Aflac Incorporated — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Unaudited interim financial statements were reviewed by KPMG, not audited. Aflac sells supplemental health and life insurance primarily in the U.S. and Japan; Japan represented 70% of first-half revenue and 83% of assets at June 30.
Financial performance
- Revenue: Q2 revenue was $5.287 billion, down 9.4% from $5.838 billion; first-half revenue was $10.513 billion, down 8.4% from $11.478 billion. Net premiums were $4.364 billion in Q2, down 10.7%, and $8.796 billion for six months, down 9.7%.
- Profit: Q2 net earnings were $573 million, versus $810 million; diluted EPS was $1.32, versus $1.78. First-half net earnings were $1.236 billion, versus $1.542 billion; diluted EPS was $2.83, versus $3.38. Management’s non-GAAP operating earnings were $651 million, or $1.50 per diluted share, in Q2, and $1.329 billion, or $3.04 per diluted share, for six months, down from $1.66 and $3.36 per share, respectively.
- Margins and segments: Q2 pretax operating earnings were $995 million, versus $1.157 billion. Japan’s Q2 pretax operating earnings were $757 million, down 18.4% in reported dollars; U.S. earnings were $293 million, down 2.0%. Japan’s pretax operating margin was 21.1%, versus 21.7%; the U.S. margin was 19.5%, versus 20.3%.
- Cash flow: First-half operating cash flow was $3.103 billion, compared with $3.132 billion. Investing cash outflow was $3.566 billion; financing cash outflow was $1.087 billion, versus $201 million of financing inflow in the prior-year period. Cash and cash equivalents fell to $3.103 billion from $4.658 billion at year-end.
- Balance sheet and capital: Total assets were $115.581 billion, down from $119.767 billion at December 31, 2014; shareholders’ equity was $17.018 billion, down from $18.347 billion. Notes payable were $5.425 billion, versus $5.282 billion. Cash dividends were $0.39 per share in Q2.
- Investments and market sensitivity: Investments and cash totaled $103.280 billion. Net unrealized investment gains in equity declined to $3.384 billion from $4.672 billion at year-end, contributing to a Q2 comprehensive loss of $1.252 billion despite net earnings. A 100-basis-point increase in rates was estimated to reduce the fair value of debt and perpetual securities by $11.919 billion.
Material changes and unusual items
- The weaker yen materially reduced reported results: the Q2 average yen/dollar rate was 121.20, 15.7% weaker than a year earlier; the first-half average rate was 120.14, 14.7% weaker. Japan’s first-half premiums declined 15.2% in dollars but 0.5% in yen.
- Q2 GAAP results included $127 million of pretax realized investment gains. First-half realized gains were $140 million, including $160 million of gains from sales and redemptions, offset by $14 million of derivative and other losses and $6 million of impairment losses.
- Aflac redeemed $850 million of 8.50% senior notes using proceeds from a $1.0 billion March debt issuance. The early redemption generated a $230 million pretax make-whole charge ($150 million after tax, or $0.35 per diluted share), excluded from operating earnings. Management cited an expected full-year interest-expense benefit of about $0.07 per diluted share.
- The company repurchased 13.5 million shares for $833 million in the first half; cash returned through dividends and repurchases was $1.2 billion. Management planned $1.3 billion of share repurchases for 2015.
- Japan entered into reinsurance transactions covering closed in-force business. These do not release Aflac from its obligations to policyholders if reinsurers fail to pay.
Outlook, commentary, and risks
- Management raised its 2015 objective for operating EPS growth to 4%–7% over 2014, excluding foreign currency translation. Assuming the yen averages 120–125 for the rest of the year, it projected full-year operating EPS of $5.88–$6.17 and Q3 operating EPS of $1.40–$1.53.
- Japan’s 2015 sales focus is cancer and medical insurance. Management expected those sales to increase 7%–10% for the year; it expected first-sector product sales to decline. U.S. new annualized premium sales objective was growth of 3%–7% in 2015.
- Management said historically low interest rates constrain reinvestment yields. Japan’s new-money yield improved as more funds went to U.S. dollar corporate bonds, bank loans and high-yield bonds; the portfolio book yield was 2.83%. First-half purchases of below-investment-grade securities increased, including senior secured loans and high-yield bonds.
- Key exposures include Japan concentration, yen/dollar movements, interest rates, credit downgrades and defaults, investment valuation judgments, perpetual securities, and market liquidity. Greece-related market uncertainty remained a risk; Aflac reported no direct Greek exposure and $2.7 billion of peripheral Eurozone investments.
- Management expected cash flows from premiums and investments to meet benefits and expenses, and stated that Aflac Japan’s solvency margin and Aflac’s U.S. risk-based capital remained strong. The filing reports compliance with debt covenants and no outstanding borrowings under disclosed credit lines. Management did not expect pending ordinary-course litigation to materially affect financial position, results or cash flows.
Important facts for investors to verify
- How much of the reported earnings decline reflects yen translation versus underlying operating performance, and whether operating EPS guidance assumptions remain on track.
- The make-whole charge, refinancing savings, and the extent to which the new debt and cross-currency swaps affect future interest expense and currency exposure.
- Credit quality, valuation and liquidity of the enlarged bank-loan and high-yield allocations, and risks in the concentrated Japan and financial-institution investment exposures.
- The drivers of the $1.288 billion first-half after-tax reduction in unrealized investment gains and the sensitivity of capital and equity to interest rates and exchange rates.
- Execution of sales objectives, reinsurance performance and counterparty capacity, repurchase plans, and the availability of subsidiary dividends and Japan profit repatriations.