Aflac Incorporated (NYSE:AFL) Q4 2023 Earnings Call Transcript

Aflac Incorporated (NYSE:AFL) Q4 2023 Earnings Call Transcript February 1, 2024

Aflac Incorporated isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Aflac Incorporated Fourth Quarter Year End 2023 Earnings and 2024 Outlook Call. [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 for Aflac Incorporated. Please go ahead.

David Young: Good morning and welcome. This morning, we will be hearing remarks about earnings for 2023 as well as our outlook for 2024. First, Dan Amos, Chairman, CEO, and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice-President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity, as well as our outlook for 2024. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted, under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans.

For Q&A, we are also joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and 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 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 investors.aflac.com and includes reconciliations of certain non- U.S. GAAP measures. I’ll now turn the call over to Dan. Dan?

Dan Amos: Thank you, David, and good morning, everyone. We’re glad you are joining us. Reflecting on 2023, it was a very good year. Our management team, employees, sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for our policyholders when they need us most, just as we promised. Aflac Incorporated delivered a very strong earnings for the year. Net earnings per diluted share for 2023 were $7.78, adjusted earnings per diluted share was $6.23 were the best in the company’s history despite the weakening yen and the impact of the reinsurance retrocession late in the fourth quarter. Beginning with Japan, Aflac Japan generated solid overall financial results in 2023.

For the year, total adjusted revenues declined 3.6% to nearly ¥1.5 trillion, largely reflecting the impacts of reinsurance and paid-up policies. But this was largely offset by a 7.3% decrease in total benefits and adjusted expenses. Pre-tax adjusted earnings increased 6% to nearly ¥457 billion for the year. As a result, Aflac Japan produced an extremely strong profit margin of 30.5%. I am pleased with Aflac Japan’s 10.9% year-over-year increase in sales, which was largely driven 26% increase in cancer insurance sales with very significant contributions from Japan Post Company and Japan Post Insurance as well as other alliances, Dai-ichi Life and Daido Life. As you may recall, Aflac Japan aims to have a product lined up to meet customers’ needs during any life stage.

Our latest medical insurance is designed to appeal to younger policyholders’ basic needs and older and existing policyholders who want additional or updated coverage. While our medical insurance sales were off for the year, they increased 6.5% year-over-year in the fourth quarter following the introduction of our new medical insurance product in mid-September. Similarly, Aflac Japan refreshed WAYS and Child Endowment in 2022 as a way of acquiring younger customers and also introducing opportunities to sell our core third-sector products to them. Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50. The level of concurrent third-sector sales remains above 50%. Given Japan’s demographics, our product strategy is to fit the needs of the customers at any stage in life.

Acquiring younger customers is critical to our success along with our intense focus on being where the customer wants to buy insurance. We have a broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial protection to the Japanese consumers. We are working hard to support each channel. While the market presents challenges, we expect to reach ¥67 billion to ¥73 billion of sales in Japan by the end of 2026. Turning to the U.S. We also generated strong overall financial results in 2023. Total adjusted revenues increased 2.1% to $6.6 billion. The decline in total net benefits and claims was slightly offset by the increase in adjusted expenses.

Pretax adjusted earnings increased 10.4% to an all-time high of $1.5 billion for the year. As a result, Aflac U.S. produced an extremely strong profit margin of 22.7%. Aflac U.S. sales increased 5% in 2023, which was at the lower end of our expectations. As you know, we’ve been focused on increasing persistence to grow profitable earned premiums. In addition, we continually evaluate new business to ensure that it is profitable. During the fourth quarter, we made some tactical decisions to avoid sales opportunities to certain less profitable larger accounts like those of high turnover. At the same time, we focused on updating our products to ensure that our policyholders continue to realize the value of — our products provide. As part of our efforts, we introduced our new cancer protection insurance policy in the second quarter of 2023.

Since that time, our cancer insurance has increased nearly 25%. 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 the products and the solutions we offer are as 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 the strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face, even when they have major medical insurance. Knowing our products help lift people up when they need us 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. We are confident that the successful execution of our strategy will lead to sales of at least $1.8 billion in the U.S. by the end of 2025. I’d like to end on addressing our ongoing commitment to prudent liquidity and capital management. We have taken proactive steps in recent years to defend our cash flow and deployable capital against the weakening yen. At the end of 2023, we had nearly $2.8 billion of liquidity at the holding company, which means more than $1 billion over the minimum balance. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of our policyholders and balance this financial strength with the tactical capital deployment.

We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both the dividend track record and the tactical share repurchase. 2023 marked the 41st consecutive year of dividend increases. We treasure our track record of dividend growth and remain committed to extending it. Last quarter, the Board put us on a path to continue this record when it increased in the first quarter of 2024 dividend 19% to $0.50. We also remain in the market, repurchasing our shares through 2023 at a historically high level of $700 million per quarter. We have remained tactical in our approach to share repurchase, deploying $2.8 billion in capital to repurchase nearly 39 million of our shares in 2023.

Combined with a dividend, this means we delivered over $3.8 billion back to the shareholders in 2023, while also investing in the growth of our business. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Overall, I think we can say that it’s been another strong year. I’ll now turn the program over to Max, who will cover more details on the financial results for this year and provide an outlook for the key drivers of earnings in 2024. Max?

Max Broden: Thank you, Dan. This morning, I’m going to address our 2023 results before providing an outlook for certain drivers for 2024 that were included in the slides with our earnings materials filed yesterday with our 8-K. Aflac Incorporated delivered very strong earnings for the year as adjusted earnings per diluted share rose 9.9% to $6.23, the highest amount in our company’s history. This result included a $0.19 negative impact from foreign currency and variable investment income was $0.14 per share below our long-term return expectations. In addition, our annual results included remeasurement gains of $0.51 per share, a $0.20 per share non-economic loss in the fourth quarter under U.S. GAAP related to the innovation of our reinsurance treaty with a third-party ceded back to the company, and a $0.04 per share write-off of certain capitalized software development costs in the third quarter.

Our liquidity remained strong with unencumbered holding company liquidity being $1 billion above our minimum balance. Likewise, our capital position remained strong and we ended the year with an SMR above 1,100% in Japan. At the end of 2023, we estimated our internally modeled ESR to be above 250% and we expect the FSA to provide final guidance on the ESR later in 2024. We also estimated our combined RBC in the U.S. to be greater than 650% at the end of 2023. These are strong capital ratios which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. In addition, impairments have remained within our expectations and with limited impact to both earnings and capital. Our Adjusted leverage remains below our leverage corridor of 20% to 25% at 19.7%.

And this will fluctuate with the yen-dollar rate, since we hold approximately two-thirds of our debt denominated in yen as part of our enterprise hedging program to protect the economic value of Aflac Japan in U.S. dollar terms. In 2023, we repurchased $2.8 billion of our own stock and paid dividends of $245 million in Q4, 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 to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Adjusted book value per share increased 10.1% and the adjusted ROE was 13.8%, an acceptable spread to our cost of capital. I’m also pleased with our continued development of our Bermuda reinsurance platform, which resulted in three transactions during 2023.

We will continue to utilize this platform to better manage risk and improve capital efficiency across the enterprise, and we expect these transactions to be part of a series that will improve our run-rate adjusted ROE by 100 to 200 basis points over time, all things being equal. Overall, we’re very pleased with these results, especially when normalizing for one-time items. Turning to Aflac Japan. Its total benefit ratio for the year was 66%, down 140 basis points from the prior year. Throughout the 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 130 basis points favorable to the benefit ratio in 2023. Long-term experience trends, as it relates to the treatment of cancer and hospitalization, have continued to lead to favorable underwriting experience.

Persistency remained solid with a rate of 93.4%, and was down 70 basis points year-over-year, reflecting elevated lapse as customers updated their cancer and medical coverage with our latest cancer and medical products. Our expense ratio in Japan was 19.8%, down 50 basis points year-over-year, driven primarily by good expense control and to some extent, by expense allowance from reinsurance transactions. For the full year, total adjusted revenues in yen were down 3.6% to ¥1.5 trillion. Net earned premiums declined 5.9% to ¥1.1 trillion, reflecting the impacts of reinsurance transactions, paid-up policies, and deferred profit liability. When excluding these three factors, net earned premiums declined an estimated 1.7%. On this same basis, we would expect net earned premiums in 2024 to decline 2.5% to 1.5% when taking into consideration the impact of reinsurance, paid-up policies, and the deferred profit liability reclassification.

Adjusted net investment income increased by 4% to ¥365.6 billion as we experienced higher yields on our U.S. dollar-denominated investments and related favorable FX. This was partially offset by a transfer of assets due to reinsurance. Pretax earnings were ¥456.9 billion or 6% higher than a year ago. For 2024, we would expect our well-priced in-force to show greater stability in terms of the benefit ratio excluding unlockings and to be in the range of 66% to 68%. This is a function of both favorable morbidity experience and improved mix of business. With the current trend in revenues, we are actively reducing our expenses. We are taking both tactical efforts as well as more long-term transformational initiatives and we would expect our expense ratio to be in the range of 19% to 21% going forward.

The pre-tax profit margin for Japan for 2023 was 30.5%, up 280 basis points year-over-year. A very good result. With approximately 30% of the Japan portfolio in U.S. dollar assets, the strength of the U.S. dollar versus the yen has increased the proportion of net investment income as a component of our pretax profit. With a greater contribution to profitability from net investment income in yen terms, our pre-tax margin is naturally pushed up. In addition, having transitioned to option-based currency hedging, we expect quarterly hedge costs to remain roughly in line with what we experienced in the fourth quarter of 2023. In combination with a lower expected benefit ratio, we expect a pretax profit margin of 29% to 31% in 2024. Turning to Aflac U.S. Our 2023 total benefit ratio came in well below expectations at 42.8%.

We estimate that the remeasurement gains impacted the benefit ratio by 500 basis points in 2023. Claims utilization has stabilized, but as we incorporate more recent experience into our reserve models, we unlocked assumptions and released reserves during the year. Persistency increased 130 basis points year-over-year to 78.6%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories. Our expense ratio in the U.S. was 40.6%, up 90 basis points year-over-year, primarily driven by our growth initiatives and higher DAC amortization. We would expect the U.S. expense ratio to decrease over time as these businesses grow to scale and improve their profitability. For the full year, total adjusted revenues were up 2.1% to $6.6 billion.

Net earned premiums increased 1.9% to $5.7 billion in 2023. Adjusted net investment income increased 8.6% to $820 million, mainly driven by higher yields on both our fixed and floating-rate portfolios. Pretax earnings were $1.5 billion or 10.4% higher than a year ago, driven primarily by the lower benefit ratio which was largely impacted by the third quarter unlock and only partially offset by the higher expense ratio. For 2024, we would expect net earned premium growth to be in the range of 3% to 5%. Profitability for the U.S. segment was solid with a pretax margin of 22.7%, driven primarily by the remeasurement gains from unlocking. Looking forward at 2024, as we grow products with a higher benefit ratio and lower expense ratio, like group life and disability, and network dental and vision, you should start to see those changes reflected in our ratios over time.

In 2024, we would expect to operate with a benefit ratio in the range of 45% to 47% and an expense ratio of 38% to 40%. This translates into an expected profit margin of 19% to 21%. In our corporate segment, we recorded a pre-tax loss of $425 million, compared to a loss of $218 million a year ago, primarily due to higher investment tax credits and the impact of the innovation of our reinsurance treaty with a third party. Adjusted net investment income was $54 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 U.S. GAAP purposes negatively by $343 million with an associated credit to the tax line.

The net impact to our bottom line was a positive $39 million. To date, these investments are performing well and in line with expectations. The impact from the reinsurance innovation was a one-time negative of $151 million. Overall, we’re very pleased with our 2023 results and our outlook for 2024. I’ll now turn the call back to David, so we can begin Q&A. David?

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 follow-up. Then you’re welcome to rejoin the queue to ask any additional questions. Betsy, we will now take the first question.

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Q&A Session

Operator: [Operator Instructions] The first question today comes from Tom Gallagher with Evercore ISI. Please go ahead.

Tom Gallagher: Good morning. One numbers question and then one on strategy. Just the numbers question. I guess for the last several years, you’ve had better portfolio yield in Japan being driven by the pivot into USD portfolio. If I look at the last couple of quarters, that seems to be flattening out. So your portfolio yield has been more stable. Can you talk about what’s driving that and what it means for 2024 NII in Japan? And then, Dan, strategy question is, just given the growth headwinds in Japan, would you guys consider anything more meaningful on M&A strategically to help facilitate growth? I know you haven’t really done this in the past, but there does seem to be an element of kind of unavoidable demographic headwind in Japan that you’re fighting against here. So curious what you think on strategy there. Thanks.

Max Broden: Thank you, Tom. I’ll kick it off and then hand over to Brad and then to Dan for the strategy question. As it relates to our investment portfolio and net investment income, you’re correct in noticing that our net investment income has increased over the last couple of years. A portion of that is driven by our increased allocation to U.S. dollar assets. And I do want to remind you that, that is primarily driven by the view that we have of hedging our economic exposure to the yen as it relates to the overall exposure that we have as a company to the yen throughout like Japan. We have now reached what we view to be more of a steady state as it relates to our total U.S. dollar allocation. So from that level, I would expect a stabilization in terms of our total allocation between yen and dollars within the investment portfolio. But as it relates to more of an outlook into 2024 for our NII, I’ll turn to Brad, and he can give you some more color.

BradDyslin: Yes. The only thing I would add is just to remind you that our new money yield is both a blend of lower yen rates as well as the higher U.S. dollar rates. Most of our deployment is planned for U.S. dollar assets and that is to maintain the balances, as Max just described. But we do still like yen spread products when we can locate acceptable outlets. When that happens, then we will put them in the portfolio, and that does result in pulling down the overall reported new money yield just because of the simple math of lower yen rates.

DanAmos: And Tom, in regards to strategy, that’s been an issue we’ve had for several years. We feel like that one of the things we are addressing is cancer or medical product suite is by starting them off on an inexpensive savings plan that gets them to participate with us. We also continue to look for new product. We have still not found that third product or third leg that we want to find and we’re continuing to try things. But I don’t know of anyone right now that I would trade places with in Japan in terms of distribution and product that we have and believe we can continue to grow our business moving forward. Saying that, we have to be realistic that it is an aging population, and it also is a position where it’s not the population is declining, but all in all, I still believe it’s the best market in the country or in the world because of the persistency and our ability to continue to grow it.

And so, I think you’re going to see growth for the next several years. We did lower that number to — from 80 billion just to be cautious, but we’re encouraged. Our Japan Post growth and what’s gone there continues to do very well, and we’ve enjoyed our relationship there. It’s our existing distribution system that was really hurt, both in the U.S. and Japan, by COVID, but more so in Japan because if you look back at COVID, it really lasted an additional year in Japan. And because our agents are commission-driven, our newer agents, when COVID hit, all of a sudden did not have an opportunity to go out and sell one-on-one. And as we’ve always said, our products are sold, they’re not bought. And so, we go out and make those presentations, and we couldn’t do it.

And so people that were normally working for us on a commission basis tried to find other jobs that were salary in nature, and that’s what we’ve been fighting, but it is coming back both in the U.S. and Japan, and I’m encouraged by what I’m seeing there.

Operator: The next question comes from Suneet Kamath with Jefferies. Please go ahead.

Suneet Kamath: Thanks. Just a couple on Japan. And the first one, Dan, just gets back to something you’re just talking about in terms of the ¥67 billion to ¥73 billion sort of target down from the ¥80 billion. Are you viewing that as sort of just a delay? And that, that ¥80 billion is ultimately achievable, maybe a year beyond your original target? Just — I wanted to think about it a little bit longer term.

DanAmos: Well, I certainly think it’s the potential out there. I don’t know what year — because the COVID, with such an anomaly, what I’d like to do is, is to let our people that are there on the — Koide or whoever wants to take this particular question can do it. And then I’ll follow up if there’s any other part you want me to directly address.

Masatoshi Koide: This is Koide Aflac Japan. So let me answer the question. And the reason why we’ve changed our target from ¥80 billion to ¥67 billion to ¥73 billion was because we knew that it would take a longer time. So we do think that we are able to achieve ¥80 billion if we look beyond 2026 or after.

Suneet Kamath: Got it. Okay. All right. And then I just had another question on, I guess, persistency in Japan. If I just think back to Aflac from years ago, it strikes me that part of the reason the persistency was so strong is because you sold at the work site and there just was very little job mobility in Japan so people just kept the products for a long time. And I guess the question is, as you’re shifting now to new distribution channels outside of the work site and to a younger population, which seems to be the objective, should we just expect a natural decline in that persistency over time?