Principal Financial Group, Inc.
Q4 2011 Earnings Call Transcript

Published: 3 Feb 2012

[Operator:]

Good morning, and welcome to the Principal Financial Group Fourth Quarter 2011 Financial Results Conference Call. [Operator Instructions] I would now like to turn the call over to John Egan, Vice President of Investor Relations.

[John Egan:]

Thank you and good morning. Welcome to the Principal Financial Group's Fourth Quarter and Full Year 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. Slides related to today's call are also on the website. 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 and Investor Services and U.S. Insurance Solutions; Jim McCaughan, Principal Global Investors; Norman Sorensen and Luis Valdez, Principal International; and Julia Lawler, Chief Investment Officer. Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or change 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. Now I'd like to turn the call over to Larry.

[Larry Donald Zimpleman:]

Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas

[Terrance J. Lillis:]

Thanks, Larry. As Larry mentioned, fourth quarter earnings were negatively impacted by headwinds. However, business fundamentals remain strong. This morning, I'll focus my comments on operating earnings for the quarter and full year; net income, including continued solid performance of our investment portfolio; and the strength of our capital position and strong balance sheet as we enter 2012. Fourth quarter 2011 operating earnings of $217 million were up 1% from a year ago quarter, on 5% higher average assets under management. There were a few notable items impacting fourth quarter 2011 operating earnings. Fourth quarter 2011 had positive DAC amortization true-ups due to the equity market performance, which benefited Full Service Accumulation, Individual Annuities and Individual Life by $0.01 each. Principal International benefited by $0.03 from foreign tax credits and the removal of a 1-month reporting lag in Brasilprev, thus reporting 4 months of earnings from that operation in the fourth quarter. Full Service Accumulation was dampened by $0.04 from lower spread and higher expenses in the quarter, and the Corporate segment was negatively impacted by $0.04 from lower variable investment income on excess capital held at the holding company from an active credit strategy. Adjusting for these items, we consider the earnings per share run rate for the fourth quarter to be $0.73 and fourth quarter 2011 earnings down 2% on a 5% increase in average assets under management, compared to adjusted fourth quarter 2010. Now let me discuss the business unit results. Full Service Accumulation operating earnings at $64 million were down 16% from a year ago quarter on a 3% increase in average account values. The earnings drop was driven by higher quarterly cost for pension and other postretirement benefits, which we refer to as security benefit cost, higher nondeferrable sales compensation expense and less variable investment income. A more normalized earnings results for this quarter would have been $72 million. In 2012, new regulation for plan sponsor and participant fee disclosures are scheduled to take effect. The Principal has been well positioned for this regulatory change and we were an early adopter of the proposed disclosure regulations in fall of 2011. Advisers and plan sponsors place business with us because of our compelling value proposition, not because we're the cheapest provider. The retirement industry is fragmented, and we expect to see the industries consolidate to the top players, such as the Principal. Let me make a couple of comments related to the Full Service Accumulation margins. Slide 6 summarizes the leading drivers of the return on assets since 2004. Factor one, which has been the largest impact, is a consumer-driven shift in business mix, which I'll give more detail on in a moment. The second factor is the current market environment, which has reduced recurring deposits. The third factor listed, growth, retention and efficiency, is one we have and will continue to influence through scale and focused execution. As depicted on Slide 7, the mix of business is shifting away from general and separate account investments into mutual funds and employer securities, reducing return on assets but improving free cash flow generation. As this business mix continues to shift and more business is written on our mutual fund platform in a nondomestic equity investment, fewer dividends are eligible for the dividend received deduction benefit, which also reduces the return on assets. Despite this, we continue to deliver industry-leading return on assets. When we measure results for Full Service Accumulation, we also look at other profit metrics, such as pretax margins and pretax return on net revenue, which are better indicators of the financial performance of the business. Slide 8 illustrates our stable track record of driving revenues to the bottom line, even as customer preferences migrate to different asset types. Return on revenue margins continues to be a key focus. 2011 Full Service Accumulation sales of $8.4 billion was very strong, up 27% over 2010. The underlying fundamentals within Full Service Accumulation continue to improve. The sales pipeline continues to build across all market sizes and distribution channels, and the close ratios continue to improve. We are actively executing on our strategy to win more business and gain market share despite the shift in business mix and environmental headwinds. Strong transfer deposits, combined with excellent client retention, drove full year net cash flow of $3.8 billion or 3.5% of beginning year account value, against an industry that ended the year flat as estimated by Cerulli. We also saw modest growth in recurring deposits year-over-year, reflecting improvement in employer matches and salary deferrals. While unemployment rates remain elevated, these trends increase our optimism about improvement in the U.S. economy in 2012. Principal Funds continues to deliver strong operating results. Operating earnings at $11 million in the fourth quarter were in line with the year ago quarter. On a full year basis, 2011 operating earnings of $48 million were up 22% on 12% increase in average account values. Full year 2011 sales were $11.2 billion, up 20% over 2010, driving full year net cash flows to a record $2.2 billion. Individual Annuities operating earnings in fourth quarter 2011 were $30 million, down $3 million from a year ago quarter. As the low interest rate environment persists, Individual Annuities will continue to experience spread compression. Fourth quarter 2011 earnings from Principal Global Investors were $18 million, down 9% from a year ago quarter on a 2% increase in average assets under management, primarily due to higher compensation cost and the acquisition cost related with our purchase of Origin Asset Management. In fourth quarter 2011, we earned performance fees on our hedge funds at Columbus Circle Investors, one of our investment boutiques. As is common in the industry, a substantial portion of those fees is shared with the investment managers. On a full year basis, earnings were up 26% on a 5% increase in average assets under management as pretax margins expanded to 21.4%, another step on our road back to the target of over 30% pretax margin. Unaffiliated net cash flow for the quarter was a negative $900 million due to market volatility causing some delay in the funding of mandates awarded until after year end. Principal Global Investors had $11 billion in mandates awarded in 2011, double the amount awarded in 2010. As Larry mentioned, as of year end, $3 billion of the 2011 total awarded had yet to fund. We remain optimistic about the likely institutional net flows for Principal Global Investors in 2012. We base this optimism on a high level of client interest in awarding new mandates for our capabilities, and also on a generally good client appreciation of our investment performance and service. Additional activities that bode well for the long-term growth are the 2012 launch of the QFII fund, as well as the expanded series of Islamic investments. However, market volatility continues to feed uncertainty about client plans, so we see this as a risk. As we continue to monitor the global economy and focus on things we can control, such as execution and fund performance, we remain cautiously optimistic as we begin 2012. Moving to Principal International, operating earnings at $51 million include one-time benefits of approximately $10 million. Of this, $7 million results from an additional month of earnings in current quarter results from Brasilprev as we closed the 1-month reporting lag for that business. This also impacts assets under management and net cash flow. After this change, we will no longer have any material operations in Principal International on a 1-month reporting lag. The remaining $3 million benefit came from some foreign tax credits we were able to recognize. Assets under management were $53 billion at year end, down 3% from third quarter 2011. Net cash flow of $1.7 billion and positive investment performance of $1.3 billion was more than offset by the negative $4.8 billion effect of exchange rates from the strengthening dollar. While the underlying growth of the companies on a local basis at approximately 15% remain strong, 2012 began with operating earnings weighted foreign exchange rates, roughly 10% less favorable than the 2011 average rates, providing a headwind to U.S. dollar reported earnings. Our financial supplement now includes foreign exchange information used for financial reporting to help you better analyze the impact of exchange rates on Principal International. A quick comment on an item that will impact Principal International in the first quarter 2012. In the Mexican AFORE pension market, participants who did not select in AFORE are assigned to various providers. The regulator of the Mexican AFORE pension market has initiated a program to reassign these participants to providers with higher net investment returns. Principal will both gain and lose participants from this recent reassignment. A reassignment of participants out of the Principal AFORE will result in an after-tax write-down of present value of future profits, while participants that transfer in will not generate capitalized expenses. In January 2012, participants were transferred out of the Principal AFORE, generating an after-tax present value future profits write-off of approximately $5 million. Future revenue loss on these accounts will be partially offset by revenues from any future participants assigned to us. Individual Life fourth quarter operating earnings were $33 million. This was in line with the year ago quarter after adjusting fourth quarter 2010 for the impact of a one-time increase in net reserves following a periodic long-term interest rate assumption review. On a full year basis, Individual Life had record operating earnings of $119 million. Full year life sales of $186 million were up 13%, driven by nonqualified product offerings, as well as continued success in the business owner and executive solutions market. Turning to Specialty Benefits, fourth quarter operating earnings were $26 million, down $4 million from a favorable year ago quarter. Premium growth and stable claim experience were more than offset by lower variable investment income and higher security benefit cost in the current quarter. On a full year basis, Specialty Benefits earnings were up 5% on a 6% increase in premium fees. Additionally, on a full year basis, loss ratios remained very stable and at the midpoint of our targeted range. Our Specialty Benefits business continues to perform very well. The Corporate segment reported an operating loss of $43 million, driven by a shortfall in performance on an active credit strategy of approximately $13 million. The loss was primarily driven by the write-down of an MF Global bond. The active credit strategy provided a 4 1/4% annualized return since inception. However, we have completely wound this strategy down as of January 2012 due to the added volatility and the continued deployment of excess capital at the holding company in 2011. As we communicated on our guidance call, we expect full year 2012 operating losses for the Corporate segment of $120 million to $130 million. For the year, total company net income was $682 million, an increase of 2% over 2010. We also experienced $147 million of credit-related investment losses for the year, a continued downward trend to a multiyear low. The evolution of our business model means we now have a much higher portion of our earnings coming from less capital intensive, more fee-based businesses. As the low interest rate environment persists, our earnings will grow but at a slower rate, as shown in Slide 9. In addition to the items I previously mentioned that will impact 2012 results in Principal International and the Corporate segment, let me provide a brief update on the impact of deferred acquisition cost guidance that went into effect in January. We continue to refine our modeled impacts from the new guidance, and Slide 10 summarizes our updated estimates. While the 2012 total company earnings impact estimate remains at $35 million to $45 million, there is a slight shift in the business segment split. Moving to our balance sheet, our net unrealized capital gain position of $1.6 billion was unchanged from third quarter 2011. As a reminder, because of our strong asset liability management, changes in net unrealized gain or loss due to interest rate movement do not result in economic impact and do not force us to sell assets. In the fourth quarter, we completed a $100 million share buyback authorization, paid $215 million for our common stock dividend and closed on the Origin acquisition for approximately $60 million. Looking at capital adequacy, we estimate our year-end risk-based capital ratio to be 445%. Relative to a 350% RBC ratio, we have approximately $1.6 billion of total excess capital, with approximately $600 million of the excess capital at the holding company. As outlined in Slide 11, in 2011, we deployed more than $1.1 billion of capital. This includes $350 million for strategic acquisitions, $550 million for opportunistic share repurchase, and the common stock dividend I previously mentioned. We expect our 2012 capital deployment strategy to be very similar to 2011. We believe our decision to move to a quarterly common stock dividend and our overall capital deployment actions demonstrate our commitment to creating long-term value for shareholders. In closing, we are very pleased with the strong underlying fundamentals of our businesses as we look into 2012 and beyond. This concludes our prepared remarks. Operator, please open the call to questions.

[Operator:]

[Operator Instructions] Your first question comes from Randy Binner with FBR.

[Randy Binner:]

Just a question on ROA. The slides are helpful and the guidance is a little bit lower, the 24 to 26 basis points. I'm just trying to get a perspective on how that might get better or get worse in 2013. It seems like the -- of the 3 bullets you laid out in your presentation, the consumer shift, as well as a lot of your initiatives on retention and efficiency, thus far, it don't change as much or maybe the market would get better. I'm just trying to think about how we want to think about that ROA a little bit longer term.

[Larry Donald Zimpleman:]

Randy, this is Larry. I think what you said makes a lot of sense. I don't think we'll see quite as dramatic shift in some of those consumer-driven components. Probably, the one that will have a little bit more impact is that -- and it's a good news event and that's the reality that we are writing on a relative basis, more and more of the business on the mutual fund platform. And it has 2 impacts

[Randy Binner:]

And just a quick one on FSA as well, the number of cases, it kind of keeps falling and I think this had been a topic on previous calls, but the cases are larger. And is that just -- is that something we can expect to continue? Is that a function of less new business creation? Or is that something you're intentionally doing, maybe to take advantage of scale?

[Larry Donald Zimpleman:]

Yes, there is -- our intention, Randy, is to write small, medium and large-sized plans, write them in all categories. And if you actually look at the number of cases written in 2011, they were up 30% over 2010. And you remember, the assets that were written in 2011 were up 27%. So obviously, we're continuing to focus on the small plan, but I'll let Dan comment on the trend overall for the platform.

[Daniel J. Houston:]

Randy, it's certainly our intention to sell across the entire platform, small, medium and large. And with an 80% plus increase in TPA sales, that gives you some indication of our reemphasizing on the small case market. But a couple of stats relative to the startup plans and plan terminations. And again, this is a differentiation between not going to another service provider, but the plan terminated itself. What we've seen is start-ups are themselves are down by about 500 contracts on an annualized basis. And if we look at plan terms, those plan terms are still up by over 10% from a year ago. So most of the shrinkages occurred in that small, less than 500 life employer market. And until we start seeing the economy turn around and we see new startup plans and we see fewer plans terminating, we probably won't see a significant increase in that space.

[Operator:]

Next question is from Ed Spehar with Bank of America.

[Edward A. Spehar:]

The question I have is on the FSA ROA roll forward from 2004. And I guess if you -- could you give us some numbers around the pieces here? Like the general account shift, I mean, I would guess that might be 3 or 4 basis points of ROA. But maybe could you give us some sense of each of those pieces? And then a related question is, you mentioned the greater use of nonproprietary options as a factor behind the ROA decline. I thought that the impact to FSA margins was 0 if depending -- regardless of whether it was a proprietary or nonproprietary fund, and that the benefit of that was where you would see the benefit of a proprietary fund was in the PGI segment. So maybe help us understand that.

[Larry Donald Zimpleman:]

Yes. Ed, this is Larry. I'm going to make a couple of comments, then I'll let Terry kind of deal with that greater bucket about consumer driven. My comment on the nonproprietary, Ed, is really more focused around the issue on new business. The reality is that most of the time, when you write new business -- and the good news is we've been writing more than our fair share of new business, you're not going to drive as much proprietary assets into that new business initially. That's just the way it's worked for decades. And so as you write new business and you write greater volumes of new business on a nonproprietary platform, that will have some negative impact. It will have some degradation in the ROA. Now what happens over time, because of the expertise of our service staff and our relationship managers, we basically convert a lot of that nonproprietary money over to proprietary assets in Years 2, 3, 4, 5, 6 as the investment lineup is reviewed and changed. And as I said in my comment, the great thing here is that our investment performance across our proprietary platform, and particularly on PGI, is exceptionally strong. It's exceptionally strong. So we do believe that we'll see that help us and become more of a tailwind as we go forward. So I'll have Terry comment on the consumer-driven component.

[Terrance J. Lillis:]

Ed, this is Terry. As we look at the roll down of the ROA since 2004 to 2011, there's a lot of components that come into it. But mix of businesses, as the slides indicated, is probably our biggest driver of it now. I'm going to give you some metrics associated with each of these types of investment but you have to realize that these are revenues that are generated, expenses are allocated to it, the equity market and the DAC amortization, all that stuff that comes into play. But in general, the general account is probably the more profitable business because there are more risks associated with that type of investment and more capital associated with that as well. But that's probably in that 70, 75 basis points range would be a profitability. Separate accounts also have profitability associated with them of around 30 to 35 basis points. Now it is where most of the DRD or the dividend received deduction benefit is coming into play. And so that's why we separated that out. As that rolls down, that tax credit we get will probably be a little bit less. But 30 to 35 basis points would probably be a good profitability measure there. The proprietary funds and the nonproprietary funds, they, as you mentioned before, have similar profitability metrics. It also comes into play as to what types of investments that they're making, whether they are passive or active or they are international fixed income equity. All that comes into play. But roughly, we're talking 15 to 20 basis points of profitability for those types of businesses. And then the employer securities, which is more of a consulting relationship, where we'll be able to benefit as those participants cash out of their plan and retain them in other markets. That's probably in that 5 basis points. So if you weight those, you get roughly what we reported in terms of the ROA roll down in our slide deck as well. Now once again, as I mentioned, you got to take into consideration some noise. The equity market improvement or decline has some play as to how much DAC amortization, but that would get you roughly those numbers.

[Edward A. Spehar:]

Yes, that's extremely helpful. Just one -- did you say 15 to 20 or 15 to 25 on proprietary?

[Larry Donald Zimpleman:]

15 to 20.

[Edward A. Spehar:]

15 to 20. And the number that you -- I can't recall if you had said -- when you gave your outlook, I think maybe you did about expected capital deployment of $800 million to $900 million for this year. Did you comment on how much of that you consider to be just the free cash flow generated versus how much of it is working down on the on balance sheet?

[Larry Donald Zimpleman:]

Well, I would say, Ed, that the vast, vast majority is really just coming. If you will, it's basically net income. So the vast majority of that -- I mean, we -- again, we have excess capital of about $1.6 billion that we want to hold an internal cushion probably around $1.1 billion or $1.2 billion. So we'd have what we have considered to be somewhere around $400 million, $450 million of sort of truly excess cash. We'll work that down, but that will be down over multiple years. So for the most part, that represents the net income that we expect in 2012.

[Operator:]

Your next question comes from Mark Finkelstein with Evercore Partners.

[A. Mark Finkelstein:]

I've got a few. Firstly, just a follow-up on Ed's question. The difference between the annuity structure and the trust structure of 30 to 35 on the annuity and the 15 to 20 on the mutual fund structure, is that purely the DRD? Are there any other factors that's driving that change in profitability?

[Terrance J. Lillis:]

Mark, this is Terry. I'd say that's entirely the DRD at this point in time.

[A. Mark Finkelstein:]

Okay. And then a few other clarifications. Just -- I think you stated it in the presentation, but the 22 to 26 that you're looking at for 2015, that compares to the 27. That doesn't compare to the 24 to 26 that you're assuming for 2012 due to the DAC. Correct?

[Terrance J. Lillis:]

The lower number, the 22 to 26 is on a post-EITF basis. That's a reduction. So that would be down from that 27 basis points that we are saying at this point in time. It's probably a good run rate.

[A. Mark Finkelstein:]

Sorry, just to clarify. So the 22 to 26 is assuming that the EITF 09-G is implemented. So it does compare to the 24 to 26 that you're assuming for 2012.

[Terrance J. Lillis:]

The 22 to 26 is on the after DAC changes.

[Larry Donald Zimpleman:]

No, the 22 to 26, Mark, is done on the same consistent basis as the 27 in 2011. If you can see from the slide, the slide says all years on a pre-DAC change basis.

[A. Mark Finkelstein:]

Right.

[Larry Donald Zimpleman:]

Yes, okay.

[A. Mark Finkelstein:]

That was my interpretation. I just want to understand.

[Terrance J. Lillis:]

I apologize.

[Larry Donald Zimpleman:]

I agree.

[A. Mark Finkelstein:]

Okay. Just a couple of questions on that. Firstly, in the explanations, you have kind of the market impacts, which I think was a negative 3 basis points. In your 22 to 26, are you assuming any recovery in some of those factors, planned terminations, et cetera? Or are you kind of assuming that where we are today is what we're going to look like 3 years from now with no recovery from market factors?

[Larry Donald Zimpleman:]

I would say -- Mark, this is Larry -- it would be our best guess that whatever trends we kind of see sort of operating in the market today, which would be, again, generally speaking, sort of a slow economic recovery, those are the trends that we would be sort of looking at between now and 2015. So we're not assuming any particular rapid recovery. We're not assuming any particular significant fall in the economy. We're assuming it looks more like it does today.

[A. Mark Finkelstein:]

Okay. And then on the capital deployment, picking up something you actually said in your opening remarks, is there any change in your thinking between M&A and buybacks in the $800 million to $900 million that's not allocated to dividends?

[Larry Donald Zimpleman:]

I wouldn't say there's any change in thinking, Randy (sic) [Mark], but the one thing that I always say is that M&A is very, very, very difficult to forecast. It's just very, very difficult to forecast. So when you'd say to anybody who sits in my seat, "How much do you expect to deploy of that $800 million to $900 million, how much do you expect to deploy in M&A for the year?" I mean, that would literally just be throwing a dart at the wall because you really don't know. What I would say is that we have a strategy that has probably the highest level of organic growth embedded into it. If anybody -- any of our competitors, whether it's on the insurance side or the asset management side. So for us, M&A needs to be the right M&A. It needs to be accretive. It needs to further augment our growth capability. And I would just say again, the real success for us in 2011, among other things, were the 3 acquisitions that we did. And if we could do that every year, I would be a very, very happy CEO.

[A. Mark Finkelstein:]

Okay. Actually, just one final quick question. In the expectations around 2015 of 22 to 26, what's the assumed AUM growth annually?

[Larry Donald Zimpleman:]

Well, you'd have -- again, generally, Randy (sic) [Mark], what you'd have there would be about 8% equity market growth. You've got some of it in fixed income. So it's not going to grow as fast. You've got a little bit of it in international. It might grow at 9%. And then again, we'd probably be looking at net cash flow, about 4% of beginning account value. That would get you to your total AUM growth.

[Operator:]

Your next question comes from Suneet Kamath with Sanford Bernstein.

[Suneet Kamath:]

Just one quick follow-up to Mark's question and I'll have another one -- excuse me. So looking at Slide 8 in the illustration for 20 to 25, as well as the title that says, "pre DAC," given there seems to be this 2 basis point reduction from the DAC accounting change, if we did it on a sort of post-DAC basis, is the 22 to 26 really 20 to 24?

[Larry Donald Zimpleman:]

Correct.

[Suneet Kamath:]

Okay. And then I guess the other thing that I'm sort of struggling with -- and I appreciate the detail on the slides. But the other thing I'm struggling with is, if you look at this business from 2004 to 2011, you had, I don't know, 84% growth in average account values just using the numbers that are on your slide. So I'm just wondering why this business, why we're not seeing -- in addition to all the issues that you laid out that are resulting in a decline in the ROA, why we're not seeing massive positive operating leverage?

[Larry Donald Zimpleman:]

Yes. Suneet, this is Larry, and I'll ask Dan to comment as well. We are driving positive operating leverage into the business. As we've shown you on the slide, we think that we've driven somewhere around 4 basis points net, 4 basis points net of efficiency that there are truly scale advantages to this business. And we've commented before about how, in the recent years, we've added very, very -- actually sort of the net employee count is actually down a little bit, but we've obviously been adding business. But one thing I would say here though, just to kind of temper that enthusiasm because there are economies of scale, but at the same time, Suneet, it is absolutely critical that we continue to invest in this business. And that means investing in distribution. It means investing in the IT platform. It means investing to make sure we have the right asset management of things in place. So we will continue to invest in this business because it is critical for the long-term success. So we have to balance that. We have to balance the need to drive operational efficiency and scale, but we also have to invest in the business. And I think, again -- actually, again, net-net on a 4 basis points over the last 7 years, that's actually a pretty good record. But maybe I'll let Dan comment.

[Daniel J. Houston:]

Yes, well said. So you set aside those consumer-driven issues and the market impact. I'm very optimistic that as the economy continues to recover here, we'll get those market, environmental component back into our operating earnings leverage. If you just look at the overall contribution that investments would have contributed to net cash flow this past year, it was -- or to our account values, it was 0. That was the overall contribution that we derived from the investment from this $1 billion -- $100 billion plus platform. The other piece of what I would call very good news comes from Chatham, and it's, "Alright, you've reduced your expense structure. You've made some investments. Are your clients satisfied?" Among our emerging clients that we surveyed recently, we had 96% satisfaction. We look at our dynamic, where Principal is 42% above the industry benchmark. When you look at institutional, we were 36% above the industry benchmark. Overall satisfaction is 97% for institutional and dynamic. So not only are we becoming more efficient, not only are we launching new products, but we're retaining customers at very record levels. So I feel as if we are establishing a very solid base here for our ability to continue to be truly one of the nation's leading providers of these retirement services to small to medium-sized businesses. Hopefully, that helps.

[Suneet Kamath:]

Yes, that's great. Just one last quick follow-up. On Slide 8 again, on this ROA versus ROE trade off for FSA, given your commentary, what was the rough ROE of this business in 2004 given versus where it is today?

[Larry Donald Zimpleman:]

I'll ask Terry.

[Terrance J. Lillis:]

Yes. Suneet, this is Terry. The -- in 2004, that business had a much more capital intensive because of the general account mix. So it was probably just slightly below the net 20% range. And so it's now plus -- 25-plus percent. So as that ROA has declined, it's freed up capital, less capital intensive businesses, and you've seen the ROE increase significantly as well.

[Operator:]

Your next question comes from Steven Schwartz with Raymond James.

[Steven D. Schwartz:]

One more on Page 8. Given what we're looking at here in terms of the return on assets, and particularly the proposed DAC, I don't think this was touched upon -- maybe I missed it. But the ability to take cash out, you've been at 60, 65 for a while. You've got up to around 70 now. If you're looking at just 2015 and this works out the way that you think, how much money do you think you can get out? What kind of percent?

[Larry Donald Zimpleman:]

Oh, you're talking -- I'm sorry. Steve, this is Larry. You're talking about the percent of asset -- the percent of the earnings that can be passed through to free cash flow?

[Steven D. Schwartz:]

Yes, that would be right.

[Larry Donald Zimpleman:]

Yes. So I'm sorry. So again, today, my guess is that we'll continue to be able to increase that. I mean, maybe it's in the range of 1 to 2 percentage points every year. So that sort of 65 becomes 67 in a couple of years, becomes 70 in couple of years. That sort of rate.

[Steven D. Schwartz:]

Okay, great. And then if I can, just on a comment, I think, Larry, you mentioned that FSA pipeline was up 25% year-over-year. Does that imply that we could be looking at a 25% increase in sales for the first quarter?

[Larry Donald Zimpleman:]

I'll let Dan take that one, Steve.

[Daniel J. Houston:]

Yes. Knowing that many of our members of the sales force are listening to the call, yes, absolutely. We do like to think that we can convert our pipeline to sales, but you know how this goes. We don't -- we're not 100% successful. We feel good about the pipeline for a couple of different reasons

[Larry Donald Zimpleman:]

I would just say, Steve, it isn't like that to get a very solid sales result in Q4, we had to clean up the pipeline. Let's just say it that way.

[Steven D. Schwartz:]

Okay, good. And then if I may, one kind of out of the blue, there was -- I think it was an investor. It was one of the trade reps. China, is something going on in the pension market in China? It looked like they might be going to some voluntary individual type of pension plan. Could you comment on that?

[Larry Donald Zimpleman:]

I'm going to let Norman comment on that one. He's been Mr. China here for several years. So Norman, take that one.

[Norman R. Sorensen:]

Basically, what's been happening since 2005 is the Chinese government has established something called enterprise annuity, which is a clone of 401(k), but it doesn't have the tax advantages that 401(k) has in the U.S. So they've been perfecting this. So far, foreign companies have not been allowed. We are first in line for this, and our application stands back to about 2007. So we're very hopeful that sooner than later, we'll get approval to enter that market with a license for the enterprise annuity. By the way, it's not an annuity. It's a misnomer. It is really a 401(k) type plan. We have enormous confidence that, that market will be very, very large. And not only us, but a number of American companies will benefit from it.

[Steven D. Schwartz:]

So there's nothing new going on. It's just the same process that's been going on now for quite a while.

[Larry Donald Zimpleman:]

That's correct.

[Norman R. Sorensen:]

The process is underway, but they're perfecting it. For example, they're beginning to add some tax advantages to the thing. They see that employees will not contribute as much unless they have tax advantages. So the tax department is working on this. It's a whole roundabout of many -- various ministries that are trying to perfect this system. The key to us, to it obviously, is our entry. We need to get entry first since no foreign company has yet been allowed.

[Operator:]

Our next question is from Chris Giovanni with Goldman Sachs.

[Christopher Giovanni:]

First question, in terms of we're seeing some better payroll data, small and medium-sized business data is finally showing a bit more momentum at least, sort of the best since '08. So, curious in terms of how we should think about the potential benefit to sales and flows, if this persists, and then ultimately, what that should imply from an ROA and ROE standpoint, things flowing through the bottom line.

[Larry Donald Zimpleman:]

Okay, well, I'll make a few comments on that. I think we'd said, going into 2011, Chris, as you remember, we expected to have sort of a muted economic recovery and we talked, for example, for full service accum, we talked about net cash flow that was in the 3% to 5% range. I would say, as you know, when things are sort of hitting on all cylinders relative to the economy and small and medium employers and we get the startup plans that Dan was talking about before, we'd expect that net cash flow to be more in that 4% to 6% of beginning account value range. So we're sort of 2/3, 3/4 of the way back towards what might be normal under the old conditions. I don't know if we'll get there exactly in 2012. It does look like we're inching closer to that. But whether we'll see that consistent growth in 2012, I don't know. My own personal view is that we've got to deal with some of the longer term and more systemic sort of budget issues. And we may need to think a little bit more about tax reform before we finally see that uncertainty, which has been sort of hanging over the American economy for some time. In terms of ROAs and ROEs and all of that, again, what I would just caution you about there is that again, with the change in EITF, you're going to see some negative impact on those ROAs. And the other thing, again, we're writing more and more the business on a mutual fund platform that doesn't allow any sort of DAC. So it looks less profitable in the early years, and more and more of the business are going on that platform. So that one is a little bit harder to predict. Anything else, Dan?

[Daniel J. Houston:]

No. The only thing I was going to throw out is we're just trying to test the markets for the economic recovery. We know that we track in our Specialty Benefits division the number of workers covered in our life and disability and dental businesses and for the first time now, we have a full trailing 12 months positive growth. It's not up to where it has historically been at that 1.5% growth per year, but it's now turning positive. So again, we feel good that there is employment growth returning to the small to medium-sized marketplace.

[Christopher Giovanni:]

Okay. And then just a follow-up then in terms of the competitive landscape. There's been the finalization of the Fee Disclosure Act that came out yesterday. There's been a lot basically saying that if you're a small business, now is the time to really be shopping 401(k) plans because you're seeing a lot of sort of new entries, Vanguard's coming out with sort of a low -- another low-cost feature. So there's been a lot of sort of pressure around continued shopping. So I'm curious in terms of what you guys are seeing there, potential opportunities and risks from the recent environment.

[Larry Donald Zimpleman:]

Sure. That's a good question. I'll let Dan comment.

[Daniel J. Houston:]

Chris, this isn't something that happened just this week or just this year. This has been going on for the last several years. All the advisers are out there, doing their jobs with their respective companies and they've put these plans out to bid. We see the fee disclosure frankly as a very positive move overall. It gives us an opportunity to clearly articulate our value proposition. It resonates with the advisers. It resonates with the plan sponsors. And then another note relative to an article earlier in the week about passive investment options and what's the implication on Principal, we have already in excess of $15 billion of passive investment options on our platform. About 24,500 of our plans, call it mid-30,000 some-odd plans, already have a passive investment option, and we have 6 passive options available to our clients. So we don't see that this is a pivotal event then all of a sudden the money migrates towards passive. And frankly, investment return for active managers like Principal Global Investors has really improved here in the last 12 months and we feel very good about getting out and not only talking about fee disclosure, but talking about TRS, talking about TPAs and option and profiling again so many of these new investment options that we have available to our customers through our relationship managers and our customer service associates that are deployed locally.

[Operator:]

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

[Larry Donald Zimpleman:]

Well, thanks again to all of you for joining us today. We're excited about 2012 when we entered the year with good momentum across all our businesses. Our financial position remains very strong and with excess capital of $1.6 billion, we look forward to the opportunities that are in front of us. Hopefully, everybody has a great day. Thanks for listening.

[Operator:]

Thank you for participating in today's conference call. This call will be available for replay beginning approximately 8 p.m. Eastern Time until the end of the day, February 10, 2012. 39011663 is the access code for the replay. The number to dial for the replay is [phone] for U.S. and Canada callers or [phone] for international callers.