Aflac Incorporated — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010. Amounts are in U.S. dollars unless otherwise stated. The interim financial statements were reviewed, not audited, by KPMG.
Business context and key financial metrics
Aflac sells supplemental health and life insurance in the United States and Japan. Japan generated 75% of nine-month revenue and represented 87% of assets at September 30, underscoring the company’s exposure to Japan and yen translation.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $5.987B | $5.394B | $16.192B | $15.438B |
| Net earnings | $744M | $690M | $1.418B | $1.907B |
| Diluted EPS | $1.59 | $1.46 | $3.02 | $4.03 |
| Pretax operating earnings | $1.188B | $1.046B | $3.488B | $3.045B |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $7.486B | $4.869B |
| Investing cash flow | Not provided for quarter | Not provided for quarter | $(7.779)B | $(5.080)B |
Premiums were $5.210B in Q3 and $15.037B for nine months. Net investment income was $843M and $2.422B, respectively. Q3 pretax operating earnings were $1.027B in Japan and $220M in the U.S.; nine-month figures were $2.937B and $719M. Reported pretax operating margins (earnings as a share of segment operating revenue) were 21.7% for Japan and 16.4% for the U.S. in Q3; for nine months, 21.7% and 18.0%, respectively.
At September 30, total assets were $114.720B, total liabilities $102.006B and shareholders’ equity $12.714B. Investments and cash totaled $100.808B, including cash and equivalents of $1.862B. Notes payable were $3.301B, up from $3.038B; debt to total capitalization, excluding unrealized investment gains and losses, was 21.6%. Nine-month cash dividends were $404M, and cash dividends per share were $0.30 in Q3.
Changes versus comparable periods
- Q3 revenue rose 11.0%; net earnings increased 7.8% and diluted EPS increased from $1.46 to $1.59. The stronger yen boosted reported results.
- Nine-month revenue increased 4.9%, while net earnings fell 25.6% and diluted EPS declined from $4.03 to $3.02. The principal reported drag was $1.330B of pretax realized investment losses, including $1.100B of other-than-temporary impairment losses, versus $127M of realized losses and $55M of impairments in 2010.
- Pretax operating earnings, which exclude realized investment gains and losses and nonrecurring items, increased 13.6% in Q3 and 14.5% for the nine-month period. Japan’s nine-month pretax operating earnings grew 18.2% in dollars; U.S. segment earnings grew 2.7%.
- For the nine months, operating cash flow increased to $7.486B, while investment outflows rose to $7.779B; cash and equivalents decreased by $259M from year-end.
Outlook, management commentary and risks
- 2011 objective: Increase net earnings per diluted share 8% over 2010, excluding realized investment gains/losses and nonrecurring items, and assuming no foreign-currency translation impact. With a 75–80 yen/dollar average rate for Q4, management expected Q4 reported EPS of $1.45–$1.52 and full-year reported EPS of $6.30–$6.37.
- 2012 objective: Increase adjusted EPS 2%–5% over 2011, excluding realized investment gains/losses, nonrecurring items and currency translation. This assumes no additional significant investment losses and no further material decline in interest rates. Management anticipated higher Q4 expenses, especially marketing and IT, and said benefit and expense ratios could rise in Q4.
- Japan sales were strong: Q3 new annualized premium sales rose 22.2% in yen, led by WAYS and bank-channel distribution. U.S. new annualized premium sales grew 5.0% in Q3, although management remained cautious about the near-term sales outlook.
- Management reported that investment derisking had substantially reduced exposure to peripheral Europe: no direct sovereign or financial investment exposure remained in Greece or Portugal, and Ireland exposure was limited to senior debt. However, banks and financial institutions still represented about 28% of debt and perpetual securities at amortized cost; unrealized investment losses totaled $5.037B.
- Japan’s March earthquake and tsunami produced a net $12M pretax claims impact and $8M of operating expenses in Q1. Management said the initial claims provision was adequate and the disaster had not materially affected results or financial position, while noting estimates could change.
- Adopting revised insurance acquisition-cost accounting on January 1, 2012 was estimated to cause a $500M–$700M after-tax cumulative charge to opening retained earnings, equivalent to 4.5%–6.3% of year-end 2010 equity; estimated effects on net income were immaterial.
- Key risks include investment impairments and issuer/sector concentration, credit and valuation risks in perpetual securities, low investment yields, yen fluctuations, Japan concentration and economic conditions, regulatory changes, and earthquake-related effects. Management said pending litigation was not expected to materially affect financial position, results or cash flows.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. The filing reported no material off-balance-sheet guarantees or similar arrangements.
Important facts for investors to verify
- Whether the 2011 and 2012 adjusted EPS objectives are achieved, and how exchange rates and higher Q4 spending affect reported results.
- Investment portfolio credit quality, especially bank/financial and perpetual-security exposures; subsequent credit deterioration, impairment decisions and recovery assumptions.
- Cash generation and liquidity in light of large policy liabilities, investment purchases, debt maturities and potential limits on remittances from Japan.
- Actual impact of the 2012 acquisition-cost accounting adoption, including the estimated retained-earnings charge.
- Whether earthquake-related claims develop beyond the initial estimate and whether Japan’s solvency position or investment requirements change.