Aflac Incorporated — Q1 2010 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2010, with comparisons to Q1 2009 unless noted. Aflac sells supplemental health and life insurance in the United States and Japan. Japan generated 74% of consolidated revenue and represented 85% of assets. KPMG reviewed the interim financial statements; this was not an audit.
Financial results and key metrics
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Total revenue | $5.065 billion | $4.818 billion; up 5.1% |
| Net earnings | $636 million | $569 million; up 11.8% |
| Diluted EPS | $1.35 | $1.22 |
| Pretax operating earnings | $1.020 billion | $869 million; up 17.4% |
| Realized investment losses | $46 million pretax | $9 million pretax |
| Operating cash flow | $1.278 billion | $1.649 billion |
- Premiums were $4.348 billion, up from $4.115 billion. Net investment income was $726 million, compared with $688 million.
- Benefits and claims were $2.857 billion; acquisition and operating expenses totaled $1.234 billion. Interest expense increased to $33 million from $8 million.
- Japan pretax operating earnings were $821 million, up from $681 million; its pretax operating margin was 21.4%, versus 19.0%. U.S. pretax operating earnings were $244 million, up from $204 million; its margin was 19.1%, versus 16.6%. The U.S. margin included a favorable effect from the termination of a large payroll account; excluding it, management reported a 16.0% margin.
- At March 31, cash and cash equivalents were $1.611 billion, down from $2.323 billion at year-end. Total assets were $85.178 billion; total liabilities were $76.191 billion and shareholders’ equity was $8.987 billion.
- Notes payable were $2.584 billion. Debt to total capitalization, excluding unrealized gains and losses on investments and derivatives, was 21.9%, versus 22.3% at year-end. The quarterly dividend was $0.28 per share.
- Investing activities used $1.969 billion; financing activities used $23 million. Cash declined by $712 million during the quarter.
Material changes and unusual items
- Results benefited from yen strength compared with Q1 2009; the average yen/dollar rate was 90.49, versus 93.37. Translation effects materially influence reported results.
- Investment impairment losses fell to $42 million pretax from $234 million. However, realized investment losses overall increased to $46 million, partly reflecting normal securities sales and newly consolidated VIE-related derivatives.
- Unrealized losses on available-for-sale debt and perpetual securities improved by $478 million during the quarter, primarily due to improved fair values. Total gross unrealized losses across investments were still $4.070 billion at March 31.
- New VIE accounting adopted January 1 required consolidation of certain entities and recognition of their underlying securities and derivatives. Adoption reduced shareholders’ equity by a cumulative after-tax $165 million; the filing says the change was applied prospectively.
- Subsequent to quarter-end, Greek financial institutions holding part of Aflac’s $1.3 billion Greek exposure were downgraded below investment grade. The exposure included $1.0 billion in Greek financial institutions and $280 million in Greek sovereign debt. Aflac stated it intended to hold the investments and recorded no impairment as of March 31.
Outlook, management commentary, and risks
- Management’s 2010 objective was 9%–12% growth in net earnings per diluted share, excluding realized investment gains and losses, ASC 815 effects, and nonrecurring items, and assuming no foreign-currency translation impact. If the yen averaged 90–95 per dollar, management expected reported Q2 diluted EPS of $1.33–$1.38.
- Japan’s 2010 new annualized premium sales objective was flat to up 5%. Q1 sales rose 10.0% in yen, supported by medical and ordinary-life products; cancer sales declined.
- Management expected U.S. sales to remain challenging, decline again in Q2, then increase modestly in the second half. It expected a modestly expanded U.S. profit margin for 2010 and relatively stable Japan operating expense ratios.
- Key risks include investment credit and valuation risk, concentrated exposure to banks and financial institutions, perpetual-security payment deferrals or impairment, yen/dollar movements, low reinvestment yields, Japan concentration, regulatory changes, and policyholder experience differing from assumptions. The filing notes that fair-value estimates rely partly on less observable inputs and management judgment.
- Aflac reported no material adverse effect expected from pending ordinary-course litigation. It reported effective disclosure controls and no material first-quarter change in internal control over financial reporting.
Investor facts to verify
- Track the Greek holdings after the post-quarter downgrades, including any later impairment, payment developments, or changes in management’s hold-to-recovery assessment.
- Assess the scale and credit quality of financial-sector and perpetual-security exposure; banks and financial institutions represented 36% of investment portfolio amortized cost including perpetual securities.
- Separate underlying operating growth from yen translation and investment-related gains, losses, and accounting effects when comparing results and assessing the 2010 EPS objective.
- Determine how much of the Q1 U.S. margin improvement came from the payroll-account termination and compare subsequent quarters with management’s normalized-margin expectation.
- Monitor cash generation, the July 2010 maturity of 39.4 billion yen of Samurai notes, and the company’s ability to maintain dividends and other capital uses.