Aflac Bets on Japan Bonds in Strategy Reversal

Aflac Inc., the largest seller of supplemental health insurance, is betting on Japanese government debt in a retreat from a plan it put in place a year ago.

Aflac said it’s turning back to Japanese government bonds to support obligations in that country, where the insurer does most of its business, amid volatility in financial markets. Aflac had been seeking to invest two-thirds of its Japanese cash flow in U.S. corporate bonds hedged to yen in a program started in July 2012, Chief Investment Officer Eric Kirsch said in May.

“We expect to allocate the majority of third-quarter cash flows to JGBs and underweight the allocation to U.S. corporate hedged bonds,” Aflac Chief Executive Officer Dan Amos said in a statement late yesterday announcing second-quarter results. “Our investment team has been carefully evaluating investment options related to our asset allocation, as well as strategies to help mitigate interest-rate risk.”

Amos hired Kirsch in 2011 from Goldman Sachs Group Inc. to revamp the portfolio, after Aflac was burned by privately negotiated investments in European banks that issued debt in yen. The company said yesterday that rising interest rates in the U.S. and Japan reduced a measure of solvency monitored by Japanese regulators.

“We’d rather stand on the sideline through the volatility, because we’re performing on all of our metrics,” Kirsch said today on a conference call with analysts. “We have just gone through, in the second quarter, one of the highest rates of volatility relative to rates that we have seen since 2008.”

Rate Hedges

Kirsch said Aflac is also considering interest-rate hedging strategies, and the company plans to move some Japanese government bonds out of the available-for-sale portfolio. That may help cushion the effects of rising bond yields on Aflac’s solvency ratio, John Nadel, an analyst at Sterne Agee & Leach Inc. said today in a research note.

The accounting change can “only be applied to Yen-denominated assets supporting Yen-denominated liabilities,” he said.

Aflac had $35.5 billion of Japanese government debt as of June 30, compared with $38 billion a year earlier. The Columbus, Georgia-based company’s investment portfolio is about $101.4 billion, and mostly backs obligations in Japan.

Market Volatility

“First and foremost was the volatility in the market,” Robin Wilkey, Aflac’s senior vice president of investor and rating agency relations, said by phone, citing the rise in U.S. interest rates. “The more conservative and prudent thing to do, with our liabilities all yen-denominated over there, was to move for the third quarter back into investing primarily in JGBs.”

Aflac is scaling back the proportion of its cash flow going to U.S. corporate bonds after the allocation exceeded the target in the first half of the year, Wilkey said.

Interest rates have risen since May, when Federal Reserve Chairman Ben S. Bernanke said the central bank may slow the pace of its economic stimulus program in its next few meetings. The bank may taper its monthly bond buying later this year and end it in mid-2014, Bernanke said last month.

Yields on 10-year Japanese government debt jumped 29.5 basis points in the second quarter to 0.855 percent, while 10-year Treasury yields gained 64 basis points. Average yields on U.S. investment-grade corporate bonds climbed to 3.44 percent from 2.83 percent in the period, according to Bank of America Merrill Lynch index data. Bond values fall when rates rise.

BOJ Purchases

Japanese bond yields have since come down, with the 10-year rate at 0.80 percent today, the lowest globally. The biggest factor in the decline is massive purchasing from the Bank of Japan, while domestic investors have started to chase higher yields overseas, said Toru Yamamoto, the chief strategist at Daiwa Securities Co.

“Aflac’s investment plan is positive for super-long-term bonds,” said Tokyo-based Yamamoto, whose company is Japan’s second-biggest brokerage.

The 30-year JGB yielded 1.72 percent today, while the 30-year rate was at 1.82 percent. The BOJ announced in April it would more than double bond purchases to defeat deflation and spur the economy.

Kirsch said in May that Aflac monitors the difference in yield between Japanese government debt and the hedged U.S. corporate bonds. Aflac uses forward contracts to hedge the U.S. debt to yen and the costs of the contracts are tied to short-term interest rates in the U.S. and Japan, he said.

‘Embarrassing Oops’

Aflac said yesterday that profit rose 84 percent in the second quarter to $889 million, after the company recorded realized investment gains. Japan new annualized premium sales fell 43 percent after Aflac raised prices for some products.

Japan Post Holdings Co., the country’s biggest holder of bank deposits, will start selling more insurance products by Aflac, the insurer said in a statement last week. Japan Post, which began offering Aflac’s cancer insurance products in October 2008, will sell the policies in as many as 20,000 post offices from the current 1,000, and the two companies will also co-develop insurance products, according to the statement.

Aflac had advanced 15 percent this year through yesterday in New York trading, compared with the 35 percent advance of the 24-company KBW Insurance Index. The company added 1.5 percent today to $61.76 at 11:22 a.m. in New York.

Eric Berg, an analyst at RBC Capital Markets, said the investment strategy that led to a decline in the solvency ratio may call into question the company’s share repurchase target.

“This is certainly not a major blow,” he wrote in a research note today. “It’s more in the category of an embarrassing ‘oops.’”

Before it's here, it's on the Bloomberg Terminal.