AFL

Business Context and Reporting Period

Company: Aflac Incorporated
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Aflac is a general business holding company primarily engaged in supplemental health and life insurance. Operations are conducted through two main segments: Aflac Japan (a branch) and Aflac U.S. (subsidiary). Aflac Japan accounted for 72% of total revenues and 82% of total assets in 2006. The company markets individually underwritten policies primarily through independent agents at worksites.

Key Financial Metrics

Profitability Margins (Pretax Operating Earnings):

• Aflac Japan: 15.8% (2006) vs 14.5% (2005)
• Aflac U.S.: 14.5% (2006) vs 14.3% (2005)

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 1.8% to $14.6 billion, driven by a 2.7% increase in earned premiums. Aflac U.S. premiums grew 9.5%, while Aflac Japan premiums grew 0.2% (flat in yen terms).
• Net Earnings: Net earnings remained flat at $1.483 billion compared to 2005. This stability occurred despite a significant decline in realized investment gains (from $262 million in 2005 to $79 million in 2006) due to the conclusion of a bond-swap program.
• Foreign Currency Impact: The yen weakened slightly against the dollar (year-end rate 119.11 vs 118.07), resulting in a negative translation effect of approximately $41 million on net earnings.
• Investment Portfolio: Total investments and cash increased to $52.0 billion. The portfolio yield for Aflac Japan was 4.14% (down from 4.22%), while Aflac U.S. yield was 7.15% (down from 7.24%).
• Claims Experience: Aflac U.S. increased its unpaid policy claims liability by $28 million in Q4 2006 due to lengthened cancer outpatient treatment durations. Aflac Japan transferred $85 million from unpaid claims to future policy benefits due to declining hospital days.

Guidance, Outlook, and Risks

Management Outlook:

• 2007 EPS Guidance: Management targets a 15% to 16% increase in net earnings per diluted share over 2006, excluding realized investment gains/losses, SFAS 133 impacts, and foreign currency translation effects.
• Sales Outlook: Aflac U.S. expects new annualized premium sales growth of 6% to 10%. Aflac Japan anticipates a challenging sales environment with a decline in the first half of 2007 followed by modest increases in the second half.
• Dividends: The board declared a Q1 2007 cash dividend of $0.185 per share, payable March 1, 2007.

Key Risks and Contingencies:

• Foreign Currency Risk: Significant exposure to yen/dollar exchange rate fluctuations, which impacts reported financial results but is viewed as a reporting issue rather than an economic event.
• Interest Rate Risk: Low investment yields in Japan and the U.S. constrain investment income growth. Reinvestment of maturing securities at lower yields could negatively impact spreads.
• Regulatory Environment: Aflac Japan is subject to a mandatory review of past claims and cash surrender value payments by the Japanese Financial Services Agency (FSA). While errors found were immaterial, the process requires ongoing monitoring.
• Competition: Increased competition in Japan's deregulated market and potential entry of Japan Post into the insurance sector.

Investor Verification Checklist

• Japan Sales Trends: Verify the sustainability of Aflac Japan's sales decline (-8.8% in 2006) and the impact of the new "WAYS" life product on future growth.
• Investment Yield Spread: Monitor the spread between investment yields and required interest rates on policy reserves, particularly in Japan where yields are low.
• Claims Reserving: Review the impact of the $28 million increase in U.S. cancer claims reserves on future profitability.
• Regulatory Compliance: Track the outcome of the FSA's mandatory claims review in Japan and any potential future assessments.
• Dividend Repatriation: Confirm the ability to repatriate profits from Japan, which is subject to solvency margin requirements and FSA approval.