on the first one, we-- we have tried, since we became a public company, to give kind of a more long-term-- long-term view relative to our sales growth. So when we first came out, we said we believe we can hit a 15% long-term growth rate and we exceeded that. In fact, we averaged about 25% full-service growth the first three or four years as a public company and then we moderated that, obviously, having given-- achieved such good success, to 10% to 12%.

So the 10% to 12% is really a longer-term target that we believe that we can achieve over the next three or four years and we really don't necessarily want to get into quarterly or even annually trying to predict where we'll come out. This is lumpy and some quarters are going to be very big and, therefore, some years are going to be larger, but we stand by our longer-term statement that over the next three or four years we can achieve 10% to 12% growth and I think when you look back three years from now at the three-year cumulative it'll be 10% to 12% growth rate.

Now might we do better than that? Sure. I mean, we're getting great success with our-- our-- particularly our Total Retirement Suite product. We are making good headway into the larger end of SMB. So, sure, there's a possibility we could do better, but there's an equal possibility that market forces will make it even more competitive. So that's why we're very comfortable with the 10% to 12% over the longer haul.

I think your second question had to do with the syn tax credit in the first quarter. Is that what you're talking about, Jimmy?

Yes. I think last quarter you mentioned you got a 2 to 250 basis point benefit on your overall tax rate. If you could update that this quarter?

Yes. Let me speak a little bit to the syn fuel deal, because obviously that's a question we've had a number of quarters and also with the price of oil being where it is today, the amount of credit that we're going to get out of that syn fuel deal is shrinking rapidly because the credit, to some extent, varies inversely with the price of oil.

So let's talk a little bit about-- about the syn fuel deal. It's really a class of structured investment which gives us a superior yield. The difference between the syn fuel investment and other investments is you get the tax benefits-- or the benefits are derived on the tax line, not the investment income line.

So when you think about it from an [OPTICS] perspective, we're getting less investment income, lower investment yield if you wanted to do a calculation of investment yield, and it also, then, you get the benefit on the tax line, which reduces the amount of taxes you pay. You net it out and the way we look at these deals is more on a net increment to operating earnings. So it would stack up relatively similarly to many other structured deals that we do that would be yield-enhancing.

Okay, with that as a background discussion, for the first quarter -- go back to first quarter last year. First quarter last year price of oil was just starting to shoot up. Last year we did not take any credit for syn fuel tax offset. So we baked into our forecast the first quarter 2005 no benefits from syn fuel.

This year we're-- this first quarter of this year, we took a half a benefit. The price of oil continued to go up and half a benefit is roughly about $3 million of tax credit. Price of oil continues to rise. We believe, as we look forward to the rest of the year, that we probably will not get any credits out of the syn fuel deal and may even reverse out the $3 million of tax credit that we took in the first quarter of 2006.

Okay, thank you.

All you ever wanted to know about syn fuel credits.

Syn fuel may be going away. It may not be an issue that we need to discuss if the price of oil continues to rise and if there's no legislative activity to change the law-- legislative backing for syn fuel tax credit.

But your current investments are expiring, I think, in 2007. Is that right?

That's correct. That was the length the deal would run if it were to run to term. Obviously, if the-- if we don't get syn fuel tax credits, we'll look for another structured deal that will give us a similar amount of yield enhancement, except it would show up in the investment income line rather than in a reduction in income tax.

Okay, thank you.

So from an operating earnings perspective, we would hope to be relatively neutral.

And your next--

Thanks, Jimmy.

Sorry. Your next question comes from Andrew Kligerman with UBS.

Hey, good morning. A question on your international asset management and accumulation revenues. It appeared that revenues were flat year-over-year when you adjust out the currency, based on what you wrote in the release and revenues were down sequentially as well. Could you give a little color around that and perhaps a sense of how much growth we might expect on the top line in international? I think I recall there was a Japanese business liquidated. Maybe that was part of it.

Well, good morning, Andrew. Sure. Larry, you want to take that?

Sure, happy. Good morning, Andrew. As it relates to the overall revenue growth in Principal International, the item there that I think-- that I understand can cause some kind of disruption as you're trying to understand the trend is that primarily the-- the retiree annuity business, which is significant for us in Chile where we're one of the market leaders, either number-- typically number one or number two. We also have an amount of that business in Mexico and when we have large amounts of sales of those retiree annuities, those amounts run through in the revenue line.

So if you look at quarter-over-quarter, first quarter '06 over first quarter '05, first quarter '05 was a very, very high quarter for annuity sales in Chile because the government put in place a new auction system at the end of '04. And, as a result of that, it distorts when you look first quarter over first quarter-- it distorts the revenue growth. So it has the flatness that you're observing.

I think our view is that the better way to kind of think about all of this in getting to your second question is really to focus on the fee revenue in the Principal International business, because the business is really shifting from annuities to mutual funds. So it's really shifting from sort of the revenue and general account-type business to fee revenue. And when you look at fee revenue, you'll see that it is up $5.6 million or 25% year-over-year for Principal International.

And then finally, you asked about kind of expectations for continuing OE growth and we remain very confident as we do our own analysis and as we speak with the local managements. We're still very focused on that 15% to 20% annual operating earnings growth, driving towards 7% ROE in '07 and 10% in 2010 and we think we're very much on track to do all of those things going forward.

Thanks a lot.

Your next question comes from Jeff Schuman with KBW.

Good morning. A couple questions around the FSA business. First of all, how much of the strong sales actually hits deposits? Was it sort of the typical two-thirds or was there anything about the timing that impacted that?

And then secondly, I think Mike talked about expecting higher margins going forward because of the accelerated integration of ABN Amro. I was wondering if you could explain what you meant by that and put any numbers around that for us, please? Thanks.

Sure, Jeff. Good to hear from you. Larry, you want to take both of those?

Sure. Jeff, on the first one, as we've said, normally about-- of sales in a quarter normally something like 65% to 70% of that might hit deposits in that particular quarter. The remainder, the 30%-35%, will hit deposits over the succeeding three quarters.

This is, quite frankly, a little more intuitive than real on my part, but what I would say is for the first quarter I don't think that 65% to 70% will be substantially different but it might be a little bit higher. We did have the large win that both Barry and Mike commented on. The percentage of that that hit first quarter was a little higher than that, so we might be a little higher than that 65% to 70%, but I would not say that it is substantially higher.

In terms of the margins, what Mike was referring to there and, again, we've commented on this in prior quarters, when we-- when we did the ABN Amro deal, basically at that point our first priority was to get that business stabilized and on to our own platform and we knew that it was not going to be until we got it on to our platform that we would start to generate the same margins on that business that we have on our own full-service accumulation business.

We have now completed that consolidation. So, thus, we will start to see somewhat-- we will see higher margins on that business going forward.

How much of an impact that has on overall full-service accum, I can't give you great certainty, but we would expect to see those margins -- all those things being equal, Jeff -- we would expect to see those margins come back slightly over the next two, three, four quarters.

I think, said another way--

If you could help us--

I think, said another way, it cost a lot more to administer that business before we brought it on to our system. So there is a fairly significant cost savings that is derived from being it on to our administrative systems.

And just help us ballpark that. What is the asset base on that business at this point?

Yes, it was-- I think we said it was about a $4 billion block of business when we-- when we acquired it. I think we commented in last quarter's earnings call, at that point, kind of net/net we were still at about-- at about the same level and then I think Mike commented in his remarks that we had about-- of course, we had investment income credited to it and then we had about $385 million of outflow in the first quarter. So I think if you net all that out, it's still generally, give or take, in that same ballpark, Jeff.

Yes.

But my point is it would be-- that number would be substantially better than what our acquisition plan was. So this is going to be, certainly, a net improvement to the full-service accumulation earnings going forward.

Great. Thank you.

Thank you.

Your next question comes from Eric Berg with Lehman Brothers.

Thanks and good morning. I was telling Tom Graf last night that I was absolutely intrigued by the fact that one hospital in the Bronx could bring Principal $1 billion. How many employees does Montefiore Hospital have? What is the average balance of the employees and what would cause--? I'm presuming that either it was price or a certain level of dissatisfaction by this hospital that would cause so much money to move. I mean, it's a major decision; it's a staggering amount of money for one employer to move to Principal.

Could you give a little bit more perspective, a little bit more color on sort of the demographics here? How many people, again? The typical employees' 401(k) balance? And what the-- as best as you know or your wholesaler knows what the former provider was doing wrong that caused such a switch? Or maybe this is more typical than I know, this type of movement.

I think you're-- you're asking some interesting questions, Eric, and we'll try to give you a little color, but I don't think we're going to go down a track of-- we're not going to be able to go down a track of giving you all the competitive specifics that go on in a case like that.

I will tell you, then I'll Larry answer this, from what I know and I have been fairly well involved in this that probably the single most important thing for us winning a case like this comes back around to our Total Retirement Suite where we're able to go in and really coordinate all of their retirement plans into a single bundled offering with consolidated statements and, very importantly, where we're able to go in and help individual employees take a look at their own individual planning and make decisions around that, something we call Retire Secure.

So I believe it was much, much more about our integrated total package and the way we offer that package than anything else. But I'll let Larry add a little color to it.

That's absolutely the case, Eric, and, again, it wouldn't, obviously, frankly, appropriate for us to talk much about numbers of employees or average account balances. What I would say is that buyers like that, who tend to be pretty sophisticated buyers -- but I don't want to say that's a lot different than our normal SMB buyer -- but sophisticated buyers, they're going to look at a wide variety of packages and features.

And the two that Barry talked about are two of the primary ones, which is the ability to actually handle multiple plans from a single perspective, so the Total Retirement Suite, but in this case, particularly our ability do the worksite financial planning, because these larger employers recognize that there is confusion out there in the marketplace and that they, as employers, share a responsibility -- or at least I think the more enlightened employers understand they share the responsibility with their employees -- to do an adequate job of planning for retirement. So that ability to do worksite financial planning is very much a differentiator.

This is our Retire Secure approach and so we're-- we're very satisfied with it. It's a great relationship. We're very excited about it. We have mutual interests in wanting to do everything we can to help every one of those employees to achieve retirement security. So we're going to see more of this going forward, I think.

I guess-- I know we're supposed to keep this to two questions, so I'll ask just one followup. If Principal's planning ability for individuals is as good as you say it is and your ability to be on site and work with employees is as good as you say it is and this hospital, Montefiore Hospital, realized this, maybe this wasn't so unusual, this $1 billion hit. I mean, should we think that we can get more of these in the future with greater frequency than you've had in the past?

Well, that's-- we're kind of speculating here, but I would say we don't typically give case size for a lot of reasons. I mean, we don't get into each case, but if you went back over the last couple of years, you'd probably be surprised at the number of $300-$400-$500-$600 million cases. So we have been-- over the last several years, we have been undertaking larger and larger cases. So I don't think this is a one-off that'll never happen again. I do think it is a pattern of us really competing extraordinarily well in the larger case market over the SMB where they really value the bundled offering and where they value some of the products and services that we have.

Well done. Congratulations.

Thank you very much.

Your next question--

Did somebody say well done?

Your next question comes from Joan Zief with Goldman Sachs.

Thank you. Good morning. I just want to talk a little bit more about the margins in USAMA. On the-- particularly on the pension business, on the FSA business, are you seeing any pressure on margins just from an industry-wide standpoint because of more competition and also the requirement of more service? And if what you're saying is that your-- one of your competitive advantages is the way you can service this account, bundle this account, provide those services to the individual, is it a-- is it a situation where just the cost of doing business is going to be rising and you couple that with competition and we should just expect a little bit lower margins going forward? That's my first question.

And then my second question is, if you could just talk to the annuity margins? They really popped up versus what you've been-- what you have shown as a return on assets for a while and I just want to know is there something structural there where we could, again, maybe see higher margins going forward on the annuity side?

Thanks, Joan. Two good questions, both for Larry, probably, but let me-- let me add a comment on the first one. I don't-- I don't think that we've been under any particular pressure on margins. It is a very competitive market and I think one of the ways we get around pressure on margins is by lots of activity, by having lots of distribution and by having a great value proposition to our customers.

And in terms of expenses rising, I think just to think back to some of the things I've said when I've been out talking to you folks and investors is our enormous investment in technology -- and I think I've had some slides in the past where I've shown how we've moved almost-- well, now we've moved all of that service over to electronic processing and we've moved the cost of that processing from a quarter or $0.30 down to a nickel and down to $0.04, down to-- so the way we have really dealt with some of the competitive pressures around offering more services is by being an industry leader in the use of technology and administrative capability and being very good at handling a lot of transactions.

So my-- the reaction to my first one would be that there's not an enormous amount of pressure. We have not succumbed to it. There's been a lot of pressure in the market, but not particularly on pressures. And I'll let Larry add to it and then get into the annuity question, as well.

Yes, good morning, Joan. Barry's pretty well covered the first one. There's not really a lot for me to add.

I would just say that as we see a little bit more demand for some of this worksite-based activity, some of the financial planning activity, that is-- by its nature, that is going to be a new activity that's going to require some additional expense delivered into the worksite. But as we have, I think, demonstrated, Joan, as we've operated this business over many, many years, we're exceptionally disciplined and recognize that if we're going to have to deploy more expense into the worksite we're going to need to generate revenue to offset that.

So I think if you just looked at the cost side, you might see costs increasing a bit in the future, but we will have revenue that will support and more than offset that increased cost. So we are looking to do this without any decrease in margins, as Barry said.

On the annuity business, there what-- the only comment I guess I'd say if it jumped up, it's not because of any underlying systemic change in margins, Joan. What it really reflects, from time to time -- and you've seen this bounce around -- it really reflects just the relative volume between fixed annuities and variable annuities. And so as that mix changes -- today it's about 60% fixed, 40% variable -- but as that mix changes slightly, you see the overall-- the overall margins on that individual annuity business change. But it's not a change in the underlying margin on fixed or the underlying margin on variable, it's simply a change in the weighting between the two. So I hope that helps.

Yes. Thank you.

Thanks, Joan.

Next we have a followup from Colin Devine with Smith Barney.

Just one quick question, Barry. It's-- the de-mutualization lockup ends this fall and we haven't brought this issue up in a while and I was just wondering if you might update us on your thoughts as to where Principal fits and the longer term strategic outlook?

No, thank you, Colin, but thanks for the question. No, I'm just kidding.

I think it is October that marks the fifth anniversary of our de-mutualization and, in fact, there was additional protection, if you want to call it that, under the de-mutualization law that does unwind then and I think, as I recall, it was no one could buy more than 5% of the company without the insurance department or the board of directors' approval and once that wears off, I think the underlying ongoing State of Iowa is a 10% requirement that requires state insurance commissioner approval.

But I think all of that is-- the real issue is for us is that we're trying to build exceptional shareholder value and we're doing it by growing the business and we maintain our high valuation by doing that and so we're really very much in tune with being able to operate this company with great shareholder value and I don't think that an event that's coming or not coming around a change in de-mutualization law really changes our outlook at all. We're driving shareholder value and we're trying to do it by providing great growth and good use of capital and that continues-- that will continue to be the way we operate the company.

Okay. Just to clarify, on the 10% rule, just so we all understand, would it require prior approval from Iowa to take more than 10% or to look at a merger?

That is correct.

Or would it come from the board first?

No one investor can purchase more than 10% without the insurance department's approval.

Okay. Thank you very much.

There are, obviously-- well, I think that's enough said. Thanks, Colin.

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

Great. Thanks and good morning. Mike, I was hoping you could just give us a little bit more detail in terms of the timing of how excess capital might be freed up and then, in conjunction with that, could you also tell us when your next board meeting is and whether or not you will likely ask for another authorization for share repurchases?

Jason, how about if I give you half an answer? Would that be all right?

Well, let me listen-- let me listen to it first. Then I'll tell you.

Well, we can definitely give you the board date.

Yes.

Okay.

Obviously, when we talk about capital, let me give you a sort of comprehensive capital overview. I mentioned last quarter we had room to maneuver and room to maneuver in terms of both debt ratios and equity capital.

Maybe just a quick comment on debt, because obviously that has an impact. We, as stated, try to run a debt-to-cap ratio of somewhere in that 20% to 25% range. If you've done the calculations, you notice that we're slightly under that, at least by some rating agencies-- the way some rating agencies calculate debt-to-cap. Obviously, we're working on ways to figure out how to put-- utilize that capacity in a way that adds value to the organization.

Secondly, we start looking at equity and equity we have really two sources. One source is what we call excess capital. That's capital that's at the holding company. And some may be wondering, well, how much excess capital did we have at the end of second-- or end of first quarter? Roughly $250 million or so.

Then the next question would be, well, the second bucket is cushion and we put out an 8-K that spoke to the fact that we had a risk-based capital ratio of-- in the 450% range. That would seem to be higher than our stated target range of somewhere in that 350 to 375, so we could have some excess capital there.

We have been working with our four rating agency gods, because we worship four gods. Our financial strength ratings are important to us. We've listened to their opinions and, obviously, do not-- do not want them to get angry with us. So we've been visiting with the rating agencies. Actually, we've completed those visits.

We're stirring their input back into our mix, need to visit with the state insurance department, plan on at least having a capital discussion with the board and the board meeting's roughly two weeks or so from now. And so we will have some ideas to present to the board and we'll see how they respond to those ideas.

Great. I think that's helpful. Thanks.

That was more than a half an answer.

I'll take it.

I think we may be getting down to our last call.

Yes, sir. Your final question comes from Dan Johnson with Citadel Investment Group.

Thank you very much. Obviously most of mine have been taken, but two please, if you would. The first is the other operating expenses within the life segment look like they came down significantly. I wonder if we could talk a little bit about that?

And then secondly, just the overall flow trends within international. If I look at that, the minus $5 billion in the quarter is, obviously, a full third of the starting assets in the quarter. I'm not quite sure how to phrase the question, but if you thought about the sort of embedded value of this segment, with redemption rates at this sort of level, how do you view the sort of real business value that's being generated here as opposed to, say, just the accounting earnings?

Thanks very much.

Sure. Good to hear from you, Dan. I appreciate you getting on the call. I'll let John answer the first question and then we'll come back to Larry on the flow within the international business. John?

Yes, we're doing a lot to manage expenses and a little bit, probably, of what you're seeing is an impact of seeing a strong management of expenses as we go forward, but the bigger piece of it, really, is the impact of sales. And single premium sales are treated in kind of an odd way where the-- the upfront expense goes through as a DAC-able expense but then gets amortized almost completely immediately in that first period. So probably a lot of what you're seeing as far as a reduction in the life expense would be the falloff of single premium business and the expenses associated with that.

Would that be going through the “other expenses” line? I'm sorry, that's actually the line I was referring to, the one that went from, call it, 66 down to 54, year-over-year.

Let me look that, maybe, while we're responding to the second half of your question.

Yes, we'll come back before we get off the phone and answer that, Dan. But in the meantime let's let Larry talk about the flows, which I think is a pretty straightforward answer as to what's going on.

Right. Right. Good morning, Dan. Just as it relates to the asset flows that you mentioned in Principal International, the vast, vast majority of that is driven by seasonal flows in India, Dan, and these are primarily money market flows that are coming from corporate clients. You saw a little bit of this-- we saw a little bit of this in fourth quarter and we see a little more of it in first quarter because the-- many of those businesses over there have a March 31st fiscal year-end and so the money, then, often will flow back in to those funds in April and May following the close of the fiscal year.

Our-- our general belief going forward is that we would expect to see, quarter-over-quarter, about $350 to $500 million of net cash flow out of these Principal International business. And so that's the expectation going forward.

And the last thing I'll comment on is that -- and Mike Gersie commented on this in his earlier remarks -- but we are seeing very strong flow out of Latin America. If you just focused on Latin America, you'd see the flows-- the net flows there are up 28% in first quarter '06 over first quarter '05. So it really is an issue that's unique to the India mutual fund markets.

And I'll turn you back to John to deal with the other question.

Yes, Dan, you're correct that my answer was not on the “other” line. It was more on the DAC lines up above. We'll have to get back to you with more detail on what's causing that.

I'm sorry, Dan. I thought we were going to make it through the call without being stumped, so we've been stumped, but Tom Graf will be back in touch with you within the hour to give you the-- give you the detail on that.

Thank you very much.

And we have reached the end of our Q&A, Mr. Griswell. Your closing remarks, please?

I just, again, want to thank you all for being on the call and for your questions and discussion. We're very proud of this quarter. We're very proud of the results that we're achieving and the shareholder value that we're creating and we look forward to continuing to work with you and we hope you have a-- you all have a wonderful summer. So thanks and take care.

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 o'clock p.m. Eastern time until end-of-day May 9th, 2006. 7218877 is the access code for the replay. The number to dial for the replay is 800-642-1687 or 706-645-9291 for international callers.

Again, thank you for joining us today and this does conclude our call. You may now disconnect.