SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT of 1934
For the quarter ended March 31, 2001
Commission File No. 1-7434
AFLAC INCORPORATED
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GEORGIA 58-1167100
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1932 WYNNTON ROAD, COLUMBUS, GEORGIA 31999
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(Address of principal executive offices and zip code)
Registrant's telephone number, including area code (706) 323-3431
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X . No .
------ ------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class May 4, 2001
- ---------------------------- ------------------
Common Stock, $.10 Par Value 525,812,832 shares
AFLAC INCORPORATED AND SUBSIDIARIES
INDEX
Page
No.
----
Part I. Financial Information:
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2001 and December 31, 2000. . . . . . . . . . 1
Consolidated Statements of Earnings -
Three Months Ended March 31, 2001 and 2000 . . . . . . . 3
Consolidated Statements of Shareholders' Equity -
Three Months Ended March 31, 2001 and 2000 . . . . . . . 4
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2001 and 2000 . . . . . . . 5
Consolidated Statements of Comprehensive Income -
Three Months Ended March 31, 2001 and 2000 . . . . . . . 7
Notes to Consolidated Financial Statements . . . . . . . . 8
Review by Independent Auditors . . . . . . . . . . . . . . 16
Independent Auditors' Review Report. . . . . . . . . . . . 17
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . . . . 18
Item 3. Quantitative and Qualitative Disclosures
about Market Risk. . . . . . . . . . . . . . . . . . . . . 32
Part II. Other Information:
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . 36
Item 4. Submission of Matters to a Vote
of Security Holders. . . . . . . . . . . . . . . . . . . . 37
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . 38
Items other than those listed above are omitted because they are not
required or are not applicable.
i
Part I. Financial Information
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
(In millions)
March 31, December 31,
2001 2000
(Unaudited)
------------ ------------
Assets:
Investments and cash:
Securities available for sale, at fair value:
Fixed maturities (amortized cost
$18,634 in 2001 and $20,405 in 2000) $ 21,696 $ 22,172
Perpetual debentures (amortized cost
$2,668 in 2001 and $2,347 in 2000) 2,757 2,046
Equity securities (cost $139 in 2001
and $161 in 2000) 176 236
Securities held to maturity, at amortized cost:
Fixed maturities (fair value $4,142 in
2001 and $3,702 in 2000) 3,915 3,645
Perpetual debentures (fair value $3,261
in 2001 and $3,323 in 2000) 3,131 3,442
Other investments 17 17
Cash and cash equivalents 1,075 609
-------- --------
Total investments and cash 32,767 32,167
Receivables, primarily premiums 324 301
Accrued investment income 316 380
Deferred policy acquisition costs 3,559 3,685
Property and equipment, at cost less
accumulated depreciation 463 481
Other 212 218
-------- --------
Total assets $ 37,641 $ 37,232
======== ========
See the accompanying Notes to Consolidated Financial Statements.
(continued)
1
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets (continued)
(In millions, except for share and per-share amounts)
March 31, December 31,
2001 2000
(Unaudited)
------------ ------------
Liabilities and Shareholders' Equity:
Liabilities:
Policy liabilities:
Future policy benefits $ 25,515 $ 26,114
Unpaid policy claims 1,704 1,745
Unearned premiums 360 361
Other policyholders' funds 383 346
-------- --------
Total policy liabilities 27,962 28,566
Notes payable 1,035 1,079
Income taxes 2,199 1,894
Payables for return of cash collateral
on loaned securities 248 127
Payable for security transactions 169 -
Other 810 872
-------- --------
Total liabilities 32,423 32,538
-------- --------
Shareholders' equity:
Common stock of $.10 par value. In thousands:
authorized 1,000,000 shares; issued 645,605
shares in 2001 and 644,813 shares in 2000 65 32
Additional paid-in capital 312 336
Retained earnings 4,112 3,956
Accumulated other comprehensive income:
Unrealized foreign currency translation gains 200 194
Unrealized gains on investment securities 1,980 1,474
Unrealized gains (losses) on derivatives (1) -
Treasury stock, at average cost (1,450) (1,298)
-------- --------
Total shareholders' equity 5,218 4,694
-------- --------
Total liabilities and shareholders' equity $ 37,641 $ 37,232
======== ========
Shareholders' equity per share $ 9.93 $ 8.87
======== ========
See the accompanying Notes to Consolidated Financial Statements.
Share and per-share amounts have been restated to reflect the two-for-one
stock split distributed March 16, 2001.
2
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Earnings
(In millions, except for share and Three Months Ended March 31,
per-share amounts - Unaudited) ----------------------------
2001 2000
-------- --------
Revenues:
Premiums, principally supplemental
health insurance $ 2,029 $ 2,020
Net investment income 382 376
Realized investment losses (1) (2)
Other income 11 4
------- -------
Total revenues 2,421 2,398
------- -------
Benefits and expenses:
Benefits and claims 1,606 1,620
Acquisition and operating expenses:
Amortization of deferred policy
acquisition costs 80 69
Insurance commissions 250 255
Insurance expenses 184 189
Interest expense 5 5
Other operating expenses 22 17
------- -------
Total acquisition and
operating expenses 541 535
------- -------
Total benefits and expenses 2,147 2,155
------- -------
Earnings before income taxes 274 243
Income taxes 96 87
------- -------
Net earnings $ 178 $ 156
======= =======
Net earnings per share:
Basic $ .34 $ .29
Diluted .33 .29
======= =======
Shares used in computing
earnings per share (In thousands):
Basic 528,180 531,199
Diluted 541,767 544,523
======= =======
Cash dividends per share $ .043 $ .038
======= =======
See the accompanying Notes to Consolidated Financial Statements.
Share and per-share amounts have been restated to reflect the two-for-one
stock split distributed March 16, 2001.
3
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(In millions, except for per-share amounts - Unaudited)
Three Months Ended March 31,
----------------------------
2001 2000
------ ------
Common Stock:
Balance at beginning of period $ 32 $ 32
Exercise of stock options 1 -
Two-for-one stock split 32 -
------ ------
Balance at end of period 65 32
------ ------
Additional paid-in capital:
Balance at beginning of period 336 310
Exercise of stock options 2 7
Gain on treasury stock reissued 6 3
Two-for-one stock split (32) -
------ ------
Balance at end of period 312 320
------ ------
Retained earnings:
Balance at beginning of period 3,956 3,356
Net earnings 178 156
Dividends to shareholders ($.043 per share
in 2001 and $.038 in 2000) (22) (19)
------ ------
Balance at end of period 4,112 3,493
------ ------
Accumulated other comprehensive income:
Balance at beginning of period 1,668 1,264
Change in unrealized foreign currency
translation gains (losses) during
period, net of income taxes 6 (51)
Change in unrealized gains (losses) on
investment securities during period, net
of income taxes 505 176
------ ------
Balance at end of period 2,179 1,389
------ ------
Treasury stock:
Balance at beginning of period (1,298) (1,094)
Purchases of treasury stock (162) (81)
Cost of shares issued 10 8
------ ------
Balance at end of period (1,450) (1,167)
------ ------
Total shareholders' equity $ 5,218 $ 4,067
====== ======
See the accompanying Notes to Consolidated Financial Statements.
Per-share amounts have been restated to reflect the two-for-one stock split
distributed March 16, 2001.
4
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In millions - Unaudited)
Three Months Ended
March 31,
2001 2000
------ ------
Cash flows from operating activities:
Net earnings $ 178 $ 156
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Increase in policy liabilities 640 688
Deferred income taxes 39 38
Change in income taxes payable 327 147
Increase in deferred policy
acquisition costs (76) (81)
Change in receivables and advance premiums 38 12
Realized investment and derivative
(gains) losses (2) 2
Other, net 137 (53)
------ ------
Net cash provided by operating activities 1,281 909
------ ------
Cash flows from investing activities:
Proceeds from investments sold or matured:
Securities available for sale:
Fixed maturities sold 618 207
Fixed maturities matured 150 121
Equity securities 58 15
Other investments, net - (1)
Costs of investments acquired:
Securities available for sale:
Fixed maturities (960) (1,377)
Perpetual debentures (509) (1)
Equity securities (24) (27)
Cash received as collateral on
loaned securities, net 137 340
Additions to property and equipment, net (16) (1)
Other, net (3) -
------ ------
Net cash used by investing activities $ (549) $ (724)
------ ------
See the accompanying Notes to Consolidated Financial Statements.
(continued)
5
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
(In millions - Unaudited)
Three Months Ended
March 31,
2001 2000
------ ------
Cash flows from financing activities:
Principal payments under debt obligations $ (3) $ (4)
Dividends paid to shareholders (21) (18)
Purchases of treasury stock (162) (81)
Treasury stock reissued 13 6
Other, net 1 7
------ ------
Net cash used by financing activities (172) (90)
------ ------
Effect of exchange rate changes on cash
and cash equivalents (94) (19)
------ ------
Net change in cash and cash equivalents 466 76
Cash and cash equivalents, beginning of period 609 616
------ ------
Cash and cash equivalents, end of period $ 1,075 $ 692
====== ======
Supplemental disclosures of cash flow information:
Cash payments during the period for:
Interest paid $ 2 $ 3
Income taxes paid 1 -
Impairment loss on available-for-sale security 42 -
Noncash financing activities:
Capital lease obligations 5 4
Treasury shares issued to AFL stock plan for:
Shareholder dividend reinvestment 1 1
Associates stock bonus 3 4
See the accompanying Notes to Consolidated Financial Statements.
6
AFLAC INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In millions - Unaudited)
Three Months Ended
March 31,
2001 2000
------ ------
Net earnings $ 178 $ 156
------ ------
Other comprehensive income, before
income taxes:
Change in unrealized foreign currency
translation gains (losses) arising
during the period 61 32
Unrealized gains (losses) on investment
securities:
Unrealized holding gains (losses)
arising during the period 697 232
Reclassification adjustment for realized
(gains) losses included in net earnings 1 2
Change in unrealized holding gains (losses)
on derivatives arising during the period (1) -
------ ------
Total other comprehensive income,
before income taxes 758 266
Income tax expense related to items
of other comprehensive income 247 141
------ ------
Other comprehensive income,
net of income taxes 511 125
------ ------
Total comprehensive income $ 689 $ 281
====== ======
See the accompanying Notes to Consolidated Financial Statements.
7
AFLAC INCORPORATED AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated
financial statements of AFLAC Incorporated and subsidiaries (the "Company")
contain all adjustments necessary to fairly present the consolidated balance
sheet as of March 31, 2001, and the consolidated statements of earnings,
cash flows, shareholders' equity and comprehensive income for the three
month periods ended March 31, 2001 and 2000. Results of operations for
interim periods are not necessarily indicative of results for the entire
year.
We prepare our financial statements in accordance with accounting
principles generally accepted in the United States of America (GAAP). These
principles are established primarily by the Financial Accounting Standards
Board and the American Institute of Certified Public Accountants. The
preparation of financial statements in conformity with GAAP requires us to
make estimates when recording transactions resulting from business
operations, based on information currently available. The most significant
items on our balance sheet that involve a greater degree of accounting
estimates and actuarial determinations subject to changes in the future are:
deferred policy acquisition costs and liabilities for future policy benefits
and unpaid policy claims. As additional information becomes available (or
actual amounts are determinable), the recorded estimates will be revised and
reflected in operating results. Although some variability is inherent in
these estimates, we believe the amounts provided are adequate.
The financial statements should be read in conjunction with the
financial statements included in our annual report to shareholders for the
year ended December 31, 2000.
Certain prior-year amounts have been reclassified to conform to the
current-year presentation.
2. Accounting Pronouncements
We adopted Statement of Financial Accounting Standards (SFAS) No. 133
as amended, Accounting for Derivative Instruments and Hedging Activities, on
January 1, 2001. This statement establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in investment securities and other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those
instruments at fair value. The accounting for changes in the fair value of
a derivative is included in either earnings or other comprehensive income
depending on the intended use of the derivative instrument.
This standard changed the accounting for our interest rate swaps and
the interest component of the cross-currency swaps. In accordance with SFAS
No. 133, we are required to recognize in net earnings the change in
unrealized gains/losses on the interest component of our cross-currency
swaps. Unrealized gains and losses in the fair value of our interest rate
swaps will be reflected in accumulated other comprehensive income.
8
The cumulative transition effect of adopting this new accounting
standard as of January 1, 2001, was immaterial. As a result of applying
this new standard during the three months ended March 31, 2001, pretax
earnings increased by $3 million for the change in fair value of the
interest component of our cross-currency swaps, and accumulated other
comprehensive income decreased by $1 million for the change in fair value of
our interest rate swaps.
See Note 5 for additional information on our derivative and
nonderivative financial instruments.
3. Segment Information
Information regarding components of operations for the three months
ended March 31 follows:
(In millions) 2001 2000
-------- --------
Revenues:
AFLAC Japan:
Earned premiums $ 1,591 $ 1,646
Net investment income 305 306
Other income (1) -
------- -------
Total AFLAC Japan revenues 1,895 1,952
------- -------
AFLAC U.S.:
Earned premiums 439 374
Net investment income 73 67
Other income 1 1
------- -------
Total AFLAC U.S. revenues 513 442
------- -------
Other business segments 8 6
------- -------
Total business segments 2,416 2,400
Realized investment and derivative
gains (losses) 2 (2)
Corporate* 9 8
Intercompany eliminations (6) (8)
------- -------
Total revenues $ 2,421 $ 2,398
======= =======
Earnings before income taxes:
AFLAC Japan $ 204 $ 188
AFLAC U.S. 81 70
------- -------
Total business segments 285 258
Realized investment and derivative
gains (losses) 1 (2)
Interest expense, noninsurance operations (4) (4)
Corporate* (8) (9)
------- -------
Total earnings before income taxes $ 274 $ 243
======= =======
*Includes investment income of $4 in 2001 and $3 in 2000.
9
Assets were as follows:
March 31, December 31,
(In millions) 2001 2000
------------ -----------
Assets:
AFLAC Japan $ 32,139 $ 31,882
AFLAC U.S. 5,247 4,964
Other business segments 78 46
-------- --------
Total business segments 37,464 36,892
Corporate 6,450 5,993
Intercompany eliminations (6,273) (5,653)
-------- --------
Total assets $ 37,641 $ 37,232
======== ========
4. Notes Payable
A summary of notes payable is as follows:
March 31, December 31,
(In millions) 2001 2000
---------- -----------
6.50% senior notes due April 2009 (principal
amount $450) $ 449 $ 449
1.55% yen-denominated Samurai notes due October
2005 (principal amount 30 billion yen) 242 261
Unsecured, yen-denominated notes payable to banks:
Reducing revolving credit agreement, due
July 2001:
2.29% fixed interest rate 91 99
Variable interest rate (.83% at
March 31, 2001) 13 14
Revolving credit agreement, due November 2002:
1.24% fixed interest rate 63 68
Variable interest rate (.78% at
March 31, 2001) 146 157
Obligations under capitalized leases payable
monthly through 2005, secured by computer
equipment in Japan 31 31
------ ------
Total notes payable $ 1,035 $ 1,079
====== ======
For those loans denominated in yen, the principal amount of the loans
as stated in dollar terms will fluctuate from period to period due to
changes in the yen/dollar exchange rate.
In September 2000, we filed a shelf registration statement with
Japanese regulatory authorities to issue up to 100 billion yen of yen-
denominated Samurai notes. These securities are not for sale to United
States residents or entities. In October 2000, we issued in Japan 30
billion yen of 1.55% Samurai notes due October 2005 ($242 million using the
March 31, 2001 exchange rate). These notes are redeemable at our option at
any time with a redemption price equal to the principal amount of the notes
being redeemed plus a premium.
10
In April 1999, we issued $450 million of 6.50% senior notes, due April
2009. The current outstanding balance after discount is $449 million. The
notes are redeemable at our option at any time with a redemption price equal
to the principal amount of the notes being redeemed plus a make-whole
amount. We have entered into cross-currency swaps that have the effect of
converting the dollar-denominated principal and interest into yen-
denominated obligations (see Note 5).
We have an unsecured reducing, revolving credit agreement that provides
for bank borrowings through July 2001 in either U.S. dollars or Japanese
yen. The current borrowing limit is $125 million. The debt is currently
payable in Japanese yen. At March 31, 2001, 11.4 billion yen ($91 million)
was outstanding at a fixed interest rate and 1.6 billion yen ($13 million)
was outstanding at a variable interest rate under this agreement.
We also have an unsecured revolving credit agreement that provides for
bank borrowings through November 2002 in either U.S. dollars or Japanese
yen. The current borrowing limit is $250 million. The debt is currently
payable in Japanese yen. At March 31, 2001, 7.8 billion yen ($63 million)
was outstanding at a fixed interest rate and 18.1 billion yen ($146 million)
was outstanding at a variable interest rate under this agreement.
At March 31, 2001, we had outstanding interest rate swaps on 19.1
billion yen ($154 million) of our variable-interest-rate yen-denominated
borrowings (see Note 5).
5. Financial Instruments
We have only limited activity with derivative financial instruments.
We do not use them for trading purposes, nor do we engage in leveraged
derivative transactions. Our risk management objectives are to minimize the
exposure of our shareholders' equity to foreign currency translation
fluctuations and also reduce our interest expense by converting the dollar-
denominated principal and interest into yen-denominated obligations. We
currently use two types of derivatives: interest rate swaps and cross-
currency swaps.
Derivative Hedging Instruments
We have cross-currency swaps outstanding related to our $450 million
senior notes (see Note 4). These cross-currency swaps have the effect of
converting the dollar-denominated principal and interest into yen-
denominated obligations. Our interest expense is reduced from 6.50% to
1.67%. The notional amount and terms of the swaps match the principal
amount and terms of the senior notes. The cross-currency swaps have been
designated as a hedge of the foreign currency exposure of our net investment
in AFLAC Japan.
The fair value of the cross-currency swaps includes three components:
the effect of changes in foreign currency exchange rates, the accrued
interest at the valuation date, and the effect of changes in interest rates.
The currency portion of our cross-currency swaps is included at fair
value in other assets at $2 million as of March 31, 2001, and in other
liabilities at $34 million at December 31, 2000. The related $36 million
increase in fair value during the three months ended March 31, 2001
11
(a $19 million increase during the three months ended March 31, 2000) is
reflected in accumulated other comprehensive income - unrealized foreign
currency translation gains (losses).
The ineffective portion of the hedge instrument is the fair value of
the interest components of the cross-currency swaps. At March 31, 2001, the
accrued interest receivable was $10 million. The balance was $4 million at
December 31, 2000. The change in the accrued interest receivable is
included in interest expense. The increase in fair value related to changes
in interest rates ($3 million) is reflected in other assets and other
income.
The fair value of the interest components, not related to accrued
interest, was not reflected in the financial statements prior to January 1,
2001.
At March 31, 2001, we had outstanding interest rate swaps on 19.1
billion yen ($154 million) of our variable-interest-rate yen-denominated
borrowings (Note 4). These swaps reduce the impact of changes in interest
rates on our borrowing costs and effectively change our interest rate from
variable to fixed. The interest rate swaps have notional principal amounts
that equal the anticipated unpaid principal amounts on a portion of these
loans. After the effect of these swap agreements, we make fixed-rate
payments at 2.29% on one loan and 1.24% on another loan and receive
floating-rate payments (.13% at March 31, 2001, plus loan costs of 25 and 20
basis points, respectively) based on three-month Japanese yen LIBOR. The
terms of these swap agreements expire in July 2001 and November 2002. For
additional information on the credit agreements, see Note 4.
Our risk management objective is to fix the net interest cash outflows
on a portion of our debt obligations. We have designated these interest
rate swaps as a cash flow hedge of our exposure to the variability in future
cash flows attributable to the variable interest payments due. These
interest rate swaps are included in other liabilities at a fair value of $1
million at March 31, 2001, and the change in such fair value during the
three months ended March 31, 2001 is reflected in accumulated other
comprehensive income. The fair value of the interest rate swaps was not
reflected in the financial statements prior to January 1, 2001. For
additional information on the adoption of SFAS No. 133 and our accounting
for derivatives, see Note 2.
Nonderivative Hedging Instruments
The following yen-denominated debt instruments (see Note 4) have been
designated as hedges of the foreign currency exposure of our net investment
in AFLAC Japan - the 1.55% Samurai notes due October 2005, principal amount
30.0 billion yen; the reducing, revolving credit agreement due July 2001,
currently payable in Japanese yen, principal amount 12.9 billion yen; and
the unsecured, revolving credit agreement due November 2002, currently
payable in Japanese yen, principal amount 25.8 billion yen.
Other Nonderivatives
We lend fixed-maturity securities to financial institutions in short-
term security lending transactions. These securities continue to be carried
as investment assets on our balance sheet during the term of the loans and
are not recorded as sales. We receive cash or other securities as
12
collateral for such loans. These short-term security lending arrangements
increase investment income with minimal risk. At March 31, 2001, and
December 31, 2000, we had security loans outstanding in the amounts of $243
million and $123 million at fair value, respectively. At March 31, 2001,
and December 31, 2000, we held cash in the amount of $248 million and $127
million, respectively, as collateral for loaned securities.
For loans involving unrestricted cash collateral, the collateral is
recorded as an asset with a corresponding liability for the return of the
collateral. For loans collateralized by securities, the collateral is not
recorded as an asset or liability.
Our security lending policy requires that the fair value of the
securities received as collateral and cash received as collateral be 102%
and 100% or more, respectively, of the fair value of the loaned securities
as of the date the securities are loaned and not less than 100% thereafter.
6. Investment Securities
Realized Investment Gains and Losses
In March 2001, we recognized a pretax impairment loss of $42 million in
realized investment gains and losses on the corporate debt securities of a
U.S. issuer, which experienced a significant credit rating downgrade during
the first quarter of 2001. These debt securities are carried in the
available-for-sale category.
We also executed several bond sales and purchase transactions during
the first quarter in an effort to increase investment income and extend
investment maturities. The sales of these debt securities resulted in
pretax realized investment gains of $21 million.
Also, in the first quarter of 2001, we realized a pretax investment
gain of $18 million related to the sale of a portion of our U.S. equity
securities portfolio in connection with a change in outside investment
managers.
Unrealized Investment Gains and Losses
The unrealized gains and losses on debt securities, less amounts
applicable to policy liabilities and deferred income taxes, are reported in
accumulated other comprehensive income. The portion of unrealized gains
credited to policy liabilities represents gains that would not inure to the
benefit of our shareholders if such gains were actually realized.
13
The net effect on shareholders' equity of unrealized gains and losses
from investment securities at the following dates was:
(In millions) March 31, December 31,
2001 2000
------------ ------------
Unrealized gains on securities
available for sale $ 3,188 $ 1,541
Unamortized unrealized gains on
securities transferred to held
to maturity 693 1,001
Less:
Policy liabilities 643 -
Deferred income taxes 1,258 1,068
--------- ---------
Shareholders' equity, net
unrealized gains on
investment securities $ 1,980 $ 1,474
========= =========
As of March 31, 2001, new Japanese accounting principles and regulatory
requirements became effective, which impact investment classifications and
solvency margin calculations on a Japanese accounting basis. As a result of
these new regulatory requirements, we re-evaluated AFLAC Japan's investment
portfolio and our holding period intent related to certain investment
securities. In order to minimize future unfavorable solvency margin results
under the new Japanese accounting methods, debt securities with amortized
cost of $1.8 billion were reclassified from the held-to-maturity category to
the available-for-sale category as of March 31, 2001. The related
unamortized unrealized gain, included in accumulated other comprehensive
income immediately prior to the transfer, was $327 million.
We also reclassified debt securities with a fair value of $2.3 billion
from the available-for-sale category to the held-to-maturity category as of
March 31, 2001. The related unrealized gain of $118 million is being
amortized from accumulated other comprehensive income to investment income
over the remaining term of the securities. The related premium in the
carrying value of the debt securities that was created when the
reclassification occurred is also being amortized as an offsetting charge to
investment income.
14
7. Common Stock
The following is a reconciliation of the number of shares of our common
stock for the three months ended March 31:
2001 2000
(In thousands of shares) ---------- ----------
Common stock - issued:
Balance at beginning of year 644,813 640,698
Exercise of stock options 792 2,292
-------- --------
Balance at end of period 645,605 642,990
-------- --------
Treasury stock:
Balance at beginning of year 115,603 109,216
Purchases of treasury stock:
Open market 5,387 4,087
Other 165 95
Shares issued to AFL Stock Plan (460) (458)
Exercise of stock options (332) (316)
-------- --------
Balance at end of period 120,363 112,624
-------- --------
Shares outstanding at end of period 525,242 530,366
======== ========
On February 13, 2001, the board of directors declared a two-for-one
stock split, consisting of 323 million shares, payable to shareholders of
record at the close of business on February 27, 2001. The stock split was
distributed on March 16, 2001. Share and per-share amounts have been
retroactively adjusted to reflect this split.
8. Litigation
We are a defendant in various litigation considered to be in the normal
course of business. Some of this litigation is pending in Alabama, where
large punitive damages bearing little relation to the actual damages
sustained by plaintiffs have been awarded against other companies, including
insurers, in recent years. Although the final results of any litigation
cannot be predicted with certainty, we believe the outcome of pending
litigation will not have a material adverse effect on our financial
position, results of operations, or cash flows.
15
REVIEW BY INDEPENDENT AUDITORS
The March 31, 2001, and 2000, financial statements included in this
filing have been reviewed by KPMG LLP, independent auditors, in accordance
with established professional standards and procedures for such a review.
The report of KPMG LLP commenting upon their review is included on
page 17.
16
KPMG LLP
Certified Public Accountants
303 Peachtree Street, N.E. Telephone: (404) 222-3000
Suite 2000 Telefax: (404) 222-3050
Atlanta, GA 30308
INDEPENDENT AUDITORS' REVIEW REPORT
The shareholders and board of directors AFLAC Incorporated:
We have reviewed the consolidated balance sheet of AFLAC Incorporated and
subsidiaries as of March 31, 2001, and the related consolidated statements
of earnings, shareholders' equity, cash flows and comprehensive income for
the three-month periods ended March 31, 2001, and 2000. These consolidated
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with auditing standards generally accepted in the
United States of America, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly,
we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the consolidated financial statements referred to above
for them to be in conformity with accounting principles generally accepted
in the United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the accompanying consolidated
balance sheet of AFLAC Incorporated and subsidiaries as of December 31,
2000, and the related consolidated statements of earnings, shareholders'
equity, cash flows and comprehensive income for the year then ended (not
presented herein); and in our report dated January 26, 2001, we expressed an
unqualified opinion on those financial statements.
KPMG LLP
Atlanta, GA
April 24, 2001
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AFLAC Incorporated is the parent company of American Family Life
Assurance Company of Columbus, AFLAC. Our principal business is
supplemental health and life insurance, which is marketed and administered
through AFLAC. Most of AFLAC's policies are individually underwritten and
marketed at worksites through independent agents, with premiums paid by the
employee. Our operations in Japan (AFLAC Japan) and the United States
(AFLAC U.S.) service the two markets for our insurance business.
On February 13, 2001, the board of directors declared a two-for-one
stock split, effectively increasing the numbers of issued and outstanding
shares by 100%. All share and per-share amounts have been restated for the
split.
RESULTS OF OPERATIONS
The following table sets forth the results of operations by business
segment for the periods shown.
SUMMARY OF OPERATING RESULTS BY BUSINESS SEGMENT
(In millions, except for per-share amounts)
Three Months Ended March 31,
--------------------------------------
Percentage Change 2001 2000
----------------- ------------------
Operating earnings:
AFLAC Japan. . . . . . . . . . . . 8.1% $ 204 $ 188
AFLAC U.S. . . . . . . . . . . . . 16.7 81 70
----- -----
Total business segments. . . . . 10.5 285 258
Interest expense,
noninsurance operations. . . . . (4.8) (4) (4)
Corporate and eliminations . . . . 2.5 (8) (8)
----- -----
Pretax operating earnings. . . . 11.0 273 246
Income taxes . . . . . . . . . . . 10.4 96 87
----- -----
Operating earnings . . . . . . . 11.4 177 159
Nonoperating items:
Derivative gains (losses), net
of tax 3 -
Realized investment gains
(losses), net of tax . . . . . . (2) (3)
----- -----
Net earnings . . . . . . . . . . 14.0 $ 178 $ 156
===== =====
Operating earnings per basic share . 10.0 $ .33 $ .30
Operating earnings per diluted share 13.8 .33 .29
===== =====
Net earnings per basic share . . . . 17.2 $ .34 $ .29
Net earnings per diluted share . . . 13.8 .33 .29
===== =====
============================================================================
18
The following discussion of earnings comparisons focuses on operating
earnings and excludes realized investment and derivative gains/losses.
Operating earnings per share amounts referenced in the following discussion
are based on the diluted number of average outstanding shares and
retroactively reflect the two-for-one stock split distributed March 16,
2001. For the first quarter of 2001, the weakening yen, or strengthening
dollar, will mask our true operating performance. Our business, in
functional currency terms, continues to be strong, and we believe it is more
appropriate to measure our performance excluding the effect of the yen in
order to understand the basic operating results of the business.
FOREIGN CURRENCY TRANSLATION
Due to the relative size of AFLAC Japan, fluctuations in the yen/dollar
exchange rate can have a significant effect on our reported results. In
years when the yen weakens, translating yen into dollars causes fewer
dollars to be reported. When the yen strengthens, translating yen into
dollars causes more dollars to be reported.
The following table illustrates the effect of foreign currency
translation by comparing our reported operating results with those that
would have been reported had foreign currency rates remained unchanged from
the comparable period in the prior year.
AFLAC Incorporated and Subsidiaries
Foreign Currency Translation Effect on Operating Results
Three Months Ended March 31, 2001
Including Excluding
Currency Currency
Percentage changes over previous year Changes Changes*
- ------------------------------------- ----------- -----------
Premium income .5% 8.6%
Net investment income 1.5 7.4
Operating revenues .8 8.5
Total benefits and expenses (.4) 7.7
Operating earnings 11.4 16.1
Operating earnings per diluted share 13.8 17.2
- ----------------------------------------------------------------------------
*Amounts excluding foreign currency changes were determined using the
same yen/dollar exchange rate for the current period as the comparable
period in the prior year.
============================================================================
The yen weakened in relation to the dollar during 2000 and the first
quarter of 2001 after a period of strengthening beginning in 1998. The
average yen-to-dollar exchange rates were 118.14 and 107.13 for the three
months ended March 31, 2001 and 2000, respectively. The weakening of the
yen in 2001 decreased operating earnings by approximately $.01 per share for
the three months ended March 31, 2001. Operating earnings per share
increased 13.8% to $.33 for the three-month period ended March 31, 2001,
compared with the same period in 2000. Operating earnings per share,
excluding the effect of foreign currency translation, increased 17.2%, to
$.34 for the quarter ended March 31, 2001 compared with the same period in
2000.
19
Our primary financial objective is the growth of operating earnings per
share excluding the effect of foreign currency fluctuations. Our objective
for 2001 and 2002 is to increase operating earnings per share by 15% to 17%
excluding the impact of currency translation.
We expect to achieve the high end of our objective for 2001. If we
achieve a 17% increase, the following table shows the likely results for
operating earnings per share in 2001 using various yen-to-dollar exchange
rate scenarios.
2001 Operating EPS Scenarios
----------------------------
Annual
Average Yen Annual Operating % Growth Yen Impact
Exchange Rate Diluted EPS Over 2000 on EPS
------------- ---------------- --------- ----------
100.00 $ 1.45 20.8% $ .05
105.00 1.42 18.3 .02
107.83* 1.40 16.7 -
110.00 1.39 15.8 (.01)
115.00 1.36 13.3 (.04)
120.00 1.33 10.8 (.07)
125.00 1.30 8.3 (.10)
130.00 1.28 6.7 (.12)
*Actual 2000 average exchange rate.
We believe we will achieve the high end of our earnings objective for
the year. If we reach that target and the yen averages 120 to 125 to the
dollar for the remainder of the year, we would expect operating earnings for
the full year to be in the range of $1.33 to $1.30 per share.
SHARE REPURCHASE PROGRAM
During the first quarter, we purchased approximately 5 million shares
of our stock. As of March 31, 2001, we had approximately 11 million shares
available for repurchase under the share repurchase program authorized by
the board of directors.
INCOME TAXES
Our combined U.S. and Japanese effective income tax rates on operating
earnings for the three months ended March 31, 2001 and 2000 were 35.2% and
35.4%, respectively.
INSURANCE OPERATIONS, AFLAC JAPAN
AFLAC Japan, a branch of AFLAC and the principal contributor to our
earnings, ranks number one in terms of premium income and profits among all
foreign life and non-life insurance companies operating in Japan. Among all
life insurance companies operating in Japan, AFLAC Japan ranked second in
terms of individual policies in force and 12th in terms of assets according
to Financial Services Agency (FSA) data as of September 30, 2000.
20
The following table presents a summary of AFLAC Japan's operating
results.
AFLAC JAPAN
SUMMARY OF OPERATING RESULTS
THREE MONTHS ENDED MARCH 31,
(In millions) 2001 2000
---------------------------
Premium income. . . . . . . . . . . . . $ 1,591 $ 1,646
Investment income . . . . . . . . . . . 305 306
Other income. . . . . . . . . . . . . . (1) -
-------- --------
Total revenues. . . . . . . . . . . . 1,895 1,952
-------- --------
Benefits and claims . . . . . . . . . . 1,334 1,385
Operating expenses. . . . . . . . . . . 357 379
-------- --------
Total benefits and expenses . . . . . 1,691 1,764
-------- --------
Pretax operating earnings . . . . . $ 204 $ 188
======== ========
- ----------------------------------------------------------------------------
Percentage changes in dollars
over previous period:
Premium income. . . . . . . . . . . . (3.4)% 17.7%
Investment income . . . . . . . . . . (.4) 17.1
Total revenues. . . . . . . . . . . . (2.9) 17.6
Pretax operating earnings . . . . . . 8.1 19.1
- ----------------------------------------------------------------------------
Percentage changes in yen
over previous period:
Premium income. . . . . . . . . . . . 6.6% 8.2%
Investment income . . . . . . . . . . 9.9 7.4
Total revenues. . . . . . . . . . . . 7.0 8.0
Pretax operating earnings . . . . . . 19.3 9.1
- ----------------------------------------------------------------------------
Ratios to total revenues:
Benefits and claims . . . . . . . . . 70.4% 70.9%
Operating expenses. . . . . . . . . . 18.9 19.5
Pretax operating earnings . . . . . . 10.7 9.6
============================================================================
The average yen/dollar exchange rate used to translate AFLAC Japan's
income statement was 118.14, compared with an average rate of 107.13 in the
first quarter of 2000. This 9.3% weakening of the average exchange rate for
the quarter held down rates of growth for AFLAC Japan in dollar terms and
inflated rates of growth in yen terms.
Despite a difficult economic environment, AFLAC Japan performed very
well in the first quarter. Premium income in yen rose 6.6%. Because
approximately 25% of AFLAC Japan's investment income is dollar denominated,
increases as reported in yen for total revenues, net investment income and
pretax operating earnings were magnified.
21
The following table illustrates the effect of foreign currency
translation on AFLAC Japan by comparing certain operating results with those
that would have been reported had foreign exchange rates remained unchanged
from the comparable period in the previous year:
Including Excluding
Currency Currency
Changes Changes*
----------- -----------
Percentage changes in yen over previous year
Net investment income 9.9% 7.2%
Total revenues 7.0 6.6
Pretax operating earnings 19.3 15.3
- ----------------------------------------------------------------------------
*Amounts excluding foreign currency changes on dollar-denominated investment
income were determined using the same yen/dollar exchange rate for the
current period as the comparable period in the prior year.
============================================================================
The operating expense ratio decline is due to the decrease in the
commission expense ratio resulting from a shift to newer products which have
lower commissions and the implementation of our alternative commission
structure which pays higher first year commissions but lower renewal
commissions for a limited time period. Partially offsetting the decrease in
commission expenses, amortization of deferred acquisition costs increased
during the quarter due to a slight decline in persistency in Japan. The
benefit ratio has decreased slightly as the mix of business continues to
shift to newer products, which have lower loss ratios than the earlier
versions of our cancer life products.
JAPANESE ECONOMY
For the last several years, Japan has been working to overcome its
depressed economy. The financial strength of many Japanese businesses
continued to deteriorate with some experiencing bankruptcy or requesting
financial protection or assistance. As we have indicated in the past,
Japan's weak economy has created a challenging environment for AFLAC Japan,
as yields available for new yen-denominated investments remain at
historically low levels and consumer confidence continues to lag. The time
required for the Japanese economy to fully recover remains uncertain.
AFLAC JAPAN SALES
AFLAC Japan's new annualized premium sales in the first quarter rose
3.6% to 23.1 billion yen, or $194 million. The cancer products and related
riders continued to lead our production. The cancer life product accounted
for 27.6% of total sales. Rider MAX, the popular rider to our cancer life
coverage, represented approximately 27.3% of total sales. Ordinary life and
annuities, which showed solid gains, represented 28.8% of sales during the
quarter.
In addition to strong sales growth, we also continued to grow our
distribution system in Japan. At the end of the first quarter, AFLAC Japan
22
was represented by more than 45,000 licensed sales associates at 9,100
corporate and individual agencies. We believe that additional agencies will
continue to be attracted to AFLAC Japan's high commissions, superior
products, customer service and brand image.
We continued to invest in marketing to improve sales. An improved
incentive pay system for AFLAC Japan's employed sales managers was
introduced in 2000 to provide better rewards for sales performance. We
introduced a new optional commission contract in July 2000 that was
structured to attract new agents. The new contract pays a higher first-year
commission and limits renewal commissions to nine years. Our original
contract pays renewal commissions for the life of the policy.
We also increased expenditures for expanded sales promotion efforts in
Japan and will continue to do so throughout 2001 and we will continue to
aggressively promote our brand and products through advertising. We plan on
improving the products we offer and introducing new ones. We will invest in
new technologies, including our laptop sales aid, to maintain our cost and
service advantages.
We also continued to refine our product line. In mid-2000, we began
selling new, lower-premium cancer life and care products to meet the needs
of cost-sensitive buyers. At the end of 2000, we introduced 21st Century
Cancer Life. This new cancer life product offers a variety of coverage
choices and low monthly premiums to our customers. As a result, employers
will be able to customize an AFLAC cancer life policy that best suits the
needs of their workers.
In the third quarter of 2000, AFLAC Japan and Dai-ichi Mutual Life
Insurance Company (Dai-ichi Life) agreed to a major marketing alliance that
anticipates the sale of each company's products through their respective
distribution systems. The initial focus will be the sale of AFLAC Japan's
cancer life and Rider MAX products through Dai-ichi Life's sales force of
50,000 people. Dai-ichi Life began its initial sales of AFLAC products at
the end of March with sales of approximately 7,800 policies to its
employees. We expect to see increased sales contributions as this alliance
matures.
AFLAC JAPAN INVESTMENTS
Reflecting the continued weakness in Japan's economy, rates of return
on yen-denominated debt securities remained low in the first quarter. For
instance, the yield of a composite index of 20-year Japanese government
bonds averaged 1.84% during the first three months of the year, compared
with 2.37% in the fourth quarter of 2000. However, we purchased yen-
denominated securities at an average yield of 3.47% in the quarter by
focusing on selected sectors of the fixed-maturity market. Including
dollar-denominated investments, our blended new money yield was 3.74% for
the quarter.
At the end of the first quarter, the yield on AFLAC Japan's fixed-
maturity portfolio was 5.00%, compared with 5.14% a year ago. The return on
average invested assets, net of investment expenses, was 4.79% for the three
months ended March 31, 2001, compared with 4.88% a year ago.
23
INSURANCE DEREGULATION IN JAPAN
Trade talks in 1994 and 1996 between the governments of the United
States and Japan, and Japan's 1996 plan for a financial "Big Bang," produced
a framework for the deregulation of the Japanese insurance industry. These
measures called for the gradual liberalization of the industry through the
year 2001 and included provisions to avoid "radical change" in the third
sector of the insurance industry. AFLAC and other foreign-owned insurers,
as well as many small to medium-sized Japanese insurers, operate primarily
in the third sector.
As of January 1, 2001, additional insurance companies were permitted to
sell the type of third-sector products that AFLAC Japan currently offers.
We anticipate that by July 1, 2001, all insurance companies will be
permitted to compete in the third sector. We recognize that we will face
increased competition in the future, however, we continue to believe we will
be a very strong competitor because our low-cost structure allows us to
provide competitive benefits and services to policyholders and above-average
compensation to our sales force.
24
INSURANCE OPERATIONS, AFLAC U.S.
The following table presents a summary of AFLAC U.S. operating results.
AFLAC U.S.
SUMMARY OF OPERATING RESULTS
THREE MONTHS ENDED MARCH 31,
(In millions) 2001 2000
--------------------------
Premium income. . . . . . . . . . . . . $ 439 $ 374
Investment income . . . . . . . . . . . 73 67
Other income. . . . . . . . . . . . . . 1 1
----- -----
Total revenues. . . . . . . . . . . . 513 442
----- -----
Benefits and claims . . . . . . . . . . 272 235
Operating expenses. . . . . . . . . . . 160 137
----- -----
Total benefits and expenses . . . . . 432 372
----- -----
Pretax operating earnings . . . . . $ 81 $ 70
===== =====
- ----------------------------------------------------------------------------
Percentage changes
over previous period:
Premium income. . . . . . . . . . . . 17.4% 13.4%
Investment income . . . . . . . . . . 9.1 15.2
Total revenues. . . . . . . . . . . . 16.2 13.7
Pretax operating earnings . . . . . . 16.7 11.4
- ----------------------------------------------------------------------------
Ratios to total revenues:
Benefits and claims . . . . . . . . . 53.0% 53.3%
Operating expenses. . . . . . . . . . 31.1 30.9
Pretax operating earnings . . . . . . 15.9 15.8
============================================================================
AFLAC U.S. SALES
New annualized premium sales rose 34.5% in the first quarter to $202
million, marking the second best quarter in AFLAC's history.
Accident/disability insurance again led our sales for the quarter,
accounting for more than 53% of total sales. Cancer expense insurance also
produced strong results, accounting for nearly 22% of total sales. AFLAC's
indemnity dental product continued to sell extremely well, accounting for
more than 7% of sales for the first three months of the year. Introduced in
July 2000, the dental product is the most successful product introduction in
our history.
AFLAC U.S. continues to rapidly expand its sales force. During the
first quarter, the average number of associates producing business on a
monthly basis increased 25.8%, compared with the three months ended March
31, 2000, to more than 12,500 agents. We believe the expansion of our
distribution system has benefited from our current advertising campaign,
which has dramatically increased awareness of AFLAC and its products.
25
AFLAC U.S. INVESTMENTS
During the first three months of 2001, available cash flow was invested
at an average yield-to-maturity of 7.87% compared with 8.11% during the
first three months of 2000. The overall return on average invested assets,
net of investment expenses, was 7.71% for the first three months of 2001
compared with 7.60% for the first three months of 2000.
AFLAC U.S. OTHER
Management expects the operating expense ratio, excluding discretionary
advertising expenses, to remain relatively level in the future. By improving
administrative systems and controlling other costs, we have been able to
redirect funds to our advertising programs without significantly affecting
the operating expense ratio.
The aggregate benefit ratio has been relatively stable. The mix of
business has shifted toward accident/disability policies, which have lower
benefit ratios than other products. We expect future benefit ratios for
some of our supplemental products to increase slightly due to our ongoing
efforts to improve policy persistency and enhance policyholder benefits.
Management expects the pretax operating profit margin to be approximately
16% for the full year.
FINANCIAL ACCOUNTING STANDARDS BOARD STATEMENTS
We adopted Statement of Financial Accounting Standard No. 133 effective
January 1, 2001 and recognized $3 million of gains in earnings for the
quarter ended March 31, 2001 from the change in the fair value of the
interest component of our cross-currency swaps. This new accounting
standard will increase volatility in reported net earnings in the future.
For additional information, see Notes 2 and 5 of the Notes to the
Consolidated Financial Statements.
ANALYSIS OF FINANCIAL CONDITION
Since December 31, 2000, our financial condition has remained strong in
the functional currencies of our operations. The investment portfolios of
AFLAC Japan and AFLAC U.S. have continued to grow with 99.5% classified as
investment-grade securities.
The yen/dollar exchange rate at the end of each period is used to
translate yen-denominated balance sheet items to U.S. dollars for reporting
purposes. The exchange rate at March 31, 2001, was 123.90 yen to one U.S.
dollar, or 7.4% weaker than the December 31, 2000 exchange rate of 114.75.
The weaker yen decreased reported investments and cash by $2.1 billion,
total assets by $2.4 billion, and total liabilities by $2.3 billion,
compared with the amounts that would have been reported for 2001 if the
exchange rate had remained unchanged from year-end 2000.
26
INVESTMENTS AND CASH
The continued growth in investments and cash reflects the substantial
cash flows in the functional currencies of our operations. Net unrealized
gains of $3.5 billion on investment securities at March 31, 2001, consisted
of $3.8 billion in gross unrealized gains and $301 million in gross
unrealized losses.
AFLAC invests primarily within the Japanese, U.S. and Euroyen debt
securities markets. We are exposed to credit risk in our investment
activity. Credit risk is a consequence of extending credit and/or carrying
investment positions. We require that all securities have an initial rating
of Class 1 or 2 as determined by the Securities Valuation Office of the
National Association of Insurance Commissioners (NAIC). We use specific
criteria to judge the credit quality and liquidity of our investments and
use a variety of credit rating services to monitor these criteria. Applying
those various credit ratings to a standardized rating system based on the
categories of a nationally recognized rating service, the percentages of our
debt securities, at amortized cost, were as follows:
March 31, December 31,
2001 2000
------------ ------------
AAA 3.7% 25.0%
AA 43.0 22.4
A 37.0 36.8
BBB 15.8 15.1
BB .5 .7
----- -----
100.0% 100.0%
===== =====
The decrease in AAA-rated debt securities during the first quarter is
primarily due to a credit rating change on Japanese government bonds.
In March 2001, we recognized a pretax impairment loss of $42 million in
realized investment gains and losses on the corporate debt securities of a
U.S. issuer, which experienced a significant credit rating downgrade during
the first quarter of 2001. These debt securities are carried in the
available-for-sale category.
We also executed several bond sales and purchase transactions during
the first quarter in an effort to increase investment income and extend
investment maturities. The sales of these debt securities resulted in
pretax realized investment gains of $21 million.
Also, in the first quarter of 2001, we realized a pretax investment
gain of $18 million related to the sale of a portion of our U.S. equity
securities portfolio in connection with a change in outside investment
managers.
As of March 31, 2001, new Japanese accounting principles and regulatory
requirements became effective, which impact investment classifications and
solvency margin calculations on a Japanese accounting basis. As a result of
these new regulatory requirements, we re-evaluated AFLAC Japan's investment
portfolio and our holding period intent related to certain investment
securities. In order to minimize future unfavorable solvency margin results
27
under the new Japanese accounting methods, debt securities with amortized
cost of $1.8 billion were reclassified from the held-to-maturity category to
the available-for-sale category as of March 31, 2001. The related
unamortized unrealized gain, included in accumulated other comprehensive
income immediately prior to the transfer, was $327 million.
We also reclassified debt securities with a fair value of $2.3 billion
from the available-for-sale category to the held-to-maturity category as of
March 31, 2001. The related unrealized gain of $118 million is being
amortized from accumulated other comprehensive income to investment income
over the remaining term of the securities. See Note 6 of the Notes to the
Consolidated Financial Statements.
Private placement investments, at amortized cost, accounted for 52.6%
and 51.5% of our total debt securities as of March 31, 2001 and December 31,
2000, respectively. Of the total private placements, reverse-dual currency
debt securities (principal payments in yen, interest payments in dollars)
accounted for 30.1% and 31.5% of total private placement investments as of
March 31, 2001 and December 31, 2000, respectively. AFLAC Japan has
invested in the private placement market to secure higher yields than those
available from Japanese government bonds. At the same time, we have adhered
to prudent standards for credit quality. Most of AFLAC's private placements
are issued under medium-term note programs and have standard covenants
commensurate with credit rankings, except when internal credit analysis
indicates that additional protective and/or event-risk covenants are
required.
28
The following table presents an analysis of investment securities:
AFLAC Japan AFLAC U.S.
------------------------- -------------------------
March 31, December 31, March 31, December 31,
(In millions) 2001 2000 2001 2000
------------------------- -------------------------
Securities available
for sale, at fair
value:
Fixed maturities $18,110 $18,616 $ 3,586* $ 3,556*
Perpetual debentures 2,580 1,877 177 169
Equity securities 74 68 102 168
------ ------ ------ ------
Total available
for sale 20,764 20,561 3,865 3,893
------ ------ ------ ------
Securities held to
maturity, at
amortized cost:
Fixed maturities 3,915 3,645 - -
Perpetual debentures 3,131 3,442 - -
------ ------ ------ ------
Total held to
maturity 7,046 7,087 - -
------ ------ ------ ------
Total investment
securities $27,810 $27,648 $ 3,865 $ 3,893
====== ====== ====== ======
*Includes securities held by the parent company of $92 at March 31,
2001, and $262 at December 31, 2000
Mortgage loans on real estate and other long-term investments remained
immaterial at both March 31, 2001 and December 31, 2000. Cash, cash
equivalents and short-term investments totaled $1.1 billion, or 3.3% of
total investments and cash, as of March 31, 2001, compared with $610
million, or 1.9% of total investments and cash, at December 31, 2000.
POLICY LIABILITIES
Policy liabilities decreased $602 million, or 2.1%, during the first
three months of 2001. AFLAC Japan decreased $683 million, or 2.6% (5.1%
increase in yen), and AFLAC U.S. increased $81 million, or 3.2%. The weaker
yen at March 31, 2001, compared with December 31, 2000, decreased reported
policy liabilities by $2.0 billion. The decrease in policy liabilities was
partially offset by increases from new business, the aging of policies in
force, and the market value adjustment for securities available for sale
(see Note 6 of the Notes to the Consolidated Financial Statements).
DEBT
The ratio of debt to total capitalization (debt plus shareholders'
equity, excluding the unrealized gains on investment securities) was 24.2%
and 25.1% as of March 31, 2001 and December 31, 2000, respectively.
29
See Note 4 of the Notes to the Consolidated Financial Statements for
information on debt outstanding at March 31, 2001.
SECURITY LENDING
AFLAC Japan uses short-term security lending arrangements to increase
investment income with minimal risk. For further information regarding such
arrangements, see Note 5 of the Notes to the Consolidated Financial
Statements.
POLICYHOLDER GUARANTY FUNDS
Under insurance guaranty fund laws in most U.S. states, insurance
companies doing business in those states can be assessed for policyholder
losses up to prescribed limits that are incurred by insolvent companies with
similar lines of business. Such assessments have not been material to us in
the past. We believe that future assessments relating to companies in the
United States currently involved in insolvency proceedings will not
materially impact the consolidated financial statements.
In 1998, the Japanese government established the Life Insurance
Policyholders Protection Corporation. Funding by the life insurance
industry, as determined by government legislation, is made over a 10-year
period. We recognize charges for our estimated share of any assessment as
funding legislation is enacted. We periodically review our estimated
liability for policyholder protection fund assessments based on updated
information and any adjustments are reflected in net earnings.
Since October 2000, three Japanese life insurance companies have filed
for court protection under a special reorganization law for financial
institutions. Japanese government officials have indicated that they do not
expect to impose any additional protection fund assessments for the
financial problems of these insurers.
SHAREHOLDERS' EQUITY
Our insurance operations continue to provide the primary sources of
liquidity. Capital needs are also supplemented by borrowed funds. The
principal sources of cash from insurance operations are premiums and
investment income. The primary uses of cash for insurance operations are
policy claims, commissions, operating expenses, income taxes and payments to
AFLAC Incorporated for management fees and dividends. Both the sources and
uses of cash are reasonably predictable. Our investment objectives provide
for liquidity through the ownership of investment-grade debt securities.
AFLAC insurance policies generally are not interest-sensitive and therefore
are not subject to unexpected policyholder redemptions due to investment
yield changes. Also, the majority of our policies provide indemnity benefits
rather than reimbursement for actual medical costs and therefore generally
are not subject to the risks of medical-cost inflation.
The achievement of continued long-term growth will require growth in
AFLAC's statutory capital and surplus. We may secure additional statutory
capital through various sources, such as internally generated statutory
earnings or equity contributions by AFLAC Incorporated from funds generated
30
through debt or equity offerings. We believe outside sources for additional
debt and equity capital, if needed, will continue to be available for
capital expenditures, business expansion and the funding of our share
repurchase program.
AFLAC Incorporated capital resources are largely dependent upon the
ability of AFLAC to pay management fees and dividends. The Georgia
insurance department imposes certain limitations and restrictions on
payments of dividends, management fees, loans and advances by AFLAC to AFLAC
Incorporated. The Georgia insurance statutes require prior approval for
dividend distributions that exceed the greater of statutory earnings for the
previous year, or 10% of statutory capital and surplus as of the previous
year-end. In addition, the Georgia insurance department must approve
service arrangements and other transactions within the affiliated group.
These regulatory limitations are not expected to affect the level of
management fees or dividends paid by AFLAC to AFLAC Incorporated. A life
insurance company's statutory capital and surplus is determined according to
rules prescribed by the National Association of Insurance Commissioners
(NAIC), as modified by the insurance department in the insurance company's
state of domicile. Statutory accounting rules are different from generally
accepted accounting principles and are intended to emphasize policyholder
protection and company solvency.
The NAIC has recodified Statutory Accounting Principles (SAP) to
promote standardization throughout the industry. These new accounting
principles were effective January 1, 2001, and are to be applied
prospectively. Previously, prescribed or permitted SAP could vary among
states and among companies. The transition adjustments to adopt the new
accounting principles increased AFLAC statutory capital and surplus by
approximately $130 million as of January 1, 2001.
The NAIC uses a risk-based capital formula relating to insurance risk,
business risk, asset risk and interest rate risk to facilitate
identification by insurance regulators of inadequately capitalized insurance
companies based upon the types and mixtures of risks inherent in the
insurer's operations. AFLAC's NAIC risk-based capital ratio remains high
and reflects a very strong capital and surplus position. Also, there are
various ongoing regulatory initiatives by the NAIC relating to insurance
products, investments, revisions to the risk-based capital formula and other
actuarial and accounting matters.
In addition to restrictions by U.S. insurance regulators, the Japanese
Financial Services Agency (FSA) may impose restrictions on transfers of
funds from AFLAC Japan. Payments are made from AFLAC Japan to AFLAC
Incorporated for management fees and to AFLAC U.S. for allocated expenses
and remittances of earnings. Total funds received from AFLAC Japan were
approximately $12 million for both the first three months of 2001 and 2000.
The FSA may not allow transfers of funds if the payment would cause AFLAC
Japan to lack sufficient financial strength for the protection of
policyholders. The FSA maintains its own solvency standards, a version of
risk-based capital requirements. AFLAC Japan's solvency margin
significantly exceeds regulatory minimums. For additional information on
regulatory restrictions on dividends, profit transfers and other
remittances, see Note 9 of the Notes to the Consolidated Financial
Statements in our annual report to shareholders for the year ended December
31, 2000.
31
For the Japanese reporting fiscal year ending March 31, 2002, AFLAC
Japan will be required to adopt a new Japanese statutory accounting standard
regarding fair value accounting for investments. Previously, debt
securities were generally reported at amortized cost for FSA purposes.
Under the new accounting standard AFLAC Japan will be required to record
debt securities in four categories: at fair value in an available-for-sale
category, at amortized cost in a held-to-maturity category, at amortized
cost in a special category for policy-reserve-matching bonds, or at fair
value in a trading category.
Under this new regulatory accounting standard, the unrealized gains and
losses on debt securities available for sale will be reported in FSA capital
and surplus and reflected in solvency margin calculations. This new
accounting standard may result in significant fluctuations in FSA equity, in
the AFLAC Japan solvency margin and in amounts available for annual profit
repatriation.
OTHER
On February 13, 2001, the board of directors approved an increase in
the quarterly cash dividend from $.043 to $.05 per share. The increase is
effective with the second quarter dividend, which is payable on June 1,
2001, to shareholders of record at the close of business on May 17, 2001.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments are exposed to primarily three types of
market risks. These are interest rate, equity price, and foreign currency
exchange rate risk.
INTEREST RATE RISK
Our primary interest rate exposure is a result of the effect of changes
in interest rates on the fair value of our investments in debt securities.
We use modified duration analysis, which provides a measure of price
percentage volatility, to estimate the amount of sensitivity to interest
rate changes in our debt securities.
We attempt to match the duration of our assets with the duration of our
liabilities. For AFLAC Japan, the duration of policy benefit liabilities is
longer than that of the related invested assets due to the unavailability of
acceptable long-duration yen-denominated securities. Currently, when our
debt securities mature, the proceeds are reinvested at a yield below that of
the interest required for the accretion of policy benefit liabilities on
policies issued in earlier years. However, the investment yield on new
investments exceeds interest requirements on policies issued in recent
years. Since 1994, premium rates on new business have been increased
several times (the latest occurred in April 2001 for ordinary life and
annuity contracts) to help offset the lower investment yields available.
At March 31, 2001, we had $3.5 billion of net unrealized gains on total
debt securities. The hypothetical reduction in the fair value of our debt
securities resulting from a 100 basis point increase in market interest
rates is estimated to be $2.9 billion based on our portfolio as of
32
March 31, 2001. The effect on yen-denominated debt securities is
approximately $2.5 billion and the effect on dollar-denominated debt
securities is approximately $424 million.
We have outstanding interest rate swaps on 19.1 billion yen ($154
million) of our variable-interest-rate yen-denominated borrowings. These
swaps reduce the impact of fluctuations in interest rates on borrowing costs
and effectively change our interest rates from variable to fixed.
Therefore, movements in market interest rates should have no material effect
on earnings.
At March 31, 2001, we also had yen-denominated bank borrowings in the
amount of 19.6 billion yen ($158 million) with a blended variable interest
rate of .78%. The effect on net earnings in the first quarter of 2001 due
to changes in market interest rates was immaterial. For further information
on our notes payable, see Note 4 of the Notes to the Consolidated Financial
Statements.
EQUITY PRICE RISK
Equity securities at March 31, 2001, totaled $176 million, or .5% of
total investments and cash on a consolidated basis. We use beta analysis to
measure the sensitivity of our equity securities portfolio to fluctuations
in the broad market. The beta of our equity securities portfolio is .88.
For example, if the overall stock market value changed by 10%, the value of
AFLAC's equity securities would be expected to change by approximately 8.8%,
or $15 million.
CURRENCY RISK
Most of AFLAC Japan's investments and cash are yen-denominated. When
yen-denominated financial instruments mature or are sold, the proceeds are
generally reinvested in yen-denominated securities and are held to fund yen-
denominated policy obligations.
In addition to the yen-denominated financial instruments held by AFLAC
Japan, AFLAC Incorporated has yen-denominated notes payable that have been
designated as a hedge of our investment in AFLAC Japan. The unrealized
foreign currency translation gains and losses related to these borrowings
are reported in accumulated other comprehensive income.
AFLAC Incorporated entered into cross-currency swaps to convert the
dollar-denominated principal and interest into yen-denominated obligations
on its $450 million senior notes that were issued in 1999. The cross-
currency swaps have a notional amount of $450 million (55.6 billion yen).
These swaps have also been designated as a hedge of our investment in AFLAC
Japan. The unrealized foreign currency translation gains and losses related
to these swaps are reported in accumulated other comprehensive income. For
information regarding new accounting requirements for derivative instruments
as of January 1, 2001, see Notes 2 and 5 of the Notes to the Consolidated
Financial Statements.
33
We attempt to match yen-denominated assets to yen-denominated
liabilities on a consolidated basis in order to minimize the exposure of our
shareholders' equity to foreign currency translation fluctuations. The
table below compares the U.S. dollar values of our yen-denominated assets
and liabilities at various exchange rates.
Dollar Value of Yen-Denominated Assets and Liabilities
At Selected Exchange Rates
(March 31, 2001)
108.90 123.90* 138.90
(In millions) Yen Yen Yen
- ----------------------------------------------------------------------------
Yen-denominated financial instruments:
Assets:
Securities available for sale:
Fixed maturities $ 18,600 $ 16,348 $ 14,583
Perpetual debentures 2,733 2,402 2,142
Equity securities 85 75 67
Securities held to maturity:
Fixed maturities 4,455 3,915 3,493
Perpetual debentures 3,563 3,131 2,793
Cash and cash equivalents 1,030 905 807
Cross-currency swaps (60) 2 50
Other financial instruments 3 4 3
------- ------- -------
Sub-total 30,409 26,782 23,938
------- ------- -------
Liabilities:
Notes payable 1,081 1,005 945
------- ------- -------
Sub-total 1,081 1,005 945
------- ------- -------
Net yen-denominated financial
instruments 29,328 25,777 22,993
Other yen-denominated assets 3,776 3,319 2,960
Other yen-denominated liabilities (31,874) (28,014) (24,989)
------- ------- -------
Consolidated yen-denominated
net assets subject to foreign
currency fluctuation $ 1,230 $ 1,082 $ 964
======= ======= =======
*Actual March 31, 2001 exchange rate
For information regarding the effect of foreign currency translation on
operating earnings per share, see Foreign Currency Translation beginning on
page 19.
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" to encourage companies to provide prospective information, so long
as those informational statements are identified as forward-looking and are
accompanied by meaningful cautionary statements identifying important
factors that could cause actual results to differ materially from those
34
discussed. We desire to take advantage of these provisions. This report
contains cautionary statements identifying important factors that could
cause actual results to differ materially from those projected in this
discussion and analysis, and in any other statements made by company
officials in oral discussions with the financial community and contained in
documents filed with the Securities and Exchange Commission (SEC). Forward-
looking statements are not based on historical information and relate to
future operations, strategies, financial results or other developments. In
particular, statements containing words such as "expect," "anticipate,"
"believe," "goal," "objective" or similar words as well as specific
projections of future results, generally qualify as forward-looking. AFLAC
undertakes no obligation to update such forward-looking statements.
We caution readers that the following factors, in addition to other
factors mentioned from time to time in our reports filed with the SEC, could
cause actual results to differ materially: regulatory developments,
assessments for insurance company insolvencies, competitive conditions, new
products, ability to repatriate profits from Japan, general economic
conditions in the United States and Japan, changes in U.S. and/or Japanese
tax laws or accounting requirements, adequacy of reserves, credit and other
risks associated with AFLAC's investment activities, significant changes in
interest rates, and fluctuations in foreign currency exchange rates.
35
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
We are a defendant in various litigation considered to be in the normal
course of business. Some of this litigation is pending in Alabama, where
large punitive damages bearing little relation to the actual damages
sustained by plaintiffs have been awarded against other companies, including
insurers, in recent years. Although the final results of any litigation
cannot be predicted with certainty, we believe the outcome of pending
litigation will not have a material adverse effect on our financial
position, results of operations, or cash flows.
36
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders was held on May 7, 2001.
Matters submitted to the shareholders were: (1) Election of 18 members to
the board of directors; (2) Ratification of the appointment of independent
auditors for 2001. The proposals were approved by the shareholders.
Following is a summary of each vote cast for, against or withheld, as
well as the number of abstention and broker non-votes, as to each such
matter, including a separate tabulation with respect to each nominee for
office.
VOTES
- ----------------------------------------------------------------------------
Absten- With- Broker
For Against tions held Non-Votes
- ----------------------------------------------------------------------------
(1) Election of 18
members to the board
of directors:
Daniel P. Amos 461,821,433 N/A N/A 4,638,104 None
J. Shelby Amos, II 464,498,974 N/A N/A 1,960,563 None
Michael H. Armacost 460,993,547 N/A N/A 5,465,990 None
Kriss Cloninger, III 464,392,078 N/A N/A 2,067,459 None
M. Delmar Edwards, M.D. 460,741,333 N/A N/A 5,718,203 None
Joe Frank Harris 463,510,314 N/A N/A 2,949,223 None
Elizabeth J. Hudson 464,362,810 N/A N/A 2,096,727 None
Kenneth S. Janke, Sr. 464,558,375 N/A N/A 1,901,161 None
Charles B. Knapp 464,334,260 N/A N/A 2,125,277 None
Takatsugu Murai 464,674,241 N/A N/A 1,785,296 None
Yoshiki Otake 464,631,432 N/A N/A 1,828,105 None
E. Stephen Purdom 463,337,938 N/A N/A 3,121,599 None
Barbara K. Rimer 464,461,591 N/A N/A 1,997,946 None
Marvin R. Schuster 464,440,549 N/A N/A 2,018,988 None
Henry C. Schwob 463,460,853 N/A N/A 2,998,684 None
J. Kyle Spencer 464,259,068 N/A N/A 2,200,469 None
Glenn Vaughn, Jr. 464,215,948 N/A N/A 2,243,589 None
Robert L. Wright 464,422,492 N/A N/A 2,037,044 None
VOTES
---------------------------------------------------
Absten- With- Broker
For Against tions held Non-Votes
- ----------------------------------------------------------------------------
(2) Ratification of
appointment of KPMG
LLP as independent
auditors 462,883,902 2,513,903 1,061,731 N/A None
37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.2 - Bylaws of the Corporation, as amended
4.0 - There are no long-term debt instruments in which the total
amount of securities authorized exceeds 10% of the total
assets of AFLAC Incorporated and its subsidiaries on a
consolidated basis. We agree to furnish a copy of any
long-term debt instruments to the Securities and Exchange
Commission upon request.
12.0 - Statement regarding the computation of ratio of earnings to
fixed charges
(b) Reports on Form 8-K:
We filed a Form 8-K on February 14, 2001, regarding the two-for-one
stock split declared by the board of directors on February 13, 2001.
Items other than those listed above are omitted because they are not
required or are not applicable.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AFLAC INCORPORATED
Date May 9, 2001 /s/ KRISS CLONINGER, III
------------------------ ---------------------------
KRISS CLONINGER,III
President; Treasurer and
Chief Financial Officer
Date May 9, 2001 /s/ NORMAN P. FOSTER
------------------------ ---------------------------
NORMAN P. FOSTER
Executive Vice President,
Corporate Finance
39
EXHIBITS FILED WITH CURRENT FORM 10-Q:
3.2 - Bylaws of the Corporation, as amended
12.0 - Statement regarding the computation of ratio of earnings to
fixed charges
40
35