CHICAGO--(BUSINESS WIRE)--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 (IDR) at 'A' and senior debt ratings at 'A-'. The Rating Outlook remains Stable for Aflac's holding company ratings and Negative for its insurance subsidiaries. A full ratings list follows at the end of this release.
KEY RATING DRIVERS
The affirmation of Aflac's ratings reflect the company's extremely strong 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. Factors contributing to the notch between Aflac's ratings and Japan's sovereign rating include 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 800% and Japanese solvency margin ratio (SMR) of 935% as of Sept. 30, 2016. 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 2015. Aflac's financial leverage ratio remains within rating expectations at 26% as of Sept. 30, 2016.
Aflac has significant investment concentration in JGBs and related agencies, which represent approximately 40% of total investments as of Sept. 30, 2016. In an effort to mitigate low yielding JGBs and enhance portfolio yields, Aflac Japan continues to employ alternative investment strategies that increase asset risk. However, Fitch views the company's overall credit quality as acceptable, evidenced by its risky asset ratio of 40% compared with approximately 80% for the industry.
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, and high yield corporate bonds. The company also increased its allocation to dividend-focused U.S. publicly traded equities and dividend-focused yen-denominated publicly traded equity securities.
Aflac's extremely strong earnings profile reflects the company's 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 increasing hedge costs. Aflac reported $2.2 billion of net operating earnings for the first nine months of 2016, a 9% increase over the prior year, which was largely driven by the stronger yen. When the impact of foreign currency translation is excluded, operating earnings declined by 5% during the period.
Pretax operating margins remained extremely strong at 21.1% for Aflac Japan and 20.5% for Aflac U.S. for the first nine months of 2016 compared with 21.7% and 19.1%, 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 management as adequate, as investments and liabilities are reasonably well matched. Aflac is exposed to material reinvestment risk due to its long duration liabilities in Japan, but has taken various steps to reduce volatility associated with interest rates.
RATING SENSITIVITIES
Key rating triggers that could result in a downgrade include:
--A downgrade of Fitch's sovereign rating (local currency) of Japan to 'A-' or lower (currently 'A'/Outlook Negative);
--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%.
An upgrade of Aflac is unlikely in the near term, given Japan's Long-Term Local Currency IDR and Outlook of 'A'/Outlook Negative.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings with a Stable Outlook:
Aflac Inc.
--Long-Term IDR at 'A';
--2.65% USD650 million senior notes due Feb. 15, 2017 'A-';
--2.4% USD550 million senior notes due March 16, 2020 'A-'
--4% USD350 million senior notes due Feb. 15, 2022 'A-';
--3.625% USD700 million senior notes due June 2023 'A-';
--3.625% USD750 million senior notes due Nov. 15, 2024 'A-';
--3.25% USD450 million senior notes due March 17, 2025 'A-';
--2.875% USD300 million senior notes due Oct. 15, 2026 'A-';
--6.9% USD400 million senior notes due Dec. 17, 2039 'A-';
--6.45% USD450 million senior notes due Aug. 15, 2040 'A-';
--4.00% USD400 million senior notes due Oct. 15, 2046 'A-';
--5.5% USD500 million junior subordinated debentures due Sept. 15, 2052 'BBB'.
Fitch has affirmed the following ratings with a Negative Outlook:
American Family Life Assurance Co. of Columbus
American Family Life Assurance Co. of New York
Aflac Japan
--IFS 'A+'.
Additional information is available on www.fitchratings.com
Applicable Criteria
Insurance Rating Methodology (pub. 15 Sep 2016)
https://www.fitchratings.com/site/re/887191
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