美國信安金融集團 (PFG) 2007 Q4 法說會逐字稿

Good morning and welcome to The Principal Financial Group fourth quarter 2007 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, Chief Operating Officer Larry Zimpleman, and CFO Mike Gersie will deliver some prepared remarks. Then we will 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 everybody on the call.

This morning, I will continue my pattern of briefly commenting on our performance for the year and the quarter. Mike Gersie will then provide a detailed review of our financial results. Larry Zimpleman will follow Mike with an operational overview.

As communicated at our Investor Day, we have three key growth engines -- U.S. Asset Accumulation, Principal Global Investors and Principal International. In 2007, each of these three asset management and accumulation segments delivered record operating earnings, driving a 9% growth in total company earnings and a 12% growth in earnings per share. Excluding the health division results, which we will discuss in more detail, total company earnings improved 15% from a year ago. In a year marked by adverse credit conditions and volatile equity markets, we view these results as particularly strong. In addition to record operating earnings of $1.1 billion for the year, total company highlights include -- record operating revenues of $11.2 billion, a 14% increase, record assets under management of $311 billion, an increase of 21%, and 16.4% return on equity at year-end, a 110 basis point improvement from year ago.

The continued strength of our growth engines was also evident in the fourth quarter. These businesses delivered outstanding results, performance that supports our outlook for continued strong long-term growth. Highlights include $5.6 billion of sales from our three key retirement and investment offerings, Full Service Accumulation, Principal Funds and Individual Annuities, a 63% increase; 20% growth in Principal Global Investors fee mandate business earnings, reflecting continued strong growth in third-party assets; and a 70% increase in Principal International's earnings in the fourth quarter, a tremendous finish to a breakout year. Earnings in our other asset management and accumulation businesses were solid as well during the fourth quarter, particularly in light of spread-widening in commercial mortgage securitization markets and volatile and declining equity markets.

Moving to the Life and Health Insurance businesses, the fundamentals of the specialty benefits and individual life divisions are sound. Each delivered solid earnings in the fourth quarter. Fourth quarter earnings of the health division fell short of expectations. We are working hard on the turnaround of the division but it will take time to implement the pricing adjustments and network discount modifications needed to bring the health business to desired profitability levels. However, we have made good progress in managing expenses to the current level of membership and we will continue to manage that appropriately. We remain committed to the success of all of our insurance businesses. Each contributes to the strength of our small and medium business franchise, each provides earnings diversification for the organization, an extremely important benefit in times of difficult equity and credit markets, and each can contribute to the organization's long-term profitable growth.

Before closing my remarks, I will comment on net income and our outlook going forward.

While we had a significant drop in net income in the fourth quarter, which Mike will discuss, much of the decline reflects market conditions. As market conditions improve, we would expect to recover a meaningful portion of the losses recognized in the fourth quarter.

Let me also comment on total company outlook given the current environment. 2008 will be a challenging year. After dropping nearly 4% in the fourth quarter, the S&P dropped another 6% in the month of January. This directly impacts our level of assets under management and therefore operating revenues and earnings.

We most recently provided estimates of the impact of equity markets on earnings at our investor day. In addition, continued adverse credit conditions translate into lost revenues and earnings from commercial mortgage loan origination and securitization.

That said, our fundamentals remain very strong. We remain committed to and confident in our ability to achieve our longer-term performance goals, 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 will spend a few minutes providing financial detail for each of our four operating segments. But before I do, a brief overview at the total company level.

While reported earnings were down from the year ago quarter, after isolating the sources of decline, primarily health division results, and the impact of falling equity markets, we see a much better picture, one of continued strong underlying performance in our asset management and accumulation businesses.

Before I begin the operating segment discussion, I will highlight a change in our reporting format. U.S. asset management and accumulation is now separated into two segments -- U.S. Asset Accumulation, which includes our U.S.-based accumulation in guaranteed businesses, and Global Asset Management which houses Principal Global Investors.

Let me start with U.S. Asset Accumulation. Segment account values are up $17.5 billion, or 11% from a year ago, to $181 billion at year end. For the full year, segment earnings increased 21%; 16% excluding the net benefit of $28 million disclosed last quarter for Full Service Accumulation.

In fourth quarter 2007, segment earnings increased 2% from a year ago to $150 million. Three items dampened the comparison. With the S&P down nearly 4% in the fourth quarter 2007 and up more than 6% in fourth quarter 2006, there was a meaningful impact on the quarterly variance from deferred-policy acquisition costs or DAC true-ups. We true-up amortization expense quarterly for actual experience including equity market performance. Between Full Service Accumulation and Individual Annuities, true-ups dampened the comparison by $6.5 million after-tax, about $4 million and about $2.5 million, respectively. Full Service Accumulation earnings were also dampened in fourth quarter 2007 by about $2 million for refinement to capitalizations, and full service payout earnings were reduced $3.5 million for our settlement with the Connecticut Attorney General. Adjusting for these items, segment earnings improved about $15 million, or 10%, in line with account value growth.

Let me now offer some additional business-specific detail, starting with Full Service Accumulation. As I mentioned, DAC amortization expense and refinement to capitalizations dampened the quarterly comparison by about $6 million in total, or about $8.5 million on a pretax basis. Adjusting for these items, pretax earnings were up about 19% as compared to 17% growth in average account values.

Moving to Principal Funds, at $11 million, earnings are up 77% from a year ago, as our mutual funds business continued to achieve good organic growth and solid post-merger performance. Principal Fund's earnings did decline $2 million on a sequential basis. This reflects normal expense fluctuations as well as the impact of poor equity markets which resulted in a $1.2 billion or 3% sequential decline in mutual fund account values.

At $15 million, Individual Annuity earnings were down 24% from a year ago on a 23% increase in average account values. The decline primarily relates to the impact of market volatility on our DAC true-ups, as discussed, as well as the net mark-to-market of our guaranteed minimum withdrawal benefit liability which we currently account for in operating earnings. As markets stabilize we'd expect Individual Annuity earnings to again grow in line with account values.

At $27 million in the fourth quarter 2007, Principal Global Investors earnings declined $5 million from a year ago. While the decline reflects commercial mortgage-backed securitization spread-widening, and increased spread hedging cost, the impact of adverse credit conditions has clearly been minimized by our shift to the U.S. Bank joint venture in our hedging program.

In spite of market conditions, Principal Global Investor earnings are up 6% for the year. This reflects continued strong fee mandate business earnings which increased 20% in the fourth quarter and 44% for the full year. The breakdown between PGI's fee earnings and their spread and securitization earnings is a new financial supplement display. It reflects our efforts to give investors greater visibility into our new segmentation.

Moving to International Asset Management and Accumulation, fourth quarter earnings were $25 million, up 70% from a year ago. The earnings increase reflects solid growth from a year ago in Brazil, Hong Kong, Chile and China. Based on normalized earnings, segment ROE was 8.8% at year end. While U.S. equity markets were down in the fourth quarter, Principal International experienced positive investment market performance of more than $800 million, or 3% of beginning of quarter assets under management. Clearly, Principal International provides another important source of earnings diversification for the Company.

Moving to the Life and Health segment, at $42 million, fourth quarter earnings were down $23 million from a year ago. Specialty Benefits delivered earnings of $26 million during the fourth quarter, a 19% improvement from a year ago, with the division growing premiums and fees by 12% while holding growth and operating expenses to 2%. Individual Life earnings were $26 million in the fourth quarter compared to $30 million a year ago. Adjusting fourth quarter 2006 results for investment earnings on a higher capital base, and lower than normal DAC amortization expense, division earnings improved modestly from a year ago.

Health division had a loss of $9 million in fourth quarter 2007. This compared to $2 million of losses in fourth quarter 2006 after adjusting that period for the development of year-end 2006 claims, as previously communicated. Due to seasonality of claims experienced in our plans with higher deductibles, we expected negligible earnings in fourth quarter 2007. However, at 89% for the quarter, the group medical incurred loss ratio was about 300 basis points higher than we had expected as actual experience continues to run above pricing. Larry will discuss the work we're doing to address this issue.

Let me now comment on fourth quarter's $212 million of realized/unrealized capital losses. This includes unrealized capital losses of $26 million, primarily from the mark-to-market of interest rate and credit default swaps. It also includes $21 million of realized capital losses related to derivative positions, $135 million of losses related to impairment of fixed maturity securities, and $34 million of impairments on equity securities. Between the fixed maturity and equity security impairments, $85 million relates to certain structured assets. Structured asset values have generally been hit hard by recent market turmoil. Because these assets have equity like characteristics, we took the conservative position and permanently impaired them. However, we continue to believe the fundamental outlook for these securities remains strong and that they will ultimately recover.

With market illiquidity reducing fair values, at year end we also conservatively valued our collateralized debt obligations which generated $49 million of losses. We believe the current fair value is significantly below the value we will ultimately recover on these assets as well.

Combined structured assets and CDOs made up approximately two-thirds of our losses in fourth quarter and, again, we believe we will see substantial recovery. The remaining losses were in line with expectations given market conditions overall, including spread widening. We remain very positive about the quality and diversification of our portfolio and about our ability to effectively manage exposures.

Before handing off to Larry, I will cover capital and provide more color on our growth expectations. We had some internal capital movements during fourth quarter. Reflecting a change in our capital formula, health division returned about $100 million to corporate and specialty benefits returned about $60 million. This was partially offset by roughly $130 million of higher capital requirements in our other segments. In terms of the external view of our capital position, we are basically at the level required by the rating agencies and have a modest amount of debt capacity.

In terms of uses of capital, organic growth and strategic acquisitions remain our top two priorities. We also continue to return capital to shareholders through share repurchases. As previously communicated, we completed the remaining $70 million of the Board's May 2007 authorization in October. We also completed half of the Board's $500 million November 2007 authorization. This was accomplished through an accelerated program under which we received 2.9 million shares in November of 2007 and an additional 900,000 shares upon completion of the contract in January 2008. We also returned $236 million to shareholders in the fourth quarter through our annual common stock dividend.

Moving to our growth expectations, some important items to keep in mind. Growth targets should be applied to normalized results. As we discussed throughout the year, we've had a number of items impacting 2007 operating earnings which on a net basis totaled $39 million after-tax. The breakdown is net benefits of $28 million for Full Service Accumulation, $19 million for Principal International, and $10 million for Corporate and Other. These benefits were partially offset by $15 million for the development of year end 2006 claims in the health division and $3 million of charges for full service payout.

Regarding our outlook for 2008, markets continue to perform below our equity market performance assumption of roughly 2% per quarter. As previously communicated, a 10% immediate decline in markets followed by a 2% per quarter increase generates a reduction in total company earnings of roughly 4% to 6%.

As Barry communicated, after a meaningful drop in the fourth quarter, the S&P declined another 6% in January. Three other noteworthy impacts on our outlook. We expect very little improvement in credit market conditions in 2008 and therefore a delay before Principal Global Investors' spread and securitization businesses again contribute to profitability. We now expect results from the spread and securitization business to range from break-even to a modest loss for the year. This compares to the $14 million PGI earned from that business in 2007. We now expect run rate earnings for the health division of approximately $35 million to $40 million for 2008 which compares to a $50 million run rate for 2007. This change reflects expected declines in the size of the block of business as well as a $4 million after-tax impact on 2008 earnings from the division's fourth quarter 2007 return of capital.

We now expect $60 million to $70 million of losses in the Corporate and Other segment for 2008. This reflects lower yields and a lower level of invested assets, interest expense on $250 million of short-term debt issued in the fourth quarter of 2007, and lower projected earnings from joint venture real estate. This compares to segment losses of just under $40 million in 2007.

Larry?

Thanks Mike.

As indicated, I will now provide an overview of operations, covering our ongoing focus on three areas, continuing growth in our asset accumulation businesses, leveraging our global asset management expertise, and profitably growing our insurance businesses.

Let me start with Life and Health. It was another strong year for specialty benefits. Premium and fees are up 12% for the year marking the fourth consecutive year of double digit growth in the business. This, combined with a 230 basis point improvement in operating expenses as a percent of premium and fees, led to a record operating earnings up 6% over a strong 2006.

In the individual life division, we continue to build sales momentum across a broad spectrum of products including double digit growth for our nonqualified offering. For the year, total premium and deposits are up 17% for the division, with particularly strong growth in first year and single premiums and deposits. Our sales success reflects good performance and increasing momentum with independent distribution. It also reflects continued strong performance from our career channel, with both agent productivity and four-year retention running significantly ahead of LIMRA industry averages. The strength of our career channel is not only benefiting the individual life division, but also the full service accumulation, mutual funds, individual annuities and individual disability businesses.

While we were disappointed in the health division's fourth quarter results, we know what the issues are and are working diligently to fix them. In addition to pricing adjustments and tightening our underwriting guidelines, we're taking a number of other actions. These include entering into more Principal-specific network contracts so we can gain greater control of our claims costs and moving toward more fixed fee arrangements in our existing network contracts. We have also evaluated our claim payment practices and are making appropriate changes. And to improve the health of our members and drive down costs, we offer our wellness product as an integral part of our health care offering.

As discussed throughout the year, diligent expense management remains a key focus. In 2007 we improved operating expenses as a percentage of premium and fees by 60 basis points for insured medical and 550 basis points for the fee for service business. We will continue to align expenses with expected membership levels going forward.

All this said, a return to membership growth and a sustainable return on equity of 15% will be a multi-year process. We continue to experience a net decline in health division covered members in the fourth quarter and we do expect further declines in membership in 2008. The decline is the result of implementing the necessary pricing adjustments to bring the business to desired profitability.

I will close the health discussion with a reminder of the longer term opportunities for the division, opportunities created by increasing market interest in consumer driven health care, health savings accounts and wellness. We continue to believe we have the expertise to capitalize on these trends in both our insured medical and fee for service businesses.

Let me now comment on our U.S. retirement businesses. I'll start with Full Service Accumulation, where account value growth, sales and net cash flow continue to reflect the business's underlying strength.

At quarter end, Full Service Accumulation account values were $103 billion, an increase of $11 billion or 12% from a year ago which compares to a 3.5% increase in the S&P 500. That strong increase reflects good growth in deposits from existing retirement plan investors, strong plan and participant-level retention and outstanding sales.

In the fourth quarter, Full Service Accumulation delivered $2.4 billion of sales, up 30% from a year ago. At $9.5 billion for 2007, we achieved our best sales year on record, improving $2.3 billion, or 31%, for the year and breaking through the $9 billion mark two years ahead of plan. Alliances continue to be an increasingly important element of our sales growth, making up 40% of 2007 sales and improving 94% from a year ago to $3.8 billion for the year. Total retirement suite remains a key driver as well at 61% of 2007 sales based on assets.

After delivering 31% growth in 2007, achieving sales growth of 10% to 12% in 2008 will clearly be challenging. That said, we remain optimistic we can do so, reflecting our strong and improving sales infrastructure, the momentum of our alliance strategy and the competitiveness of our total retirement suite offering.

Moving to net cash flows. After achieving $1.6 billion for the first half of 2007, Full Service Accumulation delivered $3.1 billion in the second half. At $4.7 billion for the year, that translates into 5.1% of beginning of year account values.

One final point on Full Service Accumulation. We continue to make meaningful investments in this business and those investments are paying off. A couple examples of some incremental gains -- our investment in expanding our large case capability has driven up our 1,000 and above employee plan count by 14% from a year ago. Our investment in enhancing our asset retention capabilities generated our first $1 billion year of additional asset capture, a 29% improvement. And our investment in Retire Secure is driving better plan economics with 13% higher participation rates and 9% higher salary deferrals.

Moving to Principal funds, post-merger earnings for the year were in line with our expectations given market conditions as were account values. Mutual fund sales were up 130% for the year with our new third party distribution contributing about 85% of that gain and our existing channels contributing about 15%. While we did experience additional outflows in the fourth quarter, flows improved from the third quarter, and our lapses as a percent of beginning of period account values remained in line with published industry rates.

Importantly, we are optimistic we can deliver solid ongoing improvement in mutual fund flows throughout 2008. We expect to have about 33% more wholesalers in place on average in 2008 than we did in 2007. And going into 2008, we have 65% more funds approved for sales on advisors' top tier platforms than we did going into 2007. We also have a great lineup of asset allocation funds which play very well in volatile environments where investors seek safety. In the fourth quarter, Lipper Research recognized us as one of three fund firms whose target date funds showed the greatest consistency over the past three years.

Moving to Global Asset Management, Principal Global Investors continues to leverage and expand its expertise. Compared to a year ago, Principal Global Investors' assets under management is up $45 billion, or 23%, to a record $236 billion. This includes a record $87 billion of third party assets, an increase of 48% from a year ago, 24% on an organic basis. At $4.5 billion for the quarter and nearly $16 billion for the year, we remain extremely pleased with Principal Global Investors' net cash flows.

Investment performance remains strong as well, with 53% of PGI's retirement plan separate accounts in the top two Morningstar quartiles for the one-year period, 76% for the three-year period, and 75% for the five-year period. That track record includes continued, strong, equity investment performance which has driven equity assets under management up 30% from a year ago to nearly $70 billion.

PGI continues to experience increasing success with institutional and sub-advisory clients, both in the U.S. and internationally. This reflects strong investment performance over a broad range of assets, innovative fund and mandate structures, and strong buildup of the global sales force. Net cash flows from these two sources were $11.5 billion in 2007, or 19% of beginning of year assets, strong growth from $8.3 billion of net flows in 2006, and $5 billion in 2005.

In 2007, Principal International again made exceptional progress, accelerating growth and profitability. Segment assets under management are up 50% from a year ago to a record $29 billion, up 38% excluding merger and acquisition. This growth includes net cash flows of $2.1 billion for the year which translates into 11% of beginning of year assets.

With over $1 billion of net cash flows over that period, Brazil has been the key contributor to organic growth in assets under management as well as earnings growth. But I would also point to solid net cash flows and earnings growth in each of our operations, and to China in particular. Reported assets under management does not include assets under management in China which have increased from approximately $1.6 billion a year ago to $3.7 billion at year end 2007. While we did experience a significant decline in assets under management in China from third quarter, this was due to market declines and the tendency for investors to withdraw from older funds to invest in new offerings.

A couple final points. Principal International continues to do a tremendous job transitioning to more fee-based businesses. Last quarter, we began disclosing some additional breakdowns for our equity method or unconsolidated subsidiaries including fee revenues. On a GAAP basis, fee revenues are up $22 million year-to-date, or 20%. However, including our equity method subsidiaries, fee revenues were up $159 million, or 72% for the year.

In light of our continued strong outlook for Principal International, we're updating our return on equity goals for this segment. We are now targeting 11% return on equity by 2010, up from our previous target of 10%. This higher target is in line with our goal to increase segment return on equity by roughly 75 basis points per year, on average, on a normalized basis.

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 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)

We will pause for just a moment to compile the Q&A roster.

The first question comes from Suneet Kamath of Sanford Bernstein.

Thank you and good morning.

Question on the health business -- Barry, you have said many times in the past that all of your businesses have to perform well to remain in the business portfolio. Based on your comments now, we are looking at flat earnings in 2008, for your comments on multi-year turnaround. My question is how much longer or how much runway will you give this business to turn around before you consider other options?

Good morning, Suneet, I appreciate the question.

We stay committed to all of our businesses having to perform solidly. That continues to be true for health. It is a little more complicated when you're dealing with a business that has a significant amount of renewals on an annual basis. It takes a bit longer amount of time to know that your turnaround is effective. I continue to believe the best thing we can do for long-term shareholder value is to turn the business around; we're focused on that.

I think we said, and I would say it is on a short leash. We have to prove it will turn around and we have some internal metrics we look at to make sure that's true and we will continue to do so. We're not just sitting here letting the business deteriorate. We're working hard on turning around and I think we going to see some signs of that in 2008. As I said, we have some metrics we're looking at and we will do the appropriate thing over time.

Thanks.

Next question is from Tamara Kravec of Banc of America.

Thank you. Good morning. A couple of questions.

First, in terms of your investment portfolio, yesterday you talked about your subprime exposure and it was around $700 million or around 1% of your invested assets and you have currently realized losses of $49 million of roughly in the fixed maturities securities category.

How comfortable are you feeling given no improvement in the credit environment this year, that you are not going to have additional issues with your subprime exposure? And the second question is, I touched on this in your comments, you talked about your hedging program and I wanted to delve more that into how it is working across your segment and what you would expect to change this year given the environment? Thanks.

Thanks, Tamara. I think I will ask Julia Lawler, our Chief Investment Officer to handle the first, and maybe the second as well.

Good morning, Tamara.

On the subprime portfolio, you recall from the Investor Day, and we're going to re-file the 8-K and update all the numbers. But you can see on the supplement that our home equity loans are about $557 million, and that is the category, you will recall, that we said is a higher quality, older vintages. That remains high quality and it would take a tremendous amount of deterioration even from our current deterioration in residential mortgage for those to be harmed. We feel very good about those.

Then you'll recall that rest of our subprime is up in that CDO category. That is where all of our impairments occurred, the subprime as part of those CDOs. We took probably more impairment than I would have anticipated. A couple reasons for that, there were probably more subprime issues that occurred than we anticipated, and the values of those declined even more than we anticipated. I am not sure we believe we will see full impairment at those levels but those are probably the two things.

What is left over in those CDO categories is about -- you will see is this in the 8-K, so I think we can say this -- about $56 million. While it's a small number, again, it will take a substantial amount of deterioration on the subprime market for those to be affected. So I think for now, we have reflected a pretty conservative impairment number for our subprime portfolio.

Before I move on to the next question I want to make sure I answered that one for you.

Thank you.

On the hedging program, we work really hard to make sure our asset liability management is tightly managed and we do that through derivatives. Despite the volatility in the market, I think that causes us to continue to be very disciplined in our hedging program. So the interest rate movement that you see, is related to our duration management. And the only kind you really see that mark to net income is when you can't get hedge accounting treatment, which means that we're either doing it short-term or daily cash position or at portfolio level. So I would see no change, and in fact continued discipline in the hedging program.

One other quick question and actually a follow-up from Suneet's question, Barry.

Is the life and health business, more the health business, is it at all in your mind, a matter of scale or is it really just more the fine-tuning of the size of the organization that you have?

Certainly, scale in that business is important. We don't think scale in that business is terribly important at a macro level. In other words, you don't have to be a certain size in total but what you do need to have is scale within individual markets. That has really been a key part of our strategy is to reduce the number of markets we operate in and make sure that we are in markets where we do have scale or where we think we can achieve scale.

There are a lot of things going on in the business that are not necessarily related to that. They are related more to some of the shifts to consumer driven health care, health savings accounts. There is quite a bit of movement in discounts, and the way discount networks are working and quite frankly some behavior changes on how people try to get around, limits within discount total. So I would say it is more about fine-tuning and getting the business on track with the current way of running the business, but not so much around scale, but we do watch scale and obviously scale is important.

One other area that is important is discount networks. We try to get around that in certain ways. As Larry mentioned, we are doing more direct contracting on discounts and also on the fee-for-service business, we have the Aetna Signature national discounts, those are just a few things we are doing in response to your question.

And you had said in your opening comments that this business is a benefit in terms of a credit markets. What specifically did you mean by that?

I think what we would argue broadly is that being in the risk business is a good diversification of earnings. And it's a good point that, unfortunately, the health business has gotten a little sideways at the time when the equity markets are more volatile.

But, generally speaking you would think being in the risk business is a good thing during times of volatility. It just happens to be, at this very moment, that our health business is a bit off. But I would remind people that the run rate on that business is still double digit ROE and even on a reported basis it is about 7%. It is not altogether bad to be in the risk business. We just need to focus on getting the health business turned around. As was mentioned, specialty benefits and the life division are performing very, very well.

Thank you.

Next question will be from Jeff Schuman of KBW.

Question on the realized and unrealized capital losses. We have the GAAP number, I believe, that's $212 million -- what did that map to on a statutory basis?

We don't have that number exactly yet. I know there is some question about that. We don't think it is going to be significantly different but we don't have the refined number. When we do we will find a way to get that out.

I guess we're seeing with some companies is that there is a spread between the GAAP write-off and the stat write-off. Mike, to the extent that there are stat and GAAP differences at this point, would we still look to the statutory capital position as being the governing determinant of your capital adequacy?

That is correct.

As Barry said, I think there are some differences of approach in terms of -- will it have the same impact on stat capital versus GAAP capital? Our expectation is it is probably close to the same but obviously, from the capital adequacy standpoint, we are exploring avenues as to making them different.

And then lastly, I want to make sure I understood you right -- when you talk about capital position, you talk about "modest debt capacity" I believe, was your phrase, I thought I understood you to say that the capital was rightsized relative to the rating that you see at this point? Is that the correct understanding?

That is correct.

That is correct.

If you think in terms of free cash flow generation or excess capital generation in 2008, look at the whole picture including the credit environment, what would be excess capital generation do you think in 2008?

That is a good question. We are actually just -- obviously, we put together capital plans initially, and update those capital plans periodically. We are just going through the process of updating our plan right now. I would have to say compared to prior years, our capital plan is probably a little more subdued for 2008 than it was in 2007.

Thank you very much.

I may have to remind everybody we need to move along, we have quite a few people in the queue on this call. If you could limit your questions to one or two, it would be appreciated.

Your next question will be from Andrew Kligerman of UBS.

Andrew? I hope I didn't scare him away.

Please check to see if you have your phone on mute. Your next question will be from Tom Gallagher of Credit Suisse.

Good morning. The only questions that I had were -- I just want to understand what's driving the big change in impairment methodology here. Are you using a much more conservative assessment for bid versus ask spreads? How does that change your outlook for investment losses for the balance of 2008?

The values have not changed. We think we have had the values right. A lot of these assets were sitting in other comprehensive income category. And I think just being prudent, at some point you say if they are going to recover, over what time would it be? You have to make a judgment. Our judgment is let's be transparent, let's be conservative, and it is a tough thing to do because there's not a lot of good bid/ask out there, so you end up taking a hit. That's why we're pretty confident a lot of these assets will come back over time, but the only change is trying to look over what period of time they might recover and making the decision to go ahead and permanently impair them. We think that is the right conservative thing to do.

Then in terms of expectations for 2008?

Maybe Julia can answer that. Obviously we are in a difficult environment to predict, but Julia, do you want to?

If you look at what we did at the end of 2007 in these numbers, the approach we took to be more conservative for the end of 2007, I actually feel barring any major recession I actually feel very good about the outlook for 2008 because we were so conservative in our position at the end of 2007. So I am actually feeling a little bit optimistic about our outlook for 2008.

And Julia, that also captures any substantial changes we have had in spreads in the first month of the year.

Yes, although I would tell you that interestingly enough on some of the structured assets that we permanently impaired at the end of the year we're seeing improvements in the market value on those assets already this year. We have seen some spreads widening yet this year. We are going to see some volatility. I will not say we will not see volatility in the markets, but I am optimistic about where our impairments might be in 2008.

Okay, thanks.

Thank you.

Your next question will be from Ed Spehar of Merrill Lynch.

Thank you, good morning. Two quick questions.

Number one, Mike, you said there was an increase in capital of $130 million at the other operating segments. I was wondering if you could talk about what the driver is. If it is in the fee business, help us understand why.

The second question was the higher loss in the corporate line, when it seems there should be more capital there, could you go over that one more time? And why you're looking for that?

The place where we stopped up the capital that was returned to corporate, a little bit of it was in the corporate segment. Actually I think maybe the majority of it was in the corporate segment -- and I think there was a little bit of additional capital that was allocated over the retirement and investor services business unit.

So you would say, Well, shouldn't that, because you have more capital now in corporate, shouldn't you then be generating a little more investment earnings on that capital? Actually, no, compared to the beginning of the year. One of the things you're seeing as you look at very low losses in the corporate segment at the beginning of the year, we had a lot of excess capital, and remember we bought in $750 million worth of shares in 2007, didn't issue any debt; so we sopped up a lot of that excess capital in 2007.

As we got to the end of the year, fewer invested assets in corporate. So that related to much lower investment earnings. On top of that, we talked about higher JV gains, income during the first half of the year, more subdued in the second half. That gets you to, why is the big number in the fourth quarter? Well, it's a number we expected, look at it going forward basis, again maybe just a shade of a tickup in capital because of the returns from the life and health businesses but for the most part, lower level of capital, expecting lower joint venture earnings. Last year was a very big year for joint ventures earnings.

So that $130 million of higher capital at other operating segments, that included an increase in corporate. But that's versus the end of 2007 or the second half? What was that versus?

That was the capital returns, basically at the end of the year. That would fall into corporate at the -- be transferred into corporate at the end of the year. Think of it as taking money out of one pocket and putting it in another.

Got it. Thanks.

Next question will be from Colin Devine of Citigroup.

A couple quick questions.

First on the investment portfolio, I appreciate the conservatism of the approach -- can you give us some comments on how the commercial mortgage business is looking? Second, on the health business, is it fair to say, Barry, this is really the first chance you have had to reprice this business since you felt it went off the rails in the fourth quarter of 2006, given the annual repricing cycle?

And then for Larry, in terms of 401K business, sometimes what gets lost is your ability to generate cash flows, in terms of assets this year, if you didn't make another sale, how much do you think you would bring in in new money? Is the number $11 billion or $12 billion or is it higher? Thanks.

I will start with Julia on the commercial mortgage outlook.

Thanks for asking about the mortgage portfolio. That portfolio continues to perform incredibly well. Again, the loan-to-values on our portfolio are very low; we're sitting at about 59% percent loan-to-value on that portfolio, very tight coverages. We have seen very, very little stress in that portfolio. I am not just talking about things that we -- are immediate issues; we can survey that portfolio pretty closely. That is the beauty of having secured assets. We can look to see what sort of leasing we have on our properties, the values we are constantly surveying that portfolio. I feel very good about our commercial mortgage portfolio.

The second point, we do have most of our renewal in January, and I think June, July. So yes, we are just now getting into the bulk of the price increases starting to take -- some of it is starting to take effect. It will take a full 18 months for it all to take effect. But I would also point out that perhaps a bigger issue right now is getting our network discount in place, and doing more Principal-specific. We are working very, very hard on that and putting some resources on it, and we are hopeful, we will bite in and start to pay off quickly, perhaps, than just pure price increases.

Larry, I think you got a specific question on deposits?

On deposits? Good Morning, Colin. I think in our financial supplement we do have a breakdown for you in there between transferred deposits which would be deposits received on new sales versus recurring deposits. Generally speaking, the recurring deposits on existing clients is somewhere between 65%, and 70% of the total deposits. I think a reasonable expectation would be we would probably be around $14 billion or so for 2008.

That is the number I was looking for, or actually a little bit better. Thank you very much.

We expect to make some sales in 2008.

I kind of figured that.

Your next question will be from Eric Berg of Lehman Brothers.

Thanks very much. Good morning, Barry and to the rest of your team. I have a couple questions.

I want to push a little bit more on the health issue and I have a question involving investments for Julia.

I am trying to understand better than I do the basis for your hope or optimism that you can turn this thing around. The reason I ask the question is in the face of price increases and in the face of efforts to focus the business, you have been steadily losing customers. So all year you lost customers and your ability to attract new target customers was also down dramatically.

My question is, if you have been working on this business for two years, and we know you have been working on it for a while because this concept of target customers goes back at least to 2005, if you have been working on your strategy for two years and all that we can see in the financials, maybe there are some other things going on good behind the scenes that we cannot see, but if all we see in the financials is a steadily shrinking business, in the face of your efforts, what is the basis for optimism that this can be fixed?

That is your only question, Eric?

No, I have a question for Julia.

I appreciate --

I am not trying to beat up on you; I am just trying to reconcile the numbers, which are clearly upsetting, to your optimism. I genuinely want to know.

I appreciate that, I really do. I will let John answer if I don't get it all the way right. But I guess I would go back to two or three years ago when we embarked maybe a little longer on this strategy, we were making good progress. There were quarters and months when our target states were growing. In fact, we hit a bump in the road. Our strategy has been derailed slightly because of some things that went on that we've explained around buying behavior changes, claims behavior changes, some changes in the discount networks. We think we have identified those things.

We have been through lots of insurance turnarounds. There is a pattern here. You have to raise prices, you have to shrink the business slightly, but you do it with the right kind of thoughtfulness, where you don't run off good customers. You do it in ways that allow you ultimately to return to a growth mode, and that is exactly what we are doing. And yes, there are some things in the background around the discount networks. There is growth in the fee business that is coming along very, very nicely. There is growth in the wellness business. One of the things I have said, and I think it will turn out to be true, is I would like to grow the fee for service business, the national account business, to be a much, much bigger part of our business. We would even be willing to invest some capital in that business. It is not business that takes a lot of risk; it is an administrative business, and a business that we know very well. We think the outlook for the wellness business is extraordinarily strong. We're not sitting here wishfully hoping and praying that this business will turn around. We have very specific plans in place, and we have benchmarks, and we have metrics we're looking at.

And I would ask John if we have missed anything, because I have not apparently gotten the message across a few times?

I think you have done a good job.

I would just reemphasize some things that Barry said. One is the business and the environment is changing. It was a very different picture at the end of 2006 and the beginning of 2007 than what we were experiencing before then. So I would say this is a new environment, new challenges that hit us in early 2007. So I argue a little bit we have not been addressing these same things maybe as long as you would say we have.

The other thing that matters important is we are losing more of the business than we want to lose as opposed to the business we don't want to lose. As we raise rates, the people that are leaving tend to be the people that have the high loss ratios and the people that we're losing money on. So we think that, in addition to all the things Barry mentioned that we're doing to improve the business, we think as we lose the right people, that is going to help us going forward.

That was helpful additional information.

My question for Julia or Mike relates to your comments about possible recovery in asset values. My question is if a majority of what you did from a realized and unrealized loss perspective in the quarter, if the majority of it was on a realized basis, there can't be any recovery. You have written off these bonds or written down the value of these bonds or written them off entirely. So I don't quite understand whether there would be -- how there could be any positive financial statement, book value impact to a recovery of assets since you have written these off. How would that happen?

Good question, Eric. Julia?

Let me describe a little bit about GAAP accounting. It is an interesting phenomenon for us. When we permanently impair an asset, it doesn't mean we have sold the assets necessarily. For some of these structured assets that we permanently impaired, when they perform, we will continue to write those up through earnings because we are going to get our interest on those deals and if we continue to hold them as we expect to, we will actually write them up through earnings. It will be as if we bought those bonds at $0.50 on the dollar.

I didn't know that. I thought permanent means permanent and that is it but you say you can write them up even though you have permanently impaired them under U.S. GAAP.

Correct. If they continue to perform, they can be written up. If they don't perform, you have written them off and they are written off. If they perform as we expect them to, ultimately over time we can write those up through earnings.

The key point there is through earnings. That means that the extra earnings that is over and above what we have written it down to come back through earnings -- you can also get there by changing classification of the asset. That may or may not be an option under 2008 GAAP accounting. As it stands now, they could come back through operating earnings.

Thank you.

Next question is from Dan Johnson of Citadel Investments.

The last question is about this unrealized losses, just to be clear, what we're calling unrealized, is just the other than temporary impairments, we're talking unrealized as it went through the income statement. Can you help me get my hands around the unrealized losses that actually went through the balance sheet only? I am having a hard time reconciling AOCI and other things like that are not as nicely laid out as you did for us on page 48 in the supplement?

Let me make sure I understand your question.

What we have separated out on the realized and unrealized, I think we tried to show you both in Mike's discussion and the release is that which is truly realized or permanently impaired. The two things that cause something to be realized is you sold it, you unwound it, if it was a derivative, or you permanently impaired it. Those are realized.

Unrealized going into that section would be marks on derivatives. We didn't realize them, and we are just marking them to market. So, remember, derivatives, no matter what kind of derivatives, not getting hedge accounting treatment, is going through this same section on page 48. That is called unrealized.

That's the two, realized and unrealized, going through our net income. What is going through our balance sheet and OCI is everything else. The mark on all of our bonds would be going through the OCI that is not being permanently impaired.

Which would include interest rates and all kinds --

What w have going on is a positive effect of interest rates -- I am trying to figure out, especially since we took losses, there is stuff that would have be in AOCI last quarter that wouldn't this quarter. So if you just tried to narrow down the bond, or let's call it the invested asset impact to AOCI in the fourth quarter, that is actually where I was going, thanks.

I don't have the unrealized number in front of me. I apologize. It will be out in our K this month. I didn't bring that number with me. Is that what you are asking for is, what's going to run through OCI?

For the most part. In some ways it helps me understand how you are marking assets in the quarter, even though you have determined there are not worthy of other than temporary impairment.

All of our assets, all of our bonds, are being marked at their market value. Either we are getting trading values or we are getting bid values. All of our bonds are getting mark to market. The only thing that we're having to realize would be the impaired asset. As of December 2007, we showed a gross unrealized loss of $1.2 billion on that portfolio. So what we are saying is, and you can see it broken down by sector, you can see that we have reduced the value on some of those bonds by that amount. So we are truly marking to market our bond portfolio.

The $1.2 billion is a cumulative number, not an impact in the fourth quarter.

Correct. That is the total cumulative number.

I will circle back; I wanted to get in one other one on the CMBS portfolio. Can you give us some color -- again this is not the mortgages that you guys have underwritten -- but can you tell us a little bit more about that portfolio in terms of vintage and rating, please?

I don't have all the vintages. We put this out in our 8-K as well. But the quality of that portfolio -- You're talking about what we are holding in our investment portfolio of CMBS?

Yes.

The quality of that portfolio is very high, and again, as I said, we will put it out in the 8-K. But over 50% of that portfolio; in fact about 55% of that portfolio is rated AA or better. All but 2% of that portfolio is investment grade.

Can you give a sense as to how much is sitting at A and BBB?

BBB we have --- again, we conservatively -- I am giving you our internal ratings, which is more conservative than the external ratings, so keep that in mind, BBB is 25%. That is all BBB.

Just by nature, vintage roughly, this is from more recent years, from 4 or 5 years ago?

We have been buying CMBS for many years. This is a skill set that we have had in-house for a long time. We would have vintages across the board, but I don't have exactly how much would be 2001, 2002, 2003, 2004, 2005.

That is fine. Thank you very much.

We have time for one more, if we have somebody on the line.

Your last question will be from Tom Cholnoky from Goldman Sachs.

Two quick questions. I will try to be quick.

One, in the group business, Barry, you mentioned rising prices and declining enrollment. To me that smells a little bit of potential for adverse selection in that your good people leave you and you are stuck with folks who can't get insurance elsewhere. What are you doing to prevent that from happening? And then just real curious, and I'm sorry if I missed this, you had provided guidance back in the fourth quarter for 2008 which incorporated a decline in the equity markets that you had seen in the third and fourth quarter, and I just wanted to clarify why you haven't really changed your guidance or given what has occurred in the month of January, or do you think the market is basically going to revert back to where you saw it originally back in the fourth quarter?

Let me answer the last one and then I will ask John to maybe give a little more color on how we're avoiding adverse selection in the medical business.

Some time ago we went to a methodology where we would give annual guidance and that guidance is good at the time that we give it, and I think Tom even read in his statement that we don't update it and we don't make any assertions that it is accurate or not accurate, and we really haven't deviated from that. So we are not in the business of trying to go back and reconcile to guidance at this point. I would strongly suggest that we have tried to give everybody as much information as we can. We have got a full year behind us of earnings and everybody knows what those earnings were and we've tried to give you as much color as we can around the balance of 2008 and the key areas we that we think are different and we think from there you ought to be able to plug into your models good estimates as to what earnings will be. But we really don't to go back to giving guidance.

John, do you want to?

Tom, one of the things that helps is the cases that have the poor experience, you're going out with a larger rate increase for. And so those are the ones with the larger rate increase that are more apt to shop it and more apt to move. We are monitoring that very closely and in great detail. But at least one high-level measure is that 40% of our total business has loss ratios in excess of the target, and 55% of our lapses have lost ratio in excess of the target. So we are lapsing more of the poor business than the percentages of what we have on the books. So we're comfortable that we're not getting that anti-selection spiral that you're talking about.

Okay, great. Thank you.

Thanks, Tom.

Let me make a few brief closing comments.

This has obviously been a more difficult call and quarter than we're used to experiencing. It is obviously reflective of the environment we are operating in, but nonetheless, I think 2007 was really a very strong year for us. I tried to make that point in my opening comments.

We're very focused on continuing to show improvement in all of our operations, including and especially the health business. But we think we are in the right businesses; we think we have the right trends going for us, in terms of the accumulation businesses, the asset management businesses, the international businesses. Our growth engines are doing extraordinarily well; we remain very confident about the long-term future of the operations. I would say that this is the same management team that took you through the IPO and has managed successfully over the last six years and we have done so in some very challenging environments. And I would just reiterate our commitment to getting through this challenging environment and doing so in a way that continues to create long-term shareholder value. So thank you all for being on the call. We appreciate it greatly. We hope you have a great year. Thanks.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. Eastern Time until end of day February 12, 2008. 28483992 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. Thank you. You may now disconnect.