Aflac Incorporated — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing is an annual report, not a standalone fourth-quarter filing; selected Q4 results are included below. Financial statements are prepared under U.S. GAAP. Aflac sells supplemental health and life insurance primarily in Japan and the United States.
Financial performance
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Total revenue | $23.939 billion | $25.364 billion | Down 5.6% |
| Net premiums | $20.135 billion | $22.148 billion | Down 9.1% |
| Net investment income | $3.293 billion | $3.473 billion | Down 5.2% |
| Realized investment gains (losses) | $399 million | $(349) million | Improved $748 million |
| Pretax earnings | $4.816 billion | $4.302 billion | Up 12.0% |
| Net earnings | $3.158 billion | $2.866 billion | Up 10.2% |
| Diluted EPS | $6.76 | $6.11 | Up 10.6% |
| Operating earnings per diluted share (non-GAAP) | $6.18 | $6.60 | Down 6.4% |
Management’s operating-earnings measure excludes realized investment gains and losses, nonrecurring items, and other non-operating results. The difference between rising GAAP earnings and lower operating earnings primarily reflects the swing in realized investment results. The 2013 realized result included $199 million of impairment losses, $262 million of net gains from security sales and redemptions, and $336 million of derivative gains.
- Cash flow: Operating cash flow was $10.547 billion, down 29.5% from $14.952 billion. Management attributed much of the decline to lower WAYS product sales and reduced cash receipts from discounted advance premiums in Japan. Investing cash flow was $(11.091) billion; financing cash flow was $1.136 billion.
- Balance sheet: Total assets were $121.307 billion versus $131.094 billion; investments and cash were $108.459 billion versus $118.219 billion. Cash and cash equivalents were $2.543 billion, up from $2.041 billion.
- Debt and equity: Notes payable rose to $4.897 billion from $4.352 billion. Adjusted debt to total capitalization was 24.3%, versus 23.4%. Shareholders’ equity declined to $14.620 billion from $15.978 billion, including the impact of foreign-exchange and investment-related other comprehensive losses and repurchases.
- Capital and liquidity: Aflac’s U.S. statutory risk-based capital ratio was 786%; Aflac Japan’s solvency margin ratio was 777%, up from 669%. A 50 billion yen revolving credit facility was undrawn at year-end. Cash returned to shareholders through dividends and treasury stock purchases was $1.4 billion.
- Margins: Japan’s pretax operating margin was 20.5%, versus 19.5% in yen terms; the U.S. margin was 17.9%, versus 17.7%. The filing does not present a single consolidated operating margin comparable to these segment measures.
Segments and material changes
- Japan: Pretax operating earnings were $3.628 billion, down 7.1% in reported dollars; the filing reports growth of 2.0% in yen. Japan represented 74% of 2013 revenue and 85% of year-end assets. The yen weakened: the average rate moved from 79.81 yen per dollar to 97.54, reducing translated results. Japan annualized premiums in force rose 5.0% in yen but fell in reported dollars to $14.9 billion.
- Japan new annualized premium sales fell 29.1% in yen and 41.7% in dollars. Lower WAYS and other first-sector life sales followed repricing and a shift in bank customers toward investment products. Cancer and medical sales combined increased 4.0%; management cited the updated EVER medical product. Bank-channel sales fell 51.3% and represented 31.3% of Japan sales, down from 45.6%.
- United States: Pretax operating earnings increased 4.1% to $1.038 billion; premium income rose 3.1% to $5.153 billion. New annualized premium sales fell 4.3% to $1.424 billion amid weak hiring, particularly at small employers. Annualized premiums in force increased 2.2%.
- Investment portfolio: Debt and perpetual securities totaled $103.913 billion at amortized cost. Investment-grade securities were 95.9% of Japan’s portfolio and 96.0% of the U.S. portfolio. The yen weakened, interest rates rose, and the net unrealized gain on investment securities in shareholders’ equity decreased to $1.035 billion from $2.570 billion.
Fourth-quarter context: Q4 2013 revenue was $5.801 billion and net earnings were $675 million, compared with $6.375 billion and $581 million in Q4 2012. Q4 realized investment gains were $20 million, versus losses of $171 million a year earlier. Q4 diluted EPS was $1.45, versus $1.24.
Outlook, commentary, risks and unusual items
- 2014 outlook: Management targeted operating EPS growth of 2% to 5%, excluding currency translation, and U.S. new annualized premium sales ranging from flat to up 5%. Japan cancer and medical sales were expected to increase 2% to 7%; management expected Japan’s overall sales decline to continue and its pretax operating margin to decline somewhat.
- Management said the 2014 EPS objective would benefit from increased repurchases but face infrastructure spending in both countries, Japan’s consumption tax increase from 5% to 8% in April 2014, and an estimated $0.05-per-share reduction from the 2013 reinsurance agreement. Currency scenarios in the filing show material sensitivity to yen/dollar rates.
- Reinsurance: Effective September 30, 2013, Aflac ceded 33.3% of hospital benefits on a closed Japan medical block. The transaction generated a $607 million deferred profit liability, to be amortized over the policies’ expected lives; the related reinsurance recoverable was $612 million. Aflac remains liable to policyholders if the reinsurer cannot perform.
- Tax and accounting items: A $237 million valuation allowance on deferred tax assets related to unrealized investment losses was recorded in Q2 and released in Q3; no valuation allowance remained at year-end. The company had approximately $1.4 billion of capital loss carryforwards, with most expiring in 2016. A change in valuation methodology for certain privately issued securities affected fair-value measurements; management reported no material Level 3 valuation impact overall from the transfer of securities to observable-input methods.
- Principal risks: Concentration in Japan and yen translation; Japanese sovereign and interest-rate exposure; low reinvestment yields; credit, spread and valuation risk across a large global bond portfolio, including financial institutions and perpetual securities; derivative counterparty and hedge rollover risks; policy lapse and reserve-estimation risk; regulatory limits on subsidiary dividends and Japanese profit repatriations; and uncertain effects of U.S. health reform and financial regulation.
- Management stated pending ordinary-course litigation was not expected to materially affect financial position, results or cash flows. No material off-balance-sheet arrangements were reported. KPMG issued unqualified opinions on the financial statements and internal control; management concluded internal control over financial reporting was effective.
Important facts for investors to verify
- How much of the reported revenue and earnings decline reflects yen translation, and how do results compare in yen and on the company’s operating-earnings basis?
- Whether the 2014 Japan sales and margin outlook, U.S. sales target, infrastructure spending and consumption-tax impacts were achieved.
- The durability and accounting treatment of the $399 million realized investment gain, the remaining unrealized portfolio losses, and valuations of privately issued and perpetual securities.
- The performance and counterparty terms of the Japan reinsurance transaction and the associated reserve credit and deferred profit amortization.
- Whether statutory capital, Japan’s solvency margin, subsidiary dividend capacity and parent-company liquidity remain adequate under adverse yen, interest-rate and credit scenarios.
- The maturity and refinancing plan for debt, including 2014 maturities, and the effect of planned $800 million to $1 billion 2014 share repurchases on capital and per-share results.