Our next speaker is Kriss Cloninger. Kriss has been CFO of Aflac since 1992, I think. We're glad to have him here. We're especially glad because he brought some ducks with him that you can take after. Kriss?
Okay. Thank you, Jimmy. It's great to be able to join you again this morning at the JPMorgan 2013 Insurance Conference. Although we believe our statements are reasonable, we can't give any assurance that they'll prove to be accurate because they are prospective in nature. Please review our annual report on Form 10-K for some of the risk factors that could cause some of our actual results to differ materially from those we discuss today. Aflac offers voluntary insurance products in the two largest insurance markets in the world, Japan and the U.S. Our policies cover more than 50 million people worldwide.
Aflac products provide a layer of financial protection against loss of income and assets by paying fixed cash benefits directly to an insured, primarily upon a specified health event or a life situation. Our strategy for growth in Japan and the U.S. has remained straightforward and consistent for many years. Aflac develops relevant products and sells them through expanded distribution channels, which yields new accounts and customers. Aflac's operations in Japan account for about three-quarters of our pre-tax insurance earnings. Today, we insure about one out of four households in Japan, and we're the number one life insurance company in Japan in terms of individual policies in force. Our third sector cancer and medical products have been and continue to be our pillar products and the foundation of our product portfolio.
Aflac Japan's ability to supplement its traditional product portfolio beyond traditional health-related products with other products such as WAYS, which is our hybrid whole life product, that strategy has helped us generate record sales in 2011 and 2012. For 2013, we plan to refocus our sales efforts on our traditional cancer and medical third sector products. Aflac Japan was represented by more than 18,000 sales agencies at the end of 2012, who employed more than 125,000 licensed sales associates. The number of agencies has decreased since the end of 2011, due in part to merging of some agencies. I would point out that the number of licensed sales associates has actually increased over that period. Our sales results have been significantly influenced over the past several years by our expansion into the bank channel, primarily due to the bank's focus on our WAYS product.
The bank channel generated about JPY 96 billion in sales in 2012, which represents an increase of 106% over 2011. That accounted for almost 46% of Aflac Japan's total new sales. More recently, we've responded to the evolving consumer environment through the launching of Aflac Consultants, which is a direct face-to-face channel specializing in consultative sales targeted toward the 20 to 40-year-old demographic. We believe that this distribution expansion gives us the opportunity to capture a segment of the market in which we were previously under-penetrated. We continue to believe that Aflac's distribution system remains one of the most efficient in Japan and represents a competitive advantage. Aflac Japan performed very well in 2012. For the third consecutive year, Aflac Japan generated record sales results. Our full-year sales rose over 30.8%, to JPY 210 billion.
Premium income increased 9.9% for the year, benefiting from the strong sales of our WAYS product. Aflac Japan's revenues in JPY grew by 9.4% for the year. Pre-tax earnings were JPY 312 billion, up 2%. For 2013, we expect Aflac Japan sales of third sector cancer and medical products to be in the range of flat to up 5%. Remaining the leader of third sector products has been and continues to be our priority in Japan. Achieving this target is a top priority for all of our management team, both in the U.S. and Japan. Following three phenomenal years of sales, we are repricing our more interest-sensitive products such as WAYS and Child Endowment on April 1st of this year.
While the discounted advanced premium, or DAP as we refer to it, will move from its current level of credited interest of one half of 1% back up to a full 1%, effective with the repricing in April. We believe our profitability on these products will increase significantly. During our fourth quarter earnings call, you may have heard us say that with these changes, we estimated that the profitability of our WAYS products would be in the range of 15%-20% of premium. This range was based on a new money yield for JGB's 20-year maturities around 1.75%. I would like to point out that we do expect the profitability of the WAYS products to more likely be in the high 20s using a more realistic new money yield outlook of about 2.5% for 2013.
Given the increased activities in the competitive landscape for investment-type products, we believe the sales of WAYS will be significantly lower in 2013 than in 2012. We expect to be able to give you some better insight into 2013 expectations when we release our first quarter results. With respect to Aflac's popularity, we've experienced a tremendous amount of success leveraging our strong brand in our efforts to drive sales. As part of these efforts, Aflac Japan has honed its ability to take the Aflac duck and to create separate and unique characters to market specific products. Most recently, we launched a campaign in Japan featuring a cat named Tama, that's famous throughout Japan, to market our most recent medical product they call More Gentle EVER. By capitalizing on the popularity of the Aflac duck and our more recent characters we've added, we've achieved brand awareness of about 97% in Japan.
We'll continue to look for new ways to connect with customers through the innovative marketing campaigns for our product line. Japan's population is covered by a universal healthcare system, but its citizens still have significant out-of-pocket costs associated with healthcare. As such, we believe the need for Aflac products will only continue to grow. Given Japan's aging population and declining birth rate, this national healthcare system has been under great financial strain, and co-payments for salaried workers under 70 have grown to 30% of the cost of medical treatments. However, as fiscal resources are tight in most areas of Japan, including medical, nursing care, and pension areas, it's clear that the difficult fiscal situation will persist going forward in Japan. As you can see, the growth of medical expenses is significantly outpacing GDP growth.
Because of the rapidly aging population and the higher co-payments for medical expenses, the market for medical products has been steadily increasing, and this trend is expected to continue. We believe we can expand our leading position as the medical market continues its growth in the future. Now let me turn to our Aflac U.S. operations. As you may know, in the United States, we primarily distribute our voluntary insurance products at the worksite on a payroll deduction basis. Our Aflac U.S. product portfolio includes a variety of voluntary insurance products designed to pay cash directly to policyholders when a serious medical event presents financial challenges. These payments are made regardless of any other insurance a policyholder may have. Our group products align well with our individual product line and give us the ability to customize our product offerings for the brokers who typically sell to the larger accounts.
It's important to leverage the brand and to offer a choice to accounts of all sizes. This is especially relevant because now more than half of the voluntary insurance product sales in the United States come from group policies. Aflac's strong brand and market leader status only serves to broaden the appeal of our products to consumers throughout the United States. We've built a diverse yet focused product line that's sold through a broad distribution network of over 76,000 commissioned sales associates. Additionally, although it's in the early stages, we're expanding our relationship with large national brokers to access the larger case market. We believe our distribution network is a competitive strength that no other company has been able to duplicate. Our strategy and competitive strengths are all designed to leverage the brand while providing valuable products to consumers.
For the year, total new annualized premium sales were roughly flat, increasing eight tenths of 1%. However, I'd note that premium income increased 5.4%, reflecting a much improved policy persistency. Aflac U.S. has experienced better than expected top and bottom line growth for the year, but sales remain challenging. For several years, small businesses have remained cautious and even skeptical about their future, and in turn, making new expenditures. This has led to limitations or freezes in hiring new employees for many of these smaller employers. Given that about 90% of our products are sold at these small businesses who've been hit the hardest, employment levels have negatively impacted our universe of potential policyholders, which has been a big challenge for us.
While we can't control the challenging economic environment in the U.S., we certainly can position our business to maximize the potential for success in the current environment. We've continued to improve the structure of our marketing and sales areas to maximize our future growth. Taking all this into account, we expect Aflac U.S. sales for 2013, through our traditional and broker channels, to be flat to up 5% in terms of new sales growth. I'd point out that for the first quarter, we wouldn't be surprised if sales are actually down slightly, taking into account that the first quarter of 2012 was our biggest percentage increase for the year. With our strong brand, consumers are more receptive to hear how Aflac products can help them. This opens up greater possibilities for our traditional sales force and broker channel alike.
We continue to believe that the U.S. represents a vast opportunity for growth, we're building our business with that potential in mind. This slide shows the most recent data from the U.S. Small Business Administration. The United States has more than 5.7 million businesses with fewer than 500 workers, and these small businesses employ more than 56 million people. While our focus has been on the smaller employers, we're expanding our reach from connecting with primarily small businesses, more to businesses of all sizes. Our portfolio of group and individual products provides consumers with outstanding value while giving the employers the choices they demand. As a result, the Aflac brand outshines those of our competitors in both the individual and group voluntary markets. Beyond just name recognition, it's important that consumers associate the Aflac brand with paying claims fairly and promptly, just as we promised.
Given the importance of PPACA, or the Patient Protection Act, otherwise known as Obamacare, we believe that 2013 will continue to be a period of uncertainty. That's because businesses and employees are trying to understand how the PPACA will affect them and what their options are. We believe that Aflac's strong brand will be even more important in this period of transition as businesses and consumers look to do business with a company that has a solid reputation. With our trusted and well-recognized brand, we believe we can be there to protect those we insure against income and asset loss when a health event presents significant financial challenges. We believe that the coming years will provide great opportunity for growth in the United States.
Let me turn to the investment portfolio and talk about our general investment philosophy, how we're adapting to the changing global economic environment, the composition of our portfolio, and our approach to managing potential financial risks. As we've stated for many years, our greatest investment challenge has been to invest Aflac Japan's significant cash flows at reasonable investment yield rates. First and foremost, we consider the nature and duration of our liabilities that our investments support. This means we primarily invest for the long term, and strong cash flows from our persistent book of business give us the ability to continue to invest from this perspective. Following four years of significant portfolio de-risking, we've considerably reduced our exposure to perpetual securities, PIGS countries, and financial institutions, especially in Europe. Our focus remains on liquidity, flexibility, and diversification.
Credit quality remains a central aspect of our investment approach. At quarter end, more than 95% of our portfolio was investment grade. The percent of our senior debt holdings increased from 86% at the end of 2011 to over 92% at the end of 2012. Our objective is to have a portfolio that's diversified by geography and industry while focused on high-quality investments. The vast majority of our investments in Japan are in JGBs that provide a measure of both liquidity and stability. Let me discuss how we've substantially enhanced our investment portfolio over the last few years. From January 2008 to the end of 2012, we dramatically cut our holdings of sovereign and financial investments in the peripheral European countries. We've also lowered our investments in the perpetual security class.
Our successful de-risking program is largely completed in mid-2012 and has enabled us to focus on enhancing portfolio quality. The U.S. corporate bond program we initiated in the third quarter of 2012 continues to be an effective means for enhancing our new money yield, particularly in our Japan portfolio. You'll recall in the last half of 2012, our objective was to invest roughly two-thirds of our investment cash flow in U.S. dollar denominated publicly traded corporate bonds and hedging the principal in currency risk. This successful investment program enabled us to surpass our budgeted new money yield for 2012, and it also provided us with greater liquidity, it enhanced the flexibility of our portfolio, and it increased our opportunity to diversify beyond JGBs. At December 31st, this program represented approximately 6.2% of our total portfolio.
In light of the success of the corporate bond program in 2012 and the strong credit fundamentals of investment grade corporate credit, we intend to continue this program in the first quarter of 2013. Consistent with our asset allocation program, we'll balance these investments with JGBs for diversification and liquidity, as well as other investment opportunities as they may arise. Our ability to continue to implement new strategies is based on the evolving capabilities of the Aflac Global Investments Division. We're going to build a framework to support investments in newer asset classes to move forward accordingly. We'll update you on our progress at our analyst meeting in May. We've defined our investment objectives as maximizing risk adjusted performance subject to our liability profile and our capital requirements.
It's important to note that all of our strategies have been back tested against our capital ratios and the ratios we're trying to achieve. I'll spend the last portion of my discussion updating you on our consolidated financial performance and capital management progress. We've delivered consistently strong operating performance, achieving a 14.7% compound annual growth rate in operating earnings per share, excluding the effect of the yen from 2002 through 2012. This achievement demonstrates our ability to generate significant cash flows and organic growth in our capital bases through various market cycles. The average yen dollar exchange rate in 2012 was 79.8, which was essentially unchanged from 79.75 in 2011. We still believe that viewing our results excluding the impact from foreign currency is the most meaningful way to evaluate our financial performance. On that basis, we were pleased with our results in 2012 from a financial perspective.
I'm also very pleased with the strength of our capital ratios, which demonstrates our commitment to maintaining financial strength and flexibility on behalf of our policyholders, shareholders, and bondholders. Through strong surplus growth, an improved portfolio risk profile, and a weaker yen, our capital ratios improved significantly during 2012. As we've communicated over the past several years, maintaining strong capital ratios as measured by the risk-based capital ratio in the U.S. and the solvency margin ratio in Japan remains a top priority for us. At the end of 2012, our RBC ratio was 630%, which was up significantly from our 2011 year-end ratio of 493%. As indicated in Japan's filed financial results, Aflac Japan's capital strength as measured by the solvency margin at year-end 2012 was also very strong at 669%.
That result was well above our targeted range of 500%-600%, and an improvement over the solvency margin ratio at September 30th, 2012 of 628%. In addition to focusing on capital levels, maintaining an industry leading return on equity is extremely important to us. Accordingly, the compensation committee of Aflac Incorporated's board of directors made a decision to include operating ROE as a component in the bonus structure for Aflac senior management in 2013. On an operating basis, our 2012 ROE was 24.6%. Keep in mind that our ROE is sensitive to currency fluctuations because we do hedge our equity primarily into dollars, but not all of our earnings.
That means that when the yen weakens, our yen earnings translate to fewer dollars and our ROE will decline, but things like our debt to total capital may also come down a bit as we have yen denominated debt on our books. If the yen remains in the range it has been for the last several weeks, that is in the JPY 95-96 area, I think it's reasonable to expect the ROE to range between 20%-25% for 2013. As we've said before, given our capital structure, our ability to repurchase shares is largely tied to our ability to repatriate profits from Japan. As we think about profit repatriation, our first consideration is protection of our policyholders, as measured by the solvency margin ratio. Next, we give consideration to the needs of the parent company, and we consult with Aflac Japan management in making a final determination.
We now expect profit repatriation for 2013 to be around JPY 50 billion, which is a reasonable estimate, assuming we have no significant additional investment losses that would impact Aflac Japan's net income. Profit repatriation in 2013 could provide us with a significant amount of capital that could be deployed for share repurchase. Our capital strength enabled us to increase our cash dividend to shareholders in the fourth quarter of 2012 for the 30th consecutive year. Our objective is to grow our dividend at a rate that's in line with earnings per share growth, again, before the impact of the yen. Given the strength of our capital ratios and parent company liquidity, we've resumed our share repurchase activities by buying approximately $100 million worth of our shares in the fourth quarter of 2012.
It's our current plan to purchase $400 million-$600 million worth of our shares in 2013. Understand that unless an extraordinary event occurs, we intend to purchase at least $400 million worth of our shares this year. We are proud that the rating agencies have recognized our financial strength and our balance sheet, as indicated by financial strength ratings of A+ Superior by AM Best, Aa3 by Moody's, and AA- by S&P. We believe that an analysis of operating earnings, which is a non-GAAP financial measure, is important to an understanding of Aflac's underlying profitability drivers. Aflac defines operating earnings as the profits derived from operations before realized investment gains and losses from securities transactions, the impact from derivative activities and hedging, as well as non-recurring items. On an operating basis, we have a long history of producing strong earnings growth.
We continue to believe that operating earnings, excluding currency, is the best measure of our success at growing our business. Excluding currency, operating earnings per diluted share rose 5.1% in 2012, which is toward the high end of our earnings growth guidance for that period. We continue to focus on maintaining strong fundamentals in our core business and building on our record of earnings growth. I want to reiterate that our objective for 2013 has not changed. Our plan is to increase operating earnings per diluted share by 4%-7%, again, excluding currency effects. This range reflects the relative impact of portfolio de-risking over the past several years, as well as investing significant cash flows in a low interest rate environment.
I'd also point out that our operating EPS in 2012 was actually better than expected, in large part due to receipt of a deferred coupon in the first quarter and a lower annual effective tax rate than we anticipated. This will make a more challenging comparison in 2013. We're in a strong position to achieve our earnings guidance objective. This slide shows how 2013 EPS might look both with and without the impact of currency. On a constant currency basis, our 4%-7% objective equates to $6.86 a share-$7.06 in operating earnings per diluted share. We estimate that a one yen change in the average annual exchange rate will equal about $0.042 in per share earnings during 2013.
We remain focused on our vision to be the leading provider of voluntary insurance in the United States and the number one provider of supplemental insurance in Japan. We have confidence in our business model, the fundamental need for our products, and most importantly, the future success of Aflac. Well, that concludes my presentation. Now I'll be pleased to respond to some questions.
Maybe just to start off, you mentioned sales in the U.S. potentially being down in the first quarter and then improving through the year. What's your expectation for the Japan business for the third sector? I think your guidance is 0%-5%, but how that ramps up through the year.
For Japan, we've decided that in 2013, we're refocusing on our core business, our real core business, which is medical and cancer products, otherwise known as third sector products. The life insurance business or the first sector products were very strong in 2012. We were up over 30% in total in 2012 with life insurance production. We think that because of the repricing of first sector products that has to occur April 1st, in conjunction with new reserve requirements put in place by the FSA and the like, we expect first sector production to fall off fairly significantly. We don't know how much, and so we're not really giving guidance on first sector production for 2013 out of Japan this year. As far as the quarters, we said in the U.S., we had a strong first quarter of 2012. We expect production to come in fairly uniformly throughout 2013.
I think we don't have expectations that we'll see major fluctuations in production levels in second, third, and fourth quarter, but we expect somewhat lower than the first quarter of 2012 and the first quarter of 2013. Japan, I'd say third sector production we would expect to see perhaps somewhat lower production increases in the first couple of quarters. We plan a product revision and a pricing revision potentially in the third quarter of 2013, and we think that that'll be leading toward modest increases of sales in the third quarter and probably strong increases of sales in the fourth quarter of third sector products in Japan. Generally, our production increases are going to be skewed toward the end of the year in 2013 in the aggregate.
Thank you. How do you see the European peripheral exposure coming down over the next year or two as you reshift your investment portfolio?
We've got very little left to change in the European peripherals. We've got some modest amount of Italian sovereign debt, but we don't have anything left in any of the other peripheral countries. We sold all of Greece back in 2010. We've got a modest amount of senior debt left in Ireland in one financial institution, but that's not sovereign. We really pretty much completed the de-risking in the peripheral Eurozone. We got very little left to do. We do have some investments in the peripheral Eurozone, but they're primarily in utilities and manufacturing and the like.
Some of those investments were private placements that had features not associated with publicly issued securities, such as below investment grade puts that we've been able to capitalize on in several situations in the past couple of years, where if an entity gets downgraded below investment grade, we're able to recover our investment at par. We've had several situations where we were able to take advantage of that provision. Our exposure to the peripherals in Europe is fairly low at this time. European financials and sovereigns in particular, almost nothing.
On your capital ratios, they're a lot higher than what your targets are, and they've obviously benefited recently from the JPY being weak. At what point would you consider maybe monetizing the increase in the RBC or solvency ratio through buybacks or something else? I'm assuming you'd want to see the JPY be stable for a while.
We've certainly got that under consideration at the present time. Our capital ratios right now are back to the level they were, say, in early 2008 before the financial crisis. In terms of our confidence in our capital structure, our confidence in our capital ratios, it's certainly much higher than it's been at any point in the last several years. We still, along with the rest of the world, know that there's some exposure to fixed income price levels and the like. We've got a lot of fixed income investments in our portfolio. We're somewhat sensitive to that. We're still a bit cautious. You've got to be cautious after you've lived with four years of financial crisis. We're not quite of the same state of mind that we were in early 2008 when we had capital ratios at this level.
At that time, we deployed over $1.4 billion in share repurchase in 2008. I don't think we're going to quite go there again that fast. Certainly, we're feeling a lot better today than we felt two years ago, or even a year ago for that matter.
Can you tell us about the competition in the bank channel in Japan, and if competition got better or worse since the last quarter, and where do you see it going?
That background noise. I heard the competition in the bank channel thing.
The competition in the Japanese bank channel.
Yeah.
Whether it's gotten better or worse since last quarter, since you talked about it, because there were a few other companies that reported their quarter last 4Q and said that there was increased competition.
Okay. Well, I'll say that in the bank channel, what you've seen is insurance companies that have competed with us, people have been adjusting production targets. People selling single premium whole life, for example, typically have put production limits in place. We'll sell, say, JPY 1 billion worth of this amount of premium, just as a hypothetical thing. We'll sell JPY 1 billion in the first six months of the fiscal year in the bank channel. Once the banks hit that limit, they have to stop selling that company's products and go to another company's products. The other insurance company would adjust their production quotas in accordance with their capital capacity and the like for the next six months. What we saw during 2012 was a situation where a number of companies selling single premium whole life had the quotas hit.
The bank channel turned to Aflac WAYS product as an appealing competitive opportunity, particularly with interest rates declining. We sold a lot of business during the latter part of 2011 and on through 2012. We had to make our own adjustments during 2012. We pulled one version of our product, left another version of the product in. That still sold pretty well. We had a feature to our product where if the customers paid all the premiums in advance, they were credited with an interest rate on the unapplied premium. We were crediting 1% interest. We had to cut that back to 0.5% interest in October. That cut the production of our business somewhat because our product became the attractiveness from the customer's point of view declined a bit. It improved our profitability, and we were trying to do that to protect our own profitability.
We saw a decline in our business in the fourth quarter of 2012. What's going to happen starting April 1, 2013, is that we're going to have to reprice WAYS, which is an annual periodic premium product. We're going to have to reprice it to recognize the effect of the FSA changing the standard valuation interest rate from 1.5% to 1%. That's going to affect our products because our products were priced at like 1.85%, and we're going to have to reduce them to a lower pricing interest rate. I think we publicly said it's one and a quarter, which is what it's going to be. That's going to raise our prices. It'll reduce our competitiveness from a customer perspective. Many of the single premium writers had already reduced the pricing interest rate on their products. They were less than 1% already.
They were pricing at, say, 0.8% and the like because they were having to invest in short duration investments to take account of the fact that single premium business doesn't have any surrender charges. You've got more liquidity risk under a single premium product than a periodic premium product like ours. Many of the single premium products were already priced at pretty low interest rates. What you've heard in the market is some of the single premium writers saying, "Well, we're cutting our premium rates," but that means they're repricing at 0.9% instead of 0.8%, and the like, or something like that. I don't know specifically what the pricing rates are, but it's that kind of order of magnitude. I don't consider that an apples and oranges. I do consider it an apples and oranges perspective in terms of comparing with us.
Long story short, we're running out of time. We expect our bank sales to fall off in 2013 when we raise the rates relative to other products. There are other types of products being distributed through the bank channel too. We're renewing our emphasis on our core products, medical and cancer, and we expect to achieve increases in sales in those product categories.
I'll just ask one last one. What's the potential impact on your U.S. business of healthcare reform, especially with the exchanges coming on, and do you see that as an opportunity or a threat?
We see it as a period of change that we're trying to convert to an opportunity. We're doing a significant amount of strategic planning relative to how distribution will look in 2015 and 2016, and we're trying to position our strategy to move toward what we think the environment will be at that time. Clearly, the exchanges have to be considered. I think it's unlikely that you'd see any Aflac products in a public exchange. We do think it's possible you'd see Aflac products in a private exchange, but that hasn't been determined yet. We've got to think about how it affects our existing distribution system, and we're trying to protect the opportunities available to that distribution system as well as to continue the broker strategy and the like that we've been engaged in for the last several years.
Thank you.
Okay. Thank you. Appreciate it.