-----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, NY/XgHLdbgSRCKCHJ/TUT9+N1n3DB4/kgpEVOfaolGl6ejBExZmHagOUCgy35Rd+ RYUcGc4Puq/h5b+Fj18y1w== 0000004977-99-000038.txt : 19991111 0000004977-99-000038.hdr.sgml : 19991111 ACCESSION NUMBER: 0000004977-99-000038 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991110 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: 99745297 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 3RD QUARTER FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 For the quarter ended September 30, 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 November 3, 1999 - ---------------------------- ------------------ Common Stock, $.10 Par Value 266,118,105 shares AFLAC INCORPORATED AND SUBSIDIARIES INDEX Page No. ---- Part I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - September 30, 1999 and December 31, 1998................ 1 Consolidated Statements of Earnings - Three Months Ended September 30, 1999 and 1998 Nine Months Ended September 30, 1999 and 1998........... 3 Consolidated Statements of Shareholders' Equity - Nine Months Ended September 30, 1999 and 1998........... 5 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1999 and 1998........... 6 Consolidated Statements of Comprehensive Income - Three Months Ended September 30, 1999 and 1998 Nine Months Ended September 30, 1999 and 1998........... 8 Notes to Consolidated Financial Statements................ 9 Review by Independent Certified Public Accountants............................................. 17 Independent Auditors' Report.............................. 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk......................................... 34 Part II. Other Information: Item 1. Legal Proceedings.................................. 37 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)
September 30, December 31, 1999 1998 (Unaudited) ----------- ------------ ASSETS: Investments and cash: Securities available for sale, at fair value: Fixed maturities (amortized cost, $17,788 in 1999 and $15,658 in 1998) $ 19,694 $ 17,617 Perpetual debentures (amortized cost, $2,458 in 1999 and $1,455 in 1998) 1,994 1,366 Equity securities (cost, $120 in 1999 and $101 in 1998) 181 177 Securities held to maturity, at amortized cost: Fixed maturities (fair value, $4,137 in 1999 and $3,691 in 1998) 4,240 3,947 Perpetual debentures (fair value, $3,509 in 1999 and $3,131 in 1998) 3,747 3,494 Other investments 19 19 Cash and cash equivalents 534 374 -------- -------- Total investments and cash 30,409 26,994 Receivables, primarily premiums 262 229 Receivables for security transactions 136 43 Accrued investment income 313 316 Deferred policy acquisition costs 3,486 3,067 Property and equipment, at cost less accumulated depreciation 493 427 Other 126 107 -------- -------- Total assets $ 35,225 $ 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)
September 30, December 31, 1999 1998 (Unaudited) ------------- ------------ Liabilities and Shareholders' Equity: Liabilities: Policy liabilities: Future policy benefits $ 25,644 $ 22,218 Unpaid policy claims 1,555 1,263 Unearned premiums 335 309 Other policyholders' funds 292 244 -------- -------- Total policy liabilities 27,826 24,034 Notes payable 1,079 596 Income taxes 1,624 1,865 Payables for return of cash collateral on loaned securities 44 - Payables for security transactions 31 173 Other 849 745 -------- -------- Total liabilities 31,453 27,413 -------- -------- Shareholders' equity: Common stock of $.10 par value. In thousands: authorized 400,000 shares; issued 319,760 shares in 1999 and 317,971 shares in 1998 32 32 Additional paid-in capital 300 235 Retained earnings 3,274 2,862 Accumulated other comprehensive income: Unrealized foreign currency translation gains 226 219 Unrealized gains on investment securities 1,002 1,332 Treasury stock, at average cost (1,062) (910) -------- -------- Total shareholders' equity 3,772 3,770 -------- -------- Total liabilities and shareholders' equity $ 35,225 $ 31,183 ======== ======== Shareholders' equity per share $ 14.21 $ 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 September 30, Nine Months Ended September 30, per share amounts - Unaudited) ------------------------------- ----------------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Revenues: Premiums, principally supplemental health insurance $ 1,847 $ 1,421 $ 5,281 $ 4,318 Net investment income 347 275 992 829 Realized investment gains (losses) (3) (2) (12) (2) Other income 5 6 14 15 ------- ------- ------- ------- Total revenues 2,196 1,700 6,275 5,160 ------- ------- ------- ------- Benefits and expenses: Benefits and claims 1,498 1,160 4,277 3,544 Acquisition and operating expenses: Amortization of deferred policy acquisition costs 62 48 183 146 Insurance commissions 235 184 680 561 Insurance expenses 160 126 453 361 Provision for mandated policyholder protection fund - - - 111 Interest expense 5 3 13 9 Other operating expenses 16 18 50 53 ------- ------- ------- ------- Total acquisition and operating expenses 478 379 1,379 1,241 ------- ------- ------- ------- Total benefits and expenses 1,976 1,539 5,656 4,785 ------- ------- ------- ------- Earnings before income taxes 220 161 619 375 Income tax expense (benefit): Operations 76 53 217 125 Deferred tax benefit from Japanese tax rate reductions - - (67) (121) ------- ------- ------- ------- Total income taxes 76 53 150 4 ------- ------- ------- ------- Net earnings $ 144 $ 108 $ 469 $ 371 ======= ======= ======= ======= (continued on next page) 3
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings (continued)
(In millions, except for share and Three Months Ended September 30, Nine Months Ended September 30, per share amounts - Unaudited) ------------------------------- ----------------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Net earnings per share: Basic $ .54 $ .40 $ 1.77 $ 1.39 Diluted .52 .39 1.70 1.34 ======= ======= ======= ======= Shares used in computing earnings per share (In thousands): Basic 265,540 265,928 265,822 266,629 Diluted 274,497 275,287 275,743 276,048 ======= ======= ======= ======= Cash dividends per share $ .075 $ .065 $ .215 $ .188 ======= ======= ======= ======= See the accompanying Notes to Consolidated Financial Statements. 4
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity
(In millions, except for per share Nine Months Ended September 30, amounts - Unaudited) ------------------------------ 1999 1998 ------ ------ Common Stock: Balance at beginning of year $ 32 $ 16 Two-for-one stock split - 16 ------ ------ Balance at end of period 32 32 ------ ------ Additional paid-in capital: Balance at beginning of year 235 227 Exercise of stock options 12 5 Gain on treasury stock reissued 53 12 Two-for-one stock split - (16) ------ ------ Balance at end of period 300 228 ------ ------ Retained earnings: Balance at beginning of year 2,862 2,442 Net earnings 469 371 Cash dividends ($.215 per share in 1999 and $.188 in 1998) (57) (50) ------ ------ Balance at end of period 3,274 2,763 ------ ------ 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 6 (62) Unrealized gains (losses) on investment securities during period, net of income taxes and reclassification adjustments (329) (33) ------ ------ Balance at end of period 1,228 1,464 ------ ------ Treasury stock: Balance at beginning of year (910) (813) Purchases of treasury stock (181) (123) Cost of shares issued 29 20 ------ ------ Balance at end of period (1,062) (916) ------ ------ Total shareholders' equity $ 3,772 $ 3,571 ====== ====== See the accompanying Notes to Consolidated Financial Statements. 5
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (In millions - Unaudited)
Nine Months Ended September 30, --------------------- 1999 1998 ------ ------ Cash flows from operating activities: Net earnings $ 469 $ 371 Adjustments to reconcile net earnings to net cash provided by operating activities: Increase in policy liabilities 1,900 1,624 Deferred income taxes (1) (174) Change in income taxes payable (224) 64 Increase in deferred policy acquisition costs (215) (161) Change in receivables and advance premiums (10) (18) Depreciation and amortization expense 20 34 Provision for mandated policyholder protection fund - 111 Other, net 205 (16) ------ ------ Net cash provided by operating activities 2,144 1,835 ------ ------ Cash flows from investing activities: Proceeds from investments sold or matured: Securities available for sale: Fixed-maturity securities sold 985 647 Fixed-maturity securities matured 177 512 Equity securities 67 49 Securities held to maturity: Fixed-maturity securities matured 18 - Other investments, net 1 9 Costs of investments acquired: Securities available for sale: Fixed-maturity securities (2,587) (2,103) Perpetual debentures (819) (671) Equity securities (61) (44) Fixed-maturity securities held to maturity (42) - Other investments, net (1) (3) Cash received as collateral on loaned securities 44 - Additions to property and equipment, net (15) (26) ------ ------ Net cash used by investing activities $(2,233) $(1,630) ------ ------ (continued) 6
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In millions - Unaudited)
Nine Months Ended September 30, --------------------- 1999 1998 ------ ------ Cash flows from financing activities: Proceeds from borrowings $ 446 $ 114 Principal payments under debt obligations (78) (122) Dividends paid to shareholders (57) (50) Purchases of treasury stock (181) (123) Treasury stock reissued 82 32 Other, net 11 5 ------ ------ Net cash provided (used) by financing activities 223 (144) ------ ------ Effect of exchange rate changes on cash and cash equivalents 26 (7) ------ ------ Net change in cash and cash equivalents 160 54 Cash and cash equivalents, beginning of year 374 236 ------ ------ Cash and cash equivalents, end of period $ 534 $ 290 ====== ====== Supplemental disclosures of cash flow information: Cash payments during the period for: Interest on debt obligations $ 9 $ 9 Income taxes 261 197 Non-cash financing activities: Capital lease obligations 4 6 See the accompanying Notes to Consolidated Financial Statements. 7
AFLAC INCORPORATED AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (In millions - Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- 1999 1998 1999 1998 ------ ------ ------ ------ Net earnings $ 144 $ 108 $ 469 $ 371 ------ ------ ------ ------ Other comprehensive income, before income taxes: Foreign currency translation adjustments: Change in unrealized foreign currency translation gains (losses) during the period (104) (25) (87) 15 Unrealized gains (losses) on investment securities: Unrealized holding gains (losses) arising during the period 36 36 (418) 25 Reclassification adjustment for realized (gains) losses included in net earnings 3 2 13 2 ------ ------ ------ ------ Total other comprehensive income, before income taxes (65) 13 (492) 42 Income tax expense (benefit) related to items of other comprehensive income (45) 8 (169) 137 ------ ------ ------ ------ Other comprehensive income, net of income taxes (20) 5 (323) (95) ------ ------ ------ ------ Total comprehensive income $ 124 $ 113 $ 146 $ 276 ====== ====== ====== ====== See the accompanying Notes to Consolidated Financial Statements. 8
AFLAC INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. Basis of Presentation In the opinion of management, the accompanying unaudited consolidated financial statements of AFLAC Incorporated and subsidiaries (the Company) contain all adjustments necessary to fairly present the financial position as of September 30, 1999, and the results of operations and comprehensive income for the three-month and nine-month periods ended September 30, 1999 and 1998, and statements of cash flows and shareholders' equity for the nine months ended September 30, 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 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. 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 and nine months ended September 30, 1999. 9 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, 2001. 10 3. Segment Information Information regarding components of operations follows: (In millions) Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 -------- -------- -------- -------- Total revenues: AFLAC Japan: Earned premiums $ 1,501 $ 1,115 $ 4,271 $ 3,425 Net investment income 280 218 804 666 Other income 2 1 3 2 ------- ------- ------- ------- Total AFLAC Japan revenues 1,783 1,334 5,078 4,093 ------- ------- ------- ------- AFLAC U.S.: Earned premiums 346 304 1,010 887 Net investment income 62 55 179 160 Other income 1 1 2 3 ------- ------- ------- ------- Total AFLAC U.S. revenues 409 360 1,191 1,050 ------- ------- ------- ------- All other business segments 5 10 16 24 ------- ------- ------- ------- Total business segments 2,197 1,704 6,285 5,167 Realized investment gains (losses) (3) (2) (12) (2) Corporate 11 8 28 24 Intercompany eliminations (9) (10) (26) (29) ------- ------- ------- ------- Total $ 2,196 $ 1,700 $ 6,275 $ 5,160 ======= ======= ======= ======= Earnings before income taxes: AFLAC Japan $ 171 $ 122 $ 481 $ 366 AFLAC U.S. 65 59 191 171 All other business segments (2) (1) (2) - ------- ------- ------- ------- Total business segments 234 180 670 537 Provision for the Japanese mandated policyholder protection fund - - - (111) Realized investment gains (losses) (3) (2) (12) (2) Interest expense, non-insurance operations (4) (2) (10) (8) Corporate (7) (15) (29) (41) ------- ------- ------- ------- Total $ 220 $ 161 $ 619 $ 375 ======= ======= ======= ======= 11 Total assets were as follows: September 30, December 31, (In millions) 1999 1998 ------------- ------------ Total assets: AFLAC Japan $ 30,445 $ 26,912 AFLAC U.S. 4,424 4,212 All other business segments 31 59 ------- ------- Total business segments 34,900 31,183 Corporate 5,094 4,674 Intercompany eliminations (4,769) (4,674) ------- ------- Total $ 35,225 $ 31,183 ======= ======= 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%. This tax rate reduction was recognized in the first quarter of 1999, and increased net earnings for the nine months ended September 30, 1999 by $67 million ($.25 per basic share, $.24 per diluted share) from the reduction of our consolidated deferred income tax liability. 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 and the Japanese income tax basis of AFLAC Japan's assets and liabilities, reduced by the limitations in the U.S. foreign tax credit provisions. At the end of March 1998, the Japanese government reduced the Japanese corporate income tax rate from 45.3% to 41.7%. This tax rate reduction was recognized in the first quarter of 1998 and increased net earnings for the nine months ended September 30, 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 was 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 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 nine months ended September 30, 1998. The after-tax charge was $65 million, or $.24 per basic and diluted share. 12 6. Notes Payable A summary of notes payable after giving effect to interest rate swaps and currency swaps is as follows: September 30, December 31, (In millions) 1999 1998 ------------ ------------ 1.67% yen-denominated senior notes due April 2009 $ 518 $ - Unsecured, yen-denominated notes payable to banks: Reducing, revolving credit agreement, due annually through July 2001: 2.29% fixed interest rate 212 294 Variable interest rate (.38% at Sept. 30, 1999) 58 35 Revolving credit agreement due November 2002: 1.24% fixed interest rate 109 134 Variable interest rate (.33% at Sept. 30, 1999) 163 115 Obligations under capitalized leases, due monthly through 2003, secured by computer equipment in Japan 19 18 ------ ------ Total notes payable $ 1,079 $ 596 ====== ====== 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 have swapped the dollar-denominated principal and interest into yen-denominated obligations. At September 30, 1999, the principal was 55.6 billion yen at an interest rate of 1.67% less a loan discount of 140 million yen, for a net payable of 55.4 billion yen ($518 million using the September 30, 1999 exchange rate). We have a reducing, revolving credit agreement that provides for bank borrowings through July 2001 in either U.S. dollars or Japanese yen. At September 30, 1999, the borrowing limit was $250 million. Under the terms of the agreement, the borrowing limit will reduce to $125 million on July 15, 2000. At September 30, 1999, 22.7 billion yen ($212 million) was outstanding at a fixed interest rate, and 6.2 billion yen ($58 million) was outstanding at a variable interest rate under this agreement. 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 September 30, 1999, 11.7 billion yen ($109 million) was outstanding at a fixed interest rate, and 17.4 billion yen ($163 million) was outstanding at a variable interest rate under this agreement. Notes payable were reduced by cash payments of 1.6 billion yen ($15 million) in October 1999. Since these loans are denominated in yen, the principal amount of the loans as stated in dollar terms at any date will fluctuate due to changes in the yen-to-dollar foreign currency exchange rate. 13 We have outstanding interest rate swaps on a portion of our variable interest rate yen-denominated borrowings. 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 (.29% at September 30, 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. 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. The net effect on shareholders' equity of unrealized gains and losses from investment securities at the following dates was: (In millions) September 30, December 31, 1999 1998 ------------ ------------ Unrealized gains on securities available for sale $ 1,503 $ 1,946 Unamortized unrealized gains on securities transferred to held to maturity 1,235 1,224 Less: Policy liabilities 858 885 Deferred income taxes 878 953 --------- --------- Shareholders' equity, net unrealized gains on investment securities $ 1,002 $ 1,332 ========= ========= We own perpetual debentures that we have classified as held-to- maturity. Although these securities have no contractual maturity, the issue-date, fixed-rate interest coupons subsequently increase to a market- 14 interest rate plus 150 to 300 basis points and change to a variable-interest rate basis, generally by the 25th year after issuance, creating an economic maturity date. 8. Security Lending We loan fixed-maturity securities to financial institutions in short- term security lending transactions. These securities continue to be carried as investment assets on our balance sheet during the term of the loans and are not recorded as sales. We receive cash or other securities as collateral for such loans. These short-term security lending arrangements increase investment income with minimal risk. At September 30, 1999, and December 31, 1998, we had security loans outstanding in the amounts of $3.2 billion and $3.0 billion at fair value, respectively. At September 30, 1999, and December 31, 1998, we held Japanese government bonds as collateral for loaned securities in the amounts of $3.2 billion and $3.1 billion, at fair value. At September 30, 1999, we also held $44 million of cash collateral for loaned securities in the amount of $43 million, at fair value. For loans involving unrestricted cash collateral, the collateral is recorded as an asset with a corresponding liability for the return of the collateral. For loans involving securities as collateral, the collateral is not recorded as an asset or liability under generally accepted accounting principles. Our security lending policy requires that the fair value of the securities received as collateral and cash received as collateral be 102% and 100% or more, respectively, of the fair value of the loaned securities as of the date the securities are loaned and not less than 100% thereafter. 9. Common Stock The following is a reconciliation of the number of shares of our common stock for the nine months ended September 30: (In thousands of shares) 1999 1998 ---------- ---------- Common stock - issued: Balance at beginning of year 317,971 316,380 Exercise of stock options 1,789 1,192 -------- -------- Balance at end of period 319,760 317,572 -------- -------- Treasury stock: Balance at beginning of year 52,287 49,944 Purchases of treasury stock: Open market 3,394 3,706 Other 183 212 Shares issued to sales associates stock bonus plan and dividend reinvestment plan (609) (940) Exercise of stock options (1,006) (302) -------- -------- Balance at end of period 54,249 52,620 -------- -------- Shares outstanding at end of period 265,511 264,952 ======== ======== 15 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, results of operations, or cash flows. 16 REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The September 30, 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 18. 17 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 Shareholders and Board of Directors AFLAC Incorporated: We have reviewed the consolidated balance sheet of AFLAC Incorporated and subsidiaries as of September 30, 1999, and the related consolidated statements of earnings and comprehensive income for the three-month and nine-month periods ended September 30, 1999 and 1998, and the consolidated statements of shareholders' equity and cash flows for the nine-month periods ended September 30, 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 October 26, 1999 18 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 Three significant items affected our net earnings during 1998 and 1999. Due to a corporate income tax rate reduction enacted in Japan during 1999, the statutory tax rate for AFLAC Japan declined from 41.7% to 36.2%. This tax rate decline caused a reduction in our deferred income tax liability which was recognized in the first quarter of 1999 and increased net earnings by $67 million ($.25 per basic share and $.24 per diluted share) for the nine months ended September 30, 1999. Also, due to a similar corporate income tax rate reduction in Japan enacted during 1998, the statutory tax rate for AFLAC Japan declined from 45.3% to 41.7%. The related deferred tax effect was recognized in the first quarter of 1998 and increased net earnings by $121 million ($.45 per basic share and $.44 per diluted share) for the nine months ended September 30, 1998. For additional information on these income tax reductions, 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. 19 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)
Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------- -------------------------------------- Percentage Change 1999 1998 Percentage Change 1999 1998 ----------------- ------------------ ----------------- ----------------- Operating earnings: AFLAC Japan....................... 40.4% $ 171 $ 122 31.5% $ 481 $ 366 AFLAC U.S......................... 10.6 65 59 11.9 191 171 All other business segments....... (2) (1) (2) - ----- ----- ----- ----- Total business segments......... 29.8 234 180 24.8 670 537 Interest expense, non-insurance operations........ (71.3) (4) (2) (34.2) (10) (8) Corporate and eliminations........ 49.5 (7) (15) 31.5 (28) (40) ----- ----- ----- ----- Pretax operating earnings....... 36.4 223 163 29.3 632 489 Income taxes...................... 45.4 80 55 30.4 227 174 ----- ----- ----- ----- Operating earnings.............. 31.8 143 108 28.7 405 315 Non-operating items: Deferred tax benefit from Japanese tax rate reductions............. - - 67 121 Provision for the Japanese mandated policyholder protection fund, net of tax..... - - - (65) Realized investment gains (losses), net of tax............ 1 - (3) - ----- ----- ----- ----- Net earnings.................... 33.5 $ 144 $ 108 26.7 $ 469 $ 371 ===== ===== ===== ===== Operating earnings per basic share.. 31.7 $ .54 $ .41 28.8 $ 1.52 $ 1.18 Operating earnings per diluted share 33.3 .52 .39 28.9 1.47 1.14 ===== ===== ===== ===== Net earnings per basic share........ 35.0 $ .54 $ .40 27.3 $ 1.77 $ 1.39 Net earnings per diluted share...... 33.3 .52 .39 26.9 1.70 1.34 ===== ===== ===== ===== ========================================================================================================================== 20
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 income 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. 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 Consolidated Supplemental Data (For the periods ended September 30, 1999) Three Months Nine Months Operating Results Operating Results --------------------- --------------------- Including Excluding Including Excluding Currency Currency Currency Currency Changes Changes* Changes Changes* --------- --------- --------- --------- Premium income 29.9% 10.3% 22.3% 9.5% Net investment income 26.3 11.8 19.7 10.0 Operating revenues 29.2 10.5 21.8 9.5 Total benefits and expenses 28.5 9.0 21.0 8.3 Operating earnings 31.8 20.1 28.7 20.9 Operating earnings per share 33.3 20.5 28.9 21.1 - ---------------------------------------------------------------------------- * 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 113.68 and 139.92 for the three months ended September 30, 1999 and 1998, and 117.09 and 134.57 for the nine months ended September 30, 1999 and 1998, respectively. The strengthening of the yen in 1999 increased operating earnings per share by approximately $.05 for the three months ended September 30, 1999, and $.09 for the nine months ended September 30, 1999. Operating earnings per share as reported increased 33.3% to $.52 for the three-month period ended September 30, 1999, compared with the same period in 1998 and increased 28.9% to $1.47 for the nine-month period ended September 30, 1999, compared with the same period in 1998. Operating earnings per share, excluding the effect of foreign currency translation, increased 20.5% for the quarter and 21.1% for the nine months ended September 30, 1999. 21 Our primary financial objective is the growth of operating earnings per share before the effect of foreign currency fluctuations. Our 1999 objective for growth in operating earnings per share is 20% before the effect of currency translation. Our objective for 2000 and 2001 is to increase operating earnings-per-share growth by 15% to 17%, excluding currency fluctuation. As we look to the next year, we will strive to perform at the high end of that range. If our 1999 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 @ 110.00 $ 2.03 30.1% $ .16 1999 @ 115.00 1.98 26.9 .11 1999 @ 120.00 1.94 24.4 .07 1999 @ 125.00 1.91 22.4 .04 1999 @ 130.89* 1.87 19.9 - 1999 @ 135.00 1.85 18.6 (.02) 1999 @ 140.00 1.82 16.7 (.05) 1999 @ 145.00 1.80 15.4 (.07) *Actual exchange rate for the year ended December 31, 1998. If the exchange rate as of September 30, 1999, remains constant for the rest of 1999, the cumulative average rate would be approximately 114.56 and the annual operating diluted earnings per share would approximate $1.98, assuming our earnings objective is met. SHARE REPURCHASE PROGRAM During the third quarter of 1999, we purchased 844,400 shares of our common stock. At the end of the third quarter of 1999, we had approximately 4.0 million shares still available for purchase under current repurchase authorizations. We have purchased 60.7 million shares (through September 30, 1999) since the inception of the share repurchase program. INCOME TAXES Our combined U.S. and Japanese effective income tax rates on operating earnings for the nine months ended September 30, 1999 and 1998, were 35.9% and 35.5%, respectively. Income tax expense for 1999 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 nine months ended September 30, 1999, was 35.5%. The 1999 reduction in the statutory tax rate in Japan, which was 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 22 provisions. We expect our effective income tax rate on operating earnings 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. 23 The following table presents a summary of AFLAC Japan's operating results. AFLAC JAPAN SUMMARY OF OPERATING RESULTS Three Months Ended Nine Months Ended September 30, September 30, (In millions) 1999 1998 1999 1998 ------------------ ------------------ Premium income................. $ 1,501 $ 1,115 $ 4,271 $ 3,425 Investment income.............. 280 218 804 666 Other income................... 2 1 3 2 ------ ------ ------ ------ Total revenues............... 1,783 1,334 5,078 4,093 ------ ------ ------ ------ Benefits and claims............ 1,280 969 3,648 2,983 Operating expenses............. 332 243 949 744 ------ ------ ------ ------ Total benefits and expenses.. 1,612 1,212 4,597 3,727 ------ ------ ------ ------ Pretax operating earnings.. $ 171 $ 122 $ 481 $ 366 ====== ====== ====== ====== - ---------------------------------------------------------------------------- Percentage changes in dollars over previous period: Premium income............... 34.6% (9.9)% 24.7% (5.3)% Investment income............ 28.4 (5.2) 20.8 (.2) Total revenues............... 33.6 (9.1) 24.1 (4.5) Pretax operating earnings.... 40.3 (8.9) 31.5 (4.3) - ---------------------------------------------------------------------------- Percentage changes in yen over previous period: Premium income............... 9.4% 7.0% 8.5% 6.5% Investment income............ 3.7 12.5 4.9 12.3 Total revenues............... 8.5 7.9 7.9 7.4 Pretax operating earnings.... 13.0 7.9 13.8 7.7 - ---------------------------------------------------------------------------- Ratios to total revenues: Benefits and claims.......... 71.9% 72.6% 71.8% 72.9% Operating expenses........... 18.6 18.3 18.7 18.2 Pretax operating earnings.... 9.5 9.1 9.5 8.9 ============================================================================ AFLAC JAPAN SALES AND MARKETING The increase in premium income in yen was due to sales of new policies and strong policy persistency. AFLAC Japan's sales results exceeded our expectations during the quarter. New annualized premium sales during the third quarter were 20.2 billion yen ($177 million), or 2.0% higher than a year ago. The 2.0% 24 increase in new business follows an exceptionally strong second quarter during which sales increased 30.6%. Our record second quarter sales results benefited from intensified sales campaigns in advance of a July premium rate increase on new business. Rider MAX, which provides accident and supplemental benefits to our cancer life plans, continued to sell very well, accounting for approximately 42% of sales during the quarter. Our ordinary life products also sold well in the quarter, increasing 129% over the third quarter of 1998. For the nine months, new sales were up 17.6% to 63.0 billion yen, or $537 million. We also stayed very focused on expanding our distribution system in Japan. Specifically, we have been aggressively recruiting new individual agencies to complement our vast channel of corporate agencies. Individual agencies allow us to better serve Japan's small businesses and individual customers, which we believe is a vast and under-penetrated market. During the first nine months of 1999, we recruited approximately 2,000 new agencies. Our target is to add 3,000 new agencies this year. Management set an objective for AFLAC Japan sales to increase 10% to 15% for the year 1999 compared with 1998. We believe our sales results will reflect the high end of the stated target for the full year. AFLAC JAPAN INVESTMENTS To combat the low level of investment yields in Japan, we continued to invest the majority of AFLAC Japan's investable cash flow in reverse dual- currency bonds (bonds with yen principal and paying interest in dollars). By doing so, we were able to invest at yields that provided a significant spread over our reserving assumptions for new business. During the third quarter, we purchased yen-denominated securities at an average yield of 4.90%. Including dollar-denominated investments, our blended new money yield was 5.02% for the quarter. At the end of the third quarter, the yield on AFLAC Japan's debt securities portfolio was 5.21%, compared with 5.24% at the end of 1998. The return on average invested assets, net of investment expenses, was 5.02% for the nine months, compared with 5.30% for the first nine months of 1998. Investment income in yen increased 4.9% for the first nine months of 1999 compared with 12.3% in the same period of 1998. This is due primarily to the effect of translating AFLAC Japan's dollar-denominated investment income into yen. The yen/dollar exchange rate was 117.09 yen to one U.S. dollar for the first nine months of 1999 compared with 134.57 for the first nine months of 1998. The stronger yen has the effect of reducing the dollar-denominated investment income as reported in yen. AFLAC JAPAN OTHER The operating expense ratio has increased due to investments in additional marketing programs including advertising and direct response efforts. The benefits ratio has declined primarily 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 13.0% and 13.8% for the three months and nine months ended September 30, 1999, respectively. This increase was largely due to the lower loss ratio during 1999. 25 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 Months Ended Nine Months Ended September 30, September 30, (In millions) 1999 1998 1999 1998 ------------------ ------------------ Premium income................. $ 346 $ 304 $1,010 $ 887 Investment income.............. 62 55 179 160 Other income................... 1 1 2 3 ----- ----- ----- ----- Total revenues............... 409 360 1,191 1,050 ----- ----- ----- ----- Benefits and claims............ 217 189 630 555 Operating expenses............. 127 112 370 324 ----- ----- ----- ----- Total benefits and expenses.. 344 301 1,000 879 ----- ----- ----- ----- Pretax operating earnings.. $ 65 $ 59 $ 191 $ 171 ===== ===== ===== ===== - ---------------------------------------------------------------------------- Percentage increases over previous period: Premium income............... 13.7% 13.2% 13.9% 12.8% Investment income............ 12.6 12.6 12.2 24.3 Total revenues............... 13.4 13.2 13.4 14.6 Pretax operating earnings.... 10.6 18.5 11.9 30.5 - ---------------------------------------------------------------------------- Ratios to total revenues: Benefits and claims.......... 53.2% 52.3% 52.9% 52.9% Operating expenses........... 30.9 31.4 31.1 30.9 Pretax operating earnings.... 15.9 16.3 16.0 16.2 ============================================================================ AFLAC U.S. SALES As we expected, new annualized premium sales increased at a single- digit rate in the third quarter of 1999. Comparisons to last year's third quarter were difficult due to the enrollment of the largest payroll account in our history a year ago. New annualized premium sales rose 7.6% in the third quarter to $133 million. For the nine months, new sales were up 13.4% to $389 million. Accident/disability insurance continued to be the strongest contributor to our sales although we also experienced solid results from other products. We are very pleased with our latest product introduction -- life insurance for the worksite. These new life products have only been available for nine months, yet they already represent the best product introduction in our history. Management has set an objective for new policy sales to increase by 12% to 15% for the year 1999 compared with 1998. 26 AFLAC U.S. INVESTMENTS Investment income increased 12.2% in the first nine months of 1999 compared with 24.3% 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 that included $125 million of a non-recurring nature. During the first nine months of 1999, available cash flow was invested at an average yield of 7.88% compared with 7.34% during the first nine months of 1998. The overall return on average invested assets, net of investment expenses, was 7.50% for the first nine months of 1999 compared with 7.43% for the first nine months 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 remained relatively stable. 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 September 30, 1999, was 106.95 yen to one U.S. dollar, 8.2% stronger than the exchange rate of 115.70 as of December 31, 1998. Management estimates that the stronger yen rate increased reported investments and cash by $1.9 billion, total assets by $2.2 billion, and total liabilities by $2.2 billion compared with the amounts that would have been reported for 1999 if the exchange rate had remained unchanged from year-end 1998. 27 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 $1.2 billion on investment securities at September 30, 1999, consisted of $2.6 billion in gross unrealized gains and $1.5 billion in gross unrealized losses. AFLAC invests primarily within the Japanese, U.S. and Euroyen debt securities 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: September 30, December 31, 1999 1998 ------------- ------------ AAA 28.8% 38.1% AA 24.4 17.6 A 32.7 31.2 BBB 12.2 13.1 BB 1.9 - ----- ----- 100.0% 100.0% ===== ===== At September 30, 1999, we owned debt securities rated below investment grade in the amount of $554 million at amortized cost, or 1.9% of total debt securities. These securities were issued by entities that had a credit rating downgrade following our purchase of the debt securities. Private placement investments accounted for 48.2% and 43.9% of our total debt securities as of September 30, 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 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. 28 The following table shows an analysis of investment securities (at cost or amortized cost): AFLAC Japan AFLAC U.S. ------------------------- ------------------------- September 30, December 31, September 30, December 31, (In millions) 1999 1998 1999 1998 ------------------------- ------------------------- Available for sale: Fixed-maturity securities $14,472 $12,886 $ 3,316 $ 2,772 Perpetual debentures 2,315 1,344 143 111 Equity securities 38 22 82 79 ------ ------ ------ ------ Total available for sale 16,825 14,252 3,541 2,962 ------ ------ ------ ------ Held to maturity: Fixed-maturity securities 4,240 3,947 - - Perpetual debentures 3,747 3,494 - - ------ ------ ------ ------ Total held to maturity 7,987 7,441 - - ------ ------ ------ ------ Total $24,812 $21,693 $ 3,541 $ 2,962 ====== ====== ====== ====== POLICY LIABILITIES The stronger yen at September 30, 1999, compared with December 31, 1998, increased reported policy liabilities by $1.9 billion. Other increases in policy liabilities were due to the addition of new business and the aging of policies in force. 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 $446 million after discount and issue costs. These proceeds have been temporarily invested in short-term securities and are being used to primarily purchase shares of our common stock. Any remaining net proceeds may be used to repay indebtedness or for general corporate purposes. We have swapped the dollar-denominated principal and interest into yen-denominated obligations. At September 30, 1999, the principal was 55.6 billion yen at an interest rate of 1.67%. See Note 6 of the Notes to the Consolidated Financial Statements for information on other debt outstanding at September 30, 1999. All of our debt is yen-denominated. The stronger yen increased reported debt by $82 million, compared with the amounts that would have been reported for 1999 if the exchange rate had remained unchanged from year-end 1998. 29 Our ratio of debt to total capitalization (debt plus shareholders' equity, excluding the unrealized gains on investment securities) was 28.0% and 19.6% as of September 30, 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 $.7 million for the nine months ended September 30, 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. In the second quarter of 1999, Toho Life Insurance Company was declared insolvent by Japanese government regulators. The policyholder protection fund, established last year, may be used to satisfy Toho's policyholder obligations. Although we cannot be certain, at this time we do not expect another assessment. 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. 30 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 earnings or equity contributions by AFLAC Incorporated from funds generated through debt or equity offerings. In April 1999, we received net proceeds of $446 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 $272 million in the first nine months of 1999, and $192 million and $386 million in the full years 1998 and 1997, respectively. These amounts include annual profit transfers from AFLAC Japan of $243 million in 1999, $154 million in 1998 and $347 million in 1997. 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 September 30, 1999, under the provisions of the recodified SAP. AFLAC's capital and surplus, as determined on the present U.S. statutory accounting basis, was $1.6 billion at September 30, 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 31 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 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 contained 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, tested and internally certified as year 2000 ready substantially all of our critical production systems in both the United States and Japan. This certification process involved remediation of code and extensive testing in our dedicated test environments. We will continue to test these systems through the end of 1999 as a quality control measure. Implementation and internal certification activities for substantially all non-critical systems has also been completed. Based on the facts currently known to us, we do not anticipate significant year 2000 related problems with respect to our critical production or other internal systems. We continue to develop and refine year 2000 contingency plans for our business systems and processes. These plans have been prepared by personnel representing a wide spectrum of the company. While these plans will continue to be periodically updated throughout 1999 based on then current information and the perceived business risk in order to promote a stable technological platform, both our United States and Japanese operations ceased installation of any new significant information technology systems effective October 1999. We have also scheduled "Year 2000 Assurance Weekend" on January 1 - 3, 2000. On these days, AFLAC will use a streamlined team from throughout the company to close year-end books and process actual data from the year 2000. While we do not anticipate that there will be significant internal operational problems related to year 2000, Assurance Weekend is designed to allow us to quickly and effectively respond to any internal or external issues which arise in an actual production environment after January 1, 2000. It is presently anticipated that the workforce will return to normal levels on January 4, 2000, and that any operational problems will have been remedied or effectively addressed from a management and operational perspective. These and other activities undertaken through the contingency planning process will hopefully allow us to effectively respond to material internal or external year 2000 related issues. 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. 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 32 could have a material adverse effect on our financial condition or results of operations. We have randomly surveyed certain group accounts in the United States to determine their year 2000 readiness. The results of these survey efforts have not disclosed any year 2000 related issues in our U.S. group account customer base that, either taken individually or as a group, reasonably indicate that we will experience major disruptions in premium payments in the United States. 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 certain of our more significant customers and payment agents in Japan to determine whether they expect their ability to pay premiums or transmit policy and claims data to be impacted by year 2000 issues. The results of our survey efforts in Japan have not disclosed any significant year 2000 related issues with our Japanese payment agents or our more significant customers that, either taken individually or as a group, reasonably indicate that we will experience major disruptions in premium payments in Japan. The reliability of the U.S. and Japanese surveys depends on the extent to which responses are accurate and complete and that our conclusions from these responses accurately represent the year 2000 readiness of our customers and Japanese payment agents. In addition to our survey efforts, testing with our key external customers and suppliers began during the second quarter of 1999 and is now substantially complete. While this testing currently has not revealed any widespread year 2000 related problems that would reasonably be expected to have a material impact on our ability to conduct business in the normal course, any adverse results from this testing will be addressed to the extent reasonably possible and incorporated into our ongoing contingency planning process. AFLAC owns publicly traded and privately placed debt 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. Since the inception of the year 2000 project, we had incurred costs of approximately $30 million for system upgrades or modifications through September 30, 1999. Of this amount, approximately $11 million was capitalized. The remaining cost to complete the various projects is currently estimated to be $4 million. We may determine that additional expenditures are necessary as the program continues to evolve. 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. Moreover, while we have attempted to gather as much information as reasonably possible with respect to the manner in which year 2000 related issues may impact our operations in Japan, it should be noted that there have been widespread reports that Japan will not, in general, be as well prepared for year 2000 events as the United States. We are unable to validate these reports, except through our survey and testing efforts discussed herein. 33 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 AFLAC Incorporated is part of an investment group that acquired NovaCare Employee Services, Inc. AFLAC Incorporated paid $14 million for an approximate 19% equity interest in NovaCare Employee Services, Inc. which is a national professional employer organization that provides small- to medium-sized businesses with human resource services. In May 1999, AFLAC Incorporated was added to the Standard & Poor's 500 index. On October 25, 1999, the board of directors approved a quarterly cash dividend of $.075 per share. The dividend is payable on December 1, 1999, to shareholders of record at the close of business on November 18, 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 longer than that of the related invested assets due to the unavailability of acceptable yen-denominated long-duration securities. Currently, when our debt securities mature, the proceeds are reinvested at a yield below that of the interest required for the accretion of policy benefit liabilities on policies issued in earlier years. However, the investment yield on new investments exceeds interest requirements on policies issued in recent years. Since 1994, premium rates have been increased several times to help offset the lower investment yields available. At September 30, 1999 we had $1.1 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 $2.5 billion based on our portfolio as of September 30, 1999. The effect on yen-denominated debt securities is approximately $2.2 billion and the effect on dollar-denominated debt securities is approximately $373 million. We had outstanding interest rate swaps on a portion of our variable- interest-rate yen-denominated borrowings at September 30, 1999. These swaps 34 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 September 30, 1999, we also had yen-denominated bank borrowings in the amount of 23.5 billion yen ($221 million) with a variable interest rate of .34%. 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 September 30, 1999, totaled $181 million, or .6% 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 1.0. 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%, or $18 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. AFLAC Incorporated has a currency swap on its $450 million senior notes. We have swapped the dollar-denominated principal and interest into yen-denominated obligations. This swap has been designated as a hedge of our investment in AFLAC Japan. The unrealized foreign currency translation gains and losses related to this swap are reported in accumulated other comprehensive income. 35 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 (September 30, 1999) 91.95 106.95* 121.95 (In millions) Yen Yen Yen --------- --------- -------- Yen-denominated financial instruments: Assets: Securities available for sale: Fixed maturities $ 16,994 $ 14,611 $ 12,814 Perpetual debentures 2,366 2,034 1,784 Equity securities 55 47 42 Securities held to maturity: Fixed maturities 4,931 4,240 3,718 Perpetual debentures 4,359 3,747 3,286 Cash and cash equivalents 398 342 300 Other financial instruments 15 13 11 ------- ------- ------- Total 29,118 25,034 21,955 ------- ------- ------- Liabilities - notes payable 1,232 1,059 929 ------- ------- ------- Net yen-denominated financial instruments 27,886 23,975 21,026 Other yen-denominated assets 4,230 3,638 3,190 Other yen-denominated liabilities (31,942) (27,463) (24,085) ------- ------- ------- Total yen-denominated net assets subject to foreign currency fluctuation $ 174 $ 150 $ 131 ======= ======= ======= * Actual September 30, 1999 exchange rate For information regarding the effect of foreign currency translation on operating earnings per share, see Foreign Currency Translation on page 21. 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 36 any other statements made by company 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. 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, results of operations, or cash flows. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 12.0 - Ratio of Earnings to Fixed Charges 27.0 - Financial Data Schedule (for SEC use only) (b) Reports on Form 8-K: We did not file any reports on Form 8-K during the quarter ended September 30, 1999. 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 November 10, 1999 /s/ KRISS CLONINGER, III ------------------------ --------------------------- KRISS CLONINGER,III Executive Vice President; Treasurer and Chief Financial Officer Date November 10, 1999 /s/ NORMAN P. FOSTER ------------------------ --------------------------- NORMAN P. FOSTER Executive Vice President, Corporate Finance 38 EXHIBITS FILED WITH CURRENT FORM 10-Q: 12.0 - Ratio of Earnings to Fixed Charges 27.0 - Financial Data Schedule (for SEC use only). 39 39 EX-12 2 RATIO OF EARNINGS EXHIBIT 12.0 AFLAC INCORPORATED AND SUBSIDIARIES Ratio of Earnings to Fixed Charges
(In thousands) Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 -------- -------- -------- -------- Fixed charges: Interest expense $ 5,036 $ 2,814 $ 13,220 $ 9,478 Rental expense deemed interest 143 91 385 289 ------- ------- ------- ------- Total fixed charges $ 5,179 $ 2,905 $ 13,605 $ 9,767 ======= ======= ======= ======= Earnings before income tax $219,711 $161,470 $619,302 $375,183 Add back: Fixed charges 5,179 2,905 13,605 9,767 ------- ------- ------- ------- Total earnings before income tax and fixed charges 224,890 164,375 632,907 384,950 Adjustments: Realized gains/(losses) (3,056) (1,863) (12,375) (2,131) ------- ------- ------- ------- Total earnings before income tax and fixed charges and realized gains/(losses) $227,946 $166,238 $645,282 $387,081 ======= ======= ======= ======= Earnings excluding realized gains/(losses) to fixed charges 44.0x 57.2x 47.4x 39.6x
EX-27 3 FDS FOR 9/30/99
7 This schedule contains summary financial information extracted from the Company's consolidated financial statements as filed in Form 10-Q for the quarter ended September 30, 1999, and is qualified in its entirety by reference to such financial statements. 1,000,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 21,688 7,987 7,646 181 0 0 29,875 534 0 3,486 35,225 27,199 335 0 292 1,079 0 0 32 3,740 35,225 5,281 992 (12) 14 4,277 183 1,196 619 150 469 0 0 0 469 1.77 1.70 0 0 0 0 0 0 0 Includes $67 benefit from Japanese tax rate reduction, $.25 per basic share and $.24 per diluted share.
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