Aflac Incorporated — Q2 2014 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2014; comparisons are with Q2 and the first six months of 2013. Aflac sells supplemental health and life insurance in the U.S. and Japan. Japan represented 75% of first-half revenue and 85% of assets; results are materially affected by yen-dollar translation. KPMG reviewed the interim statements; this was not an audit.
Financial performance and position
- Q2 revenue: $5.84 billion, down 3.4%; net earnings were $810 million, down 8.9%, and diluted EPS was $1.78 versus $1.90.
- First-half revenue: $11.48 billion, down 6.3%; net earnings were $1.54 billion, down 13.4%, and diluted EPS was $3.38 versus $3.80.
- Operating earnings (company-defined, non-GAAP): Q2 was $757 million, or $1.66 per diluted share, versus $759 million and $1.62. First-half operating earnings were $1.53 billion, or $3.36 per diluted share, versus $1.55 billion and $3.31.
- Segment operating results: Q2 pretax operating earnings were $927 million in Japan (down from $940 million) and $300 million in the U.S. (up from $283 million). First-half figures were $1.86 billion in Japan (down from $1.93 billion) and $603 million in the U.S. (up from $564 million).
- Margins: Japan’s pretax operating margin was 21.7% in Q2 and 21.9% for the first half, versus 21.5% in both 2013 periods. U.S. margins were 20.3% and 20.6%, versus 19.5% in both comparable periods.
- Cash flow: First-half operating cash flow was $3.13 billion versus $5.70 billion; investing outflow was $3.59 billion versus $5.81 billion; financing inflow was $201 million versus $526 million. Cash and equivalents ended at $2.25 billion, down from $2.54 billion at year-end.
- Balance sheet and debt: Total assets were $127.9 billion and shareholders’ equity $17.6 billion at June 30, up from $121.3 billion and $14.6 billion at December 31. Notes payable were $4.93 billion, versus $4.90 billion. Policy liabilities were $95.4 billion, up from $89.4 billion.
- Capital returns: First-half dividends were $0.74 per share, up from $0.70. Aflac repurchased 8.1 million shares for $515 million and said it planned $1 billion of repurchases for 2014.
Material changes versus prior period
- Reported revenue and net income fell, with management citing a weaker yen: the first-half average exchange rate was 102.42 yen per dollar versus 95.60 in 2013. On a yen basis, Japan’s first-half pretax operating earnings rose 3.3%.
- Realized investment gains were lower: $102 million in Q2 versus $201 million, and $56 million in the first half versus $357 million. First-half 2014 results included $31 million of other-than-temporary impairment losses; Q2 included $28 million.
- First-half comprehensive income was $3.71 billion, compared with a $1.77 billion comprehensive loss in 2013, largely reflecting the reversal in unrealized investment gains and foreign currency translation.
- Japan new annualized premium sales fell 10.9% in Q2 and 38.7% for the first half in dollars; U.S. sales fell 8.2% and 6.4%, respectively.
Guidance, commentary, risks and unusual items
- Management expected 2014 operating EPS growth of 3%–4% excluding currency translation. At average yen-dollar rates of 100–105 for the rest of the year, it indicated full-year operating EPS of $6.16–$6.30. This is guidance, not a guarantee.
- Management cited share repurchases as a benefit, offset by infrastructure spending in Japan and the U.S., Japan’s consumption-tax increase from 5% to 8%, and an estimated $0.05 per-share operating earnings impact from the reinsurance agreement. It expected higher spending and benefit ratios in the second half.
- Japan’s third-sector medical and cancer sales grew 4.5% in Q2 and 3.2% in the first half, but management expected full-year growth near the low end of its 2%–7% range. It forecast 2014 U.S. new annualized premium sales down 4%–8%.
- The September 2013 Japan reinsurance transaction ceded 33.3% of benefits on a closed medical block. Remaining deferred profit liability was $637 million; reinsurance recoverable was $650 million. Aflac remains liable to policyholders if the reinsurer cannot perform.
- Key exposures include investment credit quality and valuation, interest rates, yen-dollar movements, Japan concentration, low reinvestment yields, and regulatory or healthcare changes. Management reported $1.28 billion of gross unrealized investment losses; it considered these generally temporary and said it believed issuers could meet obligations.
- At June 30, Aflac reported no borrowings under its 50-billion-yen revolving facility and compliance with debt covenants. Management estimated U.S. RBC and Japan solvency margin ratios each exceeded 800%; statutory figures were not yet finalized. The July 2014 maturity redemption of Samurai notes totaled approximately $335 million.
- Management said pending litigation was not expected to materially adversely affect financial position, results or cash flows. The filing reports effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- How much of the reported decline in U.S.-dollar results reflects yen translation versus underlying operating performance.
- Whether Japan and U.S. premium sales, especially Japan first-sector products and U.S. distribution, improve as management’s outlook assumes.
- Investment portfolio credit quality, impairment judgments, unrealized losses, and exposure to long-duration and financial-sector securities.
- Delivery of the operating EPS outlook after second-half spending, higher benefit ratios, reinsurance effects, and the Japan consumption-tax increase.
- Actual capital and solvency ratios when finalized, and the sustainability of planned buybacks, dividends, and liquidity after the July debt redemption.