美國信安金融集團 (PFG) 2008 Q4 法說會逐字稿

Good morning. Welcome to the Principal Financial Group fourth quarter 2008 financial results 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 call 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, financial supplement, and additional investment portfolio detail can be found on our website at www.principal.com/investor.

Following a reading of the Safe Harbor Provision, Chief Executive Officer, Larry Zimpleman, and Chief Financial Officer, Terry Lillis, will deliver some prepared remarks. Larry will cover performance highlights for the quarter and the year, and provide an update on our capital position. Terry will provide a detailed overview of financials and our investment portfolio. Then we'll open up for questions.

Others available for the Q&A are our four segment heads, John Aschenbrenner, responsible for Life and Health Insurance; Dan Houston, responsible for US Asset Accumulation; Jim McCaughan, responsible for Global Asset Management; and and Norman Sorenson, responsible for International Asset Management and Accumulation. Also available is Julia Lawler, our 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 & Exchange Commission. Larry.

Thanks, Tom, and welcome to everyone on the call. Fourth quarter and 2008 were clearly challenging. Given this environment, I thought I would begin my remarks by providing investors some longer term perspective on our three growth engines. At the time of our IPO in 2001 we had a great 401(k) business focused on advisors and the small and medium-sized business market.

Over the next seven years we expanded our sales, service, and consulting into an unparalleled network of local resources, and we created distribution alliances with a dozen firms, providing access to nearly 50,000 advisors. Then we added and integrated capabilities like nonqualified and employee stock ownership plans to create total retirement suite, transforming us from the SMB 401k leader to a market leader across a range of planned types and sizes. The result, a seven-year compounded annual growth rate of 15% for full service accumulation sales. In 2001 we had great aspirations for Principal Global Investors and Principal International, but earnings for these businesses were just $43 million on a combined basis. Seven years later, PGI is not only managing assets for twelve of the top 25 U.S. pension funds, but now has clients in 55 countries with more than 40% of its institutional sales in 2008 coming from outside the U.S.

Principal International has built top five positions in many of its markets, increasing its assets under management five-fold. And combined, their earnings are up more than 400% at $220 million in 2008. We've increased total company assets under management by more than 150% despite essentially flat markets over that time, and we've improved return on equity by 520 basis points. We believe it is critical to remind investors of our track record of strong execution, because execution is what will carry us through these difficult times.

Moving to operating results and key performance measures, we were pleased with our operating results for fourth quarter and the year, particularly in light of market conditions. Operating earnings per share for fourth quarter 2008 were $0.69, with items impacting comparability which Terry will discuss, essentially offsetting each other. This compares to the First Call mean analyst estimate of $0.66 per share. Since Terry will cover quarterly results in detail including realized investment losses that drove a modest net loss for the quarter, I will focus most of my comments on full-year results.

In 2008 we again benefited from a diverse portfolio of businesses. In a year where the S&P 500 index declined 38%, driving our assets under management down 21%, we delivered $10.7 billion of operating revenues, a drop of only 4% on the strength of record revenues from Principal Global Investors and Principal International. We also delivered a very solid $943 million of operating earnings for the year, a drop of 10%. Record earnings from Principal International and strong earnings growth for the Life and Health segment helped to offset the impact of equity market declines. Importantly, we continue to see strong fundamentals and competitive strengths in our U.S. Retirement franchise and our Asset Management and Accumulation businesses overall. These strengths are evident in strong deposits and net cash flow.

For the year, our three asset management and accumulation segments produced a record $112 billion of deposits, which generated $7 billion of net cash flow. While flows are down from a year ago, this reflects our planned reduction of the investment-only block, a mutual fund industry that's been an outflow since mid-year, delays in decision making, and funding due to market volatility from retirement plan and institutional investors and lower actual fundings from these investors due to declines in asset values.

Moving to each of our three key growth engines, I will start with Full Service Accumulation which delivered $2.1 billion of sales in the fourth quarter and $8.3 billion of sales for the year. While full year sales were down from 2007, we view 2008 performance as very solid, particularly in an environment where some planned sponsors have slowed decision making in the face of extreme market volatility, some distribution partners have experienced disruption and equity market declines have driven down plan assets. On this last point we estimate that 2008 sales would have been $1.5 billion higher, or $9.8 billion of sales in total, had the markets performed in line with our 2% per quarter assumption. As previously communicated, 2007 results reflected a higher than normal proportion of employee stock ownership plan sales. Excluding ESOP assets, Full-Service Accumulation delivered $7.6 billion of sales in 2008 versus $7.2 billion in 2007, an increase of 5%. Because of higher fees on non-ESOP assets, current year sales will drive about 1% higher revenues than Full Service Accumulation sales in 2007.

In 2008, as we have seen in years past, factors that negatively impacted Full Service Accumulation sales positively impacted client and participant retention, with withdrawals down more than $900 million from 2007. The result, net cash flows were up 17% in 2008 at $5.5 billion for the year which translates into 5.4% of beginning of year account values. Our Principal connection capability and work with advisors to retain at-risk participant assets continues to be successful as well. For the year we retained nearly $2 billion of participant assets into our mutual fund, individual annuity and bank products, demonstrating the strength of our asset retention capabilities and the depth and breadth of our retail roll-over solutions.

Moving to Principal Global Investors, assets under management are down 19.6% from a year ago, again reflecting market conditions. For the year, net cash flows were positive, reflecting our depth and breadth of asset management capabilities. PGI did experience negative nonaffiliated flows of $3.6 billion in the fourth quarter which is not indicative of our outlook going forward. The biggest contributor was a single real estate advisory mandate of $2.7 billion which produced revenues of only $200,000 in 2008. As mentioned before, market volatility is causing retirement plan and institutional investors to delay making changes. They're apprehensive about investing into a falling market or being temporarily out of the market while executing a transition. As an example, we had commitments in September and October from three Sovereign institutions in Asia totaling $1.5 billion in global equities. These were expected to fund by year end, but they did not.

Looking forward, we currently expect two of these to fund at least partially in the first quarter. Because PGI's relative investment performance remains strong, particularly for the three-year and five-year periods, our level of final stage prospects remains high. At $849 million, Principal International delivered record operating revenues in 2008, an increase of 7%. Principal International continued to be an important contributor to our earnings diversification with a record $126 million of earnings for the year, an increase of 14%. In part, this reflects operations that are less equity sensitive than the U.S. Asset Accumulation and Global Asset Management segments. Of the 19% decline in assets under management from a year ago, 17% was attributable to foreign currency changes and 5% due to market declines, which were partially offset by a 3% increase from positive net cash flows.

While currency changes during fourth quarter will create headwinds for operating earnings in 2009, Principal International's long-term organic growth remains in the 14% to 17% range and we remain optimistic about the growth potential of the segment. We continue to benefit from diversification provided by the Life and Health segment as well. Segment earnings were up 22% for the year with stable earnings from Individual Life and strong improvement from a year ago for the Specialty Benefits and Health Divisions. With record nonqualified sales in the fourth quarter and for the year, we continue to see evidence of the power of our total retirement strategy.

Let me add a couple of additional thoughts on Health. We believe we are on track with the first phase of our turn-around for the division stabilizing earnings. The second phase is stabilizing, then growing membership. We continue working on a number of fronts with a particular focus on more Principal specific network contracts in key metropolitan areas and on improving terms in existing network contracts. These will help us gain greater control of the claims costs, which in turn will enable us to price more competitively. We're optimistic we will see progress in this area in 2009, but would remind investors that membership growth is a multi-year process as we are following a very disciplined approach.

I would again remind investors of three important features of our business mix. First, our three key asset management and accumulation businesses, Full Service Accumulation, Principal Global Investors, and Principal International require very little capital to support organic growth. As such, we generate substantial free cash flows historically about 70% of earnings for these three businesses combined. Second, strong general account liquidity gives us the flexibility to selectively scale back on certain capital intensive businesses to free up additional capital. Our planned reduction of the investment-only block freed up approximately $100 million in the fourth quarter. Third, we manage our investment portfolio to match our liabilities which are generally longer term and predictable. Our asset liability discipline, along with our strong liquidity position, gives us the intent and ability to hold assets until maturity. Thus, increases in gross unrealized losses are not indicative of future investment losses.

As another significant point of differentiation, we have purposely made products with varying capital charges such as variable annuities with guaranteed living benefits, a small part of our business. With only $1 billion in this block, equity market volatility has minimal impact on our Life Company capital ratios. At year end 2008 we estimate our RBC ratio will range from 420% to 445% which compares to 376% reported at December 31, 2007.

In response to market conditions, the Company has continued to improve its liquidity. In 2008 we increased cash and cash equivalent holdings by 94% to $2.6 billion at year end. During the year we made adjustments in our general account investment strategies, investing new cash flows primarily into government and agency-backed securities and other liquid investments. We also closed out our very modest general account securities lending program in the fourth quarter. As of year end, only 1.2% of our institutional GICs and funding agreements could be redeemed by the holder prior to maturity.

A few final comments. At year end, our excess capital position above that needed for our current credit rating is estimated to be approximately $800 million. Between our strong current capital position and ongoing generation of new cash flow, we continue to believe we can absorb higher credit losses, even in an environment of ongoing economic and credit stress. Our excess capital position at year end up from our Investor Day projection of $450 million reflects several items, including approximately $200 million of surplus from net statutory derivative gains and $120 million of surplus from a pending approval of a change in statutory reporting requirements.

Looking forward, there is obviously uncertainty around the length and severity of the global recession. Revenue and earnings clearly remain under pressure and market conditions signal higher than normal investment losses again in 2009. In the face of these headwinds we will continue to focus on managing capital efficiently and aligning expenses with revenues over the longer term.

We're pleased with our ongoing expense initiatives which resulted in an 8% decline in operating expenses comparing fourth quarter 2008 to the year ago quarter, as well as our efforts to remove approximately 6% from our 2009 run rate expenses. Our strategy will continue to reflect an uncompromising focus on helping businesses, individuals, and institutions achieve financial security and success. Over time, we have built broad and deep asset management capabilities that support retirement and other long-term investment strategies.

We have developed a portfolio of retirement and investment products that enables us to meet needs across the accumulation to pay out spectrum, and we have assembled an extensive local network of sales, service, and consulting capabilities. This makes us easy to do business with, helping us create long-term relationships with financial advisors, business owners, and their employees. This in turn drives outstanding sales and retention. These elements are the core of our competitive advantage in the marketplace. So while aligning expenses with revenues is a top priority, we'll also need to do it in a thoughtful way to protect the advantages we've worked so hard to build over so many years and enable us to continue to prosper when the business climate improves. Terry.

Thanks, Larry. As indicated this morning, I will spend a few minutes providing financial detail for the Company in each of our operating segments. I will also cover our investment portfolio. Let me start with total company results. At $0.69 in fourth quarter 2008, operating earnings per share was down $0.18 from a year ago. As always, there are a number of items impacting comparability between periods, but the variance primarily reflects the impact of equity markets on assets under management, and in turn, fee revenues and earnings. Between the Full Service Accumulation and Mutual Funds businesses alone, the decline in equity markets reduced earnings per share by $0.16.

Earnings were also dampened by several items, including the impact on net investment income of holding more liquid investments, severance costs due to our expense initiatives, weakening of Latin American currencies against the U.S. dollar, lower prepayment fee income, and higher amortization of deferred acquisition costs, which I will discuss in more detail shortly. These items range from about $0.02 to $0.04 each, reducing fourth quarter 2008 earnings by $0.12 per share in total.

Because of our strong liquidity and asset liability management, we were positioned to opportunistically buy back certain medium-term notes early and at a significant discount. This benefited investment only earnings by about $0.07 per share in the fourth quarter, offsetting a portion of the negative impacts. We'll continue to look for these opportunities in the future as we scale back this business. Adjusting for all of these items, with no market growth, our earnings per share would be up about 3%.

Moving to the segments, I will start with U.S. Asset Accumulation where account values were down $35 billion or 19% from a year ago, to $146 billion at year end. Negative investment performance due to equity market performance declines erased nearly $38 billion in 2008, with more than $18 billion of the decrease in the fourth quarter between Full Service Accumulation and Principal Funds. At $103 million, segment operating earnings for fourth quarter 2008 were down $47 million from a year ago due to significant equity market declines.

Full Service Accumulation earnings were $54 million for fourth quarter 2008 compared to $82 million in fourth quarter 2007, reflecting a 22% decline in daily average account values. Principal Funds earnings were $2 million for fourth quarter 2008 compared to $11 million for fourth quarter 2007, reflecting a 29% decline in average account values. For these two businesses, fee revenues dropped in line with the decline in account values, but the primary variable expense offset during the quarter was investment management fees.

While we remain focused on aligning expenses with revenues, the speed and magnitude of the fourth quarter market drop made this more difficult, and as Larry indicated, it is critical that we take a thoughtful approach to expense management, one that contemplates the long-term growth of our businesses. Individual annuity earnings were also down, with $100,000 loss in the fourth quarter 2008 compared to earnings of $15.1 million for the prior year quarter. 20% earnings growth from the Fixed Annuity business was offset by the impact of unfavorable equity markets on the Variable Annuity business, which included a true-up for deferred acquisition costs and an increase in the guaranteed minimum death benefit reserves. These items reduced fourth quarter 2008 earnings by about $12 million and $4 million after tax, respectively.

Before moving on, a couple of comments on amortization of full Full Service Accumulation deferred acquisition costs or DAC, which had $9 million for fourth quarter 2008, was down from $32 million in the year ago quarter. Our quarterly review of DAC resulted in a true-up for market performance which resulted in approximately $16 million higher expense than a year ago. This was more than offset by three items ranging from $13 million to $15 million each, reducing the expense by $42 million in total.

First, in periods of low gross earnings, GAAP accounting dictates lower amortization. Second, expense initiatives taken near the end of the quarter reduce future expenses, improving future expected gross profits, requiring us to write up the DAC asset, and, third, continued improvement in retention also resulted in a write up.

Moving to Global Asset Management, fourth quarter 2008 earnings of $27 million compared to $30 million in the year ago quarter. Higher earnings in fourth quarter 2008 from performance incentives were more than offset by the impact of lower average assets under management and the lower fees due to the slowdown in the real estate market.

Moving to International Asset Management and Accumulation, fourth quarter earnings of $18 million compared to $25 million a year ago. The decline was primarily due to weakening of Latin American currencies relative to the U.S. dollar, which reduced fourth quarter 2008 earnings by nearly $7 million after tax when compared to the same period in 2007. Both periods benefited by about $4 million after tax from higher yields on invested assets in Chile due to unusually high inflation.

A couple of other comments, first on Principal International's net cash flow. Excluding about $1.2 billion of outflows during the year from corporate money market funds in India, net cash flows would be up modestly from 2007. The global liquidity crisis has made the money market funds unprofitable and we reduced our exposure pending improvement in market conditions. Excluding India, net cash flows were 9% of beginning of year assets, with another outstanding year in Brazil which generated net cash flows of $1.4 billion.

I will also comment on Principal International's return on equity. Based upon normalized earnings, segment ROE is approximately 10.3% for the trailing twelve months. ROE is highly sensitive to foreign currency rates, and at today's levels ROE will be pressured in 2009. At $51 million, fourth quarter earnings for Life and Health Insurance were up 20% from a year ago quarter. With 2008 earnings up 22%, segment ROE improved 250 basis points from a year ago to 13.5%.

Individual Life earnings were $30 million for fourth quarter 2008 compared to $26 million for the same period in 2007, reflecting growth in the block of business overall and $3 million of additional earnings from updating the policy holder dividend scale to reflect experience of the closed block. Specialty Benefit Division earnings were $27 million for fourth quarter 2008, compared to $26 million for the same period in 2007. Favorable claims experience and the disability lines of business was partially offset by lower investment income and a return of more normal loss ratios for dental and group lifelines. Reflecting expected claims seasonality and higher deductible plans, the Health Division had a loss of $6 million in fourth quarter 2008. This compares to a loss of $9 million in the year ago quarter, with the improvement primarily due to lower loss ratios. For the year, Health Division earnings improved 79% and the division ROE was 15.5% at year end.

Let me now comment briefly on net realized capital losses. In fourth quarter 2008 we recognized capital losses of $189 million, bringing full year capital losses to $505 million. $297 million of the losses for the year are credit related, including $110 million between Lehman Brothers and Washington Mutual. Although higher than normal during this period of financial crisis, adherence to our internal credit exposure guidelines and the resulting diversification has helped limit our losses. I would also point out approximately $110 million of the net realized losses in 2008 were on securities that were marked to market through the income statement but we believe should recover when more normal investment conditions return. In effect, these losses for accounting purposes will not necessarily equate to a true loss of capital over the long-term. We recognize there is concern with gross unrealized losses which increased $3.8 billion from September 30th. Let me offer a few thoughts.

First as Larry mentioned, given the longer term nature of our liabilities and our disciplined asset liability management, we have the ability and intent to hold assets until maturity. Similar to last quarter, widening credit spreads driven more by forced selling into a thinly traded bond market than credit fundamentals was the primary driver behind the increase in gross unrealized losses. We continue to believe the fundamentals of our fixed maturity portfolio remains sound. Our assets continue to contractually perform and we expect them to mature at par. As an estimate of the significant liquidity premium being reflected in the cash market prices, if you use the more actively traded credit default swap market as observable data, the increase in gross unrealized losses on our corporate bond portfolio would have been approximately $3.4 billion lower in the fourth quarter.

In addition, using the CMBS index, gross unrealized losses on our CMBS portfolio would have been $800 million lower, so in total, gross unrealized losses of $8.2 billion would have been $4.2 billion lower using synthetic markets. We believe this demonstrates that gross unrealized losses are not representative of future investment losses. Again, while we anticipate higher than normal losses in this environment, we believe we have the ability to accommodate them.

In response to investor interest, let me also comment on bank preferred securities to which we have $2 billion of exposure. Given investor concern with certain banks in the UK. and Ireland, in particular those that have already been nationalized, or with the greatest potential to be nationalized, I will focus on these credits. Between Royal Bank of Scotland where we have Tier-1 exposure of $55 million and upper Tier-2 exposure of $46 million, Northern Rock where we with upper Tier-2 exposure of $35 million, and Bank of Ireland where we have Tier-1 exposure of $73 million, these total $209 million or $128 million of Tier-1 and $81 million of Tier-2. I would also note that all our bank preferred securities are current in their payments.

In wrapping up my comments, let me discuss our outlook going forward. I would remind you that our December 10th guidance was based on starting 2009 with $265 billion in assets under management and an average S&P in 2009 of 900. As previously communicated, a 10% immediate decline in the markets followed by a 2% per quarter increase generates a reduction in total company earnings of roughly 4% to 6%. While the equity markets have continued to under perform, there are signs that some of the other headwinds may be easing. Credit spreads which widened significantly in the fourth quarter have narrowed somewhat in 2009.

We also see some confidence returning to the inner bank and commercial paper markets. In addition, the new administration's fiscal stimulus package which is beginning to take shape could provide a meaningful boost to the economy in the second half of the year. Our challenge, then, is to continue minimizing the impact of a poor economy and markets and to continue positioning the Principal to emerge even stronger when the markets recover. This concludes our prepared remarks. I would now ask the conference call operator to open the call to questions.

Before we open for questions I would like to turn the call over to Mr. Larry Zimpleman.

Thank you. As you know, the rating agencies have the North American insurance industry on a negative outlook. This morning we received word that Moody's has affirmed the financial strength rating of Principal Life Insurance Company at AA2 with a negative outlook. We're pleased with Moody's affirmation of our ratings.

Since we're in a stronger capital and liquidity position today than when they affirmed our rating in November, it is our view the change in outlook primarily reflects market conditions as our fundamentals remain strong. Despite the negative outlook, our relative ratings remain strong and provide our customers with comfort in our ability to meet our obligations. At this time we have also not heard from any other rating agency regarding ratings changes. With that, I would ask the operator to open the call for questions.

(Operator Instructions) Our first question comes from the line of Andrew Kligerman with UBS.

Yes. Real quickly, good morning, the interest rate swaps, $200 million statutory derivative gain there, one of your competitors had a similar gain this morning, and they kind of locked in the gain. Could you review whether you locked in that gain and how that program is going to work going forward, and then I believe I can ask a follow-up question.

Okay, Andrew, good morning. This is Larry. I had a little trouble hearing you. You were cutting out a little bit. I believe you were asking about the $200 million statutory gain, and I think your words were the extent to which that is locked in?

Yes, and going forward how that might play out as you work with that derivative program, how that would play out?

Just a quick comment, and maybe Terry will want to add something on it. I think as he said in his comments, it is a net position on statutory books, and thus, it is subject to some fluctuation up and down as markets would fluctuate,but it is certainly been in all of our capital calculations in the past, so you can see it hasn't provided significant fluctuation.

Each time, of course, over time as the book of derivatives grows, the fluctuations can become slightly greater, but I wouldn't expect to see anything too dramatic going forward. That number will bounce around, wouldn't be too dramatic, and let me see if Terry has something he can add.

You're absolutely correct, Larry. The derivatives, the gain or loss in net position on gains or losses, are always in our statutory calculation. The reason that we're pointing it out this time is because of the significant drop in interest rate this quarter had a little bit more meaningful impact and that's why we're sharing it at this time.

Okay. Just one quick follow-up. With regard to the deferred tax asset, you're asking the Iowa Insurance Division to allow $120 million. I guess how you just mentioned Moody's, and they have reaffirmed your rating with a negative outlook. How are the rating agencies looking, that given that maybe the other insurers in the other states won't be able to garner that benefit? Do they look through it or do they agree with it, that that's $120 million of additional capital?

Okay. I will try to again kind of provide a little bit of color on that, Andrew. And then Terry might want to add some more. I think that, again, clearly it is based on permitted practice which the Iowa Department has indicated for this year, and I think as it relates to stat accounting, the thing I would remind everybody is that stat accounting has been and continues to be a very conservative method of accounting relative to GAAP, so the $120 million again is actually a reasonably small piece of a total deferred tax asset, and so it would be inappropriate to conclude that that change in permitted practice is somehow a real weakening of what we know to be conservative statutory accounting. So I guess I just want to provide that reminder, and then I'll have Terry comment in more detail.

You're right, Larry, the statutory accounting is very conservative in this particular aspect of the deferred tax asset. We went to the Iowa Insurance Department and asked for this permitted practice because of the nature of the deferred tax asset, at this point in time, the admissibility of it as Larry mentioned, it is a relatively small portion of it, about 9% of the gross per tax asset, and we think this is in line with the conservative nature of the asset.

And as it relates to the rating agencies, Andrew, I think again they have a real understanding of this, and they're certainly taking it into account appropriately, recognizing that it is a permitted practice at this time.

All right. Thanks a lot.

You bet.

Our next question comes from the line of John Nadel with Stern Agee.

Close enough, just a quick one on the risk-based capital. I know it is still a moving target, but within that range can you give us just a ballpark estimate on the enumerator and denominator that goes with that?

John, this is Larry. To be honest with you, I don't have that much detail. Again, we think that we estimated it is going to be in the range of 420% to 440%, but let me ask Terry if he has more on the numerator and the denominator.

Our estimate on the total adjusted capital number is about $5.1 billion at this time, although as Larry said, it is a moving target.

Understood. That's perfect. Thank you. And then the only other question I have for you is thinking about the 401(k) business and going back to your Investor Day and your outlook for net flows and sort of the organic growth of this business, I wondered if there is any reason to revisit that outlook in light of what feels like, anyway, a month or two later as you know, maybe more dramatic economic pressures in general. And then, also, we continue to watch almost day by day as more and more companies, at least in the United States, continue to eliminate their company matches, so I was wondering if you can sort of comment on what, if any, effect that might have relative to your expectations when you outline them at Investor Day?

It is a great question, John. I will certainly have Dan give you a little bit of color in all of those areas of participation and deferral and so forth. I would just note if any of you had a chance to see the Journal this morning that there was a nice article about small firms adding 401(k)s which, I think, plays to our strengths, but I will have Dan provide you more color here.

Relative to what we updated there on, I believe, December the 10th, we still feel very good about Q1. There was a modest uptick in pipeline in Q4. It trailed off a little bit from there, but again, we feel like we're having a good shot at a lot of good opportunities and you will note in the press release we announced a very large institutional win in the not-for-profit area, in particular a hospital, so again that's still a very thriving market for us.

As it relates to the elimination or, in some cases, suspension of the match, again, a lot of our business is small to medium or smaller institutional, so we have not seen a lot of decreases in match announcements to our customer base.

Two things that have impacted us on the very smaller plans we have seen some businesses go out of business, some foreclosure -- some discontinued businesses. In our mid-sized market we have seen the shut down of some plants, and some locations been reduced, but all in all, if we look at hardship withdrawals and loans, those are still on track with what I said back in December, which is a modest uptick in withdrawals relative to hardships, and actually a decrease in loans, both measured in dollars and measured in participants making requests for loans.

Interesting. Thanks for the update. Appreciate it.

You bet, John. Thanks.

Our next question comes from the line of Colin Devine with Citigroup.

Good morning. I have a couple of questions. First, could you just clarify the improvement in the RBC reflected some relief on the margins experience adjustment factor, and then two follow-ups. On the drop in book value which, of course, is impacting the stock today, why do you think the 72% drop you have had is more than double the peer group average? What is it about Principal's that is causing it to be so volatile, and finally, Larry, you mentioned the article in the Journal today.

You laid out all the distribution you have added since the IPO, okay, total retirement services, and yet the number of plans that you have has not moved, in fact, it is slightly declined since the IPO. How do we conclude this is a thriving business?

Okay. Let me talk just a little bit about the second one, Colin, around book value, and then maybe Terry can comment on the MEF factor, and Dan can do the plan count, and I think he'll also get into participant flows and so forth as well.

What I would say, Colin, on the book value, and I am going to try to be relatively brief because I know we have other people who also want to answer questions, but fourth quarter was a particularly unusual year -- or particularly unusual quarter in a lot of circumstances, and in terms of the GAAP items and the changes that you see there in book value, one of the real elements there that I think you need to take into account is exactly how derivative movements impacted GAAP book value for those writers who had large variable annuity exposure.

As you know, we have deliberately kept a very minimal exposure to variable annuity with guaranteed minimum benefits, and as a result of that, we have -- while we do have a hedging program, it is small relative to what other peer companies would be, and you have noticed as you looked at those peer companies they have all had very, very large increases in their derivative income and their net income figures all associated with that guaranteed minimum withdrawal benefit. So on the GAAP side, just because a particular movement in derivative marks this quarter has actually come through as a net income gain.

Now, on the statutory side, of course, it has the opposite effect which is why you have seen our RBC ratio increase and you have seen our excess capital position increase. So I would just caution everybody to sort of take into account as they're interpreting our results relative to peers that, again, we remain comfortable that our decisions to minimize that variable annuity exposure, while it may have had what looked to be some negative impacts in GAAP in Q4, it is still the right decision over the long-term. Let me briefly have Terry comment on MEF and then Dan on plan count.

As you're aware, last year we had some very minimal experience in terms of losses in our commercial mortgage portfolio and because of that our MEF factor was extraordinarily high. Moody's adjusted the 376% RBC to 406%. We are seeing our experiences more in line with the rest of the industry at this time and so our ME Factor is one in line with everyone else. That's why we're seeing that increase from 420% to 445% this year.

Dan, on plans.

Sure. Very quickly, Colin, we are seeing increases in the mid-sized plan, roughly 3% on those plans from 500 to 1,000, we saw an 8% increase on the over 1,000. I would say that our Alliance partners typically focus on an average case that's larger than our historical small to medium size independent career agents and brokers. I would also comment that TRS by its definition lent itself to a larger size plan because the multiple coverage is being provided. And the last comment I would make is this was a big year, of course, in the not-for-profit area, many of those plans becoming ERISA compliant. Again, hospital market and not-for-profits tend to be a little bit larger plan.

To the very specific question in the small case market, we did double our results in the TPA area with a number that exceeded $800 million, and that continues to be one of our growth areas for the small case plan market, going head to head with some major competitors, as you know, leveraging the use of local TPAs as opposed to providing that service ourselves.

Our next question is from the line of Suneet Kamath with Sanford Bernstein.

Great. Thank you. Two questions. I guess just to follow up on Colin's question on the book value, I hear what you're saying about the unrealized losses and the peer group comparisons, and I think Moody's commented in its press release, also about their view that you probably wouldn't have to realize these unrealized losses, but to Colin's point that the market seems to care about it, and I guess for Larry, you talked about dynamic management at the Investor Day in December.

What is the plan with respect to this number? Are we just going to ride this out and wait for credit spreads come back and perhaps for bonds to mature or is there anything that you can do more actively to manage this number slightly higher? And then I will have a second question.

This is Larry. I will make a comment or two on it. Again, I think we understand the point around it which is, again, why we tried to emphasize we built our liquidity position by 94%. We have always had a very disciplined asset liability management approach. We only have 1.2% of our liabilities that is can be prepaid prior to maturity, so I think we've got a lot of elements that sometimes sort of maybe aren't taken fully into account as people are looking at that.

Now, again, the other thing we have done on the asset side, Suneet, is we have tried really hard to provide just very specific measures, and I maybe have Jim McCaughan comment generally, but very specific measures of what we think the illiquidity premium is because of the nature of our assets and wanting to be call protected. We're a little bit more in private market assets which, today, do have that illiquidity premium. If you just sort of run a quick calculation based on what Terry said earlier with the $4.2 billion lower realized losses using synthetics, and you run that through book values, Suneet, what you get is get that to be about somewhere between $8.50 and $9 for book value. What you see there as sort of $7.45, in our view is actually at a minimum, would be more like $16 or $17 just based on the illiquidity premium. Maybe I can have Jim comment quickly on his thoughts around the market and the illiquidity premium and how long that might persist.

Thank you, Larry. The Fixed Income markets and, particularly, over the last three or four months have been detrusted, you know, the overworked word is unprecedented, but it really is unprecedented, the extent to which the disruption has happened, and the very low liquidity.

To give you some examples, in areas such as CMBS, the only sellers or the only trades that are in the market over the last few months have been deleveraging hedge funds and other structured products, and of course, when there is a one-way trade like that with very motivated sellers, that tends both to force prices down and to mean very, very low volumes. In fact, in some of these markets the volumes have been 1% or 2% what they were 2 years ago. The derivative market that Terry described, particularly taking the CMBX in the case of the CMBS market, is somewhat more liquid. It is not perfect. That's really the origin of the numbers that Larry gave of at least part of the liquidity premium being clearly accounted for by that number of $4.2 billion that Terry described.

To give you some kind of indication of the environment here, for some of these bonds, and I am not just talking about the CMBS area here, I am also talking about some of the corporate bonds, you're down from maybe 10 or 12 dealers to two or three dealers. Some of the dealers have gone out of business and others have withdrawn capital from the market, and those two or three dealers that are left are themselves highly conflicted because of the proprietary trading they have So I think if you add all of this up, large parts of the bond market could be described as technically in-active, and that's why although we have used them for GAAP purposes and getting to that $7.45 book value, it is very important both to test the market values and to see what really is the fair value as opposed to just a mark in a very restricted market. And also to look at the stress testing that we described in the past at Investor Day, which we have really been trying to encourage investors to see the real situation of the portfolio. I hope that helps.

No, it does, hopefully the accountants start to realize that, too. My second question is on the excess capital, and it will just be brief. In the past and I think it was when you provided guidance, you talked about there is a statement that said you have something to the effect of no plans to raise common equity for nonstrategic reasons. I don't know, I didn't see that in your current press release. I apologize if it was there. I don't think you made that statement on this call. I was wondering if you could reaffirm that statement if that is in fact the case?

Yes. This is Larry. Again, just to comment briefly on that, I say with $800 million of current excess capital, we do believe that we remain in a strong capital position, but we're going to continue to evaluate that position, given the uncertainty and the length and the depth of the recession. So I think we, like all of our peer companies, we're going to continue to monitor and evaluate all forms of capital, and we'll make decisions on what we want to do or what we want to use, if anything ,and under what terms. We've just got to remain a very dynamic environment. We feel good that we have made progress from September 30th to today, and we'll just monitor as this recession continues to grind forward.

Okay. Thank you.

Our next question comes from the line of Randy Binner with FBR Capital Markets.

Thank you. I think this question is for Julia, and I apologize if it was covered somewhat. Just to understand procedurally the cash versus the synthetic approach, have you always over the last three or four quarters used more of a cash approach than a synthetic approach, so has there been any change in that methodology, and should we read that the lower cash marks are potentially a sign of a slow return of the bond market and that we'd be stuck with lower cash marks versus synthetic for the next few quarters?

I will have Julia quickly comment. Go ahead.

We have always used cash marks or IVC type pricing in doing our financial statements. We added this quarter a spreadsheet indicating the differences between CBS and CMBX because of the dramatic move in cash prices versus synthetic prices, so it was more for to remind people the fair value really isn't representative in the cash market. We did indicate that cash spreads have improved a bit in first quarter, but I think there is an indication it is going to be a slow return.

Okay.

Does that answer it, Randy.

It is great. Thanks. Just to clarify, was there ever a point in the third or fourth quarter where you had to rely more on synthetics or have you always been cash?

We always put our financial statement and analysis around cash marks.

Okay. Great. That's perfect. Thanks, guys.

Thank you.

Our next question comes from the line of John Hall with Wachovia.

Good morning. I just wanted to quickly understand, you had cited a $5.1 billion number. I wanted to know what that number was. Was that the statutory book value at year end?

I will have Terry comment on that.

That's the total adjusted capital and the statutory books. It is made up of three parts, the statutory equity, the MSBR, plus half the dividend liability.

Okay. So in a sense that represents kind of the liquidation value?

That's basically the statutory accounting treatment of it. It wouldn't necessarily be the liquidation value of the organization.

I guess in theory. Seems that the way that I understood the statutory accounting in a broad sense,that number would represent something along the lines of a liquidation value, where as the GAAP book value is historically has been thought of as a going concern value, yet you have the two numbers upside down. I was just wondering if you can help me reconcile in my mind how that can exist for a long period of time?

John, this is Larry. I don't know that we have that detail here, and we can certainly dig into that later. Again, what I would say again, I think the key principle here is that stat accounting has been and remains a very conservative method of accounting relative to GAAP, so I think that's really the key variable, that's always been the case. I think that's appropriate. Stat is looking more at the solvency basis, so the details around that in those numbers we'll have to get back to you on, but clearly stat is a much more conservative method than GAAP.

And then Julia mentioned we have seen a little bit of recovery since the beginning of the year. I was wondering if you could just put a little bit of numbers or breadth around that?

Julia or Jim, maybe, do you have any comments you want to add on that? Jim follows that carefully as well.

Two things I would say, John. I think, firstly, it used to be the case that securities analysts that thought of stats as liquidation and GAAP as going concern, but nowadays when you're using cash mark in GAAP, it actually isn't really a going concern valuation to that extent. It's the element of the fire sale which are pretty inappropriate in an organization that is holding those assets to meet long-term liabilities, and with a very clear ability and intent to hold, so I think your dichotomy between stats and GAAP would have been right a few years ago, but I think the way it evolved is no longer so sound.

In terms of what happened so far this year, there is a lot of analysis to put numbers on it. On the corporate side you would have to say that yields have probably -- spreads have come in quite a bit and so it is probably looking better, but it is hard to quantify. On the CMBS side,the market is still frozen up, so I wouldn't hold out a lot of gains there. We continue to monitor it.

Thank you.

Our next question comes from the line of Ed Spehar with Merrill Lynch.

Good morning. Two real quick questions. First,in the Moody's release they talk about investment losses in excess of $500 million in '09 as a potential factor for downgrading. Larry, it sounds -- obviously, the number was a fair bit higher in '08 and sounds like you're suggesting that it could be higher in '09, so I am wondering if you could maybe talk a little bit about that. And then, Terry, I was wondering, can you just give us a sense of preliminary statutory operating earnings for '08 and is there any reason other than major market change for that to deviate materially in '09? Thanks.

Okay, Ed, good morning. I'll just try to cover them briefly in the interest of time here. In terms of the Moody's release, again, as Terry said in his notes, the actual credit losses during 2008 were about $300 million, and again what we have always tried to distinguish there and I think is reflected in their rating is -- there is other noise in there that , of course, doesn't necessarily reflect credit. So again, that is I think the essentially the answer to the first one and, Terry, do you want to comment on the

The second one is the statutory numbers are still being finalized, but at this time our estimate of gain from operation is $650 million.

And is that sort of a normal run rate level, or seems like that's maybe a little bit lower than normal?

It is about a normal run rate rate.

I am sorry. Can you say that again?

Yes, it is about a normal run rate for us.

Thanks.

Thanks, Ed.

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

Thank you. In closing, I do want to thank all of you for joining us, and again I appreciate all of your interest in Principal Financial Group. Certainly, we know there is challenges ahead. But we do believe we face them from a position of strong fundamentals, and probably more importantly, a very diversified set of businesses and a continuing focus on risk management. So with that, again, we appreciate your interest and we look forward to the opportunity to meet with many of you in the near future. Thank you.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1 p.m. Eastern Time and until end of day February 17, 2009. 80317341 is the access code for the replay. The number to dial in for the replay is 800-642-1687 or 706-645-9291 for international callers. Thank you and have a good day.