Aflac Incorporated — FY2016 Form 10-K
Reporting period: Year ended December 31, 2016. This is an annual filing, not a fourth-quarter-only report. Aflac sells supplemental health and life insurance in the U.S. and Japan; Japan accounted for 71% of 2016 revenue and 83% of year-end assets.
Key financial results
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $22.56 billion | $20.87 billion |
| Net premiums | $19.23 billion | $17.57 billion |
| Net investment income | $3.28 billion | $3.14 billion |
| Pretax earnings | $4.07 billion | $3.86 billion |
| Net earnings | $2.66 billion | $2.53 billion |
| Diluted EPS | $6.42 | $5.85 |
| Operating cash flow | $5.99 billion | $6.78 billion |
- Revenue rose 8.1%, mainly because the yen strengthened against the dollar; the weighted-average exchange rate was 108.70 yen per dollar versus 120.99 in 2015. Net earnings increased 5.0%.
- GAAP realized investment losses were $123 million, versus gains of $140 million in 2015. These included $255 million of derivative losses and $83 million of other-than-temporary impairment losses, partly offset by $215 million of gains on security sales and redemptions.
- On the company’s non-GAAP measure, operating earnings were $2.81 billion, or $6.79 per diluted share. Excluding current-period currency impact, operating earnings were $2.67 billion, essentially flat with 2015.
- Japan segment pretax operating earnings were $3.33 billion; its pretax operating margin was 20.7%, down from 21.9%. U.S. segment pretax operating earnings were $1.21 billion; its margin improved to 19.6% from 18.3%.
- Total assets were $129.82 billion, liabilities $109.34 billion, and shareholders’ equity $20.48 billion. Policy liabilities were $93.73 billion. Notes payable totaled $5.36 billion, compared with $4.97 billion in 2015.
- Cash and cash equivalents were $4.86 billion. Investing cash outflow was $3.86 billion and financing cash outflow was $1.62 billion; cash increased $509 million for the year. The company reported no outstanding borrowings under its disclosed credit facilities and compliance with debt and facility covenants.
Changes and capital allocation
- U.S. pretax operating earnings increased 9.7%, supported by favorable claims experience and a lower benefit ratio. Japan earnings increased 5.0% in dollars, but declined 5.7% in yen; Japan’s benefit and expense ratios rose.
- Annualized premiums in force rose to $19.68 billion from $19.17 billion, including growth in both Japan and the U.S. Japan new sales increasingly shifted toward cancer and medical products; sales of first-sector savings products fell 26.1% in yen as Aflac responded to low interest rates.
- Operating cash flow declined 11.6%. Management attributed lower Japan cash flows in part to reduced sales of products with discounted advance premiums.
- The company repurchased 21.6 million shares for $1.42 billion and returned about $2.1 billion through buybacks and dividends. The 2016 dividend was $1.66 per share, up 5.1%. Management planned $1.3–$1.5 billion of repurchases in 2017, weighted toward the first half.
- Aflac issued $700 million of senior notes and entered into 30 billion yen of term loans. It also repurchased $369 million principal of higher-coupon senior notes, recording a $137 million pretax early-extinguishment loss. Year-end debt included $650 million due in 2017.
Outlook, risks and unusual items
- For 2017, management’s stated objective was to maintain strong capital, produce stable earnings and strong cash flows, and continue product, service and distribution initiatives. It expected Japan’s low-rate environment to persist. No specific numerical earnings guidance was provided.
- Aflac announced plans to convert Aflac Japan from a branch to a Japanese subsidiary, targeting completion in mid-2018. Management expected the change to be tax-neutral and to enhance capital-management flexibility; execution, regulatory approvals, costs and potential operational disruption are identified risks.
- Key exposures include the concentration in Japan and Japanese government bonds, yen/dollar movements, prolonged low interest rates and reinvestment yields, credit deterioration, and market-driven changes in investment values and solvency ratios. JGBs were $42.9 billion at amortized cost, or 42.4% of debt and perpetual securities.
- Derivative activity creates hedge rollover, counterparty and collateral-liquidity risks. Aflac disclosed approximately $16.0 billion of notional currency forwards and options associated with hedging Japan’s U.S.-dollar investments.
- Other risks include reserve-estimate uncertainty, policy lapses, regulatory and tax changes, cybersecurity and technology disruption, and catastrophe claims. Aflac Japan’s solvency margin ratio was 945% versus 828%; Aflac’s U.S. company-action RBC ratio was 894% versus 933%.
- Aflac expected a future $10–$20 million assessment related to distressed Penn Treaty, subject to a final liquidation order. Management believed ordinary-course litigation would not materially affect results. The filing reported no material off-balance-sheet arrangements; it disclosed $779 million of contingent middle-market loan funding commitments and $19 million of commercial-mortgage commitments.
- The company reported effective internal control over financial reporting, and the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of revenue and earnings growth reflects yen translation rather than underlying operating trends; compare GAAP results with the company’s non-GAAP, currency-adjusted measure.
- Whether Japan’s product mix shift and U.S. sales-channel expansion sustain premium growth and segment margins.
- Portfolio sensitivity to interest rates, JGB credit conditions, equity markets and credit spreads, including the potential effect on Aflac Japan’s solvency ratio.
- Derivative hedge effectiveness, hedge costs, collateral requirements and counterparty concentrations.
- Progress, cost and regulatory approvals for the Japan subsidiary conversion, and the capacity to remit funds to the parent company.
- Claims-reserve assumptions and the $52 million 2016 strengthening for a block of Japan care policies; also track the anticipated Penn Treaty assessment.
- Debt maturities, capital deployment and the planned 2017 repurchases against operating cash flow and regulatory capital needs.