AFL Q1 2018 Earnings Call
Operator: Welcome to the Aflac 2018 Outlook Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded. I would now like to turn the call over to Mr. David Young, Vice President of Aflac Investor and Rating Agency Relations.
David Young: Thank you and good morning. Welcome to our 2018 Outlook call. Joining me this morning from the U.S. are Dan Amos, Chairman and CEO; Kriss Cloninger, President of Aflac Incorporated; Fred Crawford, Executive Vice President and CFO of Aflac Incorporated; Teresa White, President of Aflac U.S.; Eric Kirsch, Executive Vice President and Global Chief Investment Officer; and Todd Daniels, Executive Vice President, Global Chief Risk Officer and Chief Actuary. Also joining us from Tokyo this morning are Charles Lake, President of Aflac Japan, Masatoshi Koide, President and COO of Aflac Japan and Koji Ariyoshi, Executive Vice President and Director of Sales and Marketing. Before we start, let me remind you that some statements in this teleconference are forward-looking within the meaning of federal security laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate, because they’re prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our Annual Report on Form 10-K for some of the various risk factors that could materially impact our results. The earnings release is available on the Investors page of aflac.com and also includes reconciliations of certain non-GAAP measures. Now, I’ll turn the program over to Dan, who will begin this morning with some high-level comments in outline in the company’s strategic focus and value creation. Then Teresa will give an update on the U.S strategic focus on Aflac followed by Koise who will provide the strategic focus for our Aflac Japan operations and outlook. Fred will follow with comments about our 2018 financial outlook and capital management. Dan?
Dan Amos: Thank you, Dave. And good morning and thank you for joining us today as we share with you our outlook for 2018. At Aflac, we’ve always managed our business for the long-term while remaining laser focused on meeting our financial objectives. At the same time, we continue to work on enhancing our customer service and growing our book of business. This has propelled our successful development of strategic points of leverage in both Japan and the United States that we will use to grow and drive shareholder value. Our industry leading market share and scale in both Japan and the United States drive our administrative efficiencies, this allows us to offer affordable value coverage to our customers along with competitive compensation to our distributors. At the same time, they drive value for our shareholders. Building on the leading position in both countries will help position us for future growth. As a product innovator we have experienced remarkable success leveraging the strength of Aflac's recognized and powerful brand to drive sales. About nine out of 10 people in both the United States and Japan recognize the Aflac brand. Our brand is a combination of many elements, with the most visible being the Aflac duck, however it's also made up of the trust we build through our relationships with businesses, policy holders and consumers. With this backdrop we are very proud to be the leaders in voluntary insurance at the work site in the United States and in Japan. We also insure one out four households. In Japan and the US Aflac's established brand continues to serve as an effective door opener. With a strong brand people know and trust, individuals and businesses are more receptive to hearing about Aflac's products can provide value for them. As just one example in the US, One Day Pay our industry leading claims initiative allows us to process, approve and pay eligible claims in just one day. Our policy holders and consumers continue to tell us how our commitment to paying claims pass through one day pay, underscore Aflac's integrity and commitment to deliver on our promise faster than ever. Having diverse and productive distribution channels, is the strategic point of leverage and a vital component of our growth strategy in Japan and the United States. As such this is an area where we focused a great deal of our efforts. Our goal is to have a presence in all the outlets where consumers in both countries want to make their insurance purchasing decisions. We offer innovative products and high quality customized service to provide businesses and their employees with affordable solutions that help protect their financial wellbeing. We've established a strong capital position with stable earnings and strong cash flows. Our capital ratios demonstrate our commitment to maintaining robust capital levels and flexibility on behalf of our policy holders, bond holders and shareholders. We also regularly assess our capital adequacy to ensure we remain strong even under extreme economic scenarios. As a result, we hold among the highest financial strength ratings in the industry. Finally, we recognize the need to balance earnings growth with prudent risk management and containing volatility during a period of difficult investment conditions. These points of leverage are long in making and driven from years of investment and strong performance. But to be clear our mission and management challenge is to take advantage of these core franchise strengths to grow the business and our entire enterprise value. Before I hand the call off to Teresa, I want to take a moment to go over our strategic focus in 2018. Related to Japan branch conversion to a subsidiary, we are on budget with the conversion and approvals of moving forward according to plan and in fact just this morning we received a series of key approvals from Japan’s financial services agency. This means we are currently on track to meet our midyear 2018 timing objective and may complete the conversion as early as April 1. The conversion forms a key to the sustainable growth by bringing enhance business development flexibility and reduce strategic risk, a consistent regulatory framework aligns with global standards and improve transparency of cash flows and capital, all of which will be advantageous to all of our stakeholders. With respect to growth, we are focused on delivering innovative and relevant products in both Japan and the United States. We also continue to look for ways to expand our distribution especially in the US where our new Chief Distribution Officer will develop new growth initiatives and continued development and alignment of our current distribution strategy. We continue to evaluate and invest in digital applications and ventures with the aim of improving our customer experience and sealing new growth opportunities. We are focused on maximizing efficiencies by continuing our investment our IT infrastructure to achieve improved productivity and improved long-term expense ratios. And finally, as it relates to our financial strength, Fred will provide a more detailed outlook, but we are committed to maintain stable margins and allocating our capital to drive higher returns. You will see this in both our investment strategy and our decisions surrounding business mix in Japan. We remain committed to returning capital to our shareholders in the form of dividend and repurchase, but we also recognize the smart investment in our platform is also critical to grow earn premium and drive efficiencies which also ultimately will impact the bottom line. That investment will continue into 2018 and beyond, Teresa and Koide-san will cover this in a comment shortly. These areas of focus are viewed through the lens of strong leadership and governance. I believe we have the right leaders in the right place at the right time. This will continue to guide and propel our strong government principles and approach. Now, let me turn the program over to Teresa who will discuss the US. Teresa?
Teresa White: Thank you, Dan. I’d like to begin by sharing some key highlights of what we observed in the US market, a market we believe holds great opportunity and is capable of supporting growth provided we execute. The competitive landscape continues to expand and cause short-term industry disruption. However, competition is driving greater awareness and innovation that we believe will yield expansion of the marketplace over the long run. The need to meet variant customer preferences required investments and transformations that allows the consumer to access our products on their own terms. There are also clear growth catalysts presented in today’s market. With the evolving political climate and increasing media coverage of healthcare, the timing is right to leverage employers heightened interest and awareness around benefits. And the availability of data driven technology can help us to get closer to the potential buyer and better respond to the newer generation of consumers. These factors are indicator of strong positive outlook for the voluntary market and with this as a backdrop, we believe Aflac's benefit will not only continue to remain relevant in this environment but that’s that need for that is stronger than ever. Aflac brand recognition, distribution strength and unique solutions are competitive advantages in the market. Our 2018 strategic playbook capitalizes on these advantages and will continue to focus on growth, efficiency and customer experience. Driving growth will include further strengthening our core distribution of sales agents and brokers while building new opportunities to meet the needs of an evolving marketplace. In 2018, we will continue to focus on that mid case market where regional benefits brokers are demonstrating an interest in our enrolment solutions and voluntary benefits expertise. We will also expand our producer base through strategic partnership which opens new avenues for American workers to access Aflac, simply put we want to where consumers want to buy insurance. From a product perspective we will continue expansion of our portfolio with long-term and short-term visibility. You will recall we expanded our Life portfolio in 2017 with whole universal and term like product by partnering with other insurers with expertise in these areas. These true group products provide increased lift in our sales of the core products that we offer, in a way that minimizes risk to Aflac. At the same time, they help us to increase our productivity and case wins by offering the simply comprehensive solutions that employers need. Over the last couple of years, we've also been investing in technology with two primary objectives, enhancing customer experience and increasing operational efficiency. From a customer experience perspective Aflac is responding to the new breed of customers that expect ease, choice and simplicity. Technology, life, enterprise enrolment provides holistic view on benefit this measure medical, voluntary and value add, creating a consultative shopping experience for consumers that’s transparent and easy to understand. In 2018, we're leveraging digital tools such as decision support tools and call centre capability to further enhance the Aflac enrolment experience. One Day Pay, provides the ease and simplicity of filing claims while meeting the needs of getting claims paid quickly. One Day Pay has already improved our customer experience. This year we expect to pay 2.1 million claims in one day. In 2018 we plan to continue to leverage One Day Pay by introducing new mobile capabilities that will further empower our policy holders. Now being an incumbent in today's market we must invest in our core platforms, especially if we want to leverage digital properties of the future and drive operational efficiency. In 2018 we will leverage Empowered as our digital centre of excellence. As you recall this is a company that we purchased in 2015 and it’s the developer of our EVER world platform. In addition, we will continue our investment in our core operations to reduce our cost structure and enable ease and agility with third party integration. As I mentioned at our Investor Day in September, these investments will increase our expense ratio in the near term while lowering our expense ratio longer term. We believe we have the right strategy in play and ultimately our growth and customer experience objectives will drive strong sales and improve persistency while our efficiency objective will support lower expense ratios in the long term and strong profit margins. With that in 2018 we anticipate new annualized premium growth in the range of 3 to 5% in addition to a 2 to 3% growth in earned premiums. Thank you, and now let me turn the call over to Koide.
Masatoshi Koide: Thank you, Teresa, I will discuss Aflac's Japan's competitive market environment, our 2018 strategic playbook and provide growth outlook for 2018. Regarding the competitive environment, market player consolidation has led to fewer stronger market players, and such competition has intensified especially in the medical market where numerous products have been released. That said, that insurance providers see growing opportunity in the cyber success, where Aflac Japan is the hands down leader of new and in force annualized premium or AP continues to rise as shown on the slide. We expect these strengths to continue in 2018. It is therefore critical that we invest in our platform to both defend and expand upon our leading position. Aflac Japan's growth strategy continues to focus on developing innovative products in response to ever changing customer needs and medical advancements and on enhancement distribution channels. For 2018 there are four elements of this strategy I would like to highlight. First is promoting Aflac's Japan's five to six products. As Aflac Japan moves forward with conversion to a Japan subsidiary we are carefully considering the rollout of new products and divisions. So, I'm not able to comment on the details. We plan to introduce new and refreshed products proving Aflac's Japan conversion to a subsidiary. We will also continue to grow income support insurance by increasing awareness of this new category and focusing on those concerned about visibility, home ownership and the like. Second is further strengthening Aflac's Japan distribution initiatives. In 2018 Aflac Japan's strategic alliances will continue to strengthen and evolve especially with partners, including Japan Post where our ongoing sales training programs takes further route. For Aflac's Japan's traditional channels, our nationwide model sales office initiatives are almost complete. The initiative is aimed at enhancing sales agent productivity and further strengthening selective high high market potential agencies. While not expected to impact the sales in 2018, we will be actively investing in alternative distribution capabilities for future growth. That is a strategic placement of production type first sector products. As you know, Aflac Japan has satisfactorily reduced sales of saving type first sector products. At the same time, we will continue to sell protection type first sector products to provide our exclusive agency channel with a more comprehensive product portfolio to continue to sell with first sector products. Finally, it's our ongoing effort to enhance operational exchanges, as noted during our Financial Analyst Briefing in September, Aflac Japan is fundamentally re-examining its processes and operations, where strengthening procurements and the projects capabilities. In 2018, Aflac Japan will focus on cost structures by leveraging exchange improvement at information technology. Smartphone claims applications and voice recognition systems are just two such items we have recently adopted. And we are implementing other projects including robotics in various fields of our operations. Aflac Japan will divest a portion of the generated savings back into the organization for future -- further expenses. Aflac Japan will continue to focus on driving long-term sales growth. We will face difficult sales comparisons in the near-term, but we believe the previously mentioned strategies will enable us to achieve our long-term growth goals. Also, as noted during our third quarter earnings call, third quarter 2018 sales are expected to decline as compared to the first quarter of 2017 which benefited from our refreshed medical product launch. However, we do anticipate improved first sector sales in the second half of 2018 following introduction of a new first sector product. We expect to recover in the second half of 2018, but our overall sales results are expected to be modestly down to flat when compared to our very strong 2017. That said, over the past several years, we have increased our first sector annual sales from the mid 60 billion range in 2012 to approximately 85 billion in today and that’s good business with strong margins and leading market share. We have done so while maintaining very high persistency rates. As illustrated by earned premium this production engine generates meaningful economic value each year and best indicates long term value. Against this backdrop, first sector earned premium is expected to continue its steady growth in the 2% to 3% range, reflecting Aflac's stable sales and high consistency in Japan. In closing I'm excited about 2018 and confident that Aflac is implementing stable robust products and distribution strategy, needed to continue leading the first sector insurance market in Japan. Thank you. I will turn it over to Fred to discuss Aflac financial outlook.
Fred Crawford: Thank you, Koide-san. Before providing details on our financial forecast let me start with a few comments on corporate tax reform. Tax reform is still fluid and evolving as it makes its way through the house and senate process and potentially on to the President. While there is greater visibility into the potential tax bill at this time it is still pre-mature to provide estimates on potential financial impact. We’ve not incorporated tax reform into our 2018 financial plans and guidance. We’re focused primarily on the tax treatments of reserves, differed acquisition cost and any changes to territory and tax growth given our define franchise and recognizing we remain a branch for tax purposes. Overall lowering a corporate tax rates is expected to be a long-term positive to capital formation and cash flows. While we believe our U.S., RBC would be negatively impacted upon adoption it would recover over a few years and we see no material impact to our U.S. capital draw down plan. Turning then to the key drivers of our financial outlook, in Japan we continue to shift capital away from lower return asset leverage, first sector savings products towards our higher return third sector business. This shift emerges overtime in the form of improve FSA earnings and cash flow. However, it naturally pressured GAAP revenue and earnings as we transition. Overall margins in both our Japan and U.S. segment remains strong as we continue to experience favourable benefit ratios and underlying claims trends. Digital growth in IT initiatives are expected to elevate expenses in the near-term but we're confident will result in improved operating efficiencies and future growth. Our investment strategy is designed to drive stable returns while managing capital volatility. We continue to navigate a challenging rate environment in Japan by evolving the U.S. dollar portfolio asset mix and associated hedging to achieve consistent results. Finally, in the Europe material legal structure transition in Japan, we're actively managing and seeking to optimize the intersection of investment, capital and liquidity strategies. Now I would like to provide greater detail on the assumptions underlying our 2018 core insurance earnings drivers in Japan and the U.S. Focusing first on the Japan we're managing our way through the peak period for limited day products, mainly five pay ways reaching paid up status in 2017. This headwind will continue in 2018 negatively impacting earned premium by approximately ¥36 billion and contributing to a roughly 1.5% overall reduction in premium. As we Koide-san mentioned we expect third sector earned premium to grow at a steady rate of 2% to 3%. With the distribution of earned premium shifting towards third sector and a lower benefit ratio and a lower benefit ratio relative to first sector products, this is expected to lower our reported benefit ratio by approximately 40 basis points in 2018 as compared to 2017. We expect benefit ratios in our core lines of cancer and medical to remain strong with claims trends continuing to benefit from fundamental changes in Japan's healthcare system. We continue to invest in IT and administration with near term efficiencies gained from process improvements reinvested back into our platform. In addition, we have an active product development pipeline including investment in digital solutions, therefore we expect near term expense ratios to be elevated and we have increased our projected range. Overall profit margins remain generally consistent with recent performance. Turning to the US earned premium to grow at around 2% assuming we continue to achieve our sales target and reflecting recent improvements in persistency. We think trends in healthcare utilization and hospitalization will continue in the near term as consumers struggle to afford higher deductibles and co-pays. Our expense ratio will be elevated as we have been actively investing in our US IT and digital platforms. It's also worth noting that our capital management plans in the US impact net investment income in the segment. Overall profit margins in the US are expected to be strong but modestly lower as compared to our 2017 performance. Turning then to investment strategy, Japan net investment income is expected to increase by nearly ¥3 billion. The build of the US floating rate portfolio is positively influencing our projected new money rate in Japan. Reinvestment of higher yielding called and maturing yen fixed income investments continue as a headwind but is more than offset by the gradual build in our US dollar portfolio. Hedge costs in 2018 are projected to stay relatively neutral versus 2017. We continue to lower our hedge ratio while at the same time lengthening the average duration at modestly higher pricing. The larger floating rate portfolio will allow for increased use of shorter duration forwards for hedging and we will continue to increase the duration of the forwards back in longer US fixed income investments. Our objectives include closing the duration gap for greater stability and investment income reducing our hedge ratio, reflecting our view of long term and stressed economic value in Japan, while balancing SMR and FSA earnings volatility in managing costs. As mentioned earlier net investment income for Aflac US will naturally decline reflecting a reduction in assets backing our RBC draw down strategy. From an overall Aflac investment income perspective there is a modest shift in income from our Aflac US segment to the corporate segment. Turning to our near-term capital outlook, in the third quarter SMRs in excess of 1000% and RBC on a consolidated basis in the mid 800% range. Our SMR ratio is sensitive to market fluctuations and is elevated by unrealized gains in our AFS portfolio. We tend to focus on the quality of our SMR without unrealized gains and losses which is currently in the 800% range. As we discussed during our September FAB conference 2018 is a year of transition and we believe it prudent to carry a level of excess capital and liquidity throughout the year than looking to optimize once settled in. We are repositioning excess capital in the US to Japan in support of lowering our US dollar portfolio hedge ratio and continue on our US only RBC draw down path. In our execution of this strategy we will reduce Japan repatriation in 2018 by ¥60 billion and then spend down access capital moved out of the US entity to support a stable level of deployment. We expect 2018 repurchase to be in the range of $1.1 billion to $1.4 billion the wider range allowing us to be more tactical in our deployment strategy as opportunities emerge to invest to growth or other strategic investments. As it always the case, this assumes stable capital conditions. Leverage rooming in and around the midpoint of our 20% to 25% policy range, our holding company liquidity is expected to travel in the range of $1.5 billion to $2 billion in 2018, remembering that now we hold the minimum of $1 billion as contingent capital with additional funds for day-to-day liquidity. Concluding with our view on earnings per share, we are projecting a range for 2018 operating EPS of $6.65 to $6.95 per share assuming a foreign exchange range of ¥112 to the $1. This excludes the cost of our branch conversion which are expected to accelerate in the next few quarters. When looking at our currency neutral EPS estimates for 2018, and normalizing for certain tax and reserve benefits identified throughout 2017, the range equates to approximately to a 2% increase. We view this as a solid plan when considering incremental investments into our Japan and US digital growth in IT platforms totalling $0.15 to $0.20 a share and balance approach to capital deployment. Our plan does assumes a continuation of favourable claims trends in Japan in the US and associated reserve adjustments somewhat consistent with our experience in 2017. Our financial playbook for creating value is straight forward, defend the attractive margins in our core supplemental health business, allocate capital to stable businesses that earn comfortably above our cost of capital and invest to drive eventual top line growth and improved efficiencies. Finally, in this year of transition we continue to balance maintaining strong capital ratios with returning to capital to our shareholders. I’ll now turn the call back to David to take us into Q&A. David?
David Young: Thank you, Fred. Before we take your questions, let me remind you that to be fair to everybody, please limit yourself to one initial question and then a follow up it relates to that initial question. We will now take the first question.
Operator: Thank you, speakers. We will now begin the question-and-answer session. The first question is coming from the line of Mr. Jim Bhullar of JPMorgan. Your line is now open.
Jim Bhullar: Thanks. Hi, good morning. So, first I just had a question on long-term EPS growth potential. I think you’re indicating about 2% EPS growth this year. And there are obviously headwinds related to the investment in the business that you’re talking about, but there is also a little bit of a tailwind from drawing down the US RBC. So, to what extent do you feel this is like your long-term EPS growth potential? And as you look beyond 2018 and do you expect EPS growth to pick up or should it be close to where you’re expecting it to be next year?
Dan Amos: Yeah. Thank you, Jimmy. We – as you know we don’t tend to give what I would call long range EPS targets per se, but from a general statement our near-term EPS is weighed down a couple of natural things of most notably is the reinvestment back into the platform. I call out for example this particularly year roughly $0.15 to $0.20 of impact related to investments in both Japan and the U.S. By the way we would break that down as roughly ¥7 billion of incremental investment in IT and digital platform in Japan and around $35 million to $40 million pre-tax in the U.S. This is really backing the statements so Teresa and Koide-san. That type of investment in the platform is extremely important. It is what is going to eventually yield this both sending and growing our business going forward and with that earnings frame. The other dynamic that is starting to take hold is you’re indeed seeing a bit of a shift or turning now gradually, very gradually of investment income in Japan, there we still face headwinds related to the reinvestment of higher coupon maturities and calls largely in these old private placements that are quite sizeable when they mature. So, there is a still a headwind there, and obviously as you're seeing spreads have tightened up quite a bit, and so reinvestment rates are pressured by spreads being tight, but have been said that its starting to slow and starting to turn, so for example you're seeing some pickup even after hedge cost and net investment income this year. So, we have some things that represent tailwinds if you will to earnings growth as we move forward but that earnings growth is only going to come if we execute and invest back in our platform and take advantage of the core points of leverage that Dan outlined in his comments. So little bit near-term weakness was certainly the idea and certainly the goal if you will the long-term improvement in growth rates and EPS.
Jim Bhullar: Okay and if I could just ask just one on the buyback range, I think the past and like this year specially you did more in the first half and you're related to little bit less in the second half and you mentioned practical as you talked about buybacks what are going to be the factors that influence one, the timing of your buybacks and second, if you fall at the high end or the low end of the range.
Dan Amos: So, let's first discuss timing. You're absolutely right, we have historically had a pattern of more of a front-end loading if you will of repurchase and we've not assumed that in this plan. We’ve assumed just a balance and smooth approach to repurchase over the course of the year. So, we're not benefiting if you will from any what I would characterize as acceleration of the plan assumptions standpoint. What would cause is the change our views would be really be the view of the opportunistic if you will from the timing prospective to put our capital in the direction. We always have that ability to do it but we've not assumed that in the plan and my guidance on that would be you should assume a somewhat smoother approach to repurchase throughout this year unlike previous years. In terms of what would influence the bottom end and the top end of the range, it would largely be essentially the alternatives if you will for the use of our excess capital. To be very, very clear I have 1.1 billion to 1.4 billion of repurchase guidance for 2018 and if you recall our FAB comments in September through the course of 2017, '18 and '19 we're projecting upwards of 3.5 or 3.6 billion of repurchase. So, to be very clear we view the buying of our stock as a good long-term investment. Having said that in order to make that a good long-term investment we need to be allocating our capital towards growth rates and investments that defend our margins and manage efficiencies, so those are the types of decisions we're making and fundamentally that’s what's been a really give rise to being on the lower to high end of that range.
Operator: Thank you. The next question is coming from the line of Humphrey Lee of Dowling & Partners. Your line is open.
Humphrey Lee: Good morning and thank you for taking my question. Just a question regarding the impact of the branch conversion and the sales to the new product introduction in Japan. So, based on the prepared remarks we could see the conversion to be completed as early as April 1st. Would that accelerate your plan in terms of rolling out new products so instead of happening in the second half you would see actually the product launch in the second quarter, if you were to complete the conversion earlier.
Dan Amos: Yeah this is Dan, I'm going to let Koide-san answer that. [Foreign language]
Masatoshi Koide: This is Koide from Aflac Japan. [Foreign language] In terms of the new product launch for 2018 we are thinking of launching immediately after the conversion so we're hoping to launch the new product in the early timing of the second quarter.
Humphrey Lee: Okay, got it, I think it got cut off a little bit, but I think I get the most of it, and then a follow up question on the distribution in Japan, I think Koide-san talked about potential alternative distribution strategy in Japan, are you -- just to kind of get a sense are you talking about digital distribution or actually working with an alternative distribution partner like for example Dai-ichi recently launched a partnership with Nihon Chouzai drug store so is that something that you were looking to in terms of a strategic distribution partners. [Foreign language]
Masatoshi Koide: This is Aflac Japan Koide again. [Foreign language] Right now, we are considering digital platform and therefore we are making investments into a digital platform.
Humphrey Lee: But what about the potential partnership with another brick and mortar company.
Dan Amos: I'll answer that. We are constantly looking for ways to get to the consumer wherever they're located. So yes, we would be looking at that, we have nothing on the horizon at this particular point. Our concentration we believe in today's environment is the digital platform to make sure the younger people through cell phones were able to reach, so we have looked at that but certainly as you've seen with Dai-ichi live, Tidal live and also with Japan Post, we are constantly looking for partners and there are a few potentials out there that we've had some discussions but there's nothing on the horizon that we would announce at this particular time.
Operator: Thank you, the next question is coming from the line of Nigel Dally of Morgan Stanley, your line is now open.
Nigel Dally: Great, thank you and good morning. So, the higher investments into IT and operations, you've been making those investments in those areas for several years and as you maintain it will continue into 2018. Beyond 2018 should we expect those business to trail off, it's been a multiyear initiative just hoping to get some colour as to how long these investments will continue.
Dan Amos: The answer is yes, you should expect those to tail off. We have been – I would say for a number of years in Japan, we have been making those investments and those investments have been in fact yielding savings, but we’ve been effectively recycling if you will those savings and efficiencies back into further advancing the IT model this really as a strategy to try to maintain margins and profitability as we move along. In the US, however it’s been a bit more of a recent level of activity and therefore more accelerated and that’s impart wide in the US you see a bit more of a pronounced impact ratio in bottom line margins as appose to Japan which is remain relatively stable. But in both cases, they will eventually wind down and start the yield other results. This really frankly goes back to some of my comments at the Fab conference, where we’re talking about work underway to achieve long-term run-rate expense ratios that are improved from their current elevated levels. So, at Fab you might recall, I talked about a five-year plan if you will over the course of the next five years to drive our expense ratios down towards the midpoint of Japan's expense ratio guidance, that guidance being to 19% to 21% -- or rather 18% to 20%. So, we want to try to drive it down towards the midpoint of that range. In the US our comments were to drive down towards the low end of the expense ratio range of 33% to 35%. Now, this is a long-term plan and just like any expense ratio that obviously relies as much on revenue and revenue growth as it does on executing on the expense side. And so, it’s clearly a challenging objective overtime, but these investments are in fact expected to stabilize to start to reduce in terms of expense ratio pressure and therefore yield together with growth improved expense ratios and defence of our margins.
Operator: Thank you. The next question is coming from the line of Erik Bass of Autonomous Research. Your line is now open.
Erik Bass: Hi. Thank you. Fred, can you talk about some of the things that you’re looking at to fall into the opportunistic capital deployment bucket. And how much of this capital has already been sort of your marked your allocated and factored into your guidance?
Dan Amos: Yeah. I think there is a couple of ways to think about, let’s first adjust the first part of your question opportunities. So, first what are we doing already, well what we’re already doing is building out our venture investments and so as you know we have announced a $100 million venture capital fund, we’ve made to date both in Japan and the US, eight investments totalling approximately $25 million to give you an idea of the capital committed thus far and we would expect over the course of the next couple of years to put that $100 million in total to work. That’s one area. The second area of opportunities is similar and that it evolves around what I would characterize as digital opportunities technology investment opportunities and possibly digital and technology that relates to distribution expansion or alternative distribution. That tends to be the categories that we find most interesting. It tends not to be what I would call traditional insurance related opportunities because with our scale the depth and breadth of our product those we tend not to find those necessarily additive to our value. So, it tends to be hovered around technology, digital, distribution expansion and those types of investments. Now by definition that is not always the case but it tends to be smaller in nature and it doesn’t disrupt entirely our capital plan and deployment plan, that’s not always guarantee but it tends to be the types of things that we're looking at and find interesting. Meanwhile organically we're investing in our digital platform in Japan which includes new product development and new product delivery and then in U.S. you might recall that two years ago we acquired a company called empowered benefits in Charlotte, that acquisition was approximately $35 million to $45 million in size, but we have been adding to that platform as essentially a digital hub as well as also an incubation site for venture investments. So, we been actively building out that platform and that represents actually a good portion of the incremental 35 million to 40 million I mentioned earlier in the U.S. So those are the types of things we're looking at opportunistically, in terms of sizing it one way to size the opportunity fund if you want to call it that would be the difference between the low point and the high point of our share repurchase range. So that would suggest something in the neighbourhood of 300 million. But I would tell you that we’re generating capital a bit over and above that level and so we got the capability of investing more if necessary but we will make those decisions according to where we see the best returns for our shareholders.
Fred Crawford: But just to be clear, we had a lot of discussions about this, our first priority is share repurchase because that’s the safest thing that we like to do but we've also got to be prepared for the future. And it is changing rapidly and some of the things that we are adding to we like to do good investments and it will help us for long-term growth.
Erik Bass: Thank you. And then one other question, Fred you mentioned the RBC ration impact of tax reform and obviously the initial decline makes sense as its largely mechanical but curious about your view that the ratio would recover overtime and is that just as simple as that you would have higher statutory earnings but you would pay a similar kind of level of free cash flow to the holding company as you do currently, so you would build capital.
Fred Crawford: That’s right, that’s a fair way an assuming it. Based on the modelling, we’ve done in a course tax reform is fluid, so we have to continue to kind of watch it but based on what we understand of the treatment of just simply a lower corporate tax rate or lower tax rate in general, that you would tend to have around 15% impact to RBC, what do I mean by that, if you're running at a 1000 RBC on a U.S. only basis you would have an impact approaching 150 points. If you're running out of 500% RBC the impact would be approaching 75 points. We would expect to recover that over a roughly two to three-year period in a way of capital formation from of the higher cash flows or statutory earnings with the lower corporate tax rate. So that’s essentially the very basic math but all in it recovers very quickly and it really does not been disrupt any of our near-term capital plans.
Erik Bass: Got it that’s helpful, your overall free cash flow of holding company is the same I guess the percentage relative to your GAAP earnings would be a little bit lower.
Fred Crawford: I think that’s right.
Operator: Thank you. The next question is coming from the line of Mr. Thomas Gallagher of Evercore ISI. Your line is open.
Thomas Gallagher: So just a follow up on capital return, in terms of the 1.8 to 2.1 billion does that include the deployment of 500 million of excess and if so does that tell us that JGAAP earnings are trending lower here in terms of sort of driving the outlook, can you talk a little bit about what's happening to the Japan earning side, the dividend flow coming out of there for now.
Dan Amos: Yeah, I think we just start with the first premise of your question and that is you have to separate the deployment estimate which is the 1.8 to 2.1 from what I would call capital generation in the company, and capital generation tends to be as we've said at FAB free cash flow generation between 1.6 billion and 1.8 billion, on top of that would be the 500 million of excess capital, that is your capital generation engine as a company. So, it travels a bit north of this deployment level and that's primarily because as I mentioned in my comments we're carrying a level of excess capital and liquidity into this year of transition. We want to get through this year, settle into our new corporate structure and new cash flow rules of engagement and then optimize, optimize the capital structure and optimize cash flow. So, it’s really just being prudent during the time of transition but you have to separate capital generation from the deployment guidance that we have here they're modestly different. In terms of FSA earnings, as I mentioned in my comments by pulling back on first sector savings and continuing to grow third sector we're seeing better results in our FSA earnings. In the near term they tend to be increasing around the 3 to 5% range, the reason why that's a little bit lower is because we are investing so actively in the Japan platform as I mentioned earlier. But over time we would expect that to pick up. Now you have to set everything else equal. Obviously, FSA earnings can be subject to market volatility. But setting aside market volatility and impairment dynamics we would expect a steady, roughly mid-single digit build in FSA earnings over time and that's the free cash flow I mentioned.
Thomas Gallagher: And that and for the visibility on FSA earnings is still pretty good and you see that more as a tailwind, relative to say Japan earnings as they're reflected on a GAAP basis, you think that they should improve on a relative basis based on that trend.
Dan Amos: I focus primarily on that FSA earnings build because that's really a sign of your strategy yielding economic value creation and capital generation and we're seeing good signs there.
Thomas Gallagher: Okay, and then my follow up is, just want to get a better sense for the NII, you know I think the 1% increase in Japan is certainly a pretty good outcome just considering where interest rates are in Japan, and I know there's a mix issue with the shift into the USD portfolio that's driving it, but as you think about the next several years do you think we can remain flattish even if rates remain where they are in Japan or if rates won't remain where they are in Japan will that reinvestment headwind catch up to you at some point.
Fred Crawford: Sure Tom, obviously in a way that's a forecasting question but I would frame it to you more than just where Japan rates are because remember now the portfolio was well diversified so yen rates will impact us with reinvestment into JGBs other yen products particularly as you think about ALM, but we now have a dollar portfolio and with the build-up of the floating rate securities, besides the attractive new money yields we're getting, those will float in the future. So, it's more than just yen rates, it's also what will dollar rates do particularly into short end respect to LIBOR and that will also call it with hedge cost. And then finally, we have initiated our growth portfolio, the alternatives like private equity and real estate those are obviously be variable income, so there could be some volatility, but by and large we would expect over the next few years to get positive contributions there. So, when you add all of that up, we certainly cannot predict what rates will do in the future, but you’re premise if they stayed relatively flat, we would expect a small growth rate over the next few years to NII. We model that regularly, but obviously it’s going to be very dependent, but we’re diversified and that’s why I want to stress. So, even if Japan yields were to go down, is possible US yields go up variable income goes up and those could be tailwinds against any headwinds.
Thomas Gallagher: Thanks, Eric. And how big is the floating rate portfolio again right now?
Eric Kirsch: Right now, it’s about $6 billion, but it will grow to probably about $8 billion or $9 billion by the end of next year.
Operator: Thank you. The next question is coming from the line of Suneet Kamath of Citi. Your line is now open.
Suneet Kamath: Thanks. Good morning. Just wanted to go back to tax reform, if the tax rate does grow to 20%. Can you just talk about the impact on your GAAP tax rate? I know your tax statements will be a little different than on the GAAP basis. What happens to the tax rate?
Dan Amos: Yes. So, obviously we are as I mentioned a branch for tax purposes, we are a US tax payer. Japan’s tax rate -- corporate tax rate is 28% and so as a result if you were to lower the corporate tax rate to 20%, our effective tax rate remains in the 26% territory by virtue of Japan’s higher corporate tax rate under that scenario. I might also note that because we have been, because we’re US tax payer and have been a branch for tax purposes we don’t have any effect if you will related to things like onetime repatriation tax benefits and so forth. We have been and continue to be paying taxes on our earnings in Japan and the repatriation associated with it.
Suneet Kamath: Got it. And then for Teresa, in your outlook slide you talked about disruptive forces in the US and I just wanted to drill into that just to understand. Are these the just traditional things that we’re use thinking about other insurance companies moving into supplemental. Or are you talking about some sources of competition that we traditionally have not seen.
Teresa White: I think that you’ve got it characterized correctly. It's the traditional true group players moving into the voluntary market, but also, it’s a push for many of the digital properties moving into the insurance market as well. So, we’re not just competing our own product, we’re also competing on a digital platform as well.
Suneet Kamath: Got it. And then just lastly for you also Teresa. In terms of persistency we’ve seen a nice move over the past several years into the high 70s for the US. Any thoughts on where you think or you like to see that go given some of the initiatives that you talked about?
Teresa White: Well in our plan for 2018, our goal is to hold it steady. We’re at the highest levels we’ve been I a while, so our plan is to hold this steady, but I will say this as we continue to bring in new technology that allows us to be more efficient you can expect that then you -- it also will reduce the manual nature of some of the activities that we do which will reduce errors. So, from an operational efficiency standpoint I do believe that we still have room to improve our persistency especially when we know that some of the loss in the premium that we get is because of an error that we will make or our employees will make. So, at the end of the day I think that there is still room but our plan is basically aligned with keeping it steady.
Fred Crawford: Let me say one thing about persistency is that I want to give kudos to our U.S. and what they have done you can improve persistency by riding or keeping sick all people. So, and knocking your loss ratio through the roof, so you got to figure out how to bring the young people on with the older sicker people to make sure its balanced as you do it and we been able to do that. So, it's not just about persistency it's about the combination of the two and I just want to make note that they have done an excellent job of that and I am very pleased with it.
Eric Kirsch: This is Eric again I'm sorry, I just want to correct an answer I gave to Tom, the floating rate assets at the end of this year is expected to be 2.7 billion and at the end of next year about 5.5, just to correct that I mixed up some numbers there.
Teresa White: Okay, to end my point is that if -- as we improve our service, we will improve our persistency, I believe that.
Operator: Thank you. The next question is coming from the line of Ryan Krueger of KBW. Your line is open.
Ryan Krueger: One quick one for Greg, can you give us a sense of how much NII you expect to I guess shift from the U.S. to the corporate segment as we think about the corporate segment into next year?
Fred Crawford: I think what we're doing there Ryan is that we're attempting to select and shift as much as possible, the dividend of actual securities up to the U.S. We can only do this only within practical limits if you will, because obviously that capital as the holding company while is of a slightly more permanent nature, it needs to be somewhat ready capital. But we're doing that in an attempt to prove to preserve as much NII for the organization as we can. I'm going to give you a very round number but its approximately correct and that is we're trying to preserve around 25 million or so of annualized NII of the holding company, that’s roughly in line with what we would hope to do but I would tell you that that’s going to require very specific selection of securities and transfer, so I would suggest it’s a bit range bound around that number.
Ryan Krueger: Okay thanks and one more in tax reform. In terms of the lower RBC ratio expectation, at that point in time, do you believe you will need to rebuild the RBC back up to what it was before as a result of tax changes or do you think its possible rating agencies change their view of what the appropriate RBC is post tax reform.
Fred Crawford: It’s a great question and no doubt that a question that’s on the minds of my peers, CFOs across the industry. Because fundamentally you would expect there to be somewhat of a reset, but you know we have a lot of moving parts in RBC as it turns out, we've got the tax reform moving parts, we also have some Q1 asset charges that are being adjusted here in the near term. And so, we've got what I would call industry wide adjustments of RBC taking place now both potentially tax and Q1, so we'll have to see how all that plays out. Right now, our view is you assume effectively no change in the mine frame of a rating agency if you will relative to their standards for RBC annual ratings, but that may evolve, that may evolve as we move forward and I mentioned a couple of times optimization. US RBC is a point of optimization for this company and I think there's opportunity there over time. Japan SMR and with-it FSA earnings, earnings volatility, hedge ratio that's another area of optimization model for the company and then finally at the holding company we're carrying a fairly good amount of contingent capital and liquidity and we want to seek to optimize that. So, I would say beyond RBC we're going to be looking at those three major buckets for how we best dial it in to be the most effective for our shareholders while at the same time maintaining our industry leading ratings.
Operator: Thank you, and the next question is coming from the line of Alex Scott of Goldman Sachs, your line is now open.
Alex Scott: Hey, thanks for taking the question, I guess on the holding company liquidity and contingent capital it looks like that's expected to grow you know well above I guess the $1 billion minimum that you guys I think increased in 500 million at the FAB, so just wondering about how you think about sort of the amount of excess on the other side of coming out of the branch conversion, and maybe between that and debt capacity you know how much do you think is there to sort of optimize when you're on the other side of that.
Dan Amos: Yeah, you know in terms of debt capacity if you make the assumption that we're traveling by and large in the mid-range of our 20 to 25% leverage I'm going to round for you and say we comfortably have about a $1 billion of what I would call debt capacity available to us, if necessary or if we desire and optimize. I would tell you that leverage for this company is somewhat constrained if you will in the sense that we always have to have one eye towards the free cash flow dynamics in Japan, and with that frankly the SMR ratio which can be quite volatile. So that requires us to remain at arguably a lower level of leverage than our business model could afford. We certainly could afford more leverage but that's a tricky dynamic, and so that's at the leverage statement. In terms of holding company liquidity, the $1 billion minimum is really pure contingent capital, that is you know we need actual capital in the system on a short-term basis and we have that ability to invest that money. Beyond that we have natural liquidity needs and the largest liquidity need we have is a holding company particularly after conversion is the fact that we hold certain derivatives at the holding company. This would include swaps in our debt from dollar to yen and also repatriation hedges that we have in place. As a result, we have to be always on the ready, to not only receive but also post collateral for those derivatives, so we tend to carry a fairly good amount of excess liquidity just to make sure that we obviously don't have any adverse conditions related to the posting of collateral and we do a heck of a lot of stress testing around that. But, in that dynamic of contingent capital and contingent liquidity, that’s in fact where there are optimization opportunities. If we look at the capitalization in Japan and in the US and then we put on top of that contingent capital, we have opportunities to say what’s that really right amount to dial-in based on stress testing once we settle into our new structure. Things goes with derivatives, as we look at repatriation, or repatriation hedging strategies as we issue more debt in actual yen as we have recently as appose to dollars in swapping it that gives rise to the potential to optimize the level of stand by liquidity we have at the holding company. So, I’m going into the greater detail with you, but this is what I mean when I say optimization opportunity, but now is not the time we need to settle into this new structure then move forward.
Alex Scott: Understood. Okay. And then maybe just on Japan, the SMR that you guys are reflecting here. Does that already include the 750 I guess buffer that was going to be put in there for the USD investments or is that SMR coming down sort of I guess incremental 750 that I guess would be positive?
Dan Amos: Yeah. The more precise level of capital retention in Japan that is plan is ¥0 billion of plan retention of capital. And so, for example our actual repatriation estimates if you will, combination repatriation and dividend for 2018 is approximately ¥80 billion that is down $¥60 billion representing the retention in Japan. Okay, that equates to about $550 million depending on the conversion rate you want to use and what happens is in the SMR ratio that the level of accrual that takes place based on your plans for dividend and dividend expectations or in this case repatriation. So, in other words there is in fact an element of that planned ¥60 billion retention that is in the SMR ratio. And its part of the contribution to it being higher, but frankly the biggest contribution is the AFS portfolio and unrealized gains.
Operator: Thank you. At this time, speaker we don’t have any questions on queue. I will now turn the call over to back to Mr. David Young.
David Young: Thank you for joining us today. That concludes our call. If you have any questions please feel free to contact our Investor and Rating Agency Relations department. And we look forward to speaking with you soon.
Operator: Thank you. This concludes today’s conference call. Thank you all for joining. You may disconnect at this time.