Aflac Incorporated — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless otherwise noted. Aflac sells supplemental health and life insurance in the United States and Japan. Japan generated 75% of company revenue and represented 86% of assets. The interim statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $6.208 billion | $6.240 billion | Down 0.5% |
| Net investment income | $833 million | $882 million | Down 5.6% |
| Net realized investment gains (losses) | $156 million | $(45) million | Improved $201 million |
| Net earnings | $892 million | $785 million | Up 13.6% |
| Diluted EPS | $1.90 | $1.68 | Up 13.1% |
| Operating earnings, non-GAAP | $790 million | $814 million | Down 3.0% |
| Operating EPS, non-GAAP | $1.69 | $1.74 | Down 2.9% |
| Operating cash flow | $3.832 billion | $3.556 billion | Up $276 million |
Net earnings included $156 million of pretax realized investment gains, including $92 million of derivative and other gains, $119 million of gains from sales and redemptions, and $55 million of other-than-temporary impairment losses. The company’s non-GAAP operating earnings exclude realized investment gains and losses and nonrecurring items.
Consolidated pretax margin was approximately 21.9%, versus 19.3% a year earlier; net margin was approximately 14.4%, versus 12.6%. These comparisons reflect the swing in realized investment results. Japan’s pretax operating earnings were $989 million, down 4.8% in dollars but up 10.7% in yen; U.S. pretax operating earnings were $281 million, up 3.6%.
Balance sheet, liquidity and capital
- At March 31, total assets were $120.538 billion, total liabilities $105.003 billion and shareholders’ equity $15.535 billion. Assets declined from $131.094 billion at year-end 2012, primarily reflecting yen translation effects and changes in the investment portfolio.
- Cash and cash equivalents were $2.596 billion, up from $2.041 billion at December 31. Total investments and cash were $107.400 billion.
- Notes payable were $4.283 billion, down from $4.352 billion. Debt to total capitalization, excluding unrealized investment and derivative gains and losses, was 24.0%, versus 24.5% at year-end.
- Policy liabilities totaled $92.951 billion, down from $97.720 billion, with Japan liabilities down 5.5% in reported dollars but up 2.7% in yen.
- The company had no borrowings under its new 50 billion yen, five-year revolving credit facility at quarter-end and reported compliance with debt and credit-facility covenants.
- Operating cash flow was partly supported by a $2.4 billion increase in policy liabilities. Investing activities used $3.085 billion; financing activities used $156 million. Cash flow should be interpreted in light of insurance-reserve movements and investment transactions.
Material changes and management commentary
- The yen weakened: the quarter-average rate was 92.59 yen per dollar versus 79.59 a year earlier, reducing reported dollar results from Japan. The quarter-end rate was 94.05, versus 86.58 at year-end 2012.
- Japan premiums declined 5.9% in dollars but increased 9.8% in yen. Japan new annualized premium sales rose 2.6% in yen, while U.S. sales fell 5.2% to $332 million. Annualized premiums in force grew 10.1% in yen in Japan and 3.6% in the U.S.
- Other comprehensive income was a loss of $1.064 billion after tax, versus income of $35 million in Q1 2012, mainly reflecting unrealized investment-security losses and foreign-currency translation. Total comprehensive income was a loss of $172 million.
- Aflac changed its valuation methodology for certain privately issued securities, engaging a third-party pricing vendor and moving securities from Level 3 to Level 2 where inputs became more observable. Management said the revised method increased reported unrealized losses; it also implemented additional valuation controls.
- The company repurchased 3.0 million shares in the open market for approximately $150 million and paid $159 million in cash dividends. Management planned $400 million to $600 million of share repurchases for 2013. The quarterly dividend was $0.35 per share.
Outlook, risks and contingencies
- Management’s 2013 objective was 4% to 7% growth in operating EPS excluding foreign-currency translation. At an assumed average rate of 95–100 yen per dollar, it projected full-year operating EPS of $5.99–$6.37 and Q2 operating EPS of $1.41–$1.56.
- Aflac Japan expected 2013 cancer and medical product sales to be flat to up 5%. Aflac U.S. targeted new annualized premium sales through traditional and broker channels of flat to up 5%; management described near-term U.S. sales conditions as cautious.
- Management cited low investment yields as a headwind to earnings and described difficult comparisons with stronger-than-expected 2012 results. Japan’s first-sector life products were repriced in April 2013 following a reduction in the regulatory standard interest rate.
- Key risks include Japan concentration and yen movements; investment credit, interest-rate, liquidity and valuation risks; exposure to perpetual securities and European issuers; claims and reserving experience; regulatory changes; and operational, litigation and catastrophic-event risks.
- The company reported no material off-balance-sheet guarantees or similar arrangements and believed pending ordinary-course litigation would not materially affect financial position, results or cash flows.
- After quarter-end, Aflac sold or agreed to sell impaired CSAV and Bankia investments and expected total gains of $64 million. It also added currency hedges, bringing expected July 2013 yen profit repatriation covered by contracts to 50 billion yen.
Important facts for investors to verify
- How much of the reported earnings increase came from realized investment gains and derivative valuation, versus underlying insurance operations.
- Whether operating EPS, Japan and U.S. sales, and margins track management’s 2013 objectives, considering exchange-rate assumptions.
- The effects of the new private-security valuation methodology on fair values, unrealized losses, impairment judgments and reported equity.
- Credit quality and concentration in Japanese government bonds, financial institutions, perpetual securities and below-investment-grade holdings, including the European exposures.
- Whether liquidity, statutory capital and regulatory solvency remain adequate under adverse yen, interest-rate and credit scenarios; the filing’s reported Japan solvency ratio of 669.1% was as of December 31, 2012.