Aflac Incorporated (NYSE:AFL) Q4 2022 Earnings Call Transcript

Aflac Incorporated (NYSE:AFL) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good morning, and welcome to the Aflac Incorporated Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead.

David Young: Thank you, Andrea. Good morning, and welcome to Aflac Incorporated’s fourth quarter earnings call. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Fred Crawford, President and COO of Aflac Incorporated, who is joining us from Japan, will then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday, after the close, we posted our earnings release and financial supplement to investors.aflac.com, along with a video for Max Broden, Executive Vice President and CFO of Aflac Incorporated, who provided an update on our quarterly financial results and current capital and liquidity.

Max will be joining us for the Q&A segment of the call, along with other members of our executive management; Virgil Miller, President of Aflac U.S,; Brad Dyslin, Global Chief Investment Officer and President of Aflac Global Investments; Al Roziere, Global Chief Risk Officer and Chief Actuary; June Howard, Chief Accounting Officer; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team at Aflac Life Insurance Japan; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director; Todd Daniels, Director and CFO; and Koichiro Yoshizumi, Executive Vice President and Director of Sales and Marketing and Alliance Strategy. 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 assurances that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. And 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-GAAP U.S. measures. Please also note that after we file our 10-K, we plan to post, on our investor site, a recast quarterly financial supplement, showing the effects of the new long-duration targeted improvement accounting standard had it been applied to the 2022 and 2021 fiscal years.

I’ll now hand the call over to Dan. Dan?

Dan Amos: Thank you, David, and good morning. Thank you for joining us. Reflecting on 2022, our management team, employees and sales distribution have continued to be resilient stewards of our business, being there for the policyholders when they need us most, just as we promise. From an overall standpoint, pandemic conditions impacted operations in Japan, especially in the first half of 2022. But they are gradually improving. Meanwhile, pandemic conditions in the U.S. have largely subsided. Turning to our financials, when adjusting for material weakening in the yen, the Company delivered another quarter of solid earnings results that rounded out a year of overall strong performance, as Max addressed in this quarterly video update.

For 2022, Aflac Incorporated reported adjusted earnings per diluted share, excluding the impact of foreign currency, of $5.67, which was the Company’s second best year in the history following a record 2021. Aflac Japan generated solid overall financial results in 2022, with an extremely strong profit margin of 24.9%. One of the consistent key contributors to Aflac Japan’s strong financial results is its persistency, which was 94.1% in 2022. As anticipated, our benefit ratio returned to a more normal level in the fourth quarter after seeing a spike due to the practice of deemed hospitalizations, the scope of which was narrowed last September. Throughout the year, we continued to navigate the waves of COVID in Japan. We expected sales would pick up in the second half of the year, especially in the quarter, and that’s exactly what we saw happen.

Sales in Japan rose 10.8% in the second half of the year, including an 11. 4% increase in the fourth quarter, which led to a full year sales coming in essentially flat. These results reflected the August launch through Associates of Wings, our new cancer insurance products. They also reflected our first sector product updates in the fourth quarter that better positioned Aflac Japan for future long-term sales opportunities. Recently, Prime Minister, Kishida announced that COVID would be downgraded to the same level as seasonal flu starting in mid-May. While we’re encouraged by this announcement as a sign of daily life in Japan returning to pre-pandemic conditions, we will see how this evolves, but look to continue building on our sales momentum in 2023.

In April, Aflac Japan will begin selling through Japan Post Group, our new cancer insurance product, and subject to FSA approval, for serious diseases, which was developed in collaboration with Japan Post Group. We expect this close collaboration to produce continued gradual improvement of Aflac cancer insurance sales over the intermediate term and to further position the companies for long-term growth. Another element of our growth strategy is our intense focus on being there where consumers want to buy insurance. Our broad network of distribution channels, including agencies, alliance partners and banks continually optimized on opportunities to help provide financial protection to Japanese consumers and we are working hard to support each channel.

Turning to the U.S., for 2022, we saw a solid profit margin of 20.4% in the fourth quarter. This result was driven by lower incurred benefits and higher adjusted net income, particularly offset by higher adjusted expenses. I’m pleased with the 17.4% sales increase in the fourth quarter, which reflected the largest amount of quarterly premium in the history of Aflac U.S. and continued to a 16.1% sales increase for the year. This reflects continued improvement in the productivity of our agents and brokers as well as contributions from the build-out of our acquired platforms, namely dental and vision, group life and disability. These are relatively small parts of our sales, but key elements of our growth strategy to sell in our core supplemental health policies.

I’m encouraged by the continued improvement in the productivity of our sales associates and brokers. We are seeing success in our efforts to reengage veteran sales associates. And at a time, we’re seeing strong growth through brokers. These results reflect continued adaptation to the pandemic conditions, growth in the core products and our investment and build-out of growth initiatives. I believe that the need for the products we offer is strong or stronger than ever before in both Japan and the United States. At the same time, we know consumers’ habits and buying preferences have been evolving. We also know 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.

In the latest commercial featuring the Aflac Duck and the Gap Goat, the goat personifies the gap that people face when they get medical treatment. Fortunately, the Aflac Duck is the hero who helps overcome the problem. I know this helps demonstrate the need for our products, thus helping our sales opportunities. We continue to work toward reinforcing our leading position and building on the momentum into 2023. Related to capital deployment, we placed significant importance on achieving strong capital ratios in the United States and Japan on behalf of our policyholders and shareholders. In addition, we have taken proactive steps in recent years to defend cash flows and deployable capital against the weakening yen. We pursue value creation through our balanced actions, including growth investments, stable dividend growth and disciplined tactical stock repurchase.

With the fourth quarter’s declaration, 2022 marks the 40th consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it supported by the strength of our capital and cash flows. Additionally, the board reiterated its first quarter dividend increase of 5%. Our dividend track record is supported by the strength of our capital and cash flows. At the same time, we have remained tactical in our approach to share repurchase, deploying $2.4 billion in capital to repurchase 39.2 million shares in 2022. Combined with dividends, this means we delivered $3.4 billion back to the shareholders in 2022. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry.

We have also focused on integrating the growth investments we made in our platform. We also believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. We are well positioned as we work toward achieving long-term growth, while also ensuring we deliver on our promise to our policyholders. I’m proud of what we’ve accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long-term shareholder return. Before I turn it over to Fred, you may recall that the financial analyst briefing in November that I mentioned how Fred would be increasing his focus on Japan and spending more time over there to delve deeper into learning about the operations there.

As David mentioned, he is joining us today from Japan where he’s on assignment for the better part of 2023. As President and Chief Operating Officer, he is also continuing to focus on Aflac U.S. as well. I’ll now turn it over to Fred. Fred?

Photo by Leon Seibert on Unsplash

Fred Crawford: Thank you, Dan. I’m joined here in Tokyo by our Aflac Japan leadership team led by Masatoshi Koide, President of Aflac Japan. Let me begin by saying 2022 was an important year of operational and strategic progress across the organization. Our U.S. growth platforms, dental and vision, group life and disability and consumer markets have moved from integration to full production, with comprehensive product portfolios that are broadly filed and marketed across the U.S. under the Aflac brand. These businesses have modernized operating platforms built to support the scale we anticipate in the future and are now fully contributing to sales and earned premium growth. In Japan, our refreshed cancer product is now further enhanced with the launch of our new consulting support model after nearly a year of successful testing.

We launched a revised and tactical approach to the sale of our WAYS and child endowment products, leveraging the strengthened product appeal to promote third sector cross-sell. While navigating difficult COVID conditions, we were proactive in addressing our expense structure, defending strong margins in the face of revenue pressure. From a corporate perspective, we remain focused on risk management and capital efficiency. Two areas of focus included our approach to hedging the U. S. dollar portfolio in Japan and efforts to improve enterprise return on equity and Japan product competitiveness with the launch of Aflac Re, our Bermuda-based reinsurer. Finally, across the organization, we launched a coordinated effort to address the balancing act of investing in and delivering on growth, reducing expenses simplifying our business model and improving overall customer experience.

This includes comprehensive project governance, a network of agile teams and regular reporting up to the Board level. The financial goal is simple: to deliver on the outlook provided at this year’s investor conference with respect to growth and margins in the U. S. and Japan. We’re proud of our efforts, but it’s clear from our results that we have worked to do in a few key areas. This includes addressing weak premium persistency in the U.S. and revitalizing our production platform in Japan. Furthermore, we need to address these issues while continuing to advance our technology and associated process improvement across the organization. With that quick review, let’s turn to current conditions and what we’re focused on in 2023, starting with Aflac Japan.

As Dan noted, claims recovered in the fourth quarter, as did the benefit ratio, on January 20th, Prime Minister Kishida announced plans to downgrade under the law COVID-19 to the same level of seasonal influenza, which will be enacted in mid-May. Importantly, this removes the immediate option to implement quarantine and other restrictive measures, such as state of emergency orders. We believe this move is designed to signal and encourage a return to normal, including business activity. While claims processing volumes remain high, this is driven by a natural lag in reporting of claims generated during Japan’s seventh wave of COVID under the old deemed hospitalization rules. You can think of this as working the IBNR claims that were financially recognized in the third quarter.

Despite continued waves of COVID, we expect our team in Japan to improve on the performance in 2022 as COVID, like the common flu, appears destined to become a way of life in Japan and elsewhere. In that regard, we’re focused on the following: First, in terms of distribution recovery and productivity across our channels, our powerful associates channel requires aggressive approach to training and development to drive new customers. Separately, we are working with Japan Post on a campaign surrounding the introduction of the new cancer product in the second quarter. As Dan noted, we have strong commitment at the top of Japan Post, and we are cooperating at levels throughout the organization. It should be noted late this January we also introduced the new cancer product in our Dai-Ichi alliance as well as the financial institutions channel, both of which have performed below our expectations in recent periods.

Turning to core product refreshment, our new cancer product will add a critical illness lump sum benefit rider in April, available on old and new cancer products and through Japan Post Group and our associates channels. Cancer ecosystem development is moving from launch to expansion. When analyzing current call volume, over 50% of the calls that are coming into our consulted related service platform relate to treatment, thus suggesting a value proposition beyond the pure financial benefit of paying a claim. Our 2022 refreshed approach to first sector savings is yielding expected results, with approximately 80% of all sales representing customers who are under the age of 49 and approximately 50% of all new first sector customers purchasing a third sector product which is twice our target of 25% cross-sell.

Finally, in the face of increased competition and focus on selling the new cancer product, we have seen our medical sales decline and have plans to refresh our product in the fourth quarter. When stepping back to consider these activities, we are and have been taking broad action across product and distribution with an eye towards returning to an ¥80 billion production platform in the 2025 and 2026 period. The path to that level of production will build over time. But as we look towards 2023, we expect the continuation of our experience in the second half of 2022, where we generated consistent growth in production. Meeting our long-term targets will require strong execution on all fronts, as well as supportive market conditions and the cooperation of third-party alliances and partners to aid in driving productivity improvement.

Finally, while we have made progress, we seek further advancement in digitizing paper and manual processes for greater operating efficiency. This is not entirely an Aflac Japan issue. It’s a Japan financial service industry issue. In recent years, we have moved from 30% to approximately 50% of our applications submitted in digital form, with only 10% of claims processed digitally. Over time, we seek to drive digital applications to 80% and digital claims processed to over 40%. This will allow us to take additional cost out of our operations, but requires the commitment of our distribution partners, their agents and customers to drive adoption. I’m here in Japan in part, recognizing this is an important time for Aflac Japan. We are engaged in transformative activities that have long-term franchise implications as we seek to leverage our financial strength and leading third sector position.

My focus will be partnering with our leadership team in revitalizing our distribution, incubating new product end markets and digital adoption to drive down expenses and improve customer experience. Turning to the U.S., as Dan noted in his comments, we continue to deliver a balanced attack to the marketplace. Split by product class, group benefits were up 28%, individual benefits up 8%. Split by channel, agent sales were up 7% and broker up 25%. With respect to our expansion businesses, network dental and vision and premier life and disability sales were up 98% and 75%, respectively, for the full year. The underlying signs of momentum are encouraging. For example, in our agent small business franchise, average weekly producers are up 3%, the second consecutive year of growth after a period of steady decline.

Dental and vision is proving out our thesis of cross-sell as roughly $0.80 of supplemental health and life products are sold with every dollar of dental and vision. Our life and disability platform, not only has strong sales, but a successful renewal year, and recorded 97% premium persistency. Now fully integrated and expanding, we see 2023 as a year of leveraging this platform to both defend and grow voluntary group business. While it was a difficult year industry-wide for direct-to-consumer sales, we are encouraged by consumer markets 5% increase in sales in the fourth quarter with new alliances coming online. Finally, it was a challenging year for persistency in the U.S. Persistency has stabilized in our individual business. However, weakness earlier in the year continues to impact our trailing 12-month metric.

Group Voluntary, a smaller contributor to earned premium, drove most of the 260-basis-point decline in overall persistency. Account persistency across the organization has remained relatively flat, but we lost a few very large accounts during the year. The industry has experienced weakness in voluntary persistency, which tells us there are also labor force dynamics contributing. We have stepped up our focus on persistency, establishing a dedicated office to drive and oversee a series of efforts, including product development, client service, technology solutions and incentive designs. Turning to investment results, investment income in the quarter was stable, with strength from higher yields on floating rate portfolios offset by increased hedge costs and anticipated weakness in alternative investment income.

As expected and discussed last quarter, our alternative investment portfolio remained under pressure, posting a loss of $21 million in the quarter. By comparison, last year’s quarter enjoyed $127 million in gains. This decline was anticipated given the natural correlation to the public equity markets and the lag in private equity reporting. Despite losses in the quarter, year-to-date, the alternative portfolio generated $103 million in income following an exceptional 2021. Throughout the year, we have refined our hedging strategy, reducing $2 billion in notional currency forwards in exchange for options that reduced hedge costs while protecting capital against material moves in the yen. Overall, as we look at 2023, we are staying the course with respect to our strategic and tactical asset allocations as we watch closely the risk of economic slowdown driven by Fed action to fight inflation.

We are also watching the Bank of Japan as they introduce a new governor this spring which many believe could lead to a change in policy. Before turning the call back to David, it’s worth following up on Max’s recorded comments to reinforce how we are positioned with respect to potential for a period of U.S. or global weakness. Our morbidity-based insurance model is defensive in nature, with relative stability in sales, earned premium and profit margins through economic cycles. Among traditional life insurance peers, we maintain low asset leverage as defined by the ratio of general account assets to regulatory capital, particularly if you exclude our concentration in JGBs. We believe our portfolio is well positioned to weather the current economic uncertainty, recognizing we would anticipate some pressure on our $12 billion loan portfolios.

We work closely with our external managers for middle market and real estate loans and have conducted a comprehensive stress test designed to apply recessionary pressure to these portfolios. Our approach included a moderate and severe recession, applying loss rates consistent with past economic cycles. Both scenarios resulted in elevated, but manageable losses, with no immediate need to change our disciplined approach to these asset classes and putting new money to work. When looking at the impact of core capital ratios, we developed a market pricing, ratings migration and loss scenario that falls in between a mild and severe recession and includes the entirety of our general account assets. When applying these stress tests, our core ratios of RBC, SMR and ESR all came out the other side well above are minimum thresholds.

While it is wide to proceed with caution — wise is to proceed with caution, we do not see recessionary conditions as disruptive to our capital deployment plans. I’ll now hand the call back to David for Q&A. David?

David Young: Thank you, Fred. Now we are ready to take your questions. But first, let me ask you to please limit yourself to one initial question followed by a related question. And then get back in the queue to allow other participants an opportunity to ask a question. We’ll now take the first question, Andrea?

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Q&A Session

Operator: We will now begin the question-and-answer session. Our first question comes from Jimmy Bhullar of JP Morgan Securities. Please go ahead.

Jimmy Bhullar: So I had a question for Fred on long-term Japan sales outlook. I think you mentioned Â¥80 billion in the ’25 period. If we look back historically, that’s still — while it’s up a lot from here, it’s still consistent with what you had in 2019 and a lower number than ’18. So is it that the market opportunity is less than it was before? Or do you think — or should we assume that your market share has declined?

Fred Crawford: I think really — so first of all, over the long run that is beyond 2025 and ’26 we obviously would expect to continue some level of growth pattern. We simply stopped the timing around that time frame as a reasonable forecasting period. But there’s no doubt, in the short run, meaning the next three to four years, that one of the shortfall compared to pre-pandemic levels was strength in the Japan Post distribution platform, including some very strong years of introducing new cancer in that platform. And it’s clear to us at this point in time that while that platform is recovering, it’s going to recover in a more linear fashion over time as opposed to a step function with dramatic increases. And that’s because Japan Post is under a very diligent program of improving and investing in their platform, retraining their sales force and recovering from effectively halting and being out of the market for a period of time, as you know.

So I think it’s more of that gradual approach to the build that we expect that is playing on the slower growth rate. Now having said that, we’re doing a lot of different things, as you know, we’re refreshing our cancer product. We’re adding to that cancer product competitiveness with our consulting practice. We’re also adding lump sum critical illness benefits, and we continue to focus on our other product development, including refreshing our medical product, particularly with an eye towards competing better in non-exclusive channels that are very competitive on the medical product, and we need to compete better there and build share. And then we’re excited actually about the developments with WAYS and child endowment, particularly with WAYS.

While it is not as high a return product as our other third sector, we’re very pleased with the cross-sell activity, and it’s also serving to build a little bit of momentum back in our core associate channel who needs more product to generate more commission and have more opportunity to recruit and build the sales force. So, so far, it’s very early in that program. We’re only a few months into reviving the WAYS product, but so far, the data is very supportive of the halo effect, if you will, particularly cross-sell. So we’re doing a lot of different things here in Japan. But ultimately, the reason you see muted recovery is when we look at the throughput of these new products and capabilities, meaning the throughput through agents at Japan Post, agents at Dai-Ichi, agents and agencies in our associate channel, they’re busy recovering from COVID, getting back out into the marketplace with face-to-face meetings.

And of course, Japan Post is going through their own dynamics of recovery. So it’s really the recovery in those third-party platforms that’s causing us to be more cautious.