Aflac Incorporated — FY 2012 Form 10-K
Reporting period: Year ended December 31, 2012; this is an annual filing, not a standalone fourth-quarter report. Aflac sells supplemental health and life insurance in Japan and the United States. Japan generated 77% of 2012 revenue and represented 87% of year-end assets.
Financial performance
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenue | $25.36 billion | $22.17 billion |
| Premiums | $22.15 billion | $20.36 billion |
| Net investment income | $3.47 billion | $3.28 billion |
| Realized investment losses | $349 million | $1.55 billion |
| Pretax earnings | $4.30 billion | $2.95 billion |
| Net earnings | $2.87 billion | $1.94 billion |
| Diluted EPS | $6.11 | $4.12 |
| Operating earnings per diluted share (non-GAAP) | $6.60 | $6.27 |
| Operating cash flow | $14.95 billion | $10.84 billion |
Revenue increased 14.4%; net earnings rose 48.0%. Operating earnings, which exclude realized investment gains and losses and specified nonrecurring items, increased 5.1%. Japan pretax operating earnings were $3.90 billion (+2.0% reported; +1.7% excluding currency effects); its pretax operating margin declined to 19.5% from 20.9%. U.S. pretax operating earnings were $997 million (+10.3%), and its margin improved to 17.7% from 16.9%.
Investment impairments were $977 million pretax, down from $1.90 billion in 2011. They included $386 million on sovereign and supranational securities. Net investment gains from sales and redemptions were $474 million, while derivative valuation gains were $154 million. Net investment income grew despite low yields; Japan’s year-end portfolio yield fell to 2.87% from 3.29%, and its new-money yield was 2.40%.
Financial position, cash flow and capital
- Total assets were $131.09 billion, up from $116.24 billion; shareholders’ equity was $15.98 billion, up from $12.95 billion. Equity included $2.57 billion of net unrealized investment gains, versus $1.14 billion in 2011.
- Policy liabilities totaled $97.95 billion. Notes payable were $4.35 billion, versus $3.29 billion; debt to total capitalization, excluding unrealized investment gains and losses, rose to 24.5% from 21.8%.
- Cash and cash equivalents were $2.04 billion. Operating cash flow was $14.95 billion, investing cash flow was negative $16.95 billion, and financing cash flow was positive $1.95 billion. Operating cash flow growth partly reflected discounted advance premiums collected in Japan.
- A 50-billion-yen revolving credit facility was undrawn at year-end and scheduled to expire June 27, 2013, unless extended. Aflac’s U.S. company-action RBC ratio was 630%; Japan’s solvency margin ratio was 669.1% under revised standards.
- Cash dividends paid were $1.34 per share. The board declared a first-quarter 2013 dividend of $0.35 per share.
Material changes and unusual items
- The yen weakened 10.2% against the dollar at year-end, reducing reported dollar values of Japan’s assets and liabilities and affecting comparisons. Annualized premiums in force in Japan grew 11.1% in yen but translated to $17.2 billion, slightly below 2011’s $17.3 billion.
- Japan new annualized premium sales increased 30.8% in yen. WAYS represented 44.9% of Japan sales; bank-channel sales rose to 45.6% of Japan sales from 28.9%. U.S. new annualized premium sales increased 0.8%.
- Management strengthened future policy benefit reserves by $81 million in 2012, primarily for Japanese care and closed dementia policy blocks, citing low investment yields.
- The company retrospectively adopted revised deferred acquisition cost guidance, reducing opening shareholders’ equity by $458 million as of December 31, 2009; the reported impact on prior-year net income was immaterial.
- 2012 earnings benefited from a favorable $29.5 million tax-exam outcome and receipt of a previously written-off deferred coupon associated with investment derisking. The filing does not quantify the coupon’s earnings contribution clearly.
Outlook, commentary and principal risks
Management’s 2013 objective was 4%–7% growth in operating EPS, excluding currency translation. Its scenario table showed operating EPS of $6.86–$7.06 at the 2012 average exchange rate of ¥79.81/$, with lower reported ranges if the yen weakened. Management expected Japan cancer and medical sales to be flat to up 5%, U.S. new annualized premium sales to be flat to up 5%, and U.S. operating margins to remain similar to 2012. Japan’s WAYS-heavy sales mix and pending premium repricing were expected to make comparisons more difficult.
- Investment risks include European sovereign and bank credit, downgrades, spread widening, impairment judgments, illiquidity, and uncertain valuations. Banks and financial institutions were 18% of the debt and perpetual securities portfolio; perpetual securities totaled $4.2 billion at amortized cost.
- Interest-rate risk is significant: prolonged low yields pressure investment income and policy margins, while rising rates can reduce portfolio values and Japan’s solvency ratio. Yen-hedged U.S. bond investments totaled about $7.0 billion, with shorter-dated currency forwards creating rollover and counterparty risks.
- Japan concentration and yen/dollar movements materially affect reported results. Sales also depend on the Japanese bank channel and on worksite distribution in the U.S.; economic weakness, competition, and regulatory changes could constrain sales.
- Claims and reserve adequacy depend on actuarial assumptions. The company cited normal-course litigation and stated it did not expect pending matters to materially affect financial position, results, or cash flows. Catastrophes, operational or cyber disruptions, and rating downgrades are additional disclosed risks.
Important facts for investors to verify
- Reconcile GAAP net earnings and EPS with non-GAAP operating earnings, especially the impact of impairments, derivative marks, tax benefits, and the deferred coupon receipt.
- Review investment credit quality, European exposures, unrealized losses, and management’s valuation process for private and perpetual securities; a new third-party valuation review was expected in Q1 2013, with impact not yet estimable.
- Assess sustainability and profitability of Japan’s WAYS and bank-channel growth, including the advance-premium payment option and planned 2013 repricing.
- Track yen sensitivity against management’s 2013 EPS scenarios and the rollover, liquidity, and counterparty risks of the currency-forward hedges.
- Confirm the renewal or replacement of the 50-billion-yen credit facility and the capacity of regulated subsidiaries to upstream funds and support dividends, debt service, and planned $400–$600 million 2013 repurchases.
- Note that KPMG issued unqualified opinions on the financial statements and internal controls; management reported effective financial-reporting controls at year-end.