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AFLAC Incorporated (NYSE:AFL)

Q4 2013 Earnings Conference Call

February 5, 2014 09:00 AM ET

Executives

Dan Amos - Chairman and CEO

Kriss Cloninger - President and CFO

Paul Amos - President, Aflac

Ken Janke - President, Aflac U.S, EVP and Deputy CFO, Aflac Incorporated

Eric Kirsch - EVP and Global Chief Investment Officer

Tohru Tonoike - President and Chief Operating Officer, Aflac Japan

Teresa White - EVP, Chief Operating Officer, Aflac Columbus

Robin Wilkey - SVP, Aflac Investor and Rating Agency Relations

Analysts

Christopher Giovanni - Goldman Sachs

Yaron Kinar - Deutsche Bank

Jimmy Bhullar - JPMorgan

John Nadel - Sterne Agee

Steven Schwartz - Raymond James & Associates

Tom Gallagher - Credit Suisse

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’d now like to turn the call over to Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations.

Robin Wilkey

Good morning everyone and welcome to our fourth quarter conference call. Joining me this morning is Dan Amos, Chairman and CEO; Kriss Cloninger, President and CFO; Ken Janke, President of Aflac U.S, Executive Vice President and Deputy CFO of Aflac Incorporated; Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us today from Tokyo are Paul Amos, President of Aflac; and Tohru Tonoike, President and COO of Aflac Japan.

Before we get started, let me remind you that some statements in the 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’re 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 will begin this morning with some comments about the quarter and the year as well as our operations in Japan and the U.S. I will follow-up with a few financial highlights for the quarter and the year and then we will be taking your questions. Dan?

Dan Amos

Thank you, Robin, and good morning. I am pleased that we met and in many cases exceeded our financial targets for the quarter and for the year.

Let me begin today with an update of Aflac Japan, our largest earnings contributor. Pre-tax earnings in yen were up 16.9% for the quarter and 13.6% for the year, reflecting a stronger dollar. Sales of our third sector products were up 15.7% for the quarter and for the year third sector sales increased 4%, which was at the high-end of the annual sales target of flat 5%. The increase in third sector sales largely reflects a favorable response to our newest ever medical product introduced in August and innovative advertising promotions of this product.

As anticipated our largest medical policy has proven especially popular with consumers in their 20s to 40s. Even our under penetration of this demographic, I’m especially pleased that these efforts do appeal to consumers in their 20s to 40s that yield very positive results for us. Consistent with our expectations, Japan’s new annualized premium sales in the fourth quarter declined 33.3% for the quarter and 29.1% for the year. These results are largely attributable to the significant decline in the sale of WAYS product following the repricing of first sector products in April.

Reflecting on the expansion of our distribution channels, we’re pleased with our agreement with Aflac Japan and Japan Post Holdings. I believe that in the coming years cancer sales through Japan Post will steadily benefit our business. If you recall the first sector sales particularly WAYS were very strong in the first three months of last year leading up to the premium rate increase that took effect in April of 2013.

As a result, we expect first sector products to be down 60% in the first quarter of 2014 due to very difficult comparisons to last year. However, the second through the fourth quarter of this year we expect the sale of first sector product to be slightly down compared to last year. Most importantly, though, our focus this year will remain on growing the sales of third sector products. As such, we anticipate third sector product sales to increase 2% to 7% in 2014.

Now let me briefly discuss U.S operations. Pre-tax earnings were down 1.3% for the quarter, but up 4.1% for the year. For the year Aflac U.S pre-tax operating earnings were ahead of our target. In the fourth quarter, which typically generate our largest sales production, Aflac U.S annualized premium sales had a disappointing 10.4% decrease. This results contributed significantly to our full year sales decline of 4.3%.

In recent quarters we’ve acknowledged the impact of healthcare reform, especially to the accounts less than a 100, most notably accompanying confusion and problems associated with the federal exchange. We believe this kind of reoccurring uncertainty is linked in the sales process as small businesses, especially are more hesitant to engage in changes to healthcare reform. They want to gain greater access and -- regarding the implementation of affordable healthcare act and how it’s going to affect them. Saying that, a sales decrease of 10% in a quarter is unacceptable to us. The one constant has been and continues to be the need for our products.

There is no plan, not even the best major medical plan that is designed to cover all out-of-pocket expenses. We will continue to drive home the need for our products to businesses and ultimately their employees. You’ve heard us say many times in the past that part of our job is to gain access to employers to ensure our products are conveniently available to consumers.

I'll remind you that about 98% of our products are sold for the work site and more than 90% of those sales come through smaller employers with a 100 employees or less. As such, we’re working on several key initiatives in 2014 that support our multi-faceted distribution network in reaching out to business of all sizes.

With respect to our career agents, first we’re focusing on recruiting and training. Second, we're concentrating on performance management for the territory directors and sales coordinators. Third, we’re in the process of piloting Aflac’s proprietary exchange which is geared to employers of 100 employees or less, but those of 50 or less are our primary target. Fourth, we’re incentivising the management of our career sales agents to focus on smaller businesses, while working with brokers to write larger businesses and to that end in October we’re putting a strategic and tactical focus on businesses with less than a 100 employees by aligning our recruiting, training, compensation and market incentives to encourage specific activity and sales in that segment.

Additionally, we’re continuing to focus with brokers on a regional and national level to give us better access to mid and large markets. We have already represent more than 60 benefit administration platforms, sometimes referred to as exchanges with various brokers. I believe 2014 will be a good year for broker sales as we continue to push to segment our distribution.

Finally, we will continue to seek opportunities to leverage our strong brand and relevant product portfolio in an evolving healthcare environment. While some facets of the U.S economy has shown signs of improvement, we continue to see a challenging economic environment in the U.S. Many small employers are still very guarded with respect to their business outlook including their hiring plans. This can impact the universe of potential policy holders we’ve access to.

Taking into account all the strategic initiatives, design to empower our sales force in 2014 along with the challenge in economic environment, we expect the Aflac U.S sales in 2014 to be flat to up 5%. When we look back over our investment performance in 2013, our decision to enhance and protect our SMR by allocating more new money to JGBs suppressed our new money yields. But despite taking a more conservative investment path last year, our average new money yields of 2.47% in 2013 was still slightly higher than 2012 results.

As we enter 2014, we’re reviewing our asset allocation strategy related to Japan new money investments. Based on current capital position and market outlook we’ve resumed purchasing U.S dollar securities for Aflac Japan’s portfolio within ranges consistent with our asset and strategic allocation plans and product needs. We will continue to evaluate the allocation strategy based on investment market dynamics and capital and make tactical changes consistent with our outlook.

Turning to Aflac Incorporated, our consolidated financial performance was strong for the quarter. Excluding the impact from foreign currency, operating earnings per diluted share rose 6.8% for the quarter and 5.2% for the year. This result puts us slightly ahead of our annual expectation of a 5% increase in operating earnings per diluted share before the impact of foreign currency.

While policyholders are top of mind, we also strive to enhance shareholder value through repurchasing our shares and increasing the cash dividend. We believe these are important – the most attractive uses of capital and those are the avenues we will continue to pursue.

For the full year, we purchased $800 million of shares which greatly exceeds our original target we set at the beginning of the year of $400 million to $600 million. As we said in the third quarter, we expect share repurchase in 2014 to increase over 2013 levels to be in the range of $800 million to $1 billion. Our advice for 2014 is to frontload our purchases as such we expect to purchase $400 million to $500 million of our shares in the first quarter.

I'm also pleased that we increased our cash dividend to shareholders last year. 2013 marked our 31st consecutive year in which we've increased the dividend to shareholders. Our objective is to grow the cash dividend at a rate generally in line with our operating earnings before the impact of the yen.

Finally, taking into account the headwinds and tailwinds we've covered, I want to reiterate our primary financial objective in 2014 which is to increase operating earnings per diluted share 2% to 5% on a currency neutral basis. We continue to believe that we are well positioned in the two best insurance markets in the world. We're fortunate that we have the privilege of providing financial protection for more than 50 million people worldwide who count on us to be there when they need us most.

Now, I'll turn the program over to Robin. Robin?

Robin Wilkey

Thank you, Dan. I'd like to get through some fourth quarter and annual numbers this morning especially as related to the yen impact which was strong, and I'll start first with Aflac Japan. Beginning with the currency impact for the quarter and the year, during the quarter, the yen weakened against the dollar 19.5% and for the year, the yen weakened 18.2%.

In reference to top line in yen terms, revenues as reported were up 4.1% for the quarter. Excluding the impact of currency, revenues were up 2.6%. Investment income as reported increased 15.7%. Excluding the weaker yen in the quarter, Aflac Japan dollar denominator and investment income, net income rose 5.5%.

In terms of quarterly operating ratios, the benefit ratio to total revenues declined over last year going from 63.9 to 61.2 in the fourth quarter. Excluding the impact from the reinsurance agreement initiated in the third quarter, the benefit ratio for the quarter would have been 60.8%. Additionally, if you exclude the impact of the weaker yen, the benefit ratio for the quarter would be 62.1%.

Now looking at the expense ratio, it was up 18.9%, up from 18.4% in the fourth quarter of 2012. This increase reflected additional spending in line with our expectations. Reflecting the improvement in the benefit ratio, the pretax margin increased during the quarter going from 17.7% to 19.9%. Excluding the impact on currency, the pretax profit margin for the quarter increased 18.8%.

With the expansion of the margin, pretax earnings increased 16.9% in yen terms. Excluding the impact of the yen, pretax earnings in the quarter increased 9.3%. The reinsurance agreement from the third quarter had approximately an $8.2 million pretax income on earnings and a $5.4 million impact on an after-tax basis.

Now let me turn to Aflac U.S., total revenues rose 1.4% for the quarter. Persistency for the year was 76.8% compared to 77.1% a year ago. Looking at the operating ratios, the benefit ratio for the quarter was 52.7% compared to 50.8%. This reflected various reserve adjustments made in the fourth quarter.

The operating expense ratio improved going from 34.6% to 33.1% reflecting less than anticipated spending in the quarter. The profit margin was 14.2% compared to 14.6% a year-ago. Reflecting the increase in the benefit ratio in the quarter, pretax operating earnings decreased 1.3%.

Now turning to investment activities for the quarter, let me first start with Aflac Japan. Approximately 94% of new cash flow was invested in JGBs for an average yield of 1.37%. As a result, the total new money yield in Japan for the quarter was 1.5% down 48 basis points from September 30 and down 121 basis points from a year ago. Portfolio yield was 2.8% at the end of December, down 18 basis points from the end of September and 7 basis points lower than a year ago.

In terms of U.S. investments, the new money yield for the quarter was 4.32%, a decline of 19 basis points from September 30. The yield on the portfolio at the end of December was 6.01%, down 5 basis points from September 30.

Turning to a few other items in the quarter, non-insurance interest expense was 51 million compared with 50 million a year ago. Parent company and other expenses was 17 million compared to 6 million in the fourth quarter of 2012. On an operating basis, the tax rate was 34.4% compared to 34.1% a year ago.

As reported, operating earnings per diluted share declined 5.4% to $1.40. The significantly weaker yen decreased operating earnings by $0.18 per diluted share for the quarter. Excluding the impact of the yen, operating earnings per share for the quarter would have increased 6.8%.

Lastly, let me comment and reiterate some of the statements that Dan's already made. We have reaffirmed our objective for 2014 in the 2% to 5% increase in operating earnings per diluted share excluding the impact of the yen. This year, we estimate that 1 yen move on the average annual exchange rate will equal approximately $0.03 to $0.0325 per diluted share.

Assuming the yen dollar exchange rate remains at the 2013 full year average rate of 97.54, we would then expect 2014 objective of a 2% to 5% growth to be in the range of $6.31 per diluted share to $6.49 per diluted share.

Now we're ready to take your questions, but first let me remind you to be fair to everyone, limit yourself to one initial question and only one follow-up question that relates to your initial question. Now, we're ready to take the first call. Do we have a caller on the line?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is coming from Chris Giovanni from Goldman Sachs. Your line is now open.

Christopher Giovanni - Goldman Sachs

First question just around the outlook for third sector sales in Japan and I guess I'm wondering why the target isn't higher given the momentum you've seen with the medical product, and how underpenetrated that younger age cohort is? And then really no benefit at all to-date from cancer and my understanding is you should the post specific product kind of on-boarded here in the second half of the year?

Paul Amos

This is Paul. I'll tell you, first of all, we do expect strong momentum in the first quarter and the second quarter and that will be a continuity coming from the EVER launch in the second half of last year that drove extremely strong third and fourth quarter third sector sales. It's because of that strong third and fourth quarter that we’re up against difficult comparisons of course, medical product is going to sell in a higher level than the cancer plan in general, as well as the market is growing at a faster pace. That being said, we remain confident about our Japan Post partnership and are continuing ability to grow that. As we said, it is a long partnership that is focused on growing it steadily. We have continued to expand the number of post offices, but doing so slowly and it really been a later half of the year before we see a significant number of post offices begin to come online.

As you stated, the cancer plan is something we are focused on revising at this point pending approval from the government and focused on selling that plan with a specific plan for the Japan Post system. At this point, however, we’re still in the process of developing that plan with Japan Post. I can’t go over the specifics of that, but we feel very optimistic about it. That being -- all of that being said, all of that is modeled in the 2% to 7%. And we’re -- I think that's where we’re and I think we’re confident about the numbers and what we're going to see for this coming year.

Christopher Giovanni - Goldman Sachs

Okay and then maybe one for Eric. Can you talk about the decision kind of to get back into the U.S securities asset class and then how we should be thinking about with rates kind of back down here managing the volatility of the SMR when rates should rise again, since this -- clearly isn’t eligible for that PRM category?

Eric Kirsch

Sure. My pleasure. Well, going back in the last couple of quarters when the volatility hit last year and we change the asset allocation, you will recollect I had said that we were going to spend significant time on recalibrating our SMR given the reinsurance, how the capital position went up to the risk factors we’re exposed to, in particular, in the AFS category. And those risk factors being yen interest rate, dollar interest rate, currency and credit spread. So a great body of work has been completed on that, which was our goal during the fourth quarter, so that we could go into the year with a much clear path. And given the higher capital levels that we’ve and all of our modeling, we can sustain if rate should increase that negative impact to SMR, of credit spread should rise, yen yield should rise. So we could still be within the SMR levels that management wants us to be in. So SMR is now at a comfortable level where when those things happen in the market, we can absorb an SMR, that those impacts from unrealized gains and losses.

The other thing I would comment on as well, there is a correlation effect between these factors. So when U.S rates are going up suggesting a strong economic growth here, the dollar is strengthening, the yen is weakening. But we’ve currency exposure in our SMR. So those are risk factors that kind of offset each other. So with all of that modeling and our view of that capital market, that allowed us to go into the year with a view that we can get back on our path of the original strategic asset allocation from Goldman. However, we’re going to be much more tactical on how we implement that.

So the second part of your question is as we’re looking at the year, a few things with respect to our U.S allocation that are based on today's outlook and the capital position. One, we’ve turned on the program. Secondly, we’re not going to think of it just as corporate bonds. It’s a bucket of U.S assets and we will use our discretion within my investment group to swap, if you will, between maybe U.S treasury securities and corporate securities based on typical relative value analysis.

So as an example as you all know in the corporate world, the fundamentals are very rich. On corporate they’re very healthy, but credit spreads are at their tightest, almost at all-time lows. So we’re not expecting a lot of tightening. We're also not expecting this year given our economic outlook for the U.S., the credit spreads are going to (indiscernible) a lot. But I don't really want to overweigh the corporate allocation when corporate spreads are so tight, but I like the yield differential between U.S rates and Japan rates.

So within that U.S bucket throughout the year, we will use our discretion from a relative value standpoint on how to allocate within the U.S bucket. And the other thing I should mention as well, the U.S program last year was targeting more or less at 10-year duration. We’re targeting a lower duration now in light of the fact that our view is throughout the year, rates will rise and certainly in January we saw rates come down quite a lot because of the volatility in the emerging markets. But by putting any new money into a shorter duration bucket of U.S assets, we’re in essence building up protection for the event that rates rise, so our unrealized losses won’t be as great. But over the long-term from an economic perspective, we’re very bullish that these are very positive to the long-term health of our balance sheet and our earnings stream.

Christopher Giovanni - Goldman Sachs

Great. Thanks for the thoughts.

Operator

Thank you. The next question is coming from Yaron Kinar from Deutsche Bank. Your line is now open.

Yaron Kinar - Deutsche Bank

Hi, everybody. Dan, I think you briefly mentioned progress on the Everwell platform and on to broker exchanges in the U.S. I was wondering A, if you could give us a little more color on the Everwell progress? I think on the last call you talked about it has been 68. So where does that stand today? And then on the broker exchanges, I think you had mentioned being on 60 today, which seems significantly greater than where you were a quarter ago. So if you can give us any thoughts on both?

Dan Amos

Let me make a couple of statements and then I will have Ken talk a little bit more detail as we’re all working together to do this. The one thing I think is important that all of you understand is we introduced a major change with our field force. As you know we’re probably the only Company out there that is concentrated so heavily on accounts of 100 or less. It’s always been our bread and butter; it’s always worked very well for us. Our agents have also rolled the accounts of 100 or more. But what we’ve seen here as we’ve seen those accounts of a 100 or more shift more to dealing with brokers. So as we started several years ago, we started seeing the brokers coming in and we started to put them in our market to some degree.

But what we did in October is we made a conscientious decision to introduce to our whole management team that we were going to pay for performance by trying to get our agents to concentrate more on the accounts of 100 or less. Well, 90% was already there. So it wasn’t that big, but psychologically tell them that we really wanted them to concentrate there and not doing the 100 or more. The old timers don’t like it. That’s why new recruits are so much better because they understand that’s the way it will be done.

Now we’re not saying you can’t do it, we’re just paying to move you that way. We’re then working with the agents to where these agents will work with brokers to try to enroll what I would call the local brokers more and they end through our plans with Aflac group, we’re doing the national brokers. So this is a major shift that all occurred in the fourth quarter. And at the same time we’re now getting ready as you talked about to move to Everwell with the small businesses, which especially will be 50 and less. And of course we got the delay with the Obamacare that now it won’t go into effect till next year. So all those things kind of hit at the same time, which I think accounted for part being our problem, part being that we arrive more small business, but all in all, unacceptable numbers in my case. So I will let Ken talk a little bit about specifically your Everwell and what we're doing there and then if Teresa wants to follow-up with any comments she is welcome to. Ken.

Ken Janke

Yes. Let me start on the Everwell exchange. We’re right in the middle of the pilot. We had orchestrated an extended pilot from October 1st through the end of March of this year. It's actually in three states, one of which we’ve our appointed agents in that area have access to not only our products, but major medical as well as vision, dental and life and then the other two test states right now. They’re limited to all the products -- they’ve all the products, but not a major medical, because it is such a sweeping change in how we maybe enrolling the small businesses in the future, we wanted to take a very pragmatic and conservative approach to this. So we’ll evaluate after we finish the pilot in March. We’ll evaluate our rollout plans.

We currently anticipate that we’ll be rolling the platform out to the majority of our states throughout the balance of this year, but the exact timing of that rollout is going to be dictated by our assessment of the pilot and we're not quite done or in a position to make that assessment. I can say that generally we're pleased with what we've seen so far. We have seen higher penetration rates than we've seen in our traditional business for accounts of the same size which was one of the success metrics that we're focused on. Over the longer term, we'll focus on things retention of accounts as well as distributors. But we do expect that it will go well and that we will be a position to rollout. That said, we don't expect for it to have much of an impact on sales in 2014. But if our rollout plans meet expectations and we're able to roll it out as we currently anticipate, we should start to see an impact in '15 and beyond.

With respect to the benefit administration or exchange platforms that you referenced, we've actually had those in place for some time now but they're basically, I'd call it one-off arrangements with distributors and accounts and their overall impact to sales last year was not really material. But in thinking through our exchange strategy for the larger case market, that's something that you'll largely see come out of the core broker and then our large national broker efforts through Aflac Group in Columbia, South Carolina. The first step of which and our major focus right now is to build out distribution in Aflac Group.

We're in the process of expanding the number of employed sales people that we have that will bring relationships to us with brokers or establish relationships with brokers so that they can convince those national brokers on the case for voluntary products and more specifically that we should be the provider of choice for those voluntary products. And then we'd look at the most efficient way to enroll those clients and that would likely be through an electronic platform, like an exchange. But the first step right now we're really focused on building out the sales capacity at Aflac Group so that we are in a better position to reach the brokers and then get on those exchanges.

Dan Amos

And Ken is concentrating of course on combining the two both Aflac Group and Aflac Columbus, but Teresa maybe want to make a couple of comments on Columbus because that's still 90% of our sales. And so Teresa, you have any comment.

Teresa White

I'll just echo what Ken said with regard to Everwell. Currently, we have a couple of other platforms that we use today; our SmartApp unit that you all are familiar with. The majority of our activity is basically driving the multi distribution strategy, handing the sales operating guidelines, making sure that we have all of the alignment with compensation and sales targets so that we can migrate everybody to this new Everwell exchange.

Yaron Kinar - Deutsche Bank

It does. And one quick follow-up on that, if I could. On the national exchanges, with the national brokers, do you think that the investments you're now making in sales and in the platform will be ready to bear some fruit for 2015 enrollment; come in, in October, November of this year?

Dan Amos

Well, we're really positioning this for better growth out of the large case markets for group products in '15. This is really a build-out year of sorts. Again, we're increasing our ability to reach those broker distributors. As you know, there's a very long lead time to large cases, so we're really positioning this for – while we would hope expect there'd be much growth in the group platform in 2015.

Yaron Kinar - Deutsche Bank

Thank you very much.

Operator

Thank you. The next question is coming from Mr. Jimmy Bhullar from JPMorgan. Sir, your line is open.

Jimmy Bhullar - JPMorgan

Thank you. Good morning. On the U.S. business maybe if you could talk about just recruiting and growth in the producing agent count because it's been weak for a while and I'm not sure if that's just lack of finding good candidates or are people not willing to give up unemployment insurance or what's going on that you're having a difficult time finding recruits in the U.S.? And then there was a question earlier on – new money investments in Japan. I don't know if you mentioned how much of your new money you're intending to deploy in the U.S. securities, whether it's corporate or treasuries?

Ken Janke

Jimmy, let me start on the recruiting. We are really focused as Dan suggested in his comments. We're focused on a few very basic activities for our traditional sales force this year. We really want them to focus the majority of their efforts under 100 accounts size. We're also focusing on what we referred to as core brokers, it's really the local and regional brokers that Dan has mentioned, we're focused on asset management which is a fancy way of saying we want our career sales force to make sure they're getting the most out of their book of business, so that in effect they're not leaving business on the table by really calling on their accounts and managing their business properly. And then the other one is recruiting.

Recruiting has always been a core component of how we build our sales force. Newer agents tend to be the ones that bring us the newer accounts where we have opportunities to really grow the business. I think one of the things that we've not only focused the activities squarely on recruiting but also on the type of individuals we'd like our sales force to recruit, because I do believe that there was some effort on our sales force that rather than recruiting the career agent that we typically built this business on, there were trying to recruit brokers instead. So we've really refocused their activities this year. On referral recruiting, nominations and getting the type of sales associates that have long been known to build this business. We have seen a bit of a turn.

I think it's too early to comment with certainty but so far this year with that new focus, we're pleased on the kind of recruiting activity that we've seen. It's still down year-over-year but at a significantly lower rate of decline than what we'd seen throughout 2013. So we are focused on that. By focusing on that and also the training and getting those new agents to focus on the small business area, the accounts fewer than hundreds lives, we think we'll also be successful in pulling up the numbers of producing agents.

Robin Wilkey

I'll just follow-up with three areas of focus. One area of focus really trying to make sure that our people who are recruiting in our career channel that those folks don't compete with trying to recruit brokers as well, so we basically focused the career recruit channel on really recruiting people for that career channel and then we moved a lot of the market, the people who were recruiting for brokers into a core broker channel which really supports the distribution channel or the channel segmentation and it also supports how the market has shifted as well. The other thing that we're doing is recruiting ads and you'll see some of those recruiting ads, there were very successful in the past for us with really getting interest for Aflac and with regard to recruiting. And so we decided to bring those back. The last thing is making sure that all of our goals for recruiting are aligned within the hierarchy. So any contest, any compensation is aligned across the hierarchy with regard to recruiting as opposed to one or two people holding the goal for recruiting. The comp is tied to it.

Eric Kirsch

It's Eric to answer the second part of your question around the percentage allocation of new money. Just a couple of factors that go into that allocation. One is, when we discussed new money what we're discussing is cash flow from operations and maturities and interest from existing assets. But we also consider sort of the target balance of our asset classes at year end which ties back to the strategic asset allocation work. So, with regards to U.S. assets if you will as a target not necessarily meaning we're going to get there, 25% of the Japan assets would be our target for U.S. assets at the end of the year. When we calibrate what I discussed earlier, the new money statistics that we expect, SMR, we would currently expect no less than about 40% of our cash flows to be in U.S. dollars but again that would depend on market factors, SMR. And one other factor is during the year, which has already happened this year we may dispose of some securities like you know about Israel Electric, for instance. Those proceeds came in January, were invested into the U.S. program but that's not counted as new money but it would count towards our year-end target. So there's a variety of factors that go into that. And then finally I would remind you, I can give you some of these estimates, but as I said earlier, we will be more dynamic with respect to the risk factors in the market, what's happening with spreads, what's happening with rates. So, I think you’ll see us be more opportunistic as well as conservative from a safety standpoint depending on what's happening in the market, but certainly we’ll report throughout the year on how it all panned out relative to our expectation.

Jimmy Bhullar - JPMorgan

And the U.S. investments, those don’t qualify for policy reserves matching accounting treatment rate?

Eric Kirsch

That’s correct. Those go into AFS.

Jimmy Bhullar - JPMorgan

Good. Thank you.

Kriss Cloninger

Let me point out that on a U.S. statutory basis the assets are held at amortized cost as opposed to mark-to-market, so it's not a big factor in RBC.

Jimmy Bhullar - JPMorgan

It's more the SMR’s would have changed though, right?

Kriss Cloninger

Yes, the SMR for Japan is sensitive to fair value.

Jimmy Bhullar - JPMorgan

Got you. Thank you.

Kriss Cloninger

All AFS securities, but in the U.S. we’re not on RBC for the U.S. operations.

Operator

Thank you. The next question is coming from John Nadel of Sterne Agee. Sir, your line is open.

John Nadel - Sterne Agee

Hi, good morning everybody. Just a quick follow up on the investment side. I don’t remember the exact amount out of Japan in terms of the new money investments in total from 2013. If memory serves it was effectively an all time record given the very strong sales in the first sector channel. How much is that overall new money investment going to decline in 2014 given the continued shrinkage of the first sector, the fact that third sector sales clearly require less from the perspective of investment income?

Eric Kirsch

It's Eric. I can give you the numbers from last year and the projections this year in total cash flows and then perhaps one of my colleagues wants to discuss at that second level between sales. But to your comment earlier, last years cash flows were 1,118,000,000,000 yen, but that’s cash flow from operations, maturities and interests from the portfolio. So, there’s a lot of attribution within it. For this year again in total the projections are 771 billion yen.

John Nadel - Sterne Agee

Got it, okay. And then, I think the only other real question I have is, as you’ve done all this work around SMR sensitivity in calibrating especially post the shift to the PRM classification; can you give us some sense for how much the sensitivity of the SMR has come down especially relative to changes in interest rates?

Kriss Cloninger

This is Kriss; let me say that we have done a lot of work on that, we intent to go into that in some depth at the FAB meeting. I didn’t want to do it on this call. But let me just say that with our SMR at its current level in the mid 700’s, we believe that we’re well protected against the fall below the 500% to 600% which is kind of our overall low level operating objective. The way I am looking at SMR right now is that we don’t want to broach our fallback position which I’ll say is 500% to 600%. We clear like about staying at about 750% in today's market environment.

There are very few scenarios where we’re going to pierce below 500% to 600% for changes in U.S. interest rates, changes in Japan interest rates, changes in currency rates. So, what we’ve done is to insulate ourselves against the low side of the SMR exposure due to volatility in those macro factors. And we believe that enhances our ability to give the investment team flexibility to pursue their plans without significant concern and it just gives us more assurance that we’ll be able to manage SMR levels in a way that will allow us to achieve our plans for profit repatriation, policy holder security and the like. So, we feel like the work we did between the third quarter and fourth quarter last year has well positioned us to manage in a very flexible way in response to significant changes in macro conditions.

Eric Kirsch

I mean one our main objectives here is to never act like we had to do one time on share repurchase, to constantly be increasing it every year. And by having this bottom set we feel comfortable that we can continue to increase it unless something just unheard of happens.

Ken Janke

Hey, John this is Ken. Let me just add, if you just look at the SMR sensitivity to yen interest rates, our -- as Kriss said we will talk more about it in our analyst meeting. It is significantly less than it would have been a year-ago for a couple of reasons. Number one is implementing the PRM category which insulated us from some yen rate risk. The other is that, now we’ve more dollar assets [proportionately] [ph]. So what does that mean, while as we’ve got more exposure to dollar rate risk? So and we’ve taken some actions to try and mitigate that risk on SMR as well. When you think of the market risks that influence SMR we’re exposed to yen rate risk, dollar rate risk, credit spread risk and currency risk. And the problem is those are somewhat correlated. You can’t just aggregate one risk on top of the other to come up with an overall sensitivity and that’s why we’re doing a little more work on it to give you a better indication of what kind of buffer we feel we should be maintaining to accommodate those risks.

John Nadel - Sterne Agee

Perfect, that’s really helpful. If I can sneak one last one in because it's related, it's just -- have you done any incremental hedging particularly around yen versus dollar as you look out to 2014 and beyond to insulate your expected profit repatriation from potential currency moves?

Ken Janke

Yes, let me update you on that. Our current expectation is to repatriate about 97 billion yen. The last time we spoke we had hedged 47.5 billion yen at a little over 100 yen to the dollar. We have added incrementally another 5 billion yen. So we have roughly 52.5 billion yen hedged again a little over 100 yen to the dollar. We’ve elected to take -- use our yen cash flow from repatriation this year to service the 34.2 billion yen debt that we have maturing. And so what that does is that frees up about $400 million that we had on the balance sheet that we had previously year marked for share repurchase. So, when you look at the 52.5 billion yen plus the 34.2 you’re roughly 10 billion yen or so that it remains un-hedged. And I think it's unlikely that we’ll do much more for this year but we have already started thinking about ‘15 and taking actions to insulate against currency risk on that repatriation.

John Nadel - Sterne Agee

Perfect. Thank you so much for everything.

Ken Janke

Thank you.

Operator

Thank you. Our next question is from Steven Schwartz of Raymond James. Sir, your line is now open.

Steven Schwartz - Raymond James & Associates

Thank you. Good morning everybody. I guess this all ties in, but I do want to ask about what is going on, or what can possibly be done in reinsurance. I know, I mean you kind of started it in -- I think it was May at the FAB meeting, Kriss stated that he thought that the FSA was really against doing enforced block types of transactions to free of capital. But you’re sitting there with an SMR of 750, you’ve got PRM and you’re doing some interest rate hedging. There’s a lot of protection there. The reserves are way, way overstated in Japan relative to the U.S. which is probably overstated relative to reality anyway. You’ve got one competitor that’s done -- an American competitor that announced that they did a deal. RGA is saying that they’re seeing a lot of companies do this. I’m wondering Kriss, if you thought more about this or looked at this more?

Kriss Cloninger

Yes, we’re continuing to evaluate Steven. I don’t necessarily agree with all your comments you leashed, maybe I do but maybe not in order of magnitude. But let me just say that the -- the reinsurance we did at the end of September allowed us to achieve our objective of increasing the solvency margin substantially. We don’t feel like we need to do additional reinsurance to accomplish that. Right now we've got it in reserve in case we ever need to do it. What I do have my team exploring is the notion of doing a continuous program of reinsurance of this nature to alleviate to some extent the surplus drain we experienced relative to new business.

And what I think that would do – what it will do is to minimize the volatility of FSA earnings in responses to changes in production levels. And it would also allow us to monetize to some extent some of the differences between the economic reserves which is how I'd characterize what you're trying to get to and regulatory reserves. Keep in mind though that reinsurance of the nature we did, those have a cost. You are selling a block of business in exchange for a premium and it does have a cost and I've quantified the cost for reinsurance in 2014 at about a nickel a share, about $30 million or so after tax. So it's not like it's free.

Now let me say that relative to other companies, we don't have an internal reinsurance subsidiary where we can do this program on an intra-company basis. We've never been a reinsurance user to any great extent, we haven't needed to, we don't have a reinsurance subsidiary that deals on an arm's length basis with other companies which many companies do. So that's kind of negative for us. That being said, we do recognize the possibility that we could establish captive reinsurer and that's one thing that we're going to look at. That's not a short-term thing, something that's easily achievable in three months but it could be a cost effective or cost efficient way to do some reinsurance and we're going to investigate that further.

So let me just say we intend to evaluate the use of reinsurance. We can do more. We're going to use it to, again, protect – probably repay for any addition and the like and there will be more to come on that. But we're not just ignoring it, Steven. We're going to be using it effectively.

Steven Schwartz - Raymond James & Associates

All right, great. And then as follow-up to – on the very, very large cases, I want to try to get a handle on what's changed here in the U.S. with the exchanges you see around the platforms but you've been on the platforms for a while. I mean my understanding has been at least for a year, maybe two years, all the big alphabet houses you've been with them, but the issue seems to have been then getting their people to use you. Is this really just the same situation, they may be selling it in a different way but it's still the issue of getting the rep at Aon or Marsh & Mc [ph] to use you, is that still the issue?

Teresa White

This is Teresa White. Really the issue is making sure that we build out, as Ken said that W-2 sales force that Dan Lebish is responsible for. We're building out because most of these large broker channels which you may know, they really go to market differently and it's not a product sale, it's really understanding how they go to market. And so the importance of those relationships is to really understand how each broker channel deals with the market and then how Aflac fits within the context of that. And so the initial relationship or the initial interaction is more us understanding, Aflac understanding their go-to-market strategy, understanding and educating many of the brokers on voluntary product and then there's a process of selling.

What Ken referred to a while ago was a lot of the plumbing that was built for the six-year or so exchanges our platforms that we have today, there were specific cases that wanted Aflac. They asked for Aflac and they happened to have brokers involved. Now that's some of it but others are really where brokers have brought us in and utilized us against other competitors. So, right now that's why Ken is saying right now what we've got to do is establish that – work that sales force at Aflac Group so that we can ensure that – and we call those sales people BDEs, broker development executives, and they'll be regional vice presidents managing that process. But at the end of the day, the relationship is what's important and Aflac understanding their go-to-market strategy and how Aflac product fits.

Dan Amos

The one thing I would say that's very important here is it was somewhat murky in our organization of how brokers and agents and the new things we're all bidding together. Now, what we did in October is we defined exactly the direction we wanted everyone to go. And we cut out certain things like for example these big brokers. They don't want our agents calling directly on them. That irritates them and they control the account and we've defined that better to stop that from happening. So these are things that are major in terms of how we handle it in terms of emotional and trying to motivate our existing field force and we've done that through more commissions and shifting them. And so all of this is just part of something that's unfolding right now that I'll ultimately think will enhance our sales.

I think we're going to be much stronger. I think anyone that thinks that we're not going to be strong in the small market is mistaken because we've done so well. I think anyone things that with the big brand we've got, which everyone knows us in the supplemental industry in the United States will be mistaken when it comes to how well we're going to do with the brokers going forward. We just got to let them know that we understand their needs and we're going to fit products accordingly and that's where South Carolina will come into play with our new president over there, our new executive vice president over there and how he handles it. And Ken will be coordinating those two efforts.

Ken Janke

Steven, I’d actually argue. I think the exchange part is the easy part because that's enrolling the business. The hard part what we have to work on is we have to have the relationships, we have to demonstrate to those large national brokers the value proposition for supplemental products, again why we should be the provider of choice and how we can effectively enroll that business and service that business and get them paid quickly, to have a pain-free experience. So, the enrollment itself through an exchange I don't see that daunting. It's everything that's leading up to the enrollment that we really are working on.

Steven Schwartz - Raymond James & Associates

Okay. All right, thank you guys.

Robin Wilkey

Steven, one other thing I want to comment on since we're talking about this new distribution strategy as Dan referred to it, we're going to do a spreadsheet and try to outline the various aspects of this. It will be available online just like we have other spreadsheets out there on investments and the such to help you better understand the market segments, the channels, the products within those channels that they'll be offering, enrolling conditions, et cetera. So that should be available on the website sometime this afternoon, we'll have that up there and I think it will help everyone understand better this new strategy in the U.S.

Steven Schwartz - Raymond James & Associates

All right, I'll take a look. Thank you.

Operator

Thank you. The next question is coming from Mr. Tom Gallagher from Credit Suisse. Sir, your line is open.

Tom Gallagher - Credit Suisse

Thanks. Kriss, I wanted to come back to the comments you were making about exploring captive re and I think the comments you used were to potentially stabilize J-GAP earnings and then dividend repatriation. Should we be thinking about this whole evaluation more as making sure you have stability or would there be a significant enhancement opportunity? For instance, the 1.3 billion to 1.4 billion or J-GAP earnings that you guys are run rating right now. I mean, if there is the possibility from this kind of transaction that you could increase that 50%, if you structured it the right way or is that not the right way to think about this. Is this more of a stability exercise than an enhancement exercise?

Ken Janke

No there’s an opportunity for enhancement, Tom. I think you have to be measured in thinking about how much enhancement we’re going to have to balance cost and the overall results, and we always manage the business for the long-term as opposed to the sort term. So, I’m not looking for a quick pop on profit repatriation and a quick pop on share repurchase. I’m more interested in what we can sustain over the longer term. But there is an opportunity for enhancement and that’s one of our objectives.

Tom Gallagher - Credit Suisse

Got it. But we shouldn’t be thinking about as you said …

Ken Janke

(Indiscernible).

Tom Gallagher - Credit Suisse

Yes. Okay, got it. So more of a measured enhancement?

Ken Janke

Yes, if we got a 50% it wouldn’t be achievable year-to-year. If we went up 50% it would probably have to stay at that level, assuming we could even get there which it might be achievable, but I doubt that I’m going to go that far.

Tom Gallagher - Credit Suisse

Got it. And then, just a follow-up for Eric. Your comment that you were positioning into shorter duration, securities I guess. I think that was just related on the USD allocations, not sure if that also applies to what you’re doing on the JGB side. My follow-up on that point though is, should we be thinking about this more a short-term tactical because ultimately you have to match your liability and you have very long duration liability. So if you’re shortening the duration today, how long would you be willing to deal with tolerance of the mismatch?

Eric Kirsch

Sure. Now thank you, good questions, and to your first one, yes. That was with respect to the U.S. securities not our JGBs which are long -- the JGBs are longer in duration and more closely matched to the liabilities. The second part of your question, yes. This is more tactical and keep in mind that shorter duration is for the new money to the existing portfolio which is quite large particularly when you take the U.S. corporate program that we started as we called it, and what we used to call the Japan dollar portfolio. We’re now thinking of that as one big bucket. So that big bucket, is it approximately a 10 year duration? And we’re not changing the duration of that bucket, but the incremental new money is going in tactically the shorter duration which will bring the overall duration slightly down, but we certainly have to have that focus on ALM and matching assets and liabilities. So it is more tactical for this year at this point in time.

Tom Gallagher - Credit Suisse

Okay, thanks.

Robin Wilkey

Well, we’ve reached the top of the hour. If anybody has any follow-up calls, David and I will be in the office. So please give us a call. Otherwise we look forward to seeing everyone at our FAB meeting. The information is out there for you to register and thank you so much for joining us this morning.

Operator

That concludes today’s conference. Thank you for participating. You may now disconnect.

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