-----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, HOINfmSQ4ow01Ij94Qdnhklq7moIosiP/3MAFL1QKWJWQMyBk48ydP4ySSSNk0lQ WOL541Gec2P3lNk9ZIydQA== 0000004977-97-000020.txt : 19971104 0000004977-97-000020.hdr.sgml : 19971104 ACCESSION NUMBER: 0000004977-97-000020 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971103 SROS: NYSE SROS: PSE 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: 97706727 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, 1997 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 29, 1997 ---------------------------- ------------------ Common Stock, $.10 Par Value 135,764,644 shares AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - September 30, 1997 and December 31, 1996................ 1 Consolidated Statements of Earnings - Three Months Ended September 30, 1997 and 1996 Nine Months Ended September 30, 1997 and 1996........... 3 Consolidated Statements of Shareholders' Equity - Nine Months Ended September 30, 1997 and 1996........... 4 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1997 and 1996........... 5 Notes to Consolidated Financial Statements................ 7 Review by Independent Certified Public Accountants............................................. 13 Independent Auditors' Report.............................. 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 15 Part II. Other Information: Item 1. Legal Proceedings................................. 29 Item 6. Exhibits and Reports on Form 8-K.................. 29 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, 1997 1996 (Unaudited) ------------- ------------- ASSETS: Investments: Securities available for sale, at fair value: Fixed maturities (amortized cost, $19,486,696 in 1997 and $17,941,200 in 1996) $ 22,773,606 $ 20,327,726 Equity securities (cost, $86,824 in 1997 and $86,249 in 1996) 151,810 136,328 Mortgage loans on real estate 15,817 17,802 Other long-term investments 2,632 2,999 Short-term investments 271,106 261,680 ------------ ------------ Total investments 23,214,971 20,746,535 Cash 1,866 - Receivables, primarily premiums 231,697 226,981 Accrued investment income 237,596 253,850 Deferred policy acquisition costs 2,672,684 2,582,946 Property and equipment, net 420,292 471,907 Securities held as collateral for loaned securities 2,929,183 573,911 Intangible assets, net - 60,933 Other 100,345 105,749 ------------ ------------ Total assets $ 29,808,634 $ 25,022,812 ============ ============ See 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, 1997 1996 (Unaudited) ------------- ------------- Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 20,109,693 $ 18,697,173 Unpaid policy claims 1,074,990 1,039,257 Unearned premiums 278,577 288,976 Other policyholders' funds 240,574 208,799 ------------ ------------ Total policy liabilities 21,703,834 20,234,205 Notes payable 413,511 353,533 Income taxes, primarily deferred 1,353,690 1,181,121 Payables for return of collateral on loaned securities 2,929,183 573,911 Payables for security transactions 93,444 99,408 Other 521,197 455,065 ------------ ------------ Total liabilities 27,014,859 22,897,243 ------------ ------------ Shareholders' equity: Common stock of $.10 par value. Authorized 400,000; issued 158,080 in 1997 and 157,239 in 1996 15,808 15,724 Additional paid-in capital 221,767 208,994 Unrealized foreign currency translation gains 239,058 229,782 Unrealized gains on securities available for sale 621,277 280,154 Retained earnings 2,361,773 1,917,794 Treasury stock, at average cost (665,094) (526,425) Notes receivable for stock purchases (814) (454) ------------ ------------ Total shareholders' equity 2,793,775 2,125,569 ------------ ------------ Total liabilities and shareholders' equity $ 29,808,634 $ 25,022,812 ============ ============ Shareholders' equity per share $ 20.54 $ 15.42 ============ ============ See accompanying Notes to Consolidated Financial Statements. 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) -------------------------------- ------------------------------- 1997 1996 1997 1996 ----------- ----------- ----------- ----------- Revenues: Premiums, principally supplemental health insurance $ 1,508,697 $ 1,487,234 $ 4,412,040 $ 4,405,081 Net investment income 280,316 257,709 798,946 761,993 Realized investment gains (losses) (4,568) 4,350 (5,703) 3,921 Gain on sale of television stations - - 267,223 - Other income 5,175 26,286 33,344 76,161 ----------- ----------- ----------- ----------- Total revenues 1,789,620 1,775,579 5,505,850 5,247,156 ----------- ----------- ----------- ----------- Benefits and expenses: Benefits and claims 1,241,090 1,234,584 3,632,839 3,651,644 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 45,906 40,849 133,381 123,413 Insurance commissions 198,905 195,404 582,017 579,193 Insurance expenses 120,287 106,287 350,578 316,972 Interest expense 3,101 3,637 10,548 12,676 Other operating expenses 24,521 41,857 76,597 118,872 ----------- ----------- ----------- ----------- Total acquisition and operating expenses 392,720 388,034 1,153,121 1,151,126 ----------- ----------- ----------- ----------- Total benefits and expenses 1,633,810 1,622,618 4,785,960 4,802,770 ----------- ----------- ----------- ----------- Earnings before income taxes 155,810 152,961 719,890 444,386 Income taxes 59,731 64,616 230,861 183,771 ----------- ----------- ----------- ----------- Net earnings $ 96,079 $ 88,345 $ 489,029 $ 260,615 =========== =========== =========== =========== Net earnings per share $ .68 $ .62 $ 3.45 $ 1.80 =========== =========== =========== =========== Shares used in computing earnings per share 141,261 143,483 141,584 144,891 =========== =========== =========== =========== Cash dividends per share $ .115 $ .10 $ .33 $ .287 =========== =========== =========== =========== See accompanying Notes to Consolidated Financial Statements. 3
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In thousands - Unaudited) Nine Months Ended September 30, ------------------------------- 1997 1996 ---------- ---------- Common Stock: Balance at beginning of year $ 15,724 $ 15,636 Exercise of stock options 84 51 ---------- ---------- Balance at end of period 15,808 15,687 ---------- ---------- Additional paid-in capital: Balance at beginning of year 208,994 196,928 Exercise of stock options 4,240 4,114 Gain on treasury stock reissued 8,533 3,913 Cash in lieu of fractional shares - (83) ---------- ---------- Balance at end of period 221,767 204,872 ---------- ---------- Unrealized foreign currency translation gains: Balance at beginning of year 229,782 213,319 Change in unrealized translation gains, net of income taxes 9,276 9,669 ---------- ---------- Balance at end of period 239,058 222,988 ---------- ---------- Unrealized gains on securities available for sale: Balance at beginning of year 280,154 482,787 Change in unrealized gains (losses), net of income taxes 341,123 (212,946) ---------- ---------- Balance at end of period 621,277 269,841 ---------- ---------- Retained earnings: Balance at beginning of year 1,917,794 1,577,605 Net earnings 489,029 260,615 Cash dividends ($.33 per share in 1997 and $.287 in 1996) (45,050) (40,324) ---------- ---------- Balance at end of period 2,361,773 1,797,896 ---------- ---------- Treasury stock: Balance at beginning of year (526,425) (351,117) Purchases of treasury stock (159,479) (146,722) Cost of shares issued to sales associates stock bonus plan and dividend reinvestment plan 20,810 20,729 ---------- ---------- Balance at end of period (665,094) (477,110) ---------- ---------- Notes receivable for stock purchases (814) (504) ---------- ---------- Total shareholders' equity $ 2,793,775 $ 2,033,670 ========== ========== See accompanying Notes to Consolidated Financial Statements. 4 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands - Unaudited) Nine Months Ended September 30, --------------------------- 1997 1996 ------------ ------------ Cash flows from operating activities: Net earnings $ 489,029 $ 260,615 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 1,750,978 1,832,406 Deferred income taxes 11,235 57,626 Change in income taxes payable 3,336 (96,132) Increase in deferred policy acquisition costs (174,686) (183,533) Change in receivables and advance premiums (11,989) (41,308) Gain on sale of television stations (267,223) - Other, net 156,837 158,949 ---------- ---------- Net cash provided by operating activities 1,957,517 1,988,623 ---------- ---------- Cash flows from investing activities: Proceeds from investments sold or matured: Fixed-maturity securities sold 1,517,566 1,515,492 Fixed-maturity securities matured 295,641 459,598 Equity securities 48,256 7,695 Mortgage loans and other investments, net 2,212 4,005 Short-term investments, net - 40,530 Costs of investments acquired: Fixed-maturity securities (4,002,063) (3,881,926) Equity securities (43,013) (14,480) Short-term investments, net (13,353) - Proceeds from sale of television stations 350,633 - Additions to property & equipment, net (4,120) (8,997) ---------- ---------- Net cash used by investing activities $(1,848,241) $(1,878,083) ---------- ---------- (continued) 5 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In thousands - Unaudited) Nine Months Ended September 30, ----------------------------- 1997 1996 ------------ ------------ Cash flows from financing activities: Proceeds from borrowings $ 253,833 $ 125,937 Principal payments under debt obligations (189,570) (60,894) Dividends paid to shareholders (45,050) (40,324) Purchases of treasury stock (159,479) (146,722) Treasury stock reissued 29,343 24,642 Other, net 4,324 4,083 ---------- ---------- Net cash used by financing activities (106,599) (93,278) ---------- ---------- Effect of exchange rate changes on cash (811) (1,987) ---------- ---------- Net change in cash 1,866 15,275 Cash at beginning of year - 4,139 ---------- ---------- Cash at end of period $ 1,866 $ 19,414 ========== ========== Supplemental disclosures of cash flow information: Cash payments during the period for: Interest on debt obligations $ 9,067 $ 10,861 Income taxes 215,198 222,113 See accompanying Notes to Consolidated Financial Statements. 6 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 (none of which were other than normal recurring accruals) necessary to fairly present the financial position as of September 30, 1997, and the results of operations for the three-month and nine-month periods ended September 30, 1997 and 1996, and statements of cash flows and shareholders' equity for the nine months ended September 30, 1997 and 1996. 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, 1996. Effective January 1, 1997, the Company changed its method of determining the costs of investment securities sold from the first-in, first-out (FIFO) method to the specific identification method. The specific identification method allows the Company greater financial flexibility in the matching of its assets and liabilities. Also, the specific identification method is the predominant method used by the insurance industry. This accounting change had no material effect on net earnings for the three months and nine months ended September 30, 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. SFAS No. 125 established criteria for determining whether transfers of financial assets are sales or secured borrowings and must be applied to all applicable transactions that occurred after December 31, 1996. The adoption of the 1997 provisions of SFAS No. 125 had no material affect on the Company's net earnings or shareholders' equity. SFAS No. 127 amended the effective date for those transactions concerning secured obligations and collateral, which must now be applied prospectively to all applicable transactions occurring after December 31, 1997. Earlier or retroactive application is not permitted. Beginning in 7 1998, as required by these standards, the Company will no longer recognize securities held as collateral as an asset, nor the related liability for return of such collateral. This change will have no affect on the Company's net earnings or shareholders' equity. In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings per Share. Effective December 31, 1997, SFAS No. 128 will require the presentation of two earnings per share (EPS) numbers, basic EPS and diluted EPS, in the statements of earnings. Basic EPS is computed by dividing net earnings by the weighted-average number of shares outstanding for the period. Diluted EPS is computed by dividing net earnings by the weighted average number of shares outstanding for the period plus the shares for the dilutive affect of stock options and other common stock equivalents. The Company's present EPS calculation is the same as the diluted method prescribed by SFAS No. 128. Net earnings per share calculated under the new statement would be as follows: Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 ------------------ ------------------ Basic EPS $ .70 $ .63 $3.58 $1.85 Diluted EPS .68 .62 3.45 1.80 SFAS No. 129, Disclosures of Information about Capital Structure, was also issued in February 1997 and is also effective December 31, 1997. This Statement establishes standards for disclosing information about an entity's capital structure. No changes in the Company's present disclosures will be required under SFAS No. 129. On June 30, 1997 the FASB released SFAS No. 130, Reporting Comprehensive Income. This Statement establishes standards for reporting and displaying comprehensive income and its components in a full set of financial statements. SFAS No. 130 requires that all components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Examples of items that will be included in the Company's presentation of comprehensive income, in addition to net earnings, are unrealized foreign currency translation adjustments and unrealized gains and losses on securities available for sale. This Statement is effective beginning in 1998. SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, was also issued on June 30, 1997. This Statement requires that companies disclose segment data on the basis that is used internally for evaluating segment performance and deciding how to allocate 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. The Company is currently evaluating the necessary changes in its reporting and disclosures. This Statement is effective beginning in 1998. 8 3. Broadcast Division Sale In 1997, the Company completed the sale of its broadcast division business which consisted of seven network-affiliated television stations. The total pretax gain from the sale of the seven stations was $327.5 million. Cash sales proceeds received, after applicable selling expenses, were $449.1 million. Total sales proceeds also included advertising credits to be used over a five-year period with a fair value of $6.3 million. The Company also received cash for various current assets and liabilities. The sale of one station, WAFB-TV in Baton Rouge, Louisiana, closed on December 31, 1996. The pretax and after-tax gains recognized on the sale of WAFB-TV in the fourth quarter of 1996 were $60.3 million and $48.2 million ($.33 per share), respectively. The sale of the remaining six stations closed on April 15, 1997. The pretax and after-tax gains recognized in the second quarter of 1997 were $267.2 million and $211.2 million ($1.49 per share), respectively. The operating results of the broadcast division included in the 1996 and 1997 consolidated financial statements were as follows: Three Months Nine Months (In thousands) Ended September 30, Ended September 30, 1997 1996 1997 1996 ------------------- ------------------- Total revenues $ - $22,888 $16,107 $66,459 Earnings before interest and income taxes - 6,434 3,532 18,101 Broadcast revenues and operating expenses prior to April 15, 1997 were included in other income and other operating expenses, respectively, in the Consolidated Statements of Earnings. 4. Policyholder Protection Fund During the second quarter of 1997, Nissan Mutual Life Insurance Company, a Japanese insurer, was declared insolvent by the Japanese Ministry of Finance. All life insurers doing business in Japan previously agreed to contribute to a voluntary policyholder protection fund, that would be used to help offset insurer insolvencies. The total assessment was allocated among the life insurance companies based on relative company size. During the second quarter of 1997, AFLAC Japan recognized a non-recurring pretax charge of 3.0 billion yen ($24.9 million) for this policyholder protection fund. The after-tax amount was $13.6 million. 5. Derivative Financial Instruments The Company has only limited activity with derivative financial instruments and does not use them for trading purposes nor engage in leveraged derivative transactions. In addition, the Company does not use derivatives to hedge the foreign-currency-denominated net assets of its foreign insurance operations, except for short-term hedges of its annual profit repatriations. The Company currently uses two types of derivatives, interest rate swaps and foreign currency forward contracts. 9 Interest rate swaps are accounted for using the accrual method. The difference between amounts paid and received under such agreements is reported in interest expense in the Consolidated Statements of Earnings. Changes in the fair value of the swap agreements are not recognized in the Consolidated Balance Sheets. These swaps reduce the impact of changes in interest rates on the Company's borrowing costs and effectively change a portion of the Company's interest rate exposure from variable interest rates to fixed interest rates. The Company uses short-term foreign currency forward contracts (usually five months or less) which are designated at inception as hedges of foreign transaction exposures on annual profit transfers from AFLAC Japan. Such contracts are accounted for using the deferral method. Gains and losses during the period the contracts are outstanding and at termination of the contracts are reflected on the Consolidated Balance Sheets, in the unrealized foreign currency translation gains component of shareholders' equity. 6. Notes Payable A summary of notes payable is as follows: September 30, December 31, (In thousands) 1997 1996 ------------- ------------ Unsecured, yen-denominated notes payable to banks under reducing revolving credit agreement, due annually through July 2001: 2.58% fixed interest rate $ 292,320 $ 284,238 Variable interest rate (.88% at September 30, 1997) 82,577 - Unsecured, yen-denominated notes payable to banks, variable interest rate (.91% at September 30, 1997), paid in full October 1, 1997 7,649 17,453 9.60% to 10.72% unsecured notes payable to bank, due semiannually, through September 1998 9,444 15,389 Obligations under capitalized leases, due monthly through 2002, secured by computer equipment in Japan 21,220 25,392 Short-term yen-denominated note payable to bank under unsecured line of credit, refinanced in 1997 - 9,850 Other 301 1,211 ---------- ---------- Total notes payable $ 413,511 $ 353,533 ========== ========== The Company has a reducing revolving credit agreement that currently provides for bank borrowings in either U.S. dollars or equivalent Japanese yen. Under the terms of the agreement, the borrowing limits were reduced to $400 million at July 15, 1997 and will reduce to $325 million on July 15, 1998. At September 30, 1997, bank borrowings of 45.4 billion yen ($374.9 million) were outstanding under this agreement. When any portion of the loan is denominated in yen, the principal amount of the loan will fluctuate due to changes in the yen-to-dollar foreign currency exchange rate. 10 The Company has entered into interest rate swaps that effectively change the Company's interest rate exposure on 35.4 billion yen ($292.3 million) of this loan from variable interest rates to fixed interest rates. The fixed-rate on this portion of the loan is 2.58% after the effect of the swaps. Interest payments are made based on variable interest rates and the Company either pays to or receives from the counterparty an amount necessary to equal the fixed swap rate. The three-month Tokyo Interbank Offered Rate at September 30, 1997, plus loan costs of 25 basis points, was .83%. 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 unrealized foreign currency translation gains component in shareholders' equity. Outstanding principal and related accrued interest payable on the yen-denominated borrowings were translated into dollars at end-of-period exchange rates. Interest expense was translated at average monthly exchange rates for the period the interest expense was incurred. 7. Unrealized Gains on Fixed Maturity Securities The Company classifies all fixed-maturity securities as "available for sale." All fixed-maturity and equity securities are carried at fair value. The related unrealized gains and losses, less amounts applicable to policy liabilities and deferred income taxes, are reported in a separate component of shareholders' equity. The portion of unrealized gains credited to policy liabilities represents gains that would not inure to the benefit of the shareholders if such gains were actually realized. These amounts are necessary to cover policy reserve interest requirements based on market investment yields at these dates. The net effect of unrealized gains and losses from securities available for sale on shareholders' equity at the following dates was: (In thousands) September 30, 1997 December 31, 1996 ------------------ ----------------- Securities available for sale - unrealized gains $ 3,351,896 $ 2,436,605 Less provision for: Policy liabilities 2,400,820 2,023,107 Deferred income taxes 329,799 133,344 ------------ ------------ Shareholders' equity, net unrealized gains on securities available for sale $ 621,277 $ 280,154 ============ ============ 8. Security Lending AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. At September 30, 1997, and December 31, 1996, the Company held Japanese government bonds as collateral for loaned securities in the amounts of $2.9 billion and $573.9 million, respectively, at fair value. Securities received as collateral for such loans are reported separately in assets at fair value with a corresponding liability of the same amount for the return of such collateral at termination of the 11 loans. (Beginning in 1998, such collateral assets and the related liability will no longer be included on the balance sheet under the accounting provisions of SFAS No. 125 and SFAS No. 127. Note 2.) 9. Common Stock 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) 1997 1996 ---------- ---------- Common stock - number of shares: Issued: Balance at beginning of year 157,239 156,358 Exercise of stock options 841 517 -------- -------- Balance at end of period 158,080 156,875 -------- -------- Treasury stock - number of shares: Balance at beginning of year 19,354 14,384 Purchases of treasury stock 3,406 4,724 Shares issued to sales associates stock bonus plan and dividend reinvestment plan (563) (737) Exercise of stock options (163) (102) -------- -------- Balance at end of period 22,034 18,269 -------- -------- Shares outstanding at end of period 136,046 138,606 ======== ======== On May 5, 1997, the shareholders approved an increase in the number of shares of common stock that the Company is authorized to issue from 175 million to 400 million shares. 10. 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. 12 REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The September 30, 1997 and 1996 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 14. 13 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, 1997, and the related consolidated statements of earnings for the three-month and nine-month periods ended September 30, 1997 and 1996, and the consolidated statements of cash flows and shareholders' equity for the nine-month periods ended September 30, 1997 and 1996. 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, 1996, and the related consolidated statements of earnings, shareholders' equity and cash flows for the year then ended (not presented herein); and in our report dated January 29, 1997, we expressed an unqualified opinion on those consolidated financial statements. KPMG PEAT MARWICK LLP October 21, 1997 Atlanta, GA 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The primary business activity of AFLAC Incorporated and subsidiaries (the "Company") is supplemental health insurance, which is marketed and administered primarily through American Family Life Assurance Company of Columbus (AFLAC). Most of AFLAC's policies are individually underwritten in the payroll market, with premiums paid by the employees. The Company's operations in Japan (AFLAC Japan) and the United States (AFLAC U.S.) service the two principal markets for the Company's insurance operations. AFLAC Japan and AFLAC U.S. are the primary components for this discussion and analysis, due to their significance to the Company's consolidated financial condition and results of operations. RESULTS OF OPERATIONS In 1997, the Company completed the sale of its broadcast division business which consisted of seven network-affiliated television stations. The total pretax gain from the sale was $327.5 million. The sale of one station, WAFB-TV in Baton Rouge, Louisiana, closed on December 31, 1996. The pretax and after-tax gains recognized in 1996 on the sale of WAFB-TV were $60.3 million and $48.2 million, respectively. The pretax and after- tax gains recognized during the second quarter of 1997 on the sale of the six remaining stations were $267.2 million and $211.2 million, respectively. The effect of the after-tax gain on 1997 net earnings per share was $1.49 for the nine months ended September 30, 1997. For further information, see Note 3 of the Notes to the Consolidated Financial Statements. 15 The following table sets forth the results of operations by business component for the periods shown and the percentage change from the prior period.
SUMMARY OF OPERATING RESULTS BY BUSINESS COMPONENT (In millions, except for per-share amounts) Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------- ---------------------------------------- Percentage Change Percentage Change Over Previous Over Previous Period 1997 1996 Period 1997 1996 -------------------- ------------------ -------------------- ----------------- Insurance operations (excluding realized investment gains and losses): AFLAC Japan...................... (.4)% $ 133.6 $ 134.1 (4.3)% $ 382.3 $ 399.4 AFLAC U.S........................ 48.2 49.5 33.4 39.0 130.8 94.1 ------ ------ ------ ------ Total ......................... 9.3 183.1 167.5 4.0 513.1 493.5 Broadcast division operations........ - 6.4 3.5 18.1 Interest expense, noninsurance operations............ 16.2 (2.3) (2.7) 20.0 (8.0) (10.0) Corporate expenses, other operations and eliminations........ 9.5 (20.4) (22.6) 17.7 (50.2) (61.1) ------ ------ ------ ------ Pretax operating earnings.......... 7.9 160.4 148.6 4.1 458.4 440.5 Realized investment gains (losses)... (4.6) 4.4 (5.7) 3.9 Gain on sale of television stations.. - - 267.2 - ------ ------ ------ ------ Earnings before income taxes....... 1.9 155.8 153.0 62.0 719.9 444.4 Income taxes......................... (7.6) 59.7 64.7 25.6 230.9 183.8 ------ ------ ------ ------ Net earnings..................... 8.8 $ 96.1 $ 88.3 87.6 $ 489.0 $ 260.6 ====== ====== ====== ====== Net earnings per share........... 9.7 $ .68 $ .62 91.7 $ 3.45 $ 1.80 ====== ====== ====== ====== ============================================================================================================================= 16
The following discussion of earnings comparisons focuses on pretax operating earnings and excludes realized investment gains/losses and the gain of $267.2 million from the sale of the television stations on April 15, 1997. 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. Throughout 1997, the yen has been weaker in relation to the dollar compared with the yen/dollar levels in 1996. The average yen-to-dollar exchange rates were 117.97 for the three months ended September 30, 1997, compared with 108.99 for the third quarter of 1996, and 119.64 for the nine months ended September 30, 1997, compared with 107.50 for the first nine months of 1996. The weakening of the yen in 1997 lowered operating earnings by approximately $.04 per share during the third quarter and $.14 per share for the first nine months. This per-share amount was solely attributable to the translation effect of the fluctuations in the yen and not to any fundamental change in business operations. Operating earnings per share, which were affected by the fluctuations in the value of the yen, increased 11.3% to $.69 for the three months ended September 30, 1997, compared with the third quarter of 1996 and increased 10.0% to $1.98 for the nine months ended September 30, 1997, compared with the nine months ended September 30, 1996. The Company sets its growth objective for operating earnings per share before the effect of foreign currency fluctuations. Excluding the effect of currency fluctuations, operating earnings per share increased 17.7% for the three months ended September 30, 1997, compared with the same period in 1996, and increased 17.8% for the nine months ended September 30, 1997, compared with the same period in 1996. The table below 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. In years when the yen weakens, translating yen into dollars causes smaller increases or negative percentage changes for financial results in dollars. When the yen strengthens, translating yen into dollars causes larger increases for financial results in dollars. 17 AFLAC Incorporated and Subsidiaries Supplemental Consolidated Data Selected Percentage Changes Three Months Ended Nine Months Ended September 30, 1997 September 30, 1997 ---------------------- --------------------- Adjusted to Adjusted to Exclude Exclude Foreign Foreign As Currency As Currency Reported Changes(a) Reported Changes(a) -------- ----------- -------- ----------- Premium income 1.4% 8.3% .2% 9.4% Net investment income 8.8 15.4 4.8 13.6 Total revenues .8 7.5 4.9(b) 14.0(b) Total benefits and expenses .7 7.5 (.4) 8.8 Operating earnings(c) 10.6 16.1 7.4(d) 15.0(d) Operating earnings per share(c) 11.3 17.7 10.0(d) 17.8(d) - ---------------------------------------------------------------------------- (a) 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. (b) Includes a $267.2 million gain from the sale of the television stations in the second quarter of 1997. (c) Excludes realized investment gains/losses. (d) Excludes a $211.2 million after-tax gain, or $1.49 per share, from the sale of the television stations in the second quarter of 1997. ============================================================================ The Company's objective for 1997 is to increase operating earnings per share by 17% for the year, excluding the effect of currency translation. However, if that objective is achieved and the yen/dollar exchange rate averages 120.00 for the full year 1997, compared with the 1996 average rate of 108.84, operating earnings per share including foreign currency translation would increase by approximately 10% for the year 1997. Despite the weaker yen in 1997 compared with 1996, operating earnings per share increased for the three-month period ended September 30, 1997, compared with the third quarter of 1996 and increased for the nine months ended September 30, 1997, compared with the nine months ended September 30, 1996. The increases reflected strong earnings in the functional currencies of AFLAC's core insurance operations in Japan and the United States, additional investment income on the proceeds from the sale of the television stations, and a consolidated benefit from additional investment income associated with profit repatriations from AFLAC Japan to AFLAC U.S. Profit Repatriation AFLAC Japan repatriated 40.9 billion yen ($347.0 million) to AFLAC U.S. in July 1997, which included $124.8 million of a non-recurring nature related to gains realized from the valuation of investments as determined on a Japanese statutory accounting basis. AFLAC Japan repatriated profits to AFLAC U.S. of $217.3 million in 1996. Since the first repatriation in 1989, AFLAC Japan has repatriated $1.0 billion to the United States, which has enhanced the Company's flexibility and profitability. The profit transfers 18 to AFLAC U.S. adversely impact AFLAC Japan's investment income. However, repatriations benefit consolidated operations because higher investment yields can be earned on funds invested in the United States. Also, income tax expense is presently lower on investment income earned in the United States. Management estimates these transfers have benefited consolidated net earnings by $17.0 million and $10.2 million for the three months ended September 30, 1997 and 1996, respectively, and $28.5 million and $17.6 million for the nine months ended September 30, 1997 and 1996, respectively. In 1997, the Company entered into short-term forward exchange contracts with a notional amount of $75.2 million related to the profit transfer in July 1997. Such contracts were designated as a hedge of the Company's investment in AFLAC Japan. The contracts terminated in July, coinciding with the transfer of funds. The loss of $2.4 million at the termination of the contracts was included in the unrealized foreign currency translation gains component of shareholders' equity. Share Repurchase Program During the third quarter, the Company purchased 1.3 million shares of its common stock. The Company has purchased 23.6 million shares (through September 30, 1997) 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. 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 fourth in terms of individual policies in force and 17th in terms of 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 1997. 19 AFLAC JAPAN SUMMARY OF OPERATING RESULTS Three Months Ended Nine Months Ended September 30, September 30, (In millions) 1997 1996 1997 1996 ------------------ ------------------ Premium income................... $1,237.5 $1,245.1 $3,618.6 $3,694.6 Investment income, as adjusted*.. 241.1 231.8 690.6 686.7 Other income..................... .4 .5 1.8 1.0 ------- ------- ------- ------- Total revenues, as adjusted*... 1,479.0 1,477.4 4,311.0 4,382.3 ------- ------- ------- ------- Benefits and claims.............. 1,070.1 1,082.5 3,131.4 3,205.8 Operating expenses............... 264.6 253.5 773.2 759.4 ------- ------- ------- ------- Total benefits and expenses.... 1,334.7 1,336.0 3,904.6 3,965.2 ------- ------- ------- ------- Pretax operating earnings, as adjusted*................ 144.3 141.4 406.4 417.1 Investment income applicable to profit repatriations............ (10.7) (7.3) (24.1) (17.7) ------- ------ ------- ------- Pretax operating earnings.... $ 133.6 $ 134.1 $ 382.3 $ 399.4 ======= ====== ======= ======= - ---------------------------------------------------------------------------- Percentage changes in dollars over previous period: Premium income................. (.6)% (5.0)% (2.1)% (6.9)% Investment income*............. 4.0 (2.5) .6 (3.5) Total revenues*................ .1 (4.5) (1.6) (6.3) Pretax operating earnings*..... 2.1 (3.1) (2.6) (5.4) Pretax operating earnings...... (.4) (4.3) (4.3) (6.2) - ---------------------------------------------------------------------------- Percentage changes in yen over previous period: Premium income................. 7.6% 10.0% 9.0% 9.3% Investment income*............. 12.6 13.0 12.0 13.3 Total revenues*................ 8.4 10.6 9.5 9.9 Pretax operating earnings*..... 10.5 12.4 8.5 11.0 Pretax operating earnings...... 7.8 11.0 6.6 10.0 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims............ 72.3% 73.2% 72.7% 73.2% Operating expenses............. 17.9 17.2 17.9 17.3 Pretax operating earnings...... 9.8 9.6 9.4 9.5 Ratio of pretax operating earnings to total reported revenues..... 9.1 9.1 8.9 9.2 - ---------------------------------------------------------------------------- *Adjusted investment income, total revenues and pretax operating earnings include estimates of additional investment income for the three months ended September 30, 1997 and 1996 of $10.7 million and $7.3 million, respectively, and for the nine months ended September 30, 1997 and 1996, of $24.1 million and $17.7 million, respectively, foregone due to profit repatriations. ============================================================================ 20 AFLAC Japan Sales The increase in premium income in yen was due to sales of new policies and continued excellent policy persistency. During the third quarter of 1997, AFLAC Japan's new annualized premium sales were 15.2 billion yen ($129.0 million). Although that represented a 34.0% decrease compared with the same period last year, sales during the third quarter of 1997 were 8.4% above second quarter 1997 sales results. For the first nine months of 1997, sales were 43.2 billion yen ($362.4 million), or 28.3% lower than the first nine months of 1996. AFLAC Japan's new policy sales in 1997 have been affected by a lingering weak economy, lower consumer confidence in the life insurance industry following the April 1997 collapse of Nissan Mutual Life, and a series of premium rate increases that AFLAC and the insurance industry have implemented since 1993, including the most recent one in the fourth quarter of 1996. In addition, sales in the third quarter of 1996 were exceptionally strong, rising 51.7% over the sales of the third quarter of 1995, which made comparisons of 1997 sales to last year difficult. Annualized premiums in force were 589.3 billion yen ($4.9 billion) at September 30, 1997, increasing 6.7%, or 37.2 billion yen ($307.5 million) over September 30, 1996. Management believes there is still a strong need for the types of quality supplemental insurance products AFLAC sells in Japan. In September 1997, the co-payment for the employer-sponsored health care program increased from 10% to 20% for the primary insured, thereby increasing the portion of the costs the insured has to pay. Approximately 60% of the population is covered under this plan. The out-of-pocket expenses that Japanese consumers must pay for health care continue to rise, and AFLAC is the undisputed leader at helping fill those gaps in insurance coverage. Management has taken several actions to help mitigate the impact of the weak sales environment in Japan. First, a new economy cancer life policy was introduced in January 1997. This new plan has lower premium rates and benefit levels and was developed to combat the impact of increased premium rates for new issues. In addition, the Company has increased the use of direct-mail marketing for its products as a supplemental distribution method and will continue its popular television advertising program. The Company has also revised the incentive pay system for AFLAC Japan's employed sales managers to improve compensation for sales performance. The Company will make additional expenditures during the remainder of 1997 for expanded sales promotion efforts in Japan. A new supplemental medical rider to the cancer life policy will be introduced in 1998, subject to approval of the Japanese Ministry of Finance. Management expects sales to increase 5% to 7% in the fourth quarter of 1997, compared with the fourth quarter of 1996 and improve further in 1998. AFLAC Japan Investments Investment yields declined in the third quarter of 1997, also reflecting Japan's weak economy. The Company purchased yen-denominated securities at an average yield of 4.82% during the quarter. This new money yield compares very favorably with the 3.5% interest rate in the Company's policy liability reserving assumptions for new business. In fact, investment margins on new business continue to be the highest produced in several years. Including dollar-denominated purchases, the blended new 21 money yield was 5.28% for the third quarter of 1997. The yield on AFLAC Japan's fixed-maturity portfolio was 5.49% at the end of the third quarter of 1997, compared with 5.66% a year ago. The yield on AFLAC Japan's fixed-maturity portfolio declined from 5.58% at year-end 1996 to 5.49% at the end of the third quarter of 1997. The return on average invested assets was 5.36% for the first nine months of 1997, compared with 5.56% for the first nine months of 1996 and 5.54% for the full year 1996. AFLAC Japan Other During the second quarter of 1997, Nissan Mutual Life Insurance Company, a Japanese insurer, was declared insolvent by the Japanese Ministry of Finance. All life insurers doing business in Japan previously agreed to contribute to a voluntary policyholder protection fund that would be used to help offset insurer insolvencies. The total assessment was allocated among the life insurance companies based on relative company size. During the second quarter of 1997, AFLAC Japan recognized a non-recurring pretax charge of 3.0 billion yen ($24.9 million) for this policyholder protection fund. The after-tax amount was $13.6 million or $.10 per share. The Japanese government passed a package of tax reform bills centering on an increase in the consumption tax, which is similar to a sales tax in the United States. The consumption tax increased from the rate of 3% to 5% effective April 1, 1997. AFLAC Japan currently incurs consumption tax on agents' commissions. The Company implemented changes in its compensation arrangements with its agents to mitigate a portion of this tax increase. In March 1997, the Japanese government ratified new income tax provisions that increase income taxes on investment income received by foreign companies operating in Japan from securities issued from their home country. The new provisions are effective beginning in 1998. If the new income tax provisions had been effective January 1, 1997, AFLAC Japan's income tax expense, without any offsets or mitigation, would have been increased, and net earnings of the Company would have decreased by approximately $14.6 million for the nine months ended September 30, 1997. Management has mitigated much of the tax impact through investment alternatives and by restructuring portions of the existing investment portfolio. Management does not expect this tax change to materially affect future net earnings of the Company. 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 1997, along with estimated investment income earned from proceeds from the sale of the television stations, have been reclassified in the following presentation in order to improve comparability between periods. 22 AFLAC U.S. SUMMARY OF OPERATING RESULTS Three Months Ended Nine Months Ended September 30, September 30, (In millions) 1997 1996 1997 1996 ------------------ ------------------ Premium income................... $ 268.9 $ 238.9 $ 786.2 $ 700.9 Investment income, as adjusted*.. 26.3 22.0 77.1 64.3 Other income..................... .6 .4 1.4 1.1 ------ ------ ------ ------ Total revenues, as adjusted*... 295.8 261.3 864.7 766.3 ------ ------ ------ ------ Benefits and claims.............. 168.6 149.2 493.7 437.5 Operating expenses............... 100.3 88.2 291.6 257.6 ------ ------ ------ ------ Total benefits and expenses.... 268.9 237.4 785.3 695.1 ------ ------ ------ ------ Pretax operating earnings, as adjusted*................ 26.9 23.9 79.4 71.2 Investment income applicable to profit repatriations and in 1997, proceeds from the sale of the television stations............. 22.6 9.5 51.4 22.9 ------ ------ ------ ------ Pretax operating earnings.... $ 49.5 $ 33.4 $ 130.8 $ 94.1 ====== ====== ====== ====== - ---------------------------------------------------------------------------- Percentage increases over previous period: Premium income................. 12.5% 10.1% 12.2% 9.8% Investment income*............. 19.6 11.9 20.0 11.4 Total revenues*................ 13.2 10.5 12.8 10.0 Pretax operating earnings*..... 12.5 33.8 11.4 17.0 Pretax operating earnings...... 48.2 37.7 39.0 24.6 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims............ 57.0% 57.0% 57.1% 57.1% Operating expenses............. 33.9 33.8 33.7 33.6 Pretax operating earnings...... 9.1 9.2 9.2 9.3 Ratio of pretax operating earnings to total reported revenues..... 15.5 12.3 14.3 11.9 - ---------------------------------------------------------------------------- *Excludes estimated investment income for the three months and nine months ended September 30, 1997, of $22.6 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 stations, and for the three months and nine months ended September 30, 1996, of $9.5 million and $22.9 million, respectively, related to investment of profit repatriation funds retained by AFLAC U.S. ============================================================================ 23 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 were a record $99.7 million, an increase of 22.2%, in the third quarter of 1997, compared with the third quarter of 1996. For the first nine months of 1997, new sales were $287.7 million, also an increase of 22.2%, compared with the same period of 1996. Although accident/disability coverage continues to be the Company's best-selling product, management is also pleased with the strong contributions from other payroll-deduction products. Management intends to maintain the Company's leading position of providing supplemental insurance at the work site. Management believes AFLAC has tremendous market opportunities in the United States and expects new policy sales to increase by approximately 20% for the year 1997. AFLAC U.S. Investments The increase in investment income was primarily due to the continued cash flow from operations. Also, AFLAC has paid less dividends to the Parent Company during the first nine months of 1997 than in the first nine months of 1996. During the third quarter, available cash flow was invested at an average yield of 7.46% compared with 7.76% during the third quarter of 1996. The overall return on average invested assets, net of investment expenses, was 7.62% for the first nine months of 1997 compared with 7.30% for the same period of 1996. AFLAC U.S. Other Management expects the operating expense ratio, excluding discretionary advertising expenses, to decline slightly in the future due to continued improvements in operating efficiencies. By improving administrative systems and controlling other costs, management has been able to redirect funds to national advertising programs without significantly affecting the operating expense ratio. Management expects the pretax operating profit margin, which was 9.3% for the year 1996 excluding the effect of repatriation, to remain approximately the same in 1997, excluding the effect of repatriation and the earnings generated by investing the broadcast sale proceeds. The operating results reflect slightly higher benefit ratios 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. However, 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. 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. 24 ANALYSIS OF FINANCIAL CONDITION Since December 31, 1996, 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, 1997, was 121.10 yen to one U.S. dollar, 4.1% weaker than the exchange rate of 116.10 as of December 31, 1996. Management estimates that the weaker yen rate decreased invested assets by $812.5 million, total assets by $1.1 billion and total liabilities by $1.0 billion versus the amounts that would have been reported based on the exchange rate as of December 31, 1996. Invested Assets Securities available for sale are carried at fair value. The following table shows an analysis of invested assets (including cash): September 30, December 31, (In thousands) 1997 1996 % Change ------------- ------------ -------- AFLAC U.S.: Total invested assets, at cost or amortized cost $ 2,608,007 $ 1,910,154 36.5% Unrealized gains on securities available for sale 181,343 101,258 ----------- ----------- Total invested assets $ 2,789,350 $ 2,011,412 38.7% =========== =========== ======= AFLAC Japan: Total invested assets, at cost or amortized cost $ 17,156,859 $ 16,390,997 4.7% Unrealized gains on securities available for sale 3,170,553 2,334,537 ----------- ----------- Total invested assets $ 20,327,412 $ 18,725,534 8.6% =========== =========== ======= Consolidated: Total invested assets, at cost or amortized cost $ 19,864,941 $ 18,309,930 8.5% Unrealized gains on securities available for sale 3,351,896 2,436,605 ----------- ----------- Total invested assets $ 23,216,837 $ 20,746,535 11.9% =========== =========== ======= Net unrealized gains of $3.4 billion on securities available for sale at September 30, 1997, consisted of $3.4 billion in gross unrealized gains and $19.3 million in gross unrealized losses. 25 The continued growth of invested assets in their functional currencies reflects the strength of the Company's primary business, the substantial cash flows from operations, strong new annualized premium sales by AFLAC U.S., and the substantial renewal premiums collected by AFLAC Japan. In addition, the Company received $350.6 million in cash in the second quarter of 1997 in conjunction with the sale of the television stations. AFLAC invests primarily within the Japanese and U.S. fixed-maturity markets. The Company uses specific criteria to judge the credit quality and liquidity of its investments 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, 1997 December 31, 1996 ------------------ ----------------- AAA 40.0% 46.2% AA 20.9 19.6 A 28.8 26.0 BBB 10.3 8.2 ------ ------ 100.0% 100.0% Private placement investments accounted for 34.1% and 28.8% of the Company's total fixed-maturity securities available for sale as of September 30, 1997, and December 31, 1996, respectively. AFLAC Japan has made investments in the private sector to secure higher yields than those available from Japanese government bonds. At the same time, the Company has adhered to its conservative standards for credit quality. Policy Liabilities Policy liabilities increased $1.5 billion, or 7.3%, during the first nine months of 1997. AFLAC Japan increased $1.3 billion, or 7.2% (11.8% increase in yen), and AFLAC U.S. increased $138.7 million, or 8.2%. The weaker yen rate decreased reported policy liabilities by $853.2 million. Debt The increase in notes payable is primarily due to the financing for the share repurchase program. See Note 6 of the Notes to the Consolidated Financial Statements for further information on debt outstanding at September 30, 1997. The Company's ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized gains on securities available for sale) was 16.0% and 16.1% as of September 30, 1997, and December 31, 1996, respectively. 26 Security Lending AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. At September 30, 1997, the Company held Japanese government bonds as collateral for loaned securities in the amount of $2.9 billion at fair value. For further information regarding such arrangements, see Note 8 of the Notes to the Consolidated Financial Statements. Shareholders' Equity The Company's insurance operations continue to provide the primary sources of liquidity for the Company. Capital needs can also be supplemented by borrowed funds. The principal sources of cash from insurance operations are premiums and investment income. Primary uses of cash in the insurance operations are policy claims, commissions, operating expenses, income taxes and payments to the Parent Company for management fees and dividends. Both the sources and uses of cash are reasonably predictable. The Company's investment objectives provide for liquidity through the ownership of high-quality investment securities. AFLAC insurance policies are generally not interest-sensitive and therefore are not subject to unexpected policyholder redemptions due to investment yield changes. Also, the majority of AFLAC policies provide indemnity benefits rather than reimbursement for actual medical costs and therefore are not subject to the risks of medical cost inflation. The achievement of continued long-term growth will require growth in the statutory capital and surplus of the Company's insurance subsidiaries. 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 AFLAC Broadcast Division has increased the Company's capital resources. Management believes outside sources for additional debt and equity capital will continue to be available for capital expenditures, business expansion and the Company's share repurchase program. Parent Company capital resources are largely dependent upon the ability of the subsidiaries to pay management fees and dividends. The Georgia Insurance Department imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances by AFLAC to the Parent Company. In addition to restrictions by U.S. insurance regulators, the Japanese Ministry of Finance (MOF) imposes restrictions on, and requires approval for, the remittances of earnings from AFLAC Japan to AFLAC U.S. Payments are made from AFLAC Japan to the Parent Company for management fees, and to AFLAC U.S. for allocated expenses and remittances of earnings. Total funds received from AFLAC Japan were $374.9 million and $244.1 million in the first nine months of 1997 and 1996, respectively, and $253.6 million in the full year 1996. AFLAC Japan repatriated profits to AFLAC U.S. in the amount of $347.0 million in July 1997, including $124.8 million of a non-recurring nature. AFLAC U.S. then paid a dividend of $66.5 million to the Parent Company, which was used to reduce debt. During the last few years, the MOF has developed solvency standards, a version of risk-based capital requirements. For additional information on regulatory restrictions on dividends, profit transfers and other remittances, see Note 10 of the Notes to the Consolidated Financial Statements in the Company's annual report to shareholders for the year ended December 31, 1996. 27 Other During the third quarter of 1997, Duff & Phelps Credit Rating Company assigned AFLAC a claims-paying ability rating of "AA." AFLAC is also rated "AA" for its claims-paying ability by Standard & Poor's Corporation and "A+" by A.M. Best Company. For information regarding pending litigation, see Note 10 of the Notes to the Consolidated Financial Statements. FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" to encourage companies to provide prospective information about their companies, so long as those 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 discussion and analysis, 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 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 developments, 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 Japan tax laws, adequacy of reserves, credit and other risks associated with the Company's investment portfolio, significant changes in interest rates and fluctuations in foreign currency exchange rates. 28 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, 1997. Items other than those listed above are omitted because they are not required or are not applicable. 29 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 3, 1997 /s/ KRISS CLONINGER, III ------------------------ --------------------------- KRISS CLONINGER,III Executive Vice President; Treasurer and Chief Financial Officer Date November 3, 1997 /s/ NORMAN P. FOSTER ------------------------ --------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 30 EXHIBITS FILED WITH CURRENT FORM 10-Q: 27.0 - Financial Data Schedule (for SEC use only). 31 EX-27 2 9/97 FDS
7 This schedule contains summary financial information extracted from the Company's consolidated financial statements as filed in Form 10-Q for the quarter ended September 30, 1997, and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 22,773,606 0 0 151,810 15,817 0 23,214,971 1,866 0 2,672,684 29,808,634 21,184,683 278,577 0 240,574 413,511 0 0 15,808 2,777,967 29,808,634 4,412,040 798,946 (5,703) 300,567 3,632,839 133,381 1,019,740 719,890 230,861 489,029 0 0 0 489,029 3.45 0 0 0 0 0 0 0 0 Includes $267,223 gain from the sale of the television stations in 1997. Includes $211,190 after-tax gain ($1.49 per share) on the sale of the television stations in 1997.
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