美國信安金融集團 (PFG) 2007 Q2 法說會逐字稿

Good morning and welcome to the Principal Financial Group second-quarter 2007 conference call. There will be 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 website at www.Principal.com/investor. Following a reading of the Safe Harbor provision, Chief Executive Officer Barry Griswell, Chief Operating Officer Larry supplement and Chief Financial Officer Mike Gersie will deliver some prepared remarks; then we'll open up for questions. Others available for the Q&A are -- 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 welcome to everyone on the call. This morning I'll comment briefly on our performance for the quarter and through midyear; Mike Gersie will then provide a detailed overview of our financial results. Larry Zimpleman will follow Mike with an operational overview.

We were very, very pleased with the second-quarter results with outstanding performance from our core asset management and accumulation businesses and meaningful improvement from the first quarter 2007 for the life and health segment. Total company highlights include a record $282 billion of assets under management, an increase of 37% from a year ago; record operating earnings and record earnings per diluted share with 26% growth in earnings driving 28% growth in EPS and 80 basis points improvement in return on equity compared to the same period a year ago.

Record operating earnings and record assets under management from our U.S. and international asset management and accumulation segments drove strong total company performance. On a combined basis earnings from the two segments were up 34% from a year ago on a $75 billion or 39% increase in assets under management. Within U.S. asset management and accumulation, Principal global investors, Principal funds and full-service accumulation each delivered record earnings improving 34, 102 and 24% respectively.

As I indicated, we were pleased with the life and health segment's sequential improvement. Individual life and Specialty benefits earnings reflect improved claims and expenses. Second-quarter earnings for the health division reflect some continuing adverse claims experience; however we continue to believe reported earnings for the division will come in fairly close to the $50 million communicated at the first-quarter earnings call. As Larry will discuss, we're confident the actions we're taking will help stabilize earnings and lay the foundation for the division to achieve sustainable 15% returns.

Membership growth, particularly in the insured medical business, will be a slower turnaround, but we're already seeing some retention benefits in the fee for service business related to our network discount arrangement with Aetna Signature administrators.

Let me close my remarks with a couple final thoughts. Again, I would emphasize our commitment to our current portfolio of businesses. Our risk businesses contribute to the strength of our small to medium business franchise, provide earnings diversification and contribute to the organization's long-term profitable growth.

Our U.S. and international asset management and accumulation segments, importantly, are showing tremendous positive momentum and achieving extraordinary growth. Earnings are up $78 million or 23% through six months on a combined basis, accounting for 81% of the Company's total earnings. By comparison, these two segments made up 74% of total company earnings for the full year 2006.

One other comment on our asset management business -- reflecting broad expertise and strong investment performance we continue to move our way up the asset management rankings. Earlier this month an institutional investor recognized Principal Global Investors as the third largest U.S. money manager and the fifth largest manager of real estate based on year-end 2006 assets under management. In closing, we remain committed to and confident in our ability to achieve our longer-term performance goals of 11 to 13% average annual growth in EPS and roughly 50 basis points average annual improvement in return on equity. Mike?

Thanks, Barry. This morning I'll spend a few minutes providing financial detail for each of our operating segments including additional highlights for the three and six-month periods. Starting with U.S. asset management and accumulation, segment assets under management are up $66 billion or 38% from a year ago driving total company assets under management up $76 billion to a record $282 billion.

Segment earnings increased 30% from a year ago to $197 million in the second quarter. We continue to see strong performance in our three key retirement and investment businesses and from Principal Global Investors. At a record $85 million, full-service accumulation earnings improved 24% from the year ago quarter and 20% growth in average account values.

On a pre-tax basis earnings improved 19%. The business's underlying strength continues to show in key measures such as deposits, up 14% from the year ago quarter; sales, up 27%; participant level retention at 52% for the quarter; and plan level retention at 94% on an annualized basis. Let me briefly explain this last measure. Through six months plan level withdrawals are down $30 million on nearly $15 billion of higher average account values, an outstanding result.

At a record $12 million Principal Fund's earnings more than doubled from a year ago as our mutual funds business continues to achieve solid organic growth and good post merger performance. At $20 million individual annuities delivered its second best earnings quarter, up 32% from a year ago on continued strong account value growth.

At a record $32 million Principal Global Investor's operating earnings increased 34% from a year ago. This significant improvement primarily reflects continued strong growth in fee revenues which were up 38% from a year ago and up 27% excluding the impact of the WM Advisor acquisition. The increase from a year ago also reflects a $3.5 million after-tax benefit primarily from higher performance incentive fees.

I'd also point out that earnings from commercial mortgage securitization activities were $5 million in the current quarter, down $2 million from a year ago, reflecting our transition to the joint venture with U.S. Bank which freed up $500 million of capital for general corporate purposes.

Investment only and full-service payout earnings were up 12% and 53% respectively from the prior year quarter. Both businesses continue to achieve moderate growth in account values. Investment only earnings benefited by $2 million from higher prepayment fee income compared to the prior year quarter. Full service payout earnings benefited by about $4 million from higher mortality gains in prepayments.

Moving to international asset management and accumulation, second-quarter earnings were a record $27 million, up 66% from a year ago. The increase in earnings reflects continued strong growth in assets under management in Brazil, Chile, Hong Kong and China. Earnings also reflected a $4 million gain on a bond exchange in Brazil which is treated as operating earnings under equity method accounting. Adjusting for this item, earnings were up 41% from the year ago quarter.

Moving to the life and health segment at $60 million, second-quarter earnings were down $5 million from a year ago, but up $15 million on a sequential basis. At $23 million Specialty Benefits delivered its second best earnings quarter ever, up strongly from first quarter, but down $3 million from record earnings in the prior year quarter. The decline from a year ago primarily reflects unfavorable claims experience in the group disability line in second quarter 2007 compared to favorable experience in that line a year ago.

Individual life earnings were $24 million in the second quarter, an increase of $1.5 million or 7% from a year ago and up 53% from first quarter. Improvement over the prior year quarter reflects growth in the block of business and a return to more normal death claims. This was partially offset by $4 million of lower earnings associated with our transfer of excess statutory capital to corporate in 2006 which lowered the division's asset base.

At $13 million health division earnings were down $4 million from a year ago. We believe the health division has an earnings run rate for 2007 of approximately $60 million to $65 million. This would translate into a run rate return on equity of about 12 to 13%. We expect to report around $45 million to $50 million of earnings for 2007 reflecting the $15 million impact on first-quarter earnings from unfavorable reserve development related to 2006 claims. Larry will cover what we're doing to improve division results.

A couple of quick comments on corporate and other. As you know, the segment includes joint venture real estate operations. During the quarter highly favorable market conditions added about $7 million of earnings. The segment also benefited by $2.5 million for recovered interest income on a previously nonperforming asset. We expect lower real estate earnings in the third and fourth quarters due to lower real estate activity and estimate average losses for the segment of $[15] million per quarter for the second half of the year.

Let me briefly comment on our sub prime residential mortgage portfolio. At a high level our holdings are very high-quality and our entire exposure at 1.3% of total invested assets is very small. Specifically, of our $629 million of home equity asset backed securities, 99% are AA or better. Of our collateralized debt obligations, $177 million are backed by sub prime mortgages with 61% of our investments rated AAA and another 36% rated A or A-. Because of the level and quality of our holdings we don't view sub prime as a portfolio concern for the principal.

Let me wrap up my comments with a brief description of our capital position. At quarter end we continue to be in a very strong position with about $600 million of excess capital between the holding company and the life company and about $400 million of debt capacity. Organic growth and strategic acquisitions remain our top two priorities for use of capital. We also continue to return capital to shareholders through share repurchases.

In the second quarter we bought back 2 million shares for $118 million from the Board's November 2006 authorization bringing total repurchases to $218 million as of June 30th. We completed the remainder of that authorization during July. As you may recall, the Board authorized another $250 million program in May 2007 which we expect to begin in August. As always, we continue to look for ways to optimize our capital structure and to effectively use capital to build value for our shareholders. Larry?

Thanks, Mike. As indicated, I'll provide a brief operational overview covering our ongoing focus on three areas -- continuing growth in our asset accumulation businesses, leveraging our global asset management expertise, and profitably growing our life and health insurance businesses. Let me start with life and health.

We view the underlying operations of Individual Life and Specialty Benefits divisions as stable and improving. In the Specialty Benefits division, premium and fees are up to 13% year-to-date and operating expenses as a percent of premium and fees have improved 220 basis points through midyear. In the individual life division we continue to build sales momentum across a broad spectrum of our retail products as well as our non qualified offering, reflecting continued good performance from our career channel and strong momentum with independent distribution. Through six months total premiums and deposits are up 12% with first year premiums and deposits up 34% and single premiums and deposits up 26%. By comparison division operating expenses are up only 5%.

Moving to the health division, we recognize that before we can return the division to growth we need to stabilize earnings. Key to our success are a number of initiatives focused on controlling claims costs, including network contract management, claims processing, wellness programs and disease management. Through our efforts to date we've improved operating expense ratios on all our products as we align expenses with lower membership. As a percent of premium and fees we've improved operating expenses by 90 basis points from a year ago for insured medical and by 840 basis points for our fee for service business. Diligent expense management will continue to be a major focus for the division.

As signaled at last quarter's call, in the second quarter we announced a national network discount arrangement with Aetna Signature administrators for our fee for service business. This allows us to provide our fee for service customers with competitive discounts which, along with our focus on expenses, will help us return to fee for service business to growth and higher profitability. As mentioned, we're already seeing some retention benefits from this arrangement. We expect the benefits will become more evident with 2008 sales and retention.

Let me close the discussion of our health business with some comments on the longer-term opportunity. We view positively the increasing interest in consumer driven healthcare, health savings accounts, wellness and disease management. We believe we're well positioned for these trends in both our insured medical and national accounts businesses and that we will achieve attractive returns over time as these trends continue.

Let me now comment on our U.S. retirement businesses and full-service accumulation where significant growth in account values continues to drive strong earnings growth. At quarter end full-service accumulation account values reached a record $99 billion, an increase of $17 billion or 20% from a year ago. As mentioned, that strong increase reflects good growth in deposits from existing retirement plan investors, strong plan and participant level retention and outstanding sales. The strong increase in account values also reflects substantially better market performance than our growth assumption of roughly 2% per quarter.

I'll briefly expand on this to help investors more fully understand how variations from this assumption impact net cash flows and account values. Clearly higher than assumed market performance accelerates account value growth. In second quarter 2007 credited investment performance contributed about $2.2 billion of account values in excess of our 2% quarterly assumption.

A less obvious impact is that job changers and retirees are taking out balances that have been inflated by the market run-up which negatively impacts net cash flows. Higher than assumed equity market run-up over the past four quarters inflated second-quarter withdrawals by about $270 million and about $560 million over the trailing 12 months. This has had the effect of reducing trailing 12 months net cash flows from 5.2% of beginning of year account values to 4.5%.

Importantly, we remain confident in our ability to achieve 5% net cash flow for full-service accumulation on average over the next several years. But we expect that in any given year net cash flows will come in as high as 6% and as low as 4% of beginning of year account values reflecting market performance fluctuations as well as the natural unevenness caused by sales and termination effective dates and the timing of asset transfers.

More relevant than the full-service accumulation net cash flow measure, because it reflects our success retaining a large and growing pool of at risk member level assets is the growth of our three largest accumulation businesses on a combined basis. In total full-service accumulation, Principal funds and individual annuities earnings were up 31% from a year ago. Account values for these businesses are nearly $150 billion, up $46 billion or 43% from a year ago and up 22% excluding assets acquired in the WM Advisor transaction.

Combined sales for the quarter were outstanding as well, up $1.5 billion from a year ago driving sales of these offerings up $2.3 billion or 32% to $9.5 billion year-to-date. Over time this combined result will be the true test of how well we're extending our relationships with 401(k) plan investors and other individuals to become their provider of choice for rollover IRA and retirement income management solutions.

A couple of additional thoughts on full-service accumulation sales. At $1.4 billion we achieved our best second quarter on record, improving more than $300 million or 27% from the prior year quarter. Total retirement suite remains a key driver making up 49% of sales year-to-date based on assets and improving 17% based on plan count. Alliance sales were also very strong, up more than 86% through midyear.

Looking forward, based on pipeline and second half commitments we are highly confident we will achieve our 10 to 12% organic sales growth target for the full year. We're also very pleased with Principal Fund's fundamentals. Post merger earnings are ahead of our plan for our mutual funds business. Mutual fund sales more than doubled in the second quarter and have more than doubled year-to-date with our new third party distribution contributing about 80% of that gain and our existing channels contributing about 20%.

We are experiencing some outflows from the WM Advisor block as a result of a change in advisor compensation; but the level of outflows is in line with our acquisition plan and total account values remain ahead of plan. We expect mutual fund net cash flows to improve from second-quarter levels as we continue to build sales momentum.

Principal Global Investors continued to leverage and expand its global asset management expertise during the second quarter. As an example, Principal Global Investors' preferred security strategy is now being offered on Merrill Lynch's unified management account platform. Another positive development for the business was signing a definitive agreement to acquire Morley Financial Services, a leading stable value asset manager. This is an important capability in the 401(k) market and an investment option we believe baby boomers will increasingly demand as they move toward retirement and seek to preserve capital and generate income.

Notwithstanding the quarterly fluctuation, we're extremely pleased with Principal Global Investors' net cash flow which exceeds $12 billion for the trailing 12 months. From a year ago Principal Global Investors' assets under management are up $57 billion or 37% to a record $211 billion including a record $67 billion of third party assets, an increase of 44%.

In terms of accelerating international growth and profitability, Principal International continues to make excellent progress. Segment assets under management are up 55% from a year ago to a record $25 billion. Over the trailing 12 months segment net cash flows were $1.7 billion or 10% of beginning of period assets. In addition to continued strong earnings growth in Brazil and Hong Kong, assets under management growth also drove solid earnings improvement from a year ago in Chile and in China where we moved to profitability this quarter, more than a year earlier than planned. Based on normalized earnings, segment return on equity is approximately 7.1% and Principal International remains on track to achieve sustainable return on equity of 10% by 2010.

One final point on the segment. Principal International continues to do a tremendous job transitioning to more fee-based businesses. As reported, fee revenues are up $7 million year-to-date or 13%. However GAAP accounting masks the size and growth of fee revenues for equity method subsidiaries. Including our equity method subsidiaries, fees are more than twice the reported amount and up 37% year to date. We're currently looking at ways to expand our disclosure of this important element of Principal International's growth story.

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

(OPERATOR INSTRUCTIONS). Jamminder Bhullar, JPMorgan.

Thank you. I have a couple of questions, the first one is on the health business. If you look at the earnings projection for '07, it's about I think 40% lower than what you earned a couple years ago. And if you can discuss why the margins in that business have declined so much, whether that's because of growth in high deductible plans or you feel you mispriced the business or just to claims trends have gotten worse?

And then secondly, on your life insurance business, the sales improvement this quarter, what's driving that? I know you've got the UL7 product and if you can comment on whether you've made any pricing changes in individual life?

I'll ask John Aschenbrenner to actually take both of those.

On the health business for earnings, I think you first have to look at the run rate for this year which is about $15 million higher than what we'll report because of the $15 million in the first quarter that was really due to losses in the prior year. So I guess what I would say is two things are going on. One is we've got that $15 million hit in the first quarter; second, we were at an unsustainable level of earnings for the health business when it was running in the 22 to 24% return on equity and so it really is falling back to what I think is a more normal rate of return. And then we did have extra morbidity that we hadn't expected in our pricing. So we are a little bit under priced and we are recovering that, building our pricing back up, making changes in our underwriting.

Is that mostly high deductible plans or just the overall business?

It's the overall business. And I think when we talked last quarter we talked more about high deductible. And what happened is the pattern of high deductible I think matched a little bit some of the deterioration. So as we dug in more after the first quarter we discovered a little more deterioration than we expected. We've got the fixes in place.

What actually happened in the second quarter is the loss ratios are probably about 150 to 200 basis points better than what you would have expected coming off of the first quarter. So we're seeing some good improvement already in the second quarter, we expect that to continue throughout the year and, as mentioned in the remarks, some good improvement on the expense side as well.

Life sales, John?

On the life sales side, no major changes in products or pricing. It was improvements in sales really across the board, so both our death benefit focused universal life, our (inaudible) value accumulation universal life, our secondary guarantees, our term insurance and our survivorship products all experienced some strong growth. A lot of that is coming from really a major push in the independent market and building relationships with some strong independent distribution.

Okay, thank you.

Tom Gallagher, Credit Suisse.

Good morning. I guess just back on the health for one minute, just so I understand it. Annual earnings you're expecting to be in the $45 million to $55 million range. And if you look at, I guess ex the prior year adjustment, did you mention that 2Q actually got better than 1Q? Because it appears like it got worse from an underwriting standpoint. Maybe you could just clarify that? And then isn't that range also implying that you're going to get a nice lift into the third quarter assuming first-quarter breakeven is still the expectation?

Tom, this is John again. If I heard you right, I think you said 45 to 55 on the health earnings expectations and Mike's comment was actually 45 to 50. And we would expect the first-quarter loss ratio to be significantly lower than subsequent quarters because primarily of the high deductible health plans and the deductible kicking in in the first quarter so the claims would be significantly lower.

As we neutralize all that and compare what we would expect in the second quarter versus what we got in the first quarter, if we would have just followed what was going on in the first quarter we would have expected second quarter to be another 150 to 200 basis points higher than what it turned out to be.

And outlook for the remaining year and how does that affect third quarter, John?

Outlook for the remaining of the year -- we would expect most but not all of the remaining earnings to come in in the third quarter. As we continue to make improvements in the loss ratios and the expenses we would expect a little bit of help in the fourth quarter.

Got it, okay. So part of it is really just the seasonality of it?

Yes.

The next two questions, can you just talk a little bit about competitive dynamics in the full-service accumulation business? Is competition getting more intense? Is that part of what we're seeing here in terms of the overall net flows? And clearly based on your commentary on the outlook you still seem very positive. Maybe you could talk a little bit about the competition?

And then the last question I had was just on your investment portfolio, clearly you've had a big widening of spreads in both structured products and corporate bonds and I would assume also in commercial mortgage lending. Can you talk a little bit about maybe specifically commercial mortgage environment because you're pretty big there? Do you view this now as a good opportunity or are you becoming a little more cautious because if you just look at the CMBS market clearly spreads have gapped out. Thanks.

Very good. I'll turn to Larry in just a minute to answer the first and then Julia can comment on your second part of your three-part question because we're going to count the first one too. I think Larry will explain, but the net cash flow really had nothing to do with competition and the competitive environment, even though that's something we're always watching (inaudible). As Larry said, more a reflection of a run-up in the equity markets. But Larry, why don't you provide a little more color? And also about the competitive environment, because I know they always want to know about that.

Good morning, Tom. Let me just start with the competitive environment. Again, this business has always been competitive, it remains competitive, but having said that, I think we have demonstrated over the last five or six years that we do have a very, very strong sale infrastructure and a very competitive position and we've continued to grow and meet and exceed that 10 to 12% annual growth target.

Today what I would say, Tom, is that our value proposition is very, very strong in full-service [accume]. We've talked to you a lot about our total retirement suite platform -- that really is still an industry-leading platform, it's very, very competitive. Our pipeline is up about 18% so there's more than enough volume in the pipeline to meet our sales growth objectives for the year.

Our investment performance remains exceptionally strong and we commented on that at the opening of the call with 80% of our three-year and five-year funds performing in the top half of their universe. We have a very, very strong investment lineup and you do see all of that translating into our close rates on the business remaining very, very steady during the year. So as I said in my comments, we're very optimistic.

The flows, as Barry said, that is not a competitive issue. In fact, again, as Mike Gersie commented, the lapse rates at the employer level are actually lower this year than they have ever been -- they are at historic low levels, so that says that we're doing an excellent job of hanging on to our customers. So the flow issue is really the result of the recent run-up in equity markets; it's not a competitive issue and our competitive picture remains very, very strong. And I'll have Julia comment on the last question.

Good morning, Tom. This is Julia. You are correct, we have certainly seen a widening in spreads in the CMBS market. However the fundamentals of real estate remain extremely strong. So we actually see the widening in spreads as an opportunity as opposed to a concern or a risk. As you know, we're very, very good at both commercial mortgages on the private side as well as on the public side. So we consider this a strength and so our analysis would show that the market is actually now pricing the risk probably more appropriately than they had been, so we're treating it as a buying opportunity.

Got it. Thank you.

Jeff Hopson, AG Edwards.

Thank you. With regard to Principal Global Investors, anything there you can tell us about in terms of pipeline? And there were some higher withdrawals there, anything I guess lumpy? And then on the mutual fund side you mentioned some compensation changes; can you give us the details on that?

We'll ask Jim McCaughan to jump in on the asset management side and then we'll have Larry fill in on the mutual fund comp.

As you alluded to, the net cash flow for PGI for the quarter was down from the record first quarter of $4.4 billion to $2.1 billion in the second quarter, that's the net cash flow into PGI. The institutional mandate for the larger end tends to be quite lumpy. And the real story here is that in the first quarter we had three very large mandates, two for $1 billion each and one for $500 million which all funded in the first quarter. In the second quarter the institutional mandates were pretty good in number, but there was no single mandate over $200 million. So really those three very large mandates alone explain the downward move in the net cash flow.

In terms of pipeline, we're seeing a lot of activity and the level of activity at the large mandate end is as high as we've ever seen it. So we're confident that we can't pin any particular number on future quarters. We're confident that the trend on the institutional side is pretty strong.

In terms of the outflows from PGI, there were really a couple of things that put it above trend in the second quarter. Firstly, as has been mentioned -- this may be a lead in to the next question -- there were some outflows that hedge asset management, which is the former WMA investment group, and those amounted to about $350 million in the quarter. And secondly, we had institutional mandate withdrawals of about $500 million due to corporate changes of the client. But those are just unusual events that happen and make the cash flows a little bit lumpy. So we're pretty confident about the ongoing pattern.

Thanks, Jim. Larry, do you want to comment on the comp change on the mutual funds related WM Advisor?

Sure. The risk-based portfolios that WM Advisor had been offering for a number of years are called their SAM portfolios. And for a number of years prior to the acquisition they have had an advisor -- what I guess I'll call kind of an overlay fee on top of those same portfolios. And it had been very, very successful in generating a high level of sales on those funds and those are very popular funds, as you know.

The WM Advisors Board had made the decision I believe in March of last year, so prior to the transaction with Principal they had made the decision that given the growth in the SAM portfolios it was prudent for them to peal back that Advisor overlay fee and so they had begun to do that in March. And we had known that at the time of acquisition but anytime you make that sort of adviser comp change you're going to find some advisors and, again, given performance and the combination of those two you'll find some advisors who will look at other alternative offerings.

And so this was all planned, this was all, as we said in our comments, part of our acquisition plan. The total assets remain at or above the level we expected. So again, this is all very much in keeping with the plan and we're comfortable going forward that the transaction is very much on track.

Thank you.

Jeff Schuman, KBW.

Good morning. I'm hoping to go back and beat the health insurance a little bit more just for a moment; trying to reconcile a few things. I think as we talked last quarter, the outlook was for $50 million for the year, negligible earnings in the fourth quarter, and we now know that you are expecting a second-quarter loss ratio a couple points higher than what you actually experienced.

So I guess with all those pieces, it would have implied an extremely strong third quarter, and you're still looking for a pretty good third quarter. I didn't quite follow the explanation as to why -- is the third quarter naturally seasonally that good, or are there some unusual factors? Because it would seem like as you get beyond the first quarter and you get beyond exhausting the deductible, that earnings would kind of be pressured as you go through the year. Can you remind us, does the third quarter just tend to be just extremely strong?

Jeff, let me go back to my comment about the 150 to 200 basis points. That was not better than what we expected when we said we expected to hit the $50 million. That was better than what we would have expected based on first-quarter results if we had not taken any actions at all.

We knew when we talked to you at the first quarter, we needed to take actions to hit the $50 million. We started taking those. We actually expected or hoped to have a little more progress in the second quarter than we got, so we are a little bit behind where we would have liked to be when we gave you the $50 million projection. At this point, we still think we can get close to the 50, but certainly between the 45 and the 50.

The third quarter typically is a little bit better than the second quarter, not a lot, but a little bit better than the second quarter. And then, as I said, with the changes we are making we expect to get a little bit coming in the fourth quarter as well. So we still think we are pretty well on target for a 45 to $50 million year.

Okay, that is helpful. If we can go back to FSA for a moment, Larry explained that when the assets appreciate, then the redemptions essentially appreciate as well. I would think, though, that also you would see appreciation in the assets that you acquire, as plans transfer in that you would see inflated asset levels as well. Is there an offset there, or is that taken into account in your comments?

Good question. I will clarify that for you. Essentially, on the deposit side, if you actually go into the supplement and look, Jeff, what you'll see there is on the deposit side about 35% of the deposits roughly in a given quarter are what we call transfer deposits. So they would have that same kind of factor built in that we describe on withdrawals. But importantly, Jeff, 65% of the deposits really come from recurring payroll deduction deposits.

So 65% of the deposits have absolutely no positive or negative, but in this case they are not inflated by the equity markets on the deposit side as it is on the withdrawal side. So with 65% of the deposits really just coming out of biweekly payroll withdrawals, you really need to take that into account when you're looking at net cash flow.

And as we have said, we've tried to normalize that. That is worth about $560 million on a trailing 12-month basis. So as we look at the business, we think that our run rate net cash flow is about 5.2%, very much in line with what our expectation would be.

Okay, that makes sense in itself. Just lastly to follow up, so if we were to go back and look at some of the really big market run-ups in the past, would we have seen a similar effect or not?

Yes.

Okay, great. Thank you.

And conversely, if you had gone back and looked at sometimes when the equity markets were going down, 2002, '03 -- '01, '02, '03 -- you would see the opposite. You'd see us getting 6 to 7%. So it's just the way it works.

Okay, thanks a lot, guys.

Jones Zief, Goldman Sachs.

On the FSA, I just want to talk about the retention. You talk about it being 52%. Have you looked at it to see whether you keep -- as people change jobs your retention is high because people don't roll to another 401(k) plan? Do you see that when people actually retire they're keeping the assets with you as opposed to rolling? I was just wondering if you could just go through and just give us a little feel for what the retention is that you're talking about and what the trends are going to be that you think over time as the population starts to age.

I think I'll just go right to Larry on this, he's much closer to it.

In terms of retention, as you say, the 52% -- actually I think 53% by the time we sort of wrestle everything to the ground -- but 52% was our retention rate in the second quarter and that does reflect a combination. That's an overall retention rate from both job changers and retirees. If you actually break it down between the two, I think you'd find that job changers is slightly higher, more like 55%; retirees is slightly lower, more like 48%.

Now in terms of tracking all of this going forward, I would just say that there really are a lot of moving pieces to this because sometimes, for example, a job changer may leave his or her assets inside the plan in what we call a personal retirement account, or increasingly they're actually moving it to another product that's more in a retail setting, a mutual fund or individual annuity. And if you track the retention rate around funds and annuities, generally speaking that has been very, very acceptable certainly within the expected bounds as well.

And in terms of personal retirement account, we're actually putting a lot of efforts, doing a lot of customer relationship marketing and putting a lot of service efforts against those personal retirement account assets to make sure that we have a good relationship with those job changers so when they do get to retirement they will come and talk to us relative to their retirement options.

So it's a little early to tell. I don't really have any predictions of that at this point, but I would say we're confident we're doing all the right things to be able to position ourselves as the retirement income provider of choice.

And I guess as a follow-up, if you're looking at the very attractive growth in assets under management of the pension business, you're looking at the strong growth of the international business, the mutual fund business as you're talking about, how is that consistent with your 11 to 13% long-term growth rate? Why isn't your long-term growth rate higher than that? And I guess my -- I have a part three question. The part three is have you said anything about your earnings guidance? Is that staying the way it was?

Let me take the last one first and then I'll attempt the next to last and Larry can add to it. We have not made any comments on guidance. We give guidance and then we don't update guidance unless something material has changed. We had a little bit of a material change and we did make an adjustment last quarter, but we do not update or comment on guidance unless there's something significant in the business that might be causing confusion.

Why do we not have a higher than 11 to 13? A couple things I would point out. If you look back since we became a public company, we actually achieved about a 17%, so we have actually delivered quite a bit higher, but we also know that we are a company that has a diverse portfolio of businesses. We have risk businesses, we have a lot of things in our portfolio that can't grow. Our stable value for example, our [gig] business, those are constrained by general accounts.

So if you look at the entire mix of all the businesses we have, we think 11 to 13 is a very good number. If you really do the research and look at companies that have had that kind of sustainable growth over a long period of time, it's a pretty small group of companies and we think we're among a small group of companies that can have that kind of return. And I would point out that these past five years we have had incredible stability in our earnings -- where fewer asset managers have been up and been down, we've had very consistent earnings over a longer period of time. We think that's because of our diversified portfolio of businesses.

So is 11 to 13 the exact number? We think it's the right range and we're very confident in it. And we think if we achieve it we'll create a lot of shareholder value. Larry, did you want to add anything to that?

No, I think it's a very good explanation. Again, the last thing I would just comment, Joan, is you do have to remember that the investment markets have been delivering above what our long-term expectation -- our 11 to 13 again is based on an 8% equity market return, about 2% a quarter. So just take that into account as well when you look at and think about the 11 to 13.

Thank you.

Eric Berg, Lehman Brothers.

I have two questions. I'm looking first at a little exhibit we put together that shows the net flows as a percentage of your full-service accumulation account values. And there's no question that the June quarter is pretty much always a weaker quarter. But as I look at the trend over the span of time, this ratio has been coming down. This measure of organic growth seems to be slowing over an extended period. Now am I looking at this incorrectly? Is this not an issue, the fact that net flows as a percentage of your assets have been declining when looked at over the span of time? Is this not a worry?

Do you have a second question, Eric, and then we'll answer both of them? Or do you want to do them one at a time?

Sure. Well, I just wanted to go over two -- thanks very much, Barry -- I just wanted to go over to the issue regarding seasonality. I know you touched on it in your conversation with I believe it was Paul. But I would think again that in your health business, once you exhaust this deductible -- and I know you touched on this, but if we could elaborate -- I would think that you'd get fairly steady claims experience throughout the year. So can you review with us why the December quarter should be so modest in terms of earnings? Those are my two questions. Thank you.

We'll be glad to take them. Larry, do you want to take the net cash flow and what the long-term trend really looks like and why?

Sure. I'm not exactly sure, Eric, when you talk about the longer-term trend, I've seen the exhibit that you put together and I don't know that that goes back all that far, I think it was about two years, but let me make a few comments on that if you went back even further. If you go back to the 2000-2001 period, as Barry was indicating, you remember that in those periods the equity markets were actually negative.

So because of that actually net cash flow as a percentage of account value is going to look very, very strong, not again because the nature of the business is any different but because you're seeing equity market decline. So when you look at our net cash flow back in the '01-'02 period, we were there running a period like 7% of beginning account values net cash flow. Now you come into the current periods and you're seeing the reverse effect, not necessarily because the business is slowing, but rather because you have just the inverse of the '01-'02 effect is what you're seeing now in '06 or '07.

We still believe over the longer-term and assuming 2% per quarter and 8% a year, a 5% net cash flow objective is a very, very reasonable one. It was true in '01-'02, it's true in 2007 and it's just a matter of the equity markets that tend to put some vacillation around that. And I'll ask John to comment on the health seasonality.

Eric, I think we're all just kind of learning the last couple years on what human behavior we're going to see under high deductible plans. I think part of what's going on is that not everybody exhausts their deductible at the same time. And so as you're going through the year you're hitting more and more people and the fourth quarter obviously you're going to have a much higher percentage of your people that have exhausted their deductible.

The other thing though I think that we're finding is a number of the procedures and activities are -- may be optional or at least the timing may be optional and so that we're seeing people I think push things they might have done in January or February and gets them done in December when they'll get paid fully as opposed to doing them in January when they would be exposed to a new deductible. I think we're also seeing healthcare providers that are actually furthering that trend and helping people decide when to do certain procedures in order to maximize their insurance proceeds.

Both explanations were helpful and I thank you.

Colin Devine, Citigroup.

Good morning. I've got three. I was wondering if we could just, Larry, explain to me one more time on the net flows. Because at the end of the day they're still the weakest level you've seen in five years. And we've certainly seen markets go up-and-down, your company is much, much bigger today than it was five years ago. I'm having a little trouble reconciling the explanation, that's number one.

Number two, if you can give us an update on some of the regulatory issues in the 401(k) business and also I guess your company's legal status right now with the regulators in terms of any investigations or lawsuits that are going on?

And then lastly, for John, with respect to the health business. I caught point that it was over earning with the 24 ROEs and maybe the 17 to 18% long-term ROE level. But when we're now looking at meaningful regulatory healthcare reform starting I guess in Massachusetts, mandated loss ratios I guess in the 85% range, does staying in the group business -- forget what happened in the first quarter and the high deductibles, I'm sure you'll get that repriced, but given the change in the regulatory environment does it make sense any longer for Principal to remain in the health business when it's got so many other opportunities?

Thanks, Colin. I'll ask Larry to take the first two and then we'll turn to John.

I'll try again. I think if you go in again and just focus on second quarter for each of the last two years and let me just start by saying that's actually a little bit dangerous. Because when you focus on periods as small as a quarter you are going to do get some whip saws just based on when particular sales occur and when transfer deposits are received. But having said that, let's just go back and look at the last two years, the second quarter in each year.

If you go back and look at 2Q '06, net cash flow was about $630 million I believe and if you go back and look at 2Q '05 net cash flow was about 500 million. And yet in each of those two years we've gone on to achieve our net cash flow percentage. This year the net cash flow full-service came in at about $250 million, but as we commented earlier, there's about $270 million, if you will, that's inflated withdrawals. So if you add that back we're sort of that $550 million range.

Now again, when we look at that $550 million you might say that feels flat relative to the last two years, that would be true except for, again, we are seeing some transfer deposits on sales we've already made, commitments we've already gotten where those transfer deposits are maybe being delayed just a little bit longer than we would have expected.

So as we look at overall the business, as we look forward we think about what money is committed to come in, where we are today, what the equity markets have done, we're very, very confident that our 5% has been a good measure, it remains a good measure. Again, a lot of this is just going to be timing and equity market changes from quarter-to-quarter, but if you keep rolling things forward on a 12 month basis you'll see the underlying trends emerge.

Just following quickly on that. Within that should I expect to see recurring deposit growth of the pace we saw this quarter of about 10%? Is that a reasonable run rate or too low, too high?

Our objective is to try to get that up a little bit higher than that 10%. And so I think we'd like to see that a little bit higher than that. Again, I don't think there's -- I think again that's just kind of the noise that will happen from time to time. In the second quarter, the big factor there in that kind of employer discretionary deposits are down a little bit in the second quarter because we usually receive discretionary contribution, profit sharing contributions usually around March 15th.

So the discretionary contributions tend to be more first quarter and a little less in second, third or fourth. So recurring deposits are often -- the growth rate is a little bit less in the second quarter. So I hope that helps.

Let me take the health insurance question. I tried to explain this a little bit or I think Larry did in his script. If we were strictly in the insured medical and that's all we were doing perhaps your comment would be on point. But really there are some important trends going on in the health insurance area that we think really play well to our strengths.

And as we pointed out, it has to do with wellness, it has to do with consumer driven healthcare, it has to do with disease management. We're building a national third party administrative capability that really is not particularly in the risk businesses, it's in the administration business. Health savings accounts have an investment option.

So we really think this business beyond the insured medical is very, very attractive and we very much want to pursue that. And being in the insured medical over time is an important way to build that business because it adds lives, it helps with the claims in force and able to spread expenses around. So we do think this is a good business. It is in the heart of a small to medium business segment and we think we can manage it very well over time and we think at a 15% sustainable ROE which we'll get back to, that's still a pretty attractive business given the equity we have invested in it.

But Barry, just to pick up on that point though, that's well below the 18% you've talked about in the past for this business which tells me you're willing to let the returns go lower. And it's certainly been my consistent impression from Larry that there's very little overlap in your customer base between who's buying a health insurance plan from you and who's buying a 401(k) record keeping system.

Good points. I think we would have said that we believe that a 15% return on equity for the combined segment, the health segment is a good return. I don't know that we ever said that we were sustainable at 18% or 17 or 18%. I'll admit to you that when we tried to adjust to get our ROE down to a reasonable level to be competitive and to grow the business we probably missed the mark a bit and we're trying to get that mark back and we will get it back. I'm not sure if it's 15 or 16 or 14 but it's in that range.

And I think one of the real wild cards in all of this is if we can get the third party administrative, the national accounts business to grow, that's really where the benefit will come over time. We're not in the medical business to cross sell, we're in the medical business because it is a core offering to small and medium businesses. It helps with our market intelligence understanding the market. And I would say the Specialty Benefit, the Individual Life, all of those are critical and it just doesn't make sense to we don't think walk away from what we believe can be a very, very attractive business this third party administration keyed in on wellness.

And quite frankly, Colin, even though we haven't talked about it, we are starting to see some fairly significant new sales opportunities that are being -- doors are being opened, not so much with insured medical, but with wellness, with some of the other products that we offer.

And then on the regulatory front, the one issue in particular I'd like to hear your response to is the potential for fee regulation as what happened in the UK?

Are you talking about on the full-service on the 401(k)?

Yes.

There's an awful lot -- Larry can jump in -- there's an awful lot of discussion and a lot of publicity around this. I think at the end of the day what's going to happen is you're going to see much strengthened disclosure practices and that really at the end of the day is what this is about in my opinion. We've been a strong advocate for good disclosure and have tried to practice it. We have put out -- with other groups put out a press release supporting the Miller hearings around disclosure.

So I don't think we're, in this country, going to get to a point where the government tells you you can only charge so much for any product. But I think the real issue is going to be around good disclosure and people making decisions with that good disclosure and we're a very strong proponent of that, we will continue to be.

Okay, thank you.

We have reached the end of our Q&A. Mr. Griswell, your closing remarks, please?

Well, once again, we just want to thank you all for your interest and support of the Company. We hope that this call has been helpful to you in understanding our strategy and our commitment to creating shareholder value over the long-term and we appreciate it. We hope you have a great summer and look forward to seeing you all on the road again soon. Thanks.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 PM Eastern time until end of day August 8, 2007. 1014712 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.