Aflac Incorporated — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Aflac sells supplemental health and life insurance primarily in Japan and the United States. KPMG reviewed the interim financial statements; this was not an audit. KPMG reported no material modifications were needed for conformity with U.S. GAAP.
Financial performance
Unless otherwise noted, amounts are U.S. dollars; financial statement amounts are in millions.
- Third quarter: Revenue was $5,716, versus $5,040 in 2015; net earnings were $629, versus $567; diluted EPS was $1.53, versus $1.32. Net premiums rose to $5,022 from $4,380, and net investment income was $842 versus $784.
- Nine months: Revenue was $16,604, versus $15,553; net earnings were $1,908, versus $1,803; diluted EPS was $4.59, versus $4.14. Net premiums were $14,447 versus $13,176, and net investment income was $2,465 versus $2,343.
- Operating earnings (non-GAAP): $748, or $1.82 per diluted share, for Q3 versus $672, or $1.56, in 2015; nine-month operating earnings were $2,182, or $5.25 per diluted share, versus $2,001, or $4.60.
- Segment results: Aflac Japan pretax operating earnings were $882 in Q3 and $2,559 year to date, versus $789 and $2,365. Aflac U.S. earned $323 and $946, versus $286 and $864. Japan accounted for 74% of nine-month company revenue, including realized investment gains and losses.
- Margins and claims: Aflac Japan’s pretax operating margin was 20.7% in Q3 and 21.1% for nine months, versus 21.9% and 21.7%. Its benefit ratio was 61.0% and 60.5%. Aflac U.S.’s operating margin improved to 20.9% and 20.5%, versus 18.8% and 19.1%, as its benefit ratio declined to 46.4% and 46.5%.
- Cash flow: Nine-month operating cash flow was $4,120, compared with $4,770 in 2015; investing cash outflow was $2,638 versus $4,083, and financing cash outflow was $835 versus $1,826. Cash and cash equivalents increased $920 to $5,270.
- Balance sheet and debt: At September 30, total assets were $144,101, liabilities $121,316, and shareholders’ equity $22,785. Notes payable were $5,765, up from $4,971 at year-end 2015. Investments and cash totaled $128,935.
- Shareholder returns: Aflac repurchased 18.8 million shares for $1.2 billion in the first nine months and paid $492 million in cash dividends. Q3 dividends were $0.41 per share, up from $0.39 a year earlier.
Material changes and notable items
- A stronger yen materially increased reported dollar results: the Q3 weighted-average yen/dollar rate was 102.37 versus 122.15 a year earlier; the nine-month rate was 108.58 versus 120.81. Management cautions that translation affects reported growth, but views it as a financial-reporting rather than an economic event.
- Q3 2016 included $146 million of pretax realized investment losses, including $107 million of derivative and other losses. Nine-month realized losses were $260 million, including $278 million of derivative losses, partly offset by $87 million of net gains on sales and redemptions. Unrealized investment-security gains in equity were $6.1 billion, up from $3.0 billion at December 31, 2015.
- Japan’s annualized premiums in force increased 0.3% in yen to ¥1.62 trillion. Japan cancer and medical products were emphasized amid low interest rates; first-sector product sales fell sharply. U.S. new annualized premium sales were down 1.8% in Q3 year over year, and management said a particularly strong fourth quarter would be needed to reach its annual sales target.
- In September, Aflac issued $700 million of senior notes and entered into ¥30 billion of senior unsecured term loans. It also repaid ¥8.0 billion of Uridashi notes at maturity in September and ¥15.8 billion of Samurai notes in July. The company reported compliance with debt and credit-facility covenants and no outstanding borrowings under its revolving facilities at quarter-end.
- The 2015 comparative period included a $230 million pretax make-whole charge for early debt extinguishment ($150 million after tax); no comparable charge was reported for 2016.
Outlook, risks, and contingencies
- Management raised its 2016 operating EPS objective, excluding foreign-currency translation, to $6.40–$6.60 from $6.17–$6.41. At yen/dollar rates of 100–110, it indicated full-year operating EPS of approximately $6.75–$7.44 depending on the rate; the filing estimates Q4 operating EPS of $1.53–$1.82 under that exchange-rate scenario. These are non-GAAP objectives, with no GAAP equivalent provided.
- Management expected increased Q4 spending, particularly on promotions and IT. It expected Japan’s full-year pretax operating margin to be comparable with 2015 and U.S. benefit ratios to remain relatively stable, with expenses rising slightly.
- Key exposures include Japan business concentration, yen/dollar movements, interest rates, credit quality and investment valuation, and differences between actual claims experience and pricing/reserving assumptions. A 100-basis-point rise in Japan and U.S. rates was estimated to reduce the fair value of debt and perpetual securities by $15.3 billion at September 30, 2016; management said it generally expects to hold securities through recovery or maturity.
- Management cited Brexit-related uncertainty and continued energy-sector volatility; 88% of oil-and-gas exposure was investment grade, down from 93% at year-end 2015. It did not expect the energy portfolio to have a material effect on results at that time.
- Pending ordinary-course litigation was not expected by management to materially affect financial position, results, or cash flows. The company also had $409 million of potential middle-market loan commitments and $185 million of commercial mortgage commitments, subject to underwriting and availability. A committed ¥110 billion reinsurance facility was available as a capital contingency plan; no treaty had been executed under it as of quarter-end.
Important facts for investors to verify
- How much of reported revenue, earnings, and balance-sheet growth reflects yen translation rather than underlying operating performance.
- Whether derivative-related investment losses and hedge costs persist, and how hedging results compare with the underlying exposures.
- Whether Japan and U.S. sales targets are achieved, particularly the required strong Q4 U.S. sales performance.
- How interest-rate, credit, and valuation risks affect investment marks, policy liabilities, and regulatory capital, including Japan’s solvency margin ratio.
- Whether loan commitments are funded and how the newer loan, equity, and high-yield investment programs perform relative to their risk and yield objectives.