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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
or
[    ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-07434
aflaclogoa01a01a01a18.jpg
Aflac Incorporated
_________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
(Exact name of registrant as specified in its charter)
Georgia
 
58-1167100
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
1932 Wynnton Road, Columbus, Georgia
 
31999
(Address of principal executive offices)
 
(ZIP Code)
706.323.3431
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  þ  Yes  ¨  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).            þ  Yes  ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
   Large accelerated filer  þ
 
Accelerated filer ¨
   Non-accelerated filer    ¨ (Do not check if a smaller reporting company)
 
Smaller reporting company  ¨
 
 
Emerging growth company  ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨  Yes  þ  No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
October 24, 2018
Common Stock, $.10 Par Value
 
761,279,345



Aflac Incorporated and Subsidiaries
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2018
Table of Contents
 
PART I.
 
Page
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Three Months Ended September 30, 2018 and 2017
  Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
 
  Three Months Ended September 30, 2018 and 2017
  Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
 
  September 30, 2018, and December 31, 2017
 
 
 
 
 
 
  Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
 
  Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
PART II.
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 6.
Items other than those listed above are omitted because they are not required or are not applicable.



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Review by Independent Registered Public Accounting Firm

The September 30, 2018, and 2017, consolidated financial statements included in this filing have been reviewed by KPMG LLP, an independent registered public accounting firm, in accordance with established professional standards and procedures for such a review.

The report of KPMG LLP commenting upon its review is included on the following page.

1


Report of Independent Registered Public Accounting Firm


To the Shareholders and Board of Directors
Aflac Incorporated:

Results of Review of Interim Financial Information
We have reviewed the consolidated balance sheet of Aflac Incorporated and subsidiaries (the Company) as of September 30, 2018, the related consolidated statements of earnings, and comprehensive income (loss) for the three-month and nine-month periods ended September 30, 2018 and 2017, the related consolidated statements of shareholders' equity, and cash flows for the nine-month periods ended September 30, 2018 and 2017, and the related notes (collectively, the consolidated interim financial information). Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial information for it to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2017, and the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated February 22, 2018, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2017, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results
This consolidated interim financial information is the responsibility of the Company’s management. 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 reviews in accordance with the standards of the PCAOB. A review of consolidated interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.



/s/ KPMG LLP

Atlanta, Georgia
November 1, 2018


2


Aflac Incorporated and Subsidiaries
Consolidated Statements of Earnings
  
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
(In millions, except for share and per-share amounts - Unaudited)
2018
2017
2018
 
2017
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums, principally supplemental health insurance
 
$
4,636

 
 
$
4,648

 
 
$
14,086

 
 
$
13,951

 
Net investment income
 
870

 
 
811

 
 
2,569

 
 
2,408

 
Realized investment gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
Other-than-temporary impairment losses realized
 
(5
)
 
 
(8
)
 
 
(17
)
 
 
(27
)
 
Other gains (losses) (1)
 
61

 
 
38

 
 
(59
)
 
 
(139
)
 
Total realized investment gains (losses)
 
56

 
 
30

 
 
(76
)
 
 
(166
)
 
Other income (loss)
 
15

 
 
17

 
 
53

 
 
50

 
Total revenues
 
5,577

 
 
5,506

 
 
16,632

 
 
16,243

 
Benefits and expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Benefits and claims, net
 
3,002

 
 
3,083

 
 
9,075

 
 
9,174

 
Acquisition and operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
 
315

 
 
271

 
 
932

 
 
848

 
Insurance commissions
 
331

 
 
332

 
 
1,007

 
 
996

 
Insurance and other expenses
 
730

 
 
686

 
 
2,193

 
 
2,025

 
Interest expense
 
53

 
 
59

 
 
164

 
 
181

 
Total acquisition and operating expenses
 
1,429

 
 
1,348

 
 
4,296

 
 
4,050

 
Total benefits and expenses
 
4,431

 
 
4,431

 
 
13,371

 
 
13,224

 
Earnings before income taxes
 
1,146

 
 
1,075

 
 
3,261

 
 
3,019

 
Income taxes
 
301

 
 
359

 
 
866

 
 
998

 
Net earnings
 
$
845

 
 
$
716

 
 
$
2,395

 
 
$
2,021

 
Net earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
1.10

 
 
$
.91

 
 
$
3.10

 
 
$
2.54

 
Diluted
 
1.09

 
 
.90

 
 
3.08

 
 
2.52

 
Weighted-average outstanding common shares used in
computing earnings per share (In thousands):
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
767,049

 
 
788,958

 
 
772,807

 
 
794,645

 
Diluted
 
772,070

 
 
794,762

 
 
777,867

 
 
800,483

 
Cash dividends per share
 
$
.26

 
 
$
.22

 
 
$
.78

 
 
$
.65

 

(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.

3


Aflac Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
  
Three Months Ended
September 30,
Nine Months Ended
September 30,
(In millions - Unaudited)
2018
2017
2018
2017
Net earnings
 
$
845

 
 
$
716

 
 
$
2,395

 
 
$
2,021

 
Other comprehensive income (loss) before income taxes:
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized foreign currency translation gains (losses) during
period
 
(383
)
 
 
(58
)
 
 
(51
)
 
 
325

 
Unrealized gains (losses) on fixed maturity securities: (1)
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding gains (losses) on fixed maturity securities
during period
 
(866
)
 
 
457

 
 
(3,099
)
 
 
1,006

 
Reclassification adjustment for realized (gains) losses on
fixed maturity securities included in net earnings
 
(37
)
 
 
(50
)
 
 
(11
)
 
 
(33
)
 
Unrealized gains (losses) on derivatives during period
 
(2
)
 
 
(1
)
 
 
2

 
 
0

 
Pension liability adjustment during period
 
1

 
 
1

 
 
1

 
 
(1
)
 
Total other comprehensive income (loss) before income taxes
 
(1,287
)
 
 
349

 
 
(3,158
)
 
 
1,297

 
Income tax expense (benefit) related to items of other comprehensive
income (loss)
 
(344
)
 
 
219

 
 
(813
)
 
 
396

 
Other comprehensive income (loss), net of income taxes
 
(943
)
 
 
130

 
 
(2,345
)
 
 
901

 
Total comprehensive income (loss)
 
$
(98
)
 
 
$
846

 
 
$
50

 
 
$
2,922

 
(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.

4


Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets
(In millions)
September 30, 2018
(Unaudited)
 
December 31,
2017
Assets:
 
 
 
 
 
 
 
Investments and cash:
 
 
 
 
 
 
 
Securities available for sale, at fair value:
 
 
 
 
 
 
 
Fixed maturity securities (amortized cost $72,207 in 2018 and
$70,594 in 2017)
(1)
 
$
77,443

 
 
 
$
78,804

 
Fixed maturity securities - consolidated variable interest entities (amortized
cost $4,045 in 2018 and $4,538 in 2017)
(1)
 
4,853

 
 
 
5,509

 
Securities held to maturity, at amortized cost:
 
 
 
 
 
 
 
Fixed maturity securities (fair value $36,250 in 2018 and $38,072 in 2017)
 
30,421

 
 
 
31,430

 
Equity securities, at fair value:
 
 
 
 
 
 
 
Equity securities (1)
 
880

 
 
 
270

 
Equity securities - consolidated variable interest entities
 
179

 
 
 
753

 
Other investments (2)
 
7,009

 
 
 
3,402

 
Cash and cash equivalents
 
3,429

 
 
 
3,491

 
Total investments and cash
 
124,214

 
 
 
123,659

 
Receivables
 
784

 
 
 
827

 
Accrued investment income
 
735

 
 
 
769

 
Deferred policy acquisition costs
 
9,622

 
 
 
9,505

 
Property and equipment, at cost less accumulated depreciation
 
435

 
 
 
434

 
Other (3)
 
2,151

 
 
 
2,023

 
Total assets
 
$
137,941

 
 
 
$
137,217

 
(1) Includes perpetual securities, see Notes 1 and 3 of the Notes to the Consolidated Financial Statements
(2) Includes $5,388 in 2018 and $2,341 in 2017 of loan receivables and limited partnerships from consolidated variable interest entities
(3) Includes $190 in 2018 and $151 in 2017 of derivatives from consolidated variable interest entities
See the accompanying Notes to the Consolidated Financial Statements.



(continued)

5


Aflac Incorporated and Subsidiaries
Consolidated Balance Sheets (continued)
(In millions, except for share and per-share amounts)
September 30, 2018
(Unaudited)
 
December 31,
2017
Liabilities and shareholders’ equity:
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Policy liabilities:
 
 
 
 
 
 
 
Future policy benefits
 
$
83,856

 
 
 
$
81,857

 
Unpaid policy claims
 
4,530

 
 
 
4,392

 
Unearned premiums
 
5,224

 
 
 
5,959

 
Other policyholders’ funds
 
6,974

 
 
 
6,939

 
Total policy liabilities
 
100,584

 
 
 
99,147

 
Income taxes
 
3,887

 
 
 
4,745

 
Payables for return of cash collateral on loaned securities
 
1,970

 
 
 
606

 
Notes payable
 
5,279

 
 
 
5,289

 
Other (4)
 
2,987

 
 
 
2,832

 
Total liabilities
 
114,707

 
 
 
112,619

 
Commitments and contingent liabilities (Note 13)
 
 
 
 
 
 
 
Shareholders’ equity:
 
 
 
 
 
 
 
Common stock of $.10 par value. In thousands: authorized 1,900,000
shares in 2018 and 2017; issued 1,347,376 shares in 2018 and 1,345,762
shares in 2017
 
135

 
 
 
135

 
Additional paid-in capital
 
2,151

 
 
 
2,052

 
Retained earnings
 
31,461

 
 
 
29,895

 
Accumulated other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized foreign currency translation gains (losses)
 
(2,113
)
 
 
 
(1,750
)
 
Unrealized gains (losses) on fixed maturity securities (5)
 
4,240

 
 
 
5,964

 
Unrealized gains (losses) on derivatives
 
(24
)
 
 
 
(23
)
 
Pension liability adjustment
 
(194
)
 
 
 
(163
)
 
Treasury stock, at average cost
 
(12,422
)
 
 
 
(11,512
)
 
Total shareholders’ equity
 
23,234

 
 
 
24,598

 
Total liabilities and shareholders’ equity
 
$
137,941

 
 
 
$
137,217

 
(4) Includes $101 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.



6


Aflac Incorporated and Subsidiaries
Consolidated Statements of Shareholders’ Equity
  
Nine Months Ended
September 30,
(In millions - Unaudited)
 
2018
 
 
 
2017
 
Common stock:
 
 
 
 
 
 
 
Balance, beginning of period
 
$
135

 
 
 
$
135

 
Balance, end of period
 
135

 
 
 
135

 
Additional paid-in capital:
 
 
 
 
 
 
 
Balance, beginning of period
 
2,052

 
 
 
1,908

 
Exercise of stock options
 
30

 
 
 
33

 
Share-based compensation
 
39

 
 
 
38

 
Gain (loss) on treasury stock reissued
 
30

 
 
 
30

 
Balance, end of period
 
2,151

 
 
 
2,009

 
Retained earnings:
 
 
 
 
 
 
 
Balance, beginning of period
 
29,895

 
 
 
25,981

 
Cumulative effect of change in accounting principle - financial instruments,
net of income taxes
(1)
 
148

 
 
 
0

 
Cumulative effect of change in accounting principle - tax effects from tax reform (1)
 
(374
)
 
 
 
0

 
Net earnings
 
2,395

 
 
 
2,021

 
Dividends to shareholders
 
(603
)
 
 
 
(513
)
 
Balance, end of period
 
31,461

 
 
 
27,489

 
Accumulated other comprehensive income (loss):
 
 
 
 
 
 
 
Balance, beginning of period
 
4,028

 
 
 
2,630

 
Cumulative effect of change in accounting principle - financial instruments,
net of income taxes
(1)
 
(148
)
 
 
 
0

 
Cumulative effect of change in accounting principle - tax effects from tax reform (1)
 
374

 
 
 
0

 
Unrealized foreign currency translation gains (losses) during
period, net of income taxes
 
(38
)
 
 
 
268

 
Unrealized gains (losses) on fixed maturity securities during
period, net of income taxes and reclassification adjustments
(1)
 
(2,310
)
 
 
 
632

 
Unrealized gains (losses) on derivatives during period, net of
income taxes
 
2

 
 
 
1

 
Pension liability adjustment during period, net of income taxes
 
1

 
 
 
0

 
Balance, end of period
 
1,909

 
 
 
3,531

 
Treasury stock:
 
 
 
 
 
 
 
Balance, beginning of period
 
(11,512
)
 
 
 
(10,172
)
 
Purchases of treasury stock
 
(939
)
 
 
 
(1,053
)
 
Cost of shares issued
 
29

 
 
 
38

 
Balance, end of period
 
(12,422
)
 
 
 
(11,187
)
 
Total shareholders’ equity
 
$
23,234

 
 
 
$
21,977

 
(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.

7


Aflac Incorporated and Subsidiaries
Consolidated Statements of Cash Flows
  
Nine Months Ended September 30,
(In millions - Unaudited)
2018
 
2017
Cash flows from operating activities:
 
 
 
 
 
 
 
Net earnings
 
$
2,395

 
 
 
$
2,021

 
Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
 
 
 
Change in receivables and advance premiums
 
(27
)
 
 
 
(32
)
 
Capitalization of deferred policy acquisition costs
 
(1,082
)
 
 
 
(1,077
)
 
Amortization of deferred policy acquisition costs
 
932

 
 
 
848

 
Increase in policy liabilities
 
1,821

 
 
 
2,137

 
Change in income tax liabilities
 
38

 
 
 
323

 
Realized investment (gains) losses
 
76

 
 
 
166

 
Other, net
 
506

 
 
 
210

 
Net cash provided (used) by operating activities
 
4,659

 
 
 
4,596

 
Cash flows from investing activities:
 
 
 
 
 
 
 
Proceeds from investments sold or matured:
 
 
 
 
 
 
 
Available-for-sale fixed maturity securities
 
5,991

 
 
 
3,382

 
Equity securities
 
369

 
 
 
755

 
Held-to-maturity fixed maturity securities
 
880

 
 
 
1,714

 
Other investments - loan receivables
 
597

 
 
 
134

 
Costs of investments acquired:
 
 
 
 
 
 
 
Available-for-sale fixed maturity securities
 
(7,845
)
 
 
 
(6,827
)
 
Equity securities
 
(338
)
 
 
 
(391
)
 
Other investments - loan receivables
 
(4,150
)
 
 
 
(916
)
 
Other investments, excluding loan receivables, net
 
(136
)
 
 
 
(167
)
 
Settlement of derivatives, net
 
(141
)
 
 
 
(240
)
 
Cash received (pledged or returned) as collateral, net
 
1,413

 
 
 
(273
)
 
Other, net
 
188

 
 
 
(58
)
 
Net cash provided (used) by investing activities
 
(3,172
)
 
 
 
(2,887
)
 
Cash flows from financing activities:
 
 
 
 
 
 
 
Purchases of treasury stock
 
(923
)
 
 
 
(1,053
)
 
Proceeds from borrowings
 
0

 
 
 
524

 
Principal payments under debt obligations
 
0

 
 
 
(660
)
 
Dividends paid to shareholders
 
(595
)
 
 
 
(491
)
 
Change in investment-type contracts, net
 
(17
)
 
 
 
39

 
Treasury stock reissued
 
36

 
 
 
23

 
Other, net
 
(14
)

 
 
5

 
Net cash provided (used) by financing activities
 
(1,513
)
 
 
 
(1,613
)
 
Effect of exchange rate changes on cash and cash equivalents
 
(36
)
 
 
 
(28
)
 
Net change in cash and cash equivalents
 
(62
)
 
 
 
68

 
Cash and cash equivalents, beginning of period
 
3,491

 
 
 
4,859

 
Cash and cash equivalents, end of period
 
$
3,429

 
 
 
$
4,927

 
Supplemental disclosures of cash flow information:
 
 
 
 
 
 
 
Income taxes paid
 
$
827

 
 
 
$
693

 
Interest paid
 
124

 
 
 
144

 
Noncash interest
 
41

 
 
 
38

 
Impairment losses included in realized investment losses
 
17

 
 
 
27

 
Noncash financing activities:
 
 
 
 
 
 
 
Capital lease obligations
 
10

 
 
 
7

 
Treasury stock issued for:
 
 
 
 
 
 
 
   Associate stock bonus
 
7

 
 
 
22

 
   Shareholder dividend reinvestment
 
8

 
 
 
22

 
   Share-based compensation grants
 
2

 
 
 
1

 

See the accompanying Notes to the Consolidated Financial Statements.

8


Aflac Incorporated and Subsidiaries
Notes to the Consolidated Financial Statements
(Interim period data – Unaudited)

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 69% of the Company's total revenues in both the nine-month periods ended September 30, 2018 and 2017, respectively. The percentage of the Company's total assets attributable to Aflac Japan was 84% at September 30, 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 (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 unaudited 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.

In the opinion of management, the accompanying unaudited consolidated financial statements of the Company contain all adjustments, consisting of normal recurring accruals, which are necessary to fairly present the consolidated balance sheets as of September 30, 2018, and December 31, 2017, the consolidated statements of earnings and comprehensive income (loss) for the three- and nine-month periods ended September 30, 2018 and 2017, and the consolidated statements of shareholders' equity and cash flows for the nine-month periods ended September 30, 2018 and 2017. Results of operations for interim periods are not necessarily indicative of results for the entire year. As a result, these financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2017 (2017 Annual Report).

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 Quarterly Report on Form 10-Q.

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.

9



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

Standard
Description
Date of Adoption
Effect on Financial Statements or Other Significant Matters
Accounting Standards Update (ASU) 2018-03
Technical Corrections and Improvements to Financial Instruments - Overall
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. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted the Financial Instruments - Overall - Recognition and Measurement guidance discussed below.
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.


10


Standard
Description
Date of Adoption
Effect on Financial Statements or Other Significant Matters
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. The amendments are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Public business entities may early adopt this guidance in any interim reporting period for which financial statements have not yet been issued. The amendments should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized.
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.
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. 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, including adoption in an interim period.

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.



11


Standard
Description
Date of Adoption
Effect on Financial Statements or Other Significant Matters
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.
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 2016-16 
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 flows classification issues.
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.


12


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 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 2018-15
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.


13


Standard
Description
Effect on Financial Statements or Other Significant Matters
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 disclosures 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) requirement to update assumptions for liability for future policy benefits, 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 it is expected that the adoption will have a significant impact on the Company’s financial position, results of operations, and disclosures. The Company expects that the requirement to update assumptions for liability for future policy benefits will have the most significant impact on its results of operations, systems, processes, and controls.

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 additional (and 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.

14


Standard
Description
Effect on Financial Statements or Other Significant Matters
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.
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 2017-12
Derivatives 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 will create more transparency around how economic results are presented on 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. 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 in any interim period after issuance of the guidance.

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, under this update, 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.

15


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, loan and loan receivables and reinsurance recoverables (See Notes 3 and 7 for current balances of instruments in scope). The Company is progressing towards updating its credit loss projection models and accounting systems 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.

16


Standard
Description
Effect on Financial Statements or Other Significant Matters
ASU 2016-02
Leases
In February 2016, the FASB established Topic 842, Leases, by issuing ASU No. 2016-02, which requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. Under the new guidance, lessor accounting is largely unchanged.

The new standard is effective for the Company on January 1, 2019, as we do not plan to early adopt. 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. The transition requirements for existing leases also apply to leases entered into between the date of initial application and the effective date. 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 will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019.

The new standard provides a number of optional practical expedients in transition. The Company expects to elect the ‘package of practical expedients’, which permits it not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs. The Company does not expect to elect the use-of-hindsight.
The Company has identified certain operating leases in scope of this guidance to include office space and equipment leases (See Note 15 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for current balances of leases in scope). The leases within scope of this guidance will increase the Company's ROU assets and lease liabilities recorded on its statement of financial position, however the Company estimates leases within scope of the guidance to represent less than 1% of its total assets as of September 30, 2018. 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. 

For additional information on new accounting pronouncements and recent accounting guidance and their impact, if any, on the Company's financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.

2.
BUSINESS SEGMENT 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 follows:

17


  
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
2018
 
2017
 
2018
 
2017
 
Revenues:
 
 
 
 
 
 
 
 
Aflac Japan:
 
 
 
 
 
 
 
 
   Net earned premiums
$
3,159

 
$
3,200

 
$
9,649

 
$
9,616

 
   Net investment income, less amortized hedge costs
606

 
561

 
1,801

 
1,676

 
   Other income
10

 
11

 
31

 
31

 
               Total Aflac Japan
3,775

 
3,772

 
11,481

 
11,323

 
Aflac U.S.:
 
 
 
 
 
 
 
 
   Net earned premiums
1,426

 
1,393

 
4,280

 
4,172

 
   Net investment income
187

 
181

 
544

 
539

 
   Other income
3

 
1

 
7

 
3

 
           Total Aflac U.S.
1,616

 
1,575

 
4,831

 
4,714

 
Corporate and other
82

 
69

 
245

 
204

 
           Total adjusted revenues
5,473

 
5,416

 
16,557

 
16,241

 
Realized investment gains (losses) (1),(2),(3)
104

 
90

 
75

 
2

 
           Total revenues
$
5,577

 
$
5,506

 
$
16,632

 
$
16,243

 
(1) Amortized hedge costs related to hedging U.S. dollar-denominated investments held in Aflac Japan were $59 and $60 for the three- month periods and $168 and for both the nine-month periods ended September 30, 2018, and 2017, 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 $9 for the three-month period and $18 for the nine-month period ended September 30, 2018, respectively, 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 the three- and nine-month periods ended September 30, 2018, were reclassified from realized investment gains (losses) into net investment income when analyzing operations.


18


  
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
2018
 
2017
 
2018
 
2017
 
Pretax earnings:
 
 
 
 
 
 
 
 
Aflac Japan
$
756

 
$
748

 
$
2,411

 
$
2,308

 
Aflac U.S.
334

 
316

 
1,011

 
956

 
Corporate and other
(29
)
 
(50
)
 
(113
)
 
(150
)
 
    Pretax adjusted earnings
1,061

 
1,014

 
3,309

 
3,114

 
Realized investment gains (losses) (1),(2),(3),(4)
88

 
71

 
25

 
(57
)
 
Other income (loss) 
(3
)
 
(10
)
 
(73
)
 
(38
)
 
    Total earnings before income taxes
$
1,146

 
$
1,075

 
$
3,261

 
$
3,019

 
Income taxes applicable to pretax adjusted earnings
$
270

 
$
338

 
$
862

 
$
1,031

 
Effect of foreign currency translation on after-tax
adjusted earnings
(1
)
 
(29
)
 
27

 
(31
)
 

(1) Amortized hedge costs related to hedging U.S. dollar-denominated investments held in Aflac Japan were $59 and $60 for the three- month periods and $168 for both the nine-month periods ended September 30, 2018, and 2017, 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 $9 for the three-month period and $18 for the nine-month period ended September 30, 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 the three- and nine-month periods ended September 30, 2018, were reclassified from realized investment gains (losses) into net investment income when analyzing operations.
(4) Excluding a gain of $17 and $19 for the three-month periods and $50 and $60 for the nine-month periods ended September 30, 2018, and 2017, respectively, 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


Assets were as follows:
(In millions)
September 30,
2018
 
December 31,
2017
Assets:
 
 
 
 
 
 
 
Aflac Japan
 
$
116,181

 
 
 
$
114,402

 
Aflac U.S.
 
19,585

 
 
 
19,893

 
Corporate and other
 
2,175

 
 
 
2,922

 
    Total assets
 
$
137,941

 
 
 
$
137,217

 



19


3.
INVESTMENTS
Investment Holdings
The amortized cost for the Company's investments in debt securities, the cost for equity securities and the fair values of these investments are shown in the following tables.
  
September 30, 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
 
$
29,499

 
 
 
$
2,955

 
 
 
$
426

 
 
 
$
32,028

 
Municipalities
 
376

 
 
 
25

 
 
 
17

 
 
 
384

 
Mortgage- and asset-backed securities
 
151

 
 
 
21

 
 
 
0

 
 
 
172

 
Public utilities
 
1,685

 
 
 
303

 
 
 
9

 
 
 
1,979

 
Sovereign and supranational
 
1,116

 
 
 
133

 
 
 
1

 
 
 
1,248

 
Banks/financial institutions
 
5,317

 
 
 
602

 
 
 
159

 
 
 
5,760

 
Other corporate
 
4,618

 
 
 
683

 
 
 
36

 
 
 
5,265

 
Total yen-denominated
 
42,762

 
 
 
4,722

 
 
 
648

 
 
 
46,836

 
  U.S. dollar-denominated:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agencies
 
136

 
 
 
7

 
 
 
1

 
 
 
142

 
Municipalities
 
1,339

 
 
 
123

 
 
 
12

 
 
 
1,450

 
Mortgage- and asset-backed securities
 
154

 
 
 
8

 
 
 
1

 
 
 
161

 
Public utilities
 
4,863

 
 
 
562

 
 
 
91

 
 
 
5,334

 
Sovereign and supranational
 
248

 
 
 
61

 
 
 
0

 
 
 
309

 
Banks/financial institutions
 
2,767

 
 
 
431

 
 
 
19

 
 
 
3,179

 
Other corporate
 
23,983

 
 
 
1,677

 
 
 
775

 
 
 
24,885

 
Total U.S. dollar-denominated
 
33,490

 
 
 
2,869

 
 
 
899

 
 
 
35,460

 
Total securities available for sale
 
$
76,252

(1) 
 
 
$
7,591

 
 
 
$
1,547

 
 
 
$
82,296

(1) 

(1) Includes perpetual securities ($1,408 at amortized cost and $1,591 at fair value)

  
September 30, 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
 
$
21,224

 
 
 
$
4,652

 
 
 
$
0

 
 
 
$
25,876

 
Municipalities
 
353

 
 
 
97

 
 
 
0

 
 
 
450

 
Mortgage- and asset-backed securities
 
14

 
 
 
1

 
 
 
0

 
 
 
15

 
Public utilities
 
3,150

 
 
 
302

 
 
 
1

 
 
 
3,451

 
Sovereign and supranational
 
1,516

 
 
 
276

 
 
 
0

 
 
 
1,792

 
Banks/financial institutions
 
1,491

 
 
 
163

 
 
 
11

 
 
 
1,643

 
Other corporate
 
2,673

 
 
 
356

 
 
 
6

 
 
 
3,023

 
Total yen-denominated
 
30,421

 
 
 
5,847

 
 
 
18

 
 
 
36,250

 
Total securities held to maturity
 
$
30,421

 
 
 
$
5,847

 
 
 
$
18

 
 
 
$
36,250

 



20


  
September 30, 2018
(In millions)
 
 
 
 
 
 
Fair  
Value  
Equity securities, carried at fair value through
  net earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities: (1) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
      Yen-denominated
 
 
 
 
 
 
 
 
 
 
 
 
 
$
707

 
      U.S. dollar-denominated
 
 
 
 
 
 
 
 
 
 
 
 
 
352

 
Total equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
$
1,059

(1) 

(1) Includes perpetual securities ($66 at fair value)

  
December 31, 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)


21


  
December 31, 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

 


  
December 31, 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 the first nine months of 2018, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category.

During the third quarter of 2017, the Company did not reclassify any investments from the held-to-maturity category to
the available-for-sale category. During the second quarter of 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 amortized cost of $773 million and an unrealized gain of $47 million. During the first quarter of 2017, the Company did not reclassify any investments from the held-to-maturity category to the available-for-sale category.
Contractual and Economic Maturities
The contractual and economic maturities of the Company's investments in fixed maturity securities at September 30, 2018, were as follows:

22


(In millions)
Amortized
Cost
 
Fair
Value
 
Available for sale: (1)
 
 
 
 
 
 
 
 
Due in one year or less
 
$
691

 
 
 
$
757

 
 
Due after one year through five years
 
8,058

 
 
 
8,199

 
 
Due after five years through 10 years
 
10,282

 
 
 
10,936

 
 
Due after 10 years
 
56,916

 
 
 
62,071

 
 
Mortgage- and asset-backed securities
 
305

 
 
 
333

 
 
Total fixed maturity securities available for sale
 
$
76,252

 
 
 
$
82,296

 
 
Held to maturity:
 
 
 
 
 
 
 
 
Due in one year or less
 
$
528

 
 
 
$
533

 
 
Due after one year through five years
 
541

 
 
 
569

 
 
Due after five years through 10 years
 
1,303

 
 
 
1,415

 
 
Due after 10 years
 
28,034

 
 
 
33,718

 
 
Mortgage- and asset-backed securities
 
15

 
 
 
15

 
 
Total fixed maturity securities held to maturity
 
$
30,421

 
 
 
$
36,250

 
 

(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 were as follows:
 
September 30, 2018
 
December 31, 2017
(In millions)
Credit
Rating
 
Amortized
Cost
 
Fair
Value
 
Credit
Rating
 
Amortized
Cost
 
Fair
Value
Japan National Government(1)
A+
 
$49,603
 
$56,679
 
A
 
$48,399
 
$56,532
(1)Japan Government Bonds (JGBs) or JGB-backed securities



23


Realized Investment Gains and Losses

Information regarding pretax realized gains and losses from investments is as follows:
  
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
2018
 
2017
 
2018
 
2017
 
Realized investment gains (losses):
 
 
 
 
 
 
 
 
Fixed maturity securities: (1)
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
Gross gains from sales
$
60

 
$
18

 
$
81

 
$
40

 
Gross losses from sales
(26
)
 
(5
)
 
(99
)
 
(24
)
 
Foreign currency gains (losses) on sales and redemptions
3

 
3

 
27

 
(47
)
 
Other-than-temporary impairment losses
0

 
(1
)
 
(2
)
 
(5
)
 
Total fixed maturity securities
37

 
15

 
7

 
(36
)
 
Equity securities (1),(2)
27


39

(3) 
(1
)
 
73

(3) 
Loan loss reserves
(5
)
 
(1
)
 
(15
)
 
(4
)
 
Derivatives and other:
 
 
 
 
 
 
 
 
Derivative gains (losses)
(162
)
 
(40
)
 
(190
)
 
(143
)
 
Foreign currency gains (losses)
159

 
17

 
123

 
(56
)
 
  Total derivatives and other
(3
)
 
(23
)
 
(67
)
 
(199
)
 
  Total realized investment gains (losses)
$
56

 
$
30

 
$
(76
)
 
$
(166
)
 

(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 $6 for the three-month period and $18 for the nine-month period ended September 30, 2017

The unrealized holding gains, net of losses, recorded as a component of realized investment gains and losses for the three-month period ended September 30, 2018, that relates to equity securities still held at the September 30, 2018, reporting date was $25 million. The unrealized holding gains, net of losses, recorded as a component of realized investment gains and losses for the nine-month period ended September 30, 2018, that relates to equity securities still held at the September 30, 2018, reporting date was $1 million.

Unrealized Investment Gains and Losses
Effect on Shareholders’ Equity
The net effect on shareholders’ equity of unrealized gains and losses from investment securities was as follows:
(In millions)
September 30, 2018
 
December 31,
2017
Unrealized gains (losses) on securities available for sale
 
$
6,044

 
 
 
$
9,358

 
Deferred income taxes
 
(1,804
)
 
 
 
(3,394
)
 
Shareholders’ equity, unrealized gains (losses) on investment securities
 
$
4,240

 
 
 
$
5,964

 

See Note 1 for discussion of the accounting treatment of tax on amounts recorded in accumulated other comprehensive income pursuant to the Tax Act and for the adoption of accounting guidance on January 1, 2018 related to financial instruments.

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.


24


  
September 30, 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
 
$
80

 
 
 
$
1

 
 
 
$
80

 
 
 
$
1

 
 
 
$
0

 
 
 
$
0

 
  Japan government and
agencies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Yen-denominated
 
9,221

 
 
 
426

 
 
 
9,221

 
 
 
426

 
 
 
0

 
 
 
0

 
  Municipalities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  U.S. dollar-denominated
 
490

 
 
 
12

 
 
 
490

 
 
 
12

 
 
 
0

 
 
 
0

 
  Yen-denominated
 
224

 
 
 
17

 
 
 
224

 
 
 
17

 
 
 
0

 
 
 
0

 
Mortgage- and asset-
backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  U.S. dollar-denominated
 
81

 
 
 
1

 
 
 
81

 
 
 
1

 
 
 
0

 
 
 
0

 
  Public utilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  U.S. dollar-denominated
 
1,726

 
 
 
91

 
 
 
1,721

 
 
 
91

 
 
 
5

 
 
 
0

 
  Yen-denominated
 
381

 
 
 
10

 
 
 
381

 
 
 
10

 
 
 
0

 
 
 
0

 
  Sovereign and supranational:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Yen-denominated
 
43

 
 
 
1

 
 
 
43

 
 
 
1

 
 
 
0

 
 
 
0

 
  Banks/financial institutions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  U.S. dollar-denominated
 
552

 
 
 
19

 
 
 
517

 
 
 
18

 
 
 
35

 
 
 
1

 
  Yen-denominated
 
2,806

 
 
 
170

 
 
 
2,806

 
 
 
170

 
 
 
0

 
 
 
0

 
  Other corporate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  U.S. dollar-denominated
 
11,731

 
 
 
775

 
 
 
11,291

 
 
 
744

 
 
 
440

 
 
 
31

 
  Yen-denominated
 
1,134

 
 
 
42

 
 
 
1,134

 
 
 
42

 
 
 
0

 
 
 
0

 
  Total
 
$
28,469

 
 
 
$
1,565

 
 
 
$
27,989

 
 
 
$
1,533

 
 
 
$
480

 
 
 
$
32

 
(1) Includes perpetual securities


25


  
December 31, 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 protections, 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.


26


Other Investments

The table below reflects the composition of the carrying value for other investments as of the periods presented.
(In millions)
September 30, 2018
 
December 31, 2017
Other investments:
 
 
 
 
 
 
 
Transitional real estate loans
 
$
4,128

 
 
 
$
1,235

 
Commercial mortgage loans
 
1,026

 
 
 
908

 
Middle market loans
 
1,363

 
 
 
859

 
Policy loans
 
223

 
 
 
210

 
Short-term investments
 
2

 
 
 
57

 
Other
 
267

 
 
 
133

 
Total other investments
 
$
7,009

 
 
 
$
3,402

 


Loans and Loan Receivables

The Company classifies its transitional real estate loans (TREs), commercial mortgage loans (CMLs) and middle market loans (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 September 30, 2018, and December 31, 2017, the Company's allowance for loan losses was $25 million and $11 million, respectively. As of September 30, 2018, and December 31, 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 September 30, 2018, and December 31, 2017. The Company had no troubled debt restructurings during the nine months ended September 30, 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 September 30, 2018, the Company had $720 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 September 30, 2018, the Company had $86 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 $155 million and $109 million, as of September 30, 2018, and December 31, 2017, respectively, that is reflected in other liabilities on the consolidated balance sheets.

As of September 30, 2018, the Company had commitments of approximately $896 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 September 30, 2018, the Company had $1.0 billion in outstanding commitments to fund alternative investments in limited partnerships.

27



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.
Investments in Consolidated Variable Interest Entities
 
September 30, 2018
 
December 31, 2017
(In millions)
Cost or Amortized
Cost
 
Fair
Value
 
Cost or Amortized
Cost
 
Fair
Value
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities, available for sale (1)
 
$
4,045

 
 
 
$
4,853

 
 
 
$
4,538

 
 
 
$
5,509

 
Equity securities
 
179

 
 
 
179

 
 
 
606

 
 
 
753

 
Other investments (2)
 
5,388

 
 
 
5,369

 
 
 
2,341

 
 
 
2,328

 
Other assets (3)
 
190

 
 
 
190

 
 
 
151

 
 
 
151

 
Total assets of consolidated VIEs
 
$
9,802

 
 
 
$
10,591

 
 
 
$
7,636

 
 
 
$
8,741

 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities (3)
 
$
101

 
 
 
$
101

 
 
 
$
128

 
 
 
$
128

 
Total liabilities of consolidated VIEs
 
$
101

 
 
 
$
101

 
 
 
$
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 investment in unit trust structures, the underlying collateral assets and funding of the Company's consolidated VIEs are generally static in nature.


28


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.
Investments in Variable Interest Entities Not Consolidated
  
September 30, 2018
 
December 31, 2017
(In millions)
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities, available for sale (1)
 
$
4,746

 
 
 
$
5,261

 
 
 
$
5,004

 
 
 
$
5,724

 
Fixed maturity securities, held to maturity
 
2,402

 
 
 
2,702

 
 
 
2,549

 
 
 
2,929

 
Other investments
 
33

 
 
 
33

 
 
 
55

 
 
 
55

 
Total investments in VIEs not consolidated
 
$
7,181

 
 
 
$
7,996

 
 
 
$
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.


29


Details of the Company's securities lending activities were as follows:
Securities Lending Transactions Accounted for as Secured Borrowings
September 30, 2018
Remaining Contractual Maturity of the Agreements
(In millions)
Overnight
and
Continuous
(1)
 
Up to 30
days
 
30-90 days
 
Greater
than 90
days
 
Total
Securities lending transactions:
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
Japan government and agencies
$
15

 
$
1,516

 
1

 
$
1,158

 
$
2,690

Public utilities
17

 
0

 
0

 
0

 
17

Banks/financial institutions
48

 
0

 
0

 
0

 
48

Other corporate
365

 
0

 
0

 
0

 
365

Equity securities
8

 
0

 
0

 
0

 
8

          Total borrowings
$
453

 
$
1,516

 
$
1

 
$
1,158

 
$
3,128

Gross amount of recognized liabilities for securities lending transactions
 
 
 
 
$
1,970

Amounts related to agreements not included in offsetting disclosure in Note 4
 
 
 
 
$
1,158

(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
December 31, 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 September 30, 2018, and December 31, 2017, respectively.

Certain fixed maturity securities can be pledged as collateral as part of derivative transactions, or pledged to support state deposit requirements or certain investment programs. For additional information regarding pledged securities related to derivative transactions, see Note 4.


30


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) swaps associated with the Company's notes payable, consisting of cross-currency interest rate swaps, also referred to as foreign currency swaps, associated with certain senior notes and its subordinated debentures; (4) foreign currency swaps and credit default swaps that are associated with investments in special-purpose entities, including VIEs where the Company is the primary beneficiary; and (5) interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments. The Company does not use derivative financial instruments for trading purposes, nor does it engage in leveraged derivative transactions. 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 are 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 a fixed amount of U.S. dollar put options and sell U.S. dollar call options. The combination of these two actions 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.

Foreign currency forwards and options are also used to hedge the currency risk associated with the net investment in Aflac Japan. In these forward transactions, Aflac agrees 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 uses 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 create 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 currencies at a future date at an agreed upon exchange rate. 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 mitigate a portion of volatility risk to investment income, the Company economically hedges interest rate fluctuations for certain of its variable–rate investments by entering into receive–fixed, pay–floating interest rate swaps. These derivatives are cleared and settled through a central clearinghouse.

31


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. 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.
  
 
September 30, 2018
 
 
December 31, 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

 
 
 
$
0

 
 
 
$
(5
)
 
 
$
75

 
 
 
$
0

 
 
 
$
(8
)
 
 
Total cash flow hedges
 
75

 
 
 
0

 
 
 
(5
)
 
 
75

 
 
 
0

 
 
 
(8
)
 
 
Fair value hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forwards
 
3,172

 
 
 
0

 
 
 
(67
)
 
 
7,640

 
 
 
2

 
 
 
(221
)
 
 
Foreign currency options
 
9,279

 
 
 
0

 
 
 
(12
)
 
 
7,670

 
 
 
0

 
 
 
(2
)
 
 
Total fair value hedges
 
12,451

 
 
 
0

 
 
 
(79
)
 
 
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
 
5,373

 
 
 
302

 
 
 
(202
)
 
 
5,386

 
 
 
296

 
 
 
(189
)
 
 
Foreign currency forwards
 
10,501

 
 
 
128

 
 
 
(210
)
 
 
3,683

 
 
 
20

 
 
 
(53
)
 
 
Foreign currency options
 
373

 
 
 
0

 
 
 
0

 
 
770

 
 
 
0

 
 
 
0

 
 
Credit default swaps
 
0

 
 
 
0

 
 
 
0

 
 
88

 
 
 
1

 
 
 
0

 
 
Interest rate swaps
 
2,250

 
 
 
0

 
 
 
(1
)
 
 
0

 
 
 
0

 
 
 
0

 
 
Total non-qualifying strategies
 
18,497

 
 
 
430

 
 
 
(413
)
 
 
9,927

 
 
 
317

 
 
 
(242
)
 
 
Total derivatives
 
$
31,023

 
 
 
$
430

 
 
 
$
(497
)
 
 
$
25,751

 
 
 
$
331

 
 
 
$
(474
)
 
 
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
$
11,232

 
 
 
$
430

 
 
 
$
0

 
 
$
10,948

 
 
 
$
331

 
 
 
$
0

 
 
Other liabilities
 
19,791

 
 
 
0

 
 
 
(497
)
 
 
14,803

 
 
 
0

 
 
 
(474
)
 
 
Total derivatives
 
$
31,023

 
 
 
$
430

 
 
 
$
(497
)
 
 
$
25,751

 
 
 
$
331

 
 
 
$
(474
)
 
 

Cash Flow Hedges
Certain of the Company's consolidated VIEs have foreign currency swaps that qualify for hedge accounting treatment. For those that have qualified, the Company has designated the derivative 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 maximum length of time for which these cash flows are hedged is eight years. The remaining derivatives in the Company's consolidated VIEs that have not qualified for hedge accounting are included in “non-qualifying strategies.”
Fair Value Hedges
The Company designates and accounts for certain foreign currency forwards and options as fair value hedges when they meet the requirements for hedge accounting. These foreign currency forwards and options hedge the foreign currency exposure of certain U.S. dollar-denominated investments held in Aflac Japan. The Company recognizes gains and losses on these derivatives and the related hedged items in current earnings within other gains (losses). 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 excluded from the assessment of hedge effectiveness.
The following table presents the gains and losses on derivatives and the related hedged items in fair value hedges.

32



Fair Value Hedging Relationships
(In millions)
 
 
Hedging Derivatives
 
Hedged Items
 
 
Hedging Derivatives
Hedged Items
 
Total
Gains (Losses)
 
Gains (Losses)
Excluded from Effectiveness Testing
 
Gains (Losses)
Included in Effectiveness Testing
 
 Gains (Losses)
 
Ineffectiveness
Recognized for Fair Value Hedge
Three Months Ended September 30, 2018:
 
 
 
 
 
 
 
Foreign currency
forwards
Fixed maturity securities
 
$
(106
)
 
$
(19
)
 
$
(87
)
 
$
83

 
$
(4
)
Foreign currency
options
Fixed maturity securities
 
(7
)
 
(7
)
 
0

 
0

 
0

Nine Months Ended September 30, 2018:
 
 
 
 
 
 
 
 
 
 
Foreign currency forwards
Fixed maturity securities
 
$
93

 
$
(88
)
 
$
181

 
$
(195
)
 
$
(14
)
Foreign currency options
Fixed maturity securities
 
(10
)
 
(10
)
 
0

 
0

 
0

Three Months Ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
Foreign currency
forwards
Fixed maturity and equity securities
 
$
(114
)
 
$
(53
)
 
$
(61
)
 
$
61

 
$
0

Foreign currency options
Fixed maturity securities
 
(14
)
 
(14
)
 
0

 
0

 
0

Nine Months Ended September 30, 2017:
 
 
 
 
 
 
 
 
 
 
Foreign currency forwards
Fixed maturity and equity securities
 
$
193

 
$
(151
)
 
$
344

 
$
(326
)
 
$
18

Foreign currency options
Fixed maturity securities
 
3

 
(8
)
 
11

 
(10
)
 
1



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 8) have been designated as non-derivative hedges and, prior to April 1, 2018, foreign currency forwards and options have been designated as derivative hedges of the foreign currency exposure of the Company's net investment in Aflac Japan.

The Company's net investment hedge was effective during the three- and nine-month periods ended September 30, 2018 and 2017, respectively.
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 September 30, 2018, the Parent Company had cross-currency interest rate swap agreements related to its $550 million senior notes due March 2020, $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 8 in this report and Note 9 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.
The Company uses foreign exchange forwards and options to mitigate the currency risk of some of its U.S. dollar-denominated loan receivables held within the Aflac Japan segment. The Company has not elected to apply hedge accounting for these loan receivables due to the change in fair value of the foreign exchange forwards and the foreign

33


currency remeasurement of the loan receivables being recorded through current period earnings, and generally offsetting each other within realized investment gains (losses).
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, starting in the first quarter of 2018, the Parent Company began entering 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.

34


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.

 
  Three Months Ended September 30,
Nine Months Ended September 30,
 
2018
2017
2018
2017
(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)
Realized Investment
Gains (Losses)
Other
Comprehensive
Income (Loss)
(1)
Qualifying
hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Cash flow
    hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Foreign
         currency
         swaps
 
$
0

 
 
$
(2
)
 
 
$
0

 
 
$
(1
)
 
 
$
1

 
 
$
2

 
 
$
0

 
 
$
0

 
  Total cash flow
    hedges
 
0

 
 
(2
)
 
 
0

 
 
(1
)
 
 
1

 
 
2

 
 
0

 
 
0

 
  Fair value
    hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Foreign
         currency
         forwards(2)
 
(23
)
 
 
 
 
 
(53
)
 
 
 
 
 
(102
)
 
 
 
 
 
(133
)
 
 
 
 
       Foreign
         currency
         options(2)
 
(7
)
 
 
 
 
 
(14
)
 
 
 
 
 
(10
)
 
 
 
 
 
(7
)
 
 
 
 
  Total fair value
    hedges
 
(30
)
 
 
 
 
 
(67
)
 
 
 
 
 
(112
)
 
 
 
 
 
(140
)
 
 
 
 
  Net investment
    hedge:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Non-
         derivative
         hedging
         instruments
 
0

 
 
36

 
 
0

 
 
5

 
 
0

 
 
7

 
 
0

 
 
(13
)
 
       Foreign
         currency
         forwards
 
0

 
 
0

 
 
0

 
 
4

 
 
0

 
 
0

 
 
0

 
 
(24
)
 
       Foreign
         currency
         options
 
0

 
 
0

 
 
0

 
 
(5
)
 
 
0

 
 
(8
)
 
 
0

 
 
3

 
  Total net
    investment
    hedge
 
0

 
 
36

 
 
0

 
 
4

 
 
0

 
 
(1
)
 
 
0

 
 
(34
)
 
  Non-qualifying
    strategies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Foreign
         currency
         swaps
 
23

 
 
 
 
 
17

 
 
 
 
 
51

 
 
 
 
 
43

 
 
 
 
       Foreign
         currency
         forwards
 
(154
)
 
 
 
 
 
10

 
 
 
 
 
(129
)
 
 
 
 
 
(46
)
 
 
 
 
       Foreign
         currency
         options
 
0

 
 
 
 
 
0

 
 
 
 
 
0

 
 
 
 
 
0

 
 
 
 
       Interest
         rate
         swaps
 
(1
)
 
 
 
 
 
0

 
 
 
 
 
(1
)
 
 
 
 
 
0

 
 
 
 
  Total non-
    qualifying
    strategies
 
(132
)
 
 
 
 
 
27

 
 
 
 
 
(79
)
 
 
 
 
 
(3
)
 
 
 
 
          Total
 
$
(162
)
 
 
$
34

 
 
$
(40
)
 
 
$
3

 
 
$
(190
)
 
 
$
1

 
 
$
(143
)
 
 
$
(34
)
 
(1) Cash flow hedge items 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 shown net of effect of hedged items (see Fair Value Hedges section of this Note 4 for further detail)

The Company reclassified an immaterial amount related to its cash flow hedges from accumulated other comprehensive income (loss) into earnings for the three- and nine-month periods ended September 30, 2018 and 2017.

35


There was no gain or loss reclassified from accumulated other comprehensive income (loss) into earnings related to the net investment hedge for the three- and nine-month periods ended September 30, 2018 and 2017. As of September 30, 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, and foreign currency options is mitigated by collateral posting requirements that counterparties to those transactions must meet.

As of September 30, 2018, there were 15 counterparties to the Company's derivative agreements, with three comprising 51% of the aggregate notional amount. The counterparties to these derivatives are financial institutions with the following credit ratings:
 
September 30, 2018
December 31, 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
 
$
5,207

 
 
$
79

 
 
$
(42
)
 
 
$
4,708

 
 
$
52

 
 
$
(37
)
 
A
 
25,378

 
 
345

 
 
(401
)
 
 
20,604

 
 
271

 
 
(370
)
 
BBB
 
438

 
 
6

 
 
(54
)
 
 
439

 
 
8

 
 
(67
)
 
Total
 
$
31,023

 
 
$
430

 
 
$
(497
)
 
 
$
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 $301 million and $264 million as of September 30, 2018, and December 31, 2017, respectively. If the credit-risk-related contingent features underlying these agreements had been triggered on September 30, 2018, the Company estimates that it would be required to post a maximum of $79 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.)

36



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.

The tables below summarize the Company's derivatives and securities lending transactions, 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.

Offsetting of Financial Assets and Derivative Asset
September 30, 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
 
$
240

 
 
 
$
0

 
 
 
$
240

 
 
 
$
(118
)
 
 
$
(10
)
 
 
$
(109
)
 
 
 
$
3

 
    Total derivative
      assets subject to a
      master netting
      agreement or
      offsetting
      arrangement
 
240

 
 

0

 
 
 
240

 
 
 
(118
)
 
 
(10
)
 
 
(109
)
 
 
 
3

 
    Derivative
      assets not subject
      to a master netting
      agreement or
      offsetting
      arrangement
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
          OTC - bilateral
 
190

 
 
 
 
 
 
 
190

 
 
 
 
 
 
 
 
 
 
 
 
 
190

 
    Total derivative
      assets not subject
      to a master netting
      agreement or
      offsetting
      arrangement
 
190

 
 
 
 
 
 
 
190

 
 
 
 
 
 
 
 
 
 
 
 
 
190

 
    Total derivative
      assets
 
430

 
 
 
0

 
 
 
430

 
 
 
(118
)
 
 
(10
)
 
 
(109
)
 
 
 
193

 
Securities lending
   and similar
   arrangements
 
1,927

 
 
 
0

 
 
 
1,927

 
 
 
0

 
 
0

 
 
(1,927
)
 
 
 
0

 
    Total
 
$
2,357

 
 
 
$
0

 
 
 
$
2,357

 
 
 
$
(118
)
 
 
$
(10
)
 
 
$
(2,036
)
 
 
 
$
193

 

37



December 31, 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

 






















38


Offsetting of Financial Liabilities and Derivative Liabilities
September 30, 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
 
$
(395
)
 
 
 
$
0

 
 
 
$
(395
)
 
 
 
$
118

 
 
$
195

 
 
$
26

 
 
 
$
(56
)
 
          OTC - cleared
 
(1
)
 
 
 
0

 
 
 
(1
)
 
 
 
0

 
 
0

 
 
1

 
 
 
0

 
    Total derivative
      liabilities subject
      to a master netting
      agreement or
      offsetting
      arrangement
 
(396
)
 
 
 
0

 
 
 
(396
)
 
 
 
118

 
 
195

 
 
27

 
 
 
(56
)
 
    Derivative
      liabilities not
      subject to a
      master netting
      agreement or
      offsetting
      arrangement
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
          OTC - bilateral
 
(101
)
 
 
 
 
 
 
 
(101
)
 
 
 
 
 
 
 
 
 
 
 
 
 
(101
)
 
    Total derivative
      liabilities not
      subject to a
      master netting
      agreement or
      offsetting
      arrangement
 
(101
)
 
 
 
 
 
 
 
(101
)
 
 
 
 
 
 
 
 
 
 
 
 
 
(101
)
 
    Total derivative
      liabilities
 
(497
)
 
 
 
0

 
 
 
(497
)
 
 
 
118

 
 
195

 
 
27

 
 
 
(157
)
 
Securities lending
   and similar
   arrangements
 
(1,970
)
 
 
 
0

 
 
 
(1,970
)
 
 
 
1,927

 
 
0

 
 
0

 
 
 
(43
)
 
    Total
 
$
(2,467
)
 
 
 
$
0

 
 
 
$
(2,467
)
 
 
 
$
2,045

 
 
$
195

 
 
$
27

 
 
 
$
(200
)
 



39


December 31, 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 and Notes 1, 3 and 5 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.

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.


40


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.
  
September 30, 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
 
$
30,888

 
 
 
$
1,282

 
 
 
$
0

 
 
 
$
32,170

 
Municipalities
 
0

 
 
 
1,834

 
 
 
0

 
 
 
1,834

 
Mortgage- and asset-backed securities
 
0

 
 
 
161

 
 
 
172

 
 
 
333

 
Public utilities
 
0

 
 
 
7,209

 
 
 
104

 
 
 
7,313

 
Sovereign and supranational
 
0

 
 
 
1,557

 
 
 
0

 
 
 
1,557

 
Banks/financial institutions
 
0

 
 
 
8,916

 
 
 
23

 
 
 
8,939

 
Other corporate
 
0

 
 
 
29,959

 
 
 
191

 
 
 
30,150

 
Total fixed maturity securities
 
30,888

 
 
 
50,918

 
 
 
490

 
 
 
82,296

(1) 
Equity securities (1)
 
972

 
 
 
71

 
 
 
16

 
 
 
1,059

(1) 
Other investments
 
2

 
 
 
0

 
 
 
0

 
 
 
2

 
Cash and cash equivalents
 
3,429

 
 
 
0

 
 
 
0

 
 
 
3,429

 
Other assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency swaps
 
0

 
 
 
112

 
 
 
190

 
 
 
302

 
Foreign currency forwards
 
0

 
 
 
128

 
 
 
0

 
 
 
128

 
Total other assets
 
0

 
 
 
240

 
 
 
190

 
 
 
430

 
Total assets
 
$
35,291

 
 
 
$
51,229

 
 
 
$
696

 
 
 
$
87,216

 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency swaps
 
$
0

 
 
 
$
106

 
 
 
$
101

 
 
 
$
207

 
Foreign currency forwards
 
0

 
 
 
277

 
 
 
0

 
 
 
277

 
Foreign currency options
 
0

 
 
 
12

 
 
 
0

 
 
 
12

 
Interest rate swaps
 
0

 
 
 
1

 
 
 
0

 
 
 
1

 
Total liabilities
 
$
0

 
 
 
$
396

 
 
 
$
101

 
 
 
$
497

 
(1) Includes perpetual securities



41


  
December 31, 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





42


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.
  
September 30, 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
 
$
21,224

 
 
$
25,868

 
 
 
$
8

 
 
 
$
0

 
 
 
$
25,876

 
Municipalities
 
353

 
 
0

 
 
 
450

 
 
 
0

 
 
 
450

 
Mortgage and asset-backed
securities
 
14

 
 
0

 
 
 
0

 
 
 
15

 
 
 
15

 
Public utilities
 
3,150

 
 
0

 
 
 
3,451

 
 
 
0

 
 
 
3,451

 
Sovereign and
supranational
 
1,516

 
 
0

 
 
 
1,792

 
 
 
0

 
 
 
1,792

 
Banks/financial institutions
 
1,491

 
 
0

 
 
 
1,643

 
 
 
0

 
 
 
1,643

 
Other corporate
 
2,673

 
 
0

 
 
 
3,023

 
 
 
0

 
 
 
3,023

 
Other investments (1)
 
6,542

 
 
0

 
 
 
25

 
 
 
6,494

 
 
 
6,519

 
 Total assets
 
$
36,963

 
 
$
25,868

 
 
 
$
10,392

 
 
 
$
6,509

 
 
 
$
42,769

 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other policyholders’ funds
 
$
6,974

 
 
$
0

 
 
 
$
0

 
 
 
$
6,896

 
 
 
$
6,896

 
Notes payable
(excluding capital leases)
 
5,264

 
 
0

 
 
 
5,066

 
 
 
263

 
 
 
5,329

 
Total liabilities
 
$
12,238

 
 
$
0

 
 
 
$
5,066

 
 
 
$
7,159

 
 
 
$
12,225

 
(1) Excludes policy loans of $223 and equity method investments of $242, at carrying value

43


  
December 31, 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

44


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.

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.

45


 
 
September 30, 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
 
 
$
30,888

 
 
 
$
1,282

 
 
 
$
0

 
 
 
$
32,170

 
               Total government and agencies
 
 
30,888

 
 
 
1,282

 
 
 
0

 
 
 
32,170

 
         Municipalities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
1,834

 
 
 
0

 
 
 
1,834

 
               Total municipalities
 
 
0

 
 
 
1,834

 
 
 
0

 
 
 
1,834

 
         Mortgage- and asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
161

 
 
 
0

 
 
 
161

 
            Broker/other
 
 
0

 
 
 
0

 
 
 
172

 
 
 
172

 
               Total mortgage- and asset-backed securities
 
 
0

 
 
 
161

 
 
 
172

 
 
 
333

 
         Public utilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
7,209

 
 
 
0

 
 
 
7,209

 
            Broker/other
 
 
0

 
 
 
0

 
 
 
104

 
 
 
104

 
               Total public utilities
 
 
0

 
 
 
7,209

 
 
 
104

 
 
 
7,313

 
         Sovereign and supranational:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
1,557

 
 
 
0

 
 
 
1,557

 
               Total sovereign and supranational
 
 
0

 
 
 
1,557

 
 
 
0

 
 
 
1,557

 
         Banks/financial institutions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
8,916

 
 
 
0

 
 
 
8,916

 
            Broker/other
 
 
0

 
 
 
0

 
 
 
23

 
 
 
23

 
               Total banks/financial institutions
 
 
0

 
 
 
8,916

 
 
 
23

 
 
 
8,939

 
         Other corporate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
29,861

 
 
 
0

 
 
 
29,861

 
            Broker/other
 
 
0

 
 
 
98

 
 
 
191

 
 
 
289

 
               Total other corporate
 
 
0

 
 
 
29,959

 
 
 
191

 
 
 
30,150

 
                  Total securities available for sale
 
 
$
30,888

 
 
 
$
50,918

 
 
 
$
490

 
 
 
$
82,296

(1) 
Equity securities, carried at fair value: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
$
972

 
 
 
$
71

 
 
 
$
0

 
 
 
$
1,043

 
            Broker/other
 
 
0

 
 
 
0

 
 
 
16

 
 
 
16

 
               Total equity securities
 
 
$
972

 
 
 
$
71

 
 
 
$
16

 
 
 
$
1,059

(1) 

(1) Includes perpetual securities







46


 
 
September 30, 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
 
 
$
25,868

 
 
 
$
8

 
 
 
$
0

 
 
 
$
25,876

 
               Total government and agencies
 
 
25,868

 
 
 
8

 
 
 
0

 
 
 
25,876

 
         Municipalities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
450

 
 
 
0

 
 
 
450

 
               Total municipalities
 
 
0

 
 
 
450

 
 
 
0

 
 
 
450

 
         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

 
 
 
3,451

 
 
 
0

 
 
 
3,451

 
               Total public utilities
 
 
0

 
 
 
3,451

 
 
 
0

 
 
 
3,451

 
         Sovereign and supranational:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
1,792

 
 
 
0

 
 
 
1,792

 
               Total sovereign and supranational
 
 
0

 
 
 
1,792

 
 
 
0

 
 
 
1,792

 
         Banks/financial institutions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
1,643

 
 
 
0

 
 
 
1,643

 
               Total banks/financial institutions
 
 
0

 
 
 
1,643

 
 
 
0

 
 
 
1,643

 
         Other corporate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            Third party pricing vendor
 
 
0

 
 
 
3,023

 
 
 
0

 
 
 
3,023

 
               Total other corporate
 
 
0

 
 
 
3,023

 
 
 
0

 
 
 
3,023

 
                  Total securities held to maturity
 
 
$
25,868

 
 
 
$
10,367

 
 
 
$
15

 
 
 
$
36,250

 





47


 
 
December 31, 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




48


 
 
December 31, 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

 





49


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. 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 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 and subordinated debentures 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.

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.




50


Transfers between Hierarchy Levels and Level 3 Rollforward

During the three- and nine-month periods ended September 30, 2018 and 2017, respectively, 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.

The following tables present the changes in fair value of the Company's investments and derivatives carried at fair value classified as Level 3.
Three Months Ended
September 30, 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
$
178

 
$
106

 
$
23

 
$
196

 
$
17

 
$
110

 
$
0

 
$
630

 
Realized investment gains (losses) included
   in earnings
0

 
0

 
0

 
0

 
(1
)
 
(19
)
 
0

 
(20
)
 
Unrealized gains (losses) included in other
   comprehensive income (loss)
(6
)
 
(2
)
 
0

 
(4
)
 
0

 
(2
)
 
0

 
(14
)
 
Purchases, issuances, sales and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Issuances
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Sales
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Settlements
0

 
0

 
0

 
(1
)
 
0

 
0

 
0

 
(1
)
 
Transfers into Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Transfers out of Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Balance, end of period
$
172

 
$
104

 
$
23

 
$
191

 
$
16

 
$
89

 
$
0

 
$
595

 
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
)
 
$
(19
)
 
$
0

 
$
(20
)
 

(1) Derivative assets and liabilities are presented net
Three Months Ended
September 30, 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
$
188

 
$
53

 
$
25

 
$
77

 
$
14

 
$
7

 
$
2

 
$
366

 
Realized investment gains (losses) included in
earnings
0

 
0

 
0

 
0

 
0

 
8

 
(1
)
 
7

 
Unrealized gains (losses) included in other
comprehensive income (loss)
(2
)
 
0

 
0

 
1

 
0

 
0

 
0

 
(1
)
 
Purchases, issuances, sales and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
0

 
24

 
0

 
25

 
4

 
0

 
0

 
53

 
Issuances
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Sales
0

 
0

 
0

 
(1
)
 
0

 
0

 
0

 
(1
)
 
Settlements
(8
)
 
0

 
0

 
0

 
0

 
0

 
0

 
(8
)
 
Transfers into Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Transfers out of Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Balance, end of period
$
178

 
$
77

 
$
25

 
$
102

 
$
18

 
$
15

 
$
1

 
$
416

 
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

 
$
8

 
$
(1
)
 
$
7

 
(1) Derivative assets and liabilities are presented net

51


Nine Months Ended
September 30, 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
)
 
65

 
(1
)
 
63

 
Unrealized gains (losses) included in other
comprehensive income (loss)
(3
)
 
(4
)
 
(2
)
 
(6
)
 
0

 
2

 
0

 
(13
)
 
Purchases, issuances, sales and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
0

 
40

 
0

 
55

 
1

 
0

 
0

 
96

 
Issuances
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Sales
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Settlements
0

 
0

 
0

 
(4
)
 
0

 
0

 
0

 
(4
)
 
Transfers into Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Transfers out of Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Balance, end of period
$
172

 
$
104

 
$
23

 
$
191

 
$
16

 
$
89

 
$
0

 
$
595

 
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
)
 
$
65

 
$
(1
)
 
$
63

 
(1) Derivative assets and liabilities are presented net

Nine Months Ended
September 30, 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

 
36

 
(1
)
 
35

 
Unrealized gains (losses) included in other
   comprehensive income (loss)
4

 
0

 
0

 
3

 
0

 
0

 
0

 
7

 
Purchases, issuances, sales and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
0

 
61

 
0

 
100

 
16

 
0

 
0

 
177

 
Issuances
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Sales
0

 
0

 
0

 
(1
)
 
(1
)
 
0

 
0

 
(2
)
 
Settlements
(24
)
 
0

 
0

 
0

 
0

 
0

 
0

 
(24
)
 
Transfers into Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Transfers out of Level 3
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
Balance, end of period
$
178

 
$
77

 
$
25

 
$
102

 
$
18

 
$
15

 
$
1

 
$
416

 
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

 
$
36

 
$
(1
)
 
$
35

 
(1) Derivative assets and liabilities are presented net



52


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. Included in the tables are the inputs or range of possible inputs that have an effect on the overall valuation of the financial instruments.
September 30, 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
 
 
$
172

 
 
Consensus pricing
 
Offered quotes
 
N/A
(a) 
       Public utilities
 
 
104

 
 
Discounted cash flow
 
Credit spreads
 
N/A
(a) 
       Banks/financial institutions
 
 
23

 
 
Consensus pricing
 
Offered quotes
 
N/A
(a) 
       Other corporate
 
 
191

 
 
Discounted cash flow
 
Credit spreads
 
N/A
(a) 
  Equity securities
 
 
16

 
 
Net asset value
 
Offered quotes
 
N/A
(a) 
  Other assets:
 
 
 
 
 
 
 
 
 

 
       Foreign currency swaps
 
 
133

 
 
Discounted cash flow
 
Interest rates (USD)
 
3.27% - 3.30%
(b) 
 
 
 
 
 
 
 
 
Interest rates (JPY)
 
.36% - .96%
(c) 
 
 
 
 
 
 
 
 
CDS spreads
 
12 - 101 bps
 
 
 
 
57

 
 
Discounted cash flow
 
Interest rates (USD)
 
3.27% - 3.30%
(b) 
 
 
 
 
 
 
 
 
Interest rates (JPY)
 
.36% - .96%
(c) 
            Total assets
 
 
$
696

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
  Other liabilities:
 
 
 
 
 
 
 
 
 
 
 
       Foreign currency swaps
 
 
$
96

 
 
Discounted cash flow
 
Interest rates (USD)
 
3.27% - 3.30%
(b) 
 
 
 
 
 
 
 
 
Interest rates (JPY)
 
.36% - .96%
(c) 
 
 
 
 
 
 
 
 
CDS spreads
 
31 - 196 bps
 
 
 
 
5

 
 
Discounted cash flow
 
Interest rates (USD)
 
3.27% - 3.30%
(b) 
 
 
 
 
 
 
 
 
Interest rates (JPY)
 
.36% - .96%
(c) 
            Total liabilities
 
 
$
101

 
 
 
 
 
 
 
 

(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




53


December 31, 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



54


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, CDS Spreads, Foreign Exchange Rates

The significant drivers of the valuation of the interest and foreign exchange swaps are interest rates, foreign exchange 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).
A similar sensitivity pattern is observed for the foreign exchange rates. When the spot U.S. dollar/Japanese yen (USD/JPY) foreign exchange rate decreases and the swap is receiving a final exchange payment in JPY, the swap value will increase due to the appreciation of the JPY. Most of the Company's swaps are designed to receive payments in JPY at the termination and will thus be impacted by the USD/JPY foreign exchange rate in this way. In cases where there is no final foreign exchange receivable in JPY and the Company is paying JPY as interest payments and receiving USD, a decrease in the foreign exchange rate will lead to a decrease in the swap value.

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 and Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.

6.
POLICY LIABILITIES

Changes in the liability for unpaid policy claims were as follows:

55


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Unpaid supplemental health claims, beginning of period
 
$
3,942

 
$
3,872

 
 
 
$
3,881

 
$
3,707

 
 
Less reinsurance recoverables
 
29

 
30

 
 
 
28

 
27

 
 
Net balance, beginning of period
 
3,913

 
3,842

 
 
 
3,853

 
3,680

 
 
Add claims incurred during the period related to:
 
 
 
 
 
 
 
 
 
 
 
 
Current year
 
1,760

 
1,759

 
 
 
5,381

 
5,278

 
 
Prior years
 
(131
)
 
(126
)
 
 
 
(456
)
 
(386
)
 
 
Total incurred
 
1,629

 
1,633

 
 
 
4,925

 
4,892

 
 
Less claims paid during the period on claims incurred during:
 
 
 
 
 
 
 
 
 
 
 
 
Current year
 
1,357

 
1,357

 
 
 
3,109

 
3,074

 
 
Prior years
 
217

 
234

 
 
 
1,751

 
1,697

 
 
Total paid
 
1,574

 
1,591

 
 
 
4,860

 
4,771

 
 
Effect of foreign exchange rate changes on unpaid claims
 
(59
)
 
(14
)
 
 
 
(9
)
 
69

 
 
Net balance, end of period
 
3,909

 
3,870

 
 
 
3,909

 
3,870

 
 
Add reinsurance recoverables
 
29

 
30

 
 
 
29

 
30

 
 
Unpaid supplemental health claims, end of period
 
3,938

 
3,900

 
 
 
3,938

 
3,900

 
 
Unpaid life claims, end of period
 
592

 
468

 
 
 
592

 
468

 
 
Total liability for unpaid policy claims
 
$
4,530

 
$
4,368

 
 
 
$
4,530

 
$
4,368

 
 


The incurred claims development related to prior years reflects favorable claims experience compared to previous estimates. The favorable claims development of $456 million for the nine-month period ended September 30, 2018 comprises approximately $325 million from Japan, which represents approximately 71% of the total. Excluding the impact of foreign exchange of a loss of approximately $13 million from December 31, 2017 to September 30, 2018, the favorable claims development in Japan would have been approximately $312 million, representing approximately 68% 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.

The remainder of the favorable claims development related to prior years for the nine-month period ended September 30, 2018, reflects Aflac U.S. favorable claims experience compared to previous estimates, primarily in the cancer and accident lines of business.

7.
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 $989 million, as of September 30, 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 $917 million and $908 million as of September 30, 2018, and December 31, 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

56


weakened by approximately .5% and ceded reserves increased approximately 1.3% from December 31, 2017, to September 30, 2018.

The following table reconciles direct premium income and direct benefits and claims to net amounts after the effect of reinsurance.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(In millions)
2018
 
2017
 
2018
 
2017
Direct premium income
 
$
4,720

 
 
 
$
4,734

 
 
 
$
14,346

 
 
 
$
14,210

 
Ceded to other companies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Ceded Aflac Japan closed blocks
 
(122
)
 
 
 
(130
)
 
 
 
(378
)
 
 
 
(390
)
 
    Other
 
(15
)
 
 
 
(12
)
 
 
 
(45
)
 
 
 
(37
)
 
Assumed from other companies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Retrocession activities
 
51

 
 
 
54

 
 
 
158

 
 
 
163

 
    Other
 
2

 
 
 
2

 
 
 
5

 
 
 
5

 
Net premium income
 
$
4,636

 
 
 
$
4,648

 
 
 
$
14,086

 
 
 
$
13,951

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Direct benefits and claims
 
$
3,076

 
 
 
$
3,157

 
 
 
$
9,301

 
 
 
$
9,403

 
Ceded benefits and change in reserves for future benefits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Ceded Aflac Japan closed blocks
 
(111
)
 
 
 
(118
)
 
 
 
(343
)
 
 
 
(359
)
 
    Eliminations
 
10

 
 
 
13

 
 
 
33

 
 
 
39

 
    Other
 
(11
)
 
 
 
(9
)
 
 
 
(34
)
 
 
 
(31
)
 
Assumed from other companies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Retrocession activities
 
48

 
 
 
53

 
 
 
149

 
 
 
159

 
    Eliminations
 
(10
)
 
 
 
(13
)
 
 
 
(33
)
 
 
 
(39
)
 
    Other
 
0

 
 
 
0

 
 
 
2

 
 
 
2

 
Benefits and claims, net
 
$
3,002

 
 
 
$
3,083

 
 
 
$
9,075

 
 
 
$
9,174

 

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 2017 and is effective until December 31, 2018. 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 September 30, 2018, the Company has not executed a reinsurance treaty under this committed reinsurance facility.
8.
NOTES PAYABLE

A summary of notes payable follows:

57


(In millions)
September 30, 2018
 
December 31, 2017
2.40% senior notes due March 2020
 
$
549

 
 
 
$
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

 
Yen-denominated senior notes and subordinated debentures:
 
 
 
 
 
 
 
.932% senior notes due January 2027 (principal amount 60.0 billion yen)
 
525

 
 
 
528

 
2.108% subordinated debentures due October 2047 (principal amount 60.0 billion yen)
 
523

 
 
 
526

 
Yen-denominated loans:
 
 
 
 
 
 
 
Variable interest rate loan due September 2021 (.32% in 2018 and 2017, principal amount 5.0 billion yen)
 
44

 
 
 
44

 
Variable interest rate loan due September 2023 (.47% in 2018 and 2017, principal amount 25.0 billion yen)
 
219

 
 
 
220

 
Capitalized lease obligations payable through 2025
 
15

 
 
 
22

 
Total notes payable
 
$
5,279

 
 
 
$
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.




58


A summary of the Company's lines of credit as of September 30, 2018 follows:
Borrower
Type
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
November 30, 2018
$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(1)
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(2)
uncommitted revolving
364 days
November 30, 2018
$250 million
$0 million
USD three-month LIBOR plus 75 basis points per annum
3 months
None
General corporate purposes
Aflac Incorporated(2)
uncommitted revolving
364 days
April 2, 2019
37.5 billion yen
0.0 billion yen
Three-month TIBOR plus 80 basis points per annum
3 months
None
General corporate purposes
(1) Effective April 4, 2018, the prior expiration date of September 18, 2020 was extended to April 4, 2023.
(2) Intercompany credit agreement

The Company was in compliance with all of the covenants of its notes payable and lines of credit at September 30, 2018. No events of default or defaults occurred during the nine-month period ended September 30, 2018.

For additional information, see Notes 4 and 9 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.


59


9.
INCOME TAXES

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 imposes 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%.

The Company expects to complete its accounting for the effects of the Tax Act over the measurement period of up to one year from the enactment date, as permitted by SEC Staff Accounting Bulletin No. 118 (SAB 118). 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 Company believes that these amounts represent reasonable estimates in accordance with SAB 118. 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. As of the third quarter of 2018, the Company has no update to this estimated benefit.

The following includes an overview of the existing current and deferred balances for which calculation of income tax effects of the Tax Act has not been completed:

Japan deferred tax balances: The Tax Act reduces the U.S. tax rate to 21%, effective January 1, 2018. Prior to the reduction in rate, the Japan deferred tax balances were completely offset by an anticipatory foreign tax credit. As a result of the rate reduction, the Japan deferred tax balance will no longer be offset by an anticipatory foreign tax credit as all of the foreign tax credits will be used to offset the U.S. deferred tax balance of the Aflac Japan branch.

The Company has not yet completed its analysis of the components of the Japan tax computation, including a complete validation of the Aflac Japan tax basis. Additional time is needed to collect, analyze, and validate the detailed data underlying the deferred tax amounts in the Aflac Japan branch. As of the fourth quarter of 2017, the Company had recorded a provisional amount of $4.5 billion of net DTL related to this item.

Valuation allowances: The Company must assess whether its valuation allowance analyses are impacted by various aspects of the Tax Act with a primary focus on any unused anticipatory foreign tax credits. As the Company has recorded provisional amounts related to the Japan deferred tax balances, any corresponding determination of the need for or change in a valuation allowance is also provisional. As of the fourth quarter of 2017, the Company had recorded a provisional valuation allowance of $.7 billion against its anticipatory foreign tax credit asset.

The impact of the Tax Act may differ, possibly materially, from the recorded provisional amounts.

10.
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.

The following table is a reconciliation of the number of shares of the Company's common stock for the nine-month periods ended September 30.

60


(In thousands of shares)
2018
 
2017
Common stock - issued:
 
 
 
Balance, beginning of period
1,345,762

 
1,342,498

Exercise of stock options and issuance of restricted shares
1,614

 
2,840

Balance, end of period
1,347,376

 
1,345,338

Treasury stock:
 
 
 
Balance, beginning of period
564,852

 
530,877

Purchases of treasury stock:
 
 
 
Open market
20,443

 
27,796

Other
361

 
872

Dispositions of treasury stock:
 
 
 
Shares issued to AFL Stock Plan
(850
)
 
(1,392
)
Exercise of stock options
(430
)
 
(526
)
Other
(113
)
 
(39
)
Balance, end of period
584,263

 
557,588

Shares outstanding, end of period
763,113

 
787,750



Outstanding share-based awards are excluded from the calculation of weighted-average shares used in the computation of basic earnings per share (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 for the following periods.
 
Three Months Ended
September 30,
Nine Months Ended
September 30,
 
(In thousands)
2018
 
2017
2018
 
2017
Anti-dilutive share-based awards
 
46

 
 
 
532

 
 
34

 
 
 
670

 


Share Repurchase Program

During the first nine months of 2018, the Company repurchased 20.4 million shares of its common stock in the open market for $923 million as part of its share repurchase program. During the first nine months of 2017, the Company repurchased 27.8 million shares of its common stock in the open market for $1.0 billion as part of its share repurchase program. In August 2017, the Company's board of directors authorized the purchase of an additional 40 million shares of its common stock, which increased to 80 million shares in February 2018 in connection with the Company's stock split scheduled for March 2018. As of September 30, 2018, a remaining balance of 77.6 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors.


61


Reclassifications from Accumulated Other Comprehensive Income

The tables below are reconciliations of accumulated other comprehensive income by component for the following periods.

Changes in Accumulated Other Comprehensive Income
Three Months Ended
September 30, 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
 
$
(1,766
)
 
 
 
$
4,836

 
 
 
$
(23
)
 
 
 
$
(195
)
 
 
 
$
2,852

 
Other comprehensive
income (loss) before
reclassification
 
(347
)
 
 
 
(569
)
 
 
 
(1
)
 
 
 
(2
)
 
 
 
(919
)
 
Amounts reclassified from
accumulated other
comprehensive income
(loss)
 
0

 
 
 
(27
)
 
 
 
0

 
 
 
3

 
 
 
(24
)
 
Net current-period other
comprehensive
income (loss)
 
(347
)
 
 
 
(596
)
 
 
 
(1
)
 
 
 
1

 
 
 
(943
)
 
Balance, end of period
 
$
(2,113
)
 
 
 
$
4,240

 
 
 
$
(24
)
 
 
 
$
(194
)
 
 
 
$
1,909

 

All amounts in the table above are net of tax.


Three Months Ended
September 30, 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
 
$
(1,580
)
 
 
 
$
5,173

 
 
 
$
(23
)
 
 
 
$
(169
)
 
 
 
$
3,401

 
Other comprehensive
income (loss) before
reclassification
 
(135
)
 
 
 
296

 
 
 
0

 
 
 
(2
)
 
 
 
159

 
Amounts reclassified from
accumulated other
comprehensive income
(loss)
 
0

 
 
 
(32
)
 
 
 
0

 
 
 
3

 
 
 
(29
)
 
Net current-period other
comprehensive
income (loss)
 
(135
)
 
 
 
264

 
 
 
0

 
 
 
1

 
 
 
130

 
Balance, end of period
 
$
(1,715
)
 
 
 
$
5,437

 
 
 
$
(23
)
 
 
 
$
(168
)
 
 
 
$
3,531

 
All amounts in the table above are net of tax.


62


Nine Months Ended
September 30, 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
 
(38
)
 
 
 
(2,302
)
 
 
 
2

 
 
 
(7
)
 
 
 
(2,345
)
 
Amounts reclassified from
accumulated other
comprehensive income
(loss)
 
0

 
 
 
(8
)
 
 
 
0

 
 
 
8

 
 
 
0

 
Net current-period other
comprehensive
income (loss)
 
(38
)
 
 
 
(2,310
)
 
 
 
2

 
 
 
1

 
 
 
(2,345
)
 
Balance, end of period
 
$
(2,113
)
 
 
 
$
4,240

 
 
 
$
(24
)
 
 
 
$
(194
)
 
 
 
$
1,909

 

All amounts in the table above are net of tax.

Nine Months Ended
September 30, 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
 
268

 
 
 
653

 
 
 
1

 
 
 
(8
)
 
 
 
914

 
Amounts reclassified from
accumulated other
comprehensive income
(loss)
 
0

 
 
 
(21
)
 
 
 
0

 
 
 
8

 
 
 
(13
)
 
Net current-period other
comprehensive
income (loss)
 
268

 
 
 
632

 
 
 
1

 
 
 
0

 
 
 
901

 
Balance, end of period
 
$
(1,715
)
 
 
 
$
5,437

 
 
 
$
(23
)
 
 
 
$
(168
)
 
 
 
$
3,531

 
All amounts in the table above are net of tax.

For the nine-month period ended September 30, 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 into net earnings for the following periods.


63


Reclassifications Out of Accumulated Other Comprehensive Income
(In millions)
Three Months Ended
September 30, 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
 
$
0

 
Other-than-temporary impairment
losses realized
 
 
37

 
Other gains (losses)
 
 
37

 
Total before tax
 
 
(10
)
 
Tax (expense) or benefit(1)
 
 
$
27

 
Net of tax
Amortization of defined benefit pension items:
 
 
 
 
       Actuarial gains (losses)
 
$
(5
)
 
Acquisition and operating expenses(2)
       Prior service (cost) credit
 
0

 
Acquisition and operating expenses(2)
 
 
2

 
Tax (expense) or benefit(1)
 
 
$
(3
)
 
Net of tax
Total reclassifications for the period
 
$
24

 
Net of tax
(1) Based on 26% blended tax rate
(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 12 for additional details).

(In millions)
Three Months Ended
September 30, 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
 
$
(6
)
 
Other-than-temporary impairment
losses realized
 
 
56

 
Other gains (losses)
 
 
50

 
Total before tax
 
 
(18
)
 
Tax (expense) or benefit(1)
 
 
$
32

 
Net of tax
Amortization of defined benefit pension items:
 
 
 
 
       Actuarial gains (losses)
 
$
(4
)
 
Acquisition and operating expenses(2)
       Prior service (cost) credit
 
0

 
Acquisition and operating expenses(2)
 
 
1

 
Tax (expense) or benefit(1)
 
 
$
(3
)
 
Net of tax
Total reclassifications for the period
 
$
29

 
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 12 for additional details).

64


(In millions)
Nine Months Ended
September 30, 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
 
$
(2
)
 
Other-than-temporary impairment
losses realized
 
 
13

 
Other gains (losses)
 
 
11

 
Total before tax
 
 
(3
)
 
Tax (expense) or benefit(1)
 
 
$
8

 
Net of tax
Amortization of defined benefit pension items:
 
 
 
 
       Actuarial gains (losses)
 
$
(13
)
 
Acquisition and operating expenses(2)
Prior service (cost) credit
 
0

 
Acquisition and operating expenses(2)
 
 
5

 
Tax (expense) or benefit(1)
 
 
$
(8
)
 
Net of tax
Total reclassifications for the period
 
$
0

 
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 12 for additional details).

(In millions)
Nine Months Ended
September 30, 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
 
$
(23
)
 
Other-than-temporary impairment
losses realized
 
 
56

 
Other gains (losses)
 
 
33

 
Total before tax
 
 
(12
)
 
Tax (expense) or benefit(1)
 
 
$
21

 
Net of tax
Amortization of defined benefit pension items:
 
 
 
 
       Actuarial gains (losses)
 
$
(12
)
 
Acquisition and operating expenses(2)
Prior service (cost) credit
 
0

 
Acquisition and operating expenses(2)
 
 
4

 
Tax (expense) or benefit(1)
 
 
$
(8
)
 
Net of tax
Total reclassifications for the period
 
$
13

 
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 12 for additional details).

11.    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 September 30, 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

65


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.

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 September 30, 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 September 30, 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 years 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.

The following table provides information on stock options outstanding and exercisable at September 30, 2018.
 
Stock
Option Shares
(in thousands)
 
Weighted-Average
Remaining Term
(in years)
 
Aggregate
Intrinsic
Value
(in millions)
 
Weighted-Average
Exercise Price Per
Share
Outstanding
 
5,600

 
 
 
5.2
 
 
 
$
105

 
 
 
$
28.33

 
Exercisable
 
4,084

 
 
 
4.2
 
 
 
83

 
 
 
26.87

 


The Company received cash from the exercise of stock options in the amount of $42 million during the first nine months of 2018, compared with $48 million in the first nine months of 2017. The tax benefit realized as a result of stock option exercises and restricted stock releases was $17 million in the first nine months of 2018, compared with $37 million in the first nine months of 2017.

As of September 30, 2018, total compensation cost not yet recognized in the Company's financial statements related to restricted stock awards was $45 million, of which $20 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 1.1 years. There are no other contractual terms covering restricted stock awards once vested.

The following table summarizes restricted stock activity during the nine-month period ended September 30.
(In thousands of shares)
 
Shares
 
Weighted-Average
Grant-Date Fair Value
Per Share
Restricted stock at December 31, 2017
 
3,635

 
 
$
32.40

 
Granted in 2018
 
1,074

 
 
44.30

 
Canceled in 2018
 
(97
)
 
 
34.27

 
Vested in 2018
 
(1,164
)
 
 
31.72

 
Restricted stock at September 30, 2018
 
3,448

 
 
$
36.28

 


In February 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 the 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.


66


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.

For additional information on the Company's long-term share-based compensation plans and the types of share-based awards, see Note 12 of the Notes to the Consolidated Financial Statements included in the 2017 Annual Report.

12.
BENEFIT 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.

Pension and other postretirement benefit expenses are included in acquisition and operating expenses in the consolidated statement of earnings, which includes other components of net periodic pension cost and postretirement costs (other than service costs) of $7 million for both the three-month periods and $20 million and $22 million for the nine-month periods ended September 30, 2018 and 2017, respectively. Total net periodic cost includes the following components:
 
 
 Three Months Ended September 30,
 
 
Pension Benefits
 
Other
 
 
Japan
 
U.S.
 
Postretirement Benefits
(In millions)
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Components of net periodic
benefit cost:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 
 
$
4

 
 
 
$
4

 
 
 
$
7

 
 
 
$
6

 
 
 
$
0

 
 
 
$
0

 
Interest cost
 
 
1

 
 
 
2

 
 
 
9

 
 
 
8

 
 
 
0

 
 
 
0

 
Expected return on plan
assets
 
 
(1
)
 
 
 
(1
)
 
 
 
(7
)
 
 
 
(6
)
 
 
 
0

 
 
 
0

 
Amortization of net actuarial
loss
 
 
1

 
 
 
1

 
 
 
4

 
 
 
3

 
 
 
0

 
 
 
0

 
Net periodic (benefit) cost
 
 
$
5

 
 
 
$
6

 
 
 
$
13

 
 
 
$
11

 
 
 
$
0

 
 
 
$
0

 

67


 
 
Nine Months Ended September 30,
 
 
Pension Benefits
 
Other
 
 
Japan
 
U.S.
 
Postretirement Benefits
(In millions)
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Components of net periodic
benefit cost:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 
 
$
14

 
 
 
$
13

 
 
 
$
21

 
 
 
$
18

 
 
 
$
0

 
 
 
$
0

 
Interest cost
 
 
4

 
 
 
5

 
 
 
26

 
 
 
24

 
 
 
1

 
 
 
1

 
Expected return on plan
assets
 
 
(4
)
 
 
 
(3
)
 
 
 
(20
)
 
 
 
(17
)
 
 
 
0

 
 
 
0

 
Amortization of net actuarial
loss
 
 
1

 
 
 
2

 
 
 
12

 
 
 
10

 
 
 
0

 
 
 
0

 
Net periodic (benefit) cost
 
 
$
15

 
 
 
$
17

 
 
 
$
39

 
 
 
$
35

 
 
 
$
1

 
 
 
$
1

 

During the nine months ended September 30, 2018, Aflac Japan contributed approximately $22 million (using the weighted-average yen/dollar exchange rate for the nine-month period ending September 30, 2018) to the Japanese funded defined benefit plan, and Aflac U.S. contributed $60 million to the U.S. funded defined benefit plan.

As a result of U.S. tax reform legislation enacted in December 2017, the Company announced it would make a one-time contribution of $500 to the U.S. 401(k) plan to all employees active on December 31, 2017. This contribution was made by January 31, 2018. The Company also announced that it would increase its matching contributions to 100% of each employee's contributions which were not in excess of 4% of the employee's annual cash compensation. This increase became effective on January 1, 2018.

For additional information regarding the Company's Japanese and U.S. benefit plans, see Note 14 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.

13.
COMMITMENTS AND CONTINGENT LIABILITIES

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 credits will be realized over

68


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.

Guaranty fund assessments for the nine-month period ended September 30, 2018 were immaterial.

14.
SUBSEQUENT EVENTS

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.




69


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING INFORMATION

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” to encourage companies to provide prospective information, so long as those informational statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements. The Company desires to take advantage of these provisions. This report contains cautionary statements identifying important factors that could cause actual results to differ materially from those projected herein, and in any other statements made by Company officials in communications with the financial community and contained in documents filed with the Securities and Exchange Commission (SEC). Forward-looking statements are not based on historical information and relate to future operations, strategies, financial results or other developments. Furthermore, forward-looking information is subject to numerous assumptions, risks and uncertainties. In particular, statements containing words such as the following or similar words as well as specific projections of future results, generally qualify as forward-looking. Aflac undertakes no obligation to update such forward-looking statements.
• expect
• anticipate
• believe
• goal
• objective
• may
• should
• estimate
• intends
• projects
• will
• assumes
• potential
• target
• outlook

The Company cautions readers that the following factors, in addition to other factors mentioned from time to time, could cause actual results to differ materially from those contemplated by the forward-looking statements:

difficult conditions in global capital markets and the economy
exposure to significant interest rate risk
concentration of business in Japan
foreign currency fluctuations in the yen/dollar exchange rate
operation of the former Japan branch as a legal subsidiary
limited availability of acceptable yen-denominated investments
deviations in actual experience from pricing and reserving assumptions
ability to continue to develop and implement improvements in information technology systems
governmental actions for the purpose of stabilizing the financial markets
interruption in telecommunication, information technology and other operational systems, or a failure to maintain the security, confidentiality or privacy of sensitive data residing on such systems
ongoing changes in the Company's industry
failure to comply with restrictions on patient privacy and information security
extensive regulation and changes in law or regulation by governmental authorities
tax rates applicable to the Company may change
defaults and credit downgrades of investments
ability to attract and retain qualified sales associates, brokers, employees and distribution partners
decline in creditworthiness of other financial institutions
subsidiaries' ability to pay dividends to Aflac Incorporated
decreases in the Company's financial strength or debt ratings
inherent limitations to risk management policies and procedures
concentration of the Company's investments in any particular single-issuer or sector
differing judgments applied to investment valuations
ability to effectively manage key executive succession
significant valuation judgments in determination of amount of impairments taken on the Company's investments
catastrophic events including, but not necessarily limited to, epidemics, pandemics, tornadoes, hurricanes, earthquakes, tsunamis, war or other military action, terrorism or other acts of violence, and damage incidental to such events
changes in U.S. and/or Japanese accounting standards
loss of consumer trust resulting from events external to the Company's operations
increased expenses and reduced profitability resulting from changes in assumptions for pension and other postretirement benefit plans
level and outcome of litigation
failure of internal controls or corporate governance policies and procedures


70


MD&A OVERVIEW
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to inform the reader about matters affecting the financial condition and results of operations of Aflac Incorporated and its subsidiaries for the three- and nine-month periods ended September 30, 2018 and 2017, respectively. Results of operations for interim periods are not necessarily indicative of results for the entire year. As a result, the following discussion should be read in conjunction with the consolidated financial statements and notes that are included in the Company's annual report on Form 10-K for the year ended December 31, 2017 (2017 Annual Report). This MD&A is divided into the following sections:
 
Page


THE COMPANY'S 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. (For more information about the conversion of Aflac Japan to a legal subsidiary, see the Insurance Operations subsection of this MD&A). 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.
 
PERFORMANCE HIGHLIGHTS
Yen-denominated income statement accounts are translated to U.S. dollars using a weighted-average Japanese yen/U.S. dollar foreign exchange rate, while yen-denominated balance sheet accounts are translated to U.S. dollars using a spot Japanese yen/U.S. dollar foreign exchange rate. The spot yen/dollar exchange rate at September 30, 2018 was 113.57, or .5% weaker than the spot yen/dollar exchange rate of 113.00 at December 31, 2017. The weighted-average yen/dollar exchange rate for the three-month period ended September 30, 2018 was 111.48, or .4% weaker than the weighted-average yen/dollar exchange rate of 111.03 for the same period in 2017. The weighted-average yen/dollar exchange rate for the nine-month period ended September 30, 2018 was 109.54, or 2.1% stronger than the weighted-average yen/dollar exchange rate of 111.89 for the same period in 2017.
Total revenues were $5.6 billion in the third quarter of 2018, compared with $5.5 billion in the third quarter of 2017. Net earnings were $845 million, or $1.09 per diluted share in the third quarter of 2018, compared with $716 million, or $.90 per diluted share, in the third quarter of 2017.
Total revenues were $16.6 billion in the first nine months of 2018, compared with $16.2 billion in the first nine months of 2017. Net earnings were $2.4 billion, or $3.08 per diluted share in the first nine months of 2018, compared with $2.0 billion, or $2.52 per diluted share, in the first nine months of 2017.

Results in the third quarter of 2018 included pretax net realized investment gains of $56 million, compared with net realized investment gains of $30 million in the third quarter of 2017. Net investment gains in the third quarter of 2018 included $5 million of other-than-temporary impairment losses and changes in loan loss reserves. 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. The Company reported net gains on equity securities of $27 million in the third quarter of 2018.


71


Results in the first nine months of 2018 included pretax net realized investment losses of $76 million, compared with net realized investment losses of $166 million in the first nine months of 2017. Net investment losses in the first nine months of 2018 included $17 million of other-than-temporary impairment losses and changes in loan loss reserves. The Company reported net losses on equity securities of $1 million in the first nine months of 2018.

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 paid 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 report.

In the first nine months of 2018, the Company repurchased 20.4 million shares of its common stock in the open market for $923 million under its share repurchase program.

CRITICAL ACCOUNTING ESTIMATES
The Company prepares its financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). In this MD&A, references to U.S. GAAP issued by the FASB are derived from the FASB Accounting Standards Codification (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 estimates that the Company deems to be most critical to an understanding of Aflac’s results of operations and financial condition are those related to the valuation of investments and derivatives, deferred policy acquisition costs (DAC), liabilities for future policy benefits and unpaid policy claims, and income taxes. The preparation and evaluation of these critical accounting estimates involve the use of various assumptions developed from management’s analyses and judgments. The application of these critical accounting estimates determines the values at which 95% of the Company's assets and 80% of its liabilities are reported as of September 30, 2018, and thus has a direct effect on net earnings and shareholders’ equity. Subsequent experience or use of other assumptions could produce significantly different results.

There have been no changes in the items that the Company has identified as critical accounting estimates during the nine months ended September 30, 2018. For additional information, see the Critical Accounting Estimates section of MD&A included in the 2017 Annual Report.
New Accounting Pronouncements
For information on new accounting pronouncements and the impact, if any, on the Company's financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements.

RESULTS OF OPERATIONS

The following discussion includes references to the Company's performance measures, adjusted earnings, adjusted earnings per diluted share, and amortized hedge costs, which are not calculated in accordance with U.S. GAAP. These measures exclude items that the Company believes may obscure the underlying fundamentals and trends in the Company's insurance operations because they tend to be driven by general economic conditions and events or related to infrequent activities not directly associated with its insurance operations. The Company's management uses adjusted earnings and adjusted earnings per diluted share to evaluate the financial performance of its insurance operations on a consolidated basis, and the Company believes that a presentation of these measures is vitally important to an understanding of its underlying profitability drivers and trends of its insurance business. The Company believes that amortized hedge costs, which are a component of adjusted earnings, measure the periodic currency risk management costs associated with hedging a portion of Aflac Japan’s U.S. dollar-denominated investments and are an important component of net investment income.

Beginning with the first quarter of 2018, the Company began utilizing the term “adjusted earnings” for the measure formerly referred to as "operating earnings" on both a pretax and after-tax basis, as well as an absolute and per-share basis. This change only pertained to the label of the measure and did not alter its definition or calculation.

Aflac defines adjusted earnings (a non-U.S. GAAP financial measure) as the profits derived from operations. The most comparative U.S. GAAP measure is net 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

72


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 defines adjusted earnings per share (basic or diluted) to be adjusted earnings for the period divided by the weighted average outstanding shares (basic or diluted) for the period presented. The most comparable U.S. GAAP measure is net earnings per share.

Amortized hedge costs represent costs incurred in using foreign currency forward contracts to hedge the foreign exchange risk of a portion of U.S. dollar-denominated assets in the Company’s Japan segment investment portfolio. These amortized hedge costs are derived from the difference between the foreign currency spot rate at time of trade inception and the contractual foreign currency forward rate, recognized on a straight line basis over the term of the hedge. There is no comparable U.S. GAAP financial measure for amortized hedge costs.

Because a significant portion of the Company's business is conducted in Japan and foreign exchange rates are outside of management’s control, the Company believes it is important to understand the impact of translating Japanese yen into U.S. dollars. Adjusted earnings and adjusted earnings per diluted share excluding current period foreign currency impact are computed using the average yen/dollar exchange rate for the comparable prior year period, which eliminates fluctuations driven solely by yen-to-dollar currency rate changes.

The following table is a reconciliation of items impacting adjusted earnings and adjusted earnings per diluted share to the most directly comparable U.S. GAAP measures of net earnings and net earnings per diluted share, respectively.

73


Reconciliation of Net Earnings to Adjusted Earnings(1) 
  
In Millions
 
Per Diluted Share
 
In Millions
 
Per Diluted Share
 
 
 Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
 
Net earnings
$
845

 
$
716

 
$
1.09

 
$
.90

 
$
2,395

 
$
2,021

 
$
3.08

 
$
2.52

 
 
Items impacting net earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Realized investment (gains)
losses
(2),(3),(4),(5)
(88
)
 
(71
)
 
(.11
)
 
(.09
)
 
(25
)
 
57

 
(.03
)
 
.07

 
 
Other and non-recurring
(income) loss
3

 
10

 
.00

 
.01

 
73

 
38

 
.09

 
.05

 
 
Income tax (benefit)
expense on items excluded
from adjusted earnings
21

 
21

 
.03

 
.03

 
(7
)
 
(33
)
 
(.01
)
 
(.04
)
 
 
Tax reform adjustment (6)
11

 
0

 
.01

 
.00

 
11

 
0

 
.01

 
.00

 
 
Adjusted earnings
792

 
676

 
1.03

 
.85

 
2,447

 
2,083

 
3.15

 
2.60

 
 
Current period foreign currency impact (7)
1

 
N/A

 
.00

 
N/A

 
(27
)
 
N/A

 
(.03
)
 
N/A

 
 
Adjusted earnings excluding
current period foreign
currency impact
(8)
$
793

 
$
676

 
$
1.03

 
$
.85

 
$
2,420

 
$
2,083

 
$
3.11

 
$
2.60

 
 
(1) "Adjusted earnings" was formerly referred to as "operating earnings." Amounts may not foot due to rounding.
(2) Excludes amortized hedge costs of $59 and $60 for the three-month periods and $168 and $168 for the nine-month periods ended September 30, 2018, and 2017, respectively, related to hedging U.S. dollar-denominated investments held in Aflac Japan which are classified as a component of adjusted earnings to conform to current year reporting. See "Hedge Costs" discussion below for further information.
(3) Amortized hedge costs in Aflac Japan were partially offset by derivatives entered into as part of corporate activities and resulted in a benefit of $9 for the three-month period and $18 for the nine-month period ended September 30, 2018, respectively, which has been reclassified from realized investment gains (losses) and reported as an increase in net investment income when analyzing operations.
(4) An immaterial amount of net interest cash flows from derivatives associated with certain investment strategies in the three- and nine-month periods ended September 30, 2018, have been reclassified from realized investment gains (losses) into net investment income when analyzing operations.
(5) Excludes a gain of $17 and $19 for the three-month periods and $50 and $60 for the nine-month periods ended September 30, 2018 and 2017, respectively, related to the interest rate component of the change in fair value of foreign currency swaps on notes payable which is classified as an operating gain when analyzing segment operations
(6) The estimated impact of Tax Reform is a preliminary estimate and may be adjusted, possibly materially, due to, among other things, further refinement of the Company’s calculations, changes in interpretations and assumptions the Company has made, tax guidance that may be issued and actions the Company may take as a result of Tax Reform. An adjustment of $11 was made in the three- month period ended September 30, 2018, as a result of return-to-provision adjustments and various amended returns filed by the Company.
(7) Prior period foreign currency impact reflected as “N/A” to isolate change for current period only.
(8) Amounts excluding current period foreign currency impact are computed using the average yen/dollar exchange rate for the comparable prior-year period, which eliminates fluctuations driven solely by yen-to-dollar currency rate changes.

Realized Investment Gains and Losses

The Company's investment strategy is to invest primarily in fixed maturity securities to provide a reliable stream of investment income, which is one of the drivers of the Company’s growth and profitability. This investment strategy incorporates asset-liability matching (ALM) to align the expected cash flows of the portfolio to the needs of the Company's liability structure. The Company does not purchase securities with the intent of generating capital gains or losses. However, investment gains and losses may be realized as a result of changes in the financial markets and the creditworthiness of specific issuers, tax planning strategies, and/or general portfolio management and rebalancing. The realization of investment gains and losses is independent of the underwriting and administration of the Company's insurance products. Realized investment gains and losses include securities transactions, impairments, changes in loan loss reserves, and derivative and foreign currency activities. Effective January 1, 2018, changes in fair value of equity securities are also included in earnings as a component of realized investment gains and losses.


74


Securities Transactions, Impairments, and Gains (Losses) on Equity Securities

Securities transactions include gains and losses from sales and redemptions of investments where the amount received is different from the amortized cost of the investment. Impairments include other-than-temporary-impairment losses on investment securities as well as changes in loan loss reserves for loan receivables. Starting in the first quarter of 2018, gains and losses from changes in fair value of equity securities are recorded in earnings.

Certain Derivative and Foreign Currency Gains (Losses)

The Company's derivative activities include foreign currency forwards and options on certain fixed maturity securities; foreign currency forwards and options that economically hedge certain portions of forecasted cash flows denominated in yen and hedge the Company's long-term exposure to a weakening yen; foreign currency swaps associated with certain senior notes and subordinated debentures; foreign currency swaps and credit defaults swaps held in consolidated variable interest entities (VIEs); and interest rate swaps used to economically hedge interest rate fluctuations in certain variable-rate investments. Gains and losses are recognized as a result of valuing these derivatives, net of the effects of hedge accounting. The Company also excludes the accounting impacts of remeasurement associated with changes in the yen/dollar exchange rate from adjusted earnings. Certain derivative and foreign currency gains (losses) exclude amortized hedge costs (see Hedge Cost section below) and the interest rate component of the change in fair value of foreign currency swaps on notes payable that are both included in adjusted earnings.

Hedge Costs

Effective January 1, 2017, adjusted earnings includes the impact of amortized hedge costs. Amortized hedge costs represent costs incurred in using foreign currency forward contracts to hedge the foreign exchange risk of a portion of U.S. dollar-denominated assets in the Company's Japan segment investment portfolio. Amortized hedge costs are offset by a hedge cost amortization benefit recognized for foreign currency forwards that economically hedge the Company's long-term exposure to a weakening yen. These amortized hedge costs are derived from the difference between the foreign currency spot rate at time of trade inception and the contractual foreign currency forward rate, recognized on a straight line basis over the term of the hedge. There is no comparable U.S. GAAP financial measure for amortized hedge costs.

Hedge costs can fluctuate based upon many factors, including the derivative notional amount, the length of time of the derivative contract, changes in both U.S. and Japan interest rates, and supply and demand for dollar funding. Hedge costs have increased in recent periods due to changes in the previously mentioned factors. In late 2017, the Company
took steps to mitigate rising hedge costs by increasing the amount of unhedged U.S. dollar-denominated investments held
in Aflac Japan and to reduce hedge cost volatility by extending hedge duration. For additional information regarding
currency hedging, refer to Hedging Activities in the Analysis of Financial Condition section of this MD&A.

For additional information regarding realized investment gains and losses, including details of reported amounts for the periods presented, see Notes 3 and 4 of the Notes to the Consolidated Financial Statements.

Other and Non-recurring Items

The United States insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. The system can result in periodic charges to the Company as a result of insolvencies/bankruptcies that occur with other companies in the life insurance industry. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. These charges neither relate to the ordinary course of the Company’s business nor reflect the Company’s underlying business performance, but result from external situations not controlled by the Company.

Based on the underlying nature of these assessments, effective January 1, 2017, the Company adopted a policy of excluding any charges associated with U.S. guaranty fund assessments and the corresponding tax benefit or expense from adjusted earnings.

For the Penn Treaty liquidation that was recognized by judicial authority in March 2017, the Company estimated and recognized a discounted liability for 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. For additional information regarding guaranty fund assessments, see Note 13 of the Notes to the Consolidated Financial Statements.


75


Effective January 1, 2017, nonrecurring items also include conversion costs related to legally converting the Company's Japan business to a subsidiary; these costs primarily consist of expenditures for legal, accounting, consulting, integration of systems and processes and other similar services. These Japan branch conversion costs amounted to $3 million and $10 million for the three-month periods and $73 million and $24 million for the nine-month periods ended September 30, 2018 and 2017, respectively.

Foreign Currency Translation

Aflac Japan’s premiums and a significant portion of its investment income are received in yen, and its claims and most expenses are paid in yen. Aflac Japan purchases yen-denominated assets and U.S. dollar-denominated assets, which may be hedged to yen, to support yen-denominated policy liabilities. These and other yen-denominated financial statement items are, however, translated into dollars for financial reporting purposes. The Company translates Aflac Japan’s yen-denominated income statement into dollars using the average exchange rate for the reporting period, and the Company translates its yen-denominated balance sheet using the exchange rate at the end of the period.
Due to the size of Aflac Japan, whose functional currency is the Japanese yen, fluctuations in the yen/dollar exchange rate can have a significant effect on the Company's reported results. In periods when the yen weakens, translating yen into dollars results in fewer dollars being reported. When the yen strengthens, translating yen into dollars results in more dollars being reported. Consequently, yen weakening has the effect of suppressing current period results in relation to the comparable prior period, while yen strengthening has the effect of magnifying current period results in relation to the comparable prior period. Management evaluates the Company's financial performance both including and excluding the impact of foreign currency translation to monitor, respectively, cumulative currency impacts on book value and the currency-neutral operating performance over time.

Income Taxes

The Company's combined U.S. and Japanese effective income tax rate on pretax earnings was 26.3% for the three-month period ended September 30, 2018, compared with 33.4% for the same period in 2017. The Company's combined U.S. and Japanese effective income tax rate on pretax earnings was 26.5% for the nine-month period ended September 30, 2018, compared with 33.1% for the same period in 2017. The reduction in the tax rate for the three-month and nine-month periods ended September 30, 2018 was primarily due to the decrease in the U.S. federal statutory corporate income tax rate from 35% to 21% effective January 1, 2018. The impact of the Tax Act, including the preliminary estimate for the change in tax rate that was recorded during the fourth quarter of 2017, and the Company's combined U.S. and Japanese effective income tax rate, may be adjusted in future periods, possibly materially, due to, among other things, further refinement of the Company's calculations, changes in interpretations and assumptions the Company has made, tax guidance that may be issued and actions the Company make take as a result of the Tax Act. Without limiting the foregoing, additional forthcoming guidance from the U.S. Department of the Treasury and/or the U.S. Internal Revenue Service related to the Tax Act could significantly impact the level of valuation allowance respecting the amount of foreign tax credits claimed by the Company with regard to the operations of Aflac Japan. For further information about the impact of tax reform, see the Critical Accounting Estimates - Income Taxes section of MD&A and Note 10 in the Notes to the Consolidated Financial Statements in the 2017 Annual Report, and Note 9 of the Notes to the Consolidated Financial Statements in this report.

INSURANCE OPERATIONS

Aflac's insurance business consists of two segments: Aflac Japan and Aflac U.S. Aflac Japan is the principal contributor to consolidated earnings. Operating business segments that are not individually reportable and business activities, including reinsurance retrocession activities, not included in the Aflac Japan or Aflac U.S. are included in the "Corporate and other" category.

On December 2, 2016, the Company publicly announced that it would pursue the conversion of Aflac Japan from a branch structure to a subsidiary structure, with the subsidiary incorporated as a “Kabushiki Kaisha,” or Japanese stock corporation. The conversion was completed on April 1, 2018. While the branch structure remains an acceptable legal form, the subsidiary structure has emerged as the more prevalent structure for both domestic and foreign companies operating in Japan. In addition, emerging global regulatory standards generally favor the subsidiary structure for foreign insurance and financial service companies. The adoption of this new organizational framework is expected to be tax-neutral and not to have a material impact on the daily operations of either Aflac Japan or Aflac U.S. as a result of this conversion. In addition, the Company expects to obtain enhanced flexibility in capital management and business development as a result of the conversion. Effective January 1, 2018, investments of Aflac U.S. as well as certain sub-advised assets of Aflac Japan, are managed by the Company’s U.S. asset management subsidiary, Aflac Asset

76


Management LLC (AAM), and investments of Aflac Japan are managed pursuant to an investment advisory agreement between Aflac Japan and the Company's asset management subsidiary in Japan, Aflac Asset Management Japan Ltd. (AAMJ). AAMJ is licensed as a discretionary asset manager under the Japan Financial Instruments and Exchange Act and is subject to rules of the Japan Investment Advisors Association, a self-regulatory organization with mandatory membership for Japan investment managers. Beginning with the first quarter of 2018, AAM and AAMJ are reported in the "Corporate and other segment" category; however, the assets that they manage will be reported in the respective Aflac Japan and Aflac U.S. business segments. Effective April 1, 2018, Aflac Life Insurance Japan Ltd., a Japanese stock corporation, has assumed the business of Aflac Japan. The Parent Company had also formed wholly-owned U.S. subsidiary Aflac Holdings LLC, which is the parent company of Aflac Life Insurance Japan Ltd.

U.S. GAAP financial reporting requires that a company report financial and descriptive information about operating
segments in its annual and interim period financial statements. Furthermore, the Company is required to report a measure
of segment profit or loss, certain revenue and expense items, and segment assets.

The Company evaluates its sales efforts using new annualized premium sales, an industry operating measure, which is not directly reflected on the Company's Consolidated Statements of Earnings. New annualized premium sales, which include both new sales and the incremental increase in premiums due to conversions, generally represent the premiums that the Company would collect over a 12-month period, assuming the policies remain in force. For Aflac Japan, new annualized premium sales are determined by applications submitted during the reporting period. For Aflac U.S., new annualized premium sales are determined by applications that are issued during the reporting period. Net premium income, or earned premiums, as reflected on the Company's Consolidated Statements of Earnings, is a financial performance measure that reflects collected or due premiums that have been earned ratably on policies in force during the reporting period.

77


AFLAC JAPAN SEGMENT
Aflac Japan Pretax Adjusted Earnings
Changes in Aflac Japan’s pretax adjusted earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results for Aflac Japan.

Aflac Japan Summary of Operating Results
  
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
2018
 
2017
 
2018
 
2017
 
Net premium income
$
3,159

 
$
3,200

 
$
9,649

 
$
9,616

 
Net investment income:
 
 
 
 
 
 
 
 
Yen-denominated investment income
318

 
326

 
975

 
972

 
U.S. dollar-denominated investment income
347

 
295

 
994

 
872

 
Net investment income
665

 
621

 
1,969

 
1,844

 
Amortized hedge costs related to foreign currency denominated investments
59

 
60

 
168

 
168

 
Net investment income, less amortized hedge costs
606

 
561

 
1,801

 
1,676

 
Other income (loss)
10

 
11

 
31

 
31

 
Total adjusted revenues
3,775

 
3,772

 
11,481

 
11,323

 
Benefits and claims, net
2,232

 
2,300

 
6,763

 
6,859

 
Adjusted expenses:
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
182

 
155

 
530

 
477

 
Insurance commissions
185

 
186

 
568

 
559

 
Insurance and other expenses
420

 
383

 
1,209

 
1,120

 
Total adjusted expenses
787

 
724

 
2,307

 
2,156

 
Total benefits and expenses
3,019

 
3,024

 
9,070

 
9,015

 
           Pretax adjusted earnings(1)
$
756

 
$
748

 
$
2,411

 
$
2,308

 
Weighted-average yen/dollar exchange rate
111.48

 
111.03

 
109.54

 
111.89

 
 
In Dollars
 
In Yen
Percentage change over
 previous period:
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Net premium income
(1.3
)%
 
(11.0
)%
 
.3
%
 
(5.5
)%
 
(.9
)%
 
(3.5
)%
 
(1.8
)%
 
(2.4
)%
Net investment income,
less amortized hedge
costs
8.0

 
(7.6
)
 
7.5

 
(7.0
)
 
8.3

 
1.1

 
4.9

 
(3.4
)
Total adjusted revenues
.1

 
(10.5
)
 
1.4

 
(5.7
)
 
.4

 
(2.8
)
 
(.8
)
 
(2.5
)
  Pretax adjusted
    earnings(1)
1.1

 
(9.6
)
 
4.5

 
(5.3
)
 
1.4

 
(1.3
)
 
2.0

 
(1.8
)
(1) Aflac defines pretax adjusted earnings (a non-U.S. GAAP financial measure) as adjusted earnings before the application of income taxes. See the Results of Operations section of this MD&A for the Company's definition of adjusted earnings and a reconciliation of adjusted earnings to the most directly comparable U.S. GAAP measure of net earnings.
In the three- and nine-month periods ended September 30, 2018, Aflac Japan's net premium income decreased, in yen terms, with growth in third sector premium more than offset by the anticipated reduction in first sector premium due to savings products reaching premium paid-up status. Net investment income, net of amortized hedge costs, increased largely due to higher income from U.S. dollar-denominated floating rate assets. Pretax adjusted earnings in yen increased, driven by higher net investment income and a favorable third sector benefit ratio.
Annualized premiums in force decreased 1.6% to 1.53 trillion yen as of September 30, 2018, compared with 1.56 trillion yen as of September 30, 2017. The decrease in annualized premiums in force in yen was driven primarily by

78


limited-pay policies becoming paid-up during the year. Annualized premiums in force, translated into dollars at respective period-end exchange rates, were $13.5 billion at September 30, 2018, compared with $13.8 billion a year ago.
Aflac Japan's investment portfolios include U.S. dollar-denominated securities and reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments). In years when the yen strengthens in relation to the dollar, translating Aflac Japan's U.S. dollar-denominated investment income into yen lowers growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms. In years when the yen weakens, translating U.S. dollar-denominated investment income into yen magnifies growth rates for net investment income, total adjusted revenues, and pretax adjusted earnings in yen terms.
The following table illustrates the effect of translating Aflac Japan’s U.S. dollar-denominated investment income and related items into yen by comparing certain segment results with those that would have been reported had yen/dollar exchange rates remained unchanged from the comparable period in the prior year. In order to compare the current period to the prior period without the impact of foreign currency, the current period income statement is translated at the prior year's comparable period average exchange rate.
Aflac Japan Percentage Changes Over Previous Period
(Yen Operating Results)
For the Periods Ended September 30,
  
Including Foreign
Currency Changes
 
 
Excluding Foreign
Currency Changes(2)
 
 
Three Months
 
 
Nine Months
 
Three Months
 
 
Nine Months
  
2018
 
 
2017

 
 
2018

 
 
2017
 
 
2018
 
 
2017
 
 
2018
 
 
2017

 
Net investment income, less
amortized hedge costs
8.3
%
 
1.1

%
 
4.9

%
 
(3.4
)
%
 
8.1
%
 
(3.2
)
%
 
6.1

%
 
(4.9
)
%
Total adjusted revenues
.4
 
 
(2.8
)
 
 
(.8
)
 
 
(2.5
)
 
 
.4
 
 
(3.4
)
 
 
(.6
)
 
 
(2.8
)
 
Pretax adjusted earnings(1)
1.4
 
 
(1.3
)
 
 
2.0

 
 
(1.8
)
 
 
1.3
 
 
(4.4
)
 
 
2.8

 
 
(2.9
)
 
(1) Aflac defines pretax adjusted earnings (a non-U.S. GAAP financial measure) as adjusted earnings before the application of income taxes. See the Results of Operations section of this MD&A for the Company's definition of adjusted earnings and a reconciliation of adjusted earnings to the most directly comparable U.S. GAAP measure of net earnings.
(2) Amounts excluding foreign currency impact on U.S. dollar-denominated items (a non-U.S. GAAP measure) were determined using the same yen/dollar exchange rate for the current period as the comparable period in the prior year.
The following table presents a summary of operating ratios in yen terms for Aflac Japan.
  
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
 
 
Ratios to total revenues:
2018
 
 
2017
 
 
2018
 
 
2017
 
 
Benefits and claims, net
59.1
%
 
60.9
%
 
58.9
%
 
60.5
%
 
Adjusted expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
4.8
 
 
4.1
 
 
4.6
 
 
4.2
 
 
Insurance commissions
4.9
 
 
4.9
 
 
5.0
 
 
4.9
 
 
Insurance and other expenses
11.1
 
 
10.1
 
 
10.5
 
 
9.9
 
 
Total adjusted expenses
20.8
 
 
19.2
 
 
20.1
 
 
19.0
 
 
Pretax adjusted earnings(1)
20.1
 
 
19.9
 
 
21.0
 
 
20.4
 
 
Ratios to total premiums:
 
 
 
 
 
 
 
 
 
 
 
 
Benefits and claims, net
70.7
%
 
71.9
%
 
70.1
%
 
71.3
%
 
Adjusted expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
5.7
 
 
4.9
 
 
5.5
 
 
5.0
 
 
(1) Aflac defines pretax adjusted earnings (a non-U.S. GAAP financial measure) as adjusted earnings before the application of income taxes. See the Results of Operations section of this MD&A for the Company's definition of adjusted earnings and a reconciliation of adjusted earnings to the most directly comparable U.S. GAAP measure of net earnings.

In the three- and nine-month periods ended September 30, 2018, the benefit ratio decreased, compared with the same respective periods in the prior year, primarily due to the continued change in mix of first and third sector business as first sector products become paid-up, as well as continued favorable third sector claims trends. In the three- and nine-

79


month periods ended September 30, 2018, the adjusted expense ratio increased due to lower premium income impacted by first sector products becoming paid-up, and higher expenses primarily related to increased system development and outsourcing costs and DAC amortization. In total, the pretax adjusted profit margin increased in the three- and nine-month periods ended September 30, 2018, reflecting the decrease in the benefit ratio partially offset by a smaller increase in the expense ratio. For the full year of 2018, the Company anticipates the Aflac Japan pretax adjusted profit margin (calculated by dividing adjusted earnings by adjusted revenues) to remain stable.

Aflac Japan Sales
The following table presents Aflac Japan’s new annualized premium sales for the periods ended September 30.
  
In Dollars
In Yen
 
Three Months
 
Nine Months
 
Three Months
Nine Months
 
(In millions of dollars and billions of yen)
2018
 
2017
 
2018
 
2017
 
2018
 
2017
2018
 
2017
 
New annualized premium sales
$
212

 
$
214

 
$
655

 
$
637

 
23.6

 
23.7

71.7

 
71.2

 
Increase (decrease) over prior period
(1.0
)%
 
(17.3
)%
 
2.8
%
 
(21.3
)%
 
(.7
)%
 
(10.5
)%
.7
%
 
(19.0
)%
 
The following table details the contributions to Aflac Japan's new annualized premium sales by major insurance product for the periods ended September 30.
  
Three Months
 
 
Nine Months
 
  
2018
 
 
2017
 
 
2018
 
 
2017
 
Cancer
65.8
%
 
 
58.2
%
 
 
65.6
%
 
 
54.9
%
 
Medical
23.6

 
 
32.9

 
 
25.5

 
 
35.0

 
Income support
1.9

 
 
2.5

 
 
1.8

 
 
2.2

 
Ordinary life:


 
 
 
 
 
 
 
 
 
 
WAYS
.4

 
 
.4

 
 
.5

 
 
.6

 
Child endowment
.3

 
 
.4

 
 
.3

 
 
.6

 
Other ordinary life (1)
7.5

 
 
5.1

 
 
5.8

 
 
6.0

 
Other
.5

 
 
.5

 
 
.5

 
 
.7

 
    Total
100.0
%
 
 
100.0
%
 
 
100.0
%
 
 
100.0
%
 
(1) Includes term and whole life
The foundation of Aflac Japan's product portfolio has been, and continues to be, third sector products, which include cancer, medical and Income Support insurance products. Sales of third sector products on a yen basis decreased 2.6% during the third quarter and increased 1.8% in the first nine months of 2018, compared with the same respective periods in 2017. Third sector sales included growth in the new cancer insurance product that was launched in April 2018, however medical sales have declined compared with 2017 as a result of strong sales in 2017 driven by the introduction of the new medical insurance product in the second quarter of 2017. Aflac Japan has been focusing more on promotion of cancer and medical insurance products in this low-interest-rate environment. These products are less interest-rate sensitive and more profitable compared to first sector products. With continued cost pressure on Japan’s health care system, the Company expects the need for third sector products will continue to rise in the future and that the medical and cancer insurance products Aflac Japan provides will continue to be an important part of its product portfolio.
Independent corporate agencies and individual agencies contributed 38.7% of total new annualized premium sales for Aflac Japan in the third quarter of 2018, compared with 39.9% for the same period in 2017. Affiliated corporate agencies, which include Japan Post, contributed 55.3% of total new annualized premium sales in the third quarter of 2018, compared with 53.3% in the third quarter of 2017. Japan Post offers Aflac's cancer insurance products in more than 20,000 post offices. The Company believes this alliance with Japan Post has and will further benefit its cancer insurance sales. During the three-month period ended September 30, 2018, Aflac Japan recruited 23 new sales agencies. At September 30, 2018, Aflac Japan was represented by more than 10,100 sales agencies, with approximately 109,000 licensed sales associates employed by those agencies.
At September 30, 2018, Aflac Japan had agreements to sell its products at 371 banks, approximately 90% of the total number of banks in Japan. Bank channel sales accounted for 6.0% of new annualized premium sales in the third quarter of 2018 for Aflac Japan, compared with 6.8% during the third quarter of 2017.

80



Aflac Japan Investments

The level of investment income in yen is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, the effect of yen/dollar exchange rates on U.S. dollar-denominated investment income, and other factors.

As part of the Company's portfolio management and asset allocation process, Aflac Japan invests in yen and U.S. dollar-denominated investments. Yen-denominated investments primarily consist of JGBs and public and private fixed maturity securities. Aflac Japan's U.S. dollar-denominated investments include fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships or similar investment vehicles. Aflac Japan has been investing in both publicly-traded and privately originated U.S. dollar-denominated investment-grade and below-investment-grade fixed maturity securities and loan receivables, and has entered into foreign currency forwards and options to hedge the currency risk on the fair value of a portion of the U.S. dollar investments.

The following table details the investment purchases for Aflac Japan.
 
 
 Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
(In millions)
 
2018
 
2017
 
 
2018
 
2017
 
Yen-denominated:
 
 
 
 
 
 
 
 
 
 
  Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
     Japan government and agencies
 
$
42

 
$
212

 
 
$
3,441

 
$
3,439

 
     Other fixed maturity securities
 
721

 
359

 
 
1,755

 
1,268

 
  Equity securities
 
110

 
21

 
 
216

 
173

 
        Total yen-denominated
 
$
873

 
$
592

 
 
$
5,412

 
$
4,880

 
 
 
 
 
 
 
 
 
 
 
 
U.S. dollar-denominated:
 
 
 
 
 
 
 
 
 
 
  Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
     Other fixed maturity securities
 
$
114

 
$
138

 
 
$
1,152

 
$
219

 
     Infrastructure debt
 
0

 
40

 
 
0

 
134

 
     Bank loans (1)
 
0

 
0

 
 
346

 
0

 
  Equity securities
 
0

 
2

 
 
80

 
153

 
  Other investments:
 
 
 
 
 
 
 
 
 
 
     Transitional real estate loans
 
610

 
85

 
 
2,759

 
231

 
     Commercial mortgage loans
 
0

 
0

 
 
13

 
48

 
     Middle market loans
 
352

 
186

 
 
627

 
437

 
     Limited partnerships
 
29

 
24

 
 
201

 
65

 
        Total dollar-denominated
 
$
1,105

 
$
475

 
 
$
5,178

 
$
1,287

 
            Total Aflac Japan purchases
 
$
1,978

 
$
1,067

 
 
$
10,590

 
$
6,167

 
(1) In 2017, represents funding made to unit trust structures

Aflac Japan purchased $1.1 billion of yen-denominated private placements for the first nine months of 2018 and for
the full year of 2017.

See the Analysis of Financial Condition section of this MD&A for further discussion of these investment programs, and see Notes 3 and 4 of the Notes to the Consolidated Financial Statements and Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for more information regarding loans and loan receivables.


81


The following table presents the results of Aflac Japan’s investment yields for the periods ended September 30.
  
Three Months
 
Nine Months
 
  
2018

 
 
2017

 
 
2018

 
 
2017

 
Total purchases for the period (in millions) (1)
$
1,949

 
 
$
1,043

 
 
$
10,389

 
 
$
6,102

 
New money yield (1), (2)
3.77

%
 
3.02

%
 
3.01

%
 
1.79

%
Return on average invested assets (3)
2.35

 
 
2.29

 
 
2.31

 
 
2.31

 
Portfolio book yield, including U.S. dollar-denominated investments,
   end of period (1)
2.63

%
 
2.55

%
 
2.63

%
 
2.55

%
(1) Includes fixed maturity securities, loan receivables, equity securities, and excludes alternative investments in limited partnerships
(2) Reported on a gross yield basis; excludes investment expenses, external management fees, and amortized hedge costs
(3) Net of investment expenses and amortized hedge costs, year-to-date number reflected on a quarterly average basis

The increase in the Aflac Japan new money yield in the three- and nine-month periods ended September 30, 2018 was primarily due to increased allocations to higher yielding U.S. dollar-denominated asset classes.

See Notes 3, 4 and 5 of the Notes to the Consolidated Financial Statements and the Analysis of Financial Condition section of this MD&A for additional information on the Company's investments and hedging strategies.

AFLAC U.S. SEGMENT
Aflac U.S. Pretax Adjusted Earnings
Changes in Aflac U.S. pretax adjusted earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results for Aflac U.S.
Aflac U.S. Summary of Operating Results
  
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
2018
 
2017
 
2018
 
2017
 
Net premium income
$
1,426

 
$
1,393

 
$
4,280

 
$
4,172

 
Net investment income
187

 
181

 
544

 
539

 
Other income
3

 
1

 
7

 
3

 
Total adjusted revenues
1,616

 
1,575

 
4,831

 
4,714

 
Benefits and claims
722

 
731

 
2,163

 
2,156

 
Adjusted expenses:
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
133

 
116

 
402

 
371

 
Insurance commissions
146

 
146

 
439

 
436

 
Insurance and other expenses
281

 
266

 
816

 
795

 
Total adjusted expenses
560

 
528

 
1,657

 
1,602

 
Total benefits and expenses
1,282

 
1,259

 
3,820

 
3,758

 
             Pretax adjusted earnings(1)
$
334

 
$
316

 
$
1,011

 
$
956

 
Percentage change over previous period:
 
 
 
 
 
 
 
 
Net premium income
2.4

%
2.1

%
2.6

%
1.9

%
Net investment income
3.3

 
2.8

 
.9

 
2.5

 
Total adjusted revenues
2.6

 
2.1

 
2.5

 
1.9

 
  Pretax adjusted earnings(1)
5.7

 
(2.2
)
 
5.8

 
1.1

 
(1) Aflac defines pretax adjusted earnings (a non-U.S. GAAP financial measure) as adjusted earnings before the application of income taxes. See the Results of Operations section of this MD&A for the Company's definition of adjusted earnings and a reconciliation of adjusted earnings to the most directly comparable U.S. GAAP measure of net earnings.
In the three-month period ended September 30, 2018, net investment income increased, driven by higher income from floating rate assets partially offset from the drawdown of excess capital in the U.S. segment. Annualized premiums in force increased 2.5% to $6.1 billion at September 30, 2018, compared with $5.9 billion at September 30, 2017.

82


The following table presents a summary of operating ratios for Aflac U.S.
  
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
 
Ratios to total revenues:
2018
 
 
2017
 
 
2018
 
 
2017
 
Benefits and claims
44.7
%
 
46.4
%
 
44.8
%
 
45.7
%
Adjusted expenses:
 
 
 
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
8.2
 
 
7.4
 
 
8.3
 
 
7.9
 
Insurance commissions
9.0
 
 
9.3
 
 
9.1
 
 
9.2
 
Insurance and other expenses
17.5
 
 
16.9
 
 
16.9
 
 
16.9
 
Total adjusted expenses
34.7
 
 
33.5
 
 
34.3
 
 
34.0
 
  Pretax adjusted earnings(1)
20.7
 
 
20.1
 
 
20.9
 
 
20.3
 
Ratios to total premiums:
 
 
 
 
 
 
 
 
 
 
 
Benefits and claims
50.6
%
 
52.5
%
 
50.5
%
 
51.7
%
Adjusted expenses:
 
 
 
 
 
 
 
 
 
 
 
Amortization of deferred policy acquisition costs
9.3
 
 
8.3
 
 
9.4
 
 
8.9
 
(1) Aflac defines pretax adjusted earnings (a non-U.S. GAAP financial measure) as adjusted earnings before the application of income taxes. See the Results of Operations section of this MD&A for the Company's definition of adjusted earnings and a reconciliation of adjusted earnings to the most directly comparable U.S. GAAP measure of net earnings.

For the three-month period ended September 30, 2018, the benefit ratio decreased when compared with the same period in 2017. For the same period, the adjusted expense ratio increased compared with the same period in 2017, primarily related to planned spending increases reflecting elevated investment in the platform. The pretax adjusted profit margin (calculated by dividing adjusted earnings by adjusted revenues) increased during the period compared with the same period in 2017, as decreased benefit ratios were not quite offset by increased expense ratios.

For the nine-month period ended September 30, 2018, the benefit ratio decreased when compared with the same period in 2017, due in large part to benefit reserve releases related to slightly elevated lapses of older individual cancer policies in the first quarter of 2018. The adjusted expense ratio increased slightly for the nine-month period ended September 30, 2018, when compared to the same period in 2017, primarily due to planned spending increases reflecting elevated investments in the platform. The pretax adjusted profit margin increased slightly when compared to the same period in 2017, primarily due to lower benefit ratios.

Note that all of these ratios-to-revenue reflect reduced net investment income due to the Company's planned drawdown of excess capital to lower Risk-Based Capital (RBC) ratios. (See the Capital Resources and Liquidity section of this MD&A for further discussion of the planned reduction of RBC.)

Aflac U.S. Sales
The following table presents Aflac's U.S. new annualized premium sales for the periods ended September 30.
 
Three Months     
 
Nine Months
 
(In millions)
2018
 
 
2017

 
 
2018
 
 
2017

 
 
New annualized premium sales
$
359

 
 
$
348

 
 
$
1,064

 
 
$
1,037

 
 
Increase (decrease) over prior period
3.3

%
 
7.5

%
 
2.6

%
 
3.8

%
 
The following table details the contributions to Aflac's U.S. new annualized premium sales by major insurance product category for the periods ended September 30.

83


  
Three Months     
 
Nine Months
 
 
2018
 
 
2017
 
 
2018
 
 
2017
 
 
Accident
29.7
%
 
29.9
%
 
29.5
%
 
29.6
%
 
Short-term disability
23.3
 
 
23.6
 
 
23.3
 
 
24.1
 
 
 Critical care(1)
20.6
 
 
21.8
 
 
21.1
 
 
21.2
 
 
Hospital indemnity
15.6
 
 
14.1
 
 
15.2
 
 
14.0
 
 
Dental/vision
5.0
 
 
5.1
 
 
5.3
 
 
5.7
 
 
Life
5.8
 
 
5.5
 
 
5.6
 
 
5.4
 
 
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
(1) Includes cancer, critical illness, and hospital intensive care products

New annualized premium sales for accident insurance, the Aflac U.S. leading product category, increased 2.5%; short-term disability sales increased 2.4%; critical care insurance sales (including cancer insurance) decreased 2.6%; and hospital indemnity insurance sales increased 13.6% in the third quarter of 2018, compared with the same period in 2017.

The addition of group products has expanded Aflac U.S.'s reach and enabled Aflac U.S. to generate more sales opportunities with larger employers and through broker and sales agent channels. The Company anticipates that the appeal of Aflac U.S. group products will continue to enhance opportunities to connect with larger businesses and their employees. The Aflac U.S. portfolio of group and individual products offers businesses the opportunity to give their employees a more valuable and comprehensive selection of benefit options.

In the third quarter of 2018, the Aflac U.S. sales force included more than 8,200 U.S. agents, including brokers, who were actively producing business on a weekly basis. The Company believes that this average weekly producer equivalent metric allows sales management to monitor progress and needs.

One Day PaySM is a claims initiative that Aflac U.S. has focused on to process, approve and pay eligible claims in just one day. The Company believes that this claims practice enhances the Aflac U.S. brand reputation and the trust policyholders have in Aflac, and it helps Aflac stand out from competitors.

Aflac U.S. products provide cash benefits that can be used to help with increasing out-of-pocket medical expenses, help cover household costs, or protect against income and asset loss. Group products and relationships with insurance brokers that handle the larger-case market are helping Aflac U.S. expand its reach by selling to larger businesses. Aflac U.S. is regularly evaluating the marketplace to identify opportunities to bring the most relevant, cost-effective products to customers. The Company believes the need for its products remains very strong, and Aflac U.S. continues to work on enhancing its distribution capabilities to access employers of all sizes, including initiatives that benefit the field force and the broker community. At the same time, the Company is seeking opportunities to leverage its brand strength and attractive product portfolio in the evolving health care environment.

U.S. Regulatory Environment

Healthcare Reform Legislation

The Affordable Care Act (ACA), federal health care legislation, was intended to give Americans of all ages and income levels access to comprehensive major medical health insurance and gave the U.S. federal government direct regulatory authority over the business of health insurance. While the ACA was enacted in 2010, the major elements of the law became effective on January 1, 2014. The ACA included major changes to the U.S. health care insurance marketplace. Among other changes, the ACA included an individual medical insurance coverage mandate (which has since been repealed effective 2019 by the Tax Act), provided for penalties on certain employers for failing to provide adequate coverage, created health insurance exchanges, and addressed coverage and exclusions as well as medical loss ratios. It also imposed an excise tax on certain high cost plans, known as the “Cadillac tax,” that is currently scheduled to begin in 2020. The ACA also included changes in government reimbursements and tax credits for individuals and employers and altered federal and state regulation of health insurers. The ACA, as enacted, does not require material changes in the design of the Company's insurance products. However, indirect consequences of the legislation and regulations could present challenges that could potentially have an impact on the Company's sales model, financial condition and results of operations. The United States Congress has considered and may continue to consider legislation that would repeal and replace key provisions of the ACA. There can be no assurance that any legislation affecting the ACA will be passed by

84


Congress, nor as to the ultimate timing or provisions of any such legislation, nor as to the effect of any such legislation on the design or marketability of the Company's insurance products.

President Trump signed an Executive Order in October 2017 directing federal regulatory agencies to review and modify certain regulations issued under the ACA. The stated objectives of the Executive Order are to increase competition and consumer choices in health care markets, and to lower costs for health care, by making association health plans available to more employers, allowing employers to make better use of health reimbursement arrangements, and expanding coverage through short-term insurance. The Executive Order tasks three federal agencies, the Departments of Labor (DOL), Treasury, and Health and Human Services (HHS) with reviewing current rules and developing guidance to implement the order. While the details of any proposed modifications will not be known until further action by the agencies, the Company anticipates that the Executive Order will not have a significant impact on the availability or marketability of its products.

Tax Reform Legislation

The Tax Act was signed into law on December 22, 2017. Among other things, effective January 1, 2018, the Tax Act reduced the U.S. federal statutory corporate income tax rate from 35% to 21%, eliminated or reduced certain deductions and credits and limited the deductibility of interest expense and executive compensation.

The Tax Act also transitions international corporate taxation from a worldwide system to a modified territorial system, which in light of the current tax treatment of Aflac Japan as a branch has the effect of subjecting the earnings of Aflac Japan to Japan taxation and subjecting the Company's other earnings, including the consolidated earnings of the Parent Company, to U.S. taxation. The treatment of Aflac Japan as a branch for U.S. tax purposes did not change following the completion of its conversion from a branch structure to a subsidiary structure for legal purposes on April 1, 2018.

Aflac U.S. prices its business on an internal rate of return basis. The Aflac U.S. business has a financial structure that the Company expects to be neutral on a pricing basis from these tax changes. The Aflac U.S. products have high initial costs for marketing, underwriting and administration, which will have less tax relief under the changes and will increase the amount required to invest in new business. In addition, the Company expects that RBC requirements will increase on an after-tax basis, being another source of initial funding required for these products. The tax basis for reserves and DAC may also change the timing of tax payments in an accelerated or unfavorable direction. All of these effects will offset a favorable lower tax rate on income in later years. The overall impact is expected to be neutral on a pricing basis from these various effects.

The Tax Act changes became effective on January 1, 2018. However, because changes to tax rates are accounted for in the period of enactment, during the period ended December 31, 2017, the Company revalued its deferred tax assets and liabilities and recorded, as its current reasonable estimate, a net deferred tax liability reduction of $1.9 billion as of that date. For information on the effects of the Tax Act during the period ended December 31, 2017, see Note 10 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report. For information on the conversion of Aflac Japan from a branch to a subsidiary, see General Business under Item 1, Business, in the 2017 Annual Report and the Insurance Operations subsection of this MD&A.

Dodd-Frank Act

Title VII of the Dodd-Frank Act and regulations issued thereunder, in particular rules to require central clearing for certain types of derivatives, may have an impact on Aflac's derivative activity, including activity on behalf of Aflac Japan. In addition, in 2015 and 2016, six U.S. financial regulators, including the U.S. Commodity Futures Trading Commission (CFTC), issued final rules regarding the exchange of initial margin (IM) and variation margin (VM) for uncleared swaps that impose greater obligations on swap dealers regarding uncleared swaps with certain counterparties, such as Aflac. The requirements of such rules with respect to VM, as well as similar regulations in Europe, became effective on March 1, 2017. Full compliance with respect to all counterparties was required by September 1, 2017. The requirements of such rules with respect to IM are currently being phased in and will be fully implemented by September 1, 2020. In October of 2017, the CFTC and the European Commission each finalized comparability determinations that permit certain swap dealers who are subject to both regulatory margin regimes to take advantage of substituted compliance by complying with one set of margin requirements. The margin requirements are expected to result in more stringent collateral requirements and to affect other aspects of Aflac's derivatives activity.

The Dodd-Frank Act also established a Federal Insurance Office (FIO) under the U.S. Treasury Department to monitor all aspects of the insurance industry and of lines of business other than certain health insurance, certain long-term care insurance and crop insurance. Traditionally, U.S. insurance companies have been regulated primarily by state insurance

85


departments. The FIO does not directly regulate the insurance industry, but under Dodd-Frank it has the power to preempt state insurance regulations that are inconsistent with international agreements reached by the federal government, subject to certain requirements and restrictions. The FIO and certain federal agencies must achieve consensus positions with the state insurance regulators when taking positions on insurance proposals by certain international forums. In December 2013, the FIO released a report entitled "How To Modernize And Improve The System Of Insurance Regulation In The United States." The report was required by the Dodd-Frank Act, and included 18 recommended areas of near-term reform for the states, including addressing capital adequacy and safety/soundness issues, reform of insurer resolution practices, and reform of marketplace regulation. The report also listed nine recommended areas for direct federal involvement in insurance regulation. Some of the recommendations outlined in the FIO report released in December 2013 have been implemented. The National Association of Registered Agents and Brokers Reform Act, signed into law in January 2015, simplifies the agent and broker licensing process across state lines. The FIO has also engaged with the supervisory colleges to monitor financial stability and identify regulatory gaps for large national and internationally active insurers. The President and Congress have stated proposals to reform or repeal certain provisions of the Dodd-Frank Act, some of which have been implemented. The Company cannot predict with any degree of certainty what impact, if any, such proposals will have on Aflac's business, financial condition, or results of operations.

Insurance Guaranty Laws

Under state insurance guaranty association laws and similar laws in international jurisdictions, Aflac is subject to assessments, based on the share of business it writes in the relevant jurisdiction, for certain obligations of insolvent insurance companies to policyholders and claimants. In the United States, some states permit member insurers to recover assessments paid through full or partial premium tax offsets. The Company's policy is to accrue assessments when the entity for which the insolvency relates has met its state of domicile's statutory definition of insolvency, the amount of the loss is reasonably estimable and the related premium upon which the assessment is based is written. In most states, the definition is met with a declaration of financial insolvency by a court of competent jurisdiction.

Aflac U.S. Investments

The level of investment income is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, and other factors.

As part of the Company's portfolio management and asset allocation process, Aflac U.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. Aflac U.S. has been investing in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loan receivables.

The following table details the investment purchases for Aflac U.S.
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
(In millions)
 
2018
 
2017
 
2018
 
2017
 
  Fixed maturity securities:
 
 
 
 
 
 
 
 
 
     Other fixed maturity securities
 
$
113

 
$
284

 
$
791

 
$
770

 
     Infrastructure debt
 
0

 
10

 
97

 
25

 
  Equity securities
 
6

 
16

 
55

 
54

 
  Other investments:
 
 
 
 
 
 
 
 
 
     Transitional real estate loans
 
377

 
30

 
547

 
71

 
     Commercial mortgage loans
 
65

 
18

 
120

 
18

 
     Middle market loans
 
43

 
67

 
118

 
161

 
     Limited partnerships
 
4

 
3

 
31

 
13

 
        Total Aflac U.S. Purchases
 
$
608

 
$
428

 
$
1,759

 
$
1,112

 

See Note 3 of the Notes to the Consolidated Financial Statements and Notes 1 and 3 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for more information regarding loans and loans receivables.


86


The following table presents the results of Aflac's U.S. investment yields for the periods ended September 30.
 
Three Months     
 
Nine Months
 
  
2018
 
 
2017
 
 
2018
 
 
2017
 
Total purchases for period (in millions) (1)
$
604

 
 
$
425

 
 
$
1,728

 
 
$
1,099

 
New money yield (1), (2)
5.44

%
 
4.40

%
 
4.72

%
 
4.40

%
Return on average invested assets (3)
5.25

 
 
5.05

 
 
5.14

 
 
5.03

 
Portfolio book yield, end of period (1)
5.55

%
 
5.50

%
 
5.55

%
 
5.50

%
(1) Includes fixed maturity securities, loan receivables, equity securities, and excludes alternative investments in limited partnerships
(2) Reported on a gross yield basis; excludes investment expenses and external management fees
(3) Net of investment expenses, year-to-date number reflected on a quarterly average basis

The increase in the Aflac U.S. new money yield for the three- and nine-month periods ended September 30, 2018 was primarily due to increased allocations to higher yielding floating rate assets. See Notes 3 and 5 of the Notes to the Consolidated Financial Statements and the Analysis of Financial Condition section of this MD&A for additional information on the Company's investments.

CORPORATE AND OTHER

In the three-month period ended September 30, 2018, total revenue increased 18.8% to $82 million, reflecting net investment income of $27 million. Net investment income, which increased $17 million, benefited from a $9 million pretax contribution from the Company’s corporate yen hedging program and invested assets transferred as part of the drawdown of excess capital in the U.S. segment beginning in the fourth quarter of 2017. Pretax adjusted earnings were a loss of $29 million, compared with a loss of $50 million a year ago.

In the first nine months of 2018, total revenue increased 20.1% to $245 million, reflecting net investment income of $74 million. Net investment income, which increased $50 million, benefited from an $18 million pretax contribution from the Company’s corporate yen hedging program and invested assets transferred as part of the drawdown of excess capital in the U.S. segment beginning in the fourth quarter of 2017. Pretax adjusted earnings were a loss of $113 million, compared with a loss of $150 million a year ago.

ANALYSIS OF FINANCIAL CONDITION
The Company's financial condition has remained strong in the functional currencies of its operations. The yen/dollar exchange rate at the end of each period is used to translate yen-denominated balance sheet items to U.S. dollars for reporting purposes.

Investments

The Company’s investment strategy utilizes disciplined asset and liability management while seeking long-term risk-adjusted investment returns and the delivery of stable income within regulatory and capital objectives, and preserving shareholder value. In attempting to optimally balance these objectives, the Company seeks to maintain on behalf of Aflac Japan a diversified portfolio of yen-denominated investment assets, U.S. dollar-denominated investment portfolio hedged back to yen and a portfolio of unhedged U.S. dollar-denominated assets. As part of the Company's portfolio management and asset allocation process, Aflac U.S. invests in fixed maturity investments and growth assets, including public equity securities and alternative investments in limited partnerships. Aflac U.S. has been investing in both publicly traded and privately originated investment-grade and below-investment-grade fixed maturity securities and loans.


87


The following table details investments by segment.

Investments by Segment
  
 
Aflac Japan
 
 
Aflac U.S.
 
(In millions)
September 30,
2018
 
December 31,
2017
September 30,
2018
 
December 31,
2017
Available for sale, fixed maturity securities,
at fair value
(1)
 
$
68,325

 
 
 
$
69,338

 
 
$
12,568

 
 
 
$
13,606

 
Held to maturity, fixed maturity securities,
at amortized cost
 
30,421

 
 
 
31,430

 
 
0

 
 
 
0

 
Equity securities (1)
 
894

 
 
 
868

 
 
151

 
 
 
92

 
Other investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Transitional real estate loans
 
3,397

 
 
 
986

 
 
731

 
 
 
249

 
Commercial mortgage loans
 
768

 
 
 
767

 
 
258

 
 
 
141

 
Middle market loans
 
1,015

 
 
 
527

 
 
348

 
 
 
332

 
Policy loans
 
210

 
 
 
198

 
 
13

 
 
 
12

 
Short-term investments
 
0

 
 
 
57

 
 
2

 
 
 
0

 
Other
 
211

 
 
 
98

 
 
48

 
 
 
31

 
Total other investments
 
5,601

 
 
 
2,633

 
 
1,400

 
 
 
765

 
     Total investments
 
105,241

 
 
 
104,269

 
 
14,119

 
 
 
14,463

 
Cash and cash equivalents
 
1,400

 
 
 
636

 
 
1,003

 
 
 
1,011

 
            Total investments and cash (2)
 
$
106,641

 
 
 
$
104,905

 
 
$
15,122

 
 
 
$
15,474

 
(1) Includes perpetual securities
(2) Excludes investments and cash held by the Parent Company and other business segments of $2,451 in 2018 and $3,280 in 2017

Cash and cash equivalents totaled $3.4 billion, or 2.8% of total investments and cash, as of September 30, 2018, compared with $3.5 billion, or 2.8%, at December 31, 2017. For a discussion of the factors affecting the Company's cash balance, see the Operating Activities, Investing Activities and Financing Activities subsections of this MD&A.

In 2017, Aflac U.S. became a member of the Federal Home Loan Bank of Atlanta (FHLB). As a member, Aflac U.S. can access low-cost funding and also receive dividends on FHLB membership stock. Additional FHLB stock purchases are required based on funding activity with the FHLB. Aflac U.S. will be required to post acceptable forms of collateral for any funding from the FHLB. The FHLB stock purchased by the Company is classified as a restricted investment and is included in "other investments" in the consolidated balance sheets.

For additional information concerning the Company's investments, see Notes 3, 4, and 5 of the Notes to the Consolidated Financial Statements.

The ratings of the Company's securities referenced in the table below are based on the ratings designations provided by major Nationally Recognized Statistical Rating Organizations (NRSROs) (Moody's, S&P and Fitch) or, if not rated, are determined based on the Company's internal analysis of such securities. When the ratings issued by the rating agencies differ, the Company utilizes the second lowest rating when three or more rating agency ratings are available or the lowest rating when only two rating agency ratings are available.

88


The distributions of debt securities the Company owns, by credit rating, were as follows:

Composition of Securities Portfolio by Credit Rating
 
 
September 30, 2018
 
 
 
December 31, 2017
 
 
Amortized
Cost
 
  Fair    
  Value    
 
Amortized
Cost
 
  Fair    
  Value    
AAA
 
.9
%
 
 
 
.9
%
 
 
 
1.0
%
 
 
 
.9
%
 
AA
 
4.0

 
 
 
4.1

 
 
 
3.9

 
 
 
4.0

 
A
 
66.8

 
 
 
68.0

 
 
 
65.8

 
 
 
66.9

 
BBB
 
23.9

 
 
 
22.9

 
 
 
24.0

 
 
 
23.3

 
BB or lower
 
4.4

 
 
 
4.1

 
 
 
5.3

 
 
 
4.9

 
Total
 
100.0
%
 
 
 
100.0
%
 
 
 
100.0
%
 
 
 
100.0
%
 

As of September 30, 2018, the Company's direct and indirect exposure to securities in its investment portfolio that were guaranteed by third parties was immaterial both individually and in the aggregate.

The following table presents the 10 largest unrealized loss positions in the Company's portfolio as of September 30, 2018.
(In millions)
Credit
Rating
 
Amortized
Cost
 
Fair
Value
 
Unrealized    
Loss    
Diamond Offshore Drilling Inc.
 
B
 
 
 
$
141

 
 
 
$
98

 
 
 
$
(43
)
 
AXA
 
BBB
 
 
 
288

 
 
 
255

 
 
 
(33
)
 
Noble Holdings International Ltd.
 
CCC
 
 
 
97

 
 
 
73

 
 
 
(24
)
 
Baker Hughes Inc.
 
A
 
 
 
120

 
 
 
103

 
 
 
(17
)
 
Kommunal Landspensjonskasse (KLP)
 
BBB
 
 
 
132

 
 
 
119

 
 
 
(13
)
 
Time Warner Cable Inc.
 
BBB
 
 
 
115

 
 
 
103

 
 
 
(12
)
 
Weatherford Bermuda Holdings Ltd.
 
CCC
 
 
 
49

 
 
 
37

 
 
 
(12
)
 
Microsoft Corp.
 
AAA
 
 
 
212

 
 
 
200

 
 
 
(12
)
 
Abbvie Inc.
 
BBB
 
 
 
174

 
 
 
163

 
 
 
(11
)
 
National Oilwell Varco Inc.
 
BBB
 
 
 
82

 
 
 
71

 
 
 
(11
)
 

Generally, declines in fair values can be a result of changes in interest rates, yen/dollar exchange rate, and changes in net spreads driven by a broad market move or a change in the issuer's underlying credit quality. As the Company believes these issuers have the ability to continue making timely payments of principal and interest, the Company views these changes in fair value to be temporary and does not believe it is necessary to impair the carrying value of these securities. See the Unrealized Investment Gains and Losses section in Note 3 of the Notes to the Consolidated Financial Statements for further discussions of unrealized losses related to financial institutions and other corporate investments.

Below-Investment-Grade Securities

The Company's portfolio of below-investment-grade securities includes debt securities purchased while the issuer was rated investment grade plus other loans and bonds purchased as part of an allocation to that segment of the market. The following is the Company's below-investment-grade exposure.

89


Below-Investment-Grade Investments
 
September 30, 2018
(In millions)
Par
Value
 
Amortized
Cost
 
Fair
Value
 
Unrealized
Gain
(Loss)
Investcorp Capital Limited
$
376

 
$
376

 
$
393

 
$
17

Republic of South Africa
352

 
352

 
367

 
15

KLM Royal Dutch Airlines
264

 
194

 
230

 
36

Navient Corp.
206

 
111

 
144

 
33

Republic of Tunisia
185

 
108

 
132

 
24

Barclays Bank PLC
176

 
109

 
159

 
50

Telecom Italia SpA
176

 
176

 
223

 
47

Transnet
132

 
132

 
132

 
0

Diamond Offshore Drilling Inc.
124

 
141

 
98

 
(43
)
IKB Deutsche Industriebank AG
114

 
48

 
97

 
49

Arconic Inc.
100

 
82

 
99

 
17

Noble Holdings International Ltd.
94

 
97

 
73

 
(24
)
Petrobras International Finance Company
84

 
84

 
81

 
(3
)
EMC Corp.
80

 
79

 
74

 
(5
)
Generalitat de Catalunya
70

 
26

 
63

 
37

Teck Resources Ltd.
70

 
74

 
69

 
(5
)
Teva Pharmaceuticals
68

 
65

 
64

 
(1
)
Transocean Inc.
68

 
72

 
64

 
(8
)
National Gas Co. Trinidad and Tobago
52

 
50

 
52

 
2

Votorantim Overseas Trading IV Ltd.
50

 
49

 
52

 
3

CF Industries Inc.
50

 
48

 
48

 
0

Other Issuers (below $50 million in par value)
304

 
288

 
286

 
(2
)
          Subtotal (1)
3,195

 
2,761

 
3,000

 
239

Senior secured bank loans
1,342

 
1,330

 
1,342

 
12

High yield corporate bonds
514

 
499

 
511

 
12

Middle market loans, net of reserves (2)
1,382

 
1,363

 
1,363

 
0

          Grand Total
$
6,433

 
$
5,953

 
$
6,216

 
$
263

(1) Securities initially purchased as investment grade, but have subsequently been downgraded to below investment grade
(2) Middle market loans are carried at amortized cost

The Company invests in senior secured bank loans and middle market loans primarily to U.S. corporate borrowers, most of which have below-investment-grade ratings. The objectives of these programs include enhancing the yield on invested assets, achieving further diversification of credit risk, and mitigating the risk of rising interest rates and hedge costs through the acquisition of floating rate assets.

The Company maintains an allocation to higher yielding corporate bonds within the Aflac Japan and Aflac U.S. portfolios. Most of these securities were rated below-investment-grade at the time of purchase, but the Company also purchased several that were rated investment grade which, because of market pricing, offer yields commensurate with below-investment-grade risk profiles. The objective of this allocation was to enhance the Company's yield on invested assets and further diversify credit risk. All investments must have a minimum rating of low BB using the Company's above described rating methodology and are managed by the Company's internal credit portfolio management team.

Securities by Type of Issuance
The Company has investments in both publicly and privately issued securities. The Company's ability to sell either type of security is a function of overall market liquidity which is impacted by, among other things, the amount of outstanding securities of a particular issuer or issuance, trading history of the issue or issuer, overall market conditions, and idiosyncratic events affecting the specific issue or issuer.


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The following table details investment securities by type of issuance.

Investment Securities by Type of Issuance 
  
 
September 30, 2018
 
 
 
December 31, 2017
 
(In millions)
Amortized
Cost
 
Fair   
Value   
 
Amortized
Cost
 
Fair  
Value  
Publicly issued securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities (1)
 
$
82,166

 
 
 
$
90,901

 
 
 
$
81,454

 
 
 
$
93,025

 
Equity securities (1)
 
1,037

 
 
 
1,037

 
 
 
831

 
 
 
1,006

 
      Total publicly issued
 
83,203

 
 
 
91,938

 
 
 
82,285

 
 
 
94,031

 
Privately issued securities: (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities (1)
 
24,507

 
 
 
27,645

 
 
 
25,108

 
 
 
29,360

 
Equity securities (1)
 
22

 
 
 
22

 
 
 
15

 
 
 
17

 
      Total privately issued
 
24,529

 
 
 
27,667

 
 
 
25,123

 
 
 
29,377

 
      Total investment securities
 
$
107,732

 
 
 
$
119,605

 
 
 
$
107,408

 
 
 
$
123,408

 
(1) Includes perpetual securities
(2) Includes Rule 144A securities

The Company held $1,657 million and $1,789 million of perpetual securities at fair value ($1,474 million and $1,462 million at amortized cost) as of September 30, 2018 and December 31, 2017, respectively. The perpetual securities the Company holds were largely issued by banks that are systemically important to the financial markets of the sovereign country of domicile of the issuer. Generally, the Company believes regulatory changes made in the banking industry following the Global Financial Crisis and the European Sovereign Crisis, including increased capital and liquidity requirements and a reduction of business risk, have improved overall bank creditworthinessHowever, bank capital securities may be subject to varying bail-in/resolution regimes in their home countries, which may include conversion or write-down provisions when bank regulators determine that the institution has reached the point of non-viability. Such actions could result in lower cash flows and ratings downgrades of the affected securities, which in turn could result in a reduction of fair value of the securities and increase the Company’s regulatory capital requirements. These factors are an integral part of the Company's credit review process.

The following table details the Company's privately issued investment securities.

Privately Issued Securities
(Amortized cost, in millions)
September 30,
2018
 
December 31,
2017
Privately issued securities as a percentage of total investment securities
 
22.8
%
 
 
 
23.4
%
 
Privately issued securities held by Aflac Japan
 
$
21,714

 
 
 
$
22,354

 
Privately issued securities held by Aflac Japan as a percentage of total
investment securities
 
20.2
%
 
 
 
20.8
%
 

Reverse-Dual Currency Securities(1) 
(Amortized cost, in millions)
September 30,
2018
 
December 31,
2017
Privately issued reverse-dual currency securities
 
$
5,313

 
 
 
$
5,669

 
Publicly issued collateral structured as reverse-dual currency securities
 
1,620

 
 
 
1,390

 
Total reverse-dual currency securities
 
$
6,933

 
 
 
$
7,059

 
Reverse-dual currency securities as a percentage of total investment
securities
 
6.4
%
 
 
 
6.6
%
 
(1) Principal payments in yen and interest payments in dollars


91


Aflac Japan has a portfolio of privately issued securities to better match liability characteristics and secure higher yields than those available on Japanese government or other public corporate bonds. Aflac Japan’s investments in yen-denominated privately issued securities consist primarily of non-Japanese issuers, are rated investment grade at purchase and have longer maturities, thereby allowing the Company to improve asset/liability matching and overall investment returns. These securities are generally either privately negotiated arrangements or issued under medium-term note programs and have standard documentation commensurate with credit ratings of the issuer, except when internal credit analysis indicates that additional protective and/or event-risk covenants were required. Many of these investments have protective covenants appropriate to the specific investment. These may include a prohibition of certain activities by the borrower, maintenance of certain financial measures, and specific conditions impacting the payment of the Company's notes.

Hedging Activities

Aflac Japan’s U.S. Dollar-Denominated Investments

Most of Aflac Japan's cash, investments, and liabilities are yen-denominated. However, Aflac Japan also owns U.S. dollar-denominated investments, a portion of which Aflac Japan hedges with foreign currency forwards and options. The currency risk being hedged is generally based on fair value of hedged investments. The following table summarizes the U.S. dollar-denominated investments held by Aflac Japan.

 
September 30,
2018
 
December 31,
2017
 
(In millions)
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Available-for-sale securities:
 
 
 
 
 
 
 
 
  Fixed maturity securities (excluding bank loans) (1)
$
17,154

 
$
17,593

 
$
17,972

 
$
19,314

 
  Fixed maturity securities - bank loans (floating rate)
1,548

 
1,556

 
1,936

 
1,865

 
  Fixed maturity securities - economically converted to yen
1,641

 
2,341

 
1,650

 
2,549

 
Equity securities (1),(2)
197

 
197

 
147

 
173

 
Other investments:
 
 
 
 
 
 
 
 
  Transitional real estate loans (floating rate)
3,397

 
3,413

 
986

 
984

 
  Commercial mortgage loans
768

 
730

 
767

 
753

 
  Middle market loans (floating rate)
1,015

 
1,018

 
527

 
530

 
  Alternative investments
211

 
211

 
97

 
97

 
      Total U.S. dollar-denominated investments in Aflac Japan
$
25,931

 
$
27,059

 
$
24,082

 
$
26,265

 
(1) Includes perpetual securities
(2) Equities reported at carrying value starting in 2018

As of September 30, 2018, Aflac Japan had $10.0 billion outstanding notional amounts of foreign currency forwards and $9.7 billion outstanding notional amounts of foreign currency options, of which none were in-the-money, hedging the U.S. dollar-denominated investments, resulting in the unhedged fair value of the U.S. dollar Japan portfolio of $15.0 billion, excluding certain U.S. dollar-denominated assets shown in the table above as a result of consolidation that have been economically converted to yen using derivatives.

Foreign exchange derivatives used for hedging are periodically settled, which results in cash receipt or payment at maturity or early termination. The Company had net cash settlements of $105 million and $203 million for the three-month and $141 million and $356 million for the nine-month periods ended September 30, 2018 and 2017, respectively, associated with the currency derivatives used for hedging Aflac Japan’s U.S. dollar-denominated investments.

For additional discussion of the risks associated with the foreign currency exposure refer to the Currency Risk section in Item 7A., Quantitative and Qualitative Disclosures about Market Risk, and the Risk Factor sections titled “The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate" and “Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity" in the 2017 Annual Report. For discussion of the Company’s view on the stressed economic surplus in Aflac Japan, refer to the Investments subsection within Item 1., Business, in the 2017 Annual Report.

92



The following table presents metrics related to Aflac Japan hedge costs for the periods ended September 30.

Aflac Japan Hedge Cost Metrics(1) 
 
Three Months     
 
Nine Months
 
2018
 
2017
 
2018
 
2017
FX forward notional at end of period (in billions of dollars)(2)
10.0
 
11.4
 
10.0
 
11.4
Weighted average original tenor (in months)(3)
27.4
 
32.6
 
27.4
 
32.6
Weighted average remaining tenor (in months)(4)
16.8
 
25.2
 
16.8
 
25.2
Annualized amortized hedge costs (in basis points)(5)
236
 
217
 
229
 
201
Amortized hedge costs for period (in millions of dollars)
(59)
 
(60)
 
(168)
 
(168)
(1) See the Results of Operations section of this MD&A for the Company's definition of amortized hedge costs.
(2) Notional is reported net of any offsetting positions
(3) Tenor based on derivative's original execution date to settlement date
(4) Tenor based on period reporting date to settlement date
(5) Based on annualized amortized hedge costs divided by average FX forward notional for the period
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, starting in the first quarter of 2018, the Parent Company began entering into offsetting hedge positions using foreign exchange forwards. This activity is reported in the Corporate and other segment. As this program matures, the Company installs controls and, as has been the case with the U.S. dollar-denominated investments hedge program, includes third-party review to ensure the efficacy of the program.

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 Company has taken several courses of action. First, Aflac Japan maintains certain unhedged U.S. dollar-denominated securities, which serve as an economic currency hedge of a portion of the Company's investment in Aflac Japan. Second, the Company has designated the majority of the Parent Company’s yen-denominated liabilities (notes payable and loans) as non-derivative hedging instruments and certain foreign currency forwards and options as derivative hedges of the Company's net investment in Aflac Japan. The Company makes its accounting designation of net investment hedge at the beginning of each quarter. If the total of the designated Parent Company non-derivative and derivative notional is equal to or less than the Company's net investment in Aflac Japan, the hedge is deemed to be effective, and the currency exchange effect on the yen-denominated liabilities and the change in estimated fair value of the derivatives are reported in the unrealized foreign currency component of other comprehensive income. The Company's net investment hedge was effective during the three- and nine-month periods ended September 30, 2018 and 2017, respectively.
For the hedge of the Company's net investment in Aflac Japan, the Company has designated certain of the Parent Company's yen-denominated liabilities and foreign currency forwards and options as accounting hedges of its net investment in Aflac Japan. The Company's consolidated yen-denominated net asset position was partially hedged at $1.3 billion as of September 30, 2018, with hedging instruments comprised completely of yen-denominated debt, compared with a hedge of $1.8 billion as of December 31, 2017, with hedging instruments comprised of $1.4 billion of yen-denominated debt and $.4 billion of foreign currency forwards and options.

See Note 4 of the Notes to the Consolidated Financial Statements for additional information on the Company's hedging activities.

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Deferred Policy Acquisition Costs
The following table presents deferred policy acquisition costs by segment.
(In millions)
September 30, 2018
 
December 31, 2017
 
% Change      
Aflac Japan
 
$
6,195

 
 
 
$
6,150

 
 
 
.7
%
(1) 
Aflac U.S.
 
3,427

 
 
 
3,355

 
 
 
2.1

 
Total
 
$
9,622

 
 
 
$
9,505

 
 
 
1.2
%
 
(1)Aflac Japan’s deferred policy acquisition costs increased 1.2% in yen during the nine months ended September 30, 2018.

See Note 6 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for additional information on the Company's deferred policy acquisition costs.

Policy Liabilities
The following table presents policy liabilities by segment.
(In millions)
September 30, 2018
 
December 31, 2017
 
% Change      
Aflac Japan
 
$
90,277

 
 
 
$
89,132

 
 
 
1.3
%
(1) 
Aflac U.S.
 
10,885

 
 
 
10,625

 
 
 
2.4

 
Other
 
171

 
 
 
138

 
 
 
23.9

 
Intercompany eliminations(2)
 
(749
)
 
 
 
(748
)
 
 
 
.1

 
Total
 
$
100,584

 
 
 
$
99,147

 
 
 
1.4
%
 
(1) Aflac Japan’s policy liabilities increased 1.8% in yen during the nine months ended September 30, 2018.
(2) 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 7 of the Notes to the Consolidated Financial Statements.

Notes Payable

Notes payable totaled $5.3 billion at September 30, 2018 and December 31, 2017.

Subsequent to September 30, 2018, 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. The Parent Company intends to use the proceeds from this debt issuance to redeem $550 million of its 2.40% senior notes due in 2020, and to use the remaining proceeds, if any, for general corporate purposes.

Subsequent to September 30, 2018, 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.

See Note 8 of the accompanying Notes to the Consolidated Financial Statements for additional information on the Company's notes payable.

94



Benefit Plans
Aflac Japan and Aflac U.S. have various benefit plans. For additional information on the Company's Japanese and U.S. plans, see Note 12 of the accompanying Notes to the Consolidated Financial Statements and Note 14 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report.

Policyholder Protection

Policyholder Protection Corporation

The Japanese insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. Legislation enacted regarding the framework of the Life Insurance Policyholder Protection Corporation (LIPPC) included government fiscal measures supporting the LIPPC. On March 30, 2012, the Diet approved legislation to enhance the stability of the LIPPC by extending the government's fiscal support of the LIPPC through March 2017. On November 25, 2016, Japan's Diet passed legislation that again extends the government's fiscal support of the LIPPC through March 2022. Effective April 2014, the annual LIPPC contribution amount for the total life industry was lowered from 40 billion yen to 33 billion yen.

Guaranty Fund Assessments

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. The amount of the guaranty fund assessment that an insurer is assessed is based on its proportionate share of premiums in that state.

As of September 30, 2018, the Company has estimated and recognized the impact of its share of guaranty fund assessments resulting from the liquidation of a long-term care insurer. See Note 15 of the Notes to the Consolidated Financial Statements for further information on the assessment.

Off-Balance Sheet Arrangements

As of September 30, 2018, the Company had no material letters of credit, standby letters of credit, guarantees or standby repurchase obligations. See Note 15 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for information on material unconditional purchase obligations that are not recorded on the Company's balance sheet.


CAPITAL RESOURCES AND LIQUIDITY
Aflac Japan and Aflac U.S. provide the primary sources of liquidity to the Parent Company through dividends and management fees. The following table presents the amounts provided for the nine-month periods ending September 30.

Liquidity Provided by Aflac Japan and Aflac U.S. to Parent Company
(In millions)
2018
 
2017
 
Dividends declared or paid by Aflac
$
664

 
$
1,400

 
Management fees paid by Aflac Japan and Aflac U.S.
104

 
219

 

The decline in dividends in the first nine months of 2018 was driven by a change in the dividend regulatory approval process subsequent to the conversion of Aflac Japan from a branch to a subsidiary on April 1, 2018. The Company expects to resume dividend payments from Aflac Japan in the fourth quarter of 2018. Management fees decreased during the nine-month period ending September 30, 2018, compared to prior year due to changes in the administration of intercompany expenses between legal entities subsequent to the conversion of Aflac Japan from a branch to a subsidiary on April 1, 2018.

The primary uses of cash by the Parent Company are shareholder dividends, the repurchase of its common stock and interest on its outstanding indebtedness and operating expenses.


95


At the end of September 2018, the Company announced a change in its internal dividend policy which allows the Company to increase the proportion of regulatory earnings transferred from Aflac U.S. and Aflac Japan to the Parent Company. The Company plans to decrease the regulatory capital held at Aflac and transfer a commensurate amount of capital to the Parent Company in the fourth quarter of 2018. The Company also intends to maintain higher than historical levels of capital and liquidity at the Parent Company with the goals of addressing the Company’s hedge costs and related potential need for collateral and mitigating against long-term weakening of the Japanese yen. Further, the Company plans to continue to maintain a portfolio of unhedged U.S. dollar based investments at Aflac Japan and consider whether the amount of such investments should be increased or decreased relative to the Company’s view of economic equity surplus in Aflac Japan in light of potentially rising hedge costs and other factors. See Item 2., Management’s Discussion and Analysis of Financial Condition and Results of Operations under “Forward-Looking Information,” for a description of factors that could cause actual results to differ materially from those contemplated by the Company in regards to its capital management intentions.

The Parent Company accesses debt security markets to provide additional sources of capital. In September 2018, the Parent Company filed a shelf registration statement with the SEC that allows the Company to issue an indefinite amount of debt securities, in one or more series, from time to time until September 2021. In August 2018, the Parent Company filed a shelf registration with Japanese regulatory authorities that allows the Parent Company to conduct public offerings of bonds in Japan, including yen-denominated Samurai notes, up to 200 billion yen or its equivalent through August 2020. The shelf registration statement is for possible public offerings in Japan, but the bonds issued under the shelf may be transferred by the bondholders to U.S. persons in compliance with U.S. law. The Company believes outside sources for additional debt and equity capital, if needed, will continue to be available. For additional information, see Note 8 of the Notes to the Consolidated Financial Statements.

The principal sources of cash for the Company's insurance operations are premiums and investment income. The primary uses of cash by the Company's insurance operations are investments, policy claims, commissions, operating expenses, income taxes and payments to the Parent Company for management fees and dividends. Both the sources and uses of cash are reasonably predictable.

When making an investment decision, the Company's first consideration is based on product needs. The Company's investment objectives provide for liquidity through the purchase of investment-grade debt securities. These objectives also take into account duration matching, and because of the long-term nature of the Company's business, the Company has adequate time to react to changing cash flow needs related to benefits and expenses.

As a result of policyholder aging, claims payments are expected to gradually increase over the life of a policy. Therefore, future policy benefit reserves are accumulated in the early years of a policy and are designed to help fund future claims payments. The Company expects its future cash flows from premiums and its investment portfolio to be sufficient to meet its cash needs for benefits and expenses.

As of September 30, 2018, the Parent Company and Aflac had four lines of credit with third parties as well as two intercompany lines of credit. For additional information on the Company's lines of credit, see Note 8 of the Notes to the Consolidated Financial Statements.

As part of the FHLB funding arrangement as discussed previously in the Analysis of Financial Condition section of this MD&A, Aflac U.S. borrowed and repaid $86 million during the first nine months of 2018.

The Company's financial statements convey its financing arrangements during the periods presented. The Company has not engaged in material intra-period short-term financings during the periods presented that are not otherwise reported in its balance sheet or disclosed therein. The Company was in compliance with all of the covenants of its notes payable and lines of credit at September 30, 2018. The Company has not entered into transactions involving the transfer of financial assets with an obligation to repurchase financial assets that have been accounted for as a sale under applicable accounting standards, including securities lending transactions. See Notes 3 and 4 of the Notes to the Consolidated Financial Statements and Notes 1, 3, and 4 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for more information on the Company's securities lending and derivative activities. With the exception of disclosed activities in those referenced footnotes, the Company does not have a known trend, demand, commitment, event or uncertainty that would reasonably result in its liquidity increasing or decreasing by a material amount. The Company's cash and cash equivalents include unrestricted cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased, all of which has minimal market, settlement or other risk exposure.

96


Consolidated Cash Flows
The Company translates cash flows for Aflac Japan’s yen-denominated items into U.S. dollars using weighted-average exchange rates. In periods when the yen weakens, translating yen into dollars causes fewer dollars to be reported. When the yen strengthens, translating yen into dollars causes more dollars to be reported.
The following table summarizes consolidated cash flows by activity for the nine-month periods ended September 30.
(In millions)
2018
 
2017
 
Operating activities
$
4,659

 
$
4,596

 
Investing activities
(3,172
)
 
(2,887
)
 
Financing activities
(1,513
)
 
(1,613
)
 
Exchange effect on cash and cash equivalents
(36
)
 
(28
)
 
Net change in cash and cash equivalents
$
(62
)
 
$
68

 
Operating Activities
The following table summarizes operating cash flows by source for the nine-month periods ended September 30
(In millions)
2018
 
2017
 
Aflac Japan
$
4,059

 
$
3,657

 
Aflac U.S. and other operations
600

 
939

 
Total
$
4,659

 
$
4,596

 
Investing Activities
Operating cash flow is primarily used to purchase investments to meet future policy obligations. The following table summarizes investing cash flows by source for the nine-month periods ended September 30.
(In millions)
2018
 
2017
 
Aflac Japan
$
(2,565
)
 
$
(2,212
)
 
Aflac U.S. and other operations
(607
)
 
(675
)
 
Total
$
(3,172
)
 
$
(2,887
)
 

Prudent portfolio management dictates that the Company attempts to match the duration of its assets with the duration of its liabilities. Currently, when the Company's fixed maturity securities mature, the proceeds may be reinvested at a yield below that required for the accretion of policy benefit liabilities on policies issued in earlier years. However, the long-term nature of the Company's business and its strong cash flows provide the Company with the ability to minimize the effect of mismatched durations and/or yields identified by various asset adequacy analyses. From time to time or when market opportunities arise, the Company disposes of selected fixed maturity securities that are available for sale to improve the duration matching of assets and liabilities, improve future investment yields, and/or re-balance its portfolio. As a result, dispositions before maturity can vary significantly from year to year.

As part of its overall corporate strategy, the Company announced in September 2018 that it intends to increase its original investment in the Aflac Ventures Fund from $100 million over three years to $250 million over three to four years, as opportunities emerge. These investments are included in the other investments line in the consolidated balance sheets. The Aflac Ventures Fund is a subsidiary of Aflac Corporate Ventures which is reported in the "Corporate and other" business segment. The central mission of Aflac Corporate Ventures is to support the organic growth and business development needs of Aflac Japan and Aflac U.S. with emphasis on digital applications designed to improve the customer experience, gain efficiencies, and develop new markets in an effort to enhance and defend long-term shareholder value.

See Note 3 of the Notes to the Consolidated Financial Statements for details on certain investment commitments.


97


Financing Activities

Consolidated cash used by financing activities was $1.5 billion in the first nine months of 2018, compared with consolidated cash used by financing activities of $1.6 billion for the same period of 2017.

See the preceding discussion in this Capital Resources and Liquidity section of MD&A for details and any outstanding balances as of September 30, 2018, for the Company's lines of credit and FHLB financing arrangement.

The Company was in compliance with all of the covenants of its notes payable and lines of credit at September 30, 2018.

Cash returned to shareholders through dividends and treasury stock purchases was $1.5 billion during the nine-month periods ended September 30, 2018 and 2017, respectively.

The following tables present a summary of treasury stock activity during the nine-month periods ended September 30.

Treasury Stock Purchased
(In millions of dollars and thousands of shares)
2018
 
2017
 
Treasury stock purchases
$
923

 
$
1,053

 
Number of shares purchased:
 
 
 
 
Open market
20,443

 
27,796

 
Other
361

 
872

 
   Total shares purchased
20,804

 
28,668

 

Treasury Stock Issued
(In millions of dollars and thousands of shares)
2018
 
2017
 
Stock issued from treasury:
 
 
 
 
   Cash financing
$
36

 
$
23

 
   Noncash financing
17

 
45

 
   Total stock issued from treasury
$
53

 
$
68

 
Number of shares issued
1,393

 
1,957

 

During the first nine months of 2018, the Company repurchased 20.4 million shares of its common stock for $923 million as part of its share repurchase program. As of September 30, 2018, a remaining balance of 77.6 million shares of the Company's common stock was available for purchase under share repurchase authorizations by its board of directors. The Company currently plans to repurchase a total of $1.1 billion to $1.4 billion of its common stock in 2018, assuming stable capital conditions and the absence of compelling alternatives.

Cash dividends paid to shareholders were $.26 per share in the third quarter of 2018, compared with $.22 per share in the third quarter of 2017. The following table presents the dividend activity for the nine-month periods ended September 30.

(In millions)
2018
 
2017
 
Dividends paid in cash
$
595

 
$
491

 
Dividends through issuance of treasury shares
8

 
22

 
Total dividends to shareholders
$
603

 
$
513

 

In October 2018, the board of directors declared the fourth quarter cash dividend of $.26 per share, an increase of 18.2% compared with the same period in 2017. The dividend is payable on December 3, 2018 to shareholders of record at the close of business on November 21, 2018.


98


Regulatory Restrictions

Aflac and CAIC are domiciled in Nebraska and are subject to its regulations. Subsequent to the Japan branch conversion to a subsidiary, Aflac Japan is domiciled in Japan and subject to local regulations. See further discussion below. A life insurance company’s statutory capital and surplus is determined according to rules prescribed by the National Association of Insurance Commissioners (NAIC), as modified by the insurance department in the insurance company’s state of domicile. Statutory accounting rules are different from U.S. GAAP and are intended to emphasize policyholder protection and company solvency. Similar laws apply in New York, the domiciliary jurisdiction of Aflac's New York insurance subsidiary.

The continued long-term growth of the Company's business may require increases in the statutory capital and surplus of its insurance operations. Aflac’s insurance operations may secure additional statutory capital through various sources, such as internally generated statutory earnings, capital contributions by the Parent Company from funds generated through debt or equity offerings, or reinsurance transactions. The NAIC’s risk-based capital (RBC) formula is used by insurance regulators to help identify inadequately capitalized insurance companies. The RBC formula quantifies insurance risk, business risk, asset risk and interest rate risk by weighing the types and mixtures of risks inherent in the insurer’s operations.

As of September 30, 2018, Aflac’s U.S.-only RBC ratio remains high and reflects a strong capital and surplus position, even reflecting the full negative impact of the U.S. Tax Act, which is expected to be fully adopted in 2018. This reduction occurs as a result of writing down deferred tax assets and the increase in required capital due to the reduction in tax rates. However, Aflac expects to recover from this negative impact over a period of three to five years through additional statutory income, assuming that the additional income is fully retained. The Company expects to continue to draw down RBC levels through dividends for the remainder of 2018; however, the RBC level is still expected to be strong at the end of the year.

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 2018 in excess of $2.6 billion would be considered extraordinary and require such approval. Subsequent to the Japan branch conversion to a subsidiary, the Company intends to use extraordinary dividends as needed to actively manage to appropriate RBC levels that are lower yet sufficient to maintain ratings and support prudent capital management.

In addition to limitations and restrictions imposed by U.S. insurance regulators, after the Japan branch conversion as of April 1, 2018, the new Japan subsidiary 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 the Japan subsidiary is defined as retained earnings plus other capital reserve less net after-tax unrealized losses on available-for-sale securities. These dividend capacity requirements are generally aligned with the solvency margin ratio (SMR). Japan's Financial Services Agency (FSA) maintains its own solvency standard which is quantified through the SMR. Aflac Japan's SMR is sensitive to interest rate, credit spread, and foreign exchange rate changes, therefore the Company continues to evaluate alternatives for reducing this sensitivity. In the event of a rapid change in market risk conditions causing SMR to decline, the Company has two senior unsecured revolving credit facilities in the amounts of 100 billion yen and 55 billion yen, respectively, and a committed reinsurance facility in the amount of approximately 110 billion yen as a capital contingency plan. (See Notes 7 and 8 of the Notes to the Consolidated Financial Statements for additional information.)

The Company has already undertaken various measures to mitigate the sensitivity of Aflac Japan's SMR. For example, the Company employs policy reserve matching (PRM) investment strategies, which is a Japan-specific accounting treatment that reduces SMR interest rate sensitivity since PRM-designated investments are carried at amortized cost consistent with corresponding liabilities. In order for a PRM-designated asset to be held at amortized cost, there are certain criteria that must be maintained. The primary criteria relates to maintaining the duration of designated assets and liabilities within a specified tolerance range. If the duration difference is not maintained within the specified range without rebalancing, then a certain portion of the assets must be re-classified as available for sale and held at fair value with any associated unrealized gain or loss recorded in surplus. To rebalance, assets may need to be sold in order to maintain the duration with the specified range, resulting in realizing a gain or loss from the sale. For U.S. GAAP, PRM investments are categorized as available-for-sale. The Company also uses foreign currency derivatives to hedge a portion of its U.S. dollar-denominated investments. (See Notes 3, 4 and 8 of the Notes to the Consolidated Financial Statements in the 2017 Annual Report for additional information on the Company's investment strategies, hedging activities, and reinsurance, respectively.)


99


As of September 30, 2018, Aflac Japan's SMR remains high and reflects a strong capital and surplus position. As part of the conversion of Aflac Japan from a branch to a subsidiary on April 1, 2018, the Company experienced an accounting-driven decline in the SMR of approximately 130 points, based on the SMR as of December 31, 2017. The Company expects to be able to pay dividends out of certain accounts, thus restoring this accounting impact over an estimated three-year period. The FSA has been conducting field testing with the insurance industry concerning the introduction of an economic value-based solvency regime. The field testing will assist the FSA in determining if an economic value-based solvency regime in Japan will be appropriate for the insurance industry.

Payments are made from Aflac Japan 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. The following table details Aflac Japan remittances for the nine-month periods ended September 30.
Aflac Japan Remittances 
(In millions of dollars and billions of yen)
2018
 
2017
 
Aflac Japan management fees paid to Parent Company
$
40

 
$
73

 
Expenses allocated to Aflac Japan (in dollars)
8

 
80

 
Aflac Japan profit remittances to the Parent Company or Aflac U.S. (in dollars)
312

 
933

 
Aflac Japan profit remittances to the Parent Company or Aflac U.S. (in yen)
33.4

 
104.6

 

The Company had foreign exchange forwards and options as part of an economic hedge of foreign exchange risk on 30.0 billion yen of profit remittances received from Aflac Japan in the first nine months of 2018, resulting in $2 million more funds received when the yen were exchanged into dollars relative to what would have been received at the then-current exchange rate.
For additional information on regulatory restrictions on dividends, profit repatriations and other transfers, see Note 13 of the Notes to the Consolidated Financial Statements and the Regulatory Restrictions subsection of MD&A, both in the 2017 Annual Report.
Other

For information regarding commitments and contingent liabilities, see Note 13 of the Notes to the Consolidated Financial Statements.
Additional Information

Investors should note that the Company announces material financial information in its SEC filings, press releases and public conference calls. In accordance with SEC guidance, the Company may also use the Investor Relations section of the Company's website (http://investors.aflac.com) to communicate with investors about the Company. It is possible that the financial and other information the Company posts there could be deemed to be material information. The information on the Company's website is not part of this document.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed primarily to the following types of market risks: currency risk, interest rate risk, credit risk and equity risk. The Company regularly monitors its market risks and uses a variety of strategies to manage its exposure to these market risks. A description of the Company's market risk exposures may be found under “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A, of the 2017 Annual Report. There have been no material changes to the Company's market risk exposures from the market risk exposures previously disclosed in the 2017 Annual Report.


100


Item 4.
Controls and Procedures

Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the third fiscal quarter of 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting, with the exception of the new and revised internal controls related to the implementation of a new investment accounting reporting system. The Company had also implemented new and revised internal controls related to the upgrade to a newer version of the Company's financial accounting and reporting consolidation system effective January 2018. The Company's management believes that the implementation of these systems has improved and enhanced its internal control over financial reporting.

101


PART II. OTHER INFORMATION
 
Item 1.
Legal Proceedings

On December 14, 2017, three former independent sales contractors filed a shareholders derivative complaint in the U.S. District Court for the Southern District of New York naming the Parent Company as nominal defendant and the Parent Company’s Chairman and Chief Executive Officer, several of its directors, and a former officer and director as defendants. The complaint alleges breaches of fiduciary duty, misstatements and omissions in the Company’s public disclosures, and insider trading. The Company’s Board of Directors had previously established a special litigation committee (SLC) in July 2017 to investigate certain allegations underlying the derivative action. The SLC issued a report of its investigation in September 2017 and another report in February 2018, each of which determined that it was not in the best interests of the Company to pursue the action demanded by the shareholders. An amended complaint was filed on January 31, 2018. On February 12, 2018, this litigation was transferred to the U.S. District Court for the Middle District of Georgia. The SLC issued a third report of its investigation in May 2018 regarding certain additional allegations raised in the amended complaint, in which the SLC also determined that it was not in the best interests of the Company to pursue the action demanded by the shareholders. On August 31, 2018, the District Court granted the Company's motion and the amended complaint was dismissed. The plaintiffs have filed a notice of appeal to the United States Court of Appeals for the Eleventh Circuit. The Company believes the outcome of this litigation will not have a material adverse effect on its financial position, results of operation or cash flows.

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.


Item 1A.
Risk Factors

Readers should carefully consider the risk factors that may affect the Company’s business or operations described under “Risk Factors” in Part I, Item 1A. of the Company's 2017 Annual Report on Form 10-K for the year ended December 31, 2017 and in Part II, Item 1A. of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2018 and its Quarterly Report on Form 10-Q for the quarter ended June 30, 2018.


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
During the first nine months of 2018, the Company repurchased shares of its common stock as follows:

102


Period
Total
Number of
Shares
Purchased
 
Average
Price Paid
Per Share
 
Total
Number
of Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
 
Maximum    
Number of    
Shares that    
May Yet Be    
Purchased    
Under the    
Plans or    
Programs    
 
January 1 - January 31
2,370,284

 
$
44.31

 
2,370,284

 
95,626,488

 
February 1 - February 28
2,349,600

 
44.70

 
2,349,600

 
93,276,888

 
March 1 - March 31
1,937,161

 
44.49

 
1,920,400

 
91,356,488

 
April 1 - April 30
2,082,500

 
44.62

 
2,082,500

 
89,273,988

 
May 1 - May 31
2,558,472

 
45.17

 
2,542,900

 
86,731,088

 
June 1  - June 30
2,175,100

 
44.99

 
2,175,100

 
84,555,988

 
July 1 - July 31
2,008,123

 
43.52

 
1,994,900

 
82,561,088

 
August 1 - August 31
2,358,317

 
46.64

 
2,352,500

 
80,208,588

 
September 1  - September 30
2,668,990

 
47.20

 
2,654,401

 
77,554,187

 
Total
20,508,547

(2) 
$
45.15

 
20,442,585

 
77,554,187

(1) 
(1)The total remaining shares available for purchase at September 30, 2018, consisted of 77,554,187 shares related to an 80,000,000 share repurchase authorization by the board of directors announced in 2017.
(2)During the first nine months of 2018, 65,962 shares were purchased in connection with income tax withholding obligations related to the vesting of restricted-share-based awards during the period.



103


Item 6.
Exhibits
(a)
EXHIBIT INDEX
 
-
 
Articles of Incorporation, as amended – incorporated by reference from Form 10-Q for June 30, 2008, Exhibit 3.0 (File No. 001-07434).
 
-
 
Bylaws of the Corporation, as amended and restated – incorporated by reference from Form 8-K dated November 10, 2015, Exhibit 3.1 (File No. 001-07434).
 
-
 
Fifteenth Supplemental Indenture, dated as of October 18, 2018 between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including the form of 1.159% Senior Notes due 2030) - incorporated by reference from Form 8-K dated October 18, 2018, Exhibit 4.1 (File No. 001-7434)
 
-
 
Sixteenth Supplemental Indenture, dated as of October 18, 2018 between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including the form of 1.488% Senior Notes due 2033) - incorporated by reference from Form 8-K dated October 18, 2018, Exhibit 4.2 (File No. 001-7434)
 
-
 
Seventeenth Supplemental Indenture, dated as of October 18, 2018 between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including the form of 1.750% Senior Notes due 2038) - incorporated by reference from Form 8-K dated October 18, 2018, Exhibit 4.3 (File No. 001-7434)
 
-
 
Letter from KPMG LLP regarding unaudited interim financial information.
 
-
 
Certification of CEO dated November 1, 2018, required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
 
-
 
Certification of CFO dated November 1, 2018, required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
 
-
 
Certification of CEO and CFO dated November 1, 2018, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.INS
-
 
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
 
101.SCH
-
 
XBRL Taxonomy Extension Schema.
 
101.CAL
-
 
XBRL Taxonomy Extension Calculation Linkbase.
 
101.DEF
-
 
XBRL Taxonomy Extension Definition Linkbase.
 
101.LAB
-
 
XBRL Taxonomy Extension Label Linkbase.
 
101.PRE
-
 
XBRL Taxonomy Extension Presentation Linkbase.
 
 
 
 
 
 

104



SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
Aflac Incorporated
 
 
 
November 1, 2018
 
/s/ Frederick J. Crawford
 
 
(Frederick J. Crawford)
 
 
Executive Vice President,
Chief Financial Officer
 
 
 
November 1, 2018
 
/s/ June Howard
 
 
(June Howard)
 
 
Senior Vice President, Financial Services; Chief Accounting Officer


105