Aflac Incorporated — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Aflac primarily sells supplemental health and life insurance in the United States and Japan; Japan generated 75% of first-half revenue and represented 85% of assets at quarter-end. KPMG performed an interim review, not an audit, and reported no material modifications were needed.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Total revenue | $5.437B | $5.287B | $10.888B | $10.513B |
| Net earnings | $548M | $573M | $1.279B | $1.236B |
| Diluted EPS | $1.32 | $1.32 | $3.06 | $2.83 |
| Operating earnings (non-GAAP) | $707M | $651M | $1.433B | $1.329B |
| Operating EPS (non-GAAP) | $1.71 | $1.50 | $3.44 | $3.04 |
- Q2 net premiums were $4.823B, versus $4.364B; net investment income was $822M, versus $777M. Q2 benefits and claims were $3.254B, versus $2.937B.
- First-half net cash from operations was $2.854B (prior year $3.103B); investing cash use was $2.429B (prior year $3.566B); financing cash use was $1.281B (prior year $1.087B). Cash and equivalents ended at $3.700B, down from $4.350B at year-end 2015.
- At June 30, total assets were $141.287B, total liabilities $118.737B, and shareholders’ equity $22.550B. Notes payable were $5.009B, compared with $4.971B at year-end.
- Cash dividends were $0.41 per share in Q2. First-half repurchases totaled 16.0 million shares for $1.014B.
Changes and operating trends
- The yen strengthened: the Q2 average rate was 108.28 yen per dollar versus 121.20 a year earlier. Management said translation increased reported revenue; yen-based Japan operating results were more subdued.
- Q2 GAAP net earnings declined despite higher operating earnings. Reported results included $187M of pretax realized investment losses, including $33M of impairment losses and $167M of derivative and other losses. Q2 2015 included $127M of realized investment gains. First-half realized investment losses were $114M versus gains of $140M a year earlier.
- Aflac Japan first-half pretax operating earnings were $1.677B versus $1.576B; Aflac U.S. recorded $623M versus $578M. Japan’s yen-denominated first-half pretax operating earnings declined 0.9% year over year, while U.S. first-half pretax operating earnings increased 8.0%.
- Unrealized investment gains in accumulated other comprehensive income rose to $6.441B from $2.986B at year-end, substantially affecting reported equity and comprehensive income.
- The 2015 comparison included a $230M pretax debt make-whole payment for early extinguishment, recorded as a non-operating loss; this affected 2015 first-half earnings comparisons.
Outlook, risks and contingencies
- Management’s 2016 objective was stable operating EPS versus 2015. At the 2015 average exchange rate of 120.99 yen per dollar, its scenario range was $6.17–$6.41. For Q3, management expected approximately $1.58–$1.86 operating EPS if the yen averaged 100–110 per dollar.
- Management anticipated Japan’s 2016 pretax operating margin to be comparable with 2015. It expected second-half spending to rise, particularly for promotions and IT. Japan third-sector sales guidance was down 3% to up 2% for 2016; U.S. new annualized premium sales objective was growth of 3%–5%, with greater reliance on Q4 production.
- Japan’s new-money yield fell to 1.92% for the first half from 3.88%; management cited depressed yields and a front-loaded allocation to high-quality yen investments. U.S. first-half new-money yield was 4.16% versus 4.17%.
- Key exposures include Japan concentration, yen/dollar movements, low and negative Japanese interest rates, credit downgrades and defaults, investment valuation and impairment judgments, equity-market risk, and regulatory or operational risks. A 100-basis-point increase in U.S. and Japanese rates was estimated to reduce fair value of debt and perpetual securities by $15.806B; this is primarily an unrealized valuation sensitivity.
- Japan government and government-backed securities totaled $45.064B amortized cost, 40.87% of debt and perpetual securities. Oil-and-gas exposure was $7.230B fair value; 88% was investment grade, down from 93% at year-end.
- Management said litigation in the ordinary course was not expected to materially adversely affect results. A potential Penn Treaty guaranty-fund assessment was not accrued because timing and amount could not be estimated. Loan funding commitments were $72M for middle-market loans and $177M for commercial mortgages. Insurance reinsurance does not relieve Aflac of its policyholder obligations.
- Debt and credit covenants were in compliance, with no defaults reported. Revolving facilities and a committed reinsurance facility were described as capital contingency resources; the filing reported no borrowings under the listed revolving facilities at quarter-end.
Important facts for investors to verify
- Whether operating earnings and sales meet management’s full-year objectives, and the assumptions behind its currency scenarios.
- How much reported growth reflects yen translation versus underlying Japan and U.S. performance.
- Investment portfolio credit quality, especially Japan sovereign concentration, energy exposures, below-investment-grade loans and securities, and impairment trends.
- Effects of interest rates, currency hedging, and derivative valuation on earnings, OCI, capital, and liquidity.
- Capital adequacy and constraints on Japan profit repatriations, alongside planned repurchases, dividends, and future investment commitments.