Aflac Incorporated
Q2 2020 Earnings Call Transcript

Published: 29 Jul 2020

[Operator:]

Welcome to the Aflac Second Quarter 2020 Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded.

[David Young:]

Thank you, Fran. Good morning. And welcome to Aflac Incorporated second quarter call. As always, we have posted our earnings release and financial supplement to investors.aflac.com. This morning, we will be hearing remarks about the quarter, as well as our operations in Japan and the United States amid the COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin by discussing the impact of the pandemic and our ongoing response. Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the second quarter before providing perspective on claims exposure to COVID-19. Max Brodén, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of second quarter financial results and current capital and liquidity. Joining us this morning during the Q&A portion are members of our executive management team in the U.S., Teresa White, President of Aflac U.S.; Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments; Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; and Steve Beaver, CFO of Aflac U.S. We are also joined by members of our executive management team in Tokyo 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 Koji Ariyoshi, Director and Head of Sales and Marketing. 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 discuss 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 the company’s investor site, investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I will now hand the call over to Dan. Dan?

[Dan Amos:]

Thank you, David, and good morning. Shortly, I will provide an overview of the quarter and how we perform provide perspective on the ongoing in their families, the people who are on the frontlines fighting the spread of COVID-19 and those who are providing essential services including our own employees.

[Fred Crawford:]

Thanks, Dan. I am going to touch briefly on conditions in the second quarter, how we are tracking to COVID-19 stress testing assumptions and an update on key initiatives in Japan and in the U.S. In Japan, we track data coming from the Ministry of Health, Labor and Welfare, as well as the COVID-19 subcommittee of the Cabinet Advisory Council for infectious disease. As of July 27th, there were approximately 30,500 cases and 1,000 deaths in all of Japan. Our stress test assumed a midpoint estimate of 1.2 million confirmed cases and 100% hospitalization rate consistent with Japan’s infectious disease guidelines. When applied to our book of medical policies and assuming an average of 20 days in hospitalization, the result was a potential impact to our third sector benefit ratio of 50 basis points to 100 basis points in 2020. However, through the second quarter, Aflac Japan’s COVID-19 impact totaled only 626 claimants with claim payments totaling 138 million yen. For COVID hospitalization claims thus far, the average stay in a hospital is approximately 20 days, with two-thirds of claims in hospital and one-third at home or hotel-based hospitalization. In short, we are tracking well below any risk of stress conditions with no measurable COVID-19 impact to core ratios from paid claims. The impact is somewhat isolated to sales and a related uptick in persistency, which Max will comment on later. Turning to the U.S., the story of course, is very different. We continue to track the rate of reported cases, hospitalization and deaths from sources such as the CDC and Johns Hopkins. As a country, COVID-19 case levels in the U.S. now exceed 4.3 million, with deaths nearing 150,000. In addition, hospitalization rates in certain CDC red zones have been on the rise. Our U.S. stress test assumed 6.4 million confirmed cases in the U.S., 1.5 million hospitalizations and 150,000 deaths. In short, we are unfortunately tracking to our U.S. macro stress test assumptions. It is however important to understand the critical statistics that impact our business model that surround hospitalization and disability. Our stress test applied age-based hospitalization rates, with 40% of those hospitalized spending time in the ICU. We further assumed 75% of confirmed cases filed for short-term disability. The resulting stress test impacted our U.S. benefit ratio in the range of 300 basis points to 500 basis points for 2020.

[Max Brodén:]

Thank you, Fred. Let me begin with a review of our second quarter performance and focus on how our core capital and earnings drivers have developed over the past quarter. As was the case when we announced first quarter earnings, the timing and magnitude of the COVID-19 impact on 2020 earnings continue to be uncertain. For the second quarter, adjusted earnings per share increased 13% to $1.28, driven primarily by favorable benefit ratios in the U.S. The strengthening yen impacted earnings in the quarter by $0.01. As a result, adjusted earnings per share on a currency-neutral basis rose 12% to $1.27 per share. Adjusted book value per share, including foreign currency translation gains and losses grew 7.5% and the adjusted ROE, excluding the foreign currency impact was a strong 16.3%, a significant spread above our cost of capital. There were no one-time items to call out for normalizing purposes in the quarter. As expected, given the market conditions, our alternative investment portfolio recorded a loss in the quarter of $7 million and was approximately $20 million below our long-term return expectations for the portfolio adjusted for the J-curve. We have a modest but building portfolio, which currently stands at $657 million. Turning to our Japan segment. Total earned premium for the quarter declined 2.5%, reflecting first sector policies paid-up impacts, while earned premium for our first sector protection and third sector products was flat year-over-year. Japan’s total benefit ratio came in at 69.8% for the quarter, up 90 basis points year-over-year and the third sector benefit ratio was 59.6%, up 110 basis points year-over-year. The main driver for the increase was lower lapses associated with policyholders updating their coverage, which tends to lead to reserve releases, boosting current quarter results by lowering the benefit ratio. Given the current lower new business activity, this naturally pushes up our benefit ratio due to lower reserve releases, decreases DAC amortization and improves reported persistency. We did experience all of this in the second quarter, manifested by our persistency improving 70 basis points year-over-year. Our expense ratio in Japan was 20%, down 60 basis points year-over-year. In the current environment, we did incur lower acquisition expenses like lower promotional spend and lower surrenders brought down our DAC monetization, as previously mentioned. We view this as primarily timing related and would expect our expense ratio to increase when a new business environment normalizes. Net investment income increased 2% in yen terms, despite lower variable investment income, driven primarily by higher allocation to U.S. dollar floating rate assets early in the year. The pre-tax margin for Japan in the quarter was a strong 22%. Turning to our U.S. results. Earned premium was down 0.1% due to weaker sales results and a flat persistency year-over-year. Our total benefit ratio came in at 44.3%, 590 basis points lower than Q2 2019, driven by reduced claims from accidents, less wellness basics and elective surgeries. Our expense ratio in the U.S. was 35.3%, up 50 basis points year-over-year, as the inclusion of Argus and direct-to-consumer digital investments structurally had increased the expense ratio by 140 basis points. Lower sales bonus, travel and expenses associated with claims adjudication were a meaningful offset to the Argus consolidation and lower earned premiums. Net investment income in the U.S. was down 4.4% due to capital management actions in December 2019, leading to a reduced invested balance and 13 basis points contraction in portfolio yield year-over-year. Profitability in the U.S. segment was boosted by the previously discussed benefit ratio, leading to a pre-tax profit margin of 25.7% in Q2, up 510 basis points year-over-year. As Fred noted, we are carefully monitoring persistency in the U.S., as premium grace periods expire and economic particularly unemployment conditions develop. We expect the combination of reduced sales and persistency to weigh on revenue during the second half of 2020 and more materially as we enter 2021. We expected earned premium decline in the range of minus 3% to flat for the full year of 2020 and we will update our forecast for 2021 later in the year, given the number of variables involved. In our Corporate segment, amortized hedge income contributed $27 million on a pre-tax basis to the quarter’s earnings and we had an ending, notional position of approximately $5 billion. Our capital position remains strong and we ended the quarter with an SMR of above 900% in Japan and an RBC of approximately 600% in Aflac Columbus. Holding company liquidity stood at $4.7 billion, $2.7 billion above our minimum balance. In terms of credit conditions in our insurance general account, we took further derisking actions, selling out of approximately $320 million of COVID exposed securities, triggering a realized loss of $45 million. While total impairments and losses may appear elevated, the $166 million net investment loss includes an increase in CECL reserves of $161 million, reflecting ratings downgrades and calibrating our third-party model inputs for COVID-driven economic conditions. We remain cautious in regards to both the economic outlook and spread of COVID-19, leading us to retain more capital in our subsidiaries as a first line of defense in case of any sudden deterioration in capital markets or virus related claims. At this point, we deem it more efficient to temporarily hold capital at the subsidiary level versus at the holding company. It is the flexibility in our capital structure and capital resources that gives us this option, while continuing to deploy capital to the benefit of our shareholders through dividends and buybacks. In the second quarter, we repurchased $188 million of our stock. Going forward, we will continue to be tactical around both our capital structure and deployment in order to drive a balanced risk adjusted return on capital within the company. Now, let me turn it over to David to begin Q&A. David?

[David Young:]

Thank you, Max. Now we are ready to take your questions. But first let me ask you to please limit yourself to one initial question and one related follow-up to allow other participants an opportunity to ask a question. Fran, we will now take the first question. Fran, are we open to take questions. We are not hearing anything?

[Operator:]

Yes. We definitely are. We had a delay there. Thank you so much. Our first is from Jimmy Bhullar with JP Morgan. Sir, your line is open.

[Jimmy Bhullar:]

Hi. Thanks. Good morning. So I had a question on your sales in the U.S. and it doesn’t seem like there was much of an improvement in sales as you went through the quarter. But as businesses are opening up, are you seeing your sales recover or if the companies are still reluctant to have agents come in and try to sell to their employees. So just any sort of color on what’s going on, obviously, in the fourth quarter, the broker sales will pick up. But any color on the agency channel and I think last quarter you had given some guidance on April sales, if you have anything similar to July?

[Dan Amos:]

Teresa, would you like to answer that?

[Teresa White:]

Yeah. I will start and then I will pass it to Rich. Certainly, I think, the environment is impacting the sales results and specifically in the small case market, we see it being more pronounced. As we see states start to open back up and our sales teams starting to adjust, I think, they are trying to find the right balance between safety and productivity and so from an Aflac perspective, what we are attempting to do is provide support, ensuring that the accounts -- that our accounts and their employees have information for the sales teams. We are equipping them with information to provide to accounts. And this is really to get activity, get people back out and get people to utilizing their virtual tools, while also we are working to preserve the distribution platform for our agents, specifically by providing loans, technology and training, preparing for a virtual sales environment. So we do realize that it’s going to take time for adoption. I will let Rich speak specifically on the quarter and go forward. Rich?

[Rich Williams:]

All right. Thank you, Theresa. So specifically to the question, in the month of July, we have definitely seen levels that are better than what we experienced in the second quarter, but clearly not at pre-pandemic levels. As we think about the second half of the year, very consistent with guidance we have shared. We tend to see more broker sales in the second half of the year and in larger cases. And so the larger case market is more receptive to virtual enrollment and so we do expect to see some progress there, obviously, in the smaller business market, it will just simply depend on businesses availability and adoption of virtual enrollment. But as Teresa mentioned, the long-term play is to recover our distribution platforms for 2021 going forward to use the virtual tools that we have had for many years and really just to pivot to a new way of doing business.

[Fred Crawford:]

Jimmy, this is Fred. One other thing and Rich can comment on this. But one other dynamic that we are experiencing is recruiting. Recruiting normally strengthens during weak employment periods. That’s been our history through say normal economic cycles and it’s no different here. We can see a tick-up in eligible recruits and recruiting activity during weakness in the economy. The problem is a unique one, and that is the licensing processes at the state level are often closed or slow to operate with backlog. Some of that is related to gathering people for more larger licensing processing. And so because we recruit so many people across the country that come to us without previous insurance experience, that licensing becomes critical. It’s very different if you had a model that was recruiting previously licensed agents away from other insurance carriers, et cetera, that’s not our model. So we also would like to see that open up as time goes on at the state level and that would help with the natural volume of new sales that comes as you bring in new recruits.

[Jimmy Bhullar:]

Okay. And any comments on what you might have seen in Japan since the end of the quarter or as things are getting at least a little bit better than they were earlier?

[Dan Amos:]

All right. Japan, who would like to take that? Koji?

[Koji Ariyoshi:]

So during the state of emergency declaration in May, shops were shutdown and we were not able to conduct face-to-face sales. So we were in a very difficult position. And we have been continuing non face-to-face solicitation through phones and mail. And since June, after the state of emergency declaration has been lifted in Japan, we follow -- we have been following the guidelines issued from the government, as well as Life Insurance Association of Japan in terms of prevention of infection and we have gradually started our solicitation through face-to-face. Our shops have resumed or reopened. Now that the shops have been reopened for a while, the number of customers and the traffic coming into shops are on the increase. In June, we had about 50% of customers compared with our normal times coming into our shops and in July we are back to 70%. However, we are still not at a point where we had lots of customers coming in pre-COVID-19. And at the same time, face-to-face solicitation is also recovering as well, I mean, it is very gradual that we are starting. And because face-to-face solicitation is very challenging under the current COVID-19 situation. And since it’s very difficult to see customers face-to-face directly, what we are doing is developing a tool to have virtual face-to-face meeting with customers using digital tools on the web. And we are trying to develop this tool so that the tool itself will allow the concluding of the entire process to the application for the insurance policy. And this tool and this kind of activity is -- we are taking this activity ahead of others. So what we would like to do is to really strengthen our response capability to customers under the new normal after the COVID or -- during the COVID-19 because of the current situation. So what we are planning to do is, of course, continue to use our phones and mails as we did in our previous or the current non-face-to-face environment. But we would also like to be adding like a virtual face to face through the web and then, perhaps, have the application be submitted through this virtual web face -- non-face-to-face tool. That’s all for me.

[Jimmy Bhullar:]

Thank you.

[Operator:]

Thank you. Our next is from Humphrey Lee with Dowling & Partners. And your line is open.

[Humphrey Lee:]

Good morning and thank you for taking my question. A question related to the U.S. health benefit ratio. I think you talked about the deferral treatments have helped some of the have delayed some of the expected claim activity, but you assume some normalization. I was wondering if you can elaborate a little bit more about your kind of expectations for your claims experience for the second half of the year?

[Dan Amos:]

Yeah. We -- what we are seeing is, I think, what you are starting to see across the industry as more companies report and that is there’s been the natural putting off, if you will, of routine doctor, dentist and more routine hospital visits due to the shelter-in-place and general concerns over COVID. And we are, in fact, starting to see that open back up again in select areas of the country, where people are coming back in and we are starting to see claims pick up, particularly in the last week or so of the quarter and then into July. What I would say, is that we are still traveling at levels lower year-over-year than the claims experience in those products last year this time. So they have not recovered back up to what we would call a normal level. But they are certainly more elevated than what we experienced in the early part through, say, midway into the second quarter. What we are doing, however, is also very important and that is we are proactively reaching out to employees and employers to remind them of the benefits that they have in our policies how to consider whether or not they are eligible or have a qualified event and can file a claim, how easy it is to file a claim, how quickly the money comes directly to them. And in particular, we are focused on wellness claims, which are attached to many of our policies, but most notably our accident policy. And by proactively reaching out to policyholders to remind them that if they did in fact go to see the doctor or dentist on a routine measure or they plan to remember that they have got a wellness benefit, which will typically reimburse them to the tune of, say, $60 or so by visit. Historically, we have done this on a kind of a state-by-state basis at times and usually what we find is that there will be a pickup in utilization, which you would expect, but we also hope to achieve better persistency by reminding people of their benefits. The key time to do this is in fact typically in the third quarter, not just because of COVID dynamics, but because that’s also about the time when people are reviewing with their employer, their benefits and considering whether to sign up again. It’s also particularly important for us right now because it’s a way to moderate to some degree the risk of these state orders falling off throughout the quarter, as well as the possibility of stimulus falling off. So we would expect to do some outreach in the third quarter. We would expect that to increase utilization. It’s very difficult to project it and so we can’t really guide on what we expect. But we think those activities will recover some of the benefit ratio in the second half.

[Humphrey Lee:]

That’s helpful. Shifting gears to kind of the investment portfolio. So in Max prepared remarks you talked about there are some CECL allowance in the quarter. My understanding is that it’s largely for the middle market loan portfolio. Can you talk about for the balance of your portfolio kind of what percentage of that is on kind of potential downgrade you watch right now?

[Max Brodén:]

So, this is, as you mentioned, it’s predominantly in the middle-market loan portfolio that we did experience some rating migration. We are not going to speak to specifically on any breaking down the whole portfolio, what is sort of on any sort of watch list. But I would say that the two categories that primarily is driving the CECL reserve to increase if the middle-market loan portfolio and the transitional real estate portfolio. Those are the two asset classes that primarily drove that. Of the $161 million of this generic increase in the CECL reserve, about half of it was driven by ratings and about half is driven by updated economic outlook input into the model. And keep in mind that this model is a third-party model that we utilize and there is a lag impact. So you may question, why is the increase coming now, not at the end of the first quarter. It’s really because there’s a moving window in terms of data that goes into the model, and obviously, we now have greater weight on two quarters of, let’s call it, COVID related economic input and outlook and that’s really what’s driving it.

[Humphrey Lee:]

Okay. Thank you.

[Operator:]

Thank you. Our next is from Andrew Kligerman with Crédit Suisse. And sir, your line is open.

[Andrew Kligerman:]

Hi. Good morning. Thinking about Japan Post, just given the tremendous disruption that they have had. How are things moving along with them on the regulatory front, customer perceptions? And when might they get back on it -- assuming we could get beyond COVID-19 pressures, when might they get back on a track that was consistent with, say, 2017 or 2018 in terms of sales?

[Dan Amos:]

Well, I will start and then maybe Aflac Japan will want to make some comments as well. I think our relationship with Aflac, I mean, with Japan Post and Masuda-san is good as it could possibly be. They are positive. They are very interested in the new technology and the ability to use digital to help. In my opinion, they are wrapping up all phases of past issues, because you have got a new management team. I think the press is pretty much seen and heard everything and now it’s just been repetitive. So I am hoping that by, certainly, end of August, September, it will kind of finish out and then they will move forward. Now how the impact of that will go in regard to COVID and the ability to sell is uncertain. But the willingness on their part to want to sell and move forward is very positive. And I think they would like to see the numbers go back to where they were as well, of course, not only for sales but also being a large shareholder themselves. They are interested in that. So what I would say is, is we are well-positioned. We are looking forward to that movement and I think they are as well. So let me turn the program over to Koide to see what else he might want to add in that regard.

[Masatoshi Koide:]

This is Koide from Aflac Japan. Currently, Japan Post Group is prioritizing their activities to win back the customers trust. So Aflac Japan, of course, is supporting their activities, and for example, helping them with conducting training to really have focused on more customer-oriented activities. Under these circumstances today Japan Time -- the Japan Post Group companies, they are Japan Post Holdings, Japan Post Company and Japan Post Insurance called the press conference to announce various things.

[Dan Amos:]

All right.

[Andrew Kligerman:]

Great. And then just shifting over to capital management, I think, Max, used the term tactical with regard to…

[Masatoshi Koide:]

Excuse me, may I continue? This is Koide.

[Andrew Kligerman:]

Okay.

[Dan Amos:]

Go ahead Koide.

[Masatoshi Koide:]

Okay. All right. So let me repeat again. Today, Japan Time, the CEOs of the three Japan Post Group companies, Japan Post Holdings, Japan Post Company and Japan Post Insurance held a press conference. And the announcement that they have made in the press conference was the disciplinary actions of our sales representatives. So for the first time related to the inappropriate sales, this announcement makes clear Japan Post framework apply disciplinary action to address the market conduct issues in response to stakeholder demand. And then given the current status and the announcement that they have made, Japan Post Holdings CEO, Mr. Masuda said, that with this clarity on Japan Post framework for disciplinary action, the Japan Post Group has largely met the five evaluation criteria established by the Japan Post Reform Execution Committee for resuming sales activities. And he also stated the decision to restart sales will be made by the Board of Directors of the three Japan Post Group companies possibly within August or September. Having said that, once the decision to resume sales is made, Japan Post will begin with customer visits to express apologies. So against that backdrop, we expect it will take some time before sales of Aflac cancer Insurance to begin in earnest. And the disciplinary actions that were announced today were on the sales of Japan Post Insurance products and has nothing to do with the sale of Aflac Cancer products. And that is the current state of Japan Post.

[Dan Amos:]

Thank you, Koide. Now we have the second part to that question.

[Andrew Kligerman:]

Yeah. No. Just kind of shifting real quickly over to Max’ comment that he wanted to be tactical on capital management. You did about $188 million of buybacks in the quarter, which relative to other companies in respect it is quite strong. For this gap, I think, it’s about half the level that you have done historically, maybe a little less. So could I take tactical to mean that that’s probably the level you will going at over the next few quarters until you can get visibility on COVID-19 and maybe can you it down?

[Max Brodén:]

So Andrew, tactical, that word means tactical. We have by any matter very strong capital positions in our operating subsidiaries, and very strong capital and liquidity at the holding company. But we also recognize that the economic environment continues to be very uncertain and also the spread of the virus, obviously, is clearly linked to that. And I would say that until we get better clarity, we will continue to be fairly cautious in terms of how we deploy capital. But we will also look for opportunities and when we see that we would have a good opportunity and we think that the risk reward given all the risks out there is appropriate or is good for us, we will deploy capital. All this means that we may have -- if you think about the run rate we were running at the second quarter, we may decrease the buyback going forward. We may keep it at the current level and we may even increase it. But at this point, given everything that is going on and all the uncertainty out there, we want to keep all options available to us.

[Andrew Kligerman:]

Thanks a lot.

[Dan Amos:]

We will take one more question.

[Operator:]

Thank you very much. Our last question then is from Mr. John Barnidge with Piper Sandler. Sir, your line is open.

[John Barnidge:]

Thank you. Could you talk about how you approach the rollout of Dental and Vision nationally beginning in January when individuals are largely underutilizing dental benefits possibly catch up in 2021 and then how do you manage the pricing and rollout of such? Thank you.

[Fred Crawford:]

Sure. John, I will -- just a couple of quick things and then I will hand off to Rich and he can spell out the rollout. But just note that, we do have a dental product out there right now, which is our historical indemnity product and that continues to sell. It represents only about 3% of our earned premium and around 4% of our sales. Where we are going with the Argus acquisition and then the rollout of Dental and Vision is with a true network Dental and Vision, which is just in the building mode. I think we have, for example, this year we are targeting something less than $5 million in sales of that product once we get up and running. As mentioned in my comments, we have got the product actually rolled out and approved in 40 states, which is a more significant task or undertaking than you might think on the surface, particularly in the current environment, so we are quite pleased with that. And now we will start to be in a better position come 2021 to rollout. So, with that, Rich, why don’t you take it from here in terms of how we see the rollout.

[Rich Williams:]

Okay. Thank you, Fred. And as everyone will recall, last year at our financial analyst briefing and our outlook, we talked about 2020 being a measured rollout of Aflac Dental and Vision. And we are pleased to say, consistent with Fred’s comments that we have done that here in 2020 rolling out the product in 10 states in significant areas for our distribution. So 2020 really is the burn in and the implementation for our field training, our enrollment platform and making sure that we have a very favorable experience for our customers and for our agents and our brokers. So 2021 will be the actual ramp up of the volume for Aflac Dental and Vision and we are on track to have the national rollout in 2021.

[Dan Amos:]

Thank you, Fred. And just before we conclude our call today, I wanted to remind you that we have combined financial analyst -- combined our financial analyst briefing, as well as our 2021 outlook call for a special webcasted event on November 19th in that morning and we will have more details on that. We hope you will join us. And please feel free to contact Investor Relations for more information with any questions that you may have before then and we look forward to speaking with you soon. Wish you all continued good health. Thank you.

[Operator:]

This conference has concluded. Again, thank you for your participation. Please go ahead and disconnect. Thank you very much.