Aflac Incorporated (AFL) Earnings Call Transcript & Summary

Good morning. Welcome to day 3 of the Raymond James 42nd Annual Institutional Investors Conference, also done virtually this year. And I'm truly honored to welcome back the management team from Aflac to our conference. They've been a long-standing participant in our conference for, boy, over 15 years. And we certainly appreciate their support, and it's naturally -- it's created quite a following within our conference of the company through the years. From management today, we have David Young, who is Vice President, Investor and Rating Agency Relations; and we have Max Brodén, who's Executive Vice President and Chief Financial Officer. [Operator Instructions] So with that -- with those brief introductory comments, let's start our conversation.

And I think a good place to start is we're approaching the 1-year anniversary of COVID. And it was right after our conference last year that I think everything began to lock down. And I think because you have such significant operations in Japan and in the U.S., I think a good place to start is to just give us an update of the company and where you are with working remotely, where you are with working back in the office, what's your vision of how that might transition over the next coming months.

So first of all, thank you, Greg, for hosting us. We appreciate all the efforts that Raymond James is doing to help us reach investors. Yes. And I'll split up the discussion between Japan and the U.S. because it is a little bit different. If you start with Japan, which is about 70% of our operations and profit generation. In Japan, as you may know, the spread of the virus is significantly lower than what we are experiencing in the U.S. Also, mortality rates are also significantly lower as well. At the same time, the Japanese government have been very cautious, and there are still emergency orders in place for several prefectures, including Tokyo and the surrounding areas around Tokyo. We obviously have Olympics coming up. So I think that Japan will be very slow to get back to normal before Olympics. I think it's -- they're definitely going to make sure that they do anything that they can to make sure that they don't get any sort of spikes ahead of the Olympics. That's very important over there. In Japan, we are currently roughly a little bit more than half of our workforce are in the office today. Throughout this whole pandemic, we have had more employees in the office in Japan than what we have had in the U.S. Japan is a much more paper-based society, and quite frankly, most companies would struggle to have a full remote workforce in Japan, including us. At the peak, we had 72% of our workforce working from home, and gradually, we've been bringing back people to the office more and more. If you shift to the U.S., where we pretty quickly moved to have people work from home, this was something that was both a reaction by Japan moving early in that direction. But also us, as a company, we made that decision. And we have stayed north of 90% working from home throughout the whole pandemic. And I think, currently, we're north of 95% work from home. The plan is to gradually bring back people starting July 1. We've started small, small pockets currently, actually, that we are bringing back people. This is more on a trial basis and also a reaction to where we have seen pockets of performance slipping. This is primarily around customer service center, back-office functions, et cetera. Most of the time, it's a combination of, I would call it, connection -- connectivity issues, work-from-home fatigue and more importantly child care. So in conjunction with this, we're also opening up our child care facilities that we actually help facilitate to our employees. And that needs to go hand-in-hand. So as we bring back some smaller teams, we're also simultaneously opening up our child care centers as well in order to help people relieve that stress and make sure that they can improve their performance.

Excellent. So thanks for that comments. Let's focus, for the purpose of the conversation, on Japan first, and then we'll pivot to U.S. So in the context of -- I think you said 72% work from home at the peak and now you're 50% or so back in the office. Talk to us about sales. That's, I think, the biggest area of focus for many near-term institutional investors. And certainly, it's a focus of your management team. And maybe as part of your answer, you can also provide some update on how your relationship with Japan post is proceeding and new product introduction as well.

Yes. So the sales process in Japan, it's -- naturally, it's a face-to-face consultation process. And it's also important to understand that very often in Japan, culturally, you do not buy a product at the first meeting. Very often, this is a 2-step process, where the first meeting that you have with your agent or sales associate is basically, you go through all the different options and all the different products and discuss your needs. The actual sale and the sort of, let's call it, signing normally occurs in a second meeting. So it's -- that means that if you can't do anything face-to-face, that can initially be viewed as being more cumbersome and difficult to transact. So there's no doubt that this has had a significant impact on our new production over the last 12 months. When we think about more near term, I would say that we have gradually improved our performance in terms of new sales. This is due to both consumers and our distribution channels, pivoting and learning how to transact in this new world. That includes us introducing a virtual sales and enrollment system in October last year. That definitely helped agents reach clients virtually. And also it gives the -- in the comfort of their own home, gives the consumers the ability to buy products as well, not having to travel somewhere or go inside somewhere to meet somebody face-to-face. In terms of products, we had 1 product introduction last year, which was a cancer rider, where basically, we took a number of different riders that we have to our core cancer product chassis and bundled them all together. We call it the all-in cancer rider. This was launched through multiple marketing campaigns last year. And you don't see the same kind of spike in sales that you normally see when we refresh a cancer product because on a rider itself, you generally -- there's a lower premium associated with it. Also, what you'd normally have for our cancer product is when we come up with that refreshed product, there's a significant number of customers that then will update their coverage. And the way they do that is that they lapse the old product that they have and they buy the new one. So that -- the way it flows through our reporting is that it will boost sales and push down persistency somewhat. The net economic impact on our in-force is generally slightly positive from that activity. When you then sell a rider instead, you keep the old policy in force, and you just attach the new premium associated with the rider. It's -- which is going to be relatively small in -- if you compare it to the full base contract. But the margin on that is going to be pretty good. It also means lower commissions being paid out. So from a strictly economic standpoint, we believe that the value of new business created by these riders are quite favorable to us. It should also help persistency over time as well. If we then turn more recent, in mid-January, we launched a refreshed medical product, which we call, EVER. Our medical insurance products tends to be refreshed every 2 years. And if you followed Aflac for a while, you know that whenever there's refreshed product, there tends to be a lot of excitement around our distribution, and we tend to see sales spikes associated with that as well. That is more linked to our cancer product than our medical product. The reason why is because medical product tends to be refreshed every 2 years. There's a lot more sort of product development that goes on, and also competitive spreadsheeting going on when it comes to medical insurance than it does for cancer. It's also a reflection of our market positioning. In cancer, we have a 60% market share. So whenever we do something, we are essentially the market. So there's a lot of buzz, a lot of focus on us when that happens. Medical insurance, we have closer to a 15% market share. So we are one of the leaders in the medical insurance field, but it's not -- never going to create the same kind of buzz that a new cancer product will do. So we tend not -- historically, we have not seen the same kind of sales spikes that we have seen with a refreshed cancer product. That being said, we're encouraged about the early signs that we've seen from the launch of the new EVER product.

Excellent and maybe just building on that answer, you could just give us a little bit more color behind Japan Post. Obviously, pre-pandemic, there was the sales issue that emerged for the Japan Post that created, obviously, a lot of institutional headaches for them and for the industry, frankly. And the expectation was, coming into 2020, the things were going to return to normal. Obviously, the pandemic has caused a pivot on that. But talk to us about how you -- how Aflac is approaching Japan Post as we think about '21 and '22 and the sales outlook?

Yes. So first of all, the sale of our cancer product that Japan Post do was not part of the problem. And the investigations have clearly shown that. It's also the fact that sale of our cancer product was actually never stopped. It continued throughout the whole -- all of the investigations. That being said, obviously, the volumes dropped significantly as the whole mindset in the Japan Post family was really focused internally. And given what was going on, a lot of sales people were scared to sell as well while the investigations were ongoing. The new management team has been in place for a little bit over a year. Matsuda-san, which is the new CEO, is a well-known individual to us before he came to Japan Post, and we have a very good working relationship with him. I would also mention, which is important, that historically, there will always be internally at Japan Post -- keep in mind that Japan Post are a holding company in 3 different listed companies. You have the postal network. You have the Japan Post Bank, and you have the Japan Post Insurance. Most of our sales are obviously going through the post office. But Japan Post Insurance, which is an insurance manufacturer to the Japan Post network, obviously have a natural interest in also being an insurance provider. So there was always a little bit of back and forth between Japan Post Insurance and the rest of the Japan Post Group around them offering our cancer insurance product. And that certainly would apply to any other products in the Japan Post network. The new CEO of Japan Post Insurance, Senda-san, was actually the individual that, from the Japan Post side, was the negotiator to make the investment in Aflac and strengthening the alliance. So he is heavily involved, and he has his personal fingerprints on the alliance with Aflac. So that, we feel very good, and it sort of shows that the relationship is still very, very good, and it's a long-term relationship that we have with them. Now let's pivot to what's going on currently. So in February -- well, let me also say that the last year, Japan Post have been internally focused primarily on looking at their sales processes, looking at compliance, processes, et cetera, redesigning them and making sure that they really get this right going forward. In February, they started to open 80 of their corporate sales offices. So Japan Post is slowly starting to get back to selling products again. In Japan, obviously, they are very focused on the fiscal years, which in Japan ends on March 31. So April 1 will be an important date for them to hopefully get back to selling again. Over time, I think it's unrealistic to expect that Japan Post quickly reaches the volumes that they were at. But we would expect over time, a gradual increase in sales volumes to come from that channel. And long term, we have a very positive view on both the relationship and the distribution power of the Japan Post franchise. So we would expect them to be an important distributor of our product over time.

Makes sense. And your answer regarding just COVID and what was going on in Japan, you mentioned a comment. You said that as a society, Japan is heavily paper-based. And I know at Aflac Japan, you have a paperless initiative that's been ongoing. And I know this is expensive. So -- and so maybe you can give us an update on your initiative to become more paperless, to become more streamlined. And when do you think the heavy lifting on that will be done? And will we see some improvements in the expense ratio post that transition? Or would you take the investment you're making in that initiative and take those dollars -- or yen, I should say, and invest them in other back-office upgrades or technology upgrades?

So first of all, you're right, it's a significant investment that we're making. It's over 3 years. And we had a significant investment in 2020 already. So that's in those expenses that you saw in 2020. That continues on into 2021, and then the investment spend really drops in 2022. 2022 is when we're starting to see the benefits from the project as well, and then they ramp up, and we really start to materialize the benefits in 2023 and beyond. And those should rank -- be about JPY 3 billion per year in annual benefits from this in terms of just purely lower expenses. In terms of the impact on the expense ratio, there is a minor positive benefit, and that most certainly needs to drop to the bottom line. When you have a business like Aflac Japan, that is very, very stable. It's not going to grow fast. It's not -- it's certainly not shrinking fast either. It's -- I think about it as a super oil tanker, that whenever it make turns, it takes a long time, and it's very, very slow. But when you have a very, very stable business, then you need to be very focused on your expense efficiency and capital efficiency. And that's definitely -- I would put Aflac Japan in that category. So we should see some improvement in the expense ratio from that. Again, this is all embedded in the guidance that we gave in November for the expense ratio to be in the 20.5% to 22.5% going forward.

And then since we're tackling one side of the expense equation, it's always important to touch on the benefit side of the equation. I know you talked about some favorable developing IBNR that flowed through the fourth quarter of last year. But I think the benefit ratio for the full year was still up. I think, it was maybe a persistency issue that helped drive it up. But maybe you could just give us an updated view of just the results of the benefit ratio in 2020 and how you're thinking about the gives -- if you will, the give and takes of what's going to move it going forward?

Yes. So 2020, we saw the benefit ratio being up a few basis points, but it was relatively stable. Within that, it's important to also understand that there's a mix shift going on over time, where we have a first sector block that is a little bit over 20% of our in-force today. And our third sector block is a little bit less than 80% of our in-force. The first sector block does carry a higher benefit ratio. So as that block shrinks, you naturally should see all things being equal, our benefit ratio to decline. You have seen in our -- that's why we report out our isolated third sector benefit ratio because I think it's important when you evaluate our business, that's one very important number to sort of look at and track. Our third sector benefit ratio have, over time, come down as well. That has been more linked by a decrease in hospitalization days. So in Japan, it's been a long trend of per treatment in a hospital, the number of days you are in the hospital is gradually declining. And it's because of supply and demand. There's high demand for hospital beds, but there's very low supply. So the government are incentivizing all the hospitals to actually -- not obviously kick patients to the curb, but try to get them out faster. And the fact is that per same treatment, if you compare the U.S., Western Europe and Japan, Japan have, for the same treatment, significantly longer stays in a hospital. So there's definitely room for that to continue to shrink. And that's been a favorable tailwind for us for quite a number of years. It's also the fact that they use more outpatient services as well, which also helps that to decline as well. Overall, I would say that -- from a year-over-year basis, sometimes if we have a product introduction that drives updated coverage, and therefore, you have people lapsing policies, whenever they lapse policies, we generally end up with a reserve release. So new sales tends to lower the benefit ratio. Low sales tends to push up the benefit ratio and the associated persistency rate. So in a year like 2020, yes, the benefit ratio was up a little bit, but we don't really have any concerns about it because this is somewhat of a function of what's going on in sales. So if we have a pickup in sales, especially of cancer sales, I would say, we tend to then get a boost through increased IBNR releases and a lower benefit ratio.

Excellent. Thank you for clarifying the different moving pieces within that. I thought that was a helpful explanation. So we have about 15 minutes left. And we -- I think it's important that we shift to the U.S. operations. And I'm going to follow the same format, Max, with focus on sales and then focus on both the expense and the benefit ratio. So commenting on sales. Obviously, you provided a sense of what was going on from a work-from-home environment within your U.S. operations. And sales clearly were challenged last year. And you also have some pretty important initiatives, especially when it comes to the larger employer network and getting into -- expanding your benefits portfolio of products. So give us an update on how you're seeing -- not so much 2020 results, but how you're thinking the different moving pieces are coming together and how that's going to help improve the result for '21 and '22.

Yes. So well, let's -- I will characterize it as we're still quite dependent on an opening up of big comp. We sell and enroll primarily face-to-face at the work site and primarily towards -- and we target small businesses. This is probably one of the most challenged areas. So we are somewhat dependent on people coming back to the office. Quite frankly, I think that stimulus for small businesses is helpful for us, and that people want to transact face-to-face as well. So there are external factors clearly at play. At the same time, we will have some tailwinds from new product launches that we're doing. So I would say that we, in January, launched a national network dental and vision product. So we're now live nationally. This is a very important upgrade of our product portfolio, which, together with our acquisition last year of Zurich's Group Benefits business, that added group life and disability as well. Having those 2, what we call first-page products, are very important door openers. We like the products by themselves, but we like even more what we expect that to do to our core voluntary benefit offering as well, both in terms of getting access to more businesses, have a higher case win, have a higher penetration in those existing accounts. That should hopefully help our producers make more money, and that means that they stay in the business for longer. And ultimately, whatever that tends to do, that they service their customers better, we get better persistency out of it as well. So these will be relatively small numbers in 2021. But long term, they're very, very important to our strategy in the U.S. I would also say that things are changing somewhat in terms of how you obviously enroll and where people are. I think -- and this is the difference between the U.S. and Japan. I don't think that everybody is coming back to the office. There is a new normal. We have a lot of our employees that are not going to come back or they're going to partially come back. So how you enroll is going to be very, very important. You need a virtual -- a virtual enrollment is definitely here to stay. There's no doubt about that. Because how are you otherwise going to reach that individual that might be employed but is not in the office, right? What we know is that when you go virtual, at least that's been our experience so far, penetration rates or enrollment rates are lower, generally about half compared to when you sit face-to-face. That might be just getting used to the new virtual environment for both the consumer and the producer as well, but that's a challenge that we need to overcome as well.

It certainly is consistent with the concept that insurance is a product that has to be sold -- is best sold versus voluntarily, just willfully going along and buying a product. So I'm not surprised that you should mention that. I want to pivot -- just 10 minutes left here. So we need to talk about the benefit ratio and the expense ratio within the U.S. So first, on the benefit ratio, you had, yes, some COVID-related claim activity. You also had the effect of lower hospital utilization. Can you walk us through the different variables on that, please?

Yes. So in -- I think the fourth quarter is an interesting quarter to sort of analyze that. Earlier in the year, we had very low benefit ratios, as we reported. And that was because lower utilization by individuals. But our COVID-related claims have not been that high. In the fourth quarter, our COVID-related claims, because of much higher infection rates, we saw the big spike in mid-November and it lasted throughout the year. And then obviously, throughout the month of January, and then we started, obviously, to see infection rates go down. With that spike, we booked a pretty significant IBNR related to our COVID-related claims. And this is obviously an estimate, that we would incur significant claims in the fourth quarter. But there's always a lag from when people actually get the disease and whenever they go to a hospital, until they actually file the claims and we get notifications about it. It's not automatic. We tend to see roughly a 60-day lag for most of the products on average until we actually get the full data. So we booked a significant IBNR in anticipation of claims to come in related to the fourth quarter. Our benefit ratio in the fourth quarter was 51.6%, and about 5.1 percentage points were related to COVID claims. So that means that our underlying, excluding COVID, was 46.5%. That's still a very low benefit ratio, and it's lower than what we would expect to report over time. Now there's a negative correlation between COVID-related claims and non-COVID-related claims. And as we get some normalization in the economy, then what will happen is that our claims related to COVID will drop. At the same time, I would expect that our normal claims to pick up because, all of a sudden, people are driving more, getting into car accidents, they're out playing sports. And they get into accidents and heavy injuries. And you're also going for elective surgeries that you probably put off for over a year. So there are claims coming our way as the economy opens as well. We still feel pretty good about the guidance that we gave at Feb of 48% to 51% benefit ratio in the near term, and we would expect to run within that range.

Excellent. So 6 minutes left, I want to cover the expense ratio in the U.S. and then we have to pivot to capital management and your return on equity, benchmarks, thresholds that you guys have established. So on expenses. Obviously, last year in the U.S., there were some digital investments you made. There was also some severance. Just quickly walk us through the different moving pieces there, and then let's pivot to capital management return on equity.

Yes. So our expense ratio in the U.S., it spiked up, and it's a function of lower revenues. It's a function of accelerated technology investments. And it was a function of the voluntary separation program where we booked the severance charge in the fourth quarter. We reduced our U.S.-based workforce by 9% in the fourth quarter last year. Going forward, we would expect to be in the high 30s in terms of expense ratio in the very near term. But over time, we need to work that down to 35% to 37%. That's a function of the new business mix that we have. Some of the businesses that we're adding are in -- they are simply lower expense ratio businesses. So just because of mix, we should get lower. We also expect volume to come back. That's going to help drive down our expense ratio. And then we have significant initiatives, including a workforce reduction, but also other initiatives to drive that down as well. It's extremely important. We have to get that expense ratio down to that range in order to, quite frankly, stay competitive. So we don't really have a choice. We're going to get that expense ratio down.

Excellent. So we -- just a couple of minutes left. I think this is probably the most important area to talk upon, which is you've set an objective on returns. I think it's 600 basis points above -- from a consolidated perspective, 600 basis points above your cost of capital. Ironically, Max, a number of your property casualty counterparts in my universe also have a similar type of threshold when they think of their ROE objectives. Based on what you disclosed, it looks like you've cleared that objective and then some pretty consistently over the last couple of years. So talk about that objective because I know it's -- you're getting away from an earnings growth and focusing on that. And then if you can blend in, just the last couple of minutes, your discussion on capital management because that's also been an important part of the story.

Yes. So we have a significant balance sheet. We have about $130 billion of invested assets. That's a significant contributor to the overall profitability and returns of the company. Therefore, you cannot disregard interest rate levels and credit spread levels when you think about the return on equity. And I do think that -- that's why I think it's actually interesting to sort of instead of putting hard ROE targets out there, think about what kind of business we are in and what kind of value that we are creating. And one way to sort of think about and measure that is the sort of 600 basis points over your cost of capital. And in this case, I'm really -- since we're talking about a return on equity number, we're also talking about a cost of equity number. Now cost of capital, there's an art and a science in terms of what you think that is and how you come up with that. And we can all -- that's a debate for another session. But I do think that the risk profile of our products and our market positioning, that's a realistic sort of target and range for us to be in. Now near term, we are facing some pressures. We -- if you looked at our return on equity, we bid in the mid-teens of late over the last couple of years. Historically, we used to be significantly higher. If you go back to the early 2000s, Aflac consistently reported between 20% and 25% return on equity. Now that was on a lower capital base. So near term, we are making investments and broadening our product portfolio in the U.S. That is initially giving a drag on the ROE. And that's why near term, we're facing quite some pressure on our return on equity. Now to balance that, we do capital management. You saw us increase the dividend by 17.9% here in the first quarter, up to $0.33 per share on a quarterly basis. We bought back a little bit over $1.5 billion of stock last year. I think we were one of the financial companies that did not stop our buyback last year. So we've been a very consistent buyer of our own stock. And we're going to be tactical as we look at buybacks going forward, where we see -- where we can enhance the value of the overall enterprise by buying back our own stock.

Excellent. That is a great place to end our discussion. I thought it was a great summary, and I like the detailed perspectives you gave of the different -- the Japanese and U.S. operations. So for those listening in, of course, David Young is always reachable via e-mail or phone if you have any follow-up questions -- and of course, you can call me as well. But just to conclude everything out, I want to thank Max and David and Aflac for participating this year again. And I wish everyone a happy morning and a good day. So take care.

Thank you very much, and enjoy the conference.