Aflac Incorporated — Q2 2009 Form 10-Q
Business context and period. Aflac sells supplemental health and life insurance in the U.S. and Japan. This filing covers the quarter and six months ended June 30, 2009; interim statements are unaudited and were reviewed by KPMG, not audited. Japan generated 77% of six-month revenue.
Financial results and position
- Second quarter: Revenue was $4.313 billion, down 0.5% year over year; net earnings were $314 million, down 35.0%; diluted EPS was $0.67 versus $1.00. Pretax operating earnings, which exclude realized investment gains and losses and certain other items, rose to $854 million from $746 million.
- First six months: Revenue was $9.131 billion, up 6.1%; net earnings were $882 million, down 7.8%; diluted EPS was $1.89 versus $1.98. Pretax operating earnings increased to $1.723 billion from $1.474 billion.
- Revenue and claims: Q2 premiums were $3.995 billion versus $3.684 billion; net investment income was $668 million versus $637 million. Benefits and claims were $2.723 billion versus $2.575 billion. Six-month premiums totaled $8.110 billion and investment income $1.356 billion.
- Significant investment losses: Realized investment losses were $383 million in Q2 and $392 million for the half, including other-than-temporary impairment charges of $385 million and $619 million, respectively. Six-month securities sales and redemptions generated $227 million of pretax gains, principally from bond swaps using tax loss carryforwards.
- Segments: Q2 Japan pretax operating earnings rose 18.6% to $679 million; U.S. earnings rose 4.0% to $198 million. Japan’s six-month earnings rose 20.7% to $1.361 billion; U.S. earnings rose 5.6% to $402 million. Japan’s Q2 benefit ratio improved to 60.4% from 61.9%; the U.S. ratio improved to 51.6% from 52.8%.
- Cash flow and liquidity: Six-month operating cash flow was $2.874 billion, investing cash use was $2.308 billion, and financing cash provided was $203 million. Cash and equivalents ended June at $1.689 billion, up from $941 million at year-end. Management stated expected premium and investment cash flows would meet benefit and expense needs.
- Balance sheet and debt: Total assets were $76.041 billion versus $79.331 billion at year-end; shareholders’ equity was $6.350 billion versus $6.639 billion. Notes payable were $1.992 billion versus $1.721 billion. Debt to capitalization, excluding unrealized investment gains and losses, was 19.0%, up from 18.0%. The filing reports a 459% U.S. company-action-level risk-based capital ratio; Japan’s solvency margin exceeded regulatory minimums.
- Investment marks: Available-for-sale securities had $3.441 billion of gross unrealized losses at June 30; net unrealized investment losses in shareholders’ equity were $2.126 billion, compared with $1.211 billion at year-end.
Changes versus comparable periods
- Reported earnings fell despite growth in premiums and investment income, principally because of the 2009 impairment charges. The company’s operating-earnings measure increased in both segments.
- Six-month operating cash flow rose 17% from 2008. Financing cash flow shifted from $841 million used in 2008 to $203 million provided in 2009, including the issuance of $850 million in 10-year senior notes and repayment at maturity of $450 million in senior notes.
- Below-investment-grade debt and perpetual securities increased to 6.5% of total debt and perpetual securities at amortized cost, from 1.8% at year-end. Banks and financial institutions represented 39% of investment portfolio amortized cost.
- U.S. new annualized premium sales declined 10.9% in Q2 and 6.0% for the half. Japan sales increased 12.9% in dollars in Q2; in yen, they increased 5.0%.
Outlook, commentary and risks
- Guidance: Aflac’s 2009 objective was 13%–15% growth in diluted EPS over 2008, excluding realized investment gains/losses, SFAS 133 effects and nonrecurring items, and assuming no foreign-currency translation impact. The filing’s scenario table gives adjusted EPS ranges of $4.51–$4.59 at the actual 2008 average exchange rate of ¥103.46 per dollar. The 2010 objective was 9%–12% growth on the same stated basis.
- Sales and margins: Management said Japan sales could be flat to up 5% for 2009, but the objective could change if Japan’s economy deteriorated further. It expected Japan’s operating margin expansion to hold through 2009 and the U.S. pretax operating margin to increase slightly, while acknowledging U.S. full-year positive sales growth would be difficult. Japan planned a revised EVER medical product for August 2009.
- Investment and market risks: Management cited global market and economic stress, issuer defaults and downgrades, valuation uncertainty, credit-spread and interest-rate movements, and risks in perpetual securities, including payment deferrals and nationalization. Fair-value estimates relied in part on management judgment amid reduced pricing data. A 100-basis-point rise in rates was estimated to reduce fair value of debt and perpetual securities by $6.486 billion.
- Currency and concentration: Yen translation affects reported results; the yen weakened 5.2% against the dollar between year-end and June 30. Japan accounted for most revenue and assets. The investment portfolio had significant financial-institution exposure, with geographic concentration in Europe and the U.K.
- Other developments: In July, Aflac borrowed ¥10 billion at 3.60% for six years. It also agreed to acquire Continental American Insurance Group for $100 million, funded internally, with closing expected in Q4 2009; management expected modest accretion to 2010 earnings after integration expenses. The company reported compliance with debt covenants and effective disclosure controls. It said ordinary-course litigation was not expected to have a material adverse effect.
Important facts for investors to verify
- How much of the 2009 impairment burden reflects credit deterioration versus market valuation, and whether further impairments or realized losses emerge.
- Credit quality, payment status and fair-value assumptions for bank, financial-institution and perpetual-security holdings; assess exposure to downgrades, coupon deferrals and issuer support measures.
- Whether Japan and U.S. sales, persistency, claims experience and margins track management’s stated expectations, including the effect of currency translation.
- Progress toward adjusted EPS objectives, and reconcile those objectives with GAAP results and the filing’s exclusions.
- Debt, liquidity, regulatory capital and restrictions on transferring funds from insurance subsidiaries to the parent; also verify the acquisition’s closing, integration costs and expected contribution.