-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ScCAKxSUiXMvpSiytqEhX9YmFLLiCynctQFHkAHHANLarC8TBk38UfFLqX5uHNm5 E9sN2/c5QgXow5x/AA53IQ== 0000004977-98-000019.txt : 19981110 0000004977-98-000019.hdr.sgml : 19981110 ACCESSION NUMBER: 0000004977-98-000019 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AFLAC INC CENTRAL INDEX KEY: 0000004977 STANDARD INDUSTRIAL CLASSIFICATION: ACCIDENT & HEALTH INSURANCE [6321] IRS NUMBER: 581167100 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-07434 FILM NUMBER: 98740683 BUSINESS ADDRESS: STREET 1: 1932 WYNNTON RD CITY: COLUMBUS STATE: GA ZIP: 31999 BUSINESS PHONE: 4043233431 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN FAMILY CORP DATE OF NAME CHANGE: 19920306 10-Q 1 3RD QUARTER FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 For the quarter ended September 30, 1998 Commission File No. 1-7434 AFLAC INCORPORATED ------------------------------------------------------ (Exact name of Registrant as specified in its charter) GEORGIA 58-1167100 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1932 WYNNTON ROAD, COLUMBUS, GEORGIA 31999 ----------------------------------------------------- (Address of principal executive offices and zip code) Registrant's telephone number, including area code (706) 323-3431 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . ------ ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class October 30, 1998 - ---------------------------- ------------------ Common Stock, $.10 Par Value 265,283,460 shares AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - September 30, 1998 and December 31, 1997................ 1 Consolidated Statements of Earnings - Three Months Ended September 30, 1998 and 1997 Nine Months Ended September 30, 1998 and 1997........... 3 Consolidated Statements of Shareholders' Equity - Nine Months Ended September 30, 1998 and 1997........... 5 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 and 1997........... 6 Consolidated Statements of Comprehensive Income - Three Months Ended September 30, 1998 and 1997 Nine Months Ended September 30, 1998 and 1997........... 8 Notes to Consolidated Financial Statements................ 9 Review by Independent Certified Public Accountants............................................. 15 Independent Auditors' Report.............................. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 17 Item 3. Quantitative and Qualitative Disclosures about Market Risk......................................... 32 Part II. Other Information: Item 1. Legal Proceedings.................................. 36 Item 6. Exhibits and Reports on Form 8-K................... 36 Items other than those listed above are omitted because they are not required or are not applicable. i Part I. Financial Information AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets (In thousands)
September 30, December 31, 1998 1997 (Unaudited) ------------- ------------- ASSETS: Investments and cash: Securities available for sale, at fair value: Fixed maturities (amortized cost, $20,094,739 in 1998 and $19,121,128 in 1997) $ 24,269,830 $ 22,437,818 Equity securities (cost, $90,165 in 1998 and $80,270 in 1997) 134,737 146,326 Mortgage loans and other 7,871 16,747 Short-term investments 45,910 43,344 Cash and cash equivalents 290,178 235,675 ------------ ------------ Total investments and cash 24,748,526 22,879,910 Receivables, primarily premiums 234,147 213,469 Receivables for security transactions 2,296 2,184 Accrued investment income 248,666 264,956 Deferred policy acquisition costs 2,667,441 2,581,828 Property and equipment, net 371,999 386,049 Securities held as collateral for loaned securities - 3,034,241 Other 93,374 91,368 ------------ ------------ Total assets $ 28,366,449 $ 29,454,005 ============ ============ See the accompanying Notes to Consolidated Financial Statements. (continued)
1 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In thousands, except for per-share amounts)
September 30, December 31, 1998 1997 (Unaudited) ------------ ------------ Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 20,108,353 $ 18,398,830 Unpaid policy claims 1,091,846 1,010,519 Unearned premiums 270,593 276,673 Other policyholders' funds 212,721 199,046 ------------ ------------ Total policy liabilities 21,683,513 19,885,068 Notes payable 502,083 523,209 Income taxes 1,743,224 1,827,337 Payables for return of collateral on loaned securities - 3,034,241 Payables for security transactions 182,453 215,654 Other 683,909 538,024 ------------ ------------ Total liabilities 24,795,182 26,023,533 ------------ ------------ Shareholders' equity: Common stock of $.10 par value. Authorized 400,000 shares; issued 317,572 shares in 1998 and 316,380 shares in 1997 31,757 15,819 Additional paid-in capital 228,193 227,292 Retained earnings 2,763,063 2,442,309 Accumulated other comprehensive income: Unrealized foreign currency translation gains 211,814 274,074 Unrealized gains on securities available for sale 1,251,977 1,284,717 ------------ ------------ Total accumulated other comprehensive income 1,463,791 1,558,791 Treasury stock, at average cost (914,614) (812,672) Notes receivable for stock purchases (923) (1,067) ------------ ------------ Total shareholders' equity 3,571,267 3,430,472 ------------ ------------ Total liabilities and shareholders' equity $ 28,366,449 $ 29,454,005 ============ ============ Shareholders' equity per share $ 13.48 $ 12.88 ============ ============ See the accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect the two-for-one stock split issued June 8, 1998.
2 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings
(In thousands, except for Three Months Ended September 30, Nine Months Ended September 30, per-share amounts - Unaudited) -------------------------------- -------------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Revenues: Premiums, principally supplemental health insurance $ 1,421,280 $ 1,508,697 $ 4,317,653 $ 4,412,040 Net investment income 274,777 280,316 828,913 798,946 Realized investment gains (losses) (1,863) (4,568) (2,131) (5,703) Gain on sale of television business - - - 267,223 Other income 5,352 5,175 15,638 33,344 ---------- ---------- ---------- ---------- Total revenues 1,699,546 1,789,620 5,160,073 5,505,850 ---------- ---------- ---------- ---------- Benefits and expenses: Benefits and claims 1,159,638 1,241,090 3,544,175 3,632,839 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 47,704 45,906 146,269 133,381 Insurance commissions 184,047 198,905 561,204 582,017 Insurance expenses 125,563 120,287 361,478 350,578 Provision for mandated policyholder protection fund - - 111,279 - Interest expense 2,814 3,101 9,478 10,548 Other operating expenses 18,310 24,521 51,007 76,597 ---------- ---------- ---------- ---------- Total acquisition and operating expenses 378,438 392,720 1,240,715 1,153,121 ---------- ---------- ---------- ---------- Total benefits and expenses 1,538,076 1,633,810 4,784,890 4,785,960 ---------- ---------- ---------- ---------- Earnings before income taxes 161,470 155,810 375,183 719,890 Income taxes: Operations 53,901 59,731 125,652 230,861 Deferred tax benefit from Japan tax rate reduction - - (121,120) - ---------- ---------- ---------- ---------- Total income tax expense 53,901 59,731 4,532 230,861 ---------- ---------- ---------- ---------- Net earnings $ 107,569 $ 96,079 $ 370,651 $ 489,029 ========== ========== ========== ========== (continued on next page) 3
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings (continued)
(In thousands, except for Three Months Ended September 30, Nine Months Ended September 30, per-share amounts - Unaudited) -------------------------------- ------------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Net earnings per share: Basic $ .40 $ .35 $ 1.39 $ 1.79 Diluted .39 .34 1.34 1.73 ========== ========== ========== ========== Shares used in computing earnings per share: Basic 265,928 272,605 266,629 273,354 Diluted 275,287 282,450 276,048 282,979 ========== ========== ========== ========== Cash dividends per share $ .065 $ .058 $ .188 $ .166 ========== ========== ========== ========== See the accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect the two-for-one stock split issued June 8, 1998. 4
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity
Nine Months Ended September 30, (In thousands - Unaudited) 1998 1997 ---------- ---------- Common stock: Balance at beginning of year $ 15,819 $ 15,724 Exercise of stock options 74 84 Two-for-one stock split 15,864 - ---------- ---------- Balance at end of period 31,757 15,808 ---------- ---------- Additional paid-in capital: Balance at beginning of year 227,292 208,994 Exercise of stock options 5,049 4,240 Gain on treasury stock reissued 11,716 8,533 Two-for-one stock split (15,864) - ---------- ---------- Balance at end of period 228,193 221,767 ---------- ---------- Retained earnings: Balance at beginning of year 2,442,309 1,917,794 Net earnings 370,651 489,029 Cash dividends ($.188 per share in 1998 and $.166 in 1997) (49,897) (45,050) ---------- ---------- Balance at end of period 2,763,063 2,361,773 ---------- ---------- Accumulated other comprehensive income: Balance at beginning of year 1,558,791 509,936 Change in unrealized foreign currency translation gains (losses) during period, net of income taxes (62,260) 9,276 Unrealized gains (losses) on securities available for sale during period, net of income taxes and reclassification adjustments (32,740) 341,123 ---------- ---------- Balance at end of period 1,463,791 860,335 ---------- ---------- Treasury stock: Balance at beginning of year (812,672) (526,425) Purchases of treasury stock (122,556) (159,479) Cost of shares issued to sales associates stock bonus plan and dividend reinvestment plan 20,614 20,810 ---------- ---------- Balance at end of period (914,614) (665,094) ---------- ---------- Notes receivable for stock purchases (923) (814) ---------- ---------- Total shareholders' equity $ 3,571,267 $ 2,793,775 ========== ========== See the accompanying Notes to Consolidated Financial Statements. Per-share amounts have been adjusted to reflect the two-for-one stock split issued June 8, 1998. 5
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands - Unaudited)
Nine Months Ended September 30, ----------------------------- 1998 1997 ------------ ------------ Cash flows from operating activities: Net earnings $ 370,651 $ 489,029 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 1,623,713 1,750,978 Deferred income taxes (174,445) 11,235 Change in income taxes payable 63,978 3,336 Increase in deferred policy acquisition costs (161,446) (174,686) Change in receivables and advance premiums (18,447) (11,989) Gain on sale of television business - (267,223) Provision for mandated policyholder protection fund 111,279 - Other, net 19,304 158,267 ---------- ---------- Net cash provided by operating activities 1,834,587 1,958,947 ---------- ---------- Cash flows from investing activities: Proceeds from investments sold or matured: Fixed-maturity securities sold 647,231 1,517,566 Fixed-maturity securities matured 511,649 295,641 Equity securities 49,284 48,256 Mortgage loans and other investments, net 8,762 2,212 Short-term investments, net - 2,546 Costs of investments acquired: Fixed-maturity securities (2,773,852) (4,002,063) Equity securities (44,133) (43,013) Short-term investments, net (2,791) - Proceeds from sale of television business - 350,633 Additions to property and equipment, net (25,929) (4,120) ---------- ---------- Net cash used by investing activities $(1,629,779) $(1,832,342) ---------- ---------- (continued)
6 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In thousands - Unaudited)
Nine Months Ended September 30, ----------------------------- 1998 1997 ------------ ------------ Cash flows from financing activities: Proceeds from borrowings $ 113,758 $ 253,833 Principal payments under debt obligations (122,437) (189,570) Dividends paid to shareholders (49,897) (45,050) Purchases of treasury stock (122,556) (159,479) Treasury stock reissued 32,330 29,343 Other, net 5,123 4,324 ---------- ---------- Net cash provided/(used) by financing activities (143,679) (106,599) ---------- ---------- Effect of exchange rate changes on cash and cash equivalents (6,626) (4,318) ---------- ---------- Net change in cash and cash equivalents 54,503 15,688 Cash and cash equivalents, beginning of year 235,675 209,095 ---------- ---------- Cash and cash equivalents, end of period $ 290,178 $ 224,783 ========== ========== Supplemental disclosures of cash flow information: Cash payments during the period for: Interest on debt obligations $ 9,190 $ 9,067 Income taxes 196,523 215,198 See the accompanying Notes to Consolidated Financial Statements.
7 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (In thousands - Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- ---------------------------- 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Net earnings $ 107,569 $ 96,079 $ 370,651 $ 489,029 ---------- ---------- ---------- ---------- Other comprehensive income, before income taxes: Foreign currency translation adjustments: Change in unrealized foreign currency translation gains (losses) during the period (25,319) 22,631 14,923 8,767 Reclassification adjustment for realized currency loss on sale of subsidiary included in net earnings - - - 509 Unrealized gains (losses) on securities available for sale: Unrealized holding gains (losses) occurring during the period 35,784 100,520 24,849 532,285 Reclassification adjustment for realized (gains) losses included in net earnings 2,560 4,243 2,050 5,293 ----------- ----------- ----------- ----------- Total other comprehensive income, before income taxes 13,025 127,394 41,822 546,854 Deferred income tax expense related to items of other comprehensive income 7,735 (1,230) 136,822 196,455 ----------- ----------- ----------- ----------- Other comprehensive income (loss), net of income taxes 5,290 128,624 (95,000) 350,399 ----------- ----------- ----------- ----------- Total comprehensive income $ 112,859 $ 224,703 $ 275,651 $ 839,428 =========== =========== =========== =========== See the accompanying Notes to Consolidated Financial Statements. 8
AFLAC INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. Basis of Presentation In the opinion of management, the accompanying unaudited consolidated financial statements of AFLAC Incorporated and subsidiaries (the "Company") contain all adjustments necessary to fairly present the financial position as of September 30, 1998, and the results of operations and comprehensive income for the three-month and nine-month periods ended September 30, 1998 and 1997, and statements of cash flows and shareholders' equity for the nine months ended September 30, 1998 and 1997. Results of operations for interim periods are not necessarily indicative of results for the entire year. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, based on the best information available, in recording transactions resulting from business operations. The balance sheet amounts that involve a greater extent of accounting estimates and actuarial determinations subject to future changes are: deferred policy acquisition costs, liabilities for future policy benefits and unpaid policy claims, accrued liabilities for unfunded retirement plans for various officers and beneficiaries, and contingent liabilities. As additional information becomes available (or actual amounts are determinable), the recorded estimates may be revised and reflected in operating results. Although some variability is inherent in these estimates, management believes the amounts provided are adequate. The financial statements should be read in conjunction with the financial statements included in the Company's annual report to shareholders for the year ended December 31, 1997. 2. Accounting Pronouncements The Company adopted Statement of Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, on January 1, 1997. This Statement was amended by SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125. These statements established criteria for those transactions concerning secured obligations and collateral, which must be applied prospectively to all applicable transactions that occurred after December 31, 1997. Beginning in 1998, as required by these standards, the Company no longer recognizes securities held as collateral as an asset, nor the related liability for the return of such collateral for loan agreements entered into after December 31, 1997. The adoption of SFAS No. 125 and No. 127 had no material effect on the Company's net earnings or shareholders' equity. SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, was issued in June 1997. This Statement requires that companies disclose segment data on the basis that is used internally by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. SFAS No. 131 is effective for financial statements issued for annual periods beginning in 1998 and for interim periods beginning in 1999. The Company's current definition of its business segments will not change. 9 In February 1998, the Financial Accounting Standards Board issued SFAS No. 132, Employer's Disclosures about Pensions and Other Postretirement Benefits. This Statement revises disclosures about pension and other postretirement benefit plans, but does not change the measurement or recognition of these plans. This Statement is effective for 1998, and the new disclosures will be included in the year-end financial statements. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued in June 1998. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative will be included in either earnings or other comprehensive income depending on the intended use of the derivative instrument. The Company is currently evaluating this standard, which is effective January 1, 2000. The Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments, in December 1997. This SOP provides guidance for determining when an entity should recognize a liability for guaranty fund and other insurance-related assessments. It also provides guidance on how to measure the liability. This SOP is effective for 1999. The Company's present accounting method for guaranty fund and other insurance- related assessments substantially conforms to the requirements of this SOP. In March 1998, SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, was issued. This SOP provides guidance for determining whether costs of software developed or obtained for internal use should be capitalized or expensed as incurred. In the past, the Company has expensed all such costs as they were incurred. This SOP is effective beginning in 1999. 3. Japanese Income Taxes At the end of March 1998, the Japanese government reduced the Japanese corporate income tax rate. The tax rate for AFLAC Japan declined from 45.3% to 41.7%. For the Company, this rate change reduced income tax expense on operating earnings beginning May 1, 1998. The effect of this tax rate reduction was to lower 1998 income tax expense on operating earnings and increase net operating earnings by approximately $7.2 million for the nine months ended September 30, 1998. Under generally accepted accounting principles, the effect of the rate reduction on the deferred income tax liability must be recognized in income tax expense in the period the tax law was enacted. This tax rate reduction was recognized as of March 31, 1998 and lowered income tax expense and increased net earnings by $121.1 million. The tax rate reduction increased basic and diluted earnings per share by $.45 and $.44, respectively, for the nine months ended September 30, 1998. Effective January 1, 1998, the Japanese government changed the income tax provisions to increase income taxes on investment income and realized gains received by foreign companies operating in Japan from securities issued from their home country. This tax change decreased net operating earnings for the nine months ended September 30, 1998 by $15.7 million. 10 As a result of this Japanese tax change, the provision for deferred income taxes in the statements of comprehensive income for the nine months ended September 30, 1998, includes $58.7 million, for Japanese income taxes on unrealized gains existing as of January 1, 1998, on AFLAC Japan's dollar- denominated securities available for sale. Also, the provision for deferred income taxes on comprehensive income for the nine months ended September 30, 1998, includes Japanese income taxes of $74.6 million on certain unrealized foreign currency gains that arise for Japan tax purposes on translation of its dollar-denominated investments into yen. 4. Policyholder Protection Fund During the first quarter of 1998, the Japanese government enacted a mandatory policyholder protection fund system. The life insurance industry will be required to contribute 490 billion yen ($3.6 billion using the September 30, 1998, exchange rate) over a 10-year period. Individual company contributions are to be based on relative company size. The charge for the Company's share of the total contribution obligation was recognized in the first quarter of 1998 and decreased pretax earnings by $111.3 million for the nine months ended September 30, 1998. The after-tax charge was $64.9 million, or $.24 for both basic and diluted earnings per share. 5. Notes Payable A summary of notes payable is as follows: September 30, December 31, (In thousands) 1998 1997 ------------- ------------ Unsecured, yen-denominated notes payable to banks: Reducing, revolving credit agreement, due annually through July 2001: 2.29% fixed interest rate $ 251,570 $ 348,962 Variable interest rate (1.06% at September 30, 1998) 44,330 - Revolving credit agreement due October 2002: 1.24% fixed interest rate 114,666 149,116 Variable interest rate (1.01% at September 30, 1998) 74,621 - Obligations under capitalized leases, due monthly through 2002, secured by computer equipment in Japan 16,896 17,986 Other - 7,145 --------- --------- Total notes payable $ 502,083 $ 523,209 ========= ========= The Company has a reducing, revolving credit agreement that provides for bank borrowings through July 2001 in either U.S. dollars or Japanese yen. Under the terms of the agreement, the borrowing limit was reduced to $325 million on July 15, 1998, and will reduce to $250 million on July 15, 1999, and $125 million on July 15, 2000. At September 30, 1998, 34.1 billion yen ($251.6 million) was outstanding at a fixed interest rate and 6.0 billion yen ($44.3 million) was outstanding at a variable interest rate. 11 The Company also has an unsecured revolving credit agreement that provides for bank borrowings through October 2002 with a borrowing limit of $250 million, payable in either Japanese yen or U.S. dollars. At September 30, 1998, 15.5 billion yen ($114.7 million) was outstanding at a fixed interest rate and 10.1 billion yen ($74.6 million) was outstanding at a variable interest rate. The Company has outstanding interest rate swaps on 49.6 billion yen of its variable-interest-rate yen-denominated borrowings. These swaps reduce the impact of changes in interest rates on the Company's borrowing costs and effectively change the Company's interest rate from variable to fixed. The interest rate swaps have notional principal amounts that equal the anticipated unpaid principal amounts. Under these agreements, the Company makes fixed-rate payments at 2.29% on one loan and 1.24% on another loan and receives floating-rate payments (.65% at September 30, 1998, plus loan costs of 25 or 20 basis points, respectively) based on the three-month Tokyo Interbank Offered Rate. Since most of these loans are with Japanese banks, the Company also pays the premium that Japanese banks are charged for short- term money. This is commonly referred to as the "Japan premium." The Company has designated its yen-denominated borrowings as a hedge of its net investment in AFLAC Japan. Foreign currency translation gains/losses are included in the accumulated other comprehensive income component in shareholders' equity. Outstanding principal and related accrued interest payable on the yen-denominated borrowings were translated into dollars at end-of-period exchange rates. Interest expense was translated at average exchange rates for the period the interest expense was incurred. 6. Unrealized Gains on Securities Available for Sale The Company classifies all fixed-maturity securities as "available for sale." All fixed-maturity and equity securities are carried at fair value. The related unrealized gains and losses, less amounts applicable to policy liabilities and deferred income taxes, are reported in the accumulated other comprehensive income component of shareholders' equity. The portion of unrealized gains credited to policy liabilities represents gains that would not inure to the benefit of the shareholders if such gains were actually realized. These amounts relate to policy reserve interest requirements and reflect the difference between market investment yields and estimated minimum required interest rates at these dates. The net effect of unrealized gains and losses from securities available for sale on accumulated other comprehensive income at the following dates was: (In thousands) September 30, 1998 December 31, 1997 ------------------ ----------------- Securities available for sale - unrealized gains $ 4,219,663 $ 3,382,746 Less amounts related to: Policy liabilities 2,081,718 1,271,701 Deferred income taxes 885,968 826,328 ------------ ------------ Accumulated other comprehensive income, net unrealized gains on securities available for sale $ 1,251,977 $ 1,284,717 ============ ============ 12 7. Security Lending AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. At September 30, 1998, and December 31, 1997, the Company held Japanese government bonds as collateral for loaned securities in the amount of $3.4 billion and $3.0 billion, respectively, at fair value. The securities received as collateral in the amount of $3.4 billion at September 30, 1998, are for transactions that occurred after December 31, 1997. This collateral, and the related liability for the return of such collateral, are no longer included on the balance sheet at September 30, 1998, under the accounting provisions of SFAS No. 125 and SFAS No. 127. (See Note 2 of the Notes to the Consolidated Financial Statements.) 8. Common Stock On May 4, 1998, the board of directors declared a two-for-one stock split. This split was payable to shareholders of record as of May 22, 1998, and the additional shares were issued on June 8, 1998. All share and per- share amounts in the accompanying financial statements have been restated for this split. The following is a reconciliation of the number of shares of the Company's common stock for the nine months ended September 30: (In thousands) 1998 1997 ---------- ---------- Common stock - issued: Balance at beginning of year 316,380 314,478 Exercise of stock options 1,192 1,682 -------- -------- Balance at end of period 317,572 316,160 -------- -------- Treasury stock: Balance at beginning of year 49,944 38,708 Purchases of treasury stock: Open market 3,706 6,417 Received from employees for taxes on option exercises 212 384 Shares issued to sales associates stock bonus plan and dividend reinvestment plan (940) (1,126) Exercise of stock options (302) (314) -------- -------- Balance at end of period 52,620 44,069 -------- -------- Shares outstanding at end of period 264,952 272,091 ======== ======== 13 9. Litigation The Company is a defendant in various litigation considered to be in the normal course of business. Some of this litigation is pending in Alabama, where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies, including insurers, in recent years. Although the final results of any litigation cannot be predicted with certainty, the Company believes the outcome of pending litigation will not have a material adverse effect on the financial position of the Company. 14 REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The September 1998 and 1997 financial statements included in this filing have been reviewed by KPMG Peat Marwick LLP, independent certified public accountants, in accordance with established professional standards and procedures for such a review. The report of KPMG Peat Marwick LLP commenting upon their review is included on page 16. 15 KPMG PEAT MARWICK LLP Certified Public Accountants 303 Peachtree Street, N.E. Telephone: (404) 222-3000 Suite 2000 Telefax: (404) 222-3050 Atlanta, GA 30308 INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors AFLAC Incorporated: We have reviewed the consolidated balance sheet of AFLAC Incorporated and subsidiaries as of September 30, 1998, and the related consolidated statements of earnings and comprehensive income for the three-month and nine-month periods ended September 30, 1998 and 1997, and the consolidated statements of cash flows and shareholders' equity for the nine-month periods ended September 30, 1998 and 1997. These consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the accompanying consolidated balance sheet of AFLAC Incorporated and subsidiaries as of December 31, 1997, and the related consolidated statements of earnings, shareholders' equity, cash flows and comprehensive income for the year then ended (not presented herein); and in our report dated January 29, 1998, we expressed an unqualified opinion on those consolidated financial statements. KPMG PEAT MARWICK LLP Atlanta, GA October 26, 1998 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The primary business of AFLAC Incorporated (the Parent Company) and subsidiaries (the "Company") is supplemental health insurance, which is marketed and administered primarily through American Family Life Assurance Company of Columbus and its subsidiary (AFLAC). Most of AFLAC's policies are individually underwritten and marketed at the work site, with premiums paid by the employee. The Company's operations in Japan (AFLAC Japan) and the United States (AFLAC U.S.) service the two markets for the Company's insurance operations. RESULTS OF OPERATIONS The Company paid a two-for-one stock split on June 8, 1998. All share and per-share amounts in this report have been restated for this split. As a result of a Japanese tax rate reduction in 1998, net earnings increased $121.1 million due to a reduction in the deferred income tax liability. Also, the tax rate reduction increased net operating earnings by approximately $7.2 million for the nine months ended September 30, 1998. For further information, see Note 3 of the Notes to the Consolidated Financial Statements. Also, effective January 1, 1998, the Japanese government changed the income tax provisions to increase income tax on investment income and realized gains received by foreign companies operating in Japan from securities issued from their home country. This tax change decreased net operating earnings by $15.7 million for the nine months ended September 30, 1998. For further information, see Note 3 of the Notes to the Consolidated Financial Statements. During the first quarter of 1998, the Japanese government enacted a mandatory policyholder protection fund system. The pretax charge for the Company's share of the contribution obligation was $111.3 million. The after tax charge was $64.9 million. For further information regarding this policyholder protection fund, see Note 4 of the Notes to the Consolidated Financial Statements. The table on the following page sets forth the results of operations by business segment for the periods shown and the percentage change from the prior period. 17 SUMMARY OF OPERATING RESULTS BY BUSINESS SEGMENT (In millions, except for per-share amounts)
Three Months Ended September 30, Nine Months Ended September 30, ---------------------------------------- ---------------------------------------- Percentage Change 1998 1997 Percentage Change 1998 1997 ----------------- ----------------- ----------------- ----------------- Operating earnings: Insurance operations: AFLAC Japan................... (8.9)% $ 121.7 $ 133.6 (4.3)% $ 365.8 $ 382.3 AFLAC U.S..................... 18.5 58.7 49.5 30.5 170.6 130.8 ------ ------ ------ ------ Total ...................... (1.5) 180.4 183.1 4.6 536.4 513.1 Broadcast division operations..... - - - - - 3.5 Interest expense, noninsurance operations......... 3.2 (2.2) (2.3) 3.8 (7.7) (8.0) Corporate expenses, other operations and eliminations..... 27.6 (14.9) (20.4) 20.1 (40.1) (50.2) ------ ------ ------ ------ Pretax operating earnings....... 1.8 163.3 160.4 6.6 488.6 458.4 Income taxes.................... (11.7) 54.9 62.2 (2.3) 173.7 177.9 ------ ------ ------ ------ Operating earnings.............. 10.4 108.4 98.2 12.3 314.9 280.5 Non-operating items: Realized investment gains (losses), net of tax...................... (.8) (2.1) (.4) (2.7) Provision for the mandated policyholder protection fund, net of tax...................... - - (64.9) - Deferred tax benefit from Japan tax rate reduction.............. - - 121.1 - Gain on sale of television business, net of tax............ - - - 211.2 ------ ------ ------ ------ Net earnings.................... 12.0 $ 107.6 $ 96.1 (24.2) $ 370.7 $ 489.0 ====== ====== ====== ====== Net earnings per share: Basic......................... 14.3 $ .40 $ .35 (22.3) $ 1.39 $ 1.79 Diluted....................... 14.7 .39 .34 (22.5) 1.34 1.73 ====== ====== ====== ====== ============================================================================================================================ 18
The table on the previous page reclassifies non-operating items to facilitate the following discussion in line with how management views the business. The following discussion of earnings comparisons focuses on operating earnings and excludes realized investment gains/losses, the charge for the mandated policyholder protection system, the benefit of the Japan tax rate reduction, and in 1997, the gain from the sale of the television business. Operating earnings per share referred to in the following discussion are based on the diluted number of average outstanding shares. FOREIGN CURRENCY TRANSLATION Due to the relative size of AFLAC Japan, fluctuations in the yen/dollar exchange rate can have a significant effect on the Company's reported results. The following table illustrates the effect of foreign currency translation on the Company's reported results by comparing those results as if foreign currency rates had remained unchanged from the comparable period in the prior year. In periods when the yen weakens, translating yen into dollars causes fewer dollars to be reported. When the yen strengthens, translating yen into dollars causes more dollars to be reported. AFLAC Incorporated and Subsidiaries Selected Percentage Changes* (For the periods ended September 30, 1998) Three Months Nine Months Operating Results Operating Results --------------------- --------------------- Including Excluding Including Excluding Currency Currency Currency Currency Changes Changes** Changes Changes** --------- --------- --------- --------- Premium income (5.8)% 8.0% (2.1)% 7.5% Net investment income (2.0) 9.6 3.8 12.1 Total revenues (5.2) 8.3 (1.6) 7.9 Total benefits and expenses (5.9) 8.0 (2.3) 7.4 Operating earnings 10.4 18.6 12.3 18.2 Operating earnings per share 11.4 20.0 15.2 21.2 - ---------------------------------------------------------------------------- * The numbers in this table are presented on an operating basis and there- fore exclude: the benefit of the Japan tax rate reduction, the charge for the mandated policyholder protection fund, the sale of the television business, and realized investment gains and losses. ** Amounts excluding foreign currency changes were determined using the same yen/dollar exchange rate for the current period as the comparable period in the prior year. ============================================================================ The yen weakened in relation to the dollar throughout 1997 and the first three quarters of 1998. The average yen-to-dollar exchange rates were 139.92 for the three months ended September 30, 1998, compared with 117.97 for the third quarter of 1997, and 134.57 and 119.64 for the nine months ended September 30, 1998 and 1997, respectively. Despite the weakening of 19 the yen during 1998, operating earnings per share increased 11.4% to $.39 for the three months ended September 30, 1998, compared with the third quarter of 1997, and increased 15.2% to $1.14 per share for the nine months ended September 30, 1998, compared with the same period in 1997. The weakening of the yen in 1998 lowered operating earnings by approximately $.03 per share for the third quarter and $.06 per share for the nine months ended September 30, 1998, which was solely attributable to the translation effect of the fluctuations in the yen. The increases in operating earnings per share reflected earnings contributions in the functional currencies of AFLAC's core insurance operations in Japan and the United States, and lower income tax expense due to the tax rate reduction in Japan. The Company's share repurchase program also benefited earnings on a per-share basis. The Company's primary financial objective is the growth of operating earnings per share before the effect of foreign currency fluctuations. In 1996, the Company set this objective at an annual growth rate of 15% to 17% through the year 2000. In early 1998, the Company raised its 1998 objective for growth in operating earnings per share from a 17% increase to a 20% increase before the effect of currency translation. In April 1998, the Company raised its 1999 objective for growth in operating earnings per share to 20% from a range of 15% to 17% excluding the impact of currency fluctuations, primarily due to the benefit of the tax rate reduction in Japan. Assuming that the objective for 1998 is achieved, the following table shows various results for operating earnings per share for the year 1998 when the estimated impact of foreign currency translation is included. Annual Yen Average Annual Operating % Growth Yen Impact Exchange Rate Diluted EPS Over 1997 on EPS ------------- ---------------- --------- ---------- 1998 @ 115.00 $ 1.64 23.3% $ .04 1998 @ 120.00 1.61 21.1 .01 1998 @ 121.07* 1.60 20.3 - 1998 @ 125.00 1.58 18.8 (.02) 1998 @ 130.00 1.55 16.5 (.05) 1998 @ 135.00 1.53 15.0 (.07) 1998 @ 140.00 1.50 12.8 (.10) *Actual exchange rate for the year ended December 31, 1997. If the exchange rate as of September 30, 1998, remained constant for the remainder of 1998, the cumulative average rate would be approximately 134.77 and the annual operating diluted earnings per share would approximate $1.53, assuming the Company's earnings objective is met. PROFIT REPATRIATION AFLAC Japan repatriated profits to AFLAC U.S. of $154.2 million in 1998 and $347.0 million in 1997. The profit transfer in 1997 included $124.8 million of a non-recurring nature. The profit transfers to AFLAC U.S. adversely impact AFLAC Japan's investment income. However, repatriations benefit AFLAC U.S. investment income and consolidated operations because higher investment yields can be obtained on funds 20 invested in the United States. Also, income tax expense is lower on investment income earned in the United States. Management estimates that cumulative profit transfers from 1992 through 1998 have benefited consolidated net earnings by $23.7 million and $17.0 million for the three months ended September 30, 1998 and 1997, respectively, and $41.9 million and $28.5 million for the nine months ended September 30, 1998 and 1997, respectively. Since the first repatriation in 1989, AFLAC Japan has repatriated $1.2 billion, which has enhanced the Company's flexibility and profitability. SHARE REPURCHASE PROGRAM During the third quarter of 1998, the Company purchased 2.3 million shares of its common stock. As of September 30, 1998, the Company had approximately 7.5 million shares still available for purchase under current repurchase authorizations from the board of directors. The Company has purchased 57.3 million shares (through September 30, 1998) since the inception of the share repurchase program in February 1994. The difference in percentage increases in net earnings and net earnings per share primarily reflects the impact of the share repurchase program. INCOME TAXES The Company's effective income tax rates on operating earnings for the nine months ended September 30, 1998 and 1997 were 35.5% and 38.8%, respectively. Japanese income taxes on AFLAC Japan's operating results, which were taxed at Japan's corporate income tax rate of 45.3% through April 30, 1998, and 41.7% thereafter, accounted for most of the Company's income tax expense. The decline in the effective tax rates in 1998 and 1997 resulted primarily from the weakening of the yen and increased contributions in earnings from the Company's U.S. business segment and, in 1998, the Japan tax rate reduction. INSURANCE OPERATIONS, AFLAC JAPAN AFLAC Japan, a branch of AFLAC and the principal contributor to the Company's earnings, ranks number one in terms of premium income and profits among all foreign life and non-life insurance companies operating in Japan. Among all life insurance companies operating in Japan, AFLAC Japan ranks third in terms of individual policies in force and 16th in assets. The transfer of profits from AFLAC Japan to AFLAC U.S. distorts comparisons of operating results between years. Therefore, the AFLAC Japan summary of operations table on the following page presents investment income, total revenues and pretax operating earnings calculated on a pro forma basis in order to improve comparability between years. The pro forma adjustment represents cumulative investment income foregone by AFLAC Japan on funds repatriated to AFLAC U.S. during 1992 through 1998. 21 AFLAC JAPAN SUMMARY OF OPERATING RESULTS Three Months Ended Nine Months Ended September 30, September 30, (In millions) 1998 1997 1998 1997 ------------------ ------------------ Premium income................... $1,115.1 $1,237.5 $3,425.2 $3,618.6 Investment income, as adjusted*.. 230.6 241.1 699.6 690.6 Other income..................... .7 .4 2.0 1.8 ------- ------- ------- ------- Total revenues, as adjusted*... 1,346.4 1,479.0 4,126.8 4,311.0 ------- ------- ------- ------- Benefits and claims.............. 968.9 1,070.1 2,982.6 3,131.4 Operating expenses............... 243.7 264.6 744.1 773.2 ------- ------- ------- ------- Total benefits and expenses.... 1,212.6 1,334.7 3,726.7 3,904.6 ------- ------- ------- ------- Pretax operating earnings, as adjusted*................ 133.8 144.3 400.1 406.4 Investment income applicable to profit repatriations............ (12.1) (10.7) (34.3) (24.1) ------- ------- ------- ------- Pretax operating earnings.... $ 121.7 $ 133.6 $ 365.8 $ 382.3 ======= ======= ======= ======= - ---------------------------------------------------------------------------- Percentage changes in dollars over previous period: Premium income................. (9.9)% (.6)% (5.3)% (2.1)% Investment income*............. (4.4) 4.0 1.3 .6 Total revenues*................ (9.0) .1 (4.3) (1.6) Pretax operating earnings*..... (7.3) 2.1 (1.6) (2.6) Pretax operating earnings...... (8.9) (.4) (4.3) (4.3) - ---------------------------------------------------------------------------- Percentage changes in yen over previous period: Premium income................. 7.0% 7.6% 6.5% 9.0% Investment income*............. 13.4 12.6 14.0 12.0 Total revenues*................ 8.0 8.4 7.7 9.5 Pretax operating earnings*..... 9.7 10.5 10.7 8.5 Pretax operating earnings...... 7.9 7.8 7.7 6.6 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims............ 72.0% 72.3% 72.3% 72.7% Operating expenses............. 18.1 17.9 18.0 17.9 Pretax operating earnings...... 9.9 9.8 9.7 9.4 Ratio of pretax operating earnings to total reported revenues..... 9.1 9.1 8.9 8.9 - ---------------------------------------------------------------------------- *Adjusted investment income, total revenues and pretax operating earnings include estimates of additional investment income for the three months ended September 30, 1998 and 1997 of $12.1 million and $10.7 million, respectively, and for the nine months ended September 30, 1998 and 1997 of $34.3 million and $24.1 million, respectively, foregone due to profit repatriations. ============================================================================ 22 AFLAC JAPAN SALES The increase in premium income in yen was due to sales of new policies and excellent policy persistency. During the third quarter, new annualized premium sales rose sharply, increasing 30.0% to 19.8 billion yen, or $141.4 million. Although comparisons to last year benefited from relatively weak sales in 1997, the volume of new business produced during the quarter was the largest since the third quarter of 1996. For the nine months, new sales were up 24.0% to 53.6 billion yen, or $398.0 million. These strong sales results have benefited throughout the year from existing products as well as our latest product offering - Rider MAX. Rider MAX has proven to be a very popular product among consumers and agents, accounting for approximately 30% of sales for the first nine months of 1998. In addition to product broadening, we are also committed to expanding our sales force in Japan. Through September, we have recruited more than 1,800 new agents, compared with fewer than 700 for the entire year of 1997. We believe our strategy of adding new products, increasing distribution, and emphasizing our financial strength will allow us to continue tapping into Japan's vast insurance market. Management has set an objective for AFLAC Japan's sales to increase approximately 15% to 20% for the year 1998 compared with 1997. AFLAC JAPAN INVESTMENTS Historically low Japanese investment yields declined further in the third quarter, making the difficult task of investing substantial cash flows even more challenging. During the quarter, we purchased yen-denominated securities at an average yield of 3.34%. Including dollar-denominated investments, our blended new money yield was 3.78%. AFLAC Japan's investment portfolio remains conservatively positioned and comprises high- quality securities. We believe AFLAC Japan's financial strength is one of our greatest competitive advantages in the current environment. At the end of the third quarter, the yield on AFLAC Japan's fixed- maturity portfolio was 5.31%, compared with 5.46% at the end of 1997. The return on average invested assets, after investment expenses, was 5.30% for the first nine months of 1998, compared with 5.36% for the first nine months of 1997. INSURANCE OPERATIONS, AFLAC U.S. AFLAC U.S. pretax operating earnings continued to benefit from additional investment income earned on profit transfers received from AFLAC Japan. Estimated investment income earned from profits repatriated to and retained by AFLAC U.S. from 1992 through 1998, along with estimated investment income earned by AFLAC U.S. from the sales proceeds of the television business, have been reclassified in the following presentation in order to improve comparability between periods. 23 AFLAC U.S. SUMMARY OF OPERATING RESULTS Three Months Ended Nine Months Ended September 30, September 30, (In millions) 1998 1997 1998 1997 ------------------ ------------------ Premium income................... $ 304.3 $ 268.9 $ 886.7 $ 786.2 Investment income, as adjusted*.. 28.5 26.3 82.7 77.1 Other income..................... 1.0 .6 3.7 1.4 ------- ------- ------- ------- Total revenues, as adjusted*... 333.8 295.8 973.1 864.7 ------- ------- ------- ------- Benefits and claims.............. 188.6 168.6 555.4 493.7 Operating expenses............... 113.0 100.3 324.1 291.6 ------- ------- ------- ------- Total benefits and expenses.... 301.6 268.9 879.5 785.3 ------- ------- ------- ------- Pretax operating earnings, as adjusted*................ 32.2 26.9 93.6 79.4 Investment income applicable to profit repatriations and proceeds from the sale of the television business........................ 26.5 22.6 77.0 51.4 ------- ------- ------- ------- Pretax operating earnings.... $ 58.7 $ 49.5 $ 170.6 $ 130.8 ======= ======= ======= ======= - ---------------------------------------------------------------------------- Percentage increases over previous period: Premium income................. 13.2% 12.5% 12.8% 12.2% Investment income*............. 8.3 19.6 7.3 20.0 Total revenues*................ 12.9 13.2 12.5 12.8 Pretax operating earnings*..... 19.4 12.5 17.9 11.4 Pretax operating earnings...... 18.5 48.2 30.5 39.0 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims............ 56.5% 57.0% 57.1% 57.1% Operating expenses............. 33.9 33.9 33.3 33.7 Pretax operating earnings...... 9.6 9.1 9.6 9.2 Ratio of pretax operating earnings to total reported revenues..... 16.3 15.5 16.2 14.3 - ---------------------------------------------------------------------------- *Excludes estimated investment income for the three months ended September 30, 1998 and 1997 of $26.5 million and $22.6 million, respectively, and for the nine months ended September 30, 1998 and 1997 of $77.0 million and $51.4 million, respectively, related to investment of profit repatriation funds retained by AFLAC U.S. and investment of proceeds from the sale of the television business. ============================================================================ 24 AFLAC U.S. SALES The increase in premium income was primarily due to an increase in new sales over the last 12 months. New annualized premium sales surged 24.1% in the third quarter to $123.7 million. These results represent the best quarterly sales in the company's history, surpassing our previous record by more than $10 million. For the nine months, new sales were up 19.2% to $342.9 million. Accident/disability insurance remains our best selling product. However, we are pleased to see strong sales contributions from our cancer and hospital indemnity coverages as well. We attribute our strong U.S. growth in recent years to product broadening, distribution expansion and improved brand awareness. We believe these strengths will continue to benefit AFLAC U.S. in the future. Management has set an objective for new policy sales to increase by 12% to 15% for the year 1998. AFLAC U.S. INVESTMENTS During the third quarter, available cash flow was invested at an average yield of 7.19%, compared with 7.46% during the third quarter of 1997. The return on average invested assets, net of investment expenses, was 7.43% for the first nine months of 1998, compared with 7.62% for the first nine months of 1997. AFLAC U.S. OTHER During 1998, the Company began selling cancer expense insurance in New York and Connecticut. Massachusetts and New Jersey still have laws, regulations or regulatory practices that either prohibit the sale of specified disease insurance, such as AFLAC's cancer expense insurance, or make its sale impractical. AFLAC U.S. is marketing several of its other products in these states. Management expects the operating expense ratio, excluding discretionary advertising expenses, to decline in the future due to continued improvements in operating efficiencies. By improving administrative systems and controlling other costs, the Company has been able to redirect funds to national advertising programs without significantly affecting the operating expense ratio. The aggregate benefit ratio has been relatively stable due to the mix of business shifting towards accident and hospital indemnity policies, which have lower benefit ratios than other products. Management expects future benefit ratios for some of the Company's supplemental products to increase slightly due to the Company's ongoing efforts to improve policy persistency by enhancing policyholder benefits. In addition, potential minimum benefit ratio requirements by insurance regulators may also result in an increase to these ratios. Management expects the pretax operating profit margin to remain largely unchanged for the rest of the year. FINANCIAL ACCOUNTING STANDARDS BOARD STATEMENTS For information regarding new Statements of Financial Accounting Standards, see Note 2 of the Notes to the Consolidated Financial Statements. 25 ANALYSIS OF FINANCIAL CONDITION Since December 31, 1997, the financial condition of the Company has remained strong in the functional currencies of its operations. The investment portfolios of AFLAC Japan and AFLAC U.S. have continued to grow and consist of high-quality securities. Due to the significance of yen-denominated items in the balance sheet, changes in the yen/dollar exchange rate can have a significant effect on the Company's financial statements. The yen/dollar exchange rate at the end of each period is used to convert yen-denominated balance sheet items into U.S. dollars for reporting purposes. The exchange rate at September 30, 1998, was 135.35 yen to one U.S. dollar, 3.9% weaker than the exchange rate of 130.10 as of December 31, 1997. Management estimates that the weaker yen rate decreased reported investments and cash by $797 million, total assets by $901 million and total liabilities by $873 million compared with the amounts that would have been reported for 1998 if the exchange rate had remained unchanged from year-end 1997. INVESTMENTS AND CASH Securities available for sale are carried at fair value. The following table shows an analysis of investments and cash: September 30, December 31, (In millions) 1998 1997 % Change ------------ ------------ -------- AFLAC U.S.: Total investments and cash, at cost or amortized cost $ 2,932 $ 2,678 9.5% Unrealized gains on securities available for sale 254 228 ---------- ---------- Total investments and cash $ 3,186 $ 2,906 9.6% ========== ========== ======== AFLAC Japan: Total investments and cash, at cost or amortized cost $ 17,531 $ 16,743 4.7% Unrealized gains on securities available for sale 3,965 3,155 ---------- ---------- Total investments and cash $ 21,496 $ 19,898 8.0% ========== ========== ========= Consolidated: Total investments and cash, at cost or amortized cost $ 20,529 $ 19,497 5.3% Unrealized gains on securities available for sale 4,220 3,383 ---------- ---------- Total investments and cash $ 24,749 $ 22,880 8.2% ========== ========== ========= Net unrealized gains of $4.2 billion on securities available for sale at September 30, 1998, consisted of $4.5 billion in gross unrealized gains and $263.4 million in gross unrealized losses. 26 AFLAC invests primarily within the Japanese, U.S. and Euroyen fixed- maturity markets. The Company uses specific criteria to judge the credit quality and liquidity of its investments and utilizes a variety of credit rating services to monitor this criteria. Applying those various credit ratings to a standardized rating system based on a nationally recognized service's categories, the percentages of the Company's fixed-maturity securities available for sale, at amortized cost, were as follows: September 30, 1998 December 31, 1997 ------------------ ----------------- AAA 33.6% 38.3% AA 19.9 20.5 A 31.2 28.9 BBB 15.2 12.3 BB or lower .1 - ----- ----- 100.0% 100.0% Private placement investments accounted for 39.7% and 36.3% of the Company's total fixed-maturity securities available for sale as of September 30, 1998, and December 31, 1997, respectively. AFLAC Japan has made investments in the private placement market to secure higher yields than those available from Japanese government bonds. At the same time, the Company has adhered to its conservative standards for credit quality. AFLAC requires that all private placement issuers have an initial rating of class 1 or 2 as determined by the Securities Valuation Office of the National Association of Insurance Commissioners. Most of AFLAC's private placement issues are issued under medium term note programs and have standard covenants commensurate with credit rankings except when internal credit analysis indicates that additional protective and/or event risk covenants are required. POLICY LIABILITIES Policy liabilities increased $1.8 billion, or 9.0%, during the first nine months of 1998. AFLAC Japan increased $1.6 billion, or 9.2% (13.6% increase in yen), and AFLAC U.S. increased $151.3 million, or 8.1%. Management estimates the weaker yen rate decreased reported policy liabilities by $791.0 million. Increases in policy liabilities are caused by the addition of new business, the aging of policies in force and the effect of market value adjustments on fixed-maturity securities. (See Note 6 of the Notes to the Consolidated Financial Statements.) DEBT See Note 5 of the Notes to the Consolidated Financial Statements for information on debt outstanding at September 30, 1998. The Company's ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized gains on securities available for sale) was 17.8% and 19.6% as of September 30, 1998, and December 31, 1997, respectively. 27 SECURITY LENDING AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. This program increased AFLAC Japan's investment income by approximately $1.1 million for both the nine months ended September 30, 1998 and 1997. For further information regarding such arrangements, see Note 7 of the Notes to the Consolidated Financial Statements. POLICYHOLDER GUARANTY FUNDS Under insurance guaranty fund laws in most U.S. states, insurance companies doing business in those states can be assessed for policyholder losses up to prescribed limits that are incurred by insolvent companies with similar lines of business. Such assessments have not been material to the Company in the past. The Company believes that future assessments relating to companies in the U.S. currently involved in insolvency proceedings will not materially impact the consolidated financial statements. The Life Insurance Association of Japan, an industry organization, implemented a voluntary policyholder protection fund in 1996 to provide capital support to insolvent life insurers. AFLAC Japan pledged investment securities to the Life Insurance Association of Japan for this program. During the first quarter of 1998, the Japanese government enacted a mandatory policyholder protection fund system. The life insurance industry will contribute 690 billion yen ($5.1 billion using the September 30, 1998, exchange rate) over a 10-year period for these two funds. The Company has recorded a liability for its share of these obligations. (See Note 4 of the Notes to the Consolidated Financial Statements.) SHAREHOLDERS' EQUITY The Company's insurance operations continue to provide its primary sources of liquidity. Capital needs can also be supplemented by borrowed funds. The principal sources of cash from insurance operations are premiums and investment income. Primary uses of cash in the insurance operations are policy claims, commissions, operating expenses, income taxes and payments to the Parent Company for management fees and dividends. Both the sources and uses of cash are reasonably predictable. The Company's investment objectives provide for liquidity through the ownership of high-quality investment securities. AFLAC insurance policies are generally not interest-sensitive and therefore are not subject to unexpected policyholder redemptions due to investment yield changes. Also, the majority of AFLAC policies provide indemnity benefits rather than reimbursement for actual medical costs and therefore are not subject to the risks of medical cost inflation. The achievement of continued long-term growth will require growth in AFLAC's statutory capital and surplus. AFLAC may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Parent Company from funds generated through debt or equity offerings. The disposition of the television business increased the Company's capital resources. Management believes outside sources for additional debt and equity capital, if needed, will continue to be available for capital expenditures, business expansion and funding the Company's share repurchase program. 28 Parent Company capital resources are largely dependent upon the ability of AFLAC to pay management fees and dividends. The Georgia Insurance Department imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances by AFLAC to the Parent Company. In addition to restrictions by U.S. insurance regulators, the Japanese Ministry of Finance (MOF) imposes restrictions on, and requires approval for, the remittances of earnings from AFLAC Japan to AFLAC U.S. Payments are made from AFLAC Japan to the Parent Company for management fees, and to AFLAC U.S. for allocated expenses and remittances of earnings. Total funds received from AFLAC Japan were $183.7 million in the first nine months of 1998 and $386.0 million and $253.6 million in the full years 1997 and 1996, respectively. AFLAC Japan repatriated profits to AFLAC U.S. in the amount of $154.2 million in July 1998. The MOF has developed solvency standards, a version of risk-based capital requirements. Management believes the solvency margin of AFLAC Japan is very strong compared with other Japanese insurers. For additional information on regulatory restrictions on dividends, profit transfers and other remittances, see Note 10 of the Notes to the Consolidated Financial Statements in the Company's annual report to shareholders for the year ended December 31, 1997. Currently, prescribed or permitted statutory accounting principles (SAP) used by insurers for financial reporting to state insurance regulators may vary between states and between companies. The National Association of Insurance Commissioners (NAIC) has recodified SAP to promote standardization of accounting principles throughout the industry. These new accounting principles are presently planned by the NAIC to be effective for 2001. The most significant change is the requirement that insurance companies establish a deferred income tax liability for statutory accounting purposes. Management estimates AFLAC's deferred tax liability would be approximately $145 million at September 30, 1998, under the provisions of the recodified SAP. The capital and surplus of AFLAC, as determined on the present U.S. statutory accounting basis, was $1.8 billion at September 30, 1998. YEAR 2000 The term "year 2000 issue" generally refers to the improper processing of dates and incorrect date calculations that might occur in computer software and hardware and embedded systems as the year 2000 is approached. The use of computer programs that rely on two-digit date fields to perform computations and decision-making functions may cause systems to malfunction when processing information involving dates after 1999. For example, any computer software that has date-sensitive coding might recognize a code of "00" as the year 1900 rather than the year 2000. The Company's efforts to address year 2000 issues began in 1997. The Company has established a Year 2000 Executive Steering Committee, comprised of senior management and representatives of its information technology, financial, legal, internal audit and various operational areas to identify and address the Company's year 2000 issues throughout its U.S. and Japanese operations. The Company has also established a Year 2000 Project Office comprised of coordinators from each of the Information Technology division, Worldwide Headquarters business operations and AFLAC Japan. The Project Office established both domestic and Japanese plans to address year 2000 readiness and minimize the risk of business disruption caused by year 2000 issues. The Company has also engaged third party consultants to assist the U.S. and Japan in the year 2000 efforts. 29 The plans contain five phases: (1) the assessment phase, which includes creating awareness of the issue throughout the Company and assessment of all systems, significant business processes, facilities and third party dependencies; (2) the remediation phase, which includes updating or modifying systems which are identified as critical to the Company's efforts to become Year 2000 ready; (3) the testing phase, which includes the testing of systems which have been updated or modified; (4) the implementation phase, which includes placing systems into the production environment. Additional comprehensive testing is then conducted to identify and resolve any remaining year 2000 issues; and (5) contingency planning. The Company's U.S. based financial and administrative systems, which include its policy processing and claims administration functions, are centralized at its Worldwide Headquarters. The assessment phase for each of these functions has been completed. The assessment of the year 2000 issues for its non-financial and administrative systems in the United States, such as systems found in printers, mail processing equipment and automated building systems has also been completed. The Company has substantially completed the remediation of all critical systems in these areas except for: (i) the software system that supports the domestic forms inventory, purchasing and accounts payable functions, which is scheduled to be completed early in the second quarter of 1999; (ii) its field sales software product that permits the Company's agents to electronically process new policy applications; and (iii) the imaging systems which are used for electronic recording, storage, and retrieval of documents. Remediation for these systems is scheduled to be completed in the first quarter of 1999. Initial testing and implementation of the upgrades and modifications for the critical U.S. based systems, other than the three systems identified above, are scheduled to be completed by December 31, 1998. Follow-up testing and verification of all critical domestic systems will continue throughout 1999 as an additional precaution. Contingency planning for any critical systems for which the Company believes it is reasonably at risk for business disruption due to year 2000 issues is scheduled to take place in the first and second quarters of 1999 following the completion of testing. The Company relies on its widely distributed customer base for continued payment of premiums. Many of the systems utilized by customers are automated and date dependent. A survey of customers was initiated to determine their year 2000 readiness. If a large number of customers are unable to submit premium payments in a timely or accurate manner due to year 2000 issues, the resulting delays could have a material adverse effect on the financial condition or results of operations of the Company. It is not currently possible to predict the probability of any delays occurring or the extent of such delays. The Company has completed the assessment phase for its critical information and business systems, as well as embedded systems, in Japan and currently is in the remediation, testing and implementation phases. Each of these phases is scheduled to be completed by December 31, 1998. Follow-up testing and verification of all critical Japanese systems will continue throughout 1999 as an additional precaution. The additional testing may raise new year 2000 issues that require further remediation and implementation activities, all of which are scheduled to be completed in the second quarter of 1999. Contingency planning is scheduled to take place in 1999. 30 AFLAC Japan depends heavily on premium payments that are electronically transmitted by employers of the insured and third party payment agents. A survey of its more significant customers in Japan was recently initiated to determine whether such customers expect their ability to pay premiums in this fashion to be impacted by year 2000 issues. If a number of customers experience disruptions in their payroll or accounting systems due to year 2000 issues or if they are unable to transmit such information or payments to the Company in a timely fashion, it could cause delays in the Company's receipt of premium payments or information necessary to initiate new policies which in turn could have a material adverse effect on the Company's financial condition and results of operations. It is not currently possible to predict the probability of such delays occurring or their extent. The Company owns investments in publicly and privately placed fixed- maturity and equity securities in the U.S. and Japan, and other foreign countries. If a material portion of such securities are adversely impacted by year 2000 issues, the Company's investment portfolio may also be adversely impacted. Since the inception of the year 2000 project, the Company has incurred costs of approximately $15 million for upgrades or modifications to address year 2000 issues through September 30, 1998. Of this amount, approximately $4 million was capitalized. The remaining cost to complete the various projects is currently estimated to be $17 million, of which $5 million is expected to be capitalized. These estimates have increased from amounts reflected in the past due to refinements in the calculations. The Company, however, may determine that additional expenditures are necessary following the completion of the testing and implementation phases. The Company's Information Technology personnel have spent considerable time and effort on the project. Consequently, the prioritization of non-year 2000 related projects has been more closely reviewed by management. However, management believes that any deferral of Information Technology projects due to the year 2000 effort will not have a material adverse effect on the Company's operations or financial condition. The actions taken by management under the year 2000 plans in the U.S. and Japan are intended to significantly reduce the Company's risk of a material business interruption based on year 2000 issues. Based on the facts currently known to it, the Company believes that such activities should significantly reduce the occurrence of year 2000 related business disruptions arising from its internal systems. Due to the uncertainty inherent in year 2000 issues, particularly with regard to Japanese customers' year 2000 readiness, and the various governmental functions, public utilities, financial infrastructures and similar outside facilities on which the Company depends in both the U.S. and Japan, the Company is unable to determine at this time whether the consequences of external year 2000 failures will have a material impact on the Company's financial condition or results of operations. Although a year 2000 failure with respect to any single internal or external system may not have a material adverse effect on the Company, the failure of multiple systems may cause a material disruption to the Company's business. OTHER The board of directors declared the fourth quarter cash dividend of $.065 per share. The dividend is payable on December 1, 1998, to shareholders of record at the close of business on November 19, 1998. 31 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's financial instruments are exposed to primarily three types of market risks. These are interest rate, equity price and foreign currency exchange rate risk. INTEREST RATE RISK The primary interest rate exposure is the effect of changes in interest rates on the fair value of the Company's investments in fixed-maturity securities. The Company uses modified duration analysis to estimate the sensitivity to interest rate changes in its fixed-maturity securities. Modified duration analysis provides a measure of price percentage volatility. The Company attempts to match the duration of its assets with the duration of its liabilities. For AFLAC Japan, the duration of policy liabilities is longer than that of the related assets due to the unavailability of qualified long-duration securities. Therefore, there is a risk that reinvestment of the proceeds at maturity of such investments will be at a yield below that of the interest required for the accretion of policy liabilities. The hypothetical reduction in the fair value of the Company's total portfolio of fixed-maturity securities resulting from a 100 basis point increase in market interest rates is estimated to be $2.2 billion based on the Company's portfolio as of September 30, 1998. The effect on yen- denominated fixed-maturity securities is approximately $1.8 billion and the effect on dollar-denominated fixed-maturity securities is approximately $341.1 million. The Company does not expect to realize security holding gains and losses because it has the ability to hold such securities to maturity. The Company has outstanding interest rate swaps on 49.6 billion yen of its variable-interest-rate yen-denominated borrowings. These swaps reduce the impact of changes in interest rates on the Company's borrowing costs and effectively change the Company's interest rate on these yen-denominated borrowings from variable to fixed. Therefore, changes in market interest rates should have no material effect on earnings. At September 30, 1998, the Company also had yen-denominated borrowings in the amount of 16.1 billion yen ($119.0 million) with a variable interest rate of 1.03%. The effect on net earnings due to changes in market interest rates was immaterial. For further information on the Company's notes payable, see Note 5 of the Notes to the Consolidated Financial Statements. EQUITY PRICE RISK Equity securities at September 30, 1998, totaled $134.7 million, or .5% of total investments and cash on a consolidated basis. The Company uses beta analysis to measure the sensitivity of its equity securities portfolio to fluctuations in the broad market. The beta of the Company's equity securities portfolio is 1.01. For example, if the overall stock market value changed by 10%, the value of AFLAC's equity securities would be expected to change by approximately 10.1%, or $13.6 million. 32 CURRENCY RISK Most of AFLAC Japan's investments and cash are denominated in yen. When the yen-denominated financial instruments mature or are sold, the proceeds are generally reinvested in yen-denominated securities and are held to fund yen-denominated policy obligations rather than converted into dollars. Therefore, there is no significant economic or foreign currency transaction risk. In addition to the yen-denominated financial instruments held by AFLAC Japan, the Parent Company has yen-denominated borrowings that have been designated as a hedge of the Company's investment in AFLAC Japan. The unrealized foreign currency translation gains and losses are reported in accumulated other comprehensive income in shareholders' equity. 33 The Company attempts to match its yen-denominated assets to its yen- denominated liabilities on a consolidated basis in order to minimize the exposure of its shareholders' equity to foreign currency translation fluctuations. The table below compares the U.S. dollar values of the Company's yen-denominated assets and liabilities at various exchange rates. Dollar Value of Yen-Denominated Assets and Liabilities At Selected Exchange Rates (September 30, 1998) 120.35 135.35* 150.35 (In millions) Yen Yen Yen - ---------------------------------------------------------------------------- Yen-denominated financial instruments: Assets: Fixed-maturity securities $ 21,944.6 $ 19,512.6 $ 17,565.9 Cash and cash equivalents 230.8 205.2 184.7 Securities held as collateral** 3,770.0 3,352.2 3,017.7 Other financial instruments 25.1 22.4 20.1 --------- --------- --------- Total 25,970.5 23,092.4 20,788.4 --------- --------- --------- Liabilities: Securities held as collateral** 3,770.0 3,352.2 3,017.7 Notes payable 545.7 485.2 436.8 --------- --------- --------- Total 4,315.7 3,837.4 3,454.5 --------- --------- --------- Net yen-denominated financial instruments 21,654.8 19,255.0 17,333.9 Other yen-denominated assets 2,908.1 2,585.8 2,327.8 Other yen-denominated liabilities (primarily policy and claim reserves) (24,319.6) (21,624.4) (19,467.0) --------- --------- --------- Total yen-denominated net assets subject to foreign currency fluctuation $ 243.3 $ 216.4 $ 194.7 ========= ========= ========= * Actual September 30, 1998, exchange rate. **Off balance sheet financial instruments. For information regarding the effect of foreign currency translation on operating earnings per share, see Foreign Currency Translation on page 19. 34 FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" to encourage companies to provide prospective information, so long as those informational statements are identified as forward-looking and are accompanied by meaningful, cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. The Company desires to take advantage of these provisions. This report contains cautionary statements identifying important factors that could cause actual results to differ materially from those projected in this Form 10-Q, and in any other statements made by officers of the Company in oral discussions with analysts and contained in documents filed with the Securities and Exchange Commission (the SEC). Forward-looking statements are not based on historical information and relate to future operations, strategies, financial results or other developments. In particular, statements containing words such as "expect," "anticipate," "believe," "goal," "objective" or similar words as well as specific projections of future results generally qualify as forward-looking. The Company undertakes no obligation to update such forward-looking statements. The Company cautions that the following factors, in addition to other factors mentioned from time to time in the Company's reports filed with the SEC, could cause the Company's actual results to differ materially: regulatory requirements, assessments for insurance company insolvencies, competitive conditions, new products, Japanese Ministry of Finance approval of profit repatriations to the United States, general economic conditions in the United States and Japan, changes in U.S. and/or Japanese tax laws, adequacy of reserves, credit and other risks associated with the Company's investment activities, significant changes in interest rates, fluctuations in foreign currency exchange rates and the ability of the Company, and third parties with whom the Company does business, to achieve year 2000 readiness for significant systems on a timely basis. 35 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a defendant in various litigation considered to be in the normal course of business. Some of this litigation is pending in Alabama, where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies, including insurers, in recent years. Although the final results of any litigation cannot be predicted with certainty, the Company believes the outcome of pending litigation will not have a material adverse effect on the financial position of the Company. ITEMS 2, 3, 4 and 5 Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 27.0 - Financial Data Schedule (for SEC use only) (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the quarter ended September 30, 1998. Items other than those listed above are omitted because they are not required or are not applicable. 36 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AFLAC INCORPORATED Date November 9, 1998 /s/ KRISS CLONINGER, III ------------------------ --------------------------- KRISS CLONINGER,III Executive Vice President; Treasurer and Chief Financial Officer Date November 9, 1998 /s/ NORMAN P. FOSTER ------------------------ --------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 37 EXHIBITS FILED WITH CURRENT FORM 10-Q: 27.0 - Financial Data Schedule (for SEC use only). 38 EX-27 2 9/98 FDS
7 This schedule contains summary financial information extracted from the Company's consolidated financial statements as filed in Form 10-Q for the period ended September 30, 1998, and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 24,269,830 0 0 134,737 5,220 0 24,458,348 290,178 0 2,667,441 28,366,449 21,200,199 270,593 0 212,721 502,083 0 0 31,757 3,539,510 28,366,449 4,317,653 828,913 (2,131) 15,638 3,544,175 146,269 1,094,446 375,183 4,532 370,651 0 0 0 370,651 1.39 1.34 0 0 0 0 0 0 0 Includes provision of $111,279 for mandated policyholder protection fund. Includes ($121,120) deferred tax benefit from Japan tax rate reduction. Adjusted for the two-for-one stock split issued June 8, 1998. Prior year financial data schedules have not been restated.
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