美國家庭壽險 (AFL) 2013 Q4 法說會逐字稿

Welcome to the Aflac fourth-quarter earnings conference call.

(Operator Instructions)

Please be advised today's conference is being recorded. I would like to turn the call over to Miss Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations.

Good morning, everyone. Welcome to our fourth-quarter conference call. Joining me this morning is Dan Amos, Chairman and CEO; Kriss Cloninger, President and CFO; Ken Janke, President of Aflac US, Executive Vice President and Deputy CFO, Aflac Incorporated; Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us today from Tokyo are Paul Amos, President of Aflac; and Tohru Tonoike, President and COO of Aflac Japan.

Before we get started, let me remind you that some statements in the teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will be prove to be accurate because they are perspective in nature.

Actual results could differ materially from those we discuss today. We encourage you to look at our quarterly release for some of the various risk factors that could material impact our results.

Now I will turn the program over to Dan, who will begin this morning with some comments about the quarter and year, as well as our operations in Japan and the US. I will follow up with a few financial highlights for the quarter and year, and then we'll be taking your questions. Dan?

Thank you Robin, and good morning. I am very pleased that we met, and in many cases exceeded our financial targets for the quarter and the year. Let me begin today with an update of Aflac Japan, our largest earnings contributor. Pretax earnings in yen were up 16.9% for the quarter and 13.6% for the year, reflecting a stronger dollar.

Sales of our third sector products were up 15.7% for the quarter, and for the year third sector sales increased 4%, which was at the high end of annual sales target of flat to up 5%. The increase in third sector sales largely reflects a favorable response to our newest ever medical product introduced in August and innovative advertising promotions of this product.

As anticipated, our largest medical policy has proven especially popular with consumers in their 20s to 40s. Given our underpenetration of this demographic, I'm especially pleased of these efforts to appeal to consumers in their 20s to 40s have yielded very positive results for us.

Consistent with our expectation, Japan's new annualized premium sales in the fourth quarter declined 33.3% for the quarter and 29.1% for the year. These results are largely attributable to the significant decline in the sale of WAYS product following the repricing of first sector products in April.

Reflecting on the expansion of our distribution channels, we are pleased with our agreement with Aflac Japan and Japan Post Holding. I believe that in the coming years, cancer sales for Japan Post will steadily benefit our business.

You will recall that first sector sales, particularly WAYS, were very strong in the first three months of last year leading up to the premium rate increase that took effect in April of 2013. As a result, we expect first sector products to be down 60% in the first quarter of 2014, due to very difficult comparisons to last year. However, the second through the fourth quarter of this year we expect the sale of first sector products to be slightly down compared to last year.

Most importantly though, our focus this year will remain on growing the sales of third sector products. As such, we anticipate third sector product sales to increase 2% to 7% in 2014.

Now, let me briefly discuss US operation. Pretax earnings were down 1.3% for the quarter, but up 4.1% for the year. For the year, Aflac US pretax operating earnings were ahead of our target.

In the fourth quarter, which typically generates our largest sales production, Aflac US annualized premium sales had a disappointing 10.4% decrease. This results contributed significantly to our full year sales decline of 4.3%.

In recent quarters, we have acknowledged the impact of healthcare reform, especially to the accounts less than 100. Most notably, accompanying confusion and problems associated with the federal exchange. We believe this kind of recurring uncertainty is linked in the sales process, as small businesses especially are more hesitant to engage in changes to healthcare reform.

They want to gain greater access regarding the implementation of Affordable Healthcare Act and how it's going to affect them. Saying that, a sales decrease of 10% in a quarter is unacceptable to us.

The one constant has been and continues to be the need for our products. There is no plan, not even the best major medical plan, that is designed to cover all out-of-pocket expenses. We will continue to drive home the need for our products to businesses, and ultimately their employees.

You have heard us say many times in the past that part of our job is to gain access to employers to ensure our products are conveniently available to consumers. I will remind you that about 98% of our products are sold through the work site, and more than 90% of those sales come through smaller employers with 100 employees or less. As such, we are working on several key initiatives in 2014 that support our multifaceted distribution network in reaching out to businesses of all sizes.

With respect to our career agents, first we are focusing on recruiting and training. Second, we are concentrating on performance management for the territory directors and sales coordinators. Third, we are in the process of piloting Aflac's proprietary exchange, which is geared to employers of 100 employees or less, but those of 50 or less are our primary target.

Fourth, we are incentivizing the management of our career sales agents to focus on smaller businesses while working with brokers to write larger businesses, and to that end in October we are putting a strategic and tactical focus on businesses with less than 100 employees by aligning our recruiting, training, compensation, and market incentive to encourage specific activity and sales in that segment. Additionally, we are continuing to focus with brokers on a regional and national level to give us better access to mid- and large markets. We've already represent more than 60 benefit administration platforms, sometimes referred to as exchanges, with various brokers.

I believe 2014 will be a good year for broker sales as we continue to push to segment our distribution. Finally, we will continue to seek opportunities to leverage our strong brand and relevant product portfolio in an evolving healthcare environment.

While some facets of the US economy have shown signs of improvement, we continue to see a challenging economic environment in the US. Many small employers are still very guarded with respect to their business outlook, including their hiring plans. This can impact the universe of potential policy holders we have access to. Taking into account all the strategic initiatives designed to empower our sales force in 2014, along with the challenging economic environment, we expect Aflac US sales in 2014 to be flat to up 5%.

When we look back over our investment performance in 2013, our decision to enhance and protect our SMR by allocating more new money to JGBs suppressed our new money yields, but despite taking a more conservative investment path last year, our average new money yields of 2.47% in 2013 was still slightly higher than 2012 results. As we enter 2014, we are reviewing our asset allocation strategy related to Japan new money investments.

Based on current capital position and market outlook, we have resumed purchasing US dollar securities for Aflac Japan's portfolio within ranges consistent with our asset and strategic allocation plans and product needs. We will continue to evaluate the allocation strategy based on investment market dynamics and capital, and make tactical changes consistent with our outlook.

Turning to Aflac Incorporated, our consolidated financial performance was strong for the quarter. Excluding the impact from foreign currency, operating earnings per diluted share rose 6.8% for the quarter and 5.2% for the year. This result puts us slightly ahead of our annual expectation of a 5% increase in operating earnings per diluted share before the impact of foreign currency.

While policy holders are top of mind, we also strive to enhance shareholder value through repurchasing our shares and increasing the cash dividend. We believe these are important -- the most attractive uses of capital, and those are the avenues we will continue to pursue.

For the full year, we purchased $800 million of shares, which greatly exceeds our original target we set at the beginning of the year of $400 million to $600 million. As we said in the third quarter, we expect share repurchase in 2014 to increase over 2013 levels, to be in the range of $800 million to $1 billion. Our buys for 2014 is to front load our purchases. As such, we expect to purchase $400 million to $500 million of our shares in the first quarter.

I am also pleased that we increased our cash dividend to shareholders last year. 2013 marked our 31st consecutive year in which we have increased the dividend to shareholders. Our objective is to grow the cash dividend at a rate generally in line with our operating earnings before the impact of the yen.

Finally, taking into account the headwinds and tailwinds we have covered, I want to reiterate our primary financial objective in 2014, which is to increase operating earnings per diluted share 2% to 5% on the currency neutral basis. We continue to believe that we are well positioned in the two best insurance markets in the world. We are fortunate that we have the privilege of providing financial protection for more than 50 million people worldwide who count on us to be there when they need us most.

Now I will turn the program over to Robin. Robin?

Thank you, Dan. I'd like to go through some fourth quarter and annual numbers this morning, specially as related to the yen impact, which was strong. I will start first with Aflac Japan.

Beginning with the currency impact for the quarter and the year. During the quarter, the yen weakened against the dollar 19.5%, and for the year the yen weakened 18.2%. In reference to top line in yen terms, revenues as reported were up 4.1% for the quarter, excluding the impact of currency revenues were up 2.6%.

Investment income as reported increased 15.7%. Excluding the weaker yen in the quarter on Aflac Japan dollar denominated investment income, net income rose 5.5%.

In terms of quarterly operating ratios, the benefit ratio to total revenues declined over last year, going from 63.9% to 61.2% in the fourth quarter. Excluding the impact from the reinsurance agreement initiated in the third quarter, the benefit ratio for the quarter would have been 60.8%. Additionally, if you excluded the impact of the weaker yen, the benefit ratio for the quarter would be 62.1%.

Now looking at the expense ratio. It was up 18.9%, up from 18.4% in the fourth quarter of 2012. This increase reflected additional spending in line with our expectations.

Reflecting the improvement in the benefit ratio, the pretax margin increased during the quarter, going from 17.7% to 19.9%. Excluding the impacted on currency, the pretax profit margin for the quarter would have increased 18.8%.

With the expansion of the margin, pretax earnings increased 16.9% in yen terms. Excluding the impact of the yen, pretax earnings in the quarter increased 9.3%. The reinsurance agreement from the third quarter had approximately an $8.2 million pretax income on earnings and a $5.4 million impact on an after-tax basis.

Now let me turn to Aflac US. Total revenues rose 1.4% for the quarter. Persistency for the year was 76.8% compared to 77.1% a year ago.

In looking at the operating ratios, the benefit ratio for the quarter was 52.7% compared to 50.8%. This reflected various reserve adjustments made in the fourth quarter.

The operating expense ratio improved, going from 34.6% to 33.1%, reflecting less than anticipated spending in the quarter. The profit margin was 14.2% compared to 14.6% a year ago. Reflecting the increase in the benefit ratio in the quarter, pretax operating earnings decreased 1.3%.

Now turning to investment activities for the quarter, let me first start with Aflac Japan. Approximately 94% of new cash flow was invested in JGBs for an average yield of 1.37%.

As a result, the total new money yield in Japan for the quarter was 1.5%, down 48 basis points from September 30 and down 121 basis points from a year ago. Portfolio yield was 2.8% at the end of December, down 18 basis points from the end of September and 7 basis points lower than a year ago.

In terms of US investments, the money yield for the quarter was 4.32%, a decline of 19 basis points from September 30. The yield on the portfolio at the end of December was 6.01%, down 5 basis points from September 30.

Turning to a few other items in the quarter, non-insurance interest expense was $51 million, compared with $50 million a year ago. Parent company and other expenses was $17 million compared to $6 million in the fourth quarter of 2012.

On an operating basis, the tax rate was 34.4% compared to 34.1% a year ago. As reported, operating earnings per diluted share declined 5.4% to $1.40.

The significantly weaker yen decreased operating earnings by $0.18 per diluted share for the quarter. Excluding the impact of the yen, operating earnings per share for the quarter would have increased 6.8%.

Lastly, let me comment and reiterate some of the statements that Dan's already made. We have reaffirmed our objective for 2014 of a 2% to 5% increase in operating earnings per diluted share, excluding the impact of the yen.

This year, we estimate that a JPY1 move on the average annual exchange rate will equal approximately $0.03 to $0.035 per diluted share. Assuming the yen/dollar exchange rate remains at the 2013 full-year average rate of 97.54, we would then expect 2014 objective of a 2% to 5% growth to be in the range of $6.31 per diluted share to $6.49 per diluted share.

Now we're ready to take your questions, but first let me remind you to be fair to everyone, limit yourself to one initial question and only one follow-up question that relates to your initial question. Now we're ready to take the first call.

Do we have a caller on the line?

(Operator Instructions)

Our first question is coming from Chris Giovanni from Goldman Sachs. Your line is now open.

First question just around the outlook for third sector sales in Japan, and I guess I am wondering why the target isn't higher given the momentum you've seen with the medical product and how underpenetrated that younger age cohort is? And then really no benefit at all to date from cancer, and my understanding is you should get the Post specific product kind of on boarded here in the second half of the year.

This is Paul. I would tell you first of all, we do expect strong momentum in the first quarter and the second quarter, and that will be a continuity coming from the EVER launch in the second half of last year that drove extremely strong fourth quarter third sector sales. It's because of that strong third and fourth quarter that we're up against difficult comparisons, of course.

Of course medical product is going to sell at a higher level than the cancer plan in general, as well as the market is growing at a faster pace. That being said, we remain confident about our Japan Post partnership and our continuing ability to grow that. As we've said, it is a long partnership that is focused on growing it steadily.

We have continued to expand the number of Post offices, but doing so slowly. And it will really be the latter half of the year before we see a significant number of Post offices begin to come online.

As you stated, the cancer plan is something we're focused on revising at this point, pending approval from the government and focused on selling that plan with a specific plan for the Japan Post system. At this point however, we're still in the process of developing that plan with Japan Post, and can't go over the specifics of it but we feel very optimistic about it.

All of that being said, all of that is modeled into the 2% to 7%. And I think that's where we are, and I think we are confident about the numbers and what we are going to see for this coming year.

Okay, and then maybe one for Eric. Can you talk about the decision to get back into the US securities asset class? And then how we should be thinking about, with rates kind of back down here, managing the volatility of the SMR? When rates should rise again, since this clearly isn't eligible for that PRM category?

Sure, my pleasure. Well, going back the last couple of quarters when the volatility hit last year and we changed the asset allocation, you will recollect I had said that we were going to spend significant time on recalibrating our SMR, given the reinsurance, how the capital position went up to the risk factors we're exposed to, in particular in the AFS category, and those risk factors being yen interest rates, dollar interest rates, currency, and credit spreads.

So a great body of work has been completed on that, which was our goal during the fourth quarter, so that we could go into the year with a much clearer path. And given the higher capital levels that we have and all of our modeling, we can sustain, if rates should increase that negative impact to SMR of credit spread should rise, yen yield should rise.

So we could still be within the SMR levels that management wants us to be in. So SMR is now at a comfortable level where, when those things happen in the market, we can absorb an SMR, those impacts, from unrealized gains and losses.

The other thing I would comment on as well, there is a correlation effect between these factors. So when US rates are going up, suggesting strong economic growth here, the dollar is strengthening, the yen is weakening, but we have currency exposure in our SMR. So those are risk factors that kind of offset each other.

So with all of that modeling and our view about capital markets that allowed us to go into the year with a view that we could get back on our path of the original strategic asset allocation from Goldman. However, we're going to be much more tactical in how we implement that.

So the second part of your question is, as we're looking at the year, a few things with respect to our US allocation that are based on today's outlook and the capital position. One, we have turned on the program. Secondly, we're not going to think of it just as corporate bonds. It's a bucket of US assets, and we will use our discretion within my investment group to swap, if you will, between maybe US treasury securities and corporate securities, based on typical relative value analysis.

So as an example, as you all know in the corporate world, the fundamentals are very rich on corporate. They're very healthy, but credit spreads are at their tightest, almost at all-time lows. We are not expecting a lot of tightening. We are also not expecting this year, given economic outlook for the US, that credit spreads are going to widen out a lot.

I don't really want to overweight the corporate allocation when corporate spreads are so tight, but I like the yield differential between US rates and Japan rates. So within that US bucket throughout the year, we'll use our discretion from a relative value standpoint on how to allocate within the US bucket.

And the other thing I should mention as well, the US program last year was targeting more or less a 10-year duration. We are targeting a lower duration now, in light of the fact that our view is throughout the year rates will rise, and certainly in January we saw rates come down quite a lot because of the volatility in the emerging markets.

But by putting any new money into a shorter duration bucket of US assets, we are in essence building up protection for the event that rates rise, so our unrealized losses won't be as great. Over the long term, from an economic perspective, we're very bullish that these are very positive for the long term health of our balance sheet and our earnings stream.

Great. Thanks for the thoughts.

Thank you. The next question is coming from Yaron Kinar from Deutsche Bank. Your line is now open.

Dan, I think you had briefly mentioned progress on the Everwell [platforming] on the broker exchanges in the US. I was wondering if you can give us a little more color on the Everwell progress. I think on the last call you talked about testing six states. So where does that stand today?

And then on the broker exchanges, I think you had mentioned being on 60 today, which seems significantly greater than where you were a quarter ago. So if you can give us any thoughts on both?

Let me make a couple of statements, and then I'm going to have Ken talk a little bit more detail as we're all working together do this. The one thing I think is important that all of you understand is, we introduced a major change with our field force.

As you know, we're probably the only company out there that has concentrated so heavily on accounts of 100 or less. It's always been our bread and butter, it's always worked very well for us.

Our agents have also rolled accounts of 100 or more. But what we have seen is, we have seen those accounts of 100 or more shift more to dealing with brokers.

So as we started several years ago, we started seeing the brokers come in. We have started putting them in our market to some degree.

But what we did in October is we made a conscientious decision to introduce to our whole management team that we were going to pay for performance by trying to get our agents to concentrate more on the accounts of 100 or less. Well, 90% was already there so it wasn't that big, but psychologically telling them we really wanted them to concentrate there and not doing the 100 or more, the old-timers don't like it.

That's why new recruits are so much better, because they understand that's the way it will be done. Now, we're not saying you can't do it. We're just paying to move you that way. Within working with the agents to where these agents will work with brokers to try to enroll what I would call the local brokers more, and then through our plans with Aflac Group, we are doing the national brokers.

So this is a major shift that all occurred in the fourth quarter. And at the same time, we're now getting ready, as you talked about, to move to Everwell with the small businesses, which especially will be 50 and less, and of course we got the delay with the Obamacare that now it won't go into effect until next year.

So all those things kind of hit at the same time, which I think accounted for part being our problem, part being that we write more small business, but all in all unacceptable numbers in my case. So I will let Ken talk a little bit about specifically your Everwell and what we are doing there, and then if Theresa wants to follow up with any comment, she's welcome to. Ken?

Let me start on the Everwell exchange. We are right in the middle of the pilot. We had orchestrated an extended pilot from October 1 through the end of March of this year.

It's actually in three states, one of which we have our appointed agents in that area have access to not only our products but major medical as well as vision, dental, and life. And then in the other two test states right now, they're limited to all the products -- they have all the products but not a major medical.

Because it is such a sweeping change in how we may be enrolling the small businesses in the future, we wanted to take a very pragmatic and conservative approach to this. So we'll evaluate after we finish the pilot in March, we'll evaluate our rollout plans.

We currently anticipate that we'll be rolling the platform out to the majority of our states throughout the balance of this year, but the exact timing of that rollout is going to be dictated by our assessment of the pilot. And we're not quite done, or in a position to make that assessment.

I can say that generally we're pleased with what we have seen so far. We have seen higher penetration rates than we've seen in our traditional business for accounts of the same size, which was one of the success metrics that we're focused on.

Over the longer term, we'll focus on things like retention of accounts as well as distributors. But we do expect that it will go well and that we will be in a position to roll out.

That said, we don't expect for it to have much of an impact on sales in 2014, but if our rollout plans meet expectations and we are able to roll it out as we currently anticipate, we should start to see an impact in 2015 and beyond. With respect to the benefit administration or exchange platforms that you referenced, we have actually had those in place for sometime now, but they're basically, I call them kind of one-off arrangements with distributors and accounts, and their overall impact to sales last year was not really material.

But in thinking through our exchange strategy for the larger case market, that's something that you will largely see come out of the core broker and then our large national broker efforts through Aflac Group in Columbia, South Carolina. The first step of which, and our major focus right now, is to build our distribution at Aflac Group.

We are in the process of expanding the number of employed sales people that we have that will bring relationships to us with brokers, or establish relationships with brokers, so that they can convince those national brokers on the case for voluntary products, and more specifically that we should be the provider of choice for those voluntary products. And then we'd look at the most efficient way to enroll those clients, and that would likely be through an electronic platform like an exchange. But the first step right now, we're really focused on building out the sales capacity at Aflac Group so that we are in a better position to reach the brokers and then get on those exchanges.

And Ken is concentrating, of course, on combining the two, both Aflac Group and Aflac Columbus, but Teresa may want to make a couple of comments on Columbus because that's still 90% of our sales. And so Teresa, you have any comment?

I'll just echo what Ken said with regard to Everwell. Currently we have a couple of other platforms that we use today, our SmartApp unit that you all are familiar with. The majority of our activity is basically driving the multi-distribution strategy, handling the sales operating guidelines, making sure that we have all of the alignment with compensation and sales targets so that we can migrate everybody to this new Everwell exchange.

Okay, and one (multiple speakers) it does, and one quick follow-up on that, if I could. On the national exchanges, or the national brokers, do you think that the investments you're now making in sales and in the platform will be ready to bear some fruit for 2015 enrollment coming October, November of this year?

We're really positioning this for better growth out of the large case market for group products in 2015. This is really a build-out year of sorts. Again, we're increasing our ability to reach those broker distributors.

As you know, there is a very long lead time to large cases. So we're really positioning this for what we would hope and expect to be much better growth in the group platform in 2015.

Thank you very much.

Thank you. The next question is coming from Mr. Jimmy Bhullar from JPMorgan. Sir, your line is open.

Thank you. Hi, good morning. On the US business, maybe if you could talk about just recruiting and the growth in the producing agent count, because it's been weak for a while? Not sure if that's just lack of finding good candidates, or are people not willing to give up unemployment insurance, or what's going on that you are having a difficult time finding recruits in the US?

Then there was a question earlier on in new money investments in Japan. I don't know if you mentioned how much of your new money you are intending to deploy in the US securities, whether it's corporates or treasuries?

Jimmy, let me start on the recruiting. We are really focused, as Dan suggested in his comments, we are focused on a few very basic activities for our traditional sales force this year.

We really want them to focus the majority of their efforts in the under-100 account size. We are also focusing on what we refer to as core brokers. It's really the local and regional brokers that Dan has mentioned.

We are focused on asset management, which is a fancy way of saying we want our career sales force to make sure they're getting the most out of their book of business. So that in effect they're not leaving business on the table by really calling on their accounts and managing their business properly.

And then the other one is recruiting. Recruiting has always been a core component of how we build our sales force.

Newer agents tend to be the ones that bring us the newer accounts where you have opportunities to really grow the business. I think one of the things that we've not only focused the activities squarely on recruiting, but also on the type of individuals we'd like our sales force to recruit, because I do believe that there was some effort on our sales force that rather than recruiting the career agent that we've typically built this business on, they were trying to recruit brokers instead.

So we have really refocused their activities this year on referral recruiting nominations and getting the type of sales associates that have long been known to build this business. We have seen a bit of a turn.

I think it's too early to comment with certainty, but so far this year with that new focus we're pleased on the kind of recruiting activity that we've seen. It's still down year over year, but at a significantly lower rate of decline than what we've seen throughout 2013.

So we are focused on that. By focusing on that and also the training and getting those new agents to focus on the small business area, the accounts of fewer than 100 lives, we think we'll also be successful in pulling up the numbers of producing agents.

I'll just follow up with three areas of focus. One area of focus, really trying to make sure that our people who are recruiting in our career channel, that those folks don't compete with trying to recruit brokers as well. So we have basically focused the career recruit channel on really recruiting people for that career channel, and then we moved a lot of the market, the people who were recruiting for brokers, into a core broker channel, which really supports the distribution channel, or the channel segmentation and it also supports how the market has shifted as well.

The other thing that we're doing is recruiting ads, and you'll see some of those recruiting ads. They were very successful in the past for us with really getting interest for Aflac and with regard to recruiting, and so we decided to bring those back.

The last thing is making sure that all of our goals for recruiting are aligned within the hierarchy. So any contest, any compensation is aligned across the hierarchy with regard to recruiting, as opposed to one or two people holding a goal for recruiting. Their comp is tied to it. Eric?

It's Eric to answer the second part of your question around the percentage allocation of new money. Just a couple of factors that go into that allocation.

One is, when we discuss new money, what we're discussing is cash flow from operations and maturities and interest from existing assets, but we also consider sort of the target balance of our asset classes at year end, which ties back to the strategic asset allocation work. So with regards to US assets, if you will, as a target, not necessarily meaning we're going get there, 25% of the Japan assets would be our target for US assets at the end of the year.

When we calibrate what I discussed earlier, the new money statistics that we expect, SMR, we would currently expect no less than about 40% of our cash flows to be in US dollars, but again that would depend on market factors, SMR. One other factor is during the year, which has already happened this year, we may dispose of some securities, like you know about Israel Electric, for instance. Those proceeds came in January, were invested into the US program, but that's not counted as new money, but it would count towards our year-end target.

So there is a variety of factors that go into that. And then finally I would remind you, I can give you some of these estimates. As I said earlier, we will be more dynamic with respect to the risk factors in the market, what's happening with spreads, what's happening with rates.

I think you will see us be more opportunistic, as well as conservative from a safety standpoint, depending on what's happening in the market. But certainly we'll report throughout the year on how it all panned out relative to our expectation.

The US investments. Those don't qualify for policy or their matching accounting treatment, right?

That's correct. Those go into AFS.

Thank you.

Let me point out that on a US statutory basis, the assets are held at amortized cost as opposed to mark-to-market. So it's not a big factor in RBC.

It's more the SMR would change though, right?

Yes, the SMR for Japan is sensitive to fair value.

Got you. Thank you.

On the FS securities, but in the US we're not on RBC for the US operations.

Thank you. The next question is coming from Mr. John Nadel of Stern, Agee. Your line is open.

Good morning, everybody. Just a quick follow-up on the investment side. I don't remember the exact amount out of Japan in terms of the new money investments in total from 2013.

If memory serves, it was effectively an all-time record, given the very strong sales in the first sector channel. How much is that overall new money investment going to decline in 2014, given the continued shrinkage of the first sector. The fact that third sales are clearly require less from the perspective of investment income?

It's Eric. I can give you the numbers from last year and the projections this year in total cash flows, and then perhaps one of my colleagues wants to discuss it at that second level between sales. But to your comment earlier, last year's cash flows were JPY1.118 trillion, but that's cash flow from operations, maturities, and interest from the portfolio.

So there is a lot of attribution within it. For this year, again in total the projections are JPY771 billion.

Got it, okay. And then I think the only other real question I have is, as you've done all this work around SMR sensitivity and calibrating, especially post the shift to the PRM classification. Can you give us some sense for how much the sensitivity of the SMR has come down, especially relative to changes in interest rates?

This is Kriss. Let me say that we've done a lot of work on that. We intend to go into that in some depth at the FAB meeting. I didn't want do it on this call.

But let me just say that with our SMR at its current level in the mid-700, we believe that we're well protected against the fall below the 500% to 600%, which is kind of our overall low level operating objective.

The way I am looking at SMR right now is that we don't want to broach our fallback position, which I will say is 500% to 600%. We feel like by staying at about 750% in today's market environment, there are very few scenarios where we're going to pierce below 500% to 600% for changes in US interest rates, changes in Japan interest rates, changes in currency rates.

So what we have done is to insulate ourselves against the low side of the SMR exposure due to volatility in those macro factors. And we believe that enhances our ability to give the investment team flexibility to pursue their plans without significant concern.

And it just gives us more assurance that we'll be able to manage SMR levels in a way that will allow us to achieve our plans for profit repatriation, policyholder security, and the like. So we feel like the work we did between the third quarter and fourth quarter last year has well positioned us to manage in a very flexible way in response to significant changes in macro conditions.

One of our main objectives here is to never act like we had do one time on share repurchase.

Yes.

To constantly be increasing it every year. And by having this bottom set, we feel comfortable that we can continue to increase it unless something just unheard of happens.

John, this is Ken. Let me just add, if you just look at the SMR sensitivity to yen interest rates, our [fork in] -- as Kriss said, we'll talk more about it at our analyst meeting. It is significantly less than it would have been a year ago for a couple reasons.

Number one is implementing the PRM category which insulated us from yen rate risks. The other is that now we have more dollar assets proportionately.

Yes.

What does that mean? We've got more exposure to dollar rate risk. We've taken some actions to try and mitigate that risk on SMR as well.

When you think of the market risks that influence SMR, we are expose to yen rate risk, dollar rate risk, credit spread risk, and currency risk. The problem is, those are somewhat correlated.

You can't just aggregate one risk on top of the other to come up with an overall sensitivity. And that's why we're doing a little bit more work on it to give you a better indication of what kind of buffer we feel we should be maintaining to accommodate those risks.

Perfect. That's really helpful. If I can sneak one last one in because it's related. It's just, have you done any incremental hedging, particularly around yen verses dollar as you look out to 2014 and beyond, to insulate your expected profit repatriation from potential currency moves?

Yes, let me update you on that. Our current expectation is to repatriate about JPY97 billion. The last time we spoke, we had hedged JPY47.5 billion at a little over JPY100 to the dollar.

We have added another, incrementally another JPY5 billion. So we have roughly JPY52.5 billion hedged, again a little over JPY100 to the dollar. We have elected to take -- use our yen cash flow from repatriation this year to service the JPY34.2 billion debt that we have maturing. And so what that does is that frees up about $400 million that we had on the balance sheet that we had previously earmarked for share repurchase.

So when you look at the JPY52.5 billion plus the JPY34.2, you are roughly JPY10 billion or so that it remains unhedged. And I think it's unlikely that we'll do much more for this year, but we have already started thinking about 2015 and taking actions to insulate against currency risk on that repatriation.

Perfect. Thank you so much for everything.

Thank you.

Thank you. Our next question is from Steven Schwartz of Raymond James. Sir, your line is now open.

Thank you. Good morning everybody. I guess this all ties in, but I do want to ask about what is going on, or what can possibly be done in reinsurance? I know you kind of started it in, I think it was May.

At the FAB meeting, Kriss stated that he thought that the FSA was really against doing enforced block-types of transactions to free up capital. But you are sitting there with an SMR of 750%. You've got PRM, and you are doing interest rate hedging.

There is a lot of protection there. The reserves are way, way overstated in Japan relative to the US, which is probably overstated relative to reality anyway.

You've got one competitor that's done -- an American competitor that's announced that they did a deal. RGA is saying that they're seeing a lot of companies do this. I am wondering, Kriss, if you have thought more about this, or looked at this more?

Yes, we're continuing to evaluate it, Steven. I don't necessarily agree with all your comments, at least maybe I do, but maybe not in order of magnitude. Let me just say that the reinsurance we did at the end of September allowed us to achieve our objective of increasing the solvency margin substantially.

We don't feel like we need to do additional reinsurance to accomplish that right now. We've got it in reserve in case we ever need to do it.

What I do have my team exploring is the notion of doing a continuous program of reinsurance of this nature to alleviate to some extent the surplus strain we experience relative to new business. And what I think that would do, what it will do, is to minimize the volatility of FSA earnings in responses to changes in production levels.

And it would also allow us to monetize, to some extent, some of the differences between the economic reserves, which is how I would characterize what you are trying to get to, and the regulatory reserves. Keep in mind, though, that reinsurance of the nature we did does have a cost.

You are selling a block of business in exchange for a premium, and it does have a cost. And I have quantified the cost to reinsurance in 2014 at about $0.05 a share, about $30 million or so after tax. So it's not like it's free.

Now, let me say that relative to other companies, we don't have an internal reinsurance subsidiary where we can do this program on an intra-company basis. We've never been a reinsurance user to any great extent. We haven't needed to.

We don't have a reinsurance subsidiary that deals on an arm's-length basis with other companies, which many companies do. So that's kind of a negative for us.

That being said, we do recognize the possibility that we could establish a captive reinsurer, and that's one thing that we're going to look at. That's not a short-term thing, something that's easily achievable in three months, but it could be a cost effective or cost efficient way to do some reinsurance, and we're going to investigate that further.

So let me just say we intend to evaluate the use of reinsurance. We can do more. We're going to use it to, again, protect profit repatriation and the like.

And there will be more to come on that. But we're not just ignoring it, Steven. We're going to be using it effectively.

All right, great. And then follow-up on the very, very large cases. I want to try to get a handle on what's changed here in the US with the exchanges.

You say you're on the platforms, but you have been on the platforms for a while. I mean, my understanding has been, at least for a year, maybe two years, all the big alphabet houses, you have been with them, but the issue seems to have been, then, getting their people to use you.

Is this really just the same situation? They may be selling it in a different way, but it's still the issue of getting the rep at Aon or Marsh Mac to use you? Is that still the issue?

This is Theresa White. Really, the issue is making sure that we build out, as Ken said, that W2 sales force that Dan Lebish is responsible for. We are building out, because most of these large brokerage houses, which you may know, they really go to market differently.

And you don't -- it's not a product sale. It's really understanding how they go to market. And so the importance of those relationships is to really understand how each brokerage house deals with the market, and then how Aflac fits within the context of that.

And so the initial relationship, or the initial interaction, is more us understanding, Aflac understanding their go-to-market strategy, understanding and educating many of the brokers on voluntary product, and then there is a process of selling. What Ken referred to a while ago was a lot of the plumbing that was built for the 60 or so exchanges or platforms that we have today, there were specific cases that wanted Aflac.

They asked for Aflac, and they happened to have brokers involved. Now that's some of it. But others are really where brokers have brought us in and utilized us against other competitors.

So right now, that's why Ken's saying right now what we've got do is established that sales force at Aflac Group so that we can ensure, and we call those sales people BDEs, Broker Development Executives, and they'll be regional vice presidents there managing that process. But at the end of the day, the relationship is what's important. And Aflac understanding their go-to-market strategy and how Aflac product fits.

Okay.

The one thing I would say that's very important here is, is it was somewhat murky in our organization of how brokers and agents and the new things were all fitting together. Now what we did in October is we defined exactly the direction we wanted everyone to go. And we cut out certain things, like for example, these big brokers.

They don't want our agents calling directly on them. That irritates them, and they control the account, and we have defined that better to stop that from happening.

So these are things that are major in terms of how we handle it in terms of emotional and trying to motivate our existing field force. And we have done that through more commissions and shifting them. And so all of this is just part of something that's unfolding right now, that I ultimately think will enhance our sales.

I think we're going to be much stronger. I think anyone that thinks that we're not going to be strong in the small market is mistaken because we have done so well. I think anyone thinks that with the big brand we've got, which everyone knows us in the supplemental industry in the United States, will be mistaken when it comes to how well we're going do with the brokers going forward.

We've just got to let them know that we understand their needs and we're going to fit products accordingly. And that's where South Carolina will come into play with our new President over there, or new Executive Vice President over there and how he handles it. Ken will be coordinating those two efforts.

Steven, I would actually argue, I think the exchange part is the easy part, because that's enrolling the business. The hard part, what we have to work on, is we have to have the relationships. We have to demonstrate to those large national brokers the value proposition for supplemental products.

Again, why we should be the provider of choice and how we can effectively enroll that business and service that business, and get them paid quickly to have a pain-free experience. So the enrollment itself through an exchange, I don't see as that daunting. It's really the -- it's everything that's leading up to the enrollment that we really are working on.

Okay. All right. Thank you, guys.

Steven, one other thing I want to comment on since we are talking about this new distribution strategy, as Dan referred to it. We're going do a spreadsheet and try to outline the various aspects of this. It will be available online, just like we have other spreadsheets out there on investments and the such to help you better understand the market segment, the channels, the products within those channels that they will be offering enrollment conditions, et cetera.

So that should be available on the website sometime this afternoon. We'll have that up there. I think it will help everyone understand better this new strategy in the US.

All right. We'll take a look. Thank you.

Thank you. The next question is coming from Mr. Tom Gallagher from Credit Suisse. Sir, your line is open.

Thanks. Kriss, I wanted to come back to the comments you were making about exploring captive re, and I think the comments you used were to potentially stabilize J GAAP earnings and then dividend repatriation. Should we be thinking about this whole evaluation more as making sure you have stability?

Or would there be a significant enhancement opportunity? For instance, the JPY1.3 billion to JPY1.4 billion of J GAAP earnings that you guys are run rating right now, is there the possibility from this kind of transaction that you could increase that 50% if you structured it the right way, or is that not the right way to think about this? Is this more of a stability exercise than an enhancement exercise?

No, there is an opportunity for enhancement, Tom. I think you have to be measured in thinking about how much enhancement. We're going to have to balance cost and the overall result, and we always manage the business for the long term as opposed to the short term.

So I'm not looking for a quick pop on profit repatriation and a quick pop on share repurchase. I am more interested in what we can sustain over the longer term. But there is an opportunity for enhancement, and that's one of our objectives.

Got it. But we shouldn't be thinking about, as you said, a (multiple speakers) Okay, got it. So more of a measured enhancement.

Yes, if we got a 50%, it wouldn't be achievable year to year. If we went up 50%, it would probably have to stay at that level, assuming we can even get there, which it might be achievable but I doubt that I am going to go that far.

Got it, and then just a follow-up for Eric. Your comment that you were positioning into shorter duration securities. I guess I think that was just related on the USD allocations. I am not sure if that also applies to what you are doing on the JGB side.

My follow-up on that point, though, is should we be thinking about this more as short-term tactical, because ultimately you have to match your liability, and you have very long duration liabilities. If you shorten the duration today, how long would you be willing to deal with tolerance of the mismatch?

Sure. Thank you. Good questions. And to your first one, yes, that was with respect to the US securities, not our JGBs, which the JGBs are longer in duration and more closely matched to the liabilities.

The second part of your question, yes, this is more tactical. And keep in mind that shorter duration is for the new money.

The existing portfolio, which is quite large, particularly when you take the US corporate program that we started, as we called it, and what we used to call the Japan dollar portfolio. We are now thinking of that as one big bucket.

So that big bucket is at approximately a 10-year duration. We are not changing the duration of that bucket, but the incremental new money is going in tactically at a shorter duration, which will bring the overall duration slightly down.

But we certainly have to have that focus on ALM and matching assets and liabilities. So it is more tactical for this year at this point in time.

Okay. Thanks.

Well, we've reached the top of the hour. If anybody has any follow-up calls, David and I will be in the office, so please give us a call.

Otherwise, we look forward to seeing everyone at our FAB meeting. The information is out there for you to register. And thank you so much for joining us this morning.

That concludes today's conference. Thank you for participating. You may now disconnect.