美國信安金融集團 (PFG) 2008 Q1 法說會逐字稿

Good morning and welcome to The Principal Financial Group first quarter 2008 conference call. There will be a question-and-answer period after the speakers have completed their remarks. (OPERATOR INSTRUCTIONS)

I would now like the 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, the earnings release, financial supplement and additional information on the Company's investment portfolio can be found on our website at www.principal.com/investor. Following a reading of the Safe Harbor provision, Chairman Barry Griswell, Chief Executive Office Larry Zimpleman and Chief Financial Officer Mike Gersie will deliver some prepared remarks. Then we will open up for questions. Others available for the Q&A are Division President John Aschenbrenner, responsible for the life and health insurance segment and Jim McCaughan, responsible for Global Asset Management, and Julia Lawler, Chief Investment Officer.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the Company's most recent annual report on form 10-K filed by the Company with the Securities and Exchange Commission. Barry.

Thanks, Tom. Welcome to everyone on the call. As you know, effective May 1st, Larry Zimpleman assumed the role of CEO. As such, this will be my last earnings call. I will focus my opening comments not on the quarter but rather on the leadership team taking this Company forward. Larry and Mike Gersie will followup my remarks with an overview of the quarter and some color on execution of our growth strategy. Since our IPO in 2001 we have communicated our performance and progress in three key areas, continuing growth in our U.S. and international accumulation businesses, leveraging our Global Asset Management expertise, and profitably growing our life and health insurance businesses. The team taking us forward is the same team that has led the day-to-day operations of this organization and delivered strong performance since we went public.

I'll start with some accomplishments of three individuals whose leadership has been instrumental in driving strong growth in our U.S. and international accumulation businesses. Larry Zimpleman, Dan Houston, who recently was named president of our U.S. Asset Accumulation segment, and Norman Sorensen, CEO of Principal International, who we recently promoted to Executive Vice President. Larry and Dan, along with our outstanding retirement sales team, have cemented the Principal's leadership in the U.S. retirement industry, driving full service accumulation account values to nearly $100 billion and capturing the number one position by plans in bundled 401-k, defined benefit, nonqualified, and ESOP. Larry and Norman have taken Principal International from a loss in 2001 to more than $100 million of earnings in 2007, with more than $30 billion in assets under management as of quarter end and top five positions in most of its markets.

Moving to Global Asset Management under Jim McCaughan's leadership, we have seen third party assets under management increase nearly $80 billion or 980%, reflecting top tier investment performance, expansion of investment capabilities, strong sales force buildup and an outstanding job managing and maximizing acquisitions. Our asset management and asset accumulation businesses have been strong partners with Principle Global Investors managing more than 60% of full service accumulation account values reflecting competitive performance and strong product innovation. While 2007 was a difficult year for the life and health segment, under John Aschenbrenner's leadership, the team has achieved solid earnings growth, turned the Specialty Benefits division into a top player for nonmedical coverage and transformed individual life into a leading provider of business focused solutions. On a related note, I'd like to thank Carey Jury for his years of dedication and service. Carey retired last month as Head of the Health Division. I would also like to welcome his replacement, Dave Shafer, who brings more than 20 years of healthcare industry experience to the job.

We have a deep and experienced management team. I don't have time to cover each of them, but I will mention one other, Julia Lawler, whom you know from our investor day and quarterly earnings calls. Julia has enabled us to navigate through some extremely difficult market conditions, maintaining a high quality, well diversified investment portfolio. While I am proud of the results that Principal has delivered under my tenure as CEO, I am even more proud of the investments we have made along the way to insure strong growth into the future. We have a great strategy. Importantly, it is coupled with a great management team and a great group of employees who are executing on it each and every day. I truly believe the best days for this Company are yet to come. With that, let me turn it over to Larry.

Thanks, Barry, for your words of support and for your vision, dedication and hard work over the course of 20 years with The Principal. Because of your leadership, we are positioned to capitalize on the opportunities and face the challenges that are ahead. Before I begin my overview, a brief comment on first quarter's difficult operating environment. Equity market declines were severe, including a 9.9% drop in the S&P 500 index and the CMBS market experienced unprecedented stress as a result of the general credit crisis. So while the results for the quarter were below our long-term annual earnings per share growth target of 11% to 13%, we view 6% earnings per share growth as a very solid result. And one that demonstrates the benefit of having a diverse stream of earnings. Importantly, we were very pleased with a number of key growth indicators, measures we believe demonstrate our competitive strength and our ability to deliver on our earnings per share and ROE goals over the long-term.

Starting with the U.S. Asset Accumulation segment, full service accumulation delivered record sales of $3.5 billion, an increase of 57% compared to the year ago quarter. Two key factors are driving our continued sales success, the advantage we have in the marketplace with total retirement suite and our increasing momentum with distribution alliances. In the first quarter, total retirement suite made up 67% of sales based on assets. Alliance sales were up nearly 150% from a year ago to $2.2 billion. With gross pipeline up 18% from a year ago, we remain highly optimistic about our outlook for full year sales. Strong sales coupled with strong retention drove full service accumulation net cash flows to a record $3 billion dollars, an improvement of 126%. Deposits were up 37% from a year ago. By comparison, withdrawals increased only 6% on 12% higher beginning of year account values.

While declining equity markets contribute to lower average account balances and therefore lower withdrawals, this was nonetheless a tremendous quarter of retention, with contract and member level withdrawals of less than 4% combined. This was also another good quarter for retention of planned participant assets at risk due to retirement or job change. We retained more than $500 million in the first quarter into our mutual fund individual annuity and bank products, demonstrating the strength of our asset retention capabilities and the depth and breath of our retail rollover solutions. We also captured $310 million of additional assets in the first quarter between participants rolling other retirement plan assets into their Principal Administered Plan and moving other assets into Principal's retail offerings.

In light of accelerating boomer retirements, we continue to invest heavily in building long-term relationships with plan participants. Working with advisors and using our Retire Secure and Principal connection resources that investment is clearly paying off. Individual annuities delivered a similarly strong result in terms of sales and net cash flows. Sales more than doubled from a year ago reflecting increased penetration across multiple distribution channels and continued success with the fixed deferred annuity product we launched in the middle of 2007. Withdrawals have remained stable in absolute terms but have declined as a percent of beginning of year account values from 3.3% a year ago to 2.6% for first quarter 2008. Moving to Principal Funds, we would characterize sales and net cash flows for the quarter as solid, with signs of improvement in a national channel. Across the industry, sales have slowed and redemption rates have increased, the result of volatile markets.

To add some perspective, compared to first quarter 2007 industry cash flows are down $120 billion or 87%. As disclosed in our financial supplement, mutual fund account values are down from year-end. Equity market declines drove $2.5 billion of the reduction. We also had an outflow of $1.25 billion attributable to a single shareholder, Washington Mutual, which is shown on the other line of the account value roll forward. In spite of continued strong fund performance, Washington Mutual elected to change investment options within their 401-k plan. While we were very disappointed, this outflow was one we had built into our acquisition plan for WM advisors. Because the funds were removed right at quarter end, there was no impact on first quarter 2008 operating earnings. Going forward, this will reduce Principal Funds earnings by about $1 million per quarter. A couple of additional comments on the progress and direction of the mutual funds business.

Regarding our wholesale platform, we continue to make good progress identifying and filling open territories and retaining existing resources. Our proprietary channels continue to show increased interest in and increased sales of our expanding array of funds and we are investing in resources to support their efforts. As discussed last quarter, we have made tremendous progress getting our funds approved for sale on firm's top tier research platforms. As you know, it takes time to translate shelf space into sales. We are making progress broadly and in some cases, such as our offering of preferred securities, seeing meaningful sales momentum on a number of platforms. Moving to Global Asset Management, the first quarter was a period of continued strong investment performance. 64%, 76%, and 72% of the retirement plans separate accounts managed by Principal Global Investors ranked in the top two Morning Star quartiles for the one, three and five year periods respectively at quarter end.

Reflecting that strong performance, Principal Global Investors was awarded more than $5 billion of non-affiliated assets to manage during the quarter. First quarter net cash flows were $3.4 billion contributing to nearly $15 billion of net cash flows over the trailing 12 months. In spite of significant equity market declines, Principal Global Investors fee mandate business continued to perform well with 13% growth in earnings. However, volatile conditions in the global credit markets, which in turn impacted the CMBS market, drove losses in the spread and securitization business. As a reminder, we are a 49% owner in the securitization business. We stopped originating loans in November, 2007. And to minimize the risk of further mark to market losses, since year-end, we have reduced loan inventory by approximately two thirds to about $540 million. We have accomplished this reduction due to the very high quality of our portfolio.

In light of recent transactions, we are confident our marks are consistent with the view of values of potential buyers in the marketplace. As such, we now believe that over the remaining three quarters of 2008, the spread and securitization business will come in at or near breakeven. All this said, for the full year we expect Principal Global Investors earnings to come in around $95 million. This incorporates our expectation for continued double digit earnings growth from the fee mandate business, reflecting our increasing emphasis on this key growth engine. Returning to the point of earnings diversification, Principal International delivered its second best earnings quarter, as did life and health. Principal International's strong earnings reflect significant growth in assets under management, which are up 37% from a year ago to a record $30 billion, with 43% growth in Latin America and 28% growth in Asia. Net cash flows continue to be strong as well at $730 million for the quarter or 2.5% of beginning of year assets.

Based on normalized earnings, Principal International's return on equity is just under 10%. The segment remains on track to achieve the new target established at year-end, sustainable return on equity of 11% by 2010. First quarter was a period of solid earnings improvement for the life and health segment, even after adjusting for favorable reserve developments, benefiting first quarter 2008 results. And other items impacting comparability, which Mike will discuss. At 15.9% return on equity, Specialty Benefits continues to operate at desired profitability levels. Premium and fees were up 5% compared to the year ago quarter, as the division maintained pricing discipline in difficult economic conditions and a highly competitive market. Expense management remains sound and we are working on a number of initiatives to continue driving sustainable, profitable growth for the division.

The Individual Life division continued to build sales momentum across a broad spectrum of products, including 18% growth from a year ago for our nonqualified offering, one of the four pillars of total retirement suite. First year and single premiums and deposits are up 48% for the division, reflecting solid performance from the career channel and increasing momentum with new independent distribution relationships. The Health division posted strong first quarter earnings, even after adjusting for the development of 2007 year-end claims. Return on equity improved to 12.8%. In light of first quarter's results, we now expect the division to earn between $45 million and $55 million for the year on a reported basis. Our strategy for growing covered members is highly focused on local markets, analyzing conditions to identify availability of better network discounts and principle specific provider contracts.

We are also highly focused on claims and expense management, which contribute to improving our overall price competitiveness. While a return to membership growth and a sustainable return on equity of 15% is a multi-year process, I reiterate the longer term opportunities for the division. In consumer driven healthcare, health savings accounts and wellness, and our belief that we have the expertise to capitalize on these trends in both the insured medical and fee for service businesses. Mike.

Thanks, Larry. This morning I will spend a few minutes providing financial detail for each of our four operating segments, including items impacting comparability between periods. I will start with U.S. Asset Accumulation. Segment account values are up $6.8 billion or 4% from a year ago to $175 billion at quarter end, while segment earnings decreased $16 million or 10%. Full service accumulation, mutual funds and individual annuities made up the vast majority of the change in account values and earnings for the segment. That's where I will focus my remarks, starting with a high level comment on the impact of recent market performance. Had markets performed in first quarter 2008 consistent with our 2% per quarter assumption, Full Service Accumulation would have ended the quarter with an additional $8 billion plus of account values and the mutual fund business with an additional $3 billion plus. The sharp drop in markets has significantly impacted revenues.

And this revenue decline occurred at a time when we are increasing our strategic investments in retire secure, asset retention and retirement income management in Full Service Accumulation business and in expanding investment offerings and ramping up distribution in the funds business. During the first quarter we initiated a corporate-wide expense reduction effort to offset a significant portion of the impact of revenue decline. These efforts helped but did not totally eliminate pressure on near-term earnings. While we are absolutely committed to aligning expenses with revenues over the long-term, we believe doing so demands a measured, thoughtful approach. Should weak markets persist, we will respond accordingly. That said, we continue to make ongoing investments we believe are needed to drive strong sales growth and outstanding customer retention over the long-term.

Moving to my detailed review. At $68 million in the first quarter, full service accumulation earnings were down $14 million or 17% from a year ago and a 7% increase in mean account values. As communicated in our press release, several items impacted comparability between periods. First quarter 2007 earnings benefited $6 million in total from tax and reserve true ups. First quarter 2008 earnings were dampened by $10 million in total due to a change from a year ago in the mix of investments in 401-k plans, lower income tax benefits and the impact of declining interest rates on market value adjustments on customer withdrawals. While some of these items are market driven and more temporary in nature, as previously communicated, changes in business mix are affecting return on account values by impacting revenue collections and tax benefits. In 2007, excluding the large deferred acquisition cost adjustment in the third quarter, our return on account values was 34 basis points.

Given investments in our business and changes to our mix, we believe 30 to 32 basis points is a better range over the next several years. Clearly though, we would expect to be above and below it on a regular basis due to normal business and economic fluctuations. Importantly, we expect the positive impact on return on equity over the long-term because the change in business mix has been toward products that require less equity. Before I move to Principal Funds, I will briefly discuss full service accumulation, deferred policy acquisition costs, amortization expense. Specifically, why expense is down from a year ago. As you know, we review experience each quarter and a number of components can contribute to the associated true up. As expected, the severe drop in equity markets in the first quarter 2008 did result in an increase to amortization expense, approximately $10 million.

However, our review also identified favorable experience adjustments relative to revenue and lapse assumptions, which resulted in an offsetting decrease to amortization expense of approximately $12 million. Moving to Principal Funds, at $8 million in the first quarter earnings were down nearly $4 million from a year ago on essentially flat account values. There are several passthrough items that have no net effect on earnings for the business, but impact fee revenue, commission expense and other expense lines. Excluding those items, fee revenues are down about $2.5 million from a year ago and other expenses are up about $3.5 million. The decline in revenues reflect recent changes to mix with fund investors moving assets into lower fee investments. The increase in expenses reflects buildup of infrastructure to support our growth expectations for the business as well as ongoing investment. As always with all of our businesses, we continue to keep a close eye on expenses relative to revenue.

Moving to individual annuities at $17 million, earnings were up 6% from a year ago. Several items dampened first quarter 2008 earnings, one dampened first quarter 2007. In the current quarter, between a guaranteed minimum withdrawal benefit reserve true up and lower than normal investment prepayments, earnings were dampened by about $3 million after tax. We also had some minor spread compression, which reduced current quarter earnings by about $1 million. First quarter 2007 earnings were dampened by about $1.5 million due to asset and liability derivative mark to market changes. After adjusting for items in both periods, earnings were up about 19% compared to a 22% increase in average account values. At $3 million in the first quarter, Principal Global Investors earnings compared to $24 million a year ago. Fee mandate business earnings were $19 million in first quarter 2008, an increase of 13%.

Higher fee mandate earnings were offset by losses in the spread and securitization business, reflecting unprecedented volatility in global credit markets and its impact on commercial mortgage backed securities market. The spread and securitization business lost $16 million in first quarter 2008 compared to $7 million of earnings in the first quarter 2007 due to volatility of spreads and the resulting mark to market losses on commercial mortgage loan inventory held in the CMBS joint venture. Moving to International Asset Management Accumulation. First quarter earnings were up 64% from a year ago. The improvement primarily reflects continued strong asset under management growth and operational efficiencies. It also reflects a benefit of $6 million after tax due to favorable currency exchange rates and an unusually high first quarter inflation in Chili, which increased our yield on inflation-linked assets.

At $79 million, first quarter earnings were up $34 million from a year ago for the life and health segment. Trailing 12 months return on invested capital improved 80 basis points from a year ago to 12.5%. Individual life earnings were $21 million compared to $15 million a year ago. The increase from a year ago reflects a return to more normal lapses and death claims and growth in the block of business. As Larry indicated, at $35 million, this was a strong earnings quarter for the Health division. First quarter 2008 earnings were positively impacted by $7 million due to favorable development of year-end 2007 claims. First quarter 2007 earnings of $12 million were negatively impacted by $15 million due to unfavorable development of year-end 2006 claims. In thinking about the remainer of the year, keep in mind that the accounting treatment of high deductible health plans typically results in the highest level of earnings in the first quarter, moderate earnings in the second and third quarters, and losses in the fourth quarter.

Specialty Benefits earnings were $24 million, an increase of $6 million from first quarter 2007. The increase reflects growth in the business and a favorable reserve adjustment in the individual disability line of $4 million after tax. I would also remind you that all three Life and Health divisions return capital to corporate during 2007, resulting in lower earnings from investment income in the current quarter of $3 million after tax. Let me also comment briefly on our net realized, unrealized capital losses for the quarter. In first quarter 2008, we recognized $75 million of capital losses through the income statement, which includes $29 million of losses related to impairments of fixed maturity securities, including $7 million related to subprime, $16 million of impairments on equity securities and unrealized capital losses of $22 million, primarily mark to market of credit defaults loss.

Given the volatility of credit markets, predominantly driven by technicals, we view this level of losses as reasonable. Also reflecting tremendous market volatility, we recognize through the balance sheet approximately $840 million of net unrealized losses net of DAC and tax. These losses were included in other comprehensive income because we believe the recent declines in market value are temporary, that the fundamentals are not being reflected in the values of these assets and that we have the intent and ability to hold them until they recover. Our policy does not include bright-line test, but rather a rigorous process to assess a bond's ability to perform. In light of the magnitude of net unrealized losses this quarter, we posted a breakdown of gains and losses by sector on our website.

Given ongoing investor interest and our exposure to certain investments, we posted on our website some additional detail on commercial mortgages and CMBS as well. I will comment specifically on why we are comfortable with our commercial mortgage loan and commercial mortgage backed securities holding. Regarding commercial mortgages, 90% occupancy, 58% loan to value, and 1.9 times interest coverage, we are extremely comfortable with our portfolio. Even in a slowing economy, we have a tremendous amount of cushion. Regarding our CMBS holdings, delinquencies in the underlying mortgages were 58/100s of 1% through March. When we apply a recession scenario, the cumulative default rate increases to 12%, which would produce losses of less than $30 million over the life of the portfolio. The current pricing reflected in our unrealized loss figure implies cumulative losses four to five times greater than our recession scenario.

I would emphasize a couple of additional key points. Market pricing does not reflect current or expected fundamental performance. In fact we saw a $70 million improvement in values of our CMBS portfolio just in the month of April. As a leading real estate asset manager, we use our strong technical expertise to review the underlying loans in the CMBS pool and assess the quality before investing, as well as on an ongoing basis. Given the high quality of our holdings and the large amount of subordination to take first losses, our CMBS portfolio could withstand a significant increase in delinquencies from today's level and still perform well. To wrap up my comments, let me quickly cover capital. At quarter end we were basically at the level required by the rating agencies and have a modest amount of debt capacity. Today we have completed half of the board's November, 2007 $500 million repurchase authorization.

As always we will continue to look for ways to optimize our capital structure and effectively use capital to build value for our shareholders. This concludes our prepared remarks and I would now ask the conference call operator to open the call to questions.

(OPERATOR INSTRUCTIONS) Your first question is from Tom Cholnoky with Goldman Sachs.

Good morning. Just a couple of quick questions, I guess number one, you talked about capital a little bit and I just wanted to kind of understand a little bit how that impacted your decision apparently not to buyback any stock during the first quarter when it averaged $58 and in '07 you were relatively aggressive buying it back at closer to $66 a share and even -- so I am just a little bit -- I want to get a little bit more clarity on your buyback and then I can followup with another question.

Good morning, Tom. We will let, this is Barry, we will let Mike maybe chime in. But I think I would answer that it is primarily a amount of capital we had. We don't normally try to buy shares back opportunistically based on share price. We typically have an authorization and we often use a 10-B-5 and go out into the market. So it really was related more to our capital adequacy and the volatility in the markets to make sure that we were being prudent more so than the stock price. Mike, you want to add.

I think that's right, Barry. The other thing you have to remember is this organization generates a lot of free cash. So as we look out over the remainder of the year, I think as we said in the past, roughly half of our operating earnings sports organic growth, the rest can be used for either dividends or share repurchase or acquisitions. So, I think we have got adequate capital resources but, as Barry said, I think we like other companies are keeping a little bit of dry powder given all the volatility in the markets.

Okay. So we shall expect in the balance of the year you to pick up a little bit on the share buyback?

I think it would be premature for me to indicate that. But that certainly is a possibility.

Okay. And then if I can just followup. Sorry, I apologize if this is well known to people, but just if you can just review the group life, why you end up having the loss in the fourth quarter and the accounting issues that derive that in the health business.

I'm sorry, in the -- .

In the health business, I think you were mentioning that the second and third quarter ought to be relatively positive, the fourth quarter a loss.

Sure, Tom. We will cover that very briefly. John.

Tom basically, as we get more and more of our business under high deductible health plans, the accounting would have you reflect those claims in the quarter that they're incurred and so you are going to have lower health claims in the first quarter when the deductible hasn't been satisfied yet and you are going to have much higher health claims in the fourth quarter after the deductible is fully satisfied.

Got you. Okay. That makes sense. All right. Thank you.

Thanks, Tom.

Your next question is from Eric Berg with Lehman Brothers.

Thanks. Pardon me. Thanks very much and good morning. My question concerns the securitization business. While I realize that you have paired back your exposure significantly in the warehouse and perhaps that is the big reason why you are more confidence than you had been or you continue to be confident that this business will breakeven perspectively, I think you told us this in the past and yet we had a noticeable loss in the quarter. My question if you thought you had a handle on it the first time and things turned out to be materially different from what you expected, why should we have confidence now that your forecast will be reasonable? Thank you.

Thanks, Eric, and good morning. Think I will let Jim McCaughan answer. Jim.

Yes, thanks, Eric. It is true that at the last earnings call we indicated the expectations of the business could breakeven for the rest of the year. What we didn't know and what nobody knew at that time was the extreme credit market disruption in March and in particular the very large moves and spreads over the Bear Stearns weekend in the middle of March. As you know, the securitization inventory is daily mark to market and during that period, the CMBS prices went down so much that it was marked right to whole loan prices, which meant that the hedging effectiveness really went away. So the extreme disruption meant that the hedging got disrupted. That was an extraordinary event and, absent such an extraordinary event, we are pretty confident we can manage with hedging and with a much lower inventory.

As I think was pointed out during the prepared remark, at the end of April the inventory in the joint venture, and remember 49% of this is attributable to Principle's stake. The inventory in the joint venture was down to $540 million from $1.7 billion at the beginning of the year. The reduction reflects the very high quality well underwritten loans that have been in that inventory and we have seen very good demand both from some securitization where we securitized over $600 million in February and also from whole loan buyers. So we are seeing very good demand for those loans and, while not under pressure, we feel pretty confident we can keep this inventory at a pretty low level and hedge it effectively absent any extreme disruption of the type that we saw in mid-March.

And, Eric, I would just add that this is a business we are committed to. We think this will come back and be a very profitable business for us in the future. For our way of thinking, this is not the time to discontinue the business or get out of it. Good days are ahead in this business, we believe.

I have one final question relating to credit. I believe Mike Gersie said in his prepared remarks he cited technical factors in explaining, I hope I have this right, why certain income securities were trading at material discounts to, say, amortized cost, reasons other than credit. Could you elaborate what you mean by technical factors, in other words why would a bond, in your opinion, trade at a significant discount from amortized cost for an extended period for reasons other than credit?

Okay, thanks, Eric. We'll ask Julia to answer that.

Yes, Eric, thank you very much. Well, the spreads widen, there's no question, and what we mean by technical versus fundamentals, is that trading behavior was driven more by ownership of CMBS or the index or shorting that index, as the case may be. So I would say that what happened in March, again back to Jim's comments about the disruption, is that we had lots of players in the market that were needing to either liquidate their portfolio so they chose what was able to be liquidated, which was high quality CMBS, or they were needing to short a hedged position or change a hedged position which affected the value of bonds. I will compare that to fundamentals that effect spreads. Fundamentals is predominantly around default rates increasing, foreclosures increasing, losses on actual commercial mortgages increasing. None of that has occurred. That's how I would compare technical to fundamental.

Very clear. Thanks, Julia. I'm all set.

Thanks, Eric.

Your next question is from Suneet Kamath with Sanford Bernstein.

Thanks and good morning. I had a question about the full service accumulation business and the commentary about the lower return on asset number going forward. I think you have talked about this qualitatively but you haven't quantified it in the past. I just want to understand what the major driver here is. Is it fund performance or the proliferation of target date funds or the move to more larger cases. I mean, what's going on underneath. And then in terms of the pipeline, Larry, I think you said that the pipeline for FSA is up I think it was 18%. Do you have a nominal amount of money in terms of the pipeline and I think in the past you have talked about a close rate of 14%. Is that still a good close rate over a 12 month period? Thanks.

Good morning, Suneet, this is Larry. On the second one, I will take that first. In terms of the close rate, you are right, the historical close rate actually, Suneet, has been more around 12%, somewhere in that 11% to 12% range. In the first quarter our close rate was closer to 18%. So you can see why it was such an outstanding sales quarter. Again, I would not -- while I am not going to sit here and predict an 18% close rate, I think that is support however for the comments that our total retirement suite capability as well as the strong investment performance at PGI and our partners continues to churn out does put us in a very strong position. Again I don't view the 18% as a statistical blip, although I am not going to sit here and predict that the close rate would be that high every quarter.

Again, it has typically been in that kind of 12% range. It was 18% in the first quarter and again we remain optimistic because of the competitive nature of our offering. On the first question I think you were really looking there, Suneet, for what are some of the drivers that are kind of impacting the return, whether it is ROA, return on asset, or ROE. I think, again, there's a number of factors but the one more dominant than anything else is simply that with our total retirement suite initiative you are seeing more employer securities being embedded into the account values. We show this in our financial supplement. Today the employer securities are around 6% of the total account value. That was about 4% a year ago. That would have been 0% three or four years ago and the nature of employer securities is that the fees we get on that are primarily consulting and a small amount of administrative fee. You don't have the larger asset management fees embedded in those employer securities.

So what we are talking about here is I think it is important for everybody not to draw the conclusion that the ROA going down is a bad thing. The fact that we can compete on TRS and include employer securities allows us to have a bigger opportunity in the market to grow our total account value and asset base and we accept as a tradeoff for that that the ROA is going be slightly less but the net opportunity to grow full service accumulation earnings is definitely enhanced as a result of having employer securities. I hope that helps a little bit.

No, it does. Just followup on the pipeline, do you have a nominal amount for the -- as of the end of the year, end of the quarter excuse me.

A nominal amount of the dollar amount of the pipeline?

Exactly

I think it tends to run somewhere in the $20 billion, $25 billionish range. Maybe closer to $30 billion at any point in time, again depending a little bit on seasonality, Suneet.

Okay. That's comparable to the up 18% that you mentioned in your comments?

Yes, that was the estimate.

Yes.

Okay, got it. Thanks very much.

He nodded.

Perfect. Thank you.

Thanks, Suneet.

Your next question is from Steven Schwartz with Raymond James and Associates.

Hi, everybody, just a couple of questions. One more a theory question, article yesterday in the Wall Street Journal about people looking to take loans into cash in their 401-k's, I was wondering if you had, given the economic environment, I was wondering if you had thoughts on that and how that may affect your business. And then second, you might have touched on, you might have gotten this with Tom, but I didn't get it. Health insurance, the guidance $45 million to $55 million, you did $37 million in the first quarter, maybe you can talk about what you see happening there. Okay.

Steven, good morning, this is Larry.

Good morning, Larry.

I will take one and John can followup on your health question. In terms of the 401-k loans, or I will say maybe more broadly the impact of a slowing economy and what impact that has on 401-k withdrawals, again, quickly there are two ways that 401-k members, how you could see the impact of the slowing economy. One would be through actual hardship withdrawals. Some plans do have hardship withdrawal and you can have the opportunity as a 401-k plan member to gain access to some of your account value through a financial hardship. I would say on that side of the withdrawals we are really not seeing any impact. When we look at our experience in Q1 as compared to prior quarters, no disearnable trend. So I think that's positive.

The other way you could access in a slowing economy would be through plan loans, as your question was directed. There what I would say is we are seeing a very, very slight, very slight uptick in the number of calls to our contact center around plan loans, but we are not really seeing any, again, disearnable trend or increase in plan loans. So it would be -- to even call it a rounding error as it relates to plan loans it would probably be to over state it. But there are just a few more calls that come into the call center but usually, again, once apprised of other opportunities, most plan members understand it is really not in their interest to take a plan loan. There are many other ways, more effective ways to handle some sort of a slowing economy or financial emergency. I'll ask John to talk about your health question.

Sure, Steve. Last quarter we indicated that we expected health earnings for this year to be in the $35 million to $40 million range. Because of the very strong results that we are seeing in the first quarter, we have increased that $10 million to $15 million and we expect earnings to be in the $45 million to $55 million range for the year.

Okay. I understand the loss ratios move up, but really by that much? That just strikes me as a considerable effect of where you are even absent the reserve development.

Yes. We are -- have moved now to where we have about 67% of our health business is in higher deductible plans. That really will drive, again, heavy claims in the fourth quarter compared to the first quarter. So you might expect something in the range of $12 million earnings in the second and third quarter and maybe a $5 million to a $10 million loss in the fourth quarter to reflect the seasonality of the health claims based on high deductible plans.

Okay. I got it. Thank you.

Thank you.

Your next question is from --

That was $12 million each second quarter and third quarter.

Thanks.

Your next question is from Ed Spehar with Merrill Lynch.

Morning. Thank you. I had a couple of questions. Larry, in terms of thinking about the impact on ROA from PRF, can you give us some sense of if you look at the just the TRS portion of the book, what percentage of the assets would be employer securities and maybe more specifically, if we are just thinking about the marginal ROA for this business, can you give us some sense of what it would be for the TRS and the alliance sales relative to your other sales?

Sure, Ed. Good morning. First of all, if you focus around our total retirement suite, again, I think there is some tendency, probably through our own communication, that we have sort of tended to have you think that TRS is somehow kind of a subtext for employer securities. That's not necessarily the case. In other words, you can find employer securities in medium size plans and even some smaller size plans, where they may be more private employer securities not necessarily public employer securities. So, the range for any given plan, what percentage of it is employer securities, obviously ranges all over the lot from 0% for many to something maybe as high as 20%, 25% for some plans. Now again this, Ed, is all part of the underwriting process that we go through at the front end. And obviously we make sure, as a part of our underwriting process, that the revenue that we are going receive, holistically, whether it is from the employer securities, from the other assets, that is going to pay us with the necessary ROA for the work we do.

So don't read into it that we have sort of different ROA targets by TRS versus plans that are not TRS or plans that have employer securities versus plans that don't have employer securities. Again, these all just -- it is just part of the underwriting process that we go through. In terms of your other question, on marginal ROA, actually I have to tell you, Ed, I don't think we look at the business that way. We don't really think about trying to kind of write business on a sort of marginal basis. That's just never been a part of our philosophy here. So our goal remains that same sort of overall ROA that we have been talking about kind of in that 32 basis point range as we said in our comments. So, I hope that's somewhat helpful.

Ed, this is Barry. I would also add that the first quarter, this first quarter we just had 3.5 billion, we had very little employer securities in that quarter. I don't want anybody to get the trend, the feeling that all of our business is starting to go that way. In fact I don't know we had any large cases at all with ESOP.

In the first quarter we had, of that $3.5 billion, 6% of it was in employer securities. Again, these things will ebb and flow back and forth. I think Barry's comments are important to understand.

Okay. If I could just followup with one question. If you expect, though, that some of the business you are writing today has a lower ROA but higher ROE, why would the return on assets outlook over the next several years according to, I think the comment that Mike made was 30 to 32 basis points other the next several years. Why wouldn't that naturally move lower over time given the mix of business?

Yes, I mean, I think that is the point that Mike was trying to explain. Again, if you go back two or three years, there was no employer securities in the account value, Ed. So basically everything there were dollars where we are getting some sort of an embedded asset management fee in the business. Now where we are at today is the employer securities don't have this embedded asset management fee. The other assets do, whether they are proprietary or nonproprietary and it now depends on the long-term trends as to ultimately what percentage of account value in full service accum is employer securities.

As I said earlier, that was about 4% of account value a year ago, that's about 6% of account value today. I don't really know and can't really sort of forecast for you where that may go. I think it is always going to remain a relatively small percentage in total account value because, again, our value proposition is so strong, whether it is at the small end, which may not involve employer securities, a mid size plans or the large plans. So I think it will just depend on time and we will see where it goes, but I don't think it will grow substantially but it might get a little higher than the 6% it is today.

Okay. Thank you very much.

Your next question is from Tom Gallagher with Credit Suisse.

Good morning. I guess another one for Larry. Not to beat a dead horse, but let me take a different approach at the whole mix shift going on in full service. If you calculate it as a revenue yield, Full Service Accumulation revenue yield went down from about 98 basis points in 1Q last year to about 89 basis points this quarter. And if I think about it that way, what would the fee-based revenue yield be on some of these larger, let's say, bigger mandates that you have been winning recently, if I think about 1000 or larger lives. Is the number 50 basis points on average, is it 30, and a small case, north of 100, can you give us a little perspective on -- because I think it is important to think about there's going be obviously higher associated costs on the small end but at least we can understand the dynamic of revenue yield to help us think about at least what we will be seeing on the top-line.

Okay. Let me take a shot at that time, Tom. Obviously, I don't know that I can relate to revenue yield as you may have defined it, but let me make some general comments that I think will be helpful to your question. We actually manage the Full Service Accumulation business not as one single overall business, but we have incredible discipline in how we go at the business and we actually manage it as a series of interrelated businesses. When we think about Full Service Accumulation, we actually manage it as a grouping of smaller plans, which we will for the sake of discussion call generally 0 to 5 million in assets, kind of medium size plans which we would think somewhere between 5 and 50 million, and then the larger plans somewhere between 50 million and above.

We have very, very detailed, both revenue expense and overall P&L statements that we run for every one of those businesses. We are extremely disciplined, Tom, both in the underwriting at the front end as well as the ongoing expense management and ultimately the revenue yield, if you will, that you see to make sure that we are absolutely not subsidizing in order to get one business at one end at the expense of business at another. We have seen others make that mistake. We will absolutely not go down that path. When you see the overall ROAs or ROEs of the Full Service Accumulation business, you can be confident that if you were to drill down and look at the small, medium or larger end you would see very, very consistent ROAs or ROEs no matter whether you are looking at small plans or large plans.

Okay. That's helpful. Is there any broad ranges you could give us, even anecdotes, to think about how -- what the fees as a percent of AUM would look like for a typical smaller plan versus a very large plan. Like how extreme is that difference. I don't know if that is something you can share.

Again, in terms of gross fees, total fees that somebody might pay, I would say for a very small plan it could be somewhere in the sort of 250, 270 basis point range and for very large plans it would probably get down to where it is certainly well under 100 basis points, probably closing in on 70 or 80 basis points. But the real driving factor around that, Tom, is going to be whatever lineup of investment options they choose to put into the plan. The extent to which, for example, they have index type options versus managed options, that is going to be the biggest driver of the fees they pay.

Okay. That's helpful. And then just one more follow up for me. I guess this would be for Jim. The Global Asset Management fee-based earnings guidance of $95 million, are you including any performance fees in that number?

The one word answer is yes. Looking at the first quarter, the fee earnings were somewhat depressed or they were somewhat below trend, I think really for three reasons. One is there were some extraordinary costs in there, including about $1 million of severance because of people in the more structured products area that got attributed to the fee business. Secondly, there were absolutely no performance fees or incentive fees in the first quarter and thirdly, because of very low activity in real estate there were no transaction or borrower fees or very low transaction and borrower fees in the first quarter.

If you look at the fee business operating earnings, although it was nicely up on a year ago, it was because of the volume growth in the business, it was definitely below trend for those reasons. And we've assumed much more of a normalized trend in thinking about that 95 million expectation. Clearly, you have latched on to the piece that's most volatile. That could come in ahead or behind and that would probably be the most likely, if you are using your crystal ball, the most likely thing to have us come in above or below that $95 million expectation that Mike expressed.

That's heavily weighted toward the fourth quarter. Right, Jim?

If you look at our past trend, actually, on quarterly operating earnings on our fee mandate business, the fourth quarter is usually above trend because of incentive fees.

So, Jim, for the most part you are not accruing those you are waiting to the fourth quarter to make sure those are in the bank?

Oh absolutely. There's no -- I mean, there are -- we have from week to week and day-to-day some beliefs about what is likely to come through, but really you don't know them until you bank them. That's when we account for them.

Okay. Thanks.

Thank you.

Your next question is from Tamara Kravec with Banc of America.

Thank you, good morning.

Good morning, Tamara.

First off congratulations, Barry, and I wish you the best in your retirement.

Well, thank you.

You're welcome. I just wanted to talk about the individual annuity business and ask how your hedging programs are fairing and what -- there has been a lot of new product innovation. Quite a few of your peers are coming out with, with newer riders and other guaranteed provisions for those products. So, Ed, I would be curious for your outlook on that business in more detail and a quick followup on the CMBS securitization, just so I understand. Your breakeven forecast for the rest of this year, is that assuming that some of the markets reverse themselves, or are you assuming that they stay the way they are? Thanks.

Thanks. Tamara. On the -- let me just take those last one very quickly, that does not anticipate recovery marks. That's just the business going forward as it is today and Larry you want to take the annuities?

Sure, I will just comment briefly, Tamara, on the individual annuity. First of all, we don't, unfortunately, have the opportunity in these calls to maybe spend as much time on that business, what we call the retail annuity business, as we would like. But there is -- you have certainly seen very, very consistent stable growth, quite actually quite impressive growth, well above industry average in that business. And that is because we have a very talented team there, both an operations team and a sales team that has been working very hard to expand distribution and you see that coming through quarter after quarter after quarter in increasing sales that are certainly well above industry experience.

We appreciate that you noticed that. In terms of the hedging, what I would say is that we believe that we are extremely sophisticated, certainly at the same level as all the other writers that are in that individual annuity business. We study intently the success of our hedging strategy. It will obviously vary from period to period, but in rough terms, very rough terms and over the longer term we think that our hedges are about 80% to 90% effective in accommodating the various risks of that business. So we are comfortable with it. We have executed very well and we plan to continue to kind of grow that on a consistent basis as we have in the past.

Great. Thank you.

Thank you.

Your next question is from Jeff Schuman with KBW.

Good morning. Larry, I was wondering if you could give us a few thoughts about the ING CitiStreet deal. First of all, I am wondering whether it is large enough to -- that means it will put a meaningful number of accounts sort of in play, what is the chance to gather some business. Secondly, does it signal any acceleration in industry M&A, do you think. And thirdly can you remind us about your level of interest and appetite to look at properties like that that are focused maybe a little larger case than your current core business? Thanks.

Sure, Jeff just a couple of comments on that. Obviously there's nothing or there is very little, certainly nothing of that size that moves in the market that we are not aware of. So you can just sort of take that as a given. I don't think anybody has been anymore active than we have around consolidation. Does this signal new consolidation? You know, I don't know. Not necessarily. I tend to believe, Jeff, that the issues that drove the CitiStreet transaction were relatively unique both to Citi and to State Street. First of all I don't think that joint venture structure was ever a long-term structure. They don't tend to be people who play well in joint ventures. Obviously, Citi has their own issues that they need to deal with.

So I think it was more of a one-off unique situation. In terms of will it create opportunity, answer absolutely yes. When these things go in play, let me just say that clients don't necessarily just march along. There will be a lot of opportunity. It is a very complicated block. It has a number of very small plans and then a few handfuls of very large plans. It will be difficult, it will be complicated and we'll have the opportunity to kind of pick and choose where we want to play and how we want to play versus trying to have to absorb and digest the entire animal. We look forward to that opportunity. Great, thanks a lot

I think we have time for one more.

Your next question comes from Dan Johnson with Citadel Investment .

Could you run through the WM asset, I'm sorry, the Washington Mutual asset withdrawal outlook again? And then secondly, the real estate loss in other, can you give us a little more color on what that was? And final the 34 basis points of ROA in '07 FSA does that only include the third quarter adjustment or does that include some of the other adjustments, such as the ones you have identified in the first quarter of '07? Thank you.

Good morning, Dan, this is Larry. I will maybe take the first one and the last one. In terms of the WM withdrawal, let me try be clear on that, it may mot have been clear. That was actually, the 1.24 was actually a withdrawal attributable to their own home office plan, their own corporate plan. It was not withdrawal attributed to withdrawal of assets which had come to us through financial advisors as part of Washington Mutual's distribution platform. So this was a $1.24 billion withdrawal attached to their corporate plan. They have been evaluating the platform on which they have -- that they have offered to Washington Mutual employees. We were aware of that at the time of the acquisition. We, as was said in the comments, priced that into the acquisition. While we are sorry to see that go, it was not unexpected and again it is not something that we haven't taken into account.

On the 34 basis points, what I would say, Dan, is you ought to think about that as kind of the noiseless ROA. Unfortunately, there's never going be a quarter that is noiseless. But you want to think about if I was building a long-term model of what I would expect the Full Service Accumulation earnings to be, I would be plugging in 34 basis points today, trending down to that sort of 30 to 32 basis points over time, but recognize that in any quarter there's going be a bit of noise.

Julia.

Yes. Thanks Dan. It is a little unusual for us to show real estate losses, so let me describe that fund. That's actually a real estate fund that PGI manages, that Principal Life took a minority interest in and therefore we are using equity method of accounting and inside that real estate fund there's actually some CMBS and as we have been describing in March, CMBS had a huge blowout in spreads, so the market came through in our other line as a negative number. Our hope is, obviously, that will reverse itself for the rest of the year, but that's what that is.

Thank you very much.

Well, thank you all very much for being on the call today. We appreciate your interest and your support. I would like to express my sincere thanks to our investors and to the sell side analysts for the time we have been able to work together over the last several years, it has been a very good experience for me and I hope it has been for you. I have thoroughly enjoyed it. I really do believe that this Company is a better run Company because our interaction with investors and with analysts and it keeps us on our toes and we appreciate that and we think, as I said, makes us a well run Company.

I would also like to thank the board and senior management, excuse me, for allowing for the smooth transition that is undertaken between myself and Larry. And lastly I would just like to express my sincere thanks to our employees and managers and all of the team that works here and express my sincere confidence in what we are going to achieve going forward. I know under Larry's leadership and the senior team we are going to do great things. We have great employees. I can assure you this Company will be focused on doing what's right by our customers, doing what's right by our employees with integrity and foremost will be focused on creating and sustaining shareholder value. Thank you all so much and have a great day.

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