FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" to
encourage companies to provide prospective information, so long as those
informational statements are identified as forward-looking and are accompanied
by meaningful cautionary statements identifying important factors that could
cause actual results to differ materially from those included in the
forward-looking statements. We desire to take advantage of these provisions.
This report contains cautionary statements identifying important factors that
could cause actual results to differ materially from those projected herein, and
in any other statements made by Company officials in communications with the
financial community and contained in documents filed with the Securities and
Exchange Commission (SEC). Forward-looking statements are not based on
historical information and relate to future operations, strategies, financial
results or other developments. Furthermore, forward-looking information is
subject to numerous assumptions, risks and uncertainties. In particular,
statements containing words such as "expect," "anticipate," "believe," "goal,"
"objective," "may," "should," "estimate," "intends," "projects," "will,"
"assumes," "potential," "target" or similar words as well as specific
projections of future results, generally qualify as forward-looking. Aflac
undertakes no obligation to update such forward-looking statements.
We caution readers that the following factors, in addition to other factors
mentioned from time to time, could cause actual results to differ materially
from those contemplated by the forward-looking statements:
• difficult conditions in global capital markets and the economy
• governmental actions for the purpose of stabilizing the financial markets
• defaults and credit downgrades of securities in our investment portfolio
• impairment of financial institutions
• credit and other risks associated with Aflac's investment in perpetual
securities
• differing judgments applied to investment valuations
• significant valuation judgments in determination of amount of impairments
taken on our investments
• limited availability of acceptable yen-denominated investments
• concentration of our investments in any particular single-issuer or sector
• concentration of business in Japan
• ongoing changes in our industry
• exposure to significant financial and capital markets risk
• fluctuations in foreign currency exchange rates
• significant changes in investment yield rates
• deviations in actual experience from pricing and reserving assumptions
• subsidiaries' ability to pay dividends to Aflac Incorporated
• changes in law or regulation by governmental authorities
• ability to attract and retain qualified sales associates and employees
• decreases in our financial strength or debt ratings
• ability to continue to develop and implement improvements in information
technology systems
• changes in U.S. and/or Japanese accounting standards
• failure to comply with restrictions on patient privacy and information
security
• level and outcome of litigation
• ability to effectively manage key executive succession
• impact of the recent earthquake and tsunami natural disaster and related
events at the nuclear plant in Japan and their aftermath
• catastrophic events including, but not necessarily limited to, tornadoes,
hurricanes, earthquakes, tsunamis, and damage incidental to such events
• failure of internal controls or corporate governance policies and procedures
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MD&A OVERVIEW
Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is intended to inform the reader about matters affecting the
financial condition and results of operations of Aflac Incorporated and its
subsidiaries for the three-month and six-month periods ended June 30, 2012 and
2011. Results of operations for interim periods are not necessarily indicative
of results for the entire year. As a result, the following discussion should be
read in conjunction with the consolidated financial statements and notes that
are included in our annual report to shareholders for the year ended
December 31, 2011. This MD&A is divided into the following sections:
• Our Business
• Performance Highlights
• Critical Accounting Estimates
• Results of Operations, consolidated and by segment
• Analysis of Financial Condition, including discussion of market risks of
financial instruments
• Capital Resources and Liquidity, including discussion of availability of
capital and the sources and uses of cash
OUR BUSINESS
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the
Company) primarily sell supplemental health and life insurance in the United
States and Japan. The Company's insurance business is marketed and administered
through American Family Life Assurance Company of Columbus (Aflac), which
operates in the United States (Aflac U.S.) and as a branch in Japan (AflacJapan). Most of Aflac's policies are individually underwritten and marketed
through independent agents. Aflac U.S. markets and administers group products
through Continental American Insurance Company (CAIC), branded as Aflac Group
Insurance. Our insurance operations in the United States and our branch in Japan
service the two markets for our insurance business.
PERFORMANCE HIGHLIGHTS
Results for the second quarter of 2012 benefited from the stronger yen/dollar
exchange rate. Total revenues rose 16.0% to $5.9 billion, compared with
$5.1 billion in the second quarter of 2011. Net earnings were $483 million, or
$1.03 per diluted share, compared with $274 million, or $.58 per diluted share,
in the second quarter of 2011.
Results for the first six months of 2012 also benefited from the stronger
yen/dollar exchange rate. Total revenues rose 19.0% to $12.1 billion, compared
with $10.2 billion in the first half of 2011. Net earnings were $1.3 billion, or
$2.71 per diluted share, compared with $663 million, or $1.41 per diluted share,
for the first six months of 2011.
Results in the second quarter of 2012 included pretax net realized investment
losses of $418 million ($272 million after-tax), compared with net realized
investment losses of $668 million ($453 million after-tax) in the second quarter
of 2011. Net investment losses in the second quarter of 2012 included $343
million ($223 million after-tax) of other-than-temporary impairment losses; $8
million of net losses ($5 million after-tax) from the sale or redemption of
securities; and $67 million of net losses ($44 million after-tax) from valuing
derivatives.
Results for the first six months of 2012 included pretax net realized investment
losses of $463 million ($301 million after-tax), compared with net realized
investment losses of $1.2 billion ($830 million after-tax) in the first six
months of 2011. Net investment losses in 2012 included $546 million ($355
million after-tax) of other-than-temporary impairment losses; $70 million of net
gains ($45 million after-tax) from the sale or redemption of securities; and $13
million of net gains ($9 million after-tax) from valuing derivatives.
Shareholders' equity included a net unrealized gain on investment securities and
derivatives of $1.5 billion at June 30, 2012 and $1.2 billion at December 31,
2011.
CRITICAL ACCOUNTING ESTIMATES
We prepare our financial statements in accordance with U.S. generally accepted
accounting principles (GAAP). These principles are established primarily by the
Financial Accounting Standards Board (FASB). In this MD&A, references to GAAP
issued by the FASB are derived from the FASB Accounting Standards Codification™
(ASC). The preparation of
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financial statements in conformity with GAAP requires us to make estimates based
on currently available information when recording transactions resulting from
business operations. The estimates that we deem to be most critical to an
understanding of Aflac's results of operations and financial condition are those
related to the valuation of investments and derivatives, deferred policy
acquisition costs (DAC), liabilities for future policy benefits and unpaid
policy claims, and income taxes. The preparation and evaluation of these
critical accounting estimates involve the use of various assumptions developed
from management's analyses and judgments. The application of these critical
accounting estimates determines the values at which 96% of our assets and 80% of
our liabilities are reported as of June 30, 2012, and thus has a direct effect
on net earnings and shareholders' equity. Subsequent experience or use of other
assumptions could produce significantly different results.
See Note 1 of the Notes to the Consolidated Financial Statements for information
on changes to the accounting policy for deferred policy acquisition costs, costs
associated with acquiring or renewing insurance contracts. There have been no
other changes in the items that we have identified as critical accounting
estimates during the six months ended June 30, 2012. For additional information,
see the Critical Accounting Estimates section of MD&A included in our annual
report to shareholders for the year ended December 31, 2011.
New Accounting Pronouncements
On January 1, 2012, we retrospectively adopted amended accounting guidance on
accounting for costs associated with acquiring or renewing insurance contracts,
or DAC. Under the previous guidance, we capitalized costs that varied with and
were primarily related to the acquisition of a policy. Under the amended
accounting guidance, only incremental direct costs associated with the
successful acquisition of new or renewal contracts may be capitalized, and
direct-response advertising costs may be capitalized under certain conditions.
As of December 31, 2010, approximately 70% of our unadjusted deferred
acquisition cost balance was related to compensation paid to third parties for
successful sales and was therefore still deferrable under the new rules. The
remaining 30% of the deferred acquisition costs balance was evaluated for
deferral under the amended accounting guidance. The retrospective adoption of
this accounting standard resulted in an after-tax cumulative reduction to
retained earnings of $408 million and an after-tax cumulative reduction to
unrealized foreign currency translation gains in accumulated other comprehensive
income of $108 million, resulting in a total reduction to shareholders' equity
of $516 million as of December 31, 2010. The adoption of this accounting
standard had an immaterial impact on net income in 2011 and for all preceding
years.
For additional information on new accounting pronouncements and the impact, if
any, on our financial position or results of operations, see Note 1 of the Notes
to the Consolidated Financial Statements.
RESULTS OF OPERATIONSThe following table is a presentation of items impacting net earnings and net
earnings per diluted share.
Items Impacting Net Earnings
In Millions Per Diluted Share In Millions Per Diluted Share
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011 2012 2011 2012 2011
Net earnings $ 483 $ 274 $ 1.03 $ .58 $ 1,268 $ 663 $ 2.71 $ 1.41
Items impacting
net earnings,
net of tax:
Realized
investment gains
(losses):
Securities
transactions
and impairments (228 ) (480 ) (.49 ) (1.03 ) (310 ) (838 ) (.66 ) (1.78 )
Impact of
derivative and
hedging activities (44 ) 27 (.09 ) .06 9 8 .02 .02
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
Realized Investment Gains and Losses
Our investment strategy is to invest in fixed-income securities to provide a
reliable stream of investment income, which is one of the drivers of the
Company's profitability. This investment strategy aligns our assets with our
liability structure, which our assets support. We do not purchase securities
with the intent of generating capital gains or losses.
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However, investment gains and losses may be realized as a result of changes in
the financial markets and the creditworthiness of specific issuers, tax planning
strategies, and/or general portfolio maintenance and rebalancing. The
realization of investment gains and losses is independent of the underwriting
and administration of our insurance products, which are the principal drivers of
our profitability.
Securities Transactions and Impairments
During the three-month period ended June 30, 2012, we realized pretax investment
losses, net of gains, of $8 million ($5 million after-tax) from sales and
redemptions of securities. These net losses primarily resulted from sales
related to our plan to reduce the risk exposure in our investment portfolio. We
realized pretax investment losses of $343 million ($223 million after-tax) as a
result of the recognition of other-than-temporary impairment losses, primarily
for certain securities issued by Spanish institutions and further impairments on
several securities that had previously been impaired in the fourth quarter 2011.
During the six-month period ended June 30, 2012, we realized pretax investment
gains, net of losses, of $70 million ($45 million after-tax) from sales and
redemptions of securities. These gains primarily resulted from both the
redemption of a previously impaired perpetual security and sales related to our
plan to reduce the risk exposure in our investment portfolio. We realized pretax
investment losses of $546 million ($355 million after-tax) as a result of the
recognition of other-than-temporary impairment losses, primarily impairments
recognized in the first quarter for two Tier I securities that were sold in the
second quarter of 2012 and certain impairments in the second quarter as
discussed above.
During the three- and six-month periods ended June 30, 2011, we realized pretax
investment losses of $528 million ($343 million after-tax) and $933 million
($607 million after-tax), respectively, as a result of the recognition of
other-than-temporary impairments on certain securities, and we realized pretax
investment losses, net of gains, of $182 million ($137 million after-tax) and
$326 million ($231 million after-tax), respectively, from the sale of securities
as a result of a plan to reduce the risk exposure in our investment portfolio.
We recorded a valuation allowance of $19 million in the second quarter of 2011
on the deferred tax asset for our realized investment losses, which is reflected
in the tax-effected realized investment losses for securities transactions
reported above.
See Note 3 of the Notes to Consolidated Financial Statements for a more detailed
discussion of these investment activities.
The following table details our pretax impairment losses by investment category.
Three Months Ended Six Months Ended
June 30, June 30,
(In millions) 2012 2011 2012 2011
Perpetual securities $ 76 $ 184 $ 216 $ 184
Corporate bonds 120 343 183 740
Mortgage- and asset-backed securities 3 1 3 7
Municipalities 0 0 0 1
Sovereign and supranational 144 0 144 0
Equity securities 0 0 0 1
Total other-than-temporary impairment
losses realized $ 343 (1) $ 528 (2) $ 546 (1) $ 933 (2)
(1)Includes $267 and $295 for the three- and six-month periods ended June 30,
2012, respectively, for credit-related
impairments and $76 and $251 for the three- and six-month periods ended June 30,
2012, respectively, from change in
intent to sell securities
(2) Consisted completely of credit-related impairments
Impact of Derivative and Hedging Activities
Our derivative activities include foreign currency, interest rate and credit
default swaps in variable interest entities that are consolidated,
cross-currency interest rate swaps associated with our senior notes due February
2017 and February 2022, and an interest rate swap associated with our variable
interest rate yen-denominated debt. We realized pretax investment losses, net of
gains, of $67 million ($44 million after-tax) for the three-month period ended
June 30, 2012, compared with pretax investment gains, net of losses, of $42
million ($27 million after-tax) for the same period in 2011, as a result of
valuing the swaps described above. During the six-month period ended June 30,
2012, we realized pretax investment gains, net of losses, of $13 million ($9
million after-tax), compared with pretax investment gains, net of losses, of $12
million ($8 million after-tax) for the same period in 2011, as a result of
valuing these swaps.
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For a description of other items that could be included in the Impact of
Derivative and Hedging Activities, see the Hedging Activities subsection of MD&A
and Note 4 of the accompanying Notes to the Consolidated Financial Statements.
For additional information regarding realized investment gains and losses, see
Notes 3 and 4 of the Notes to the Consolidated Financial Statements.
Foreign Currency Translation
Aflac Japan's premiums and most of its investment income are received in yen.
Claims and expenses are paid in yen, and we primarily purchase yen-denominated
assets to support yen-denominated policy liabilities. These and other
yen-denominated financial statement items are translated into dollars for
financial reporting purposes. We translate Aflac Japan's yen-denominated income
statement into dollars using an average exchange rate for the reporting period,
and we translate its yen-denominated balance sheet using the exchange rate at
the end of the period. However, it is important to distinguish between
translating and converting foreign currency. Except for a limited number of
transactions, we do not actually convert yen into dollars.
Due to the size of Aflac Japan, where our functional currency is the Japanese
yen, fluctuations in the yen/dollar exchange rate can have a significant effect
on our reported results. In periods when the yen weakens, translating yen into
dollars results in fewer dollars being reported. When the yen strengthens,
translating yen into dollars results in more dollars being reported.
Consequently, yen weakening has the effect of suppressing current period results
in relation to the comparable prior period, while yen strengthening has the
effect of magnifying current period results in relation to the comparable prior
period. As a result, we view foreign currency translation as a financial
reporting issue for Aflac and not an economic event to our Company or
shareholders. Because changes in exchange rates distort the growth rates of our
operations, management evaluates Aflac's financial performance excluding the
impact of foreign currency translation.
Income Taxes
Our combined U.S. and Japanese effective income tax rate on pretax earnings was
34.8% for the three-month period ended June 30, 2012, compared with 38.3% for
the same period in 2011. The decrease in the effective income tax rate was due
primarily to a $19 million valuation allowance recognized in the second quarter
of 2011 related to the deferred tax assets associated with realized investment
losses discussed above. Our combined U.S. and Japanese effective income tax rate
on pretax earnings for the six-month period ended June 30, 2012 was 34.7%,
compared with 36.0% for the same period in 2011.
Earnings Guidance
We communicate earnings guidance in this report based on the growth in net
earnings per diluted share. However, certain items that cannot be predicted or
that are outside of management's control may have a significant impact on actual
results. Therefore, our comparison of net earnings includes certain assumptions
to reflect the limitations that are inherent in projections of net earnings. In
comparing period-over-period results, we exclude the effect of realized
investment gains and losses (securities transactions, impairments, and the
impact of derivative and hedging activities) and nonrecurring items. We also
assume no impact from foreign currency translation on the Aflac Japan segment
and the Parent Company's yen-denominated interest expense for a given period in
relation to the prior period.
Subject to the preceding assumptions, our objective for 2012 is to increase net
earnings per diluted share in the range of 3% to 6% over 2011. If the yen
averages 80 for the full year, we believe that net earnings per diluted share
will be $6.45 to $6.52 for the year, which is toward the lower end of the range,
primarily due to the continued low level of investment yields. Using that same
exchange rate assumption, we would expect third quarter net earnings per diluted
share of $1.64 to $1.69. Based on our stated objective for 2012, the following
table shows the likely results for 2012 net earnings per diluted share,
including the impact of foreign currency translation using various yen/dollar
exchange rate scenarios.
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2012 Net Earnings Per Share (EPS) Scenarios(1)
Weighted-Average
Yen/Dollar Net Earnings Per % Growth Yen Impact
Exchange Rate Diluted Share Over 2011 on EPS
70.00 $7.06 - 7.25 12.6 - 15.6% $.60
75.00 6.73 - 6.92 7.3 - 10.4 .27
79.75(2) 6.46 - 6.65 3.0 - 6.1 .00
80.00 6.45 - 6.64 2.9 - 5.9 (.01)
85.00 6.21 - 6.40 (1.0) - 2.1 (.25)
(1)Excludes realized investment gains/losses (securities transactions,
impairments, and the impact of derivative and hedging activities) and
nonrecurring items in 2012 and 2011
(2)Actual 2011 weighted-average exchange rate
Our objective for 2013 is to increase net earnings per diluted share by 4% to 7%
over 2012, excluding the effect of realized investment gains and losses
(securities transactions, impairments, and the impact of derivative and hedging
activities), nonrecurring items, and foreign currency translation. This earnings
objective assumes no significant impact on investment income from realized
investment losses and no further material decline in interest rates.
INSURANCE OPERATIONS
Aflac's insurance business consists of two segments: Aflac Japan and Aflac U.S.
Aflac Japan, which operates as a branch of Aflac, is the principal contributor
to consolidated earnings. GAAP financial reporting requires that a company
report financial and descriptive information about operating segments in its
annual and interim period financial statements. Furthermore, we are required to
report a measure of segment profit or loss, certain revenue and expense items,
and segment assets.
We measure and evaluate our insurance segments' financial performance using
operating earnings on a pretax basis. We define segment operating earnings as
the profits we derive from our operations before realized investment gains and
losses (securities transactions, impairments, and the impact of derivative and
hedging activities) and nonrecurring items. We believe that an analysis of
segment pretax operating earnings is vitally important to an understanding of
the underlying profitability drivers and trends of our insurance business.
Furthermore, because a significant portion of our business is conducted in
Japan, we believe it is equally important to understand the impact of
translating Japanese yen into U.S. dollars.
We evaluate our sales efforts using new annualized premium sales, an industry
operating measure. New annualized premium sales, which include both new sales
and the incremental increase in premiums due to conversions, represent the
premiums that we would collect over a 12-month period, assuming the policies
remain in force. For Aflac Japan, new annualized premium sales are determined by
applications submitted during the reporting period. For Aflac U.S., new
annualized premium sales are determined by applications that are issued during
the reporting period. Premium income, or earned premiums, is a financial
performance measure that reflects collected or due premiums that have been
earned ratably on policies in force during the reporting period.
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AFLAC JAPAN SEGMENT
Aflac Japan Pretax Operating Earnings
Changes in Aflac Japan's pretax operating earnings and profit margins are
primarily affected by morbidity, mortality, expenses, persistency and investment
yields. The following table presents a summary of operating results for AflacJapan.
Aflac Japan Summary of Operating Results
Three Months Ended Six Months Ended
June 30, June 30,
(In millions) 2012 2011 2012 2011
Premium income $ 4,216 $ 3,770 $ 8,364 $ 7,472
Net investment income:
Yen-denominated investment income 473 434 946 866
Dollar-denominated investment income 218 202 475 419
Net investment income 691 636 1,421 1,285
Other income (loss) 0 5 16 25
Total operating revenues 4,907 4,411 9,801 8,782
Benefits and claims 3,044 2,633 6,011 5,213
Operating expenses:
Amortization of deferred policy acquisition costs 177 162 355 315
Insurance commissions 290 290 585 578
Insurance and other expenses 432 401 846 777
Total operating expenses 899 853 1,786 1,670
Total benefits and expenses 3,943 3,486 7,797 6,883
Pretax operating earnings(1) $ 964 $ 925 $ 2,004 $ 1,899
Weighted-average yen/dollar exchange rate 80.19 81.57 79.88 81.95
In Dollars In Yen
Three Months Six Months Three Months Six Months
Percentage change over Ended June 30, Ended June 30, Ended June 30, Ended June 30,
previous period: 2012 2011 2012 2011 2012 2011 2012 2011
Premium income 11.8 % 18.3 % 11.9 % 16.9 % 9.7 % 5.1 % 8.8 % 5.0 %
Net investment income 8.6 7.3 10.6 8.4 6.9 (5.0 ) 7.8 (2.8 )
Total operating revenues 11.2 16.8 11.6 15.5 9.2 3.7 8.5 3.7 Pretax operating earnings(1) 4.2 16.9 5.5 18.2 2.4 3.5 2.8 6.0
(1) See the Insurance Operations section of this MD&A for our definition of
segment operating expenses.
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
The percentage increases in premium income in yen reflect the growth of premiums
in force. Annualized premiums in force increased 10.8% to 1.42 trillion yen as
of June 30, 2012, compared with 1.29 trillion yen as of June 30, 2011. The
increase in annualized premiums in force in yen reflect the sales of new
policies combined with the high persistency of Aflac Japan's business.
Annualized premiums in force, translated into dollars at respective period-end
exchange rates, were $18.0 billion at June 30, 2012, compared with $15.9 billion
a year ago.
Aflac Japan maintains a portfolio of dollar-denominated and reverse-dual
currency securities (yen-denominated debt securities with dollar coupon
payments). Dollar-denominated investment income from these assets accounted for
approximately 34% of Aflac Japan's investment income in the first six months of
2012, compared with 33% a year ago. In periods when the yen strengthens in
relation to the dollar, translating Aflac Japan's dollar-denominated investment
income into yen lowers growth rates for net investment income, total operating
revenues, and pretax operating earnings in yen terms. In periods when the yen
weakens, translating dollar-denominated investment income into yen magnifies
growth rates for net investment income, total operating revenues, and pretax
operating earnings in yen terms. Excluding foreign currency changes from the
prior period, dollar-denominated investment income accounted for approximately
34% of Aflac Japan's investment income during the first six months of 2012,
compared with 35% a year ago.
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The following table illustrates the effect of translating Aflac Japan's
dollar-denominated investment income and related items into yen by comparing
certain segment results with those that would have been reported had yen/dollar
exchange rates remained unchanged from the comparable period in the prior year.
Aflac Japan Percentage Changes Over Previous Period
(Yen Operating Results)
For the Periods Ended June 30,
Including Foreign Excluding Foreign
Currency Changes Currency Changes(2)
Three Months Six Months Three Months Six Months
2012 2011 2012 2011 2012 2011 2012 2011
Net investment income 6.9 % (5.0 )% 7.8 % (2.8 )% 7.4 % (.9 )% 8.6 % .9 %
Total operating revenues 9.2 3.7 8.5 3.7 9.6 4.5 8.7 4.3
Pretax operating earnings(1) 2.4 3.5 2.8 6.0 3.0
7.1 3.2 8.5
(1) See the Insurance Operations section of this MD&A for our definition of
segment operating earnings.
(2) Amounts excluding foreign currency changes on dollar-denominated items were
determined using the same yen/dollar exchange rate for the current period as the
comparable period in the prior year.
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
The following table presents a summary of operating ratios for Aflac Japan.
Three Months Ended Six Months Ended
June 30, June 30,
Ratios to total revenues: 2012 2011 2012 2011
Benefits and claims 62.0 % 59.7 % 61.3 % 59.4 %
Operating expenses:
Amortization of deferred policy
acquisition costs 3.6 3.7 3.6 3.6
Insurance commissions 5.9 6.6 6.0 6.6
Insurance and other expenses 8.9 9.1 8.6 8.8
Total operating expenses 18.4 19.4 18.2 19.0
Pretax operating earnings(1) 19.6 20.9 20.5 21.6
(1) See the Insurance Operations section of this MD&A for our definition of
segment operating earnings.
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
Aflac Japan's financial results for the first quarter of 2011 reflected a
provision of 3.0 billion yen, or $37 million, for claims related to the
earthquake and tsunami that occurred in Japan on March 11, 2011. These claims
were offset by reserve releases and reinsurance of 2.0 billion yen, or $25
million, resulting in a net income statement impact of 1.0 billion yen, or $12
million, in 2011. The financial results also reflected .7 billion yen, or $8
million, of operating expenses in the first quarter of 2011 resulting from the
earthquake and tsunami. Based on our claims experience to date and our claims
estimates, we believe that our initial provision is adequate. The natural
disaster and its related events have not had a material impact on our financial
position or results of operations.
In the past several years, the benefit ratio for our health products has been
positively impacted by favorable claim trends, primarily in our cancer product
line. We expect this downward claim trend to continue. However, for several
years, the rate of decline in Aflac Japan's benefit ratio has moderated, due
primarily to strong sales results in our ordinary products, including WAYS and
child endowment. These products have higher benefit ratios and lower expense
ratios than our health products. The benefit ratio has also been impacted by the
effect of low investment yields and portfolio derisking, both of which impact
our profit margin by reducing the spread between investment yields and required
interest on policy reserves. In the three- and six- month periods ended June 30,
2012, the benefit ratio increased and the operating expense ratio decreased,
resulting in a lower pretax operating profit margin, compared with the same
respective periods in 2011. For the full year of 2012, we expect to achieve our
profit objectives through better-than-average premium growth associated with the
life products and somewhat lower profit margins due to the change in business
mix discussed above.
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Aflac Japan Sales
Aflac Japan's second quarter 2012 production set a new annualized premium sales
record for the fourth consecutive quarter. Aflac Japan's new annualized premium
sales exceeded our expectations in the second quarter of 2012 and increased
47.4% in yen, compared with the same period in 2011. The following table
presents Aflac Japan's new annualized premium sales for the periods ended
June 30.
In Dollars In Yen
Three Months Six Months Three Months Six Months
(In millions of dollars and
billions of yen) 2012 2011 2012 2011 2012 2011 2012 2011
New annualized premium sales $ 664 $ 442 $ 1,323 $ 856 53.2 36.1 105.6 70.2
Increase (decrease) over
comparable period
in prior year 50.1 % 20.1 % 54.5 % 22.0 % 47.4 % 6.6 % 50.5 % 9.4 %
The following table details the contributions to new annualized premium sales by
major insurance product for the periods ended June 30.
Three Months Six Months
2012 2011 2012 2011
Medical 17 % 25 % 17 % 26 %
Cancer 14 24 13 21
Ordinary life:
Child endowment 12 17 13 20
WAYS 45 19 45 18
Other ordinary life 8 11 8 11
Other 4 4 4 4
Total 100 % 100 % 100 % 100 %
The bank channel generated new annualized premium sales of 24.7 billion yen in
the second quarter of 2012, an increase of 224.2% over the second quarter of
2011. Bank channel sales accounted for 46% of new annualized premium sales for
Aflac Japan in the second quarter of 2012, compared with 21% during the same
period a year ago. WAYS, a unique hybrid whole-life product that we first
introduced in 2006 and introduced to the bank channel in 2009, has been a
significant contributor to bank sales growth. The average premium for WAYS sold
through the bank channel, the primary distribution outlet for this product, is
about ten times the average premium for cancer and medical products, making it a
strong contributor to revenue growth. The profit margin on WAYS is lower than
our health insurance products, however the profit margin is significantly
enhanced when policyholders elect to pay premiums upfront using the "discounted
advance premium" option. More than 90% of customers at banks choose this payment
option. We are employing strategies to enhance the profitability of our WAYS
product. Sales of WAYS were 24.1 billion yen during the second quarter of 2012,
an increase of 258.7% over the second quarter of 2011.
The foundation of Aflac Japan's product portfolio has been, and continues to be,
our cancer and medical products. Cancer insurance sales decreased 19.0% during
the second quarter of 2012, compared with the same period a year ago, reflecting
a difficult comparison to prior year sales which had benefited from the
favorable consumer response to our new base cancer policy, DAYS, which was
introduced at the end of March 2011. We remain convinced that the affordable
cancer products Aflac Japan provides will continue to be an important part of
our product portfolio.
Medical insurance sales increased 1.4% during the second quarter of 2012,
compared with the same period a year ago, and we maintained our position as the
number one seller of medical insurance policies in Japan. We expect our new
non-standard medical product introduced in July 2012 to benefit medical sales in
the second half of the year. With continued cost pressure on Japan's health care
system, we expect the need for medical products will continue to rise in the
future, and we remain encouraged about the outlook for the medical insurance
market.
At June 30, 2012, we had agreements to sell our products at 374 banks, or more
than 90% of the total number of banks in Japan. We have seen sales steadily
improve at many of these bank branches as training has taken place and as many
banks expand their offerings of Aflac products. We believe we have significantly
more banks selling our third sector insurance products than any other insurer
operating in Japan. Japanese consumers rely on banks not only to provide
traditional bank services, but also to provide insurance solutions, among other
services. Approximately 80% of our customers at banks are new customers to
Aflac. We believe our long-standing and strong relationships within the
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Japanese banking sector, along with our strategic preparations, have proven to
be an advantage as this channel opened up for our types of products. Our
partnership with banks provides us with a wider demographic of potential
customers than we would otherwise have been able to reach, and it also allows
banks to expand their product and service offerings to consumers. Our access
through the bank channel gives us the opportunity to cross-sell our more
profitable medical and cancer policies along with WAYS and child endowment
policies.
We remain committed to selling through our traditional channels. These channels,
consisting of affiliated corporate agencies, independent corporate agencies and
individual agencies, accounted for 52% of total new annualized premium sales for
Aflac Japan in the second quarter of 2012. During the three-month period ended
June 30, 2012, we recruited nearly 940 new sales agencies. At June 30, 2012,
Aflac Japan was represented by approximately 19,600 sales agencies and more than
123,300 licensed sales associates employed by those agencies.
Overall, Aflac Japan performed well in the second quarter of 2012. We believe
that there is a continued need for our products in Japan. Facing difficult sales
comparisons in the third and fourth quarter of 2012, we expect new annualized
premium sales in the last half of this year to be flat to up 5%. However,
combining this second half sales expectation with the results we produced in the
first half of the year, we are upwardly revising our annual 2012 sales target to
a 22% to 25% increase.
Aflac Japan Investments
Growth of investment income in yen is affected by available cash flow from
operations, the timing of investing the cash flow, yields on new investments,
and the effect of yen/dollar exchange rates on dollar-denominated investment
income. Aflac Japan has invested in privately issued securities to secure higher
yields than those available on Japanese government or other public corporate
bonds, while still adhering to prudent standards for credit quality. All of our
privately issued securities are rated investment grade at the time of purchase.
These securities are generally issued with documentation consistent with
standard medium-term note programs. In addition, many of these investments have
protective covenants appropriate to the specific issuer, industry and country.
These covenants often require the issuer to adhere to specific financial ratios
and give priority to repayment of our investment under certain circumstances.
The following table presents the results of Aflac Japan's investment yields for
the periods ended June 30.
Three Months Six Months
2012 2011 2012 2011
New money yield - yen only 1.89 % 2.16 % 1.92 % 2.24 %
New money yield - blended 1.97 2.67 2.00 2.88
Return on average invested assets, net of
investment expenses 2.93 3.15 3.06 3.23
The decrease in Aflac Japan's new money yield reflects the low level of interest
rates. At June 30, 2012, the yield on Aflac Japan's investment portfolio,
including dollar-denominated investments, was 3.10%, compared with 3.51% a year
ago. See Notes 3 and 5 of the Notes to the Consolidated Financial Statements and
the Analysis of Financial Condition section of this MD&A for additional
information on our investments.
Japanese Economy
The Bank of Japan's July 2012 Monthly Report of Recent Economic Developments
stated that Japan's economic activity has started improving moderately as
domestic demand is supported by reconstruction-related demand. Exports and
production have shown signs of improvement. Public investment and housing
investment have continued to increase, and private consumption has increased
moderately. The report projected that Japan's economy is expected to return to a
moderate recovery path as overseas economies emerge from a deceleration phase
and reconstruction demand related to the tsunami and earthquake disaster remains
firm. Exports and production are expected to increase moderately. Public
investment and housing investment are expected to continue to increase, while
private consumption is expected to remain firm as the employment situation is on
an improving trend. For additional information, see the Japanese Economy
subsection of MD&A in our annual report to shareholders for the year ended
December 31, 2011.
Japanese Regulatory Environment
Japan'sFinancial Services Agency (FSA) maintains a solvency standard, which is
used by Japanese regulators to monitor the financial strength of insurance
companies. The FSA has applied a revised method of calculating the solvency
margin ratio for life insurance companies as of fiscal year-end 2011 (March 31,
2012). The FSA had commented that the revision would generally reduce life
insurance companies' solvency margin ratios to approximately half the level of
those reported under the former calculation method. Aflac Japan's solvency
margin ratio, most recently reported as of March 31,
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2012, was 609.6% under the new standards. As expected, based on the results of
the calculation of the solvency margin ratio under the new standards, AflacJapan's relative position within the industry has not materially changed.
In 2005, legislation aimed at privatizing Japan's postal system (Japan Post) was
enacted into law. The privatization laws split Japan Post into four operating
entities that began operations in October 2007. In 2007, one of these entities
selected Aflac Japan as its provider of cancer insurance to be sold through its
post offices, and, in 2008, we began selling cancer insurance through these post
offices. Japan Post has historically been a popular place for consumers to
purchase insurance products. Currently, our products are being offered in
approximately 1,000 post offices. Japan's three major political parties recently
submitted legislation regarding postal reform. This legislation will merge two
of the postal operating entities (the one that delivers the mail and the one
that runs the post offices). This legislation passed the Diet in April 2012.
However, at the current time, it is not possible to predict with any degree of
certainty what impact, if any, this legislation will have on Aflac Japan's
operations. Regardless, we believe that postal reform is unlikely to change
Aflac Japan's relationship with the post office company.
AFLAC U.S. SEGMENT
Aflac U.S. Pretax Operating Earnings
Changes in Aflac U.S. pretax operating earnings and profit margins are primarily
affected by morbidity, mortality, expenses, persistency and investment yields.
The following table presents a summary of operating results for Aflac U.S.
Aflac U.S. Summary of Operating Results
Three Months Ended Six Months Ended
June 30, June 30,
(In millions) 2012 2011 2012 2011
Premium income $ 1,251 $ 1,186 $ 2,482 $ 2,356
Net investment income 153 148 304 291
Other income 2 3 5 6
Total operating revenues 1,406 1,337 2,791 2,653
Benefits and claims 719 676 1,397 1,319
Operating expenses:
Amortization of deferred policy
acquisition costs 92 89 202 196
Insurance commissions 142 138 282 271
Insurance and other expenses 195 191 381 373
Total operating expenses 429 418 865 840
Total benefits and expenses 1,148 1,094 2,262 2,159 Pretax operating earnings(1) $ 258$ 243 $
529 $ 494
Percentage change over previous period:
Premium income 5.5 % 3.4 % 5.3 % 2.9 %
Net investment income 3.6 9.7 4.5 9.2
Total operating revenues 5.2 4.0 5.2 3.6
Pretax operating earnings(1) 6.3 7.8 7.2 5.0
(1) See the Insurance Operations section of this MD&A for our definition of
segment operating earnings.
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
Annualized premiums in force increased 5.1% to $5.3 billion as of June 30, 2012,
compared with $5.0 billion as of June 30, 2011.
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The following table presents a summary of operating ratios for Aflac U.S.
Three Months Ended Six Months Ended
June 30, June 30,
Ratios to total revenues: 2012 2011 2012 2011
Benefits and claims 51.1 % 50.6 % 50.1 % 49.7 %
Operating expenses:
Amortization of deferred policy
acquisition costs 6.6 6.7 7.2 7.4
Insurance commissions 10.1 10.3 10.1 10.2
Insurance and other expenses 13.9 14.3 13.6 14.1
Total operating expenses 30.6 31.3 30.9 31.7
Pretax operating earnings(1) 18.3 18.1 19.0 18.6
(1)See the Insurance Operations section of this MD&A for our definition of
segment operating earnings.
Prior-year amounts have been adjusted for the adoption of accounting guidance on
January 1, 2012 related to deferred policy acquisition costs.
The benefit ratio increased in the three- and six- month periods ended June 30,
2012, compared with the same periods a year ago. The expense ratio decreased
during those periods, resulting in a slight expansion in the pretax operating
profit margin compared with the same respective periods in 2011. For the
remainder of 2012, we expect the pretax operating profit margin to be similar to
that experienced in 2011.
Aflac U.S. Sales
In the second quarter of 2012, Aflac U.S. generated moderate sales growth,
compared with the same period in 2011. We believe this sales growth reflects our
focus on supporting our field force with enhanced products, including group
products, and other resources that help our sales force approach selling in the
challenging economic environment more effectively. The following table presents
Aflac's U.S. new annualized premium sales for the periods ended June 30.
Three Months Six Months
(In millions) 2012 2011 2012 2011
New annualized premium sales $ 359 $ 353 $ 709 $ 689
Increase (decrease) over comparable
period in prior year 1.5 % 5.9 % 3.0 % 6.1 %
The following table details the contributions to new annualized premium sales by
major insurance product category for the periods ended June 30.
Three Months Six Months
2012 2011 2012 2011
Income-loss protection:
Short-term disability 20 % 17 % 20 % 17 %
Life
6 6 6 6
Asset-loss protection:
Accident 30 31 30 31
Critical care(1) 22 23 23 23
Supplemental medical:
Hospital indemnity 15 16 15 16
Dental/vision 7 7 6 7
Total 100 % 100 % 100 % 100 %
(1) Includes cancer, critical illness, and hospital intensive care products
New annualized premium sales for accident insurance, our leading product
category, decreased 0.5%, short-term disability sales increased 24.3%, critical
care insurance sales (including cancer insurance) decreased 4.1%, and hospital
indemnity insurance sales decreased 2.8% in the second quarter of 2012, compared
with the same period a year ago.
As part of our U.S. sales strategy, we continue to focus on growing and
enhancing the effectiveness of our U.S. sales force. We recruited nearly 6,400
new sales associates in the second quarter of 2012, resulting in approximately
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76,900 licensed sales associates as of June 30, 2012.
In addition to expanding the size and capabilities of our traditional sales
force, we are encouraged about the opportunities to broaden our distribution by
pursuing and strengthening relationships with insurance brokers. Insurance
brokers have been a historically underleveraged sales channel for Aflac, so we
have been developing relationships with brokers the past several years that
complement our traditional distribution system. We have a management team
experienced in broker sales, and we are supporting this initiative with
streamlined products, targeted broker-specific advertising campaigns, customized
enrollment technology, and competitive compensation. At the beginning of 2012,
Aflac U.S. launched an initiative to address the largest insurance brokers. We
believe that we have significant potential for growth in this larger-case
market.
Our group products sold through Aflac Group Insurance have enhanced sales
opportunities not only for brokers but also for our traditional sales force of
individual associates, especially when they pursue larger payroll accounts. For
the three-month period ended June 30, 2012, sales from Aflac Group Insurance
increased 10.6%, compared with the same period in the prior year, to $38
million, representing 11% of new annualized premium sales for Aflac U.S. For the
six-month period ended June 30, 2012, sales from Aflac Group Insurance increased
24.8%, compared with the same period in the prior year, to $88 million,
representing 12% of new annualized sales for Aflac U.S.
Although we remain somewhat cautious in the short-term sales outlook for Aflac
U.S. due to the relatively weak economic environment, our longer-term view has
not changed. We believe the need for the products we sell remains strong, and
that the United States provides a vast and accessible market for our products.
We are taking measures to better reach potential customers through our product
and distribution strategy, which includes broadening our product portfolio to
include group products in addition to our traditional individually issued
products. The addition of the group product platform and our growing broker
initiative only serve to enhance our ability to leverage the Aflac brand to
reach employees at more companies, large and small, across the United States. We
believe employers and consumers will increasingly come to understand the need
for the products we offer, just as they have in Japan. For 2012, our objective
is for Aflac U.S. new annualized premium sales to increase in the range of 3% to
8%.
Aflac U.S. Investments
The following table presents the results of Aflac's U.S. investment yields for
the periods ended June 30.
Three Months Six Months
2012 2011 2012 2011
New money yield 4.37 % 5.72 % 4.57 % 5.74 %
Return on average invested assets, net of
investment expenses 6.42 6.41 6.45 6.42
The decrease in the U.S. new money yield for the three- and six-month periods
ended June 30, 2012 reflects a low level of interest rates and tightening credit
spreads. At June 30, 2012, the portfolio yield on Aflac's U.S. portfolio was
6.59%, compared with 6.76% a year ago. See Notes 3 and 5 of the Notes to the
Consolidated Financial Statements and the Analysis of Financial Condition
section of this MD&A for additional information on our investments.
U.S. Economy
Operating in the U.S. economy continues to be challenging. We generated sales
growth that exceeded our expectations for 2011, but even so, ongoing low
confidence levels from consumers and small businesses coupled with fewer
employees at the worksite continue to pose challenges to our U.S. sales growth.
Our group products and growing relationships with insurance brokers that handle
the larger-case market are helping us as we expand our reach to do business with
larger businesses. However, most of our business continues to revolve around
small business owners and accounts with fewer than 100 employees. Small
businesses, in particular, have proven to be especially vulnerable to ongoing
economic weakness, and both small-business owners and their workers are anxious
about the future. Workers at small businesses are holding back on increasing
their spending for voluntary insurance products. Although we believe that the
weakened U.S. economy has dampened our sales growth, we also believe our
products remain affordable to the average American consumer. We believe that
consumers' underlying need for our U.S. product line remains strong, and that
the United States remains a sizeable and attractive market for our products.
U.S. Regulatory Environment
In March 2010, President Barack Obama signed the Patient Protection and
Affordable Care Act (PPACA) to give Americans of all ages and income levels
access to comprehensive major medical health insurance. The primary subject of
the new legislation is major medical insurance, therefore, the PPACA, as
enacted, does not directly affect the design of
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our insurance products or our sales model. Our experience with Japan's national
health care environment leads us to believe that the need for our products will
only increase over the coming years.
In July 2010, President Obama signed the Dodd-Frank Wall Street Reform and
Consumer Protection Act, commonly known as the Dodd-Frank Act, which, among
other things, created a Financial Stability and Oversight Council. The Council
may designate by a two-thirds vote whether certain insurance companies and
insurance holding companies pose a grave threat to the financial stability of
the United States, in which case such nonbank financial companies would become
subject to prudential regulation by the Board of Governors of the U.S. Federal
Reserve (the Board), including capital requirements, leverage limits, liquidity
requirements and examinations. The Board may limit such company's ability to
enter into merger transactions, restrict its ability to offer financial
products, require it to terminate one or more activities, or impose conditions
on the manner in which it conducts activities. The Dodd-Frank Act also
established a Federal Insurance Office under the U.S. Treasury Department to
monitor all aspects of the insurance industry and of lines of business other
than certain health insurance, certain long-term care insurance and crop
insurance. Traditionally, U.S. insurance companies have been regulated primarily
by state insurance departments. The Dodd-Frank Act requires extensive
rule-making and other future regulatory action, which in some cases will take a
period of years to implement. We believe that Aflac would not likely be
considered a company that would pose a systemic risk to the financial stability
of the United States. However, at the current time, it is not possible to
predict with any degree of certainty what impact, if any, the Dodd-Frank Act
will have on our U.S. business, financial condition, or results of operations.
