(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2019 related to leases.
Certain statements included in this section constitute forward-looking statements within the meaning of the U.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.
The impact of the COVID-19 global pandemic on the Company continues to evolve, and its future effects remain uncertain. At the onset of the pandemic, the majority of the Company’s employees in Japan and the U.S. shifted to remote working environments, with returns to office undertaken throughout the year as warranted by local conditions. Both Aflac Japan and Aflac U.S. took measures to address employee health and safety and increase employees’ ability to develop and maintain more flexible working conditions. The Company established command centers to monitor and communicate on developments, and operations remained stable throughout the year. The Company also took prompt action at the beginning of the pandemic to strengthen its capital and liquidity position, and it continued to undertake de-risking activity in its investment portfolios and to adjust to market conditions throughout the year. Both Aflac Japan and Aflac U.S. also accelerated investments in digital initiatives to improve productivity, efficiency and customer service over the long term.
As a result of market volatility, the Company has made tactical adjustments to its existing foreign currency-hedging program in Aflac Japan to mitigate hedging cost and settlement risk while maintaining a strong SMR. Prior to and continuing through the pandemic, Aflac Japan has maintained a collar program on a portion of its U.S. dollar program to mitigate against more extreme moves in foreign exchange rates and therefore support SMR. In the first quarter of 2020, the Company reduced the size of the collar program by approximately $3 billion. In December 2020, the Company reduced the total size of the forward and collar programs by approximately $5 billion and purchased foreign currency options to hedge approximately $5 billion of U.S. dollar-denominated assets. While these adjustments will moderately increase the Company's exposure to SMR volatility, the Company believes that they will also 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 collar program. The Company is continually evaluating other adjustments, including the possibility of changing the level of hedging employed with the U.S. dollar-denominated investments. See the Liquidity and Capital Resources section of this MD&A for additional information regarding other potential sources of liquidity and capital resources.
The Company has crisis command centers set up in Japan and the U.S. These command centers are generally utilized for any type of crisis, including natural disasters and cybersecurity events. The command centers participate in regular updates to the Company's leadership regarding developments in Japan and the U.S., including government and regulatory actions, operations, employee policies and conditions and distribution status. In addition, capital market, central bank and government stimulus updates are provided, as well as updates on cybersecurity, including with respect to the Company's remote workforce. Moreover, the Company's financial leadership group meets more frequently and has focused on the capital markets, capital and liquidity position, stress testing and any defensive actions that may be necessary as the crisis unfolds.
Aflac Japan remains focused on generating new business through direct mail made to existing and prospective customers. In addition, Aflac Japan is promoting digital and web-based sales to groups and introduced a new system that enables smart device-based insurance application by allowing the customer and an Aflac Japan operator to see the same screen through their smart devices. Further, in October 2020, Aflac Japan implemented a new virtual sales tool that enables online consultations and policy applications to be completed entirely online. During 2020, Aflac Japan also accelerated investments in digital and paperless initiatives designed to increase long term productivity, efficiency, customer service and business continuity. Face-to-face sales have been challenged and are having an impact on sales results. In 2020, Aflac Japan experienced a sales decline of 36.2% on a yen basis, compared to 2019, primarily due to the impact of the COVID-19 pandemic and the continuing effects of the Japan Post investigation. See the Aflac Japan Segment of this MD&A for additional information regarding sales in the Japan Post channel and the strategic alliance with Japan Post.
To assist with the COVID-19 pandemic, Aflac Japan has donated ¥500 million to the Japan Medical Associations and to identified municipalities where Aflac Japan has operations.
Aflac U.S. is focused on supporting its agency channel, most of which are small businesses, by offering zero-interest loans and cash stipends in lieu of canceled recognition trips.
Aflac U.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. 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. In addition, licensure of newly recruited agents has been delayed in some states due to the unavailability or difficulty of temporary licenses or online training. Further, despite government stimulus measures, the long-term economic effects of the pandemic on prospective and existing customers is still largely unknown. Similar to Aflac Japan, the Aflac U.S. sales team has worked to adjust its sales approach given the reduction in face-to-face sales. Key elements to this approach include realizing sales at the worksite through 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 Aflac U.S. broker sales team is focused on product enhancements due to COVID-19 as well as leveraging technology based solutions to drive enrollment. Further, during 2020 Aflac U.S. also accelerated investments in digital initiatives designed to improve long term productivity, efficiency and customer service. Aflac U.S. is in its second year of the build-out of the Consumer Markets business for the digital direct-to-consumer sale of insurance and sales made through that platform have continued to grow.
Face-to-face sales have been challenged and are having an impact on sales results. In 2020, Aflac U.S. experienced a sales decline of 30.8%, compared to 2019, reflecting the impacts of the pandemic. The Aflac U.S. benefit ratio decreased in 2020, as compared to 2019; however, the ratio began to recover in the second half of 2020, which management believes may indicate the beginning of a return to levels seen over the past several years. The Company expanded a previously piloted wellness initiative beginning in the third quarter of 2020, using digital and direct account engagement to raise awareness among policyholders as to the availability of valuable wellness benefits. The Company estimates this effort had an impact on incurred claims of approximately $19 million since September 2020.
In September 2020, the Company announced a voluntary separation program for certain U.S. employees. The program provided eligible employees with a severance package, including twelve months of salary, the employee's targeted bonus payout for 2020 and one year of Consolidated Omnibus Budget Reconciliation Act (COBRA) or retiree medical, if eligible. Employees accepted into this program were notified in October 2020 and most transitions were completed by December 31, 2020, with a small number continuing into the first quarter of 2021. The Company recorded a one-time severance charge of $43 million in the fourth quarter of 2020 related to the program.
In 2020, the Parent Company contributed $6 million to organizations that are providing assistance for health care workers assisting with the COVID-19 pandemic.
Government authorities in Japan and the U.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 in Japan 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. Moreover, following the expansion of the impact of COVID-19, the FSA 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 Life Insurance Japan Ltd. implemented a measure to pay accidental death benefits and accidental serious disability benefits under its accidental death benefit rider, etc. in cases of death or specified serious disabilities from COVID-19.
In April 2020, the Cabinet of Japan approved ¥117 trillion or more than 20% of GDP in emergency stimulus measures, including various tax measures. In May 2020, the Cabinet of Japan approved a second ¥117 trillion stimulus package. The Diet passed a supplementary budget to fund the package in June 2020. The second stimulus package was intended to help small and mid-sized businesses fund leave allowances for furloughed workers and provides rent assistance for business operations.
In the U.S., initial statewide shelter in place or stay at home orders were lifted although reopening plans have been paused or reversed in certain states experiencing an increase in cases, and shelter in place orders have been reinstated in some areas.
The U.S. government took action in response to the COVID-19 pandemic by providing broad-based relief and economic support to all aspects of the economy.
The Federal Reserve has also taken various actions in an effort to support the economy and markets in response to heightened volatility and uncertainty. These actions include reducing by 1.5% each the rate that it charges for direct loans to banks, as well as the target for the rate banks charge each other for overnight funds (federal funds rate); initiating quantitative easing with no stated cap on purchases; committing to purchase U.S. Treasury securities, agency mortgage-backed and agency commercial mortgaged-backed securities; re-establishing the Term Asset-Backed Securities Loan Facility (TALF) originally launched in 2009, through which it will lend to holders of AA-rated asset-backed securities; and establishing facilities to support purchase of corporate bonds from large investment-grade companies.
Shareholders’ equity was $33.6 billion, or $48.46 per share, at December 31, 2020, compared with $29.0 billion, or $39.84 per share, at December 31, 2019. Shareholders’ equity at December 31, 2020 included a net unrealized gain on investment securities and derivatives of $10.3 billion, compared with a net unrealized gain of $8.5 billion at December 31, 2019. Shareholders’ equity at December 31, 2020 also included an unrealized foreign currency translation loss of $1.1 billion, compared with an unrealized foreign currency translation loss of $1.6 billion at December 31, 2019. The annualized return on average shareholders’ equity in 2020 was 15.3%, driven primarily by a benefit from new tax regulations.
(1) Yen/U.S. dollar exchange rates are based on the published MUFG Bank, Ltd. telegraphic transfer middle rate (TTM).
The Company is impacted by financial markets, economic conditions, regulatory oversight and a variety of trends that affect the industries where it competes.
See Item 1. Business - Aflac Japan Government Regulation and Aflac U.S. Government Regulation for a discussion of regulatory developments that may impact the Company and the associated risks.
See Item 1. Business - Aflac Japan Competitive Markets and Aflac U.S. Competitive Markets for a discussion of the competitive environment and the basis on which the Company competes in each of its segments.
The Company's objectives in 2021 are to navigate the COVID-19 pandemic while maintaining strong pre-tax margins in its Aflac Japan and Aflac U.S. segments, continuing to accelerate the pace of investment in its 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.
In Japan, the Company anticipates that the shift in earned premium 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 expenses to be elevated in 2021 as Aflac Japan’s investments in its paperless initiative and other digital projects are being accelerated. The Company also anticipates 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 in 2020. For the 2020 through 2022 period, the Company expects a decline in Aflac Japan revenue in the range of 2.0% to 3.0% on a compound annual growth rate basis.
The Company expects corporate segment results to reflect stable net investment income in 2021 compared to 2020, assuming that U.S. interest rates remain stable.
•Adjusted earnings per share (basic or diluted) are adjusted earnings for the period divided by the weighted average outstanding shares (basic or diluted) for the period presented. The most comparable U.S. GAAP measure is net earnings per share.
•Adjusted book value is the U.S. GAAP book value (representing total shareholders' equity), less AOCI as recorded on the U.S. GAAP balance sheet. The most comparable U.S. GAAP measure is total book value. The Company considers adjusted book value important as it excludes AOCI, which fluctuates due to market movements that are outside management's control.
•Adjusted return on equity (ROE) excluding foreign currency impact is calculated using adjusted earnings excluding current period foreign currency impact divided by average shareholders’ equity, excluding AOCI. The most comparable U.S. GAAP financial measure is return on average equity as determined using net earnings and average total shareholders’ equity.
(4) Net interest cash flows from derivatives associated with certain investment strategies of $12 in 2020 and $(17) in 2019 have been reclassified from net investment gains (losses) and included in adjusted earnings as a component of net investment income.
(8) Prior period foreign currency impact reflected as “N/A” to isolate change for current period only.
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. Prior to January 1, 2020, impairments include other-than-temporary impairment losses on investment securities as well as changes in loan loss reserves for loan receivables. Effective January 1, 2020, credit losses include losses for held-to-maturity fixed maturity securities, available-for-sale fixed maturity securities, loan receivables, loan commitments and reinsurance recoverables.
•foreign currency swaps that are associated with variable interest entity (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
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 both U.S. and Japan interest rates, and supply and demand for dollar funding. Amortized hedge costs and income have fluctuated in recent periods due to changes in the previously mentioned factors. For additional information regarding foreign currency hedging, refer to Hedging Activities in the Investments section of this MD&A.
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 the U.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.
The Company's combined U.S. and Japanese effective income tax rate on pretax earnings was (14.9)% in 2020 and 25.7% in 2019. In 2020, the combined effective tax rate differs from the U.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 the U.S. Treasury and Internal Revenue Service in September 2020, and resulted in a one-time income tax benefit of $1.4 billion in the third quarter of 2020. Total income taxes were $(.6) billion in 2020 and $1.1 billion in 2019. Japanese income taxes on Aflac 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.
In 2020, Aflac Japan sales for protection-type first sector and third sector products decreased 36.9% and total sales decreased 36.2% on a yen basis, compared to 2019, primarily due to the impact of the COVID-19 pandemic and the continuing effects of the Japan Post investigation. Sales from Aflac U.S. were down 30.8% in 2020, as compared to 2019, due to social distancing efforts, which eliminated face-to-face sales opportunities beginning in mid-March 2020. The respective Aflac Japan and Aflac U.S. platforms and distribution partners continue to work to adapt to the new environment. The Company continues to monitor the effects of COVID-19 on its operating results and has taken several steps to mobilize its resources to ensure adequate liquidity, a strong capital position, business continuity and employee safety during this pandemic. See the Executive Summary subsection of this MD&A for additional information.
Consistent with U.S. GAAP guidance for segment reporting, pretax adjusted earnings is the Company's U.S. GAAP measure of segment performance. The Company believes that a presentation of this measure is vitally important to an understanding of the underlying profitability drivers and trends of its business. Additional performance measures used to evaluate the financial condition and performance of the Company's segments are listed below.
For additional information on the Company’s performance measures included in this MD&A, see the Glossary of Selected Terms found directly following Part II. Other Information. See Note 2 of the Notes to the Consolidated Financial Statements for the reconciliation of segment results to the Company's consolidated U.S. GAAP results and additional information.
conditions. Adjusted net investment income increased in 2020 primarily due to higher income from U.S. dollar-denominated assets and lower hedge costs.
In 2020, the benefit ratio to total premiums increased, compared to the prior year, primarily due to higher persistency, resulting in an increase in future policy benefit reserves, partially offset by the continued change in mix of first and third sector business as first sector products become paid-up. In 2020, the adjusted expense ratio increased mainly due to the decrease in total revenues and an increase in expenses related to the paperless and COVID-19 initiatives, which include the expansion of and enhancements to virtual desktops and telework terminals to support a remote workforce, partially offset by lower DAC amortization due to higher persistency. In total for 2020, the pretax adjusted profit margin decreased slightly as compared to 2019. For 2021, the Company will continue to monitor the situation with respect to COVID-19, and potential impacts on the pretax adjusted profit margin and benefit ratio.
Sales of protection-type first sector and third sector products on a yen basis decreased 36.9% in 2020, compared with 2019. The decline in sales primarily reflects the impact of the COVID-19 pandemic and the continuing effects of the Japan Post investigation.
Sales of Aflac Japan cancer products in the Japan Post Group channel experienced a material decline beginning in August 2019 and continued in 2020. For additional information, see the risk factor entitled "Events related to the ongoing Japan Post investigation and other matters regarding sales of Japan Post Insurance products could negatively impact the Company’s sales and results of operations," in Part I, Item 1A. Risk Factors. Aflac Japan experienced a sharp drop-off in total sales, beginning in the second quarter of 2020 and continuing into 2021, due to the impact of the COVID-19 pandemic and continuing effects of the Japan Post investigation.
In 2020, Aflac Japan recruited 48 new sales agencies. At December 31, 2020, Aflac Japan was represented by more than 8,500 sales agencies, with approximately 112,000 licensed sales associates employed by those agencies. The number of sales agencies has declined in recent years due to Aflac Japan's focus on supporting agencies with strong management frameworks, high productivity and more producing agents.
Japan Post offers Aflac's cancer insurance products in more than 20,000 postal outlets. Notwithstanding the recent reduction in sales of Aflac Japan's cancer products in the Japan Post channel, the Company believes this alliance with Japan Post has benefited and will continue to benefit its cancer insurance sales over the long term.
At December 31, 2020, Aflac Japan had agreements to sell its products at 361 banks, approximately 90% of the total number of banks in Japan.
In light of the fact that the shares acquired by the Trust, like all Aflac 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 decrease in the Aflac Japan new money yield in 2020 was primarily due to lower yields on floating rate asset classes.
New annualized premium sales for accident insurance, the Aflac U.S. leading product category, decreased 36.6%, short-term disability sales decreased 31.5%, critical care insurance sales (including cancer insurance) decreased 30.1%, and hospital indemnity insurance sales decreased 25.2% in 2020, compared with 2019. Overall sales decreased in 2020 as well net earned premium decreased .9%. Primarily, the decline in sales for Aflac U.S. is attributable COVID-19 social distancing efforts, which limited face-to-face sales opportunities beginning in mid-March 2020. See the Executive Summary section entitled "COVID-19" of this MD&A for additional information.
metric allows sales management to monitor progress and needs, as well as serve as a leading indicator of future production capacity.
See Note 3 of the Notes to the Consolidated Financial Statements and the Market Risks of Financial Instruments - Credit Risk subsection of
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of the Company's management, including its principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013. Based on the Company's evaluation under this framework, management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2020.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules II, III, and IV (collectively, the consolidated financial statements), and our report dated February 23, 2021 expressed an unqualified opinion on those consolidated financial statements.
We have audited the accompanying consolidated balance sheets of Aflac Incorporated and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules II, III, and IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013, and our report dated February 23, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls, with the involvement of valuation professionals when appropriate, over the Company’s process to estimate the fair value of such securities and derivative instruments. This included controls over the Company’s evaluation of the inputs, assumptions and estimates of fair value obtained from its third party pricing vendor. We involved valuation professionals with specialized skills and knowledge to assist in assessing the estimated fair values of such securities and derivative instruments, which included:
-Evaluating the inputs and assumptions used in the models to estimate the fair value of the privately issued securities, including an assessment of the determination of comparable securities and/or CDS spreads used by the third party pricing vendor for a selection of privately issued securities.
-Assessing the internal models used by the Company to evaluate the fair values for privately issued securities and derivatives associated with VIEs obtained from the third party pricing vendor. We observed that differences, if any, in fair value between the Company and the third party pricing vendor above pre-established tolerances were investigated by the Company.
-Developing an independent estimate of the fair value for a selection of privately issued securities and derivative instruments associated with VIEs and comparing our independent estimate to the fair value measurement recorded by the Company.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness, with the involvement of actuarial professionals when appropriate, certain internal controls over the Company’s process to estimate the unpaid policy claims liability. This included controls related to the evaluation of the actuarial methodologies and assumptions used in the calculation of the unpaid policy claims liability. We involved actuarial professionals with specialized skills and knowledge to assist in assessing the unpaid policy claims liability, which included:
-Assessing the actuarial methodologies and assumptions utilized by the Company by comparing them to generally accepted actuarial methodologies and historical results.
-Evaluating the Company’s estimate of the unpaid policy claims liability by comparing to historical results and our expectations of changes in the estimate.
-Evaluating the Company’s historical ability to estimate unpaid policy claims by comparing the unpaid policy claims liability for certain products recorded by the Company at various historical periods to an independent range developed using claims paid through December 31, 2020.
(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018.
(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2020.
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States (U.S.) and Japan. The Company's insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac) in the U.S. and, effective April 1, 2018, through Aflac Life Insurance Japan Ltd. (ALIJ) in Japan. Prior to April 1, 2018, the Company's insurance business was marketed in Japan as a branch of Aflac. The Company’s operations consist of two reportable business segments: Aflac U.S., which includes Aflac, and Aflac Japan, which includes ALIJ. American Family Life Assurance Company of New York (Aflac New York) is a wholly owned subsidiary of Aflac. Most of Aflac's policies are individually underwritten and marketed through independent agents. Additionally, Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC), branded as Aflac Group Insurance. The Company's insurance operations in the U.S. and Japan service the two markets for the Company's insurance business. Aflac Japan's revenues, including realized gains and losses on its investment portfolio, accounted for 68% of the Company's total revenues in 2020, compared with 69% in 2019 and 70% in 2018. The percentage of the Company's total assets attributable to Aflac Japan was 83% at both December 31, 2020 and 2019.
In November 2019, the Company acquired Argus Holdings, LLC and its subsidiary Argus Dental & Vision, Inc. (Argus), a benefits management organization and national network dental and vision company, which provides a platform for Aflac Dental and Vision. The Company paid $75 million at closing and made an additional commitment of up to $21 million in contingent consideration payable over three years based on the achievement by Argus of certain performance targets. The contingent consideration was completed in 2020 with a payment of approximately $14 million. Argus is an addition to the Aflac U.S. segment.
The consolidated financial statements include the accounts of the Parent Company, its subsidiaries, and those entities required to be consolidated under applicable accounting standards. All material intercompany accounts and transactions have been eliminated.
The Company entered the crisis having maintained capital ratios in Japan and the U.S. at a level designed to absorb a degree of market volatility. To further support liquidity and capital resources, the Parent Company, in March 2020, issued four series of senior notes totaling ¥57.0 billion and, in April 2020, issued $1.0 billion in senior notes through public debt offerings under its U.S. shelf registration statement. The Company has available liquidity in its unsecured revolving credit facilities of $1.0 billion and ¥100.0 billion and currently has no borrowings under either of these facilities. In April 2020, Aflac increased its internal limit for Federal Home Loan Bank of Atlanta (FHLB) borrowings to $800 million, $300 million of which the Company has designated to be used for short-term liquidity needs of the U.S. insurance subsidiaries and subject to qualified collateral availability and other conditions. The Company has the ability to adjust cash flow management from other sources of liquidity including reinvestment cash flows and selling investments.
Insurance Revenue and Expense Recognition: Substantially all of the supplemental health and life insurance policies the Company issues are classified as long-duration contracts. The contract provisions generally cannot be changed or canceled during the contract period; however, the Company may adjust premiums for supplemental health policies issued in the U.S. within prescribed guidelines and with the approval of state insurance regulatory authorities.
Investments: The Company's debt securities consist of fixed maturity securities, which are classified as either held to maturity or available for sale. Securities classified as held to maturity are securities that the Company has the ability and intent to hold to maturity or redemption and are carried at amortized cost. All other fixed maturity debt securities are classified as available for sale and are carried at fair value. If the fair value is higher than the amortized cost for debt securities, the excess is an unrealized gain, and if lower than cost, the difference is an unrealized loss. The net unrealized gains and losses on securities available for sale, less related deferred income taxes, are recorded through other comprehensive income and included in accumulated other comprehensive income.
Amortized cost of debt securities is based on the Company's purchase price adjusted for accrual of discount, or amortization of premium, and recognition of impairment charges, if any. The amortized cost of debt securities the Company purchases at a discount or premium will equal the face or par value at maturity or the call date, if applicable. Interest is reported as income when earned and is adjusted for amortization of any premium or discount.
event of default. For those entities where the Company is the primary beneficiary, the consolidated entity's assets are segregated on the balance sheet by the caption "consolidated variable interest entities," and consist of fixed maturity securities, equity securities, loan receivables, limited partnerships and derivative instruments.
Commercial mortgage and other loans include transitional real estate loans (TREs), commercial mortgage loans (CMLs) and middle market loans (MMLs). The Company's investments in TREs, CMLs, and MMLs are accounted for as loan receivables and are recorded at amortized cost on the acquisition date. The Company has the intent and ability to hold these loan receivables for the foreseeable future or until they mature and therefore, they are considered held for investment and are carried at amortized cost in the commercial mortgage and other loans line in its consolidated balance sheets. The amortized cost of the loan receivables reflects allowances for expected lifetime losses estimated as of each reporting date.
Other investments include policy loans, limited partnerships, and short-term investments with maturities at the time of purchase of one year or less, but greater than 90 days. Limited partnerships are accounted for using the equity method of accounting. Under the equity method of accounting, the Company reports its portion of partnership earnings as a component of net investment income in its consolidated statements of earnings. The underlying investments held by the Company’s limited partnerships primarily consist of private equity and real estate. Short-term investments are stated at amortized cost, which approximates fair value.
Credit Losses: Effective January 1, 2020, the Company adopted ASC 326: Financial Instruments - Credit Losses. The newly adopted accounting standard requires the Company to estimate an expected lifetime credit loss on financial assets measured at amortized cost including short-term receivables including premiums receivable, held-to-maturity fixed maturity securities, loan receivables, loan commitments and reinsurance recoverables. For the Company’s available-for-sale fixed maturity securities, the newly adopted guidance requires an entity to evaluate estimated credit losses only when the fair value of the available-for-sale fixed maturity security is below its amortized cost basis. Credit loss changes are recorded as a component of net investment gains and losses for the Company’s held-to-maturity and available-for-sale securities, loan receivables, loan commitments and reinsurance recoverables, whereas credit losses on premium receivables are recorded in net premiums. The Company’s off-balance sheet credit exposure is primarily attributable to loan commitments that are not unconditionally cancellable. The Company considers the contractual period of exposure to credit risk, the likelihood that funding will occur, the risk of loss, and the current conditions and expectations of future economic conditions to develop the estimate of expected credit losses. The Company records the estimate of expected credit losses for certain loan commitments within other liabilities in the consolidated balance sheet.
Write-offs and partial write-offs are recorded as a reduction to the amortized cost of the loan or fixed maturity security balance and a corresponding reduction to the credit allowance.
The Company records due premium receivable net of current expected credit losses in the receivables line item in the consolidated balance sheet, utilizing an aging methodology based on historical loss information, adjusted for current conditions and reasonable and supportable forecasts. Changes in the estimated credit losses related to premium receivable are recorded in net premiums in the consolidated statement of earnings.
Prior to January 1, 2020, the Company presented losses in accordance with the then effective guidance, where the Company primarily evaluated the financial instrument’s and issuer’s creditworthiness to determine whether an impairment in value of the Company's fixed maturity securities was other-than-temporary.
Derivatives and Hedging: Freestanding derivative instruments are reported in the consolidated balance sheet at fair value and are reported in other assets and other liabilities, with changes in value reported in earnings and/or other comprehensive income. These freestanding derivatives are foreign currency forwards, foreign currency options, foreign currency swaps, interest rate swaps and interest rate swaptions. The Company does not use derivatives for trading purposes, nor does the Company engage in leveraged derivative transactions.
For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the hedged item and the portion of the hedging instrument included in the assessment of effectiveness are recorded in the line item of the consolidated statements of earnings in which gain or loss on the hedged item is recorded. When assessing the effectiveness of the Company's fair value hedges, the Company excludes the changes in fair value related to the difference between the spot and the forward rate on its foreign currency forwards, the fair value not resulting from fluctuations in spot currency rates on the final notional exchange on cross currency swaps, and the time value of money of foreign exchange options and interest rate swaptions. For interest rate swaptions and cross-currency interest rate swaps designated under fair value hedges of interest rate risk, the change in the time value of money is recognized in other comprehensive income (loss) and amortized into earnings (net investment income) over its legal term.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the estimated cash flows or fair value of a hedged item; (2) the derivative is de-designated as a hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.
When hedge accounting is discontinued on a cash flow hedge or fair value hedge, the derivative is carried in the consolidated balance sheets at its estimated fair value, with changes in estimated fair value recognized in current period earnings. For discontinued cash flow hedges, including those where the derivative is sold, terminated or exercised, amounts previously deferred in other comprehensive income (loss) are reclassified into earnings when earnings are impacted by the cash flow of the hedged item.
The Company receives and pledges cash or other securities as collateral on open derivative positions. Cash received as collateral is reported as an asset with a corresponding liability for the return of the collateral. Cash pledged as collateral is recorded as a reduction to cash, and a corresponding receivable is recognized for the return of the cash collateral. The Company generally can repledge or resell collateral obtained from counterparties, although the Company does not typically exercise such rights. Securities received as collateral are not recognized unless the Company was to exercise its right to sell that collateral or exercise remedies on that collateral upon a counterparty default. Securities that the Company has pledged as collateral continue to be carried as investment assets on its balance sheet.
Riders can be considered internal replacements that are either integrated or non-integrated resulting in either substantially changed or substantially unchanged treatment. Riders are evaluated based on the specific facts and circumstances of the rider and are considered an expansion of the existing benefits with additional premium required. Non-integrated riders to existing contracts do not change the Company's profit expectations for the related products and are treated as a new policy establishment for incremental coverage.
Goodwill: Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. The amount of goodwill recognized is also impacted by measurement differences resulting from certain assets and liabilities not recorded at fair value (e.g. income taxes, employee benefits). Goodwill is not amortized, but is tested for impairment at a level of a reporting unit at least annually, in the same reporting period each year. Goodwill is included in the line item “Other” assets in the consolidated balance sheets and was $269 million as of December 31, 2020, compared with $140 million at December 31, 2019. A significant majority of the goodwill balance is attributable to the following business combinations within the Aflac U.S. segment, which represents the reporting unit for goodwill impairment testing: (i) CAIC acquisition in 2009, (ii) Empowered Benefits acquisition in 2015, (iii) Argus acquisition in 2019, and (iv) acquisition of Zurich's business in the fourth quarter of 2020.
Policy Liabilities: Future policy benefits represent insurance claims that are expected to occur in the future and are computed following a net level premium method using estimated future investment yields, persistency and recognized morbidity and mortality tables modified to reflect the Company's experience, including a provision for adverse deviation. These assumptions are generally established and considered locked at policy inception. These assumptions may only be unlocked in certain circumstances based on the results of periodic DAC recoverability and premium deficiency testing.
Other policyholders’ funds liability consists primarily of the fixed annuity line of business in Aflac Japan which has fixed benefits and premiums.
Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
Reference Rate Reform (Topic 848): Relief Extended to Derivatives Impacted by Discounting Transition
In January 2021, the FASB issued a standard to permit entities to apply optional expedients in ASC 848 to derivative instruments modified because of discounting transition. Discounting transition refers to the changing of interest rates used for margining, discounting, or contract price alignment of derivative instruments to transition to alternative rates.The amendment is effective immediately.
In April 2019, the FASB issued Codification improvements to clarify and correct certain areas of guidance amended as part of ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities; ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments; and ASU 2017-12, Derivative and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.
The other amendments related to ASU 2017-12 and 2016-01 are either not significant, or were previously implemented as part of the related ASU adoptions.
Derivatives and Hedging Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes
Compensation - Retirement Benefits - Defined Benefit Plans - General, Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans
Technical Corrections and Improvements to Financial Instruments - Overall Recognition and Measurement of Financial Assets and Financial Liabilities
In May 2017, the FASB issued amendments to provide guidance clarifying when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. An entity should apply modification accounting if the fair value, vesting conditions or classification of the award (as an equity instrument or liability instrument) changes as a result of the change in terms or conditions of the award. January 1, 2018 The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures.
In March 2017, the FASB issued amendments to shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount. Early adopted as of July 1, 2018 The adoption of this guidance did not have a significant impact on the Company’s financial position, results of operations, or disclosures.
In February 2017, the FASB issued amendments that clarify the scope and accounting guidance for the derecognition of a nonfinancial asset or a financial asset that meets the definition of an "in substance nonfinancial asset." The amendments define an "in substance nonfinancial asset" and provide additional accounting guidance for partial sales of nonfinancial assets. January 1, 2018 The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures.
In January 2017, the FASB issued amendments clarifying when a set of assets and activities is a business. The amendments provide a screen to exclude transactions where substantially all the fair value of the transferred set is concentrated in a single asset, or group of similar assets, from being evaluated as a business. January 1, 2018 The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures.
ASU 2016-15 Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments
ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326), Targeted Transition Relief
Standard Description Date of Adoption Effect on Financial Statements or Other Significant Matters
In December 2018, an amendment to the Leases Update was issued to clarify: 1) lessor accounting for all sales (and other similar) taxes; 2) the handling of certain lessor costs when the amount of those costs is not readily determinable; and 3) lessor allocation of certain variable payments to the lease and non-lease components. January 1, 2019 The Company has operating and finance leases for office space and equipment. The Company elected the short-term lease exemption for all classes of leases which allows the Company to not recognize right-of-use assets and lease liabilities on the consolidated balance sheet and allows the Company to recognize the lease expense for short-term leases on a straight-line basis over the lease term. The Company elected the practical expedient to not separate lease and non-lease components and applied it to all classes of leases where the non-lease components are not significant. Some of the Company's leases include options to extend or terminate the lease and the lease terms may include such options when it is reasonably certain that the Company will exercise that option. Certain leases also include options to purchase the leased property. The leases within scope of the leases update increased the Company's right-of-use assets and lease liabilities recorded in its beginning 2019 consolidated balance sheet by $134 million.
The Company elected the optional transition method and as a safe harbor, the practical expedient provided to lessors.
In January 2020, the FASB issued amendments clarifying that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method.
The amendments are effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on the Company's financial position, results of operations, or disclosures.
Financial Services - Insurance (Topic 944): Effective Date and Early Application
adjusted expenses. The adjustments to both revenues and expenses account for certain items that cannot be predicted or that are outside management’s control. Adjusted revenues are U.S. GAAP total revenues excluding net investment gains and losses, except for amortized hedge costs/income related to foreign currency exposure management strategies and net interest cash flows from derivatives associated with certain investment strategies. Adjusted expenses are U.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 Aflac’s underlying business performance. The Company excludes income taxes related to operations to arrive at pretax adjusted earnings. Information regarding operations by reportable segment and Corporate and other for the years ended December 31 follows:
(4) Amortized hedge income of $97, $89 and $36 in 2020, 2019 and 2018, respectively, related to certain foreign currency exposure management strategies has been reclassified from net investment gains (losses) and reported as an increase to net investment income when analyzing operations.
(1) Amortized hedge costs of $206, $257 and $236 in 2020, 2019 and 2018, respectively, related to certain foreign currency exposure management strategies have been reclassified from net investment gains (losses) and reported as a deduction from net investment income when analyzing operations.
(5) A gain of $56, $66 and $67 in 2020, 2019 and 2018, respectively, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable have been reclassified from net investment gains (losses) and included in adjusted earnings when analyzing operations.
During 2020, as a result of the adoption of ASU 2019-04 discussed in Note 1, the Company reclassified $6.9 billion (at amortized cost) of pre-payable fixed-maturity securities from the held-to-maturity category to the available-for-sale category. This reclassification resulted in recording in accumulated other comprehensive income a net unrealized gain of $848 million on an after-tax basis. During 2019 and 2018, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category.
Assuming no credit-related factors develop, unrealized gains and losses on fixed maturity securities are expected to diminish as investments near maturity. Based on its credit analysis, the Company believes that the issuers of its fixed maturity investments in the sectors shown in the table above have the ability to service their obligations to the Company, and the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity.
However, the Company has identified certain available-for-sale fixed maturity securities where the amortized cost basis exceeds the present value of the cash flows expected to be collected due to credit related factors and as a result, a credit allowance has been calculated. As of December 31, 2020, the Company held an allowance of $38 million. Refer to the Credit Losses section below for additional information.
(1) U.S. GAAP guidance adopted as of January 1, 2020 has superseded these losses, included for comparative purposes only.
Transitional real estate loans are commercial mortgage loans that are typically relatively short-term floating rate instruments secured by a first lien on the property. These loans provide funding for properties undergoing a change in their physical characteristics and/or economic profile and do not typically require any principal repayment prior to the maturity date. This loan portfolio is generally considered to be investment grade. As of December 31, 2020, the Company had $601 million in outstanding commitments to fund transitional real estate loans. These commitments are contingent on the final underwriting and due diligence to be performed.
As of December 31, 2020, the Company had commitments of approximately $2.2 billion of which $2.0 billion was a result of a new agreement with an external manager during the first quarter of 2020 to fund future middle market loans. These commitments are contingent upon the availability of middle market loans that meet the Company's underwriting criteria.
The credit allowance for held-to-maturity fixed maturity securities and loan receivables is estimated using a PD / LGD method, discounted for the time value of money. For held-to-maturity fixed maturity securities, available-for-sale fixed maturity securities and loan receivables, the Company includes the change in present value due to the passage of time in the change in the allowance for credit losses. The Company’s methodology for estimating credit losses utilizes the contractual maturity date of the financial asset, adjusted when necessary to reflect the expected timing of repayment (such as prepayment options, renewal options, call options, or extension options). The Company applies reasonable and supportable forecasts of macroeconomic variables that impact the determination of PD/LGD over a two-year period for held-to-maturity fixed maturity securities and MMLs. The Company reverts to historical loss information over one year, following the two-year forecast period. For the CML and TRE portfolio, the Company applies reasonable and supportable forecasts of macroeconomic variables as well as national and local real-estate market factors to estimate future credit losses where the market factors revert back to historical levels over time with the period being dependent on current market conditions, projected market conditions and difference in the current and historical market levels for each factor. The Company continuously monitors the estimation methodology, due to changes in portfolio composition, changes in underwriting practices and significant events or conditions and makes adjustments as necessary.
An investment in an available-for-sale fixed maturity security is impaired if the fair value falls below amortized cost. The Company regularly reviews its fixed maturity security investments portfolio for declines in fair value. The Company's debt impairment model focuses on the ultimate collection of the cash flows from its investments and whether the Company has the intent to sell or if it is more likely than not the Company would be required to sell the security prior to recovery of its amortized cost. The determination of the amount of impairments under this model is based upon the Company's periodic evaluation and assessment of known and inherent risks associated with the respective securities. Such evaluations and assessments are revised as conditions change and new information becomes available.
When determining the Company's intention to sell a security prior to recovery of its fair value to amortized cost, the Company evaluates facts and circumstances such as, but not limited to, future cash flow needs, decisions to reposition its security portfolio, and risk profile of individual investment holdings. The Company performs ongoing analyses of its liquidity needs, which includes cash flow testing of its policy liabilities, debt maturities, projected dividend payments, and other cash flow and liquidity needs.
As of December 31, 2020 and 2019, the Company had an immaterial amount (cost basis) of loans and fixed maturities on nonaccrual status.
For assets that are subject to the credit loss measurement, the change in credit loss allowance will be significantly impacted by purchases and sales in those assets during the period as well as entering into new non-cancelable loan commitments. During the first quarter of 2020, the Company entered into a loan commitment with an external manager that met the requirements to recognize a credit loss on over $2.2 billion of loan commitments over the next few years. The estimate of credit losses for loan commitments as of December 31, 2020 was $35 million.
The table below reflects the composition of the carrying value for other investments as of December 31.
As of December 31, 2020, the Company had $1.6 billion in outstanding commitments to fund alternative investments in limited partnerships.
The following table presents the cost or amortized cost, fair value and balance sheet caption in which the assets and liabilities of consolidated VIEs are reported as of December 31.
therefore not required to consolidate them. The Company classifies these investments as Other investments in the consolidated balance sheets.
Details of collateral by loaned security type and remaining maturity of the agreements as of December 31 were as follows:
In connection with securities lending, in addition to cash collateral received, the Company received from counterparties securities collateral of $6,654 million and $4,759 million at December 31, 2020 and 2019, respectively, which may not be sold or re-pledged, unless the counterparty is in default. Such securities collateral is not reflected on the consolidated financial statements.
At December 31, 2020, debt securities with a fair value of $18 million were on deposit with regulatory authorities in the U.S. (including U.S. territories). The Company retains ownership of all securities on deposit and receives the related investment income.
•bond purchase commitments at the inception of investments in consolidated VIEs.
notional amounts. Foreign currency swaps are used primarily in the consolidated VIEs in the Company's Aflac Japan portfolio to convert foreign-denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations. The Company also uses foreign currency swaps to economically convert certain of its U.S. dollar-denominated senior note and subordinated debenture principal and interest obligations into yen-denominated obligations.
In order to reduce investment income volatility from its variable-rate investments, the Company enters into receive-fixed, pay-floating interest rate swaps. These derivatives are cleared and settled through a central clearinghouse.
Swaptions are used to mitigate the adverse impact resulting from significant changes in the fair value of U.S. dollar-denominated available-for-sale securities due to fluctuation in interest rates. In a payer swaption, the Company pays a premium to obtain the right, but not the obligation, to enter into a swap contract where it will pay a fixed rate and receive a floating rate. Interest rate swaption collars are combinations of two swaption positions. In order to maximize the efficiency of the collars while minimizing cost, a collar strategy is used whereby the Company purchases a long payer swaption (the Company purchases an option that allows it to enter into a swap where the Company will pay the fixed rate and receive the floating rate of the swap) and sells a short receiver swaption (the Company sells an option that provides the counterparty with the right to enter into a swap where the Company will receive the fixed rate and pay the floating rate of the swap). The combination of purchasing the long payer swaption and selling the short receiver swaption results in no net premium being paid (i.e. a costless or zero-cost collar).
Bond purchase commitments result from repackaged bond structures that are consolidated VIEs whereby there is a delay in the trade date and settlement date of the bond within the structure to ensure completion of all necessary legal agreements to support the consolidated VIE that issues the repackaged bond. Since the Company has a commitment to purchase the underlying bond at a specified price, the agreement meets the definition of a derivative where the value is derived based on the current market value of the bond compared to the fixed purchase price to be paid on the settlement date.
For certain variable-rate U.S. dollar-denominated available-for-sale securities held by Aflac Japan via consolidated VIEs, foreign currency swaps are used to swap the USD variable rate interest and principal payments to fixed rate JPY interest and principal payments. The Company has designated foreign currency swaps as a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset (“cash flow” hedge). The remaining maximum length of time for which these cash flows are hedged is six years. The derivatives in the Company's consolidated VIEs that are not designated as accounting hedges are discussed in the "non-qualifying strategies" section of this note.
The Company designates and accounts for certain foreign currency forwards, options, and interest rate swaptions as fair value hedges when they meet the requirements for hedge accounting. The Company recognizes gains and losses on these derivatives as well as the offsetting gain or loss on the related hedged items in current earnings.
Foreign currency forwards and options hedge the foreign currency exposure of certain U.S. dollar-denominated available-for-sale fixed-maturity investments held in Aflac Japan. The change in the fair value of the foreign currency forwards related to the changes in the difference between the spot rate and the forward price is excluded from the assessment of hedge effectiveness. The change in fair value of the foreign currency option related to the time value of the option is recognized in current earnings and is excluded from the assessment of hedge effectiveness.
Interest rate swaptions hedge the interest rate exposure of certain U.S. dollar-denominated available-for-sale securities held in Aflac Japan. For these hedging relationships, the Company excludes time value from the assessment of hedge effectiveness and recognizes changes in the intrinsic value of the swaptions in current earnings within net investment
income. The change in the time value of the swaptions is recognized in other comprehensive income (loss) and amortized into earnings (net investment income) over its legal term.
(2) Gains and losses on foreign currency forwards and options and related hedged items are reported in the consolidated statement of earnings as net investment gains (losses). For interest rate swaptions and related hedged items, gains and losses included in the hedge assessment, premium amortization and time value amortization while the hedge items are still outstanding are reported within net investment income. The time value gains and losses for interest rate swaptions when the related hedged items are redeemed are reported in net investment gains and losses consistent with the impact of the hedged item. For the years ended December 31, 2020 and 2019, gains and losses included in the hedge assessment on interest rate swaptions and related hedged items were immaterial.
The Company's investment in Aflac Japan is affected by changes in the yen/dollar exchange rate. To mitigate this exposure, the Parent Company's yen-denominated liabilities (see Note 9) have been designated as non-derivative hedges. Beginning in July 2019, certain foreign currency forwards and options were designated as derivative hedges of the foreign currency exposure of the Company's net investment in Aflac Japan.
For the Company's derivative instruments in consolidated VIEs that do not qualify for hedge accounting treatment, all changes in their fair value are reported in current period earnings within net investment gains (losses). The amount of gain or loss recognized in earnings for the Company's VIEs is attributable to the derivatives in those investment structures. While the change in value of the swaps is recorded through current period earnings, the change in value of the available-for-sale fixed maturity securities associated with these swaps is recorded through other comprehensive income.
As of December 31, 2020, the Parent Company had $2.3 billion notional amount of cross-currency interest rate swap agreements related to certain of its U.S. dollar-denominated senior notes to effectively convert a portion of the interest on the notes from U.S dollar to Japanese yen. Changes in the values of these swaps are recorded through current period earnings. For additional information regarding these swaps, see Note 9.
Prior to July 2019, in order to economically mitigate currency risk of future yen dividends from Aflac Japan while lowering consolidated hedge costs associated with Aflac Japan's U.S. dollar investment hedging, the Parent Company entered into offsetting hedge positions using foreign exchange forwards. This activity is reported in the Corporate and other segment. As of July 1, 2019, the Parent Company designates these foreign exchange forward contracts as accounting hedges of its net investment in Aflac Japan.
The Company uses interest rate swaps to economically convert the variable rate investment income to a fixed rate on certain variable-rate investments.
The following table summarizes the impact to earnings and other comprehensive income (loss) from all derivatives and hedging instruments for the years ended December 31.
(1) Interest expense/income on cash flow hedges are recorded in net investment income. For interest rate swaptions classified as fair value hedges, the change in the time value of the swaptions is recognized in other comprehensive income (loss) and amortized into net investment income over its legal term. If the swaption is early terminated but the hedge item is still outstanding, the amortization of disposal amount of the swaptions is recorded in net investment income over the remaining life of the hedged items.
(3) Impact of cash flow hedges reported as net investment gains (losses) includes an immaterial amount of gains or losses reclassified from accumulated other comprehensive income (loss) into earnings. It also includes an immaterial amount excluded from effectiveness testing during the years ended December 31, 2020, 2019 and 2018, respectively. Impact shown net of effect of hedged items (see Fair Value Hedges section of this Note 4 for further detail)
For the foreign currency and credit default swaps associated with the Company's VIE investments for which it is the primary beneficiary, the Company bears the risk of loss due to counterparty default even though it is not a direct counterparty to those contracts.
As of December 31, 2020, all of the Company's derivative agreement counterparties were investment grade.
(1) Excludes policy loans of $260 and equity method investments of $1,004, at carrying value
A third party pricing vendor has developed valuation models to determine fair values of privately issued securities. These models are discounted cash flow (DCF) valuation models, but also use information from related markets, specifically the credit default swaps (CDS) market to estimate expected cash flows. These models take into consideration any unique characteristics of the securities and make various adjustments to arrive at an appropriate issuer-specific loss adjusted credit curve. This credit curve is then used with the relevant recovery rates to estimate expected cash flows and modeling of additional features, including illiquidity adjustments, if necessary, to price the security by discounting those loss adjusted cash flows. In cases where a credit curve cannot be developed from the specific security features, the valuation methodology takes into consideration other market observable inputs, including:
4) bond indices that are comparative in rating, industry, maturity and region.
The pricing data and market quotes the Company obtains from outside sources, including third party pricing services, are reviewed internally for reasonableness. 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. Beginning in the third quarter of 2020, the Company refined these valuation models to explicitly incorporate currency basis swap adjustments (market observable data) to assumed interest rate curves where appropriate. 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.
The following tables present the pricing sources for the fair values of the Company's fixed maturity and equity securities as of December 31.
The following is a discussion of the determination of fair value of the Company's remaining financial instruments.
(2) Transfer due to reclassification of level 3 securities from HTM to AFS
The following tables summarize the significant unobservable inputs used in the valuation of the Company's Level 3 investments and derivatives carried at fair value as of December 31. Included in the tables are the inputs or range of possible inputs that have an effect on the overall valuation of the financial instruments.
For additional information on the Company's investments and financial instruments, see the accompanying Notes 1, 3 and 4.
Personnel, compensation and benefit expenses as a percentage of insurance expenses were 59% in 2020, compared with 57% in 2019 and 54% in 2018. Advertising expense, which is included in insurance expenses in the consolidated statements of earnings, was as follows for the years ended December 31:
(1) Elimination entry necessary due to recapture of a portion of policy liabilities ceded externally, as a result of the reinsurance retrocession transaction as described in Note 8 of the Notes to the Consolidated Financial Statements
The incurred claims development related to prior years reflects favorable claims experience compared to previous estimates. The favorable claims development of $540 million for 2020 comprises approximately $334 million from Japan and $206 million from the U.S., representing approximately 62% and 38% of the total, respectively. Excluding the impact of foreign exchange of a gain of approximately $7 million from December 31, 2019 to December 31, 2020, the favorable claims development in Japan would have been approximately $327 million, representing approximately 61% of the total.
As of December 31, 2020 and 2019, the largest component of the other policyholders' funds liability was the Company's annuity line of business in Aflac Japan. The Company's annuities have fixed benefits and premiums. These annuities represented 97% of other policyholders' funds liability at December 31, 2020 and 2019.
The Company has recorded a deferred profit liability related to reinsurance transactions. The remaining deferred profit liability of $1.0 billion, as of December 31, 2020, is included in future policy benefits in the consolidated balance sheet and is being amortized into income over the expected lives of the policies. The Company has also recorded a reinsurance recoverable for reinsurance transactions, which is included in other assets in the consolidated balance sheet and had a remaining balance of $1.0 billion and $970 million as of December 31, 2020 and 2019, respectively. The increase in the reinsurance recoverable balance was driven by two aggregating factors: yen strengthening and the growth in reserves related to the business that has been reinsured as the policies age. The spot yen/dollar exchange rate strengthened by approximately 5.9% and ceded reserves increased approximately 8.9% from December 31, 2019 to December 31, 2020.
These reinsurance transactions are indemnity reinsurance that do not relieve the Company from its obligations to policyholders. In the event that the reinsurer is unable to meet their obligations, the Company remains liable for the reinsured claims.
As a part of its capital contingency plan, the Company entered into a committed reinsurance facility agreement on December 1, 2015, with reserves of approximately ¥120 billion as of December 31, 2020. This reinsurance facility agreement was renewed in 2020 and is effective until December 31, 2021. There are also additional commitment periods of a one-year duration each of which are automatically extended unless notification is received from the reinsurer within 60 days prior to the expiration. The reinsurer can withdraw from the committed facility if Aflac‘s Standard and Poor's (S&P) rating drops below BBB-. As of December 31, 2020, the Company had not executed a reinsurance treaty under this committed reinsurance facility.
In April 2020, the Parent Company issued $1.0 billion of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 3.60% per annum, payable semi-annually, and will mature in April 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 a U.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.
In June 2013, the Parent Company issued $700 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 3.625% per annum, payable semi-annually, and will mature in June 2023. 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 treasury rate plus 20 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. The Parent Company had entered into cross-currency interest rate swaps to reduce interest expense by converting the U.S. dollar-denominated principal and interest on the senior notes it issued into yen-denominated obligations. By entering into these swaps, the Parent Company economically converted its $700 million liability into a ¥69.8 billion liability and reduced the interest rate on this debt from 3.625% in dollars to 1.50% in yen.
The following table presents the contractual maturities and present value of lease liabilities as of December 31, 2020.
Operating lease costs, included in insurance expenses in the consolidated statements of earnings, were $56 million, $54 million and $73 million for the years ended December 31, 2020, 2019 and 2018, respectively. Operating cash outflows for operating leases were $54 million and $52 million for the years ended December 31, 2020 and 2019, respectively.
A summary of the Company's lines of credit as of December 31, 2020 follows:
The Parent Company was in compliance with all of the covenants of its notes payable and lines of credit at December 31, 2020. No events of default or defaults occurred during 2020 and 2019.
necessary. Deferred foreign tax credits are foreign tax credits generated in the current tax year by the Japanese life company, but are unable to be utilized until 2021 due to Japan's current tax year not closing until March 31, 2021. The release of the valuation allowance on the deferred foreign tax credit is also due to the foreign tax credit regulations released September 29, 2020. Based upon a review of the Company's anticipated future taxable income, and including all other available evidence, both positive and negative, the Company's management has concluded that, notwithstanding the items noted above, it is more likely than not that all other deferred tax assets will be realized.
The Company files federal income tax returns in the U.S. and Japan as well as state or prefecture income tax returns in various jurisdictions in the two countries. The Company is currently under audit by the IRS for the 2013-2018 amended federal income tax returns. There are currently no other open Federal, State, or local U.S. income tax audits. U.S. federal income tax returns for years before 2016 are no longer subject to examination. Japan corporate income tax returns for years before 2016 are no longer subject to examination. Management believes it has established adequate tax liabilities and final resolution of all open audits is not expected to have a material impact on the Company's consolidated financial statements.
Outstanding share-based awards are excluded from the calculation of weighted-average shares used in the computation of basic EPS. The following table presents the approximate number of share-based awards to purchase shares, on a weighted-average basis, that were considered to be anti-dilutive and were excluded from the calculation of diluted EPS at December 31:
The weighted-average shares used in calculating EPS for the years ended December 31 were as follows:
Share Repurchase Program: During 2020, the Company repurchased 37.9 million shares of its common stock in the open market for $1.5 billion. The Company repurchased 32.0 million shares for $1.6 billion in 2019 and 28.9 million shares for $1.3 billion in 2018. In August 2020, the Company's board of directors authorized the purchase of an additional 100 million shares of its common stock. As of December 31, 2020, a remaining balance of 99.2 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors.
As of December 31, 2020, the Company has outstanding share-based awards under the Aflac Incorporated Long-Term Incentive Plan (the Plan). Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations, and other factors.
The following table presents the impact of the expense recognized in connection with share-based awards for the periods ended December 31.
The aggregate intrinsic value in the following table represents the total pretax intrinsic value, and is based on the difference between the exercise price of the stock options and the quoted closing common stock price of $44.47 as of December 31, 2020, for those awards that have an exercise price currently below the closing price. As of December 31, 2020, the aggregate intrinsic value of stock options outstanding was $43 million, with a weighted-average remaining term of 3.9 years. The total number of in-the-money stock options exercisable as of December 31, 2020, was 3.0 million shares. The aggregate intrinsic value of stock options exercisable at that same date was $43 million, with a weighted-average remaining term of 3.8 years.
Under the Plan, the Company grants selected executive officers performance-based restricted stock awards (PBRS) each February whose vesting is contingent upon meeting various performance goals. PBRS are generally granted at-the-money and contingently cliff vest over a period of three years, generally subject to continued employment. In February 2020, the Company granted 409 thousand performance-based stock awards, which are contingent on the achievement of the Company's financial performance metrics and its market-based conditions. On the date of grant, the Company
The Company's insurance subsidiaries are required to report their results of operations and financial position to insurance regulatory authorities on the basis of statutory accounting practices prescribed or permitted by such authorities.
Aflac, CAIC and TOIC report statutory financial statements that are prepared on the basis of accounting practices prescribed or permitted by the Nebraska Department of Insurance (NDOI). The NDOI recognizes statutory accounting principles and practices prescribed or permitted by the state of Nebraska for determining and reporting the financial condition and results of operations of an insurance company, and for determining a company's solvency under Nebraska insurance law.
The table below represents statutory capital and surplus based on statutory accounting practices for the Company’s U.S. life insurance subsidiaries as of December 31.
As of December 31, 2020, the capital and surplus for each of the Company's U.S. life insurance subsidiaries exceeded the required company action level capital and surplus.
The table below represents net income (loss) based on statutory accounting practices for the Company’s U.S. life insurance subsidiaries as of December 31.
The maximum amount of dividends that can be paid to the Parent Company by Aflac, CAIC and TOIC without prior approval of Nebraska's director of insurance is 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. In 2020, Aflac declared dividends of $853 million. Dividends declared by Aflac during 2021 in excess of $872 million would require such approval. CAIC and TOIC did not declare dividends during 2020.
The Company has funded defined benefit plans in Japan and the U.S., however the U.S. plan was frozen to new participants effective October 1, 2013. The Company also maintains non-qualified, unfunded supplemental retirement plans that provide defined pension benefits in excess of limits imposed by federal tax law for certain Japanese, U.S. and former employees, however the U.S. plan was frozen to new participants effective January 1, 2015. U.S. employees who are not participants in the defined benefit plan receive a nonelective 401(k) employer contribution.
The Company provides certain health care benefits for eligible U.S. retired employees, their beneficiaries and covered dependents (other postretirement benefits). The health care plan is contributory and unfunded. Effective January 1, 2014, employees eligible for benefits included the following: (1) active employees whose age plus service, in years, equaled or exceeded 80 (rule of 80); (2) active employees who were age 55 or older and have met the 15 years of service requirement; (3) active employees who would meet the rule of 80 in the next five years; (4) active employees who were age 55 or older and who would meet the 15 years of service requirement within the next five years; and (5) current retirees. For certain employees and former employees, additional coverage is provided for all medical expenses for life.
Information with respect to the Company's benefit plans' assets and obligations as of December 31 was as follows:
(1) The net amount of projected benefit obligation and plan assets for the underfunded (including unfunded) Japan pension plan was $57 and $92 at December 31, 2020 and 2019, respectively, and was classified as liabilities on the statement of financial position.
(2) The net amount of projected benefit obligation and plan assets for the underfunded (including unfunded) U.S. pension plan was $380 and $414 at December 31, 2020 and 2019, respectively, and was classified as liabilities on the statement of financial position.
(2)For the years 2020, 2019 and 2018, the health care cost trend rates are expected to trend down to 3.7% in 53 years, 3.8% in 54 years, and 4.1% in 61 years, respectively.
The 401(k) contributions by the Company, included in acquisition and operating expenses in the consolidated statements of earnings, were $20 million in 2020 and $18 million in both 2019 and 2018. The plan trustee held approximately 2.5 million shares of the Company's common stock for plan participants at December 31, 2020.
In September 2020, the Company announced a voluntary separation program for certain U.S. employees. The program provides eligible employees with a severance package, including twelve months of salary, the employee's targeted bonus payout for 2020 and one year of Consolidated Omnibus Budget Reconciliation Act (COBRA) or retiree medical, if eligible. Employees accepted into this program were notified in October 2020 and most transitions were completed by December 31, 2020, with a small number continuing into the first quarter of 2021. The Company recorded a one-time severance charge of $43 million in the fourth quarter of 2020 related to the program.
The Company has one outsourcing agreement with a management consulting and technology services company to provide application maintenance and development services for its Japanese operation. The agreement has a remaining term of one year with an aggregate remaining cost of ¥3.3 billion ($32 million using the December 31, 2020, exchange rate).
The Company has two outsourcing agreements with information technology and data services companies to provide application maintenance and development services for its Japanese operation. The first agreement has a remaining term of two years with an aggregate remaining cost of ¥3.0 billion ($29 million using the December 31, 2020, exchange rate). The second agreement has a remaining term of five years with an aggregate remaining cost of ¥13.7 billion ($133 million using the December 31, 2020, exchange rate).
The U.S. insurance industry has a policyholder protection system that is monitored and regulated by state insurance departments. These life and health insurance guaranty associations are state entities (in all 50 states as well as Puerto Rico and the District of Columbia) created to protect policyholders of an insolvent insurance company. All insurance companies (with limited exceptions) licensed to sell life or health insurance in a state must be members of that state’s guaranty association. Under 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.
In 2009, the Pennsylvania Insurance Commissioner placed long-term care insurer Penn Treaty Network America Insurance Company and its subsidiary American Network Insurance Company (collectively referred to as Penn Treaty), neither of which is affiliated with Aflac, in rehabilitation and petitioned a state court for approval to liquidate Penn Treaty. A final order of liquidation was granted by a recognized judicial authority on March 1, 2017, and as a result, Penn Treaty is in the process of liquidation. The Company estimated and recognized the impact of its share of guaranty fund assessments resulting from the liquidation using a discounted rate of 4.25%. The Company recognized a discounted liability for the assessments of $62 million (undiscounted $94 million), offset by discounted premium tax credits of $48 million (undiscounted $74 million), for a net $14 million impact to net income in the quarter ended March 31, 2017. The Company paid a majority of these assessments by December 31, 2020. The Company used the cost estimate provided as of the liquidation date by the National Organization of Life and Health Guaranty Associations (NOLHGA) to calculate its estimated assessments and tax credits. Other guaranty fund assessments for the years ended December 31, 2020, 2019, and 2018 were immaterial.