In 2008/2009, when the tide went out, it developed that Aflac (NYSE:AFL) was swimming naked. Under pressure from regulators and rating agencies, the company derisked, taking capital losses totaling $4.193 billion from 2008 to 2011. Ouch!
This article is about Aflac's future investment performance, and as such doesn't include a full analysis of operations. I see Aflac as a steady performer on the underwriting front, with a fine niche in the Accident and Health business. A majority of the income is from Japan, and reported results will vary with the performance of the yen vs. the dollar. I'm comfortable taking exposure to the yen and Japanese government bonds, as part of a diversified portfolio.
Yields on debt denominated in yen have been skimpy for years now, and at times are less than policy guarantees. As noted, past answers to this difficulty ended badly. This article explores reservations on the topic of risk management, as it relates to investments.
Hiring Top Talent
In November 2011 Eric M. Kirsch joined Aflac as global chief investment officer. He previously served as managing general director at Goldman Sachs Asset Management.
In June 2012 Brad Dyslin was hired to the newly created position of managing director, global head of credit in Aflac's Investment Division, reporting to Kirsch and based in the recently opened Aflac Global Investments office in New York. He previously served as head of research and portfolio manager for Hartford Investment Management.
That same month, Timothy "Chip" Stevens was hired to the newly created position of managing director; global head of trading in Aflac's Investment Division, reporting to Kirsch and based in the Aflac Global Investments office. His prior experience was at Blackrock Investment Management, as managing director; head of fixed income trading for the Americas.
Mr. Kirsch's salary increased rapidly, from $1 million his first year to well over $3 million at year three, placing him among the 5 most highly compensated members of management and on a par with those in charge of Aflac US and Aflac Japan.
A Sour Note
In January 2013 Lori M. Evangel was hired to the newly created position of managing director; global chief risk officer in Aflac's Global Investment Division, reporting to Kirsch. She had extensive prior experience, most recently at MetLife, and has since (sour note here) been hired away by Genworth.
The short tenure of Ms. Evangel might possibly reflect tension around risk, or it might reflect conflict in the executive suite, or possibly opportunism on her part, with skills that are in demand. She was replaced promptly. From the press release:
COLUMBUS, Ga., Jan. 10, 2014 /PRNewswire/ -- Aflac Incorporated announced today that J. Todd Daniels has been named senior vice president and global chief risk officer, reporting to Kriss Cloninger, president and chief financial officer of Aflac Incorporated. In his new role, Daniels will be responsible for leading the development and implementation of all strategic and tactical global risk management programs and policies for the company. He will oversee the risk management functions for Aflac U.S. and Aflac Japan, including Aflac Global Investments.
Daniels joined Aflac in 2002 and has been promoted to positions of increasing responsibility, most recently as senior vice president; deputy corporate actuary. Prior to joining Aflac, he worked as an actuary for Liberty National Life Insurance Company. Daniels earned a bachelor's degree in applied mathematics from Auburn University. He is a Fellow of the Society of Actuaries and a member of the American Academy of Actuaries.
Commenting on Daniels' appointment to this new position, Kriss Cloninger said, "Todd has demonstrated his ability to work effectively with all segments of our insurance operations. We believe that his proven management skills, combined with an in-depth understanding of our insurance operations as well as risk management principles and practices, well-position him to lead Aflac Incorporated's global risk function."
Approximately 80% of Aflac's net income is derived from its fixed income portfolio. As such, it seems reasonable to value the company on the quality of its bond holdings. Underwriting results are stable and provide a steady source of float for investment.
However, the past history of managing investment risk is atrocious. Corrective action is underway, but there is evidence of internal conflict, and the development and implementation of policies and procedures is a work in progress.
Chasing yield is dangerous: you might catch it. An increasing amount of Aflac Japan's float is invested in bonds denominated in US dollars, with the exchange rate hedged with derivatives. Hopefully the hedges can be managed so as to effectively neutralize currency risk.
If Aflac is able to develop strong risk management of the investment area, and establish market confidence in the stability of its fixed income portfolio, shares will be worth something in the $90 to $100 area.
Aflac's debt maturing in 2039 recently traded to yield 4.7%. At current prices under $60, the equity investor is receiving a return of 11% on Aflac's bond portfolio, while I believe something on the order of 6.7% would be more appropriate. As such, I'm investing on the basis that shares are worth $82.
The hiring of Eric Hirsch, his rapidly increasing compensation, and his team-building efforts reflect an increased focus on investment excellence. Fixed income has become increasingly more complex and it's important to have qualified personnel to perform this vital function.
There are sour notes around risk management - the early departure of Lori Evangel and the changed reporting relationships for the risk management function. On the plus side, the chain of command as it now stands is more consistent with appropriate management of investment risk. On the other hand, Daniels' background as an actuary may not be as strong as his predecessor's major league experience in risk management.
Taken together, these developments suggest Aflac is paying serious attention to the fixed income investment function, and the associated risk management issues. Given the evidence of turmoil or tension around risk, it isn't possible to form a strong positive opinion as to success on that front.
Holding at a recent price in the $60 area, I believe I have a reasonable expectation of an increasing flow of dividend income, with eventual share price appreciation. The apparent tension around the risk management function will bear watching, and stands as a reservation.
In due course Mr. Daniels will make a presentation on his area of responsibility. It will be important to review this material when it becomes available, as it is key to valuation.
Disclosure: The author is long AFL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.