Aflac Incorporated (NYSE:AFL) Scotiabank GBM Financials Summit September 5, 2013 11:15 AM ET
Kenneth Janke, Jr. - President, Aflac U.S. and Executive Vice President, Deputy Chief Financial Officer
Joanne Smith - Scotiabank GBM
Joanne Smith - Scotiabank GBM
Okay. We are moving along. We are running a little bit tight here. So our next presentation will come from Aflac and representing the company today will be Kenneth Janke, Jr., President, Aflac U.S.; Executive Vice President and Deputy Chief Financial Officer of Aflac Incorporated. Ken oversees Aflac's U.S. insurance operations. He joined Aflac in 1985 as Manager of Investor Relations and was promoted to Senior Vice President in 1993. Under Ken's leadership Aflac's investor relations department was recognized by Investor Relations Magazine as the best overall investor relations department for a large capitalization company. And Mr. Janke has been named the Best Investor Relations Officer for a large cap company. The department has also been named as Best Investor Relations Department by Institutional Investor Magazine a number of times.
In 2010, Ken was promoted to Executive Vice President and Deputy Chief Financial Officer. In 2013, he added the role of President, Aflac U.S., and he chairs the company's corporate disclosure committee. Ken earned a bachelor's degree in political science from the University of Michigan and a master's degree in business administration from Oakland University School of Business. So I would like to welcome Ken.
Kenneth Janke, Jr.
Thank you, Joanne. Good morning, everybody. I appreciate you taking the time to listen to Aflac today and it's a pleasure to be here at Scotia's Capital Financial Summit. Before we start let me remind you that some of the statements in this presentation are forward-looking within the meaning of federal securities laws, and although we believe these statements are reasonable, we can give you no assurance they will be prove to be accurate because they are prospective in nature. Please look at our annual report on Form 10-K or the 10-Q for some of the risk factors that could cause our actual results to differ materially from those that I will discuss today.
Our strategy for growth in Japan and the United States has remained straight forward 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 does business in the two largest insurance markets in the world, Japan and the United States. Our policies cover more than 50 million people worldwide and Aflac's products provide a layer of financial protection against loss of income and assets by paying fixed cash benefits directly to the insured based upon a specific health event.
Aflac's operations in Japan account for about three-quarters of our pretax 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 insurance policies in force. Our third sector, cancer and medical insurance products have been and continue to be our pillar products in the foundation of our product portfolio. For 2013, we have been refocusing our sales efforts on our traditional cancer and medical insurance products. In fact, we introduced a new medical insurance product just last month that was designed to appeal primarily to consumers in their 20s and 40s, which is an area that we believe is currently underpenetrated for Aflac.
Although it's too early to determine actual sales results, we expect the product will be very well received by distributors and consumers alike. Aflac Japan was represented by more than 17,600 sales agencies at the end of the second quarter, equaling about 84,000 licensed sales associates who were employed by those agencies. With continued distribution expansion in mind, we were very pleased with the recent announcement of an agreement between Aflac Japan and the Japan Post. As our CEO has indicated, we believe that this alliance is a game changer for Aflac Japan. Japan Post intends to gradually expand the number of post offices that offer Aflac's insurance products from 1000 to 20,000 postal outlets.
Also, pending regulatory approval from the FSA, we hope and expect that Japan Post Insurance or Kampo will enter into an agency contract with Aflac Japan to begin distributing our cancer insurance products to all of Kampo's 79 sales outlets. In consultation with the Japan Post group, Aflac Japan will also consider developing an exclusive cancer insurance product to be sold through Japan Post and Kampo. We believe that Japan Post can and will have a meaningful impact on our sales results in the future.
Let me update you on Aflac Japan's performance for the first half of the year. Overall sales for the first six months of the year were down 20.4% to 84.1 billion yen. For the first half of the year in yen terms, premium income increased 9.2% and revenues were up 9.8%. Pretax earnings were 184 billion yen or about a 15% increase over the prior period. Keep in mind that in the second half of the year we anticipate stepping up our spending on advertising and promotional expenditures as well as projects to enhance our business over the long run.
I also want to remind you that for 2013, our sales target is based on Aflac Japan's third sector product sales which includes 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 sales target is a top priority for us and our entire management team in the United States and Japan is focused on achieving that target. Taking into account the launch of our new medical product last month, we believe our 2013 objective of a flat to 5% increase in third sector sales remains reasonable as well as achievable.
We have experienced a tremendous amount of success leveraging our strong brand in our efforts to drive sales. For example, to promote our new medical product, we launched a campaign in Japan featuring what is known as the black swan, a dark blue [ph] character that represents the arch nemesis of the lovable Aflac duck. The black swan's goal is actually to tempt consumers to make bad decisions about life, their health, and insurance. But fortunately the Aflac duck comes in and saves the day and reminds consumers about the importance of making sound choices in life, including the decisions to buy medical insurance from us.
By leveraging the popularity of the Aflac duck through different characters over the years, nine out of ten people recognize the Aflac brand in Japan. We will continue to look for new ways to connect with consumers through innovative marketing campaigns for our specific product.
Japan's population as you many know is covered by a compulsory universal healthcare system. But citizens there still have significant out of pocket expenses 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, the national healthcare system has been under great financial strain and copayments for salaried workers under 70 have grown to 30% for the cost of medical treatment.
As you can see, the growth of medical expenses is significant outpacing GDP growth. Because of the rapidly aging population and higher copayments 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 in the medical insurance market in the future.
Now let met turn to Aflac's U.S. operations. As you may know, we primarily distribute voluntary insurance products at the worksite on a payroll deduction basis in the U.S. 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. Those payments are made regardless of any other insurance the policyholder might have.
Our group products align well with the individual product portfolio and give us the ability to customize our product offerings for brokers who tend to serve the larger case market in the U.S. This is especially relevant because more than half of voluntary insurance sales sold in the U.S. 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 currently more than 76,000 commissioned independent sales associates. Additionally, we continue to work on initiatives that expand our relationships with brokers to give us access to the larger case market. We believe our distribution network is a competitive strength for Aflac that has been very challenging for other companies to try and duplicate. Our strategy and competitive strengths are all designed to leverage the brand while providing valuable products to consumers.
For the first half of the year total new sales were down 1.9%. We believe the market for our products has been impacted somewhat by the extent of uncertainty and confusion caused by the pending implementation of the Affordable Care Act. However, I would note the premium income increased 3.8% at the same time reflecting strong and improving policy persistency. While we are busy laying the ground work for future growth, we are still working hard to achieve our annual sales target. Our growth for Aflac U.S. for 2013 is to increase sales by flat to 5% both through our traditional and broker channels. 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 for the broker channel as well.
We continue to believe that the U.S. represents a vast opportunity for growth and we are building our business with that potential in mind. This slide shows the most recent data from the U.S. small business administration. You will note that the United States has more than 5.7 million businesses with fewer than 500 workers and that these businesses employ about 55 million people. Although our traditional focus has been on smaller sized payroll accounts, we believe our strategy for reaching larger brokers will better position Aflac to the larger case market as well. Our portfolio of group and individual products provides consumers with outstanding value while giving employers the choices that they demand.
We do believe our strong brand will be even more important in this period of transition as businesses and consumers look to do business with a company that has a solid reputation. With our trusted and well recognized brands, we believe we can be there to protect those that we insure against income loss and asset loss when a significant health even occurs. We also believe the coming years will provide great opportunity for growth in the U.S. market.
Now let be briefly turn to the investment portfolio. As we have stated for many years, our greatest investment challenge has been to invest Aflac Japan's significant cash flows and suitable investments that provide investments returns that meet or exceed our pricing and reserving assumptions. Foremost on our mind is to invest in a way that takes our policy liabilities into consideration. Following four years of significant portfolio derisking, we have considerably reduced our exposure to perpetuals, to peripheral European economies and financials especially in Europe. We are very pleased with the progress and the focus remains on investment liquidity, flexibility and diversification.
Our investment strategies have evolved since the financial crisis and we manage each of our portfolios with specific objective. Almost 12% of our portfolio is made up of liquid U.S. corporate bonds in Japan with the principal hedged into yen. Next year we expect to enhance our diversification by including other asset classes. Overall, we remain very pleased that the balance sheet has improved in quality, liquidity, return profile, as well as asset diversification. Our objective is to have a portfolio that’s also diversified by geography and industry while focused on quality. The vast majority of our investments in Japan are JGBs that provide us with a significant measure of liquidity as well as stability.
Our ability to implement new strategies is based on the evolving capabilities of Aflac's global investment decision that’s housed in New York. We have defined our investment objectives as maximizing risk adjusted performance, subject to our liability profile and capital requirements. We are pleased with our Japan new money yield for the first half of this year which was 3.02% and considerably higher than the budgeted yield of 2% -- excuse me, the actual yield of 2% in the first half of 2012. In light of 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 our third quarter cash flow to JGBs and under-weight the allocation to U.S. corporate bonds. We remain committed to further building out our investment functions and our capabilities to enable us to respond to changing economic environment. Now let me spend just the last portion of this discussion updating you on our 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 currency market.
While the yen was little changed in relation to the dollar from 2011 to 2012, it has obviously weakened dramatically in 2013. Due to the significant contribution of Aflac Japan's operations, a weaker yen suppresses our results as reported in dollars. However, Aflac's currency exposure is mostly translation related as opposed to currency transaction. As such, we believe that viewing our results excluding the impact of foreign currency is the most meaningful way of evaluating our overall financial performance. We remain very focused on capital ratios which demonstrate our commitment to maintaining financial strength on behalf of our policyholders, our shareholders, and our bondholders.
The strong surplus growth and improved portfolio risk profile and a weaker yen, our capital ratios improved significantly in 2012. Our estimated risk-based capital ratio in the U.S. at June 30 was 724%, which is a significant improvement over the year-end ratio of 630%. Additionally, Aflac Japan's solvency margin ratio or SMR was 585% at the end of June compared with 686% at the end of March. The decline in the SMR was primarily due to the spike in U.S. interest rates and increase in Japanese interest rates as well, which lowered the market values of our available for sale investment portfolio in Japan. However, I would note that the second quarter SMR of 585% remained at the high end of our range of 500% to 600%.
As we think about capital levels and how they try to [indiscernible] repatriation, our first consideration is protection of policyholders as measured by the SMR. Next we give consideration to the needs of the parent company and consult with Japanese management before we make a repatriation transfer. In July we repatriated 76.8 billion yen, the majority of which we had hedged into dollars in anticipation of a weaker yen at an average exchange rate of about 96 yen to the dollar. We believe that an analysis of operating earnings, a non-GAAP financial measure, is important to understanding our business and its underlying profitability drivers.
Our definition of operating earnings is profits we 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 was held back by the weakening of the yen to the dollar for the first half of 2013. However, excluding that impact, growth in EPS was strong and actually ahead of our target. As we have said for many years, when it comes to deploying excess capital, we still believe that the cash dividends and repurchasing our shares are the most attractive means and those are the avenues that we will continue to pursue.
Our objective remains to grow the dividend at a rate that’s in line with the operating earnings per diluted share growth before the impact of the yen. Aflac had purchased about 129 million of our shares with about 2.3 million shares in the second quarter, and for the first half of the year we had purchased $279 million of our shares. We have a lot of flexibility in terms of parent company liquidity and it's still our intention to purchase $600 million of our shares for the full year of 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 4% to 7% before the effective currency. Although we are above that range for the first half of the year, we do plan on increasing spending in the second half of the year. As such we expect operating earnings to increase to approximately 5% for the full year before the effective currency translation.
Generating an industry-leading return on equity, excluding the yen impact, is also an important objective. And for the second quarter that ROE was 22.1%. However, had the yen remained unchanged during the period, our ROE on a currency neutral basis was actually 26.4%. And based on year-to-date results, we are confident that we will meet or exceed our targeted ROE for this year of 20% to 25% before the effect of the yen.
Lastly, let me just show you how 2013 earnings per share might look with and without the impact of currency. On a constant currency basis, our expectation of the 5% increase equates to operating earnings per diluted share of $6.93. We estimate that a one year change on the annual exchange rate would equal about 4.3 cents and earnings per share. So if the yen averages 100 to a dollar for the full year, we would expect reporting earnings per share to be in the area of about $6.06.
We remain very focused on our vision of being the leading provider of voluntary insurance in the United States and the number one provider of supplemental insurance in Japan. We have great degree of confidence in our business model, the fundamental need for our products, and more importantly the future success of Aflac both in the United States and Japan. I think we have just a little time left for any questions and I would be happy to entertain those at this time.
Joanne Smith - Scotiabank GBM
We can take probably one question, if there is anything from the audience. Okay, then I will take that question. The Japan Post obviously is a different agreement than what you signed with them in 2008 for the 1000 post offices back then. And it's expanded to 20,000 this time around. What is the anticipated rollout of that? When can we expect to start to see something in terms of the sales results from those? And what new territories or markets does this provide Aflac access to in Japan that it may not have had previously?
Kenneth Janke, Jr.
Well, there is a lot to that. But the notion of the new or current agreement that we have with Japan Post is that this will now extend to the full network of 20,000 outlets whereas the prior agreement was really limited to 1000 postal outlets of the postal companies choosing. And really what I would consider to be an extended test. This agreement or the extension of this agreement on the other hand will have specific production targets and a timeline for ramping us up to the full 20,000 postal outlets which will take a period of years. And there is clearly training resources that we will have to dedicate to all of those outlets in order to get them up to speed. Fortunately, we do have the training resources that we can unlock a portion of which from the bank channel distribution and shift to Japan Post.
But importantly, the leadership at Japan Post has tied the success of this to their desire to IPO Japan Post in the very near future, in 2015. So we think there is a lot of interest in them driving sales to this relationship that we really hadn’t seen under the prior agreement. And this will really give us broader reach in the marketplace. Historically, the strength of our sales has been in the large population centers of Tokyo, Osaka, Yokohama and so forth. This will get us into more rural areas where postal offices are really a provider of insurance and financial services. So we remain very very excited about it.
Joanne Smith - Scotiabank GBM
Okay. We are out of time. Thanks so much, Ken.
Kenneth Janke, Jr.
Thank you for your attention.
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