Aflac Incorporated (AFL) KBW Insurance Conference (Transcript)

Aflac Incorporated (NYSE:AFL) KBW Insurance Conference September 7, 2023 3:05 PM ET

Company Participants

David Young - VP, Investor and Rating Agency Relations

Conference Call Participants

Ryan Krueger - KBW

Ryan Krueger

We're going to get started. I'm Ryan Krueger from KBW. And it's great to have David Young from Aflac on stage with me. David is Vice President of Investor and Rating Agency Relations.

Question-and-Answer Session

Q - Ryan Krueger

I'll just jump right in. Maybe we'll start with Japan first and specifically on sales in Japan. Maybe just as a backdrop, can you talk a little bit about kind of what sales conditions are like in Japan at this point? Is the country fully back to normal? Or are there still any restrictions still when it comes to face-to-face sales?

David Young

Yes. And first of all, thank you for having us here today, Ryan. It's been great. In terms of Japan, the way we view the environment there, they're obviously a little behind the U.S. as they emerge from this pandemic. It was just recently, you would say, May, where the Infectious Diseases Control Law changed the status of COVID-19 to lower level in line with influenza. So it went from the serious infectious disease down to a lower level of influenza. That really sent a signal across the country that things were going to become a little more normal. Now that is still evolving.

Anecdotally, earlier this week, I had a conversation with my colleagues in Japan as I do each week and asked them how are things? What's it like there on the ground with the pandemic conditions? And the quick response from my colleague was, well, look, I'm not wearing a mask, and he was in the office.

Now, before the pandemic, they - the Japanese people were wearing masks as they had a cold, being very courteous not to spread germs in that way, and I would expect that to continue. But I really do think that where we stand right now, they're making progress emerging from this pandemic. And I think we've seen that reflected in our sales results, too. I mean, if you look at what we've done, our first half sales were up 18.9%. That was year-over-year.

And second quarter total sales were up 26.6%. If you look even further product line, cancer sales were up 60%. So, that right there is telling us that there's a - there's other factors involved with that, but emerging from this pandemic is definitely one of the factors. The other factor I would point to would be product. And...

Ryan Krueger

Yes. I guess, on products, so you've rolled out a new cancer product across your distribution now, including the Japan Post in April. Can you discuss how the traction has been so far on the new cancer products? And also just you clearly had some momentum. How sustainable do you think that momentum is going forward?

David Young

Sure. This introduction of the new cancer product, WINGS, is a little different than introductions that we've done in the past in that it was a staged rollout of that cancer insurance. So we began in third quarter last year through our associates channel and through Daido Life, and that kicked off the sale of the product.

We then, in January of this year, launched the product through Dai-ichi Life and banks, mainly regional and Shinkin banks, and then most recently, in April, introduced the product through Japan Post and Japan Post Insurance. And those two entities, the Japan Post and Japan Post Insurance were a significant contributor to that 60% increase in cancer sales that we saw in the second quarter. So we had this staged rollout of cancer insurance.

And when you look at what is ahead of us, we obviously also have announced that our medical insurance will launch mid-September, September 19, as announced through a press release there in Japan. That will really be a focus for our agency or our associates channel. And then, when you look at - well, in the past, typically, when we launch a new product, we see a lot of attention go to that new product. It's just natural.

You have marketing, advertising, perhaps direct mail and phone campaigns tied to launches of products. And so, it's easy for salespeople to call upon their clients and talk to them about this new product and how it could enhance the protection versus what they currently have. It's also a way of retaining their customers to ensure that someone else, a competitor doesn't come in and sell a new product to them.

So in this case, we would expect associates to turn their attention to medical and obviously still sell cancer insurance, but medical will be the focus. At the same time, as I mentioned, Japan Post, Japan Post Insurance and Dai-ichi have been selling our cancer insurance for less than a year. And so, as a result, there's still some momentum. We think there's still legs in that. And overall, we would expect a moderate increase in sales in the second half of this year.

Ryan Krueger

Is that - that's an all-in number across products, medical, cancer and other?

David Young

Yes.

Ryan Krueger

Okay. And then, total sales. Got it. I guess if you shift to your first sector sales strategy, where you're selling life insurance products, I think one of the key things you've talked about is a cross-sell opportunity with first sector life products then creating new customers for your third sector products. Can you give an update on how that's going?

David Young

Yes. For cross-sell, that's really been a focus there for first sector and also targeting a younger demographic as well. So if you looked at what we've been doing, we are trying to bring in - obviously, the older demographic is a growing demographic in Japan. Younger demographic, though, is still a good, productive age group to focus upon. And so, it's a way to capture those customers earlier in the stage of life.

That's been a focus for our strategy in Japan, and then, when they are ready for medical policy later on in life, to introduce them to that and then cancer being the disease of age, again, would you - have you considered protecting yourself, protecting your family from cancer through the purchase of a cancer insurance policy? So bringing them in, making them - converting them to an Aflac customer at that point and riding that through that life cycle.

Since the launch of the refreshed WAYS, 80% of those sales have been to that younger demographic, people who are under the age of 50. And then on top of that, when you look at the concurrent sales of third sector products, that's been around 50%. So it's been a very effective strategy for us, and it's also going to play into how we approach the medical product. So, that medical product is going to be ever simple.

Lo and behold, it will be a simple way to sell a policy, easy to understand, whether you're young or old. For a younger demographic, it's going to be the fact that you're new to adding medical - supplemental medical coverage and you might not be looking for all the bells and whistles essentially that an older person would be looking for. So there are ways to add protection for an older policyholder but give a little lighter level of policy for somebody younger, again, bring them into becoming an Aflac policyholder, add protection over life as they grow and need that protection for themselves and for their family.

Ryan Krueger

Got it. When you typically - I guess, when you introduce new products, you've typically had this phenomenon of some level of lapse and reissue activity. I guess, can you talk a little bit about what you've seen in that regard after you've introduced the new cancer products recently?

David Young

Sure. You're absolutely right. In terms of lapse and reissue, again, whenever we introduce a new policy, it's - one of the first calls probably for an agent is to reach out to their customer base and say, look, we've just introduced this new cancer insurance policy. You haven't updated in five years, 10 years, what have you. And here's the enhanced protection that this policy offers.

And as a result, that leads to a significant amount of lapse and reissue activity. We - it's high in the early periods of launch, and it comes down over time. In the first quarter, with the cancer insurance policy sales, the - sorry, the lapse and reissue activity was much higher than it was in the second quarter, ended second quarter in that mid-50% range, I believe. So, that was something that we addressed on our earnings call, and it's really in line with what we would expect, and we would expect that to come down over time.

Ryan Krueger

Sticking with Japan growth but moving to premium growth, I think headline Japan premiums were down about 6% year-over-year in the second quarter, but there were some one-off impacts, the internal reinsurance transaction, the paid-up policies. So I think on a core basis, it was down more like 2%. And so, my question is, kind of where do you need Japan sales to build back up to before you could get closer to that breakeven level of premium growth again in Japan?

David Young

Yes. I would say, we haven't really given guidance in that way, Ryan. What we have said is, we're targeting JPY 80 billion in that 2025 to 2026 range, I believe. That was really more of a level to get us back to a pre-pandemic type level of sales, and that's what we're aiming for.

Now, in regard to the impacts of - to earned premium, you're right, when we backed out, I believe it was $8 billion negative impact to earned premium as a result of reinsurance and then roughly another $8 billion as a result of deferred profit liability that's attached to paid-up policies, our - the change in earned premium - net earned premiums for Japan was a negative 1.9%.

That places us right in the middle of that range that Max gave at our Financial Analyst Briefing last year that was a negative 1.5% to negative 2.5% range for net earned premium, that CAGR through 2024. And one thing I would add too is that I just want to make sure everyone knew that we will be hosting our FAB event every other year.

I want to make sure to advertise that beginning next year, we'll have our FAB in 2024. So I would be looking for that in 2024, and we'll be giving some guidance around fourth quarter for - on our fourth quarter call for the 2024 time frame, as well as maybe updating some nuggets of information that we usually share at our FAB to mind that gap.

Ryan Krueger

Shifting to the benefit ratio in Japan, it's continued to be quite favorable even as we've moved further away from the pandemic. Can you talk about the key factors that are driving the favorability? And also, I guess, as we move further away from the pandemic, if they're starting to see more permanent in nature?

David Young

Sure. We - going into the pandemic, there were trends that were already relating to the - or impacting the benefit ratio in a favorable way. And as we've gone through this pandemic, we've learned a number of things. Coming into the pandemic, it was an extreme risk scenario for us, and certain things didn't turn out the way we would have expected coming in. The benefit ratio is one of those things. And we were entering a period where hospitals, emergency rooms were turning people away unless you had an extreme case of COVID.

That impacts the normal behavior that people had coming into it when people would maybe go to the emergency rooms for anything. And as a result, one of the things that we've seen is that shorter hospitalization stays, especially as it relates to cancer. And first diagnosis of cancer has reverted to more normal levels now in Japan, but at the same time, the surgeries and hospitalization trends are still relatively muted.

So those are some of the things that have led to a lower benefit ratio as well as an increase in outpatient services. So if those trends continue, we would expect it to lead to a lower benefit ratio as it has already, and we're kind of seeing some of those trends stick, and I think time will tell as to how permanent they are.

Ryan Krueger

Got it. On expenses in Japan, I know Max has kind of talked about that it's becoming a little more difficult to maintain your Japan expense ratio at the same level it's been at, given that premiums are declining. What actions are you taking to become more efficient in Japan to try to preserve the expense ratio at current levels?

David Young

Yes. I think for the expense ratio, when - Max is right when he says that it's going to be harder for us to maintain a low below 20% expense ratio in Japan. Part of that, though, is related to what we were just discussing around the impact of the deferred profit liability, the paid-up impact, as well as reinsurance. Those are reducing the earned premium, which as a result, reduces the revenue.

So the denominator of that ratio is going to be on the decline. And so, to be able to maintain a low ratio like that, it's going to be hard. Some of what we might be doing to address this is some things that we've already had in the works.

And you have heard about some of the digital adoption and digital transformation that we've been working on in Japan to make it easier for customers and more efficient processes from enrollment through processing of claims. So those are some of the things that we're working on, have been working on, but it's really going to be a challenging dynamic as we continue to have impact to earned premiums as a result of the reinsurance and also paid-up policies.

Ryan Krueger

Got it. I'm going to switch over to the U.S. now. I guess the first question is maybe a more difficult one. But in your most recent 10-Q, you had a risk factor for - and it was really discussing a new rule that's been proposed by the DOL, HHS and Treasury in July, and it's in regards to certain fixed benefit policies. So I guess the question is, one, can you just explain kind of what this proposal is? And then secondly, how it could impact Aflac if it is passed?

David Young

Sure. I'll do my best. And I know we don't have a lot of time, but this goes back to a proposed rule that came out in July from the Departments of Labor, Treasury, and Health and Human Services. The main target that primarily was short-term limited duration insurance. And I want to be clear that short-term limited duration insurance is not the same thing as short-term disability and it is not a product that Aflac sells.

And it was a primary concern from the perspective of these agencies because consumers may not fully understand the difference between buying one of these policies and an ACA-compliant policy, the Affordable Care Act-compliant policy. And just to be clear, too, the policies that we sell at Aflac are supplemental to major medical. They're not a replacement for major medical. So, that is something to be clear on. And that's where we feel like the main focus is for this tri-agency rule - proposed rule, I should say.

And as it's written, it has a significant limitation though on the structure benefits for hospital indemnity plans and the financial protection that these plans offer. It would - the proposed rule would eliminate the ability to vary the benefits, the amount of benefits by the services or items received, the severity of the events themselves or the illness, as well as the characteristics particular to a course of treatment.

And in addition, this proposed rule also proposes to change the tax treatment of all supplemental benefits. Under the proposal, if premiums were paid on a pretax basis, either by the employer or the employee through salary - pretax salary deduction, then the entire amount of the benefit would be taxable.

Currently, it's just the excess of the benefit relative to the actual medical services provided. It's that excess benefit that is taxable. So in this case, all the entire benefits would be subject to tax. Currently, about half of our supplemental policies are sold on a taxable basis, and the trend is increasing in that respect.

So for now, the agencies, they're in a comment period up until September 11. And we are going to be working to make sure that - we're not going to speculate on the various paths that this could take because it could range from going away to coming out with a revised comment, proposal for comment or a revised rules.

So I don't really want to speculate on how this goes, but we're making sure that we stand up for the value that our policyholders receive and that we continue to be there for our policyholders when they need us most and making sure that these agencies understand that too. So that's where we stand right now to - within this process, and we're, was it four days, off from wrapping up that comment period.

Ryan Krueger

All right. Well, thank you. I'll move on from that fun topic. I guess, just going back to business as usual in the U.S, can you discuss the sales trends that you're seeing there and also just how they differ between the more traditional carrier agency channel and the broker distribution?

David Young

Yes. I think our sales in the U.S. were up 6.4% in the second quarter of this year. That's pretty much in line with what you would expect for industry - supplemental industry. And when it comes to the brokers and agents, we've had great success of reengaging veteran agents and then also working with brokers. And they really focus on two different markets but - meaning that the agency channel, we've really focused on smaller case where they're successful brokers, or in larger cases, over - really over 1,000 employees. And those markets work in different ways.

On the individual side, the small case, you're working with a proprietary who doesn't necessarily have an HR benefits department, and they're making those decisions themselves to what kind of benefits to offer their employees. The brokers, they are working with an HR benefit manager, putting together a proposal that a company accepts or that HR benefit manager says, yes, this is the package we want to go with, and then typically like an online enrollment that occurs in the fourth quarter - third, fourth quarter of the year.

So both sides, on the smaller case, larger case, we tend to see more concentration of activity, third, fourth quarter, especially, and that's increased as we've gone to larger cases. But we've also had a very good success at partnering our brokers and agents, meaning the brokers are going together and they're putting the packages, but our agents are very well versed on how supplemental policies work and how they fit with the major medical that the employer offers.

So they're able to go and do on-site brown bag lunches or what have you to do enrollments on behalf of brokers to make more sales. And so we've had a good success with that. But like I said, fourth quarter is going to be - should continue to see that seasonality in the third and fourth quarter, fourth especially, as we've grown out to the larger cases, and that's become a larger portion of the business.

Ryan Krueger

Can you discuss some of the newer growth initiatives you have in the U.S., direct-to-consumer, the dental, vision, the traditional group, and how they're progressing so far and how much they're contributing to your sales?

David Young

Sure. I think dental and vision - network dental and vision and direct-to-consumer, as well as the group life and disability, those are platforms that we've been investing in. The dental and vision and the group life and disability were platforms that were fairly small and new that we built up, and direct-to-consumer has been more of an organic from a very small start to where it is now. You put all of them together, I think, in aggregate, they led to a 50% year-over-year increase in sales in the second quarter from a very small base.

And at 2022, they were, I think, around 12% or so of the total sales, check me on that number. But it's a large part of the growth strategy or an important part of the growth strategy, I should say, network in dental, that's something that we can lead with an account. And it's typically the second most desired benefit right after major medical. So it enters Aflac into the conversation earlier in that enrollment process, and it also provides a good segue to offer our other core supplemental policies to the employer and its employees.

Ryan Krueger

And then, I know these new build-outs have had some - led to some higher expenses for you. I think at times, you've talked about how much of a drag they've had on the expense ratio. I guess where does that stand currently? And then, is there any sort of time frame you have in mind for kind of when you'd expect that to subside as they build scale?

David Young

Yes. So I think in terms of - if Max were here, he would say, the build is over. Now it's a matter of getting them up to scale. That's where the focus is. They added 260 basis points to our second quarter expense ratio. And we expect that to turn. I think I don't have the specific timing as to when that will turn for this year, but we expect it to remain high. And I believe we also indicated on our - or said on our last earnings call to - the expense ratio, expect that to be above that 47% to 50% range that we gave.

Ryan Krueger

Got it. And then, I guess there's been some pockets at times of weaker persistency in the U.S. over the last year or so or I guess 12 to 18 months. What have you seen there? And then like what type of actions have you been taking to try to get persistency back to where you want it in the U.S.?

David Young

Yes. I'm sorry, I want to just correct something I think I just said. The expense ratio range was 37% to 40%. We expect to be above - slightly above that range.

Ryan Krueger

Got it.

David Young

In regard to the persistency, that's - your question is like what are we doing in that regard?

Ryan Krueger

Yes. What are you doing to improve U.S. persistency? And it seems like it's had some positive effects, but what are you seeing there?

David Young

Yes. I think for one, it's a little early to point to some of the initiatives that we have underway to improve persistency, but I think we saw a 10% improvement in premium persistency in the second quarter and - a 10 basis point improvement. And part of that is just high lapse period rolling out. But then part of what we're doing is, when we see drops in persistency, that's a flag to us that the customer is not seeing the value in the policy. That's a concern.

We want to be - we want to pay benefits or claims, and we want to be there quickly as well because when a majority of Americans don't have $1,000 to cover an emergency expense that could be caused by a medical event, that's a concern, and that's why we're here to help them cover that gap. And so, one of the simple things that we've done in the past is, a lot of our policies have a wellness benefit attached to it.

A wellness benefit is something that you go to get a checkup, a regular checkup, and after you do that, you go to your MyAflac app and you just upload your paperwork there really quickly by taking a photo, submit your claim, within like 24 hours, you should have your wellness benefit claimed. By reaching out to people and reminding them that, hey, you have a wellness benefit attached to your policy but you haven't filed it.

Surely, you've gone for a checkup. Especially as we emerge from the pandemic, regular checkups are coming back into play, but just reminding them of that, that simple act really helps improve persistency going forward. We have that in the data. And then, there's also efforts underway around like our cancer policy, cancer assurance protection that we've talked about on our last call about adding benefits without increasing the premium for the policyholder.

That right there demonstrates value to the customer. And I think if you received a notification that you have increased benefits as a result of some action on behalf of your insurer, I think you would respond positively to that, especially when you found out that, oh, it doesn't cost you anything more. So we're really taking these actions to boost that premium persistency because we know that the longer a policy stays in our books, the better off, the more efficient it is for us and the more profitable as well. So it's just a better way of doing business for everyone.

Ryan Krueger

And then, kind of similar to the Japan, the U.S. has also had favorable benefit ratios that have continued post pandemic. Can you also talk about the reasons whether they are similar or different from what you're seeing in Japan? What is causing the continued favorable claims experience in the U.S.? And I guess, similar to my question about Japan, is there anything you really see at this point that could - that would suggest this might not just continue?

David Young

Yes. I think there are some similarities there. I think, as Max noted on our last call, we would have expected for utilization to have returned to more normal level by the second quarter of '23, and we're still a little bit off of where we would have expected that utilization to be. And as a result, we've taken some of the actions that we just discussed to try and improve this.

And we're seeing less use of emergency rooms, greater use of local facilities. People are not really going to - or having in-hospital services. So it's that outpatient trend that we spoke to earlier in Japan. And so overall, I think if these trends continue, that will continue to have a favorable impact on the benefit ratio. But at the same time, we're a company that wants to pay claims and be there when they need us most and cover that gap. So that's what we're focused on in the U.S., that persistency.

Ryan Krueger

And then moving to capital, you established an internal Bermuda reinsurance entity earlier this year. It freed up close to $1 billion of capital. Can you go through how you're deploying that capital? And also how do you think about the use of Bermuda going forward and how meaningful it could be?

David Young

Sure. I think the - for Bermuda, when we look at that, we freed up about $1 billion in capital and a dividend of, I think, $400 million to the holding company. We don't look upon that capital any differently than other deployable capital that we have. Just to kind of go back to what Max said at our Financial Analyst Briefing last November, we generate around $2.6 billion to $3 billion in capital each year. On top of that, we would expect to generate capital through other means like reinsurance.

And we look at the reinsurance as not just a one-off. It is a program, but it is not something that we haven't really said we're going to do it at this pace or at this amount to a large degree. So, I would say that we will continue to use that platform to the degree that we can and look upon the capital in the same way we do other deployable capital. We hold pretty dear that increase in annual dividend. So we've gone 40 years. We would love to see that be 41. And then repurchase of shares too is another option. But we're deploying it at what really makes the greatest IRR, and that would also include anything to support the growth of the core business itself. But those are the main uses right there.

Ryan Krueger

Then just one on the investment portfolio. Can you give an update on your middle market loan and transitional real estate portfolios and how they're performing?

David Young

Sure. I think Brad did a great job of focusing on this at our earnings call, and a lot of the focus has been on our transitional real estate and the middle market loans that transitional real estate makes up about $6.4 billion or 3/4 of the $8.1 billion of our commercial mortgage loan portfolio. When we look at that, we've got a watch list that's really remained pretty constant around $900 million, and we've talked about within that $900 million, about $500 million, we would expect to go into foreclosure.

Now, that is a very - that whole process, the workout process is a complex process. It involves a lot of negotiations and ebbs and flows, and so it swings from time to time. But we're watching that very closely, and we update that watch list frequently as a result of our monitoring of the process.

However, that total value has remained relatively stable with only a modest increase in this last quarter. As we mentioned, we marked the carrying value of those loans to the fair market value of the underlying property assets. And our average loan to value has been 65%. The accounting process resulted in a small $11 million additional reserves in the second quarter.

Turning to the middle market loans, those have performed fairly well, and we've been pretty pleased with how they have performed. This is a primary outlet for our below investment-grade exposure and was purposely built with quality bias to perform well during difficult periods for credit.

And our strategy of allowing only a modest level of first lien leverage on growing companies in noncyclical industries owned by supportive sponsors has really turned out to our benefit and resulted in good adjusted - risk-adjusted returns thus far. So those are - that's, I guess, the latest and low down on those two asset classes, Ryan.

Ryan Krueger

Great. We're almost out of time. As there's probably time for one question, just open it to the audience to see if there's any questions. All right. So, we've got one.

Unidentified Analyst

Just any comments on ESR in Japan and what it means? What do you think about SMR and that going away, sort of the counterintuitive movements in SMR rates? Just thoughts on it, regulations are going to come in 2025?

David Young

Yes. The ESR, economic solvency ratio, that is going to come into play in Japan in 2025. We've been reporting that out at our FAB meeting. So that's something that we may provide an update on here in the third quarter to bridge the gap until we do an update in 2024. We've been supportive of this. As we've gone along, we - you look at our business through an economic lens like the ESR, we are very comfortable with that.

So we've been reporting as part of that underlying self-reporting with the voluntary - with the FSA. And at the same time, though, we are in an SMR regime right now, and that's one of the guideposts that we use when we're making capital decisions to dividend and what have you that we look to, the strength of the SMR. So ESR comes into play in 2025. I believe it's going to be March 31, 2026, that end of that fiscal year in Japan when you actually see the first ESRs reported, but that's where we are with the ESR.

Ryan Krueger

All right. I think we're going to wrap it up there. Thanks a lot, David and Aflac, for attending.