Aflac Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2022

Key Takeaways

  • Aflac delivered solid Q2 results with net EPS of $2.16 and adjusted EPS of $1.46, supported by pandemic-related low benefit ratios and better-than-expected investment income.
  • In Japan, Aflac Japan posted a profit margin of 27.4%, beating its outlook, with strong persistency and sequential growth in cancer insurance sales via its Japan Post alliance.
  • In the U.S., sales rose 15.6% in Q2 alongside a 21.4% profit margin, driven by growth in core supplemental health products and investments in dental, vision, group life/disability, and digital platforms.
  • Rising short-term rates on its $12 billion floating-rate portfolio are forecast to boost net investment income by approximately $160 million in 2022, although inflationary pressure on wages and expenses warrants monitoring.
  • Resurgent COVID-19 cases in Japan may elevate medical claims under the infectious disease law and could pressure benefit ratios, with potential legislative changes pending in September.
AI Generated. May Contain Errors.
Earnings Conference Call
Aflac Q2 2022
00:00 / 00:00

There are 15 speakers on the call.

Operator

Morning, and welcome to the Aflac Incorporated Second Quarter 2022 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Ratings Agency Relations and ESG. Please go ahead.

Speaker 1

Thank you, Andrea. This morning, we will be hearing remarks about the quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated. Craig Crawford, President and COO of Aflac Incorporated We'll then touch briefly on conditions in the quarter and discuss key initiatives. Yesterday after the close, we posted our earnings release and financial supplement to investors. Aflac.com, along with a video with Max Broden, Executive Vice President and CFO of Aflac Incorporated, providing an update on our quarterly financial results and current capital and liquidity.

Speaker 1

Max will also be joining us for the Q and A segment of the call, Along with other members of our U. S. Executive management, Teresa White, President of Aflac U. S. Virgil Miller, Deputy President of Aflac U.

Speaker 1

S. Eric Kirsch, Global Chief Investment Officer and President of Aflac Global Investments Brad Disland, Deputy Global Chief Investment Officer Al Ruggieri, Global Chief Risk Officer and Chief Actuary June Howard, Chief Accounting and Steve Beaver, CFO of Aflac U. S. We are also joined by members of our executive management team at Aflac Life Insurance Japan Charles Lake, Chairman and Representative Director, President of Aflac International Masatoshi Kouide, President and Representative Director Todd Daniels, Director and CFO Koijiro Yoshitsumi, Director, Deputy President and Director, Sales and Marketing. Before we begin, some statements in the teleconference are forward looking within the meaning of federal securities laws.

Speaker 1

Although we believe these statements are reasonable, we can give no assurance We encourage you to look at our annual report on Form 10 ks for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors. Aflac.com and include reconciliations of certain non U. S. GAAP measures.

Speaker 1

I'll now hand the call over to Dan. Dan? Good morning and thank you for joining us. As I reflect on the Q2 of 2022, our management team, employees and sales force continue to adapt and work tirelessly to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated reported Solid results for the 2nd quarter with net earnings per diluted share of $2.16 and $3.73 year to date.

Speaker 1

Adjusted earnings per diluted share were solid at $1.46 in the 2nd quarter $2.88 for the 1st 6 months, supported in part by the continuation of the low benefit ratio associated with the pandemic conditions. Also contributing was a better than expected investment income, including returns from alternative investments. We remain cautiously optimistic as our efforts focus on growth and efficiency initiatives amid this evolving pandemic backdrop. Looking at our operation in Japan in the second quarter, Aflac Japan generated strong overall financial results with a profit margin of 27.4%. This was again above the outlook range we provided at the November 2021 financial analyst briefing.

Speaker 1

Persistency remains strong. However, sales continued to be somewhat constrained as the pandemic conditions to impact our ability to meet face to face with customers. Also contributed to the quarterly results was the 2021 comparison following the launch of our new medical product. Regarding Japan Post Strategic Alliance, As part of our ongoing collaboration and governance framework, I traveled to Japan toward the end of June to meet with Japan Post Holdings CEO, Mr. Masuda, along with the Presidents of Japan Post Postal and Insurance Companies.

Speaker 1

We had an understanding and productive visit discussing our plans. This indeed This included a renewed commitment from executive management to drive sales with a focus on distribution, Growth and Marketing of Cancer Insurance. Aflac Japan has continued to offer sales support to Japan Post, especially after the new fiscal year began in April of 2022 and following Japan Post sales structure transformation. This support includes further aligning of our sales offices with Japan Post Regional Offices to strengthen support and to share our best practices. As you may recall, under the new structure, Sales employees focused solely on selling Japan Post insurance products and Aflac Japan's cancer insurance product.

Speaker 1

We have made gradual progress toward providing cancer insurance protection to more consumers demonstrated by the increased proposal activity and sequential monthly sales growth during the 2nd quarter. There is more progress to be made and we continue to work to strengthen the strategic alliance To create a sustained cycle of growth for both companies, we believe that sales through Japan Post crew will improve in the second half of the year as sales employees gain more experience and momentum. As we look forward to 2023, we will introduce our new cancer insurance product through Japan Post likely in the second quarter. This will allow both entities to invest in a more complex coordinated required by the distribution system of this size. We plan to launch our revised cancer product in agencies in the second half of twenty twenty two and we continue to expect stronger overall sales in the Q2 of the year.

Speaker 1

This assumes that pandemic conditions do not escalate and that sales productivity continues to improve at Japan Post Group and that we execute on our product introductions and refreshment plans. Turning to the U. S, we saw solid profit margin of 21.4%. I'm pleased with the U. S.

Speaker 1

Sales momentum has continued with a 15.6% sales increase in the 2nd quarter. This reflects continued adaptation due to the pandemic conditions, growth in the core products and our investment and build out of growth initiatives. While Aflac Network Dental and Vision and Group Premier Life, Absence Management And disability solutions, which we call Plaids, are relatively small part of our sales. We are pleased with how they are contributing to our growth. Our growth initiatives modestly impacted the top line in the short term, but also tend to be accompanied by the sale of our core supplemental health products.

Speaker 1

In combination with our core products, They also better position Aflac U. S. For future long term success. The need for our products we offer is a strong or stronger than ever before. At the same time, we know consumers habits and buying preferences have been evolving.

Speaker 1

We remain focused on being able to sell and service customers whether in person or virtually. This is part of the ongoing To increase access, penetration and retention. Turning to capital deployment, we placed significant importance on continuing to achieve strong capital ratios in the U. S. And Japan on behalf of our policyholders and shareholders.

Speaker 1

We continue to generate strong investment results, while remaining in a defensive position as we monitor evolving economic conditions. In addition, we've taken proactive steps in recent years to defend cash flow and deployable capital against a weakening yen. When it comes to capital deployment, we pursue value creation through a balance of actions including growth investments, Stable dividend growth and disciplined and tactical stock repurchase. It goes without saying that we treasure our 39 year track record dividend growth and we remain committed to extending it supported by the strength of capital and cash flows. In 2022, we remained in the market repurchasing shares with a tactical approach.

Speaker 1

In the Q2, Aflac Incorporated deployed $650,000,000 in capital to repurchase $11,200,000 of its common shares, bringing the 6 month total to $1,150,000,000 in purchase and $19,200,000 of the shares. With this approach, we look to emerge from this period in a continued position of strength and leadership. Keep in mind, in addition, we have among the highest return on capital and the lowest cost of capital in the industry. We've also focused on integrating the growth investments that we've made. We are well positioned as we work toward achieving long term growth, while also ensuring we deliver on our promise to the policyholders.

Speaker 1

I don't think it's a coincidence that we have achieved success while focusing on doing the right thing for the policyholders, shareholders, employees, Sales distribution, business partners and communities. I'm proud of what we've accomplished in terms of both our social purpose and financial results, which have ultimately translated into strong long term shareholder return. We also believe that the underlying strength of our business and our potential for continued growth in Japan and the United States, the 2 of the largest life insurance markets in the world. Thank you again for joining us this morning. Now

Speaker 2

Over to Brett. Brett? Thank you, Dan. Before commenting on our results, let me start with some perspective on how we're positioned when considering current U. S.

Speaker 2

Economic conditions. We have not witnessed this level of inflation in the U. S. In many years and we are closely monitoring conditions. Wage inflation and full employment is generally supportive of growth in worksite benefits.

Speaker 2

However, when considering voluntary product, there is a question as to how much of any increased income is available for supplemental products as real wages are likely neutral to down. Our benefits are defined at time of purchase and do not adjust for healthcare inflation. Therefore, we do not expect any measurable impact on claims. In terms of recruiting and retaining agents, it can be more of a challenge as agents are commission only and need to keep pace with any increase in costs. When looking at enterprise margins, the impact of inflation does apply upward pressure on expenses.

Speaker 2

However, this is mitigated by rising rates and additional investment income having built a significant floating rate loan portfolio. In terms of the risk of economic slowdown and recession, our business model is generally defensive in nature with low asset leverage and exposure to risk assets. Profits and cash flow are driven largely by morbidity margins that tend to remain stable during periods While employment levels may decrease, we often benefit in the recruiting side during an economic slowdown versus today's tight labor markets. Max spoke in his recorded comments to the work we have done to defend our cash flow from weakness in the yen. We have built a sizable unhedged U.

Speaker 2

S. Dollar portfolio in Japan, shifted most of our senior debt to yen for both hedging and cost of capital purposes and maintain a flexible hedging position at the holding company. It's important to understand what makes all this possible. Significant economic value, strong capital ratios and predictable cash flow out of Japan. Overall, and recognizing the balance we have in operating in the U.

Speaker 2

S. And Japan, we like How we are positioned to defend our performance under today's U. S. Inflationary conditions and the potential for economic slowdown. We see no interruption in our core margins and return of capital to shareholders, including dividend pattern and share repurchase.

Speaker 2

Turning back to our businesses and beginning with Japan, COVID cases have surged again with daily new cases reaching 200,000 up significantly from already elevated levels earlier in July and considerably higher than levels experienced in the 2nd quarter. However, hospitalization and deaths remain low. Based on commentary from the Japanese government, there does not appear to be plans to introduce a nationwide state of emergency, which are typically triggered by both increasing cases and declining hospital capacity. We continue to experience elevated COVID incurred claims driven by its designation as an infectious disease and deemed hospitalization, which allows for payment of claims for care outside the hospital. We would expect the recent surge in COVID cases to apply pressure to near term benefit ratios.

Speaker 2

While not guaranteed, this may be partially offset by other drivers of hospitalization and care, which have remained low during periods of higher COVID. Our data suggests this is driven by increased and less expensive outpatient treatments as policyholders and their doctors seek to avoid going to the hospital with COVID cases on the rise. With respect to COVID's classification under the infectious disease law, August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing COVID's classification under the law. Revision of the classification requires amending the law, which is expected to be discussed at the extraordinary diet session beginning in September at the earliest. Having just spent a few weeks in Japan, the general population remains cautious with respect to the potential for COVID infection.

Speaker 2

With widespread infection, this is not simply a matter of customer behavior and face to face interaction, Our work continues to position Japan for sales recovery in the second half of the year and as we move into 2023. These actions include items that Dan referenced in his comments such as accelerating the launch of our new cancer product, Direct marketing campaigns more closely tied to targeted TV advertising and adjusting our distribution model for better alignment with our 3rd party partners. We continue to review our broader product portfolio, both 1st and third sector, for enhancements designed to increase the value proposition for our policyholders, offer a broad product lineup for our core distribution partners and secure our competitive position in the market. We have been making investments in technology and in working with our distribution partners to reduce launch costs associated with product refreshment and development. It's becoming clear that both the competitive environment and our broader product line creates a product refreshment cycle that is more continuous in nature.

Speaker 2

Separately, our incubated businesses continue to develop. We are seeing favorable results piloting Hatch Healthcare, our provider of non insurance support to develop the ecosystem for both cancer and nursing care policyholders and expect to expand availability in early 2023. Our short term insurance subsidiary, Sidachi, was launched in early 2021 and currently offers 2 products, a substandard medical product and a disability product aimed at the contingent or freelance workforce in Japan. Sudachi serves 2 strategic purposes: to grow and develop these specialized markets and second, as a proof of concept platform for product innovation that may become more broadly popular in the future. We can't control COVID conditions, but we are not standing still.

Speaker 2

We will develop these themes in more detail at our financial analyst briefing in November. Turning to the U. S. And as you are aware, Conditions are also elevated. This is not currently causing any issue in terms of either our operations or distribution in the U.

Speaker 2

S. We saw persistency recover to more normal levels when isolating results in the quarter and accounting for seasonality. Account persistency has remained stable through the year. So we believe this is driven by an increase in employee turnover with tight labor markets. There are moving parts when looking year over year, including the retirement of state mandates that serve to reduce lapsation.

Speaker 2

As Dan noted in his comments, we continue to deliver a balanced performance. We see recovery in the small business market with growth in veteran weekly producers, while also continuing to strengthen relationships with our broker partners. For example, Split by product type, group voluntary was up 16%, individual benefits up 11%. Split by channel, agent sales were up 11% and broker up 22%. The combination of Network Dental and Vision and Premier Life and Disability were ahead of our plan as we continue to see strong performance With our buy to build properties, we were up 175%, albeit off a smaller but building base.

Speaker 2

Direct to consumer is down 7% and largely the result of the increase in costs associated with organically generating, purchasing and converting leads and meeting our return expectations. In terms of the U. S. Expense ratio, it's important to identify the impact of our Build Investments. We have 3 important business initiatives underway that are essential to the future growth of the company.

Speaker 2

These investments include group life, Disability and absent management, network dental and vision and having a digital direct to consumer platform to reach consumers that are outside the traditional workforce. In the quarter, investment in these efforts impacted our expense ratio by 2 80 basis points and we would expect this pace of investment to continue for the rest of 2022 and into 2023. Our 2021 outlook for a 3% to 5% Compound annual growth rate in revenue through 2026 is largely driven by these 3 growth platforms and related halo impact of cross sell and retention of core voluntary products. In the next 3 years, We expect a natural swing in these platforms from contributing to an elevated expense ratio to being the principal driver of returning to more normalized levels. In the interim, we are navigating investment in the future growth, Advancements in our digital platform while maintaining strong profitability.

Speaker 2

Turning to global investments, with the rise in Short term interest rates driven by Federal Reserve as they combat inflation together with deployment activity, Net investment income generated from our $12,000,000,000 floating rate portfolio is currently estimated to increase approximately $160,000,000 for the year as compared to our original plan. As mentioned last quarter, We have locked in the favorable LIBOR curve on a large portion of our portfolio and expect continued tailwinds to floating rate income going into 2023. Along with being an attractive asset class and strategic to our U. S. Dollar program in Japan, Our floating rate book acts as a logical hedge against inflationary cost pressure.

Speaker 2

We maintain a book of foreign exchange hedge instruments on our U. S. Our portfolio in Japan that is also impacted by inflation as the cost of these forward contracts are generally aligned with short term rates in the U. S. However, we have locked in those costs for 2022 and have offsetting hedge instruments at the holding company that served to neutralize the impact to the enterprise.

Speaker 2

Our alternatives portfolio continues to deliver strong results. We fully expect lower valuations of these portfolios in the second half of the year as private equity marks track Public equity valuations likely resulting in giving back much of their 2022 gains. There is a well understood lag in reporting numbers on private equity and this is a natural expectation given private equity's correlation to the public Naturally, we are closely monitoring economic conditions in the chance of recession. We maintain a defensive position to risk assets. In terms of private and real estate equity, our investment thesis and risk appetite remains the same.

Speaker 2

We are willing to accept some equity market volatility to earn 10 plus percent over the long term, adding to NII or net investment income on a risk adjusted basis. We maintain a conservative allocation of under 3% of our invested assets with marginal growth expected over the next 5 years. We closely monitor our middle market and Transitional real estate portfolios where recessionary impacts could be felt sooner. We expect these portfolios to perform well given their senior secured 1st lien structure, protective covenants, reasonable leverage and private equity sponsorship for middle market loans as well as a high degree of diversification. The portfolios performed well during the stressful period of COVID and we expect they will continue to.

Speaker 2

I'll now hand the call back to David to take us to Q and A. David?

Speaker 1

Thank you, Fred. Now we are ready to take your questions, but first let me ask Andrea, we'll now take the first question.

Operator

Our first question will come from Nigel Daley of Morgan Stanley, please go ahead.

Speaker 3

Great. Thanks and good morning. So I wanted to touch on U. S. Lasses.

Speaker 3

Last quarter, it was a little troubling. This quarter, it seemed to return to more normal levels. Can you talk

Speaker 4

a little more about what

Speaker 3

was driving that? Was it purely just macro conditions? Or I know you're looking at various initiatives to help improve it. Was that a play as well? And then also looking forward, do you expect higher inflation to have an impact on excess activity as well?

Speaker 2

Nigel, it's Fred. Let me comment On lapse rates, when we talk about as you know, we report our lapse rates on a trailing 12 month basis. And as a result, You'll see pressure in our reported lapse ratios year over year. And so what we have done is looked at our quarterly lapse rates Seasonally adjusted when we make our comments about a recovery in lapse rates. And let me give you an idea.

Speaker 2

Our lapse rate in the quarter or said differently, our persistency in the quarter for the 2nd quarter only was around 79% and that is approximately equal to the pre COVID levels of lapse rates that we tend to enjoy or persistency that we tend to enjoy in the Q2. To give you an idea, before COVID, We would travel again around that 79% rate. It rose up into the 81% territory over the last couple of years, And we believe that's largely related to the state mandates that require keeping policies in place. As those started to expire and have now largely expired, We've traveled back into normal persistency. In the Q1, what spooked us is that our persistency in that quarter was around 74.5% and that seasonally adjusted was about 200 basis points lower than we expect.

Speaker 2

We always expect the Q1 persistency to be lower because it has implications, it's time related to annual enrollment process and year end process. So it's normally a lower persisting quarter, but in this case, it traveled about 200 basis points lower than we would have expected and that's what gave rise to our comments Last quarter. So we're very pleased to see a recovery back to normal seasonal adjustments in the second quarter, and that would be my comment there. We'll have to obviously monitor it as we go forward. To my comments on inflation, I would tell you that we don't see necessarily the implications of inflation lapse rates per se.

Speaker 2

Right now, we haven't seen any evidence of that, But it's a very unusual inflationary period and quite honestly, we don't have a lot of history of inflation at these levels and watching how our business behaves and that's why I have some of the cautionary language. Thus far, I would tell you we don't see any acute implications from inflation, But we simply want to note the fact that we're going to monitor that. Again, we see offsetting dynamics related to inflation, so we don't see this as having an impact

Operator

The next question comes from Jimmy Bhullar of JPMorgan Securities. Please go ahead.

Speaker 5

Hi, good morning. So I had a question on sales trends in the U. S. And in Japan. And if you could talk about how sales trended Through the quarter and specifically on Japan, it seems like your comments are pretty positive on an expected improvement in sales.

Speaker 5

Are you seeing that or are you just hopeful that things will get better? And then just relatedly any impact that you're seeing on your Production activities in Japan because of the recent increase in COVID cases.

Speaker 1

Let me let Yoshi Nimi answer that.

Operator

This is Yoshizimi. Let me answer your question. While the Q2 of 2022 saw a downturn Continuing from Q1 as sales of the new medical insurance product had run its course after its release in January last year. Additionally, COVID-nineteen continued to have a negative impact on sales activities as the number of new cases increased 8.2 times compared to the same period last year, although intensive infection prevention measures have been lifted. Well, COVID-nineteen infections have been rapidly increasing since the start of July.

Operator

Japan is experiencing its 7th wave and uncertainty remains. Having said that, from the Q3, we are hopeful that sales will exceed last year's results, Building on the new cancer insurance product launch and the gradual recovery of Japan Post Group sales. That's all for me.

Speaker 6

I'll ask Virgil to respond to the U. S. Sales question.

Speaker 4

Thank you, Theresa. As Fred and Dan shared earlier, We did see 15.6% increase in the Thank you, Teresa. As further than Dan We did see a 15.6% increase in sales, very pleased with the 2nd quarter performance. I think Fred said it well though. It's a combination of what we're Seeing from our distribution channels, if you think about the small market, which was disrupted quite heavily in the beginning from COVID, We've seen a solid recovery.

Speaker 4

It's really driven by our veterans returning to producing. We saw another increase in our Veteran average weekly producers and we saw an increase in productivity from our veterans. And then when you look at the large case base, It was less disrupted by COVID. We continue to see great performance from our broker partners in that space. We saw a 24% Quarter over quarter increase in production from our brokers.

Speaker 4

So when you look at it, how we're going to the market in large with our brokers, large case space with our brokers and continue to see recovery in the small market with our veterans. Overall, we're pleased with that quarter.

Speaker 5

Thank you.

Operator

The next question comes from Alex Scott of Goldman Sachs. Please go ahead.

Speaker 7

Good morning. First one I had is on the Japan benefit ratios. I guess, when I think about the I think it was 190 basis points you caught out of unfavorable COVID claims and but then the normalized benefit ratio that's Maturely higher. Could you help us think through, I think it was over 400 basis point delta associated with these IBNR releases When you sort of go through that. And I struggle with it because I know you guys have had favorable IBNR over time.

Speaker 7

I mean, do you have any way of sort of breaking that apart a little for us and helping us think through like What portion of it is more the outpatient treatments associated with COVID specifically? I mean, any help with how to sort of Figure out where things should be on a run rate basis.

Speaker 8

If you start with obviously, you make the walk from the reported benefit ratio of 67.4% to adjusting for all the sort of special factors in the quarter, you get to 69.8%. What I think is reasonable to sort of add back is this sort of run rate more Permanent or somewhat permanent reserve releases that we have experienced from favorable hospitalization trends, etcetera. Those added up in the quarter to about 170 basis points and that's what we have seen historically run through our results. So if I were to adjust for that to sort of get to sort of adding back what we normally see As an ongoing reserve release in each quarter, you get back to a 68.1% instead of an Adjusted underlying benefit ratio for the quarter. Going forward over time, These reserve releases have been running relatively high recently, and we would expect those to continue.

Speaker 8

Maybe not at the level of 170 basis points, but we certainly expect an element of that going forward.

Speaker 7

Got it. That was really helpful. Thank you. Next one I had is just on inflation and the expenses. I heard some of the comments That could put upward pressure on expenses.

Speaker 7

I mean is that material enough for us to think about maybe a different Range for expense ratios, I know things are a little more focused on the back half for expenses as well. So I was just wondering if there's any update to sort of the expense ratio Got it. Do you guys have out there?

Speaker 2

I think essentially where we face inflation is in just a couple areas. 1 predominantly is simply wage inflation. So your overall headcount and what we're all experiencing and seeing in the market With wage inflation and salary inflation. And we've got to do that. We've got to fall in line to retain and keep our talent and we'll do so.

Speaker 2

Having said that, for a company our size, our employment levels are quite manageable. I mean, we're a very large U. S. Japan company, but we have 5,300 employees in the U. S.

Speaker 2

And approximately 7,000 in Japan. And so we don't have the type of business model that is overly concentrated from that perspective. And so therefore, the wage inflation numbers, while they do apply There's also certain contracts that we have and quite frankly the industry has that will have inflation riders. And so certain IT and servicing contracts often have inflationary provisions that kick into place when inflation gets out of control. That can also come back down as inflation gets back into control.

Speaker 2

Overall, what I would tell you is inflation in of is not causing us to rethink our guidance on expense ratios. The bigger moves on expense ratios is what I noted And the fact that we're heavily investing in growth platforms, we're very pleased to see that the growth is coming through in those platforms, as I mentioned in my comments. But it's going to that's really going to weigh on expense ratios in the U. S. More than inflationary pressure issues.

Speaker 8

And just to add one reminder, obviously, expense ratio, it's a ratio and you have net investment income coming into play here as well, And it helps boost the top line and therefore gives you some relief on the expense ratio when you think about the inflationary pressures. And the last piece is that, yes, we do obviously acknowledge that it is putting upward pressure on expenses in dollar terms as well. And we are taking active actions in order to combat that as well.

Speaker 1

And I'll also remind you that a

Speaker 8

year and

Speaker 1

a half ago, We had a voluntary program for retirement in the U. S. And about 10% of our workforce retired. So This is not something that has not been top of mind. Operator?

Operator

The next question comes from Erik Bass of Autonomous Research. Please go ahead.

Speaker 9

Hi, thank you. I was hoping you can provide a little bit more detail on the NII outlook. I think Fred mentioned $160,000,000 of higher Expected NII in 2022 than the original plan. Just wanted to confirm, is this gross or net of hedge costs? And then how should we think about the impact moving into 2023 when, I guess floating rate NII should continue to build, but hedge costs will also reset and Probably move

Speaker 10

higher. Ed, would you like me to take that?

Speaker 2

Yes, please, Eric. Yes.

Speaker 11

Sure thing. The numbers that Fred quoted are gross of currency hedge costs. They are net of interest rate hedging, because we've done some interest rate hedging with respect to the floating rate book. So I just want to bifurcate Those two buckets. And as a reminder, for this year, our FX hedge costs are primarily locked in like 98% of those hedge costs are pretty locked in.

Speaker 11

Clearly, going into next year, the cost of hedging is substantially higher And we still carry about $4,100,000,000 or so forwards on the Japan dollar program. So the hedge cost next year will certainly go up. But as a reminder, we have what we call the back to back program or sort of countering forwards at Inc. So for the enterprise, the FX hedge costs from a forward perspective should stay relatively stable on a net basis. We do have some FX options on the book as well that help us with tail protection for the unhedged portion of the Dollar program in Japan and those are based on options pricing.

Speaker 11

We do expect those to go up, which won't necessarily have an offset, but we do Often look at our hedge ratios and how much we want hedged. So the amount of that could be a variable, but we would expect the option cost to go up as well. And then, more broadly speaking, when you look at next year's forecast from the perspective of where do we think our floating rate income Going. As Fred said, we still expect tailwinds. The forward curve for LIBOR is still upward sloping.

Speaker 11

We're all watching the Fed, and assuming it stays where it is, we would expect further tailwinds in floating rate income for next year. But again, the Fed is moving with inflation in the markets. The latest Fed meeting was a little A bit more dovish than hawkish for the future. So it's so that's going to be a moving target, if you will. However, having said that, We reported on this before.

Speaker 11

On our floating rate book, we have put on interest rate hedges and we did that because at the beginning of the year With the aggressive Fed hikes and increase in LIBOR, when we do our financial planning over a 3 5 year period, We saw that there is a substantial increase based on the forward curves in that floating rate income over that time period, But we also know that there's no guarantee we'll get that. It all depends on where LIBOR is at that time. So the purpose of the interest rate hedge was to say, Given that potential large increase in income, why not lock in a good portion of it and put better surety around that, Which we did. So it gives us great protection now in case in the future there's recession and the Fed starts to lower rate, But we didn't hedge all of it. So we still have some upside as well if rates should continue to go up.

Speaker 11

So that's a picture, if you will, Of the future and some specifics on the hedge class.

Speaker 9

Thank you. That's helpful.

Speaker 3

And just to

Speaker 9

confirm then given the back to back program, Should we really think of most of the kind of NII uplift from the higher floating rate yields dropping to the bottom line at an enterprise level, realizing it may not You may see less of an impact in the Japan segment and more of it in corporate?

Speaker 2

That's correct. Basically, you would see as the locked in hedge costs roll off and we go into a new level Of hedge costs in Japan, you would see those hedge costs increase, but then that same Increase would be offset by increased hedge income at the corporate level so that there'd be no effective impact to the enterprise. And then also keep in mind what Eric said that of the $12,000,000,000 in floating rate portfolio, Our hedge instruments are around $4,000,000,000 notional. And so, we still have an ability to enjoy Outside net investment income despite the rise in hedge costs.

Speaker 1

Got it. Thank you.

Operator

The next question comes from Suneet Kamal of Jefferies. Please go ahead.

Speaker 6

Thanks. Just a follow-up on Eric's question. So if we're getting $160,000,000 of higher NII from the floaters, does that influence your thinking around expense initiatives, maybe an opportunity to accelerate that in order to generate maybe faster growth going forward?

Speaker 2

Well, there are 2 different topics. What I would tell you, if what you're saying is would you Accelerate your initiatives and actually increase the pace of investment with added net investment income. We're not really adjusting our Plans around NII up or down. The plans we have around investing in our platform are really related to core growth And earned premium policies in force, sales and overall efficiency measures. So it really would not Render any impact on those plans.

Speaker 2

And I do want to highlight, as Dan mentioned in his comments, We are very much at work in terms of addressing the long term expense structure both in Japan and in the U. S. And have several initiatives underway to drive productivity improvements and efficiency improvements. Those do require near term investment, But we have plans in place to help our expense dynamics and certainly combat any inflationary pressure as we go forward. But none of that, Suneet, is really impacted by watching NII move up and down.

Speaker 6

Okay, got it. And then just shifting to Japan, I was hoping to get a little bit more color on this COVID as an infectious disease policy that the government has. Maybe what are your expectations for the, I guess, early September conversation around this that the government will have? And I believe that your products have certain caps in terms of number of days, where benefits can be drawn. Is there any risk And potentially that changing in the future.

Speaker 6

Thanks.

Speaker 2

I think perhaps Quita san can address that. We can add our Color here in the U. S, but Kuita san maybe address your views of the diet conversation in September.

Speaker 6

Yes. This is Aflac Japan.

Operator

So as Fred mentioned earlier, The discussion and deliberation related to COVID-nineteen infectious disease law discussion is really gaining momentum. And in light of the situation, experts from the Government Committee on Countermeasures Against Infectious Disease Law and New Coronaviruses and the National Governors Association have proposed a review of the classification. And also as Fred mentioned earlier, starting from August 1, a special committee of the Ministry of Health, Labor and Welfare started reviewing a COVID-nineteen classification under the law. Under the infectious disease law requires amending the law, which is expected to be discussed at the extraordinary diet session beginning in September at the earliest. So we cannot predict the outcome of the diet discussion, and we would highlight that it is not focused on the insurance industry.

Operator

Rather, it is focused on how the law has pressured the overall health care system. However, we feel it is a positive development that dialogue is taking place on the issue. That's all for me.

Speaker 2

So I would also just note something that I think is Perhaps obvious, but just to be clear, this is really not uniquely an Aflac issue. The major insurance companies in Japan are all facing substantial increased claims activity on medical All season fact, we're not even among the top few in terms of the volume of claims we have relative to other Peers in the industry, domestic insurers with large platforms. So this is really broadly based. We can't confirm some of these statistics, But there's been recent news articles suggesting that the amount of claims paid in the month of June, for example, under medical policies was up nearly twelvefold over the same time period last year this time. So it is absolutely pressuring the system and we think that The legislative community in Japan is taking this under consideration and realizing they've got to contemplate a change in the law.

Speaker 2

But saying that, we're still very comfortable with our projections for 2022.

Speaker 1

So I want to make sure you grasp that.

Speaker 5

Okay. Thanks.

Operator

The next question comes from Ryan Krueger of KBW. Please go ahead.

Speaker 12

Hi, thanks. Good morning. First, could you just Give us some sense of how much NII uplift in the current quarter did you realize from higher short term rates on the floating portfolio?

Speaker 1

Yes. Yes. Go ahead,

Speaker 12

Eric. Yes.

Speaker 1

Go ahead, Eric.

Speaker 11

And It's Eric. It was about $38,000,000 for the quarter, but that's in total for the portfolio, but just from rates alone is around $2,000,000 to 4,000,000 Dollars. And that's pretty logical because if you think about the ascent of LIBOR, it really didn't start increasing Until February, March, April, and these are 1 month of quarterly reset. So the impact from just rates alone on the floaters was rather small, We did have other portfolio activity around deployment. The new money yield on deployment was better than planned.

Speaker 11

We were able to purchase some floating rate assets ahead of plan from a particular provider. So a number of portfolio activities Really added to most of that increase, but as the year goes by, the impact from rates alone just continues to get higher because of that substantial rise in LIBOR.

Speaker 12

Thanks. I guess just to clarify, is the $38,000,000 part of the $160,000,000 or should we think about the $2,000,000 to $3,000,000 as

Speaker 2

The piece of the one The $138,000,000

Speaker 11

is part of the $160,000,000 that's just for the Q2 and the $160,000,000 is for the full year forecast.

Speaker 12

Okay, understood. And then, I guess, in the U. S, did you see any normalization in the benefit ratio As we went through the quarter or pretty similar throughout?

Speaker 8

Thank you. It's relatively well spread out over the quarter. There was no specific movements between the different 14 months in the quarter.

Speaker 12

Got it. Thank you.

Speaker 2

One thing back on Japan to just make sure that you're capturing is, Capturing is, again, when it comes to these COVID cases we're talking about, Just want to make sure you take to heart Max's comments and Dan's comments and my script comments. And that is The very same dynamic that is giving rise to these higher infectious disease COVID claims, We believe are absolutely impacting the rate of hospitalization on other claims activities, not the least of which is Cancer insurance related claims. And remember, again, as you all know, we are a dominant cancer insurance Provider. And so when the world of Japan Healthcare moves to more outpatient treatment, that has Material implications for your cancer claims and how they trend over time. So this is why despite all of the comments around COVID claims and increases in medical claims, you still see a low benefit ratio In Japan, even by historical standards, there's no guarantee of that direct correlation, but it's Certainly what we have seen in the data thus far.

Operator

The next question will come from Tom Gallagher of Evercore ISI. Please go ahead.

Speaker 13

Good morning. First question back on the floating rate portfolio. So the $12,000,000,000 floating rate portfolio and the transitional real estate, Eric, how do you feel about the quality of those portfolios If we do enter into a recession, would you expect the higher yield you're getting on an To keep the higher yield on a net basis or would you expect some portion of that's going to be given back through impairments? And are you looking to grow that portfolio or are you keeping it steady?

Speaker 11

Sure thing. And Tom, Since we have Brad Disland on the call, who is my deputy, but also in charge of credit, I'm going to shift that question over to Brad.

Speaker 10

Thank you, Eric. Good morning and thank you for the question, Tom. We're definitely paying very close attention to both of these portfolios. As I think Fred mentioned in his opening comments, we think this is where as the economy slows down, we could see the first sign of any issues. We're really focused, as you would expect, on their ability, especially in our middle market loan portfolio, their ability to pass along these Cost increases and absorb higher financing costs.

Speaker 10

We've worked very closely with our managers. We stressed the portfolio for some very severe outcomes. And we think any potential losses is going to be very manageable. When you look across the space, we feel we have a Relatively high quality portfolio across middle market lending. It's all first lien.

Speaker 10

We have modest leverage. It's a very well diversified portfolio. We think there's some inherent characteristics that allowed us to perform well during COVID And we the COVID shock and we think it will continue to support the portfolio with a downturn. Now of course, We don't expect to come through entirely unscathed. We would be surprised if we didn't have a few losses.

Speaker 10

If we get the kind of downturn that is possible, But we don't expect it to be overly material. In the real estate portfolio, again, it all boils down to the quality of assets you underwrite, The leverage you have, and in the case of transitional real estate, how well we underwrite the actual transition of the asset, The strength of the sponsor and the strength of the business plan, again, we stress this portfolio with our managers And we feel really good about how we're positioned and don't currently expect we'll have any losses in real estate. But of course, We're keeping a very close eye on it.

Speaker 11

Tom, I would also just add to Brad's remarks. Just as a reminder, For our TREs and middle market loans, these are 1st lien senior secured assets. We take a more conservative approach to those asset classes. We definitely earned higher yields and spreads, but that's to offset the risk that we're taking. The other reminder is just from a financial standpoint, we do take a CECL reserve for these asset classes And those are generally speaking based on long term historical default rates.

Speaker 11

Based on Brad's comments And our actual expected performance, while certainly we won't come out of this unscathed, my suspicion is we will Outperformed those CECL reserves and in essence, while there could be some losses in the future depending on how deep a recession is, how long it will be, It will be much better performance than the expected CECL reserves that we've taken already.

Speaker 13

Hey, thanks, Brad and Eric. Just one quick follow-up. The U. S. Earned premium It's still modestly declining despite the sales recovery and some improved persistency.

Speaker 13

And I know there's a bit of a lag here in terms of how that earns in. But based on what you're seeing now, would you expect earned premium to begin to grow again in the second half, and then maybe pick up in 2023?

Speaker 8

Well, we would expect an improvement throughout the year and then that it really picks up in 2023 As lapses come down and we continue to see sales growth.

Speaker 13

Okay. Thanks, Max.

Operator

The next question comes from John Barnidge of Piper Sandler. Please go ahead.

Speaker 10

Thank you very much. Can you maybe talk about foot traffic in shops in Japan in 2Q versus 1Q? Because I know that's a metric you've discussed previously.

Speaker 2

Are you talking about Our walk in shops and shop traffic,

Speaker 5

is that the question?

Speaker 2

Yes, that's correct. Yes. I think I would Yoshizumi san in Japan to answer that question. I don't have that data right in front of me. Yoshizumi san, do you have any data on The level of traffic through our retail shops.

Speaker 6

Yes. Thank you, Fred.

Operator

Let me answer the question. This is Yoshizumi. Well, the number of customers in store or the shop in the 2nd quarter was at the same level as the previous year. Which indicates a recovery from the Q1 where we had a negative 9.3%. That said, this figure has not yet returned to pre COVID-nineteen levels, and we will continue monitoring the trend in the number of visiting customers.

Operator

And that's all for me. The next question comes from Mike Ward of Citi. Please go ahead.

Speaker 14

Hey, guys. Thanks for the question. I just wanted to expand on the concept of delayed cancer screenings. I think Dan I was actually talking about this on CNBC this morning, but just wondering if you could maybe give an update on what you're seeing in terms of cancer severity and the impact Potential impact from delayed screening in the U. S.

Speaker 14

And Japan?

Speaker 1

Well, I mentioned it on CNBC when I was talking to Joe. And we have not seen an enormous jump in of any kind that was not Actuarially computated. So we're falling within our ranges saying that it's now getting From the original, it's getting out to be 2.5 years it's been. So I think the chances are less and less as we move forward. But at the same time, it's just to show you How you don't know what you have ahead of you and but all of our tracking says that We should have seen more if it was going to really spike by now.

Speaker 1

And I've got The guy that knows all the actual world complications shaking his head, that's correct. So that's the answer.

Speaker 8

One thing I would add to that answer is that we have seen first occurrence coming back to more normal levels. Obviously, that tends to be should be a leading indicator for our overall total cancer claims. So overall, we're still running a little bit low, where we would expect to be in below pre pandemic levels, but then component of first diagnosis and first occurrence is generally back both in the U. S. And in Japan Yes, to more normal levels.

Speaker 8

And we've said before and we still expect that there is sort of a level of Cancer out there to be detected within our policyholder base that we think will come our way at some point. We just Haven't seen the full impact of that yet and all of that is incorporated in our guidance for benefit ratios going forward.

Speaker 1

But I think most people that were going to the doctor and whatever they were having checkups are now back to normal It's been going on probably for a year or so. So we feel pretty good about those numbers and that's one reason We said overall, we feel good about even the issue in Japan regarding the government's move here and how we can Handle those claims, we feel well positioned.

Speaker 14

Thanks very much guys. Appreciate it.

Speaker 1

All right. Thank you, Mike, and thank you, Andrea. I believe that was our last question and we're We'll pass the top of the hour. I want to thank you all for joining us. Hope you'll mark your calendars for Tuesday, November 15th for our financial analyst briefing And we look forward to seeing and talking to you then.

Speaker 1

Until then, please reach out to Investor and Rating Agency Relations with any questions that you may have. And we look forward to talking to you soon. Take care.

Operator

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.

Powered by Quartr