Aflac Incorporated — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Aflac primarily sells supplemental health and life insurance in Japan and the U.S.; Japan accounted for 69% of nine-month revenue and 83% of assets. KPMG reviewed the interim statements; this was not an audit.
Financial performance and condition
- Q3 results: Revenue was $5.51 billion, down from $5.72 billion a year earlier. Net earnings rose to $716 million from $629 million; diluted EPS was $1.80 versus $1.53. The earnings increase primarily reflected a swing to $30 million of realized investment gains from $164 million of losses in Q3 2016.
- Nine-month results: Revenue was $16.24 billion versus $16.60 billion; net earnings were $2.02 billion versus $1.91 billion; diluted EPS was $5.05 versus $4.59. Revenue decline primarily reflected yen translation.
- Operating earnings (non-GAAP): Q3 was $676 million, or $1.70 per diluted share, versus $713 million, or $1.74. Nine-month operating earnings were $2.08 billion, or $5.20 per diluted share, versus $2.10 billion, or $5.06. Excluding current-period currency impact, nine-month operating EPS was $5.28.
- Segments: Q3 pretax operating earnings were $748 million in Japan (versus $827 million) and $316 million in the U.S. (versus $323 million). Japan’s pretax operating margin was 19.9% versus 19.6%; U.S. margin was 20.1% versus 20.9%.
- Cash flow and liquidity: Nine-month operating cash flow was $4.60 billion, up from $4.12 billion; investing cash outflow was $2.89 billion and financing cash outflow was $1.61 billion. Cash and equivalents were $4.93 billion at quarter-end, little changed from year-end 2016.
- Balance sheet and debt: Total assets were $136.08 billion, liabilities $114.11 billion, and shareholders’ equity $21.98 billion at September 30. Notes payable were $5.25 billion, down from $5.36 billion at year-end. The company reported compliance with debt and credit-facility covenants and no facility borrowings outstanding.
- Capital returns: The company repurchased 13.9 million shares for $1.05 billion in the first nine months and paid $491 million in cash dividends. The quarterly dividend was $0.43 per share, compared with $0.41 a year earlier.
Material changes and management commentary
- Japan premiums and earnings were affected by paid-up limited-pay policies, weaker dollar translation, lower reinvestment yields, and higher amortized hedge costs. Japan new annualized premium sales fell 17.3% in Q3 in dollars; third-sector sales grew 2.1% in yen, while first-sector sales fell 66.7%.
- U.S. new annualized premium sales increased 7.5% in Q3. U.S. operating expenses rose, reflecting investment in the platform and a shift of costs from commissions to insurance expenses.
- Favorable prior-year claims development was $386 million for the first nine months, primarily from Japan. Management cited continued favorable Japan health-claims trends, including shorter cancer-related hospital stays and more outpatient treatment.
- Investment gains/losses remain volatile: nine-month realized investment losses were $166 million, versus $358 million in 2016, including $199 million of derivative and foreign-currency losses. The portfolio’s debt and perpetual securities were 23.6% BBB and 4.9% BB-or-lower by fair value; Japan government exposure was a significant concentration.
Outlook, risks, and unusual items
- For full-year 2017, management expected Japan’s pretax operating margin to be comparable to 2016; for the U.S., it expected a slightly lower benefit ratio and marginally higher expense ratios.
- Assuming stable capital conditions and no compelling alternatives, the company planned $1.3 billion to $1.5 billion of 2017 share repurchases. It expected Japan to repatriate 120 billion to 140 billion yen for the full year, subject to stable capital conditions and regulatory capacity.
- In October 2017, the board declared a $0.45-per-share fourth-quarter dividend. Also in October, Aflac issued 60 billion yen of 30-year subordinated debentures; it intended to use proceeds to redeem $500 million of existing subordinated debentures, with any remainder for general purposes.
- Unusual items included a $14 million net-income impact in Q1 from estimated U.S. guaranty-fund assessments related to Penn Treaty’s liquidation, and $24 million of Japan branch-conversion costs for the first nine months. Q2 and Q3 guaranty-fund assessments were immaterial.
- Key risks include Japan and yen concentration, interest-rate and credit risks, investment valuation and impairment judgments, claims experience differing from assumptions, regulation, cybersecurity and IT disruption, and the ability to repatriate Japan earnings. Management said market-risk exposures had not materially changed from year-end disclosures.
Important facts for investors to verify
- Reconcile GAAP net earnings with non-GAAP operating earnings and assess the contribution of realized investment items, favorable claims development, hedge costs, and currency translation.
- Track Japan sales, paid-up policy effects, yen-denominated results, and whether expected profit remittances and Japan solvency remain within management’s stated assumptions.
- Review portfolio credit quality and concentration, including below-investment-grade exposure, Japan government holdings, unrealized losses, and valuation sensitivity.
- Monitor capital returns, planned repurchases, the October debt issuance and intended redemption, and regulatory constraints on subsidiary dividends and repatriations.