Aflac Incorporated (AFL) Earnings Call Transcript & Summary

Well, everything is relative, as you know, and the way you positioned it is the right way. You mentioned at the introduction that I've been at a few different insurance companies over my career and in the position as CFO. And what I tend to tell investors is, the good news is we're not exposed relative to the sector to low-for-long interest rates nor are we exposed to equity market volatility. But at times, the bad news is that we're not exposed to low interest rates, and we're not exposed to equity market volatility. So if rates are viewed as recovering over time and generating better spread opportunities for spread players in the market. And if equity markets continue on their March defying gravity, in many cases, I would say, then you're going to find a lower-beta, morbidity-based player like Aflac going to, on a relative basis, underperform some of those metrics. So there's that dynamic, and that's our business model, and we've signed up to it, and we like it, okay? But in terms of catalysts driving performance going forward, we believe there's really 2 keys to driving value right now. One is short term and one is longer term. In the short term, we absolutely need to recover in a post-pandemic environment and that first sign of recovery, I believe, is going to be sales, and it's going to be sales in the eyes of our investors and as a leading indicator of the company. In Japan, you're needing obviously pandemic conditions to improve, but you're also needing Japan Post to recover and rebuild from its glory point before falling into difficulty. And then in the U.S., it's largely pandemic recovery in the short run. And then over the long run, you have to build upon these investments that we've made in 2019 and 2020 to set the stage for executing on those platforms. So it's easy to say sales recovery, but realize what's embedded in sales recovery. It's -- what's embedded in that is, you have come out the other side of the pandemic with no damage done to our franchise, okay? You've come out the other side of the pandemic with a recovering and rebuilding Japan Post, and you've come out the other side of the pandemic with a viable platform in the U.S. where products are filed and ready to go. They're loaded on to systems with agents and brokers trained and educated. You have sales forces in place. They have digital tools that allow them to operate in a modest pandemic environment or an improved dynamic. The table is set. And the first sign of those payoff is working, including product introduction in Japan is in the sales. So it's easy to say sales improvement. But I think what you and I know, Andrew, you from covering our company for quite a while is that it's not really just sales. It's what that says about the overall model and its progression. So that's what we're focused on. That's what we're focused on. That's what we believe to be the catalyst. I can't peg a stock price for you. That's your job. But clearly, the catalysts are delivering on that storyline and that strategic plan.

And maybe, Fred, just kind of shifting to the sales topic in Japan. Maybe you could give us a kind of a view of how you're seeing '21 to shape up in terms of potential growth and then the longer term. And you've got the new cancer rider in the fourth quarter that came out and then the new medical product in this first quarter. So maybe a little color around that as well.

Yes. Let's talk about Japan first. So one common denominator in both Japan and the U.S. is that we see pandemic conditions as continuing in the first half of the year. Now we study the dynamics, just like all of you are studying the dynamics. And there'll be some mornings where you see very promising signs of reduced cases, vaccine starting to come out. We have yet another vaccine, I think, approved today in the news for rollout. So a third vaccine being rolled out. So in Japan, they're only at around 470,000 or so cases in Japan with 7,500 fatalities. And so while Japan is a very concerned community with states of emergency in play, they are seeing a reduction in cases. They have a very low level of cases and mortality dynamics. And so we see signs that the notion of a second half of the year being more robust than the first half of the year from a pandemic standpoint seems to make sense to us and seems to be tracking that way. The second major issue in Japan beyond the pandemic is Japan Post. Japan Post had a press release, press conference on February 9. And what was very promising and what they said is that they were reopening -- Japan Post Insurance, they were reopening 80 company-owned offices, sales offices, that cater to corporate clients. The term corporate offices or corporate sales offices in Japan is their terminology for work site. So these are offices that are dedicated to typically major corporations and selling insurance into their employees at the work site. And so they reopened 80 of those offices. Those same 80 offices were taking inbound or what I would call reverse inquiries, if you will, people phoning up proactively and requesting insurance policies. So they're not proactively going out to sell, but they are processing inbound inquiries over additional insurance policies. More important than the specifics of that announcement is just the announcement itself. What it tells us is that they indeed have made great progress on their so-called apology tour, meaning going out to existing clients, formally apologizing and restoring the relationship with those individuals that they've made good progress on that. They're starting to see light at the end of the tunnel in the form of opening up certain offices under Japan Post Insurance. And what we have said is we would expect them to be on a track to sort of reopen again in a traditional sense, their post offices for the sale of Aflac cancer policies in the second half of the year or by the second half of the year. If that comes earlier, so be it. But right now, we're -- the best we can tell is we think we're in alignment with their planning by saying second half of the year, but we'll have to monitor that going forward. So that's the Japan dynamic. And then future growth in Japan is related to product. So we did introduce -- we introduced a simplified cancer rider in the fourth quarter, and that has done well. It served to kind of prop up cancer insurance, but realize cancer insurance is going to ebb and flow based on Japan Post. That's a cancer-only alliance, and they are a substantial piece of our cancer sales in Japan. And so we need to see them recover. When they do, they also will be afforded this simplified rider package, which we think will do well in the post office system. We introduced a new medical product in January. And as we mentioned on our fourth quarter call, we only had 2 weeks under our belt, but we're very experienced at product launches in Japan, as you know, on the medical and cancer side, years and years and years of experience. And we can tell early on whether there's traction in the product and whether we're seeing that traction and excitement. And what Dan commented on is we were seeing only a few weeks into January that it was responding. The product was responding in a way that we would normally hope for it to respond even in a pandemic environment. So we think that holds promise. We'll have to see how the rest of the quarter tracks, and then we'll comment on that, but the early days felt good to us. And then as we go long range in Japan, it's really going to be about whether or not we can develop a viable, what we would call, third pillar, if you will, to our third sector lineup. We're a cancer medical, medical cancer, cancer medical company. And at some point in time, we need either income products which are more disability in nature or care products which are sort of supplemental elderly care type coverage. We need those markets to develop in a way and in a robust enough way and risk-adjusted way that they can offer us additional opportunities behind cancer and medical. And we have those products in place. We have development underway but we've yet to really promote it and drive it in the marketplace, and that will be something we'll address over time. U.S. similar story pandemic wise, first half of the year, a little more navigating the pandemic, particularly the first quarter realized we're still up against a very difficult comparable. The first quarter last year was essentially a traditional quarter through about mid-March, where we started to see pandemic conditions start to creep into our sales practice. But really, wasn't a first quarter event pandemic-wise last year. So we're up against a tough comparable in the first quarter. But as we move then into the second quarter, it starts to switch on you, where the second quarter was a particularly depressed quarter in 2020, down some 60% or so in the U.S., similarly in Japan. And so we'll start to see some percentage-wise recovery as we make our way into the second quarter. But we still believe the second half of the year is going to be a better marker for us in the U.S. Now the table is set in the U.S. and by that, what I mean is our dental and vision product is now filed and loaded in 40 states, and we're building state by state throughout 2021. In 2020, we had a 10-state pilot going on for very little sales just to make sure the system was working, the products were working, the administration was working. Now we're truly launching it. And that is all the way down to small business, all the way up to large corporate or large cases. The true group life and disability acquisition from Zurich that is a product that's ready to go right now in the marketplace. The nature of that product is that we do not need to wait on -- and the nature of the reinsurance structure with Zurich is that we do not need to wait on product filings, which could take upwards of 6 to 9 months before you're in the market. We're already now in the market. In fact, we actually sold a $5 million case in the November-December time frame, just as we acquired that we closed on the acquisition in November. So that platform is up and ready to go, will not miss a sale season and is ready to sell product. And then our direct-to-consumer was just now launched and rolled out in 30 states, where we have 3 products that we're offering accident hospital critical illness and those products are out there in the marketplace. It's very slow going, but we think that the D2C platform will be a building platform over time for us. So we spent a lot of time in 2020 in the U.S. Yes, navigating the pandemic, but also readying the stage for a recovery in 2021.

Interesting. So just kind of going back to Japan, then I want to go to U.S. right after. So you're targeting JPY 80 billion to JPY 90 billion by '25. That compares with JPY 51 billion in 2018 and -- '19, JPY 96 billion in 2018. And there were some spikes in 2018, I get that. But I don't know, is there a potential for materially more if you go into those other product areas that you described, Fred?

Yes, income and care, the answer is yes. I think when we look over a 5-year period of time, quite honestly, pandemic recovery, we can see that springing back more in its trajectory. But we are assuming a really slower path of recovery and build in the Japan Post system. Because their issues were not strictly pandemic related. Of course, there was more market conduct related issues that they need to recover from, rebuild from and restructure, and we need to be supportive of them and patient in making sure they do what they need to do to get it done right and create a strong foundation going forward. They're 2 important an institution in Japan and for us to not allow that to happen. So we are assuming a more gradual build and recovery in the Japan Post system. There's not really a reason for that, meaning that's not some sort of plan that was dictated between the parties. We would all like to see a speedy and sharper recovery in that system. But we just think it's prudent to be more conservative given their dynamics. And then what that brings you back to, you're absolutely right. It brings you back to a third sector level that is commensurate with pre-pandemic levels, and I would say, pre-pandemic and pre-Japan Post challenge levels, which was more in that 2016 to '19 or '18 period. '18, we introduced a new cancer product. So you saw Japan Post shoot it up as well as our overall cancer business because that was quite a robust product improvement in design build. So that was a bit of an outlier year in that regard, but you'll see that from time to time. In order for us to move -- when I joined the company, not quite 6 years ago, we were a JPY 65-ish billion kind of player in the third sector space. And then we had augmented that with a first sector savings product called WAYS which was popular in the banking market -- bank distribution because it had that savings component to it. And when I joined the company, it was shortly after that, that we had good news and bad news. The good news was Japan Post started to really build to become a prominent play in our alliance and our sale of third sector business. But offsetting that was the Bank of Japan's 2016 announcement to go to negative interest rates, and we very quickly ascertain that, hey, you can't properly price a first sector savings product or it's at minimum, dangerous to be in that marketplace in a negative interest rate environment. So we just flat dead shut it down. I think we may have been the first major player of any kind in Japan to shut it down. And we did that. And I've been involved in businesses that are interest-rate sensitive. And so we did that. It was not an easy thing to do, and we really pivoted to becoming a third sector player. Fortunately, then we built that JPY 60 billion franchise up into the 90 -- JPY 80 billion to JPY 90 billion franchise, and we want it to be back at that level, that's job one. To go beyond that is really going to require age cohorts. It's going to require grabbing a younger cohort through income, i.e., disability-type insurance and an older cohort through so-called care products, sometimes called nursing care product. Now remember, in both these products, they're supplemental in nature. They have very defined benefit structures so they don't have the type of tail risk that you see with long-term disability in the U.S. or obviously, long-term care in the U.S. So you should not confuse those 2 because these are supplemental in nature, and we're not taking the first dollar losses on those risks are taken by the government in both cases or the Social Security system or the Health system. And so we're very supplemental defined, and that creates an opportunity for us. Those have to build in my mind for us to really take the third sector business franchise to another level. Realize we're #1 in Japan. Japan is the second largest insurance market in the world and the highest penetration of supplemental health products in the world. And so we're talking about moving a franchise up from a pretty, a pretty nice position as a company. It's not like we're a small player looking to build. So again, as I've said to you before, Andrew, my biggest issue is when I look at growth, I look at it and I got a balance to do not risk those 2 most important points of Japan. It delivers us a 200 basis point cost of capital advantage over the rest of the competition in the U.S., and it delivers me JPY 200 billion or close to $2 billion a year in cash flow. And those are 2 precious commodities that while we grow, we cannot risk.

I see. So okay. So then if you think about the U.S. and you've highlighted some amazing opportunities, dental and vision who benefits direct-to-consumer. And I look at Aflac's kind of longer-term guidance out to 2025 of $1.8 billion. That would represent roughly a 2.2% CAGR versus 2019 sales of '20. So the question is, Fred, are you being conservative here? Or do you think that's really the absolute right peg?

It's our -- I think what I would tell you is, so remember, in this business of buying to -- buy to build. So the strategy we've taken, as you know, in the U.S. is to buy the footprint and the franchise and the capabilities and technology, the delivery and the talent that comes with it and then breathe life into it through what Aflac brings to the table in the way of brand, distribution, capital, et cetera. So we have subscribed to a buy-to-build strategy. That buy-to-build strategy has good news and bad news associated with it. The good news associated with it is it wasn't writing very large checks in a seller's market and booking a lot of goodwill and paying for somebody else's growth rate basically. And that's good because we tend to not find a lot of value in the goodwill asset because usually, when we look at a property, we're the ones that are delivering the growth opportunity, not the seller, if you will, or not the property itself. And so we subscribe to that. The bad news is, is because you don't amortize goodwill and because you book restructuring costs or integration costs, oftentimes are defined out of adjusted earnings. The build portion of our strategy is dilutive to operating earnings. It may be the economic long-term right decision for our investors, but it can be painful in terms of the build cost and its operating earnings dynamic. However, what we believe is that done right with our voluntary business, which is really why build makes so much sense and done right, bringing down market, which is a unique Aflac dynamic, the dental and vision opportunities for us can be quite robust as well as true group life and disability. We're not looking to be the biggest player in the marketplace in both those categories. But we're looking to be a top player in the U.S., and we're looking for it to be very profitable and particularly create halo effect in our products. And what do we mean by halo effect? Voluntary products suffer from a couple of things, one of which is penetration. If you are an employer with 1,000 employees, and we offer our voluntary products in your company, we're lucky to get 150 to 200 of your employees or 15% to 20% of your employees to buy our products. And that's because we're on Page 2, if you will, of the benefit enrollment platform. As you move into dental and vision and true group life and disability, dental and vision has an 80%, 85% penetration rate. So now all of a sudden, we're touching 850 of your employees with an Aflac product. And on true group life and disability, it's typically in the 60s, 60%, 65% of your employees. And by touching more of those employees in small companies and big companies, we have much more voluntary capability to drive the voluntary sales, which has very strong risk return dynamics for us as a company given our scale. So the halo effect is as important to us as the actual sale of dental and vision and the sale of true group life and disability. And we think that can be a catalyst to lifting the overall boat. So it's a slow road though. When we bought CAIC in 2009, it was doing about $100 million a year in premium, and we bought it for about $100 million. And today, that platform does nearly $700 million in earned premium, okay? And that represents -- and it went from 125 customers to, today it has 7,600 customers. So we took a platform that was large case and smaller. And over a 10-year period of time, we built it to larger with many more cases, bringing it down market. That's why we have 7,600 customers on that platform. But it did take 10 years. And I might say to you -- you might say, what's your compounded annual growth rate in CAIC, Fred? And I would say, well, from a revenue standpoint, it was about a 20% CAGR and you would say, well, that's fantastic. But it did take 10 years to get from $100 million of premium to $700 million of premium. And so when you look at dental and vision build and you look at group life and disability build, those will naturally build, I think, a little quicker primarily because of the higher penetration dynamic. You have much more premium at stake that you can bring in. So they'll move faster. And we've given guidance on the growth rates in those sectors. But it still takes time. So are we being conservative? I think we're being appropriately prudent, if you will, in realizing that it is a gradual build process. And we obviously are working hard every day to do better than that.

Got it. I guess we're kind of coming down to the hour. But maybe one last question, Fred, about capital. If you -- if we look at the prior to COVID, the payout ratio was about 65% to 80%. But your forward guidance and increased dividend appear to suggest 80% to 90% in the long -- in the near term. So I'm wondering how does Aflac view its longer-term payout ratio as a percent of operating earnings?

I think the -- one, I would say, it stands to reason that you would see our payout ratio migrate up in the short run. And it goes back to my comments. So look, we are asking you as investors to be patient with a buy-to-build strategy in the U.S. and effectively a product-launch strategy in Japan, and that takes patience. And again, the good news is we can do that without disrupting our capital deployment activities, everything from dividend and dividend growth rate to using our capital to defend, if you will, earnings per share growth rates during this period of time. And naturally, in the insurance industry, as you know, when sales are more depressed, you often have more robust cash flows in your corporate setting because you're not paying out as much in the way of acquisition costs, which tend to be heaped or front ended. And as a result, you see more robust cash flows coming out of U.S. and Japan during a period of weakness in sales. We've diverted some of that money towards reinvestment in the platform. We originally were holding on to it for risk purposes, watching the pandemic unfold. We gradually started to release that exercise when we saw that we were migrating materially better than our stress testing was suggesting, as we learned more and more and more about the trajectory of the pandemic. And so we started to pivot then into releasing that capital. You saw that in our share repurchase of $0.5 billion, I believe it was in the fourth quarter. And so you saw that pivot. So what we're really doing right now is we're saying, look, during this period of free cash flow generation, why -- we, again, set the table for another stair-step of growth, particularly in the U.S. We're going to increase the amount of capital deployed as a percentage of our payout ratio to support all of you as investors, reward all of you as investors while you are patient with our build strategy. And that's only fair to do because we otherwise could have acquired a company and announced something "accretive in year 2", which I always put in quotes. And do it that way, but we've chose to build. So it's only fair that we return capital to you while we are going through this period of time. So that's the tact we're taking. We'll then settle into a more consistent payout ratio, which I think is largely defined -- as you put it, Andrew, it's largely defined around being in a position to pay out 80% to 100% of what we would call our FSA earnings and our statutory earnings in Japan and the U.S. and the good news about a third sector platform in Japan and a supplemental health platform or morbidity play in the U.S. is you tend to have a very high ratio of statutory earnings to GAAP earnings and that supports a higher payout ratio of capital. So we do think that payout ratio will continue to be a strength of our stock and the strength of our company. But we're trying to balance that with investing in a build strategy because ultimately, our ability to go from 37 years to 67 years of dividend increase is going to be entirely on the back of being successful with these growth initiatives that grow future cash flow and earnings. So we've got to balance the 2.

Awesome. Well, Fred, great, great insights. Thank you for sharing them, and we appreciate the time.

No, it's my pleasure. Thank you for the good questions. It's good to see you again. I hope everybody is staying safe.

Likewise. Take care now.