Aflac Incorporated — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Aflac sells supplemental health and life insurance primarily in Japan and the United States; Japan generated 71% of company revenue. Financial statements are unaudited and were reviewed by KPMG, which expressed no opinion on them. Per-share data reflects the two-for-one stock split completed in March 2018.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $5.464 billion | $5.309 billion |
| Net earnings | $717 million | $592 million |
| Diluted EPS | $0.91 | $0.73 |
| Adjusted earnings (non-GAAP) | $821 million; $1.05 per diluted share | $676 million; $0.84 per diluted share |
| Net investment income | $837 million | $794 million |
| Realized investment losses | $134 million | $140 million |
| Operating cash flow | $1.238 billion | $1.757 billion |
| Cash and cash equivalents (quarter-end) | $4.080 billion | $3.491 billion at December 31, 2017 |
| Notes payable (quarter-end) | $5.372 billion | $5.289 billion at December 31, 2017 |
Revenue rose about 3% and net earnings about 21% year over year. The effective tax rate declined to 27.0% from 34.1%, principally reflecting the reduction in the U.S. federal corporate tax rate. Q1 2018 comprehensive income was $374 million, versus $594 million, including a substantial unrealized loss on fixed-maturity securities in other comprehensive income. Cash dividends were $0.26 per share, compared with $0.22.
Segments and material changes
- Aflac Japan: Pretax adjusted earnings increased to $818 million from $769 million. The benefit ratio improved to 59.4% from 60.8%; the expense ratio rose to 19.5% from 18.7%; and the pretax adjusted margin increased to 21.1% from 20.5%. In yen terms, premiums declined 2.6%, while pretax adjusted earnings increased 0.9%. New annualized premium sales fell 13.0% in yen.
- Aflac U.S.: Pretax adjusted earnings increased to $337 million from $310 million. The benefit ratio improved to 43.5% from 45.2%, while the expense ratio increased to 35.6% from 35.1%; the pretax adjusted margin rose to 21.0% from 19.7%. New annualized premium sales were $335 million, up 0.6%.
- Consolidated adjusted earnings: $821 million versus $676 million; excluding current-period currency effects, adjusted earnings were $800 million versus $676 million. These are non-GAAP measures and exclude specified investment and other items.
- Currency and investments: The yen strengthened about 5.1% on the quarterly average against the dollar year over year, lifting reported-dollar results. Japan investment income after hedge costs increased to $588 million from $557 million. Annualized hedge costs increased to 225 basis points from 184.
- Claims and expenses: Favorable prior-year claims development was $192 million, including approximately $97 million in Japan. Total acquisition and operating expenses rose to $1.440 billion from $1.359 billion.
Liquidity, capital and outlook
Operating cash flow declined year over year. Investing activities used $199 million, versus $1.527 billion in Q1 2017; Q1 2018 investing cash flows included more than $4 billion of net cash collateral received through securities lending, partly offset by investment purchases. The related return-of-collateral liability increased to $5.368 billion from $606 million at year-end, so this movement should not be interpreted as ordinary operating liquidity. Financing activities used $473 million. Total shareholders’ equity was $24.287 billion, down from $24.598 billion at December 31, 2017.
Management said it expects Aflac Japan’s full-year 2018 pretax adjusted margin to remain stable. For Aflac U.S., it expects benefit ratios to be relatively stable versus 2017 and expense ratios somewhat higher as it invests in its platform. The company planned $1.1 billion to $1.4 billion of 2018 share repurchases, subject to stable capital conditions and no compelling alternatives. The board declared a Q2 dividend of $0.26 per share.
Aflac Japan’s conversion from a branch to a legal subsidiary was completed April 1, 2018. Management expects the change to be tax-neutral and not materially affect daily operations, while providing greater capital-management and business-development flexibility. The company expects an accounting-driven decline of approximately 130 points in Japan’s solvency margin ratio, based on the December 2017 ratio, with a potential restoration over about three years subject to regulatory approval.
Risks, contingencies and unusual items
- The company’s large Japan concentration exposes results and capital to yen movements, interest rates, credit spreads, investment availability and Japan solvency rules. Japan represented 85% of assets at quarter-end.
- Available-for-sale securities had $1.585 billion of gross unrealized losses at March 31, 2018, compared with $813 million at year-end. Management attributed fixed-income losses primarily to market rates, currency and credit spreads, and said it believed issuers could meet their obligations.
- The Tax Act accounting remains provisional: the company had not completed its analysis of Japan deferred-tax balances and related valuation allowances. It stated that the final impact could differ, possibly materially, from estimates.
- The investment portfolio includes below-investment-grade exposures and loan programs; management identified expected-credit-loss accounting as potentially most significant for loans, loan receivables and held-to-maturity securities.
- Other stated risks include cyber and privacy incidents, regulatory changes, policyholder claims differing from assumptions, ratings downgrades, counterparty risk, litigation and operational risks associated with the Japan conversion. The company reported no material change in market-risk exposures from its 2017 Form 10-K.
- Two shareholder-related lawsuits were disclosed, including a derivative action and a putative securities class action. Management stated it did not expect either to have a material adverse effect. Ordinary-course litigation and investment commitments also remain.
- The quarter included $29 million of Japan branch-conversion costs, excluded from adjusted earnings. Adoption of new accounting guidance also changed equity-security fair-value accounting, with Q1 equity-security losses recognized in earnings.
Important facts for investors to verify
- Whether reported earnings growth is sustained after considering the lower tax rate, stronger yen and favorable prior-year claims development.
- How interest-rate and credit-market changes affect unrealized losses, capital measures, Japan subsidiary dividend capacity and investment valuations.
- Actual repurchases versus the $1.1–$1.4 billion 2018 plan, and the effect of capital distributions on insurer capital ratios.
- Final Tax Act accounting, including Japan deferred taxes and valuation allowances, and the effect of the Japan legal-entity conversion.
- Progress in Japan sales and premiums in force, U.S. platform investment and expense trends, and the performance and credit quality of newer loan and alternative investments.