AFLAC Incorporated (NYSE:AFL)
KBW Insurance Conference
September 26, 2013 09:30 AM ET
Kriss Cloninger - President and CFO
Jeff Schuman - KBW
Jeff Schuman - KBW
Okay it’s great to have some folks from Aflac with us today. First of all let me introduce couple of people at front, Robin Wilkey, Head of the Investor Relations team and David Young who works with her in that group, thanks for being here. Our speaker today is well known to many of you Kriss Cloninger, who’s been with Aflac for many-many years and continues to serve as Aflac Incorporated's President and CFO and welcome back to conference Kriss.
Well thank you Jeff and good morning to all of you, it’s a pleasure to join you at this year’s KBW Insurance Conference.
Before we start, let me remind you that some statements in this presentation are forward looking within the meaning of U.S. federal securities laws; and 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. Please review our annual report on Form 10-K, for some of the risk factors that could cause the actual results to differ materially from those we discuss today.
Aflac strategy for growth in Japan and the United States has remained straightforward and consistent for many years. We developed relevant voluntary insurance products and sells them through expanded distribution channels, which yields new accounts and customers. Aflac does business in the two largest insurance markets in the world, Japan and the United States. Our products and policies cover more than 50 million people worldwide.
And our products provide a layer of financial protection against the loss of income and assets by paying fixed cash benefits directly to an insured based on health of event or a life situation. Our operations in Japan account for about three-quarters of our pre-tax insurance earnings. 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 enforce.
Our third sector cancer and medical products have been and continue to be our pillar products and the foundation of our portfolio. For 2013, we are refocusing our sales efforts on our traditional cancer and medical third sector products. In fact, we introduced a new medical product last month that was designed to appeal the consumers in the age range from 20 to 40 which is an area where we are currently underpenetrated. Although it's too early to determine actual results, we expect this product will be very well received by consumers.
Aflac Japan was represented by more than 17,600 sales agencies at the end of the second quarter, equating to more than 84,000 licensed sales associates employed by those agencies. With continued distribution expansion inland, we are very pleased with the new alliance Aflac Japan signed with the Japan Post group in July.
As Dan Amos, our CEO indicated, we believe this alliance will be a game changer for us. Japan Post intends to gradually expand the number of post offices that offer Aflac’s cancer product from 1,000 to over 20,000 postal outlets. Also, pending regulatory approval, Japan Post Insurance or Kampo, will enter into an agency contract with Aflac Japan to begin distributing Aflac Japan's cancer insurance products at all of Kampo's 79 sales offices.
In consultation with the Japan Post group, Aflac Japan will consider developing an exclusive cancer product to be sold through Japan Post and Kampo. We believe Japan Post can and will be a meaningful contributor to our sales.
As you may know, we announced earlier this month that we have also formed a business partnership with Daido Life Insurance Company. Daido will sell Aflac’s cancer insurance policies to members of Houjinkai which is a nonprofit association, associated with 900,000 small and medium sized firms across Japan. Our new partnerships with the Japan Post Group and Daido Life further demonstrates the overall strength of the Aflac brand, a reputation for quality customer service and the value of our cancer insurance products.
Let me update you on Aflac Japan's performance for the first half of the year. Our overall sales for the first six months of the year were down 20.4%, ¥84.1 billion. For the first half of the year in yen terms premium income increased 9.2% and revenues grew by 9.8. Pretax earnings were ¥184 billion, up 15.2%. But keep in mind that in the second half of the year we anticipate stepping up our spending on advertising and promotional expenditures and projects that will improve our businesses over the long term.
I also want to remind you that for this year our sales target is based on Aflac Japan's third sector products which include the cancer and medical insurance. Remaining the leader of third sector products is important to us and continues to be the foundation of our product portfolio. Achieving this target is a top priority for our entire management team in the U.S. and Japan; taking into account the launch of our new medical product we believe our 2013 objective of a flat to 5% increase in third sector sales is reasonable and achievable.
We have experienced a tremendous amount of success leveraging our strong brand and our efforts to drive sales. For example to promote our new medical product we launched a campaign in Japan featuring the Black Swan, a new dark character that represents the arch nemesis of the Aflac Duck. Black Swan's goal is to tempt consumers to make bad decisions about life and health insurance but the Aflac Duck saves the day by reminding consumers to make a sound positive and healthy choice in life including the decision to purchase medical insurance.
Now let me just say that this is a Japanese team that comes up with these ideas, not me. But they are pretty good because they tend to work. By leveraging the popularity of the Aflac Duck through different characters over the years, nine out of 10 people in Japan recognize the Aflac brand. And we'll 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 citizens still have significant at pocket cost associated with healthcare, and as such we believe the need to Aflac's products will only continue to grow. Given Japan's aging population and declining birthrate this national healthcare system is been under great financial strain and co-payments for salary workers under age 70 have grown to 30% of the calls to medical treatments.
However these fiscal resources are tied in all areas including medical, nursing care and pension benefits, it's clear that this difficult financial situation will persist in Japan. As you can see the growth of medical expenses is significantly outpacing GDP growth, because of the rapidly aging population and how our co-payments for medical expenses, the market for medical products have been steadily increasing 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 Aflac U.S. operations. As you may know we distribute our voluntary insurance products at the worksite on a payroll deduction basis in the United States. The Aflac U.S. product portfolio includes a variety of voluntary insurance products designed to pay cash directly to consumers when a serious medical event presents financial challenges. These payments are made regardless of any other insurers the policy holders may have.
Our group products align well with our individual product line and give us the ability to customize our product offerings for the brokers who typically sell to larger accounts. This is especially relevant because now more than half of the voluntary insurance products sold in the United States come from group policies. Aflac's strong brand and market leading status broaden the appeal of our products to consumers throughout the United States.
Our diverse yet focused product line is sold through a broad distribution network of more than 76,000 commissioned to sales associates. Additionally we continue to work on initiatives to expand our relationship with brokers to access the larger case market. And we believe our distribution network is a competitive strength that no other company has been able to replicate.
Our strategy and comparative strengths are all designed to leverage the Aflac brand while providing valuable products to consumers. For the first half of this year total new annualized premium sales were down 1.9%. We believe the market for our product has been impacted to some extent by uncertainty and confusion associated with the pending implementation of the Affordable Care Act. However, I would note the premium income increased 3.8% reflecting the strong policy persistency.
While we’re busy letting the ground work for future growth, we’re still working hard to achieve our annual sales target. Our goal is for Aflac U.S. sales in 2013 through our traditional and broker channels to be flat to 5%. With our strong brand consumers are more receptive to hear how Aflac products can help them. This opens up greater possibilities for our traditional sales force and broker channel alike.
We continue to believe that Aflac over the U.S. represents vast opportunity for growth and we’re building our businesses with that potential in mind. And this slide shows the most recent data from the U.S. small business administration. In the Unites States we’re more than 5.7 million businesses with fewer than 500 workers. And these small businesses employ that 55 million people.
Our traditional focus is been on smaller size payroll accounts, we believe our strategy for reaching large brokers, we’re better position Aflac in the large case market as well. Our portfolio of group and individual products provide consumers with outstanding value for giving employers the choices they demand. We believe our strong brand will be even more important and there is period of transition as businesses in consumers look to do business with the company. They has a solid reputation with our trusted and more recognized brand, we believe we can be there to product those we ensure against income and asset loss when a help event causes financial challenges. We also believe the coming years will provide great opportunity for growth in the United States.
Now let me turn to our investment portfolio. As we have stated for many years our greatest investment challenge is been to invest Aflac Japan’s significant cash flows and suitable investment that provide investment returns that meet or exceed our pricing and reserving assumptions. For almost on our mind is to invest in a way that takes our policy liabilities into consideration. Following four years of significant portfolio the risking we have conservable reduced our exposure to perpetual securities, big countries and financial institutions especially in Europe.
We are pleased with our progress and our focus remains on liquidity, flexibility and diversification. Our investment strategies have evolved in the sense of financial crisis and we manage these portfolio with specific objective. Almost 12% of our portfolio is made up of liquid U.S. corporate bonds with the principle hedge building in. Next year we expect to enhance our diversification by including other asset classes.
Overall, we’re pleased with the balance sheet to its improving quality, liquidity, return profile and diversification. Our objective is to have a portfolio there is diversified by geography in industry while focused on high quality investments. The vast majority of our investments in Japan or in JGBs have provide both measure of liquidity and stability.
Our ability to continue to implement new strategies is based on the evolving capabilities of our global investment division. We’ve defined our investment objectives as maintaining -- as maximizing risk adjusted performance subject to our liability profile and our capital requirements.
We’re pleased that our Japan new money yield for the first half of the year was 3.02% which is considerably higher than our new money yield of 2% in the first half of 2012. In light of the financial market volatility in both the United States and Japan in the second quarter our investment team has been carefully analyzing our asset allocation as well as strategies to help mitigate interest rate risk.
As such we expect to allocate the majority of third quarter cash flows to JGBs and underwrite the allocation to U.S. corporate hedge bonds we remain committed to further building out our investment functions and capacities to enable us to respond to a changing economic environment.
I’ll spend the last portion of my discussion updating you on the consolidated financial performance and capital management. Aflac Incorporated has a long history of delivering strong financial performance, although that performance has been periodically distorted by changes in the foreign exchange market. while the yen was little changed from 2011 to 2012, it weakened dramatically in 2013 due to the significant contribution of Aflac Japan’s operation to our overall financial results so weaker yen suppressed our results as reported in dollars. However our actually currency exposure is mostly translation related as opposed to currency transactions. As such we believe that during our financial results excluding the impact from foreign currency is the most meaningful way to evaluate our financial performance and that’s the basis that we have communicated to the street for many-many years.
We remain very focused on our capital ratios which demonstrate our commitment to maintaining financial strength on behalf of our policyholders, our shareholders and bond holders.
Through strong surplus growth and improved portfolio risk profile and a weaker yen, our capital ratios improved significantly in 2012. Our estimated RBC ratio at June 30 was 724 which is higher than our 2012 yearend ratio of 630%. Additionally, Aflac Japan solvency margin or SMR was 585% at the end of June compared to 686 at the end of March this year. That decline in SMR was primarily due to spike in U.S. interest rates and the increase in Japanese interest rates, which lowered the market values of the available-for-sale investment portfolio in Japan. I point out at that the second quarter SMR remains at the high end of our targeted range of 500% to 600%.
As we think about capital levels and how they tied to profit repatriation, our first consideration is the protection of our policyholders as measured by the SMR. Next we consider the needs of the parent company and consult with Japan management in making determination regarding repatriation. And in July we repatriated 76.8 billion yen.
You will recall that we entered in hedging transactions for the vast majority of our anticipated repatriation at a weighted average exchange rate of 96.4 to dollar and that resulted in a dollar repatriation of approximately $800 million in July.
We believe that in the analysis of operating earnings which is a non-GAAP financial measure is important to an understanding of Aflac underlying profitability drivers. Aflac defines operating earnings as profits derived from our operations before realized investment gains and losses on the securities transactions, the impact from derivative activities and hedging as well as nonrecurring items.
On an operating basis, we have a long history of producing strong earnings growth. As this chart shows the growth in operating earnings for diluted share was held back by the weakening of the yen to the dollar in the first half of 2013. However excluding that impact growth and earnings per share was strong.
As we have said for many years, when it comes to deploying excess capital, we still believe the growing the cash dividend and repurchasing our shares are the most attracted means in those of the avenues we will continue to pursue. Our objective remains to grow the dividend at rate that’s in line with operating earnings per share growth before the impact to the yen.
We repurchased approximately $129 million or about 2.3 million shares of our common stock during the second quarter. For the first half of the year, we repurchased 279 million or 5.3 million shares.
We have a lot of flexibility at the parent company in terms of liquidity and it’s still our intention to repurchase approximately $600 million of our shares for the full year 2013.
We continue to focus on maintaining strong fundamentals in our core business and building on our record of earnings growth. Our objective for 2013 is to increase operating earnings per diluted share, about 4% to 7% excluding the impact to the yen. Although, we are above that range for the first half of the year, we do plan on increasing spending in the second half of 2013, in Japan we will increase expenditures on advertising and promotion for our new product launch, in the United States we anticipate increased cost associated with initiatives related to healthcare reform. As such we expect operating earnings to increase approximately 5% for the full year, before the impact of foreign currency. Generating an industry leading return on equity, again I am excluding the earning impact is also an important objective.
On an operating basis, our second quarter annualized ROE was 22.1% and had the Yen remained unchanged since the end of March, our operating ROE would have been 25.4% in the second quarter. Based on our year-to-date returns we expect to meet or exceed our ROE target of 20% to 25% excluding currency for the full year.
This slide shows our 2013 EPS might look both with and without the impact of currency. On a costing currency basis, our expectation of a 5% increase equates to operating earnings for diluted share of $6.93. We estimate that one year change in the average annual exchange rate will equal about $0.043 per share in earning in 2013.
If the Yen average is 100 for the full year, we would expect reporting operating earnings of about $6.06 per diluted share. We remain focused on our vision to be the leading provider of voluntary insurance in the United States and the No.1 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 Aflac.
Thank you that concludes my presentation. Now we will be happy to respond to some questions, if we have time Jeff.
Jeff Schuman - KBW
We do have some time for questions. Thanks for your comments. And I certainly will get to some questions in the audience. But I am going to kick off with one myself here. You alluded to the fact that you have been working to reduce the SMR rate sensitivity. I think you said recently that you had moved about 600 billion yen into the policy matching reserves structure. I wonder if you can give us a perspective on the extent to which that moved, and maybe some hedging in the U.S. corporate portfolio. You have actually mitigated some of the volatility and what is the end goal here in terms of how much you really want to damp out of that?
Okay, well at the last conference I spoke at a couple of weeks ago, I did tell the investment community that we had moved approximately 600 to 700 billion yen, JGBs from being classified as available for sale status that gets mark-to-market in the financial statements. Two of so-called policy reserve matching status on our Japan regulatory statements and well, Japan regulatory statements had determined the solvency margin.
During the second quarter, I think it was somewhere between 30% and 40% of the interest rate change on Japan and interest rates that caused volatility in our mark-to-market, that affected SMR so the 600 to 700 billion yen, and is not all of our JGB portfolio that's classified as available for sale. But it’s all of it that’s not required to be held for liquidity purposes under our investment guidelines, so about two thirds of that mark-to-market on the JGBs got eliminated from the sensitivity.
In addition told the audience that we had hedged a portion of our U.S. corporate dollar bond holdings that had been hedged into yen, less than a majority but a significant portion. And so that’s been used to minimize volatility in U.S. centers rates against the impact on SMR. I talked about a couple of other measures that we would use to improve SMR that we would considered reinsurance being one of them and we have continued to investigate that sort of opportunity during the third quarter.
Jeff Schuman - KBW
So if the JGB have accounted for 30% to 40% of the second quarter volatility, is the balance entirely attributable to the U.S. corporates or is there another element in there somewhere?
No, the U.S. corporates would be, most of the difference has, I think like many other categories, right on top of my head that contributed significantly to that, so the U.S corporates would be the bulk of the remainder.
Jeff Schuman - KBW
Okay, then in terms of the reserve matching structure, is there any downside to adopting that structure, and do you think there is not a lot of downside, is there some reason why have precluded from or didn’t sort of move to that structure at a different point in time?
Well the policy reserve matching structure had been available for a number of years. We had not previously used it because we classified a significant portion of our JGBs as held to maturity. We didn’t believe we needed to trade those so we classified them as held at maturity and they are automatically carried an amortized cost. There are some documentation requirements when you use the policy reserve matching category. You have to match a block of assets against a specific block of liabilities and there is some internal things that have to do you have to do but we decided that given the volatility and interest rates we were better off taking the advantage of that opportunity to utilize that classification this quarter.
Jeff Schuman - KBW
Okay, thank you. Questions from the floor, okay, I’ll keep going. Can you give us a little more perspective on the what you describe as a tactical decision to direct new money more towards JGBs than U.S. corporates in the third quarter. Is that some of that simply to once again by JGBs because they are more available to the reserve matching structure or is it some kind of market call or what really sort of has driven that decision?
Well, I think that we have made significant commitment to investing in the hedged U.S. corporate bond program over the last three quarters and we’ve reached the point in our investment portfolio where we decided to take a breather basically because we have to utilize currency hedges on the principle of those corporate bonds to achieve our currency matching objectives. And we also decided that we want to further evaluate the use of interest rate callers and other derivatives to minimize the interest rate risk associated with assets we’ve bought primarily in the third quarter. So I’ll say it’s a pause just allowing us to sit back and evaluate where we are today and where we are going forward in light of the increased volatility in the interest rate market.
Jeff Schuman - KBW
Okay, can you maybe talk a little bit more about Japan Post? I know that you’re not able to talk in terms of numerical targets but maybe a little help in terms of kind of roughly how that might roll out? Is this something that we should think is going to roll out very gradually over a period of couple of years or is it more quickly than that or how might that kind of roll out?
Yes, we’ve been in a test effort for the last several years with Japan Post. But the leadership of Japan Post was restructured in late June of this year. The board composition was changed rather significantly and it became a highly business oriented board. I think to align with the objectives of possibly having an IPO associated with Japan Post Holdings. And the way that affected Aflac was the new leadership of Japan Post decided to expand the program allowing Japan Post agents and compo agents to write the Aflac cancer policy. And so we expand to see we expect to see an expansion of the number of postal outlets that actively market the Aflac cancer product to expand over a several year period we can’t go from 1,000 post offices to 20,000 post offices October 1 but I think we’ll gradually see a ramp up of the number of postal offices in which Aflac products are available and distributed to increase over the next several years. And I believe that our distribution will be more immediately available through the compo sales offices.
Jeff Schuman - KBW
Do you have to build out a lot of wholesaling capacity to support this or not?
A lot of what capacity?
Jeff Schuman - KBW
Wholesaling capacity, for example did you actually have posted was it will be dedicated to the post offices or not?
We’ve been working with the bank channel quite a bit for the last five years and we have gradually ramped up our training processes with the banks and the bank branches. And I think we’ll apply those kinds of resources and experiences to helping develop the marketing relationship with the Japan Post. So if that’s primarily which you’re talking about in terms of wholesale capacity I think that’s a…
Jeff Schuman - KBW
You guys have you’ve been talking for some time about building more robust investment strategy. Can you give us some specifics on what you’re trying to do now and what we might expect in the future in that group?
Yes, our team continues -- our global investment team continues to develop their transformations strategy with the assistance of McKenzie (ph). They have been working with that organization for probably the last 18 months to flesh out other strategies for Aflac including utilization of outsourcing capabilities and evaluating different asset classes that might be utilized in our investment portfolios.
So I would say that you will get an update on that during the third quarter conference call. I think that updates better coming from our Global COO than myself because he is more intermittently familiar with the progress on that. But our investment committee of the board has been inactively engaged and evaluating and overseeing the changes in our investments strategy. And right now, I think we're as I earlier described the kind of sitting back and evaluating the progress we've made over the last 12 months and looking forward to how we ought to allocate our new asset acquisition strategies over the next six months in light of the changes in interest rate environment and the like.
Jeff Schuman - KBW
Maybe I'll just get one in here. The Affordable Care Act is obviously a big deal in your U.S. world, I guess, you’ve talked a little about the current impact and some disruption in the marketplace, so I guess the first question is, does that disruption get maybe worse before it gets better? And as you kind of look through that to maybe more of a voluntary benefits world that’s something that plays well to Aflac and maybe just give us a little more information on your plans to have your own private exchange?
Right, well we do -- we have developed the ability to offer an Aflac exchange that will distribute both Aflac voluntary products and partner company major medical products. What we envision is that some of our small account customers will evaluate the ways in which they help their employees acquire health insurance and we intend to offer them the opportunity to have their employees purchase major medical insurance through a partner company over the Aflac exchange and to determine whether they need additional voluntary insurance coverage using some our traditional core products such as accident disability, cancer, hospital indemnity and the like.
So we we’re going to be testing those effective October 1st which is the date some of the state exchanges are going to start to operate and the like. As far as how that all goes, I think the verdict is out relative to how streamlined the activity within the state exchanges and the like is going to be and I think that will impact to how exchanges are viewed by the American Health Insurance consumer going forward.
Right now, we’re sort of optimistic that it will go well with the Aflac Insurance Exchange and we hope it goes with the other states exchanges and we hope that because we’d like to see some of the confusion and uncertainty regarding health insurance availability clarified particularly in the small business markets so that our customers will have a better sense of how they ought to go about helping their employees acquire health insurance.
Jeff Schuman - KBW
That’s very helpful and we’re going to need to leave it there, but thank a lot guys.
Thank you very much. We appreciate the opportunity.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!