Welcome to the Aflac 2016 Outlook Conference Call. Your lines have been placed on listen only until the question and answer session. Please be advised today's conference is being recorded. I would now like to turn the call over to Ms. Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations. Ma'am, you may begin.
Good morning, and welcome to our 2016 outlook call. Joining me this morning from the U.S. is Dan Amos, Chairman and CEO, Chris Cloninger, President of Aflac Incorporated, Fred Crawford, Executive Vice President and CFO of Aflac Incorporated, Teresa White, President of Aflac U.S., and Eric Kirsch, Executive Vice President and Global Chief Investment Officer. Also from Tokyo, joining us today is Paul Amos, President of Aflac, Hiroshi Yamauchi, President and COO of Aflac Japan. 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're prospective in nature. Actual results could differ materially from those we discuss today.
We encourage you to look at these quarterly earnings releases for some of the various risk factors that can materially impact our results. Now, I'll turn the program over to Dan, who will begin this morning with some high-level comments and outline of the company's strategic vision. Paul will provide the strategic focus for our Japan operations and outlook. Teresa will give an update on the U.S. strategy and focus. Fred will follow up with comments about our capital management strategy and financial outlook. Dan will follow up at the end. Dan?
Good morning, and thank you for joining us. Many of you probably heard me speak about the importance of the promises that we make to our policyholders and being there when they need us most. Today, we're going to share with you our outlook for 2016. Before we do, I'd like to share Aflac's Strategic Vision: to offer high-quality voluntary products, solutions, and services through diverse distribution outlets. In doing so, we are ultimately building upon our market-leading position to drive long-term shareholder value. At Aflac, we've always managed our business for the long term while maintaining a sharp focus on the financial objectives. At the same time, we continue to work on enhancing our customer service and building our book of business.
In doing so, we've successfully established strategic points of leverage in both Japan and the U.S. that we will use to grow and drive shareholder value. Our industry-leading market share and scale in both Japan and the U.S. drive our administrative efficiencies. This allows us to offer affordable and value coverage to our customers and competitive compensation to our distributors. At the same time, it drives value for our shareholders. Leveraging our leading position in both countries will help position us for growth going forward. As product innovators, we've experienced a tremendous amount of success in leveraging the strength of Aflac's recognition and powerful brand to drive sales. About 9 out of 10 people in both countries recognize the Aflac brand. Our brand is a combination of many elements, with the most visible being the Aflac duck.
It's also made up of trust that we build through relationships with businesses, the policyholders, and consumers. In Japan and the U.S., Aflac's established brand has served as an effective door-opener. In turn, this serves as a catalyst for customers to be more receptive to hearing how Aflac's products can help them. As just one example, in the U.S., One Day Pay, our industry-leading claims initiative, allows us to process, approve, and pay eligible claims in just one day. Our policyholders and consumers continue to tell us how our commitment to paying claims fast through One Day Pay underscores Aflac's integrity and commitment to delivering on our promise. Having diverse and productive distribution channels is a strategic point of leverage and a vital component of our growth strategy in Japan and in the U.S.
This is one area that we focused a great deal of our efforts. Our goal is to have a presence in all outlets where consumers in both countries want to make their insurance purchase decisions. We offer innovative products and high-quality customized service to provide businesses and their employees with solutions that protect financial well-being. We've established a strong capital position with stable earnings and cash flow. Our capital ratios demonstrate our commitment to maintaining strong capital levels and flexibility on behalf of our policyholders, bondholders, and shareholders. We also regularly assess our capital adequacy to ensure we maintain strong even under economic scenarios. Now, let me turn the program over to Paul, who will talk about Aflac Japan. Paul?
Thank you, Dan. Japan faces the unprecedented challenges of keeping its economy running against the backdrop of social change and reform. As you are aware, the Japanese economy has recently dipped into a technical recession. At the same time, Japan's government is under increasing financial strain to support a growing number of retirees. Given Japan's aging population, declining birth rate, and rising medical treatment costs, the healthcare system has been under increasing financial pressure. These factors present an opportunity. As health-related expenditures continue to grow, so does the need for insurance across all ages, especially the type of products we offer, insurance for daily living. We believe Aflac's products are more vital than ever before, and we are committed to being there for our policyholders in their time of need. Another factor of social change in Japan relates to Womenomics, or the increased participation of women in the workforce.
Womenomics represents the primary way the government is attempting to address challenges of a shrinking workforce. At Aflac Japan, diversity management is an integral part of our overall management strategy. For example, last year, we implemented a comprehensive leadership initiative called the Women's Empowerment Program, and we are working to raise the percentage of leadership positions held by women. Research from various sources, including McKinsey & Company, has proven that diverse organizations deliver better financial results, which will impact both Japan's economy and continue to help Aflac Japan. Turning to the third sector market, with many insurance companies seeing growth opportunities, the landscape remains competitive. While the number of competitors has decreased, medical product competitiveness is on the rise with an increasing variety of products that have shorter life cycles. At the same time, the ongoing low interest rate environment has created changes in the first sector marketplace.
Amid this evolving market environment, Aflac is determined to maintain and further expand its position as the leading insurance company in Japan's third sector market by providing solutions for our policyholders as they face a heavy financial burden related to healthcare costs. In 2015, Aflac Japan significantly expanded its third sector product sales and distribution. Notably, we've strengthened our relationship with Japan Post Holdings. With respect to third sector products, you'll recall at the end of 2014, Aflac Japan introduced the latest version to our cancer product line, New Cancer DAYS, and its strong momentum continued into 2015 across all distribution channels. In June 2015, we enhanced our EVER Medical Insurance with the introduction of riders related to critical illnesses. As we have experienced in the past, the launch of these two significant products served to boost sales in 2015.
We anticipate that in 2016, the new product schedule will focus on product refinements, including the potential to enter a new area of the third sector market. In terms of first sector products, the market is further segmented as level premium protection-oriented products are largely sold in traditional channels, and lump sum savings-oriented products are popular in the bank channel. We are refining our approach and will concentrate on level premium products for cross-selling and stability of returns. The goal is to split the sector into those products that we want to sell based on their characteristics, profitability, and limited capital strain. The low interest rate environment has impacted our view on selling first sector products, and the action we took in 2012 in terms of limiting the sale of WAYS, for instance, was the right path for us to take.
Going forward, we believe the sale of level premium products not only enhances the sale of third sector products through cross-selling, but importantly, the product profitability of these level premium products is more stable with returns that exceed our cost of capital and benefit from the cross-sell of higher return third sector products. Given the very strong sales growth in the first nine months and our expectation for the remainder of the year, we now anticipate that 2015 sales growth for third sector products will be at the high end of the 10%-13% range. The successful launch of two products in the cancer and health lines creates difficult 2015 sales comparisons. As such, we anticipate third sector sales in 2016 will be down mid-single digits.
While these results from 2015 create a tough comparison, we are looking to drive a compound annual growth rate for third sector products in the range of 4%-6% over the long term. We believe that a continued revision and expansion of our third sector product line will aid in achieving this objective. With respect to first sector sales, 2016 will be a year of transition, making specific guidance more challenging. We expect our proactive approach will drive lump sum product sales down considerably, while level premium product will essentially track third sector sales down modestly during the year. Recognizing we have an Aflac policy in one out of four households in Japan, we pay careful attention to the social change and have a track record of developing products and solutions to meet the evolving needs of our customers.
Thank you. Now let me turn it over to Teresa White, who'll be covering Aflac U.S.
Thank you, Paul Amos. I'd like to begin by sharing some highlights of what we're observing in the U.S. market, much of which has been impacted by the Affordable Care Act or ACA. We continue to see employers opt for high deductible health plans to reduce expenses associated with offering employee benefits. Although small employers, meaning those fewer than 50 employees, are not required to offer major medical, they continue to look for ways to assist their employees with health coverage. In addition, mid to large employers are still overwhelmed by the regulatory aspects of ACA. These employers are seeking ways to make coverage affordable while at the same time reduce the administrative burden of the regulations. Nevertheless, workers continue to look to employers for healthcare solutions, especially since 52% of U.S. workers can't even afford $1,000 in out-of-pocket expenses.
This dynamic has caused many brokers to look to voluntary to help their clients fill gaps brought by high deductible health plans. From a competitive standpoint, the U.S. market remains very dynamic and has been subject to continual change. Group players are entering the voluntary market by either shifting some of their employer paid offerings to voluntary or creating voluntary products of their own. The ACA has introduced new rules and greater complexity, especially in HR processes, which has led to an increased administrative burden to the employer. In response, this has prompted a renewed focus on technology to help with decision support, HR benefits enrollment, and to help employees to navigate the complex healthcare systems. This environment creates additional opportunities for Aflac, which leads me to our strategic playbook for 2016.
As a backdrop, our goal in 2015 was to build out our two-channel distribution model more specifically by clarifying roles within each channel. Historically, these channels have competed, which created channel conflict. To manage this, we've leveraged the strength of each channel. We've been focusing our career agents on the smaller employers, since they typically enjoy the most success by serving employers with less than 50 employees. Here we're using Everwell to drive growth, and I'll talk a little bit more about this in a few minutes. For the mid to large case market, we're attracting more brokers than ever before. In fact, the strong performance in many of our successful market operations is due in part to increased collaboration between brokers and career agents.
We've made great strides and now have one of the more dynamic value-add distribution models in the industry, which gives us the potential to be unstoppable. Looking to 2016, we'll continue to focus on enhancing the productivity of our sales distribution. The Affordable Care Act has opened up two opportunities for Aflac to fill gaps created by the high deductible health plans. First, gaps in ACA coverage have allowed us to position Aflac products alongside major medical as a holistic solution. Everwell allows our agents to take a consultative approach to offer this comprehensive solution of major medical and voluntary products to the small case market. Therefore, we'll continue to focus on recruiting career agents, training them, and promoting the use of Everwell to support growth in this segment.
In addition, as more brokers have entered the voluntary market, we continue to deepen existing relationships with our broker partners who serve the mid to large case segment by providing tools and services to support broker needs, such as proposal management tools, improved underwriting systems and enrollment integration. As Dan mentioned, One Day Pay will continue to be a key differentiator for us, especially as some of the major medical players have entered the voluntary market. Despite these new entrants, we believe One Day Pay, our industry-leading claim initiative, stands out to consumers because it gets cash in the hands of those consumers when they need it the most. We'll continue to promote One Day Pay to the consumer as we feel that this will help drive increased brand loyalty and account penetration.
Lastly, as the voluntary market continues to grow with the broker channel group products growing at a faster rate, scale and efficiency will become increasingly important. Although we have made some investments in our platform to support our broker partners, we need to make additional technology investments to support continued growth while enhancing persistency and efficiency of the business. Looking ahead, keep in mind that as our production through brokers grows, we anticipate sales will be increasingly concentrated in the fourth quarter, more specifically, the last four weeks of the year. In addition, this is the first full year in which the broker sales forecasting model has been in play.
We continue to believe that we're on track to meet the lower end of the 3%-7% range in U.S. in 2015, and we're assuming that all the enrollments that are expected will proceed as planned at the end of the year. As we look to 2016, we believe sales will increase in the range of 3%-7%. The voluntary worksite market is currently projected to grow at 5% over the next three years, and as you know, we won't be satisfied until we're growing at or above industry rate. Thank you, and now let me turn the call over to Fred.
Thank you, Teresa. Let me start with a few of the key areas we are focused on in terms of financial management as we enter 2016. We continue to execute on our general account investment strategy, expanding into new asset classes and mandating external managers where we lack the expertise. In terms of core asset classes, we added middle market loans over the last year and are in the process of building out a commercial loan portfolio and will initiate a modest investment in equities in the next few weeks. Additionally, in the coming years, we will take a measured approach to adding growth assets, which include public and private equity, hedge funds, and other alternative asset classes that are both consistent with our liability structure and industry practices. This is a slow ramp-up with growth assets expected to reach roughly $3 billion in 2017.
We expect these new asset classes will add significant excess investment income in the long term, recognizing we will incur near-term expenses during the building process. In terms of risk management, we are working to reduce potential volatility in Aflac Japan's regulatory solvency margin ratio, or SMR, which is sensitive to interest rates, spreads, and exchange rates. Reducing volatility allows for greater clarity in identifying excess capital, improves consistency and free cash flow generation, and ultimately drives a lower risk profile and cost of capital. Measuring our excess capital position includes a block-by-block assessment of the regulatory reserves in Japan and associated reinsurance capacity, testing regulatory capital measures under stress conditions, and comprehensive economic capital analysis. We have successfully used reinsurance in the past to unlock excess capital in Japan.
We also believe excess capital exists in the U.S. when considering the stability and low risk profile of our business model. Importantly, we do not see any change in our core principles surrounding risk and capital management. In accordance with our risk appetite, we will maintain strong SMR and RBC ratios at a minimum range of 500%-600%, leverage at or below 25%, and hold roughly $500 million in excess capital and liquidity at the holding company at all times. Deployment priorities include supporting our dividend growth track record and a bias towards repurchasing our stock absent compelling alternatives. Turning to slide 17 and a discussion of assumptions underlying our 2016 earnings drivers, we expect stability in our core margins. Consistent with comments on our third quarter earnings call, we expect premium growth rates in the low single digits, supported by stable persistency and our sales outlook.
Note that Japan premium is somewhat impacted by the combination of reinsurance, the effect of limited pay products reaching paid-up status, and steady decline in first sector sales as we further refine our strategy. I would note that while limited pay product is a headwind to premium growth, it has no impact on profitability as we release a deferred profit liability into earnings. Net investment income, primarily in Japan, is expected to decline by roughly 1%-2% in 2016 as a result of calls and maturities of private placement holdings. New money will be reinvested according to our strategic asset allocation, though at lower rates due to lower market yields. Arguably, will reinforce our strategy of having a more diverse and higher quality portfolio as we remain cautious on the go-forward credit environment.
We expect core benefit ratios to remain stable and consistent with our generally favorable experience thus far in 2015, and relative to our forecasted long-term ranges discussed at our May financial analyst briefing. In Japan, we anticipate continued strong claims trends in our cancer block in particular. In the U.S., expense ratios are up modestly as a result of investment in overall IT, group administration, and Everwell platforms. Turning to slide 18, we expect overall capital conditions to remain stable, are keeping an eye on credit conditions. We have seen the early signs of a credit cycle, with spreads widening in recent months and downgrades modestly outpacing upgrades. We expect to maintain our SMR and RBC ratios in the mid to high 800% range, subject to market value changes.
Our SMR ratio is sensitive to rates and spreads, with a roughly 220-point volatility provision that recognizes the unrealized gains in our AFS portfolio and the potential for stress conditions. Leverage will remain in the 23%-25% range, and we expect to prefund approximately 1 billion of maturities prior to coming due later in the year and early in 2017. We have revised our plans for repatriation in 2015 and now expect to repatriate an additional JPY 60 billion this month, which represents the remaining capital released from our 2015 reinsurance transaction. The December repatriation and associated statutory dividends to the holding company support our $1.4 billion of targeted repurchase for 2016, front-end loading roughly 1 billion of our repurchase in the first half of the year. Note that our 2016 repatriation estimate does not currently assume any reinsurance and represents a stable repatriation of after-tax FSA earnings.
We have reviewed in detail our 2016 and three-year excess capital position and remain comfortable with a deployable capital range of $6.3 billion-$7.5 billion through 2017. The lower end of the range, consistent with our organic free cash flow, and the range itself representing additional deployable capital we believe is embedded in our Japan and U.S. businesses. Finally, I'll close with my comments on specific EPS outlook and a few thoughts on driving long-term valuation. We expect stable growth in EPS in the 3%-7% range, excluding the impact of currency movement. As a basis for our growth rate estimate, for 2015, we assume the midpoint of our $1.36-$1.56 EPS range for the fourth quarter and normalized for a net $0.05 of positive items called out in our earnings releases during the year.
We provide specific EPS guidance and sensitivities to the yen, which remains largely consistent with our third quarter disclosures. We estimate that every one yen move on the annual average exchange rate will equal an approximately $0.025 per share impact on next year's earnings. ROE is expected to remain in the 18%-21% range, excluding the impact of currency. Our cost of capital is among the lowest in the industry, benefiting from low exposure to more volatile and capital-intensive equity market and interest rate sensitive retirement businesses, transparent profit margins, and generating yen cash flows, which allows us to borrow in yen at very low rates. In addition, we believe our work in recent years to reduce concentrated and potentially volatile exposures in the general account have also contributed. Our financial playbook for creating value is straightforward. Defend attractive margins in our core supplemental health businesses.
In Japan, allocate capital away from more volatile return and capital-intensive businesses to stable businesses that earn comfortably above our cost of capital. Invest to improve service and efficiency in our fast-growing U.S. brokerage and group business. Manage the risk in our investment portfolio on associated SMR volatility. Finally, identify idle or excess capital for future deployment at higher rates of excess return or returning back to shareholders. With that, I'll turn the call back over to Dan for some closing comments.
Thank you, Fred. I want to close with some thoughts that should be top of mind as we look to next year. Everything that you've heard today is designed around growing our franchise, protecting policyholders, and ultimately driving shareholder value. In Japan and the United States, we dominate our market, and we plan to keep it that way. Aflac Japan, the leading provider of third sector products, will be focused on new product innovation in the third sector market. While we expect sales of first sector products to decline in 2016, those first sector products we do sell will encourage the cross-selling of third sector products. Aflac U.S. is concentrating on leveraging our brand to fuel our growth and benefit our distribution channels while investing to enhance customer experience and efficiencies.
To follow up on Fred's comments, our goal is to achieve stable EPS growth while also investing in the business to drive future growth. When it comes to dividend increases, we belong to an elite club. This year marked the 33rd year of increasing our cash dividend. In addition, by the end of 2015, we expect to have repurchased $1.3 billion of common stock and plan for a modest increase in 2016, absence more compelling opportunities. I want to reiterate what we said at the financial analyst briefing in May. We still believe there's an opportunity to deploy approximately $6.3 billion-$7.5 billion in capital when looking at a three-year period ending 2017. We will continue to evaluate all options when it comes to deploying capital and growing the business. As in the past, we remain disciplined.
I've already heard me say that my job is to balance the interest of all stakeholders. I think we did a good job of that this year, just as we did in the past, and I believe we're going to do it again next year by delivering on our promises to our policyholders and ultimately enhancing shareholder value. I'll turn the program back over to Robin. Robin?
Thank you, Dan. We're ready to take your questions. First, let me remind you that to be fair to everyone, please limit yourself to one question and only one follow-up that relates to the initial question. All right, we're ready to go. We'll take the first question, please.
Thank you. The first question is coming from Mr. Jimmy Bhullar from JPMorgan. You may now ask your question.
On Japan sales, and I thought your guidance of sales, I think you mentioned down in the mid-single-digits seemed slightly more conservative than what I would have assumed. A big part of your growth in 2015 has been through the Japan Post, where you continue to add new branches. I would have thought that that would have provided a tailwind to sales. Maybe if, Paul, you could give us a few more details on what's behind your expectation of a mid-single-digit decline.
Sure, Jimmy, be glad to do that. First and foremost, if you look at 2016 in comparison to 2014, we're moving along exactly where we originally expected. The reality is that 2015 came in significantly higher than we expected. As you recall, I think we originally had a range of between 1% and 5% for this year, and we've moved that up on several different occasions, and we now expect to hit the top end of that
to 10% to 13% range. 2015 has been a year where we feel we've outperformed our expectations. We do expect to grow long-term at a 4%-6% CAGR, and we expect that to be onward and moving upward. At the same time, we also acknowledge that our product cycles have an effect and impact on our annual sales. We've had back-to-back years where we've launched our new cancer plan, as well as some revisions and new riders to our medical plan. This coming year, we expect there to be some product revisions, we do expect that we could potentially enter a new segment of the third sector market. Anytime you go into a brand-new product, that can create a circumstance where you have to create that market, and it can take a period of time to do so.
We feel that we're setting ourselves up for the long term. It does mean the potential for sales being down slightly, we still feel that we're making the right decisions for growing our sales long term in the compound annual growth rate that we previously mentioned.
Okay. If I could ask just one more of Fred. You mentioned that your guidance doesn't assume anything in terms of reinsurance deals, what are you looking at in terms of whether you decide to do additional reinsurance deals in 2016? If you do do them, what do you view as the most likely use of the capital?
Yeah. Thanks, Jimmy. I think a couple things about releasing additional excess capital, particularly in Japan where we've done it before, is as you know, what we're doing there essentially is through reinsurance, we're unlocking the difference in regulatory reserves relative to Japan and U.S. and freeing up that capital. In some cases, we retain that capital to support our SMR ratios. That's being done on a block-by-block basis, as you know, so it requires assessing each block. As you move forward and look at additional blocks, the level of complexity increases. Depending on the block of business, you may even see pricing differences, i.e., reinsurance getting more pricey.
The reason I point out that complexity and some of the pricing is that it really goes to the main motivation, which is if we're going to go in and unlock additional capital, we want to make sure that we can generate very attractive returns on the deployment of that capital. I view that exercise of unlocking excess capital over and above our free cash flow as somewhat opportunistic. We want to see good, attractive excess returns. Now, that may be in the form of buying back our stock, it may be other opportunities, and we want that optionality to look at it. The key is it's available. It's available for defensive measures. It's available to reinvest back in our model. It's available to take advantage of opportunities. The key is driving excess capital with that release.
Thank you.
Thank you. The next question is coming from Randy Binner of FBR. You may now ask your question.
Thanks. I was hoping to follow up on the new third sector product commentary. Is there any help you can give us on understanding what that might look like?
Unfortunately, Randy, we can't comment on that at this time. All I can tell you is that we continue to look at third sector products because of their product characteristics, the strong profitability, and we would be looking to enter a potential product there, but we have to work with our regulators as well as finalizing that product. We'll look to hopefully launch that sometime in 2016.
Okay. Sticking with sales, on the U.S. side, the range of three to seven, I guess, is pretty wide, what would have to happen, I guess, for you to hit the high end, the 7%? Can you walk us through what all needs to go right for that to happen in 2016?
2016 range, I believe I meant to say three to five.
Okay.
I mustn't have said 3 to 7, but the slide deck has the appropriate number, but it's 3 to 5. The changes that we've made with the distribution, and the growth that we're seeing from a broker perspective, we believe as we continue to mature, our market offices continue to mature, that we will be on track with meeting the high end of that range.
Let me make a comment about U.S. sales. I don't think our biggest challenge is external. I believe it's been internal. One thing I think Teresa's done a stellar job of is we've got two now separate distribution channels. You go back 4 or 5 years ago, we really only had one, and that was our field force, which is very important to us, and it's still the foundation on which everything's been built. As we're writing the bigger accounts with the brokers, in the past, there's been real conflict, and what we tried to do is to bring them together as one and use our field force, in certain cases, to help with the enrollments, and it's working out quite well. The easiest thing we could have done would to have had two separate companies, kept them totally apart.
The problem was everybody wanted the Aflac brand, we couldn't separate them. Everyone wanted it, we brought them together, which has created internal conflict over the last couple of years. It is much, much better, and I give Teresa and Andy and everyone else credit for helping that come together. It is still, it's been years of competitiveness, let's call it. It doesn't just go away overnight. You have to work through it, as you all know. That's one of the challenges. As we continue to make and show examples of people working together and writing big accounts, it's going to only open the door.
As we are driving our new associates and others to writing the 100 or less, which we've been working on for a couple of years, as we work on getting the big accounts to be written with the large brokers through the group platform, that continues to work well. The area that's still the conflict is the 100 to about the 1,000 accounts.
Those are the ones that we deal with. As we work through that, I think the opportunity for future growth is tremendous. Again, I give Teresa credit for fighting that battle because it isn't an easy one because they've been in a competitive environment since inception of the company. I do think it's coming together. Watch out when it does, because that's when you'll see the growth.
Thanks. Just one more on U.S. sales, and sorry if I missed it, but how significant is the Everwell piece of that? Because most of what you're talking about is kind of the traditional sales organization and the changes that have been made there over the last year. Would Everwell, if you were going to hit the high end of the 2017 sales guide, it does maybe if that was higher, does that become more material then?
Absolutely. Everwell becomes very material. One of the things that we're seeing with our adoption of Everwell, and especially during the pilot, we see a 40% increase in penetration when people utilize Everwell. It positions us quite nicely with the Affordable Care Act, where we have major medical and the high deductible health plans being presented alongside voluntary. It gives the small case market something that they've not had, which is an opportunity to shop for their coverage on one exchange that allows them to see voluntary and major medical.
All right. Thank you.
Thank you. The next question is coming from Jay Gelb of Barclays. Your line is now open.
Thanks, good morning. I want to turn back to slide 17, if we could, the key assumptions on earnings drivers. I'm trying to understand the comment that Aflac expects current benefit ratios in the U.S. and Japan to benefit from favorable claims trends, but at the same time, it looks like the benefit ratio 2016 relative to 2015 is going to be largely unchanged.
Yeah, what we're saying there is if you go back to FAB, the FAB meeting this year, I'd call your attention to some of the long range ranges or long-term ranges that we put in for benefit ratios, both in the U.S. and Japan. What you'll notice is that year to date in 2015, we've been tracking in a fairly material way at the favorable end of those ranges. Really what we're saying in our 2016 projections is that relative to our year-to-date performance, we would expect to move forward with continued favorability. Now it moves a little bit from what we're seeing year to date, but realize how much more favorable it is relative to our FAB guidance. For example, our guidance on U.S. benefit ratios at FAB was 50%-52%.
We've been year to date tracking very low at roughly 48%, and we're suggesting 47%-49% as the range. That's really what I mean by that comment, is a continuation of what we believe to be really favorable or net favorable performance in 2015.
All right. Thanks for clarifying that. On the Japan Post opportunity, I guess following up on an earlier question, I would have thought that that would have continued momentum into 2016. Am I thinking about that the wrong way?
Unfortunately, we cannot comment on Japan Post. I can tell you that we continue to be very happy with the relationship. We continue to succeed in not only the implementation of the 20,000 post offices, but the use of the additional product as well as the Aflac core product through the sale of that channel, along with selling through combo insurance. All three of those continue to meet or exceed our expectations, and we're happy with what's happening there. At the same time, we can't give any comments on specifics or numbers related to our Japan Post relationship.
All right. Thank you.
Thank you. The next question is coming from Eric Berg of RBC. Your line is now open.
Thanks very much, and good morning. In Japan next year, you've indicated that you plan to focus at least on the life insurance side, if I understand your comments correctly, on level premium as opposed to the single premium. To me, this sounds like permanent life insurance and that you'll be going head to head against companies whose brands in this area, namely the largest career agent-oriented companies in the country, whose brands are as strong as yours are in that corner of the market. My one question is twofold. One, what is Aflac's history in successfully selling level premium first sector products? To what extent have you done them, and to what extent have you been successful?
Why should we think that given the different competitive nature and the relative less strength of your brand in the first sector market than the third sector, that you can be successful?
This is Paul. Eric, let me say that our exclusive agencies have always been offered a well-rounded product portfolio that was, of course, driven first and foremost by third sector products, beginning with cancer and now medical, but also with first sector products, both lump sum and level premium. As I have said on several calls, we have made a commitment to continue to offer those to our exclusive agencies, all forms of those products, because we believe that is what's necessary for them to be competitive in the marketplace and part of their commitment to us by providing us the exclusivity of only offering Aflac products. What we are saying, however, is that in the highly competitive bank channel and other markets, when it comes to lump sum premium products, we believe we want to significantly de-emphasize those products.
We're taking measures in order to continue the decline in the sale of those products. We have seen such a high cross-sale ratio between our level premium first sector to our third sector products by our associates and other traditional channels, that we believe that selling those products is not only an enhancement because it exceeds our cost of capital, but it's also an enhancement because it drives the additional premium at the higher profit margin that we're achieving through the third sector sale.
If I could just get one in quickly, actually, for Teresa, and it is this. I have always looked at your regularly reported tally of producing agents because I've just viewed that historically as an important indicator of the future of sales. Those numbers have not been going in the right direction. They've been declining in the United States for some time. As we look forward into 2016, whether you, Teresa, Dan, or whoever feels appropriate to answer this question, will the count of producing agents be as important in terms of understanding Aflac in the future as it was in the past? What should we expect for this census, this count of producing agents? Thanks.
Eric, this is Teresa. One of the things that I've discussed in the past is how the bifurcation of the model, creating the career agent distribution and then separating it from the broker distribution will, I think, help you in doing exactly what you're attempting to do. One of the things that we've done this year is we've started to separate those. Yes, we will continue to drive career recruiting. Today, that number is a holistic number that represents career recruiting and brokers. What we wanted to do is we wanted to separate those numbers, and I believe in 2016, that's the plan. Robin's shaking her head yes. That's our plan for the briefing go forward. We had this year where we basically had to settle in and get everybody in the right bucket. From there, go forward, the plan is to continue career recruiting.
You've heard me express from a broker perspective, deepening the relationships with our current existing brokers. We will continue to grow our broker relationships, but quite frankly, what I wanted to concentrate on in 2015 and in 2016 is deepening the relationships that we have with our current broker partners. We have a number of broker partners out there that we're not selling a lot of Aflac insurance. I think there's tremendous opportunity there, that's the plan.
Thank you very much.
Thank you. The next question is coming from Mr. Seth Weiss from Bank of America Merrill Lynch. Your line is now open.
Hi, good morning. Thank you. I'd like to follow up on the discussion around margins. Could you clarify exactly what the dynamics are that are going to lead to, again, beneficial experience in 2016? Maybe more specifically, what it is you're expecting that changes in potentially 2017 and beyond that causes that to come back down to the margin ranges that you gave earlier this year at FAB?
Sure, Seth, it's Fred. A couple things. In Japan, what we're seeing is really predominantly a continuation of the favorable experience we've been enjoying really in the cancer block of business. As that continues, we would expect that to generate the lower end of the benefit ratio. If you recall back to our third quarter discussion, you have a couple dynamics going on there. Not only do you have favorable claims dynamics due to hospitalization rates and other issues that are trending in Japan, you also have to constantly review and look at your reserving dynamics as well, IBNR and the like. It's not uncommon for us to see quarter-to-quarter benefits from both the trends and the review of the reserves, particularly year to year. That's really what's driving Japan.
Otherwise, we see relative stability across the other lines of business in terms of benefit ratio, including first sector, which as you know, carries naturally a higher benefit ratio and lower expense ratio. In the U.S., it's really a general continuation of good performance. Nothing unusual spiking out in 2016, just an overall continuation as we track that business. I think the bigger mover to pay attention to in the U.S. as it relates to margins is actually the expense ratio. As I noted in my comments, it remains a little elevated, about 100 basis points or so elevated. That's actually predominantly due to what Teresa commented on in terms of our proactive need to invest in both IT, automation, and end-to-end administration around our fast-growing broker-driven group product sales.
That is really a proactive decision on our part, which adds about 80 basis points to our expense ratio, but obviously has very tight return on investment characteristics with it as we roll forward. What I would comment on in terms of 2017 and 2018 is we'll obviously refresh all of our margin views at this year's FAB and roll forward a three-year look. Yes, at the moment, we're sticking with the current ranges that were discussed earlier in the year. Obviously, as we go quarter-to-quarter and year-by-year, we'll continue to review those trends and whether or not we expect them to stay around longer or deteriorate or improve.
Okay, thank you. Is it fair to categorize those longer-term trends that there's some conservatism built in, a cushion for that?
Sure. When we use the term favorable, what we're suggesting to you is that indeed they're running favorable to what we otherwise would have expected over a long run. That is true. We've been enjoying that in 2015. You've seen that in our results. As we sit here today, we think we are traveling on the favorable end of benefit ratios, both in Japan and in the U.S., and that should be noted. We're going to continue to monitor that for what we think is more sustainable going forward, or whether or not we would see some natural leakage. Keep in mind that when I think about these benefit ratios, these are still supporting extremely strong return on equity and return on overall IRR on all of our voluntary supplemental health businesses.
Great. Thank you.
Thank you. The next question is coming from Mr. Thomas Gallagher from Credit Suisse. Your line is now open.
Good morning, Fred. I wanted to discuss Japan revenues. I know you mentioned NII is expected to be down a bit.
You mentioned what you expect on overall margins in Japan. How about premium revenue growth in 2016 versus 2015?
Sure. A couple things, and then I will maybe add a little more color on the NII in the process too. In terms of Japan revenue, a couple things to be mindful of. I think it's natural for you to come to the table saying, coming off a particularly a year of very strong sales in the third sector, that we would see a little more robust growth in Japan revenue. We've got a couple things going on. One is math, meaning with the very, very large in-force size of our business that's generating in and around JPY 1.5 trillion a year of earned premium. When you have even the very strong persistency we enjoy, or roughly say 5% lapse rates, you've got to have one whole heck of a growth engine, if you will, to just keep pace with the natural lapsation.
For example, if you look at third sector, we would expect to see something in the way of 5% natural runoff or lapsation. That's on a 1.1 trillion JPY earned premium book. That suggests to you that your third sector sales engine alone needs to be doing much better than 55 billion JPY or 60 billion JPY in sales just to keep some growth rate going. Now, as you look more expansive, the good news is that Paul and his team have generated a very good engine. If you look at that chart, if you go back a couple years, the distribution platform was generating in and around 60 billion JPY to 65 billion JPY a year of new sales.
That engine now, even as we look forward to 2016, is now approaching a JPY 75 billion to as high as JPY 80 billion distribution engine. That's going to serve to help grow third sector earned premium in and around the 1.5%-2% range, would be my estimate. When you look at first sector, however, you got a couple things going on. One, naturally, you're going to see premium come down because, as Paul has outlined, we're refining our approach to it, moving away from lump sum. The other thing you have going on is, you also have some of the more limited pay product. If you recall back to this year's FAB meeting, we have limited pay product. When it reaches paid-up status, you'll see a more drop-off in the premium levels.
In fact, moving from 2015 to 2016, we're seeing about 30 billion JPY of drop-off just related to the paid-up status of these limited premium pay product. Now, again, remember, that doesn't impact profitability because we have a liability that we release into earnings, which keeps profitability constant, but it does pressure premium. When you think of the combination of reinsurance, which is now tailing off, we had reinsurance effect this year compared to next year, probably around 5 billion JPY or so of depressed growth related to reinsurance. If you look at that plus the first sector, plus the limited pay product now starting to reach paid-up status, all of those things are contributing to a muted premium growth rate in Japan.
Fred, just following you on that math with the 30 billion JPY drop-off, are we getting a point or two of a decline in premium revenue? Is that directionally close?
Yeah. If you just isolate first sector business, which runs about a half a billion yen a year in earned premium.
That just that paid up status is contributing to roughly a 1% decline year-over-year in the earned premium.
Got it.
That's 2016.
Got it. You said third sector is supposed to grow 1.5%-2%.
Is it fair to say then you'd still get kind of flattish to maybe modest growth overall then?
Well, as I said in my comments, we're expecting about 1% growth in premium overall.
1% growth. Got it. Okay. That's helpful color. I appreciate it. Just my follow-up is.
In terms of the product shift, moving away from lump sum sales of first sector, can you all remind us what % of Japanese sales this year in first sector were lump sum versus level pay?
I don't have that handy. I don't know, Paul, if you happen to have that handy or not.
We're looking for it right here. Give us just one second.
Thinking roughly a third.
A third would've been lump sum or a third would've been level pay?
A third lump sum.
A third lump sum. Got it.
If we need to correct that, Tom, we'll do that.
We'll look at it and verify that.
Okay. Thank you.
Really quickly, just looking at our projections just to verify, it's about half and half. It's split almost down the middle on a premium, on an AP basis.
Paul, and that roughly half of first sector sales, is that going to go to zero? Or is that just a substantial decline, but you'll still have some level of lump sum sales?
Still going to have some for a couple of different reasons, Tom. First of all, as I mentioned earlier when Eric asked, we're going to continue to allow our exclusive agencies to offer that lump sum product because they have to have it in order to be competitive. We are going to significantly change certain rates, in order to make that happen. At the same time, we also have commitments to the bank channel, those commitments tend to last six months at a time. We'll continue to see that happen through the first quarter of next year, because as you know, the Japan fiscal calendar begins April the first. We'll probably see a slower tapering in the first quarter with a faster tapering beyond the first quarter.
Okay, thanks.
Nicole? We're reaching the top of the hour, I think we have time for one last question, please.
Thank you. The last question is coming from Suneet Kamath from UBS. Your line is now open.
Thanks. Good morning. Question on Japan sales and the long-term target of 4%-6% for the third sector. It just seems like in recent years we've been experiencing really strong growth in a particular year when you've had a new product introduction, and then when you faced comps that were difficult in the subsequent year, have had less robust sales growth. I guess my question is, as we think about this 4%-6% long-term guidance and the shortening product cycle that the industry is experiencing, Paul, do you think that we can get to a point where you're generating 4%-6% third sector sales growth on a consistent basis?
That would certainly be the ideal situation. That said, certain products are going to have a higher level of attractiveness than others. The reaction to our cancer plan exceeded all of our expectations, and we certainly want to take that premium, and offer those products that exceeded our total sales number. What I would tell you is that one of the reasons we'd like to enter an additional product line in the third sector is we'd like to see a revision on an annual basis on a three-year cycle. If we had three core products in third sector with one product revision every year, that would put hopefully a smoother number for us in attempting to achieve that CAGR. That said, it's very difficult to predict market receptiveness, but that is the objective.
As I said, part of the reason this year that we not only face difficult comps, but in trying to launch a brand-new product, in an industry and with a sales distribution that tends to be slower to adapt new products as opposed to new product revisions, we're just trying to be mindful of that as we head into 2016 and think that we can prepare ourselves better for the longer term in achieving that CAGR.
I want to say something, Suneet. This is Dan. In the old days, I would have had a contest that started in the first quarter to shift some of the business from the fourth quarter to the first quarter to try to level it out. It was a conference call that we had with all of you where everyone said, "Get the business when you can, as quick as you can." We shifted back to getting the business as fast and as quick as we can. We felt like it's better to have the 13% now than if we'd have ended up with six and five, or whatever those totals might be the sum of. Ultimately, we were just trying to get it in. We could have made it more level by shifting the contest, not literally holding business, but just shifting things.
It is our outstanding production in the fourth quarter that's causing our problem for 2016. I just want to be clear on that.
No, that's appreciated. One quick follow-up on Japan. I know you can't give us any specifics about Japan Post, and I appreciate that. If I go back, Dan, to the relationship that you had with Dai-ichi years ago when you first started it, my recollection is that sales growth was quite strong in that first year, and then the relationship became somewhat of a drag on growth in subsequent years because even though you were generating new business, it wasn't quite at the level of that extremely strong first year. I guess my question is, directionally, should we think that Japan Post will be any different from that situation that you experienced?
The reason you should is with Dai-ichi Life, we hit it all at once. It's been rolled out in, Japan Post has been rolled out by over a period of years, not just one quick shot. Will it eventually slow down? Probably so, unless we come up with something else new, innovative that we can get together with them on. Let me just say that I give our relationship with Japan Post from what I thought it would be to where it is today, an A. That's all I can say about that. I think Aflac Japan and the leadership that Paul and Yamauchi, the sales force, all the people get an A on what's been going on.
Our relationship is stronger today with Japan Post than it has ever been, and I look for it to continue to be strong because it's helping not only us, but it's helping Japan Post, and it's helping the policyholders in Japan.
All right. Thanks, Dan.
Okay.
Thank you very much for joining us this morning. If you want to follow up with any information or any calls, please contact us in investor relations, and we'll be glad to take your call. Again, thank you for joining this morning. Bye-bye.
That concludes today's conference. Thank you for participating. You may now disconnect.