Aflac 2006 Annual Report Download - page 40

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The estimated effect of potential increases in interest rates on
the fair values of debt securities we own, notes payable, cross-
currency swaps and our obligation for the Japanese
policyholder protection fund as of December 31 follows:
Changes in the interest rate environment have contributed to
the unrealized gains on debt securities we own. However, we
do not expect to realize a majority of these unrealized gains
because we have the intent and ability to hold these securities
to maturity. Likewise, should significant amounts of unrealized
losses occur because of increases in market yields, we would
not expect to realize these losses because we have the intent
and ability to hold such securities to maturity or recovery of
value. For additional information on unrealized losses on debt
securities, see Note 3 of the Notes to the Consolidated
Financial Statements.
We attempt to match the duration of our assets with the
duration of our liabilities. The following table presents the
approximate duration of our yen-denominated assets and
liabilities, along with premiums, as of December 31.
The table at the top of the page shows a comparison of
average required interest rates for future policy benefits and
investment yields, based on amortized cost, for the years
ended December 31.
In response to low interest rates in the United States, we
lowered our required interest assumption for newly issued
products to 5.5% in 2005. In Japan, we lowered our required
interest assumption for some newly issued products to 2.5%
in 2005. However, the majority of Japan’s newly issued
products have a required interest assumption of 3.0%. We
continue to monitor the spread between our new money yield
and the required interest assumption for newly issued
products in both the United States and Japan and will re-
evaluate those assumptions as necessary.
Over the next two years, we have yen-denominated securities
that will mature with yields in excess of Aflac Japan’s current
net investment yield of 3.88%. These securities total $1.1
billion at amortized cost and have an average yield of 5.80%.
Currently, when debt securities we own mature, the proceeds
may be reinvested at a yield below that of the interest
required for the accretion of policy benefit liabilities on
policies issued in earlier years. As a result, securities that
mature may contribute to a decline in our overall portfolio
yield. However, adding riders to our older policies has helped
offset the negative investment spread. And despite negative
investment spreads, adequate overall profit margins still exist
in Aflac Japan’s aggregate block of business because of profits
that have emerged from changes in mix of business and
favorable experience from mortality, morbidity, and expenses.
Investments and Cash
Our investment philosophy is to maximize investment income
while emphasizing liquidity, safety and quality. Our investment
objective, subject to appropriate risk constraints, is to fund
policyholder obligations and other liabilities in a manner that
enhances shareholders’ equity. We seek to achieve this objective
through a diversified portfolio of fixed-income investments that
reflects the characteristics of the liabilities it supports. Aflac
invests primarily within the debt securities markets.
Sensitivity of Fair Values of Financial
Instruments to Interest Rate Changes
2006 2005
+100+
+100
Fair Basis Fair Basis
(In millions) Value Points Value Points
Debt securities:
Fixed-maturity securities:
Yen-denominated $32,328 $28,712 $29,791 $26,427
Dollar-denominated 9,845 9,033 9,190 8,407
Perpetual debentures:
Yen-denominated 7,735 6,965 7,911 7,086
Dollar-denominated 698 653 711 661
Total debt securities $50,606 $45,363 $47,603 $42,581
Notes payable* $ 1,421 $ 1,386 $ 1,395 $ 1,362
Cross-currency and interest
rate swap liabilities $7$5 $12 $10
Japanese policyholder
protection fund $ 175 $ 175 $ 203 $ 203
*Excludes capitalized lease obligations
(In years) 2006 2005
Yen-denominated debt securities 13 12
Policy benefits and related expenses to be paid in future years 13 13
Premiums to be received in future years on policies in force 10 10
Comparison of Interest Rates for Future
Policy Benefits and Investment Yields
(Net of investment expenses)
2006 2005 2004
U.S. *Japan* U.S. *Japan* U.S. *Japan*
Policies issued during year:
Required interest on
policy reserves 5.50% 2.77% 5.50% 2.88% 6.36% 2.97%
New money yield on
investments 6.40 3.12 6.11 3.01 6.25 3.00
Policies in force during year:
Required interest on
policy reserves 6.28 4.71 6.36 4.79 6.40 4.87
Return on average
invested assets 6.86 3.88 6.54 3.92 6.68 4.02
*Represents yen-denominated investments for Aflac Japan that support policy obligations and
therefore excludes Aflac Japan’s annuities, and dollar-denominated investments and related investment income