Aug 2, 2011
Executives
Daniel Houston - President of Retirement, Insurance and Financial Services James McCaughan - President of Principal Global Investor Larry Zimpleman - Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of Principal Life, Chief Executive Officer of the Principal Life and President of Principal Life Terrance Lillis - Chief Financial Officer, Chief Accounting Officer and Senior Vice President Julia Lawler - Chief Investment Officer, Senior Vice President, Chief Investment Officer of Principal Life Insurance Company and Senior Vice President of Principal Life Insurance Company John Egan - Vice President of Investor Relations
Analysts
Andrew Kligerman - UBS Investment Bank Randy Binner - FBR Capital Markets & Co. John Nadel - Sterne Agee & Leach Inc.
Jamminder Bhullar - JP Morgan Chase & Co Suneet Kamath - Sanford C. Bernstein & Co., Inc.
Steven Schwartz - Raymond James & Associates, Inc. Edward Spehar - BofA Merrill Lynch Christopher Giovanni - Goldman Sachs Group Inc.
Operator
Good morning and welcome to the Principal Financial Group Second Quarter 2011 Financial Results Conference Call. There will be a question-and-answer period after speakers have completed their prepared remarks.
[Operator Instructions] I would now like to turn the conference over to John Egan, Vice President of Investor Relations.
John Egan
Thank you, and good morning. Welcome to the Principal Financial Group Second Quarter Earnings Conference Call.
As always, our earnings release, financial supplement and additional investment portfolio detail are available on our website at www.principal.com/investor. Following the reading of the Safe Harbor 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, 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 changes in strategy. Risk and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K and quarterly report on Form 10-Q filed by the company with the Securities and Exchange Commission.
I would now like to turn the call over to Larry.
Larry Zimpleman
Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas.
First, I'll briefly discuss second quarter and year-to-date results. Second, I'll discuss the ongoing implementation of our strategy and its long-term potential, and I'll close with some comments about our strong financial flexibility and an update on capital deployment.
Then Terry will cover the financial results in more detail. We view second quarter results as very good.
Total company operating earnings for the quarter are up 25% over the year-ago quarter on 15% higher average assets under management. With 14% earnings growth on a year-to-date basis, we've had a strong first-half of 2011.
Second quarter continued the trend of increasing momentum in our businesses. Let me highlight some of the growth metrics that speak to the strength of our competitive position and success in attracting and retaining business.
At the end of the second quarter, total company assets under management stood at $336 billion, a company record, and an increase of $8 billion or 3% over first quarter and up 18% over the year-ago quarter. With 60% of our operating earnings now coming from fee-based businesses, assets under management is the single best leading indicator for future revenue and operating earnings.
Full-service accumulation produced very strong sales growth through the first 6 months of the year, up 40% over 2010. With the active pipeline up 13% and close ratios improving, we now expect to grow full-year sales by at least 20% over full year 2010 sales.
Principal Funds continues to drive strong sales, improving 29% over the prior year on a year-to-date basis. Strong quarterly net cash flows from the Retirement and Investor Services Accumulation businesses with net inflows of $1.4 billion as compared to $160 million of net outflows in the year-ago quarter.
Principal Global Investors had positive unaffiliated net cash flows of $400 million in the second quarter, reflecting 27% growth in deposits from the year-ago quarter. Deposits this quarter include strong flows of $180 million in the Dublin Series funds, a global platform for non-U.S.
investors. Total mandates won by Principal Global Investors and the affiliated boutiques are $5.3 billion year-to-date.
Principal International finished the quarter with record assets under management of $53 billion driven by strong net cash flows of $1.8 billion. On a trailing 12-month basis, Principal International had record net cash flows of $5.9 billion.
Momentum continues to build in U.S. Insurance Solutions.
Individual Life sales are up 21% year-to-date, with 62% of the sales coming from the business market. Additionally, Specialty Benefits continues to see strong growth with premium up 6% and sales up 42% over prior year on a year-to-date basis.
With our focus on small-to-medium-sized businesses in the U.S., the elevated unemployment rate continues to put pressure on the pace of the economic recovery and on the growth of our U.S. businesses.
Despite that, we continued to see growth across our businesses, which reflects the competitiveness of our product solutions and our strong alliances with key distribution platforms in the U.S. market.
So while the economic recovery continues to be fragile, we remain optimistic about our growth continuing in the second half of 2011. Now let me move to some comments on the ongoing implementation of our strategy and how that positions us over the longer term.
We remain a leader in the U.S. retirement market.
Our Principal Total Retirement Suite strategy continues to be a differentiator that captures assets and drives cash flows. Total Retirement Suite close ratios are double the close ratios for single-product retirement sales, and we see significantly better persistency in this block.
Plan sponsors and advisors like the breadth of best in class products that Total Retirement Suite offers, as well as the ability to seamlessly integrate these retirement products. Since launching this strategy in 2004, 50% of all Full Service Accumulation assets are now from our Total Retirement Suite block.
Additionally and consistent with historical results, Total Retirement Suite sales accounted for 66% of total Full Service Accumulation sales in the second quarter, demonstrating the ongoing power of this strategy. We also recognize that about 1/3 of the smaller plan retirement market prefers a third-party administrator or TPA arrangement.
We've intensified our commitment to this market by expanding our array of flexible solutions that meet the needs of TPAs in order to effectively capture market share. Our ability to work with TPAs grows our advisor base by giving us access to advisors that prefer this solution and creates the opportunity for even greater success over the longer term as we execute our multichannel distribution strategy.
Year-to-date, TPA sales were $350 million, up 52% over the prior year. This powerful combination of both bundled and unbundled solutions will allow us to extend our market leadership.
Investment performance is solid, and longer-term performance continues to improve, particularly in areas where plan sponsors and advisors focus, such as in fixed income and domestic equities. This bodes well for sales and retention going forward.
In a recent survey of retirement plan sponsors conducted by Cogent Research, The Principal received a top ranking in plan provider brand equity. Equally as important, in the same survey, Principal Global Investors is among the top defined contribution investment managers that garnered favorable impression scores from its clients.
According to the survey, attributes where Principal Global Investors excels include outstanding service and support, a strong understanding of global markets, and understanding of the defined contribution market. This recognition, combined with our recent recognition as Investment Brand of the Year in the 2011 Harris Poll EquiTrend study, further demonstrates our position as a leading retirement plan provider and asset manager.
These recognitions provide strong affirmation of The Principal’s leadership in the retirement industry, and we remain very optimistic about our growth opportunities in the retirement market. While our U.S.
retirement leadership is reasonably well-known, we continue to successfully implement our International Retirement and Global Asset Management strategies. We will strengthen our multi-boutique platform in Principal Global Investors with the acquisition of a majority stake in 2 asset managers based in London, Finisterre Capital and Origin Asset Management.
The Finisterre acquisition closed as expected on July 1, and we expect the Origin deal to close in October. These 2 asset managers have great track records and increase our investment capabilities in emerging market debt and in global equities where additional high-quality investment capacity is in high demand but in relatively short supply.
As a further expansion of our Global Asset Management business, we also recently opened a representative office in the Netherlands and are in the process of opening one in Dubai, further expanding our global distribution footprint. Institutional Investor’s recent annual rankings of the top 300 asset managers reaffirmed Principal Global Investors at number 29.
The recently announced acquisitions and global expansion contribute to our ability to grow even further. We continue to see exceptional growth from Principal International as we execute our international retirement strategy.
The announced acquisition of HSBC's mandatory retirement business in Mexico reflects our strategy to go deeper in the countries we're already in. This deal, which we announced in April and expect to close in August, will be immediately accretive to earnings as we add scale to Principal International, one of our higher margin, higher growth businesses.
In short, I am extremely pleased with our strategy implementation as we continue to build 2 significant growth businesses, Principal Global Investors and Principal International, alongside our U.S. retirement leadership.
No other company is better positioned than The Principal for the opportunities created by aging populations all over the world and the need for private market solutions. This is the strategy to drive consistent growth over many years.
Now let me close with some comments on our capital deployment strategy and our financial position. Given our original goal to deploy $700 million in capital in 2011, I am pleased with the actions we've taken so far.
In addition to the strategic acquisitions, which increase our earnings power going forward, we also reinstated our share buyback program in May. In early July, we completed the $250 million authorization, repurchasing 8.4 million shares in total.
These actions fuel both near and longer term earnings per share growth as we continue to focus on creating long-term value for our shareholders. As we have said many times, our hybrid business model, which includes 60% of our operating earnings from high-growth, low-capital intensive businesses, continues to generate increasing amounts of free cash flow as operating earnings recover post the financial crisis.
This allows us to invest in our businesses and return capital to shareholders while still maintaining a strong financial position. Given the strong operating earnings year-to-date, along improvement in credit characteristics of our general account portfolio, we now have up to $1 billion available capital for deployment in 2011.
This is a $300 million increase to the original full year estimate of $700 million. Year-to-date, we have announced acquisitions and a share repurchase totaling $600 million, giving us up to $400 million of capital available for deployment in the second half of 2011.
This is in addition to capital we expect to use for our annual common stock dividend, which we will announce in pay in the fourth quarter. Of course, given the uncertainties in the markets, we will be prudent as we proceed with this deployment.
Our financial position remains at its strongest point in our 132-year history with $10.7 billion of stockholders' equity. Book value per share excluding AOCI increased 7% to $29.20, and book value per share including AOCI rose 20% to $31.43, which are both record levels.
This includes $2.1 billion of excess capital as of midyear and a risk-based capital ratio of 445% for the life company, which Terry will discuss in more detail. Before I turn the call over to Terry, I want to mention some additional recognition we received this quarter that I am extremely proud of.
First, The Principal received a 2011 Freedom Award from the Employer Support of the Guard and Reserve Group, a Department of Defense agency. The Freedom Award is the Department of Defense's highest recognition given to employers for exceptional support of their employees serving in the guard and reserve.
The Principal was one of only 15 companies to receive the award out of more than 4,000 nominations. Additionally, The Principal was recently named a Best Place to Work in Information Technology by IDG's Computerworld magazine, which marks a decade of consistent appearances on this list for The Principal.
We have an exceptionally talented and committed group of employees, and I am very proud of the work they do every day. Terry?
Terrance Lillis
Thanks, Larry. In second quarter 2011, we continued to create momentum across our businesses.
This momentum resulted in very good growth in the second quarter and, more importantly, will carry forward as we move into the second half of the year. This includes strong, diversified earnings and building sales momentum across multiple products as well as a strong balance sheet with tremendous flexibility.
This morning, I'll focus my comments on operating earnings for the quarter; net income, including the continued solid performance of the investment portfolio; and some additional detail on our 2011 capital position and deployment strategy. Starting with total company results, once again, we ended the quarter with record assets under management now at $336 billion.
Total company earnings of $237 million are up 25% from a year-ago quarter on 15% higher average assets under management. There were a few items influencing comparability between second quarter 2011 and second quarter 2010.
Second quarter 2010 had a higher economic interest in our Brasilprev joint venture for 2 of the 3 months. Reserve and amortization changes negatively impacted second quarter 2010, and model and assumption changes negatively impacted Individual Life in second quarter 2011.
Adjusting for these items, second quarter 2011 earnings were up 21% on a 15% increase in average assets under management compared to second quarter 2010, a very good result reflecting continued operational leverage. There can be volatility for many reasons on a quarter-by-quarter basis, which levels out when you look at a longer time frame.
Therefore, when we look at the first half of 2011, operating earnings are up 19% over 2010 when we adjust for the reduced economic interest in our Brasilprev joint venture. This improvement in earnings reflects ongoing momentum of our businesses.
Let me quickly comment on the items impacting second quarter 2011 reported earnings per share of $0.73. Principal International benefited in second quarter 2011 from gains on the sale of bonds in our Brazilian joint venture.
Individual Life was negatively impacted by model and assumption changes and unfavorable mortality. The net impact of these items was negative $0.01 in second quarter 2011.
On an adjusted basis, we consider the EPS run rate for this quarter to be $0.74. This continues the steady trend of EPS improvement quarter-over-quarter.
Now let me discuss business unit results. Retirement and Investor Services earnings of $161 million in the second quarter were driven by record account values of $187 billion at quarter end.
Full Service Accumulation operating earnings at $83 million were up 22% from a year ago quarter on an 18% increase in average account values. On a trailing 12-month basis, Full Service Accumulation return on assets was 30 basis points.
We maintain that the long-term run rate for return on assets for this business is 30 to 32 basis points, though there will be volatility around this target as market conditions fluctuate. In addition, we continue to invest in our businesses to take advantage of future growth opportunities, such as building out our TPA infrastructure and other technology enhancements.
Full Service Accumulation sales in the second quarter were very strong at $1.7 billion, our highest second quarter ever and nearly double that of second quarter 2010, as we continue to see an increase in proposal activity and improvement in our close ratios. Strong transfer deposits and favorable retention drove net cash flows of nearly $1 billion contributing to the record account values of $115 billion at quarter end.
As Larry mentioned, we continue to see our sales pipeline build across all market sizes and all distribution channels, giving us momentum for strong full-year sales, which we expect to be at least 20% higher than full year 2010. Principal Funds continues to deliver strong operating leverage.
Operating earnings at $13 million in the second quarter were up 28% over the year-ago quarter on a 24% increase in average account values. Principal Funds delivered strong sales of $2.6 billion dollars in the second quarter and strong net cash flows of $530 million.
On a trailing 12-month basis, Principal Funds delivered $11 billion in deposits, demonstrating the strength of our multiproduct and multichannel distribution model. Competitive investment performance also contributed to the result.
This includes particular strength in asset allocation where, at quarter end, 84% of our target date and target risk runs were in the top half on 1-year basis, 78% on a 3-year basis and 77% on a 5-year basis. Individual Annuities and Bank and Trust Services achieved solid operating earnings this quarter.
Both divisions finished the quarter with strong account values contributing to record overall account values for the Retirement Investor Services Accumulation Businesses. Earnings from Principal Global Investors at $21 million improved 69% from the year-ago quarter on a 9% improvement in average assets under management as pretax margins expanded to 25%.
This strong operating leverage result was driven by improving fees for actively managed funds and increasing real estate mandates. Principal Global Investors year-to-date mandates awarded grew to $5.3 billion.
As of quarter end, approximately $3 billion of these mandates had funded. In addition, since quarter end, a large Latin American Central bank mandate has funded, giving a strong start to third quarter deposits.
We are pleased with improvement from the year ago quarter and sequentially in both deposits and redemption and look for flows to continue to improve over coming quarters. As Larry mentioned, our acquisition of Finisterre Capital, an emerging market debt manager, closed on July 1 as expected.
Integration teams are in place, and the transition is going as planned. We were also excited about the growth and potential of our announced acquisition of Origin Asset Management, a global equity manager which is expected to close October 2011.
We expect both of these transactions to be neutral to earnings per share in 2011 and accretive in 2012. Combining our global distribution platform with the expertise of these asset managers, we expect the assets under management for both firms to grow 3 to 5 times over the next 5 years.
This growth is consistent with that achieved following the acquisition of other boutique managers such as Columbus Circle Investors and Spectrum Asset Management. These acquisitions, again, demonstrate our commitment to reinvesting capital in our high-margin, high-growth businesses with strong strategic fit.
Moving to Principal International, operating earnings of $38 million are up 7% from the second quarter 2010 despite a lower economic interest in our Brazilian joint venture, Brasilprev. Adjusting for the lower economic interest and for a $2 million benefit in second quarter 2011 from gains on the sales of bonds in Brasilprev, earnings growth is in line with the 38% growth in average assets under management.
Principal International finished the quarter with record assets under management of $53 billion, driven by strong net cash flow of $1.8 billion. The total exceeds $60 billion if you add the assets of our Chinese joint venture, which are not included in reported assets under management.
We expect to close HSBC retirement unit acquisition in early August. This transaction will increase our scale in the mandatory retirement business in Mexico.
We reaffirm that we expect an immediate $0.02 to $0.03 earnings per share accretion in the second half of 2011 and $0.06 to $0.08 for full year 2012. This acquisition aligns with our existing platform.
We anticipate minimal integration risk and expect to capitalize on significant synergies. U.S.
Insurance Solutions' operating earnings were $50 million for the quarter, essentially flat compared to the year-ago quarter. Individual Life operating earnings were $24 million.
Current quarter results were dampened by $7 million reflecting 2 items. First, a $3 million shortfall was due to unfavorable mortality experience in the quarter.
Second, the remaining $4 million was due to model and assumption changes. During the second quarter, we performed a review of our integrated life reserve model and assumptions, which created volatility within certain income statement line items that essentially offset each other.
We believe the run rate for Individual Life operating earnings remains in the range of $31 million to $33 million per quarter with expected volatility in any one quarter. The favorable mortality experience that we saw in the first quarter of 2011 was offset by current quarter's unfavorable mortality experience.
With the exception of the model and assumption changes, we feel that the first 6 months’ earnings are on track to meet full year expectations. Turning to Specialty Benefits, operating earnings improved 8% from a year ago to $26 million driven by membership growth and stable loss ratio results, which are key drivers of profitability.
Specialty Benefits had sales of $60 million this quarter, up 23% over second quarter 2010. Additionally, the wind-down following our decision to exit the Insured Medical business is progressing well and continues on plan.
Shifting to total company net income, we delivered $258 million this quarter, our best quarter of net income since before the financial crisis and nearly double that of second quarter 2010. With credit-related investment losses of $39 million after-tax, we continue to see improvement in corporate credit and commercial mortgage whole loan losses.
CMBS losses also improve and continue to be manageable. Our investment portfolio performance continues to reflect the benefit of broad asset diversification.
The evolution of our hybrid business model creates a blend of less capital-intensive businesses as we derisk the organization over time. It also helps us weather the current low interest rate environment.
Of our $57 billion of Principal Life's general and guaranteed separate account assets, $19 billion or 33% includes a guaranteed minimum interest rate, and only $6 billion or 11% is currently at those minimums. For the remaining portion not yet at minimums, we have an average of 75 basis points of cushion above the guaranteed minimum rate.
Given our active interest rate risk management, we estimate a very modest earnings impact due to the low interest rate environment. If the quarter end interest rate environment persists, we would expect less than 1% impact on our 2011 and 2012 earnings.
Moving to our balance sheet, in [ph] street reflects the ongoing improvement in credit markets as the U.S. economy rebuilds.
And at $1.6 billion, our net unrealized capital gains position increased $300 million from first quarter 2011 as a $500 million gain from the impact of decreasing interest rates was partially offset by widening spreads. 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 an economic impact.
Now moving to capital adequacy. As of quarter end, we estimate our risk-based capital ratio to be 445% after a distribution of $300 million this quarter from the Life company up to the holding company.
This follows the $200 million distribution in first quarter. Relative to a 350% RBC ratio, we have approximately $2.1 billion in total excess capital as of the end of the second quarter.
$1.1 billion of the excess capital is at the holding company. Of the $700 million we originally identified for acquisition and share repurchase in 2011, year-to-date, we have committed a total of $350 million towards acquisition, and $250 million has been used for share repurchase.
We still have $100 million available to deploy in the second half of 2011. However, due to improvement in our earnings and in the credit characteristics of their general account portfolio, our available capital position has improved.
As Larry said, we now have up to an additional $300 million to deploy for strategic acquisitions and additional share repurchases during the second half of 2011. This is in addition to the deployable capital for our annual common stock dividend.
We're pleased with the financial flexibility our business model provides as we generate meaningful amounts of free cash flow quarter after quarter. A couple announcements before I close.
First, we announced a few weeks ago that we will host a Principal International workshop on September 16 in New York City. At this event, we will provide greater detail about our international businesses and show why it is a tremendous growth opportunity for The Principal.
Additional detail around the key drivers and metrics will also be provided. We'll provide more information as the event gets closer.
Second, our third quarter earnings call will be held Friday, October 28. To capitalize on efficiencies gained in our financial close process, we will be moving up our earnings call to an earlier date starting next quarter.
Again, we are very pleased with the strong financial results of our businesses this quarter. Momentum continues to build as does our long-term growth potential.
This concludes our prepared remarks. Operator, please open the call to questions.
Operator
[Operator Instructions] Your first question comes from the line of John Nadel with Sterne Agee.
John Nadel - Sterne Agee & Leach Inc.
A question on FSA. Could you give us a little bit more detail, maybe color around where the real success in the quarter was from a sales perspective?
I'm really thinking more about size of case.
Daniel Houston
Couple of comments. In terms of large wins.
On the last 6 months, we got 4 large wins worth about $1.2 billion. For the quarter, we had one large case that generated about $800-and-some-odd million.
If you compare that to the second quarter of 2010 through 6 months, we had about $560 million. So you saw nice increase in large wins, but at the same time, it doesn't tell the whole story because across our emerging and dynamic space, we had really strong sales.
TPA sales were up 52%. Our Allianz relationships were up roughly 37%, TRS continues to be the lead offering from PFG.
So across-the-board, TPA, Allianz, large and small, we had a really, really strong year. And we're fortunate not to have all that falling in any one category.
The other comment I would make is we did not lose a single institutional case, which speaks to our favorable contract retention for the period.
John Nadel - Sterne Agee & Leach Inc.
Okay. So just a follow-up then.
I guess when we're looking at year-over-year sales in the first half of the year, I think 40%, little over 40% growth. I guess it's sort of the -- maybe you're being a bit conservative thinking about maybe some of these larger case sales don't repeat in the back half, and that's why sales growth is sort of at the upper end of your prior 15% to 20% as opposed to something better.
Daniel Houston
John, just a reminder. Remember in the second half 2010, that was really a strong year for us.
We really poured it on, and we're off to a good start this year. And again, we feel good about that 20% number.
We're optimistic, as Larry cited, in his opening comments, pipeline, active pipelines up about 13%, good activity, and frankly, we're just looking for this economy to continue to find some stability to start contributing in a more meaningful way to the reoccurring deposits as well.
John Nadel - Sterne Agee & Leach Inc.
Okay. And if I could just sneak one more in, you guys provided some information on peripheral European exposures in your investment supplement, the total of $1.7 billion.
It was hard to tell from that disclosure how much of that is in the general account versus in Principal International. And I guess -- I assume that it would be fair for us to think of the exposure in Principal International as really having no risk to shareholders, maybe more of an earnings issue or a flow issue.
But can you split out the $1.7 billion between the general account exposure and Principal International?
Terrance Lillis
John, I don't actually consider any of the $1.7 billion to necessarily be at risk relative to shareholders.
John Nadel - Sterne Agee & Leach Inc.
I hope you're right.
Terrance Lillis
Well, just to be clear on that. Because, again, in many cases, they may be cited there.
They don't necessarily have businesses there. But the split in rough terms is about $1.1 billion or $1.2 billion general account, and it's about $500 million in Principal International.
But most of the PI stuff really are the 2 large Spanish banks, although we don't really see any particular risk there. So hopefully that gives you a little better insight.
Operator
Your next question comes from the line Jimmy Bhullar with JPMorgan.
Jamminder Bhullar - JP Morgan Chase & Co
I had a question on FSA, the draws. In the past couple of years, the draws have actually gone up in the second quarter.
This quarter obviously was much better than the first quarter was. So maybe you could talk about what it is you're doing on the retention side.
And then secondly, on the PGI, you had very good flows this quarter. Obviously, the last few years have been weak.
You've had large withdrawals in the past. So just talk about your outlook for flows in the PGI business and also if the large withdrawals you’ve seen in the past few quarters are done already.
Larry Zimpleman
Sure, this is Larry. I'll just make a high-level comment on the withdrawals.
I think we've commented in quarters before that our team has been working hard on that. Frankly, one of the things that’s helped a lot is just the economic headwinds aren't quite as strong.
They remain, but they're not quite as strong so at least we're seeing membership, generally speaking, membership is staying sort of flat. Participant deferrals are actually up a little bit on a year-to-date basis.
So the key elements that sort of go into withdrawals, some of that noise has gone away, but the last thing I'd say, as we commented, Jimmy, is we're seeing very, very good investment performance. Our service teams and our relationship managers are just doing an outstanding job of performing day in and day out.
As Dan said, we've had no withdrawals from our institutional blocks, so he may want to add a comment or 2 and then I'll have Jim talk about PGI flows.
Daniel Houston
Yes, that really does capture it, Larry. We're very fortunate.
We had a lot of customer contact. The other comment I might throw out, and this is in large part due to Jim's strong investment performance within Principal Global Investors, but we continue to see a rebound in our asset allocation investment performance along with our fixed income investment performance, and that goes a long way towards aligning our interest with those of our customers.
Then lastly, as you know, we had that RESA queue [ph] in place. That no longer's in place.
Those things kind of flushed out in the latter half of '10, first part of '11. So we've got a lot of the investment noise out of the system, and again, it can stand a good overall customer service at this point.
James McCaughan
And Jimmy, on the Institutional Principal Global Investors withdrawals. I'd remind you in the first quarter of this year, we had the large withdrawal of $2.1 billion from core fixed income by the State Board of Florida.
I think I'm safe in mentioning that because it was widely covered in the trade press at the time, and they allocated away from all of their core fixed income. They remain a client for real estate and for international equities, so actually, they remain, if anything, a more important client than they were a year or 2 ago when we had that mandate.
This is very characteristic of what we're seeing in the industry, which is core mandates are tending to be rebalanced away from, with clients moving to passive and liability-driven investing. In the fourth quarter last year we had a similar one with a mandate over $1 billion, another a very low fee core mandate that we lost.
This quarter was mercifully free of that. So what you're seeing is some degree of reallocation by clients.
But the merits of our high-added value strategy that really suits the tendency that clients have to move towards satellite and higher added value mandates. And that's contributing both to the positive flows and to the richer revenues we're seeing.
As we sit right now, we don't see any core mandates that are really at critical danger, and we're pretty optimistic for flows given the investment performance that's been referred to and the change in client buying behavior that really suits our multi-boutique structure.
Jamminder Bhullar - JP Morgan Chase & Co
And lastly, could I -- Larry, maybe you could talk about the $400 million that you have to deploy for the rest of this year. How does the deal pipeline look?
And I'm assuming you're still looking within asset management or international and then just comment on how the environment is for acquisition.
Larry Zimpleman
Jimmy, this is Larry. So again, I think the nature of our transition to fee-based businesses is what's giving us the additional flexibility here, plus, as we said, some improvement in the overall for the credit conditions in the general account.
Having said that, I'm obviously not going to comment on any specific deal. What I would say is that we do think there continues to be some level of opportunity as we've done earlier this year with the HSBC acquisition and the 2 boutique acquisitions.
Our priorities remain exactly as they have been in the past. Our priorities are around our international businesses, both to add scale and add competencies as well as asset management.
So we will continue to be active, and we would expect to hopefully have the possibility, but it's probably going to be a quarter or 2 before you see that happen.
Operator
Your next question comes from the line of Randy Binner with FBR Capital Markets.
Randy Binner - FBR Capital Markets & Co.
Just a quick one on the SFI thing. It seems like Principal and some of the other midsize life insurers are at last a part of that conversation and even Met and Pru seem quite confident they would be non-bank SFIs if at all.
Your capital deployment comments certainly don't feel that constrained by it. So just kind of wanted to get an update there if you've made any progress on how you feel about how that might affect your capital planning.
Larry Zimpleman
Sure, Randy. Just maybe a few comments on that.
There's still uncertainty around the whole issue of SFIs. But having said that, I guess I would personally have kind of an intuitive feeling that whatever the probability might have been at the start of the year that we would have fallen into that bucket, I would say that my feeling today is the probability is lower than it was at the start of the year.
And I say that for several reasons. Number 1, it seems a little bit clearer that the FSOC, the Financial Stability Oversight Council, it seems now more likely to want to have a relatively smaller number of institutions in that designation than perhaps I might have thought 6 months ago.
So I think that helps us. Two, I think they're starting to understand the insurance industry better.
As you may know, they confirmed this week the insurance member to the FSOC, so we think that will add further education and understanding to that. So the last thing I guess I would say around that is that we have made efforts.
First of all, our financial flexibility is high, and our capital position is strong. And we’ve made our best attempts to convert, if you will, our current capital ratios over to what they would be if we tried to apply sort of the banking interpretations to those.
And when we do that, assuming again, we've done that in a correct way, and that's a bit of an assumption because there's a translation that's needed, we would find ourselves already with capital ratios that would be at or above the level that Basel III would require. So again, we think as long as we're able to maintain the sort of high capital ratios and financial flexibility we have, we don't see that as having a significant impact going forward.
But again, there's more to come on that. But that's the feeling today.
Randy Binner - FBR Capital Markets & Co.
And if I could sneak one more in on international. There's increasingly good sales there, and there's a rule of thumb we've had for FSA where, like 60% of sales drop down in the first quarter, then 20% in each of the next quarter.
Is there a rule of thumb that we could think of that's similar to that for international?
Larry Zimpleman
I think the rule of thumb is that sales equal deposits because there's not really across those businesses, Randy, there's not really anything that is sort of , of any magnitude. There's nothing that's really a kind of payroll-deduct business where there's a transfer deposit and some of that may come in over a period of time.
So it operates much more like our U.S. Mutual Fund business, pretty much where sales equal deposits.
Operator
Your next question comes from the line of Andrew Kligerman with UBS Security.
Andrew Kligerman - UBS Investment Bank
First question, I'm just curious with the potential for U.S. credit rating downgrade.
What are you doing to prepare potentially for that in terms of liquidity and your investment portfolio, if anything?
Larry Zimpleman
Sure. I'll make a few high level comments, and then Julia can add to that.
On one hand, certainly, the disruption or uncertainty that has been present in the market over the last, I don't know, certainly several months as the debt ceiling debate has been discussed, has been concerning, to say the least. And people smarter than me seem to be forecasting that whether the U.S.
would lose its AAA credit rating, now or 2 months from now, or 6 months from now, or 12 months from now. It's probably more likely that it's going to happen somewhere in the kind of near to intermediate term.
To your point, I don't know that there's a lot that you can do about that, and I'll have Julia give you some of the rules of the road. But having said that, we don't see it as being particularly disruptive, given that we have a very, very small percentage of our portfolio in anything that would be closely tied to that.
So we only have about 5% or 6% in treasuries or agencies that would be at immediate risk if the U.S. were to be downgraded.
But I'll have Julia fill in some of the blanks.
Julia Lawler
Larry got that exactly right. We would see very little capital impact to our portfolio.
Our liquidity position going into this is very strong. So we're really not doing a lot different than we were doing.
We derisked the portfolio significantly in the last 2 years. We've improved liquidity a lot.
So we see little impact, really, for a downgrade. The bigger issue for me, as I look forward, is not so much the rating downgrade but looking forward to the economy.
So I'm much more looking forward to what could happen to the economy and that impact than the downgrade.
Andrew Kligerman - UBS Investment Bank
And then maybe just shifting back to FSA flows. Clearly, very good progress and on the positive side, I'd be curious as to what you're doing in the TPA channel to get sales up more than 50% year-over-year there.
And then, the transfer deposits have been big. Why have they been so strong as well?
You gave a few stats a little earlier. But on the flip side, it looks like recurring deposits are down about 7%.
So I'm curious what's going on, on that front and whether that might shift in a positive direction as well.
Larry Zimpleman
Just quickly on recurring deposits, don't read too much into one quarter. If you look year-to-date, recurring deposits are relatively flat.
Deferrals are actually up a little bit. The profit-sharing contributions are a little bit lumpy.
So that's really where -- a slight bit of noise, but I wouldn't draw any conclusions. So my high-level takeaway is that on recurring deposits, we’re fine, and I'll let Dan talk a little bit about what we're doing around TPA because that's a really good story.
Daniel Houston
So on TPA, as I cited last time we chatted, we do extend to our TPA partners the same set of services that we make available to our full-service clients. And that, I mean that we provide Total Retirement Solutions in that we can provide defined benefit, defined contribution.
ESOP as well as non-qualified deferred compensation -- recordkeeping for those TPAs. We do make service reps available.
We can implement our retire secure [ph], which keeps [ph] at increasing the participation in local level. I think there was some pent-up demand from Principal not having been out there in the past and, frankly, there's a few other competitors who have changed some of the way in which they're working with TPAs, which is -- perhaps endear them to work with Principal and listen to our value proposition.
So pent-up demand and flexibility in services would be the main drivers, Andrew.
Operator
Your next question comes from the line of Ed Spehar with Bank of America-Merrill Lynch.
Edward Spehar - BofA Merrill Lynch
One question on FSA and one on PGI. First on FSA, there's a lot of focus, obviously, on the ROA and 30 basis points seems to be the magic number that you cross over and people get concerned.
I guess the question I have about the driver of FSA ROA, if you were to be below your 30-basis-point target on a sustained basis, what's the chance that, that would come from the spread-based portion of FSA versus the fee-based? Everyone's focused on sort of the pressure on fees, but you look at this quarter and I think you had pressure on the ROA because of the spread business.
So that's the first question.
Larry Zimpleman
Okay. And I'll just comment quickly on that.
I do appreciate that observation. I think we've commented in every earnings call for I don't know how long that you can't look at one single component of this and draw a conclusion.
And so to your point, if you look at relative to a year ago, if you look at over the last few years, there has been sort of a steady lessening interest on the part of plan participants for, if you will, guaranteed-type options, which is the spread-based earnings, the spread-based revenue that you're talking about, and that makes perfect sense when you're talking about interest rates that are essentially 0 or something in the order of 1%. So if you look at relative to a year ago, that share, that percentage share that's in the general account guaranteed options down about 2%, and so that alone is going to speak to about 1 basis point decline in revenue.
So to your point, there is a shift going on from higher ROA, more capital-intensive options to lower ROA, higher capital flow options, which again we view, quite frankly, as a positive. So it's very, very important not to over-read one quarter, it's very, very important not to over-read one metric like revenue.
I would say this block continues to get healthier and healthier, and we're very, very happy with the margins that we're earning.
Edward Spehar - BofA Merrill Lynch
Then the question on PGI. If I look at the earnings run rate this quarter, is this a sort of sustainable number that would grow based on AUM?
And then if we're looking out next year, adjusted up by, let's say, $5 million to $6 million after tax a quarter considering what you've told us about accretion from the HSBC feasibilities.
James McCaughan
On the last point, Ed, note that the HSBC acquisition is in Principal International rather than Principal Global Investors. Having said that, I think the way to think about your question is actually to look at pretax margins, which is how -- the return on revenue, which is how most asset managers would look at it.
And during the financial crisis, our really bad year was 2009 when that measure went down to 15%. We're currently running at about 25%, which I regard as a partial recovery to our long-term target, which would be a little bit over 30% pretax margin.
So what I'm really saying is over the next 2 or 3 years, absent another financial crisis, like 2008, '09, absent that, we should be able to build back to margins over, or a little bit over, 30% together with the accretion from the couple of acquisitions we've already done plus the acquisitions that we're hoping to do over the next year or 2. So if you put it all together, you're recall that I put a fairly aggressive, or it looked aggressive at that time, projection for Principal Global Investors earnings at the Investor Day last December.
The way I would put it is we are ahead of schedule and moving towards that 30% margin I talked about in December. And with what we've said on flows, what Larry and Terry said on flows, we're feeling pretty optimistic about that.
So I hope that puts the current run rate into context.
Operator
Your next question comes from the line of Steven Schwartz with Raymond James.
Steven Schwartz - Raymond James & Associates, Inc.
A lot were asked already but I do have 2. Larry, Terry maybe you could give us a -- remind us of the plan to cut expenses in corporate and other in light of getting out of the major medical business and how that is going.
And then maybe an update about what you're thinking about in terms of maybe looking at next year free cash flow to operating earnings, how that might work out?
Larry Zimpleman
I'm sure Terry will probably want to comment on both of those. Maybe just a quick comment on the second one, Steven.
We, of course, obviously, do continuing projections on a regular basis. We commented in our earlier comments that 60% of our earnings are now coming from our fee-based businesses.
So I would say, in rough terms, we would be in position again forecasting a little bit forward here. But next year, we probably need somewhere around 30% to 35% of our operating earnings to support the organic growth of our business.
So somewhere between 65% and 70% of our earnings would be available for free cash flow. But the other comment I would make there is that, as you well know, there are some other pieces in there.
Primarily, again, issues around C1 credit that could add or subtract, if you will, in terms of cash flow that we can use for other purposes. So over the course of the last couple of years, we've incurred a fair bit of negative credit drift, and this is really the first quarter where we started to see just a very slight turnaround in that.
It's probably too early to forecast that of any sizable magnitude given the problems with the U.S. and the potential downgrade of U.S.
credit. But that's just something to kind of keep your eye on as we go forward, which could be some positive trends around credit drifts.
So I'll have Terry talk about the corporate and other.
Terrance Lillis
Steven, I’d agree with Larry's comments on the free cash flow. It does -- 2/3 of the net income is going towards free cash flow, as we don't need as much to support the organic growth.
As terms of overhead that we are now seeing in the corporate segment, we said at the beginning of the year that would be about $8 million per quarter. And as we progress through the year, we've reduced that amount, and it is getting lower, currently around $6 million in the current quarter.
Other businesses are growing into that overhead. We're reducing some expenses as well.
So we are managing that, and we're in line to remove that overhead over the 18 to 24 months that we'd mentioned last fall.
Steven Schwartz - Raymond James & Associates, Inc.
So on a quarterly run rate, we're still talking about another $6 million to go?
Larry Zimpleman
Yes, probably $6 million this quarter. We'll be working that down.
But for this year, I would say $6 million is a pretty good number for overhead.
Terrance Lillis
It actually will drop off reasonably quickly because the business in the second -- the Insured Medical business will really start dropping off more quickly in the second half when we'll have the ability to basically non-renew, and they'll transition more quickly over to United or some other carrier.
Operator
Your next question comes from the line of Chris Giovanni with Goldman Sachs.
Christopher Giovanni - Goldman Sachs Group Inc.
Within FSA, based on the number of plans, we're seeing plan count at the larger employers increase while retracting in some of the smaller employers. So can you talk about this shift maybe in the context of what you're seeing from competitors, maybe your outlook for small, medium businesses?
And then any shift in strategy within the larger corporations?
Larry Zimpleman
Yes, I'll have Dan comment, Chris. Again I would say that our goal remains to be competitive, and we are competitive at small, medium and large.
One thing, depending again on what your point of comparison is there and your question whether you're looking at just last quarter or whether you're looking at a year ago, one of the things that you need to remember is the impact of the RESA queue [ph]. So the RESA queue [ph] had about 1,400 contracts in there in the year-ago quarter.
So you just need to be cognizant of that as you kind of make your analysis and comparison. But I'm sure Dan's got more comments.
Daniel Houston
Yes, just a couple, Larry. The first of which is just the lack of new plan formation that continues to be a drag in particular in that small to medium-sized market segment which is, historically, where about half of our growth came from.
And we're still seeing a fairly steady diet of plan terminations. Not contract terms but plan terms.
They're eliminating their plans. That's not unexpected in difficult economic times.
Larger employers, more stability, winning on transfer cases, obviously, and we're retaining those. So we remain just as committed to the small- and medium-sized business marketplace.
We like it. We have a lot of success.
We got good scale. We’ve got our TPA initiative.
We have our Allianz partners. And so again, we haven't lost our enthusiasm for the small- to medium-sized market segment.
Albeit, it's been a difficult economic environment for those small employers.
Christopher Giovanni - Goldman Sachs Group Inc.
Okay. And then given the U.S.
debt issues, how are you guys thinking about sort of the risk of some of the budget proposals we have seen in the life insurers over the years actually maybe getting pushed through? And what would the potential impact be on like DRD, et cetera?
I think a couple of quarters ago you talked around maybe in the around $0.20. But I just wanted to see sort of how you're viewing that risk as we move forward.
Larry Zimpleman
Well, I think it's a little early to tell, Chris, whether there will in fact be serious consideration of tax reform in the near future. My personal belief would be is that between now and election in November 2012, it'd be highly unlikely that we would get into a debate that's going to be as confrontational as that one is.
I think if the election in 2012 provided some clarity either way, relative to political party, then there's maybe some possibility of that in, say, 2013. So that -- my point is, it would be a ways out there if there was going to be any discussion, and it would be very much dependent on the election.
Having said that, we are, of course, much less, if you will, life insurance than many of our peers. So if inside buildup is an issue, that's a little bit less of an issue for us.
And the last thing I'd say is that sort of DRD, as we've said in the past, that's somewhere in the range of a benefit of roughly $80 million a year.
Christopher Giovanni - Goldman Sachs Group Inc.
Okay. And then just one last quick one, if I could, maybe for Terry.
Have you done any sort of preliminary work around the EITF 09-G in terms of what the implications could be if you're going to look at it retrospectively or not?
Terrance Lillis
Chris, we have looked at this, and we're anticipating it will probably on a retrospective basis. But we're working with E&Y at this point in time to make sure that they're comfortable with our methodology as well.
And we'll probably discuss that later in the year.
Operator
Your next question comes from the line of Suneet Kamath from Sanford Bernstein.
Suneet Kamath - Sanford C. Bernstein & Co., Inc.
I guess during the quarter, one of your competitors in the Full Service business was, I guess, a lot less enthusiastic about it relative to the past. And in follow-on discussions with them, one of the things they cited was this trend towards increased unbundling sort of making its way into the small case market and perhaps that having an impact on the business.
So can you just talk a little bit about how you're viewing that? Is it a risk to your margins?
Are you prepared to go to a complete unbundling strategy if that's what the clients want?
Larry Zimpleman
Sure, Suneet. This is Larry.
Let me just assure you that our enthusiasm for what we do in terms of the U.S. retirement space is as high or higher than it's ever been.
And I think that, at a high level, what happens here is people, other companies look at that space, they understand just how appealing it is, they move into that space, and then they discover that, you know what, there's actually a lot of issues around that. And again, having been in this business 35 years, I've seen and I've commented before many competitors kind of come in and out and sort of -- we know who you're referring to that sort of has come in a couple of years ago and is finding that it's very, very difficult.
So again, I would just emphasize here, our long-term record, our very successful record, our very successful platform, the extent and depth of our service team, our sales team, our Allianz sales, so our enthusiasm. And I think frankly, Suneet, our opportunity is as high today as it's ever been.
But I'll let Dan talk about unbundling.
Daniel Houston
We do try to use a lot of discipline. Our market segment strategy is helping us do that to make sure we're getting appropriate levels of margins regardless of the size of the case.
Tim Minard and his team have done a good job allocating resources facing off each one of those market segments. We still are convinced that the TRS model is a great differentiator.
We’ve got a very strong value proposition for our Allianz partners, they value the local sales and services that we provide. We continue to make investments in that.
We've leveraged those Allianz relationships, not only to include Full Service but mutual funds and annuities. So again, it's a very comprehensive view.
It's inclusive of also asset management and our insurance products, payroll deductions, lack of government's commitment to retirement security means it’s going to go to the private sector. So again, we feel very optimistic about that.
And as we work towards fee disclosure and some of the issues around fiduciary, there will be a few competitors that bail out. We're committed to it.
We've got the scale, and we've got the right people and the strategy in place to continue to be a strong leader in this area.
Suneet Kamath - Sanford C. Bernstein & Co., Inc.
Understood. So bottom line, if we go to an unbundled business model, it really shouldn't have an impact on your margins, that's what you're saying?
Daniel Houston
Exactly.
Suneet Kamath - Sanford C. Bernstein & Co., Inc.
Got it. And then just the last question on the whole TPA strategy.
I get that, that's where the market's going and that's obviously where you need to be. But is there a risk in terms of your non-TPA distribution force, your sales force of perhaps maybe alienating them, or any risk like that as you start to move more towards the TPA channel?
Larry Zimpleman
I just want to make one comment -- this is Larry. I just want to make one comment here quickly, Suneet.
First of all, I don't think that there's any evidence that the market is moving toward a TPA solution. Let me be very clear, the market, about 30% of the market has typically preferred an unbundled solution and you can track that going back literally decades, and that continues to be about where that is.
The reason we've begun to talk a little bit more about it is because we PFG have begun to be more active in that TPA market than we have historically. So it's not that there are more -- that there's more interest by advisors or by plan sponsors in TPA.
It's that we now have, because of the investments we’ve made over the last couple of years and the distribution alliances, we now have the capability to be competitive in that market. So that's the difference.
Terrance Lillis
And the only thing I would say in terms of competition, it’s our Full Service Accumulation reps, they've got the benefit of selling a bundled or a unbundled solution. We don't have 2 competing wholesale sales forces out there competing with one another.
We're competing against the competitors. And again back to what Larry had said, we think this is about 25% to 30% of the marketplace.
So we look to make the pie bigger, not to carve out and reduce the number of cases nor account -- assets for Full Service Accumulation. And then a closing comment there, again, if you look at trailing 12-month sales for Full Service Accumulation, it's up 87% through 6/30 of 2011 relative to 6/30 of '10.
And again, it gets back to Allianz, it gets back to TPA, it gets back to TRS. So it's just one of the drivers for growth for PFG.
Operator
We have reached the end of our Q&A. Mr.
Zimpleman, your closing comments, please.
Larry Zimpleman
I just want to thank everybody for joining us, and I do appreciate everybody's continuing interest. As I said at opening part of the call, we're very pleased with our results for second quarter and year-to-date, but we know that there will continue to be a lot of challenges in the global economy.
We do think our transition to a fee-based company with higher levels of free cash flow is going to give us the opportunity for higher growth but also capital flexibility, which is going to remain key in this uncertain environment. So thank you very much.
We look forward to seeing many of you in our visits over the next quarter and hope everybody has a great day.
Operator
Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 8:00 p.m.
Eastern time until end of day August 9, 2011. 79538107 is the access code for the replay.
The number to dial for the replay is (800) 642-1687 U.S. and Canadian callers or (706) 645-9291 international callers.