AFLAC INC quarterly report, Q2 FY2017

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Aflac Incorporated — Q2 2017 Form 10-Q

Period: Three and six months ended June 30, 2017. Aflac sells supplemental health and life insurance in the U.S. and Japan; Japan generated 69% of first-half revenue and represented 84% of assets at quarter-end. Interim financial statements were reviewed by KPMG, not audited.

Financial performance

  • Q2 revenue: $5.428 billion, essentially unchanged from $5.437 billion a year earlier. Net premiums were $4.665 billion, down 3.3%; net investment income was $802 million, down 2.4%.
  • Q2 earnings: Pretax earnings were $1.045 billion versus $834 million; net earnings were $713 million versus $548 million. Diluted EPS was $1.79 versus $1.32. The improvement primarily reflected smaller derivative and foreign-currency losses.
  • First half: Revenue was $10.737 billion versus $10.888 billion; net earnings were $1.305 billion versus $1.279 billion; diluted EPS was $3.25 versus $3.06. Non-GAAP operating earnings were $1.406 billion ($3.50 per diluted share), versus $1.388 billion ($3.32).
  • Q2 non-GAAP operating earnings: $731 million, or $1.83 per diluted share, versus $683 million, or $1.65. Operating earnings exclude specified realized investment, derivative, foreign-currency and nonrecurring items; the company also revised its hedge-cost presentation.
  • Segment results, Q2: Japan pretax operating earnings were $791 million, down from $802 million; U.S. earnings were $330 million, up from $291 million. Pretax operating margins were 20.9% for Japan (19.9% prior year) and 21.0% for the U.S. (19.0%).
  • Cash flow, first half: Operating cash flow was $3.165 billion, investing outflow $2.517 billion, and financing outflow $1.231 billion. Cash declined $595 million to $4.264 billion.
  • Balance sheet and debt: Total assets were $135.394 billion and shareholders’ equity $21.503 billion at June 30. Notes payable were $5.252 billion, down from $5.360 billion at year-end 2016. Cash and investments totaled $121.896 billion. The filing reports compliance with debt covenants and no borrowings on its listed credit facilities.
  • Shareholder returns: First-half treasury-stock purchases were $813 million; cash dividends paid were $328 million. The quarterly dividend was $0.43 per share. Shares outstanding were approximately 396.0 million at June 30.

Changes and business trends

  • Japan first-half net premiums fell 2.5% in yen; Japan annualized premiums in force declined 3.3% in yen year over year. Japan new annualized premium sales fell 18.3% in Q2 in dollars and 16.0% in yen, reflecting sharply lower sales of interest-sensitive first-sector products. Third-sector sales rose 5.8% in yen in Q2.
  • U.S. Q2 new annualized premium sales increased 2.4%; annualized premiums in force grew 2.2% to $5.9 billion. Higher U.S. insurance and other expenses partly offset improved claims experience.
  • First-half favorable prior-year claims development was $260 million, primarily in Japan. Management cited shorter hospital stays and changes in cancer treatment as factors in favorable Japan claims trends.
  • Net realized investment losses were $56 million in Q2 versus $223 million in Q2 2016. First-half losses were $196 million versus $194 million. First-half derivative and foreign-currency losses were $176 million.
  • Net unrealized gains on investment securities in shareholders’ equity were $5.173 billion, compared with $4.805 billion at year-end. Three investments with $773 million amortized cost were reclassified from held-to-maturity to available-for-sale after credit downgrades; they had a $47 million unrealized gain at transfer.

Outlook, risks and unusual items

  • Management expected Japan’s 2017 pretax operating margin to be comparable to 2016. For the U.S., it expected the full-year benefit ratio to be stable to slightly lower than 2016 and expense ratios to rise marginally as it invested in its platform.
  • Management planned $1.3–$1.5 billion of 2017 share repurchases, assuming stable capital conditions and no compelling alternatives. It expected to repatriate 120–140 billion yen from Japan for the year, subject to capital conditions.
  • A $14 million after-tax charge was recognized in Q1 for estimated U.S. guaranty-fund assessments related to the Penn Treaty liquidation, net of expected premium-tax credits. Japan branch conversion costs were $14 million in the first half. The filing gives no consolidated full-year earnings or revenue guidance.
  • Key exposures include yen/dollar movements, interest rates, credit downgrades/defaults, investment valuation judgments, Japan concentration, insurance claims and reserving assumptions, regulatory changes, litigation, and information-technology and data-security risks. Aflac Japan’s solvency margin and ability to remit funds can be affected by market movements and regulatory limits.
  • Japan government bonds and related securities were a significant investment concentration: $55.723 billion fair value at June 30. The portfolio included 4.8% of securities at fair value rated BB or lower. Management considered reported unrealized losses generally temporary, but future credit deterioration could change that assessment.

Investor verification priorities

  1. Reconcile GAAP earnings growth with the narrower realized investment losses and compare it with non-GAAP operating earnings and its exclusions.
  2. Track Japan premium trends, product mix, sales through Japan Post and other distribution channels, and the sustainability of favorable claims development.
  3. Review yen exposure, hedging costs, Japan regulatory capital and solvency measures, and the assumptions underlying the 120–140 billion yen repatriation expectation.
  4. Assess credit quality and concentration in Japan government securities, below-investment-grade assets, loans and securities moved out of held-to-maturity status.
  5. Confirm the timing and execution of planned repurchases, dividend funding, and the impact of Penn Treaty assessments and Japan conversion costs.