Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|
|
|
|
Item 2.
|
|
Managements 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:
|
|
|
legislative and regulatory developments
|
|
|
|
|
assessments for insurance company insolvencies
|
|
|
|
|
competitive conditions in the United States and Japan
|
|
|
|
|
new product development and customer response to new products and new marketing
initiatives
|
|
|
|
|
ability to attract and retain qualified sales associates and employees
|
|
|
|
|
ability to repatriate profits from Japan
|
|
|
|
|
changes in U.S. and/or Japanese tax laws or accounting requirements
|
|
|
|
|
credit and other risks associated with Aflacs investment activities
|
|
|
|
|
significant changes in investment yield rates
|
|
|
|
|
fluctuations in foreign currency exchange rates
|
|
|
|
|
deviations in actual experience from pricing and reserving assumptions including, but
not limited to, morbidity, mortality, persistency, expenses, and investment yields
|
|
|
|
|
level and outcome of litigation
|
|
|
|
|
downgrades in the Companys credit rating
|
|
|
|
|
changes in rating agency policies or practices
|
|
|
|
|
subsidiarys ability to pay dividends to Parent Company
|
|
|
|
|
ineffectiveness of hedging strategies
|
|
|
|
|
catastrophic events
|
|
|
|
|
general economic conditions in the United States and Japan
|
21
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
Companys 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 Aflacs 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.
Managements 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 interim period from December 31,
2006, to September 30, 2007. 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, 2006.
This MD&A is divided into four primary sections. In the first section, we discuss our
critical accounting estimates. We then follow with a discussion of the results of our operations
on a consolidated basis and by segment. The third section presents an analysis of our financial
condition as well as a discussion of market risks of financial instruments. We conclude by
addressing the availability of capital and the sources and uses of cash in the Capital Resources
and Liquidity section.
CRITICAL ACCOUNTING ESTIMATES
We prepare our financial statements in accordance with U.S. generally accepted accounting
principles (GAAP). 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 Aflacs
results of operations and financial condition are those related to investments, deferred policy
acquisition costs and policy liabilities. The preparation and evaluation of these critical
accounting estimates involve the use of various assumptions developed from managements analyses
and judgments. The application of these critical accounting estimates determines the values at
which 96% of our assets and 85% of our liabilities are reported and thus have a direct effect on
net earnings and shareholders equity. Subsequent experience or use of other assumptions could
produce significantly different results. There have been no changes in the items that we have
identified as critical accounting estimates during the nine months ended September 30, 2007. 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, 2006.
New Accounting Pronouncements
For 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.
22
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 September 30,
|
|
Nine Months Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
In millions
|
|
Per Diluted Share
|
|
In millions
|
|
Per Diluted Share
|
|
Net earnings
|
|
$
|
420
|
|
|
$
|
367
|
|
|
$
|
.85
|
|
|
$
|
.73
|
|
|
$
|
1,251
|
|
|
$
|
1,150
|
|
|
$
|
2.53
|
|
|
$
|
2.29
|
|
Items impacting net
earnings, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment
gains (losses)
|
|
|
1
|
|
|
|
7
|
|
|
|
-
|
|
|
|
.01
|
|
|
|
18
|
|
|
|
47
|
|
|
|
.04
|
|
|
|
.10
|
|
Impact from SFAS 133
|
|
|
2
|
|
|
|
(3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Realized Investment Gains and Losses
Our investment strategy is to invest in fixed-income securities in order to provide a
reliable stream of investment income, which is one of the drivers of the Companys profitability.
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. Realized investment gains in the first nine months of 2007 primarily resulted from
securities sold or redeemed during the period in the normal course of business. Realized
investment gains in the first nine months of 2006 primarily resulted from our bond-swap program,
which took advantage of tax loss carryforwards, and sales transactions in the normal course of
business.
Impact from SFAS 133
We entered into cross-currency swap agreements to effectively convert our
dollar-denominated senior notes, which mature in 2009, into a yen-denominated obligation.
Statement of Financial Accounting Standards 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. 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.
We have also 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 and
the notional amounts of the cross-currency swaps exceed our investment in Aflac Japan, we would be
required to recognize the foreign currency effect on the excess, or ineffective portion, in net
earnings. The ineffective portion would be included in the impact from SFAS 133. These hedges
were effective during the nine-month period ended September 30, 2007; therefore, there was no
impact on net earnings.
We have entered into 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. SFAS 133 requires that the change in the fair value of the swap contracts be recorded
in
23
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 nine-month period ended September 30, 2007; 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, 2006.
Foreign Currency Translation
Aflac Japans 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 Japans
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 Aflacs financial performance excluding the impact of foreign
currency translation.
Income Taxes
Our combined U.S. and Japanese effective income tax rate on pre-tax earnings was 34.6%
for the nine-month period ended September 30, 2007, compared with 34.5% for the same period in
2006.
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 managements
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 Companys yen-denominated
interest expense for a given period in relation to the prior period.
Subject to the preceding assumptions, our objective for 2007 is to increase net earnings
per diluted share by 15% to 16% over 2006. If we achieve this objective, the following table shows
the likely results for 2007 net earnings per diluted share, including the impact of foreign
currency translation using various yen/dollar exchange rate scenarios.
24
2007 Net Earnings Per Share (EPS) Scenarios*
|
|
|
|
|
|
|
Weighted-Average
|
|
|
|
|
|
|
Yen/Dollar
|
|
Net Earnings Per
|
|
% Growth
|
|
Yen Impact
|
Exchange Rate
|
|
Diluted Share
|
|
Over 2006
|
|
on EPS
|
|
105.00
|
|
$ 3.47 - 3.50
|
|
21.8 - 22.8%
|
|
$ .19
|
110.00
|
|
3.38 - 3.41
|
|
18.6 - 19.6
|
|
.10
|
116.31**
|
|
3.28 - 3.31
|
|
15.1 - 16.1
|
|
-
|
120.00
|
|
3.23 - 3.26
|
|
13.3 - 14.4
|
|
(.05)
|
125.00
|
|
3.18 - 3.21
|
|
11.6 - 12.6
|
|
(.10)
|
|
|
|
|
*Excludes realized investment gains/losses, impact from SFAS 133 and nonrecurring items in 2007 and 2006
|
|
**
Actual 2006 weighted-average exchange rate
|
Our objective for 2008 is to increase net earnings per diluted share by 13% to 15%, on
the basis described above.
INSURANCE OPERATIONS
Aflacs 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, the impact from SFAS 133, 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. Total new annualized premium sales, which include 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. 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.
25
AFLAC JAPAN SEGMENT
Aflac Japan Pretax Operating Earnings
Changes in Aflac Japans 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)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Premium income
|
|
$
|
2,266
|
|
|
$
|
2,204
|
|
|
$
|
6,651
|
|
|
$
|
6,558
|
|
Net investment income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yen-denominated investment income
|
|
|
278
|
|
|
|
271
|
|
|
|
812
|
|
|
|
796
|
|
Dollar-denominated investment income
|
|
|
178
|
|
|
|
159
|
|
|
|
523
|
|
|
|
464
|
|
|
Net investment income
|
|
|
456
|
|
|
|
430
|
|
|
|
1,335
|
|
|
|
1,260
|
|
Other income
|
|
|
-
|
|
|
|
9
|
|
|
|
18
|
|
|
|
21
|
|
|
Total operating revenues
|
|
|
2,722
|
|
|
|
2,643
|
|
|
|
8,004
|
|
|
|
7,839
|
|
|
Benefits and claims
|
|
|
1,735
|
|
|
|
1,746
|
|
|
|
5,103
|
|
|
|
5,120
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs
|
|
|
75
|
|
|
|
70
|
|
|
|
225
|
|
|
|
212
|
|
Insurance commissions
|
|
|
212
|
|
|
|
212
|
|
|
|
629
|
|
|
|
645
|
|
Insurance and other expenses
|
|
|
232
|
|
|
|
208
|
|
|
|
654
|
|
|
|
598
|
|
|
Total operating expenses
|
|
|
519
|
|
|
|
490
|
|
|
|
1,508
|
|
|
|
1,455
|
|
|
Total benefits and expenses
|
|
|
2,254
|
|
|
|
2,236
|
|
|
|
6,611
|
|
|
|
6,575
|
|
|
Pretax operating earnings*
|
|
$
|
468
|
|
|
$
|
407
|
|
|
$
|
1,393
|
|
|
$
|
1,264
|
|
|
Weighted-average yen/dollar exchange rate
|
|
|
117.88
|
|
|
|
116.17
|
|
|
|
119.37
|
|
|
|
115.82
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In Dollars
|
|
|
In Yen
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
Percentage change over
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
previous period:
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Premium income
|
|
|
2.8
|
%
|
|
|
1.2
|
%
|
|
|
1.4
|
%
|
|
|
(1.4
|
)%
|
|
|
4.2
|
%
|
|
|
5.8
|
%
|
|
|
4.5
|
%
|
|
|
6.0
|
%
|
Net investment income
|
|
|
6.2
|
|
|
|
4.9
|
|
|
|
5.9
|
|
|
|
2.3
|
|
|
|
7.7
|
|
|
|
9.6
|
|
|
|
9.1
|
|
|
|
9.9
|
|
Total operating revenues
|
|
|
3.0
|
|
|
|
1.9
|
|
|
|
2.1
|
|
|
|
(.8
|
)
|
|
|
4.3
|
|
|
|
6.4
|
|
|
|
5.2
|
|
|
|
6.6
|
|
Pretax operating earnings*
|
|
|
15.0
|
|
|
|
3.8
|
|
|
|
10.2
|
|
|
|
7.3
|
|
|
|
16.7
|
|
|
|
8.4
|
|
|
|
13.6
|
|
|
|
15.3
|
|
|
*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.
Annualized premiums in force in yen increased 4.3% to 1.12 trillion yen as of September 30, 2007,
compared with 1.07 trillion yen a year ago, and reflect the high persistency of Aflac Japans
business and the sales of new policies. Annualized premiums in force, translated into dollars at
respective period-end exchange rates, were $9.7 billion at September 30, 2007, compared with $9.1
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 39% of Aflac Japans investment
income in the first nine months of 2007, compared with 37% a year ago. In periods when the yen
strengthens in relation to the dollar, translating Aflac Japans dollar-denominated investment
income into yen lowers growth rates for net investment income, total operating revenues, and pretax operating
earnings in yen
26
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 38% of Aflac Japans investment income during the
first nine months of 2007. The following table illustrates the effect of translating Aflac Japans
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
Yen Operating Results
For the Periods Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Including Foreign Currency Changes
|
|
|
Excluding Foreign Currency Changes**
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Net investment income
|
|
|
7.7
|
%
|
|
|
9.6
|
%
|
|
|
9.1
|
%
|
|
|
9.9
|
%
|
|
|
7.1
|
%
|
|
|
7.8
|
%
|
|
|
7.9
|
%
|
|
|
7.1
|
%
|
Total operating
revenues
|
|
|
4.3
|
|
|
|
6.4
|
|
|
|
5.2
|
|
|
|
6.6
|
|
|
|
4.2
|
|
|
|
6.2
|
|
|
|
5.0
|
|
|
|
6.2
|
|
Pretax operating
earnings*
|
|
|
16.7
|
|
|
|
8.4
|
|
|
|
13.6
|
|
|
|
15.3
|
|
|
|
16.0
|
|
|
|
6.7
|
|
|
|
12.5
|
|
|
|
12.6
|
|
|
*
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 period in the prior year.
The following table presents a summary of operating ratios for Aflac Japan.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
Ratios to total revenues, in dollars:
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Benefits and claims
|
|
|
63.7
|
%
|
|
|
66.1
|
%
|
|
|
63.8
|
%
|
|
|
65.3
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs
|
|
|
2.8
|
|
|
|
2.6
|
|
|
|
2.8
|
|
|
|
2.7
|
|
Insurance commissions
|
|
|
7.8
|
|
|
|
8.0
|
|
|
|
7.9
|
|
|
|
8.2
|
|
Insurance and other expenses
|
|
|
8.5
|
|
|
|
7.9
|
|
|
|
8.1
|
|
|
|
7.7
|
|
|
Total operating expenses
|
|
|
19.1
|
|
|
|
18.5
|
|
|
|
18.8
|
|
|
|
18.6
|
|
Pretax operating earnings*
|
|
|
17.2
|
|
|
|
15.4
|
|
|
|
17.4
|
|
|
|
16.1
|
|
|
*See
the Insurance Operations section of this MD&A for our definition of segment operating earnings.
The benefit ratio has declined over the past several years, reflecting the impact of
newer products with lower loss ratios. We have also experienced favorable claim trends in our
major product lines. We expect the benefit ratio to continue to decline in future years, primarily
reflecting the shift to newer products and riders and the impact of favorable claim trends.
Although the operating expense ratio increased in the first nine months of 2007, due to improvement
in the benefit ratio, the pretax operating profit margin expanded from 15.4% to 17.2% for the
three-month period and from 16.1% to 17.4% for the nine-month period ended September 30, 2007. We
expect Aflac Japans operating expense ratio to be higher for the balance of the year than it was
in the first nine months of 2007 due in part to our intention to increase Aflac Japans advertising
and promotional expenditures. As a result, we believe Aflac Japans pretax operating profit margin
in the fourth quarter of 2007 will be lower than Aflac Japans profit margin for the first nine
months of 2007. However, we expect this would still result in a higher fourth quarter pretax
operating profit margin than we produced in the fourth quarter of 2006. We expect continued
expansion in the profit margin in 2008.
27
Aflac Japan Sales
Consistent with our objective for the second half of 2007, Aflac Japans total new
annualized premium sales in yen increased 2.2% in the third quarter of 2007, compared with the
third quarter of 2006. For the nine months ended September 30, 2007, total new annualized premium
sales declined 4.1%, compared with the same period a year ago. The following table presents Aflac
Japans total new annualized premium sales for the periods ended September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In Dollars
|
|
|
In Yen
|
|
|
(In millions of dollars and
|
|
Three Months
|
|
|
Nine Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
billions of yen)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Total new annualized
premium sales
|
|
$
|
236
|
|
|
$
|
235
|
|
|
$
|
706
|
|
|
$
|
759
|
|
|
|
27.9
|
|
|
|
27.3
|
|
|
|
84.3
|
|
|
|
87.9
|
|
Percentage change
over comparable period
in prior year
|
|
|
.7
|
%
|
|
|
(15.7
|
)%
|
|
|
(7.0
|
)%
|
|
|
(12.3
|
)%
|
|
|
2.2
|
%
|
|
|
(11.9
|
)%
|
|
|
(4.1
|
)%
|
|
|
(5.8
|
)%
|
|
The following table details the contributions to total new annualized premium sales by
major product for the periods ended September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Medical policies
|
|
|
34
|
%
|
|
|
35
|
%
|
|
|
32
|
%
|
|
|
34
|
%
|
Cancer life
|
|
|
33
|
|
|
|
27
|
|
|
|
34
|
|
|
|
27
|
|
Ordinary life
|
|
|
22
|
|
|
|
23
|
|
|
|
22
|
|
|
|
24
|
|
Rider MAX
|
|
|
7
|
|
|
|
9
|
|
|
|
7
|
|
|
|
10
|
|
Other
|
|
|
4
|
|
|
|
6
|
|
|
|
5
|
|
|
|
5
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
After several quarters of significant declines, medical sales declined only .4% in the
third quarter of 2007, compared with the same period a year ago. We believe the improvement in
medical sales reflects a favorable initial response to Gentle EVER, our new medical product.
Gentle EVER, a non-standard medical product, was introduced on August 1. Sales of our cancer
insurance product category were again strong during the third quarter of 2007, improving 21.8% over
the same period a year ago. We believe our cancer product sales benefited from advertising and
promotional efforts for that product, in addition to accelerated purchases before a premium rate
increase which occurred on September 2, resulting from adoption of new mortality tables. Ordinary
life sales were down slightly in the third quarter of 2007 by 1.7%, compared with the same period a
year ago.
We remain encouraged about the prospects for improvement in sales, and we continue to
believe that sales will be flat to up 4% in the second half of the year.
Aflac Japan Investments
Growth of investment income in yen is affected by available cash flow from operations,
timing of and yields on new investments, and the effect of yen/dollar exchange rates on
dollar-denominated investment income. Aflac Japan has invested in privately issued securities to
secure higher yields than Japanese government or other public corporate bonds would have provided,
while still adhering to prudent standards for credit quality. All of our privately issued
securities are rated investment
grade at the time of purchase. These securities are generally issued with standard documentation
for medium-term note programs and have appropriate covenants.
28
The following table presents the results of Aflac Japans investment activities for the
periods ended September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
New money yield yen only
|
|
|
3.23
|
%
|
|
|
3.66
|
%
|
|
|
3.20
|
%
|
|
|
3.11
|
%
|
New money yield blended
|
|
|
3.89
|
|
|
|
4.20
|
|
|
|
3.61
|
|
|
|
3.39
|
|
Return on average invested assets, net of
investment expenses
|
|
|
4.09
|
|
|
|
4.14
|
|
|
|
4.10
|
|
|
|
4.11
|
|
|
At September 30, 2007, the yield on Aflac Japans investment portfolio, including
dollar-denominated investments, was 4.06%, compared with 4.18% a year
ago. See the Investments and
Cash section of this MD&A for additional information.
Japanese Economy
Japan continues to show signs of economic improvement, and while recent events indicate
that Japans economy has begun to recover, the time required for a full economic recovery remains
uncertain. For additional information, see the Japanese Economy section of MD&A in our annual
report to shareholders for the year ended December 31, 2006.
Japanese Regulatory Environment
Japans Financial Services Agency (FSA) adopted new mortality tables effective April 2007
that will be used when developing our policy premium and reserving assumptions on newly
underwritten policies. These new tables reflect recent improvements in survival rates in Japan and
have generally resulted in a decrease in policy premiums for death benefit products and an increase
in premium rates for third sector (health) products and annuities. We reflected the impact of the
new mortality table in our product pricing for the first sector (life) products in April 2007. For
the third sector, the revised tables were reflected in our product pricing in September 2007.
Additionally, the FSA has implemented a new rule for third sector product reserving. The
new reserving rule was effective April 1, 2007. Under the new rule, we are required to conduct
stress testing of our reserves using a prescribed method that incorporates actual morbidity. The
results of the tests and their relation to our reserves will determine whether reserve
strengthening is required. While this new reserve requirement will not impact our GAAP financial
statements, we currently estimate that adoption of this requirement will not have a material impact
on our 2007 FSA-based financial statements or on our product pricing.
As disclosed in our 2006 Form 10-K, Aflac Japan, along with the entire Japanese life
insurance industry, began a review of the last five years of paid claims to determine if those
claims were paid fully and accurately. On April 13, 2007, Aflac Japan reported the findings of its
review to the FSA. On October 5, 2007, the insurance industry updated its data for underpaid
claims. The updated data included an increase in the number of cases and yen amount of
underpayment compared to the data that was first reported in April, primarily a result of a type of
underpayment where companies did not notify policyholders of their potential eligibility for
additional benefit payments. Our initial estimate for
that type of underpayment was fairly accurate; however, we recently reported 26,700 cases of
delayed interest payments on cash surrender values, which on average was 75 yen per case
(approximately $.65 per case using the September 30, 2007, period-end exchange rate). In total, we
reported 1.9 billion yen of underpaid claims in April, and we revised the amount to 2.1 billion yen
in October. We are using this review to identify process changes that will help ensure that
payment
29
errors such as these are not repeated. The financial impact of paying the claims that were
in error was immaterial to our operations and has been provided for in our financial statements.
In late December 2007, remaining restrictions on the sale of insurance products by
banking institutions in Japan are scheduled to be fully eliminated. The FSA plans to review the
market conduct rules that apply to banks selling insurance and will draft proposed changes to the
existing rules, subject to public comment, in time to meet the December 22, 2007, deadline for
lifting the restrictions on the sale of the remaining insurance products. We believe that it will
take time for momentum to build in the bank channel for selling third sector products, however our
strong brand as the leading seller of cancer and medical insurance products in Japan and our
extensive, long-standing relationships with more than 60% of Japans banks places us in a strong
position to sell through this new channel.
AFLAC U.S. SEGMENT
Aflac U.S. Pretax Operating Earnings
Changes in Aflac U.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 U.S.
Aflac U.S. Summary of Operating Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
(In millions)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Premium income
|
|
$
|
993
|
|
|
$
|
898
|
|
|
$
|
2,926
|
|
|
$
|
2,642
|
|
Net investment income
|
|
|
127
|
|
|
|
120
|
|
|
|
373
|
|
|
|
345
|
|
Other income
|
|
|
2
|
|
|
|
3
|
|
|
|
7
|
|
|
|
7
|
|
|
Total operating revenues
|
|
|
1,122
|
|
|
|
1,021
|
|
|
|
3,306
|
|
|
|
2,994
|
|
|
Benefits and claims
|
|
|
596
|
|
|
|
545
|
|
|
|
1,751
|
|
|
|
1,595
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs
|
|
|
76
|
|
|
|
68
|
|
|
|
235
|
|
|
|
213
|
|
Insurance commissions
|
|
|
119
|
|
|
|
113
|
|
|
|
356
|
|
|
|
330
|
|
Insurance and other expenses
|
|
|
149
|
|
|
|
133
|
|
|
|
441
|
|
|
|
397
|
|
|
Total operating expenses
|
|
|
344
|
|
|
|
314
|
|
|
|
1,032
|
|
|
|
940
|
|
|
Total benefits and expenses
|
|
|
940
|
|
|
|
859
|
|
|
|
2,783
|
|
|
|
2,535
|
|
|
Pretax operating earnings*
|
|
$
|
182
|
|
|
$
|
162
|
|
|
$
|
523
|
|
|
$
|
459
|
|
|
Percentage change over previous period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium income
|
|
|
10.7
|
%
|
|
|
9.5
|
%
|
|
|
10.8
|
%
|
|
|
9.6
|
%
|
Net investment income
|
|
|
5.4
|
|
|
|
12.1
|
|
|
|
8.0
|
|
|
|
10.2
|
|
Total operating revenues
|
|
|
10.0
|
|
|
|
9.8
|
|
|
|
10.4
|
|
|
|
9.7
|
|
Pretax operating earnings*
|
|
|
12.3
|
|
|
|
21.7
|
|
|
|
13.9
|
|
|
|
15.7
|
|
|
*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 of 10.5% in the first nine months of 2007 and 9.3% for
the same period of 2006 were favorably affected by sales at the worksite primarily through
cafeteria plans and a slight improvement in the persistency of several products. Annualized
premiums in force at September 30, 2007, were $4.3 billion, compared with $3.9 billion a year ago.
30
The following table presents a summary of operating ratios for Aflac U.S.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
Ratios to total revenues:
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Benefits and claims
|
|
|
53.1
|
%
|
|
|
53.4
|
%
|
|
|
53.0
|
%
|
|
|
53.3
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs
|
|
|
6.7
|
|
|
|
6.6
|
|
|
|
7.1
|
|
|
|
7.1
|
|
Insurance commissions
|
|
|
10.6
|
|
|
|
11.0
|
|
|
|
10.8
|
|
|
|
11.0
|
|
Insurance and other expenses
|
|
|
13.3
|
|
|
|
13.1
|
|
|
|
13.3
|
|
|
|
13.3
|
|
|
Total operating expenses
|
|
|
30.6
|
|
|
|
30.7
|
|
|
|
31.2
|
|
|
|
31.4
|
|
Pretax operating earnings*
|
|
|
16.3
|
|
|
|
15.9
|
|
|
|
15.8
|
|
|
|
15.3
|
|
|
*See
the Insurance Operations section of this MD&A for our definition of segment operating earnings.
The benefit ratio declined in the first nine months of 2007. As a percentage of premium
income, the benefit ratio was 59.8% in the first nine months of 2007, compared with 60.4% in the
first nine months of 2006. We expect the benefit ratio to decline slightly in 2007 due to
favorable claim cost trends and the operating expense ratio for 2007 to remain relatively stable,
compared with 2006. Overall, the pretax operating profit margin is expected to increase slightly in
2007.
Aflac U.S. Sales
We were pleased with our U.S. sales results, with total new annualized premium sales
rising 11.0% during the third quarter and 11.1% for the nine-month period ended September 30, 2007.
The following table presents Aflacs U.S. total new annualized premium sales for the periods ended
September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
(In millions)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Total new annualized premium sales
|
|
$
|
368
|
|
|
$
|
332
|
|
|
$
|
1,085
|
|
|
$
|
976
|
|
Percentage change over comparable
period in prior year
|
|
|
11.0
|
%
|
|
|
11.7
|
%
|
|
|
11.1
|
%
|
|
|
9.7
|
%
|
|
The following table details the contributions to total new annualized premium sales by
major product category for the periods ended September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Accident/disability coverage
|
|
|
51
|
%
|
|
|
52
|
%
|
|
|
52
|
%
|
|
|
52
|
%
|
Cancer expense insurance
|
|
|
17
|
|
|
|
16
|
|
|
|
16
|
|
|
|
17
|
|
Hospital indemnity products
|
|
|
14
|
|
|
|
13
|
|
|
|
14
|
|
|
|
13
|
|
Fixed-benefit dental coverage
|
|
|
6
|
|
|
|
7
|
|
|
|
6
|
|
|
|
7
|
|
Other
|
|
|
12
|
|
|
|
12
|
|
|
|
12
|
|
|
|
11
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
Total new annualized premium sales for accident/disability, our leading product category,
increased 10.3% in the third quarter of 2007, while cancer expense insurance increased 13.0% and
our hospital indemnity group increased 21.1%, compared with the same period a year ago.
We remain very satisfied with our progress in the ongoing expansion of our U.S. sales
force. Despite the anticipated decline in newly recruited sales associates compared to a year ago,
we still recruited approximately 6,200 new sales associates in the third quarter of 2007, bringing
the number
31
of newly recruited sales associates to more than 18,600 for the first nine months of the
year. The number of average weekly producing sales associates increased 5.0% to approximately
10,700 in the third quarter of 2007, compared with the same period a year ago. For the first nine
months of 2007, the number of average weekly producing associates rose 6.1% over a year ago. We
believe that the average weekly producing sales associates metric allows our sales management to
actively monitor progress on a real-time basis. Furthermore, we believe the increase in producing
sales associates reflects the success of the training programs we implemented over the last few
years.
For the first nine months of 2007, total new annualized premium sales increased 11.1%
over the same period last year, however we face a challenging sales comparison in the fourth
quarter of this year. Sales in the fourth quarter of 2006 rose 21.2% due to the re-enrollment of a
large payroll account. Despite that difficult comparison, we still believe we are well-positioned
to achieve our objective of a 6% to 10% increase in new annualized premium sales for the full year.
Aflac U.S. Investments
The following table presents the results of Aflacs U.S. investment activities for the
periods ended September 30.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
New money yield
|
|
|
7.01
|
%
|
|
|
6.61
|
%
|
|
|
6.45
|
%
|
|
|
6.44
|
%
|
Return on average invested assets, net of
investment expense
|
|
|
6.70
|
|
|
|
6.98
|
|
|
|
6.75
|
|
|
|
6.85
|
|
|
At September 30, 2007, the portfolio yield on Aflacs U.S. portfolio was 7.01%, compared
with 7.17% a year ago. See the Investments and Cash section of this MD&A for additional
information.
ANALYSIS OF FINANCIAL CONDITION
Our financial condition has remained strong in the functional currencies of our
operations during the last two years. The yen/dollar exchange rate at the end of each period is
used to translate yen-denominated balance sheet items to U.S. dollars for reporting purposes. The
exchange rate at September 30, 2007, was 115.43 yen to one dollar, or 3.2% stronger than the
December 31, 2006, exchange rate of 119.11. The stronger yen increased reported investments and
cash by $1.3 billion, total assets by $1.5 billion, and total liabilities by $1.5 billion, compared
with the amounts that would have been reported for the third quarter of 2007 if the exchange rate
had remained unchanged from December 31, 2006.
Market Risks of Financial Instruments
Because we invest in fixed-income securities, our financial instruments are exposed
primarily to two types of market risks: currency risk and interest rate risk.
Currency Risk
The functional currency of Aflac Japans insurance operation is the Japanese yen. All of
Aflac Japans premiums, claims and commissions are received or paid in yen, as are most of its
investment income and other expenses. Furthermore, most of Aflac Japans investments, cash and
liabilities are yen-denominated. When yen-denominated securities mature or are sold, the proceeds
are generally
32
reinvested in yen-denominated securities. Aflac Japan holds these yen-denominated
assets to fund its yen-denominated policy obligations. In addition, Aflac Incorporated has
yen-denominated notes payable and cross-currency swaps related to its dollar-denominated senior
notes.
Although we generally do not convert yen into dollars, we do translate financial
statement amounts from yen into dollars for financial reporting purposes. Therefore, reported
amounts are affected by foreign currency fluctuations. We report unrealized foreign currency
translation gains and losses in accumulated other comprehensive income.
On a consolidated basis, we attempt to minimize the exposure of our shareholders equity
to foreign currency translation fluctuations. We accomplish this by investing a portion of Aflac
Japans investment portfolio in dollar-denominated securities, by the Parent Companys issuance of
yen-denominated debt and by the use of cross-currency swaps (see the
Hedging Activities section of this MD&A for additional information). As a result, the effect of currency
fluctuations on our net assets is mitigated. The dollar values of our yen-denominated net assets,
which are subject to foreign currency translation fluctuations for financial reporting purposes,
are summarized as follows (translated at end-of-period exchange rates):
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
December 31,
|
(In millions)
|
|
2007
|
|
2006
|
|
Aflac Japan yen-denominated net assets
|
|
$
|
2,061
|
|
|
$
|
2,317
|
|
Parent Company yen-denominated net liabilities
|
|
|
(1,480
|
)
|
|
|
(1,434
|
)
|
|
Consolidated yen-denominated net assets subject to
foreign currency translation fluctuations
|
|
$
|
581
|
|
|
$
|
883
|
|
|
33
The following table demonstrates the effect of foreign currency fluctuations by
presenting the dollar values of our yen-denominated assets and liabilities, and our consolidated
yen-denominated net asset exposure at selected exchange rates.
Dollar Value of Yen-Denominated Assets and Liabilities
at Selected Exchange Rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions)
|
|
September 30, 2007
|
|
|
December 31, 2006
|
|
|
Yen/dollar exchange rates
|
|
|
100.43
|
|
|
|
115.43
|
*
|
|
|
130.43
|
|
|
|
104.11
|
|
|
|
119.11
|
*
|
|
|
134.11
|
|
|
Yen-denominated financial instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
22,599
|
|
|
$
|
19,662
|
|
|
$
|
17,401
|
|
|
$
|
21,712
|
|
|
$
|
18,978
|
|
|
$
|
16,856
|
|
Perpetual debentures
|
|
|
4,125
|
|
|
|
3,589
|
|
|
|
3,176
|
|
|
|
4,246
|
|
|
|
3,711
|
|
|
|
3,296
|
|
Equity securities
|
|
|
26
|
|
|
|
23
|
|
|
|
20
|
|
|
|
29
|
|
|
|
25
|
|
|
|
22
|
|
Securities held to maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
|
17,906
|
|
|
|
15,579
|
|
|
|
13,788
|
|
|
|
15,404
|
|
|
|
13,464
|
|
|
|
11,958
|
|
Perpetual debentures
|
|
|
4,538
|
|
|
|
3,948
|
|
|
|
3,494
|
|
|
|
4,565
|
|
|
|
3,990
|
|
|
|
3,544
|
|
Cash and cash equivalents
|
|
|
303
|
|
|
|
263
|
|
|
|
233
|
|
|
|
383
|
|
|
|
335
|
|
|
|
297
|
|
Other financial instruments
|
|
|
56
|
|
|
|
49
|
|
|
|
43
|
|
|
|
32
|
|
|
|
28
|
|
|
|
25
|
|
|
Subtotal
|
|
|
49,553
|
|
|
|
43,113
|
|
|
|
38,155
|
|
|
|
46,371
|
|
|
|
40,531
|
|
|
|
35,998
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable
|
|
|
1,155
|
|
|
|
1,005
|
|
|
|
889
|
|
|
|
1,117
|
|
|
|
976
|
|
|
|
868
|
|
Cross-currency swaps
|
|
|
553
|
|
|
|
481
|
|
|
|
426
|
|
|
|
534
|
|
|
|
467
|
|
|
|
414
|
|
Japanese policyholder
protection fund
|
|
|
172
|
|
|
|
149
|
|
|
|
132
|
|
|
|
200
|
|
|
|
175
|
|
|
|
155
|
|
|
Subtotal
|
|
|
1,880
|
|
|
|
1,635
|
|
|
|
1,447
|
|
|
|
1,851
|
|
|
|
1,618
|
|
|
|
1,437
|
|
|
Net yen-denominated
financial instruments
|
|
|
47,673
|
|
|
|
41,478
|
|
|
|
36,708
|
|
|
|
44,520
|
|
|
|
38,913
|
|
|
|
34,561
|
|
Other yen-denominated assets
|
|
|
6,099
|
|
|
|
5,306
|
|
|
|
4,696
|
|
|
|
5,550
|
|
|
|
4,852
|
|
|
|
4,309
|
|
Other yen-denominated liabilities
|
|
|
(53,104
|
)
|
|
|
(46,203
|
)
|
|
|
(40,890
|
)
|
|
|
(49,060
|
)
|
|
|
(42,882
|
)
|
|
|
(38,086
|
)
|
|
Consolidated yen-denominated
net assets subject to foreign
currency fluctuation
|
|
$
|
668
|
|
|
$
|
581
|
|
|
$
|
514
|
|
|
$
|
1,010
|
|
|
$
|
883
|
|
|
$
|
784
|
|
|
*Actual period-end exchange rate
We are exposed to economic currency risk only when yen funds are actually converted into
dollars. This primarily occurs when we repatriate funds from Aflac Japan to Aflac U.S., which is
done annually. The exchange rates prevailing at the time of repatriation will differ from the
exchange rates prevailing at the time the yen profits were earned. These repatriations have not
been greater than 80% of Aflac Japans prior year earnings determined in accordance with standards
established by the FSA. A portion of the repatriation may be used to service Aflac Incorporateds
yen-denominated notes payable with the remainder converted into dollars.
Interest Rate Risk
Our primary interest rate exposure is to the impact of changes in interest rates on the
fair value of our investments in debt securities. On our held-to-maturity and available-for-sale
debt securities portfolios combined, we had $38 million of net unrealized gains at September 30,
2007, compared with $1.7 billion of net unrealized gains at December 31, 2006. We estimate that
the reduction in the
fair value of debt securities we own resulting from a 100 basis point increase in market interest
rates, based
34
on our portfolios at September 30, 2007, and December 31, 2006, would be as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
December 31,
|
(In millions)
|
|
2007
|
|
2006
|
|
Effect on yen-denominated debt securities
|
|
$
|
(4,604
|
)
|
|
$
|
(4,386
|
)
|
Effect on dollar-denominated debt securities
|
|
|
(927
|
)
|
|
|
(857
|
)
|
|
Effect on total debt securities
|
|
$
|
(5,531
|
)
|
|
$
|
(5,243
|
)
|
|
Changes
in the interest rate environment impact the fair value of our debt
securities and as a result directly
affect the balance of unrealized gains or losses for a given period in relation to a prior period.
Decreases in market yields generate unrealized gains and increases in market yields generate
unrealized losses, however, we would not expect to realize a majority of those unrealized gains or
losses because we have the intent and ability to hold such securities to maturity or recovery of
value.
We attempt to match the duration of our assets with the duration of our liabilities.
Currently, when our debt securities mature, the proceeds may be reinvested at a yield below that of
the interest required for the accretion of policy benefit liabilities on policies issued in earlier
years. Also, our strategy of developing and marketing riders to our older policies has helped
offset the negative investment spread. Despite negative investment spreads, adequate overall
profit margins still exist in Aflac Japans aggregate block of business because of profits that
have emerged from changes in mix of business and favorable experience from mortality, morbidity,
and expenses. For additional information, see the Interest Rate Risk section of MD&A in our annual
report to shareholders for the year ended December 31, 2006.
Investments and Cash
Our investment philosophy is to maximize investment income while emphasizing liquidity,
safety and quality. Our investment objective, subject to appropriate risk constraints, is to fund
policyholder obligations and other liabilities in a manner that enhances shareholders equity. We
seek to achieve this objective through a diversified portfolio of fixed-income investments that
reflects the characteristics of the liabilities it supports. Aflac invests primarily within the
debt securities markets. The following table details investment securities by segment.
Investment Securities by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aflac Japan
|
|
|
Aflac U.S.
|
|
|
|
|
September 30,
|
|
December 31,
|
|
September 30,
|
|
December 31,
|
(In millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Securities available for sale, at
fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
22,987
|
|
|
$
|
22,044
|
|
|
$
|
6,968
|
*
|
|
$
|
6,659
|
*
|
Perpetual debentures
|
|
|
3,691
|
|
|
|
3,935
|
|
|
|
367
|
|
|
|
473
|
|
Equity securities
|
|
|
23
|
|
|
|
25
|
|
|
|
-
|
|
|
|
-
|
|
|
Total available for sale
|
|
|
26,701
|
|
|
|
26,004
|
|
|
|
7,335
|
|
|
|
7,132
|
|
|
Securities held to maturity, at
amortized cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
|
15,579
|
|
|
|
13,464
|
|
|
|
20
|
|
|
|
19
|
|
Perpetual debentures
|
|
|
3,948
|
|
|
|
3,990
|
|
|
|
-
|
|
|
|
-
|
|
|
Total held to maturity
|
|
|
19,527
|
|
|
|
17,454
|
|
|
|
20
|
|
|
|
19
|
|
|
Total investment securities
|
|
$
|
46,228
|
|
|
$
|
43,458
|
|
|
$
|
7,355
|
|
|
$
|
7,151
|
|
|
*Excludes investment-grade available-for-sale fixed-maturity securities held by the Parent Company of $105 in 2007 and $102 in 2006.
35
We have investments in both publicly issued and privately issued securities. However,
the status of issuance should not be viewed as an indicator of liquidity or as a limitation on the
determination of fair value. The outstanding amount of a particular issuance, as well as the level
of activity in a particular issuance and the state of the market, including credit events and the
interest rate environment, affect liquidity regardless of type of issuance. We routinely assess
the fair value of all of our investments. This process includes evaluating quotations provided by
outside securities pricing sources and/or compiled using data provided by external debt and equity
market sources, as described more fully in Note 3 of the Notes to the Consolidated Financial
Statements included in our annual report to shareholders for the year ended December 31, 2006. The
following table details investment securities by type of issuance.
Investment Securities by Type of Issuance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
|
December 31, 2006
|
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
(In millions)
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
Publicly issued securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
15,801
|
|
|
$
|
16,667
|
|
|
$
|
15,092
|
|
|
$
|
16,269
|
|
Perpetual debentures
|
|
|
173
|
|
|
|
159
|
|
|
|
173
|
|
|
|
176
|
|
Equity securities
|
|
|
13
|
|
|
|
19
|
|
|
|
13
|
|
|
|
22
|
|
|
Total publicly issued
|
|
|
15,987
|
|
|
|
16,845
|
|
|
|
15,278
|
|
|
|
16,467
|
|
|
Privately issued securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
|
28,914
|
|
|
|
28,361
|
|
|
|
25,490
|
|
|
|
25,905
|
|
Perpetual debentures
|
|
|
8,037
|
|
|
|
7,776
|
|
|
|
8,158
|
|
|
|
8,256
|
|
Equity securities
|
|
|
3
|
|
|
|
4
|
|
|
|
3
|
|
|
|
3
|
|
|
Total privately issued
|
|
|
36,954
|
|
|
|
36,141
|
|
|
|
33,651
|
|
|
|
34,164
|
|
|
Total investment securities
|
|
$
|
52,941
|
|
|
$
|
52,986
|
|
|
$
|
48,929
|
|
|
$
|
50,631
|
|
|
The fair values of our debt securities as compared to their respective amortized cost
declined from December 31, 2006, to September 30, 2007, primarily as a result of the effects of a
rising interest rate environment in Japan, wider credit spreads globally, and foreign currency
effect.
Privately issued securities accounted for 69.8% of total debt securities, at amortized
cost, as of September 30, 2007, compared with 68.8% at December 31, 2006. Privately issued
securities held by Aflac Japan at amortized cost accounted for $34.6 billion, or 65.3%, of total
debt securities at September 30, 2007, compared with $31.3 billion, or 64.0%, of total debt
securities at December 31, 2006. Reverse-dual currency debt securities accounted for $10.9
billion, or 29.6%, of total privately issued securities as of September 30, 2007, compared with
$9.7 billion, or 28.9%, of total privately issued securities at December 31, 2006. Aflac Japan has
invested in privately issued securities to secure higher yields than those available from Japanese
government bonds. Aflac Japans investments in yen-denominated privately issued securities consist
primarily of non-Japanese issuers and have longer maturities, thereby allowing us to improve our
asset/liability matching and our overall investment returns. Most of our privately issued
securities are issued under medium-term note programs and have standard documentation commensurate
with issuer credit ratings, except when internal credit analysis indicates that additional
protective and/or event-risk covenants are required.
Our investment activities expose us to credit risk, which is a consequence of extending
credit and/or carrying investment positions. However, we continue to adhere to prudent standards
for credit quality. We accomplish this by considering our product needs and the overall corporate
objectives, in addition to credit risk. Our investment policy requires that all securities be
rated investment grade at the time of purchase. In evaluating the initial rating, we look at the
overall senior issuer rating, the explicit rating for the actual issue or the rating for
36
the
security class, and, where applicable, the appropriate designation from the Securities Valuation
Office (SVO) of the National Association of Insurance Commissioners (NAIC). All of our securities
have ratings from either a nationally recognized statistical rating organization or the SVO of the
NAIC. In addition, we perform extensive internal credit reviews to ensure that we are consistent
in applying rating criteria for all of our securities. We have no direct investment exposure to
the sub-prime lending market. In light of recent market activity surrounding the sub-prime lending
market, we have performed a review of our investment portfolio and have not identified any material
indirect exposure to that market.
We use specific criteria to judge the credit quality of both existing and prospective
investments. Furthermore, we use several methods to monitor these criteria, including credit
rating services and internal credit analysis. The distributions by credit rating of our purchases
of debt securities, based on acquisition cost, were as follows:
Composition of Purchases by Credit Rating
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
Twelve Months Ended
|
|
Nine Months Ended
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
September 30, 2006
|
|
AAA
|
|
|
21.8
|
%
|
|
|
10.6
|
%
|
|
|
10.1
|
%
|
AA
|
|
|
40.8
|
|
|
|
48.9
|
|
|
|
46.9
|
|
A
|
|
|
27.5
|
|
|
|
35.1
|
|
|
|
39.5
|
|
BBB
|
|
|
9.9
|
|
|
|
5.4
|
|
|
|
3.5
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
The large percentage of securities purchased in the AAA rated category primarily reflects
the purchase of U.S. Treasury Bills by Aflac Japan prior to repatriating profits to Aflac U.S. in
the third quarter of 2007.
The distributions of debt securities we own, by credit rating, were as follows:
Composition by Credit Rating
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
|
|
Amortized
|
|
Fair
|
|
Amortized
|
|
Fair
|
|
|
Cost
|
|
Value
|
|
Cost
|
|
Value
|
|
AAA
|
|
|
6.5
|
%
|
|
|
6.4
|
%
|
|
|
5.8
|
%
|
|
|
5.7
|
%
|
AA
|
|
|
44.7
|
|
|
|
45.8
|
|
|
|
35.0
|
|
|
|
35.8
|
|
A
|
|
|
29.7
|
|
|
|
29.4
|
|
|
|
39.4
|
|
|
|
39.2
|
|
BBB
|
|
|
17.2
|
|
|
|
16.9
|
|
|
|
17.2
|
|
|
|
17.2
|
|
BB or lower
|
|
|
1.9
|
|
|
|
1.5
|
|
|
|
2.6
|
|
|
|
2.1
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
The increase in AAA and AA rated holdings compared with December 31, 2006, resulted from
purchases and credit rating upgrades by rating agencies; the offset was a corresponding decrease in
the A rated holdings. The decline in BB or lower rated securities resulted from the upgrade of KLM
Royal Dutch Airlines from below investment grade to investment grade during the second quarter of
2007.
In the event of a credit rating downgrade to below-investment-grade status, we do not
automatically liquidate our position. However, if the security is in the held-to-maturity
portfolio, we immediately transfer it to the available-for-sale portfolio so that the securitys
fair value and its unrealized gain or loss are reflected on the balance sheet.
37
Once we designate a security as below investment grade, we intensify our monitoring of
the issuer. We do not automatically recognize an impairment if the securitys amortized cost
exceeds its fair value. Our investment management starts by reviewing its credit analysis.
Included in this process are an evaluation of the issuer, its current credit posture and an
assessment of the future prospects for the issuer. We then obtain fair value information from at
least three independent pricing sources. Upon determining the fair value, we move our focus to an
analysis of whether or not the decline in fair value, if any, is other than temporary. For
securities with an amortized cost in excess of fair value, investment management then reviews the
issue based on our impairment policy to determine if the investment should be impaired and/or
liquidated. The assessment of whether a decline is other than temporary requires significant
management judgment and is discussed more fully in the Critical Accounting Estimates section of
MD&A in our annual report to shareholders for the year ended December 31, 2006. Securities
classified as below investment grade were as follows:
Below-Investment-Grade Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
|
|
Amortized
|
|
Fair
|
|
Amortized
|
|
Fair
|
(In millions)
|
|
Cost
|
|
Value
|
|
Cost
|
|
Value
|
|
Ahold
|
|
$
|
308
|
|
|
$
|
251
|
|
|
$
|
300
|
|
|
$
|
245
|
|
Ford Motor Credit
|
|
|
260
|
|
|
|
229
|
|
|
|
252
|
|
|
|
229
|
|
KLM Royal Dutch Airlines
|
|
|
*
|
|
|
|
*
|
|
|
|
252
|
|
|
|
229
|
|
CSAV
|
|
|
208
|
|
|
|
142
|
|
|
|
201
|
|
|
|
145
|
|
Ford Motor Company
|
|
|
122
|
|
|
|
99
|
|
|
|
122
|
|
|
|
100
|
|
BAWAG
|
|
|
121
|
|
|
|
91
|
|
|
|
118
|
|
|
|
103
|
|
Tennessee Gas Pipeline
|
|
|
*
|
|
|
|
*
|
|
|
|
30
|
|
|
|
35
|
|
Patrick Family Housing (Patrick AFB)
|
|
|
2
|
|
|
|
2
|
|
|
|
*
|
|
|
|
*
|
|
|
Total
|
|
$
|
1,021
|
|
|
$
|
814
|
|
|
$
|
1,275
|
|
|
$
|
1,086
|
|
|
*Investment grade at respective reporting date
Occasionally a debt security will be split rated. This occurs when one rating agency
rates the security as investment grade while another rating agency rates the same security as below
investment grade. Our policy is to review each issue on a case-by-case basis to determine if a
split-rated security should be classified as investment grade or below investment grade. Our
review includes evaluating the issuers credit position as well as current market pricing and other
factors, such as the issuers or securitys inclusion on a credit rating downgrade watch list.
Split-rated securities as of September 30, 2007, represented .7% of total debt securities at
amortized cost and were as follows:
Split-Rated Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
|
|
Moodys
|
|
S&P
|
|
Fitch
|
|
Investment-Grade
|
(In millions)
|
|
Cost
|
|
Rating
|
|
Rating
|
|
Rating
|
|
Status
|
|
Signum (Ahold)
|
|
$
|
277
|
|
|
Baa3
|
|
BB+
|
|
BB+
|
|
Below Investment Grade
|
Tennessee Gas Pipeline
|
|
|
31
|
|
|
Baa3
|
|
BB
|
|
BBB-
|
|
Investment Grade
|
Union Carbide Corp.
|
|
|
15
|
|
|
Ba2
|
|
BBB-
|
|
BBB
|
|
Investment Grade
|
Ahold Finance USA Inc.
|
|
|
15
|
|
|
Baa3
|
|
BB+
|
|
BB+
|
|
Below Investment Grade
|
Bell Canada
|
|
|
9
|
|
|
Baa1
|
|
BB+
|
|
BB-
|
|
Investment Grade
|
|
38
The following table provides details on amortized cost, fair value and unrealized gains
and losses for our investments in debt securities by investment-grade status as of September 30,
2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Total
|
|
Percent
|
|
Gross
|
|
Gross
|
|
|
Amortized
|
|
Fair
|
|
of Fair
|
|
Unrealized
|
|
Unrealized
|
(In millions)
|
|
Cost
|
|
Value
|
|
Value
|
|
Gains
|
|
Losses
|
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade securities
|
|
$
|
32,357
|
|
|
$
|
33,304
|
|
|
|
62.9
|
%
|
|
$
|
1,786
|
|
|
$
|
839
|
|
Below-investment-grade securities
|
|
|
1,021
|
|
|
|
814
|
|
|
|
1.5
|
|
|
|
2
|
|
|
|
209
|
|
Held-to-maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade securities
|
|
|
19,547
|
|
|
|
18,845
|
|
|
|
35.6
|
|
|
|
352
|
|
|
|
1,054
|
|
|
Total
|
|
$
|
52,925
|
|
|
$
|
52,963
|
|
|
|
100
|
%
|
|
$
|
2,140
|
|
|
$
|
2,102
|
|
|
The following table presents an aging of securities in an unrealized loss position as of
September 30, 2007.
Aging of Unrealized Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months
|
|
|
|
|
Total
|
|
Total
|
|
Less Than Six Months
|
|
to 12 Months
|
|
Over 12 Months
|
|
|
Amortized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
(In millions)
|
|
Cost
|
|
Loss
|
|
Cost
|
|
Loss
|
|
Cost
|
|
Loss
|
|
Cost
|
|
Loss
|
|
Available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
$
|
15,268
|
|
|
$
|
839
|
|
|
$
|
6,516
|
|
|
$
|
196
|
|
|
$
|
2,002
|
|
|
$
|
85
|
|
|
$
|
6,750
|
|
|
$
|
558
|
|
Below-investment-
grade securities
|
|
|
988
|
|
|
|
209
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
988
|
|
|
|
209
|
|
Held-to-maturity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
|
13,356
|
|
|
|
1,054
|
|
|
|
4,182
|
|
|
|
133
|
|
|
|
1,727
|
|
|
|
164
|
|
|
|
7,447
|
|
|
|
757
|
|
|
Total
|
|
$
|
29,612
|
|
|
$
|
2,102
|
|
|
$
|
10,698
|
|
|
$
|
329
|
|
|
$
|
3,729
|
|
|
$
|
249
|
|
|
$
|
15,185
|
|
|
$
|
1,524
|
|
|
The following table presents a distribution of unrealized losses by magnitude as of
September 30, 2007.
Percentage Decline from Amortized Cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Total
|
|
Less than 20%
|
|
20% to 46%
|
|
|
Amortized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
(In millions)
|
|
Cost
|
|
Loss
|
|
Cost
|
|
Loss
|
|
Cost
|
|
Loss
|
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade securities
|
|
$
|
15,268
|
|
|
$
|
839
|
|
|
$
|
14,848
|
|
|
$
|
736
|
|
|
$
|
420
|
|
|
$
|
103
|
|
Below-investment-
grade securities
|
|
|
988
|
|
|
|
209
|
|
|
|
310
|
|
|
|
37
|
|
|
|
678
|
|
|
|
172
|
|
Held-to-maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade securities
|
|
|
13,356
|
|
|
|
1,054
|
|
|
|
12,658
|
|
|
|
831
|
|
|
|
698
|
|
|
|
223
|
|
|
Total
|
|
$
|
29,612
|
|
|
$
|
2,102
|
|
|
$
|
27,816
|
|
|
$
|
1,604
|
|
|
$
|
1,796
|
|
|
$
|
498
|
|
|
39
The following table presents the 10 largest unrealized loss positions in our portfolio as
of September 30, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
|
|
Amortized
|
|
Fair
|
|
Unrealized
|
(In millions)
|
|
Rating
|
|
Cost
|
|
Value
|
|
Loss
|
|
SLM Corp
|
|
BBB
|
|
$
|
291
|
|
|
$
|
173
|
|
|
$
|
118
|
|
CSAV
|
|
BB
|
|
|
208
|
|
|
|
142
|
|
|
|
66
|
|
Nordea Bank
|
|
AA
|
|
|
346
|
|
|
|
285
|
|
|
|
61
|
|
Ahold
|
|
BB
|
|
|
308
|
|
|
|
251
|
|
|
|
57
|
|
KBC Group
|
|
A
|
|
|
234
|
|
|
|
184
|
|
|
|
50
|
|
Credit Suisse Group
|
|
AA
|
|
|
525
|
|
|
|
478
|
|
|
|
47
|
|
Royal Bank Of Scotland
|
|
AA
|
|
|
276
|
|
|
|
239
|
|
|
|
37
|
|
Erste Bank
|
|
A
|
|
|
390
|
|
|
|
355
|
|
|
|
35
|
|
Unicredito Italiano
|
|
A
|
|
|
408
|
|
|
|
375
|
|
|
|
33
|
|
Ford Motor Credit
|
|
B
|
|
|
260
|
|
|
|
229
|
|
|
|
31
|
|
|
The fair value of our investments in debt securities can fluctuate as a result of changes
in interest rates, foreign currency exchange rates, and credit issues. Declines in fair value
noted above resulted from changes in the interest rates, yen/dollar exchange rates, and issuer
credit status. However, we believe that it would be inappropriate to recognize impairment charges
because we believe the changes in fair value are temporary. Based on our evaluation and analysis
of specific issuers in accordance with our impairment policy, impairment charges recognized during
the nine-month periods ended September 30, 2007 and 2006 were immaterial.
Realized losses on debt securities, as a result of sales and impairment charges, were as
follows:
Realized Losses on Debt Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30, 2007
|
|
September 30, 2007
|
|
|
|
|
|
|
Realized
|
|
|
|
|
|
Realized
|
(In millions)
|
|
Proceeds
|
|
Loss
|
|
Proceeds
|
|
Loss
|
|
Investment-grade securities, length of
consecutive unrealized loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than six months
|
|
$
|
11
|
|
|
$
|
-
|
|
|
$
|
134
|
|
|
$
|
1
|
|
Six months to 12 months
|
|
|
-
|
|
|
|
-
|
|
|
|
16
|
|
|
|
-
|
|
Over 12 months
|
|
|
5
|
|
|
|
1
|
|
|
|
29
|
|
|
|
2
|
|
Below-investment-grade securities, length
of consecutive unrealized loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Over 12 months
|
|
|
-
|
|
|
|
2
|
|
|
|
-
|
|
|
|
2
|
|
|
Total
|
|
$
|
16
|
|
|
$
|
3
|
|
|
$
|
179
|
|
|
$
|
5
|
|
|
There were no disposals of below-investment-grade securities which resulted in losses
during the first nine months of 2007.
Cash, cash equivalents, and short-term investments totaled $1.3 billion, or 2.4% of total
investments and cash, as of September 30, 2007, compared with $1.2 billion, or 2.3%, at December
31, 2006.
For additional information concerning our investments, see Notes 3 and 4 of the Notes to
the Consolidated Financial Statements.
40
Deferred Policy Acquisition Costs
Deferred policy acquisition costs totaled $6.5 billion at September 30, 2007, an increase
of $456 million, or 7.6%, compared with $6.0 billion at December 31, 2006. The following table
presents deferred policy acquisition costs by segment.
|
|
|
|
|
|
|
|
|
(In millions)
|
|
September 30, 2007
|
|
December 31, 2006
|
|
Aflac Japan
|
|
$
|
4,168
|
|
|
$
|
3,857
|
|
Aflac U.S.
|
|
|
2,313
|
|
|
|
2,168
|
|
|
Aflac Japans deferred policy acquisition costs increased 8.1% (4.7% increase in yen) for
the nine months ended September 30, 2007. The stronger yen at September 30, 2007, increased
reported deferred policy acquisition costs by $129 million. Deferred policy acquisition costs of
Aflac U.S. increased 6.7% for the nine-month period ended September 30, 2007. The increase in
total deferred policy acquisition costs was primarily driven by total new annualized premium sales.
Policy Liabilities
Policy liabilities totaled $49.3 billion at September 30, 2007, an increase of $3.9
billion, or 8.6%, compared with $45.4 billion at December 31, 2006. The following table presents
policy liabilities by segment.
|
|
|
|
|
|
|
|
|
(In millions)
|
|
September 30, 2007
|
|
December 31, 2006
|
|
Aflac Japan
|
|
$
|
43,501
|
|
|
$
|
40,072
|
|
Aflac U.S.
|
|
|
5,832
|
|
|
|
5,365
|
|
|
Aflac Japans policy liabilities increased 8.6% (5.2% increase in yen) for the nine
months ended September 30, 2007. The stronger yen at September 30, 2007, increased reported policy
liabilities by $1.3 billion. Policy liabilities of Aflac U.S. increased 8.7% for the nine-month
period ended September 30, 2007. The increase in total policy liabilities is the result of the
growth and aging of our in-force business.
Notes Payable
Notes payable totaled $1.5 billion at September 30, 2007, compared to $1.4 billion at
December 31, 2006. The ratio of debt to total capitalization (debt plus shareholders equity,
excluding the unrealized gains and losses on investment securities) was 15.9% as of September 30,
2007, compared with 17.2% as of December 31, 2006. See Note 5 of the Notes to the Consolidated
Financial Statements for additional information.
Benefit Plans
Aflac U.S. and Aflac Japan have various benefit plans. For additional information on our
U.S. and Japanese plans, see Note 8 of the Notes to the Consolidated Financial Statements and Note
12 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for
the year ended December 31, 2006.
41
Policyholder Protection Fund
The Japanese insurance industry has a policyholder protection system that provides funds
for the policyholders of insolvent insurers. See the Policyholder Protection Fund section of MD&A
in our annual report to shareholders for the year ended December 31, 2006, for additional
information.
Hedging Activities
Aflac has limited hedging activities. Our primary exposure to be hedged is our
investment in Aflac Japan, which is affected by changes in the yen/dollar exchange rate. In order
to mitigate this exposure, we have taken the following courses of action. First, Aflac Japan owns
dollar-denominated securities, which serve as an economic currency hedge of a portion of our
investment in Aflac Japan. Second, we have designated the Parent Companys yen-denominated
liabilities (Samurai and Uridashi notes payable and cross-currency swaps) as a hedge of our
investment in Aflac Japan. If the total of these yen-denominated liabilities is equal to or less
than our net investment in Aflac Japan, the hedge is deemed to be effective and the related
exchange effect is reported in the unrealized foreign currency component of other comprehensive
income. Should these yen-denominated liabilities exceed our investment in Aflac Japan, the portion
of the hedge that exceeds our investment in Aflac Japan would be deemed ineffective. As required
by SFAS 133, we would then recognize the foreign exchange effect on the ineffective portion in net
earnings (other income). We estimate that if the ineffective portion was 10 billion yen, we would
report a foreign exchange gain/loss of approximately $1 million for every one yen
weakening/strengthening in the end-of-period yen/dollar exchange rate. At September 30, 2007, our
hedge was effective with yen-denominated assets exceeding yen-denominated liabilities by 67.3
billion yen, compared with 105.4 billion yen at December 31, 2006. The decrease in our
yen-denominated net asset position resulted from an increasing interest rate environment in
Japan and widening credit spreads globally.
During the third quarter of 2006, we entered into interest rate swap agreements related
to the 20 billion yen variable interest rate Uridashi notes. By entering into these contracts, we
have been able to lock in our interest rate at 1.52% in yen. We have designated these interest
rate swaps as a hedge of the variability in our interest cash flows associated with the variable
interest rate Uridashi notes. 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. Changes in the fair value of the swap contracts are recorded in other comprehensive
income. The fair value of these swaps and related changes in fair value were immaterial during the
three- and nine-month period ended September 30, 2007.
Off-Balance Sheet Arrangements
As of September 30, 2007, we had no material unconditional purchase obligations that were
not recorded on the balance sheet. Additionally, we had no material letters of credit, standby
letters of credit, guarantees or standby repurchase obligations.
CAPITAL RESOURCES AND LIQUIDITY
Aflac provides the primary sources of liquidity to the Parent Company through dividends
and management fees. Aflac paid dividends to the Parent Company in the amount of $810 million in
the first nine months of 2007, compared with $601 million for the same period in 2006. During the
first nine months of 2007, Aflac paid $60 million to the Parent Company for management fees,
compared with $52 million for the same period of 2006. The primary uses of cash by the Parent
Company are shareholder dividends and our share repurchase program. The Parent Companys sources
and uses of cash are reasonably predictable and are not expected to change materially in the
future.
42
The Parent Company also accesses debt security markets to provide additional sources of
capital. Capital is primarily used to fund business expansion and capital expenditures. We have a
Shelf Registration Statement (SRS) on file with Japanese regulatory authorities to issue up to 100
billion yen of yen-denominated Samurai notes in Japan. In June 2007, the Parent Company issued 30
billion yen of yen-denominated Samurai notes from this SRS. If issued, the remaining 70 billion
yen (approximately $606 million using the September 30, 2007, exchange rate) of yen-denominated
Samurai notes will not be available to U.S. persons. We also have an SRS on file with Japanese
regulatory authorities to issue up to 100 billion yen of Uridashi notes in Japan. As of September
30, 2007, the Parent Company had issued 45 billion yen of yen-denominated Uridashi notes from this
SRS. If issued, the remaining 55 billion yen (approximately $476 million using the September 30,
2007, period-end exchange rate) of yen-denominated Uridashi notes will not be available to U.S.
persons. We believe outside sources for additional debt and equity capital, if needed, will
continue to be available. For additional information, see Note 5 of the Notes to the Consolidated
Financial Statements.
The principal sources of cash for our insurance operations are premiums and investment
income. The primary uses of cash by our insurance operations are policy claims, commissions,
operating expenses, income taxes and payments to the Parent Company for management fees and
dividends. Both the sources and uses of cash are reasonably predictable.
When making an investment decision, our first consideration is based on product needs.
Our investment objectives provide for liquidity through the purchase of investment-grade debt
securities. These objectives also take into account duration matching, and because of the
long-term nature of our business, we have adequate time to react to changing cash flow needs.
As a result of policyholder aging, claims payments are expected to gradually increase over
the life of a policy. Therefore, future policy benefit reserves are accumulated in the early years
of a policy and are designed to help fund future claims payments. We expect our future cash flows
from premiums and our investment portfolio to be sufficient to meet our cash needs for benefits and
expenses.
Consolidated Cash Flows
We translate cash flows for Aflac Japans yen-denominated items into U.S. dollars using
weighted-average exchange rates. In periods when the yen weakens, translating yen into dollars
causes fewer dollars to be reported. When the yen strengthens, translating yen into dollars causes
more dollars to be reported. The following table summarizes consolidated cash flows by activity
for the nine-month periods ended September 30.
Consolidated Cash Flows by Activity
|
|
|
|
|
|
|
|
|
(In millions)
|
|
2007
|
|
2006
|
|
Operating activities
|
|
$
|
3,342
|
|
|
$
|
3,244
|
|
Investing activities
|
|
|
(2,714
|
)
|
|
|
(2,884
|
)
|
Financing activities
|
|
|
(510
|
)
|
|
|
(283
|
)
|
Exchange effect on cash and cash equivalents
|
|
|
7
|
|
|
|
4
|
|
|
Net change in cash and cash equivalents
|
|
$
|
125
|
|
|
$
|
81
|
|
|
43
Operating Activities
In the first nine months of 2007, consolidated cash flow from operations increased 3.0%,
compared with the first nine months of 2006. The increase in cash flows resulted primarily from
the timing of Aflac Japans tax payments in 2007 and 2006 related to our bond-swap program that
started in the last half of 2005 and concluded in the first half of 2006. The following table
summarizes operating cash flows by source for the nine-month periods ended September 30.
Cash Provided by Operating Activities
|
|
|
|
|
|
|
|
|
(In millions)
|
|
2007
|
|
2006
|
|
Aflac Japan
|
|
$
|
2,550
|
|
|
$
|
2,482
|
|
Aflac U.S. and Other Operations
|
|
|
792
|
|
|
|
762
|
|
|
Investing Activities
Operating cash flow is primarily used to purchase debt securities to meet future policy
obligations. The following table summarizes investing cash flows by source for the nine-month
periods ended September 30.
Cash Used by Investing Activities
|
|
|
|
|
|
|
|
|
(In millions)
|
|
2007
|
|
2006
|
|
Aflac Japan
|
|
$
|
2,209
|
|
|
$
|
2,335
|
|
Aflac U.S. and Other Operations
|
|
|
505
|
|
|
|
549
|
|
|
Prudent portfolio management dictates that we attempt to match the duration of our assets
with the duration of our liabilities. Currently, when our debt securities mature, the proceeds may
be reinvested at a yield below that required for the accretion of policy benefit liabilities on
policies issued in earlier years. However, the long-term nature of our business and our strong
cash flows provide us with the ability to minimize the effect of mismatched durations and/or yields
identified by various asset adequacy analyses. When market opportunities arise, we dispose of
selected debt securities that are available for sale to improve the duration matching of our assets
and liabilities, improve future investment yields, and/or rebalance our portfolio. As a result,
dispositions before maturity can vary significantly from year to year. Dispositions before
maturity were approximately 1% of the year-to-date average investment portfolio of debt securities
available for sale during the nine-month period ended September 30, 2007, compared with
approximately 6% a year ago.
Financing Activities
Consolidated cash used by financing activities was $510 million in the first nine months
of 2007, compared with $283 million for the same period of 2006. In June 2007, we received $242
million in connection with the Parent Companys issuance of yen-denominated Samurai notes, and we
paid $242 million in connection with the maturity of the 2002 Samurai notes. In June 2006, the
Parent Company paid $355 million in connection with the maturity of the 2001 Samurai notes. In
September 2006, the Parent Company received $382 million from its issuance of yen-denominated
Uridashi notes. Cash returned to shareholders through treasury stock purchases and dividends was
$246 million higher in the first nine months of 2007, compared with the same period in 2006.
44
The following table presents a summary of treasury stock activity during the nine-month
periods ended September 30.
|
|
|
|
|
|
|
|
|
(In millions of dollars and thousands of shares)
|
|
2007
|
|
2006
|
|
Treasury stock purchases
|
|
$
|
479
|
|
|
$
|
327
|
|
|
Shares purchased
|
|
|
9,551
|
|
|
|
7,133
|
|
|
Stock issued from treasury
|
|
$
|
37
|
|
|
$
|
29
|
|
|
Shares issued
|
|
|
2,265
|
|
|
|
2,061
|
|
|
Dividends to shareholders in the first nine months of 2007 of $.595 per share increased
52.6% over the same period of 2006. The following table presents the sources of dividends paid to
shareholders for the nine-month periods ended September 30.
|
|
|
|
|
|
|
|
|
(In millions)
|
|
2007
|
|
2006
|
|
Dividends paid in cash
|
|
$
|
277
|
|
|
$
|
183
|
|
Dividends through issuance of treasury shares
|
|
|
15
|
|
|
|
10
|
|
|
Total dividends to shareholders
|
|
$
|
292
|
|
|
$
|
193
|
|
|
Regulatory Restrictions
Aflac is domiciled in Nebraska and is subject to its regulations. In addition to
limitations and restrictions imposed by U.S. insurance regulators, Japans FSA may not allow profit
repatriations from Aflac Japan if the transfers would cause Aflac Japan to lack sufficient
financial strength for the protection of Aflac Japan policyholders.
Payments are made from Aflac Japan to the Parent Company for management fees and to Aflac
U.S. for allocated expenses and remittances of earnings. During the first nine months of 2007,
Aflac Japan paid $25 million to the Parent Company for management fees, compared with $18 million
for the same period in 2006. Expenses allocated to Aflac Japan were $25 million for the nine-month
period ended September 30, 2007, compared with $23 million a year ago. During the first nine
months of 2007, Aflac Japan remitted profits of $567 million (67.8 billion yen) to Aflac U.S.,
compared with $442 million (50.0 billion yen) in the first nine months of 2006.
For additional information on regulatory restrictions on dividends, profit repatriations
and other transfers, see Note 11 of the Notes to the Consolidated Financial Statements and the
Regulatory Restrictions section of MD&A, both in our annual report to shareholders for the year
ended December 31, 2006.
Rating Agencies
Aflac is rated AA by both Standard & Poors and Fitch Ratings and Aa2 (Excellent) by
Moodys for financial strength. A.M. Best assigned Aflac an A+ (Superior) rating for financial
strength and operating performance. Aflac Incorporateds senior debt, Samurai notes and Uridashi
notes are rated A by Standard & Poors, A+ by Fitch Ratings, and A2 by Moodys.
Other
In October 2007, the board of directors declared the fourth quarter cash dividend of
$.205 per share. The dividend is payable on December 3, 2007, to shareholders of record at the
close of business on November 16, 2007. In February 2006, the board of directors authorized the
purchase of an additional
45
30.0 million shares of our common stock. As of September 30, 2007, approximately 27.6 million
shares were available for purchase under our share repurchase authorization.
For information regarding commitments and contingent liabilities, see Note 10 of the
Notes to the Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The information required by Item 3 is incorporated by reference from the Market Risks of
Financial Instruments section of MD&A in Part I, Item 2 of this report.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures
The Companys management, with the participation of the Companys Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this
quarterly report (the Evaluation Date). Based on such evaluation, the Companys Chief Executive
Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Companys
disclosure controls and procedures are effective.
Changes in Internal Control Over Financial Reporting
There have not been any changes in the Companys internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during
the third fiscal quarter of 2007 that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
46