-----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, RD5AvMjfxwzHufT4aVcBjzEBNR0PGUL1pbJZRnDDGE2T5BDqofx5Iulhip5tdjsB ADxCBm3xqELbq1Jx3oa3Kw== 0000004977-98-000009.txt : 19980513 0000004977-98-000009.hdr.sgml : 19980513 ACCESSION NUMBER: 0000004977-98-000009 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980512 SROS: NYSE SROS: PCX 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: 98616351 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 1ST 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 March 31, 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 May 6, 1998 - ---------------------------- ------------------ Common Stock, $.10 Par Value 267,696,238 shares AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - March 31, 1998 and December 31, 1997................... 1 Consolidated Statements of Earnings - Three Months Ended March 31, 1998 and 1997.............. 3 Consolidated Statements of Shareholders' Equity - Three Months Ended March 31, 1998 and 1997.............. 4 Consolidated Statements of Cash Flows - Three Months Ended March 31, 1998 and 1997.............. 5 Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 1998 and 1997.............. 7 Notes to Consolidated Financial Statements................ 8 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 Item 3. Quantitative and Qualitative Disclosures about Market Risk......................................... 30 Part II. Other Information: Item 1. Legal Proceedings.................................. 33 Item 4. Submission of Matters to a Vote of Security Holders....................................... 33 Item 6. Exhibits and Reports on Form 8-K................... 34 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) March 31, December 31, 1998 1997 (Unaudited) ------------- ------------- ASSETS: Investments and cash: Securities available for sale, at fair value: Fixed maturities (amortized cost, $19,351,066 in 1998 and $19,121,128 in 1997) $ 22,597,866 $ 22,437,818 Equity securities (cost, $85,091 in 1998 and $80,270 in 1997) 166,954 146,326 Mortgage loans and other 15,240 16,747 Short-term investments 45,322 43,344 Cash and cash equivalents 145,395 235,675 ------------ ------------ Total investments and cash 22,970,777 22,879,910 Receivables, primarily premiums 214,142 215,653 Accrued investment income 236,104 264,956 Deferred policy acquisition costs 2,603,945 2,581,828 Property and equipment, net 380,755 386,049 Securities held as collateral for loaned securities 1,027,868 3,034,241 Other 94,637 91,368 ------------ ------------ Total assets $ 27,528,228 $ 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) March 31, December 31, 1998 1997 (Unaudited) ------------ ------------- Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 18,655,339 $ 18,398,830 Unpaid policy claims 1,051,577 1,010,519 Unearned premiums 277,768 276,673 Other policyholders' funds 199,036 199,046 ------------ ------------ Total policy liabilities 20,183,720 19,885,068 Notes payable 511,186 523,209 Income taxes 1,694,185 1,827,337 Payables for return of collateral on loaned securities 1,027,868 3,034,241 Payables for security transactions 9,519 215,654 Other 648,053 538,024 ------------ ------------ Total liabilities 24,074,531 26,023,533 ------------ ------------ Shareholders' equity: Common stock of $.10 par value. Authorized 400,000 shares; issued 317,097 shares in 1998 and 316,380 shares in 1997 15,855 15,819 Additional paid-in capital 232,366 227,292 Retained earnings 2,587,529 2,442,309 Accumulated other comprehensive income: Unrealized foreign currency translation gains 230,139 274,074 Unrealized gains on securities available for sale 1,201,618 1,284,717 ------------ ------------ Total accumulated other comprehensive income 1,431,757 1,558,791 Treasury stock, at average cost (812,329) (812,672) Notes receivable for stock purchases (1,481) (1,067) ------------ ------------ Total shareholders' equity 3,453,697 3,430,472 ------------ ------------ Total liabilities and shareholders' equity $ 27,528,228 $ 29,454,005 ============ ============ Shareholders' equity per share $ 12.92 $ 12.88 ============ ============ See the accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect a two-for-one stock split declared on May 4, 1998. 2 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings (In thousands, except for Three Months Ended March 31, per-share amounts - Unaudited) ---------------------------------- 1998 1997 Revenues: ----------- ----------- Premiums, principally supplemental health insurance $ 1,472,399 $ 1,436,087 Net investment income 278,563 251,629 Realized investment gains (losses) 183 (443) Other income 5,881 20,270 ---------- ---------- Total revenues 1,757,026 1,707,543 ---------- ---------- Benefits and expenses: Benefits and claims 1,213,924 1,187,069 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 47,464 41,662 Insurance commissions 192,037 188,803 Insurance expenses 117,589 105,550 Provision for mandated policyholder protection fund 111,279 - Interest expense 3,273 3,334 Other operating expenses 17,936 32,006 ---------- ---------- Total acquisition and operating expenses 489,578 371,355 ---------- ---------- Total benefits and expenses 1,703,502 1,558,424 ---------- ---------- Earnings before income taxes 53,524 149,119 Income taxes: Operations 14,242 58,962 Deferred tax benefit from Japan tax rate reduction (121,120) - ---------- ---------- Total income taxes (106,878) 58,962 ---------- ---------- Net earnings $ 160,402 $ 90,157 ========== ========== Net earnings per share: Basic $ .60 $ .33 Diluted .58 .32 ========== ========== Shares used in computing earnings per share: Basic 266,831 274,255 Diluted 276,294 283,632 ========== ========== Cash dividends per share $ .058 $ .05 ========== ========== See the accompanying Notes to Consolidated Financial Statements. Share and per-share amounts have been adjusted to reflect a two-for-one stock split declared on May 4, 1998. 3 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In thousands - Unaudited) Three Months Ended March 31, ---------------------------- 1998 1997 ---------- ---------- Common Stock: Balance at beginning of year $ 15,819 $ 15,724 Exercise of stock options 36 11 ---------- ---------- Balance at end of period 15,855 15,735 ---------- ---------- Additional paid-in capital: Balance at beginning of year 227,292 208,994 Exercise of stock options 2,668 969 Gain on treasury stock reissued 2,406 2,620 ---------- ---------- Balance at end of period 232,366 212,583 ---------- ---------- Retained earnings: Balance at beginning of year 2,442,309 1,917,794 Net earnings 160,402 90,157 Cash dividends ($.058 per share in 1998 and $.05 in 1997) (15,182) (13,700) ---------- ---------- Balance at end of period 2,587,529 1,994,251 ---------- ---------- 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 (43,935) 10,966 Unrealized gains (losses) on securities available for sale during period, net of income taxes and reclassification adjustments (83,099) 144,131 ---------- ---------- Balance at end of period 1,431,757 665,033 ---------- ---------- Treasury stock: Balance at beginning of year (812,672) (526,425) Purchases of treasury stock (7,497) (70,109) Cost of shares issued to sales associates stock bonus plan and dividend reinvestment plan 7,840 6,679 ---------- ---------- Balance at end of period (812,329) (589,855) ---------- ---------- Notes receivable for stock purchases (1,481) (691) ---------- ---------- Total shareholders' equity $ 3,453,697 $ 2,297,056 ========== ========== See the accompanying Notes to Consolidated Financial Statements. Per-share amounts have been adjusted to reflect a two-for-one stock split declared on May 4, 1998. 4 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands - Unaudited) Three Months Ended March 31, ----------------------------- 1998 1997 ------------ ------------ Cash flows from operating activities: Net earnings $ 160,402 $ 90,157 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 569,820 589,071 Deferred income taxes (160,896) 13,508 Change in income taxes payable (46,734) (53,658) Increase in deferred policy acquisition costs (52,528) (66,166) Change in receivables and advance premiums 5,450 3,635 Provision for mandated policyholder protection fund 111,279 - Other, net 33,945 38,513 ---------- ---------- Net cash provided by operating activities 620,738 615,060 ---------- ---------- Cash flows from investing activities: Proceeds from investments sold or matured: Fixed-maturity securities sold 302,145 1,033,228 Fixed-maturity securities matured 161,926 79,347 Equity securities 10,154 17,841 Mortgage loans and other investments, net 1,463 822 Short-term investments, net - 470 Costs of investments acquired: Fixed-maturity securities (1,147,456) (1,103,036) Equity securities (16,660) (18,313) Short-term investments, net (2,049) - Additions to property and equipment, net (6,262) (797) ---------- ---------- Net cash provided/(used) by investing activities $ (696,739) $ 9,562 ---------- ---------- (continued) 5 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In thousands - Unaudited) Three Months Ended March 31, ----------------------------- 1998 1997 ------------ ------------ Cash flows from financing activities: Proceeds from borrowings $ - $ 169,689 Principal payments under debt obligations (4,728) (4,986) Dividends paid to shareholders (15,182) (13,700) Purchases of treasury stock (7,497) (70,109) Treasury stock reissued 10,246 9,299 Other, net 2,705 980 ---------- ---------- Net cash provided/(used) by financing activities (14,456) 91,173 ---------- ---------- Effect of exchange rate changes on cash and cash equivalents 177 (5,438) ---------- ---------- Net change in cash and cash equivalents (90,280) 710,357 Cash and cash equivalents, beginning of year 235,675 209,095 ---------- ---------- Cash and cash equivalents, end of period $ 145,395 $ 919,452 ========== ========== Supplemental disclosures of cash flow information: Cash payments during the period for: Interest on debt obligations $ 2,826 $ 2,753 Income taxes 102,875 98,778 See the accompanying Notes to Consolidated Financial Statements. 6 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (In thousands - Unaudited) Three Months Ended March 31, ----------------------------- 1998 1997 ------------ ------------ Net earnings $ 160,402 $ 90,157 Other comprehensive income, before income taxes: Foreign currency translation adjustments: Change in unrealized foreign currency translation gains during the period 6,736 10,457 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) arising during the period (48,321) 331,271 Reclassification adjustment for realized losses included in net earnings 24 444 ---------- ---------- Total other comprehensive income, before income taxes (41,561) 342,681 Income tax expense related to items of other comprehensive income 85,473 187,584 ---------- ---------- Other comprehensive income, net of income taxes (127,034) 155,097 ---------- ---------- Total comprehensive income $ 33,368 $ 245,254 ========== ========== 7 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 March 31, 1998, and the results of operations and statements of cash flows, shareholders' equity and comprehensive income for the three months ended March 31, 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. On May 4, 1998, the board of directors declared a two-for-one stock split. This split is payable to shareholders of record as of May 22, 1998 and the additional shares will be issued on June 8, 1998. All share and per-share amounts in the accompanying financial statements have been restated for this split. 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. 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 that occurred after December 31, 1997. Earlier or retroactive application was not permitted. 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 affect on the Company's net earnings or shareholders' equity. 8 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. 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. The Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3 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 such costs as they were incurred. This SOP is also effective for 1999. 3. Japanese Income Taxes In March 1997, the Japanese government ratified new income tax provisions that increase income taxes on investment income and realized gains received by foreign companies operating in Japan from securities issued from their home country. The new provisions are effective for 1998. Management has mitigated some of the income tax impact on operating earnings through investment alternatives and by restructuring portions of the existing investment portfolio. Management estimates the net impact of this tax change will decrease 1998 net operating earnings by $13 million. At the end of March 1998, the Japanese government reduced the Japanese corporate income tax rate. The tax rate for AFLAC Japan will decline from 45.3% to 41.7%. For the Company, this rate change will reduce income tax expense on operating earnings beginning May 1, 1998. According to 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 lowered income tax expense and increased net earnings by $121.1 million for the three months ended March 31, 1998. The tax rate reduction increased basic and diluted earnings per share by $.45 and $.44, respectively, for the three months ended March 31, 1998. 9 4. Policyholder Protection Fund During the first quarter of 1998, the Japanese Ministry of Finance and the Life Insurance Association of Japan agreed upon a new mandatory policyholder protection fund system. The life insurance industry will be required to contribute 490 billion yen ($3.7 billion using the March 31, 1998 exchange rate) over a 10-year period. Individual company contributions are to be based on relative company size. During the quarter ended March 31, 1998, AFLAC Japan recognized a pretax charge of $111.3 million for its estimated share of the total contribution obligation. The after-tax charge is $64.9 million or $.24 for both basic and diluted earnings per share. 5. Notes Payable A summary of notes payable is as follows: March 31, December 31, (In thousands) 1998 1997 ----------- ------------ Unsecured, yen-denominated notes payable to banks: 2.29% reducing, revolving credit agreement, due annually through July 2001 $ 343,679 $ 348,962 1.24% revolving credit agreement, due October 2002 146,858 149,116 9.60% to 10.72% unsecured notes payable to bank, due semiannually, through September 1998 5,222 6,944 Obligations under capitalized leases, due monthly through 2002, secured by computer equipment in Japan 15,327 17,986 Other 100 201 --------- --------- Total notes payable $ 511,186 $ 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. The current borrowing limit is $400 million. Under the terms of the agreement, the borrowing limit will reduce to $325 million on July 15, 1998, $250 million on July 15, 1999, and $125 million on July 15, 2000. At March 31, 1998, 45.4 billion yen ($343.7 million) was outstanding under this agreement. The Company also has an unsecured revolving credit agreement with a borrowing limit of $250 million, payable in either Japanese yen or U.S. dollars. At March 31, 1998, 19.4 billion yen ($146.9 million) was outstanding under this agreement. The Company has outstanding interest rate swaps on all of its variable- interest-rate yen-denominated borrowings (64.8 billion yen). 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 (.73% at March 31, 1998 plus loan costs of 25 or 20 basis points, respectively) based on the three-month Tokyo Interbank Offered Rate. 10 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 shareholders' equity at the following dates was: (In thousands) March 31, 1998 December 31, 1997 ------------------ ----------------- Securities available for sale - unrealized gains $ 3,328,663 $ 3,382,746 Less amounts related to: Policy liabilities 1,265,915 1,271,701 Deferred income taxes 861,130 826,328 ------------ ------------ Shareholders' equity, net unrealized gains on securities available for sale $ 1,201,618 $ 1,284,717 ============ ============ The increase in deferred income taxes applicable to unrealized gains on securities available for sale for the three months ended March 31, 1998 includes a provision of $58.7 million for additional Japanese income taxes effective January 1, 1998 on unrealized gains from dollar-denominated securities issued from the United States. (See the first paragraph of Note 3.) 7. Security Lending AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. At both March 31, 1998, and December 31, 1997, the Company held Japanese government bonds as collateral for loaned securities in the amount of $3.0 billion, at fair value. At March 31, 1998, securities received as collateral for transactions that occurred prior to January 1, 1998, in the amount of $1.0 billion, 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 loans. Securities received as collateral in the amount of $2.0 billion for transactions that occurred after December 31, 1997, and the related 11 liability for the return of such collateral, are no longer included on the balance sheet at March 31, 1998 under the accounting provisions of SFAS No. 125 and SFAS No. 127. (Note 2.) 8. Common Stock On May 4, 1998, the board of directors declared a two-for-one stock split. This split is payable to shareholders of record as of May 22, 1998 and the additional shares will be 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 three months ended March 31: (In thousands) 1998 1997 ---------- ---------- Common stock - issued: Balance at beginning of year 316,380 314,478 Exercise of stock options 717 223 -------- -------- Balance at end of period 317,097 314,701 -------- -------- Treasury stock: Balance at beginning of year 49,944 38,708 Purchases of treasury stock: Open market 114 3,394 Received from employees for taxes on option exercises 139 16 Shares issued to sales associates stock bonus plan and dividend reinvestment plan (280) (425) Exercise of stock options (201) (48) -------- -------- Balance at end of period 49,716 41,645 -------- -------- Shares outstanding at end of period 267,381 273,056 ======== ======== 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. 12 REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The March 31, 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 14. 13 KPMG PEAT MARWICK LLP Certified Public Accountants 303 Peachtree Street, N.E. Telephone: (404) 222-3000 Suite 2000 Telefax: (404) 222-3050 Atlanta, GA 30308 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors AFLAC Incorporated: We have reviewed the consolidated balance sheet of AFLAC Incorporated and subsidiaries as of March 31, 1998, and the related consolidated statements of earnings for the three-month periods ended March 31, 1998 and 1997, and the consolidated statements of cash flows, shareholders' equity and comprehensive income for the three-month periods ended March 31, 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 May 4, 1998 14 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 On May 4, 1998, the board of directors declared a two-for-one stock split. This split is payable to shareholders of record as of May 22, 1998 and the additional shares will be issued on June 8, 1998. All share and per-share amounts in this report have been restated for this split. At the end of March 1998, the Japanese government reduced the Japanese corporate income tax rate. The tax rate for AFLAC Japan will decline from 45.3% to 41.7%. For the Company, this rate change will reduce income tax expense on operating earnings beginning May 1, 1998. Management estimates the impact of this tax change on 1998 operating results will be approximately $10.0 million. According to 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 lowered income tax expense and increased net earnings by $121.1 million for the three months ended March 31, 1998. The tax rate reduction increased basic and diluted earnings per share by $.45 and $.44, respectively, for the three months ended March 31, 1998. During the first quarter of 1998, the Japanese Ministry of Finance and the Life Insurance Association of Japan agreed upon a new mandatory policyholder protection fund system. The life insurance industry will be required to contribute 490 billion yen ($3.7 billion using the March 31, 1998 exchange rate) over a 10-year period. Individual company contributions are to be based on relative company size. During the quarter ended March 31, 1998, AFLAC Japan recognized a pretax charge of $111.3 million for its estimated share of the total contribution obligation. The after-tax charge is $64.9 million or $.24 for both basic and diluted earnings per share. 15 The following table sets forth the results of operations by business segment for the periods shown and the percentage change from the prior period. SUMMARY OF OPERATING RESULTS BY BUSINESS SEGMENT (In millions, except for per-share amounts) Percentage Change Three Months Over Previous Ended March 31, Period 1998 1997 ----------------- ------------------ Operating earnings: Insurance operations: AFLAC Japan.................. (1.5)% $ 125.3 $ 127.2 AFLAC U.S.................... 50.3 56.3 37.4 ------ ------ Total ..................... 10.3 181.6 164.6 Broadcast division operations.... - 3.5 Interest expense, noninsurance operations........ (4.6) (2.7) (2.6) Corporate expenses, other operations and eliminations.... 11.2 (14.3) (15.9) ------ ------ Pretax operating earnings...... 10.1 164.6 149.6 Income taxes..................... 2.9 60.9 59.0 ------ ------ Operating earnings............. 14.6 103.7 90.6 Non-operating items: Realized investment gains (losses), net of tax .5 (.4) Provision for the mandated policyholder protection fund, net of tax (64.9) - Deferred tax benefit from Japan tax rate reduction 121.1 - ------ ------ Net earnings................... 77.9 $ 160.4 $ 90.2 ====== ====== Net earnings per share: Basic........................ 81.8 $ .60 $ .33 Diluted...................... 81.3 .58 .32 ====== ====== ============================================================================ The table above 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 policyholder protection system, and the benefit of the tax rate reduction. Operating earnings per share referred to in the following discussion are based on the diluted number of average outstanding shares. 16 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 years 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 Supplemental Consolidated Data* Three Months Ended March 31, 1998 Adjusted to Exclude Foreign As Reported Currency Changes** ----------- ---------------- Premium income 2.5% 7.1% Net investment income 10.7 14.8 Total revenues 2.9 7.4 Total benefits and expenses 2.2 6.8 Operating earnings 14.6 17.6 Operating earnings per share 18.8 21.9 - ---------------------------------------------------------------------------- * The numbers in this table are presented on an operating basis and there- fore exclude: the benefit of the tax rate reduction, the charge for the new policyholder protection fund, 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 quarter of 1998. The average yen-to-dollar exchange rates were 128.09 and 121.28 for the three months ended March 31, 1998 and 1997, respectively. Operating earnings per share, which were affected by the fluctuations in the value of the yen, increased 18.8% to $.38 for the three months ended March 31, 1998 compared with the same period in 1997. The 5.3% weakening of the yen in 1998 lowered operating earnings by approximately $.01 per share for the three months ended March 31, 1998 which was solely attributable to the translation effect of the fluctuations in the yen. Despite the weakening of the yen during 1998, operating earnings per share increased for the three-month period ended March 31, 1998 compared with the same period in 1997. The increase in operating earnings per share reflected earnings contributions 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 business in 1996 and 1997, and a consolidated benefit from additional investment income associated with profit repatriations from AFLAC Japan to AFLAC U.S. The Company's share repurchase program also benefited earnings on a per share basis. 17 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. Assuming that objective 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 @ 110.00 $ 1.68 26.3% $ .08 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 1.52 14.3 (.08) *Actual exchange rate for the year ended December 31, 1997. If the exchange rate as of April 30, 1998, would remain constant for the remainder of 1998, the cumulative average rate would be approximately 131.26 and the annual operating diluted earnings per share would approximate $1.54, assuming the Company's earnings objective is met. 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. PROFIT REPATRIATION AFLAC Japan repatriated profits to AFLAC U.S. of $347.0 million in 1997 and $217.3 million in 1996. The profit transfer in 1997 included $124.8 million of a non-recurring nature. Since the first repatriation in 1989, AFLAC Japan has repatriated $1.0 billion, which has enhanced the Company's flexibility and profitability. 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 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 1997 have benefited consolidated net earnings by $13.2 million and $8.6 million for the quarters ended March 31, 1998 and 1997, respectively. The Company expects to repatriate, subject to approval by the Japanese Ministry of Finance, approximately 20 billion yen ($151 million using the March 31, 1998 exchange rate) from AFLAC Japan to AFLAC U.S. in July 1998. 18 SHARE REPURCHASE PROGRAM During the first quarter of 1998, the Company purchased 114,216 shares of its common stock through a program conducted to facilitate the sale of odd-lot share positions. Following the purchase of 6.3 million shares in the fourth quarter of 1997, the Company was not active in purchasing AFLAC stock during the first quarter of this year. At the end of the first quarter, the Company had approximately 11.1 million shares still available for purchase under current repurchase authorizations from the board of directors. The Company has purchased 53.7 million shares (through March 31, 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 three months ended March 31, 1998 and 1997 were 37.0% and 39.5%, respectively. Japanese income taxes on AFLAC Japan's operating results, which were taxed at Japan's corporate income tax rate of 45.3%, accounted for most of the Company's income tax expense. The decline in the effective tax rates in 1998 and 1997 resulted primarily from increased earnings from the Company's U.S. business segment and the weakening of the yen. 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 15th 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-MONTH PERIOD ENDED MARCH 31, In Dollars (In millions) 1998 1997 -------------------------- Premium income......................... $ 1,180.9 $ 1,176.7 Investment income, as adjusted*........ 237.2 221.5 Other income........................... 1.0 .3 ---------- ---------- Total revenues, as adjusted*......... 1,419.1 1,398.5 ---------- ---------- Benefits and claims.................... 1,029.0 1,023.6 Operating expenses..................... 253.4 241.1 ---------- ---------- Total benefits and expenses.......... 1,282.4 1,264.7 ---------- ---------- Pretax operating earnings, as adjusted*...................... 136.7 133.8 Investment income applicable to profit repatriations.................. (11.4) (6.6) ---------- ---------- Pretax operating earnings.......... $ 125.3 $ 127.2 ========== ========== - ---------------------------------------------------------------------------- Percentage changes in dollars over previous period: Premium income....................... .4% (3.9)% Investment income*................... 7.1 (2.4) Total revenues*...................... 1.5 (3.7) Pretax operating earnings*........... 2.1 (3.2) Pretax operating earnings............ (1.5) (4.4) - ---------------------------------------------------------------------------- Percentage changes in yen over previous period: Premium income....................... 6.0% 10.2% Investment income*................... 13.0 11.9 Total revenues*...................... 7.2 10.4 Pretax operating earnings*........... 7.8 11.1 Pretax operating earnings............ 3.9 9.7 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims.................. 72.5% 73.2% Operating expenses................... 17.9 17.2 Pretax operating earnings............ 9.6 9.6 Ratio of pretax operating earnings to total reported revenues........... 8.9 9.1 - ---------------------------------------------------------------------------- *Adjusted investment income, total revenues and pretax operating earnings include estimates of additional investment income of $11.4 million in 1998 and $6.6 million in 1997, foregone due to profit repatriations. ============================================================================ 20 AFLAC JAPAN SALES The increase in premium income in yen was due to sales of new policies and excellent policy persistency. As anticipated, AFLAC Japan's sales improved during the first quarter. New annualized premium sales increased 10.3% to 15.4 billion yen, or $120.2 million. These sales results are particularly rewarding given the difficult marketing environment facing Japan's life insurers. Although AFLAC Japan just began selling its latest product offering, "Rider MAX," in the first quarter, management is pleased with its initial reception. Rider MAX, which provides consumers with accident and supplemental benefits for general hospitalization, accounted for about 17% of first quarter sales. Due to a recent increase in the copayments of Japan's national health care system, the need for this type of coverage has become increasingly apparent to the consumer. As a rider to the popular cancer life policy, Rider MAX is affordable and appealing to AFLAC Japan's customers and agents. The Company is aggressively promoting the new rider with unique television advertisements throughout Japan, and management expects this new policy's success to continue throughout the year. Cancer life policy sales also improved during the first quarter, accounting for 58.7% of new annualized premium sales. Approximately 48% of cancer life unit sales were from the economy cancer life policy introduced in January 1997. The economy plan, which has lower premium rates and benefit levels, can be effectively packaged with Rider MAX. To improve its position in the marketplace, AFLAC Japan has expanded its recruitment of individual sales agents. For the first three months of the year, AFLAC Japan recruited about 500 new agents, compared with less than 700 for the entire year of 1997. In addition, the Company also increased the use of direct-mail marketing as a means to increase the effectiveness of its agencies' sales campaigns. 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 Japan's weak economy also resulted in an extremely low level of available investment yields during the quarter. Given the depressed investment yields, investing AFLAC Japan's huge cash flows was challenging. However, by focusing on selected sectors, the Company purchased yen- denominated securities at an average yield of 4.54% during the quarter without compromising investment quality. Including dollar-denominated investments, the blended new money yield was 4.75% for the quarter. As of April 13, the Company had invested or committed to invest approximately 36% of its expected 1998 cash flow at an average yield of 4.71%. This yield compares very favorably with the yield of Japanese government bonds and provides a significant spread over the 3.5% interest assumption used in computing policy reserves for new business. At the end of the first quarter, the yield on AFLAC Japan's fixed- maturity portfolio was 5.43%, compared with 5.46% at the end of 1997. The return on average invested assets, after investment expenses, was 5.30% for the quarter, compared with 5.40% a year ago. 21 AFLAC JAPAN OTHER In March 1997, the Japanese government ratified new income tax provisions that increase income taxes on investment income and realized gains received by foreign companies operating in Japan from securities issued from their home country. The new provisions are effective for 1998. Management has mitigated some of the income tax impact on operating earnings through investment alternatives and by restructuring portions of the existing investment portfolio. Management estimates the net impact of this tax change will decrease 1998 net operating earnings by $13 million. 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 the sales proceeds of the television business, have been reclassified in the following presentation in order to improve comparability between periods. 22 AFLAC U.S. SUMMARY OF OPERATING RESULTS THREE-MONTH PERIOD ENDED MARCH 31, (In millions) 1998 1997 -------------------------- Premium income......................... $ 289.5 $ 256.8 Investment income, as adjusted*........ 26.5 23.9 Other income........................... 1.9 .4 -------- -------- Total revenues, as adjusted*......... 317.9 281.1 -------- -------- Benefits and claims.................... 182.9 160.8 Operating expenses..................... 103.6 94.6 -------- -------- Total benefits and expenses.......... 286.5 255.4 -------- -------- Pretax operating earnings, as adjusted*...................... 31.4 25.7 Investment income applicable to profit repatriations and proceeds from the sale of the television business....... 24.9 11.7 -------- -------- Pretax operating earnings.......... $ 56.3 $ 37.4 ======== ======== - ---------------------------------------------------------------------------- Percentage increases over previous period: Premium income....................... 12.7% 12.1% Investment income*................... 10.9 13.7 Total revenues*...................... 13.1 12.2 Pretax operating earnings*........... 22.2 10.2 Pretax operating earnings............ 50.3 24.8 - ---------------------------------------------------------------------------- Ratios to total revenues, as adjusted:* Benefits and claims.................. 57.5% 57.3% Operating expenses................... 32.6 33.6 Pretax operating earnings............ 9.9 9.1 Ratio of pretax operating earnings to total reported revenues........... 16.4 12.8 - ---------------------------------------------------------------------------- *Excludes estimated investment income of $24.9 million in 1998 and $11.7 million in 1997, related to investment of profit repatriation funds retained by AFLAC U.S. and investment of proceeds from the sale of the television business. ============================================================================ AFLAC U.S. SALES The increase in premium income was primarily due to an increase in new sales over the last 12 months. AFLAC U.S. again produced strong sales results. New annualized premium sales surpassed the $100 million mark for the second consecutive quarter, rising 14.5% compared with the first quarter 23 of 1997, to $108.0 million. Accident/disability insurance again generated the greatest sales, with strong contributions from cancer, intensive care and hospital indemnity coverage. The Company attributes the continued sales success in the United States to the quality and affordable premiums of the products, an effective and growing distribution system, and increasing brand awareness through a national advertising program. Management has set an objective for new policy sales to increase by 12% to 15% for the year 1998. AFLAC U.S. INVESTMENTS The increase in investment income was primarily due to the continued cash flow from operations. During the first quarter, available cash flow was invested at an average yield-to-maturity of 7.47% compared with 7.78% during the first quarter of 1997. The overall return on average invested assets, net of investment expenses, increased slightly for the first three months of 1998 compared with the first quarter of 1997, to 7.37% from 7.28%. AFLAC U.S. OTHER In April 1998, the Company began selling cancer expense insurance in New York. There are still two other states that 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. These states are Massachusetts and New Jersey. 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 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. Management expects the pretax operating profit margin, which was 9.3% for the year 1997 excluding the effect of repatriation, to increase slightly in 1998. 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. 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. 24 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 March 31, 1998, was 132.10 yen to one U.S. dollar, 1.5% 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 $282.2 million, total assets by $337.7 million, and total liabilities by $323.3 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: March 31, December 31, (In millions) 1998 1997 % Change --------- ------------ -------- AFLAC U.S.: Total investments and cash, at cost or amortized cost $ 2,755 $ 2,678 2.8% Unrealized gains on securities available for sale 232 228 ---------- ---------- Total investments and cash $ 2,987 $ 2,906 2.8% ========== ========== ======== AFLAC Japan: Total investments and cash, at cost or amortized cost $ 16,816 $ 16,743 .4% Unrealized gains on securities available for sale 3,096 3,155 ---------- ---------- Total investments and cash $ 19,912 $ 19,898 .1% ========== ========== ========= Consolidated: Total investments and cash, at cost or amortized cost $ 19,642 $ 19,497 .7% Unrealized gains on securities available for sale 3,329 3,383 ---------- ---------- Total investments and cash $ 22,971 $ 22,880 .4% ========== ========== ========= Net unrealized gains of $3.3 billion on securities available for sale at March 31, 1998 consisted of $3.4 billion in gross unrealized gains and $33.0 million in gross unrealized losses. 25 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: March 31, 1998 December 31, 1997 -------------- ----------------- AAA 36.2% 38.3% AA 19.9 20.5 A 30.3 28.9 BBB 13.6 12.3 ----- ----- 100.0% 100.0% The Company does not hold any securities rated below BBB. Private placement investments accounted for 38.2% and 36.3% of the Company's total fixed-maturity securities available for sale as of March 31, 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. The Company's purchases in the private placement market are often done through Euro medium-term note programs. Securities in these programs are more marketable due to standardized documentation and relatively wide distribution. All of the Company's private placement investments are rated as Class 1 or 2 by the Securities Valuation Office of the National Association of Insurance Commissioners. POLICY LIABILITIES Policy liabilities increased $298.7 million, or 1.5%, during the first three months of 1998. AFLAC Japan increased $238.8 million, or 1.3% (2.9% increase in yen), and AFLAC U.S. increased $58.1 million, or 3.1%. Management estimates the weaker yen rate decreased reported policy liabilities by $279.7 million. Items that offset this decrease in policy liabilities caused by the weaker yen are the addition of new business and the aging of policies in force. The effect of market value adjustments on fixed-maturity securities also caused a decrease in policy liabilities (see Note 6 of Notes to the Consolidated Financial Statements). DEBT See Note 5 of the Notes to the Consolidated Financial Statements for information on debt outstanding at March 31, 1998. The Company's ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized gains on securities available for sale) was 18.5% and 19.6% as of March 31, 1998 and December 31, 1997, respectively. 26 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 $.3 million for the three months ended March 31, 1998 and by approximately $1.5 million for the year 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 has pledged investment securities to the Life Insurance Association of Japan for this program. During the first quarter of 1998, the Japanese Ministry of Finance and the Life Insurance Association of Japan agreed upon a new mandatory policyholder protection fund system. The life insurance industry will be required to contribute 490 billion yen ($3.7 billion using the March 31, 1998 exchange rate) over a 10-year period. The total liability recorded in the Consolidated Balance Sheets for the Company's share of both the voluntary and mandatory funds is $136.8 million at March 31, 1998. (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 AFLAC Broadcast Division has increased the Company's capital resources. Management believes outside sources 27 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. 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 $11.2 million in the first quarter of 1998 and $386.0 million and $253.6 million in the full years 1997 and 1996, respectively. Profit repatriations have been remitted annually from AFLAC Japan to AFLAC U.S. in July. During the last few years, 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) 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 1999. One change is the requirement that insurance companies establish a deferred income tax liability for statutory accounting purposes. Management estimates AFLAC's deferred tax liability under the provisions of the project is approximately $180 million at December 31, 1997 using SAP. The capital and surplus of AFLAC, as determined on a U.S. statutory accounting basis, was $1.8 billion at December 31, 1997. YEAR 2000 The use of computer programs that rely on two digit date fields to perform computations and decision making functions may cause computer systems to malfunction when processing information involving dates after 1999. If this were to occur, disruptions in premium and claim processing could occur. The Company is currently in the process of converting and testing the changes necessary to be year-2000 compliant. Based on its current assessment, the Company estimates the total remaining cost of the year 2000 system conversion project to be approximately $4 million. Management expects the year 2000 efforts to be completed on a timely basis. For additional information, see the Year 2000 System Conversion Costs section of the Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's annual report to shareholders for the year ended December 31, 1997. 28 OTHER On May 4, 1998, the board of directors approved an increase in the quarterly cash dividend from $.058 to $.065 per share. The increase is effective with the second quarter dividend, which is payable on June 1, 1998, to shareholders of record at the close of business on May 21, 1998. 29 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 fixed- maturity securities resulting from a 100 basis point increase in market interest rates is estimated to be $2.0 billion based on the Company's portfolio as of March 31, 1998. The effect on yen-denominated fixed- maturity securities is approximately $1.6 billion and the effect on dollar- denominated fixed-maturity securities is approximately $329.2 million. The Company has outstanding interest rate swaps on all 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. Therefore, there was no effect on earnings due to changes in market interest rates. 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 March 31, 1998, totaled $167.0 million, or .7% 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 .95. 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 9.5%, or $15.9 million. 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. 30 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. 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 (March 31, 1998) 117.10 132.10* 147.10 (In millions) Yen Yen Yen - ---------------------------------------------------------------------------- Yen-denominated financial instruments: Assets: Fixed-maturity securities $20,603.2 $18,263.7 $16,401.3 Cash and cash equivalents 86.1 76.3 68.6 Securities held as collateral 1,159.5 1,027.9 923.1 Other financial instruments 21.2 18.8 16.8 -------- -------- -------- Total 21,870.0 19,386.7 17,409.8 -------- -------- -------- Liabilities: Securities held as collateral 1,159.5 1,027.9 923.1 Notes payable 553.4 490.5 440.5 -------- -------- -------- Total 1,712.9 1,518.4 1,363.6 -------- -------- -------- Net yen-denominated financial instruments 20,157.1 17,868.3 16,046.2 Other yen-denominated assets 2,913.9 2,583.0 2,319.6 Other yen-denominated liabilities (primarily policy and claim reserves) (22,565.4) (20,003.1) (17,963.4) -------- -------- -------- Total yen-denominated net assets subject to foreign currency fluctuation $ 505.6 $ 448.2 $ 402.4 ======== ======== ======== *Actual March 31, 1998 rate. For information regarding the effect of foreign currency translation on operating earnings per share, see Foreign Currency Translation on page 17. 31 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 developments, 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 and fluctuations in foreign currency exchange rates. 32 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. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of the Shareholders was held on May 4, 1998. Matters submitted to the shareholders were: (1) Election of 17 members to the board of directors; (2) Ratification of the selection of auditors for 1998. The two proposals were approved by the shareholders. Following is a summary of each vote cast for, against or withheld, as well as the number of abstention and broker non-votes, as to each such matter, including a separate tabulation with respect to each nominee for office. These votes have not been adjusted to reflect the two-for-one stock split declared May 4, 1998. VOTES --------------------------------------------------- Absten- With- Broker For Against tions held Non-Votes ---------------------------------------------------- (1) Election of 17 members to the board of directors: Paul S. Amos 265,461,388 N/A N/A 1,295,995 153,421 Daniel P. Amos 265,607,863 N/A N/A 1,149,520 153,421 J. Shelby Amos, II 265,641,257 N/A N/A 1,116,126 153,421 Michael H. Armacost 263,924,336 N/A N/A 2,833,047 153,421 M. Delmar Edwards, M.D. 265,516,056 N/A N/A 1,241,327 153,421 George W. Ford, Jr. 265,461,166 N/A N/A 1,296,217 153,421 Joe Frank Harris 265,183,549 N/A N/A 1,573,834 153,421 Elizabeth J. Hudson 265,609,440 N/A N/A 1,147,943 153,421 Kenneth S. Janke, Sr. 265,729,322 N/A N/A 1,028,061 153,421 Charles B. Knapp 265,665,232 N/A N/A 1,092,151 153,421 Hisao Kobayashi 265,687,116 N/A N/A 1,070,267 153,421 Yoshiki Otake 265,684,359 N/A N/A 1,073,024 153,421 E. Stephen Purdom 265,611,276 N/A N/A 1,146,107 153,421 Barbara K. Rimer 265,649,073 N/A N/A 1,108,310 153,421 Henry C. Schwob 265,523,990 N/A N/A 1,233,393 153,421 J. Kyle Spencer 265,431,802 N/A N/A 1,325,581 153,421 Glenn Vaughn, Jr. 265,551,712 N/A N/A 1,205,671 153,421 33 VOTES --------------------------------------------------- Absten- With- Broker For Against tions held Non-Votes ---------------------------------------------------- (2) Ratification of appointment of KPMG Peat Marwick LLP as independent auditors 265,379,409 926,363 605,030 N/A None 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 March 31, 1998. Items other than those listed above are omitted because they are not required or are not applicable. 34 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 May 12, 1998 /s/ KRISS CLONINGER, III ------------------------ --------------------------- KRISS CLONINGER,III Executive Vice President; Treasurer and Chief Financial Officer Date May 12, 1998 /s/ NORMAN P. FOSTER ------------------------ --------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 35 EXHIBITS FILED WITH CURRENT FORM 10-Q: 27.0 - Financial Data Schedule (for SEC use only). 36 EX-27 2 3/98 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 March 31, 1998, and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 22,597,866 0 0 166,954 12,626 0 22,825,382 145,395 0 2,603,945 27,528,228 19,706,916 277,768 0 199,036 511,186 0 0 15,855 3,437,842 27,528,228 1,472,399 278,563 183 5,881 1,213,924 47,464 442,114 53,524 (106,878) 160,402 0 0 0 160,402 .60 .58 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 payable June 8, 1998. Prior year financial data schedules have not been restated.
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