Aflac Incorporated — Q3 2014 Form 10-Q
Business context and period. Aflac sells supplemental health and life insurance in the United States and Japan. This unaudited quarterly report covers the three and nine months ended September 30, 2014, compared with the same 2013 periods. Japan represented 74% of nine-month revenue and 85% of assets. KPMG reviewed the interim statements; this was not an audit.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $5.736 billion | $5.886 billion | $17.214 billion | $18.138 billion |
| Net earnings | $706 million | $702 million | $2.248 billion | $2.483 billion |
| Diluted EPS | $1.56 | $1.50 | $4.93 | $5.31 |
| Operating earnings, non-GAAP | $685 million | $687 million | $2.216 billion | $2.236 billion |
| Operating EPS, non-GAAP | $1.51 | $1.47 | $4.86 | $4.78 |
- Q3 revenue declined about 2.5% year over year, while net earnings rose about 0.6%; nine-month revenue fell about 5.1% and net earnings about 9.5%. Nine-month diluted EPS declined about 7.2%.
- Net premiums were $4.841 billion in Q3 and $14.583 billion for nine months. Net investment income was $841 million and $2.511 billion, respectively. Q3 benefits and claims were $3.355 billion; nine-month benefits and claims were $9.868 billion.
- Operating earnings exclude realized investment gains and losses, nonrecurring items and other non-operating income or loss. Nine-month GAAP results included $72 million of realized investment gains, versus $379 million in 2013, including $31 million of other-than-temporary impairment losses.
- Segment pretax operating earnings: Japan $828 million in Q3 and $2.688 billion year to date; U.S. $269 million and $872 million, respectively. Japan’s nine-month pretax operating margin was 21.1%, versus 20.7% in 2013; U.S. was 19.8%, versus 19.2%.
Financial position, cash flow and capital
- At September 30, total assets were $127.253 billion, total liabilities $109.400 billion and shareholders’ equity $17.853 billion. Assets rose from $121.307 billion at year-end 2013; equity rose from $14.620 billion.
- Investments and cash totaled $114.691 billion, including $2.666 billion in cash and cash equivalents. Notes payable were $4.558 billion, down from $4.897 billion at December 31, 2013. Policy liabilities totaled $90.200 billion.
- Nine-month operating cash flow was $4.577 billion, down from $7.159 billion in 2013; investing cash outflow was $4.144 billion versus $7.521 billion. Financing cash outflow was $322 million, compared with $1.133 billion of inflow. Cash increased $123 million to $2.666 billion.
- The company repurchased 11.1 million shares for approximately $690 million in the first nine months and paid $486 million in cash dividends. Cash returned through dividends and repurchases totaled $1.2 billion. Q3 dividends were $0.37 per share.
- Aflac reported no borrowings on its 50 billion yen revolving facility and compliance with debt and credit-facility covenants. Management estimated statutory risk-based capital above 775% for Aflac and Japan solvency margin above 750%; final statutory results were not yet complete.
Changes, outlook and management commentary
- The yen weakened: the Q3 average yen/dollar rate was 103.92 versus 98.93 a year earlier, and the nine-month average was 102.89 versus 96.61. Management attributed much of the reported dollar revenue and earnings decline to translation. In yen, Japan nine-month pretax operating earnings increased 3.1%.
- Japan nine-month new annualized premium sales fell 30.3% in yen; Q3 sales fell 20.8%. Management cited weak first-sector sales and the prior-year reinsurance transaction. It expected 2014 third-sector cancer and medical sales growth toward the low end of its 2%–7% expectation.
- U.S. nine-month new annualized premium sales fell 4.5%; management’s revised full-year expectation was a 2%–4% decline. U.S. premium income grew 1.1% in the first nine months.
- Management maintained 2014 operating EPS growth guidance of 3%–4% excluding currency translation. At yen/dollar rates of 105–110 for the remainder of 2014, it projected full-year operating EPS of $6.14–$6.23 and Q4 of $1.28–$1.37. Its 2015 objective was 2%–7% currency-neutral operating EPS growth. Spending on infrastructure and U.S. sales-force repositioning, Japan’s consumption-tax increase, and the reinsurance treaty were identified as pressures; the treaty was expected to reduce 2014 operating EPS by about $0.05.
- Management raised its 2014 share-repurchase objective to $1.2 billion and stated a current plan to repurchase $1.3 billion in 2015. The board declared a Q4 dividend of $0.39 per share, a 5.4% increase year over year.
- After quarter-end, Aflac ceded an additional 16.7% of a closed Japan medical block, entered into additional yen forwards, and established a $100 million uncommitted credit line. On October 20, it sold $1.4 billion of U.S. Treasuries, realizing a $46 million gain.
Risks, contingencies and unusual items
- Key exposures include yen exchange rates, interest rates, credit downgrades/defaults, investment valuation and impairment judgments, low investment yields, concentration in Japan, and policyholder experience differing from assumptions. A 100-basis-point rise in market rates was estimated to reduce the fair value of debt and perpetual securities by $13.206 billion; management said it generally intends and is able to hold securities through recovery or maturity.
- Investment concentration includes Japan government securities and financial institutions; banks and financial institutions were 14% of debt and perpetual securities at amortized cost. The portfolio also has perpetual securities subject to possible payment deferrals or regulatory actions. The filing reported $1.186 billion of gross unrealized losses, which management generally attributed to market rates, currency and spreads.
- Reinsurance does not release Aflac from obligations to policyholders if the reinsurer fails. The company had $593 million of deferred profit liability and $608 million of related reinsurance recoverable at September 30. Ordinary-course lawsuits were not expected by management to materially affect financial position, results or cash flows; ultimate outcomes remain uncertain.
- Management cited uncertainty around U.S. health-care reform and Japan regulation, as well as operational, cybersecurity, litigation and catastrophe risks. No material off-balance-sheet letters of credit, guarantees or standby repurchase obligations were reported.
Most important facts for investors to verify
- How much of reported performance reflects yen translation versus underlying yen-denominated business trends, particularly Japan sales and premiums.
- Whether the 2014 and 2015 operating EPS outlooks are achieved, including the stated currency assumptions, higher spending and reinsurance impact.
- Investment portfolio credit quality, unrealized losses, financial-institution and Japan concentration, and the sensitivity of fair values and capital to rates and currency.
- Cash-flow sustainability and capital-return plans alongside debt maturities, dividend capacity, and the final statutory RBC and Japan solvency-margin results.
- Performance and collectability of the ceded Japan block reinsurance and the effect of the additional post-quarter-end cession.