AFLAC Inc. (NYSE:AFL)
Citi 2013 U.S. Financial Services Conference Transcript
March 6, 2013 8:20 AM ET
Kriss Cloninger - Chief Financial Officer
Okay. Well, thank you, [Eric], and good morning to everyone. It’s a pleasure to join you this year’s Citi Financial Services Conference. Before we start, let me remind you that some statements in this presentation are forward-looking within the meaning of federal securities laws, although we believe our statements are reasonable, we can give no assurance that they’ll prove to be accurate because they are prospective in nature. Please look at our annual report on Form 10-K to see some of the risk factors that could cause actual results to differ materially from those we discussed today.
AFLAC offers voluntary insurance products in the two largest insurance markets in the world, Japan and United States. Our policies cover more than 50 million people world-wide.
AFLAC products provide a layer of financial protection against loss of income and assets, by paying fixed cash benefits directly to an insured, primarily upon a specified health event or life situation.
Our strategy for growth in Japan and United States has remained straight-forward and consistent for many years, and we believe they have been effective. AFLAC develops relevant products and sales them through expanded distribution channels, which yield new accounts and customers.
AFLAC operations in Japan account for about three quarter of our pre-tax insurance earnings. Now today we insure about one out of four households in Japan and we are the number one life insurance company in Japan in terms of individual policies and force.
Our third sector cancer and medical products have been and continue to be our pillar products, and the foundation of our product portfolio. AFLAC Japan’s ability to supplement its traditional product portfolio beyond traditional health related products with other products such as WAYS which is our hybrid whole-life insurance product has helped us to generate record sales in 2011 and ’12. For 2013, we are going to refocus our sales efforts on our traditional cancer and third medical -- third sector medical products.
AFLAC Japan was represented by more than 18,000 sales agencies at the end of 2012 equating to more than 125,000 licensed sales associates employed by those agencies. As a number of agencies have decreased since the end of 2011 due in part to the merging of some agencies, however, I’d like to point out that the number of licensed sales associates has actually increased.
Our sales results have been significantly influenced over the past several years by our expansion into the bank channel in Japan, primarily due to the bank’s focus on our WAYS product.
The bank channel generated almost 96 billion yen in sales in 2012, which represents an increase of over 106% from 2011 and accounted for almost 46% of AFLAC Japan’s total new sales.
More recently we’ve responded to the evolving consumer environment through the launching of AFLAC Consultants which is a direct face-to-face channel specializing in consultative sales targeted toward the 20 to 40-year old demographic.
We believe that this distribution expansion gives us the opportunity to capture a segment of the market in which we were previously under penetrating. We continue to believe that AFLAC distribution system remains one of the most efficient in Japan and represents the competitive advantage for us.
AFLAC Japan performed very well in 2012. For the third consecutive year, AFLAC Japan generated record sales results. Our full year sales rose 30.8% to 210.6 billion yen. Premium income increased 9.9% for the year, benefiting from the strong sales of our WAYS product.
AFLAC Japan’s revenues in yen grew by 9.4% for the year. Pre-tax earnings were 312 billion up 2%. For 2013, we expect AFLAC Japan sales for third sector cancer and medical products to be in the range of flat to up 5%.
Remaining the leader of third sector products has been and continues to be our priority, achieving this target is a top priority for our whole management team both in the U.S. and Japan.
Following three phenomenal years of sales, we are repricing our more interest sensitive product such as WAYS and child endowment on April 1, 2013. While the discounted advance premium or DAP as I’ll refer to it will move from its current level back up to a full 1% effective crediting rate with the repricing in April. We believe our profitability will increase significantly.
During our fourth quarter earnings call, you may have heard us say that with these changes we estimate that our -- the profitability for our WAYS product would be in the range of 15% to 20% of the premium. This range was based on the new money yield assumptions for JGB is around 1.75% for the longer duration securities.
However, I would like to point out that we would expect the profitability of WAYS products to more likely be in the high 20s using a more probably new money yield outlook of about 2.5% or better using the asset allocations, I’ll discuss a little bit later.
Given the increased activities in the competitive landscape for investment type products, we believe the sale of WAYS will be significantly lower in 2013. We expect to be able to give you some better sight when we release first quarter earnings results.
With respect to AFLAC’s popularity, we’ve experienced the tremendous amount of success leveraging our strong brand in our effort to drive sales. As part of these efforts, AFLAC Japan has honed its ability to take the AFLAC duck and create separate and unique characters to market-specific products.
Most recently, we launched a campaign featuring Tama, an actual cat that's famous throughout Japan, to market our more -- most recently medical product we call More Gentle EVER.
By capitalizing on the popularity of the AFLAC duck and our more recent characters, we've achieved brand awareness of around 97% in Japan. And we will continue to look for new ways to connect with consumers through innovative marketing campaigns for our product line.
Japan’s population is covered by universal healthcare system, but its citizens still have significant out of pocket costs associated with healthcare. As such, we believe that the need for our products will only continue to grow.
Given Japan’s aging population and declining birth rate, this national health care system has been under great financial strain and co-payments for salaried workers under age 70 have grown to about 30% of the medical costs.
However, as fiscal resources are tight in all areas, including medical, nursing care and pension benefits, it's clear that this difficult fiscal situation for Japan will persist going forward.
As you can see, the growth of medical expenses is significantly outpacing GPD growth. Because of the rapidly aging population and higher co-payments for medical expenses, the market for medical products has been steadily expanding and this trend is expected to continue. We believe we can expand our leading position as the medical market continues its growth in the future.
Now let me turn to our U.S. operations. As you may know, in the United States we primarily distribute our voluntary insurance products at the worksite on a payroll deduction basis.
Our AFLAC U.S. product portfolio includes a variety of voluntary insurance products designed to pay cash directly to policyholders when a serious medical event presents financial challenges. These payments are made regardless of any other insurance policyholders might have.
Our group products aligned well with our individual product line and give us the ability to customize product offerings for the brokers who typically sell to larger accounts. It’s important to leverage the brand and offer a choice to accounts of all sizes.
This is especially relevant because now more than half of voluntary insurance product sales in U.S. come from group policies. Our strong brand and market-leading status only serve to broaden the appeal of our products to consumers throughout the United States.
We've built a diverse yet focused product line that's sold through broad distribution network of over 76,000 commission sales associates. Additionally, although it's in the early stages, we're expanding our relationships with large national brokers to access the larger case market. We believe our distribution network is a competitive strength that no other company has been able to replicate.
Our strategy and competitive strengths are all designed to leverage our brand, while providing valuable products to consumers. For the year, total new annualized premium sales were roughly flat increasing eight-tenths of 1%. However, I’d note that our premium income increased 5.4% reflecting much improve policy persistency.
AFLAC U.S. has experienced better than expected top and bottom line growth for 2012, but sales will remain challenging in 2013. For several years small businesses remain cautious and even skeptical about their future, and in turn about making expenditures.
This has led to low rates of hiring new employees for many of these employees and given that about 90% of our products are sold at these small businesses who have been hit the hardest employment levels have negatively impacted, our universal potential policyholders which has been a big challenge for us.
While we can't control the challenging economic environment in the U.S., we certainly can position our business to maximize potential for success in the current environment. We've continued to improve the structure of our marketing and sales area to maximize our future growth. Taking this into account we expect AFLAC U.S. sales for 2013 through our traditional and broker channels to be in the range of flat to up 5% sales growth.
I’d like to point out that the first quarter will present the most difficult challenge. We wouldn’t be surprised if sales were down slightly considering that the first quarter of 2012 reflected our biggest percentage increase last year.
With our strong brand, consumers are more receptive to hearing how AFLAC products can help them. This opens up greater possibilities for our traditional sales for us and broker channel alike. We continue to believe that the U.S. represents the vast opportunity for growth. And we’re building our business with that potential in mind.
This slide shows the most recent data from the U.S. small business administration. The United States has more than 5.7 million businesses with fewer than 500 workers. And these small businesses employ more than 56 million people.
While our focus has been on the smaller employers that we’re expanding our reach from connecting with primarily small businesses to businesses of all sizes. Our portfolio of group and individual products provides consumers with outstanding value while giving the employers the choices that they demand.
As a result, the AFLAC brand outshines those of its competitors in both the individual and group voluntary markets. So beyond just name recognition, it’s important that consumers associated to AFLAC brand were paying claims fairly and properly.
Just as we promised, given the importance of the healthcare reform, otherwise known as PPACA or sometimes referred to as Obamacare. We believe that as our sample merit in 2013 and going forward, that will have some uncertainty in the market. And that’s because business and employees will try to understand how these changes in healthcare delivery and healthcare financing will affect them and as they find out what their different options are.
We believe our strong brand will be more important in this period of transition as businesses and consumers look to do business with the accompany that has a solid reputation. With our trusted and well recognized brand, we believe that we can be there to protect those, we ensure against income and asset loss when the health of that causes these financial challenges. We believe that coming years will provide a significant opportunity for growth in the U.S.
Now, let me discuss our general investment philosophy, including how we’re adapting to the changing global economic environment, the composition of our portfolio and our approach to managing potential financial risk. As we have stated for many years, our greatest investment challenge has been to invest AFLAC’s significant cash flows that have reasonable investment deals.
First and foremost, we consider the nature and the relation as the liabilities on our investment support. This means, we primarily invest over the long term and the strong cash flows through our persistent book of business give us the ability to continue to invest from this perspective.
Following four years of significant portfolio de-risking, we have considerably reduced our exposure to perpetual securities to investments and the peripheral European zone and financial institutions especially in Europe. We’re pleased with our progress and our focus today continues to be on liquidity, flexibility and diversification.
Credit quality remains the central aspect of our investment approach. At quarter end, more than 95% of our portfolio was investment grade. And the portion of our senior debt holdings increased from 86% at the end of 2011 to over 92% at the end of 2012.
Our objective is to have a portfolio that’s diversified by the geography and industry while focused -- remaining focused on high quality investments. The vast majority of these investments in Japan are in JGBs which provide a measure of liquidity and stability.
Now, let me discuss how we’ve substantially enhanced our investment portfolio over the last few years. From January 2008 to the end of 2012, we dramatically cut our holdings of sovereign and financial instruments in the PIGS countries. We’ve also lowered our investments in perpetual securities. And the successful derisking program that we completed in mid 2012 has enabled us to focus on enhancing portfolio quality.
The U.S. corporate bond program we initiated in the third quarter of 2012 continues to be an effective means for enhancing our new money yields in the Japan portfolio. You’ll recall in the last half of 2012, our objective was to invest roughly two-thirds of our investment cash flow and U.S. dollar denominated publicly traded corporate bonds and then hedged the currency risk on principal back to yen.
This successful investment program enabled us to surpass our budgeted new money yield for 2012. And it has also provided greater liquidity and enhanced the flexibility of our portfolio while increasing the opportunities to diversify our portfolio beyond JGBs.
At December 31, this U.S. corporate bond program represented about 6.2% of our total portfolio. In light of the success of the corporate bond program last year and strong credit fundamentals of the investment grade corporate credits, we intend to continue this program in the first quarter of this year. Consistent with our asset allocation program, we’ll balance these investments with some JGBs for diversification and liquidity as well as other investment opportunities as they arise.
Our ability to continue to implement new strategies is based on the evolving capabilities of the AFLAC global investment division. We’re going to continue to build this framework to support investments and newer asset classes and then move forward accordingly and we’ll update you on our progress with our analyst meeting in May.
We’ve defined our investment objectives as maximizing risk adjusted performance subject to our liability profile and capital requirements. It’s important to note that all of our strategies have been back tested against our capital ratios and the ratios we’re trying to achieve.
Now, let me spend the last portion of my discussion updating you on the consolidated financial performance and capital management at AFLAC. We’ve delivered consistently strong operating performance achieving 14.7% compound annual growth rate and operating earnings per share from 2002 through 2012.
This achievement demonstrates our ability to generate significant cash flows and organic growth in our capital basis for various market cycles. The average yen-dollar exchange rate in 2012 was 79.81 yen to the dollar, which was essentially unchanged from the 79.75 statistic rate in 2011.
However, we still believe that viewing our results, excluding the impact from foreign currency, it was the most meaningful way to evaluate our financial performance. On that basis, we were pleased with our results this year from a financial perspective.
I’m also very pleased with the strength of our capital ratios, which demonstrates our commitment to maintaining financial strength and flexibility on behalf of our policyholders, shareholders and bondholders. Through strong plus growth and improved portfolio risk profile and a weaker yen, our capital ratio has improved significantly in 2012.
As we’ve communicated over the past several years, maintaining strong capital ratios is measured by the risk-based capital ratio in the U.S. and the solvency margin in Japan remains the top priority for us. As you’ll recall, our goal was to reach year-end 2012 with an RBC ratio in the range of 400% to 500%.
And at the end of 2012, we actually achieved 630% which was up significantly from our 2011 year-end ratio of 493%. As indicated in Japan’s filed financial results, AFLAC Japan’s capital strength is measured by the solvency margin was also very strong at 669% as of December 31, 2012.
This result was well above our targeted range of 500% to 600% and an improvement over the solvency margin ratio at September 30, 2012 that came in 628%. In addition to focusing on our capital levels, maintaining an industry leading return on equity is also important to us.
Accordingly, the compensation committee of AFLAC’s Board of Directors made a decision just last week to include the operating return on equity as a component of our bonus structure for AFLAC senior management. On an operating basis, our 2012 ROE was 24.6%.
Now, keep in mind that our ROE is sensitive to currency fluctuations because we’ve hedged most of our equity but not our earnings in the dollars. This means when yen weakens our ROE may decline although our debt-to-total capital will also come down a bit as we have the yen-denominated debt on our books.
Therefore the yen remains in the range as it has been for the last several weeks. I think it’s reasonable to expect our ROE for 2013 to range between 20% and 25%. As we’ve said before, given our capital structure, our ability to repurchase shares is largely tied to profit repatriation from Japan.
And in contemplating profit repatriation, our first consideration is the protection of our policyholders as measured by the solvency margin ratio. And next, we give consideration to the needs of the parent company and consult with the Japan management in making our final determination.
We now expect profit repatriation to approximately 50 billion yen in 2013, which we believe is a reasonable estimate, assuming that we have no significant additional investment losses, which would reduce AFLAC Japan’s net income.
Profit repatriation in 2013, could provide us with a significant amount of capital that can be deployed through share repurchase. Our capital strength, enable us to increase our cash dividend to shareholders in the fourth quarter for the 30th consecutive year. Our objective is to grow our dividend, shareholder dividend at a rate that’s in line with our earnings per share growth, considering the affect of the yen.
Given the strength of our capital ratios in our parent company liability, the liquidity, we resumed our share repurchase activities by buying approximately $100 million worth of our shares in the fourth quarter in 2012. And it’s our current plan to purchase $400 million to $600 million of shares in 2013.
I understand that unless an extraordinary event occurs, we intend to purchase at least $400 million worth of our shares this year. We are proud that the rating agencies have recognized our financial strength and balance sheet. Our financial strength continues to be rated A+ by A.M. Best, Aa3 by Moody's and AA- by S&P.
And we believe that in the analysis of operating earnings, which is a non-GAAP financial measure is important to understanding of AFLAC’s underlying profitability drivers. We define operating earnings as profit derived from our operations, before realized investment gains and losses from the securities transactions, any impact from derivative activities in hedging and non-recurring items that might occur.
On an operating basis, we have a long history of producing strong operating earnings growth. We continue to believe that these operating earnings excluding currency change is the best measure of our success to growing our business. Exclusive to currency changes, the operating earnings per share diluted share was 5.1% in 2012, which was toward the high-end of our 2012 earnings objective that we had estimated at 3% to 6%.
We continue to focus on maintaining strong fundamentals in our core business and building on our record of earnings growth. I also want to reiterate that our objective for 2013 is not changed. We want to increase operating earnings per diluted share about 4% to 7%, excluding the affect of currency. This range reflects the impact of portfolio derisking over the last several years and investing our significant cash flows in the low interest rate environment.
I’d also like to point out that our operating EPS in 2012 was actually better than we expected. In large part, due to a deferred coupon we received on our security that we had impaired and an effective lower annual tax rate. This will present a more challenging comparison in 2013 than we expected, when we first established those estimated earnings goals for 2013. But we are in a strong position to achieve our objective.
This slide shows our 2013 earnings might look, both with and without the impact of currency. Again, on a constant currency basis of 4% to 7% objective would yield something in the range of $6.86 to $7.06 in operating earnings per diluted share. And we estimate that one yen change in the average annual exchange rate would equate to about $4.02 in per share earnings in 2013.
In summary, we would like to report that we remain focused on our vision to be the leading provider of voluntary insurance in the United States and the number one provider of supplemental insurance in Japan. We have confidence in our business model, the fundamental need for our products and most importantly, the future success of our AFLAC.
Thank you for your attention. Now, if we have any time I will be glad to respond to some questions.
It’s the Q&A. So, I will kick off with just one and then open it up with anybody in the audience who has a question. Maybe you could start just talking a little bit about competitive trends in Japan across different channels and products, and maybe what gives you confidence that you will be able to grow cancer medical sales in 2013?
We are the leading provider of both cancer and medical insurance in Japan. Most of you know, many of you know, 2012 was a big year in the bank channel and we wrote a lot of life insurance in the bank channel in Japan. Part of that was created by declining trends of interest rates that started in the latter part of 2011 and continued on through 2012.
When the bank channel was first deregulated to allow banks to sell life and annuity products and medical products that occurred late 2007, we put a big emphasis on trying to get our medical products into the bank channel. We already had good relationships with almost all of the 400, some 400 banks in Japan because they had AFLAC agencies that would sell.
They had insurance agencies that would sell AFLAC products to their employees that when the liberalization of the distributing rules came about they were permitted to sale third-sector products and life insurance products to their customers as well as their employees. And so that created a new source of profits for the banks that have been in financial -- weak financial condition for sometime, gave them a good opportunity to have a new profit sale.
So as part of selling more and more insurance products and they sold. They traditionally have sold annuity business and investment trust type products and they got into the variable annuity business a lot and some of that suffered in the financial crisis. And so what happened was after the financial crisis, they turn to companies that did not have difficulty, AFLAC had some difficulty with its investments in the life. We didn’t have the same kind of difficulty. Some of the other foreign companies in Japan had so.
They looked at AFLAC as a trusted financially strong company and they really started selling a lot of our life insurance business. And as interest rates started to decline in 2011 and going on through 2012, some of the other life companies pulled back some of their products and because our product is not an hypersensitive product in the sense that we vary the rate we created to customers and our products sells significant surrender charges that give us some protection against this intermediation risk. We continue to sell through the bank distribution and they found our products relatively attractive to other products that will be unsold.
So we had a big increase in life sales throughout 2012. As interest rates continue to decline, we started feeling some margin pressure on that. So we adjusted some of our product power points. We pulled the 5-pay version of our WAYS product and ramped with our -- our 10-pay version gave us a 10-year period that we could assess surrender charges in the event of early lapse. We finally cut the discounted advanced premium rate. We were crediting our own premium deposit funds from 1% to 0.5%. That restored some of our profitability margin in the life.
And what’s going to happen next is April 1, 2013, the FSA is having to change its so called standard valuation interest rate from 1.5% to 1% on all products, all life products in Japan. So many underwriters will be increasing premium rates and that will help restore profitability through at that time. We are going to increase our premium rates in response to that changing rate and we think that will restore the profit margin on our WAYS product to about the same level that we have on our health products.
And so we think that that will also cause a reduction in the life sales to some extent. So you frame the question in terms of competition early on. We expect that we will be somewhat less competitive in the life side of things, but I think it will be what I’m referring to as kind of a return to normal thing where life sales aren’t half of our portfolio.
We intend to reemphasize selling third-sector health products, which is our core competency in Japan. And we are the leading seller of the third-sector medical and cancer business there and we intend to continue to reemphasize that in 2013. We think we’ll achieve a lot of success with that and we are emphasizing that both in our bonus structure, in our sales incentives in the life. So that’s what we expect to see in 2013.
Okay. Thank you. Unfortunately, I think we don’t have a lot of time but I appreciate your comments.
Okay. Well, thank you very much. We’ll have some one-on-one sessions later. Thank you.
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