Aflac 2006 Annual Report Download - page 29

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business operations. The estimates that we deem to be most
critical to an understanding of Aflac’s results of operations and
financial condition are those related to investments, deferred
policy acquisition costs and policy liabilities. The preparation
and evaluation of these critical accounting estimates involve
the use of various assumptions developed from management’s
analyses and judgments. The application of these critical
accounting estimates determines the values at which 95% of
our assets and 84% of our liabilities are reported and thus
have a direct effect on net earnings and shareholders’ equity.
Subsequent experience or use of other assumptions could
produce significantly different results.
Investments
Aflac’s investments in debt and equity securities include both
publicly issued and privately issued securities. For privately
issued securities, we receive pricing data from external sources
that take into account each security’s credit quality and
liquidity characteristics. We also routinely review our
investments that have experienced declines in fair value to
determine if the decline is other than temporary. These
reviews are performed with consideration of the facts and
circumstances of an issuer in accordance with SEC Staff
Accounting Bulletin No. 59, Accounting for Non-Current
Marketable Equity Securities; Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities; Financial
Accounting Standards Board (FASB) Staff Position 115-1, The
Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments and related guidance. The
identification of distressed investments, the determination of
fair value if not publicly traded, and the assessment of
whether a decline is other than temporary involve significant
management judgment and require evaluation of factors,
including but not limited to:
•percentage decline in value and the length of time during
which the decline has occurred
•recoverability of principal and interest
•market conditions
•ability to hold the investment to maturity
•review of the issuer’s overall operating performance
•rating agency opinions and actions regarding the issuer’s
credit standing
•adverse changes in the issuer’s availability of production
resources, revenue sources and technological conditions
•adverse changes in the issuer’s economic, regulatory or
political environment
Deferred Policy Acquisition Costs
and Policy Liabilities
Aflac’s products are generally long-duration fixed-benefit
indemnity contracts. As such, our products are accounted for
under the requirements of SFAS No. 60, Accounting and
Reporting by Insurance Enterprises. We make estimates of
certain factors that affect the profitability of our business to
match expected policy benefits and deferrable acquisition
costs with expected policy premiums. These assumptions
include persistency, morbidity, mortality, investment yields and
expenses. If actual results match the assumptions used in
establishing policy liabilities and the deferral and amortization
of acquisition costs, profits will emerge as a level percentage
of earned premiums. However, because actual results will vary
from the assumptions, profits as a percentage of earned
premiums will vary from year to year.
We measure the adequacy of our policy reserves and
recoverability of deferred policy acquisition costs (DAC)
annually by performing gross premium valuations on our
business. Our testing indicates that our insurance liabilities
are adequate and that our DAC is recoverable.
Deferred Policy Acquisition Costs
Under the requirements of SFAS No. 60, certain costs of
acquiring new business are deferred and amortized over the
policy’s premium payment period in proportion to anticipated
premium income. Future amortization of DAC is based upon
our estimates of persistency, interest, and future premium
revenue generally established at the time of policy issuance.
However, the unamortized balance of DAC reflects actual
persistency. As presented in the table at the top of the
following page, the ratio of unamortized DAC to annualized
premiums in force has been relatively stable for Aflac U.S. over
the last three years. The ratio of unamortized DAC to
annualized premiums in force has shown a slight upward trend
for Aflac Japan for the last three years. This trend is a result of
a greater proportion of our annualized premium being under
the alternative commission schedule, which pays a higher
commission on first-year premiums and lower commissions on
renewal premiums. This schedule is very popular with our new
agents as it helps them with cash flow for personal and
business needs as they build their business. While this has
resulted in a higher unamortized DAC balance, the overall cost
to the company has been reduced.