Aflac Incorporated — Q3 2019 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2019. Aflac sells supplemental health and life insurance in the United States and Japan; Japan generated 69% of consolidated revenue in the first nine months. Interim financial statements are unaudited and were reviewed by KPMG, which reported no material modifications needed for GAAP conformity.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $5.536B | $5.577B | $16.704B | $16.632B |
| Net earnings | $777M | $845M | $2.523B | $2.395B |
| Diluted EPS | $1.04 | $1.09 | $3.37 | $3.08 |
| Operating cash flow | Not presented for the quarter | $4.263B | $4.659B |
- Net premiums were $4.736B in Q3 versus $4.636B, and $14.109B year to date versus $14.086B. Net investment income was $936M in Q3 versus $870M, and $2.692B year to date versus $2.569B.
- GAAP earnings included realized investment losses of $153M in Q3, compared with gains of $56M a year earlier; nine-month losses were $147M versus $76M. In Q3 2019, investment results included $125M net losses from certain derivatives and foreign currency activities.
- Management’s non-GAAP adjusted earnings were $863M ($1.16 diluted EPS) in Q3, versus $792M ($1.03); nine-month adjusted earnings were $2.558B ($3.41 per diluted share), versus $2.447B ($3.15). These exclude specified investment and other items and are not GAAP measures.
- Q3 pretax adjusted earnings were $838M in Aflac Japan, $335M in Aflac U.S., and a $17M loss in Corporate and other. Adjusted pretax margins were 21.4% in Japan (20.1% prior year) and 20.6% in the U.S. (20.7%). Nine-month margins were 21.7% and 20.3%, respectively.
- Operating cash flow was $4.263B; investing activities used $2.946B and financing activities used $1.429B. Cash and equivalents ended at $4.216B, compared with $4.337B at year-end 2018.
- At September 30, total assets were $154.137B, policy liabilities $107.530B, total liabilities $124.699B, and shareholders’ equity $29.438B. Notes payable and lease obligations were $6.233B, including $125M of operating lease liabilities. The filing reports no current ratio or comparable conventional liquidity measure.
Changes versus comparable periods
- Q3 revenue declined about 0.7% and net earnings declined about 8% year over year, while nine-month revenue rose about 0.4% and net earnings rose about 5%. Q3 GAAP diluted EPS fell; nine-month diluted EPS increased.
- Year-to-date operating cash flow decreased $396M. The company repurchased 23.1M shares for $1.2B in the first nine months, compared with 20.4M shares for $923M a year earlier. Cash dividends were $0.27 per share in Q3 versus $0.26.
- Net unrealized gains on available-for-sale fixed maturity securities increased shareholders’ equity by $8.970B at September 30, up from $4.234B at December 31, 2018. Aflac attributed unrealized losses on securities principally to market interest rates, foreign exchange rates, and credit spreads.
Outlook, commentary, and risks
- Management expected Aflac Japan’s full-year 2019 adjusted pretax profit margin to remain stable and projected 1%–2% earned premium growth for protection-type first- and third-sector products.
- Japan Post channel sales were materially weaker amid the ongoing investigation of Japan Post Insurance sales practices. Aflac’s review of more than 1.2 million cancer policies found a small number of lapsed-and-reissued policies not aligned with customer intent (about 0.006% of reviewed new policies); corrective action was planned. Assuming trends continued, management said Japan Post channel sales could decline by as much as 50% for 2019 and total protection sales could be down in the mid-teens. Further effects, including in 2020, were uncertain.
- Aflac Japan’s new annualized premium sales fell 18.7% in Q3 and 14.4% for the first nine months in dollars. Aflac U.S. sales fell 4.2% in Q3 and 1.6% year to date. Japan’s annualized premiums in force declined 2.2% in yen; U.S. annualized premiums in force increased 1.5%.
- The company anticipated $1.3B–$1.7B of 2019 share repurchases, subject to stable capital conditions and no compelling alternatives. The board declared a Q4 dividend of $0.27 per share.
- Management estimated that adoption of the expected-credit-loss standard in January 2020 could require an allowance of up to $150M, primarily for loans and loan receivables. It was also planning a one-time reclassification of approximately $6B–$8B of eligible held-to-maturity securities to available-for-sale; estimated after-tax unrealized gains on those securities were $600M–$1B at September 30. The long-duration insurance accounting standard is expected to have a significant impact, particularly on earnings and equity.
- Key exposures include Japan and yen concentration, interest rates, investment credit and valuation, and Japan Post distribution. Japan government bonds and government-backed securities represented an investment exposure exceeding 10% of equity. The company reported strong regulatory capital, compliance with debt covenants, and $1B of parent-company capital reserve plus $1B of contingent liquidity for derivative-related needs.
- Aflac agreed to acquire Argus Holdings for $75M at closing plus up to $21M tied to performance, subject to approvals and closing conditions. Routine litigation was not expected by management to have a material adverse effect; an appealed shareholder derivative suit dismissal was affirmed in September 2019.
Important facts for investors to verify
- Whether Japan Post channel disruption persists, and its effect on cancer-policy sales, total sales, and earned-premium growth.
- Underlying operating trends apart from realized investment and currency/derivative effects; reconcile GAAP results with management’s adjusted earnings measure.
- Investment portfolio credit quality, Japan government concentration, unrealized valuation gains, and the planned 2020 securities reclassification and credit-loss allowance.
- Capital and liquidity at the parent and regulated insurance subsidiaries, including dividend capacity, hedging collateral needs, and planned repurchases.
- Implementation impacts of the new credit-loss and long-duration insurance accounting standards, and the status and terms of the Argus acquisition.