November 22, 2017 / 5:19 PM / a year ago

Fitch Affirms Aflac Inc.'s Ratings; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, November 22 (Fitch) Fitch Ratings has affirmed the 'A+' Insurance Financial Strength (IFS) ratings of Aflac Inc.'s (Aflac) insurance subsidiaries. Fitch has also affirmed Aflac's Issuer Default Rating at 'A' and senior debt ratings at 'A-'. The Rating Outlook is Stable. A full ratings list follows at the end of this release. KEY RATING DRIVERS The affirmation of Aflac's ratings reflect the company's competitive position in the supplemental accident and health insurance markets in Japan and the U.S., extremely strong earnings profile and very strong capitalization. The ratings also incorporate the impact of slow economic growth in Aflac's key Japanese market and its sizeable exposure to Japanese sovereign risk including significant concentration in Japanese government bonds (JGB). Aflac's IFS rating is capped at one notch above Japan's sovereign rating of 'A', due to Aflac Japan's exposure to Japan's economy. Aflac Japan comprises more than two-thirds of Aflac's assets, capital and profitability, making Japan's economy a significant business and ratings factor. The one notch difference between Aflac's ratings and Japan's sovereign rating reflects Aflac's sizeable global diversification and its ability to generate strong financial results from its U.S. operations. Aflac maintains a dominant market position in both Japan and the U.S. selling cancer and other supplemental accident and health insurance products. The company's key competitive advantages include its low-cost operations, continued product innovation and brand name recognition. However, Aflac faces growing competition in both Japan and the U.S. Fitch views Aflac's capitalization as very strong with an estimated NAIC RBC ratio above 900% and Japanese solvency margin ratio (SMR) of 1045% as of Sept. 30, 2017. Aflac Japan's SMR is bolstered by unrealized investment gains and remains sensitive to interest rate and foreign exchange rate changes, although the company has taken steps to mitigate this risk. Also supporting Fitch's view of Aflac's capitalization is its Prism capital model score of 'Extremely Strong' at year-end 2016. Aflac's financial leverage ratio remains within rating expectations at 24% as of Sept. 30, 2017. Aflac has significant investment concentration in JGBs and related agencies, which represent approximately 45% of total investments as of Sept. 30, 2017. In an effort to mitigate low yielding JGBs and enhance portfolio yields, Aflac Japan continues to utilize alternative investment strategies that increase asset risk. However, Fitch views the company's overall credit quality as strong, evidenced by its risky asset ratio of 36% compared with approximately 80% for the industry at year-end 2016. Aflac Japan's yield enhancement strategies include yen-denominated private placements and an expanded U.S. dollar program, which is partially hedged. The U.S. dollar program includes senior secured bank loans, most of which have below-investment-grade ratings, high yield corporate bonds, commercial mortgage loans and infrastructure debt. While many of these assets are less liquid than investment-grade corporate bonds, Fitch believes the company's need for liquidity remains negligible due to extremely strong cash flow generation and minimal optionality in its products. Aflac's extremely strong earnings profile reflects the company's profitable product profile, disciplined underwriting over an extended period of time and limited exposure to market-sensitive products. However, the company faces earnings headwinds from low interest rates and elevated hedge costs. Aflac reported $2.1 billion of net operating earnings for the first nine months of 2017, a 1% decrease over the prior year, which was largely driven by a weaker yen. Pretax operating margins remained extremely strong at 20% for both Aflac Japan and Aflac U.S. for the first nine months of 2017 compared with 20% and 21%, respectively, in the prior year period. Fitch expects the company's profitability metrics to continue to exceed rating expectations over the intermediate term, due to its scale advantage, disciplined underwriting of mortality and morbidity risks and its shift away from lower-return interest-sensitive first sector products. Fitch views Aflac's asset/liability and liquidity management as strong. The company attempts to match the duration of its assets with its liabilities to minimize reinvestment risk. However, the dearth of long-dated, yen-denominated, fixed-income securities makes this particularly challenging, which has been further exacerbated by the very low, and at times, negative interest rate environment in Japan. Similar to many Japanese life insurers, Aflac Japan's economic duration gap is wide compared with U.S. life insurers. Aflac has taken various steps to reduce volatility associated with interest rates. Aflac's previously announced plans to convert its Aflac Japan branch into a subsidiary of Aflac remains on track for completion in April 2018 and is viewed as neutral to its ratings. Fitch believes the conversion will enhance Aflac's flexibility by destacking the branch and converting it to an indirect subsidiary of Aflac. While the conversion will free up capital in the U.S. by eliminating foreign currency risk and the investment concentration in JGBs, capital metrics in Japan will temporarily decline due to an accounting reclassification. Aflac announced that, following the branch conversion, its intention to draw down approximately USD1 billion of the excess capital in its U.S. subsidiary over the next two years. Fitch expects capitalization to remain within rating guidelines. RATING SENSITIVITIES An upgrade of Aflac's ratings could result from an upgrade of Japan's Long-Term Local Currency Issuer Default Rating to 'A+' or higher. Key rating sensitivities that could result in a downgrade include: --A downgrade of Fitch's sovereign rating (local currency) of Japan to 'A-' or lower (currently 'A'/Stable Outlook); --Significant investment impairments or losses in Aflac's capital position; --A decline in Aflac's run-rate pre-tax operating margin below 17% in Japan or 15% in U.S.; --A significant increase in either operating (greater than 16x) or financial leverage (greater than 30%); --NAIC RBC less than 400%, a Prism capital model score below 'Extremely Strong' or SMR sustained below 800%. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings with a Stable Outlook: Aflac Inc. --Long-Term Issuer Default Rating 'A'; --Senior notes 'A-'; --Subordinated notes 'BBB'. American Family Life Assurance Co. of Columbus American Family Life Assurance Co. of New York Aflac Japan --IFS 'A+'. Contacts: Primary Analyst Dafina M. Dunmore, CFA Director +1-312-368-3136 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Nelson Ma, CFA Director +1-212-908-0273 Tertiary Analyst Teruki Morinaga Director +81 3 3288 2781 Committee Chairperson Martha M. Butler, CFA Senior Director +1-312-368-3191 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: Additional information is available on Applicable Criteria Insurance Rating Methodology (pub. 26 Apr 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. 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