Aflac Incorporated — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Aflac sells supplemental health and life insurance primarily in Japan and the United States; Japan accounted for 70% of Q1 revenue. The interim financial statements were reviewed by KPMG, not audited; KPMG reported no material modifications were needed for GAAP conformity.
Key financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $5.226 billion | $5.640 billion | Down 7.3% |
| Net premiums | $4.432 billion | $4.854 billion | Down 8.7% |
| Net investment income | $782 million | $827 million | Down 5.4% |
| Earnings before income taxes | $1.013 billion | $1.104 billion | Down 8.2% |
| Net earnings | $663 million | $732 million | Down 9.4% |
| Diluted EPS | $1.51 | $1.60 | Down 5.6% |
| Operating earnings, non-GAAP | $678 million; $1.54 per diluted share | $774 million; $1.69 per diluted share | Down 12.4% in dollars |
| Operating cash flow | $1.460 billion | $1.615 billion | Down 9.6% |
All amounts are U.S. dollars. The yen weakened substantially year over year: the average rate was 119.16 yen per dollar versus 102.70, reducing translated Japanese results. Management noted that Japan pretax operating earnings increased 1.8% in yen, but declined 2.9% excluding foreign-currency effects on dollar-denominated items.
Segments, margins and sales
- Aflac Japan: Revenue was $3.699 billion versus $4.231 billion; pretax operating earnings were $819 million versus $933 million. In yen, pretax operating earnings rose 1.8%. The pretax operating margin was 22.1% versus 22.0%; the benefit ratio increased to 60.2% from 59.9%. New annualized premium sales were down 2.2% in yen, with third-sector cancer and medical sales strengthening and first-sector life sales declining.
- Aflac U.S.: Revenue rose to $1.508 billion from $1.455 billion, while pretax operating earnings fell to $285 million from $303 million. The pretax operating margin fell to 18.9% from 20.8%, mainly as insurance and other expenses increased. New annualized premium sales were down 0.5%.
- Consolidated insurance claims and expenses: Benefits and claims were $2.952 billion versus $3.220 billion. Total benefits and expenses were $4.213 billion versus $4.536 billion. Consolidated pretax earnings were approximately 19.4% of revenue, compared with 19.6% a year earlier.
Balance sheet, debt and liquidity
- At March 31, total assets were $121.401 billion, total liabilities $102.764 billion, and shareholders’ equity $18.637 billion. Cash and cash equivalents were $4.363 billion, down from $4.658 billion at year-end 2014.
- Notes payable rose to $6.282 billion from $5.282 billion, reflecting $1.0 billion of senior notes issued in March. The notes were swapped into yen obligations at stated effective rates of 0.24% and 0.82%. In April, the company used the proceeds to redeem $850 million of 8.50% notes and pay part of a $230 million make-whole premium.
- Cash flows were $1.460 billion provided by operations, $2.078 billion used in investing, and $322 million provided by financing; cash decreased by $295 million during the quarter. Financing included $989 million of borrowing proceeds and $610 million of treasury-stock purchases.
- The company reported compliance with debt and credit-facility covenants and no outstanding borrowings under its $50 million and $100 million uncommitted lines or its 50 billion yen revolving facility. Management said expected premiums and investment cash flows should fund benefits and expenses.
- Quarterly cash dividends were $0.39 per share. The company repurchased 9.8 million shares for $600 million and said it planned $1.3 billion of share repurchases in 2015.
Outlook, material developments and risks
- 2015 earnings objective: Increase operating earnings per diluted share by 2%–7% versus 2014, excluding foreign-currency translation. At an average yen/dollar rate of 120–125, management expected full-year operating EPS of $5.74–$6.15 and Q2 EPS of $1.46–$1.57.
- The April debt redemption was expected to create a non-operating Q2 charge of approximately $0.34 per share, while reducing full-year interest expense by approximately $0.07 per share. Management also planned total 2015 profit repatriations of 200 billion yen.
- Management expected Japan’s pretax operating margin to remain approximately level with 2014. It targeted 3%–7% growth in Aflac U.S. new annualized premium sales for 2015, despite ongoing uncertainty around U.S. health-care reform and sales-force changes.
- Japan’s low interest rates remain a challenge: Aflac Japan’s new-money yield declined to 1.13% from 1.99%. In Q1, the company increased senior secured bank-loan allocations by approximately $750 million and high-yield corporate-bond allocations by $500 million; the latter was partly funded by quarter-end. These investments raise credit risk relative to traditional investment-grade holdings.
- A March 31 reinsurance transaction ceded 30% of sickness hospital benefits on a closed Japan block. A $600 million deferred profit liability and matching reinsurance recoverable were recorded; the profit is to be recognized over the policies’ expected lives. Reinsurance does not remove Aflac’s policyholder obligations if a reinsurer fails.
- Key exposures include Japan concentration, yen exchange-rate movements, low or changing interest rates, credit downgrades and defaults, perpetual securities, investment valuation judgments, and investment concentration. Banks and financial institutions represented 13% of the investment portfolio at amortized cost. Gross unrealized investment losses were $719 million; management attributed most declines to market factors and said it considered them temporary. Greece and broader European market conditions remained under monitoring.
- The company was a defendant in ordinary-course litigation and said pending matters were not expected to materially affect financial position, results or cash flows. No material off-balance-sheet guarantees or similar arrangements were reported. Management stated disclosure controls were effective and reported no materially affecting changes to internal control over financial reporting.
Important facts for investors to verify
- How much of the revenue, earnings and premium decline reflects yen translation versus underlying policy, claims and investment trends.
- Whether the 2015 operating EPS objective and segment sales targets remain achievable, including the effect and accounting classification of the April make-whole payment.
- Performance, credit quality, liquidity and valuation of the expanded below-investment-grade bank-loan and high-yield bond programs.
- Reinsurance recoverability, the timing of deferred-profit recognition and the continuing exposure to policyholder claims.
- Capacity to sustain planned repurchases, dividends and profit repatriations while maintaining U.S. statutory capital and Japan’s solvency margin.