AFL-6.30.2012 10Q
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 June 30, 2012
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)
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| | |
Georgia | | 58-1167100 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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1932 Wynnton Road, Columbus, Georgia | | 31999 |
(Address of principal executive offices) | | (ZIP Code) |
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706.323.3431 |
(Registrant's telephone number, including area code) |
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(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 ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ | | Accelerated filer ¨ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | | Smaller reporting company ¨ |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). |
¨ 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.
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| | |
Class | | July 27, 2012 |
Common Stock, $.10 Par Value | | 468,271,629 |
Aflac Incorporated and Subsidiaries
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2012
Table of Contents
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PART I. | | |
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Item 1. | | |
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| Three Months Ended June 30, 2012 and 2011 Six Months Ended June 30, 2012 and 2011 | |
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| Three Months Ended June 30, 2012, and 2011 Six Months Ended June 30, 2012 and 2011 | |
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| June 30, 2012 and December 31, 2011 | |
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| Six Months Ended June 30, 2012, and 2011 | |
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| Six Months Ended June 30, 2012, and 2011 | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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PART II. | | |
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Item 2. | | |
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Item 6. | | |
Items other than those listed above are omitted because they are not required or are not applicable.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Review by Independent Registered Public Accounting Firm
The June 30, 2012, and 2011, consolidated 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 the following page.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Aflac Incorporated:
We have reviewed the consolidated balance sheet of Aflac Incorporated and subsidiaries (the Company) as of June 30, 2012, and the related consolidated statements of earnings and comprehensive income (loss) for the three-month and six-month periods ended June 30, 2012 and 2011, and the consolidated statements of shareholders' equity and cash flows for the six-month periods ended June 30, 2012 and 2011. These consolidated financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), 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 reviews, 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 U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Aflac Incorporated and subsidiaries as of December 31, 2011, and the related consolidated statements of earnings, shareholders' equity, cash flows and comprehensive income (loss) for the year then ended (not presented herein); and in our report dated February 24, 2012, we expressed an unqualified opinion on those consolidated financial statements. Our report refers to a change in the method of evaluating the consolidation of variable interest entities (VIEs) and qualified special purpose entities (QSPEs) in 2010 and a change in the method of evaluating other-than-temporary impairments of debt securities in 2009. As described in Note 1, on January 1, 2012, the Company adopted amended accounting guidance on accounting for costs associated with acquiring or renewing insurance contracts on a retrospective basis resulting in a revision of the December 31, 2011, consolidated balance sheet. We have not audited and reported on the revised balance sheet reflecting the adoption of this new guidance.
Atlanta, Georgia
August 3, 2012
Aflac Incorporated and Subsidiaries
Consolidated Statements of Earnings
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| | | | | | | | | | | | | | |
| Three Months Ended June 30, | Six Months Ended June 30, |
(In millions, except for share and per-share amounts - Unaudited) | 2012 | | 2011 | 2012 | | 2011 |
Revenues: | | | | | | |
Premiums, principally supplemental health insurance | $ | 5,467 |
| | $ | 4,956 |
| $ | 10,845 |
| | $ | 9,828 |
|
Net investment income | 845 |
| | 784 |
| 1,728 |
| | 1,579 |
|
Realized investment gains (losses): | | | | | | |
Other-than-temporary impairment losses realized | (343 | ) | | (528 | ) | (546 | ) | | (933 | ) |
Sales and redemptions | (8 | ) | | (182 | ) | 70 |
| | (326 | ) |
Derivative and other gains (losses) | (67 | ) | | 42 |
| 13 |
| | 12 |
|
Total realized investment gains (losses) | (418 | ) | | (668 | ) | (463 | ) | | (1,247 | ) |
Other income | 8 |
| | 16 |
| 32 |
| | 44 |
|
Total revenues | 5,902 |
| | 5,088 |
| 12,142 |
| | 10,204 |
|
Benefits and expenses: | | | | | | |
Benefits and claims | 3,763 |
| | 3,310 |
| 7,409 |
| | 6,532 |
|
Acquisition and operating expenses: | | | | | | |
Amortization of deferred policy acquisition costs | 269 |
| | 251 |
| 557 |
| | 511 |
|
Insurance commissions | 432 |
| | 427 |
| 867 |
| | 849 |
|
Insurance expenses | 587 |
| | 565 |
| 1,150 |
| | 1,098 |
|
Interest expense | 62 |
| | 46 |
| 119 |
| | 92 |
|
Other operating expenses | 48 |
| | 45 |
| 97 |
| | 86 |
|
Total acquisition and operating expenses | 1,398 |
| | 1,334 |
| 2,790 |
| | 2,636 |
|
Total benefits and expenses | 5,161 |
| | 4,644 |
| 10,199 |
| | 9,168 |
|
Earnings before income taxes | 741 |
| | 444 |
| 1,943 |
| | 1,036 |
|
Income taxes | 258 |
| | 170 |
| 675 |
| | 373 |
|
Net earnings | $ | 483 |
| | $ | 274 |
| $ | 1,268 |
| | $ | 663 |
|
Net earnings per share: | | | | | | |
Basic | $ | 1.04 |
| | $ | .59 |
| $ | 2.72 |
| | $ | 1.42 |
|
Diluted | 1.03 |
| | .58 |
| 2.71 |
| | 1.41 |
|
Weighted-average outstanding common shares used in computing earnings per share (In thousands): | | | | | | |
Basic | 466,788 |
| | 466,498 |
| 466,337 |
| | 467,317 |
|
Diluted | 468,590 |
| | 469,752 |
| 468,561 |
| | 470,990 |
|
Cash dividends per share | $ | .33 |
| | $ | .30 |
| $ | .66 |
| | $ | .60 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
Aflac Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
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| | | | | | | | | | | | | | |
| Three Months Ended June 30, | Six Months Ended June 30, |
(In millions - Unaudited) | 2012 | | 2011 | 2012 | | 2011 |
Net earnings | $ | 483 |
| | $ | 274 |
| $ | 1,268 |
| | $ | 663 |
|
Other comprehensive income (loss) before income taxes: | | | | | | |
Unrealized foreign currency translation gains (losses) during period | 32 |
| | (93 | ) | (68 | ) | | (89 | ) |
Unrealized gains (losses) on investment securities: | | | | | | |
Unrealized holding gains (losses) on investment securities during period | (319 | ) | | 473 |
| 5 |
| | (136 | ) |
Reclassification adjustment for realized (gains) losses on investment securities included in net earnings | 368 |
| | 716 |
| 497 |
| | 1,243 |
|
Unrealized gains (losses) on derivatives during period | 4 |
| | 17 |
| (8 | ) | | (38 | ) |
Pension liability adjustment during period | (2 | ) | | 0 |
| 3 |
| | 4 |
|
Total other comprehensive income (loss) before income taxes | 83 |
| | 1,113 |
| 429 |
| | 984 |
|
Income tax expense (benefit) related to items of other comprehensive income (loss) | (89 | ) | | 293 |
| 222 |
| | 300 |
|
Other comprehensive income (loss), net of income taxes | 172 |
| | 820 |
| 207 |
| | 684 |
|
Total comprehensive income (loss) | $ | 655 |
| | $ | 1,094 |
| $ | 1,475 |
| | $ | 1,347 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets
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(In millions - Unaudited) | June 30, 2012 | | December 31, 2011 | |
Assets: | | | | |
Investments and cash: | | | | |
Securities available for sale, at fair value: | | | | |
Fixed maturities (amortized cost $41,699 in 2012 and $40,534 in 2011) | $ | 44,036 |
| | $ | 42,222 |
| |
Fixed maturities - consolidated variable interest entities (amortized cost $5,262 in 2012 and $4,822 in 2011) | 5,745 |
| | 5,350 |
| |
Perpetual securities (amortized cost $4,383 in 2012 and $5,365 in 2011) | 3,966 |
| | 5,149 |
| |
Perpetual securities - consolidated variable interest entities (amortized cost $899 in 2012 and $1,532 in 2011) | 766 |
| | 1,290 |
| |
Equity securities (cost $21 in 2012 and $22 in 2011) | 23 |
| | 25 |
| |
Securities held to maturity, at amortized cost: | | | | |
Fixed maturities (fair value $52,229 in 2012 and $45,817 in 2011) | 52,098 |
| | 46,366 |
| |
Fixed maturities - consolidated variable interest entities (fair value $311 in 2012 and $566 in 2011) | 315 |
| | 643 |
| |
Other investments | 176 |
| | 168 |
| |
Cash and cash equivalents | 2,130 |
| | 2,249 |
| |
Total investments and cash | 109,255 |
| | 103,462 |
| |
Receivables | 747 |
| | 680 |
| |
Accrued investment income | 813 |
| | 802 |
| |
Deferred policy acquisition costs | 9,961 |
| | 9,789 |
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Property and equipment, at cost less accumulated depreciation | 603 |
| | 617 |
| |
Other | 830 |
| (1) | 887 |
| (1) |
Total assets | $ | 122,209 |
| | $ | 116,237 |
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(1) Includes $281 in 2012 and $375 in 2011 of derivatives from consolidated variable interest entities
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
(continued)
Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets (continued)
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(In millions, except for share and per-share amounts - Unaudited) | June 30, 2012 | | December 31, 2011 | |
Liabilities and shareholders’ equity: | | | | |
Liabilities: | | | | |
Policy liabilities: | | | | |
Future policy benefits | $ | 80,078 |
| | $ | 79,278 |
| |
Unpaid policy claims | 4,057 |
| | 3,981 |
| |
Unearned premiums | 2,068 |
| | 1,704 |
| |
Other policyholders’ funds | 13,210 |
| | 9,630 |
| |
Total policy liabilities | 99,413 |
| | 94,593 |
| |
Notes payable | 3,672 |
| | 3,285 |
| |
Income taxes | 2,635 |
| | 2,308 |
| |
Payables for return of cash collateral on loaned securities | 192 |
| | 838 |
| |
Other | 2,118 |
| (2) | 2,267 |
| (2) |
Commitments and contingent liabilities (Note 10) |
| |
| |
Total liabilities | 108,030 |
| | 103,291 |
| |
Shareholders’ equity: | | | | |
Common stock of $.10 par value. In thousands: authorized 1,900,000 shares in 2012 and 2011; issued 664,532 shares in 2012 and 663,639 shares in 2011 | 66 |
| | 66 |
| |
Additional paid-in capital | 1,453 |
| | 1,408 |
| |
Retained earnings | 16,108 |
| | 15,148 |
|
|
Accumulated other comprehensive income (loss): | | | | |
Unrealized foreign currency translation gains | 865 |
| | 984 |
|
|
Unrealized gains (losses) on investment securities: | | | | |
Unrealized gains (losses) on securities not other-than-temporarily impaired | 1,470 |
| | 1,143 |
| |
Unrealized gains (losses) on derivatives | 4 |
| | 9 |
| |
Pension liability adjustment | (168 | ) | | (171 | ) | |
Treasury stock, at average cost | (5,619 | ) | | (5,641 | ) | |
Total shareholders’ equity | 14,179 |
| | 12,946 |
|
|
Total liabilities and shareholders’ equity | $ | 122,209 |
| | $ | 116,237 |
|
|
(2) Includes $474 in 2012 and $531 in 2011 of derivatives from consolidated variable interest entities
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
Aflac Incorporated and Subsidiaries
Consolidated Statements of Shareholders’ Equity
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| | | | | | | |
| Six Months Ended June 30, |
(In millions - Unaudited) | 2012 | | 2011 |
Common stock: | | | |
Balance, beginning of period | $ | 66 |
| | $ | 66 |
|
Balance, end of period | 66 |
| | 66 |
|
Additional paid-in capital: | | | |
Balance, beginning of period | 1,408 |
| | 1,320 |
|
Exercise of stock options | 15 |
| | 15 |
|
Share-based compensation | 16 |
| | 18 |
|
Gain (loss) on treasury stock reissued | 14 |
| | 19 |
|
Balance, end of period | 1,453 |
| | 1,372 |
|
Retained earnings: | | | |
Balance, beginning of period | 15,148 |
| | 13,787 |
|
Net earnings | 1,268 |
| | 663 |
|
Dividends to shareholders | (308 | ) | | (281 | ) |
Balance, end of period | 16,108 |
| | 14,169 |
|
Accumulated other comprehensive income (loss): | | | |
Balance, beginning of period | 1,965 |
| | 753 |
|
Unrealized foreign currency translation gains (losses) during period, net of income taxes: | | | |
Change in unrealized foreign currency translation gains (losses) during period, net of income taxes | (119 | ) | | (14 | ) |
Unrealized gains (losses) on investment securities during period, net of income taxes and reclassification adjustments: | | | |
Change in unrealized gains (losses) on investment securities not other- than-temporarily impaired, net of income taxes | 327 |
| | 716 |
|
Change in unrealized gains (losses) on other-than-temporarily impaired investment securities, net of income taxes | 0 |
| | 3 |
|
Unrealized gains (losses) on derivatives during period, net of income taxes | (5 | ) | | (25 | ) |
Pension liability adjustment during period, net of income taxes | 3 |
| | 3 |
|
Balance, end of period | 2,171 |
| | 1,436 |
|
Treasury stock: | | | |
Balance, beginning of period | (5,641 | ) | | (5,386 | ) |
Purchases of treasury stock | (10 | ) | | (231 | ) |
Cost of shares issued | 32 |
| | 26 |
|
Balance, end of period | (5,619 | ) | | (5,591 | ) |
Total shareholders’ equity | $ | 14,179 |
| | $ | 11,452 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
Aflac Incorporated and Subsidiaries
Consolidated Statements of Cash Flows
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| | | | | | | |
| Six Months Ended June 30, |
(In millions - Unaudited) | 2012 | | 2011 |
Cash flows from operating activities: | | | |
Net earnings | $ | 1,268 |
| | $ | 663 |
|
Adjustments to reconcile net earnings to net cash provided by operating activities: | | | |
Change in receivables and advance premiums | 3,135 |
| | 926 |
|
Increase in deferred policy acquisition costs | (311 | ) | | (204 | ) |
Increase in policy liabilities | 2,679 |
| | 1,922 |
|
Change in income tax liabilities | 105 |
| | (89 | ) |
Realized investment (gains) losses | 463 |
| | 1,247 |
|
Other, net | (94 | ) | | (87 | ) |
Net cash provided (used) by operating activities | 7,245 |
| | 4,378 |
|
Cash flows from investing activities: | | | |
Proceeds from investments sold or matured: | | | |
Securities available for sale: | | | |
Fixed maturities sold | 982 |
| | 1,767 |
|
Fixed maturities matured or called | 938 |
| | 775 |
|
Perpetual securities sold | 897 |
| | 226 |
|
Perpetual securities matured or called | 376 |
| | 61 |
|
Securities held to maturity: | | | |
Fixed maturities matured or called | 1,058 |
| | 325 |
|
Costs of investments acquired: | | | |
Securities available for sale: | | | |
Fixed maturities acquired | (3,265 | ) | | (4,822 | ) |
Securities held to maturity: | | | |
Fixed maturities acquired | (8,418 | ) | | (3,484 | ) |
Cash received as collateral on loaned securities, net | (646 | ) | | 147 |
|
Other, net | 20 |
| | (29 | ) |
Net cash provided (used) by investing activities | (8,058 | ) | | (5,034 | ) |
Cash flows from financing activities: | | | |
Purchases of treasury stock | (10 | ) | | (222 | ) |
Proceeds from borrowings | 749 |
| | 0 |
|
Principal payments under debt obligations | (339 | ) | | (1 | ) |
Dividends paid to shareholders | (296 | ) | | (260 | ) |
Change in investment-type contracts, net | 601 |
| | 275 |
|
Treasury stock reissued | 11 |
| | 26 |
|
Other, net | 9 |
| | 7 |
|
Net cash provided (used) by financing activities | 725 |
| | (175 | ) |
Effect of exchange rate changes on cash and cash equivalents | (31 | ) | | 1 |
|
Net change in cash and cash equivalents | (119 | ) | | (830 | ) |
Cash and cash equivalents, beginning of period | 2,249 |
| | 2,121 |
|
Cash and cash equivalents, end of period | $ | 2,130 |
| | $ | 1,291 |
|
Supplemental disclosures of cash flow information: | | | |
Income taxes paid | $ | 355 |
| | $ | 460 |
|
Interest paid | 113 |
| | 72 |
|
Impairment losses included in realized investment losses | 546 |
| | 933 |
|
Noncash financing activities: | | | |
Capitalized lease obligations | 2 |
| | 1 |
|
Treasury stock issued for: | | | |
Associate stock bonus | 19 |
| | 0 |
|
Shareholder dividend reinvestment | 12 |
| | 21 |
|
Share-based compensation grants | 4 |
| | 2 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
See the accompanying Notes to the Consolidated Financial Statements.
Aflac Incorporated and Subsidiaries
Notes to the Consolidated Financial Statements
(Interim period data – Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States and Japan. The Company's insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac), which operates in the United States (Aflac U.S.) and as a branch in Japan (Aflac Japan). Most of Aflac's policies are individually underwritten and marketed through independent agents. Additionally, Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC), branded as Aflac Group Insurance. Our insurance operations in the United States and our branch in Japan service the two markets for our insurance business. Aflac Japan's revenues, including realized gains and losses on its investment portfolio, accounted for 77% and 73% of the Company's total revenues in the six-month periods ended June 30, 2012, and 2011, respectively. The percentage of the Company's total assets attributable to Aflac Japan was 87% at June 30, 2012, and December 31, 2011.
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). In these Notes to the Consolidated Financial Statements, references to GAAP issued by the FASB are derived from the FASB Accounting Standards CodificationTM (ASC). 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, liabilities for future policy benefits and unpaid policy claims, and income taxes. 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 unaudited consolidated financial statements include the accounts of the Parent Company, its 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 the Company contain all adjustments, consisting of normal recurring accruals, which are necessary to fairly present the consolidated balance sheets as of June 30, 2012, and December 31, 2011, the consolidated statements of earnings and comprehensive income (loss) for the three- and six-month periods ended June 30, 2012, and 2011, and the consolidated statements of shareholders' equity and cash flows for the six-month periods ended June 30, 2012, and 2011. 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, 2011.
Significant Accounting Policies
We have revised the accounting policy for deferred policy acquisition costs as a result of the adoption of amended accounting guidance effective January 1, 2012, and we have updated the disclosure in the accounting policy for income taxes. All other categories of significant accounting policies remain unchanged from our annual report to shareholders for the year ended December 31, 2011.
Deferred Policy Acquisition Costs: Certain direct and incremental costs of acquiring new business are deferred and amortized with interest over the premium payment periods in proportion to the ratio of annual premium income to total anticipated premium income. Anticipated premium income is estimated by using the same mortality, persistency and interest assumptions used in computing liabilities for future policy benefits. In this manner, the related acquisition expenses are matched with revenues. Deferred costs include the excess of current-year commissions over ultimate renewal-year commissions and certain incremental direct policy issue, underwriting and sales expenses. All of these
incremental costs are directly related to successful policy acquisition.
For some products, policyholders can elect to modify product benefits, features, rights or coverages by exchanging a contract for a new contract or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. These transactions are known as internal replacements. For internal replacement transactions where the resulting contract is substantially unchanged, the policy is accounted for as a continuation of the replaced contract. Unamortized deferred acquisition costs from the original policy continue to be amortized over the expected life of the new policy, and the costs of replacing the policy are accounted for as policy maintenance costs and expensed as incurred. Internal replacement transactions that result in a policy that is not substantially unchanged are accounted for as an extinguishment of the original policy and the issuance of a new policy. Unamortized deferred acquisition costs on the original policy that was replaced are immediately expensed, and the costs of acquiring the new policy are capitalized and amortized in accordance with our accounting policies for deferred acquisition costs.
Income Taxes: Income tax provisions are generally based on pretax earnings reported for financial statement purposes, which differ from those amounts used in preparing our income tax returns. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which we expect the temporary differences to reverse. We record deferred tax assets for tax positions taken based on our assessment of whether the tax position is more likely than not to be sustained upon examination by taxing authorities. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized.
As discussed in the Translation of Foreign Currencies section in Note 1 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2011, Aflac Japan maintains a dollar-denominated investment portfolio on behalf of Aflac U.S. While there are no translation effects to record in other comprehensive income, the deferred tax expense or benefit associated with foreign exchange gains or losses on the portfolio is recognized in other comprehensive income until the securities mature or are sold. Total income tax expense (benefit) related to items of other comprehensive income (loss) included a tax benefit of $96 million during the three-month period ended June 30, 2012, and a tax benefit of $112 million during the three-month period ended June 30, 2011, for this dollar-denominated portfolio. Excluding these amounts from total taxes on other comprehensive income would result in an effective income tax rate on pretax other comprehensive income (loss) of 8.3% and 36.4% in the three-month periods ended June 30, 2012 and 2011, respectively. Total income tax expense (benefit) related to items of other comprehensive income (loss) included tax expense of $61 million during the six-month period ended June 30, 2012, and a tax benefit of $50 million during the six-month period ended June 30, 2011, for this dollar-denominated portfolio. Excluding these amounts from total taxes on other comprehensive income would result in an effective income tax rate on pretax other comprehensive income (loss) of 37.5% and 35.8% in the six-month periods ended June 30, 2012 and 2011, respectively.
On August 2, 2012, the Internal Revenue Service notified us of the final settlement of our tax returns for the years ended December 31, 2008 and 2009. As a result, we estimate that will recognize an income tax benefit ranging from $20 to $25 million, excluding interest, as a result of this final settlement.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Presentation of comprehensive income: In June 2011, the FASB issued guidance to amend the presentation of comprehensive income. The amendment requires that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We adopted this guidance as of January 1, 2012 and elected the option to report comprehensive income in two separate but consecutive statements. The adoption of this guidance did not have an impact on our financial position or results of operations. The amendment also requires reclassification adjustments for items that are reclassified from other comprehensive income to net income to be presented in the statements where the components of net income and the components of other comprehensive income are presented; however, in December 2011, the FASB issued guidance to temporarily defer the effective date of this additional requirement.
Fair value measurements and disclosures: In May 2011, the FASB issued guidance to amend the fair value measurement and disclosure requirements. Most of the amendments are clarifications of the FASB's intent about the application of existing fair value measurement and disclosure requirements. Other amendments change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. The new fair
value measurement disclosures include additional quantitative and qualitative disclosures for Level 3 measurements, including a qualitative sensitivity analysis of fair value to changes in unobservable inputs, and categorization by fair value hierarchy level for items for which the fair value is only disclosed. We adopted this guidance as of January 1, 2012. The adoption of this guidance impacted our financial statement disclosures, but it did not affect our financial position or results of operations.
Accounting for costs associated with acquiring or renewing insurance contracts: In October 2010, the FASB issued amended accounting guidance on accounting for costs associated with acquiring or renewing insurance contracts. Under the previous guidance, costs that varied with and were primarily related to the acquisition of a policy were deferrable. Under the amended guidance, only incremental direct costs associated with the successful acquisition of a new or renewal contract may be capitalized, and direct-response advertising costs may be capitalized only if they meet certain criteria. This guidance is effective on a prospective or retrospective basis for interim and annual periods beginning after December 15, 2011. We retrospectively adopted this guidance as of January 1, 2012. The retrospective adoption of this accounting standard resulted in an after-tax cumulative reduction to retained earnings of $408 million and an after-tax cumulative reduction to unrealized foreign currency translation gains in accumulated other comprehensive income of $108 million, resulting in a total reduction to shareholders' equity of $516 million as of December 31, 2010. The adoption of this accounting standard had an immaterial impact on net income in 2011 and for all preceding years.
Recent accounting guidance not discussed above is not applicable or did not have an impact to our business.
For additional information on new accounting pronouncements and recent accounting guidance 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, 2011.
2. BUSINESS SEGMENT INFORMATION
The Company consists of two reportable insurance business segments: Aflac Japan and Aflac U.S., both of which sell 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 (securities transactions, impairments, and the impact of derivative and hedging activities) and 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 June 30, | | Six Months Ended June 30, |
(In millions) | 2012 | | 2011 | | 2012 | | 2011 |
Revenues: | | | | | | | |
Aflac Japan: | | | | | | | |
Earned premiums | $ | 4,216 |
| | $ | 3,770 |
| | $ | 8,364 |
| | $ | 7,472 |
|
Net investment income | 691 |
| | 636 |
| | 1,421 |
| | 1,285 |
|
Other income | 0 |
| | 5 |
| | 16 |
| | 25 |
|
Total Aflac Japan | 4,907 |
| | 4,411 |
| | 9,801 |
| | 8,782 |
|
Aflac U.S.: | | | | | | | |
Earned premiums | 1,251 |
| | 1,186 |
| | 2,482 |
| | 2,356 |
|
Net investment income | 153 |
| | 148 |
| | 304 |
| | 291 |
|
Other income | 2 |
| | 3 |
| | 5 |
| | 6 |
|
Total Aflac U.S. | 1,406 |
| | 1,337 |
| | 2,791 |
| | 2,653 |
|
Other business segments | 10 |
| | 13 |
| | 24 |
| | 28 |
|
Total business segment revenues | 6,323 |
| | 5,761 |
| | 12,616 |
| | 11,463 |
|
Realized investment gains (losses) | (418 | ) | | (668 | ) | | (463 | ) | | (1,247 | ) |
Corporate | 64 |
| | 60 |
| | 128 |
| | 121 |
|
Intercompany eliminations | (67 | ) | | (65 | ) | | (139 | ) | | (133 | ) |
Total revenues | $ | 5,902 |
| | $ | 5,088 |
| | $ | 12,142 |
| | $ | 10,204 |
|
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(In millions) | 2012 | | 2011 | | 2012 | | 2011 |
Pretax earnings: | | | | | | | |
Aflac Japan | $ | 964 |
| | $ | 925 |
| | $ | 2,004 |
| | $ | 1,899 |
|
Aflac U.S. | 258 |
| | 243 |
| | 529 |
| | 494 |
|
Total business segment pretax operating earnings | 1,222 |
| | 1,168 |
| | 2,533 |
| | 2,393 |
|
Interest expense, noninsurance operations | (45 | ) | | (41 | ) | | (89 | ) | | (82 | ) |
Corporate and eliminations | (18 | ) | | (15 | ) | | (38 | ) | | (28 | ) |
Pretax operating earnings | 1,159 |
| | 1,112 |
| | 2,406 |
| | 2,283 |
|
Realized investment gains (losses) | (418 | ) | | (668 | ) | | (463 | ) | | (1,247 | ) |
Total earnings before income taxes | $ | 741 |
| | $ | 444 |
| | $ | 1,943 |
| | $ | 1,036 |
|
Income taxes applicable to pretax operating earnings | $ | 404 |
| | $ | 384 |
| | $ | 837 |
| | $ | 789 |
|
Effect of foreign currency translation on operating earnings | 6 |
| | 51 |
| | 26 |
| | 99 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
Assets were as follows:
|
| | | | | | | |
(In millions) | June 30, 2012 | | December 31, 2011 |
Assets: | | | |
Aflac Japan | $ | 106,832 |
| | $ | 101,692 |
|
Aflac U.S. | 14,630 |
| | 13,942 |
|
Other business segments | 162 |
| | 160 |
|
Total business segment assets | 121,624 |
| | 115,794 |
|
Corporate | 17,645 |
| | 16,182 |
|
Intercompany eliminations | (17,060 | ) | | (15,739 | ) |
Total assets | $ | 122,209 |
| | $ | 116,237 |
|
Prior-year amounts have been adjusted for the adoption of accounting guidance on January 1, 2012 related to deferred policy acquisition costs.
3. INVESTMENTS
Investment Holdings
The amortized cost for our investments in debt and perpetual securities, the cost for equity securities and the fair values of these investments are shown in the following tables.
|
| | | | | | | | | | | | | | | |
| June 30, 2012 |
(In millions) | Cost or Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Securities available for sale, carried at fair value: | | | | | | | |
Fixed maturities: | | | | | | | |
Yen-denominated: | | | | | | | |
Japan government and agencies | $ | 11,678 |
| | $ | 741 |
| | $ | 1 |
| | $ | 12,418 |
|
Mortgage- and asset-backed securities | 852 |
| | 47 |
| | 1 |
| | 898 |
|
Public utilities | 3,939 |
| | 73 |
| | 233 |
| | 3,779 |
|
Sovereign and supranational | 2,006 |
| | 46 |
| | 65 |
| | 1,987 |
|
Banks/financial institutions | 4,226 |
| | 177 |
| | 436 |
| | 3,967 |
|
Other corporate | 6,217 |
| | 141 |
| | 367 |
| | 5,991 |
|
Total yen-denominated | 28,918 |
| | 1,225 |
| | 1,103 |
| | 29,040 |
|
Dollar-denominated: | | | | | | | |
U.S. government and agencies | 94 |
| | 22 |
| | 0 |
| | 116 |
|
Municipalities | 1,052 |
| | 144 |
| | 7 |
| | 1,189 |
|
Mortgage- and asset-backed securities | 296 |
| | 80 |
| | 1 |
| | 375 |
|
Public utilities | 3,251 |
| | 572 |
| | 28 |
| | 3,795 |
|
Sovereign and supranational | 473 |
| | 103 |
| | 3 |
| | 573 |
|
Banks/financial institutions | 3,449 |
| | 341 |
| | 41 |
| | 3,749 |
|
Other corporate | 9,428 |
| | 1,555 |
| | 39 |
| | 10,944 |
|
Total dollar-denominated | 18,043 |
| | 2,817 |
| | 119 |
| | 20,741 |
|
Total fixed maturities | 46,961 |
| | 4,042 |
| | 1,222 |
| | 49,781 |
|
Perpetual securities: | | | | | | | |
Yen-denominated: | | | | | | | |
Banks/financial institutions | 4,634 |
| | 27 |
| | 570 |
| | 4,091 |
|
Other corporate | 338 |
| | 4 |
| | 0 |
| | 342 |
|
Dollar-denominated: | | | | | | | |
Banks/financial institutions | 310 |
| | 7 |
| | 18 |
| | 299 |
|
Total perpetual securities | 5,282 |
| | 38 |
| | 588 |
| | 4,732 |
|
Equity securities | 21 |
| | 4 |
| | 2 |
| | 23 |
|
Total securities available for sale | $ | 52,264 |
| | $ | 4,084 |
| | $ | 1,812 |
| | $ | 54,536 |
|
|
| | | | | | | | | | | | | | | |
| June 30, 2012 |
(In millions) | Cost or Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Securities held to maturity, carried at amortized cost: | | | | | | | |
Fixed maturities: | | | | | | | |
Yen-denominated: | | | | | | | |
Japan government and agencies | $ | 26,927 |
| | $ | 605 |
| | $ | 5 |
| | $ | 27,527 |
|
Municipalities | 539 |
| | 37 |
| | 2 |
| | 574 |
|
Mortgage- and asset-backed securities | 115 |
| | 5 |
| | 0 |
| | 120 |
|
Public utilities | 5,377 |
| | 214 |
| | 165 |
| | 5,426 |
|
Sovereign and supranational | 3,633 |
| | 167 |
| | 102 |
| | 3,698 |
|
Banks/financial institutions | 10,957 |
| | 184 |
| | 809 |
| | 10,332 |
|
Other corporate | 4,865 |
| | 160 |
| | 162 |
| | 4,863 |
|
Total yen-denominated | 52,413 |
| | 1,372 |
| | 1,245 |
| | 52,540 |
|
Total securities held to maturity | $ | 52,413 |
| | $ | 1,372 |
| | $ | 1,245 |
| | $ | 52,540 |
|
|
| | | | | | | | | | | | | | | |
| December 31, 2011 |
(In millions) | Cost or Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Securities available for sale, carried at fair value: | | | | | | | |
Fixed maturities: | | | | | | | |
Yen-denominated: | | | | | | | |
Japan government and agencies | $ | 11,108 |
| | $ | 670 |
| | $ | 0 |
| | $ | 11,778 |
|
Mortgage- and asset-backed securities | 912 |
| | 43 |
| | 1 |
| | 954 |
|
Public utilities | 3,850 |
| | 59 |
| | 226 |
| | 3,683 |
|
Sovereign and supranational | 1,704 |
| | 87 |
| | 16 |
| | 1,775 |
|
Banks/financial institutions | 4,312 |
| | 74 |
| | 359 |
| | 4,027 |
|
Other corporate | 6,213 |
| | 120 |
| | 459 |
| | 5,874 |
|
Total yen-denominated | 28,099 |
| | 1,053 |
| | 1,061 |
| | 28,091 |
|
Dollar-denominated: | | | | | | | |
U.S. government and agencies | 31 |
| | 4 |
| | 0 |
| | 35 |
|
Municipalities | 1,060 |
| | 107 |
| | 8 |
| | 1,159 |
|
Mortgage- and asset-backed securities | 310 |
| | 74 |
| | 0 |
| | 384 |
|
Public utilities | 3,052 |
| | 517 |
| | 27 |
| | 3,542 |
|
Sovereign and supranational | 449 |
| | 89 |
| | 5 |
| | 533 |
|
Banks/financial institutions | 3,324 |
| | 223 |
| | 121 |
| | 3,426 |
|
Other corporate | 9,031 |
| | 1,433 |
| | 62 |
| | 10,402 |
|
Total dollar-denominated | 17,257 |
| | 2,447 |
| | 223 |
| | 19,481 |
|
Total fixed maturities | 45,356 |
| | 3,500 |
| | 1,284 |
| | 47,572 |
|
Perpetual securities: | | | | | | | |
Yen-denominated: | | | | | | | |
Banks/financial institutions | 6,217 |
| | 155 |
| | 604 |
| | 5,768 |
|
Other corporate | 344 |
| | 17 |
| | 0 |
| | 361 |
|
Dollar-denominated: | | | | | | | |
Banks/financial institutions | 336 |
| | 3 |
| | 29 |
| | 310 |
|
Total perpetual securities | 6,897 |
| | 175 |
| | 633 |
| | 6,439 |
|
Equity securities | 22 |
| | 4 |
| | 1 |
| | 25 |
|
Total securities available for sale | $ | 52,275 |
| | $ | 3,679 |
| | $ | 1,918 |
| | $ | 54,036 |
|
|
| | | | | | | | | | | | | | | |
| December 31, 2011 |
(In millions) | Cost or Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Securities held to maturity, carried at amortized cost: | | | | | | | |
Fixed maturities: | | | | | | | |
Yen-denominated: | | | | | | | |
Japan government and agencies | $ | 18,775 |
| | $ | 297 |
| | $ | 1 |
| | $ | 19,071 |
|
Municipalities | 553 |
| | 35 |
| | 4 |
| | 584 |
|
Mortgage- and asset-backed securities | 129 |
| | 5 |
| | 0 |
| | 134 |
|
Public utilities | 5,615 |
| | 188 |
| | 166 |
| | 5,637 |
|
Sovereign and supranational | 4,200 |
| | 148 |
| | 183 |
| | 4,165 |
|
Banks/financial institutions | 12,389 |
| | 170 |
| | 1,079 |
| | 11,480 |
|
Other corporate | 5,348 |
| | 149 |
| | 185 |
| | 5,312 |
|
Total yen-denominated | 47,009 |
| | 992 |
| | 1,618 |
| | 46,383 |
|
Total securities held to maturity | $ | 47,009 |
| | $ | 992 |
| | $ | 1,618 |
| | $ | 46,383 |
|
The methods of determining the fair values of our investments in debt securities, perpetual securities and equity securities are described in Note 5.
During the second quarter of 2012, we reclassified five investments from the held-to-maturity portfolio to the available-for-sale portfolio as a result of significant declines in the issuers' creditworthiness. At the time of transfer, the securities had an aggregate amortized cost of $842 million and an aggregate unrealized loss of $268 million. Included in this transfer were securities issued by UniCredit and Bankia SA, financial institutions, and Generalitat de Catalunya and Junta de Andalucia, regional governments in Spain. During the first quarter of 2012, we reclassified one investment from the held-to-maturity portfolio to the available-for-sale portfolio as a result of a significant decline in the issuer's creditworthiness. At the time of transfer, the security had an amortized cost of $122 million and an unrealized loss of $23 million. This investment was issued by Energias de Portugal SA (EDP), an integrated electric utility domiciled in Portugal.
During the second quarter of 2011, we did not reclassify any investments from the held-to-maturity portfolio to the available-for-sale portfolio. During the first quarter of 2011, we reclassified eight investments from the held-to-maturity portfolio to the available-for-sale portfolio as a result of significant declines in the issuers’ creditworthiness. At the time of the transfer, the securities had an aggregate amortized cost of $1.6 billion and an aggregate unrealized loss of $270 million. The securities transferred included investments in the Republic of Tunisia and securities associated with financial institutions in Portugal and Ireland. The investments from the financial institutions in Portugal were subsequently sold by the end of the third quarter of 2011.
Contractual and Economic Maturities
The contractual maturities of our investments in fixed maturities at June 30, 2012, were as follows:
|
| | | | | | | | | | | | | | | |
| Aflac Japan | | Aflac U.S. |
(In millions) | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Available for sale: | | | | | | | |
Due in one year or less | $ | 1,980 |
| | $ | 2,012 |
| | $ | 13 |
| | $ | 13 |
|
Due after one year through five years | 2,455 |
| | 2,569 |
| | 352 |
| | 379 |
|
Due after five years through 10 years | 4,133 |
| | 4,447 |
| | 984 |
| | 1,138 |
|
Due after 10 years | 28,095 |
| | 28,889 |
| | 7,681 |
| | 8,919 |
|
Mortgage- and asset-backed securities | 1,104 |
| | 1,217 |
| | 44 |
| | 57 |
|
Total fixed maturities available for sale | $ | 37,767 |
| | $ | 39,134 |
| | $ | 9,074 |
| | $ | 10,506 |
|
Held to maturity: | | | | | | | |
Due in one year or less | $ | 412 |
| | $ | 419 |
| | $ | 0 |
| | $ | 0 |
|
Due after one year through five years | 839 |
| | 908 |
| | 0 |
| | 0 |
|
Due after five years through 10 years | 3,298 |
| | 3,635 |
| | 0 |
| | 0 |
|
Due after 10 years | 47,749 |
| | 47,458 |
| | 0 |
| | 0 |
|
Mortgage- and asset-backed securities | 115 |
| | 120 |
| | 0 |
| | 0 |
|
Total fixed maturities held to maturity | $ | 52,413 |
| | $ | 52,540 |
| | $ | 0 |
| | $ | 0 |
|
At June 30, 2012, the Parent Company had a portfolio of investment-grade available-for-sale fixed-maturity securities totaling $120 million at amortized cost and $141 million at fair value, which is not included in the table above.
Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.
The majority of our perpetual securities are subordinated to other debt obligations of the issuer, but rank higher than the issuer's equity securities. Perpetual securities have characteristics of both debt and equity investments, along with unique features that create economic maturity dates for the securities. Although perpetual securities have no contractual maturity date, they have stated interest coupons that were fixed at their issuance and subsequently change to a floating short-term interest rate of 125 to more than 300 basis points above an appropriate market index, generally by the 25th year after issuance, thereby creating an economic maturity date. The economic maturities of our investments in perpetual securities, which were all reported as available for sale at June 30, 2012, were as follows:
|
| | | | | | | | | | | | | | | |
| Aflac Japan | | Aflac U.S. |
(In millions) | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Due in one year or less | $ | 315 |
| | $ | 317 |
| | $ | 0 |
| | $ | 0 |
|
Due after one year through five years | 1,289 |
| | 1,299 |
| | 5 |
| | 5 |
|
Due after five years through 10 years | 457 |
| | 461 |
| | 0 |
| | 0 |
|
Due after 10 years | 3,047 |
| | 2,488 |
| | 169 |
| | 162 |
|
Total perpetual securities available for sale | $ | 5,108 |
| | $ | 4,565 |
| | $ | 174 |
| | $ | 167 |
|
Investment Concentrations
Our investment discipline begins with a top-down approach for each investment opportunity we consider. Consistent with that approach, we first approve each country in which we invest. In our approach to sovereign analysis, we consider the political, legal and financial context of the sovereign entity in which an issuer is domiciled and operates. Next we approve the issuer's industry sector, considering such factors as the stability of results and the importance of the sector to the overall economy. Specific credit names within approved countries and industry sectors are evaluated for their market position and specific strengths and potential weaknesses. Structures in which we invest are chosen for specific portfolio management purposes, including asset/liability management, portfolio diversification and net investment income.
Banks and Financial Institutions
After Japanese government bonds (JGBs), our second largest investment concentration as of June 30, 2012, was banks and financial institutions. Within the countries we approve for investment opportunities, we primarily invest in financial institutions that are strategically crucial to each approved country's economy. The bank and financial institution sector is a highly regulated industry and plays a strategic role in the global economy. We achieve some degree of diversification in the bank and financial institution sector through a geographically diverse universe of credit exposures. Within this sector, the more significant concentration of our credit risk by geographic region or country of issuer at June 30, 2012, based on amortized cost, was: Europe, excluding the United Kingdom (34%); United States (24%); United Kingdom (8%); Japan (8%); and other (26%).
Our total investments in the bank and financial institution sector, including those classified as perpetual securities, were as follows:
|
| | | | | | | | | | | | | | | | | | | | | |
| June 30, 2012 | | December 31, 2011 |
| Total Investments in Banks and Financial Institutions Sector (in millions) | | Percentage of Total Investment Portfolio | | Total Investments in Banks and Financial Institutions Sector (in millions) | | Percentage of Total Investment Portfolio |
Fixed maturities: | | | | | | | | | | | | | | | |
Amortized cost | | $ | 18,632 |
| | | | 18 | % | | | | $ | 20,025 |
| | | | 20 | % | |
Fair value | | 18,048 |
| | | | 17 |
| | | | 18,933 |
| | | | 19 |
| |
Perpetual securities: | | | | | | | | | | | | | | | |
Upper Tier II: | | | | | | | | | | | | | | | |
Amortized cost | | $ | 3,311 |
| | | | 3 | % | | | | $ | 4,285 |
| | | | 5 | % | |
Fair value | | 3,052 |
| | | | 3 |
| | | | 4,244 |
| | | | 4 |
| |
Tier I: | | | | | | | | | | | | | | | |
Amortized cost | | 1,633 |
| | | | 2 |
| | | | 2,268 |
| | | | 2 |
| |
Fair value | | 1,338 |
| | | | 1 |
| | | | 1,834 |
| | | | 2 |
| |
Total: | | | | | | | | | | | | | | | |
Amortized cost | | $ | 23,576 |
| | | | 23 | % | | | | $ | 26,578 |
| | | | 27 | % | |
Fair value | | 22,438 |
| | | | 21 |
| | | | 25,011 |
| | | | 25 |
| |
Derisking
During the three- and six-month periods ended June 30, 2012, we continued our efforts which began in the first quarter of 2011 of pursuing strategic investment activities to lower the risk profile of our investment portfolio. Our primary focus during the first half of 2012 was on reducing our exposure to perpetual and other subordinated securities of European issuers, particularly in the financial sector. See further details in the Realized Investment Gains and Losses section below.
Realized Investment Gains and Losses
Information regarding pretax realized gains and losses from investments is as follows:
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| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(In millions) | 2012 | | 2011 | | 2012 | | 2011 |
Realized investment gains (losses) on securities: | | | | | | | |
Fixed maturities: | | | | | | | |
Available for sale: | | | | | | | |
Gross gains from sales | $ | 19 |
| | $ | 10 |
| | $ | 33 |
| | $ | 36 |
|
Gross losses from sales | (35 | ) | | (132 | ) | | (36 | ) | | (319 | ) |
Net gains (losses) from redemptions | 2 |
| | (1 | ) | | 2 |
| | 6 |
|
Other-than-temporary impairment losses | (267 | ) | | (344 | ) | | (330 | ) | | (748 | ) |
Held to maturity: | | | | | | | |
Net gains (losses) from redemptions | 3 |
| | 0 |
| | 3 |
| | 0 |
|
Total fixed maturities | (278 | ) | | (467 | ) | | (328 | ) | | (1,025 | ) |
Perpetual securities: | | | | | | | |
Available for sale: | | | | | | | |
Gross gains from sales | 0 |
| | 48 |
| | 70 |
| | 54 |
|
Gross losses from sales | 3 |
| | (107 | ) | | (62 | ) | | (109 | ) |
Net gains (losses) from redemptions | 0 |
| | 0 |
| | 60 |
| | 0 |
|
Other-than-temporary impairment losses | (76 | ) | | (184 | ) | | (216 | ) | | (184 | ) |
Total perpetual securities | (73 | ) | | (243 | ) | | (148 | ) | | (239 | ) |
Equity securities: | | | | | | | |
Other-than-temporary impairment losses | 0 |
| | 0 |
| | 0 |
| | (1 | ) |
Total equity securities | 0 |
| | 0 |
| | 0 |
| | (1 | ) |
Derivatives and other: | | | | | | | |
Derivative gains (losses) | (67 | ) | | (25 | ) | | 13 |
| | (55 | ) |
Other | 0 |
| | 67 |
| | 0 |
| | 73 |
|
Total derivatives and other | (67 | ) | | 42 |
| | 13 |
| | 18 |
|
Total realized investment gains (losses) | $ | (418 | ) | | $ | (668 | ) | | $ | (463 | ) | | $ | (1,247 | ) |
During the three-month period ended June 30, 2012, sales and redemptions of securities generated a net realized investment loss. However, for the six-month period ended June 30, 2012, sales and redemptions of securities generated a net realized investment gain. The overall net gain for the six-month period primarily resulted from both the redemption in the first quarter of 2012 of a previously impaired perpetual security and sales related to our plan to reduce the risk exposure in our investment portfolio (see the Investment Concentrations section above for more information). The other-than-temporary losses that we recognized in the six-month period ended June 30, 2012 were largely composed of impairments recognized in the first quarter for two Tier I securities that were sold in the second quarter of 2012, and impairments in the second quarter on certain securities issued by Spanish institutions and further impairments on several securities that had previously been impaired in the fourth quarter 2011.
During the three- and six-month periods ended June 30, 2011, we recognized other-than-temporary impairment losses and realized investment losses from the sale of securities, primarily a result of a plan to reduce the risk exposure in our investment portfolio coupled with the continued decline in the creditworthiness of issuers of certain investments. A valuation allowance of $19 million was recorded in the second quarter of 2011 related to deferred tax assets associated with realized investment losses.
Other-than-temporary Impairment
The fair value of our debt and perpetual security investments fluctuates based on changes in interest rates and credit spreads in the global financial markets. Credit spreads are most impacted by market rates of interest, the general and specific credit environment and global market liquidity. We believe that fluctuations in the fair value of our investment securities related to changes in credit spreads have little bearing on whether our investment is ultimately recoverable. Generally, we consider such declines in fair value to be temporary even in situations where an investment remains in an unrealized loss position for a year or more.
However, in the course of our credit review process, we may determine that it is unlikely that we will recover our investment in an issuer due to factors specific to an individual issuer, as opposed to general changes in global credit spreads. In this event, we consider such a decline in the investment's fair value, to the extent it is below the investment's cost or amortized cost, to be an other-than-temporary impairment of the investment and write the investment down to its fair value.
In addition to the usual investment risk associated with a debt instrument, our perpetual security holdings may be subject to the risk of nationalization of their issuers in connection with capital injections from an issuer's sovereign government. We cannot be assured that such capital support will extend to all levels of an issuer's capital structure. In addition, certain governments or regulators may consider imposing interest and principal payment restrictions on issuers of hybrid securities to preserve cash and build capital. In addition to the cash flow impact that additional deferrals would have on our portfolio, such deferrals could result in ratings downgrades of the affected securities, which in turn could result in a reduction of fair value of the securities and increase our regulatory capital requirements. We take factors such as these into account in our credit review process.
When determining our intention to sell a security prior to recovery of its fair value to amortized cost, we evaluate facts and circumstances such as, but not limited to, sales of securities to meet cash flow needs and decisions to reposition our security portfolio. We perform ongoing analyses of our liquidity needs, which includes cash flow testing of our policy liabilities, debt maturities, projected dividend payments and other cash flow and liquidity needs. Our cash flow testing includes extensive duration matching of our investment portfolio and policy liabilities. Based on our analyses, we have concluded that we have sufficient excess cash flows to meet our liquidity needs without liquidating any of our investments prior to their maturity. We have performed analyses of our investment portfolio, and we have determined that certain securities are no longer within our investment risk exposure guidelines. Therefore, we have started to reposition our security portfolio in an effort to enhance diversification and our credit profile by reducing our risk exposure through opportunistic investment transactions.
The following table details our pretax other-than-temporary impairment losses by investment category that resulted from our impairment evaluation process.
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| | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, | |
(In millions) | 2012 | | 2011 | | 2012 | | 2011 | |
Perpetual securities | $ | 76 |
| | $ | 184 |
| | $ | 216 |
| | $ | 184 |
| |
Corporate bonds | 120 |
| | 343 |
| | 183 |
| | 740 |
| |
Mortgage- and asset-backed securities | 3 |
| | 1 |
| | 3 |
| | 7 |
| |
Municipalities | 0 |
| | 0 |
| | 0 |
| | 1 |
| |
Sovereign and supranational | 144 |
| | 0 |
| | 144 |
| | 0 |
| |
Equity securities | 0 |
| | 0 |
| | 0 |
| | 1 |
| |
Total other-than-temporary impairment losses realized | $ | 343 |
| (1) | $ | 528 |
| (2) | $ | 546 |
| (1) | $ | 933 |
| (2) |
(1) Includes $267 and $295 for the three- and six-month periods ended June 30, 2012, respectively, for credit-related impairments
and $76 and $251 for the three- and six-month periods ended June 30, 2012, respectively, from change in intent to sell securities
(2) Consisted completely of credit-related impairments
Unrealized Investment Gains and Losses
Effect on Shareholders’ Equity
The net effect on shareholders’ equity of unrealized gains and losses from investment securities was as follows:
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| | | | | | | |
(In millions) | June 30, 2012 | | December 31, 2011 |
Unrealized gains (losses) on securities available for sale | $ | 2,272 |
| | $ | 1,761 |
|
Unamortized unrealized gains on securities transferred to held to maturity | 26 |
| | 34 |
|
Deferred income taxes | (828 | ) | | (652 | ) |
Shareholders’ equity, unrealized gains (losses) on investment securities | $ | 1,470 |
| | $ | 1,143 |
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Gross Unrealized Loss Aging
The following tables show the fair value and gross unrealized losses of our available-for-sale and held-to-maturity investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
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| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2012 |
| Total | | Less than 12 months | | 12 months or longer |
(In millions) | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
Fixed maturities: | | | | | | | | | | | |
Japan government and agencies: | | | | | | | | | | | |
Yen-denominated | $ | 1,397 |
| | $ | 6 |
| | $ | 1,397 |
| | $ | 6 |
| | $ | 0 |
| | $ | 0 |
|
Municipalities: | | | | | | | | | | | |
Dollar-denominated | 51 |
| | 7 |
| | 19 |
| | 0 |
| | 32 |
| | 7 |
|
Yen-denominated | 61 |
| | 2 |
| | 0 |
| | 0 |
| | 61 |
| | 2 |
|
Mortgage- and asset- backed securities: | | | | | | | | | | | |
Dollar-denominated | 10 |
| | 1 |
| | 10 |
| | 1 |
| | 0 |
| | 0 |
|
Yen-denominated | 149 |
| | 1 |
| | 0 |
| | 0 |
| | 149 |
| | 1 |
|
Public utilities: | | | | | | | | | | | |
Dollar-denominated | 347 |
| | 28 |
| | 210 |
| | 14 |
| | 137 |
| | 14 |
|
Yen-denominated | 4,810 |
| | 398 |
| | 1,822 |
| | 141 |
| | 2,988 |
| | 257 |
|
Sovereign and supranational: | | | | | | | | | | | |
Dollar-denominated | 57 |
| | 3 |
| | 6 |
| | 0 |
| | 51 |
| | 3 |
|
Yen-denominated | 2,355 |
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