Welcome to the Aflac second quarter earnings conference call. Your lines have been placed on listen-only mode until the question and answer session. Please be advised today's conference is being recorded. I'll now like to turn the call over to Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations.
Good morning, welcome to our second quarter call. Joining me this morning is Dan Amos, Chairman and CEO, Kriss Cloninger, President and CFO, Paul Amos, President of Aflac, Ken Janke, Executive Vice President and Deputy CFO, Aflac Incorporated, and President of Aflac U.S., Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also joining us from Tokyo is Tohru Tonoike, who is President and COO of Aflac Japan. Before we start this morning, let me remind you that some of the statements in this teleconference are forward-looking within the meaning of Federal Securities laws. 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 that we discuss today.
We encourage you to look at our quarterly release for some of the various risk factors that could materially impact our results. I'll turn the program over to Dan, who will begin this morning with some comments about the quarter. Dan?
Good morning, and thank you for joining us. I am very pleased that we met, and in many cases exceeded, our financial targets for the second quarter. Let me begin today with an update on Aflac Japan, our largest earnings contributor. For the quarter, pre-tax operating earnings in JPY were up 2% on a reported basis and 0.8% on a currency neutral basis. Our focus remains on growing the sales of the third sector products, which were up 4.5% for the quarter and in line with our annual sales target. For the six months, third sector sales were up 3.2%. Sales of the first sector products declined 20.3% for the second quarter, which was down somewhat more than we had anticipated. Third sector sales grew sequentially over the first quarter, primarily reflecting an increase in cancer insurance sales from Japan Post.
The number of postal outlets selling our cancer insurance rose from 1,500 to 2,980 in March of 2014 and has remained at that level as of June 30th, 2014. We were very pleased that at the end of June, Kampo, also known as Japan Post Insurance Co., Ltd., received FSA approval to sell Aflac's cancer insurance. Kampo began selling our cancer product last week through their 79 outlets that employ approximately 1,200 sales agents. Another important aspect of our agreement is the sales education and training support that Kampo provides to post offices selling our products. This support, which includes sales practices and compliance, helps expand our reach to agents selling our products. Looking ahead, we believe this alliance will further strengthen when we roll out the exclusive cancer product for Japan Post. Pending FSA approval, we anticipate introducing this new product later in the year.
We remain encouraged with our growing partnership with Japan Post Holdings. We believe this alliance will gradually but steadily benefit our cancer insurance sales. With respect to third sector sales, we've seen the contribution from traditional agencies slowing down. We've developed partnerships with new channels that help offset that decline. These channels include Japan Post, and we're making gradual but steady progress with advancing our sales through the postal outlets. The second half of the year will present us with difficult comparisons due to the medical product we introduced in August of last year. Taking these factors into account, we anticipate third sector sales for the full year will trend toward the low end of our expectations of a 2%-7% increase. Now let me turn to the U.S. operations. In the second quarter, Aflac U.S. pre-tax earnings were up 5.7%.
As anticipated, our second quarter sales results continued to be challenged, declining 8.2%. For the first half of the year, new sales were down 6.4%. You'll recall at our May analyst meeting, I told you that I was laser focused on a number of initiatives we are implementing to improve sales. We have spent a lot of time evaluating the market and our business model. We determined our sales model is not as effective as it was in the past and needs to be enhanced. As such, we're implementing tactical initiatives centered around better performance management and competitive compensation. It's more closely tied to our corporate goals. These measures are designed to more effectively link sales management success to Aflac's success.
First, we are enhancing compensation through an incentive bonus for our District Sales Coordinators, the first level of sales management, who are primarily responsible for their own personal production and training new sales associates. On July 1, District Sales Coordinators began receiving a bonus based on new sales written at small businesses for under 100. If it proves to be effective, which we expect it to be, we will use it again next year. We believe its hierarchy have the potential to earn the best compensation in the industry. Second, we've made the decision to eliminate the commission-based position of the state sales coordinator. To better manage our state operations, we've introduced the new position of market director. Market directors will be salaried with the opportunity to earn sales-related bonuses. We believe this will enhance our performance management and better align their pay with the new business results.
This change will be effective on October the 1st of this year. Further, we think this approach will allow us to more effectively and consistently manage the execution of the U.S. sales strategy over all state operations. This is especially critical given our strong brand, the rapidly changing marketplace, and the expanding distribution that includes broker and career agents. From a sales perspective, changes of this magnitude will be disruptive in the short run and take some time to gain traction. These changes are not without cost. We currently estimate that the quarterly cost related to these U.S. sales initiatives will be around $0.02 per diluted share beginning in the fourth quarter of 2014. We will finalize 2015 expense estimates for these initiatives in our budgeting process, and they will be reflected in the 2015 guidance that we will provide in October with the third quarter earnings release.
Given these changes in the sales results in the first half of the year, we now expect 2014 sales to be down 4%-8%. Now I'll provide you an update on the consolidated financial performance. Operating earnings per diluted share excluding currency were strong, rising 4.3% for the quarter and 5.4% for the six months. I will remind you that the second half of the year, we expect to see increased expenses on various initiatives in both the U.S. and Japan. As such, we currently expect that the 2014 operating earnings per diluted share on a currency-neutral basis will be up 3%-4% for the full year. On an operating basis, our second quarter annualized ROE was 21.3%. Based on our year-to-date financial results, we expect to meet our annual ROE target of 20%-25%, excluding the impact of currency.
We remain committed to generating strong capital ratios, both on the RBC and the SMR, on behalf of our policyholders and bondholders. Although we've not yet finalized our statutory financial statements, we estimate that our second quarter 2014 RBC ratio will exceed 800%. Additionally, we expect that Aflac Japan's estimated second quarter SMR will be above 800%. You'll recall that at our analyst meeting in May, we raised our profit repatriation estimate from JPY 100 billion-JPY 127 billion. By tomorrow, we will have repatriated JPY 131.4 billion. As such, we have the utmost confidence in this year's plan to repurchase $1 billion of our common stock. For the first half of this year, the company purchased more than $515 million of its shares. For six decades, Aflac has been delivering on the promise to be there for the policyholders when they need us most by paying claims fairly and promptly.
While I'm pleased with our financial results, I won't rest until sales are better reflected in Aflac's full potential. Now I'll turn the program over to Robin. Robin?
Thank you, Dan. I'd like to go over some second quarter numbers this morning, starting with Aflac Japan. Beginning with the currency impact for the quarter, the JPY weakened against the $ 3.3%. In reference to top line in JPY terms, revenues as reported were up 0.7% for the quarter. Premium income declined 0.4% in the quarter. Reinsurance lowered premium income by 2%. Excluding the impact of currency, revenues were up 0.4%. Excluding the weaker JPY in the quarter on Aflac Japan's $-denominated investment income, net investment income rose 5.8%. In terms of quarterly operating ratios, the benefit ratio to total revenues declined over last year, going from 61.5%-60.6% in the second quarter. Excluding the impact of the weaker JPY, the benefit ratio for the quarter would've been 60.8%. Reinsurance had a 50 basis points positive impact on the benefit ratio in the quarter.
Additionally, the benefit ratio improved in the quarter due to favorable claims experience in our cancer block, as well as typical seasonality, which usually increases as the year progresses. The expense ratio increased in the quarter to 17.7%, up from 17.0% in the second quarter of 2013. The pre-tax profit margin increased during the quarter, going from 21.5%-21.7%. Excluding the impact of the JPY, the pre-tax profit margin for the quarter would've been 21.5%. With the expansion of the margin, pre-tax earnings increased 2% in JPY terms, and excluding the JPY in the quarter, pre-tax earnings would've been 0.8%. Let me turn to Aflac U.S. Total revenues rose 1.3% in the quarter, and persistency was 76.4%, slightly up compared to 76.3% a year ago. Looking at the operating ratios, the benefit ratio for the quarter was 41.1%, compared to 49.1% a year ago.
The operating expense ratio increased slightly, going from 31.4%-31.6%. Pre-tax operating earnings increased 5.7% in the quarter. Turning to investment activity for the quarter. Let me start with Japan. Approximately 26% of the new cash flow was invested in JGBs at a weighted average of 1.32%. During the quarter, 74%, or $1.5 billion of the new cash flow was invested in U.S. securities for a weighted average yield of 3.02%. As a result, total new money yield in Japan for the quarter was 2.58%, up 59 basis points from March 31 and down 44 basis points from a year ago. The portfolio yield was 2.85% at the end of June, down one basis point from March and 16 basis points lower than a year ago. Turning to a few other items in the quarter, non-insurance expense was $51 million, compared to $48 million a year ago.
Parent company and other expenses were $19 million, compared to $18 million a year ago. On an operating basis, the corporate tax rate was 34.5%, compared to 34.4% last year. As reported, operating earnings per diluted share were $1.66, compared to $1.62 a year ago. The weaker JPY decreased operating earnings by $0.03 per diluted share for the quarter. Excluding the JPY's impact, operating earnings per diluted share would have increased 4.3%. Lastly, let me comment on and reiterate some of the statements Dan has already made. We've tightened our range for our 2014 objective and now expect a range of 3%-4% increase in operating earnings per diluted share. For the third quarter, if the JPY averages between JPY 100-JPY 105, we would expect operating earnings to be in the range of $1.38-$1.47 per diluted share.
Using the same currency assumptions for the remainder of the year, we would expect to report operating EPS of $6.16 to $6.30 per diluted share for 2014. We're ready to take your questions. First, let me remind you that to be fair to everyone, limit yourself to one initial question and only one follow-up that relates to the initial question. We'll now start with the first question. Carol?
Randy Binner, FBR Capital Markets, your line is open.
Great. Thank you. Good morning. I wanted to ask a question kind of higher level about U.S. sales. I appreciate all the commentary on the various initiatives regarding mostly incentives for managers, but other structural changes. I guess my question is, you're not the only one who's seen maybe bumpy sales, kind of in your segment of the supplemental health market in the U.S. Is there something going on from a macro perspective, from your perspective, meaning the economy, how things are changing in certain regions you have, or is it Obamacare? What is it from a macro perspective that's maybe causing some of this headwind?
Well, we've spent a lot of time trying to analyze this. I believe that we've been doing business basically the same way for 50 years.
Right.
Our structure is paid absolutely the same way, what we've always said, the founders, going back to my dad and others, was that if the agent does well, everybody else up the structure does well. It's gotten out of proportion to some degree. We needed our districts to make more money, and we needed to make sure that everyone was aligned to where if the company did well, the others. I think that's our problem, and I think we've addressed that. I'm not so much worried at this particular time. I will say that there still is uncertainty with people trying to figure out, and there's no one just tearing the numbers up in terms of sales growth, in our particular sector, no matter what. I think we can do much better, and I think focusing them on that will allow that.
I'll just give you an idea. At our state level, one of the problems we have is when a person comes in and was taking over a state, because it was an independent contractor status, they would take on such high expenses that it was hard for some people to ever take that position. Now we're going to pay everything, and our state sales coordinators will be the highest paid, or we're going to call them market directors now, will be the highest paid in the industry. We don't have to worry anymore about anyone being able to take on the expenses. We're going to cover that. Over a three-year period, it should break even for us. That will make a big difference. It means not only can we hire internally.
Before we couldn't talk to them because there was no way they could take on those expenses that were in the hundreds of thousands of dollars. I think it's positioned us correctly in the new environment we're in, and I'm very pleased with the attitude of our state people and their willingness to adapt. They get it. They understand that the company has to do well, and they have to do well. I just believe long term, this is going to be very effective for us, and I still believe that the market is huge and has great potential. Until everything goes into effect, there still is uncertainty in the marketplace as people look for it to happen.
Yeah. Just, I guess to follow up there, your answer is, you think it's tactics, and that's very clear. Does that mean that, whatever this Obamacare distraction has been, are you through the worst of that? Are people getting more organized in how they approach that and maybe getting closer to make buying decisions?
Well, every day it's in the press about, is this going to pass or is that going to pass? I said all along that once it got put in, it was never going away. You can argue any way you want, but the idea that it'll ever go away, I just don't think will happen because you've got to get a Republican president, or if you've got a Democratic president, you've got to get 60 people on the Senate side. That is not something that is likely to happen. We'll just have to wait and see. There's still uncertainty. As long as that's going on, we'll have to wait. I think the worst is probably over, but there's still a lot of people that are waiting and seeing.
Saying that is, I'm not going to use any of that as an excuse to why we shouldn't be up. I expect us to be up.
All right. Very good. Thank you.
John Nadel, Sterne Agee, your line is open.
Hi. Good morning, everybody. Maybe a couple of quick questions, one on Japan. I guess I'll phrase it this way. Dan, perhaps I'm reading too much into the commentary in the press release, you talked about gradual this morning, not long ago, you talked about the Post relationship and Kampo as a game changer, now it seems you're really tempering expectations there. We're looking at the full year third sector sales being maybe at the lower end of your outlook, you already knew the back half of the year was going to be a tough comparison. I guess if you could help us understand what's changed there, that would be helpful.
This is Paul. I'll start, then I'll let Tohru chime in. Ultimately, we had hoped that the first half of the year would be slightly better than where it is today. I'll let Tohru talk about some of the reasons for that. When we gave you an update at FAB, we had data as late as the month of April that gave us better indications of some things that would have happened in the second quarter that we thought would produce overall better results. We do see Post as improving. Post in the first quarter did not meet expectations, in the second quarter, we saw them moving in the right direction, we believe that will continue.
As Dan stated earlier, the headwinds that we face due to the launch of the medical plan in August of last year will make the second half of the year substantially more difficult to overcome than the first half of the year. Tohru, do you want to chime in on the specifics around the corporate-affiliated agencies?
Yes. For the second quarter, our largest disappointment was the sales by our large corporate affiliate agencies. Particularly there, the sales Post employees to our customer companies. In April, typically, they had a solicitation to the new employees of our customer companies, which were very good. The result of that kind of sale was in line with our expectations, more or less. In May and in June, when our corporate affiliate agencies tried to solicit the existing employees, the sale was less than they had expected. That's where the largest disappointment came. In addition to that, we had some disappointment with the sales, the individual agents. That impact is largely offset by the growth of our sales to the large non-exclusive agencies. That's the reason why our expectation for the year is somewhat changed.
Dan is quite right that the Japan Post sales can be a game changer, Japan Post is a huge organization, it takes time to realize the entire potential of the channel. The sales of the Japan Post is improving month-to-month or quarter-to-quarter, still, it has not quite reached the full potential of the channel. I think that's the overall situation of the Japan sales.
John, I want to make one more comment about the game changer. It is a game changer. It is a game changer, it was the only outlet that was left that could possibly be major and go against us in cancer insurance. When we nailed that outlet down, that new distribution channel, took it over and now control it, that was a major game changer for us. From a compensation or really a production basis, it is going to be a game changer. I believe that. I still believe that, I think the numbers will reflect that as we move forward. These numbers could be larger. Our job is not to predict what we hope it will be, but to be conservative.
Okay.
We could've given a higher number, I don't like to ever disappoint. I've said this before, I'll say it again. We're not very good at predicting sales. Everybody else predicts revenues, we like to predict sales. It's 13 weeks, it's the best we know. There is enormous variance in how they do that. I'll continue to monitor that, I feel Japan Post is exactly where we want it to be right now. I didn't like first quarter as much, I do like second quarter, I do like what July is looking like and going forward. I'm very pleased with that. Let me be clear on the phone. If nothing else, Japan Post is a winner, I'm thrilled with it.
Okay.
The rollout of the product is the unknown what will happen there. They are committed, we are committed, I feel good. The individual or agencies and the corporate agencies are our challenge. We've seen consumers move away from writing business at the work site or buying at the work site. That's why we've done the shops. That's why we're doing other things. That's why we're adding these new channels because we do see consumers move in that direction. That's our challenge what we have to find ways. It's not so many of the new employees, it's the old employees who have had the mail outs for many times, that's been going on for many years now, we will continue to monitor that and work toward that.
Okay. I appreciate all those comments. My follow-up question is sort of unrelated. I am just curious, after you take this JPY 131 billion back to the U.S. or the remainder of it, I suppose, how do we think about the impact on a pro forma basis for your SMR ratio in Japan? How much does that come down? Related to that is just the question, back half of the year expenses being higher, is that simply a matter of timing, you were slower to spend in the first half, or is there something truly incremental about those expense levels?
John, this is Ken. Let me start off. Kriss may want to add something to this. First, on the SMR, the profit repatriation estimate or the number of JPY 131.4 is fully reflected in the SMR estimate of around 800 that we've announced.
Excellent. Got it.
Already reflected in there. As far as the expenses go, for Aflac Japan, we had expected to see their earnings more front-loaded this year in terms of our internal forecasting and modeling. Part of that is just related to the expected infrastructure expenses that we talked about last year with our third quarter release and our guidance as kind of one of the headwinds, for instance. Clearly, the restructuring of the state position from a commission-based position to a salary position, which starts in October, is something new, but also would result in higher expenses in the fourth quarter.
Okay. Aside from that $0.02 in 4Q, the rest of it's really just timing.
Yeah. I'd also point out, too, that we have benefited in the first half of the year from lower benefit ratios than we had in prior periods. If you look back historically, you'll see that generally the second half benefit ratios for both Japan and the U.S. are higher-
Yeah
than they are in the first half of the year. We'd expect them to increase.
Okay. Thank you very much.
Yaron Tsinman, Deutsche Bank, your line is open.
Good morning. Ken, going back to your last comments on kind of the expense ramp-up in Japan. If I remember correctly, the CVP program was supposed to be about $0.12 of a headwind this year. I think if we're looking at the G&A in Japan to date, we see about $0.01 maybe. Just want to get a better understanding of kind of the ramp-up process. Are you still expecting those $0.12 to fully materialize this year? And how much of a success that would end up being for this year's ability to maybe come out with products at a faster pace? I guess I have two questions in here.
One being the expense load and the ramp-up of the CVP, and two being kind of that impact on the ability to come out with products at a faster clip, which I think was also built into the sales expectation number for this year originally, that has since come down slightly.
Well, I'll let Paul address the second part because clearly a shorter time to market or a faster speed is something that we want to accomplish in Japan, kind of the nature of the long-term Corporate Value Enhancement Project. There's really no expected change in the emergence of those expenses related to our spending in Japan.
In terms of the ability to launch products quicker, that is one of the primary goals of CVEP. Currently, we are working on multiple different initiatives. One of those is the new business process. The new business process is the single largest element that we must work on in order to bring products to market faster. I feel like we've prioritized correctly what we're doing there. It is going to take a period of time in order for that to come together. I feel confident that we're trying to move things in the right direction.
That said, as we continue to expand our channels, and we continue to work with groups like Tohru mentioned, with the non-exclusive agencies, it's essential that we be able to simultaneously fix whatever we need to in order to compete in the marketplace today, while also focusing on what the long-term solutions will be for what Japan is as a market in the long term, including cost efficiency to make sure we're maximizing our profit levels on our products.
I think, a little while back, you talked about maybe coming out with another medical product in Japan this year. Is that still a possibility?
We had talked about an additional third sector product this year, that being the revision of our cancer plan, and we are currently working through the final details around that with the Japanese government and internally.
Thank you.
Steven Schwartz, Raymond James & Associates. Your line is open.
Hey, good morning, everybody. Just some follow-ups. Dan, the corporate affiliate agencies, that's been a problem for forever and ever and ever. Maybe there's nothing to be done there, what can you do with the individual agencies?
Well, I think that we continue to look at different aspects of the way they're operating and try to run more ads for them than we've done. We've done better training. We eat away a little bit by adding distribution channels to the situation, like with the banks. It does impact individual sales to some degree when we do that. It's been the new channels to me that would offset it more than anything else. Tohru, would you like to comment or have any comments, I should say?
Sure. Dan, you're right. Individual agents will continue to be the important part of our distribution channel. There is no question about that. However, there are some other channels which are growing faster than the individual agent. The biggest one of such growing channel is the large non-exclusive agencies. Like Dan said, we are focusing more on our business with those large non-exclusive agencies, as well as other types of distributors, such as the Japan Post. On a comparative basis, we are shifting away from the individual agents. They will continue to be producing as much as they are doing now, I think.
I think what I would say about it is, it's a stable block, and we'll continue to grow it, but we're going to where the consumers are going, and the consumers are moving more towards other places, and we're trying to make sure that we're there for them to fill those needs. That's very important and what we'll continue to do. We do care about our individual agents. We do constantly focus on that. We have contests. We want to grow it, but that is not where we see the real growth channel going forward.
Okay. Then I'll sheet a little move to the U.S. as a follow-up. I get the move from state sales coordinator to market director. I get that. I'm not getting the compensation to the DSCs. I get trying to incentivize them to go to the right accounts and what have you. Are you implying that these people don't make enough money?
Well-
Therefore aren't out there selling?
What I believe is that we have more District Sales Coordinators than a lot of our competitors, we need to focus on making sure that they are making the money we want with them to make. I'd like to have strong districts that are making good livings. We've promoted a lot of people. If they've got renewals, they make very high numbers. When they're coming on, they need more front money. We're trying to concentrate on that and making sure that they're able to grow their business. What we've done over a period of time is we've made some adjustments by, an example would be, we might cut in a new level of management. That means that we have cut the commissions back a little bit to take that into account. At that time, the districts were for it.
We were for it. You take a little that they were in 2008, and I think ultimately will benefit us. We've always said that the district levels are the key to our organization, that and the associates. Trying to make sure they are high paid is very important to us, and we want to make sure that continues to happen going forward. We think this cements that and allows us to really grow the business because they're the ones training the new people, and we've got to hire more new people, and that requires a lot of time and effort on their part, and they're going to be working harder, so we want to pay them more for working hard.
Pay these guys more on their sales, on the same level of sales. They could live and then go out and use the extra time to train.
Let's be clear. Almost every time they're selling, they're not selling by themselves. They're taking somebody with them. They're splitting the commissions on what they're doing when they're out training a new person. We're trying to make sure that they're better positioned. Frankly, this, I think, will put us in a position where we'll be able to hire more people and at the District level and really grow the business long term.
Okay.
Shifting some money to them is exactly what we need to do.
Okay, one more, if I may, very quickly. California, I don't know if you all have looked at this, but California AB 1962 with regards to MLRs for dental, have you guys looked at that?
I don't know anything about that now, but I'll find out and get back with you.
All right. Thank you.
Jimmy Bhullar, J.P. Morgan, your line is open.
Hi, good morning. On the changes that you're making in the U.S., you mentioned in the release it's about a $0.02 expense per quarter in the fourth quarter. Should that actually stay about the same next year, or would it go up or go down? How long would it take for you to get a return on this? I'm assuming it's like a 1%-2% headwind on earnings growth next year, but you could let me know if that's right or not. On share buybacks, obviously, your capital position's fairly strong. Just wondering, and you stayed with the $1 billion guidance, but just wondering why you did less in the second quarter than we would have expected given your billion-dollar guidance.
This is Ken. Regarding the expenses related to the change to the salary position, we'll know a lot more in the next couple of months as we budget because of that amount, about half is related to the state operating expenses that Aflac will now be responsible for. In addition, it also includes the overhead that it will take to manage, in effect, 66 teleworkers around the country, plus their whatever administrative staff they have, a secretary or admin that we also pull in on. We'll have to tighten down those expenses, but that's the best estimate right now. We're layering on fixed costs. There's an expected offset with a reduction in variable costs because you should see total commission expense as a percentage of revenues decline going forward because we're not going to be paying out renewals for that level of the hierarchy any longer.
The more that we sell, the shorter the payback period in terms of that reduction in variable expense offsetting the fixed expense that we'll be putting on the income statement.
The $0.02 is sort of like the net of the higher fixed minus the variable. It's more like an ongoing expense, at least initially, as opposed to a one-time type expense.
Right. It is more. You'll see in year two, meaning the second 12 months, you see a larger offset because the District Sales Coordinator position will still be, in effect, they're still earning commissions on business that they had written all the way up to September or will write all the way up to September 30th of this year. The drag is really greater in the first year than it would be in the second year.
Got you. Yes.
On your follow-up question on share repurchase, when we buy, we want to make sure that we're buying in a manner that we're acting as a responsible investor. We try and buy below the VWAP, which we did in the second quarter, and we've generally been able to do. We want to stay on track for the full year amount of $1 billion and try and be as opportunistic as we can. Really, it was just some judgment on our part based on market conditions, volumes, the way the stock was trading, so on and so forth. We still, again, expect to be at the billion-dollar mark for the full year. We'll have to see how that plays out between third and fourth quarter.
Okay. Thank you.
Jay Gelb, Barclays. Your line is open.
Thank you. I want to circle back on something that was mentioned earlier in the prepared remarks with regard to Japan Post. I believe it discussed rolling out the new Japan Post specific policy. My sense was that was going to be done earlier. Can you give us some perspective on what's the delay there?
You want Tohru to answer it? Tohru?
The cancer product designed specifically for the Japan Post, our plan was, I don't know if we had
told the market that we are going to introduce that product earlier. We are working on that. We are working exactly as we have been planning. I don't seem to understand exactly what your question is.
Sure. Well, my understanding is it's a pretty simplified product, I'm not sure what the delay is in terms of launching it specifically within the Japan Post system.
Well, this is Kriss. I'll just kick in. We have to get it approved by the FSA. We had a target date at pretty much the anniversary of the new agreement, which would be around October 1st. We didn't anticipate implementing it prior to that time, if you had the impression we were doing it earlier, it was somewhat inaccurate. We are more or less on track with our original plan to get the JP specific product in their hands, hopefully around the beginning of the fourth quarter.
Okay. My follow-up question is also on Japan for the third sector growth outlook for 2015-2016. At FAB, you discussed the range of 2%-8%, given that's been narrowed for 2014, I'd like to see if you can update your confidence level in achieving that target for 2015-2016.
I think it's too early. What we don't know is the uncertainty of Japan Post and specifically, how Kampo will do with the new product. At the end of the third quarter, we can probably shed a lot better light on that.
I don't believe those were actually our sales projections. I believe those were data that was placed into Kriss's financial projections that he shared with you and clearly articulated at the time that they really aren't meant to be projections, but meant to be ranges of assumptions that we would articulate. When we get to the end of this year, we will do as we typically do and give out our sales guidance for the coming year. I feel like at that time, we'll be better able to give you forward-looking guidance.
All right. Look forward to that. Thank you.
Thomas Gallagher, Credit Suisse, your line is open.
Good morning. I just wanted to ask a question about the change in seasonality, the earnings pattern here. If I go back three or four years ago, you saw what was an emerging pattern of four Q earnings would be lower based on what you guys had flagged as timing of higher expenditures in four Q. Now, you've definitely seen that spill into three Q. It started happening last year, and it seems to be more pronounced now. You're getting a very big delta between what you were earning in the first half of the year versus second half of the year. You flagged some of the higher back half expenses, and I get that, when you gave out guidance. The order of magnitude here is a lot bigger than I would have guessed, looking at a 15% earnings drop sequentially, that you've guided to.
Can you peel back the onion a little bit and talk about how much of that is expenses, how much of that is benefit ratio change that we've seen on some of these newer products and anything else you could elaborate on?
Tom, Kriss, I'll try to address that. Yeah, we have had lower earnings in the second half of the year than the first half. Part of it's due to the reasons you identified. Sometimes we're cautious on our expense initiatives in the first half of the year. As we move through the year and gain more certainty that we're going to be able to achieve our annual EPS guidance, we kind of loosen the purse strings a bit. Particularly in the marketing promotion area may have larger expenses. That's been true, gosh, for years now. Not just the last three or four years, maybe more recently in Japan.
The other thing that has gone on traditionally, Tom, is that now that we've had all this SOX in place for years and years, we've had to define the process of evaluating our claim reserve estimates and the like with the auditors, and we've got a particular process in place where we evaluate certain reserves in the third quarter and certain other reserves in the fourth quarter. The historic patterns reflected some reserve strengthening, for example, in closed blocks like dementia due to lower interest rates than anticipated in the reserving and the like. We've had some reserve strengthening over time for that tends to occur to some extent in the third quarter, some extent in the fourth quarter. That's been more a financial reporting seasonality than an actual benefit reserve seasonality. This past year, we did a reinsurance agreement in the fourth quarter.
That actually improved benefit ratios in the fourth quarter relative to the third. We'll have the reporting of that reinsurance fully integrated into our benefit ratios by the end of the third quarter, and we'll get some In the third quarter benefit ratio in 2014 compared to the third quarter of 2013, Robin identified that was about a half a point improvement in the benefit ratio in the second quarter this year and will be again in the third quarter. In the fourth quarter, that'll be in the system. We'll have direct comparability so that improvement will go away. We do have some seasonality claim patterns that we reflect in the financial statement more today than we used to.
We used to be able to smooth them out a little bit, these days the accountants are more sensitive to smoothing anything out, so we have to go more with the actual seasonality of things. Claims tend to be lower in the first part of the year as people, they tend to backload the visits to the doctor and the actual claim processing, partly due to deductibles and the like, but partly just due to the holidays and other seasonal patterns. That's a long answer to a pretty short question, but, I focus more on the accuracy of the annual estimates and we did because we exceeded our six-month EPS increase ex-yen exceeded our annual high end of the range of 5.4%. It was greater than our annual range of 2% to 5%.
Because of some of the anticipated expenses we've talked about earlier, we decided to tighten the range within the 2% to 5% going to 3% to 4%. That's some of the rationale behind it.
Got it. That's helpful, Kriss. If I'm interpreting your answer correctly, this is a pattern that we will continue to see each year directionally much greater order of magnitude in terms of first half earnings to second half earnings, in part normal higher expenditures, but also, the benefit ratio change being more directly reflective of claim payment patterns. Is that a fair way to put it?
Yeah, that's a fair way to put it. I do want to just say that I specifically mentioned dementia reserves, and we've had a couple of increases over the last couple of years, but right now we don't anticipate doing that in the third and fourth quarter. We'll have to look at the interest assumptions behind the reserves, but with the stabilization of investment yields in the total portfolio and the like, we don't think we've got that kind of interest rate exposure we had in the past that's led to some reserve increases. That's a favorable thing.
Okay, thanks.
Christopher Giovanni, Goldman Sachs, your line is open.
Thanks so much. Good morning. I guess first one just on in terms of medical sales, clearly alluded to the tough comp in the back half of this year. Wanted to think about the sustainability of the quarterly sales we've seen so far year to date.
Sustainability of quarterly sales year to date.
Medical sales.
We have seen beginning last year very strong sales in our medical product. We anticipated that the medical sales would sustain slightly better growth in the first half of this year than we originally saw. That said, we still believe that the product continues to go in a strong manner. We're focused on the standard medical plan, not our Gentle EVER plan at this time. We believe those products will continue to sell well in the coming quarters. That said, it is the reality that competition continues to put out more and more new products all the time.
One of the things that we have to continue to do, one of the key reasons I mentioned earlier, our desire to be able to launch products in a quicker manner is the sustainability of the length of time that a product lasts in terms of the boost to new sales. We are constantly monitoring that. We do believe we still have continued tailwinds with our medical plan for some period of time, but we continue to notice that the amount of time that a new product is lasting is slightly less than it used to be.
Okay. For Dan, sort of a silly question, but given your recognition that you won't be growing at the pace you have in the past, the increased focus you have on capital generation, returning capital to shareholders, I guess why continue to have such an emphasis or heavy emphasis on publicly stated goals around sales targets?
We're a sales company, and I expect sales to grow. I believe it sets a trend for us of what ultimately earnings are going to be, and persistency is in that number and other elements. I believe that ultimately, when the agent does well, everybody else will do well. That's what we've got to see happen here. I am committed to fixing this in the U.S. and believe we'll be able to do it. I've put my reputation on the line of trying to fix this, and that's what I get paid the big bucks to do, is to fix things. I understand that's the way it works. I'm willing to go out on a limb and tell you. I expect third quarter sales to be down, but I want to see an upward movement in that fourth quarter.
I know that's quick, knowing how hard it is to make changes sometimes, but that's where I'm focused, and that's what I'm going to continue to do.
This is Kriss. I pushed Dan a bit The revenues to build the house, the house of earnings. We've done well at building earnings over the period. Sales are an important part of the earnings for Aflac U.S. The premium income for Aflac U.S. is probably at least 25% first year and about 75% renewal. In Japan, it's not as big. It's a little less than 10% first-year premium, 90%-92% renewal. I need that growth in first-year premium to help grow the revenues overall if we're going to get earnings growth. That's why it's important to keep getting new sales and to keep pushing on new sales estimates and the like to achieve our overall financial objectives, which include growth in earnings per share.
Thank you.
Carol, we're coming up to the top of the hour, we'll have one last question, please.
Joanne Smith, Scotia Capital, your line is open.
I've always thought that those were the guys who had the biggest existing books of business.
Wait a minute. We didn't catch any of your question. You just came on in the middle. Start back so we can hear what your question is.
Okay. Can you hear me better now?
Now we can.
Okay. If my recollection is correct, my understanding of the state sales coordinators has been that they are the ones that have the largest historical in-force book, and that they're earning most of their money on the commissions that they're getting from that, and those aren't going away. If those state sales coordinators do not choose to take on the new position of market director, what is the outlook for those books of business? Is there the potential for them to move those to some other carrier if, in fact, they move to a different company as a rep?
First of all, their book of business is based on the people that work for our company. I was a state sales coordinator for 10 years, I understand it totally. No, you can't move it that easily. That won't happen. The other thing is, we have not had a single state sales coordinator not go for this new program. It's going to be the highest paid in the industry. They like it. There's a wonderful retirement where for your salary, we put up equal amount for retirement. They like it very much. They will become more of a manager than just a sales manager. They'll look at profits. They'll look at all aspects. I am very pleased with we had them sign confidentiality agreements, and we introduced it a week ago to just them in six locations.
We had them at the exact same time, took away all cell phones, everything, we are very pleased because we're pleased of what we're offering them. This is a great deal for them. It is a great deal for the company because we now can be a united front. We don't have 50 independent people running state organizations, or in this case, 65, going different directions. We will unite with the strongest brand that's out there in the insurance industry, and be able to push forward with what I believe will ultimately drive our sales. Again, I warn you the third quarter, the fourth quarter and going forward, I am been in sales, it's in my blood, and I just think we can do this. We'll wait and see, but that's the way I look at it now.
Okay. Dan, just as a follow-up real quick. The fourth quarter, you're looking for an uptick. Is this something that you think this is not a major change that would be disruptive for an extended period of time. Is that what you're suggesting? That people are on board, that now they're going to be directed towards what the overall objective of the company is, which is to bring in the sales of the core small business employer for some of these agents that are not going after the large cases, et cetera. You think that this is something that can get implemented, and it could be back to business as usual by fourth quarter, and we should start to see some improvement then?
One reason I'm optimistic about an uptick in the fourth quarter was it was such a rotten fourth quarter last year. I didn't like our sales last year, that's the reason that I'm encouraged about that. I don't want to be too optimistic in terms of it not being somewhat disruptive. Remember, all these people are used to being independent contractors, it's a change of the way they've operated. We think that we can mold the way we're going to do it in a way that they're going to like it, and it'll be less disruptive for them. Anytime you change jobs, and this is a change in job, there is some disruption. I think the districts making higher money in between is going to help offset the disruption because here these districts are, as we're announcing this, making more money.
They need to be out there selling because we've only guaranteed it through the end of the year. Although I hope we'll possibly continue it if it works. While we've got this disruption at the state level, we've got this enormous positive thing happening at the district level, which I think will help drive sales. That's why I'm encouraged, but look, I'm an eternal optimist when it comes to sales. I don't want to overstep it, but as I said, I will be very disappointed if I don't see an uptick in the fourth quarter, and then going forward, I expect to see improvements.
Okay. Thanks very much, Dan.
Carol, I think we're out of time. If anybody wants to follow up with more questions, I or my colleagues will be available in investor relations, and thank you for joining us today. Goodbye.
This does conclude our conference for today. All participants may disconnect at this time. Thank you.