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Executives

Daniel Houston - President of Retirement, Insurance and Financial Services

Larry Zimpleman - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Director of Principal Life

James McCaughan - President of Principal Global Investor

Terrance Lillis - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

John Egan - Vice President of Investor Relations

Analysts

John Nadel - Sterne Agee & Leach Inc.

Randy Binner - FBR Capital Markets & Co.

Jamminder Bhullar - JP Morgan Chase & Co

Suneet Kamath - Sanford C. Bernstein & Co., Inc.

A. Mark Finkelstein - Macquarie Research

Steven Schwartz - Raymond James & Associates, Inc.

Edward Spehar - BofA Merrill Lynch

Colin Devine - Citigroup Inc

Principal Financial Group (PFG) Q1 2011 Earnings Call May 3, 2011 10:00 AM ET

Operator

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

John Egan

Thank you, and good morning. Welcome to the Principal Financial Group's First Quarter Earnings Conference Call.

As always, our earnings release, financial supplement and additional investment portfolio detail are available on our website at www.principal.com/investor. Following the reading of the Safe Harbor provision, CEO Larry Zimpleman; and CFO, Terry Lillis, will deliver some prepared remarks. Then, we will open up the call for questions. Others available for the Q&A are Dan Houston, Retirement and Investor Services and U.S. Insurance Solutions; Jim McCaughan, Principal Global Investors; Norman Sorensen, Principal and Financial; and Julia Lawler, Chief Investment Officer.

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. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K, filed by the company with the Securities and Exchange Commission.

I would like to now turn the call over to Larry.

Larry Zimpleman

Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas. First, I will briefly discuss first quarter 2011 results. Second, I'll discuss the ongoing implementation of our strategy and the long-term potential of that strategy, and I'll close with some comments about our financial position and our outlook for the rest of 2011. Then, Terry will cover the financial results in more detail.

We view our first quarter financial results as very solid. Total company operating earnings are up on a nominal basis, 8% over fourth quarter 2010 and 5% over the year-ago quarter. On a normalized basis, adjusting for the ownership change of our Brazil joint venture and our decision to scale back our Investment Only business, our operating earnings were up 18% over the year-ago quarter while average assets under management increased 12%.

We've mentioned in the last 2 earnings calls that we have begun to see increasing signs of growth across our businesses. That trend picked up further momentum in first quarter and we view our growth metrics as being very positive. Let me highlight some of those growth metrics.

Full Service Accumulation sales of $2 billion were very solid. And when combined with the fourth quarter sales of $3 billion, our total sales of $5 billion in the past 2 quarters is the highest consecutive quarterly sales total since early 2008. We had another record quarter for mutual fund sales of nearly $3 billion. Strong net cash flow with $870 million for Full Service Accumulation, $620 million for Principal Funds and $1.3 billion for Principal International.

First quarter mandates awarded to Principal Global Investors were $2.1 billion as compared to $2 billion for all of 2010. While Principal Global Investors unaffiliated flows were negative due to the loss of a large core fixed income mandate, the new mandates bode well for unaffiliated flows in the next few quarters. Individual Life sales, up 35% from a year ago with the business market representing 70% of Life sales compared to 54% in first quarter 2010. Record sales for our Specialty Benefits businesses this quarter with loss ratio staying well within our targeted range. First quarter sales are up 56% from the year-ago quarter.

In summary, we saw a good growth across our business portfolio, driving company assets under management to $327 billion, which is a company record. Assets under management are a good leading indicator for revenue and profitability for the rest of 2011. While we're pleased by these signs of improving growth, we know that the recovery is still fragile. But we are seeing early signs of employee growth in our employer-sponsored businesses with participation and participants salary deferrals showing small improvements. We expect the ongoing recovery to be slow but we do believe it is sustainable and is gaining momentum.

Now let me move to some comments on the ongoing implementation of our strategy and its long-term potential. We know that 30% to 40% of the Retirement business is sold on an unbundled basis involving a third-party administrator platform as compared to a bundled offering. Several years ago, we began initiatives to capture an increasing share of the third-party administrator market as well as continuing our leadership within the bundled portion of the market. The third-party administrator initiative has begun to gain real traction with record sales this quarter along with strong sales using our Total Retirement Suite platform, which remains best-in-class among retirement providers.

Our investment performance remains very competitive with 78% of funds above median for the one-year period. This performance was recognized by Barron's annual rankings of best fund families by naming Principal Funds as the third best fund family for investment performance across all asset classes for the one-year ranking and the seventh best fund family for the past 10 years. Our focus on the emerging middle class in key developing economies of the world continues to fuel growth for Principal International. Two examples of this, we saw new sales within our Brasilprev joint venture increase 75% and net cash flows increase by 92%, both over first quarter 2010.

In short, we believe we have exactly the right strategy involving a hybrid model of asset accumulation, asset management and risk businesses positioned in the best markets in the U.S. and developing countries to drive consistent growth over many years. This hybrid model will produce increasing amounts of free cash flow that will allow us to continue to build our businesses over time as well as return capital to investors while maintaining a strong financial position.

The highlights of our ongoing strategy implementation in first quarter were the announcements of our acquisition of HSBC's Mexican AFORE pension company and the acquisition of a majority stake in Finisterre Capital, an emerging market fixed income specialist in London. As we have said for several years, our priorities for deploying capital are to first, add mass or scale to an existing business or second, to add new capabilities, which we believe will provide substantial growth opportunities in the future.

The HSBC acquisition gives us the scale to be a leader in the Mexico AFORE business. We will be the #4 in number of customers and #6 in assets under management. We expect to close the deal in the third quarter, and it will be immediately accretive to earnings. With the acquisition, we also gain the exclusive right to distribute AFORE products through the 1,100 HSBC branches for the next 5 years, which is the fourth largest bank network in Mexico. The AFORE business compliments our mutual fund and voluntary pension savings businesses in Mexico, adding further growth to our existing businesses.

Finally, as the regulators in Mexico begin to allow AFORE assets to be invested outside Mexico, it will create an opportunity for Principal Global Investors to provide the needed Global Asset Management expertise. We expect the same trend to occur in other emerging markets including China, Brazil and India, which will create increasing synergy between Principal International and Principal Global Investors.

Now, a few comments on Finisterre Capital. They are an emerging market fixed income specialist based in London with a strong track record. While we already have a substantial position in managing emerging market investments with Principal International and Principal Global Investors managing a combined $67 billion, the interest in emerging market securities is enormous. Finisterre Capital adds to this capability with their unique and proven approach, and we expect substantial growth for Finisterre as we help them build through our global distribution platform.

Now let me close with some comments on our financial position and our outlook for 2011. In terms of financial position, our book value per share was at another record level this quarter with book value, excluding AOCI, increasing to $28.38, up 6% over first quarter and book value, including AOCI, at $30.02, up 20% over a year ago. Total common equity stood at $9.6 billion, another company record. In short, we are at the strongest financial position in our 132-year history.

As mentioned previously, we expect that we will have approximately $700 million in deployable capital in 2011. With the HSBC and Finisterre acquisitions, we still have approximately $400 million of deployable capital for the remainder of 2011 for a combination of acquisition and return of capital to shareholders. As always, we'll be disciplined in our capital deployment, staying mindful of accounting or regulatory changes that could impact our capital position.

Looking forward, we are pleased with our first quarter results and are excited about the rest of 2011. Our general account investment portfolio continues to perform well. Our competitive position remains strong, and our employees are excited about our future. In the past 2 months, I've attended sales conferences in the U.S., Latin America and Asia, and I have never seen the enthusiasm as high as it is today. It is clearer than ever that aging populations, global competition among employers to attract and retain top-notch employees and financially constrained governments, together drive an unprecedented need for our businesses. We're in the right businesses in the right markets with employees that have proven their ability to deliver.

Before I turn the call over to Terry, let me comment briefly on our new branding and educational effort called Dream Again with the Principal. Our educational effort provides the tools advisors need to help employers and individuals consider their dreams and rebuild their financial futures. The early indicators say this message continues the positive response to our integrated America Rebuilds campaign as people move on from the financial crisis. In fact, the Principal was recently named Investment Brand of The Year in the 2011 Harris Poll EquiTrend study. Terry?

Terrance Lillis

Thanks, Larry. We start out 2011 where we left off 2010 with strong diversified earnings, good sales momentum across the board and flexible capital position. First quarter results reflect the continued momentum that started to build in the second half of 2010.

This morning, I'll focus my comments on operating earnings for the quarter, net income including the continued solid performance of our investment portfolio and the strength and flexibility of our capital position and continued implementation of our capital management strategy.

Starting with total company results. Once again, we ended the quarter with record assets under management now at $327 billion. Total company earnings of $232 million are up 5% from a year ago quarter on 12% higher average assets under management.

There are 3 main items influencing comparability between the first quarter 2011 and first quarter 2010: the reduced economic interest in our Brasilprev joint venture that began on June 1, 2010; the fees due to the opportunistic early retirement of Investment Only liabilities and associated recovery of the receivable in the year-ago quarter; and variances between the periods for the recognition of deferred acquisition cost amortization expense and dividends received deduction. Adjusting for these items, first quarter 2011 earnings were up 18% on a 12% increase in average assets under management compared to first quarter 2010, a very solid result reflecting strong operational leverage.

Let me quickly identify the items impacting first quarter 2011 reported earnings per share of $0.71. A prior year dividend received deduction accrual true-up and stronger than expected DAC amortization true-up negatively impacted Full Service Accumulation by $0.02. Stronger than expected net investment income benefited Individual Annuities by $0.01, amortization expense true-up for rising interest rates in Mexico negatively impacted Principal International by $0.01 and favorable mortality experience benefited Individual Life by $0.01. On an adjusted basis, we consider the EPS run rate for this quarter to be $0.72. This continues the steady trend of normalized EPS improvement.

Now let me discuss the business unit results. Retirement and Investor Services earnings of $159 million in the first quarter are the segment's third highest quarterly earnings. The segment had record account values of $185 billion at quarter end. Full Service Accumulation operating earnings at $76 million were flat with the year-ago quarter on a 13% increase in average account values. As I mentioned, the current quarter was negatively impacted by a lower dividend received deduction accrual true-up than in the year-ago quarter and higher DAC amortization from experience true-ups. Adjusting for these items, operating earnings are in line with the 13% growth in average account values. Full Service Accumulation sales in the first quarter were very strong at $2 billion, up 16% over first quarter 2010 as we continue to see an increase in proposal activity and improvement in our close ratios.

Contract withdrawals moderated from fourth quarter 2010 as we expected. Combined, these items drove net cash flows of $870 million, contributing to record account values of $113 billion at quarter end. In addition, our pipeline continues to build, giving us momentum for strong full year sales, which we expect to be 15% to 20% higher than full year 2010. Principal Funds continues to deliver a series of excellent quarters. Operating earnings at $12 million in the first quarter were up 18% over a year ago quarter on a 19% increase in average account values. Principal funds delivered record sales of nearly $3 billion in first quarter and strong net cash flows of $620 million, the second highest quarterly net cash flow.

During the past 3 quarters combined, Principal Funds has achieved nearly $2 billion in positive net cash flows. We continue to benefit from the strength of our multi-channel distribution model, with strong growth across our national, proprietary and defined contribution Investment Only channels. Continued strong investment performance also contributed to the results. As of quarter end, 87% of our asset allocation funds were in the top half on a one-year basis, 78% on a 3-year basis and 69% on a 5-year basis.

Individual Annuities achieved record operating earnings this quarter of $37 million, driven by strong net investment income and record account values of $19 billion. The stronger-than-expected net investment income for the current quarter benefited from prepayments and gains on sales of assets. Bank and trust services had operating earnings of $9 million and net income of $7 million for the quarter. On a near term, go-forward basis, we expect bank and trust services to deliver quarterly net income of $2 million to $4 million, which is better than previous estimates due to the improving fundamentals and continued paydown and overall improvement in the home equity portfolio.

Earnings from Principal Global Investors at $17 million improved 38% from a year-ago quarter on a 6% improvement in average assets under management. This reflects the improving fees for an actively managed funds, increased real estate mandates and strong operating leverage. Of the $3 billion net outflows of unaffiliated assets under management at Principal Global Investors this quarter, $2.1 billion was due to the state of Florida rotating from a core-plus fixed income mandate to an internally managed passive account. This asset allocation decision was part of the reallocation of billions of dollars away from multiple core-plus managers. The state of Florida remains a client of Principal Global Investors and other asset categories.

We are optimistic about revenue growth and net cash flows in Principal Global Investors for the remainder of the year. Mandates awarded in the first quarter 2011 were greater than full year 2010, and we see an increase in searches and specialized investment strategies where we have expertise such as real estate, currency, high yield and international equities.

As Larry mentioned, we're excited about the growth potential that our acquisition of a majority stake in Finisterre Capital brings us. Assuming a third quarter close, we expect the transaction to be EPS neutral in 2011 and accretive in 2012. Combining our global distribution platform with the expertise of Finisterre Capital and capitalizing on anticipated synergies, we expect Finisterre's assets under management to grow 3 to 5x over the next 5 years. This level of growth is consistent with that achieved following our acquisition of other boutique managers such as Columbus Circle Investors and Spectrum Asset Management.

Moving to Principal International. Operating earnings at $29 million were down 25% from first quarter 2010. Adjusting for the lower economic interest in our Brazilian joint venture, Brasilprev, and an amortization true-up in Mexico, earnings were up 20% over the prior year quarter. Our run rate for the current period earnings is $32 million to $33 million. Principal International finished the quarter with record assets under management of $49 billion, driven by strong net cash flows of $1.3 billion. Given the rapidly growing middle-class populations, we're excited about the organic growth opportunities for defined contribution pensions and mutual funds in the emerging markets where we already have a presence.

The acquisition of the HSBC AFORE in Mexico is a perfect example. This is the fourth AFORE transaction. We have proven success in efficiently merging these acquisitions and quickly gaining synergies. We've seen a compounded annual growth rate in assets under management of 33% from the 3 previous acquisitions. We expect the transaction to be immediately accretive as we add HSBC's assets under management to our existing infrastructure. Assuming this transaction closes in early third quarter of this year, we expect an increase of earnings per share of $0.02 to $0.03 in the second half of 2011 and $0.06 to $0.08 in 2012. This deal is projected to have an ROA of between 70 to 80 basis points, which is consistent with our existing Mexican AFORE business.

U.S. Insurance solutions operating earnings of $60 million is an increase of 35% compared to first quarter 2010, driven by favorable claims experience and increasing momentum in the underlying businesses. Individual Life had operating earnings of $37 million, up 20% over the prior year quarter due to improved mortality experience. The business market accounted for 70% of the total sales in the first quarter 2011, highlighting our success in serving the needs of business owners and key executives. Reflecting growth in the business, the run rate for Individual Life operating earnings is in the range of $31 million to $33 million per quarter.

Turning to Specialty Benefits. Operating earnings of $23 million were up 69% over the year-ago quarter, driven by investment performance and an improved loss ratio that remains comfortably within our targeted range. The decline in the sequential earnings is due to a normal seasonality in dental claims. Specialty benefits had record sales of $113 million this quarter, up 56% over a challenging first quarter 2010. Metrics such as premium, in-force lives and existing case membership continues to build momentum.

Shifting to total company net income, we delivered $196 million this quarter, up 3% over first quarter 2010. After-tax net realized capital losses of $53 million are lower than a year-ago quarter. We continue to see improvement in corporate credit-related and commercial mortgage whole loan losses. CMBS losses also improved and continue to be manageable. Our investment portfolio performance continues to reflect the benefit of broad asset diversification. The strength of our balance sheet reflects the ongoing improvement in the credit markets as the U.S. economy rebuilds. At $1.2 billion in net unrealized capital gains, we were up $300 million from fourth quarter 2010. During the quarter, we had a $700 million gain due to tightening of credit spreads offset by a $400 million loss from the impact of rising interest rates. Let me remind you that because of our strong asset liability management, changes in net unrealized gain or loss due to interest rate movement did not result in an economic impact.

Moving to capital adequacy, as of quarter end, we estimate our risk-based capital ratio to be 425%. This improvement from year-end 2010 reflects current period statutory net income and a $200 million distribution from the life company to the holding company in the first quarter. Relative to a 350% RBC ratio, we have approximately $1.9 billion of total excess capital. $1.1 billion of excess capital is at the holding company, with $280 million committed to our recent acquisitions that we expect to fund in the third quarter.

In addition to our capital cushion, we still have more than $400 million left to deploy in 2011 for appropriate acquisitions and return of capital to shareholders. As we continue to shift to a more fee-based business model, less capital is needed to support organic growth, which results in an enhanced stability to generate free cash flow. This furthers our ability to increase shareholder value over time through strategic capital redeployment. The strength of our balance sheet gives us good financial flexibility and we look for opportunities to grow the enterprise in 2011 and beyond. Again, we're very pleased with the financial results of our businesses this quarter. Momentum continues to build as does our long-term growth potential.

This concludes our prepared remarks. Operator, please open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question will come from Randy Binner with FBR Capital Market.

Randy Binner - FBR Capital Markets & Co.

So on FSA. Appreciate the sales guidance there but if transfer deposits, I guess, were lower than our expectations just from a timing perspective and for modeling purposes, I want to get a sense of kind of how those sales work their way in. I guess last year, the first quarter was good and then it kind of dipped down and ended the year strong. Should we kind of expect a similar pattern this year?

Larry Zimpleman

Randy, this is Larry. I think just to reiterate sort of the longer-term sort of guidance we've given around that, I think we've generally talked in terms of sales, about 65% of that turns into transfer deposits within that particular quarter. And then it sort of rolls out roughly 20, 10 and 5. I don't think that there's anything necessarily that has changed that. I would say that the fourth quarter sales -- the first quarter sales didn't quite turn into deposits of that same 65% rate, but these are all within the normal variations. Let me see if Dan's got any more he wants to add on that.

Daniel Houston

No. The only other thing I would call out is we did have a large case, over $100 million in the fourth quarter of '10 and a $1.5 billion total. Whereas in the first quarter of '11, it was $285 million. So what we're seeing in the first quarter is a significant increase in the number of cases partially due to our third-party administration rollout and fewer larger cases. And again, as Larry said, one of the larger cases deposit will actually come in the first part of the second quarter as opposed to funding in the first quarter. Hopefully that helps.

Randy Binner - FBR Capital Markets & Co.

No, it does. Absolutely. Just one other question, I'll go on the queue. On the DRD, can we go through specifically what affected that true-up and if that could possibly be recurring?

Larry Zimpleman

Well, yes, the DRD true-up, again, is more a comparison, Randy, of what the true-up was this year as compared to what it was a year ago. So this year was a little bit unusual in that the DRD true-up has historically been a small positive, so it's typically been in the range. Last year, it was about $4 million positive, $4.5 million positive. This year was a little bit unusual in the sense that it was actually slightly negative, about $1.5 million negative. So that swing is a little over $6 million, $6.5 million. So that's the item that you kind of need to take into account when you're thinking about what the true return is within the Full Service Accumulation.

Randy Binner - FBR Capital Markets & Co.

I guess why was it negative is the question.

Larry Zimpleman

Well, it's just a matter of estimating it. So you estimated in one quarter and so again, whether you're estimating what dividend flows are going to be coming out of the portfolio as we hold within our -- generally speaking within our group annuity contracts. So it's just an estimation issue. But, Terry, do you want to add anymore to that?

Terrance Lillis

No. No, you're absolutely right, Larry. At each quarter, we're required to look at our estimate of our effective tax rate for the entire year and have to adjust accordingly. And so you have to make an estimate of the dividends that you'll receive, as Larry mentioned, in the first quarter and then throughout the year, you true that up as you go along. However, once you get into the first quarter of each year, you have to true-up for the prior year, and that's where the estimate comes into play.

Operator

The next question will come from Jimmy Bhullar with JPMorgan.

Jamminder Bhullar - JP Morgan Chase & Co

I had a couple of questions. The first one is just on your FSA plans. They've been going down steadily over the last several quarters. I think you're down about 7% from last year. So what's causing that and what your outlook is? And then second and maybe for Jim, in the PGI business, obviously, your performance has been good and you cited that on the call but you haven't had the positive quarter in terms of flows, I think, since the first quarter of '09. So what your outlook is for flows, what do you think is holding you guys back and do you expect to turn positive flows at some point in the next few quarters? Thanks.

Larry Zimpleman

Okay, let me just make a couple of high-level comments on both of those. Again, I think the plan counts, while it is still a negative story, that is primarily due to the economic environment involving a combination of fewer start-up plans as well as a few more plan terminations, and I'll turn it to Dan in a second to talk about sort of the outlook. And then as it relates to PGI, I'll have -- again, I'll have Jim comment when Dan gets done. But again, the real story there is that the momentum at least in terms of mandates is now beginning to pick up and we saw good activity in Q1. So we're optimistic. But again, I'll have Jim comment after Dan talks about the plan count.

Daniel Houston

Thanks, Larry. So we actually did see in that group from 100 to 500, they go up 1%. 1,000 or plus actually went up 5%, and we're a little bit down in that 500 to a 1,000 range. And as Larry pointed out, there's fewer start-ups, which is the largest contributor in the under-100 life market. As we said in the earlier comments on the script, if we look at just case counts, it's up 29% through our TPA model. We hit $384 million in sales in the first quarter. You can roll back a few years ago and that would have been an annual sort of number. So again, 23% improvement in case count sales from the first quarter of '11 from the fourth quarter of '10. If we look at first quarter of '11 versus the first quarter of '10, it's up actually 29% from 640 plans, day 28. So the momentum is coming back in terms of the small group marketplace where we're focusing our sales force in addition to the TPA strategy. And I would just make one closing comment, we're one of the very few TPA solutions out there that actually is inclusive of our TRS model. So they can use DB, DC nonqualified deferred comp and ESOP along with a third-party administrator, which is unique in the marketplace. Larry, I'll turn it back to you.

Larry Zimpleman

Okay. Jim, you want to comment on PGI flows going forward?

James McCaughan

Yes. Thanks for the questions, Jimmy. I think the point to make really here is that this quarter, the loss of the large mandate for Florida, $2 billion, that is a large core, very low fee mandate. 10 or 11 basis point is typical for that sort of mandate. And you'll recall that we lost one of these large loan low fee mandate last quarter as well.

I think it's symptomatic of the fact that institutional buying behavior is somewhat changing, and we're seeing a lot of institutions move to passive and in some cases liability-driven investing for their large core mandates. That is obviously negative for our flows. However, at the same time, they are committing to high added value satellite mandates in a number of areas. You've seen more of a bifurcation of buying behavior. And we are seeing a lot of interest because of our multi-boutique structure in these high added value mandates. This would include high yields and other niche-fixed income; international, including emerging equities, as Terry mentioned; real estate. So we're extremely well-placed to supply in these higher added value at smaller mandates. And do bear in mind that the mandate we lost this time would have been a very low fee. This satellite mandates are more like 50, 60, 70 basis points. Or in some unusual cases, with performance fees, they can be 1 and 20 or even 2 and 20. So I think what I would sum it up by saying is, I have become more optimistic, if anything, about revenues even as the asset potential looks less than I thought it was maybe 6 months ago when we talked at Investor Day. So I think this changed buying behavior is -- is actually, we'll have to see how it goes. But it does make me quite confident about the revenue outlook. Larry and Terry both alluded to the fact that our sales activity, our awarded mandates has picked up very strongly in the first quarter. It's been a long time coming. It's kind of odd that the very sophisticated institutions seem to have taken longer to get their confidence back in a way than many of the defined contribution investors. But I can tell you it is happening. Our pipeline is looking very buoyant right now. I hope that helps.

Jamminder Bhullar - JP Morgan Chase & Co

Okay, sure. And then, Dan, another one just on FSA. If you look at the past couple of years, the first quarter, your flows have been higher than the full year numbers. So could you talk a little bit about the quarterly, better than you expect, should we expect the same this year and that the first quarter will be higher than the year? Or should you -- are you expecting more of an improvement in the second half?

Daniel Houston

Yes. Well, yes, I think we're actually off to a good start. And as we said in the script, we would anticipate sales being up about 15% to 20% over last year's sales and note 2010 sales were 32% higher than the 2009 sales. In terms of the pattern that we cited to the earlier question, some of the first quarter actual receipt of the cash is spilling over into the second quarter. We won't get into the gory details on a couple of cases with that, that transpired but I would anticipate actually fairly up into the right sort of movement for the balance of 2010 transfer deposits.

Larry Zimpleman

I'll give you just 2 quick factoids that might be helpful relative to recurring deposits. In the first quarter, Jimmy, we saw participant deferrals actually increase about 6% in first quarter over first quarter a year ago. And I think one thing that I think shows how profits are coming back is we saw employer matches were 32% higher in first quarter '11 over first quarter '10. So I think It gives us a bit more confidence around the recurring deposits stream. And we you then add to that, the transfer deposits Dan talked about, I'd hope we'd end up with net cash flow for '11 back closer to what it was for 2009.

Operator

The next question will come from Colin Devine with Citi.

Colin Devine - Citigroup Inc

A couple of questions. First, Larry, why don't we just pick up on your comments here about deferrals and employer matches. And perhaps you can put some numbers behind that because if I'm looking at recurring deposits year-over-year, they were flat. And I think we'd all appreciate understanding a little bit more what's going on underneath that. Second, with respect to capital management, I appreciate you did the deals but you certainly, I think, given the very strong indication you'd be in the market, buying in shares sooner than later and nothing happened this quarter. And sort of what's going on there? Clearly, some in the quarter, given the market reaction to your stock this morning, something seems to be a bit of a disconnect with what you've been saying and how the markets read again.

Larry Zimpleman

Okay, well, let me -- I'll comment on both of those and Dan may want to comment on the recurring deposits as well. Again, when you look out comparison to a year ago, as Dan said, there was some -- a little bit of noise in what was recurring deposits a year ago because we have some ESOP plans who will occasionally do some pre-funding, and we had a little bit of that going on in first quarter '10. That's actually a positive sign relative to the economy picking up in 2010. But it makes the comparison in 2011 recurring deposits a little more challenging. As I said, we are seeing deferrals up. We're seeing matches up. So again, we're optimistic about that going forward. In terms of capital management, Colin, certainly again we have been clear that we believe we'll have approximately $700 million to deploy in capital during the entire year of 2011. I think it's always been true that it never -- we'd expect that to be a mix. We expect that to be a mix of acquisitions as well as some sort of return of capital to shareholders. And we knew a quarter ago, of course, we knew that we were highly likely to be closing the acquisitions that we announced. So it would be reasonable that we couldn't be in the market doing any sort of share repurchase if we knew we were on the verge of closing a couple of acquisitions. Now as we go forward, again, we continue to look for appropriate acquisitions and we'll always do that. But we also recognize it's unlikely that there's probably that level of acquisition out there. But we also need to be cognizant about some of the carrying and regulatory changes. But I do expect, over time, we will have enough capital to distribute both in the form of acquisitions as well as return of capital to shareholders. And I expect that to happen during 2011.

Colin Devine - Citigroup Inc

Okay, just -- again, it would be helpful to get some actual numbers behind what deferrals and company matches are. But also tied to that, you've put out what I thought was certainly a fairly aggressive goal this year for FSA net flows of up to 3% to 5%. Are you reaffirming that this morning or how do we look here today?

Larry Zimpleman

Again, just to be clear, as far as deferrals, the deferrals right now are running at about an annualized rate of about 7.4% of salary. So that's up a little bit over what it has been the last couple of years. So again, I think that's an optimistic sign. I'd say in terms of net cash flow, as I said, it's awfully hard to predict it off of one quarter. But if you look at flows in 2008, they were about 5% of beginning balance. If you look at flows in 2009, they were about 2.5% of beginning balance. If you look at flows in 2010, they were basically flat. And I would expect that what we'd end up with for 2011 would be something that looks like 2009. So it would be more in that 2% to 3% of beginning of period account value.

Operator

The next question will come from Steven Schwartz with Raymond James & Associates.

Steven Schwartz - Raymond James & Associates, Inc.

A couple of follow-ups. Jim, could you -- going back to the passive investment that moved or the core that moved to passive of last quarter, the core that move to passive it this quarter, how should we think about -- what kind of exposure you have there? How much in assets could you see that possibly occurring to?

James McCaughan

Sorry, I'll take that straightaway, if that's all right, Larry?

Larry Zimpleman

Yes, go ahead.

James McCaughan

It's difficult to say because what has happened with the Florida mandate is it's a move from active core to passive by the client. So it's very hard to know how much of our active core is liable to move in that direction. Having said that, with the investment performance we've talked about, we are certainly not the first target when most of those clients increase their passive element. They will tend to part with the weakest performing core mandates. And so I think that there are a lot of other asset managers and you're seeing some with very large institutional outflows, I don't know how they're explaining it but I think what's happening to them in industry terms is that the weaker core mandates are being transferred rather more aggressively to passive. So our exposure, I think, should be modest. By this stage in the quarter, we would probably know if we're going to lose another big one this quarter. As of now, I'm not aware of one. So I think that the sort of phenomenon with one large mandate that happened last quarter is pretty unlikely this quarter. But you know, anybody who's got a lot of core mandates when there is a cyclical moved towards passive has a certain degree of vulnerability. I just think where we are in the lead tables insulates us somewhat. But the more important thing that gets us really going is these smaller satellite mandates where the opportunities are increasing.

Steven Schwartz - Raymond James & Associates, Inc.

Okay, thank you. That's good info. And then, Terry, if I may, just kind of a geography question, if you will. Looking at the -- it sounded like you're suggesting $2 million to $4 million quarterly run rate for bank and trust. For modeling purposes, how would we get there from the close to $9 million that you put up in the -- I'm sorry, I'm looking at operating earnings, forget that question. I'll leave it there. Thanks, guys.

Operator

The next question will come from Mark Finkelstein with Macquarie.

A. Mark Finkelstein - Macquarie Research

I just wanted to get through -- Larry, I think you touched in your earlier comments, you talked about 30%, 40% of industry-wide total business being sold on kind of an unbundled platform, if you will, and that you're kind of moving more into that area through your TPA platform, at least trying to access that. I guess I'd be curious about what percent of your sales are actually unbundled or on a TPA platform or however you want to characterize it? And how does that number compare to say, a year ago?

Larry Zimpleman

I think we'll just let Dan go ahead and cover that. Dan?

Daniel Houston

Yes, if you look at total sales for FSA of say, $6.6 billion a year ago, total TPA sales would have been kind of closer to that $600 million to $700 million range. Right now, you'd think about increasing sales by 15% to 20%. My expectation is the TPA will make up a lot of ground on that, and it wouldn't surprise me to start seeing that number start getting up to say 15%, 16%, 17% of total sales coming through third-party administrator. And again, I would emphasize that to make sure you're not comparing samples in arduous because a lot of these opportunities on our full service platform tend to be more TRS in nature. And although we provide TRS solutions to the TPA marketplace, a lot of those would be stand-alone 401(k) sorts of mandates so it's not directly comparable. Does that help, Mark?

A. Mark Finkelstein - Macquarie Research

It does. I mean, I guess how should we think about the differences in terms of margins. If more of this business is being sold on kind of a TPA platform, how should we think about in terms of a 30 to 32 basis point margin target?

Daniel Houston

We think they're very comparable between full service and TPA. Remember, this is a smaller block of business. We're making investments in distribution. We're making investments in some of these TPAs. We're doing some programming that enhances our technology to support them. So we've got some higher cost deploying the TPA strategy over the next few years. But I would say as we target long-term, 30 to 32 basis points after-tax ROAs, we would anticipate both the TPA and the full service to be in the same zip code.

A. Mark Finkelstein - Macquarie Research

Okay. And then just one follow-up on PGI. I mean if you look at PGI margins, call it revenue margins, they've trended up nicely over -- as the markets have improved. This quarter, they actually went down a little bit. And I'm just curious if there's anything specific that occurred in this quarter or why didn't we see some operating leverage in that business?

James McCaughan

The point about this quarter is the first quarter has a lot less incentive fees than the fourth quarter. And to be precise on incentive fees, it has about $8 million in gross in the fourth quarter of last year and under $1 million this year. These incentive fees tend to be back-end loaded in the calendar year. So if you look back at the quarterly pattern, you'll see in the last 3 or 4 years that the fourth quarters tended to be the strongest earnings one for PGI. That's really all that's going on. If you look at it on an annual basis, our margins obviously took a bit of a dropping in the financial crisis. In the worst year, they were down to sort of 14% or 15%. We are rebuilding towards -- our belief in the next 2 or 3 years is we can get the pretax margins up to 30% or a bit more. We won't be there in 2011. But with increasing scale and with, therefore, increasing operating leverage, we think that's where the margin should go over the next 2 or 3 years.

Operator

The next question will come from Ed Spehar with Bank of America.

Edward Spehar - BofA Merrill Lynch

I want to follow-up on the margin question in TPA. I guess one of the arguments for TRS has been that the number of competitors you go up against with the bundled solution is a handful versus, I think you said in the past, I don't know, 10, 20 players you might go up against when it's a stand-alone 401(k) plan. I guess it doesn't seem to me that you could have as much confidence that the margins would be the same considering that the number of competitors you're up against is multiples of what it is in TRS. So could you expand upon that a little bit?

Larry Zimpleman

Yes, this is Larry and I'll have Dan comment. I would -- I wanted to quickly follow-up on your comment about TRS metrics because I think we have commented from time to time in the past as we've launched TRS that we had a belief that because of the multi-product relationship that we have on TRS where it's defined benefit, defined contribution, nonqualified and ESOP or some combination of those 4, we felt like over time that was definitely going to create a stickier relationship. We know that our close rates are about twice as high when we're quoting a TRS set of planned solutions rather than stand-alone 401(k). But obviously, it was going to take some time before we could begin to measure the stickiness of those relationships. And I would say that we've now begun to do that. It's becoming more credible, certainly, as we've had now TRS for 4 or 5 years. And in rough terms, what we had expected to see is exactly what we are seeing. We're seeing about a 20% improvement in lapse rates on our TRS block than we are on our, if you will, our regular block or a non-TRS block or our stand-alone 401(k) block. So I just wanted to comment on that because you had mentioned it and I think we're seeing some good things develop. And I think it certainly is worthy of mention as again we think about that 30 to 32 basis point ROA margin. So I'll let Dan talk about TPA.

Daniel Houston

Yes. So just a couple of quick comments, Ed, about our TPA differentiators relative to maybe the other similar competitors in the space. The reality is we do have TRS available, which resonates in the sales process to talk about that. Even if it's a stand-alone today, it has the ability to be upgraded at some later date. Our technology is very refined, very custom. As you know, we have a proprietary platform. We rolled out a very comprehensive automated Form 5500 solution, not only to our full service platform but also to our TPA so they've got that upgrade. Again, I won't go into gory details today but it suffices to say it's a very robust tool. We still make retire secure available through our local sales and service offices, which, as you know, is the workplace, enrollment and cross-sell initiative to drive assets to the platforms, so retire secure is available for TPA. Local service is available if they choose to have it, which again is a differentiator relative to the competition. And then lastly, I would tell you that our investment lineup resonates to strong proprietary competitively priced investment lineup. You heard in the script, some favorable comments about our Barron's ranking. So I wouldn't let it just always get boiled down to price when you're talking about TPA. And again, our sales people and service people are very astute in recognizing what it is that the advisor wants to compete in a marketplace. Hopefully that helps.

Edward Spehar - BofA Merrill Lynch

It does, Dan, but I guess still going back to I think a core message from you guys has been that the TRS model dramatically reduces the number of competitors you're going up against. So I appreciate that you have selling points beyond price. But I think from the outside looking in, it's a little hard for us to sort of agree that the ability to get the same margins in TPA is evident. And maybe what we're missing and maybe you can help us with this is, do you see a higher percentage of the deposits from TPA going into PGI funds versus under TRS?

Larry Zimpleman

Well, I think -- this is Larry, Ed. I mean, I think you are now on what is really going to be among other things, first of all, I think there's going to be 2 things that are going to ultimately tell the tale relative to the margins in a third-party administrator-type situation. One is, will TRS add value to the point that we're going to see the same improvements in lapse rates that we're seeing on our full service block? And of course, again, we don't know enough yet. It will be a couple of years before we know that. But the second one is exactly what your question is talking about, which is can we still drive that 65% to 70% of TPA assets into a proprietary platform? So I think that's what's going to be -- at the end of the day, is going to be a significant relative to getting that same margin. I don't know yet if we have enough experience.

Daniel Houston

We don't. But generally again, those TPA plans tend to be smaller plans. It's generally fewer than a couple of hundred employees. The local advisor has a lot of control working with the plan sponsor. Generally, they like the idea that the TPA is locally -- is local. There's strong working relationships there. We enjoy very strong relationships with advisors. And again, on smaller plans is where we tend to see higher percentage of the dollars in total go to proprietary investment options. But that's worthy of noting, Ed. We'll make sure we'll be able to address this in more detail on future calls as we get a larger block of TPA business.

Edward Spehar - BofA Merrill Lynch

You said 65% to 70% would be kind of what you would hope for and how does that compare versus TRS?

Larry Zimpleman

That is what TRS is, Ed. So TRS is in that entire bundled block is in that 65% to 75% of account values being proprietary.

Operator

The next question will come from Suneet Kamath with Sanford Bernstein.

Suneet Kamath - Sanford C. Bernstein & Co., Inc.

Just a quick follow-up to Ed's line of questioning on the 65% to 70%. I know that you're still sort of trying to figure out how this is going to play out over time but how much of a swing factor is that in the 30 to 32 basis points? In other words, if you got maybe half of the 65% to 70% with the TPA, how much would that change that margin that you kind of guided us to?

Larry Zimpleman

This is Larry, Suneet. It would not -- in sort of the next year or so, it's unlikely that it would have any significance on our ability to achieve a 30 to 32. I would answer your question this way, however. If we ended up let's say 2 years from now, we ended up with the proprietary assets within our TPA block in our third-party administrator block being in let's just hypothetically say 35% to 40% of account value, we have to rethink the entire kind of TPA strategy. I would again say, if you look at our investment performance where 78% of our entire platform is above median and 87% of our asset allocation funds are above median, that gives us a strong opportunity to drive those proprietary assets. So it is sort of a foundational part of our TPA strategy that we're going to be driving assets at that same level or we're -- then we're not interested in investing in growing that part of the business.

Suneet Kamath - Sanford C. Bernstein & Co., Inc.

Okay. And then I guess a couple of questions for Terry, if I could, on capital. First, in terms of the $700 million of capital that you're looking to redeploy this year, does that include expected 2011 operating earnings generation?

Terrance Lillis

Suneet, this is Terry. No, we said at the beginning of the year and actually at Investor Day that we felt we had $700 million of deployable capital in 2011 of which we've already deployed about $280 million of that. Earnings will be generated throughout the year on top of that, and we'll be able to look at that in future years.

Suneet Kamath - Sanford C. Bernstein & Co., Inc.

But I guess as we get towards the end of the year and we think about your, I think, you'd pay your dividend in the fourth quarter, you're talking about around $400 million of additional capital redeploy. I think the dividend is somewhere in the neighborhood of $200 million, which would suggest $200 million of available capital for buybacks and other things. As we get towards the end of the year, if that doesn't include the earnings generation that you're doing this year, why couldn't that number be higher than $400 million?

Terrance Lillis

Well, the $200 million that you've mentioned, the hypothetical number for the common stock would be part of the earnings that were generated throughout the year. You asked about the $700 million that we said at the beginning of the year, and we felt that we have that at the end of 2010 and we felt we would deploy it in 2011. We will continue to generate additional amounts of capital throughout the year, and we'll look for other ways of deploying that in future years as well. But we put the $700 million as an appropriate metric for 2011.

Larry Zimpleman

And Suneet, this is Larry. Just to be -- to try to add a little bit of clarity around this. The whole -- as I commented or as I mentioned in my comments at the opening of the call, I mean there still remains a lot of uncertainties in the environment relative to capital standards and accounting changes and other issues that are going to continue to play out from Dodd-Frank relative to things like systemically significant. So we have purposely tried to be I would say reasonable but, if you will, slightly conservative in our $700 million. So again, I think that's really what Terry is trying to say. And those uncertainties relative to changing capital standards or accounting changes, I'd say those uncertainties, while we would have hoped they would begin to be clarified over time, I'd say they would still remain uncertainties. I think as you know as well as anybody, a lot of the implementation around Dodd-Frank is dragging. I think it's going to continue to drag. So we're not going to have as much clarity around that as soon in 2011 as we would frankly had anticipated at Investor Day.

Suneet Kamath - Sanford C. Bernstein & Co., Inc.

Understood. If I could just throw in one quick follow-up just on the capital. Some of your competitors have sort of been pretty vocal about perhaps prioritizing common stock dividend increases going forward more so than share repurchases at least relative to what we've seen in pre-crisis years. Can you just maybe give us your thoughts on how you think about those 2 levers? Thanks.

Larry Zimpleman

Yes, absolutely. Again, as I said -- Suneet, this is Larry. So as I've said, over time and time would be, let's just for the sake of discussion say 4 to 6 quarters, I would expect that our capital deployment would include all 3 levers of organic growth, which, of course, is always there, acquisitions as well as return of capital to shareholders. So when you look at it over a 4 to 6 quarter period, you would see reasonable proportions going into all 3 tranches. We knew a quarter ago. We knew a quarter ago, when we had the earnings call that we were very, very close on some possible acquisitions that we're strategically very important to us. And the good news is, is that we were able to do those deals. So consequently, in terms of the prioritization, that takes priority. Now as we sit here today, of course, it doesn't mean that environment is isn't still allowing us to do our acquisitions. It is but obviously, we've now closed those. So now it's more likely that again it would be a blend of something involving acquisition or some sort of return to shareholders. So again, it's going to be a blend over time. Its front loaded toward the acquisition, and we'll see how the rest of the year plays out.

Operator

The next question will come from John Nadel with Sterne Agee.

John Nadel - Sterne Agee & Leach Inc.

Just a couple of quick ones to round it out for me anyway. Just in follow-up to Suneet, just to clarify, when we think about the $700 million of deployable capital for this year, is that including the expected common dividends?

Larry Zimpleman

Yes, this is Larry, John. What I would say is that the $700 million wouldn't necessarily be taking account of what we might expect to pay as the common dividend. As Terry said, we have the earnings during the year to sort of help guide us as to where we are with our capital position towards the end of the year so we didn't necessarily budget. Within the $700 million, we didn't necessarily budget an amount for any common stock dividend inside of that.

John Nadel - Sterne Agee & Leach Inc.

Understood. I'm glad to hear that. It was my expectation that, that was over and above the dividend. And I think many on the street expected the same. So thanks for that. And then, just a quick question on the Florida mandate that was lost and maybe some similar things that we've been hearing. I'm curious and maybe a bit naive here but losing -- why would like a state of Florida choose to leave a mandate that has cost only 10 to 11 basis points. How much are they actually saving switching to a more "passive" strategy. Is there truly a cost savings involved there?

Larry Zimpleman

That's a great question. Jim, do you want to help him out?

James McCaughan

Yes, sure. In the large passive mandates like that in either equities or bonds will typically have fees of 2 or 3 basis points. So those are -- I mean it's a total scale business. You have to run a trillion dollars to have a real business there and there's only 2 or 3 players. I do believe though also in the case of some of the big state funds, there have been hedge [ph] teams running in. They would believe that their operating cost are down in the 2 or 3 basis points range.

John Nadel - Sterne Agee & Leach Inc.

I might wonder whether their belief is reality. Okay, and then just a question. I think Steven started going here and stopped that. But bank and trust, I think I heard the same thing from you, Terry, $2 million to $4 million as a quarterly run rate. Was that -- Did I hear that correctly? And what's the driver there and when do we expect that?

Terrance Lillis

Yes, John. This is Terry. Yes, you're absolutely right. We think that operating earnings as Steven asked about was in the $9 million range. The net income was around $7 million this quarter because of an improvement that we're seeing. But we think that net income number on a quarterly basis would be more in that $2 million to $4 million range. Earlier this year, we talked about it breaking even because of the HELOC portfolio but we've seen a lot of improvement in that portfolio as it winds down. So we think that the net income for bank and trust services over the next few quarters will be in that $2 million to $4 million range rather than break even.

John Nadel - Sterne Agee & Leach Inc.

Okay. So that's not an operating earnings comment. Okay. And then just the last one for me really quick is just thinking about seasonality for FSA, I know so much in the world has changed relative to the way things used to look pre the financial crisis but historically, if we looked at your first quarter for your FSA business the seasonally strongest sales quarter, seasonally strongest flow quarter. Flows, I think as I looked back pre-crisis, were in the first quarter roughly 2x or maybe little bit more than that, the full year flows. I mean, should we expect that historical relationship or historical seasonality to persist from here? Is there some reason why it wouldn't?

Larry Zimpleman

I'll let Dan comment there.

Daniel Houston

Sure. I think, again as I cited earlier, John, that we're going to see some of the first quarter sales actually have rolled into second quarter sales. So again, I think it's going to be a little lighter at $2 billion than we historically would have seen. And then again, our view is today, it goes up into the right from here. But as long as we're on that topic, something worth at least mentioning in the call today, if you go back and look at just FSA sales on a trailing 12-month basis through the month of January, through 2011, that number is $6.91 billion. If you look at that same trailing month period of time through 1/31/10, that number was just short of $4 billion. We've seen a $3 billion increase on a trailing 12-month basis through those 2 January periods, which is a 76% increase during that time. So I don't think there's any question that the momentum continues. And again, with the increase in pipeline of roughly 30% and we're seeing improvement in close ratios and we did come out with a relatively strong, very strong Q4 of 2010 and a decent first quarter of 2011, we think the momentum is definitely in our favor at this point as it relates to FSA. And frankly, we're very excited about the latter half of 2011.

John Nadel - Sterne Agee & Leach Inc.

Okay. And just a point of clarification, the 30% growth in the pipeline, that's year-over-year, right?

Daniel Houston

It is.

Operator

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

Larry Zimpleman

Well, I want to say thanks to everybody for joining us. We appreciate your continuing interest. As I mentioned in my opening comments, we really believe our businesses continue to gain momentum as the recovery continues and we're very focused on continuing our strategy. We think we have the right strategy and the right team to grow our business over time. We look forward to seeing many of you in our visits over the next quarter. Everybody have a great day. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference call. This call will be available for replay beginning at approximately 8:00 p.m. Eastern Time until end of day, May 10, 2011. 54521548 is the access code for the replay. The number to dial for the replay is (800) 642-1687 for U.S. and Canadian callers or (706) 645-9291 for international callers. Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.

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