美國信安金融集團 (PFG) 2012 Q2 法說會逐字稿

Good morning, and welcome to the Principal Financial Group's second-quarter 2012 financial results conference call. There will be a question-and-answer period after the speakers have completed their prepared remarks.

(Operator Instructions) We would ask that you be respectful of others, and limit your questions to one and a follow-up, so we can get to everyone in the queue.

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

Thank you, and good morning. Welcome to the Principal Financial Group's second-quarter earnings conference call. As always, our earnings release, financial supplement, additional investment portfolio detail, and slides related to today's call are available on our website at www.Principal.com/investor. Following a reading of the Safe Harbor provision, CEO Larry Zimpleman and CFO Terry Lillis will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A are Dan Houston, Retirement Investor Services and US Insurance Solutions; Jim McCaughan, Principal Global Investors; Luis Valdes, Principal International; and 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 and Exchange Commission.

I'd like to take a quick moment to remind you of our upcoming Investor Day on September 21. We look forward to the opportunity to provide you an update on our strategy and long-term growth opportunities, as well as a deep dive into our distribution strategy for each of our businesses.

Now, I would like to turn the call over to Larry.

Thanks, John, and welcome to everyone on the call. As usual, I'll comment on three areas. First, I'll briefly discuss second-quarter results. Second, I'll provide an update on the continued successful execution of our strategy. Then I'll close with some comments on M&A, and capital deployment. As John mentioned, we provided slides related to today's call. Slide 4 outlines the themes for the quarter.

Second quarter saw a continuation of recent trends, with strong momentum in sales and flows, while macroeconomic events impacted operating earnings. Despite a 6% decrease from the year-ago quarter, second-quarter total Company operating earnings were solid at $216 million. Earnings per share were up 1% due to our share repurchases during the past year. The operating earnings result reflects persistent macroeconomic headwinds, including negative equity markets, low interest rates, strengthening of the US dollar, and stagnant job growth. We also had lower variable investment income in the first half of 2012 compared to the prior-year period, which Terry will comment on.

Despite these macroeconomic headwinds, the fundamentals of our business remain strong, and we continue to see sales pipelines grow. We ended the quarter with record assets under management of $367 billion. Second-quarter net cash flows were $7.3 billion, which are more than double second-quarter 2011 net cash flows. And so far in 2012, we have over $15 billion in net cash flows. The sequential improvement in operating earnings demonstrates that we remain focused on execution as we strike the right balance between growth and profitability in this challenging environment.

Our competitive position remained strong due to our innovative solutions, such as Total Retirement Suite for our retirement clients, voluntary benefit choices for our specialty-benefits customers, and outcome-oriented investment solutions for our mutual fund and institutional asset-management clients. We also continue to deepen and strengthen our relationships with key distribution partners.

Key growth metrics from the quarter include Full Service Accumulation sales of $2.3 billion, up 34% compared to second-quarter 2011. Net cash flows of $1.9 billion were nearly double that of the year-ago quarter, and reflect not only great sales momentum, but also excellent client retention and growth in recurring deposits. Principal Funds had sales of $3.4 billion, our second-highest on record, contributing to our second-highest quarterly net cash flow on record at $1.1 billion. Principal Global Investors ended the quarter with unaffiliated assets under management of $92.3 billion, a 16% increase over the year-ago quarter, and unaffiliated net cash flows of $2.1 billion, a strong improvement over second-quarter 2011.

Reported record assets under management for Principal International were $60.3 billion, up 14% over the year-ago quarter, and net cash flows of $2.3 billion are up 28% over the same time last year despite foreign-currency exchange rate pressures and lower inflation in the second quarter in Latin America, which reduces investment income. In US Insurance Solutions, individualized sales of $45 million were up 6% over second-quarter 2011. Specialty Benefits premium and fees grew 5% over the year-ago quarter to $361 million.

Our mix of businesses continues to shift, with 65% of second-quarter earnings coming from our fee-based businesses. This creates increasing amounts of deployable capital, and increases financial flexibility due to the absence of long-term equity or interest rate guarantees in this business.

Now, let me provide comments on the ongoing implementation of our strategy. Our strategy remains the same -- to help businesses, individuals, and institutional investors save for the long-term, invest for growth, and protect their assets. At our Investor Day in September, we'll provide greater detail about our investment management plus strategy, and discuss how the synergies and interrelationships of our businesses provide an opportunity to build long-term value for our customers, advisors, and shareholders.

Starting with Full Service Accumulation, our Total Retirement Suite platform, and advisor-centric model position us as a retirement leader, and we continue to gain market share. As the baby-boomer generation continues to move towards retirement, we are focusing on all stages of retirement readiness, from hire through retire. We are also seeing increased interest in Retirement Solutions, including payout annuities. Our year-to-date sales of income annuities is $160 million, nearly double the sales for all of 2011, and does not reflect a $500 million single-premium annuity sold in third quarter. The growing demand and limited supply of proven providers for this business creates attractive returns for us.

Principal Funds continues to drive strong sales due to demand for investment solutions designed to generate income in a near-zero interest rate world, limit volatility, and hedge against inflation. We've had 10 straight quarters of positive net cash flows, reflecting our success with many strategies across the platform. Investment performance, a key leading indicator for growth for our retirement and investment management businesses, continues to be strong overall in several key investment options, including equity income, large growth, and diversified international. These strategies represent asset classes that advisors and clients focus on for retirement and retail solutions.

In addition, our Principal Global Diversified Income Fund is now a Morningstar rated five-star fund. Principal Global Investors's multi-boutique strategy offers a nimble approach that allows us to meet the changing needs of institutional clients around the world. A recent report from Create-Research and Principal Global Investors identified investor appetite for a more dynamic approach to managing volatility and asset allocation. The studies signal that in prolonged periods of market turbulence, such as the current market, client demand for Principal Global Investors's multi-boutique and value-added strategies increases.

Moving now to Principal International, we are strongly positioned in the emerging markets that continue to experience rapid growth in the middle-class income segment. The acquisition of Claritas, a leading Brazilian mutual fund and asset management company, was announced in the first quarter, and closed in April. Entering the Brazilian mutual fund market has been a strategic priority for the Principal. This acquisition is off to a great start, including the launch of a real estate fund that raised $75 million in the second quarter. We anticipate that Claritas will expand beyond the retail mutual fund market to the institutional investor market as that develops over time.

We continue to have traction in emerging markets in Asia as well. Last quarter, we announced that the Malaysian government approved a new employer-based, defined-contribution system, and CIMB Principal, our joint venture with CIMB, was one of eight companies approved to provide solutions in the new market, which begins later this year. Additionally, Principal won Asian Investor Magazine's 2012 Investment Performance Award for Hong Kong mandatory pension fund service providers.

Providing risk protection continues to be a key strategic focus for the Principal. For our US Insurance Solutions business, we continue to focus on the business market, with 54% of second-quarter sales coming from our business owner and executive solutions market, along with non-qualified deferred compensation. For Specialty Benefits, we continue to see growing demand for voluntary solutions that plays to our employee enrollment and education capabilities.

Now, I'll close with some comments on capital management. We continued to actively deploy excess capital in the second quarter. In the first half of the year, we committed $475 million of excess capital for deployment. During the second quarter, we completed the February $100 million share repurchase authorization, announced the authorization of a $200 million share repurchase, and paid $54 million in quarterly dividends to shareholders.

We recognize the importance of a quarterly dividend to shareholders, and anticipate a pattern of increasing our dividend payout ratio year-over-year, as our earnings continue to shift towards fee-based earnings. We remain on track to deploy $800 million to $900 million of excess capital in 2012. We have an active M&A pipeline, with opportunities that provide a strategic fit and complement our existing capabilities. However, we will continue to take a disciplined approach in evaluating these opportunities, since we have a strong organic growth capability.

As evidence of the significance of our fee-based earnings, we have recently done some analysis of our capital deployment for the last four quarters relative to our insurance peer companies. Thanks to our growing fee-based businesses, we rank in the upper quartile of capital deployed to shareholders as a percentage of market capitalization. This is validation of our business model being shareholder friendly, with increasing amounts of deployable capital. Excess capital at the end of the second quarter was $1.5 billion, a level that's been pretty consistent over the past year. We have indicated that we intend to hold a higher amount of capital than prior to the financial crisis, but we believe that we will still be reducing our excess capital levels by $300 million to $400 million over the next couple of years.

In closing, the trends that have shaped our investment-management strategy are now firmly in place around the world. While we expect ongoing volatility in the markets, and macroeconomic headwinds from time to time, we remain optimistic about the long-term growth potential of our strategy.

Terry?

Thanks, Larry. As Larry mentioned, second-quarter earnings were solid, and our growth metrics continue to show strong business fundamentals. This morning, I will focus my comments on -- operating earnings and the impact from headwinds; net income, including continued solid performance in the investment portfolio; and the strength of our capital position and strong balance sheet.

There are several factors that negatively impacted the year-to-date growth of our underlying businesses, but I'm going to focus on three. First, the first half of 2011 benefited from opportunistic real estate sales, which were not repeated in the second half of 2011 or in the first half of 2012. Second, the continued declining interest rate environment has resulted in increased accrued expenses in 2012 of our post-retirement benefits, which we call security benefits. Third, the strengthening of the US dollar against Latin American currencies has had a negative impact on Principal International's operating earnings in 2012. Adjusting for these factors, year-to-date earnings increased 3% over prior year on a 7% growth in average assets under management. Second-quarter 2012 operating earnings of $216 million were down $13 million from a year-ago quarter, reflecting these same factors.

While we expect the volatile equity markets, low interest rates, and the foreign exchange headwinds to continue to impact 2012, our business fundamentals remain strong as we focus on what we can control. For example, Retirement and Investor Service Accumulation businesses continue to deliver strong sales, client retention, and growth in recurring deposits, which will lead to market share gains and future earnings growth. Principal Global Investors will benefit from back-end loaded performance fees and lower expenses. Principal International is expected to continue its strong trends and long-term growth despite unfavorable macroeconomics. US Insurance Solutions should benefit from claims seasonality and continued stable loss ratios. And opportunistic real estate sales and expense management will benefit the entire organization.

Now, I'll discuss the business unit results. Full Service Accumulation operating earnings at $73 million were down $5 million, primarily due to pressure on fee growth. Pre-tax return on net revenue was 29% on a trailing-12-month basis. Let me make a few comments related to Full Service Accumulation margins. Slide 5 summarizes the leading factors impacting the trends in margins. These same trends are continuing in 2012.

Year-to-date 2012 Full Service Accumulation net revenue is down 2% compared to year-to-date 2011 due to pressure on asset management fees and lower variable investment income. However, we now expect full-year 2012 net revenue to grow between 2% to 4% based on an average S&P 500 index level of 1,370. Additionally, we expect to maintain pre-tax return on net revenue of 30% to 32% for the full year because of improving market performance and variable income.

Full Service Accumulation is a fee-based business that is focused on growing revenues, managing expenses, and maintaining profit margins, making return on revenue measures a better indicator of the financial performance of the business. The bottom of slide 6 illustrates our stable track record of driving revenues to the bottom line, even as customers' preferences migrate to different asset types.

Return on revenue margins are a key focus for us. The underlying fundamentals within Full Service Accumulation continue to improve. Year-to-date, recurring deposits are growing. The sales pipeline continues to build across market sizes and distribution channels, and close ratios continue to improve. We are actively executing on our strategy to win more business and gain market share.

Second-quarter 2012 Full Service Accumulation sales of $2.3 billion were strong. And year-to-date sales were up 49% over the same period a year ago. Whereas in 2011 sales and flows were more back-end loaded, in 2012 they are more front-end loaded. That said, we now expect sales growth of approximately 20% to 25% over 2011, and we expect net cash flows to be between 3% to 5% of beginning-of-year account values. Operating earnings for our Principal Funds at $12 million for the quarter were down $1 million compared to the year-ago quarter. This was due to higher compensation and sales-related expenses, as we invest in growing the business.

Sales of $3.4 billion and net cash flow of $1.1 billion reflect strength across multiple strategies, including Global Diversified Income Fund, Preferred Securities, Mid Cap Blend Fund, high-yield, and target risk allocations. Investment performance continues to be strong across asset classes, and is a leading indicator of future sales and net cash flows. The strong performance includes particular strength in asset allocation, where at quarter-end, 90% of our target date and target risk funds were ranked by Morningstar in the top half on a one-year basis, 100% on a three-year basis, and 73% on a five-year basis. Individual annuities operating earnings in second-quarter 2012 were $25 million, down $5 million from a year-ago quarter due to lower spread and higher DAC amortization. Normalized operating earnings are approximately $27 million, taking into account continued spread compression.

Second-quarter 2012 earnings for Principal Global Investors were $18 million, down $3 million from a year-ago quarter on an 8% increase in average assets under management. With a focus on growing our global investment management leadership position, we added distribution and investment professionals across select boutiques, which has increased expenses compared to a year ago. Unaffiliated net cash flows for the quarter were $2.1 billion, driven by positive flows into a variety of asset classes, including currency, stable value, fixed-income, and real estate. The recent opening of our office in the Netherlands has already generated $158 million of mandates awarded, with $58 million of that funding in the second quarter. Our strategy to invest for the future is working.

Moving to Principal International, operating earnings at $37 million were dampened by roughly $3 million due to one-time acquisition expenses from closing the Claritas deal. The underlying growth of the companies on a local basis remains strong. The strengthening dollar has created a headwind of roughly 10% to US-dollar-reported earnings, which we expect to continue into the second half of the year. As a reminder, our financial supplement now includes foreign exchange rate information used for financial reporting to help you better analyze the impact of exchange rates on Principal International.

Individual Life second-quarter operating earnings were $28 million, up $4 million from a year-ago quarter due to better mortality experience in the current quarter. Second-quarter 2012 results were in line with expectations.

Turning to Specialty Benefits, second-quarter operating earnings were $23 million, down $3 million from a year-ago quarter, primarily due to stable loss ratios and stronger-than-normal net investment income in 2011. The increase in sequential earnings is due to normal seasonality in dental claims and sales-related expenses. With the negative impact of seasonality behind us, we would look to see consistent loss ratios, strong retention, and growth in premium and fees for the remainder of 2012.

The Corporate segment reported an operating loss of $31 million, right in line with our expected quarterly result of $30 million to $35 million. For the quarter, total Company net income was $173 million. After-tax credit-related losses remain steady at $27 million. Our investment-related losses continue to be in line or better than our loss projections, and better than market expectations, reflecting sustainable recovery in commercial real estate. This improvement has given us additional financial flexibility.

Moving to our balance sheet, our net unrealized capital gain position of $2.3 billion increased $300 million from first-quarter 2012, predominantly due to lower interest rates. As a reminder, because of the strong asset liability management, changes in net unrealized gain or loss due to interest rate movement do not result in an economic impact, and in periods of stress, do not force us to sell assets. The evolution of our business model means we now have a much higher portion of earnings coming from less capital-intensive, more fee-based businesses that have limited or no guarantees associated with them.

As the low interest rate environment persists, our earnings will continue to grow, but at a slower rate, as shown on slide 7. We view this modest headwind to earnings growth as very manageable, which speaks to the strength of our investment management plus strategy. Although we continuously monitor all assumptions, including the interest rate environment, third quarter is historically when we conduct our periodic review of assumptions and actuarial model enhancements.

The persistent low interest rate environment could result in a reduction in the long-term interest rate assumption used to model deferred acquisition cost and related actuarial balances. If we were to lower our long-term interest rate assumption by 25 basis points for every segment across the Company, it may result in an additional one-time after-tax reduction of operating earnings of approximately $25 million.

Looking now at capital adequacy, we estimate our second-quarter risk-based capital ratio to be 440%. Relative to a 350% RBC ratio, we have approximately $1.5 billion of total excess capital, with over $500 million of the excess capital in the holding company. As outlined on slide 8, so far in 2012, we have allocated $475 million of capital for strategic acquisitions, opportunistic share repurchase, and two quarterly common stock dividends. During the quarter, we completed the remaining portion of our $100 million February share buyback authorization, and started our $200 million May authorization. So far, we have purchased approximately $125 million worth of the current authorization. As Larry said, we anticipate a pattern of increasing dividend payout ratio year-over-year.

We remain on target to deploy $800 million to $900 million of capital in 2012, with approximately $400 million left to deploy. With our commitment to increasing long-term value for shareholders, our focus continues to be on deploying excess capital through quarterly dividends, strategic acquisitions, and opportunistic share repurchases. As we have demonstrated in the past, we will be prudent as we continue to look for additional opportunities to deploy excess capital. In closing, we're very pleased with the continued growth and momentum of our businesses throughout the second half of 2012 and beyond.

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

(Operator Instructions)

John Nadel, Sterne Agee.

You covered in prepared remarks a lot of the pressures that we're seeing, but I was hoping we could talk about a little bit more about your guidance and perhaps some of the changes in the environment, and specifically quantifying some of them? How that impacts your outlook relative to what you were originally baking into your guidance a few quarters ago? For instance, your guidance now is assuming the S&P averages I think 1,370. That's actually 100 points or about 7% higher than your original guidance assumed. That, I would think that's a tailwind. I would think your organic growth is probably better than you were assuming, but obviously some serious headwinds, rates, et cetera. Maybe you can tie that all together for us?

Good morning, John. This is Larry. I will make a few comments and then I will see if Terry wants to add anything. I will start by saying, of course, we don't really update guidance. We provide it based on conditions back in December. We give you our best forward-looking estimate of we thought 2012 earnings would be. But to try to be responsive to your question, let me walk through a number of the factors that you mentioned and hopefully this will provide some help for you.

If you take the first two quarters, what we know is we've got $1.42 of EPS so far in the first two quarters. To your point, we also know we've had a fair number of headwinds that I think we could all sit and speculate for the rest of this call about whether they are going to turn around and become tailwinds. But let me just hit a few of the business of the fundamentals and how they may act in second quarter as compared to first quarter.

For example, we know generally speaking, in the second half of the year, SBD, Specialty Benefits, has positive claim seasonalities. You can look at past practice and see if you can quantify that. We also know in the past historically, there have been some performance fees in Principal Global Investors. Again, you can get a sense of what the magnitude of that might be.

Relative to Principal International, I would say again, that's been the one that has been most impacted by macroeconomic conditions. And so I think in the second half, the performance in the local markets is very strong. The question will be will we see stabilization, or maybe even turnaround, in FX rates and will we see the return of higher inflation, particularly in Latin America, which would have a positive impact on net investment income.

Then of course, we could talk about whether we are going to see any equity market growth. Again, typically, in our guidance, which we gave last December, we would have assumed 2% per quarter. So we would assume in the second half of the year something like 4% equity market growth. And then finally, what I would say is the one thing we do know relative to having a tailwind is we should see about a 5%, roughly, increase in EPS, just based on the change in the share repurchase or the share counts that have happened between the start of the year and end of the year. So, you put all that together, you take $1.42.

Again you have to apply your own assumptions, John, as to what you think the equity market FX is going to do, but clearly, and particularly relative to the second half of 2011, you would think we would see some increase. Again, just for the record, in 2011, in the second half of the year, EPS was $1.27, and again, we're running at about $1.40 right now. So I hope that gives some help.

That's really quite helpful. And Larry, I've got one more for you, and maybe a little bit tougher topic, but I can't recall a two-quarter or a one-half-of-the-year period where Principal has generated the kind of organic growth that you guys did in the first half of this year. But I look at in the face of that, your stock is flat. And the S&P is up 9%. Broader financials are up 12%. I am curious what you and the management team take away from that relative under-performance, at least in your stock price, and whether it causes you and management to think differently about how you deliver value?

Sure. Again, those are all great questions, and they are questions that we spend a lot of time on as a management team, and we spend a lot of time on them in discussions with the Board. That is why, John, we have been trying to communicate -- first of all, let me speak to relative share price performance.

I would say first of all, while we haven't necessarily significantly outperformed peer companies, if you define them more from the standpoint of your peer insurance companies, and we might differ on that a little bit. But if we just take that peer set for a second, what I would say is, our performance has been in line or slightly better than has been average of that peer performance. So, the point is - is that all financials, all peer insurance companies, continue to be heavily impacted primarily by what is perceived to be the impact of very low interest rates. We have tried to make the point again and again and again, and I think it's a point of opportunity for buy-side investors; we have tried to make the point that we are less impacted by low interest rates than many of our peers, because 65% of our earnings come from fee-based earnings.

In addition to that, you've seen the Board, our Board, be very responsive to the situation by deploying significant amounts of capital, primarily through common share dividends. And as I said in my comments, if you actually look at capital deployed, capital deployed adjusted for market cap size, we are in the top quartile. And there really are very few companies that have been more active in deploying capital, either through increased dividends, share repurchase, or M&A than we've been.

I think we're doing all the right things. I think the reason that the share price had modest relative outperformance is because of interest rates, and probably, until the macroeconomic conditions turn around, you're not going to see substantial change. But these sets of conditions aren't going to be around forever. The world is going to go on. These economies are going to grow, and our earnings are going to continue to grow.

If you take our $2.66, which was our EPS for last year, and again, you take our $1.42, and you can do whatever you want, but I think you can see that we're certainly still on track for some sort of 7% to 10% growth in EPS in a year, John, and quite frankly it's very, very challenging. We're going to be very much in line with our long-term belief in EPS, and hopefully investors will see that over time, and they'll reward us.

Larry, I really appreciate your response on this. Thank you.

Jay Gelb, Barclays.

Thank you, and good morning. I want to hone in a bit on the FSA growth potential there. Can you walk us through how the changes in that market is affecting it broadly? And then how that's filtering down through the results?

Yes, this is Larry. I'll have Dan talk to you a little bit about the competitive environment. I just want to make one hopefully helpful comment on the latter part of your question, Jay. And that is that walk through how all this translates into earnings, and I just want to make a quick comment and then have Dan talk about the competitive environment, which of course shows that we're performing very well.

But if you look at second quarter as an example, and you look at the change in the Full Service Accumulation account value during second quarter, that essentially was all done through net cash flow generation. And most of that was done through new sales. So, essentially, the increase in account value is all coming through new sales.

And when you think about which sources of account value are more lucrative relative to revenue and earnings, the best way to get account value revenue earnings growth is when the market gives it to you. The toughest way to get earnings growth is when you have to go out and sell new plans where you take on acquisition expenses and administration expenses to bring on those new dollars. Frankly, when we look at the performance of Full Service Accumulation, given where the increase in account value came from in second quarter, I think the performance of the Business was actually decent.

Again, when we get back to a mode where we're seeing more 2% per quarter equity market growth, then you are going to see the revenue increase at a faster rate, and you're going to see earnings increase at a faster rate.

With that, let me ask Dan to talk about the competitive environment.

Thanks, Larry.

From a competitive environment, we still have some of those headwinds that we've talked about in the past, and there is a handout in your online in the investor section talking about the business mix. We still see migration away from general account. We still see healthy sales in ESOP. There is a movement from proprietary to nonproprietary options that generally increases when you sell larger cases. That certainly gives us the window of opportunity to go in and resell those plans on additional investment options provided by Principal Global Investors.

The second component from a competitive perspective is that there's still -- we're not recovered on re-occurring deposits. Those are still weak relative to historical past, although they are improving. It's still one of our main contributors to success.

And then as it relates specifically to the competitive environment, we're continuing to win business in the same manner we have in the past. We've done it with Total Retirement Suite. The TPA strategy is working. The alliance strategies are working.

The one area that we continue to see pressure on, obviously, is around the competitive pricing from the competition. When we look at that, we think back to the pre-crisis mode, there is occasionally some outliers that were aggressive in their pricing during the crisis. There was not a lot of movement. I think small- to medium-sized employers frankly were more focused on running their businesses. And then you had advisors trying to retain business.

In the post-economic crisis environment, the fee-disclosure environment, and the excess capacity in the industry, there is more pressure on getting revenue growth, and that certainly impacts, not only new case, but also impacts your ability to -- on your in force block, and so retaining of that business.

So one of the things we did during the crisis was to give our customers choices on pricing, choice pricing as we called it, dialing up and down their services. Today in the marketplace with the excess capacity, there are competitors that are selling bundled full-service solutions at discounted prices. We don't know if that's a short-term or a long-term problem that we'll have to confront.

Obviously, we'll take the necessary steps, as we historically have, to align our expenses with what the revenues are that customers are willing to pay us, but this thing is clearly a mixed bag, a lot of variables. Clearly, our ability to retain business, clearly, our ability to attract new business is a sign that they certainly value the local service that we provide, Total Retirement Suite. And again, about 60% of all new sales are tied to a bundled Total Retirement Suite approach.

Hopefully that helps, Jay.

It does. Thank you.

Steven Schwartz, Raymond James.

A couple, if I may. The Chilean peso --not the Chilean peso, but Chilean inflation -- obviously left a bit of a mark. You've reference that a couple of times, Terry. Could you possibly put a number on that?

Sure. Go ahead, Terry.

Yes, Steven, this is Terry. As you look at the Chilean inflation this quarter, it had about a $2 million impact on the operating earnings. Now, that was this quarter. Last quarter, we actually received a favorable $2 million. So year-to-date, it is volatile and fluctuates quite a bit. On a year-to-date basis, there's probably no impact, but this quarter, it was about a $2 million reduction.

Okay. Larry, I think you referenced a very big SPIA deal, $500 million in the third quarter. Could you talk about what that is?

Steven, these are the traditional single premium, both immediate and deferred annuities, that we've been active in this market for 70 years. We've been one of the top three, four, five players in the plan termination market. These are essentially defined benefit type obligations that, for whatever reason, are needing to be wound up.

So this particular one was again, similar to a couple of the ones that you've seen in the marketplace, a $500 million placement. Credit quality matters here. Your financial strength ratings matter. There is, as I said in my comments, Steven, there's a limited supply of proven providers in this marketplace, and we feel fortunate that we are one of the ones that's there.

As I said, we had $160 million of sales in the income annuity space in the first two quarters, another $500 million sale in the third quarter. So, we are seeing more interest there. We'll certainly stay disciplined as we price those particular deals, but we would expect that we'll see more opportunity there. And if and when interest rates would ever rise, I think you would see even substantially more growth in that part of the Business.

Larry, I was interested if it was a termination deal. What kind of return are you pricing for on that?

Normally, what we're looking for is something that's clearly well in the double-digit range. And of course, the thing with a deferred and immediate annuity like that, Steven, is you're not going to really know what you get for another 30, 40, 50 years as far as a return. But certainly, our pricing is based on, if you will, a fairly conservative set of future interest rate assumptions. We calculate our IRRs against that fairly conservative set of assumptions. So, again, you're well into the double-digit range here.

Okay, good. And then Dan, if I may, one more. We've been in the new disclosure regime now for all of a month, but I am wondering if any surprises have come out of it?

You know, Steven, it really hasn't. The call center volume has been muted. Remember that we had gone out with notification to our clients back in November of 2011. The requirement was by July 1 it had to be out. And of course now the next step is the participant disclosure, and we have no reason to believe that that's going to create a huge volume of work for us as we near a year-end fourth quarter when those requirements will be a place.

Okay, thank you.

Christopher Giovanni, Goldman Sachs.

Thanks so much. I wanted to see if you could talk a little bit about how you're thinking about your bank status and if there are any plans to potentially change?

Chris, this is Larry. I'll make a few comments. The comments I would have today would be, I think, entirely consistent with the comments that we have said in the past. Again, as of I think most of you know, we are a savings and loan holding company. We are -- after July 1, 2011 we have the Fed now regulating the savings and loan holding company.

We continue to have what I would consider to be extremely positive discussions. They are coming up to speed on how to think about a company like Principal Financial Group with primarily fee-based businesses, although many still think about us an insurance company. But our businesses are mostly fee-based businesses. I think they are -- they've been, in my view, Chris, they've been very thoughtful, in our interactions. We consult with them very regularly.

I said in my comments that if you look at the last four quarters, so those would be exactly the four quarters that we've regulated by the Fed. If you look at the capital that we have deployed, either for common share dividend or share repurchase or for M&A, if you aggregate that and adjust for market cap, we would be within the top two or three or four of our entire competitive peer set in terms of how much capital we've deployed. That would say, I think, the conclusion there would be that we've not found anything there that is necessarily concerning.

I think going forward; the question will be there is a notice of proposed rulemaking that is out there relative to non-bank financials. That process will go on, and we will provide our comments, as well as everyone else, and then we will see where we end up. This one is near the top of the agenda of things that we are watching, and we are investing a lot of time and energy in having them understand our Business.

But ultimately, the Board will make the right decision for shareholders over the long-term. I would say again, so far, so good. Great interaction. I think they have great respect for how we run our businesses. Certainly have not been disruptive at all, and we'll just have to see where we go going forward.

Okay. And then on inflation that you guys have been talking about in terms of Latin America, and I understand potentially some of the near-term earnings headwinds from lower investment income. But doesn't lower inflation really help accelerate your retirement and asset management strategy in that region? Curious how you're thinking about the balancing of these two areas?

Maybe I will ask Luis to comment in just a minute, but for the sake of clarity, Chris, I will try to set the stage on what we mean when we talk about inflation. Latin America as a region is a region that has been plagued, if you will, with inflation for many, many decades. Unlike the way fixed-income markets work here in the US, in Latin America, at least particularly Brazil and Chile, not quite so much Mexico, but certainly in Brazil and Chile, it is very common to have inflation-linked securities. So the fixed-income return is directly linked to, and in many cases the crediting rate for products, is directly linked to certain inflation indexes. When inflation is higher, then investment income is higher, and the crediting to the customer is higher.

When we talk about the impact of inflation, essentially what we're talking about is the net investment income we're receiving on the, if you will, the surplus that we have invested in those companies in Latin America. I hope that's helpful in terms of understanding how inflation impacts and ask Luis if he has thoughts on what the inflation outlook might be for the second half.

The first thing to repeat what Terry said, if you're looking the entire year, first quarter and second quarter, essentially we had a positive environment in the first quarter and a negative one in the second quarter. The whole year 2012 looks a kind of wash. But anyway, it's fair to mention also the second quarter 2012 was a kind of unusual. We had a depreciation of the local currency. Normally when you're having that kind of depreciation of the local currency are coming with higher inflation. This particular quarter, we had the two unusual things, the depreciation of the local currency and also this lower inflation.

So we think that going forward, these two things have to come much more in a by-the-book process going forward. And anyway, we don't have any particular assumption about inflation in Latin America different than in the neighborhood of 3%. And still, those countries are, particularly Mexico and Chile, they're still, in order to get that kind of inflation for the whole year, 3.0%.

And maybe Jim McCaughan wants make a comment here as well?

Yes, Chris, I think one of the things that's really going to make a longer-term difference here is when those Latin countries converge towards a capital market structure that is more like we have seen in the developed world. What I have in mind here is to take our very big business in Brazil, the investors there, both by regulation and by preference, have concentrated on Brazilian assets, short-term Brazilian government debt. And you really can't blame them when the yield on it was 11%. It's hard for international investments to compete.

If you look at much lower rates that we're now seeing with the financial and currency recession that Luis described, we're getting to something of a tipping point here, where investors based in those countries are likely to see much more attraction in equity investment capabilities and international capabilities. That is going to be a huge opportunity for the next two or three years for Principal Financial Group, so I think there is good and bad in the lower interest rates. And maybe it doesn't affect the quarter-to-quarter, but there's a great longer-term optionality here in terms of providing international services to those investors.

Okay, Jim. That's exactly what I was trying to get at, so thanks. That comment was very helpful.

Randy Binner, FBR.

Thanks. I just wanted to clarify the comment on the $25 million reduction relative to a 25 basis point decrease in the overall earned rate. That seems like it would be part of the third-quarter DAC review, and that 25 basis points reduction, that's really just the typical portfolio bleed you would see as you turn over the portfolio in a low-rate environment. Are those correct takeaways?

This is Larry, Randy. I would say that's generally correct. Let me see if Terry wants to add any additional to that?

Randy, this is Terry. What we talked about in terms of the long-term interest rate assumption, the reduction of 25 basis points in that, would be the impact it would have on a reduction in our DAC and actuarial balances. So, it would be more of a one-time hit to earnings. As you mentioned, in the third quarter is typically when we review our assumptions, and interest rate will be one of them, as well as look at enhancements to our actuarial models. Now, we also look throughout the year, but third quarter is when we really focus on that, and that's what I'm referring to in the $25 million hit to a 25 basis point reduction in the long-term interest rate assumption.

Okay. And that would be -- that's 25 after tax?

Yes.

Yes.

Okay, one other quick clean-up item. I wanted to clarify in the context of the guidance discussion. If there is a variable income catch-up, or tailwind if you will, in the back half of 2012, would that mostly be from potential CRE sales?

That's right. It would be mostly from CRE sales. That's generally speaking what we're talking about when we talk about variable investment income. And I don't know, Julia, would you like to make any further comment?

No, that's exactly right, Randy. It's coming from our opportunistic portfolio where we purchase value-add real estate, and when the market is right, we sell it.

Is the market -- Sorry, I was going to say is the market right for that right now? Right now is a good market that?

Yes.

And this is Larry, Randy. To give you, again, a sense, in the first half of 2011, and again, this is a pre-tax number, but we had about $22 million in gains on this sort of activity in the first half of 2011. That was the reason Terry went through the differences and talked about even though reported earnings are down, if you actually strip out the one-timers and things, actually there is earnings growth first half 2012 over first half 2011, because we had these front-loaded real estate sales last year.

And I might add that since Larry gave the dollar amount last year, that's going to be hard replace that size of a sale. That was a very large opportunity that we sold at a gain that was really exceeded our expectations. So, I wouldn't expect that kind of opportunistic sale, but we still have opportunities out there.

Okay. So something more like maybe $0.03 or $0.04, but not as big as one-half 2011?

Probably something lower than that.

All right. Very good. Thanks so much.

Suneet Kamath, UBS.

Thanks, and good morning. I wanted to start with a follow-up to the comment that Larry was making in response to Jay's question about it mattering where the growth comes from in FSA. Meaning, if it comes from the market, you don't have the acquisition costs, and I thought that was a great point. But that leads me to page 6 of your conference call deck, where I look at the margins, and I'm not talking about ROA. I'm talking about the pre-tax return on net revenue and the pre-tax margin, and if I look at 2011 and I compare that to 2015, there's not a whole lot of upside, meaning you're kind of right in the range already. And I would imagine that this illustration is based on an assumption that there is normal market growth between now and 2015. My question is why aren't we seeing upside in those margins as we move forward in time? Thanks.

Sure. Suneet, first of all, congratulations on the new assignment. I hope it goes well for you. Let me just make a couple of comments, and I'll say I'm looking at Dan and Terry here. But let me make a couple of comments relative to pre-tax return on net revenue. As I said before, if you look at a quarter like second quarter, and again, we should all be careful to take a quarter and somehow annualize that or assume that that now reflects the new dynamic going forward. Because as I said, particularly in second quarter, because of the strong sales, strong net cash flow, I would say it's highly unusual when all of -- actually more than the increase in account value all came from net cash flows, meaning the market was negative and it was the net cash flows that grew your account value.

In that scenario, again, there's going to be pressure not only on ROA, there's going to be pressure on return on net revenue. That's why you've seen a slight diminution in return on net revenue in this quarter. If you go out to this 2015 and you say well, why aren't you going to see more lift in that pre-tax return on revenue, what I would say to that, Suneet, is we would like to sit here and tell you that there is tremendous operational leverage. But the reality is, think about it. The reality is if a $25 million plan becomes a $50 million plan by 2015, they're not going to allow you to charge the same fees when they are a $50 million plan in 2015 that you charge them when they are a $25 million plan in 2012.

What happens in this business is what would happen in any competitively efficient business in that you are going to the see a paralleling, if you will, between the fees. The fees are going to go down as the plan gets bigger, and you're going to have to re-price that periodically, and that's just the new dynamic of the environment we are in. That is why you hear our comments talking about aligning expenses with revenues. And so that's a reality of the business. But we should not be negative about that. Because again, you talk about pre-tax return on net revenue of 30%.

That would be one of the highest returns in all of financial services. And if you talk about an ROA, return on assets, of 24 to 26 basis points, that's an ROE that's, again, in that 25%, 30% range. So these are very, very healthy margins, and again, to assume we could increase them further I think would be a little bit naive. So hopefully that helps.

No, it does. It does. I don't know if Dan wanted to comment?

Maybe just a couple quick comments in terms of where you get additional lift as there continues to be pressure on the margins. Obviously, the investment preference, we think it'll swing back towards equity. We think there's good upside in some of the emerging market. And again, our investment performance, proprietary, is very strong. The whole notion of retirement readiness, getting this group of baby boomers ready for retirement, that's going to involve a lot of taking advantage of our work site deployment strategies.

The roll-ins come there, and we in essence will have an excess of $1 billion of roll-ins this year. And the other point I would make relative to the pressure we have on Full Service Accum, remember that with our DCIO strategy, and we double the sales in our mutual fund defined contribution-only strategies this year from a year ago, that's getting our investment product on our competitors' 401(k) platforms and their IRA platforms. So again, good growth for overall PFG, although it may not show up in the FSA line. And then as we come out of this very sluggish economy, it's the increase in salary deferrals. It's the increase in participation that also will contribute to a net growth in these plans in terms of earnings.

Hopefully that helps.

It does. I had a quick follow-up in terms of the quarter.

I think in the commentary around FSA flows, there was some discussion about the strong client retention, which is obviously a good thing. Wondering when we think about the plans that you are retaining, particularly the ones that are perhaps up for bid, and you keep them, what are the pricing dynamics there? If you can compare what you're getting on those retained plans today versus perhaps what you got when you originally put them on the books? Is it meaningfully different? And any order of magnitude would be helpful. Thanks.

The reality is they are different, and of course, it all depends on the size of the plans. You don't see as much pressure on our core small to medium size. I will put that in plans of less than, say $10 million. There's always points of discussion. But again, they're looking for very comprehensive services. They value the proposition that we bring. On the larger plans, a lot of registered investment advisors are involved.

A lot of the reduction in revenue may very well come from that. RIA recommending other investment options for a range of reasons, diversity, and to the extent that that's money that moves away from our general account or moves away from our proprietary separate accounts or mutual funds, that does have a negative impact on the plan. And I would say the order of magnitude, they all vary. But to retain a large piece of business today might involve reducing pricing in that maybe 10% to 12% range. But again, it all depends on which investment options they've chosen and what services that they're looking for.

Suneet, this is Larry. I'd like to add one comment, which is that -- one of the reasons that you -- the best way to mitigate the issue that you talked about is really our Total Retirement Suite platform. And that's really why we put so much emphasis on what percentage of our sales are in TRS, and we're now again at the point where well over half of the account value inside a Full Service Accumulation is actually tied to some other program.

It's tied to a non-qualified plan. It's tied to a DB plan. It's tied to an ESOP or some combination of those. And that's really the way, because the reality is it's much harder in the competitive environment -- you can't just move -- the easiest to move is a 401(k) only. It's really difficult to move one if you've got a 401(k), a DB, and an ESOP, for example. So the whole key to retention here, and the key to being able to provide value-added services, is really the TRS strategy, and that remains a best-in-class platform today.

Great. That's helpful. Thanks. And thanks, Larry, for your comments at the start of your response.

Mark Finkelstein, Evercore Partners.

I had a question, back to FSA on revenues. If I look at net revenue growth year-over-year, it's down 1% to 2%. AUM is up about 6%. My first question is can you help explain the -- the delta there is a little surprising to me, the extent of it. I understand the fee pressures, but I guess the delta is a little surprising to me, so help explain that. And then secondly, what gives you the confidence that that what is negative 1% to 2% can shift to 2% to 4% through the year, if my numbers are right?

Mark, this is Larry. I'll have Dan comment, but this is -- this delta that you are describing, again, is very much to the point of is the new account value coming from brand-new sales, where again, the least profitable part of your -- the lifecycle of a 401(k) plan is when you set it up. So when most of the new account value comes from new sales, the return on revenue and the delta between account value growth and revenue growth is going to be at its widest. The delta between account value growth and revenue growth is going to be at its narrowest when you see large lift coming from the equity markets. That's really the dynamic that's in play. But I am sure Dan can add some more to that.

The 1% to 2% negative revenue relative to account value growth of 6% is not new information. This has been going on now for last couple of years. And it gets back to, and I won't reiterate all of my previous comments, but certainly, mix of business is contributing to that, investment preference, all of those drivers. We are still dealing with 8% unemployment out there in the marketplace, so the recurring deposits have not come back.

Again, I might -- I'm confident that long-term, we get back into this 2% to 3%, 4% growth in net revenues. Although I suspect we'll be fighting this headwind for the near future. And again, we'll align our expenses ultimately with what it is our customers are willing to pay for. We actually have a -- our institutional client conference coming up here in September. It will be our 100 plus large institutional clients. We will have a two-day discussion with them, and that's where we get into a lot of our discussions around retirement readiness, fees, disclosure, and understand the mood.

And in addition to having record retention, I would tell you our customer-service feedback scores are some of the highest that we've had. I think we're going to fight through this pressure that we have on getting revenue growth, but it is not as good as it was, say five to six years ago, when you pick up 8% from the market, 5% from net cash flow, and then operational efficiencies. So we will continue to take steps to manage expenses accordingly.

Mark, this is Terry. Just to add on to what those two have said, we did have some of the variable income that went through the Full Service Accumulation line last year. And that had a benefit, too, and that caused some of the delta.

Okay. You have an assumption of 2% to 4% net revenue growth, which I assume is for the full year. And the first half of the year is I think, by my numbers, negative 1.6%, negative 1.7%. The question is - is there something specific that you are seeing in the book that is going to have what is actually a fairly sizable shift, or is it purely just the assumption around markets improving?

Yes, it's primarily the assumption, Mark, around -- again, and our guidance is always based on 2% per quarter. So we are assuming the second half is going to have some equity market lift, which is going to be the most helpful contributor to getting back to a closer delta between account value growth and revenue growth. They are never going to equal. That's not possible.

That's saying that you can charge a plan at $100 million the same you charged it when it was $50 million. That's not realistic. That's not going to happen. But you don't necessarily see that delta be as wide as it was in second quarter, just because of where the account value changes came from. So, we think we're going by the end of the year, we would assume we're going to get back to a more normal delta between account value growth and revenue growth.

Okay. And just one final question for Jim McCaughan is, I understand that there was some expenses in the first half of the year in PGI that are largely nonrecurring in the second half of the year. Can you just frame out how large those expenses were so that we can model appropriately?

Yes, sure, Mark. Thank you. The only piece that's really completely nonrecurring, and I'll talk about this in terms of second quarter just reported versus the year-ago second quarter. The only piece that's strictly nonrecurring is employee termination costs of about $1 million. We do not anticipate that recurring in the second half of the year.

The second piece of increased expense is sales commission, which was about $1 million higher in second quarter 2012 than it was in 2011. In a way, because that shows your organic growth in the business, I want that number to get bigger. That's one expense category where you don't mind spending a bit. What that implies actually, though, is that for these pieces of new business we're putting on, the profitability in the first two years when you are paying sales commission is less, or quite a lot less than it will be in year three. So there's a lagged impact of the new business on earnings.

And then the third category of incremental cost is what we've categorized as investment for growth. That spending on increasing our workforce, for example in China, the Dubai and Amsterdam offices, increasing US sales, and getting investment people increased numbers in some of the growth areas of capital markets. Now from all that, the incremental cost second quarter 2012 over second quarter 2011 was $2 million in the quarter.

We actually have got to a point where there are no further plans to increase that investment for growth. So, what I am really saying here is that has been a drag on earnings in the first half. From now on, that should sequentially cease to be a drag on earnings, because we reckon that with the big opportunities we've got following investment performance, following the development of our investment capabilities, that we have really invested in that growth. The run rate won't increase further. So we should be seeing less of a drag on earnings from that, albeit with the continued, hopefully, increase in flows.

Okay, all right. Thank you.

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

Thanks, everybody, for joining us. We do appreciate your continuing interest. As we said during our comments, despite the macroeconomic conditions, we do believe our businesses continue to have strong momentum and that we do have the right strategy and the right management team to grow our businesses over the long-term. We hope to see many of you at our Investor Day on September 21 in New York, as John mentioned. And other than that, we hope everybody has a great day. Thank you very much.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 8.00 PM Eastern Time until end of day August 3, 2012. 20811 is the access code for the replay. The number to dial for the replay is 855-859-2056, and that's US and Canadian callers, or 404-537-3406 for international callers.