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| AFL > SEC Filings for AFL > Form 10-Q on 7-Aug-2009 | All Recent SEC Filings |
7-Aug-2009
Quarterly Report
• governmental actions for the purpose of stabilizing the financial markets
• defaults and downgrades in certain securities in our investment portfolio
• impairment of financial institutions
• credit and other risks associated with Aflac's investment in perpetual securities
• differing judgments applied to investment valuations
• subjective determinations of amount of impairments taken on our investments
• realization of unrealized losses
• limited availability of acceptable yen-denominated investments
• concentration of our investments in any particular sector
• concentration of business in Japan
• ongoing changes in our industry
• exposure to significant financial and capital markets risk
• fluctuations in foreign currency exchange rates
• significant changes in investment yield rates
• deviations in actual experience from pricing and reserving assumptions
• subsidiaries' ability to pay dividends to the Parent Company
• changes in law or regulation by governmental authorities
• ability to attract and retain qualified sales associates and employees
• ability to continue to develop and implement improvements in information technology systems
• changes in U.S. and/or Japanese accounting standards
• decreases in our financial strength or debt ratings
• level and outcome of litigation
• ability to effectively manage key executive succession
• catastrophic events
• failure of internal controls or corporate governance policies and procedures
COMPANY OVERVIEW
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively,
the Company) primarily sell supplemental health and life insurance in the United
States and Japan. The Company's insurance business is marketed and administered
through American Family Life Assurance Company of Columbus (Aflac), which
operates in the United States (Aflac U.S.) and as a branch in Japan (Aflac
Japan). Most of Aflac's policies are individually underwritten and marketed
through independent agents. Our insurance operations in the United States and
our branch in Japan service the two markets for our insurance business.
MD&A OVERVIEW
Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is intended to inform the reader about matters affecting the
financial condition and results of operations of Aflac Incorporated and its
subsidiaries for the period from December 31, 2008, to June 30, 2009. As a
result, the following discussion should be read in conjunction with the
consolidated financial statements and notes that are included in our annual
report to shareholders for the year ended December 31, 2008. This MD&A is
divided into the following sections:
• Critical accounting estimates
• Results of operations, consolidated and by segment
• Analysis of financial condition, including discussion of market risks of financial instruments
• Capital Resources and Liquidity, including discussion of availability of capital and the sources and uses of cash
RESULTS OF OPERATIONS
The following table is a presentation of items impacting net earnings and net
earnings per diluted share.
Items Impacting Net Earnings
Three Months Ended June 30, Six Months Ended June 30,
2009 2008 2009 2008 2009 2008 2009 2008
In Millions Per Diluted Share In Millions Per Diluted Share
Net earnings $ 314 $ 483 $ .67 $ 1.00 $ 882 $ 957 $ 1.89 $ 1.98
Items impacting
net earnings,
net of tax:
Realized
investment gains
(losses) (249 ) (1 ) (.53 ) - (255 ) (5 ) (.54 ) (.01 )
Impact from SFAS
133 - (3 ) - (.01 ) (3 ) - (.01 ) -
Gain on
extinguishment
of debt 1 - - - 11 - .02 -
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Realized Investment Gains and Losses
Our investment strategy is to invest in investment-grade fixed-income
securities to provide a reliable stream of investment income, which is one of
the drivers of the Company's profitability. This investment strategy aligns our
assets with our liability structure, which our assets support. We do not
purchase securities with the intent of generating capital gains or losses.
However, investment gains and losses may be realized as a result of changes in
the financial markets and the creditworthiness of specific issuers, tax planning
strategies, and/or general portfolio maintenance and rebalancing. The
realization of investment gains and losses is independent of the underwriting
and administration of our insurance products, which are the principal drivers of
our profitability.
During the first six months of 2009, sales and redemptions of securities resulted in realized pretax investment gains of $227 million ($148 million after-tax). These gains were primarily the result of bond swaps that took advantage of tax loss carryforwards from previously incurred investment losses. We realized total pretax investment losses of $619 million ($402 million after-tax) as a result of the recognition of other-than-temporary impairment losses. The following table details our pretax impairment losses by investment category.
Three Months Ended Six Months Ended
(In millions) June 30, 2009 June 30, 2009
Perpetual securities $ 144 $ 209
Corporate bonds 238 288
Collateralized debt obligations - 113
Collateralized mortgage obligations 3 9
Total other-than-temporary impairments $ 385 $ 619
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Realized investment losses in the first six months of 2008 primarily resulted
from securities sold or redeemed in the normal course of business.
See Note 3 of the Notes to the Consolidated Financial Statements for more
information on our realized investment gains and losses.
Impact from SFAS 133
We had cross-currency swap agreements which economically converted our
dollar-denominated senior notes, which matured in April 2009, into a
yen-denominated obligation. Until April 2009, we designated the foreign currency
component of these cross-currency swaps as a hedge of the foreign currency
exposure of our investment in Aflac Japan. The effect of issuing fixed-rate,
dollar-denominated debt and swapping it into fixed-rate, yen-denominated debt
has the same economic impact on Aflac as if we had issued yen-denominated debt
of a like amount. However, the accounting treatment for cross-currency swaps is
different from issuing yen-denominated Samurai and Uridashi notes. SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities, as amended,"
(SFAS 133), requires that the change in the fair value of the interest rate
component of the cross-currency swaps, which does not qualify for hedge
accounting, be reflected in net earnings. This change in fair value is
determined by relative dollar and yen interest rates and has no cash impact on
our results of operations. At maturity, the fair value equaled initial contract
fair value, and the cumulative impact of gains and losses from the changes in
fair value of the interest component was zero. We had the ability and intent to
retain the cross-currency swaps until they expired in April 2009. The impact
from SFAS 133 includes the change in fair value of the interest rate component
of the cross-currency swaps, which does not qualify for hedge accounting, and is
included in other income. Prior to the expiration of the swaps in April 2009, we
de-designated the swaps as a hedge of our net investment in Japan when we
performed our hedge designations at the beginning of second quarter 2009.
We have issued yen-denominated Samurai and Uridashi notes. We have designated
these notes as a hedge of our investment in Aflac Japan. If the value of these
yen-denominated notes exceeds our investment in Aflac Japan, we would be
required to recognize the foreign currency effect on the excess in net earnings
(other income). The foreign currency gain or loss on the excess liabilities
would be included in the impact from SFAS 133. At the beginning of second
quarter of 2009 when we performed our hedge designations, the notional amount of
our yen-denominated liabilities exceeded our yen net asset position in Aflac
Japan, therefore we de-designated this excess portion of our yen-denominated
liabilities from our net investment hedge. An immaterial loss was recorded in
net earnings (other income) and included in the impact from SFAS 133 during the
quarter ended June 30, 2009, as a result of the negative foreign currency effect
on the portion of our yen-denominated liabilities that was not designated as a
hedge. Our net investment hedge was effective during the six-month period ended
June 30, 2008; therefore, there was no impact on net earnings.
We have interest rate swap agreements related to the 20 billion yen variable
interest rate Uridashi notes and have designated the swap agreements as a hedge
of the variability of the debt cash flows. The notional
amounts and terms of the swaps match the principal amount and terms of the
variable interest rate Uridashi notes, and the swaps had no value at inception.
SFAS 133 requires that the change in the fair value of the swap contracts be
recorded in other comprehensive income so long as the hedge is deemed effective.
Any ineffectiveness would be recognized in net earnings (other income) and would
be included in the impact from SFAS 133. These hedges were effective during the
six-month periods ended June 30, 2009 and 2008; therefore, there was no impact
on net earnings.
For additional information, see the Impact from SFAS 133 section of MD&A and
Notes 4 and 7 of the Notes to the Consolidated Financial Statements in our
annual report to shareholders for the year ended December 31, 2008.
Debt Extinguishment
During the first six months of 2009, we extinguished portions of our
yen-denominated Uridashi and Samurai debt by buying the notes on the open
market. We realized a total gain from extinguishment of debt of 1.6 billion yen,
or $17 million ($11 million after-tax), which we included in other income.
Foreign Currency Translation
Aflac Japan's premiums and most of its investment income are received in yen.
Claims and expenses are paid in yen, and we primarily purchase yen-denominated
assets to support yen-denominated policy liabilities. These and other
yen-denominated financial statement items are translated into dollars for
financial reporting purposes. We translate Aflac Japan's yen-denominated income
statement into dollars using an average exchange rate for the reporting period,
and we translate its yen-denominated balance sheet using the exchange rate at
the end of the period. However, it is important to distinguish between
translating and converting foreign currency. Except for a limited number of
transactions, we do not actually convert yen into dollars.
Due to the size of Aflac Japan, where our functional currency is the Japanese
yen, fluctuations in the yen/dollar exchange rate can have a significant effect
on our reported results. In periods when the yen weakens, translating yen into
dollars results in fewer dollars being reported. When the yen strengthens,
translating yen into dollars results in more dollars being reported.
Consequently, yen weakening has the effect of suppressing current period results
in relation to the comparable prior period, while yen strengthening has the
effect of magnifying current period results in relation to the comparable prior
period. As a result, we view foreign currency translation as a financial
reporting issue for Aflac and not an economic event to our Company or
shareholders. Because changes in exchange rates distort the growth rates of our
operations, management evaluates Aflac's financial performance excluding the
impact of foreign currency translation.
Income Taxes
Our combined U.S. and Japanese effective income tax rate on pretax earnings
was 34.3% for the six-month period ended June 30, 2009, compared with 34.7% for
the same period in 2008.
Earnings Guidance
We communicate earnings guidance in this report based on the growth in net
earnings per diluted share. However, certain items that cannot be predicted or
that are outside of management's control may have a significant impact on actual
results. Therefore, our comparison of net earnings includes certain assumptions
to reflect the limitations that are inherent in projections of net earnings. In
comparing period-over-period results, we exclude the effect of realized
investment gains and losses, the impact from SFAS 133 and nonrecurring items. We
also assume no impact from foreign currency translation on the Aflac Japan
segment and the Parent Company's yen-denominated interest expense for a given
period in relation to the prior period.
Subject to the preceding assumptions, our objective for 2009 is to increase
net earnings per diluted share by 13% to 15% over 2008. If we achieve this
objective, the following table shows the likely results for 2009 net
earnings per diluted share, including the impact of foreign currency translation
using various yen/dollar exchange rate scenarios.
2009 Net Earnings Per Share (EPS) Scenarios*
Weighted-Average
Yen/Dollar Net Earnings Per % Growth Yen Impact
Exchange Rate Diluted Share Over 2008 on EPS
85.00 $5.04 - 5.12 26.3 - 28.3% $ .53
90.00 4.87 - 4.96 22.1 - 24.3 .37
95.00 4.73 - 4.81 18.5 - 20.6 .22
100.00 4.59 - 4.68 15.0 - 17.3 .09
103.46 ** 4.51 - 4.59 13.0 - 15.0 -
105.00 4.47 - 4.55 12.0 - 14.0 (.04 )
110.00 4.37 - 4.44 9.5 - 11.3 (.15 )
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* Excludes realized investment gains/losses, impact from SFAS 133 and nonrecurring items in 2009 and 2008
** Actual 2008
weighted-average
exchange rate
Our objective for 2010 is to increase net earnings per diluted share by 9% to
12%, on the basis described above.
AFLAC JAPAN SEGMENT
Aflac Japan Pretax Operating Earnings
Changes in Aflac Japan's pretax operating earnings and profit margins are
primarily affected by morbidity, mortality, expenses, persistency, and
investment yields. The following table presents a summary of operating results
for Aflac Japan.
Aflac Japan Summary of Operating Results
Three Months Ended Six Months Ended
June 30, June 30,
(In millions) 2009 2008 2009 2008
Premium income $ 2,901 $ 2,620 $ 5,913 $ 5,205
Net investment income:
Yen-denominated investment income 357 322 728 637
Dollar-denominated investment income 187 186 377 367
Net investment income 544 508 1,105 1,004
Other income 15 14 22 13
Total operating revenues 3,460 3,142 7,040 6,222
Benefits and claims 2,092 1,946 4,294 3,868
Operating expenses:
Amortization of deferred policy
acquisition costs 121 100 245 196
Insurance commissions 256 239 523 478
Insurance and other expenses 312 284 617 553
Total operating expenses 689 623 1,385 1,227
Total benefits and expenses 2,781 2,569 5,679 5,095
Pretax operating earnings* $ 679 $ 573 $ 1,361 $ 1,127
Weighted-average yen/dollar exchange rate 97.53 104.50 95.44 104.77
In Dollars In Yen
Three Months Ended Six Months Ended Three Months Ended Six Months Ended
Percentage change over June 30, June 30, June 30, June 30,
previous period: 2009 2008 2009 2008 2009 2008 2009 2008
Premium income 10.7 % 19.7 % 13.6 % 18.7 % 3.1 % 3.6 % 3.3 % 3.6 %
Net investment income 7.2 14.8 10.0 14.3 (.2 ) (.7 ) .2 (.3 )
Total operating revenues 10.1 18.9 13.1 17.8 2.5 2.9 2.9 2.8
Pretax operating earnings* 18.6 24.3 20.7 21.7 10.7 7.5 10.0 6.1
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* See the Insurance Operations section of this MD&A for our definition of segment operating earnings.
The percentage increases in premium income reflect the growth of premiums in
force. The increases in annualized premiums in force in yen of 2.9% in the first
six months of 2009 and 3.6% for the same period of 2008 reflect the high
persistency of Aflac Japan's business and the sales of new policies. Annualized
premiums in force at June 30, 2009, were 1.18 trillion yen, compared with 1.14
trillion yen a year ago. Annualized premiums in force, translated into dollars
at respective period-end exchange rates, were $12.2 billion at June 30, 2009,
compared with $10.7 billion a year ago.
Aflac Japan maintains a portfolio of dollar-denominated and reverse-dual
currency securities (yen-denominated debt securities with dollar coupon
payments). Dollar-denominated investment income from these assets accounted for
approximately 34% of Aflac Japan's investment income in the first six months of
2009, compared with 37% a year ago. In periods when the yen strengthens in
relation to the dollar, translating Aflac
Japan's dollar-denominated investment income into yen lowers growth rates for
net investment income, total operating revenues, and pretax operating earnings
in yen terms. In periods when the yen weakens, translating dollar-denominated
investment income into yen magnifies growth rates for net investment income,
total operating revenues, and pretax operating earnings in yen terms. On a
constant currency basis, dollar-denominated investment income accounted for
approximately 36% of Aflac Japan's investment income during the first six months
of 2009. The following table illustrates the effect of translating Aflac Japan's
dollar-denominated investment income and related items into yen by comparing
certain segment results with those that would have been reported had yen/dollar
exchange rates remained unchanged from the comparable period in the prior year.
Aflac Japan Percentage Changes Over Previous Period
For the Periods Ended June 30,
Including Foreign Currency Changes Excluding Foreign Currency Changes**
Three Months Six Months Three Months Six Months
2009 2008 2009 2008 2009 2008 2009 2008
Net investment
income (.2 )% (.7 )% .2 % (.3 )% 2.3 % 5.0 % 3.4 % 5.0 %
Total operating
revenues 2.5 2.9 2.9 2.8 3.0 3.7 3.4 3.8
Pretax operating
earnings* 10.7 7.5 10.0 6.1 13.1 11.3 12.2 11.0
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* See the Insurance Operations section of this MD&A for our definition of segment operating earnings.
** Amounts excluding
foreign currency
changes on
dollar-denominated
items were
determined using
the same
yen/dollar
exchange rate for
the current period
as the comparable
. . .
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