Aflac Incorporated — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Aflac sells supplemental health and life insurance in the United States and Japan; Japan generated 75% of revenue in the first nine months. Financial statements are unaudited and were reviewed, not audited, by KPMG.
Financial performance
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | $5.394B | $4.526B | $15.438B | $13.657B |
| Net earnings | $690M | $363M | $1.907B | $1.245B |
| Diluted EPS | $1.46 | $0.77 | $4.03 | $2.66 |
| Pretax operating earnings | $1.046B | $896M | $3.045B | $2.620B |
| Net cash from operating activities | Not stated for quarter | Not stated for quarter | $4.869B | $4.403B |
- Q3 premiums were $4.607B versus $4.165B; net investment income was $765M versus $692M. Nine-month premiums were $13.288B versus $12.274B and investment income was $2.218B versus $2.048B.
- Q3 net realized investment gains were $9M, versus losses of $347M in Q3 2009. Nine-month realized losses were $127M, compared with $739M in 2009. The prior-year comparison included substantially higher impairment charges.
- Japan Q3 pretax operating earnings were $866M, up 19.5% in dollars and 9.5% in yen; U.S. earnings were $228M, up 5.8%. For nine months, Japan earned $2.485B, up 19.1% in dollars, and the U.S. earned $699M, up 13.3%.
- Japan new annualized premium sales rose 15.5% in yen in Q3; U.S. sales declined 5.3%. The U.S. benefit ratio improved year over year for the first nine months.
Financial position, cash flow and capital
- At September 30, total assets were $97.843B, including $85.585B of investments and cash and $2.434B of cash and cash equivalents. Total liabilities were $86.710B and shareholders’ equity was $11.133B, up from $8.417B at year-end 2009.
- Policy liabilities were $78.913B, including $69.329B of future policy benefits. Notes payable were $3.008B, up from $2.599B. Debt to total capitalization, excluding unrealized investment and derivative gains and losses, was 22.2%, compared with 22.3% at year-end.
- Nine-month operating cash flow was $4.869B; investing cash outflow was $5.080B and financing cash inflow was $266M. Cash increased $111M to $2.434B. Dividends paid were $395M; cash dividends were $0.28 per share in Q3.
- Reported equity benefited from investment-market recovery: net unrealized investment gains, including derivatives, were $592M at September 30, versus net unrealized losses of $640M at December 31, 2009.
- Aflac’s U.S. company-action-level RBC ratio exceeded 580%; Aflac Japan’s most recently reported solvency margin ratio was 939.3% at March 31, 2010.
Changes, outlook and risks
- Management attributed earnings growth partly to yen strength and lower investment losses. The average yen-dollar rate was 85.74 in Q3 2010 versus 93.56 in Q3 2009; the stronger yen increased translated dollar results.
- New VIE accounting guidance adopted January 1, 2010 required consolidation of certain entities, adding underlying securities and derivatives to the balance sheet. Initial adoption reduced shareholders’ equity by $165M after tax. It also changed the presentation of investment and derivative gains and losses.
- Management’s 2010 objective was 9%–12% growth in diluted EPS excluding specified investment, derivative, nonrecurring and currency effects; it expected about $5.34 per diluted share before currency translation. The filing gives Q4 EPS of $1.31–$1.36 assuming a yen-dollar rate of 80–85, and full-year reported EPS of about $5.52–$5.57 under that assumption. The separate scenario table gives a different range at 85 yen per dollar; investors should reconcile these figures.
- For 2011, management targeted 8%–12% EPS growth on a similarly adjusted basis, but said persistently low interest rates could place growth at the low end.
- Japan’s investment portfolio is concentrated in financial institutions: total exposure was $28.963B amortized cost, or 35% of the investment portfolio. Exposure to financial institutions in Greece, Ireland, Italy, Portugal and Spain was $3.618B amortized cost ($2.544B fair value); Greek financial-institution holdings were below investment grade. Aflac said it expected to collect contractual cash flows, but acknowledged credit and valuation risks.
- Management cited low investment yields, credit downgrades, market liquidity and valuation uncertainty, currency fluctuations, Japan concentration, claims and reserving experience, and regulatory changes as risks. A 100-basis-point rate increase was estimated to reduce the fair value of debt and perpetual securities by $9.610B.
- Aflac reported no material adverse effect expected from pending litigation and no material off-balance-sheet letters of credit, guarantees or standby repurchase obligations. Management said disclosure controls were effective and reported no material Q3 change in internal financial controls.
Investor verification points
- Reconcile the 2010 EPS guidance narrative with the scenario table, including the exchange-rate assumptions and excluded items.
- Assess Greek and other European financial-institution exposure, below-investment-grade holdings, impairments and subsequent credit developments.
- Review the effect of VIE consolidation on comparability, reported earnings, equity and derivative volatility.
- Separate underlying operating growth from yen translation and investment gains or losses; verify sustainability of Japan and U.S. sales trends.
- Monitor portfolio yields, interest-rate and fair-value sensitivity, liquidity, capital ratios, and restrictions on upstreaming subsidiary funds.