美國家庭壽險 (AFL) 2016 Q2 法說會逐字稿

Welcome to the Aflac second-quarter earnings conference call. (Operator Instructions) Please be advised today's conference is being recorded.

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

Good morning, everyone, and welcome to our second-quarter conference call. Joining me this morning from Columbus is Dan Amos, our Chairman and CEO. Kriss Cloninger, President of Aflac Incorporated; Paul Amos, President of Aflac; Brad Crawford, Executive Vice President and CFO of Aflac Incorporated; Teresa White, President of Aflac US. Also joining us from New York, Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us this morning from Tokyo is Hiroshi Yamauchi-san, President and COO of Aflac Japan, and Koji Ariyoshi-san, Executive Vice President and Director of Sales and Marketing.

Before we start this morning, let me remind you that some statements in our teleconference are forward-looking within the meaning of the federal securities guidelines. 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 discuss 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 will turn the program over to Dan this morning, who will begin with some comments about the quarter as well as our operations in Japan and the US. Then Fred will follow-up with some brief comments about our financial performance for the quarter and outlook for the year. Dan?

Thank you, Robin. Good morning, and thank you for joining us today. Let me begin by saying that the second quarter rounded out a good first half of the year for Aflac. I will lead off by providing an update on Aflac Japan, our largest earnings contributor.

From a distribution perspective, our traditional agencies have been and remain viable contributors to our success. This was certainly true in the second quarter. Additionally, all of our Alliance partners continued to produce strong results. I am especially pleased with Japan Post and their 20,000-plus postal outlets selling out cancer insurance. Our goal remains to be where the customers want to buy in our various distribution outlets, broaden our reach to support the scope.

From a product perspective, our priority is to remain in step with the wants and the needs of the Japanese consumers and our distribution channels. Managing through the low interest rate environment is nothing new to Aflac Japan. This entails working through our taxable approach on several prompts including strategies for product, investment, and risk and capital management. Fred will cover more of the financial aspect, but let me expand on our efforts related to products, starting with core sector products.

We are encouraged that the actions that we've taken throughout the second quarter to limit the sale of core sector products has been yielding the desired results. First-sector products sales decreased 24.7% in the quarter. These actions include a combination of product caps, commission restructuring, product repricing in select cases and product discontinuance. Recognizing that many of these actions were initiated in the second quarter, we continue to anticipate a sharp decline of at least 50% in first-sector sales in the second half of the year compared to the second half of 2015.

Turning to the third-sector products, you'll recall the last quarter we introduced a cancer insurance product designed for those who have previously been diagnosed with cancer and have been cancer-free for five years. This is similar to the product we offer in the United States. Last quarter, we also introduced an enhanced nonstandard medical product. We are pleased with the reception of both products in the marketplace.

You'll recall from the May financial analyst briefing that we anticipated sales of third-sector products would be in the range of down three to up two, and that is still the case. With Aflac Japan's third-sector products up 11.2 in the quarter at 6.4 year to date, we are running ahead of expectation for third-sector sales. But there is no one single aspect of the business that has contributed to our outperformance. It is simply stronger-than-expected productivity across the majority of the distribution channels.

Keep in mind sales in the bank channels have been moderate by restricting our sales of the first-sector products. We continue to believe that the long-term compound rate of third-sector products will be in the range of 4% to 6%. We will continue to be innovative in providing options that millions of Japanese consumers are looking for as they struggle for financial burden of higher medical expenses.

Turning to Aflac US, as we indicated before, we see 2016 as a year of stabilization and opportunities as we continue to execute on our strategies. Our efforts are focused on enhancing the relationships we've established with brokers and providing our career agents with the tools to increase productivity.

While sales in the second quarter were below expectations, keep in mind that sales in the second half of 2015 contributed to 55.6% of the total sales. Our projections show that we are still on track to achieve our target of increasing Aflac sales 3% to 5% for the year.

I do want to emphasize once again that we anticipate our sales will be increasingly concentrated toward the end of the fourth quarter. But what we've achieved prior to that time lays the groundwork for our overall success.

As you all well know, success breeds competition. US health care reform has been highlighting and clarifying the need for the products we sell. This has resulted in a number of other companies entering the voluntary supplemental insurance markets such as traditional major medical carriers and companies that sell voluntary insurance.

As a result, we are executing on strategies designed to set Aflac apart and further enhance our runs and relevance to the employer, the employees and brokers. Aflac's single focus on supplemental voluntary products has greatly contributed to our dominant position of selling voluntary insurance at the work site, and I believe it will continue to drive our competitive edge. Keep in mind that so far this year, we have written more business than the other two competitors combined.

One Day Pay also remains a key differentiator for Aflac. We will continue our promotion of One Day Pay to the consumers, which we believe will help drive increased brand loyalty, account penetration and production. Here's an amazing statistic. In 2015 and continuing through the second quarter of 2016, 100% of the eligible One Day Pay claims submitted were paid within one day. We have processed, approved and paid over 1 million One Day Pay claims in the first six months of 2016. And get this: 96% of our policyholders that use One Day Pay or SmartClaim, as we call it, said that they are likely to refer other people to Aflac. I am convinced that this will result in more new sales going forward. Paying claims fast and fairly sets us apart from the competition.

Turning to capital deployment, Fred will provide more detail shortly. But let me just say that we continue to view growing the cash dividend and repurchasing our shares as the most attractive means for deploying capital, particularly in the absence of a compelling alternative. We believe the capital strengths positions us to repatriate in the range of JPY120 billion to JPY150 billion for the calendar year 2016. Despite market volatility, our capital position remains strong and reinforces our plan to repurchase $1.4 billion of shares of our stock, with the majority being concentrating in the first half of this year.

One other message I'm sending as CEO is we are laser-focused on leveraging opportunities for the future. I'm letting everyone know that innovation and change are vital aspects of the business environment here at Aflac Japan, and that's what has continued to propel our long-term growth and our success. We have maintained our focus of controlling the things that we have the power to control. We can and we will control our efforts to build our business and to take care of our customers, our employees and our distribution network. By doing this, I believe we will continue to enhance shareholder value while delivering on our promise to our policyholders.

Now I'll turn the program over to Fred, who will cover the financial results. Fred?

Thanks, Dan. You have all had a chance to review the details in our earnings release. As Dan noted in his comments, the second quarter represents a continuation of the strong financial results we reported in the first quarter and executing on key initiatives covered at this year's financial analyst briefing in May. Second quarter showed continued progress towards achieving our full-year 2016 earnings guidance. Our results were driven by strong overall margins in both the US and Japan, and there were no notable earnings items to speak of in the quarter.

Our Japan segment margins were solid, with both benefit and expense ratios coming in as expected and generally in line with our guidance. In the US, benefit ratios performed within our expected range after a seasonally strong performance in the first quarter. Our expense ratio is modestly favorable in the quarter. Consistent with previous years, we fully expect our expenses to pick up in the latter half of the year as we progress on certain strategic initiatives and increase promotional spend entering the enrollment season. In both Japan and the US, we would expect our benefits ratios, expense ratios and overall margins to trend within our December outlook call guidance ranges for the remainder of the year.

Turning to investments, new money rates in Japan were understandably down in the period as we navigate the low yield environment, but also influenced by a tactical strategy of temporarily investing in low-yielding but high-quality and liquid securities pending development of more attractive long-term investments. We continue to be on plan in terms of Japan's net investment income for 2016.

US new money rates were influenced by an increased allocation to corporate investment-grade purchases, which served to lower new money rates in the quarter. You may recall in the first quarter we had elevated new money rates as we concentrated investments in higher-yielding middle-market loans. So, to some degree, the second-quarter purchases are balancing out our allocations.

Let me comment for a moment on market developments since our FAB meeting in May and its influence on our investment strategy as we look forward in 2016. Specifically, the negative rate environment in Japan and movement and hedge costs supporting our US dollar investment strategy.

Post-Brexit announcement, we experienced another move down in rates as JGVs and US treasuries continue to be the world's flight-to-quality currencies and investments. While having modestly recovered in the past few weeks, we have seen 30-year JGBs grind down to near zero at times. Curtailing interest-sensitive premium flows is essential. And, as Dan noted, we are taking further action to reduce the sale of first-sector savings products, namely eliminating the sale of product in certain channels and accelerating pricing actions. We will continue to sell repriced saving products in support of our exclusive relationships where the ratio of third-sector to first-sector sales is significantly in favor of third sector.

Specific to investment strategy, we remain in good position for 2016 asset flows and defending net investment income, but we are undertaking a review of our strategic and tactical asset allocation and associated risk limits in preparation for 2017 flows. We hope to provide additional color at our September FAB meeting in Japan. But at a high level, the plan explores developing alternative high-quality yen investments, a measured entry back into yen private placements, and US dollar investments where we can hedge effectively in optimizing investment income consistent with our risk limits, ALM and capital objectives.

Turning to US dollar program, our hedge costs in the second quarter were essentially flat with the first quarter at $0.08 a share. However, hedge costs have continued to increase in recent weeks with market volatility and speculation on DOJ and Federal Reserve actions. At our May FAB meeting we guided to realized hedge costs of 110 basis points on $13 billion notional investment in forwards, assuming no movement in pricing or change in our hedging strategy.

In the weeks leading into Brexit decision, post-Brexit and anticipation of last night's DOJ announcement, one-year forward pricing is now closer to 160 basis points. As you know from our previous comments, the rising hedge cost was fully expected, as recent years have experienced abnormally low costs relative to historical norms. Note also that we currently recorded the full cost of forwards upfront in the quarter purchase instead of amortizing the cost over the life of the hedge. Thus, the timing of what is rolling on and off the program can make a difference in our reported costs.

In addition to market pricing, as we move into the second half of the year, we intend on executing on a couple of tactical moves that will result in an increase in our recorded hedge cost. First, we have done some rebalancing and have moved to hedge additional dollar asset classes and expect to increase our net notional forward position by roughly $2.9 billion, including $1.9 billion in bank loans hedged in July. Bank loans are ideal to hedge, as these are floating rates and better match for shorter-dated forwards. In addition, we will look to cover a building equity and commercial real estate loan portfolio under our hedge program.

Importantly, hedging these additional US dollar asset classes along with other related rebalancing activities are expected to strengthen our SMR ratio once completed. We estimate in the range of 30 to 50 points at a net cost of approximately $10 million to execute on the overall strategy.

Isolating the increase in the cost of hedging and our move to cover additional asset classes increases our hedge cost to the $215 million range for the year.

Finally, we have seen the forward pricing curve flatten, thus making it more economical to lengthen the weighted average tenure of our forwards. Together with our house view that hedge cost may rise, we are exploring lengthening the average maturity of our forwards by rolling a portion into longer-dated positions. This strategy may increase our estimated cost in the $40 million to $60 million range, recognizing our current method of reporting cost at the time of purchase. This strategy may evolve as markets move, and we will continue to guide accordingly as we proceed through the year.

While increasing our reported costs, these moves are favorable from a risk and capital management standpoint. Importantly, the dollar program overall and expanded asset classes continue to perform well, even when considering rising hedge costs and when compared to low-yielding yen alternatives. This is why we have seen a surge in dollar and currency programs among Japanese insurance players over the past few quarters. As we move forward, we will update our guidance accordingly, and, as is always the case, our guidance could change based on precise asset flows and market conditions.

Turning to capital, SMR remains in the mid-800% range, with unrealized gains up significantly in the quarter. RBC remains strong despite FX impacting the ratio negatively, with the yen strengthening and realizing our Japan branch is embedded in our US statutory results.

Impairments in the quarter were modest and primarily related to our Japan equity portfolio where market declines have triggered impairments in accordance with our internal accounting policies. Overall credit conditions remain stable, and we have seen a recovery in energy names including our below-investment-grade holdings. We do not see any immediate risk with respect to Brexit and our European holdings.

Overall capital liquidity conditions are strong and support our continue return of deployable capital to shareholders. Between dividends and repurchase, we returned $570 million to our shareholders in the quarter. Depending on the overall capital conditions, we expect to repatriate 80% to 100% of FSA earnings in 2016, or roughly JPY120 billion to JPY150 billion. We continue to spend down excess capital held at the holding company and are on pace to achieve our $1.4 billion in repurchase for the full year.

We have made no adjustments to our earnings guidance of $6.17 to $6.41 per share, assuming the same average exchange rate as last year, which was roughly JPY121 to the dollar. Given strength in the yen during the quarter, we have provided in our press release an ATS range in the third quarter assuming a yen-to-dollar of 100 to 110.

When annualizing our performance year to date, we are poised for strong performance in 2016. However, we are midway through the year, and we need to be conscious of the low rate environment, headwinds to investment income and associated actuarial review of select interest-sensitive closed blocks of business in Japan. In addition, from a corporate perspective, postretirement benefit liabilities are sensitive to long-term rate assumptions, and we typically review these corporate liabilities in the fourth quarter.

Overall, we remain well-positioned in terms of our core margins and capital strength.

Thank you, and I will now turn the call over to Robin to begin Q&A. Robin?

Thank you very much, Fred. And as Fred just said, we are ready to begin Q&A. So, we are ready to take the first question, please.

(Operator Instructions) Nigel Dally.

Fred, with the hedge costs, you went through a number of different changes -- increasing the size of the program, changing the costs given by conditions, extending the duration. Putting all those together, what do you expect to be the overall negative impact on the earnings for 2017? And also, why not report these costs on an amortized cost basis rather than all up front? It would seem to be a more economic way of reporting them.

Sure. A couple of comments. Let me handle the last -- second part of your question first. We are, in fact, putting under review our definition -- really, our non-GAAP definition of hedge costs and how we want to report it in our definition of operating earnings. And, in fact, it's very likely, Nigel, that we go to exactly what you're talking about, and that is more of an amortized cost approach, very similar to how you would expect coupons on bonds to behave or interest costs on debt.

So, that is really where we are going to move. We will give more detail on this -- more precise detail on this during our outlook call along with recognizing that we would have to some degree adjust, if you will, our previous-year results so that you could see really the comparables year over year.

But, ultimately, the goal is exactly what you're alluding to, and that is we want to get to a definition of hedge costs that moves logically with how you would expect. If pricing is increasing, we would expect hedge costs to go up. If we are lengthening the tenure and it's a steep curve, they would go up and vice versa. And, of course, if we are doing more volume, covering more notional, they would go up or down depending on the strategy. What we want to avoid is what we're seeing right now, is we don't want any mark-to-market noise, nor do we want the sheer timing of what rolls to influence it.

Now, to your first question, as we roll into 2017, of course, what I just talked about will play into what I'm about ready to say. But you will generally find a more smoother and logical approach to the cost. So, a good way to think about it is if we are covering now moving from roughly [$12.7 billion] notional of forwards to upwards of [$5.7 billion] or [$5.6 billion] notional forwards, you would expect as you move into 2017 to roughly apply the pricing or average -- weighted-average pricing you would expect on those forwards.

Now, the pricing depends on the market, so it's very difficult for us to estimate what that would be. As I mentioned in my comments, we have seen pricing rise. A one-year forward, for example, right now if you went out and purchased it would be about 160 basis points.

What you could expect is that when we get our outlook call, we will provide these types of details and ranges and sensitivities as part of our operating earnings. But that will give you, I think, a little color.

Fred, sorry, it's Eric. I just wanted to correct something. It's at year-end [$15.6 billion] of forwards. I think you said [$5.6 billion].

Oh, I don't know. I thought I said [$15 billion]. But sorry; my apologies.

Great. Thank you. Appreciate the color.

Eric Berg, RBC.

What would you say would be the general trajectory for -- I realize you're not going to project your statutory earnings. But what would you say would be -- given the growth of the in-force at this point both here and in Japan, would you expect statutory earnings to continue to increase? And if so, in the absence of strong premium growth -- strong in-force growth, why would that be the case? Thank you.

Statutory results is an interesting conversation with us because really what you're talking about is bifurcating between Japan and the US. So in Japan, you're talking about essentially FSA earnings. And you can sort of -- implied in our guidance, if you will, where we talk about repatriating 80% to 100% of FSA earnings or that being JPY120 billion to JPY150 billion, that gives you an idea of our expectation around FSA earnings for this year.

So, what are the types of things that will cause trend lines in those statutory earnings? You have mentioned a couple of them -- growth rates -- realized over time because we are seeing growth in third sector, which was way down on FSA earnings. We also seeing a gradual decline, obviously, and, frankly, more than a gradual decline in first-sector sales, which would really promote or help, if you will, FSA earnings. So I expect those would probably largely level out.

Now, you do have some other things playing into FSA earnings. You do have foreign exchange that plays into it as we convert dollar-based coupon income, if you will, in Japan back into yen. You'll see some headwinds, if you will, related to a strengthening yen from that perspective. We have some of that factored into our guidance, as you can imagine. But nevertheless, that plays a weight on it.

Then hedge costs -- I always remind folks hedge costs are in fact brought through FSA earnings. So, as those rise they could be weighing down on your FSA earnings as well.

I would note, however, that, interestingly enough, even with the rising pricing here this year, we actually had planned for hedge costs coming in right around where we are seeing them or projecting them today. So I don't see the recent rise in hedge costs as having implications for our 2016 cash flow.

When you roll over to the US, it's a bit of a different matter. So, starting with just isolating the notion of US-only statutory income, we don't drive a US-only statutory income, so it ends up being excess cash flows produced in the US. And those have remained relatively steady. I would say we are seeing some growth rate in the US, and we are also investing in the US platform in the form of technology improvements and infrastructure. So, some of those are headwinds to statutory earnings. But otherwise, our sheer margins in the US, generally favorable benefit ratios, expense ratios generally under control have been really helpful to stat earnings.

So, I don't see any sort of what I would call capital-related or growth or lack thereof related pressures on statutory earnings in the US. I would see it more to do with the pace of investment in the platform.

Thank you.

Ryan Krueger, KBW.

I had a follow-up on the hedge costs. Fred, you talked about 160 basis points for a one-year forward, but then I think you were talking about potentially extending the duration of the book. Can you give a sense of how much more it costs on the longer-duration hedges you're potentially considering?

Yes. One of the things that's happened in the marketplace is, while we have seen hedge costs rise, they have also -- the curve is flat. And so, for example, in really just the last few months, the difference between a six-month forward and an 18-month forward has narrowed by some 25 basis points. And so if it costs you upwards of 150 basis points to lock in a six-month forward, it may cost you more in the 170-, 175-basis-point range to do an 18-month forward. And so as a tactical strategy, you may want to take advantage of some lengthening where you can, and that's what I was alluding to in my comments.

The reason why that results in a more acute cost in 2016 -- this $40 million to $60 million range I mentioned my comments -- is recognizing that we would pull that whole 18-month cost right into the current period. And so, again, as Nigel pointed out, as we move to a more amortized approach, you won't have that type of fluctuation. And so that gives you an idea of the relative difference and curved difference of extension.

Something to remember is that at FAB, we talked about 110 basis points. And remember, that is a realized cost estimate. That was taking roughly $13 billion or so of notional and $140 million or so of expected costs.

So, when you think about $215 million of costs, setting aside the duration extension, that's right around 140 basis points. So, there's a difference between the actual pricing in the market and our realize costs because, of course, we've locked in certain costs and have this accounting issue.

Got it. Then just to clarify, does the $215 million, does that -- that does not include the $40 million to $60 million of additional that was from lengthening the duration?

That's correct.

Okay. And then just a follow-up on the 30- to 50-point benefit to the SMR from repositioning the portfolio. I guess a couple questions. Is that just due to lower risk charges associated with locking in the hedges there? And then I guess is this anticipated in the three-year capital plan that you provided at FAB?

Yes. The answer to your first question is yes. And that is, when you put those hedges on, you just gather more favorable SMR treatment, if you will, as opposed to not having it due to essentially what amounts to ALM-related issues, i.e., a dollar investment backing a potential yen liability. So you gain certain benefits.

We also are covering asset classes that could be of a higher charge order such as bank loans, for example, which will tend to be lower rated, if you will, in general. So, again, makes it even particularly helpful.

And as I mentioned in my comments, what I really like about the bank loan coverage, which took some time to qualify -- when you are talking about floating short-dated investments and short-dated investments that are being managed by third-party asset managers, it took some time to work through the system and qualify for all the appropriate hedge treatment. We were able to get that done here in the last couple of months so we could expand asset class. So, it's a particularly all-in beneficial asset class to hedge. So we're really happy with the progress we've made there.

But that's where you pick up the SMR benefits.

In terms of it factoring into our capital plan, yes. Yes in the sense that one of the missions of the hedge program -- only one of the missions -- is in fact to stabilize and secure our capital dynamics in Japan such that we can be as confident as we can on the steady repatriation of cash flows for deployment. So, no matter what the magnitude, it is helpful to our capital plan. I would not view it, though, as some sort of just boost or jump in the capital plan; more playing good defense.

Okay. Great. Thank you.

Suneet Kamath, UBS.

I wanted to just move to sales, if we could. Just in terms of Japan third sector, you are reiterating your guidance for down 3 to up 2. Obviously, year to date we are running above that, as I think Dan mentioned in his prepared remarks. And I see that the comps get a little bit more difficult, but I don't know if they are dramatically difficult. So, just curious if there is anything in the second quarter that maybe was particularly favorable that we should think about adjusting for as we think about the balance of the year in terms of third-sector sales.

This is Paul. I will follow up and start on that, and then I will ask Eddie or Yamauchi-san or Koji to comment as well. First of all, as Dan mentioned in his comments, second quarter represented just an outperformance by almost all channels with the exclusion of the bank channel and strong performance in both the cancer and the medical lines of business. So, I do not believe there's anything you should be removing. And you should just see it as straight -- strong performance across our channels and a desire by Japanese consumers to purchase our products.

In terms of the second half of the year, the comparisons are there, and we do have to go up against stronger numbers. That said, we are running ahead of where we expect it to be. And I think at the mini-FAB meeting in September, we would be in a better position to comment on whether we thought sales would continue to trend better than they have.

As you know, we launched our MIT product this past week. And so by the time we get to our mini-FAB meeting in September we should be able to give you some idea about the receptively of that product. But as I've told you in the past, with any new product line, we are always tentative about how it will be received and how long it will take the Japanese agencies to adopt it and begin selling it.

We are very -- seeing very favorable results out of both our cancer for cancer survivors insurance as well as our revision of our nonstandard medical plan.

So I remain very optimistic, but at this point we're not ready to change that range. Yamauchi-san or Ariyoshi-san, would you like to comment further?

(spoken in foreign language) Nothing particular to add. However, what I would like to mention is that JP channel is going as planned, and, as Paul just mentioned, our nonstandard medical is doing well.

Okay. Thanks. And then I guess maybe a bigger-picture question for Fred, obviously lots of moving pieces in terms of product mix shifts and hedging costs and all that. But if we just take a high-level view of Japan in particular and we think about your new business returns or your marginal ROE, how would you say that compares to your in-force returns?

Well, in-force returns have been very strong, and that's in part because what we had historically priced for, if you will, has moved over time favorable to our pricing expectations. So in general, this is, I think, part of the Aflac story, frankly, over the years both in Japan and the US that we have a generally very profitable in-force overall.

In terms of some of the new pricing, obviously we tried to remain very disciplined on that front. I think in Japan, there hasn't been much movement on that. We have been growing the old-fashioned way, which is expanded distribution, new product launches. And we remain somewhat consistent, in my view, on our purchase pricing.

One difference, of course, is really focusing in on first-sector and third-sector savings. I would say when you turn your attention to those products, not surprisingly from an in-force perspective, those products are bit more under pressure because the opposite has happened. What we had priced for has not played out quite as well in terms of, obviously, yields and investment income on those products.

So that certainly offsets my comments. And it's why we are taking significant action to make sure that we reduce the flows and shift the balance of sales and eventually in-force over time. So that's the way I would describe it. But obviously from the in-force perspective on the third-sector side and really the entirety of the US platform, it continues to be a very strong story.

Got it. And I just -- if I could sneak one more in, just a clarification, when -- I think Brad in your prepared remarks, you talked about the channels where you continue to sell first sector, and I think you said the mix in those channels is skewed towards third sector. When you think about that mix, is that based on number of contracts, or is that based on annualized premiums?

I will let Paul comment.

This is Paul. That's based on annualized premiums. So we don't -- because of the size -- relative size of first-sector contracts and their strength, we are thinking about the ratio in terms of premium itself.

Helpful. Thanks.

Humphrey Lee, Dowling and Partners.

Shifting gears a little to the US, the productivity continues to see a good improvement on a year-over-year basis. Given the ongoing investments, how sustainable is the current pace of improvements and how should we think about it going forward?

This is Teresa. I want to make sure I understand the question. You are speaking in terms of the productivity from a producer standpoint, or a profit standpoint?

The profit standpoint -- the production divided by the agent count.

Yes, that would be agent productivity.

Okay. I do still feel that there is opportunity with agent productivity. As I spoke about in May -- I think at the May FAB meeting, we are continuing to see a number of great indicators. New account growth is increasing the productivity per producer of the (inaudible) increasing. And the whole goal here is to ensure that when we bring new agents into the business, that we are able to get them trained, ensure that they stay with Aflac so that they can have a good career with us. So, we are seeing that happen. We're excited about what we are seeing in the numbers.

I am somewhat concerned about the recruiting as a whole. And I think out comparisons -- we expected recruiting to be down for this quarter of this year. And, really, I think a lot of that is some of the noise that were in the contracts last year as we changed the contract this year to pay not for recruiting, but for producers. And so because that's how we are compensating our sales organization, I think that we will continue to see growth in productivity.

And one thing I would comment on is to some degree your comment was how does this all sort of drive down to the bottom line. Just a couple comments. One is, of course, when you are talking about relative spend on distribution and productivity, you are now getting into adaptable, if you, will expenses. So, you wouldn't see typically much in the way of big bottom-line movements.

I think from an overall investment in the US platform, I would just call your attention back to our comments at FAB and, in particular, some comments and some projections we showed around the group business where we are actually investing in the platform and expecting there to be an improvement in profitability on just a group side over the course of the next three to five years.

That continues on plan, continues on pace. There's been really no material adjustments from our comments at FAB.

Okay. Then maybe more a strategy question for Dan. In your prepared remarks you talk about a greater competition in a voluntary product side coming from other players. And I recall in the FAB meeting, you guys talked about you may consider providing a more full suite of group solutions in the US. Any updates on what you are thinking about at all? What type of opportunities you are seeing?

Yes. What I would say is that we are trying through our Everwell platform, which is an enrollment platform (technical difficulty) we are positioning ourselves to where we are trying to be the solution for the human resources department. And in doing so, for example, through this Everwell platform, if it's an account under 50 in size and they want to go to buy Obamacare products, then they will be able to do that through our platform to go in and do that. So, it also allows us to see everyone on a one-on-one basis. So, that ultimately should increase our enrollment.

As far as other products, we are looking at other products. Teresa is studying that right now. We have not made any final decisions. But the type products would be group life. And if we did something along those lines, some of our competitors offer that, and we feel that we will either have to offer it as -- through another company and bring it on in some form or fashion. But we want to make sure, because it's a lower-profit-margin product, that we don't have our sales force concentrating on it. But rather, it is a product that opens the door for higher sales of our third-sector products (inaudible) -- I'm used to seeing that because of dealing with Japan so much -- of our supplemental products in the US.

Got it. Thank you for the color.

Jimmy Bhullar, JPMorgan.

The first question is for Teresa on US sales. The results are getting better. I think first quarter you had almost a 4% increase in sales, and this quarter they got worse. So, wondering if you could just give us a little bit of the details -- a little bit more detail on what happened to US sales and how that affect -- how second-quarter results affect your outlook for the rest of the year.

I'll handle the last comment first. We continue to believe that the outlook, 3% to 5%, will materialize over the year. As Dan said in his comments, we do expect that to be closer to the fourth quarter, so it will skew there.

One of the things in the second quarter, what we're seeing, is we saw really favorable comps for the -- not favorable comps, but favorable performance in the broker business. We basically grew the broker business by about 15%. So we felt good there.

The weak spot was our career size. And we are -- have some markets that have underperformed, and we are confident, though, that we have some -- the leaders -- the right leaders in place to address those issues that we have with those markets. But at this point, I feel good about the 3% to 5% for the year.

I'll make one other comment. As I -- we've told you at FAB and other places, our struggle is trying to bring brokers on in a -- we are probably the only organization to have such a -- well, I know we are -- that has such a dynamic field force. So, we're trying to push our field force into writing the accounts of 100 or less. The overlap is between the 100 and the 1,000. And over 1,000, we tend to see brokers. Now, our brokers are also using our field forces as enrollers. So, that doesn't break out exactly that way because that shows us broker productivity.

But all in all, it is beginning to evolve in a way that will ultimately, I think, increase our production. But it has been a struggle, and Teresa has done an exceptional job in bringing those together. When that is really clicking, that is when you're going to see it take off. And that's what we continue to work on is that. And the production being off a little bit is because of our field force. But we think with Everwell and our way of enrollments increasing dramatically, of the 40% if you go through that process, that's going to help our field force and the tools that we give them.

So it's a delicate balance here, but we're getting closer and closer. And the thing that told me that was in a recent meeting I had when some of our managers at our field level said they wanted the managers at our broker level to be at their meetings. They didn't used to want to get together, and now they are working together as a team. I think it's only going to get better as we move forward, and I'm very encouraged about that. But it is slower than I like.

Yes, and you had made a lot of changes in your field force. So, I would have thought that as we get further and further away from the disruption because of those changes, your results would actually slowly trend higher. So, I recognize it's one quarter, but it's a little surprising even in the wrong direction.

I will say this again. It takes time with the field force and, again, trying to move them to -- you should look at the overall number. And the number, I understand what you're saying. But the field force will continue to make up the small accounts, but the big accounts are going to be coming in. And in the second quarter, our broker business was way up. So, it was our field force that was down slightly. And of course, they account for two-thirds of our business. So, that's the other thing that's dragging us back. But I think, long-term, we have got a solution for that, and it will continue to improve.

Then just one more for Eric on Japan new money yields, they had dropped this quarter. And I'm just wondering if you could give us some details on what exactly it is that you are investing in in the Japanese portfolio. How much are you allocating to US dollar investments? And if JGB yields remain where they are, what would you expect your allocation to be roughly as you look into 2017?

Sure. Thank you. No worries. There's a few different components to that. But obviously, as you know, yields have been trending down both in the US and Japan. So that's partially the decline for the second quarter new money yield.

But the bigger attribution of the decline was -- and Fred referenced this in his speech. As we are entering into new asset classes such as infrastructure, commercial mortgage loans, those take time to fund. Unlike when we buy investment-grade bonds, we get into the market and fund those pretty quickly.

Now, since we are turning those asset classes on for the first time, we knew that there would be a delay in funding them. And, therefore, during the quarter we had a buildup of cash, because it is taking us a little longer for our first time entering those asset classes.

When we are sitting on cash, that doesn't go into the new money yield in the way we've defined it. But nevertheless, sitting on cash is not optimal for us, and we didn't want to do that. So we did put a little over $1 billion to work during the second quarter into yen assets, mostly residential -- Japan residential mortgage-backed securities and some JGBs as a temporary home, if you will. So that when the infrastructure and commercial mortgage loans are ready to be funded, as our managers call us up and say, we have circled deals for your portfolio, we will then shift out of there and put it into those assets.

But because we put that cash to work -- and we did keep it in yen for now; we didn't want to move it back and forth between yen and dollars -- that had the result of, on average, being invested at 30-basis-point yield or so. So, for the quarter, that impacted the new money yield and brought it down.

But as we redeploy that money in the future from yen back to dollars, later on, whether it be later on this year or early next year, you'll see the new money yield go in the opposite direction and be higher than it normally would be.

I should also mention by putting that cash to work, we are earning for this year, based on estimates of timing of reversal, about $2 million extra in net investment income versus it just sitting idly in cash. So, that explains most of the decline for the second quarter versus our planned new money yield.

More broadly speaking, for the second quarter, about 50% of the assets that we had to invest in the second quarter -- and I'm using Aflac Japan numbers, which was about JPY224 billion -- did go into yen assets because of that extra money that I just referred to. And the other half went into dollar assets -- US equity, investment-grade, commercial mortgage loans, bank loans.

The nice thing is, as you look at the mixture, we continue to diversify the asset base, which gives us as investors a multitude of choices not only from a risk return standpoint, but in this very volatile environment, particularly of negative rates in Japan, as our SAA and our outsourcing program and our in-house programs build out, those choices are opportunistic for us to balance out those things.

Then, very lastly, in terms of the view of JGB yields and impact to next year's cash flow, let me say this. At negative rates, which the 10-year is still negative, about three weeks ago the 20-year and the 30-year JGV were both under 10 basis points. We have put a moratorium on buying JGBs. And if they should stay at those low levels, we would not be buying JGVs. But, as Fred has mentioned, we are actively exploring other yen investments because we do need yen investments certainly from an ALM standpoint. Our liabilities, as you know, in Japan are in yen. And there are some promising things on that front, perhaps restarting our yen private placement program. But if we do, it will be in a measured pace. And obviously with a global credit team with much stricter risk limits than we had in the past, bringing down our private placements to about 24% of the portfolio, we do feel that there's some capacity there. But we still have to test the market in terms of supply and whether or not the structure of those types of things will meet our requirements.

There are yen corporate bonds that we could be looking at. There are some ratings -- regulatory things we need to explore. But all of that is a way to say that the ultimate rate on those assets would be based off the JGB yield curve, but we would be earning a credit spread. And that is something that we like because we are very bullish and confident of our credit analysis and ability to analyze credit and therefore get the right return for the risk we are willing to take.

So looking at next year, this is just so early. But consistent with prior SAA, it would probably be about 30% to 40% yen assets, 50% to 60% dollar assets. But Fred mentioned earlier we are right now reviewing SAA in light of negative rates and how that -- the implications of that to the programs. Then from a tactical standpoint, as we look at these new asset classes, that will bear in to our ultimate decisions for next year. So, very preliminary view and outlook for next year.

In terms of infrastructure for the new asset classes that you are going into both in Japan and in the US, are you fully staffed or would these require either more spending on your part, or are you using -- are you outsourcing some of the assets?

Yes, infrastructure would be outsourced. And as you recollect, we built our external manager platform teams. So that's been built. And, therefore, we get the leverage of being able to decide, gee, we like an asset class; now let's go to market, find the best managers, do RFPs and those sorts of things. And we are in the final stretches of that and about to make some selections, which, either by mini-FAB or perhaps by the next quarterly earnings call, we can tell you more about that. But we are committed to that, and that is in the final legs of going online.

Thank you.

As we reach the top of the hour, we've got time for just one more question, please.

Tom Gallagher, Evercore ISI.

Fred, I just wanted to ask a question about how you are thinking about capital adequacy right now. I know your SMR ratio is quite strong, but I'm guessing with negative rates, SMR is no longer the best measure of capital adequacy here. So, in that regard, can you talk about just broadly how you are thinking about valuing capital adequacy? Are you using some type of internal economic capital model? And, if so, what is it telling you right now?

It's -- I would not discount SMR. It remains critical and really arguably the most critical measure in Japan. I think what's more important is be realistic about your understanding of what is moving SMR. In other words, there is a difference between SMR rising because of sheer retention and build of capital and SMR rising because of unrealized gains in your portfolio. So, you know from following us, we are quite -- I will use the term -- sober in terms of understanding that our SMR may go up at times, but it's driven by unrealized gains. That doesn't necessarily give way to the release of additional capital, et cetera. So we look at it on that basis, but pay careful attention to it.

I think, in addition to that, we look at just sheer cash flow performance. And I commented earlier on dynamics involving our FSA earnings. The reason why we have 80% to 100% of FSA earnings repatriation as a policy is that in times of stress we may retain more capital.

Right now, as I look at the risk as we go forward -- I mentioned in my comments that we do have to be conscious of a couple small close blocks of business that are more sensitive to low-for-long interest rates and actuarial sensitivity. I think it's really too early to tell at the moment whether we will see any impact from that. We have, of course, got other blocks of business that tend to be somewhat rich quote unquote with respect to reserves and ID&R and so forth. So, there could be offsetting issues. So, at the moment, I think we're just being cautious and looking at those issues.

I do think that if you think about where we are in the credit cycle, if you think about the interest rate environment in Japan and the associated volatility, I think it is in fact a time to be cautious about the notion of sizing, if you will, excess capital and deployable capital on a purely Japan basis. Cash flow remains good. I would not really move off of any of the comments I made at FAB. But we are more carefully watching it.

Now, contrast that with the US where, if you were to look at a US-only basis, our business remains very strong, very stable. It's by definition a low-risk-profile business. We run at very high RBC levels, if you were to look on a standalone basis.

So I continue to promote the notion that, while we are moderating our views of excess capital in Japan, we continue to be bullish on the notion of there being excess capital levels in the US. And we will try to balance that out as we go forward.

Got it. And Fred, just a follow-up. Are you using some alternative measure, whether that's just for your purposes as another cut looking at the economics of your Japanese business, or are you really relying on SMR now to determine capital adequacy?

No, Tom. Thanks for asking the question because -- let me just step back and say that everything starts at the root of our capital planning with just our view of the risk, not a formula's view of the risk. And by that, I'd say we have developed, as you can imagine, certain economic capital approaches to stressing our business, looking at adequacy both in Japan and the US; a little more of an issue in Japan given the low rate environment.

And very, very importantly, don't lose sight of the stress testing. We do pretty extensive stress testing both in Japan and the US looking at all the variables you are accustomed to in terms of moving our ratios around. And under those stress tests, that can guide us to some degree in how much capital we carry.

So, I've got my partner, Todd Daniels, right next to me, and he is our risk manager globally. He and I worked in very close contact along with Eric in looking at these stresses, looking at economic capital-oriented capital ratios as well as the stated ratios. So, you are right to ask that question. We do do that and it guides our behavior.

Got you. And even -- I'm sorry, one last follow-up. When you consider economic capital, you still -- you feel like you are in good position, all things equal. Is that fair to say?

Yes, if you look at -- if you follow Japanese insurance companies, you'll note that on their economic value analysis, that they have lost economic value related to the very low interest rate. Remember that their business models tend to be much more heavily weighted towards the types of businesses that will take it on the chin, so to speak, with respect to low-for-long rates.

Now, we're not immune from that. We have businesses. Most notably, first-sector savings-oriented businesses that will get depressed. Some of the longer-duration businesses can get depressed related to low-for-long rates even on the third sector side. So, we are not any different than the Japanese companies in the sense that we have seen headwinds on those ratios. But realize on a relative basis we tend to perform much better, we tend to model out more favorably because of the sheer strength and size of our third-sector business in dominant positions.

So, no question, there have been headwinds to those type of what I call traditional economic capital positions, but we tend to do well on a relative basis and that helps us out.

Okay. Thanks a lot.

Before we end the call today, I would like to take the opportunity to remind everyone of our upcoming Tokyo financial analyst briefing to be held on September 12. For further details, please don't hesitate to call us, and we look forward to seeing you there. And thank you again for joining us today for the call. Goodbye.

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