AFLAC INCORPORATED OPERATIONS
Certain statements included in this section constitute forward-looking statements within the meaning of theU.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are made based on management's current expectations and beliefs concerning future developments and their potential effects upon the Company. The Company's actual results may differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. Certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements can be found in the "Risk Factors" and "Forward-Looking Statements" sections herein. MD&A OVERVIEW The following financial review provides a discussion of the Company's results of operations and financial condition, as well as a summary of the Company's critical accounting estimates. This section should be read in conjunction with Part I - Item 1. Business and the audited consolidated financial statements and accompanying notes included in Part II - Item 8. Financial Statements and Supplementary Data of this report. This MD&A is divided into the following sections: Page Executive Summary 33 Industry Trends 35 Outlook 36 Results of Operations 37 Investments 51 Hedging Activities 55 Policy Liabilities 58 Benefit Plans 59 Policyholder Protection 59 Liquidity and Capital Resources 59 Critical Accounting Estimates 66 The Company elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented in Item 8. Financial Statements and Supplementary Data. Readers should refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 , filed onFebruary 23, 2021 , for reference to discussion of the year endedDecember 31, 2019 , the earliest of the three years presented. Amounts reported in this MD&A may not foot due to rounding. 32
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY
COVID-19
The impact of the COVID-19 global pandemic on the Company continues to evolve.
Both Aflac Japan and Aflac U.S. have taken measures to address employee health
and safety and increase employees' ability to develop and maintain more flexible
working conditions, with return to office undertaken as warranted by local
conditions, and operations have remained stable throughout 2021. The Company
continues to monitor its investment portfolios to adjust to market conditions,
including the continuing recovery, changes in monetary policy and inflation.
Both Aflac Japan and Aflac U.S. have accelerated investments in digital
initiatives to improve productivity, efficiency and customer service over the
long term.
In 2021, sales for Aflac Japan in yen terms increased 7.7%, compared to 2020,
reflecting the launch of a new medical product in January 2021 and a new nursing
care product in September 2021 , and favorable comparisons due to pandemic
conditions in 2020. In 2021, sales for Aflac U.S. increased 16.9%, compared to
2020, reflecting increased sales activity as a result of the ongoing economic
reopening in the U.S. and favorable comparisons due to pandemic conditions in
2020.
Pandemic-related claims and associated reserve increases in both Japan and the
U.S. did not materially impact financial results in 2021 and were more than
offset by a reduction in claims related to non-COVID-19 medical needs. The
pandemic's impact on economic conditions contributed to sales declines in 2020
and headwinds to sales in 2021, pressuring premium growth rates, which have been
partially offset by lower lapse rates in the U.S. The Company has not
experienced material realized losses or impairments and credit losses associated
with the pandemic. The Company continues to monitor the effects and risks of
COVID-19, including its variants (both known and emerging), to assess its impact
on economic conditions in Japan and the U.S. and on the Company's business,
financial condition, results of operations, liquidity and capital position.
Those impacts may cause changes to estimates of future earnings, capital
deployment, regulatory capital position, segment dividend payout ratios and
other measures the Company provides in this MD&A.
The Company's efforts and other developments are outlined below.
•Investment Portfolio
The Company's investment portfolio was well-positioned entering the crisis, and the Company continues to follow its strategy of investing primarily in fixed maturity securities to generate a reliable stream of income. Fundamental credit analysis and actively managing the risk profile of the portfolio contributed to the current quality of the Company's investments. Economic and market conditions have continued to improve since the onset of the pandemic. The continued path of the recovery remains uncertain given the potential longer term impacts of the pandemic. This includes structural changes in employment patterns which are impacting multiple sectors of the economy and contributing to disruptions in the global supply chain, triggering price increases across several areas of the broader economy. Supply shortages, upward pressure on wages to attract employees and higher commodity prices have all driven near-term increases in inflation. It remains unclear whether the current elevated levels of inflation are transitory or more lasting, making the ultimate impact on the global economy and markets uncertain, with resulting uncertainty as to the impact on the Company's investments.
•Aflac Japan initiatives
As of
Aflac Japan remains focused on generating new business from existing and prospective customers through direct mail and digital methods.Aflac Japan has also accelerated investments in digital and paperless initiatives designed to increase long term productivity, efficiency, customer service and business continuity.
•Aflac
As ofDecember 31, 2021 , over 50% ofU.S. employees were working remotely. The Company's return to worksite forU.S. based employees is expected to be a phased approach that begins in the first quarter of 2022, subject to factors including vaccination rates, the return schedule of school systems and the availability of child care, the 33
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations number of COVID-19 cases and the COVID-19 replication rate, and the emergence of new variants and hospital capacity in areas of theU.S. where the Company has significant operations. For those employees who are working in one of the Company's worksites, safety protocols have been put in place that align with or exceed those recommended by theCenters for Disease Control and Prevention (CDC ). After the return to worksite, the Parent Company and AflacU.S. expect to adopt a workforce model comprised of a mix of full time office employees, full time remote employees, and employees who will split their time between office and remote work.
AflacU.S. policy sales, enrollment and agent recruiting functions are highly dependent upon face-to-face interaction between independent agents and brokers with prospective and new customers and agents. Throughout the pandemic, opportunities for such interaction have been significantly reduced by reactions to the pandemic, such as social distancing, shelter in place orders and work from home initiatives. Notwithstanding the general improvement of economic conditions to date, the impact of pandemic conditions on AflacU.S. sales remains subject to uncertainty as the effects of varying levels of vaccination and the emergence of COVID-19 variants continue to develop. AflacU.S. has accelerated investments in digital initiatives designed to improve long term productivity, efficiency and customer service. Further, AflacU.S. is in its third year of the build-out of its business in the Consumer Markets channel for the digital direct-to-consumer sale of insurance and sales made through that platform have continued to grow.
•Major government initiatives
Government authorities inJapan and theU.S. have implemented several initiatives in response to the COVID-19 pandemic, including actions designed to mitigate the adverse health effects of the virus and those designed to provide broad-based relief and economic support to all aspects of the economy. The FSA has requested that financial service providers inJapan respond appropriately while continuing their essential operations. This request includes insurance companies, which have been asked to continue essential operations such as benefits and claims payment, including policyholder loans. The FSA has also requested insurance companies to consider flexible interpretation and application of insurance policy provisions and measures required for products from the standpoint of protecting policyholders. In accordance with the FSA's request,Aflac Japan implemented a measure to pay accidental death benefits and accidental serious disability benefits under its accidental death benefit rider in cases of death or specified serious disabilities from COVID-19. Throughout the pandemic,Aflac Japan has also followed the guidance of the FSA in terms of treating customers with care, ensuring ease and timeliness of claims payments and extended coverage for temporary medical facilities and telemedicine in certain circumstances, and waiver of interest on certain policyholder loans. In mid-2021, in response to the state of emergency declaration issued by theGovernment of Japan inJuly 2021 andAugust 2021 , the grace period on certain premium payments was extended toJanuary 31, 2022 andFebruary 28, 2022 , respectively. Throughout the pandemic, AflacU.S. has taken steps to comply with COVID-19-related directives issued by state regulatory authorities, including those requiring or requesting premium grace periods. As ofDecember 31, 2021 , premium grace periods remained in effect in two states andPuerto Rico . AflacU.S. continues to work with policyholders in these states upon notification of COVID-19-related impacts. AflacU.S. experienced some increase in policy lapses in 2021 in certain states where premium grace periods expired. As the few remaining premium grace periods expire, AflacU.S. expects an increase in lapse rates, and a decrease in corresponding persistency rates.
Performance Highlights
For the full year of 2021, total revenues were down .2% to$22.1 billion , compared with$22.1 billion for the full year of 2020. Net earnings were$4.3 billion , or$6.39 per diluted share, compared with$4.8 billion , or$6.67 per diluted share, for the full year of 2020. Net earnings in 2020 reflect a$1.4 billion benefit primarily from the release of valuation allowances on deferred foreign tax credits, which were allowed due toU.S. tax regulations released inSeptember 2020 . 34
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results for 2021 included pretax net investment gains of$468 million , compared with net investment losses of$270 million in 2020. Net investment gains in 2021 included a decrease in credit loss allowances of$27 million ;$264 million of net gains from certain derivative and foreign currency gains or losses;$164 million of net gains on equity securities; and$13 million of net gains from sales and redemptions.
The average yen/dollar exchange rate(1) in 2021 was 109.79, or 2.7% weaker than the rate of 106.86 in 2020.
Adjusted earnings(2) for the full year of 2021 were$4.0 billion , or$5.94 per diluted share, compared with$3.6 billion , or$4.96 per diluted share, in 2020. The weaker yen/dollar exchange rate impacted adjusted earnings per diluted share by$.06 . Total investments and cash atDecember 31, 2021 were$143.0 billion , compared with$149.8 billion atDecember 31, 2020 . In 2021,Aflac Incorporated repurchased$2.3 billion , or 43.3 million of its common shares. AtDecember 31, 2021 , the Company had 55.8 million remaining shares authorized for repurchase. Shareholders' equity was$33.3 billion , or$50.99 per share, atDecember 31, 2021 , compared with$33.6 billion , or$48.46 per share, atDecember 31, 2020 . Shareholders' equity atDecember 31, 2021 included a net unrealized gain on investment securities and derivatives of$9.6 billion , compared with a net unrealized gain of$10.3 billion atDecember 31, 2020 . Shareholders' equity atDecember 31, 2021 also included an unrealized foreign currency translation loss of$2.0 billion , compared with an unrealized foreign currency translation loss of$1.1 billion atDecember 31, 2020 . The annualized return on average shareholders' equity in 2021 was 12.9%. Shareholders' equity excluding accumulated other comprehensive income (AOCI) (adjusted book value)(2) was$25.9 billion , or$39.65 per share atDecember 31, 2021 , compared with$24.6 billion , or$35.56 per share, atDecember 31, 2020 . The annualized adjusted return on equity excluding foreign currency impact(2) in 2021 was 16.1%.(1) Yen /U.S. dollar exchange rates are based on the publishedMUFG Bank, Ltd. telegraphic transfer middle rate (TTM). (2) See the Results of Operations section of this MD&A for a definition of this non-U.S. GAAP financial measure. INDUSTRY TRENDS
The Company is impacted by financial markets, economic conditions, regulatory oversight and a variety of trends that affect the industries where it competes.
Financial and Economic Environment
The Company's business and results of operations are materially affected by conditions in the global capital markets and the economy generally. Stressed conditions, volatility and disruptions in global capital markets, particular markets, or financial asset classes can have an adverse effect on the Company, in part because the Company has a large investment portfolio and its insurance liabilities and derivatives are sensitive to changing market factors. See Item 1A. Risk Factors for the risk factor entitled, "Difficult conditions in global capital markets and the economy, including those caused by COVID-19, could have a material adverse effect on the Company's investments, capital position, revenue, profitability, and liquidity and harm the Company's business."
Demographics
Aflac Japan Segment
With Japan's aging population and the rise in healthcare costs, supplemental health care insurance products remain attractive. However, due to the aging population and decline in birthrate, new opportunities for customer demographics are not as readily available. Japan's existing customers and potential customers seek products that are easily understood, cost-effective and can be accessed through technology-enabled devices.
Aflac
Customer demographics continue to evolve and new opportunities present
themselves in different customer segments such as the millennial and
multicultural markets. Customer expectations and preferences are changing.
Trends indicate existing customers and potential customers seek cost-effective
solutions that are easily understood and can be accessed through
technology-enabled devices. Additionally, income protection and the health needs
of retiring baby boomers are continuing to shape the insurance industry.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Regulatory Environment
See Item 1. Business - Aflac Japan Government Regulation and Aflac
Competitive Environment
See Item 1. Business - Aflac Japan Competitive Markets and Aflac
2022 OUTLOOK
The Company's strategy to drive long-term shareholder value is to pursue growth
through product development, distribution expansion and digital advancements to
improve the customer experience.
The Company's objectives in 2022 are to navigate the COVID-19 pandemic while
maintaining strong pre-tax margins in its Aflac Japan and Aflac U.S. segments,
continuing to invest in digital technology, and integrating and building upon
recent acquisitions. The Company believes that its strategy of positioning
itself for future growth and efficiency while defending and leveraging its
market-leading position, powerful brand recognition and diverse distribution in
Japan and the U.S. will provide support toward these objectives.
The Company announced a 21.2% increase in the first quarter 2022 dividend
compared to the prior quarter, and it intends to maintain strong capital ratios
in Aflac Japan and Aflac U.S. in support of its commitment to shareholder
dividends while remaining tactical in its deployment of capital in the form of
share repurchases and opportunistic investments. The Company intends to maintain
a minimum SMR of 500% for Aflac Japan and a target minimum RBC of approximately
400% for Aflac, consistent with the Company's risk management practices.
Aflac Japan Segment
ForAflac Japan , the Company anticipates that the shift in premiums over the last five years from first sector savings products to third sector cancer and medical products and first sector protection products, will continue to result in moderately lower benefit ratios in the Aflac Japan segment. The Company expects that benefit and expense ratios will continue to experience some level of revenue pressure due to the impact of paid up policies and reduced sales during the COVID-19 pandemic. For the 2022 through 2023 period, the Company expects a decline inAflac Japan revenue in the range of 3.0% to 4.0% on a compound annual growth rate basis, with a benefit ratio in the range of 67.0% to 69.0% and an expense ratio in the range of 20.5% to 22.5%. The Company expectsAflac Japan to continue to operate with an expense ratio toward the upper end of the range in 2022. AflacU.S. Segment For AflacU.S. , the Company expects benefit ratios to normalize in 2022 and for expense ratios to remain elevated in light of investments intoU.S. platforms, while revenues that have faced pressure due to the impact of the global pandemic are anticipated to return to growth in the near term. For the 2022 through 2023 period, the Company expects AflacU.S. revenue growth of 1.0% to 4.0% on a compound annual growth rate basis, with a benefit ratio in the range of 48.0% to 52.0% and an expense ratio in the range of 38.0% to 41.0%.
Corporate and other
The Company expects Corporate and other results to reflect stable net investment
income in 2022 compared to 2021, assuming that
For important disclosures applicable to statements made in this 2022 Outlook,
please see the Risk Factors section and the statement on Forward-Looking
Information at the beginning of Item 1. Business, the Risk Factors identified in
Item 1A. and Item 7. Management Discussion and Analysis.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
The Company earns its revenues principally from insurance premiums and
investments. The Company's operating expenses primarily consist of insurance
benefits provided and reserves established for anticipated future insurance
benefits, general business expenses, commissions and other costs of selling and
servicing its products. Profitability for the Company depends principally on its
ability to price its insurance products at a level that enables the Company to
earn a margin over the costs associated with providing benefits and
administering those products. Profitability also depends on, among other items,
actuarial and policyholder behavior experience on insurance products, and the
Company's ability to attract and retain customer assets, generate and maintain
favorable investment results, effectively deploy capital and utilize tax
capacity, and manage expenses.
This document includes references to the Company's financial performance
measures which are not calculated in accordance with United States generally
accepted accounting principles (U.S. GAAP) (non-U.S. GAAP). The financial
measures exclude items that the Company believes may obscure the underlying
fundamentals and trends in insurance operations because they tend to be driven
by general economic conditions and events or related to infrequent activities
not directly associated with insurance operations.
Due to the size of Aflac Japan , where the functional currency is the Japanese
yen, fluctuations in the yen/dollar exchange rate can have a significant effect
on reported results. In periods when the yen weakens, translating yen into
dollars results in fewer dollars being reported. When the yen strengthens,
translating yen into dollars results in more dollars being reported.
Consequently, yen weakening has the effect of suppressing current period results
in relation to the comparable prior period, while yen strengthening has the
effect of magnifying current period results in relation to the comparable prior
period. A significant portion of the Company's business is conducted in yen and
never converted into dollars but translated into dollars for U.S. GAAP reporting
purposes, which results in foreign currency impact to earnings, cash flows and
book value on a U.S. GAAP basis. Management evaluates the Company's financial
performance both including and excluding the impact of foreign currency
translation to monitor, respectively, cumulative currency impacts on book value
and the currency-neutral operating performance over time. The average yen/dollar
exchange rate is based on the published MUFG Bank, Ltd. telegraphic transfer
middle rate (TTM).
The Company defines the non-
•Adjusted earnings are adjusted revenues less benefits and adjusted expenses. Adjusted earnings per share (basic or diluted) are the adjusted earnings for the period divided by the weighted average outstanding shares (basic or diluted) for the period presented. The adjustments to both revenues and expenses account for certain items that cannot be predicted or that are outside management's control. Adjusted revenues areU.S. GAAP total revenues excluding adjusted net investment gains and losses. Adjusted expenses areU.S. GAAP total acquisition and operating expenses including the impact of interest cash flows from derivatives associated with notes payable but excluding any nonrecurring or other items not associated with the normal course of the Company's insurance operations and that do not reflect the Company's underlying business performance. Management uses adjusted earnings and adjusted earnings per diluted share to evaluate the financial performance of the Company's insurance operations on a consolidated basis and believes that a presentation of these financial measures is vitally important to an understanding of the underlying profitability drivers and trends of the Company's insurance business. The most comparableU.S. GAAP financial measures for adjusted earnings and adjusted earnings per share (basic or diluted) are net earnings and net earnings per share, respectively. •Adjusted net investment gains and losses are net investment gains and losses adjusted for i) amortized hedge cost/income related to foreign currency exposure management strategies and certain derivative activity, ii) net interest cash flows from foreign currency and interest rate derivatives associated with certain investment strategies, which are both reclassified to net investment income, and iii) the impact of interest cash flows from derivatives associated with notes payable, which is reclassified to interest expense as a component of total adjusted expenses. The Company considers adjusted net investment gains and losses important as it represents the remainder amount that is considered outside management's control, while excluding the components that are within management's control and are accordingly reclassified to net investment income and interest expense. The most comparableU.S. GAAP financial measure for adjusted net investment gains and losses is net investment gains and losses. •Amortized hedge costs/income represent costs/income incurred or recognized as a result of using foreign currency derivatives to hedge certain foreign exchange risks in the Company's Japan segment or in Corporate and other. These amortized hedge costs/ income are estimated at the inception of the derivatives based on the specific terms of each contract and are recognized on a straight-line basis over the term of the hedge. The 37 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Company believes that amortized hedge costs/income measure the periodic currency risk management costs/income related to hedging certain foreign currency exchange risks and are an important component of net investment income. There is no comparableU.S. GAAP financial measure for amortized hedge costs/ income. •Adjusted earnings excluding current period foreign currency impact are computed using the average foreign currency exchange rate for the comparable prior-year period, which eliminates fluctuations driven solely by foreign currency exchange rate changes. Adjusted earnings per diluted share excluding current period foreign currency impact is adjusted earnings excluding current period foreign currency impact divided by the weighted average outstanding diluted shares for the period presented. The Company considers adjusted earnings excluding current period foreign currency impact and adjusted earnings per diluted share excluding current period foreign currency impact important because a significant portion of the Company's business is conducted inJapan and foreign exchange rates are outside management's control; therefore, the Company believes it is important to understand the impact of translating foreign currency (primarily Japanese yen) intoU.S. dollars. The most comparableU.S. GAAP financial measures for adjusted earnings excluding current period foreign currency impact and adjusted earnings per diluted share excluding current period foreign currency impact are net earnings and net earnings per share, respectively. •Adjusted book value is theU.S. GAAP book value (representing total shareholders' equity), less AOCI as recorded on theU.S. GAAP balance sheet. Adjusted book value per common share is adjusted book value at the period end divided by the ending outstanding common shares for the period presented. The Company considers adjusted book value and adjusted book value per common share important as they exclude AOCI, which fluctuates due to market movements that are outside management's control. The most comparableU.S. GAAP financial measures for adjusted book value and adjusted book value per common share are total book value and total book value per common share, respectively. •Adjusted return on equity excluding foreign currency impact is adjusted earnings excluding the current period foreign currency impact divided by average shareholders' equity, excluding AOCI. The Company considers adjusted return on equity excluding foreign currency impact important as it excludes changes in foreign currency and components of AOCI, which fluctuate due to market movements that are outside management's control. The most comparableU.S. GAAP financial measure for adjusted return on equity excluding foreign currency impact is ROE as determined using net earnings and average total shareholders' equity. •U.S. dollar-denominated investment income excluding foreign currency impact represents amounts excluding foreign currency impact onU.S. dollar-denominated investment income using the average foreign currency exchange rate for the comparable prior year period. The Company considersU.S. dollar-denominated investment income excluding foreign currency impact important as it eliminates the impact of foreign currency changes on the Aflac Japan segment results, which are outside management's control. The most comparableU.S. GAAP financial measure forU.S. dollar-denominated investment income excluding foreign currency impact is the corresponding net investment income amount from theU.S. dollar denominated investments translated to yen. The following table is a reconciliation of items impacting adjusted earnings and adjusted earnings per diluted share to the most directly comparableU.S. GAAP financial measures of net earnings and net earnings per diluted share, respectively, for the years endedDecember 31 . 38
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Reconciliation of Net Earnings to Adjusted Earnings
In Millions Per Diluted Share
2021 2020 2021 2020
Net earnings $ 4,325 $ 4,778 $ 6.39 $ 6.67
Items impacting net earnings:
Adjusted net investment (gains) losses (1) (462) 229 (.68) .32
Other and non-recurring (income) loss 73 28 .11 .04
Income tax (benefit) expense on items
excluded from adjusted earnings 83 (72) .12 (.10) Tax valuation allowance release (2) 0 (1,411) .00 (1.97) Adjusted earnings 4,019 3,552 5.94 4.96 Current period foreign currency impact (3) 38 N/A .06 N/A
Adjusted earnings excluding current period
foreign currency impact$ 4,057 $ 3,552 $ 6.00 $ 4.96 (1) See reconciliation of net investment (gains) losses to adjusted net investment (gains) losses below. (2) One-time tax benefit recognized in 2020 representing the release of valuation allowances on deferred foreign tax credits due to new tax regulations. (3) Prior period foreign currency impact reflected as "N/A" to isolate change for current period only. Reconciling Items
Net Investment Gains and Losses
Reconciliation of Net Investment (Gains) Losses to Adjusted Net Investment
(Gains) Losses
(In millions) 2021 2020
Net investment (gains) losses $ (468) $ 270
Items impacting net investment (gains) losses:
Amortized hedge costs (76) (206)
Amortized hedge income 57 97
Net interest cash flows from derivatives associated with certain investment strategies
(30) 12
Interest rate component of the change in fair value of foreign currency swaps on
notes payable 55 56 Adjusted net investment (gains) losses $
(462)
The Company's investment strategy is to invest primarily in fixed maturity securities to provide a reliable stream of investment income, which is one of the drivers of the Company's profitability. This investment strategy incorporates asset-liability matching (ALM) to align the expected cash flows of the portfolio to the needs of the Company's liability structure. The Company does not purchase securities with the intent of generating investment gains or losses. However, investment gains and losses may be realized as a result of changes in the financial markets and the creditworthiness of specific issuers, tax planning strategies, and/or general portfolio management and rebalancing. The realization of investment gains and losses is independent of the underwriting and administration of the Company's insurance products. Net investment gains and losses excluded from adjusted earnings include the following: •Securities Transactions •Credit Losses •Changes in the Fair Value ofEquity Securities •Certain Derivative and Foreign Currency Activities.
Securities Transactions, Credit Losses and Changes in the Fair Value of
Securities transactions include gains and losses from sales and redemptions of
investments where the amount received is different from the amortized cost of
the investment. Credit losses include losses for held-to-maturity fixed maturity
securities, available-for-sale fixed maturity securities, loan receivables, loan
commitments and reinsurance recoverables. Changes in the fair value of equity
securities are the result of gains or losses driven by fluctuations in market
prices.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain Derivative and Foreign Currency Activities
The Company's derivative activities include:
•foreign currency forwards and options used in hedging foreign exchange risk onU.S. dollar-denominated investments inAflac Japan's portfolio, with options used on a standalone basis and/or in a collar strategy
•foreign currency forwards and options used to economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long term exposure to a weakening yen
•cross-currency interest rate swaps, also referred to as foreign currency swaps, associated with certain senior notes and subordinated debentures
•foreign currency swaps that are associated with VIE bond purchase commitments, and investments in special-purpose entities, including VIEs where the Company is the primary beneficiary
•interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments
•interest rate swaptions used to hedge changes in the fair value associated with
interest rate fluctuations for certain
•bond purchase commitments at the inception of investments in consolidated VIEs.
Gains and losses are recognized as a result of valuing these derivatives, net of the effects of hedge accounting. The Company also excludes from adjusted earnings the accounting impacts of remeasurement associated with changes in the foreign currency exchange rate. For additional information regarding net investment gains and losses, including details of reported amounts for the periods presented, see Notes 3 and 4 of the Notes to the Consolidated Financial Statements.
Other and Non-recurring Items
TheU.S. insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. The system can result in periodic charges to the Company as a result of insolvencies/bankruptcies that occur with other companies in the life insurance industry. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. These charges neither relate to the ordinary course of the Company's business nor reflect the Company's underlying business performance, but result from external situations not controlled by the Company. The Company excludes any charges associated withU.S. guaranty fund assessments and the corresponding tax benefit or expense from adjusted earnings. In Japan, the government also requires the insurance industry to contribute to a policyholder protection corporation that provides funds for the policyholders of insolvent insurers; however, these costs are calculated and administered differently than in theU.S. In Japan, these costs are not directly related to specific insolvencies or bankruptcies, but are rather a regular operational cost for an insurance company. Based on this structure, the Company does not remove the Japan policyholder protection expenses from adjusted earnings. Other items excluded from adjusted earnings included integration costs related to the Company's acquisition ofZurich North America's U.S. Corporate Life and Pensions business; these costs primarily consist of expenditures for legal, accounting, consulting, integration of systems and processes and other similar services. These integration costs amounted to$26 million and$13 million for the years endedDecember 31, 2021 and 2020, respectively. The Company considers the costs associated with the early redemption of its debt to be unrelated to the underlying fundamentals and trends in its insurance operations. Additionally, these costs are driven by changes in interest rates subsequent to the issuance of the debt, and the Company considers these interest rate changes to represent economic conditions not directly associated with its insurance operations. InMay 2021 , the Parent Company used a portion of the net proceeds from itsApril 2021 issuance of various series of senior notes to redeem$700 million of its 3.625% senior notes dueJune 2023 . The pretax expense due to the early redemption of these notes was$48 million . InJanuary 2020 , the Parent Company used the net proceeds from senior notes issued inDecember 2019 to redeem$350 million of its 4.00% senior notes dueFebruary 2022 . The pretax expense due to the early redemption of these notes was$15 million . 40
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Income Taxes
The Company's combinedU.S. and Japanese effective income tax rate on pretax earnings was 18.7% in 2021 and (14.9)% in 2020. In 2021, the combined effective tax rate differs from theU.S. statutory rate primarily due to new tax regulations released in the third quarter of 2020 and historic and solar tax credits. In 2020, the combined effective tax rate differs from theU.S. statutory rate primarily due to the release of certain valuation allowances established on the Company's deferred foreign tax credit benefits. The release of these valuation allowances was a result of the issuance of Final and Proposed Regulations by theU.S. Treasury and Internal Revenue Service inSeptember 2020 , and resulted in a one-time income tax benefit of$1.4 billion in the third quarter of 2020. Total income taxes were$1.0 billion in 2021 and$(.6) billion in 2020. Japanese income taxes onAflac Japan's results account for most of the Company's consolidated income tax expense.
For additional information, see Note 10 of the Notes to the Consolidated Financial Statements and the Critical Accounting Estimates - Income Taxes section of this MD&A.
The Company expects that its effective tax rate for future periods will be approximately 20%. The effective tax rate continues to be subject to future tax law changes both in theU.S. and in foreign jurisdictions. See the risk factor entitled "Tax rates applicable to the Company may change" in Part I, Item 1A. Risk Factors for more information.
Foreign Currency Translation
Aflac Japan's premiums and a significant portion of its investment income are received in yen, and its claims and most expenses are paid in yen.Aflac Japan purchases yen-denominated assets andU.S. dollar-denominated assets, which may be hedged to yen, to support yen-denominated policy liabilities. Yen-denominated income statement accounts are translated toU.S. dollars using the weighted average Japanese yen/U.S. dollar foreign exchange rate for the reporting period, except realized gains and losses on securities transactions which are translated at the exchange rate on the trade date of each transaction. Yen-denominated balance sheet accounts are translated toU.S. dollars using the spot Japanese yen/U.S. dollar foreign exchange rate at the end of the reporting period. RESULTS OF OPERATIONS BY SEGMENTU.S. GAAP financial reporting requires that a company report financial and descriptive information about operating segments in its annual and interim period financial statements. Furthermore, the Company is required to report a measure of segment profit or loss, certain revenue and expense items, and segment assets. The Company's insurance business consists of two segments:Aflac Japan and AflacU.S. Aflac Japan is the principal contributor to consolidated earnings. In addition, the Parent Company, other business units that are not individually reportable, and business activities, including reinsurance retrocession activities, not included inAflac Japan or AflacU.S. are included in Corporate and other. See the Item 1. Business section of this Form 10-K for a summary of each segment's products and distribution channels.
Consistent with
•Operating Ratios •New Annualized Premium Sales •New Money Yield •Return on Average Invested Assets •Average Weekly Producer For additional information on the Company's performance measures included in this MD&A, see the Glossary of Selected Terms found directly following Part IV. See Note 2 of the Notes to the Consolidated Financial Statements for the reconciliation of segment results to the Company's consolidatedU.S. GAAP results and additional information. 41
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
AFLAC JAPAN SEGMENTAflac Japan Pretax Adjusted Earnings
Changes inAflac Japan's pretax adjusted earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results forAflac Japan for the years endedDecember 31 . Aflac Japan Summary of Operating Results
(In millions) 2021 2020 Net earned premiums$ 11,853 $ 12,670 Net investment income:(1) Yen -denominated investment income 1,262
1,296
U.S. dollar-denominated investment income 1,845
1,569
Net investment income 3,107
2,865
Amortized hedge costs related to certain foreign currency
exposure management strategies 76
206
Adjusted net investment income 3,031 2,659 Other income (loss) 41 42 Total adjusted revenues 14,925 15,371 Benefits and claims, net 7,963 8,851 Adjusted expenses: Amortization of deferred policy acquisition costs 653 644 Insurance commissions 706 740 Insurance and other expenses 1,849 1,873 Total adjusted expenses 3,208 3,257 Total benefits and adjusted expenses 11,171
12,108
Pretax adjusted earnings$ 3,754 $ 3,263 Weighted-average yen/dollar exchange rate 109.79 106.86 In Dollars In Yen Percentage change over previous period: 2021 2020 2021 2020 Net earned premiums (6.4) % (.8) % (3.9) % (2.8) % Adjusted net investment income 14.0 6.5 17.6 4.4 Total adjusted revenues (2.9) .4 (.2) (1.7) Pretax adjusted earnings 15.0 .1 18.5 (2.0)
(1) Net interest cash flows from derivatives associated with certain investment
strategies of
In yen terms,Aflac Japan's net earned premiums decreased in 2021, primarily due to constrained sales during the COVID-19 pandemic and an anticipated decrease in first sector and third sector premiums as policies reached premium paid-up status. Adjusted net investment income increased in 2021 primarily due to higher alternative and floating rate income and lower hedge costs. Annualized premiums in force atDecember 31, 2021 , were ¥1.36 trillion, compared with ¥1.43 trillion in 2020. The decrease in annualized premiums in force in yen of 4.7% in 2021 and 4.2% in 2020 was driven primarily by limited-pay products reaching paid up status and lower sales during the COVID-19 pandemic. Annualized premiums in force, translated into dollars at respective year-end exchange rates, were$11.8 billion in 2021 and$13.8 billion in 2020.Aflac Japan's investment portfolios includeU.S. dollar-denominated securities and reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments). In years when the yen strengthens in relation to the dollar, translatingAflac Japan's U.S. dollar-denominated investment income into yen lowers growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms. In years when the yen weakens, translating 42 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsU.S. dollar-denominated investment income into yen magnifies growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms. The following table illustrates the effect of translatingAflac Japan's U.S. dollar-denominated investment income and related items into yen by comparing certain segment results with those that would have been reported had foreign currency exchange rates remained unchanged from the prior year. Amounts excluding foreign currency impact onU.S. dollar-denominated investment income were determined using the average foreign currency exchange rate for the comparable prior year period. See non-U.S. GAAP financial measures defined above. Aflac Japan Percentage Changes Over Prior Year (Yen Operating Results) For the Years Ended December 31, Including Foreign Excluding Foreign Currency Changes Currency Changes 2021 2020 2021 2020 Adjusted net investment income 17.6 % 4.4 % 15.6 % 5.7 % Total adjusted revenues (.2) (1.7) (.5) (1.5) Pretax adjusted earnings 18.5 (2.0) 16.9 (1.0)
The following table presents a summary of operating ratios in yen terms for
Ratios to total adjusted revenues: 2021 2020 Benefits and claims, net 53.3 % 57.6 % Adjusted expenses: Amortization of deferred policy acquisition costs 4.4 4.2 Insurance commissions 4.7 4.8 Insurance and other expenses 12.4 12.2 Total adjusted expenses 21.5 21.2 Pretax adjusted earnings 25.2 21.2 Ratios to total premiums: Benefits and claims, net 67.2 % 69.9 % Adjusted expenses: Amortization of deferred policy acquisition costs 5.5 5.1 In 2021, the benefit ratio to total premiums decreased, compared to the prior year, primarily due to favorable third sector claims experience, higher surrenders inAflac Japan's third sector business, and the continued change in mix of first and third sector business. In 2021, the adjusted expense ratio increased slightly mainly due to an increase in personnel expenses and an increase in advertising expenses related to promotion of new medical and care products. In total for 2021, the pretax adjusted profit margin increased primarily due to lower benefit ratios.
The following table presentsAflac Japan's new annualized premium sales for the years endedDecember 31 . In Dollars In Yen (In millions of dollars and billions of yen) 2021 2020 2021 2020 New annualized premium sales$ 499 $ 477 ¥ 54.8 ¥ 50.9 Increase (decrease) over prior period 4.6 % (34.8) % 7.7 % (36.2) % 43
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following table details the contributions to
2021 2020
Cancer 49.2 % 56.6 %
Medical 37.2 31.2
Income support .5 1.0
Ordinary life:
WAYS .8 .7
Child endowment .3 .4
Other ordinary life (1) 9.0 9.5
Other 3.0 .6
Total 100.0 % 100.0 %
(1) Includes term and whole life
The foundation ofAflac Japan's product portfolio has been, and continues to be, third sector products, which include cancer, medical and income support insurance products.Aflac Japan has been focusing more on promotion of cancer and medical insurance products in this low-interest-rate environment. These products are less interest-rate sensitive and more profitable compared to first sector savings products. With continued cost pressure on Japan's health care system, the Company expects the need for third sector products will continue to rise in the future and that the medical and cancer insurance productsAflac Japan provides will continue to be an important part of its product portfolio. Sales of protection-type first sector and third sector products on a yen basis increased 7.8% in 2021, compared with 2020. The increase reflected the introduction of new products in the first and third quarters of 2021. Nevertheless, during 2021 Aflac Japan continued to face various degrees of COVID-19 related restrictions inJapan that served to limit face-to-face sales opportunities. Sales ofAflac Japan cancer products in theJapan Post Group channel experienced a material decline beginning inAugust 2019 which continued in 2021. Japan Post Group resumed proactive sales of cancer insurance policies onApril 1, 2021 andAflac Japan continues to strengthen the strategic alliance. InApril 2022 , approximately 10,000 employees ofJapan Post Co. are expected to be transferred to Japan Post Insurance.Japan Post Group has informedAflac Japan that these employees' responsibilities will include sales of Japan Post Insurance products andAflac Japan products to the exclusion of other financial products. The Company expects continued collaboration to further position both companies for long-term growth and a gradual improvement ofJapan Post Group cancer insurance sales in the intermediate term. For example, during 2021 Aflac Japan has observed an increase in the number of proposals to potential customers in theJapan Post Group channel, and theJapan Post Group is expected to conduct a nationwide campaign to improve certain sales process practices. For additional information, see the risk factor entitled "Sales of the Company's products and services are dependent on its ability to attract, retain and support a network of qualified sales associates, brokers and employees in theU.S. and sales associates and other distribution partners inJapan ," in Part I, Item 1A. Risk Factors. In response to the COVID-19 pandemic,Aflac Japan continues to promote digital and web-based sales to groups and use of its system that enables smart device-based insurance application by allowing the customer and anAflac Japan operator to see the same screen through their smart devices. Further,Aflac Japan continues to utilize its virtual sales tool that enables online consultations and policy applications to be completed entirely online.
The following table details the contributions to
2021 2020
Independent corporate and individual 51.1 % 52.3 %
Affiliated corporate (1) 43.7 42.6
Bank 5.2 5.1
Total 100.0 % 100.0 %
(1) Includes Japan Post
44-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2021,Aflac Japan recruited 62 new sales agencies. AtDecember 31, 2021 ,Aflac Japan was represented by more than 8,000 sales agencies, with approximately 112,000 licensed sales associates employed by those agencies. The number of sales agencies has declined in recent years due toAflac Japan's focus on supporting agencies with strong management frameworks, high productivity and more producing agents.
At
As previously reported, onDecember 19, 2018 , the Parent Company andAflac Japan entered into a Basic Agreement with Japan Post Holdings Co., Ltd., a Japanese corporation (Japan Post Holdings). Pursuant to the terms of the Basic Agreement, among other items, Japan Post Holdings andAflac Japan agreed to reconfirm existing initiatives regarding cancer insurance and to consider new joint initiatives, including leveraging digital technology in various processes and cooperation in new product development to promote customer-centric business management. InJune 2021 , the Parent Company,Aflac Japan andJapan Post Group agreed to pursue several specific initiatives toward building a "'Co-creation Platform' to support customers and local communities," consistent with Japan Post Group's medium-term management plan announced inMay 2021 . The initiatives are directed at, among other items, the promotion ofAflac Japan cancer insurance, digital transformation within theJapan Post Group , and certain diversity efforts. OnFebruary 28, 2019 , the Parent Company entered a Shareholders Agreement with Japan Post Holdings,J&A Alliance Holdings Corporation , aDelaware corporation, solely in its capacity as trustee ofJ&A Alliance Trust , aNew York voting trust (Trust), andGeneral Incorporated Association J&A Alliance , a Japanese general incorporated association. Pursuant to the Shareholders Agreement, Japan Post Holdings agreed to cause the Trust to use commercially reasonable efforts to acquire, through open market or private block purchases in theU.S. , beneficial ownership of approximately 7% of the Common Stock in connection with the Basic Agreement. According to a Schedule 13G/A filed by Japan Post Holdings with theSEC onJanuary 6, 2021 , the Trust had beneficially acquired 7.45% of the outstanding Common Shares as ofDecember 31, 2020 . Japan Post Holdings is the sole beneficiary of the Trust. OnMay 1, 2020 , the Parent Company filed a registration statement on Form S-3 that registered the sale of its common stock from time to time byJ&A Alliance Holdings Corporation in its capacity as trustee of the Trust. The filing was made strictly pursuant to a contractual requirement contained in the Shareholders Agreement. Notwithstanding the filing of the Form S-3, the Trust continues to be subject to a lockup period for a period expiring four years after the Trust acquired 7% of the Parent Company's outstanding shares. After expiration of such period, the Trust has agreed not to own more than the greater of 10% of the Parent Company's outstanding shares or such shares representing 22.5% of the voting rights in the Parent Company. In light of the fact that the shares acquired by the Trust, like allAflac Incorporated common shares, will be eligible for 10-for-1 voting rights after being held for 48 consecutive months, the Shareholders Agreement further provides for voting restrictions that effectively limit the trustee's voting rights to no more than 20% of the voting rights in the Parent Company and further restrict the trustee's voting rights with respect to certain change in control transactions. Japan Post Holdings will not have a Board seat on the Parent Company's Board of Directors and will not have rights to control, manage or intervene in the management of the Parent Company. The foregoing is subject to and qualified in its entirety by reference to the full text of the Basic Agreement, a copy of which is attached as Exhibit 10.1 to the Company's Current Report on Form 8-K filedDecember 19, 2018 , and the Shareholders Agreement, a copy of which is attached as Exhibit 10.50 to the Company's Quarterly Report on Form 10-Q filedApril 26, 2019 , the terms of which exhibits are incorporated herein by reference.
Aflac Japan Investments
The level of investment income in yen is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, the effect of yen/dollar exchange rates onU.S. dollar-denominated investment income, and other factors. As part of the Company's portfolio management and asset allocation process,Aflac Japan invests in yen andU.S. dollar-denominated investments. Yen-denominated investments primarily consist of JGBs, public and private fixed maturity securities and public equity securities.Aflac Japan's U.S. dollar-denominated investments include fixed maturity investments and growth assets, including alternative investments in limited partnerships or similar investment vehicles.Aflac Japan has been investing in both publicly-traded and privately originatedU.S. dollar-denominated investment-grade 45 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and below-investment-grade fixed maturity securities and loan receivables, and has entered into foreign currency forwards and options to hedge the currency risk on the fair value of a portion of theU.S. dollar investments. The following table details the investment purchases forAflac Japan for the years endedDecember 31 . (In millions) 2021 2020 Yen-denominated: Fixed maturity securities: Japan government and agencies$ 1,208 $ 736 Private placements 695 574 Other fixed maturity securities 171 385 Equity securities 216 276 Other Investments 10 0 Total yen-denominated$ 2,300 $ 1,971 U.S. dollar-denominated: Fixed maturity securities: Other fixed maturity securities$ 1,963 $ 1,393 Infrastructure debt 52 101 Collateralized loan obligations 216 300 Equity securities 8 0 Commercial mortgage and other loans: Transitional real estate loans 1,768 688 Commercial mortgage loans 31 12 Middle market loans 2,428 2,215 Other investments 404 279 Total dollar-denominated$ 6,870 $ 4,988 Total Aflac Japan purchases$ 9,170 $ 6,959
See the Investments section of this MD&A for further discussion of these investment programs, and see Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements for more information regarding loans and loan receivables.
Funds available for investment include cash flows from operations, investment income, and funds generated from maturities, redemptions, securities lending, and other securities transactions. Securities lending is also used from time to time to accelerate the availability of funds for investment. Purchases of securities from period to period are determined based on multiple objectives including appropriate portfolio diversification, the relative value of a potential investment and availability of investment opportunities, liquidity, credit and other risk factors while adhering to the Company's investment policy guidelines.
The following table presents the results of
2021 2020
Total purchases for the period (in millions) (1) $ 8,756 $ 6,680
New money yield (1),(2) 3.50 % 3.75 %
Return on average invested assets (3) 2.72 2.38
Portfolio book yield, including
2.60 % 2.59 %
(1) Includes fixed maturity securities, commercial mortgage and other loans, equity securities, and excludes alternative investments in limited partnerships (2) Reported on a gross yield basis; excludes investment expenses, external management fees, and amortized hedge costs (3) Net of investment expenses and amortized hedge costs, year-to-date number reflected on a quarterly average basis
The decrease in the Aflac Japan new money yield in 2021 was primarily due to lower yields on floating rate asset classes.
46
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
See Notes 3, 4 and 5 of the Notes to the Consolidated Financial Statements and
the Investments and Hedging Activities sections of this MD&A for additional
information on the Company's investments and hedging strategies.
AFLAC U.S. SEGMENT
Aflac
Changes in AflacU.S. pretax adjusted earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results for AflacU.S. for the years endedDecember 31 . Aflac U.S. Summary of Operating Results (In millions) 2021 2020 Net earned premiums$ 5,614 $ 5,758 Adjusted net investment income (1) 754 705 Other income 121 102 Total adjusted revenues 6,489 6,565 Benefits and claims 2,447 2,765 Adjusted expenses: Amortization of deferred policy acquisition costs 517 570 Insurance commissions 550 576 Insurance and other expenses 1,498 1,386 Total adjusted expenses 2,564 2,532 Total benefits and adjusted expenses 5,011 5,297 Pretax adjusted earnings$ 1,478 $ 1,268 Percentage change over previous period: Net earned premiums (2.5) % (.9) % Adjusted net investment income 7.0 (2.1) Total adjusted revenues (1.2) .2 Pretax adjusted earnings 16.6 (.3) (1) Net interest cash flows from derivatives associated with certain investment strategies of$2 and$3 in 2021 and 2020, respectively, have been reclassified from net investment gains (losses) and included in adjusted earnings as a component of net investment income. In 2021, AflacU.S. net earned premiums decreased, primarily due to constrained sales as a result of the COVID-19 pandemic. Total adjusted revenues decreased in 2021, mainly due to the decline in net earned premiums from reduced sales activity, partially offset by the increase in adjusted net investment income from higher variable net investment income. The increase in pretax adjusted earnings was primarily driven by the lower-than-expected benefit ratios due to lower incurred claims related to pandemic conditions. Annualized premiums in force decreased 1.6% in 2021 and decreased 3.2% in 2020. Annualized premiums in force atDecember 31 were$6.0 billion in 2021, compared with$6.1 billion in 2020. 47
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table presents a summary of operating ratios for AflacU.S. for the years endedDecember 31 . Ratios to total adjusted revenues: 2021 2020 Benefits and claims 37.7 % 42.1 % Adjusted expenses: Amortization of deferred policy acquisition costs 8.0 8.7 Insurance commissions 8.5 8.8 Insurance and other expenses 23.1 21.1 Total adjusted expenses 39.5 38.6 Pretax adjusted earnings 22.8 19.3 Ratios to total premiums: Benefits and claims 43.6 48.0 Adjusted expenses: Amortization of deferred policy acquisition costs 9.2 9.9 The benefit ratio to total premiums decreased in 2021, compared with 2020, reflecting reduced estimates of both COVID-19-related and non-COVID-19-related incurred claims since the advent of the pandemic. The adjusted expense ratio increased in 2021, compared with 2020, primarily due to planned spending on buy-to-build investments, offset slightly by lower deferred policy acquisition cost (DAC) amortization related to elevated persistency. The pretax adjusted profit margin increased in 2021 when compared with 2020, primarily due to lower benefit ratios. Aflac U.S. Sales
The following table presents Aflac's
(In millions) 2021 2020 New annualized premium sales$ 1,278 $ 1,093
Increase (decrease) over prior period 16.9 % (30.8) %
New annualized premium sales for accident insurance, the leading AflacU.S. product category, increased 12.7%, disability sales increased 14.2%, critical care insurance sales (including cancer insurance) increased 13.0%, and hospital indemnity insurance sales increased 6.6% in 2021, compared with 2020. The increase in sales for AflacU.S. in 2021 is primarily attributable to increased sales activity as a result of the ongoing economic reopening in theU.S. and favorable comparisons due to pandemic conditions in 2020. AflacU.S. expects this trend of increasing sales to continue in 2022. See the Executive Summary section entitled COVID-19 of this MD&A for additional information.
The following table details the contributions to Aflac's
2021 2020
Accident 25.1 % 26.1 %
Disability 23.1 22.3
Critical care (1) 21.3 22.2
Hospital indemnity 16.4 18.0
Dental/vision 5.1 4.1
Life 9.0 7.3
Total 100.0 % 100.0%
(1) Includes cancer, critical illness and hospital intensive care products
In 2021, the AflacU.S. sales force included an average of approximately 6,000U.S. agents, including brokers, who were actively producing business on a weekly basis. The Company believes that this average weekly producer equivalent metric allows sales management to monitor progress and needs, as well as serve as a leading indicator of future production capacity. AflacU.S. believes that during 2021, constraints in the labor market limited its recruiting of new sales agents, and that limitations on face-to-face sales opportunities during the COVID-19 pandemic suppressed the development of newly recruited agents into business producers and the productivity of veteran agents and brokers. While 48
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
gains were made in recruiting in 2021 compared to 2020, most notably among recruited brokers, AflacU.S. believes that the above factors have acted as a headwind to sales and to growth in the number of average weekly producers during 2021. AflacU.S. remains focused on mitigating and reversing these trends as theU.S. economy continues to recover from the pandemic. In response to the COVID-19 pandemic, AflacU.S. remains focused on supporting its agency channel, most of which are small businesses, by offering financial support and an extended value proposition. The AflacU.S. sales team has pivoted to accommodate preferred enrollment conditions which include realizing sales at the worksite through in-person enrollment, an enrollment call center, video enrollment through co-browsing and self-enrollment. The traditional agent sales team is also using virtual recruiting and training through video conferencing in order to maintain or increase the recruiting pipeline. The AflacU.S. broker sales team is focused on product enhancements due to COVID-19 as well as leveraging technology based solutions to drive enrollment. InNovember 2020 , the Company, through its insurance subsidiaries Aflac and Aflac New York, acquiredZurich North America's U.S. Corporate Life and Pensions business, which consists of group life, disability and absence management products. Aflac and Aflac New York agreed to reinsure on an indemnity basisZurich North America's U.S. in-force group life and disability policies with annualized earned premium of over$100 million . Aflac also acquired assets needed to support the group life and disability business, along with an absence management platform. AflacU.S. Investments
The level of investment income is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, and other factors.
As part of the Company's portfolio management and asset allocation process, AflacU.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. AflacU.S. has been investing in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loan receivables.
The following table details the investment purchases for Aflac
(In millions) 2021 2020
Fixed maturity securities:
Other fixed maturity securities $ 770 $ 573
Infrastructure debt 91 45
Collateralized loan obligations 65 150
Equity securities 213 8
Commercial mortgage and other loans:
Transitional real estate loans 525 143
Commercial mortgage loans 276 52
Middle market loans 190 79
Other investments 45 31
Total Aflac U.S. Purchases $ 2,175 $ 1,081
Funds available for investment include cash flows from operations, investment
income, and funds generated from maturities, redemptions, and other securities
transactions. Purchases of securities from period to period are determined based
on multiple objectives, including appropriate portfolio diversification, the
relative value of a potential investment and availability of investment
opportunities, liquidity, credit and other risk factors while adhering to the
Company's investment policy guidelines.
49
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following table presents the results of Aflac's U.S. investment yields for
the years ended and as of December 31 .
2021 2020
Total purchases for period (in millions) (1)
3.41 % 3.04 %
Return on average invested assets (3) 4.87 4.90
Portfolio book yield, end of period (1) 4.94 % 5.18 %
(1) Includes fixed maturity securities, commercial mortgage and other loans,
equity securities, and excludes alternative investments in limited partnerships
(2) Reported on a gross yield basis; excludes investment expenses and external
management fees
(3) Net of investment expenses, year-to-date number reflected on a quarterly
average basis
The increase in the Aflac
See Note 3 of the Notes to the Consolidated Financial Statements and the Market
Risks of Financial Instruments - Credit Risk subsection of Item 7A. for more
information regarding the sector concentrations of the Company's investments.
CORPORATE AND OTHER
Changes in the pretax adjusted earnings of Corporate and other are primarily
affected by investment income. The following table presents a summary operating
results for Corporate and other for the years ended December 31 .
Corporate and Other Summary of Operating Results(In millions) 2021 2020 Net earned premiums$ 180 $ 194 Net investment income (1) (73) 80
Amortized hedge income related to certain foreign currency
management strategies 57
97
Adjusted net investment income (16) 177 Other income 11 13 Total adjusted revenues 175 384 Benefits and claims, net 166 180 Adjusted expenses: Interest expense 165 164 Other adjusted expenses 142 155 Total adjusted expenses 307 319 Total benefits and adjusted expenses 473 499 Pretax adjusted earnings$ (298) $ (115) (1) The change in value of federal historic rehabilitation and solar investments in partnerships of$138 in 2021 is included as a reduction to net investment income. Tax credits on these investments of$115 in 2021 have been recorded as an income tax benefit in the consolidated statement of earnings. See Note 3 of the Notes to the Consolidated Financial Statements for additional information on these investments. In 2021, the decrease in total adjusted revenues was primarily driven by a decline in adjusted net investment income as a result of the change in value of federal historic rehabilitation and solar investments in partnerships discussed below, as well as lower amortized hedge income. The decrease in pretax adjusted earnings in 2021 was primarily driven by lower adjusted net investment income.The Parent Company invests in partnerships that specialize in rehabilitating historic structures or the installation of solar equipment in order to receive federal historic rehabilitation and solar tax credits. These investments are classified as limited partnerships and included in other investments in the consolidated balance sheet. The change in value of each investment is recorded as a reduction to net investment income. Tax credits generated by these investments are recorded as an income tax benefit in the consolidated statement of earnings. 50
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2020, the Company purchased newly issued common stock of Trupanion, Inc., a provider of medical insurance for pets inthe United States andCanada , resulting in the Company owning approximately 9% of the outstanding common stock of Trupanion, Inc. The shares were registered for resale and, pursuant to the Shareholder Agreement, subject to certain exceptions, the Company has agreed that it will not transfer its shares of Trupanion, Inc. common stock during a restricted period ending onNovember 13, 2023 . The Company also entered into an alliance agreement with Trupanion, Inc. to sell pet insurance in worksites in theU.S. , subject to certain exceptions, and to explore on an exclusive basis potential distribution opportunities for pet insurance inJapan . INVESTMENTS The Company's investment strategy utilizes disciplined asset and liability management while seeking long-term risk-adjusted investment returns and the delivery of stable income within regulatory and capital objectives, and preserving shareholder value. In attempting to optimally balance these objectives, the Company seeks to maintain on behalf ofAflac Japan a diversified portfolio of yen-denominated investment assets,U.S. dollar-denominated investment portfolio hedged back to yen and a portfolio of unhedgedU.S. dollar-denominated assets. As part of the Company's portfolio management and asset allocation process, AflacU.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. AflacU.S. invests in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loans. Additionally, onNovember 17, 2021 , the Company became a signatory to thePrinciples for Responsible Investment , a global framework for incorporating environmental, social and governance (ESG) considerations into investment and ownership decisions.
For additional information concerning the Company's investments, see Notes 3, 4, and 5 of the Notes to the Consolidated Financial Statements.
The following tables detail investments by segment as of
Investment Securities by Segment
2021
Corporate and
(In millions) Aflac Japan Aflac U.S. Other Total
Available for sale, fixed maturity
securities,
at fair value $ 81,793 $ 14,910 $ 1,993 $ 98,696
Held to maturity, fixed maturity
securities,
at amortized cost (1) 22,000 0 0 22,000
Equity securities 714 226 663 1,603
Commercial mortgage and other loans:
Transitional real estate loans (1) 4,226 1,020 45 5,291
Commercial mortgage loans (1) 1,217 669 8 1,894
Middle market loans (1) 4,297 304 0 4,601
Other investments:
Policy loans 216 20 0 236
Short-term investments (2) 590 302 834 1,726
Limited partnerships 1,534 169 155 1,858
Other 0 22 0 22
Total investments 116,587 17,642 3,698 137,927
Cash and cash equivalents 2,053 681 2,317 5,051
Total investments and cash $ 118,640 $ 18,323 $ 6,015 $ 142,978
(1) Net of allowance for credit losses
(2) Includes securities lending collateral
51--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
2020
Corporate and
(In millions) Aflac Japan Aflac U.S. Other Total
Available for sale, fixed maturity
securities,
at fair value $ 88,757 $ 15,133 $ 1,992 $ 105,882
Held to maturity, fixed maturity
securities,
at amortized cost (1) 24,464 0 0 24,464
Equity securities 674 66 543 1,283
Commercial mortgage and other loans:
Transitional real estate loans (1) 4,331 900 0 5,231
Commercial mortgage loans (1) 1,268 420 0 1,688
Middle market loans (1) 3,365 270 0 3,635
Other investments:
Policy loans 242 18 0 260
Short-term investments (2) 449 242 448 1,139
Limited partnerships 828 91 85 1,004
Other 0 26 0 26
Total investments 124,378 17,166 3,068 144,612
Cash and cash equivalents 2,001 785 2,355 5,141
Total investments and cash $ 126,379 $ 17,951 $ 5,423 $ 149,753
(1) Net of allowance for credit losses
(2) Includes securities lending collateral
The ratings of the Company's securities referenced in the table below are based
on the ratings designations provided by major rating organizations such as
Moody's, Standard & Poor's and Fitch or, if not rated, are determined based on
the Company's internal analysis of such securities. When the ratings issued by
the rating agencies differ, the Company utilizes the second lowest rating when
three or more rating agency ratings are available or the lowest rating when only
two rating agency ratings are available.
The distributions of fixed maturity securities the Company owns, by credit
rating, as of
Composition of Fixed Maturity Securities by Credit Rating
2021 2020
Amortized Fair Amortized Fair
Cost Value Cost Value
AAA 1.0 % .9 % 1.0 % .9 %
AA 5.1 5.2 4.5 4.6
A 68.9 68.5 69.3 69.5
BBB 22.5 22.8 21.9 21.9
BB or lower 2.5 2.6 3.3 3.1
Total 100.0 % 100.0 % 100.0 % 100.0 %
As of
The following table presents the 10 largest unrealized loss positions in the
Company's portfolio as of
52--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Credit Amortized Fair
(In millions) Rating Cost Value Unrealized Loss
KLM Royal Dutch Airlines B $ 146 $ 128 $ (18)
Commonwealth of the Bahamas B 42 36 (6)
Intesa Sanpaolo Spa BBB 135 129 (6)
Nippon Prologis REIT Inc. A 87 82 (5)
Grenke Finance PLC BBB 61 56 (5)
Kommunal Landspensjonskasse (KLP) BBB 130 126 (4)
Lloyds Banking Group PLC A 200 196 (4)
Banco de Chile A 174 170 (4)
Mitsui Fudosan Co. Ltd. A 91 88 (3)
Heathrow Funding Ltd. BBB 87 84 (3)
Generally, declines in fair values can be a result of changes in interest rates,
yen/dollar exchange rate, and changes in net spreads driven by a broad market
move or a change in the issuer's underlying credit quality. The Company believes
these issuers have the ability to continue making timely payments of principal
and interest. See the Unrealized Investment Gains and Losses section in Note 3
of the Notes to the Consolidated Financial Statements for further discussions of
unrealized losses related to financial institutions and other corporate
investments.
The Company's portfolio of below-investment-grade securities includes debt
securities purchased while the issuer was rated investment grade plus other
loans and bonds purchased as part of an allocation to that segment of the
market. The following is the Company's below-investment-grade exposure at
Below-Investment-Grade Investments
2021
Unrealized
Par Amortized Fair Gain
(In millions) Value Cost (1) Value (Loss)
Investcorp Capital Limited $ 372 $ 371 $ 373 $ 2
Commerzbank 348 245 397 152
Pemex Project Funding Master Trust 261 261 268 7
Autostrade Per Litalia Spa 174 172 203 31
KLM Royal Dutch Airlines 174 146 128 (18)
Telecom Italia SpA 174 174 218 44
Apache Corporation 138 121 170 49
IKB Deutsche Industriebank AG 113 52 104 52
Arconic Inc. 100 81 118 37
Generalitat de Catalunya 70 27 86 59
Other Issuers 252 250 277 27
Subtotal (2) 2,176 1,900 2,342 442
High yield corporate bonds 842 806
872 66
Middle market loans 4,394 4,260 4,316 56
Grand Total $ 7,412 $ 6,966 $ 7,530 $ 564
(1) Net of allowance for credit losses
(2) Securities initially purchased as investment grade, but have subsequently
been downgraded to below investment grade
The Company invests in middle market loans primarily to U.S. corporate
borrowers, most of which have below-investment-grade ratings. The objectives of
this program include enhancing the yield on invested assets, achieving further
diversification of credit risk, and mitigating the risk of rising interest rates
and hedge costs through the acquisition of floating rate assets.
53--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company maintains an allocation to higher yielding corporate bonds within the Aflac Japan and AflacU.S. portfolios. Most of these securities were rated below-investment-grade at the time of purchase, but the Company also purchased several that were rated investment grade which, because of market pricing, offer yields commensurate with below-investment-grade risk profiles. The objective of this allocation was to enhance the Company's yield on invested assets and further diversify credit risk. All investments in this program must have a minimum rating at purchase of low BB using the Company's above described rating methodology and are managed by the Company's internal credit portfolio management team.
The Company maintains diversification in investments by sector to avoid concentrations to any one sector, thus managing exposure risk. The following table shows the distribution of fixed maturities by sector classification as ofDecember 31 . 2021 Gross Amortized Unrealized Gross Unrealized % of
(In millions) Cost (1) Gains Losses Fair Value Total Government and agencies $ 51,617$ 7,964 $ (61)$ 59,520 48.0 % Municipalities 2,867 613 (7) 3,473 2.7 Mortgage- and asset-backed securities 1,197 52 (3) 1,246 1.1 Public utilities 8,286 1,827 (6) 10,106 7.8 Electric 6,723 1,508 (4) 8,228 6.3 Natural Gas 287 52 0 338 .3 Other 599 127 (1) 725 .6 Utility/Energy 677 140 (1) 815 .6 Sovereign and Supranational 1,496 275 (6) 1,764 1.4 Banks/financial institutions 10,132 1,534 (76) 11,591 9.5 Banking 6,034 994 (30) 6,999 5.6 Insurance 1,881 367 (21) 2,227 1.8 Other 2,217 173 (25) 2,365 2.1 Other corporate 31,774 6,170 (80) 37,865 29.5 Basic Industry 2,844 692 (6) 3,531 2.5 Capital Goods 3,340 576 (8) 3,908 3.1 Communications 3,258 775 (2) 4,031 3.0 Consumer Cyclical 2,688 523 (2) 3,210 2.5 Consumer Non-Cyclical 6,986 1,288 (10) 8,264 6.5 Energy 3,411 754 (12) 4,153 3.2 Other 1,452 204 (3) 1,652 1.4 Technology 4,162 530 (13) 4,679 3.9 Transportation 3,633 828 (24) 4,437 3.4 Total fixed maturity securities $ 107,369$ 18,435 $ (239) $ 125,565 100.0 %
(1) Net of allowance for credit losses
Securities by Type of Issuance
The Company has investments in both publicly and privately issued securities.
The Company's ability to sell either type of security is a function of overall
market liquidity which is impacted by, among other things, the amount of
outstanding securities of a particular issuer or issuance, trading history of
the issue or issuer, overall market conditions, and idiosyncratic events
affecting the specific issue or issuer.
54--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table details investment securities by type of issuance as ofDecember 31 . Investment Securities by Type of Issuance 2021 2020 Amortized Fair Amortized Fair (In millions) Cost (1) Value Cost (1) Value Publicly issued securities: Fixed maturity securities$ 88,552 $ 103,034 $ 95,545 $ 111,479 Equity securities 950 950 740 740 Total publicly issued 89,502 103,984 96,285 112,219 Privately issued securities: (2) Fixed maturity securities (3) 18,817 22,531 20,511 24,802 Equity securities 653 653 543 543 Total privately issued 19,470 23,184 21,054 25,345 Total investment securities$ 108,972 $ 127,168 $ 117,339 $ 137,564
(1) Net of allowance for credit losses
(2) Primarily consists of securities owned by
The following table details the Company's reverse-dual currency securities as of
Reverse-Dual Currency Securities(1)
(Amortized cost, in millions) 2021 2020
Privately issued reverse-dual currency securities $ 4,784
1,596 1,775
Total reverse-dual currency securities $ 6,380 $ 7,075
Reverse-dual currency securities as a percentage of total
investment
securities 5.9 % 6.0 %
(1)Principal payments in yen and interest payments in dollars
Aflac Japan has a portfolio of privately issued securities to better match liability characteristics and secure higher yields than those available on Japanese government or other public corporate bonds.Aflac Japan's investments in yen-denominated privately issued securities consist primarily of non-Japanese issuers, are rated investment grade at purchase and have longer maturities, thereby allowing the Company to improve asset/liability matching and overall investment returns. These securities are generally either privately negotiated arrangements or issued under medium-term note programs and have standard documentation commensurate with credit ratings of the issuer, except when internal credit analysis indicates that additional protective and/or event-risk covenants were required. Many of these investments have protective covenants appropriate to the specific investment. These may include a prohibition of certain activities by the borrower, maintenance of certain financial measures, and specific conditions impacting the payment of the Company's notes. HEDGING ACTIVITIES The Company uses derivative contracts to hedge foreign currency exchange rate risk and interest rate risk. The Company uses various strategies, including derivatives, to manage these risks. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk for more information about market risk and the Company's use of derivatives.
Derivatives are designed to reduce risk on an economic basis while minimizing the impact on financial results. The Company's derivatives programs vary depending on the type of risk being hedged. See Note 4 of the Notes to the Consolidated Financial Statements for:
•A description of the Company's derivatives, hedging strategies and underlying
risk exposure.
•Information about the notional amount and fair market value of the Company's
derivatives.
•The unrealized and realized gains and losses impact on adjusted earnings of
derivatives in cash flow, fair value, net investments in foreign operations, or
non-qualifying hedging relationships.
55--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Foreign Currency Exchange Rate Risk Hedge Program
The Company has deployed the following hedging strategies to mitigate exposure to foreign currency exchange rate risk:
•Aflac Japan hedges
•Aflac Japan maintains certain unhedged
•The Parent Company designates yen-denominated liabilities (notes payable and
loans) as non-derivative hedging instruments and designates certain foreign
currency forwards and options as derivative hedges of the Company's net
investment in
•The Parent Company enters into forward and option contracts to accomplish a dual objective of hedging foreign currency exchange rate risk related to dividend payments by its subsidiary, ALIJ, and reducing enterprise-wide hedge costs. (see Enterprise Corporate Hedging Program below). The following table presents metrics related toAflac Japan's U.S. dollar-denominated hedge program and the Parent Company's enterprise corporate hedging program, including associated amortized hedge costs/income, for the years endedDecember 31 . See the Results of Operations section of this MD&A for the Company's definition of amortized hedge costs/income. 2021 2020Aflac Japan : FX Forwards
FX forward (sell USD, buy yen) notional at end of period (in billions) (1)
$6.4 $6.4 Weighted average remaining tenor (in months) (2) 2.6 12.7 Amortized hedge income (cost) for period (in millions)$(55) $(197) FX Options FX option notional at the end of period (in billions) (1)$11.6 $13.1 Weighted average remaining tenor (in months) (2) 6.0 5.3 Amortized hedge income (cost) for period (in millions)$(22) $(9) Corporate and Other (Parent Company): FX Forwards
FX forward (buy USD, sell yen) notional at end of period (in billions)(1)
$5.0 $5.0 Weighted average remaining tenor (in months)(2) 11.5 12.1 Amortized hedge income (cost) for period (in millions)$62 $102 FX Options FX option notional at the end of period (in billions) (1)$1.9 $2.0 Weighted average remaining tenor (in months) (2) 7.3 7.2 Amortized hedge income (cost) for period (in millions)$(5) $(5) (1) Notional is reported net of any offsetting positions withinAflac Japan or the Parent Company, respectively. (2) Tenor based on period reporting date to settlement date Amortized hedge costs/income can fluctuate based upon many factors, including the derivative notional amount, the length of time of the derivative contract, changes in bothU.S. and Japan interest rates, and supply and demand for dollar funding. Amortized hedge costs/income have fluctuated in recent periods due to changes in the previously mentioned factors.
Aflac Japan buysU.S. dollar-denominated investments, typically corporate bonds, and hedges them back to yen with foreign currency forwards and options to hedge foreign currency exchange rate risk. This economically creates yen assets that match yen liabilities during the life of the derivative and provides favorable capital treatment under the Japan SMR 56 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations calculations. The currency risk being hedged is generally based on fair value of hedged investments. The following table summarizes theU.S. dollar-denominated investments held byAflac Japan as ofDecember 31 . 2021 2020 Amortized Fair Amortized Fair (In millions) Cost (1) Value Cost (1) Value
Available-for-sale securities:
Fixed maturity securities (excluding bank loans)
Fixed maturity securities - bank loans (floating rate) 0 0
319 283
Equity securities 24 24 20 20
Commercial mortgage and other loans:
Transitional real estate loans (floating rate) 4,226 4,293 4,331 4,298 Commercial mortgage loans 1,217 1,265 1,268 1,365 Middle market loans (floating rate) 4,297 4,352 3,365 3,377 Other investments 1,534 1,534 828 828 Total U.S. Dollar Program 28,913 31,946 29,380 31,279
Available-for-sale securities:
Fixed maturity securities - economically converted to yen
2,236 3,328 2,085 3,094
Total
$ 31,149 $
35,274
(1) Net of allowance for credit losses
TheU.S. Dollar Program includes allU.S. dollar-denominated investments inAflac Japan other than the investments in certain consolidated VIEs where the instrument is economically converted to yen as a result of a derivative in the consolidated VIE. The Company uses one-sided foreign currency put options to mitigate the settlement risk onU.S. dollar-denominated assets related to extreme foreign currency rate changes. From time to time,Aflac Japan also maintains a collar program on a portion of itsU.S. Dollar Program to mitigate against more extreme moves in foreign exchange and therefore support SMR. As ofDecember 31, 2021 , there were no collars inAflac Japan , and none of the Company's foreign currency options hedgingAflac Japan's U.S. dollar-denominated assets were in-the-money. In 2021, the Company moved to a strategy that contains one-sided put options, fewer foreign currency forwards and no collars. The Company believes that the new strategy will reduce its exposure to pricing volatility and the related risk of negative settlements should there be a material weakening in the yen. Depending on further developments, including the possibility of further market volatility, there may be additional costs associated with maintaining the options program. The Company is continually evaluating other adjustments, including the possibility of changing the level of hedging employed with theU.S. dollar-denominated investments.
As of
Foreign exchange derivatives used for hedging are periodically settled, which results in cash receipt or payment at maturity or early termination. The following table presents the settlements associated with the Company's currency derivatives used for hedgingAflac Japan's U.S. dollar-denominated investments for the years endedDecember 31 . (In millions) 2021 2020
Net cash inflows (outflows)
Enterprise Corporate Hedging Program
The Company has designated certain yen-denominated liabilities and foreign currency forwards and options of the Parent Company as accounting hedges of its net investment inAflac Japan . The Company's consolidated yen-denominated net asset position was partially hedged at$10.2 billion as ofDecember 31, 2021 , with hedging instruments comprised of$3.3 billion of yen-denominated debt and$6.9 billion of foreign currency forwards and options, compared with$9.9 billion as ofDecember 31, 2020 , with hedging instruments comprised of$2.9 billion of yen-denominated debt and$7.0 billion of foreign currency forwards and options. 57
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The Company makes its accounting designation of net investment hedge at the beginning of each quarter. If the total of the designated Parent Company non-derivative and derivative notional is equal to or less than the Company's net investment inAflac Japan , the hedge is deemed to be effective, and the currency exchange effect on the yen-denominated liabilities and the change in estimated fair value of the derivatives are reported in the unrealized foreign currency component of other comprehensive income. The Company's net investment hedge was effective during the years endedDecember 31, 2021 and 2020, respectively. For additional information on the Company's net investment hedging strategy, see Note 4 of the Notes to the Consolidated Financial Statements. In order to economically mitigate risks associated with the enterprise-wide exposure to the yen and the level and volatility of hedge costs, the Parent Company enters into foreign exchange forward and option contracts. By buyingU.S. dollars and selling yen, the Parent Company is effectively lowering its overall economic exposure to the yen, whileAflac Japan's U.S. dollar exposure remains reduced as a result ofAflac Japan's U.S. Dollar Program that economically creates yen assets. Among other objectives, this strategy is intended to offset the enterprise-wide amortized hedge costs by generating amortized hedge income. This activity is reported in Corporate and Other. The Company continually evaluates the program's efficacy.
Interest Rate Risk Hedge Program
Aflac Japan and AflacU.S. use interest rate swaps from time to time to mitigate the risk of investment income volatility for certain variable-rate investments. Additionally, to manage interest rate risk associated with itsU.S. dollar-denominated investments held byAflac Japan , from time to time the Company utilizes interest rate swaptions. For additional discussion of the risks associated with the foreign currency exposure refer to the Currency Risk section in Item 7A., Quantitative and Qualitative Disclosures about Market Risk, and Item 1A, specifically to the Risk Factors titled "The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate" and "Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity."
See Note 4 of the Notes to the Consolidated Financial Statements for additional information on the Company's hedging activities.
POLICY LIABILITIES
The following table presents policy liabilities by segment and in total for the
years ended December 31 .
(In millions) 2021 2020
Japan segment:
Future policy benefits $ 81,176 $ 88,652
Unpaid policy claims 2,903 3,177
Other policy liabilities 9,534 11,299
Total Japan policy liabilities 93,613 103,128
U.S. segment:
Future policy benefits 9,865 9,674
Unpaid policy claims 1,933 2,010
Other policy liabilities 119 126
Total U.S. policy liabilities 11,916 11,810
Consolidated:
Future policy benefits 90,588 97,783
Unpaid policy claims 4,836 5,187
Other policy liabilities 9,648 11,421
Total consolidated policy liabilities (1) $ 105,072 $ 114,391 (1) The sum of the Japan and
See Note 7 of the Notes to the Consolidated Financial Statements for additional information on the Company's policy liabilities.
58--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
BENEFIT PLANS
POLICYHOLDER PROTECTIONThe Japanese insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. Legislation enacted regarding the framework of theLife Insurance Policyholder Protection Corporation (LIPPC) included government fiscal measures supporting the LIPPC. InNovember 2016 , Japan's Diet passed legislation that again extends the government's fiscal support of the LIPPC throughMarch 2022 . OnFebruary 1, 2022 , the FSA submitted legislation to Japan's Diet that would extend the government's fiscal support of the LIPPC throughMarch 2027 , subject to final approval in the Diet. EffectiveApril 2014 , the annual LIPPC contribution amount for the total life industry was lowered from ¥40 billion to ¥33 billion.Aflac Japan recognized an expense of ¥1.8 billion and ¥1.9 billion for LIPPC assessments in the years endedDecember 31, 2021 and 2020, respectively.
Guaranty Fund Assessments
UnderU.S. state guaranty association laws, certain insurance companies can be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of impaired or insolvent insurance companies that write the same line or similar lines of business. The amount of the guaranty fund assessment that an insurer is assessed is based on its proportionate share of premiums in that state. See Note 15 of the Notes to the Consolidated Financial Statements for further information on guaranty fund assessments. LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to the ability to generate sufficient cash resources to meet the payment obligations of the Company. Capital refers to the long-term financial resources available to support the operations of the businesses, fund business growth and provide for an ability to withstand adverse circumstances. Financial leverage (leverage) refers to an investment strategy of using debt to increase the potential ROE. The Company targets and actively manages liquidity, capital and leverage in the context of a number of considerations, including: •business investment and growth needs •strategic growth objectives •financial flexibility and obligations •capital support for hedging activity •a constantly evolving business and economic environment •a balanced approach to capital allocation and shareholder deployment.
The governance framework supporting liquidity, capital and leverage includes global senior management and board committees that review and approve all significant capital related decisions.
The Company's cash and cash equivalents include unrestricted cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased, all of which has minimal market, settlement or other risk exposure. The target minimum amount for the Parent Company's cash and cash equivalents is approximately$2.0 billion to provide a capital buffer and liquidity support at the holding company. This amount excludes$400 million of proceeds from the issuance of senior sustainability notes discussed below, unallocated proceeds of which contribute to total cash but are not intended to support holding company liquidity. Amid the COVID-19 pandemic, the Company remains committed to prudent liquidity and capital management. AtDecember 31, 2021 , the Company held$5.1 billion in cash and cash equivalents for stress conditions, which includes the Parent Company's target minimum amount of$2.0 billion .Aflac Japan and AflacU.S. generate cash flows from their operations and provide the primary sources of liquidity to the Parent Company through management fees and dividends, withAflac Japan being the largest contributor. The primary uses of cash by the Parent Company are shareholder dividends, the repurchase of its common stock, interest on its outstanding indebtedness and operating expenses. 59
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table presents the amounts provided to the Parent Company for the years endedDecember 31 . Liquidity Provided by Subsidiaries to Parent Company (In millions) 2021 2020 Management fees paid by subsidiaries$ 130 $ 131 Dividends declared or paid by subsidiaries 2,791 2,068
The following table details
Aflac Japan Remittances
(In millions of dollars and billions of yen) 2021 2020
Aflac Japan management fees paid to Parent Company $ 59
2,138 1,215
¥ 129.8
The Company intends to maintain higher than historical levels of liquidity and
capital at the Parent Company for stress conditions and with the goals of
addressing the Company's hedge costs and related potential need for collateral
and mitigating against long-term weakening of the Japanese yen. Further, the
Company plans to continue to maintain a portfolio of unhedged U.S.
dollar-denominated investments at Aflac Japan and to consider whether the amount
of such investments should be increased or decreased relative to the Company's
view of economic equity surplus in Aflac Japan in light of potentially rising
hedge costs and other factors. See the Hedging Activity subsection of this MD&A
for more information.
The Company believes that its balance of cash and cash equivalents and cash generated by operations will be sufficient to satisfy both its short-term and long-term cash requirements and plans for cash, including material cash requirements from known contractual obligations and returning capital to shareholders through share repurchases and dividends.
The following table presents the estimated payments of the Company's material cash requirements from known contractual obligations as ofDecember 31, 2021 . The Company translated its yen-denominated obligations using theDecember 31, 2021 , exchange rate. Actual future payments as reported in dollars will fluctuate with changes in the yen/dollar exchange rate. 60
--------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Total Total Short-term Long-term
(In millions) Liability(1) Payments Payments Payments
Future policy benefits liability (Note 7)(2)
4,836 4,836 3,081 1,755
Other policyholders' funds (Note 7)(4) 7,072 8,885 367 8,518
Long-term debt - principal (Note 9) 7,839 7,898 0 7,898
Long-term debt - interest (Note 9) 52 2,832 204 2,628
Cash collateral on loaned securities (Note 3) 2,162 2,162 2,162 0
Operating service agreements (Note 15) N/A 517 176 341
Operating lease obligations (Note 9) 105 111 48 63
Finance lease obligations (Note 9) 12 12 4 8
Total contractual obligations $ 112,666 $ 250,790 $ 15,009 $ 235,781
(1) Liability amounts are those reported on the consolidated balance sheet as of
December 31, 2021 .
(2) The estimated payments reflect future estimated cash payments to be made to
policyholders and others for future policy benefits. These projected cash
outflows are based on assumptions for future policy persistency, mortality,
morbidity, and other assumptions comparable with the Company's experience,
consider future premium receipts on current policies in force and assume market
growth and interest crediting consistent with assumptions used in amortizing
deferred acquisition costs. These cash outflows are undiscounted with respect to
interest and, as a result, the sum of the cash outflows exceeds the
corresponding liability amount. Due to the significance of the assumptions used,
actual cash outflow amounts and timing will differ, possibly materially, from
these estimates.
(3) The estimated payments include assumptions as to the timing of policyholders
reporting claims for prior periods and the amount of those claims. Actual
amounts and timing of unpaid policy claims payments may differ significantly
from the estimates above.
(4) These cash outflows are undiscounted with respect to interest and, as a
result, the sum of the cash outflows exceeds the corresponding liability amount.
In addition to cash and cash equivalents, the Company also maintains credit
facilities, both intercompany and with external partners, and a number of other
available tools to support liquidity needs on a global basis. In September 2021 ,
the Parent Company filed a shelf registration statement with the SEC that allows
the Company to issue an indefinite amount of debt securities, in one or more
series, from time to time until September 2024 . The Company believes outside
sources for additional debt and equity capital, if needed, will continue to be
available. Additionally, as of December 31, 2021 , the Parent Company and Aflac
had four lines of credit with third parties and ten intercompany lines of
credit. The Company was in compliance with all of the covenants of its notes
payable and lines of credit at December 31, 2021 . For additional information,
see Note 9 of the Notes to the Consolidated Financial Statements.
The Company's consolidated financial statements convey its financing
arrangements during the periods presented. The Company has not engaged in
material intra-period short-term financings during the periods presented that
are not otherwise reported in its balance sheet or disclosed therein. As of
December 31, 2021 , the Company had no material letters of credit, standby
letters of credit, guarantees or standby repurchase obligations. The Company has
not entered into transactions involving the transfer of financial assets with an
obligation to repurchase financial assets that have been accounted for as a sale
under applicable accounting standards, including securities lending
transactions. See Notes 1, 3, and 4 of the Notes to the Consolidated Financial
Statements for more information on the Company's securities lending and
derivative activities. With the exception of disclosed activities in those
referenced footnotes and the Risk Factors entitled, "The Company is exposed to
foreign currency fluctuations in the yen/dollar exchange rate" and "Lack of
availability of acceptable yen-denominated investments could adversely affect
the Company's results of operations, financial position or liquidity," the
Company is not aware of any trend, demand, commitment, event or uncertainty that
would reasonably result in its liquidity increasing or decreasing by a material
amount.
Consolidated Cash Flows
The Company consistently generates positive cash flows from operations, and has the ability to adjust cash flow management from other sources of liquidity including reinvestment cash flows and selling investments in order to meet short-term cash needs.
The Company translates cash flows forAflac Japan's yen-denominated items intoU.S. dollars using weighted-average exchange rates. 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. 61
-------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table summarizes consolidated cash flows by activity for the years endedDecember 31 . (In millions) 2021 2020 Operating activities$ 5,051 $ 5,958 Investing activities (2,378) (4,619) Financing activities (2,739) (1,115)
Exchange effect on cash and cash equivalents (24) 21
Net change in cash and cash equivalents
Operating Activities
The principal cash inflows for the Company's insurance activities come from
insurance premiums and investment income. The principal cash outflows are the
result of policy claims, operating expenses, income tax, as well as interest
expense. As a result of policyholder aging, claims payments are expected to
gradually increase over the life of a policy. Therefore, future policy benefit
reserves are accumulated in the early years of a policy and are designed to help
fund future claims payments.
The Company expects its future cash flows from premiums and investment
portfolios to be sufficient to meet its cash needs for benefits and expenses.
Consolidated cash flow from operations decreased 15.2% in 2021, compared with
2020.
Investing Activities
The Company's investment objectives provide for liquidity primarily through the
purchase of publicly traded investment-grade debt securities. Prudent portfolio
management dictates that the Company attempts to match the duration of its
assets with the duration of its liabilities. Currently, when the Company's fixed
maturity securities mature, the proceeds may be reinvested at a yield below that
required for the accretion of policy benefit liabilities on policies issued in
earlier years. However, the long-term nature of the Company's business and its
strong cash flows provide the Company with the ability to minimize the effect of
mismatched durations and/or yields identified by various asset adequacy
analyses. From time to time or when market opportunities arise, the Company
disposes of selected fixed maturity securities that are available for sale to
improve the duration matching of assets and liabilities, improve future
investment yields, and/or re-balance its portfolio. As a result, dispositions
before maturity can vary significantly from year to year.
As part of its overall corporate strategy, the Company has committed
$400 million to Aflac Ventures, LLC (Aflac Ventures ), as opportunities emerge.
Aflac Ventures is a subsidiary of Aflac Global Ventures, LLC (Aflac Global
Ventures ) which is reported in Corporate and other. The central mission of Aflac
Global Ventures is to support the organic growth and business development needs
of Aflac Japan and Aflac U.S. with an emphasis on digital applications designed
to improve the customer experience, gain efficiencies, and develop new markets
in an effort to enhance and defend long-term shareholder value. Investments are
included in equity securities or the other investments line in the consolidated
balance sheets.
As part of an arrangement with Federal Home Loan Bank of Atlanta (FHLB), Aflac
U.S. obtains low-cost funding from FHLB supported by acceptable forms of
collateral pledged by Aflac U.S. In 2021, Aflac U.S. borrowed and repaid $309
million under this program. As of December 31, 2021 , Aflac U.S. had outstanding
borrowings of $400 million reported in its balance sheet.
See Note 3 of the Notes to the Consolidated Financial Statements for details on certain investment commitments.
Financing ActivitiesCash flows from financing activities consist primarily of share repurchases, dividends to shareholders and from time to time debt issuances and redemptions.
InApril 2021 , the Parent Company issued five series of senior notes totaling ¥82.0 billion through a public debt offering under its then existingU.S. shelf registration statement. The first series, which totaled ¥30.0 billion, bears interest at a fixed rate of .633% per annum, payable semi-annually, and will mature inApril 2031 . The second series, which totaled ¥12.0 billion, bears interest at a fixed rate of .844% per annum, payable semi-annually, and will mature inApril 2033 . The third series, which totaled ¥10.0 billion, bears interest at a fixed rate of 1.039% per annum, payable semi-annually, and will mature inApril 2036 . The fourth series, which totaled ¥10.0 billion, bears interest at a fixed rate of 1.264% per annum, payable semi-annually, and will mature inApril 2041 . The fifth series, which totaled ¥20.0 billion, bears interest at a fixed 62 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations rate of 1.560% per annum, payable semi-annually, and will mature inApril 2051 . The notes are redeemable at the Parent Company's option (i) at any time, in whole but not in part, upon the occurrence of certain changes affectingU.S. taxation, as specified in the indenture governing the terms of the issuance or (ii) on or after the date that is six months prior to the stated maturity date of the series, in whole or in part, at a redemption price equal to the aggregate principal amount to be redeemed plus accrued and unpaid interest on the principal amount to be redeemed to, but excluding, the date of redemption.
In
InMarch 2021 , the Parent Company issued$400 million of senior sustainability notes through aU.S. public debt offering. The notes bear interest at a fixed rate of 1.125% per annum, payable semi-annually, and will mature inMarch 2026 . The Company intends, but is not contractually committed, to allocate an amount at least equivalent to the net proceeds from this issuance exclusively to existing or future investments in, or financing of, assets, businesses or projects that meet the eligibility criteria of the Company's sustainability bond framework described in the offering documentation in connection with such notes. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the yield to maturity for aU.S. Treasury security with a maturity comparable to the remaining term of the notes, plus 10 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date. InApril 2020 , the Parent Company issued$1.0 billion of senior notes through aU.S. public debt offering. The notes bear interest at a fixed rate of 3.60% per annum, payable semi-annually, and will mature inApril 2030 . These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the yield to maturity for aU.S. Treasury security with a maturity comparable to the remaining term of the notes, plus 45 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date. InMarch 2020 , the Parent Company issued four series of senior notes totaling ¥57.0 billion through a public debt offering under itsU.S. shelf registration statement. The first series, which totaled ¥12.4 billion, bears interest at a fixed rate of .300% per annum, payable semi-annually and will mature inSeptember 2025 . The second series, which totaled ¥13.3 billion, bears interest at a fixed rate of .550% per annum, payable semi-annually, and will mature inMarch 2030 . The third series, which totaled ¥20.7 billion, bears interest at a fixed rate of .750% per annum, payable semi-annually and will mature inMarch 2032 . The fourth series, which totaled ¥10.6 billion, bears interest at a fixed rate of .830% per annum, payable semi-annually, and will mature inMarch 2035 . These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affectingU.S. taxation, as specified in the indenture governing the terms of the issuance.
In
See Note 9 of the Notes to the Consolidated Financial Statements for further information on the debt issuances discussed above.
Cash returned to shareholders through treasury stock purchases and dividends was
63
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following tables present a summary of treasury stock activity during the
years ended December 31 .
Treasury Stock Purchased
(In millions of dollars and thousands of shares) 2021 2020
Treasury stock purchases $ 2,301 $ 1,537
Number of shares purchased:
Share repurchase program 43,327 37,899
Other 437 542
Total shares purchased 43,764 38,441
Treasury Stock Issued
(In millions of dollars and thousands of shares) 2021 2020 Stock issued from treasury:
Cash financing$ 26 $ 34 Noncash financing 55 54 Total stock issued from treasury$ 81 $ 88 Number of shares issued 1,721 2,393 InAugust 2020 , the Company's board of directors authorized the purchase of 100 million shares of its common stock. As ofDecember 31, 2021 , a remaining balance of 55.8 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors. See Note 11 of the Notes to the Consolidated Financial Statements for additional information. Cash dividends paid to shareholders in 2021 of$1.32 per share increased 17.9% over 2020. The following table presents the dividend activity for the years endedDecember 31 . Dividends Paid to Shareholders (In millions) 2021 2020 Dividends paid in cash$ 855 $ 769
Dividends through issuance of treasury shares 32 29 Total dividends to shareholders
$ 887 $ 798 InNovember 2021 , the board of directors announced a 21.2% increase in the quarterly cash dividend, effective with the first quarter of 2022. The first quarter 2022 cash dividend of$.40 per share is payable onMarch 1, 2022 , to shareholders of record at the close of business onFebruary 16, 2022 . Regulatory Restrictions
Aflac Japan is required to meet certain financial criteria as governed by Japanese corporate law in order to provide dividends to the Parent Company. Under these criteria, dividend capacity at the Japan subsidiary is basically defined as total equity excluding common stock, accumulated other comprehensive income amounts, capital reserves (representing statutorily required amounts inJapan ) but reduced for net after-tax unrealized losses on available-for-sale securities. These dividend capacity requirements are generally aligned with the SMR. Japan's FSA maintains its own solvency standard which is quantified through the SMR.Aflac Japan's SMR is sensitive to interest rate, credit spread, and foreign exchange rate changes, therefore the Company continues to evaluate alternatives for reducing this sensitivity, including the reduction of subsidiary dividends paid to the Parent Company and Parent Company capital contributions. In the event of a rapid change in market risk conditions causing SMR to decline, the Company has one senior unsecured revolving credit facility in the amount of ¥100 billion and a committed reinsurance facility in the amount of approximately ¥120 billion as a capital contingency plan. Additionally, the Company could take action to enter into derivatives on unhedgedU.S. dollar-denominated investments with foreign currency options or forwards. See Notes 8 and 9 of the Notes to the Consolidated Financial Statements for additional information. 64
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company has already undertaken various measures to mitigate the sensitivity ofAflac Japan's SMR. For example, the Company employs policy reserve matching (PRM) investment strategies, which is a Japan-specific accounting treatment that reduces SMR interest rate sensitivity since PRM-designated investments are carried at amortized cost consistent with corresponding liabilities. In order for a PRM-designated asset to be held at amortized cost, there are certain criteria that must be maintained. The primary criterion relates to maintaining the duration of designated assets and liabilities within a specified tolerance range. If the duration difference is not maintained within the specified range without rebalancing, then a certain portion of the assets must be re-classified as available for sale and held at fair value with any associated unrealized gain or loss recorded in surplus. To rebalance, assets may need to be sold in order to maintain the duration with the specified range, resulting in realizing a gain or loss from the sale. ForU.S. GAAP, PRM investments are categorized as available for sale. The Company also uses foreign currency derivatives to hedge a portion of itsU.S. dollar-denominated investments. See Notes 3, 4 and 8 of the Notes to the Consolidated Financial Statements for additional information on the Company's investment strategies, hedging activities, and reinsurance, respectively.Aflac Japan's SMR ratio remains high and reflects a strong capital and surplus position. As ofDecember 31, 2021 ,Aflac Japan's SMR was 1,012%, compared with 963% atDecember 31, 2020 . The Company is committed to maintaining strong capital levels throughout the pandemic, consistent with maintaining current insurance financial strength and credit ratings. The FSA is considering the introduction of an economic value-based solvency regime based on the Insurance Capital Standards (ICS) for insurance companies inJapan . The FSA is currently conducting field testing with insurance companies inJapan for the purpose of investigating the impact of the introduction of regulations. Provisional specifications are expected to be decided in 2022, and a new capital regime to replace the current solvency regime may be introduced as early as 2025. AflacU.S. A life insurance company's statutory capital and surplus is determined according to rules prescribed by the NAIC, as modified by the insurance department in the insurance company's state of domicile. Statutory accounting rules are different fromU.S. GAAP and are intended to emphasize policyholder protection and company solvency. The continued long-term growth of the Company's business may require increases in the statutory capital and surplus of its insurance operations. The Company's insurance operations may secure additional statutory capital through various sources, such as internally generated statutory earnings, reduced dividends paid to the Parent Company, capital contributions by the Parent Company from funds generated through debt or equity offerings, or reinsurance transactions. The NAIC's RBC formula is used by insurance regulators to help identify inadequately capitalized insurance companies. The RBC formula quantifies insurance risk, business risk, asset risk and interest rate risk by weighing the types and mixtures of risks inherent in the insurer's operations. The combined RBC ratio for AflacU.S. as ofDecember 31, 2021 was 659%, compared with 550% as ofDecember 31, 2020 . The Company calculates its combined RBC ratio to include allU.S. regulated life insurance entities as if a single combinedU.S. RBC entity net of intercompany items related to capital resources and risk.
The table below presents RBC ratios for the Company's
2021 2020
Aflac 635 % 508 %
CAIC 832 975
TOIC 5,829 6,964
Aflac New York 1,089 1,077
The NAIC completed its Solvency Modernization Initiative (SMI) process relating
to updating the U.S. insurance solvency regulation framework. The SMI focused on
key issues such as capital requirements, governance and risk management, group
supervision, reinsurance, statutory accounting and financial reporting matters.
The NAIC still has some ongoing initiatives related to SMI, such as monitoring
the international efforts on group capital requirements as well as RBC. In 2020,
the NAIC formally adopted a group capital calculation (GCC) that conceptually
uses an RBC aggregation methodology for all entities within the insurance
company holding system. The GCC is intended to be a regulatory tool used by
regulators as a means to standardize group capital requirements. In 2021, the
NAIC concluded its analysis of bond factor changes and formally adopted the new
factors as proposed by Moody's Analytics . This initiative expanded the
65
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RBC bond factors from six designations to 20 designations to more closely align
with rating scales used by rating agencies. The adopted changes resulted in
increased capital requirements. As of December 31, 2021 , the updated bond
factors did not have a significant impact on the combined RBC ratio for Aflac
U.S.
Aflac, CAIC and TOIC are domiciled in Nebraska and are subject to its
regulations. The NDOI imposes certain limitations and restrictions on payments
of dividends, management fees, loans and advances to the Parent Company. Under
Nebraska insurance law, prior approval of the NDOI is required for dividend
distributions that exceed the greater of the net income from operations, which
excludes net investment gains, for the previous year determined under statutory
accounting principles, or 10% of statutory capital and surplus as of the
previous year-end. Dividends declared by Aflac during 2022 in excess of $1.1
billion would be considered extraordinary and require such approval. Similar
laws apply in New York , the domiciliary jurisdiction of Aflac New York.
Privacy and Cybersecurity Governance
The Company's Board of Directors has adopted an information security policy
directing management to establish and operate a global information security
program with the goals of monitoring existing and emerging threats and ensuring
that the Company's information assets and data, and the data of its customers,
are appropriately protected from loss or theft. The Board has delegated
oversight of the Company's information security program to the Audit and Risk
Committee . The Company's senior officers, including its Global Security and
Chief Information Security Officer, are responsible for the operation of the
global information security program and communicates quarterly with the Audit
and Risk Committee on the program, including with respect to the state of the
program, compliance with applicable regulations, current and evolving threats,
and recommendations for changes in the information security program. The global
information security program also includes a cybersecurity incident response
plan that is designed to provide a management framework across Company functions
for a coordinated assessment and response to potential security incidents. This
framework establishes a protocol to report certain incidents to the Global
Security and Chief Information Security Officer and other senior officers, with
the goal of timely assessing such incidents, determining applicable disclosure
requirements and communicating with the Audit and Risk Committee . The incident
response plan directs the executive officers to report certain incidents
immediately and directly to the Lead Non-Management Director.
OtherFor information regarding commitments and contingent liabilities, see Note 15 of the Notes to the Consolidated Financial Statements.
Additional Information
Investors should note that the Company announces material financial information
in its SEC filings, press releases and public conference calls. In accordance
with SEC guidance, the Company may also use the Investor Relations section of
the Company's website (http://investors.aflac.com) to communicate with investors
about the Company. It is possible that the financial and other information the
Company posts there could be deemed to be material information. The information
on the Company's website is not part of this document. Further, the Company's
references to website URLs are intended to be inactive textual references only.
CRITICAL ACCOUNTING ESTIMATES
The Company prepares its financial statements in accordance with U.S. GAAP.
These principles are established primarily by the FASB. In this MD&A, references
to U.S. GAAP issued by the FASB are derived from the FASB Accounting Standards
Codification™ (ASC). The preparation of financial statements in conformity with
U.S. GAAP requires the Company to make estimates based on currently available
information when recording transactions resulting from business operations. The
estimates that the Company deems to be most critical to an understanding of its
results of operations and financial condition are those related to the valuation
of investments and derivatives, DAC, liabilities for future policy benefits and
unpaid policy claims, and income taxes. The preparation and evaluation of these
critical accounting estimates involve the use of various assumptions developed
from management's analyses and judgments. The application of these critical
accounting estimates determines the values at which 94% of the Company's assets
and 80% of its liabilities are reported as of December 31, 2021 , and thus has a
direct effect on net earnings and shareholders' equity. Subsequent experience or
use of other assumptions could produce significantly different results.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Valuation of Investments, Including Derivatives
The Company's investments, primarily consisting of debt and equity securities, include both publicly issued and privately issued securities. For publicly issued securities, the Company determines the fair values from quoted market prices readily available from public exchange markets and price quotes and valuations from third party pricing vendors. For the majority of privately issued securities within the Company's investment portfolio, a third party pricing vendor has developed valuation models that the Company utilizes to determine fair values. Starting inJune 2021 , these models and associated processes and controls were transitioned to and executed by Company personnel. For the remaining privately issued securities, the Company uses non-binding price quotes from outside brokers. InSeptember 2020 , the Company refined its valuation model for private placements to explicitly incorporate currency basis swap adjustments (market observable data) to assumed interest rate curves where appropriate as noted in Note 5 of the Notes to the Consolidated Financial Statements. The Company estimates the fair values of its securities on a monthly basis. The Company monitors the estimated fair values obtained from its pricing vendors and brokers for consistency from month to month, while considering current market conditions. The Company also periodically discusses with its pricing brokers and vendors the pricing techniques they use to monitor the consistency of their approach and periodically assess the appropriateness of the valuation level assigned to the values obtained from them. If a fair value appears unreasonable, the Company will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, the Company may compare the inputs to relevant market indices and other performance measurements. Based on management's analysis, the valuation is confirmed or may be revised if there is evidence of a more appropriate estimate of fair value based on available market data. The Company has performed verification of the inputs and calculations in any valuation models to confirm that the valuations represent reasonable estimates of fair value. Inputs used to value derivatives include, but are not limited to, interest rates, credit spreads, foreign currency forward and spot rates, and interest volatility. The Company estimates an expected lifetime credit loss on investments measured at amortized cost including held-to-maturity fixed maturity securities, loan receivables and loan commitments on a quarterly basis. For the Company's available-for-sale fixed maturity securities, the Company evaluates estimated credit losses only when the fair value of the available-for-sale fixed maturity security is below its amortized cost basis The Company's approach to estimating credit losses is complex and incorporates significant judgments. In addition to a security, or an asset class, or an issuer-specific credit fundamentals, it considers past events, current economic conditions and forecasts of future economic conditions. The Company's estimates are revised as conditions change and new information becomes available. See the tabular disclosure entitled "Sensitivity of Fair Values of Financial Instruments to Interest Rate Change" in Item 7A. Quantitative and Qualitative Disclosures About Market Risk and Notes 1, 3, 4 and 5 of the Notes to the Consolidated Financial Statements for additional information.
Deferred Policy Acquisition Costs and Policy Liabilities
Insurance premiums for most of the Company's health and life policies, including cancer, accident, hospital, critical illness, dental, vision, term life, whole life, long-term care and disability, are recognized as earned premiums over the premium-paying periods of the contracts when due from policyholders. When earned premiums are reported, the related amounts of benefits and expenses are charged against such revenues, so that profits are recognized in proportion to earned premiums during the period the policies are expected to remain in force. This association is accomplished by means of annual additions to the liability for future policy benefits and the deferral and subsequent amortization of policy acquisition costs. Premiums from the Company's products with limited-pay features, including term life, whole life, WAYS, and child endowment, are collected over a significantly shorter period than the period over which benefits are provided. Premiums for these products are recognized as earned premiums over the premium-paying periods of the contracts when due from policyholders. Any gross premium in excess of the net premium is deferred and recorded in earnings, such that profits are recognized in a constant relationship with insurance in force. Benefits are recorded as an expense when they are incurred. A liability for future policy benefits is recorded when premiums are recognized using the net premium method.
Deferred Policy Acquisition Costs
The calculation of DAC and the liability for future policy benefits requires the
use of estimates based on sound actuarial valuation techniques. For new policy
issues, the Company reviews its actuarial assumptions and deferrable acquisition
67
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
costs each year and revise them when necessary to more closely reflect recent
experience and studies of actual acquisition costs. For policies in force, the
Company evaluates DAC by major product groupings to determine that they are
recoverable from future revenues, and any amounts determined not to be
recoverable are charged against net earnings. See Note 6 of the Notes to the
Consolidated Financial Statements for a detail of the DAC activity for the past
two years.
Policy Liabilities
The Company's policy liabilities, which are determined in accordance with
applicable guidelines as defined under
Future policy benefits provide for claims that will occur in the future and are generally calculated as the present value of future expected benefits to be incurred less the present value of future expected net benefit premiums. The Company calculates future policy benefits based on assumptions of morbidity, mortality, persistency and interest. These assumptions are generally established and considered locked at the time a policy is issued. The assumptions used in the calculations are closely related to those used in developing the gross premiums for a policy. As required byU.S. GAAP, the Company also includes a provision for adverse deviation, which is intended to accommodate adverse fluctuations in actual experience. These assumptions may only be unlocked in certain circumstances based on the results of periodic DAC recoverability and premium deficiency testing. Unpaid policy claims include those claims that have been incurred and are in the process of payment as well as an estimate of those claims that have been incurred but have not yet been reported to the Company. The Company computes unpaid policy claims on a non-discounted basis using statistical analyses of historical claims payments, adjusted for current trends and changed conditions. The Company updates the assumptions underlying the estimate of unpaid policy claims regularly and incorporates its historical experience as well as other data that provides information regarding the Company's outstanding liability. The Company's insurance products provide fixed-benefit amounts per occurrence that are not subject to medical-cost inflation. Furthermore, the Company's business is widely dispersed in both theU.S. and Japan. This geographic dispersion and the nature of the Company's benefit structure mitigate the risk of a significant unexpected increase in claims payments due to localized epidemics and events of a catastrophic nature. Claims incurred under the Company's policies are generally reported and paid in a relatively short time frame. The unpaid claims liability is sensitive to morbidity assumptions, in particular, severity and frequency of claims. Severity is the ultimate size of a claim, and frequency is the number of claims incurred. The Company's claims experience is primarily related to the demographics of its policyholders. As a part of its established financial reporting and accounting practices and controls, the Company performs detailed annual actuarial reviews of its policyholder liabilities (gross premium valuation analysis) and reflects the results of those reviews in its results of operations and financial condition as required byU.S. GAAP. ForAflac Japan , the Company's annual reviews in 2021 and 2020 indicated no need to strengthen liabilities associated with policies inJapan . For AflacU.S. , the Company's annual reviews in 2021 and 2020 indicated no need to strengthen liabilities associated with policies in theU.S. 68 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The table below reflects the growth of the future policy benefits liability for the years endedDecember 31 . Future Policy Benefits (In millions of dollars and billions of yen) 2021 2020 Aflac U.S.$ 9,865 $ 9,674 Growth rate 2.0 % 2.9 % Aflac Japan$ 81,176 $ 88,652 Growth rate (8.4) % 8.8 % Consolidated$ 90,588 $ 97,783 Growth rate (7.4) % 8.2 % Yen/dollar exchange rate (end of period) 115.02 103.50 Aflac Japan ¥ 9,337 ¥ 9,176 Growth rate 1.8 % 2.8 % The growth of the future policy benefits liability in yen forAflac Japan and in dollars for AflacU.S. has been due to the aging of the Company's in-force block of business and the addition of new business. The following table summarizes certain significant assumptions made in establishing reserves for the Company's products and the net impact that could result from changes in these assumptions should they occur. UnderU.S. GAAP, the Company's reserves for its limited pay and long duration contracts are primarily calculated using locked-in assumptions. As such, the adverse hypothetical impacts illustrated in the table below are those that would increase the Company's best estimate reserves, but would not result in a premium deficiency requiring strengthening of reserves or write-off of DAC. The favorable hypothetical impacts in the table below would decrease the Company's best estimate reserves but they would not result in an immediate decrease to itsU.S. GAAP reserves (given that the Company would be required to leave the current assumptions locked in); rather, the positive impacts would be recognized in net earnings over the life of the policies in force. The information below is for illustrative purposes and includes the impacts of changes in a single assumption and not changes in any combination of assumptions. As a result of emerging experience, changes in current assumptions and the related impact that could result in the listed financial statement balances that are in excess of the amounts illustrated may occur in future periods. Increase (Decrease) in Best Estimate Reserves Assumption Current Assumption Assumption Change (in millions) (1) Expected portfolio book yields over Increase 25 basis points / Investment return the life of the business Decrease 25 basis points$(2,600) to$2,800 Pricing expectations adjusted to Increase / Decrease Expected Expected future claim best estimate based on Company Future Claim Payments: +5% to payments / base mortality experience -5%$5,300 to$(5,300) Pricing expectations adjusted to
Increase / Decrease Expected
best estimate based on Company Total Termination Rates: +5% to
Total termination rates experience -5% $(600) to $600 (1) Best estimate reserves are equal to the present value of claims, cash values, expenses, and commissions minus the present value of gross premiums, using current best estimate assumptions.
In computing the estimate of unpaid policy claims, the Company considers many factors, including the benefits and amounts available under the policy; the volume and demographics of the policies exposed to claims; and internal business practices, such as incurred date assignment and current claim administrative practices. The Company monitors these conditions closely and makes adjustments to the liability as actual experience emerges. Claim levels are generally stable from period to period; however, fluctuations in claim levels may occur. In calculating the unpaid policy claim liability, the Company does not calculate a range of estimates. The following table shows the expected sensitivity of the unpaid policy claims liability as ofDecember 31, 2021 , to changes in severity and frequency of claims. 69
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Sensitivity of Unpaid Policy Claims Liability
(In millions) Total Severity
Decrease Decrease Increase Increase
Total Frequency by 2% by 1% Unchanged by 1% by 2%
Increase by 2% $ (1) $ 26 $ 52 $ 79 $ 106
Increase by 1% (27) 0 26 53 79
Unchanged (52) (26) 0 26 52
Decrease by 1% (78) (52) (26) 0 26
Decrease by 2% (104) (78) (52) (27) (1)
Other policy liabilities, which accounted for 9% of total policy liabilities as
of December 31, 2021 , consisted primarily of annuity and unearned premium
reserves, and discounted advance premiums on deposit from policyholders in
conjunction with their purchase of certain Aflac Japan insurance products. These
advanced premiums are deferred upon collection and recognized as earned premiums
over the contractual premium payment period. Advanced premiums represented 15%
and 19% of the December 31, 2021 and 2020 other policy liabilities balances,
respectively. See the Aflac Japan segment subsection of this MD&A for further
information.
Income Taxes
Income tax provisions are generally based on pretax earnings reported for
financial statement purposes, which differ from those amounts used in preparing
the Company's income tax returns. Deferred income taxes are recognized for
temporary differences between the financial reporting basis and income tax basis
of assets and liabilities, based on enacted tax laws and statutory tax rates
applicable to the periods in which the Company expects the temporary differences
to reverse. The evaluation of a tax position in accordance with U.S. GAAP is a
two-step process. Under the first step, the enterprise determines whether it is
more likely than not that a tax position will be sustained upon examination by
taxing authorities. The second step is measurement, whereby a tax position that
meets the more-likely-than-not recognition threshold is measured to determine
the amount of benefit to recognize in the financial statements. A valuation
allowance is established for deferred tax assets when it is more likely than not
that an amount will not be realized. The determination of a valuation allowance
for deferred tax assets requires management to make certain judgments and
assumptions.
In evaluating the ability to recover deferred tax assets, the Company's
management considers all available evidence, including taxable income in open
carry back years, the existence of cumulative losses in the most recent years,
forecasted earnings, future taxable income exclusive of reversing temporary
differences and carryforwards, future taxable temporary difference reversals,
and prudent and feasible tax planning strategies. In the event the Company
determines it is not more likely than not that it will be able to realize all or
part of its deferred tax assets in the future, a valuation allowance would be
charged to earnings in the period such determination is made. Likewise, if it is
later determined that it is more likely than not that those deferred tax assets
would be realized, the previously provided valuation allowance would be
reversed. Future economic conditions and market volatility, including increases
in interest rates or widening credit spreads, can adversely impact the Company's
tax planning strategies and in particular the Company's ability to utilize tax
benefits on previously recognized capital losses. The Company's judgments and
assumptions are subject to change given the inherent uncertainty in predicting
future performance and specific industry and investment market conditions.
In September 2020 , the U.S. Treasury and Internal Revenue Service issued Final
and Proposed Regulations. Under the guidance of these regulations, the Company
recognized a one-time income tax benefit of $1.4 billion due to the release of
previously established valuation allowances related to deferred foreign tax
credit benefits. The Company believes this will also reduce the effective tax
rate in future periods, subject to any future changes in the U.S. tax policy.
An increase or decrease in the Company's effective tax rate by one percentage
point would have resulted in an increase or decrease in the Company's 2021
income tax expense of $49 million .
For additional information on income tax, see Note 10 of the Notes to the
Consolidated Financial Statements presented in this report.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Future Adoption of Accounting Standard for Long-Duration Insurance Contracts
InAugust 2018 , the FASB issued Accounting Standards Update 2018-12, "Financial Services - Insurance, Targeted Improvements to the Accounting for Long-Duration Contracts" (The ASU). The update significantly changes how insurers account for long-duration contracts, amends existing recognition, measurement, presentation, and disclosure requirements applicable to the Company. Issues addressed in the new guidance include: 1) a requirement to review and, if there is a change, update cash flow assumptions for the liability for future policy benefits at least annually, and to update the discount rate assumption quarterly, 2) accounting for market risk benefits at fair value, 3) simplified amortization for deferred acquisition costs, and 4) enhanced financial statement presentation and disclosures. The Company has no products with market risk benefits. Since the initial issuance, the FASB has deferred the ASU effective date for two years, such that the amendments are now effective for the Company for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2022 . Early application of the amendments is permitted, however, the Company will not early adopt the updated standard. The Company plans to use the additional time to educate investors and analysts on the adoption impact, conduct robust testing and analysis, enhance the control environment, and perform parallel financial reporting. The Company continues to evaluate the impact of adoption and expects that the adoption will have a significant impact on the Company's financial position, results of operations, and disclosures. The Company anticipates that the requirement to update assumptions for liability for future policy benefits (LFPB) will have a significant impact on its results of operations, systems, processes and controls and that the requirement to update discount rates will have a significant impact on its AOCI and equity. The ultimate impact on these items from the Company's implementation of the updated standard is subject to assessments that are dependent on many variables, including but not limited to (i) how certain aspects of the new standard will be interpreted and implemented by the Company and other similar companies, such as (but not limited to) amortization of deferred acquisition costs and selection of discounting methodologies and inputs, as well as establishment of policies, processes and controls for setting, monitoring and periodically updating reserve assumptions, and (ii) changes in the interest rate environment in theU.S. and Japan. There are two permitted transition methods upon adoption and the Company has selected the modified retrospective transition method. The new guidance requires that discount rates used for the discounting of insurance liabilities be initially adjusted on the adoption date and subsequently at each reporting period to the market levels for the upper-medium-grade (low credit risk) fixed income instrument yields (single-A in the currency of the underlying insurance contract) reflecting the duration of the Company's insurance liabilities. The primary impact on transition under the modified retrospective method is driven by updating discount rates that increase reserves and lower AOCI by the corresponding amount, net of tax. The Company currently estimates that theJanuary 1, 2021 transition date (Transition Date) impact from adoption is likely to result in a decrease in AOCI in a range between$18 billion and$20 billion . The preliminary impact results from updating discount rate assumptions from the rates locked in for reserves held as of the Transition Date to rates determined by reference to the Transition Date market level yields for upper-medium-grade (low credit risk) fixed income instruments (as ofDecember 31, 2020 ). The variability around the impact of adoption results from the Company making certain estimates, primarily related to the determination of Transition Date market level yields. Based on the Company's current discount rate methodology developed under the new ASU, if interest rates increased or decreased by 25 basis points as ofDecember 31, 2020 , the Company's AOCI as of that date would increase or decrease by$1.0 billion and$1.3 billion , respectively. As discussed in detail in Note 1 of the Notes to the Consolidated Financial Statements, the Company has advanced and continues to refine the design of its discount rate methodology for both theU.S. and Japan insurance business. Upon adoption of the new ASU, discount rates will be updated each reporting period. The impact to the Company's reported financial statements underU.S. GAAP is greatly influenced by the nature of the Company's business model. Adoption of the new guidance reflects the Company's concentration inJapan third-sector business, in particular cancer insurance, with respect to which the duration of liabilities is materially longer than asset durations, while Japan's aggregate block of business continues to see favorable experience from mortality, morbidity, and expenses. The long duration of the Company's third-sector insurance liabilities inJapan coupled with limited-to-no-liquidity of the Japanese long-dated fixed-income market creates challenges in application of the market-based discount rate guidance and will require the Company to apply significant judgments in designing discount rate methodologies for its Japanese third-sector liabilities. Under the modified retrospective method, the impact of a low discount rate applied to long-duration third sector liabilities is recognized at adoption, while associated favorable morbidity margins are recognized 71 -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations over time thus driving a pronounced timing impact toU.S. GAAP equity. In addition, with respect to the Japan segment, the Company maintains a large portfolio of assets designated as held-to-maturity (HTM) as a strategy to reduce capital (solvency margin ratio or SMR) volatility. In a low interest rate environment, such as presently exists inJapan , assets designated as HTM that were purchased in a higher interest rate environment have significant embedded gains not reflected in AOCI (HTM securities are carried at amortized cost underU.S. GAAP), which serves as an economic offset to a low discount rate applied to policy liabilities. AtDecember 31, 2021 , the Company's HTM portfolio was$22.0 billion at amortized cost and had$4.9 billion in net unrealized gains. After adoption of ASU 2018-12, the Company also expects net earnings and net earnings per share (which were$4.3 billion and$6.39 per diluted share, respectively, in 2021) to reflect larger quarterly fluctuations due to the new requirement to update assumptions for liability for future policy benefits. In the near term, the expected impact on the Company's key financial ratios is limited. Generally, benefit ratios are expected to be slightly higher as favorable experience is absorbed into reserves, while expense ratios are expected to be modestly lower due to amortizing deferred acquisition costs at a slower rate. This results in a slightly higher profit margin inJapan and an insignificant impact to theU.S. profit margin. The Company has created a robust governance framework and a plan to support implementation of the updated standard. As part of its implementation plan, the Company has made preliminary policy elections on key accounting policy decisions (discount rate, cash flow assumptions, and deferred acquisition costs amortization). See Note 1 of the Notes to the Consolidated Financial Statements for additional information on preliminary policy elections. The Company has also advanced the modernization of its actuarial technology platform to enhance its modeling, data management, experience study and analytical capabilities, increase the end-to-end automation of key reporting and analytical processes and optimize its control framework. The Company has also put in place internal controls related to the new processes created as part of implementing the updated standard and will continue to refine and maturate these internal controls until the formal implementation in the first quarter of 2023. The Company expects that while the adoption of this new accounting guidance will affect the Company's financial statements underU.S. GAAP, it will not impact financial statements forAflac Japan under FSA requirements or for AflacU.S. under applicable statutory requirements. Therefore, the Company does not expect adoption of the updated standard to impact its overall cash flows, subsidiaries' dividend capacity or their ability to meet applicable regulatory capital standards, nor does the Company anticipate adoption to affect its existing debt covenants or strategies for capital deployment.
New Accounting Pronouncements
During the last three years, various accounting standard-setting bodies have been active in soliciting comments and issuing statements, interpretations and exposure drafts. For information on new accounting pronouncements and the impact, if any, on the Company's financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements.
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