Aflac Incorporated — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparisons are with Q1 2011 unless otherwise noted. Aflac sells supplemental health and life insurance in the U.S. and Japan; Japan generated 77% of consolidated revenue. Interim financial statements were reviewed by KPMG, not audited. Unless stated otherwise, amounts are in U.S. dollars.
Financial results and key metrics
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Total revenue | $6.240 billion | $5.117 billion |
| Premiums | $5.378 billion | $4.872 billion |
| Net investment income | $882 million | $794 million |
| Realized investment gains (losses) | ($45) million | ($579) million |
| Earnings before income taxes | $1.202 billion | $591 million |
| Net earnings | $785 million | $389 million |
| Diluted EPS | $1.68 | $0.83 |
| Pretax operating earnings, excluding realized investment gains/losses | $1.247 billion | $1.170 billion |
| Operating cash flow | $3.556 billion | $2.167 billion |
- Revenue rose 21.9% and net earnings approximately doubled. Management said the stronger yen increased reported results; the average yen/dollar rate was 79.59 versus 82.32.
- Q1 2012 realized losses included $203 million of other-than-temporary impairment charges, offset in part by $78 million of net gains on security sales/redemptions and $80 million of derivative gains. The prior-year period included $405 million of impairment losses and $144 million of net losses on sales/redemptions.
- Aflac Japan pretax operating earnings were $1.040 billion, up 6.8% in dollars and 3.2% in yen. Its pretax operating margin was 21.3%, versus 22.3%; its benefit ratio rose to 60.6% from 59.0%.
- Aflac U.S. pretax operating earnings were $271 million, up 8.1%. Its pretax operating margin was 19.6%, versus 19.1%; the benefit ratio was nearly unchanged at 49.0% versus 48.8%.
- Cash and cash equivalents were $2.210 billion at quarter-end, compared with $2.249 billion at year-end 2011. Total investments and cash were $103.104 billion. The filing describes insurance cash flows and liquidity as adequate to meet expected needs; conventional current-liability ratios are not provided.
- Notes payable were $3.964 billion, up from $3.285 billion at December 31, 2011. Debt-to-capitalization, excluding unrealized investment gains and losses, increased to 24.5% from 21.0%. Interest expense was $57 million versus $45 million.
- Total assets were $115.552 billion, total liabilities $101.909 billion, and shareholders’ equity $13.643 billion at March 31. The quarterly cash dividend was $0.33 per share, up from $0.30.
Material changes and unusual items
- In February, Aflac issued $750 million of senior notes: $400 million due 2017 at 2.65% and $350 million due 2022 at 4.00%. Cross-currency swaps convert these economically to yen obligations at stated rates of 1.22% and 2.07%. Proceeds were intended in part to redeem approximately $324 million of yen Samurai notes maturing in June 2012.
- The company retrospectively adopted revised insurance acquisition-cost accounting on January 1, 2012. Adoption reduced shareholders’ equity by $516 million as of December 31, 2010; the filing says prior-year net income impact was immaterial. Comparative figures were adjusted.
- Operating cash flow exceeded investing cash outflow; investing activity was driven largely by purchases of fixed-maturity securities. Financing cash flow included the new debt issuance. The company made no open-market share repurchases in the quarter.
- Japan annualized premium sales increased 53.8% in yen, led by bank-channel sales and the WAYS product. U.S. new annualized premium sales grew 4.5%; group insurance sales rose 38.4%.
Guidance, management commentary, and risks
- For full-year 2012, management raised its objective for diluted EPS growth to 3%–6% over restated 2011, excluding realized investment gains/losses and nonrecurring items and assuming no foreign-exchange translation impact. The filing’s scenario table indicates results vary materially with yen/dollar rates.
- Management expects 2013 earnings growth to improve over 2012 as portfolio de-risking and low investment yields are absorbed. It expects Japan full-year new annualized premium sales to increase 10%, revising its prior expectation of a decline; the U.S. target is 3%–8% sales growth.
- Low interest rates and portfolio de-risking are pressuring investment yields and margins. Japan’s new-money yields fell year over year, and management expects somewhat lower Japan margins from product mix, including stronger ordinary-life sales. U.S. sales remain exposed to weak consumer and small-business conditions.
- Investment risks include exposure to financial institutions, perpetual and subordinated securities, credit downgrades, interest rates, foreign exchange, and valuation assumptions. Banks and financial institutions represented 24% of the investment portfolio at fair value; European financial holdings and peripheral European issuer exposures were specifically discussed. Management reported $5.730 billion of direct funded exposure to Ireland, Italy, Portugal, and Spain at amortized cost, with no direct Greece exposure.
- Aflac Japan is a substantial geographic concentration. Japan’s revised solvency-margin calculation reduced its reported ratio from 985.8% under the former method to 547.3% under the new method; management said its relative industry position was not materially changed. U.S. statutory RBC was estimated at 500%–540%.
- Management said pending ordinary-course litigation was not expected to materially adversely affect financial position, results, or cash flows. No material off-balance-sheet guarantees or standby obligations were reported. KPMG’s interim review found no material modifications necessary, but expressed no audit opinion. Management reported disclosure controls were effective and no material first-quarter change in internal control; a new SAP reporting system was implemented in April for use beginning Q2.
Important facts for investors to verify
- How much of the earnings increase reflects underlying insurance operations versus yen translation and the substantially smaller realized investment loss?
- Whether the 2012 EPS objective is achieved under the stated exchange-rate assumptions, and how much subsequent yen movement affects reported results.
- Credit quality, impairment judgments, liquidity, and potential downgrade exposure within European financial, utility, and perpetual-security holdings.
- Whether Japan premium growth, especially bank-channel WAYS sales, can be sustained without further pressure on profit margins.
- Execution of the June 2012 Samurai-note redemption, debt levels, investment yields, and the effect of continued low rates on asset-liability spreads.
- Any material developments in litigation, Japanese regulatory requirements, postal reform, or the SAP system implementation.