Aflac Incorporated — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; compared with Q1 2016 unless noted. Aflac sells supplemental health and life insurance in the U.S. and Japan. Japan generated 69% of Q1 2017 revenue and represented 84% of assets at quarter-end. The interim financial statements were reviewed by KPMG, not audited; KPMG reported no material modifications were known to be necessary.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Total revenue | $5.309 billion | $5.451 billion; down 2.6% |
| Net premiums | $4.638 billion | $4.602 billion; up 0.8% |
| Net investment income | $794 million | $801 million; down 0.9% |
| Realized investment gains (losses) | $(140) million | $30 million |
| Earnings before income taxes | $898 million | $1.117 billion |
| Net earnings | $592 million | $731 million; down 19.0% |
| Diluted EPS | $1.47 | $1.74 |
| Operating earnings (non-GAAP) | $676 million; $1.67 per diluted share | $705 million; $1.68 per diluted share |
| Operating cash flow | $1.757 billion | $1.331 billion |
| Cash and cash equivalents | $4.205 billion at March 31 | $4.859 billion at December 31, 2016 |
| Total assets / shareholders’ equity | $133.650 billion / $20.340 billion | $129.819 billion / $20.482 billion at December 31, 2016 |
| Notes payable | $5.250 billion | $5.360 billion at December 31, 2016 |
| Cash dividend per share | $0.43 | $0.41 |
Reported pretax margin was approximately 16.9% of revenue, versus 20.5% a year earlier. Segment pretax operating margins were 20.5% for Aflac Japan (21.3% in Q1 2016) and 19.7% for Aflac U.S. (21.5%).
Material changes versus the prior comparable period
- Reported revenue and earnings fell chiefly because realized investment results swung from a $30 million gain to a $140 million loss, and Aflac Japan had lower investment income after hedge costs.
- Operating earnings declined 4.1%; operating earnings per diluted share was nearly flat. The company’s operating measure excludes specified investment, currency, nonrecurring and other items, so it is not directly equivalent to GAAP earnings.
- Aflac Japan pretax operating earnings decreased to $769 million from $806 million; net investment income after hedge costs fell to $557 million from $590 million. Japan’s yen-denominated annualized premiums in force declined 2.0% year over year.
- Aflac U.S. pretax operating earnings fell to $310 million from $332 million despite higher premiums and investment income; the company cited higher claims and expenses compared with unusually low Q1 2016 ratios.
- Japan’s stronger yen affected reported results: the quarter-end yen was 3.8% stronger against the dollar than at December 31, 2016. Unrealized investment-securities gains in shareholders’ equity decreased to $4.474 billion from $4.805 billion at year-end.
Outlook, management commentary, risks and unusual items
- Management expected Aflac Japan’s full-year 2017 pretax operating margin to be comparable with 2016. It anticipated continued emphasis on less interest-sensitive cancer and medical products; Japan Q1 new annualized premium sales were down 29.2% in yen, while third-sector sales rose 7.6% and first-sector sales fell 81.3%.
- For Aflac U.S., management expected the benefit ratio for the remainder of 2017 to be stable versus full-year 2016 and expense ratios to rise slightly with platform investment. U.S. Q1 new annualized premium sales increased 1.7%.
- The company planned $1.3 billion–$1.5 billion of 2017 share repurchases, front-loaded in the first half, assuming stable capital conditions and no compelling alternatives. The board declared a Q2 dividend of $0.43 per share, payable June 1, 2017.
- Q1 results included a $14 million net-income impact from estimated U.S. guaranty-fund assessments related to Penn Treaty’s liquidation, after estimated premium tax credits; the assessment estimate could increase when additional information becomes available. Japan branch conversion costs were $6 million. Management excluded these and guaranty-fund assessment effects from operating earnings under its stated policy.
- Key risks include Japan concentration, yen-dollar movements, low interest rates and reinvestment yields, credit downgrades/defaults, investment valuation uncertainty, regulatory changes, and market and operational risks. The portfolio had significant Japan government exposure; Japan government bonds and backed securities had $54.971 billion fair value at quarter-end. Management said insurance capital positions remained strong and the company was compliant with debt covenants.
- Normal-course litigation was not expected by management to materially adversely affect financial position, results or cash flows. Reinsurance does not release Aflac from its obligations to policyholders if a reinsurer cannot pay. The filing reported no material change in market-risk exposures from the 2016 annual report.
Most important facts for investors to verify
- Whether Japan’s investment income, hedge costs, yen exchange rates and product mix support management’s full-year margin outlook.
- Drivers and potential persistence of the Q1 increase in U.S. claims and operating expenses, and the trajectory of segment margins.
- Assumptions behind the $14 million net guaranty-fund assessment impact, including possible revisions and timing of assessment payments and tax credits.
- Credit quality, concentration and valuation sensitivity of the investment portfolio, including Japan government exposure, below-investment-grade assets and unrealized losses.
- Whether planned repurchases and dividends remain consistent with capital needs, regulatory solvency requirements and the stated assumption of stable capital conditions.