How much of Aflac's 2004 earnings growth came from one-time items rather than core operations?

A meaningful portion. Net earnings of $1.299 billion included a $128 million tax benefit from releasing a deferred tax valuation allowance, a $6 million Japanese pension gain, and a $39 million favorable currency translation effect, offset by a $12 million realized investment loss and a $15 million SFAS 133 loss. Pretax operating earnings rose 19.5% to $1.83 billion, a more representative measure of underlying growth, though the 2004 EPS objective of $2.21 was exceeded even after adjusting for these items.

How exposed is Aflac to yen/dollar exchange rate movements?

Highly exposed in reported results. Aflac Japan's yen-denominated earnings and balance sheet are translated into dollars, so a weaker yen reduces reported income and assets. Management's 2005 EPS scenarios show that a yen at 95 per dollar would add about $0.19 to EPS, while a yen at 115 would subtract about $0.08. Aflac partly hedges this through dollar-denominated Japanese investments and $450 million of cross-currency swaps and yen-denominated Samurai notes, but yen-denominated net assets subject to translation were still $735 million at year-end 2004.

What are the main risks to Aflac's growth and profitability going forward?

Key risks include declining investment spreads, since new money yields in both Japan (about 3%) and the U.S. are below the interest required on policy reserves, which the company has said may force reassessment of new-business interest assumptions; slowing Japanese sales growth, with yen sales up just 1.1% and Dai-ichi Life cancer policy sales falling; the U.S. sales slowdown tied to sales management changes; the eventual opening of Japan's bank distribution channel by 2007; and reliance on Japanese profit repatriations, which fell to $220 million in 2004 from $385 million. Credit exposure is modest, with 98.3% of Japan's fixed maturities investment grade and below-investment-grade holdings at 1.8% of debt securities.

Is Aflac's dividend and capital return policy sustainable?

The dividend is well covered and rising. The 2004 dividend totaled $0.38 per share (up 26.7%), and the first 2005 quarterly dividend was declared at $0.11. Total dividends to shareholders were $192 million, against net earnings of $1.3 billion. Aflac also repurchased $392 million of stock in 2004, with about 27 million shares remaining under the authorization. Statutory constraints apply: Nebraska law requires prior approval for parent-level dividends above $1.1 billion in 2005, which is far above current levels. Parent-company cash flow depends on subsidiary dividends (Aflac declared $643 million in 2004) and management fees.

How will the adoption of SFAS 123R affect Aflac's reported earnings?

Aflac will begin expensing stock options effective January 1, 2005, using the modified-retrospective method. Under prior APB 25 accounting, no option expense was recognized. Pro forma disclosures show the fair-value expense would have been about $33 million after tax in 2004 ($0.07 per diluted share), and the 2005 EPS objective of $2.56 already reflects this change. Management indicated it does not expect a material change in future grant activity, so the earnings impact should be modest and largely predictable.

AFL 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 10, 2005. Cited figures are marked; the original filing is the authoritative source.

Aflac's 2004 10-K shows a strong year for the company, with net earnings rising to $1.299 billion^a ($2.52 per diluted share) from $795 million in 2003.

That figure is flattered by non-recurring items: a $128 million^b tax benefit from releasing a valuation allowance (after the American Jobs Creation Act eliminated the foreign tax credit limitation), a $6 million pension gain, and a $39 million favorable currency translation effect. Excluding these and realized investment losses, management's operating view is more modest. Total revenues grew 16% to $13.3 billion, premiums rose 14% to $11.3 billion, and total assets reached $59.3 billion.

Shareholders' equity grew to $7.6 billion^c. Aflac Japan remains the dominant engine, generating 75% of revenues, 80% of assets, and most pretax operating earnings ($1.4 billion of $1.8 billion). Its growth is substantially sensitive to the yen/dollar rate, which strengthened to 104.21 at year-end from 107.13, and its new annualized premium sales rose only 1.1% in yen terms, below management's expectations.

Aflac U.S. grew more slowly: new sales rose 5.1%^d, its benefit ratio is edging up, and new money yields in the U.S. are below required interest on reserves, a spread pressure management flagged explicitly. Investment yields are declining across both segments, which management expects to continue to weigh on margins.

For investors, the key forward items are management's 2005 EPS objective of at least $2.56 (14.8% growth, assuming SFAS 123R adoption and no currency effect), the decline in Japanese investment spreads, the reliance on Japanese profit repatriation (remittances fell to $220 million from $385 million), and the concentration of risk in yen-denominated assets and liabilities. Credit quality remains high, with 98.3% of Aflac Japan's fixed maturities investment grade.

02—Key points

Key Highlights

Net earnings rose 63% to $1.299 billion ($2.52 diluted EPS), but include a $128 million ($0.25/share) one-time tax valuation allowance release and other non-recurring items.
Total revenues grew 16% to $13.28 billion; premiums increased 14% to $11.30 billion, driven by growth in annualized premiums in force (up 10.1% to $12.6 billion in total).
Aflac Japan generated 75% of revenues and 80% of total assets; its pretax operating earnings rose 23% to $1.40 billion, though yen new annualized premium sales grew only 1.1%.
Aflac U.S. pretax operating earnings rose 11.5% to $502 million, but U.S. new money yields fell below required reserve interest rates, and the benefit ratio is expected to rise further in 2005.
Investment yields continue to decline: Aflac Japan's new money yield was 3.13% and Aflac U.S.'s portfolio yield fell to 7.39%, pressuring spreads; cash and equivalents rose to $3.8 billion largely from securities lending collateral.
Management guides 2005 net EPS of at least $2.56 (up 14.8%) and 2006 growth of 15%, excluding currency effects, realized gains/losses, and SFAS 133 impacts; share repurchases totaled $392 million in 2004.
Shareholders' equity rose to $7.57 billion and the dividend increased to $0.38 per share (up 26.7%); the parent's debt-to-capitalization ratio improved to 21.7% from 24.6%.

03—Questions

Frequently Asked Questions

How much of Aflac's 2004 earnings growth came from one-time items rather than core operations?
A meaningful portion. Net earnings of $1.299 billion included a $128 million tax benefit from releasing a deferred tax valuation allowance, a $6 million Japanese pension gain, and a $39 million favorable currency translation effect, offset by a $12 million realized investment loss and a $15 million SFAS 133 loss. Pretax operating earnings rose 19.5% to $1.83 billion, a more representative measure of underlying growth, though the 2004 EPS objective of $2.21 was exceeded even after adjusting for these items.
How exposed is Aflac to yen/dollar exchange rate movements?
Highly exposed in reported results. Aflac Japan's yen-denominated earnings and balance sheet are translated into dollars, so a weaker yen reduces reported income and assets. Management's 2005 EPS scenarios show that a yen at 95 per dollar would add about $0.19 to EPS, while a yen at 115 would subtract about $0.08. Aflac partly hedges this through dollar-denominated Japanese investments and $450 million of cross-currency swaps and yen-denominated Samurai notes, but yen-denominated net assets subject to translation were still $735 million at year-end 2004.
What are the main risks to Aflac's growth and profitability going forward?
Key risks include declining investment spreads, since new money yields in both Japan (about 3%) and the U.S. are below the interest required on policy reserves, which the company has said may force reassessment of new-business interest assumptions; slowing Japanese sales growth, with yen sales up just 1.1% and Dai-ichi Life cancer policy sales falling; the U.S. sales slowdown tied to sales management changes; the eventual opening of Japan's bank distribution channel by 2007; and reliance on Japanese profit repatriations, which fell to $220 million in 2004 from $385 million. Credit exposure is modest, with 98.3% of Japan's fixed maturities investment grade and below-investment-grade holdings at 1.8% of debt securities.
Is Aflac's dividend and capital return policy sustainable?
The dividend is well covered and rising. The 2004 dividend totaled $0.38 per share (up 26.7%), and the first 2005 quarterly dividend was declared at $0.11. Total dividends to shareholders were $192 million, against net earnings of $1.3 billion. Aflac also repurchased $392 million of stock in 2004, with about 27 million shares remaining under the authorization. Statutory constraints apply: Nebraska law requires prior approval for parent-level dividends above $1.1 billion in 2005, which is far above current levels. Parent-company cash flow depends on subsidiary dividends (Aflac declared $643 million in 2004) and management fees.
How will the adoption of SFAS 123R affect Aflac's reported earnings?
Aflac will begin expensing stock options effective January 1, 2005, using the modified-retrospective method. Under prior APB 25 accounting, no option expense was recognized. Pro forma disclosures show the fair-value expense would have been about $33 million after tax in 2004 ($0.07 per diluted share), and the 2005 EPS objective of $2.56 already reflects this change. Management indicated it does not expect a material change in future grant activity, so the earnings impact should be modest and largely predictable.

04—Continue

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