AFLAC Incorporated (NYSE:AFL)
Goldman Sachs Financial Services Conference
December 10, 2013, 12:30 PM ET
Kriss Cloninger - President, Chief Financial Officer and Treasurer
We're going to get started here with our next presentation. We're pleased to have Kriss Cloninger, President and CFO of Aflac with us. Kriss joined Aflac in 1992 as the CFO, and earlier this year was announced he is committed to staying with the company for at least another four more years. Over the years he's been recognized on a number of occasions as one of the best CFOs within the insurance space.
So with that, I'm going to turn things over to Kriss.
Well, thank you, and good afternoon. It's a pleasure to join you at this year's Goldman Sachs Conference. But before we start, let me remind you that some statements in this presentation will be forward-looking within the meaning of federal securities laws. Although, we believe these 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 for some of those risk factors that could cause actual results to differ materially from those we discuss today.
Aflac does business in the two largest insurance markets in the world, Japan and the United States. And our policies cover more than 50 million people worldwide. Aflac products provide a layer of financial protection against loss of income and assets by paying fixed cash benefits directly to an insured based on a health event.
Our strategy for growth in Japan and the United States has remained straightforward and consistent for many years. Aflac develops relevant voluntary insurance products and sells them through expanded distribution channels, which yield new accounts and customers. Aflac's operations in Japan account for about three quarters of our pre-tax insurance earnings. Today, we're the number one life insurance company in Japan in terms of individual policies in force.
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're refocusing our sales efforts on our traditional cancer and medical products. In fact, we introduce a new medical product in August that was designed to appeal to customers in their 20s to age 40s, which is nearly that we're currently underpenetrated. This product has been very well received by consumers in the short term it's been out and we expect it will continue to be well-received in the long run.
Aflac Japan was represented by more than 16,900 sales agencies at the end of the third quarter, equating to more than 127,000 licensed sales associates employed by those agencies. With continued distribution and expansion in mind, we're very pleased with our new alliance agreement Aflac Japan signed with the Japan Post, in July of this year.
As Dan Amos, our CEO, has indicated, we believe this alliance is a game changer for Aflac. Japan Post intends to gradually expand the number of postal offices that offer Aflac's cancer policy from about 1,000 postal outlets today to over 20,000, total 20,000 postal outlets in a few years.
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 product 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 Aflac Japan sales.
Now, let me update you on Aflac Japan's performance for the first three quarters of this year. Overall, sales for the first nine months of the year were down 27.8% to JPY116.5 billion. For the first three quarters of the year in yen terms, premium income increased 8.3% and revenues grew by 9.1%. Pre-tax earnings were JPY268 billion, up 12.6%.
Keep in mind, that in the fourth quarter we anticipate stepping up our spending on advertising and promotional expenditures as well as projects that improve our business 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 cancer and medical insurance. Remaining the leader of third sector product distribution is important to us and continues to be the foundation of our product emphasis. Achieving this target is a top priority for our entire management team in Japan and the U.S.
And taking into account the launch of our new medical product that we believe our 2013 objective of achieving flat to 5% increase in third sector sales is both reasonable and achievable. We have experienced tremendous amount of success leveraging our strong brand in our efforts to drive sales for example to promote our new medical product in August.
We launched an advertising campaign in Japan featuring the, Black Swan, a dark new 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 sound, positive and healthy choices in life, including the decision to purchase medical insurance.
By leveraging popularity of the Aflac Duck through different characters over the years, nine out of 10 people recognize the Aflac brand. 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 the citizens have significant out-of-pocket costs associated with healthcare. As such, we believe the need for Aflac products will only continue to grow. Given Japan's aging population and declining birth rate, this national healthcare system has been under great financial strain and co-payments for salaried workers under age 70, have grown to 30% of the cost of their medical treatments.
However, as national fiscal resources are tight in all areas including medical, nursing care and pensions benefits, it's clear that this difficult fiscal situation will persist in Japan. As you can see the growth of medical expenses is significant outpacing GDP growth. And because of the rapidly aging population and higher co-payments for medical expenses, the market for medical products has been steadily increasing and this trend is expected to continue. We believe we can expand our leading position as the medical market continues to grow in the future.
Now, let met turn to Aflac U.S. operations. As you may know, we primarily distribute our voluntary insurance products, at the worksite on a payroll reduction basis in the U.S. To help grow our U.S. business, we're pursuing initiatives that fall into four strategic pillars. The first three pillars include enhancing our distribution capabilities, focusing on product innovation and owning our customer experience. And the fourth pillar centers around strengthening our low-cost model. In fact, this initiative helps fortify and fund the first three pillars.
Aflac is always focused on being a low-cost producer and we don't view this endeavor as cutting expenses to the bone, rather we view it as allocating our resources deliberately and exclusively toward initiatives that help us achieve our sales and financial objectives. The 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. Now, these payments are made regardless of any other insurance policyholders 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. Now, 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 only broadens the appeal of our products to consumers throughout the United States.
Our job is to be where consumers want to purchase Aflac products. It's our intension to sell through traditional distribution channels as well as non-traditional channels. These include commission sales associates, brokers both large and small. Our diverse, yet focused product line is sold through a broad distribution network of almost 76,000 commission sales associates. And we believe our distribution network is a competitive strength that no other company has been able to duplicate.
We're also currently focused on a pilot, where our proprietary Aflac exchange is a means to help solidify our leading position in the small business market, which represents our core market. Following our assessment of this pilot program, which will run through early 2014, will determine the best course of action for rolling out our exchange throughout the rest of the United States.
Additionally, as I mentioned, we're continuing to work with brokers on a local, regional and national basis, to give us better access to the large case market. We're already represented on about 60 enrolment platforms with various brokers and as we work at expanding and enhancing relationships with large brokers, we'll also pursue private exchange opportunities with those brokers.
We also continue to seek opportunities to leverage our strong brand and relevant product portfolio in the evolving healthcare environment. Our strategy and competitive strengths are all designed to leverage the brand, while providing valuable products to consumers.
For the first nine months of this year, total new annualized premium sales were down 1.7%. And we believe the market for our product has been impacted to some extent by uncertainty and confusion caused by the pending implementation of the Affordable Care Act. And while the unemployment rate has shown some improvement in the United States, hiring remains weak, especially at smaller employers, where 90% of our business is written. I would like to note, however, that premium income increased 3.5%, primarily reflecting strong policy persistency.
While we're busy laying the groundwork for future growth, we're still working hard to achieve our annual sales target. Our goal is for Aflac U.S. sales for 2013 through our traditional and broker channels to be flat-to-up 5%. Aflac's strong brand has served as an effective door opener that has been a catalyst for many consumers and payroll accounts to be more receptive in hearing how Aflac products can help them.
At the same time, our well-known brand has increased expectations for servicing from our payroll accounts, our distributors, consumers and policyholders. That's why our focus on customer service is one of our strategic pillars and we have initiatives underway to support that pillar. Doing so, should open up greater possibilities for our traditional sales force and the broker channel alike. We continue to believe that the U.S. represents a vast opportunity for growth, and we're building our business with that potential in mind.
In order to enhance the relationships, we have large insurance brokers throughout the United States, who are working to build out our sales force with Aflac Group Insurance in Columbia, South Carolina. This will help position us to continue to develop relationships with larger brokers, who can in turn offer voluntary products to their clientele. In many cases, taking voluntary products to their clientele means partnering with brokers and are being represented on their exchange and that's certainly a path that we will pursue.
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 about 55 million people. Although, our traditional focus has been on smaller sized payroll accounts, we believe our strategy for reaching large brokers will better position Aflac in the large case market as well.
Our portfolio of group and individual products provides consumers without spending value, while giving employers the choices they demand. We believe that our strong brand will be even more important in this period of transition as businesses and consumers alike look to do business with companies that have a solid reputation.
With our trusted and well-recognized brand, we believe we can be there to protect those that we insure against income and asset loss, when a health event causes financial challenges. We also believe that the coming years will provide great opportunity for growth in United States.
Now, let me turn our investment portfolio. As we have stated for many years our greatest investment challenge has been to invest Aflac Japan's significant cash flows in suitable investments that provide investment returns that meet or exceed our pricing and reserving assumptions. Foremost in our mind is to invest in a way that takes our policy liabilities into consideration.
Following four years of significant portfolio derisking after the financial crisis, we have considerably reduced our exposure to perpetual securities, peripheral Eurozone countries and financial institutions, especially in Europe. We are with our progress, and our focus remains on liquidities, flexibility and diversification. Our below investment grade securities have been reduced to 4.5% from 6.9% in 2009.
Let me remind you of how successful we've been in enhancing the quality of our investment portfolio between January 2008 and the end of the third quarter. Over that period, we dramatically cut our holdings of sovereign and financial investments in the peripheral Eurozone countries from 5.9% to 0.9% of our total portfolio.
We've also lowered our investments in perpetual securities from 14.7% to 3.1%. Additionally, our investments in financial exposures have been meaningfully reduced from about 42% of the total portfolio to 15.6%. Finally, we've also lowered our investments in European holdings from 35.1% to 18.2%.
Our investment strategies have evolved since the financial crisis, and we managed each portfolio with specific objectives. Almost 12% of our portfolio is made up of liquid U.S. corporate bonds, with the principal hedged in again. Later next year, we expect to enhance our diversification by including other asset classes.
Overall, we're pleased that the balance sheet has improved in quality liquidity, return profile and diversification. Our objective is to have a portfolio that's diversified by geography and industry while focusing on high quality, the vast majority of our investments in Japan, our JGBs that provide both, the measure of liquidity and stability.
Our ability to continue to implement new strategies is based on the evolving capabilities of the Aflac global investment division. We've defined our investment objectives as maximizing risk adjusted performance, subject to our liability profile and our capital requirements.
We're pleased with our Japan new money yield for the first nine months of this year. It was 2.87%, which is considerably higher than our new money yield of 2.27% in the first three quarters of 2012.
In light of the financial market volatility in both the United States and Japan during 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 allocated the majority of third quarter cash flows to JGBs. We remain committed to further building out our investment functions and capabilities to enable us to respond to the changing economic environment.
I'll spend the last portion of this discussion updating you on our consolidated financial performance and our capital management activities. 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 between 2011 and '12, it has weakened dramatically in 2013 due to the significant contribution of Aflac Japan's operation to our overall earnings.
The weaker yen suppresses the results as reported in dollars. However Aflac's currency exposure is mostly a translation-related as opposed to transaction-oriented. As such, we still believe that during our results excluding the impact from foreign currency is the most meaningful way to evaluate our financial performance. We remain very focused on our capital ratios, which demonstrate our commitment to maintaining financial strength on behalf of our policyholders, shareholders and bond holders.
Through strong surplus growth and improved portfolio risk profile and a weaker yen, our capital ratios improved significantly during 2012. Our estimated risk based capital ratio as of September 30 is around 769%, which is significantly higher than our 2012 yearend ratio of 630%. Additionally, Aflac Japan solvency margin or SMR at the end of September was about 732% compared with 585% at the end of June this year. The increase in the SMR was primarily due to the execution of the reinsurance agreement in Japan.
As we think about capital levels and how they tied to profit repatriation, our first consideration is protection of our policyholders as measured by the SMR. Next we give consideration to the needs of the parent company, and we consult with Japan management in making a final determination.
In July, we've repatriated JPY76.8 billion and you may recall we entered into hedging transactions for the vast majority of our anticipated transaction at a weighted average exchange rate of JPY96.4 to the dollar.
We believe that analysis of operating earnings, which is a non-GAAP financial measure is important to an understanding Aflac's underlying profitability drivers. We define operating earnings as the profits derived from our operations before realized investment gains and losses from securities transactions, the impact from derivative activities and hedging as well as non-recurring items.
On an operating basis, we have a long history of producing strong earnings growth. As this chart shows growth in operating earnings per diluted share were held back by the weakening of the yen to the dollar for the first three quarters of 2013. However excluding that currency impact growth in earnings per share was strong.
As we have said for many years, when it comes to deploying excess capital, we still believe that growing the cash dividend and repurchasing our shares are the most attractive means and those are the avenues we will continue to pursue. Our objective remains to grow the dividend at a rate that's in line with operating earnings per share growth before the impact of the yen.
Aflac repurchased approximately $18 million or about 308,000 shares of common stock in the third quarter and for the first three quarters of this year the company repurchased $298 million or 5.6 million shares. We have a lot of flexibility at the parent company in terms of liquidity and it's our intension to increase our fourth quarter repurchase to about $500 million, which will bring total share repurchase in 2013 to $800 million worth of our shares for the full year.
We anticipate that our 2014 share repurchase will be in the range of $800 million to $1 billion worth of shares. 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 to about 4% to 7% excluding the impact to the yen.
We're nearer to the low end of that range for the first nine months of the year, but we still expect operating earnings to increase approximately 5% for the full year, before the impact of currency. If the yen averages 95 to a 100 yen to the dollar for the fourth quarter 2013 and for the full year of 2014, we would expect to achieve an EPS growth rate of approximately 2% to 5% per diluted share on a currency neutral basis for the full year.
This slide shows our 2013 EPS, might look both with and without the impact of currency. On a constant currency basis, our expectation of a 5% increase equates to operating earnings per diluted share of $6.93. And we estimate for the JPY1 change on the average exchange rate for the year will equal about $4.03 in per share earning in 2013.
So if the yen averages 100 for the full year, we would expect reported operating earnings to be 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 number one provider of supplemental insurance in Japan. We have confidence in our business model, and the fundamental need for our products, and most importantly the future success of Aflac.
Thank you. That concludes my formal presentation. Now, I'll be glad to respond to some questions, if we have some time Chris.
We have about five minutes or so for questions. If anyone has, anyone, please raise your hand. Maybe we can start towards the back half of your comments around capital management. We think about the third quarter call, you and Dan, both made the comment around capital returns accelerating, kind of the message that you heard from shareholders, and somewhat the reinsurance transaction went along those lines. And then you made a comment around the $2 billion potentially in terms of capital returns. Could you help frame kind of what type of environment would get us to that $2 billion number and over what period of time? Do you think that could be achievable?
Yes. Well, the actions we took there in the third quarter in Japan were meant to increase the absolute value of the solvency margin ratio and to enhance the stability or to minimize the volatility of the impact of interest rates and currency rates on the solvency margin ratio. And the reason, we want to stabilize the amount and volatility of the SMR is that it's a significant factor in deciding how much profit repatriation we can move from Japan to United States. Historically, we've moved about 80% of our operating earnings in Japan to the United States to primarily support share repurchase activity.
In 2013, we're going to pay approximately $600 million out to shareholder dividend and our repatriation target is about $800 million -- not the repatriation target, but the share repurchase target is about $800 million. So that totals about $1.4 billion of capital return to shareholders.
We said on the call that in 2014, our objective is to encourage share repurchase to the $800 million to the $1 billion range, which if we had the same shareholder dividend, it would equate to about $1.4 billion to $1.6 billion capital return to shareholders.
The $2 billion number that you referred to was kind of my next milestone, in my view. If we're able to increase Japan operating earnings over the next several years in a meaningful way, then it's possible that we would achieve the ability to have share repurchase and corporate dividends total $2 billion, but that's not part of our formal objective yet. I had to make a comment, well, maybe I shouldn't have thrown out that number, until we were ready to do it, but in my mind, the next stepping stone from a $1.4 billion to a $1.6 is $2 billion. And so that's what I've got insight in the foreseeable future.
In the U.S. you alluded to your exchange healthcare reform. You talked about being represented kind of on 60 platforms. Can you give a little insight in terms of those platforms that you're being represented on, kind of the relationships there? The product offering that you have? And when would we see kind of some key actions in terms of this being, a more meaningful piece to the story in the U.S.?
Well, the platforms I referred to are the conduit that the large brokers used to administer their own exchanges. I think they in many cases go to third-party providers of the software support and the like, and my administrative people refer to it as piping. We have piping between Aflac and the platforms used to administer these exchanges, so that we can automatically transfer the ability of that platform to support the issuance of an Aflac product.
So that's in place and we're working to establish relationships with brokers, so that Aflac products can be offered on their exchanges, and obviously that's an in-process activity. So we hope to see some results during 2014. And I don't know when it will be a meaningful impact on sales, but I hope 2014, I just can't guarantee that yet. So those are the prospects. That's what we're working toward as an objective. So that's a nutshell.
I think we're out of time. So thanks Kriss, thanks Aflac for your participation again this year.
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