Aflac Incorporated: Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Aflac sells supplemental health and life insurance, principally in the United States and Japan. Japan represented 69% of nine-month revenue and 84% of assets. The statements are unaudited; KPMG conducted an interim review and reported it was not aware of material modifications needed for GAAP conformity. Per-share data reflects the March 2018 two-for-one stock split.
Key financial results
Amounts are in millions of U.S. dollars, except per-share data and percentages.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $5,577 | $5,506 | $16,632 | $16,243 |
| Net earnings | $845 | $716 | $2,395 | $2,021 |
| Diluted GAAP EPS | $1.09 | $0.90 | $3.08 | $2.52 |
| Pretax adjusted earnings | $1,061 | $1,014 | $3,309 | $3,114 |
| Adjusted earnings per diluted share | $1.03 | $0.85 | $3.15 | $2.60 |
- Q3 revenue rose about 1.3% year over year and net earnings about 18%; nine-month revenue increased about 2.4% and net earnings about 18.5%.
- Net premiums were $4,636 in Q3, versus $4,648; nine-month premiums were $14,086, versus $13,951. Net investment income was $870 in Q3 and $2,569 for nine months, up from $811 and $2,408, respectively.
- Q3 benefits and claims were $3,002, compared with $3,083; nine-month amounts were $9,075, compared with $9,174. Q3 total benefits and expenses were unchanged at $4,431; nine-month expenses increased to $13,371 from $13,224.
- Effective tax rates on pretax earnings were 26.3% for Q3 and 26.5% for nine months, versus 33.4% and 33.1% a year earlier. The lower U.S. corporate rate under the Tax Act was the primary factor.
- Q3 GAAP realized investment gains were $56, versus $30; nine-month realized losses were $76, versus losses of $166. These figures include derivative and currency effects, and, beginning in 2018, fair-value changes on equity securities.
Segments and operating trends
- Aflac Japan: Pretax adjusted earnings were $756 in Q3 and $2,411 for nine months, compared with $748 and $2,308. Nine-month premiums were $9,649, up from $9,616. Earnings benefited from higher investment income and favorable claims experience. Annualized premiums in force fell 1.6% in yen to ¥1.53 trillion, mainly as limited-pay policies became paid-up. Management expected the full-year 2018 pretax adjusted profit margin to remain stable.
- Japan’s nine-month net investment income, after amortized hedge costs, rose to $1,801 from $1,676. Annualized hedge costs were 229 basis points for nine months, versus 201; hedge costs in dollars were $168 in both periods.
- Aflac U.S.: Pretax adjusted earnings were $334 in Q3 and $1,011 for nine months, up from $316 and $956. Nine-month premiums rose to $4,280 from $4,172. New annualized premium sales increased 3.3% in Q3 and 2.6% for nine months.
- Consolidated adjusted earnings are a non-GAAP measure. The company excludes certain realized investment items and nonrecurring items; currency-adjusted comparisons are also presented. These measures should not be treated as substitutes for GAAP results.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $4,659, versus $4,596; investing cash use was $3,172, versus $2,887; financing cash use was $1,513, versus $1,613. Cash and cash equivalents declined $62 during the period to $3,429.
- At September 30, total assets were $137,941, total liabilities $114,707 and shareholders’ equity $23,234. Investments and cash totaled $124,214. Policy liabilities were $100,584.
- Notes payable were $5,279, approximately unchanged from year-end 2017. The company reported no outstanding borrowings on its listed credit facilities at quarter-end and said it complied with debt and credit-line covenants.
- Cash dividends paid were $595 in the first nine months; the company also repurchased 20.4 million shares for $923. Management planned total 2018 repurchases of $1.1 billion to $1.4 billion, subject to stable capital conditions and no compelling alternatives. The board declared a Q4 dividend of $0.26 per share, an 18.2% increase year over year.
- Japan’s conversion from a branch to a legal subsidiary was completed April 1, 2018. The transition affected regulatory dividend approvals and reduced remittances to the parent during the period. Aflac expected Japan dividend payments to resume in Q4. Management announced plans to transfer capital to the parent and maintain higher-than-historical parent-company capital and liquidity.
Material developments, outlook and risks
- Other comprehensive income was a loss of $2,345 for the first nine months, versus income of $901 a year earlier; total comprehensive income was $50, versus $2,922. The decline mainly reflected unrealized fixed-maturity security losses. Net unrealized gains on available-for-sale securities, after tax, fell to $4,240 from $5,964 at year-end 2017.
- Management attributed favorable prior-year claims development of $456 for nine months to Japan ($325) and the U.S.; it cited improving Japanese cancer-treatment patterns and shorter hospital stays. Such reserve development may not recur.
- Other investments increased to $7,009 from $3,402 at year-end 2017, including transitional real estate loans of $4,128 versus $1,235. The company reported a $25 loan-loss allowance, versus $11; no loans were past due, nonaccrual or impaired at quarter-end.
- The company’s major stated risks include Japan and yen concentration, interest-rate and currency movements, credit deterioration and investment valuation, insurance pricing and reserving experience, regulation and tax changes, operational and cybersecurity risks, and litigation. Fixed-income fair values were exposed to rate, currency and credit-spread movements; management characterized most unrealized losses as market-driven and temporary, subject to its credit review.
- The company said the 2018 Tax Act accounting remained subject to refinement, including Japan deferred-tax and foreign-tax-credit analyses; the impact could differ materially from provisional estimates. Separately, adoption of the new long-duration insurance-contract standard was expected to have a significant impact, particularly from updating assumptions for future policy benefit liabilities.
- Subsequent to quarter-end, the parent issued $550 million of 4.750% 30-year notes, with proceeds intended in part to redeem $550 million of 2.40% notes due 2020. It also issued ¥53.4 billion of long-term notes in three series.
- A shareholder derivative lawsuit was dismissed on August 31, 2018; plaintiffs appealed. The company said pending litigation was not expected to materially adversely affect its financial position, results or cash flows.
Important facts for investors to verify
- How much of earnings growth reflects the lower tax rate, favorable claims development, and investment or currency effects, versus recurring insurance operations?
- Whether Japan’s subsidiary dividend capacity and solvency margin support the planned capital transfers and parent-level liquidity strategy.
- The sustainability and risk profile of the sharply higher real estate and other loan investments, including future credit-loss allowances and funding commitments.
- The effect of interest rates, yen movements, credit spreads and hedge costs on investment values, earnings, regulatory capital and collateral needs.
- The eventual Tax Act accounting and the expected financial and operational impact of the long-duration insurance-contract accounting standard.
- Execution of the planned share repurchases and Japan dividend resumption, and the outcome of the appeal in the derivative lawsuit.