Aflac Incorporated (AFL) Earnings Call Transcript & Summary

Good morning, everyone. I'm Ryan Krueger from KBW, and we're going to get started with the next session. It's great to have Max Broden, the CFO of Aflac, up on stage with me. Also wanted to recognize David Young from Investor Relations and Capital Markets at Aflac in the front row. Unfortunately, Ben Affleck, their new spokesman, was unable to join us for the fireside this year, maybe next year.

So yes, maybe just to start -- I just want to start with Japan. Certainly, hard to not notice that interest rates are the highest they've been there in 25 years. And you had done some investment repositioning in the second quarter. I think you had indicated maybe more in the third quarter. So hoping to get some sense of, kind of, how much more opportunity there could be to do investment repositioning and take advantage of these higher rates?

Yes. So in Japan, we find ourselves in a situation, obviously, with the yen yield curve being as steep as it is, both in terms of the level of the steepness, but also the absolute levels of yields that we haven't seen for a very, very long period of time. So what we have sort of been looking at for quite some time, and we've been able to execute on in the second quarter is a number of repositioning trades. We, at Aflac, we hold a pretty significant U.S. dollar portfolio on our Japanese balance sheet. And what that means is that when we then run this through our capital level in Japan and when we run this through our local statutory earnings, it creates pretty significant FX, either gains or losses depending on where the dollar-yen rate is. And as the yen has weakened pretty substantially despite, obviously, what's happened over the last week, that means that we have found ourselves in a pretty significant FX gain position. And that's all well and fine, but this coinciding with the steep yield curve has meant that, obviously, our JGB portfolio has found itself in pretty significant unrealized loss position. And what we've been able to do is to transact and reposition the dollar portfolio generating loss -- sorry, gains and reposition the JGB portfolio generating losses, and they, kind of, more or less offset each other. And that means that without leaking anything in terms of taxes out of the company, we've been able to reposition those 2 portfolios now yielding higher yields. So even though the earnings impact on a local statutory basis is essentially neutral from these transactions, it means that going forward, the net investment income of the total portfolios will be on an annual run-rate basis, $50 million higher. The other thing is that it reduces risk overall for us as well. So in Japan, you have an impairment test. So even if you have purely -- even if it's purely driven by rate, if you are down 50% on a security, you have to impair it for local statutory purposes. That -- and the local statutory earnings is predominantly the main driver for your ability to then send dividends out of that entity up to the holding company. So for us, if you have significant impairment risk, that also means that down the line, there could be impacts to your ability to send dividends. And we have greatly with this reduced our total unrealized loss on the JGB portfolio and therefore, also significantly reduced that impairment risk as well. So this was partly an exercise in reducing future risk, but also an exercise in increasing future earnings.

And then just to -- I think it was 5% of your portfolio that you repositioned. Like could you do -- is there an opportunity to do as much as that again? Or any sense of the magnitude that -- of the opportunity that's left?

Yes. So transacting 5% of our total portfolio in 1 quarter is a lot. It's a lot. So our team was very, very active executing on this. When you start a process like this, you should expect that you begin with what is the most impactful and what is sort of the easiest to do. And some of that is behind us. I definitely expect that our investment team will continue to execute on this in a good way. So there is more to come, but I would just keep in mind that 5% is a very, very significant number.

And then the higher rate environment is also driving more demand for savings-oriented products. In Japan, you sell a first sector life product called Tsumitasu, which has had good sales growth recently. I guess, can you talk a little more about what your first-sector strategy is at Aflac in Japan, the risk return profile of the Tsumitasu product and just how much you're willing to grow there relative to your more legacy kind of core third-sector business?

Yes. I'll take the word legacy. Yes, our core business, it is really our cancer and medical business in Japan. And our life insurance and our savings business, I would define as more opportunistic. And the reason why is because now we're exposing ourselves much more to macro risks. That means that there are times where we want to push the gas and there are times where we're going to hit the brakes. Right now, specifically, not only -- I'm coming back to not just the yield level, but more importantly is the steepness on the yield curve is making life insurance very, very attractive from a savings vehicle standpoint in a way that you have not seen for the last 30, 40 years. And it's really the steepness that is doing this because most other savings products, like, for example, CDs or savings accounts, well, they price off of the short end of the yield curve. And the life insurance products, they are priced off of the long end of that yield curve. So that means that the steepness, that is really what defines the relative competitiveness of these products relative to other savings products. So I think from a total demand standpoint, we have a real opportunity in the marketplace right now. That's not just Aflac, it's the whole industry that is benefiting from this. The other angle to it is that the higher yields mean that we can now engineer products with actually very good returns. So right now, I'm seeing new business IRRs that are extremely good for us. We have, on top of that, also designed over the last couple of years, reinsurance solutions and capacity internally that further reduces those returns. So when I look at the IRRs on a post-reinsurance basis, they're highly, highly attractive. So we -- right now, we do want to grow this business. There will be a time where my answer is completely different. And that's what I mean by this being opportunistic. The other angle to it is that Tsumitasu also gives us access to a younger clientele that we can grow into. And that has very significant strategic value to us because that means that 1 year or 2 down the line, we can then cross-sell our cancer and medical policies into this younger cohort of policyholders. So there's both economic and strategic value to grow our life insurance business right now.

And shifting to the third sector. So you grew sales 24% in 2025. A lot of that was driven by the strength of the Miraito cancer product. Now you have a refreshed medical product, too, but you're also lapping the tougher comps with the cancer product. How are you thinking about sales growth for third sector in the second half of this year? And then just any further thoughts on just your strategy to grow the third sector business?

Yes. So our cancer product, Miraito, is fully through its refreshment cycle. It has been out in the market for 1.5 years at this point. That means that it's meeting that sort of maturity level. So we would expect that from a growth standpoint, that will flatten out. And from now on, we're still looking for that product to sort of grow a little bit, but sort of defend the levels it is at. As it relates to our medical business, so Anshin Palette, we refreshed that product. It came out late last year. We had a full first half with obviously, from a growth rate standpoint, very significant growth of that product year-over-year. But in terms of absolute volumes of yen sold, it's still at a pretty low level. So that's a business that we really need and want to take to that next level. Historically, I think we've done pretty well selling that product through our exclusive agency channel. We have not done so well selling through the nonexclusive agency channels. And that's actually a part of the marketplace that has grown a lot in medical over the last 10, 15 years. So I think that's an opportunity for us to strengthen our positioning in that distribution channel with our medical product.

Got it. So third-party reinsurance out of Japan is a newer opportunity for Aflac. You've done one transaction so far with Japan Post. What types of liabilities are you pursuing there? Any early indications on counterparty conversations? And how meaningful do you think this business can become for the company?

So we would not get into a business unless we think it has the opportunity to become meaningful, not just to Aflac Re, but overall to the totality of Aflac as an enterprise. The liabilities that we are looking for is we have capabilities across the spectrum. That means that we can underwrite -- we're willing to take on both biometric risk, longevity risk, and we are willing to take on asset risk as well. If I were to define where I think our sweet spot really lies is really in taking on mortality, longevity, and spread risk. And this may come a little bit as a surprise to you given that if you think about what Aflac generally is, which is a morbidity company, i.e., we're very, very long morbidity. But the fact of the matter is that is what gives us this opportunity. So when we co-mingle our reserve and liability risks that we have, and we are very, very long morbidity and we add a small level of mortality risk to that balance sheet, we add a small level of longevity risk to that balance sheet and a small level of spread risk to that balance sheet, we get very significant diversification benefits, both through an economic lens, but also from a regulatory capital lens. And that is significant competitive advantage for us. That packaged with us having an AA rating of our reinsurance entity means that we have some real core competitive advantages relative to some other players in Japan. And that is something that we're pushing pretty hard on as we continue to have conversations with cedants.

And your Japan benefit ratio has been trending towards the higher end of the 60% to 63% target for the year. Can you, I guess, go over a little bit more details why that's happening, what your outlook is going forward? And then is the general trend of downward movement in the Japan benefit ratio due to favorable claim patterns and mix shift still something you expect longer term?

Yes. So I would generally divide our benefit ratio. And here, we're talking about Japan for a second. It's a combination of the claims incidence rates that are coming in, and it's a function of what we're seeing on the back book. And in our case, lapsation of the back book has a pretty significant impact on our benefit ratio from a quarter-to-quarter basis. When we look at claims trends, they're actually coming in, in line with our expectations. So in the first half, we have seen a reported U.S. GAAP benefit ratio a little bit higher than what we expected. It is not driven by incidence trends. It's not driven by the severity trends in terms of claims. It's really driven by what's happening on the back book in terms of lapsation. Total lapsation is actually in line with our expectations. But what we have experienced is a little bit higher lapsation of younger policies and a little bit lower lapsation of older policies. Why does this matter? Well, if you have a young policy, that means that -- and keep in mind that we are selling regular premium products, that means that the reserve builds up over time. So there's a relatively small reserve that has been built up on, for example, a 5-year-old policy that is now lapsing through our results. When that is lapsing and it runs through the results, that full reserve gets released. And if you have a relatively small reserve being released through the benefit ratio, it pushes the benefit ratio only down just a little bit. If you have an old policy that's been on the books for 20, 25, 30 years, there's a very significant reserve that has been built up. That full reserve gets released through the results, pushing down that benefit ratio quite significantly. So that mix impact between old and younger policies being lapsed is really the key component to it. Now the thing is that when you actually go in and you look at, has there been a significant shift in the number of old policies being lapsed, not really. And part of the reason is that the reserve per policy is actually very, very high. So it doesn't take that many policies to not lapse to actually have an impact on our benefit ratio. So that's been a little bit of an impact over the first half. We would expect this to normalize in the second half of the year and going forward. That's why we do expect that for the full year that our benefit ratio in Japan will still remain at the upper end of our target range of 60% to 63%.

Got it. I guess there have been some encouraging recent developments in cancer treatment with the Moderna mRNA vaccine and there's the Revolution pancreatic cancer drug. I mean I know it's early, of course, but like how are you thinking about the potential impacts of those types of advancements if they continue to be successful over the longer term?

Medical advancements for treatment of cancer is very important from a societal standpoint. And it's also been very good to us. The way our products are designed is that we pay benefits for a specific trigger or a specific treatment. We don't pay for the treatment. What that means is that if you have more use of new treatments coming in, it generally has meant historically that you have less use of some of the benefits that we have written 20, 25 years ago on our in-force block. So what's happened then is that we actually have seen that very favorable claims experience of those older policies being written when there's been new medical advancements or new treatments coming out. What it also means is that it increases demand on the front end to our new policies as we incorporate coverage for these new treatments as well. And that is what's triggering some of this lapse and reissue activity that we talk about pretty much every quarter that policyholders are refreshing their coverage as well. So generally speaking, we view this as positive drivers, both short term and potentially even long term for our business.

On the expenses in Japan, a couple of...

Sorry, I do want to mention one more thing. As it relates to when we get more personalized treatments and personalized vaccines, obviously, the cost of that is likely to be quite high. The way our products are designed, we do cover vaccines, but it's a very limited benefit. So generally speaking, I'll give you one example that we would have a treatment benefit that may be $200 to $300. And it doesn't matter if the vaccine treatment is $500 or if the vaccine treatment is $150,000. We're going to pay the same amount on that. So that means that even though the severity or the cost of the treatment is very, very high, it doesn't necessarily hit the severity claims cost for us.

I had a question on Japan expenses. A couple of years ago, you had guided to a somewhat higher expense ratio going forward as you were making strategic investments in the business. It has picked up some, but it has still also been trending towards the lower end of the target that you have provided. Can you unpack that a little bit? And I assume there's some maybe efficiency actions that are also going on that have kept it lower.

There has been -- and there's also been good work by -- well, maybe I do hope that our Japan colleagues are listening into this, that they should have some credit for good expense management because it is tough to run a business when you have revenue decline. And when you continuously have to cut expenses, it's a difficult environment to operate in. But they've been successful in managing that over time. The other angle to it that have also helped is that we've been driving higher net investment income in Japan relative to the overall income statement. So your proportion of revenues coming from net investment income has increased as yields have increased. And that obviously helps your reported expense ratio. So even though we've done some improvements in terms of absolute expense management, that you've had a further benefit pushing the benefit ratio lower by higher net investment income driven by higher yields as well. So some of that has been given to us, but it's also been good execution. Long term, I do think the right level for our business is in that 20% to 23% range.

Okay. Then broader question just on AI and how is Aflac going about using AI to -- across the company? And what do you actually think it's going to ultimately result in as a benefit for the company?

So obviously, we are deploying use cases across the board in many different areas right now. There is a little bit of a shotgun approach. You have to have that at this point in time. We know that some of these use cases will work out really well and some of them will fail. And it's important that we get those use cases because we don't know exactly what's going to work and what's not going to work. So it's important to try many different areas, but make sure that we fail fast where it's not working. Fundamentally, I absolutely believe that we will achieve significant operational efficiency driven by AI. There's no doubt about that. I am not convinced that it will lead to expense efficiency, though, and that it will ultimately lead to lower expense ratios for us. When you go back and you look at technology advancements in the past, you have seen significant improvements, but it turns out these fantastic technology companies, they want to charge for their products as well. So it sort of comes through in the shape and form of higher IT expenses overall. So we are not banking on or planning necessarily that we will drive or get significant expense efficiency driven by AI. If we get that, that would be fantastic, and that will be upside for us. But we are not assuming that, that will happen, and that sort of will bail us out. If it's one area where I think we and to some extent, the industry could have some pretty good results over the next couple of years, it's really on the policy administration platform side. So we and the industry generally sit on legacy systems. And what AI technology is really giving you the opportunity is migration off of those systems onto either in-house built solutions or other platforms is going to be a lot less risky, a lot cheaper and a lot quicker. And when you add those 3 up, it makes it very, very attractive. So I think when I look at our business today, and from what I've seen in terms of AI use cases that we are deploying, that is probably the area that I think we're going to -- we -- in the near term, over the next couple of years, probably going to see the most impact.

Since I asked about AI, there have started to be some questions from investors about just exposure in the investment portfolio to data centers and hyperscalers. Do you have any update there on Aflac?