Oct 28, 2011
Executives
Daniel Houston - President of Retirement, Insurance and Financial Services Larry Donald 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 J. Lillis - Chief Financial Officer, Chief Accounting Officer and Senior Vice President James Patrick McCaughan - President of Principal Global Investor Julia M.
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
Colin W. Devine - Citigroup Inc, Research Division Ryan Krueger - Dowling & Partners Securities, LLC Suneet Kamath - Sanford C.
Bernstein & Co., LLC., Research Division Randy Binner - FBR Capital Markets & Co., Research Division Christopher Giovanni - Goldman Sachs Group Inc., Research Division John M. Nadel - Sterne Agee & Leach Inc., Research Division Steven D.
Schwartz - Raymond James & Associates, Inc., Research Division Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division
Operator
Good morning, and welcome to the Principal Financial Group Third Quarter 2011 Financial Results Conference Call. [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's Third Quarter Earnings Conference Call.
As always, our earnings release, financial supplement and additional investment portfolio detail are available on our website at www.principal.com/investor. Following the reading of the Safe Harbor provision, CEO Larry Zimpleman and CFO Terry Lillis will deliver some prepared remarks.
Then we will open up the call for questions. Others available for the Q&A are Dan Houston, Retirement Investor Services and U.S.
Insurance Solutions; Jim McCaughan, Principal Global Investors; Norman Sorensen, Principal International; and Julia Lawler, Chief Investment Officer. Also joining us today is Luis Valdes, President and CEO of Principal International.
Some of the comments made during the conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy.
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-Q filed by the company with the Securities and Exchange Commission. Now, I'd like to turn the call over to Larry.
Larry Donald Zimpleman
Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas.
First, I'll discuss financial results. Third quarter had more than the usual amount of noise associated with market events that may mask underlying growth, which remains strong.
Second, I'll provide an update on the continued successful implementation and execution of our strategy and I'll close with some comments on the regulatory environment, as well as other items that demonstrate the growing strength of the Principal. Then Terry will cover the financial results in more detail and discuss the long-term impact of low interest rates and impacts to the 2012 results from the new deferred acquisition cost guidance.
Overall, while third quarter financial results were impacted by external market factors which I'll discussed briefly, we are pleased with the continuing momentum of our businesses. That momentum has been building throughout 2011 and is reflected in strong year-to-date results in all of our businesses.
Despite the economic and market headwinds, we remain optimistic that the ongoing momentum and strong underlying fundamentals of our business will carry on into fourth quarter. Let's look at the third quarter financial results in more detail.
As Terry will discuss, we incurred approximately $22 million or $0.07 per share of market-related deferred acquisition cost impacts caused by the 14% decline in the S&P 500 for the quarter. In addition, we saw the variable investment income on excess capital held at the holding company be reduced by $12 million or $0.04 per share due to negative marks caused by widening of credit spreads during the quarter.
Despite the impact of these on our quarterly financial results, the growth metrics of sales and net cash flow continue to be outstanding for the quarter, including Full Service Accumulation sales of $1.5 billion for the quarter, up 72% over third quarter 2010, driving net cash flows to $350 million compared to negative net cash flows of $200 million in third quarter 2010. Principal Funds' third quarter sales of $2.6 billion drove $180 million of net cash flows this quarter.
Principal Global Investors' unaffiliated net cash flows were $1.2 billion this quarter as a result of strong sales and $5.6 billion in deposits. And Principal International net cash flows of $700 million in third quarter 2011 were down slightly from third quarter 2010, caused by slower growth in Asia.
Importantly, pipelines remain strong across our businesses, although continuing economic uncertainty may have an impact over time. Because quarterly financial results are often impacted by short-term economic and market events, it is more constructive to look at year-to-date results for both sales and financial results to see the health of the businesses.
Full Service Accumulation sales are $5.2 billion year-to-date, and year-to-date net cash flow is $2.2 billion. For full-year 2011, we expect Full Service Accumulation sales to increase 20% to 25% over 2010 sales.
Principal Funds' year-to-date sales are up 20%, and year-to-date net cash flows have increased 29% over 2010. For the full year, we expect Funds' sales to be up approximately 15% and net cash flows to be approximately 5% of beginning account value.
Principal Global Investors' operating revenues are up 14% year-to-date, and operating earnings are up 44%. Investment performance remains solid, and our unaffiliated pipeline continues to be strong.
Principal International continues to have another solid year, with $3.8 billion of net cash flows year-to-date, which are up 32% over 2010 and record assets under management of $55 billion, which are up 29% over 2010. In U.S.
Insurance Solutions, individualized sales are up 14% year-to-date. Premiums and deposits are up 11% year-to-date, driven by sales in the nonqualified and business owner market, which now account for 58% of Individual Life sales.
Specialty Benefits sales are up 29% year-to-date, driving premium and fees up 6% year-to-date. Importantly, we have now had 5 consecutive quarters of growth with new sales premium exceeding client lapses.
This momentum across our businesses positions us for continuing growth in the U.S. and the international markets where we operate.
We also benefit from the overall diversification in the sources of our revenues and operating earnings, with 60% of operating earnings coming from fee-based businesses. Next I'll provide an update on the continued successful execution of our strategy.
The key differentiator for Full Service Accumulation continues to be our Principal Total Retirement Suite, with 51% of sales on the Total Retirement Suite platform. Total Retirement Suite close ratios continue to be double those of single retirement product sales.
Persistency is better for this block as well, with a 20% improvement in last rates compared to non-Total Retirement Suite plans. Our focus on the Allianz distribution channel continues to drive strong Full Service Accumulation sales, with year-to-date Allianz sales up 46% over the prior year.
We continue to gain traction with third-party administrator sales as well. Our increased focus on this market gives us access to a broader base of advisors and helps us capture additional market share.
Moving now to Principal Funds. Sales results are driven by good investment performance and demand for our innovative products, such as the Principal Global Diversified Income Fund.
To further meet the growing need for retirement income solutions, this month we launched the Global Multi-Strategy Fund, which seeks to achieve long-term capital appreciation with an emphasis on positive total returns and relatively low volatility. A couple of quick comments about the execution of our boutique strategy in Principal Global Investors.
We successfully closed on the acquisition of a majority stake in Origin, a London-based global equity specialist, on October 3. Origin's strong performance track record, combined with our global distribution network, provides us additional capacity in international equities.
The onboarding of Finisterre, an emerging market fixed income boutique also based in London, has been very successful as well. We've had tremendous support from Finisterre's key consultants and have retained all of their clients during this transition.
Finisterre's impressive track record combined with our distribution network, sets the stage to attract a significant flow in the future, as investors see opportunities for diversification in emerging markets. We continue to see increasing demand for higher yield products as well as other areas where we have expertise, such as preferred securities, real estate and emerging markets which generate higher revenue and higher margins.
As we said at the Principal International workshop, the carefully selected emerging markets in Asia and Latin America, which we are operating in today, have tremendous growth in middle-class populations and privatization of retirement systems is rapidly taking hold. Our strategy is to export our retirement and investment management expertise to these key emerging markets to work with marquis distribution partners in these countries and to go deeper in these markets through organic growth and opportunistic acquisitions.
Our focused execution has resulted in rapid growth of the businesses. We were early entrants into these markets, and we continue to see growth in operating earnings of 15% to 20%.
We are well positioned to capitalize on the growth opportunities in these markets as we move forward. Overall, I'm very pleased with the continued execution of our strategy across the businesses.
With a strategy that is focused on long-term growth, our outlook remains positive despite market volatility and continued choppy economic recovery. Let me quickly comment on the impact of extended period of low interest rates.
The evolution of our business model towards fee-based businesses creates a blend of less capital-intensive businesses that helps us weather the current low interest rate environment. Terry will go into more detail on the impact if low interest rates persist over time, but let me simply say that the current low interest rates would have to continue for an extended period, at least 3 years, before they would have a meaningful impact on our operating earnings.
Moving now to some comments on the strength and flexibility of our financial position, I'm very pleased with the capital deployment actions we've taken in 2011, which reflect execution of 3 acquisitions, 2 share repurchase programs, and as we announced yesterday, a 27% increase in our annual common stock dividend, which will be paid in early December. Our shift to a more fee-based business model means we need less cash to support organic growth and enables us to deploy more capital towards strategic acquisitions and return more capital to shareholders.
As of the end of the third quarter, we have $1.8 billion of excess capital. This gives us continuing capital flexibility in what remains an uncertain environment.
Let me move to some positive regulatory developments. Based on recent updates, it appears unlikely that we'll be named a systemically important financial institution or be considered a major swap participant.
Therefore, I remain confident in our ability to continue with our current successful business model. In closing, I'd like to take a moment to recognize a significant milestone for the company.
Last Sunday was the 10th anniversary of our initial public offering on the New York Stock Exchange. Becoming a public company set the stage for a decade of growth, as the Principal continued its evolution from a once-largely insurance-based organization to its status today as an investment management leader.
The Principal was named Investment Brand of the Year in the 2011 Harris Poll Equitrend study, which further demonstrates the transformation of our business model over the last 10 years. As the first U.S.
company to go public after 9/11, we recognize the significance of moving forward, while never forgetting the tragic events of that day. In commemoration of the 10th anniversary of our IPO in 9/11, we'll be making charitable gifts to several programs in support of families of New York City police and firefighters and deployed service personnel.
As further recognition of our commitment to those that serve in the military, the Principal was one of only 15 companies out of more than 4,000 nominations to receive a 2011 Freedom Award from the Employer Support of the Guard and Reserve group, a Department of Defense agency. It's the highest recognition given to employers for exceptional support of their employees serving in the guard and reserve.
Terry?
Terrance J. Lillis
Thanks, Larry. The trend of strong business fundamentals continued in the third quarter.
This morning I'll focus my comments on operating earnings and net income for the quarter, more detail around our modest exposure to a sustaining low interest rate environment, an update on our capital position and deployment strategy and an overview over the projected impact of new deferred acquisition cost guidance starting in 2012. Starting with total company results, operating earnings of $192 million were down 12% from a year-ago quarter on 11% higher average assets under management.
There were a few items impacting third quarter 2011 operating earnings. Two of the major items were: third quarter 2011 had negative DAC amortization true-ups due to the equity market performance which impacted Full Service Accumulation, Individual Annuities and Individual Life by $0.07 in total; and in third quarter 2011, the Corporate segment was impacted by $0.04 from lower variable interest income on excess capital held at the holding company due to negative marks caused by widening of credit spreads.
Adjusting for these items, we consider the earnings-per-share run rate for the third quarter to be $0.72, and third quarter 2011 earnings up 12% on an 11% increase in average assets under management compared to an adjusted third quarter 2010. Now let me discuss business unit results.
Full Service Accumulation operating earnings at $71 million were down 12% from a year-ago quarter on a 12% increase in average account values as a result of higher DAC amortization from negative equity market returns. With the recent market volatility, looking over an extended period of time provides a more normalized view.
On a year-to-date basis, adjusting for the equity market impact, 2011 operating earnings are in line with the increase in average account values as compared to 2010. We continue to see our Full Service Accumulation sales pipeline build across market sizes and distribution channels and close ratios that returned to pre-crisis levels.
This will help drive full-year net cash flow results that we now expect to be approximately 3% of beginning account values. Principal Funds continues to deliver strong operating leverage.
Operating earnings at $13 million in the third quarter were up 47% over a year-ago quarter on a 16% increase in average account values. Though the retail industry experienced outflows this quarter as investors pulled back a bit, our innovative product solutions and multichannel distribution model continue to generate strong sales growth and positive flows.
Competitive investment performance also contributed strong fund sales. This includes particular strength in asset allocation where at quarter end, 84% of target date and target risk funds were in the top half on a 1-year basis, 78% on a 3-year basis and 69% on a 5-year basis.
Individual Annuities' operating earnings at $15 million were lower because of higher DAC amortization due to negative equity market returns in the current quarter, while a year-ago quarter saw a positive equity market returns and had positive true-ups. Adjusting for this, earnings are comparable between the 2 periods.
Earnings from Principal Global Investors at $19 million improved 27% from a year-ago quarter on a 6% increase in average assets under management, reflecting the operating leverage in this business. Client search activity continues despite current market volatility and because of this, we remain optimistic about flows over the next few quarters.
Moving to Principal International, operating earnings at $37 million were up 11% from the third quarter 2010. Principal International finished the quarter with record assets under management of $55 billion, $62 billion when including China despite recently strengthening dollar.
This growth was driven by organic net cash flows of $700 million and $3.1 billion of operations acquired with the HSBC Mexican AFORE business. We closed this transaction in early August and fully integrated the companies in September.
This transaction increases our scale in the mandatory retirement business in Mexico. Since this acquisition leverages our existing infrastructure, it was immediately accretive in the third quarter.
The benefit of the third quarter was partially offset by acquisition costs. We expect the benefit of $5 million to $6 million per quarter to be fully realized in the fourth quarter.
Individual Life operating earnings were $26 million. Current quarter results were adversely impacted by higher DAC amortization due to negative equity market returns and slightly unfavorable mortality experience.
After adjusting for these items, operating earnings remain in line with previously communicated expectations. Turning to Specialty Benefit, operating earnings declined 12% from the year-ago quarter to $22 million, reflecting quarterly volatility in claims experience.
While third quarter 2010 loss ratios were at the low end of our 65% to 71% targeted range, third quarter 2011 loss ratios were on the higher end of that range. However, the year-to-date loss ratio comparison between the 2 periods is equal, and year-to-date operating earnings are up 14% on 6% higher premiums.
Corporate reported operating loss of $40 million, driven by approximately $12 million earnings shortfall from lower variable investment income on excess capital held at the holding company due to negative marks caused by widening of credit spreads. We view the quarterly run rate earnings for Corporate to be a $30 million operating loss, with some volatility around this result.
Total company net income of $64 million this quarter was impacted by a court ruling regarding some uncertain tax positions and the estimated obligation associated with the New York State Insurance Department's liquidation plan for the Executive Life Insurance Co. of New York.
We also experienced $38 million of credit-related investment losses during the quarter. While the credit environment remains choppy, the losses remain manageable and we continue to see improvement in our portfolio, reflecting the benefit of broad asset diversification.
As Larry mentioned, with the evolution of our business model, we now have much higher portion of earnings coming from less capital-intensive businesses. Of our $57 billion of Principal Life's general and guaranteed separate account assets, $19 billion or 34% includes a guaranteed minimum interest rate, and only $7 billion or 12% is currently at those minimums.
For the remaining portion not at the minimums, we have an average of 70 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 low interest environment.
If the quarter-end low interest rate environment persists, we would a 1% to 2% impact on our expected 2012 earnings, growing to 3% to 8% impact if conditions persist beyond that. If the low interest rate period were to persist for an extended period of time, it may result in a reduction in our long-term interest rate assumption used to model deferred acquisition costs and related actuarial balances.
If we were to lower our long-term interest rate assumption by 25 basis points for every segment across the company, it may result in an additional onetime $25 million to $35 million after-tax reduction to operating earnings. As part of our periodic review of assumptions, we monitor the interest rate environment and do not expect an immediate need to lower our long-term interest rate assumption.
Moving to our balance sheet. Our net unrealized gain position of $1.6 billion was unchanged from second quarter 2011.
Our $1.2 billion gain from impact of decreasing interest rates was offset by widening credit 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, and it does not force us to sell assets.
Now moving to capital adequacy. As of quarter-end, we estimate our risk-based capital ratio to be 455%.
Relative to a 350% RBC ratio, we have approximately $1.8 billion of total excess capital as of the end of the third quarter, with $700 million of the excess capital at the holding company. Including the Origin acquisition that closed on October 3, we have deployed $350 million for strategic acquisition and $450 million for share repurchase.
Additionally, we have announced a $0.70 per share common stock dividend, a 27% increase over last year's $0.55 per share common stock dividend. This brings our total capital deployed year-to-date to $1 billion and reflects the improvement in the free cash flow generation of our business model that is more fee-based, and the long-term commitment that we made to turn excess capital to shareholders.
As always, we'll continue to evaluate additional capital deployment opportunities. I'd now like to take a moment to provide an overview of the expected impact of the new deferred acquisition cost guidance on our businesses and starting in 2012.
In October 2010, the FASB issued an update that narrows the definition of acquisition costs that can be capitalized and deferred by insurance companies. Starting in January 2012, only incremental direct costs of contract acquisitions can be deferred.
All other costs are to be expensed as incurred. We expect to apply this guidance retrospectively.
This will result in less capitalization of acquisition costs, resulting in increased current period expenses. It will also result in a reduction of our deferred acquisition cost asset, as well as eliminate any future amortization associated with deferred acquisition cost assets written off as of the beginning of the year.
For growing companies like the Principal, the reduction in first year costs that can be capitalized could be greater than the reduction in the annual amortization of the lower deferred acquisition cost asset. Consequently, near-term operating earnings will be lower than under the current methodology.
However, this is a change in timing of earnings recognition and the economic earnings of the underlying businesses remain unchanged. We are still evaluating the full impacts of implementing this guidance, but we currently estimate that our adoption will result in a reduction to the opening balance of retained earnings between $550 million to $750 million at January 1, 2012.
We also currently estimate that adopting this new guidance will result in a net $35 million to $45 million full-year reduction to 2012 operating earnings. These estimates are based upon our current operating assumptions and current interpretation of the guidance and are subject to change.
The majority of this impact will be in Full Service Accumulation an Individual Life, with much smaller impacts on Individual Annuities, Principal International and Specialty Benefits division. On a positive note, going forward we will have less earnings volatility in Full Service Accumulation since there will be a lower deferred acquisition cost asset subject to true-ups from equity market, returns and experience adjustments.
Before I close, I'd like to also announce that on December 1 we will provide our 2012 EPS guidance and an update on our capital deployment strategy. We'll provide more details as the event gets closer.
In closing, we are very pleased with the strong underlying fundamentals of the businesses as we look into 2012 and beyond. This concludes our prepared remarks.
Operator, please open the call to questions.
Operator
[Operator Instructions] The first question comes from Steven Schwartz with Raymond James.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
I just want to confirm one thing on the capital permit I thought I had it, and then I got confused again. The original was, I think you were going to spend $700 million between acquisitions and share repurchase.
And then you went up to $1 billion. What I'm not clear about is this extra $200 million of dividends.
Is that -- was that foreseen in the $1 billion initial guidance? Or are we still sitting here with $200 million of excess?
Larry Donald Zimpleman
Steve, this is Larry. I'll comment on that.
When we started 2011, we were sort of estimating that the budget that we would have for acquisitions and share repurchase was in the range of $800 million.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
$800 million, okay.
Larry Donald Zimpleman
And at the second quarter call a quarter ago, we estimated that we thought that $800 million was probably closer to $1 billion. So those 2 numbers didn't necessarily include anything that we would do with the common stock dividend.
So as you know, we now deployed $800 million for acquisitions and share repurchase as compared to the potential budget of $1 billion. And in addition to that, we've now declared a common stock dividend that is, give or take, roughly $200 million.
So there would be a potential of an additional amount up to $200 million that could still be in that strategic acquisition and share repurchase bucket. But I would tell you that obviously the world looks a little bit different today than it did at the end of the second quarter, so I think there's a little more caution that we'd want to apply around whether we would actually utilize that full $200 million in 2011 or whether some of that might, in fact, carryover and be looked at in 2012.
Steven D. Schwartz - Raymond James & Associates, Inc., Research Division
Okay. And then, if I may, one more.
On Group Life mortality, that looked like a very high number on the loss ratio, maybe 10 points higher than where it had been tracking the previous 4 quarters. I know you think that, that number for this quarter was in line but at the high-end, can we take away from that, that the last 4 quarters have just been running really, really good?
Larry Donald Zimpleman
I'll have Dan comment on that, Steve.
Daniel Houston
Yes, I think -- I mean, bottom line is we had a high quarter, and we actually think that the previous run rate is actually closer to what we would expect relative to pricing. It's a bit of an outlier, and it's obviously not one of those things that allows the customer to gain the system.
So again we will look at this as an anomaly relative to a run rate. Does that help, Steven?
Operator
Your next question comes from the line of Jimmy Bhullar with JPMorgan.
Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division
I have a question for Dan, just on the FSA business. I thought you had decent flows this quarter.
But just wondering if you could address why your FSA plan counts have been declining. It's down, I think, close to 2,000 plans over the last year.
And it's especially down more in the smaller case, sort of core-type market. And then related to that, if you could just talk about what you're seeing in terms of employer and employee behavior in terms of deferrals.
Have you seen any uptick in 401(k) loans? Or what are you seeing in terms of behavior, both on the part of employees and employers in terms of matching and deferrals and stuff?
Daniel Houston
Yes. I mean...
Larry Donald Zimpleman
Maybe just make a quick comment, Jimmy. The one thing that you need to take into account when you're looking at that plan count over the last year or so is that there were a number of contracts in there that were in the third quarter 2010 number that fell out in fourth quarter 2010 because of the unwinding of the real estate queue.
So the actual growth in contract count based on normalizing for that has actually been positive for a number of quarters. But I'll let Dan get into the detail.
Daniel Houston
Yes. When we just look at just startup plans, if you go back to the era of '05, '06 and '07, there were 1,500 to 1,800 startup plans.
If we look at where we're at year-to-date, startup plans was about 820. If you annualize it, you kind of get to that 1,100 or so plans for our full-year 2011.
So in terms of just contributing to positive case count growth, we're only running about 65% or 70% of where we had historically been running for those startup plans. The second negative impact that you have on plan counts are just the plan terminations.
Again, we've talked about this on previous calls. But it's businesses that have gone out of business, and therefore they've terminated the plan.
When we look at the ongoing flow of new cases relative to those that we've lost, we've had 6 consecutive positive quarters now of growth for case count. So again, I think this has far more to do with the external environment about the lack of startup plans and plan terminations due to going out of business than anything else.
In terms of deferrals and matches and participation, participation is about where it has historically run, recognizing there's a little bit of downside. There's a bit of a positive upside on participation due to some of the plans having auto-enroll, auto-escalate and those kind of come in at 25% to 30% range.
If we look at average deferrals it's up a little bit, which is a very positive component when you think about the number of new people that might be -- being added at the low end of the range. Hardship withdrawals are flat.
And then if we look at loans, loans are up about 5% relative to a year ago but those loans, again as a percentage of the total assets, is still a relatively small number. So again the fundamentals of the business, both from case count participation, deferrals look good.
My closing comment would be around matching contributions. We've said in previous calls that about 80% of our plans are discretionary, about 20% are stated matches.
And of those stated matches that someone had previously made a change in either decreasing or suspending their match, about 1/3 of those individuals or those corporations have now put their match back in place either at the same level or increased it. Hopefully that helps, Jimmy.
Operator
Your next question comes from the line of Randy Binner with FBR.
Randy Binner - FBR Capital Markets & Co., Research Division
I'm going to pick up on FSA. The way we measure fees, just as a percentage of overall assets, seems to continue to tick down.
And I just wanted to get some color on, I guess, transparency changes with the product and competition and just get a feel for how we should try and model fees relative to assets in the FSA segment going forward?
Larry Donald Zimpleman
Yes, I'll ask Dan to take that.
Daniel Houston
Sure. So on the fees relative to Full Service Accumulation, remember that about 75% to 80% of those fees are a direct correlation to the account balances themselves.
20%, 25% of those fees are effectively based upon some more fixed amount, either for administrative services. So roughly 75% should track with account balances.
This year has been a very good year for us in the ESOP area. About 23% of our new case sales have had an ESOP component.
And remember in the absence of having that as part of our TRS strategy, we probably wouldn't have gotten the underlying 401(k) assets along with those. So I would attribute to some of the decline this year in terms of fees tracking account values with the very positive results that we're having for our ESOP consulting division.
And maybe I'll just pause and see if there's a follow-up there.
Randy Binner - FBR Capital Markets & Co., Research Division
Well, yes. I mean that's helpful.
I mean, the flows are improving overall. And then -- so perhaps it's hard for us to model it properly between the asset-tied and the fee-based.
But I guess on a go-forward basis, as long as flows are improving, would you expect fees to grow on a gross basis for FSA? Is that maybe an easier way of us to think about it?
Larry Donald Zimpleman
It is. And of course you're looking at mix of the business, too, then depending on whether or not that goes into international equity account versus a money market or a fixed income accounts.
And we've talked about this in the past, just in terms of geography of where the money lands, in which buckets. And some, as you know, have better revenue streams than others.
And certainly, ESOP has lower revenue streams. But recognize, as I stated earlier, it would if we have the underlying 401(k) assets without those.
And the other one is large case versus small case. It's a little richer in the small size case versus the upper end.
But again, when you look at where we're coming in on these margins, this 28 to 32 range where -- which is where we've been these last 48 months or so, is still a very positive place to be relative to our competitors and allows us to be very street competitive today. And that's not only true for attracting new business.
I would attribute all the same characteristics to our ability to retain customers. And you can tell from the withdrawals, we've really improved that here in the last 12 to 18 months.
Operator
Your next question comes from the line of John Nadel with Sterne Agee.
John M. Nadel - Sterne Agee & Leach Inc., Research Division
I just have a couple of quick ones. Terry, I was trying to keep up with some of those unusual items that you were mentioning, but I may have missed it.
Did you quantify the court ruling impact, the tax item and the executive life costs? And just a clarification, were those in your operating income?
Or were those below the line?
Larry Donald Zimpleman
They were -- this is Larry, John. They were below the line, but I'll let Terry give you the breakdown between those 2.
Terrance J. Lillis
Yes, John, this is Terry. The run rate that we talked about, the items we called out, we said that we had $0.61 EPS.
But we thought that, that was low $0.07 because of the DAC asset and the amortization, the unfavorable impact of the equity markets. And that was about $0.03 in Full Service Accumulation, $0.03 in the Individual Annuities and $0.01 in the Life business.
And then we also had a $0.04 number we called out in Corporate because of the variable investment income. That had a run rate that we feel is appropriate for this quarter of $0.72.
And as Larry mentioned, those other 2 adjustments, the tax decision, the court decision as well as the Executive Life of New York went below the line as -- in part of our other after-tax adjustments.
John M. Nadel - Sterne Agee & Leach Inc., Research Division
Got it. On that Corporate strategy, the investment strategy, is there some benchmark or some -- is there some external benchmark that we can look at to sort of get a better feel for how that tracks?
Larry Donald Zimpleman
Let me -- this is Larry. I'll have Julia give you a little bit of color around that strategy and kind of how it's performed and why we do what we do.
So, Julia?
Julia M. Lawler
Let me give you a little bit of background, first of all. A couple of years ago, we determined that we'd like to earn more than cash return on a portion of that excess capital before that excess capital got deployed.
So PGI manages a credit strategy and that's very simply they purchase investment grade bonds, they hedge out the interest rate risk and then they more actively trade that credit. And you know the PGI fixed income has a skill set at that.
Because the strategy is more actively traded then the rest of our portfolio, all of that return including the marks, run through net investment income. The strategy worked very well for us since inception through third quarter, so including this quarter.
And that has returned about 9%. So clearly better than cash.
So third quarter's performance was clearly an underperformance relative to our expectation. And the expectation again for any kind of active strategy is tough, but we would expect that to be in that $3 million to $4 million range per quarter rather than the negative $7 million we had this quarter.
Does that help?
John M. Nadel - Sterne Agee & Leach Inc., Research Division
Got it. That's very helpful.
And then just the last question is, Larry, can you give us some -- with the buyback authorization having been, I guess exhausted, any expectation on the timing for going back to the board?
Larry Donald Zimpleman
Sure. Well as I kind of said it, I think in response to Steven's questions, the world looks a little bit different today than it did in June or July.
So we continue to have a very active dialogue with the board. I think the good news is we have more capability to do capital deployment.
But again, I think we're going to take a close look at that over time and make some decisions about how much of that budget do we really want to spend in 2011 versus 2012. I would just say again, one of the differentiating points I think for us was fee-based businesses now being 60% of the operating earnings of the company.
We're going to continue to be strong capital generators. So I think that's really the key for investors over time and it's much less, whether it's some incremental piece of that capital done in 4Q11 versus first quarter, second quarter '12, it's probably really less of an issue for us over the long term.
We're going to be careful, prudent. We're going to work closely with the board as we always have.
John M. Nadel - Sterne Agee & Leach Inc., Research Division
Yes, I know. I apologize.
I wasn't trying to get at the exact timing of spending $100 million in this quarter or that quarter. Just wondering the timing for getting yourself in a position that you'd have an authorization in place to be able to take advantage of if the market gave you some dislocations.
Larry Donald Zimpleman
Sure. I mean our tendency or our approach on this, John, is maybe a little bit different.
And again I'm not -- I don't know what's better or worse. But our approach tends to be a little bit different than some other companies in the sense that once we say we're going to do something, then we do it.
We're not as -- frankly, we're not as comfortable with sort of the larger multi-year kind of multi-billion dollar. Even though I think our business model gives us that capability, I think we're just a little less.
Maybe it's our kind of midwestern conservatism, John. I don't know.
But I think we're a little less -- we're a lot less willing to make those kind of big, big type programs. So what you're going to see from us are going to be more incremental.
There are going to be programs that we announce and then we execute on, on a consistent basis. And we're going to be doing more of them at a smaller level than some sort of big multi-year authorization.
Operator
The next question comes from the line of Colin Devine with Citi.
Colin W. Devine - Citigroup Inc, Research Division
Just a couple of questions. First Larry, I was wondering if we could talk a little bit about the bank and your current thinking on that and certainly with the transition of fee-based businesses.
I mean if I look at the bank, really since you've come public, I'm not sure by the time we get to this year that even cumulatively, on a net basis, it's earned anything. And is there really any strategic reason to keeping this?
Secondly, with respect to the realized capital gains and losses this quarter, you certainly highlighted in the press release what came from credit impairments, and again the CMBS problem this quarter. What was the remainder?
Was that just derivatives? Or was that on the commercial mortgage book?
And then lastly for Dan, could you talk about pressures on fees on 401(k) plans as you're doing renewals and stuff? Are you having to get fees down?
Or is that more of a creation of the media?
Larry Donald Zimpleman
Okay, I appreciate that, Colin. Let me speak to the kind of the bank issue.
And first of all, the bank has been a net contributor to profitability over time. And for example, in the current quarter, it was a contributor in the range of sort of $3 million or $4 million positive for the current quarter.
So it has been a positive contributor. We obviously wouldn't -- we wouldn't have a banking business if it wasn't profitable.
We don't believe in loss leaders. That's just not part of our makeup.
So it's a given that the bank is going to have to perform at an acceptable level, acceptably profitable level and it's done that. Now in terms of the strategic rationale for the bank, I would say the strategic rationale for the bank is really in 2 areas.
One is job changers, and the second is retirees. The reality is, is that the most commonly understood financial products by the sort of middle-income population or banking products.
And so the ability to use banking products as a receptacle, as a rollover IRA sort of receptacle for job changers has been very powerful. And as you know, we've had a lot of success with asset retention for job changers.
We stay right in that sort of low 50% range. And frankly, having the bank is one critical component of that.
I think the emerging opportunity for the bank at which, frankly, we have yet to capitalize on, is we need to do a better job, we need to position the bank strategically to be that income management receptacle for people as they enter into retirement. So people today, retirees in particular are quite mobile.
And I think the opportunity around an Internet bank so they can get access to funds no matter where they are in the U.S. or internationally is something that's very powerful.
But we have to do a little more work to build that out. But I think the strategic rationale of the bank is actually very solid.
And obviously we have to match that up against whatever other elements there may be to having a bank, and we're obviously very well aware of all those items. And we'll continue to monitor all of that and see where we come out.
But from a strategic perspective, let me be very clear, the bank does have and plays today a very, very meaningful role. So let me have Julia comment on the credit losses, and then Dan can comment on 401(k) fees.
Colin W. Devine - Citigroup Inc, Research Division
One thing, Larry, before we leave that. How much capital is the bank tying up?
Because I think many of us are trying to figure out why isn't PFG's ROE higher than it is? And I'm looking at the bank, I mean, it lost a lot of money last year, broke even the year before.
What sort of ROE is it producing? And is it tying up a significant amount of capital or not?
Larry Donald Zimpleman
Yes, it is not tying up a significant amount of capital. The ROEs for the bank would be kind of -- are in that range today.
That would be in -- I'm going to say in the low double-digit range, the low double-digit range, Colin. Okay?
Julia?
Julia M. Lawler
Colin, if you were to look in our supplement on Page 44 that kind of breaks down our realized gains and losses, the fixed maturity or credit impairment is very much in line with last quarter and actually for the last 5 quarters. And even the losses on CMBS are exactly flat from the last 2 quarters.
So our impairments related to our fixed income securities are very much in line for the year. And if you look at commercial mortgage, the same is true.
In fact, things continue to improve in our mortgage portfolio. So none of the increase comes from really the investment portfolio.
What you would see, and if you just compared it to last quarter, you'll recall that last quarter was a positive because we sold stocking catalyst. And we said that, that was kind of a onetime event and not repeatable.
That's about $40 million of the change. The other is predominantly in that DAC amortization line.
Is that helpful?
Colin W. Devine - Citigroup Inc, Research Division
Yes.
Larry Donald Zimpleman
Okay. And we'll have Dan cover the 401(k) fees, Colin.
Daniel Houston
Yes, Colin. On fees, fees are part of every single conversation with a prospective client, as well as an existing client.
There's 3 areas they're going to emphasize. One is going to be fees, the second is going to be the services for those fees and the last one's going to be your investment performance.
And I don't know that that's changed in the 27 years I've been around the topic. Fees have probably taken a higher priority in the last couple of years due to small-, medium-sized businesses having pressure on their cost of running their businesses.
So what have we done to respond to that? Part of it is à la carte pricing, eliminating services that our customers don't value and unwilling to pay for.
We're also managing our own expenses here. We're taking advantage of our scale.
We've also tried to make sure that we're emphasizing the value of Total Retirement Suite, which is a different value proposition than just standalone 401(k). Customers put a lot of value on our Retire Secure, our ability to go out there and educate our -- those plan participants from small- to medium-sized businesses.
And we also do a fair amount of consulting, as you know, around deferred comp and ESOP and Defined Benefit. And the other comment maybe I would make is on all plans greater than $5 million, which if you look at that based on assets, it's probably 2/3 of our assets, there's a customized expense solution for every one of those clients.
Here's the cost that we had in providing our services, and here's the charges that we need in order to reimburse ourselves accordingly. So it is a big part of every conversation.
It's not going to go way. We, as you know, have already -- in the midstream of rolling out fee disclosure to the plan sponsors.
And we got to be able to represent our products, our services as being a good value for all of our clients.
Colin W. Devine - Citigroup Inc, Research Division
And I guess to sum it up then, as you're looking at the margins you're making on your 401(k) business today, are they getting better? Are they getting flat?
Are they getting tighter?
Daniel Houston
In the most recent 36-month period of time, they're flat and we've not been able to get that expansion for all the obvious reasons. We've had incredible headwinds from the economy.
Small- to medium-sized employers are under a lot of pressure. And the real question perhaps is, in the long run, as things recover, as we continue to see some of our competitors not being able to compete in this marketplace because of lack of capabilities or size, we think we'll take advantage of that.
And our hope is that we'll see margin expansion at some point. But at this juncture, everyone's fighting the same battle.
We know from third parties that our profitability is quite strong, and it's our intent to continue to stay in that 28% to 32% range.
Larry Donald Zimpleman
Yes, let me -- this is Larry. I'll just close with a couple of comments, Colin.
First of all, if you think -- if you look at this business, how it's performed over the last few quarters by a couple of other metrics, because we've talked about the sort of 28- to 30-basis point ROA, it has about a 29% return on revenue and has about a 26% return on equity based on our own internal allocations of capital. So those are very, very attractive margins by any sort of product in the financial services space.
So we're very happy with that, and I think shareholders will be very happy with that as well if we can keep that going.
Operator
Your next question comes from the line of Chris Giovanni with Goldman Sachs.
Christopher Giovanni - Goldman Sachs Group Inc., Research Division
I wanted to try and focus some on PGI. I mean you're having success here, probably the most success you've had in 3 years.
And I wanted to see maybe if Jim could comment some on kind of behavior and the kind of strategies you're seeing either domestically or internationally in terms of full momentum.
Larry Donald Zimpleman
Sure, we appreciate the question. I'll have Jim respond to that, Chris.
James Patrick McCaughan
Chris, as I think it's hinted in your question, there has been quite a lot of change in client buying behavior over the last 4 or 5 years. What we are seeing is a strong client appetite across many different types of client for income-based products.
So our high-yield, preferreds, mortgages and emerging market debt are all seeing very good receptions from clients. And that speaks, by the way, into what Larry and Terry said about the strong growth in principal mutual fund sales, because the retail clients in the U.S.
like those income-based products. Secondly, we've seen very strong demand for specialty equity products, including emerging markets.
But of course by principal, Global Investors working with Principal International, we have principal of a very strong footprint in emerging markets. And that's been a big positive in terms of the client reception of our investment products.
And then thirdly real estate, which is a very long-established specialty of Principal, but one that's come very much into focus in the last year or 2. So if you add these up, that's why we have seen such a strong performance in the last quarter and actually masked by a few large core client redemptions for several quarters now, and why we've expressed some optimism about the pipeline.
And then these products that I've mentioned, these capabilities that are appealing to clients, the strong performance is also fed into the asset allocation performance that Terry described in the prepared remarks. So I think all of this is really playing well into the growth of our fee-based businesses across the Principal platform.
Principal Mutual Funds, Dan mentioned the importance of investment performance and capabilities for Full Service Accumulation. We are quietly pretty confident about how that whole investment platform is developing for the benefit of our fee-based businesses.
Christopher Giovanni - Goldman Sachs Group Inc., Research Division
Great. And then one question, I guess on the portfolio.
I mean obviously, there's an incredible search for yield here. And I noticed Page 48 of the supplement within the commercial mortgage loan portfolio.
You've been grilling more in the larger loan size amounts, so the $30 million and over versus all the other loan sizes where you've been shrinking here over the past couple of years. So can you talk about maybe if there has been a change in strategy?
Or is it just the overall market that's kind of pushing you more towards the larger case size?
Larry Donald Zimpleman
Yes. No.
No overall change in strategy, but I'll have Julia comment on that.
Julia M. Lawler
Chris, I would say not a change in strategy, but a change in opportunity. Through this recovery period, I would suggest that certain markets and certain property types have performed better, faster.
And some of those happen to be in a little larger size range. But those still are allowing us to do very high-quality mortgages, and I'm talking 50% loan-to-value or better.
So I would say it's because of the opportunity in the recovery, not a change in strategy.
Operator
Your next question comes from the line of Suneet Kamath with Sanford Bernstein.
Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division
I have 2 questions. One, just a quick follow-up, I guess, to Colin's line of questioning.
Larry, I think when you answered his question, you mentioned the ROA and FSA at 28 to 30 basis points. And I'm pretty sure if I go back to a couple of transcripts ago, Dan was saying 30 to 32.
And again I don't want to nitpick, but I just want to know what the benchmark is in terms of where we should be looking for that margin.
Larry Donald Zimpleman
Sure. Well obviously, Suneet, first, let me just say that's going to get recrafted as a result of EITF.
So we've been talking around that 30-basis-point range. So whether you want to go 30, 32, whether you go 28, 32, that's -- there's really not any -- there's -- please don't over read or misread anything different around that.
It's been holding in that kind of 29-basis-point period. Obviously, the EITF is going to have some negative impact on that.
So one of the things we'll be talking about when we get to the earnings guidance in December is kind of what those new ranges are going to be. But that's not because we're recrafting anything, that's just going to be the accounting impact.
Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division
Okay. So no economic impact?
This is just a...
Larry Donald Zimpleman
Correct.
Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division
Okay, got it. And then, Terry, in your prepared remarks you talked about the interest rate environment.
And I think you said if you change your long-term interest rate assumption by 25 basis points, you'd get a onetime hit of $28.5 million to $30 million. My question is if that's right, what is the long-term interest rate assumption that you're using?
And how does that compare to sort of where you're investing new money today?
Terrance J. Lillis
Suneet, this is Terry. Long-term interest rate varies by product.
Obviously the longer-term product, the longer-duration product has a higher interest rate associated with it. But if you look at all the products across the board, we are probably in the 5.5% to 6.25% long-term.
Obviously, the Life would be probably on the longer end and maybe some of the group disability products on the shorter end of that. Now that said, it's considerably higher than what we're currently investing in this environment.
However, once again, we're looking at 40, 50, 60 or even longer in terms of some of those longer-term duration products. So what we do is we take into consideration where we are currently and then grade into that longer term over the life of the products.
So hopefully that's helpful.
Larry Donald Zimpleman
Just to be clear, Suneet, what Terry's talking about here is the DAC interest rate assumption as compared to reserves. Reserves is, again, a line-by-line thing where you can go into Specialty Benefits area, for example, and new group disability reserves are being set up in 4.25.
So what Terry is talking about is the DAC interest assumption.
Operator
Your next question comes from the line Ryan Krueger with Dowling & Partners.
Ryan Krueger - Dowling & Partners Securities, LLC
I have a -- my first question is for Larry -- actually for Terry. On the 3% to 8% longer-term impact of low interest rate, what time period does that refer to?
And is that a cumulative impact over time? Or is that an annual incremental impact?
Terrance J. Lillis
No, Ryan. What we said is if the current interest rate environment persists, over 2012 we'd be 1% to 2%.
But as you move out over that 4, 5-year, 6 years, you'd incrementally get a bit larger. So we'd be in that 3% to 8% range during that extended period of maybe in the 4- or 5-year range.
Ryan Krueger - Dowling & Partners Securities, LLC
Okay. But in other words, is the 3% to 8% a decline communicatively over that entire period?
Or is it increment when you get out 5 years from now, that would happen in one year?
Terrance J. Lillis
When we get out 5 years from now, we'd expect a 3% to 8% drop from current levels of earnings.
Ryan Krueger - Dowling & Partners Securities, LLC
Okay, perfect. And then I have a question on FSA expenses.
The comp and other line was down 4% sequentially. I was a little bit surprised that you were able to reduce that much in response to the decline in revenue.
What led to that?
Larry Donald Zimpleman
I'll let Dan talk about that.
Daniel Houston
Sure. I mean, it's -- frankly, it's very disciplined expense management on the part of Greg Rose [ph] and the team leading the FSA business.
Some of that may also have to do a little bit with timing of some of those expenses.
Ryan Krueger - Dowling & Partners Securities, LLC
Is the run rate from the third quarter a reasonable base to grow going forward? Or was there anything unusual?
Daniel Houston
No, I think probably the best way to look at it over the course of the last 9 months and look at that run rate and make your determinations from that, I think just like most of these, every quarter's got a little bit of noise in it. And although we did a very nice job managing expense in the quarter, there are some issues related to timing.
So I'd look at it on a 9-month basis, and let that probably be a better guide for your models.
Ryan Krueger - Dowling & Partners Securities, LLC
Okay. And then quick one for Dan.
Can you just give an update on where the pipeline stands in [indiscernible]?
Daniel Houston
Yes. So pipeline is good.
It's up over 20%, and it's with -- across our Allianz partners, it's across our various products as well. And I'd be remiss not to make a comment that we're not only seeing good traction in Full Service Accumulation pipeline, we're seeing very good traction with our mutual fund complex.
We've got some very competitive products that we've partnered with Jim McCaughan and his team on. And so pipeline for the Funds business looks solid.
As you can see sales are very good, and we're finally starting to see some good traction with that DCIO or the Defined Contribution Investment Only, where we don't provide recordkeeping administration. We're getting the traction with our mutual fund offerings on our competitors' 401(k) platform.
So again, we feel very good about our pipeline and hitting the 20% to 25% improvement in Full Service Accumulation sales for full-year 2011.
Operator
We have reached the end of our Q&A. Mr.
Zimpleman, your closing comments, please.
Larry Donald Zimpleman
Well, thanks again to everyone for joining us for the call today. As Terry mentioned in his comments, we'll be releasing our 2012 earnings guidance on December 1.
And so let me just close by saying we're very pleased with the momentum of our businesses thus far in 2011, and we'll continue working hard to continue that momentum for the rest of the year. So thanks again.
We look forward to seeing many of you out on the road in the near future. Have a great day.
Operator
Thank you for participating in today's conference. This call will be available for replay beginning at approximately 8:00 p.m.
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