Aflac Incorporated — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; balance-sheet comparisons are against December 31, 2010. Aflac sells supplemental health and life insurance in Japan and the United States. Japan generated 73% of first-half 2011 revenue and represented 87% of assets. KPMG reviewed the interim statements; this was not an audit.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $5.088B | $4.980B | $10.204B | $10.044B |
| Net earnings | $280M | $581M | $674M | $1.217B |
| Diluted EPS | $0.60 | $1.23 | $1.43 | $2.58 |
| Pretax operating earnings | $1.121B | $978M | $2.299B | $1.998B |
| Cash dividends per share | $0.30 | $0.28 | $0.60 | $0.56 |
- Q2 revenue rose 2.2%, but net earnings fell about 52% and diluted EPS fell about 51%. First-half revenue increased 1.6%, while net earnings fell about 45%.
- Results included realized investment losses of $668M pretax in Q2 and $1.247B pretax for the first half, versus $89M and $135M losses, respectively, in 2010. First-half other-than-temporary impairment losses were $933M, compared with $42M.
- Excluding realized investment gains and losses and other specified items, pretax operating earnings increased 15% in Q2 and 15% in the first half. Aflac Japan pretax operating earnings were $931M in Q2 and $1.911B for the first half; Aflac U.S. reported $246M and $499M, respectively.
- At June 30, total assets were $106.232B, total liabilities $94.251B, shareholders’ equity $11.981B, cash and equivalents $1.291B, and notes payable $3.048B. At year-end 2010, these were $101.039B, $89.983B, $11.056B, $2.121B, and $3.038B, respectively. The debt-to-total-capitalization ratio, excluding unrealized investment and derivative gains/losses, was 21.4%, versus 21.7%.
- First-half operating cash flow was $4.378B, investing cash flow was negative $5.034B, and financing cash flow was negative $175M; cash declined $830M. Cash flow includes substantial insurance-liability movements and investment activity.
- Investment securities totaled $90.456B at amortized cost. Bank and financial institution investments were 30% of debt and perpetual securities at amortized cost; below-investment-grade debt and perpetual securities were 5.3% of that portfolio.
Material changes and operating trends
- Stronger yen translation boosted reported results: the average yen/dollar rate was 81.54 in Q2 2011 versus 92.05 a year earlier. Aflac said currency translation affects reported U.S.-dollar results but is not itself an economic event for the company.
- Aflac Japan premiums rose 18.3% in dollars in Q2, but 5.1% in yen; first-half yen premium growth was 5.0%. Japan’s first-half pretax operating earnings grew 6.0% in yen. Japan new annualized premium sales rose 6.6% in yen in Q2 and 9.4% for the first half.
- Aflac U.S. Q2 premiums grew 3.4%; pretax operating earnings increased 8.3%. U.S. new annualized premium sales rose 5.9% in Q2 and 6.1% for the first half, reversing prior-period declines.
- Investment derisking drove significant sales, impairments, and realized losses. Aflac reported no direct investment exposure to Greece at June 30, only senior indebtedness in Ireland, and materially lower Portuguese exposure. It sold Greek holdings and certain Irish and Portuguese securities and recognized related losses and impairments.
- Unrealized investment gains reported in shareholders’ equity increased to $752M at June 30 from $33M at December 31, 2010; the filing’s broader MD&A measure including derivatives was $758M versus $64M.
Outlook, risks, and unusual items
- Guidance: The 2011 objective was 8% growth in diluted EPS excluding realized investment gains/losses, nonrecurring items, and foreign currency translation. Assuming an average yen/dollar rate of 80–85, management projected reported 2011 EPS of $6.09–$6.34 and Q3 EPS of $1.54–$1.60. For 2012, the objective was 2%–5% EPS growth on the same adjusted basis, assuming no further significant investment losses and no further material decline in interest rates.
- Aflac Japan raised its 2011 new annualized premium sales target from down 2% to up 3% to flat to up 5%. Aflac U.S. expected 2011 sales growth of flat to up 5%, while remaining cautious about the near-term environment.
- Management said Japan benefit and expense ratios and pretax operating margin were expected to remain relatively stable through 2011. In the U.S., it expected the benefit ratio to rise as healthcare utilization normalizes and expenses to increase with planned marketing and other investment.
- Japan earthquake and tsunami claims produced a net $12M first-quarter benefits expense after reserve releases and reinsurance, plus $8M of operating expenses. Management considered the initial claims provision adequate and said the disaster had not materially affected results or financial position to date; actual claims could differ.
- Important risks include credit deterioration and valuation uncertainty in investments, concentrated bank/financial exposure, perpetual-security payment or impairment risk, low investment yields and reinvestment spreads, yen fluctuations, and Aflac’s substantial Japan concentration. The filing also identifies Japanese disaster and economic risks, regulation, and U.S. sales sensitivity to weak consumer and small-business confidence.
- Management stated that it had sufficient excess cash flows to meet liquidity needs without selling investments before maturity. It reported compliance with debt covenants and no material off-balance-sheet letters of credit, guarantees, or standby repurchase obligations. Aflac planned to use existing cash to redeem 35 billion yen of Uridashi notes due September 2011.
- After quarter-end, Aflac issued 50 billion yen of Samurai notes in July 2011. The board declared a $0.30-per-share Q3 dividend. Management expected share repurchases to finish near the low end of its 6–12 million-share 2011 target.
Important facts for investors to verify
- How much of the large 2011 realized investment loss was one-time derisking versus continuing credit deterioration, and whether further impairments or sales were likely.
- Current credit quality, valuation assumptions, and loss exposure in the bank/financial, peripheral Eurozone, and perpetual-security portfolios; assess the significance of the $2.528B gross unrealized losses on debt and perpetual securities.
- Whether the 2011 and 2012 adjusted EPS objectives remain achievable under the stated currency, interest-rate, and investment-loss assumptions; distinguish those objectives from reported GAAP earnings.
- Whether strong Japan premium growth and sales-channel expansion translate into sustainable profits amid low yields, product-mix changes, and the effects of yen translation.
- Subsequent claims experience from the Japan earthquake and tsunami, and whether regulatory solvency calculations, remittances, or other restrictions affect capital available to the parent.
- Cash, operating cash flow, planned debt redemption, and capital returns after the quarter; the filing notes that interim cash flows and results are not necessarily indicative of full-year performance.