美國家庭壽險 (AFL) 2015 Q1 法說會逐字稿

Welcome to the AFLAC first-quarter earnings conference call. Your lines have been placed on listen only until the question-and-answer session. (Operator instructions)

I will now like to turn the call over to Ms. Robin Wilkey; Senior Vice President of Aflac Investor and Rating Agency Relations. You may begin.

Thank you and good morning, everyone, and welcome to our first-quarter conference call. Joining me this morning in the US is Dan Amos, Chairman and CEO; Kriss Cloninger, President and CFO; Ken Janke, Executive Vice President, Deputy CFO; Theresa White, President of Aflac US; and Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us from Tokyo are Paul Amos, President of AFLAC; and Hiroshi Yamauchi, President and COO of AFLAC Japan.

Before we start this morning let me remind you that some of the statements in this teleconference are forward-looking within the meaning of securities guideline. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our quarterly release for some of the various risk factors that could materially impact our results.

Now I'll turn the program over to Dan who will begin this morning with some comments on the quarter, as well as our operations in Japan and the United States. Dan?

Thank you, Robin. Good morning, and thank you for joining us today. Let me begin with an update of the AFLAC Japan, our largest earnings contributor.

Sales of Aflac Japan third sector products were up 21.3% in the quarter. This result established a strong start toward our expectations that third sector sales would average an increase of 15% for the first nine months of the year.

Sales of cancer insurance continued to be extremely strong following the introduction of the end of the third quarter, the new Cancer Days product, which includes an exclusive policy sold for Japan Post. Following an outstanding fourth quarter in 2014 reception of this product, cancer insurance sales in the first quarter generated 118% increase through all distribution channels and outlets.

Our distribution side, our strategic alliance with Japan Post, continues to be enormously beneficial. This alliance leverages Japan's post position as the largest distribution network in Japan. With AFLAC Japan status is the leading industry in the pioneer of cancer insurance.

Our tremendous progress continues at more than 10,000 postal outlets offering our cancer insurance to their customers. I believe this alliance will continue to benefit both companies, as the opportunity to purchase cancer insurance is extended to more and more Japanese consumers.

At the same time our traditional agencies have been and remain key to our success. Our goal is to have a presence where consumers want to make their insurance decisions and our various distribution outlets broaden for that reach.

Now let me turn to the US operations. As I mentioned during the fourth-quarter conference call, we expected the first-quarter sales would be challenging.

As we communicated, the expense ratio increased during the quarter, primarily reflecting the expenses related to the changes we made to our sales organization over the last several months. We believe these changes, which were implemented to enhance our sales growth, are better positioning AFLAC US for the future.

At the same time, we just started something no one in the industry has ever attempted, no less done, and that is the One Day Pay. The industry first initiative means that we process, approve, and pay in just one day.

We're delivering on our promise to our policyholders in a more meaningful way of getting cash in their hands faster than ever. Faster than anyone in, in fact. We estimate that 70% of our policyholders can use One Day Pay for their claims. In 2015 we expect to process nearly two million claims within the parameters of this initiative.

One Day Pay has generated a lot of excitement with our distribution channels, our accounts, and our policyholders. Along with the strong brand and relevant products, I believe One Day Pay will continue to help AFLAC standout.

As I mentioned last quarter I'm not willing to say that Aflac US sales have turned the corner until we see the results for the first half of the year. At the same time, I remain encouraged by the progress that we've seen and continue to see. I still believe Aflac US sales will increase 3% to 7% for the year.

We'll continue to advance our efforts toward expanding our distribution to access employers of all sizes. Doing so will allow us more opportunity to leverage our brand and have attractive products in the portfolio in an ever changing healthcare environment.

Having covered operations, let me turn to a topic that I know are top of mind with our shareholders. That is capital deployment. Our commitment to maintaining strong capital ratios on behalf of our policyholders puts us in an excellent position to repatriate about 200 billion yen to the United States for the calendar year 2015. This reinforces our plan to repurchase 1.3 billion of our common stock in 2015, and puts us in a good position for next year as well.

I wanted to reiterate that our objective for 2015 remains to increase operating earnings per diluted share 2% to 7% before the effect of currency. Challenging financial markets and a very low interest rate make it difficult to invest cash flows at attractive yields. Therefore, we will continue to be very disciplined in selling first sector products in Japan which will reduce investable cash flows.

As always, we are working very hard to achieve our earnings per share objectives, while also delivering on our promise to our policyholders. I am pleased with AFLAC's position in Japan and the United States, the two largest insurance markets in the world. AFLAC has earned the distinction of being the best branded Company for voluntary and supplemental products in each country.

We continue to believe Japan and the United States each have characteristics that make them extremely well suited for the products that we offer. Importantly, both markets offer opportunities for growth. We are fortunate that in the process of growing our business we had the privilege of providing financial protection to more than 50 million people worldwide. Now, I'll turn the program back over to Robin.

Thank you, Dan. Now in the interest of time we are going to start taking calls.

Could I have the first question please?

(Operator Instructions)

One moment. Randy Binner, FBR Capital Markets.

I would like to get some more color on the reinsurance deal that was announced in the quarter as part of your capital management plan. First, to understand how this may have differed from the previous two deals in regard to the subject matter risk that's covered -- if it's with a different reinsurance partner? You noted that there was a recapture almost immediately. Can we take that last piece to mean that this is less expensive than the previous two deals?

This is Kriss Cloninger, I'll handle that.

The substance of the reinsurance agreement was materially the same as the two previous transactions that we did. They involved blocks of our in-force medical insurance that had demonstrated financial characteristics and the like. It was done with a different reinsurer. The previous agreements had been done with Swiss Re, and this one was done with Munich. We had been talking with several reinsurance partners, and we wanted to expand our track record of business relationships. So we did that.

The retrocession was similar in substance to the previous retrocession we did in the second tranche with Swiss Re, but it was a higher amount. It was 90% of the block instead of 50% that we did in the second deal. Accordingly, there will be a lower net cost to Aflac on a consolidated basis than there was in the previous transaction.

Just two follow-ups -- one, we can think economically the full JPY130 billion as being freed up? I want to clarify that.

Also, do you give us color of how many more of these transactions we can expect? Our view has been that there's a lot of capacity for a series of transactions that free up more of the capital reserve differential between Japan and the US. But I'd like to understand how many more of these or how systematic these may be?

Let me first say that we do have additional capacity. We're always primarily interested in making sure that our policyholders in Japan are protected at a very high level. Freeing up some of the FSA basis reserves allows us to increase our solvency margin in Japan, is a first step that gives us more security that we will be able to perform with response to our policyholder obligations.

We do have significant capacity remaining, I believe, and we haven't gotten a specific plan. We don't have a specific plan for additional transactions, but I think that we'll talk about that in some more depth in our upcoming financial analyst briefing in May when we talk about sources and uses of capital. I think you can anticipate that there will be more transactions. We've been taking this one step at a time. The very first transaction we did, we did to increase the SMR, to reduce the exposure that we had to volatility and interest rates and currency and the like. The second one we did to achieve the same objectives, that were to reduce cost that did the first retrocession deal. This third one has essentially the same objectives in the initial transactions that further reduced costs through the reinsurance -- the retrocession. I think we will give you more color at FAB in May.

Great. Thanks.

Nigel Dally of Morgan Stanley.

Speaking of capital, given the sizable repatriation, it seems like you could easily do more buybacks than your current guidance. The first question -- what is holding you back from increasing your buyback guidance?

Doing the additional reinsurance deal does increase our financial flexibility going forward. As I said, we'll talk more about our capital uses plan at FAB meeting. I think it's fair to say, Nigel, in response to that, that we do have more flexibility, but at this point we're early in the year. We had a target for repurchase in 2015 of $1.3 billion. We're going to stick with that. Things are still a bit early, and so we'll give you more color on that in May.

[Fall off] in the reinsurance transaction you mentioned there will be lower net cost given the higher retrocession. Can you quantify what that net cost will be?

Let's see, in terms of cents per share, it has to --

Nigel, this is Ken.

With tranches 1 and 2 we were looking at an annual run rate of about $0.07 per share that would be reduced by about a penny or so from the retrocession of half of tranche 2. Given the size of the retrocession with tranche 3, with the most recent transaction, we don't look at it as materially impacting the net cost of the program in the short run. When you think about an EPS drag, for instance, for calendar 2015, it's still going to be in the $0.05-$0.06 per share for the first three tranches for the full year of this year.

Thanks.

Thank you. Jimmy Bhullar of JPMorgan.

First, I had a question on your EPS guidance. I'm a little surprised that you left the guidance unchanged at 2% to 7% since you are going to have the $0.07 reduction in your interest expense. I'm wondering if that is this year, and obviously next year it should be around 10%? I wonder if that is a part of your guidance? If it isn't, is there anything else that you see as a potential headwind that would offset the benefit of that?

Secondly, on Japan sales, even if sales sustain at the recent level that they've been, it seems like your guidance, at least through the first three quarters of the year for the 15% increase, is somewhat conservative. I'm just wondering why sales wouldn't sustain as they are right now? I assume that you probably would get more production from the Japan Post as you keep adding additional branches.

Let me start with the EPS guidance and address that, and then we'll address the Japan sales guidance.

We gave you a pretty wide range. I consider 2% to 7% increase in EPS on a currency-neutral basis to be a fairly wide range. We do wide ranges because we know that some things are going to go well, some things aren't going to go quite as well. And we're always working at activities that will move us up in the range. So, clearly, taking advantage of the opportunity to redeem those high interest expense senior notes, the $850 million of senior notes that had a 8.5% coupon, will benefit us going forward. That wasn't directly reflected in the original EPS guidance, but again, it's too early in the year to say that we're going to narrow the range at this point, that we initially established.

Clearly, that particular transaction will increase our certainty that we'll be able to perform within that range. And certainly it adds to our ability to perform more strongly than we originally anticipated. That's as far as I'm willing to go at the moment.

Now, let's turn to --

Let Yamauchi or Paul take that on the Japan sales guidance.

This is Paul.

I'll start and if Yamauchi wants to add additional comments I will let him do so. First of all, you are correct that we have had strong sales in the fourth quarter of last year and in the first quarter of this year, and we feel that the market's desire for our new cancer plan has been extremely strong. As we noted in the previous call, we are expecting the first three quarters of this year to be strong, with a 15% growth over those three quarters. At this point we are not changing that number. If we see sales continue to go extremely strong through the end of the second quarter we will, at that time, talk about any kind of revision.

But given the size of the fourth quarter of 2014 and the hurdle that is to overcome, I am hesitant yet to talk about any changes in annual sales guidance. But I have to say overall I'm very pleased with the sales, not only through Japan Post, but across the board. All of our channels have been extremely receptive. I do, however, believe there are many things we're doing to continue to increase our long-term sales. Anytime we announce a new product announcement, things of that nature, there can be an adverse impact to short-term sales in a 13-week period. As we move further into the year, there are things that may not necessarily cause us to perform at the same optimum level we are performing at today, but we will still achieve excellent results. And so we are very excited about where it's going to go forward from here.

Seth Weiss, Bank of America Merrill Lynch.

If I could ask another question on the capital and proceeds reserves released from the reinsurance transaction. So, the reinsurance deal releases JPY130 billion -- call it JPY80 billion or JPY90 billion after tax. You increased your repatriation plan by JPY30 billion to JPY50 billion. Can you help us think about the plan for that remaining JPY40 billion that gets released from the reinsurance deal that will supposedly stay in the Japan entity?

I don't know -- Ken, do you want to add any color on that?

We did this additional reinsurance transaction. We increased the anticipated repatriation sum. It's not really a one-for-one deal, but it's directionally correct in the equivalent. We reevaluated the whole scenario, as far as repatriation and the like, and the JPY200 billion is our best estimate and what is provided for in our FSA financials as of March 31, 2015.

That's the color I'm able to provide.

And a portion of it, Seth, is provision for potentially future profit transfers. And a portion would support the current SMR that we have in Japan. We've got a lot of flexibility.

Great. On the earnings side, I understand there is very little net impact just for the case of our models. Should we think about a transferring of earnings from the Japan entity to the US entity? And if you could give us any quantification of that, that would be helpful.

Well, that's what the repatriation is -- the JPY200 billion is a transfer from Aflac Japan to Aflac US. Within the insurance entity, then the question remains how much of that would be dividended to the parent. But the JPY200 billion is the transfer from Japan to the US.

I may have been unclear. I mean on the earnings standpoint, thinking about the retrocession specifically, which I believe goes to the CAIC entity.

Right.

Well, I earlier commented that there is very little marginal effect on EPS of this transaction because it was 90% retroceded in terms of the cost. We do report the full cost in the Aflac Japan segment and the benefit of the retrocession will come through in our financial reporting identified in the so-called Other segment. We didn't include it in the Aflac US segment because it wasn't really an Aflac US transaction. The net cost for corporate will be reflected in the consolidated financials.

I'm not sure I'm totally answering your question, but --

Yes, it comes to trying to look at Aflac Japan in a year-over-year basis. Apples to apples. So, thinking about how much earnings may be lost there and transferring into other -- just so we could get a better view of underlying growth in that entity if we want to strip out earnings, which is essentially being transferred to Other. Thanks.

This is Robin.

Let me just say, especially for those that may not have reviewed the statistical supplement in detail, we made two major changes to the statistical supplement, and one of them is on page 21. We broke out the impact on both premium and on benefits for premiums gross versus premiums ceded. We went back from the first tranche, so that you will be able to see trends on this and it should help you model on a go-forward basis. So, we did extend the information that we are giving you on that, and so if you will have a look at that we will be glad to talk you through that also, following the call, if you'd like to.

The second thing I would mention while we're at it -- the second change we made in the statistical supplement -- and as you all know we make it in the first quarter of the year so that we do not have any partial-year anomalies occur -- we enhanced what we think is the reporting of the persistency modeling in the US. It now includes CAIC and additionally it is on a rolling 12-month basis versus taking each quarter to date and annualizing that number. We found in talking from analysts that was a better understood metric and it caused us to be able to eliminate some of those anomalies, especially as you annualized first-quarter, which really didn't give you much of an idea of the trend in persistency.

I apologize. I want to make a statement. It's on page -- it was 22, where you can find that breakout of the ceded and -- on 21. On the ceded and gross premium.

I don't have enough profit impact directly in front of me, but as I recall -- and I'm talking to my internal team here -- the net effect on Japan P&L was approximately $5 million for the quarter. It's right at about $5 million for the three transactions combined. And as I said, that will show up in the Japan segment as a gross number and then the retrocession effect will show up in the other segment. But the impact on consolidated P&L ought to be probably less than $1 million. For the third transaction -- third tranche.

Okay. Thank you.

Eric Best of Citigroup.

Good morning. Thank you.

Can you talk about the trends in US recruiting and the incentives you put in place to try to increase the agent force? Given the changes you've made in the middle of last year and the increased commission payments, I'm a little surprised that recruiting hasn't accelerated in recent quarters.

This is Teresa. I'll answer that.

First, let me explain the recruited agent metric. The metric includes both career agent recruits as well as broker recruits. As I mentioned in the fourth quarter, we did expect disruption in the number as we started consolidation of that broker organization; and we redirected a lot of their efforts, at least in the short term, to focus on existing broker relationships. So we had done a really good job at recruiting brokers, but what we wanted to do was enhance the relationships and obviously help to increase penetration with regard to Aflac business.

So, even with this, results are not acceptable; we know that we have to have a marked improvement in the long term. But it's important to note that the changes that we've made are really driving one side of the operation to look at career recruiting, and the other side of the operation to focus on broker recruiting. And developing of those relationships.

How do you think about the sales growth pattern for the US? Given the relatively flat producing agent levels on the traditional channels, do you expect to see material growth from that channel over the next quarter? Or will most of the year-over-year growth come in the fourth quarter when you see the higher group sales?

As we start increasing the volume of group product, we do anticipate that more of the sales will skew toward the fourth quarter. And that's just a natural progression as you increase your sales with brokers in the group market. So we do see a skew toward the fourth quarter with sales growth.

Thank you.

Steven Schwartz, Raymond James and Associates.

A couple of questions.

Teresa, just to follow up on that, anything you can say with regards to progress with the alphabet brokerages would be appreciated.

Certainly. We are seeing progress with many of the large brokerage houses. As a matter of fact, they are in our top five now. And before, as far as sales production -- and before, we couldn't say that. We were seeing marginal improvement but now they've moved in our top five as far as sales growth. We're seeing tremendous improvement there. Obviously, we continue to work with each of those brokerage houses and we've now created an organization, I think, that will help us to further enhance relationships in those brokerage houses as well as other relationships with regard to regional and large case brokerage.

And let me say one thing: because the number is so big, our associates or agents that work for us are writing accounts of 100 or less. We must maintain continued stability there. We do have growth there, and so this has been an evolution as we're going through this process of trying to add on brokers while protecting and building our existing field force.

That's been a real challenge for us, but under Teresa's leadership it is doing very well and I'm very encouraged about that. I think long term these decisions that we've made have been the right ones.

I will make one comment about recruiting, and that is that we've made so many changes from a production perspective that there's a lot going on; and so all of its tying together. I like the One Day Pay. I like that we set it up in a way that these people, our important market directors, will do very well if the Company does very well and they won't if we don't. So I think it's all working nicely together.

And as I said in my comments, I'm not willing to declare victory, but it is certainly going the direction. I'd like it to go faster, as Teresa would, but it's still moving in the right direction of what we ultimately want to accomplish. I do find it interesting, with all the changes we made that we did not lose any market directors, and so there's probably a few that will change out that if they don't do as well, they won't make as much and they may retire or whatever.

So there are still some changes, probably, to take place. But all in all, I think we are going down the path of that is going to prove that it's working the right way. It's just a question of how fast it's working.

As a follow-up, part of what I think I heard you say, at least at the beginning when you started talking -- you didn't say it in so many words -- but that trying to keep the career agents, in a sense, where they belong at smaller accounts under 100 people is continuing and is working.

Yes, we are paying them more to write there. So it's been an enhancement of moving them in that direction by paying, because that's where they're the most effective. And it's also the least area of competition.

Okay. Just an accounting question. I don't know, Kriss, if you know this answer or not, but given the retrocession back to the US, is there any increase in the deferred profit liability?

You're talking GAAP, not statutory. Well, the retrocession would be a proportion of the direct transaction, and we do use -- well, let's see, on a GAAP basis we use deferred profit liability to minimize any profit recognition effect. So --

So it would be right in Japan, I guess?

Yes, in Japan.

Thank you.

Tom Gallagher of Credit Suisse.

Good morning.

Wanted to ask Eric a question in terms of the new money yield in Japan -- it was only 1.1% this quarter. I think the plan for the year is 2%. Can you comment on why you just invested in JGBs this quarter? Is that just a timing issue?

The second question related to that for Kriss -- and I appreciate that the first sector sales fell [a lot], but they are still north of 20% of your Japan sales for the quarter in terms of ways and endowment. Are you actually making a profit for those products earning 1.1%?

Thanks, Tom. This is Eric. I'll go first. Thank you for asking that question, because I know it sticks out a little bit.

The short answer and the simple answer is, our cash flows for the first quarter were insignificant, and that was primarily and all planned for because, as you know, we increased the frequency of repatriation. We had tax payments, so the amount of money we had to invest was inconsequential and not reflective at all of our strategic asset allocation. We do expect in the second quarter cash flows to be relatively low as well, but in the second half of the year they will pick up. And our new money yield at that point will reflect the types of investments you're used to us making, whether those be in dollars or other products. But for the first quarter it was simply an inconsequential amount of new money.

And, Eric, when you say inconsequential, would that be less than 10% of the money you expect to invest in the year? Is there a way you could quantify?

It was about 4.5%-5% of the total new money for the whole year. So it really is back-ended in the second half of the year.

And, Tom, on your question about profitability of the first sector business [chow] endowment and what it is we are still writing -- those are profitable at the anticipated annual investment yield of about 2%. Recall that reserving was reduced to a 1% FSA interest assumption, and we repriced the products with an interest assumption of around 1.25%. We have a positive spread in our anticipated yield for the year. If we looked at first quarter only at 1.1% it would be pretty marginal. There are sources of profits other than interest. For the quarter itself it would be closer to breakeven than profitable on that first sector business.

But keep in mind, we are writing the first sector business primarily is an accommodation to keep distribution alive and maintain relationships primarily with the banks. So, to some extent first sector business today is an accommodation and we do have caps on total production to try to mitigate the lower anticipated profit opportunity at these low interest rates.

Paul or Yamauchi, do you want to make any comments about that?

I'll be glad to.

Our exclusive agencies have continued to be obviously dedicated to Aflac and all of its products. As a result, we continue to allow those exclusive agencies to offer, not only our third sector products, but in order to be competitive in the marketplace they do still offer certain levels of our first sector products.

In terms of the other channels, as Kriss mentioned, we are holding back and putting in caps for certain areas in certain channels in terms of the total sales. I believe this meets our objectives. We obviously talk about these caps on an annual basis, and we continue to look at them and how that will be affected throughout the remainder of this year as the sales reach those caps.

That is helpful. One final question if I could.

By the way, could Yamauchi weigh in very quickly here?

(interpreted) Basically what Paul has said is absolutely correct. For our agencies to be selling the first sector product they --

We can't hear you. It's not clear. Do it the way you were just talking.

(interpreted) Let me repeat -- as Paul had just mentioned, the third sector (inaudible) our agency, in order for them to do so the first sector (inaudible) for our customers (inaudible) in the back channels we are capping the first sector. And for our customers that is needed in order for retaining the customers to be purchasing the third sector products.

All of that are in our numbers. With the earnings per share guidance we've given, all of that is taken into account and there's nothing there that we are shocked about going forward.

That's clear. Thanks, guys.

Eric Berg of RBC Capital Markets.

My first question is for Dan or Kriss.

While I certainly understand value appreciate what you are doing on the capital account side of things, with the reinsurance and repatriation and so forth, and related share repurchase, I can't help noticing that your business in Japan on a constant currency basis is reporting lower earnings. Your profits are down this year on a constant currency basis and it's not the yen.

My question is, when do you expect to start seeing the earnings? Not the earnings per share, but the earnings of your business in Japan growing? And relatedly, what would you view at this point in the history of the Company as the sustainable growth rate? The long-term sustainable growth rate of your Japan business?

This is Kriss.

I will take a first shot at that and if Dan wants to supplement he can. First, regarding first-quarter Japan operating results, we were down a little bit on a currency-neutral basis. We had lower benefit ratios last year in the first quarter than we had this year. But that was primarily due to the order of magnitude of claim reserve adjustments. Last year we had some release of claim reserves to get us down to the high end of the range that our auditors like to see. And last year we had a larger release than we had this year.

We did have some release this year, but again, we maintained conservative claim reserves, I believe. We try to be within the range that the auditors independently recalculate. And so we just had -- is was really a more difficult comparison, so to speak, of earnings first quarter 2015 versus 2014.

Overall, I would say that we've had the headwinds primarily of low interest rates, somewhat lower cash flows and the like impacting our operating earnings in Japan. And keep in mind, our margins in Japan are the highest in the industry and we really don't anticipate that they'll increase significantly. We've got a bit of a mix shift going on still between first and third sector, and even though first sector sales are down relative to where they had been as previously pointed out, they are still significant. And we're still having a larger proportion of our overall premium income be associated with the first sector products as the business continues to earn out on the premium-paying basis.

Long-term growth rates, Eric -- the way I look at it is, at least related to third sector business -- the medical and cancer -- I relate our fundamental business to the level of healthcare expenditures in the country. And in Japan we anticipate the level of healthcare expenditures will continue to increase. Independent statistics have numbers in the 5% range, and our fundamental business in the third sector is to help our policyholders meet their share of the healthcare costs that they have to bear in Japan.

Right now there's a national healthcare program and the copayments are 30%. We think those will either remain stable or increase going forward. And that might increase our opportunity to further our medical sales.

Regarding first sector sales, it's going to depend on the trend in interest rates. Right now the profit margins are lower than what we want to have in our portfolio, so we're deemphasizing the production of first sector business.

In fact, what we try to make sure of is that if they sell the first sector, they have to sell the third sector as well. Pretty much what I would have said Kriss covered, especially when it comes to third sector, because that's really the way I view our business. The first sector is nothing but an introduction of selling ultimately third sector products. And I would like to see a growth rate of 5% in new sales. It gets tougher as the number gets bigger, but that's a goal that is certainly worthy of us continuing to strive for. And no one's got the distribution system that we have. So, we are always looking for new products and ways to do that. And if we are right now working on another new product, which we can't talk about, but that we are doing, we'll constantly be revamping.

And the wild card, as Kriss said, is whether or not the co-pays and deductibles go up. I don't have any reason to think they are tomorrow, other than if you look at the issues they're having regarding their budgets. They're continuing to have problems and they've got to find a way to bring down their deficits. And with an aging population there's a much higher likelihood that it's going to continue to go up, not down. So I would think there'll be more pressure on reviewing and seeing if they want to increase the co-pays and deductibles, and if they do that, that's a game changer for us.

Let me add one thing, Eric. A little advertisement for the FAB meeting. I do talk about anticipated margins between first and third sector during the FAB speech, as you can refer back to our FAB booklet for what I forecast for 2014-16 as far as benefit ratios, expense ratios, and profit margins separately for our first and third sector business. And I'll update those in May.

So I can tell you right now there's no major change in our margins that we anticipate. So that is a bit of a preview. But it says that a lot of our future growth will be related to revenue growth, not margin expansion.

One follow-up and I'll end it there. I have a question, too, about the reinsurance.

I tended to think of the cost of reinsurance, in a coinsurance deal like this one, as the amount of premiums and the amount of assets that you have to cede -- invested assets that you have to cede to the reinsurer in order to be relieved of a certain amount of risk. So I guess my question is, are you really reducing the cost of the reinsurance? Or, more accurately, are you just insuring significantly less than would be the case if you weren't retroceding the business?

That's a way to look at it. The retrocession reduces the direct cession, obviously. And so, instead of reinsuring 100% of a block of business, you've reinsured 10% of it. And accordingly, you have 10% of the cost.

It is a risk-sharing transaction between Aflac Japan and the reinsurer. And then it's a risk-sharing transaction between the reinsurer back to the US subsidiary CAIC that's the legal entity that picks up the retrocession. So, clearly there are cost transfers, but [napt] to the overall Company. You're correct.

Let me just tell you that we haven't had to do asset transfers in this coinsurance. The prospect of cash flows on the block of business is such that no asset transfer was done in any of the tranches. We just ceded the liability for future claims in exchange for a share of the gross premium. And there is a net cost associated with it.

Just to review: the very first tranche that we did for capital-raising purposes in Japan -- basically we did it because that was the lowest cost of capital of any alternative we had. And we've reduced the cost, or reduced the size of the future tranches through the retrocession. So we are achieving some reserve relief on an FSA basis, enhancing our solvency margin, continuing to protect policyholders and the like, but continuing to free up some of what I sometimes refer to as sterile capital. So, that's an overview.

Thank you.

Humphrey Lee of Dowling and Partners.

Thank you for taking my questions.

A quick follow-up on the reinsurance. Kriss mentioned there would be additional capacity for the reinsurance. Can you tell me on the appetite -- in other words, what factors will [appreciably] do more this year as opposed to last year?

Well, I think I mentioned on the last conference call, I don't want to do reinsurance just for the sake of doing reinsurance. I want there to be an appropriate use of capital in order to incur the cost. Regardless of how small the cost may be, there is still a capital cost associated with doing the deal. And unless we've got an appropriate use for the reinsurance we are not going to have the appetite.

I've covered the uses of capital from the reinsurance we've done so far. We've certainly got additional capacity in terms of the blocks of third sector business in Japan. We certainly continue to have an excess of FSA reserves over US statutory reserves on the same block. And I'm confident that the US statutory reserves are adequate. So we believe we've got some opportunity to relieve ourselves of some of the excess reserves we are holding on an FSA basis.

But there's no point in doing a reinsurance arrangement unless you have an appropriate use of capital. And again, I'll give you some more color on that in May. I don't want to do it on this call. But we do have significantly more financial flexibility today after having done the reinsurance and particularly at a lower net cost than we had 18 months ago.

So, I think we're in a much stronger and more flexible financial position having done each of these three transactions, and proven we can do it. We continue to have reinsurance capacity both from the two companies we've done business with so far, and we've got other parties that continue to knock on our door and ask for opportunities. So, we're happy with where we are.

Thank you for the color.

Another question on the US side of business -- expenses were a little bit elevated. I think that's in part because of the compensation structure changes and also some of the ongoing initiatives going on in the US. How should I think about the expense ratio? How the expenses for the quarter that will be considered more of a recurring expense due to the compensation structure change as opposed to initiatives going on?

This is Ken. Let me comment on that.

I talked a little bit about that in the fourth quarter when we released our guidance and talked about what went into it. In the first quarter of this year, the added expense from the changes we made to our field force structure was approximately $19.5 million net of capitalization. And we expect it to run in the $20 million-$22 million or so and we expected it to run around $22 million is a run rate for the four quarters of this year. So we're a little bit lower than in the first quarter than what we anticipated. But it was, again, about $19.5 million of additional fixed expense coming from those changes.

Thank you.

So, we are coming to the top of the hour now. We have time for one more question, please.

Suneet Kamath, UBS.

Question on these reinsurance deals. Can you remind us -- does the FSA or US regulators need to approve these transactions?

We've reviewed the reinsurance transaction with both the FSA and the US regulators. We've reviewed both the direct reinsurance agreement and the retrocession agreement with the FSA. Certainly we've covered the first tranche with them.

With the FSA we approached them -- we approached the FSA with an opportunity to discuss the retrocession arrangement. They appropriately observed that Aflac Japan was not a party to the retrocession agreement and wondered why we had brought it to their attention. So we apologized and thanked them for their interest. We just wanted to make them aware of the transaction.

But, yes, we've covered both aspects of the agreement with the FSA and, of course, we have covered them with the State of Nebraska both on all three tranches, and South Carolina with respect to the retrocession. We are in good shape on regulatory relationships and approvals with respect to these transactions.

Yes, we want to make sure that we are not only taking care of the shareholders, but also making sure that we have strong capital position on behalf of the policyholders for Japan. So that's important to us, too. And everyone seems happy at this point.

My second question is on Japan sales. You've talked about this on earlier calls, the benefit of staying in the first sector area in terms of your ability to sell third sector products. But have you quantified that? In other words, if you decided to significantly scale down, even incremental to what you are doing now, for sector sales, how big of an impact do you think that would have on your ability to sell third sector products?

Well, I'll just answer that for the time running out. I think we're safe for this year. We feel very comfortable with the quotas we've set and what will take place. As the year goes on, and according to what interest rates do, we'll have to review it, but we're not going to be selling products at losses. So, we'll take it on and figure accordingly. But that's a problem for the industry, not just for us. If it's affecting us it is affecting everyone else in the industry.

So, what we have seen in the past is, as interest rates have stayed down we've used lower assumptions, which has ultimately mean a rate increase on the premiums. So I would expect if rates continue to stay down then we probably have rate increases on policies going forward and that would help solve part of our problem.

Let me add one thing. And it's not earth shattering, but I think what will happen is that if the low interest rate environment continues, you'll see a migration away from the asset accumulation element of life insurance contracts, or first sector contracts, more to the protection element. You know, there's a need for protection in the first sector products, and I think that will become a larger part of the first sector products that we sell -- the pure insurance elements that are still required by policyholders. And we may move more to a protection product in first sector, but I think we'll still do first sector.

And keep in mind that we sold first sector products for a long time and we really started seeing spikes in first sector sales, probably around 2010 when interest rates started moving the way they did. And of course we had to respond to the truly low interest-rate environment in 2013. If you lopped off the spike in our sales you'll see that we're about where we were, pre interest-rate volatility. So that's about it.

Thank you.

Thank you very much, and I will reiterate what Kriss said several times, that we will be having our financial analyst briefing meeting in May. It will be on May 21 in New York. We hope to see you all there. And please give us a call if we can help you with any of those details. And we do have an online registration site. And we appreciate you listening this morning. Be sure to give us a call if we can follow up with anything.

Thank you very much. Goodbye.

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

Editor: Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring the event. End of transcript