Aflac Incorporated — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Aflac sells supplemental health and life insurance principally in the U.S. and Japan. Japan represented 70% of first-half revenue and 85% of assets at June 30. KPMG reviewed the interim statements; this was not an audit.
Financial performance
Amounts are U.S. dollars in millions, except per-share data. Period comparisons are to 2017.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $5,589 | $5,428 | $11,054 | $10,737 |
| Net premiums | $4,706 | $4,665 | $9,450 | $9,303 |
| Net investment income | $862 | $802 | $1,699 | $1,596 |
| Net earnings | $832 | $713 | $1,550 | $1,305 |
| Diluted EPS | $1.07 | $0.89 | $1.98 | $1.62 |
| Adjusted earnings (non-GAAP) | $835 | $731 | $1,655 | $1,406 |
| Pretax adjusted earnings (non-GAAP) | $1,138 | $1,073 | $2,247 | $2,100 |
| Realized investment gains (losses), pretax | $3 | $(56) | $(131) | $(196) |
- Revenue increased about 3% in both the quarter and first half. Net earnings rose about 17% and 19%, respectively; diluted EPS rose about 20% and 22%. The lower effective tax rate following U.S. tax reform contributed to the earnings comparison.
- Q2 adjusted earnings increased about 14%; first-half adjusted earnings increased about 18%. These are company-defined non-GAAP measures and should be considered alongside GAAP results.
- Segment pretax adjusted earnings increased: Japan to $836 million from $791 million in Q2 and $1,654 million from $1,560 million for six months; U.S. to $340 million from $330 million and $677 million from $640 million, respectively.
- Japan’s Q2 pretax adjusted margin was 21.8%, versus 20.9%; U.S. was 21.1%, versus 21.0%. Japan’s full-year 2018 pretax adjusted margin was expected to remain stable.
Cash flow, balance sheet and capital
- First-half operating cash flow was $2,807 million, down from $3,165 million. Investing activities used $1,443 million, compared with $2,517 million; financing activities used $988 million, compared with $1,231 million. Cash and equivalents ended at $3,847 million, up from $3,491 million at year-end 2017.
- At June 30, total assets were $141,986 million, liabilities $118,186 million and shareholders’ equity $23,800 million. Total policy liabilities were $102,310 million.
- Notes payable were $5,315 million, broadly stable against $5,289 million at year-end. The company reported compliance with debt and credit-line covenants and no defaults. Available credit facilities were undrawn; amounts and terms vary by facility.
- Cash dividends paid were $396 million in the first half, and treasury-stock purchases used $601 million. Management planned $1.1–$1.4 billion of 2018 repurchases, subject to stable capital conditions and no compelling alternatives. In July, the board declared a $0.26-per-share third-quarter dividend.
- Available-for-sale fixed-maturity securities had $1,451 million of gross unrealized losses at June 30, compared with $813 million at year-end. First-half other comprehensive income was a loss of $1,402 million; Q2 total comprehensive income was approximately break-even at a loss of $1 million. These results included substantial currency-translation and securities-value movements.
Material changes, outlook and risks
- Aflac Japan completed its conversion from a branch to a Japanese legal subsidiary on April 1, 2018. Management cited potential flexibility in capital management and business development; the conversion also creates execution, regulatory and tax risks. The company retained capital in Japan during Q1 following the conversion.
- Japan’s pretax adjusted earnings benefited from higher investment income and favorable claims experience. Japan’s first-half new annualized premium sales rose 4.7% in dollars but 1.4% in yen; Q2 sales rose 16.1% in dollars and 14.0% in yen, supported by a new cancer product. Japan premiums in force declined 1.8% in yen, partly as limited-pay policies became paid-up.
- U.S. first-half new annualized premium sales increased 2.3%. Management attributed U.S. earnings improvement to investment income and, for the first half, lower benefit ratios; it also noted planned platform spending.
- Favorable prior-year claims development totaled $325 million in the first half, including approximately $210 million from Japan. Management described continued favorable Japan cancer-claims trends. Investors should note the potential variability of claims experience and reserve estimates.
- The 2018 effective tax rates were 26.4% for Q2 and 26.7% for the first half, lower mainly because the U.S. statutory rate fell to 21%. The company’s Tax Act accounting remained subject to refinement; management stated the ultimate impact could differ, possibly materially.
- Key disclosed risks include Japan and yen concentration, interest-rate and credit-spread movements, investment defaults or downgrades, limited availability of suitable yen assets, insurance pricing/reserving deviations, regulation, systems and cybersecurity, and the Japan subsidiary transition. The company also identified a shareholder derivative suit and other ordinary-course litigation; management did not expect pending litigation to have a material adverse effect.
- Investment loss positions were attributed primarily to market interest rates, foreign-exchange rates and credit spreads; management said its credit analysis supported continued issuer payments. This assessment is not a guarantee against future losses.
Important facts for investors to verify
- Reconcile GAAP earnings growth with adjusted earnings, including investment gains/losses, nonrecurring Japan conversion costs and the lower tax rate.
- Track Japan subsidiary regulatory capital, dividend capacity and progress on restoring the conversion-related solvency-margin impact; verify the status of tax treatment and the IRS private-letter ruling assumptions.
- Monitor Japan and U.S. claims trends, reserve development and premiums in force, particularly the effect of paid-up policies and favorable prior-period claims adjustments.
- Review portfolio concentration and sensitivity to Japanese government bonds, interest rates, credit spreads, currency moves and rising hedge costs; assess the growth in loan and alternative-investment exposures.
- Compare future cash generation, repurchases and dividends with capital requirements and the company’s stated 2018 repurchase plan.