Aflac Incorporated (AFL) Earnings Call Transcript & Summary

All right. Let's go ahead and get this session started. So joining me today are Fred Crawford. COO; and Max Broden, CFO of Aflac. So thank you for being with us today. And thanks to everybody who's joining us in person as well as virtually.

So let's kick it off. First question I had for you is in Japan, I thought maybe we could start with the growth strategy to fuel growth there and improve the growth outlook. I was just wondering if you could discuss some of the components of that and how you'd expect it to impact sales over time.

Sure. First, Alex, thank you for having us, and it's nice to be in person in New York after being away for a while for all of us. Let me comment first. First job or first order of importance is recovery in Japan. And by that, I would say a recovery in our face-to-face model, if you will, distribution model in Japan with COVID. So as many of you may or may not know, Japan has had a very low case count in Japan, and that has actually contributed to strong margins in terms of low benefit ratios as compared to what we thought might be the case when we first entered into the pandemic. But they are quick in Japan to move to states of emergency and clamp down on the risk of the spread of infection. And the reason for that is Japan has very limited hospital capacity. And so they will tend to roll in and out of states of emergency prefecture by prefecture. And in fact, in the third quarter of this year, it peaked out at, I think, over 30 prefectures across Japan in states of emergency, which really reduces the level of activity, the level of proposals that are made by the various agents out in the field. And again, this is a face-to-face method of selling in Japan of, frankly, all goods and services. They don't really have as much of a digital direct-to-consumer dynamic in Japan. So number one is seeing a level of recovery coming off of COVID and having that build. The second area of recovery is, of course, Japan Post. So we have a very large relationship with Japan Post. We sell cancer insurance through 20,000 post offices throughout Japan. Japan Post went through a dynamic prior to COVID that related to selling practices within the insurance operations of Japan Post, not actually associated with Aflac because we sell through the actual post offices themselves. But they had to really go in and shut down to then work with the FSA, the regulator, before reopening again to distribute insurance again. And that really weighed down on our results. And they started the process of reopening just in time to move into the heat of COVID and obviously reduce traffic at post offices and made it very long to recover longer than it might normally take. So we're working with Japan Post to see that a level of recovery takes place in that platform because they're a major contributor to our sales in Japan. So job 1 is recovery from that environment, and we are quite confident that we'll see recovery. But certainly, it's going to be -- require some patience and require some time to recover. But it will recover. Remember, Japan Post owns roughly 7% of Aflac stock. So we, together, have a mutual economic interest in seeing that alliance come back and be strong again. And so we're confident it will. It's a matter of time and over what time frame. Besides that, though, there are certain things we're going to advance the ball. So we've launched a new product in Japan, most notably, our recent care product, we call. Care in Japan is short for elderly care product. And obviously, with an aging population, that's a very important and popular product. It should not be confused with traditional long-term care in the U.S., which I know has plagued the industry in very difficult ways throughout many years. This is a supplemental care product. It's not the primary care that's provided by the government. It's limited in its benefits and in both in -- and so it's not exposed to health care inflation. And it also has very limited interest rate risk because it doesn't build the types of reserves nor does it have any sort of significant reliance yields to support the product. Plus you're also pricing the product at a time of near 0 interest rates in Japan. And so you're covered to that degree, too. So we're quite positive about that product. We think it could be a new and emerging area. We have made markets in Japan before we effectively created what today is known as the cancer market in Japan, effectively created the early days of the medical products. So we really produced the third sector business of Japan, which is health insurance, and we think we can apply that same type of innovation to the care product. We also are building noninsurance services around both cancer and care. We're in 1 in 4 households. And so one of the things that we can do having that market position in Japan is we can provide noninsurance services that surround cancer treatment, diagnosis, living with cancer, screening for cancer. We can also do the same around the care product, and that has actually grown in popularity in Japan. We're not unique in that regard. Many of the large insurance companies in Japan have been building slowly noninsurance services supporting their products, and that's an area that we're building right now.

I think through some of these growth avenues in Japan, when I think about Japan Post and the recovery there, they have shown some -- I mean, Japan Post has kind of shown some projections around insurance commissions that look like they expect it to continue to go down. So I guess, I was just interested in, do you think that, that dynamic of Japan Post will still allow you to see the kind of recovery that you sort of expected there? And when we think about the most recent sales guidance or outlook that you've provided, how big is like the Japan Post component versus the care product and some of the other drivers? Is there a way to dimension that for us?

How big is the Japan compared to the other distribution channels or...

Yes. I mean in terms of the recovery in growth, how impactful is the Japan Post component of it relative to the new product rollout?

There's no question, Japan Post is easily the most significant dynamic related to recovery, and that's simply because they represented at their peak something in the neighborhood of 1/4 of our third sector sales in Japan. So I mean, this is a major distribution platform, even though it's isolated to cancer insurance. And so there's no question that it needs to recover and needs to be part of the recovery story and would be the biggest part of it. We do have high hopes for some of these new products. We do think over time they can mature into being meaningful products, but it will take quite a while to get up to the level of what you were producing through Japan Post at its peak, certainly in over the last 3 to 5 years. In terms of the commission dynamic that you talked about, I am and we are less concerned about the dynamics of what may take place in the way of commission structures as we are. Right now, what you're seeing with the FSA is, as a result of selling practice missteps in the industry, none of which were made by Aflac. But some of the domestic major players, including Japan Post, have tripped over themselves on certain selling practices. And as a result, the FSA is very, very carefully watching companies on their selling practices and their methods of marketing, including incentive programs that are designed to drive that. And so fortunately, we are not in the crosshairs of that. We've never had that type of dynamic. Please realize that there's a very big difference between a health -- supplemental health product and suitability and a life and annuity product, particularly a retirement-like product. And one of the things we benefit from is it's almost always the case. It's very difficult to make an argument that somebody somehow didn't need or saw no value in having cancer coverage or medical coverage in Japan. Whereas retirement and investment-oriented products can be much more dangerous if sold improperly into the marketplace or illustrated improperly. And that's where I think you see a lot of the attention being played, including attention in the banking industry that is spread over to the insurance industry. So we're not immune to it. I think it makes the road to recovery within Japan Post a little slower and a little more apprehensive because they're trying to recover their distribution, while at the same time being one of the players that has been scrutinized over their selling practices. And so as you can imagine, they're being very careful as well as their sales leadership are being very careful and -- but it will recover. It will recover. Japan Post is too large and too important institution also somewhat owned by the Japanese government that they don't come back and become a meaningful player in the insurance and banking market in Japan.

Maybe just in terms of product refreshes, can you walk us through what that looks like over the next 12 months? Is there any products that are going through bigger refreshes in terms of the medical or cancer that we should be thinking about?

Cancer and medical are on cycles, and those cycles are timed around the development of medical treatments and practices more so than influenced by competitive dynamics. And so every few years, every 2, sometimes 3 years, you're typically doing a refresh to your medical product because of advancements and also needing to watch competitive changes and adjustments in the marketplace. On the cancer side, less competitive and more advances in cancer care, cancer medicine treatment, types of cancer exploratory treatments that become more mainstream. And as that takes place, we tend to refresh that product more on a 4 to sometimes 5-year cycle. The last time we refreshed cancer was 2018, and we effectively refreshed medical last year, later in the year heading into this year -- very late in the year heading into this year. And so you can sort of take from my comments when to anticipate the next basic refreshing. Basically, both products are coming up over the next couple of years for refreshment. That usually does spur activity, as you would hope and expect in terms of sales levels. One thing that's very important to understand is if you're going to refresh your cancer product and Japan Post is your major distribution partner in cancer, it stands to reason that you'd want to time the refreshing of the product for the recovery of the platform to take full advantage of that new product. And so that's on a similar time line that we're watching carefully and working together with Japan Post.

So I also wanted to ask you about the nursing care product, I think, called care. I thought maybe you could shed some light on just how you view the risk profile. And then also, what kind of -- how do we think about the targeted returns of that product versus maybe some of the other products that Aflac sells in Japan? You have a lot of morbidity margins sort of been priced in over time for some of those products. So I'd just be interested in any kind of comparing contrast you could give us.

One of the things I say to folks is this is where a Japan franchise learned the intensity of a U.S. ownership when it comes to using terminology around elderly care or long-term care. So you can only imagine that when the Japan product team and growth team came and said there's a real opportunity in the care market. We're not taking advantage of it. We're the largest third sector player in Japan. And Japan is the second-largest insurance market in the world. We probably -- it's an aging population. As we all know, we could probably see a lot of opportunity there. And in all of their excitement incomes, U.S. actuarial oversight, people like Max and myself raining on the parade saying, okay, here's what it can't ever be. And literally, you did what effectively did at our investor conference, you put all of the side-by-side of what all went wrong in traditional long-term care or is simply difficult to manage even in newer forms of long-term care and why that just can't be part of the story in what we look to do in Japan that's never going to pay off. And our industry learned that the hard way, even though the demand has always been there for long-term care and always will be there. So what we did is we structured, obviously, supplemental in nature, which means we stress test that, no interest rate or low interest rate exposure, which we want to have and then limited benefits where the tail is quite a bit more narrow. In fact, in the early stages of needing nursing care, the first -- there's 4 stages of severity in Japan. The first 2 stages, you only get a lump sum payment. There's no continuing payment. It's just a lump sum. As you progress or if you progress into the more severe levels of long-term care, it's a 10-year annuity capped, and the benefit amount is capped, and the time allotment is capped. And that allows you, without any inflation riders or anything that can create a tail event over those 10 years, you can very precisely price the product and understand what the morbidity estimates need to be. And then because it's a relatively new and structured product, we do what you always do and what served us very well as a company. We put in place pads or provisions for adverse deviation that creates a level of comfort. So interestingly enough, the return aspects of that product are very similar to what we would achieve in our blended cancer and medical products across the platform. And in fact, Max actually sent me a note on this and said, by and large, as we look at it, the actual profit stream, IRR and returns near that of our other supplemental products. And that was the goal. We want this to be a lot more looking like medical and cancer and not at all looking like what you picture with traditional long-term care.

And just to add to that. So in fact, when you compare what we expect from the care product and you compare that to our cancer product, you see a lot of similarities. So very low lapses, very strong persistency, long duration of the policy, but also overall, the cash profile on an actuarial basis is very similar. Therefore, we would expect that the risk return would also be very similar to our cancer block.

And unlike medical, it's not like a spreadsheeted dynamic. This is a bit of -- this is a very small market right now that we're looking to grow by having our brand power behind it and our distribution power behind it. So it's different. Medical is highly, highly competitive. I use the term spreadsheeted, meaning you are going into distribution channels where you're being compared to 5, 6, 7, 8 very, very competitive, large, strong companies. Cancer, we've got such a footprint and such a dominant and exclusive distribution relationships that we don't have that same pressure. Same thing on nursing care. This is not one where we're sitting down and we're lining up 5 different products and needing to be the cheapest one on the block or anything like that. It's looking to build a market. And our basic approach to the market in Japan is the richness of benefits. We tend to never be the cheapest product. In fact, that's what holds us back sometimes. We tend to not do well, for example, in independent, nonexclusive channels because we try to sell on the value of the benefit, not the low premium dynamic. And that's a harder sell, unfortunately. It shouldn't be. But it's a harder sell to say, look, comparing this policy to this policy, if you get into health problems, you're far better off with our policy. Therefore, it's worth the money. That's a harder sell than just here's the cheapest one. So -- but that's what we have built our franchise on, and we believe in that.

So before we leave Japan, I figured now would be a good time to ask a question on the FX hedging strategy. And I think as an outside observer, sometimes it's difficult to see exactly how the strategy and all interacts. But I think at a high level on the surface, it seems like the hedge ratio has sort of come down recently. And so one could kind of conclude that maybe there's some more FX risk taking being done there, investing in USD assets and yen-based business. And so maybe you could help us think through that and sort of what goes on at the corporate level as well.

Yes. So it's a correct observation that over time, our U.S. dollar exposure associated with our Japan balance sheet has increased over time. And the reason for that is not that we want to take on more currency risk. In fact, we want to limit the currency risk as much as possible, both for Japan policyholders but also for U.S. dollar investors as well. So there's a balancing act between those 2 that we always need to balance. And the philosophy that we have is that claims payments going out to Japanese policyholders, we need to hold that expected capital or those reserves in Japanese yen. Everything that is not going to be eventually paid out in claims to Japanese policyholders belongs ultimately to the shareholders and will find its way through dividends and other sources up to the holding company. And that holding company ultimately would want to get those payments in U.S. dollars. So therefore, when we look at what is the economic surplus of Aflac Japan, that is what we ultimately want to have in U.S. dollars. And we can gain that exposure through a range of different instruments that can be held on balance sheet in Aflac Japan as investments into U.S. dollar securities, but it can also be gained at the holding company by issuing debt securities in -- denominated in yen. And we also enter into forward contracts where we gain exposure to the yen at the holding company as well. So all of this sort of adds up to what we view to be the stressed economic value of Aflac Japan and that, over time, will find its way up to the holding company and ultimately back to shareholders. So what we want to do is to limit that FX exposure and that currency risk as much as possible. Now doing this means that we have been holding more U.S. dollar assets on balance sheet in Japan. And for that, obviously, we have higher capital charges associated with that. So from a Japan lens perspective, that becomes a return on capital calculation. So we have to hold more capital. At the same time, we earn a higher rate of return relative to the equivalent yen asset. And as long as that makes economic sense from a Japan perspective, it also makes economic sense from a holding company investor standpoint as well, then this makes sense. So that is sort of how our thinking has evolved over time. And we have found ways to, on a risk-adjusted return basis, improve the overall risk profile, we believe, of the company.

And I guess, just going on the question or the comments on the use of excess capital. Specifically, I think you guys have talked about it in terms of the current solvency margin ratio. I'd just be interested, are there any differences in the way the economic solvency ratio that I know is still a long way off, but I think you guys have been a little more transparent around communicating that ratio to us as well, are there any implications to that ratio and the sensitivity there?

So from a currency standpoint, very little. And also, from a credit risk standpoint, very little. Where there is significant change is on -- when it comes to interest rate risk. So currently, we are obviously mark-to-market the assets for the interest rate component but not the liabilities of the balance sheet. Therefore, when interest rates move down, then the solvency margin ratio goes up, which is counterintuitive for an insurance company, obviously. When we move into the ESR world, this is going to change. And in fact, the opposite will be true where interest rates going down will lead to a lower ESR. So over time, we believe that this moves the capital regime more towards an economic capital regime, and you would also see more stability in the overall capital ratio.

Got it. Okay.

Meanwhile, we do have a strong ESR and SMR. So our SMR is traveling up north of 900%. Our ESR is traveling north of 200%. And those are extremely strong by any measure, and that's largely because, at the end of the day, we're a morbidity play. And morbidity, particularly granular morbidity over 25 million policies, plays well in those types of economic capital models. And so we benefit from that.

All right. Maybe switching gears over to the U.S. side of things. When I look at the big picture there, can you help me think through the different ways that you're looking to spur more growth out of the U.S. business? I'd love to hear more about the employee benefits, the direct and also just sort of the recovery in face-to-face and some of the things going on with the business you've been in.

Yes. So albeit more dynamic, similar to Japan, job 1 is first see the recovery in your core platform. Now interestingly, our group voluntary benefit platform, which has -- is now 11 years old, going on 12, that is doing very well, has been doing very well, did actually reasonably well during COVID and has recovered very quickly coming through COVID or the severity of COVID. And so that business from a sales perspective is growing nicely sort of a high single-digit-ish type growth rate. The part of the business that needs to recovery is the small business, agent-driven and yes, again, face-to-face environment. And again, in the U.S., we are a worksite company. And so it's very easy to understand why you might see quick recovery on the group side because, like many of us in this audience who work for larger companies, we sign up for our benefits every year online through a systematic approach to our employer. Small businesses are enrolled often face-to-face with agents that come into the company and go person by person. We're talking about the 3 employee to 99 employee businesses, that's why we define small business. And that agent being in that worksite, okay, is important in actually making the sale and converting sales. They also, interestingly enough, do that in part by going around to everybody who actually has an Aflac policy to make sure that they've done everything they need to do on filing claims and seeing the value in the policy. Interestingly enough, when face-to-face goes down in the small business market in the U.S., yes, you see sales come down. You also see claims come down, not as much in the way claims are generated by these agents in there, educating everybody on the policy and asking very simple questions. Did anything happen to the family, you, your spouse? Did you go to the doctor and you're eligible for a wellness benefit? All of those issues lag, if you will, when there's not that face-to-face interaction. And what you had is many small businesses that were not allowing agents rightfully so into the worksite, sometimes allowing for a virtual method of enrollment through Zoom or what have you. But interestingly, the agents I talked to, they would tell me -- this is not particularly scientific, but generally, what I would gather is their close rate on a Zoom call would be about half that of meeting face-to-face. And that doesn't really seem to surprise anybody on the surface when you think about it, but it's meaningful when you talk about the effectiveness of an agent selling on commission only and needing to do the job. So that fortunately in the U.S. is recovering more quickly, more quickly than Japan. It's opening up more. You're seeing more of that activity, and you're seeing it in our numbers with sales trajectory improving quite a bit quarter to quarter to quarter. I think we're now operating at 85% of pre-pandemic levels, which is very good, and I think it's improving from here. I would say then there's the 3 new businesses, and these are the real deltas in our business model. And by 3 new businesses, I mean, the true group life and disability that we acquired from Zurich. We're very pleased with that business. We're particularly pleased with the quality of that business. They have the benefit of starting from scratch. Most of these true group life and disability platforms that are out there with much larger players, with much more scale also have a lot of legacy systems they have to work through. And those legacy systems make it more difficult on the expense ratio, but they also make it more difficult in data and analytics supplied to the employer, particularly around leave management. So Zurich did the right thing at the time. They started from scratch with a bunch of experienced people, and they built it the way it should be built. We stepped in mid-build, bought that property, and we're continuing to build under the Aflac umbrella. And so what we're particularly proud of is that it's got good products, but the products are fairly generic across the industry. The big difference makers, do you know how to do leave management? Can you do it well? Best example of that is the State of Connecticut that awarded us their Paid Family Medical Leave administration business for the entire State of Connecticut and all eligible citizens in Connecticut. That's a testimony to being good enough at that and dynamic enough at that to be able to award -- be awarded a contract like that. Our network dental and vision business is growing. It's growing slowly because before pandemic, we made the conscious decision to introduce network dental and vision in the small business market first, because that's a very needed product in that market, and it benefits from halo effect. If we can sell network dental and vision to a company that reaches 60% of their employees, that helps the sale of our voluntary product, where, on average, we tend to only sell to about 15% to maybe 20% of the employees in a given business. So that halo effect allowed us to really justify the acquisition and really grow it organically, but it started in small business just in time to be hit by COVID. So that will pop up as small business recovers and our small business franchise recovers. And then direct-to-consumer, we've always been in it, but we wrap a bow around it, put more science around it, put more systems in it, design products especially for it. And basically, that's a leveraging of our brand. We're just leveraging our brand, our brand awareness. We do about $30 million to $40 million a year of direct-to-consumer. By accident, people see our ads on Saturday morning football or whatever the case may be, and they try to contact us, and they call our 1-800 number, and we process that. We decided a few years back, now let's make this an outright fundamental business, do it right, grow it and have a real digital answer in the marketplace. And so we're happy with it. All of those together, those 3 businesses have gone from 5% of our sales in the first quarter of this year to 13% of our sales in the third quarter. So we've gone through the acquisition, integration, launch mode, and we're now into the benefit realization mode and expected things from those businesses.

So maybe we can move on to the accounting changes coming in 2023. I think you all have provided more disclosures than most companies thus far. So I'd just be interested to hear, maybe if you could just take us through some of the more impacted areas and how you view the accounting changes versus the actual economic impacts.

Yes. Absolutely. So accounting has gone really exciting all of a sudden. And so in our most recent Q, we announced that the LDTI adoption upon and implementation, which is the implementation is next year, but the adoption date was actually December 31 of last year. So at that time, we expect to record an $18 billion to $20 billion adjustment to our AOCI, which obviously will impact our total shareholders' equity, but obviously, more importantly, the ex-AOCI shareholders' equity will not be impacted by this adoption. So why is it such a big impact? It all leads back to a big, big block of business in Japan and predominantly our cancer block, which is a very long duration, generally more than 20 years. And when you have such long durational policies that were written a long time ago in a much, much higher interest rate environment and we locked those rates in when those policies were written under FAS 60, we now are resetting those rates. So the negative investment margin that we have earned over time gets accelerated in upon the adoption date through AOCI. But what we also know is that we have had a very favorable morbidity experience. So the morbidity margin over time have been significantly larger than the negative investment margin. But what we're not doing is that we're not accelerating in the very favorable morbidity margin. If we were to do that, if FASB would have allowed us to do that, we would have had actually a very favorable AOCI component instead of a very negative. So all this being said, what does it actually lead to? Well, on an ex-AOCI basis, no change. Obviously, on a total shareholders' equity, an $18 billion to $20 billion decline in shareholders' equity. When you then turn to economics and cash flows, there's actually no change. No change to our capital levels, capital ratios, either in Japan or the U.S. No change to our FSA earnings, which drives dividends out of Japan. No change to our statutory earnings, which is driving dividends out of our U.S. entities. And most importantly of all is that we are not changing the way we view, evaluate, manage the company, products or how we manage capital within the firm as well. So all that being said, the $18 billion to $20 billion is an eye-popping number, but it's a noneconomic number, and it doesn't lead to any change or view that we have in the way we either manage the company or view the value of our business.

So I thought I'd open it up. Does anybody have a question in the audience? All right. So maybe I'll ask a question about your ESG efforts. I know Aflac has done a lot there. So maybe if you could take us through some of that.

Well, I think like most companies that appear at the conference here, folks are working really, really hard and have been for several years, long before ESG, to be a good corporate citizen, and quite frankly, governance has been front and center for everybody for quite a while. I think where we're focused right now in ESG is real tangible, measurable advancements that we can put forward as objectives, tie it to incentive comp, meet those objectives and report on those objectives. And so we'll be very tangible about it because I think the world as well as investors are probably getting a little bit wary of the constant drumbeat of the story line, if you will, of ESG. And they just want to know why it matters and what you're doing. So what we did when we sat down this year going into ESG, is we said, look, let's set 5 basic objectives. So number one, let's advance the ball on our investment practices to be ESG-ready with all of the screens in place. We capped that off with a tangible move and announcement a couple of weeks ago where we are officially a PRI, Principles for Responsible Investing, signatory. This is becoming more important in the U.S., but I can tell you, it's exceptionally important in Japan. And so being a PRI signatory commits you to advancing the ball in very stringent guidelines of how you invest your capital. The second is we wanted to issue a sustainability bond. We did that. We issued a $400 million sustainability bond to put that money to work. And that was a real milestone because in order to issue a sustainability bond, you can't get there unless the audited practices of how you use the money and invest the money square with the requirements to be designated the sustainability bonds, so a real tangible thing. Diversity and inclusion. We want to hit 23% women in officer positions in Japan, and we're on track to do that. We have a long-range target of 30%. Women in officer positions is a major, major effort in Japan as a corporate dynamic. It is really their diversity initiative. It's got economic implications to Japan as well as cultural implications. We're on pace to do that. We committed to put $600 million to work for diversity and inclusion investments, social good investments out of our general account, and we have committed to doing that. That included a sound point investment that we made in equity ownership that is designated towards opportunity zones, investing in transitional real estate located in opportunity zones where we can make good money on those investments. It fits into our portfolio guidelines, our loan guidelines and yet still advances the ball in a tangible way. And last but not least, the reporting, and so issuing a sustainability report through TCFD, advancing that ball. I would say, what capped that off is we learned a couple of weeks ago that we were added to the Dow Jones Industrial Sustainability Index, which we think is meaningful, and it's important recognition. So what we're trying to do is say, look, we have a great story. Many companies have a great story. We have an incredibly diverse Board and executive team. We have sent $130 million of donation to the Aflac Cancer Center and have one of the leading platforms, leading cancer in children or cancer and blood disorder. We have done a lot of good things as a company. But what we want to do is be very, very specific, very targeted goals embedded in incentive comp, so that if we do what we say we're going to do, you see incentive comp bump up 5%. If we don't achieve everything, okay, and it's a zero tolerance, you have to achieve everything, okay, it's either flat comp or down 5%, okay? So put it in your incentive comp as well. And that's the way we've approached ESG. And that's the way we're going to continue to approach it.

Well, thank you for joining us. We should wrap it up here. And thanks, everybody, in the audience as well.

Thanks.

Thank you.