美國信安金融集團 (PFG) 2006 Q2 法說會逐字稿

Good morning and welcome to the Principal Financial Group's second 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 quarterly conference call. If you don't already have a copy, our earnings release and financial supplement can be found on our website at www.principal.com/investor. Following a reading of the Safe Harbor provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks, then we'll open up for questions. Others available for the Q and A are Larry Zimpleman, President and Chief Operating Officer, Division President John Aschenbrenner, responsible for the Life and Health Insurance segment, and Jim McCaughan, responsible for Global Asset Management, and Julia Lawler, Chief Investment Officer.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company does not revise or update them to reflect new information, subsequent events, or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed on the Company's most recent annual report on From 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 this morning. The second quarter was a very solid quarter for the Principal. At $225 million of operating earnings, it was second only to our record first quarter 2006 performance, driven by very strong results for U.S. Asset Management and Accumulation.

This morning as always Mike will provide a detailed overview of our quarterly financials including items impacting comparability as well as an update on capital. I'll focus my comments on some key performance highlights for the three and six months and on our continued progress in three key areas: Accelerating growth in our U.S. and international asset accumulation businesses, creating a successful global asset manager, and achieving profitable growth in our life and health insurance businesses.

As I mentioned, we are very pleased with the results for U.S. Asset Management and Accumulation, particularly in light of equity market declines in the second quarter. Operating earnings improved 16% from second quarter 2005, driven by double-digit growth for principal global investors, full-service accumulation, mutual funds, and individual annuities.

Other second quarter highlights include record total Company assets under management of $206 billion, up $25 billion or 14% over the prior period quarter, record account values for our U.S. asset is accumulation businesses, up $16 billion or 14% to $128 billion, and an 8% improvement in operating earnings per diluted share over a tough comparison quarter a year ago.

Highlights for the six months ending June 30th, 2006, include 16% improvement in EPS compared to the same period a year ago, 15% improvement in operating earnings for U.S. Asset Management and Accumulation, and 18% improvement in earnings for international Asset Management and Accumulation. We have also achieved 20% improvement in U.S. asset accumulation deposits and a 50 plus percent improvement in U.S. asset accumulation net cash flows through six months, and very strong sales of our three key retirement and investment products, with full-service accumulation up 57%, mutual funds up 20%, and individual annuities up 13% for the six-month period.

Before moving on, I'd like to cover some key highlights for the life and health segment. While earnings were down in the quarter, and through six months, which Mike will discuss, there continues to be a number of areas of meaningful progress. The second quarter was our 7th consecutive quarter of record operating revenues for the segment, driven by record revenues in the health and specialty benefits divisions. We delivered continued good growth in ensured medical covered members and we had another strong performance in specialty benefits division. Division earnings were a record $26 million in the second quarter with continued strong in force premium and fee growth contributing to a 21% increase in earnings over the year-ago quarter and a 29% increase through six months.

As I mentioned, we remain highly focused on several critical areas. I have just described some of our progress in the life and health segment, so I will spend the next few minutes on the performance of three key asset accumulation and asset management businesses. I will start with full service accumulation, which had a very solid quarter, contributing to very strong results for the six months. With earnings up 12% over second quarter 2005, full service accumulation was a key driver of strong performance for U.S. Asset Management and Accumulation.

Compared to a year, a full service accumulation account values were up $11 billion or 16% to $82 billion. Sales for the seasonally low second quarter were solid at $1.1 billion, a 5% decline from a year ago based on assets but actually quite strong in the emerging and dynamic market segments. Second quarter net cash flow, also seasonally low, was up about $120 million, or 23% from a year ago, to $630 million. As you know, full service accumulation sales and net cash flow come in very unevenly from quarter to quarter. That's why we focus on long-term targets and gauge the health of continues by looking at results over multiple quarters. For the six months, full service accumulation sales are $4 billion, up 57% from the same period 2005.

Deposits through six months are up nearly $2 billion or 27%. That is significantly ahead of withdrawals, which are up 18% or $1.1 billion, driving net cash flow up nearly $900 million, or 71% through mid-year. Before moving on, a couple of additional points on full service accumulation sales. Reflecting the ongoing shift in demand toward total retirement solutions, total retirement suite continues to drive strong sales, representing nearly 46% of total sales through six months.

Year to date, we have achieved strong growth in cases and assets sold across all segments of the small to medium business market. Improved close ratios and significant advances in sales rep productivity. Importantly, outstanding first half sales position us strongly relative to our longer term organic sales growth target of 10 to 12%.

Moving to international Asset Management and Accumulation, we continue to make significant progress in driving growth. During the quarter, Principal International achieved record net cash flows in excess of $1 billion. At quarter end, Principal International's assets under management reached a record $16 billion, an increase of 23% from a year ago on an organic basis. Strong AUM growth continues to drive strong growth in fee revenues and in turn, operating earnings which I mentioned are up 18% through midyear.

We also continue to make very good progress creating a successful global asset manager. Investment performance continues to be strong across all asset classes. Of the retirement plans separate accounts managed by Principal Global Investors at June 30, 2006, 86% ranked in the top two Morningstar quartiles for the one-year period and 89% for the three-year period, and 88% 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 $8 billion, or 20%. Before I close, let me briefly cover a couple of other areas.

As you know, last week we announced the acquisition of W M advisors from Washington Mutual. Our full presentation can be accessed through tomorrow at our website. I'd like to communicate again just how excited we are about the acquisition and the outlook for our mutual funds business going forward.

The transaction expands our retail mutual funds, a business critical to meeting the needs of baby boomers. It gives us significant third party distribution to capture the increasing flow of individual retirement and investment assets, enhances our asset management capabilities, improves our product suite overall, and solidifies our leadership in lifecycle funds. It also grows our size and presence in the industry much more quickly with positive implications for securing shelf space and building brand and generating economies of scale.

Larry Zimpleman and his team did a great job making this acquisition a reality, and Larry will take the lead in answering any additional questions you may have on the transaction during the Q and A period at the end of the call. I'd also like to recognize Larry on his promotion to President and Chief Operating Officer and his election to the board of directors during the second quarter. We look to Larry to continue playing an invaluable role in developing and executing our growth strategy and his new role overseeing all domestic and global operations.

Moving to outlook going forward, I would remind investors that we no longer update annual guidance as the year progresses. The 2006 is guidance provided in November 2005 spoke only to the date on which it was made. That being said, we are clearly very pleased to be so strongly positioned through mid-year with respect to our longer-term EPS growth target of 11 to 13%, and we remain confident in our ability to achieve that target over the longer term.

We're also very pleased with the progress that we have made improving return on equity and we continue to target a 50 basis point improvement per year. I'd remind investors that our longer term EPS growth objective is based on certain assumptions including domestic equity market returns of roughly 2% per quarter. In closing, we remain sharply focused on executing our growth strategy. As always, we'll continue working hard to extend our leadership in the industry to meet the needs of growing businesses and their employees and to deliver superior long-term results for our shareholders.

Mike?

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

As Barry indicated, second quarter performance was very solid. Earnings per share increased 8% from the year-ago quarter on an actual to actual basis and more than 12% on a comparable basis, excluding items benefiting the prior year quarter. A $7 million benefit in the individual life division and a $1 million tax benefit for Principal International, which I'll discuss shortly.

Moving to the segments, I'll start with highlights for U.S. Asset Management and Accumulation. Assets under management for the segment increased $20 billion, or 13% from a year, a driving total company assets under management to a record $206 billion at quarter end. Operating earnings for the segment increased 21 million, or 16% in the second quarter, to $151 million. The biggest contributors were Principal Global Investors and full service accumulation, each improving $8 million from second quarter 2005. At $70 million, full service accumulation earnings improved 12%.

This increase was driven primarily by higher fees from growth in account values which were up 16%, or $11 billion from a year ago. We view the second quarter 2006 result as particularly strong, in light of higher deferred acquisition costs, amortization expense of nearly $14 million over the prior year period, and in light of equity market declines which dampened account value growth in the current quarter. As Barry mentioned, because of the significant fluctuations in full service accumulation net cash flows between quarters, impacted by new plan effective dates and timing of receipt of transfer assets we're highly focused on longer term targets.

As a percent of beginning of year account values net cash flow is 2.7% through six months, putting us well on track to achieve our 5% target for the year. Over the trailing 12 months, we have achieved net cash flows of more than $4 billion which equates to 5.9% of beginning of period account values. We remain highly focused on levers of net cash flow. Looking at our sales outlook, including the competitive advantage we have built with Total Retirement Suite, our strong plan level retention, our ongoing success increasing participation and deferral rates, we remain confident that 5% of beginning of year account values remains an achievable long-term target for full-service accumulation net cash flow.

Moving back to the segment earnings discussion, Principal Global Investors delivered a record $24 million of earnings. The 51% improvement over the prior year quarter reflects strong growth in management fees. Principal Global Investors continues to deliver strong growth in net cash flows as well with an increase of $1.7 billion or 31% year to date. Through six months, Principal Global Investors earnings are up $9 million, or 25%. As we continue to transition the commercial mortgage securitization business to the joint venture with U.S. Bank, we'd expect some dampening of Principal Global Investors earnings growth over the next 12 months.

The individual annuity and mutual fund businesses also contributed to segment growth with earnings improving 10% and 85% respectively. Reflecting strong sales and good retention of at-risk assets, both businesses continued to deliver excellent growth and account values with individual annuities up 18% and mutual funds up 26% compared to second quarter 2005. To expand on the asset retention discussion, we have retained more than 54% of at-risk assets through six months, including more than $700 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 to Principal International, second quarter earnings were $16 million, a solid quarter. Though earnings were down from the year-ago quarter on an actual to actual basis, the underlying earnings power of the business has improved solidly. You may recall second quarter 2005 earnings of $19 million benefited from a number of items. On a comparable basis, excluding high inflation-linked investment yields in Chile and the tax benefit associated with the American Jobs Creation Act both in the second quarter of 2005, the segment achieved double-digit earnings growth from a year ago.

Principal international's return on equity for the trailing twelve months is 8.7%. Adjusting for the items benefiting earnings during that period, segment return on equity is around 6.9%, up roughly 200 basis points from the year-ago quarter. The segment remains on track to achieve sustainable return on equity of 7% by 2007, 10% by 2010.

Moving to life and health insurance, second quarter 2006 earnings were $65 million compared to $76 million a year ago. As you may recall, second quarter 2005 earnings included a $7 million benefit in the individual life division, primarily due to methodology improvements related to reinsurance values.

Excluding that benefit, earnings for the segment were down $4.5 million, with $2.5 million of the decline coming from the individual life division. The decline in individual life earnings was caused by higher death claim costs which tend to vary period to period. As you know, in May we launched our new UL secondary guarantee product. While early in the game, the pipeline is building, and we expect it to be a competitive solidly profitable product for the individual life division.

Earnings for the specialty benefit division improved 21% to a record $26 million, and included approximately $3 million in benefits related to the change in reserving on long-term disability claims that we previously communicated. This compares to $21 million in the second quarter 2005, which, as you may recall, benefited from favorable long-term disability claims experience. For the year we continue to estimate in that total the new reserving approach will add $10 million to division operating earnings. Moving to our health business, division earnings were $17 million, down from $24 million in the year-ago quarter which benefited from favorable loss ratios.

As Barry mentioned, we're very pleased with our continued meaningful growth and insured medical covered members. This was our 8th straight quarter of target state member growth and 6th straight quarter of growth in total. Compared to a year ago, insured medical covered members are up 17% in target states and more than 9% in total, reflecting strong sales and improving retention. Going forward, as we continue to focus on our key health business drivers, network discounts, expense management, integration of the wellness business, rebuilding fees for service membership, and rate strengthening as needed, we expect to drive higher revenue and earnings as well.

I'll close with a discussion on capital management. As always, our first priority for use of excess capital is funding organic growth. Our second priority is strategic acquisition with a primary focus on enhancing capabilities and or accelerating growth in our U.S. and International Asset Management and Accumulation businesses. Our third priority is to return capital to shareholders through share repurchase and dividends.

As you may recall, in may we announced we had executed an accelerated share repurchase program. Under the terms of the program, the Company paid $500 million and received the initial delivery of approximately 7.7 million common shares. Depending on the volume-weighted market trading price over the execution period, additional shares may be delivered to the Company in the fourth quarter. Through six months, under board-authorized share repurchase programs, the Company has bought back $750 million of shares.

Going forward, we'll continue to look for additional opportunities across our businesses to more effectively deploy capital. As an example in the second quarter, we freed up nearly $200 million through statutory reserve refinements in the individual life division. As mentioned in our call last week, we expect to fund our acquisition of W M Advisors from a combination of excess capital and debt hybrid issuance, but we won't firm up the mix until we near closing. That said, we received a ought of interest in what our capital position will be post-transaction. We define excess capital as free cash from investments as a holding company. In addition we generally maintain a cushion of capital in the life company. Statutory surplus in excess of the minimum amount needed to maintain our current financial strength ratings.

We'd estimate having a small amount of excess capital at year end and several hundred million dollars of cushion at the life company based on certain key assumptions. If we fund the acquisition with half debt and half excess capital, then we produce additional excess capital as we generate income, and that we pay our annual dividend to common stockholders in December. In addition, we should have over $500 million of excess debt capacity.

As you know, we try to maintain some flexibility in our capital structure to respond to changing conditions and capitalize on opportunities. 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 Dan Johnson with Citadel Investment Group.

Great. Thank you very much. A couple questions. Could we start out on the health side, in terms of what you saw there in terms of the increase in the medical benefits ratio. Can you try to provide some color in terms of the source of that, geography, business mix, anything that might be helpful there?

Good morning, Dan. Sure, we'll ask John Aschenbrenner to jump right in and answer your question.

Basically what's happening there, about $1 million of extra claims that were primarily some large claims a number of large claims that we normally don't see. Then another $3 million that is timing of claims. A million of that is around the seasonality that we would expect second quarter to be about $1 million higher than average, and the other couple million is really coming from the number of business days in the quarter. So really $3 million of it we would say is timing, and $1 million of it is extra claims that we hadn't expected.

In terms of the days in the quarter, wouldn't that have also influenced the premium as well and therefore not the ratio?

It doesn't. Unfortunately, the accounting for it puts the revenue on a monthly basis and the claims come through on a daily basis.

It's an odd outcome, Dan, but that's the way it is.

Okay. Then can we go over to the life sales. Maybe you could talk a little bit about the environment for the UL marketplace and how you'd view the sales production in the second quarter.

Sure. The sales were off a little bit in the second quarter. I think you are probably familiar that we had repriced our UL with secondary guarantee last year, and had had had a product that was not at all competitive.

We have now -- and so the sales were falling off because of that in the UL marketplace. We now came out with a new product in May that is both priced to generate our 15% return on equity target as well as put us in a more competitive situation, not top of the pack by any means. So we're starting to see the momentum build up now in the UL marketplace for us, so we should start to see some improvements in sale there.

On the other side, the other big piece of our sales is the non qualified 401(k) excess plans that are funded with life insurance, and that has been very strong this year, much stronger the first half of the year than last year. Second quarter was a little bit slowed down because of some reorganization we did in our field force. But that momentum is starting to pick back up again.

Great. Larry, finally, on the international side, net flows were great in the quarter. The business continues to sort of amaze me in terms of the amount of assets that both come in and out in the quarter, and so in light of that, could you explain, one, at least this quarter it looked like there was negative DAC. Then overall with what looks like a business that turns really quickly, how is there sort of any DAC given sort of the speed that the assets can move in and out?

Dan, this is Larry. I'll try to answer those questions for you. I would say that what you see in terms of the flows kind of coming in and out, I would say there's kind of two factors there in the second quarter to point out for you. The primary one, really, is the situation with regard to India, where because of fiscal year end, which over there is a 3/31 fiscal year end, we do see the withdrawals sometimes in fourth quarter and first quarter as they restore their balance sheet and then those moneys come back into -- typically they're more money market type funds. They come back in during the second quarter. I would say, however, that while that is an influencing factor, our focus there is really not to grow our money market funds.

In fact, if you dig into the detail you will find that we're having good growth in, if you will, long-term-type mutual funds in our Indian business. So the money markets are a factor. That's what drives a lot of the noise back and forth but our strategy really is to focus on the longer term AUM.

Another factor that can come in would be -- it's not really reflected in those flows because it's not accounted for that way but I would also note in countries like China where you have sort of the IPO process, that also has potential to cause some noise in there. The DAC that you have in international, the second quarter issues there were directly associated with our 4A business in Mexico.

We did our annual review. There was a true-up there between the DAC capitalization and the present value future profits. Just to give you an expectation going forward, Dan, I think you ought to expect to see the DAC amortization about $2 million a quarter. You ought to expect to see the depreciation and amortization line about $4 million a quarter, so going forward, we should see about $6 million a quarter there in amortization. . Hope all that helps. I apologize for all the detail, but --

That was great. The only other piece of that was just -- maybe these assets are stickier than would it appear but I tend to think of DAC as something that's accumulated on product that have multiyear duration. Maybe that's an incorrect --

That is really our strategy, and the DAC is associated with that, and absent the situation with India money market funds, which, again, is not a major part of that business, but that's the only one that has that very kind of short-term cyclical nature. Everything else really is truly long-term and thus have the DAC associated with it.

Thanks for answering all the questions.

You bet.

Your next question comes from Joan Zief with Goldman Sachs.

Two questions. First is on your return on equity and your return on equity goals, you're very close to 15% ROE, and yet you're talking about your goals being 50 basis points a year improvement. Do you think you can achieve 50 basis points improvement from these levels? And what would be reasonable ROE given your capital structure over the next, say, three years?

Good question, Joan, and we appreciate it very much. I do believe that we'll end this year somewhere close to 15. That's about where we are now. Obviously we've had a very strong first half of the year. I would expect that we will be able to increase our ROE by 50 basis points over the coming several years. How long, how many years, I don't know. But if you look at our most profitable businesses, certainly the asset management, asset accumulation, 17, 18, 19, 20% some of them, if you really got asset management down it would be much higher than that.

So I think it really is a matter of how quickly we shift our business to more of the assess accumulation and asset management businesses. It also will depend on how quickly we can get the international business up and we're having good success there but I don't know that I want to tie myself to a number, but clearly this overall complex ought to be generating a couple hundred basis points more than 15% over the next three, four, five years.

Okay. My other question is about the 401(k) market, and competition there. We're starting to see a lot of companies talking about this marketplace, starting to talk about their success in growing the assets there. And I was wondering if you were seeing any increased competition, if you were seeing competition for distribution, and, up, how you feel your ability to maintain market share is in that market given the other company -- the other big companies that are focused there.

Sure, Joan. Let me just make an overall comment, then I'll turn it over to Larry. First of all, I understand there may be some static on the call. I do apologize greatly if it's irritating. We're trying to get it fixed.

I'll let Larry give you the details but from my perspective we're having a lot of success in the marketplace. I think if you looked across all of the market segments, and we really break them into emerging dynamic and institutional we are doing quite well. I would say, in the emerging and dynamic this has been one of our very best years. We're increasing case count. While it is very much true that it is a very competitive landscape, my perspective is that we're doing quite well and holding our own.

Larry is a bit closer to the. I'll see if he wants to add some color.

Not really a lot more to add to it. Barry has already said. We have commented before that it is a very competitive market. I don't think you'll hear anybody from Principal indicate anything other than it's competitive. But having said that, again, I think we bring a number of very unique elements to the competitive landscape that do give us a relative advantage. One is, again, our wholesale distribution network, approximately 150 sales reps who are very, very local to the advisors and to the brokers that we work with. And that, again, is a slightly different business model than most of our competitors, and that up-close and personal assistance that our retirement wholesalers provide to advisors and to brokers is very critical to winning their business.

Second thing I'd say is that, again, our TRS platform, which I think Barry commented at the start of the call was 46% of our sales year to date, that TRS model is a very winning model. The toughest sale we have is that 401(k) stand-alone sale. So the more we can move the RFP from 401(k) stand alone to something involving 401(k), DB, non-qualified and AESOP, the better we stand to win the business. So far, we're very pleased. Our close ratios are up 2%, or two percentage points, or about 20%. So we're still seeing positive signs, and the pipeline is building.

Thank you.

Thank you, Joan.

Your next question comes from Eric Berg with Lehman Brothers.

Thanks. Good morning to Barry and to the team, there. Two questions regarding Washington Mutual and the transactions there. It looks like the earnings, I think you said we should think in the neighborhood of 40 million, in that neighborhood. Why should we look favorably on a transaction that will initially produce, I guess, what will be a -- basically a government bond type of return on equity, right, $40 million of earnings on something north of $700 million in investment.

Yeah, I mean, obviously, first you've got incorporated into that is amortization of the goodwill and boba, and so forth so you've got to look at it. It would certainly be quite larger than that on a cash flow basis, but why should you look favorable? I would go beyond the financials for a year or two or three, and I would certainly say this is an enormously positive strategic fit. It positions us to capture more of the assets from baby boomers, it gives us a real significant foot into retail mutual funds and IRAs, gives us wholesale distribution, gives us another platform to sell our retirement products.

So from my way of thinking, and by the way, the long-term return will be in the 15% IRR. So I think you've got a very strong financial case but more importantly is a good strategic fit. Lastly, as you've heard us say many times, it gives us an incredible foothold into the lifecycle side of the business with their risk-based funds and our time-based funds, we really do become a market leader in terms of offering those kinds of investments. A bit of a recap of what we said on the call Eric, but those are some of the things that I think are very positive.

No, I hear you today, and that came through loudly and clearly when you did the Washington Mutual call. I guess my follow-up question then will be this. When I think of people retiring today, say leaving their last jobs, and now they're going to take a -- sort of a big, big chunk of money, in many cases of hundreds of thousands if not north of $1 million in some cases, out of their 401(k), money that they have accumulated typically from three, four employers over the course of a career, and now they're thinking of where to put it, it's just my sense that people tend to think in terms of the big major stockbrokers. I'm going to put my money with Smith Barney now to manage it. I'm going to put my money with Prudential, with UBS, with the big financial oriented stockbrokers.

My question is, does the Washington Mutual transaction, or other things that you are doing at Principal, position you to get this money that -- and let's assume that Principal is not the 401(k) carrier of this make-believe person and he's now thinking where he's going to place this 700,000, 800,000, whatever the balance is for the rest of his life. Does the Washington Mutual transaction better position you to get that money, or are you doing other things in this regard? Thank you.

You bet, Eric. That's a great question. It really speaks to one of the primary reasons we purchased W M advisors, is because they have an enormous foothold in regional wirehouses, stock brokerage firms, individual financial planners, and to some extent in the major wire houses, but we have a number of other initiatives going on.

We are getting our mutual fund platform prepared with our great investment results to be taking into -- taken into the wire houses. We're doing special SMAs, special managed accounts with some of our better performing funds. So we've got an all-out assault on trying to make sure that we do capture this huge growth that's coming at us, not just in our own 401(k), but more broadly in the market in general. Jim, you want to add a little bit?

Yes, thanks, Barry. Eric, I would add that with some of the very strong performing investment approaches we've got, we are getting shelf space for SMAs, separately managed account, with several of the major wire houses, including Merrill, Morgan Stanley, and some of the others. And we believe that that SMA shelf space will give us an entry to those wire houses to also offer mutual funds in coming years. One of the gaps at PGI is that we haven't had a mutual fund wholesaling group to hand that over to, and the Washington Mutual transaction gives us that mutual fund wholesaling group who can work with our more institutionally based SMA group. As baby boomer retirements accumulate and pick up steam, a lot of initiatives we have got throughout Principal that will help us gather more assets.

Thank you.

Thanks, Eric.

Your next question comes from James Ellman with Seacliff.

Quick question would be based on your earnings versus expectations and what the sell side analysts have been putting together for models. Over the last couple of years you've averaged 8, 10% higher earnings than the consensus expectation, and this is the first quarter where it was much closer to expectations. Is that primarily just due to volatile market, or is there something that's -- that's changed in the business or allowed analysts to catch up with the reality of the strength of your earnings stream? Thank you.

I'm not sure I have a good answer for that. I mean, you know, we're running our business to get the best result we can, and it's hard for us to know exactly what analysts are or aren't doing and why sometimes they're off and sometimes they're on. I suspect part of it may be that, we quit giving guidance on a quarterly basis, and I guess when we were giving it maybe -- there was a certain amount of conservatism in making sure -- we wanted to make sure we achieved what we were presenting, or forecasting, and so maybe some of that. But basically we don't really get too concerned in looking at what they do, and so I really can't speak to in that any great detail.

Typically, one of the problems we've had in the past has been that we've had a number of one-timers, and obviously, analysts would have a hard time predicting -- in fact, we have a hard time predicting when one-timers are coming, and this was a quarter that was relatively clean. So I think that's a lot of what you're seeing. When you have those one-timers, the analysts discount it anyway, so we feel very good about our results.

I would just close with our ongoing commitment to 11 to 13% earnings per share growth over the long haul, and we're much more focused on that than we are in any given quarter and quite frankly in any given year because we believe we can do that over a long haul.

Great. One other quick question with a bit of a follow-up to Mr. Berg's question a moment ago. Can you help us understand why you wanted to engage in the W M transaction? I understand there may be some significant growth down the line but I would imagine the cost of completing the deal certainly means that you will be able to buy back less stock in 2006 which would help 2006 earnings as well as 2007 earnings, and forward, versus this deal where there's some integration risk I would imagine and we're probably not going to really see any improvement in earnings in it until 2008.

That's an interesting question. Any management team has to balance results for today and results for the future, and you have to take a long term view of the capabilities that you're building for the future, and if we simply took every dollar we had and repurchased stock and only did an acquisition, when it it made immediate financial sense, then we would -- we would not have a very bright future. I would suspect that back in the 70s and 80s, when we developed the 401(k) market, we never could have done that if we took the idea that we're only going to do share repurchase.

So this is a reasonable acquisition with a 15% IRR or above, that helps us build for the future and grow for the future, and so that's the way we think about it. And we have not done a lot of large transactions because they had to make good financial sense and they have to make good strategic sense, and this one actually does both. So we remain very excited about it.

Very good. Thank you so much for the time and also appreciate, you're one of the few companies left in the space that still allow buy side analysts to ask questions on calls and I certainly appreciate it.

we appreciate you calling in, James. Have a good day.

your next question comes from Ed Spehar with Merrill Lynch.

Good morning. Can you hear me okay?

We can. Go right ahead, sir.

Mike, I just wanted to see if you could clarify some of the comments I guess on excess capital. Is it a reasonable assumption at this point, given the fact that you said you want to maintain some flexibility with debt capacity, is it a reasonable expectation to assume whatever we might estimate free cash flow is would be the most likely source of any buyback activity going forward?

Ed, that's a difficult question, because obviously what we do as we forecast and we're continually updating forecasts, is look at the opportunities we have and the situation that we have, and then fit it into the categories of priorities that we have, so organic growth, acquisitions, and then carefully managing capital, perhaps returning some capital to shareholders. I'd say -- I think could you safely say that having done a $0.5 billion of share repurchase, and then using an additional $0.75 billion, a little more than that, to buy the WAMU transaction, certainly we're more constrained today than we were.

But we still have some ability if -- depending on conditions to dip into our debt capacity or to dip into our capital, yes. But I think doing that fairly judiciously. So I think that the essence of it is cash flow is probably a primary driver. But do we have, as I said earlier this year, some room to maneuver? Yes, we do. And I think we'll just have to see how the future plays out.

Thank you.

Thanks, Eric. Ed. I'm sorry.

Your next question comes from Colin Devine with Citigroup.

Barry, I'm somewhat surprised you maintain your long-term growth rate despite that we may be on the cusp of pension reform legislation that would seem to me potentially impact Larry's business. Perhaps you could talk a little bit about that. And also, bring us up to date where you are a bit more on the variable annuity business where it seems your product have somewhat lagged some of the peers which seem a little more focused with the spousal riders and lifetime income benefits on the retirement market.

Sure, Colin. Appreciate the questions. On the pension reform, I guess we don't want tomorrow bed any additional growth until Congress passes it, and I'm not sure if they're ever going to pass it. But, you know --

I think we got Congress passed it, don't we?

No. We've got the House passed it. We don't have the Senate passing it. I think there are a number of very, very positive things in the pension reform bill, and you're well aware of them. Investment advice, there's making permanent the extra provisions of increased amounts.

Just a lot of -- automatic enrollment. There's some annuitization benefit to us, and I would certainly expect that over the long haul those things would benefit and cause the 401(k) market to grow more rapidly. There's clarification on hybrids. So I think that market would certainly pick up. So there's a lot of positive in there. But I think it's going to be several years before you start to see these really impact on the growth of the business and on -- and, therefore, profitability But clearly a positive sign.

Larry, did you have anything to add on the pension reform? You're closer to it.

No, not really, Colin. Barry's covered it well. I do think that change tends to cause opportunity as it relates to our ability to differentiate ourselves in terms of consulting both with our existing client base and with new advisors and new clients. If you look in the past, every time we've had legislative change it's tended to have some small positive impact on our sales and we'd certainly expect that to be the case in the future.

On the variable annuity, Colin, we have never set out to nor do we want to be a major, major variable annuity player. It is a very difficult market. It's, I believe, priced irrationally, and -- in many areas, so we very much use variable annuity as an important tool for, primarily our own career distribution, primarily for retirement planning, for our own plans. We do try to price it very appropriately. You're right, we don't have a lot of very complicated bells and whistles variable annuity and we think that's appropriate for the marketplace and yet we know it's an important tool to people as they head toward retirement but we try to keep a balance and therefore we tonight want it to be an overly significant part of our business.

What are you using as your primary product to address the retirement income market? We've talked a lot about focusing on that in the past. What are your advisors out there selling?

We have two things. We have the Principal income IRA, which we've talked to you about, it's very modern, it's a comprehensive tool that people can annuitize, move back and forth, but quite frankly because of the simplicity the number one product we probably have right now is the minimum withdrawal variable annuity.

It's a very straightforward 5% guaranteed withdrawal benefit, and it's very, very popular. People like the simplicity of it and we think it's priced appropriately. I tell you, some of these other products with 5 or 6 riders added to the same product, I don't know exactly how people are expected to understand complexities of it it. We find a lot of comfort in having a very straightforward product that people can understand.

Thanks, Barry.

Your next question comes from Suneet Kamath with Sanford Bernstein.

Thanks. Two questions. First, in terms of your EPS growth target of 11 to 13% over the long term, if I look over the past few years, I think you hit better than 11 to 13% growth both in terms of operating earnings as well as in terms of EPS. As I look at my model over the next couple of years, it seems to me that you might fall below that range in terms of operating earnings but you will hit it or fall in the range because of the impact of share buybacks. Do you think that's fair? The second question I have is, do you have any comments about potential exposure to Scottish Re given the company's announcement yesterday?

Sure. On the first one, one of the slides I use is is to go back since our IPO, and you think I show a little over a 10% compound growth rate in OE and a 5% reduction in shares over that period, and you get a 17% EPS CAGR since IPO, which I think is a very, very impressive number. If you look forward I think would you seat more toward the normal end of 11 to 13 but we are still confident that it will be, given the numbers we have achieved so far, still be 11 to 13% going forward. Obviously we have never said that the OE would be 11 to 13. We said EPS would be 11 to 13.

No doubt it will require share repurchase, but exactly what percentages and what order I don't know. But I think your assumption is reasonable, that the OE will be less than 10% or 11%, or in that range, probably a little less, and the rest will be made up with share repurchase. Not exactly sure what the exact makeup will be.

Your second question I'm having a hard time remembering. Scottish Re -- . We have, I think, about $35 million that we hold in our general account, exposure. They are an asset management client. Obviously we do reinsurance with them but on the reinsurance side we are very well diversified among a number of reinsurers and certainly not overexposed to any one, and certainly not to Scottish re. So it's not a significant issue on our minds right now. We're watching it, we're aware of it, and we'll be prudent to do whatever we need to, but at this point we don't see it as being a major event.

Thanks, Barry.

Thank you.

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

Well, again, I'd just like to thank everyone for being on the call, for your interest. We're extremely proud of the quarter. It was a very solid quarter. We're very confident about our future going forward. We see a lot of great opportunities, and we again thank you for your support. So have a great day, and thanks for the call.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. eastern time until end of day August 8th, 2006. 206-8246 is the access code for the replay. The number to dial for the replay is 800-642-1687 for U.S. and Canadian callers, or 706-645-9291 for international callers.