Aflac Incorporated (NYSE:AFL)
2017 Outlook Conference Call
December 2, 2016 9:00 AM ET
Robin Wilkey - Senior Vice President, Investor and Rating Agency Relations
Daniel Amos - Chairman and Chief Executive Officer
Kriss Cloninger - President
Paul Amos - President of Aflac
Fred Crawford - Executive Vice President and Chief Financial Officer
Teresa White - President, Aflac U.S.
Charles Lake - President of Aflac International and Chairman of Aflac Japan
Eric Kirsch - Executive Vice President and Global Chief Investment Officer
Hiroshi Yamauchi - President and Chief Operating Officer, Aflac Japan
Jimmy Bhullar - JPMorgan
Seth Weiss - Bank of America Merrill Lynch
Erik Bass - Autonomous Research LLP
Thomas Gallagher - Evercore ISI
Humphrey Lee - Dowling & Partners
John Nadel - Credit Suisse
Ryan Krueger - Keefe, Bruyette & Woods, Inc.
Welcome to the Aflac 2017 Outlook 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 would now like to turn the call over to Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations. Ma’am, you may begin.
Thank you and good morning. And welcome to our 2017 outlook call. Joining me this morning from the U.S. is Dan Amos, Chairman and CEO; Kriss Cloninger, President of Aflac Incorporated; Paul Amos, President of Aflac; Fred Crawford, Executive Vice President and CFO of Aflac Incorporated; Teresa White, President of Aflac U.S.; Charles Lake, President of Aflac International and Chairman of Aflac Japan; and Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us from Tokyo this morning is Hiroshi Yamauchi, President and COO of Aflac Japan.
Before we start, let me remind you that some of the statements in this teleconference are forward-looking within the meaning of securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our quarterly earnings releases for some of the various risk factors that can materially impact our results.
Now, I’m going to turn the program over to Dan who will begin this morning with some high level comments and outlook for the Company’s strategic vision for 2017. Then Teresa will give an update on the U.S. strategy and focus followed by Paul who will provide a strategic focus for our Japan operations and outlook. Fred will then follow with comments about capital management, strategies and financial outlook and Dan will give us a close.
And Dan we are going to start with you now. Thank you.
Thank you, Robin. Good morning, everyone. We're glad you joined us today as we share with you our outlook for 2017, but before we do, I’d like to reiterate Aflac’s strategic vision to offer high quality, voluntary product, solutions, and services through diverse distribution outlets. In doing so, we ultimately are building upon our market leading position to drive long-term shareholder value.
We pursue this vision through the lens of delivering on the promises that we made to our policyholders and being there for them when they need us most. At Aflac, we've always managed our business for the long-term while remaining laser focused on meeting our financial objectives.
At the same time, we continue to work on enhancing our customer service and growing our book of business. This has propelled our successful development and strategic points of leverage in both Japan and the United States that we use to grow and drive shareholder value.
Our industry leading market share and scale in both Japan and the United States drive our administrative efficiencies. This allows us to offer affordable and valued coverage to our customers and competitive compensation to our distributors. At the same time, it drives value for our shareholders. Building on our leading position in both countries, we will help position us to growth going forward.
As a product innovator, we have experienced remarkable success leveraging the strength of Aflac’s recognized and powerful brand to drive sales. Almost nine out of 10 people in both countries recognized the Aflac brand. Our brand is the combination of many elements with the most visible being the Aflac duck, but it's also made up of the trust that we've built through relationship with businesses, policyholders, and consumers.
To this end, we are very proud to be the leader in the voluntary insurance sales at the work site in the United States and insure one out of four households in Japan. In Japan and in the U.S., Aflac’s established brand has served as an effective door opener. In turn, this serves as a catalyst for customers to be more receptive to hearing how Aflac’s products can help them.
As just one example in the U.S., one day pay, our industry leading claims initiative allows us to process, approve, and pay eligible claims in just one day. Our policyholders and consumers continue to tell us how our commitment to paying claims fast through one day pay underscores Aflac’s integrity and commitment to delivering on our promise. Having diverse and productive distribution channels as a strategic point of leverage as a vital component of our growth strategy in Japan and in the United States, as such this is one area we've been focused a great deal of our efforts on .
Our goal is to have a presence in all the outlets where consumers in both countries want to make their insurance purchasing decisions. We offer innovative products, high quality, and customized service to provide businesses and their employees with affordable solutions that protect their financial well being.
We established a strong capital position with stable earnings in strong cash flows. Our capital ratios demonstrate our commitment to maintaining robust capital levels and flexibility on behalf of our policyholders, our bondholders, and our shareholders. We also regularly assessed our capital adequacy to ensure we remain strong even under extreme economic scenarios.
Paul and Fred will cover this in their comments, but as you all are well aware, Japan's insurance companies were handed an interesting challenge at the beginning of the year with the Bank of Japan's negative rate monetary policy. Our plan recognized the need to balance earnings growth with prudent risk management containing volatility during a period of unusual investment conditions.
We believe our shareholders value Aflac’s stability. You will see in this that both our investment strategy and our decision surrounding the mix of businesses in Japan. Finally, we remain committed to returning capital to our shareholders in the form of dividend and repurchase, but smart investments in our platform is also critical to the growth of the topline; that investment continues in 2017.
Paul and Teresa will cover this in their comments. In just a moment, I will be handing the call over to Teresa to cover the U.S. strategic outlook. But first as many of you are aware, we periodically evaluate the optimal legal structure for our Company over the years as it relates to Aflac Japan's current branch status. The biggest obstacle that we faced in the past is that a change in the structure of Aflac Japan from a branch to a subsidiary would result in a tax obligation that would not be in the best interest of our stakeholders including shareholders and policyholders.
We are extremely pleased to say that we’ve found a solution that enables us to put in place an optimal organizational framework on a tax neutral basis. I believe the conversion of Aflac Japan branch to a subsidiary will be advantageous to all stakeholders. It’s important to remember that this has no implication to our day-to-day business operations and strategic efforts to grow our business and expand our platform in both countries. In fact, this transaction will result and Aflac looking like every other insurance and financial services company globally.
Fred and Paul will provide more detail shortly, but first let me turn the program over to Teresa who will talk about Aflac U.S. Teresa?
Thank you, Dan. I would like to begin by sharing some highlights of what we’re observing in the U.S. market, much of which has been impacted by the evolving healthcare environment. We continue to see employers opt for high-deductible health plans to reduce expenses associated with offering employee benefits.
Employers of all sizes continue to look for ways to assist their employees with health coverage while also shifting more of the cost to workers. Employers are seeking ways to make coverage affordable, and at the same time reduce administrative burden of regulation. This dynamic has caused many brokers to look to voluntary products to help their clients fill the gaps created by these high-deductible health plans.
Meanwhile, we expect that Donald Trump’s election to the Presidency coupled with the Republican majorities in both the U.S. Senate and House will likely reshape the nation's dialogue on healthcare even further. Also reshaping the public's perspective on healthcare and the approach that we take is the expectation that millennials will grow to make up more than half of the nation's workforce by year 2020. With his knowledge benefits providers must start positioning themselves now to meet the needs of this next generation of consumer.
According to the 2016 Aflac workforces report 24% of millennials don't think they spent enough time researching their health insurance options last year, which resulted in 69% of these millennials admitting that they wasted money due to their benefit decisions. Given the importance of having information readily available online, many businesses are solely offering benefits education through email and online resources including webcast and podcast.
Taking these factors into considerations, it's clear that technology will play a key role in our long-term strategy highlighted in our 2017 U.S. strategic playbook. As you recall, in 2016 it was a year of stabilization of our sales channels. We focused on leveraging the strengths of each channel to increase the long-term productivity of the entire distribution.
From a career agent perspective, we drove adoption of Everwell which allows us to position Aflac products alongside major medical as a holistic one-stop shop solution. This also allows our agents to take a consultative approach by offering an array of products including major medical products in addition to our supplemental voluntary product in the small case market. This will help to ensure that our distribution channels are equipped with the products, value added services and tools needed to succeed in servicing their client base.
In addition, we focused on deepening relationships with broker partners who traditionally serve the mid to large case market segment by providing the tools and services to support brokers needs such a proposal management, improving underwriting systems and integration of our enrollment solutions. If we look to next year, our attention will be on three key areas of focus: sales growth, efficiency and customer experience.
First, I'll talk about our growth initiatives. From a sales perspective, the changes we've made over the last couple of years have resulted in a positive impact on pay for performance. Although, we've not yet seen the sales lift expected, I still believe that we have the right strategy in place and that will result in long-term sales growth. In 2017, we’ll continue to focus on distribution expansion and aligning compensation with activities designed to drive sales results for the Company.
Secondly, we will continue to drive the adoption of technology specifically Everwell which we believe will be a catalyst for our growth in the future. Everwell helps increase account penetration and improves the retention of employers while enhancing the delivery of value-added services.
At the end of October, we announced the expansion of our Group Life product portfolio by partnering with another insurance carrier. So in 2017, we'll continue to expand our product partnering efforts to drive improvement in account access and more profitable and sustainable business relationships with brokers.
Our goal is to leverage Aflac’s unmatched brand recognition while insurance product administration and risk management are supported by a partner with a strong reputation and extensive experience in the market. As the workforce dynamics change we're also preparing to meet the workers when, where and how they want to do business with Aflac.
As the voluntary market continues to grow with the broker channel growing at a faster rate scale and efficiency continue to be increasingly important. As we've discussed we're making technology investments to support this evolving marketplace. With that I expect to see a slightly elevated expense ratio in the short-term as we position ourselves to drive down our expense ratios over the longer-term.
And finally, you've heard us say many times that one day pay will benefit our business. In fact, 96% of our policyholders that use one day pay say that they will be likely to refer a person to Aflac. So in 2017 we’ll continue to promote one day pay to increase customer satisfaction, drive deeper account penetration and ultimately enhance the customer experience.
Now keep in mind as broker production grows we anticipate sales will be increasingly concentrated in our fourth quarter more specifically in the very last few weeks of the year. And as I mentioned in the third quarter call Aflac U.S. will require a particularly strong December as we've had in the last two years in order to meet the low end of our three to five target increase for 2016.
To be candid our recent performance has fallen below our expectations and as you know has been at the low end of our guidance. With that, we've made significant changes in our field leadership where we've seen underperformance and as I mentioned we've invested in areas of our business that we believe will help open new accounts create better account persistency and penetration.
We also believe that these investments in our business will aid in deepening our broker relationships. Our actions have yielded success in certain areas of our business and we're taking every opportunity to build on those successful models. As we look to 2017 and beyond we anticipate that the long-term compounded annual growth rate for Aflac U.S. will be in the range of 3% to 5%. Thank you, so much.
And I'll turn the call over to Paul.
Thank you, Teresa. I would like to cover Aflac Japan’s outlook for 2017. In Japan, the government maintains a focus on keeping the economy growing amid unprecedented demographic and social challenges. When we delivered last year's outlook call you may remember that Japan had just dipped into a recession it’s second in two years.
In 2016, Japan's Prime Minister Shinzo Abe has continued to press forward with his economic reform agenda known as Abenomics and Japan's economy has experienced three consecutive quarters of GDP growth. The low interest rate environment however will continue to be one of the biggest issues for the entire industry in 2017.
Given Japan’s ageing population declining birth rates and raising medical treatment costs, the healthcare system has been under increasing financial pressure. As health related expenditures continue to grow showed us the need for supplemental insurance across all ages. Especially the type of products we offer insurance for daily living.
As you know, Aflac’s Japan strategy for growth over the decades has been simple. We offer relevant voluntary products sold through expanded distribution channels to yield new accounts and customers. Against that backdrop, our strategic focus continues to be on developing innovative products in response to ever changing customer needs and medical advancements.
As we discussed in September at our Tokyo Financial Analysts Briefing, Aflac Japan has formulated a mid to long-term strategy called Vision 2024 to provide direction for the Company through its 50th anniversary in Japan in 2024 and to achieve sustainable growth in a dynamic environment. This vision will serve as the foundation for Aflac’s business planning and product strategy which I will touch upon now.
The third sector landscape remains competitive as insurance companies are increasingly looking to this area for growth opportunities. In the cancer insurance space, Aflac has achieved a dominant number one position which facilitates a cost effective approach as Aflac Japan can release cancer insurance product revisions every two to three years.
In March 2016, we launched an innovative cancer insurance product and offer protection to our customers who have survived cancer and made revisions to our Gentle EVER product to enhance its alignment with changing customer needs. In July, we launched a new third sector product, income support insurance which is designed to provide cash benefits to those unable to work due to injury or illness. This established a new product category in the third sector market for us.
In 2017, we will continue to develop and drive these product refinements and consider additional revisions to our product development schedule. For 2016, the Bank of Japan's implementation of a negative interest rate policy had a significant impact on our first sector product strategy.
In 2017, as the Bank of Japan continues to assess its interest rate policy, we will remain vigilant about refining our approach to reflect current market conditions. Our focus remains on the exclusive agency channel and certain local shinkin banks both of which have similar operating models with respect to the cross selling of first sector products with third sector products.
Overall for the first sector, our focus will be on the level premium products that are repriced using current interest rate assumptions. You may recall that in November, we repriced WAYS, our largest selling and most interest sensitive first sector product.
In addition to maintaining a solid product portfolio, our business strategy also strives to lead the industry in distribution channel diversity. At Aflac Japan, we have enhanced and expanded our distribution network to give us more opportunities to be where the customer wants to purchase insurance products. Our traditional channels which include individual agencies, independent corporate agencies and corporate affiliated agencies have been and will continue to be a key to our success in 2017.
Additionally, strategic alliances through partners such as Dai-ichi Life, Daido Life and Japan Post continue to strengthen and evolve. These alliances ultimately improve our market access, increase the touch points we have with our existing and potential customers and allow us to associate with other trusted brands. Additionally, banks and large non-exclusive agencies allow us additional avenues to reach consumers and offer products while where consumers want to purchase insurance products.
I would like to add the diversity is a critical focus for Aflac Japan and it is an initiative in which we have taken significant action steps. As I indicated during last year's outlook call, diversity management is an integral part of our overall management strategy. We are working to raise the percentage of leadership positions held by women to 30% by the year 2020. And I am pleased to say that we are making tremendous progress toward this goal.
In fact, the share of women’s leadership at Aflac Japan has grown from 17.6% when the program was introduced in 2014 to 23.4% this year. We will continue to focus on growing our diversity in 2017 with a view toward achieving the 30% objective. On top of the tremendous 2015 results, Aflac Japan experienced strong sales growth in the first nine months of 2016, partially reflecting robust sales through our expanded distribution channels.
As sales to Japan post continue to stabilize, we believe our recent product innovations will begin to gain traction. Consistent with our plan, we believe third sector sales for the final quarter of 2016 will be down slightly compared to the same quarter last year. Additionally as you recall, we expect fourth quarter sales of first sector products to be down at least 50%. While this year's results created a tough comparison for 2017. We anticipate generating a long-term compound annual growth rate for third sector product in the range of 4% to 6% from 2013 through 2019.
Let me now comment on what Dan mentioned earlier regarding the conversion of the Aflac Japan branch. We believe this is a net positive to our long-term regulatory framework, risk profile, strategic positioning and overall health of the franchise. Aflac’s post conversion capital management strategy has been developed to be consistent with our current financial strength ratings and enterprise risk framework.
We also believe this structure allows us greater financial and business flexibility, while at the same time enhancing transparency especially related to capital management. We recognized that this process will require management’s attention. However, the advantages justify all costs both management and financial. Ultimately, the left graph of this slide shows the structure we envision once we've completed the conversion. This structure will be more streamlined and provide greater transparency.
Although we made the decision to undertake the conversion of our Aflac Japan branch into a subsidiary, we prioritized four prerequisites. First, the conversion would need to be implemented in a tax neutral manner. Second, it could not be disruptive to day-to-day operations in both the U.S. and Japan. Third, it could not have a material impact to core ratios and financial strength ratios. And finally, we needed to be able to secure the necessary regulatory approvals in the U.S. and Japan. We believe the resulting legal structures have satisfactorily addressed these prerequisites while also providing greater financial flexibility and enhanced capital efficiency and management.
Let me outline the major steps to convert the Japan branch into a subsidiary. The U.S. insurance business excluding the South Carolina and New York subsidiaries will be transferred to a newly formed subsidiary as required by regulatory authorities in Japan, the investment function or transfer from the internal department into two subsidiaries, our Japan investment subsidiary reporting to the U.S. investments subsidiary.
Finally, the Japan branch will become a subsidiary to Aflac Incorporated. We believe that all the necessary steps in the process will be completed by mid-2018. We expect this will lay a foundation for long-term success for our shareholders and all of our stakeholders alike.
In closing, I am excited about 2017 and confident that Aflac is implementing the nimble, robust, product and distribution strategy needed to continue leading the third sector insurance market in Japan.
Thank you. Now let me turn it over to Fred, who will discuss our financial outlook for 2017 which includes the financial impact from the conversion.
Thank you, Paul. Let me start with a few high level observations on cash flow and then I'll turn to capital considerations as it pertains to our conversion. Currently, Aflac has a stacked structure for moving cash flow to the holding company for deployment, meaning we must first satisfy Japan's financial service agency conditions for repatriation and then the Nebraska Department of Insurance conditions for dividends to the holding company.
Our conversion to a Japan subsidiary simplifies or unstacks our legal structure allowing for one layer of regulatory review before transferring capital. This is a more transparent structure that is generally favored by rating agencies, bond and equity investors. As the Japanese subsidiary dividends to the parent company are governed by Japanese corporate law which limits dividends to a distributable amount that is equal to retained earnings less net after tax unrealized losses on available for sale assets. This is somewhat consistent with managing SMR which also fluctuates with unrealized gains and losses.
As a result of the conversion we will be reclassifying our retained earnings to capital reserves. We will pay dividends out of capital reserves in the early years following the conversion to rebuild retained earnings providing an ample cushion for future dividends. We believe the move from repatriation to dividends provides greater clarity for moving cash flow to the U.S. parent.
Aflac Japan will continue to pay allocated expenses to Aflac Columbus as well as management fees directly to Aflac Incorporated. One distinction between the current state and upon conversion is the use of a tax sharing agreement between the Japan subsidiary and the parent company as a U.S. taxpayer post conversion. These agreements collectively provide for steady and uninterrupted cash flow from Japan.
Turning to our capital ratios both SMR and RBC are impacted by the conversion. In the case of SMR when we transfer our retained earnings account to capital reserves, we lose a tax gross-up factor on retained earnings that benefits our SMR by approximately 100 points. By paying dividends out of capital reserves we restore our retained earnings and associated benefit to SMR to pre-conversion levels over a projected three-year period.
Importantly this is an accounting driven adjustment to SMR, there is no economic impact to capital. In terms of RBC the conversion will provide material capital benefits. Going forward our RBC will be a U.S. only calculation and will not be impacted by either foreign exchange fluctuations or capital charges applied to our concentration in JGB’s.
As a result we estimate our U.S. only RBC will jump approximately 140 points to roughly 1000%. Post conversion we plan to run our U.S. business closer to 500% RBC, which we believe is robust given our risk profile. This potentially unlocks around $1.7 billion in excess capital. We believe it's prudent to retain a level of contingency capital in light of the SMR ratio sensitivity to extreme market conditions.
Therefore we would target an increase in U.S. deployable capital in the $1 billion range and we'll start releasing portions of that capital as early as 2017. While the excess capital is always been in our U.S. operation it has been much harder to define given our branch structure. A more transparent U.S. cash flow and excess capital profile secures our three-year deployable capital range at or above the midpoint of our $5.8 billion to $7 billion guidance range and should allow us to extend our strong capital deployment to the benefit of our shareholders beyond 2018.
We have reviewed our capital management plans with the rating agencies. In all cases the agencies view the conversion as net positive to our overall ratings profile and we expect they will affirm both senior debt and insurance company ratings at their current strong levels. There was no material impact to holding company core capital ratios namely financial leverage and cash flow coverage. And we remain committed to our current strong insurance and debt ratings.
Turning now to our financial outlook for 2017, I'll start with a few of the key areas of reporting enhancements designed to align our reporting with driving economic value. We will be moving our U.S. dollar hedge costs into our definition of operating earnings as a non-GAAP financial measure beginning first quarter 2017 and reporting on an amortized basis over the life of the hedge instrument.
As we continue to lengthen the duration of our hedged dollar portfolio this approach is a more accurate way to reflect the true cost of the forwards in the period reported. These amortized costs will be incorporated into the Japan segment impacting earnings and margins accordingly. While not incorporated into our operating earnings until 2017, please note that we will begin using the amortized method to reflect these costs in the fourth quarter of 2016.
An additional disclosure documents showing the current and prior periods on an amortized basis is posted to the Aflac IR website to assist in modeling 2017. Note that this revised definition has no implications for reporting GAAP net income. I noted at our May Financial Analysts Briefing that our currency neutral operating return on equity calculates operating earnings or the numerator on a currency neutral basis, but our average equity has impacted by unrealized foreign exchange translation gains and losses.
This has resulted in a volatile reported ratio in years where the currency moves dramatically as it has in 2016. We believe removing this equity line item from our definition in 2017, much like unrealized gains and losses on investments makes sense in order to isolate the key economic drivers of ROE year-over-year. Finally, we anticipate the costs associated with converting our Japan branch to be in the range of $80 million pretax for 2017.
Consistent with the non-recurring aspect of these conversion costs, we will exclude from our definition of operating earnings, but fully disclose the costs until completion. We believe these adjustments better align our key non-GAAP measures of operating earnings and return on equity with the true economic progress of the Company in value creation.
Before providing details related to our earnings and capital plan, I want to highlight the key drivers of our near-term earnings and capital forecast. First, we are making great progress in pulling back from first sector savings products in Japan. We are effectively shifting capital away from lower return asset leverage products towards Aflac’s dominant and high return third sector business. This emerges in the form of improved FSA earnings given the capital intensive nature of saving products. However, the strategy naturally pressures GAAP earnings and revenues as we transition.
Earlier this year and shortly after the BOJ’s actions, we formed an internal team to further evaluate our investment strategies to navigate the rate environment in Japan was involved a comprehensive approach to product pricing, asset allocation, hedge costs, capital management, accounting and actuarial testing considerations.
Our tactical approach has implications for both net investment income and hedge costs in 2017 and focuses on ensuring long-term stability of income, capital and cash flow. Finally, we are also actively investing in our global platforms. IT initiatives in both the U.S. and Japan will elevate expenses in the near-term, but we are confident we will pay dividends in the form of operating efficiencies and future growth.
Turning then to investment strategy, a significant challenge is lower reinvestment rates and portfolio turnover. We have steady cash flows to invest every year and since 2015 those have been primarily generated from the investment portfolio including interest income, redemptions and costs.
In the chart at the top of this slide, you can see that the decline in cash flow from operations in 2016 and projected for 2017 compared to recent years as sales of first sector products diminish. As we look forward to 2017, our average runoff yield is approximately 3% with new money yields of 1.5% net of hedge costs. Note that 2016 is impacted by a tactical shift in the portfolio which I'll touch on in a moment.
In terms of new money investment strategy, for 2017 we estimate that 70% of our allocation will be to yen fixed income, 30% to dollar fixed income and growth assets. The allocation to yen fixed income will impact their new money rate estimates and way down on our investment income, but helps in stabilizing hedge costs and our SMR, and is generally better from an ALM perspective. We expect to selectively reenter yen privately issued securities to earn additional credit spread though we will ramp up slowly as we are disciplined with respect to credit risk.
At the beginning of November, we initiated a switch trade selling 2.5 billion of fixed rate corporate bonds with proceeds earmarked for building out an allocation to floating rate loans. Floating rate investments are a good fit for our hedging program given their relatively short duration spreads to LIBOR in high correlation to hedge costs. In other words with floating rate assets, we ensure a more stable net margin. We are holding proceeds from the switch trade in JGB’s, while we qualify new floating rate investments, so there will be a natural drag on 2017 net investment income offset by lower hedge costs as we tactically build out the portfolio.
In the fourth quarter, we have continued to proactively manage the risk of rising hedge costs by lengthening the average duration to 1.5 years. With a larger floating rate portfolio, we will naturally use shorter duration forwards for hedging and we will assign our longer duration forwards to back our fixed income investments. The goal is to close the duration gap by up to three years between hedge instruments and hedge assets for greater stability, a strategy accelerated by the switch trade.
We have established internal tolerances for hedge costs overall and annual volatility. We have locked in approximately 90% of the hedge cost for 2017 and 30% into 2018. Similar to our approach to repatriation hedging, we will then roll forward the hedge portfolio thus moderating annual volatility.
For 2017, we estimate hedge costs in the range of $250 million to $270 million pretax and we will build back to a notional of approximately $15 billion by year end 2017 as we build the floating rate portfolios. In summary, we have made a proactive shift in the dollar program to reduce our near-term exposure to rising hedge costs and improve and stabilize our investment income in future periods.
Now, I would like to detail assumptions underlying our 2017 core insurance earnings drivers in Japan and in the U.S. In Japan, we expect total earned premium growth to be negative recognizing we are entering the peak of our paid up status on five-pay WAYS products and continue to execute on our first sector strategy. While not impacting overall profitability given the amortization of our deferred profit liability, roughly 60 billion yen in WAYS premium has reached the paid up status.
Together with modest incremental platform investments, this modestly elevates our expense ratios. In terms of benefit ratios, shown on the slide relative to premium, we expect favorable trends in the core health in other product lines to continue. Investment income in our Japan segment is the main driver of margin performance as we deal with the realities of capital markets conditions namely lower rates and rising hedge costs.
In the U.S., cumulative sales growth and modest improvements in persistency are contributing to an earned premium growth rate in excess of 2%. We expect continued favorable margins overall with a continuation of strong benefit ratios. As Teresa outlined, we are actively investing in our U.S. platform for future growth and efficiencies. This will result in a modest pickup in our expense ratios prior to experiencing the payoffs that come later in life for the project as we retire certain systems platforms. We anticipate our expense ratios to run around 50 to 75 basis points higher as a result of this multiyear effort which ramped up throughout 2016.
Turning to a discussion on capital outlook, in the third quarter SMR was 935% and RBC was in the mid-800% range. As you know, our SMR ratio is sensitive to market fluctuations with roughly a 335 basis point provision that in part recognizes the unrealized gains in our AFS portfolio and the potential for stress conditions. There is no material change in our repatriation plans for calendar year 2016 as we continue to target approximately 138 billion yen for calendar 2016.
Note that we show FSA earnings and repatriation on this slide for Japan's fiscal year ending March 31 basis and project an increase in FSA earnings as we continue to pull back from first sector savings products despite assumed rising hedge cost. Our range of repatriation is arguably conservative and we will adjust depending on credit conditions and the stability of our SMR ratio. In terms of holding company metrics, leverage will remain around 21%. We estimate ending the year with holding company liquidity of roughly $1.5 billion of which $1 billion is available to shareholders.
We expect 2017 repurchase guidance to be in the range of $1.3 billion and $1.5 billion and we planned a front end load roughly 60% to 70% of our repurchase in the first half of the year depending on conditions. As is always the case, this assumes stable capital conditions and repurchase as the optimal use of deployable capital.
We are projecting a range for 2017 operating EPS under our new definition of $6.40 to $6.65 per share assuming a foreign exchange rate of 110 yen to the dollar. This excludes the cost of our branch conversion. When looking at EPS estimates for 2016 assuming the yen at 110 and including our estimate for amortized hedge costs the range equates to approximately flat to up 3%.
Our somewhat muted EPS growth rate is primarily impacted by the tactical investment strategy outlined earlier where investment income net of hedge costs weighs down on 2017 EPS by approximately $0.25 a share as compared to 2016. Incremental investment back in our Japan and U.S. platforms accounts for roughly $0.12 to $0.15 a share in both Japan and the U.S. and is supported by viable return expectations in the future.
These natural headwinds are offset by continued strong underlying insurance margins and return of capital to shareholders in the form of repurchase. Currency neutral operating ROE under our new definition is expected to be around 16% for 2017 our weighted average cost of capital sits at approximately 8% and is among the lowest in the industry.
Our goal is to defend and preferably widen the gap between return on capital and cost of capital. Our financial playbook for creating value is straightforward, defend the attractive margins in our core supplemental health businesses, allocate capital away from more volatile and capital intensive businesses to stable businesses that earn comfortably above our cost of capital and invest to improve service and efficiency.
Finally, manage the risk in the investment portfolio and investment income volatility and identify idle or excess capital for future deployment at high rates of return or returning back to our shareholders.
With that, I'll turn the call back to Dan for closing comments.
Well, I want to close with some thoughts that should be top of mind as we look at next year. Our activities are centered on growing our franchise, protecting policyholders and driving shareholder value. In Japan and the United States, we dominate our market and we plan to keep it that way. Aflac Japan the leading provider of third sector products will focus on new product innovation in the third sector market. We’re extremely encouraged with the significant progress we’ve made in limiting the sale of our first sector products putting a squarely on track to reduce first sector sales by at least 50% in the second half of the year.
Looking ahead to 2017 we expect the sales of first sector products will be down over 50% compared to 2016 and most importantly interest sensitive first sector products are expected to decline even more significantly. Aflac U.S. is concentrating on leveraging our brand to fuel our growth and benefit our distribution channels while investing in enhanced customer experiences and efficiencies.
To follow-up on Fred’s comments our goal is to achieve a stable EPS growth while also investing in the business to drive future growth. When it comes to dividend increases we belong in an elite club. This year marked the 34th consecutive year of increasing our cash dividend. We anticipate increasing the dividend again in 2017. By the end of 2016 we expect to have purchased $1.4 billion of common shares. We plan to repurchase $1.3 billion to $1.5 billion in 2017.
We will continue to evaluate all options when it comes to deploying capital and growing the business, but as in the past we will remain very disciplined, as always we continue to keep you updated related to the branch conversion. In terms of our brands conversion management is being proactive in placing our company in a favored regulatory framework, and providing greater clarity and transparency into the ongoing capital generation.
Paul and Fred gave you the details, but let me just reiterate that we simply undertaking an effort to look like the rest of the industry and move to the standard global structure similar to the peers and the insurance and broader financial services industry. We believe this puts us in a better and more flexible position to grow in the future.
You’ve all ready heard me say that my job is the balance of interest of all stakeholders. I think we did a good job of that this year just as we did in the past. I believe that we're going to do that again next year by delivering on our promises to our policyholders and enhancing shareholder value.
Now, I’ll turn the program over to Robin so we can have Q&A. Robin?
Thank you, Dan. Now, we’re ready to take your questions. Let me remind you, to be fair to everybody please limit yourselves to one initial question and only one follow-up that relates to that question. We will now begin.
Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] We have our first question from Jimmy Bhullar with JPMorgan. Your line is now open.
Hi. Good morning. So Fred, if you could talk about just assuming that the tax rate in the U.S. don't change, should the legal structure change have a positive implication I'm assuming on your tax rate going forward once it's completed? And if yes, would your new tax rate just be the weighted average of earnings in Japan and the U.S.?
Sure. Actually Jimmy in this particular transaction, we really don't change our current tax status, we remain a U.S. taxpayer, and so it really ends up being not an impact pre or post conversion. So to then your question, I've read a number of research reports covering the industry impact, and people generally have the conditions sized up properly for Aflac. And that is if you were to assume a corporate tax rate in the U.S. to be dropped, let's just pick a number for argument sake, say 20%. Obviously, as we move on down in that tax rate, we get stopped, there's a floor associated with the fact that we paid 28% tax rate in Japan.
So as a result, if you just do that simple math, we will see a reduction in our effective tax rate, but it stops at a certain point. The rough, rough calculation on that would be in the range of 26%, but realize there's likely some additional moving parts associated with some of the benefits related to carrying over certain taxes and tax credits, and we have to assess that. There will be speculation to go further. But that's the simple math absent any other changes in the way U.S. tax credits are applied.
And then just on the U.S. business, what's the implication if there are changes in Obama care to your U.S. business because of uncertainty, could you see maybe activity slowing down a lot as employers are trying to evaluate what the changes could be? And have you heard any of that from the employers or your customers?
Jimmy. This is Teresa. At this point, we have not heard anything as it relates to slowdown of our business. What we do know is that the conversation continues as it relates to policy. Now at the end of the day, consumers are still having to pay – and as a matter of fact especially with the exchanges they've experienced double-digit increases in their premiums, so consumers still need the product. So I don't anticipate at this point any issues as it relates to the presidency, the change, transition in presidency on U.S.
Our next question is from Seth Weiss with Bank of America. Your line is now open.
Hi. Thanks for taking the question. Fred, on the conversion from branch to subsidiary, just trying to understand here the concrete benefits on the capital implication. And If I'm understanding it right, there will be about a $1 billion release of U.S. excess capital over time. How else should we think of the concrete benefits above and beyond, maybe this release of capital in the U.S.?
Yes. I think as we move beyond the three-year period we use, which is 2016 to 2018, there will be continued benefits. I should note that I mentioned that we expect to be at or above the midpoint of our range in part given this particular transition and the $1 billion. That is assuming really only a portion of that $1 billion of deployable capital in that period, so as you move out of 2018 and into 2019, in other words as we move beyond 2018, there will be continued positive implications related to the deployable capital created in the U.S.
The way I think of the benefits of this is that for the first time in 40 years, print an actual blue book in the U.S., and what I'm particularly excited about is I know obviously firsthand that the risk profile of Aflac U.S. is a materially favorable risk profile as compared to more asset intensive business models involving say annuities and universal life and obviously other interest sensitive businesses.
So the business model of Aflac in the U.S. is particularly helpful in managing to a more optimal risk-based capital, and right now we call that 500%. As I mentioned in my comments, what's been problematic for us is that our U.S. RBC owning a branch really fluctuates with FX and so the volatility in our RBC has been something we've had to manage and be careful about.
The other thing I would note is where the concentration in JGB’s, which is understandably a risk free asset in Japan; it's not necessarily considered a risk free asset when you pull it back into the RBC C1 charge component. In this particular case, you all know that there's work being done on C1 charges going forward. They're likely to change the way we allocate capital to various securities including A and A plus rating securities, so this type of a concentration is something that now is avoided.
So you really end up with a very strong risk profile business, an ability to manage down the capital. And as we go forward, you're going to see an actual pure free cash flow development coming out of our business in the U.S. and excess capital and that's what’s supporting the $1 billion.
So to follow-up on that and the better risk profile in the U.S., 500% RBC target seems high considering your mix of business and what others run at. So just curious if you would extrapolate on that a bit more?
Yes. I mean my view is, you dial it in at a comfortable level and particularly a level commensurate with our very high senior debt and financial strength ratings and that's what's allowed the caution if you will in the 500%. As we go forward, we can think about whether we can optimally manage that capital in a different way, but right now that feels like a comfortable number.
Remember, our ratings are among the highest among stock companies in the U.S. We like that. We think that goes to our brand in the U.S. in particular as we start expanding our business into the brokerage model, we think brokers particularly the large brokers and larger and midsize groups start to value that strong brand in the marketplace and we want to leverage that.
So I think over time, we'll settle into a good understanding of free cash flow, the balance of risk and we may have opportunity there, but right now we want to be conservative and appropriate and most importantly defend our strong ratings.
Our next question is from Erik Bass with Autonomous Research. Your line is now open.
Hi. Thank you. Fred, maybe on your – the last point that you made on the free cash flow, I think at the FAB you had provided a general guidance on free cash flow under your current structure. So can you walk through how you expect that to change and potentially improve under the new structure?
I think the actual pure cash flow and as I mentioned in my comments, interest coverage when looking at the holding company for example does not change materially, okay, but the quality of that cash flow and the transparency into where those cash flows are coming doesn't prove in my opinion and it does so in that you're able to really tie it back to FSA earnings and earnings creation in Japan which is always been the case, but now you have a very disciplined, somewhat codified approach to dividend, dividend capacity moving cash flow.
I noted the various contracts we have in place. These are customary as you all know, it's quite customary to have management fee arrangements and allocated cost arrangements and tax sharing. But what I like about that is we end up increasing our contractual cash flows out of Japan and that is a very steady and stable level of cash flow.
So I like that, I think that improves the transparency. And then in the U.S., very simply you're able to see our statutory earnings, an actual statutory net income in the U.S. only and that will make for more clarity around the amount of cash flow each year. In previous years we haven't really had something we call the U.S. statutory income. We've had to pull it all together and make a broad-based judgment which combined the income of the branch as well as U.S., now we see that clarity.
So I am not expecting necessarily a large increase in raw cash flow, I am expecting an increase in excess capital identified in the U.S. which will contribute for a while the cash flow. But once we are beyond that excess capital it's much more clarity and I think quality of cash flow is the bigger issue.
Perfect. Thank you. That helps and then just one follow-up. How much of your U.S. excess capital do you contemplate using in your 2017 capital return plan for the buybacks and dividends?
Sure. That the way I've framed it internally here is we're making a down payment if you will on this announcement in the form of capital deployment. And it's just shy right now we're modeling just shy of $300 million. And really what we're doing Erik is we're effectively spreading that deployable capital over a three-year period. This is why creep 2017 into 2018 and then beyond into 2019 which is beyond our current guidance range time period.
But we'll provide those types of additional updates when we get to our Financial Analysts Briefing and 2017 as we customarily do, but that's the number we're focusing on. I might also make one other comment based on your first question because this has been on my mind. Aflac has one of the highest fixed charge coverage ratios in the industry. And it does for very obvious reasons, we generate strong cash flow but we also have a very low interest expense because we borrow in yen.
And so we tend to have a leverage of 21% which is quite customary and I think appropriate, but a very strong coverage ratio. Part of what I see as the long-term benefits of this structure is as we get into a reliable and predictable and transparent set of cash flows. We have an opportunity to look at our overall leverage structure and cost of capital structure and see whether there is any opportunity there. I can't call that now I don't want to predict that now but certainly as a financial engineer that's what we're hoping to achieve over time.
Great. Thank you very much.
Our next question is from Thomas Gallagher with Evercore ISI. Your line is now open.
Good morning. Paul, I just had a question on your commentary around Japan from a sales standpoint. I don't think there was any commentary on the third sector 2017 sales outlook other than it was a difficult comp. Can you talk at all about what your expectations are there? And in particular, I think you mentioned sort of steady sales related to Japan post. Anyway, any commentary, you can give there would be appreciated?
Sure. Be glad to, Tom. First of all, we expect the first quarter of 2017 to be a very difficult comparison. It’s going to happen in part due to some of our partnerships, but it is something that we've anticipated and we're knowledgeable of it really has to do with the completion of the Japan fiscal year for some of our key strategic partners. We anticipate that the second half of the year will be strong, that sales will continue to improve.
As I said in my comments the reality of opening a brand new product line in Japan like our income support product is that unlike other products that we might launch, it takes a period of time not only for our distribution to understand and get comfortable with the product, but to also get consumers comfortable with that product.
Now we've seen some very positive results and we continue to be very happy with what we've seen so far. But certainly it's not on the scale by any stretch of the imagination at this point with cancer or medical launch. And so we will continue to invest and see that grow. We do have a product rollout schedule for 2017 that I think will generate a good second half of the year results.
But frankly Tom, as you look at the next three years 2018 is actually the year that I expect to be very strong again. I expect this year to be a good result and when we can be comfortable with but 2018 we should see significant growth and so as I look to the three-year CAGR and that reflects a specific plan that we have in place our three-year medium-term management plan which is part of our Vision 2024.
I think that you're seeing numbers that we're comfortable with and really reflect what we have to do from a product standpoint as we release revisions of those products tied to specific timing and the demands of the market.
Okay. So Paul, you guys are really getting away from year-to-year sales targets looking more longer-term so not providing any explicit 2017 sales guidance.
Really and truly as you've seen Tom the focus is on the longer-term growth and so not necessarily having specific targets because so much is tied to product launches and other things that we think it really is about maintaining the long-term growth rate of 4% to 6%.
This is Fred. As you might have noticed that in both Teresa’s slides and Paul’s slides, the year, the CAGR is 2019. That's not an accident. We have a three-year plan. We have a three-year sales plan. We have three-year sales targets. And so this not aspirational, this is what we are managing towards and investing in to try to achieve.
This is Dan. The only other comment I'll make is when it's only three years, you can't get far behind on any of those targets that’s the average for that period of time and not make it. So there’s not an enormous variation here of what we're going to do, but it just gives you a general range because one-year may do a little bit better than another, but all-in-all they've got to be pretty close for us to make the numbers.
Understood, Dan. And then, just one follow-up. When you contemplated the branch to subsidiary conversion, is there any thought to optionality of under various scenarios, considering a bigger corporate restructuring like breaking the Company up or is that just not something under contemplation?
Yes. I'll certainly welcome any comments. This is Fred. Tom, I’ll welcome any comments from Paul and Dan. But just an observation in that is, I think we have a uniquely optimal business model and I've been able to see it live at work since joining the Company 17 months ago. We were in the two largest insurance markets on the planet. We have by far leading market share in the businesses we operate in and strong strength of brand, distribution and platform and we have a relatively simple model, it's hard to be both global and simple in your design.
And then last but not least, it's also hard these days to be a $30 billion market cap financial service company and not being inside some sort of special restrictive regulatory environment. And so we've dialed in an optimal structure as a Company. As a financial practitioner I would tell you is that there's no magic in that 7% to 8% cost of equity. That is a very real in a very low cost of capital I should say and that cost of capital is driven in part by the combined financial dynamics of both the Japan and U.S. platform and we think could be a weapon if you will in growing, applying that cost of capital to really grow the business. So my personal view financially oriented is I like the optionality of the business model for all those reasons.
And Tom I will say that, I’ve always believed as a CEO to kind of work in a herd mentality. You maybe at the head of the herd or you maybe behind at the end of the herd because you don't want any risk on something or whatever it is. But when you get outside the herd, as we are in our branch position, that’s when you get picked off. And right now, we're in great relationship with our regulators. But regulators change and we are so well positioned right now, it's a perfect time to be put in the herd to where we don't have any issues with regulators later on because we're so different.
So this is a move for all the financial reasons that you heard. It’s also a rule for all the regulatory reasons that you might think up to. So it's a combination of – we just think it’s the best possible way for us to do business and we think that this move ultimately will enhance shareholder value and we can do it better as a one unit, just like Met does theirs, like Pru does theirs, like other companies does their subsidiaries. And we'll continue to do that as long as we think it enhances shareholder value.
I'd like to add one comment Tom. Being in somewhat unique perspective of having worked with Aflac U.S. and in Aflac Japan, I can tell you that the synergies between these two businesses remain extremely strong. 15, 20 years ago when Aflac U.S. was only focused on the small account market and wasn't in the broker business and when Japan was only focused on corporate affiliated agencies perhaps the synergy weren't as strong.
But in the last 10 years, we have seen an incredible convergence between our two businesses that have allowed us synergies, not only on the sales and marketing side, but on the IT side as well as on the operational infrastructure side, the way we're dealing with claims there are a variety of different things that we continue to learn from each other.
As you reflect back on my comments that I made at mini FAB in Tokyo, this is a real positive for us as a company and allows us to take the strength of Aflac Japan as well as the strength of Aflac U.S. I emerge them together to benefit the shareholders and policyholders of Aflac Incorporated.
Okay. Thanks guys.
Our next question is from Humphrey Lee with Dowling & Partners. Your line is now open.
Good morning and thank you for taking my questions. Just a comment related for Teresa. You mentioned that expanding your partnership in the U.S. on the group platform. Are you looking expanding beyond what was announced earlier this quarter, or just simply referring to kind of based on that relationship only?
We currently have expansion of partnerships through our Everwell platform where we are selling major medical products as well as or offering major medical products as well as vision and dental life products. The other expansion that we're looking at and that we continue the one that we referenced – that I referenced in October of this year, we introduced. So we are continuing and we have a plan as Paul spoke about, we have a plan, specific plan to continue to expand our portfolio either with changes to our current product or adjustment to our current product and partnerships as well. So we're doing both.
Okay. So basically the announcement from October that was not an exclusive relationship, that you could potentially add more partnerships through your Everwell platform?
That’s correct. We currently do today. That's correct.
Okay. All right. And then maybe a question for Fred. For the conversion costs, I know it's going to be excluded from operating earnings, but just a modeling perspective, how should we think about the timing of those kinds of expenses to be incurred through 2017 and 2018?
Yes. What we are projecting right now, pretax is about $80 million in 2017 and then $40 million to $50 million in 2018. So I think if you recall, I think Paul has a slide this is $120 million to $130 million that's how it would spread out Humphrey. And again, I want to reiterate, we will be fully disclosing these costs so you will see how they're trending and how they're coming through and we're obviously able to comment on them and how they are progressing as we report.
All right. Thank you.
Our next question is from John Nadel with Credit Suisse. Your line is now open.
Cost disclosure on your website. Can you just tell us what the comparable amortized cost was in 2016 and how much we should expect for the fourth quarter of 2016?
Let me give you the full-year or maybe I think I know the number the fourth quarter, Eric you can correct me, but the full-year on an amortized basis for 2016, we are estimating at $190 million pretax and or roughly $0.30 a share, okay. And then for the fourth quarter, I believe it's approximately $50 million pretax is what we're estimating for that quarter.
And I say estimate because of course we're in the quarter still and we've also done a fairly good amount of trading as part of lengthening the duration of our hedges and of course incorporated in the switch trade. So we have that there for an estimate, but that’s about the number John, if that helps.
It’s actually $63 million for the fourth quarter.
$63 million, okay. So you have that $63 million pretax is the estimate.
Got it. And then real quick, where geographically in the Japanese segment income statement, where should we see that, is it going to be netted against the U.S. dollar investment income or is it a true expense item?
Yes. So what we're planning right now is this, as I mentioned it's in the Japan segment earnings, but the way and just follow me here the way we would see it broken down is that you're going to have the U.S. dollar net investment income, the yen net investment income, a subtotal, then hedge costs, then another grand total, net investment income including hedge costs. So pretty straightforward, but you'll be able to see and that's really the way we think about the program, we fundamentally think about it as incorporated in our net investment income and that's how we want to talk and show to it.
That's perfect. That makes sense and then just a higher level question. So zero to three means I think apples-to-apples you're talking about 0% to 3% EPS growth in 2017 constant currency. There's a lot of moving parts, there's a little bit of investment going on in the U.S. and Japan, there's some repositioning portfolio. As we look out a little bit further, where should we expect that 0% to 3% can move up to on a longer-term basis?
Yes, John. I would say that at this juncture that’s the type of question I'd prefer to take to our briefing meetings because we tend to give that more longer range growth rate whether it be earnings or ROE targets. But there's a few moving parts I would just comment on I think the core ratios of the Company that is the insurance underwriting ratios of the Company, remain strong and solid and we see them remaining strong that is benefit ratios for a period of time.
You will have some elevated expense ratios as we invest for a period of time then eventually calming down. But these are multi-year projects if you will to overhaul the kind of systems platforms we're talking about in the U.S. and I'm going in Japan.
But again not material in the way of a drag to our overall margins, particularly recognizing I think we've come off record margins for the company in 2016 and they remain very attractive going into 2017. When you get to the investment portfolio you got a few things going on. What we will see is some natural build in NII if you will from putting some of that JGB’s to work in floating rate assets as we come off the switch trade.
But also we have an eye towards what's going on with hedge costs as we move forward. What I like about lengthening the duration is not only does it create greater stability of that net investment income, but it also allows management to make appropriate adjustments as capital markets move around.
And so I like that rolling extended duration so that we can make some moves and try to manage our tolerances around volatility and absolute hedge costs. So those are pressures that I would just highlight at the moment, but otherwise perhaps we can talk more long-term trends as we get to our conference.
But I'll just say above three. I’m not going to go out; Fred is got to look at all the investment income and all the aspects of the negative environment we are in right now. But the way the insurance operation is running, if we can get any movement at all, we ought to be back on track and moving back ahead. And I think of course doing this branch deal to a subsidiary is a big deal for us, it’s going to help accelerate our ability to buy back stock too, so all those things together.
Thank you very much. I appreciate all the responses.
Thank you. Our next question is from Ryan Krueger with KBW. Your line is now open.
Hi. Thanks. Good morning. I first had a question about the switch trade cost. I think it looks like that is in the ballpark of $80 million or $85 million of a pretax headwind in 2017, I guess is that the right range of the magnitude?
Yes. What you're referring to is my reference to the $0.25 per share drag related to the switch trade. Yes, it's a combination of moving for a period of time into JGB’s as we gradually put the money to work in floating rate assets, realizing you're talking about building a floating rate portfolio. It's loan-by-loan, security-by-security basis and so you've got to do your credit work and you've got to build that portfolio, you can't just flip a switch if you will and put that money to work immediately.
But offsetting that is you have the hedge costs come down because you're obviously not hedging your JGB portfolio. But when you take the two combined they represent a drag as we make our way through 2017 as compared to 2016 of about $0.25 a share. But realize in doing that it is also creating a much more stable and we believe higher quality go forward U.S. dollar portfolio. And that's really what we're after here is really avoiding the kind of volatility that we think would not be good for us, not be good for our shareholders and so we're trying to manage that carefully.
Okay. And then I guess trying to think a little bit longer-term, you get the – as you build out the floating rate portfolio you'll get that dragged back, but then hedge costs are running higher.
Yes. But remember, the whole beauty of the floating rate asset right is don't forget my comments and there's a correlation between a spread over a LIBOR and where that's moving and where likely hedge costs are moving because presumably you've got a short end of the curve rising rate environment due to inflation that is pressuring your hedge costs up, but it's also driving your net investment income on floating rate assets up.
Also I’ve coupled that with you by definition are using very short dated forwards which will tend to be less expensive than longer dated forwards. And so again, while you're building that floating rate portfolio, the same write up in hedge costs should be a natural write up and putting the money to work at higher spreads to LIBOR.
Okay. Understood. Thank you.
End of Q&A
This is Robin. And I believe we’re going past the top of the hour, so if we have anyone left we'll have one more question and then we'll end the call and take your questions later in IR.
All right. I think we’ve answered all the questions and thank you so much for joining us today and please if you have any questions or follow-up please contact us in Investor Relations or Rating Agency Relation, we'll be glad to help you. Thank you again, and have a good day.
And that concludes today’s conference. Thank you for your participation. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!