Aflac Incorporated — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; financial statements are unaudited and were reviewed by KPMG. Aflac sells supplemental health and life insurance primarily in Japan and the U.S. Japan generated 70% of nine-month revenue and represented 83% of assets.
Financial performance and position
Amounts are in U.S. dollars unless noted.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $5.04B | $5.74B | $15.55B | $17.21B |
| Net earnings | $567M | $706M | $1.80B | $2.25B |
| Diluted EPS | $1.32 | $1.56 | $4.14 | $4.93 |
| Operating earnings per diluted share (non-GAAP) | $1.56 | $1.51 | $4.60 | $4.86 |
| Operating cash flow | Not presented quarterly | $4.77B | $4.58B |
- Q3 revenue fell about 12% and net earnings about 20% year over year. Nine-month revenue and net earnings declined about 10% and 20%, respectively. Management attributed much of the reported decline to yen translation: the average yen/dollar rate was 14.9% weaker in Q3 and 14.8% weaker year to date.
- Net investment income was $784M in Q3 and $2.34B year to date, versus $841M and $2.51B in the comparable 2014 periods. Q3 realized investment losses were $114M, including $137M of other-than-temporary impairment losses; nine-month realized gains were $26M, including $143M of impairments.
- Segment pretax operating earnings: Japan $789M in Q3 and $2.37B year to date; U.S. $286M and $864M. Japan’s reported earnings were pressured by currency translation; in yen, Japan pretax operating earnings increased 12.1% for Q3 and 3.3% year to date.
- Operating margins (pretax operating earnings as a share of segment revenue): Japan 21.9% in Q3 versus 19.6%, and 21.7% year to date versus 21.1%. U.S. 18.8% versus 18.4% in Q3, and 19.1% versus 19.8% year to date.
- At September 30, assets were $117.46B, liabilities $100.20B, and shareholders’ equity $17.26B. Cash and cash equivalents were $3.52B, down from $4.66B at year-end 2014. Notes payable were $5.01B, down from $5.28B; policy liabilities were $87.19B.
- Nine-month investing cash use was $4.08B and financing cash use was $1.83B, leaving a $1.14B decrease in cash. Financing included $1.08B of share repurchases and $489M of cash dividends.
Material changes and notable items
- Aflac issued $1.0B of senior notes in March at 2.40% and 3.25%, and used proceeds to redeem $850M of 8.50% notes. The early redemption generated a $230M pretax make-whole charge ($150M after tax, or $0.35 per diluted share), classified as non-operating. Management said lower interest expense should benefit full-year 2015 operating EPS by approximately $0.07.
- The company repurchased 17.4M shares for $1.1B in the first nine months and authorized another 40M shares. It planned $1.3B of repurchases for 2015; 52.1M shares remained authorized at September 30.
- Japan’s yen-denominated annualized premiums in force grew 1.5% year over year. Japan new annualized premium sales rose 23.4% in yen in Q3, while U.S. sales were up 0.4% in Q3 and 1.1% year to date.
- Japan entered new quota-share/retrocession arrangements covering closed blocks. The company says reinsurance does not relieve it of its obligations to policyholders if a reinsurer fails.
- Investment changes included increasing Japan allocations to senior secured bank loans by about $850M and high-yield corporate bonds by about $650M, and starting a Japan REIT ETF investment; the latter was valued at $103M at quarter-end.
Outlook, risks and contingencies
- Management’s 2015 objective was 4%–7% growth in operating EPS excluding foreign currency translation. If the yen/dollar rate averaged 120–125 in Q4, management expected Q4 operating EPS of $1.36–$1.56 and full-year operating EPS of $5.96–$6.16.
- Japan’s 2015 third-sector (medical and cancer) sales growth target was raised to 10%–13%. The U.S. target remained growth at the lower end of a 3%–7% range. Management expected Japan’s full-year operating expense ratio and pretax operating margin to be approximately in line with 2014; it expected U.S. benefit ratios to be relatively stable and the Q4 expense ratio to be lower than in Q4 2014.
- Management described U.S. risk-based capital and Japan’s solvency margin ratio as high, but the filing does not provide clear ratio values here. Aflac reported compliance with debt and credit-facility covenants and no borrowings under its 55B-yen revolving facility at quarter-end. It expected to meet or exceed its approximately 200B-yen 2015 profit-repatriation target; transfers remain subject to Japanese regulatory restrictions.
- Key exposures include yen/dollar movements, interest rates, credit downgrades/defaults, investment valuation and impairment judgments, perpetual securities, concentration in Japan and financial institutions, and potentially lower reinvestment yields. A 100-basis-point rise in rates was estimated to reduce debt and perpetual securities’ fair value by $11.99B at September 30; management said it generally intends and is able to hold securities through recovery or maturity.
- Below-investment-grade securities totaled $4.95B at fair value, including $1.29B of senior secured bank loans and $587M of high-yield bonds. Lawsuits are described as ordinary-course matters; management did not expect a material adverse effect. A Japan technology outsourcing agreement had $316M of remaining cost and 5.3 years remaining.
Most important facts for investors to verify
- How much of the earnings and revenue decline reflects yen translation versus underlying business trends, particularly in Japan.
- The credit circumstances behind the $131M bank/financial-institution impairment and the outlook for further impairments.
- Performance, credit quality, liquidity, and risk limits for the rapidly expanded bank-loan and high-yield portfolios.
- Whether the stated EPS, sales, repurchase, and profit-repatriation objectives were achieved, and the exchange-rate assumptions behind them.
- Insurance capital and solvency ratios, policy-liability assumptions, and the effect of reinsurance counterparties’ ability to pay.