Aflac Incorporated (NYSE:AFL) Goldman Sachs 2022 U.S Financial Services Conference December 6, 2022 10:40 AM ET
Company Participants
Frederick Crawford – President and Chief Operating Officer
Max Brodén – EVP and Chief Financial Officer
Conference Call Participants
Unidentified Analyst
All right. We’ll go ahead and get started here. First I’d like to welcome Fred Crawford COO of Aflac and Max Brodén, CFO of Aflac. Thanks very much for being with us today. So, to kick it off, I wanted to ask it would be more of a high level question for you. I thought we can start with a general update of the strategy that you outlined at your Investor Day. Could you run us through your strategic focus that you outlined there in Japan and the U.S. for spurring more sales growth?
Frederick Crawford
Sure. And I – hear me. So, I think one of the underlying themes of our investor conference a few weeks ago here in New York was that there are a lot of things that are very well positioned, capital, cash flow generation, core margins in the company are all very strong earnings and earnings performance has been very strong and it’s been quite resilient through COVID.
And we expect to remain resilient in current conditions related to inflation and recessionary dynamics. However, what we have been very focused on in recent years is growth. That is where we have seen weakness. Certainly some of it brought on by COVID and the face-to-face dynamics of our sales model in the U.S. and Japan, but not just COVID.
There are investments that we have needed to make and changes in our business model to set the stage for better growth or another leg of growth going forward. So we spent a lot of time on Japan and U.S., what types of investments are those. In Japan, I would very simply say this, we are expanding our third sector, which is basically supplemental health portfolio in Japan to attract new customers and approach new demographics mainly younger demographic and carry that customer relationship through their lifecycle.
So, for example, introducing a disability product naturally attracts a younger working generation in Japan. The renewal of our approach to small denominated life insurance and savings related products tends to be popular with the younger generation. One of the products being Child Endowment for example where within a whole life policy you effectively put deposits in there to save and then pay for your child to reach his college age in Japan.
So bringing that younger generation in through disability products and renewed savings products is part of the strategy. Then we carry them through the lifecycle by then as you age, you naturally become more a candidate for medical insurance and medical coverage, as you become a working individual, married family, et cetera, then, later in life our cancer business becomes very popular because cancer is still a disease of age although you will find the younger generations inflicted with cancer in Japan.
It is still a disease of age and then we introduced elderly care products which are supplemental elderly care products not to be confused with long-term care that we are used to in the U.S. This is a different type of product that has a very different, in fact, lower risk profile than you would expect. But it’s carried that customer through the lifecycle and refreshing that product on a more continuous basis.
So, obviously, our two big products in Japan are cancer and medical and we have refreshed our cancer product this year. We expect to introduce that product into Japan post this coming year which is one of our largest distributors of cancer insurance in Japan and we are refreshing our medical product later in the year. So a fast refreshment cycle, as well as expanding through the lifecycle.
You go to the U.S. and that growth strategy is really an outright build strategy and buy to build strategy where we have acquired and entered into the group life and disability business, as well as the network dental and vision business.
Why? While we are moving into those businesses because if we can offer what’s called first page benefits meaning benefits that you are interested in on the first page of your enrollment experience when you enroll each year for your benefits that will naturally attract a higher penetration rate inside the company more employees within the company like the first sector – the first page benefits impart because your employer is often subsidizing those benefits.
So why wouldn’t you sign up for them. But if it can be offered alongside our voluntary product we’ll see halo effect, we call it, where we sell more of our voluntary product as a halo impact of offering dental and vision through life and disability. So it’s not just the growth of those acquired platforms but it’s that halo effect or benefit or increased sale of our core voluntary alongside those new lines of business.
And then we launch direct-to-consumer business for many, many years people have said you have such an amazing brand. I am surprised you don’t go Direct-to-Consumer and the answer has always been actuarial and that is adverse selection. Imagine for a moment that the individual who wakes up in the morning and goes shopping online for a supplemental health insurance, critically illness insurance, accident, cancer, et cetera, right, so actuarially you got to be very careful and understand that’s likely to be the case.
So you need to structure your product and target your market in such a way to get a broad and diverse set of individuals that you can actuarially meet the loss ratio expectations that are priced into the product. We now have that sorted through and figured out and it’s really important to have a Direct-to-Consumer model now, why? Because the gig economy is the fastest growing part of the labor force in the U.S. and they don’t have a traditional payroll deduction W2 relationship with their employer.
So we must get to them through the phone and direct and that’s why we built that program. So those are our core, in a quick statement, those are our core growth aspects. But it’s addition by subtraction meaning we are focused on growth because quite candidly every other aspect of our financial model in growth and value model is actually performing very, very well and through the pandemic, it’s all about growth.
Unidentified Analyst
Maybe just drilling into the Japan post that you made as part of that response. That’s been bit of a recovery story over the last year or so. How do you expect the new product launches that you mentioned, as well as more face-to-face interaction as the pandemic hopefully subsides here in Japan? How do those factors drive that sales growth back towards the historical levels that you got there?
Max Brodén
Sure. Now, first what I would say is COVID in Japan has played out much different than it has here in the U.S. and they are now on their seventh wave of various strains of COVID running through the system. The strains of COVID that you are accustomed to and have read about, but the nature of society in Japan is that when there are these waves of COVID, you will see pieces of the economy shut down and close up.
Once upon a time it was through emergency orders and actually government regulation and government’s pressure to shut down. More recently, the government is doing the opposite in trying to encourage businesses and consumers to open up despite the COVID environment, because the severity level and hospitalization has been quite low, everything we’ve experienced in the U.S.
Yet, Japanese society is not opening up during periods of COVID for the same reasons they were masked during cold and flu season, they wear a mask and they avoid contacts and density, if you will or experiences that jeopardize the density during COVID. That is impacting not just the sales but also Japan Post and think about it, traffic through a post office and face-to-face meetings of the Japan Post Insurance agents who we sell through are all down.
What people often miss is that, when you have a large wave through Japan, it’s not just a matter of an inability to schedule a face-to-face meeting. And by the way, you should know, in Japan that is the way sales are done. There really isn’t a robust digital sales environment in Japan. It is face-to-face. It’s often two meetings, not only – not just one meeting before a sale is made. But it’s not just a face-to-face meetings, you quite literally have thousands of agents who have come down with COVID and are unable to actually go out in the marketplace and work and make sales.
So, Japan Post, like everybody else, given the size of their army, I mean, right now we sell through 20,000 post offices in Japan and 10,000 agents at Japan Post Insurance. If those numbers are down due to COVID and the traffic is down, that has an impact. So they need to recover from COVID.
Beyond that, Japan Post obviously went through some well-recognized compliance issues. They were quite literally shut down for a period of time by the FSA. You shut down a sales model getting that rev back up again from zero is very difficult. It’s not just that Japan Post was down, they went down to near zero sales because of regulatory restrictions.
So it has been slow to build back but each month we are seeing increased proposal activity. Each month we are seeing increased sales and when we launched the new cancer product in their system in the second quarter, history has suggested that there is a lot of excitement and a lot of activity around that. In fact, the last time at the peak sales we ever did through Japan Post Insurance was deep in the relationship when we refreshed the cancer product. So we would expect a similar reaction this time around albeit not at the levels, pre-COVID because of what I mentioned earlier.
Frederick Crawford
So, sales can be quite volatile and you have seen it over the last over the last couple of years. But net earned premium continues to be very, very stable because of the very high persistency we have in that Japanese business. Yeah, when we move into and going forward, we would expect that to be negative 1.5% to negative 2.5% on an underlying runrate basis going forward.
In 2023, there is some important changes that are taking place. One is accounting related. So we have the installation of LBPI starting on January 1st. With that, we are going to make one, we are going to elect to do one accounting change and that is how we account for deferred profit liability, which historically, we have run through the benefits line, but we are now going to reflect that in the earned premium line or set.
This is really in a much better way reflects the growth rate of the underlying business. The essence of this is that it will rebase our earned premium in Japan in that segment and it will rebase downwards by 200 basis points. We are also on January 1st going to execute a reinsurance transaction where we will seed business, to block the business from – by Bermuda. What that means is that, from an accounting standpoint, that will lower the net earned premiums recognized in the Japan segment, but they will then occur in the corporate and other segment.
This will lower net earned premium in Japan by about 300 basis points. So that holds a sort of a rebasing of the net earned premium. From this new base, we would expect to, going forward, have a growth rate of negative 1.5% to 2.5% in Japan.
Unidentified Analyst
That’s all really helpful. Maybe shifting to the U.S. business for a moment. Could you talk about the – your performance you are seeing headed into the end of the year to the open enrollment process. This in terms of take up rates and we consider maybe inflationary pressure on some of the consumers and whether you are seeing that. More face-to-face in your distribution for us – able to get back out there in a bigger way this year?
Frederick Crawford
Unlike Japan, I would say conditions in the U.S. have in fact improved considerably. In fact, the notion of a COVID-related impact to your sales model is really not in existence than more I would say. The only implications of the COVID environment to our sales model in the U.S. right now is actually a continuation of remote working that accelerated during COVID and what I mean by that is, remember, we have agents in the small business category that are going into a business and meeting face-to-face with the employees. And if more and more of those employees are working remote, the only way to get out to them is through more electronic enrollment with medium-sized companies and larger companies that’s always been the case that everybody is electronic enrollment, very little in the way of face-to-face and so there is no real impact to that business, the group business, the broker-driven larger and mid-sized company business continues to march along and that is the fastest growing part of our business and we continue to see that momentum. You have little more of a backlog dynamic that you can track in those businesses where you know a little bit earlier how things are coming together same with glad and we know already that we are heading towards a continued level of growth rate and good growth rate in the group business. The small business individual sector is one where is it a little bit more difficult to predict. You don’t have that backlog type dynamic and that’s the one that’s most impacted by things like face-to-face COVID remote working conditions. What we are focused on there is recruiting. Recruiting has been weak in that small business agent category and we are now working hard to create incentives and embed incentives to drive as much recruiting as we do outright sales and we would expect that model to come back. It typically have weak recruiting atmosphere during periods of strong employment. This is one of the things that makes our business model very defensive in nature heading into a recession. It’s usually in times of recession, you don’t have much impact on morbidity margins for obvious reasons and that’s the biggest part of profitability. So what happens is in lower employment levels even though there are less employees to see, identify and sell, you end up with a lot more agents, because you can recruit much better to a commission only job in a period of weak employment. And there is so much blue ocean opportunity in what we do, meaning very low penetration rates in the U.S. That the more feet you have on the street to interface with more small businesses, the more sales will grow. And so we tend to have a resilient model, even a growth model during periods of recession. So, the key to our growth model in the U.S. is delivering on our buy to build acquisitions, delivering on the halo effect, continuing the momentum in the brokerage business, which we expect to be strong. And then bringing back to life through recruiting and development our core agent platform which includes 30,000 licensed agents across the U.S. It’s a big engine and when it’s weaker, bringing that back is ultimately going to be an underpinning to recovery and sales in the U.S. And we are projecting a good recovery. We expect to get back to about $1.8 billion in sales which would be a peak level of sales in our company’s history by 2025 and we expect to add incrementally a considerable amount of earned premium or revenue over that timeframe incrementally upwards of $1 billion of earned premium incrementally through those buy to build platforms and related halo effect. So, we definitely are on the growth path in the U.S. and at the end of the day, we have a mature model in Japan. That’s the math of it. But the end of the mature model that’s been priced properly and run properly. It’s throws up a considerable amount of cash flow each and every year. Parts of that cash flow are being redeployed into where we see more blue ocean, more low penetration, higher opportunity and that’s in the U.S. market and that’s what we’ve been doing over the last few years.
Unidentified Analyst
So one of the key disclosures you all made at the recent Investor Day was around the Bermuda reinsurance structure. Max you touched on briefly. But I thought maybe we can just come back to that for a minute. Can you discuss some of the advantages that it will provide you both on the existing book of business as well as the product development?
Max Brodén
Yes. So, There is really two reasons why we are doing this. And the first one is really for us to be able to manage risk better around the Group and then obviously release and the redeploying capital in a more efficient manner. So, what we are doing is, when we see blocks of business from predominantly Japan through Bermuda, what you will find is, these blocks of business are very capital-intensive.
And that is the cause of very stringent reserve requirements that exists in Japan today. Over time, what that will do when we can hold that at a more economic basis, which we can in Bermuda that always frees up capital. The other element to it is more of an offensive strategy, because in Japan we have seen all the time that more and more competitors have moved into our space.
They also become more price competitive, as well. So what it gives us to this platform is an opportunity to be a little more aggressive in terms of the pricing, because if we can utilize reinsurance, then we can still generate very strong IRRs and very good returns on a business that we write. But at the same time we can share some of those economics with the consumers going forward.
This is especially important as you look at our medical business where we have been losing market share for quite some time. In an old path we then look to become little bit more competitive in the first sector space as well.
Unidentified Analyst
Maybe sticking on capital for a minute, I mean one of the things that’s evident as we kind of look to your business is that the capital levels are very strong. You operate with higher RBC ratios than most companies in the U.S. and I think, you probably have higher ESR in Japan and most of the companies, as well. When I think through those capital levels, that’s sort of even separate from considering the Bermuda reinsurance that you just discussed, I mean, how much flexibility that provides you? How will you potentially look to redeploy that and could you get a little more aggressive over time than maybe over the past handful of years?
Max Brodén
Yes. So, we hold a lot of capital. We generate a lot of capital and the reinsurance platform gives us even more capital which is, better words to saying that see folks not doing – which is we can debate. And the fact that the matter is, we’ve been traveling with high levels of capital for a good reason where supplemental health insurance company and we’ve been going through a global pandemic, that’s one of the largest tail risks that we have from an operating basis as a company. But that made a lot of sense to actually travel with a lot of capital. Now we are facing a potential recession and I feel very good about going into a recession with high levels of capital. That being said, this is not the kind of level where we would like to operate long-term. We’ve been explicit in the U.S. saying that over time we would expect to run at a 400% RBC ratio.
And in Japan, we continue to hold very strong levels of capital as we mentioned both on an SMR and ESR basis. And during this, we also generate strong levels of capital of $2.6 billion to $3 billion of underlying capital generation each year. Now all of this obviously is only good if we can deploy it and deploy that to good returns on capital.
Otherwise, it doesn’t do much for us. So, we obviously been continued to increase the dividend. We have also bought back quite a lot of stock in recent years and I would expect these to continue. And on the M&A front, we have broadened our strategic positioning especially in the U.S. with a few smaller acquisitions.
That is something that we potentially could continue to do. It gives us flexibility, but execute the strategic agenda, but over time I think that, we had essentially laid out the growth platform right now. And I would expect that going forward capital deployed will be through writing new business and sort of accelerate the growth rate.
So the new business streams would help us get those capital levels down maybe if you want to call it that way. But then also, the vast majority of it will come back to shareholders through dividends, buybacks. And I think our recent past is a pretty good predictor of what we will do going forward. We try to be balanced and the company has always held a philosophy balancing the way we deploy the capital. So, in recent years, we’ve invested about $575 million in buy to build platforms. We’ve invested another $500 million in what we would call opportunistic investments in alliance partners and our venture capital investments. Meanwhile, we are buying back stock at a clip of at or north of $500 million a quarter. Keep in mind, we increased the dividend 20%, two consecutive years in a row into a pandemic. And that’s a lot to say for a company that’s now 40 years of an increased dividend track record. So, we try to look at this balancing act of first maintain robust and healthy ratios with strong ratings and good relationships with the regulators who often act as gatekeepers to that free cash flow. That’s developed and released, invest into your company, but invest for good returns and you see the good returns being in the U.S. and opportunity. And then, keep that dividend track record and when the capital is in excess above that, buyback your favorite security and for us we buy our stock back as we believe in the economic value growth and strategies that we’ve put together. So, that’s really a part through, don’t put our eggs in one basket. We try to be diverse and balanced in what we do. And that’s particularly is nice heading into a recession where you know having those good capital ratios even after all that buyback and dividend is a good place to be.
Unidentified Analyst
That’s helpful. Next we had gears on cancer screenings and it’s a little bit of a crisis as we sit here and think through reopening. I think the U.S. has normalized a bit more, but in Japan I think medical utilization bookings somewhat depressed. What was your perspective on that? You feel lot more the numbers than I do. So I’d just be interested in your perspective on that and what you anticipate over the next years as things normalize?
Frederick Crawford
So, a couple of comments I would make and Max can jump in anywhere he’d like. But, so first, let me just talk a bit about what we are seeing in actually what was a spiking COVID-related claims in Japan in the third quarter and as we talked about, this was related to a policy that the Japanese government had, so-called being hospitalization where if you were diagnosed with COVID and even if you did not have severe symptoms and were being treated at home, you are eligible to receive claims on those COVID policies. The government then changed their stands because it was clear that hospitalization rates, mortality, severity was all very low as much more common cold like symptoms what we are experiencing in the U.S. And so they moved to more of a posture of no, you are eligible for claims if you are more vulnerable, i.e., elderly as in over the age of 65 or pregnant or have other pre-existing health conditions that could give rise to more acute hospitalization and severity. Those individuals are allowed to draw a claim on their policy hospitalized or not, but everybody else can’t do that. And so, as a result, we’ve seen the incurred claims trend down and it’s trended down in the month of October versus September, November versus October and even in the final week of November it dipped down much more severely. So, all of our comments at the Investor Conference on the fourth quarter call about returning to a more normalized benefit ratios in Japan seem to be on pace as of our latest data.
Your question is a lag question of over a period of less in a way of screening diagnosis, doctor visits around cancer aren’t you anticipating larger cancer claims experience. So far, the simple answer is, in Japan, we have not seen that. There is speculation as to why that maybe and maybe that of all of the possible concerns you have over your health in Japan, cancer is not one to fool around. We then therefore paying attention to cancer screening and cancer diagnosis was more of an acute or higher order activity in Japan. But that’s speculation. So far we simply haven’t seen it incidence rates more severity. In the U.S., we’ve seen incidence rates climb to around 105% to 110%, in other words, up around 5% or 10% over 2019 pre-COVID levels. So we appear to be seeing a little bit of that delayed or lagged incident levels up. What’s interesting though, is both in Japan and in the U.S., it’s not pressuring our benefit ratios and the reason for that is hospitalization is down considerably. In other words, what transpired during COVID or accelerated was much more out of the hospital at home treatment or outpatient treatment surrounding various types of cancer and that’s both in the U.S. and Japan. And remember, our policies pay you not just on incidents, but also hospitalization, particularly when you are talking about advanced stages of cancer. And so, what we are seeing in the U.S. and Japan is even though incidence rates in the U.S. has risen a bit, the hospitalization rates have come down. So the overall claims experience is remaining low. So, we continue to monitor and track it. It is too early to declare some sort of victory or conclusion on this, but that’s what we are seeing so far.
Max Brodén
And I would add that the main component of total claims for cancer is hospitalization and surgery. It is not first occurrence that Fred mentioned. The other thing as well is that, cancer is a disease of age just because of somebody is getting cold does not mean that they are not going to get cancer. So, we actually do believe and there is no medical evidence that cancer took a break from COVID so to speak. So the fact that the matter is that we do expect that diagnosis will continue to run relatively high in the near term so the first occurrence and those benefits, because it’s essentially within the takes. A lot of cancers during COVID and when we now detect them it’s not as paid zero or one, it might be, unfortunately it takes three or four. So, we would expect that to continue. That being said, the impact on our overall results for claims for cancer is still going to be looks somewhat muted like a little bit above long-term trend is what we expect going into 2023. All of that is incorporated in our benefit ratio guidance.
Frederick Crawford
It’s interesting. We’ve always been viewed as a safe place to hide within the financial service industry if you are heading into –
Max Brodén
Good socket buys now.
Frederick Crawford
Yeah, if you are heading into volatile conditions, the idea of a low beta, morbidity based company that has low asset leverage and that’s usually the assets that are most challenging when you head into weak economic conditions. And that’s always been the profile and the makeup of the company. Whether you talk to a rating agency or a stock analyst, that doesn’t matter regulator, it’s always that general view and it’s really true about our business model.
What’s interesting is the worst thing you ever could have handled a company like ours is a global pandemic. And that’s the one stress test if you will that we always ran that could be obviously of great concern and so here we had at least one form of test run and we all know that the next pandemic is not going to look like the last pandemic. And so you are not – you need to kind of always keep that in mind.
And what we found with our model is the number one impact of the pandemic is our sales model, okay as we talked about earlier. But remember what happens to the business model of an insurance company when sales are down, when sales are down, and because of the pandemic claims are up, capital generation remains steady.
Why, because of the number one use of capital, a good use of capital is if you are growing the acquisition cost associated with putting policies on the books, paying the associated commissions, that is expense at the time of spend for statutory or cash flow.
And what happens is, what you may experience in the way of elevated claims you are getting back in the way of lower sales and lower capital off the door because of this lower sales to your capital and capital generation and cash flow remains strong. So it’s still proving out to be a quite resilient business model. The supplemental nature of what we do.
Unidentified Analyst
And we have a couple minutes left here. I know you guys laid out guidance at your Investor Day. There is nuances around LDTI the new accounting changes. I think you touched on some of it already, but was there anything else that you wanted to flush out there or just the way is it revenue and the margins are flown in?
Max Brodén
It was really on what I talked about the impacts to Japan. But – and then also, everybody should know that everything that’s going forward, all the guidance that we’ve given is on a fully on an LDTI basis. I am always joking internally in saying that as late for me, legacy GAAP is retired on December 31 and January 1, it does not exist anymore. It is LDTI going forward and that’s just a lay of the land, and that’s how we’re running it going forward.
Unidentified Analyst
All right. Well, with that…
Frederick Crawford
The good news is that if you have good morbidity margins and good underwriting and good underwriting experience, LDTI that new accounting flushes that out into your results in a very transparent way, and we are blessed to have that. We have suffered from low-interest rates, and that also gets flushed out as a source of earnings, but the morbidity experience of the company has far and away outweighed any negative headwinds related to the low interest rate environment and for that, we’re very fortunate.
Unidentified Analyst
All right. We’re just out of time. So I’ll stop it there. Thank you for joining. It’s very helpful. Thank you all for being here.
Frederick Crawford
Thank you for having us. Thanks.
Question-And-Answer Session
End of Q&A
Be the first to comment