Aflac Incorporated — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Aflac sells supplemental health and life insurance primarily in Japan and the United States. Unless noted otherwise, amounts are U.S. dollars.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $5.665 billion | $5.536 billion | $16.234 billion | $16.704 billion |
| Pretax earnings | $1.153 billion | $1.036 billion | $2.942 billion | $3.388 billion |
| Net earnings | $2.456 billion | $777 million | $3.826 billion | $2.523 billion |
| Diluted EPS | $3.44 | $1.04 | $5.31 | $3.37 |
| Net premiums | $4.623 billion | $4.736 billion | $13.969 billion | $14.109 billion |
| Net investment income | $896 million | $936 million | $2.669 billion | $2.692 billion |
| Net investment gains (losses) | $108 million | $(153) million | $(525) million | $(147) million |
- Q3 net earnings included a $1.4 billion one-time tax benefit, principally from releasing valuation allowances on deferred foreign tax credits after new U.S. tax regulations. The unusual benefit drove reported earnings well above pretax earnings. Management said the tax rate in future periods is expected to be approximately 20%, subject to tax-law changes.
- Excluding specified investment and other items, adjusted earnings were $994 million, or $1.39 per diluted share, in Q3, up from $863 million, or $1.16, a year earlier. Nine-month adjusted earnings were $2.797 billion, or $3.88 per diluted share, versus $2.558 billion, or $3.41.
- Q3 pretax adjusted earnings were $747 million for Aflac Japan (down 10.9%) and $329 million for Aflac U.S. (down 1.8%). Nine-month results were $2.442 billion for Japan (down 2.5%) and $1.082 billion for the U.S. (up 8.6%).
- Q3 pretax adjusted profit margins were 19.4% for Japan and 20.5% for the U.S.; nine-month margins were 21.3% and 21.9%, respectively. Japan’s quarterly margin declined from 21.4% a year earlier; the U.S. margin was broadly stable against 20.6%.
Cash flow, balance sheet and capital
- Nine-month operating cash flow was $4.601 billion, compared with $4.263 billion in 2019. Investing activities used $3.511 billion; financing activities used $431 million. Cash and cash equivalents rose to $5.563 billion from $4.896 billion at year-end 2019.
- At September 30, total assets were $160.955 billion and shareholders’ equity was $32.479 billion, up from $152.768 billion and $28.959 billion, respectively, at December 31, 2019. Equity included $9.520 billion of unrealized gains on fixed-maturity securities.
- Notes payable and lease obligations were $7.825 billion, versus $6.569 billion at year-end. The company issued $1.0 billion of U.S. senior notes and ¥57.0 billion of yen senior notes during 2020, and redeemed $350 million of senior notes. It reported compliance with debt and credit-facility covenants and no defaults.
- Aflac reported $1.0 billion and ¥100 billion of available unsecured revolving credit capacity, with no borrowings under those facilities. It also raised its internal FHLB borrowing limit to $800 million, subject to collateral and other conditions. Management cited a $2.0 billion minimum holding-company cash target and said leverage remained adequate for current ratings.
- The company repurchased 26.1 million shares for $1.0 billion during the first nine months and paid $580 million in cash dividends. The board authorized an additional 100 million shares for repurchase; 110.9 million shares remained authorized at quarter-end. The October-declared quarterly dividend was $0.28 per share.
Material changes and management commentary
- Revenue declined 2.8% for the first nine months, primarily reflecting larger net investment losses. Q3 revenue increased 2.3%, while premiums declined in both periods. The Q3 net investment gain included a $142 million reduction in estimated credit-loss allowances; nine-month investment losses included $179 million of credit losses and $183 million of derivative and foreign-currency losses.
- COVID-19 significantly curtailed in-person insurance sales. Q3 new annualized premium sales fell 32.0% in Japan and 35.7% in the U.S.; nine-month U.S. sales declined 32.7%. Management reported that Japan’s face-to-face sales remained challenged and that the Japan Post investigation continued to weigh on that channel.
- Lower U.S. claims activity amid social distancing reduced the U.S. benefit ratio for the nine-month period. Management cautioned that the Q3 U.S. benefit ratio rose from Q2 and could be returning toward historical levels. Japan experienced favorable prior-year claims development of $408 million for the nine months, while higher persistency and policy-benefit reserves affected its benefit ratio.
- Management expected 2020 Aflac U.S. earned premiums to be flat to down 3% versus 2019, given reduced sales and persistency pressures. It did not provide a clear consolidated earnings or revenue forecast in the supplied filing text.
- Management continued investment-portfolio de-risking, citing uncertainty about the recovery and exposure in travel, lodging, leisure, non-emergency medical and energy sectors. Lower interest rates and reinvestment yields may pressure future investment income. Japan’s foreign-currency collar program was reduced by approximately $3 billion to $9 billion and marginally widened; further hedging adjustments and costs remain possible.
- The company adopted expected-credit-loss accounting effective January 1, 2020, reducing opening retained earnings by $56 million net of tax. It also reclassified $6.9 billion of securities from held-to-maturity to available-for-sale, recording an $848 million after-tax unrealized gain in accumulated other comprehensive income.
- Subsequent events: Aflac agreed to invest approximately $200 million in Trupanion and entered an alliance to sell pet insurance; about $60 million closed in October. Aflac U.S. contributed $100 million to its pension plan in October. A voluntary separation program is expected to result in an approximately $45 million Q4 2020 charge.
Risks, contingencies and outlook
- The effects of COVID-19 on sales, claims, persistency, economic conditions, investment credit quality, liquidity and capital remain uncertain. Premium grace periods could increase future lapse rates as they expire.
- Aflac Japan represented 68% of nine-month revenue and 83% of assets, leaving the company exposed to Japan concentration and yen/dollar movements. Regulatory capital measures are sensitive to market volatility, credit downgrades and defaults.
- Investment risks include lower reinvestment yields, credit deterioration, concentrated exposures and valuation uncertainty. Commercial mortgage, transitional real estate and below-investment-grade middle-market lending warrant attention; COVID-related loan modifications were reported as immaterial at quarter-end.
- The company has approximately $2.3 billion of middle-market loan commitments, including a new external-manager agreement, and $1.5 billion of commitments to alternative investments. Commitments are subject to underwriting, availability or other conditions.
- Pending lawsuits are described as arising in the ordinary course; management does not expect them to have a material adverse effect. The filing also identifies Japan Post-related matters, cybersecurity, regulatory, tax, foreign exchange and policy-liability estimation risks.
- The long-duration insurance accounting standard is expected to have a significant impact on financial position, results and disclosures. The filing describes a proposed additional deferral that would make Aflac’s expected effective date January 1, 2023; finalization was still pending.
Investor verification priorities
- Separate recurring operating performance from the $1.4 billion tax benefit; verify the adjusted-earnings reconciliation and the expected future tax rate.
- Track new sales, persistency and earned premiums in both segments, including recovery in Japan Post distribution and the impact of U.S. premium grace-period expirations.
- Assess whether lower claims frequency reverses, and monitor Japan benefit ratios and the durability of favorable prior-year claims development.
- Review investment credit quality, allowance changes, loan commitments and exposures to vulnerable sectors, alongside the effect of lower rates on investment income.
- Monitor liquidity, subsidiary dividends, capital ratios, debt issuance and share repurchases as pandemic conditions and currency markets evolve.