UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2006
OR
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from		to
Commission File Number:   001-07434

	Aflac Incorporated
(Exact name of registrant as specified in its charter)

 

GEORGIA	58-1167100
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1932 Wynnton Road, Columbus, Georgia	31999
(Address of principal executive offices)	(ZIP Code)
706.323.3431
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)

 

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.	þ Yes   o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
	o Yes   þ No

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class				October 31, 2006
Common Stock, $.10 Par Value					494,503,936 shares

 

 

Aflac Incorporated and Subsidiaries
Table of Contents

			Page
Part I.   Financial Information:
Item 1.	Financial Statements.
	Consolidated Statements of Earnings Three Months Ended September 30, 2006, and 2005 Nine Months Ended September 30, 2006, and 2005		1
	Consolidated Balance Sheets September 30, 2006, and December 31, 2005		2
	Consolidated Statements of Shareholders’ Equity Nine Months Ended September 30, 2006, and 2005		4
	Consolidated Statements of Cash Flows Nine Months Ended September 30, 2006, and 2005		5
	Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2006, and 2005 Nine Months Ended September 30, 2006, and 2005		7
	Notes to the Consolidated Financial Statements		8
	Review by Independent Registered Public Accounting Firm		19
	Report of Independent Registered Public Accounting Firm		20
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.		49
Item 4.	Controls and Procedures.		49
Part II.   Other Information:
Item 1.	Legal Proceedings.		49
Item 1A.	Risk Factors.		49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.		50
Item 6.	Exhibits.		51

 

Items other than those listed above are omitted because they are not required or are not applicable.

i

Table of Contents

 

PART I.  FINANCIAL INFORMATION

Item 1.            Financial Statements.

Aflac Incorporated and Subsidiaries
Consolidated Statements of Earnings

		Three Months				Nine Months
		Ended				Ended
		September 30,				September 30,
(In millions, except for share and per-share amounts - Unaudited)		2006		2005		2006		2005
Revenues:
Premiums, principally supplemental health insurance		$3,102		$2,997		$9,200		$9,058
Net investment income		548		522		1,614		1,554
Realized investment gains (losses)		11		140		75		155
Other income (losses)		11		10		40		29
Total revenues		3,672		3,669		10,929		10,796
Benefits and expenses:
Benefits and claims		2,291		2,237		6,715		6,733
Acquisition and operating expenses:
Amortization of deferred policy acquisition costs		137		129		425		399
Insurance commissions		325		319		975		986
Insurance expenses		334		311		973		922
Interest expense		4		6		14		17
Other operating expenses		24		22		71		72
Total acquisition and operating expenses		824		787		2,458		2,396
Total benefits and expenses		3,115		3,024		9,173		9,129
Earnings before income taxes		557		645		1,756		1,667
Income taxes		190		190		606		548
Net earnings		$  367		$  455		$1,150		$1,119
Net earnings per share:
Basic		$   .74		$   .91		$  2.32		$  2.23
Diluted		.73		.90		2.29		2.20
Common shares used in computing earnings per share (In thousands):
Basic		494,923		500,557		496,626		501,555
Diluted		500,952		507,323		502,926		508,250
Cash dividends per share		$   .13		$   .11		$   .39		$   .33

 

See the accompanying Notes to the Consolidated Financial Statements.

 

1

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets

		September 30,		December 31,
(In millions - Unaudited)		2006		2005
Assets:
Investments and cash:
Securities available for sale, at fair value:
Fixed maturities (amortized cost $26,454 in 2006 and $25,860 in 2005)		$  27,938		$  28,142
Perpetual debentures (amortized cost $4,259 in 2006 and $4,255 in 2005)		4,256		4,370
Equity securities (cost $17 in 2006 and $30 in 2005)		38		84
Securities held to maturity, at amortized cost:
Fixed maturities (fair value $12,451 in 2006 and $10,839 in 2005)		12,864		10,867
Perpetual debentures (fair value $4,150 in 2006 and $4,252 in 2005)		4,157		4,172
Other investments		55		57
Cash and cash equivalents		1,378		1,297
Total investments and cash		50,686		48,989
Receivables, primarily premiums		522		479
Receivables for security transactions		-		105
Accrued investment income		506		484
Deferred policy acquisition costs		5,930		5,590
Property and equipment, at cost less accumulated depreciation		450		448
Other		259		266
Total assets		$  58,353		$  56,361

 

See the accompanying Notes to the Consolidated Financial Statements.

(continued)

2

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets (continued)

		September 30,					December 31,
(In millions, except for share and per-share amounts - Unaudited)		2006					2005
Liabilities and shareholders’ equity:
Liabilities:
Policy liabilities:
Future policy benefits			$	40,142				$	37,853
Unpaid policy claims			2,660					2,504
Unearned premiums			639					594
Other policyholders’ funds			1,527					1,378
Total policy liabilities			44,968					42,329
Notes payable			1,439					1,395
Income taxes			2,260					2,577
Payables for return of cash collateral on loaned securities			440					622
Other			1,219					1,511
Commitments and contingent liabilities (Notes 8 and 9)
Total liabilities			50,326					48,434
Shareholders’ equity:
Common stock of $.10 par value. In thousands:
authorized 1,000,000 shares; issued 655,366
shares in 2006 and 654,522 shares in 2005			66					65
Additional paid-in capital			866					791
Retained earnings			9,005					8,048
Accumulated other comprehensive income:
Unrealized foreign currency translation gains			74					77
Unrealized gains on investment securities			1,275					1,917
Minimum pension liability adjustment			(37		)			(37		)
Treasury stock, at average cost			(3,222		)			(2,934		)
Total shareholders’ equity			8,027					7,927
Total liabilities and shareholders’ equity			$	58,353				$	56,361
Shareholders’ equity per share			$	16.23				$	15.89

 

See the accompanying Notes to the Consolidated Financial Statements.

 

3

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Statements of Shareholders’ Equity

	Nine Months Ended September 30,
(In millions, except for per-share amounts - Unaudited)		2006			2005
Common stock:
Balance, beginning of period		$	65		$	65
Exercise of stock options		1			-
Balance, end of period		66			65
Additional paid-in capital:
Balance, beginning of period		791			676
Exercise of stock options, including income tax benefits		22			33
Share-based compensation		25			23
Gain on treasury stock reissued		28			22
Balance, end of period		866			754
Retained earnings:
Balance, beginning of period		8,048			6,785
Net earnings		1,150			1,119
Dividends to shareholders ($.39 per share in 2006 and $.33 per share in 2005)		(193		)	(166		)
Balance, end of period		9,005			7,738
Accumulated other comprehensive income:
Balance, beginning of period		1,957			2,611
Change in unrealized foreign currency translation gains (losses) during period, net of income taxes		(3		)	(95		)
Change in unrealized gains (losses) on investment securities during period, net of income taxes		(642		)	(241		)
Minimum pension liability adjustment during period, net of income taxes		-			1
Balance, end of period		1,312			2,276
Treasury stock:
Balance, beginning of period		(2,934		)	(2,561		)
Purchases of treasury stock		(327		)	(317		)
Cost of shares issued		39			51
Balance, end of period		(3,222		)	(2,827		)
Total shareholders’ equity		$	8,027		$	8,006

 

See the accompanying Notes to the Consolidated Financial Statements.

 

4

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
(In millions - Unaudited)		2006			2005
Cash flows from operating activities:
Net earnings		$	1,150		$	1,119
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in receivables and advance premiums		(28		)	(23		)
Increase in deferred policy acquisition costs		(339		)	(339		)
Increase in policy liabilities		2,473			2,555
Change in income tax liabilities		(8		)	177
Realized investment (gains) losses		(75		)	(155		)
Other, net		71			130
Net cash provided by operating activities		3,244			3,464
Cash flows from investing activities:
Proceeds from investments sold or matured:
Securities available for sale:
Fixed maturities sold		2,046			1,840
Fixed maturities matured		257			490
Perpetual debentures sold		1			35
Equity securities sold		46			-
Costs of investments acquired:
Securities available for sale:
Fixed maturities		(3,001		)	(2,580		)
Perpetual debentures		-			(429		)
Securities held to maturity:
Fixed maturities		(2,033		)	(2,290		)
Cash received as collateral on loaned securities, net		(186		)	(2,558		)
Other, net		(14		)	(19		)
Net cash used by investing activities		$	(2,884	)	$	(5,511	)

 

See the accompanying Notes to the Consolidated Financial Statements.

 

(continued)

 

5

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Statements of Cash Flows (continued)

 

 

	Nine Months Ended September 30,
(In millions - Unaudited)		2006			2005
Cash flows from financing activities:
Proceeds from borrowings		$	382		$	360
Principal payments under debt obligations		(360		)	(6		)
Purchases of treasury stock		(327		)	(317		)
Change in investment-type contracts, net		157			195
Dividends paid to shareholders		(183		)	(158		)
Treasury stock reissued		29			39
Other, net		19			33
Net cash (used) provided by financing activities		(283		)	146
Effect of exchange rate changes on cash and cash equivalents		4			(50		)
Net change in cash and cash equivalents		81			(1,951		)
Cash and cash equivalents, beginning of period		1,297			3,813
Cash and cash equivalents, end of period		$	1,378		$	1,862
Supplemental disclosures of cash flow information:
Income taxes paid		$	569		$	367
Interest paid		9			12
Noncash financing activities:
Capitalized lease obligations		6			1
Treasury shares issued for:
Associate stock bonus		26			25
Shareholder dividend reinvestment		10			8
Stock compensation grants		2			1

 

See the accompanying Notes to the Consolidated Financial Statements.

 

6

---

Table of Contents

 

Aflac Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(In millions - Unaudited)		2006			2005			2006			2005
Net earnings		$	367		$	455		$	1,150		$	1,119
Other comprehensive income (loss) before income taxes:
Foreign currency translation adjustments:
Change in unrealized foreign currency translation gains (losses) during period		(3		)	6			(8		)	33
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) arising during the period		1,076			(1,039		)	(913		)	(239		)
Reclassification adjustment for realized (gains) losses included in net earnings		(11		)	(140		)	(75		)	(155		)
Minimum pension liability adjustment during period		-			-			-			1
Total other comprehensive income (loss) before income taxes		1,062			(1,173		)	(996		)	(360		)
Income tax expense (benefit) related to items of other comprehensive income		405			(376		)	(351		)	(26		)
Other comprehensive income (loss) net of income taxes		657			(797		)	(645		)	(334		)
Total comprehensive income (loss)		$	1,024		$	(342	)	$	505		$	785

 

See the accompanying Notes to the Consolidated Financial Statements.

7

Table of Contents

 

Aflac Incorporated and Subsidiaries

Notes to the Consolidated Financial Statements

 

1.           BASIS OF PRESENTATION

We prepare our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). The preparation of financial statements in conformity with GAAP requires us to make estimates when recording transactions resulting from business operations based on currently available information. The most significant items on our balance sheet that involve a greater degree of accounting estimates and actuarial determinations subject to changes in the future are the valuation of investments, deferred policy acquisition costs, and liabilities for future policy benefits and unpaid policy claims. These accounting estimates and actuarial determinations are sensitive to market conditions, investment yields, mortality, morbidity, commission and other acquisition expenses, and terminations by policyholders. As additional information becomes available, or actual amounts are determinable, the recorded estimates will be revised and reflected in operating results. Although some variability is inherent in these estimates, we believe the amounts provided are adequate.

The consolidated financial statements include the accounts of the Parent Company, its majority-owned subsidiaries and those entities required to be consolidated under applicable accounting standards. All material intercompany accounts and transactions have been eliminated.

In the opinion of management, the accompanying unaudited consolidated financial statements of Aflac Incorporated and subsidiaries (the “Company”) contain all adjustments, consisting of normal recurring accruals, which are necessary to fairly present the consolidated balance sheets as of September 30, 2006 and December 31, 2005, the consolidated statements of earnings and comprehensive income for the three- and nine-month periods ended September 30, 2006 and 2005, and the consolidated statements of shareholders’ equity and cash flows for the nine-month periods ended September 30, 2006 and 2005. Results of operations for interim periods are not necessarily indicative of results for the entire year. As a result, these financial statements should be read in conjunction with the financial statements and notes thereto included in our annual report to shareholders for the year ended December 31, 2005.

New Accounting Pronouncements: In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158). The provisions of SFAS 158 apply to all plan sponsors who offer defined benefit postretirement plans. SFAS 158 requires a plan sponsor to recognize the plan’s funded status as an asset or liability in its balance sheet, and to measure plan assets and liabilities as of the end of the sponsor’s fiscal year. It also requires an entity to recognize changes in the funded status of a defined benefit postretirement plan in comprehensive income in the year in which the changes occur. However, SFAS 158 does not change the amount of net periodic benefit cost, or expense, included in net earnings. The recognition and disclosure requirements of SFAS 158 are effective as of the end of the fiscal year ending after December 15, 2006. The measurement date provisions are effective for fiscal years ending after December 15, 2008. Earlier application of the measurement date provisions is encouraged. We do not expect the adoption of this statement to have a significant impact on our financial position or results of operations.

     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements.  This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute.  Accordingly, this Statement does not require any new fair value measurements.  Where applicable, this Statement simplifies and codifies related guidance within GAAP.  SFAS 157 is effective for fiscal years beginning after November 15, 2007 with earlier application encouraged under limited circumstances.  We do not expect the adoption of this statement to have a material effect on our financial position or results of operations.

8

---

Table of Contents

 

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in current year financials. Under the provisions of SAB 108, a reporting entity must quantify and evaluate errors using a balance sheet approach and an income statement approach. After considering all relevant quantitative and qualitative factors, if either approach results in a misstatement that is material, a reporting entity’s financial statements must be adjusted. SAB 108 applies to SEC registrants and is effective for fiscal years ending after November 15, 2006. We are presently evaluating the requirements of SAB 108 and cannot determine its effect on our financial position or results of operations until our evaluation is complete.

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. The provisions of FIN 48 clarify the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 with earlier application encouraged. We do not expect the adoption of this statement to have a material effect on our financial position or results of operations.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140 (SFAS 155). The provisions of SFAS 155 are effective for all financial instruments acquired or issued after the beginning of the first fiscal year after September 15, 2006. Earlier adoption is permitted. SFAS 155 amends the accounting for hybrid financial instruments and eliminates the exclusion of beneficial interests in securitized financial assets from the guidance under SFAS 133. It also eliminates the prohibition on the type of derivative instruments that qualified special purpose entities may hold under SFAS 140. Furthermore, SFAS 155 clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. In accordance with the standard’s early adoption provisions, we adopted the provisions of SFAS 155 on January 1, 2006. The adoption of this standard did not have any impact on our financial position or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised), Share-Based Payment (SFAS 123R).  This standard amends SFAS No. 123, Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.  SFAS 123R establishes the accounting for grants of share-based awards in which an entity exchanges its equity instruments for goods or services.  It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or transactions that may be settled by the issuance of those equity instruments.  SFAS 123R requires that companies use a fair value method to value share-based awards and recognize the related compensation expense in net earnings.  The provisions of SFAS 123R, as amended by the Securities and Exchange Commission, were effective as of the beginning of the first fiscal year after June 15, 2005, although earlier application was encouraged.  In accordance with the standard's early adoption provisions, we began accounting for share-based awards using the modified-retrospective application method effective January 1, 2005.

For additional information on new accounting pronouncements and their impact, if any, on our financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2005.

2.   BUSINESS SEGMENT INFORMATION

The Company consists of two reportable insurance business segments: Aflac Japan and Aflac U.S., both of which sell individual supplemental health and life insurance. Operating business segments that are not individually reportable are included in the “Other business segments” category. We do not allocate corporate overhead expenses to business segments.

We evaluate and manage our business segments using a financial performance measure called pretax operating earnings. Our definition of operating earnings excludes the following items from net earnings on an after-tax basis: realized investment gains/losses, the impact from SFAS 133, and

9

---

Table of Contents

 

nonrecurring items. We then exclude income taxes related to operations to arrive at pretax operating earnings. Information regarding operations by segment follows:

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
(In millions)		2006		2005		2006		2005
Revenues:
Aflac Japan:
Earned premiums		$     2,204		$     2,177		$     6,558		$     6,648
Net investment income		430		410		1,260		1,232
Other income		9		7		21		23
Total Aflac Japan		2,643		2,594		7,839		7,903
Aflac U.S.:
Earned premiums		898		820		2,642		2,410
Net investment income		120		107		345		313
Other income		3		2		7		7
Total Aflac U.S.		1,021		929		2,994		2,730
Other business segments		8		10		30		28
Total business segment revenues		3,672		3,533		10,863		10,661
Realized investment gains (losses)		11		140		75		155
Corporate		11		35		62		54
Intercompany eliminations		(22	)	(39	)	(71	)	(74	)
Total revenues		$     3,672		$     3,669		$   10,929		$   10,796

 

 

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
(In millions)		2006		2005		2006		2005
Pretax earnings:
Aflac Japan		$       407		$       392		$    1,264		$    1,178	*
Aflac U.S.		162		133		459		396
Other business segments		-		(3	)	2		(1	)
Total business segments		569		522		1,725		1,573
Interest expense, noninsurance operations		(3	)	(5	)	(12	)	(15	)
Corporate and eliminations		(15	)	(9	)	(32	)	(34	)
Pretax operating earnings		551		508		1,681		1,524
Realized investment gains (losses)		11		140		75		155
Impact from SFAS 133		(5	)	(3	)	-		(12	)
Total earnings before income taxes		$       557		$       645		$    1,756		$    1,667
Income taxes applicable to pretax operating earnings		$       188		$       175		$       579		$       530
Effect of foreign currency translation on operating earnings		(6	)	(2	)	(39	)	6

*Includes a charge of $18 related to the write-down of previously capitalized systems development costs for Aflac Japan’s administration system.

10

---

Table of Contents

 

Assets were as follows:

 

		September 30,				December 31,
(In millions)		2006				2005
Assets:
Aflac Japan			$  47,444				$ 46,200
Aflac U.S.			10,070				9,547
Other business segments			94				90
Total business segments			57,608				55,837
Corporate			9,686				9,559
Intercompany eliminations			(8,941	)			(9,035	)
Total assets			$  58,353				$ 56,361

 

3.   INVESTMENTS

Realized Investment Gains and Losses

During the quarter ended September 30, 2006, we realized pretax investment gains of $11 million (after-tax, $7 million, or $.01 per diluted share) primarily as a result of securities sales. For the nine months ended September 30, 2006, we realized pretax investment gains of $75 million (after-tax $47 million, or $.10 per diluted share) as a result of securities sales and bond swaps. The bond swaps executed during the first and second quarters of 2006 conclude the bond-swap program that we began in the third quarter of 2005 to take advantage of tax loss carryforwards. Impairment charges were immaterial during the nine months ended September 30, 2006.

For the quarter ended September 30, 2005, we realized pretax investment gains of $140 million (after-tax, $89 million, or $.18 per diluted share) primarily as a result of the execution of bond swaps that enabled the Company to take advantage of tax loss carryforwards. For the nine months ended September 30, 2005, we realized pretax investment gains of $155 million (after-tax, $99 million, or $.19 per diluted share). Impairment charges were immaterial during the nine months ended September 30, 2005.

Unrealized Investment Gains and Losses

The net effect on shareholders’ equity of unrealized gains and losses from investment securities at the following dates was:

 

		September 30,				December 31,
(In millions)		2006				2005
Unrealized gains on securities available-for-sale			$  1,502				$  2,452
Unamortized unrealized gains on securities transferred to held to maturity			393				430
Deferred income taxes			(620	)			(965	)
Shareholders’ equity, net unrealized gains on investment securities			$  1,275				$  1,917

 

The decrease in unrealized gains on available-for-sale securities primarily resulted from a rising interest rate environment.

11

---

Table of Contents

 

Special Purpose and Variable Interest Entities

As part of our investment activities, we own investments in qualified special purpose entities (QSPEs). At September 30, 2006, available-for-sale QSPEs totaled $2.2 billion at fair value ($2.3 billion at amortized cost, or 4.7% of total debt securities), compared with $2.2 billion at fair value ($2.3 billion at amortized cost, or 5.0% of total debt securities) at December 31, 2005. We have no equity interests in any of the QSPEs, nor do we have control over these entities. Therefore, our loss exposure is limited to the cost of our investment.

We also own yen-denominated investments in variable interest entities (VIEs) totaling $1.8 billion at fair value ($1.9 billion at amortized cost, or 4.0% of total debt securities) at September 30, 2006. We are the primary beneficiary of VIEs totaling $1.5 billion at fair value ($1.7 billion at amortized cost) and have consolidated our interests in these VIEs in accordance with FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities. The activities of these VIEs are limited to holding debt securities and utilizing the cash flows from the debt securities to service our investments therein. The terms of the debt securities mirror the terms of the notes held by Aflac. The consolidation of these investments does not impact our financial position or results of operations. We also have interests in VIEs that we are not required to consolidate totaling $239 million at fair value ($241 million at amortized cost) as of September 30, 2006. The loss on any of our VIE investments would be limited to its cost.

Security Lending

We lend fixed-maturity securities to financial institutions in short-term security lending transactions. These securities continue to be carried as investment assets on our balance sheet during the term of the loans and are not recorded as sales. We receive cash or other securities as collateral for such loans. These short-term security lending arrangements increase investment income with minimal risk. Our security lending policy requires that the fair value of the securities and/or cash received as collateral be 102% or more of the fair value of the loaned securities. At September 30, 2006, we had security loans outstanding with a fair value of $425 million, and we held cash in the amount of $440 million as collateral for these loaned securities. At December 31, 2005, we had security loans outstanding with a fair value of $605 million, and we held cash in the amount of $622 million as collateral for these loaned securities. For additional information, see Notes 1 and 3 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2005.

4.   FINANCIAL INSTRUMENTS

We have only limited activity with derivative financial instruments. We do not use them for trading purposes, nor do we engage in leveraged derivative transactions.

We have outstanding cross-currency swap agreements related to the $450 million senior notes (see Note 5). We have designated the foreign currency component of these cross-currency swaps as a hedge of the foreign currency exposure of our investment in Aflac Japan. The notional amounts and terms of the swaps match the principal amount and terms of the senior notes.

12

---

Table of Contents

 

The components of the fair value of the cross-currency swaps were reflected as an asset or (liability) in the balance sheet as follows:

 

		September 30,				December 31,
(In millions)		2006				2005
Interest rate component			$       6				$      6
Foreign currency component			(21	)			(22	)
Accrued interest component			10				4
Total fair value of cross-currency swaps			$     (5	)			$   (12	)

 

The following is a reconciliation of the foreign currency component of the cross-currency swaps as included in accumulated other comprehensive income for the nine-month periods ended September 30.

 

(In millions)		2006				2005
Balance, beginning of period			$    (22	)			$    (91	)
Increase (decrease) in fair value of cross-currency swaps			7				44
Interest rate component not qualifying for hedge accounting reclassified to net earnings			(6	)			7
Balance, end of period			$    (21	)			$    (40	)

 

We have also entered into interest rate swap agreements related to the 20 billion yen variable interest rate Uridashi notes (see Note 5). By entering into these contracts, we have been able to lock-in our interest expense at 1.52% in yen. We have designated these interest rate swaps as a hedge of the variability in our interest cash flows associated with the variable interest rate Uridashi notes. The notional amounts and terms of the swaps match the principal amount and terms of the variable interest rate Uridashi notes. The swaps had no value at inception. Changes in the fair value of the swap contracts are recorded in other comprehensive income. The fair value of these swaps and related changes in fair value were immaterial during the three-month period ended September 30, 2006.

5.   NOTES PAYABLE

A summary of notes payable follows:

 

		September 30,				December 31,
(In millions)		2006				2005
Yen-denominated Uridashi notes:
1.52% notes due September 2011 (principal amount 15 billion yen)			$    127				$         -
2.26% notes due September 2016 (principal amount 10 billion yen)			85				-
Variable interest rate notes due September 2011 (.71% at September 2006, principal amount 20 billion yen)			170				-
Yen-denominated Samurai notes:
.87% notes paid June 2006 (principal amount 40 billion yen)			-				339
.96% notes due June 2007 (principal amount 30 billion yen)			254				254
.71% notes due July 2010 (principal amount 40 billion yen)			339				339
6.50% senior notes due April 2009			450				450
Capitalized lease obligations payable through 2012			14				13
Total notes payable			$ 1,439				$ 1,395

 

13

---

Table of Contents

 

In August 2006, the Parent Company filed a Shelf Registration Statement with Japanese regulatory authorities to issue up to 100 billion yen of yen-denominated Uridashi notes in Japan. In September 2006, the Parent Company issued three tranches of Uridashi notes totaling 45 billion yen. The first tranche totaled 15 billion yen and has a five-year maturity. The second tranche totaled 10 billion yen and has a 10-year maturity. The third tranche totaled 20 billion yen and has a five-year maturity and a variable interest coupon of six-month yen LIBOR plus a spread. We have entered into interest rate swaps related to the 20 billion yen variable interest rate notes (see Note 4). Each tranche of Uridashi notes pays interest semiannually, may only be redeemed prior to maturity upon the occurrence of a tax event as specified in the respective bond agreement and is not available to U.S. persons. If issued, the 55 billion yen of Uridashi notes remaining under the August 2006 Shelf Registration Statement will not be available to U.S. persons.

In 2001, 2002, and 2005 the Parent Company issued yen-denominated Samurai notes, each with five-year maturities. Each series of Samurai notes pays interest semiannually, may only be redeemed prior to maturity upon the occurrence of a tax event as specified in the respective bond agreement and is not available to U.S. persons. In June 2006, we paid in full the .87% Samurai notes issued in 2001.

For our yen-denominated loans, the principal amount as stated in dollar terms will fluctuate from period to period due to changes in the yen/dollar exchange rate. We have designated all of our yen-denominated notes payable as a hedge of the foreign currency exposure of our investment in Aflac Japan. We have also designated the interest rate swaps on our variable interest rate Uridashi notes as a hedge of the variability in our interest cash flows associated with these notes.

The Parent Company filed a Shelf Registration Statement with Japanese regulatory authorities in February 2006 to issue up to 100 billion yen of yen-denominated Samurai notes in Japan. If issued, these securities will not be available to U.S. persons.

In 1999, we issued $450 million of senior notes. These notes pay interest semiannually and are redeemable at our option at any time with a redemption price equal to the principal amount of the notes redeemed plus a make-whole premium. We have entered into cross-currency swaps related to these notes (see Note 4).

We were in compliance with all of the covenants of our notes payable at September 30, 2006. No events of default or defaults occurred during the nine months ended September 30, 2006.

14

---

Table of Contents

 

6.   SHAREHOLDERS’ EQUITY

The following table is a reconciliation of the number of shares of the Company’s common stock for the nine-month periods ended September 30.

(In thousands of shares)		2006		2005
Common stock - issued:
Balance, beginning of period		654,522		652,628
Exercise of stock options		844		1,237
Balance, end of period		655,366		653,865
Treasury stock:
Balance, beginning of period		155,628		149,020
Purchases of treasury stock:
Open market		7,131		7,582
Other		2		156
Dispositions of treasury stock:
Shares issued to AFL Stock Plan		(1,093	)	(1,148	)
Exercise of stock options		(884	)	(1,767	)
Other		(84	)	(261	)
Balance, end of period		160,700		153,582
Shares outstanding, end of period		494,666		500,283

 

We exclude outstanding share-based awards from the calculation of weighted-average shares used in the computation of basic earnings per share. For the quarter ended September 30, 2006, stock options to purchase approximately 2.2 million shares, weighted-average basis, were considered to be anti-dilutive and were excluded from the calculation of diluted earnings per share, compared with 1.8 million for the quarter ended September 30, 2005. For the nine months ended September 30, 2006, stock options to purchase approximately 1.6 million shares, weighted-average basis, were considered to be anti-dilutive and were excluded from the calculation of diluted earnings per share, compared with 2.9 million for the nine month period a year ago.

In February 2006, the board of directors authorized the purchase of 30 million shares of our common stock. As of September 30, 2006, approximately 40 million shares were available for purchase under our share repurchase programs.

7.   SHARE-BASED TRANSACTIONS

 

The Company has two long-term incentive compensation plans. The first is a stock option plan, which allows grants for both incentive stock options (ISOs) to employees and non-qualifying stock options (NQSOs) to employees and non-employee directors. The options have a term of 10 years and time-based vesting conditions. The strike price of options granted under this plan is equal to the fair market value of a share of our common stock at the date of grant. At September 30, 2006, approximately 760 thousand shares were available for future grants under this plan.

The second long-term incentive compensation plan allows awards to Company employees for ISOs, NQSOs, restricted stock, restricted stock units, and stock appreciation rights. Non-employee directors are eligible for grants of NQSOs, restricted stock, and stock appreciation rights. Generally, the awards vest based upon time-based conditions or time-and-performance-based conditions. Performance-based vesting conditions generally include the attainment of goals related to Company financial performance. As of September 30, 2006, the only performance-based awards issued and outstanding were restricted stock awards. At September 30, 2006, approximately 24 million shares were available for future grants under this plan.

15

---

Table of Contents

 

Share-based awards granted to U.S.-based grantees are settled upon exercise with authorized but unissued Company stock, while those issued to Japan-based grantees are settled upon exercise with treasury shares. We estimate the fair value of each stock option granted using the Black-Scholes-Merton multiple option approach. The value of restricted stock awards is based on the fair market value of our common stock at the date of grant.

We adopted SFAS 123R to account for share-based awards effective January 1, 2005. In accordance with the modified-retrospective application method, we adjusted previously reported results to reflect the effect of expensing share-based awards.

The following table provides information on stock options outstanding and exercisable.

 

		Stock		Weighted-Average
		Option		Exercise Price
(In thousands of shares)		Shares		Per Share
Outstanding at September 30, 2006		20,088			$    29.55
Exercisable at September 30, 2006		16,730			26.95

 

As of September 30, 2006, the aggregate intrinsic value of stock options outstanding was $328 million, with a weighted-average remaining term of 5.4 years. The aggregate intrinsic value of stock options exercisable at that same date was $316 million, with a weighted-average remaining term of 4.6 years. We received $26 million and $41 million in cash from the exercise of stock options during the nine-month periods ended September 30, 2006 and 2005, respectively. The tax benefit realized as a result of stock option exercises was $12 million for the first nine months of 2006, compared with $27 million in the first nine months of 2005.

As of September 30, 2006, total compensation cost not yet recognized in our financial statements related to restricted stock awards was $18 million, of which $8 million (309 thousand shares) was related to share-based awards with a performance-based vesting condition. We expect to recognize these amounts over a weighted-average period of approximately 2.0 years. There are no other contractual terms covering restricted stock awards once vested.

For additional information on our long-term share-based compensation plans and the types of share-based awards, see Note 9 of the Notes to the Consolidated Financial Statements included in our annual report to shareholders for the year ended December 31, 2005.

16

---

Table of Contents

 

8.   BENEFIT PLANS

Our basic employee defined-benefit pension plans cover substantially all of our full-time employees in the United States and Japan. The components of retirement expense for the Japanese and U.S. pension plans were as follows:

 

 

As of September 30, 2006, approximately $17 million (using the September 30, 2006 exchange rate) had been contributed to the Japanese pension plan. As of September 30, 2006, $20 million had been contributed to the U.S. pension plan.

For additional information regarding our Japanese and U.S. pension plans, see Note 11 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2005.

9.   COMMITMENTS AND CONTINGENT LIABILITIES

Commitments: We have employee benefit plans that provide pension and various post-retirement benefits. For additional information regarding our benefit plans, see Note 11 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2005.

We lease office space and equipment under various agreements that expire in various years through 2021. For further information regarding lease commitments, see Note 12 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2005.

In 2005, we announced a multi-year building project for additional office space in Columbus, Georgia. The initial phase is to be completed in 2007 and is expected to cost approximately $26 million.

We have entered into an outsourcing agreement with IBM to provide mainframe computer operations and support for our Japanese operations. The agreement has a term of 10 years with an aggregate cost of 28.2 billion yen ($240 million using the September 30, 2006 exchange rate).

Litigation: We are a defendant in various lawsuits considered to be in the normal course of business. Some of this litigation is pending in states where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies,

17

---

Table of Contents

 

including insurers, in recent years. Although the final results of any litigation cannot be predicted with certainty, we believe the outcome of pending litigation will not have a material adverse effect on our financial position, results of operations, or cash flows.

18

---

Table of Contents

 

REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The September 30, 2006, and 2005, financial statements included in this filing have been reviewed by KPMG LLP, an independent registered public accounting firm, in accordance with established professional standards and procedures for such a review.

The report of KPMG LLP commenting upon its review is included on Page 20.

19