Aflac Incorporated — 2009 Form 10-K
Business context and reporting period. This is an annual report for the year ended December 31, 2009, not a standalone fourth-quarter filing. Aflac sells supplemental health and life insurance in Japan and the United States. Japan generated 73% of 2009 revenue and represented 85% of year-end assets. The filing also presents unaudited quarterly results, including fourth-quarter 2009.
Financial performance and position
| Metric | 2009 | 2008 |
|---|---|---|
| Total revenue | $18.254 billion | $16.554 billion |
| Premium income | $16.621 billion | $14.947 billion |
| Net investment income | $2.765 billion | $2.578 billion |
| Realized investment gains (losses) | $(1.212) billion | $(1.007) billion |
| Pretax earnings | $2.235 billion | $1.914 billion |
| Net earnings | $1.497 billion | $1.254 billion |
| Diluted EPS | $3.19 | $2.62 |
| Operating cash flow | $6.161 billion | $4.965 billion |
| Total assets | $84.106 billion | $79.331 billion |
| Shareholders’ equity | $8.417 billion | $6.639 billion |
| Notes payable | $2.599 billion | $1.721 billion |
- Revenue increased 10.3%; net earnings rose 19.4%. Management said results benefited from yen strength. The reported net margin was approximately 8.2% of revenue.
- Net realized investment losses were $1.212 billion. Pretax other-than-temporary impairment losses recognized in earnings were $1.361 billion, partly offset by gains from sales and portfolio transactions.
- Japan pretax operating earnings rose 24.4% in dollars and 12.4% in yen; excluding currency effects on dollar-denominated items, yen operating earnings rose 15.1%. Japan’s pretax operating margin was 19.3%, versus 17.7% in 2008. U.S. pretax operating earnings rose 4.1% to $776 million, with a 15.7% operating margin versus 15.6%.
- Japan new annualized premium sales increased 6.7% in yen. U.S. sales fell 6.4%; annualized premiums in force nevertheless grew 3.5% in the U.S. and 3.3% in Japan in yen.
- Cash and cash equivalents were $2.323 billion, up from $941 million. Cash flow from operations increased 24%; investing activities used $5.476 billion and financing activities provided $699 million.
- Debt-to-capitalization, excluding unrealized investment gains and losses, increased to 22.3% from 18.0%. A $428 million equivalent Samurai note maturity was due in July 2010; management planned to repay it with existing cash.
Material changes and unusual items
- Aflac acquired Continental American Insurance Group, including CAIC, for $100 million in the fourth quarter. The acquisition added a voluntary group-products platform for broker and worksite distribution.
- The company issued $850 million of 10-year senior notes and $400 million of 30-year senior notes, and entered into yen-denominated loans totaling 15 billion yen. It suspended open-market share repurchases; 2009 treasury stock purchases were primarily for tax withholding.
- Japan profit remittances to Aflac U.S. fell to $230 million from $598 million as Aflac Japan retained more earnings to support its solvency margin. Japan’s solvency margin ratio was 885.5%; proposed regulatory methodology changes were expected to reduce reported industry ratios substantially.
- New consolidation rules effective January 1, 2010 were expected to bring $4.4 billion of former QSPE interests and $496 million of VIE interests onto the balance sheet. The estimated after-tax reduction in shareholders’ equity was $211 million.
Outlook, management commentary and risks
- Management’s 2010 objective was 9%–12% growth in diluted EPS, excluding realized investment gains and losses, ASC 815 effects, nonrecurring items and specified currency effects. At the 2009 average exchange rate of 93.49 yen per dollar, the filing estimated EPS of $5.29–$5.43. Results remain sensitive to exchange rates.
- Japan sales guidance was flat to up 5% in 2010. Management expected U.S. sales to remain challenging, with declines in the first half and modest increases in the second half. It expected Japan’s operating margin to continue expanding and U.S. benefit and expense ratios to decline.
- Major risks include investment credit deterioration and further impairments, especially in financial institutions and perpetual securities; valuation uncertainty and illiquidity; low yields and reinvestment risk; yen/dollar movements; and the company’s substantial concentration in Japan. Banks and financial institutions represented about 38% of debt and perpetual securities at amortized cost; perpetual securities totaled approximately $7.6 billion.
- Other risks include U.S. economic weakness affecting discretionary worksite insurance sales, changes to U.S. health and financial-services regulation, rating downgrades, restrictions on subsidiary dividends or Japan profit repatriations, and deviations from claims and reserve assumptions. Litigation was described as ordinary-course; management did not expect pending matters to materially affect financial position, results or cash flows.
- Ratings outlooks from S&P, Moody’s and A.M. Best were negative, although Aflac reported a 479% U.S. company-action-level RBC ratio. The filing states that operating cash flows and the investment portfolio are expected to meet benefit and expense needs.
- Fourth-quarter 2009 net earnings were $251 million, or $0.53 diluted EPS, compared with $197 million, or $0.42, in fourth-quarter 2008. Fourth-quarter revenue was $4.597 billion versus $4.260 billion.
Important facts for investors to verify
- Whether investment impairments, below-investment-grade exposures, and Level 3 valuation assumptions changed materially after year-end.
- How much of 2009 earnings growth reflects underlying operations versus yen translation, and whether 2010 EPS guidance assumptions remain achievable.
- Progress on repaying the July 2010 Samurai notes and the effect of higher debt and interest expense on parent-company liquidity.
- Whether Aflac Japan can sustain adequate solvency while supporting policyholders and future remittances, particularly under revised solvency calculations.
- Whether the CAIC acquisition and broker initiative improve U.S. sales, and whether U.S. sales recover as management expected.
- The realized balance-sheet and equity effects of the 2010 QSPE/VIE consolidation and any subsequent changes in accounting or impairment rules.