Aflac Incorporated (AFL)

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AFLAC Incorporated (AFL)

September 09, 2012 8:00 pm ET

Executives

Robin Y. Wilkey - Senior Vice President of Investor & Rating Agency Relations

Ichiro Murakami

Kriss Cloninger - President, Chief Financial Officer, Treasurer, Director, Chief Financial Officer of American Family Life Assurance Company and Executive Vice President of American Family Life Assurance Company

Toru Tonoike - President of Aflac Japan and Chief Operating Officer of Aflac Japan

Koji Ariyoshi - Executive Vice President of Aflac Japan and Director of Marketing & Sales - Aflac Japan

Hiroshi Takeuchi

Yuichi Sugiyama

Hisayuki Shinkai - Senior Vice President and Director of Sales

Koji Yokota

Charles D. Lake - Chairman of Aflac Japan

Jun Isonaka - Chief Administrative Officer of Aflac Japan and First Senior Vice President of Aflac Japan

Eric M. Kirsch - Global Chief Investment Officer and Executive Vice President of Global Investments

Hitoshi Oda

Susan R. Blanck - Executive Vice President of Corporate Actuary and First Senior Vice President of Aflac Japan

Analysts

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Scott Russell - Macquarie Research

Stephan Petersen

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Jeffrey R. Schuman - Keefe, Bruyette, & Woods, Inc., Research Division

Suneet L. Kamath - UBS Investment Bank, Research Division

Edward A. Spehar - BofA Merrill Lynch, Research Division

Ryan Krueger - Dowling & Partners Securities, LLC

Sean Dargan - Macquarie Research

Presentation

Robin Y. Wilkey

Good morning. I'm Robin Wilkey, Senior Vice President of Investor and Rating Agency Relations, and I want to welcome all of you today to the event. The good news is, I'll only be up here a short period of time; and my colleague, Ichiro Murakami San, who is the manager of Investor Relations here. He and his team, have done a great job in organizing the event and he is going to be the emcee for today. So with that, I'm going to turn that over to him. But before he starts, I do have a bit of news. A couple of people have asked about Wi-Fi reception, and the hotel does not have Wi-Fi reception as of now. So they're working on it, but as of now, they do not have it and I apologize for that.

Ichiro Murakami

Thank you, Robin San. My name is Ichiro Murakami, general manager of IR department here in Tokyo. And good morning again, everyone. I'm glad to have so many of you can join today.

Before we start, though I just want to cover a couple of things to help make today run smoothly. This is important as our event is being webcast. Also, if you need assistance, Aflac employees will have all name badges are oranges on top and blue on the bottom to make them more easily identifiable.

First, in the morning session, we are going to focus primarily on marketing and sales activities of Aflac Japan. Additionally, we will have presentations representing 3 different distribution channels. Following these presentations, there will be a Q&A for the morning session. Please note that external speakers are only available to take questions in this morning's session. We will then break for lunch. Then, we will reconvene the afternoon session at 1:00 p.m. In the afternoon, we will cover Japan's public policy and regulatory environment, administration, investments, as well as financials. After that, we will have another Q&A conclude today's meeting. Although I'm sure you will probably have a lot of questions, please just hold them until those Q&A sessions.

Today, we are providing translation services. Please use the earpiece in front of you and turn it into Channel 2 for English and 1 for Japanese translation services whenever you find you need. In that regard, please note that all speeches, except for that of our agency, will be delivered in English. But in the 2 Q&A sessions, we probably be -- have more back-and-forth between the 2 languages.

Before we begin today's program, let me first remind you that some of statements you will hear today are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Our actual results could differ materially from those we discuss today. And please look at our latest 10-Q filing for some of the various risk factors that could materially impact our results. Also, please remember this presentation is being webcast. [Operator Instructions] Also, there will be 2 Q&A question today, so there will be ample time to get your questions answered.

With those announcements out of the way, we will begin this morning's program with a few words from Aflac Incorporated President and CFO, Kriss Cloninger. Kriss Cloninger graduated from the University of Texas at Austin with Bachelors and Masters degrees in Business Administration. He joined Aflac in 1992 as Senior Vice President and Chief Financial Officer. In 1993, he was promoted to Executive Vice President. In 2001, he was appointed President of Aflac and elected to the Board of Directors. He's primarily responsible for overseeing the financial management of all company operations. He has been named Best CFO in the Insurance Life Category in America by Institutional Investor magazine 3 times. Chris also serves on the Board of Directors for Tupperware Brand Corporation and Total Systems Inc. So Kriss San, give us a few words. Thank you.

Kriss Cloninger

Okay. Thank you, Murakami San. And let me add my welcome to you. Because of the presentations that follow are specific to Japan, I wanted to take the opportunity to make a few opening remarks about the overall status of things within the corporation and I'll be available during the Q&A sessions too, but they'll be primarily focused on Japan, so I'm going to make a few opening remarks about our sales in the U.S. and Japan, our capital management activities and our expectations for EPS growth. I'll first touch on our expectation for sales in the U.S.

For the first half of the year, total new annualized premium sales rose 3%, which you'll recall was at the low end of our 2012 sales target of a 3% to 8% increase. As we've discussed, achieving the high end of the range was based on an improvement in the economic landscape in the U.S. And as most of you know, while some aspects of the U.S. economy have shown slight signs of improvement this year, the business environment continues to be difficult, especially for small employers where over 90% of our business is written. As we think of the third quarter, we may see U.S. sales down slightly, though we do expect an improvement in the fourth quarter. And at this point, we still believe our objective of a 3% to 8% increase is achievable. However, it's more likely to come in at the low end of the range.

You'll also recall from our second quarter conference call, we've recently made changes to the sales and marketing structure at Aflac U.S. to enhance our overall sales efforts. And we're also continuing our efforts at enhancing broker sales in the U.S. We believe our new marketing structure and expanded distribution will position us for stronger sales growth in the future. I'd also note that the persistency of the U.S. business remains very strong and continues to help drive our revenue and earnings growth in the U.S. operation. Overall, we believe Aflac U.S. will have a very good year in its financial performance.

Now, a few words about Aflac Japan, which you'll hear more about shortly. Sales here continue to be strong, especially through the bank channel. For the third quarter, we expect sales to be up significantly over last year. While Ariyoshi San and Shinkai San will give you more details later, I want to reiterate that we expect to achieve a sales increase of 20% to 25% in 2012. I'd remind you that this represents a significant increase from our original target of flat to up 5%. Of course, our very strong sales results in 2012 will cause difficult sales comparisons in 2013. But like Aflac U.S., we expect the Aflac Japan to continue to generate solid financial results for the year, reflecting both strong sales and persistency and new money yields that should exceed our original budget. With our operating segments performing very well, I want to reaffirm the 2012 EPS objective that we communicated in the second quarter conference call. We expect to see an increase in operating earnings per diluted share toward the low end of the 3% to 6% range, excluding the impact of the yen. I also want to reaffirm our 2013 EPS target. We expect operating earnings per diluted share in 2013 to increase 4% to 7%, again on a currency neutral basis.

Let me comment briefly on our thoughts on capital management. Our strong capital ratios show that we're committed to maintaining financial results -- financial strength for all concerned: Our policyholders, our bondholders and our shareholders. We need to be balanced in our approach to deploying capital. That means that first and foremost, we'll maintain strong capital ratios. We'll likely increase dividends in line with our EPS growth on the currency neutral basis and we'll look to repurchase our shares to enhance our EPS growth and returns. I want to stress that we will be prudent in my decision -- and any decision we will make, we'll certainly take into account challenges within the macroeconomic environment, especially as it relates to Europe. However, given the strength of our capital ratios and our Parent Company liquidity, we believe we can allocate up to $100 million toward the purchase of our shares in the fourth quarter of this year. Purchasing shares late in the year will not have much of an impact on this year's earnings growth, although it will benefit our 2013 per share results. As we have frequently discussed, profit repatriation remains the primary source for funding share repurchase. At the end of the second quarter, we communicated our profit repatriation outlook for 2013, reflecting incurred investment losses to date. You may remember from the second quarter call that our profit repatriation was likely to be around JPY 65 billion in 2013, and we still believe that's a reasonable estimate assuming that we have no additional material investment losses that would reduce Aflac Japan's operating income. If we continue to feel comfortable with our capital ratios and the overall macro environment, next year's profit repatriation could provide us with significant amount of capital that could be deployed for share repurchase.

I know this covers a lot of ground in a few minutes, but remember, we have a Q&A sessions at the end of the program. Let me end by saying, I think you can gain a lot of insight into our Japanese operations from the presentations you're about to receive. So I'm going to turn it back to Murakami San. And once again, let me thank you for traveling so far to join us today. Thank you.

Ichiro Murakami

Thank you very much, Kriss San. Our next speaker is Toru Tonoike. And Tonoike San is a former Aflac Incorporated board member, who joined our management team in 2007. He's President and Chief Operating Officer of Aflac Japan. This morning, he will offer an overview of Aflac Japan and its market. So Tonoike San, please.

Toru Tonoike

Good morning. Today, I'd like to outline the insurance market in Japan and Aflac Japan's business management. After my presentation, our officers will cover the sales and operations of their areas of responsibility. I hope this discussion will give you a further understanding of Aflac Japan's current state, competitive strength and growth opportunities.

Still fresh in our memories is the great East Japan earthquake that hit Japan on March 11, 2011, causing enormous damage, particularly in the Tohoku region. As of July 25, 2012, the death toll stood at 15,867 and 2,904 people are still missing. According to the statistics of the Life Insurance Association of Japan, the amount of claims and the benefits paid for the earthquake damage by the Life Insurance industry as a whole totaled JPY 157.3 billion as of July 31, 2012. Tomorrow marks 1.5 years since the devastating earthquake and I thought it would be appropriate for me to update you on the state of Japanese economy. The lifelines and public services are largely restored and the industries in the affected areas are also seeing a gradual recovery. The graph on the slide shows the comparison of that indices of industrial production between the affected regions and the non-affected regions. The indices of industrial production are comprehensive indices of production, shipments and inventories in the domestic mining and production industries to indicate the state of industrial production activities in Japan. These indices are prepared by the Ministry of Economy, Trade and Industry every month. The indices of industrial production of the affected regions plunged in March 2011 when the earthquake happened, but have almost returned to the levels before the earthquake. Meanwhile, however, the regions severely struck by tsunami and the evacuation zone around the Fukushima number 1 nuclear power plant are in the midst of its recovery from the earthquake. Only 15.5% of the earthquake debris have been cleared and 341,235 people are still evacuated. Striving toward restoration and reconstruction of the second [ph] area, the Japanese government has allocated a special budget of JPY 3.8 trillion for reconstruction for 2012. The great East Japan earthquake had a huge impact on the Japanese economy.

Before the earthquake, exports and industrial production were picking up and we were gradually recovering from the slow economy; however, the earthquake caused a significant decline in industrial production in some areas due to supply chain disruptions and the power supply restrictions. A [indiscernible] significantly pushed down personal consumption and recovery quickly lost its momentum. The graph shows the real GDP growth rates and the contributions of our domestic and foreign demands to the growth rates before and after the earthquake. As you can see, GDP and domestic and foreign demands substantially declined from the January to March 2011 period. For the October to December 2011 period, exports temporarily decreased because of the slowdown in overseas economies and the strength in yen. However, supply-side restrictions were gradually eased, both household and the business sentiment improved and the reconstruction needs became clear. As a result, some areas of our economy, such as domestic demand, are showing modest signs of returning to levels seen prior to the disaster.

Now, I'd like to update you on the insurance market here in Japan. The number of life insurance policies in force in Japan increased last year due to strong bank sales and the growth in the policy count of subsector products, including cancer and medical insurance. The total number of policies in force for all life insurance rose 5.3 million from March 2011, to 127.2 million at the end of March 2012. Of that 127.2 million, 48.4 million came from third sector products. Aflac Japan's number of policies in force has been steadily increasing over the past 38 years as a result of growth in new business and high persistency of our in force business. We established a solid position as Japan's #1 life insurance company in terms of the number of individual policies in force in fiscal year 2003 and have remained #1 since then. Aflac's number of policies in force at the end of March 2012 exceeded 21.8 million and accounted for 17% of total number of individual policies in force of all the life insurance in Japan.

The total number of new standalone life insurance policies in Japan, including first sector and third sector products, declined from fiscal year 2003 through fiscal year 2006. However, this number turned upward in fiscal year 2007. The increase reflects the fact that life insurance statistics began including new policies sold by Kampo, previously known as Japan Post Insurance. Kampo, a company that exclusively sells first sector-based policies took over the postal life insurance operation following the start of a privatization process in October 2007. Although the inclusion of Compo in the total life insurance new business increased the overall first sector contribution, thereby reducing the overall third sector contribution, the third sector still accounts for around 40% of combined sales. We believe consumers continue to find value in products that provide living benefits such as cancer and medical.

One major reason consumers choose living benefits centers around Japan's rapidly aging society. According to the latest results of the national census, which is carried out every 5 years, it was in 2010 that Japan's population peaked. Currently, the number of deaths has been exceeding the number of births resulting in a population decline. Japan's population was 127.63 million as of February 2012 and is anticipated to drop below 100 million by 2050.

To support this forecast, let me share with you some results of population estimate conducted by Japan's Ministry of Internal Affairs and Communications as of October 1, 2011. According to this estimate, 40 out of Japan's 47 prefectures saw a decline in population. As a large portion of the baby boomers began reaching retirement age, the population aged 65 and older surpassed 30 million, accounting for more than 23.5% of the Japanese population by the end of February 2012. What's more, the primary reason for Japan's shrinking population is its low birthrate. The birthrate was 1.39 in 2011, far below the estimated level of 2.08 that is required to maintain a stable population size. The population in Japan is expected to continue to decline because young people represent a decline in percentage of the total population, as the birthrate remains very low. As shown in the graph, national medical expenses are rising every year with the rapid aging of the Japanese Society. Japan has a national healthcare system that covers all Japanese citizens; however, as fiscal resources are tight in all areas, including medical, nursing care and pension benefits, it is clear that the difficult fiscal situation will persist going forward. According to the government's estimate, the nation's medical expenses will increase by JPY 6 trillion by 2015 and JPY 21 trillion by 2025.

As you can see, the growth of medical expenses is significantly outpacing GDP growth. Under the circumstances, the government has been pursuing a comprehensive reform of the Social Security and taxes systems to ensure a sustainable Social Security system even in such an aging and low birthrate society. The related bills to the reform passed the Diet on August 10 this year, but there are still many issues to be discussed with respect to the specific of the Social Security system. Therefore, Japanese citizens continue to require to make self help efforts preparing for their life after retirement. Against this backdrop, the market for third sector products has been steadily expanding and this trend is expected to continue. As a natural consequence, the competition among private insurers in the third sector market has intensified; however, we believe we can expand our leading position of the [indiscernible] market continues its growth in the future.

When Aflac began its operations in Japan in 1974, we were the first life insurance company to sell cancer insurance in Japan. However, mid-sized insurers and other foreign insurers followed suit and entered the market in the early 1980s. This market was open to all life and nonlife insurance in 2001. As of July 2012, Japan had total 39 competitors selling standalone medical products and 26 selling standalone cancer products, including both life and nonlife companies. While this represents slight declines from previous years in the actual number of competitors, it doesn't mean the threat from competitors is lessening. The margin of some nonlife insurers result in the merger of their subsidiary life insurers, thereby reducing the total number of competitors. Given a series of new products launches and product revisions in the pipeline from our competitors, we believe the market for third sector products will remain very competitive.

Amid this competitive market, newspapers reported in June 2012 that the financial services agency is planning to lower the assumed interest rate of standard reserves or a standard interest rate in April 2013 from 1.5% to 1% for the first time in 12 years. The standard interest rate is an interest rate used to calculate appropriate levels of policy reserves which life insurers maintain in accordance with changes in the investment environment. The life insurers determine their assumed interest rates based on the standard interest rate. Every year, the standard interest rate is calculated by the FSA based on average 10-year JGB yield as of September using the lesser of the 3-year average or the 10-year average. This graph shows the yields on JGBs for the October 2009 to July 2012 period, which are taken into account in the computation of the standard interest rate to be applied from April 2013. JGB yield has been at ultralow levels of around 1% since the beginning of 2012 after the European debt crisis emerged. Given the yields to date, it is considered virtually certain that standard interest rate will be lower in April 2013.

If the standard interest rate is lowered, life insurers have to make additional provisions for their policy reserves under the insurance business act. In order to secure funds for additional provisions, it is necessary to consider raising assumed interest rates or insurance premiums. With this FSA move in mind, we are currently considering revisions to product design and premium rates. The impact on overall profitability will be discussed by Sue Blanck in the financial results update session to be held in the afternoon.

Next, I'd like to show you some data related to Aflac Japan's core lines of business: Cancer and medical products. These slides reflect FSA-based fiscal year data and include products sold only by life insurers. The data reflects the latest figures based on each life insurance financial statements for fiscal year 2011. Additionally, some nonlife insurers also sell medical insurance products. Because third sector sales data is not disclosed by nonlife companies, we are not able to include it in the statistics shown on these slides. The graph on the left side shows that a number of policies in force for standalone cancer products in the life insurance industries growing each year. The graph on the right side illustrates Aflac Japan's share of in force business for cancer insurance. Aflac Japan remains the market leader with a market share of 74% of in force cancer business as of March 31, 2012. As shown in the graph on the right side, AFLAC's share of new business for cancer insurance remains high at 49.4% for April 2011 to March 2012 period. Aflac's share in the cancer insurance market rose in 2011, thanks to the strong sales of DAYS. This enhanced product has benefits that provide extensive coverage for outpatient treatments in light of the latest advances in cancer treatment and the changing demand of cancer patients. This product certainly serve as a culmination of AFLAC Japan. DAYS attracted a lot of consumers and further solidified our presence in the market. At the same time as I mentioned, we vigorously promoted partnerships with local governments in cancer prevention and education and we have partnership agreement with all of the 47 prefectures in Japan. Following the enactment of the Cancer Control act, local governments and the consumers are increasingly aware of the necessity for cancer prevention and insurance. Because Aflac is a pioneer of cancer insurance coverage, consumers have placed their trust in our company and our products. We work hard each day to be good stewards of that trust. We do not only continue our never-ending efforts to create superior products that remain relevant to diverse consumer needs, but also focus on cancer education activities, providing the latest information on cancer prevention and cutting-edge medical treatment through the network of local governments. I believe that these activities are our social responsibility of the insurer who has supported the largest number of customers fighting against cancer in Japan. This slide illustrates the growth of policies in force for standalone medical insurance and Aflac Japan's share of the market. Aflac has a 19% share of in-force business at the end of March 2012. Although we are not the first insurer to enter the medical insurance market in Japan, we quickly became the leader in that market when we launched EVER in 2002 and we are committed to remain in that position.

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