Aflac Incorporated — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Aflac sells supplemental health and life insurance primarily in Japan and the United States. Japan represented 68% of six-month revenue and 85% of assets. KPMG reviewed the interim statements; this was a review, not an audit.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $5.511B | $5.589B | $11.168B | $11.054B |
| Net earnings | $817M | $832M | $1.745B | $1.550B |
| Diluted EPS | $1.09 | $1.07 | $2.32 | $1.98 |
| Pretax adjusted earnings, non-GAAP | $1.143B | $1.138B | $2.282B | $2.247B |
| Adjusted diluted EPS, non-GAAP | $1.13 | $1.07 | $2.25 | $2.12 |
Q2 GAAP revenue and net earnings declined year over year; the quarter included $66M of realized investment losses versus $3M of gains a year earlier. Six-month realized investment gains were $5M, compared with $131M of losses in 2018. Adjusted earnings exclude specified investment and other items; review the company’s reconciliation when comparing performance.
Six-month net premiums were $9.373B, down from $9.450B. Net investment income was $1.756B, up from $1.699B. Q2 net premiums were $4.681B versus $4.706B, while net investment income was $878M versus $862M.
Segment pretax adjusted margins were 21.9% for Japan in Q2 (21.8% prior year) and 20.6% for U.S. (21.1% prior year). Management expected Japan’s full-year 2019 pretax adjusted margin to remain stable. U.S. margin pressure reflected higher expenses, including investments in the U.S. platform, distribution and customer experience.
Cash flow, balance sheet and capital
- Six-month operating cash flow was $2.357B, down from $2.807B. Investing activities used $2.727B; financing activities used $978M.
- Cash and cash equivalents were $3.019B at June 30, versus $4.337B at year-end 2018. Total assets were $151.4B; total liabilities $123.2B; shareholders’ equity $28.2B.
- Notes payable and lease obligations totaled $6.231B, including $121M of operating lease liabilities. The company issued ¥30B of perpetual subordinated bonds in April. It reported compliance with debt covenants and no outstanding borrowings on listed credit facilities, although Aflac U.S. had $484M of FHLB borrowings.
- Six-month shareholder returns included $847M of share repurchases and $389M of cash dividends. Management planned $1.3B–$1.7B of 2019 repurchases, subject to stable capital conditions and absent compelling alternatives. The Q3 dividend was declared at $0.27 per share.
- The Parent Company held a $1.0B capital reserve and an additional $1.0B of contingent liquidity for derivative-related liquidity risk. Management described insurance cash flows as reasonably predictable and expected premiums and investments to fund claims and expenses.
Comparative trends, outlook and notable items
- Japan’s six-month net premiums declined, primarily as limited-pay savings policies reached paid-up status. Japan new annualized premium sales fell 12.4% in dollars for the first half; Q2 sales declined 17.9%. U.S. first-half sales were nearly flat, down 0.3%, and annualized premiums in force rose 2.3% to $6.2B.
- Japan reported favorable claims development of $303M for the first half, including approximately $198M from Japan; management cited continuing favorable claims trends. U.S. claims ratios also declined, but expense ratios increased.
- Management cited increased allocations to higher-yielding U.S.-dollar assets as supporting investment income and new-money yields. Japan’s portfolio book yield was 2.59%; its new-money yield was 3.50% for the first half. The company’s investment portfolio remains exposed to rates, credit, currency and equity markets.
- Japan Post Holdings’ trust began purchasing Aflac shares under an agreement targeting approximately 7% ownership, subject to regulatory approvals. Separately, Aflac disclosed news reports of improper sales practices at Japan Post Insurance, an affiliate; the impact on Aflac’s cancer sales was uncertain. Japan Post-affiliated agencies contributed 57.8% of Japan Q2 new annualized premium sales.
- After quarter-end, Aflac agreed to acquire Argus Holdings for $75M at closing plus up to $21M over three years based on performance, subject to approvals and other conditions.
- The company expects adoption of the long-duration insurance-contract accounting standard to have a significant impact, particularly from assumption updates and discount-rate changes. It planned to adopt the credit-loss standard on January 1, 2020 and was evaluating its impact.
- A shareholder derivative lawsuit, dismissed by a district court in 2018, remained on appeal. The company said it did not expect pending litigation to have a material adverse effect. It also reported normal-course lawsuits and various investment funding commitments.
Important facts for investors to verify
- How much of earnings growth reflects underlying adjusted operations versus realized investment results and foreign-exchange movements.
- Japan premium and sales trends as paid-up policies affect in-force premiums, and the potential effects of Japan Post-related developments on distribution.
- Investment portfolio credit and concentration exposure, including Japan government securities, below-investment-grade assets and loan commitments.
- Whether planned buybacks, dividends and parent-company liquidity remain consistent with regulatory capital needs and the Japan subsidiary’s dividend capacity.
- Potential financial and equity effects of upcoming insurance-contract and credit-loss accounting standards, and the completion terms and approvals for the Argus acquisition and Japan Post investment.