Aflac Incorporated
Q4 2020 Earnings Call Transcript

Published: 4 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Aflac Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded.

[David Young:]

Thank you, Carol, and good morning and welcome to Aflac Incorporated fourth quarter earnings 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 and the year related to our operations in Japan and the United States amid the ongoing COVID-19 pandemic. Dan Amos, Chairman and CEO of Aflac Incorporated, will begin with an overview of our operations in Japan and the U.S.; Fred Crawford, President and COO of Aflac Incorporated, will then touch briefly on conditions in the fourth quarter and discuss key initiatives, including how we are navigating the pandemic; Max Broden, Executive Vice President and CFO of Aflac Incorporated, will conclude our prepared remarks with a summary of fourth quarter financial results and current capital on liquidity. Members of our U.S. Executive Management team joining us for the Q&A segment of the call are Teresa White, President of Aflac U.S.; Virgil Miller, President of Individual Benefits; Rich Williams, President of Group Benefits; Eric Kirsch, Global Chief investment Officer and President of Aflac Global Investments; Al Riggieri, 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 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 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-U.S. GAAP measures. I’ll now hand the call over to Dan. Dan?

[Dan Amos:]

Thank you. Good morning and thank you for joining us. At this time last year, it would have been very difficult to foresee the gravity of what was soon to unfold for society and for the company due to COVID-19. I’m proud of our employees, our sales distribution and Board of Directors for their decisive people first initiatives, we spearheaded early on in both the United States and Japan to protect our workforce and to be here for our policyholders throughout this trying time.

[Fred Crawford:]

Thank you, Dan. I’m going to touch briefly on conditions in the fourth quarter with respect to the pandemic. I’ll then provide an update on key initiatives in Japan and the U.S. Japan has experienced approximately 400,000 COVID-19 cases and 6,000 confirmed deaths since inception of the virus. While quite low as compared to other developed countries and the U.S., these statistics have more than doubled since the end of the third quarter. Earlier this week, the government of Japan extended their state of emergency for Tokyo and nine other prefectures through March 7. This action includes the suspension of domestic tourism campaign and entry of foreigners into Japan. We have responded with again moving more of our workforce to working from home unlike the state of emergency declared last year in the initial stages of the virus, government restrictions are more balanced with economic recovery considerations, and we have not prohibited face-to-face consultations and/or closed our sales shops. Meanwhile, Prime Minister, Suga, has announced a goal of beginning vaccinations mid-February.

[Max Broden:]

Thank you, Fred. We finished the year with stable fourth quarter earnings in a year marked by significant mortality and morbidity events, as well as continued low interest rates. Fourth quarter adjusted earnings per share increased 3.9% to $1.07, and the full year EPS was a record $4.96, up 11.7% year-over-year. Adjusted book value per share including foreign currency translation gains and losses grew 19.1% both for the quarter and full year. The adjusted ROE excluding the foreign currency impact was 12.1% in the fourth quarter and a respectable 15.1% for the full year, a material spread to our cost of capital. This quarter benefited from favorable marks on our alternative investment portfolio to the amount of $47 million pre-tax above our long-term return expectations, a very good outcome on our building alternatives portfolio. We also booked the severance charge associated with our previously announced voluntary separation program or VSP, in our U.S. and corporate segments, totaling pre-tax $43 million, included in adjusted earnings. Turning to our Japan segment, total earned premium for the quarter declined 3.5%, reflecting mainly first sector policies paid-up impacts, while earned premium for our third sector products was down 1.9%. For the full year, total earned premium was down 2.8%, while totaling policies in force declined by a lesser rate at 1.2%. As policies in force are not impacted by the paid-up status, it tends to serve as a better indicator of the growth of the underlying business. Persistency has been on a positive trajectory inched up slightly sequentially to 95.1%, up 70 basis points year-over-year. Japan’s total benefit ratio came in at 68.9% for the quarter, down 110 basis points year-over-year. And the third sector benefit ratio was 58.6%, down 150 basis points year-over-year. The main driver for the lower benefit ratio was a higher than normal IBNR release due to a sustained lower paid claims environment in 2020. We estimate that this lowered the benefit ratio by roughly 130 basis points compared to what we would deem a normal IBNR release to be. For the full year, the reported total benefit ratio was 69.9%, up 40 basis points year-over-year. And our third sector benefit ratio was 59.7%, also up 40 basis points year-over-year, largely due to improved persistency. The expense ratio in Japan was 23%, up 130 basis points year-over-year. The main driver was our paperless initiative, which kicked in at a higher gear as we digitize our operations and drive efficiencies throughout the value chain to a future state with significantly reduced paper usage. This investment increases our quarterly expense ratio by 85 basis points. For the quarter, adjusted net investment income increased 11.9% in yen terms, led by strong returns in our alternatives portfolio, but also strong results from the loan book like transactional real estate and middle market loans. For the full year, adjusted net investment income rose 4.4%. The pre-tax margin in the quarter was 20.9%, up 110 basis points year-over-year, as the combined effect from the lower benefit ratio and higher expense ratio was still positive. For the full year, the pre-tax margin was a respectable 21.2%. Turning to U.S. results, earned premium was down 2.3% for the quarter, due to weaker sales results. Persistency improved 160 basis points to 79.3%. This was driven by emergency orders in various states and by lower sales in 2020, as new policies lapsed at a higher rate than in force policies older than one year. Removing these factors would result in a stable year-over-year persistency rate. And we view that as a good outcome to date, given a pandemic environment impact on our policyholders and reflecting our efforts to retain accounts and keep premium in force. For the full year, earned premium was down 0.9%. Our total benefit ratio came in at 51.6%, which was 250 basis points higher than Q4 2019. Pandemic conditions continue to be very relevant when analyzing our benefit ratio. Due to the recent increase in infection rates, we estimate incurred claims impact of $72 million of which $58 million was an increase to IBNR, resulting in an impact to the benefit ratio of 5.1 percentage points from COVID related claims. This is somewhat offset by favorable non-COVID related claims activity, generating an underlying benefit ratio of 46.5%. COVID and non-COVID related claims tend to have a negative correlation, which clearly can be seen in our quarterly results throughout 2020. We would expect this pattern to continue in early 2021. Going forward we still expect the guided range of FAB of 48% to 51% to be a reasonable future benefit ratio. Our expense ratio in the U.S. was 43.5%, up 360 basis points year-over-year. The severance charge for our VSP explains 220 basis points of the rise, while the residual is primarily driven by digital investments and the reduction in revenues. The full year expense ratio landed at 38.6%. Adjusted net investment income in the U.S. was up 1.1% due to strong alternative investment income, while the portfolio book yield contracted 22 basis points year-over-year. Full year adjusted net investment income declined 2.1%. As both the benefit and expense ratio rose, profitability did come under pressure with a pre-tax margin of 11.6% in the quarter. For the full year, we still reported a solid pre-tax margin of 19.3% in line with recent historical average. In our Corporate segment, the pre-tax loss widened to $47 million in the quarter compared to $9 million from a year-ago. Lower net investment income on our short duration Hold Co. cash position, increased retirement expenses and $8 million of VSP severance expense were the main components of the delta. For the full year, the Corporate segment pre-tax loss was $115 million. Our capital position remains strong and stable. We ended the quarter with an SMR of north of 900% in Japan and an RBC of approximately 525% in Aflac Columbus. Holding company liquidity stood at $4 billion, $2 billion above our minimum balance. With a leverage of 23%, we continue to travel in the middle of our stated leverage range of 20% to 25% offering ample debt capacity. The continued spread of COVID-19 leads us to remain cautious in how we manage our capital base, make investments, and deploy capital to the benefit of the shareholder. In the quarter, we repurchased $500 million of our own stock and paid dividends of $196 million, offering good relative IRR on these capital deployments. For the full year, we paid $798 million of dividends and returned an additional $1.5 billion to shareholders in a formal share repurchases. 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 meaningful spread to our cost of capital. A recent example is the board’s decision to increase the quarterly dividend by 17.9% to $0.33 per share. Before going into Q&A, I would characterize our 2020 financial performance as solid, despite significant external challenges. As we look forward into 2021, we do not see any fundamental drivers causing us to change the outlook provided at our financial analyst briefing in November. In order to achieve these objectives, we remain laser-focused on executing on our growth initiatives, expense efficiency and continue to drive ROE at the significant spread to our cost of capital. With that, let me turn over to David to begin Q&A.

[David Young:]

Thank you, Max. Now, we are ready to take your questions. But first, let me ask that you please limit yourself to one initial question and then one related follow-up to allow other participants an opportunity to ask a question. Carol, we will now take the first question, please.

[Operator:]

Thank you. Your first question comes from Nigel Dally from Morgan Stanley. Please go ahead.

[Nigel Dally:]

Great. Thanks and good morning. Wanted to ask about Japan sales. You mentioned the new medical product had exceeded initial expectations. Can you elaborate somewhat on that? And how sustainable should that improve demand base, more just a first quarter phenomena or should we expect that group momentum to continue into the second quarter and perhaps move on?

[Dan Amos:]

This is Dan, and I’m going to let Japan. But let me just say that it tracked to me more of what other products in past introductions have done. It’s really too early to tell. It’s really only been out two weeks. So to go ahead forecast on two weeks, it’s a little too early to tell, but I am certainly optimistic that the field force or our agents are excited about it and the consumer seem to be excited about it, which means it’s a good product at a good time to be introducing. Of course, we’ll know much more details next quarter, but I would expect it to have the same pattern that we’ve seen with past introductions. Koji?

[Koji Ariyoshi:]

And this new medical product is being very much well taken by the agencies because of the new coverage and the functions that we offer. And this product also is designed to be able to be sold through the non-exclusive agencies and be competitive in that market as well. So we are expecting that the sale of this product will increase in a non-exclusive market as we have taken a product strategy with more competitive advantage with this product. So we do believe that this product will last for a long time as this product will be very popular among younger generation as well. And although it only has been two weeks since the launch of the product, the actual number of new insurance policies coming in are increasing and at the same time a pay per policy is also on the increase. I think we have been able to get a much better start this time under the current environment compared with the medical product that we launched in 2019 as Rider. And we are expecting to see improvements in sales this quarter much more and we have seen some improvements in the fourth quarter last year as well, but we were planning to have more improved this quarter. And that’s all for me.

[Nigel Dally:]

That’s great. That’s very helpful. The second question is just on U.S. sales, understand broker-driven sales are holding in better than agency sales. Is it possible to get some quantification behind how much better I think with brokeraging group becoming much larger part of the strategy and business would find it helpful to understand how sales are trending along distribution lines.

[Dan Amos:]

I think it’s probably best for Teresa and Rich to handle the aperture. The premise of your question is correct. Broker group driven sales will hold up better under this environment than agent-driven small business sales for sure. So Teresa and Rich.

[Teresa White:]

Well, I’ll let Rich answer, but I’ll just make the comment that, yes, the broker sales are traditionally a lot more automated. We have a lot more digital presence in the broker environment just from the beginning. But I’ll let Rich response.

[Rich Williams:]

Thank you, Teresa. As Dan alluded to in his comments, we’ve seen reduced face-to-face activity, which certainly impacts agency sales. And then from a broker sales perspective, given that they tend to work with larger accounts, they are less dependent on face-to-face activity. And as a result in particular with our group business, our group business saw results in the single-digit decline whereas our traditional businesses saw it at a larger decline. But all those comments between Teresa, Fred and myself, I think, kind of speak to the question.

[Nigel Dally:]

That’s great. Thanks a lot.

[Operator:]

Our next question comes from John Barnidge from Piper Sandler. Please go ahead.

[John Barnidge:]

Yes. Thank you very much. I saw a headline the other day that Japan had banned chanting and required masks in the preparation to try and host the 2021 Olympics. Assuming that were to go through, I know previously you talked about joint marketing and product campaigns with Japan Post. Is there a possibility of some increased marketing expenses in the mid-year?

[Dan Amos:]

Koji? Yes, we’ll have Koji or Koide-san address that. I would tell you that if what your question is, do you expect to build some form of marketing campaign surrounding the Olympics that is not in the plans and not normally what we would do. What we are doing, however, is building marketing campaigns around the launch of our new products and particularly taking advantage of a heightened awareness for supplemental health products in the COVID environment. So Koji and Koide-san, you can address it with more detail.

[Masatoshi Koide:]

And this is Koide from Japan. And we are not planning on having any particular campaign around the Olympics.

[Fred Crawford:]

John, I don’t know if that’s a correct thing you’re–

[John Barnidge:]

Yes, Fred, it addressed, thank you very much. And then the follow-up, the wellness program you’ve started in 3Q 2020, is that still in play, because I think last time you said it would carry over a little bit? And how should we think about cost of that?

[Fred Crawford:]

Yes, it is still in play in the sense that there’s sort of a – I’ll call it a tail to, if you will. In other words, we did the mailings. We saw, as you recall from last quarter, a spike in some of the wellness claims which will be flaunt, we hadn’t anticipate because we believe the payoff of that is not only persistency, but also being able to come back into companies. Let me explain that for a second. A lot of what our agents will do with their business clients is they will phone them up and say, based on our analysis you’ve got a certain number of employees that have wellness benefits. And we can help with understanding whether they are fully utilizing those wellness benefits to get money back in their pockets. As you can imagine, particularly as a small employer that’s an attractive proposition these days to get money in the pockets of your employees. And so that ends up lead or leading us into the account to talk about future enrollments and cross-selling and up-selling et cetera. And so that has been fairly successful. So it’s a very important piece of our product features and one that we would continue. If what you’re asking is what are we looking at in terms of ongoing, perhaps elevated claims related to wellness, that’s factored into some of our IBNR estimates, for example, where we’ll set up those types of reserves in anticipation of a trend line of wellness claims. And so at the moment, I’ll ask Max to give color, but I don’t anticipate that being a mover for our benefit ratio.

[Max Broden:]

That’s right, Fred. And John, as you remember, we did a – we had a campaign in the third quarter and obviously we had the impact on our benefit ratio in the U.S. in the third quarter both from paid claims, but also that we established an IBNR associated with that wellness campaign. As you now look at the impact on the fourth quarter, you did not really see any impact follow through into the fourth quarter because of the IBNR that we established in the third quarter. Going forward, we would expect these to be more normal activity for us. There may be instances with any significant campaigns that could trigger an increase in claims temporarily, but generally be relatively small. But if you refer specifically to the campaign, the big campaign we had in the third quarter, that hit the benefit ratio in the third quarter and we didn’t really have much of a follow through into the fourth quarter.

[John Barnidge:]

Great. Thank you very much.

[Operator:]

Our next question comes from Suneet Kamath from Citi. Please go ahead.

[Suneet Kamath:]

Thanks. Good morning. I wanted to go to the Japan benefit ratio. I think you said that some of the improvement or the lower than expected result or better than expected result was due to reserve releases. How are you guys planning for benefit ratios as you think about a world where the economy opens up again? And maybe we see the more people in Japan going to hospitals versus what we’re seeing right now, which I understand is a sort of subdued level of activity.

[Max Broden:]

Let me kick it off at a high level. And I have Todd to fill in the blanks as well. Specifically for the fourth quarter, we had an reserve release all of about JPY 7 billion that is higher than we would normally incur in a quarter. We estimate that lowered the benefit ratio by about a 130 basis points in the quarter. And this is because of the paid claims pattern that we’re seeing primarily to the non-COVID-related claims activity as – that Fred referred to in his prepared remarks. Going forward, you could obviously see an impact on the benefits ratio temporarily from an element of the sort of pent-up demand for hospitalizations, like elective surgery, physicals, et cetera. I think that’s much more the case in the U.S. than in Japan, where the Japan hospital system have been running at a more normal level than what we’ve seen here in the U.S. So you could see a little bit of a higher benefit ratio from that, but this has been taken into consideration when we gave you the benefit ratio range at FAB of 68.5% to 71% in our outlook. So I’ll leave it at that and Todd, please feel free to give some additional comments.

[Todd Daniels:]

No, Max. I think you’re right, especially if you think about our hospitalizations as it relates to accident hospitalizations, they won’t come back, accidents that have happened and you’ve recovered. However, there could be a level of sickness hospitalizations that would increase in the future. One other aspect of our benefit ratio that I’ll mention, if we get our sales back to more normal level and we start with introducing product when people refresh product that has a slight impact on the benefit ratio as well in the form of reserve releases on old policy. So last year as we saw in our results, persistency increased which led to a slightly higher net benefit reserve with those policy holders hanging onto those policies.

[Suneet Kamath:]

Okay, thanks. And then just my follow-up is on U.S. sales. Dan, you had commented that you’re optimistic about a recovery in the second half. How much of that is just due to sort of recovery in face-to-face sales versus some of the things that you’re doing to try to improve the penetration of the direct-to-consumer or the digital virtual sales?

[Dan Amos:]

Well, I think it’s a combination of both. And of course, you’re going against much easier numbers, especially in the second quarter and so that within itself makes it easier. But all-in-all we have been working on trying to find ways to do less face-to-face and more virtual. And we’ve been preparing for that and it just got accelerated. I will say, the new norm today is much improved over six months ago in terms of ability to get around as the vaccines are getting out. So we are seeing some stability from that standpoint. Teresa, would you like to make any comments specifically?

[Teresa White:]

Yes, I’ll make a couple of comments. I agree if the combination of both the virtual environment and as our agents get better with adopting some of the virtual tools, I think we’ll continue to see improvement. But the other thing that I think that we are excited about is the idea of having new product that has been introduced, the dental vision product specifically in some of the broker and the small case market as well as in the larger case market having some of the life and disability products available as well. So we have a great opportunity in the second half to really start selling some of the newer product that we have out there. And so I think that’s what gives us – that’s what makes us excited about the second half of the year, of course vaccines, et cetera.

[Suneet Kamath:]

Okay. Thanks.

[Operator:]

Our next question comes from Gregory Peters from Raymond James. Please go ahead.

[Gregory Peters:]

Good morning. Thanks for squeezing me in. I want a just big picture on – you talked about risk adjusted return on equities, when we look at your slide deck, I mean you have a great track record of ROE. We’ve seen a number of other large insurance companies sort of get away from earnings per share guidance and focus on sort of setting ROE target. So given all the changes and challenges you’ve dealt with last year and with growth being uncertain at least in the near-term. How should we be thinking about sort of the ROE objectives for your company for 2021 and 2022?

[Dan Amos:]

Yes. So Greg, I think we will be operating in a fairly stable environment. We obviously are running at fairly high capital levels and that is putting some pressure on ROE as we go forward. So it makes it somewhat challenging to continue to sort of operating in the strong ROE levels that we have been in the mid-teens. Like for example this year, we came in slightly above 15% for the full year. That being said, I do think that long-term, one way to sort of think about our business is, it’s a fairly capital light products that we sell, both in Japan and in the U.S. And over time I would expect that we should sort of run into sort of 600 basis points above our cost of capital is a reasonable way to sort of think about where our ROE should be over time. Because we don’t have a whole lot of interest rate sensitivity, but it does play a factor in terms of what sort of driving the ROE as well.

[Max Broden:]

Yes. One thing Greg to I would add is, yes, you’re seeing a bit of a migration from EPS to ROE, but also from GAAP earnings to cash flow valuation and the cash flow dynamics of the company remain extremely strong even further advanced than that. I think particularly soon when it comes to Aflac, you’re going to want to focus in on economic value. And what I mean by that is, if you think about our goal with the new businesses we’ve brought on, which is network dental and vision, absentee management, disability and life true group if you will, and then the direct-to-consumer. These are businesses that we expect to combine, contribute upwards of $1 billion of earned premium over the next five to seven years. And that earned premium will have a different GAAP profit dynamic associated with it because it’s in building mode. And as you know, direct-to-consumer, you don’t DAC expenses and so by definition you have lower reported profit. At the same time that business if actuarially appraised, absolutely has value and some would argue great value as you can imagine. So I think as we communicate going forward, it’s not just communicating on EPS and ROE, but it’s also communicating on cash flow and the economic value that we’re driving in the company for the long run.

[Gregory Peters:]

Got it. The second question is more in the weeds, but I know, on you’re prepared comments you talked about, now that COVID – we’ve got a year of COVID under the belt. You’re looking at reserves and using the data sort of set the reserve levels. And I’m just curious, both in Japan and in the U.S., how you’re reconciling one-year’s results with the fact that there’s a rollout of a vaccine? And that may cause data to shift entirely in a different direction over the course of the next 12 months?

[Fred Crawford:]

I commented a bit on this in my script and Max commented on it. Look, it’s a very interesting science right now for valuation actuaries establishing reserves, particularly incurred but not reported reserves. These are practices that these models and so-called completion factors, if you want to use the technical language, are built-off of years-and-years and quarters-and-quarters of information that gives particularly for a stable business like ours, very high confidence in the level of IBNR to set up on a per-product basis. Here, you have pandemic conditions, but you also have not a linear dynamic but a convex dynamic of infections. And as you said, you’ve got these new wrinkles as in vaccination, the amount of vaccinations that rolls out, the acceptance and absorption of the vaccination among the public et cetera. And so it is a tricky environment, but these are incurred but not yet reported claims. Meaning it’s our best estimate right now of what we believe to be claims coming in and in-hand. It is still however an estimate and it’s an estimate under a convex environment. And so we’ll have to continue to back test, monitor and adjust our completion factors accordingly.

[Gregory Peters:]

Got it. Thanks for the answers.

[Operator:]

This concludes the Q&A portion of our call. And I’ll turn it back for any closing remarks.

[Dan Amos:]

Thank you, Carol, and thank you all for joining our call this morning. We look forward to speaking with you soon, if you have any additional follow-ups. And I wish you all continued good health. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.