Aflac Incorporated — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparative period is Q1 2013. Aflac sells supplemental health and life insurance in Japan and the U.S. Japan generated 75% of quarterly revenue and represented 85% of assets. KPMG reviewed the interim statements; this was not an audit.
Key financial results
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total revenues | $5.640 billion | $6.208 billion |
| Net premiums | $4.854 billion | $5.184 billion |
| Net investment income | $827 million | $833 million |
| Realized investment gains (losses) | $(46) million | $156 million |
| Earnings before income taxes | $1.104 billion | $1.361 billion |
| Net earnings | $732 million | $892 million |
| Diluted EPS | $1.60 | $1.90 |
| Operating earnings, non-GAAP | $774 million; $1.69 per diluted share | $790 million; $1.69 per diluted share |
| Operating cash flow | $1.615 billion | $3.832 billion |
All dollar amounts are U.S. dollars. Net margin was approximately 13.0% of revenue versus 14.4%. Segment pretax operating margins were 22.0% for Japan (21.5% prior year) and 20.8% for the U.S. (19.5%).
Financial position and liquidity
- At March 31, total assets were $123.292 billion, total liabilities $107.616 billion, and shareholders’ equity $15.676 billion.
- Investments and cash totaled $110.493 billion, including $1.994 billion of cash and cash equivalents, down from $2.543 billion at year-end 2013.
- Notes payable were $4.913 billion, versus $4.897 billion at year-end. Adjusted debt to total capitalization was 23.6%, compared with 24.3%.
- The company reported no borrowings on its 50 billion yen revolving credit facility and compliance with debt and credit-facility covenants. Management said projected operating and investment cash flows should meet benefit and expense needs.
- Cash used in investing activities was $2.123 billion; financing activities used $32 million. Cash declined by $549 million during the quarter.
- Operating cash flow was lower year over year, including because the increase in policy liabilities contributed $978 million, compared with $2.400 billion in Q1 2013.
Material changes and operating trends
- Reported revenue declined about 9% and net earnings about 18% year over year. Management attributed much of the reported-dollar decline to yen weakness: the average yen/dollar rate was 102.70 versus 92.59, and yen-denominated income represented 82.2% of net earnings.
- Japan premiums fell 8.8% in dollars but rose 1.4% in yen; Japan pretax operating earnings fell 5.7% in dollars but increased 4.6% in yen. U.S. pretax operating earnings rose 7.9% to $303 million.
- Japan new annualized premium sales fell 48.7% in yen, following unusually strong prior-year first-sector sales ahead of a product repricing. Third-sector cancer and medical sales increased 1.8%. U.S. new annualized premium sales declined 4.4% to $318 million.
- Reported investment results swung from $156 million of realized gains to $46 million of losses, largely reflecting derivative valuation losses of $84 million versus gains of $92 million a year earlier. Other-than-temporary impairment losses were $3 million, down from $55 million.
- Unrealized investment gains in accumulated other comprehensive income rose to $1.944 billion from $1.035 billion at year-end; total comprehensive income was $1.602 billion, versus a loss of $172 million in Q1 2013.
- The company repurchased 6.5 million shares for $415 million in the open market and paid $163 million in cash dividends. Cash dividends per share were $0.37, versus $0.35.
Outlook, risks, and contingencies
- Management’s 2014 objective was 2%–5% growth in operating earnings per diluted share over 2013, excluding foreign currency translation. At average yen/dollar rates of 100–105, it indicated full-year operating EPS of $6.06–$6.40 and Q2 operating EPS of $1.54–$1.68.
- Management expected share repurchases to support EPS, while higher infrastructure spending in Japan and the U.S., Japan’s consumption tax increase from 5% to 8%, and a roughly $0.05-per-share reinsurance impact would weigh on results. It expected higher spending and benefit ratios as the year progressed.
- For 2014, management targeted Japan third-sector cancer and medical sales growth of 2%–7%, and U.S. new annualized premium sales ranging from flat to up 5%. Japan’s full-year pretax operating margin was expected to decline somewhat; U.S. operating ratios were expected to remain fairly stable.
- Key exposures include yen/dollar movements, interest-rate and credit-spread changes, investment impairments and downgrades, long-duration policy liabilities, financial-institution and perpetual-security concentrations, and the heavy reliance on Japan. A 100-basis-point rise in rates was estimated to reduce debt and perpetual-security fair value by $13.318 billion; management said it generally expects to hold securities until recovery or maturity.
- Management estimated statutory capital measures above 775% for Aflac’s risk-based capital ratio and above 750% for Aflac Japan’s solvency margin ratio; both estimates were preliminary. Profit transfers from Japan may be restricted if policyholder protection requires it.
- The company was defending lawsuits arising in the ordinary course and did not expect pending litigation to materially affect its financial position, results, or cash flows. It reported no material off-balance-sheet letters of credit, guarantees, or standby repurchase obligations. Reinsurance does not remove Aflac’s underlying obligation to policyholders if the reinsurer fails to pay.
Important facts for investors to verify
- How much of reported earnings movement reflects yen translation versus underlying yen-based operating trends, and whether operating EPS guidance remains achievable.
- Whether Japan’s sales mix, benefit ratios, repricing effects, and distribution partnerships support the stated sales and margin outlook.
- The composition, credit quality, valuation sensitivity, and impairment outlook for the investment portfolio, particularly Japan government debt, financial institutions, perpetual securities, and below-investment-grade holdings.
- Whether cash generation, statutory capital and solvency measures, and regulatory limits support planned dividends, repurchases, and future profit repatriation.
- The size and timing of planned buybacks, infrastructure expenditures, Japan’s consumption-tax effects, and the reinsurance-related earnings reduction.