Aflac Incorporated — Q1 2016 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2016. Aflac primarily sells supplemental health and life insurance in Japan and the United States. The financial statements are unaudited interim statements reviewed by KPMG; KPMG reported no material modifications it believed were needed for GAAP conformity. Japan generated 74% of revenue and represented 84% of assets, making results particularly sensitive to Japanese market and currency conditions.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 / comparator |
|---|---|---|
| Total revenue | $5.451 billion | $5.226 billion |
| Net premiums | $4.602 billion | $4.432 billion |
| Net investment income | $801 million | $782 million |
| Net realized investment gains | $73 million | $13 million |
| Earnings before income taxes | $1.117 billion | $1.013 billion |
| Net earnings | $731 million | $663 million |
| Diluted EPS | $1.74 | $1.51 |
| Operating earnings (non-GAAP) | $726 million; $1.73 per diluted share | $678 million; $1.54 per diluted share |
| Operating cash flow | $1.331 billion | $1.460 billion |
| Cash and cash equivalents | $3.449 billion | $4.350 billion at Dec. 31, 2015 |
| Notes payable | $4.984 billion | $4.971 billion at Dec. 31, 2015 |
| Total assets / shareholders’ equity | $127.766 billion / $20.021 billion | $118.256 billion / $17.708 billion at Dec. 31, 2015 |
Operating cash flow was more than offset by investing cash outflows of $1.487 billion and financing cash outflows of $766 million; cash declined $901 million during the quarter. The company returned $779 million to shareholders through repurchases and dividends. Cash dividends were $0.41 per share versus $0.39 a year earlier. Available-for-sale investment securities had a net unrealized gain of $4.684 billion at quarter-end, up from $2.986 billion at year-end; this contributed to comprehensive income of $3.042 billion.
Segment pretax operating earnings were $838 million in Japan (versus $819 million) and $332 million in the U.S. (versus $285 million). The Japan pretax operating margin was 22.0% versus 22.1%; the U.S. margin was 21.5% versus 18.9%.
Material changes versus the prior comparable period
- Revenue increased about 4%; net earnings increased about 10%, and diluted EPS rose about 15%. The stronger yen amplified reported dollar results: the average yen/dollar rate was 115.35 versus 119.16, and management reported Japan operating earnings down 0.8% in yen terms despite a 2.4% increase in dollars.
- Operating earnings increased about 7% and operating EPS about 12%. Higher insurance premiums and investment income, and stronger U.S. segment earnings, contributed; net investment gains were also higher than in the prior-year quarter.
- Q1 2016 net investment gains included $91 million of gains on sales and redemptions, offset in part by $14 million of impairment losses and $4 million of derivative and other losses. Q1 2015 included $68 million of sales/redemption gains, $6 million of impairments, and $49 million of derivative and other losses.
- Japan new annualized premium sales increased 15.5% in yen, while U.S. sales increased 3.7%. U.S. benefit ratio improved to 44.7% from 47.1%; Japan’s fell to 59.9% from 60.2%.
- Cash fell from year-end while total assets and equity rose. Management attributed substantial balance-sheet translation effects to the yen strengthening 7% against the dollar from December 31.
Guidance, management commentary, risks and unusual items
- Management’s 2016 objective was stable operating EPS versus 2015. At the 2015 average exchange rate of 120.99 yen per dollar, the indicated range was $6.17–$6.41; at exchange rates of 105, 110, 115, and 125, the indicated ranges were respectively $6.66–$6.90, $6.49–$6.73, $6.34–$6.58, and $6.07–$6.31. These are operating, non-GAAP measures and exclude specified investment, derivative, nonrecurring, and other non-operating items.
- For Q2, if the yen/dollar rate averaged 105–115, management expected operating EPS of approximately $1.55–$1.82. Japan’s full-year pretax operating margin was expected to be comparable with 2015; U.S. benefit and expense ratios were expected to remain relatively stable. U.S. 2016 new annualized premium sales objective was growth of 3%–5%; management expected fourth-quarter production to become increasingly important.
- Management cited depressed interest rates and volatile markets as challenges to investing cash flows at attractive yields. Japan’s new-money yield declined to 2.14% from 3.88%, while the portfolio book yield was 2.75% versus 2.81%. Management expected Japan third-sector product sales to decline mid-single digits for 2016, while emphasizing medical and cancer products.
- Risks include Japan concentration, yen/dollar movements, interest-rate and credit risk, investment valuation and impairment judgments, equity exposure, and policy claims/reserving assumptions. A 100-basis-point increase in Japan and U.S. rates was estimated to reduce the fair value of debt and perpetual securities by $14.156 billion. Japan government/JGB-backed holdings were $40.655 billion at amortized cost, approximately 40% of debt and perpetual securities.
- Energy-related fixed-maturity exposure was $6.094 billion available for sale and $719 million held to maturity; 88% was investment grade versus 93% at year-end. Management did not expect these holdings to have a material effect on results, but warned volatility could continue.
- Litigation was described as ordinary-course and not expected to have a material adverse effect. Penn Treaty-related guaranty assessments were not accrued because timing and amount of any insolvency could not be estimated. The company reported compliance with debt covenants and no defaults; no borrowings were outstanding under the disclosed revolving credit facilities.
- The board declared a Q2 dividend of $0.41 per share, up 5.1% year over year. The company planned $1.4 billion of 2016 share repurchases, with most expected in the first half; $600 million had been repurchased in Q1.
Most important facts for investors to verify
- Reconcile GAAP net earnings/EPS with non-GAAP operating earnings/EPS, particularly the impact of investment gains, impairments, derivatives, and foreign exchange.
- Assess how much reported growth reflects yen translation versus underlying yen-denominated performance, especially in Japan.
- Review investment portfolio concentration, unrealized gains and losses, energy and below-investment-grade exposure, and sensitivity to interest rates and credit deterioration.
- Monitor claims experience, reserving assumptions, and segment benefit/expense ratios against management’s outlook.
- Check liquidity and capital capacity after repurchases and dividends, including Japan statutory solvency and restrictions on profit repatriation; the filing characterizes RBC and Japan solvency margin ratios as high but does not provide clear numerical values here.