Aflac Incorporated — Q3 2009 Form 10-Q
Business context and period. Aflac sells supplemental health and life insurance in the United States and Japan. This filing covers the quarter and nine months ended September 30, 2009; interim financial statements are unaudited and were reviewed, not audited, by KPMG. Japan generated 78% of nine-month revenue and represented 86% of assets.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Total revenue | $4.526B | $3.691B | $13.657B | $12.294B |
| Net earnings | $363M | $100M | $1.245B | $1.057B |
| Diluted EPS | $0.77 | $0.21 | $2.66 | $2.19 |
| Pretax operating earnings | $896M | $752M | $2.620B | $2.226B |
- Revenue and earnings: Premiums were $4.165B in Q3 and $12.274B year to date, versus $3.647B and $10.966B, respectively, in 2008. Net investment income also increased year to date to $2.048B from $1.901B.
- Investment losses: Realized investment losses were $347M in Q3 and $739M for nine months. Nine-month other-than-temporary impairment charges were $987M pretax ($642M after tax), compared with $380M pretax in 2008. These losses materially reduced reported earnings; pretax operating earnings exclude realized investment gains and losses.
- Segments and margins: Japan pretax operating earnings rose to $725M in Q3 and $2.086B year to date; U.S. earnings were $216M and $617M. Japan operating margin was 20.0% in Q3 and 19.5% year to date, versus 18.3% and 18.2% in 2008. U.S. margin was 17.5% and 16.7%, versus 16.9% and 16.3%.
- Cash flow: Nine-month operating cash flow was $4.403B, up from $3.648B. Investing activities used $3.887B; financing provided $346M, compared with $1.492B used in 2008. Cash and equivalents were $1.804B at September 30, versus $941M at year-end 2008.
- Balance sheet and debt: Total assets were $82.616B and shareholders’ equity $7.882B, compared with $79.331B and $6.639B at December 31, 2008. Notes payable increased to $2.231B from $1.721B; debt to total capitalization, excluding unrealized investment gains and losses, rose to 19.9% from 18.0%. The company reported compliance with debt covenants.
- Shareholder returns: Nine-month cash dividends were $393M, or $0.84 per share, up from $327M and $0.72 per share. The board declared a Q4 dividend of $0.28 per share. Management said share repurchases during 2009 were unlikely.
Material changes, outlook and risks
- Japan premiums and sales continued to grow: nine-month new annualized premium sales increased 3.7% in yen. U.S. new annualized premium sales fell 6.4% for nine months amid weak economic conditions; management expected no full-year U.S. sales growth.
- Management’s 2009 objective was 13%–15% growth in adjusted diluted EPS, excluding realized investment gains/losses, ASC 815 impacts and nonrecurring items. Assuming a 90–95 yen/dollar exchange rate in Q4, it forecast Q4 reported EPS of $1.08–$1.16 and full-year EPS of $4.75–$4.83. Its 2010 objective was 9%–12% adjusted EPS growth. These are objectives and exchange-rate-dependent estimates, not guarantees.
- Investment risk is significant: banks and financial institutions represented 39% of the investment portfolio at amortized cost. Below-investment-grade securities increased to 7.1% of debt and perpetual securities from 1.8% at year-end 2008. Gross unrealized losses on debt and perpetual securities were $5.583B. Management noted credit, market-liquidity, valuation, downgrade and potential payment-deferral risks, particularly for perpetual securities and financial institutions.
- Japan’s currency translation, investment yields, credit conditions, insurance claims and persistency may affect results. Management cited low investment yields as a constraint on margins and warned that U.S. health-care reform could affect its U.S. business, with effects not yet predictable.
- Aflac agreed to acquire Continental American Insurance Group for $100M; the acquisition closed in October 2009. Management did not expect pending ordinary-course litigation to have a material adverse effect. Aflac Japan remitted no profits to Aflac U.S. in the first nine months of 2009, compared with $598M in dollar remittances in 2008.
Important facts for investors to verify
- Whether the large investment impairment charges and below-investment-grade exposures lead to further losses, payment deferrals or capital needs.
- How much of reported earnings growth reflects core insurance operations versus investment marks, impairments, currency translation and other excluded items.
- Whether Japan’s sales, persistency and margins—and the weaker U.S. sales trend—track management’s outlook.
- Whether the stated EPS objectives are achieved under actual yen/dollar exchange rates and investment conditions.
- The effect of the CAIC acquisition, capital and dividend restrictions, and evolving U.S. health-care regulation.