Aflac Incorporated — FY2014 Form 10-K
Reporting period: Year ended December 31, 2014. This is an annual filing, not a standalone fourth-quarter report. Aflac sells supplemental health and life insurance in the United States and Japan; Japan generated 72% of 2014 revenue and represented 82% of year-end assets. The financial statements are prepared under U.S. GAAP.
Financial results and liquidity
| Metric | 2014 | 2013 | Change / context |
|---|---|---|---|
| Total revenue | $22.728 billion | $23.939 billion | Down 5.1%, significantly affected by yen depreciation |
| Net premiums | $19.072 billion | $20.135 billion | Down 5.3% |
| Net investment income | $3.319 billion | $3.293 billion | Up slightly; low new-money yields remain a constraint |
| Realized investment gains | $215 million | $399 million | Lower year over year; 2014 included $31 million of impairment losses |
| Pretax earnings | $4.491 billion | $4.816 billion | Down 6.8% |
| Net earnings | $2.951 billion | $3.158 billion | Down 6.6%; diluted EPS was $6.50 versus $6.76 |
| Operating earnings (non-GAAP) | $2.797 billion | $2.887 billion | Diluted operating EPS was $6.16 versus $6.18; excluding currency translation, operating EPS increased 3.9% |
| Operating cash flow | $6.550 billion | $10.547 billion | Down 37.9%, primarily reflecting lower Japan cash receipts from discounted advance premiums as WAYS sales declined |
| Cash and cash equivalents | $4.658 billion | $2.543 billion | Year-end balance increased |
| Total assets / shareholders’ equity | $119.767 billion / $18.347 billion | $121.307 billion / $14.620 billion | Equity increased, including higher unrealized investment gains |
| Notes payable | $5.282 billion | $4.897 billion | Includes $750 million of senior notes issued in November |
Cash dividends were $1.50 per share for 2014, up from $1.42. The company repurchased 19.7 million shares for $1.21 billion. It reported $4.7 billion of net unrealized gains on investment securities and derivatives in shareholders’ equity at year-end, versus $1.0 billion a year earlier. The audited financial statements received an unqualified opinion, and management and the auditor reported effective internal control over financial reporting.
Segments and operating trends
- Aflac Japan: Pretax operating earnings were $3.458 billion, down 4.7% in reported dollars, while increasing 3.1% in yen. Yen-denominated annualized premiums in force rose 1.7%; new annualized premium sales fell 23.3% in yen. Third-sector cancer and medical sales increased 6.1%; first-sector sales fell 47.3%. The benefit ratio improved, and the pretax operating margin was 20.9% in yen.
- Aflac U.S.: Pretax operating earnings rose 3.3% to $1.073 billion. Premium income increased 1.1%, new annualized premium sales increased 0.7%, and the pretax operating margin improved to 18.3%. Management attributed the improvement in the benefit ratio to lower benefit-reserve growth from new product designs.
Material changes versus the prior year
- The yen weakened 7.5% on a weighted-average basis and 12.6% at year-end versus 2013. This reduced reported Japan revenue and earnings in dollars and lowered reported balance-sheet amounts.
- Consolidated annualized premiums in force declined to $18.894 billion from $20.440 billion, including a $1.897 billion foreign-currency translation reduction. In Japan, premiums in force increased in yen despite declining in dollars.
- Japan profit repatriations to Aflac U.S. rose to $1.704 billion from $771 million. The company began increasing the frequency of transfers in the fourth quarter to manage cash flows.
- Aflac Japan entered an additional quota-share reinsurance arrangement in the fourth quarter, ceding part of hospital benefits on a closed block and releasing approximately 55 billion yen of Japanese regulatory reserves. Earlier 2013 and 2014 transactions on the block generated a deferred profit liability of $820 million at year-end 2014, to be amortized over the policies’ expected lives.
- The company issued $750 million of 3.625% senior notes due 2024 and economically converted the principal and interest into yen obligations through cross-currency swaps. It redeemed approximately $335 million of Samurai notes at maturity.
- Year-end Japanese solvency margin ratio increased to 857% from 777%; Aflac’s U.S. company-action-level risk-based capital ratio was 945%.
Outlook, risks and unusual items
- 2015 earnings outlook: Management targeted 2%–7% growth in operating EPS over 2014, excluding currency translation. At the 2014 average exchange rate of 105.46 yen per dollar, the filing’s scenario table showed operating EPS of $6.29–$6.59; at 115 yen per dollar, $6.01–$6.31. These are objectives, not guarantees.
- Sales outlook: Aflac U.S. targeted 3%–7% growth in new annualized premium sales, with a 5% target. Japan expected first-sector sales to remain lower and aimed to focus on third-sector products; management anticipated average third-sector sales growth of 15% in the first nine months, with difficult comparisons in the fourth quarter.
- Management expected Japan’s pretax operating margin to be comparable with 2013–2014 levels and U.S. benefit and expense ratios to be relatively stable. It cautioned that low interest rates, lower investment cash flows, and potential changes in benefit ratios could affect results.
- Key exposures: Japan concentration, yen/dollar movements, low investment yields, interest-rate and credit-spread changes, and credit deterioration in investment holdings. Japan government bonds were $37.0 billion, or 38.9% of the $95.1 billion debt and perpetual-securities portfolio at amortized cost; a rating agency downgraded JGBs during 2014. The portfolio also included $2.4 billion of perpetual securities.
- Derivative positions create counterparty, rollover and collateral risks. Derivative liabilities were $2.423 billion at year-end; the company reported $1.6 billion of collateral posted and estimated up to $482 million of additional collateral could be required if specified credit-related triggers occurred.
- Other risks include policy-claim and reserve assumptions, investment impairment judgments, regulatory change, competition, technology and cybersecurity, and restrictions on transfers from regulated subsidiaries. Management did not expect pending ordinary-course litigation to materially adversely affect results; no material off-balance-sheet guarantees or similar arrangements were reported.
- Subsequent to year-end, Aflac announced expanded allocations to bank loans, high-yield corporate bonds and middle-market loans. The planned increases were approximately $750 million, $500 million and $300 million, respectively; only portions had been funded by the filing date.
Important facts for investors to verify
- How much of reported revenue, earnings and book-value movement reflects yen translation versus underlying yen-denominated operating performance?
- Whether Japan’s third-sector sales growth and Japan Post distribution expansion offset continuing weakness in first-sector and bank-channel sales.
- Whether operating cash flow and Japan profit repatriations remain sufficient to support policy obligations, dividends, buybacks and parent-company debt service.
- The credit quality, valuation and liquidity of the JGB-heavy investment portfolio, including perpetual securities, private placements and newly expanded loan and high-yield allocations.
- Whether investment yields and claims experience support reserve adequacy and the 2015 operating EPS and sales objectives; these targets are management expectations, not assurances.
- The effects of reinsurance on regulatory capital, future earnings recognition and Aflac Japan’s solvency margin ratio, as well as the potential collateral and hedge-rollover demands from derivatives.