Aflac Incorporated — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Aflac sells supplemental health and life insurance in Japan and the United States; Japan generated 78% of nine-month revenue and represented 88% of assets. Interim financial statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $6.847B | $5.987B | $18.989B | $16.192B |
| Net earnings | $1.017B | $736M | $2.285B | $1.399B |
| Diluted EPS | $2.16 | $1.57 | $4.87 | $2.98 |
| Pretax operating earnings | $1.194B | $1.175B | $3.600B | $3.459B |
| Cash dividends per share | $0.33 | $0.30 | $0.99 | $0.90 |
Q3 revenue increased 14.4%; net earnings rose to $1.017 billion from $736 million, benefiting from realized investment gains and a lower annual effective tax rate. Nine-month revenue increased 17.3% and net earnings increased to $2.285 billion from $1.399 billion. Results also reflected yen translation effects; management’s operating-earnings comparisons exclude realized investment gains and losses, nonrecurring items and specified currency effects.
- Q3 realized investment result: $286 million pretax gain, versus an $83 million loss in Q3 2011. The 2012 result included $288 million net gains from sales/redemptions, $95 million derivative gains and $97 million impairment losses. Japanese government bond sales in a bond-swap program were a principal source of gains.
- Nine-month realized investment result: $177 million pretax loss, substantially narrower than the $1.330 billion loss in 2011. Impairment losses were $643 million versus $1.100 billion.
- Segment operating earnings, Q3 / nine months: Japan $994 million / $2.998 billion; U.S. $260 million / $789 million. Japan’s Q3 operating earnings declined 2.5% in dollars, while U.S. operating earnings rose 21.5%. Japan’s nine-month operating earnings increased 2.7% in dollars; U.S. rose 11.5%.
- Margins and claims: Japan’s Q3 pretax operating margin was 19.3%, down from 21.6%; its benefit ratio rose to 62.6% from 59.6%. U.S. margin increased to 18.4% from 16.0%, with the benefit ratio improving to 50.4% from 52.5%.
- Cash flow, nine months: Operating cash flow was $11.451 billion, investing cash outflow $12.499 billion and financing cash inflow $1.781 billion. Cash increased $736 million to $2.985 billion. Operating cash flow was supported by changes in receivables/advance premiums and policy liabilities; investment purchases remained substantial.
Balance sheet, debt and liquidity
- At September 30, total assets were $137.840 billion, total liabilities $121.855 billion and shareholders’ equity $15.985 billion. Investment securities and cash totaled $124.215 billion.
- Notes payable were $4.401 billion, up from $3.285 billion at year-end 2011. Debt-to-total-capitalization, excluding unrealized investment gains/losses, increased to 24.3% from 21.0%.
- Cash and cash equivalents were $2.985 billion. A 50 billion yen, 364-day revolving credit facility was undrawn at quarter-end; the company reported compliance with debt and credit-facility covenants.
- New debt issued during 2012 included $750 million of senior notes in February, an additional $250 million of senior notes in July, and $450 million of 5.50% subordinated debentures in September. An additional $50 million of subordinated debentures was issued in October, after quarter-end. Yen cross-currency swaps reduced the effective yen interest costs on specified dollar debt.
- Policy liabilities totaled $105.328 billion, up 11.3% from December 31, 2011. The increase included business growth and currency translation effects.
Material changes and unusual items
- Aflac retrospectively adopted amended deferred policy acquisition cost guidance on January 1, 2012. Adoption reduced shareholders’ equity by $516 million as of December 31, 2010; management said the effect on 2011 and earlier net income was immaterial. Comparative amounts were adjusted.
- Investment portfolio derisking continued, particularly through reductions in European financial-sector and perpetual/subordinated securities. Debt and perpetual securities exposure to peripheral Eurozone sovereign and financial issuers had declined to $1.9 billion, or 1.5% of investments and cash, by quarter-end, from $3.3 billion at the start of 2008.
- The company reported $5.678 billion amortized-cost direct exposure to Ireland, Italy, Portugal and Spain, with no direct exposure to Greece. Spanish exposures included impaired securities and below-investment-grade positions. After quarter-end, rating actions prompted further steps, including beginning to exercise a put on Junta de Andalucia securities and tendering a BBVA subordinated investment at its impaired value.
- Q3 other comprehensive income, net of tax, was $915 million, largely reflecting investment-security valuation gains; the nine-month amount was $1.122 billion. Unrealized investment-security gains in equity were $2.260 billion at quarter-end, versus $1.143 billion at year-end 2011.
Outlook, commentary and risks
- For 2012, management expected diluted EPS growth of 3%–6%, excluding realized investment gains/losses, nonrecurring items and specified currency impacts. At an assumed yen rate of 80 per dollar for the final quarter, the company projected Q4 EPS of $1.46–$1.51 and full-year EPS of $6.58–$6.63. Its 2013 objective was 4%–7% EPS growth on the same adjusted basis.
- Japan sales exceeded expectations: Q3 new annualized premium sales rose 31.7% in yen, led by WAYS and bank distribution. Management expected full-year 2012 Japan sales growth of 30%–35%, but anticipated a flatter-to-15% increase in Q4 amid a difficult comparison and a changed advance-premium interest credit. Product repricing was planned for April 2013.
- Japan’s business mix was shifting toward ordinary-life products, including WAYS, which management described as having lower margins than traditional health products. Japan’s benefit ratio increased and operating margin declined in the reported periods; management expected full-year objectives to rely on strong premium growth despite somewhat lower margins.
- U.S. Q3 new annualized premium sales declined 1.5%. Management expected 2012 U.S. sales to be roughly flat, citing economic weakness and small-business exposure; it noted improving persistency and longer-term opportunity in broker and group distribution.
- Key risks include Japan concentration, yen/dollar movements, low investment yields and reinvestment spreads, credit downgrades/defaults and valuation judgments, European and financial-sector exposures, perpetual-security payment restrictions, regulatory changes, and claims differing from pricing/reserving assumptions. Management said pending ordinary-course litigation was not expected to materially affect financial position, results or cash flows.
- The board declared a Q4 dividend of $0.35 per share, up 6.1% year over year. Management said it could allocate up to $100 million to share repurchases in Q4, subject to market conditions; no open-market repurchases occurred in the first nine months.
Most important facts for investors to verify
- How much reported earnings growth reflects recurring insurance operations versus investment gains, impairment charges, tax benefits and currency translation.
- Whether Japan’s strong sales—particularly WAYS and bank-channel sales—translate into sustainable margins, persistency and claims experience.
- Developments in European issuer credit quality, including Spanish regional exposures, below-investment-grade holdings, put options and any further impairments or sales.
- Investment portfolio sensitivity to interest rates and credit spreads, and the ability to reinvest maturing assets at yields sufficient to support policy liabilities.
- Debt growth, future financing needs, capital ratios and availability of cash from Japan, including regulatory limits on profit remittances.
- Actual full-year 2012 results against EPS and Japan/U.S. sales outlook; these are management objectives and assumptions, not guarantees.