filings.toolsItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management's Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013. Based on our evaluation under this framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2018.
KPMG LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of internal control over financial reporting as of December 31, 2018, which is included herein.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Aflac Incorporated:
Opinion on Internal Control Over Financial Reporting
We have audited Aflac Incorporated and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and financial statement schedules II, III, and IV (collectively, the “consolidated financial statements”), and our report dated February 25, 2019 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| /s/ KPMG LLP |
Atlanta, Georgia
February 25, 2019
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Aflac Incorporated:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Aflac Incorporated and subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three‑year period ended December 31, 2018, and the related notes and financial statement schedules II, III, and IV (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three‑year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
| /s/ KPMG LLP |
We have served as the Company’s auditor since 1963.
Atlanta, Georgia
February 25, 2019
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Statements of Earnings
Years Ended December 31,
| (In millions, except for share and per-share amounts) | 2018 | 2017 | 2016 | ||||||||||||||
| Revenues: | |||||||||||||||||
| Net premiums, principally supplemental health insurance | $ | 18,677 | $ | 18,531 | $ | 19,225 | |||||||||||
| Net investment income | 3,442 | 3,220 | 3,278 | ||||||||||||||
| Realized investment gains (losses): | |||||||||||||||||
| Other-than-temporary impairment losses realized | (81 | ) | (37 | ) | (85 | ) | |||||||||||
| Other gains (losses) (1) | (349 | ) | (114 | ) | 71 | ||||||||||||
| Total realized investment gains (losses) | (430 | ) | (151 | ) | (14 | ) | |||||||||||
| Other income (loss) | 69 | 67 | 70 | ||||||||||||||
| Total revenues | 21,758 | 21,667 | 22,559 | ||||||||||||||
| Benefits and expenses: | |||||||||||||||||
| Benefits and claims, net | 12,000 | 12,181 | 12,919 | ||||||||||||||
| Acquisition and operating expenses: | |||||||||||||||||
| Amortization of deferred policy acquisition costs | 1,245 | 1,132 | 1,141 | ||||||||||||||
| Insurance commissions | 1,320 | 1,316 | 1,368 | ||||||||||||||
| Insurance and other expenses (2) | 2,988 | 2,780 | 2,796 | ||||||||||||||
| Interest expense | 222 | 240 | 268 | ||||||||||||||
| Total acquisition and operating expenses | 5,775 | 5,468 | 5,573 | ||||||||||||||
| Total benefits and expenses | 17,775 | 17,649 | 18,492 | ||||||||||||||
| Earnings before income taxes | 3,983 | 4,018 | 4,067 | ||||||||||||||
| Income tax expense: | |||||||||||||||||
| Current | 1,379 | 631 | 884 | ||||||||||||||
| Deferred | (316 | ) | (1,217 | ) | 524 | ||||||||||||
| Income taxes | 1,063 | (586 | ) | 1,408 | |||||||||||||
| Net earnings | $ | 2,920 | $ | 4,604 | $ | 2,659 | |||||||||||
| Net earnings per share: | |||||||||||||||||
| Basic | $ | 3.79 | $ | 5.81 | $ | 3.23 | |||||||||||
| Diluted | 3.77 | 5.77 | 3.21 | ||||||||||||||
| Weighted-average outstanding common shares used in computing earnings per share (In thousands): | |||||||||||||||||
| Basic | 769,588 | 792,042 | 822,942 | ||||||||||||||
| Diluted | 774,650 | 797,861 | 827,841 |
(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018 related to financial instruments.
(2) Includes expense of $13 in 2017 and $137 in 2016 for the early extinguishment of debt
See the accompanying Notes to the Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
Years Ended December 31,
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Net earnings | $ | 2,920 | $ | 4,604 | $ | 2,659 | |||||||||||
| Other comprehensive income (loss) before income taxes: | |||||||||||||||||
| Unrealized foreign currency translation gains (losses) during period | 232 | 286 | 283 | ||||||||||||||
| Unrealized gains (losses) on fixed maturity securities: (1) | |||||||||||||||||
| Unrealized holding gains (losses) on fixed maturity securities during period | (3,155 | ) | 1,731 | 2,852 | |||||||||||||
| Reclassification adjustment for realized (gains) losses on fixed maturity securities included in net earnings | 46 | 2 | (53 | ) | |||||||||||||
| Unrealized gains (losses) on derivatives during period | 2 | 1 | 3 | ||||||||||||||
| Pension liability adjustment during period | (25 | ) | 9 | (45 | ) | ||||||||||||
| Total other comprehensive income (loss) before income taxes | (2,900 | ) | 2,029 | 3,040 | |||||||||||||
| Income tax expense (benefit) related to items of other comprehensive income (loss) | (797 | ) | 631 | 1,035 | |||||||||||||
| Other comprehensive income (loss), net of income taxes | (2,103 | ) | 1,398 | 2,005 | |||||||||||||
| Total comprehensive income (loss) | $ | 817 | $ | 6,002 | $ | 4,664 |
(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018 related to financial instruments.
See the accompanying Notes to the Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets
December 31,
| (In millions) | 2018 | 2017 | ||||||
| Assets: | ||||||||
| Investments and cash: | ||||||||
| Securities available for sale, at fair value: | ||||||||
| Fixed maturity securities (amortized cost $73,007 in 2018 and $70,594 in 2017) (1) | $ | 78,429 | $ | 78,804 | ||||
| Fixed maturity securities - consolidated variable interest entities (amortized cost $3,849 in 2018 and $4,538 in 2017) (1) | 4,466 | 5,509 | ||||||
| Securities held to maturity, at amortized cost: | ||||||||
| Fixed maturity securities (fair value $36,722 in 2018 and $38,072 in 2017) | 30,318 | 31,430 | ||||||
| Equity securities, at fair value: | ||||||||
| Equity securities (1) | 827 | 270 | ||||||
| Equity securities - consolidated variable interest entities | 160 | 753 | ||||||
| Other investments (2) | 7,706 | 3,402 | ||||||
| Cash and cash equivalents | 4,337 | 3,491 | ||||||
| Total investments and cash | 126,243 | 123,659 | ||||||
| Receivables | 851 | 827 | ||||||
| Accrued investment income | 773 | 769 | ||||||
| Deferred policy acquisition costs | 9,875 | 9,505 | ||||||
| Property and equipment, at cost less accumulated depreciation | 443 | 434 | ||||||
| Other (3) | 2,221 | 2,023 | ||||||
| Total assets | $ | 140,406 | $ | 137,217 |
(1) Includes perpetual securities, see Notes 1 and 3 of the Notes to the Consolidated Financial Statements
(2) Includes $5,856 in 2018 and $2,341 in 2017 of loan receivables and limited partnerships from consolidated variable interest entities
(3) Includes $182 in 2018 and $151 in 2017 of derivatives from consolidated variable interest entities
See the accompanying Notes to the Consolidated Financial Statements.
(continued)
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets (continued)
December 31,
| (In millions, except for share and per-share amounts) | 2018 | 2017 | ||||||
| Liabilities and shareholders’ equity: | ||||||||
| Liabilities: | ||||||||
| Policy liabilities: | ||||||||
| Future policy benefits | $ | 86,368 | $ | 81,857 | ||||
| Unpaid policy claims | 4,584 | 4,392 | ||||||
| Unearned premiums | 5,090 | 5,959 | ||||||
| Other policyholders’ funds | 7,146 | 6,939 | ||||||
| Total policy liabilities | 103,188 | 99,147 | ||||||
| Income taxes | 4,020 | 4,745 | ||||||
| Payables for return of cash collateral on loaned securities | 1,052 | 606 | ||||||
| Notes payable | 5,778 | 5,289 | ||||||
| Other (4) | 2,906 | 2,832 | ||||||
| Total liabilities | 116,944 | 112,619 | ||||||
| Commitments and contingent liabilities (Note 15) | ||||||||
| Shareholders’ equity: | ||||||||
| Common stock of $.10 par value. In thousands: authorized 1,900,000 shares in 2018 and 2017; issued 1,347,540 shares in 2018 and 1,345,762 shares in 2017 | 135 | 135 | ||||||
| Additional paid-in capital | 2,177 | 2,052 | ||||||
| Retained earnings | 31,788 | 29,895 | ||||||
| Accumulated other comprehensive income (loss): | ||||||||
| Unrealized foreign currency translation gains (losses) | (1,847 | ) | (1,750 | ) | ||||
| Unrealized gains (losses) on fixed maturity securities (5) | 4,234 | 5,964 | ||||||
| Unrealized gains (losses) on derivatives | (24 | ) | (23 | ) | ||||
| Pension liability adjustment | (212 | ) | (163 | ) | ||||
| Treasury stock, at average cost | (12,789 | ) | (11,512 | ) | ||||
| Total shareholders’ equity | 23,462 | 24,598 | ||||||
| Total liabilities and shareholders’ equity | $ | 140,406 | $ | 137,217 |
(4) Includes $102 in 2018 and $128 in 2017 of derivatives from consolidated variable interest entities
(5) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018 related to financial instruments.
See the accompanying Notes to the Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Statements of Shareholders’ Equity
Years Ended December 31,
| (In millions, except for per-share amounts) | 2018 | 2017 | 2016 | ||||||||
| Common stock: | |||||||||||
| Balance, beginning of period | $ | 135 | $ | 135 | $ | 135 | |||||
| Balance, end of period | 135 | 135 | 135 | ||||||||
| Additional paid-in capital: | |||||||||||
| Balance, beginning of period | 2,052 | 1,908 | 1,760 | ||||||||
| Exercise of stock options | 34 | 38 | 46 | ||||||||
| Share-based compensation | 54 | 51 | 64 | ||||||||
| Gain (loss) on treasury stock reissued | 37 | 55 | 38 | ||||||||
| Balance, end of period | 2,177 | 2,052 | 1,908 | ||||||||
| Retained earnings: | |||||||||||
| Balance, beginning of period | 29,895 | 25,981 | 24,007 | ||||||||
| Cumulative effect of change in accounting principle - financial instruments, net of income taxes (1) | 148 | 0 | 0 | ||||||||
| Cumulative effect of change in accounting principle - tax effects from tax reform (1) | (374 | ) | 0 | 0 | |||||||
| Net earnings | 2,920 | 4,604 | 2,659 | ||||||||
| Dividends to shareholders ($1.04 per share in 2018, $.87 per share in 2017 and $.83 per share in 2016) | (801 | ) | (690 | ) | (685 | ) | |||||
| Balance, end of period | 31,788 | 29,895 | 25,981 | ||||||||
| Accumulated other comprehensive income (loss): | |||||||||||
| Balance, beginning of period | 4,028 | 2,630 | 625 | ||||||||
| Cumulative effect of change in accounting principle - financial instruments, net of income taxes (1) | (148 | ) | 0 | 0 | |||||||
| Cumulative effect of change in accounting principle - tax effects from tax reform (1) | 374 | 0 | 0 | ||||||||
| Unrealized foreign currency translation gains (losses) during period, net of income taxes | 228 | 233 | 213 | ||||||||
| Unrealized gains (losses) on fixed maturity securities during period, net of income taxes and reclassification adjustments (1) | (2,316 | ) | 1,159 | 1,819 | |||||||
| Unrealized gains (losses) on derivatives during period, net of income taxes | 2 | 1 | 2 | ||||||||
| Pension liability adjustment during period, net of income taxes | (17 | ) | 5 | (29 | ) | ||||||
| Balance, end of period | 2,151 | 4,028 | 2,630 | ||||||||
| Treasury stock: | |||||||||||
| Balance, beginning of period | (11,512 | ) | (10,172 | ) | (8,819 | ) | |||||
| Purchases of treasury stock | (1,317 | ) | (1,391 | ) | (1,422 | ) | |||||
| Cost of shares issued | 40 | 51 | 69 | ||||||||
| Balance, end of period | (12,789 | ) | (11,512 | ) | (10,172 | ) | |||||
| Total shareholders’ equity | $ | 23,462 | $ | 24,598 | $ | 20,482 |
(1) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018.
See the accompanying Notes to the Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31,
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net earnings | $ | 2,920 | $ | 4,604 | $ | 2,659 | |||||||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||||||||||||
| Change in receivables and advance premiums | (55 | ) | (91 | ) | 42 | ||||||||||||
| Capitalization of deferred policy acquisition costs | (1,504 | ) | (1,468 | ) | (1,447 | ) | |||||||||||
| Amortization of deferred policy acquisition costs | 1,245 | 1,132 | 1,141 | ||||||||||||||
| Increase in policy liabilities | 2,343 | 2,890 | 3,331 | ||||||||||||||
| Change in income tax liabilities | 64 | (1,240 | ) | (93 | ) | ||||||||||||
| Realized investment (gains) losses | 430 | 151 | 14 | ||||||||||||||
| Other, net | 571 | 150 | 340 | (1) | |||||||||||||
| Net cash provided (used) by operating activities | 6,014 | 6,128 | 5,987 | ||||||||||||||
| Cash flows from investing activities: | |||||||||||||||||
| Proceeds from investments sold or matured: | |||||||||||||||||
| Available-for-sale fixed maturity securities | 7,888 | 4,680 | 6,723 | ||||||||||||||
| Equity securities | 429 | 902 | 350 | ||||||||||||||
| Held-to-maturity fixed maturity securities | 1,670 | 2,212 | 1,399 | ||||||||||||||
| Other investments - loan receivables | 936 | 303 | 90 | ||||||||||||||
| Costs of investments acquired: | |||||||||||||||||
| Available-for-sale fixed maturity securities | (9,086 | ) | (9,867 | ) | (10,890 | ) | |||||||||||
| Equity securities | (440 | ) | (446 | ) | (1,079 | ) | |||||||||||
| Other investments - loan receivables | (4,848 | ) | (2,115 | ) | (1,110 | ) | |||||||||||
| Other investments, excluding loan receivables, net | (414 | ) | (206 | ) | (98 | ) | |||||||||||
| Settlement of derivatives, net | (241 | ) | (621 | ) | 1,252 | ||||||||||||
| Cash received (pledged or returned) as collateral, net | 348 | (205 | ) | (416 | ) | ||||||||||||
| Other, net | 176 | (68 | ) | (76 | ) | ||||||||||||
| Net cash provided (used) by investing activities | (3,582 | ) | (5,431 | ) | (3,855 | ) | |||||||||||
| Cash flows from financing activities: | |||||||||||||||||
| Purchases of treasury stock | (1,301 | ) | (1,351 | ) | (1,422 | ) | |||||||||||
| Proceeds from borrowings | 1,020 | 1,040 | 986 | ||||||||||||||
| Principal payments under debt obligations | (550 | ) | (1,161 | ) | (610 | ) | |||||||||||
| Dividends paid to shareholders | (793 | ) | (661 | ) | (658 | ) | |||||||||||
| Change in investment-type contracts, net | (31 | ) | 35 | 159 | |||||||||||||
| Treasury stock reissued | 58 | 33 | 46 | ||||||||||||||
| Other, net | (19 | ) | 0 | (120 | ) | (1) | |||||||||||
| Net cash provided (used) by financing activities | (1,616 | ) | (2,065 | ) | (1,619 | ) | |||||||||||
| Effect of exchange rate changes on cash and cash equivalents | 30 | 0 | (4 | ) | |||||||||||||
| Net change in cash and cash equivalents | 846 | (1,368 | ) | 509 | |||||||||||||
| Cash and cash equivalents, beginning of period | 3,491 | 4,859 | 4,350 | ||||||||||||||
| Cash and cash equivalents, end of period | $ | 4,337 | $ | 3,491 | $ | 4,859 | |||||||||||
| Supplemental disclosures of cash flow information: | |||||||||||||||||
| Income taxes paid | $ | 998 | $ | 780 | $ | 1,526 | |||||||||||
| Interest paid | 181 | 196 | 211 | ||||||||||||||
| Noncash interest | 41 | 44 | 57 | ||||||||||||||
| Impairment losses included in realized investment losses | 81 | 37 | 85 | ||||||||||||||
| Noncash financing activities: | |||||||||||||||||
| Capital lease obligations | 11 | 12 | 1 | ||||||||||||||
| Treasury stock issued for: | |||||||||||||||||
| Associate stock bonus | 7 | 29 | 30 | ||||||||||||||
| Shareholder dividend reinvestment | 8 | 29 | 27 | ||||||||||||||
| Share-based compensation grants | 2 | 1 | 4 |
(1) Operating activities excludes and financing activities includes a cash outflow of $137 in 2016 for the payments associated with the early extinguishment of debt
See the accompanying Notes to the Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data
Aflac Incorporated and Subsidiaries
Notes to the Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States and Japan. The Company's insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac) in the United States (Aflac U.S.) and, effective April 1, 2018, through Aflac Life Insurance Japan Ltd. in Japan (Aflac Japan). Prior to April 1, 2018, the Company's insurance business was marketed in Japan as a branch of Aflac. American Family Life Assurance Company of New York (Aflac New York) is a wholly owned subsidiary of Aflac. Most of Aflac's policies are individually underwritten and marketed through independent agents. Additionally, Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC), branded as Aflac Group Insurance. The Company's insurance operations in the United States and Japan service the two markets for the Company's insurance business. Aflac Japan's revenues, including realized gains and losses on its investment portfolio, accounted for 70% of the Company's total revenues in 2018, compared with 70% in 2017 and 71% in 2016. The percentage of the Company's total assets attributable to Aflac Japan was 84% at December 31, 2018, compared with 83% at December 31, 2017.
Basis of Presentation
The Company prepares its financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). In these Notes to the Consolidated Financial Statements, references to U.S. GAAP issued by the FASB are derived from the FASB Accounting Standards CodificationTM (ASC). The preparation of financial statements in conformity with U.S. GAAP requires the Company to make estimates based on currently available information when recording transactions resulting from business operations. The most significant items on the Company's balance sheet that involve a greater degree of accounting estimates and actuarial determinations subject to changes in the future are the valuation of investments and derivatives, deferred policy acquisition costs (DAC), liabilities for future policy benefits and unpaid policy claims, and income taxes. These accounting estimates and actuarial determinations are sensitive to market conditions, investment yields, mortality, morbidity, commission and other acquisition expenses, and terminations by policyholders. As additional information becomes available, or actual amounts are determinable, the recorded estimates will be revised and reflected in operating results. Although some variability is inherent in these estimates, the Company believes the amounts provided are adequate.
The consolidated financial statements include the accounts of the Parent Company, its subsidiaries, and those entities required to be consolidated under applicable accounting standards. All material intercompany accounts and transactions have been eliminated.
Significant Accounting Policies
Foreign Currency Translation: The functional currency of Aflac Japan is the Japanese yen. The Company translates its yen-denominated financial statement accounts into U.S. dollars as follows. Assets and liabilities are translated at end-of-period exchange rates. Realized gains and losses on security transactions are translated at the exchange rate on the trade date of each transaction. Other revenues, expenses, and cash flows are translated using average exchange rates for the period. The resulting currency translation adjustments are reported in accumulated other comprehensive income. The Company includes in earnings the realized currency exchange gains and losses resulting from foreign currency transactions.
The Parent Company has designated a majority of its yen-denominated liabilities (notes payable and yen-denominated loans) as non-derivative hedges and from time-to-time may designate certain foreign currency forwards and options as derivative hedges of the foreign currency exposure of the Company's net investment in Aflac Japan. Outstanding principal and related accrued interest on these Parent Company liabilities and the fair value of these derivatives are translated into U.S. dollars at end-of-period exchange rates. Currency translation adjustments and changes in the fair value of these derivatives are recorded as unrealized foreign currency translation gains (losses) in other comprehensive income and are included in accumulated other comprehensive income.
Insurance Revenue and Expense Recognition: Substantially all of the supplemental health and life insurance policies the Company issues are classified as long-duration contracts. The contract provisions generally cannot be
Item 8. Financial Statements and Supplementary Data
changed or canceled during the contract period; however, the Company may adjust premiums for supplemental health policies issued in the United States within prescribed guidelines and with the approval of state insurance regulatory authorities.
Insurance premiums for most of the Company's health and life policies, including cancer, accident, hospital, critical illness, dental, vision, term life, whole life, long-term care and disability, are recognized as revenue over the premium-paying periods of the contracts when due from policyholders. When revenues are reported, the related amounts of benefits and expenses are charged against such revenues, so that profits are recognized in proportion to premium revenues during the period the policies are expected to remain in force. This association is accomplished by means of annual additions to the liability for future policy benefits and the deferral and subsequent amortization of policy acquisition costs.
Premiums from the Company's products with limited-pay features, including term life, whole life, WAYS, and child endowment, are collected over a significantly shorter period than the period over which benefits are provided. Premiums for these products are recognized as revenue over the premium-paying periods of the contracts when due from policyholders. Any gross premium in excess of the net premium is deferred and recorded in earnings, such that profits are recognized in a constant relationship with insurance in force. Benefits are recorded as an expense when they are incurred. A liability for future policy benefits is recorded when premiums are recognized using the net premium method.
At the policyholder's option, customers can also pay discounted advanced premiums for certain of the Company's products. Advanced premiums are deferred and recognized when due from policyholders over the regularly scheduled premium payment period.
The calculation of DAC and the liability for future policy benefits requires the use of estimates based on sound actuarial valuation techniques. For new policy issues, the Company reviews its actuarial assumptions and deferrable acquisition costs each year and revises them when necessary to more closely reflect recent experience and studies of actual acquisition costs. For policies in force, the Company evaluates DAC by major product groupings to determine that they are recoverable from future revenues, and any amounts determined not to be recoverable are charged against net earnings. The Company has not had any material charges to earnings for DAC that was determined not to be recoverable in any of the years presented in this Form 10-K.
Advertising expense is reported as incurred in insurance expenses in the consolidated statements of earnings.
Cash and Cash Equivalents: Cash and cash equivalents include cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased.
Investments: The Company's debt securities consist of fixed maturity securities, which are classified as either held to maturity or available for sale. Securities classified as held to maturity are securities that the Company has the ability and intent to hold to maturity or redemption and are carried at amortized cost. All other fixed maturity debt securities are classified as available for sale and are carried at fair value. If the fair value is higher than the amortized cost for debt securities, the excess is an unrealized gain, and if lower than cost, the difference is an unrealized loss. The net unrealized gains and losses on securities available for sale, less related deferred income taxes, are recorded through other comprehensive income and included in accumulated other comprehensive income.
Amortized cost of debt securities is based on the Company's purchase price adjusted for accrual of discount, or amortization of premium, and recognition of impairment charges, if any. The amortized cost of debt securities the Company purchases at a discount or premium will equal the face or par value at maturity or the call date, if applicable. Interest is reported as income when earned and is adjusted for amortization of any premium or discount.
The Company has investments in equity securities which are carried at fair value. Effective January 1, 2018 upon the adoption of new accounting guidance, changes in fair value of equity securities are recorded in earnings as a component of realized investment gains and losses. Prior to January 1, 2018, equity securities were carried at fair value with unrealized gains and losses, less related deferred income taxes, recorded in other comprehensive income and included in accumulated other comprehensive income.
The Company has investments in variable interest entities (VIEs). Criteria for evaluating VIEs for consolidation focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. The Company is the primary beneficiary of certain VIEs, and therefore consolidates these entities in its financial statements. While the consolidated VIEs generally operate within a defined set of contractual
Item 8. Financial Statements and Supplementary Data
terms, there are certain powers that are retained by the Company that are considered significant in the conclusion that the Company is the primary beneficiary. These powers vary by structure but generally include the initial selection of the underlying collateral; the ability to obtain the underlying collateral in the event of default; and, the ability to appoint or dismiss key parties in the structure. In particular, the Company's powers surrounding the underlying collateral were considered to be the most significant powers because those most significantly impact the economics of the VIE. The Company has no obligation to provide any continuing financial support to any of the entities in which it is the primary beneficiary. The Company's maximum loss is limited to its original investment. Neither the Company nor any of its creditors have the ability to obtain the underlying collateral, nor does the Company have control over the instruments held in the VIEs, unless there is an event of default. For those entities where the Company is the primary beneficiary, the consolidated entity's assets are segregated on the balance sheet by the caption "consolidated variable interest entities," and consist of fixed maturity securities, equity securities, loan receivables, limited partnerships and derivative instruments.
For the mortgage- and asset-backed securities held in the Company's fixed maturity portfolio, the Company recognizes income using a constant effective yield, which is based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in mortgage- and asset-backed securities is adjusted to the amount that would have existed had the new effective yield been applied at the time of acquisition. This adjustment is reflected in net investment income.
The Company uses the specific identification method to determine the gain or loss from securities transactions and report the realized gain or loss in the consolidated statements of earnings. Securities transactions are accounted for based on values as of the trade date of the transaction.
An investment in a fixed maturity security is impaired if the fair value falls below amortized cost. The Company regularly reviews its fixed maturity security investments portfolio for declines in fair value. The Company's fixed maturity security investments are evaluated for other-than-temporary impairment using its debt impairment model. The Company's debt impairment model focuses on the ultimate collection of the cash flows from its investments and whether the Company has the intent to sell or if it is more likely than not the Company would be required to sell the security prior to recovery of its amortized cost. The determination of the amount of impairments under this model is based upon the Company's periodic evaluation and assessment of known and inherent risks associated with the respective securities. Such evaluations and assessments are revised as conditions change and new information becomes available.
When determining the Company's intention to sell a security prior to recovery of its fair value to amortized cost, the Company evaluates facts and circumstances such as, but not limited to, future cash flow needs, decisions to reposition its security portfolio, and risk profile of individual investment holdings. The Company performs ongoing analyses of its liquidity needs, which includes cash flow testing of its policy liabilities, debt maturities, projected dividend payments, and other cash flow and liquidity needs.
The determination of whether an impairment in value of the Company's fixed maturity securities is other than temporary is based largely on the Company's evaluation of the issuer's creditworthiness. The Company must apply considerable judgment in determining the likelihood of its fixed maturity securities recovering in value. Factors that may influence this include the overall level of interest rates, credit spreads, the credit quality of the underlying issuer, and other factors. This process requires consideration of risks which can be controlled to a certain extent, such as credit risk, and risks which cannot be controlled, such as interest rate risk and foreign currency risk.
If, after monitoring and analyses, management believes that fair value will not recover to amortized cost, the Company recognizes an other-than-temporary impairment of the security. Once a security is considered to be other-than-temporarily impaired, the impairment loss is separated into two components: the portion of the impairment related to credit and the portion of the impairment related to factors other than credit. The Company recognizes a charge to earnings for the credit-related portion of other-than-temporary impairments. Impairments related to factors other than credit are charged to earnings in the event the Company intends to sell the security prior to the recovery of its amortized cost or if it is more likely than not that the Company would be required to dispose of the security prior to recovery of its amortized cost; otherwise, non-credit-related other-than-temporary impairments are charged to other comprehensive income.
The Company lends fixed maturity and public equity securities to financial institutions in short-term security-lending transactions. These securities continue to be carried as investment assets on the Company's balance sheet during the terms of the loans and are not reported as sales. The Company receives cash or other securities as collateral for such loans. For loans involving unrestricted cash or securities as collateral, the collateral is reported as an asset with a corresponding liability for the return of the collateral. For loans where the Company receives as collateral securities that the Company is not permitted to sell or repledge, the collateral is not reported as an asset.
Item 8. Financial Statements and Supplementary Data
Other investments include transitional real estate loans (TREs), commercial mortgage loans (CMLs), middle market loans (MMLs), policy loans, limited partnerships, and short-term investments with maturities at the time of purchase of one year or less, but greater than 90 days. The Company's investments in TREs, CMLs, and MMLs are accounted for as loan receivables and are recorded at amortized cost on the acquisition date. The Company has the intent and ability to hold these loan receivables for the foreseeable future or until they mature and therefore, they are considered held for investment and are carried at amortized cost in the other investments line in its consolidated balance sheets. The amortized cost of the loan receivables reflects allowances for expected incurred losses estimated based on past events and current economic conditions as of each reporting date. Limited partnership investments are accounted for using the equity method of accounting. Under the equity method of accounting, the Company reports its portion of partnership earnings as a component of net investment income in its consolidated statements of earnings. The underlying investments held by the Company’s limited partnerships primarily consist of private equity and real estate. Short-term investments are stated at amortized cost, which approximates fair value.
Derivatives and Hedging: Freestanding derivative instruments are reported in the consolidated balance sheet at fair value and are reported in other assets and other liabilities, with changes in value reported in earnings and/or other comprehensive income. These freestanding derivatives are foreign currency forwards, foreign currency options, foreign currency swaps, interest rate swaps, interest rate swaptions, and, in prior year periods, credit default swaps (CDSs). Foreign currency forwards and options are used in hedging foreign exchange risk on U.S. dollar-denominated investments in Aflac Japan's portfolio. Foreign currency forwards and options are also used to economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long term exposure to a weakening yen. Cross-currency interest rate swaps, also referred to as foreign currency swaps, are used to economically convert certain U.S. dollar-denominated note obligations into yen-denominated principal and interest obligations. Foreign currency swaps are used within special-purpose entities, including VIEs where the Company is the primary beneficiary, to hedge the risk arising from interest rate and currency exchange risk. Interest rate swaps are used to economically hedge interest rate fluctuations in certain variable-rate investments. Interest rate swaptions, which are options to enter into interest rate swaps, are used to hedge interest rate fluctuations on certain U.S. dollar-denominated available-for-sale securities in Aflac Japan's portfolio. The Company does not use derivatives for trading purposes, nor does the Company engage in leveraged derivative transactions.
From time to time, the Company purchases certain investments that contain an embedded derivative. The Company assesses whether this embedded derivative is clearly and closely related to the asset that serves as its host contract. If the Company deems that the embedded derivative's terms are not clearly and closely related to the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the derivative is separated from that contract, held at fair value, and reported with the host instrument in the consolidated balance sheet, with changes in fair value reported in earnings. If the Company has elected the fair value option, the embedded derivative is not bifurcated, and the entire investment is held at fair value with changes in fair value reported in earnings.
See Note 5 for a discussion on how the Company determines the fair value of its derivatives. Accruals on derivatives are typically recorded in accrued investment income or within other liabilities in the consolidated balance sheets.
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated risk attributable to the hedged item. At the inception of hedging relationships the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategies for undertaking the respective hedging relationship, and the methodology that will be used to assess the effectiveness of the hedge relationship at and subsequent to hedge inception. The Company documents the designation of each hedge as either (i) a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability or the hedge of a forecasted transaction ("cash flow hedge"); (ii) a hedge of the estimated fair value of a recognized asset or liability ("fair value hedge"); or (iii) a hedge of a net investment in a foreign operation. The documentation process includes linking derivatives and non-derivative financial instruments that are designated as hedges to specific assets or groups of assets or liabilities in the statement of financial position or to specific forecasted transactions and defining the effectiveness testing methods to be used. At the hedge inception and on an ongoing quarterly basis, the Company also formally assesses whether the derivatives and non-derivative financial instruments used in hedging activities have been, and are expected to continue to be, highly effective in offsetting their designated risk. Hedge effectiveness is assessed using qualitative and quantitative methods. The assessment of hedge effectiveness determines the accounting treatment of changes in fair value.
For assessing hedge effectiveness, qualitative methods may include the comparison of critical terms of the derivative to the hedged item, and quantitative methods may include regression, dollar offset, or other statistical analysis of changes in fair value or cash flows associated with the hedge relationship. For derivative instruments that are designated and
Item 8. Financial Statements and Supplementary Data
qualify as cash flow hedges, the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. In cash flow hedges, all components of each derivative's gain or loss are included in the assessment of hedge effectiveness and are recorded in the line item of the consolidated statements of earnings in which the cash flows of the hedged item are recorded.
For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the hedged item and the portion of the hedging instrument included in the assessment of effectiveness are recorded in the line item of the consolidated statements of earnings in which gain or loss on the hedged item is recorded. When assessing the effectiveness of the Company's fair value hedges, the Company excludes the changes in fair value related to the difference between the spot and the forward rate on its foreign currency forwards and the time value of foreign exchange options and interest rate swaptions.
For hedges of the Company's net investment in Aflac Japan, the Company has designated the majority of the Parent Company's yen-denominated liabilities (notes payable and yen-denominated loans) as non-derivative hedging instruments and from time to time may designate certain foreign currency forwards and options as derivative hedging instruments. The Company makes its net investment hedge designation at the beginning of each quarter. For assessing hedge effectiveness of net investment hedges, if the total of the designated Parent Company non-derivative and derivatives notional is equal to or less than its net investment in Aflac Japan, the hedge is deemed to be effective. If the hedge is effective, the related exchange effect on the yen-denominated liabilities is reported in the unrealized foreign currency component of other comprehensive income. For derivative hedging instruments designated as net investment hedges, Aflac follows the forward-rate method. According to that method, all changes in fair value, including changes related to the forward-rate component of foreign currency forward contracts and the time value of foreign currency options, are reported in the unrealized foreign currency component of other comprehensive income. Should these designated net investment hedge positions exceed the Company's net investment in Aflac Japan, the foreign exchange effect on the portion that exceeds its investment in Aflac Japan would be recognized in current earnings within derivative and other gains (losses).
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the estimated cash flows or fair value of a hedged item; (2) the derivative is de-designated as a hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.
When hedge accounting is discontinued on a cash flow hedge or fair value hedge, the derivative is carried in the consolidated balance sheets at its estimated fair value, with changes in estimated fair value recognized in current period earnings. For discontinued cash flow hedges, including those where the derivative is sold, terminated or exercised, amounts previously deferred in other comprehensive income (loss) are reclassified into earnings when earnings are impacted by the cash flow of the hedged item.
If a derivative is not designated as an accounting hedge or its use in managing risk does not qualify for hedge accounting, changes in the estimated fair value of the derivative are generally reported within derivative and other gains (losses), which is a component of realized investment gains (losses). The fluctuations in estimated fair value of derivatives that have not been designated for hedge accounting can result in volatility in net earnings.
The Company receives and pledges cash or other securities as collateral on open derivative positions. Cash received as collateral is reported as an asset with a corresponding liability for the return of the collateral. Cash pledged as collateral is recorded as a reduction to cash, and a corresponding receivable is recognized for the return of the cash collateral. The Company generally can repledge or resell collateral obtained from counterparties, although the Company does not typically exercise such rights. Securities received as collateral are not recognized unless the Company was to exercise its right to sell that collateral or exercise remedies on that collateral upon a counterparty default. Securities that the Company has pledged as collateral continue to be carried as investment assets on its balance sheet.
Deferred Policy Acquisition Costs: Certain direct and incremental costs of acquiring new business are deferred and amortized with interest over the premium payment periods in proportion to the ratio of annual premium income to total anticipated premium income. Anticipated premium income is estimated by using the same mortality, persistency and interest assumptions used in computing liabilities for future policy benefits. In this manner, the related acquisition expenses are matched with revenues. Deferred costs include the excess of current-year commissions over ultimate renewal-year commissions and certain incremental direct policy issue, underwriting and sales expenses. All of these incremental costs are directly related to successful policy acquisition.
Item 8. Financial Statements and Supplementary Data
For some products, policyholders can elect to modify product benefits, features, rights or coverages by exchanging a contract for a new contract or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. These transactions are known as internal replacements. The Company performs a two-stage analysis of the internal replacements to determine if the modification is substantive to the base policy. The stages of evaluation are as follows: 1) determine if the modification is integrated with the base policy, and 2) if it is integrated, determine if the resulting contract is substantially changed.
For internal replacement transactions where the resulting contract is substantially unchanged, the policy is accounted for as a continuation of the replaced contract. Unamortized deferred acquisition costs from the original policy continue to be amortized over the expected life of the new policy, and the costs of replacing the policy are accounted for as policy maintenance costs and expensed as incurred. Examples include conversions of same age bands, certain family coverage changes, pricing era changes (decrease), and ordinary life becomes reduced paid-up and certain reinstatements.
An internal replacement transaction that results in a policy that is substantially changed is accounted for as an extinguishment of the original policy and the issuance of a new policy. Unamortized deferred acquisition costs on the original policy are immediately expensed, and the costs of acquiring the new policy are capitalized and amortized in accordance with the Company's accounting policies for deferred acquisition costs. Further, the policy reserves are evaluated based on the new policy features, and any change (up or down) necessary is recognized at the date of contract change/modification. Examples include conversions to higher age bands, certain family coverage changes, pricing era changes (increase), lapse & re-issue, certain reinstatements and certain other contract conversions.
Riders can be considered internal replacements that are either integrated or non-integrated resulting in either substantially changed or substantially unchanged treatment. Riders are evaluated based on the specific facts and circumstances of the rider and are considered an expansion of the existing benefits with additional premium required. Non-integrated riders to existing contracts do not change the Company's profit expectations for the related products and are treated as a new policy establishment for incremental coverage.
The Company measures the recoverability of DAC and the adequacy of its policy reserves annually by performing gross premium valuations on its business. (See the following discussion for further information regarding policy reserves.)
Policy Liabilities: Future policy benefits represent claims that are expected to occur in the future and are computed following a net level premium method using estimated future investment yields, persistency and recognized morbidity and mortality tables modified to reflect the Company's experience, including a provision for adverse deviation. These assumptions are generally established and considered locked at policy inception. These assumptions may only be unlocked in certain circumstances based on the results of periodic DAC recoverability and premium deficiency testing.
Unpaid policy claims are estimates computed on an undiscounted basis using statistical analyses of historical claims experience adjusted for current trends and changed conditions. The ultimate liability may vary significantly from such estimates. The Company regularly adjusts these estimates as new claims experience emerges and reflects the changes in operating results in the year such adjustments are made.
Other policy liabilities consist primarily of discounted advance premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan limited-pay insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period.
For internal replacements that are determined to not be substantially unchanged, policy liabilities related to the original policy that was replaced are immediately released, and policy liabilities are established for the new insurance contract; however, for internal replacements that are considered substantially unchanged, no changes to the reserves are recognized.
Reinsurance: The Company enters into reinsurance agreements with other companies in the normal course of business. For each reinsurance agreement, the Company determines if the agreement provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. Reinsurance premiums and benefits paid or provided are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums, benefits and DAC are reported net of insurance ceded.
Income Taxes: Income tax provisions are generally based on pretax earnings reported for financial statement purposes, which differ from those amounts used in preparing the Company's income tax returns. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and
Item 8. Financial Statements and Supplementary Data
liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the Company expects the temporary differences to reverse. The Company records deferred tax assets for tax positions taken based on its assessment of whether the tax position is more likely than not to be sustained upon examination by taxing authorities. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized.
Policyholder Protection Corporation and State Guaranty Association Assessments: In Japan, the government has required the insurance industry to contribute to a policyholder protection corporation. The Company recognizes a charge for its estimated share of the industry's obligation once it is determinable. The Company reviews the estimated liability for policyholder protection corporation contributions on an annual basis and reports any adjustments in Aflac Japan's expenses.
In the United States, each state has a guaranty association that supports insolvent insurers operating in those states. See Note 15 of the Notes to the Consolidated Financial Statements for further discussion of the guaranty fund assessments charged to the Company.
Treasury Stock: Treasury stock is reflected as a reduction of shareholders' equity at cost. The Company uses the weighted-average purchase cost to determine the cost of treasury stock that is reissued. The Company includes any gains and losses in additional paid-in capital when treasury stock is reissued.
Share-Based Compensation: The Company measures compensation cost related to its share-based payment transactions at fair value on the grant date, and the Company recognizes those costs in the financial statements over the vesting period during which the employee provides service in exchange for the award. The Company has formalized its entity-wide accounting policy election to estimate the number of awards that are expected to vest and the corresponding forfeitures.
Earnings Per Share: The Company computes basic earnings per share (EPS) by dividing net earnings by the weighted-average number of unrestricted shares outstanding for the period. Diluted EPS is computed by dividing net earnings by the weighted-average number of shares outstanding for the period plus the shares representing the dilutive effect of share-based awards.
Stock Split: On February 13, 2018, the Board of Directors of the Parent Company declared a two-for-one stock split of the Company’s common stock in the form of a 100% stock dividend payable on March 16, 2018 to shareholders of record at the close of business on March 2, 2018. The stock split was payable in the form of one additional common stock share for every share of common stock held. All equity and share-based data, including the number of shares outstanding and per share amounts, have been adjusted to reflect the stock split for all periods presented in this Annual Report on Form 10-K.
Reclassifications: Certain reclassifications have been made to prior-year amounts to conform to current-year reporting classifications. These reclassifications had no impact on net earnings or total shareholders' equity.
Perpetual securities have been reclassified in prior periods from a separate line item to fixed maturity securities to conform to current period reporting classifications. This reclassification had no impact on net earnings or total shareholder’s equity.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| Accounting Standard Update (ASU) 2018-16 Derivatives and Hedging Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes | In October 2018, the FASB issued amendments to permit use of the Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the Treasury obligations of the U.S. government (UST), the London Interbank Offered Rate (LIBOR) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. | Early adopted as of October 1, 2018 | The adoption of this guidance did not have a significant impact on the Company’s financial position, results of operations or disclosures. |
| ASU 2018-03 Technical Corrections and Improvements to Financial Instruments - Overall Recognition and Measurement of Financial Assets and Financial Liabilities | In February 2018, the FASB issued amendments to clarify certain aspects of the guidance issued in the original Financial Instruments - Overall - Recognition and Measurement pronouncement summarized below. Specifically, for entities who have chosen the measurement alternative approach for equity securities without readily determinable fair values, the amendments clarify that entities may change from a measurement alternative approach to a fair value method through an irrevocable election that would apply to a specific equity security and all identical or similar investments of the same issuer; entities should use an observable price at the date of the transaction rather than reporting date for the measurement alternative calculation; and insurance companies should use a prospective transition method when applying the measurement alternative. | Early adopted as of January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company’s financial position, results of operations, or disclosures. |
| ASU 2018-02 Income Statement - Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income | In February 2018, the FASB issued amendments which allow a reclassification from accumulated other comprehensive income (AOCI) to retained earnings of the effects of the change in the U.S. federal income tax rate resulting from the Tax Cuts and Jobs Act (Tax Act) on the gross deferred tax amounts and the corresponding valuation allowances related to items remaining in AOCI. The amendments eliminate the stranded tax effects resulting from the Tax Act and also require certain disclosures about the reclassified tax effects. | Early adopted as of January 1, 2018 | The amounts reclassified from AOCI to retained earnings include the income tax effects of the change in the federal corporate tax rate enacted by the Tax Act. The Company’s policy is to follow the portfolio approach for releasing income tax effects from AOCI. The adoption of this guidance resulted in an increase to beginning 2018 AOCI of $374 million with a corresponding decrease to beginning 2018 retained earnings as of January 1, 2018. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2017-12Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities | In August 2017, the FASB issued guidance which improves and simplifies the accounting rules around hedge accounting and creates more transparency around how economic results are presented in financial statements. Issues addressed in this new guidance include: 1) risk component hedging, 2) accounting for the hedged item in fair value hedges of interest rate risk, 3) recognition and presentation of the effects of hedging instruments, and 4) amounts excluded from the assessment of hedge effectiveness. | Early adopted as of October 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2017-09 Compensation - Stock Compensation: Scope of Modification Accounting | In May 2017, the FASB issued amendments to provide guidance clarifying when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. An entity should apply modification accounting if the fair value, vesting conditions or classification of the award (as an equity instrument or liability instrument) changes as a result of the change in terms or conditions of the award. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2017-08 Receivables - Nonrefundable Fees and Other Costs: Premium Amortization on Purchased Callable Debt Securities | In March 2017, the FASB issued amendments to shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount. | Early adopted as of July 1, 2018 | The adoption of this guidance did not have a significant impact on the Company’s financial position, results of operations, or disclosures. |
| ASU 2017-07 Compensation - Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost | In March 2017, the FASB issued amendments requiring that an employer report the service cost component of net periodic pension cost and net periodic postretirement benefit cost in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net periodic pension cost and net periodic postretirement benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2017-05 Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets | In February 2017, the FASB issued amendments that clarify the scope and accounting guidance for the derecognition of a nonfinancial asset or a financial asset that meets the definition of an "in substance nonfinancial asset." The amendments define an "in substance nonfinancial asset" and provide additional accounting guidance for partial sales of nonfinancial assets. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2017-01 Business Combinations: Clarifying the Definition of a Business | In January 2017, the FASB issued amendments clarifying when a set of assets and activities is a business. The amendments provide a screen to exclude transactions where substantially all the fair value of the transferred set is concentrated in a single asset, or group of similar assets, from being evaluated as a business. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2016-18 Statement of Cash Flows: Restricted Cash | In November 2016, the FASB issued amendments requiring that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, statements of cash flows, or disclosures. |
| ASU 2016-17 Consolidation - Interests Held through Related Parties That Are under Common Control | In October 2016, the FASB issued amendments which clarify the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. | January 1, 2017 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2016-16 Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory | In October 2016, the FASB issued amendments that require an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2016-15 Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments | In August 2016, the FASB issued amendments that provide guidance on eight specific statement of cash flow classification issues, including distributions received from equity method investees. | January 1, 2018 | The Company elected nature of distribution for distributions received from equity method investees. The adoption of this guidance did not have a significant impact on the Company's financial position, statement of cash flows, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2016-09 Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting | In March 2016, the FASB issued amendments which simplify several aspects for share-based payment award transactions, including the income tax consequences, classification of awards as either liability or equity, classification of taxes paid on the statement of cash flows and treatment of forfeitures. | January 1, 2017 | As a result of applying this requirement, the Company believes that recognition of excess tax benefits will increase volatility in its statement of operations and the Company made an entity-wide accounting policy election to estimate the number of awards that are expected to vest (consistent with the Company's prior policy), but the adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, statements of cash flows, or disclosures. |
| ASU 2016-07 Investments - Equity Method and Joint Ventures - Simplifying the Transition to the Equity Method of Accounting | In March 2016, the FASB issued amendments which eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. Per the amendments, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. | January 1, 2017 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2016-06 Derivatives and Hedging - Contingent Put and Call Options in Debt Instruments | In March 2016, the FASB issued amendments which clarify what steps are required when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. | January 1, 2017 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2016-05 Derivatives and Hedging - Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships | In March 2016, the FASB issued amendments which clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria remain intact. | January 1, 2017 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2016-01 Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities | In January 2016, the FASB issued guidance to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The main provisions of this guidance require certain equity investments to be measured at fair value with changes in fair value recognized in net earnings; separate presentation in other comprehensive income for changes in fair value of financial liabilities measured under the fair value option that are due to instrument-specific credit risk; and changes in disclosures associated with the fair value of financial instruments. The guidance also clarifies that entities should evaluate the need for a valuation allowance on a deferred tax asset (DTA) related to available-for-sale (AFS) securities in combination with the entity's other DTAs. | January 1, 2018 | The Company recorded a cumulative effect adjustment with an increase to beginning 2018 retained earnings and a decrease to beginning 2018 AOCI of $148 million, net of taxes. |
| ASU 2015-16 Business Combinations - Simplifying the Accounting for Measurement-Period Adjustments | In September 2015, the FASB issued guidance requiring that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustments are determined. In the same period’s financial statements, the acquirer is required to record income effects of the adjustments as if the accounting had been completed at the acquisition date. The acquirer is also required to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. | January 1, 2016 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2015-09 Financial Services - Insurance - Disclosures about Short-Duration Contracts | In May 2015, the FASB issued updated guidance requiring enhanced disclosures by all insurance entities that issue short-duration contracts. The amendments require insurance entities to disclose for annual reporting periods information about the liability for unpaid claims and claim adjustment expenses. The amendments also require insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses. In addition, the amendments require insurance entities to disclose for annual and interim reporting periods a roll-forward of the liability for unpaid claims and claim adjustment expenses. For health insurance claims, the amendments require the disclosure of the total of incurred-but-not-reported liabilities and expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses. | December 31, 2016 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2015-07 Fair Value Measurement - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) | In May 2015, the FASB issued updated guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. | January 1, 2016 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2015-03 Interest - Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs | In April 2015, the FASB issued updated guidance to simplify presentation of debt issuance costs. The updated guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this amendment. In August 2015, the FASB issued updated Securities and Exchange Commission (SEC) Staff guidance pertaining to the presentation of debt issuance costs related to line-of-credit arrangements. The guidance states that an entity may defer and present debt issuance costs as an asset, subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. | January 1, 2016 | The retrospective adoption of this accounting standard resulted in a $40 million reduction to notes payable and other assets as of December 31, 2015, the earliest balance sheet date presented in the period of adoption, but did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2015-02 Consolidation - Amendments to the Consolidation Analysis | In February 2015, the FASB issued updated guidance that affects evaluation of whether limited partnerships and similar legal entities (limited liability corporations and securitization structures, etc.) are VIEs, evaluation of whether fees paid to a decision maker or a service provider are a variable interest, and evaluation of the effect of fee arrangements and the effect of related parties on the determination of the primary beneficiary under the VIE model for consolidation. The updated guidance eliminates the presumption that a general partner should consolidate a limited partnership. Limited partnership and similar legal entities that provide partners with either substantive kick-out rights or substantive participating rights over the general partner will now be evaluated under the voting interest model rather than the VIE model for consolidation. In situations where no single party has a controlling financial interest in a VIE, the related party relationships under common control should be considered in their entirety in determining whether that common control group has a controlling financial interest in the VIE. | January 1, 2016 | The adoption of this guidance impacted the Company's footnote disclosures, but did not have a significant impact on its financial position or results of operations. |
| ASU 2014-16 Derivatives and Hedging - Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity | In November 2014, the FASB issued guidance to clarify how to evaluate the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. The guidance also clarifies that an entity should assess the substance of the relevant terms and features when considering how to weight those terms and features. | January 1, 2016 | The adoption of this guidance impacted the Company's footnote disclosures, but did not have a significant impact on its financial position or results of operations. |
| ASU 2014-15 Presentation of Financial Statements - Going Concern - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern | In August 2014, the FASB issued this amendment that provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The new guidance requires a formal assessment of going concern by management based on criteria prescribed in the new guidance. | December 31, 2016 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations or disclosures and no substantial doubt currently exists about the Company's ability to continue as a going concern. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Date of Adoption | Effect on Financial Statements or Other Significant Matters |
| ASU 2014-12 Compensation - Stock Compensation - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period | In June 2014, the FASB issued this amendment that provides guidance on certain share-based payment awards that require a specific performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance to awards with performance conditions that affect vesting to account for such awards. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. | January 1, 2016 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2014-09 Revenue from Contracts with Customers | In May 2014, the FASB issued updated guidance that affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. | January 1, 2018 | The adoption of this guidance did not have a significant impact on the Company's financial position, results of operations, or disclosures. |
Accounting Pronouncements Pending Adoption
| Standard | Description | Effect on Financial Statements or Other Significant Matters |
| ASU 2018-20 Leases: Narrow-Scope Improvements for Lessors | In December 2018, the FASB issued narrow-scope improvements for lessors which 1) provide an accounting policy election for lessors to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price; 2) require lessors to exclude the costs from variable lease revenue and the associated expense when the amount of those costs is not readily determinable by the lessor; and 3) require lessors to allocate (rather than recognize) certain variable payments to the lease and nonlease components when the changes in facts and circumstances on which the variable payment is based occur. The amendments are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. | The Company has made an accounting policy election to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price. The adoption of this guidance is not expected to have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Effect on Financial Statements or Other Significant Matters |
| ASU 2018-17 Consolidation: Targeted Improvements to Related Party Guidance for Variable Interest Entities | In October 2018, the FASB issued targeted improvements which provide that indirect interests held through related parties under common control should be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. The amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. | The adoption of this guidance is not expected to have a significant impact on the Company’s financial position, results of operations or disclosures. |
| ASU 2018-15 Intangibles - Goodwill and Other - Internal-Use Software, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract | In August 2018, the FASB issued amendments to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. | The adoption of this guidance is not expected to have a significant impact on the Company’s financial position, results of operations or disclosures. |
| ASU 2018-14 Compensation - Retirement Benefits - Defined Benefit Plans - General, Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans | In August 2018, the FASB issued amendments to modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Accordingly, six disclosure requirements were removed, two added and two clarified. The amendments are effective for public business entities for fiscal years beginning after December 15, 2020. Early adoption is permitted. | The adoption of this guidance is not expected to have a significant impact on the Company’s financial position, results of operations, or disclosures. |
| ASU 2018-13 Fair Value Measurement, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement | In August 2018, the FASB issued amendments to the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The amendments remove, modify, and add certain disclosures. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of this Update. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this update and delay adoption of the additional disclosures until their effective date. | The adoption of this guidance is not expected to have a significant impact on the Company’s financial position, results of operations, or disclosures. |
| ASU 2018-12 Financial Services - Insurance, Targeted Improvements to the Accounting for Long-Duration Contracts | In August 2018, the FASB issued amendments that will significantly change how insurers account for long-duration contracts. The amendments will change existing recognition, measurement, presentation, and disclosure requirements. Issues addressed in the new guidance include: 1) a requirement to review and, if there is a change, update assumptions for the liability for future policy benefits at least annually, and to update the discount rate assumption quarterly, 2) accounting for market risk benefits at fair value, 3) simplified amortization for deferred acquisition costs, and 4) enhanced financial statement presentation and disclosures. The amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application of the amendments is permitted. | The Company is thoroughly evaluating the impact of adoption and expects that the adoption will have a significant impact on the Company’s financial position, results of operations, and disclosures. The Company anticipates that the requirement to update assumptions for liability for future policy benefits will have a significant impact on its results of operations, systems, processes and controls while the requirement to update the discount rate will have a significant impact on its equity. The Company does not expect to early adopt the updated standard. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Effect on Financial Statements or Other Significant Matters |
| ASU 2018-11 Leases, Targeted Improvements | In July 2018, the FASB issued targeted improvements to Topic 842 Leases. The amendments in the update provide entities with an optional transition method to adopt the new leases standard by recording a cumulative effect adjustment to beginning retained earnings. Additionally, the amendments provide lessors with a practical expedient to not separate nonlease components from associated lease components and instead account for those components as a single component under certain conditions. The amendments are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. | The Company has elected the optional transition method. The adoption of this guidance is not expected to have a significant impact on the Company’s financial position, results of operations, or disclosures. |
| ASU 2018-10 Codification Improvements to Topic 842, Leases | In July 2018, the FASB issued guidance which clarifies, corrects errors in, or makes minor improvements to the Codification related to ASU 2016-02, Leases (Topic 842). The amendments in this ASU affect narrow aspects of the guidance issued in the amendments to ASU 2016-02, including but not limited to, Residual Value Guarantees, Rate Implicit in the Lease, Lessee Reassessment of Lease Classification and Variable Lease Payments that Depend on an Index or a Rate. Amendments within this ASU follow the effective dates of Topic 842, which are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. | The adoption of this guidance is not expected to have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2018-01 Leases: Land Easement Practical Expedient for Transition to Topic 842 | In January 2018, the FASB issued guidance which provides an entity with the option to elect a transition practical expedient to not evaluate, under Topic 842, land easements that exist or expired before the entity's adoption of Topic 842 and that were not previously accounted for as leases under Topic 840. The amendments clarify that new or modified land easements should be evaluated under the new leases standard once an entity has adopted the new standard. The amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. | As of December 31, 2018, the Company did not have land easements, but has elected this practical expedient as a safe harbor. The adoption of this guidance is not expected to have a significant impact on the Company's financial position, results of operations, or disclosures. |
| ASU 2017-04 Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment | In January 2017, the FASB issued amendments simplifying the subsequent measurement of goodwill. An entity is no longer required to perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, the entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The amendments are effective for public business entities that are SEC filers for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for any goodwill impairment tests performed on testing dates after January 1, 2017. | The adoption of this guidance is not expected to have a significant impact on the Company's financial position, results of operations, or disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Effect on Financial Statements or Other Significant Matters |
| ASU 2016-13 Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments | In June 2016, the FASB issued amendments that require a financial asset (or a group of financial assets) measured on an amortized cost basis to be presented net of an allowance for credit losses in order to reflect the amount expected to be collected on the financial asset(s). The measurement of expected credit losses is amended by replacing the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform about a credit loss. Credit losses on available-for-sale debt securities will continue to be measured in a manner similar to current U.S. GAAP; however, the amendments require that credit losses be presented as an allowance rather than as a write-down. Other amendments include changes to the balance sheet presentation and interest income recognition of purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (PCD financial assets). The amendments are effective for public companies for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Companies may early adopt this guidance as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The amendments will be adopted following a modified-retrospective approach resulting in a cumulative effect adjustment in retained earnings as of the beginning of the year of adoption. Two exceptions to this adoption method are for PCD financial assets and debt securities for which other-than-temporary impairment (OTTI) will have been recognized before the effective date. Loans purchased with credit deterioration accounted for under current U.S. GAAP as "purchased credit impaired" (PCI) financial assets will be classified as PCD financial assets at transition and PCD guidance will be applied prospectively. Debt securities that have experienced OTTI before the effective date will follow a prospective adoption method which allows an entity to maintain the same amortized cost basis before and after the effective date. | The Company has identified certain financial instruments in scope of this guidance to include certain fixed maturity securities, loans and loan receivables and reinsurance recoverables (See Notes 3 and 7 for current balances of instruments in scope). The Company is continuing its progress towards updating its credit loss projection models and accounting systems in order to comply with the required changes in measurement of credit losses. The Company currently expects loans and loan receivables and held-to-maturity fixed maturity securities to be the asset classes most significantly impacted upon adoption of the guidance. The Company continues to evaluate the impact of adoption of this guidance on its financial position, results of operations, and disclosures. |
Item 8. Financial Statements and Supplementary Data
| Standard | Description | Effect on Financial Statements or Other Significant Matters |
| ASU 2016-02 Leases | In February 2016, the FASB issued updated guidance for accounting for leases. Per the amendments, lessees will be required to recognize all leases on the balance sheet with the exception of short-term leases. A lease liability will be recorded for the obligation of a lessee to make lease payments arising from a lease. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The new standard is effective for the Company on January 1, 2019. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. The Company is electing to use its effective date as its date of initial application. Because the Company expects to adopt the new standard on January 1, 2019 and use the effective date as the date of initial application, financial information is not required to be updated and the disclosures required under the new standard are not required to be provided for dates and periods before January 1, 2019. The new standard provides a number of optional practical expedients. The Company has elected the "package of practical expedients," which permits the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs. Under the new guidance, lessor accounting is largely unchanged. The amendments are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. | The Company has identified certain operating leases in scope of this guidance to include office space and equipment leases (See Note 15). The leases within scope of this guidance will increase the Company's right-of-use assets and lease liabilities recorded on its statement of financial position by approximately $100 to $200 million. The Company estimates that the adoption of this guidance will not have a significant impact on its financial position, results of operations, or disclosures. |
Recent accounting guidance not discussed above is not applicable, did not have, or is not expected to have a material impact to the Company's business.
| 2. | BUSINESS SEGMENT AND FOREIGN INFORMATION |
The Company consists of two reportable insurance business segments: Aflac Japan and Aflac U.S., both of which sell supplemental health and life insurance. Operating business segments that are not individually reportable and business activities, including reinsurance retrocession activities, not included in Aflac Japan or Aflac U.S. are included in the "Corporate and other" category.
The Company does not allocate corporate overhead expenses to business segments. Consistent with U.S. GAAP accounting guidance for segment reporting, the Company evaluates and manages its business segments using a financial performance measure called pretax adjusted earnings. Adjusted earnings are adjusted revenues less benefits and adjusted expenses. The adjustments to both revenues and expenses account for certain items that cannot be predicted or that are outside management’s control. Adjusted revenues are U.S. GAAP total revenues excluding realized investment gains and losses, except for amortized hedge costs related to foreign currency exposure management strategies and net interest cash flows from derivatives associated with certain investment strategies. Adjusted expenses are U.S. GAAP total acquisition and operating expenses including the impact of interest cash flows from derivatives associated with notes payable but excluding any nonrecurring or other items not associated with the normal course of the Company’s insurance operations and that do not reflect Aflac’s underlying business performance. The Company excludes income taxes related to operations to arrive at pretax adjusted earnings. Information regarding operations by segment for the years ended December 31 follows:
Item 8. Financial Statements and Supplementary Data
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Revenues: | |||||||||||||||||
| Aflac Japan: | |||||||||||||||||
| Net earned premiums: | |||||||||||||||||
| Cancer | $ | 5,849 | $ | 5,612 | $ | 5,639 | |||||||||||
| Medical and other health | 3,516 | 3,379 | 3,429 | ||||||||||||||
| Life insurance | 3,397 | 3,761 | 4,469 | ||||||||||||||
| Net investment income, less amortized hedge costs | 2,403 | 2,235 | 2,368 | ||||||||||||||
| Other income | 41 | 41 | 40 | ||||||||||||||
| Total Aflac Japan | 15,206 | 15,028 | 15,945 | ||||||||||||||
| Aflac U.S.: | |||||||||||||||||
| Net earned premiums: | |||||||||||||||||
| Accident/disability | 2,611 | 2,537 | 2,469 | ||||||||||||||
| Cancer | 1,311 | 1,308 | 1,299 | ||||||||||||||
| Other health | 1,508 | 1,445 | 1,415 | ||||||||||||||
| Life insurance | 278 | 273 | 271 | ||||||||||||||
| Net investment income | 727 | 721 | 703 | ||||||||||||||
| Other income | 8 | 5 | 10 | ||||||||||||||
| Total Aflac U.S. | 6,443 | 6,289 | 6,167 | ||||||||||||||
| Corporate and other | 339 | 272 | 275 | ||||||||||||||
| Total adjusted revenues | 21,988 | 21,589 | 22,387 | ||||||||||||||
| Realized investment gains (losses) (1),(2),(3) | (230 | ) | 78 | 172 | |||||||||||||
| Total revenues | $ | 21,758 | $ | 21,667 | $ | 22,559 |
(1) Amortized hedge costs related to hedging U.S. dollar-denominated investments held in Aflac Japan were $236*,* $228 and $186 for 2018*,* 2017 and 2016*, respectively, and have been reclassified from realized investment gains (losses) and reported as a deduction from net investment income when analyzing segment operations.*
(2) Amortized hedge costs in Aflac Japan were partially offset by derivatives entered into as part of corporate activities and resulted in a benefit of $36 for 2018*, which has been reclassified from realized investment gains (losses) and reported as an increase in net investment income when analyzing operations.*
(3) An immaterial amount of net interest cash flows from derivatives associated with certain investment strategies in 2018*, were reclassified from realized investment gains (losses) into net investment income when analyzing operations.*
Item 8. Financial Statements and Supplementary Data
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Pretax earnings: | |||||||||||||||||
| Aflac Japan | $ | 3,208 | $ | 3,054 | $ | 3,148 | |||||||||||
| Aflac U.S. | 1,285 | 1,245 | 1,208 | ||||||||||||||
| Corporate and other | (139 | ) | (212 | ) | (239 | ) | |||||||||||
| Pretax adjusted earnings | 4,354 | 4,087 | 4,117 | ||||||||||||||
| Realized investment gains (losses) (1),(2),(3),(4) | (297 | ) | 0 | 87 | |||||||||||||
| Other income (loss) (5) | (74 | ) | (69 | ) | (137 | ) | |||||||||||
| Total earnings before income taxes | $ | 3,983 | $ | 4,018 | $ | 4,067 | |||||||||||
| Income taxes applicable to pretax adjusted earnings | $ | 1,129 | $ | 1,370 | $ | 1,426 | |||||||||||
| Effect of foreign currency translation on after-tax adjusted earnings | 28 | (41 | ) | 141 |
(1) Amortized hedge costs related to hedging U.S. dollar-denominated investments held in Aflac Japan were $236*,* $228 and $186 for 2018*,* 2017 and 2016*, respectively, and have been reclassified from realized investment gains (losses) and reported as a deduction from pretax adjusted earnings when analyzing segment operations.*
(2) Amortized hedge costs in Aflac Japan were partially offset by derivatives entered into as part of corporate activities and resulted in a benefit of $36 for 2018*, which has been reclassified from realized investment gains (losses) and reported as an increase in pretax adjusted earnings when analyzing operations.*
(3) An immaterial amount of net interest cash flows from derivatives associated with certain investment strategies in 2018, were reclassified from realized investment gains (losses) into net investment income when analyzing operations.
(4) Excluding a gain of $67 in 2018*,* $77 in 2017 and $85 in 2016*, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable which is included in adjusted earnings when analyzing segment operations*
(5) Includes expense of $13 in 2017 and $137 in 2016 for the early extinguishment of debt
Assets as of December 31 were as follows:
| (In millions) | 2018 | 2017 | ||||||||||
| Assets: | ||||||||||||
| Aflac Japan | $ | 118,342 | $ | 114,402 | ||||||||
| Aflac U.S. | 19,100 | 19,893 | ||||||||||
| Corporate and other | 2,964 | 2,922 | ||||||||||
| Total assets | $ | 140,406 | $ | 137,217 |
Yen-Translation Effects: The following table shows the yen/dollar exchange rates used for or during the periods ended December 31. Exchange effects were calculated using the same yen/dollar exchange rate for the current year as for each respective prior year.
| 2018 | 2017 | 2016 | |||||||||||||||
| Statements of Earnings: | |||||||||||||||||
| Weighted-average yen/dollar exchange rate*(1)* | 110.39 | 112.16 | 108.70 | ||||||||||||||
| Yen percent strengthening (weakening) | 1.6 | % | (3.1 | )% | 11.3 | % | |||||||||||
| Exchange effect on pretax operating earnings (in millions) | $ | 38 | $ | (63 | ) | $ | 218 |
| 2018 | 2017 | ||||||||||
| Balance Sheets: | |||||||||||
| Yen/dollar exchange rate at December 31*(1)* | 111.00 | 113.00 | |||||||||
| Yen percent strengthening (weakening) | 1.8 | % | 3.1 | % | |||||||
| Exchange effect on total assets (in millions) | $ | 1,362 | $ | 2,593 | |||||||
| Exchange effect on total liabilities (in millions) | 1,270 | 2,848 |
(1) Rates are based on the published MUFG Bank, Ltd. telegraphic transfer middle rate (TTM)
Transfers of funds from Aflac Japan: Aflac Japan makes payments to the Parent Company for management fees, allocated expenses and remittances of earnings. Prior to the Aflac Japan branch conversion on April 1, 2018, Aflac Japan paid allocated expenses and profit remittances to Aflac U.S. Information on transfers for each of the years ended December 31 is shown below. See Note 13 for information concerning restrictions on transfers from Aflac Japan.
Item 8. Financial Statements and Supplementary Data
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Management fees | $ | 136 | $ | 93 | $ | 79 | |||||||||||
| Allocated expenses | 24 | 109 | 106 | ||||||||||||||
| Profit remittances | 808 | 1,150 | 1,286 | ||||||||||||||
| Total transfers from Aflac Japan | $ | 968 | $ | 1,352 | $ | 1,471 |
Property and Equipment: The costs of buildings, furniture and equipment are depreciated principally on a straight-line basis over their estimated useful lives (maximum of 50 years for buildings and 20 years for furniture and equipment). Expenditures for maintenance and repairs are expensed as incurred; expenditures for betterments are capitalized and depreciated. Classes of property and equipment as of December 31 were as follows:
| (In millions) | 2018 | 2017 | |||||||||
| Property and equipment: | |||||||||||
| Land | $ | 168 | $ | 168 | |||||||
| Buildings | 456 | 441 | |||||||||
| Equipment and furniture | 400 | 372 | |||||||||
| Total property and equipment | 1,024 | 981 | |||||||||
| Less accumulated depreciation | 581 | 547 | |||||||||
| Net property and equipment | $ | 443 | $ | 434 |
Receivables: Receivables consist primarily of monthly insurance premiums due from individual policyholders or their employers for payroll deduction of premiums, net of an allowance for doubtful accounts. At December 31, 2018, $334 million, or 39.2% of total receivables, were related to Aflac Japan's operations, compared with $334 million, or 40.4%, at December 31, 2017.
3. INVESTMENTS
Net Investment Income
The components of net investment income for the years ended December 31 were as follows:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Fixed maturity securities | $ | 3,142 | $ | 3,173 | $ | 3,308 | |||||||||||
| Equity securities | 38 | 42 | 35 | ||||||||||||||
| Other investments | 369 | 94 | 31 | ||||||||||||||
| Short-term investments and cash equivalents | 41 | 25 | 11 | ||||||||||||||
| Gross investment income | 3,590 | 3,334 | 3,385 | ||||||||||||||
| Less investment expenses | 148 | 114 | 107 | ||||||||||||||
| Net investment income | $ | 3,442 | $ | 3,220 | $ | 3,278 |
Item 8. Financial Statements and Supplementary Data
Investment Holdings
The amortized cost for the Company's investments in fixed maturity securities, the cost for equity securities and the fair values of these investments at December 31 are shown in the following tables.
| 2018 | |||||||||||||||||||||||
| (In millions) | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| Securities available for sale, carried at fair value through other comprehensive income: | |||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||
| Yen-denominated: | |||||||||||||||||||||||
| Japan government and agencies | $ | 30,637 | $ | 3,700 | $ | 140 | $ | 34,197 | |||||||||||||||
| Municipalities | 385 | 32 | 9 | 408 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 155 | 22 | 0 | 177 | |||||||||||||||||||
| Public utilities | 1,732 | 280 | 4 | 2,008 | |||||||||||||||||||
| Sovereign and supranational | 826 | 123 | 0 | 949 | |||||||||||||||||||
| Banks/financial institutions | 5,440 | 502 | 238 | 5,704 | |||||||||||||||||||
| Other corporate | 4,852 | 649 | 44 | 5,457 | |||||||||||||||||||
| Total yen-denominated | 44,027 | 5,308 | 435 | 48,900 | |||||||||||||||||||
| U.S. dollar-denominated: | |||||||||||||||||||||||
| U.S. government and agencies | 137 | 9 | 1 | 145 | |||||||||||||||||||
| Municipalities | 1,343 | 120 | 8 | 1,455 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 155 | 8 | 1 | 162 | |||||||||||||||||||
| Public utilities | 4,772 | 496 | 105 | 5,163 | |||||||||||||||||||
| Sovereign and supranational | 251 | 60 | 0 | 311 | |||||||||||||||||||
| Banks/financial institutions | 2,860 | 389 | 35 | 3,214 | |||||||||||||||||||
| Other corporate | 23,311 | 1,343 | 1,109 | 23,545 | |||||||||||||||||||
| Total U.S. dollar-denominated | 32,829 | 2,425 | 1,259 | 33,995 | |||||||||||||||||||
| Total securities available for sale | $ | 76,856 | (1) | $ | 7,733 | $ | 1,694 | $ | 82,895 | (1) |
(1) Includes perpetual securities (**$1,139 at amortized cost and $1,140 at fair value)
| 2018 | |||||||||||||||||||||||
| (In millions) | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | |||||||||||||||||||||||
| Fixed maturity securities: | |||||||||||||||||||||||
| Yen-denominated: | |||||||||||||||||||||||
| Japan government and agencies | $ | 21,712 | $ | 5,326 | $ | 0 | $ | 27,038 | |||||||||||||||
| Municipalities | 359 | 110 | 0 | 469 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 14 | 1 | 0 | 15 | |||||||||||||||||||
| Public utilities | 2,727 | 254 | 8 | 2,973 | |||||||||||||||||||
| Sovereign and supranational | 1,551 | 289 | 0 | 1,840 | |||||||||||||||||||
| Banks/financial institutions | 1,445 | 158 | 20 | 1,583 | |||||||||||||||||||
| Other corporate | 2,510 | 332 | 38 | 2,804 | |||||||||||||||||||
| Total yen-denominated | 30,318 | 6,470 | 66 | 36,722 | |||||||||||||||||||
| Total securities held to maturity | $ | 30,318 | $ | 6,470 | $ | 66 | $ | 36,722 |
Item 8. Financial Statements and Supplementary Data
| 2018 | |||||||||||||||||
| (In millions) | Fair Value | ||||||||||||||||
| Equity securities, carried at fair value through net earnings: | |||||||||||||||||
| Equity securities: (1) | |||||||||||||||||
| Yen-denominated | $ | 641 | |||||||||||||||
| U.S. dollar-denominated | 346 | ||||||||||||||||
| Total equity securities | $ | 987 | (1) |
(1) Includes perpetual securities (**$62 at fair value)
| 2017 | |||||||||||||||||||||||
| (In millions) | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| Securities available for sale, carried at fair value: | |||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||
| Yen-denominated: | |||||||||||||||||||||||
| Japan government and agencies | $ | 27,980 | $ | 3,363 | $ | 271 | $ | 31,072 | |||||||||||||||
| Municipalities | 314 | 28 | 12 | 330 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 242 | 29 | 0 | 271 | |||||||||||||||||||
| Public utilities | 1,635 | 352 | 6 | 1,981 | |||||||||||||||||||
| Sovereign and supranational | 1,380 | 190 | 1 | 1,569 | |||||||||||||||||||
| Banks/financial institutions | 4,742 | 811 | 53 | 5,500 | |||||||||||||||||||
| Other corporate | 4,085 | 809 | 7 | 4,887 | |||||||||||||||||||
| Total yen-denominated | 40,378 | 5,582 | 350 | 45,610 | |||||||||||||||||||
| U.S dollar-denominated: | |||||||||||||||||||||||
| U.S. government and agencies | 146 | 13 | 1 | 158 | |||||||||||||||||||
| Municipalities | 872 | 168 | 0 | 1,040 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 161 | 12 | 0 | 173 | |||||||||||||||||||
| Public utilities | 5,116 | 884 | 27 | 5,973 | |||||||||||||||||||
| Sovereign and supranational | 267 | 73 | 0 | 340 | |||||||||||||||||||
| Banks/financial institutions | 2,808 | 633 | 8 | 3,433 | |||||||||||||||||||
| Other corporate | 25,384 | 2,620 | 418 | 27,586 | |||||||||||||||||||
| Total U.S. dollar-denominated | 34,754 | 4,403 | 454 | 38,703 | |||||||||||||||||||
| Total securities available for sale | $ | 75,132 | (1) | $ | 9,985 | $ | 804 | $ | 84,313 | (1) |
(1) Includes perpetual securities (**$1,462 at amortized cost and $1,789 at fair value)
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||||||||||||
| (In millions) | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | |||||||||||||||||||||||
| Fixed maturity securities: | |||||||||||||||||||||||
| Yen-denominated: | |||||||||||||||||||||||
| Japan government and agencies | $ | 21,331 | $ | 5,160 | $ | 0 | $ | 26,491 | |||||||||||||||
| Municipalities | 357 | 105 | 0 | 462 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 26 | 1 | 0 | 27 | |||||||||||||||||||
| Public utilities | 3,300 | 398 | 0 | 3,698 | |||||||||||||||||||
| Sovereign and supranational | 1,523 | 312 | 0 | 1,835 | |||||||||||||||||||
| Banks/financial institutions | 2,206 | 190 | 9 | 2,387 | |||||||||||||||||||
| Other corporate | 2,687 | 485 | 0 | 3,172 | |||||||||||||||||||
| Total yen-denominated | 31,430 | 6,651 | 9 | 38,072 | |||||||||||||||||||
| Total securities held to maturity | $ | 31,430 | $ | 6,651 | $ | 9 | $ | 38,072 |
| 2017 | |||||||||||||||||
| (In millions) | Fair Value | ||||||||||||||||
| Equity securities, carried at fair value: | |||||||||||||||||
| Equity securities: | |||||||||||||||||
| Yen-denominated | $ | 695 | |||||||||||||||
| U.S. dollar-denominated | 328 | ||||||||||||||||
| Total equity securities | $ | 1,023 |
The methods of determining the fair values of the Company's investments in fixed maturity securities and equity securities are described in Note 5.
During 2018, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category. During 2017, the Company reclassified three investments from the held-to-maturity category to the available-for-sale category as a result of the issuers' credit rating being downgraded to below investment grade. At the time of the transfer, the securities had an aggregate amortized cost of $773 million and an aggregate unrealized gain of $47 million. During 2016, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category.
Item 8. Financial Statements and Supplementary Data
Contractual and Economic Maturities
The contractual maturities of the Company's investments in fixed maturity securities at December 31, 2018, were as follows:
| (In millions) | Amortized Cost | Fair Value | ||||||||
| Available for sale: (1) | ||||||||||
| Due in one year or less | $ | 810 | $ | 861 | ||||||
| Due after one year through five years | 8,313 | 8,312 | ||||||||
| Due after five years through 10 years | 9,805 | 10,355 | ||||||||
| Due after 10 years | 57,618 | 63,028 | ||||||||
| Mortgage- and asset-backed securities | 310 | 339 | ||||||||
| Total fixed maturity securities available for sale | $ | 76,856 | $ | 82,895 | ||||||
| Held to maturity: | ||||||||||
| Due in one year or less | $ | 180 | $ | 182 | ||||||
| Due after one year through five years | 915 | 948 | ||||||||
| Due after five years through 10 years | 927 | 1,004 | ||||||||
| Due after 10 years | 28,282 | 34,573 | ||||||||
| Mortgage- and asset-backed securities | 14 | 15 | ||||||||
| Total fixed maturity securities held to maturity | $ | 30,318 | $ | 36,722 |
(1) Includes perpetual securities, categorized in accordance with their respective economic maturities (the expected maturity date created by the combination of features in the financial instrument)
Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.
Investment Concentrations
The Company's process for investing in credit-related investments begins with an independent approach to underwriting each issuer's fundamental credit quality. The Company evaluates independently those factors that it believes could influence an issuer's ability to make payments under the contractual terms of the Company's instruments. This includes a thorough analysis of a variety of items including the issuer's country of domicile (including political, legal, and financial considerations); the industry in which the issuer competes (with an analysis of industry structure, end-market dynamics, and regulation); company specific issues (such as management, assets, earnings, cash generation, and capital needs); and contractual provisions of the instrument (such as financial covenants and position in the capital structure). The Company further evaluates the investment considering broad business and portfolio management objectives, including asset/liability needs, portfolio diversification, and expected income.
Investment exposures that individually exceeded 10% of shareholders' equity as of December 31 were as follows:
| 2018 | 2017 | ||||||||||
| (In millions) | Credit Rating | Amortized Cost | Fair Value | Credit Rating | Amortized Cost | Fair Value | |||||
| Japan National Government*(1)* | A+ | $51,207 | $59,945 | A | $48,399 | $56,532 |
*(1)*Japan Government Bonds (JGBs) or JGB-backed securities
Realized Investment Gains and Losses
Information regarding pretax realized gains and losses from investments for the years ended December 31 follows:
Item 8. Financial Statements and Supplementary Data
| (In millions) | 2018 | 2017 | 2016 | |||||||||
| Realized investment gains (losses): | ||||||||||||
| Fixed maturity securities: (1) | ||||||||||||
| Available for sale: | ||||||||||||
| Gross gains from sales | $ | 101 | $ | 51 | $ | 177 | ||||||
| Gross losses from sales | (156 | ) | (68 | ) | (62 | ) | ||||||
| Foreign currency gains (losses) on sales and redemptions | 73 | (48 | ) | 4 | ||||||||
| Other-than-temporary impairment losses | (64 | ) | (7 | ) | (26 | ) | ||||||
| Total fixed maturity securities | (46 | ) | (72 | ) | 93 | |||||||
| Equity securities (1),(2) | (131 | ) | 71 | (3) | (35 | ) | (3) | |||||
| Loan receivables: | ||||||||||||
| Loan loss reserves | (17 | ) | (8 | ) | (2 | ) | ||||||
| Other gains (losses) on loans | (2 | ) | 0 | 0 | ||||||||
| Total loan receivables | (19 | ) | (8 | ) | (2 | ) | ||||||
| Derivatives and other: | ||||||||||||
| Derivative gains (losses) | (224 | ) | (109 | ) | (255 | ) | ||||||
| Foreign currency gains (losses) | (10 | ) | (33 | ) | 185 | |||||||
| Total derivatives and other | (234 | ) | (142 | ) | (70 | ) | ||||||
| Total realized investment gains (losses) | $ | (430 | ) | $ | (151 | ) | $ | (14 | ) |
(1) Includes perpetual securities
(2) See Note 1 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance on January 1, 2018 related to financial instruments.
(3) Includes impairments of $22 in 2017 and $57 in 2016
The unrealized holding losses, net of gains, recorded as a component of realized investment gains and losses for the year ended December 31, 2018, that relates to equity securities still held at the December 31, 2018, reporting date was $124 million.
Unrealized Investment Gains and Losses
Information regarding changes in unrealized gains and losses from investments recorded in AOCI for the years ended December 31 follows:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Changes in unrealized gains (losses): | |||||||||||||||||
| Fixed maturity securities, available for sale (1) | $ | (3,142 | ) | $ | 1,657 | $ | 2,711 | ||||||||||
| Equity securities (2) | 0 | 71 | 88 | ||||||||||||||
| Total change in unrealized gains (losses) | $ | (3,142 | ) | $ | 1,728 | $ | 2,799 |
(1) Includes perpetual securities
(2) See Note 1 and Note 11 of the Notes to the Consolidated Financial Statements for the adoption of accounting guidance and the cumulative effect of the change in accounting principle related to financial instruments effective January 1, 2018.
Effect on Shareholders' Equity
The net effect on shareholders' equity of unrealized gains and losses from investment securities at December 31 was as follows:
| (In millions) | 2018 | 2017 | |||||||||
| Unrealized gains (losses) on securities available for sale | $ | 6,039 | $ | 9,358 | |||||||
| Deferred income taxes | (1,805 | ) | (3,394 | ) | |||||||
| Shareholders’ equity, unrealized gains (losses) on investment securities | $ | 4,234 | $ | 5,964 |
See Notes 1 and 10 for discussion of the accounting treatment of tax on amounts recorded in accumulated other comprehensive income pursuant to the Tax Act and Note 1 for the adoption of accounting guidance on January 1, 2018 related to financial instruments.
Item 8. Financial Statements and Supplementary Data
Gross Unrealized Loss Aging
The following tables show the fair values and gross unrealized losses of the Company's available-for-sale and held-to-maturity investments that were in an unrealized loss position, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31.
| 2018 | |||||||||||||||||||||||||||||||||||
| Total | Less than 12 months | 12 months or longer | |||||||||||||||||||||||||||||||||
| (In millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||||||||||||||
| U.S. government and agencies: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | $ | 67 | $ | 1 | $ | 67 | $ | 1 | $ | 0 | $ | 0 | |||||||||||||||||||||||
| Japan government and agencies: | |||||||||||||||||||||||||||||||||||
| Yen-denominated | 3,604 | 140 | 3,604 | 140 | 0 | 0 | |||||||||||||||||||||||||||||
| Municipalities: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 515 | 8 | 515 | 8 | 0 | 0 | |||||||||||||||||||||||||||||
| Yen-denominated | 148 | 9 | 148 | 9 | 0 | 0 | |||||||||||||||||||||||||||||
| Mortgage- and asset- backed securities: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 74 | 1 | 74 | 1 | 0 | 0 | |||||||||||||||||||||||||||||
| Public utilities: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 1,585 | 105 | 892 | 48 | 693 | 57 | |||||||||||||||||||||||||||||
| Yen-denominated | 604 | 12 | 604 | 12 | 0 | 0 | |||||||||||||||||||||||||||||
| Banks/financial institutions: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 625 | 35 | 340 | 19 | 285 | 16 | |||||||||||||||||||||||||||||
| Yen-denominated | 3,057 | 258 | 3,057 | 258 | 0 | 0 | |||||||||||||||||||||||||||||
| Other corporate: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 12,899 | 1,109 | 5,782 | 407 | 7,117 | 702 | |||||||||||||||||||||||||||||
| Yen-denominated | 1,306 | 82 | 1,306 | 82 | 0 | 0 | |||||||||||||||||||||||||||||
| Total | $ | 24,484 | $ | 1,760 | $ | 16,389 | $ | 985 | $ | 8,095 | $ | 775 |
(1) Includes perpetual securities
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||||||||||||||||||||||||
| Total | Less than 12 months | 12 months or longer | |||||||||||||||||||||||||||||||||
| (In millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||||||||||||||
| U.S. government and agencies: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | $ | 74 | $ | 1 | $ | 74 | $ | 1 | $ | 0 | $ | 0 | |||||||||||||||||||||||
| Japan government and agencies: | |||||||||||||||||||||||||||||||||||
| Yen-denominated | 5,255 | 271 | 1,264 | 9 | 3,991 | 262 | |||||||||||||||||||||||||||||
| Municipalities: | |||||||||||||||||||||||||||||||||||
| Yen-denominated | 129 | 12 | 10 | 0 | 119 | 12 | |||||||||||||||||||||||||||||
| Public utilities: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 785 | 27 | 221 | 3 | 564 | 24 | |||||||||||||||||||||||||||||
| Yen-denominated | 83 | 6 | 0 | 0 | 83 | 6 | |||||||||||||||||||||||||||||
| Sovereign and supranational: | |||||||||||||||||||||||||||||||||||
| Yen-denominated | 309 | 1 | 309 | 1 | 0 | 0 | |||||||||||||||||||||||||||||
| Banks/financial institutions: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 362 | 8 | 316 | 5 | 46 | 3 | |||||||||||||||||||||||||||||
| Yen-denominated | 1,507 | 62 | 394 | 4 | 1,113 | 58 | |||||||||||||||||||||||||||||
| Other corporate: | |||||||||||||||||||||||||||||||||||
| U.S. dollar-denominated | 7,741 | 418 | 2,839 | 50 | 4,902 | 368 | |||||||||||||||||||||||||||||
| Yen-denominated | 440 | 7 | 349 | 4 | 91 | 3 | |||||||||||||||||||||||||||||
| Total | $ | 16,685 | $ | 813 | $ | 5,776 | $ | 77 | $ | 10,909 | $ | 736 |
(1) Includes perpetual securities
Analysis of Securities in Unrealized Loss Positions
The unrealized losses on the Company's fixed maturity securities investments have been primarily related to general market changes in interest rates, foreign exchange rates, and/or the levels of credit spreads rather than specific concerns with the issuer's ability to pay interest and repay principal.
For any significant declines in fair value of its fixed maturity securities, the Company performs a more focused review of the related issuers' credit profile. For corporate issuers, the Company evaluates their assets, business profile including industry dynamics and competitive positioning, financial statements and other available financial data. For non-corporate issuers, the Company analyzes all sources of credit support, including issuer-specific factors. The Company utilizes information available in the public domain and, for certain private placement issuers, from consultations with the issuers directly. The Company also considers ratings from Nationally Recognized Statistical Rating Organizations (NRSROs), as well as the specific characteristics of the security it owns including seniority in the issuer's capital structure, covenant predictions, or other relevant features. From these reviews, the Company evaluates the issuers' continued ability to service the Company's investment through payment of interest and principal.
Assuming no credit-related factors develop, unrealized gains and losses on fixed maturity securities are expected to diminish as investments near maturity. Based on its credit analysis, the Company believes that the issuers of its fixed maturity investments in the sectors shown in the table above have the ability to service their obligations to the Company.
Item 8. Financial Statements and Supplementary Data
Other Investments
The table below reflects the composition of the carrying value for other investments as of December 31.
| (In millions) | 2018 | 2017 | |||||||||
| Other investments: | |||||||||||
| Transitional real estate loans | $ | 4,377 | $ | 1,235 | |||||||
| Commercial mortgage loans | 1,064 | 908 | |||||||||
| Middle market loans | 1,478 | 859 | |||||||||
| Policy loans | 232 | 210 | |||||||||
| Short-term investments | 152 | 57 | |||||||||
| Other | 403 | 133 | |||||||||
| Total other investments | $ | 7,706 | $ | 3,402 |
Loans and Loan Receivables
The Company classifies its TREs, CMLs, and MMLs as held-for investment and includes them in the other investments line on the consolidated balance sheets. The Company carries them on the balance sheet at amortized cost less an estimated allowance for loan losses. The Company's allowance for loan losses is established using both general and specific allowances. The general allowance is used for loans grouped by similar risk characteristics where a loan-specific or market-specific risk has not been identified, but for which the Company estimates probable incurred losses. The specific allowance is used on an individual loan basis when it is probable that a loss has been incurred. As of December 31, 2018 and 2017, the Company's allowance for loan losses was $27 million and $11 million, respectively. As of December 31, 2018 and 2017, the Company had no loans that were past due in regards to principal and/or interest payments. Additionally, the Company held no loans that were on nonaccrual status or considered impaired as of December 31, 2018 and 2017. The Company had no troubled debt restructurings during the years ended December 31, 2018 and 2017.
Transitional Real Estate Loans
Transitional real estate loans are commercial mortgage loans that are typically relatively short-term floating rate instruments secured by a first lien on the property. These loans provide funding for properties undergoing a change in their physical characteristics and/or economic profile. As of December 31, 2018, the Company had $605 million in outstanding commitments to fund transitional real estate loans. These commitments are contingent on the final underwriting and due diligence to be performed.
Commercial Mortgage Loans
As of December 31, 2018, the Company had $25 million in outstanding commitments to fund commercial mortgage loans. These commitments are contingent on the final underwriting and due diligence to be performed.
Middle Market Loans
Middle market loans are generally considered to be below investment grade. The carrying value for middle market loans included an unfunded amount of $56 million and $109 million, as of December 31, 2018, and 2017, respectively, that is reflected in other liabilities on the consolidated balance sheets.
As of December 31, 2018, the Company had commitments of approximately $521 million to fund potential future loan originations related to this investment program. These commitments are contingent upon the availability of middle market loans that meet the Company's underwriting criteria.
Other
Other investments primarily includes investments in limited partnerships. As of December 31, 2018, the Company had $916 million in outstanding commitments to fund alternative investments in limited partnerships.
Item 8. Financial Statements and Supplementary Data
Variable Interest Entities (VIEs)
As a condition of its involvement or investment in a VIE, the Company enters into certain protective rights and covenants that preclude changes in the structure of the VIE that would alter the creditworthiness of the Company's investment or its beneficial interest in the VIE.
For those VIEs other than certain unit trust structures, the Company's involvement is passive in nature. The Company has not, nor has it been, required to purchase any securities issued in the future by these VIEs.
The Company's ownership interest in VIEs is limited to holding the obligations issued by them. The Company has no direct or contingent obligations to fund the limited activities of these VIEs, nor does it have any direct or indirect financial guarantees related to the limited activities of these VIEs. The Company has not provided any assistance or any other type of financing support to any of the VIEs it invests in, nor does it have any intention to do so in the future. For those VIEs in which the Company holds debt obligations, the weighted-average lives of the Company's notes are very similar to the underlying collateral held by these VIEs where applicable.
The Company's risk of loss related to its interests in any of its VIEs is limited to the carrying value of the related investments held in the VIE.
VIEs - Consolidated
The following table presents the cost or amortized cost, fair value and balance sheet caption in which the assets and liabilities of consolidated VIEs are reported as of December 31.
Investments in Consolidated Variable Interest Entities
| 2018 | 2017 | ||||||||||||||||||||||
| (In millions) | Cost or Amortized Cost | Fair Value | Cost or Amortized Cost | Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Fixed maturity securities, available for sale (1) | $ | 3,849 | $ | 4,466 | $ | 4,538 | $ | 5,509 | |||||||||||||||
| Equity securities | 160 | 160 | 606 | 753 | |||||||||||||||||||
| Other investments (2) | 5,856 | 5,834 | 2,341 | 2,328 | |||||||||||||||||||
| Other assets (3) | 182 | 182 | 151 | 151 | |||||||||||||||||||
| Total assets of consolidated VIEs | $ | 10,047 | $ | 10,642 | $ | 7,636 | $ | 8,741 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Other liabilities (3) | $ | 102 | $ | 102 | $ | 128 | $ | 128 | |||||||||||||||
| Total liabilities of consolidated VIEs | $ | 102 | $ | 102 | $ | 128 | $ | 128 |
(1) Includes perpetual securities
(2) Consists of TREs, CMLs, MMLs, and alternative investments in limited partnerships
(3) Consists entirely of derivatives
The Company is substantively the only investor in the consolidated VIEs listed in the table above. As the sole investor in these VIEs, the Company has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and is therefore considered to be the primary beneficiary of the VIEs that it consolidates. The Company also participates in substantially all of the variability created by these VIEs. The activities of these VIEs are limited to holding invested assets and foreign currency swaps, as appropriate, and utilizing the cash flows from these securities to service its investment. Neither the Company nor any of its creditors are able to obtain the underlying collateral of the VIEs unless there is an event of default or other specified event. For those VIEs that contain a swap, the Company is not a direct counterparty to the swap contracts and has no control over them. The Company's loss exposure to these VIEs is limited to its original investment. The Company's consolidated VIEs do not rely on outside or ongoing sources of funding to support their activities beyond the underlying collateral and swap contracts, if applicable. With the exception of its investments in unit trust structures, the underlying collateral assets and funding of the Company's consolidated VIEs are generally static in nature.
Item 8. Financial Statements and Supplementary Data
Investments in Unit Trust Structures
The Company also utilizes unit trust structures in its Aflac Japan segment to invest in various asset classes. As the sole investor of these VIEs, the Company is required to consolidate these trusts under U.S. GAAP.
VIEs - Not Consolidated
The table below reflects the amortized cost, fair value and balance sheet caption in which the Company's investment in VIEs not consolidated are reported as of December 31.
Investments in Variable Interest Entities Not Consolidated
| 2018 | 2017 | ||||||||||||||||||||||
| (In millions) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Fixed maturity securities, available for sale (1) | $ | 4,575 | $ | 4,982 | $ | 5,004 | $ | 5,724 | |||||||||||||||
| Fixed maturity securities, held to maturity | 2,007 | 2,254 | 2,549 | 2,929 | |||||||||||||||||||
| Other investments | 49 | 49 | 55 | 55 | |||||||||||||||||||
| Total investments in VIEs not consolidated | $ | 6,631 | $ | 7,285 | $ | 7,608 | $ | 8,708 |
(1) Includes perpetual securities
The Company holds alternative investments in limited partnerships that have been determined to be VIEs. These partnerships invest in private equity and structured investments. The Company’s maximum exposure to loss on these investments is limited to the amount of its investment. The Company is not the primary beneficiary of these VIEs and is therefore not required to consolidate them. The Company classifies these investments as Other investments in the consolidated balance sheets.
Certain investments in VIEs that the Company is not required to consolidate are investments that are in the form of debt obligations from the VIEs that are irrevocably and unconditionally guaranteed by their corporate parents or sponsors. These VIEs are the primary financing vehicles used by their corporate sponsors to raise financing in the capital markets. The variable interests created by these VIEs are principally or solely a result of the debt instruments issued by them. The Company does not have the power to direct the activities that most significantly impact the entity's economic performance, nor does it have the obligation to absorb losses of the entity or the right to receive benefits from the entity. As such, the Company is not the primary beneficiary of these VIEs and is therefore not required to consolidate them.
Securities Lending and Pledged Securities
The Company lends fixed maturity and public equity securities to financial institutions in short-term security-lending transactions. These short-term security-lending arrangements increase investment income with minimal risk. The Company's security lending policy requires that the fair value of the securities received as collateral be 102% or more of the fair value of the loaned securities and that unrestricted cash received as collateral be 100% or more of the fair value of the loaned securities. These securities continue to be carried as investment assets on the Company's balance sheet during the terms of the loans and are not reported as sales. The Company receives cash or other securities as collateral for such loans. For loans involving unrestricted cash or securities as collateral, the collateral is reported as an asset with a corresponding liability for the return of the collateral. For loans where the Company receives as collateral securities that the Company is not permitted to sell or repledge, the collateral is not reported as an asset.
Item 8. Financial Statements and Supplementary Data
Details of our securities lending activities as of December 31 were as follows:
| Securities Lending Transactions Accounted for as Secured Borrowings | |||||||||||||||
| 2018 | |||||||||||||||
| Remaining Contractual Maturity of the Agreements | |||||||||||||||
| (In millions) | Overnight and Continuous**(1)** | Up to 30 days | Greater than 90 days | Total | |||||||||||
| Securities lending transactions: | |||||||||||||||
| Fixed maturity securities: | |||||||||||||||
| Japan government and agencies | $ | 0 | $ | 387 | $ | 1,190 | $ | 1,577 | |||||||
| Municipalities | 5 | 0 | 0 | 5 | |||||||||||
| Public utilities | 27 | 0 | 0 | 27 | |||||||||||
| Banks/financial institutions | 74 | 0 | 0 | 74 | |||||||||||
| Other corporate | 549 | 0 | 0 | 549 | |||||||||||
| Equity securities | 10 | 0 | 0 | 10 | |||||||||||
| Total borrowings | $ | 665 | $ | 387 | $ | 1,190 | $ | 2,242 | |||||||
| Gross amount of recognized liabilities for securities lending transactions | $ | 1,052 | |||||||||||||
| Amounts related to agreements not included in offsetting disclosure in Note 4 | $ | 1,190 |
(1) These securities are pledged as collateral under the Company's U.S. securities lending program and can be called at its discretion; therefore, they are classified as Overnight and Continuous.
| Securities Lending Transactions Accounted for as Secured Borrowings | ||||||||||||
| 2017 | ||||||||||||
| Remaining Contractual Maturity of the Agreements | ||||||||||||
| (In millions) | Overnight and Continuous*(1)* | Up to 30 days | Total | |||||||||
| Securities lending transactions: | ||||||||||||
| Fixed maturity securities: | ||||||||||||
| Japan government and agencies | $ | 0 | $ | 49 | $ | 49 | ||||||
| Public utilities | 73 | 0 | 73 | |||||||||
| Banks/financial institutions | 54 | 0 | 54 | |||||||||
| Other corporate | 415 | 0 | 415 | |||||||||
| Equity securities | 15 | 0 | 15 | |||||||||
| Total borrowings | $ | 557 | $ | 49 | $ | 606 | ||||||
| Gross amount of recognized liabilities for securities lending transactions | $ | 606 | ||||||||||
| Amounts related to agreements not included in offsetting disclosure in Note 4 | $ | 0 |
(1) These securities are pledged as collateral under the Company's U.S. securities lending program and can be called at its discretion; therefore, they are classified as Overnight and Continuous.
The Company did not have any repurchase agreements or repurchase-to-maturity transactions outstanding as of December 31, 2018 and 2017, respectively.
Certain fixed maturity securities can be pledged as collateral as part of derivative transactions, or pledged to support state deposit requirements on certain investment programs. For additional information regarding pledged securities related to derivative transactions, see Note 4.
At December 31, 2018, debt securities with a fair value of $19 million were on deposit with regulatory authorities in the United States (including U.S. territories) and Japan. The Company retains ownership of all securities on deposit and receives the related investment income.
For general information regarding the Company's investment accounting policies, see Note 1.
Item 8. Financial Statements and Supplementary Data
4. DERIVATIVE INSTRUMENTS
The Company's freestanding derivative financial instruments have historically consisted of: (1) foreign currency forwards and options used in hedging foreign exchange risk on U.S. dollar-denominated investments in Aflac Japan's portfolio; (2) foreign currency forwards and options used to economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long term exposure to a weakening yen; (3) cross-currency interest rate swaps, also referred to as foreign currency swaps, associated with certain senior notes and subordinated debentures; (4) foreign currency swaps and, in prior periods, credit default swaps that are associated with investments in special-purpose entities, including VIEs where the Company is the primary beneficiary; (5) interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments; and (6) interest rate swaptions used to hedge changes in the fair value associated with interest rate fluctuations for certain U.S. dollar-denominated available-for-sale fixed-maturity securities. Some of the Company's derivatives are designated as cash flow hedges, fair value hedges or net investment hedges; however, other derivatives do not qualify for hedge accounting or the Company elects not to designate them as accounting hedges.
Derivative Types
Foreign currency forwards and options are executed for the Aflac Japan segment in order to hedge the currency risk on the carrying value of certain U.S. dollar-denominated investments. The average maturity of these forwards and options can change depending on factors such as market conditions and types of investments being held. In situations where the maturity of the forwards and options is shorter than the underlying investment being hedged, the Company may enter into new forwards and options near maturity of the existing derivative in order to continue hedging the underlying investment. In forward transactions, Aflac Japan agrees with another party to buy a fixed amount of yen and sell a corresponding amount of U.S. dollars at a specified future date. Aflac Japan also executes foreign currency option transactions in a collar strategy, where Aflac Japan agrees with another party to simultaneously purchase put options and sell call options. In the purchased put transactions, Aflac Japan obtains the option to buy a fixed amount of yen and sell a corresponding amount of U.S. dollars at a specified future date. In the sold call transaction, Aflac Japan agrees to sell a fixed amount of yen and buy a corresponding amount of U.S. dollars at a specified future date. The combination of purchasing the put option and selling the call option results in no net premium being paid (i.e. a costless or zero-cost collar). The foreign currency forwards and options are used in fair value hedging relationships to mitigate the foreign exchange risk associated with U.S. dollar-denominated investments supporting yen- denominated liabilities.
Prior to April 1, 2018, foreign currency forwards and options (through a collar strategy, as discussed above) were used to hedge the currency risk associated with the net investment in Aflac Japan. In these forward transactions, Aflac agreed with another party to buy a fixed amount of U.S. dollars and sell a corresponding amount of yen at a specified price at a specified future date. In the option transactions, the Company used a combination of foreign currency options to protect expected future cash flows by simultaneously purchasing yen put options (options that protect against a weakening yen) and selling yen call options (options that limit participation in a strengthening yen). The combination of these two actions created a zero-cost collar.
The Company enters into foreign currency swaps pursuant to which it exchanges an initial principal amount in one currency for an initial principal amount of another currency, with an agreement to re-exchange the principal amounts at a future date. There may also be periodic exchanges of payments at specified intervals based on the agreed upon rates and notional amounts. Foreign currency swaps are used primarily in the consolidated VIEs in the Company's Aflac Japan portfolio to convert foreign-denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations. The Company also uses foreign currency swaps to economically convert certain of its U.S. dollar-denominated senior note and subordinated debenture principal and interest obligations into yen-denominated obligations.
In order to reduce investment income volatility from its variable-rate investments, the Company enters into receive–fixed, pay–floating interest rate swaps. These derivatives are cleared and settled through a central clearinghouse.
Interest rate swaption collars are combinations of two swaption positions. Swaptions are used to mitigate the adverse impact resulting from significant changes in the fair value of U.S. dollar-denominated available-for-sale securities due to fluctuation in interest rates. In order to maximize the efficiency of the collars while minimizing cost, a collar strategy is used whereby the Company purchases a long payer swaption (the Company purchases an option that allows it to enter into a swap where the Company will pay the fixed rate and receive the floating rate of the swap) and sells a short receiver swaption (the Company sells an option that provides the counterparty with the right to enter into a swap where the Company will receive the fixed rate and pay the floating rate of the swap). The combination of purchasing the long payer swaption and selling the short receiver swaption results in no net premium being paid (i.e. a costless or zero-cost collar).
Item 8. Financial Statements and Supplementary Data
Derivative Balance Sheet Classification
The tables below summarize the balance sheet classification of the Company's derivative fair value amounts, as well as the gross asset and liability fair value amounts, at December 31. The fair value amounts presented do not include income accruals. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and are not reflective of exposure or credit risk.
| 2018 | 2017 | |||||||||||||||||||||||||||||||||
| (In millions) | Asset Derivatives | Liability Derivatives | Asset Derivatives | Liability Derivatives | ||||||||||||||||||||||||||||||
| Hedge Designation/ Derivative Type | Notional Amount | Fair Value | Fair Value | Notional Amount | Fair Value | Fair Value | ||||||||||||||||||||||||||||
| Cash flow hedges: | ||||||||||||||||||||||||||||||||||
| Foreign currency swaps | $ | 75 | $ | 1 | $ | (4 | ) | $ | 75 | $ | 0 | $ | (8 | ) | ||||||||||||||||||||
| Total cash flow hedges | 75 | 1 | (4 | ) | 75 | 0 | (8 | ) | ||||||||||||||||||||||||||
| Fair value hedges: | ||||||||||||||||||||||||||||||||||
| Foreign currency forwards | 2,086 | 0 | (34 | ) | 7,640 | 2 | (221 | ) | ||||||||||||||||||||||||||
| Foreign currency options | 9,070 | 3 | (1 | ) | 7,670 | 0 | (2 | ) | ||||||||||||||||||||||||||
| Interest rate swaptions | 500 | 0 | (1 | ) | 0 | 0 | 0 | |||||||||||||||||||||||||||
| Total fair value hedges | 11,656 | 3 | (36 | ) | 15,310 | 2 | (223 | ) | ||||||||||||||||||||||||||
| Net investment hedge: | ||||||||||||||||||||||||||||||||||
| Foreign currency forwards | 0 | 0 | 0 | 5 | 0 | 0 | ||||||||||||||||||||||||||||
| Foreign currency options | 0 | 0 | 0 | 434 | 12 | (1 | ) | |||||||||||||||||||||||||||
| Total net investment hedge | 0 | 0 | 0 | 439 | 12 | (1 | ) | |||||||||||||||||||||||||||
| Non-qualifying strategies: | ||||||||||||||||||||||||||||||||||
| Foreign currency swaps | 5,387 | 284 | (230 | ) | 5,386 | 296 | (189 | ) | ||||||||||||||||||||||||||
| Foreign currency forwards | 16,057 | 126 | (117 | ) | 3,683 | 20 | (53 | ) | ||||||||||||||||||||||||||
| Foreign currency options | 430 | 0 | 0 | 770 | 0 | 0 | ||||||||||||||||||||||||||||
| Credit default swaps | 0 | 0 | 0 | 88 | 1 | 0 | ||||||||||||||||||||||||||||
| Interest rate swaps | 4,750 | 3 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||
| Total non-qualifying strategies | 26,624 | 413 | (347 | ) | 9,927 | 317 | (242 | ) | ||||||||||||||||||||||||||
| Total derivatives | $ | 38,355 | $ | 417 | $ | (387 | ) | $ | 25,751 | $ | 331 | $ | (474 | ) | ||||||||||||||||||||
| Balance Sheet Location | ||||||||||||||||||||||||||||||||||
| Other assets | $ | 23,713 | $ | 417 | $ | 0 | $ | 10,948 | $ | 331 | $ | 0 | ||||||||||||||||||||||
| Other liabilities | 14,642 | 0 | (387 | ) | 14,803 | 0 | (474 | ) | ||||||||||||||||||||||||||
| Total derivatives | $ | 38,355 | $ | 417 | $ | (387 | ) | $ | 25,751 | $ | 331 | $ | (474 | ) |
Cash Flow Hedges
For certain variable-rate U.S. dollar-denominated available-for-sale securities held by Aflac Japan via consolidated VIEs, foreign currency swaps are used to swap the USD variable rate interest and principal payments to fixed rate JPY interest and principal payments. The Company has designated foreign currency swaps as a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset (“cash flow” hedge). The remaining maximum length of time for which these cash flows are hedged is seven years. The derivatives in the Company's consolidated VIEs that are not designated as accounting hedges are discussed in the "non-qualifying strategies" section of this note.
Fair Value Hedges
The Company designates and accounts for certain foreign currency forwards, options, and interest rate swaptions as fair value hedges when they meet the requirements for hedge accounting. The Company recognizes gains and losses on these derivatives as well as the offsetting gain or loss on the related hedged items in current earnings.
Item 8. Financial Statements and Supplementary Data
Foreign currency forwards and options hedge the foreign currency exposure of certain U.S. dollar-denominated available-for-sale fixed-maturity investments held in Aflac Japan. The change in the fair value of the foreign currency forwards related to the changes in the difference between the spot rate and the forward price is excluded from the assessment of hedge effectiveness. The change in fair value of the foreign currency option related to the time value of the option is recognized in current earnings and is excluded from the assessment of hedge effectiveness.
Interest rate swaptions hedge the interest rate exposure of certain U.S. dollar-denominated available-for-sale securities held in Aflac Japan. For these hedging relationships, the Company excludes time value from the assessment of hedge effectiveness and recognizes changes in the intrinsic value of the swaptions in current earnings within net investment income. The change in the time value of the swaptions is recognized in other comprehensive income (loss) and amortized into earnings (net investment income) over its legal term.
The following table presents the gains and losses on derivatives and the related hedged items in fair value hedges for the years ended December 31.
Fair Value Hedging Relationships
| (In millions) | Hedging Derivatives | Hedged Items | |||||||||||||||||||
| Hedging Derivatives | Hedged Items | Total Gains (Losses) | Gains (Losses) Excluded from Effectiveness Testing**(2)** | Gains (Losses) Included in Effectiveness Testing**(1)** | Gains (Losses) (1) | Net Realized Gains (Losses) Recognized for Fair Value Hedge | |||||||||||||||
| 2018: | |||||||||||||||||||||
| Foreign currency forwards | Fixed maturity securities | $ | 126 | $ | (104 | ) | $ | 230 | $ | (242 | ) | $ | (12 | ) | |||||||
| Foreign currency options | Fixed maturity securities | 4 | 4 | 0 | 0 | 0 | |||||||||||||||
| Interest rate swaptions | Fixed maturity securities | (1 | ) | (1 | ) | 0 | 0 | 0 | |||||||||||||
| Total gains (losses) | $ | 129 | $ | (101 | ) | $ | 230 | $ | (242 | ) | $ | (12 | ) | ||||||||
| 2017: | |||||||||||||||||||||
| Foreign currency forwards | Fixed maturity and equity securities | $ | 98 | $ | (202 | ) | $ | 300 | $ | (278 | ) | $ | 22 | ||||||||
| Foreign currency options | Fixed maturity securities | 21 | 10 | 11 | (10 | ) | 1 | ||||||||||||||
| Total gains (losses) | $ | 119 | $ | (192 | ) | $ | 311 | $ | (288 | ) | $ | 23 | |||||||||
| 2016: | |||||||||||||||||||||
| Foreign currency forwards | Fixed maturity and equity securities | $ | 207 | $ | (338 | ) | $ | 545 | $ | (566 | ) | $ | (21 | ) | |||||||
| Foreign currency options | Fixed maturity securities | (95 | ) | (18 | ) | (77 | ) | 70 | (7 | ) | |||||||||||
| Total gains (losses) | $ | 112 | $ | (356 | ) | $ | 468 | $ | (496 | ) | $ | (28 | ) |
(1) Gains and losses on foreign currency forwards and options and related hedged items are reported in the consolidated statement of earnings as realized investment gains (losses). For interest rate swaptions and related hedged items, gains and losses included in the hedge assessment are reported within net investment income. For the year ended December 31, 2018, those gains and losses on interest rate swaptions and related hedged items were immaterial.
(2) Gains (losses) excluded from effectiveness testing includes the forward point on foreign currency forwards and time value change on foreign currency options which are reported in the consolidated statement of earnings as realized investment gains (losses). It also includes the change in the fair value of the interest rate swaptions related to the time value of the swaptions which is recognized as a component of other comprehensive income (loss).
The following table shows the December 31, 2018 carrying amounts of assets designated and qualifying as hedged items in fair value hedges of interest rate risk and the related cumulative hedge adjustment included in the carrying amount.
Item 8. Financial Statements and Supplementary Data
| (In millions) | Carrying Amount of the Hedged Assets/(Liabilities)****(1) | Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of Hedged Assets/(Liabilities) | |||||||||
| 2018 | 2018 | ||||||||||
| Fixed maturity securities | $ | 6,593 | $ | 294 |
(1) The balance includes $294 million of hedging adjustment on discontinued hedging relationships.
As of December 31, 2018*, the total notional amount of the Company's interest rate swaptions was* $500 million*. The hedging adjustment related to these derivatives was immaterial.*
Net Investment Hedge
The Company's investment in Aflac Japan is affected by changes in the yen/dollar exchange rate. To mitigate this exposure, the Parent Company's yen-denominated liabilities (see Note 9) have been designated as non-derivative hedges and, prior to April 1, 2018, foreign currency forwards and options were designated as derivative hedges of the foreign currency exposure of the Company's net investment in Aflac Japan. The Company designated net investment hedges under this strategy during the years ended December 31, 2018, 2017 and 2016.
Non-qualifying Strategies
For the Company's derivative instruments in consolidated VIEs that do not qualify for hedge accounting treatment, all changes in their fair value are reported in current period earnings within realized investment gains (losses). The amount of gain or loss recognized in earnings for the Company's VIEs is attributable to the derivatives in those investment structures. While the change in value of the swaps is recorded through current period earnings, the change in value of the available-for-sale fixed maturity securities associated with these swaps is recorded through other comprehensive income.
As of December 31, 2018, the Parent Company had cross-currency interest rate swap agreements related to its $350 million senior notes due February 2022, $700 million senior notes due June 2023, $750 million senior notes due November 2024 and $450 million senior notes due March 2025. Changes in the values of these swaps are recorded through current period earnings. For additional information regarding these swaps, see Note 9.
The Company uses foreign exchange forwards and options to economically mitigate the currency risk of some of its U.S. dollar- denominated loan receivables held within the Aflac Japan segment. These arrangements are not designated as accounting hedges, as the foreign currency remeasurement of the loan receivables impacts current period earnings, and generally offsets gains and losses from foreign exchange forwards within realized investment gains (losses). The Company also has certain foreign exchange forwards on U.S. dollar-denominated AFS securities where hedge accounting is not being applied.
In order to economically mitigate currency risk of future yen dividends from Aflac Japan while lowering consolidated hedge costs associated with Aflac Japan's U.S. dollar investment hedging the Parent Company entered into offsetting hedge positions using foreign exchange forwards. This activity is reported in the Corporate and other segment.
The Company uses interest rate swaps to economically convert the variable rate investment income to a fixed rate on certain variable-rate investments.
Item 8. Financial Statements and Supplementary Data
Impact of Derivatives and Hedging Instruments
The following table summarizes the impact to realized investment gains (losses) and other comprehensive income (loss) from all derivatives and hedging instruments for the years ended December 31.
| 2018 | 2017 | 2016 | ||||||||||||||||||||||||||||
| (In millions) | Realized Investment Gains (Losses) | Other Comprehensive Income (Loss)****(1) | Realized Investment Gains (Losses) | Other Comprehensive Income (Loss)(1) | Realized Investment Gains (Losses) | Other Comprehensive Income (Loss)(1) | ||||||||||||||||||||||||
| Qualifying hedges: | ||||||||||||||||||||||||||||||
| Cash flow hedges: | ||||||||||||||||||||||||||||||
| Foreign currency swaps | $ | 0 | $ | 3 | $ | 0 | $ | 1 | $ | 1 | $ | 3 | ||||||||||||||||||
| Total cash flow hedges | 0 | (2) | 3 | 0 | (2) | 1 | 1 | (2) | 3 | |||||||||||||||||||||
| Fair value hedges: | ||||||||||||||||||||||||||||||
| Foreign currency forwards (3) | (116 | ) | (180 | ) | (359 | ) | ||||||||||||||||||||||||
| Foreign currency options (3) | 4 | 11 | (25 | ) | ||||||||||||||||||||||||||
| Interest rate swaptions (3) | 0 | (1 | ) | 0 | 0 | 0 | 0 | |||||||||||||||||||||||
| Total fair value hedges | (112 | ) | (1 | ) | (169 | ) | 0 | (384 | ) | 0 | ||||||||||||||||||||
| Net investment hedge: | ||||||||||||||||||||||||||||||
| Non-derivative hedging instruments | 0 | (32 | ) | 0 | (15 | ) | 0 | 0 | ||||||||||||||||||||||
| Foreign currency forwards | 0 | 0 | 0 | (25 | ) | 0 | (118 | ) | ||||||||||||||||||||||
| Foreign currency options | 0 | (8 | ) | 0 | 5 | 0 | 73 | |||||||||||||||||||||||
| Total net investment hedge | 0 | (40 | ) | 0 | (35 | ) | 0 | (45 | ) | |||||||||||||||||||||
| Non-qualifying strategies: | ||||||||||||||||||||||||||||||
| Foreign currency swaps | 20 | 53 | 117 | |||||||||||||||||||||||||||
| Foreign currency forwards | (135 | ) | 8 | 9 | ||||||||||||||||||||||||||
| Credit default swaps | 0 | (1 | ) | 2 | ||||||||||||||||||||||||||
| Interest rate swaps | 3 | 0 | 0 | |||||||||||||||||||||||||||
| Total non- qualifying strategies | (112 | ) | 60 | 128 | ||||||||||||||||||||||||||
| Total | $ | (224 | ) | $ | (38 | ) | $ | (109 | ) | $ | (34 | ) | $ | (255 | ) | $ | (42 | ) |
(1) Cash flow hedge items and the change in the fair value of interest rate swaptions related to the time value of the swaptions in fair value hedges are recorded as unrealized gains (losses) on derivatives and net investment hedge items are recorded in the unrealized foreign currency translation gains (losses) line in the consolidated statement of comprehensive income (loss).
(2) Impact of cash flow hedges reported as realized investment gains (losses) includes an immaterial amount of gains or losses reclassified from accumulated other comprehensive income (loss) into earnings. It also includes an immaterial amount excluded from effectiveness testing during the years ended December 31, 2018 and 2017 *and $*1 million during the year ended December 31, 2016.
*(3)*Impact shown net of effect of hedged items (see Fair Value Hedges section of this Note 4 for further detail)
The impact on earnings from derivatives in cash flow hedge relationships also included a loss of $2 million during the year ended December 31, 2018 and an immaterial amount during the years ended December 31, 2017 and 2016 resulting from reclassifications from accumulated other comprehensive income (loss) to net investment income. There was no gain or loss reclassified from accumulated other comprehensive income (loss) into earnings related to the net investment hedge for the years ended December 31, 2018, 2017 and 2016. As of December 31, 2018, deferred gains and losses on derivative instruments recorded in accumulated other comprehensive income that are expected to be reclassified to earnings during the next twelve months were immaterial.
Credit Risk Assumed through Derivatives
For the foreign currency and credit default swaps associated with the Company's VIE investments for which it is the primary beneficiary, the Company bears the risk of loss due to counterparty default even though it is not a direct counterparty to those contracts.
The Company is a direct counterparty to the foreign currency swaps that it has entered into in connection with certain of its senior notes and subordinated debentures; foreign currency forwards; and foreign currency options, and therefore the Company is exposed to credit risk in the event of nonperformance by the counterparties in those contracts. The risk of counterparty default for the Company's foreign currency swaps, certain foreign currency forwards, foreign currency options is mitigated by collateral posting requirements that counterparties to those transactions must meet.
Item 8. Financial Statements and Supplementary Data
As of December 31, 2018, there were 16 counterparties to the Company's derivative agreements, with three comprising 52% of the aggregate notional amount. The counterparties to these derivatives are financial institutions with the following credit ratings as of December 31:
| 2018 | 2017 | |||||||||||||||||||||||||||||
| (In millions) | Notional Amount of Derivatives | Asset Derivatives Fair Value | Liability Derivatives Fair Value | Notional Amount of Derivatives | Asset Derivatives Fair Value | Liability Derivatives Fair Value | ||||||||||||||||||||||||
| Counterparties' credit rating: | ||||||||||||||||||||||||||||||
| AA | $ | 5,399 | $ | 63 | $ | (23 | ) | $ | 4,708 | $ | 52 | $ | (37 | ) | ||||||||||||||||
| A | 32,513 | 350 | (311 | ) | 20,604 | 271 | (370 | ) | ||||||||||||||||||||||
| BBB | 443 | 4 | (53 | ) | 439 | 8 | (67 | ) | ||||||||||||||||||||||
| Total | $ | 38,355 | $ | 417 | $ | (387 | ) | $ | 25,751 | $ | 331 | $ | (474 | ) |
The Company engages in over-the-counter (OTC) bilateral derivative transactions directly with unaffiliated third parties under International Swaps and Derivatives Association, Inc. (ISDA) agreements and other documentation. Most of the ISDA agreements also include Credit Support Annexes (CSAs) provisions, which generally provide for two-way collateral postings at the first dollar of exposure. The Company mitigates the risk that counterparties to transactions might be unable to fulfill their contractual obligations by monitoring counterparty credit exposure and collateral value while generally requiring that collateral be posted at the outset of the transaction. In addition, a significant portion of the derivative transactions have provisions that give the counterparty the right to terminate the transaction upon a downgrade of Aflac’s financial strength rating. The actual amount of payments that the Company could be required to make depends on market conditions, the fair value of outstanding affected transactions, and other factors prevailing at and after the time of the downgrade.
The Company also engages in OTC cleared derivative transactions through regulated central clearing counterparties. These positions are marked to market and margined on a daily basis (both initial margin and variation margin), and the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to these derivatives.
Collateral posted by the Company to third parties for derivative transactions can generally be repledged or resold by the counterparties. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position by counterparty was approximately $139 million and $264 million as of December 31, 2018 and 2017, respectively. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2018, the Company estimates that it would be required to post a maximum of $34 million of additional collateral to these derivative counterparties. The Company is generally allowed to sell or repledge collateral obtained from its derivative counterparties, although it does not typically exercise such rights. (See the Offsetting tables below for collateral posted or received as of the reported balance sheet dates.)
Offsetting of Financial Instruments and Derivatives
Most of the Company's derivative instruments are subject to enforceable master netting arrangements that provide for the net settlement of all derivative contracts between the Parent Company or Aflac and its respective counterparty in the event of default or upon the occurrence of certain termination events. Collateral support agreements with the master netting arrangements generally provide that the Company will receive or pledge financial collateral at the first dollar of exposure.
The Company has securities lending agreements with unaffiliated financial institutions that post collateral to the Company in return for the use of its fixed maturity and public equity securities (see Note 3). When the Company has entered into securities lending agreements with the same counterparty, the agreements generally provide for net settlement in the event of default by the counterparty. This right of set-off allows the Company to keep and apply collateral received if the counterparty failed to return the securities borrowed from the Company as contractually agreed. For additional information on the Company's accounting policy for securities lending, see Note 1.
The tables below summarize the Company's derivatives and securities lending transactions as of December 31, and as reflected in the tables, in accordance with U.S. GAAP, the Company's policy is to not offset these financial instruments in the Consolidated Balance Sheets.
Item 8. Financial Statements and Supplementary Data
Offsetting of Financial Assets and Derivative Assets
| 2018 | |||||||||||||||||||||||||||||||||||||||
| Gross Amounts Not Offset in Balance Sheet | |||||||||||||||||||||||||||||||||||||||
| (In millions) | Gross Amount of Recognized Assets | Gross Amount Offset in Balance Sheet | Net Amount of Assets Presented in Balance Sheet | Financial Instruments | Securities Collateral | Cash Collateral Received | Net Amount | ||||||||||||||||||||||||||||||||
| Derivative assets: | |||||||||||||||||||||||||||||||||||||||
| Derivative assets subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | $ | 231 | $ | 0 | $ | 231 | $ | (152 | ) | $ | (23 | ) | $ | (55 | ) | $ | 1 | ||||||||||||||||||||||
| OTC - cleared | 3 | 0 | 3 | 0 | 0 | (3 | ) | 0 | |||||||||||||||||||||||||||||||
| Total derivative assets subject to a master netting agreement or offsetting arrangement | 234 | 0 | 234 | (152 | ) | (23 | ) | (58 | ) | 1 | |||||||||||||||||||||||||||||
| Derivative assets not subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | 183 | 183 | 183 | ||||||||||||||||||||||||||||||||||||
| Total derivative assets not subject to a master netting agreement or offsetting arrangement | 183 | 183 | 183 | ||||||||||||||||||||||||||||||||||||
| Total derivative assets | 417 | 0 | 417 | (152 | ) | (23 | ) | (58 | ) | 184 | |||||||||||||||||||||||||||||
| Securities lending and similar arrangements | 1,029 | 0 | 1,029 | 0 | 0 | (1,029 | ) | 0 | |||||||||||||||||||||||||||||||
| Total | $ | 1,446 | $ | 0 | $ | 1,446 | $ | (152 | ) | $ | (23 | ) | $ | (1,087 | ) | $ | 184 |
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||||||||||||||||||||||||||||
| Gross Amounts Not Offset in Balance Sheet | |||||||||||||||||||||||||||||||||||||||
| (In millions) | Gross Amount of Recognized Assets | Gross Amount Offset in Balance Sheet | Net Amount of Assets Presented in Balance Sheet | Financial Instruments | Securities Collateral | Cash Collateral Received | Net Amount | ||||||||||||||||||||||||||||||||
| Derivative assets: | |||||||||||||||||||||||||||||||||||||||
| Derivative assets subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | $ | 180 | $ | 0 | $ | 180 | $ | (82 | ) | $ | 0 | $ | (98 | ) | $ | 0 | |||||||||||||||||||||||
| Total derivative assets subject to a master netting agreement or offsetting arrangement | 180 | 0 | 180 | (82 | ) | 0 | (98 | ) | 0 | ||||||||||||||||||||||||||||||
| Derivative assets not subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | 151 | 151 | 151 | ||||||||||||||||||||||||||||||||||||
| Total derivative assets not subject to a master netting agreement or offsetting arrangement | 151 | 151 | 151 | ||||||||||||||||||||||||||||||||||||
| Total derivative assets | 331 | 0 | 331 | (82 | ) | 0 | (98 | ) | 151 | ||||||||||||||||||||||||||||||
| Securities lending and similar arrangements | 592 | 0 | 592 | 0 | 0 | (592 | ) | 0 | |||||||||||||||||||||||||||||||
| Total | $ | 923 | $ | 0 | $ | 923 | $ | (82 | ) | $ | 0 | $ | (690 | ) | $ | 151 |
Item 8. Financial Statements and Supplementary Data
Offsetting of Financial Liabilities and Derivative Liabilities
| 2018 | |||||||||||||||||||||||||||||||||||||||
| Gross Amounts Not Offset in Balance Sheet | |||||||||||||||||||||||||||||||||||||||
| (In millions) | Gross Amount of Recognized Liabilities | Gross Amount Offset in Balance Sheet | Net Amount of Liabilities Presented in Balance Sheet | Financial Instruments | Securities Collateral | Cash Collateral Pledged | Net Amount | ||||||||||||||||||||||||||||||||
| Derivative liabilities: | |||||||||||||||||||||||||||||||||||||||
| Derivative liabilities subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | $ | (285 | ) | $ | 0 | $ | (285 | ) | $ | 152 | $ | 37 | $ | 68 | $ | (28 | ) | ||||||||||||||||||||||
| Total derivative liabilities subject to a master netting agreement or offsetting arrangement | (285 | ) | 0 | (285 | ) | 152 | 37 | 68 | (28 | ) | |||||||||||||||||||||||||||||
| Derivative liabilities not subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | (102 | ) | (102 | ) | (102 | ) | |||||||||||||||||||||||||||||||||
| Total derivative liabilities not subject to a master netting agreement or offsetting arrangement | (102 | ) | (102 | ) | (102 | ) | |||||||||||||||||||||||||||||||||
| Total derivative liabilities | (387 | ) | 0 | (387 | ) | 152 | 37 | 68 | (130 | ) | |||||||||||||||||||||||||||||
| Securities lending and similar arrangements | (1,052 | ) | 0 | (1,052 | ) | 1,029 | 0 | 0 | (23 | ) | |||||||||||||||||||||||||||||
| Total | $ | (1,439 | ) | $ | 0 | $ | (1,439 | ) | $ | 1,181 | $ | 37 | $ | 68 | $ | (153 | ) |
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||||||||||||||||||||||||||||
| Gross Amounts Not Offset in Balance Sheet | |||||||||||||||||||||||||||||||||||||||
| (In millions) | Gross Amount of Recognized Liabilities | Gross Amount Offset in Balance Sheet | Net Amount of Liabilities Presented in Balance Sheet | Financial Instruments | Securities Collateral | Cash Collateral Pledged | Net Amount | ||||||||||||||||||||||||||||||||
| Derivative liabilities: | |||||||||||||||||||||||||||||||||||||||
| Derivative liabilities subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | $ | (346 | ) | $ | 0 | $ | (346 | ) | $ | 82 | $ | 245 | $ | 10 | $ | (9 | ) | ||||||||||||||||||||||
| Total derivative liabilities subject to a master netting agreement or offsetting arrangement | (346 | ) | 0 | (346 | ) | 82 | 245 | 10 | (9 | ) | |||||||||||||||||||||||||||||
| Derivative liabilities not subject to a master netting agreement or offsetting arrangement | |||||||||||||||||||||||||||||||||||||||
| OTC - bilateral | (128 | ) | (128 | ) | (128 | ) | |||||||||||||||||||||||||||||||||
| Total derivative liabilities not subject to a master netting agreement or offsetting arrangement | (128 | ) | (128 | ) | (128 | ) | |||||||||||||||||||||||||||||||||
| Total derivative liabilities | (474 | ) | 0 | (474 | ) | 82 | 245 | 10 | (137 | ) | |||||||||||||||||||||||||||||
| Securities lending and similar arrangements | (606 | ) | 0 | (606 | ) | 592 | 0 | 0 | (14 | ) | |||||||||||||||||||||||||||||
| Total | $ | (1,080 | ) | $ | 0 | $ | (1,080 | ) | $ | 674 | $ | 245 | $ | 10 | $ | (151 | ) |
For additional information on the Company's financial instruments, see the accompanying Notes 1, 3 and 5.
| 5. | FAIR VALUE MEASUREMENTS |
Fair Value Hierarchy
U.S. GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. These two types of inputs create three valuation hierarchy levels. Level 1 valuations reflect quoted market prices for identical assets or liabilities in active markets. Level 2 valuations reflect quoted market prices for similar assets or liabilities in an active market, quoted market prices for identical or similar assets or liabilities in non-active markets or model-derived valuations in which all significant valuation inputs are observable in active markets. Level 3 valuations reflect valuations in which one or more of the significant inputs are not observable in an active market.
The following tables present the fair value hierarchy levels of the Company's assets and liabilities that are measured and carried at fair value on a recurring basis as of December 31.
Item 8. Financial Statements and Supplementary Data
| 2018 | |||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Securities available for sale, carried at fair value: | |||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||
| Government and agencies | $ | 32,993 | $ | 1,349 | $ | 0 | $ | 34,342 | |||||||||||||||
| Municipalities | 0 | 1,863 | 0 | 1,863 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 0 | 162 | 177 | 339 | |||||||||||||||||||
| Public utilities | 0 | 7,062 | 109 | 7,171 | |||||||||||||||||||
| Sovereign and supranational | 0 | 1,260 | 0 | 1,260 | |||||||||||||||||||
| Banks/financial institutions | 0 | 8,895 | 23 | 8,918 | |||||||||||||||||||
| Other corporate | 0 | 28,789 | 213 | 29,002 | |||||||||||||||||||
| Total fixed maturity securities | 32,993 | 49,380 | 522 | 82,895 | (1) | ||||||||||||||||||
| Equity securities (1) | 874 | 67 | 46 | 987 | (1) | ||||||||||||||||||
| Other investments | 152 | 0 | 0 | 152 | |||||||||||||||||||
| Cash and cash equivalents | 4,337 | 0 | 0 | 4,337 | |||||||||||||||||||
| Other assets: | |||||||||||||||||||||||
| Foreign currency swaps | 0 | 103 | 182 | 285 | |||||||||||||||||||
| Foreign currency forwards | 0 | 126 | 0 | 126 | |||||||||||||||||||
| Foreign currency options | 0 | 3 | 0 | 3 | |||||||||||||||||||
| Interest rate swaps | 0 | 3 | 0 | 3 | |||||||||||||||||||
| Total other assets | 0 | 235 | 182 | 417 | |||||||||||||||||||
| Total assets | $ | 38,356 | $ | 49,682 | $ | 750 | $ | 88,788 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Other liabilities: | |||||||||||||||||||||||
| Foreign currency swaps | $ | 0 | $ | 132 | $ | 102 | $ | 234 | |||||||||||||||
| Foreign currency forwards | 0 | 151 | 0 | 151 | |||||||||||||||||||
| Foreign currency options | 0 | 1 | 0 | 1 | |||||||||||||||||||
| Interest rate swaptions | 0 | 1 | 0 | 1 | |||||||||||||||||||
| Total liabilities | $ | 0 | $ | 285 | $ | 102 | $ | 387 |
(1) Includes perpetual securities
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Securities available for sale, carried at fair value: | |||||||||||||||||||||||
| Fixed maturity securities: (1) | |||||||||||||||||||||||
| Government and agencies | $ | 30,109 | $ | 1,121 | $ | 0 | $ | 31,230 | |||||||||||||||
| Municipalities | 0 | 1,370 | 0 | 1,370 | |||||||||||||||||||
| Mortgage- and asset-backed securities | 0 | 269 | 175 | 444 | |||||||||||||||||||
| Public utilities | 0 | 7,886 | 68 | 7,954 | |||||||||||||||||||
| Sovereign and supranational | 0 | 1,909 | 0 | 1,909 | |||||||||||||||||||
| Banks/financial institutions | 0 | 8,908 | 25 | 8,933 | |||||||||||||||||||
| Other corporate | 0 | 32,327 | 146 | 32,473 | |||||||||||||||||||
| Total fixed maturity securities | 30,109 | 53,790 | 414 | 84,313 | (1) | ||||||||||||||||||
| Equity securities | 1,001 | 6 | 16 | 1,023 | |||||||||||||||||||
| Other investments | 57 | 0 | 0 | 57 | |||||||||||||||||||
| Cash and cash equivalents | 3,491 | 0 | 0 | 3,491 | |||||||||||||||||||
| Other assets: | |||||||||||||||||||||||
| Foreign currency swaps | 0 | 146 | 150 | 296 | |||||||||||||||||||
| Foreign currency forwards | 0 | 22 | 0 | 22 | |||||||||||||||||||
| Foreign currency options | 0 | 12 | 0 | 12 | |||||||||||||||||||
| Credit default swaps | 0 | 0 | 1 | 1 | |||||||||||||||||||
| Total other assets | 0 | 180 | 151 | 331 | |||||||||||||||||||
| Total assets | $ | 34,658 | $ | 53,976 | $ | 581 | $ | 89,215 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Other liabilities: | |||||||||||||||||||||||
| Foreign currency swaps | $ | 0 | $ | 69 | $ | 128 | $ | 197 | |||||||||||||||
| Foreign currency forwards | 0 | 274 | 0 | 274 | |||||||||||||||||||
| Foreign currency options | 0 | 3 | 0 | 3 | |||||||||||||||||||
| Total liabilities | $ | 0 | $ | 346 | $ | 128 | $ | 474 |
(1) Includes perpetual securities
Item 8. Financial Statements and Supplementary Data
The following tables present the carrying amount and fair value categorized by fair value hierarchy level for the Company's financial instruments that are not carried at fair value as of December 31.
| 2018 | ||||||||||||||||||||||||||||
| (In millions) | Carrying Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | ||||||||||||||||||||||||||||
| Fixed maturity securities: | ||||||||||||||||||||||||||||
| Government and agencies | $ | 21,712 | $ | 27,030 | $ | 8 | $ | 0 | $ | 27,038 | ||||||||||||||||||
| Municipalities | 359 | 0 | 469 | 0 | 469 | |||||||||||||||||||||||
| Mortgage and asset-backed securities | 14 | 0 | 0 | 15 | 15 | |||||||||||||||||||||||
| Public utilities | 2,727 | 0 | 2,973 | 0 | 2,973 | |||||||||||||||||||||||
| Sovereign and supranational | 1,551 | 0 | 1,840 | 0 | 1,840 | |||||||||||||||||||||||
| Banks/financial institutions | 1,445 | 0 | 1,583 | 0 | 1,583 | |||||||||||||||||||||||
| Other corporate | 2,510 | 0 | 2,804 | 0 | 2,804 | |||||||||||||||||||||||
| Other investments (1) | 6,945 | 0 | 26 | 6,893 | 6,919 | |||||||||||||||||||||||
| Total assets | $ | 37,263 | $ | 27,030 | $ | 9,703 | $ | 6,908 | $ | 43,641 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||
| Other policyholders’ funds | $ | 7,146 | $ | 0 | $ | 0 | $ | 7,067 | $ | 7,067 | ||||||||||||||||||
| Notes payable (excluding capital leases) | 5,765 | 0 | 5,606 | 270 | 5,876 | |||||||||||||||||||||||
| Total liabilities | $ | 12,911 | $ | 0 | $ | 5,606 | $ | 7,337 | $ | 12,943 |
(1) Excludes policy loans of $232 and equity method investments of $377*, at carrying value*
Item 8. Financial Statements and Supplementary Data
| 2017 | ||||||||||||||||||||||||||||
| (In millions) | Carrying Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | ||||||||||||||||||||||||||||
| Fixed maturity securities: | ||||||||||||||||||||||||||||
| Government and agencies | $ | 21,331 | $ | 26,491 | $ | 0 | $ | 0 | $ | 26,491 | ||||||||||||||||||
| Municipalities | 357 | 0 | 462 | 0 | 462 | |||||||||||||||||||||||
| Mortgage and asset-backed securities | 26 | 0 | 8 | 19 | 27 | |||||||||||||||||||||||
| Public utilities | 3,300 | 0 | 3,698 | 0 | 3,698 | |||||||||||||||||||||||
| Sovereign and supranational | 1,523 | 0 | 1,835 | 0 | 1,835 | |||||||||||||||||||||||
| Banks/financial institutions | 2,206 | 0 | 2,387 | 0 | 2,387 | |||||||||||||||||||||||
| Other corporate | 2,687 | 0 | 3,172 | 0 | 3,172 | |||||||||||||||||||||||
| Other investments (1) | 3,017 | 0 | 15 | 2,987 | 3,002 | |||||||||||||||||||||||
| Total assets | $ | 34,447 | $ | 26,491 | $ | 11,577 | $ | 3,006 | $ | 41,074 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||
| Other policyholders’ funds | $ | 6,939 | $ | 0 | $ | 0 | $ | 6,841 | $ | 6,841 | ||||||||||||||||||
| Notes payable (excluding capital leases) | 5,267 | 0 | 5,288 | 265 | 5,553 | |||||||||||||||||||||||
| Total liabilities | $ | 12,206 | $ | 0 | $ | 5,288 | $ | 7,106 | $ | 12,394 |
(1) Excludes policy loans of $210 and equity method investments of $118*, at carrying value*
Fair Value of Financial Instruments
Fixed maturity and equity securities
The Company determines the fair values of fixed maturity securities and public and privately-issued equity securities using the following approaches or techniques: price quotes and valuations from third party pricing vendors (including quoted market prices readily available from public exchange markets) and non-binding price quotes the Company obtains from outside brokers.
A third party pricing vendor has developed valuation models to determine fair values of privately issued securities to reflect the impact of the persistent economic environment and the changing regulatory framework. These models are discounted cash flow (DCF) valuation models, but also use information from related markets, specifically the CDS market to estimate expected cash flows. These models take into consideration any unique characteristics of the securities and make various adjustments to arrive at an appropriate issuer-specific loss adjusted credit curve. This credit curve is then used with the relevant recovery rates to estimate expected cash flows and modeling of additional features, including illiquidity adjustments, if necessary, to price the security by discounting those loss adjusted cash flows. In cases where a credit curve cannot be developed from the specific security features, the valuation methodology takes into consideration other market observable inputs, including: 1) the most appropriate comparable security(ies) of the issuer; 2) issuer-specific CDS spreads; 3) bonds or CDS spreads of comparable issuers with similar characteristics such as rating, geography, or sector; or 4) bond indices that are comparative in rating, industry, maturity and region.
The pricing data and market quotes the Company obtains from outside sources, including third party pricing services, are reviewed internally for reasonableness. If a fair value appears unreasonable, the Company will re-examine the inputs and assess the reasonableness of the pricing data with the vendor. Additionally, the Company may compare the inputs to relevant market indices and other performance measurements. Based on management's analysis, the valuation is confirmed or may be revised if there is evidence of a more appropriate estimate of fair value based on available market data. The Company has performed verification of the inputs and calculations in any valuation models to confirm that the valuations represent reasonable estimates of fair value.
Item 8. Financial Statements and Supplementary Data
The fixed maturity securities classified as Level 3 consist of securities with limited or no observable valuation inputs. For Level 3 securities, the Company estimates the fair value of these securities by obtaining non-binding broker quotes from a limited number of brokers. These brokers base their quotes on a combination of their knowledge of the current pricing environment and market conditions. The Company considers these inputs to be unobservable. The Company also considers a variety of significant valuation inputs in the valuation process, including forward exchange rates, yen swap rates, dollar swap rates, interest rate volatilities, credit spread data on specific issuers, assumed default and default recovery rates, and certain probability assumptions. In obtaining these valuation inputs, the Company has determined that certain pricing assumptions and data used by its pricing sources are difficult to validate or corroborate by the market and/or appear to be internally developed rather than observed in or corroborated by the market. The use of these unobservable valuation inputs causes more subjectivity in the valuation process for these securities.
For the periods presented, the Company has not adjusted the quotes or prices it obtains from the pricing services and brokers it uses.
The following tables present the pricing sources for the fair values of the Company's fixed maturity and equity securities as of December 31.
Item 8. Financial Statements and Supplementary Data
| 2018 | ||||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||
| Securities available for sale, carried at fair value: | ||||||||||||||||||||||||
| Fixed maturity securities: (1) | ||||||||||||||||||||||||
| Government and agencies: | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 32,993 | $ | 1,349 | $ | 0 | $ | 34,342 | ||||||||||||||||
| Total government and agencies | 32,993 | 1,349 | 0 | 34,342 | ||||||||||||||||||||
| Municipalities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,863 | 0 | 1,863 | ||||||||||||||||||||
| Total municipalities | 0 | 1,863 | 0 | 1,863 | ||||||||||||||||||||
| Mortgage- and asset-backed securities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 162 | 0 | 162 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 177 | 177 | ||||||||||||||||||||
| Total mortgage- and asset-backed securities | 0 | 162 | 177 | 339 | ||||||||||||||||||||
| Public utilities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 7,062 | 0 | 7,062 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 109 | 109 | ||||||||||||||||||||
| Total public utilities | 0 | 7,062 | 109 | 7,171 | ||||||||||||||||||||
| Sovereign and supranational: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,260 | 0 | 1,260 | ||||||||||||||||||||
| Total sovereign and supranational | 0 | 1,260 | 0 | 1,260 | ||||||||||||||||||||
| Banks/financial institutions: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 8,895 | 0 | 8,895 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 23 | 23 | ||||||||||||||||||||
| Total banks/financial institutions | 0 | 8,895 | 23 | 8,918 | ||||||||||||||||||||
| Other corporate: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 28,789 | 0 | 28,789 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 213 | 213 | ||||||||||||||||||||
| Total other corporate | 0 | 28,789 | 213 | 29,002 | ||||||||||||||||||||
| Total securities available for sale | $ | 32,993 | $ | 49,380 | $ | 522 | $ | 82,895 | (1) | |||||||||||||||
| Equity securities, carried at fair value: (1) | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 874 | $ | 67 | $ | 0 | $ | 941 | ||||||||||||||||
| Broker/other | 0 | 0 | 46 | 46 | ||||||||||||||||||||
| Total equity securities | $ | 874 | $ | 67 | $ | 46 | $ | 987 | (1) |
(1) Includes perpetual securities
Item 8. Financial Statements and Supplementary Data
| 2018 | ||||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | ||||||||||||||||||||||||
| Fixed maturity securities: | ||||||||||||||||||||||||
| Government and agencies: | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 27,030 | $ | 8 | $ | 0 | $ | 27,038 | ||||||||||||||||
| Total government and agencies | 27,030 | 8 | 0 | 27,038 | ||||||||||||||||||||
| Municipalities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 469 | 0 | 469 | ||||||||||||||||||||
| Total municipalities | 0 | 469 | 0 | 469 | ||||||||||||||||||||
| Mortgage- and asset-backed securities: | ||||||||||||||||||||||||
| Broker/other | 0 | 0 | 15 | 15 | ||||||||||||||||||||
| Total mortgage- and asset-backed securities | 0 | 0 | 15 | 15 | ||||||||||||||||||||
| Public utilities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 2,973 | 0 | 2,973 | ||||||||||||||||||||
| Total public utilities | 0 | 2,973 | 0 | 2,973 | ||||||||||||||||||||
| Sovereign and supranational: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,840 | 0 | 1,840 | ||||||||||||||||||||
| Total sovereign and supranational | 0 | 1,840 | 0 | 1,840 | ||||||||||||||||||||
| Banks/financial institutions: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,583 | 0 | 1,583 | ||||||||||||||||||||
| Total banks/financial institutions | 0 | 1,583 | 0 | 1,583 | ||||||||||||||||||||
| Other corporate: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 2,804 | 0 | 2,804 | ||||||||||||||||||||
| Total other corporate | 0 | 2,804 | 0 | 2,804 | ||||||||||||||||||||
| Total securities held to maturity | $ | 27,030 | $ | 9,677 | $ | 15 | $ | 36,722 |
Item 8. Financial Statements and Supplementary Data
| 2017 | ||||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||
| Securities available for sale, carried at fair value: | ||||||||||||||||||||||||
| Fixed maturity securities: (1) | ||||||||||||||||||||||||
| Government and agencies: | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 30,109 | $ | 1,121 | $ | 0 | $ | 31,230 | ||||||||||||||||
| Total government and agencies | 30,109 | 1,121 | 0 | 31,230 | ||||||||||||||||||||
| Municipalities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,370 | 0 | 1,370 | ||||||||||||||||||||
| Total municipalities | 0 | 1,370 | 0 | 1,370 | ||||||||||||||||||||
| Mortgage- and asset-backed securities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 269 | 0 | 269 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 175 | 175 | ||||||||||||||||||||
| Total mortgage- and asset-backed securities | 0 | 269 | 175 | 444 | ||||||||||||||||||||
| Public utilities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 7,886 | 0 | 7,886 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 68 | 68 | ||||||||||||||||||||
| Total public utilities | 0 | 7,886 | 68 | 7,954 | ||||||||||||||||||||
| Sovereign and supranational: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,807 | 0 | 1,807 | ||||||||||||||||||||
| Broker/other | 0 | 102 | 0 | 102 | ||||||||||||||||||||
| Total sovereign and supranational | 0 | 1,909 | 0 | 1,909 | ||||||||||||||||||||
| Banks/financial institutions: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 8,908 | 0 | 8,908 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 25 | 25 | ||||||||||||||||||||
| Total banks/financial institutions | 0 | 8,908 | 25 | 8,933 | ||||||||||||||||||||
| Other corporate: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 32,327 | 0 | 32,327 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 146 | 146 | ||||||||||||||||||||
| Total other corporate | 0 | 32,327 | 146 | 32,473 | ||||||||||||||||||||
| Total securities available for sale | $ | 30,109 | $ | 53,790 | $ | 414 | $ | 84,313 | (1) | |||||||||||||||
| Equity securities, carried at fair value: | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 1,001 | $ | 6 | $ | 0 | $ | 1,007 | ||||||||||||||||
| Broker/other | 0 | 0 | 16 | 16 | ||||||||||||||||||||
| Total equity securities | $ | 1,001 | $ | 6 | $ | 16 | $ | 1,023 |
(1) Includes perpetual securities
Item 8. Financial Statements and Supplementary Data
| 2017 | ||||||||||||||||||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | ||||||||||||||||||||
| Securities held to maturity, carried at amortized cost: | ||||||||||||||||||||||||
| Fixed maturity securities: | ||||||||||||||||||||||||
| Government and agencies: | ||||||||||||||||||||||||
| Third party pricing vendor | $ | 26,491 | $ | 0 | $ | 0 | $ | 26,491 | ||||||||||||||||
| Total government and agencies | 26,491 | 0 | 0 | 26,491 | ||||||||||||||||||||
| Municipalities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 462 | 0 | 462 | ||||||||||||||||||||
| Total municipalities | 0 | 462 | 0 | 462 | ||||||||||||||||||||
| Mortgage- and asset-backed securities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 8 | 0 | 8 | ||||||||||||||||||||
| Broker/other | 0 | 0 | 19 | 19 | ||||||||||||||||||||
| Total mortgage- and asset-backed securities | 0 | 8 | 19 | 27 | ||||||||||||||||||||
| Public utilities: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 3,698 | 0 | 3,698 | ||||||||||||||||||||
| Total public utilities | 0 | 3,698 | 0 | 3,698 | ||||||||||||||||||||
| Sovereign and supranational: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 1,835 | 0 | 1,835 | ||||||||||||||||||||
| Total sovereign and supranational | 0 | 1,835 | 0 | 1,835 | ||||||||||||||||||||
| Banks/financial institutions: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 2,387 | 0 | 2,387 | ||||||||||||||||||||
| Total banks/financial institutions | 0 | 2,387 | 0 | 2,387 | ||||||||||||||||||||
| Other corporate: | ||||||||||||||||||||||||
| Third party pricing vendor | 0 | 3,172 | 0 | 3,172 | ||||||||||||||||||||
| Total other corporate | 0 | 3,172 | 0 | 3,172 | ||||||||||||||||||||
| Total securities held to maturity | $ | 26,491 | $ | 11,562 | $ | 19 | $ | 38,072 |
The following is a discussion of the determination of fair value of the Company's remaining financial instruments.
Derivatives
The Company uses derivative instruments to manage the risk associated with certain assets. However, the derivative instrument may not be classified in the same fair value hierarchy level as the associated asset. The Company uses pricing models to determine the estimated fair value of derivatives. Inputs used to value derivatives include, but are not limited to, interest rates, credit spreads, foreign currency forward and spot rates, and interest volatility. The significant inputs to pricing derivatives are generally observable in the market or can be derived by observable market data. When these inputs are observable, the derivatives are classified as Level 2.
The fair values of the foreign currency forwards and options associated with certain investments; the foreign currency forwards and options used to hedge foreign exchange risk from the Company's net investment in Aflac Japan and economically hedge certain portions of forecasted cash flows denominated in yen; and the foreign currency swaps associated with certain senior notes are based on the amounts the Company would expect to receive or pay. The determination of the fair value of these derivatives is based on observable market inputs, therefore they are classified as Level 2.
To determine the fair value of its interest rate derivatives, the Company uses inputs that are generally observable in the market or can be derived from observable market data. Interest rate swaps are cleared trades. In a cleared swap contract the clearinghouse provides benefits to the counterparties similar to contracts listed for investment traded on an exchange since it maintains a daily margin to mitigate counterparties credit risk. These derivatives are priced using
Item 8. Financial Statements and Supplementary Data
observable inputs, accordingly, they are classified as Level 2. For its interest rate swaptions, the Company estimates their fair values using observable market data, including interest rate curves and volatilities. Their fair values are also classified as Level 2.
For derivatives associated with VIEs where the Company is the primary beneficiary, the Company is not the direct counterparty to the swap contracts. As a result, the fair value measurements incorporate the credit risk of the collateral associated with the VIE. The Company receives valuations from a third party pricing vendor for these derivatives. Based on an analysis of these derivatives and a review of the methodology employed by the pricing vendor, the Company determined that due to the long duration of these swaps and the need to extrapolate from short-term observable data to derive and measure long-term inputs, certain inputs, assumptions and judgments are required to value future cash flows that cannot be corroborated by current inputs or current observable market data. As a result, the derivatives associated with the Company's consolidated VIEs are classified as Level 3 of the fair value hierarchy.
Other investments
Other investments where fair value is disclosed above include short-term investments and loan receivables. Loan receivables include transitional real estate loans, commercial mortgage loans, and middle market loans. The Company's loan receivables do not have readily determinable market prices and generally lack market liquidity. Fair values for loan receivables are determined based on the present value of expected future cash flows discounted at the applicable U.S. Treasury or London Interbank Offered Rate (LIBOR) yield plus an appropriate spread that considers other risk factors, such as credit and liquidity risk. These spreads are provided by the applicable asset managers based on their knowledge of the current loan pricing environment and market conditions. The spreads are a significant component of the pricing inputs and are generally considered unobservable. Therefore, these investments have been assigned a Level 3 within the fair value hierarchy.
Other policyholders' funds
The largest component of the other policyholders' funds liability is the Company's annuity line of business in Aflac Japan. The Company's annuities have fixed benefits and premiums. For this product, the Company estimates the fair value to be equal to the cash surrender value. This is analogous to the value paid to policyholders on the valuation date if they were to surrender their policy. The Company periodically checks the cash value against discounted cash flow projections for reasonableness. The Company considers its inputs for this valuation to be unobservable and have accordingly classified this valuation as Level 3.
Notes payable
The fair values of the Company's publicly issued notes payable are determined by utilizing available sources of observable inputs from third party pricing vendors and are classified as Level 2. The fair values of the Company's yen-denominated loans approximate their carrying values and are classified as Level 3.
Transfers between Hierarchy Levels and Level 3 Rollforward
There were no transfers between Level 1 and 2 for assets and liabilities that are measured and carried at fair value on a recurring basis for the years ended December 31, 2018 and 2017, respectively.
The following tables present the changes in fair value of the Company's investments and derivatives carried at fair value classified as Level 3 as of December 31.
Item 8. Financial Statements and Supplementary Data
| 2018 | ||||||||||||||||||||||||||||||||
| Fixed Maturity Securities | Equity Securities | Derivatives**(1)** | ||||||||||||||||||||||||||||||
| (In millions) | Mortgage- and Asset- Backed Securities | Public Utilities | Banks/ Financial Institutions | Other Corporate | Foreign Currency Swaps | Credit Default Swaps | Total | |||||||||||||||||||||||||
| Balance, beginning of period | $ | 175 | $ | 68 | $ | 25 | $ | 146 | $ | 16 | $ | 22 | $ | 1 | $ | 453 | ||||||||||||||||
| Realized investment gains (losses) included in earnings | 0 | 0 | 0 | 0 | (1 | ) | 54 | (1 | ) | 52 | ||||||||||||||||||||||
| Unrealized gains (losses) included in other comprehensive income (loss) | 2 | 1 | (2 | ) | 1 | 0 | 4 | 0 | 6 | |||||||||||||||||||||||
| Purchases, issuances, sales and settlements: | ||||||||||||||||||||||||||||||||
| Purchases | 0 | 40 | 0 | 56 | 31 | 0 | 0 | 127 | ||||||||||||||||||||||||
| Issuances | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Sales | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Settlements | 0 | 0 | 0 | (6 | ) | 0 | 0 | 0 | (6 | ) | ||||||||||||||||||||||
| Transfers into Level 3 | 0 | 0 | 0 | 16 | 0 | 0 | 0 | 16 | ||||||||||||||||||||||||
| Transfers out of Level 3 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Balance, end of period | $ | 177 | $ | 109 | $ | 23 | $ | 213 | $ | 46 | $ | 80 | $ | 0 | $ | 648 | ||||||||||||||||
| Changes in unrealized gains (losses) relating to Level 3 assets and liabilities still held at the end of the period included in realized investment gains (losses) | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | (1 | ) | $ | 54 | $ | (1 | ) | $ | 52 |
(1) Derivative assets and liabilities are presented net
| 2017 | ||||||||||||||||||||||||||||||||
| Fixed Maturity Securities | Equity Securities | Derivatives**(1)** | ||||||||||||||||||||||||||||||
| (In millions) | Mortgage- and Asset- Backed Securities | Public Utilities | Banks/ Financial Institutions | Other Corporate | Foreign Currency Swaps | Credit Default Swaps | Total | |||||||||||||||||||||||||
| Balance, beginning of period | $ | 198 | $ | 16 | $ | 25 | $ | 0 | $ | 3 | $ | (21 | ) | $ | 2 | $ | 223 | |||||||||||||||
| Realized investment gains (losses) included in earnings | 0 | 0 | 0 | 0 | 0 | 43 | (1 | ) | 42 | |||||||||||||||||||||||
| Unrealized gains (losses) included in other comprehensive income (loss) | 3 | 0 | 0 | 2 | 0 | 0 | 0 | 5 | ||||||||||||||||||||||||
| Purchases, issuances, sales and settlements: | ||||||||||||||||||||||||||||||||
| Purchases | 0 | 76 | 0 | 122 | 16 | 0 | 0 | 214 | ||||||||||||||||||||||||
| Issuances | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Sales | 0 | 0 | 0 | (2 | ) | (1 | ) | 0 | 0 | (3 | ) | |||||||||||||||||||||
| Settlements | (26 | ) | 0 | 0 | 0 | 0 | 0 | 0 | (26 | ) | ||||||||||||||||||||||
| Transfers into Level 3 | 0 | 0 | 0 | 24 | (2) | 0 | 0 | 0 | 24 | |||||||||||||||||||||||
| Transfers out of Level 3 | 0 | (24 | ) | (2) | 0 | 0 | (2 | ) | (3) | 0 | 0 | (26 | ) | |||||||||||||||||||
| Balance, end of period | $ | 175 | $ | 68 | $ | 25 | $ | 146 | $ | 16 | $ | 22 | $ | 1 | $ | 453 | ||||||||||||||||
| Changes in unrealized gains (losses) relating to Level 3 assets and liabilities still held at the end of the period included in realized investment gains (losses) | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 43 | $ | (1 | ) | $ | 42 |
(1) Derivative assets and liabilities are presented net
(2) Transfer due to sector classification change
(3) Transfer due to change in accounting method
Item 8. Financial Statements and Supplementary Data
Fair Value Sensitivity
Level 3 Significant Unobservable Input Sensitivity
The following tables summarize the significant unobservable inputs used in the valuation of the Company's Level 3 investments and derivatives carried at fair value as of December 31. Included in the tables are the inputs or range of possible inputs that have an effect on the overall valuation of the financial instruments.
| 2018 | |||||||||||||
| (In millions) | Fair Value | Valuation Technique(s) | Unobservable Input | Range (Weighted Average) | |||||||||
| Assets: | |||||||||||||
| Securities available for sale, carried at fair value: | |||||||||||||
| Fixed maturity securities: | |||||||||||||
| Mortgage- and asset-backed securities | $ | 177 | Consensus pricing | Offered quotes | N/A | (a) | |||||||
| Public utilities | 109 | Discounted cash flow | Credit spreads | N/A | (a) | ||||||||
| Banks/financial institutions | 23 | Consensus pricing | Offered quotes | N/A | (a) | ||||||||
| Other corporate | 213 | Discounted cash flow | Credit spreads | N/A | (a) | ||||||||
| Equity securities | 46 | Net asset value | Offered quotes | N/A | (a) | ||||||||
| Other assets: | |||||||||||||
| Foreign currency swaps | 125 | Discounted cash flow | Interest rates (USD) | 2.75% - 2.84% | (b) | ||||||||
| Interest rates (JPY) | .18% - .71% | (c) | |||||||||||
| CDS spreads | 19 - 120 bps | ||||||||||||
| 57 | Discounted cash flow | Interest rates (USD) | 2.75% - 2.84% | (b) | |||||||||
| Interest rates (JPY) | .18% - .71% | (c) | |||||||||||
| Total assets | $ | 750 | |||||||||||
| Liabilities: | |||||||||||||
| Other liabilities: | |||||||||||||
| Foreign currency swaps | $ | 98 | Discounted cash flow | Interest rates (USD) | 2.75% - 2.84% | (b) | |||||||
| Interest rates (JPY) | .18% - .71% | (c) | |||||||||||
| CDS spreads | 28 - 211 bps | ||||||||||||
| 4 | Discounted cash flow | Interest rates (USD) | 2.75% - 2.84% | (b) | |||||||||
| Interest rates (JPY) | .18% - .71% | (c) | |||||||||||
| Total liabilities | $ | 102 |
(a) N/A represents securities where the Company receives unadjusted broker quotes and for which there is no transparency into the providers' valuation techniques or unobservable inputs.
(b) Inputs derived from U.S. long-term rates to accommodate long maturity nature of the Company's swaps
(c) Inputs derived from Japan long-term rates to accommodate long maturity nature of the Company's swaps
Item 8. Financial Statements and Supplementary Data
| 2017 | |||||||||||||
| (In millions) | Fair Value | Valuation Technique(s) | Unobservable Input | Range (Weighted Average) | |||||||||
| Assets: | |||||||||||||
| Securities available for sale, carried at fair value: | |||||||||||||
| Fixed maturity securities: | |||||||||||||
| Mortgage- and asset-backed securities | $ | 175 | Consensus pricing | Offered quotes | N/A | (a) | |||||||
| Public utilities | 68 | Discounted cash flow | Credit spreads | N/A | (a) | ||||||||
| Banks/financial institutions | 25 | Consensus pricing | Offered quotes | N/A | (a) | ||||||||
| Other corporate | 146 | Discounted cash flow | Credit spreads | N/A | (a) | ||||||||
| Equity securities | 16 | Net asset value | Offered quotes | N/A | (a) | ||||||||
| Other assets: | |||||||||||||
| Foreign currency swaps | 80 | Discounted cash flow | Interest rates (USD) | 2.40% - 2.54% | (b) | ||||||||
| Interest rates (JPY) | .26% - .85% | (c) | |||||||||||
| CDS spreads | 9 - 90 bps | ||||||||||||
| 70 | Discounted cash flow | Interest rates (USD) | 2.40% - 2.54% | (b) | |||||||||
| Interest rates (JPY) | .26% - .85% | (c) | |||||||||||
| Credit default swaps | 1 | Discounted cash flow | Base correlation | 46.33% - 49.65% | (d) | ||||||||
| CDS spreads | 25 bps | ||||||||||||
| Recovery rate | 37.24% | ||||||||||||
| Total assets | $ | 581 | |||||||||||
| Liabilities: | |||||||||||||
| Other liabilities: | |||||||||||||
| Foreign currency swaps | $ | 120 | Discounted cash flow | Interest rates (USD) | 2.40% - 2.54% | (b) | |||||||
| Interest rates (JPY) | .26% - .85% | (c) | |||||||||||
| CDS spreads | 13 - 157 bps | ||||||||||||
| 8 | Discounted cash flow | Interest rates (USD) | 2.40% - 2.54% | (b) | |||||||||
| Interest rates (JPY) | .26% - .85% | (c) | |||||||||||
| Total liabilities | $ | 128 |
(a) N/A represents securities where the Company receives unadjusted broker quotes and for which there is no transparency into the providers' valuation techniques or unobservable inputs.
(b) Inputs derived from U.S. long-term rates to accommodate long maturity nature of the Company's swaps
(c) Inputs derived from Japan long-term rates to accommodate long maturity nature of the Company's swaps
(d) Range of base correlation for the Company's bespoke tranche for attachment and detachment points corresponding to market indices
Item 8. Financial Statements and Supplementary Data
The following is a discussion of the significant unobservable inputs or valuation techniques used in determining the fair value of securities and derivatives classified as Level 3.
Net Asset Value
The Company holds certain unlisted equity securities whose fair value is derived based on the financial statements published by the investee. These securities do not trade on an active market and the valuations derived are dependent on the availability of timely financial reporting of the investee. Net asset value is an unobservable input in the determination of fair value of equity securities.
Offered Quotes
In circumstances where the Company's valuation model price is overridden because it implies a value that is not consistent with current market conditions, the Company will solicit bids from a limited number of brokers. The Company also receives unadjusted prices from brokers for its mortgage and asset-backed securities. These quotes are non-binding but are reflective of valuation best estimates at that particular point in time. Offered quotes are an unobservable input in the determination of fair value of mortgage- and asset-backed securities, certain banks/financial institutions, certain other corporate, and equity securities investments.
Interest Rates and CDS Spreads
The significant drivers of the valuation of the interest and foreign exchange swaps are interest rates and CDS spreads. Some of the Company's swaps have long maturities that increase the sensitivity of the swaps to interest rate fluctuations. For the Company's foreign exchange or cross currency swaps that are in a net asset position, an increase in yen interest rates (all other factors held constant) will decrease the present value of the yen final settlement receivable (receive leg), thus decreasing the value of the swap as long as the derivative remains in a net asset position.
Foreign exchange swaps also have a lump-sum final settlement of foreign exchange principal amounts at the termination of the swap. Assuming all other factors are held constant, an increase in yen interest rates will decrease the receive leg and decrease the net value of the swap. Likewise, holding all other factors constant, an increase in U.S. dollar interest rates will increase the swap's net value due to the decrease in the present value of the dollar final settlement payable (pay leg).
The extinguisher feature in most of the Company's VIE swaps results in a cessation of cash flows and no further payments between the parties to the swap in the event of a default on the referenced or underlying collateral. To price this feature, the Company applies the survival probability of the referenced entity to the projected cash flows. The survival probability uses the CDS spreads and recovery rates to adjust the present value of the cash flows. For extinguisher swaps with positive values, an increase in CDS spreads decreases the likelihood of receiving the final exchange payments and reduces the value of the swap.
For additional information on the Company's investments and financial instruments, see the accompanying Notes 1, 3 and 4.
6. DEFERRED POLICY ACQUISITION COSTS AND INSURANCE EXPENSES
Consolidated policy acquisition costs deferred were $1.5 billion in 2018, compared with $1.5 billion in 2017 and $1.4 billion in 2016. The following table presents a rollforward of deferred policy acquisition costs by segment for the years ended December 31.
| 2018 | 2017 | ||||||||||||||||||||||
| (In millions) | Japan | U.S. | Japan | U.S. | |||||||||||||||||||
| Deferred policy acquisition costs: | |||||||||||||||||||||||
| Balance, beginning of year | $ | 6,150 | $ | 3,355 | $ | 5,765 | $ | 3,228 | |||||||||||||||
| Capitalization | 833 | 669 | 839 | 629 | |||||||||||||||||||
| Amortization | (710 | ) | (534 | ) | (630 | ) | (502 | ) | |||||||||||||||
| Foreign currency translation and other | 111 | 1 | 176 | 0 | |||||||||||||||||||
| Balance, end of year | $ | 6,384 | $ | 3,491 | $ | 6,150 | $ | 3,355 |
Item 8. Financial Statements and Supplementary Data
Commissions deferred as a percentage of total acquisition costs deferred were 72% in 2018, compared with 72% in 2017 and 74% in 2016.
Personnel, compensation and benefit expenses as a percentage of insurance expenses were 54% in 2018, compared with 56% in 2017 and 53% in 2016. Advertising expense, which is included in insurance expenses in the consolidated statements of earnings, was as follows for the years ended December 31:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Advertising expense: | |||||||||||||||||
| Aflac Japan | $ | 108 | $ | 100 | $ | 100 | |||||||||||
| Aflac U.S. | 110 | 110 | 124 | ||||||||||||||
| Total advertising expense | $ | 218 | $ | 210 | $ | 224 |
Depreciation and other amortization expenses, which are included in insurance expenses in the consolidated statements of earnings, were as follows for the years ended December 31:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Depreciation expense | $ | 48 | $ | 50 | $ | 48 | |||||||||||
| Other amortization expense | 1 | 3 | 6 | ||||||||||||||
| Total depreciation and other amortization expense | $ | 49 | $ | 53 | $ | 54 |
Lease and rental expense, which are included in insurance expenses in the consolidated statements of earnings, were as follows for the years ended December 31:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Lease and rental expense: | |||||||||||||||||
| Aflac Japan | $ | 53 | $ | 52 | $ | 53 | |||||||||||
| Aflac U.S. | 16 | 21 | 21 | ||||||||||||||
| Other | 4 | 2 | 1 | ||||||||||||||
| Total lease and rental expense | $ | 73 | $ | 75 | $ | 75 |
7. POLICY LIABILITIES
Policy liabilities consist of future policy benefits, unpaid policy claims, unearned premiums, and other policyholders' funds, which accounted for 84%, 4%, 5% and 7% of total policy liabilities at December 31, 2018, respectively. The Company regularly reviews the adequacy of its policy liabilities in total and by component.
The liability for future policy benefits as of December 31 consisted of the following:
Item 8. Financial Statements and Supplementary Data
| Liability Amounts | Interest Rates | |||||||||||||||
| (In millions) | Policy Issue Year | 2018 | 2017 | Year of Issue | In 20 Years | |||||||||||
| Health insurance: | ||||||||||||||||
| Japan: | 1992 - 2018 | $ | 11,598 | $ | 10,167 | 1.0 - 2.5 | % | 1.0 - 2.5 | % | |||||||
| 1974 - 2013 | 1,161 | 1,133 | 2.7 - 2.75 | 2.25 - 2.75 | ||||||||||||
| 1998 - 2018 | 12,764 | 12,386 | 3.0 | 3.0 | ||||||||||||
| 1997 - 1999 | 2,452 | 2,454 | 3.5 | 3.5 | ||||||||||||
| 1994 - 1996 | 3,056 | 3,046 | 4.0 - 4.5 | 4.0 - 4.5 | ||||||||||||
| 1987 - 1994 | 14,722 | 14,829 | 5.5 | 5.5 | ||||||||||||
| 1985 - 1991 | 1,779 | 1,816 | 5.25 - 6.75 | 5.25 - 5.5 | ||||||||||||
| 1978 - 1984 | 1,964 | 2,037 | 6.5 | 5.5 | ||||||||||||
| U.S.: | 2013 - 2018 | 96 | 82 | 3.0 - 3.5 | 3.0 - 3.5 | |||||||||||
| 2012 - 2018 | 1,682 | 1,366 | 3.75 | 3.75 | ||||||||||||
| 2011 | 353 | 343 | 4.75 | 4.75 | ||||||||||||
| 2005 - 2010 | 2,946 | 2,944 | 5.5 | 5.5 | ||||||||||||
| 1988 - 2004 | 641 | 656 | 8.0 | 6.0 | ||||||||||||
| 1986 - 2004 | 1,245 | 1,296 | 6.0 | 6.0 | ||||||||||||
| 1981 - 1986 | 151 | 159 | 6.5 - 7.0 | 5.5 - 6.5 | ||||||||||||
| 1998 - 2004 | 1,311 | 1,310 | 7.0 | 7.0 | ||||||||||||
| Other | 17 | 18 | ||||||||||||||
| Intercompany eliminations: | 2015 | (583 | ) | (1) | (609 | ) | (1) | 2.0 | 2.0 | |||||||
| Life insurance: | ||||||||||||||||
| Japan: | 2001 - 2018 | 10,296 | 8,850 | 1.0 - 1.85 | 1.0 - 1.85 | |||||||||||
| 2011 - 2017 | 5,116 | 4,763 | 2.0 | 2.0 | ||||||||||||
| 2009 - 2011 | 3,867 | 3,393 | 2.25 | 2.25 | ||||||||||||
| 1992 - 2006 | 5 | 5 | 2.19 | 1.55 | ||||||||||||
| 2005 - 2011 | 1,769 | 1,642 | 2.5 | 2.5 | ||||||||||||
| 1985 - 2006 | 2,057 | 2,048 | 2.7 | 2.25 | ||||||||||||
| 2007 - 2011 | 1,380 | 1,319 | 2.75 | 2.75 | ||||||||||||
| 1999 - 2011 | 2,249 | 2,189 | 3.0 | 3.0 | ||||||||||||
| 1996 - 2009 | 678 | 675 | 3.5 | 3.5 | ||||||||||||
| 1994 - 1996 | 901 | 908 | 4.0 - 4.5 | 4.0 - 4.5 | ||||||||||||
| U.S.: | 1956 - 2018 | 695 | 632 | 3.5 - 6.0 | 3.5 - 6.0 | |||||||||||
| Total | $ | 86,368 | $ | 81,857 |
(1) Elimination entry necessary due to recapture of a portion of policy liabilities ceded externally, as a result of the reinsurance retrocession transaction as described in Note 8 of the Notes to the Consolidated Financial Statements
The weighted-average interest rates reflected in the consolidated statements of earnings for future policy benefits for Japanese policies were 3.3% in 2018, compared with 3.4% in 2017 and 3.5% in 2016; and for U.S. policies, 5.3% in 2018, compared with 5.4% in 2017 and 5.5% in 2016.
Item 8. Financial Statements and Supplementary Data
Changes in the liability for unpaid policy claims were as follows for the years ended December 31:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Unpaid supplemental health claims, beginning of period | $ | 3,884 | $ | 3,707 | $ | 3,548 | |||||||||||
| Less reinsurance recoverables | 30 | 27 | 26 | ||||||||||||||
| Net balance, beginning of period | 3,854 | 3,680 | 3,522 | ||||||||||||||
| Add claims incurred during the period related to: | |||||||||||||||||
| Current year | 7,101 | 6,979 | 7,037 | ||||||||||||||
| Prior years | (563 | ) | (518 | ) | (465 | ) | |||||||||||
| Total incurred | 6,538 | 6,461 | 6,572 | ||||||||||||||
| Less claims paid during the period on claims incurred during: | |||||||||||||||||
| Current year | 4,612 | 4,530 | 4,613 | ||||||||||||||
| Prior years | 1,898 | 1,822 | 1,865 | ||||||||||||||
| Total paid | 6,510 | 6,352 | 6,478 | ||||||||||||||
| Effect of foreign exchange rate changes on unpaid claims | 43 | 65 | 64 | ||||||||||||||
| Net balance, end of period | 3,925 | 3,854 | 3,680 | ||||||||||||||
| Add reinsurance recoverables | 27 | 30 | 27 | ||||||||||||||
| Unpaid supplemental health claims, end of period | 3,952 | 3,884 | 3,707 | ||||||||||||||
| Unpaid life claims, end of period | 632 | 508 | 338 | ||||||||||||||
| Total liability for unpaid policy claims | $ | 4,584 | $ | 4,392 | $ | 4,045 |
The incurred claims development related to prior years reflects favorable claims experience compared to previous estimates. The favorable claims development of $563 million for 2018 comprises approximately $419 million from Japan, which represents approximately 74% of the total. Excluding the impact of foreign exchange of a gain of approximately $14 million from December 31, 2017 to December 31, 2018, the favorable claims development in Japan would have been approximately $404 million, representing approximately 72% of the total.
The Company has experienced continued favorable claim trends in 2018 for its core health products in Japan. The Company's experience in Japan related to the average length of stay in the hospital for cancer treatment has shown continued decline in the current period. In addition, cancer treatment patterns in Japan are continuing to be influenced by significant advances in early-detection techniques and by the increased use of pathological diagnosis rather than clinical exams. Additionally, follow-up radiation and chemotherapy treatments are occurring more often on an outpatient basis. Such changes in treatment not only increase the quality of life and initial outcomes for the patients, but also decrease the average length of each hospital stay, resulting in favorable claims development.
As of December 31, 2018 and 2017, unearned premiums consisted primarily of discounted advance premiums on deposit. Discounted advance premiums are premiums on deposit from policyholders in conjunction with their purchase of certain Aflac Japan limited-pay insurance products. These advanced premiums are deferred upon collection and recognized as premium revenue over the contractual premium payment period. These advanced premiums represented 69% of the December 31, 2018 and 73% of the December 31, 2017 unearned premiums balances.
As of December 31, 2018 and 2017, the largest component of the other policyholders' funds liability was the Company's annuity line of business in Aflac Japan. The Company's annuities have fixed benefits and premiums. These annuities represented 97% of other policyholders' funds liability at December 31, 2018, compared with 98% at December 31, 2017 .
Item 8. Financial Statements and Supplementary Data
8. REINSURANCE
The Company periodically enters into fixed quota-share coinsurance agreements with other companies in the normal course of business. For each of its reinsurance agreements, the Company determines whether the agreement provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. Reinsurance premiums and benefits paid or provided are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and benefits are reported net of insurance ceded.
The Company has recorded a deferred profit liability related to reinsurance transactions. The remaining deferred profit liability of $1.0 billion, as of December 31, 2018, is included in future policy benefits in the consolidated balance sheet and is being amortized into income over the expected lives of the policies. The Company has also recorded a reinsurance recoverable for reinsurance transactions, which is included in other assets in the consolidated balance sheet and had a remaining balance of $941 million and $908 million as of December 31, 2018 and 2017, respectively. The increase in the reinsurance recoverable balance was driven by two aggregating factors: yen strengthening and the growth in reserves related to the business that has been reinsured as the policies age. The spot yen/dollar exchange rate strengthened by approximately 2% and ceded reserves increased approximately 2% from December 31, 2017, to December 31, 2018.
The following table reconciles direct premium income and direct benefits and claims to net amounts after the effect of reinsurance for the years ended December 31.
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||
| Direct premium income | $ | 19,018 | $ | 18,875 | $ | 19,592 | |||||||||
| Ceded to other companies: | |||||||||||||||
| Ceded Aflac Japan closed blocks | (497 | ) | (515 | ) | (560 | ) | |||||||||
| Other | (58 | ) | (51 | ) | (48 | ) | |||||||||
| Assumed from other companies: | |||||||||||||||
| Retrocession activities | 208 | 216 | 234 | ||||||||||||
| Other | 6 | 6 | 7 | ||||||||||||
| Net premium income | $ | 18,677 | $ | 18,531 | $ | 19,225 | |||||||||
| Direct benefits and claims | $ | 12,293 | $ | 12,486 | $ | 13,240 | |||||||||
| Ceded benefits and change in reserves for future benefits: | |||||||||||||||
| Ceded Aflac Japan closed blocks | (450 | ) | (473 | ) | (509 | ) | |||||||||
| Eliminations | 43 | 51 | 58 | ||||||||||||
| Other | (44 | ) | (44 | ) | (38 | ) | |||||||||
| Assumed from other companies: | |||||||||||||||
| Retrocession activities | 209 | 209 | 222 | ||||||||||||
| Eliminations | (53 | ) | (51 | ) | (58 | ) | |||||||||
| Other | 2 | 3 | 4 | ||||||||||||
| Benefits and claims, net | $ | 12,000 | $ | 12,181 | $ | 12,919 |
These reinsurance transactions are indemnity reinsurance that do not relieve the Company from its obligations to policyholders. In the event that the reinsurer is unable to meet their obligations, the Company remains liable for the reinsured claims.
As a part of its capital contingency plan, the Company entered into a committed reinsurance facility agreement on December 1, 2015 in the amount of approximately 110 billion yen of reserves. This reinsurance facility agreement was renewed in 2018 and is effective until December 31, 2019. There are also additional commitment periods of a one-year duration each of which are automatically extended unless notification is received from the reinsurer within 60 days prior to the expiration. The reinsurer can withdraw from the committed facility if Aflac‘s Standard and Poor's (S&P) rating drops below BBB-. As of December 31, 2018, the Company had not executed a reinsurance treaty under this committed reinsurance facility.
Item 8. Financial Statements and Supplementary Data
9. NOTES PAYABLE
A summary of notes payable as of December 31 follows:
| (In millions) | 2018 | 2017 | |||||||||
| 2.40% senior notes paid November 2018 | $ | 0 | $ | 548 | |||||||
| 4.00% senior notes due February 2022 | 348 | 348 | |||||||||
| 3.625% senior notes due June 2023 | 698 | 697 | |||||||||
| 3.625% senior notes due November 2024 | 746 | 745 | |||||||||
| 3.25% senior notes due March 2025 | 447 | 446 | |||||||||
| 2.875% senior notes due October 2026 | 297 | 297 | |||||||||
| 6.90% senior notes due December 2039 | 220 | 220 | |||||||||
| 6.45% senior notes due August 2040 | 254 | 254 | |||||||||
| 4.00% senior notes due October 2046 | 394 | 394 | |||||||||
| 4.750% senior notes due January 2049 | 540 | 0 | |||||||||
| Yen-denominated senior notes and subordinated debentures: | |||||||||||
| .932% senior notes due January 2027 (principal amount 60.0 billion yen) | 538 | 528 | |||||||||
| 1.159% senior notes due October 2030 (principal amount 29.3 billion yen) | 262 | 0 | |||||||||
| 1.488% senior notes due October 2033 (principal amount 15.2 billion yen) | 136 | 0 | |||||||||
| 1.750% senior notes due October 2038 (principal amount 8.9 billion yen) | 79 | 0 | |||||||||
| 2.108% subordinated debentures due October 2047 (principal amount 60.0 billion yen) | 536 | 526 | |||||||||
| Yen-denominated loans: | |||||||||||
| Variable interest rate loan due September 2021 (.32% in 2018 and 2017, principal amount 5.0 billion yen) | 45 | 44 | |||||||||
| Variable interest rate loan due September 2023 (.47% in 2018 and 2017, principal amount 25.0 billion yen) | 225 | 220 | |||||||||
| Capitalized lease obligations payable through 2025 | 13 | 22 | |||||||||
| Total notes payable | $ | 5,778 | $ | 5,289 |
Amounts in the table above are reported net of debt issuance costs and issuance premiums or discounts, if applicable, that are being amortized over the life of the notes.
In October 2018, the Parent Company issued $550 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 4.750% per annum, payable semi-annually, and have a 30-year maturity. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the yield to maturity for a United States Treasury security with a maturity comparable to the remaining term of the notes, plus 25 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date.
In October 2018, the Parent Company issued three series of senior notes totaling 53.4 billion yen through a public debt offering under its U.S. shelf registration statement. The first series, which totaled 29.3 billion yen, bears interest at a fixed rate of 1.159% per annum, payable semi-annually, and has a 12-year maturity. The second series, which totaled 15.2 billion yen, bears interest at a fixed rate of 1.488% per annum, payable semi-annually, and has a 15-year maturity. The third series, which totaled 8.9 billion yen, bears interest at a fixed rate of 1.750% per annum, payable semi-annually, and has a 20-year maturity. These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affecting U.S. taxation, as specified in the indenture governing the terms of the issuance.
In October 2017, the Parent Company issued 60.0 billion yen of subordinated debentures through a U.S. public debt offering. The debentures bear interest at an initial rate of 2.108% per annum through October 22, 2027, or earlier redemption. Thereafter, the rate of the interest of the debentures will be reset every five years at a rate of interest equal to the then-current JPY 5-year Swap Offered Rate plus 205 basis points. The debentures are payable semi-annually in arrears and have a 30-year maturity. The debentures are redeemable (i) at any time, in whole but not in part, upon the occurrence of certain tax events or certain rating agency events, as specified in the indenture governing the terms of the
Item 8. Financial Statements and Supplementary Data
debentures or (ii) on or after October 23, 2027, in whole or in part, at a redemption price equal to their principal amount plus accrued and unpaid interest to, but excluding, the date of redemption.
In January 2017, the Parent Company issued 60.0 billion yen of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of .932% per annum, payable semi-annually, and have a 10-year maturity. These notes may only be redeemed before maturity, in whole but not in part, upon the occurrence of certain changes affecting U.S. taxation, as specified in the indenture governing the terms of the issuance.
In September 2016, the Parent Company issued two series of senior notes totaling $700 million through a U.S. public debt offering. The first series, which totaled $300 million, bears interest at a fixed rate of 2.875% per annum, payable semi-annually and has a 10-year maturity. The second series, which totaled $400 million, bears interest at a fixed rate of 4.00% per annum, payable semi-annually, and has a 30-year maturity.
In September 2016, the Parent Company entered into two series of senior unsecured term loan facilities totaling 30.0 billion yen. The first series, which totaled 5.0 billion yen, bears an interest rate per annum equal to the Tokyo interbank market rate (TIBOR), or alternate TIBOR, if applicable, plus the applicable TIBOR margin and has a five-year maturity. The applicable margin ranges between .20% and .60%, depending on the Parent Company's debt ratings as of the date of determination. The second series, which totaled 25.0 billion yen, bears an interest rate per annum equal to TIBOR, or alternate TIBOR, if applicable, plus the applicable TIBOR margin and has a seven-year maturity. The applicable margin ranges between .35% and .75%, depending on the Parent Company's debt ratings as of the date of determination.
In March 2015, the Parent Company issued two series of senior notes totaling $1.0 billion through a U.S. public debt offering. The first series, which totaled $550 million, bore interest at a fixed rate of 2.40% per annum, payable semi-annually, and had a five-year maturity. The second series, which totaled $450 million, bears interest at a fixed rate of 3.25% per annum, payable semi-annually, and has a 10-year maturity. The Parent Company has entered into cross-currency swaps that convert the U.S. dollar-denominated principal and interest on the senior notes into yen-denominated obligations which results in lower nominal net interest rates on the debt. By entering into these cross-currency swaps, the Parent Company economically converted its $550 million liability into a 67.0 billion yen liability and reduced the interest rate on this debt from 2.40% in dollars to .24% in yen, and the Parent Company economically converted its $450 million liability into a 55.0 billion yen liability and reduced the interest rate on this debt from 3.25% in dollars to .82% in yen. In November 2018, the Parent Company used the net proceeds from the October 2018 issuance of its senior notes to redeem $550 million of the Parent Company's 2.40% senior notes due 2020.
In November 2014, the Parent Company issued $750 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 3.625% per annum, payable semi-annually, and have a 10-year maturity. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the treasury rate plus 20 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date. The Parent Company entered into cross-currency interest rate swaps to reduce interest expense by converting the U.S. dollar-denominated principal and interest on the senior notes it issued into yen-denominated obligations. By entering into the swaps, the Parent Company economically converted its $750 million liability into an 85.3 billion yen liability and reduced the interest rate on this debt from 3.625% in dollars to 1.00% in yen.
In June 2013, the Parent Company issued $700 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 3.625% per annum, payable semi-annually, and have a 10-year maturity. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the aggregate principal amount of the notes to be redeemed or (ii) the amount equal to the sum of the present values of the remaining scheduled payments for principal of and interest on the notes to be redeemed, not including any portion of the payments of interest accrued as of such redemption date, discounted to such redemption date on a semiannual basis at the treasury rate plus 20 basis points, plus in each case, accrued and unpaid interest on the principal amount of the notes to be redeemed to, but excluding, such redemption date. The Parent Company had entered into cross-currency interest rate swaps to reduce interest expense by converting the U.S. dollar-denominated principal and interest on the senior notes it issued into yen-denominated obligations. By entering into these swaps, the Parent Company economically converted its $700 million liability into a 69.8 billion yen liability and reduced the interest rate on this debt from 3.625% in dollars to 1.50% in yen.
Item 8. Financial Statements and Supplementary Data
In February 2012, the Parent Company issued $350 million of senior notes through a U.S. public debt offering. The notes bear interest at a fixed rate of 4.00% per annum, payable semiannually, and have a 10-year maturity. These notes are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the principal amount of the notes or (ii) the present value of the remaining scheduled payments of principal and interest to be redeemed, discounted to the redemption date, plus accrued and unpaid interest. The Parent Company entered into cross-currency interest rate swaps to reduce interest expense by converting the U.S. dollar-denominated principal and interest on the senior notes it issued into yen-denominated obligations. By entering into these swaps, the Parent Company economically converted its $350 million liability into a 27.0 billion yen liability and reduced the interest rate on this debt from 4.00% in dollars to 2.07% in yen.
In 2010 and 2009, the Parent Company issued senior notes through U.S. public debt offerings; the details of these notes are as follows. In August 2010, the Parent Company issued $450 million of senior notes that have a 30-year maturity. In December 2009, the Parent Company issued $400 million of senior notes that have a 30-year maturity. These senior notes pay interest semiannually and are redeemable at the Parent Company's option in whole at any time or in part from time to time at a redemption price equal to the greater of: (i) the principal amount of the notes or (ii) the present value of the remaining scheduled payments of principal and interest to be redeemed, discounted to the redemption date, plus accrued and unpaid interest. In December 2016, the Parent Company completed a tender offer in which it extinguished $176 million principal of its 6.90% senior notes due 2039 and $193 million principal of its 6.45% senior notes due 2040. The pretax loss due to the early redemption of these notes was $137 million.
For the Company's yen-denominated notes and loans, the principal amount as stated in dollar terms will fluctuate from period to period due to changes in the yen/dollar exchange rate. The Company has designated the majority of its yen-denominated notes payable as a nonderivative hedge of the foreign currency exposure of the Company's investment in Aflac Japan.
The aggregate contractual maturities of notes payable during each of the years after December 31, 2018, are as follows:
| (In millions) | Long-term Debt | Capitalized Lease Obligations | Total Notes Payable | ||||||||||||||
| 2019 | $ | 0 | $ | 5 | $ | 5 | |||||||||||
| 2020 | 0 | 3 | 3 | ||||||||||||||
| 2021 | 45 | 2 | 47 | ||||||||||||||
| 2022 | 350 | 1 | 351 | ||||||||||||||
| 2023 | 925 | 1 | 926 | ||||||||||||||
| Thereafter | 4,493 | 1 | 4,494 | ||||||||||||||
| Total | $ | 5,813 | $ | 13 | $ | 5,826 |
Item 8. Financial Statements and Supplementary Data
A summary of the Company's lines of credit as of December 31, 2018 follows:
| Borrower | Type | Original Term | Expiration Date | Capacity | Amount Outstanding | Interest Rate on Borrowed Amount | Maturity Period | Commitment Fee | Business Purpose |
| Aflac Incorporated and Aflac | uncommitted bilateral | 364 days | December 27, 2019 | $100 million | $0 million | The rate quoted by the bank and agreed upon at the time of borrowing | Up to 3 months | None | General corporate purposes |
| Aflac Incorporated | unsecured revolving | 3 years | March 31, 2019, or the date commitments are terminated pursuant to an event of default | 100.0 billion yen | 0.0 billion yen | A rate per annum equal to (a) Tokyo interbank market rate (TIBOR) plus, the alternative applicable TIBOR margin during the availability period from the closing date to the commitment termination date or (b) the TIBOR rate offered by the agent to major banks in yen for the applicable period plus, the applicable alternative TIBOR margin during the term out period | No later than March 31, 2019 | .30% to .50%, depending on the Parent Company's debt ratings as of the date of determination | General corporate purposes, including a capital contingency plan for the operations of the Parent Company |
| Aflac Incorporated and Aflac | unsecured revolving | 5 years | April 4, 2023, or the date commitments are terminated pursuant to an event of default | 55.0 billion yen, or the equivalent amount in U.S. dollars | 0.0 billion yen | A rate per annum equal to, at the Company's option, either, (a) London Interbank Offered Rate (LIBOR) adjusted for certain costs or (b) a base rate determined by reference to the highest of (1) the federal funds rate plus 1/2 of 1%, (2) the rate of interest for such day announced by Mizuho Bank, Ltd. as its prime rate, or (3) the eurocurrency rate for an interest period of one month plus 1.00%, in each case plus an applicable margin | No later than April 4, 2023 | .085% to .225%, depending on the Parent Company's debt ratings as of the date of determination | General corporate purposes, including a capital contingency plan for the operations of the Parent Company |
| Aflac Incorporated and Aflac | uncommitted bilateral | None specified | None specified | $50 million | $0 million | A rate per annum equal to, at the Parent Company's option, either (a) a eurocurrency rate determined by reference to the agent's LIBOR for the interest period relevant to such borrowing or (b) the base rate determined by reference to the greater of (i) the prime rate as determined by the agent, and (ii) the sum of 0.50% and the federal funds rate for such day | Up to 3 months | None | General corporate purposes |
| Aflac*(1)* | uncommitted revolving | 364 days | November 29, 2019 | $250 million | $0 million | USD three-month LIBOR plus 75 basis points per annum | 3 months | None | General corporate purposes |
| Aflac Incorporated*(1)* | uncommitted revolving | 364 days | April 2, 2019 | 50.0 billion yen | 0.0 billion yen | Three-month TIBOR plus 80 basis points per annum | 3 months | None | General corporate purposes |
(1) Intercompany credit agreement
The Parent Company was in compliance with all of the covenants of its notes payable and lines of credit at December 31, 2018. No events of default or defaults occurred during 2018 and 2017.
Item 8. Financial Statements and Supplementary Data
10. INCOME TAXES
The components of income tax expense (benefit) applicable to pretax earnings for the years ended December 31 were as follows:
| (In millions) | Foreign | U.S. | Total | ||||||||||||||
| 2018: | |||||||||||||||||
| Current | $ | 771 | $ | 608 | $ | 1,379 | |||||||||||
| Deferred | 93 | (409 | ) | (316 | ) | ||||||||||||
| Total income tax expense | $ | 864 | $ | 199 | $ | 1,063 | |||||||||||
| 2017: | |||||||||||||||||
| Current | $ | 722 | $ | (91 | ) | $ | 631 | ||||||||||
| Deferred | (24 | ) | (1,193 | ) | (1,217 | ) | |||||||||||
| Total income tax expense | $ | 698 | $ | (1,284 | ) | $ | (586 | ) | |||||||||
| 2016: | |||||||||||||||||
| Current | $ | 650 | $ | 234 | $ | 884 | |||||||||||
| Deferred | 136 | 388 | 524 | ||||||||||||||
| Total income tax expense | $ | 786 | $ | 622 | $ | 1,408 |
The Japan income tax rate for the fiscal year 2016 was 28.8%. The rate was reduced to 28.2% for the fiscal year 2017 and was further reduced to 28.0% for the fiscal year 2018.
For the United States, the Tax Cuts and Jobs Act (Tax Act) was signed into law on December 22, 2017. Effective January 1, 2018, the Tax Act imposed a broad number of changes in tax law, including the permanent reduction of the U.S. federal statutory corporate income tax rate from 35% to 21%.
In accordance with Staff Accounting Bulletin 118 (SAB 118) issued by the U.S. Securities and Exchange Commission in December 2017, the Company recorded provisional amounts for certain items for which the income tax accounting was not complete. As of the enactment date, the Company estimated provisional amounts for its deferred taxes, including related valuation allowance, resulting in a reduction of its deferred tax assets (DTAs) by approximately $1.0 billion and its deferred tax liabilities (DTLs) by $2.9 billion, for a net DTL reduction of approximately $1.9 billion. The provisions of ASC 740-10, Income Taxes, require that the effects of changes in tax law on deferred taxes be recognized as a component of the income tax provision in the period the tax rate change was enacted. Therefore, the $1.9 billion provisional amount of net DTL reduction was recorded in the fourth quarter of 2017 as a reduction in the “Income tax expense, Deferred” line item of the Company’s consolidated statement of earnings.
In 2018, the Company recorded additional income tax expense of $.4 million resulting from a decrease in the SAB 118 provisional estimate related to Japan deferred tax balances. No further adjustment was made to the SAB 118 provisional estimate related to the valuation allowance. As of December 31, 2018, the Company has completed its accounting for the Tax Act in accordance with SAB 118.
Income tax expense in the accompanying statements of earnings varies from the amount computed by applying the expected U.S. tax rate of 21% in 2018 and 35% in 2017 and 2016 to pretax earnings. The principal reasons for the differences and the related tax effects for the years ended December 31 were as follows:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Income taxes based on U.S. statutory rates | $ | 836 | $ | 1,406 | $ | 1,424 | |||||||||||
| Foreign rate differential | 220 | 0 | 0 | ||||||||||||||
| Write-down of U.S. deferred tax liabilities for tax reform change | 0 | (1,933 | ) | 0 | |||||||||||||
| Utilization of foreign tax credit | (3 | ) | (27 | ) | (30 | ) | |||||||||||
| Nondeductible expenses | 21 | 10 | 8 | ||||||||||||||
| Other, net | (11 | ) | (42 | ) | 6 | ||||||||||||
| Income tax expense | $ | 1,063 | $ | (586 | ) | $ | 1,408 |
Item 8. Financial Statements and Supplementary Data
Total income tax expense for the years ended December 31 was allocated as follows:
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Statements of earnings | $ | 1,063 | $ | (586 | ) | $ | 1,408 | ||||||||||
| Other comprehensive income (loss): | |||||||||||||||||
| Unrealized foreign currency translation gains (losses) during period | 10 | 52 | 70 | ||||||||||||||
| Unrealized gains (losses) on investment securities: | |||||||||||||||||
| Unrealized holding gains (losses) on investment securities during period | (787 | ) | 575 | 962 | |||||||||||||
| Reclassification adjustment for realized (gains) losses on investment securities included in net earnings | (12 | ) | 1 | 18 | |||||||||||||
| Unrealized gains (losses) on derivatives during period | 0 | 0 | 1 | ||||||||||||||
| Pension liability adjustment during period | (8 | ) | 3 | (16 | ) | ||||||||||||
| Total income tax expense (benefit) related to items of other comprehensive income (loss) | (797 | ) | 631 | 1,035 | |||||||||||||
| Additional paid-in capital (exercise of stock options) | 0 | 0 | (10 | ) | |||||||||||||
| Total income taxes | $ | 266 | $ | 45 | $ | 2,433 |
The income tax effects of the temporary differences that gave rise to deferred income tax assets and liabilities as of December 31 were as follows:
| (In millions) | 2018 | 2017 | |||||||||
| Deferred income tax liabilities: | |||||||||||
| Deferred policy acquisition costs | $ | 3,404 | $ | 3,285 | |||||||
| Unrealized gains and other basis differences on investments | 1,307 | 2,882 | |||||||||
| Premiums receivable | 149 | 104 | |||||||||
| Policy benefit reserves | 3,828 | 3,557 | |||||||||
| Total deferred income tax liabilities | 8,688 | 9,828 | |||||||||
| Deferred income tax assets: | |||||||||||
| Unfunded retirement benefits | 8 | 8 | |||||||||
| Other accrued expenses | 40 | 141 | |||||||||
| Policy and contract claims | 775 | 870 | |||||||||
| Foreign currency loss on Aflac Japan | 38 | 67 | |||||||||
| Deferred compensation | 163 | 155 | |||||||||
| Capital loss carryforwards | 5 | 0 | |||||||||
| Depreciation | 119 | 114 | |||||||||
| Anticipatory foreign tax credit | 4,040 | 4,504 | |||||||||
| Deferred foreign tax credit | 591 | 0 | |||||||||
| Other | 150 | 57 | |||||||||
| Total deferred income tax assets before valuation allowance | 5,929 | 5,916 | |||||||||
| Valuation allowance | (738 | ) | (657 | ) | |||||||
| Total deferred income tax assets after valuation allowance | 5,191 | 5,259 | |||||||||
| Net deferred income tax liability | 3,497 | 4,569 | |||||||||
| Current income tax liability | 523 | 176 | |||||||||
| Total income tax liability | $ | 4,020 | $ | 4,745 |
The application of U.S. GAAP requires the Company to evaluate the recoverability of deferred tax assets and establish a valuation allowance if necessary to reduce the deferred tax asset to an amount that is more likely than not expected to be realized. As noted above, the Company has determined a $577 million valuation allowance against its anticipatory foreign tax credit is necessary. The anticipatory foreign tax credit represents the foreign tax credit the Company will generate from the reversal of Japan deferred tax liabilities in the future. The Company has also determined a $161 million valuation allowance against its deferred foreign tax credits is necessary. Deferred foreign tax credits are foreign tax credits generated in the current tax year by the Japanese life company, but are unable to be utilized until 2019
Item 8. Financial Statements and Supplementary Data
due to Japan's current tax year not closing until March 31, 2019. Based upon a review of the Company's anticipated future taxable income, and including all other available evidence, both positive and negative, the Company's management has concluded that, notwithstanding the items noted above, it is more likely than not that all other deferred tax assets will be realized.
Under U.S. income tax rules, only 35% of non-life operating losses can be offset against life insurance taxable income each year. For current U.S. income tax purposes, as of December 31, 2018, there were non-life operating loss carryforwards of $21 million available to offset against future taxable income. The Company has capital loss carryforwards of $22 million available to offset capital gains, of which $4 million expires in 2021 and $18 million expires in 2023.
The Company files federal income tax returns in the United States and Japan as well as state or prefecture income tax returns in various jurisdictions in the two countries. The Company is currently under audit by the State of Georgia for tax years 2014-2016. There are currently no other open Federal, State, or local U.S. income tax audits. U.S. federal income tax returns for years before 2015 are no longer subject to examination. Japan corporate income tax returns for years before 2017 are no longer subject to examination. Management believes it has established adequate tax liabilities and final resolution of all open audits is not expected to have a material impact on the Company's consolidated financial statements.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows for the years ended December 31:
| (In millions) | 2018 | 2017 | ||||||||
| Balance, beginning of year | $ | 14 | $ | 294 | ||||||
| Additions for tax positions of prior years | 1 | 0 | ||||||||
| Reductions for tax positions of prior years | 0 | (280 | ) | |||||||
| Balance, end of year | $ | 15 | $ | 14 |
Included in the balance of the liability for unrecognized tax benefits at December 31, 2018, are $14 million of tax positions for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility, compared with $13 million at December 31, 2017. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate, but would accelerate the payment of cash to the taxing authority to an earlier period. The Company has accrued approximately $1 million as of December 31, 2018, for permanent uncertainties, which if reversed would not have a material effect on the annual effective rate.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company recognized approximately $1 million in interest and penalties in 2018, compared with $1 million in 2017 and $13 million in 2016. The Company has accrued approximately $2 million for the payment of interest and penalties as of December 31, 2018, compared with $2 million a year ago.
As of December 31, 2018, there were no material uncertain tax positions for which the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
| 11. | SHAREHOLDERS' EQUITY |
See Note 1 for a discussion of the stock split that occurred in March 2018. All share and per-share amounts have been adjusted to reflect the stock split for any of the periods presented.
Item 8. Financial Statements and Supplementary Data
The following table is a reconciliation of the number of shares of the Company's common stock for the years ended December 31.
| (In thousands of shares) | 2018 | 2017 | 2016 | ||
| Common stock - issued: | |||||
| Balance, beginning of period | 1,345,762 | 1,342,498 | 1,339,446 | ||
| Exercise of stock options and issuance of restricted shares | 1,778 | 3,264 | 3,052 | ||
| Balance, end of period | 1,347,540 | 1,345,762 | 1,342,498 | ||
| Treasury stock: | |||||
| Balance, beginning of period | 564,852 | 530,877 | 490,686 | ||
| Purchases of treasury stock: | |||||
| Open market | 28,949 | 35,510 | 43,236 | ||
| Other | 392 | 1,018 | 662 | ||
| Dispositions of treasury stock: | |||||
| Shares issued to AFL Stock Plan | (1,306) | (1,782) | (2,130) | ||
| Exercise of stock options | (519) | (734) | (1,366) | ||
| Other | (114) | (37) | (211) | ||
| Balance, end of period | 592,254 | 564,852 | 530,877 | ||
| Shares outstanding, end of period | 755,286 | 780,910 | 811,621 |
Outstanding share-based awards are excluded from the calculation of weighted-average shares used in the computation of basic EPS. The following table presents the approximate number of share-based awards to purchase shares, on a weighted-average basis, that were considered to be anti-dilutive and were excluded from the calculation of diluted earnings per share at December 31:
| (In thousands) | 2018 | 2017 | 2016 | |||||||||||
| Anti-dilutive share-based awards | 44 | 510 | 1,822 |
The weighted-average shares used in calculating earnings per share for the years ended December 31 were as follows:
| (In thousands of shares) | 2018 | 2017 | 2016 | |||||
| Weighted-average outstanding shares used for calculating basic EPS | 769,588 | 792,042 | 822,942 | |||||
| Dilutive effect of share-based awards | 5,062 | 5,819 | 4,899 | |||||
| Weighted-average outstanding shares used for calculating diluted EPS | 774,650 | 797,861 | 827,841 |
Share Repurchase Program: During 2018, the Company repurchased 28.9 million shares of its common stock in the open market, compared with 35.5 million shares in 2017 and 43.2 million shares in 2016. As of December 31, 2018, a remaining balance of 69.0 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors.
Voting Rights: In accordance with the Parent Company's articles of incorporation, shares of common stock are generally entitled to one vote per share until they have been held by the same beneficial owner for a continuous period of 48 months, at which time they become entitled to 10 votes per share.
Reclassifications from Accumulated Other Comprehensive Income
The tables below are reconciliations of accumulated other comprehensive income by component for the years ended December 31.
Item 8. Financial Statements and Supplementary Data
Changes in Accumulated Other Comprehensive Income
| 2018 | |||||||||||||||||||||||||||||
| (In millions) | Unrealized Foreign Currency Translation Gains (Losses) | Unrealized Gains (Losses) on Investment Securities | Unrealized Gains (Losses) on Derivatives | Pension Liability Adjustment | Total | ||||||||||||||||||||||||
| Balance, beginning of period | $ | (1,750 | ) | $ | 5,964 | $ | (23 | ) | $ | (163 | ) | $ | 4,028 | ||||||||||||||||
| Cumulative effect of change in accounting principle - financial instruments | 0 | (148 | ) | 0 | 0 | (148 | ) | ||||||||||||||||||||||
| Cumulative effect of change in accounting principle - tax effects from tax reform | (325 | ) | 734 | (3 | ) | (32 | ) | 374 | |||||||||||||||||||||
| Other comprehensive income (loss) before reclassification | 228 | (2,350 | ) | 2 | (30 | ) | (2,150 | ) | |||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | 0 | 34 | 0 | 13 | 47 | ||||||||||||||||||||||||
| Net current-period other comprehensive income (loss) | 228 | (2,316 | ) | 2 | (17 | ) | (2,103 | ) | |||||||||||||||||||||
| Balance, end of period | $ | (1,847 | ) | $ | 4,234 | $ | (24 | ) | $ | (212 | ) | $ | 2,151 |
All amounts in the table above are net of tax.
| 2017 | |||||||||||||||||||||||||||||
| (In millions) | Unrealized Foreign Currency Translation Gains (Losses) | Unrealized Gains (Losses) on Investment Securities | Unrealized Gains (Losses) on Derivatives | Pension Liability Adjustment | Total | ||||||||||||||||||||||||
| Balance, beginning of period | $ | (1,983 | ) | $ | 4,805 | $ | (24 | ) | $ | (168 | ) | $ | 2,630 | ||||||||||||||||
| Other comprehensive income (loss) before reclassification | 233 | 1,158 | 1 | (6 | ) | 1,386 | |||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | 0 | 1 | 0 | 11 | 12 | ||||||||||||||||||||||||
| Net current-period other comprehensive income (loss) | 233 | 1,159 | 1 | 5 | 1,398 | ||||||||||||||||||||||||
| Balance, end of period | $ | (1,750 | ) | $ | 5,964 | $ | (23 | ) | $ | (163 | ) | $ | 4,028 |
All amounts in the table above are net of tax.
Item 8. Financial Statements and Supplementary Data
| 2016 | |||||||||||||||||||||||||||||
| (In millions) | Unrealized Foreign Currency Translation Gains (Losses) | Unrealized Gains (Losses) on Investment Securities | Unrealized Gains (Losses) on Derivatives | Pension Liability Adjustment | Total | ||||||||||||||||||||||||
| Balance, beginning of period | $ | (2,196 | ) | $ | 2,986 | $ | (26 | ) | $ | (139 | ) | $ | 625 | ||||||||||||||||
| Other comprehensive income (loss) before reclassification | 213 | 1,854 | 2 | (32 | ) | 2,037 | |||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | 0 | (35 | ) | 0 | 3 | (32 | ) | ||||||||||||||||||||||
| Net current-period other comprehensive income (loss) | 213 | 1,819 | 2 | (29 | ) | 2,005 | |||||||||||||||||||||||
| Balance, end of period | $ | (1,983 | ) | $ | 4,805 | $ | (24 | ) | $ | (168 | ) | $ | 2,630 |
All amounts in the table above are net of tax.
For the year ended December 31, 2018, see Note 1 for discussion of the amounts reclassified between AOCI and retained earnings upon the adoption of new accounting pronouncements.
The tables below summarize the amounts reclassified from each component of accumulated other comprehensive income based on source for the years ended December 31.
Reclassifications Out of Accumulated Other Comprehensive Income
| (In millions) | 2018 | |||||
| Details about Accumulated Other Comprehensive Income Components | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Statements of Earnings | ||||
| Unrealized gains (losses) on available-for-sale securities | $ | (63 | ) | Other-than-temporary impairment losses realized | ||
| 17 | Other gains (losses) | |||||
| (46 | ) | Total before tax | ||||
| 12 | Tax (expense) or benefit*(1)* | |||||
| $ | (34 | ) | Net of tax | |||
| Amortization of defined benefit pension items: | ||||||
| Actuarial gains (losses) | $ | (18 | ) | Acquisition and operating expenses*(2)* | ||
| Prior service (cost) credit | 0 | Acquisition and operating expenses*(2)* | ||||
| 5 | Tax (expense) or benefit*(1)* | |||||
| $ | (13 | ) | Net of tax | |||
| Total reclassifications for the period | $ | (47 | ) | Net of tax |
(1) Based on 27% blended tax rate
(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see
Note 14 for additional details).
Item 8. Financial Statements and Supplementary Data
| (In millions) | 2017 | |||||
| Details about Accumulated Other Comprehensive Income Components | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Statements of Earnings | ||||
| Unrealized gains (losses) on available-for-sale securities | $ | (29 | ) | Other-than-temporary impairment losses realized | ||
| 27 | Other gains (losses) | |||||
| (2 | ) | Total before tax | ||||
| 1 | Tax (expense) or benefit*(1)* | |||||
| $ | (1 | ) | Net of tax | |||
| Amortization of defined benefit pension items: | ||||||
| Actuarial gains (losses) | $ | (17 | ) | Acquisition and operating expenses*(2)* | ||
| Prior service (cost) credit | 0 | Acquisition and operating expenses*(2)* | ||||
| 6 | Tax (expense) or benefit*(1)* | |||||
| $ | (11 | ) | Net of tax | |||
| Total reclassifications for the period | $ | (12 | ) | Net of tax |
(1) Based on 35% tax rate
(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 14 for additional details).
| (In millions) | 2016 | |||||
| Details about Accumulated Other Comprehensive Income Components | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Statements of Earnings | ||||
| Unrealized gains (losses) on available-for-sale securities | $ | (83 | ) | Other-than-temporary impairment losses realized | ||
| 136 | Other gains (losses) | |||||
| 53 | Total before tax | |||||
| (18 | ) | Tax (expense) or benefit*(1)* | ||||
| $ | 35 | Net of tax | ||||
| Amortization of defined benefit pension items: | ||||||
| Actuarial gains (losses) | $ | (15 | ) | Acquisition and operating expenses*(2)* | ||
| Prior service (cost) credit | 11 | Acquisition and operating expenses*(2)* | ||||
| 1 | Tax (expense) or benefit*(1)* | |||||
| $ | (3 | ) | Net of tax | |||
| Total reclassifications for the period | $ | 32 | Net of tax |
(1) Based on 35% tax rate
(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 14 for additional details).
12. SHARE-BASED COMPENSATION
See Note 1 for a discussion of the stock split that occurred in March 2018. All share and per-share amounts have been adjusted to reflect the stock split for any of the periods presented.
As of December 31, 2018, the Company has outstanding share-based awards under the Aflac Incorporated Long-Term Incentive Plan (the "Plan"). Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations, and other factors.
The Plan, as amended on February 14, 2017, allows for a maximum number of shares issuable over its term of 75 million shares including 38 million shares that may be awarded in respect of awards other than options or stock appreciation rights. If any awards granted under the Plan are forfeited or are terminated before being exercised or settled for any reason other than tax forfeiture, then the shares underlying the awards will again be available under the Plan.
Item 8. Financial Statements and Supplementary Data
The Plan allows awards to Company employees for incentive stock options (ISOs), non-qualifying stock options (NQSOs), restricted stock, restricted stock units, and stock appreciation rights. Non-employee directors are eligible for grants of NQSOs, restricted stock, and stock appreciation rights. As of December 31, 2018, approximately 40.3 million shares were available for future grants under this plan. The ISOs and NQSOs have a term of 10 years, and the share-based awards generally vest upon time-based conditions or time and performance-based conditions. Time-based vesting generally occurs after three years. Performance-based vesting conditions generally include the attainment of goals related to Company financial performance. As of December 31, 2018, the only performance-based awards issued and outstanding were restricted stock awards.
Stock options and stock appreciation rights granted under the amended Plan have an exercise price of at least the fair market value of the underlying stock on the grant date and have an expiration date no later than 10 years from the grant date. Time-based restricted stock awards, restricted stock units and stock options granted after January 1, 2017 generally vest on a ratable basis over three years, and awards granted prior to the amendment vest on a three-year cliff basis. The Compensation Committee of the Board of Directors has the discretion to determine vesting schedules.
Share-based awards granted to U.S.-based grantees are settled with authorized but unissued Company stock, while those issued to Japan-based grantees are settled with treasury shares.
Summary of Share-Based Compensation Expense
Share-based compensation expense consists primarily of expenses for stock options, restricted stock awards (including performance based restricted stock awards), and restricted stock units granted to employees.
The following table presents the impact of the expense recognized in connection with share-based awards for the periods ended December 31.
| (In millions, except for per-share amounts) | 2018 | 2017 | 2016 | ||||||||||||||
| Impact on earnings from continuing operations | $ | 57 | $ | 51 | $ | 68 | |||||||||||
| Impact on earnings before income taxes | 57 | 51 | 68 | ||||||||||||||
| Impact on net earnings | 45 | 35 | 46 | ||||||||||||||
| Impact on net earnings per share: | |||||||||||||||||
| Basic | $ | .06 | $ | .05 | $ | .06 | |||||||||||
| Diluted | .06 | .05 | .06 |
Stock Options
The following table summarizes stock option activity under the employee stock option plan.
| (In thousands of shares) | Stock Option Shares | Weighted-Average Exercise Price Per Share | ||||||||
| Outstanding at December 31, 2015 | 15,836 | $ | 25.47 | |||||||
| Granted in 2016 | 1,328 | 30.70 | ||||||||
| Canceled in 2016 | (362 | ) | 27.82 | |||||||
| Exercised in 2016 | (4,122 | ) | 24.46 | |||||||
| Outstanding at December 31, 2016 | 12,680 | 26.28 | ||||||||
| Granted in 2017 | 626 | 35.80 | ||||||||
| Canceled in 2017 | (236 | ) | 24.95 | |||||||
| Exercised in 2017 | (5,766 | ) | 30.11 | |||||||
| Outstanding at December 31, 2017 | 7,304 | 28.03 | ||||||||
| Granted in 2018 | 67 | 44.59 | ||||||||
| Canceled in 2018 | (167 | ) | 32.11 | |||||||
| Exercised in 2018 | (1,874 | ) | 26.78 | |||||||
| Outstanding at December 31, 2018 | 5,330 | $ | 28.54 |
Item 8. Financial Statements and Supplementary Data
| (In thousands of shares) | 2018 | 2017 | 2016 | |||||||||||
| Shares exercisable, end of year | 3,917 | 4,208 | 8,986 |
The Company estimates the fair value of each stock option granted using the Black-Scholes-Merton multiple option approach. Expected volatility is based on historical periods generally commensurate with the estimated terms of the options. The Company uses historical data to estimate option exercise and termination patterns within the model. Separate groups of employees that have similar historical exercise patterns are stratified and considered separately for valuation purposes. The expected term of options granted is derived from the output of the Company's option model and represents the weighted-average period of time that options granted are expected to be outstanding. The Company bases the risk-free interest rate on the Treasury note rate with a term comparable to that of the estimated term of the options. The weighted-average fair value of options at their grant date was $8.81 per share for 2018, compared with $7.64 for 2017 and $6.35 in 2016. The following table presents the assumptions used in valuing options granted during the years ended December 31.
| 2018 | 2017 | 2016 | |||||||||
| Expected term (years) | 7.0 | 5.9 | 6.4 | ||||||||
| Expected volatility | 22.0 | % | 26.0 | % | 27.0 | % | |||||
| Annual forfeiture rate | 3.6 | 3.4 | 3.2 | ||||||||
| Risk-free interest rate | 2.5 | 2.5 | 2.2 | ||||||||
| Dividend yield | 2.4 | 2.5 | 2.9 |
The following table summarizes information about stock options outstanding and exercisable at December 31, 2018.
| (In thousands of shares) | Options Outstanding | Options Exercisable | ||||||||||||||||||||||||||||||||
| Range of Exercise Prices Per Share | Stock Option Shares Outstanding | Wgtd.-Avg. Remaining Contractual Life (Yrs.) | Wgtd.-Avg. Exercise Price Per Share | Stock Option Shares Exercisable | Wgtd.-Avg. Exercise Price Per Share | |||||||||||||||||||||||||||||
| $ | 11.07 | - | $ | 24.28 | 1,181 | 1.8 | $ | 20.76 | 1,181 | $ | 20.76 | |||||||||||||||||||||||
| 24.75 | - | 28.97 | 1,718 | 4.8 | 27.76 | 1,026 | 26.95 | |||||||||||||||||||||||||||
| 29.04 | - | 31.21 | 1,226 | 5.8 | 30.77 | 1,221 | 30.77 | |||||||||||||||||||||||||||
| 31.22 | - | 37.22 | 1,134 | 7.5 | 34.44 | 488 | 33.86 | |||||||||||||||||||||||||||
| 38.76 | - | 44.59 | 71 | 9.3 | 44.21 | 1 | 38.76 | |||||||||||||||||||||||||||
| $ | 11.07 | - | $ | 44.59 | 5,330 | 5.0 | $ | 28.54 | 3,917 | $ | 27.14 |
The aggregate intrinsic value in the following table represents the total pretax intrinsic value, and is based on the difference between the exercise price of the stock options and the quoted closing common stock price of $45.56 as of December 31, 2018, for those awards that have an exercise price currently below the closing price. As of December 31, 2018, the aggregate intrinsic value of stock options outstanding was $91 million, with a weighted-average remaining term of 5.0 years. The total number of in-the-money stock options exercisable as of December 31, 2018, was 3.9 million. The aggregate intrinsic value of stock options exercisable at that same date was $72 million, with a weighted-average remaining term of 4.1 years.
The following table summarizes stock option activity during the years ended December 31.
| (In millions) | 2018 | 2017 | 2016 | ||||||||||||||
| Total intrinsic value of options exercised | $ | 34 | $ | 87 | $ | 41 | |||||||||||
| Cash received from options exercised | 48 | 58 | 68 | ||||||||||||||
| Tax benefit realized as a result of options exercised and restricted stock releases | 25 | 74 | 45 |
Performance-Based Restricted Stock Awards
Under the Plan, the Company grants selected executive officers performance-based restricted stock awards (PBRS) each February whose vesting is contingent upon meeting various performance goals. PBRS are generally granted at-the-money and contingently cliff vest over a period of three years, generally subject to continued employment. In February
Item 8. Financial Statements and Supplementary Data
2018, the Company granted 432 thousand performance-based stock awards, which are contingent on the achievement of the Company's financial performance metrics and its market-based conditions. On the date of grant, the Company estimated the fair value of restricted stock awards with market-based conditions using a Monte Carlo simulation model. The model discounts the value of the stock at the assumed vesting date based on a risk-free interest rate. Based on estimates of actual performance versus the vesting thresholds, the calculated fair value percentage pay-out estimate will be updated each quarter. Actual performance, including modification for relative total shareholder return, may result in the ultimate award of 0% to 200% percent of the initial number of PBRS issued, with the potential for no award if company performance goals are not achieved during the three-year period. PBRS subject to accelerated vesting at the date of retirement eligibility is recognized over the implicit service period.
The Company uses third-party analyses to assist in developing the assumptions used in, as well as calibrating, a Monte Carlo simulation model. The Company is responsible for determining the assumptions used in estimating the fair value of its share-based payment awards.
Key assumptions used to value PBRS granted during 2018 follows:
| (In millions) | 2018 | ||||
| Expected volatility (based on Aflac Inc. and peer group historical daily stock price) | 16.48 | % | |||
| Expected life from grant date (years) | 2.9 | ||||
| Risk-free interest rate (based on U.S. Treasury yields at the date of grant) | 2.29 | % |
Restricted Stock Awards and Units
The value of restricted stock awards and restricted stock units is based on the fair market value of our common stock at the date of grant. The following table summarizes restricted stock activity during the years ended December 31.
| (In thousands of shares) | Shares | Weighted-Average Grant-Date Fair Value Per Share | ||||||||
| Restricted stock at December 31, 2015 | 3,630 | $ | 29.21 | |||||||
| Granted in 2016 | 1,756 | 30.84 | ||||||||
| Canceled in 2016 | (152 | ) | 30.33 | |||||||
| Vested in 2016 | (1,498 | ) | 26.84 | |||||||
| Restricted stock at December 31, 2016 | 3,736 | 30.88 | ||||||||
| Granted in 2017 | 1,118 | 36.48 | ||||||||
| Canceled in 2017 | (202 | ) | 32.23 | |||||||
| Vested in 2017 | (1,018 | ) | 31.09 | |||||||
| Restricted stock at December 31, 2017 | 3,634 | 32.40 | ||||||||
| Granted in 2018 | 1,121 | 44.27 | ||||||||
| Canceled in 2018 | (105 | ) | 34.39 | |||||||
| Vested in 2018 | (1,243 | ) | 31.64 | |||||||
| Restricted stock at December 31, 2018 | 3,407 | $ | 36.52 |
As of December 31, 2018, total compensation cost not yet recognized in the Company's financial statements related to restricted stock awards and restricted stock units was $36 million, of which $15 million (799 thousand shares) was related to restricted stock awards with a performance-based vesting condition. The Company expects to recognize these amounts over a weighted-average period of approximately 1.0 year. There are no other contractual terms covering restricted stock awards once vested.
Item 8. Financial Statements and Supplementary Data
13. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
The Company's insurance subsidiaries are required to report their results of operations and financial position to insurance regulatory authorities on the basis of statutory accounting practices prescribed or permitted by such authorities. Statutory accounting practices primarily differ from U.S. GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis.
Aflac reports statutory financial statements that are prepared on the basis of accounting practices prescribed or permitted by the Nebraska Department of Insurance (NDOI). The NDOI recognizes statutory accounting principles and practices prescribed or permitted by the state of Nebraska for determining and reporting the financial condition and results of operations of an insurance company, and for determining a company's solvency under Nebraska insurance law. The National Association of Insurance Commissioners' (NAIC) Accounting Practices and Procedures Manual (SAP) has been adopted by the state of Nebraska as a component of those prescribed or permitted practices. Additionally, the Director of the NDOI has the right to permit other specific practices which deviate from prescribed practices. Prior to the Japan branch conversion on April 1, 2018, Aflac had been given explicit permission by the Director of the NDOI for two such permitted practices. These permitted practices, which did not impact the calculation of net income on a statutory basis or prevent the triggering of a regulatory event in the Company's RBC calculation, were as follows:
| • | Aflac reported as admitted assets the refundable lease deposits on the leases of commercial office space which house Aflac Japan's sales operations. These lease deposits are unique and part of the ordinary course of doing business in the country of Japan; these assets would be non-admitted under SAP. |
| • | Aflac entered into a reinsurance agreement effective March 31, 2015 with a then unauthorized reinsurer. The effective date of this agreement predated the effective date of Nebraska's Amended Credit for Reinsurance statute (44-416) allowing certified reinsurers and also predated the subsequent approval of the agreement's assuming reinsurer as a Certified Reinsurer, which occurred on August 30, 2015 and December 24, 2015, respectively. Aflac obtained a permitted practice to recognize this treaty and counterparty as a Certified Reinsurer for the purpose of determining the collateral required to receive reinsurance reserve credit. |
On April 1, 2018, the Company entered into a series of transactions in order to complete the conversion of the Japan branch into a Japanese insurance corporation. As a result of the conversion, the permitted practices were no longer necessary, therefore they were canceled by the NDOI effective April 2, 2018. A reconciliation of Aflac's capital and surplus between SAP and practices permitted by the state of Nebraska is shown below for the years ended December 31:
| (In millions) | 2018 | 2017 | |||||||||
| Capital and surplus, Nebraska state basis | $ | 2,600 | $ | 11,001 | |||||||
| State Permitted Practice: | |||||||||||
| Refundable lease deposits – Japan | 0 | (43 | ) | ||||||||
| Reinsurance - Japan | 0 | (818 | ) | ||||||||
| Capital and surplus, NAIC basis | $ | 2,600 | $ | 10,140 |
As of December 31, 2018, Aflac's capital and surplus significantly exceeded the required company action level capital and surplus of $.5 billion. As determined on a U.S. statutory accounting basis, Aflac's net income was $1.3 billion in 2018, $2.6 billion in 2017 and $2.8 billion in 2016.
Aflac Japan must report its results of operations and financial position to the Japanese Financial Services Agency (FSA) on a Japanese regulatory accounting basis as prescribed by the FSA. Capital and surplus of Aflac Japan, based on Japanese regulatory accounting practices, was $6.4 billion at December 31, 2018, compared with $6.7 billion at December 31, 2017. Japanese regulatory accounting practices differ in many respects from U.S. GAAP. Under Japanese regulatory accounting practices, policy acquisition costs are expensed immediately; policy benefit and claim reserving methods and assumptions are different; premium income is recognized on a cash basis; different consolidation criteria apply to VIEs; reinsurance is recognized on a different basis; and investments can have a separate accounting classification and treatment referred to as policy reserve matching bonds (PRM).
The Parent Company depends on its subsidiaries for cash flow, primarily in the form of dividends and management fees. Consolidated retained earnings in the accompanying financial statements largely represent the undistributed earnings of the Company's insurance subsidiary. Amounts available for dividends, management fees and other payments
Item 8. Financial Statements and Supplementary Data
to the Parent Company by its insurance subsidiaries may fluctuate due to different accounting methods required by regulatory authorities. These payments are also subject to various regulatory restrictions and approvals related to safeguarding the interests of insurance policyholders. Aflac must maintain adequate RBC for U.S. regulatory authorities, and Aflac Japan must maintain adequate solvency margins for Japanese regulatory authorities.
The maximum amount of dividends that can be paid to the Parent Company by Aflac without prior approval of Nebraska's director of insurance is the greater of the net income from operations, which excludes net realized investment gains, for the previous year determined under statutory accounting principles, or 10% of statutory capital and surplus as of the previous year-end. Dividends declared by Aflac during 2019 in excess of $1.3 billion would require such approval. Aflac declared dividends of $12.3 billion during 2018, including non-cash extraordinary dividends of $11.0 billion which represented the statutory book value of Aflac Japan on April 2, 2018.
After the Japan branch conversion as of April 1, 2018, Aflac Japan is required to meet certain financial criteria as governed by Japanese corporate law in order to provide dividends to the Parent Company. Under these criteria, dividend capacity at Aflac Japan is basically defined as retained earnings excluding capital reserves, which represent equity generated by capital profits that are statutorily required in Japan, less net after-tax unrealized losses on available-for-sale securities based on the previous fiscal year-end. Prior to April 1, 2018, a portion of Aflac Japan earnings, as determined on a Japanese regulatory accounting basis, could be remitted each year to Aflac U.S. after complying with solvency margin provisions and satisfying various conditions imposed by Japanese regulatory authorities for protecting policyholders. Profit remittances to the United States could fluctuate due to changes in the amounts of Japanese regulatory earnings. Among other items, factors affecting regulatory earnings include Japanese regulatory accounting practices and fluctuations in currency translation of Aflac Japan's U.S. dollar-denominated investments and related investment income into yen. Profits remitted by Aflac Japan to the Parent Company, after April 1, 2018, and to Aflac U.S., prior to April 1, 2018, were as follows for the years ended December 31:
| In Dollars | In Yen | |||||||||||||||||||||||||||||||
| (In millions of dollars and billions of yen) | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||||||||||||
| Profit remittances | $ | 808 | $ | 1,150 | $ | 1,286 | 89.7 | 129.3 | 138.5 |
14. BENEFIT PLANS
Pension and Other Postretirement Plans
The Company has funded defined benefit plans in Japan and the United States, however the U.S. plan was frozen to new participants effective October 1, 2013. The Company also maintains non-qualified, unfunded supplemental retirement plans that provide defined pension benefits in excess of limits imposed by federal tax law for certain Japanese, U.S. and former employees, however the U.S. plan was frozen to new participants effective January 1, 2015. U.S. employees who are not participants in the defined benefit plan receive a nonelective 401(k) employer contribution.
The Company provides certain health care benefits for eligible U.S. retired employees, their beneficiaries and covered dependents ("other postretirement benefits"). The health care plan is contributory and unfunded. Effective January 1, 2014, employees eligible for benefits included the following: (1) active employees whose age plus service, in years, equaled or exceeded 80 (rule of 80); (2) active employees who were age 55 or older and have met the 15 years of service requirement; (3) active employees who would meet the rule of 80 in the next five years; (4) active employees who were age 55 or older and who would meet the 15 years of service requirement within the next five years; and (5) current retirees. For certain employees and former employees, additional coverage is provided for all medical expenses for life.
Information with respect to the Company's benefit plans' assets and obligations as of December 31 was as follows:
Item 8. Financial Statements and Supplementary Data
| Pension Benefits | Other | ||||||||||||||||||||||||||||||||
| Japan | U.S. | Postretirement Benefits | |||||||||||||||||||||||||||||||
| (In millions) | 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||||
| Projected benefit obligation: | |||||||||||||||||||||||||||||||||
| Benefit obligation, beginning of year | $ | 341 | $ | 329 | $ | 908 | $ | 798 | $ | 36 | $ | 37 | |||||||||||||||||||||
| Service cost | 19 | 20 | 27 | 24 | 0 | 0 | |||||||||||||||||||||||||||
| Interest cost | 7 | 6 | 31 | 40 | 1 | 1 | |||||||||||||||||||||||||||
| Actuarial (gain) loss | 35 | (10 | ) | (69 | ) | 65 | 4 | 0 | |||||||||||||||||||||||||
| Benefits and expenses paid | (11 | ) | (14 | ) | (22 | ) | (19 | ) | (4 | ) | (2 | ) | |||||||||||||||||||||
| Effect of foreign exchange rate changes | 5 | 10 | 0 | 0 | 0 | 0 | |||||||||||||||||||||||||||
| Benefit obligation, end of year | 396 | 341 | 875 | 908 | 37 | 36 | |||||||||||||||||||||||||||
| Plan assets: | |||||||||||||||||||||||||||||||||
| Fair value of plan assets, beginning of year | 270 | 229 | 448 | 359 | 0 | 0 | |||||||||||||||||||||||||||
| Actual return on plan assets | (9 | ) | 16 | (30 | ) | 61 | 0 | 0 | |||||||||||||||||||||||||
| Employer contributions | 34 | 32 | 69 | 47 | 4 | 2 | |||||||||||||||||||||||||||
| Benefits and expenses paid | (11 | ) | (14 | ) | (22 | ) | (19 | ) | (4 | ) | (2 | ) | |||||||||||||||||||||
| Effect of foreign exchange rate changes | 5 | 7 | 0 | 0 | 0 | 0 | |||||||||||||||||||||||||||
| Fair value of plan assets, end of year | 289 | 270 | 465 | 448 | 0 | 0 | |||||||||||||||||||||||||||
| Funded status of the plans**(1)** | $ | (107 | ) | $ | (71 | ) | $ | (410 | ) | $ | (460 | ) | $ | (37 | ) | $ | (36 | ) | |||||||||||||||
| Amounts recognized in accumulated other comprehensive income: | |||||||||||||||||||||||||||||||||
| Net actuarial (gain) loss | $ | 95 | $ | 44 | $ | 174 | $ | 203 | $ | 9 | $ | 6 | |||||||||||||||||||||
| Prior service (credit) cost | (2 | ) | (2 | ) | (4 | ) | (4 | ) | 0 | 0 | |||||||||||||||||||||||
| Total included in accumulated other comprehensive income | $ | 93 | $ | 42 | $ | 170 | $ | 199 | $ | 9 | $ | 6 | |||||||||||||||||||||
| Accumulated benefit obligation | $ | 356 | $ | 307 | $ | 746 | $ | 756 | N/A | (2) | N/A | (2) |
(1) Recognized in other liabilities in the consolidated balance sheets
(2) Not applicable
| Pension Benefits | Other | ||||||||||||||||||||||||||||
| Japan | U.S. | Postretirement Benefits | |||||||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||||
| Weighted-average actuarial assumptions: | |||||||||||||||||||||||||||||
| Discount rate - net periodic benefit cost | 1.25 | % | 1.25 | % | 1.75 | % | 3.75 | % | 4.25 | % | 4.50 | % | 3.75 | % | 4.25 | % | 4.50 | % | |||||||||||
| Discount rate - benefit obligations | 1.25 | 1.25 | 1.25 | 4.25 | 3.75 | 4.25 | 4.25 | 3.75 | 4.25 | ||||||||||||||||||||
| Expected long-term return on plan assets | 2.00 | 2.00 | 2.00 | 6.50 | 6.75 | 7.00 | N/A | (1) | N/A | (1) | N/A | (1) | |||||||||||||||||
| Rate of compensation increase | N/A | (1) | N/A | (1) | N/A | (1) | 4.00 | 4.00 | 4.00 | N/A | (1) | N/A | (1) | N/A | (1) | ||||||||||||||
| Health care cost trend rates | N/A | (1) | N/A | (1) | N/A | (1) | N/A | (1) | N/A | (1) | N/A | (1) | 7.40 | (2) | 5.40 | (2) | 5.20 | (2) |
(1) Not applicable
(2)For the years 2018, 2017 and 2016*, the health care cost trend rates are expected to trend down to* 4.1% in 61 years*,* 4.5% in 77 years*, and* 4.5% in 74 years*, respectively.*
The Company determines its discount rate assumption for its pension retirement obligations based on indices for AA corporate bonds with an average duration of approximately 20 years for the Japan pension plans and 17 years for the U.S. pension plans, and determination of the U.S. pension plans discount rate utilizes the 85-year extrapolated yield
Item 8. Financial Statements and Supplementary Data
curve. In Japan, participant salary and future salary increases are not factors in determining pension benefit cost or the related pension benefit obligation.
The Company bases its assumption for the long-term rate of return on assets on historical trends (10-year or longer historical rates of return for the Japanese plan assets and 15-year historical rates of return for the U.S. plan assets), expected future market movement, as well as the portfolio mix of securities in the asset portfolio including, but not limited to, style, class and equity and fixed income allocations. In addition, the Company's consulting actuaries evaluate its assumptions for long-term rates of return under Actuarial Standards of Practice (ASOP). Under the ASOP, the actual portfolio type, mix and class is modeled to determine a best estimate of the long-term rate of return. The Company in turn use those results to further validate its own assumptions.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one-percentage point increase and decrease in assumed health care cost trend rates would have the following effects as of December 31, 2018:
| (In millions) | ||||||
| One percentage point increase: | ||||||
| Increase in total service and interest costs | $ | 0 | ||||
| Increase in postretirement benefit obligation | 1 | |||||
| One percentage point decrease: | ||||||
| Decrease in total service and interest costs | $ | 0 | ||||
| Decrease in postretirement benefit obligation | 1 |
Components of Net Periodic Benefit Cost
Pension and other postretirement benefit expenses are included in acquisition and operating expenses in the consolidated statements of earnings, which includes $25 million, $35 million and $17 million of other components of net periodic pension cost and postretirement costs (other than services costs) for the years ended December 31, 2018, 2017 and 2016, respectively. Total net periodic benefit cost includes the following components:
| Pension Benefits | Other | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Japan | U.S. | Postretirement Benefits | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| (In millions) | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||||||||||||||||||||
| Service cost | $ | 19 | $ | 20 | $ | 16 | $ | 27 | $ | 24 | $ | 23 | $ | 0 | $ | 0 | $ | 1 | ||||||||||||||||||||||||||||||||||||
| Interest cost | 7 | 6 | 9 | 31 | 40 | 29 | 1 | 1 | 2 | |||||||||||||||||||||||||||||||||||||||||||||
| Expected return on plan assets | (6 | ) | (5 | ) | (4 | ) | (26 | ) | (24 | ) | (23 | ) | 0 | 0 | 0 | |||||||||||||||||||||||||||||||||||||||
| Amortization of net actuarial loss | 1 | 2 | 1 | 16 | 14 | 13 | 1 | 1 | 1 | |||||||||||||||||||||||||||||||||||||||||||||
| Amortization of prior service cost (credit) | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | (11 | ) | ||||||||||||||||||||||||||||||||||||||||||||
| Net periodic (benefit) cost | $ | 21 | $ | 23 | $ | 22 | $ | 48 | $ | 54 | $ | 42 | $ | 2 | $ | 2 | $ | (7 | ) |
Changes in Accumulated Other Comprehensive Income
The following table summarizes the amounts recognized in other comprehensive loss (income) for the years ended December 31:
Item 8. Financial Statements and Supplementary Data
| Pension Benefits | Other | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Japan | U.S. | Postretirement Benefits | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| (In millions) | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||||||||||||||||||||
| Net actuarial loss (gain) | $ | 52 | $ | (21 | ) | $ | 26 | $ | (13 | ) | $ | 28 | $ | 27 | $ | 4 | $ | 0 | $ | (4 | ) | |||||||||||||||||||||||||||||||||
| Amortization of net actuarial loss | (1 | ) | (2 | ) | (1 | ) | (16 | ) | (14 | ) | (13 | ) | (1 | ) | (1 | ) | (1 | ) | ||||||||||||||||||||||||||||||||||||
| Amortization of prior service cost | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 11 | |||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 51 | $ | (23 | ) | $ | 25 | $ | (29 | ) | $ | 14 | $ | 14 | $ | 3 | $ | (1 | ) | $ | 6 |
No transition obligations arose during 2018, and the transition obligations amortized to expense were immaterial for the years ended December 31, 2018, 2017 and 2016. Amortization of actuarial losses to expense in 2019 is estimated to be $4 million for the Japanese plans, $11 million for the U.S. plans and $1 million for the other postretirement benefits plan. Amortization of prior service costs and credits and transition obligations for all plans is expected to be negligible in 2019.
Benefit Payments
The following table provides expected benefit payments, which reflect expected future service, as appropriate.
| Pension Benefits | Other | ||||||||||||||||
| (In millions) | Japan | U.S. | Postretirement Benefits | ||||||||||||||
| 2019 | $ | 12 | $ | 25 | $ | 3 | |||||||||||
| 2020 | 12 | 26 | 3 | ||||||||||||||
| 2021 | 12 | 27 | 4 | ||||||||||||||
| 2022 | 19 | 36 | 4 | ||||||||||||||
| 2023 | 15 | 34 | 4 | ||||||||||||||
| 2024-2028 | 89 | 199 | 17 |
Funding
The Company plans to make contributions of $33 million to the Japanese funded defined benefit plan and $10 million to the U.S. funded defined benefit plan in 2019. The funding policy for the Company's non-qualified supplemental defined benefit pension plans and other postretirement benefits plan is to contribute the amount of the benefit payments made during the year.
Plan Assets
The investment objective of the Company's Japanese and U.S. funded defined benefit plans is to preserve the purchasing power of the plan's assets and earn a reasonable inflation-adjusted rate of return over the long term. Furthermore, the Company seeks to accomplish these objectives in a manner that allows for the adequate funding of plan benefits and expenses. In order to achieve these objectives, the Company's goal is to maintain a conservative, well-diversified and balanced portfolio of high-quality equity, fixed-income and money market securities. As a part of its strategy, the Company has established strict policies covering quality, type and concentration of investment securities. For the Company's Japanese plan, these policies include limitations on investments in derivatives including futures, options and swaps, and low-liquidity investments such as real estate, venture capital investments, and privately issued securities. For the Company's U.S. plan, these policies prohibit investments in precious metals, limited partnerships, venture capital, and direct investments in real estate. The Company is also prohibited from trading on margin.
The plan fiduciaries for the Company's funded defined benefit plans have developed guidelines for asset allocations reflecting a percentage of total assets by asset class, which are reviewed on an annual basis. Asset allocation targets as of December 31, 2018 were as follows:
Item 8. Financial Statements and Supplementary Data
| Japan Pension | U.S. Pension | |||||||||
| Domestic equities | 5 | % | 40 | % | ||||||
| International equities | 18 | 20 | ||||||||
| Fixed income securities | 66 | 40 | ||||||||
| Other | 11 | 0 | ||||||||
| Total | 100 | % | 100 | % |
The U.S. Pension Plan had $39 million in cash at December 31, 2018. The plan fiduciaries authorized investing a contribution made to the Plan in 2018 on a graduated basis over a period of time.
The following table presents the fair value of Aflac Japan's pension plan assets that are measured at fair value on a recurring basis as of December 31. All of these assets are classified as Level 2 in the fair value hierarchy.
| (In millions) | 2018 | 2017 | |||||||||
| Japan pension plan assets: | |||||||||||
| Equities: | |||||||||||
| Japanese equity securities | $ | 14 | $ | 37 | |||||||
| International equity securities | 50 | 50 | |||||||||
| Fixed income securities: | |||||||||||
| Japanese bonds | 34 | 91 | |||||||||
| International bonds | 160 | 62 | |||||||||
| Insurance contracts | 31 | 30 | |||||||||
| Total | $ | 289 | $ | 270 |
The following table presents the fair value of Aflac U.S.'s pension plan assets that are measured at fair value on a recurring basis as of December 31. All of these assets are classified as Level 1 in the fair value hierarchy.
| (In millions) | 2018 | 2017 | |||||||||
| U.S. pension plan assets: | |||||||||||
| Mutual funds: | |||||||||||
| Large cap equity funds | $ | 120 | $ | 124 | |||||||
| Mid cap equity funds | 17 | 22 | |||||||||
| Real estate equity funds | 13 | 13 | |||||||||
| International equity funds | 92 | 108 | |||||||||
| Fixed income bond funds | 179 | 175 | |||||||||
| Aflac Incorporated common stock | 5 | 5 | |||||||||
| Cash and cash equivalents | 39 | 1 | |||||||||
| Total | $ | 465 | $ | 448 |
The fair values of the Company's pension plan investments categorized as Level 1, consisting of mutual funds and common stock, are based on quoted market prices for identical securities traded in active markets that are readily and regularly available to the Company. The fair values of the Company's pension plan investments classified as Level 2 are based on quoted prices for similar assets in markets that are not active, other inputs that are observable, such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks, and default rates, or other market-corroborated inputs.
Item 8. Financial Statements and Supplementary Data
401(k) Plan
The Company sponsors a 401(k) plan in which it matches a portion of U.S. employees' contributions. The plan provides for salary reduction contributions by employees and provides for matching contributions which, starting January 1, 2018, the Company increased to 100% of each employee's contributions which were not in excess of 4% of the employee's annual cash compensation as a result of tax reform. In 2017 and 2016, the plan provided for matching contributions by the Company of 50% of each employee's contributions which were not in excess of 6% of the employee's annual compensation. Also, as a result of U.S. tax reform legislation enacted in December 2017, the Company announced it would made a one-time contribution of $500 to the 401(k) plan to all employees active on December 31, 2017. This contribution was made by January 31, 2018. The Company also provides a nonelective contribution to the 401(k) plan of 2% of annual cash compensation for employees who opted out of the future benefits of the U. S. defined benefit plan and for new U. S. employees.
The 401(k) contributions by the Company, included in acquisition and operating expenses in the consolidated statements of earnings, were $18 million in 2018, $15 million in 2017 and $11 million in 2016. The plan trustee held approximately 2.7 million shares of the Company's common stock for plan participants at December 31, 2018.
Stock Bonus Plan
Aflac U.S. maintains a stock bonus plan for eligible U.S. sales associates. Plan participants receive shares of Aflac Incorporated common stock based on their new annualized premium sales and their first-year persistency of substantially all new insurance policies. The cost of this plan, which was capitalized as deferred policy acquisition costs, amounted to $31 million in 2018, 2017 and 2016.
15. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has two outsourcing agreements with a technology and consulting corporation. The first agreement provides mainframe computer operations, distributed mid-range server computer operations, and related support for Aflac Japan. It has a remaining term of four years and an aggregate remaining cost of 36.1 billion yen ($326 million using the December 31, 2018, exchange rate). The second agreement provides application maintenance and development services for Aflac Japan. It has a remaining term of five years and an aggregate remaining cost of 8.6 billion yen ($77 million using the December 31, 2018, exchange rate).
The Company has an outsourcing agreement with a management consulting and technology services company to provide application maintenance and development services for its Japanese operation. The agreement has a remaining term of three years with an aggregate remaining cost of 10.4 billion yen ($94 million using the December 31, 2018, exchange rate).
The Company has two outsourcing agreements with information technology and data services companies to provide application maintenance and development services for its Japanese operation. The first agreement has a remaining term of one year with an aggregate remaining cost of .6 billion yen ($5 million using the December 31, 2018, exchange rate). The second agreement has a remaining term of four years with an aggregate remaining cost of 5.8 billion yen ($52 million using the December 31, 2018, exchange rate).
The Company leases office space and equipment under agreements that expire in various years through 2028. Future minimum lease payments due under non-cancelable operating leases at December 31, 2018, were as follows:
| (In millions) | |||
| 2019 | $ | 63 | |
| 2020 | 47 | ||
| 2021 | 35 | ||
| 2022 | 31 | ||
| 2023 | 8 | ||
| Thereafter | 18 | ||
| Total future minimum lease payments | $ | 202 |
Item 8. Financial Statements and Supplementary Data
The Company is a defendant in various lawsuits considered to be in the normal course of business. Members of the Company's senior legal and financial management teams review litigation on a quarterly and annual basis. The final results of any litigation cannot be predicted with certainty. Although some of this litigation is pending in states where large punitive damages, bearing little relation to the actual damages sustained by plaintiffs, have been awarded in recent years, the Company believes the outcome of pending litigation will not have a material adverse effect on its financial position, results of operations, or cash flows.
See Note 3 of the Notes to the Consolidated Financial Statements for details on certain investment commitments.
Guaranty Fund Assessments
The United States insurance industry has a policyholder protection system that is monitored and regulated by state insurance departments. These life and health insurance guaranty associations are state entities (in all 50 states as well as Puerto Rico and the District of Columbia) created to protect policyholders of an insolvent insurance company. All insurance companies (with limited exceptions) licensed to sell life or health insurance in a state must be members of that state’s guaranty association. Under state guaranty association laws, certain insurance companies can be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of impaired or insolvent insurance companies that write the same line or similar lines of business.
In 2009, the Pennsylvania Insurance Commissioner placed long-term care insurer Penn Treaty Network America Insurance Company and its subsidiary American Network Insurance Company (collectively referred to as Penn Treaty), neither of which is affiliated with Aflac, in rehabilitation and petitioned a state court for approval to liquidate Penn Treaty. A final order of liquidation was granted by a recognized judicial authority on March 1, 2017, and as a result, Penn Treaty is in the process of liquidation. The Company estimated and recognized the impact of its share of guaranty fund assessments resulting from the liquidation using a discounted rate of 4.25%. The Company recognized a discounted liability for the assessments of $62 million (undiscounted $94 million), offset by discounted premium tax credits of $48 million (undiscounted $74 million), for a net $14 million impact to net income in the quarter ended March 31, 2017. The Company paid a majority of these assessments by March 31, 2018, and a majority of the tax credit will be realized over the next four years. The Company used the cost estimate provided as of the liquidation date by the National Organization of Life and Health Guaranty Associations (NOLHGA) to calculate its estimated assessments and tax credits. Other guaranty fund assessments for the years ended December 31, 2018, 2017, and 2016 were immaterial.
16. UNAUDITED CONSOLIDATED QUARTERLY FINANCIAL DATA
In management's opinion, the following quarterly financial information fairly presents the results of operations for such periods and is prepared on a basis consistent with the Company's annual audited financial statements.
Item 8. Financial Statements and Supplementary Data
| (In millions, except for per-share amounts) | March 31, 2018 | June 30, 2018 | September 30, 2018 | December 31, 2018 | |||||||||||||||||||
| Net premium income | $ | 4,745 | $ | 4,706 | $ | 4,636 | $ | 4,591 | |||||||||||||||
| Net investment income | 837 | 862 | 870 | 874 | |||||||||||||||||||
| Realized investment gains (losses) | (134 | ) | 3 | 56 | (355 | ) | |||||||||||||||||
| Other income (loss) | 16 | 18 | 15 | 16 | |||||||||||||||||||
| Total revenues | 5,464 | 5,589 | 5,577 | 5,126 | |||||||||||||||||||
| Total benefits and expenses | 4,482 | 4,458 | 4,431 | 4,404 | |||||||||||||||||||
| Earnings before income taxes | 982 | 1,131 | 1,146 | 722 | |||||||||||||||||||
| Total income tax | 265 | 299 | 301 | 197 | |||||||||||||||||||
| Net earnings | $ | 717 | $ | 832 | $ | 845 | $ | 525 | |||||||||||||||
| Net earnings per basic share | $ | .92 | $ | 1.08 | $ | 1.10 | $ | .69 | |||||||||||||||
| Net earnings per diluted share | .91 | 1.07 | 1.09 | .69 | |||||||||||||||||||
| Quarterly amounts may not agree in total to the corresponding annual amounts due to rounding. | |||||||||||||||||||||||
| (In millions, except for per-share amounts) | March 31, 2017 | June 30, 2017 | September 30, 2017 | December 31, 2017 | |||||||||||||||||||
| Net premium income | $ | 4,638 | $ | 4,665 | $ | 4,648 | $ | 4,580 | |||||||||||||||
| Net investment income | 794 | 802 | 811 | 812 | |||||||||||||||||||
| Realized investment gains (losses) | (140 | ) | (56 | ) | 30 | 15 | |||||||||||||||||
| Other income (loss) | 17 | 17 | 17 | 17 | |||||||||||||||||||
| Total revenues | 5,309 | 5,428 | 5,506 | 5,424 | |||||||||||||||||||
| Total benefits and expenses | 4,411 | 4,383 | 4,431 | 4,425 | |||||||||||||||||||
| Earnings before income taxes | 898 | 1,045 | 1,075 | 999 | |||||||||||||||||||
| Total income tax | 306 | 332 | 359 | (1,585 | ) | ||||||||||||||||||
| Net earnings | $ | 592 | $ | 713 | $ | 716 | $ | 2,584 | |||||||||||||||
| Net earnings per basic share | $ | .74 | $ | .90 | $ | .91 | $ | 3.29 | |||||||||||||||
| Net earnings per diluted share | .73 | .89 | .90 | 3.27 |
Quarterly amounts may not agree in total to the corresponding annual amounts due to rounding.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
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