CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Aflac Inc.'s (AFL) 'A' long-term Issuer Default Rating (IDR) and the 'AA-' Insurance Financial Strength (IFS) ratings of AFL's insurance subsidiaries. The Rating Outlook is Stable. A complete list of ratings appears at the end of this release.
KEY RATING DRIVERS
The affirmation of Aflac's ratings reflects the company's strong, steady earnings, leverage ratios that are consistent with expectations for the rating category, strong balance sheet, and high regulatory risk-based capital (RBC) ratios. The ratings also incorporate Fitch's view that Aflac's GAAP basis shareholders' equity is highly exposed to interest rate risk compared to peers, as well as the impact of overall low economic growth in the company's key Japanese market.
Well over two-thirds of Aflac's assets, capital, and profitability are associated with its branch operation in Japan, making the economic picture of that country a significant business and ratings factor. Fitch's sovereign rating on Japan is 'A+', with a Negative Outlook. Fitch's view of Aflac's Japan branch is that its standalone IFS ratings are capped by the sovereign rating of Japan at 'A+'.
Fitch's consolidated view of Aflac is that its group IFS ratings can be retained at their current 'AA-' level provided Japan's sovereign rating remains 'A' or higher. Fitch views Aflac's ability to generate comparably strong financial results during periods of weak economic conditions in Japan, partially due to earnings from its U.S. business, as well as the capital flexibility bought by the company's branch operation structure, as contributing factors to the notch between Aflac's ratings and Japan's sovereign rating.
Fitch's expectation is that Aflac will continue to generate strong operating earnings in the near term. Aflac's pre-tax operating margins of 20.5% in Japan and 17.9% in the U.S., which generated GAAP business segment pre-tax income (before net realized losses) of $4.4 billion and $4.7 billion in 2013 and full year 2012, respectively are considered strong. GAAP interest coverage and maximum statutory dividend interest coverage were 7.8x and 2.4x, respectively for 2013 and 2012. For 2014, GAAP interest coverage is expected to remain consistent with current levels.
Aflac has taken steps over the last two and a half years to reduce its investment risk and diversify its portfolio, resulting in general improvements in investment credit quality. Decreases in perpetual preferred, financial institution, and GIIPS exposure have occurred, while exposures to broader geographic markets have increased.
Investment impairments in the company's fixed maturities and perpetual preferred securities portfolio have dropped, and the investment situation in Europe has improved. Gross unrealized investment losses on Aflac's perpetual preferred and financial sector investments remained flat at $0.8 billion for both year-end 2013 and year-end 2012.
Total adjusted capital (TAC) was $9.8 billion at Dec. 31, 2013, a 10% increase compared to year-end 2012 and its consolidated NAIC RBC ratio increased 156 basis points (bps) to a very strong 786% at Dec. 31, 2013. The operating leverage ratio was a strong 10x versus 12x at year-end 2012.
Aflac's Japanese Solvency Margin Ratio (SMR) remains strong at a reported 777% compared 669% at year-end 2012. The positive change is due to a reinsurance transaction and increased use of interest rate hedges.
Fitch notes that due to the long duration of Aflac's investment portfolio the company's GAAP shareholders' equity is susceptible to significant mark-to-market volatility from changes in interest rates, particularly in Japanese Government Bonds (JGB). Aflac has taken steps to sell and repurchase a significant portion of its JGBs that were held as available for sale and reclassified them as policy reserve matching securities that can be carried at amortized cost. JGBs and agencies represent approximately 39% of total investments at Dec. 31, 2013.
Fitch's concerns in asset/liability management are also tempered by Aflac's liability profile which limits liquidity risks and, in Fitch's view, enhances Aflac's ability to hold long duration investments to maturity. Additionally, the agency believes Aflac's investments and liabilities are reasonably well matched.
Aflac's leverage ratios remain within rating expectations. The financial leverage ratio increased to 25% at Dec. 31, 2013 from 24% at Dec. 31, 2012 and the total financing and commitments ratio (TFC) decreased slightly to 0.72x from 0.78x, due to a 2013 $700 million debt issuance and a small decrease in use of securities lending.
The key rating triggers that could result in an upgrade include:
--Continued effective management of investment risks;
--A decrease in operating leverage below the 10x range;
--RBC of 500% or more over several periods, recognizing exchange rates can cause volatility;
--Financial leverage of 20% or below;
--Statutory interest coverage above 6x.
The key rating triggers that could result in a downgrade include:
--A downgrade in Fitch's Sovereign Rating (local currency) of Japan to 'A-', or lower (currently 'A+'/Negative 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%);
--Prolonged RBC less than 400%.
Fitch has affirmed the following ratings, with a Stable Outlook:
--Issuer Default Rating (IDR) at 'A';
--3.65% USD 700 million senior notes due June 2023 at 'A-';
--2.26% Uridashi notes due September 2016 at 'A-';
--1.47% Samurai notes due July 2014 at 'A-';
--1.84% Samurai notes due July 2016 at 'A-';
--Variable Samurai notes due July 2014 at 'A-';
--8.5% senior notes due May 15, 2019 at 'A-';
--6.9% senior notes due Dec. 17, 2039 at 'A-'.
--3.45% USD 300 million senior notes due Aug. 15, 2015 at 'A-';
--6.45% USD 450 million senior notes due Aug. 15, 2040 at 'A-'
--2.65% USD 650 million senior notes due Feb. 15, 2017 at 'A-';
--4.0% USD 350 million senior notes due Feb. 15, 2022 at 'A-'.
--5.5% USD 500 million junior subordinated debentures due Sept. 15, 2052 at 'BBB'.
American Family Life Assurance Co. of Columbus
American Family Life Assurance Co. of New York
--IFS at 'AA-'.
THE ISSUER DID NOT PARTICIPATE IN THE RATING PROCESS OTHER THAN THROUGH THE MEDIUM OF ITS PUBLIC DISCLOSURE.
The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Insurance Rating Methodology (November 2013).
Applicable Criteria and Related Research:
Insurance Rating Methodology