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Aflac Incorporated (NYSE:AFL)

Q4 2012 Earnings Call

February 6, 2013 9:00 am ET

Executives

Robin Y. Wilkey – Senior Vice President - Investor Relations

Dan Amos – Chairman and Chief Executive Officer

Kriss Cloninger – President and Chief Financial Officer

Paul Amos –President of Aflac and Chief Operating Officer of U.S. Operations

Ken Janke – Executive Vice President and Deputy Chief Financial Officer

Eric Kirsch – Executive Vice President, Global Chief Investment Officer

Tohru Tonoike – President and Chief Operating Officer of Aflac Japan

Analysts

Nigel Dally – Morgan Stanley

Jimmy Bhullar – JPMorgan

Eric Berg – RBC Capital Markets

Chris Giovanni – Goldman Sachs

Randy Binner – FBR Capital Markets

Thomas Gallagher – Credit Suisse

Eric Bass – Citigroup

John Nadel – Sterne, Agee

Operator

Welcome to the Aflac’s Fourth Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded.

I would now like to turn the call over to, Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations. Ma’am you may begin.

Robin Y. Wilkey

Thank you, and good morning and welcome to our fourth quarter call. Joining me this morning is Dan Amos, Chairman and CEO; Kriss Cloninger, President and CFO; Paul Amos, President of Aflac and COO of U.S. Operations; Ken Janke, Executive Vice President and Deputy CFO; Eric Kirsch, Executive Vice President, Global Chief Investment Officer; Tohru Tonoike, President and COO of Aflac Japan who is joining us from Tokyo.

Before we start, let me remind you that some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our quarterly release for some of the various risk factors that could materially impact our results.

Now, I’ll turn the program over to Dan, who’ll begin this morning with some comments about the quarter and year as well as our operations in Japan and the United States. I will then follow-up with a few financial highlights for the quarter and the year and then we will be glad to take your questions. Dan?

Daniel P. Amos

Thank you, Robin. Good morning and thank you for joining us. The final quarter of 2012 concluded another great year for Aflac. Let me start in more detail about the accomplishments in 2012 and our outlook for 2013 beginning with Aflac Japan, our largest earnings contributor.

Following five straight quarters of record breaking production, Aflac Japan’s new annualized premium sales in the fourth quarter were up slightly. Sales were ¥49.3 billion, an increase of 1.5% over the fourth quarter of 2011. For the third consecutive year, Aflac Japan generated record sales results. Our full year sales results rose 30.8% to ¥210.6 billion. You’ll recall that in the third quarter we said that Aflac Japan sales would be challenging for the remainder of the year and that’s exactly what we saw three primary factors affected our results, two of which we discussed in the third quarter.

The first and foremost factor was difficult comparisons to a year ago, which primarily reflected our expansion into the bank channel. Bank distribution has been a great benefit to us, because about 70% of the bank customers are new to Aflac. However, after selling through the banks for over last several years, we’ve already cycled through the first major pass, it selling products to a large portion of the bank customers particularly our higher premium WAYS product.

Second, you’ll recall, we expected that the consumers interest in WAYS would decline in the fourth quarter as we lower the rate for the discount advanced premium from 1% to 0.5% in October. We believe the impact from the lower DAP which was essentially a premium increase was much larger than we originally anticipated.

Third, over the last several months, we’re seeing some insurance companies and financial institutions are being more investment type products that compete with WAYS. We believe competition amongst various companies selling investment type products will not only continue, but we’ll actually intensifies we get closer to April 1, and the repricing of these type of products will be implemented. We anticipate repricing will suppress sales, however, it’s important to note that the pricing revisions will benefit us overall from a profitability standpoint.

When thanking of repricing for our first sector products like WAYS, our objective is to balance profitability and competitiveness. Our profitability will be enhanced by higher premiums we will be charging. However, to remain competitive, we just announced that we will rise the DAP from the current 0.5% back up to the 1% effective April 1. After reprising the DAP change, we estimate the profitability of our WAYS product will range between 15% and 20%, which is an acceptable margin to us.

We know the Aflac brand is strong throughout Japan and this enhances the appeal of our products, in particular our third sector cancer and medical had been and will continue to be our pillar products in the foundation of the product portfolio. In 2012, we maintained our position as the number one seller of third sector medical and cancer products in Japan. This number one status confirms the popularity of these products and also helps drive sales because consumers want to buy from the leading [flatter].

Let me be clear, remaining the number one seller of cancer and medical sales in Japan, is a top priority for me. We mentioned in May at the Analyst Briefing that we are currently underpenetrated with the consumers who are in their 20s to 40s, that’s the segment where we are going to focus our efforts on to increase sales of the third sector products.

As you may know, banks have relationships with multiple insurance providers. This combined with the changes in the competitive product landscape make it more challenging than ever to accurately project future Aflac Japan sales through the banks. Clearly, bank channel sales will be challenging following fast rate quarters of record-breaking sales results.

Keep in mind, we won’t gain insight into the bank strategies or 2013 product offerings until closer to the start of Japan’s fiscal year which is April 1. Hopefully, by that time, we release first quarter results we’ll be able to provide you with an update of what we’ve learned about bank plan to sell our products.

On the other hand, we continue to have good visibility into the sales of our third sector cancer and medical products. Our traditional channels has historically been the primary driver of third sector sales. For 2013, we expect Aflac Japan sales of third sector cancer and medical products to be flat to up 5%. Achieving this target is a top priority for me and our management in Japan and it affects Aflac Japan’s bonus, as well as those in the corporate management.

Now, let me turn to the U.S. operation. From a financial perspective, Aflac U.S. performed very well in 2012. I think we’ve done a good job in managing our U.S. operations, including budgets, people resources. Although new sales growth continued to be constraining our top line results had been consistently strong throughout the year, in part, reflecting an improved persistency.

Aflac U.S. new annualized premium sales were in line with our most recent guidance flat for the year. We believe persistency has improved for a couple of reasons. First, we’ve enhanced our customer experience at critical touch points, which has resulted in better payroll retention.

And second, with the economic uncertainty, we’ve seen over the last several years, many employees are less likely to switch [stops] and therefore are more likely to keep their current benefits. While there are external factors we can’t control, we are driven to improve the factors we can influence.

First, we continue to improve the structure of our marketing and sales area to maximize our future growth and focus on our distribution channels. Within this new structure, we are working on new training initiatives, we believe will benefit our sales force and help them be more productive in the evolving environment.

Second, with the brand recognition of 94%, we continue to leverage the strength to capture the attention of consumers with the ultimate goal of driving sales. We want to continue to educate consumers on our products while at the same time entertaining them.

Third, we evaluate and enhance our products to ensure we are in staff with the needs of consumers, particularly on the economic landscape. In 2013, we are planning aggressive new individual and group product launches. With our strong brand recognition and reputation for paying clients quickly and fairly, we believe consumers are more receptive to our products and this can only benefit us in the future.

Additionally, we will continue to evaluate other opportunities as it relates to the change in the current healthcare environment, specifically the Affordable Care Act. We do expect the changing healthcare environment to have an impact on how people choose to purchase insurance going forward.

As such we are looking at ways that we can effectively operate within the environment of state and federal healthcare delivery system. One thing we note from our nearly four decades in Japan is that, even with the national healthcare system, consumers have significant out-of-pocket expenses and our products continue to be relevant to consumers.

We believe the national healthcare actually present that life with opportunities as consumers become better aware of the financial protection at life’s products. However, there are still external factors in the microenvironment that affect our business, while some aspects of the U.S. economy has shown slight signs of improvement in 2012, we can continue to see the economic landscape and the U.S. is challenging, that’s especially true for small business segment, where more than 90% of our products are sold.

In fact, the National Federal of Independent Businesses which focuses on small business owners reported this month that the small business optimism index in December was the second lowest since March of 2010. This means more small employers are still very guarded with respect to their business outlook, including their hiring plans. This is important, because gains or losses in employment impact our universe of potential policyholders.

Before we can say we are optimistic about our sales opportunities, we need to seek sustained optimism particularly surrounding the employment level to smaller businesses. Taking all that into account for 2013, we expect Aflac U.S. sales through the traditional and broker channel to be flat to up 5%. I’ll point out that for the first quarter we won’t be surprised if sales down considering the first quarter of 2012 was our biggest percentage increase for the year.

Having discussed our operations let me give you an update on the investment function. I remain pleased with continued progress in our global investment transformation. We continue to grow our investment team and we’ve made excellent progress in the build out that’s ultimately designed to improve the risk adjustment returns and the profile of our balance sheet.

As we’ve stated for many years, our greatest investment challenge has been to invest Aflac Japan significant cash flows at reasonable investment yields. The U.S. corporate bond program was initiated in the third quarter continues to be an effective means for enhancing our new money yields in Japan.

You’ll recall that our fourth quarter objective was to invest roughly two-thirds of our invested cash flow in U.S. dollar denominated publicly traded corporate bonds and then hedged the currency risk. This successful investment program enabled us to surpass our budgeted new money yield for 2012. It’s also provided greater liquidity, enhanced flexibility of our portfolio, and increased the opportunities to diversify beyond JGBs.

At December 31, this program represented 6.2% of the total portfolio, which is well below our asset allocation target. In light of the success of the bond program with strong credit fundamentals of investment grade corporate credits, we intend to continue the program in 2013. Consistent with our asset allocation program, we will valid these investments with JGBs for diversification and liquidity as well as other investment opportunities as it may arise.

As I mentioned, Aflac consolidated financial performance was strong for the quarter and for the year. Excluding the impact of foreign currency, operating earnings per diluted share rose 4.8% for the quarter and 5.1% for the year. As the program progressed, operating earnings per diluted share were better-than-expected and we finish the year towards a high-end of the objective of the 3% to 6% increase before the impact of currency.

I’m also very pleased with the strength of the capital ratios, which demonstrates our commitment to maintaining financial strength and flexibility on behalf of the policyholders to shareholders and bondholders through strong surplus growth and improved portfolio risk profile and a weaker yen, our capital ratios improved significantly in 2012. We previously conveyed that our goal in 2012 with an RBC in the range of 400 to 500.

While we have not yet completed our statutory financial statements, we believe the RBC ratio at the year-end was significantly higher than our targets. Additionally, we expect that Aflac Japan’s solvency margin at the end improved over the solvency margin ratio at September 30 for 628%. That would put the year-end SMR well above our target range of 500% to 600%.

As we have indicated, given our capital structure, our ability to repurchase shares is largely tied to profit repatriation. Contemplating profit repatriation, our first consideration is protection of the policyholders as measured by the SMR. Next, we give consideration to the needs of the parent company and consult with Japan’s management in making the determination. We now expect profit repatriation to be around ¥50 billion for 2013, which is a reasonable estimate assuming that we have no additional investment losses that would reduce Aflac Japan’s operating income.

Profit repatriation in 2013 could provide us with the significant amount of capital that could be deployed for share repurchase. As we’ve said for many years, when it comes to deploying capital for the benefit of our shareholders, we still believe that growing the cash dividend and repurchasing our shares are the most attractive means and that is something that we will continue to pursue.

Our capital strength enables us to increase cash dividend to the shareholders in the fourth quarter for the 30 consecutive year. Our objective is to grow the dividend and a rate that is in line with our earnings per share growth before the impact of the yen. Given the strength of our capital ratios and the parent company liquidity, we resume our share repurchase activities by buying approximately a $100 million for the shares in the fourth quarter of 2012.

At our current plan to purchase 400 million to 600 million of our shares in 2013, understand unless there is extraordinary then occurs, we intend to purchase at least $400 million of our shares.

Remember, we are driving the company for increased profitability, not sales. Sales are important in that, our management is bonused on them, but there is still just one component of earnings. Let me also say that we haven’t missed an earnings target because of lower sales nor do we expect that to happen. This year the other components that need into the profitability include persistency, investment income, claims management and expense controls.

It’s often difficult to foresee the specifics of how these factors ultimately produce our earnings. Sometimes one aspect of the business might be a little stronger, and one might prove to be a little more challenging, but we anticipate these type of things in the budgeting process. Ultimately, the accomplishments of the fundamental facets of our business align and create another year in which we deliver on our financial growth objectives.

I want to reiterate that objectives for 2013 have not changed. The increased operating earnings per diluted share 4% to 7%, this range reflects the impact of the portfolio of derisking and investing significant cash flows at low interest rates.

I would also point out that we had a better year in 2012 than expected in large part due to the receipts of the deferred coupon in the first quarter and lower annual effective tax rate. This will make it a more challenging comparison to 2013, but we will achieve it.

In addition to operating earnings growth, we’ve also focused on producing industry leading return on equity. On an operating basis, 2012 ROE was 24.6% and as we conveyed at our financial analyst briefing for 2013, we believe that it’s reasonable to see our operating ROE in the range of 22% to 26%. Overall, I am pleased with Aflac’s position in Japan and the U.S., the two largest insurance markets in the world.

First and foremost, we are focused on protecting our policyholders in providing value to our investors. We are fortunate within the process of doing so; we have the privilege of providing financial protection to more than 50 million people worldwide. Robin?

Robin Y. Wilkey

Thank you, Dan. Let me go through some fourth quarter numbers starting with Aflac Japan. Beginning with top line, in the interim revenues were up 10.5% for the quarter, investment income was up 5.2%. Excluding the effect of the weaker yen in the quarter on Aflac Japan’s dollar denominated investment income, net investment income rose 3.6%. The persistency rate improved in the quarter and the annualized rate excluding annuities for the year was 94.9% compared with 94.4% a year ago.

In terms of quarterly operating ratio, the benefit ratio, the total premium increased over last year going from 72.9% a year go to 74.5% in this quarter. This is primarily due to the growth of the net benefit reserves for our ordinary line of business most notably our WAYS product. The expense ratio was 18.4%, down from 19.1% in the fourth quarter of 2011. The decrease reflected tight general expense control as well as lower commission cost associated with the sales of our first sector products, primarily the WAYS again.

Pretax profit margin declined during the quarter going from 18.8% to 17.7%, with the contraction of the margin pretax earnings increased 4.1% in yen terms.

Now, let me turn to Aflac U.S., total revenues rose 5.8% for the quarter, the annualized persistency rate for the year improved from 76.2% a year ago to 77.1%, and looking at the operating ratios for the quarter as the benefit ratio to total premium declined slightly from 57.7% a year ago to 57.4% in the quarter.

The operating expense ratio increased slightly going from 34.2% a year ago to 34.6%. The profit margin for the quarter was unchanged from a year ago at 14.6%. Pretax operating earnings increased 5.9% for the quarter.

Turning to the investment activity for the quarter starting with Aflac Japan for the quarter approximately $3.1 billion of Aflac Japan’s new cash flow was invested in the corporate bond program for the growth yield of 3.22% at an annualized hedge cost 41 bips, the yield net of hedge cost was 2.81%.

Additionally, we invested $1.4 billion from the proceeds generated as the result of the booking activity. This brings the total cash flow invested in the corporate bond program for the year to approximately $7 billion with a total yield on the corporate bond program of 3.3%. Approximately, 35% of our new cash flow was invested in JGBs in the fourth quarter for an average yield of 1.77%. In Japan, the total new money yields for the quarter was 2.73%, down three basis points from September 30, and up 65 basis points from a year ago. The portfolio yield was 2.87% at the end of December or 3 basis points from end of September and 42 basis points lower than year ago.

JGC yield saw some increase towards the end of December, as December the 31 full year JGB yield were 1.75%, 11 basis points increase from September 30. Ten-year JGB yield as of December 31 were 0.79%, a one dip increase from September 30.

In terms of U.S. investments to new money yield for the quarter was 3.52%, a decline of 42 basis points from September 30 and 183 points from a year ago. The yield on the portfolio at the end of December was 6.35%, down 16 basis points from September 30 and 37 basis points from a year ago.

Turning to some other items in the quarter, non-insurance interest expense in the quarter was $50 million compared with $42 million a year ago. The higher interest expense primarily reflected increased borrowing during the year compared to a year ago. Total company pre-tax operating margins declined reflecting the increase of the benefit ratio in Japan caused by strong sales of ordinary line of business.

Parent company and other expenses decreased from $20 million a year ago to $6 million in the fourth quarter of 2012. On operating basis, the tax rate is 34.1% compared with 34.6% a year ago. Consistent with what we said last quarter, going forward, we expect the effective tax rate throughout 2013 to be between 34% and 34.5%, excluding tax benefits recognized in 2012 and assuming FSA earned premiums on year-over-year, which is in line with Dan’s comments earlier.

As Dan mentioned, we’ve taken several actions during the year to utilize capital loss that will expire in 2013 and only significantly reduce the losses that are scheduled to expire in 2014.

We expect to continue the actions we have initiated to utilize the remaining capital loss carryforwards in managing our investment portfolio. As reported, operating earnings per diluted share rose 2.1% to $1.48 in the quarter, which again decreased operating earnings by $0.04 per diluted share, excluding the yen impact operating earnings per share increased 4.8% for the quarter.

Lastly, let me comment on the earnings outlook for 2013. As you’ve heard Dan say, we’ve affirmed our guidance for 2013 of 4% to 7% increase in operating earnings per diluted share, excluding the impact of the yen. To understand the significant our 2013 EPS objective over 2012 actual results winning to this perspective for you.

In 2012, we received tax benefit from our tax exempt for the years 2008 and 2009, and we’ve made a revision for the full year impact of tax effective tax rate. The unusual benefits received in 2012 totaled approximately $38 or $0.08 per share. We also recovered a previously written-off coupon as part of the sales transaction executed during the year that resulted in a one-time benefit to operating earnings of $23 million, or $0.05 per share. If you exclude the impact of these benefits from the 2012 operating earnings note, operating earnings per diluted share in sale would have been $6.47.

This year we estimate that a ¥1 move on the average annual exchange rate will equal approximately $4.3 for diluted share. Considering the weakening of the yen in recent months, if we achieve our objective of 47% increase in operating earnings per diluted share for the year at yen averages 90% for the full year, we would expect operating EPS to be in the range of $6.37 to $6.57 per diluted share.

Now, we’re ready to take your questions. To be fair to everybody, please remember to limit yourselves to one initial question and only one follow-up that relates to the initial question.

Now, we’ll be happy to take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Nigel Dally from Morgan Stanley.

Nigel Dally – Morgan Stanley

Great, thank you. Good morning, everyone. So we see Japan benefit ratio, clearly quite a large increase this quarter on a sequential basis. But at least historically, fourth quarter – did we have some reserve recalibrations? I’m hoping to get some color on how much reserve recalibrations impacted the ratio this quarter and with around back of the trends we’ve seen emerge whether we should be expecting a somewhat higher benefit ratio in 2013 than your previous year guidance back in Investor day? Thanks.

Kriss Cloninger III

Hey Nigel, it’s Kriss Cloninger, bit of a scratchy voice this time. But you’re correct that the fourth quarter benefit ratio was higher than those we experienced in the first three quarters partly because of (inaudible) reserve recalibrations. And we typically do in conjunction with reviews of primarily closed lots of business in Japan and U.S., where we look at the reserve balances that we forecasted. Relative to the interest rates you used in valuing those blocks in the prior year, our SOX procedure is required that we do this and the fourth quarter is kind of a routine thing.

And this year we increased the benefit reserves on a Japanese block of business that we call Dementia. You’ve probably heard of it before. It’s similar to long-term care in the U.S. and that was approximately ¥3 billion reserve increase in the fourth quarter.

I believe we had a similar adjustment in the fourth quarter of the prior year. And actually the fourth quarter of the prior year was up even more than the first three quarters. But that doesn’t indicate that that’s going to have a trend going forward, Nigel. The ratios excluding that reserve adjustment were right in the middle of the trends I’ve shown at the FAB meeting last May, or work out what the expected benefit expense ratios and profit margins were for the core health and other block and the ordinary block separately and then I aggregated on the total.

And all of our ratios fell within those ranges that I guided to last May, and I believe that those ranges will continue to prevail throughout 2013. As I indicated last May, there are two year weighted-average ratio expected for 2012 and 2013, and so we’re still in good shape in that regard.

As a matter of fact, our 2012 experienced profit margin came in right in the middle of the range 19.5%. Benefit ratio was a little bit higher. Expense ratio was a little bit lower. In the aggregate, because we produced more WAYS than we produced health benefits and so that affected the weighted-average.

The final thing I’ll say is that I do caveat things last May saying okay, these are ratios that will prevail over the course of the two year period, but you’re going to see some seasonal fluctuations and I was thinking primarily of the fourth quarter adjustments that we made that you saw and pointed out. So I’ll conclude just by saying I believe everything is in line with what we had expected.

Nigel Dally – Morgan Stanley

Very helpful. Thanks, Kriss.

Operator

Your next question comes from Jimmy Bhullar of JPMorgan.

Jimmy Bhullar – JPMorgan

Hi, good morning. I had question on capital repatriation, just wondering how you think about or actually capital deployment? How do you think about the pick-up in RBC and the solvency margin given the weaker yen? Would you be willing to deploy the extra points for buybacks or something else or is that unlikely given that the currency can move around. And then related to that just maybe Dan if you could comment on or Kriss just the pace of buybacks expected for 2013, should it be more front-end loaded or would you do it either later through the year?

Kenneth S. Janke Jr.

Jimmy, this is Ken. Let me start out with the RBC SMR question. Clearly, we are benefitting from a weaker yen. ¥1 move probably adds about 3 to 4 points in the SMR, about 4, 5 points on the RBC. But what we’ll do is, we’ll have to evaluate it as we get a little bit closer especially with respect to repatriation. We’ve always discussed our RBC and SMR in terms of the yen sensitivity, so we do want to make sure that we provide for some kind of buffer if we see a reversal in the yen weakening, because strengthening the yen would penalize a little bit.

Daniel P. Amos

What was the other question I’ve got?

Jimmy Bhullar – JPMorgan

just the pace of buybacks?

Daniel P. Amos

I think, if there is an opportunity in the first quarter we’ll take advantage of it a little bit more so than we would in the second half, because it just ensures earnings growth and it benefits us.

Kenneth S. Janke Jr.

And I add to that Jimmy, we do have pretty good liquidity at the parent company. Our operating cash balance was about $770 million at the end of 2012. And clearly buying earlier in the year has a greater benefit to EPS for the year.

Jimmy Bhullar – JPMorgan

And you mentioned the $400 million at a minimum on buybacks, but the top end of your range is $600 million. How likely is $600 million given that, if you look at current exchange rates, your repatriation amounts actually implies some $500 million at current exchange rate?

Daniel P. Amos

Well, we have no problem with that additional capital at the corporate level if we need it to being able to do that. So, we are going to take it as it evolves, but I think the way you should do this is that, 400 million where we’re trying to, unless some cataclysmic event guarantee and we like to do more than that, and we’ll watch it as the year goes on and make a decision accordingly.

Jimmy Bhullar – JPMorgan

Okay. Thank you.

Operator

Your next question comes from Eric Berg, RBC Capital Markets.

Eric Berg – RBC Capital Markets

Thanks very much. I apologize for the background noise. I’ll go on mute if necessary after asking my question. So you have your discounted advance premium and with a greater boom to sales, but then it sort of profitability, so you took it away. But that hurt sales terribly, so now you are bringing it back.

Two questions, one, where does it leave you from a profitability point of view? In other words, you did you do this and where does this lead, why was this great decision to take it away and then bring it back. And don’t you on the risk of confusing customers and distributors by well flip flopping right a bit? Thank you.

Daniel P. Amos

Well, it’s actually not so much flip flopping, because we are only putting it in effect when the rate increase goes into effect. So in essence, we didn’t want to double rate increase to them. So what we’ve done is we put the rate increase in effect although the DAP going from 1 to 0.5 and then we are bringing it back because we’ve got another rate increase on top of that, and Kriss can talk about that, but the actual rate increase was more appropriate last year at this time with the declining interest rate and an increasing interest rate that we’re moving into right now. Kriss?

Kriss Cloninger III

Well, I just say Eric as we saw declining interest rates throughout 2012, we felt like we will be in pressure to own profitability from the MEMS popularity of the 1% DAP rate and the significant impact on production of WAYS. I mean we were getting extraordinary volumes and WAYS production and we felt like may be we were selling dollar bills for $0.50 kind of thing. So we felt like in order to project the margins going forward, we needed to diminish some of the perhaps above average appeal for the WAYS product by cutting the DAP rate to the level that most other companies were crediting, which was in the neighborhood of 0.5%.

So we implemented that in October. We did several other things during the same period of time when interest rates were declining during 2012. We with some production caps on child endowment and we revisit the five WAYS and things like that. So we were trying to protect the profitability that the analyst community and we were concerned about. And so we try to protect our core profitability when we made those changes.

Now, from April 1, we are going to reprise products given the change in the standard valuation interest rate down to 1% premium rates and the WAYS products are going to go up 15% to 20%, the margins are going to go up towards 20% as a percent of premium and we felt like we needed to restore some of the market appeal of the discount advanced premium rate, so we decided we could easily afford to change it back from 0.5% to 1% in order to better foster us competitively in the industry. So it’s not a flip-flop, it’s a reaction to changes and market conditions is how I will characterize it.

Daniel P. Amos

Let me say this Eric, we knew when we introduced cutting the DAP that this was a possibility we might do in April. So we told the bank that was always a possibility that it could happen.

Eric Berg – RBC Capital Markets

So here then is my follow-up. Let’s not call a foot path, that’s too harsh a word, it is what it is, you make one decision and as you’ve changed of course. By taking the tax as you have, I get some interest, it sounds like you will not be as well off from a profitability point of view, or March in point of view as would have been the case if you kept this DAP in place. But net-net where will all these actions leave you once you have and the outline is total dollar profit, not margins, right. It’s about total dollar profits and up-sell, not up margins but total dollar profit. So net-net, when you have the price increase in April, but you restore the full DAP, where will that leave you relative to what would have been the case if you were kept the DAP in place? Thank you.

Daniel P. Amos

Well, you are exactly right, Eric. It’s a question of the trade-off and volume versus margin. And that’s what I said when we went into WAYS in the first place relative to the third sector of health. We are going to ride a higher volume of products with a lower margin. We finally decided, okay, the margins got too low given the interest rate environment.

So we took the repricing action of lowering the DAP in order to restore some margin. When we do that we knew we were going to loose some volume that which we did here in the fourth quarter. So that’s – but if you say the impact of total profitability, you can get as much profit with a lower volume of higher margin products and you end with a higher volume of lower margin products. That come April 1, we’re being forced by market changes to increase the base policy premium rates on the WAYS. But in order to stay competitive, we believe it is necessary to go ahead and increase the DAP rate, so that we don’t lose so much volume associated with being uncompetitive that we don’t achieve the margin.

So you are right, if we maintain DAP at 0.5%, our margin would have been higher, but it would have been closer to 25% then say the high-teens to 20% that we expect after we rise the DAP back to 1%. And we think that, that will pass us in the market to be competitive, and will achieve a higher volume of production at a reasonable margin and enhance the overall profitability of company.

Daniel P. Amos

Yeah, I want to say one thing, this is not uncommon in the life insurance area when you are dealing with these type of issues. We knew it going in, we knew that when we decreased the DAP, we could raise it back, because of the other depending on what was happening. If we had been an environment where between October and now, we saw interest rates going down, we certainly would have kept it enforce. But it gives us flexibility to monitor and adjust, but there is nothing that our competitors are not doing too, and we are totally aware of it. Now from your standpoint, its new – in the third sector products we never had these issues. But we are very aware of it, we are on top of it, and we understand what we’re doing.

Eric Berg – RBC Capital Markets

Thank you for your very complete answer.

Operator

Your next question comes from Chris Giovanni, Goldman Sachs.

Chris Giovanni – Goldman Sachs

Thanks so much. I guess first question around the independent agency count in Japan, which showed a significant decline quarter-over-quarter and now down to I think levels seen in 2008. So just want to be curious, what’s going on there, is that really what you are kind of playing for and focusing on with the focus now on cancer and typical third sector product sales?

Daniel P. Amos

Tohru, you want to answer that?

Tohru Tonoike

Yes, thank you. Yes, let me say that the decline in the number of the recruits of the individual agents is something we intended to do, because we found that, in the past couple of years we found that recruiting too many agents and training them are not effective – efficient enough for us to do it. So instead we decided to shift some of our resources used for that purpose to other more productive areas including the bank channel development.

So we shifted the people and money from that to other areas. And that as a result, as you may see, the number of the recruits dropped substantially. But we’ve made more efforts in training them – training the smaller number of the new ridicules, so that we can be productive in short period of time. So even though the number of recruits declined over more than 30% the rate of – I would say the success rate of the first year recruits, the ratio of the newly recruited agents becoming productive within the year increased by 13%. So net-net the annual premium, our sales produced by these first year recruits were down around, more than 20%. But in subsequent of the yen, the growing was somewhat less than ¥600 million. Let’s put it in the perspective that is on the – less than 0.3% of our total annual premium.

So we believe that decline was made up or more than made up by the growth in other areas to which we shifted our resources. If don’t tell how much will be increased by them. But we are confident that was – we did it on purpose and we are confident that we did the things right.

Chris Giovanni – Goldman Sachs

Okay. And then just my follow-up question, you obviously talked about rising the DAP now. You didn’t make a number of other changes to kind of restrict some sales in the bank channel. So curious if, now that Eric’s getting better new money ratio over there if you guys would consider loosening up any of those other changes as well if sales don’t come true?

Daniel P. Amos

We have loosened up the restrictions on the Charles Dalmon. We have put some production limits, employees that we’ve loosened up. We’re not changing the 5-pay WAYS decision. We feel like that was a good decision to put the emphasis more on the 10-pay WAYS. It has 10 years of inter-charge, so we’re not changing that, but we are staying with the whole life WAYS and making changes to the discounted advanced premium rate and of course, premium levels or WAYS in general. We’re also looking at sales incentives to certain banks and to address competitive situation for other companies that come in and given incentives and the like.

So, the market response to competitive conditions is multifaceted should I say and we’re trying to stay on top of it all, because we have relationships with virtually all the banks in Japan. So we get feedbacks (inaudible) and we’re continuing to emphasis staying competitive.

Daniel P. Amos

But I think the message that I would give you is that the foundation that it build out life Japan which is cancer. And now medical is what we are concentrating on, because it was a somewhat of an anomaly the way it happened with the banks and our ability to write that first sector product specifically WAYS. We took it, because it was there and it was a great profit for us. But we’re now shifting money and resources back to the traditional channel, which where is we believe is, we want to stay number one in both medical and cancer. And that’s what we plan on doing going forward and that’s where the bonuses are tied and now we just get back to hit. But it was a strategic decision we’ve made at that time. We told you that we didn’t know how long it would last. We now see it coming more to an end and we see us concentrating on bank and the profit margins we discussed in the past and going back to doing that on the third sector.

Chris Giovanni – Goldman Sachs

Thanks so much.

Operator

Your next question comes from Randy Binner, FBR.

Randy Binner – FBR Capital Markets

Great, thanks. Just want to pick up on the repatriation conversation from a different angle. I think Jimmy was asking about how the currency impacts, but I was more curious to kind of understand what the methodology was that led to these impairments this quarter on Tunisia and UniCredit. And just to clarify if those were impaired or sold, I guess what I’m trying to get to is to understand if there is other bonds that are still kind of in low mark-to-market positions if those could be at risk in the next couple of quarters and if that would work against potential repatriation.

Daniel P. Amos

Let me start by reminding everybody that the strategy throughout 2012 particularly after the first quarter when we did a very specific derisking program was to look at our portfolio throughout the year and be opportunistic with respect to when good opportunities presented themselves to improve the quality of the balance sheet that we would do that, but only do that but it represented good value for our policy and shareholders.

We did not sell anything in a panic throughout the year. We’re very careful and we had a very successful year altogether reducing about $4.6 billion of multiple positions throughout Europe and the financial and we do not have a specific derisking strategy going forward. Having said that, we will always look for opportunities to improve the risk return profile this balance sheet for the long-term, and if we see something of value then of course we’ll take advantage of that.

With respect to your two specific questions, with respect to UniCredit that’s a good example. That’s an example of a credit, it could have been comfortable holding but amongst our holdings we felt there were some respect to UniCredit itself and it’s not going to affect our particular holdings. I can tell you early in 2012, we saw values for those particular assets that did not represent good value for our shareholders or policyholders and we said thanks, but no thanks. In an improved market as we’ve had, we saw particularly good value and in fact that (inaudible) is associated with the sale of those securities.

To measure on the other hand, it’s slightly different in terms of the risk that we see. As you may know in December I got downgraded by one of the agencies and in our view, the risk with Tunisia is more geopolitical risk as opposed to credit risk, but nevertheless because of the situation in the Middle East, the risk will cognizant enough.

With those things in mind, we did decide to take an impairment reflecting our current views on Tunisia, which we thought that was the conservative thing to do. On a forward-looking basis, there is no specific derisking program. But of course, we will always look at our holdings, we will react to credit ratings, we will react to market conditions and take appropriate actions when we feel necessary.

I think as you look over the next 12 months, Europe is still of course a concern, prior authorizations in Europe have decreased. As you look at that as a percentage of portfolio, it’s down from about a year ago 30% to 20%. And I have said as that bucket of assets continue to decrease, the quality of what we hold in Europe is actually increasing vis-à-vis the total bucket of what we had in Europe.

I don’t expect Europe to become volatile as it did during 2011 and 2012, but you can’t rule that out. So assuming anything from a stable environment, we won’t expect much activity or impact to our holdings. Of course, Europe should become more volatile that would create for our holdings perhaps some rating pressures, but again the size of our assets in Europe, the financials have all been reduced substantially. So it’s much lower risk than we faced when I arrived a little over a year ago.

Randy Binner – FBR Capital Markets

Thank you for that. Those were very comprehensive. One quick follow-up just kind of from me – there is a little bit of overlap or timing issues with FSA year and then the way we look at the company. But just to clarify the risk to the repatriation would be whatever credit losses could happen in the first and second quarter of 2013. Is that correct?

Kenneth S. Janke, Jr.

This is Ken, Randy. Yeah, that’s correct. It’s really until we file our FSA financial statements, which is typically done at early mid-June.

Randy Binner – FBR Capital Markets

Perfect, thanks.

Kenneth S. Janke, Jr.

All the losses that we incurred through the fourth quarter of 2012 are reflected in our current outlook for FSA results.

Randy Binner – FBR Capital Markets

Understood. Thank you.

Operator

Your next question comes from Tom Gallagher, Credit Suisse.

Thomas Gallagher – Credit Suisse

Good morning. I guess for Dan or Kriss, if you are not able to give us WAYS sales guidance for 2013, how confident are you for 2013 EPS guidance? And just asking that obviously, because WAYS were about 45% of your sales in Japan last year.

Daniel P. Amos

I’m extremely confident. I’ve never missed earnings guidance since I’ve been CEO on 23 years. Saying that, it’s harder now that it used to be, but in my mind I have a number for what I think bank sales will be. But I will remind you that last year I told you would be down 10% on this call and we were up 30%. So to make a projection when there was that most volatility last year just seeing some – it would not be a realistic number.

So I just want to wait, so I get a little closer and see what’s going to happen. But with all the things we have and going on in terms of persistency, the controls we’ve had over the budget, the claims and how they track exactly where we said we would, the new money rate on an upward trajectory, all those things made me confident that we will achieve it. But again it’s a little harder because of different things.

Kenneth S. Janke, Jr.

Yeah, Tom, this is Ken, let me add one thing, because you’ve seen this story before. You recall in early 2000s, we had sales pressures in Japan following the liberalization of their market. We had sales pressures in the United States following our duck bubble and sales hit done so well for a period of a few years. In all of those times, we didn’t miss earnings and largely that’s because the vast majority of our revenues and earnings come from a renewable source.

When you consider the persistency rates, about 90% of Japan’s premium income comes from renewals and investment income is largely from a renewal source. So we have a pretty good idea right now what about 80% to 85% of our revenues are going to look like for 2013, and with the stability of the and predictability of the benefit and expense ratios, that’s what gives us visibility into earnings. So the bottom line is we have more visibility into the income statement than we do right now for the sales to the bank channel.

Thomas Gallagher – Credit Suisse

That’s helpful. And just my follow-up is the 15% to 20% acceptable margin, I just want to make sure I understand the parameters of that and Kriss, that’s 15% to 20% versus premium or is that total revenues?

Kriss Cloninger III

It’s like present value profits to present value premiums, it’s kind of an actuarial thing, but it’s really representative of the GAAP profit margin as a percent of well it be revenues.

Thomas Gallagher – Credit Suisse

And when you say present value, is there – are we going to see any accounting disconnect from that in the first year or two that those products come on the books, meaning, is it lower in the initial years, or where we see that level of profitability emerge from a GAAP accounting standpoint kind of right out of the gate?

Daniel P. Amos

Well, for all of our business we’ve got several calls at a non-referable that we expensed in the first year. But other than those non-referable expenses, the margins tend to be level for each year of the product life as a percent of revenue.

Thomas Gallagher – Credit Suisse

Got it. So for a year or two that’s when you see emerge year one the same.

Daniel P. Amos

Right, right.

Thomas Gallagher – Credit Suisse

Okay, thanks.

Daniel P. Amos

Okay.

Operator

Your next question comes from Eric Bass, Citigroup.

Eric Bass – Citigroup

Hi, good morning. Robin touched a little bit on the deferred tax assets, and I was just hoping if you could provide a little bit more color on what you are doing and kind of what the cash tax benefit is to the company? And then I guess related if there is any potential to accelerate some of the tax assets that are maturing in future years?

Kenneth S. Janke

So Eric, this is Ken. We entered into series of transactions last year without getting a great detail, but that allowed us to offset all of the tax base losses that we incurred for 2012, as well as to eliminate the carryforwards, all of the carryforwards to 2013, which amounted to $214 million. In a substantial portion about 60% of the tax loss carryforwards that expire in 2014, about 60%.

So we feel like we’re in pretty good shape. We’re going to continue to explore transactions like economic sense to the company first and foremost then that would benefit our operations and hopefully we’ll be able to address those in the process.

Eric Bass – Citigroup

Okay. And just remind that’s kind of what the aggregate amount of future potential deferred tax assets you have remaining?

Kriss Cloninger III

We’ve got about $2 billion remaining, little less than $2 billion. The most significant portion of which is $1.3 billion of losses that were generated in 2011 that would expire in 2016.

Eric Bass – Citigroup

Okay. Thank you.

Robin Y. Wilkey

Thank you, Eric. And we have time for one more question.

Operator

Your last question comes from John Nadel, Sterne, Agee.

John Nadel – Sterne, Agee

Thank you. Most of my questions have been asked and answered, but maybe I’ll follow-up a little bit on WAYS. In the second half of 2012, your new money investment rate in Japan was considerably above the 2.50% level where I think in the past you’ve indicated, you need that level of investment rate to be able to hit that 17% to 21% targeted margin on your prior WAYS design. So we ignore Kriss the impact of those non-deferrable costs that you mentioned in the response to Tom, would you say that your WAYS sales in the second half of 2012 were achieving those targeted margins?

Kriss Cloninger III

Yes, I believe they were John, particularly with the higher investment yield and the like combined with the reduction in the discounted advance premium rate. Actually, if we could continue say the 2.5% that investment yield on new money, I wish we didn’t have to change anything as far as discounted advance premium and gross premium rates, which we didn’t have to go through this re-pricing activity. We’ve got to go through on April 1.

So margins were good in my mind, so we have no choice relative to re-pricing April 1, because if we don’t re-price there is going to be significant regulatory surplus associated with the higher reserves associated with the 1% standard valuation rate. I was comfortable with the fourth quarter margin given the higher net investment yield and that’s why we feel confident that we can restore discounted advance premium rate from April 1.

John Nadel – Sterne, Agee

And then just a quick follow-up. So if we then, if we are thinking about that hitting that targeted margin with the 2.5% or better investment yield, new money investment yield, in your one with taking into account to non-deferrable cost, how much does that cut into that margin in year one. I mean I’m thinking about it this way, you had massive WAYS sales in 2011, they more than doubled in 2012, I mean is it possible that with those non-deferrable cost behind you at least on those two big years of sales that the margin jumps in 2013?

Kriss Cloninger III

Certainly well on that block of business that’s for sure.

John Nadel – Sterne, Agee

And I mean order of magnitude, Kriss, can you give us a sense for how much those non-deferrable cost drag that margin in year one?

Kriss Cloninger III

Yeah let me think for just a second. I would say they could train at 20% to 30% of premium. So, we might be looking at flat virtually zero to slightly negative margin. In the actual reported in the first 12 months of the businesses in effect, actually it pretty much a course of the issue at the time of issue, because when the business goes on the books, we first put up the deferred acquisition cost and that’s an offset to the expenses incurred. But the asset we established is not as high as the actual expenses that we incur particularly into the new DAC standard that we have to implement recently.

So that’s a bit of a drain, but it happens all the time and so we got a mixed year of second year business coming in with a higher margin and new business going on the books with lower. But you are right, the big volume of WAYS we put on the books depress the margin in particularly the third and fourth quarter.

John Nadel – Sterne, Agee

And I’m sorry if I could sneak one more follow-up on it, because I think it’s important. I mean it sort of comes back to the question around expectation for sales of this product in 2013 if the year one margin is zero to slightly negative, but the year two margin can be mid-teens or higher, then it seems pretty important to understand, or to have some expectation as to whether WAYS sales are going to be down, up, or flat in 2013 versus 2012?

Kenneth S. Janke, Jr.

Yeah. Well, you are right. And then we will relieve some of that strain associated with non-deferrable acquisition cost and the new business will come on in a higher margin. That’s what I was trying to get to back in Eric Bird’s question. If you ride up higher volume and lower margin business, you achieve one level of profit. Then subsequently if you ride a lower volume and higher margin business, you can be similar and in total profitability, I think that’s what you are getting at is that, even though sales are going to be down, profits are going to be down nearly as much and may impact the up.

John Nadel – Sterne, Agee

Well, I mean in fact it seems based on your answers around the non-deferrable cost for instance, if we have sales R&D down year-over-year in 2013, that profits has to be up or else equal…

Kenneth S. Janke, Jr.

If you get to Ken’s point about, 90% of the profits being associated with renewal business. So…

John Nadel – Sterne, Agee

Plus the lack of the non-deferrable costs?

Kenneth S. Janke, Jr.

Yeah. For all the margin, you are correct.

John Nadel – Sterne, Agee

All right. Thank you very much.

Robin Y. Wilkey

Thanks. All right. Thank you very much. If you want to call later on the office in to ask any follow-up questions, please do so. If not, we have everything out on our website and we appreciate you attending the conference call. Thank you.

Operator

This does conclude today’s conference. Thank you for attending. You may disconnect at this time.

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