Certain statements included in this section constitute forward-looking statements within the meaning of theU.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are made based on management's current expectations and beliefs concerning future developments and their potential effects upon the Company. The Company's actual results may differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. Certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements can be found in the "Risk Factors" and "Forward-Looking Statements" sections herein. MD&A OVERVIEW The following financial review provides a discussion of the Company's results of operations and financial condition, as well as a summary of the Company's critical accounting estimates. This section should be read in conjunction with Part I - Item 1. Business and the audited consolidated financial statements and accompanying notes included in Part II - Item 8. Financial Statements and Supplementary Data of this report. This MD&A is divided into the following sections: Page Executive Summary 35 Industry Trends 35 Outlook 36 Results of Operations 37 Investments 49 Policy Liabilities 57 Benefit Plans 57 Policyholder Protection 57 Off Balance Sheet Arrangements 57 Liquidity and Capital Resources 58 Critical Accounting Estimates 64 The Company elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented in Item 8. Financial Statements and Supplementary Data. Readers should refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2018 , filed onFebruary 25, 2019 , for reference to discussion of the year endedDecember 31, 2017 , the earliest of the three years presented. Amounts reported in this MD&A may not add due to rounding. 34
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY For the full year of 2019, total revenues were up 2.5% to$22.3 billion , compared with$21.8 billion for the full year of 2018. Net earnings were$3.3 billion , or$4.43 per diluted share, compared with$2.9 billion , or$3.77 per diluted share, for the full year of 2018. Results for 2019 included pretax net realized investment losses of$135 million , compared with net realized investment losses of$430 million in 2018. Net investment losses in 2019 included$31 million of other-than-temporary impairment losses and changes in loan loss reserves;$236 million in net losses from certain derivatives and foreign currency gains or losses;$101 million of net gains on equity securities; and$31 million of net gains from sales and redemptions.
The average yen/dollar exchange rate(1) in 2019 was 109.07, or 1.2% stronger than the rate of 110.39 in 2018.
Adjusted earnings(2) for the full year of 2019 were$3.3 billion , or$4.44 per diluted share, compared with$3.2 billion , or$4.16 per diluted share, in 2018. The stronger yen/dollar exchange rate impacted adjusted earnings per diluted share by$.02 . Total investments and cash at the end ofDecember 2019 were$138.1 billion , compared with$126.2 billion atDecember 31, 2018 . In 2019,Aflac Incorporated repurchased$1.6 billion , or 32.0 million of its common shares. At the end of December, the Company had 37.1 million remaining shares authorized for repurchase. Shareholders' equity was$29.0 billion , or$39.84 per share, atDecember 31, 2019 , compared with$23.5 billion , or$31.06 per share, atDecember 31, 2018 . Shareholders' equity atDecember 31, 2019 included a net unrealized gain on investment securities and derivatives of$8.5 billion , compared with a net unrealized gain of$4.2 billion atDecember 31, 2018 . Shareholders' equity atDecember 31, 2019 also included an unrealized foreign currency translation loss of$1.6 billion , compared with an unrealized foreign currency translation loss of$1.8 billion atDecember 31, 2018 . The annualized return on average shareholders' equity in 2019 was 12.6%. Shareholders' equity excluding accumulated other comprehensive income (AOCI)(2) (adjusted book value) was$22.3 billion , or$30.74 per share atDecember 31, 2019 , compared with$21.3 billion , or$28.22 per share, atDecember 31, 2018 . The annualized adjusted return on equity excluding foreign currency impact(2) in 2019 was 15.1%. INDUSTRY TRENDS
The Company is impacted by financial markets, economic conditions, regulatory oversight and a variety of trends that affect the industries where it competes.
Financial and Economic Environment
The Company's business and results of operations are materially affected by conditions in the global capital markets and the economy generally. Stressed conditions, volatility and disruptions in global capital markets, particular markets, or financial asset classes can have an adverse effect on the Company, in part because the Company has a large investment portfolio and its insurance liabilities and derivatives are sensitive to changing market factors. See Item 1A. Risk Factors for the risk factor entitled, "Difficult conditions in global capital markets and the economy could have a material adverse effect on the Company's investments, capital position, revenue, profitability, and liquidity and harm the Company's business."
Demographics
Japan Business - With Japan's aging population and the rise in healthcare costs, supplemental health care insurance products remain attractive. However, due to the aging population and decline in birthrate, new opportunities for customer demographics are not as readily available. Japan's existing customers and potential customers seek products that are easily understood, cost-effective and can be accessed through technology-enabled devices.
(1) Yen /U.S. dollar exchange rates are based on the publishedMUFG Bank, Ltd. telegraphic transfer middle rate (TTM). (2) See the Results of Operations section of this MD&A for a definition of this non-U.S. GAAP financial measure. 35
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
U.S. Business - Customer demographics continue to evolve and new opportunities present themselves in different customer segments such as the millennial and multicultural markets. Customer expectations and preferences are changing. Trends indicate existing customers and potential customers seek cost-effective solutions that are easily understood and can be accessed through technology-enabled devices. Additionally, income protection and the health needs of retiring baby boomers are continuing to shape the insurance industry.
Regulatory Environment
See Item 1. Business - Aflac
Competitive Environment
See Item 1. Business -Aflac U.S. Competition andAflac Japan Competition for a discussion of the competitive environment and the basis on which the Company competes in each of its segments. 2020 OUTLOOK The Company's strategy to drive long-term shareholder value is to pursue growth through product development, distribution expansion and digital advancements to improve the customer experience. The Company's objectives in 2020 are to maintain strong pre-tax margins in its Aflac Japan and AflacU.S. segments through disciplined product pricing, stable investment returns and leveraging a period of favorable benefit ratios to invest in its platform for future growth and efficiency. The Company believes that its market-leading position, powerful brand recognition and diverse distribution inJapan and theU.S. will provide support toward these objectives. The Company believes that its efforts will support its prudent strategies for capital deployment in the form of dividends, share repurchases, and opportunistic investments that enhance the Company's business with a focus on digital distribution and leveraging the Company's brand, distribution and scale. The Company has stated that the dividend payout ratio from its Aflac Japan segment is likely to be to 100% of FSA earnings from Aflac Japan and 100% ofU.S. statutory earnings from AflacU.S. In its AflacU.S. segment, the Company plans to maintain a risk-based capital (RBC) ratio in the 500% range for 2020. Aflac Japan Segment In Japan, the Company anticipates that the shift in earned premium from first sector savings products to third sector cancer and medical products and first sector protection products, will continue to result in moderately lower benefit ratios in the Aflac Japan segment. The Company also expects this shift in business mix, plus continued investment in IT and digital advancements, to result in moderately higher expense ratios for Aflac Japan. The Company anticipates the Japan segment will face revenue challenges in 2020 due to the run-off and paid-up status of first sector savings and third sector products. The Company expects a decline in the range of .7% in third sector and first sector protection earned premium for 2020. In addition, net investment income is expected to decline modestly as compared to 2019, due in part to the low interest rate environment inJapan and de-risking of the portfolio, partially offset by lower hedge cost as a result of a reduction in the hedge ratio in the fourth quarter of 2019. AflacU.S. Segment The Company expects the profit margins for the AflacU.S. segment to remain strong, providing a prudent opportunity to reinvest profits back into theU.S. business. The Company anticipates that in 2020, benefit ratios in theU.S. will remain stable and that expense ratios will continue to be elevated in light of investments intoU.S. platforms in both the individual and group channels. The Company expects AflacU.S. to generate earned premium growth in the range of 1% in 2020. Net investment income is expected to decline modestly, primarily as the result of the Company's implementedU.S. capital and RBC draw-down plan. Corporate and Other Segment The Company expects corporate segment results to benefit from net investment income driven by increased capital and liquidity held at the Parent Company, as well as the increase in size of the Company's enterprise currency hedging strategy. The anticipated increase in investment income is expected to be partially offset by increased costs associated with continued investment inAflac Corporate Ventures initiatives. 36
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
For important disclosures applicable to statements made in this 2020 Outlook, please see the Risk Factors section and the statement on Forward-Looking Information at the beginning of Item 1. Business, the Risk Factors identified in Item 1A. and Item 7. Management Discussion and Analysis. RESULTS OF OPERATIONS The Company earns its revenues principally from insurance premiums and investments. The Company's operating expenses primarily consist of insurance benefits provided and reserves established for anticipated future insurance benefits, general business expenses, commissions and other costs of selling and servicing its products. Profitability for the Company depends principally on its ability to price its insurance products at a level that enables the Company to earn a margin over the costs associated with providing benefits and administering those products. Profitability also depends on, among other items, actuarial and policyholder behavior experience on insurance products, and the Company's ability to attract and retain customer assets, generate and maintain favorable investment results, effectively deploy capital and utilize tax capacity, and manage expenses. Yen-denominated income statement accounts are translated toU.S. dollars using a weighted average Japanese yen/U.S. dollar foreign exchange rate, except realized gains and losses on security transactions which are translated at the exchange rate on the trade date of each transaction. Yen-denominated balance sheet accounts are translated toU.S. dollars using a spot Japanese yen/U.S. dollar foreign exchange rate. The following discussion includes references to the Company's performance measures, adjusted earnings, adjusted earnings per diluted share, and amortized hedge costs/income, which are not calculated in accordance withU.S. GAAP (non-U.S. GAAP). These measures exclude items that the Company believes may obscure the underlying fundamentals and trends in the Company's insurance operations because they tend to be driven by general economic conditions and events or related to infrequent activities not directly associated with its insurance operations. The Company's management uses adjusted earnings and adjusted earnings per diluted share to evaluate the financial performance of its insurance operations on a consolidated basis, and the Company believes that a presentation of these measures is vitally important to an understanding of its underlying profitability drivers and trends of its insurance business. The Company believes that amortized hedge costs/income, which are a component of adjusted earnings, measure the periodic currency risk management costs/income related to hedging certain foreign currency exchange risks and are an important component of net investment income.
The Company defines the non-
• Adjusted earnings are the profits derived from operations.The most
comparable
adjusted revenues less benefits and adjusted expenses. The adjustments to
both revenues and expenses account for certain items that cannot be
predicted or that are outside management's control. Adjusted revenues are
except for amortized hedge costs/income related to foreign currency
exposure management strategies and net interest cash flows from
derivatives associated with certain investment strategies. Adjusted
expenses are
the impact of interest cash flows from derivatives associated with notes payable but excluding any nonrecurring or other items not associated with the normal course of the Company's insurance operations and that do not reflect the Company's underlying business performance.
• Adjusted earnings per share (basic or diluted) are adjusted earnings for
the period divided by the weighted average outstanding shares (basic or
diluted) for the period presented. The most comparable
is net earnings per share.
• Amortized hedge costs/income represent costs/income incurred or recognized
in using foreign currency forward
contracts to hedge certain foreign exchange risks in the Company's Japan segment (costs) or in the Corporate and Other segment (income). These amortized hedge costs/income are derived from the difference between the foreign currency spot rate at time of trade inception and the contractual foreign currency forward rate, recognized on a straight line basis over the term of the hedge. There is no comparableU.S. GAAP financial measure for amortized hedge costs/income.
• Adjusted earnings and adjusted earnings per diluted share excluding
current period foreign currency impact are computed using the average
yen/dollar exchange rate for the comparable prior year period, which eliminates fluctuations driven solely by yen-to-dollar currency rate changes. 37
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
• Amounts excluding foreign currency impact on
investment income were determined using the average dollar/yen exchange
rate for the comparable prior year period. • Adjusted book value is theU.S. GAAP book value (representing total
shareholders' equity), less AOCI as recorded on the
sheet. The Company considers adjusted book value important as it excludes
AOCI, which fluctuates due to market movements that are outside management's control. • Adjusted return on equity (ROE) excluding foreign currency impact is
calculated using adjusted earnings excluding the impact of the yen/dollar
exchange rate, as reconciled with total
average shareholders' equity, excluding AOCI. The most comparable
GAAP financial measure is return on average equity as determined using net
earnings and average total shareholders' equity.
The following table is a reconciliation of items impacting adjusted earnings and adjusted earnings per diluted share to the most directly comparableU.S. GAAP measures of net earnings and net earnings per diluted share, respectively, for the years endedDecember 31 . Reconciliation of Net Earnings to Adjusted Earnings(1) In Millions Per Diluted Share 2019 2018 2019 2018 Net earnings$ 3,304 $ 2,920 $ 4.43 $ 3.77 Items impacting net earnings: Realized investment (gains) losses (2),(3),(4),(5) 15 297 .02 .38 Other and non-recurring (income) loss 1 75 .00 .10 Income tax (benefit) expense on items excluded from adjusted earnings (3 ) (83 ) .00 (.11 ) Tax reform adjustment (6) (4 ) 18 (.01 ) .02 Adjusted earnings 3,314 3,226 4.44 4.16 Current period foreign currency impact (7) (15 ) N/A (.02 ) N/A Adjusted earnings excluding current period foreign currency impact$ 3,299 $ 3,226
(1) Amounts may not foot due to rounding. (2) Amortized hedge costs of$257 in 2019 and$236 in 2018, related to certain foreign currency exposure management strategies have been reclassified from realized investment gains (losses) and included in adjusted earnings as a decrease to net investment income. See "Hedge Costs/Income" discussion below for further information. (3)Amortized hedge income of$89 in 2019 and$36 in 2018, related to certain foreign currency exposure management strategies have been reclassified from realized investment gains (losses) and included in adjusted earnings as an increase to net investment income. See "Hedge Costs/Income" discussion below for further information. (4) Net interest cash flows from derivatives associated with certain investment strategies of$(17) in 2019 and an immaterial amount for 2018 have been reclassified from realized investment gains (losses) and included in adjusted earnings as a component of net investment income. (5) A gain of$66 in 2019 and$67 in 2018, respectively, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable have been reclassified from realized investment gains (losses) and included in adjusted earnings as a component of interest expense. (6) The impact of Tax Reform was adjusted in 2018 for return-to-provision adjustments, various amended returns filed by the company, and final true-ups of deferred tax liabilities. Further impacts were recorded in 2019 a result of additional guidance released by theIRS . (7) Prior period foreign currency impact reflected as "N/A" to isolate change for current period only. Reconciling Items
Realized Investment Gains and Losses
The Company's investment strategy is to invest primarily in fixed maturity securities to provide a reliable stream of investment income, which is one of the drivers of the Company's growth and 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. The Company does 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 management and rebalancing. The realization of investment gains and losses is independent of the underwriting and administration of the Company's insurance products. Realized investment gains and 38
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
losses include securities transactions, impairments, changes in loan loss reserves, derivative and foreign currency activities and changes in fair value of equity securities. Securities Transactions, Impairments, and Gains (Losses) onEquity Securities Securities transactions include gains and losses from sales and redemptions of investments where the amount received is different from the amortized cost of the investment. Impairments include other-than-temporary-impairment losses on investment securities as well as changes in loan loss reserves for loan receivables. Starting in the first quarter of 2018, gains and losses from changes in fair value of equity securities are recorded in earnings. Certain Derivative and Foreign Currency Gains (Losses) The Company's derivative activities include foreign currency forwards and options on certain fixed maturity securities; foreign currency forwards and options that economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long-term exposure to a weakening yen; foreign currency swaps associated with certain senior notes and subordinated debentures; foreign currency swaps and credit defaults swaps held in consolidated variable interest entities (VIEs); interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments; and interest rate swaptions to hedge changes in the fair value associated with interest rate changes for certain dollar-denominated available-for-sale securities. Gains and losses are recognized as a result of valuing these derivatives, net of the effects of hedge accounting. The Company also excludes the accounting impacts of remeasurement associated with changes in the yen/dollar exchange rate from adjusted earnings. Amortized hedge costs/ income related to certain foreign currency exposure management strategies (see Amortized Hedge Cost/Income section below), and net interest cash flows from derivatives associated with certain investment strategies and notes payable are reclassified from realized investment gains (losses) and included in adjusted earnings. Amortized hedge costs/income can fluctuate based upon many factors, including the derivative notional amount, the length of time of the derivative contract, changes in bothU.S. and Japan interest rates, and supply and demand for dollar funding. Amortized hedge costs and income have fluctuated in recent periods due to changes in the previously mentioned factors. For additional information regarding foreign currency hedging, refer to Hedging Activities in the Investments section of this MD&A.
For additional information regarding realized investment gains and losses, including details of reported amounts for the periods presented, see Notes 3 and 4 of the Notes to the Consolidated Financial Statements.
Other and Non-recurring Items
TheU.S. insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. The system can result in periodic charges to the Company as a result of insolvencies/bankruptcies that occur with other companies in the life insurance industry. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. These charges neither relate to the ordinary course of the Company's business nor reflect the Company's underlying business performance, but result from external situations not controlled by the Company. The Company excludes any charges associated withU.S. guaranty fund assessments and the corresponding tax benefit or expense from adjusted earnings. In Japan, the government also requires the insurance industry to contribute to a policyholder protection corporation that provides funds for the policyholders of insolvent insurers; however, these costs are calculated and administered differently than in theU.S. In Japan, these costs are not directly related to specific insolvencies or bankruptcies, but are rather a regular operational cost for an insurance company. Based on this structure, the Company does not remove the Japan policyholder protection expenses from adjusted earnings. Nonrecurring items also include conversion costs related to legally converting the Company's Japan business to a subsidiary; these costs primarily consist of expenditures for legal, accounting, consulting, integration of systems and processes and other similar services. These Japan branch conversion costs were an immaterial amount for the year-endedDecember 31, 2019 and$75 million for the year-endedDecember 31, 2018 .
Income Taxes
The Company's combinedU.S. and Japanese effective income tax rate on pretax earnings was 25.7% in 2019 and 26.7% in 2018. The decrease in theU.S. federal statutory corporate income tax rate from 35% to 21% effectiveJanuary 1, 2018 drove the reduction in the effective tax rate for 2019 and 2018. Total income taxes were$1.1 billion in both 2019 and 2018. Japanese income taxes on Aflac Japan's results account for most of the Company's consolidated income tax expense. 39
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
For further information, see "Critical Accounting Estimates - Income Taxes" in this MD&A, and Note 10 of the Notes to the Consolidated Financial Statements for additional information.
Foreign Currency Translation
Aflac Japan's premiums and a significant portion of its investment income are received in yen, and its claims and most expenses are paid in yen. Aflac Japan purchases yen-denominated assets andU.S. dollar-denominated assets, which may be hedged to yen, to support yen-denominated policy liabilities. These and other yen-denominated financial statement items are, however, translated into dollars for financial reporting purposes. The Company translates Aflac Japan's yen-denominated income statement into dollars using the average exchange rate for the reporting period, and the Company translates its yen-denominated balance sheet using the exchange rate at the end of the period. Due to the size of Aflac Japan, whose functional currency is the Japanese yen, fluctuations in the yen/dollar exchange rate can have a significant effect on the Company's 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. Management evaluates the Company's financial performance both including and excluding the impact of foreign currency translation to monitor, respectively, cumulative currency impacts on book value and the currency-neutral operating performance over time. RESULTS OF OPERATIONS BY SEGMENTU.S. GAAP financial reporting requires that a company report financial and descriptive information about operating segments in its annual and interim period financial statements. Furthermore, the Company is required to report a measure of segment profit or loss, certain revenue and expense items, and segment assets. Aflac's insurance business consists of two segments: Aflac Japan and AflacU.S. Aflac Japan is the principal contributor to consolidated earnings. Businesses that are not individually reportable, such as the Parent Company, asset management subsidiaries and business activities, including reinsurance retrocession activities are included in the Corporate and other segment. See the Item 1. Business section of this Form 10-K for a summary of each segment's products and distribution channels, and a discussion of the conversion of Aflac Japan from a branch to a subsidiary and the creation of asset management subsidiaries in 2018. Consistent withU.S. GAAP guidance for segment reporting, pretax adjusted earnings is the Company'sU.S. GAAP measure of segment performance. See Note 2 of the Notes to the Consolidated Financial Statements for the reconciliation of segment results to the Company's consolidatedU.S. GAAP results and additional information. AFLAC JAPAN SEGMENT
Aflac Japan Pretax Adjusted Earnings
Changes in Aflac Japan's pretax adjusted 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 for the years endedDecember 31 . 40
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Aflac Japan Summary of Operating Results (In millions) 2019 2018 Net premium income$ 12,772 $ 12,762 Net investment income: Yen-denominated investment income 1,307
1,283
U.S. dollar-denominated investment income 1,446
1,356
Net investment income 2,753
2,639
Amortized hedge costs related to certain foreign currency exposure management strategies
257
236
Net investment income, less amortized hedge costs 2,496 2,403 Other income (loss) 45 41 Total adjusted revenues 15,313 15,206 Benefits and claims, net 8,877 8,913 Adjusted expenses: Amortization of deferred policy acquisition costs 709 710 Insurance commissions 731 735 Insurance and other expenses 1,734 1,640 Total adjusted expenses 3,174 3,085 Total benefits and adjusted expenses 12,051
11,998
Pretax adjusted earnings$ 3,261 $
3,208
Weighted-average yen/dollar exchange rate 109.07
110.39
In Dollars In Yen
Percentage change over previous period: 2019 2018 2019 2018 Net premium income
.1 % .1 % (1.1 )% (1.5 )%
Net investment income, less amortized
hedge costs 3.9 7.5 2.2 5.5 Total adjusted revenues .7 1.2 (.6 ) (.5 ) Pretax adjusted earnings 1.7 5.0 .2 3.1 In yen terms, Aflac Japan's net premium income decreased in 2019, primarily due to limited-pay products reaching paid-up status. Net investment income, net of amortized hedge costs, increased in 2019 primarily due to increased investments inU.S. dollar-denominated floating rate assets and$25 million of income related to a partial call of a concentrated yen-denominated exposure. Annualized premiums in force atDecember 31, 2019 , were ¥1.49 trillion, compared with ¥1.53 trillion in 2018. The decrease in annualized premiums in force in yen of 2.5% in 2019 and 1.6% in 2018 was driven primarily by limited-pay products reaching paid up status. Annualized premiums in force, translated into dollars at respective year-end exchange rates, were$13.6 billion in 2019 and$13.8 billion in 2018. Aflac Japan's investment portfolios includeU.S. dollar-denominated securities and reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments). In years when the yen strengthens in relation to the dollar, translating Aflac Japan'sU.S. dollar-denominated investment income into yen lowers growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms. In years when the yen weakens, translatingU.S. dollar-denominated investment income into yen magnifies growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms. The following table illustrates the effect of translating Aflac Japan'sU.S. dollar-denominated investment income and related items into yen by comparing certain segment results with those that would have been reported had dollar/yen exchange rates remained unchanged from the prior year. Amounts excluding foreign currency impact onU.S. dollar-denominated investment income, a non-U.S. GAAP financial measure, were determined using the average dollar/yen exchange rate for the comparable prior year period. See non-U.S. GAAP financial measures defined above. 41
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Aflac Japan Percentage Changes Over Prior Year (Yen Operating Results) For the Years Ended December 31, Including Foreign Excluding Foreign Currency Changes Currency Changes 2019 2018 2019 2018 Net investment income, less amortized hedge costs 2.2 % 5.5 % 2.9 % 6.4 % Total adjusted revenues (.6 ) (.5 ) (.5 ) (.3 ) Pretax adjusted earnings .2 3.1 .7 3.7
The following table presents a summary of operating ratios in yen terms for
Aflac Japan for the years ended
2019 2018 Benefits and claims, net 58.0 % 58.6 % Adjusted expenses: Amortization of deferred policy acquisition costs 4.6 4.7 Insurance commissions 4.8 4.8 Insurance and other expenses 11.3 10.8 Total adjusted expenses 20.7 20.3 Pretax adjusted earnings 21.3 21.1 Ratios to total premiums: Benefits and claims, net 69.5 % 69.9 % Adjusted expenses: Amortization of deferred policy acquisition costs 5.5 5.6 In 2019, the benefit ratio decreased, compared to the prior year, primarily due to the continued change in mix of first and third sector business as first sector products become paid-up. In 2019, the adjusted expense ratio increased mainly due to lower premium income from paid-up first sector products and higher expenses for advanced technology implementation. In total for 2019, the pretax adjusted profit margin (calculated by dividing adjusted earnings by adjusted revenues) increased reflecting continued strength in benefit ratios and favorable net investment income. For 2020, the Company anticipates the Aflac Japan pretax adjusted profit margin (calculated by dividing adjusted earnings by adjusted revenues) to remain stable. For further information, see the 2020 Outlook section of this MD&A.
The following table presents Aflac Japan's new annualized premium sales for the
years ended
In Dollars In Yen (In millions of dollars and billions of yen) 2019 2018 2019
2018
New annualized premium sales$ 731 $ 869 ¥ 79.7
¥ 95.9 Increase (decrease) over prior period (15.9 )% 2.7 % (16.9 )% 1.1 %
The following table details the contributions to Aflac Japan's new annualized
premium sales by major insurance product for the years ended
42
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
2019 2018 Cancer 59.2 % 65.8 % Medical 31.0 25.0 Income support 1.2 1.8 Ordinary life: WAYS .5 .5 Child endowment .2 .3 Other ordinary life (1) 7.4 6.1 Other .5 .5 Total 100.0 % 100.0 %
(1) Includes term and whole life
The foundation of Aflac Japan's product portfolio has been, and continues to be, third sector products, which include cancer, medical and income support insurance products. Aflac Japan has been focusing more on promotion of cancer and medical insurance products in this low-interest-rate environment. These products are less interest-rate sensitive and more profitable compared to first sector savings products. With continued cost pressure on Japan's health care system, the Company expects the need for third sector products will continue to rise in the future and that the medical and cancer insurance products Aflac Japan provides will continue to be an important part of its product portfolio. Sales of protection-type first sector and third sector products on a yen basis decreased 16.8% in 2019, compared with 2018. Earned premium growth for third and first sector protection products was 1.3%, which was consistent with the Company's expectation. The decline in sales primarily reflected reduced sales of cancer insurance through theJapan Post channel following the 2018 launch of Aflac Japan's revised cancer insurance product. In addition, the approach to refreshing the medical insurance product in 2019 took a rider versus whole policy approach. This was designed for improved economics but naturally resulted in lower reported sales. Additional factors include a change in corporate tax law, which slowed the pace of certain third sector medical products and some cancer products in both our associate channel and the bank channel, as well as increased competition from large life insurers who are increasing their focus on the third sector. Sales of Aflac Japan cancer products in theJapan Post Group channel experienced a material decline beginning inAugust 2019 which has continued into 2020. For 2019, sales in theJapan Post Group channel declined by approximately 50.0% compared with 2018. The Company expects very little sales production in theJapan Post channel during the first half of 2020 and is uncertain with regard to production during the second half of the year. See the 2020 Outlook section of this MD&A for information on Aflac Japan earned premium expectations. Independent corporate agencies and individual agencies contributed 45.7% of total new annualized premium sales for Aflac Japan in 2019, compared with 40.1% in 2018. Affiliated corporate agencies, which include Japan Post, contributed 50.0% of total new annualized premium sales in 2019, compared with 55.3% in 2018. Japan Post offers Aflac's cancer insurance products in more than 20,000 postal outlets. Notwithstanding the recent reduction in sales of Aflac Japan's cancer products in theJapan Post channel, the Company believes this alliance with Japan Post has and will benefit its cancer insurance sales over the long term. In 2019, Aflac Japan recruited 77 new sales agencies. AtDecember 31, 2019 , Aflac Japan was represented by more than 9,000 sales agencies, with more than 109,000 licensed sales associates employed by those agencies. AtDecember 31, 2019 , Aflac Japan had agreements to sell its products at 367 banks, approximately 90% of the total number of banks inJapan . Bank channel sales accounted for 4.3% of new annualized premium sales in 2019 for Aflac Japan, compared with 4.6% in 2018.
OnDecember 19, 2018 , the Parent Company and Aflac Japan entered into a Basic Agreement with Japan Post Holdings a Japanese corporation. Pursuant to the terms of the Basic Agreement, Japan Post Holdings agreed to form a capital relationship with the Parent Company, and Japan Post Holdings and Aflac Japan agreed to reconfirm existing initiatives regarding cancer insurance and to consider new joint initiatives, including leveraging digital technology in various processes, cooperation in new product development to promote customer-centric business management, cooperation in domestic and/or overseas business expansion and joint investment in third party entities and cooperation regarding asset management. 43
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
OnFebruary 28, 2019 , the Parent Company entered a Shareholders Agreement with Japan Post Holdings,J&A Alliance Holdings Corporation , aDelaware corporation, solely in its capacity as trustee ofJ&A Alliance Trust , aNew York voting trust (Trust), andGeneral Incorporated Association J&A Alliance , a Japanese general incorporated association. Pursuant to the terms of the Shareholders Agreement, the Trust will use commercially reasonable efforts to acquire, through open market or private block purchases in theU.S. , beneficial ownership of approximately 7% of the outstanding shares of the Parent Company's common stock within a period of 12 months following the date the Trust begins acquiring such stock. OnMay 7, 2019 , a press release issued by Japan Post Holdings announced that purchases of shares of the Parent Company's common stock commenced onApril 29, 2019 through the Trust and that it planned to complete such purchases within Japan Post's fiscal year 2019 (which endsMarch 31, 2020 ). The Trust has agreed not to own more than 10% of the Parent Company's outstanding shares for a period expiring on the earlier of four years after the Trust acquires 7% of such shares, five years after it acquires 5% of such shares, or ten years after the Trust begins acquiring the Parent Company's stock. After expiration of such period, the Trust has agreed not to own more than the greater of 10% of the Parent Company's outstanding shares or such shares representing 22.5% of the voting rights in the Parent Company. In light of the fact that the shares acquired by the Trust, like allAflac Incorporated common shares, will be eligible for 10-for-1 voting rights after being held for 48 consecutive months, the Shareholders Agreement further provides for voting restrictions that effectively limit the trustee's voting rights to no more than 20% of the voting rights in the Parent Company and further restrict the trustee's voting rights with respect to certain change in control transactions. Japan Post Holdings will not have a Board seat on the Parent Company's Board of Directors and will not have rights to control, manage or intervene in the management of the Parent Company. As ofDecember 31, 2019 , all regulatory approvals expressly set forth in the Shareholders Agreement have been obtained. The Shareholders Agreement requires the parties to use reasonable best efforts to cooperate in connection with any ongoing regulatory matters related to or arising from the Trust's acquisition or ownership or control of the shares of Company Common Stock, including any applications or filings in connection with a direct or indirect acquisition of control of or merger with an insurer by the Company or its affiliates. The foregoing is subject to and qualified in its entirety by reference to the full text of the Shareholders Agreement, a copy of which is attached as Exhibit 10.50 to the Company's Quarterly Report on Form 10-Q filedApril 26, 2019 , and the terms of which exhibit are incorporated herein by reference.
Aflac Japan Investments
The level of investment income in yen is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, the effect of yen/dollar exchange rates onU.S. dollar-denominated investment income, and other factors. As part of the Company's portfolio management and asset allocation process, Aflac Japan invests in yen andU.S. dollar-denominated investments. Yen-denominated investments primarily consist of JGBs and public and private fixed maturity securities. Aflac Japan'sU.S. dollar-denominated investments include fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships or similar investment vehicles. Aflac Japan has been investing in both publicly-traded and privately originatedU.S. dollar-denominated investment-grade and below-investment-grade fixed maturity securities and loan receivables, and has entered into foreign currency forwards and options to hedge the currency risk on the fair value of a portion of theU.S. dollar investments.
The following table details the investment purchases for Aflac Japan for the
years ended
44
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (In millions) 2019 2018 Yen-denominated: Fixed maturity securities:
Japan government and agencies
Private placements 1,122 1,185
Other fixed maturity securities 542 796
Equity securities 212 221 Total yen-denominated$ 2,459 $ 6,097 U.S. dollar -denominated: Fixed maturity securities:
Other fixed maturity securities
Infrastructure debt 66 0 Bank loans 0 346 Equity securities 58 120
Commercial mortgage and other loans:
Transitional real estate loans 1,846 3,168
Commercial mortgage loans 565 13 Middle market loans 1,442 839 Other investments 145 314 Total dollar-denominated$ 6,889 $ 6,099 Total Aflac Japan purchases$ 9,348 $ 12,196
See the Investments section of this MD&A for further discussion of these investment programs, and see Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements for more information regarding loans and loan receivables.
Funds available for investment include cash flows from operations, investment income, and funds generated from maturities, redemptions, securities lending, and other securities transactions. Securities lending is also used from time to time to accelerate the availability of funds for investment. Purchases of securities from period to period are determined based on multiple objectives including appropriate portfolio diversification, the relative value of a potential investment and availability of investment opportunities, liquidity, credit and other risk factors while adhering to the Company's investment policy guidelines.
The following table presents the results of Aflac Japan's investment yields for
the years ended and as of
2019
2018
Total purchases for the period (in millions) (1)$ 9,203 $ 11,882 New money yield (1),(2) 3.83 % 3.06 % Return on average invested assets (3) 2.33
2.33
Portfolio book yield, including
2.64 %
2.61 %
(1) Includes fixed maturity securities, commercial mortgage and other loans, equity securities, and excludes alternative investments in limited partnerships (2) Reported on a gross yield basis; excludes investment expenses, external management fees, and amortized hedge costs (3) Net of investment expenses and amortized hedge costs, year-to-date number reflected on a quarterly average basis
The increase in the Aflac Japan new money yield in 2019 was primarily due to decreased allocations to lower yielding yen-denominated asset classes.
See Notes 3, 4 and 5 of the Notes to the Consolidated Financial Statements and the Investments section of this MD&A for additional information on the Company's investments and hedging strategies. 45
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
AFLACU.S. SEGMENT
Aflac
Changes in AflacU.S. pretax adjusted 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 AflacU.S. for the years endedDecember 31 . AflacU.S. Summary of Operating Results
(In millions) 2019 2018 Net premium income$ 5,808 $ 5,708 Net investment income 720 727 Other income 22 8 Total adjusted revenues 6,550 6,443 Benefits and claims 2,871 2,887
Adjusted expenses: Amortization of deferred policy acquisition costs 573 534 Insurance commissions
590 585 Insurance and other expenses 1,244 1,152 Total adjusted expenses 2,407 2,271 Total benefits and adjusted expenses 5,279 5,158 Pretax adjusted earnings$ 1,272 $ 1,285 Percentage change over previous period: Net premium income 1.8 % 2.6 % Net investment income (1.0 ) .8 Total adjusted revenues 1.7 2.4 Pretax adjusted earnings (1.0 ) 3.2 Annualized premiums in force increased 1.1% in 2019 and 3.0% in 2018. Annualized premiums in force atDecember 31 were$6.3 billion in 2019, compared with$6.2 billion in 2018. The following table presents a summary of operating ratios for AflacU.S. for the years endedDecember 31 . Ratios to total adjusted revenues: 2019 2018 Benefits and claims 43.8 % 44.8 % Adjusted expenses: Amortization of deferred policy acquisition costs 8.7 8.3 Insurance commissions 9.0 9.1 Insurance and other expenses 19.0 17.9 Total adjusted expenses 36.7 35.2 Pretax adjusted earnings 19.4 19.9 Ratios to total premiums: Benefits and claims 49.4 50.6 Adjusted expenses: Amortization of deferred policy acquisition costs 9.9 9.4 The benefit ratio decreased in 2019, compared with 2018, primarily due to somewhat elevated lapses and a change in business mix from higher loss ratio, reserve building products to lower loss ratio, guaranteed issue products. The adjusted expense ratio increased in 2019, compared with 2018, primarily due to deferred policy acquisition costs (DAC) capitalization related to lower than anticipated sales as well as anticipated spending increases reflecting ongoing investments in theU.S. platform, distribution, and customer experience. Both the lower benefit and higher DAC amortization ratios were also impacted by increases in lapses as a result of large case volatility and replacement of an administrative partner. These items impacted persistency in the short-term but are expected to drive profitable earned premium growth in future periods. The pretax adjusted 46
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
profit margin declined in 2019 when compared with 2018, due to higher expense ratios, offset somewhat by lower benefit ratios. For expectations for 2020, see the 2020 Outlook section of this MD&A.
Aflac
The following table presents Aflac'sU.S. new annualized premium sales for the years endedDecember 31 . (In millions) 2019 2018
New annualized premium sales
The following table details the contributions to Aflac's
2019 2018 Accident 28.5 % 29.2 %
Short-term disability 22.5 22.7
Critical care (1) 21.9 22.1 Hospital indemnity 16.6 15.8 Dental/vision 4.4 4.7 Life 6.1 5.5 Total 100.0 % 100.0%
(1) Includes cancer, critical illness and hospital intensive care products
New annualized premium sales for accident insurance, the AflacU.S. leading product category, decreased 3.8%, short-term disability sales decreased 2.4%, critical care insurance sales (including cancer insurance) decreased 2.4%, and hospital indemnity insurance sales increased 3.7% in 2019, compared with 2018. While overall sales decreased in 2019, net earned premium increased 1.8%. In 2019, the AflacU.S. sales forces included an average of approximately 8,200U.S. agents, including brokers, who were actively producing business on a weekly basis. The Company believes that this average weekly producer equivalent metric allows sales management to monitor progress and needs. InNovember 2019 , the Company acquiredArgus Holdings, LLC and its subsidiaryArgus Dental & Vision, Inc. (Argus), a benefits management organization and national network dental and vision company, which provides a platform for Aflac Dental and Vision. This transaction represents a commitment of$75 million in capital at closing and an additional$21 million in consideration paid over three years based on the achievement by Argus of certain performance targets.Tampa, Florida will serve as the home for Aflac Dental and Vision. This acquisition is a strategic entry point into the network dental and vision market and is expected to provide opportunities for sales growth, improved account penetration and distribution productivity. AflacU.S. Investments The level of investment income is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, and other factors. As part of the Company's portfolio management and asset allocation process, AflacU.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. AflacU.S. has been investing in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loan receivables.
The following table details the investment purchases for Aflac
47
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
(In millions) 2019 2018
Fixed maturity securities:
Other fixed maturity securities
Infrastructure debt 119 97 Equity securities 58 76
Commercial mortgage and other loans:
Transitional real estate loans 423 610
Commercial mortgage loans 104 163 Middle market loans 99 141 Other investments 16 44
Total Aflac
Funds available for investment include cash flows from operations, investment income, and funds generated from maturities, redemptions, and other securities transactions. Purchases of securities from period to period are determined based on multiple objectives, including appropriate portfolio diversification, the relative value of a potential investment and availability of investment opportunities, liquidity, credit and other risk factors while adhering to the Company's investment policy guidelines.
The following table presents the results of Aflac's
2019 2018
Total purchases for period (in millions) (1)
4.51 % 4.55 % Return on average invested assets (3) 5.07 5.16
Portfolio book yield, end of period (1) 5.40 % 5.55 %
(1) Includes fixed maturity securities, commercial mortgage and other loans, equity securities, and excludes alternative investments in limited partnerships (2) Reported on a gross yield basis; excludes investment expenses and external management fees (3) Net of investment expenses, year-to-date number reflected on a quarterly average basis
See Note 3 of the Notes to the Consolidated Financial Statements and the Market Risks of Financial Instruments - Credit Risk subsection of MD&A for more information regarding the sector concentrations of the Company's investments.
48
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
CORPORATE AND OTHER Changes in the pretax adjusted earnings of Corporate and other are primarily affected by investment income. The following table presents a summary operating results for Corporate and other for the years endedDecember 31 . Corporate and Other Summary of Operating Results (In millions) 2019 2018 Premium income$ 200 $ 208 Net investment income 88 77
Amortized hedge income related to certain foreign currency
management strategies 89 36 Net investment income, including amortized hedge income 177 113 Other income 15 18 Total adjusted revenues 393 339 Benefits and claims, net 194 199 Adjusted expenses: Interest expense 133 120 Other adjusted expenses 137 159 Total adjusted expenses 270 279 Total benefits and adjusted expenses 464 478 Pretax adjusted earnings$ (72 ) $ (139 ) Net investment income benefited from the Company's enterprise corporate hedging program for the years endedDecember 31, 2019 and 2018, respectively. See the Hedging Activities subsection of this MD&A for further information on the enterprise corporate hedging program. InDecember 2018 , the Parent Company invested$20 million inSingapore Life Pte. Ltd. (Singapore Life), a digitally-focused life insurance company based inSingapore .The Parent Company made an additional investment of$16 million in the second quarter of 2019, bringing the total investment to$36 million . As part of the relationship, Aflac entered into a reinsurance agreement on certain protection products with Singapore Life inSeptember 2019 . However, the Company does not currently expect the equity investment or the reinsurance agreement to have a material impact on its financial position or results of operations. INVESTMENTS The Company's investment strategy utilizes disciplined asset and liability management while seeking long-term risk-adjusted investment returns and the delivery of stable income within regulatory and capital objectives, and preserving shareholder value. In attempting to optimally balance these objectives, the Company seeks to maintain on behalf of Aflac Japan a diversified portfolio of yen-denominated investment assets, aU.S. dollar-denominated investment portfolio hedged back to yen and a portfolio of unhedgedU.S. dollar-denominated assets. As part of the Company's portfolio management and asset allocation process, AflacU.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. AflacU.S. invests in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loans.
For additional information concerning the Company's investments, see Notes 3, 4, and 5 of the Notes to the Consolidated Financial Statements.
49
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following tables detail investments by segment as of
Investment Securities by Segment 2019 Corporate and (In millions) Aflac Japan Aflac U.S. Other Total Available for sale, fixed maturity securities, at fair value$ 75,780 $ 13,703 $ 1,779 $ 91,262 Held to maturity, fixed maturity securities, at amortized cost 30,085 0 0 30,085 Equity securities 657 67 78 802 Commercial mortgage and other loans: Transitional real estate loans 4,507 943 0 5,450 Commercial mortgage loans 1,308 399 0 1,707 Middle market loans 2,141 271 0 2,412 Other investments: Policy loans 234 16 0 250 Short-term investments (1) 386 242 1 629 Limited partnerships 496 55 17 568 Other 0 30 0 30 Total investments 115,594 15,726 1,875 133,195 Cash and cash equivalents 1,674 417 2,805 4,896 Total investments and cash$ 117,268 $ 16,143 $ 4,680 $ 138,091
(1) Includes securities lending collateral
2018 Corporate and (In millions) Aflac Japan Aflac U.S. Other Total Available for sale, fixed maturity securities, at fair value$ 69,409 $ 12,132 $ 1,354 $ 82,895 Held to maturity, fixed maturity securities, at amortized cost 30,318 0 0 30,318 Equity securities 806 137 44 987 Commercial mortgage and other loans: Transitional real estate loans 3,621 756 0 4,377 Commercial mortgage loans 763 301 0 1,064 Middle market loans 1,144 334 0 1,478 Other investments: Policy loans 219 13 0 232 Short-term investments (1) 0 141 11 152 Limited partnerships 333 37 7 377 Other 0 26 0 26 Total investments 106,613 13,877 1,416 121,906 Cash and cash equivalents 1,779 641 1,917 4,337 Total investments and cash$ 108,392 $ 14,518 $ 3,333 $ 126,243
(1) Includes securities lending collateral
The ratings of the Company's securities referenced in the table below are based on the ratings designations provided by major NRSROs or, if not rated, are determined based on the Company's internal analysis of such securities. When the ratings issued by the rating agencies differ, the Company utilizes the second lowest rating when three or more rating agency ratings are available or the lowest rating when only two rating agency ratings are available. 50
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The distributions of fixed maturity securities the Company owns, by credit
rating, as of
Composition of Fixed Securities Portfolio by Credit Rating 2019 2018 Amortized Fair Amortized Fair Cost Value Cost Value AAA 1.1 % 1.0 % 1.0 % .9 % AA 4.3 4.4 3.9 4.0 A 68.6 69.8 67.9 69.9 BBB 23.1 22.1 23.2 21.6 BB or lower 2.9 2.7 4.0 3.6 Total 100.0 % 100.0 % 100.0 % 100.0 %
As of
The following table presents the 10 largest unrealized loss positions in the
Company's portfolio as of
Credit Amortized Fair
Unrealized
(In millions) Rating Cost Value
Loss
Diamond Offshore Drilling Inc. CCC$ 64 $ 32 $ (32 ) AXA BBB 296 271 (25 ) Transocean Inc. CCC 50 37 (13 ) Intesa Sanpaolo Spa BBB 142 132 (10 ) Baker Hughes Inc. A 123 114 (9 ) Kommunal Landspensjonskasse (KLP) BBB 137 129 (8 ) Mirvac Group Finance Ltd. A 91 84 (7 ) Autostrade Per Litalia Spa BBB 182 175 (7 ) Downer Group Finance Pty LTD BBB 91 85 (6 ) Chevron Corp. AA 148 142 (6 ) Generally, declines in fair values can be a result of changes in interest rates, yen/dollar exchange rate, and changes in net spreads driven by a broad market move or a change in the issuer's underlying credit quality. As the Company believes these issuers have the ability to continue making timely payments of principal and interest, the Company views these changes in fair value to be temporary. See the Unrealized Investment Gains and Losses section in Note 3 of the Notes to the Consolidated Financial Statements for further discussions of unrealized losses related to financial institutions and other corporate investments.Below-Investment-Grade Securities The Company's portfolio of below-investment-grade securities includes debt securities purchased while the issuer was rated investment grade plus other loans and bonds purchased as part of an allocation to that segment of the market. The following is the Company's below-investment-grade exposure. 51
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Below-Investment-Grade Investments December 31, 2019 Unrealized Par Amortized Fair Gain (In millions) Value Cost Value (Loss) Investcorp Capital Limited$ 388 $ 388 $ 452 $ 64 Republic of South Africa 365 365 372 7 Barclays Bank PLC 183 115 157 42 KLM Royal Dutch Airlines 183 136 143 7 Telecom Italia SpA 183 183 241 58 IKB Deutsche Industriebank AG 118 51 102 51 Arconic Inc. 100 85 111 26 EMC Corp. 80 80 82 2 Generalitat de Catalunya 73 27 80 53 Teva Pharmaceuticals 68 66 61 (5 ) Other Issuers 456 436 420 (16 ) Subtotal (1) 2,197 1,932 2,221 289 Senior secured bank loans 462 480 459 (21 ) High yield corporate bonds 726 723 755 32
Middle market loans, net of reserves (2) 2,455 2,412 2,420
8 Grand Total$ 5,840 $ 5,547 $ 5,855 $ 308 (1) Securities initially purchased as investment grade, but have subsequently been downgraded to below investment grade (2) Middle market loans are carried at amortized cost
The Company invests in senior secured bank loans and middle market loans
primarily to
The Company maintains an allocation to higher yielding corporate bonds within the Aflac Japan and AflacU.S. portfolios. Most of these securities were rated below-investment-grade at the time of purchase, but the Company also purchased several that were rated investment grade which, because of market pricing, offer yields commensurate with below-investment-grade risk profiles. The objective of this allocation was to enhance the Company's yield on invested assets and further diversify credit risk. All investments in this program must have a minimum rating at purchase of low BB using the Company's above described rating methodology and are managed by the Company's internal credit portfolio management team.Fixed Maturity Securities by Sector The Company maintains diversification in investments by sector to avoid concentrations to any one sector, thus managing exposure risk. The following table shows the distribution of fixed maturities by sector classification as ofDecember 31 . 52
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 2019 Amortized % of (In millions) Cost Total Government and agencies$ 53,463 48.8 % Municipalities 2,414 2.2 Mortgage- and asset-backed securities 394 .4 Public utilities 8,194 7.5 Electric 6,471 5.9 Natural Gas 303 .3 Other 695 .6 Utility/Energy 725 .7 Sovereign and Supranational 2,042 1.9 Banks/financial institutions 9,947 9.1 Banking 6,029 5.5 Insurance 1,948 1.8 Other 1,970 1.8 Other corporate 33,002 30.1 Basic Industry 3,484 3.2 Capital Goods 3,187 2.9 Communications 4,057 3.7 Consumer Cyclical 3,271 3.0 Consumer Non-Cyclical 6,280 5.7 Energy 4,281 3.9 Other 1,464 1.3 Technology 3,129 2.9 Transportation 3,849 3.5 Total fixed maturity securities$ 109,456 100.0 % Securities by Type of Issuance The Company has investments in both publicly and privately issued securities. The Company's ability to sell either type of security is a function of overall market liquidity which is impacted by, among other things, the amount of outstanding securities of a particular issuer or issuance, trading history of the issue or issuer, overall market conditions, and idiosyncratic events affecting the specific issue or issuer. 53
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following table details investment securities by type of issuance as of
Investment Securities by Type of Issuance 2019 2018 Amortized Fair Amortized Fair (In millions) Cost Value Cost Value Publicly issued securities: Fixed maturity securities$ 89,625 $ 105,557 $ 83,482 $ 93,255 Equity securities 717 717 936 936 Total publicly issued 90,342 106,274 84,418 94,191 Privately issued securities: (1) Fixed maturity securities 19,831 (2 ) 23,299 (2 ) 23,692 26,362 Equity securities 85 85 51 51 Total privately issued 19,916 23,384 23,743 26,413 Total investment securities$ 110,258 $ 129,658 $ 108,161 $ 120,604
(1) Primarily consists of securities owned by Aflac Japan (2) Excludes Rule 144A securities starting in the first quarter of 2019
The following table details the Company's reverse-dual currency securities as of
Reverse-Dual Currency Securities (1) (Amortized cost, in millions) 2019
2018
Privately issued reverse-dual currency securities
1,678
1,657
Total reverse-dual currency securities$ 6,671 $ 6,777 Reverse-dual currency securities as a percentage of total investment securities 6.1 % 6.3 %
(1)Principal payments in yen and interest payments in dollars
Aflac Japan has a portfolio of privately issued securities to better match liability characteristics and secure higher yields than those available on Japanese government or other public corporate bonds. Aflac Japan's investments in yen-denominated privately issued securities consist primarily of non-Japanese issuers, are rated investment grade at purchase and have longer maturities, thereby allowing the Company to improve asset/liability matching and overall investment returns. These securities are generally either privately negotiated arrangements or issued under medium-term note programs and have standard documentation commensurate with credit ratings of the issuer, except when internal credit analysis indicates that additional protective and/or event-risk covenants were required. Many of these investments have protective covenants appropriate to the specific investment. These may include a prohibition of certain activities by the borrower, maintenance of certain financial measures, and specific conditions impacting the payment of the Company's notes. HEDGING ACTIVITIES The Company uses derivative contracts to hedge foreign currency exchange rate risk and interest rate risk. The Company uses various strategies, including derivatives, to manage these risks. See item "7A. Quantitative and Qualitative Disclosures About Market Risk" for more information about Market risk and the Company's use of derivatives.
Derivatives are designed to reduce risk on an economic basis while minimizing the impact on financial results. The Company's derivatives programs vary depending on the type of risk being hedged. See Note 4 of the Notes to the Consolidated Financial Statements for:
• A description of the Company's derivatives, hedging strategies and underlying risk exposure. • Information about the notional amount and fair market value of the Company's derivatives.
• The unrealized and realized gains and losses impact on adjusted earnings
of derivatives in cash flow, fair value, net investments in foreign operations, or non-qualifying hedging relationships. 54
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Foreign Currency Exchange Rate Risk Hedge Program
The Company has deployed the following hedging strategies to mitigate exposure to foreign currency exchange rate risk:
• Aflac Japan hedgesU.S. dollar-denominated investments back to yen (see Aflac Japan'sU.S. Dollar-Denominated Hedge Program below).
• Aflac Japan maintains certain unhedged
which serve as an economic currency hedge of a portion of the Company's
investment in Aflac Japan (see Aflac Japan'sU.S. Dollar-Denominated Hedge Program below).
•
and loans) as non-derivative hedging instruments and designates certain
foreign currency forwards and options as derivative hedges of the
Company's net investment in Aflac Japan (see Enterprise Corporate Hedging
Program below).
•
a dual objective of hedging foreign currency exchange rate risk related to
dividend payments by its subsidiary, ALIJ, and reducing enterprise-wide
hedge costs. (see Enterprise Corporate Hedging Program below).
Aflac Japan's
Aflac Japan buysU.S. dollar-denominated investments, typically corporate bonds, and hedges them back to yen with foreign currency forwards and options to hedge foreign currency exchange rate risk. This economically creates yen assets that match yen liabilities during the life of the derivative and provides capital relief. The currency risk being hedged is generally based on fair value of hedged investments. The following table summarizes theU.S. dollar-denominated investments held by Aflac Japan as ofDecember 31 . 2019 2018 Amortized Fair Amortized Fair (In millions) Cost Value Cost Value Available-for-sale securities: Fixed maturity securities (excluding bank loans)$ 18,012 $ 19,542 $
17,101
Fixed maturity securities - bank loans (floating rate) 677 649 1,296 1,238 Equity securities 19 19 177 177 Commercial mortgage and other loans: Transitional real estate loans (floating rate) 4,507 4,543
3,621 3,625
Commercial mortgage loans 1,308 1,319
763 736
Middle market loans (floating rate) 2,141 2,153 1,144 1,146 Other investments 496 496 333 333 Total U.S. Dollar Program 27,160 28,721 24,435 24,258 Available-for-sale securities: Fixed maturity securities - economically converted to yen 1,700 2,608
1,679 2,269
TotalU.S. dollar-denominated investments in Aflac Japan$ 28,860 $ 31,329 $ 26,114 $ 26,527 U.S. Dollar Program includes allU.S. dollar-denominated investments in Aflac Japan other than the investments in certain consolidated VIEs where the instrument is economically converted to yen as a result of a derivative in the consolidated variable interest entity. As ofDecember 31, 2019 , Aflac Japan had$8.8 billion outstanding notional amounts of foreign currency forwards and$21.1 billion outstanding notional amounts of foreign currency options, of which none were in-the-money, hedging theU.S. dollar-denominated investments. The fair value of Aflac Japan's unhedgedU.S. dollar-denominated portfolio was$19.9 billion (excluding certainU.S. dollar-denominated assets shown in the table above as a result of consolidation that have been economically converted to yen using derivatives). Foreign exchange derivatives used for hedging are periodically settled, which results in cash receipt or payment at maturity or early termination. The Company had net cash outflows of$20 million in 2019, net cash inflows of$272 million in 55
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
2018 and net cash outflows of
Enterprise Corporate Hedging Program
The Company has designated certain yen-denominated liabilities and foreign currency forwards and options of the Parent Company as accounting hedges of its net investment in Aflac Japan. The Company's consolidated yen-denominated net asset position was partially hedged at$9.1 billion as ofDecember 31, 2019 , compared with$1.8 billion as ofDecember 31, 2018 . The Company makes its accounting designation of net investment hedge at the beginning of each quarter. If the total of the designated Parent Company non-derivative and derivative notional is equal to or less than the Company's net investment in Aflac Japan, the hedge is deemed to be effective, and the currency exchange effect on the yen-denominated liabilities and the change in estimated fair value of the derivatives are reported in the unrealized foreign currency component of other comprehensive income. The Company's net investment hedge was effective during the years endedDecember 31, 2019 and 2018, respectively. For additional information on the Company's net investment hedging strategy, see Note 4 of the Notes to the Consolidated Financial Statements. In order to economically mitigate risks associated with the enterprise-wide exposure to the yen and the level and volatility of hedge costs, the Parent Company enters into foreign exchange forward and option contracts. By buyingU.S. dollars and selling yen, the Parent Company is effectively lowering its overall economic exposure to the yen, while Aflac Japan'sU.S dollar exposure remains reduced as a result of Aflac Japan'sU.S. dollar-denominated hedge program that economically creates yen assets. Among other objectives, this strategy is intended to offset the enterprise-wide amortized hedge costs by generating amortized hedge income. The portion of the enterprise-wide amortized hedge income contributed by this strategy was$89 million in 2019 and$36 million in 2018. This activity is reported in Corporate and Other. As this program evolves, the Company will continue to evaluate the program's efficacy. See the Results of Operations section of this MD&A for the Company's definition of amortized hedge costs/income. The following table presents metrics related to Aflac Japan amortized hedge costs and the Parent Company amortized hedge income for the years endedDecember 31 . Aflac Japan Hedge Cost Metrics(1) 2019 2018 Aflac Japan:
FX forward (sell USD, buy yen) notional at end of period (in billions)(2)
$8.8
Weighted average remaining tenor (in months)(3) 8.5
21.4
Amortized hedge income (cost) for period (in millions)
FX forward (buy USD, sell yen) notional at end of period (in billions)(2)
$4.9
Weighted average remaining tenor (in months)(3) 13.7
16.1
Amortized hedge income (cost) for period (in millions)
(1) See the Results of Operations section of this MD&A for the Company's definition of amortized hedge costs/income. (2) Notional is reported net of any offsetting positions within Aflac Japan or the Parent Company, respectively. (3) Tenor based on period reporting date to settlement date
Interest Rate Risk Hedge Program
Aflac Japan and Aflac
For additional discussion of the risks associated with the foreign currency exposure refer to the Currency Risk section in Item 1A, specifically to the Risk Factors titled "The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate" and "Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity." 56
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
See Note 4 of the Notes to the Consolidated Financial Statements for additional information on the Company's hedging activities.
POLICY LIABILITIES The following table presents policy liabilities by segment and in total for the years endedDecember 31 . (In millions) 2019 2018 Japan segment: Future policy benefits$ 81,462 $ 77,812 Unpaid policy claims 2,879 2,857 Other policy liabilities 11,452 12,122 Total Japan policy liabilities 95,793 92,791 U.S. segment: Future policy benefits 9,405 9,137 Unpaid policy claims 1,779 1,727 Other policy liabilities 111 117 Total U.S. policy liabilities 11,295 10,981
Consolidated:
Future policy benefits 90,335 86,368 Unpaid policy claims 4,659 4,584 Other policy liabilities 11,560 12,236
Total consolidated policy liabilities (1)
(1) The sum of the Japan and
See Note 7 of the Notes to the Consolidated Financial Statements for additional information on the Company's policy liabilities.
BENEFIT PLANS
Aflac Japan and Aflac
POLICYHOLDER PROTECTION
The Japanese insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. Legislation enacted regarding the framework of theLife Insurance Policyholder Protection Corporation (LIPPC) included government fiscal measures supporting the LIPPC. InNovember 2016 , Japan's Diet passed legislation that again extends the government's fiscal support of the LIPPC throughMarch 2022 . EffectiveApril 2014 , the annual LIPPC contribution amount for the total life industry was lowered from ¥40 billion to ¥33 billion. Aflac Japan recognized an expense of ¥1.9 billion and ¥2.0 billion for the years endedDecember 31, 2019 and 2018, respectively, for LIPPC assessments.
Guaranty Fund Assessments
UnderU.S. state guaranty association laws, certain insurance companies can be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of impaired or insolvent insurance companies that write the same line or similar lines of business. The amount of the guaranty fund assessment that an insurer is assessed is based on its proportionate share of premiums in that state. See Note 15 of the Notes to the Consolidated Financial Statements for further information on the assessment. OFF-BALANCE SHEET ARRANGEMENTS As ofDecember 31, 2019 , the Company had no material letters of credit, standby letters of credit, guarantees or standby repurchase obligations. See Note 15 of the Notes to the Consolidated Financial Statements for information on material unconditional purchase obligations that are not recorded on the Company's balance sheet. 57
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to the ability to generate sufficient cash resources to meet the payment obligations of the Company. Capital refers to the long-term financial resources available to support the operations of the businesses, fund business growth and provide for an ability to withstand adverse circumstances. Financial leverage (leverage) refers to an investment strategy of using debt to increase the potential return on equity. The Company targets and actively manages liquidity, capital and leverage in the context of a number of considerations, including:
• business investment and growth needs
• strategic growth objectives
• financial flexibility and obligations
• capital support for hedging activity
• a constantly evolving business and economic environment
• a balanced approach to capital allocation and shareholder deployment.
The governance framework supporting liquidity, capital and leverage includes global senior management and board committees that review and approve all significant capital related decisions.
The Company's cash and cash equivalents include unrestricted cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased, all of which has minimal market, settlement or other risk exposure. The target minimum amount for the Parent Company's cash and cash equivalents is approximately$2.0 billion to provide available capital and liquidity support at the holding company. Aflac Japan and AflacU.S. provide the primary sources of liquidity to the Parent Company through the payment of dividends and management fees. The following table presents the amounts provided to the Parent Company for the years endedDecember 31 . Liquidity Provided by Subsidiaries to Parent Company (In millions) 2019 2018
Dividends declared or paid by subsidiaries
151 204 The decline in dividends during 2018 was driven by a change in the dividend regulatory approval process subsequent to the conversion of Aflac Japan from a branch to a subsidiary onApril 1, 2018 . The Company resumed dividend payments from Aflac Japan in the fourth quarter of 2018. Management fees decreased during 2019 and 2018, compared to prior years, due to changes in the administration of intercompany expenses between legal entities subsequent to the conversion, as well. Prior to the Aflac Japan branch conversion, Aflac Japan paid allocated expenses and profit remittances to AflacU.S. The following table details Aflac Japan remittances for the years endedDecember 31 . Aflac Japan Remittances (In millions of dollars and billions of yen) 2019
2018
Aflac Japan management fees paid to Parent Company$ 75 $ 136 Expenses allocated to Aflac Japan (in dollars) 4
24
Aflac Japan profit remittances to the Parent Company or Aflac
2,070
808
Aflac Japan profit remittances to the Parent Company or Aflac U.S. (in yen) ¥ 225.2 ¥ 89.7 In 2018, the Company announced a change in its internal dividend policy which allows the Company to increase the proportion of regulatory earnings transferred from AflacU.S. and Aflac Japan to the Parent Company. The Company intends to maintain higher than historical levels of capital and liquidity at the Parent Company with the goals of addressing the Company's hedge costs and related potential need for collateral and mitigating against long-term weakening of the Japanese yen. Further, the Company plans to continue to maintain a portfolio of unhedgedU.S. dollar based investments at Aflac Japan and consider whether the amount of such investments should be increased or decreased relative to the Company's view of economic equity surplus in Aflac Japan in light of potentially rising hedge costs and other factors. See the "Hedging Activity" subsection in this MD&A for more information. 58
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
In addition to cash and equivalents, the Company also maintains credit facilities, both intercompany and with external partners, and a number of other available tools to support liquidity needs on a global basis. InSeptember 2018 , the Parent Company filed a shelf registration statement with theSEC that allows the Company to issue an indefinite amount of debt securities, in one or more series, from time to time untilSeptember 2021 . InAugust 2018 , the Parent Company filed a shelf registration with Japanese regulatory authorities that allows the Parent Company to conduct public offerings of bonds inJapan , including yen-denominated Samurai notes, up to ¥200 billion or its equivalent throughAugust 2020 . The shelf registration statement is for possible public offerings inJapan , but the bonds issued under the shelf may be transferred by the bondholders toU.S. persons in compliance withU.S. law. The Company believes outside sources for additional debt and equity capital, if needed, will continue to be available. Additionally, as ofDecember 31, 2019 , the Parent Company and Aflac had four lines of credit with third parties and three intercompany lines of credit. For additional information, see Note 9 of the Notes to the Consolidated Financial Statements. The primary uses of cash by the Parent Company are shareholder dividends, the repurchase of its common stock and interest on its outstanding indebtedness and operating expenses. Major Contractual Obligations The following table presents the estimated payments by period of the Company's major contractual obligations as ofDecember 31, 2019 . The Company translated its yen-denominated obligations using theDecember 31, 2019 , exchange rate. Actual future payments as reported in dollars will fluctuate with changes in the yen/dollar exchange rate. Distribution of Payments by Period Less Total Total Than One to Four to After (In millions) Liability(1) Payments One Year Three Years Five Years Five Years Future policy benefits liability (Note 7)(2)$ 90,335 $ 244,884 $ 9,221 $ 18,151 $ 18,224 $ 199,288 Unpaid policy claims liability (Note 7)(3) 4,659 4,660 2,985 980 394 301 Other policyholders' funds (Note 7)(3) 7,317 9,902 341 389 706 8,466 Long-term debt - principal (Note 9) 6,408 6,458 0 350 1,450 4,658 Long-term debt - interest (Note 9) 44 2,036 171 320 262 1,283 Cash collateral on loaned securities (Note 3) 1,876 1,876 1,876 0 0 0 Operating service agreements (Note 15) N/A (4) 463 179 279 5 0 Operating lease obligations (Note 9) 149 159 49 68 20 22 Finance lease obligations (Note 9) 12 12 4 5 3 0 Total contractual obligations$ 110,800 $ 270,450 $ 14,826 $ 20,542 $ 21,064 $ 214,018 Liabilities for unrecognized tax benefits in the amount of$17 have been excluded from the tabular disclosure above because the timing of cash payment is not reasonably estimable. (1)Liability amounts are those reported on the consolidated balance sheet as ofDecember 31, 2019 . (2)The estimated payments due by period reflect future estimated cash payments to be made to policyholders and others for future policy benefits. These projected cash outflows are based on assumptions for future policy persistency, mortality, morbidity, and other assumptions comparable with the Company's experience, consider future premium receipts on current policies in force, and assume market growth and interest crediting consistent with assumptions used in amortizing deferred acquisition costs. These cash outflows are undiscounted with respect to interest and, as a result, the sum of the cash outflows shown for all years in the table of$244,884 exceeds the corresponding liability amount of$90,335 . The Company has made significant assumptions to determine the future estimated cash outflows related to the underlying policies and contracts. Due to the significance of the assumptions used, actual cash outflow amounts and timing will differ, possibly materially, from these estimates. (3)Includes assumptions as to the timing of policyholders reporting claims for prior periods and the amount of those claims. Actual amounts and timing of unpaid policy claims payments may differ significantly from the estimates above. (4)Not applicable
For more information on the Company's major contractual obligations, see the applicable Note in the Notes to the Consolidated Financial Statements as indicated in the line items in the table above.
The Company's financial statements convey its financing arrangements during the periods presented. The Company has not engaged in material intra-period short-term financings during the periods presented that are not otherwise reported in its balance sheet or disclosed therein. The Company was in compliance with all of the covenants of its notes payable and lines of credit atDecember 31, 2019 . The Company has not entered into transactions involving the transfer of financial assets with an obligation to repurchase financial assets that have been accounted for as a sale under applicable accounting standards, 59
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
including securities lending transactions. See Notes 1, 3, and 4 of the Notes to the Consolidated Financial Statements for more information on the Company's securities lending and derivative activities. With the exception of disclosed activities in those referenced footnotes and the Risk Factors entitled, "The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate" and "Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity," the Company is not aware of a trend, demand, commitment, event or uncertainty that would likely result in its liquidity increasing or decreasing by a material amount. Consolidated Cash Flows The Company translates cash flows for Aflac Japan's yen-denominated items intoU.S. dollars using weighted-average exchange rates. In years 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 years endedDecember 31 . (In millions) 2019 2018 Operating activities$ 5,455 $ 6,014 Investing activities (3,171 ) (3,582 ) Financing activities (1,713 ) (1,616 )
Exchange effect on cash and cash equivalents (12 ) 30
Net change in cash and cash equivalents
Operating Activities The principal cash inflows for the Company's insurance activities come from insurance premiums and investment income. The principal cash outflows are the result of policy claims, operating expenses, income tax, as well as interest expense. 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. The Company expects its future cash flows from premiums and its investment portfolio to be sufficient to meet its cash needs for benefits and expenses. Consolidated cash flow from operations decreased 9.3% in 2019, compared with 2018. Investing Activities The Company's investment objectives provide for liquidity primarily through the purchase of publicly traded investment-grade debt securities. Prudent portfolio management dictates that the Company attempts to match the duration of its assets with the duration of its liabilities. Currently, when the Company's fixed maturity 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 the Company's business and its strong cash flows provide the Company with the ability to minimize the effect of mismatched durations and/or yields identified by various asset adequacy analyses. From time to time or when market opportunities arise, the Company disposes of selected fixed maturity securities that are available for sale to improve the duration matching of assets and liabilities, improve future investment yields, and/or re-balance its portfolio. As a result, dispositions before maturity can vary significantly from year to year. As part of its overall corporate strategy, the Company has announced an increase in its commitment to theAflac Ventures Fund from$250 million to$400 million , as opportunities emerge. These investments are included in equity securities or the other investments line in the consolidated balance sheets.The Aflac Ventures Fund is a subsidiary ofAflac Corporate Ventures which is reported in the Corporate and other segment. The central mission ofAflac Corporate Ventures is to support the organic growth and business development needs of Aflac Japan and AflacU.S. with emphasis on digital applications designed to improve the customer experience, gain efficiencies, and develop new markets in an effort to enhance and defend long-term shareholder value. As part of an arrangement withFederal Home Loan Bank of Atlanta (FHLB), AflacU.S. obtains low-cost funding from FHLB supported by acceptable forms of collateral pledged by AflacU.S. AflacU.S. borrowed and repaid$217 million under this program during 2019. As ofDecember 31, 2019 , AflacU.S. had outstanding borrowings of$403 million reported in its balance sheet. 60
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
See Note 3 of the Notes to the Consolidated Financial Statements for details on certain investment commitments.
Financing Activities
Consolidated cash used by financing activities was
InDecember 2019 , the Parent Company issued four series of senior notes totaling ¥38.0 billion through a public debt offering under itsU.S. shelf registration statement. The first series, which totaled ¥12.6 billion, bears interest at a fixed rate of .500% per annum, payable semi-annually, and will mature inDecember 2029 . The second series, which totaled ¥9.3 billion, bears interest at a fixed rate of .843% per annum, payable semi-annually, and will mature inDecember 2031 . The third series, which totaled ¥9.8 billion, bears interest at a fixed rate of .934% per annum, payable semi-annually, and will mature inDecember 2034 . The fourth series, which totaled ¥6.3 billion, bears interest at a fixed rate of 1.122% per annum, payable semi-annually, and will mature inDecember 2039 . These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affectingU.S. taxation, as specified in the indenture governing the terms of the issuance. InSeptember 2019 , the Parent Company renewed a ¥30.0 billion senior term loan facility. The first tranche of the facility, which totaled ¥5.0 billion, bears interest at a rate per annum equal to theTokyo interbank market rate (TIBOR), or alternate TIBOR, if applicable, plus the applicable TIBOR margin and will mature inSeptember 2026 . The applicable margin ranges between .30% and .70%, depending on the Parent Company's debt ratings as of the date of determination. The second tranche, which totaled ¥25.0 billion, bears interest at a rate per annum equal to the TIBOR, or alternate TIBOR, if applicable, plus the applicable TIBOR margin and will mature inSeptember 2029 . The applicable margin ranges between .45% and 1.00%, depending on the Parent Company's debt ratings as of the date of determination. InApril 2019 , ALIJ issued ¥30.0 billion (par value) of perpetual subordinated bonds. These bonds bear interest at a fixed rate of .963% per annum and then at six-month Euro Yen LIBOR plus an applicable spread on and after the day immediately followingApril 18, 2024 . The bonds will be callable on each interest payment date on and afterApril 18, 2024 . InNovember 2019 , ALIJ amended the bonds to change their duration from perpetual to a stated maturity date ofApril 16, 2049 and to remove provisions that permitted ALIJ to defer payments of interest under certain circumstances. InOctober 2018 , the Parent Company issued$550 million of senior notes through aU.S. public debt offering. The notes bear interest at a fixed rate of 4.750% per annum, payable semi-annually, and will mature inJanuary 2049 . These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the yield to maturity for a U.S.Treasury security with a maturity comparable to the remaining term of the notes, plus 25 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date. InOctober 2018 , the Parent Company issued three series of senior notes totaling ¥53.4 billion through a public debt offering under itsU.S. shelf registration statement. The first series, which totaled ¥29.3 billion, bears interest at a fixed rate of 1.159% per annum, payable semi-annually, and will mature inOctober 2030 . The second series, which totaled ¥15.2 billion, bears interest at a fixed rate of 1.488% per annum, payable semi-annually, and will mature inOctober 2033 . The third series, which totaled ¥8.9 billion, bears interest at a fixed rate of 1.750% per annum, payable semi-annually, and will mature inOctober 2038 . These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affectingU.S. taxation, as specified in the indenture governing the terms of the issuance.
In
See Note 9 of the Notes to the Consolidated Financial Statements for further information on the debt issuances discussed above.
The Company was in compliance with all of the covenants of its notes payable and
lines of credit at
Cash returned to shareholders through treasury stock purchases and dividends was
The following tables present a summary of treasury stock activity during the
years ended
61
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Treasury Stock Purchased (In millions of dollars and thousands of shares) 2019 2018 Treasury stock purchases$ 1,627 $ 1,301 Number of shares purchased: Share repurchase program 31,994 28,949 Other 592 392 Total shares purchased 32,586 29,341 Treasury Stock Issued
(In millions of dollars and thousands of shares) 2019 2018 Stock issued from treasury:
Cash financing$ 49 $ 58 Noncash financing 50 17 Total stock issued from treasury$ 99 $ 75 Number of shares issued 2,324 1,939 Under share repurchase authorizations from the Company's board of directors, the Company purchased 32.0 million shares of its common stock in 2019, compared with 28.9 million shares in 2018. As ofDecember 31, 2019 , a remaining balance of 37.1 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors. The Company currently plans to repurchase$1.3 billion to$1.7 billion of its common stock in 2020, assuming stable capital conditions and absent compelling alternatives. See Note 11 of the Notes to the Consolidated Financial Statements for additional information. Cash dividends paid to shareholders in 2019 of$1.08 per share increased 3.8% over 2018. The following table presents the dividend activity for the years endedDecember 31 . Dividends Paid to Shareholders (In millions) 2019 2018 Dividends paid in cash$ 771 $ 793
Dividends through issuance of treasury shares 30 8 Total dividends to shareholders
$ 801 $ 801 InJanuary 2020 , the board of directors announced a 3.7% increase in the quarterly cash dividend, effective with the first quarter of 2020. The first quarter 2020 cash dividend of$.28 per share is payable onMarch 2, 2020 , to shareholders of record at the close of business onFebruary 19, 2020 . Regulatory Restrictions Aflac, CAIC and TOIC are domiciled inNebraska and are subject to its regulations. Subsequent to the Japan branch conversion to a subsidiary, Aflac Japan is domiciled inJapan and subject to local regulations. TheNebraska Department of Insurance imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances to the Parent Company. UnderNebraska insurance law, prior approval of theNebraska Department of Insurance is required for dividend distributions that exceed the greater of the net income from operations, which excludes net realized investment gains, for the previous year determined under statutory accounting principles, or 10% of statutory capital and surplus as of the previous year-end. In addition, theNebraska insurance department must approve service arrangements and other transactions within the affiliated group of companies. These regulatory limitations are not expected to affect the level of management fees or dividends paid to the Parent Company. (See below for discussion of restrictions imposed by Japanese insurance regulators.) A life insurance company's statutory capital and surplus is determined according to rules prescribed by the NAIC, as modified by the insurance department in the insurance company's state of domicile. Statutory accounting rules are different fromU.S. GAAP and are intended to emphasize policyholder protection and company solvency. Similar laws apply inNew York , the domiciliary jurisdiction of Aflac New York. 62
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The continued long-term growth of the Company's business may require increases in the statutory capital and surplus of its insurance operations. Aflac's insurance operations may secure additional statutory capital through various sources, such as internally generated statutory earnings, capital contributions by the Parent Company from funds generated through debt or equity offerings, or reinsurance transactions. The NAIC's RBC formula is used by insurance regulators to help identify inadequately capitalized insurance companies. The RBC formula quantifies insurance risk, business risk, asset risk and interest rate risk by weighing the types and mixtures of risks inherent in the insurer's operations. Aflac's company action level RBC ratio was 539% as ofDecember 31, 2019 , compared with 560% atDecember 31, 2018 . Aflac's RBC ratio remains high and reflects a strong capital and surplus position. As ofDecember 31, 2019 , Aflac's total adjusted capital of$2.2 billion exceeded the company action level required capital and surplus of$.4 billion by$1.8 billion . With the announcement of the Japan branch conversion to a subsidiary, we had announced our intention to remove excess capital out of Aflac, targeting a 500% RBC by the end of 2019. As ofDecember 31, 2019 , the Company has completed the RBC drawdown plan and has moved$1.75 billion of capital from Aflac to the Parent Company, supporting the Company's capital deployment and risk management activities. The maximum amount of dividends that can be paid to the Parent Company by Aflac, CAIC and TOIC without prior approval ofNebraska's director of insurance is the greater of the net income from operations, which excludes net realized investment gains, for the previous year determined under statutory accounting principles, or 10% of statutory capital and surplus as of the previous year-end. Dividends declared by Aflac during 2020 in excess of$864 million would be considered extraordinary and require such approval. Following the Japan branch conversion to a subsidiary, the Company used extraordinary dividends as needed to actively manage to appropriate RBC levels that are lower yet sufficient to maintain ratings and support prudent capital management. Similar laws apply inNew York , the domiciliary jurisdiction of Aflac New York. See Note 13 of the Notes to the Consolidated Financial Statements for information regarding the impact of permitted practices by theNebraska Department of Insurance on the Company's statutory capital and surplus. The NAIC considers its Solvency Modernization Initiative (SMI) process relating to updating theU.S. insurance solvency regulation framework to be ongoing. The SMI has focused on key issues such as capital requirements, governance and risk management, group supervision, reinsurance, statutory accounting and financial reporting matters. Many of these key issues have been finalized and/or are near completion; however, the NAIC still has some ongoing initiatives related to SMI, such as monitoring the international efforts on group capital requirements as well as RBC. In addition, the NAIC is also considering changes to investment risk factors. Any negative developments by the NAIC in these areas could result in increased capital requirements for the Company. Aflac is subject to the NAIC's Own Risk and Solvency Assessment (ORSA). Through the ORSA requirements, Aflac is expected to regularly, no less than annually, conduct an ORSA to assess the adequacy of its risk management framework, and its current and estimated projected future solvency position; internally document the process and results of the assessment; and provide a confidential high-level ORSA Summary Report annually to the lead state commissioner if the insurer is a member of an insurance group. InNovember 2019 , Aflac filed its ORSA report with theNebraska Department of Insurance . In addition to limitations and restrictions imposed byU.S. insurance regulators, after the Japan branch conversion onApril 1, 2018 , the new Japan subsidiary is required to meet certain financial criteria as governed by Japanese corporate law in order to provide dividends to the Parent Company. Under these criteria, dividend capacity at the Japan subsidiary is basically defined as total equity excluding common stock, accumulated other comprehensive income amounts, capital reserves (representing statutorily required amounts inJapan ) but reduced for net after-tax unrealized losses on available-for-sale securities. These dividend capacity requirements are generally aligned with the SMR. Japan's FSA maintains its own solvency standard which is quantified through the SMR. Aflac Japan's SMR is sensitive to interest rate, credit spread, and foreign exchange rate changes, therefore the Company continues to evaluate alternatives for reducing this sensitivity. In the event of a rapid change in market risk conditions causing SMR to decline, the Company has one senior unsecured revolving credit facility in the amount of ¥100 billion and a committed reinsurance facility in the amount of approximately ¥110 billion as a capital contingency plan. Additionally, the Company could take action to enter into derivatives on unhedgedU.S. dollar-denominated investments with foreign currency options or forwards. See Notes 8 and 9 of the Notes to the Consolidated Financial Statements for additional information. The Company has already undertaken various measures to mitigate the sensitivity of Aflac Japan's SMR. For example, the Company employs policy reserve matching (PRM) investment strategies, which is a Japan-specific accounting treatment that reduces SMR interest rate sensitivity since PRM-designated investments are carried at amortized cost consistent with corresponding liabilities. In order for a PRM-designated asset to be held at amortized cost, there are certain criteria that must be maintained. The primary criteria relates to maintaining the duration of designated assets and liabilities within a specified tolerance range. If the duration difference is not maintained within the specified range without rebalancing, then a certain 63
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
portion of the assets must be re-classified as available for sale and held at fair value with any associated unrealized gain or loss recorded in surplus. To rebalance, assets may need to be sold in order to maintain the duration with the specified range, resulting in realizing a gain or loss from the sale. ForU.S. GAAP, PRM investments are categorized as available for sale. The Company also uses foreign currency derivatives to hedge a portion of itsU.S. dollar-denominated investments. (See Notes 3, 4 and 8 of the Notes to the Consolidated Financial Statements for additional information on the Company's investment strategies, hedging activities, and reinsurance, respectively.) Aflac's SMR ratio remains high and reflects a strong capital and surplus position. As ofDecember 31, 2019 , Aflac Japan's SMR was 1,043%, compared with 965% atDecember 31, 2018 . As part of the conversion of Aflac Japan from a branch to a subsidiary onApril 1, 2018 , the Company experienced an accounting-driven decline in the SMR of approximately 130 points, compared with the SMR as ofDecember 31, 2017 . The Company expects to be able to pay dividends out of certain accounts, thus restoring this accounting impact over an estimated three-year period. The FSA has been conducting field testing with the insurance industry concerning the introduction of an economic value-based solvency regime. The field testing will assist the FSA in determining if an economic value-based solvency regime inJapan will be appropriate for the insurance industry. Privacy and Cybersecurity Governance The Company's Board of Directors has adopted an information security policy directing management to establish and operate a global information security program with the goals of monitoring existing and emerging threats and ensuring that the Company's information assets and data, and the data of its customers, are appropriately protected from loss or theft. The Board has delegated oversight of the Company's information security program to theAudit and Risk Committee . The Company's senior officers, including its Global Security and Chief Information Security Officer, are responsible for the operation of the global information security program and regularly communicate with theAudit and Risk Committee on the program, including with respect to the state of the program, compliance with applicable regulations, current and evolving threats, and recommendations for changes in the information security program. The global information security program also includes a cybersecurity incident response plan that is designed to provide a management framework across Company functions for a coordinated assessment and response to potential security incidents. This framework establishes a protocol to report certain incidents to the Global Security and Chief Information Security Officer and other senior officers, with the goal of timely assessing such incidents, determining applicable disclosure requirements and communicating with theAudit and Risk Committee . The incident response plan directs the executive officers to report certain incidents immediately and directly to the Lead Non-Management Director. Other
For information regarding commitments and contingent liabilities, see Note 15 of the Notes to the Consolidated Financial Statements.
Additional Information Investors should note that the Company announces material financial information in itsSEC filings, press releases and public conference calls. In accordance withSEC guidance, the Company may also use the Investor Relations section of the Company's website (http://investors.aflac.com) to communicate with investors about the Company. It is possible that the financial and other information the Company posts there could be deemed to be material information. The information on the Company's website is not part of this document. Further, the Company's references to website URLs are intended to be inactive textual references only. CRITICAL ACCOUNTING ESTIMATES The Company prepares its financial statements in accordance withU.S. GAAP. These principles are established primarily by the FASB. In this MD&A, references toU.S. GAAP issued by the FASB are derived from the FASB Accounting Standards Codification™ (ASC). The preparation of financial statements in conformity withU.S. GAAP requires the Company to make estimates based on currently available information when recording transactions resulting from business operations. The estimates that the Company deems 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, 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 at which 94% of the Company's assets and 81% of its liabilities are reported as 64
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
of
Valuation of Investments, Including Derivatives, and Recognition of Other-than-Temporary Impairments
Aflac's investments, primarily consisting of debt and equity securities, include both publicly issued and privately issued securities. For publicly issued securities, the Company determines the fair values from quoted market prices readily available from public exchange markets and price quotes and valuations from third party pricing vendors. For the majority of privately issued securities within the Company's investment portfolio, a third party pricing vendor has developed valuation models that the Company utilizes to determine fair values. For the remaining privately issued securities, the Company uses non-binding price quotes from outside brokers. The Company estimates the fair values of its securities on a monthly basis. The Company monitors the estimated fair values obtained from its pricing vendors and brokers for consistency from month to month, while considering current market conditions. The Company also periodically discusses with its pricing brokers and vendors the pricing techniques they use to monitor the consistency of their approach and periodically assess the appropriateness of the valuation level assigned to the values obtained from them. If a fair value appears unreasonable, the Company will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, the Company may compare the inputs to relevant market indices and other performance measurements. Based on management's analysis, the valuation is confirmed or may be revised if there is evidence of a more appropriate estimate of fair value based on available market data. The Company has performed verification of the inputs and calculations in any valuation models to confirm that the valuations represent reasonable estimates of fair value. Inputs used to value derivatives include, but are not limited to, interest rates, credit spreads, foreign currency forward and spot rates, and interest volatility. The Company routinely reviews its investments that have experienced declines in fair value to determine if the decline is other than temporary. The identification of distressed investments, the determination of fair value if not publicly traded and the assessment of whether a decline is other than temporary involve significant management judgment. The Company must apply considerable judgment in determining the likelihood of the security recovering in value while the Company owns it. Factors that may influence this include the Company's assessment of the issuer's ability to continue making timely payments of interest and principal, the overall level of interest rates and credit spreads, and other factors. This process requires consideration of risks, which can be controlled to a certain extent, such as credit risk, and risks which cannot be controlled, such as interest rate risk. Management updates its evaluations regularly and reflects impairment losses in the Company's net earnings or other comprehensive income, depending on the nature of the loss, as such evaluations are revised.
See Notes 1, 3, 4 and 5 of the Notes to the Consolidated Financial Statements for additional information.
Deferred Policy Acquisition Costs and Policy Liabilities
Insurance premiums for most of the Company's health and life policies, including cancer, accident, hospital, critical illness, dental, vision, term life, whole life, long-term care and disability, are recognized as revenue over the premium-paying periods of the contracts when due from policyholders. When revenues are reported, the related amounts of benefits and expenses are charged against such revenues, so that profits are recognized in proportion to premium revenues during the period the policies are expected to remain in force. This association is accomplished by means of annual additions to the liability for future policy benefits and the deferral and subsequent amortization of policy acquisition costs. Premiums from the Company's products with limited-pay features, including term life, whole life, WAYS, and child endowment, are collected over a significantly shorter period than the period over which benefits are provided. Premiums for these products are recognized as revenue over the premium-paying periods of the contracts when due from policyholders. Any gross premium in excess of the net premium is deferred and recorded in earnings, such that profits are recognized in a constant relationship with insurance in force. Benefits are recorded as an expense when they are incurred. A liability for future policy benefits is recorded when premiums are recognized using the net premium method.
Deferred Policy Acquisition Costs
The calculation of DAC and the liability for future policy benefits requires the use of estimates based on sound actuarial valuation techniques. For new policy issues, the Company reviews its actuarial assumptions and deferrable acquisition costs each year and revise them when necessary to more closely reflect recent experience and studies of actual acquisition costs. For policies in force, the Company evaluates DAC by major product groupings to determine that they are recoverable from future revenues, and any amounts determined not to be recoverable are charged against net earnings. See Note 6 of the Notes to the Consolidated Financial Statements for a detail of the DAC activity for the past two years. 65
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Policy Liabilities
The Company's policy liabilities, which are determined in accordance with
applicable guidelines as defined under
Future policy benefits provide for claims that will occur in the future and are generally calculated as the present value of future expected benefits to be incurred less the present value of future expected net benefit premiums. The Company calculates future policy benefits based on assumptions of morbidity, mortality, persistency and interest. These assumptions are generally established at the time a policy is issued. The assumptions used in the calculations are closely related to those used in developing the gross premiums for a policy. As required byU.S. GAAP, the Company also includes a provision for adverse deviation, which is intended to accommodate adverse fluctuations in actual experience. Unpaid policy claims include those claims that have been incurred and are in the process of payment as well as an estimate of those claims that have been incurred but have not yet been reported to the Company. The Company computes unpaid policy claims on a non-discounted basis using statistical analyses of historical claims payments, adjusted for current trends and changed conditions. The Company updates the assumptions underlying the estimate of unpaid policy claims regularly and incorporates its historical experience as well as other data that provides information regarding the Company's outstanding liability. The Company's insurance products provide fixed-benefit amounts per occurrence that are not subject to medical-cost inflation. Furthermore, the Company's business is widely dispersed in both theU.S. and Japan. This geographic dispersion and the nature of the Company's benefit structure mitigate the risk of a significant unexpected increase in claims payments due to epidemics and events of a catastrophic nature. Claims incurred under Aflac's policies are generally reported and paid in a relatively short time frame. The unpaid claims liability is sensitive to morbidity assumptions, in particular, severity and frequency of claims. Severity is the ultimate size of a claim, and frequency is the number of claims incurred. The Company's claims experience is primarily related to the demographics of its policyholders. As a part of its established financial reporting and accounting practices and controls, the Company performs detailed annual actuarial reviews of its policyholder liabilities (gross premium valuation analysis) and reflects the results of those reviews in its results of operations and financial condition as required byU.S. GAAP. For Aflac Japan, the Company's annual reviews in 2019 and 2018 indicated no need to strengthen liabilities associated with policies inJapan . For AflacU.S. , the Company's annual reviews in 2019 and 2018 indicated no need to strengthen liabilities associated with policies in theU.S.
The table below reflects the growth of the future policy benefits liability for
the years ended
Future Policy Benefits (In millions of dollars and billions of yen) 2019 2018 Aflac U.S.$ 9,405 $ 9,137 Growth rate 2.9 % 3.8 % Aflac Japan$ 81,462 $ 77,812 Growth rate 4.7 % 5.6 % Consolidated$ 90,335 $ 86,368 Growth rate 4.6 % 5.5 % Yen/dollar exchange rate (end of period) 109.56 111.00 Aflac Japan ¥ 8,925 ¥ 8,637 Growth rate 3.3 % 3.8 % The growth of the future policy benefits liability in yen for Aflac Japan and in dollars for AflacU.S. has been due to the aging of the Company's in-force block of business and the addition of new business. In computing the estimate of unpaid policy claims, the Company considers many factors, including the benefits and amounts available under the policy; the volume and demographics of the policies exposed to claims; and internal business practices, such as incurred date assignment and current claim administrative practices. The Company monitors these conditions closely and make adjustments to the liability as actual experience emerges. Claim levels are generally stable from period to period; however, fluctuations in claim levels may occur. In calculating the unpaid policy claim liability, the Company 66
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
does not calculate a range of estimates. The following table shows the expected sensitivity of the unpaid policy claims liability as ofDecember 31, 2019 , to changes in severity and frequency of claims. Sensitivity of Unpaid Policy Claims Liability (In millions) Total Severity Decrease Decrease Increase Increase Total Frequency by 2% by 1% Unchanged by 1% by 2% Increase by 2%$ 0 $ 25 $ 50 $ 76 $ 101 Increase by 1% (25 ) 0 25 50 76 Unchanged (49 ) (25 ) 0 25 50 Decrease by 1% (73 ) (49 ) (25 ) 0 25 Decrease by 2% (97 ) (73 ) (49 ) (25 ) 0 Other policy liabilities, which accounted for 11% of total policy liabilities as ofDecember 31, 2019 , consisted primarily of annuity and unearned premium reserves, and discounted advance premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period. Advanced premiums represented 24% and 29% of theDecember 31, 2019 and 2018 other policy liabilities balances, respectively. See the Aflac Japan segment subsection of this MD&A for further information. Income Taxes Income tax provisions are generally based on pretax earnings reported for financial statement purposes, which differ from those amounts used in preparing the Company's income tax returns. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the Company expects the temporary differences to reverse. The evaluation of a tax position in accordance withU.S. GAAP is a two-step process. Under the first step, the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination by taxing authorities. The second step is measurement, whereby a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized. The determination of a valuation allowance for deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, the Company's management considers all available evidence, including taxable income in open carry back years, the existence of cumulative losses in the most recent years, forecasted earnings, future taxable income exclusive of reversing temporary differences and carryforwards, future taxable temporary difference reversals, and prudent and feasible tax planning strategies. In the event the Company determines it is not more likely than not that it will be able to realize all or part of its deferred tax assets in the future, a valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Future economic conditions and market volatility, including increases in interest rates or widening credit spreads, can adversely impact the Company's tax planning strategies and in particular the Company's ability to utilize tax benefits on previously recognized capital losses. The Company's judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions.
For additional information on income tax, see Note 10 of the Notes to the Consolidated Financial Statements presented in this report.
67
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Future Adoption of Accounting Standard for Long-Duration Insurance Contracts
InAugust 2018 , the FASB issued ASU 2018-12, "Financial Services - Insurance, Targeted Improvements to the Accounting for Long-Duration Contracts." The update, which is expected to significantly change how insurers account for long-duration contracts, amends existing recognition, measurement, presentation, and disclosure requirements applicable to the Company. Issues addressed in the new guidance include: 1) a requirement to review and, if there is a change, update cash flow assumptions for the liability for future policy benefits at least annually, and to update the discount rate assumption quarterly, 2) accounting for market risk benefits at fair value, 3) simplified amortization for deferred acquisition costs, and 4) enhanced financial statement presentation and disclosures. InNovember 2019 , the FASB issued ASU 2019-09, "Financial Services - Insurance (Topic 944): Effective Date", which defers the effective date of ASU 2018-12 for all entities. The amendments are effective for public business entities that meet the definition of anSEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC,for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2021 . Early application of the amendments is permitted, however, the Company does not expect to early adopt the updated standard. The Company is thoroughly evaluating the impact of ASU 2018-12 adoption and expects it will have a significant impact on the Company's reported financial position, results of operations, and disclosures underU.S. GAAP accounting. The Company anticipates that the requirement to update assumptions for liability for future policy benefits will have a significant impact on its results of operations, systems, processes and controls while the requirement to update the discount rate will have a significant impact on its AOCI and equity. The Company currently has no products with market risk benefits. There are two permitted transition methods upon adoption. The default transition method is a modified retrospective approach or companies may elect to apply the amendments using a full retrospective approach.
Under the modified retrospective method, the opening reserve balance at the
transition date,
Regardless of the transition method selected, the new guidance requires that discount rates used for discounting of insurance liabilities be initially adjusted on the adoption date and subsequently at each reporting period to the market levels for the upper-medium-grade (low credit risk) fixed income instrument yields (single-A in the currency of the underlying insurance contract) reflecting the duration of the company's insurance liabilities. Long duration of the Company's third-sector insurance liabilities inJapan coupled with limited-to-no-liquidity of the Japanese long-dated fixed-income market creates challenges in application of the market-based discount rate guidance and will require the Company to apply significant judgments in designing discount rate methodologies for its Japanese third-sector liabilities. The update of the discount rate would be recognized in AOCI under both transition methods. Under the full retrospective method, the Company would restate all historical periods based upon actual historical experience as of contract inception and its updated view of the contractual cash flow projections at transition. A cumulative catch-up adjustment to opening retained earnings would be recognized to reflect the actual experience and updated projections. Companies are permitted to apply a full retrospective transition approach if actual historical information is available for all contracts that will be affected by the new guidance.
The Company has selected the modified retrospective transition method.
The Company expects that under either transition method, the impact to its reported financial statements underU.S. GAAP will be greatly influenced by the nature of the Company's business model. Adoption of the new guidance will reflect the Company's concentration inJapan third-sector business, in particular cancer insurance, with respect to which the duration of liabilities is materially longer than asset durations, while Japan's aggregate block of business continues to see favorable experience from mortality, morbidity, and expenses. Under the modified retrospective method, the impact of a low discount rate applied to long-duration third sector liabilities is recognized at adoption, while associated favorable morbidity margins are recognized over time thus driving a pronounced timing impact toU.S. GAAP equity. In addition, with respect to the Japan segment, the Company maintains a large portfolio of assets designated as held-to-maturity (HTM) as a strategy to reduce capital (solvency margin ratio or SMR) volatility. In a low interest rate environment, such as presently exists inJapan , assets designated as HTM that were purchased in a higher interest rate environment have significant embedded gains not reflected in AOCI (HTM securities are carried at amortized cost underU.S. GAAP), which serves as an economic offset to a low discount rate applied to policy liabilities. AtDecember 31, 2019 , the Company's HTM portfolio was$30.1 billion at amortized cost and had$7.5 billion in net unrealized gains. Pursuant to the implementation of ASU 2019-04, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial 68
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Instruments" (see Note 1 for additional details of this ASU), effective onJanuary 1, 2020 , the Company anticipates the reclassification of approximately$6.9 billion (at amortized cost) of pre-payable fixed maturity securities from the HTM to the available-for-sale (AFS) category. This reclassification is expected to result in recording in AOCI a net unrealized gain of approximately$800 million on an after-tax basis based on the securities' fair values on the reclassification date. After adoption of ASU 2018-12, the Company also expects net earnings and net earnings per share (which were$3.3 billion and$4.43 per diluted share, respectively, in 2019) to reflect larger quarterly fluctuations due to the new requirement to update assumptions for liability for future policy benefits. As an example of the potential impact of the new guidance, and for illustrative purposes only, under the modified retrospective method and in a low interest rate environment, the Company would expect AOCI (which was$6.6 billion atDecember 31, 2019 ) to significantly decline upon adoption and to thereafter reflect larger quarterly fluctuations due to the new requirement to quarterly adjust discount rates. Conversely, in a higher interest rate environment, and assuming adoption of the modified retrospective method, the Company would expect AOCI to decline less or even increase (depending on the specifics of the interest rate environment), as well as to reflect quarterly fluctuations. Under the full retrospective method, the Company would expect lesser declines or increases in total equity upon adoption compared to the modified retrospective method due to the potential offsetting effect from updating experience and cash flow projections. The ultimate impact on these items from the Company's implementation of the updated standard is subject to assessments that are dependent on many variables, including but not limited to (i) the transition method selected by the Company, (ii) how certain aspects of the new standard will be interpreted and implemented by the Company and other similar companies, such as (but not limited to) amortization of deferred acquisition costs and selection of discounting methodologies and inputs, as well as establishment of policies, processes and controls for setting, monitoring and periodically updating reserve assumptions, and (iii) changes in the interest rate environment in the US and Japan. The impact on transition under the modified retrospective method will be driven by updating discount rates that will increase reserves and lower AOCI by the corresponding amount. The Company expects that while the adoption of this new accounting guidance will affect the Company's financial statements underU.S. GAAP, it will not impact financial statements for Aflac Japan under FSA requirements or for AflacU.S. under applicable statutory requirements. Therefore, the Company does not expect adoption of the updated standard to impact its overall cash flows, subsidiaries' dividend capacity or their ability to meet applicable regulatory capital standards, nor does the Company anticipate adoption to affect its existing debt covenants or strategies for capital deployment.
New Accounting Pronouncements
During the last three years, various accounting standard-setting bodies have been active in soliciting comments and issuing statements, interpretations and exposure drafts. For information on new accounting pronouncements and the impact, if any, on the Company's financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements.
© Edgar Online, source