-----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, Hvf8mQK+deLzUZnIMNFwyV+PrFX2s5NQR1tT/sa29l5W8Zwat+BpYKi/IvaCWXyB i/YT1B/rgRGiie9uZn9W+A== 0000004977-99-000019.txt : 19990513 0000004977-99-000019.hdr.sgml : 19990513 ACCESSION NUMBER: 0000004977-99-000019 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990512 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: 99618180 BUSINESS ADDRESS: STREET 1: 1932 WYNNTON RD CITY: COLUMBUS STATE: GA ZIP: 31999 BUSINESS PHONE: 7063233431 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, 1999 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 4, 1999 - ---------------------------- ------------------ Common Stock, $.10 Par Value 267,201,404 shares AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - March 31, 1999 and December 31, 1998................... 1 Consolidated Statements of Earnings - Three Months Ended March 31, 1999 and 1998.............. 3 Consolidated Statements of Shareholders' Equity - Three Months Ended March 31, 1999 and 1998.............. 4 Consolidated Statements of Cash Flows - Three Months Ended March 31, 1999 and 1998.............. 5 Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 1999 and 1998.............. 7 Notes to Consolidated Financial Statements................ 8 Review by Independent Certified Public Accountants............................................. 15 Independent Auditors' Report.............................. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 17 Item 3. Quantitative and Qualitative Disclosures about Market Risk......................................... 32 Part II. Other Information: Item 1. Legal Proceedings.................................. 36 Item 4. Submission of Matters to a Vote of Security Holders....................................... 36 Item 6. Exhibits and Reports on Form 8-K................... 37 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 millions) March 31, December 31, 1999 1998 (Unaudited) ----------- ------------ ASSETS: Investments and cash: Securities available for sale, at fair value: Fixed maturities (amortized cost, $15,779 in 1999 and $15,658 in 1998) $ 17,873 $ 17,617 Perpetual debentures (amortized cost, $1,826 in 1999 and $1,455 in 1998) 1,730 1,366 Equity securities (cost, $102 in 1999 and $101 in 1998) 180 177 Securities held to maturity, at amortized cost: Fixed maturities (fair value, $3,686 in 1999 and $3,691 in 1998) 3,803 3,947 Perpetual debentures (fair value, $3,091 in 1999 and $3,131 in 1998) 3,344 3,494 Mortgage loans and other 9 9 Short-term investments 9 10 Cash and cash equivalents 269 374 -------- -------- Total investments and cash 27,217 26,994 Receivables, primarily premiums 230 229 Receivables for security transactions 25 43 Accrued investment income 279 316 Deferred policy acquisition costs 3,040 3,067 Property and equipment, at cost less accumulated depreciation 450 427 Other 108 107 -------- -------- Total assets $ 31,349 $ 31,183 ======== ======== See the accompanying Notes to Consolidated Financial Statements. (continued)
1 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In millions, except for share and per-share amounts)
March 31, December 31, 1999 1998 (Unaudited) ----------- ----------- Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 22,119 $ 22,218 Unpaid policy claims 1,305 1,263 Unearned premiums 306 309 Other policyholders' funds 246 244 -------- -------- Total policy liabilities 23,976 24,034 Notes payable 573 596 Income taxes 1,733 1,865 Payables for security transactions 437 173 Other 771 745 -------- -------- Total liabilities 27,490 27,413 -------- -------- Shareholders' equity: Common stock of $.10 par value. In thousands: authorized 400,000 shares; issued 318,570 shares in 1999 and 317,971 shares in 1998 32 32 Additional paid-in capital 241 235 Retained earnings 3,040 2,862 Accumulated other comprehensive income: Unrealized foreign currency translation gains 214 219 Unrealized gains on investment securities 1,243 1,332 Treasury stock, at average cost (910) (910) Notes receivable for stock purchases (1) - -------- -------- Total shareholders' equity 3,859 3,770 -------- -------- Total liabilities and shareholders' equity $ 31,349 $ 31,183 ======== ======== Shareholders' equity per share $ 14.47 $ 14.19 ======== ======== See the accompanying Notes to Consolidated Financial Statements.
2 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings
(In millions, except for share and Three Months Ended March 31, per-share amounts - Unaudited) ---------------------------- 1999 1998 -------- -------- Revenues: Premiums, principally supplemental health insurance $ 1,728 $ 1,472 Net investment income 320 279 Realized investment gains (losses) (5) - Other income 5 6 ------- ------- Total revenues 2,048 1,757 ------- ------- Benefits and expenses: Benefits and claims 1,400 1,214 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 57 47 Insurance commissions 226 192 Insurance expenses 142 118 Provision for mandated policyholder protection fund - 111 Interest expense 4 3 Other operating expenses 16 19 ------- ------- Total acquisition and operating expenses 445 490 ------- ------- Total benefits and expenses 1,845 1,704 ------- ------- Earnings before income taxes 203 53 Income tax expense (benefit): Operations 74 14 Deferred tax benefit from Japanese tax rate reductions (67) (121) ------- ------- Total income taxes 7 (107) ------- ------- Net earnings $ 196 $ 160 ======= ======= Net earnings per share: Basic $ .74 $ .60 Diluted .71 .58 ======= ======= Shares used in computing earnings per share (In thousands): Basic 266,115 266,831 Diluted 276,769 276,294 ======= ======= Cash dividends per share $ .065 $ .058 ======= ======= See the accompanying Notes to Consolidated Financial Statements.
3 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity
(In millions, except for per-share amounts - Unaudited) Three Months Ended March 31, ---------------------------- 1999 1998 ------ ------ Common Stock: Balance at beginning and end of period $ 32 $ 16 ------ ------ Additional paid-in capital: Balance at beginning of year 235 227 Exercise of stock options 3 3 Gain on treasury stock reissued 3 2 ------ ------ Balance at end of period 241 232 ------ ------ Retained earnings: Balance at beginning of year 2,862 2,442 Net earnings 196 160 Cash dividends ($.065 per share in 1999 and $.058 in 1998) (18) (14) ------ ------ Balance at end of period 3,040 2,588 ------ ------ Accumulated other comprehensive income: Balance at beginning of year 1,551 1,559 Change in unrealized foreign currency translation gains during period, net of income taxes (5) (44) Unrealized gains (losses) on investment securities during period, net of income taxes and reclassification adjustments (89) (83) ------ ------ Balance at end of period 1,457 1,432 ------ ------ Treasury stock: Balance at beginning of year (910) (813) Purchases of treasury stock (11) (7) Cost of shares issued 11 8 ------ ------ Balance at end of period (910) (812) ------ ------ Notes receivable for stock purchases (1) (2) ------ ------ Total shareholders' equity $ 3,859 $ 3,454 ====== ====== See the accompanying Notes to Consolidated Financial Statements.
4 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In millions - Unaudited)
Three Months Ended March 31, ---------------------- 1999 1998 ------ ------ Cash flows from operating activities: Net earnings $ 196 $ 160 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 620 570 Deferred income taxes (41) (161) Change in income taxes payable (73) (47) Increase in deferred policy acquisition costs (69) (53) Change in receivables and advance premiums 2 5 Depreciation and amortization expense 7 7 Provision for mandated policyholder protection fund - 111 Other, net 53 29 ------ ------ Net cash provided by operating activities 695 621 ------ ------ Cash flows from investing activities: Proceeds from investments sold or matured: Securities available for sale: Fixed-maturity securities sold 279 302 Fixed-maturity securities matured 63 162 Equity securities 16 10 Securities held to maturity: Fixed-maturity securities matured 9 - Mortgage loans and other investments, net - 1 Short-term investments, net 1 - Costs of investments acquired: Securities available for sale: Fixed-maturity securities (648) (869) Perpetual debentures (434) (278) Equity securities (19) (17) Securities held to maturity: Fixed-maturity securities (42) - Short-term investments, net - (2) Additions to property and equipment, net (3) (6) ------ ------ Net cash used by investing activities $ (778) $ (697) ------ ------ (continued)
5 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In millions - Unaudited)
Three Months Ended March 31, ---------------------- 1999 1998 ------ ------ Cash flows from financing activities: Principal payments under debt obligations $ (3) $ (5) Dividends paid to shareholders (18) (14) Purchases of treasury stock (11) (7) Treasury stock reissued 14 10 Other, net 5 1 ------ ------ Net cash used by financing activities (13) (15) ------ ------ Effect of exchange rate changes on cash and cash equivalents (9) - ------ ------ Net change in cash and cash equivalents (105) (91) Cash and cash equivalents, beginning of year 374 236 ------ ------ Cash and cash equivalents, end of period $ 269 $ 145 ====== ====== Supplemental disclosures of cash flow information: Cash payments during the period for: Interest on debt obligations $ 3 $ 3 Income taxes 139 103 See the accompanying Notes to Consolidated Financial Statements.
6 AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (In millions - Unaudited)
Three Months Ended March 31, ---------------------- 1999 1998 ------ ------ Net earnings $ 196 $ 160 ------ ------ Other comprehensive income, before income taxes: Foreign currency translation adjustments: Change in unrealized foreign currency translation gains during the period 24 7 Unrealized gains (losses) on investment securities: Unrealized holding gains (losses) arising during the period (95) (48) Reclassification adjustment for realized (gains) losses included in net earnings 4 (1) ------ ------ Total other comprehensive income, before income taxes (67) (42) Income tax expense related to items of other comprehensive income 27 85 ------ ------ Other comprehensive income, net of income taxes (94) (127) ------ ------ Total comprehensive income $ 102 $ 33 ====== ======
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, 1999, and the results of operations and statements of cash flows, shareholders' equity and comprehensive income for the three months ended March 31, 1999 and 1998. Results of operations for interim periods are not necessarily indicative of results for the entire year. We prepare our financial statements in accordance with generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants. The preparation of financial statements in conformity with GAAP requires us to make estimates when recording transactions resulting from business operations, based on information currently available. The most significant items on our balance sheet that involve a greater degree of accounting and actuarial estimates subject to changes in the future are: deferred policy acquisition costs, liabilities for future policy benefits and unpaid policy claims, accrued liabilities for unfunded retirement plans 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, we believe the amounts provided are adequate. The financial statements should be read in conjunction with the financial statements included in our annual report to shareholders for the year ended December 31, 1998. 2. Accounting Pronouncements We adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information in 1998. 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 was effective for financial statements issued for annual periods beginning in 1998 and for interim periods beginning in 1999. The required interim period information is presented in Note 3. On January 1, 1999, we adopted Statement of Position (SOP) 97-3, Accounting by Insurance and Other Enterprises for Insurance Related Assessments. 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. There was no effect on net earnings or shareholders' equity due to our adoption of this SOP since our previous accounting method for guaranty fund and other insurance related assessments conformed to the requirements of this SOP. 8 We also adopted SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, on January 1, 1999. 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, we have expensed all such costs as they were incurred. The adoption of this SOP had no material effect on net earnings for the three months ended March 31, 1999. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued in June 1998. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in investment securities and other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative will be included in either earnings or other comprehensive income depending on the intended use of the derivative instrument. We are currently evaluating this standard, which is effective January 1, 2000. 9 3. Segment Information Information regarding components of operations for the three months ended March 31 follows: (In millions) 1999 1998 -------- -------- Total revenues: AFLAC Japan: Earned premiums $ 1,398 $ 1,181 Net investment income 262 226 Other income - 1 ------- ------- Total AFLAC Japan revenues 1,660 1,408 ------- ------- AFLAC U.S.: Earned premiums 330 289 Net investment income 58 51 Other income - 3 ------- ------- Total AFLAC U.S. revenues 388 343 ------- ------- All other business segments 7 7 ------- ------- Total business segments 2,055 1,758 Realized investment gains (losses) (5) - Corporate 7 8 Intercompany eliminations (9) (9) ------- ------- Total $ 2,048 $ 1,757 ======= ======= Earnings before income taxes: AFLAC Japan $ 158 $ 125 AFLAC U.S. 63 56 All other business segments 1 - ------- ------- Total business segments 222 181 Provision for the Japanese mandated policyholder protection fund - (111) Realized investment gains (losses) (5) - Interest expense, non-insurance operations (3) (3) Corporate (11) (14) ------- ------- Total $ 203 $ 53 ======= ======= 4. Japanese Income Taxes At the end of March 1999, the Japanese government reduced the Japanese corporate income tax rate from 41.7% to 36.2%, which increased net earnings for the first quarter of 1999 by $67 million ($.25 per basic share, $.24 per diluted share) from the reduction of our consolidated deferred income tax liability as of March 31, 1999. This was the net effect of recalculating Japanese deferred income taxes at the new 36.2% rate on the temporary differences between the financial reporting basis of AFLAC Japan's assets and liabilities reduced by the limitations in the U.S. foreign tax credit provisions. 10 At the end of March 1998, the Japanese government reduced the Japanese corporate income tax rate from 45.3% to 41.7%, which increased net earnings for the first quarter of 1998 by $121 million ($.45 per basic share, $.44 per diluted share) from the reduction of AFLAC Japan's deferred income tax liability. The deferred tax reduction represented the effect of recalculating Japanese deferred income taxes at the 41.7% rate on the temporary differences between the financial reporting basis and the Japanese income tax basis of AFLAC Japan's assets and liabilities. The 1998 rate reduction for AFLAC Japan was effective May 1, 1998 for purposes of calculating income tax expense on operating earnings and the 1999 rate reduction is effective April 1, 1999. 5. Policyholder Protection Fund During the first quarter of 1998, the Japanese government enacted a mandatory policyholder protection fund system. The life insurance industry is required to contribute $4.1 billion to this fund over a 10-year period. The total charge for our share of the contribution obligation was recognized in the first quarter of 1998 and decreased pretax earnings by $111 million for the three months ended March 31, 1998. The after-tax charge was $65 million, or $.24 per basic and diluted share. 6. Notes Payable A summary of notes payable is as follows: March 31, December 31, (In millions) 1999 1998 ---------- ------------ Unsecured, yen-denominated notes payable to banks: Reducing, revolving credit agreement, due annually through July 2001: 2.29% fixed interest rate $ 282 $ 294 Variable interest rate (.93% at March 31, 1999) 32 35 Revolving credit agreement due November 2002: 1.24% fixed interest rate 129 134 Variable interest rate (.95% at March 31, 1999) 112 115 Obligations under capitalized leases, due monthly through 2003, secured by computer equipment in Japan 18 18 ----- ----- Total notes payable $ 573 $ 596 ===== ===== We have 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 $325 million. Under the terms of the agreement, the borrowing limit will reduce to $250 million on July 15, 1999, and $125 million on July 15, 2000. At March 31, 1999, 34.1 billion yen ($282 million) was outstanding at a fixed interest rate and 3.8 billion yen ($32 million) was outstanding at a variable interest rate under this agreement. 11 We also have an unsecured revolving credit agreement that provides for bank borrowings through November 2002 with a borrowing limit of $250 million, payable in either U.S. dollars or Japanese yen. At March 31, 1999, 15.5 billion yen ($129 million) was outstanding at a fixed interest rate and 13.5 billion yen ($112 million) was outstanding at a variable interest rate under this agreement. We have outstanding interest rate swaps on a portion of our variable interest rate yen-denominated borrowings (49.6 billion yen). These swaps reduce the impact of changes in interest rates on our borrowing costs and effectively change our interest rate from variable to fixed. The interest rate swaps have notional principal amounts that equal the anticipated unpaid principal amounts. Under these agreements, we make fixed rate payments at 2.29% on one loan and 1.24% on another loan and receive floating rate payments (.19% at March 31, 1999 plus loan costs of 25 or 20 basis points, respectively) based on the three-month Tokyo Interbank Offered Rate. We have designated our yen-denominated borrowings as a hedge of our net investment in AFLAC Japan. Foreign currency translation gains/losses are included in accumulated other comprehensive income. 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. On April 21, 1999, we issued $450 million of senior notes with a 6.50% coupon, paid semiannually, due April 15, 2009. The notes are redeemable at our option and at any time at a redemption price equal to the principal amount of the notes being redeemed plus a make-whole amount. We received net proceeds of $445 million. We intend to use the proceeds primarily to purchase shares of our common stock. Any remaining proceeds may be used to repay indebtedness or for general corporate purposes. We intend to swap the dollar-denominated principal and interest to be yen-denominated. 7. Unrealized Gains on Investment Securities On October 1, 1998, we reclassified certain debt securities from "available for sale" to "held to maturity." The related net unrealized gains and losses at the date of transfer on these securities are being amortized over the remaining term of the securities. These unamortized net unrealized gains and losses, plus the net unrealized gains and losses on securities available for sale, less amounts applicable to policy liabilities and deferred income taxes, are reported in accumulated other comprehensive income. The portion of unrealized gains credited to policy liabilities represents gains that would not inure to the benefit of 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. 12 The net effect on shareholders' equity of unrealized gains and losses from investment securities at the following dates was: (In millions) March 31, December 31, 1999 1998 ------------ ------------ Unrealized gains on securities available for sale $ 2,076 $ 1,946 Unamortized unrealized gains on securities transferred to held to maturity 1,149 1,224 Less: Policy liabilities 1,032 885 Deferred income taxes 950 953 --------- --------- Shareholders' equity, net unrealized gains on investment securities $ 1,243 $ 1,332 ========= ========= 8. Security Lending AFLAC Japan uses short-term security lending arrangements to increase investment income with minimal risk. At March 31, 1999 and December 31, 1998 we had security loans outstanding in the amounts of $543 million and $3.0 billion at fair value, respectively. At March 31, 1999, and December 31, 1998, we held Japanese government bonds as collateral for loaned securities in the amounts of $547 million and $3.1 billion, at fair value. Our security lending policy requires that the fair value of the securities received as collateral be 105% or more of the fair value of the loaned securities as of the date the securities are loaned and not less than 100% thereafter. 13 9. Common Stock The following is a reconciliation of the number of shares of our common stock for the three months ended March 31: (In thousands of shares) 1999 1998 ---------- ---------- Common stock - issued: Balance at beginning of year 317,971 316,380 Exercise of stock options 599 717 -------- -------- Balance at end of period 318,570 317,097 -------- -------- Treasury stock: Balance at beginning of year 52,287 49,944 Purchases of treasury stock: Open market 150 114 Received from employees for taxes on stock option exercises 98 139 Shares issued to sales associates stock bonus plan and dividend reinvestment plan (191) (280) Exercise of stock options (429) (201) -------- -------- Balance at end of period 51,915 49,716 -------- -------- Shares outstanding at end of period 266,655 267,381 ======== ======== 10. Litigation We are 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, we believe the outcome of pending litigation will not have a material adverse effect on our financial position. 14 REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The March 31, 1999 and 1998 financial statements included in this filing have been reviewed by KPMG LLP, independent certified public accountants, in accordance with established professional standards and procedures for such a review. The report of KPMG LLP commenting upon their review is included on page 16. 15 KPMG 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, 1999, and the related consolidated statements of earnings for the three-month periods ended March 31, 1999 and 1998, and the consolidated statements of shareholders' equity, cash flows and comprehensive income for the three-month periods ended March 31, 1999 and 1998. 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, 1998, 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 28, 1999, we expressed an unqualified opinion on those consolidated financial statements. KPMG LLP Atlanta, GA April 27, 1999 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AFLAC Incorporated is the parent company of American Family Life Assurance Company of Columbus, AFLAC. Our principal business is supplemental health insurance, which is marketed and administered through AFLAC. Most of AFLAC's policies are individually underwritten and marketed at worksites through independent agents, with premiums paid by the employee. Our operations in Japan (AFLAC Japan) and the United States (AFLAC U.S.) service the two markets for our insurance operations. RESULTS OF OPERATIONS Due to a corporate income tax rate reduction in Japan during 1999, the statutory tax rate for AFLAC Japan declined from 41.7% to 36.2%. This tax rate decline resulted in a reduction in our deferred income tax liability as of March 31, 1999, which increased net earnings by $67 million ($.25 per basic share and $.24 per diluted share) in 1999. For additional information on the income tax reduction, see Note 4 of the Notes to the Consolidated Financial Statements. Also, due to a corporate income tax rate reduction in Japan during 1998, the statutory tax rate for AFLAC Japan declined from 45.3% to 41.7%. This tax rate decline resulted in a reduction in our deferred income tax liability as of March 31, 1998, which increased net earnings by $121 million ($.45 per basic share and $.44 per diluted share) in 1998. For additional information on the income tax reduction, see Note 4 of the Notes to the Consolidated Financial Statements. Another factor affecting net earnings was a policyholder protection fund system mandated by the Japanese government during the first quarter of 1998. The pretax charge for our obligation to the protection fund was $111 million ($65 million after tax, or $.24 per both basic and diluted shares). For further information regarding this policyholder protection fund, see Note 5 of the Notes to the Consolidated Financial Statements. 17 The following table sets forth the results of operations by business segment for the periods shown. SUMMARY OF OPERATING RESULTS BY BUSINESS SEGMENT (In millions, except for per-share amounts) Percentage Change Three Months Over Previous Ended March 31, Period 1999 1998 ----------------- ------------------ Operating earnings: AFLAC Japan....................... 26.2% $ 158 $ 125 AFLAC U.S......................... 11.4 63 56 All other business segments....... 1 - ----- ----- Total business segments......... 22.3 222 181 Interest expense, non-insurance operations........ 2.4 (3) (3) Corporate and eliminations........ 16.5 (12) (13) ----- ----- Pretax operating earnings....... 26.0 207 165 Income taxes...................... 23.8 75 61 ----- ----- Operating earnings.............. 27.3 132 104 Non-operating items: Deferred tax benefit from Japan tax rate reduction.............. 67 121 Provision for the Japanese mandated policyholder protection fund, net of tax..... - (65) Realized investment gains (losses), net of tax............ (3) - ----- ----- Net earnings.................... 21.9 $ 196 $ 160 ===== ===== Operating earnings per basic share.. 28.2 $ .50 $ .39 Operating earnings per diluted share 26.3 .48 .38 ===== ===== Net earnings per basic share........ 23.3 $ .74 $ .60 Net earnings per diluted share...... 22.4 .71 .58 ===== ===== ============================================================================ The following discussion of earnings comparisons focuses on operating earnings and excludes realized investment gains/losses, the charge for the mandated policyholder protection fund, and the deferred income tax benefit from the Japanese tax rate reductions. Operating earnings per share referred to in the following discussion are based on the diluted number of average outstanding shares. FOREIGN CURRENCY TRANSLATION Due to the relative size of AFLAC Japan, fluctuations in the yen/dollar exchange rate can have a significant effect on our reported results. 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. 18 The following table illustrates the effect of foreign currency translation on our reported results by comparing those results as if foreign currency rates had remained unchanged from the comparable period in the prior year. AFLAC Incorporated and Subsidiaries Selected Percentage Changes for Supplemental Consolidated Data* Three Months Ended March 31, 1999 Including Excluding Currency Currency Changes Changes** ----------- ----------- Premium income 17.4% 8.8% Net investment income 14.8 8.1 Operating revenues 16.8 8.6 Total benefits and expenses 15.9 7.4 Operating earnings 27.3 22.2 Operating earnings per share 26.3 21.1 - ---------------------------------------------------------------------------- * The numbers in this table are presented on an operating basis and there- fore exclude: the deferred income tax benefit from the tax rate reductions, the charge for a mandated 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 began to strengthen in relation to the dollar at the end of 1998 after several years of weakening. The average yen-to-dollar exchange rates were 116.58 and 128.09 for the three months ended March 31, 1999 and 1998, respectively. The 9.9% strengthening of the yen in 1999 increased operating earnings by approximately $.02 per share for the three months ended March 31, 1999. Operating earnings per share increased 26.3% to $.48 for the three-month period ended March 31, 1999 compared with the same period in 1998. Our primary financial objective is the growth of operating earnings per share before the effect of foreign currency fluctuations. In 1996, we set this objective at an annual growth rate of 15% to 17% through the year 2000. In 1998, we raised our 1999 objective for growth in operating earnings per share to 20% before the effect of currency translation. 19 If that objective is achieved, the following table shows the likely results for operating earnings per share for the year 1999 when the estimated impact from various foreign currency translations are included. Annual Average Yen Annual Operating % Growth Yen Impact Exchange Rate Diluted EPS Over 1998 on EPS ------------- ---------------- --------- ---------- 1999 @ 115.00 $ 2.00 28.2% $ .13 1999 @ 120.00 1.95 25.0 .08 1999 @ 125.00 1.91 22.4 .04 1999 @ 130.89* 1.87 19.9 - 1999 @ 135.00 1.84 17.9 (.03) 1999 @ 140.00 1.82 16.7 (.05) 1999 @ 145.00 1.79 14.7 (.08) *Actual exchange rate for the year ended December 31, 1998. If the exchange rate as of March 31, 1999, would remain constant for the remainder of 1999, the cumulative average rate would be approximately 119.56 and the annual operating diluted earnings per share would approximate $1.96, assuming our earnings objective is met. PROFIT REPATRIATION AFLAC Japan repatriated profits to AFLAC U.S. of $154 million in 1998 and $347 million in 1997. The profit transfer in 1997 included $125 million of a non-recurring nature. Since the first repatriation in 1989, AFLAC Japan has repatriated $1.2 billion, which has enhanced our flexibility and profitability. We expect to repatriate approximately 19 billion yen ($160 million using the March 31, 1999 exchange rate) from AFLAC Japan to AFLAC U.S. in July 1999. SHARE REPURCHASE PROGRAM During the first quarter of 1999, we purchased 150,000 shares of our common stock. At the end of the first quarter of 1999, we had approximately 7.2 million shares still available for purchase under current repurchase authorizations. We have purchased 57.5 million shares (through March 31, 1999) since the inception of the share repurchase program. The difference in percentage increases in net earnings and net earnings per share primarily reflects the impact of the share repurchase program. INCOME TAXES Our combined U.S. and Japanese effective income tax rates on operating earnings for the three months ended March 31, 1999 and 1998 were 36.4% and 37.0%, respectively. Japanese income taxes on AFLAC Japan's operating results, which were taxed at Japan's corporate income tax rate of 45.3% through April 30, 1998, and 41.7% thereafter, accounted for most of our income tax expense. The decline in the effective tax rate in 1999 resulted primarily from the 1998 Japanese tax rate reduction. Income tax expense for the first quarter of 1999 also includes approximately $2 million of additional taxes from our recent income tax audit in Japan. Excluding that amount the effective income tax rate on operating earnings for the first quarter was 35.4%, the same as the rate for the full year 1998. 20 The 1999 reduction in the statutory tax rate in Japan, which is effective April 1, 1999, will not significantly change our combined U.S./Japan effective tax rate as it will largely shift income tax expense from Japan operations to U.S. operations due to the U.S. foreign tax credit provisions. We expect our effective income tax rate for financial statement purposes will be in the range of 35% to 36% for the full year 1999. INSURANCE OPERATIONS, AFLAC JAPAN AFLAC Japan, a branch of AFLAC and the principal contributor to our 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 second in terms of individual policies in force and 16th in assets. 21 The following table presents a summary of AFLAC Japan's operating results. AFLAC JAPAN SUMMARY OF OPERATING RESULTS THREE-MONTH PERIOD ENDED MARCH 31, (In millions) 1999 1998 --------------------------- Premium income......................... $ 1,398 $ 1,181 Investment income...................... 262 226 Other income........................... - 1 -------- -------- Total revenues....................... 1,660 1,408 -------- -------- Benefits and claims.................... 1,196 1,029 Operating expenses..................... 306 254 -------- -------- Total benefits and expenses.......... 1,502 1,283 -------- -------- Pretax operating earnings.......... $ 158 $ 125 ======== ======== - ---------------------------------------------------------------------------- Percentage changes in dollars over previous period: Premium income....................... 18.4% .4% Investment income.................... 15.8 5.1 Total revenues....................... 17.9 1.1 Pretax operating earnings............ 26.2 (1.5) - ---------------------------------------------------------------------------- Percentage changes in yen over previous period: Premium income....................... 7.8% 6.0% Investment income.................... 5.5 10.9 Total revenues....................... 7.3 6.8 Pretax operating earnings............ 15.0 3.9 - ---------------------------------------------------------------------------- Ratios to total revenues: Benefits and claims.................. 72.0% 73.1% Operating expenses................... 18.5 18.0 Pretax operating earnings............ 9.5 8.9 ============================================================================ AFLAC JAPAN SALES The increase in premium income in yen was due to sales of new policies and excellent policy persistency. AFLAC Japan's new annualized premium sales were up sharply in the quarter, rising 22.3% to 18.8 billion yen, or $161 million. These strong sales resulted from the popularity of our latest product offering, Rider MAX, which has broadened the appeal of our founding product, cancer life 22 insurance. During the quarter, we sold nearly 282,000 of these riders and about 50% of our cancer life sales were with Rider MAX. Rider MAX accounted for approximately 40% of sales during the first quarter. New sales also benefited from the timing of sales campaigns in advance of a scheduled mid-year premium rate increase on new policy issues. All life insurance companies are raising premium rates in 1999 to compensate for the low level of investment yields. We anticipate that many of our insurance agencies will aggressively market our policies before the new rates become effective. Therefore, sales increases will likely be greater in the first half of the year than in the second half of the year when the new premium rates take effect. However, our new pricing assumptions will have virtually no impact on the cost of Rider MAX and term life plans, and the premium increases to other lines of business will be less than in previous years. As a result, we believe that the rate increase in July of this year should be less disruptive to our future sales results than previous rate increases. We continue to make strides toward increasing the breadth of our distribution system. We are adding more individual agencies to complement our large network of corporate agencies. The individual agencies will give us better access to Japan's substantial market of small businesses and individual customers. During the first quarter, we recruited about 360 new agencies. Our objective is to recruit 3,000 new agencies for the full year and we expect our recruiting to increase in the second quarter. Although Japan's economy remains weak, we continue to believe it is one of the best insurance markets in the world and one of great opportunities for growth. We have set an objective for AFLAC Japan's sales to increase approximately 10% to 15% for the year 1999 compared with 1998. AFLAC JAPAN INVESTMENTS Over the last several years, Japan's weak economy has produced an extremely challenging investment environment. Investment yields available to us in the first quarter improved over the fourth quarter of last year. However, they still remain at historically depressed levels. For instance, the yield on a composite index of 20-year Japanese government bonds averaged 2.52% during the first quarter, compared with 4.10% in the first quarter of 1995. By purchasing reverse dual-currency bonds (bonds with yen principal and a dollar coupon), we were able to invest in yen-denominated securities at an average yield of 4.36% during the quarter. Including dollar- denominated investments, our blended new money yield was 4.49% for the quarter. As of April 16, we had invested or committed to invest approximately 60% of our expected 1999 cash flow at an average yield of 4.69%. Not only do these yields compare very favorably with the yield of Japanese government bonds, they also provide a significant spread over our reserving assumptions for new business. At the end of the first quarter, the yield on AFLAC Japan's debt securities portfolio was 5.22%, compared with 5.24% at the end of 1998. The return on average invested assets, net of investment expenses, was 5.01% for the quarter, compared with 5.30% a year ago. Investment income in yen increased 5.5% in 1999 compared with 10.9% in 1998. This is due to the effect of translating dollar-denominated investment income into yen. The yen/dollar exchange rate was 128.09 yen to 23 one U.S. dollar for the first three months of 1998 compared with 116.58 for the first three months of 1999. AFLAC JAPAN OTHER The operating expense ratio has increased slightly due to investments in additional marketing programs including advertising and direct response efforts. The benefits ratio has declined due to the mix of business shifting to newer products that have a lower loss ratio than the traditional cancer life insurance and also due to favorable claims experience on cancer life insurance. Pretax operating earnings in yen increased 15.0% for the three months ended March 31, 1999. This increase was largely due to the lower loss ratio during the quarter. 24 INSURANCE OPERATIONS, AFLAC U.S. The following table presents a summary of AFLAC U.S. operating results. AFLAC U.S. SUMMARY OF OPERATING RESULTS THREE-MONTH PERIOD ENDED MARCH 31, (In millions) 1999 1998 -------------------------- Premium income......................... $ 330 $ 289 Investment income...................... 58 51 Other income........................... - 3 ----- ----- Total revenues....................... 388 343 ----- ----- Benefits and claims.................... 205 183 Operating expenses..................... 120 104 ----- ----- Total benefits and expenses.......... 325 287 ----- ----- Pretax operating earnings.......... $ 63 $ 56 ===== ===== - ---------------------------------------------------------------------------- Percentage increases over previous period: Premium income....................... 13.9% 12.7% Investment income.................... 12.8 44.1 Total revenues....................... 13.3 17.1 Pretax operating earnings............ 11.4 50.3 - ---------------------------------------------------------------------------- Ratios to total revenues: Benefits and claims.................. 52.8% 53.4% Operating expenses................... 31.1 30.2 Pretax operating earnings............ 16.1 16.4 ============================================================================ AFLAC U.S. SALES New annualized premium sales in the United States continued to grow at a rapid pace. New sales topped $100 million for the seventh consecutive quarter, rising 15.8% to $125 million. Accident/disability insurance was once again our best selling product. However, sales of our founding product, cancer expense insurance, were extremely robust. Cancer expense sales rose 28.5% for the quarter. In addition to strong sales growth, we continue to see increased use of our electronic sales system, SmartApp. In the first quarter, we processed more than 60% of our new business electronically. With savings from innovative work processes like SmartApp, we have increased our commitment to our national television advertising. We believe that growing name recognition through advertising is one of the factors that has contributed to our strong sales growth and expanding distribution system. We have set 25 an objective for AFLAC U.S. sales to increase by 12% to 15% for the year 1999. AFLAC U.S. INVESTMENTS Investment income increased 12.8% in the first three months of 1999 compared with 44.1% in the same period of 1998. The large increase in 1998 is the result of investment income received from investment of the proceeds from the sale of the television business in the second quarter of 1997 and from investment of profit repatriation funds of $347 million in 1997 which included $125 million of a non-recurring nature. During the first quarter of 1999, available cash flow was invested at an average yield-to-maturity of 8.08% compared with 7.47% during the first quarter of 1998. The overall return on average invested assets, net of investment expenses, was 7.52% for the first three months of 1999 compared with 7.37% for the first quarter of 1998. AFLAC U.S. OTHER Management expects the operating expense ratio, including discretionary television advertising expenses, to remain approximately level in the future. By improving administrative systems and controlling other costs, we have been able to redirect funds to national television advertising programs without significantly affecting the operating expense ratio. The aggregate benefit ratio has tended to decline slightly. The mix of business has shifted toward accident and hospital indemnity policies, which have lower benefit ratios than other products. We expect future benefit ratios for some of our supplemental products to increase slightly due to our ongoing efforts to improve policy persistency and enhance policyholder benefits. Management expects the pretax operating profit margin, which was 16.2% for the year 1998, to remain approximately the same in 1999. 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, 1998, our financial condition has remained strong in the functional currencies of our operations. The investment portfolios of AFLAC Japan and AFLAC U.S. have continued to grow and primarily consist of investment grade 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 our financial statements. The yen/dollar exchange rate at the end of each period is used to translate yen-denominated balance sheet items to U.S. dollars for reporting purposes. The exchange rate at March 31, 1999, was 120.55 yen to one U.S. dollar, 4.0% weaker than the exchange rate of 115.70 as of December 31, 1998. Management estimates that the weaker yen rate decreased reported investments and cash by $932 million, total assets by 26 $1.1 billion, and total liabilities by $1.0 billion compared with the amounts that would have been reported for 1999 if the exchange rate had remained unchanged from year-end 1998. INVESTMENTS AND CASH The continued growth in investments and cash reflects the substantial cash flows in the functional currencies of our operations. Net unrealized gains of $1.7 billion on investment securities at March 31, 1999, consisted of $2.5 billion in gross unrealized gains and $818 million in gross unrealized losses. AFLAC invests primarily within the Japanese, U.S. and Euroyen fixed- maturity markets. We use specific criteria to judge the credit quality and liquidity of our investments and use a variety of credit rating services to monitor these criteria. Applying those various credit ratings to a standardized rating system based on the categories of a nationally recognized rating service, the percentages of our debt securities, at amortized cost, were as follows: March 31, December 31, 1999 1998 ----------- ------------ AAA 36.3% 38.1% AA 18.3 17.6 A 30.8 31.2 BBB 12.8 13.1 BB 1.8 - ----- ----- 100.0% 100.0% ===== ===== As of December 31, 1998, we held no debt securities rated below `BBB.' However, in January 1999, the credit ratings of several major Japanese financial institutions were downgraded. We owned debt securities issued by a major Japanese bank in the amount of $436 million, or 1.8% of total debt securities at March 31, 1999. Following the downgrade, these securities were rated `Ba1' by Moody's and `BB+' by Standard & Poor's. Private placement investments accounted for 46.5% and 43.9% of our total debt securities as of March 31, 1999 and December 31, 1998, 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, we have adhered to historically conservative standards for credit quality. We require that all private placement issuers have an initial rating of Class 1 or 2 as determined by the Securities Valuation Office of the National Association of Insurance Commissioners (NAIC). Most of AFLAC's private placement issues are issued under medium- term note programs and have standard covenants commensurate with credit rankings, except when internal credit analysis indicates that additional protective and/or event-risk covenants are required. During the fourth quarter of 1998, we revised our investment management policy regarding the holding-period intent for certain of our private placement debt securities. Our past practice was to hold these 27 securities to their contractual or economic maturity dates. We have now made this our formal policy. Accordingly, debt securities carried at a fair value of $6.4 billion were reclassified as of October 1, 1998, from the category "available of sale" to "held to maturity." The related unrealized gains of $1.1 billion as of October 1, 1998, on these securities are being amortized over the remaining term of the securities. Securities that are available for sale are reported in the balance sheet at fair value and securities that are held to maturity are reported at amortized cost. The following table shows an analysis of investment securities (at cost or amortized cost): AFLAC Japan AFLAC U.S. ---------------------- ---------------------- March 31, December 31, March 31, December 31, (In millions) 1999 1998 1999 1998 ---------------------- ---------------------- Available for sale: Fixed-maturity securities $12,950 $12,886 $ 2,829 $ 2,772 Perpetual debentures 1,710 1,344 116 111 Equity securities 28 22 74 79 ------ ------ ------ ------ Total available for sale 14,688 14,252 3,019 2,962 ------ ------ ------ ------ Held to maturity: Fixed-maturity securities 3,803 3,947 - - Perpetual debentures 3,344 3,494 - - ------ ------ ------ ------ Total held to maturity 7,147 7,441 - - ------ ------ ------ ------ Total $21,835 $21,693 $ 3,019 $ 2,962 ====== ====== ====== ====== POLICY LIABILITIES Policy liabilities decreased $58 million, or .2%, during the first three months of 1999. AFLAC Japan decreased $126 million, or .6% (3.6% increase in yen), and AFLAC U.S. increased $68 million, or 3.2%. Changes in policy liabilities were primarily due to the addition of new business, the aging of policies in force, the weaker yen and the effect of the market value adjustment for securities available for sale (see Note 7 of the Notes to the Consolidated Financial Statements). The weaker yen at March 31, 1999 compared with December 31, 1998 decreased reported policy liabilities by $915 million. DEBT On April 21, 1999, we issued $450 million of senior notes with a 6.50% coupon, paid semiannually, due April 15, 2009. The notes are redeemable at our option and at any time at a redemption price equal to the principal amount of the notes being redeemed plus a make-whole amount. We received net proceeds of $445 million. We intend to use the proceeds primarily to purchase shares of our common stock. Any remaining proceeds may be used to repay indebtedness or for general corporate purposes. We intend to swap the dollar-denominated principal and interest to be yen-denominated. 28 See Note 6 of the Notes to the Consolidated Financial Statements for information on other debt outstanding at March 31, 1999. Our ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized gains on investment securities) was 18.0% and 19.6% as of March 31, 1999 and December 31, 1998, respectively. 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, 1999 and by approximately $1 million for the year 1998. For further information regarding such arrangements, see Note 8 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 us in the past. We believe that future assessments relating to companies in the U.S. currently involved in insolvency proceedings will not materially impact the consolidated financial statements. The Life Insurance Association of Japan, an industry organization, implemented a voluntary policyholder protection fund in 1996 to provide capital support to insolvent life insurers. AFLAC Japan pledged investment securities to the Life Insurance Association of Japan for this program. During the first quarter of 1998, the Japanese government enacted a mandatory policyholder protection fund system. The life insurance industry is making contributions to these funds over a 10-year period. We have recorded a liability for our share of these obligations. SHAREHOLDERS' EQUITY Our insurance operations continue to provide the 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 AFLAC Incorporated for management fees and dividends. Both the sources and uses of cash are reasonably predictable. Our 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. We may secure additional statutory capital through various sources, such as internally generated statutory 29 earnings or equity contributions by AFLAC Incorporated from funds generated through debt or equity offerings. In April 1999 we received net proceeds of $445 million from an issuance of $450 million of senior notes which increased our capital resources. We believe outside sources for additional debt and equity capital, if needed, will continue to be available for capital expenditures, business expansion, and the funding of our share repurchase program. AFLAC Incorporated capital resources are largely dependent upon the ability of AFLAC to pay management fees and dividends. The Georgia Insurance Department imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances by AFLAC to AFLAC Incorporated. In addition to restrictions by U.S. insurance regulators, the Japanese Financial Supervisory Agency (FSA) may impose restrictions on transfers of funds from AFLAC Japan. Payments are made from AFLAC Japan to AFLAC Incorporated for management fees, and to AFLAC U.S. for allocated expenses and remittances of earnings. Total funds received from AFLAC Japan were $11 million in the first quarter of 1999 and $192 million and $386 million in the full years 1998 and 1997, respectively. Profit repatriations have been remitted annually from AFLAC Japan to AFLAC U.S. in July. The FSA maintains solvency standards, a version of risk-based capital requirements. AFLAC Japan's solvency margin remains high and reflects a strong capital and surplus position. 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 our annual report to shareholders for the year ended December 31, 1998. Currently, prescribed or permitted statutory accounting principles (SAP) used by insurers for financial reporting to state insurance regulators may vary between states and between companies. The National Association of Insurance Commissioners (NAIC) has recodified SAP to promote standardization throughout the industry. These new accounting principles are presently planned by the NAIC to be effective for 2001. The most significant change to AFLAC is the requirement that insurance companies establish a deferred income tax liability for statutory accounting purposes. We estimate AFLAC's deferred tax liability would be approximately $142 million at March 31, 1999 under the provisions of the recodified SAP. AFLAC's capital and surplus, as determined on the present U.S. statutory accounting basis, was $1.7 billion at March 31, 1999. YEAR 2000 The term "year 2000 issue" generally refers to incorrect date calculations that might occur in computer software and hardware as the year 2000 approaches. The use of computer programs that rely on two-digit date fields to perform computations and decision-making functions may cause systems to malfunction when processing information involving dates after 1999. For example, any computer software that has date-sensitive coding might recognize a code of "00" as the year 1900 rather than the year 2000. Our efforts to address year 2000 issues began in 1997. We established a Year 2000 Executive Steering Committee, made up of senior management and representatives of our information technology, financial, legal, internal audit and various operational areas to identify and address year 2000 issues throughout our U.S. and Japanese operations. We also established a Year 2000 Project Office consisting of department coordinators from Information 30 Technology, Worldwide Headquarters business operations and AFLAC Japan. The Project Office established both domestic and Japanese plans to address year 2000 readiness and minimize the risk of business disruption caused by year 2000 issues. We also engaged third party consultants to assist AFLAC U.S. and AFLAC Japan with their year 2000 efforts. The plans contain five phases: (1) the assessment phase, which includes creating awareness of the issue throughout the company and assessment of all systems, significant business processes, facilities and third party dependencies; (2) the remediation phase, which includes updating or modifying systems which are identified as critical to our efforts to become year 2000 ready; (3) the testing phase, which includes the testing of systems that have been updated or modified; (4) the implementation phase, which includes placing systems into the production environment, as well as additional comprehensive testing to identify and resolve any remaining year 2000 issues; and (5) contingency planning. We have remediated substantially all of our critical production systems in both the United States and Japan. Verification that the critical production systems have been correctly remediated will continue through the third quarter of 1999 in a year 2000 test environment. The additional testing may raise new issues that require further remediation and implementation activities, all of which are scheduled to be completed in the third quarter of 1999. Testing and any further remediation and implementation activities required for non-critical systems will continue through the end of 1999. Currently, we are in the process of developing and refining contingency plans for our business systems and processes. These plans will be periodically updated throughout 1999 based on currently available information and the perceived business risk. We rely on a widely distributed customer base in the United States and Japan for continued payment of premiums. Many of the systems utilized by our group accounts are automated and date dependent. We randomly surveyed group accounts in the United States to determine their year 2000 readiness. AFLAC Japan depends heavily on substantial premium payments that are electronically transmitted by third party payment agents from employers of the insured. We have surveyed our more significant customers in Japan to determine whether such customers expect their ability to pay premiums or transmit policy and claims data in this fashion to be impacted by year 2000 issues. We will be conducting tests with our key external customers and suppliers during the second quarter of 1999. Any adverse results from this testing will be incorporated into our ongoing contingency planning process. If a large number of customers (in the U.S. and/or Japan) are unable to submit premium payments in a timely or accurate manner due to year 2000 issues, the resulting delays could have a material adverse effect on our financial condition or results of operations. It is not currently possible to predict the probability of any delays occurring or the extent of such delays. AFLAC owns publicly traded and privately placed fixed-maturity and equity securities in the U.S. and Japan, and other foreign countries. If a material portion of such securities are adversely impacted by year 2000 issues, our investment portfolio may also be adversely impacted. 31 Since the inception of the year 2000 project, we had incurred costs of approximately $25 million for system upgrades or modifications through March 31, 1999. Of this amount, approximately $10 million was capitalized. The remaining cost to complete the various projects is currently estimated to be $7 million, of which $1 million is expected to be capitalized. We may determine that additional expenditures are necessary as testing continues. Company personnel have spent considerable time and effort on the project, and we intend to continue to devote additional internal resources and personnel to work on the project. However, we believe that any deferral of information technology projects due to the year 2000 effort will not have a material adverse effect on our operations or financial condition. Due to the uncertainty inherent in year 2000 issues, particularly with regard to Japanese customers' year 2000 readiness and the various governmental functions, public utilities, financial infrastructures and similar outside facilities on which we depend in both the United States and Japan, we are unable to determine at this time whether the consequences of external year 2000 failures will have a material impact on our financial condition or results of operations. Although a year 2000 failure with respect to any single internal or external system may not have a material adverse effect on AFLAC, the failure of multiple systems may cause a material disruption to our business which may have a material adverse effect on our operations or financial condition. All statements made herein regarding our year 2000 efforts are "Year 2000 Readiness Disclosures" made pursuant to the Year 2000 Information and Readiness Disclosure Act, and to the extent applicable, are entitled to the protections of such act. OTHER In April 1999, Standard & Poor's announced that AFLAC Incorporated will be added to the Standard & Poor's 500 index. On May 3, 1999, the board of directors approved an increase in the quarterly cash dividend from $.065 to $.075 per share. The increase is effective with the second quarter dividend, which is payable on June 1, 1999, to shareholders of record at the close of business on May 20, 1999. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our 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 Our primary interest rate exposure is a result of the effect of changes in interest rates on the fair value of our investments in debt securities. We use modified duration analysis to estimate the sensitivity to interest rate changes in our debt securities. Modified duration analysis provides a measure of price percentage volatility. We attempt to match the duration of our assets with the duration of our liabilities. For AFLAC Japan, the duration of policy benefit liabilities is 32 longer than that of the related invested assets due to the unavailability of acceptable yen-denominated long-duration securities. When our debt securities mature, there is a risk that the proceeds will be reinvested at a yield below that of the interest required for the accretion of policy liabilities. At March 31, 1999 we had $1.6 billion of net unrealized gains on debt securities. The hypothetical reduction in the fair value of our debt securities resulting from a 100 basis point increase in market interest rates is estimated to be $2.3 billion based on our portfolio as of March 31, 1999. The effect on yen-denominated debt securities is approximately $2.0 billion and the effect on dollar-denominated debt securities is approximately $352 million. We have outstanding interest rate swaps on 49.6 billion yen ($411 million) of our variable-interest-rate yen-denominated borrowings. These swaps reduce the impact of fluctuations in interest rates on our borrowing costs and effectively change our interest rates from variable to fixed. Therefore, movements in market interest rates should have no material effect on earnings. For further information on our notes payable, see Note 6 of the Notes to the Consolidated Financial Statements. At March 31, 1999, we also had yen-denominated bank borrowings in the amount of 17.3 billion yen ($144 million) with a variable interest rate of .95%. The effect on net earnings in 1999 due to changes in market interest rates was immaterial. For further information on our notes payable, see Note 6 of the Notes to the Consolidated Financial Statements. EQUITY PRICE RISK Equity securities at March 31, 1999, totaled $180 million, or .7% of total investments and cash on a consolidated basis. We use beta analysis to measure the sensitivity of our equity securities portfolio to fluctuations in the broad market. The beta of our equity securities portfolio is 1.03. For example, if the overall stock market value changed by 10%, the value of AFLAC's equity securities would be expected to change by approximately 10.3%, or $19 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 foreign currency transaction risk. In addition to the yen-denominated financial instruments held by AFLAC Japan, AFLAC Incorporated has yen-denominated borrowings that have been designated as a hedge of our investment in AFLAC Japan. The unrealized foreign currency translation gains and losses related to these borrowings are reported in accumulated other comprehensive income. 33 We attempt to match our yen-denominated assets to our yen-denominated liabilities on a consolidated basis in order to minimize the exposure of our shareholders' equity to foreign currency translation fluctuations. The table below compares the U.S. dollar values of our yen-denominated assets and liabilities at various exchange rates. Dollar Value of Yen-Denominated Assets and Liabilities At Selected Exchange Rates (March 31, 1999) 105.55 120.55* 135.55 (In millions) Yen Yen Yen - ---------------------------------------------------------------------------- Yen-denominated financial instruments: Assets: Securities available for sale: Fixed maturities $15,122 $13,240 $11,775 Perpetual debentures 1,838 1,609 1,431 Equity securities 37 33 29 Securities held to maturity: Fixed maturities 4,343 3,803 3,382 Perpetual debentures 3,819 3,344 2,973 Cash and cash equivalents 235 205 183 Other financial instruments 11 9 9 ------ ------ ------ Total 25,405 22,243 19,782 ------ ------ ------ Liabilities - notes payable 634 555 493 ------ ------ ------ Net yen-denominated financial instruments 24,771 21,688 19,289 Other yen-denominated assets 3,474 3,042 2,705 Other yen-denominated liabilities (27,467) (24,049) (21,388) ------ ------ ------ Total yen-denominated net assets subject to foreign currency fluctuation $ 778 $ 681 $ 606 ====== ====== ====== * Actual March 31, 1999 exchange rate For information regarding the effect of foreign currency translation on operating earnings per share, see Foreign Currency Translation on page 18. 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. We desire 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 company 34 officers in oral discussions with analysts and contained in documents filed with the Securities and Exchange Commission (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. AFLAC undertakes no obligation to update such forward-looking statements. We caution readers that the following factors, in addition to other factors mentioned from time to time in our reports filed with the SEC, could cause actual results to differ materially: regulatory developments, assessments for insurance company insolvencies, competitive conditions, new products, ability to repatriate profits from Japan, 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 AFLAC's investment activities, significant changes in interest rates, fluctuations in foreign currency exchange rates, and the ability of AFLAC, and third parties with whom it does business, to achieve year 2000 readiness for significant systems on a timely basis. 35 PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS We are 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, we believe the outcome of pending litigation will not have a material adverse effect on our financial position. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of the Shareholders was held on May 3, 1999. Matters submitted to the shareholders were: (1) Election of 17 members to the board of directors; (2) Adopt an amended and restated Management Incentive Plan; (3) Ratification of the selection of auditors for 1999. The 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. VOTES --------------------------------------------------- Absten- With- Broker For Against tions held Non-Votes ---------------------------------------------------- (1) Election of 17 members to the board of directors: Paul S. Amos 521,390,429 N/A N/A 1,351,642 6,604,760 Daniel P. Amos 521,729,418 N/A N/A 1,012,653 6,604,760 J. Shelby Amos, II 521,336,681 N/A N/A 1,405,390 6,604,760 Michael H. Armacost 481,838,356 N/A N/A 40,903,715 6,604,760 M. Delmar Edwards, M.D. 521,144,743 N/A N/A 1,597,328 6,604,760 Joe Frank Harris 521,008,378 N/A N/A 1,733,693 6,604,760 Elizabeth J. Hudson 521,629,248 N/A N/A 1,112,823 6,604,760 Kenneth S. Janke, Sr. 521,959,982 N/A N/A 782,089 6,604,760 Charles B. Knapp 521,699,403 N/A N/A 1,042,668 6,604,760 Hisao Kobayashi 521,945,848 N/A N/A 796,223 6,604,760 Yoshiki Otake 521,960,985 N/A N/A 781,086 6,604,760 E. Stephen Purdom 521,637,995 N/A N/A 1,104,076 6,604,760 Barbara K. Rimer 521,294,474 N/A N/A 1,447,597 6,604,760 Henry C. Schwob 521,471,257 N/A N/A 1,270,814 6,604,760 J. Kyle Spencer 521,403,448 N/A N/A 1,338,623 6,604,760 Glenn Vaughn, Jr. 521,275,212 N/A N/A 1,466,859 6,604,760 Robert L. Wright 521,280,154 N/A N/A 1,461,917 6,604,760 36 VOTES --------------------------------------------------- Absten- With- Broker For Against tions held Non-Votes ---------------------------------------------------- (2) Adopt an Amended and Restated Management Incentive Plan 519,301,427 7,578,832 2,466,572 N/A None (3) Ratification of appointment of KPMG LLP as independent auditors 526,866,723 662,923 1,817,185 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, 1999. We filed a report on Form 8-K on April 7, 1999 regarding our issuance of $450 million of senior notes. Items other than those listed above are omitted because they are not required or are not applicable. 37 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, 1999 /s/ KRISS CLONINGER, III ------------------------ --------------------------- KRISS CLONINGER,III Executive Vice President; Treasurer and Chief Financial Officer Date May 12, 1999 /s/ NORMAN P. FOSTER ------------------------ --------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 38 EXHIBITS FILED WITH CURRENT FORM 10-Q: 27.0 - Financial Data Schedule (for SEC use only). 39 1 EX-27 2 3/99 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 March 31, 1999, and is qualified in its entirety by reference to such financial statements. 1,000,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 19,603 7,147 6,777 180 0 0 26,948 269 0 3,040 31,349 23,424 306 0 246 573 0 0 32 3,827 31,349 1,728 320 (5) 5 1,400 57 388 203 7 196 0 0 0 196 .74 .71 0 0 0 0 0 0 0 Includes $67 benefit from Japanese income tax rate reduction.
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