Aflac Incorporated — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparisons are with Q1 2010 unless stated otherwise. Aflac sells supplemental health and life insurance in the United States and Japan. Japan generated 74% of revenue and accounted for 86% of assets. The interim statements were reviewed by KPMG, not audited; KPMG reported that it was not aware of material modifications needed for GAAP conformity.
Financial performance and condition
| Metric | Q1 2011 | Q1 2010 / prior date |
|---|---|---|
| Total revenue | $5.117 billion | $5.065 billion; up 1.0% |
| Premiums | $4.872 billion | $4.348 billion |
| Net investment income | $794 million | $726 million |
| Realized investment losses | $579 million pretax | $46 million pretax |
| Net earnings / diluted EPS | $395 million / $0.84 | $636 million / $1.35 |
| Pretax operating earnings | $1.179 billion | $1.020 billion |
| Operating cash flow | $2.167 billion | $1.278 billion |
| Cash and cash equivalents | $2.088 billion | $2.121 billion at Dec. 31, 2010 |
| Notes payable | $3.017 billion | $3.038 billion at Dec. 31, 2010 |
| Shareholders’ equity | $11.023 billion | $11.056 billion at Dec. 31, 2010 |
Reported earnings declined sharply because realized investment losses increased, principally from impairment charges and portfolio risk-reduction sales. The $405 million pretax impairment charge included $397 million for corporate bonds, primarily remaining Greek bank holdings. Aflac also recorded $161 million of net pretax losses on securities sold as part of derisking. The company reported a 34.2% effective tax rate, versus 34.7%.
By segment, Aflac Japan pretax operating earnings rose to $980 million from $821 million; its operating margin was 22.4%, versus 21.4%. Aflac U.S. pretax operating earnings rose to $253 million from $244 million; its margin was 19.2%, versus 19.1%. Stronger yen translation benefited reported results. Average yen/dollar rates were 82.29 in Q1 2011 and 90.49 in Q1 2010.
Cash from operations exceeded investment outflows of $2.013 billion. Financing used $171 million, including $184 million for treasury-stock purchases and $135 million in cash dividends. Debt was 21.5% of total capitalization under the company’s stated calculation, compared with 21.7% at year-end. The company reported estimated U.S. company-action-level RBC of 500%–525%; Aflac Japan’s reported solvency margin ratio was 897.5% at Dec. 31, 2010.
Material changes and business developments
- Japan premiums increased 15.5% in dollars and 4.8% in yen. New annualized premium sales rose 12.6% in yen to ¥34.1 billion, a record first quarter; bank-channel sales grew substantially.
- U.S. new annualized premium sales increased 6.3% to $336 million, the first positive growth in nine quarters. Aflac’s 2010 U.S. results had benefited from a one-time large payroll-account reserve and acquisition-cost release, affecting the comparison of benefit ratios.
- Japan’s investment portfolio yield was 3.56%, down from 3.75% a year earlier. Japan yen-only new-money yield was 2.36%, versus 2.46%; U.S. portfolio yield was 6.84%, versus 7.06%.
- The company reduced selected concentrated and European financial-sector exposures. During Q1 it sold its Alpha Bank holding at a $177 million pretax loss and recognized impairment losses on remaining Greek bank holdings. It sold EFG Eurobank in April and exercised a put on a Portuguese investment at par after quarter-end.
- Available-for-sale and held-to-maturity securities had substantial gross unrealized losses. Management attributed most unrealized losses to market spreads, rates, or currency factors and stated that it generally did not expect to sell securities before recovery.
Guidance, risks, and unusual items
- For 2011, management’s objective was 8%–12% growth in net earnings per diluted share, excluding realized investment gains and losses and nonrecurring items, and assuming no foreign-currency translation effect. Management expected results near the low end, citing low interest rates, especially in Japan.
- At an assumed full-year yen/dollar rate of 80–85, reported 2011 EPS guidance was $6.09–$6.34; Q2 reported EPS guidance was $1.51–$1.57. These reported ranges include currency translation and should not be confused with the underlying growth objective.
- Japan’s 2011 new annualized premium sales objective was down 2% to up 3%; the U.S. objective was flat to up 5%. The company anticipated repurchasing 6–12 million shares in 2011.
- The March 11 earthquake and tsunami resulted in a ¥3.0 billion ($37 million) claims provision, offset by ¥2.0 billion ($25 million) of reserve releases and reinsurance, for a net benefits-expense impact of $12 million; related operating expense was $8 million. Management said the initial impact was not material but cautioned that claims and economic effects could worsen.
- Key risks include concentrated holdings in banks and financial institutions (33% of debt and perpetual securities), exposure to European financial institutions and sovereign conditions, investment valuation and impairment judgments, interest rates, credit spreads, yen exchange rates, and Japan’s economic and disaster-related recovery. The company also cited possible regulatory changes in Japan and the United States.
- Management said pending ordinary-course litigation was not expected to materially affect financial position, results, or cash flows. It reported no material off-balance-sheet arrangements and no defaults under debt covenants.
Important facts for investors to verify
- Reconcile the $579 million realized investment loss, including the $405 million impairment charge, to reported and operating earnings; review subsequent disposition and recovery outcomes for impaired or downgraded holdings.
- Track exposure and valuation changes in European banks, perpetual securities, and other concentrated positions, including the company’s assumptions supporting temporary impairment conclusions.
- Assess whether Japan and U.S. sales objectives, margins, and earnings guidance remain achievable, while separating operating growth from yen translation and investment results.
- Monitor actual earthquake-related claims, business disruption, Japan’s economic conditions, and potential effects on Japanese government securities and regulatory solvency measures.
- Review liquidity and capital resources against the September 2011 maturity of ¥35 billion of Uridashi notes, planned shareholder returns, and the company’s stated investment and liability cash-flow needs.