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Executives

Tom Graf – SVP, IR

Larry Zimpleman – President and CEO

Terry Lillis – SVP and CFO

Julia Lawler – SVP and Chief Investment Officer

Dan Houston – President, Retirement and Investor Services

John Aschenbrenner – President, Insurance and Financial Services

Jim McCaughan – President, Global Asset Management

Analysts

Nigel Dally – Morgan Stanley

Jimmy Bhullar – JP Morgan

Suneet Kamath – Sanford Bernstein

Randy Binner – FBR Capital Markets

Colin Devine – Citigroup

Andrew Kligerman – UBS

Dan Johnson – Citadel

Edward Spehar – Merrill Lynch

Eric Berg – Barclays Capital

Principal Financial Group, Inc. (PFG) Q3 2008 Earnings Call Transcript November 4, 2008 10:00 AM ET

Operator

Good morning and welcome to the Principal Financial Group third quarter 2008 financial results conference call. There will be a question and answer period after the speakers have completed their remarks. (Operator instructions)

I would now like to turn the conference over to Tom Graf, Senior Vice President of Investor Relations.

Tom Graf

Thank you. Good morning and welcome to the Principal Financial Group’s quarterly conference call. A brief announcement before moving on. In the next few days, invitations will be distributed by e-mail to our Investor Day, which will take place at the Mandarin Oriental Hotel in New York City on December 10. Our Investor Day will also be accessible via webcast. Details will be publicly announced about a week in advance of the event.

Moving back to the third quarter call, as always, if you don’t already have a copy, the earnings release, financial supplement, and additional information on the company’s investment portfolio can be found on our website at www.principal.com/investor.

Following our reading of the Safe Harbor Provision, Chief Executive Officer, Larry Zimpleman; and Chief Financial Officer, Terry Lillis will deliver some prepared remarks. Larry will cover performance highlights and our capital strategy. Terry will provide a detailed overview of financials and our investment portfolio. Then we will open up for questions. Others available for the Q&A are our three Division Presidents, John Aschenbrenner, responsible for the Life and Health Insurance segment; Dan Houston, responsible for the U.S. Asset Accumulation segment; and Jim McCaughan, responsible for Global Asset Management. Also available is Julia Lawler, our Chief Investment Officer.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company’s most recent annual report on Form 10-K and quarterly report on Form 10-Q filed by the company with the Securities and Exchange Commission.

Larry?

Larry Zimpleman

Thanks, Tom, and welcome to everyone on the call. As indicated, I will start this morning by commenting on operating results and key performance measures. Our results for the third quarter were again very solid, particularly in light of a weakening economy and challenging market conditions. We again saw the value and benefit of a diverse portfolio of businesses, with record revenues and earnings from Principal International and another strong quarter overall for the Life and Health Insurance segment. And we continue to see the strength of our US Retirement franchise and our Asset Management and Accumulation businesses overall, as demonstrated by strong deposit growth and positive net cash flows.

At $11.1 billion for the trailing 12 months, we have increased operating revenues by 2%, demonstrating continued revenue stability in spite of poor equity markets which have erased nearly $34 billion of assets under management over the trailing four quarters. Our competitive strengths continue to be evident in deposits and net cash flows, at the time when a number of asset management peers are experiencing weaker deposits, heavy redemptions, and negative net cash flows. Over the trailing 12 months, our Asset Management and Accumulation segments have produced $121 billion of deposits, an increase of 23%. Coupled with strong retention, these segments have produced nearly $17 billion of net cash flows over the same period.

In the third quarter, Full Service Accumulation delivered $1.3 billion of sales, against our second best result on record in the year ago quarter. While nine-month sales of $6.2 billion are down from the same period a year ago, we view the third quarter and 2008 performance as strong, particularly in an environment where equity market declines have driven down plan assets, plan sponsors have slowed decision-making in the face of extreme market volatility, and some of our distribution partners have experienced disruption. As previously communicated, our 2007 results reflected exceptional employee stock ownership plan sales. Excluding ESOP from both periods, Full Service Accumulation sales are actually up 8% through nine months. Because of the higher returns on non-ESOP assets, current year-to-date sales will drive about 4% higher revenues and sales for the first nine months of 2007.

As we have seen in years past, factors that negatively impact Full Service Accumulation sales often have a positive impact on withdrawals. Based on assets, contract level withdrawals are down 15% year to date. The net result, Full Service Accumulation net cash flows at $4.9 billion through nine months are up 33% from the same period a year ago. For the trailing 12 months, net cash flows equate to 5.7% of beginning of period account values toward the top of our 4% to 6% target range.

Our work with advisers to retain at-risk participant assets continues to be successful as well. Through nine months, we’ve retained nearly $1.5 billion of participant assets into our mutual fund, individual annuity, and bank products, demonstrating the strength of our asset retention capabilities and the depth and breadth of our retail rollover solutions.

Moving to Principal Global Investors, assets under management are down 6% from a year ago. By comparison, a number of asset management peers have reported asset under management declines 2 to 4 times that level, reflecting a depth and breadth of asset management capabilities, Principal Global Investors continues to deliver strong net cash flows, nearly $14 billion over the trailing 12 months, offsetting a substantial portion of the impact of poor equity market performance. Principal Global Investors continues to be highly successful gathering unaffiliated assets as well, driving continued strong growth in third-party asset management fees, which Terry will discuss in more detail.

Relative investment performance remained strong, particularly for the three-year and five-year periods with 63% and 75% of the retirement plan separate accounts, managed by Principal Global Investors in the top two Morningstar quartiles, reflecting short-term fluctuations and the nature of investing in volatile markets for the one-year period, that number dropped from 64% at midyear to 40% at September 30. We are keeping an eye on all our funds, but believe they will continue to do well over the full market cycle.

At $265 million, Principal International delivered record operating revenues in the third quarter, bringing year-to-date revenues to $700 million, an increase of nearly 30% over the prior year period. Principal International continues to be an important contributor to our earnings diversification, with $108 million of earnings year to date, an increase of 26%. In part, this reflects operations that are less equity sensitive than the US Asset Accumulation and Global Asset Management segments. Through nine months, declines due to market performance were less than 2.5% of Principal International’s beginning-of-year assets under management.

We continue to benefit from diversification provided by the Life and Health segment as well. Segment earnings are up 23% year to date, with strong improvement from a year ago for the Health and Specialty Benefit divisions, and stable earnings from Individual Life division on a lower capital base. With external conditions being so difficult, we believe it is also important to address three interrelated areas – our outlook for realized investment losses, capital management, and our insurer financial strength ratings.

As you know, the rating agencies have placed a negative outlook on the North American life insurance sector. This reflects concern that market conditions are likely to produce higher realized investment losses over time, putting pressure on capital ratios. This is clearly a concern of the investment community as well. As we look at the environment, we anticipate that higher than normal realized investment losses on corporate credits will continue. While losses to date on commercial mortgages have been minimal, we anticipate defaults and losses on commercial mortgages will increase in the future.

A key point, though, is that we believe the increase will occur over a period of several years. Thus, we also believe we will have the ability to accommodate these losses going forward through the use of a number of capital management levers.

I would remind investors of three important features of our business mix. First, our three key growth businesses require little capital to support organic growth, which enables us to generate substantial free cash flows on an ongoing basis. Second, because of strong liquidity in our general account, we have the flexibility to selectively scale back on certain capital-intensive businesses to free up additional capital. And third, we manage our investment portfolio to match our liabilities, which are longer term. This, along with our strong liquidity position, drives our intent and ability to hold, which is especially important in these turbulent times.

As another significant point of differentiation, I would remind you that we purposefully made variable annuities with guaranteed living benefits a small part of our business. With only $1 billion in this block, equity market volatility has minimal impact on earnings for the Individual Annuities business and Life company capital ratios are not leveraged to equity market changes like many of our peers.

Reflecting dynamic market conditions, the company has continued to enhance liquidity, increasing cash and cash equivalent holdings by more than 50% from June 30 to $2.3 billion at quarter end. We have made adjustments in our general account investment strategies, investing new cash flows primarily into government and agency-backed securities and other liquid investments. And over the past several weeks, we have closed out our very modest general account securities lending program.

As also communicated in our pre-announcement, only 4% of our institutional-guaranteed interest contracts and funding agreements can be redeemed prior to maturity for any reason. To be clear, as we have regularly stated, strong relative ratings remain important to us. They provide customers with comfort in our ability to meet our obligations. But with the sector on negative outlook, it is likely there will be more downgrades than upgrades. As such, we think it is important for investors to understand that our key growth engines, US Asset Accumulation, Principal Global Investors, and Principal International would continue to operate successfully at a lower rating, particularly if downgrades are industry-wide.

Before turning the call over to Terry, I would like to expand on the discussion in our pre-announcement around actions we have already taken to build capital cushion above our September 30 position of $375 million of capital in excess of what is needed to maintain our current credit rating between the Life and holding companies. As indicated in the pre-release, management has suspended purchases under the existing share repurchase authorization and as another measure of prudent capital management, the Board decided to adjust the common stock dividend.

As also indicated, we are working on a number of ways to maximize internally-generated capital above and beyond what is currently being generated from ongoing operations. This includes managing growth of the capital-intensive businesses and new expense initiatives, including limitations on new hiring and reducing 2009 merit increases by more than 75%. We expect these efforts to be a source of approximately $400 million of additional capital over the next four quarters.

As a savings and loan holding company, we are eligible to participate in certain government programs. As details emerge, we’re evaluating our options and considering our strategy to utilize these additional sources of capital flexibility. Importantly, there is an opportunistic element to our strategy. It encompasses organic sales growth as well as acquisitions where we see a growing number of prospects, particularly in Asset Management and International Retirement services, two of the company’s three growth engines. Additional capital cushion will help position us to capitalize on these organic growth and acquisition opportunities. As we assess these, we will also continue to evaluate the wide range of financing options available to us. To be clear, our actions and the options we are exploring reflect prudent capital management in a time of volatile and uncertain market conditions. They are not a signal of concern about our investment portfolio, which as Terry will discuss, continues to perform very well.

Terry?

Terry Lillis

Thanks, Larry. As indicated, this morning I’ll spend a few minutes providing financial detail for the company and each of our operating segments, including items impacting comparability between periods. I will also cover our investment portfolio.

Let me start with total company results. At $0.96 in third quarter 2008, operating earnings per share were down $0.22 from a year ago. As communicated in last year’s release, third quarter 2007 earnings had $37 million or $0.14 a share in benefiting items. The largest item, a $30 million benefit in Full Service Accumulation from refining deferred revenue and expense assumptions. By comparison, we have no net benefits in the current quarter, so we view reported earnings per share as our run rate for the quarter. The remainder of the variance primarily reflects the impact of poor equity markets on the current quarter deferred policy acquisition cost asset. This resulted in true ups driving higher deferred acquisition cost amortization expense of approximately $0.07 a share, and a couple of smaller items, including partnership losses in the corporate segment and lower earnings from pre-payment fee income. These dampened current quarter earnings by $0.03 a share in total. Excluding these, earnings increased about 2%, consistent with our increase in average assets under management. Had market performance over the past four quarters been consistent with our 2% per quarter assumption, we would have finished the quarter with an additional $60 billion-plus of assets under management. Using current business and product mix, this would conservatively translate into an additional $0.18 to $0.22 of earnings per share for the quarter, and double digit earnings per share growth over a normalized third quarter 2007.

Moving to US Asset Accumulation, segment account values decreased $15.5 billion or 8.5% from a year ago to $166 billion at quarter end. Negative investment performance due to equity market declines has erased nearly $22 billion over the trailing four quarters, with $11.6 billion of that decrease coming during third quarter 2008 between Full Service Accumulation and Principal Funds. That $137 million segment operating earnings for third quarter 2008 were down $50 million from third quarter 2007. The decline in segment earnings primarily reflects results for the Full Service Accumulation business which generated $65 million of earnings in third quarter 2008. This compares to $111 million in third quarter 2007, which as I mentioned, included a $30 million after-tax benefit. The decrease from a year ago for Full Service Accumulation also reflects a true up in third quarter 2008 to the deferred policy acquisition cost asset, resulting in a higher DAC amortization expense of $7 million after tax, and a 5% drop in average account values from third quarter 2007. Both of these are due to significant equity market declines. The decline also reflects lower income tax benefits of about $4.5 million. On this last point, as you know, Full Service Accumulation receives a tax benefit for domestic dividends in our separate accounts. Due to a number of factors, we are receiving lower dividends from domestic equities within these accounts and as a result, have a lower tax benefit. Those factors include lower gains, change in product mix, and investors moving out of equities.

One other point, as you know, the revenue impact of a sharp sequential drop in account values is immediate. On the other hand, it takes time to align expenses with lower revenue and our actions have to contemplate ongoing investments and long term growth. That said, excluding the deferred policy acquisition cost impact through ongoing expense management initiatives, we’ve reduced segment operating expenses by 6% compared to second quarter 2008 and full service accumulation expenses by 5%.

Moving to Global Asset Management, third quarter earnings of $24 million compared to $28 million a year ago. The decline from a year ago reflects a decrease in net investment income due to lower rates on escrows, lower transaction and borrower fees due to slowdown in the real estate market, and third quarter 2008 severance costs. Excluding these items, earnings were up about 1% on the 2% increase in average assets under management. Similar to Full Service Accumulation, we are seeing some institutional investors delaying decisions in response to market volatility. That said, Principal Global Investors continues to be highly successful gathering third party assets with unaffiliated deposits of nearly $1 billion or 16% compared to the prior-year quarter and up $3 billion or 18% year to date.

Fees for managing third party assets are up 15% over the prior-year quarter and 24% year to date, reflecting continued success in equities and high yield. The increase also reflects our third quarter 2007 acquisition of Morley, which has proven to be a very timely transaction with market conditions increasing investor appetite for stable value options. As indicated in our pre-announcement, during the third quarter, we decided to terminate the segment’s commercial mortgage securities issuance operation. We had already reduced the loan inventory to a very low level and we now view the market for new commercial mortgage backed securities issuances as unlikely to revive in the foreseeable future. Historical financials have been restated and are reported through net income in the other after-tax adjustments line, including $4.8 million of losses or $0.02 per share from that operation in third quarter 2008.

Moving to International Asset Management and Accumulation, third quarter earnings were up 13% from a year ago to a record $44 million. Third quarter 2008 earnings included a $5 million unlocking benefit for price changes in Brazil, and a $7 million experience benefit from higher yields on invested assets in Chile, due to unusually-high inflation. Third quarter 2007 earnings included a $9 million unlocking benefit from regulations enacted that quarter in Mexico, and a $5 million experience benefit also due to unusually high inflation in Chile. Excluding items from both periods, earnings increased about 30%. The increase reflects organic growth that remains in the 15% to 20% range, plus the benefit of favorable currency exchange. I would point out that in the first several weeks of the fourth quarter we have seen the US dollar strengthen significantly against our Latin American currencies. Should this continue, we will see pressure on segment earnings going forward.

A couple of other comments, first on net cash flow. During the quarter, we had roughly $1 billion of outflows from liquid corporate money market funds in India. The global liquidity crisis has made this part of our business temporarily unprofitable and we are reducing our exposure until market conditions and profitability improves.

I will also comment on Principal International’s return on equity. Based on normalized earnings, segment return on equity is approximately 10.5% for the trailing 12 months. We remain on track to achieve sustainable return on equity of 11% by 2010 even in the face of a strengthening US dollar. At $74 million, third quarter earnings for the Life and Health segment were up 1% against a very solid prior-year quarter result. With year-to-date earnings up 23%, trailing 12-month return on equity improved 150 basis points from a year ago to 12.8%. At $21 million, Individual Life earnings were down $6 million from a strong year-ago quarter, but essentially flat excluding higher DAC amortization expense due to equity market declines and lower pre-payment fee income of about $2 million after tax. Specialty Benefits delivered record earnings of $31 million, an increase of 14%, reflecting improved claims results in three of the division’s four lines. Health earnings were $22 million for the quarter, an increase of 13%, primarily reflecting favorable development of claims from June 30, and continued success aligning expenses with revenues. As previously indicated, we continue to expect accounting treatment of high deductible health plans to result in losses in the fourth quarter for the Health division in the range of $5 million to $10 million.

Let me now comment briefly on net realized capital losses. In third quarter 2008, we recognized $156 million of capital losses through the income statement, which includes $114 million of losses related to sale and permanent impairments of fixed maturity securities, $16 million of losses from the mark-to-market of seed money investments, and $13 million of impairment on equity securities. $89 million of this total loss relate to Lehman and Washington Mutual. Our internal credit exposure guidelines and resulting broad portfolio diversification have helped to limit our losses during this period of financial crisis. During the quarter, widening credit spreads, driven more by forced selling into a thinly traded bond market than credit fundamentals was the primary driver of our $1.7 billion increase in gross unrealized losses.

We continue to believe the fundamentals of our fixed maturity portfolio remains sound, and that gross unrealized losses are a highly inaccurate representation of future investment losses. As communicated in our pre-release, using the more actively traded credit default swap market as observable data, we estimated the increase in gross unrealized losses would have been $1 billion lower. As another example of the market not reflecting underlying asset values or recognizing the importance of terms of the structure, in the third quarter, we had $441 million of credit CDOs payoff at par. This reduced our exposure to this asset class by 67% and reversed $243 million of gross unrealized losses from June 30. We recognize there is a concern with our increasing gross unrealized losses, but we believe too much emphasis is being given to scenarios in which significant portions of our gross unrealized losses become realized over a short period of time.

Given the long term nature of our liabilities, our disciplined asset liability matching, and our strong liquidity position, we have the ability and intent to hold assets until maturity. As such, we do not have to sell assets to generate cash. In addition, history indicates that losses tend to emerge over a multi-year period during a credit cycle, and that commercial real estate losses tend to occur at the latter part of the cycle. Looking at our history from the last credit cycle, losses emerged over three years, 2001 to 2003. Our heaviest losses in any one quarter were just over 0.5% of beginning of year fixed maturity securities. Heaviest losses for our full year were just under 1%. Based on our current level of fixed maturity securities, that would translate into after-tax losses of about $350 million over the course of a year. In an effort to promote transparency, we’ve updated on our website some additional investment details. I’ll briefly note that we have no exposure to the big three US auto makers.

To wrap up my remarks, I’ll comment specifically on three exposures – commercial mortgages, financials, and commercial mortgage-backed securities. Starting with commercial mortgages. Every single loan of our $11 billion portfolio is performing on schedule, coupled with 91% occupancy, 58% loan to value, and 1.8 times interest coverage, we remain extremely comfortable with our portfolio. Moving to financials, while we’ve realized some losses as a result of unprecedented market conditions, we believe the worst is over for this sector. Governments around the world are protecting their banking systems through capital infusions, guarantees on deposits, and other programs, creating a safety net for financial institutions that just doesn’t exists for other sectors. With banks being the largest component of our sector holdings, we view our current exposure to financials as a positive.

Regarding our commercial mortgage-backed securities holdings, we’ve included in our September 30, 2008 investment detail some new analysis applying Fitch's moderate and severe stress scenarios for 2006 and later vintages to our portfolio. As you know, the market has expressed specific concern about originator underwriting of these vintages. Under their moderate scenario, which produces total loan level losses of 3.6%, we’d experience cumulative after-tax losses of $62 million, with 75% of those losses coming in years eight through ten. Even under Fitch's severe stress scenario, which applies a 40% decrease to appraised market values and negative 11% gross domestic product, our portfolio holds up very well. After tax losses, which would occur over an eight year period starting in year four, would be about $260 million in aggregate and we’d estimate the maximum after-tax loss in any one year to be $71 million.

This concludes our prepared remarks. I would now ask the conference call operator to open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Nigel Dally of Morgan Stanley.

Nigel Dally – Morgan Stanley

Great. Thank you. Good morning. First question, can you discuss the rationale behind the $250 million funding agreement with the Federal Home Loan Bank? Was that to bolster your capital? Also, do you have updated number for the amount of capital you got from that facility through the end of the third quarter? And I’ve just got couple of follow ups as well.

Larry Zimpleman

Okay. Good morning, Nigel. This is Larry. The FHLB program is not really a program focused around building up capital. It is rather just a program focused around making sure that liquidity is where it needs to be, and market conditions like these are. And maybe I’ll just have Terry comment a little further about that.

Terry Lillis

Good morning, Nigel. The $250 million issuance was at the end of the second quarter, since the second quarter, in the third quarter we’ve added an additional $750 million to bring it up to a total of $1 billion. They are all in the form of funding agreements at this time.

Nigel Dally – Morgan Stanley

Okay. Then second question is just on the political landscape. I wonder Obama’s policy is just to allow planned participants to withdraw 15% of their account balance, up to $10,000 without any penalty. Can you discuss how that will likely impact your pension business if that is enacted?

Larry Zimpleman

Yes, Nigel. This is Larry. I’ll comment on that. I mean I think that obviously at this time in a political season, and by the way I hope everybody takes advantages of their opportunity to get out and vote today. But this is the season for anybody and everybody to sort of throw their ideas out there, and the one that you mentioned is just one of a couple of handfuls of legislative ideas that everybody has. But as I think as you know, we have a very dedicated staff in Washington that is in very close contact with all the legislators and all the policy makers and I don’t think that we foresee that in the near term. And I would say near term would be at least through 2009 onto 2010, there is going to be anything that’s going to be very significant or in any way disruptive to 401(k) system. I think the policy makers understand that 401(k) system has actually put a nice safety net, if you will, into our capital markets, given the regular flow of capital that comes into both the equity and debt markets, and I think they are very reluctant to want to do too much to tinker with that. So, appreciate your questions.

Nigel Dally – Morgan Stanley

Great. And just one last clarification question on gross unrealized losses. Last quarter, you’ve provided us the data as to how much within relation to spread widening versus interest rates. Do you the same breakdown for us this quarter?

Larry Zimpleman

Sorry, in relation to what, Nigel?

Nigel Dally – Morgan Stanley

The breakdown between spread widening versus interest rate moves. You gave us a breakdown of the change in the gross unrealized losses last quarter. Do you have a similar breakdown this quarter?

Larry Zimpleman

Sure. I will have Julia just comment quickly.

Julia Lawler

Good morning, Nigel. Yes, basically in the third quarter 100% of the increase came from credit spread.

Nigel Dally – Morgan Stanley

So, wasn’t there an offset with interest rates moving down? So, it would have been more than a 100%?

Julia Lawler

There was some improvement in interest, sort of small enough. So, it is easy to say a 100% of it is credit spreads. It was pretty small on interest rate movement.

Nigel Dally – Morgan Stanley

Okay, very good. Thank you.

Larry Zimpleman

Thanks, Nigel.

Operator

Your next question comes from the line of Jimmy Bhullar of JP Morgan.

Jimmy Bhullar – JP Morgan

Hi, thank you. I have a couple of questions. The first one if you could talk in a little bit more detail about just your pipeline for the pension business, given how the market is, I think you had mentioned in your remarks that just sponsors are unwilling to really transfer cases in this type of an environment, but anyway, if you could talk about your pipeline for the next few quarters. And then secondly on your Individual Life sale, you’ve grown at a very fast rate the last several quarters. I think this quarter your growth was about 13%, 43% in the second quarter. A lot of companies have been saying the market is very competitive, especially in the UL and term side, and if you could just talk about what’s allowing you to grow so fast. I know you would have actually updated your UL-7 [ph] policy, and came out with some competitive products, but if you could talk about is it price that you are leading when there is something else that’s driving your sales.

Larry Zimpleman

Okay. Jimmy, good morning. This is Larry. I will certainly have Dan Houston comment on the Full Service Accum and then John Aschenbrenner comment on Individual Life sales. Again, what I would really emphasis here is that the fundamentals of our business, no matter which particular segment, remain very, very solid and the sales increases that we are talking about whether it is our pension business, whether it’s our Individual Life business, really our fundamental sales increase is occurring across the board. They are not related to any one segment. They are not related to any one product. They really represent the really hard work that we’ve been going through over the last three or four years to build up new distribution partnerships and that we really having a success is sort of broadly across the landscape. Now I will turn it Dan to talk about Full Service Accum.

Dan Houston

Thanks, Larry. You know Jimmy, the Full Service Accumulation pipeline is up about 3% if we just measure that by assets, it’s down about 8% if you look at cases. If we look at where we are active right now, I would tell you, as Larry was pointing out, very healthy along our total retirement suite, including going after the non-qualified plans to complement the Full Service Accum. DC pipeline is up as well as a little bit less activity in the current quarter with regards to ESOP. The thing I would emphasize and not pick on words, but it’s not all planned sponsors that are deferring these decisions, some planned sponsors are delaying some of their decisions due to a lot of volatility out there in the market. There is some volatility with our alliance partners, and again, advisers are out there retaining business as well as trying to take some of these out to market. So, we actually feel very good about our fourth quarter pipeline and sales opportunities. Thank you.

Larry Zimpleman

John, you want to comment on Individual Life?

John Aschenbrenner

Sure. As Larry was saying, it really is across a broad spectrum of products. There is not a single product that’s generating the growth. So, it would be across UL, fixed UL, UL with secondary guarantees, some growth in term, some growth in survivorship, some good growth in our non-qualified offering, which utilizes variable life insurance. And it’s across a wide range of distribution. And as Larry mentioned, the key is not incredibly competitive pricing as much as it is reasonable pricing and a significant expansion of our distribution. And it is expansion that is very, very focused. So, it is not across a wide range of distribution partners, but is building very strong relationships with a small core of distribution partners as we go forward.

Jimmy Bhullar – JP Morgan

And just a follow up, John, on the Health business, I think previously you had said that for 2008, you expected earnings of $45 million to $55 million. Now you are saying a $5 million to $10 million loss in the fourth quarter, which gives you $58 million to $63 million for the Health. Is that right? Are you improving your outlook for the Health business?

John Aschenbrenner

That’s correct, Jimmy. It’s now $58 million to $63 million.

Jimmy Bhullar – JP Morgan

And the change is just better claims spend or is there something else that you have done?

John Aschenbrenner

The change is really very fundamental. We’ve other among this, for example, we brought in a new Chief Medical Officer and we’ve begun to really manage expenses and costs of care in a more intensive fashion. So, it really does reflect improved loss ratios really, again just good hard on-the-ground work and we believe in essence that it is sustainable.

Jimmy Bhullar – JP Morgan

Okay. Thank you.

Larry Zimpleman

You are welcome.

Operator

Your next question comes from the line of Suneet Kamath of Sanford Bernstein.

Suneet Kamath – Sanford Bernstein

Great. Thanks. Couple questions for Larry. First of all, with respect to your ratings, Larry, you mentioned that your three growth engines are not really rating sensitive. Should we take away from that, if you were faced with a downgrade to AA minus or A, by one of the major rating agencies, and the alterative was that you’d either have to raise equity capital or get capital injection from, say, another firm, that you would perhaps be willing to accept the downgrade given the lack of impact on those three growth engines? And then the second question is – as you’ve talked about – I think you said, you would expect over the next four quarters to generate $400 million of capital and I think you walked through a couple of the components of that. I just wondering if, perhaps, maybe I wasn’t listening carefully, but if you could walk through those again and maybe just highlight the ones that you think are the most significant. Thanks.

Larry Zimpleman

Okay. Very good question there. On the ratings issues, let me just start by saying that I think when you are in a challenging time like this and we know in fact that the rating agencies have all put the Life sector on negative outlook. I don’t know, Suneet, with all due respect, it’s going to be sort of helpful to sit here and speculate about what the rating agencies may or may not do, vis-a-vis Principal Financial Group or frankly even the sector in total. The point that I tried to make, and I will just re-emphasize it again around ratings, is that strong relative ratings is really what we are more focused on. We don’t really control the level at which any rating agencies would set the insurance sector. So, what is important to us is strong relative ratings and we think we have all the fundamentals of our businesses to maintain relative rating. So, I think I would just leave it at that and I wouldn’t really try to speculate about what would happen with a certain level of one notch, two notch, whatever. I think that’s all hypothetical and I really want to stay away from that at a time where there is so much uncertainty in the market. In regard to the $400 million, there are a number of elements to that. I would say, frankly that the two of that are most significant would be, number one, all the expense initiatives, many of which, several of which the most important I mentioned as well as the ability to selectively scale back on some of the capital intensive businesses. So, that’s where the majority of that comes from.

Suneet Kamath – Sanford Bernstein

Okay. Thanks.

Operator

Your next question comes from the line of Randy Binner of FBR Capital Markets.

Randy Binner – FBR Capital Markets

Thank you. Just a follow up on the $400 million of excess capital. Could we assume that would come ratably over the next four quarters, meaning a $100 million per quarter, or would it be more back end loaded?

Larry Zimpleman

You know I would say – this is Larry, Randy. I mean, yes, I would say that it would come somewhat ratably over the four quarters, maybe just slightly less in, say, the first quarter out, and then maybe building just slightly more toward the end. But that’s really more just a function of as expense initiatives kick in.

Randy Binner – FBR Capital Markets

Okay, great. I apologize if I missed it in the call. Did you confirm that the excess capital currently is $375 million?

Larry Zimpleman

Yes, we did. And again, just for clarification, I want to make sure that you understand the $400 million would be on – that we’ve been discussing, Randy, would be on top of the normal free cash flow that would otherwise be inherent in the earnings of the business. So, that’s an additional source of $400 million.

Randy Binner – FBR Capital Markets

Right. And is it fair, I think in the past you’ve talked about having to re-invest roughly 50% of the operating earnings into organic growth. I know you have the option. I guess, you could scale that back based on the $400 million number. But is that a good starting point for us to think about the free excess capital that’s generated?

Larry Zimpleman

Yes, I think the 50% is still a good starting point, Randy.

Randy Binner – FBR Capital Markets

Okay. And then, one another question. And I don’t know if this is too hypothetical. But to touch back on the rating agency issue, I mean if there were a downgrade, maybe across the space, is it possible, maybe Terry could give us more color on – in the institutional products that are more rating sensitive. I mean, if not it would be a total loss if that income source or how would you continue to compete in that area, assuming kind of a broad downgrade across the space.

Larry Zimpleman

Terry, you want to comment?

Terry Lillis

Sure. Randy, if you look at the ratings that currently are being held, right now the AA rating would be needed for institutional investment-only business, as well as our full service payout business, as well as the immediate payout annuities of which all three of those are slower growth businesses at this point in time. And so, that’s what I think Larry was saying that a growth engine, the accumulation business as the International business, as well as our Global Asset Management businesses are not tied to that AA rating in this current environment.

Randy Binner – FBR Capital Markets

Okay. Fair enough. I’ll jump back in the queue. Thank you.

Larry Zimpleman

Thanks, Randy.

Operator

Your next question comes from the line of Colin Devine of Citigroup.

Colin Devine – Citigroup

Good morning, gentlemen. Couple of questions. First, I just want to confirm what you expect the RBC is going to end the year at? And how much of the improvement is coming from the dividend cut? Second with respect to the investment portfolio, Larry, the part that never seems to get really addressed on these calls is focusing on the credit risk. If we look at the BBBs and take the commercial mortgages, which appreciate your larger BBBs. But certainly that’s the way the rating agencies see them best on the capital charges. That’s almost half of your portfolio. And that’s seems to be unusually large and if you could comment if that’s going to continue to be the policy? With respect to the dividend cut, you know everything you said today, if it’s also good and you can generate all those extra capital, then why did you have to take the very severe step of cutting the dividend by 50%. I mean that to me says do you think your investment portfolio is in trouble. And then the final one, again, all the very things about the defined contribution business and certainly the recurring deposits are very strong at 14%. Then why is the number of plans not growing, it remains very, very low, if this is such a thriving business, it seems to me you are losing market share within the DC business.

Larry Zimpleman

Okay, let’s see. I think I got all those Colin. And let me first comment a little bit very quickly on the dividend cut. I know we have a number of people here and I want to continue to move through the queue. But let me say unequivocally in terms of the dividend cut, obviously that was a decision that the Board of Directors made, and I believe that from the standpoint of the Board, the dividend change and setting the dividend for 2008 was very clearly and very simply an issue of prudent capital management at a time of market uncertainty. And it is not in any reflection, Colin, any indication of any expected future losses of the investment portfolio. Again, I just want to emphasize that it really is a matter of just overall prudent capital management. Now in terms of the construction, if you will, the overall general account portfolio – let me just say again that that is a collaborative, ongoing dynamic process that does involve our entire senior management, all of our business heads, our Chief Investment Officer, and all of our asset management professionals. And in our case, I think we are different than some of our peer companies in that our liability structure is different as we commented earlier; it is longer and more specifically, Colin, I think we are more focused around the discipline of asset liability matching and more concerned about durational asset characteristics and perhaps not as willing to take interest rate risk or take optionality risk, which many of our peer companies perhaps are a little bit more willing to do. So, in terms of the construction of our portfolio, while there is, as we say, commercial mortgage and there is corporate credit that is in there, we believe that the combination works together very well. We have very tight internal exposure guidelines that limit our exposure and you certainly saw that work during the third quarter. And today, we actually feel, like we said in our prepared remarks, more comfortable with our financial exposure than certainly than any time in the more recent past, given the reduced systemic risks. So, I think that is a very manageable exposure. We remain very comfortable with that. I will have Dan comment very quickly on FSA plans.

Colin Devine – Citigroup

And the RBC for the end of the year.

Larry Zimpleman

Yes, we will get to that one too.

Dan Houston

This DC market share, you know, we have added 226 new cases in terms of growth from a year ago. We have added just short of a quarter of a million new plan members at 224,000. We have had growth in that 500 to 999 of roughly 4.3%. Cases of over 1000 employees, we've grown by 8.9%; and if we just looked at our alliance partners, which effectively did not exist in 2002, we have six of those appliance partners generating more than $100 million in new sales for us year to date in ‘08. I would say in the most recent quarter, we have transferred deposits which have not kept up, that is attributable to some of the lumpiness in some of these accounts, and as Larry was pointing out, if you take out the ESOP sales in ‘07 and ‘08 year to date, you’d see actual growth in assets for Full Service Acum of approximately 8%. So I would say actually it is performing quite well.

Colin Devine – Citigroup

Then why are the number of plans only growing at 1% to 2%, that has been consistent despite all your efforts. I mean, you are adding them, but clearly then you are losing them.

Larry Zimpleman

Well again, I would just quickly comment, Colin. You have seen, for example, record keeping lines were up about 7%, which is certainly a good measure. You are seeing recurring deposits that are growing at about 14% annual pay. So I don't know that plan count would necessarily be the single or frankly, even the best measure that you would have around whether the block is growing and is healthy. And I will have Terry comment quickly on the RBC.

Terry Lillis

Sure, the RBC, you know, as you are very well aware, there's a lot of things that go into this calculation. At the end of 2007, our RBC ratio was 376%. We expect it to be around 380% to 400% at the end of 2008. In terms of the impact or the volatility of the ratio, a good rule of thumb is about $100 million change in capital will have about a 10% movement in the ratio.

Colin Devine – Citigroup

So the dividend cut basically has what boosted the ratio?

Larry Zimpleman

Whether the more elements in it or not, but that is one of the pieces that goes into it, but there certainly are more pieces than that, so –

Colin Devine – Citigroup

All right. Well, I think it is $100 million. So – okay, thanks.

Larry Zimpleman

Thanks, Colin.

Operator

Your next question comes from the line of Andrew Kligerman of UBS.

Andrew Kligerman – UBS

Hey, good morning.

Larry Zimpleman

Good morning, Andrew.

Andrew Kligerman – UBS

Good morning. I have three questions for you. First, with regard to Argentina, there has been some unusual pension reform there and I would like to get a sense of how that might affect your income going forward and your investment on the balance sheet. Second question is with respect to the investments, and the net realized losses that you generated in the quarter, that was a $156 million, and you know, I didn't see much coming from CMBS, I didn't see much coming from corporate outside of what was credit impaired in a big way, which we all knew was Lehman and WAMU et cetera. I didn't see anything else where you might make the decision to do it other than temporarily impaired on your own. Given again, you know, we have seen sharp pressures on some of these indices, we have seen it in the corporates, we have seen high yield indices down by 20%, CMBSes are probably down in that ballpark in October, I mean, we have seen some sharp moves in the fourth quarter. If you had to just give us some sense right now, you know, and I know you don't do bright-line testing, do you think that you will take any impairments at all in the fourth quarter regarding corporates and CMBSes? And then just lastly, you used to talk a lot about your commitment to the Health and the Specialty Benefits businesses. Are you still very committed to those businesses, or would you consider divesting?

Larry Zimpleman

Okay, Andrew. Thanks. Let me cover the first one, the last one and maybe I will have Julia comment quickly on the second one, the impairments; although, again, I think trying to forecast anything relative to the end of the year is certainly more of an art than a science. But in terms of Argentina, again, as you said, the government has proposed privatizing that. I think there are still some issues and some challenges going on with that. We have been out of Argentina for a number of years and I think most people who are knowledgeable and expert in Latin America understand that Argentina is a bit of a one-off. The major issue that is going on there is really more of a currency issue and we commented on that in our prepared marks, and it looks like even the currency issue is settling down a little bit. But we do not expect any contagion follow on from Argentina.

In terms of the Health and the Specialty Benefits businesses, let me just say again, reiterate that from a strategic perspective, we think that having both of those businesses is very important to the ultimate success of our SMB strategy. Health insurance remains, and Specialty Benefits remains one of the very first employee benefits that an employer puts in, it remains one of the most active areas that advisers continue to be active in. So it introduces us to a lot of SMBs, introduces us to a lot of advisers. In terms of financially, those businesses are performing extremely well, extremely strongly. Any decision to exit those businesses would be done on a dilutive basis, so it certainly would not be a shareholder-friendly event. And finally, what I would say, and perhaps something that doesn't get often enough stirred into the mix, but there is a positive covariance benefit in the standpoint of the rating agencies that is attached to those as well. So, our real approach here is to try to continue to execute those successfully, have a combination of growth and profitability and that is what our strategy remains.

And I will see Julia wants to comment anymore around potential Q4 impairments.

Julia Lawler

Good morning, Andrew. Thank you for the question. As you already mentioned, we do not have a bright-line test. So spread movements in of themselves do not indicate whether we permanently impair something or not. As it relates to CMBS specifically, we put in additional information around stress scenarios, specifically, say, we can show that those losses would occur much later in the cycle. So, the performance of those bonds continues to be strong. It is not to say they won't change, but the fundamentals remain strong. So we have not impaired them for third quarter, and predict would not expect to impair them for the fourth, if their fundamentals stay in shape.

Andrew Kligerman – UBS

Okay, thanks a lot.

Larry Zimpleman

Thanks, Andrew.

Operator

Your next question comes from the line of Dan Johnson of Citadel.

Dan Johnson – Citadel

I will try to talk fast. October, tough month for below investment grade and CMBS, can you give us an updated unrealized number for the end of October for the fixed income portfolio. Two, can we talk about year-to-date GAAP versus stat [ph] unrealized and OTTI impacts on capital? Obviously, we have the GAAP numbers updated, but can you compare that with the stat? And then finally, you have borrowed $1 billion from the Federal Home Loan Bank and said it was liquidity, but then you mentioned it went into funding agreement product. Maybe you can help me understand what you mean by liquidity. Thank you very much.

Larry Zimpleman

Okay, Dan. This is Larry. Let me – actually, in regards to the realized losses as of the end of October, that is not something that we necessarily go in and do a deep diagnostic on, but what I think might be helpful, just to kind of frame that or understand that is maybe ask Jim McCaughan to talk just a little bit from his perspective around what’s been happening with the market and sort of where it might around sit around the end of October. Jim?

Jim McCaughan

Yes. Clearly the subprime was the original trigger for a massive de-leveraging that has happened by investment banks hedge funds and commercial banks, as they have got into risk reduction, withdrawal of credit lines, and in the case of hedge funds, enormous redemptions from investors. All of this has meant there have been heavy forced sellers and very few buyers, which means in factors like CMBSes, there has been very thin trading, and the market values are basically not reliable. In most cases, they are not a reflection of likely defaults. They are a reflection of distressed sellers. And, you know the financial sector bankruptcies that happened to date, notably Lehman and WAMU, have been partly because of the lack of long-term funding, the withdrawal of short-term funding, which has really put these institutions into potentially a forced seller position. After the Lehman bankruptcy in mid-September, there was a lot of systemic risk and the risk of runs on the bank on a global basis. That really has been settled by governments refunding and re-capitalizing their banking system, starting with the UK and the US and then various of the European governments recapitalizing their banking systems. That is leading to some good signs in the credit market, notably financial spreads narrowing, LIBOR coming down, signs of credits easing. But it is still the case that in the CMBS markets, you have this enormous avalanche of distressed sellers selling. That is no sign of any likely real stress in the underlying investments, which we have the ability and intent to hold, and that is really why in Terry's comments, when Terry Lillis went through our stress test, given Fitch’s scenarios – that is actually a very important element to bear in mind as you look at our assets relative to our liabilities. So I think that that position of the financial sector and the beginning of the improvement is the first sign. But as you remarked, CMBS is looking heavily sold in the last month. That actually is irrelevant to us in the sense that we have the ability and intent to hold.

Dan Johnson – Citadel

On the below investment grade, wouldn't that be more of a change in the economic outlook that we probably all had in the last six weeks, and maybe not just a sign of liquidity?

Jim McCaughan

No, the change in the economic outlook clearly is there, you are right. And arguably, we are headed into a pretty nasty recession, which people have said might be the worst in the last 30 years of the worst in the last 50. If that happens, then you are going to see a first wave of bankruptcies among people like autos and retailers and maybe shipping companies and building materials. Those are dangerous areas to be in, especially if the companies are highly leveraged. And our diversification has been designed to put us in a good position to absorb the shock if they happen. So I think that that is a very important point. And you know, the third quarter was a pretty ugly one for the financial sector, but our losses were pretty moderate relative to the portfolio, because we diversified well and controlled the risks well. We expect to do the same in these other sectors. It is tough managing when there are a lot of shocks in the system. So that is really what we are doing during this very difficult period. So we recognize that the economic outlook may have deteriorated quite a lot, but we do believe that our risk management is standing up in a really difficult situation.

Dan Johnson – Citadel

Okay, I’m sorry, I don't want to take any more time. Can we just go ahead and jump to the GAAP versus stat and the FHLB? Thanks for the answers.

Terry Lillis

Good morning, Dan. In terms of GAAP and stat treatment; other than temporary impairments, we treat them both the same, so there is no difference between the two. In terms of the FHLB, in terms of the liquidity, you have to realize that we have an asset liability management, a portfolio of assets supporting a portfolio of liabilities, and we can use FHLB just like any other funding agreement or guaranteed interest contract to provide liquidity or liability, and to also provide for investment opportunities within that portfolio.

Dan Johnson – Citadel

On the OTTI stuff, I was looking for actual dollar amount realized and OTTI GAAP versus stat dollars please.

Terry Lillis

The OTTI, I don't know that off hand. I think it is $140 million on fixed securities, and $13 million on equity securities?

Larry Zimpleman

Correct.

Dan Johnson – Citadel

For stat year-to-date?

Terry Lillis

For both GAAP and stat.

Larry Zimpleman

And that is the third quarter number, Dan.

Dan Johnson – Citadel

Got it. Okay, I will follow-up on the Federal Home Loan stuff. Thank you.

Larry Zimpleman

All right. Thank you.

Operator

Your next question comes from the line of Edward Spehar of Merrill Lynch.

Edward Spehar – Merrill Lynch

Thank you, good morning. Very quickly, you pointed out that your savings in loan at the holding company level – I'm sorry it is hard to keep up here, but is it your interpretation that you could participate in the CPP program?

Larry Zimpleman

Yes, Ed, that is correct. We would be eligible to participate in the Capital Purchase Program. That is correct.

Edward Spehar – Merrill Lynch

Okay, and could you give us a sense of what the maximum, if you were going to do preferred issuance, regardless of who is buying it, what you would consider to be the maximum that you could do, at this point, and maybe you could just remind us of what the terms of that would be in your view with the CPP?

Larry Zimpleman

Well, the calculation, Ed, as we understand, and again, we made no decision as to whether we are going to participate or not, but the calculation is based on something called risk weighted assets. And the translation of risk weighted assets is a little bit loose in terms of from the banking sector to the insurance sector, but our estimate would be – is between 1% and 3% of risk weighted assets. And we think, Ed, that that corridor is roughly in the range of about – at the low end, $650 million, and at the high end, about $2 billion. So we think that it's roughly the 1% to 3% corridor. But again, we have made no decision yet as to whether we want to apply for that at this point.

Edward Spehar – Merrill Lynch

I guess just ask you then, but given the sort of the target capital ratios that you would have historically, how would you say what is your capacity today for any preferred issuance regardless of who you are issuing it to?

Larry Zimpleman

Yes, I mean we haven't really done all of that analysis, what I would say and I think you may be generally familiar, there is quite a bit of information. The CPP structure is very well defined. I mean the Treasury has made that very clear. It’s a 5% preferred for the first five years and then I believe it escalates to 9% after that. So, part of what anyone who would seek eligibility would be would have to sort of work through that ratio. What I can tell you is based on, again, the kind of limited analysis we have done is that relative to current commercial terms, I think those terms that I just described would be pretty favorable. So, in that sense, I think it is something that we and others who are eligible would look at among a wide range of options for capital management. But again, no final decision but the economics there do look pretty favorable.

Edward Spehar – Merrill Lynch

Okay. Just on your debt, the way that you look at and think about sort of debt to capital, debt plus preferred to capital, could you just remind us where – are those numbers in the supplement the way rating agencies think about them or is there some other number you would like to give us?

Larry Zimpleman

Terry, you want to comment?

Terry Lillis

Sure. Debt to capital ratio is about 22% or 19% at this time. The rating agencies look at it up to 25%, depending on whether or not you have hybrids or not, but you know, I think the numbers that you are seeing in the supplement will be a fair assessment.

Edward Spehar – Merrill Lynch

Thank you very much.

Larry Zimpleman

Thanks, Ed.

Operator

Our next question comes from the line of Eric Berg of Barclays Capital.

Eric Berg – Barclays Capital

Thanks very much and good morning.

Larry Zimpleman

Good morning Eric.

Eric Berg – Barclays Capital

Good morning to everyone. My first question is regard to the CPP portion of the TARP program. A number of insurers have expressed the fact that they – and Principal has this morning as well, qualified; but it is one thing to qualify, and it is quite another to get the money, because not everyone who qualifies to apply will receive funding. There has to be, as I understand it, a valid public purpose served. So my question is, my first question is, what is your sense of the government’s view at this point, and I realize you are a company not the government, but you do – you are reading the papers, you do have your sources in Washington; what is your sense of the government's appetite to include the insurers in general, and if you where to apply, Principle in particular in this program, could you get the money? How would you handicap the odds? It is not whether you can apply, but whether you would get the money?

Larry Zimpleman

Eric, this is Larry. Let me just make a couple of points on that. First of all, as we said in our comments, we believe that as a savings and loan holding company, we meet the eligibility criteria, although as you indicated, there is an application process for the CPP, the Capital Purchase Program and ultimately, you do have to be approved by a US Treasury. The other discussion that is in the trade press about whether insurance companies would be eligible is a separate discussion not applicable to Principal, because we are already a savings and loan holding company. So I just want to make that point of differentiation. On the other kinds of questions that you asked about, again, not having had any discussion with Treasury, it would be speculative for us to know how they would react, but generically, what I would say and I think we have seen this from the banking sector, and we see this pretty much reported in the press every day, the Treasury has an inclusive mindset around wanting healthy companies to feel comfortable that they can access the Capital Purchase Program. And I would assume that they would have the same view whether a company like Principal was applying or not. The final point that I would make here is that as we assess whether this is of interest to us, I want to make sure that I communicate that this again is around the opportunistic element of our strategy. As we said in the call, we do see the opportunity for perhaps some unique situations to grow our business, particularly in asset management and in the international arena. So to the extent that an economically efficient vehicle like the CPP is at least one of the many range of options, we think it is very incumbent on us to do that, and again, we believe that Treasury, generally speaking, is exclusive [ph] about our willingness to have that discussion.

Eric Berg – Barclays Capital

My next question is to Julia and it has to do with her comments around credit spreads and the unrealized losses. First, when you have a more than doubling of your unrealized losses, which you have in the September quarter versus the June quarter, how do you know what caused that unrealized, I mean, bonds can’t speak, they are inanimate objects, how do you know what caused the price of the bond to increase, how do you know it was “just credit spreads”? And then I have one final follow-up. Thank you.

Larry Zimpleman

Julia, I will have you quickly comment on that, in the interest of time.

Julia Lawler

Well, as Jim mentioned, in his description of what is going on in the market for – in October, it is a similar that happened in the third quarter in that we can tell by watching the market and finding out who the sellers, why they are selling. So, there is an indication that there is much more forced selling going on than equal buyers and sellers on this part of the table. The second way that we can tell is, we know fundamentally by understanding these individual credits’ balance sheets and income statements, how they are performing on a fundamental basis. So that is how we can tell it is not all fundamental driven. Does that help, Eric?

Eric Berg – Barclays Capital

Sort of. I guess my question is, they are called credit spreads for a reason, they are not call some other spreads, they called credit spreads. And sort of, I grew up believing that if credit spreads where widening on a bond, it may be the result of illiquidity, but the illiquidity in turn is reflecting the anxiety of buyers and sellers that people are becoming increasingly anxious about the cash flows on that bond, or am I not think about this correctly, in other words, somehow we are being asked to think that this widening of credit spreads is not a bad thing, or it doesn't have to do with anxiety about repayment. And I'm just wondering if sort of how will that work? Because I thought credit spreads widening always has to do with deteriorating perceived credit worthiness.

Larry Zimpleman

Eric, this is Larry. Let me just ask – I will have Jim comment on that, because this is obviously the world that Jim lives in as well every day, but let me just say that this last period is one that I have regularly described as sort of tossing out everything you ever learned in business school about why things work the way they do. So with that, maybe I have Jim comment.

Jim McCaughan

Eric, like you, I was brought up with efficient markets, willing buyers, willing sellers, good price discovery, and credit spreads being a reflection of default probability plus illiquidity. You know, that is kind of Credit 101. The problem is that we have had 8 years to 10 years of extreme leveraging up by all kinds of financial institutions, and because of the triggers that I mentioned earlier, this de-leveraging is trying to get itself undone in a matter of weeks, rather than years. And that is leading to utterly disrupted markets. And we daily see bonds quoted 10%, 20% different to what they were a week or two before, simply because the markets are dysfunctional. In normal circumstances, the kind of marks we are seeing would not be regarded as good mark. The market will get back into willing buyer/willing seller mode, but that’s only as credit markets warm up and as investors commit liquidity, and as these distressed and overleveraged investors de-leverage. I hope that helps.

Eric Berg – Barclays Capital

It does. Absolute last one. Why does the decision to cut the common dividend, why does that have anything to do with the risk-based capital ratio of your Life company? I think you said that earlier.

Larry Zimpleman

Yes, Eric. I guess I have – Terry, do you have any comments on that?

Terry Lillis

It doesn't really have an impact on that, it has an impact on the amount of available capital or excess capital; it doesn't have an impact on the RBC ratio.

Eric Berg – Barclays Capital

Of your Life company, because the common dividend has nothing to do with the Life company, it is coming out of the holding company, correct?

Terry Lillis

Exactly, it is on the holding company, it is not part of the Life company.

Eric Berg – Barclays Capital

Thank you for that clarification. I'm all set.

Larry Zimpleman

Okay, Eric, thank you. I think in the interest of time, we will go ahead and wrap up. I again want to thank everybody for joining us on the call today and certainly we appreciate very, very much your continuing interest. I would just in the form of wrap up emphasize that our business fundamentals remain very, very strong, particularly I think in light of what is a challenging investment market. Again, as we emphasized, we do not believe that our September 30 unrealized losses do reflect any accurate indicator of future realized losses and we do believe it reflects more a market of fore-sellers and thin trading. We do expect our losses to increase over time, but that will be over a period of years, and we think that between our current excess capital of approximately $375 million, ongoing capital generation from operating earnings and additional sources using internal capital management, we do believe we will be able to accommodate future realized losses. And as a final point, I would say that many of the issues that have been significant for our competitors are non-issues for us. This includes a variable annuity with living benefits, where we only have $1 billion of total exposure, and general accounts securities lending, which, as we said earlier, we have completely unwound. So with that, I just want to say, again, thanks for joining us on the call. We look forward to seeing many of you at our Investor Day in December and in the months to follow. Hope everybody has a great day. Thank you.

Operator

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 PM Eastern time today until the end of day November 11, 2008.

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Source: Principal Financial Group, Inc. Q3 2008 Earnings Call Transcript
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