美國信安金融集團 (PFG) 2006 Q4 法說會逐字稿

Good morning, and welcome to the Principal Financial Group fourth quarter 2006 conference call. There will be a question-and-answer period after the speakers have completed their remarks. (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 Web site at www.Principal.com/investor. Following a reading of the Safe Harbor Provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks. Then we will open up for questions. Others available for the Q&A are Larry Zimpleman, President and Chief Operating Officer, Division Presidents 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 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 good morning, and welcome to everyone on the call. The fourth quarter was an excellent finish to an outstanding year for the Principal, with continued strong growth in operating earnings, earnings per share, assets under management and account values. As always, during the call Mike will provide a detailed overview of our financial results, including items impacting comparability, as well as an update on capital. I'll focus my comments on some key performance highlights for the year, and on our continued progress in three key areas -- accelerating growth in our U.S. and international asset accumulation businesses, leveraging our global asset management expertise, and profitable growth in our Life and Health Insurance businesses. In addition, we'll both provide some added color on growth expectations.

2006 was again a very good year for the Principal. We delivered a record $257 billion in assets under management, up 62 billion from 2005 in total, and up 34 billion, or 17%, on an organic basis; a record $163 billion in account values for U.S. asset accumulation, up 43 billion in total, and up 21 billion, or 17%, on an organic basis; record net income of $1 billion, up 14%; record operating earnings of $972 million, up 13%; and record operating earnings per diluted share of $3.53, a 19% improvement.

As I mentioned, we remain highly focused on several critical areas, including accelerating growth in our U.S. and international retirement businesses. I'll start with full-service accumulation, where significant growth in account values continues to drive strong growth in earnings.

In addition to a record fourth quarter, full-service accumulation achieved record earnings for the year of $292 million, an increase of 18%. At year end, account values reached a record $92 billion, an increase of 14 billion, or 19%, reflecting double-digit growth in deposits from existing retirement plan investors, strong plan and participant level retention, and outstanding sales growth. Full-service accumulation net cash flows were $1.3 billion in the fourth quarter, bringing the full-year to 4.2 billion, or 5.4% of beginning-year account values.

Full-service accumulation sales grew 18%, based on assets, to $7.2 billion for the year, and 25% based on case count, reflecting continued improvement in sales rep productivity and increasing demand for our retirement offerings. Sales growth was strong across each of our market segments. Based on assets, emerging market sales grew 24%, dynamic sales grew 39%, and institutional sales grew 6%.

Total retirement suite continues to be a key sales growth driver, making up 58% of total sales for the year, compared to 34% in 2005 and 24% in 2004. Total retirement suite sales more than doubled from a year ago, based on plan count, and increased 89% from a year ago, based on assets, to $4 billion for the year. These results demonstrate the shift in demand toward total retirement solutions and, importantly, the responsiveness of our broad integrated offerings to plan sponsor needs.

A couple of additional thoughts on full-service accumulation sales. 2006 was again a remarkable sales year, with an 18% increase from 2005, well above our target. We continued to strengthen our portfolio of retirement solutions, our powerful sales system, and our exceptional distribution reach. In doing so, we continued to reinforce full-service accumulation's ability to deliver 10 to 12% organic sales growth over the longer-term.

Let me also reiterate that retention remains a major focus. In addition to being an industry leader in employer-level retention, which came in at 94% in 2006, our member-level retention continues to significantly outpace the industry. In 2006 we retained 54% of assets that became at risk when plan participants changed jobs or retired. To add some perspective, we retained more than $3.8 billion of at-risk assets for the year, including nearly 1.4 billion directly into our retail rollover products.

For Principal Global Investors, 2006 was another remarkable year; record operating earnings of $103 million, a 39% improvement, reflecting continued strong growth in nonaffiliated assets under management and strong execution of mortgage securitizations; record net cash flows of nearly $13 billion, an increase of 41%; and a record $191 billion in assets managed, including 60 billion of third-party assets. From a year ago, third-party assets under management are up 42%, up 29% excluding assets acquired as part of the WM Advisors transaction.

At year end of the retirement plan separate account managed by Principal Global Investors, 84% ranked in the top two Morningstar quartiles for the one-year period, 96% for the three-year period, and 88% for the five-year period; very high-performance, which bodes extremely well for sales and asset retention. Strong performance across asset classes has made us increasingly search competitive. Principal Global Investors now manages assets for 10 of the top 25 largest U.S. pension funds, and won third-party mandates in 2006 representing $6.7 billion, including 1.2 billion in equity mandates.

In terms of accelerating international growth and profitability, Principal International continued to make good progress in 2006. Segment assets under management increased strongly, up 24% to a record $19 billion at year end. The increase reflects a record 2 billion in net cash flows for the year, but does not include assets under management from CCB Principal, our joint venture with China Construction Bank.

Principal International's earnings were a record $72 million in 2006. Excluding items impacting comparability, which Mike will discuss, earnings were flat in the fourth quarter, but improved about 11% for the year -- below our longer-term growth expectations, due primarily to deflation in Chile and current high level of [AFORE] transfer activity in Mexico.

In 2007 we expect earnings growth for the segment will be more in line with our longer-term expectations, around 15% on a normalized basis. We expect continued strong earnings growth in Brazil and continued strong fee growth in Hong Kong and India, to be accompanied by stabilization of results in Mexico. But we are clearly keeping a watchful eye on the economic and business conditions that negatively impacted segment results in 2006.

Our primary focus for Principal international in 2007 will continue to be on organic growth, leveraging and expanding our distribution and sales networks, launching new funds and new product solutions, and preparing to capitalize on pension reform as it unfolds in Chile, India, Brazil and China.

Life and Health segment earnings were a record $283 million for the year, up 8 million. As you may recall, on a normalized basis we improved operating earnings for the Life and Health segment by about $20 million a year in both 2004 and 2005. After such solid growth in the two prior years, we are, clearly, not satisfied with segment earnings for 2006, which, on a normalized basis, were basically flat from a year ago. In 2007 we are continuing to focus on a number of important growth drivers, which Mike will discuss.

That said, we did make solid progress during the year in a number of key areas. For the segment we improved operating revenue by 8% to a record $4.7 billion. The fourth quarter marks 16 consecutive quarters of record operating revenue for the Specialty Benefits division, and nine consecutive quarters for the segment. In the Specialty Benefits division, return on equity exceeded 15% for the year. Full-year sales were up 21% for the division, reflecting growth and seasoning of our wholesaling force, and increasing success with our voluntary worksite programs.

In the Individual Life division, we updated our product portfolio during the year, and at year end began building some momentum with our new UL with secondary guarantee product and our nonqualified offerings. We expect a return to double-digit sales growth for the division in 2007.

At year end we also completed our second phase of our statutory reserve relief efforts, which in total for the year released $346 million to corporate. This resulted in a sequential improvement in ROE from third to fourth quarter 2006. It will positively impact division and segment ROE in 2007 as well. But, as Mike will cover in more detail, it will negatively impact earnings in 2007 for the division and the segment.

In the health division, we continue to deliver solid returns as we refine and execute our target state growth strategy. Though off slightly at year end, reflecting some price strengthening earlier in the year, we grew target state insured medical covered members by 9% in 2006. At nearly 17% ROE for the trailing 12 months, we remain pleased with returns for the division.

Before I close let me cover a couple of other areas. In terms of effective use of capital, organic growth and strategic acquisitions remain our top two priorities. As you may recall, earlier in the fourth quarter we announced that through acquisition, our CIMB/Principal joint venture would become Malaysia's leading retail and institutional asset manager, providing a strong platform for growth in Southeast Asia. The transaction is closing this week.

Effective December 31st we closed our acquisition of WM Advisors. The acquisition accelerates our ongoing shift in business mix toward asset management and accumulation. The combination of Principal funds and WM funds expands our suite of retail mutual funds and gives us significant third-party distribution to capture the increasing flow of individual retirement and investment assets. It also enhances our asset management capabilities and solidifies our leadership in life cycle funds, one of the fastest-growing asset classes in the U.S. Importantly, we completed the fund mergers in mid-January. Our team accomplished this formidable task with extraordinary speed, an effort we believe will have a meaningful positive impact on client retention, as well as our future fund sales.

We also continued to return capital to shareholders through repurchases and cash dividends. In 2006 we bought back 14.4 million shares for $750 million. As of year end, we had yet to begin the Board's $250 million November 2006 authorization, but we did repurchase $33 million of shares in the month of January. We also paid a cash dividend to common stockholders of $0.80 per share in the fourth quarter, a 23% increase from 2005 and a 220% increase from our initial dividend.

In 2006, we accomplished a great deal. Driven by strong performance, ROE improved 150 basis points to 15.3% for the trailing 12 months. We remain confident that we will continue to expand ROE over the next several years at an average rate of roughly 50 basis points per year.

2006 also contributed to very strong longer-term results. For the five years since our IPO, our performance includes compounded annual growth rates of 11% for operating earnings and 17% for EPS. Since 2001 we've also improved return on equity by 640 basis points and added nearly $160 billion in assets under management. This outstanding track record has helped build significant shareholder value, with our shares appreciating 186% from the opening of trading following our IPO through year end 2006.

I'd be remiss if I didn't also remind investors that Principal continues to receive some very important third-party recognition. In January of this year, we made the Fortune 100 Best Companies to Work For list, our fifth consecutive year. This award communicates the strength of our commitment to our employees, which we believe is creating value for our customers and our shareholders alike.

In closing, we remain sharply focused on executing our growth strategy. As always, we will continue working hard to extend our leadership in the industry, to meet the needs of growing business 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 financial detail for each of our operating segments and additional highlights for the quarter and the year. I'll close with some brief comments on our growth expectations for 2007 and over the longer term.

As Barry indicated, we are very pleased with our results. We delivered strong earnings per share growth, with an increase of 21% in the fourth quarter and 19% for the year. Certain items impacted operating earnings, netting to a benefit of approximately $0.01 a share in the fourth quarter and $0.11 a share for the full year. I will cover these shortly.

Moving to the segments, I'll start with highlights for U.S. Asset Management and Accumulation. Segment assets under management increased $58 billion during 2006, driving total company assets under management to a record $257 billion at year end. Excluding the WM Advisors acquisition, total company assets under management increased $34 billion, or 17%, and segment assets under management increased $30 billion, or 18%.

Compared to a year ago, segment earnings increased 31% in the fourth quarter 2006 to $179 million. Full-service accumulation and Principal Global Investors were the biggest contributors to segment growth, with both delivering record earnings. At $79 million, full-service accumulation earnings improved 22% on 16% growth and average account values. Better-than-expected market performance reduced deferred policy acquisition cost amortization expense in fourth quarter 2006 by about $3 million before tax. Excluding this impact, earnings growth was consistent with the growth in average account values over the period.

As Barry mentioned, full-service accumulation net cash flow for the year was a very solid 5.4% of beginning-of-year account values. I would remind you that net cash flows tend to come in unevenly throughout the year, reflecting the timing of sales-effective dates and transfer deposits, so we focus on how this measure emerges over multiple quarters.

At $32 million, Principal Global Investors earnings improved $13 million from the year-ago quarter. Prior-year quarter earnings were dampened by $5 million due to marked-to-market on mortgage securitization inventory. Excluding this item, Principal Global Investors earnings improved about 33% from the year-ago quarter. I would remind you that there is some seasonality in this business, and performance incentive fees benefited earnings for both fourth quarter 2005 and fourth quarter 2006.

For the full year, earnings for U.S. Asset Management and Accumulation improved $107 million, or 20%, to a record $645 million. In addition to full-service accumulation and Principal Global Investors, which Barry already mentioned, three other businesses in the segment produced record earnings for the full-year.

Individual annuity earnings improved 23% to $69 million on 21% growth in account values. Individual annuity sales were a record $2.5 billion in 2006, up 25%, reflecting meaningful growth in the Fidelity channel. Mutual fund earnings improved 56% to $25 million for the year on 25% growth in account values, excluding the WM Advisors transaction. At $3.8 billion, mutual fund sales were a record as well and up 12% for the year. Bank and trust services also delivered strong improvement, with $8 million of earnings in 2006 after breaking even in 2005.

As communicated last quarter, we believe it is increasingly important for investors to look at full-service accumulation, mutual funds, individual annuities and the bank as a set of interconnected businesses, designed to meet the entire spectrum of investor needs, from accumulation through retirement income management. In 2006 on a combined basis, account values for these businesses were up 20% on an organic basis, driving 23% growth in earnings.

Moving on to International Asset Management and Accumulation, earnings for the year were solid, particularly in light of some difficult operating conditions. There were several items impacting both fourth-quarter and full-year comparisons, which I will cover shortly.

Principal International's fourth-quarter earnings, after adjusting for items impacting comparability, were essentially flat compared to the year-ago quarter. As you may recall, fourth quarter 2005 earnings were about $14 million, after excluding net benefits of $9 million. Fourth quarter 2006 earnings of $15 million included a net benefit of $1 million. Tax benefits of $6 million, predominantly refinement for deferred taxes in Chile, were substantially offset by several other items, totaling $7 million on a pre-tax basis and $5 million after tax. The primary offsetting items were deflation in Chile and organizational restructuring costs to improve our position going forward.

For the year, Principal International's earnings were $63 million after adjusting for items impacting comparability, an increase of 11%. As Barry mentioned, we expect segment earnings in 2007 to be in line with our longer-term expectations. Based on normalized earnings of $63 million, Principal International's return on equity was approximately 6.8% over the trailing 12 months. The segment remains on track to achieve sustainable return on equity of 7% by the end of 2007 and 10% by 2010.

Moving to Life and Health Insurance, operating earnings increased 3% for the year to a record $283 million, and increased 3% in the fourth quarter to $65 million. After adjusting for items impacting comparability, segment earnings were down about $1 million in the fourth quarter and basically unchanged for the year at $264 million.

Specialty Benefit earnings were basically flat in the fourth quarter but increased 19% for the year to a record $89 million. Division earnings benefited by $9 million in 2006, including $3 million in the fourth quarter from the previously communicated group long-term disability reserving refinements. Excluding the reserve-related benefits, division earnings were up 6% in 2006 from a very strong 2005, which reflected strong performance in all the Specialty Benefits lines.

At $30 million of operating earnings in the fourth quarter, Individual Life results were strong following a solid third-quarter result. For the year, earnings for the division were $111 million, a decline of $8 million on a reported basis. After adjusting for items impacting comparability, as well as $4 million of lower earnings in the second half related to the return of capital to corporate, Individual Life division earnings improved by about $2 million for the year.

The decline in Health division earnings in fourth quarter 2006 to $13 million from $16 million a year ago is primarily due to an increased incidence of large claims. For the year, Health division earnings were down about $3 million on a normalized basis, but still generated a strong return on equity of nearly 17%.

As Barry mentioned, we achieved solid growth in insured medical covered members in our target states for the year. We continue to be challenged by shrinking fee-for-service membership and our highly focused on improving the performance of this business. In 2007 we'll continue working to improve network discounts to better align expenses to revenues and to integrate wellness more fully into our offerings.

Looking forward, we expect the Specialty Benefits division to continue to deliver strong sales and in-force premium growth and a return to double-digit earnings growth on a normalized basis in 2007. I will add that reserve refinements, which added $9 million to earnings in 2006, are expected to contribute around $3 million less to Specialty Benefits earnings in 2007, or about $6 million for the year.

After normalization and after adjusting for the earnings impact of our two-phased return of capital, we expect the Individual Life division to deliver moderate earnings growth in 2007, reflecting underlying growth in the business and ongoing expense management.

As Barry indicated, for the year the division returned $346 million of capital to corporate. The lower amount of invested capital will reduce Individual Life division and Life and Health segment earnings by $10 million during 2007, the majority in the first half of the year.

We expect the Health business to return to moderate earnings growth for the year on a normalized basis as well, while maintaining a strong return on equity. The division had 10% higher premiums and fees in 2006, and we're starting 2007 with 4% higher insured medical covered members. We expect loss ratios to improve in 2007 and believe our aggressive focus on network discounts will continue to improve our competitiveness.

Before taking questions, I'd like to cover excess capital, to revisit growth expectations and to summarize items benefiting 2006 operating earnings. I'll also comment briefly on SOP 05-1.

In the fourth quarter, several transactions impacted our capital position. We completed the acquisition of WM Advisors for $725 million, subject to post-closing adjustments, and incurred $16 million for acquisition-related expenses. We also issued $600 million in debt and paid our annual cash dividend to common stockholders, approximately $215 million.

Entering 2007, we continue to be in a strong capital position, with around $200 million of excess capital at the Holding company, several hundred million dollars of cushion at the Life company, and several hundred million dollars of debt capacity. We'd also expect to generate significant additional free capital as the year progresses and we generate earnings.

In terms of our growth expectations, some important items to keep in mind. Growth targets should be applied to normalized results, and actual and annual results may vary from average annual ranges. Our longer-term EPS growth target of 11 to 13% incorporates equity market improvement of roughly 2% per quarter. Our growth target is based on longer-term annual operating earnings growth ranges of 9 to 12% for U.S. Asset Management and Accumulation, 14 to 17% for Principal International, and 5 to 8% for the Life and Health segment.

For Corporate and Other, I would remind you of the range provided in December -- losses of 50 to $60 million for the year. Compared to 2006 actual, this amount reflects higher interest expense on debt in 2007 associated with our fourth-quarter issuance of senior notes.

For Principal Global Investors, we expect earnings from commercial mortgage securitization activities to be about $10 million lower in 2007 than 2006. I would remind investors that in 2006, securitization earnings came from two sources -- securing substantially all of the commercial mortgage loan inventory that was on our balance sheet at year-end 2005 with only minor carryover into 2007, and shared earnings from the new joint venture.

In 2007, while we expect joint venture earnings to grow, that growth will only partially offset the drop in earnings from securitizing pre-joint-venture inventory. I would also remind investors that over the long-term, moving this business to the joint venture allows us to grow it more quickly and that it freed up approximately $500 million of capital for general corporate use.

As discussed in this call and throughout the year, we had a number of items impacting operating earnings in 2006, which on a net basis totaled $30 million. For the Life and Health segment, total benefits were approximately $18 million, for Principal International, approximately 9 million, and for Corporate and Other, approximately $3 million.

Finally, SOP 05-1, we expect no material impact from guidance on our financials. More specifically, we do not capitalize policy acquisition costs in the group business within the Life and Health segment, and we see no impact on our variable annuity block because we have no internal exchanges.

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

(OPERATOR INSTRUCTIONS). Andrew Kligerman, UBS.

Just a couple of quick one-off questions. Transfer deposits looked very strong in the quarter. Was there any unusual kind of -- any unusual deposits that probably would have normally gone into the first quarter? And if so, could you specify how much you think would have flown into the first quarter?

Secondly, with regard to DAC, the amortization seemed quite low, particularly in USAMA, and in Life as well. Was there some reversion to the mean accounting there? What was it? And what might be making it unusually low?

And just lastly, Corporate and Other. The guidance, I think, is for 12 million to 15 million in losses per quarter for next year; at least that's implied in your guidance. How does that stack up with the 6.5 million in losses in 4Q '06? What might be the differential as we look to '07?

Thank you, Andrew, and good morning. Let me ask Larry first of all to take the deposit question, and then I'll ask Mike to maybe do both the DAC and the corporate segment earnings.

On the transfer deposits, I don't know if there's anything unusual other than our comment before that the effective dates can bounce around. There is some seasonality. For example, in the fourth quarter, we had, I think, basically eight full-service accumulation sales of $100 million over for 2006, and four of those were in the fourth quarter of this year. So, that speaks to the very strong full-service accumulation sales. And so, when you typically see sales be a little higher, you see transfer deposits be a little higher, and that basically explains what's going on in Q4.

And you feel good going into Q1?

Our pipeline remains good. We continue to focus, as both Barry and Mike said, on deepening our relationships and continuing to push our total retirement suite, which was 58% of our sales last year. And we think we will continue to have a competitive advantage going forward there.

Mike, you want to take the DAC and corporate?

I had a very elegant answer on DAC, but given that our comments ran a little long, I will give you the Reader's Digest version. If you think about what normal DAC amortization would have been for the fourth quarter, for Individual Life it would have been something around $16 million, annuity would have been about 12, full-service accumulation somewhere between 27 and 28. And so, when you compare it to the actual amortization that we showed in our financials, [it would] be about 5 million less for individual, about 1 million less for annuity, about 3 to 4 million less for full-service accumulation.

Why was it less than normal? It was less than normal because in individual, we had some experience true-ups, and experience true-ups came to roughly $3.5 million or so. And then on top of that, we had some equity market -- because of the increasing equity market and the impact that that has on DAC amortization -- it's kind of counterintuitive; when equity markets go up, DAC amortization goes down. That had about a $1 million impact on Individual Life, about $1 million impact on annuity, and about $3 million to $4 million impact on the full-service accumulation business. Does that answer your question, Andrew?

Perfectly.

Talk about corporate -- we would expect corporate, first of all, to be a little higher next year because of the interest expense on the $600 million of debt that we issued in the fourth quarter. So, when you think about the impact on a per-quarter basis, I believe it would be somewhere around 50 million -- $5 million of OE, an after-tax OE number. So, you can take the 6.5 this quarter and add about another 5 to it. We also, I think, had a little bit stronger investment income this quarter than we would normally expect as well. So again, going into next year, I think, we're pretty comfortable with that 50 to 60 million negative for -- as a full-year estimate.

Colin Devine, Citigroup.

I had a couple questions for this morning. First, if you could give us some comment on the pension closeout business, in terms of what sort of quoting you're seeing going on out there, and how strong, perhaps, you think this is going to be.

Second, I think since the IPO the goal has been to grow the full-service business at a rate of at least net flows being 5% of opening AUM. Now we've got the Pension Protection Act out there. Is that still a realistic goal, or, I guess, should it be higher? Clearly you beat it in '06, and certainly higher goals (indiscernible) certainly a higher long-term growth rate for Principal. And then lastly, if you could give us some sense, Mike, just a range perhaps of where you think RBC is going to end the year, and if you have any plans to increase the amount of leverage on PFG's balance sheet in '07.

We'll tick those off for you. I'll ask, I think, Larry to go ahead and cover both pension closeout business as well as the Pension Protection Act, and how that might impact on net cash flows.

Just, again, briefly on both of those, in the pension closeout business, again this year we sold about 300 million of that business, which was just down a little bit from a year ago. In terms of the Pension Protection Act and some of the freezing and, ultimately, terminating of defined benefit plans, I think there's reason for a belief that there would be some increase in that business. Having said that, I would say, at this point as we look at the marketplace, we are seeing some increasing quote activity, but we're not necessarily seeing that there are placements, actual placements going on. Again, it's typical in this business that plan sponsors will go out and they'll seek a quote, just to kind of understand how underfunded they might be. And so, you have to understand that quotes don't necessarily translate into sales. We are seeing more quotes; we're not necessarily seeing more sales at this point.

Quickly, on the 5% net cash flow, we have modeled what we think the impact of Pension Protection Act will be. We believe that if you look at deposits now -- not net cash flow, but deposits -- we think Pension Protection Act, with auto enrollment and step-up contributions, might increase deposits on a plan somewhere around 10 to 12%. But ultimately, the degree to which plan sponsors engage all those tools is going to take time to phase in. Today that's only about 20% of the block. What that goes to and over what period of time, we don't really know.

So, we're not really looking to change our 5% net cash flow assumption at this point. And I'm certain you recognize somewhat offsetting that is the maturing of the Baby Boom generation. So, we are going to see a pickup in member-level withdrawals on the outside as well. So, we're going to stay with our 5% for now.

I would just add to that, I think, as Mike said in his remarks, we really need to start thinking about all of these businesses as being somewhat an integrated group of products. Because as the rollovers begin, and as we're successful retaining those, [you're going to] see a positive to the net cash flow, but it's going to be going to other products. So you're going to have to be able to see where those dollars actually track. So, maybe it's going to be good to look at the block as a whole instead of one piece at a time. Mike, you want to cover the (multiple speakers)

Barry, just to follow-up on that quickly before we go to Mike, there seems to be a lot more regulatory scrutiny on the 401(k) business today, whether it's disclosure of fees, but also on the rollover business. And who exactly is benefiting that? Is it the plan sponsor or the participant? If you can just make some comments, perhaps, as to what you're seeing out there, and whether that may impede your ability to retain as much of the business going forward as you are today.

I understood the first part of that question. There, obviously, is a fair amount of discussion going on around the fees in the 401(k) business and disclosures. And obviously, we think we're among the very best in that. But there are some issues around that, but I have not heard any issues necessarily around that issue and rollover, so I'm not exactly sure what that is referring to. The way we go at the rollover business is very straightforward and it is offering products and services that are sometimes with the Principal, sometimes not, but basically, we think, is all in the best interest of the plan participant to have good advice as to how they roll over and protect the tax advantage. So, I'm not quite sure what the focus of that question is.

Maybe to clarify, on the rollovers -- on the retention, is your focus on keeping them within the existing 401(k) plan, or to put them into a Principal IRA, or some vehicle that is outside the 401(k) plan they're in?

Our primary focus is to get them ultimately in an IRA rollover vehicle where they can -- and we can help them manage those assets over the long-term. Sometimes the easiest thing to do for them is to stay in the plan. Sometimes they like the continuity, not in the plan, but in assets that look like the plan. And sometimes their focus is to have the simplicity of that. But, I guess, at the end of the day we're wanting to do whatever the customer wants and whatever makes sense for the customer. But long-term, it would seem that as their retirement needs change and as they try to get ready to have enough income, that would bode for either an IRA or a Principal IRA, or some kind of a vehicle which allows them to manage their income.

Now, Mike; RBC.

Colin, I think, the quick answer about looking at NAIC RBC -- so we're talking about on a statutory basis -- it will be around 400. It might be a little higher -- above it, might be a little below it, but right around 400.

When we start thinking about capital, though, is we've got to deal with not only NAIC RBC, but also other rating agency measures. So, as you are well aware, S&P is developing a new capital model; that's going to factor into our thinking. Fitch has developed a new capital model; that will factor into our thinking. I thing even AM Best has changed some of their capital requirements. So, it's always a moving picture. It's difficult to get calibrated.

We do have capacity. We are being a bit cautious. We want to see how things shake out, and they should be shaking out in the first quarter or so. You might remember, we really do have a tier of the way we deploy capital -- organic, then acquisitions, then share repurchase. And in terms of leverage, we want to stay under a 25% debt to cap. And we do have a bit of capacity to be able to issue additional debt.

So, we'll be looking at all that really hard. We do it on a quarterly basis. We update, basically, rolling quarter looking out five quarters as to where we think we'll be from a capital position, from acquisitions, etcetera. So, it's work in progress, I guess, is the best answer I can give you.

Eric Berg, Lehman Brothers.

I actually had two questions also, both related to each other and related to growth. My first question is about the 401(k) business in general. I've heard and I have read that for some time the number of plans in the country has been essentially flat, that with companies going out of business, companies merging, new companies formed, that really the number of plans in the country is not growing.

So, my first question -- and I'll have one more after this -- is is that true? And if so, is it correct to think about the 401(k) business in terms of a really growth business? And if so, what is the nature of the growth generally that is taking place? That's my first question.

Probably should let Larry answer (multiple speakers)

I'll just talk about that quickly. I do think that from a plan account perspective, there continues to be very slight growth. But as you know, Eric, it is more in the S end of SMB -- that is, the small end of the marketplace -- where you do see typically maybe a one-half of 1% to 1% increased penetration in that under 100 life level. So, that -- while that's a big slice of the market, one-half to 1% increase of penetration is -- it's tens of thousands of plans, but, relative to the industry, not a big number.

On the other hand, the 401(k) industry, in my view, remains the growth industry. Because you have the opportunity when you're a leader, as Principal Financial Group is, with something as strong as our TRS model -- our opportunity is to gain market share from other competitors who really can't match the set of solutions and asset management capability that Principal Financial Group can do. So, our opportunity, really, is a combination of grabbing market share plus market growth.

My second question -- and you sort of answered it already, but maybe you'd like to expand -- is, because the number of plans at Principal has also not been growing -- you seem to be getting your growth through increasing average the size of the plans, that is to say the number of employees per plan, as well as getting ongoing assets from your existing plan participants. My question is where is -- what is your best summary description of where your growth -- this $5 billion in one quarter. Where is it coming from? Is it overwhelmingly that you are taking business from competitors, or is there what we might call sort of virgin plans that are being started? As you think about the bulk of the growth, what has it been about in 2006 -- taking business from competitors or new plans being started?

Actually, Eric, it's both. If you look at our case count in 2006, our case count -- just the number of cases that we put on the books in 2006 -- was up about 25%. And then, as Barry and Mike commented, our sales -- that's an asset base number -- was up 18%. And as you know, we deployed a set of sales representatives really focused on the smaller transfer market and the start-up market. And they are having tremendous traction in that end of the market.

At the end of the day, we have to be good at everything. We have to be good at new plans, start-up plans. We have to be good at transfer plans. We have to be good at institutional plans. It's interesting in that in 2006, our relative growth was actually higher in what we call emerging and dynamic, which would be plans of 50 million and under. In 2005 our growth actually came more in the 50 million and over segment. So, again, we'll take the opportunity where we find it. At the end of the day, we're going to be good at start-ups and at transfers.

Steven Schwartz, Raymond James.

Three questions; two very quick. There have been a number of changes in the Japanese laws regarding their own 401(k) system. You were in that market. You got out of that market. I've been wondering if you've now looked at that market again, and whether there's an opportunity for Principal.

Sure. Good morning. Let me just let Larry answer that. I think I know the answer, but let's make sure we get the expert.

This is not intended to be any surprise for the CEO. We exited that market, as you said, primarily because there's limited opportunity for -- there is no opportunity today for what we call salary deferrals; that is, contributions by members. All the contributions have to be by the employer, and it's at a relatively low level that's around, U.S. dollars, about $2500 a year per employee. So, that's still a pretty constrained defined contribution system. And that was really the reason that we exited. There is going to be some takeup. As we get closer to 2012 there'll be some take up, because they have to phase out of some other plans. But we have no intention to go back into the Japanese market.

I would add that one of the plays for Japan for us, as in Europe and other places, is through the asset management group. Jim, maybe you want to make just a quick comment.

We are still in the Japanese market and, in fact, have a growing business there managing assets for institutional clients. That's well over $1 billion out of PGI's non-affiliate business. We are increasing our resources in Japan, and we'll be in touch with that market through the institutional business looking forward.

On the life side, the Senate, I believe, in the minimum wage bill has what has been termed a pretty Draconian limit in terms of deferred comp plans. I'm wondering what you guys are thinking about that and how that may affect your business.

I think that's right; it is rather Draconian. And, I think, unfortunately, it's somewhat misguided. Because I think while it's intended to get at, perhaps, CEOs and very highly compensated, the way they've structured it really gets at a much broader group, and I don't think that was really the intent. It has a long way to go to be enacted. But even if it were, I think, if you look at our block of deferred compensation business, you would be, I think, amazed at how the average account balance in our deferred comp is relatively modest. I think 80% is under 100,000. 90% is under 200,000. And yet there is -- we know there is a big segment of that (indiscernible) highly compensated that would be impacted. We don't think this would be an incredibly devastating event for us, given the makeup of our business. But having said that, we don't think it's good legislation, and we are going to do everything we can to influence changing of it to make it more directed at what it was intended to -- the truly highly compensated.

Finally, looking at Specialty Benefits -- maybe this was touched; this is going along pretty fast. Group [LPB], the loss ratio was very high, as reported. I'm not quite sure the accounting, but maybe even higher if you take out the benefit. I'm not sure if it runs through there. What is driving that? Is this something -- is it just a variance that happens, or is there something endemic in that book of business that you've discovered?

Thanks, Steven. I'll ask John to get into that a little bit. He's right here ready to go.

Basically, there is one cell of our group long-term disability that is underperforming. We've narrowed it down. We understand the cell. We understand why it is underperforming, and we have changes in place to get it back to normal performance.

Tamara Kravec, Banc of America Securities.

A couple of questions. Maybe I can broach the retention question a little differently. You had said that 54% of your assets -- of the assets that are leaving are being retained. And you compared it to being better than the industry. And I'm just curious, from your prospective, how much better do you think that retention can actually get, in light of some of the comments that were made earlier? And is there a sensitivity, in terms of raising the retention by a percent or two -- is able to boost your assets by so much? So, if you can discuss that.

My second question was just on the UL market in terms of what you're seeing there. And we've seen a securitization or two, and some are in the works, and you're expecting a return to double-digit sales growth. So, curious about that. And then, finally, the health benefits ratio seemed high this quarter, and I wasn't sure if you had mentioned why.

Thank you very much and good morning. On the retention, I'll take a quick stab, and Larry can kind of fill in behind me. We've gone back and forth on what that number might be over time, and nobody really knows for sure. I will say that we are doing some things that, I think, are incredibly important and could be powerful over the long haul.

Right now, we're basically having to deal with people as they get ready to retire and as they get ready -- if they change a job, and sometimes we don't have as good a relationship with them prior to that period. And what we're trying to do is to build in through Work Secure and Retire Secure that we have a better relationship with all plan participants. So, when that event comes, it is so natural for them to want to continue to do business with us.

So it's in my mind not inconceivable that over a longer period of time, that that could get up into the 60%, maybe two-thirds. It's just hard to know. But it's going to take a while, and it's going to be -- some tools are going to have to be in place. We're going to have to really get focused on it. And the fact that we're already so much better, we think, than the industry, I think -- it's more difficult to get from 54 to 65 than it is to get from 19 to 20 or 30. So, it's a little bit rougher sledding when you get to these high numbers.

In terms of the impact, I guess you could do the math and say that if we retained 3.8 billion and that represented 54%, you could do the math and get to a point where every 1% is worth so much. What that doesn't really get at is the block grows quite significantly over time. So, if you were to project out five years, that 3.some-odd billion may be 6 billion. So, I guess, the point is it's a very significant number. Larry, I don't know if you want to quantify it anymore than that.

The only comment, quickly, I would add, Tamara, is that one of the big initiatives to actually grow the front end of the business, which is to write new 401(k) plans, is with our alliance partners as we describe them. And we have to have a very cooperative relationship with these alliance partners and understanding as to how the back-end asset retention effort is going to go. Because in some cases, they may want opportunities around some set or subset of the plan members. And we can certainly accommodate that, because one of the things that we're doing with the help of PGI and some of our other resources is putting our mutual fund and resale and rollover IRA products on the shelves of some of these other alliance providers, so that their own financial advisers can take them into their own rollover products but, again, use Principal mutual funds. All of that is why you heard us comment earlier that you need to think about these as an interconnected set of businesses. And you might see asset retention percentage have a certain trend in it, but that may mask the actual movement of money that is happening through somebody else's rollover IRA, but back into Principal mutual funds.

John, do you want to take the UL question?

On the UL market, as you know, we've been on somewhat of a roller coaster with our UL with secondary guarantee products, where we in 2004 had a very competitive product. And because of some changes in reinsurance and the cells we were marketing in, we were writing too much in the wrong cells. And we took a -- made a change and developed a completely new UL product that pretty much took us out of the market for a short period of time.

We've now come out in May of 2006 with a new product that we think hits the appropriate middle ground. With the reserve refinements that we made during the year, we believe it's appropriately reserved, and reserved at a level that will allow us to achieve appropriate levels of profit. We are starting to see some growth in it, but it's not going to be anywhere near the type of growth or the level of sales that we had with the original product.

The other thing, I think, is important to note is that in 2006, if you looked at all of our life sales, excluding secondary guarantee -- so, you just look at the non-secondary guarantee life sales -- we had a 17% growth in sales for the year. So, we're seeing some very good growth in the non-secondary guarantee market, so we're not nearly as dependent on those products to get our growth going forward. I think your last question was around help loss ratios. Is that correct?

Right, yes; the health benefit ratio, the loss ratio.

Basically in the fourth quarter, two things happened. One is there's seasonality. We always expect the fourth quarter loss ratio to be higher. So, that's a portion of it. The other portion was some unexpected claims. And what happened there is we had a higher incidence of large amount claims. We think that was just an abnormal fluctuation in the fourth quarter that should return to more normal levels going forward.

Joan Zief, Goldman Sachs.

I have two questions. The first is just -- could you just talk a little bit about what you're expecting on the spread business that you have, whether it's the fixed annuities or the full-service payout and the I/O, just to give us a feel for how that's doing and what you're expecting? And then, my next question is, now that there really is some attractive -- now that it's very clear that there is this attractive growth in the pension area, and as you say, you can expand it out through this whole solutions thing, with -- you add in the annuities and you add in the mutual funds, etcetera, etcetera -- how -- and you seem to be taking a lot of capital out of the life area. How important is it to you to stay in the life or the health or the disability business? What does it really add to what Principal provides to the customer and where you're going strategically?

We'll certainly be glad to answer those. Let me take the last one, and then I'll have Larry come back and talk about the spread businesses. I guess we've covered this a bit, and I don't think things have changed. We are fundamentally a company that is focused on the small to medium business segment, and we offer financial solutions to them, which are basically employee benefit-related. And while our core business, clearly, is the retirement business, we also find it to be a great advantage to be able to offer other complementary products. And I think the greatest example right now would be to look at the qualified, nonqualified solutions.

So, to be able to go into a plan sponsor and say we can offer the world-class 401(k). And by the way, for your highly compensated who can't fully participate, we have other solutions, some of which are involving annuities, some mutual funds, some life insurance. And while you could, I guess, get somebody else's product to do that, that would seem not to be consistent with our easy to do business with and our wanting to have bundled solutions for our customers.

The health insurance is a little bit different in that we're not in all states and in all markets. But where we are operating, it is a great advantage to be able to offer a full array of employee benefit products and services for the small to medium business. And I would say beyond that, if you look back since we became a public company, we went through three or four years when the equity markets were very depressed, and the risk businesses provided great lift and earnings during that period of time, and provided earnings stability. So, I really think there are a number of reasons. And we have great expertise in these products. And quite frankly, to exit these products, I think, would be a difficult thing. We don't want to be just a small pure play; we want to be a large financial services company that's focused on the employee benefit market, small to medium businesses. And the fact that we also are in the asset management business because of the retirement business is yet another great business.

So, that would be my shorthanded answer to why this makes a lot of sense strategically to be in these multiple businesses. But I will be quick to say we are shareholder-friendly. We are managing these businesses to get good performance. We have demonstrated in the past if a business ever gets to a point where it's not adding value over the long haul, we'll do what is necessary. But at this point, we certainly like the businesses we're in. Larry, you want to talk about (multiple speakers)

Real quickly on spread zone -- of course, like all things, it just depends on your point of comparison. Spreads in the fourth quarter on, basically, the primary parts of our general account that drive our business were actually up just a little bit. Again, it's a pretty broad range of fixed income capability that we have in PGI. So, they were up relative to the last quarter or two. They were about flat relative to a year ago. And if you went back a little bit further, two and three years, you might say that they're down slightly. But they really have not had dramatic change. I would say going forward we would expect them to be approximately at the same level that they are today. So, again, we're doing well there.

Have you changed any strategy in the way you're investing your money? Have you added more alternative investments? Are you going out on the risk curve a little bit more? Anything?

Let me take a shot at answering that. I would say that we (technical difficulty) has developed a significant amount of expertise in several different areas, and structured products is certainly one of those. So, we are adding that to our portfolio. We are not adding a tremendous amount of what you would refer to as alternative investments, which is typically hedge funds and private equity and that type of thing. We're already in real estate, so that's already an expertise we had. And no, I would argue; we're not going out significantly on the risk curve.

I think we are at the appointed hour. We've run out of time. We apologize; our prepared remarks were perhaps a little longer this time than normal, but there was a lot to cover. Hopefully we did answer your questions through the prepared remarks and the Q&A.

Again, we thank you for your support; we thank you for your interest. We are very proud of our first five years as a public company and the results we've achieved. But I can assure you, we understand that that was the past, and we've got to continue to perform. And that's what we intend to do. So, thank you all very much, and look forward to seeing you all soon.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 PM Eastern Time until end of day February 13, 2007. 458-7874 is the access code for the replay. The number to dial for the replay is 800-642-1687, or 706-645-9291. You may now disconnect.