Aflac Incorporated (NYSE:AFL) Q3 2023 Earnings Call Transcript

Aflac Incorporated (NYSE:AFL) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Good morning, and welcome to the Aflac Incorporated Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead.

David Young: Good morning and welcome. This morning, we will be hearing remarks about the third quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated, and Fred Crawford, President and COO of Aflac Incorporated. Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results in current capital and liquidity, which can also be found with the materials that we posted along with our earnings release and financial supplement on investors.aflac.com. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max provided his quarterly video update, which you will find there also.

Other members of our executive management team who are joining us for Q&A include Virgil Miller, President of Aflac US; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results.

As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I’ll now hand the call over to Dan. Dan?

Dan Amos: Thank you, David. Good morning. We’re glad you joined us. Reflecting on the third quarter of 2023, our management team, employees, and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and for the first nine months. Beginning with Japan, I am pleased with our 12.4% year-over-year increase in sales, which was largely driven by a nearly 23% increase in cancer insurance sales, with a significant contribution from Japan Post Company and Japan Post Insurance. I am also pleased to see continued improvements in cancer insurance sales through our other alliances, Dai-ichi Life and Daido Life.

These alliance partners, along with agencies and banks, combine to form our extensive distribution channels that are so important to being where the customer wants to buy insurance and providing them with financial protection. We continue to work hard to support each channel. We also introduced our new medical insurance product on September 19. The product design is simple to appeal to younger policyholders with basic needs and older or existing policyholders who desire additional or updated coverage. While it’s too early to evaluate the success of this product launch, early indications show that it’s being well received. We continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell our third sector products.

Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50, and the level of concurrent third sector sales remains approximately 50%. Thus far, our product strategy in Japan has served us well, and I’m encouraged by our progress so far. Turning to the US, I’m encouraged by our sales increase of 7.5% in the quarter. This reflects continued productivity improvements and the contribution from our growth initiatives of group life and disability, consumer markets, network dental and vision. We remain focused on driving scale, stabilizing new platforms, and leveraging our ability to bundle essential product lines as we work with brokers on larger groups. Agents and brokers contributed to the growth of our individual business.

Our group platform benefited significantly from the sales of group life and disability. I am very excited about our new cancer protection assurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for our products and solutions we offer is strong or stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatments, even though they may have major medical insurance.

Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders. At the same time, we are listening to our shareholders and understanding the importance of prudent liquidity and capital management.

We remain committed to maintaining strong capital ratios on behalf of the policyholder and balance this financial strength with tactical capital deployment. I am very pleased with the Board’s declaration of the fourth quarter dividend and declaring this dividend of 2023 marks the 41st consecutive year of dividend increases, a record that we treasure. I am even more pleased with the Board’s action to increase the first quarter of 2024 dividend by 19% to $0.50 per share. We also remain in the market purchasing shares at a historically high level of $700 million, as seen in the first two quarters of this year. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows, which support both our dividend track record and tactical share repurchase.

Overall, I think we can say that it has been a very strong quarter, especially when a vast number of factors are in our favor. Aflac Japan had a strong quarter for sales as we executed product and distribution strategy. Aflac US continued to build on its momentum as it nears pre-pandemic levels. Pre-tax profit margins remain strong in both Japan at 32.8% and the US at 28.8%. Plus, our capital ratios remain very strong, and our quarterly share repurchase was, like last quarter, one of the largest in the company’s history. Before I hand it over to Fred, I want to address an announcement of his retirement. I have enjoyed working closely with Fred over the last eight years and certainly understand his desire to retire and spend more time with the family and personal interests.

Fred, you will be missed, and I look forward to working with you and Aflac’s executive team to ensure a smooth transition until your official retirement day. And I wish you many happy years. As for me and the company, we have some outstanding candidates who are capable of running Aflac. It is my responsibility to continue to train and watch the progress of these potential heir apparent while the Board oversees the process. To be prepared for any unknowns, we have always had an interim CEO ready should something abruptly happen to me, as well as a strong process within the Board’s corporate governance committee. I recently had a physical at Emory University and received an excellent report. So I plan on being around to prepare our leaders for the future and drive shareholder value.

With that, I’ll now turn the program over to Fred. Fred?

Fred Crawford: Thank you, Dan. As announced last night, I plan to retire in September of next year to spend more time with my family and pursue other interests. It’s a personal decision, but also a recognition of the very capable leadership team surrounding Dan and the company being in a very strong position. While I believe this is the best for me and my family, I also believe it is in the best interest of Aflac. I’ve enjoyed 25 years as an executive in the insurance industry and feel blessed to have worked with talented professionals and leaders throughout. However, the highlight has clearly been my time here working for Dan and for Aflac. Over the next year, I will be focused on transition and helping on select initiatives where I can add value. I’ll now hand the call back over to Max. Max?

Max Broden: Thank you, Fred. For the third quarter, adjusted earnings per diluted share increased 27.8% year-over-year to $1.84 with a $0.06 negative impact from FX in the quarter. With this being the third quarter under the new LDTI accounting regime, we evaluate our reserve assumptions for morbidity, persistency, and mortality, at least annually, to see if an update is needed. If necessary, these assumptions will be unlocked on a prospective basis as they were in this quarter, leading to remeasurement gains of $205 million. Variable investment income ran $13 million or $0.02 per share below our long-term return expectations. We also wrote down certain software intangibles in our US segment, impacting our results by $0.04 per share.

Adjusted book value per share, including foreign currency translation gains and losses, increased 10.3%, and the adjusted ROE was 15.6%, a significant spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premium for the quarter declined 2.8%, reflecting the impact of paid-up policies, our January 1 reinsurance transaction and deferred profit liability. Lapses were somewhat elevated but within our expectations. However, if adjusting for all these factors, the earned premium declined an estimated 1.7%. Japan’s total benefit ratio came in at 65.1% for the quarter, down 170 basis points year-over-year, and the third sector benefit ratio was 54.8%, down approximately 460 basis points year-over-year.

We continue to experience favorable actual to expected on our well-priced, large and mature in-force block. We estimate the impact from remeasurement gains to be 260 basis points favorable to the benefit ratio in Q3. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place, leading to favorable underwriting experience. Persistency remained solid with a rate of 93.5% but was down 80 basis points year-over-year. With product refreshments, we tend to experience some elevation in lapses as customers update and refresh their coverage, which was the case with the recently refreshed cancer and first sector products. Our expense ratio in Japan was 19%, down 100 basis points year-over-year, driven primarily by good expense control and, to some extent, by expense allowance from reinsurance transactions and DAC commission true-up.

For the full year, we would expect to end up towards the low end of our expense ratio range of 20% to 22%. Adjusted net investment income in yen terms was up 7.2% as we experienced higher yields on our US dollar-denominated investments and related favorable FX and a return on our alternatives portfolio, more in line with our long-term return expectations. This was offset by transfer of assets due to reinsurance. In the quarter, we reduced our FX forwards and increased FX put options notional, leading to lower run rate hedge costs and a more efficient use of our investment risk capital. The pretax margin for Japan in the quarter was 32.8%, up 350 basis points year-over-year, a very good result for the quarter. Turning to US results, net earned premium was up 3.2%.

Persistency increased 80 basis points year-over-year to 78.7%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories, especially group voluntary benefits. Our total benefit ratio came in lower than expected at 35.9%, a full 890 basis points lower than Q3 2022. We estimate that the remeasurement gains impacted the benefit ratio by 12.1 percentage points in the quarter. Claims utilization remains subdued. And as we incorporate more recent experience into our reserve models, we have released some reserves. For the full year, we now estimate our benefit ratio to be materially below our outlook range of 47% to 50%. Excluding remeasurement gains, however, we are tracking well within the 47% to 50% outlook range.

Our expense ratio in the US was 40.6%, up 70 basis points year-over-year. This includes a 190 basis points impact from a software intangibles write-down. Adjusting for this write-down, we are trending in the right direction. Our growth initiatives, group life and disability, network dental and vision, direct-to-consumer increased our total expense ratio by 330 basis points. We would expect this impact to decrease over time as these businesses grow to scale and improve their profitability. For the full year, we now expect our expense ratio to come in slightly above our outlook range of 37% to 40%. Adjusted net investment income in the US was up 13%, mainly driven by higher yields on both our fixed and floating rate portfolios and variable investment income in the quarter more in line with long-term return expectations.

Profitability in the US segment was solid with a pretax margin of 28.8%, driven primarily by the remeasurement gains from unlocking. As you know, the commercial real estate markets are going through the worst cycle in decades, especially in the office subsector. We’re seeing most property values quoted down 25% to 40%, but some distressed situations are driving market values down as much as 60%, far exceeding the 35% to 40% declines of the financial crisis. Our total commercial real estate watch list remains approximately $1 billion, with around two-thirds of these in active foreclosure proceedings. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $34 million this quarter. We also moved two properties into real estate owned, which resulted in a $53 million write-down.

We do not believe the current distressed market is indicative of the true intrinsic economic value of the underlying properties currently undergoing a foreclosure process. We continue to believe our ability to take ownership of these quality buildings and manage them through this cycle will allow us to maximize our recoveries. In our Corporate segment, we recorded a pretax loss of $49 million, which is somewhat smaller than a year ago, primarily due to our reinsurance transaction. Adjusted net investment income was $8 million lower than last year due to an increased volume of tax credit investments. Higher rates began to earn in and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $64 million with an associated credit to the tax line.

The net impact to our bottom line was a positive $3.8 million in the quarter. To date, these investments are performing well and in line with expectations. We are continuing to build out our reinsurance platform, and I’m pleased with the outcome and performance. In Q4, we intend to execute another tranche with similar structure and economics to our first transaction from January this year. Our capital position remains strong, and we ended the quarter with an SMR above 1,000% in Japan. And our combined RBC, while not finalized, we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $3.3 billion, $1.6 billion above our minimum balance. These are strong capital ratios which we actively monitor, stress and manage to withstand credit cycles as well as external shocks.

US stat impairments were $4 million and Japan FSA impairments JPY2.9 billion or roughly $20 million. This is well within our expectations and with limited impact to both earnings and capital. Leverage remains at a comfortable 18.8%, just below our leverage corridor of 20% to 25%. The decline in the quarter is primarily driven by the weakening yen. As we hold approximately two-thirds of our debt denominated in yen, our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. We repurchased $700 million of our own stock and paid dividends of $248 million in Q3, offering good relative IRR on these capital deployments.

We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now hand the call back to David to begin Q&A.

David Young: Thank you, Max. Before we begin our Q&A we ask that you please limit yourself to one initial question and a related a follow-up. Then, you are welcome to rejoin the queue to ask an additional question. We will now take the first question.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from Tom Gallagher with Evercore ISI. You may now go ahead.

Tom Gallagher: Good morning. Dan, wanted to start with your comment about succession planning and having several strong candidates. Should we take that to mean you won’t be looking to do an outside search to replace Fred? And are you looking to replace Fred in the COO role? A little bit of color on what you’re thinking overall there. Thanks.

Dan Amos: Sure. First, I would say that you have to understand that one of the reasons that we created the Chief Operating Officer and also for Fred to go to Japan, part of it was due to the COVID period of time and that we had a situation where with COVID, we wanted more interaction with Japan. And so Fred was willing to go over there and do that. And that was very helpful to us. And we continue to rotate people over to Japan and from Japan to the United States. And it’s — for example, Steve Beaver, who you probably know has been around a long time, will be working with him. As far as how and what will evolve, these decisions ultimately come from the Board. I think there’s always two ways to look at transition and what would take place would be abruptness of something happening and then well it was structured.

So we work with the concept that this will be planned over a long period of time and we’ve had internal candidates. It’s always been my preference that it’d be internal candidates because of the Japanese operation and the uniqueness that we have there. Saying that, I would say the Board would — the Corporate Governance Committee specifically and then the full Board would be reviewing every aspect to make sure you have the best person for the job. And so we would also take that into consideration as we’re moving forward. As I said in my comments, I’m enjoying life. I’m enjoying working with the company and want to continue to do so. At the same time, these adjustments of people retiring and moving on happens, and I’ve been around to see a lot of them.

But I think there’s a little element of pride that keeps me around because of the family. And frankly, I just enjoy doing it. So I look forward to working with these people. There are several that are on the horizon. We continue to add new people that have potential. So I’m encouraged about that and I think we’re in a strong position. I think this quarter sent a signal of how strong we are, managerially-wise, and we’ll continue to do that.

Tom Gallagher: Got you. Thanks for that, Dan. And just an operational question for my follow-up. Max, can you comment on what’s behind the bigger reserve release in the US and if there’s a go-forward earnings impact associated with that? I would have thought there might have been a bigger benefit coming from Japan, just given how strong and this efficiency of margins there are. So any — maybe any color comparing and contrasting how the actuarial review stacked up US versus Japan? Thanks.

Max Broden: Thank you, Tom. So obviously, this is the first year we’re running on an LDTI basis, and the third quarter is when we do the unlockings, including prospective unlockings. When you think about it, if you go back and look at the last couple of years and you see the morbidity trends and also trends in hospitalization and outpatient treatment, and you compare and contrast Japan and the United States, in the US, we shut down a lot more than what you ended up doing in Japan as it relates to how people went to the hospital and how people changed their behavior. And that is coming through in our morbidity experience. So we did see, for example, accident hospitalizations, et cetera, drop a lot more in the United States than what you saw in Japan.