May 6, 2008
Executives
Tom Graf - Senior Vice President, Investor Relations Barry Griswell - Chairman Larry Zimpleman - Chief Operating Officer Mike Gersie - Chief Financial Officer John Aschenbrenner - President, Life and Health Insurance Segment Jim McCaughan - President, Global Asset Management Julia Lawler - Chief Investment Officer
Analysts
Tom Kilmokie - Goldman Sachs Eric Berg - Lehman Brothers Suneet Kamath - Sanford Bernstein Steven Schwartz - Raymond James & Associates Ed Spehar - Merrill Lynch Tom Gallagher with Credit Suisse Tamara Kravec - Banc of America Jeff Schuman - KBW Dan Johnson - Citadel Investments
Operator
Good morning and welcome to the Principal Financial Group First Quarter 2008 Conference Call. There will be a question-and-answer period after the speakers have completed their remarks.
(Operator Instructions). I would now like to turn the conference over to Tom Graf, Senior Vice President of Investor Relations.
Tom Graf - Senior Vice President, Investor Relations
Thank you. Good morning and welcome to the Principal Financial Group’s quarterly conference call.
If you don’t already have a copy, the earnings release, financial supplement and additional information on the company’s investment portfolio, can be found on our website at www.principal.com/investor. Following our reading of the Safe Harbor Provision, Chairman, Barry Griswell; Chief Operating Officer, Larry Zimpleman; and Chief Financial Officer, Mike Gersie will deliver some prepared remarks.
Then we’ll open up for questions. Others available for the Q&A are: Division Presidents, John Aschenbrenner, responsible for the Life and Health Insurance segment, and Jim McCaughan, responsible for Global Asset Management; and Julia Lawler, Chief Investment Officer.
Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events, or changes in strategy.
Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company’s most recent annual report on Form 10-K filed by the company with the Securities and Exchange Commission. Barry?
Barry Griswell - Chairman
Thanks, Tom, and welcome to everyone on the call. As you know effective May 1, Larry Zimpleman assumed the role of CEO.
As such this will be my last earnings call. I will focus my opening comments not on the quarter but rather on the leadership team taking this company forward.
Larry and Mike Gersie will follow my remarks with an overview of the quarter and some color on execution of our growth strategy. Since our IPO in 2001, we have communicated our performance and progress in three key areas: continuing growth in our US and international accumulation businesses, leveraging our Global Asset Management expertise and profitably growing our Life and Health insurance businesses.
The team taking us forward is the same team that has led the day-to-day operations of this organization and delivered strong performance since we went public. I will start with some accomplishments of three individuals whose leadership has been instrumental in driving strong growth in our US and international accumulation businesses; Larry Zimpleman, Dan Houston, who recently was named President of our US Asset Accumulation segment and Norman Sorensen, CEO of Principal International who we recently promoted to Executive Vice President.
Larry and Dan along with our outstanding retirement sales team have submitted the Principal’s leadership in the US retirement industry driving full service accumulation account values to nearly $100 billion and capturing the number one position by plans in bundle 401(k), defined benefit non-qualified and ESOP. Larry and Norman have taken Principal International from a loss in 2001 to more than a $100 million of earnings in 2007 with more than $30 billion in assets under management as of quarter end and top five positions in most of its markets.
Moving to Global Asset Management, under Jim McCaughan’s leadership, we have seen third party assets under management increase nearly $80 billion or 980%, reflecting top tier investment performance, expansion of investment capabilities, strong sales force build up and an outstanding job managing and maximizing acquisitions. Our asset management and asset accumulation businesses have been strong partners with Principal Global Investors managing more than 60% of full service accumulation account values reflecting competitive performance and strong product innovation.
While 2007 was a difficult year for the Life and Health segment, under John Aschenbrenner’s leadership, the team has achieved solid earnings growth, turned the specialty benefits division into a top player for non-medical coverage and transformed individual life into a leading provider of business focus solutions. On a related note, I would like to thank Carey Jury for his years of dedication and service.
Carey retired last month as Head of the Health Division. I would also like to welcome his replacement, Dave Shafer, who brings more than 20 years of healthcare industry experience to the job.
We have a deep and experienced management team, I don’t have time to cover each of them but I will now mention one other, Julia Lawler, whom you know from our investor day and quarterly earnings calls. Julia has enabled us to navigate through some extremely difficult market conditions, maintaining a high quality, well diversified investment portfolio.
While I am proud of the results that Principal has delivered under my tenure as CEO, I am even more proud of the investments we have made along the way to ensure strong growth into the future. We have a great strategy.
Importantly, it’s coupled with a great management team and a great group of employees who are executing on it each and every day. I truly believe the best days for this company are yet to come.
With that, let me turn it over to Larry.
Larry Zimpleman - Chief Operating Officer
Thanks Barry for your words of support and for your vision, dedication and hard work over the course of 20 years with the Principal. Because of your leadership, we are positioned to capitalize on the opportunities and face the challenges that are ahead.
Before I begin my overview, a brief comment on first quarter’s difficult operating environment. Capital market declines were severe including a 9.9% drop in the S&P 500 index.
And the CMBS market experienced unprecedented stress as a result of the general credit crisis. So, while the results for the quarter were below our long term annual earnings per share growth target of 11 to 13%, we have used 6% earnings per share growth as a very solid result and one that demonstrates the benefit of having a diverse stream of earnings.
Importantly, we were very pleased with the number of key growth indicators, measures we believe demonstrate our competitive strengths and our ability to deliver on earnings per share and ROE goals over the long term. Starting with the US asset accumulation segment, full service accumulation delivered record sales of $3.5 billion, an increase of 57% compared to the year ago quarter.
Two key factors are driving our continued sales success. The advantage we have in the marketplace with Total Retirement Suite and our increasing momentum with distribution alliances.
In the first quarter, Total Retirement Suite made up 67% of sales based on assets. Alliance sales were up nearly 150% from a year ago to $2.2 billion.
With gross pipeline of 18% from year ago, we remain highly optimistic about our outlook for full year sales. Strong sales coupled with strong retention drove full service accumulation net cash flows to a record $3 billion, an improvement of 126%.
Deposits were up 37% from a year ago. By comparison, withdrawals increased only 6% on 12% higher beginning of year account values.
While declining equity markets contribute to lower average account balances and therefore lower withdrawals, this was nonetheless a tremendous quarter of retention with contract and member level withdrawals of less than 4% combined. This was also another good quarter for retention of plan and participant assets at risk due to retirement or job change.
We retained more than $500 million in the first quarter into mutual fund, individual annuity and bank products demonstrating the strength of our asset retention capabilities and the depth and breadth of our retail rollover solutions. We also captured $310 million of additional assets in the first quarter between participants rolling other retirement plan assets into their Principal administrative plan and moving other assets into Principal’s retail offering.
In light of accelerating boomer retirements we continue to invest heavily in building long term relationships with planned participants. Working with advisors and using our Retire Secure in Principal connection resources that investment is clearly paying off.
Individual annuities delivered a similarly strong result in terms of sales and net cash flows. Sales more than doubled from a year ago reflecting increased penetration across multiple distribution channels and continued success with a fixed deferred annuity product we launched in the middle of 2007.
Withdrawals have remained stable in absolute terms but have declined as a percent beginning of year account values from 3.3% a year ago to 2.6% for first quarter 2008. Moving to Principal Funds we characterize sales and net cash flows for the quarter as solid with signs of improvement in the national channel.
Across the industry, sales have slowed and redemption rates have increased, the result of volatile markets. To add some perspective, compared to first quarter 2007, industry cash flows are down $120 billion or 87%.
As disclosed in our financial supplement mutual fund account values are down from year end. Equity market declines drove $2.5 billion of the reduction.
We also had an outflow of $1.25 billion attributable to a single shareholder, Washington Mutual, which is shown on the other line of the account value roll forward. In spite of continued strong fund performance Washington Mutual elected to change investment options within their 401K plan.
While we were very disappointed this outflow was one we had built into our acquisition plan WM advisors. Because of fund were removed right at quarter end there was no impact on first quarter 2008 operating earnings.
Going forward this will reduce Principal Funds earnings by about $1 million per quarter. A couple of additional comments on the progress and direction of the mutual funds business, regarding our wholesale platform we continue to make good progress identifying and filling open territories and retaining existing resources.
Our proprietary channels continue to show increased interest in an increased sales of our expanded array of funds and we are investing in resources to support their efforts. As discussed last quarter we made tremendous progress getting our funds approved for sale on firms top tier research platforms.
As you know it takes time to translate shelf space into sales. We are making progress broadly and in some cases such as our offering of preferred securities seeing meaningful sales momentum on a number of platforms.
Moving to Global Asset Management the first quarter was a period of continued strong investment performance. 64%, 76% and 72% of the retirement plan separate accounts managed by Principal Global investors ranked in the top two Morningstar quartiles for the one, three and five year periods respectively at quarter end.
Reflecting that strong performance Principal Global Investors was awarded more than $5 billion of non-affiliated assets to manage during the quarter. First quarter net cash flow was worth $3.4 billion contributing to nearly $15 billion of net cash flows over the trailing 12 months.
In spite of significant equity market declines Principal Global Investors’ fee mandate business continued to perform well with 13% growth in earnings. However, volatile conditions in the global credit markets which in turn impacted the CMBS market drove losses in the spread and securitization business.
As a reminder we are a 49% owner in the securitization business. We start to originating loans in November 2007 and to minimize the risk of further mark-to-market losses, since year end we reduced loan inventory by approximately two-thirds to about $540 million.
We have accomplished this reduction due to the very high quality of our portfolio. In light of recent transactions we are confident our marks are consistent with the view of values of potential buyers in the marketplace.
As such, we now believe that over the remaining three quarters of 2008 spread and securitization business will come in at or near breakeven. All this said, for the full year we expect Principal Global Investors’ earnings to come in around $95 million, this incorporates our expectation for continued double digit earnings growth from the fee mandate business reflecting our increasing emphasis on this key growth engine.
Returning to the point of earnings diversification, Principal International delivered its second best earnings quarter as did Life and Health. Principal International’s strong earnings reflect significant growth in assets under management, which are up 37% from a year ago to a record $30 billion with 43% growth in Latin America and 28% growth in Asia.
Net cash flows continue to be strong as well at $730 million for the quarter or 2.5% beginning of year assets. Based on normalized earnings Principal International’s return on equity is just under 10%, this segment remains on track to achieve a new target established at year end, sustainable return on equity of about 11% by 2010.
First quarter was a period of solid earnings improvement for the Life and Health segment even after adjusting for favorable reserve developments benefiting first quarter 2008 results and other items impacting comparability, which Mike will discuss. At 15.9% return on equity specialty benefits continues to operate at desired profitability levels.
Premiums and fees were up 5% compared to the year ago quarter as the division maintained pricing discipline in difficult economic conditions and a highly competitive market. Expense management remains sound and we are working on a number of initiatives to continue driving sustainable profitable growth for the division.
Individual life division continues to build sales momentum across a broad spectrum of products including 18% growth from a year ago for our non-qualified offering, one of the 4 pillars of Total Retirement Suite. First year and single premiums and deposits are up 48% for the division, reflecting solid performance from the career channel and increasing momentum with new independent distribution relationships.
The health division posted strong first quarter earnings even after adjusting for the development of 2007 year end claims. Return on equity improved to 12.8%, in light of first quarter’s results we now expect the division to earn between $45 million and $55 million for the year on a reported basis.
Our strategy for growing covered members is highly focused on local markets, analyzing conditions to identify availability of better network discounts and Principal specific provider contracts. We are also highly focused on claims and expense management, which contribute to improving our overall price competitiveness.
While I return to membership growth and a sustainable return on equity of 15% is a multi-year process, I’d reiterate the longer term opportunities for the division. In consumer driven healthcare, health savings accounts and wellness and our belief that we have the expertise to capitalize on these trends in both the insured medical and fee for service businesses.
Mike?
Mike Gersie - Chief Financial Officer
Thanks Larry. This morning I’ll spend a few minutes providing financial detail for each of our four operating segments including items impacting comparability between periods.
I will start with US asset accumulation, segment account values are up $6.8 billion or 4% from a year ago to $175 billion at quarter end. Well, segment earnings decreased $16 million or 10%, also this accumulation mutual funds and individual annuities made up the vast majority of the change in account values and earnings for the segment.
That’s where I’ll focus my remarks starting with a high level comment and the impact of recent market performance. Debt markets performed in first quarter 2008 consistent with our 2% per quarter assumption, full service accumulation would have ended the quarter with an additional $8 plus billion of account values, in the mutual fund business with an initial $3 plus billion.
The sharp drop in markets has significantly impacted revenues and this revenue decline occurred at a time when we were increasing our strategic investments. In Retire Secure, asset retention and retirement income management in full service accumulation business and an expanding investment offerings and ramping up distribution in the funds business.
During the first quarter, we initiated a corporate wide expense reduction effort to offset a significant portion of the impact of revenue decline. These efforts helped but did not totally eliminate pressure on new term earnings.
Well, we absolutely committed to aligning expenses with revenues over the long term. We believe doing so, demands are measured thoughtful approach.
Should weak markets persist over, we will respond accordingly. That said we continue to make ongoing investments, we believe are needed drive strong sales growth and outstanding customer retention over the long term.
Moving to my detailed review, at $68 million in the first quarter full service accumulation earnings were down $14 million or 17% from a year ago and a 7% increase in mean account values. As communicated in our press release, several items impact that comparability between periods.
First quarter 2007 earnings benefited $6 million in total from tax and reserve true ups. First quarter 2008 earnings were dampened by $10 million in total due to a change from a year ago in the mix of investments in 401K plans, lower income tax benefits and the impact of declining interest rates on market value adjustments and customer withdrawals.
Some of these items are market driven and more temporary in nature as previously communicated. Changes in business mix are affecting return on account values by impacting revenue collections and tax benefits.
In 2007, excluding the large deferred acquisition cost adjustment in the third quarter, our return in account values was 34 basis points. Given investments in our business and changes to our mix, we believe 30 to 32 basis points is a better range over the next several years.
Clearly though we’d expect to be above and below it on a regular basis to do normal business and economic fluctuations. Importantly, we expect the positive impact on return on equity over the long term, because the change in business mix has been through our products that require a less equity.
Before I move to Principal Funds, I will briefly discuss full service accumulation, deferred policy acquisition cost amortization expense, specifically, why expense is down from a year ago. As you know, we review experience each quarter and a number of components can contribute to the associated true up.
As expected the severe drop in equity markets in the first quarter 2008, did result in an increase to amortization expense approximately $10 million. However, our review also identified favorable experience adjustments relative to revenue and lapse assumptions, which resulted in an offsetting decrease to amortization expense of approximately $12 million.
Moving to Principal Funds at $8 million in the first quarter, earnings were down nearly $4 million from a year ago and essentially flat account values. There are several pass through items that have no net effect on earnings for the business, but impact fee revenue, commission expense, and other expense lines.
Excluding those items, fee revenues are down about $2.5 million from a year ago and other expenses are up about $3.5 million. The decline in revenues, reflect recent changes to mix with fund investors moving assets into lower fee investments.
The increase in expenses reflects build up of infrastructure to support our growth expectations for the business as well as ongoing investment. As always with all of our businesses we continue to keep a close eye on expenses relative to revenue.
Moving to individual annuities at $17 million, earnings were up 6% from a year ago. Several items dampened first quarter 2008 earnings, one dampen first quarter of 2007.
In the current quarter, between a guaranteed minimum withdrawal benefit reserved true up and lower than normal investment prepayments earnings were dampened by about $3 million after tax. We also had some minor spread compression, which reduced current quarter earnings by about a $1 million.
First quarter 2007 earnings were dampened by about $1.5 million due to asset liability derivative mark-to-market changes. After adjusting for items in both periods, earnings were up about 19% compared to a 22% increase in average account values.
At $3 million in the first quarter, Principal Global Investors’ earnings compared to $24 million a year ago. Fee mandate business earnings were $19 million in the first quarter of 2008, an increase of 13%.
Higher fee mandate earnings were offset by losses in the spread and securitization business reflecting unprecedented volatility in global credit markets and its impact on commercial mortgage backed securities market. The spread and securitization business lost $16 million in the first quarter 2008, compared to $7 million of earnings in the first quarter of 2007, due to volatility of spreads and the resulting mark-to-market losses and the commercial mortgage loan inventory held in the CMBS joint venture.
Moving to International Asset Management accumulation, first quarter earnings were up 64% from a year ago. The improvement primarily reflects continued strong asset under management growth and operational efficiencies.
It also reflects a benefit of $6 million after tax due to favorable currency exchange rates and an unusually high first quarter inflation in Chile, which increased our yield and inflation linked assets. At $79 million first quarter earnings were up $34 million from a year ago for the Life and Health segment.
Trailing 12 months return on invested capital improved 80 basis points from a year ago to a 12.5%. Individual life earnings were $21 million compared to $15 million a year ago.
The increase from the year ago reflects returned to more normal lapses in death claims and growth in the block of business. As Larry indicated, at $35 million, this was a strong earnings quarter for the health division.
First quarter 2008 earnings were positively impacted by $7 million due to a favorable development at year end 2007 claims. First quarter 2007 earnings of $12 million were negatively impacted by $15 million due to unfavorable development at year end 2006 claims.
When thinking about the remainder of the year, keep in mind that the accounting treatment of high deductible health plans typically results in the highest level of earnings in the first quarter, moderate earnings in the second and third quarters and losses in the fourth quarter. Specialty benefits earnings were $24 million, an increase of $6 million from the first quarter of 2007.
The increase reflects growth in the business and a favorable reserve adjustment in the individual disability line of $4 million after tax. I would also remind you that all three Life and Health divisions return to capital to corporate during 2007, resulting in lower earnings from investment income in the current quarter of $3 million after tax.
Let me also comment briefly on our net realized, unrealized capital losses for the quarter. In first quarter 2008 we recognized $75 million of capital losses through the income statement, which includes $29 million of losses related to impairments of fixed maturity securities, including $7 million related to subprime.
$16 million in impairments and equity securities and unrealized capital losses of $22 million primarily mark-to-market of credit default swaps. Given the volatility of credit markets predominantly driven by technicals, we view this level of losses as reasonable.
Also reflecting tremendous market volatility we recognized through the balance sheet approximately $840 million of net unrealized losses net of debt and tax. These losses were included in other comprehensive income because we believe the recent declines in market value are temporary that the fundamentals are not being reflected in the values of these assets and that we have the intent and ability to hold them until they recover.
Our policy does not include bright line test but rather a rigorous process to access abeyance ability to perform. In light of the magnitude of net unrealized losses this quarter we posted a breakdown of gains and losses by sector on our website.
Due to an ongoing investor interest in our exposure to certain investments we posed on our website some additional detail on commercial mortgages and CMBS as well. I’ll comment specifically on why we are comfortable with our commercial mortgage loan and commercial mortgage backed securities holding.
Regarding commercial mortgages 90% occupancy, 58% loan to value and 1.9 times interest coverage, we are extremely comfortable with our portfolio. Even in a slowing economy we have tremendous amount of cushion.
Regarding our CMBS holdings, delinquencies in the underlying mortgages were [5,800] of 1% through March. When we apply our recession scenario, the cumulative default rate increases to 12%, which would produce losses of less than $30 million over the life of the portfolio.
The current pricing reflected in our unrealized loss figure implies cumulative losses four to five times greater than our recession scenario. I would emphasize a couple of additional key points.
Market pricing does not reflect current or expected fundamental performance. In fact, we saw a $70 million improvement in values of our CMBS portfolio just in the month of April.
And as a leading real estate asset manager, he is our strong technical expertise to review the underlying loans in the CMBS pool and assess the quality before investing as well as on an ongoing basis. Given the high quality of our holdings in the large amount of subordination to take first losses, our CMBS portfolio stand a significant increase in delinquencies from today’s level and still perform well.
To wrap up my comments let me quickly cover capital. At quarter end we were basically at the level required by the rating agencies and have a modest amount of debt capacity.
Today we have completed half of the board’s November 2007 $500 million repurchase authorization. As always, we will continue to look for ways to optimize our capital structure and effectively use capital to build value for our shareholders.
This concludes our prepared remarks and I would now ask the conference call operator to open the call to questions.
Operator
(Operator instructions). Your first question is from Tom Kilmokie with Goldman Sachs.
Tom Kilmokie
Hi, good morning. Just a couple of quick questions, I guess number one you talked about capital little bit and I just wanted to kind of understand a little bit how that impacted your decision apparently not to buyback any stock during the first quarter when it averaged $58 and in ’07, you were relatively aggressive buying it back at closer to $66 bucks a share and even -- so I am just a little bit, I want to get some little bit more clarity on your buyback and then I could follow up with another question?
Barry Griswell
Well, good morning Tom. This is Barry, we will let Mike maybe chime in.
but I think I would answer that it’s primarily amount of capital we had and we don’t normally try to buy shares back opportunistically based on share price, we typically have an authorization and we often use a 10b5 and go out into the market. So, it really was related more to our capital adequacy and the volatility in the markets to make sure that we are being prudent and more so than the stock price.
Mike you want to add.
Mike Gersie
I think that is right, Barry. I think the other thing you have to remember is this organization generates a lot of free cash so as we look out over the remainder of the year I think as we said in the past roughly half of our operating earnings, organic growth the rest can be used for either dividends or share repurchase or acquisitions.
So, I think we have got adequate capital resources but as Barry said I think we like other companies are keeping a little bit of dry powder given all the volatility in the markets.
Tom Kilmokie
Okay. So, we should expect in the balance of the year that you would pick up a little bit on the share buyback?
Barry Griswell
I think it will be premature or for me to indicate but that certainly a possibility.
Tom Kilmokie
Okay. And that if I can just follow up sorry I apologize if this is well known to people.
But, just that you can just review the group life, why you end up having the loss in the fourth quarter and the coming issues that drive help that in the health business?
Barry Griswell
I am sorry.
Tom Kilmokie
In the health business I think you were mentioning third and fourth, second and third quarter all to be relatively positive and the fourth quarter a loss?
Barry Griswell
Sure, Tom we will cover that very briefly. John.
John Aschenbrenner
Yeah, Tom. Basically as we get more and more business under high deductible health plans, the accounting would have reflect those claims in the quarter that they are incurred.
And so, you are going to have lower health claims in the first quarter when the deductible hasn’t been satisfied yet and you are going to have much higher health claims in the fourth quarter after the deductible is fully satisfied.
Tom Kilmokie
Got you. Okay, that makes sense.
Alright thank you.
Barry Griswell
Thanks Tom.
Operator
Your next question is from Eric Berg with Lehman Brothers.
Eric Berg
Thanks very much and good morning. My question concerns to securitization business well I realize you have paired back your exposure significantly in the warehouse and perhaps that is a big reason why you are more confident than you have been or you continue to be confident that this business will breakeven prospectively, I think you told us this in the past and yet we had a noticeable loss in the quarter.
My question if you thought you had a handle on it first time and things turned out to be materially different from what you expected, why should we have confidence now that your forecast will be reasonable? Thank you.
Barry Griswell
Thanks Eric and good morning. I think I will let Jim –
Eric Berg
Thank you Barry.
Barry Griswell
Jim?
Jim McCaughan
Yeah, Barry. It’s true that the last earning call we indicated the expectation the business could breakeven for the rest of the year.
What we didn’t know and nobody knew at that time was the extreme credit market disruption in March and in particular the very large moves and spreads over the Bear Stearns weekend in the middle of March and as you know the securitization inventory is daily mark-to-market and during that period the CMBS prices went down so much that it was marked right to whole loan prices, which meant that the hedging effect really went away. So, the extreme disruption that was the hedging got disrupted and you know that was an extraordinary event and absent such an extraordinary event we are pretty confident that we can manage with hedging and with a much lower inventory.
As I think was pointed out during the prepared remarks at the end of April the inventory in the joint venture and remember 49% of business attributable to Principal stake the inventory in the joint venture was down to $540 million from $1.7 billion at the beginning of the year. The reduction reflects the very high quality well under written loans that have been in that inventory and we have seen very good demand both from some securitization where we securitize over 600 million in February and also from whole loan buyers.
So, we are seeing very good demand for the little ones and while not under pressure we feel pretty confident that we can keep this inventory at a pretty low level and hedge it effectively absent any extreme disruption of the type that we saw in mid March.
Barry Griswell
And Eric I would just add that this a business we are committed to, we think this will come back and be a very profitable business force in the future. So, for our way I think this is not the time to discontinue the business or get out of it.
Good days are ahead in this business we believe.
Eric Berg
I have one final question relating to credit, I believe Mike Gersie said in his prepared remarks he cited little factors in explaining I hope I have this right. Why certain income securities were trading at material discounts to say amortizing costs, reasons other than credit, could you elaborate what you mean by technical factors in other words why would a bond in your opinion trade at a significant discount from amortized cost to an extended for reasons other than credit?
Barry Griswell
Okay, thanks Eric. We will ask Julia to answer that.
Julia Lawler
Yeah, Eric thank you very much. Well, the spread wide there is no question and what we mean by technical versus fundamental is that trading behavior was driven more by ownership of CMBS or the index or shorting that index as the case may be.
So, I would say that what’s happened in March to get back to Jim’s comments about the disruption is that we had lots of players in the market that were needing to either liquidate their portfolio so they chose what was able to be liquidated which was high quality CMBS or they were needing to short a hedged position or change a hedged position, which affected the value of bonds. I will compare that to fundamental that affect spread, fundamental just predominantly around default rates increasing, foreclosures increasing, losses on actual commercial mortgages increasing.
None of that had occurred. That's how I would compare technical to fundamental.
Eric Berg
Very clear, Thank you Julia, I’m all set.
Barry Griswell
Thanks, Eric.
Operator
Your next question is from Suneet Kamath with Sanford Bernstein.
Suneet Kamath
Thanks and good morning. I had a question about the full serves culmination business and the commentary about the low return on asset number going forward.
I think you’ve talked about this qualitatively but you haven't quantified it in the past. I guess I just want to understand what the major driver here is, is it fund performance or the proliferation of target date funds or the move tomorrow larger cases.
I mean what’s going on underneath? And then in terms of the pipeline Larry, I think you said that the pipeline for FSA is up I think it was 18%.
Do you have a nominal amount of money in terms of the pipeline? And I think in the past you’ve talked about a close rate of 14%, is that still a good close rate over a 12 month period?
Thanks.
Larry Zimpleman
Good morning Suneet. This is Larry, on the second one I will take that first, in terms of the close rate, the, you’re right.
I mean the historical close rate actually Suneet, it’s been more than 12% somewhere in that 11%-12% range. And in the first quarter our close rate was closer to 18.
So, you can see why it was such an outstanding sales quarter. And again I would not, well, I’m not going to sit here and predict an 18% close rate, I think that is support however, for our comments that our total retirement sweet capability as well as the strong investment performance of PGI and our partners continues to churn out, thus put us in a very strong position.
So, again I don’t do the 18% as a statistical blip although I’m not going to sit here and predict because that would be that high every quarter. But again it’s typically been in that kind of 12% range, with 18% in the first quarter and again we remain optimistic because of the competitive nature of our offering.
On the first question I think you were really looking there is any poor, whether some of the drivers that are kind of impacting the return, whether it’s ROA return the asset to ROE, I think again there is a number of factors but the one more dominant than anything else is simply that with our Total Retirement Suite initiative you are seeing more employer securities being embedded into the account values. And we showed it in our financial supplement today the employer securities are around 6% of the total account value that was about 4% a year ago that would have been 0% three or four years ago and the nature of employer securities is that the fees we get on that are primarily consulting and a small amount of administrative fee so you do not have the larger asset management fees and better than those employer securities, so what we are talking about here is I think it is important for everybody not to draw the conclusion that the our way going down is a bad thing the fact that we can compete on TRS and include employer securities allows us to have a bigger opportunity in the market to grow our total account value and asset base and we accept as a trade-off for that that the ROA is going to be slightly less but the net opportunity to grow full service accumulation earnings is definitely enhanced as a result of having employer security so I hope that helps a little bit.
Suneet Kamath
No, it does. Just follow up in the pipeline you have a normal amount as of end of the quarter season?
Larry Zimpleman
A normal amount or the dollar amount the pipeline.
Suneet Kamath
Exactly.
Larry Zimpleman
I think it tends to run somewhere in the sort of $20-25 billion range maybe closer to $30 billion in any point in time again depending a little bit on seasonality, Suneet.
Suneet Kamath
Okay that is comparably up 18% that you mentioned in your comments.
Barry Griswell
Yes. That was a yes.
Suneet Kamath
Okay got it, thanks very much. Perfect thank you.
Barry Griswell
Okay, thanks Suneet. You bet.
Operator
Your next question is from Steven Schwartz with Raymond James & Associates.
Steven Schwartz
Hi everybody, just a couple of questions one more I guess a theory question article yesterday in the Washington journal about people looking to take loans into cash and therefore in case I was wondering if you had given the economic environment I was wondering if you all had had thoughts on that and how that they affect your business and then second you might have gotten this with time but I did not get it the health insurance guidance 45 to 55 million or 37 million in the first quarter maybe if you talk about what you see happening there?
Larry Zimpleman
Okay, Steven good morning this is Larry
Steven Schwartz
Good morning Larry.
Larry Zimpleman
I will take one and John can follow up on your health question. In terms of the 401K loans or I will say maybe more broadly the impact of a slowing economy in what impact that has on 401K withdrawals is again quickly there are two ways that 401K loans members were how you could see the impact is slowing economy, one would be through actual hardship withdrawals some plans do have hardship withdrawal and you can have the opportunity as a 401K loans plan member to gain access to some of your account value through a financial hardship.
I would say on that side of the withdrawal we are really not seeing any impact when we look at our experience in Q1 as compared to prior quarters no discernable trends I think that’s positive. On the other way you could access in a flowing economy would be through planned loans as your question was directed, there what I would say is we’re seeing a very, very slight uptick in a number of calls to our contact centre around plan loans, but we’re not really seeing any again discernable trend or increase in planned loans.
So, it would be even call it a rounding error as it relates to planned loans and probably be to overstated, but there are at least a few more calls that are coming to the call center, but usually again once apprise of other opportunities and most planned members understand and it’s really not in their interest to take the planned loan and there are many other ways, more effective ways to handle some sort of slowing economy or financial emergency. And now I’ll ask John to talk about your health question.
John Aschenbrenner
Sure Steve. Last quarter we indicated that we expected health earnings for this year to be in the 35 to $40 million range.
Steven Schwartz
Okay.
John Aschenbrenner
Because of the very strong results that we are seeing in the first quarter we’ve increased that $10 million to $15 million and we expect earnings to be in the 45 to $55 million range for the year.
Steven Schwartz
Okay. I understand the loss ratios move up that really by that much I mean it’s that’s just strikes me as a considerable effect of where you are, you have been the reserve development?
John Aschenbrenner
Yeah, we have moved now to where we have about 67% of our health business is in higher deductible plans and that really will drive again heavy claims in the fourth quarter compared to the first quarter. So, you might expect something in the range of $12 million earnings in the second and third quarter and maybe a 5 to a $10 million loss in the fourth quarter to reflect the seasonality of the health claim based on high deductible plans.
Steven Schwartz
Okay. I got it.
Thank you.
Barry Griswell
Thank you.
John Aschenbrenner
$12 million each second quarter and third quarter.
Operator
Your next question is from Ed Spehar with Merrill Lynch.
Ed Spehar
Good morning, thank you. I had a couple of questions Larry in terms of thinking about the impact on ROA from TRS, can you give us some sense of, if you look at the just TRS portion of the book what percentage of the asset would be employer security and maybe more specifically and just thinking about the marginal ROA for this business, can you give us some sense of what it would be for the TRS and the alliance sales relative to your other sales?
Barry Griswell
Sure, good morning. First of all, if you focus around our Total Retirement Suite, again I think there is some tendency probably through our own communication that we have sort of tended to have you think that TRS is somehow kind of a subtext for employer securities and that’s not necessarily the case in other words you can find employer securities in medium sized plans and even some smaller sized plans where they maybe more private employer securities not necessarily public employer securities so the range for any given plan what percentage of it is employer securities obviously ranges all over the lot from 0% for many, to something maybe as high as 20-25% for some plans.
Now again this add as all part of the underwriting process that we go through at front end and obviously we make sure as a part of our underwriting process that the revenue we are going to receive holistically whether it’s from the employer securities, from the other assets that’s going to pay us with a necessary ROA for the work we do so don’t read into that we have sort of different ROA targets by TRS versus plans that are not TRS or plans that have employer securities versus plans, that don’t have employer securities. And again, these are all just part of the underwriting process that we go through.
In terms of your other question on marginal ROA actually I have to tell you that I do not think we look at the business that way, we don’t really think about trying to kind of write business on a sort of marginal basis that’s just never been a part of our philosophy here so our goal remains that that same sort of overall ROA that we have been talking about kind of in that 32 bases point range as we said in our comments so I hope that someone helpful.
Larry Zimpleman
Ed, this is Larry I would also add that this first quarter we just had $3.5 billion we had very little employer securities in that quarter so I don’t want anybody get the turn that prevented all of our businesses starting to build that way, in fact, I do not know that we had any large cases at all with these. Yeah we had, in the first quarter we had that $3.5 billion 6% of that was an employer security so again these things will having to flow back and forth and I think various comments are important to understand.
Okay, likely to just follow up with one question. If you expect though that some of the business you are writing today has a lower ROA but higher ROE.
Why would the return on assets outlook over the next several years according I think the comment that might made was 30 to 32 basis points over the next several years why wouldn’t that surely move lower over time given the mix of business.
Barry Griswell
Yeah, I mean, I think that is the point that Mike was trying to explain. Again if you go back two or three years there was no employer securities in the account valued so basically everything there were dollars what we are getting some sort of an embedded asset management fee in the business, now today is the employer securities don’t have this embedded asset management fee the other assets do whether they are proprietary or nonproprietary and it now depends on the long terms trends as to ultimately what percentage of account value in full service accumulation is employer securities as I said earlier that was about 4% of account value a year ago that is about 6% of account value today I don’t really know and cannot really sort of forecast for you where that may go I think it is always going to remain a relatively small percentage of total account value because again our value proposition is so strong whether it is at the small end, which may not involve employer securities, the mid sized plans, or the large plans so I think it will just depend on time and we’ll see where it goes, but I don’t think it will grow substantially but it might get a little higher at 6% it is today.
Ed Spehar
Okay thank you very much.
Operator
Your next question is from Tom Gallagher with Credit Suisse.
Tom Gallagher
Good morning. I guess another one to Larry not to be the dead horse, but let me it take different approach at the whole mixture is going on in full service.
If you calculate it as revenue yield full service accumulation revenue yield went down from about 98 basis points in 1Q last year to about 89 basis points this quarter and if I think about it that way what would be fee base revenue yield be on some of these larger what say bigger mandates that you have been winning recently if I think about 1000 or larger lives I mean it’s in number 50 basis points on average, is it 30 in a small case and what’s if 100 can you give us a little perspective on because I think it is important to think about. There’s going to be obviously higher associated class on the small end but at least we can understand that dynamic of revenue yield to help us think about at least what we will be seeing on the top line.
Larry Zimpleman
Okay, let me take it short that obviously I don’t know that I can relate to revenue yield that you may have defined but let me make some general comments that I think will be helpful to your question. We actually manage the full service accumulation business not as one single overall business.
We have incredible discipline and how we go at the business and we actually manage it as a series of interrelated businesses. So when we think about full service accumulation, we actually manage it as a grouping of smaller plans, which we will for the sake of discussion call generally 0 to 5 million in assets kind of medium size plans that we would think somewhat between 5 and 15 million and then the larger plans somewhere between 50 million an above.
And we have very, very detailed both revenue expense and overall P&L statements that we run for every one of those businesses. And we are extremely discipline Tom both in the underwriting at the front end as well as the ongoing expense management and ultimately the revenue yield if you will that you see to make sure that we are absolutely not subsidizing in order to get one business at one end at the expense of business at another.
We have seen others make that mistake; we will absolutely not go down that path. So when you see the overall ROAs or ROEs of the full service accumulation business you can be confident that if you were to drill down and look at the small, medium or larger and you would see consistent ROAs or ROEs no matter whether you’re looking it is small plan or large plans.
Tom Gallagher
Okay. That's helpful.
And is there any broad range you could give us, I don’t know even an anecdote to think about what the fees as a percent of AUM would look like for a typical smaller plan versus a large plan. How extreme is that difference on enough that something you can share.
Larry Zimpleman
Well, I mean Again in terms of gross fees, in a total fees, somebody might pay I say for a very small plant it can be in the 250, 270 basis point range and for very large plans it would probably get down to where it is well under 100 basis points probably closing in on 70 or 80 basis points but the real driving factor around that, Tom is going to be whatever line of investment options they choose to put into the plan extant to wish for example they have index type options versus managed options, that is going to be the biggest driver of the fees they pay.
Tom Gallagher
Okay. That's helpful.
And just one more follow up for me. I guess this would be for Jim.
The Global Asset Management fee based earnings guidance of $95 million, are you including any performance fees in that number.
Larry Zimpleman
The one word answer is yes. Looking at the first quarter, the fee earnings were somewhat depressed, or they were somewhat below trend I think really for three reasons.
One is there were some extraordinary costs including $1 million of severance because of people in the more structured products area that got attributed to the fee business. Secondly, there were absolutely no performance fees or incentive fees in the first quarter.
And thirdly, because of very low activity in real estate, there were no transaction or borrower fees or very low transaction and borrower fees in the first quarter. So, if you look at the fee business operating earnings, although it was nicely up on a year ago, it was because of the volume growth on the business.
It was definitely below trend for those reasons and we have assumed much more of normalized trend thinking about that 95 million expectations. Clearly you’ve latched on to the piece that's most volatile and that could come in at or behind and that would probably be the most likely if you are using a crystal ball, the most likely thing to help us come in above or below that 95 million expectation that Mike expressed.
Barry Griswell
And that’s heavily weighted toward the fourth quarter, right?
Larry Zimpleman
Yeah, if you look at our past trend actually on quarterly operating earnings on our fee mandate business, the fourth quarter is usually above trend because of the incentive fees.
Tom Gallagher
That’s the reason for most part you’re not accruing those, you are waiting to the fourth quarter to make sure those are in the bank?
Larry Zimpleman
Absolutely. There is no -- I mean there are -- we have from week-to-week and days-to-days some beliefs of what's likely to come through, but really you don’t know until you bank them and that’s when we account for them.
Tom Gallagher
Okay, thanks.
Operator
Your next question is from Tamara Kravec with Banc of America.
Tamara Kravec
Thank you, good morning.
Barry Griswell
Good morning.
Tamara Kravec
First off congratulations, Barry and I wish you the best in your retirement.
Barry Griswell
Well, thank you.
Tamara Kravec
You’re welcome and I just wanted to talk about the individual annuity business and ask how your hedging programs are faring and what -- there has been a lot of new product innovation quite a few of your peers are coming out with, with newer riders and other guaranteed provisions for those products. So, I would be curious for your outlook on that business in more detail and then a quick follow-up on the CMBS securitization just so I understand, your breakeven forecast for the rest of this year, is that assuming that -- some of the markets reverse or are you assuming that they stay the way they are?
Thanks.
Barry Griswell
Thanks. Tamara, Let me take the last one very quickly, that does not anticipate recovery more extent.
Just a business going forward as it is today and Larry you want to take this.
Larry Zimpleman
Sure, I’ll just comment briefly Tamara on the individual annuity and first of all we don’t unfortunately have the opportunity in these calls or maybe spend as much time on that business, what we call the retail annuity business as we’d like but there is you have certainly seen very, very consistent stable growth, quite actually quite impressive growth well above the industry average in the business and as because we have a very talented team there both the operations team and sales team that has been working very hard to expand distribution and you see that coming through quarter-after-quarter after quarter in increasing sales that are certainly well above the industry experience so we appreciate that you noticed that. In terms of hedging what I would say, is that know, we believe that we are extremely sophisticated certainly at the same level as all the other riders there are in that individual innovative business.
We study intently the success of our hedging strategy. It will obviously vary from period to period but in rough terms, very rough terms and over the longer term we think our hedges are 80%-90% effective in accommodating the various risks of that business.
So, we are comfortable with it. We have executed very well and plan to continue kind of grow that on a consistent basis as we have in the past.
Tamara Kravec
Thank you.
Barry Griswell
Thank you.
Operator
Your next question is from Jeff Schuman with KBW.
Jeff Schuman
Good morning, Larry, I was wondering if you could give us a few thoughts about the ING city street deal. First of all I am wondering, whether it’s large enough to, that means it will put a meaningful number of accounts sort of in place with a chance to gather some business.
Secondly, does it signal any acceleration industry I mean in do you think, and thirdly can you remind us about your level of interest and appetite to look at properties like that that are focused maybe a little larger case than your current core business?
Larry Zimpleman
Sure Jeff, just a couple of comments on that, I mean obviously there's nothing or there is very little certainly nothing of that size that moves in the market we are not aware of. So you can just sort of take that as a given, I don't think anybody has been anymore active than we have around consolidation.
Jeff Schuman
Does this signal new consolidation?
Larry Zimpleman
I don’t know, not necessarily, I tend to believe Jeff, that the issues that drove the city street transaction were relatively unique both to city and state street. First of all I don’t think that during venture structure was ever a long term structure, they don’t tend to be people who play well in joint ventures.
Obviously City has their own issues, that they need to deal with so, I think it was more of a one off unique situation. In terms of what great opportunity answer absolutely yes, when these things go and play, let me just say that the clients don’t necessarily just march along.
So, there would be a lot of opportunity it’s a very complicated block, it has a number of very small plans. And then a few handful’s of very large plans.
It will be difficult, it will be complicated and will have the opportunity to kind of pick and choose where we want to play and how we want to play versus try and to have to absorb and digest the entire animal so, we will look forward to that opportunity.
Jeff Schuman
Great, thanks a lot.
Barry Griswell
We have time for one more.
Operator
Your next question comes from Dan Johnson with Citadel Investments.
Dan Johnson
Could you run through the WM asset, the Washington mutual asset withdrawal outlook again and then secondly, the real estate loss in other can you give us a little more color on what that was and finally, the 34 basis points of ROA in ’07 FSA is that only include the third quarter adjustments or does that include some of the other adjustments such as the one you have identified in the first quarter of ’07? Thanks.
Larry Zimpleman
Dan this is Larry, I may take the first one and then the last one, in terms of the WM withdrawal let me try to be clear on that I mean not have been clear that was actually the 1.24 was actually a withdrawal attributable to their own home office plans, their own corporate plans, it was not withdrawal attributed to withdrawal of assets which had come to us through financial advisors as part of Washington Mutual distribution platform. So, this was a $1.24 billion withdrawal cash to their corporate plan they have been evaluating the platform on which they have that they have offered to Washington Mutual employees we are aware of that at the time of the acquisition, we as well said in the comments priced on into the acquisition.
While we are sorry to see that go, it was not unexpected and again it’s not something that we haven’t taken into account. On the 34 basis points what I would say Dan is you want to think about that as kind of the noise [inaudible] are away.
Unfortunately, there is never going to be a quarter that is noiseless, but you want to think about If I was building a long term model what I would expect the full service accumulation earnings to be I would be plugging in 34 basis points to day trending down to that sort of 30 to 32 basis points over time recognize on any quarter and it’s going to be bit a noise.
Barry Griswell
Julia?
Julia Lawler
Yeah, thanks Dan, it’s little unusual for us to show real estate losses let me describe that fund, that actually a real estate fund that PTI manages that Principal Life took a minority interest in and therefore we are using equity method of accounting and inside that real estate fund there is actually some CMBS, and as we have been describing in March CMBS had a huge parameter spread so that market change through in our other lines as a negative number. I hope you have obviously that reverse it though through the rest of the year but that’s what that is.
Dan Johnson
Thank you, very much.
Barry Griswell
Well, thank you all very much for being on the call today. We appreciate your interest and your support.
I would like to express my sincere thanks to our investors and to the sales side analysts for time we have been able to work together over the last several years it’s been a pretty good experience for me and hope it has been for you. I thoroughly enjoyed it, I really do believe that this company is a better run company because our interaction with investors and with analyst then it keep us on our toes and we appreciate that and we think as I stated makes us well run company.
I would also like to thank the board and senior management for allowing for the smooth transition that is undertaken between myself and Larry and then lastly I would just like to express my sincere thanks to our employees and managers and all the team that works here and express my sincere confidence and what we are going to achieve going forward. I know under Larry’s leadership and senior team we are going to do great things we have great employees and I can assure you this company will be focussed on doing what is right for our customers, doing what is right for our employees with integrity, and almost will be focussed on creating a sustaining shareholder value, so thank you so much and have a great day.
Operator
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