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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the Aflac’s Fourth Quarter 2018 Earnings 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 & Rating Agency Relations. You may begin.
Thank you. Good morning and welcome to our fourth quarter call. This morning, we will be hearing remarks from Dan Amos, Chairman and CEO of Aflac Incorporated, about the quarter as well as our operations in Japan and the United States. Then, Fred Crawford, Executive Vice President and CFO of Aflac Incorporated, will follow with more details about our financial results, Eric Kirsch, Global Chief Investment Officer, will also provide some updated related to investments, before we open our call to questions.
In addition, joining us this morning during the Q&A portion are members of our executive management team in the United States, Teresa White, President of Aflac U.S. Rich Williams, Chief Distribution Officer; Al Riggieri, Global Chief Risk Officer and Chief Actuary; and Max Brodén, Treasurer and Head of Corporate Development.
We are also joined by members of our executive management team in Tokyo at Aflac Life Insurance Japan, Charles Lake, Chairman, and Representative Director; President of Aflac International, Masatoshi Koide, President and Representative Director; Todd Daniels, Director and Principal Financial Officer; Koji Ariyoshi, Director and Head 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 securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are 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 Aflac's website at investors.aflac.com and includes reconciliations to certain non-GAAP measures.
I'll now hand the call over to Dan.
Good morning and thank you for joining us. Let me kick off this morning by saying that 2018 was another great year for Aflac as we continue to focus on supplemental insurance in the United States and in Japan. That focus sets us apart from every other competitors and has been a major contributor to our success.
Through Aflac Incorporated subsidiaries in Japan and United States we have the privilege of helping provide protections to more than 50 million people. In both countries, we have earned our position as a leading supplemental insurer by paying cash fast and when the policyholders get sick or injured.
I'm especially pleased with the Company's overall performance in 2018. Total pre-tax adjusted earnings increased 6.6% which exceeded our expectations. This increase was driven by an increased pre-tax profit margins especially in Japan.
These results are even more meaningful when you consider that we have increased our investment in our core technology platforms and growth initiatives with the goal of driving future growth and operating effectiveness. Investing in growth and innovation will continue to be a critical strategic focus in 2019.
In 2018, Aflac Japan our largest earnings contributor converted from a branch to a subsidiary at the beginning of April and generated strong financial results. Aflac Japan's 2018 third sector sales resulted in 1.6% increase, which was consistent with our expectations of the low-single digit third sector sales growth for the year. 2018 also marked Aflac Japan's largest combined sales of third and first sector prediction products in more than a decade with ¥93.9 billion in sales.
As medical sales came off a strong 2017, bolstered a refreshed cool product, our distribution turned this focus in 2018 to watch of a Cancer Days One and Cancer Days One Plus and was tremendously successful. This laid the foundation and the groundwork for a great year for Aflac Japan's third sector sales, which came in at ¥88.8 billion.
As we progressed into 2019, we expect we expect to see the slight decline in Aflac Japan's total earned premium in 2019 mainly due to the limited paid policies reaching paid up status. We expect net earned premium of third sector and first sector protection products combined to grow at the 1% to 2% range.
Our focus remains on maintaining our leadership position in the sale of third sector products. In addition, while we don't lead that the first sector sales products, they complement our third sector lineup products very well and have similar profitability.
From a profitability perspective, we tend to be agnostic when it comes to selling cancer, medical or first sector protection insurance. To that end, we will continue to refine our existing product portfolio to introduce innovative new products that our policyholders want and need and where they will want to purchase them.
And I think that the December announcement of the enhanced strategic alliance with Japan Post holding is an indicator that we are doing just that. Japan Post announcements plan to purchase approximately 7% of Aflac Incorporated’s common shares, speaks volumes about the overall strength and reputation of the Aflac brand and our products. We look forward to working with Japan Post to explore areas to grow our respective franchises in 2019.
Turning to Aflac U.S., we are pleased with our strong financial performance. 2018 was another year which Aflac U.S. produced record new annualized premium sales and more importantly produced record pre-tax adjusted earnings. The pre-tax profit margin exceeded our expectations both in the quarter and the year.
And as I mentioned, this results indicates increased expenses as a result of accelerated investments in our platform following U.S. Tax Reform. Aflac U.S. sales for the year rose 3.2% while our net earned premium increased 2.6% both of which were in line with our expectation.
As we indicated on our most recent outlook call, we expect Aflac U.S. to deliver continued solid growth in 2019 with earned premium growth in the 2% to 3% range and stable sales growth. As you consider our U.S. sales. keep in mind that Aflac is unique with respect to our peers and the majority of our sales come from independent sales managers and associates.
We are fortunate to have such a strong independent field force which is truly distinctive within our industry. These career sales agents are best positioned within the industry to accept and therefore succeed with smaller employers and groups with fewer than 100 employees.
Aflac’s independent career agents have been the powerhouse behind Aflac’s ability to dominate the smaller case market and I continue to believe this market is our highest growth. Aflac’s agents have also partnered with local and regional brokers as we continue to grow broker sales and while a team of broker sales professionals have made great enhancements bolstering Aflac’s relationships within the large brokerage community. While broker business a smaller percentage of our overall business it is representing a larger portion of sales in the market as well as at Aflac.
It is very encouraging that as a brokers look for solutions for their clients, they have found that Aflac’s product portfolio provide solutions that help fill those needs. Brokers are looking to connect with a strong brand like Aflac and leverage our outstanding track record of experience and expensive fulfillment capabilities.
Aflac’s expert agents and our independent feel had demonstrated their ability to accelerate growth by working with brokers and broker sales professionals. Across the Company we continue to invest in digital initiatives designed to address pain points in the development, sales, administration and customer experience related to our products.
I am very pleased with our progress both in Japan and in the United States and our ability to continue these investments without losing focus on driving strong profits. Our investment support, our distribution strategy, which is focused on being where the customer wants us to purchase protection.
Turning to capital deployment, we remain committed to maintain strong capital ratios on behalf of the bondholders, the shareholders and the policyholders and the same time we are balancing our financial strength with increasing the dividend, repurchasing shares and reinvesting in our business.
We continue to anticipate that we will repurchase in the range of $1.3 billion to $1.7 billion of our shares in 2019 within the range allowing us to be more tactical in our deployment strategy. Of course it goes without saying that we treasure our record of dividend growth. And I'm pleased with the Board's recent decision to increase the dividend coming off 2018, which was the 36th consecutive year of dividend increase. Our dividend track record is a nice reminder of the relative stability of our business model and earnings.
Looking ahead, we believe that our strong earnings growth will continue to reflect underlying earnings power of our business in Japan and the United States as well as our disciplined approach to deploying excess capital in a way that balances the interest of the stakeholders. And at the same time, it reinforces our dedication to delivering all our promise we made to our policyholders.
I'll conclude by reiterating how proud I am of our management team, our employees and our sales organization in Japan and the United States, as they have worked incredibly hard to generate strong results that we have shared.
Now, I'll turn the program over to Fred for the financial results. Fred?
Thank you Dan. As Dan noted in his opening remarks, we are very pleased with our overall financial performance in 2018. Earnings results for both the quarter and the full-year exceeded our expectations.
For the quarter, adjusted earnings per share of $1.02, primarily benefited from stronger than expected pre-tax margins in Japan. For the full-year adjusted earnings per share on a currency neutral basis came in at $4.13 per share, above our guidance range of $3.90 to $4.06 a share.
Setting aside the impact to tax reform on our effective tax rate and currency impact, pre-tax earnings for the year were up 5.7%, coupled with 1.3 billion of share repurchases, we generated strong core EPS growth and impressive shareholders returns in a year of increased market volatility.
In terms of segment results for the quarter, and beginning with Japan, our benefit ratio expense ratio and investment income came in favorable to our expectations. The lower benefit ratio reflects continued favorable claims strengths and associated reserve adjustments.
In addition, our new cancer insurance product has driven alleviated lapse and reissue activity. We believe this is a result of an improved value proposition as the product now includes a new premium waver feature.
Depending on the mix of policies being replaced, alleviated lapse and reissue activity has the effect of lowering our benefit ratio, increasing our expense ratio and on-balance contributing only marginally to profitability.
Investment income in the quarter was driven by efforts earlier in the year to increase our allocation to floating rate loans which benefited from both higher spreads and higher LIBOR rates.
In addition we experienced approximately ¥2 billion in variable income which includes alternative investment returns and ¥1billion of one time call premium and consent fee income. Variable and onetime sources of investment income are not embedded in our run rate expectations.
Finally, while our expense ratio came in higher as compared to last year's quarter, overall expenses came in below our fourth quarter forecast and a result of lower sales promotion and systems development spend. Overall we posted a 21.4% pre-tax margin in Japan among the highest quarterly performances in recent history and a very strong 21.1% for 2018.
Turning to our U.S. results, our total benefit ratio for the quarter was in line with guidance. Along with favorable claims trends we are seeing the effects of business mix with a gradual shift towards product lines with a naturally lower benefit ratio and higher expense ratio. Our expense ratio in the U.S. for the quarter came in as previously guided at 38% accelerated spend related to post tax reform investments and timing related to advertising spend drove expenses higher.
Our U.S. pre-tax profit margin for the quarter was 17% and for the year was 19.9%. As Dan noted, 2018 represents a record level of U.S. segment pre-tax earnings. For both Japan and the U.S., our fourth quarter performance does not change our 2019 guidance ranges for benefit ratios, expense ratios and pre-tax profit margins.
I would now like to ask Eric Kirsch, our Chief Investment Officer to discuss the positioning of our investment portfolio in view of credit markets in 2019. Eric?
Thank you Fred and good morning everyone. So we don't try to predict exact market moves or starting and ending dates of economic and credit cycles. We do analyze market themes. As investors, we want to position our portfolios with a long-term investment strategy in mind.
For the last year or so, we have been of the opinion that the credit cycle was in its late innings and we could see it turn soon. With this in mind we have managed our credit portfolio with a bias for higher quality supported by a disciplined underwriting process for new investments and an eye towards improving our credit profile to mitigate potential impairments and losses positioning us well for future changes in the credit cycle
Let me review highlights of the actions we have taken this past year, perspective insights as well as reviewing key portfolio characteristics. Over the past 12 months, I would highlight the following investment activity; from a relative value point of view we have been underway with our investment grade corporate bond purchases, given how tight spreads have become. The recent spread widening validated our concerns of not getting paid for the credit risk.
We focused a large amount of our new money investments in private markets such as middle market loans and transitional real estate. I want to stress that we have high underwriting standards and diversification goals. Our discipline has kept our exposure to some of the private market issues you read about such as excessive leverage, lack of confidence and aggressive underwriting to the bare minimum.
While we have seen spreads compress in these markets, in the latter part of 2018, the majority of our purchases were made in the first half of the year at higher spreads. We have cut back our deployment goals in 2019 while maintaining our high underwriting standards.
We implemented a number of derisking strategies designed to eliminate or reduce credit positions that felt could underperformed in a shifting credit cycle. Highlights include in 2018, we disposed of over ¥34 billion of our more illiquid legacy private placements, all below investment grade. Some names we reduced that I would mention include exposure to the governments of South Africa, Tunisia, Trinidad and Tobago and Catalonia. We also reduced exposure to Navient Corporation.
In December, we initiated a $550 million relevant value derisking trade, of which $500 million was to reduce exposure to energy names including approximately $150 million to CCC rated issuers. The proceeds will be reinvested across the diversified pool of investment grade credits.
In fact, throughout 2018, including the $550 million trade initiated in December. We traded over $3.4 billion of public bonds to improve the health of our credit portfolio. This includes selling $1.2 billion of investment grade bonds held by Aflac Japan including reducing energy by $243 million and swapping $340 million of BBB assets into higher rated transitional real estate while improving our maturity profile and income.
Selling $500 million of BBB rated investment grade names in Aflac U.S. and reinvesting in AA rated tax advantage municipal bonds, improving quality and increasing after-tax income. Selling $600 million of BBB rated bonds in the Aflac U.S. portfolio to fund corporate capital activity.
Most recently, as you know PG&E has been in the news and this week filed for bankruptcy. We hold about $147 million and conservatively decided to take a $21 million impairment as of December 31. This slurry will take time to sort out. We currently believe holding our position to the bankruptcy process will provide the best economic outcome.
Let me also mention that these activities supporting our high quality bias, comes at a cost to net investment income, with new investment opportunities such as private credit, we have been able to offset some of these headwinds. Our main objectives is always to ensure the safety and quality of our portfolio to minimize potential losses while balancing our objective of delivering appropriate risk adjusted net investment income.
At the end of the year, we had managed to improve the credit quality of the overall portfolio, by having 4.6% in below investment grade credit of which 2.2% are fallen angels and the remainder are high-yield bonds and loans that we purchased within our credit standards.
We also maintained that we believe to be a lower consolidated exposure to BBB names than our peers. BBBs make up approximately 23% of the portfolio and have an average position size if slightly over $50 million dollars.
Overall we continually look to maintain a very diversified portfolio and shape it with an eye toward safety through the cycle. As we look forward despite a strong equity recovery in January, credit spreads remain elevated and we believe it is signaling that credit investors are concerned that this may be the initial innings of a turn in the credit cycle.
Regardless our view will continue to be a bias towards maintaining a relatively higher quality overall portfolio and proactively managing exposure to creditors performance may be challenged under a slower growth backdrop.
Finally, I should highlight that this type of market environment also presents opportunities especially when dislocations occur. Our strong current portfolio combined with a healthy capital position will allow my team to put new money to work and capture those opportunities that become apparent which will improve future performance.
Now back to Fred.
Thanks Eric. Picking up where I left off, let me comment briefly on our corporate segment. We continue to make progress on managing our economic exposure to the yen while lowering enterprise wide hedge costs associated with Japan's U.S. dollar portfolio.
We accomplished this by entering into an offsetting hedge position at the holding company which ended the quarter at a notional amount of approximately 2.5 billion and contributed 18 million on a pre-tax basis to the quarter's earnings.
In terms of capital, we ended the year in a strong position. As of year-end our Japan solvency margin ratio is estimated at approximately 970% and our U.S. risk based capital ratios estimate is in the mid 600% range. 2019 will continue the access capital drawdown process in the U.S. as we target 500% by year end. Overtime, we believe we can run our U.S. RBC down towards 400% given the risk profile of our U.S. business.
We ended the quarter with approximately $2.8 billion of capital and liquidity at the holding company recognizing this balance naturally fluctuates. We have set aside one billion as a capital buffer and an additional one billion of contingent liquidity. Our liquidity position is in support of our holding company derivative positions that serve to lower our enterprise exposure to currency movement.
Including dividends and share repurchase, we returned $574 million to our shareholders in the quarter and $2.1 billion for 2018. As Dan highlighted in his comments, the Aflac Board approved an increase in our quarterly common stock dividend by 3.8% after back to back increases raised dividends 19.5% in 2018. The Board continues to take a balanced approach with a desire to sustain our long-term track record of increases.
While we ended 2018 strong, we need to manage through national headwinds in 2019. Net investing net investment income is expected to modestly decline as compared to 2018 due impart to the risking activity Eric noted in his - and rolling U.S. dollar hedge positions into higher cost contracts.
While reacting somewhat to market developments. Our forecast remains essentially unchanged from the outlook call, but we ended 2018 stronger than expected. We anticipate lap and rereissue activity in Japan will slow in the second half of 2019. We are enhancing our medical products through offering Riders that address a range of coverage needs and are available to existing policyholders.
This strategy preserves and builds upon the favorable economics of our enforce policies, but naturally pressure sales as defined by incremental annual Rider premium versus a lap stand reissued four policy.
Finally with long-term top-line growth as a primary objective, we continue our investment in product development, digital consumer driven distribution and overall venture and incubation efforts to create future market opportunities.
We have affirmed our currency neutral EPS guidance of $4.10 and $4.30 per share and as Dan noted, we are maintaining our range for share repurchase at $1.3 billion to $1.7 billion. We remain tactical within the range guided by relative returns and other options for our use of excess capital.
I'll now hand the call back to David to begin Q&A session. David?
Thank you Fred. Before we begin the Q&A, please limit yourself to one initial question and one related follow up to allow everyone an opportunity to ask a question. And we will now take that first question.
Thank you. Our first question comes from the line of Andrew Kligerman from Credit Suisse. Your line is now open.
Hey good morning. Question on Japan sales guidance of low to mid-single digit decrease. Does that contemplate the possibility that you might sell an additional product through Japan post?
I'm going to let Japanese operation to answer that. so Koji Ari or whoever will, but I will say that no that does not contemplate Japan post. 2018 was being able to work out the deal, 2019 is the planning process have coming up with something that we think might be benefit their customers. And then 2020 I think would be more in the execution line. So I'll let Koji then talk.
[Foreign Language]
In terms of Japan it is not changed since this call last time. In terms of target, really the allowing with the customers' need and we will be setting the target accordingly. In January, we have launched a protection type prospective product in medical product.
And this medical product has a concept to be able to have the customers' review their medical or the insurance product depending on the last stage. And at this time enables customers to add a lump sum type of coverage especially for the young customers that we do have income support type of Rider and then for elderly customers that we make available our nursing care type of Rider.
And for the system policyholders, we have introduced mid-term Rider addition a type of - to allow our customers to be able to add to their existing base policy. And so this will be a shift from just focusing on the new business - just focusing on the new business, we will now allow our existing customers to be able to expand their coverage and update their coverage based on the policies they have.
And because this - are addition there will be invest new AP in that effort, AP per policy for that additional would be smaller. However, we will be able to maintain our existing policy which means that this will contribute positively to our earned premium.
And so this is our strategy to be able to really maintain the base policies of the existing customers without having them to purchase a total new policy.
[Foreign language]
This is Koide from Aflac Japan. And I just want to make sure the new medical product that Koje has just explained about the product that we have launched in January, this is a product that is offered through channel except for the Japan Post, all the other channels apart Japan Post offers us this new product.
I want to just make sure all of you on the line pick this up because this is a little bit of a change and it's very similar to the way we used to do business in the United States was we would convert a policy.
In essence what you are talking about here is there won't be a new policy written-in one laps, we will keep the existing policy in force which will be a medical product and we will add a Rider on top of it and therefore the premium of that Rider will be a smaller amount than a normal policy.
However they won't be less than the old policy, so they earned premium will ultimately be growing. But you will see a lower sales number because of that impact. So I just want to make sure everyone got that.
Yes that makes a lot of sense and just a quick follow-up on corporate and other where investment income went to $38 million versus $11 million and that was the drive down of excess capital. And then Fred mentioned that you might go from a mid 600s RBC to 500 again drawing down more capital. So the question is, can we expect this elevated investment income incorporate another to kind of keep ticking up. Where is it possible you might even be able to achieve your $1.3 billion to $1.7 billion guidance on buybacks.
At this point in time I wouldn't change our guidance on the range of buyback that range in buyback takes into account moving additional excess capital of approximately $500 million up to the holding company.
What I would say though is that from an investment income line item perspective in corporate and other you will see that most likely increase, but not necessarily because of the volume if you will of assets at the holding company and associated investment income. It's more driven because that's the line item where we house the benefits of our enterprise hedging program offsetting the hedge costs and hedging dynamics in Japan.
And as you may recall from the outlook call, we guided to pre-tax approximately $60 million to $80 million worth of amortized offset if you will to the hedge costs in Japan that will run through that line. To give you a comparison that was approximately $36 million or $37 million - $36 million in 2008.
So you will see as you look at corporate and other, essentially the last page of our FAB supplement, most of those line items will remain relatively consistent in terms of revenue lines and expense lines.
The one line that stands out as you will see movement in investment income, not so much because of the excess capital at the holding company, more so moving because of our enterprise hedging program.
Thank you.
Thank you. The next question comes from the line as Jamie Bhullar from JPMorgan. Your line is now open.
Hi good morning. So I just had a question on the portfolio. And Eric, you mentioned sort of positioning it conservatively given the environment but you had fairly high investment losses in 4Q. So maybe if you could talk about to what extent do you think this is representative of what you would expect if the environment remains challenging or was this more of an aberration, given how much the market moved in 4Q?
Sure, you really need to look and attribute all the gain and loss numbers. But if I think about impairments and loan losses, they were about $61 million for the quarter. For us, that probably was a bit elevated versus where we have been running but recollect over the last two to three years, our loan losses and impairments have just been very minimal.
And also part of that $61 million was the PG&E situation which is $21 million of it. So if I take the PG&E situation out to $40 million or so is really kind of expected with a large loan portfolio now, other assets, nothing really too surprising in there.
I certainly know going forward that the credit cycle is beginning to change with a large portfolio like ours and other insurers. We are going to expect certain industries may have some challenges. And we will be tracking that closely.
And as I said, our job is to continue to shape the portfolio to avoid those credits that in a tougher cycle may have trouble and we have been proactive as I said in my speech doing that. So no doubt if the credit cycle changes we will have probably larger impairments than we have had over the last three years, but I believe they will be very manageable and minimal relative to the industry.
And we made a decision after the financial crisis that we were going to be all - would have all types of assets to where we were never in a position like happened before and therefore, when you are everywhere, as you well know, the likelihood of having hits are much - will be escalated a lot, but they will be small hits and that's what supported.
Exactly and just to build on that. Which you all know, we have attracted over the history. We are diversified by different asset classes, by different strategies and importantly from a risk perspective with diversified by position size. We no longer hold these oversized concentrated positions. So when something should occur, it will be in a much smaller size versus where we were historically.
Okay and then maybe if I could ask one more Fred. Just on the timing of buybacks. So I think the Japan Post can begin buying either late-February early-March when your structure is completed. Would you consider front ending buybacks to not be active at the same time as the post is buying shares, or do you believe it will be more evenly spread through the year?
Yes. We are not tactically changing our approach to buyback based on the Japan Post agreement. What we are doing is what we always do and that is we will be tactical at times. For example we accelerated a bit of our buyback rights here just at year end to take advantage of what we thought were compelling economics and so we will be tactical within the range that will always continue. But we are not designing or being tactical with our repurchase surrounding the Japan Post agreement and their building of our share count. So you should expect generally spread over the year in other words.
Okay. Thank you.
Thank you. The next question comes from the line of Suneet Kamath from Citi. Your line is now open.
Thanks. Just on the first sector protection products in Japan. My sense is the market is pretty saturated with first sector products which maybe one reason why a lot of the domestics are moving into the third sector in the first place. So can you give us a sense of what is it about your first sector protection product that stands out versus the group and are you essentially selling to the same customers that you already have or is it allowing you to reach a new group of customers.
Koji?
[Foreign language].
In many cases we are selling our first sector protection tied to our existing power shareholders because the ability to have their policy, we are standing on top of the existing policies. Because of special discount, we have achieved a premium wage that is very attractive to non-smokers.
And the coverage with this smaller amount is also made available. And because we were able to set our premiums relatively low, many customers like the product. And it was not it takes about 5% of the protection type sales.
Okay. And then on the medical Rider. Yes I think you guys went through this years and years ago with Rider Max where it sort of was a source of sales for a number of years. So how long do you think you will have this ability to sell this medical ride, like how many how long will it take you to kind of work through your existing customer base in terms of folks that might be interested in adding the Rider.
Koji, would take that.
[Foreign language].
And in terms of the product this time is of course this is for our existing policy holders and we have different products for different age group of customer, for example young customers have certain Riders that we can have them attach and older customers we have Riders that cater for their needs.
And particularly that enforce number of medical policy we have is number one in industry. So it does make it possible to take in or retain our customer for a long time using our customer base. And this is a differentiator against our competitors and this will also contribute to the increase in our earned premium.
Okay. Thanks.
Thank you. The next question comes from the line of Humphrey Lee from Dowling & Partners. Your line is now open.
Good morning. And thank you for taking my questions. In Fred's prepared remarks, you talked about there are some redundant reserve releases because of the last time we issue - the activities that happened in the quarter. I was just wondering can you size the benefit of those redundant reserve releases in a quarter? And maybe how we should think about that kind of throughout 2019?
Yes. Let me step back and give you some attribution and then answer beyond that in terms of what we are now with the reserves in the quarter in Japan. I don't know that I would use the term redundant reserves they are rather just released when the policies lapsed, but let me explain.
So the lapse and reissue activity, we would estimate impacts when measured against premium, okay will serve to reduce your benefit ratio, we estimate about 30 to 50 basis points 2018 versus 2017. It's important to note that lapse and reissue activity takes place naturally in every year, it's just this year and to some degree last year was a bit more elevated due to a more medical product but more particularly this year with the new cancer product.
Importantly though while the benefit ratio measured against premium goes down 30 to 50 basis points you have a somewhat equal impact to the expense ratio because you are now essentially amortizing the deck more quickly or writing down the deck upon the last policy. And that has the effect of increasing your expense ratio measured against premium again 30 to 50 basis points and so you end up with the somewhat negligible impact to your bottom line.
Now within those ranges, you could have more of one and less of the other and so it can either. impact positively or negatively your earnings and that depends a lot on the age of the actual policies that are being lapsed and relapsed.
And the fourth quarter it was a bit more pronounced, those metrics were like 70 to 80 basis points in the fourth quarter improvement to the benefit ratio. And then similarly increasing the expense ratio. And you can see that in our actual numbers of course in the quarter. So that would be the attribution.
So set as aside, lapse and reissue in terms of pre-tax profit margins, because it's fairly insignificant. In terms of the quarter and the strong pre-tax profit margins it was largely just the positive trends and claims and as a result of those positive trends, particularly in our cancer blockade business, the associated release of IBNR.
And we released about ¥3 billion of IBNR predominantly related to the cancer book of business, but I would note that this is not entirely unusual in the sense that we have been doing these types of releases now for a few years if not multiple years and primarily because of the continued trends in the cancer book.
There is no guarantee that that will continue and every year represents a variable, but there has been a pattern of this because of the trends have been quite consistent.
Yes thank you for the color. Yes, I understand that the improvement in benefit ratio is offset by the expense ratio but thank you for the color. And then also I guess in part of your early remarks, you talked about longer term, you think you could have draw obviously down to kind of 400% overtime. Do you understand in terms of timing like how long would you start contemplating to move down from 500% target to 400% target.
Yes I think right now the idea would be let's settle down into the 500% target. As I have mentioned before, this will represent the first year we have printed U.S. Blue book and in a long, long time. Let us make sure we can digest the statutory moving parts.
We had very strong statutory income for 2018 up around $830 million helped somewhat by tax reform, but that was a very strong state earnings year and that's what we would expect came in right about where we predicted, because it's a very stable business.
And so my view is with the stability of our business the low asset leverage in our U.S. business we can comfortably move it down to 400%. What I would plan to do is take this Blue book take our final year end results, start working with the rating agencies and my guess is that in 2020 we will start to work that ratio down.
That's helpful. Thank you.
Thank you. The next question comes from the line of Tom Gallagher from Evercore. Your line is now open.
Thanks. Eric, when I hear you have shifted out of public corporate bond purchases and emphasized middle market loans in transitional real estate, I guess from a category standpoint it's not clear that's a risk upgrade. Can you give some examples or statistics about how that risk is better or lower.
Sure absolutely. First I would say it's diversified and that goes to the point of diversification pays dividends overtime. But remember in our program for middle market loans for example, we determined the underwriting standards.
So we have first lien secured loans, highly diversified, high degree of components and the market has gotten fluffy and we are aware of that, but we have not lowered our underwriting standards.
Which is why as I said in 2019 our deployment goals are a bit less than they were in 2018 and we were fortunate to build a good portion of that portfolio in the first half of the year. So it comes down to underwriting.
And in addition because those companies we are lending them money, we have first insight into whether or not they are having any difficulties with their business. Now most of them are doing quite healthy and very seldomly do have any issues, but when they do we can walk in and make a difference.
Now in the public sector they are bigger companies, but we can't influence what company managements necessarily are going to do. So when the credit cycle changes, we have got to be more proactive in trading those assets.
And then finally I would say, when you look historically at the private markets even through tough times the default rates are low and the recovery rates are fairly high because of the strong negotiating leverage that you have.
And Eric, from a yield standpoint, was it a yield enhancement from shifting out of the public corporate going into the trend transitional real estate and middle market loans, are you still making that excess spread.
Absolutely Tom. Absolutely. So thank you for raising that. Substantial, I mean you are getting paid for the additional risk for sure. So in the investment grade space currently for you know BBB type of names or in the 375 or four area with long duration.
In the loan space middle market loans growth yields we are looking at 6.5% to 7% those are typically three to seven year maturities. So coupons are based off of LIBOR which is been in our favor since we started the program. So you earn a substantial yield advantage for a shorter duration of maturity.
And finally, let me add just to put total context and remember those floaters play a very important role in our dollar program and particularly with respect to the hedging program. Because of that yield advantage, I'm starting out with the 6% to 7% instrument paying 3% or so in hedge cost and I have got a net spread of 4% with an investment grade bond I have got a duration mismatch between the asset and the hedge. And I maybe might be earning a spread of 1%.So again it goes to diversification and looking at the entirety of the risk and the return.
So thank you again for bringing up the return side of it, that's obviously an important element.
Okay. Thanks.
Thank you. The next question comes from the line of John Barnidge from Sandler O'Neill. Your line is now open.
Thank you. This is a question on U.S. productivity. I know there are some seasonality that wait 4Q more heavily. But this looks to be a record this year. Do you see this more coming from any crack in the distribution for broker or not or more from a efficiencies that have been delivered on some of your tech and digital investments. As a reference point I'm talking about Page 18 of the supplement.
Okay. So as we noted definitely it was a record sales year and it really coming off momentum of eight consecutive quarters of growth and really it was the balanced delivery. Our veteran associates provide strong contribution to our sales growth, broker sales as you mentioned continued deposit of momentum.
And that's growth with our broker sales professionals and our associates who work with brokers. And then as Teresa’s continued to mention, we continue to focus on improving producer productivity and their long-term development. So I would say it's the balance of all of those.
Okay. And then my follow-up dug tailing on that. the recruited agent brokers definitely increased in the fourth quarter year-over-year and was twice what it was in 4Q, 2016. I know you talked about recruitment when the economy is doing really well, it's harder for the agents because of the commission structure. The brokers hasn’t worked that way correct? And that is somewhat opposite of maybe how the agent improvement flows through the economic cycle. Or could you talk about that little bit more?
Certainly. Obviously recruiting overall is important, just like them we will continue to be so. And more and more brokers are getting into supplemental insurance voluntary benefits. And so I think as you look at the increase in the broker recruiting that's reflective of the overall market more broadly.
And as Dan alluded, brokers want to work with the company like Aflac that has a strong brand. So I think that's where you are seeing elevation and as we mentioned if we continue to want to increase the number of local regional brokers that work with Aflac in addition to our national broker partners.
Great. Thanks for your answers.
Thank you. The next question comes from the line of Alex Scott from Goldman Sachs. Your line is now open.
Hey. The first question was kind of a follow-up on the investment conversations. Most of what you have talked about are U.S. dollar investments and if you get a good amount of detail there. I guess I'm just looking at the tenure JGBs there are back down to basically zero. And certainly there must be limitations to how much you can kind of keep investing in the U.S. dollar portfolio. So I’m just kind of wondering like how should we think about new money rates, new money yields rather in Japan and where that should trend and at what point you sort of have to begin the investing more heavily again in JGBs or yen denominated assets more broadly.
Yes, thank you. Good question. First if you look at last year's final tally we were about a little over 50% in yen assets and the rest in dollar assets. So it's not like it's predominantly just dollar assets because we do have risk limits and limitations to our dollar allocation.
Secondly, just to frame, I know the 10 years JGB is the benchmark yields for Japan. But it's not the benchmark yield for us from an investment standpoint. We have long-term liabilities, so when we are in the yen fixed income markets we are typically thinking about 20 to 30 year type maturities and duration and 20 to 30 year of JGBs are anywhere from 70 to 90 basis points depending where on the curve but it's in that range.
Thirdly and very critically just as a reminder from an asset liability management standpoint, all of our liabilities in Japan are in yen. And when we think about economic capital, other solvency ratios yen is the baseline. So when we think about the strategic asset allocation about 70% of our book is targeted towards yen assets precisely to manage our asset liability management and obligations to our policy holders and our regulators there. So yen assets will always be positive.
Next, we are not just buying JGBs. We would acknowledge amongst our choices in yen JGBs are the least attractive, but the choices we have include yen private placements, which over the last few years we have improved our private placement program through higher diversification standards and finding better deals and typically we get paid for that risk. It just depends on the deal and the maturity, but 20 to 30 basis points over JGB.
And then also in the Japan market there is a growing yen credit market and yen municipal market and we deploy in that sector quite a lot. And we are also typically earning anywhere from 20 to 30, 40 basis points over JGB.
So while we don't like the low yields, buying in assets does serve our capital and serves our asset liability management. But we are using our tools through the investment team to find non-JGB yen investments and at least earn a spread commensurate with the risk over the JGB yield.
That's really helpful. Thanks. Second question I had was just on the Riders of Japan. I was wondering if you could give more color on what the Riders are and what is the sort of mix expected from nursing Riders versus income protection Riders and so forth. And I mean with the nursing care Riders specifically I mean could you just talk a little bit quickly about how that's different from sort of standalone long-term care risk in the United States and what sort of makes you more comfortable with that Rider in Japan.
Yes and I might I might say, Koji you may be good to just discuss the Riders we are talking about and importantly the notion of as you have mentioned carrying the policy through the lifecycle of the policyholder from income to nursing. Todd it may be good for you to chime in on how this nursing care Rider should not be confused with the types of goods that one takes long-term care type benefit. Koji?
[Foreign Language]
And let me start from nursing there. This is a type of caring that offers long-term benefit to the customers. And level of the nursing care needs is determined by the commissioner of certification or eligibility by that national government. And we are making this lump sum amount payment to read the limit the risk amount. And since this will be paid based on the eligibility determined by the national government there now will be limited.
And for the middle to younger generation we do offer income support Rider. And this is also a lump sum type of coverage that will be paid when the policyholder is not able to work. And we also have a standalone product income support product.
And because this standalone product coverage is extended for a longer period of time and it requires explanation of the social welfare benefit that is being offered by the government. So the standalone product is not carrying as well as counsel or medical.
And at this kind of dimension that Rider is lump sum payment type of product and explanation is much simpler. So if you are able to identify the needs of this kind of product, we might want to think about revising our income support standalone product.
And with the medical insurance that we have launched this time it’s not only the hospitalization benefit or the surgery benefit that we have always had, new product also allow to offer outpatient product as well. And as I mentioned earlier, we are the number one medical policy offering insurance company in the industry, so there is a big potential in terms of our business here.
I'll just add what Koji lead with, you don't often get marketing leading with risk aspects of the product. But just to emphasize on the care Rider, it is a lump sum benefit. And the definition of a claim is tied to the government definition. And those two things we believe differentiated from a long-term care products in the U.S.
Thank you. Our last question comes from the line of Erik Bass from Autonomous Research. Your line is now open.
Hi. Thank you. You recently announced an investment in Singapore Life and I was just hoping you could talk about the opportunity you see in the business and whether you expect to look at other investments in new markets with higher growth potential overtime.
Yes, Max Broden led that investment for us and so I’ll have Max, comment on the nature of investment and our expectations.
So we made a small investment of $20 million dollars Singapore Life. And this is going to life insurance company in a region that we see great potential in four protection type products. Together with that announcement we also announced that we will collaborate on product development to develop cancer and protection types of products together with Singapore Life. And we also will enter into reinsurance agreements with them, but we would reinsure those products back to Aflac.
So we see this as a very interesting opportunity for Aflac to use some of our skill set to deploy in this region. But we also understand that it might be tricky for us to do this by ourselves. And that's why we have aligned ourselves with a very strong partner with very strong and dedicated digital experience and that's what we intend to lead with.
Yes I think it is. It's steps you back to really the broader strategy and that is if we are going to enter or be involved in any way in a new geography it’s going to be on the back of digital, it's going to be with on the ground partners so that it doesn't consume management time and attention. It's going to be with a measured amount of capital at risk and it's going to be careful.
But we don't see the sense in what we would call kind of a traditional entry into those types of markets on the back of large scale acquisition, large capital at risk, the building out of traditional distribution platforms of agents and so forth. That technically is a lot of money a lot of risk and your ability to compete with other players in the market is questionable. So we think of this as a smart way of entertaining and exploring what might be possible and that's our philosophy.
And thank you operator, I believe that's the end of our call, we have reached and exceeded the top of the hour. Please feel free to contact investor and rating agency relation if there are any other questions or for more information and we look forward to speaking with you soon. Thank you all for joining us today.
Thank you. And that concludes today's conference, thank you all for joining. You may now disconnect.