Aflac Incorporated — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Aflac sells supplemental health and life insurance primarily in the U.S. and Japan through Aflac U.S. and Aflac Japan. Japan represented 67% of six-month revenue and 83% of assets.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $5.407 billion | $5.511 billion | $10.569 billion | $11.168 billion |
| Net earnings | $805 million | $817 million | $1.370 billion | $1.745 billion |
| Diluted EPS | $1.12 | $1.09 | $1.89 | $2.32 |
| Net investment gains (losses) | $(170) million | $(66) million | $(633) million | $5 million |
| Adjusted earnings (non-GAAP) | $921 million | $846 million | $1.803 billion | $1.695 billion |
| Adjusted diluted EPS (non-GAAP) | $1.28 | $1.13 | $2.49 | $2.25 |
Six-month operating cash flow was $2.601 billion, versus $2.357 billion a year earlier. Investing cash outflow was $2.120 billion; financing provided $152 million. Cash and cash equivalents ended June at $5.528 billion, up from $4.896 billion at year-end 2019.
Total assets were $157.087 billion and shareholders’ equity was $29.420 billion at June 30. Notes payable and lease obligations totaled $7.771 billion, compared with $6.569 billion at year-end. Aflac issued $1 billion of 3.60% senior notes due 2030 and ¥57 billion of senior notes during the first half; it also repaid $350 million of senior notes. The company reported compliance with debt covenants and no borrowings on its unsecured revolving facilities.
Cash dividends were $0.28 per share in Q2, up from $0.27. Six-month share repurchases were $637 million for 15.2 million shares. Return on average equity was 11.5% annualized for Q2; adjusted return on equity excluding foreign-currency impact was 16.3%.
Changes versus the prior comparable period
- Q2 revenue and net earnings declined modestly; for the first half, revenue fell about 5% and net earnings about 21%. Management attributed the GAAP earnings decline primarily to larger investment losses.
- Adjusted earnings increased in both periods, led in Q2 by favorable Aflac U.S. benefit ratios. These non-GAAP results exclude specified investment and other items.
- Six-month investment results swung from a $5 million gain to a $633 million loss, including $321 million of credit losses, $135 million of derivative and foreign-currency losses, $118 million of equity-security losses, and $59 million of net losses from sales and redemptions.
- U.S. new annualized premium sales fell 55.6% in Q2 and 31.2% for the first half. Japan sales fell 58.8% in Q2 and 44.1% for the first half, measured in yen.
- U.S. benefit ratios decreased as accidents, wellness visits, and routine procedures declined amid distancing measures. Japan’s benefit ratio increased slightly, partly due to persistency and reserve effects. Favorable prior-year claims development was $302 million for the first half.
Outlook, risks, and unusual items
- Management said COVID-19’s future effects remain uncertain and may change earnings, capital deployment, regulatory capital, subsidiary dividends, and other previously issued guidance. The filing does not provide a clear updated consolidated earnings forecast.
- Aflac U.S. expects 2020 earned premiums to range from flat to a 3% decline versus 2019, reflecting reduced sales and possible lapses as premium grace periods expire. Management said reduced claims activity and the resulting lower benefit ratio may be temporary and remains uncertain.
- Management is taking a tactical approach to repurchases and plans to defer further subsidiary dividends to the parent until Q4, subject to developments. It intends to maintain Aflac U.S. RBC in the 400% range for 2020. Japan and U.S. subsidiaries had reduced planned remittances to the parent.
- Liquidity measures included maintaining $5.5 billion in cash, issuing debt, increasing the internal FHLB borrowing limit to $800 million (subject to collateral and other conditions), and retaining $1 billion and ¥100 billion of unused revolving credit capacity. Management said capital and liquidity entered the crisis at levels intended to absorb market volatility.
- Investment risks include credit deterioration and defaults, lower reinvestment yields, volatile interest rates and exchange rates, and exposures to energy, travel, lodging, leisure, and other affected sectors. Commercial mortgage and other loans were $10.7 billion net; the company recorded a $242 million allowance for credit losses. It also had approximately $2.5 billion of middle-market loan commitments, including a new $2.2 billion external-manager commitment.
- Other notable exposures include the continuing Japan Post investigation’s effect on Japan sales, the company’s concentration in Japan, and sensitivity to yen/dollar exchange rates. The company reduced and widened part of its currency collar program. Pending ordinary-course litigation was not expected by management to have a material adverse effect. COVID-related loan modifications had no material impact on results through June 30.
- The adoption of long-duration insurance accounting guidance is expected to have a significant impact on financial position, results, and disclosures; adoption is scheduled for periods beginning after December 15, 2021. A separate accounting change reclassified $6.9 billion of securities from held-to-maturity to available-for-sale and increased opening AOCI by $848 million after tax.
Important facts for investors to verify
- Track sales recovery, persistency, policy lapses, and the effects of COVID-19 and the Japan Post investigation in both segments.
- Assess whether unusually low U.S. claims and favorable claims development persist, and whether benefit ratios normalize.
- Monitor credit-loss allowances, loan modifications, commitments, and exposures to stressed sectors, alongside future investment income and reinvestment yields.
- Review capital and liquidity trends, subsidiary remittances, debt levels, repurchases, and the sensitivity of Japan solvency measures to market movements.
- Distinguish GAAP earnings from adjusted earnings and evaluate the investment losses and non-GAAP exclusions underlying the reported improvement in adjusted results.