SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 For the quarter ended June 30, 1996 Commission File No. 1-7434 AFLAC INCORPORATED ------------------------------------------------------ (Exact name of Registrant as specified in its charter) GEORGIA 58-1167100 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1932 WYNNTON ROAD, COLUMBUS, GEORGIA 31999 ----------------------------------------------------- (Address of principal executive offices and zip code) Registrant's telephone number, including area code (706) 323-3431 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . ------ ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class August 2, 1996 ---------------------------- ------------------ Common Stock, $.10 Par Value 139,450,624 shares
AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - June 30, 1996 and December 31, 1995.................... 1 Consolidated Statements of Earnings - Three Months Ended June 30, 1996 and 1995 Six Months Ended June 30, 1996 and 1995................. 3 Consolidated Statements of Shareholders' Equity - Six Months Ended June 30, 1996 and 1995................. 4 Consolidated Statements of Cash Flows - Six Months Ended June 30, 1996 and 1995................. 5 Notes to Consolidated Financial Statements................ 7 Review by Independent Certified Public Accountants............................................. 10 Independent Auditors' Report.............................. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 12 Part II. Other Information: Item 1. Legal Proceedings................................. 25 Item 6. Exhibits and Reports on Form 8-K.................. 25 Items other than those listed above are omitted because they are not required or are not applicable. i
Part I. Financial Information AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets (In thousands - Unaudited) June 30, December 31, 1996 1995 ------------- ------------- ASSETS: Investments: Securities available for sale, at fair value: Fixed maturities (amortized cost $17,205,532 in 1996 and $17,104,743 in 1995) $ 19,159,359 $ 19,675,006 Equity securities (cost $82,633 in 1996 and $80,912 in 1995) 121,847 108,062 Mortgage loans on real estate 19,164 22,213 Other long-term investments 2,996 3,343 Short-term investments 490,701 232,201 ------------ ------------ Total investments 19,794,067 20,040,825 Cash 3,695 4,139 Receivables, primarily premiums 226,391 320,543 Receivables for security transactions 19,889 568 Accrued investment income 269,091 256,659 Deferred policy acquisition costs 2,558,524 2,565,027 Property and equipment, net 516,576 552,061 Securities held as collateral for loaned securities 1,068,551 1,378,197 Intangible assets, net 101,239 104,546 Other 112,856 115,421 ------------ ------------ Total assets $ 24,670,879 $ 25,337,986 ============ ============ See accompanying Notes to Consolidated Financial Statements. (continued) 1
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In thousands, except for per-share amounts - Unaudited) June 30, December 31, 1996 1995 ------------ ------------- Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 17,881,500 $ 18,000,296 Unpaid policy claims 1,041,412 1,016,295 Unearned premiums 289,060 301,452 Other policyholders' funds 196,150 316,938 ------------ ------------ Total policy liabilities 19,408,122 19,634,981 Notes payable 412,997 327,268 Income taxes, primarily deferred 1,264,127 1,397,709 Payables for return of collateral on loaned securities 1,068,551 1,378,197 Payables for security transactions 72,896 80,014 Other 416,900 385,676 ------------ ------------ Total liabilities 22,643,593 23,203,845 ------------ ------------ Shareholders' equity: Common stock of $.10 par value. Authorized 175,000; issued 156,826 in 1996 and 156,358 in 1995 15,683 15,636 Additional paid-in capital 203,211 196,928 Unrealized foreign currency translation gains 221,298 213,319 Unrealized gains on securities available for sale 274,140 482,787 Retained earnings 1,723,503 1,577,605 Treasury stock (409,963) (351,117) Notes receivable for stock purchases (586) (1,017) ------------ ------------ Total shareholders' equity 2,027,286 2,134,141 ------------ ------------ Total liabilities and shareholders' equity $ 24,670,879 $ 25,337,986 ============ ============ Shareholders' equity per share $ 14.42 $ 15.03 ============ ============ Shares outstanding at end of period 140,605 141,974 ============ ============ See accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect the three-for-two stock split paid on March 18, 1996. 2
<TABLE> AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings <CAPTION> (In thousands, except for Three Months Ended June 30, Six Months Ended June 30, per-share amounts - Unaudited) --------------------------- --------------------------- 1996 1995 1996 1995 Revenues: ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Premiums, principally supplemental health insurance $ 1,461,484 $ 1,634,094 $ 2,917,847 $ 3,085,866 Net investment income 252,885 274,010 504,284 513,043 Realized investment gains (losses) 214 (435) (429) 149 Other income 27,074 25,102 49,875 47,389 ----------- ----------- ----------- ----------- Total revenues 1,741,657 1,932,771 3,471,577 3,646,447 ----------- ----------- ----------- ----------- Benefits and expenses: Benefits and claims 1,208,051 1,355,114 2,417,060 2,560,060 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 41,348 44,492 82,564 82,833 Insurance commissions 191,819 214,832 383,789 407,274 Insurance expenses 108,734 115,197 210,685 211,948 Interest expense 3,953 4,419 9,039 8,010 Other operating expenses 43,510 38,792 77,015 70,456 ----------- ----------- ----------- ----------- Total acquisition and operating expenses 389,364 417,732 763,092 780,521 ----------- ----------- ----------- ----------- Total benefits and expenses 1,597,415 1,772,846 3,180,152 3,340,581 ----------- ----------- ----------- ----------- Earnings before income taxes 144,242 159,925 291,425 305,866 Income taxes 58,495 67,009 119,155 128,077 ----------- ----------- ----------- ----------- Net earnings $ 85,747 $ 92,916 $ 172,270 $ 177,789 =========== =========== =========== =========== Net earnings per share $ .59 $ .61 $ 1.18 $ 1.17 =========== =========== =========== =========== Shares used in computing earnings per share 144,879 151,711 145,623 152,284 =========== =========== =========== =========== Cash dividends per share $ .10 $ .087 $ .187 $ .164 =========== =========== =========== =========== See accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect the three-for-two stock split paid on March 18, 1996. 3 </TABLE>
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In thousands - Unaudited) Six Months Ended June 30, 1996 1995 Common stock: ------------------------- Balance at beginning of year $ 15,636 $ 15,600 Exercise of stock options 47 26 --------- --------- Balance at end of period 15,683 15,626 --------- --------- Additional paid-in capital: Balance at beginning of year 196,928 192,899 Exercise of stock options 3,617 1,930 Gain on treasury stock reissued 2,749 710 Cash in lieu of fractional shares (83) - --------- --------- Balance at end of period 203,211 195,539 --------- --------- Unrealized foreign currency translation gains: Balance at beginning of year 213,319 174,091 Change in unrealized translation gains 7,979 51,793 --------- --------- Balance at end of period 221,298 225,884 --------- --------- Unrealized gains (losses) on securities available for sale: Balance at beginning of year 482,787 228,844 Change in unrealized gains and losses (208,647) 309,449 --------- --------- Balance at end of period 274,140 538,293 --------- --------- Retained earnings: Balance at beginning of year 1,577,605 1,277,487 Net earnings 172,270 177,789 Cash dividends on common stock ($.187 per share in 1996, $.164 per share in 1995) (26,372) (24,260) --------- --------- Balance at end of period 1,723,503 1,431,016 --------- --------- Treasury stock: Balance at beginning of year (351,117) (135,776) Purchases of treasury stock (2,356 shares in 1996 and 3,426 shares in 1995) (71,810) (91,692) Shares issued to sales associates stock bonus plan and dividend reinvestment plan 12,964 3,684 --------- --------- Balance at end of period (409,963) (223,784) --------- --------- Notes receivable for stock purchases (586) (1,180) --------- --------- Total shareholders' equity $2,027,286 $2,181,394 ========= ========= See accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect the three-for-two stock split paid on March 18, 1996. 4
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands - Unaudited) Six Months Ended June 30, ----------------------------- 1996 1995 ------------ ------------ Cash flows from operating activities: Net earnings $ 172,270 $ 177,789 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 1,209,231 1,259,901 Deferred income taxes 37,748 35,271 Decrease in income taxes payable (48,612) (44,623) Increase in deferred policy acquisition costs (119,442) (131,115) Increase in receivables and advance premiums (41,643) (6,536) Other, net 56,737 90,179 ----------- ----------- Net cash provided by operating activities 1,266,289 1,380,866 ----------- ----------- Cash flows from investing activities: Proceeds from investments sold or matured: Fixed-maturity securities sold 547,855 353,379 Fixed-maturity securities matured or called 416,808 356,788 Equity securities 7,695 9,146 Mortgage loans, net 2,814 2,364 Other long-term investments, net 347 170 Costs of investments acquired: Fixed-maturity securities (1,982,971) (1,980,425) Equity securities (9,337) (10,394) Short-term investments, net (270,561) (77,857) Additions to property and equipment, net (5,126) (10,429) ----------- ----------- Net cash used by investing activities (1,292,476) (1,357,258) ----------- ----------- (continued) 5
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In thousands - Unaudited) Six Months Ended June 30, ----------------------------- 1996 1995 ------------ ------------ Cash flows from financing activities: Proceeds from borrowings 125,918 87,000 Principal payments under debt obligations (19,863) (11,315) Dividends paid to shareholders (26,372) (24,260) Purchases of treasury stock (71,810) (91,692) Treasury stock reissued 15,713 4,394 Other, net 3,581 1,956 ----------- ----------- Net cash provided (used) by financing activities 27,167 (33,917) ----------- ----------- Effect of exchange rate changes on cash (1,424) 4,333 ----------- ----------- Net change in cash (444) (5,976) Cash at beginning of year 4,139 17,643 ----------- ----------- Cash at end of period $ 3,695 $ 11,667 =========== =========== Supplemental disclosures of cash flow information: Cash payments during the year for: Interest on debt obligations $ 7,491 $ 6,962 Income taxes 130,042 80,275 Non-cash financing activities included capital lease obligations incurred for computer equipment totaling $874 in 1996 and $2,166 in 1995. See accompanying Notes to Consolidated Financial Statements. 6
AFLAC INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. In the opinion of management, the accompanying unaudited consolidated financial statements of AFLAC Incorporated and subsidiaries (the "Company") contain all adjustments (none of which were other than normal recurring accruals) necessary to fairly present the financial position as of June 30, 1996, and the results of operations for the three-month and six-month periods ended June 30, 1996 and 1995, and changes in shareholders' equity and cash flows for the six months ended June 30, 1996 and 1995. Results of operations for interim periods are not necessarily indicative of results for the entire year. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, based on the best information available, in recording transactions resulting from business operations. The balance sheet amounts that involve a greater extent of accounting estimates and actuarial determinations subject to future changes are: deferred policy acquisition costs, liabilities for future policy benefits and unpaid policy claims, accrued liabilities for unfunded retirement plans for various officers and beneficiaries, and contingent liabilities. When additional information becomes available (or actual amounts are determinable), the recorded estimates may be revised and reflected in operating results. The financial statements should be read in conjunction with the financial statements included in the Company's annual report to shareholders for the year ended December 31, 1995. All share and per-share amounts have been adjusted to reflect the three-for-two stock split paid on March 18, 1996. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed Of, effective January 1, 1996. This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to (1) those assets to be held and used in the business, and (2) for assets to be disposed of. There was no material effect on the financial statements from the adoption of this new accounting standard. SFAS No. 123, Accounting for Stock-Based Compensation, is effective for 1996. This statement provides a choice of accounting methods for employee stock compensation plans. A company can elect to use the new fair-value- based method of accounting for employee stock compensation plans, under which compensation cost is measured and recognized in results of operations, or continue to account for these plans under the method prescribed by Accounting Principles Board Opinion No. 25 (APB No. 25). Entities electing to remain with the method prescribed by APB No. 25 must make disclosures of what net income and earnings per share would have been if the fair-value- based method of accounting had been applied. The Company plans to continue to account for employee stock options using the method prescribed by APB No. 25 and include the required disclosures in the year-end financial statements. The Financial Accounting Standards Board issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and 7
Extinguishments of Liabilities, in June 1996. This statement establishes standards regarding which transfers should be considered as sales of all or part of the assets or as secured borrowings. It also establishes how transferors and transferees should account for sales and secured borrowings and extinguishment of liabilities. The Company is evaluating this new accounting standard. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. 2. The Company has a loan agreement which provides for bank borrowings up to $500 million in either U.S. dollars or Japanese yen. During the first quarter of 1996, the Company borrowed an additional 13.1 billion yen ($125.9 million) under this agreement. At June 30, 1996, borrowings of 37.0 billion yen ($337.9 million) were outstanding under this agreement. The Company has entered into interest rate swaps with notional amounts equal to the unpaid principal amount during the six-year term of the loan. These transactions effectively change the Company's interest rate exposure on this loan from floating rates to fixed interest rates. The fixed-rate is 2.74% after the effect of the swaps. Interest payments are made based on floating interest rates and the Company either pays to or receives from the counterparty an amount necessary to equal the fixed swap rate. At June 30, 1996, the floating rate, based on the six-month Tokyo Interbank Offered Rate (TIBOR) plus 25 basis points, was 1.04%. In the second quarter, the Company converted another loan agreement with outstanding principal of $29.3 million and a 5.965% fixed rate (after interest rate swap) from dollar denominated to yen denominated amounts with a floating interest rate based on TIBOR plus 25 basis points. At June 30, 1996, bank borrowings of 3.1 billion yen ($28.6 million) were outstanding under this agreement at a floating interest rate of .87%. The Company has designated these yen-denominated borrowings as a hedge of its net investment in AFLAC Japan. Foreign currency translation gains/losses are included in the unrealized foreign currency translation gains component in shareholders' equity. Outstanding principal and related accrued interest payable on the yen-denominated borrowings were translated into dollars at end-of-period exchange rates. Interest expense is translated at average monthly exchange rates for the period the interest expense is incurred. 3. The Company classifies all fixed-maturity securities as "available for sale." All fixed-maturity and equity securities are carried at fair value. The related unrealized gains and losses, less amounts applicable to policy liabilities and deferred income taxes, are reported in a separate component of shareholders' equity. The portion of unrealized gains credited to policy liabilities represents gains that would not inure to the benefit of the shareholders if such gains were actually realized. These amounts are necessary to cover policy reserve interest requirements based on market investments yields at these dates. 8
The effect on shareholders' equity at the following dates was: (In thousands) June 30, 1996 December 31, 1995 ---------------- ----------------- Securities available for sale - unrealized gains $ 1,993,041 $ 2,597,413 Less: Policy liabilities 1,521,373 1,865,077 Deferred income taxes 197,528 249,549 ------------- ------------- Shareholders' equity, net unrealized gains on securities available for sale $ 274,140 $ 482,787 ============= ============= 4. AFLAC Japan uses short-term (usually seven days) security lending arrangements to increase investment income with minimal risk. At June 30, 1996 and December 31, 1995, the Company held Japanese government bonds as collateral for loaned securities in the amount of $1.1 billion and $1.4 billion, respectively, at market value. The Company's security lending policy requires that the fair value of the securities received as collateral be 105% or more of the fair value of the loaned securities as of the date the securities are loaned and not less than 100% thereafter. 5. The Company is a defendant in various litigation considered to be in the normal course of business. Some of this litigation is pending in Alabama, where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies, including insurers, in recent years. Although the final results of any litigation cannot be predicted with certainty, the Company believes the outcome of pending litigation will not have a material adverse effect on the financial position of the Company. The outstanding income tax issues with the Internal Revenue Service (IRS) in connection with their examination of the Company's U.S. consolidated income tax returns for the years 1989 through 1991 were settled in July 1996. These issues are described in Note 8 of the Notes to the Consolidated Financial Statements in the Company's annual report to shareholders for the year 1995. There are no material adjustments to the income tax returns as originally filed. The IRS is currently examining the Company's U.S. consolidated income tax returns for the years 1992 through 1994. 9
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The June 30, 1996 and 1995 financial statements included in this filing have been reviewed by KPMG Peat Marwick LLP, independent certified public accountants, in accordance with established professional standards and procedures for such a review. The report of KPMG Peat Marwick LLP commenting upon their review is included on page 11. 10
KPMG PEAT MARWICK LLP Certified Public Accountants 303 Peachtree Street, N.E. Telephone: (404) 222-3000 Suite 2000 Telefax: (404) 222-3050 Atlanta, GA 30308 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors AFLAC Incorporated: We have reviewed the accompanying consolidated balance sheet of AFLAC Incorporated and subsidiaries as of June 30, 1996, and the related consolidated statements of earnings for the three-month and six-month periods ended June 30, 1996 and 1995, and the consolidated statements of cash flows and shareholders' equity for the six-month periods ended June 30, 1996 and 1995. These consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the accompanying consolidated balance sheet of AFLAC Incorporated and subsidiaries as of December 31, 1995, and the related consolidated statements of earnings, shareholders' equity and cash flows for the year then ended (not presented herein); and in our report dated January 29, 1996, we expressed an unqualified opinion on those consolidated financial statements. KPMG PEAT MARWICK LLP July 23, 1996 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The primary business activity of AFLAC Incorporated and subsidiaries (the "Company") is supplemental health insurance, which is marketed and administered primarily through American Family Life Assurance Company of Columbus (AFLAC). Most of AFLAC's policies are individually underwritten in the payroll market, with premiums paid by the employees. The Company's operations in Japan (AFLAC Japan) and the United States (AFLAC U.S.) service the two principal markets for the Company's insurance operations. AFLAC Japan and AFLAC U.S. are the primary components for this discussion and analysis, due to their significance to the Company's consolidated financial condition and results of operations. The Company paid a three-for-two stock split on March 18, 1996. All share and per-share amounts have been restated for the stock split. 12
<TABLE> RESULTS OF OPERATIONS The following table sets forth the results of operations by business component for the periods shown and the percentage change from the prior period. <CAPTION> SUMMARY OF OPERATING RESULTS BY BUSINESS COMPONENT (In millions, except for per-share amounts) Three Months Ended June 30, Six Months Ended June 30, -------------------------------------- -------------------------------------- Percentage Change Percentage Change Over Previous Over Previous Period 1996 1995 Period 1996 1995 ----------------- ------------------ ----------------- ------------------ <S> <C> <C> <C> <C> <C> <C> Pretax operating earnings: Insurance operations (excluding realized investment gains and losses): AFLAC Japan..................... (13.0)% $132.2 $152.0 (7.2)% $265.3 $285.8 AFLAC U.S....................... 18.4 30.7 25.9 18.5 60.7 51.2 ------ ------ ------ ------ Total U.S. and Japan insurance................... (8.4) 162.9 177.9 (3.3) 326.0 337.0 Realized investment gains (losses).................... .2 (.4) (.4) .1 Broadcast division.................. 12.2 7.3 6.5 11.6 11.7 10.5 Interest expense, noninsurance operations........... (3.1) (3.3) (7.2) (5.9) Corporate expenses, other operations and eliminations....... (11.3) (23.1) (20.8) (7.5) (38.7) (35.8) ------ ------ ------ ------ Earnings before income taxes...... (9.8) 144.2 159.9 (4.7) 291.4 305.9 Income taxes.......................... (12.7) 58.5 67.0 (7.0) 119.1 128.1 ------ ------ ------ ------ Net earnings...................... (7.7) $ 85.7 $ 92.9 (3.1) $ 172.3 $ 177.8 ====== ====== ====== ====== Net earnings per share................ (3.3) $ .59 $ .61 .9 $ 1.18 $ 1.17 ====== ====== ====== ====== - -------------------------------------------------------------------------------------------------------------------------- ========================================================================================================================== 13 </TABLE>
As in the first quarter, AFLAC's financial results as reported in dollars were depressed due to the weakening of the yen. However, the Company's performance during the second quarter excluding the effect of unrealized foreign currency translation was strong. In both Japan and the United States, the Company continued to demonstrate market leadership, producing significant gains in new sales and solid financial performance in local-currency terms. Excluding the impact of the yen, operating earnings per share were up 16.4% for both the second quarter and the first six months of 1996 compared with the respective periods in 1995. Those results exceeded the Company's primary corporate objective of 13% to 15% annual growth in operating earnings per share before currency fluctuations. The weakening of the yen in relation to the dollar lowered the Company's operating earnings by $.12 per share during the second quarter and $.17 per share for the first six months. This is solely attributable to the translation effect of the weakening yen and not to any fundamental change in business. If the exchange rate in 1996 had remained unchanged from its 1995 level, the increases in revenues, benefits, expenses and earnings would have been significantly higher than reported, as the following table illustrates. Supplemental Consolidated Data Selected Percentage Changes Three Months Ended Six Months Ended June 30, 1996 June 30, 1996 --------------------- --------------------- Adjusted to Adjusted to Exclude Exclude Foreign Foreign As Currency As Currency Reported Changes* Reported Changes* -------- ----------- -------- ----------- Premium income (10.6)% 9.2% (5.4)% 8.9% Net investment income (7.7) 11.4 (1.7) 12.3 Total revenues (9.9) 9.5 (4.8) 9.3 Total benefits and expenses (9.9) 9.6 (4.8) 9.4 Operating earnings (7.7) 11.1 (2.7) 10.9 Operating earnings per share (3.3) 16.4 1.7 16.4 - ---------------------------------------------------------------------------- *Amounts excluding foreign currency changes were determined using the same yen/dollar exchange rate for the current period as the comparable period in the prior year. ============================================================================ The yen began to weaken in relation to the dollar in the third quarter of 1995, and management and most currency commentators expect it to remain weaker in 1996 than in 1995. A weaker yen has a negative effect on net earnings reported in U.S. dollars. However, all of AFLAC Japan's premiums and claims and most of its investment income and expenses are yen- denominated. The majority of AFLAC Japan's invested assets are also denominated in yen. Therefore, the translation of results from yen into U.S. dollars does not affect AFLAC Japan's financial condition or its results of operations in real economic terms. 14
The Company's objective for 1996 is to increase operating earnings per share by 15% for the year, excluding the effect of currency translation. However, if that objective is achieved and the yen/dollar exchange rate averages 108.00 for the year, compared with the 1995 average rate of 94.10, operating earnings per share as reported (including foreign currency translation) would only increase by approximately 3% for the year 1996. AFLAC Japan's pretax operating earnings (excluding realized investment gains/losses) in yen increased 9.8% for the three months ended June 30, 1996, compared with the second quarter of 1995 and increased 9.6% for the six months ended June 30, 1996, compared with the six months ended June 30, 1995. The reported U.S. dollar results for AFLAC Japan were negatively affected by the unfavorable average yen-to-dollar exchange rate of 106.75 for the six months ended June 30, 1996, compared with 90.39 for the first six months of 1995. As a result, the percentage change in U.S. dollars for AFLAC Japan's pretax operating earnings was a decrease of 13.0% for the three months ended June 30, 1996, compared with the second quarter of 1995 and a decrease of 7.2% for the six months ended June 30, 1996, compared with the six months ended June 30, 1995. During the second quarter, AFLAC purchased 2.1 million shares of its common stock. At the end of June 1996, the Company had approximately 4.6 million shares available for purchase under the board of directors' current authorization. The Company has purchased 16.7 million shares (through June 30, 1996) since the inception of the share repurchase program in February 1994. The difference in percentage changes in net earnings and net earnings per share primarily reflects the impact of the share repurchase program. AFLAC Japan repatriated profits to AFLAC U.S. of $140.5 million in 1995, $132.9 million in 1994, $97.9 million in 1993, and $33.4 million in 1992. The profit transfers to AFLAC U.S. adversely impact AFLAC Japan's investment income. However, repatriations benefit consolidated operations because higher investment yields can be earned on funds invested in the United States. Also, income tax expense is presently lower on investment income earned in the United States. Management estimates these transfers have benefited consolidated net earnings by $5.2 million and $2.4 million for the three months ended June 30, 1996 and 1995, respectively and $10.2 million and $5.0 million for the six months ended June 30, 1996 and 1995, respectively. In July 1996, AFLAC Japan repatriated profits to AFLAC U.S. in the amount of $217.3 million (23.5 billion yen). AFLAC U.S. in turn made an additional dividend payment to the Parent Company in the amount of $36.2 million. Repatriated profits represent a portion of the net earnings as reported to the Japanese Ministry of Finance as of March 31 each year. Such regulatory basis earnings are based on accounting principles that differ materially from generally accepted accounting principles. Such differences relate primarily to valuation of investments, policy benefit and claim reserves, acquisition costs, and deferred income taxes. Japanese regulatory earnings and related profit repatriations may therefore vary materially from year to year because of these differences. At present, management believes that the 1997 profit repatriation may fall between the amounts transferred in 1995 and 1996. 15
The Company had approximately $76.9 million in short-term forward foreign exchange contracts outstanding related to the profit transfer in 1996. These contracts were in a net gain position which is recorded in the unrealized foreign exchange gain component of shareholders' equity at June 30, 1996. These contracts closed in July, coinciding with the transfer of the funds. AFLAC JAPAN AFLAC Japan, a branch of AFLAC and the principal contributor to the Company's earnings, is the fourth largest life insurance company in Japan in terms of individual policies in force. As discussed above, AFLAC Japan transferred profits to AFLAC U.S., which distorts comparisons of operating results between periods. The AFLAC Japan summary of operations tables on the following pages present investment income, total revenues and pretax operating earnings calculated on a pro forma basis in order to improve comparability between periods. The pro forma adjustment represents cumulative investment income foregone by AFLAC Japan on funds repatriated to AFLAC U.S. during 1992 through 1995. 16
AFLAC JAPAN SUMMARY OF OPERATING RESULTS THREE MONTHS ENDED JUNE 30, In Dollars (In millions) 1996 1995 -------------------------- Premium income...................... $ 1,225.4 $ 1,418.2 Investment income, as adjusted*..... 227.9 254.1 Other income........................ .1 .5 --------- --------- Total revenues, as adjusted*...... 1,453.4 1,672.8 --------- --------- Benefits and claims................. 1,058.8 1,220.2 Operating expenses.................. 257.2 295.7 --------- --------- Total benefits and expenses....... 1,316.0 1,515.9 --------- --------- Pretax operating earnings, as adjusted*................... 137.4 156.9 Investment income applicable to profit repatriations............... (5.2) (4.9) --------- --------- Pretax operating earnings....... $ 132.2 $ 152.0 ========= ========= - --------------------------------------------------------------------------- In Dollars In Yen 1996 1995 1996 1995 ---------------- ---------------- Percentage changes over previous period: Premium income.............. (13.6)% 34.5% 9.2% 10.7% Investment income*.......... (10.3) 37.1 13.1 13.0 Total revenues*............. (13.1) 34.9 9.7 11.0 Pretax operating earnings*.. (12.4) 32.3 10.5 9.0 Pretax operating earnings... (13.0) 30.6 9.8 7.6 - --------------------------------------------------------------------------- 1996 1995 ------------------ Ratios to total revenues, as adjusted:* Benefits and claims................ 72.8% 72.9% Operating expenses................. 17.7 17.7 Pretax operating earnings.......... 9.5 9.4 Ratio of pretax operating earnings to total reported revenues......... 9.1 9.1 - ---------------------------------------------------------------------------- *Adjusted investment income, total revenues and pretax operating earnings include estimates of additional investment income of $5.2 million in 1996 and $4.9 million in 1995, foregone due to profit repatriations. ============================================================================ 17
AFLAC JAPAN SUMMARY OF OPERATING RESULTS SIX MONTHS ENDED JUNE 30, In Dollars (In millions) 1996 1995 -------------------------- Premium income...................... $ 2,449.5 $ 2,656.1 Investment income, as adjusted*..... 454.9 473.6 Other income........................ .5 1.7 --------- --------- Total revenues, as adjusted*...... 2,904.9 3,131.4 --------- --------- Benefits and claims................. 2,123.3 2,291.9 Operating expenses.................. 505.9 544.5 --------- --------- Total benefits and expenses....... 2,629.2 2,836.4 --------- --------- Pretax operating earnings, as adjusted*................... 275.7 295.0 Investment income applicable to profit repatriations............... (10.4) (9.2) --------- --------- Pretax operating earnings....... $ 265.3 $ 285.8 ========= ========= - --------------------------------------------------------------------------- In Dollars In Yen 1996 1995 1996 1995 ---------------- ---------------- Percentage changes over previous period: Premium income.............. (7.8)% 30.5% 8.9% 11.7% Investment income*.......... (3.9) 31.6 13.4 12.8 Total revenues*............. (7.2) 30.6 9.5 11.9 Pretax operating earnings*.. (6.5) 27.6 10.3 9.4 Pretax operating earnings... (7.2) 26.0 9.6 8.0 - --------------------------------------------------------------------------- 1996 1995 ------------------ Ratios to total revenues, as adjusted:* Benefits and claims................ 73.1% 73.2% Operating expenses................. 17.4 17.4 Pretax operating earnings.......... 9.5 9.4 Ratio of pretax operating earnings to total reported revenues......... 9.2 9.2 - ---------------------------------------------------------------------------- *Adjusted investment income, total revenues and pretax operating earnings include estimates of additional investment income of $10.4 million in 1996 and $9.2 million in 1995, foregone due to profit repatriations. ============================================================================ As previously mentioned, the yen continued to weaken against the dollar in the second quarter. The average exchange rate for the first six months of 1996 was 106.75, which was 15.3% weaker than the average rate of 18
90.39 for the first six months of 1995. As a result, growth rates for AFLAC Japan in dollar terms were lower than those reported in yen. The average exchange rate for the full year 1995 was 94.10. The increase in premium income in yen was due to sales of new policies and continued excellent policy persistency. For the second quarter, new annualized premium sales rose 15.6%, to 19.7 billion yen. For the six months, new annualized premium sales in yen were up 7.7%, to 37.2 billion yen. These results have benefited not only from the Company's broadened product line, but also from a television advertising campaign that was initiated earlier in the year. The Company remains very optimistic about sales of its new and traditional products. Management's goal is to increase new sales, excluding conversions, by 10% in yen for the year 1996. The Company's new living benefit life product continued to make significant contributions to AFLAC Japan's new sales. This new product, which is being sold primarily as a rider to the cancer policies, accounted for more than 40% of new annualized premium sales during the quarter and nearly 44% of new sales for the first half of the year. The living benefit life rider is extremely popular among consumers and agents alike, and management expects its success to continue. Due to the continued low level of available investment yields in Japan, the Ministry of Finance has permitted insurers to increase premium rates on new policy issues in recent years. AFLAC Japan increased premium rates by an average of 16% on all cancer policy sales made after July 1, 1994. Premium rates on care policy new issues were increased by an average of 10% in both November 1993 and 1995. As a result of continuing low yields, the Company expects to increase premium rates by approximately 12-14% on all new policy issues beginning in the fourth quarter of 1996. For several years, finding attractive investment yields for the Company's substantial cash flows in Japan has been management's greatest challenge. The yield to maturity on AFLAC Japan's fixed-maturity portfolio was 5.73% at the end of the second quarter, compared with 6.00% a year ago, reflecting the cumulative effect of low yields. However, new money yields have improved this year over the mid-year 1995 levels. During the second quarter, the Company purchased yen-denominated securities at an average yield to maturity of 4.10%. Including dollar-denominated purchases, the blended yield to maturity was 4.24%. The return on average invested assets was 5.59% for the first six months, compared with 5.87% for the first six months of 1995 and 5.81% for the full year 1995. As a result of the improvement in yields and favorable changes in Japan's investment regulations, AFLAC's investment results have exceeded management's expectations this year. In looking forward, management is optimistic about the possibility of higher interest rates, and therefore improved investment returns, as Japan's economic recovery continues. AFLAC U.S. AFLAC U.S. pretax operating results improved substantially, assisted by additional investment income earned on profit transfers received from AFLAC Japan. A portion of the profit transfers, in turn, were used to increase dividend payments from AFLAC U.S. to the Parent Company in the amounts of $14.8 million in the first six months of 1996, and $21.2 million, $51.9 million and $10.1 million for the full years 1995, 1994 and 1993, 19
respectively. Estimated investment income earned from profits repatriated to and retained by AFLAC U.S. from 1992 through 1995 has been reclassified in the following presentation in order to improve comparability between periods. AFLAC U.S. SUMMARY OF OPERATING RESULTS Three Months Ended Six Months Ended June 30, June 30, (In millions) 1996 1995 1996 1995 ------------------ ------------------ Premium income................... $ 232.9 $ 211.8 $ 462.0 $ 421.5 Investment income, as adjusted*.. 21.2 19.4 42.3 38.0 Other income..................... .3 .2 .6 .6 ------ ------ ------ ------ Total revenues, as adjusted*... 254.4 231.4 504.9 460.1 ------ ------ ------ ------ Benefits and claims.............. 146.6 131.9 288.4 261.9 Operating expenses............... 83.8 77.7 169.2 155.2 ------ ------ ------ ------ Total benefits and expenses.... 230.4 209.6 457.6 417.1 ------ ------ ------ ------ Pretax operating earnings, as adjusted*................ 24.0 21.8 47.3 43.0 Investment income applicable to profit repatriations............ 6.7 4.1 13.4 8.2 ------ ------ ------ ------ Pretax operating earnings.... $ 30.7 $ 25.9 $ 60.7 $ 51.2 ====== ====== ====== ====== - --------------------------------------------------------------------------- Percentage increases over previous period: Premium income................. 9.9% 7.9% 9.6% 8.3% Investment income*............. 9.2 14.4 11.1 14.0 Total revenues*................ 9.9 7.8 9.8 8.4 Pretax operating earnings*..... 10.0 12.9 10.0 14.7 Pretax operating earnings...... 18.4 20.1 18.5 21.9 - --------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims............ 57.6% 57.0% 57.1% 56.9% Operating expenses............. 33.0 33.6 33.5 33.7 Pretax operating earnings...... 9.4 9.4 9.4 9.4 Ratio of pretax operating earnings to total reported revenues...... 11.7 11.0 11.7 10.9 - ---------------------------------------------------------------------------- *Excludes estimated investment income for the three months ended June 30, 1996 and 1995 of $6.7 million and $4.1 million, respectively, and for the six months ended June 30, 1996 and 1995 of $13.4 million and $8.2 million, respectively, related to investment of profit repatriation funds retained by AFLAC U.S. ============================================================================ 20
The increase in premium income primarily resulted from strong increases in new sales during the last 12 months. Total new annualized premium sales were very strong in the second quarter. Except for the first quarter of this year, the second quarter sales were the best in the Company's history. Total new sales in the second quarter rose 16.3% to $75.8 million. For the first six months, new annualized premium sales increased 15.9% to $153.7 million. As in the last two years, accident/disability coverage has continued to be the Company's best-selling product. At the same time, the Company has produced strong sales growth in its traditional products. Management remains focused on providing quality supplemental insurance products to the payroll deduction market in the United States, and believes there are tremendous market opportunities for strong new sales growth in the future. Management's goal is to increase new policy sales by 12% to 15% for the year. The increase in investment income was primarily due to the increase in invested assets. During the second quarter, available cash flow was invested at an average yield-to-maturity of 7.71% compared with 7.67% during the second quarter of 1995. The overall return on average invested assets, net of investment expenses, was 7.36% for the first six months of 1996 compared with 7.38% for the same period of 1995. Management expects future benefit ratios for some of the Company's supplemental products to increase slightly due to the Company's ongoing efforts to improve policy persistency by enhancing policyholder benefits. In addition, potential minimum benefit ratio requirements by insurance regulators may also result in an increase to these ratios. At the same time, management expects the operating expense ratio, excluding discretionary advertising expenses, to decline in the future due to continued improvements in operating efficiencies. By improving administrative systems and controlling other costs, management has been able to redirect funds to national advertising programs without significantly affecting the operating expense ratio. The Company's advertising expense was $10.0 million and $7.5 million for the six months ended June 30, 1996 and 1995, respectively. Management expects the pretax operating profit margin, which was 8.9% for the year 1995 excluding the effect of repatriation, to range between 9.0% and 9.5% for the year 1996. FINANCIAL ACCOUNTING STANDARDS BOARD'S STATEMENTS For information regarding Statements of Financial Accounting Standards (SFAS) adopted during 1996 and those to be adopted in 1997, see Note 1 of the Notes to the Consolidated Financial Statements. ANALYSIS OF FINANCIAL CONDITION Since December 31, 1995, the financial condition of the Company has remained strong in the functional currencies of its operations. Due to the relative size of AFLAC Japan, changes in the yen/dollar exchange rate can have a significant effect on the Company's reported financial condition. The yen/dollar exchange rate at the end of each period is used to convert yen-denominated balance sheet items into U.S. dollars for reporting purposes. The exchange rate at June 30, 1996, was 109.50 yen to one U.S. dollar, 6.0% weaker than the exchange rate of 102.95 as of December 31, 1995. Management estimates that the weaker yen rate decreased invested 21
assets by $1.1 billion, total assets by $1.3 billion, and total liabilities by $1.3 billion versus the amounts that would have been reported based on the exchange rate as of December 31, 1995. Fixed-maturity securities available for sale are carried at fair value. Net unrealized gains of $2.0 billion on investments in fixed-maturity securities at June 30, 1996, consisted of $2.0 billion in gross unrealized gains and $79.3 million in gross unrealized losses. During 1996, net unrealized gains decreased by $616.4 million, which was primarily due to the rise in general-market interest rates in Japan and the United States. The following table shows the effect of unrealized gains and losses on invested assets at: (In thousands) June 30, December 31, % Change 1996 1995 ----------- ------------ ---------- AFLAC U.S.: Total invested assets $ 1,662,623 $ 1,672,246 (.6)% Unrealized gains/(losses) on securities available for sale 47,770 128,697 ---------- ---------- Total invested assets excluding unrealized gains on securities available for sale $ 1,614,853 $ 1,543,549 4.6 ========== ========== AFLAC Japan: Total invested assets $18,078,811 $18,392,101 (1.7) Unrealized gains/(losses) on securities available for sale 1,944,781 2,468,018 ---------- ---------- Total invested assets excluding unrealized gains on securities available for sale $16,134,030 $15,924,083 1.3 ========== ========== Consolidated: Total invested assets $19,797,762 $20,044,964 (1.2) Unrealized gains/(losses) on securities available for sale 1,993,041 2,597,413 ---------- ---------- Total invested assets excluding unrealized gains on securities available for sale $17,804,721 $17,447,551 2.0 ========== ========== The continued growth in invested assets reflects the strength of the Company's primary business, the substantial cash flows from operations, the strong new annualized premium sales by AFLAC U.S. and the substantial renewal premiums collected by AFLAC Japan. Offsetting these positive factors was the weaker yen/dollar exchange rate and a decrease in unrealized market gains. 22
Investments continued to consist of high-quality securities. AFLAC invests primarily within the Japanese and U.S. fixed-maturity markets. The Company uses specific criteria to judge the credit quality and liquidity of its investments. The Company utilizes a variety of credit rating services to monitor this criteria. The following table presents the percentages of the Company's fixed-maturity securities available for sale, at amortized cost by quality rating. June 30, 1996 December 31, 1995 ------------- ----------------- AAA 49.0% 49.2% AA 20.9 22.2 A 25.0 24.6 BBB 5.1 4.0 ----- ----- 100.0% 100.0% Private placement investments comprised 25.3% and 23.1% of the Company's total fixed-maturity securities available for sale as of June 30, 1996 and December 31, 1995, respectively. AFLAC Japan has made investments in the private sector to secure higher yields than those available from Japanese government bonds. At the same time, the Company has adhered to its conservative standards for credit quality. Policy liabilities decreased $226.9 million, or 1.2%, during the first six months of 1996. AFLAC Japan decreased $311.9 million, or 1.7% (4.5% increase in yen), and AFLAC U.S. increased $81.6 million, or 5.4%. The weaker yen rate decreased reported policy liabilities by $1.1 billion. Offsetting increases in policy liabilities are due to the addition of new business and the aging of policies in force. The effect of SFAS No. 115 also caused a decrease in policy liabilities (see Note 3). The income tax liability decreased by $133.6 million, or 9.6%, since December 31, 1995. The decrease is primarily due to a tax payment in Japan during the first quarter and the weaker yen. The Company's ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized market gains on securities available for sale) was 19.1% and 16.5% as of June 30, 1996 and December 31, 1995, respectively. For further information concerning notes payable, see Note 2 of the Notes to the Consolidated Financial Statements. For information concerning security lending arrangements, see Note 4 of the Notes to the Consolidated Financial Statements. The Company's insurance operations continue to provide the primary sources of liquidity for the Company. Capital needs can also be supplemented by borrowed funds. The principal sources of cash from insurance operations are premiums and investment income. Primary uses of cash in the insurance operations are policy claims, commissions, operating expenses, income taxes and payments to the Parent Company for management fees and dividends. Both the sources and uses of cash are reasonably predictable. The Company's investment objectives provide for liquidity through the ownership of high-quality investment securities. AFLAC insurance policies are generally not interest-sensitive and therefore are not subject to unexpected policyholder redemptions due to investment yield changes. Also, the majority of AFLAC policies provide indemnity benefits rather than reimbursement for actual medical costs and therefore are not subject to the increasing risks of medical cost inflation. 23
The achievement of continued long-term growth will require growth in the statutory capital and surplus of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Parent Company from funds generated through debt or equity offerings. Management believes outside sources for additional debt and equity capital will continue to be available for capital expenditures, business expansion, and treasury share purchases. Parent Company capital resources are largely dependent upon the ability of the subsidiaries to pay management fees and dividends. The Georgia Insurance Department imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances by AFLAC to the Parent Company. In addition to restrictions by U.S. insurance regulators, the Japanese Ministry of Finance (MOF) imposes restrictions on, and requires approval for, the remittances of earnings from AFLAC Japan to AFLAC U.S. Payments are made from AFLAC Japan to the Parent Company for management fees and to AFLAC U.S. for allocated expenses and remittances of earnings. Total funds received from AFLAC Japan were $17.5 million and $18.1 million in the first six months of 1996 and 1995, respectively, and $179.5 million in the full year 1995. In July 1996, AFLAC Japan repatriated profits to AFLAC U.S. in the amount of $217.3 million. The MOF requires that certain solvency standards be met in order for profit transfers to occur. These standards are similar to U.S. risk-based capital requirements. For additional information on regulatory restrictions on dividends, profit transfers and other remittances, see Note 10 of the Notes to the Consolidated Financial Statements in the Company's annual report to shareholders for the year ended December 31, 1995. For information regarding pending litigation, see Note 5 of the accompanying Notes to the Consolidated Financial Statements. The board of directors has declared a third quarter cash dividend of $.10 per share. The dividend is payable on September 3, 1996, to shareholders of record at the close of business on August 16, 1996. 24
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a defendant in various litigation considered to be in the normal course of business. Some of this litigation is pending in Alabama where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies, including insurers, in recent years. Although the final results of any litigation cannot be predicted with certainty, the Company believes the outcome of pending litigation will not have a material adverse effect on the financial position of the Company. ITEMS 2, 3, 4 and 5 Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 3.0 - ByLaws of the Company, as amended. 27.0 - Financial Data Schedule (for SEC use only) (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the quarter ended June 30, 1996. 25
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AFLAC INCORPORATED Date: August 6, 1996 /s/ KRISS CLONINGER, III ------------------------ --------------------------------- KRISS CLONINGER, III Executive Vice President; Treasurer and Chief Financial Officer Date: August 6, 1996 /s/ NORMAN P. FOSTER ------------------------ --------------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 26 EXHIBITS FILED WITH CURRENT FORM 10-Q: 3.0 - ByLaws of the Company, as amended. 27.0 - Financial Data Schedule (for SEC use only) 27