In the United States, Aflac owns land and buildings that comprise two primary campuses located in Columbus, Georgia. These campuses include buildings that serve as our worldwide headquarters and house administrative support and information technology functions for our U.S. operations. Aflac leases office space in Columbia, South Carolina, which houses our CAIC subsidiary. Aflac leases office space in New York that houses our Global Investment division. Aflac leases administrative office space in Georgia, South Carolina, New York, Nebraska, and in 39 additional states throughout the United States, as well as Washington, D.C. and Puerto Rico.
Capital Resources and Liquidity, including discussion of availability of capital and the sources and uses of cash
Yen-denominated income statement accounts are translated to U.S. dollars using a weighted-average Japanese yen/U.S. dollar foreign exchange rate, while yen-denominated balance sheet accounts are translated to U.S. dollars using a spot Japanese yen/U.S. dollar foreign exchange rate. The spot yen/dollar exchange rate at December 31, 2015 was 120.61, or .05% weaker than the December 31, 2014 spot yen/dollar exchange rate of 120.55. The weighted-average yen/dollar exchange rate for the year ended December 31, 2015 was 120.99, or 12.8% weaker than the weighted-average yen/dollar exchange rate of 105.46 for the same period in 2014.
Reflecting the weaker yen/dollar exchange rate, total revenues decreased 8.2% to $20.9 billion in 2015, compared with $22.7 billion in 2014. Net earnings in 2015 were $2.5 billion, or $5.85 per diluted share, compared with $3.0 billion, or $6.50 per diluted share, in 2014.
Results for 2015 included pretax net realized investment gains of $140 million ($91 million after-tax), compared with net realized investment gains of $215 million ($140 million after-tax) in 2014. Net investment gains in 2015 consisted of $303 million of net gains ($197 million after-tax) from the sale or redemption of securities; $153 million ($100 million after-tax) of other-than-temporary impairment losses; and $10 million of net losses ($7 million after-tax) from valuing derivatives.
Shareholders' equity included a net unrealized gain on investment securities and derivatives of $3.0 billion at December 31, 2015, compared with a net unrealized gain of $4.7 billion at December 31, 2014.
In October 2015, the Parent Company and Aflac jointly entered into a 364-day uncommitted bilateral line of credit that provides for borrowings in the amount of $100 million. In September 2015, the Parent Company and Aflac amended a 50 billion yen revolving credit facility, resulting in jointly entering into an unsecured revolving credit facility agreement with a syndicate of financial institutions that provides for borrowings in the amount of 55 billion yen. In February 2015, the Parent Company and Aflac jointly entered into an uncommitted bilateral line of credit with a third party that provides for borrowings in the amount of $50 million. For further information regarding these transactions, see Note 9 of the Notes to the Consolidated Financial Statements and the Capital Resources and Liquidity section of this MD&A.
We repurchased 21.2 million shares of our common stock in the open market for $1.3 billion under our share repurchase program in 2015, compared with 19.7 million shares repurchased in 2014.
We must apply considerable judgment in determining the likelihood of the security recovering in value while we own it. Factors that may influence this include our assessment of the issuer’s ability to continue making timely payments of interest and principal, the overall level of interest rates and credit spreads, and other factors. This process requires consideration of risks which can be controlled to a certain extent, such as credit risk, and risks which cannot be controlled, such as interest rate risk. Management updates its evaluations regularly and reflects impairment losses in the Company's net earnings or other comprehensive income, depending on the nature of the loss, as such evaluations are revised.
Certain costs of acquiring new business are deferred and amortized over the policy's premium payment period in proportion to anticipated premium income. Future amortization of DAC is based upon our estimates of persistency, interest and future premium revenue generally established at the time of policy issuance. However, the unamortized balance of DAC reflects actual persistency. See Note 6 of the Notes to the Consolidated Financial Statements for a detail of the DAC activity for the past two years.
The following table provides details of policy liabilities by segment and in total as of December 31.
(1) The sum of the Japan and U.S. segments exceeds the total due to reinsurance and retrocession activity.
Our policy liabilities, which are determined in accordance with applicable guidelines as defined under U.S. GAAP and Actuarial Standards of Practice, include two components that involve analysis and judgment: future policy benefits and unpaid policy claims, which accounted for 80% and 4% of total policy liabilities as of December 31, 2015, respectively.
As a part of our established financial reporting and accounting practices and controls, we perform detailed annual actuarial reviews of our policyholder liabilities (gross premium valuation analysis) and reflect the results of those reviews in our results of operations and financial condition as required by U.S. GAAP. For Aflac Japan, our annual review in 2015 indicated that we needed to strengthen the liability associated with a block of care policies, primarily due to low investment yields. We strengthened our future policy benefits liability by $18 million in 2015 as a result of this review. Our review in 2014 and 2013 indicated no need to strengthen liabilities associated with policies in Japan. For Aflac U.S., our annual reviews in 2015 and 2014 indicated no need to strengthen liabilities associated with policies in the United States. Our review in 2013 indicated that we needed to strengthen the liability associated primarily with long-term care in the United States. We strengthened our future policy benefits liability by $20 million in 2013 as a result of this review.
Other policy liabilities, which accounted for 16% of total policy liabilities as of December 31, 2015, consisted primarily of discounted advance premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period. Advanced premiums represented 43% and 47% of the December 31, 2015 and 2014 other policy liabilities balances, respectively. See the Aflac Japan segment subsection of this MD&A for further information.
Interest rates and credit spreads in both the United States and Japan are not the only factors that impact the Company’s unrealized gain/loss position and the evaluation of a need for a valuation allowance on the Company’s deferred tax asset, but they do have a direct and significant effect on both. Based on our methodology described above for evaluating the need for a valuation allowance, we have determined that it is more likely than not that our deferred tax assets will be realized in the future, therefore we have not recorded a valuation allowance as of December 31, 2015.
The following discussion includes references to our performance measures, operating earnings and operating earnings per diluted share, that are not based on U.S. GAAP. Operating earnings is the measure of segment profit or loss we use to evaluate segment performance and allocate resources. Consistent with U.S. GAAP accounting guidance for segment reporting, operating earnings is our measure of segment performance. Aflac believes that an analysis of operating earnings is vitally important to an understanding of our underlying profitability drivers and trends of our insurance business. Furthermore, because a significant portion of our business is conducted in Japan, we believe it is equally important to understand the impact of translating Japanese yen into U.S. dollars.
(2) Includes a loss of $13, after tax, in 2015 related to the change in value of yen repatriation received in advance of settlement of certain foreign currency derivatives. This loss was offset by derivative gains included in other derivative and hedging activities.
Our investment strategy is to invest in fixed-maturity securities to provide a reliable stream of investment income, which is one of the drivers of the Company’s growth and profitability. This investment strategy incorporates asset-liability matching (ALM) to align the expected cash flows of the portfolio to the needs of the Company's liability structure. We do not purchase securities with the intent of generating capital gains or losses. However, investment gains and losses may be realized as a result of changes in the financial markets and the creditworthiness of specific issuers, tax planning strategies, and/or general portfolio management and rebalancing. The realization of investment gains and losses is independent of the underwriting and administration of our insurance products, which are the principal drivers of our profitability.
During 2015, we realized pretax investment gains, net of losses, of $303 million ($197 million after-tax) from sales and redemptions of securities. These net gains primarily resulted from sales of Japanese Government Bonds (JGBs) as part of a portfolio repositioning exercise. We realized pretax investment losses of $153 million ($100 million after-tax) as a result of the recognition of other-than-temporary impairment losses on certain securities. Investment losses were primarily related to the recognition of an other-than-temporary impairment loss on a single holding.
During 2014, we realized pretax investment gains, net of losses, of $215 million ($140 million after-tax) from sales and redemptions of securities. These net gains primarily resulted from gains on sales of JGBs and our U.S. Treasury holdings, currency gains from transactions by our externally managed portfolio of U.S. dollar-denominated bank loans, and assorted other bond sales and calls. We realized pretax investment losses of $31 million ($20 million after-tax) as a result of the recognition of other-than-temporary impairment losses on certain securities.
During 2013, we realized pretax investment gains, net of losses, of $262 million ($170 million after-tax) from sales and redemptions of securities. These net gains primarily resulted from sales of JGBs as part of a portfolio repositioning exercise. We also realized modest gains from bond tender offers of several of our holdings. We realized pretax investment losses of $199 million ($129 million after-tax) as a result of the recognition of other-than-temporary impairment losses on certain securities.
Our combined U.S. and Japanese effective income tax rate on pretax earnings was 34.4% in 2015, 34.3% in 2014 and 34.4% in 2013. Total income taxes were $1.3 billion in 2015, compared with $1.5 billion in 2014 and $1.7 billion in 2013. Japanese income taxes on Aflac Japan's results account for most of our consolidated income tax expense. See Note 10 of the Notes to the Consolidated Financial Statements for additional information.
Our original objective for 2015 was to increase operating earnings per diluted share by 2% to 7% over 2014, and we revised the objective during the year to a 4% to 7% increase, excluding the effect of foreign currency translation. In April 2015, we executed a make-whole transaction to enhance our consolidated capital position (see the Capital Resources and Liquidity section of this MD&A for further discussion). As a result of this transaction, we incurred a non-operating charge of $.35 to operating earnings per diluted share in the second quarter of 2015. However, operating earnings per diluted share benefited by approximately $.07 for the full year 2015 due to a net reduction in interest expense. We reported 2015 net earnings per diluted share of $5.85. Adjusting that number for after-tax realized investment gains ($.09 per diluted share), other non-operating expense ($.40 per diluted share), and foreign currency translation (an expense of $.46 per diluted share), we finished the year above the top of the target range with a 7.5% increase in operating earnings per diluted share.
Stronger than expected earnings growth from 2015 will create tough comparisons in 2016. Our objective for 2016 is to produce stable operating earnings per diluted share of $6.17 to $6.41, assuming the average exchange rate in 2015 of 120.99 yen to the dollar. With volatile financial markets and interest rates at significantly depressed levels, it is difficult to safely invest cash flows at attractive yields. Additionally, 2016 benefit ratios in both the U.S. and Japan anticipate continued favorable experience. If we achieve our objective for 2016, the following table shows the likely results for operating earnings per diluted share, including the impact of foreign currency translation using various yen/dollar exchange rate scenarios.
1.57 trillion yen in 2013. The increases in annualized premiums in force in yen of 1.5% in 2015, 1.7% in 2014 and 5.0% in 2013 reflect the sales of new policies combined with the high persistency of Aflac Japan's business. Annualized premiums in force, translated into dollars at respective year-end exchange rates, were $13.4 billion in 2015, $13.2 billion in 2014, and $14.9 billion in 2013.
Aflac Japan's investment portfolios include dollar-denominated securities and reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments). U.S. dollar-denominated investment income from these assets accounted for approximately 50% of Aflac Japan's investment income in 2015, compared with 46% in 2014 and 44% in 2013. In years when the yen strengthens in relation to the dollar, translating Aflac Japan's U.S. dollar-denominated investment income into yen lowers growth rates for net investment income, total operating revenues, and pretax operating earnings in yen terms. In years when the yen weakens, translating U.S. dollar-denominated investment income into yen magnifies growth rates for net investment income, total operating revenues, and pretax operating earnings in yen terms. Excluding foreign currency changes from the respective prior year, U.S. dollar-denominated investment income accounted for approximately 46% of Aflac Japan's investment income during 2015, compared with 44% in 2014 and 39% in 2013.
The following table illustrates the effect of translating Aflac Japan's U.S. dollar-denominated investment income and related items into yen by comparing certain segment results with those that would have been reported had yen/dollar exchange rates remained unchanged from the prior year.
(2)Amounts excluding foreign currency changes on U.S. dollar-denominated items were determined using the same yen/dollar exchange rate for the current year as each respective prior year.
In 2015, the benefit ratio decreased compared with 2014, resulting from the impact of reinsurance; changes in foreign currency; and favorable claims experience. The three reinsurance agreements that we entered into since the end of the third quarter of 2013 reduced the benefit ratio by approximately 99 basis points for 2015. The benefit ratio has also been influenced by the effect of low investment yields, which impacts our profit margin by reducing the spread between investment yields and required interest on policy reserves (see table and discussion in the Interest Rate Risk subsection of this MD&A). In 2015, the operating expense ratio remained relatively stable, compared with 2014. In total, the pretax operating profit margin improved in 2015, compared with 2014. For 2016, we anticipate the pretax operating profit margin to be comparable with the 2015 and 2014 levels.
The foundation of Aflac Japan's product portfolio has been, and continues to be, our third sector cancer and medical products. Sales of third sector products increased 13.4% in 2015, compared with the same period in 2014, exceeding the high end of our revised sales target range of 10% to 13%. We have been focusing more on promotion of our cancer and medical products in this low-interest-rate environment. These products are less interest-rate sensitive and more profitable compared to first sector products.
Aflac Japan’s first sector product sales, which include WAYS and child endowment, were down 7.3% in 2015, compared with 2014. We expect that for 2016, the sale of first sector products will continue to be down in comparison to 2015, as our focus remains on less interest-sensitive third sector products.
We remain committed to selling through our traditional channels. These channels, consisting of affiliated corporate agencies, independent corporate agencies and individual agencies, accounted for 85.1% of total new annualized premium sales for Aflac Japan in 2015. In 2015, we recruited over 300 new sales agencies. At December 31, 2015, Aflac Japan was represented by more than 13,100 sales agencies and approximately 114,000 licensed sales associates employed by those agencies.
Aflac Japan and Japan Post Holdings entered into a new agreement in July 2013, further expanding a partnership that was established in 2008 (see Japanese Regulatory Environment). At the end of June 2014, Japan Post Insurance(Kampo) received Financial Services Agency (FSA) regulatory approval to enter into an agency contract with Aflac Japan to begin distributing Aflac Japan's cancer insurance products at all of Kampo's 79 directly managed sales offices. Aflac Japan has developed a unique Aflac-branded cancer product for Japan Post and Kampo that was introduced on October
1, 2014. In the fourth quarter of 2014, the number of postal outlets selling our cancer products expanded to approximately 10,000, and starting July 1, 2015, Japan Post expanded the number of post offices that offer Aflac's cancer products to more than 20,000 postal outlets. We believe this alliance with Japan Post will further benefit our cancer insurance sales.
We believe that there is still a continued need for our products in Japan. Our sales target and focus in 2016 will continue to be centered around the sale of Aflac Japan's third sector products, including cancer and medical. Although our traditional channels remain key to our success, we have developed partnerships with new channels to help increase our overall sales growth. These channels include Japan Post, and we are making steady progress with our sales through postal outlets. In 2016, we believe that third sector sales will be down mid-single digits in comparison to 2015. We believe that the long-term compound annual growth rate will be in the range of 4% to 6%.
In 2005, legislation aimed at privatizing Japan's postal system (Japan Post) was enacted into law. The privatization laws split Japan Post into four operating entities that began operations in October 2007. In 2007, one of these entities selected Aflac Japan as its provider of cancer insurance to be sold through its post offices, and, in 2008, we began selling cancer insurance through these post offices. Japan Post has historically been a popular place for consumers to purchase insurance products. Legislation to reform the postal system passed the Diet in April 2012 and resulted in the merger of two of the postal operating entities (the one that delivers the mail and the one that runs the post offices) on October 1, 2012. In July 2013, Aflac Japan entered into a new agreement with Japan Post Holdings to further expand a partnership that was established in 2008 (see Aflac Japan Sales).
During the third and fourth quarters of 2015, we increased our investment in yen-denominated publicly traded equity securities, including new investments in exchange traded funds (ETFs) holding Japan real estate investment trusts. These securities are classified as available for sale and carried on our balance sheet at fair value. As of December 31, 2015, the fair value of our investment in yen-denominated publicly traded equity securities was $485 million.
We use specific criteria to judge the credit quality of both existing and prospective investments. Furthermore, we use several methods to monitor these criteria, including credit rating services and internal credit analysis. The ratings referenced in the two tables below are based on the ratings designations provided by the major credit rating agencies (Moody's Investors Service (Moody's), Standard & Poor's Ratings Services (S&P), and Fitch Ratings (Fitch)) or, if not rated, are determined based on our internal credit analysis of such securities. For investment-grade securities where the ratings assigned by the major credit agencies are not equivalent, we use the second lowest rating that is assigned. For a description of the ratings methodology that we use when a security is below investment grade or split-rated (one rating agency rates the security as investment grade while another rating agency rates the same security as below investment grade), see “Market Risks of Financial Instruments - Below-Investment-Grade and Split-Rated Securities” in the Analysis of Financial Condition section of this MD&A.
The new money yield in the table above excludes certain purchases of senior secured bank loans and high yield corporate bonds funded from the reinvestment of unplanned sales proceeds. The increase in the Aflac Japan new money yield in 2015 was primarily due to a large portion of 2015 new money being allocated to U.S. dollar-denominated investments rather than relatively low-yielding JGBs.
(1)Includes 1.9% and 2.6% of perpetual securities at December 31, 2015 and 2014, respectively
The overall credit quality of Aflac Japan's investments remained high. At the end of 2015, 94.8% of Aflac Japan's debt and perpetual securities were rated investment grade, on an amortized cost basis.
Annualized premiums in force increased 1.6% in 2015, 1.8% in 2014 and 2.2% in 2013. Annualized premiums in force at December 31 were $5.8 billion in 2015, compared with $5.7 billion in 2014 and $5.6 billion in 2013.
associated with changes in the Aflac U.S. sales structure. In total, the pretax operating profit margin remained stable in 2015, compared with 2014. In 2016, we expect the benefit and expense ratios to be relatively stable compared with 2015.
New annualized premium sales for accident insurance, our leading product category, increased 10.2%, short-term disability sales increased 7.6%, critical care insurance sales (including cancer insurance) increased 6.0%, and hospital indemnity insurance sales decreased 7.5% in 2015, compared with 2014.
In 2015, our traditional U.S. sales forces included more than 9,200 U.S. associates who were actively producing business on a weekly basis. We believe that the average weekly producing sales associates metric allows our sales management to actively monitor progress and needs on a real-time basis. Beyond expanding the size and capabilities of our traditional sales force, we remain encouraged about establishing and developing relationships with insurance brokers that typically handle the larger-case market.
The addition of group products has expanded our reach and enabled us to generate more sales opportunities with larger employers, brokers, and our traditional sales agents. We anticipate that the appeal of our group products will continue to enhance our opportunities to connect with larger businesses and their employees. Our portfolio of group and individual products offers businesses the opportunity to give their employees a more valuable and comprehensive selection of benefit options.
We believe that changes we made to our career and broker management infrastructure over the last 18 months are laying the foundation for expanded long-term growth opportunities. During 2014, Aflac U.S. implemented tactical initiatives centered around providing competitive compensation to our career agent sales hierarchy and positioning us to more effectively and consistently execute on the U.S. sales strategy across all states. These measures are designed to more effectively link sales management's success to Aflac's success. For example, we enhanced compensation through an incentive bonus for the first level of our sales management, district sales coordinators, who are primarily responsible for selling Aflac products and training new sales associates. Additionally, we eliminated the commission-based position of state sales coordinator. To better manage our state operations, we introduced the new position of market director, effective October 1, 2014. Market directors are salaried with the opportunity to earn sales-related bonuses. We believe these changes have enhanced and will continue to enhance performance management and better align compensation with new business results.
The Affordable Care Act (ACA) is intended to give Americans of all ages and income levels access to comprehensive major medical health insurance. The major elements of the bill became effective on January 1, 2014. The primary subject of the legislation is major medical insurance; as enacted, the ACA does not materially affect the design of our insurance products. However, indirect consequences of the legislation and regulations, including uncertainty related to implementation, could present challenges and/or opportunities that could potentially have an impact on our sales model, financial condition and results of operations. Our experience with Japan’s national health care environment leads us to believe that the need for supplemental insurance will only increase over the coming years.
The legislation also makes the tax deductible by the payer. If employers fund coverage on a pre-tax basis, Aflac, as the insurer, would be liable for its pro-rata share of any tax on excess coverage, determined based on the cost of Aflac coverage compared to the total cost of the applicable health coverage in which each employee is enrolled. Making the tax deductible would then reduce the economic impact of any tax that is imposed and payable by Aflac.
Many employers are concerned about the tax and what impact it will have on benefit offerings in the future. There is confusion in the market about how the tax is calculated and who pays the tax, presenting a risk that some employers will mistakenly conclude that all supplemental health products are included in the calculation for the tax regardless of pre-tax funding status or whether an employer’s health coverage exceeds the trigger for the tax. Some employers may decide simply to drop coverage of affected supplemental health products, rather than convert it to an after-tax basis. During this extended implementation period, Aflac will be assessing the impact of this tax; educating employers about the tax; and investigating ways to mitigate the impact of the tax. Having employees pay for the coverage on an after-tax basis would exempt affected supplemental health products from the tax.
The Dodd-Frank Act, which was signed into law in 2010, created, among other things, a Financial Stability Oversight Council (the Council). In April 2012, the Council released a final rule describing the general process it will follow in determining whether to designate a nonbank financial company for supervision by the Board of Governors of the U.S. Federal Reserve System (the Board). The Council may designate by a two-thirds vote whether certain nonbank financial companies, including certain insurance companies and insurance holding companies, could pose a threat to the financial stability of the United States, in which case such nonbank financial companies would become subject to prudential regulation by the Board. On April 3, 2013, the Board published a final rule that establishes the requirements for determining when a nonbank financial company is "predominantly engaged in financial activities" - a prerequisite for designation by the Council. Prudential regulation by the Board includes supervision of capital requirements, leverage limits, liquidity requirements and examinations. The Board may limit such company’s ability to enter into mergers, acquisitions and other business combination transactions, restrict its ability to offer financial products, require it to terminate one or more activities, or impose conditions on the manner in which it conducts activities. The Council
The Dodd-Frank Act also established a FIO under the U.S. Treasury Department to monitor all aspects of the insurance industry and of lines of business other than certain health insurance, certain long-term care insurance and crop insurance. Traditionally, U.S. insurance companies have been regulated primarily by state insurance departments. In December 2013, the FIO released a report entitled "How To Modernize And Improve The System Of Insurance Regulation In The United States." The report was required by the Dodd-Frank Act, and included 18 recommended areas of near-term reform for the states, including addressing capital adequacy and safety/soundness issues, reform of insurer resolution practices, and reform of marketplace regulation. The report also listed nine recommended areas for direct federal involvement in insurance regulation. Some of the recommendations outlined in the FIO report released in December 2013 have been implemented. Of the nine recommended areas for direct federal involvement in insurance regulation that are applicable to Aflac, the president signed the National Association of Registered Agents and Brokers Reform Act into law in January 2015, which simplifies the agent and broker licensing process across state lines. The FIO has also engaged with the supervisory colleges to monitor financial stability and identify regulatory gaps for large national and internationally active insurers.
securitized assets and alternative asset classes, all of which we believe will improve diversification and enhance long-term returns in 2016 and thereafter.
We use specific criteria to judge the credit quality of both existing and prospective investments. Furthermore, we use several methods to monitor these criteria, including credit rating services and internal credit analysis. The ratings referenced in the two tables below are based on the ratings designations provided by the major credit rating agencies (Moody's, S&P, and Fitch) or, if not rated, are determined based on our internal credit analysis of such securities. For investment-grade securities where the ratings assigned by the major credit agencies are not equivalent, we use the second lowest rating that is assigned. For a description of the ratings methodology that we use when a security is below investment grade or split-rated (one rating agency rates the security as investment grade while another rating agency rates the same security as below investment grade), see “Market Risks of Financial Instruments - Below-Investment-Grade and Split-Rated Securities” in the Analysis of Financial Condition section of this MD&A.
The increase in purchases of BBB rated securities in 2015 was due primarily to the purchase of U.S. dollar-denominated corporate fixed-income publicly traded securities. The increase in purchases of BB or lower rated securities during 2015 was due to investment in high yield corporate bonds.
The increase in the Aflac U.S. new money yield in 2015 was primarily due to wider credit spreads achieved in portfolio investing activities.
The following table presents the composition of total investments by sector, at cost or amortized cost, and cash for Aflac U.S. ($13.7 billion in 2015 and $12.7 billion in 2014) as of December 31.
See Note 3 of the Notes to the Consolidated Financial Statements and the Market Risks of Financial Instruments - Credit Risk subsection of MD&A for more information regarding the sector concentrations of our investments.
The overall credit quality of Aflac U.S. investments remained high. At the end of 2015, 95.3% of Aflac U.S. debt and perpetual securities were rated investment grade, on an amortized cost basis. See Notes 3 and 5 of the Notes to the Consolidated Financial Statements and the Analysis of Financial Condition section of this MD&A for additional information on our investments.
The following table demonstrates the effect of the change in the yen/dollar exchange rate by comparing select balance sheet items as reported at December 31, 2015, with the amounts that would have been reported had the exchange rate remained unchanged from December 31, 2014.
(1)Excludes available-for-sale fixed-maturity securities held by the Parent Company and other business segments of $523 in 2015 and
Because we invest primarily in fixed-maturity securities, our financial instruments are exposed primarily to three types of market risks: currency risk, interest rate risk, and credit risk. In 2015, we increased our investment allocation to yen-denominated equity securities, thereby increasing our exposure to equity risk.
billion, at amortized cost, and yen-denominated equity securities of $472 million, at cost, at December 31, 2015. However, Aflac Japan also owns U.S. dollar-denominated fixed income securities of $14.9 billion, at amortized cost, whose fair value is hedged against currency risk as well as $7.8 billion of fixed income securities, at cost, that are not hedged. Aflac Japan owns U.S. dollar-denominated equity securities of $4 million, at cost, as of December 31, 2015. Yen-denominated investment income accounted for 50% of Aflac Japan's investment income in 2015, with the remainder denominated in U.S. dollars. In addition, Aflac Incorporated has yen-denominated debt obligations.
We are exposed to currency risk as an economic event only when yen funds are actually converted into dollars. This occurs when we repatriate yen-denominated funds from Aflac Japan to Aflac U.S. The exchange rates prevailing at the time of repatriation will differ from the exchange rates prevailing at the time the yen profits were earned. A portion of the yen repatriation may be used to service Aflac Incorporated's yen-denominated notes payable with the remainder converted into dollars. In order to economically hedge foreign exchange risk for a portion of the profit repatriation received in yen from Aflac Japan, we had foreign exchange forwards and options as part of a hedging strategy on 30.0 billion yen, 102.5 billion yen, 25.0 billion yen, and 85.0 billion yen received in February 2015, July 2015, September 2015, and December 2015, respectively. As of December 31, 2015, we had foreign exchange forwards and options to economically hedge foreign exchange risk on 124.1 billion yen of future profit repatriation from Aflac Japan.
In addition to profit repatriation, certain investment activities for Aflac Japan expose us to economic currency risk when yen are converted into dollars. As noted above, we invest a portion of our yen cash flows in U.S. dollar-denominated assets. This requires that we convert the yen cash flows to U.S. dollars before investing. As previously discussed, for certain of our U.S. dollar-denominated securities, we enter into foreign currency forward and option contracts to hedge the currency risk on the fair value of the securities. The dollar coupon payments received on these investments are not hedged and are subject to foreign exchange fluctuations, which are realized in earnings. Also, Aflac Japan has invested in reverse-dual currency securities (RDCs, or yen-denominated debt securities with dollar coupon payments), which exposes Aflac to changes in foreign exchange rates. The foreign currency effect on the yen-denominated securities is accounted for as a component of unrealized gains or losses on available-for-sale securities in accumulated other comprehensive income, while the foreign currency effect on the dollar coupons is realized in earnings. The RDCs provided a higher yield at the time of purchase than those available on Japanese government or other public corporate bonds, while still adhering to our investment standards at the time of the transaction. The yen/dollar exchange rate would have to strengthen to approximately 29 before the yield on these instruments would equal that of a comparable JGB instrument.
(1)Represents investments for Aflac Japan that support policy obligations and therefore excludes Aflac Japan’s annuity products
For further information on interest rate derivatives, see Note 4 of the accompanying Notes to the Consolidated Financial Statements.
A significant portion of our investment portfolio consists of debt securities or perpetual securities that expose us to the credit risk of the underlying issuer. We carefully evaluate this risk on every new investment and closely monitor the credit risk of our existing investment portfolio. We incorporate the needs of our products and liabilities, the overall requirements of the business, and other factors in addition to our underwriting of the credit risk for each investment in the portfolio.
Evaluating the underlying risks in our credit portfolio involves a multitude of factors including but not limited to our assessment of the issuers business activities, assets, products, market position, financial condition, and future prospects. We also must incorporate the assessment of the NRSROs in assigning credit ratings to our specific portfolio holdings. We perform extensive internal assessments of the credit risks for all our portfolio holdings and potential new investments.
The ratings of our securities referenced in the two tables below are based on the ratings designations provided by major NRSROs (Moody's, S&P and Fitch) or, if not rated, are determined based on our internal analysis of such securities. For investment-grade securities where the ratings assigned by the major credit agencies are not equivalent, we use the second lowest rating that is assigned. For a description of the ratings methodology that we use when a security is below
investment grade or split-rated, see "Market Risks of Financial Instruments - Below-Investment-Grade and Split-Rated Securities" in the Analysis of Financial Condition section of this MD&A.
Since 2008, many countries in Europe, and specifically Greece, Ireland, Italy, Portugal, and Spain (collectively the "peripheral Eurozone" countries), have experienced a debt crisis. Collective action by multiple parties including the European Central Bank (ECB), International Monetary Fund (IMF), European Council, and individual member states' governments had largely improved market perception of the situation across Europe. In exchange for this support, affected countries generally agreed to implement a series of measures to improve their fiscal situation in exchange for loans and other aid. Most countries continue to implement the prescribed austerity measures and have seen improvement in their economies, which in turn has seen their creditworthiness improve or stabilize.
The primary factor considered when determining the domicile of investment exposure is the legal country risk location of the issuer. However, other factors such as the location of the parent guarantor, the location of the company's headquarters or major business operations (including location of major assets), location of primary market (including location of revenue generation) and specific country risk publicly recognized by rating agencies can influence the assignment of the country (or geographic) risk location. When the issuer is a special financing vehicle or a branch or subsidiary of a global company, then we consider any guarantees and/or legal, regulatory and corporate relationships of the issuer relative to its ultimate parent in determining the proper assignment of country risk.
As of December 31, 2015, our investments in peripheral Eurozone countries totaled $2.8 billion, or 2.9% of our total debt and perpetual securities, at amortized cost. We have no direct exposure to Greece. Apart from our direct investments in peripheral Eurozone sovereign debt totaling $262 million, our other exposures as of December 31, 2015 to the European sovereign debt crisis were investments in peripheral Eurozone banks and financial institutions of $488 million, peripheral Eurozone non-banks (excluding sovereigns) of $2.0 billion, core Eurozone1 banks and financial institutions of $1.7 billion, core Eurozone non-banks (excluding sovereigns) of $4.2 billion, core Eurozone sovereigns of $486 million, and non-Eurozone2 holdings throughout the balance of Europe of $5.0 billion, all at amortized cost. Other investment risks stemming from the European sovereign debt crisis that are not possible to measure and include the impact of slower economic activity throughout Europe and its impact on global economic growth and market disruption including illiquidity and impaired valuations due to heightened concerns and lack of investor confidence.
1Core Eurozone includes Germany, France, Netherlands, Austria, Belgium, Finland and Luxembourg.
We use specific criteria to judge the credit quality of both existing and prospective investments. The ratings referenced in the tables below are based on the ratings designations provided by the major credit rating agencies (Moody's, S&P, and Fitch) or, if not rated, are determined based on our internal credit analysis of such securities. When the ratings issued by the rating agencies differ, we utilize the second lowest rating, regardless of how many of the three rating agencies actually rated the instrument. Split-rated securities are those where the ratings are not equivalent and one
or more of the ratings is investment grade and one or more is below investment grade. For these split-rated securities, if there are only two ratings assigned by the credit rating agencies, we take the lower below-investment-grade rating. If there are three ratings assigned, and two of the three are below investment grade, we consider it a below-investment-grade security. If there are three ratings and two are investment grade, we consider it an investment grade security unless our evaluation and assessment shows a below-investment-grade rating is warranted despite two of the three rating agencies rating it investment grade.
(2) 2014 includes notes issued by Deutsche Bank Capital Trust and Deutsche Postbank AG; 2015 includes only notes issued by Deutsche Postbank AG
(3) Includes 15 issuers in 2015 and 18 issuers in 2014
(4) Securities initially purchased as investment grade, but have subsequently been downgraded to below investment grade
(5) Includes 201 issuers in 2015 and 196 in 2014; all issuers below $25 million in par value
yield on invested assets, achieving further diversification of credit risk, and mitigating the risk of rising interest rates through the acquisition of floating rate assets. Our investments in this program totaled $1.4 billion at December 31, 2015, compared with $501 million at December 31, 2014, on an amortized cost basis.
The following table presents an aging of fixed maturities, perpetual securities, and equity securities in an unrealized loss position as of December 31, 2015.
The following table presents the 10 largest unrealized loss positions in our portfolio as of December 31, 2015.
Generally, declines in fair values can be a result of changes in interest rates, yen/dollar exchange rate, and changes in net spreads driven by a broad market move or a change in the issuer's underlying credit quality. In the fourth quarter of 2015, market volatility increased markedly, especially in the energy and commodity-related sectors. Most of the declines noted above are related to issuers in those sectors. As we believe these issuers have the ability to continue making timely payments of principal and interest, we view these changes in fair value to be temporary and do not believe it is necessary to impair the carrying value of these securities. See the Unrealized Investment Gains and Losses section in Note 3 of the Notes to the Consolidated Financial Statements for further discussions of unrealized losses related to financial institutions, including perpetual securities, and other corporate investments.
For those investments accounted for as loan receivables, we record those investments at amortized cost on the acquisition date and carry at adjusted amortized cost. The adjusted amortized cost of the loan receivables reflects
(1) Aflac Japan’s policy liabilities increased 5.3% in yen during the year ended December 31, 2015.
Notes payable totaled $5.0 billion at December 31, 2015, compared with $5.3 billion at December 31, 2014.
In August 2015, we paid off $300 million of 3.45% fixed-rate senior notes upon their maturity and paid off a 5.0 billion yen loan at its maturity date (a total of approximately $41 million using the exchange rate at the specific maturity date). In July 2015, we paid off a 10.0 billion yen loan at its maturity date (a total of approximately $81 million using the exchange rate at the specific maturity date).
due May 2019 and to pay a portion of the corresponding $230 million make-whole premium due to the investors of these notes.
Aflac Japan and Aflac U.S. have various benefit plans. For additional information on our Japanese and U.S. plans, see Note 14 of the Notes to the Consolidated Financial Statements.
The dollar values of our yen-denominated net assets, including economic yen-denominated investments for net investment hedging purposes as discussed above, are summarized as follows (translated at end-of-period exchange rates) for the years ended December 31:
In October 2015, the Parent Company and Aflac jointly entered into a 364-day uncommitted bilateral line of credit that provides for borrowings in the amount of $100 million. Borrowings will bear interest at the rate quoted by the bank and agreed upon at the time of making such loan and will have a three-month maturity period. There are no related facility fees, upfront expenses or financial covenant requirements. Borrowings under this credit agreement may be used for general corporate purposes. Borrowings under the financing agreement will mature no later than three months after the last drawdown date of October 15, 2016. As of December 31, 2015, we did not have any borrowings outstanding under our $100 million credit agreement.
Our financial statements convey our financing arrangements during the periods presented. We have not engaged in material intra-period short-term financings during the periods presented that are not otherwise reported in our balance sheet. We were in compliance with all of the covenants of our notes payable and lines of credit at December 31, 2015. We have not entered into transactions involving the transfer of financial assets with an obligation to repurchase financial assets that have been accounted for as a sale under applicable accounting standards, including securities lending transactions. See Notes 1, 3, and 4 of the Notes to the Consolidated Financial Statements for more information on our securities lending and derivative activities. With the exception of disclosed activities in those referenced footnotes, we do not have a known trend, demand, commitment, event or uncertainty that would reasonably result in our liquidity increasing or decreasing by a material amount. Our cash and cash equivalents include unrestricted cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased, all of which has minimal market, settlement or other risk exposure.
The following table presents the estimated payments by period of our major contractual obligations as of December 31, 2015. We translated our yen-denominated obligations using the December 31, 2015, exchange rate. Actual future payments as reported in dollars will fluctuate with changes in the yen/dollar exchange rate.
(1)Liability amounts are those reported on the consolidated balance sheet as of December 31, 2015.
(2)The estimated payments due by period reflect future estimated cash payments to be made to policyholders and others for future policy benefits. These projected cash outflows are based on assumptions for future policy persistency, mortality, morbidity, and other assumptions comparable with our experience, consider future premium receipts on current policies in force, and assume market growth and interest crediting consistent with assumptions used in amortizing deferred acquisition costs. These cash outflows are undiscounted with respect to interest and, as a result, the sum of the cash outflows shown for all years in the table of $234,854 exceeds the corresponding liability amount of $69,687. We have made significant assumptions to determine the future estimated cash outflows related to the underlying policies and contracts. Due to the significance of the assumptions used, actual cash outflow amounts and timing will differ, possibly materially, from these estimates.
(3)Includes assumptions as to the timing of policyholders reporting claims for prior periods and the amount of those claims. Actual amounts and timing of unpaid policy claims payments may differ significantly from the estimates above.
Consolidated cash flow from operations increased 3.5% in 2015, compared with 2014. The following table summarizes operating cash flows by source for the years ended December 31.
Prudent portfolio management dictates that we attempt to match the duration of our assets with the duration of our liabilities. Currently, when our fixed-maturity securities and perpetual securities mature, the proceeds may be reinvested at a yield below that required for the accretion of policy benefit liabilities on policies issued in earlier years. However, the long-term nature of our business and our strong cash flows provide us with the ability to minimize the effect of mismatched durations and/or yields identified by various asset adequacy analyses. When needed or when market opportunities arise, we dispose of selected fixed-maturity and perpetual securities that are available for sale to improve the duration matching of our assets and liabilities, improve future investment yields, and/or re-balance our portfolio. As a result, dispositions before maturity can vary significantly from year to year. Dispositions before maturity were approximately 5% of the annual average investment portfolio of fixed maturities and perpetual securities available for sale during the year ended December 31, 2015, compared with 6% in 2014 and 16% in 2013.
Consolidated cash used by financing activities was $2.2 billion in 2015 and $147 million in 2014, compared with cash provided by financing activities of $1.1 billion in 2013.
Cash dividends paid to shareholders in 2015 of $1.58 per share increased 5.3% over 2014. The 2014 dividend paid of $1.50 per share increased 5.6% over 2013. The following table presents the dividend activity for the years ended December 31.
In February 2016, the board of directors declared the first quarter 2016 cash dividend of $.41 per share. The dividend is payable on March 1, 2016, to shareholders of record at the close of business on February 16, 2016.
Aflac is domiciled in Nebraska and is subject to its regulations. The Nebraska Department of Insurance imposes certain limitations and restrictions on payments of dividends, management fees, loans and advances by Aflac to the Parent Company. Under Nebraska insurance law, prior approval of the Nebraska Department of Insurance is required for dividend distributions that exceed the greater of the net income from operations, which excludes net realized 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 addition, the Nebraska insurance department must approve service arrangements and other transactions within the affiliated group of companies. These regulatory limitations are not expected to affect the level of management fees or dividends paid by Aflac to the Parent Company. A life insurance company’s statutory capital and surplus is determined according to rules prescribed by the NAIC, as modified by the insurance department in the insurance company’s state of domicile. Statutory accounting rules are different from U.S. GAAP and are intended to emphasize policyholder protection and company solvency. Similar laws apply in New York and South Carolina, the domiciliary jurisdictions of the Parent Company's other insurance subsidiaries, Aflac New York and CAIC.
The continued long-term growth of our business may require increases in the statutory capital and surplus of our insurance operations. Aflac’s insurance operations may secure additional statutory capital through various sources, such as internally generated statutory earnings, equity contributions by the Parent Company from funds generated through debt or equity offerings, or reinsurance transactions. The NAIC’s risk-based capital (RBC) formula is used by insurance regulators to help identify inadequately capitalized insurance companies. The RBC formula quantifies insurance risk, business risk, asset risk and interest rate risk by weighing the types and mixtures of risks inherent in the insurer’s operations. Aflac's company action level RBC ratio was 933% as of December 31, 2015, compared with 945% at December 31, 2014. Aflac's RBC ratio remains high and reflects a strong capital and surplus position. As of December 31, 2015, Aflac's total adjusted capital of $11.7 billion exceeded the company action level required capital and surplus of $1.3 billion by $10.4 billion. The maximum amount of dividends that can be paid to the Parent Company by Aflac without prior approval of Nebraska's director of insurance is the greater of the net income from operations, which excludes net realized investment gains, for the previous year determined under statutory accounting principles, or 10% of statutory capital and surplus as of the previous year-end. Dividends declared by Aflac during 2016 in excess of $2.3 billion would require such approval. See Note 13 of the Notes to the Consolidated Financial Statements for information regarding the impact of permitted practices by the Nebraska Department of Insurance on our statutory capital and surplus. The NAIC considers its Solvency Modernization Initiative (SMI) process relating to updating the U.S. insurance solvency regulation framework to be ongoing. The SMI has focused on key issues such as capital requirements, governance and risk management, group supervision, reinsurance, statutory accounting and financial reporting matters. Many of these key issues have been finalized and/or are near completion; however, the NAIC still has some ongoing initiatives related to SMI, such as monitoring the international efforts on group capital requirements and group supervision as well as risk-based capital.
We entered into foreign exchange forwards and options as part of an economic hedge on foreign exchange risk on 242.5 billion yen of profit repatriation received in 2015, resulting in $71 million of additional funds received when the yen were exchanged into dollars.
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our 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 our evaluation under this framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2015.
In our opinion, Aflac Incorporated maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have audited the accompanying consolidated balance sheets of Aflac Incorporated and subsidiaries (the Company) as of December 31, 2015 and 2014, and 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, 2015. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aflac Incorporated and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, 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), Aflac Incorporated's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2016, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States and Japan. The Company's insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac), which operates in the United States (Aflac U.S.) and as a branch in Japan (Aflac Japan). 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. Our insurance operations in the United States and our branch in Japan service the two markets for our insurance business. Aflac Japan's revenues, including realized gains and losses on its investment portfolio, accounted for 70% of the Company's total revenues in 2015, compared with 72% in 2014 and 74% in 2013. The percentage of the Company's total assets attributable to Aflac Japan was 83% at December 31, 2015, compared with 82% at December 31, 2014.
Prior to October 1, 2013, Aflac Japan maintained an investment portfolio of U.S. dollar-denominated securities on behalf of Aflac U.S., which served as an economic currency hedge of a portion of our investment in Aflac Japan. The functional currency for these investments was the U.S. dollar. The related investment income and realized/unrealized investment gains and losses were denominated in U.S. dollars. Since the functional currency of this portfolio was the U.S. dollar, there was no translation adjustment to record in other comprehensive income for these investments when the yen/dollar exchange rate changed. The foreign exchange gains and losses related to this portfolio continue to be taxable in Japan and the U.S. when the securities matured or were sold. Until maturity or sale, deferred tax expense or benefit associated with the foreign exchange gains or losses is recognized in income tax expense on other comprehensive income. As of October 1, 2013, these investments were transferred into the Aflac Japan investment portfolio. These investments began to have remeasurement and translation effects recorded in other comprehensive income in the fourth quarter of 2013.
Insurance premiums for most of the Company's health and life policies are recognized ratably as earned income over the premium payment periods of the policies. When revenues are reported, the related amounts of benefits and expenses are charged against such revenues, so that profits are recognized in proportion to premium revenues during the period the policies are expected to remain in force. This association is accomplished by means of annual additions to the liability for future policy benefits and the deferral and subsequent amortization of policy acquisition costs.
Amortized cost of debt and perpetual securities is based on our purchase price adjusted for accrual of discount, or amortization of premium, and recognition of impairment charges, if any. The amortized cost of debt and perpetual securities we purchase 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.
An investment in a fixed maturity, perpetual security or equity security is impaired if the fair value falls below book value. We regularly review our entire investment portfolio for declines in value. Our fixed maturities and investment-grade perpetual securities investments are evaluated for other-than-temporary impairment using our debt impairment model. Our debt impairment model focuses on the ultimate collection of the cash flows from our investments. The determination of the amount of impairments under this model is based upon our 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.
The determination of whether an impairment in value of our debt securities is other than temporary is based largely on our evaluation of the issuer's creditworthiness. We must apply considerable judgment in determining the likelihood of the security recovering in value while we own it. Factors that may influence this include the overall level of interest rates, credit spreads, the credit quality of the underlying issuer, and other factors. This process requires consideration of risks which can be controlled to a certain extent, such as credit risk, and risks which cannot be controlled, such as interest rate risk.
Our investments in perpetual securities that are rated below investment grade and equity securities are evaluated for other-than-temporary impairment under our equity impairment model. Our equity impairment model focuses on the severity of a security's decline in fair value coupled with the length of time the fair value of the security has been below amortized cost and the financial condition and near-term prospects of the issuer. For equity securities that have declines in value that are deemed to be temporary, we make an assertion as to our ability and intent to retain the security until recovery. Once identified, these equity securities are restricted from trading unless authorized based upon events that could not have been foreseen at the time we asserted our ability and intent to retain the security until recovery.
For those relationships where we seek hedge accounting, we formally document all relationships between hedging instruments and hedged items, as well as our risk-management objectives and strategies for undertaking various hedge transactions. This process includes linking derivatives and non-derivative financial instruments that are designated as hedges to specific assets or liabilities on the balance sheet. We also assess, both at inception and on an ongoing basis, whether the derivatives and non-derivative financial instruments used in hedging activities are highly effective in offsetting changes in fair values or cash flows of the hedged items. The assessment of hedge effectiveness determines the accounting treatment of noncash changes in fair value.
Changes in the fair value of any of our derivatives that are designated and qualify as cash flow hedges are recorded in other comprehensive income as long as they are deemed effective. Any hedge ineffectiveness is recorded immediately in current period earnings within derivative and other gains (losses). Periodic derivative net coupon settlements are recorded in the line item of the consolidated statements of earnings in which the cash flows of the hedged item are recorded.
We have designated the majority of the Parent Company's yen-denominated liabilities (Samurai and Uridashi notes and yen-denominated loans) as non-derivative hedges and designated certain derivatives as hedges of the foreign currency exposure to our investment in Aflac Japan. At the beginning of each quarter, we make our net investment hedge designation. If the total of the designated Parent Company non-derivative and derivatives notional is equal to or less than our net investment in Aflac Japan, the hedge is deemed to be effective, and the exchange effect on the yen-denominated
Other policy liabilities consist primarily of discounted advance premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan limited-pay insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period.
For internal replacements that are determined to not be substantially unchanged, policy liabilities related to the original policy that was replaced are immediately released, and policy liabilities are established for the new insurance contract.
As discussed in the Translation of Foreign Currencies section above, Aflac Japan maintains certain dollar-denominated investments that, prior to October 1, 2013, did not have any foreign currency translation adjustments recognized in other comprehensive income. However, the deferred tax expense or benefit associated with foreign exchange gains or losses on these investments is recognized in other comprehensive income (loss) until the securities mature or are sold. Total income tax expense (benefit) related to items of other comprehensive income (loss) included a deferred tax expense of $614 million in 2013 for these U.S. dollar-denominated investments. Excluding these amounts from total taxes on other comprehensive income would result in an effective income tax rate on pretax other comprehensive income (loss) of 31% in 2013.
Share-Based Compensation: We measure compensation cost related to our share-based payment transactions at fair value on the grant date, and we recognize those costs in the financial statements over the vesting period during which the employee provides service in exchange for the award.
Income Statement - Extraordinary and Unusual Items - Simplifying income statement presentation by eliminating the concept of extraordinary items: In January 2015, the FASB issued updated guidance that eliminates from U.S. GAAP the concept of extraordinary items. Presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained. The amendments in this updated guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We adopted this guidance as of January 1, 2015. The adoption of this guidance did not have a significant impact on our financial position, results of operations, or disclosures.
Receivables - Troubled debt restructurings by creditors - Reclassification of residential real estate collateralized consumer mortgage loans upon foreclosure: In January 2014, the FASB issued updated guidance for troubled debt restructurings clarifying when an in substance repossession or foreclosure occurs, and when a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. We adopted the guidance as of January 1, 2015. The adoption of this guidance did not have a significant impact on our financial position or results of operations.
Presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists: In July 2013, the FASB issued guidance to amend the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The new guidance states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However, to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. We adopted this guidance as of January 1, 2014. The adoption of this guidance did not have a significant impact on our financial position or results of operations.
Compensation - Stock Compensation - Accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period: In June 2014, the FASB issued this amendment that provides guidance on certain share-based payment awards that require a specific performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance to awards with performance conditions that affect vesting to account for such awards. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. The adoption of this guidance will not have a significant impact on our financial position or results of operations.
We do not allocate corporate overhead expenses to business segments. We evaluate and manage our business segments using a financial performance measure called pretax operating earnings. Our definition of operating earnings includes interest cash flows associated with notes payable and excludes the following items from net earnings on an after-tax basis: realized investment gains/losses (securities transactions, impairments, and the impact of derivative and hedging activities), nonrecurring items and other non-operating income (loss). We then exclude income taxes related to operations to arrive at pretax operating earnings. Information regarding operations by segment for the years ended December 31 follows:
(2) Includes a loss of $20 related to the change in value of yen repatriation received in advance of settlement of certain foreign currency derivatives. The loss was offset by derivative gains included in realized investment gains (losses).
(3) Includes expense of $230 for the make-whole payment associated with the early extinguishment of debt
During 2015, we did not reclassify any investments from the held-to-maturity category to the available-for-sale category. During 2014, we reclassified three investments from the held-to-maturity category to the available-for-sale category as a result of the issuers being downgraded to below investment grade. At the time of the transfer, the securities had an aggregate amortized cost of $424 million and an aggregate unrealized loss of $54 million. During 2013, we reclassified two investments from the held-to-maturity category to the available-for-sale category as a result of the issuer being downgraded to below investment grade. At the time of the transfer, the securities had an aggregate amortized cost of $492 million and an aggregate unrealized loss of $153 million.
Our process for credit-related investments begins with an independent approach to underwriting each issuer's fundamental credit quality. We evaluate independently those factors which we believe could influence an issuer's ability to make payments under the contractual terms of our instruments. This includes a thorough analysis of a variety of items including the issuer's country of domicile (including political, legal, and financial considerations); the industry in which the issuer competes (with an analysis of industry structure, end-market dynamics, and regulation); company specific issues (such as management, assets, earnings, cash generation, and capital needs); and contractual provisions of the instrument (such as financial covenants and position in the capital structure). We further evaluate the investment considering broad business and portfolio management objectives, including asset/liability needs, portfolio diversification, and expected income.
The majority of our fixed maturity and perpetual security investments are evaluated for other-than-temporary impairment using our debt impairment model. Our debt impairment model focuses on the ultimate collection of the cash flows from our investments and whether we have the intent to sell or if it is more likely than not we would be required to sell the security prior to recovery of its amortized cost. The fair values of our fixed maturity and perpetual security investments fluctuate based on changes in interest rates, foreign exchange, and credit spreads in the global financial markets. Fair values can also be heavily influenced by the values of the assets of the issuer and expected ultimate recovery values upon a default, bankruptcy or other financial restructuring. Credit spreads are most impacted by the general credit environment and global market liquidity. Interest rates are driven by numerous factors including, but not limited to, supply and demand, governmental monetary actions, expectations of inflation and economic growth. We believe that fluctuations in the fair values of our investment securities related to general changes in the level of credit spreads or interest rates have little bearing on underlying credit quality of the issuer, and whether our investment is ultimately recoverable. Generally, we consider such declines in fair values to be temporary even in situations where an investment remains in an unrealized loss position for an extended period of time.
In the course of our review process, we may determine that it is unlikely that our fixed maturity or perpetual security investment will recover in value within an acceptable time frame. Factors which may influence this determination include the severity of the price decline, the length of time the price has been impaired, if the price decline was driven by issuer credit deterioration, and our view of the likelihood of the security defaulting or otherwise being subject to an unfavorable restructuring. In those cases where we believe the security will not recover in price within an acceptable period of time, we consider such a decline in the investment's fair value, to the extent it is below the investment's cost or amortized cost, to be an other-than-temporary impairment of the investment and reduce the book value of the investment to its fair value.
(1) Includes $131 and $45 for the years ended December 31, 2015 and 2013, respectively, for credit-related impairments; $26 for the year ended December 31, 2013 for impairments due to severity and duration of decline in fair value; and $22, $31 and $128 for the years ended December 31, 2015, 2014 and 2013, respectively, from change in intent to sell securities
The unrealized losses on our fixed income or perpetual securities investments have been primarily related to general market changes in interest rates, foreign exchange rates, and/or the levels of credit spreads rather than specific concerns with the issuer's ability to pay interest and repay principal. The unrealized losses on our investments in equity securities are primarily related to general market conditions which reflect prospects for the economy as a whole or due to specific information pertaining to an industry or an individual company.
The following table provides more information on our unrealized loss position on fixed maturities and perpetual securities as of December 31.
We are exposed to credit losses within our CDO that could result in principal losses to our investment. However, we have mitigated the risk of credit loss through the structure of the VIE, which contractually requires the subordinated tranches within the VIE to absorb the majority of the expected losses from the underlying credit default swaps. We currently own only senior mezzanine CDO tranches. Based on our statistical analysis models and the current subordination levels in our CDO, the VIE can sustain a reasonable number of defaults in the underlying reference entities in the CDS with no loss to our investment.
The VIEs that we are not required to consolidate are investments that are in the form of debt obligations from the VIEs that are irrevocably and unconditionally guaranteed by their corporate parents or sponsors. These VIEs are the primary financing vehicles used by their corporate sponsors to raise financing in the capital markets. The variable interests created by these VIEs are principally or solely a result of the debt instruments issued by them. We do not have the power to direct the activities that most significantly impact the entity's economic performance, nor do we have (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. As such, we are not the primary beneficiary of these VIEs and are therefore not required to consolidate them. These VIE investments comprise securities from 169 separate issuers with an average credit rating of BBB.
As of December 31, 2015, our investment in middle market loan receivables was $118 million, of which $53 million was unfunded, while the associated allowance for expected losses was immaterial. As of December 31, 2015, we had commitments of $182 million to fund potential future loan originations related to this investment program. These commitments are contingent upon the availability of middle market loans that meet our underwriting criteria.
During the fourth quarter of 2015, we initiated our commercial mortgage loan investment program. As of December 31, 2015, we had not yet funded any commercial mortgage loans. Once funded, we intend to classify our commercial mortgage loans as held-for-investment, and we will carry them on the balance sheet at amortized cost less an estimated allowance for loan losses. Our commercial mortgage loan allowance for losses will be established using both specific and general allowances. The specific allowance will be used on an individual loan basis for those impaired loans where we expect to incur a loss. The general allowance will be used for loans grouped by similar risk characteristics where a property-specific
or market-specific risk has not been identified, but for which we expect to incur a loss. As of December 31, 2015, we had $10 million in outstanding commitments to fund commercial mortgage loans. These commitments are contingent on the final underwriting and due diligence to be performed, and may or may not be funded.
We lend fixed-maturity securities to financial institutions in short-term security-lending transactions. These short-term security-lending arrangements increase investment income with minimal risk. Our security lending policy requires that the fair value of the securities and/or unrestricted cash received as collateral be 102% or more of the fair value of the loaned securities. These securities continue to be carried as investment assets on our balance sheet during the terms of the loans and are not reported as sales. We receive cash or other securities as collateral for such loans. For loans involving unrestricted cash or securities as collateral, the collateral is reported as an asset with a corresponding liability for the return of the collateral.
For general information regarding our investment accounting policies, see Note 1.
Foreign currency forwards and options with short-term maturities are executed for the Aflac Japan segment in order to hedge the currency risk on the fair value of certain fixed-maturity U.S. dollar-denominated securities. In forward transactions, Aflac Japan agrees with another party to buy a fixed amount of yen and sell a corresponding amount of U.S. dollars at a specified future date. Aflac Japan also executes foreign currency option transactions in a collar strategy, where Aflac Japan agrees with another party to simultaneously purchase a fixed amount of U.S. dollar put options and sell U.S. dollar call options. The combination of these two actions results in no net premium being paid (i.e. a costless or zero-cost collar). The foreign currency forwards and options are used in fair value hedging relationships to mitigate the foreign exchange risk associated with U.S. dollar-denominated investments supporting yen-denominated liabilities.
Foreign currency forwards and options are also used to hedge the currency risk associated with the net investment in Aflac Japan. In these forward transactions, Aflac agrees with another party to buy a fixed amount of U.S. dollars and sell a corresponding amount of yen at a specified future date. In the option transactions, we use a combination of foreign currency options to protect expected future cash flows by simultaneously purchasing yen put options (options that protect against a weakening yen) and selling yen call options (options that limit participation in a strengthening yen). The combination of these two actions results in no net premium being paid (i.e. a costless or zero-cost collar).
entered into, the cash flow streams exchanged by the counterparties are equal in value. No cash or principal payments are exchanged at the inception of the contract. Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed-maturity securities contracts to fixed rates. These derivatives are predominantly used to better match cash receipts from assets with cash disbursements required to fund liabilities.
Periodically, depending on general economic conditions, we may enter into other derivative transactions.
For the foreign currency and credit default swaps associated with our VIE investments for which we are the primary beneficiary, we bear the risk of foreign exchange loss due to counterparty default even though we are not a direct counterparty to those contracts. We are a direct counterparty to the foreign currency swaps that we have entered into in connection with certain of our senior notes, subordinated debentures, and Samurai notes; foreign currency forwards; foreign currency options; and interest rate swaptions, and therefore we are exposed to credit risk in the event of nonperformance by the counterparties in those contracts. The risk of counterparty default for our VIE swaps, foreign currency swaps, certain foreign currency forwards, foreign currency options and interest rate swaptions is mitigated by collateral posting requirements that counterparties to those transactions must meet. As of December 31, 2015, there were 15 counterparties to our derivative agreements, with five comprising 63% of the aggregate notional amount. The counterparties to these derivatives are financial institutions with the following credit ratings as of December 31:
We engage in derivative transactions directly with unaffiliated third parties under International Swaps and Derivatives Association, Inc. (ISDA) agreements and other documentation. Most of the ISDA agreements also include Credit Support Annex (CSA) provisions, which generally provide for two-way collateral postings, in certain cases at the first dollar of exposure and in other cases once various rating and exposure threshold levels are triggered. We mitigate the risk that counterparties to transactions might be unable to fulfill their contractual obligations by monitoring counterparty credit exposure and collateral value while generally requiring that collateral be posted at the outset of the transaction or that additional collateral be posted upon the occurrence of certain events or circumstances. In addition, a significant portion of the derivative transactions have provisions that require collateral to be posted upon a downgrade of our long-term debt ratings or give the counterparty the right to terminate the transaction upon a downgrade of Aflac’s financial strength rating. The actual amount of collateral required to be posted to counterparties in the event of such downgrades, or the aggregate amount of payments that we could be required to make, depends on market conditions, the fair value of outstanding affected transactions, and other factors prevailing at and after the time of the downgrade.
The fair value of the collateral posted by us to third parties for derivative transactions was $20 million at December 31, 2015, which consisted of $17 million of pledged securities and $3 million of cash, compared with $1.6 billion at December 31, 2014, which consisted entirely of pledged securities. This collateral can generally be repledged or resold by the counterparties. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position by counterparty was approximately $26 million and $2.1 billion as of December 31, 2015 and 2014, respectively. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2015, we estimate that we would be required to post a maximum of $6 million of additional collateral to these derivative counterparties. Collateral obtained by us from third parties for derivative transactions was $412 million
and $619 million at December 31, 2015 and 2014, respectively. We are generally allowed to sell or repledge collateral obtained from our derivative counterparties, although we do not typically exercise such rights.
Freestanding derivatives are carried at estimated fair value in our consolidated balance sheets either as other assets or as other liabilities. See Note 5 for a discussion on how we determine the fair value of our derivatives. Accruals on derivatives are recorded in accrued investment income or within other liabilities in the consolidated balance sheets.
For the hedge of our net investment in Aflac Japan, we have designated Parent Company yen-denominated liabilities as non-derivative hedging instruments and have designated certain foreign currency forwards and options as derivative hedging instruments. We make our net investment hedge designation at the beginning of each quarter. For assessing hedge effectiveness of net investment hedges, if the total of the designated Parent Company non-derivative and derivatives notional is equal to or less than our net investment in Aflac Japan, the hedge is deemed to be effective. If the hedge is effective, the related exchange effect on the yen-denominated liabilities is reported in the unrealized foreign currency component of other comprehensive income. For derivatives designated as net investment hedges, Aflac follows the forward-rate method. According to that method, all changes in fair value, including changes related to the forward-rate component of foreign currency forward contracts and the time value of foreign currency options, are reported in the unrealized foreign currency component of other comprehensive income. Should these designated net investment hedge
positions exceed our net investment in Aflac Japan, the foreign exchange effect on the portion that exceeds our investment in Aflac Japan would be recognized in current earnings within derivative and other gains (losses).
in the fair value of the interest rate swaptions related to the time value of the option is excluded from the assessment of hedge effectiveness.
Our net investment hedge was effective for the years ended December 31, 2015, 2014 and 2013.
For our 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 derivative and other gains (losses). The amount of gain or loss recognized in earnings for our 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 or perpetual securities associated with these swaps is recorded through other comprehensive income.
(1) Consists of $86 of pledged securities and $326 of cash.
U.S. GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. These two types of inputs create three valuation hierarchy levels. Level 1 valuations reflect quoted market prices for identical assets or liabilities in active markets. Level 2 valuations reflect quoted market prices for similar assets or liabilities in an active market, quoted market prices for identical or similar assets or liabilities in non-active markets or model-derived valuations in which all significant valuation inputs are observable in active markets. Level 3 valuations reflect valuations in which one or more of the significant inputs are not observable in an active market.
The pricing data and market quotes we obtain from outside sources, including third party pricing services, are reviewed internally for reasonableness. If a fair value appears unreasonable, we will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, we may compare the inputs to relevant market indices
For the periods presented, we have not adjusted the quotes or prices we obtain from the pricing services and brokers we use.
There were no transfers between Level 1 and 2 for the years ended December 31, 2015 and 2014, respectively.
Foreign exchange swaps also have a lump-sum final settlement of foreign exchange principal receivables at the termination of the swap. An increase in yen interest rates will decrease the value of the final settlement foreign exchange receivables and decrease the value of the swap, and an increase in U.S. dollar interest rates increase the swap value.
Consolidated policy acquisition costs deferred were $1.3 billion in 2015 and 2014, compared with $1.4 billion in 2013. The following table presents a rollforward of deferred policy acquisition costs by segment for the years ended December 31.
Commissions deferred as a percentage of total acquisition costs deferred were 74% in 2015, compared with 77% in 2014 and 81% in 2013.
Personnel, compensation and benefit expenses as a percentage of insurance expenses were 52% in 2015 and 2014, compared with 51% in 2013. Advertising expense, which is included in insurance expenses in the consolidated statements of earnings, was as follows for the years ended December 31:
Policy liabilities consist of future policy benefits, unpaid policy claims, unearned premiums, and other policyholders' funds, which accounted for 80%, 4%, 9% and 7% of total policy liabilities at December 31, 2015, respectively. We regularly review the adequacy of our policy liabilities in total and by component.
As of December 31, 2015 and 2014, unearned premiums consisted primarily of discounted advance premiums on deposit. Discounted advance premiums are premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan limited-pay insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period. These advanced premiums represented 77% of the December 31, 2015 and 80% of the December 31, 2014 unearned premiums balances.
As of December 31, 2015 and 2014, the largest component of the other policyholders' funds liability is our annuity line of business in Aflac Japan. Our annuities have fixed benefits and premiums. These annuities represented 98% of the December 31, 2015 and 2014 other policyholders' funds liability.
We enter into fixed quota-share coinsurance agreements with other companies in the normal course of business. For each of our reinsurance agreements, we determine whether the agreement provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. Reinsurance premiums and benefits paid or provided are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and benefits are reported net of insurance ceded.
(1) Principal amount plus an issuance premium that is being amortized over the life of the notes
(3) Principal amount net of an issuance discount that is being amortized over the life of the notes
In March 2015, the Parent Company issued two series of senior notes totaling $1.0 billion through a U.S. public debt offering. The first series, which totaled $550 million, bears interest at a fixed rate of 2.40% per annum, payable semi-annually, and has a five-year maturity. The second series, which totaled $450 million, bears interest at a fixed rate of 3.25% per annum, payable semi-annually, and has a ten-year maturity. We have entered into cross-currency swaps that convert the U.S. dollar-denominated principal and interest on the senior notes into yen-denominated obligations which results in lower nominal net interest rates on the debt. By entering into these cross-currency swaps, we economically converted our $550 million liability into a 67.0 billion yen liability and reduced the interest rate on this debt from 2.40% in dollars to .24% in yen, and we economically converted our $450 million liability into a 55.0 billion yen liability and reduced the interest rate on this debt from 3.25% in dollars to .82% in yen. In April 2015, the Parent Company used the proceeds from the March 2015 issuance of its fixed-rate senior notes to redeem $850 million of our 8.50% fixed-rate senior notes due May 2019 and to pay a portion of the corresponding $230 million make-whole premium due to the investors of these notes.
senior notes we issued into yen-denominated obligations. By entering into the swaps, we economically converted our $750 million liability into an 85.3 billion yen liability and reduced the interest rate on this debt from 3.625% in dollars to 1.00% in yen.
We were in compliance with all of the covenants of our notes payable and lines of credit at December 31, 2015. No events of default or defaults occurred during 2015 and 2014.
Japan enacted an income tax rate reduction effective for fiscal years beginning after March 31, 2012. The rate was reduced to 33.3% effective April 1, 2012, and an additional reduction to 30.8% became effective January 1, 2015.
We file federal income tax returns in the United States and Japan as well as state or prefecture income tax returns in various jurisdictions in the two countries. U.S. federal income tax returns for years before 2011 are no longer subject to examination. In Japan, the National Tax Agency (NTA) has completed exams through tax year 2012.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. We recognized approximately $11 million in interest and penalties in 2015, 2014 and 2013. The Company has accrued approximately $22 million for the payment of interest and penalties as of December 31, 2015, compared with $30 million a year ago.
As of December 31, 2015, there were no material uncertain tax positions for which the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
Share Repurchase Program: During 2015, we purchased 21.2 million shares of our common stock in the open market, compared with 19.7 million shares in 2014 and 13.2 million shares in 2013. In August 2015, our board of directors authorized the purchase of an additional 40.0 million shares of our common stock. As of December 31, 2015, a remaining balance of 48.4 million shares of our common stock was available for purchase under share repurchase authorizations by our board of directors.
The following table summarizes information about stock options outstanding and exercisable at December 31, 2015.
As of December 31, 2015, total compensation cost not yet recognized in our financial statements related to restricted stock awards was $44 million, of which $20 million (849 thousand shares) was related to restricted stock awards with a performance-based vesting condition. We expect to recognize these amounts over a weighted-average period of approximately 1.1 years. There are no other contractual terms covering restricted stock awards once vested.
As of December 31, 2015, Aflac's capital and surplus significantly exceeded the required company action level capital and surplus of $1.3 billion. As determined on a U.S. statutory accounting basis, Aflac's net income was $2.3 billion in 2015 and $2.4 billion in 2014 and 2013.
Aflac Japan must report its results of operations and financial position to the Japanese Financial Services Agency (FSA) on a Japanese regulatory accounting basis as prescribed by the FSA. Capital and surplus of the Japan branch, based on Japanese regulatory accounting practices, was $4.7 billion at December 31, 2015, compared with $5.6 billion at December 31, 2014. Japanese regulatory accounting practices differ in many respects from U.S. GAAP. Under Japanese regulatory accounting practices, policy acquisition costs are expensed immediately; policy benefit and claim reserving methods and assumptions are different; premium income is recognized on a cash basis; different consolidation criteria apply to VIEs; reinsurance is recognized on a different basis; and investments can have a separate accounting classification and treatment referred to as policy reserve matching bonds (PRM).
The Parent Company depends on its subsidiaries for cash flow, primarily in the form of dividends and management fees. Consolidated retained earnings in the accompanying financial statements largely represent the undistributed earnings of our insurance subsidiary. Amounts available for dividends, management fees and other payments to the Parent Company by its insurance subsidiary may fluctuate due to different accounting methods required by regulatory authorities. These payments are also subject to various regulatory restrictions and approvals related to safeguarding the
A portion of Aflac Japan earnings, as determined on a Japanese regulatory accounting basis, can be repatriated each year to Aflac U.S. after complying with solvency margin provisions and satisfying various conditions imposed by Japanese regulatory authorities for protecting policyholders. Profit repatriations to the United States can fluctuate due to changes in the amounts of Japanese regulatory earnings. Among other items, factors affecting regulatory earnings include Japanese regulatory accounting practices and fluctuations in currency translation of Aflac Japan's U.S. dollar-denominated investments and related investment income into yen. Profits repatriated by Aflac Japan to Aflac U.S. were as follows for the years ended December 31:
(2)For the years 2015, 2014 and 2013, the health care cost trend rates are expected to trend down to 4.5% in 78 years, 4.6% in 78 years, and 4.6% in 78 years, respectively.
We determine our discount rate assumption for our pension retirement obligations based on indices for AA corporate bonds with an average duration of approximately 20 years for the Japan pension plans and 17 years for the U.S. pension plans, and determination of the U.S. pension plans discount rate utilizes the 85-year extrapolated yield curve. In Japan,
Prior service credits of $51 million were incurred in 2013 for the plan amendment related to the change in eligibility for postretirement medical benefits mentioned above. No transition obligations arose during 2015, and the transition obligations amortized to expense were immaterial for the years ended December 31, 2015, 2014 and 2013. Amortization of actuarial losses to expense in 2016 is estimated to be $1 million for the Japanese plans, $13 million for the U.S. plans and $1 million for the other postretirement benefits plan. Amortization of prior service credits in 2016 is estimated to be $10 million for the other postretirement benefits plan due to the negative plan amendment in 2013. The amortization of prior service costs and credits for other plans and transition obligations for all plans is expected to be negligible in 2016.
We plan to make contributions of $20 million to the Japanese funded defined benefit plan and $10 million to the U.S. funded defined benefit plan in 2016. The funding policy for our non-qualified supplemental defined benefit pension plans and other postretirement benefits plan is to contribute the amount of the benefit payments made during the year.
The plan fiduciaries for our funded defined benefit plans have developed guidelines for asset allocations reflecting a percentage of total assets by asset class, which are reviewed on an annual basis. Asset allocation targets as of December 31, 2015 were as follows:
The following table presents the fair value of Aflac U.S.'s pension plan assets that are measured at fair value on a recurring basis as of December 31. All of these assets are classified as Level 1 in the fair value hierarchy.
The Company sponsors a 401(k) plan in which we match a portion of U.S. employees' contributions. The plan provides for salary reduction contributions by employees and, in 2015, 2014, and 2013, provided matching contributions by the Company of 50% of each employee's contributions which were not in excess of 6% of the employee's annual cash compensation.
The 401(k) contributions by the Company, included in acquisition and operating expenses in the consolidated statements of earnings, were $9 million in 2015, $7 million in 2014 and $5 million in 2013. The plan trustee held approximately one million shares of our common stock for plan participants at December 31, 2015.
We have two outsourcing agreements with a technology and consulting corporation. The first agreement provides mainframe computer operations, distributed mid-range server computer operations, and related support for Aflac Japan. It has a remaining term of five years and an aggregate remaining cost of 36.0 billion yen ($298 million using the December 31, 2015, exchange rate). The second agreement provides application maintenance and development services for Aflac Japan. It has a remaining term of two years and an aggregate remaining cost of 2.4 billion yen ($20 million using the December 31, 2015, exchange rate).
We have two outsourcing agreements with information technology and data services companies to provide application maintenance and development services for our Japanese operation. The first agreement has a remaining term of one year with an aggregate remaining cost of 637 million yen ($5 million using the December 31, 2015, exchange rate). The second agreement has a remaining term of two years with an aggregate remaining cost of 1.6 billion yen ($13 million using the December 31, 2015, exchange rate).
As of December 31, 2015, we have commitments of $182 million to fund potential future loan originations related to our investment in middle market loans. These commitments are contingent upon the availability of middle market loans that meet our underwriting criteria. See Note 3 of the Notes to the Consolidated Financial Statements for more details on this investment program.
We lease office space and equipment under agreements that expire in various years through 2026. Future minimum lease payments due under non-cancelable operating leases at December 31, 2015, were as follows:
bearing little relation to the actual damages sustained by plaintiffs, have been awarded in recent years, we believe the outcome of pending litigation will not have a material adverse effect on our financial position, results of operations, or cash flows.