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Will Underperforming Japan Business Weigh on Aflac (AFL)?

Zacks Equity Research

Investors are currently concerned about Aflac Inc. AFL business loss in Japan due to its sales practices within a key distribution channel in the region.

Nearly 80% of Aflac’s revenues come from its Japan business. This business has been underperforming over the years due to the ultra low interest rates in the region. In an effort to deal with the low interest rate, the company shifted its product offering to third sector products that are less interest rate sensitive and have strong and stable margins.

The effect of low interest rates is much pronounced on life insurance companies given their rate-sensitive products and investments. Companies like American International Group Inc. AIG, MetLife, Inc. MET and Lincoln National Corp. LNC are some of the major life insurers in the industry.

Last year, this business hit another roadblock as Japan Post Holdings (consisting of JPI, JPC and Japan Post Group), one of the major distributors of cancer insurance, was accused of improper sales practices. JPC and JPI are important distribution and alliance partners of the company, which in 2019 collectively accounted for approximately 25% of Aflac Japan’s third sector sales. The investigation into the matter is continuing and is likely to be completed by the end of June 2020.

There is no surety of re-initiation of sales of JPI insurance products. Notwithstanding the JPI investigation and the three-month suspension orders promulgated by the FSA and the Japan Ministry of Internal Affairs and Communications, the sale of Aflac Japan cancer policies has continued through JPC and JPI.

However, while the sale of Aflac Japan cancer insurance products is not within the scope of the suspension orders, beginning in August 2019, the company experienced a material decrease of sales in the Japan Post Group channel. This decline has continued into 2020. The company believes that sales of Aflac Japan cancer insurance through JPC and JPI are unlikely to return to 2018 levels in the near term.  In 2019, new annualized premium sales declined 15.9% year over year.

For 2020, the company expects a decline of 0.7% in third sector and first sector protection earned premium for the year. Also, net investment income is expected to decrease modestly as compared to 2019, due to the low interest rate environment in Japan and de-risking of the portfolio, partially offset by lower hedge cost as a result of a reduction in the hedge ratio in the fourth quarter of 2019.

Thus, pressure on revenues from Japan is likely to hurt earnings till the investigation resolves.

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