Aflac Incorporated — FY 2018 Form 10-K
Reporting period: Year ended December 31, 2018; comparisons are generally with FY 2017. This is an annual report, not a standalone fourth-quarter filing. Aflac sells supplemental health and life insurance primarily in Japan and the United States. Japan generated 70% of 2018 revenue and accounted for 84% of year-end assets.
Financial performance and position
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $21.758 billion | $21.667 billion |
| Net premiums | $18.677 billion | $18.531 billion |
| Net investment income | $3.442 billion | $3.220 billion |
| Realized investment losses | $430 million | $151 million |
| Pretax earnings | $3.983 billion | $4.018 billion |
| Net earnings / diluted EPS | $2.920 billion / $3.77 | $4.604 billion / $5.77 |
| Adjusted earnings / adjusted diluted EPS | $3.226 billion / $4.16 | $2.716 billion / $3.40 |
| Operating cash flow | $6.014 billion | $6.128 billion |
All amounts are U.S. dollars. Adjusted earnings are non-GAAP; the company excludes certain investment and other items. FY 2017 GAAP earnings included an estimated $1.9 billion benefit from U.S. tax reform, materially affecting the year-over-year comparison.
- Segment results: Aflac Japan pretax adjusted earnings were $3.208 billion, up from $3.054 billion; its pretax adjusted margin was 21.1%, versus 20.4%. Aflac U.S. pretax adjusted earnings were $1.285 billion, up from $1.245 billion; margin was 19.9%, versus 19.8%.
- Balance sheet at year-end: Assets were $140.406 billion, including $126.243 billion in investments and cash and $4.337 billion in cash and cash equivalents. Policy liabilities were $103.188 billion; notes payable were $5.778 billion; shareholders’ equity was $23.462 billion.
- Cash and capital allocation: Cash from operations exceeded cash used in investing and financing, and cash rose $846 million during the year. Aflac repurchased 28.9 million shares for $1.3 billion; cash dividends were $793 million, or $1.04 per share. The 2018 dividend per share rose 19.5% from 2017.
- Regulatory capital: Aflac Japan’s solvency margin ratio was 965%, down from 1,064%; its regulatory capital and surplus was $6.4 billion, versus $6.7 billion. Aflac’s U.S. company-action-level RBC ratio was 560%, compared with 831% in 2017; management noted that the 2018 figure included Japan for the first quarter and reflected the Japan-entity conversion.
Material changes versus the prior period
- Revenue increased 0.4%, while pretax earnings edged down. Net income fell principally because 2017 included the tax-reform benefit; 2018 also had larger realized investment losses.
- Realized investment losses included $81 million of impairment and loan-loss-reserve items, $234 million of net derivative and foreign-currency losses, and $131 million of equity-security losses. The equity-security accounting change took effect in 2018.
- Operating cash flow declined 1.9%. Cash and cash equivalents increased to $4.337 billion from $3.491 billion.
- Japan premiums were broadly flat in reported dollars, while annualized premiums in force declined 1.6% in yen, mainly as limited-pay policies became paid-up. U.S. annualized premiums in force increased 3.0%.
- Aflac Japan became a Japanese-incorporated subsidiary on April 1, 2018. The company reported the conversion as tax-neutral and said it did not materially change daily operations, but it affected dividend approvals, remittances, and regulatory capital measures.
- Other comprehensive income was a $2.103 billion loss, largely reflecting lower unrealized gains on fixed-maturity securities; year-end shareholders’ equity fell from $24.598 billion to $23.462 billion.
Outlook, commentary, risks and unusual items
For 2019, management targeted maintaining strong pretax margins through pricing discipline, stable investment returns, and investment in digital, technology, and distribution capabilities. It expected the Japan pretax adjusted margin to remain stable, but anticipated revenue challenges from run-off and paid-up savings products and a modest decline in net investment income. For the U.S., it expected strong margins and favorable benefit ratios, alongside higher expenses from platform investment and modestly lower investment income as capital is drawn down. The company planned $1.3–$1.7 billion in 2019 share repurchases, subject to stable capital conditions, and announced a 3.8% increase in its quarterly dividend.
- Management stated that Japan dividend payout was likely to be 80%–100% of FSA earnings. Aflac U.S. planned to reduce its RBC ratio toward the 500% range by the end of 2019. Both plans depend on regulatory capacity and capital conditions.
- Japan Post Holdings agreed to pursue a purchase of approximately 7% of Aflac’s outstanding shares through a voting trust, subject to regulatory approvals then expected in the second half of 2019. At December 31, 2018, the trust held no shares. The agreement restricts voting and ownership; Japan Post receives no board seat or management control.
- Key exposures include Japan concentration and JGB holdings, low Japanese interest rates, yen/dollar movements, hedge rollover costs and collateral needs, credit and market losses, and possible restrictions on subsidiary dividends. The unhedged U.S.-dollar portfolio in Japan was approximately $14.4 billion; the company disclosed cumulative net cash outflows of $3.9 billion since 2012 on currency derivatives hedging Japan dollar investments.
- The Japan branch-to-subsidiary conversion carries U.S. tax audit risk: the IRS could challenge its tax-free treatment despite a private letter ruling. The company also faces policy-claim and reserve-estimation risk, competition, cybersecurity and technology risks, regulation, litigation, and uncertainty around tax and health-care policy.
- New long-duration insurance accounting requirements, effective for Aflac after 2020, are expected to materially affect reported U.S. GAAP results, equity, and volatility; management did not expect an effect on regulatory capital or dividend capacity. The company also cited expected-credit-loss accounting changes for loans and held-to-maturity securities.
- A shareholder derivative lawsuit was dismissed in August 2018; plaintiffs appealed. Aflac said routine litigation was not expected to materially affect its financial position, earnings, or cash flows. KPMG issued an unqualified opinion on the consolidated financial statements, and management and the auditor concluded internal control over financial reporting was effective.
Fourth-quarter reference: Reported Q4 2018 revenue was $5.126 billion and net earnings were $525 million, compared with $5.424 billion and $2.584 billion, respectively, in Q4 2017. The prior-year quarter included the tax-reform benefit; quarterly results also reflected investment gains and losses.
Important facts for investors to verify
- Reconcile GAAP net income with adjusted earnings, especially the 2017 tax benefit and 2018 realized investment losses.
- Review investment portfolio quality, the concentration in Japan government securities, and sensitivity to interest rates, credit spreads, and yen exchange rates.
- Assess the cost, cash settlements, rollover exposure, and collateral demands of Japan’s currency hedging strategy, including the unhedged portfolio.
- Track Japan and U.S. regulatory capital, permitted subsidiary dividends, and progress toward the stated 2019 capital and payout objectives.
- Confirm regulatory approvals and implementation of the Japan Post strategic investment and any resulting sales or distribution effects.
- Monitor the adoption impact of long-duration insurance accounting and expected-credit-loss standards, as well as the IRS position on the Japan conversion.