美國信安金融集團 (PFG) 2010 Q3 法說會逐字稿

Good morning. And welcome to The Principal Financial Group third quarter 2010 financial results conference call.

There will be a question-and-answer period after the speakers have completed their prepared remarks. We would ask that you be respectful of others, and limit your questions to one and a follow-up, so we can get everyone in the queue.

I would now like to turn the conference over to Mr. John Egan, Vice President of Investor Relations.

Thank you and good morning. Welcome to The Principal Financial Group's third quarter earnings conference call.

As always, our earnings release, financial supplement, and additional investment portfolio detail, are available on our website, at www.principal.com/investor. Following the reading of the Safe Harbor provisions, CEO Larry Zimpleman, and CFO Terry Lillis, will deliver some prepared remarks. Then we'll open up the call for questions. Others available for the Q&A are Dan Houston, US Asset Accumulation and US Insurance Solutions; Jim McCaughan, Principal Global Investors; Norman Sorensen, Principal International; and Julia Lawler, Chief Investment Officer.

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

Before I turn the call over to Larry, I'd like to remind everyone that The Principal Financial Group will host its 2010 Investor Day, the afternoon of December 9, at the Saint Regis Hotel in midtown Manhattan. We'll give a detailed look at our lines of business, our strategy in the US, and in international markets where we operate. And discuss our vision for the future. We hope everyone can attend, or listen via the webcast. Additionally, we will announce 2011 EPS guidance, prior to the Investor Day, to our press release and conference call. You will receive details about the call shortly. Larry?

Thanks, John, and welcome to everyone on the call. I will focus my comments on three areas this morning. First, results for the third quarter, and the first nine months of 2010. Second, thoughts on capital management. And third, progress on implementation of our strategy during these challenging times. Terry will then cover financial results in more detail, following my comments.

Overall, we are pleased with the performance of our businesses in third quarter, and see increasing signs of growth across the businesses. We saw sequential improvement in operating earnings, Assets Under Management, book value per share, and net income. Operating earnings for the third quarter were $219 million, up 15% from last quarter, and up 15% from the year ago quarter, on a normalized basis. Year-to-date earnings increased 19% over last year, primarily due to higher Assets Under Management, and our ongoing expense discipline.

During the quarter, we saw Assets Under Management grow by over 7%, and had $2.3 billion of positive net cash flow from our growth engines. To remind you, we define the Accumulation businesses within US Asset Accumulation, Principal Global Investors and Principal International, as our higher-growth engines. As we look deeper at the business segments, US Asset Accumulation financial results were solid, and the sales picture continues to improve. We view Full Service Accumulation year-to-date sales of $3.5 billion, as positive, in an environment that remains challenging. As a reminder, we said Full Service Accumulation sales will be higher in the second half of this year. And we remain confident that we will finish 2010, with full-year sales, 15% to 20% above 2009 full-year results of $5 billion. Total retirement suite continues to set us apart from competitors, contributing 60% of total Full Service Accumulation sales for 2010.

Principal Funds continues to see very strong growth, as a result of having some new and innovative products that appeal to investors. Principal Funds generated a record $790 million of net cash flow for the quarter. An example of these innovative products, is our Global Diversified Income Fund. Still in its infancy at less than two years old, the fund reached $1 billion in Assets Under Management, this quarter. Fewer than 3% of all funds registered at the same time, have reached the $1 billion milestone. The market continues to search for yield, putting our high-yield and preferred securities strategies in high demand. And showcasing our Retirement Asset Allocation expertise, all 11 of our target date fund options, have top quartile Morningstar peer group performance, for the one-year period.

Principal Global Investors saw a return to a somewhat more normal quarter. Positive unaffiliated net cash flow of $800 million, highlights our success in attracting money to specialized investment options, such as real estate and currency, as well as in high-yield and international equities. While the number of institutional clients seeking mandates is still depressed, we are seeing activity build each quarter.

Shifting our focus to international markets. Principal International had an outstanding third quarter, with strong net cash flow and investment performance, leading to a record $42 billion in Assets Under Management. Despite a lower economic interest in the BrasilPrev, Principal International remains a strong growth driver, as we continue to deliver our retirement and asset management expertise in key emerging markets.

Our reach in these markets is extensive. In Brazil, China, and Malaysia alone, we have access to more than 200 million individual customers, and more than five million business customers, through our partnerships with Banco do Brasil, the largest bank in Latin America, China Construction Bank, the second largest commercial bank in the world, and CIMB Group, the fifth largest financial services provider in Southeast Asia. Our presence in key international markets, most for more than 10 years, gives us an advantage over competitors to capitalize on the rapidly growing middle class, and privatization of pensions systems.

Moving to the risk businesses. In light of our decision to exit insured medical and the administrative services-only businesses, we renamed the Life and Health segment, US Insurance Solutions. Which now comprises the Individual Life and Specialty Benefits divisions. With year-to-date operating earnings of $141 million, the segment contributes solid earnings, and a return on equity of 11.5%. Importantly, this business provides product depth and breadth, for the broader financial security needs of small- to medium-sized businesses and individuals, and keeps us connected to thousands of advisors that are active in these businesses.

Let me comment quickly on our investment portfolio performance this quarter. Once again, credit losses trended down. The portfolio continues to perform better than our beginning of the year expectations, thanks to a strong recovery in both corporate credit and commercial real estate. Our portfolio is built for the long-term, and the portfolio construction is the right fit to support our liabilities. Purposeful diversification continues to benefit our financial results during this challenging time, whether it be the strength of our international operations, offsetting a slowdown in the US retirement market during the economic crisis, or our mix of fee-based and risk-based products. Today, approximately 65% of our Company earnings are tied to fee-based products, which are not directly impacted by a low interest rate environment. Less than 10% of Principal Life's general and guaranteed separate accounts, are crediting interest at the minimum guaranteed levels, which means our earnings are much less impacted than our peers, in this low interest rate environment.

Signs in the third quarter, indicate that the risk of a double-dip recession is fading. However, we expect the US economic recovery to continue to be choppy. The September US Small Business Optimism Index remains unchanged since June, and the job market recovery is still sluggish. Despite this, as I mentioned at the outset of the call, our businesses are seeing increased signs of growth, and we believe we are at or near, an inflection point. Most notably, recurring deposits in Full Service Accumulation, relative to third quarter 2009, increased for the second straight quarter, which we see as a sign of future growth. We're seeing increased interest in Employee Stock Ownership Plans, or ESOPs. Thus far in 2010, we have been selected to assist in more than 70 ESOP consulting opportunities, up from 14 in 2009.

ESOP engagements are a window into what is happening in the small- and medium-sized business market. Our ESOP expertise provides a unique opportunity to cross sell other retirement products, and further capture the assets as the relationship grows over time. A return to positive long-term fund flows in the mutual fund industry, and record net cash flow for Principal Funds. Continued strong net cash flow and record Assets Under Management for Principal International. An increase in global institutional search activity driving positive unaffiliated net cash flow for Principal Global Investors. An increase in specialty benefits premiums for the second quarter in a row, after five quarters of decline, as well as a stabilization of membership levels, and a recovery in Individual Life sales, both quarter-over-quarter, and year-over-year. Overall, the results continue to demonstrate, that Principal has the right mix of products and services, that advisors, businesses and individuals are looking for, as the US economy continues to rebuild.

Now I want to touch on capital management. First of all, as we announced yesterday, we are pleased that our Board of Directors has approved a 10% common stock dividend increase, which is a sign of our confidence in our businesses, as well as our commitment to deliver shareholder value. We will continue to weigh all of the options to deploy capital, and make decisions that are in the long-term interests of our shareholders. We see increased merger and acquisition opportunities in the international areas and Global Asset Management, which would fit nicely within our business model. In addition, we view share repurchase as an attractive option. With all options, we will be very disciplined, as we look to put excess capital to work. And we look forward to providing more details on our capital strategy, at our Investor Day on December 9.

My third and final topic, is to discuss the ongoing implementation of our strategy. Our focus remains the same. To help growing businesses, individuals and institutional clients, achieve financial security and success. We have continued to work on the implementation of our strategy, even during the financial crisis, with important steps like renewing our BrasilPrev joint venture for 23 years, entering attractive new emerging markets, like Indonesia and Thailand, and adding new US distribution relationships, like Bank of America-Merrill Lynch. We are excited about the long-term growth opportunities for all of our businesses. We have the expertise and right business mix, to work with advisors, to help the large under-served and under-penetrated market of small- to medium-size businesses, meet their business owner and employee benefits needs. In the US, helped 78 million Baby Boomers, 80 million Echo Boomers, and everyone in between, with their savings, protection and retirement income needs.

To continue to export and grow our retirement and asset management expertise, in select international markets, where we already have an established footprint and strong local distribution partners. And to grow our proven global multi- boutique asset management model. Obviously, the biggest strategic decision for the quarter, was to wind down the health business, which demonstrates our discipline to focus on our opportunities for growth, while maintaining a diversified business portfolio. The investment needed to achieve scale, to stay competitive in a rapidly changing healthcare industry, did not make sense for us, as we focus on overall value for our shareholders. We do not expect the wind down to have any meaningful impact on our specialty benefits business.

Over the past few years, we have deliberately built Specialty Benefits as a stand-alone business, with a dedicated sales team, and focused employees and infrastructure. Less than 5% of Specialty Benefits premiums are tied to medical. Overall, our hybrid business model of Asset Management and risk-based products, is poised for superior growth, as we look out over the next 10 to 15 years and beyond. We export our US leadership and expertise in Retirement, Asset Accumulation, and Asset Management, to select emerging markets. We are in markets with fast-growing, middle income populations. We're optimistic about the positive momentum we are seeing in all our lines of business. All opportunities, both domestically and abroad, will deliver long-term results and shareholder value.

Before I turn the call over to Terry, I want to point out some recent recognition that we received across our businesses. CIMB Principal Islamic Asset Management, was recently named Best Asset Management House, at the International Takaful Awards in London 2010. While currently a small portion of our Global Asset Management business, there is little doubt that Shariah-compliant funds have great growth potential. We are pleased to get in on the ground floor and win awards as we go. Additionally, The Principal was named Information Week 500, for the 13th straight year, and made our ninth appearance on the Working Mother 100 Best Companies list. We believe, this third-party recognition, demonstrates the true character of the organization, and that The Principal remains a company advisors and customers want to do business with, and investors can trust.

Terry?

Thanks, Larry.

This morning I'll focus on operating earnings, including continued strong expense management, details on the accounting implications of our exit from the health business, net income, including continued solid performance of the investment portfolio, and finally, an update on our improving capital position and strong balance sheet. Again, we view third quarter as solid, and have seen several inflection points for many of our lines of business. As Larry highlighted, we are seeing many positive trends, and are excited about our growth opportunities going forward.

Starting with total Company results, third-quarter 2010 operating earnings were $219 million, or $0.68 per share, flat compared to third quarter last year. However, there were a number of items influencing comparability between periods. These include opportunistic early redemption of medium-term notes in third quarter 2009, the reduced economic interest in our BrasilPrev joint venture, and the impact of equity markets, model enhancements and assumption changes on DAC amortization. Excluding these items, total Company earnings improved 15% over third quarter 2009, on 10% higher average Assets Under Management, a very solid result reflecting our operational leverage.

Let me quickly quantify the larger items influencing third quarter 2010, reported earnings per share of $0.68. DAC amortization true-ups for equity market performance, and modeling assumptions, benefited Full Service Accumulation, Individual Annuities and Principal International by $0.04, and negatively impacted Individual Life by $0.02. Adjusting for significant impacts to DAC amortization, both positive and negative, is consistent with prior periods. As a result, the run rate of earnings for the quarter, is $0.66 per share.

Now let me discuss the business units results. Starting with US Asset Accumulation earnings, normalized for strong fee income from early redemption of medium-term notes in third quarter 2009, and DAC amortization true-ups, due to equity markets, current quarter earnings are in line with the increase in average account values, compared to a prior-year period. Reflecting continued expense management, Full Service Accumulation's third quarter 2010 operating earnings, are up 14% on a 9% increase in average account values, compared to the prior-year quarter. To reinforce Larry's earlier comments, our strong October sales further reinforces our confidence, that we expect Full Service Accumulation sales, to be up 15% to 20% over last year. We expect to end the year with a positive net cash flow of $800 million to $1 billion, against the projected industry outflows in 2010, according to the independent research firm, Cerulli.

In the third quarter, Principal Funds had $2.5 billion in sales, record net cash flow of $790 million, and continued success from our extensive retail distribution network. The drop in individual annuities earnings from a year ago, primarily reflects a $6 million after-tax increase in DAC amortization expense, due to equity markets, compared to third quarter 2009, and reduced interest margins in our fixed deferred annuity business. Earnings from Principal Global Investors improved 43% from a year ago. The improvement reflects a 5% growth in average Assets Under Management, strong expense management, and a significant increase in transaction fees, which are trending up more to normal levels. Additionally, unaffiliated net cash flow was a positive $800 million. We are cautiously optimistic about future flows, as we're starting to see mandates fund in specialized investment options, where we have expertise, such as real estate, currency, high-yield and international equities.

We are pleased with the third quarter funding of our China Qualified Domestic Institutional Investor, or QDII, which is a fund issued by CCB Principal Asset Management, that invests in international securities for Chinese investors. The majority of these assets will be managed by PGI. We are one of a select group that has been authorized by the Chinese government to offer this product. And although a small step, this is a great opportunity going forward.

Moving to Principal International, where operating earnings were $33 million, third quarter 2010 benefited from a $3 million of DAC amortizations, due to favorable market conditions. Principal International has added $8 billion of Assets Under Management year-to-date. $3 billion of that is positive net cash flow, resulting in a record $42 billion of Assets Under Management. Earnings were strong, despite lower economic interest in our joint venture business, BrasilPrev, which was offset by solid investment performance. When we adjust for foreign exchange, inflation in Latin America, and a new ownership percentage in BrazilPrev, Principal International operating earnings grew at 20% year-over-year.

US Insurance Solutions had operating earnings of $47 million for the third quarter, compared to $56 million in the prior-year quarter. Individual Life with operating earnings of $23 million, compared to $30 million in the year-ago quarter, accounted for the majority of this difference. Operating earnings were negatively impacted by updates to the DAC model and assumptions. Mortality was in line for the quarter, despite GAAP reinsurance accounting that required us to defer recognition, partially offset by DAC amortization expense. The current quarterly run rate for Life's operating earnings remains about $30 million. Individual Life sales are up 12% quarter-over-quarter, and 26% year-over-year.

Turning to Specialty Benefits, operating earnings were $25 million for the third quarter 2010, compared to $26 million to the prior-year quarter, largely due to the decline in members from a year ago. However, we are pleased that membership is stabilizing, and premiums grew again for the second straight quarter, after five quarters of premium declines. Overall, sales were very strong in the quarter, up 16% over the year-ago quarter, because of strong individual disability sales, and an increased focus on our core markets for our group lines of business.

Next, I would like to review the accounting treatment impact from the Health exit. Earnings from Health, which are premiums, fees and claims paid, are now excluded from operating earnings, and show up in the corporate segment below the line, as an other after-tax adjustment. The corporate overhead that was allocated to Health, approximately $8 million after-tax per quarter, is now being included in the corporate segment's operating earnings. These changes are retroactive, and we estimate they will reduce full-year 2010 operating earnings per share results $0.18 to $0.20. Therefore, the short-term quarterly run rate for the corporate operating segment will be a negative $25 million to $30 million. As we have demonstrated in the past, we will diligently manage expenses against revenue, to offset this additional overhead. And over time, we expect the corporate operating earnings run rate to return to the current quarterly run rate of a negative $20 million to $25 million.

Corporate operating earnings for the third quarter 2010, was a negative $24 million. This includes the allocation of overhead expenses from the Health exit, which was offset by higher interest on excess capital. Additionally, third quarter 2010 corporate segment net income, includes $49 million of one-time after-tax expenses related to planned severance and goodwill write-down, as a result from our exit from our Health business. The net capital we expect to free up as a result of this transaction, is between $100 million and $120 million, and will become available as the liabilities roll off our balance sheet. In addition, we anticipate receiving compensation from United Healthcare, as the membership transitions, which will be reflected in the other after-tax adjustments in the corporate segment. We will earn a portion of this starting in fourth quarter 2010, and the rest will be spread throughout the transition period.

Moving to total Company net income, we view our $142 million result in the third quarter as solid, once you reconcile the accounting treatment for the Health business exit. After-tax net realized capital losses continue to trend lower at $31 million in third quarter, compared to $53 million in the year-ago quarter, as we continue to see a pattern of improvement in credit-related losses over the past several quarters. We also continue to see sequential improvement in CMBS and commercial mortgage whole loans. Commercial mortgages, at $7 million after-tax, had it's lowest quarter of losses since year-end 2008. Corporate credit losses also remain very low. Our investment portfolio performance continues to reflect the benefit of broad asset diversification and strong asset liability management.

Quickly looking at other financial metrics, book value per share, excluding AOCI, ended the quarter at a record $27.71, up 5% from a year-ago quarter. We finished the quarter at a $1.5 billion net unrealized capital gain position, up $1.2 billion from last quarter. This is the primary reason that book value per share, including AOCI, was $29.20, also an all-time record. Additionally, our debt-to-capital ratio is 15%. The increase in these financial metrics, reflect the ongoing improvement in credit markets, as the US economy rebuilds.

As Larry indicated, our hybrid business model is less capital intensive, and will help us weather the current low interest rate environment of our nearly $60 billion of Principal Life's general and guaranteed separate accounts, roughly a third includes a minimum interest rate guarantee, and less than 10% is currently at those minimums. Of the remaining portion not yet at minimums, we have an average of 75 basis points of cushion above the guaranteed minimum rate. Given our ability to reduce crediting rates, coupled with our active interest rate risk management, we estimate a very modest earnings impact, due to a low interest rate environment. Interest rates in the International markets we're in, are currently increasing, providing a natural hedge to our US business. If the current interest rate environment persists for the foreseeable future, we would expect 2011 earnings to be reduced by 1% to 2%.

Moving to capital adequacy, as of quarter end, we estimate our risk-based capital ratio to be around 450%. Relative to a 350% RBC ratio, we have approximately $2.2 billion of total excess capital, split evenly between the Life Company and the holding Company. Even with our commitment to hold a higher component of excess capital as cushion, currently around $1 billion, we clearly have substantial financial flexibility. As you know, three of the four rating agencies have the Life Insurance industry on Stable Outlook. This, along with improving market fundamentals, and our businesses' ongoing ability to generate free cash flow, gives us the ability to increase shareholder value over time, through strategic capital redeployment. Once again, we are pleased with our solid results. More importantly, we are excited about the developing positive trends in our businesses.

This concludes our prepared remarks. Operator, please open the call to questions.

(Operator Instructions). We will pause for just a moment to compile the Q&A roster.

The first question comes from the line of John Nadel with Sterne Agee.

Hi, good morning, everybody. Two quick ones. First, can you give us some help on what I think would be a normal, using your terms, a normalized run rate for DAC amortization, especially in FSA? I look back on my notes and I've been expecting it to run at a normalized level of maybe $20 million to $25 million quarterly. But it seems your normalizing this quarter's results to something that's more in the mid-teens. I just want to make sure I've got that right.

Okay, John. This is Larry. I'll have Terry comment on that. I would say I just - - for the benefit of kind of recognizing that from quarter-to-quarter there are going to be some variances around DAC amortization as we do true-ups and unlocking. But one point I would make before I turn it over to Terry, is that I would tell you if you actually look year-to-date for FSA, you'll see that the account value is up about 16%. But the DAC amortization for year-to-date are up about 44% over the comparable quarters for 2009, so - -. Again, these are the kinds of things that from quarter-to-quarter will go back and forth. But when you string the quarters together I think you get a better picture of how the DAC amortization's are going. So I kind of encourage you to look at that on a year-to-date basis. But I will have Terry give you the expected quarterly rates.

Thank you.

Exactly, Larry. As you mentioned, John, the run rate we've typically set for FSA is in that $20 million to $25 million range. This quarter we had $7 million of actual DAC amortization. The equity market also reduced that because of being up almost 11% this quarter, so there was about $7 million there. That gets you into that mid-teen range as you mentioned before. But as Larry mentioned, - - every quarter has some moving parts. And what we have typically done is called out the equity component of that because they do fluctuate quite a bit. Abnormal variances, we will cull those out as well. But we just didn't see anything abnormal this quarter. So that's why we've only called out the equity market component.

Okay. And my second question is just on capital management. Larry, I guess I'd be remiss if I didn't try to get a little bit more from you other than "Stay Tuned for Investor Day". So maybe if I can ask this question this way, can we expect you to manage back down to a 350% risk-based capital ratio? I mean in other words, should we really be viewing excess capital as the full $2.2 billion that you guys highlight relative to a 350? Or is the deployable amount - - let's say in the relatively near-term, next one- to two-years? Is the deployable amount really something lower than that?

It's a great question, John. - - what I'd say to be really candid with you and others that are listening, is nobody knows. Nobody knows whether over time it's 350 going to become the standard or is the new standard going to be something closer to 400? I hear - - you and others speculate on that over time. And I think the reality is that none of us know the answer to that. Which is partly why I think we will continue to be a little bit cautious. Having said that, we're obviously at the strongest point in our history.

Another point I guess I would make is that I think that the insurance industry, just like the banking industry, undergoing Basel III. We're going to see new prudential standards. We're going to see solvency II, were going to see Principles based reserves coming to the insurance industry sometime in 2013 - 2014. I think the good news for us is that with the lesser percentage of our businesses tied to insurance, that we'll have a less dramatic impact. But having said that, there is still some uncertainty. But - - realistically, I would say that deployable capital today is probably somewhere in that maybe $500 million to $750 million range. I think that the action the Board took yesterday in terms of a 10% increase in dividends should tell you a lot about both how the Board thinks that our businesses are operating as well as how the Board kind of sees our excess capital position.

Okay, thank you. And just a quick follow-up. In your pricing models today for new business, what level of capital are you pricing for?

We're pricing for around a 350.

Okay, thank you.

Your next question comes from the line of Jimmy Bhullar with JPMorgan.

Thank you. Terry, you mentioned in your remarks that the run rate EPS was $0.66. I just wanted to get an idea if that was a good baseline number to use for future periods? And the reason I'm asking is that corporate investment income seems very high this quarter, I think it's around $30 million versus $12.5 million in the second quarter, and you didn't allude to that as an unusual.

No, Jimmy, this is Terry. I think the $0.66 that we alluded to in the call is a good run rate for this quarter. One of the things that we've talked about in the past is you can't necessarily have the run rate off of that because of seasonality. Now with the exit of the Health business we have seen less seasonality. So on a go-forward basis, this probably would be a better base to move off of. - - there are a lot of moving parts in terms of EPS and there's a lot of things that we could call out one direction or another. But we thought that the $0.66 was a good solid EPS number for this quarter.

Okay. And then the corporate you mentioned, I think it was the corporate earnings this quarter, $23.9 million negative. You were expecting that to deteriorate next quarter, right?

Yes, Jimmy, this is Terry. I would say, yes, we had some benefits from some cash management. Or more aggressive cash management this quarter compared to a year-ago quarter. But the run rate that we feel for the corporate segment is more in that $25 million to $30 million.

Yes, Jimmy, this is Larry. The reason that you will see it go down a little bit next quarter it will have the component of corporate overhead from the Health business, it's about $7 million, be in there. So all other things being equal, you would see that change in the corporate segment.

Okay. And just a quick one on capital deployment. You mentioned you had deployable capital in the $500 million plus range. How should we think about, obviously, you did raise the dividend. But how should we think about buy backs? Are you likely to deploy most of that over the next year or would it be more over the next couple of years? Or how do you think about how you're going to use of that capital?

Well, yes. This is Larry again, Jimmy. Again just to reiterate, the good news is that we are, we are seeing our businesses perform at a higher level. We are seeing AUM now back at I think $306 billion. The highest point we reached prior to the financial crisis was $311 billion. So I think that says a lot about the opportunities for growing our operating earnings going forward.

Having said that, again, I think there remains reason for caution as I was describing earlier. I guess the way I would think about that is, I think that as we continue to get into each quarter of 2011, I think the likelihood increases around the opportunity to potentially have some budget if you will for M&A as well as some budget for return of capital to shareholder in some fashion. And obviously, given where the stock is trading today, a share repurchase is a very, very attractive option, as I said in my comments. So I would expect we will be able to do both M&A and some level of return of capital during 2011.

But unlikely that you use up most of it?

Well I think that will again depend on a number of events that we will know more about between now and then. So - -

Okay, thank you.

You bet.

The next question comes from the line of Thomas Gallagher with Credit Suisse.

Good morning. Larry, first, just wanted to go back to you mentioned Solvency II, as a constraint by 2013-2014. How, that's a European capital standard. How is that specifically going to affect Principal? That is my first question. Why don't I start there and I have a few follow-ups.

Okay, we'll try to deal with them fairly quickly. I mean the reality is of course I mention Solvency II just because they are further along in Europe than they are here in the US. And the reality is that not only do the Europeans not have clarity exactly on how Solvency II, but if the US is behind that, there is even sort of less clarity for US companies.

But I think, Tom, that any reasonable person would conclude that having gone through the financial crisis that we've gone through, capital standards are likely to increase, they're not likely to decrease. And furthermore, I'd say we have the unknown here in the United States of not knowing exactly what Dodd Frank is going to do relative to systemically significant institutions. While again, we may know more about that in six months or nine months, but that I think also remains one of the things that we have to think about as we get over the longer-term.

Okay. Understood. The next two questions I had, first, is I don't know if Dan Houston is there? Can you comment on what gives you the confidence in the FSA sales guidance? I understand the October sales are strong, but we still got two months left.

Are they a few large cases in the pipeline so maybe a little more granularity there? And then the next couple are, overall, do you expect a meaningful change in your corporate tax rate into 2011? Whether it's due to the DRD or foreign tax rate changes? And then lastly, when you commented on your ESOP mandates being quite strong, is this included in your FSA sales? And if so, is that a much lower margin business? I'll leave it there. Thanks.

Okay. I'll maybe try to comment quickly on these because again, I know we're trying to get others in as well. But the ESOP that we discussed in the comments, Tom, is just relative to ESOP consulting assignments. Those haven't necessarily turned in at this point to FSA sales or ongoing ability to manage and generate assets. Again what we're trying to give you is a leading indicator of where that particular part of the business is going which is a very positive one. They do have, as you said, lesser margins, we've commented on that. It's primarily consulting fees.

In terms of corporate tax rate, the DRD is running about the same level as it has run in years past. It's been around the range of $75 million. I suppose one could speculate that maybe corporations sitting with $1 trillion of cash on their collective balance sheets might be paying out more dividends, but we haven't seen sort of clear trends in that. We are seeing on the international side, I think there is going to be some increase in tax rates, we've sort of burned through. It's a good problem, but we've kind of burned through some of the loss carry forwards relative to international. Maybe I will have Dan comment on FSA sales.

Yes, a couple of quick comments, Tom. The ESOP assets are counted in our Full Service numbers. The number for our third quarter was $220 million versus the prior-quarter at $129 million. So you can see that's not a hugely disproportionate percentage of our sales. And again, we write very few standalone ESOP. Most of these come along with a significant 401-K set of assets as well.

Just a couple of quick measures that give us confidence around Q4. One would be around the sheer number of advisors requesting a proposal, we are likely to be on track this year to hit a record high which tells us that our efforts in building out our alliance partnerships are good. We've got about a 5% increase on a year-to-date basis of our pipeline. Our close rates have ticked up nicely. We also had, if you look at the number of plans sold, roughly up 21% and we are showing a good track record there. And the other closing comment I would make is the TPA initiative is well underway. We are seeing very good traction working with those advisors that prefer a local TPA. We've dedicated a lot of time and resources this past year and we feel like there is good demand in Q4, moving forward. Hopefully that helps.

Yes, it does. Thanks.

Thanks, Tom.

The next question comes from Randy Binner with FBR Capital Markets.

Hi. Thanks for the quantification on 2011 relative to reinvestment risks. Just a few detailed follow-ups there. One is, I think Terry mentioned, the sustained low interest rate environment. Is there a 10-year treasury yield or other metrics we could tie to that? And also I was curious if it's just kind of the net investment income impact on earnings or if it would involve DAC since you have a large asset management business if you are incorporating AUM impacts in there as well?

Yes, this is Larry. We're really thinking about it, Randy, more from the standpoint of operating earnings impact. We don't envision at this point that it would it have implications for us relative to having to write-off DAC or anything more dramatic along those lines. I'll have Terry comment on your ten-year treasury question.

The ten-year treasury is at the same level it currently is. That's what we're saying that it's staying at the same level.

Just explicitly, what is that? I mean are you saying, is at 250? Is it relative today?

It's about 2.5 today.

Okay, so 2.50? And then just to follow-up on one of the piece of those comments. You mentioned that you had a natural offset from interest rates rising in other countries. Is that a reference to kind of foreign bonds you hold in the general account? Or is that more a comment on how AUM would benefit through the income statement?

Well, I would say its just more of a general comment. Maybe I'll ask Jim to sort of comment relative to the things he's seeing in the global market around rising rates. I mean, again, you've seen a number of central banks already begin to raise rates. So Jim, might want to comment.

Yes. I mean the very low interest-rate environment, quantitative easing which we're probably going to see announced by the Federal Reserve this week. It's going to lead to very sustained low rates here, I think the 2.50 rate that was talked about for the 10-year yield is really our forecast, but it could be lower, could go a bit higher. And obviously that is problematic for the US business.

But you've seen them - - you've seen some rate rises from economies that are growing much faster, Brazil, China and Australia. And that will continue and it will and that has a beneficial impact on some of our businesses in Principal International. It's not foreign bonds within the general account. We are very tightly managed and tightly matched in the general account. That's not what it is. But it's the impact more on Assets Under Management and on our general accounts in our international businesses.

Thank you very much.

Thanks, Randy.

Your next question comes from the line of Ed Spehar with Bank of America-Merrill Lynch.

Thank you. Two questions. First on capital management. Larry, the stock is at book value. And you talk about being near it - - feeling like your near an inflection point for the business. - - a business that's got you more than a two times book value multiple pre-crisis. I'm not saying that we're going back there, but I guess I just want to hear how compelling would some type of acquisition have to be that would make it even close to as attractive as what your stock is today? Then I have just one quick follow-up.

Sure. No, I think that's a good question, Ed, and trust me, relative to the management team and the board, I mean we get that. So, I mean we do understand that. I will say, however, that I think that there are some, I do think that there are some M&A possibilities. They are not nearly as, to be honest, they're not nearly as large and sort of headline-grabbing as something like an Alico might be. But I will also tell you that I think over the long-term they may actually be more a value-creation.

Because I think we have demonstrated very clearly over the time we've been a public Company that one of our greatest capabilities is to take some sort of competency and attach that to our distribution engine whether it's here in the US or our global distribution platform and really maximize the value coming out of that. So as we look forward, for example, we see a lot of opportunities and need around Emerging Market Asset Management, it's going to be huge. And we are extremely well positioned to do that. So we see that, and it's not an either/or question here, Ed. What I'm trying to communicate here is, we see a possibility to do some very attractive over the longer-term M&A.

It may not be quite as accretive in the near-term. It will be very attractive in the long-term. And that still wouldn't necessarily keep us from doing some level of share repurchase as we get into the middle part and later part in 2011. So it's not either/or, it's both. And I think you'll see us taking action as we get into 2011.

Okay. And the one follow-up is on your discussion around run rate EPS. I think we've got sort of a definitional issue, perhaps, where you talk about $0.66 for this quarter as being a run rate number. But I don't know that - - when we think about run rate it sort of what we would think about growing earnings off of. And I guess is it fair to say that if we had more normalized DAC amortization, more normalized corporate, that maybe that number could grow off of it is more like $0.63 rather than $0.66?

Well, I think we're trying to communicate the same thing. Maybe we're not saying it in exactly the same lingo, Ed. But once again there is a number of kind of offsetting factors that go into there. So there seems to be, as you have indicated, maybe there's a lesser amount this quarter. Maybe there is a lesser amount of FSA DAC amortization but there would be equal numbers of offsetting factors that in our view would say we think that $0.66 is a fair run rate. And you then apply the normal metrics relative to growing AUM and other things that would then get you do what would be the Q4 run rate and going into 2011. So I think we're talking the same thing when we talk about $0.66.

Okay, thank you.

You bet.

Your next question comes from the line of Mark Finkelstein with Macquarie.

Thank you. Good morning. I wanted to explore one area which is - - I mean obviously the commentary is more positive around the sales numbers. But the plan count continues to decline, about 3% year-over-year, continues to decline sequentially, albeit slightly better than it did last quarter.

I guess in the past you attributed it to plan terminations, fewer new plan startups. I guess the question is, when do you think that the plans are going to stabilize generally? But I think more important than that is, if you stripped out the impact of plan terminations and normalized for kind of new starts, what would plan count look like - - sequentially or year-over-year, however you want to look at it?

Sure. Dan will want to comment. But in rough terms what we've been seeing the last few quarters, again predicting the future is not quite as easy, Mark. But in rough terms what we have been seeing in the past is we have been saying about 200 plans per quarter fewer startup plans, about 200 per quarter. And we've been seeing in rough terms about 100 more plan terminations per quarter. So that's kind of that net difference of about 300 plans per quarter over the last kind of four to six quarters. So, I will let Dan be the prognosticator to when all that's going to go away.

I hope so. A couple of quick comments. The takeover plans are down approximately 30% from where they were a year ago. Startup plans from a year ago were down 50%. If we just look at plan terms, remember that's different from contract terms, these are people who have eliminated they're plans, there down 30% from a year ago, and contract terms are up about 10%. When we look at that period of time in the historical 2004 through kind of the 2007 timeframe.

What you really find out is our contract withdrawals are up about 100 basis points from a normal run rate. Still the biggest deficiency we have is around transfer deposits. It's off over 300 basis points compared to that same period of time. If you look closely and talk to the advisors, what they would tell you is it seems like we've reached kind of the bottom here relative to the economic recovery and it's a slow build out from here. But we feel generally optimistic about our ability to retain plans through some of our revised service models that helped lower the price through our TPA initiative and through our expanded alliance partnerships.

Okay. I guess just on some of the new fee disclosures that are required, have you seen any changes in pricing or have you yourselves made any material changes in pricing directly as a result of some of the new disclosures? I know that you guys kind of have historically disclosed maybe a little bit more than some others have. But what has been the impact on pricing generally and how should we think of that in terms of FSA margins?

Go ahead, Dan.

I don't think it's moved the needle at all today to today's pricing. Remember we've got a July of 2011 date which employers will have to disclose this. And there is a participant disclosure that takes place January 1, 2012. There is still a lot of back-and-forth with the Department of Labor finding the most efficient way to illustrate that both as a basis point and a dollar amount.

But to your point, Mark, we have been quite aggressive in disclosure in the past, we work with our very large clients. So there's no surprises out there. This probably has way more to do with geography and how to illustrate then it that it does in changing the overall pricing.

Okay, all right, thank you.

Thanks, Mark.

Your next question comes from the line of Eric Berg with Barclays Capital.

Thanks very much, and good morning. What I'm trying to understand, what I'm trying to do is to reconcile the continued cautious commentary by the leading group insurers, many of which are operating in the same market as you with your optimism. In other words, if the unemployment rate remains as high as it is, and if business confidence remains by your own acknowledgement, quite subdued, especially in the middle market. And as well, if the group insurance, the big sellers of Group Life and Group Disability against whom you compete in the same middle of the market are saying that business remains very slow reflecting an overall soft economy. Why is it - - my first question, I have only two. Why do you think the 401-K business is at an inflection point?

Well, Eric, this is Larry. I mean, again, the only thing I can look at, the only thing I know about is the actual history and again we have seen now for the second quarter in a row, we have seen increases in the recurring deposits coming out of Full Service Accumulation kind of quarter-over-quarter. So that's, I think the most powerful lead indicator that I can give you that as Dan said a minute ago, it's sort of reached a bottom and we have now started to actually build back on a positive basis.

That's not necessarily because employment is growing, but at least employment shrinkage has stopped. We're starting to see deferrals come up a little bit. So we're starting to see matches come back a little bit. So those things is what's driving the increase in recurring deposits. We have now seen that two quarters in a row and we would expect that to continue based on everything we see everyday.

Okay. That's a helpful response. My second and final question relates to your forecast of what I believe is based on the arithmetic here more than a doubling of December quarter sales, over a year ago December quarter sales. At least I think that's what you forecast for the middle of the range for growth would imply. My question is, do you really truly think that's fair to sort of reach that conclusion so early on based on things like requests for bids from brokers and the fact that you have some more consulting assignments? I mean, I would think a much firmer handle could be had by answering the question, how many deals do we have in place in which we are extremely close, not how many times is the phone ringing or how many consulting assignments do we have?

I just want to know whether - - why you think that these variables that you have cited are enough to make what would appear to be a very optimistic sales forecast for the remaining two months of the year. Or is their more that you're not telling us at this point? Thank you. That will be all.

This is Larry. I think we're all on the same page, right? We're all on the same page. What we are talking about are what we believe to be our best estimates, if you will, of commitments. That is plans that do have every intention to transfer to us over the remaining if you will, now two months of the year. So it is in large measure based on commitments. Having said that, having said that, I've been around this business long enough that I have seen plans that told us they were going to transfer on December 15 come in on January 15, 2011.

Now that's not going to make any difference over the longer-term trendlines for the business. But there's always just a level of cautiousness and conservatism relative to is everything that we are told going to show up in December? Might some of that carry over into the first quarter? All of that's possible.

But if we apply all of our kind of normal experience, we look at all of the measures that we get from our sales offices, we do expect to have the kind of fourth quarter in the range that you indicate. But there's always one or two plans that could fall one way or the other that might influence it. But we feel very good about where are going for the reasons Dan mentioned. Close rates are up and investment performance is strong, advisors are coming back. So we think we are going into a period where were going to have wind at our back.

Very helpful. Thank you.

You bet.

Your next question comes from the line of Colin Devine with Citi.

Good morning. Larry, a couple of questions. First, you talked about Solvency III and principles based reserving. But it would seem to me that certainly relative to the Life peer group, the protection businesses are a much smaller part of your story. All of the focus is, whether it's solvency or whether it's IFRS, or really driven on the liability side which is again where you haven't taken the risk unlike perhaps a variable annuity writer. So I'm not sure why you're as cautious about that. Maybe you could help us with that.

Secondly, and I think the big question here on capital management, Larry, is I remember an analyst meeting a couple of years ago where you were up there and talking - - about an ROE projection getting up to 16%, 17%, 18%. Here we're stuck at under 10%, and if I take your number okay of what the true, if we like excess, is of 5 to 750, and we take that out. Maybe we can stretch the ROE for the Company this quarter to 11%. But what doesn't seem to be addressed to me, is why are you running 400, 500, 600 points and below what you said before was your goal when the protection business is even going to be smaller now?

And then finally, Terry, could you just clarify what the DAC adjustments were on the Life line? Was that related to secondary guarantee UL, and what did you change? Thanks.

Just quickly on your questions as we're kind of closing in on time here. But as it relates to Solvency II, I think I indicated in my response, Colin, on one of the earlier questions that again, we agree that while we will be impacted less by whatever Solvency II new capital requirements are. This Company will be impacted by them to a lesser degree. But having said that, it is one of the important things that we're looking at along with as I said before, the whole question from the Financial Stability Oversight Council as to what is going to be a systemically significant institution?

I think that is one that probably is going to happen sooner and may well in fact involve us as compared to some of the other Life peers. So that's something that we need to think about. In terms of ROE, again the issues, if you look at the fundamental businesses that we are running, I will still argue, much as I did three or four years ago, that we have the ability to build ROE to a higher level than do many of our Life peers. Now at the current time, again, we are in a period where there doesn't seem to be that much value from the standpoint of investors in terms of wanting to see that ROE improvement.

I think that we'll change over time, and I think we will be more confident in rationalizing our capital base to grow our ROE over time. But I am every bit as confident of our ability over the long-term to hit a 15% ROE today as I was back in 2004 and 2005. And in fact we do projections every year. We do very detailed projections.

And as you know, we remain committed to that one rule of thumb that indicates we plan to grow ROE 50 basis points a year because as we have begun to shift toward International and Asset Management and Asset Accumulation, our ROE potential is probably higher today than it was in 2005. So again, it's just a matter of time that's a rationalization of the capital. And I'll let Terry cover the DAC amortization.

Yes, Colin, the DAC amortization in the Life line is on a run rate basis is probably more in that $15 million to $20 million range. It was lower than that this quarter because of some noise that we had as a result of reinsurance not getting reflected in the current period comparable to what last period. Although we didn't call it out as such because our mortality more than offset that, our expected losses were in line with what we expected. But in terms of the DAC amortization was increased because on each year annually we review our models and our assumptions and this quarter is when we did that. We had an impact of probably around on an after-tax basis of around $6 million. So that had the impact this quarter. That's why we called it out.

Terry, I was asking what assumptions did you change? - - we have heard about Ameriprise doubling their VA DAC from 20 to 40 years, - - their fixed annuity taking it to 30. What assumptions did you change?

There were a wide variety of assumptions took into consideration lapses. In terms of earnings, in terms of capitalizations that we've had in the past as well.

So we look at all of the experience assumptions, Colin, and we did not make any particular changes in those same comparable things that Ameriprise talked about. Ours if you will is just a tweaking of the various experience assumptions that go into a DAC calculation. We do it once a year. It's a typical exercise.

Okay, Larry, with all due respect, and maybe you can do this on Investor Day. But you really did not answer the question as to why the ROE is sitting at under 10 today. It's back where it was, really, in 2003. What's under-achieving? Because just simply deploying your excess capital gets you to 11. And by the way, your goals back in 2003 and 2004 is what you laid out was you were marching to a 17 or 18 ROE. But I just don't understand what's the shortfall because of - - and until you can identify that, I don't know how you can expect us to have comfort that Principal can get back to 15. Because you haven't addressed why is below that now.

Sure. As I said, Colin, our businesses can produce ROEs at the same level they have historically and we need to work our way through the financial crisis. We need to work our way through to a period where I think both managements and boards feel more comfortable in rationalizing the denominator. It's a denominator issue as compared to if you will an inherent run rate of the businesses. But we'll look forward to talking more about it at Investor Day. Thanks.

Your next question comes from the line of Christopher Giovanni with Goldman Sachs.

Most have been answered. Just one question in terms of the favorable outlook in October. If you can comment in terms of the sales, has it been one or two large cases that have driven that or has it been broad strength of the small- and mid- case channels?

First, Chris, I will have Dan answer that. I appreciate the pick-up in coverage from you in this quarter, so thanks for that. I'll let Dan answer the question.

Yes, it really is, Chris, a combination of both a couple of nicer size cases. But frankly, an increase in just the sheer number of small- to medium-size businesses driven by our TPA Solutions that drove our numbers up for October.

Okay. And then lastly, I think last quarter you commented that roughly 20% or so of the companies that pulled they're match copies had reinstated. Can you provide us with an update this quarter?

That number is about 25%, give or take, but there are certainly a lot of discussions going on. We just held a large institutional client conference on the West Coast with about 120 of our biggest clients. And clearly top of mind for them was discussions around matches and eligibility and fee disclosure. I would anticipate that continues to unthaw as we march through each one of these quarters.

Great. Thanks, guys.

Thanks, Chris.

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

Well, thanks to all of you for joining us and we appreciate your interest. As we've tried to communicate during the call, we are seeing signs of stability in the small/medium sector which we believe will lead us to be able to grow our businesses over time. We remain very optimistic about the long-term potential of our hybrid business model strategy to create value. And we look forward to seeing many of you at our Investor Day on December 9 in New York. Thanks and have a great day.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximate 8.00 pm Eastern time until end of day November 9, 2010. 16027050 is the access code for the replay. The number to dial for the replay is 800-642-1687 for US and Canadian callers or 706-645-9291 for international callers.