Summary of AFLAC INC - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING INFORMATION

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" to encourage companies to provide prospective information, so long as those informational statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements. We desire to take advantage of these provisions. This report contains cautionary statements identifying important factors that could cause actual results to differ materially from those projected herein, and in any other statements made by Company officials in communications with the financial community and contained in documents filed with the Securities and Exchange Commission (SEC). Forward-looking statements are not based on historical information and relate to future operations, strategies, financial results or other developments. Furthermore, forward-looking information is subject to numerous assumptions, risks and uncertainties. In particular, statements containing words such as "expect," "anticipate," "believe," "goal," "objective," "may," "should," "estimate," "intends," "projects," "will," "assumes," "potential," "target" or similar words as well as specific projections of future results, generally qualify as forward-looking. Aflac undertakes no obligation to update such forward-looking statements.

We caution readers that the following factors, in addition to other factors mentioned from time to time, could cause actual results to differ materially from those contemplated by the forward-looking statements:

• difficult conditions in global capital markets and the economy

• governmental actions for the purpose of stabilizing the financial markets

• defaults and credit downgrades of 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

• significant valuation judgments in determination of amount of impairments taken on our investments

• limited availability of acceptable yen-denominated investments

• concentration of our investments in any particular single-issuer or 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 Aflac Incorporated

• changes in law or regulation by governmental authorities

• ability to attract and retain qualified sales associates and employees

• decreases in our financial strength or debt ratings

• ability to continue to develop and implement improvements in information technology systems

• changes in U.S. and/or Japanese accounting standards

• failure to comply with restrictions on patient privacy and information security

• level and outcome of litigation

• ability to effectively manage key executive succession

• impact of the recent earthquake and tsunami natural disaster and related events at the nuclear plant in Japan and their aftermath

• catastrophic events including, but not necessarily limited to, tornadoes, hurricanes, earthquakes, tsunamis, and damage incidental to such events

• failure of internal controls or corporate governance policies and procedures

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 three- and nine-month periods ended September 30, 2012 and 2011. Results of operations for interim periods are not necessarily indicative of results for the entire year. 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, 2011. This MD&A is divided into the following sections:

• Our Business

• Performance Highlights

• 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

OUR BUSINESS 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. Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC), branded as Aflac Group Insurance. Our insurance operations in the United States and our branch in Japan service the two markets for our insurance business.

PERFORMANCE HIGHLIGHTS Reflecting a slightly weaker yen/dollar exchange rate, total revenues rose 14.4% to $6.8 billion in the third quarter of 2012, compared with $6.0 billion in the third quarter of 2011. Net earnings were $1.0 billion, or $2.16 per diluted share, compared with $736 million, or $1.57 per diluted share, in the third quarter of 2011, benefiting from realized investment gains and a lower annual effective tax rate.
Results for the first nine months of 2012 benefited from a slightly stronger yen/dollar exchange rate. Total revenues rose 17.3% to $19.0 billion, compared with $16.2 billion in the first nine months of 2011. Net earnings were $2.3 billion, or $4.87 per diluted share, compared with $1.4 billion, or $2.98 per diluted share, for the first nine months of 2011.
Results in the third quarter of 2012 included pretax net realized investment gains of $286 million ($186 million after-tax), compared with net realized investment losses of $83 million ($34 million after-tax) in the third quarter of 2011. Net investment gains in the third quarter of 2012 included $97 million ($63 million after-tax) of other-than-temporary impairment losses; $288 million of net gains ($187 million after-tax) from the sale or redemption of securities; and $95 million of net gains ($62 million after-tax) from valuing derivatives. Results for the first nine months of 2012 included pretax net realized investment losses of $177 million ($115 million after-tax), compared with net realized investment losses of $1.3 billion ($864 million after-tax) in the first nine months of 2011. Net investment losses in 2012 included $643 million ($418 million after-tax) of other-than-temporary impairment losses; $358 million of net gains ($233 million after-tax) from the sale or redemption of securities; and $108 million of net gains ($70 million after-tax) from valuing derivatives. Shareholders' equity included a net unrealized gain on investment securities and derivatives of $2.3 billion at September 30, 2012, compared with a net unrealized gain of $1.2 billion at December 31, 2011.

CRITICAL ACCOUNTING ESTIMATES We prepare our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). In this MD&A, references to GAAP issued by the FASB are derived from the FASB Accounting Standards Codification™ (ASC). The preparation of financial statements in conformity with GAAP requires us to make estimates based on currently available information when recording transactions resulting from business operations. The estimates that we deem to be most critical to an understanding of Aflac's results of operations and financial condition are those related to the valuation of investments and derivatives, deferred policy acquisition costs (DAC), liabilities for future policy benefits and unpaid policy claims, and income taxes. The preparation and evaluation of these critical accounting estimates involve the use of various assumptions developed from management's analyses and judgments. The application of these critical accounting estimates determines the values for which 95% of our assets and 74% of our liabilities are reported as of September 30, 2012, and thus has a direct effect on net earnings and shareholders' equity. Subsequent experience or use of other assumptions could produce significantly different results.
Other than the change in the accounting for DAC as discussed in the next section below, there have been no other changes in the items that we have identified as critical accounting estimates during the nine months ended September 30, 2012. For additional information, see the Critical Accounting Estimates section of MD&A included in our annual report to shareholders for the year ended December 31, 2011.
New Accounting Pronouncements
On January 1, 2012, we retrospectively adopted amended accounting guidance on accounting for DAC, costs associated with acquiring or renewing insurance contracts. Under the previous guidance, we capitalized costs that varied with and were primarily related to the acquisition of a policy. Under the amended accounting guidance, only incremental direct costs associated with the successful acquisition of new or renewal contracts may be capitalized, and direct-response advertising costs may be capitalized under certain conditions. As of December 31, 2010, approximately 70% of our unadjusted deferred acquisition cost balance was related to compensation paid to third parties for successful sales and was therefore still deferrable under the new rules. The remaining 30% of the deferred acquisition costs balance was evaluated for deferral under the amended accounting guidance. The retrospective adoption of this accounting standard resulted in an after-tax cumulative reduction to retained earnings of $408 million and an after-tax cumulative reduction to unrealized foreign currency translation gains in accumulated other comprehensive income of $108 million, resulting in a total reduction to shareholders' equity of $516 million as of December 31, 2010. The adoption of this accounting standard had an immaterial impact on net income in 2011 and for all preceding years.
For additional information on new accounting pronouncements and the impact, if any, on our financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements.

                             RESULTS OF OPERATIONS
The following table is a presentation of items impacting net earnings and net
earnings per diluted share.
                          Items Impacting Net Earnings
                       In Millions            Per Diluted Share             In Millions           Per Diluted Share
                           Three Months Ended September 30,                    Nine Months Ended September 30,
                     2012        2011          2012           2011       2012        2011          2012         2011
Net earnings       $ 1,017     $  736     $    2.16         $ 1.57     $ 2,285     $ 1,399     $    4.87      $ 2.98
Items impacting
net earnings,
net of tax:
Realized
investment gains
(losses):
Securities
transactions
and impairments        124        112           .26            .23        (185 )      (681 )        (.40 )     (1.45 )
Impact of
derivative and
hedging activities      62       (146 )         .13           (.31 )        70        (182 )         .15        (.39 )

Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.

Realized Investment Gains and Losses
Our investment strategy is to invest in 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 incorporates asset-liability matching (ALM) to align the expected cash flows of the portfolio to the needs of the Company's liability structure. 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. Securities Transactions and Impairments
During the three-month period ended September 30, 2012, we realized pretax investment gains, net of losses, of $288 million ($187 million after-tax) from sales and redemptions of securities. These net gains primarily resulted from sales of Japanese government bonds (JGBs) in a bond-swap program. We realized pretax investment losses of $97 million ($63 million after-tax) as a result of the recognition of other-than-temporary impairment losses.
During the nine-month period ended September 30, 2012, we realized pretax investment gains, net of losses, of $358 million ($233 million after-tax) from sales and redemptions of securities. These gains primarily resulted from the bond-swap program in the third quarter of 2012 as discussed above. Other gains resulted from the redemption in the first quarter of 2012 of a previously impaired perpetual security and sales related to our plan to reduce the risk exposure in our investment portfolio. We realized pretax investment losses of $643 million ($418 million after-tax) as a result of the recognition of other-than-temporary impairment losses, primarily composed of impairments recognized in the first quarter for two Tier I securities that were sold in the second quarter of 2012, impairments recognized on certain securities issued by Spanish institutions, and further impairments on several securities that had previously been impaired.
During the three- and nine-month periods ended September 30, 2011, we realized pretax investment losses of $166 million ($108 million after-tax) and $1.1 billion ($715 million after-tax), respectively, as a result of other-than-temporary impairments on certain securities, and we realized pretax investment gains, net of losses, of $307 million ($200 million after-tax) and $49 million ($32 million after-tax), respectively, from the sale of securities as we executed our plan to reduce the risk exposure in our investment portfolio. See Note 3 of the Notes to Consolidated Financial Statements for a more detailed discussion of these investment activities.
The following table details our pretax impairment losses by investment category.

                                            Three Months Ended                 Nine Months Ended
                                               September 30,                     September 30,
(In millions)                               2012           2011               2012            2011
Perpetual securities                     $     27        $   122          $    243          $   306
Corporate bonds                                70             43               253              783
Mortgage- and asset-backed securities           0              1                 3                9
Municipalities                                  0              0                 0                1
Sovereign and supranational                     0              0               144                0
Equity securities                               0              0                 0                1
Total other-than-temporary impairment
losses realized                          $     97   (1)  $   166   (2)    $    643     (1)  $ 1,100   (2)

(1) Includes $70 and $365 for the three- and nine-month periods ended September 30, 2012, respectively, for credit-related impairments; $0 and $251 for the three- and nine-month periods ended September 30, 2012, respectively, from change in intent to sell securities; and $27 for the three- and nine-month periods ended September 30, 2012 for impairments due to severity and duration of decline in fair value
(2) Consisted completely of credit-related impairments

Impact of Derivative and Hedging Activities Our derivative activities include foreign currency, interest rate and credit default swaps in variable interest entities that are consolidated, foreign currency forwards on certain fixed-maturity securities, cross-currency interest rate swaps associated with our senior notes due February 2017 and February 2022 and subordinated debentures due September

2052, and an interest rate swap associated with our variable interest rate yen-denominated debt. We realized pretax investment gains, net of losses, of $95 million ($62 million after-tax) for the three-month period ended September 30, 2012, compared with pretax investment losses, net of gains, of $224 million ($146 million after-tax) for the same period in 2011, as a result of valuing the swaps described above. During the nine-month period ended September 30, 2012, we realized pretax investment gains, net of losses, of $108 million ($70 million after-tax), compared with pretax investment losses, net of gains, of $279 million ($182 million after-tax) for the same period in 2011, as a result of valuing these swaps.
For a description of other items that could be included in the Impact of Derivative and Hedging Activities, see the Hedging Activities subsection of MD&A and Note 4 of the accompanying Notes to the Consolidated Financial Statements. For additional information regarding realized investment gains and losses, see Notes 3 and 4 of the Notes to the Consolidated Financial Statements. 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 31.3% and 33.2% for the three- and nine-month periods ended September 30, 2012, compared with 32.6% and 34.3% for the three-and nine-month periods ended September 30, 2011, respectively. The decrease in the effective income tax rate for the three- and nine-month periods ended September 30, 2012 reflected the revision to our estimate of the full-year effective tax rate, which lowered income tax expense by $17.5 million. In addition, the favorable outcome of a routine tax exam for the years 2008 and 2009 reduced income tax expense by $29.5 million.
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 (securities transactions, impairments, and the impact of derivative and hedging activities) 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, we expect net earnings per diluted share for 2012 to increase in the range of 3% to 6% over 2011. If the yen averages 80 for the last three months of the year, we would expect fourth quarter net earnings per diluted share of $1.46 to $1.51. Using that same exchange rate assumption, we would expect net earnings per diluted share to be $6.58 to $6.63 for the full year. Based on our stated objective for 2012, the following table shows the likely results for 2012 net earnings per diluted share, including the impact of foreign currency translation using various yen/dollar exchange rate scenarios.

2012 Net Earnings Per Share (EPS) Scenarios(1)

Weighted-Average
   Yen/Dollar      Net Earnings Per      % Growth      Yen Impact
 Exchange Rate      Diluted Share       Over 2011        on EPS
     70.00           $7.06 - 7.25       12.6 - 15.6%      $.60
     75.00            6.73 - 6.92        7.3 - 10.4        .27
     79.75(2)         6.46 - 6.65        3.0 - 6.1         .00
     80.00            6.45 - 6.64        2.9 - 5.9        (.01)
     85.00            6.21 - 6.40       (1.0) - 2.1       (.25)

(1)Excludes realized investment gains/losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items in 2012 and 2011
(2)Actual 2011 weighted-average exchange rate

Our objective for 2013 is to increase net earnings per diluted share by 4% to 7% over 2012, excluding the effect of realized investment gains and losses (securities transactions, impairments, and the impact of derivative and hedging activities), nonrecurring items, and foreign currency translation.

INSURANCE OPERATIONS Aflac's insurance business consists of two segments: Aflac Japan and Aflac U.S. Aflac Japan, which operates as a branch of Aflac, is the principal contributor to consolidated earnings. GAAP financial reporting requires that a company report financial and descriptive information about operating segments in its annual and interim period financial statements. Furthermore, we are required to report a measure of segment profit or loss, certain revenue and expense items, and segment assets.
We measure and evaluate our insurance segments' financial performance using operating earnings on a pretax basis. We define segment operating earnings as the profits we derive from our operations before realized investment gains and losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items. We believe that an analysis of segment pretax operating earnings is vitally important to an understanding of the underlying profitability drivers and trends of our insurance business. Furthermore, because a significant portion of our business is conducted in Japan, we believe it is equally important to understand the impact of translating Japanese yen into U.S. dollars.
We evaluate our sales efforts using new annualized premium sales, an industry operating measure. New annualized premium sales, which include both new sales and the incremental increase in premiums due to conversions, represent the premiums that we would collect over a 12-month period, assuming the policies remain in force. For Aflac Japan, new annualized premium sales are determined by applications submitted during the reporting period. For Aflac U.S., new annualized premium sales are determined by applications that are issued during the reporting period. Premium income, or earned premiums, is a financial performance measure that reflects collected or due premiums that have been earned ratably on policies in force during the reporting period.

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                Nine Months Ended
                                                         September 30,                     September 30,
(In millions)                                           2012           2011              2012          2011
Premium income                                    $    4,405         $ 4,018         $   12,769     $ 11,490
Net investment income:
Yen-denominated investment income                        492             461              1,439        1,327
Dollar-denominated investment income                     221             234                695          653
Net investment income                                    713             695              2,134        1,980
Other income (loss)                                       22               7                 38           33
Total operating revenues                               5,140           4,720             14,941       13,503
Benefits and claims                                    3,219           2,813              9,231        8,027
Operating expenses:
Amortization of deferred policy acquisition costs        181             173                535          488
Insurance commissions                                    299             302                884          880
Insurance and other expenses                             447             413              1,293        1,190
Total operating expenses                                 927             888              2,712        2,558
Total benefits and expenses                            4,146           3,701             11,943       10,585
      Pretax operating earnings(1)                $      994         $ 1,019         $    2,998     $  2,918
Weighted-average yen/dollar exchange rate              78.64           77.78              79.47        80.50


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