AFLAC INC quarterly report, Q2 FY2012

Aflac Incorporated — Q2 2012 Form 10-Q

Reporting period: Three and six months ended June 30, 2012. Aflac sells supplemental health and life insurance in Japan and the U.S.; Japan generated 77% of first-half revenue and represented 87% of assets. The interim statements were reviewed by KPMG, not audited. KPMG reported no material modifications it believed were needed for GAAP conformity.

Financial performance

Metric	Q2 2012	Q2 2011	First half 2012	First half 2011
Total revenue	$5.902B	$5.088B	$12.142B	$10.204B
Net earnings	$483M	$274M	$1.268B	$663M
Diluted EPS	$1.03	$0.58	$2.71	$1.41
Pretax operating earnings	$1.159B	$1.112B	$2.406B	$2.283B
Realized investment losses, pretax	$418M	$668M	$463M	$1.247B

Premiums rose 10.3% in Q2 and 10.3% in the first half; net investment income rose 7.8% and 9.4%, respectively. Reported revenue and earnings also benefited from yen translation, as the yen was stronger on average than in the comparable 2011 periods.
Operating earnings exclude realized investment gains and losses and nonrecurring items. Q2 pretax operating earnings increased 4.2%; first-half operating earnings increased 5.4%. These measures provide a view of underlying insurance performance distinct from GAAP net earnings.
Q2 pretax realized losses included $343M of other-than-temporary impairments and $67M of derivative and other losses. First-half impairments were $546M; securities sales and redemptions generated $70M in net gains.
Q2 Aflac Japan pretax operating earnings were $964M, up 4.2% in dollars; Aflac U.S. earned $258M, up 6.3%. First-half segment operating earnings were $2.004B for Japan and $529M for the U.S.
Segment profit ratios showed pressure in Japan: Q2 pretax operating margin was 19.6% versus 20.9% a year earlier, as the benefit ratio rose. U.S. Q2 pretax operating margin was 18.3% versus 18.1%.

Cash flow, balance sheet and capital

First-half operating cash flow was $7.245B, up from $4.378B; investing cash outflow was $8.058B, compared with $5.034B. Financing provided $725M, versus $175M used in the prior-year period. Cash and equivalents ended at $2.130B, down $119M from year-end.
Cash from operations included a $3.135B positive change in receivables and advance premiums and a $2.679B increase in policy liabilities; operating cash flow should be considered in light of these items. The company primarily reinvests operating cash in securities supporting policy obligations.
Total assets were $122.209B, total liabilities $108.030B and shareholders’ equity $14.179B at June 30. Notes payable were $3.672B, versus $3.285B at year-end; debt-to-total-capitalization, excluding unrealized investment and derivative gains and losses, was 22.4%, up from 21.0%.
The company reported $99.413B in policy liabilities. Cash and cash equivalents were 1.9% of investments and cash. Management said projected premium and investment cash flows were expected to meet benefit and expense needs; no borrowings were outstanding on its new 50 billion yen revolving facility at quarter-end.
Cash dividends were $0.33 per share for Q2, compared with $0.30 in Q2 2011. No shares were repurchased in the open market in the first half; the company paid $296M in cash dividends.

Changes, outlook and significant items

Japan new annualized premium sales rose 47.4% in yen in Q2, with WAYS and bank distribution contributing strongly. Japan’s full-year 2012 sales target was raised to 22%–25% growth; management expected second-half sales to be flat to up 5% against difficult comparisons.
U.S. new annualized premium sales increased 1.5% in Q2 and 3.0% in the first half. The 2012 sales objective was 3%–8% growth. Management cited weak consumer and small-business confidence as near-term challenges.
Management’s 2012 EPS objective was 3%–6% growth over 2011, excluding realized investment items, nonrecurring items and currency translation. At an assumed full-year yen rate of 80 per dollar, the narrative forecasts EPS of $6.45–$6.52 and Q3 EPS of $1.64–$1.69. The filing’s scenario table instead shows $6.45–$6.64 at 80 yen per dollar. The 2013 EPS growth objective was 4%–7%, subject to stated exclusions and assumptions, including no further material decline in interest rates.
Management cited low investment yields as a constraint on earnings and spreads. Japan’s portfolio yield was 3.10% at June 30 versus 3.51% a year earlier; new-money yields were also lower. The company noted that yen/dollar movements can materially affect reported results.
Aflac continued to reduce European financial and subordinated-security exposure. It recognized impairments related to Spanish issuers, including $144M on Generalitat de Catalunya and $120M on Bankia; it also transferred certain securities from held-to-maturity to available-for-sale after credit deterioration. In July, it tendered Credit Suisse perpetual securities with $485M amortized cost, expected to result in an approximately $25M pretax Q3 loss.
Other post-quarter items: Aflac issued an additional $250M of 2.65% senior notes due 2017 in July; Aflac Japan remitted 37B yen of profits in July, and management expected no further 2012 remittances. The IRS finalized 2008–2009 tax returns in August; the company estimated a $20M–$25M tax benefit, excluding interest.
Effective January 1, 2012, Aflac retrospectively adopted revised insurance acquisition-cost accounting. The adoption reduced shareholders’ equity by $516M as of December 31, 2010; management said the impact on 2011 and earlier net income was immaterial.
Principal risks include investment credit downgrades/defaults and impairment judgments, exposure to European financial issuers and perpetual securities, low or changing yields, yen exchange-rate movements, Japan business concentration, policyholder experience differing from assumptions, regulatory changes and litigation. Management said pending litigation was not expected to materially affect financial position, results or cash flows. It also reported effective disclosure controls and no material adverse change in internal financial controls, while noting implementation of a new SAP reporting system.

Important facts for investors to verify

Reconcile the 2012 EPS guidance at the 80 yen scenario: narrative range $6.45–$6.52 versus table range $6.45–$6.64.
Track realized impairment and derivative losses, subsequent Credit Suisse settlement results, and developments in Spanish and other European exposures.
Assess the contribution of yen translation to reported growth against yen-denominated segment trends and the company’s currency assumptions.
Monitor investment yields, policy benefit ratios and margins, Japan sales mix (including lower-margin WAYS), and U.S. sales against management’s targets.
Review debt growth, the July note issuance, capital and solvency measures, and the extent to which operating cash flow reflects changes in receivables and policy liabilities.