The Company elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented in Item 8. Financial Statements and Supplementary Data. Readers should refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in the Company's Annual Report on Form 10-K for the year ended December 31, 2018, filed on February 25, 2019, for reference to discussion of the year ended December 31, 2017, the earliest of the three years presented. Amounts reported in this MD&A may not add due to rounding.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results for 2019 included pretax net realized investment losses of $135 million, compared with net realized investment losses of $430 million in 2018. Net investment losses in 2019 included $31 million of other-than-temporary impairment losses and changes in loan loss reserves; $236 million in net losses from certain derivatives and foreign currency gains or losses; $101 million of net gains on equity securities; and $31 million of net gains from sales and redemptions.
Total investments and cash at the end of December 2019 were $138.1 billion, compared with $126.2 billion at December 31, 2018. In 2019, Aflac Incorporated repurchased $1.6 billion, or 32.0 million of its common shares. At the end of December, the Company had 37.1 million remaining shares authorized for repurchase.
U.S. Business - Customer demographics continue to evolve and new opportunities present themselves in different customer segments such as the millennial and multicultural markets. Customer expectations and preferences are changing. Trends indicate existing customers and potential customers seek cost-effective solutions that are easily understood and can be accessed through technology-enabled devices. Additionally, income protection and the health needs of retiring baby boomers are continuing to shape the insurance industry.
The Company's objectives in 2020 are to maintain strong pre-tax margins in its Aflac Japan and Aflac U.S. segments through disciplined product pricing, stable investment returns and leveraging a period of favorable benefit ratios to invest in its platform for future growth and efficiency. The Company believes that its market-leading position, powerful brand recognition and diverse distribution in Japan and the U.S. will provide support toward these objectives.
The Company believes that its efforts will support its prudent strategies for capital deployment in the form of dividends, share repurchases, and opportunistic investments that enhance the Company’s business with a focus on digital distribution and leveraging the Company’s brand, distribution and scale. The Company has stated that the dividend payout ratio from its Aflac Japan segment is likely to be to 100% of FSA earnings from Aflac Japan and 100% of U.S. statutory earnings from Aflac U.S. In its Aflac U.S. segment, the Company plans to maintain a risk-based capital (RBC) ratio in the 500% range for 2020.
The Company expects the profit margins for the Aflac U.S. segment to remain strong, providing a prudent opportunity to reinvest profits back into the U.S. business. The Company anticipates that in 2020, benefit ratios in the U.S. will remain stable and that expense ratios will continue to be elevated in light of investments into U.S. platforms in both the individual and group channels. The Company expects Aflac U.S. to generate earned premium growth in the range of 1% in 2020. Net investment income is expected to decline modestly, primarily as the result of the Company’s implemented U.S. capital and RBC draw-down plan.
For important disclosures applicable to statements made in this 2020 Outlook, please see the Risk Factors section and the statement on Forward-Looking Information at the beginning of Item 1. Business, the Risk Factors identified in Item 1A. and Item 7. Management Discussion and Analysis.
The Company earns its revenues principally from insurance premiums and investments. The Company’s operating expenses primarily consist of insurance benefits provided and reserves established for anticipated future insurance benefits, general business expenses, commissions and other costs of selling and servicing its products. Profitability for the Company depends principally on its ability to price its insurance products at a level that enables the Company to earn a margin over the costs associated with providing benefits and administering those products. Profitability also depends on, among other items, actuarial and policyholder behavior experience on insurance products, and the Company's ability to attract and retain customer assets, generate and maintain favorable investment results, effectively deploy capital and utilize tax capacity, and manage expenses.
Yen-denominated income statement accounts are translated to U.S. dollars using a weighted average Japanese yen/U.S. dollar foreign exchange rate, except realized gains and losses on security transactions which are translated at the exchange rate on the trade date of each transaction. Yen-denominated balance sheet accounts are translated to U.S. dollars using a spot Japanese yen/U.S. dollar foreign exchange rate.
The following discussion includes references to the Company's performance measures, adjusted earnings, adjusted earnings per diluted share, and amortized hedge costs/income, which are not calculated in accordance with U.S. GAAP (non-U.S. GAAP). These measures exclude items that the Company believes may obscure the underlying fundamentals and trends in the Company's insurance operations because they tend to be driven by general economic conditions and events or related to infrequent activities not directly associated with its insurance operations. The Company's management uses adjusted earnings and adjusted earnings per diluted share to evaluate the financial performance of its insurance operations on a consolidated basis, and the Company believes that a presentation of these measures is vitally important to an understanding of its underlying profitability drivers and trends of its insurance business. The Company believes that amortized hedge costs/income, which are a component of adjusted earnings, measure the periodic currency risk management costs/income related to hedging certain foreign currency exchange risks and are an important component of net investment income.
Adjusted earnings are the profits derived from operations.The most comparable U.S. GAAP measure is net earnings. Adjusted earnings are adjusted revenues less benefits and adjusted expenses. The adjustments to both revenues and expenses account for certain items that cannot be predicted or that are outside management’s control. Adjusted revenues are U.S. GAAP total revenues excluding realized investment gains and losses, except for amortized hedge costs/income related to foreign currency exposure management strategies and net interest cash flows from derivatives associated with certain investment strategies. Adjusted expenses are U.S. GAAP total acquisition and operating expenses including the impact of interest cash flows from derivatives associated with notes payable but excluding any nonrecurring or other items not associated with the normal course of the Company’s insurance operations and that do not reflect the Company's underlying business performance.
Adjusted earnings per share (basic or diluted) are adjusted earnings for the period divided by the weighted average outstanding shares (basic or diluted) for the period presented. The most comparable U.S. GAAP measure is net earnings per share.
Amortized hedge costs/income represent costs/income incurred or recognized in using foreign currency forward
contracts to hedge certain foreign exchange risks in the Company's Japan segment (costs) or in the Corporate and Other segment (income). These amortized hedge costs/income are derived from the difference between the foreign currency spot rate at time of trade inception and the contractual foreign currency forward rate, recognized on a straight line basis over the term of the hedge. There is no comparable U.S. GAAP financial measure for amortized hedge costs/income.
(2) Amortized hedge costs of $257 in 2019 and $236 in 2018, related to certain foreign currency exposure management strategies have been reclassified from realized investment gains (losses) and included in adjusted earnings as a decrease to net investment income. See "Hedge Costs/Income" discussion below for further information.
(3)Amortized hedge income of $89 in 2019 and $36 in 2018, related to certain foreign currency exposure management strategies have been reclassified from realized investment gains (losses) and included in adjusted earnings as an increase to net investment income. See "Hedge Costs/Income" discussion below for further information.
(5) A gain of $66 in 2019 and $67 in 2018, respectively, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable have been reclassified from realized investment gains (losses) and included in adjusted earnings as a component of interest expense.
(7) Prior period foreign currency impact reflected as “N/A” to isolate change for current period only.
The Company's investment strategy is to invest primarily in fixed maturity securities to provide a reliable stream of investment income, which is one of the drivers of the Company’s 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. The Company does 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 the Company's insurance products. Realized investment gains and
Securities transactions include gains and losses from sales and redemptions of investments where the amount received is different from the amortized cost of the investment. Impairments include other-than-temporary-impairment losses on investment securities as well as changes in loan loss reserves for loan receivables. Starting in the first quarter of 2018, gains and losses from changes in fair value of equity securities are recorded in earnings.
The U.S. insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. The system can result in periodic charges to the Company as a result of insolvencies/bankruptcies that occur with other companies in the life insurance industry. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. These charges neither relate to the ordinary course of the Company’s business nor reflect the Company’s underlying business performance, but result from external situations not controlled by the Company. The Company excludes any charges associated with U.S. guaranty fund assessments and the corresponding tax benefit or expense from adjusted earnings.
U.S. GAAP financial reporting requires that a company report financial and descriptive information about operating segments in its annual and interim period financial statements. Furthermore, the Company is required to report a measure of segment profit or loss, certain revenue and expense items, and segment assets. Aflac's insurance business consists of two segments: Aflac Japan and Aflac U.S. Aflac Japan is the principal contributor to consolidated earnings. Businesses that are not individually reportable, such as the Parent Company, asset management subsidiaries and business activities, including reinsurance retrocession activities are included in the Corporate and other segment. See the Item 1. Business section of this Form 10-K for a summary of each segment's products and distribution channels, and a discussion of the conversion of Aflac Japan from a branch to a subsidiary and the creation of asset management subsidiaries in 2018. Consistent with U.S. GAAP guidance for segment reporting, pretax adjusted earnings is the Company's U.S. GAAP measure of segment performance. See Note 2 of the Notes to the Consolidated Financial Statements for the reconciliation of segment results to the Company's consolidated U.S. GAAP results and additional information.
In yen terms, Aflac Japan's net premium income decreased in 2019, primarily due to limited-pay products reaching paid-up status. Net investment income, net of amortized hedge costs, increased in 2019 primarily due to increased investments in U.S. dollar-denominated floating rate assets and $25 million of income related to a partial call of a concentrated yen-denominated exposure.
Annualized premiums in force at December 31, 2019, were ¥1.49 trillion, compared with ¥1.53 trillion in 2018. The decrease in annualized premiums in force in yen of 2.5% in 2019 and 1.6% in 2018 was driven primarily by limited-pay products reaching paid up status. Annualized premiums in force, translated into dollars at respective year-end exchange rates, were $13.6 billion in 2019 and $13.8 billion in 2018.
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 dollar/yen exchange rates remained unchanged from the prior year. Amounts excluding foreign currency impact on U.S. dollar-denominated investment income, a non-U.S. GAAP financial measure, were determined using the average dollar/yen exchange rate for the comparable prior year period. See non-U.S. GAAP financial measures defined above.
Sales of protection-type first sector and third sector products on a yen basis decreased 16.8% in 2019, compared with 2018. Earned premium growth for third and first sector protection products was 1.3%, which was consistent with the Company's expectation. The decline in sales primarily reflected reduced sales of cancer insurance through the Japan Post channel following the 2018 launch of Aflac Japan's revised cancer insurance product. In addition, the approach to refreshing the medical insurance product in 2019 took a rider versus whole policy approach. This was designed for improved economics but naturally resulted in lower reported sales. Additional factors include a change in corporate tax law, which slowed the pace of certain third sector medical products and some cancer products in both our associate channel and the bank channel, as well as increased competition from large life insurers who are increasing their focus on the third sector.
Sales of Aflac Japan cancer products in the Japan Post Group channel experienced a material decline beginning in August 2019 which has continued into 2020. For 2019, sales in the Japan Post Group channel declined by approximately 50.0% compared with 2018. The Company expects very little sales production in the Japan Post channel during the first half of 2020 and is uncertain with regard to production during the second half of the year. See the 2020 Outlook section of this MD&A for information on Aflac Japan earned premium expectations.
Independent corporate agencies and individual agencies contributed 45.7% of total new annualized premium sales for Aflac Japan in 2019, compared with 40.1% in 2018. Affiliated corporate agencies, which include Japan Post, contributed 50.0% of total new annualized premium sales in 2019, compared with 55.3% in 2018. Japan Post offers Aflac's cancer insurance products in more than 20,000 postal outlets. Notwithstanding the recent reduction in sales of Aflac Japan's cancer products in the Japan Post channel, the Company believes this alliance with Japan Post has and will benefit its cancer insurance sales over the long term. In 2019, Aflac Japan recruited 77 new sales agencies. At December 31, 2019, Aflac Japan was represented by more than 9,000 sales agencies, with more than 109,000 licensed sales associates employed by those agencies.
As of December 31, 2019, all regulatory approvals expressly set forth in the Shareholders Agreement have been obtained. The Shareholders Agreement requires the parties to use reasonable best efforts to cooperate in connection with any ongoing regulatory matters related to or arising from the Trust’s acquisition or ownership or control of the shares of Company Common Stock, including any applications or filings in connection with a direct or indirect acquisition of control of or merger with an insurer by the Company or its affiliates. The foregoing is subject to and qualified in its entirety by reference to the full text of the Shareholders Agreement, a copy of which is attached as Exhibit 10.50 to the Company’s Quarterly Report on Form 10-Q filed April 26, 2019, and the terms of which exhibit are incorporated herein by reference.
The following table details the investment purchases for Aflac Japan for the years ended December 31.
The increase in the Aflac Japan new money yield in 2019 was primarily due to decreased allocations to lower yielding yen-denominated asset classes.
See Notes 3, 4 and 5 of the Notes to the Consolidated Financial Statements and the Investments section of this MD&A for additional information on the Company's investments and hedging strategies.
The benefit ratio decreased in 2019, compared with 2018, primarily due to somewhat elevated lapses and a change in business mix from higher loss ratio, reserve building products to lower loss ratio, guaranteed issue products. The adjusted expense ratio increased in 2019, compared with 2018, primarily due to deferred policy acquisition costs (DAC) capitalization related to lower than anticipated sales as well as anticipated spending increases reflecting ongoing investments in the U.S. platform, distribution, and customer experience. Both the lower benefit and higher DAC amortization ratios were also impacted by increases in lapses as a result of large case volatility and replacement of an administrative partner. These items impacted persistency in the short-term but are expected to drive profitable earned premium growth in future periods. The pretax adjusted
profit margin declined in 2019 when compared with 2018, due to higher expense ratios, offset somewhat by lower benefit ratios. For expectations for 2020, see the 2020 Outlook section of this MD&A.
In November 2019, the Company acquired Argus Holdings, LLC and its subsidiary Argus Dental & Vision, Inc. (Argus), a benefits management organization and national network dental and vision company, which provides a platform for Aflac Dental and Vision. This transaction represents a commitment of $75 million in capital at closing and an additional $21 million in consideration paid over three years based on the achievement by Argus of certain performance targets. Tampa, Florida will serve as the home for Aflac Dental and Vision. This acquisition is a strategic entry point into the network dental and vision market and is expected to provide opportunities for sales growth, improved account penetration and distribution productivity.
The level of investment income is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, and other factors.
Net investment income benefited from the Company’s enterprise corporate hedging program for the years ended December 31, 2019 and 2018, respectively. See the Hedging Activities subsection of this MD&A for further information on the enterprise corporate hedging program.
The ratings of the Company's securities referenced in the table below are based on the ratings designations provided by major NRSROs or, if not rated, are determined based on the Company's internal analysis of such securities. When the ratings issued by the rating agencies differ, the Company utilizes the second lowest rating when three or more rating agency ratings are available or the lowest rating when only two rating agency ratings are available.
The distributions of fixed maturity securities the Company owns, by credit rating, as of December 31 were as follows:
As of December 31, 2019, the Company's direct and indirect exposure to securities in its investment portfolio that were guaranteed by third parties was immaterial both individually and in the aggregate.
The following table presents the 10 largest unrealized loss positions in the Company's portfolio as of December 31, 2019.
(1) Securities initially purchased as investment grade, but have subsequently been downgraded to below investment grade
The Company maintains an allocation to higher yielding corporate bonds within the Aflac Japan and Aflac U.S. portfolios. Most of these securities were rated below-investment-grade at the time of purchase, but the Company also purchased several that were rated investment grade which, because of market pricing, offer yields commensurate with below-investment-grade risk profiles. The objective of this allocation was to enhance the Company's yield on invested assets and further diversify credit risk. All investments in this program must have a minimum rating at purchase of low BB using the Company's above described rating methodology and are managed by the Company's internal credit portfolio management team.
The following table details the Company's reverse-dual currency securities as of December 31.
Aflac Japan has a portfolio of privately issued securities to better match liability characteristics and secure higher yields than those available on Japanese government or other public corporate bonds. Aflac Japan’s investments in yen-denominated privately issued securities consist primarily of non-Japanese issuers, are rated investment grade at purchase and have longer maturities, thereby allowing the Company to improve asset/liability matching and overall investment returns. These securities are generally either privately negotiated arrangements or issued under medium-term note programs and have standard documentation commensurate with credit ratings of the issuer, except when internal credit analysis indicates that additional protective and/or event-risk covenants were required. Many of these investments have protective covenants appropriate to the specific investment. These may include a prohibition of certain activities by the borrower, maintenance of certain financial measures, and specific conditions impacting the payment of the Company's notes.
Derivatives are designed to reduce risk on an economic basis while minimizing the impact on financial results. The Company’s derivatives programs vary depending on the type of risk being hedged. See Note 4 of the Notes to the Consolidated Financial Statements for:
Information about the notional amount and fair market value of the Company's derivatives.
The unrealized and realized gains and losses impact on adjusted earnings of derivatives in cash flow, fair value, net investments in foreign operations, or non-qualifying hedging relationships.
The Parent Company designates yen-denominated liabilities (notes payable and loans) as non-derivative hedging instruments and designates certain foreign currency forwards and options as derivative hedges of the Company’s net investment in Aflac Japan (see Enterprise Corporate Hedging Program below).
Aflac Japan buys U.S. dollar-denominated investments, typically corporate bonds, and hedges them back to yen with foreign currency forwards and options to hedge foreign currency exchange rate risk. This economically creates yen assets that match yen liabilities during the life of the derivative and provides capital relief. The currency risk being hedged is generally based on fair value of hedged investments. The following table summarizes the U.S. dollar-denominated investments held by Aflac Japan as of December 31.
Foreign exchange derivatives used for hedging are periodically settled, which results in cash receipt or payment at maturity or early termination. The Company had net cash outflows of $20 million in 2019, net cash inflows of $272 million in
The Company has designated certain yen-denominated liabilities and foreign currency forwards and options of the Parent Company as accounting hedges of its net investment in Aflac Japan. The Company's consolidated yen-denominated net asset position was partially hedged at $9.1 billion as of December 31, 2019, compared with $1.8 billion as of December 31, 2018.
The Company makes its accounting designation of net investment hedge at the beginning of each quarter. If the total of the designated Parent Company non-derivative and derivative notional is equal to or less than the Company's net investment in Aflac Japan, the hedge is deemed to be effective, and the currency exchange effect on the yen-denominated liabilities and the change in estimated fair value of the derivatives are reported in the unrealized foreign currency component of other comprehensive income. The Company's net investment hedge was effective during the years ended December 31, 2019 and 2018, respectively. For additional information on the Company's net investment hedging strategy, see Note 4 of the Notes to the Consolidated Financial Statements.
In order to economically mitigate risks associated with the enterprise-wide exposure to the yen and the level and volatility of hedge costs, the Parent Company enters into foreign exchange forward and option contracts. By buying U.S. dollars and selling yen, the Parent Company is effectively lowering its overall economic exposure to the yen, while Aflac Japan's U.S dollar exposure remains reduced as a result of Aflac Japan's U.S. dollar-denominated hedge program that economically creates yen assets. Among other objectives, this strategy is intended to offset the enterprise-wide amortized hedge costs by generating amortized hedge income. The portion of the enterprise-wide amortized hedge income contributed by this strategy was $89 million in 2019 and $36 million in 2018. This activity is reported in Corporate and Other. As this program evolves, the Company will continue to evaluate the program’s efficacy. See the Results of Operations section of this MD&A for the Company's definition of amortized hedge costs/income.
The following table presents policy liabilities by segment and in total for the years ended December 31.
The Japanese insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. Legislation enacted regarding the framework of the Life Insurance Policyholder Protection Corporation (LIPPC) included government fiscal measures supporting the LIPPC. In November 2016, Japan's Diet passed legislation that again extends the government's fiscal support of the LIPPC through March 2022. Effective April 2014, the annual LIPPC contribution amount for the total life industry was lowered from ¥40 billion to ¥33 billion. Aflac Japan recognized an expense of ¥1.9 billion and ¥2.0 billion for the years ended December 31, 2019 and 2018, respectively, for LIPPC assessments.
The decline in dividends during 2018 was driven by a change in the dividend regulatory approval process subsequent to the conversion of Aflac Japan from a branch to a subsidiary on April 1, 2018. The Company resumed dividend payments from Aflac Japan in the fourth quarter of 2018. Management fees decreased during 2019 and 2018, compared to prior years, due to changes in the administration of intercompany expenses between legal entities subsequent to the conversion, as well.
Prior to the Aflac Japan branch conversion, Aflac Japan paid allocated expenses and profit remittances to Aflac U.S. The following table details Aflac Japan remittances for the years ended December 31.
In addition to cash and equivalents, the Company also maintains credit facilities, both intercompany and with external partners, and a number of other available tools to support liquidity needs on a global basis. In September 2018, the Parent Company filed a shelf registration statement with the SEC that allows the Company to issue an indefinite amount of debt securities, in one or more series, from time to time until September 2021. In August 2018, the Parent Company filed a shelf registration with Japanese regulatory authorities that allows the Parent Company to conduct public offerings of bonds in Japan, including yen-denominated Samurai notes, up to ¥200 billion or its equivalent through August 2020. The shelf registration statement is for possible public offerings in Japan, but the bonds issued under the shelf may be transferred by the bondholders to U.S. persons in compliance with U.S. law. The Company believes outside sources for additional debt and equity capital, if needed, will continue to be available. Additionally, as of December 31, 2019, the Parent Company and Aflac had four lines of credit with third parties and three intercompany lines of credit. For additional information, see Note 9 of the Notes to the Consolidated Financial Statements.
The primary uses of cash by the Parent Company are shareholder dividends, the repurchase of its common stock and interest on its outstanding indebtedness and operating expenses.
(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 the Company's experience, consider future premium receipts on current policies in force, and assume market growth and interest crediting consistent with assumptions used in amortizing deferred acquisition costs. These cash outflows are undiscounted with respect to interest and, as a result, the sum of the cash outflows shown for all years in the table of $244,884 exceeds the corresponding liability amount of $90,335. The Company has 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.
including securities lending transactions. See Notes 1, 3, and 4 of the Notes to the Consolidated Financial Statements for more information on the Company's securities lending and derivative activities. With the exception of disclosed activities in those referenced footnotes and the Risk Factors entitled, "The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate" and "Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity," the Company is not aware of a trend, demand, commitment, event or uncertainty that would likely result in its liquidity increasing or decreasing by a material amount.
The Company expects its future cash flows from premiums and its investment portfolio to be sufficient to meet its cash needs for benefits and expenses. Consolidated cash flow from operations decreased 9.3% in 2019, compared with 2018.
The Company's investment objectives provide for liquidity primarily through the purchase of publicly traded investment-grade debt securities. Prudent portfolio management dictates that the Company attempts to match the duration of its assets with the duration of its liabilities. Currently, when the Company's fixed maturity securities mature, the proceeds may be reinvested at a yield below that required for the accretion of policy benefit liabilities on policies issued in earlier years. However, the long-term nature of the Company's business and its strong cash flows provide the Company with the ability to minimize the effect of mismatched durations and/or yields identified by various asset adequacy analyses. From time to time or when market opportunities arise, the Company disposes of selected fixed maturity securities that are available for sale to improve the duration matching of assets and liabilities, improve future investment yields, and/or re-balance its portfolio. As a result, dispositions before maturity can vary significantly from year to year.
As part of an arrangement with Federal Home Loan Bank of Atlanta (FHLB), Aflac U.S. obtains low-cost funding from FHLB supported by acceptable forms of collateral pledged by Aflac U.S. Aflac U.S. borrowed and repaid $217 million under this program during 2019. As of December 31, 2019, Aflac U.S. had outstanding borrowings of $403 million reported in its balance sheet.
In September 2019, the Parent Company renewed a ¥30.0 billion senior term loan facility. The first tranche of the facility, which totaled ¥5.0 billion, bears interest at a rate per annum equal to the Tokyo interbank market rate (TIBOR), or alternate TIBOR, if applicable, plus the applicable TIBOR margin and will mature in September 2026. The applicable margin ranges between .30% and .70%, depending on the Parent Company's debt ratings as of the date of determination. The second tranche, which totaled ¥25.0 billion, bears interest at a rate per annum equal to the TIBOR, or alternate TIBOR, if applicable, plus the applicable TIBOR margin and will mature in September 2029. The applicable margin ranges between .45% and 1.00%, depending on the Parent Company's debt ratings as of the date of determination.
In November 2018, the Parent Company used the net proceeds from the October 2018 issuance of its senior notes to redeem $550 million of the Parent Company's 2.40% senior notes due in 2020.
The Company was in compliance with all of the covenants of its notes payable and lines of credit at December 31, 2019.
Under share repurchase authorizations from the Company's board of directors, the Company purchased 32.0 million shares of its common stock in 2019, compared with 28.9 million shares in 2018. As of December 31, 2019, a remaining balance of 37.1 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors. The Company currently plans to repurchase $1.3 billion to $1.7 billion of its common stock in 2020, assuming stable capital conditions and absent compelling alternatives. See Note 11 of the Notes to the Consolidated Financial Statements for additional information.
In January 2020, the board of directors announced a 3.7% increase in the quarterly cash dividend, effective with the first quarter of 2020. The first quarter 2020 cash dividend of $.28 per share is payable on March 2, 2020, to shareholders of record at the close of business on February 19, 2020.
Aflac's company action level RBC ratio was 539% as of December 31, 2019, compared with 560% at December 31, 2018. Aflac’s RBC ratio remains high and reflects a strong capital and surplus position. As of December 31, 2019, Aflac's total adjusted capital of $2.2 billion exceeded the company action level required capital and surplus of $.4 billion by $1.8 billion. With the announcement of the Japan branch conversion to a subsidiary, we had announced our intention to remove excess capital out of Aflac, targeting a 500% RBC by the end of 2019. As of December 31, 2019, the Company has completed the RBC drawdown plan and has moved $1.75 billion of capital from Aflac to the Parent Company, supporting the Company's capital deployment and risk management activities.
The maximum amount of dividends that can be paid to the Parent Company by Aflac, CAIC and TOIC without prior approval of Nebraska's director of insurance is the greater of the net income from operations, which excludes net 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 2020 in excess of $864 million would be considered extraordinary and require such approval. Following the Japan branch conversion to a subsidiary, the Company used extraordinary dividends as needed to actively manage to appropriate RBC levels that are lower yet sufficient to maintain ratings and support prudent capital management. Similar laws apply in New York, the domiciliary jurisdiction of Aflac New York. 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 the Company's statutory capital and surplus.
Aflac is subject to the NAIC’s Own Risk and Solvency Assessment (ORSA). Through the ORSA requirements, Aflac is expected to regularly, no less than annually, conduct an ORSA to assess the adequacy of its risk management framework, and its current and estimated projected future solvency position; internally document the process and results of the assessment; and provide a confidential high-level ORSA Summary Report annually to the lead state commissioner if the insurer is a member of an insurance group. In November 2019, Aflac filed its ORSA report with the Nebraska Department of Insurance.
In addition to limitations and restrictions imposed by U.S. insurance regulators, after the Japan branch conversion on April 1, 2018, the new Japan subsidiary is required to meet certain financial criteria as governed by Japanese corporate law in order to provide dividends to the Parent Company. Under these criteria, dividend capacity at the Japan subsidiary is basically defined as total equity excluding common stock, accumulated other comprehensive income amounts, capital reserves (representing statutorily required amounts in Japan) but reduced for net after-tax unrealized losses on available-for-sale securities. These dividend capacity requirements are generally aligned with the SMR. Japan's FSA maintains its own solvency standard which is quantified through the SMR. Aflac Japan's SMR is sensitive to interest rate, credit spread, and foreign exchange rate changes, therefore the Company continues to evaluate alternatives for reducing this sensitivity. In the event of a rapid change in market risk conditions causing SMR to decline, the Company has one senior unsecured revolving credit facility in the amount of ¥100 billion and a committed reinsurance facility in the amount of approximately ¥110 billion as a capital contingency plan. Additionally, the Company could take action to enter into derivatives on unhedged U.S. dollar-denominated investments with foreign currency options or forwards. See Notes 8 and 9 of the Notes to the Consolidated Financial Statements for additional information.
Aflac's SMR ratio remains high and reflects a strong capital and surplus position. As of December 31, 2019, Aflac Japan's SMR was 1,043%, compared with 965% at December 31, 2018. As part of the conversion of Aflac Japan from a branch to a subsidiary on April 1, 2018, the Company experienced an accounting-driven decline in the SMR of approximately 130 points, compared with the SMR as of December 31, 2017. The Company expects to be able to pay dividends out of certain accounts, thus restoring this accounting impact over an estimated three-year period.
The Company’s Board of Directors has adopted an information security policy directing management to establish and operate a global information security program with the goals of monitoring existing and emerging threats and ensuring that the Company’s information assets and data, and the data of its customers, are appropriately protected from loss or theft. The Board has delegated oversight of the Company’s information security program to the Audit and Risk Committee. The Company’s senior officers, including its Global Security and Chief Information Security Officer, are responsible for the operation of the global information security program and regularly communicate with the Audit and Risk Committee on the program, including with respect to the state of the program, compliance with applicable regulations, current and evolving threats, and recommendations for changes in the information security program. The global information security program also includes a cybersecurity incident response plan that is designed to provide a management framework across Company functions for a coordinated assessment and response to potential security incidents. This framework establishes a protocol to report certain incidents to the Global Security and Chief Information Security Officer and other senior officers, with the goal of timely assessing such incidents, determining applicable disclosure requirements and communicating with the Audit and Risk Committee. The incident response plan directs the executive officers to report certain incidents immediately and directly to the Lead Non-Management Director.
The Company estimates the fair values of its securities on a monthly basis. The Company monitors the estimated fair values obtained from its pricing vendors and brokers for consistency from month to month, while considering current market conditions. The Company also periodically discusses with its pricing brokers and vendors the pricing techniques they use to monitor the consistency of their approach and periodically assess the appropriateness of the valuation level assigned to the values obtained from them. If a fair value appears unreasonable, the Company will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, the Company may compare the inputs to relevant market indices and other performance measurements. Based on management's analysis, the valuation is confirmed or may be revised if there is evidence of a more appropriate estimate of fair value based on available market data. The Company has performed verification of the inputs and calculations in any valuation models to confirm that the valuations represent reasonable estimates of fair value. Inputs used to value derivatives include, but are not limited to, interest rates, credit spreads, foreign currency forward and spot rates, and interest volatility.
The Company routinely reviews its investments that have experienced declines in fair value to determine if the decline is other than temporary. The identification of distressed investments, the determination of fair value if not publicly traded and the assessment of whether a decline is other than temporary involve significant management judgment. The Company must apply considerable judgment in determining the likelihood of the security recovering in value while the Company owns it. Factors that may influence this include the Company's 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.
Future policy benefits provide for claims that will occur in the future and are generally calculated as the present value of future expected benefits to be incurred less the present value of future expected net benefit premiums. The Company calculates future policy benefits based on assumptions of morbidity, mortality, persistency and interest. These assumptions are generally established at the time a policy is issued. The assumptions used in the calculations are closely related to those used in developing the gross premiums for a policy. As required by U.S. GAAP, the Company also includes a provision for adverse deviation, which is intended to accommodate adverse fluctuations in actual experience.
The Company's insurance products provide fixed-benefit amounts per occurrence that are not subject to medical-cost inflation. Furthermore, the Company's business is widely dispersed in both the U.S. and Japan. This geographic dispersion and the nature of the Company's benefit structure mitigate the risk of a significant unexpected increase in claims payments due to epidemics and events of a catastrophic nature. Claims incurred under Aflac's policies are generally reported and paid in a relatively short time frame. The unpaid claims liability is sensitive to morbidity assumptions, in particular, severity and frequency of claims. Severity is the ultimate size of a claim, and frequency is the number of claims incurred. The Company's claims experience is primarily related to the demographics of its policyholders.
In computing the estimate of unpaid policy claims, the Company considers many factors, including the benefits and amounts available under the policy; the volume and demographics of the policies exposed to claims; and internal business practices, such as incurred date assignment and current claim administrative practices. The Company monitors these conditions closely and make adjustments to the liability as actual experience emerges. Claim levels are generally stable from period to period; however, fluctuations in claim levels may occur. In calculating the unpaid policy claim liability, the Company
does not calculate a range of estimates. The following table shows the expected sensitivity of the unpaid policy claims liability as of December 31, 2019, to changes in severity and frequency of claims.
Other policy liabilities, which accounted for 11% of total policy liabilities as of December 31, 2019, consisted primarily of annuity and unearned premium reserves, and discounted advance premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period. Advanced premiums represented 24% and 29% of the December 31, 2019 and 2018 other policy liabilities balances, respectively. See the Aflac Japan segment subsection of this MD&A for further information.
In August 2018, the FASB issued ASU 2018-12, “Financial Services - Insurance, Targeted Improvements to the Accounting for Long-Duration Contracts.” The update, which is expected to significantly change how insurers account for long-duration contracts, amends existing recognition, measurement, presentation, and disclosure requirements applicable to the Company. Issues addressed in the new guidance include: 1) a requirement to review and, if there is a change, update cash flow assumptions for the liability for future policy benefits at least annually, and to update the discount rate assumption quarterly, 2) accounting for market risk benefits at fair value, 3) simplified amortization for deferred acquisition costs, and 4) enhanced financial statement presentation and disclosures. In November 2019, the FASB issued ASU 2019-09, “Financial Services - Insurance (Topic 944): Effective Date”, which defers the effective date of ASU 2018-12 for all entities. The amendments are effective for public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC,for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021. Early application of the amendments is permitted, however, the Company does not expect to early adopt the updated standard.
Under the modified retrospective method, the opening reserve balance at the transition date, January 1, 2020, would generally be the same as the closing balance before transition; however, it would be updated for changes in the discount rate required under the new guidance.
Regardless of the transition method selected, the new guidance requires that discount rates used for discounting of insurance liabilities be initially adjusted on the adoption date and subsequently at each reporting period to the market levels for the upper-medium-grade (low credit risk) fixed income instrument yields (single-A in the currency of the underlying insurance contract) reflecting the duration of the company’s insurance liabilities. Long duration of the Company’s third-sector insurance liabilities in Japan coupled with limited-to-no-liquidity of the Japanese long-dated fixed-income market creates challenges in application of the market-based discount rate guidance and will require the Company to apply significant judgments in designing discount rate methodologies for its Japanese third-sector liabilities. The update of the discount rate would be recognized in AOCI under both transition methods.
Under the full retrospective method, the Company would restate all historical periods based upon actual historical experience as of contract inception and its updated view of the contractual cash flow projections at transition. A cumulative catch-up adjustment to opening retained earnings would be recognized to reflect the actual experience and updated projections. Companies are permitted to apply a full retrospective transition approach if actual historical information is available for all contracts that will be affected by the new guidance.
The Company expects that under either transition method, the impact to its reported financial statements under U.S. GAAP will be greatly influenced by the nature of the Company’s business model. Adoption of the new guidance will reflect the Company’s concentration in Japan third-sector business, in particular cancer insurance, with respect to which the duration of liabilities is materially longer than asset durations, while Japan’s aggregate block of business continues to see favorable experience from mortality, morbidity, and expenses. Under the modified retrospective method, the impact of a low discount rate applied to long-duration third sector liabilities is recognized at adoption, while associated favorable morbidity margins are recognized over time thus driving a pronounced timing impact to U.S. GAAP equity. In addition, with respect to the Japan segment, the Company maintains a large portfolio of assets designated as held-to-maturity (HTM) as a strategy to reduce capital (solvency margin ratio or SMR) volatility. In a low interest rate environment, such as presently exists in Japan, assets designated as HTM that were purchased in a higher interest rate environment have significant embedded gains not reflected in AOCI (HTM securities are carried at amortized cost under U.S. GAAP), which serves as an economic offset to a low discount rate applied to policy liabilities. At December 31, 2019, the Company’s HTM portfolio was $30.1 billion at amortized cost and had $7.5 billion in net unrealized gains. Pursuant to the implementation of ASU 2019-04, ”Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial
Instruments” (see Note 1 for additional details of this ASU), effective on January 1, 2020, the Company anticipates the reclassification of approximately $6.9 billion (at amortized cost) of pre-payable fixed maturity securities from the HTM to the available-for-sale (AFS) category. This reclassification is expected to result in recording in AOCI a net unrealized gain of approximately $800 million on an after-tax basis based on the securities’ fair values on the reclassification date. After adoption of ASU 2018-12, the Company also expects net earnings and net earnings per share (which were $3.3 billion and $4.43 per diluted share, respectively, in 2019) to reflect larger quarterly fluctuations due to the new requirement to update assumptions for liability for future policy benefits.
As an example of the potential impact of the new guidance, and for illustrative purposes only, under the modified retrospective method and in a low interest rate environment, the Company would expect AOCI (which was $6.6 billion at December 31, 2019) to significantly decline upon adoption and to thereafter reflect larger quarterly fluctuations due to the new requirement to quarterly adjust discount rates. Conversely, in a higher interest rate environment, and assuming adoption of the modified retrospective method, the Company would expect AOCI to decline less or even increase (depending on the specifics of the interest rate environment), as well as to reflect quarterly fluctuations. Under the full retrospective method, the Company would expect lesser declines or increases in total equity upon adoption compared to the modified retrospective method due to the potential offsetting effect from updating experience and cash flow projections.
KPMG LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of internal control over financial reporting as of December 31, 2019, which is included herein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, 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, 2019, and the related notes and financial statement schedules II, III, and IV (collectively, the consolidated financial statements), and our report dated February 21, 2020 expressed an unqualified opinion on those consolidated financial statements.
We have audited the accompanying consolidated balance sheets of Aflac Incorporated and subsidiaries (the Company) as of December 31, 2019 and 2018, 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, 2019, and the related notes and financial statement schedules II, III, and IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 5 to the consolidated financial statements, the Company has certain privately issued securities and derivative instruments associated with variable interest entities (VIEs) that require significant judgment in the estimation of fair value. The fair value of privately issued securities are estimated using valuation models developed by a third party pricing vendor and require judgment to determine the inputs and assumptions used in the valuation models, such as credit default swap (CDS) spreads and the selection of comparable securities, when appropriate. The fair value of the Company’s derivatives associated with VIEs are also estimated using valuation models developed by a third party pricing vendor. Given the long duration of derivatives associated with VIEs, the estimate of the fair value requires judgment to extrapolate short-term observable data into long-term inputs for use in the valuation models. As of December 31, 2019, the value of privately issued securities are included within the financial statement captions of fixed maturity securities available for sale, at fair value; fixed maturity securities available for sale - consolidated variable interest entities, at fair value; and, fixed maturity securities held to maturity, at amortized cost, which totaled $86,950 million, $4,312 million, and $30,085 million, respectively. As of December 31, 2019, the fair value of derivatives associated with VIEs are included within the financial statement captions of other assets and other liabilities, which totaled $2,368 million and $3,440 million, respectively.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls, with the involvement of valuation professionals when appropriate, over the Company’s process to estimate the fair value of such securities and derivative instruments, including controls over the Company’s evaluation of the inputs, assumptions and estimates of fair value obtained from its third party pricing vendor. We involved valuation professionals with specialized skills and knowledge to assist in assessing the estimated fair values of such securities and derivative instruments, which included:
Assessing the internal models used by the Company to evaluate the fair values for privately issued securities and derivatives associated with VIEs obtained from the third party pricing vendor. We observed that differences, if any, in fair value between the Company and the third party pricing vendor above pre-established tolerances were investigated by the Company.
Developing an independent estimate of the fair value for a selection of privately issued securities and derivative instruments associated with VIEs and comparing our independent estimate to the fair value measurement recorded by the Company.
The primary procedures we performed to address this critical audit matter included the following. We tested, with the involvement of actuarial professionals when appropriate, certain internal controls over the Company’s process to estimate the unpaid policy claims liability, including controls related to the evaluation of the actuarial methodologies and assumptions used in the calculation of the unpaid policy claims liability. We involved actuarial professionals with specialized skills and knowledge to assist in assessing the unpaid policy claims liability, which included:
Evaluating the Company’s estimate of the unpaid policy claims liability by comparing to historical results and our expectations of changes in the estimate.
Developing an independent range for the estimate of unpaid policy claims for certain products to evaluate the Company’s recorded liability and assessing any movement of the recorded liability within our range.
Evaluating the Company’s historical ability to estimate unpaid policy claims by comparing the unpaid policy claims liability for certain products recorded by the Company at various historical periods to an independent range developed using claims paid through December 31, 2019.
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States (U.S.) and Japan. The Company's insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac) in the U.S. and, effective April 1, 2018, through Aflac Life Insurance Japan Ltd. (ALIJ) in Japan. Prior to April 1, 2018, the Company's insurance business was marketed in Japan as a branch of Aflac. The Company’s operations consist of two reportable business segments: Aflac U.S., which includes Aflac, and Aflac Japan, which includes ALIJ. American Family Life Assurance Company of New York (Aflac New York) is a wholly owned subsidiary of Aflac. Most of Aflac's policies are individually underwritten and marketed through independent agents. Additionally, Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC), branded as Aflac Group Insurance. The Company's insurance operations in the U.S. and Japan service the two markets for the Company's insurance business. Aflac Japan's revenues, including realized gains and losses on its investment portfolio, accounted for 69% of the Company's total revenues in 2019, compared with 70% in both 2018 and 2017. The percentage of the Company's total assets attributable to Aflac Japan was 83% at December 31, 2019, compared with 84% at December 31, 2018.
derivatives are recorded as unrealized foreign currency translation gains (losses) in other comprehensive income and are included in accumulated other comprehensive income.
Cash and Cash Equivalents: Cash and cash equivalents include cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased.
The Company has investments in variable interest entities (VIEs). Criteria for evaluating VIEs for consolidation focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. The Company is the primary beneficiary of certain VIEs, and therefore consolidates these entities in its financial statements. While the consolidated VIEs generally operate within a defined set of contractual terms, there are certain powers
For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. In cash flow hedges, all components of each derivative's gain or loss are included in the assessment of hedge effectiveness.
As discussed in Note 4, from time to time the Company designates net investment hedges of its net investment in Aflac Japan. The Company makes its net investment hedge designation at the beginning of each quarter. For derivative hedging instruments designated as net investment hedges, Aflac follows the spot-rate method. According to that method, the change in fair value of the hedging instrument due to fluctuations in the spot exchange rate is recorded in the unrealized foreign currency component of other comprehensive income and reclassified to earnings only when the hedged net investment is sold, or when a liquidation of the respective net investment in the foreign entity is substantially completed. If and when a sale or liquidation occurs, the changes in fair value of the derivative deferred in the unrealized foreign currency component of other comprehensive income will be released in the same income statement line item where the gain (loss) on the hedged net investment would be recorded upon sale. All other changes in fair value of the hedging instrument are considered the “excluded component” and are accounted for in realized investment gains (losses). Should these designated net investment hedge positions exceed the Company's net investment in Aflac Japan, the foreign exchange effect on the portion that exceeds its investment in Aflac Japan would be recognized in current earnings within realized investment gains (losses).
For internal replacement transactions where the resulting contract is substantially unchanged, the policy is accounted for as a continuation of the replaced contract. Unamortized deferred acquisition costs from the original policy continue to be amortized over the expected life of the new policy, and the costs of replacing the policy are accounted for as policy maintenance
costs and expensed as incurred. Examples include conversions of same age bands, certain family coverage changes, pricing era changes (decrease), and ordinary life becomes reduced paid-up and certain reinstatements.
Unpaid policy claims are estimates computed primarily on an undiscounted basis using statistical analyses of historical claims experience adjusted for current trends and changed conditions. The ultimate liability may vary significantly from such estimates. The Company regularly adjusts these estimates as new claims experience emerges and reflects the changes in operating results in the year such adjustments are made.
In the U.S., each state has a guaranty association that supports insolvent insurers operating in those states. The Company's policy is to accrue assessments when the entity for which the insolvency relates has met its state of domicile's statutory definition of insolvency, the amount of the loss is reasonably estimable and the related premium upon which the assessment is based is written. See Note 15 of the Notes to the Consolidated Financial Statements for further discussion of the guaranty fund assessments charged to the Company.
In October 2018, the FASB issued amendments to permit use of the Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the Treasury obligations of the U.S. government (UST), the London Interbank Offered Rate (LIBOR) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate.
Income Statement - Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
In March 2017, the FASB issued amendments requiring that an employer report the service cost component of net periodic pension cost and net periodic postretirement benefit cost in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net periodic pension cost and net periodic postretirement benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable.
In October 2016, the FASB issued amendments which clarify the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE.
The Company recorded a cumulative effect adjustment with an increase to beginning 2018 retained earnings and a decrease to beginning 2018 AOCI of $148 million, net of taxes.
Clarifying the interactions between Topic 321, Topic 323, and Topic 815
The most significant of these improvements to the Company was related to the Codification improvement to ASU 2017-12 and the clarification that a one-time reclassification of assets that are eligible to be hedged under the last-of-layer method (i.e., certain pre-payable securities) from held-to-maturity to available-for-sale is allowed under the new hedge accounting guidance and would not impact the Company’s ability to continue to classify other bonds as held-to-maturity. This clarification is effective for the Company beginning January 1, 2020, with early adoption permitted. If a reclassification is elected, it must be reflected as of the date of adoption of this update.
The Company is thoroughly evaluating the impact of adoption and expects that the adoption will have a significant impact on the Company’s financial position, results of operations, and disclosures. The Company anticipates that the requirement to update assumptions for liability for future policy benefits will have a significant impact on its results of operations, systems, processes and controls while the requirement to update the discount rate will have a significant impact on its equity. The Company has no products with market risk benefits. The Company does not expect to early adopt the updated standard and has tentatively selected a modified retrospective transition method.
ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments- Credit Losses
In April 2019, the Credit Losses ASU was amended to allow entities to make a policy election about presentation and disclosure of accrued interest receivable and the related credit losses, whereby entities that write off uncollectible accrued interest receivable in a timely manner can make a policy election not to measure an allowance on the accrued interest receivable. Other amendments made within this Update clarify and address stakeholders’ specific issues about certain aspects of the Credit Losses ASU.
The Company has identified the following financial instruments in scope of the new guidance: certain fixed maturity securities, loans and loan receivables, reinsurance recoverable, as well as certain other receivable balances and off-balance sheet arrangements.
The Company has substantially completed the review and validation of credit models, methodologies and inputs for all asset classes. The Company performed parallel runs during the second, third and fourth quarters and refined its estimation process with additional parallel testing throughout 2019. The Company has estimated the adoption-date net after-tax impact at a $56 million decrease to retained earnings. As noted above relative to ASU 2019-04, the Company is planning a one-time reclassification as of January 1, 2020 of approximately $6.9 billion (amortized cost as of December 31, 2019) of its eligible fixed-maturity securities from held-to-maturity to available-for-sale category. The aforementioned reclassification has been reflected in the expected impact estimate from adoption of ASU 2016-13. The Company plans to adopt this ASU on January 1, 2020.
The Company does not allocate corporate overhead expenses to business segments. Consistent with U.S. GAAP accounting guidance for segment reporting, the Company evaluates and manages its business segments using a financial performance measure called pretax adjusted earnings. Adjusted earnings are adjusted revenues less benefits and adjusted expenses. The adjustments to both revenues and expenses account for certain items that cannot be predicted or that are outside management’s control. Adjusted revenues are U.S. GAAP total revenues excluding realized investment gains and losses, except for amortized hedge costs/income related to foreign currency exposure management strategies and net interest cash flows from derivatives associated with certain investment strategies. Adjusted expenses are U.S. GAAP total acquisition and operating expenses including the impact of interest cash flows from derivatives associated with notes payable but excluding any nonrecurring or other items not associated with the normal course of the Company’s insurance operations and that do not reflect Aflac’s underlying business performance. The Company excludes income taxes related to operations to arrive at pretax adjusted earnings. Information regarding operations by reportable segment and Corporate and other for the years ended December 31 follows:
(1) Amortized hedge costs of $257, $236 and $228 in 2019, 2018 and 2017, respectively, related to certain foreign currency exposure management strategies have been reclassified from realized investment gains (losses) and reported as a deduction from net investment income when analyzing operations.
(4) A gain of $66 in 2019, $67 in 2018 and $77 in 2017, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable have been reclassified from realized investment gains (losses) and included in adjusted earnings when analyzing operations.
(5) Includes $135, $122 and $122 of interest expense on debt in 2019, 2018 and 2017
Receivables: Receivables consist primarily of monthly insurance premiums due from individual policyholders or their employers for payroll deduction of premiums, net of an allowance for doubtful accounts. At December 31, 2019, $258 million, or 31.2% of total receivables, were related to Aflac Japan's operations, compared with $334 million, or 39.2%, at December 31, 2018.
During 2019 and 2018, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category. During 2017, the Company reclassified three investments from the held-to-maturity category to the available-for-sale category as a result of the issuers' credit rating being downgraded to below investment grade. At the time of the transfer, the securities had an aggregate amortized cost of $773 million and an aggregate unrealized gain of $47 million.
The contractual and economic maturities of the Company's investments in fixed maturity securities at December 31, 2019, were as follows:
The unrealized holding gains, net of losses, recorded as a component of realized investment gains and losses for the year ended December 31, 2019, that relates to equity securities still held at the December 31, 2019, reporting date was $64 million.
The net effect on shareholders' equity of unrealized gains and losses from fixed maturity securities at December 31 was as follows:
For any significant declines in fair value of its fixed maturity securities, the Company performs a more focused review of the related issuers' credit profile. For corporate issuers, the Company evaluates their assets, business profile including industry dynamics and competitive positioning, financial statements and other available financial data. For non-corporate issuers, the Company analyzes all sources of credit support, including issuer-specific factors. The Company utilizes information available in the public domain and, for certain private placement issuers, from consultations with the issuers directly. The Company also considers ratings from Nationally Recognized Statistical Rating Organizations (NRSROs), as well as the specific characteristics of the security it owns including seniority in the issuer's capital structure, covenant protections, or other relevant features. From these reviews, the Company evaluates the issuers' continued ability to service the Company's investment through payment of interest and principal.
Transitional real estate loans are commercial mortgage loans that are typically relatively short-term floating rate instruments secured by a first lien on the property.These loans provide funding for properties undergoing a change in their physical characteristics and/or economic profile and do not typically require any principal repayment prior to the maturity date. This loan portfolio is generally considered to be investment grade. As of December 31, 2019, the Company had $875 million in outstanding commitments to fund transitional real estate loans. These commitments are contingent on the final underwriting and due diligence to be performed.
Commercial mortgage loans are typically fixed rate loans on commercial real estate with partial repayment of principal over the life of the loan with the remaining outstanding principal being repaid upon maturity. This loan portfolio is generally considered higher quality investment grade loans. As of December 31, 2019, the Company had $27 million of outstanding commitments to fund commercial mortgage loans. These commitments are contingent on the final underwriting and due diligence to be performed.
As of December 31, 2019, the Company had commitments of approximately $502 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 the Company's underwriting criteria.
The key credit quality indicators used by the Company in establishing the general and specific loan loss reserves, as well as in determining whether or not a loan should be impaired, include loan-to-value and debt service coverage ratios for CMLs and TREs and ratings for its middle market loan portfolio. Given that transitional real estate loans involve properties undergoing renovation or construction, loan-to-value provides the most insight on the credit risk of the property. Middle market loans generally have below-investment-grade ratings. The performance of the loans are monitored and reviewed periodically, but not less than quarterly.
which the Company holds debt obligations, the weighted-average lives of the Company's notes are very similar to the underlying collateral held by these VIEs where applicable.
The Company's risk of loss related to its interests in any of its VIEs is limited to the carrying value of the related investments held in the VIE.
The table below reflects the amortized cost, fair value and balance sheet caption in which the Company's investment in VIEs not consolidated are reported as of December 31.
(1) The related loaned security, under the Company's Aflac U.S. securities lending program, can be returned to the Company at the transferee's discretion; therefore, they are classified as Overnight and Continuous.
foreign currency forwards and options used in hedging foreign exchange risk on U.S. dollar-denominated investments in Aflac Japan's portfolio
foreign currency forwards and options used to economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long term exposure to a weakening yen
foreign currency swaps and, in prior periods, credit default swaps that are associated with investments in special-purpose entities, including VIEs where the Company is the primary beneficiary
interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments
Some of the Company's derivatives are designated as cash flow hedges, fair value hedges or net investment hedges; however, other derivatives do not qualify for hedge accounting or the Company elects not to designate them as accounting hedges.
The Company enters into foreign currency swaps pursuant to which it exchanges an initial principal amount in one currency for an initial principal amount of another currency, with an agreement to re-exchange the principal amounts at a future date. There may also be periodic exchanges of payments at specified intervals based on the agreed upon rates and notional amounts. Foreign currency swaps are used primarily in the consolidated VIEs in the Company's Aflac Japan portfolio to convert foreign-denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations. The Company also uses foreign currency swaps to economically convert certain of its U.S. dollar-denominated senior note and subordinated debenture principal and interest obligations into yen-denominated obligations.
The table below summarizes the balance sheet classification of the Company's derivative fair value amounts, as well as the gross asset and liability fair value amounts, at December 31. The fair value amounts presented do not include income accruals. Derivative assets are included in “Other Assets,” while derivative liabilities are included in “Other Liabilities” within the Company’s Consolidated Balance Sheets. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and are not reflective of exposure or credit risk.
(1) Gains (losses) excluded from effectiveness testing includes the forward point on foreign currency forwards and time value change on foreign currency options which are reported in the consolidated statement of earnings as realized investment gains (losses). It also includes the change in the fair value of the interest rate swaptions related to the time value of the swaptions which is recognized as a component of other comprehensive income (loss).
The following table shows the carrying amounts of assets designated and qualifying as hedged items in fair value hedges of interest rate risk and the related cumulative hedge adjustment included in the carrying amount as of December 31.
(1) The balance includes hedging adjustment on discontinued hedging relationships of $256 in 2019 and $294 in 2018.
The total notional amount of the Company's interest rate swaptions was $243 in 2019 and $500 in 2018. The hedging adjustment related to these derivatives was immaterial.
The Company's net investment hedge was effective during the years ended December 31, 2019, 2018 and 2017.
(1) Cash flow hedge items and the change in the fair value of interest rate swaptions related to the time value of the swaptions in fair value hedges are recorded as unrealized gains (losses) on derivatives and net investment hedge items are recorded in the unrealized foreign currency translation gains (losses) line in the consolidated statement of comprehensive income (loss).
The Company is a direct counterparty to the foreign currency swaps that it has entered into in connection with certain of its senior notes and subordinated debentures; foreign currency forwards; and foreign currency options, and therefore the Company is exposed to credit risk in the event of nonperformance by the counterparties in those contracts. The risk of counterparty default for the Company's foreign currency swaps, certain foreign currency forwards, and foreign currency options is mitigated by collateral posting requirements that counterparties to those transactions must meet.
As of December 31, 2019, all of the Company's derivative agreement counterparties were investment grade.
Collateral posted by the Company to third parties for derivative transactions 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 $301 million and $139 million as of December 31, 2019 and 2018, respectively. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2019, the Company estimates that it would be required to post a maximum of $46 million of additional collateral to these derivative counterparties. The Company is generally allowed to sell or repledge collateral obtained from its derivative counterparties, although it does not typically exercise such rights. (See the Offsetting tables below for collateral posted or received as of the reported balance sheet dates.)
For additional information on the Company's financial instruments, see the accompanying Notes 1, 3 and 5.
(1) Excludes policy loans of $232 and equity method investments of $377, at carrying value
A third party pricing vendor has developed valuation models to determine fair values of privately issued securities to reflect the impact of the persistent economic environment and the changing regulatory framework. These models are discounted cash flow (DCF) valuation models, but also use information from related markets, specifically the CDS market to estimate expected cash flows. These models take into consideration any unique characteristics of the securities and make various adjustments to arrive at an appropriate issuer-specific loss adjusted credit curve. This credit curve is then used with the relevant recovery rates to estimate expected cash flows and modeling of additional features, including illiquidity adjustments, if necessary, to price the security by discounting those loss adjusted cash flows. In cases where a credit curve cannot be developed from the specific security features, the valuation methodology takes into consideration other market observable inputs, including:
The pricing data and market quotes the Company obtains from outside sources, including third party pricing services, are reviewed internally for reasonableness. If a fair value appears unreasonable, the Company will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, the Company may compare the inputs to
relevant market indices and other performance measurements. Based on management's analysis, the valuation is confirmed or may be revised if there is evidence of a more appropriate estimate of fair value based on available market data. The Company has performed verification of the inputs and calculations in any valuation models to confirm that the valuations represent reasonable estimates of fair value.
To determine the fair value of its interest rate derivatives, the Company uses inputs that are generally observable in the market or can be derived from observable market data. Interest rate swaps are cleared trades. In a cleared swap contract the clearinghouse provides benefits to the counterparties similar to contracts listed for investment traded on an exchange since it maintains a daily margin to mitigate counterparties credit risk. These derivatives are priced using observable inputs, accordingly, they are classified as Level 2. For its interest rate swaptions, the Company estimates their fair values using observable market data, including interest rate curves and volatilities. Their fair values are also classified as Level 2.
For derivatives associated with VIEs where the Company is the primary beneficiary, the Company is not the direct counterparty to the swap contracts. As a result, the fair value measurements incorporate the credit risk of the collateral associated with the VIE. The Company receives valuations from a third party pricing vendor for these derivatives. Based on
an analysis of these derivatives and a review of the methodology employed by the pricing vendor, the Company determined that due to the long duration of these swaps and the need to extrapolate from short-term observable data to derive and measure long-term inputs, certain inputs, assumptions and judgments are required to value future cash flows that cannot be corroborated by current inputs or current observable market data. As a result, the derivatives associated with the Company's consolidated VIEs are classified as Level 3 of the fair value hierarchy.
(b) Inputs derived from U.S. long-term rates to accommodate long maturity nature of the Company's swaps
The significant drivers of the valuation of the foreign exchange swaps are interest rates and CDS spreads. Some of the Company's swaps have long maturities that increase the sensitivity of the swaps to interest rate fluctuations. For the Company's foreign exchange or cross currency swaps that are in a net asset position, an increase in yen interest rates (all other factors held constant) will decrease the present value of the yen final settlement receivable (receive leg), thus decreasing the value of the swap as long as the derivative remains in a net asset position.
Consolidated policy acquisition costs deferred were $1.5 billion in 2019, 2018 and 2017. 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 2019, compared with 72% in both 2018 and 2017.
Personnel, compensation and benefit expenses as a percentage of insurance expenses were 57% in 2019, compared with 54% in 2018 and 56% in 2017. 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 85%, 4%, 4% and 7% of total policy liabilities at December 31, 2019, respectively. The Company regularly reviews the adequacy of its policy liabilities in total and by component.
The weighted-average interest rates reflected in the consolidated statements of earnings for future policy benefits for Japanese policies were 3.2% in 2019, compared with 3.3% in 2018 and 3.4% in 2017; and for U.S. policies, 5.3% in 2019, compared with 5.3% in 2018 and 5.4% in 2017.
As of December 31, 2019 and 2018, 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 64% of the December 31, 2019 and 69% of the December 31, 2018 unearned premiums balances.
The Company has recorded a deferred profit liability related to reinsurance transactions. The remaining deferred profit liability of $1.0 billion, as of December 31, 2019, is included in future policy benefits in the consolidated balance sheet and is being amortized into income over the expected lives of the policies. The Company has also recorded a reinsurance recoverable for reinsurance transactions, which is included in other assets in the consolidated balance sheet and had a remaining balance of $970 million and $941 million as of December 31, 2019 and 2018, respectively. The increase in the reinsurance recoverable balance was driven by two aggregating factors: yen strengthening and the growth in reserves related to the business that has been reinsured as the policies age. The spot yen/dollar exchange rate strengthened by approximately 1.3% and ceded reserves increased approximately 1.4% from December 31, 2018, to December 31, 2019.
In December 2019, the Parent Company issued four series of senior notes totaling ¥38.0 billion through a public debt offering under its U.S. shelf registration statement. The first series, which totaled ¥12.6 billion, bears interest at a fixed rate of .500% per annum, payable semi-annually, and will mature in December 2029. The second series, which totaled ¥9.3 billion, bears interest at a fixed rate of .843% per annum, payable semi-annually, and will mature in December 2031. The third series, which totaled ¥9.8 billion, bears interest at a fixed rate of .934% per annum, payable semi-annually, and will mature in December 2034. The fourth series, which totaled ¥6.3 billion, bears interest at a fixed rate of 1.122% per annum, payable semi-annually, and will mature in December 2039. These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affecting U.S. taxation, as specified in the indenture governing the terms of the issuance.
In September 2019, the Parent Company renewed a ¥30.0 billion senior term loan facility. The first tranche of the facility, which totaled ¥5.0 billion, bears interest at a rate per annum equal to the Tokyo interbank market rate (TIBOR), or alternate TIBOR, if applicable, plus the applicable TIBOR margin and will mature in September 2026. The applicable margin ranges between .30% and .70%, depending on the Parent Company's debt ratings as of the date of determination. The second tranche, which totaled ¥25.0 billion, bears interest at a rate per annum equal to the TIBOR, or alternate TIBOR, if applicable,
In January 2017, the Parent Company issued ¥60.0 billion of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of .932% per annum, payable semi-annually, and will mature in January 2027. These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affecting U.S. taxation, as specified in the indenture governing the terms of the issuance.
In November 2014, the Parent Company issued $750 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 3.625% per annum, payable semi-annually, and will mature in November 2024. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the treasury rate plus 20 basis points, plus in each case, accrued and unpaid interest on the principal
In February 2012, the Parent Company issued $350 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 4.00% per annum, payable semiannually, and will mature in February 2022. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the principal amount of the notes or (ii) the present value of the remaining scheduled payments of principal and interest to be redeemed, discounted to the redemption date, plus accrued and unpaid interest. The Parent Company entered into cross-currency interest rate swaps to reduce interest expense by converting the U.S. dollar-denominated principal and interest on the senior notes it issued into yen-denominated obligations. By entering into these swaps, the Parent Company economically converted its $350 million liability into a ¥27.0 billion liability and reduced the interest rate on this debt from 4.00% in dollars to 2.07% in yen.
In 2010 and 2009, the Parent Company issued senior notes through U.S. public debt offerings; the details of these notes are as follows. In August 2010, the Parent Company issued $450 million of senior notes that will mature in August 2040. In December 2009, the Parent Company issued $400 million of senior notes that will mature in December 2039. These senior notes pay interest semiannually and are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the principal amount of the notes or (ii) the present value of the remaining scheduled payments of principal and interest to be redeemed, discounted to the redemption date, plus accrued and unpaid interest. In December 2016, the Parent Company completed a tender offer in which it extinguished $176 million principal of its 6.90% senior notes due December 2039 and $193 million principal of its 6.45% senior notes due August 2040. The pretax loss due to the early redemption of these notes was $137 million.
Operating lease costs, included in insurance expenses in the consolidated statements of earnings, were $54 million, $73 million and $75 million for the years ended December 31, 2019, 2018 and 2017, respectively. Operating cash outflow for operating leases was $52 million for the year ended December 31, 2019.
In 2018, the Company recorded additional income tax expense of $.4 million resulting from a decrease in the SAB 118 provisional estimate related to Japan deferred tax balances. No further adjustment was made to the SAB 118 provisional estimate related to the valuation allowance. As of December 31, 2018, the Company has completed its accounting for the Tax Act in accordance with SAB 118.
allowance on the deferred foreign tax credit has increased due to the utilization of prior year credits as well as the recognition of the current year deferred foreign tax credit. Based upon a review of the Company's anticipated future taxable income, and including all other available evidence, both positive and negative, the Company's management has concluded that, notwithstanding the items noted above, it is more likely than not that all other deferred tax assets will be realized.
For the year ended December 31, 2018, see Note 1 for discussion of the amounts reclassified between AOCI and retained earnings upon the adoption of new accounting pronouncements.
As of December 31, 2019, the Company has outstanding share-based awards under the Aflac Incorporated Long-Term Incentive Plan (the Plan). Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations, and other factors.
restricted stock, and stock appreciation rights. As of December 31, 2019, approximately 39.3 million shares were available for future grants under this plan. The ISOs and NQSOs have a term of 10 years, and the share-based awards generally vest upon time-based conditions or time and performance-based conditions. Time-based vesting generally occurs after three years. Performance-based vesting conditions generally include the attainment of goals related to Company financial performance. As of December 31, 2019, the only performance-based awards issued and outstanding were restricted stock awards and units.
Stock options and stock appreciation rights granted under the amended Plan have an exercise price of at least the fair market value of the underlying stock on the grant date and have an expiration date no later than 10 years from the grant date. Time-based restricted stock awards, restricted stock units and stock options granted after January 1, 2017 generally vest on a ratable basis over three years, and awards granted prior to the amendment vest on a three-year cliff basis. The Compensation Committee of the Board of Directors has the discretion to determine vesting schedules.
The Company estimates the fair value of each stock option granted using the Black-Scholes-Merton multiple option approach. Expected volatility is based on historical periods generally commensurate with the estimated terms of the options. The Company uses historical data to estimate option exercise and termination patterns within the model. Separate groups of employees that have similar historical exercise patterns are stratified and considered separately for valuation purposes. The expected term of options granted is derived from the output of the Company's option model and represents the weighted-average period of time that options granted are expected to be outstanding. The Company bases the risk-free interest rate on the Treasury note rate with a term comparable to that of the estimated term of the options. There were no options granted in 2019. The weighted-average fair value of options at their grant date was $8.81 for 2018 compared with $7.64 in 2017. The following table presents the assumptions used in valuing options granted during the years ended December 31.
As of December 31, 2019, total compensation cost not yet recognized in the Company's financial statements related to restricted stock awards and restricted stock units was $60 million, of which $30 million (1.5 million shares) was related to restricted stock awards with a performance-based vesting condition. The Company expects 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.
Aflac reports statutory financial statements that are prepared on the basis of accounting practices prescribed or permitted by the Nebraska Department of Insurance (NDOI). The NDOI recognizes statutory accounting principles and practices prescribed or permitted by the state of Nebraska for determining and reporting the financial condition and results of operations of an insurance company, and for determining a company's solvency under Nebraska insurance law. Statutory Accounting Principles (SAP) as detailed by the National Association of Insurance Commissioners' (NAIC) Accounting Practices and Procedures Manual has been adopted by the state of Nebraska as a component of those prescribed or permitted practices. Additionally, the Director of the NDOI has the right to permit other specific practices which deviate from prescribed practices. Prior to the Japan branch conversion on April 1, 2018, Aflac had been given explicit permission by the Director of the NDOI for two such permitted practices. On April 1, 2018, the Company entered into a series of transactions in order to complete the conversion of the Japan branch into a Japanese insurance corporation. As a result of the conversion, the permitted practices were no longer necessary, therefore they were canceled by the NDOI effective April 2, 2018. Aflac had no permitted practices as of December 31, 2019 and 2018.
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 Aflac Japan, based on Japanese regulatory accounting practices, was $7.8 billion at December 31, 2019, compared with $6.4 billion at December 31, 2018. 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 maximum amount of dividends that can be paid to the Parent Company by Aflac and CAIC 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 2020 in excess of $864 million would require such approval. Aflac declared dividends of $1.3 billion during 2019.
After the Japan branch conversion as of April 1, 2018, Aflac Japan is required to meet certain financial criteria as governed by Japanese corporate law in order to provide dividends to the Parent Company. Under these criteria, dividend capacity at Aflac Japan is basically defined as retained earnings excluding capital reserves, which represent equity generated by capital profits that are statutorily required in Japan, less net after-tax unrealized losses on available-for-sale securities based on the previous fiscal year-end. Prior to April 1, 2018, a portion of Aflac Japan earnings, as determined on a Japanese regulatory accounting basis, could be remitted 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 remittances to the U.S. could 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 remitted by Aflac Japan to the Parent Company, after April 1, 2018, and to Aflac U.S., prior to April 1, 2018, were as follows for the years ended December 31:
(1) The net amount of projected benefit obligation and plan assets for the underfunded (including unfunded) Japan pension plan was $92 and $107 at December 31, 2019 and 2018, respectively, and was classified as liabilities on the statement of financial position.
(2) The net amount of projected benefit obligation and plan assets for the underfunded (including unfunded) U.S. pension plan was $414 and $410 at December 31, 2019 and 2018, respectively, and was classified as liabilities on the statement of financial position.
Information for other postretirement benefit plans with an accumulated postretirement benefit obligation in excess of plan assets has been disclosed in the note on “Obligations and Funded Status” because all the other postretirement benefit plans are unfunded or underfunded.
Pension and other postretirement benefit expenses are included in acquisition and operating expenses in the consolidated statements of earnings, which includes $8 million, $25 million and $35 million of other components of net periodic pension cost and postretirement costs (other than services costs) for the years ended December 31, 2019, 2018 and 2017, respectively. Total net periodic benefit cost includes the following components:
The plan fiduciaries for the Company's 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, 2019 were as follows:
The U.S. Pension Plan had $100 million in cash at December 31, 2019. The plan fiduciaries authorized investing a contribution made to the Plan in 2019 on a graduated basis over a period of time.
Aflac U.S. maintains a stock bonus plan for eligible U.S. sales associates. Plan participants receive shares of Aflac Incorporated common stock based on their new annualized premium sales and their first-year persistency of substantially all new insurance policies. The cost of this plan, which was capitalized as deferred policy acquisition costs, amounted to $31 million in 2019, 2018 and 2017.
The Company is a defendant in various lawsuits considered to be in the normal course of business. Members of the Company's senior legal and financial management teams review litigation on a quarterly and annual basis. The final results of any litigation cannot be predicted with certainty. Although some of this litigation is pending in states where large punitive damages, bearing little relation to the actual damages sustained by plaintiffs, have been awarded in recent years, the Company believes the outcome of pending litigation will not have a material adverse effect on its financial position, results of operations, or cash flows.
In January 2020, the Parent Company used proceeds from senior notes issued in December 2019 to redeem $350 million of its 4.00% fixed-rate senior notes due February 2022.