Japan Deals AFLAC a Losing Hand -- for Now

Image: Aflac.

Most Americans know AFLAC for its popular duck commercials, which highlight the insurer's unique supplemental insurance products geared toward individual employees. Yet what many people don't realize about Aflac is that the company does most of its business in Japan, where its products are arguably even more popular, and contribute the lion's share of Aflac's overall profits.

Given the declines in the Japanese yen during the past year, investors came into Tuesday afternoon's first-quarter financial report with concerns about whether Aflac would be able to avoid dramatic declines in revenue and income. Those concerns proved justified, as the company's results were even weaker than many had expected. Let's look more closely at how Aflac did last quarter, and whether long-term shareholders should really worry.

The strong dollar saps Aflac's growth Aflac clearly felt the impact of the yen's weakness in its financial performance. Total revenue dropped more than 7%, to $5.23 billion, which was even worse than the $5.3 billion in sales that many had expected the insurer to post. Similarly, diluted earnings of $1.51 per share were down from year-ago figures, and even using Aflac's preferred measure of operating earnings, results of $1.54 per share were down almost 9% from the previous year's first quarter.

Just looking at the assumptions that Aflac used in its financial statements shows just how huge the currency fluctuations have been. The yen/dollar exchange rate weakened by 14% during the past year alone, with the dollar climbing from less than 103 yen to more than 119 yen, on average, during the respective quarters. Aflac said that the yen hurt operating earnings by $0.13 per share, and that without it, constant-currency operating earnings would have declined by just 1.2%.

A look at Aflac's two major geographic segments paints a different picture of the company's health. In local-currency terms, Aflac Japan saw premium income remain flat and investment income rise 7%; but translated to dollars, premium income fell almost 14% and investment income fell more than 7%. Sales of cancer and medical products coverage jumped by 21%, but sales of child-endowment and other products that constitute what Aflac calls first-sector sales dropped by 30%.

The cost of cancer treatments that often aren't covered under conventional insurance is a major selling point for Aflac's supplemental products. Source: Aflac.

Meanwhile, the U.S. business saw premium income rise 3.5%, with net investment income climbing 3.3%, helping revenue rise by nearly 4%. Still, even in the U.S., pre-tax operating earnings fell 6% as the company paid higher expenses from structural changes to its sales organization.

Can Aflac get its growth back? Despite the currency problems, CEO Daniel Amos wasn't disappointed by the results, pointing to successes in the Japanese business in yen terms, and to the emphasis on cancer, medical products, and other third-sector product sales. Amos expects Japan's third-sector sales to climb 15% during the first three quarters of 2015 before tougher comparisons start challenging further growth. In the U.S., Amos believes that changes to Aflac's distribution system will help produce sales gains of 3% to 7% in 2015.

Aflac made substantial progress during the quarter in improving its capital position, with a new reinsurance agreement freeing up more than $1 billion in reserves in its Japanese unit. It hopes to repatriate a sizable amount of money to its U.S. parent, where it expects to buy back another $1.3 billion in stock during the 2015 year. In the first quarter alone, Aflac spent $600 million buying back about 9.8 million shares, yet the company has almost 20 million shares more under its current authorizations for repurchases.

In giving guidance, Aflac largely aims for currency-neutral results, ignoring foreign-exchange fluctuations. With the goal of raising operating earnings by 2% to 7% this year, Aflac believes that it will remain challenging to achieve the investment returns it needs to support earnings growth, especially in light of low rates. That has made Aflac double down on ensuring the strongest underwriting standards, and focusing on the best insurance products to keep loss ratios as low as possible.

Aflac shares moved downward by 2% in after-hours trading following the announcement; but for long-term investors, the insurance company didn't really say anything unexpected in its report. Eventually, currency pressures will ease up. When that happens, the fundamental strength of Aflac's business will have a better chance to shine through and reward those who stay the course.

The article Japan Deals AFLAC a Losing Hand -- for Now originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Aflac. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.