FORM 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[ X ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

or

[    ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number:    001-07434

LOGO

Aflac Incorporated

 

(Exact name of registrant as specified in its charter)

 

Georgia   58-1167100
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
1932 Wynnton Road, Columbus, Georgia   31999
(Address of principal executive offices)   (ZIP Code)

706.323.3431

 

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.            þ  Yes  ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).            þ  Yes  ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  þ   Accelerated filer  ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                                                                                                                           ¨  Yes  þ  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class       July 28, 2011
Common Stock, $.10 Par Value     467,160,513 shares


Table of Contents

Aflac Incorporated and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2011

Table of Contents

 

         Page  

PART I.

  FINANCIAL INFORMATION:   

Item 1.

  Financial Statements (Unaudited)   
  Review by Independent Registered Public Accounting Firm      1     
  Report of Independent Registered Public Accounting Firm      2     
 

Consolidated Statements of Earnings

  Three Months Ended June 30, 2011, and 2010

  Six Months Ended June 30, 2011, and 2010

     3     
 

Consolidated Balance Sheets

  June 30, 2011 and December 31, 2010

     4     
 

Consolidated Statements of Shareholders’ Equity

  Six Months Ended June 30, 2011, and 2010

     6     
 

Consolidated Statements of Cash Flows

  Six Months Ended June 30, 2011, and 2010

     7     
 

Consolidated Statements of Comprehensive Income (Loss)

  Three Months Ended June 30, 2011, and 2010

  Six Months Ended June 30, 2011, and 2010

     9     
  Notes to the Consolidated Financial Statements      10     

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      49     

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      82     

Item 4.

  Controls and Procedures      82     

PART II.

  OTHER INFORMATION:   

Item 1A.

  Risk Factors      83     

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      84     

Item 6.

  Exhibits      85     

Items other than those listed above are omitted because they are not required or are not applicable.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Review by Independent Registered Public Accounting Firm

The June 30, 2011, and 2010, consolidated financial statements included in this filing have been reviewed by KPMG LLP, an independent registered public accounting firm, in accordance with established professional standards and procedures for such a review.

The report of KPMG LLP commenting upon its review is included on the following page.

 

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Table of Contents

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Aflac Incorporated:

We have reviewed the consolidated balance sheet of Aflac Incorporated and subsidiaries (the Company) as of June 30, 2011, and the related consolidated statements of earnings and comprehensive income (loss) for the three-month and six-month periods ended June 30, 2011 and 2010, and the consolidated statements of shareholders’ equity and cash flows for the six-month periods ended June 30, 2011 and 2010. These consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Aflac Incorporated and subsidiaries as of December 31, 2010, and the related consolidated statements of earnings, shareholders’ equity, cash flows and comprehensive income (loss) for the year then ended (not presented herein); and in our report dated February 25, 2011, we expressed an unqualified opinion on those consolidated financial statements. Our report refers to a change in the method of evaluating the consolidation of variable interest entities (VIEs) and qualified special purpose entities (QSPEs) in 2010 and a change in the method of evaluating other-than-temporary impairments of debt securities in 2009. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2010, is fairly stated in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

LOGO
Atlanta, Georgia
August 5, 2011

 

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Aflac Incorporated and Subsidiaries

Consolidated Statements of Earnings

     

Three Months Ended

June 30,

   

Six Months Ended        

June 30,        

 
(In millions, except for share and per-share amounts - Unaudited)    2011     2010     2011     2010        

Revenues:

        

Premiums, principally supplemental health insurance

   $ 4,956      $ 4,333      $ 9,828        $    8,681            

Net investment income

     784        727        1,579        1,453            

Realized investment gains (losses):

        

Other-than-temporary impairment losses realized

     (528     0        (933     (42)           

Sales and redemptions

     (182     14        (326     (7)           

Derivative and other gains (losses)

     42        (103     12        (86)           

Total realized investment gains (losses)

     (668     (89     (1,247     (135)           

Other income

     16        9        44        45            

Total revenues

     5,088        4,980        10,204        10,044            

Benefits and expenses:

        

Benefits and claims

     3,310        2,885        6,532        5,741            

Acquisition and operating expenses:

        

Amortization of deferred policy acquisition costs

     264        229        542        509            

Insurance commissions

     427        398        849        801            

Insurance expenses

     543        508        1,051        988            

Interest expense

     46        33        92        66            

Other operating expenses

     45        38        86        76            

Total acquisition and operating expenses

     1,325        1,206        2,620        2,440            

Total benefits and expenses

     4,635        4,091        9,152        8,181            

Earnings before income taxes

     453        889        1,052        1,863            

Income taxes

     173        308        378        646            

Net earnings

   $ 280      $ 581      $ 674      $     1,217            
                                  

Net earnings per share:

        

Basic

   $ .60      $ 1.24      $ 1.44      $       2.60            

Diluted

     .60        1.23        1.43        2.58            
                                  

Weighted-average outstanding common shares used in computing earnings per share (In thousands):

        

Basic

     466,498        468,824        467,317        468,377            

Diluted

     469,752        472,539        470,990        472,497            
                                  

Cash dividends per share

   $ .30      $ .28      $ .60      $          .56            
                                  

See the accompanying Notes to the Consolidated Financial Statements.

 

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Aflac Incorporated and Subsidiaries

Consolidated Balance Sheets

 

(In millions)    June 30,
2011
(Unaudited)
     December 31,
2010
 

Assets:

     

Investments and cash:

     

Securities available for sale, at fair value:

     

Fixed maturities (amortized cost $46,415 in 2011 and $43,133 in 2010)

     $    47,380              $     43,100               

Fixed maturities - consolidated variable interest entities (amortized cost $4,853 in 2011 and $4,969 in 2010)

     5,126              5,255               

Perpetual securities (amortized cost $5,627 in 2011 and $6,209 in 2010)

     5,559              5,974               

Perpetual securities - consolidated variable interest entities (amortized cost $1,632 in 2011 and $1,618 in 2010)

     1,544              1,538               

Equity securities (cost $21 in 2011 and $22 in 2010)

     23              23               

Securities held to maturity, at amortized cost:

     

Fixed maturities (fair value $31,405 in 2011 and $29,899 in 2010)

     31,289              29,470               

Fixed maturities - consolidated variable interest entities (fair value $577 in 2011 and $570 in 2010)

     619              614               

Other investments

     153              135               

Cash and cash equivalents

     1,291              2,121               

Total investments and cash

     92,984              88,230               

Receivables

     879              661               

Accrued investment income

     739              738               

Deferred policy acquisition costs

     10,028              9,734               

Property and equipment, at cost less accumulated depreciation

     611              620               

Other

     991 (1)            1,056(1)            

Total assets

   $     106,232            $ 101,039               
                   

 

(1) 

Includes $495 in 2011 and $564 in 2010 of derivatives from consolidated variable interest entities

 

See the accompanying Notes to the Consolidated Financial Statements.

(continued)

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Aflac Incorporated and Subsidiaries

Consolidated Balance Sheets (continued)

 

(In millions, except for share and per-share amounts)    June 30,    
2011    
(Unaudited)   
     December 31,
2010

Liabilities and shareholders’ equity:

        

Liabilities:

        

Policy liabilities:

        

Future policy benefits

     $    74,472              $    72,103         

Unpaid policy claims

     3,855              3,719         

Unearned premiums

     1,306              1,197         

Other policyholders’ funds

     6,733              5,437           

Total policy liabilities

     86,366              82,456         

Notes payable

     3,048              3,038         

Income taxes

     2,186              1,969         

Payables for return of cash collateral on loaned securities

     338              191         

Other

     2,313(2)           2,329(2)      

Commitments and contingent liabilities (Note 10)

                      

Total liabilities

     94,251              89,983           

Shareholders’ equity:

        

Common stock of $.10 par value. In thousands: authorized 1,900,000 shares in 2011 and 2010; issued 663,412 shares in 2011 and 662,660 shares in 2010

     66              66         

Additional paid-in capital

     1,372              1,320         

Retained earnings

     14,587              14,194         

Accumulated other comprehensive income (loss):

        

Unrealized foreign currency translation gains

     914              926         

Unrealized gains (losses) on investment securities:

        

Unrealized gains (losses) on securities not other-than-temporarily
impaired

     752              36         

Unrealized gains (losses) on other-than-temporarily impaired securities

     0              (3)        

Unrealized gains (losses) on derivatives

     6              31         

Pension liability adjustment

     (125)             (128)        

Treasury stock, at average cost

     (5,591)             (5,386)          

Total shareholders’ equity

     11,981              11,056           

Total liabilities and shareholders’ equity

     $  106,232              $  101,039           
                        

 

(2) 

Includes $584 in 2011 and $741 in 2010 of derivatives from consolidated variable interest entities

See the accompanying Notes to the Consolidated Financial Statements.

 

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Aflac Incorporated and Subsidiaries

Consolidated Statements of Shareholders’ Equity

      Six Months Ended June 30,  
(In millions - Unaudited)            2011          2010      

Common stock:

     

Balance, beginning of period

   $ 66        $ 66            

Balance, end of period

     66          66            

Additional paid-in capital:

     

Balance, beginning of period

     1,320          1,228            

Exercise of stock options

     15          32            

Share-based compensation

     18          17            

Gain (loss) on treasury stock reissued

     19          (6)           

Balance, end of period

     1,372          1,271            

Retained earnings:

     

Balance, beginning of period

     14,194          12,410            

Cumulative effect of change in accounting principle, net of income taxes

             (25)           

Net earnings

     674          1,217            

Dividends to shareholders

     (281)         (262)           

Balance, end of period

     14,587          13,340            

Accumulated other comprehensive income (loss):

     

Balance, beginning of period

     862          29            

Unrealized foreign currency translation gains (losses) during period, net of income taxes:

     

Cumulative effect of change in accounting principle, net of income taxes

             (320)           

Change in unrealized foreign currency translation gains (losses) during period, net of income taxes

     (12)         143            

Unrealized gains (losses) on investment securities during period, net of income taxes and reclassification adjustments:

     

Cumulative effect of change in accounting principle, net of income taxes

             180            

Change in unrealized gains (losses) on investment securities not other-than-temporarily impaired, net of income taxes

     716          587            

Change in unrealized gains (losses) on other-than-temporarily impaired investment securities, net of income taxes

             10            

Unrealized gains (losses) on derivatives during period, net of income taxes

     (25)         (1)           

Pension liability adjustment during period, net of income taxes

             1            

Balance, end of period

     1,547          629            

Treasury stock:

     

Balance, beginning of period

     (5,386)         (5,316)           

Purchases of treasury stock

     (231)         (5)           

Cost of shares issued

     26          45            

Balance, end of period

     (5,591)         (5,276)           

Total shareholders’ equity

   $ 11,981        $ 10,030            
                   

See the accompanying Notes to the Consolidated Financial Statements.

 

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Aflac Incorporated and Subsidiaries

Consolidated Statements of Cash Flows

      Six Months Ended June 30,  
(In millions - Unaudited)            2011         2010        

Cash flows from operating activities:

    

Net earnings

   $ 674         $       1,217            

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Change in receivables and advance premiums

     926         423            

Increase in deferred policy acquisition costs

     (225)        (164)           

Increase in policy liabilities

     1,922         1,473            

Change in income tax liabilities

     (82)        181            

Realized investment (gains) losses

     1,247         135            

Other, net

     (84)        (242)           

Net cash provided (used) by operating activities

     4,378         3,023            

Cash flows from investing activities:

    

Proceeds from investments sold or matured:

    

Securities available for sale:

    

Fixed maturities sold

     1,767         1,055            

Fixed maturities matured or called

     775         312            

Perpetual securities sold

     226         582            

Perpetual securities matured or called

     61         0            

Equity securities sold

            328            

Securities held to maturity:

    

Fixed maturities matured or called

     325         2            

    Costs of investments acquired:

    

Securities available for sale:

    

Fixed maturities acquired

     (4,822)        (4,606)           

Equity securities acquired

            (330)           

Securities held to maturity:

    

Fixed maturities acquired

     (3,484)        (642)           

    Cash received as collateral on loaned securities, net

     147         134            

    Other, net

     (29)        (11)           

Net cash provided (used) by investing activities

   $ (5,034)      $   (3,176)           

See the accompanying Notes to the Consolidated Financial Statements.

 

(continued)

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Aflac Incorporated and Subsidiaries

Consolidated Statements of Cash Flows (continued)

 

      Six Months Ended June 30,  
(In millions - Unaudited)    2011      2010        

Cash flows from financing activities:

     

Purchases of treasury stock

     $   (222)         $     (5)           

Principal payments under debt obligations

     (1)         (2)           

Dividends paid to shareholders

     (260)         (262)           

Change in investment-type contracts, net

     275          191            

Treasury stock reissued

     26          36            

Other, net

             35            

Net cash provided (used) by financing activities

     (175)         (7)           

Effect of exchange rate changes on cash and cash equivalents

             21            

Net change in cash and cash equivalents

     (830)         (139)           

Cash and cash equivalents, beginning of period

     2,121          2,323            

Cash and cash equivalents, end of period

     $ 1,291          $2,184            
                   

Supplemental disclosures of cash flow information:

     

Income taxes paid

     $    460          $   532            

Interest paid

     72          52            

Impairment losses included in realized investment losses

     933          42            

Noncash financing activities:

     

Capitalized lease obligations

             1            

Treasury stock issued for:

     

Shareholder dividend reinvestment

     21          0            

Share-based compensation grants

             3            
                   
                   

See the accompanying Notes to the Consolidated Financial Statements.

 

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Aflac Incorporated and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

 

      Three Months Ended
June 30,
     Six Months Ended
June 30,
 
(In millions - Unaudited)        2011              2010              2011              2010      

Net earnings

     $      280            $      581              $      674            $      1,217        

Other comprehensive income (loss) before income taxes:

           

Unrealized foreign currency translation gains (losses) during period

     (82)           61              (86)           43        

Unrealized gains (losses) on investment securities:

           

Unrealized holding gains (losses) on investment securities during period

     473            555              (136)           878        

Reclassification adjustment for realized (gains) losses on investment securities included in net earnings

     716            (14)             1,243            49        

Unrealized gains (losses) on derivatives during period

     17            8              (38)           (2)       

Pension liability adjustment during period

     0            0              4            2        

Total other comprehensive income (loss) before income taxes

     1,124            610              987            970        

Income tax expense (benefit) related to items of other comprehensive income (loss)

     292            74              302            230        

Other comprehensive income (loss), net of income taxes

     832            536              685            740        

Total comprehensive income (loss)

     $   1,112            $   1,117              $   1,359            $      1,957        
                                     

See the accompanying Notes to the Consolidated Financial Statements.

 

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Aflac Incorporated and Subsidiaries

Notes to the Consolidated Financial Statements

(Interim period data – Unaudited)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States and Japan. The Company’s insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac), which operates in the United States (Aflac U.S.) and as a branch in Japan (Aflac Japan). Most of Aflac’s policies are individually underwritten and marketed through independent agents. Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC). Our insurance operations in the United States and our branch in Japan service the two markets for our insurance business. Aflac Japan’s revenues, including realized gains and losses on its investment portfolio, accounted for 73% and 75% of the Company’s total revenues in the six-month periods ended June 30, 2011, and 2010, respectively. The percentage of the Company’s total assets attributable to Aflac Japan was 87% and 86% at June 30, 2011, and December 31, 2010, respectively.

Basis of Presentation

We prepare our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). In these Notes to the Consolidated Financial Statements, references to GAAP issued by the FASB are derived from the FASB Accounting Standards CodificationTM (ASC). The preparation of financial statements in conformity with GAAP requires us to make estimates when recording transactions resulting from business operations based on currently available information. The most significant items on our balance sheet that involve a greater degree of accounting estimates and actuarial determinations subject to changes in the future are the valuation of investments, deferred policy acquisition costs, liabilities for future policy benefits and unpaid policy claims, and income taxes. These accounting estimates and actuarial determinations are sensitive to market conditions, investment yields, mortality, morbidity, commission and other acquisition expenses, and terminations by policyholders. As additional information becomes available, or actual amounts are determinable, the recorded estimates will be revised and reflected in operating results. Although some variability is inherent in these estimates, we believe the amounts provided are adequate.

The unaudited consolidated financial statements include the accounts of the Parent Company, its subsidiaries and those entities required to be consolidated under applicable accounting standards. All material intercompany accounts and transactions have been eliminated.

In the opinion of management, the accompanying unaudited consolidated financial statements of the Company contain all adjustments, consisting of normal recurring accruals, which are necessary to fairly present the consolidated balance sheets as of June 30, 2011, and December 31, 2010, the consolidated statements of earnings and comprehensive income (loss) for the three- and six-month periods ended June 30, 2011, and 2010, and the consolidated statements of shareholders’ equity and cash flows for the six-month periods ended June 30, 2011, and 2010. Results of operations for interim periods are not necessarily indicative of results for the entire year. As a result, these financial statements should be read in conjunction with the financial statements and notes thereto included in our annual report to shareholders for the year ended December 31, 2010.

Significant Accounting Policies

We have refined the explanation of our accounting policies for the translation of foreign currencies and income taxes. All other categories of significant accounting policies remain unchanged from our annual report to shareholders for the year ended December 31, 2010.

Translation of Foreign Currencies: The functional currency of Aflac Japan’s insurance operations is the Japanese yen. We translate our yen-denominated financial statement accounts into U.S. dollars as follows. Assets and liabilities are translated at end-of-period exchange rates. Realized gains and losses on security transactions are translated at the exchange rate on the trade date of each transaction. Other revenues, expenses and cash flows are translated using average exchange rates for the period. The resulting currency translation adjustments are reported in accumulated other comprehensive income. We include in earnings the realized currency exchange gains and losses resulting from transactions.

 

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Aflac Japan maintains an investment portfolio of dollar-denominated securities on behalf of Aflac U.S., which serves as an economic currency hedge of a portion of our investment in Aflac Japan. The functional currency for these investments is the U.S. dollar. The related investment income and realized/unrealized investment gains and losses are also denominated in U.S. dollars. Since the functional currency of Aflac Japan’s dollar-denominated portfolio is the U.S. dollar, there is no translation adjustment to record in other comprehensive income for these investments when the yen/dollar exchange rate changes. However, the foreign exchange gains and losses related to this portfolio are taxable in Japan and the U.S. when the securities mature or are sold. Until maturity or sale, deferred tax expense or benefit associated with the foreign exchange gains or losses are recognized in the income tax expense on other comprehensive income.

We have designated the yen-denominated Uridashi and Samurai notes and yen-denominated loans issued by the Parent Company as a hedge of our investment in Aflac Japan. Outstanding principal and related accrued interest on these items are translated into U.S. dollars at end-of-period exchange rates. Currency translation adjustments are recorded through other comprehensive income and are included in accumulated other comprehensive income.

Income Taxes: Income tax provisions are generally based on pretax earnings reported for financial statement purposes, which differ from those amounts used in preparing our income tax returns. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which we expect the temporary differences to reverse. We record deferred tax assets for tax positions taken based on our assessment of whether the tax position is more likely than not to be sustained upon examination by taxing authorities. A valuation allowance is established for deferred tax assets when it is more likely than not that an amount will not be realized.

As discussed in the Translation of Foreign Currencies section above, Aflac Japan maintains a dollar-denominated investment portfolio on behalf of Aflac U.S. While there are no translation effects to record in other comprehensive income, the deferred tax expense or benefit associated with foreign exchange gains or losses on the portfolio is recognized in other comprehensive income until the securities mature or are sold. Total income tax expense (benefit) related to items of other comprehensive income (loss) included a tax benefit of $112.4 million and $117.8 million during the three-month periods ended June 30, 2011 and 2010, respectively, for this dollar-denominated portfolio. Excluding these amounts from total taxes on other comprehensive income would result in an effective income tax rate on pretax other comprehensive income (loss) of 36.0% and 31.5% in the three-month periods ended June 30, 2011 and 2010, respectively. Total income tax expense (benefit) related to items of other comprehensive income (loss) included a tax benefit of $50.4 million and $95.3 million during the six-month periods ended June 30, 2011 and 2010, respectively, for this dollar-denominated portfolio. Excluding these amounts from total taxes on other comprehensive income would result in an effective income tax rate on pretax other comprehensive income (loss) of 35.7% and 33.5% in the six-month periods ended June 30, 2011 and 2010, respectively.

New Accounting Pronouncements

Recently Adopted Accounting Pronouncements

Fair value measurements and disclosures: In January 2010, the FASB issued amended accounting guidance on fair value disclosures. This guidance requires the activity in fair value hierarchy Level 3 for purchases, sales, issuances, and settlements to be reported on a gross, rather than net, basis. We adopted this guidance as of January 1, 2011. The adoption did not have an impact on our financial position or results of operations.

Accounting for variable interest entities and transfers of financial assets: In June 2009, the FASB issued amended guidance on accounting for variable interest entities (VIEs) and transfers of financial assets. As discussed above, this guidance defines new criteria for determining the primary beneficiary of a VIE; increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a VIE; eliminates the exemption for the consolidation of qualified special purpose entities (QSPEs); establishes conditions for reporting a transfer of a portion of a financial asset as a sale; modifies the financial asset derecognition criteria; and requires additional disclosures. We adopted the provisions of this guidance on January 1, 2010 as a cumulative effect of change in accounting principle. We were required to consolidate certain of the VIEs with which we are currently involved. We were not required to deconsolidate any VIEs on January 1, 2010.

Upon the initial consolidation of the VIEs on January 1, 2010, the assets, liabilities, and noncontrolling interests of the VIEs were recorded at their carrying values, which is the amounts at which the assets, liabilities, and noncontrolling interests would have been carried in the consolidated financial statements when we first met the conditions to be the primary beneficiary. For any of the VIEs that were required to be consolidated, we also considered whether any of the derivatives in these structures qualified on January 1, 2010, as a cash flow hedge of the changes in cash flows attributable to foreign currency and/or interest rate risk. Certain of the swaps did not qualify for hedge accounting since the swap had a

 

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fair value on January 1, 2010. Other swaps did not qualify for hedge accounting since they increased, rather than reduced, cash flow risk.

For additional information concerning our investments in VIEs and derivatives, see Notes 3 and 4, respectively.

Accounting Pronouncements Pending Adoption

Presentation of comprehensive income: In June 2011, the FASB issued guidance to amend the presentation of comprehensive income. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment also requires reclassification adjustments for items that are reclassified from other comprehensive income to net income to be presented in the statements where the components of net income and the components of other comprehensive income are presented. This guidance is effective for interim and annual periods beginning after December 15, 2011. We do not expect the adoption of this guidance to have any impact on our financial position or results of operations.

Fair value measurements and disclosures: In May 2011, the FASB issued guidance to amend the fair value measurement and disclosure requirements. Most of the amendments are clarifications of the FASB’s intent about the application of existing fair value measurement and disclosure requirements. Other amendments change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. The new fair value measurement disclosures include additional quantitative and qualitative disclosures for Level 3 measurements, including a qualitative sensitivity analysis of fair value to changes in unobservable inputs, and categorization by fair value hierarchy level for items for which the fair value is only disclosed. This guidance is effective for interim and annual periods beginning after December 15, 2011. We are currently evaluating the impact of adopting this guidance on our financial position and results of operations.

Accounting for costs associated with acquiring or renewing insurance contracts: In October 2010, the FASB issued amended accounting guidance on accounting for costs associated with acquiring or renewing insurance contracts. Only incremental direct costs associated with the successful acquisition of a new or renewal contract may be capitalized. The amendment also prohibits capitalizing direct-response advertising costs unless they meet certain criteria. This guidance is effective for interim and annual periods beginning after December 15, 2011. We are currently evaluating the impact of adopting this guidance on our financial position and results of operations.

Recent accounting guidance not discussed above is not applicable or did not have an impact on our business.

For additional information on new accounting pronouncements and recent accounting guidance and their impact, if any, on our financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

2.   BUSINESS SEGMENT INFORMATION

The Company consists of two reportable insurance business segments: Aflac Japan and Aflac U.S., both of which sell supplemental health and life insurance. Operating business segments that are not individually reportable are included in the “Other business segments” category.

We do not allocate corporate overhead expenses to business segments. We evaluate and manage our business segments using a financial performance measure called pretax operating earnings. Our definition of operating earnings excludes the following items from net earnings on an after-tax basis: realized investment gains/losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items. We then exclude income taxes related to operations to arrive at pretax operating earnings. Information regarding operations by segment follows:

 

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Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
(In millions)            2011                      2010                      2011                      2010          

Revenues:

           

  Aflac Japan:

           

Earned premiums

   $     3,770          $     3,186            $     7,472          $     6,393        

Net investment income

     636            593              1,285            1,186        

Other income

     5            (1)             25            26        

  Total Aflac Japan

     4,411            3,778              8,782            7,605        

  Aflac U.S.:

           

Earned premiums

     1,186            1,147              2,356            2,289        

Net investment income

     148            135              291            267        

Other income

     3            3              6            5        

  Total Aflac U.S.

     1,337            1,285              2,653            2,561        

  Other business segments

     13            11              28            23        

  Total business segment revenues

     5,761            5,074              11,463            10,189        

  Realized investment gains (losses)

     (668)           (89)             (1,247)           (135)       

  Corporate

     60            49              121            101        

  Intercompany eliminations

     (65)           (54)             (133)           (111)       

  Total revenues

   $ 5,088          $ 4,980            $ 10,204          $ 10,044        
                                     
           
     

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
(In millions)            2011                      2010                      2011                      2010          

Pretax earnings:

           

  Aflac Japan

   $ 931          $ 798            $ 1,911          $ 1,619        

  Aflac U.S.

     246            227              499            471        

  Other business segments

     0            (1)             0            (2)       

Total business segment pretax operating earnings

     1,177            1,024              2,410            2,088        

  Interest expense, noninsurance operations

     (41)           (31)             (82)           (63)       

  Corporate and eliminations

     (15)           (15)             (29)           (27)       

Pretax operating earnings

     1,121            978              2,299            1,998        

  Realized investment gains (losses)

     (668)           (89)             (1,247)           (135)       

Total earnings before income taxes

   $ 453          $ 889            $ 1,052          $ 1,863        
                                     

  Income taxes applicable to pretax operating earnings

   $ 388          $ 339            $ 795          $ 693        

  Effect of foreign currency translation on operating earnings

     51            12              99            33        
                                     

 

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Assets were as follows:

 

(In millions)   

June 30,    

    2011        

   

December 31,   

    2010        

 

Assets:

    

  Aflac Japan

   $ 92,290      $ 87,061   

  Aflac U.S.

     13,208        13,095   

  Other business segments

     162        155   

Total business segment assets

     105,660        100,311   

  Corporate

     14,950        14,047   

  Intercompany eliminations

     (14,378     (13,319

Total assets

   $ 106,232      $ 101,039   
   

 

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3.   INVESTMENTS

Investment Holdings

The amortized cost for our investments in debt and perpetual securities, the cost for equity securities and the fair values of these investments are shown in the following tables.

 

      June 30, 2011  
(In millions)    Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
       Fair
  Value
 

Securities available for sale,

  carried at fair value:

           

  Fixed maturities:

           

Yen-denominated:

           

Japan government and agencies

   $     17,436               $        556             $             12             $     17,980       

Mortgage- and asset-backed securities

     923                 32               5               950       

Public utilities

     2,575                 71               117               2,529       

Sovereign and supranational

     1,721                 119               19               1,821       

Banks/financial institutions

     4,766                 134               410               4,490       

Other corporate

     5,860                 154               485               5,529       

  Total yen-denominated

     33,281                 1,066               1,048               33,299       

Dollar-denominated:

           

U.S. government and agencies

     1,816                 71               0               1,887       

Municipalities

     1,027                 19               21               1,025       

Mortgage- and asset-backed securities(1)

     451                 98               1               548       

Collateralized debt obligations

     4                 0               0               4       

Public utilities

     2,824                 266               35               3,055       

Sovereign and supranational

     392                 67               3               456       

Banks/financial institutions

     3,298                 180               52               3,426       

Other corporate

     8,175                 700               69               8,806       

  Total dollar-denominated

     17,987                 1,401               181               19,207       

  Total fixed maturities

     51,268                 2,467               1,229               52,506       

  Perpetual securities:

           

Yen-denominated:

           

Banks/financial institutions

     6,570                 200               374               6,396       

Other corporate

     332                 25               0               357       

Dollar-denominated:

           

Banks/financial institutions

     357                 16               23               350       

  Total perpetual securities

     7,259                 241               397               7,103       

  Equity securities

     21                 4               2               23       

  Total securities available for sale

   $     58,548               $     2,712             $         1,628             $     59,632       
   

 

(1)

Includes less than $1 million of other-than-temporary non-credit-related losses

 

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      June 30, 2011  
(In millions)    Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    

Fair  

Value  

 

Securities held to maturity,

  carried at amortized cost:

           

  Fixed maturities:

           

Yen-denominated:

           

Japan government and agencies

   $         3,216             $     70            $         4           $       3,282        

Municipalities

     535               19              4             550        

Mortgage- and asset-backed securities

     136               4              0             140        

Public utilities

     6,396               260              127             6,529        

Sovereign and supranational

     4,173               198              89             4,282        

Banks/financial institutions

     12,303               211              589             11,925        

Other corporate

     5,149               214              89             5,274        

  Total yen-denominated

     31,908               976              902             31,982        

  Total securities held to maturity

   $   31,908             $   976            $   902           $   31,982        
   

 

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      December 31, 2010  
(In millions)    Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    

  Fair

  Value

 

Securities available for sale,

  carried at fair value:

           

  Fixed maturities:

           

Yen-denominated:

           

Japan government and agencies

   $     16,607               $     584             $     14             $     17,177       

Mortgage- and asset-backed securities

     1,224                 35               15               1,244       

Public utilities

     2,554                 117               80               2,591       

Sovereign and supranational

     903                 47               12               938       

Banks/financial institutions

     5,927                 152               1,177               4,902       

Other corporate

     5,733                 136               457               5,412       

  Total yen-denominated

     32,948                 1,071               1,755               32,264       

Dollar-denominated:

           

U.S. government and agencies

     32                 4               0               36       

Municipalities

     1,006                 9               42               973       

Mortgage- and asset-backed securities(1)

     485                 90               13               562       

Collateralized debt obligations

     5                 0               0               5       

Public utilities

     2,568                 246               36               2,778       

Sovereign and supranational

     395                 63               2               456       

Banks/financial institutions

     3,496                 143               108               3,531       

Other corporate

     7,167                 662               79               7,750       

  Total dollar-denominated

     15,154                 1,217               280               16,091       

  Total fixed maturities

     48,102                 2,288               2,035               48,355       

  Perpetual securities:

           

Yen-denominated:

           

Banks/financial institutions

     7,080                 172               533               6,719       

Other corporate

     328                 15               0               343       

Dollar-denominated:

           

Banks/financial institutions

     419                 61               30               450       

  Total perpetual securities

     7,827                 248               563               7,512       

  Equity securities

     22                 3               2               23       

  Total securities available for sale

   $     55,951               $     2,539             $     2,600             $     55,890       
                                     

 

(1) 

Includes $4 of other-than-temporary non-credit-related losses

 

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      December 31, 2010  
(In millions)    Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    

Fair

Value

 

Securities held to maturity,

  carried at amortized cost:

           

  Fixed maturities:

           

Yen-denominated:

           

Japan government and agencies

   $       344             $       4            $          4           $       344        

Municipalities

     407               18              2             423        

Mortgage- and asset-backed securities

     146               5              0             151        

Public utilities

     6,339               326              120             6,545        

Sovereign and supranational

     4,951               305              65             5,191        

Banks/financial institutions

     12,618               216              526             12,308        

Other corporate

     5,279               274              46             5,507        

  Total yen-denominated

     30,084               1,148              763             30,469        

  Total securities held to maturity

   $   30,084             $   1,148            $   763           $   30,469        
                                     

The methods of determining the fair values of our investments in debt securities, perpetual securities and equity securities are described in Note 5.

Included in the available-for-sale fixed maturities portfolio are securities with embedded derivatives for which we have elected the fair value option. These securities were recorded at a fair value of $637 million at June 30, 2011, compared with $619 million at December 31, 2010. We recognized in earnings investment gains of $9 million and $12 million during the three- and six-month periods ended June 30, 2011, respectively, compared with less than $1 million of losses during the three- and six-month periods ended June 30, 2010, for the changes in fair value of these securities, which excludes the effects of foreign currency translation and additional fair value option elections.

During the second quarter of 2011, we did not reclassify any investments from the held-to-maturity portfolio to the available-for-sale portfolio. During the first quarter of 2011, we reclassified eight investments from the held-to-maturity portfolio to the available-for-sale portfolio as a result of significant declines in the issuers’ credit worthiness. At the time of the transfer, the securities had an aggregate amortized cost of $1.6 billion and an aggregate unrealized loss of $270 million. The securities transferred in the first quarter of 2011 included our investments in the Republic of Tunisia that had an aggregate amortized cost of $769 million and four securities associated with financial institutions in Portugal and Ireland with an aggregate amortized cost of $631 million. See the Investment Concentration section below for a discussion of these financial institutions in Portugal and Ireland.

During the second quarter of 2010, we reclassified four investments from the held-to-maturity portfolio to the available-for-sale portfolio as a result of significant downgrades of the issuers’ credit rating. At the time of transfer, the securities had an aggregate amortized cost of $1.2 billion and an aggregate unrealized loss of $665 million. We did not reclassify any investments from the held-to-maturity portfolio to the available-for-sale portfolio during the first quarter of 2010.

 

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Contractual and Economic Maturities

The contractual maturities of our investments in fixed maturities at June 30, 2011, were as follows:

 

      Aflac Japan      Aflac U.S.  
(In millions)    Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair  
Value  
 

Available for sale:

           

Due in one year or less

   $ 1,515       $ 1,558       $ 56       $ 57     

Due after one year through five years

     3,755         3,964         255         287     

Due after five years through 10 years

     3,697         3,951         936         1,076     

Due after 10 years

     32,370         32,378         7,199         7,619     

Mortgage- and asset-backed securities

     1,327         1,441         47         56     

Total fixed maturities available for sale

   $ 42,664       $ 43,292       $     8,493       $     9,095     
                                     

Held to maturity:

           

Due in one year or less

   $ 714       $ 724       $ 0       $ 0     

Due after one year through five years

     1,172         1,265         0         0     

Due after five years through 10 years

     3,103         3,439         0         0     

Due after 10 years

     26,782         26,413         0         0     

Mortgage- and asset-backed securities

     137         141         0         0     

Total fixed maturities held to maturity

   $     31,908       $     31,982       $ 0       $ 0     
                                     

At June 30, 2011, the Parent Company had a portfolio of investment-grade available-for-sale fixed-maturity securities totaling $111 million at amortized cost and $119 million at fair value, which is not included in the table above.

Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.

The majority of our perpetual securities are subordinated to other debt obligations of the issuer, but rank higher than the issuer’s equity securities. Perpetual securities have characteristics of both debt and equity investments, along with unique features that create economic maturity dates for the securities. Although perpetual securities have no contractual maturity date, they have stated interest coupons that were fixed at their issuance and subsequently change to a floating short-term interest rate of 125 to more than 300 basis points above an appropriate market index, generally by the 25th year after issuance, thereby creating an economic maturity date. The economic maturities of our investments in perpetual securities, which were all reported as available for sale at June 30, 2011, were as follows:

 

      Aflac Japan      Aflac U.S.  
(In millions)    Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair  
Value  
 

Due in one year or less

   $ 435       $ 497       $ 0       $ 0     

Due after one year through five years

     1,498         1,555         5         5     

Due after five years through 10 years

     838         881         0         0     

Due after 10 years

     4,311         3,992         172         173     

Total perpetual securities available for sale

   $       7,082       $       6,925       $        177       $        178     
                                     

Investment Concentrations

Our investment discipline begins with a top-down approach for each investment opportunity we consider. Consistent with that approach, we first approve each country in which we invest. In our approach to sovereign analysis, we consider the political, legal and financial context of the sovereign entity in which an issuer is domiciled and operates. Next we approve the issuer’s industry sector, including such factors as the stability of results and the importance of the sector to the overall economy. Specific credit names within approved countries and industry sectors are evaluated for their market position and specific strengths and potential weaknesses. Structures in which we invest are chosen for specific portfolio management purposes, including asset/liability management, portfolio diversification and net investment income.

 

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Banks and Financial Institutions

Our largest investment industry sector concentration is banks and financial institutions. Within the countries we approve for investment opportunities, we primarily invest in financial institutions that are strategically crucial to each approved country’s economy. The bank and financial institution sector is a highly regulated industry and plays a strategic role in the global economy. We achieve some degree of diversification in the bank and financial institution sector through a geographically diverse universe of credit exposures. Within this sector, the more significant concentration of our credit risk by geographic region or country of issuer at June 30, 2011, based on amortized cost, was: Europe, excluding the United Kingdom (43%); United States (21%); United Kingdom (8%); Japan (8%); and other (20%).

Our total investments in the bank and financial institution sector, including those classified as perpetual securities, were as follows:

 

      June 30, 2011   December 31, 2010
      Total Investments in
Banks and Financial
Institutions Sector
(in millions)
     Percentage of
Total Investment
Portfolio
  Total Investments in
Banks and Financial
Institutions Sector
(in millions)
     Percentage of
Total Investment    
Portfolio

Debt Securities:

          

Amortized cost

   $         20,367                      22  %   $         22,041                 26  %    

Fair value

     19,841                      22          20,741                 24         

Perpetual Securities:

          

Upper Tier II:

          

Amortized cost

   $         4,426                       5  %   $           4,957                     6  %       

Fair value

     4,432                     5        4,748                  5         

Tier I:

          

Amortized cost

     2,501                      3          2,542                  3         

Fair value

     2,314                      2          2,421                  3         
          

Total:

          

Amortized cost

   $         27,294                       30  %   $         29,540                 35  %    

Fair value

     26,587                       29          27,910                  32          
                            

Investments in Greece, Ireland, Italy, Portugal and Spain

Our investment exposure to sovereign debt and financial institutions in Greece, Ireland, Italy, Portugal and Spain was as follows:

 

      June 30, 2011      December 31, 2010  
(In millions)    Amortized
Cost
    Fair   
Value   
     Amortized
Cost
    Fair   
Value   
 

Sovereign and supranational:

         

Italy

       $ 310       $ 304             $ 307       $ 306     

Spain

     737         768           730         782     

Total

       $ 1,047       $ 1,072             $ 1,037       $ 1,088     
                                   

Banks and financial institutions:

         

Greece

       $   0       $ 0             $   1,152       $ 391     

Ireland

     525         379           710         659     

Italy

     186         182           184         183     

Portugal

     282         282           859         770     

Spain

     531         499           526         503     

Total

        $ 1,524 (1)    $ 1,342              $ 3,431 (1)    $ 2,506     
                                   
(1) 

Represents 6% in 2011 and 12% in 2010 of total investments in the banks and financial institutions sector, and 1% in 2011 and 4% in 2010 of total investments in debt and perpetual securities

 

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Ireland

During the second quarter of 2011, we sold our holdings in Irish Life and Permanent PLC, which were below-investment-grade perpetual securities that had previously been impaired, at a pretax loss of $74 million ($48 million after-tax). This followed the sale of another of our impaired below-investment-grade Irish financial institution securities in the first quarter of 2011 at a $2 million pretax gain. As of June 30, 2011, senior securities included in the table above issued by an Irish financial institution with amortized cost and fair value totaling $248 million and $139 million, respectively, were rated below investment grade. We believe that these unrealized losses are linked more to Ireland’s systemic problems rather than issuer-specific credit factors. The Irish government has stated that it does not support burden-sharing for senior debt holdings such as ours. This Irish bank is current on its obligation to us, and we believe it has the ability to meet its obligations to us. In addition, as of June 30, 2011, we had the intent to hold this investment to recovery in value. As a result, we did not recognize an other-than-temporary impairment for this investment as of June 30, 2011.

Greece

During the second quarter of 2010, our investments in Greek financial institutions, Alpha Bank, EFG Eurobank Ergasias, and National Bank of Greece (NBG), all of which were Lower Tier II subordinated debt, were downgraded to below investment grade. As a result of the downgrades, we reclassified these investments from held to maturity to available for sale. At that time, we believed the downgrade of the Greek banks was largely related to the problems of the Greek government and its poor fiscal management, rather than the banks’ specific credit profiles. The three Greek bank issuers that comprised our Greek financial institution holdings had, on average, Tier I capital ratios higher than their peers in other troubled European sovereigns. Their capital was at a level that we felt could sustain deterioration in assets and operations that accompany economic conditions, such as those that the Greek economy was encountering in 2010 and those expected in the next few years. All three Greek banks had sufficient capital under the stress testing applied by the Committee of European Banking Supervisors (CEBS) in July 2010. However, the problems of the Greek government and related ratings downgrades have caused a decline in the confidence of depositors and capital market participants in the Greek banking system. As a result, the banks have significantly relied upon the European Central Bank (ECB) for liquidity via posting of collateral, which tends to be in the form of Greek Government Bonds (GGBs) or debt guaranteed by the sovereign. As of December 31, 2010, all of the Greek banks were current on their obligations to us. While these financial institutions have significant investments in GGBs, as of December 31, 2010, we believed that these institutions would be solvent even if there were a future restructuring of GGBs and they would have the ability to meet their obligations to us. In addition, as of December 31, 2010, we had the intent to hold these investments to recovery in value. As a result, we did not recognize an other-than-temporary impairment for these investments as of December 31, 2010.

Subsequent to December 31, 2010, Greece remained under pressure, which has also continued to weigh on the Greek banks. Skepticism over the rigor of the capital stress tests applied by the CEBS in July 2010 grew, especially as further problems have developed in the capital of the Irish banks. On February 18, 2011, NBG announced its proposal for a “friendly merger” with Alpha Bank, but Alpha Bank rejected this proposal. However, this proposal highlighted risks that accompany consolidation among the top three banks in Greece. While the proposal could have created a national champion in Greek banking, it also would have concentrated ownership of GGBs in the combined entity and formed a very low-rated entity among our top ten largest investment holdings. Two rating agencies downgraded the Greek banks subsequent to downgrading the sovereign during the first quarter of 2011 (on January 17, 2011, and March 9, 2011). In the latter action, the rating agency lowered the ratings indicative of the banks’ intrinsic financial strength due to the persistent pressure on liquidity, asset quality and material exposure to GGBs. In light of the above increased risks and, in particular, the March 9, 2011 downgrade, we no longer supported our previous intent to hold our Greek bank investments to recovery in value. In March 2011, we sold our investment in Alpha Bank and recognized an investment loss of $177 million ($115 million after-tax). In the first quarter of 2011, we recognized other-than-temporary impairment losses of $397 million ($258 million after-tax) for the remaining two Greek bank holdings. In the second quarter of 2011, we sold our investment in EFG Eurobank Ergasias for $2 million more than its recorded impaired value, and we sold our remaining Greek bank investment, NBG, for $47 million less than its recorded impaired value.

Portugal

As of December 31, 2010 and the end of first quarter 2011, the issuers of our Portuguese bank and financial investments, Banco BPI S.A., Caixa Geral de Depositos S.A., and Banco Espirito Santo S.A., were current on their obligations to us, were profitable and had adequate Tier I capital ratios. During the first quarter of 2011, these investments were downgraded to below-investment-grade. However, at that time we believed that these ratings and the unrealized loss position of the investments were the result of the fiscal problems in the Eurozone region rather than the banks’ specific credit profiles. We believed that Portugal’s financial institutions were stronger than their other Eurozone peers and had not required much state support. It was challenging to separate the difficulties of the sovereign from the banks since the banks’ sources of liquidity are limited due to the financial situation of the sovereign. We believed the government of Portugal had exercised

 

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more prudent fiscal policies and was in a better financial situation than some of its other Eurozone peers. However, on May 16, 2011 when the European Union officially announced a fiscal support package for Portugal, there was an increase in risk that Portugal could experience a stressed economic environment similar to that experienced in Greece and Ireland. We believed the terms of this fiscal support package could result in liquidity constraints on the banks and there could be a need for the banks to improve their liquidity and core capital. Such a situation could negatively impact our Lower Tier II securities and our ability to recover full principal and interest. Due to the reasonably possible risk that our Portuguese bank holdings could suffer further negative declines, we no longer supported our previous intent to hold our Portuguese bank investments to recovery in value and concluded that we would take steps to reduce our exposure in the region. In the second quarter of 2011, we sold our investment in Banco BPI, S.A. at a loss of $99 million ($64 million after-tax), and we recognized other-than-temporary impairment losses of $112 million ($73 million after-tax) and $163 million ($106 million after-tax) on our investments in Caixa Geral de Depositos S.A. and Banco Espirito Santo S.A., respectively.

With the exception of the securities discussed above, all other securities included in the table above were rated investment grade as of June 30, 2011.

Derisking

During the three- and six-month periods ended June 30, 2011, we pursued strategic investment activities to lower the risk profile of our investment portfolio. Our primary focus was on reducing our exposure to peripheral Eurozone investments (discussed in the preceding section), certain perpetual securities, and investments in certain banks or financial institutions. As a result of these derisking activities, we have no direct investment exposure in Greece, only senior indebtedness in Ireland, and materially lower exposure to Portuguese investments. Additional derisking activities have resulted in a reduction in exposure to some of our largest concentrated investment positions. See further details in the Realized Investment Gains and Losses section below.

Realized Investment Gains and Losses

Information regarding pretax realized gains and losses from investments is as follows:

 

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      Three Months Ended
June 30,
   

Six Months Ended

June 30,

 
(In millions)        2011             2010             2011             2010      

Realized investment gains (losses) on securities:

        

Debt securities:

        

Available for sale:

        

Gross gains from sales

   $ 10      $ 0      $ 36      $ 51   

Gross losses from sales

     (132     (110     (319     (190

Net gains (losses) from redemptions

     (1     1        6        1   

Other-than-temporary impairment losses

     (344     0        (748     0   

Total debt securities

     (467     (109     (1,025     (138

Perpetual securities:

        

Available for sale:

        

Gross gains from sales

     48        125        54        133   

Gross losses from sales

     (107     0        (109     0   

Other-than-temporary impairment losses

     (184     0        (184     (41

Total perpetual securities

     (243     125        (239     92   

Equity securities:

        

Gross losses from sales

     0        (2     0        (2

Other-than-temporary impairment losses

     0        0        (1     (1

Total equity securities

     0        (2     (1     (3

Other assets:

        

Derivative gains (losses)

     (25     (103     (55     (86

Other

     67        0        73        0   

Total other assets

     42        (103     18        (86

Total realized investment gains (losses)

   $ (668   $ (89   $ (1,247   $ (135
                                  

During the three- and six-month periods ended June 30, 2011, net investment losses from the sales of securities and recognized impairments were primarily a result of an implemented plan to reduce the risk exposure in our investment portfolio coupled with the continued decline in the credit worthiness of issuers of certain investments. See the Investment Concentrations section above for more information. A valuation allowance of $19 million was recorded in the second quarter of 2011 related to the deferred tax assets associated with our realized investment losses.

During the three- and six-month periods ended June 30, 2010, net investment losses from securities sold or redeemed occurred in the normal course of business.

Other-than-temporary Impairment

The fair value of our debt and perpetual security investments fluctuates based on changes in credit spreads in the global financial markets. Credit spreads are most impacted by market rates of interest, the general and specific credit environment and global market liquidity. We believe that fluctuations in the fair value of our investment securities related to changes in credit spreads have little bearing on whether our investment is ultimately recoverable. Generally, we consider such declines in fair value to be temporary even in situations where an investment remains in an unrealized loss position for a year or more.

However, in the course of our credit review process, we may determine that it is unlikely that we will recover our investment in an issuer due to factors specific to an individual issuer, as opposed to general changes in global credit spreads. In this event, we consider such a decline in the investment’s fair value, to the extent below the investment’s cost or amortized cost, to be an other-than-temporary impairment of the investment and write the investment down to its fair value. The determination of whether an impairment is other than temporary is subjective and involves the consideration of various factors and circumstances, which includes but is not limited to the following:

 

   

issuer financial condition, including profitability and cash flows

 

   

credit status of the issuer

 

   

the issuer’s specific and general competitive environment

 

   

published reports

 

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general economic environment

 

   

regulatory, legislative and political environment

 

   

the severity of the decline in fair value

 

   

the length of time the fair value is below cost

 

   

other factors as may become available from time to time

In addition to the usual investment risk associated with a debt instrument, our perpetual security holdings may be subject to the risk of nationalization of their issuers in connection with capital injections from an issuer’s sovereign government. We cannot be assured that such capital support will extend to all levels of an issuer’s capital structure. In addition, certain governments or regulators may consider imposing interest and principal payment restrictions on issuers of hybrid securities to preserve cash and build capital. In addition to the cash flow impact that additional deferrals would have on our portfolio, such deferrals could result in ratings downgrades of the affected securities, which in turn could impair the fair value of the securities and increase our regulatory capital requirements. We take factors such as these into account in our credit review process.

Another factor we consider in determining whether an impairment is other than temporary is an evaluation of our intent or requirement to sell the security prior to recovery of its amortized cost. We perform ongoing analyses of our liquidity needs, which includes cash flow testing of our policy liabilities, debt maturities, projected dividend payments and other cash flow and liquidity needs. Our cash flow testing includes extensive duration matching of our investment portfolio and policy liabilities. Based on our analyses, we have concluded that we have sufficient excess cash flows to meet our liquidity needs without liquidating any of our investments prior to their maturity. In addition, provided that our credit review process results in a conclusion that we will collect all of our cash flows and recover our investment in an issuer and the investment is within our target investment risk exposure limits, we generally do not sell investments prior to their maturity.

The majority of our investments are evaluated for other-than-temporary impairment using our debt impairment model. Our debt impairment model focuses on the ultimate collection of the cash flows from our investments. Our investments in perpetual securities that are rated below investment grade are evaluated for other-than-temporary impairment under our equity impairment model. Our equity impairment model focuses on the severity of a security’s decline in fair value coupled with the length of time the fair value of the security has been below amortized cost.

The following table details our pretax other-than-temporary impairment losses by investment category.

 

      Three Months Ended
June 30,
     Six Months Ended
June 30,
 
(In millions)        2011          2010          2011              2010      

Perpetual securities

   $ 184       $ 0       $ 184       $ 41   

Corporate bonds

     343         0         740         0   

Mortgage- and asset-backed securities

     1         0         7         0   

Municipalities

     0         0         1         0   

Equity securities

     0         0         1         1   

Total other-than-temporary impairment losses realized

   $ 528       $ 0       $ 933       $ 42   
                                     

We apply the debt security impairment model to our perpetual securities provided there has been no evidence of deterioration in credit of the issuer, such as a downgrade of the rating of a perpetual security to below investment grade. Subsequent to our initial investment, the perpetual securities of four issuers we own had been downgraded to below investment grade as of June 30, 2011. As a result of these downgrades, we were required to evaluate these securities for other-than-temporary impairment using the equity security impairment model rather than the debt security impairment model. Use of the equity security model limits the forecasted recovery period that can be used in the impairment evaluation and, accordingly, affects both the recognition and measurement of other-than-temporary impairment losses. We did not recognize any other-than-temporary impairment losses for perpetual securities from evaluation under our equity impairment model during the three- and six-month periods ended June 30, 2011. However, we recognized an other-than-temporary impairment loss of $184 million ($120 million after-tax) on perpetual securities during the three- and six-month periods ended June 30, 2011 due to further deterioration in the issuer’s creditworthiness. We recognized other-than-temporary impairment losses for perpetual securities from evaluation under our equity impairment model of $41 million ($27 million after-tax) during the six-month period ended June 30, 2010, however none of those impairment losses were recognized in the three-month period ended June 30, 2010.

Certain of our mortgage- and asset-backed securities had other-than-temporary impairments recognized prior to 2010 that had credit-related and non-credit-related components. The following table summarizes cumulative credit-related impairment losses on the securities still held at the end of the reporting period, for which other-than-temporary losses have been recognized and only the amount related to credit loss was recognized in earnings.

 

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Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
(In millions)        2011              2010              2011              2010      

Cumulative credit loss impairments, beginning of period

   $ 4       $ 23         $ 13         $ 24     

Securities sold during period

     0         (10)          (9)          (11)    

Cumulative credit loss impairments, end of period

   $ 4       $ 13         $ 4         $ 13     
                                     

Unrealized Investment Gains and Losses

Effect on Shareholders’ Equity

The net effect on shareholders’ equity of unrealized gains and losses from investment securities was as follows:

 

(In millions)   

June 30,

2011

   

December 31,

2010

 

Unrealized gains (losses) on securities available for sale

   $ 1,084      $ (61)       

Unamortized unrealized gains on securities transferred to held to maturity

     98        135        

Deferred income taxes

     (430     (41)       

Shareholders’ equity, unrealized gains (losses) on investment securities

   $ 752      $ 33        
                  

Gross Unrealized Loss Aging

The following tables show the fair value and gross unrealized losses, including the portion of other-than-temporary impairment recognized in accumulated other comprehensive income, of our available-for-sale and held-to-maturity investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

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      June 30, 2011  
      Total      Less than 12 months      12 months or longer  
(In millions)    Fair
    Value    
     Unrealized
Losses
     Fair
    Value    
     Unrealized
Losses
     Fair
    Value    
    

Unrealized  

Losses  

 

Fixed maturities:

                 

Japan government and agencies:

                 

Yen-denominated

   $ 1,590       $ 16       $ 1,590       $ 16       $ 0       $ 0     

Municipalities:

                 

Dollar-denominated

     405         21         365         9         40         12     

Yen-denominated

     58         4         0         0         58         4     

Mortgage- and asset- backed securities:

                 

Dollar-denominated

     20         1         5         0         15         1     

Yen-denominated

     154         5         12         1         142         4     

Public utilities:

                 

Dollar-denominated

     636         35         585         28         51         7     

Yen-denominated

     4,340         244         1,886         42         2,454         202     

Sovereign and supranational:

                 

Dollar-denominated

     62         3         29         1         33         2     

Yen-denominated

     2,115         108         968         16         1,147         92     

Banks/financial institutions:

                 

Dollar-denominated

     1,074         52         535         15         539         37     

Yen-denominated

     9,517         999         1,111         29         8,406         970     

Other corporate:

                 

Dollar-denominated

     1,882         69         1,512         43         370         26     

Yen-denominated

     4,739         574         1,248         53         3,491         521     

Total fixed maturities

     26,592         2,131         9,846         253         16,746         1,878     

Perpetual securities:

                 

Dollar-denominated

     210         23         117         3         93         20     

Yen-denominated

     3,096         374         482         21         2,614         353     

Total perpetual securities

     3,306         397         599         24         2,707         373     

Equity securities

     8         2         6         1         2         1     

Total

   $ 29,906       $ 2,530       $ 10,451       $ 278       $ 19,455       $ 2,252     
                                                       

 

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      December 31, 2010  
      Total      Less than 12 months      12 months or longer  
(In millions)    Fair
    Value    
     Unrealized
Losses
     Fair
    Value    
     Unrealized
Losses
     Fair
    Value    
     Unrealized  
Losses  
 

Fixed maturities:

                 

Japan government and agencies:

                 

Yen-denominated

   $ 1,634       $ 18       $ 1,634       $ 18       $ 0       $ 0            

Municipalities:

                 

Dollar-denominated

     682         42         632         28         50         14            

Yen-denominated

     59         2         0         0         59         2            

Mortgage- and asset- backed securities:

                 

Dollar-denominated

     78         13         20         0         58         13            

Yen-denominated

     415         15         415         15         0         0            

Public utilities:

                 

Dollar-denominated

     556         36         498         28         58         8            

Yen-denominated

     2,877         200         766         47         2,111         153            

Sovereign and supranational:

                 

Dollar-denominated

     45         2         12         0         33         2            

Yen-denominated

     1,579         77         428         1         1,151         76            

Banks/financial institutions:

                 

Dollar-denominated

     1,484         108         753         22         731         86            

Yen-denominated

     10,609         1,703         1,506         40         9,103         1,663            

Other corporate:

                 

Dollar-denominated

     1,741         79         1,456         52         285         27            

Yen-denominated

     4,503         503         507         45         3,996         458            

Total fixed maturities

     26,262         2,798         8,627         296         17,635         2,502            

Perpetual securities:

                 

Dollar-denominated

     208         30         149         19         59         11            

Yen-denominated

     4,171         533         1,793         119         2,378         414            

Total perpetual securities

     4,379         563         1,942         138         2,437         425            

Equity securities

     13         2         13         1         0         1            

Total

   $ 30,654       $ 3,363       $ 10,582       $ 435       $ 20,072       $ 2,928            
   

Analysis of Securities in Unrealized Loss Positions

The unrealized losses on our investments have been primarily related to changes in interest rates, foreign exchange rates or the widening of credit spreads rather than specific issuer credit-related events. In addition, because we do not intend to sell and do not believe it is likely that we will be required to sell these investments before a recovery of fair value to amortized cost, we do not consider any of these investments to be other-than-temporarily impaired as of and for the six-month period ended June 30, 2011. The following summarizes our evaluation of investment categories with significant unrealized losses and securities that were rated below investment grade. All other investment categories with securities in an unrealized loss position that are not specifically discussed below were composed of investment grade fixed maturities.

 

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Municipalities and Mortgage- and Asset-Backed Securities

As of June 30, 2011, 71% of the unrealized losses on investment securities in the municipalities sector and 70% of the unrealized losses on investment securities in the mortgage- and asset-backed securities sector were related to investments that were investment grade, compared with 82% and 54%, respectively, at December 31, 2010. We have determined that the majority of the unrealized losses on the investments in these sectors were caused by widening credit spreads. However, we have determined that the ability of the issuers to service our investments has not been compromised. Unrealized gains or losses related to prevailing interest rate environments are impacted by the remaining time to maturity of an investment. Assuming no credit-related factors develop, as investments near maturity the unrealized gains or losses can be expected to diminish.

Public Utilities

As of June 30, 2011, 95% of the unrealized losses on investments in the public utilities sector were related to investments that were investment grade, compared with 100% at December 31, 2010. For any credit-related declines in fair value, we perform a more focused review of the related issuer’s credit ratings, financial statements and other available financial data, timeliness of payment, competitive environment and any other significant data related to the issuer. From those reviews, we evaluate the issuers’ continued ability to service our investments. We have determined that the majority of the unrealized losses on the investments in the public utilities sector was caused by a decline in creditworthiness of a couple issuers in this sector. Also impacting the unrealized losses in the public utilities sector was widening credit spreads. Based on our credit analysis, we believe that our investments in this sector have the ability to service their obligations to us.

Bank and Financial Institution Investments

The following table shows the composition of our investments in an unrealized loss position in the bank and financial institution sector by fixed-maturity securities and perpetual securities. The table reflects those securities in that sector that were in an unrealized loss position as a percentage of our total investment portfolio in an unrealized loss position and their respective unrealized losses as a percentage of total unrealized losses.

 

      June 30, 2011   December 31, 2010
      Percentage of
Total Investments in
an Unrealized Loss
Position
  Percentage of
Total
Unrealized
Losses
  Percentage of
Total Investments in
an Unrealized Loss
Position
  Percentage of
        Total        
Unrealized
        Losses        

Fixed maturities

    35  %    41  %   39  %    54  %

Perpetual securities:

        

Upper Tier II

   5       6       9       10    

Tier I

   6       10       5       7    

Total perpetual securities

   11       16         14         17      

Total

    46  %   57  %   53  %    71  %
                  

As of June 30, 2011, 78% of the $1.4 billion in unrealized losses on investments in the bank and financial institution sector, including perpetual securities, were related to investments that were investment grade, compared with 53% at December 31, 2010. This improvement is primarily due to the recognition of other-than-temporary impairments and sales of bank and financial institution securities during the first six months of 2011. Of the $13.9 billion in investments, at fair value, in the bank and financial institution sector in an unrealized loss position at June 30, 2011, only $.8 billion ($.3 billion in unrealized losses) were below investment grade. Two investments comprised nearly 83% of the $.3 billion unrealized loss. The remaining investments that comprised the unrealized loss were divided among eight issuers with average unrealized losses per investment of less than $7 million. We conduct our own independent credit analysis for investments in the bank and financial sector. Our assessment includes analysis of financial information, as well as consultation with the issuers from time to time. Based on our credit analysis, we have determined that the majority of the unrealized losses on the investments in this sector were caused by widening credit spreads, the downturn in the global economic environment and, to a lesser extent, changes in foreign exchange rates. Unrealized gains or losses related to prevailing interest rate environments are impacted by the remaining time to maturity of an investment. Assuming no credit-related factors develop, as investments near maturity, the unrealized gains or losses can be expected to diminish. Based on our credit analysis, we believe that our investments in this sector have the ability to service their obligations to us.

Other Corporate Investments

As of June 30, 2011, 61% of the unrealized losses on investments in the other corporate sector were related to investments that were investment grade, compared with 51% at December 31, 2010. For any credit-related declines in market

 

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value, we perform a more focused review of the related issuer’s credit ratings, financial statements and other available financial data, timeliness of payment, competitive environment and any other significant data related to the issuer. From those reviews, we evaluate the issuers’ continued ability to service our investments. We have determined that the majority of the unrealized losses on the investments in the other corporate sector was caused by widening credit spreads. Also impacting the unrealized losses in this sector is the decline in creditworthiness of certain issuers in the other corporate sector. Based on our credit analysis, we believe that our investments in this sector have the ability to service their obligation to us.

Perpetual Securities

At June 30, 2011, 93% of the unrealized losses on investments in perpetual securities were related to investments that were investment grade, compared with 83% at December 31, 2010. This improvement is primarily a result of the recognition of other-than-temporary impairments and sales of perpetual securities during the second quarter of 2011. The majority of our investments in Upper Tier II and Tier I perpetual securities were in highly rated global financial institutions. Upper Tier II securities have more debt-like characteristics than Tier I securities and are senior to Tier I securities, preferred stock, and common equity of the issuer. Conversely, Tier I securities have more equity-like characteristics, but are senior to the common equity of the issuer. They may also be senior to certain preferred shares, depending on the individual security, the issuer’s capital structure and the regulatory jurisdiction of the issuer.

Details of our holdings of perpetual securities were as follows:

Perpetual Securities

            June 30, 2011     December 31, 2010  
(In millions)    Credit
Rating
   Amortized
Cost
     Fair
Value
     Unrealized
Gain (Loss)
    Amortized
Cost
     Fair
Value
     Unrealized
Gain (Loss)
 

Upper Tier II:

                   
   AA    $ 192       $ 204       $ 12      $ 190       $ 201       $ 11   
   A      3,247         3,260         13        3,279         3,250         (29
   BBB      1,051         1,057         6        1,274         1,164         (110
   BB or lower      268         268         0        542         476         (66

  Total Upper Tier II

          4,758         4,789         31        5,285         5,091         (194

Tier I:

                   
   A      601         524         (77     632         568         (64
   BBB      1,531         1,446         (85     1,386         1,296         (90
   BB or lower      369         344         (25     524         557         33   

  Total Tier I

          2,501         2,314         (187     2,542         2,421         (121

  Total

      $ 7,259       $ 7,103       $ (156   $ 7,827       $ 7,512       $ (315
                                                           

As discussed previously in the Investments Concentration section, a component of our efforts during the first half of 2011 to reduce risk in our investment portfolio included sales of certain investments in perpetual securities. With the exception of the Icelandic bank securities that we completely impaired in 2008, all of the perpetual securities we own were not in default on interest and principal payments at June 30, 2011. During the three-month period ended June 30, 2011, we wrote-off accrued interest income and stopped accruing further interest income for the Dexia S.A. Upper Tier II perpetual securities which have a deferred coupon and were impaired in the second quarter of 2011. Based on amortized cost as of June 30, 2011, the geographic breakdown of our perpetual securities by issuer was as follows: European countries, excluding the United Kingdom, (70%); the United Kingdom (10%); Japan (14%); and other (6%). To determine any credit-related declines in fair value, we perform a more focused review of the related issuer’s credit ratings, financial statements and other available financial data, timeliness of payment, competitive environment and any other significant data related to the issuer. From those reviews, we evaluate the issuer’s continued ability to service our investment.

We have determined that the majority of our unrealized losses in the perpetual security category has been principally due to widening credit spreads, largely as the result of the contraction of liquidity in the capital markets. However, there was some credit tightening in the first six months of 2011 that improved our net unrealized loss position. Based on our reviews, we concluded that the ability of the issuers to service our investment has not been compromised by these factors. Unrealized gains or losses related to prevailing interest rate environments are impacted by the remaining time to maturity of an investment. Assuming no credit-related factors develop, as the investments near economic maturity, the unrealized gains or losses can be expected to diminish. Based on our credit analyses, we believe that our investments in this sector have the ability to service their obligation to us.

 

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Variable Interest Entities (VIEs)

As discussed in Note 1, effective January 1, 2010, we have consolidated all of the components of each former QSPE investment, including a fixed-maturity or perpetual investment and a corresponding derivative transaction. Our risk of loss over the life of each investment is limited to the amount of our original investment. In addition, new criteria for determining the primary beneficiary of a VIE that was effective January 1, 2010, resulted in the consolidation of additional VIE investments. The following table details our investments in VIEs.

Investments in Variable Interest Entities

      June 30, 2011     December 31, 2010      
(In millions)    Amortized
Cost
    Fair
Value
    Amortized
Cost
   

Fair

Value  

 

VIEs:

        

Consolidated:

        

  Total VIEs consolidated

   $ 7,104      $ 7,247      $ 7,201      $ 7,363     

Not consolidated:

        

CDOs

     4        4        5        5     

Other

     13,044        13,191        13,914        13,214     

  Total VIEs not consolidated

     13,048        13,195        13,919        13,219     

  Total VIEs

   $ 20,152      $     20,442      $ 21,120      $ 20,582     
                                  

As a condition to our involvement or investment in a VIE, we enter into certain protective rights and covenants that preclude changes in the structure of the VIE that would alter the creditworthiness of our investment or our beneficial interest in the VIE.

Our involvement with all of the VIEs in which we have an interest is passive in nature, and we are not the arranger of these entities. Except as relates to our review and evaluation of the structure of these VIEs in the normal course of our investment decision-making process, we have not been involved in establishing these entities. Further, we have not been nor are we required to purchase the securities issued in the future by any of these VIEs.

Our ownership interest in the VIEs is limited to holding the obligations issued by them. All of the VIEs in which we invest are static with respect to funding and have no ongoing forms of funding after the initial funding date. We have no direct or contingent obligations to fund the limited activities of these VIEs, nor do we have any direct or indirect financial guarantees related to the limited activities of these VIEs. We have not provided any assistance or any other type of financing support to any of the VIEs we invest in, nor do we have any intention to do so in the future. The weighted-average lives of our notes are very similar to the underlying collateral held by these VIEs where applicable.

Our risk of loss related to our interests in any of our VIEs is limited to our investment in the debt securities issued by them.

VIEs-Consolidated

We are substantively the only investor in the consolidated VIEs listed in the table above. As the sole investor in these VIEs, we have the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and are therefore considered to be the primary beneficiary of the VIEs that we consolidate. We also participate in substantially all of the variability created by these VIEs. The activities of these VIEs are limited to holding debt and perpetual securities and interest rate, foreign currency, and/or credit default swaps (CDSs), as appropriate, and utilizing the cash flows from these securities to service our investment. Neither we nor any of our creditors are able to obtain the underlying collateral of the VIEs unless there is an event of default or other specified event. For those VIEs that contain a swap, we are not a direct counterparty to the swap contracts and have no control over them. Our loss exposure to these VIEs is limited to our original investment. Our consolidated VIEs do not rely on outside or ongoing sources of funding to support their activities beyond the underlying collateral and swap contracts, if applicable. With the exception of our investment in senior secured bank loans through a unit trust structure that we began investing in during the second quarter of 2011, the underlying collateral assets and funding of our consolidated VIEs are generally static in nature and the underlying collateral and the reference corporate entities covered by any CDS contracts are all investment grade at the time of issuance.

We are exposed to credit losses within any consolidated collateralized debt obligations (CDOs) that could result in principal losses to our investments. We have mitigated our risk of credit loss through the structure of the VIE,

 

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which contractually requires the subordinated tranches within these VIEs to absorb the majority of the expected losses from the underlying credit default swaps. We currently own only senior CDO tranches. Based on our statistical analysis models, each of these VIEs can sustain a reasonable number of defaults in the underlying reference corporate entities in the CDSs with no loss to our investment.

VIEs-Not Consolidated

With the exception of one CDO investment, the VIEs that we are not required to consolidate are investments that are limited to loans in the form of debt obligations from the VIEs that are irrevocably and unconditionally guaranteed by their corporate parents. These VIEs are the primary financing vehicles used by their corporate sponsors to raise financing in the international capital markets. The variable interests created by these VIEs are principally or solely a result of the debt instruments issued by them. We do not have the power to direct the activities that most significantly impact the entity’s economic performance, nor do we have (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. As such, we are not the primary beneficiary of these VIEs and are therefore not required to consolidate them. These VIE investments are comprised of securities from 167 separate issuers which have an average credit rating of A.

Securities Lending

We lend fixed-maturity securities to financial institutions in short-term security-lending transactions. These short-term security-lending arrangements increase investment income with minimal risk. Our security lending policy requires that the fair value of the securities and/or unrestricted cash received as collateral be 102% or more of the fair value of the loaned securities. The following table presents our security loans outstanding and the corresponding collateral held:

 

(In millions)    June 30,    
2011  
     December 31,    
2010  
 

Security loans outstanding, fair value

   $ 328           $ 186       

Cash collateral on loaned securities

     338             191       
                   

All security lending agreements are callable by us at any time.

4.   DERIVATIVE INSTRUMENTS

We do not use derivative financial instruments for trading purposes, nor do we engage in leveraged derivative transactions. The majority of our freestanding derivatives are interest rate, foreign currency and credit default swaps that are associated with investments in special-purpose entities, including VIEs where we are the primary beneficiary. The remaining derivatives are interest rate swaps associated with our variable interest rate yen-denominated debt.

Derivative Types

Interest rate and credit default swaps involve the periodic exchange of cash flows with other parties, at specified intervals, calculated using agreed upon rates or other financial variables and notional principal amounts. Generally, no cash or principal payments are exchanged at the inception of the contract. Typically, at the time a swap is entered into, the cash flow streams exchanged by the counterparties are equal in value. Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed-maturity securities contracts to fixed rates. These derivatives are predominantly used to better match cash receipts from assets with cash disbursements required to fund liabilities.

Credit default swaps are used to assume credit risk related to an individual security or an index. These contracts entitle the consolidated VIE to receive a periodic fee in exchange for an obligation to compensate the derivative counterparty should the referenced security issuers experience a credit event, as defined in the contract. The consolidated VIE is also exposed to credit risk due to embedded derivatives associated with credit-linked notes.

Foreign currency swaps exchange an initial principal amount in two currencies, agreeing to re-exchange the currencies at a future date, at an agreed upon exchange rate. There may also be a periodic exchange of payments at specified intervals based on the agreed upon rates and notional amounts. Foreign currency swaps are used primarily in the consolidated VIEs in our Aflac Japan portfolio to convert foreign denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations.

 

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Credit Risk Assumed through Derivatives

Our exposure to credit risk in the event of nonperformance by counterparties to our interest rate swaps associated with our variable interest rate Uridashi notes as of June 30, 2011, was immaterial. For the interest rate, foreign currency, and credit default swaps associated with our VIE investments for which we are the primary beneficiary, we do not bear the risk of loss for counterparty default. We are not a direct counterparty to those contracts.

As a result of consolidation of certain VIE investments on January 1, 2010, we began recognizing related credit default swaps that assume credit risk from an asset pool. Those consolidated VIEs will receive periodic payments based on an agreed upon rate and notional amount and will only make a payment by delivery of associated collateral, which consists of highly rated asset-backed securities, if there is a credit event. A credit event payment will typically be equal to the notional value of the swap contract less the value of the referenced obligations. A credit event is generally defined as a default on contractually obligated interest or principal payments or bankruptcy of the referenced entity. The credit default swaps in which the consolidated VIE assumes credit risk primarily reference investment grade baskets. The diversified portfolios of corporate issuers are established within sector concentration limits.

The following tables present the maximum potential risk, fair value, weighted-average years to maturity, and underlying referenced credit obligation type for credit default swaps.

 

      June 30, 2011  
     

Less than

one year

    

One to

three years

    

Three to

five years

   

Five to

ten years

    Total  
(In millions)    Maximum
potential
risk
     Estimated
fair value
     Maximum
potential
risk
     Estimated
fair value
     Maximum
potential
risk
    Estimated
fair value
    Maximum
potential
risk
    Estimated
fair value
    Maximum
potential
risk
    Estimated
fair value
 

Index exposure:

  

                     

Corporate bonds

   $ 0       $ 0       $ 0       $ 0       $ (141   $ (11   $ (418   $ (242   $ (559   $ (253
                                                                                      

 

      December 31, 2010  
     

Less than

one year

    

One to

three years

    

Three to

five years

   

Five to

ten years

    Total  
(In millions)    Maximum
potential
risk
     Estimated
fair value
     Maximum
potential
risk
     Estimated
fair value
     Maximum
potential
risk
    Estimated
fair value
    Maximum
potential
risk
    Estimated
fair value
    Maximum
potential
risk
    Estimated
fair value
 

Index exposure:

  

                     

Corporate bonds

   $ 0       $ 0       $ 0       $ 0       $ (340   $ (118   $ (416   $ (225   $ (756   $ (343
                                                                                      

Derivative Balance Sheet Classification

The tables below summarize the balance sheet classification of our derivative fair value amounts, as well as the gross asset and liability fair value amounts. The fair value amounts presented do not include income accruals. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated. Notional amounts are not reflective of credit risk.

 

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      June 30, 2011  
(In millions)    Net Derivatives     Asset
Derivatives
     Liability
Derivatives
 
Hedge Designation/ Derivative Type    Notional
Amount
     Fair Value     Fair Value      Fair Value  

Cash flow hedges:

          

Interest rate swaps

     $ 248         $ (1)        $ 0         $ (1)   

Foreign currency swaps

       575           71           94           (23)   

Total cash flow hedges

       823           70           94           (24)   

Non-qualifying strategies:

          

Interest rate swaps

       546           121           125           (4)   

Foreign currency swaps

       3,927           (27)          276           (303)   

Credit default swaps

       559           (253)          0           (253)   

Total non-qualifying strategies

       5,032           (159)          401           (560)   

Total cash flow hedges and non-qualifying strategies

     $ 5,855         $ (89)        $ 495         $ (584)   
                                    

Balance Sheet Location

                                  

Other assets

     $ 2,267         $ 495         $ 495         $   

Other liabilities

       3,588           (584)          0           (584)   

Total derivatives

     $ 5,855         $ (89)        $ 495         $ (584)   
                                    
          
      December 31, 2010  
(In millions)    Net Derivatives     Asset
Derivatives
     Liability
Derivatives
 
Hedge Designation/ Derivative Type    Notional
Amount
     Fair Value     Fair Value      Fair Value  

Cash flow hedges:

          

Interest rate swaps

   $ 245       $ (2)      $ 0       $ (2)   

Foreign currency swaps

     615         170         180         (10)   

Total cash flow hedges

     860         168         180         (12)   

Non-qualifying strategies:

          

Interest rate swaps

     743         56         124         (68)   

Foreign currency swaps

     3,815         (58)        260         (318)   

Credit default swaps

     756         (343)        0         (343)   

Total non-qualifying strategies

     5,314         (345)        384         (729)   

Total cash flow hedges and non-qualifying strategies

   $ 6,174       $ (177)      $ 564       $ (741)   
                                    

Balance Sheet Location

                                  

Other assets

   $ 2,364       $ 564      $ 564       $ 0   

Other liabilities

     3,810         (741     0         (741

Total derivatives

   $ 6,174       $ (177   $ 564       $ (741
                                    

Hedging

Certain of our consolidated VIEs have interest rate and/or foreign currency swaps that qualify for hedge accounting treatment. For those that have qualified, we have designated the derivative as a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset (“cash flow” hedge). We expect to continue this hedging activity for a weighted-average period of approximately 25 years. The remaining derivatives in our consolidated VIEs that have not qualified for hedge accounting have been designated as held for other investment purposes (“non-qualifying strategies”).

 

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We have interest rate swap agreements related to our 20 billion yen variable interest rate Uridashi notes that will mature in September 2011 and our 5.5 billion yen variable interest rate Samurai notes that we issued subsequent to the end of the second quarter in July 2011 (see Note 6). By entering into these contracts, we swapped the variable interest rate to a fixed interest rate of 1.52% for the Uridashi notes and 1.475% for the Samurai notes. We have designated these interest rate swaps as a hedge of the variability in our interest cash flows associated with the respective variable interest rate notes. The notional amounts and terms of the swaps match the principal amount and terms of the corresponding variable interest rate notes, and the swaps had no value at inception. Changes in the fair value of the swap contracts are recorded in other comprehensive income so long as the hedge is deemed effective. Should any portion of the hedge be deemed ineffective, that value would be reported in net earnings.

Hedge Documentation and Effectiveness Testing

To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated changes in cash flow of the hedged item. At hedge inception, we formally document all relationships between hedging instruments and hedged items, as well as our risk-management objective and strategy for undertaking each hedge transaction. The documentation process includes linking derivatives that are designated as cash flow hedges to specific assets or liabilities on the statement of financial position or to specific forecasted transactions and defining the effectiveness and ineffectiveness testing methods to be used. At the hedge’s inception and on an ongoing quarterly basis, we also formally assess whether the derivatives that are used in hedging transactions have been and are expected to continue to be highly effective in offsetting changes in cash flows of hedged items. Hedge effectiveness is assessed using qualitative and quantitative methods. Qualitative methods may include the comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in cash flows associated with the hedge relationship. Hedge ineffectiveness of the hedge relationships is measured each reporting period using the “Hypothetical Derivative Method.”

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings as a component of realized investment gains (losses). All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

Discontinuance of Hedge Accounting

We discontinue hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the cash flows of a hedged item; (2) the derivative is de-designated as a hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.

When hedge accounting is discontinued on a cash-flow hedge, including those where the derivative is sold, terminated or exercised, amounts previously deferred in other comprehensive income are reclassified into earnings when earnings are impacted by the cash flow of the hedged item.

Cash Flow Hedges

The following tables present the components of the gain or loss on derivatives that qualify as cash flow hedges:

Derivatives in Cash Flow Hedging Relationships

 

(In millions)   Gain (Loss) Recognized in
Other Comprehensive Income
on  Derivative (Effective Portion)
    Net Realized Investment Gains (Losses)
Recognized in Income
on Derivative (Ineffective Portion)
 
    

Three Months Ended

June 30, 2011

   

Six Months Ended

June 30, 2011

   

Three Months Ended

June 30, 2011

   

Six Months Ended

June 30, 2011

 

Interest rate swaps

  $ 0      $ 1      $ 0      $ 0   

Foreign currency swaps

    17        (39     2        (2

Total

  $ 17      $ (38   $ 2      $ (2 )  
                                 

 

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Derivatives in Cash Flow Hedging Relationships

 

(In millions)    Gain (Loss) Recognized in
Other Comprehensive Income
on  Derivative (Effective Portion)
    Net Realized Investment Gains (Losses)
Recognized in Income
on Derivative (Ineffective Portion)
 
      Three Months Ended
June 30, 2010
     Six Months Ended
June 30, 2010
   

Three Months Ended

June 30, 2010

   

Six Months Ended

June 30, 2010

 

Interest rate swaps

   $            0       $            1      $            0      $            0   

Foreign currency swaps

     8         (3     3        0   

Total

   $ 8       $ (2   $ 3      $ 0   
                                   

There was no gain or loss reclassified from accumulated other comprehensive income into earnings related to our cash flow hedges for the three- and six-month periods ended June 30, 2011 and 2010. As of June 30, 2011, pretax deferred net gains on derivative instruments recorded in accumulated other comprehensive income that are expected to be reclassified to earnings during the next twelve months are immaterial.

Non-qualifying Strategies

For our derivative instruments in consolidated VIEs that do not qualify for hedge accounting treatment, all changes in their fair value are reported in current period earnings as net realized investment gains (losses). The following table presents the gain or loss recognized in income on non-qualifying strategies:

Non-qualifying Strategies

Gain (Loss) Recognized within Net Realized Investment Gains (Losses)

 

(In millions)    Three Months Ended
June 30, 2011
    Six Months Ended
June 30, 2011
 

Interest rate swaps

   $ 4      $ (1

Foreign currency swaps

     3        (26

Credit default swaps

     (43     (38

Other

     9        12   

Total

   $ (27   $ (53
   

Non-qualifying Strategies

Gain (Loss) Recognized within Net Realized Investment Gains (Losses)

(In millions)    Three Months Ended
June 30, 2010
    Six Months Ended
June 30, 2010
 

Interest rate swaps

   $ 8      $ 3   

Foreign currency swaps

     (48     (44

Credit default swaps

     (66     (45

Total

   $ (106   $ (86
   

The amount of gain or loss recognized in earnings for our VIEs is attributable to the derivatives in those investment structures. While the change in value of the swaps is recorded through current period earnings, the change in value of the available-for-sale fixed income or perpetual securities associated with these swaps is recorded through other comprehensive income.

Nonderivative Hedges

Our primary exposure to be hedged is our net investment in Aflac Japan, which is affected by changes in the yen/dollar exchange rate. To mitigate this exposure, we have taken the following courses of action. First, Aflac Japan maintains an investment portfolio of dollar-denominated securities on behalf of Aflac U.S., which serves as an economic currency hedge of a portion of our investment in Aflac Japan. The functional currency for these investments is the U.S. dollar. The related investment income and realized/unrealized investment gains and losses are also denominated in U.S. dollars. The foreign exchange gains and losses related to this portfolio are taxable in Japan and the U.S. when the

 

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securities mature or are sold. Until maturity or sale, deferred tax expense or benefit associated with the foreign exchange gains or losses are recognized in other comprehensive income.

Second, we have designated the Parent Company’s yen-denominated liabilities (Samurai and Uridashi notes and yen-denominated loans - see Note 6) as nonderivative hedges of the foreign currency exposure of our investment in Aflac Japan. Our net investment hedge was effective during the six-month periods ended June 30, 2011, and 2010; therefore, there was no impact on net earnings during those periods for the foreign exchange effect of the designated Parent Company yen-denominated liabilities. There was no gain or loss reclassified from accumulated other comprehensive income into earnings related to our net investment hedge for the six-month periods ended June 30, 2011 and 2010.

For additional information on our financial instruments, see the accompanying Notes 1, 3 and 5 and Notes 1, 3 and 5 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

5.  FAIR VALUE MEASUREMENTS

We determine the fair values of our debt, derivative, perpetual and privately issued equity securities primarily using three pricing approaches or techniques: quoted market prices readily available from public exchange markets, a discounted cash flow (DCF) pricing model, and price quotes we obtain from outside brokers.

Our DCF pricing model incorporates an option adjusted spread and utilizes various market inputs we obtain from both active and inactive markets. The estimated fair values developed by the DCF pricing model is most sensitive to prevailing credit spreads, the level of interest rates (yields) and interest rate volatility. Prior to March 31, 2010, credit spreads were derived based on pricing data obtained from investment brokers and took into account the current yield curve, time to maturity and subordination levels for similar securities or classes of securities. Subsequent to March 31, 2010, credit spreads were derived from using a bond index to create a credit spread matrix which takes into account the current credit spread, ratings and remaining time to maturity, and subordination levels for securities that are included in the bond index. Our DCF pricing model is based on a widely used global bond index that is comprised of investments in active markets. The index provides a broad-based measure of the global fixed-income bond market. This bond index covers bonds issued by European and American issuers, which account for the majority of bonds that we hold. We validate the reliability of the DCF pricing model periodically by using the model to price investments for which there are quoted market prices from active and inactive markets or, in the alternative, are quoted by our custodian for the same or similar securities.

The pricing data and market quotes we obtain from outside sources are reviewed internally for reasonableness. If a fair value appears unreasonable, the inputs are re-examined and the value is confirmed or revised.

In recent years, on the price quotes we obtain from outside brokers, we have noted a continued reduction in the availability of pricing data from this source. As a result, we have noted that available pricing data has become more volatile. The reduction in available pricing sources coupled with the increase in price volatility has increased the degree of management judgment required in the final determination of fair values. We assess the reasonableness of the pricing data we receive by comparing it to relevant market indices and other performance measurements.

Fair Value Hierarchy

GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. These two types of inputs create three valuation hierarchy levels. Level 1 valuations reflect quoted market prices for identical assets or liabilities in active markets. Level 2 valuations reflect quoted market prices for similar assets or liabilities in an active market, quoted market prices for identical or similar assets or liabilities in non-active markets or model-derived valuations in which all significant valuation inputs are observable in active markets. Level 3 valuations reflect valuations in which one or more of the significant valuation inputs are not observable in an active market. The vast majority of our financial instruments subject to the classification provisions of GAAP relate to our investment securities classified as securities available for sale in our investment portfolio. We determine the fair value of our securities available for sale using several sources or techniques based on the type and nature of the investment securities.

 

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The following tables present the fair value hierarchy levels of the Company’s assets and liabilities that are measured at fair value on a recurring basis.

 

      June 30, 2011  
(In millions)    Level 1      Level 2      Level 3      Total  

Assets:

           

Fixed maturities:

           

Government and agencies

   $ 19,189       $ 678       $ 0       $ 19,867     

Municipalities

     0         1,025         0         1,025     

Mortgage- and asset-backed securities

     0         1,241         257         1,498     

Public utilities

     0         5,584         0         5,584     

Collateralized debt obligations

     0         0         4         4     

Sovereign and supranational

     0         2,277         0         2,277     

Banks/financial institutions

     0         7,518         398         7,916     

Other corporate

     0         14,335         0         14,335     

Total fixed maturities

     19,189         32,658         659         52,506     

Perpetual securities:

           

Banks/financial institutions

     0         6,746         0         6,746     

Other corporate

     0         357         0         357     

Total perpetual securities

     0         7,103         0         7,103     

Equity securities

     14         5         4         23     

Other assets:

           

Interest rate swaps

     0         125         0         125     

Foreign currency swaps

     0         150         220         370     

Total other assets

     0         275         220         495     

  Total assets

   $   19,203       $   40,041       $   883       $   60,127     
   

Liabilities:

           

Interest rate swaps

   $ 0       $ 5       $ 0       $ 5     

Foreign currency swaps

     0         270         56         326     

Credit default swaps

     0         0         253         253     

  Total liabilities

   $ 0       $ 275       $ 309       $ 584     
   

 

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      December 31, 2010  
(In millions)    Level 1      Level 2      Level 3      Total  

Assets:

           

Fixed maturities:

           

Government and agencies

   $   16,534       $ 679       $ 0       $ 17,213     

Municipalities

     0         973         0         973     

Mortgage- and asset-backed securities

     0         1,539         267         1,806     

Public utilities

     0         5,369         0         5,369     

Collateralized debt obligations

     0         0         5         5     

Sovereign and supranational

     0         1,394         0         1,394     

Banks/financial institutions

     0         8,047         386         8,433     

Other corporate

     0         13,162         0         13,162     

Total fixed maturities

     16,534         31,163         658         48,355     

Perpetual securities:

           

Banks/financial institutions

     0         7,169         0         7,169     

Other corporate

     0         343         0         343     

Total perpetual securities

     0         7,512         0         7,512     

Equity securities

     14         5         4         23     

Other assets:

           

Interest rate swaps

     0         124         0         124     

Foreign currency swaps

     0         151         289         440     

Total other assets

     0         275         289         564     

  Total assets

   $   16,548       $   38,955       $   951       $   56,454     
   

Liabilities:

           

Interest rate swaps

   $ 0       $ 70       $ 0       $ 70     

Foreign currency swaps

     0         280         48         328     

Credit default swaps

     0         0         343         343     

  Total liabilities

   $ 0       $ 350       $ 391       $ 741     
   

Approximately 45% of our fixed income and perpetual investments classified as Level 2 are valued by obtaining quoted market prices from our investment custodian. The custodian obtains price quotes from various pricing services that estimate fair values based on observable market transactions for similar investments in active markets, market transactions for the same investments in inactive markets or other observable market data where available.

The fair value of approximately 51% of our Level 2 fixed income and perpetual investments is determined using our DCF pricing model. The significant valuation inputs to the DCF model are obtained from, or corroborated by, observable market sources from both active and inactive markets.

For the remaining Level 2 investments that are not quoted by our custodian and cannot be priced under the DCF pricing model, we obtain specific broker quotes from up to three outside securities brokers and generally use the average of the quotes to estimate the fair value of the securities.

We use derivative instruments to manage the risk associated with certain assets. However, the derivative instrument may not be classified with the same fair value hierarchy as the associated asset. Derivative instruments are reported in Level 2 of the fair value hierarchy, except CDSs and certain foreign currency swaps which are classified as Level 3.

The interest rate and certain foreign currency derivative instruments classified as Level 2 were priced by broker quotations using inputs that are observable in the market. Inputs used to value derivatives include, but are not limited to, interest rates, foreign currency forward and spot rates, and interest volatility. For derivatives associated with any of our VIEs where we are the primary beneficiary, we are not the direct counterparty to the swap contracts. As a result, the fair value measurements provided by the broker incorporate the credit risk of the collateral associated with the VIE and counterparty credit risk.

 

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The fair value of our interest rate swap contracts associated with our variable interest rate yen-denominated debt is based on the amount we would expect to receive or pay to terminate the swaps. The prices used to determine the value of the swaps are obtained from the respective swap counterparties and take into account current interest rates, duration and credit risk.

The fixed maturities, perpetual securities and derivatives classified as Level 3 consist of securities for which there are limited or no observable valuation inputs. We estimate the fair value of these securities by obtaining broker quotes from a limited number of brokers. These brokers base their quotes on a combination of their knowledge of the current pricing environment and market conditions. We consider these inputs unobservable. The equity securities classified in Level 3 are related to investments in Japanese businesses, each of which are insignificant and in the aggregate are immaterial. Because fair values for these investments are not readily available, we carry them at their original cost. We review each of these investments periodically and, in the event we determine that any are other-than-temporarily impaired, we write them down to their estimated fair value at that time.

Historically, we have not adjusted the quotes or prices we obtain from the brokers and pricing services we use.

The following tables present the changes in our available-for-sale investments and derivatives classified as Level 3.

 

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Three Months Ended

June 30, 2011

 
     Fixed Maturities     Perpetual
Securities
    Equity
Securities
    Derivatives         
(In millions)   Mortgage-
and
Asset-
Backed
Securities
    Public
Utilities
    Collateralized
Debt
Obligations
    Sovereign
and
Supranational
    Banks/
Financial
Institutions
    Other
Corporate
    Banks/
Financial
Institutions
          Foreign
Currency
Swaps
    Credit
Default
Swaps
    Total  

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, beginning of period

  $ 248      $ 0      $ 5      $ 0      $ 420      $ 0      $ 0      $ 4      $ 126      $ (338   $ 465   

Realized gains or losses included in earnings

    0        0        (1     0        0        0        0        0        25        (43     (19

Unrealized gains or losses included in other comprehensive income

    12        0        0        0        (22     0        0        0        13        0        3   

Purchases, issuances, sales and settlements:

                     

Purchases

    0        0        0        0        0        0        0        0        0        0        0   

Issuances

    0        0        0        0        0        0        0        0        0        0        0   

Sales

    0        0        0        0        0        0        0        0        0        0        0   

Settlements

    (3     0        0        0        0        0        0        0        0        128        125   

Transfers into Level 3

    0        0        0        0        0        0        0        0        0        0        0   

Transfers out of Level 3

    0        0        0        0        0        0        0        0        0        0        0   

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

  $ 257      $ 0      $ 4      $ 0      $ 398      $ 0      $ 0      $ 4      $ 164      $ (253   $ 574   

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized gains (losses) still held(1)

  $ 0      $ 0      $ (1   $ 0      $ 0      $ 0      $ 0      $ 0      $ 25      $ (7   $ 17   

 

   

 

 

   

 

 

   

 

 

   

 

 

 
(1) 

Represents the amount of total gains or losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets classified as Level 3 that were still held at June 30, 2011

 

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Three Months Ended

June 30, 2010

 
     Fixed Maturities     Perpetual
Securities
    Equity
Securities
    Derivatives         
(In millions)   Mortgage-
and
asset-
backed
securities
    Public
utilities
    Collateralized
debt
obligations
    Sovereign
and
supranational
    Banks/
financial
institutions
    Other
corporate
    Banks/
financial
institutions
          Credit default
swaps
    Total  

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, beginning of period

  $ 63      $ 488      $ 4      $ 298      $ 1,103      $ 1,253      $ 1,695      $ 9      $ (291   $ 4,622   

Realized gains or losses included in earnings

    0        0        0        0        0        0        125        0        (66     59   

Unrealized gains or losses included in other
comprehensive income

    1        0        0        0        1        1        (125     0        0        (122

Purchases, issuances,
sales and settlements:

                   

Purchases

    0        0        0        0        0        0        0        0        0        0   

Issuances

    0        0        0        0        0        0        0        0        0        0   

Sales

    (1     (2     0        0        0        0        (531     0        0        (534

Settlements

    0        0        0        0        0        0        0        0        0        0   

Transfers into Level 3(1)

    219        0        0        0        330        0        0        0        0        549   

Transfers out of Level 3(2)

    0        (459     0        (298     (1,082     (1,202     (1,164     (5     0        (4,210

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

  $ 282      $ 27      $ 4      $ 0      $ 352      $ 52      $ 0      $ 4      $ (357   $ 364   

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized gains (losses)
still held(3)

  $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ (66   $ (66

 

   

 

 

   

 

 

   

 

 

   

 

 

 
(1) 

Due to a lack of visibility to observe significant inputs to price and credit downgrades of respective issuers of securities to below investment grade

(2) 

A result of changing our pricing methodology to using a pricing index for estimating fair value instead of obtaining pricing of the securities from brokers or arrangers

(3)

Represents the amount of total gains or losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets classified as Level 3 that were still held at June 30, 2010

 

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Six Months Ended
June 30, 2011
 
     Fixed Maturities     Perpetual
Securities
    Equity
Securities
    Derivatives         
(In millions)   Mortgage-
and
Asset-
Backed
Securities
    Public
Utilities
    Collateralized
Debt
Obligations
    Sovereign
and
Supranational
    Banks/
Financial
Institutions
    Other
Corporate
    Banks/
Financial
Institutions
          Foreign
Currency
Swaps
    Credit
Default
Swaps
    Total  
                                   

Balance, beginning of period

  $ 267      $ 0      $ 5      $ 0      $ 386      $ 0      $ 0      $ 4      $ 241      $ (343   $ 560   

Realized gains or losses included in earnings

    (6     0        (1     0        1        0        0        0        (39     (38     (83

Unrealized gains or losses included in other comprehensive income

    2        0        0        0        11        0        0        0        (38     0        (25

Purchases, issuances, sales and settlements:

                     

Purchases

    0        0        0        0        0        0        0        0        0        0        0   

Issuances

    0        0        0        0        0        0        0        0        0        0        0   

Sales

    0        0        0        0        0        0        0        0        0        0        0   

Settlements

    (6     0        0        0        0        0        0        0        0        128        122   

Transfers into Level 3

    0        0        0        0        0        0        0        0        0        0        0   

Transfers out of Level 3

    0        0        0        0        0        0        0        0        0        0        0   
                                   

Balance, end of period

  $ 257      $ 0      $ 4      $ 0      $ 398      $ 0      $ 0      $ 4      $ 164      $ (253   $ 574   
                                   

Change in unrealized gains (losses) still held(1)

  $ (6   $ 0      $ (1   $ 0      $ 1      $ 0      $ 0      $ 0      $ (39   $ (15   $ (60
                                   
(1) 

Represents the amount of total gains or losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets classified as Level 3 that were still held at June 30, 2011

 

 

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Six Months Ended
June 30, 2010
 
     Fixed Maturities     Perpetual
Securities
    Equity
Securities
    Derivatives         
(In millions)   Mortgage-
and
asset-
backed
securities
    Public
utilities
    Collateralized
debt
obligations
    Sovereign
and
supranational
    Banks/
financial
institutions
    Other
corporate
    Banks/
financial
institutions
          Credit default
swaps
    Total  
                                   

Balance, beginning of period

  $ 62      $ 497      $ 267      $ 293      $ 1,240      $ 1,248      $ 1,441      $ 9      $ 0      $ 5,057   

Effect of change in accounting principle (1)

    0        0        (263     0        0        0        0        0        (312     (575

Revised balance, beginning of period

    62        497        4        293        1,240        1,248        1,441        9        (312     4,482   

Realized gains or losses included in earnings

    0        0        0        0        5        0        108        0        (45     68   

Unrealized gains or losses included in other comprehensive income

    2        (9     0        5        34        6        51        0        0        89   

Purchases, issuances, sales and settlements:

                   

Purchases

    0        0        0        0        0        0        0        0        0        0   

Issuances

    0        0        0        0        0        0        0        0        0        0   

Sales

    (1     (2     0        0        (175     0        (585     0        0        (763

Settlements

    0        0        0        0        0        0        0        0        0        0   

Transfers into Level 3(2)

    219        0        0        0        330        0        149        0        0        698   

Transfers out of Level 3(3)

    0        (459     0        (298     (1,082     (1,202     (1,164     (5     0        (4,210
                                   

Balance, end of period

  $ 282      $ 27      $ 4      $ 0      $ 352      $ 52      $ 0      $ 4      $ (357   $ 364   
                                   

Change in unrealized gains (losses)
still held(4)

  $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ 0      $ (45   $ (45
                                   
(1) 

Change in accounting for VIEs effective January 1, 2010. See Notes 1, 3, and 4 for additional information.

(2) 

Due to a lack of visibility to observe significant inputs to price and credit downgrades of respective issuers of securities to below investment grade

(3) 

A result of changing our pricing methodology to using a pricing index for estimating fair value instead of obtaining pricing of the securities from brokers or arrangers

(4)

Represents the amount of total gains or losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets classified as Level 3 that were still held at June 30, 2010

As discussed in Notes 1 and 3, we adopted new accounting guidance on VIEs effective January 1, 2010, and as a result have consolidated certain VIE investments. Upon consolidation, the beneficial interest was derecognized and the underlying securities and derivatives were recognized. In many cases, the fair value hierarchy level differed between the

 

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original beneficial interest asset and the underlying securities that are now being recognized. In the Level 3 rollforward, we have separately disclosed the impact of consolidating these VIE investments that were previously categorized as Level 3 and now the underlying securities are Level 2. As noted in the Level 3 rollforward above, the CDSs which are separately recognized as a result of this change in accounting are reported as Level 3 investments. In addition, approximately $1.0 billion of Level 2 investments were reclassified upon the adoption of this guidance, and their underlying securities are being reported as Level 1 as of January 1, 2010.

The significant valuation inputs that are used in the valuation process for the below-investment-grade, callable RDC and private placement investments classified as Level 3 include forward exchange rates, yen swap rates, dollar swap rates, interest rate volatilities, credit spread data on specific issuers, assumed default and default recovery rates, certain probability assumptions, and call option data.

Some of these securities require the calculation of a theoretical forward exchange rate which is developed by using yen swap rates, U.S. dollar swap rates, interest rate volatilities, and spot exchange rates. The forward exchange rate is then used to convert all future dollar cash flows of the bond, where applicable, into yen cash flows. Additionally, credit spreads for the individual issuers are key valuation inputs of these securities. Finally, in pricing securities with a call option, the assumptions regarding interest rates in the U.S. and Japan are considered to be significant valuation inputs. Collectively, these valuation inputs are included to estimate the fair values of these securities at each reporting date.

In obtaining the above valuation inputs, we have determined that certain pricing assumptions and data used by our pricing sources are becoming increasingly more difficult to validate or corroborate by the market and/or appear to be internally developed rather than observed in or corroborated by the market. The use of these unobservable valuation inputs causes more subjectivity in the valuation process for these securities and consequently, causes more volatility in their estimated fair values.

Fair Value of Financial Instruments

The carrying values and estimated fair values of the Company’s financial instruments were as follows:

 

      June 30, 2011      December 31, 2010  
(In millions)    Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
 

Assets:

           

Fixed-maturity securities

   $ 78,669       $ 78,785       $ 72,570       $ 72,999    

Fixed-maturity securities - consolidated variable interest entities

     5,745         5,703         5,869         5,825    

Perpetual securities

     5,559         5,559         5,974         5,974    

Perpetual securities - consolidated variable interest entities

     1,544         1,544         1,538         1,538    

Equity securities

     23         23         23         23    

Interest rate, foreign currency, and credit default swaps

     495         495         564         564    

Liabilities:

           

Notes payable (excluding capitalized leases)

     3,042         3,283         3,032         3,248    

Interest rate, foreign currency, and credit default swaps

     584         584         741         741    

Obligation to Japanese policyholder protection corporation

     89         89         108         108    
                                     

As mentioned previously, we determine the fair values of our debt, perpetual and privately issued equity securities and our derivatives using three basic pricing approaches or techniques: quoted market prices readily available from public exchange markets, pricing models, and price quotes we obtain from outside brokers.

The fair values of notes payable with fixed interest rates were obtained from an independent financial information service. The fair value of the obligation to the Japanese policyholder protection corporation is our estimated share of the industry’s obligation calculated on a pro rata basis by projecting our percentage of the industry’s premiums and reserves and applying that percentage to the total industry obligation payable in future years.

The carrying amounts for cash and cash equivalents, receivables, accrued investment income, accounts payable, cash collateral and payables for security transactions approximated their fair values due to the short-term nature of these instruments. Consequently, such instruments are not included in the above table. The preceding table also excludes liabilities for future policy benefits and unpaid policy claims as these liabilities are not financial instruments as defined by GAAP.

 

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DCF Sensitivity

Our DCF pricing model utilizes various market inputs we obtain from both active and inactive markets. The estimated fair values developed by the DCF pricing models are most sensitive to prevailing credit spreads, the level of interest rates (yields), and, for our callable securities, interest rate volatility. Management believes that under normal market conditions, a movement of 50 basis points (bps) in interest rates and credit spreads and 50 percent in interest rate volatility would be sufficiently reasonable stresses for these risk factors. Therefore, we selected these magnitudes of movements and provided both upward and downward movements in these key assumptions used to estimate fair values. Since the changes in fair value are relatively linear, readers of these financial statements can make their own judgments as to the movement in interest rates and the change in fair value based upon this data. The following scenarios provide a view of the sensitivity of our securities priced by our DCF pricing model.

The fair values of our available-for-sale fixed-maturity and perpetual securities valued by our DCF pricing model totaled $20.3 billion at June 30, 2011. The estimated effect of potential changes in interest rates, credit spreads and interest rate volatility on these fair values as of such date is as follows:

 

Interest Rates     Credit Spreads     Interest Rate Volatility  
Factor change   

Change in

fair value

  (in millions)  

    Factor change   

Change in

fair value

  (in millions)  

    Factor change   

Change in

fair value

  (in millions)  

 

    +50 bps

     $(1,069   +50 bps      $(1,054   +50 %      $(248

    -50 bps

     1,140      -50 bps      1,122      -50 %      33   
   

The fair values of our held-to-maturity fixed-maturity securities valued by our DCF pricing model totaled $27.2 billion at June 30, 2011. The estimated effect of potential changes in interest rates, credit spreads and interest rate volatility on these fair values as of such date is as follows:

 

Interest Rates     Credit Spreads     Interest Rate Volatility  
Factor change   

Change in

fair value

  (in millions)  

    Factor change   

Change in

fair value

  (in millions)  

    Factor change   

Change in

fair value

  (in millions)  

 

    +50 bps

     $ (1,696   +50 bps      $(1,557   +50 %      $(385

    -50 bps

     1,747      -50 bps      1,572      -50 %      357   
   

For additional information on our investments and financial instruments, see the accompanying Notes 1, 3 and 4 and Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

 

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6.  NOTES PAYABLE

A summary of notes payable follows:

 

(In millions)   

June 30,

2011

    December 31,
2010
 

8.50% senior notes due May 2019

   $ 850      $ 850   

6.45% senior notes due August 2040

     448    (1)      448   (1) 

6.90% senior notes due December 2039

     396    (2)      396   (2) 

3.45% senior notes due August 2015

     300        300   

Yen-denominated Uridashi notes:

    

1.52% notes due September 2011 (principal amount 15 billion yen)

     186        184   

2.26% notes due September 2016 (principal amount 8 billion yen)

     99        98   

Variable interest rate notes due September 2011 (.58% at June 2011, principal amount 20 billion yen)

     248        245   

Yen-denominated Samurai notes:

    

1.87% notes due June 2012 (principal amount 26.6 billion yen)

     329        327   

Yen-denominated loans:

    

3.60% loan due July 2015 (principal amount 10 billion yen)

     124        123   

3.00% loan due August 2015 (principal amount 5 billion yen)

     62        61   

Capitalized lease obligations payable through 2016

     6        6   

Total notes payable

   $ 3,048      $ 3,038   
   

(1) $450 issuance net of a $2 underwriting discount that is being amortized over the life of the notes

(2) $400 issuance net of a $4 underwriting discount that is being amortized over the life of the notes

In July 2011, we issued three series of Samurai notes totaling 50.0 billion yen through a public debt offering. The first series, which totaled 28.7 billion yen (approximately $356 million using the June 30, 2011, exchange rate), bears interest at a fixed rate of 1.47% per annum, payable semi-annually, and has a three-year maturity. The second series, which totaled 15.8 billion yen (approximately $196 million using the June 30, 2011, exchange rate), bears interest at a fixed rate of 1.84% per annum, payable semi-annually, and has a five-year maturity. The third series, which totaled 5.5 billion yen (approximately $68 million using the June 30, 2011, exchange rate), bears interest at a variable rate of three-month yen LIBOR plus a spread, payable quarterly, and has a three-year maturity. We have entered into an interest rate swap related to the 5.5 billion yen variable interest rate notes to swap the variable interest rate to a fixed interest rate of 1.475% (see Note 4). These Samurai notes are not available to U.S. persons.

We have no restrictive financial covenants related to our notes payable. We were in compliance with all of the covenants of our notes payable at June 30, 2011. No events of default or defaults occurred during the six-month period ended June 30, 2011.

For additional information, see Notes 4 and 8 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

7.   SHAREHOLDERS’ EQUITY

The following table is a reconciliation of the number of shares of the Company’s common stock for the six-month periods ended June 30.

 

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(In thousands of shares)    2011           2010  

Common stock - issued:

       

Balance, beginning of period

     662,660           661,209   

Exercise of stock options and issuance of restricted shares

     752             672   

Balance, end of period

     663,412             661,881   

Treasury stock:

       

Balance, beginning of period

     192,999           192,641   

Purchases of treasury stock:

       

Open market

     4,100           0   

Other

     155           95   

Dispositions of treasury stock:

       

Shares issued to AFL Stock Plan

     (745        0   

Exercise of stock options

     (85        (1,535

Other

     (79          (89

Balance, end of period

     196,345             191,112   

Shares outstanding, end of period

     467,067           470,769   
   

Outstanding share-based awards are excluded from the calculation of weighted-average shares used in the computation of basic earnings per share. The following table presents the approximate number of share-based awards to purchase shares, on a weighted-average basis, that were considered to be anti-dilutive and were excluded from the calculation of diluted earnings per share for the following periods.

 

     

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
(In thousands)          2011            2010            2011            2010  

Anti-dilutive share-based awards

     4,246         4,610         3,419         3,530   
                                     

Share Repurchase Program: During the first six months of 2011, we repurchased 4.1 million shares of our common stock in the open market. During the first six months of 2010, we did not repurchase any shares of our common stock.

As of June 30, 2011, a remaining balance of 26.3 million shares of our common stock was available for purchase under a share repurchase authorization by our board of directors in 2008.

8.   SHARE-BASED COMPENSATION

The Company has two long-term incentive compensation plans. The first plan, which expired in February 2007, is a stock option plan which allowed grants for incentive stock options (ISOs) to employees and non-qualifying stock options (NQSOs) to employees and non-employee directors. Options granted before the plan’s expiration date remain outstanding in accordance with their terms. The second long-term incentive plan allows awards to Company employees for ISOs, NQSOs, restricted stock, restricted stock units, and stock appreciation rights. Non-employee directors are eligible for grants of NQSOs, restricted stock, and stock appreciation rights. As of June 30, 2011, approximately 15.2 million shares were available for future grants under this plan, and the only performance-based awards issued and outstanding were restricted stock awards.

Share-based awards granted to U.S.-based grantees are settled with authorized but unissued Company stock, while those issued to Japan-based grantees are settled with treasury shares.

The following table provides information on stock options outstanding and exercisable at June 30, 2011.

 

      Stock
Option Shares
(in thousands)
  

  Weighted-Average  
Remaining Term

(in years)

  

Aggregate
Intrinsic
Value

  (in millions)  

     Weighted-Average  
Exercise Price Per
Share

Outstanding

   14,608    5.3    $97    $42.51

Exercisable

   11,197    4.3      66      42.93
                     

 

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We received cash from the exercise of stock options in the amount of $13.0 million during the first six months of 2011, compared with $46 million in the first six months of 2010. The tax benefit realized as a result of stock option exercises and restricted stock releases was $11.9 million in the first six months of 2011, compared with $20 million in the first six months of 2010.

As of June 30, 2011, total compensation cost not yet recognized in our financial statements related to restricted-share-based awards was $32.4 million, of which $16.4 million (688 thousand shares) was related to restricted-share-based awards with a performance-based vesting condition. We expect to recognize these amounts over a weighted-average period of approximately 1.5 years. There are no other contractual terms covering restricted stock awards once vested.

For additional information on our long-term share-based compensation plans and the types of share-based awards, see Note 11 of the Notes to the Consolidated Financial Statements included in our annual report to shareholders for the year ended December 31, 2010.

9.  BENEFIT PLANS

Our basic employee defined-benefit pension plans cover substantially all of our full-time employees in Japan and the United States. The components of retirement expense for the Japanese and U.S. pension plans were as follows:

 

      Three Months Ended June 30,      Six Months Ended June 30,  
     2011      2010      2011      2010  
(In millions)    Japan      U.S.      Japan      U.S.      Japan      U.S.      Japan      U.S.  

Components of net periodic benefit cost:

                       

Service cost

   $ 4            $ 3            $  4            $ 3            $ 8            $ 7            $ 7            $ 6        

Interest cost

     2              4              1              4              3              8              2              7        

Expected return on plan assets

     (1)             (3)             0              (3)             (2)             (7)             (1)             (6)       

Amortization of net actuarial loss

     1              2              0              1              2              3              1              2        

Net periodic benefit cost

   $ 6            $ 6            $  5            $ 5            $ 11            $ 11            $ 9            $ 9        
                     

During the six months ended June 30, 2011, Aflac Japan contributed approximately $11 million (using the June 30, 2011, exchange rate) to the Japanese pension plan, and Aflac U.S. did not make a contribution to the U.S. pension plan.

For additional information regarding our Japanese and U.S. benefit plans, see Note 13 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

10.   COMMITMENTS AND CONTINGENT LIABILITIES

We are a defendant in various lawsuits considered to be in the normal course of business. Members of our senior legal and financial management teams review litigation on a quarterly and annual basis. The final results of any litigation cannot be predicted with certainty. Although some of this litigation is pending in states where large punitive damages, bearing little relation to the actual damages sustained by plaintiffs, have been awarded in recent years, we believe the outcome of pending litigation will not have a material adverse effect on our financial position, results of operations, or cash flows.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING INFORMATION

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” to encourage companies to provide prospective information, so long as those informational statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements. We desire to take advantage of these provisions. This report contains cautionary statements identifying important factors that could cause actual results to differ materially from those projected herein, and in any other statements made by Company officials in communications with the financial community and contained in documents filed with the Securities and Exchange Commission (SEC). Forward-looking statements are not based on historical information and relate to future operations, strategies, financial results or other developments. Furthermore, forward-looking information is subject to numerous assumptions, risks and uncertainties. In particular, statements containing words such as “expect,” “anticipate,” “believe,” “goal,” “objective,” “may,” “should,” “estimate,” “intends,” “projects,” “will,” “assumes,” “potential,” “target” or similar words as well as specific projections of future results, generally qualify as forward-looking. Aflac undertakes no obligation to update such forward-looking statements.

We caution readers that the following factors, in addition to other factors mentioned from time to time, could cause actual results to differ materially from those contemplated by the forward-looking statements:

 

   

difficult conditions in global capital markets and the economy

 

   

governmental actions for the purpose of stabilizing the financial markets

 

   

defaults and downgrades in certain securities in our investment portfolio

 

   

impairment of financial institutions

 

   

credit and other risks associated with Aflac’s investment in perpetual securities

 

   

differing judgments applied to investment valuations

 

   

subjective determinations of amount of impairments taken on our investments

 

   

limited availability of acceptable yen-denominated investments

 

   

concentration of our investments in any particular single-issuer or sector

 

   

concentration of business in Japan

 

   

ongoing changes in our industry

 

   

exposure to significant financial and capital markets risk

 

   

fluctuations in foreign currency exchange rates

 

   

significant changes in investment yield rates

 

   

deviations in actual experience from pricing and reserving assumptions

 

   

subsidiaries’ ability to pay dividends to Aflac Incorporated

 

   

changes in law or regulation by governmental authorities

 

   

ability to attract and retain qualified sales associates and employees

 

   

decreases in our financial strength or debt ratings

 

   

ability to continue to develop and implement improvements in information technology systems

 

   

changes in U.S. and/or Japanese accounting standards

 

   

failure to comply with restrictions on patient privacy and information security

 

   

level and outcome of litigation

 

   

ability to effectively manage key executive succession

 

   

impact of the recent earthquake and tsunami natural disaster and related events at the nuclear plant in Japan and their aftermath

 

   

catastrophic events including, but not necessarily limited to, tornadoes, hurricanes, earthquakes, tsunamis, and damage incidental to such events

 

   

failure of internal controls or corporate governance policies and procedures

 

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MD&A OVERVIEW

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to inform the reader about matters affecting the financial condition and results of operations of Aflac Incorporated and its subsidiaries for the three-month and six-month periods ended June 30, 2011 and 2010. Results of operations for interim periods are not necessarily indicative of results for the entire year. As a result, the following discussion should be read in conjunction with the consolidated financial statements and notes that are included in our annual report to shareholders for the year ended December 31, 2010. This MD&A is divided into the following sections:

 

   

Our Business

 

   

Performance Highlights

 

   

Critical Accounting Estimates

 

   

Results of Operations, consolidated and by segment

 

   

Analysis of Financial Condition, including discussion of market risks of financial instruments

 

   

Capital Resources and Liquidity, including discussion of availability of capital and the sources and uses of cash

OUR BUSINESS

Aflac Incorporated (the Parent Company) and its subsidiaries (collectively, the Company) primarily sell supplemental health and life insurance in the United States and Japan. The Company’s insurance business is marketed and administered through American Family Life Assurance Company of Columbus (Aflac), which operates in the United States (Aflac U.S.) and as a branch in Japan (Aflac Japan). Most of Aflac’s policies are individually underwritten and marketed through independent agents. Aflac U.S. markets and administers group products through Continental American Insurance Company (CAIC). Our insurance operations in the United States and our branch in Japan service the two markets for our insurance business.

PERFORMANCE HIGHLIGHTS

Results for the second quarter of 2011 benefited from the stronger yen/dollar exchange rate. However, realized investment losses were higher, compared with the same period a year ago. Total revenues rose 2.2% to $5.1 billion, compared with $5.0 billion in the second quarter of 2010. Net earnings were $280 million, or $.60 per diluted share, compared with $581 million, or $1.23 per diluted share, in the second quarter of 2010.

Results for the first six months of 2011 also benefited from the stronger yen. Total revenues rose 1.6% to $10.2 billion, compared with $10.0 billion in the first half of 2010. Net earnings were $674 million, or $1.43 per diluted share, compared with $1.2 billion, or $2.58 per diluted share, for the first six months of 2010.

Results in the second quarter of 2011 included pretax net realized investment losses of $668 million ($453 million after-tax), compared with losses of $89 million ($58 million after-tax) in the second quarter of 2010. A valuation allowance of $19 million was recorded in the second quarter of 2011 related to the deferred tax assets associated with our realized investment losses and is reflected in the tax-effected total net realized investment losses stated above. The investment losses in 2011 included $528 million ($343 million after-tax) of other-than-temporary impairments and $182 million of losses, net of gains, ($118 million after-tax) from securities sold, primarily as a result of an implemented plan to reduce the risk exposure in our investment portfolio coupled with the continued decline in the creditworthiness of issuers of certain investments.

Results for the first six months of 2011 included pretax net realized investment losses of $1.2 billion ($829 million after-tax), compared with losses of $135 million ($88 million after-tax) in the first six months of 2010. The valuation allowance of $19 million that was recorded in the second quarter of 2011 related to the deferred tax assets associated with our realized investment losses is reflected in the tax-effected total net realized investment losses stated above. The investment losses in 2011 included $933 million ($606 million after-tax) of other-than-temporary impairments and $326 million of losses, net of gains, ($212 million after-tax) from securities sold, primarily as a result of an implemented plan to reduce the risk exposure in our investment portfolio coupled with the continued decline in the creditworthiness of issuers of certain investments.

Shareholders’ equity at June 30, 2011 included a net unrealized gain on investment securities (including derivatives) of $758 million, compared with a net unrealized gain of $64 million at December 31, 2010.

 

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CRITICAL ACCOUNTING ESTIMATES

We prepare our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These principles are established primarily by the Financial Accounting Standards Board (FASB). In this MD&A, references to GAAP issued by the FASB are derived from the FASB Accounting Standards CodificationTM (ASC). The preparation of financial statements in conformity with GAAP requires us to make estimates based on currently available information when recording transactions resulting from 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 the valuation of investments and derivatives, deferred policy acquisition costs, liabilities for future policy benefits and unpaid policy claims, and income taxes. 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 96% of our assets and 85% of our liabilities are reported as of June 30, 2011, and thus has a direct effect on net earnings and shareholders’ equity. Subsequent experience or use of other assumptions could produce significantly different results.

There have been no changes in the items that we have identified as critical accounting estimates during the six months ended June 30, 2011. For additional information, see the Critical Accounting Estimates section of MD&A included in our annual report to shareholders for the year ended December 31, 2010.

New Accounting Pronouncements

For information on new accounting pronouncements and the impact, if any, on our financial position or results of operations, see Note 1 of the Notes to the Consolidated Financial Statements.

RESULTS OF OPERATIONS

The following table is a presentation of items impacting net earnings and net earnings per diluted share.

 

Items Impacting Net Earnings  
      Three Months Ended June 30,           Six Months Ended June 30,  
      2011     2010     2011     2010           2011     2010     2011     2010  
      In Millions     Per Diluted Share           In Millions     Per Diluted Share  

Net earnings

   $     280      $     581      $     .60      $     1.23         $     674      $     1,217      $     1.43      $     2.58   

Items impacting net earnings, net of tax:

                   

Realized investment gains (losses):

                   

Securities transactions and impairments

     (480     8        (1.02     .02           (838     (33     (1.78     (.06

Impact of derivative and hedging activities

     27        (66     .06        (.14        8        (55     .02        (.12
   

Realized Investment Gains and Losses

Our investment strategy is to invest in fixed-income securities to provide a reliable stream of investment income, which is one of the drivers of the Company’s profitability. This investment strategy aligns our assets with our liability structure, which our assets support. We do not purchase securities with the intent of generating capital gains or losses. However, investment gains and losses may be realized as a result of changes in the financial markets and the creditworthiness of specific issuers, tax planning strategies, and/or general portfolio maintenance and rebalancing. The realization of investment gains and losses is independent of the underwriting and administration of our insurance products, which are the principal drivers of our profitability.

Securities Transactions and Impairments

During the three- and six-month periods ended June 30, 2011, we realized investment losses as a result of the recognition of other-than-temporary impairments on certain securities, and we realized investment losses, net of gains, from the sale of securities as a result of an implemented plan to reduce the risk exposure in our investment portfolio. We recorded a valuation allowance of $19 million in the second quarter of 2011 on the deferred tax asset for our realized

 

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investment losses, which is reflected in the tax-effected realized investment losses for securities transactions and impairments shown in the table above. During the three-month period ended June 30, 2010, we realized pretax investment losses, net of gains, from the sale or redemption of securities in the normal course of business. For the six-month period ended June 30, 2010, we realized investment losses as a result of the recognition of other-than-temporary impairments on certain securities, and we realized pretax investment losses, net of gains, from the sale or redemption of securities in the normal course of business. See Note 3 of the Notes to Consolidated Financial Statements for a more detailed discussion of these investment activities.

The following table details our pretax impairment losses by investment category.

 

      Three Months Ended
June 30,
           Six Months Ended
June 30,
 
(In millions)    2011      2010            2011      2010      

Perpetual securities

   $ 184       $ 0          $ 184       $ 41       

Corporate bonds

     343         0            740         0       

Mortgage- and asset-backed securities

     1         0            7         0       

Municipalities

     0         0            1         0       

Equity securities

     0         0              1         1       

Total other-than-temporary impairment losses realized

   $     528       $     0          $     933       $     42       
   

Impact of Derivative and Hedging Activities

Our derivative activities, which are primarily passive in nature, include foreign currency, interest rate and credit default swaps in variable interest entities that are consolidated, and securities with embedded derivatives.

For a description of other items that could be included in the Impact of Derivative and Hedging Activities, see the Hedging Activities subsection of MD&A and Note 4 of the accompanying Notes to the Consolidated Financial Statements.

For additional information regarding realized investment gains and losses, see Notes 3 and 4 of the Notes to the Consolidated Financial Statements.

Foreign Currency Translation

Aflac Japan’s premiums and most of its investment income are received in yen. Claims and expenses are paid in yen, and we primarily purchase yen-denominated assets to support yen-denominated policy liabilities. These and other yen-denominated financial statement items are translated into dollars for financial reporting purposes. We translate Aflac Japan’s yen-denominated income statement into dollars using an average exchange rate for the reporting period, and we translate its yen-denominated balance sheet using the exchange rate at the end of the period. However, it is important to distinguish between translating and converting foreign currency. Except for a limited number of transactions, we do not actually convert yen into dollars.

Due to the size of Aflac Japan, where our functional currency is the Japanese yen, fluctuations in the yen/dollar exchange rate can have a significant effect on our reported results. In periods when the yen weakens, translating yen into dollars results in fewer dollars being reported. When the yen strengthens, translating yen into dollars results in more dollars being reported. Consequently, yen weakening has the effect of suppressing current period results in relation to the comparable prior period, while yen strengthening has the effect of magnifying current period results in relation to the comparable prior period. As a result, we view foreign currency translation as a financial reporting issue for Aflac and not an economic event to our Company or shareholders. Because changes in exchange rates distort the growth rates of our operations, management evaluates Aflac’s financial performance excluding the impact of foreign currency translation.

Income Taxes

Our combined U.S. and Japanese effective income tax rate on pretax earnings was 38.3% for the three-month period ended June 30, 2011, compared with 34.6% for the same period in 2010. The increase in the effective income tax rate was due primarily to a $19 million valuation allowance recognized in the second quarter of 2011 related to the deferred tax assets associated with our realized investment losses discussed above. The effect of this valuation allowance was reflected in our combined U.S. and Japanese effective income tax rate on pretax earnings for the six-month period ended June 30, 2011 of 36.0%, compared with 34.7% for the same period in 2010.

 

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Earnings Guidance

We communicate earnings guidance in this report based on the growth in net earnings per diluted share. However, certain items that cannot be predicted or that are outside of management’s control may have a significant impact on actual results. Therefore, our comparison of net earnings includes certain assumptions to reflect the limitations that are inherent in projections of net earnings. In comparing period-over-period results, we exclude the effect of realized investment gains and losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items. We also assume no impact from foreign currency translation on the Aflac Japan segment and the Parent Company’s yen-denominated interest expense for a given period in relation to the prior period.

Subject to the preceding assumptions, our objective for 2011 is to increase net earnings per diluted share by 8% over 2010. If the yen/dollar exchange rate averages 80 to 85 for the full year, we would expect reported net earnings to be in the range of $6.09 to $6.34 per diluted share. Using that same exchange rate assumption, we would expect third quarter 2011 reported net earnings per diluted share to be in the range of $1.54 to $1.60. Based on our stated objective for 2011, the following table shows the likely results for 2011 net earnings per diluted share, including the impact of foreign currency translation using various yen/dollar exchange rate scenarios.

 

2011 Net Earnings Per Share (EPS) Scenarios(1)

Weighted-Average

Yen/Dollar

Exchange Rate

  

Net Earnings Per

Diluted Share

  

% Growth

Over 2010

  

Yen Impact

on EPS

  80.00

   $ 6.34    14.6 %    $  .37                

  85.00

      6.09    10.1            .12                

      87.69 (2)

      5.97      8.0          0                

  90.00

      5.87      6.1          (.10)               

  95.00

      5.68      2.7          (.29)               
                

 

(1) 

Excludes realized investment gains/losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items in 2011 and 2010

(2) 

Actual 2010 weighted-average exchange rate

Our objective for 2012 is to increase net earnings per diluted share by 2% to 5% over 2011, excluding the effect of realized investment gains and losses (securities transactions, impairments, and the impact of derivative and hedging activities), nonrecurring items, and foreign currency translation. This earnings objective assumes no additional significant investment losses and no further material decline in interest rates. Once the effects of our investment derisking program and low interest rate yields on investments have been fully integrated into our financial results, we believe the rate of earnings growth in future years should improve.

INSURANCE OPERATIONS

Aflac’s insurance business consists of two segments: Aflac Japan and Aflac U.S. Aflac Japan, which operates as a branch of Aflac, is the principal contributor to consolidated earnings. GAAP financial reporting requires that a company report financial and descriptive information about operating segments in its annual and interim period financial statements. Furthermore, we are required to report a measure of segment profit or loss, certain revenue and expense items, and segment assets.

We measure and evaluate our insurance segments’ financial performance using operating earnings on a pretax basis. We define segment operating earnings as the profits we derive from our operations before realized investment gains and losses (securities transactions, impairments, and the impact of derivative and hedging activities) and nonrecurring items. We believe that an analysis of segment pretax operating earnings is vitally important to an understanding of the underlying profitability drivers and trends of our insurance business. Furthermore, because a significant portion of our business is conducted in Japan, we believe it is equally important to understand the impact of translating Japanese yen into U.S. dollars.

We evaluate our sales efforts using new annualized premium sales, an industry operating measure. New annualized premium sales, which include both new sales and the incremental increase in premiums due to conversions, represent the premiums that we would collect over a 12-month period, assuming the policies remain in force. For Aflac Japan, new annualized premium sales are determined by applications submitted during the reporting period. For Aflac U.S., new annualized premium sales are determined by applications that are issued during the reporting period. Premium income, or

 

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earned premiums, is a financial performance measure that reflects collected or due premiums that have been earned ratably on policies in force during the reporting period.

AFLAC JAPAN SEGMENT

Aflac Japan Pretax Operating Earnings

Changes in Aflac Japan’s pretax operating earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results for Aflac Japan.

 

Aflac Japan Summary of Operating Results   
      Three Months Ended June 30,      Six Months Ended June 30,  
(In millions)    2011      2010            2011      2010        

Premium income

     $3,770         $3,186               $7,472         $6,393         

Net investment income:

           

Yen-denominated investment income

     434         392               866         793         

Dollar-denominated investment income

     202         201               419         393         
                     

Net investment income

     636         593               1,285         1,186         

Other income (loss)

     5         (1)              25         26         
                     

Total operating revenues

     4,411         3,778               8,782         7,605         
                     

Benefits and claims

     2,633         2,229               5,213         4,505         

Operating expenses:

           

Amortization of deferred policy acquisition costs

     167         139               329         282         

Insurance commissions

     290         263               578         535         

Insurance and other expenses

     390         349               751         664         

Total operating expenses

     847         751               1,658         1,481         

Total benefits and expenses

     3,480         2,980               6,871         5,986         

Pretax operating earnings(1)

     $   931         $   798               $1,911         $1,619         
                                     

Weighted-average yen/dollar exchange rate

     81.54         92.05               81.93         91.26         
                                     
      In Dollars     In Yen  

Percentage change over

previous period:

   Three Months
Ended June 30,
    Six Months
Ended June 30,
    Three Months
Ended June 30,
    Six Months
Ended June 30,
 
   2011     2010     2011     2010     2011     2010     2011     2010  

  Premium income

     18.3     9.8     16.9     8.1     5.1     3.8     5.0     3.5

  Net investment income

     7.3        9.0        8.4        7.4        (5.0     3.0        (2.8     2.7   

  Total operating revenues

     16.8        9.2        15.5        8.0        3.7        3.2        3.7        3.4   

  Pretax operating earnings(1)

     16.7        17.4        18.0        19.0        3.4        10.8        6.0        13.7   
   

 

(1) 

See the Insurance Operations section of this MD&A for our definition of segment operating earnings.

The percentage increases in premium income reflect the growth of premiums in force. The increases in annualized premiums in force in yen of 5.2% in the first six months of 2011 and 3.9% for the same period of 2010 reflect the high persistency of Aflac Japan’s business and the sales of new policies. Annualized premiums in force at June 30, 2011, were 1.29 trillion yen, compared with 1.22 trillion yen a year ago. Annualized premiums in force, translated into dollars at respective period-end exchange rates, were $15.9 billion at June 30, 2011, compared with $13.8 billion a year ago.

Aflac Japan maintains a portfolio of dollar-denominated and reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments). Dollar-denominated investment income from these assets accounted for approximately 33% of Aflac Japan’s investment income in the first six months of 2011 and 2010. In periods when the yen strengthens in relation to the dollar, translating Aflac Japan’s dollar-denominated investment income into yen lowers growth rates for net investment income, total operating revenues, and pretax operating earnings in yen terms. In periods when the yen weakens, translating dollar-denominated investment income into yen magnifies growth rates for net investment income, total operating revenues, and pretax operating earnings in yen terms. On a constant currency basis, dollar-denominated investment income accounted for approximately 35% of Aflac Japan’s investment income during the first six months of 2011, compared with 34% a year ago. The following table illustrates the effect of translating Aflac Japan’s

 

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dollar-denominated investment income and related items into yen by comparing certain segment results with those that would have been reported had yen/dollar exchange rates remained unchanged from the comparable period in the prior year.

Aflac Japan Percentage Changes Over Previous Period

(Yen Operating Results)

For the Periods Ended June 30,

     

Including Foreign

Currency Changes

   

Excluding Foreign

Currency Changes (2)

 
      Three Months     Six Months     Three Months     Six Months  
      2011     2010     2011     2010     2011     2010     2011     2010  

Net investment income

     (5.0 )  %      3.0   %      (2.8 )  %      2.7   %      (.9 )  %      5.1   %      .9   %      4.3   % 

Total operating revenues

     3.7        3.2        3.7        3.4        4.5        4.0        4.3        3.7   

Pretax operating earnings(1)

     3.4        10.8        6.0        13.7        6.9        14.7        8.4        15.2   
   

 

(1) 

See the Insurance Operations section of this MD&A for our definition of segment operating earnings.

(2) 

Amounts excluding foreign currency changes on dollar-denominated items were determined using the same yen/dollar exchange rate for the current period as the comparable period in the prior year.

The following table presents a summary of operating ratios for Aflac Japan.

 

      Three Months Ended
June 30,
     Six Months Ended
June 30,
 
Ratios to total revenues:    2011               2010               2011               2010           

Benefits and claims

     59.7  %             59.0  %             59.4  %             59.2  %       

Operating expenses:

           

Amortization of deferred policy acquisition costs

     3.8                  3.7                  3.7                  3.7            

Insurance commissions

     6.6                  7.0                  6.6                  7.0            

Insurance and other expenses

     8.8                  9.2                  8.6                  8.8            

Total operating expenses

     19.2                  19.9                  18.9                  19.5            

Pretax operating earnings(1)

     21.1                  21.1                  21.7                  21.3            
   

 

(1) 

See the Insurance Operations section of this MD&A for our definition of segment operating earnings.

Aflac Japan’s financial results for the first quarter of 2011 reflected a provision of 3.0 billion yen, or $37 million, for claims related to the earthquake and tsunami that occurred in Japan on March 11, 2011. These claims were offset by reserve releases and reinsurance of 2.0 billion yen, or $25 million, resulting in a net income statement impact of 1.0 billion yen, or $12 million, for benefits expense in the first quarter of 2011. The financial results for the first quarter of 2011 also reflected .7 billion yen, or $8 million, of operating expenses resulting from the earthquake and tsunami. Based on our claims experience to date and our claims estimates, we believe that our initial provision is adequate. The natural disaster and its related events have not had a material impact on our financial position or results of operations.

In the past several years, the benefit ratio has declined, driven primarily by favorable claim trends in our cancer product line. We expect this downward claim trend to continue. Our operating ratios have also been impacted by strong sales results in our ordinary products including child endowment and WAYS. These products have higher benefit ratios and lower expense ratios than our third sector products. The benefit ratio has also been impacted by the effect of low investment yields, which impacts our profit margin by reducing the spread between investment yields and required interest on policy reserves. Additionally, in the second quarter of 2011, net investment income was impacted by the write-off of the accrued interest income on our investments in Dexia S.A. and Irish Life and Permanent PLC, totaling $32 million, which caused the ratio of benefits to total revenue to be higher than it otherwise would have been due to the lower total revenue. Although the benefit ratio increased, the operating expense ratio decreased, resulting in the pretax operating profit margin remaining consistent in the three-month period ended June 30, 2011 compared with the level in prior year, and expanding in the six-month period ended June 30, 2011, compared with the same period a year ago. We expect the benefit and expense ratios and pretax profit margin to remain relatively stable throughout 2011.

 

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Aflac Japan Sales

In 2011, Aflac Japan has generated its largest first- and second-quarter production in its 36-year history. New annualized premium sales exceeded our expectations in the second quarter of 2011 and rose to 36.1 billion yen, a 6.6% increase compared with the same period in prior year. The following table presents Aflac Japan’s new annualized premium sales for the periods ended June 30.

 

      In Dollars     In Yen  
      Three Months     Six Months     Three Months     Six Months  
(In millions of dollars and billions of yen)    2011      2010      2011      2010      2011       2010       2011       2010    

New annualized premium sales

   $ 442        $ 368        $ 856        $ 702          36.1          33.9          70.2          64.1     

Increase (decrease) over comparable period in prior year

     20.1       19.1       22.0       16.7       6.6       12.6       9.4       11.4  
   

The following table details the contributions to new annualized premium sales by major insurance product for the periods ended June 30.

 

      Three Months     Six Months  
      2011       2010       2011       2010    

Medical

     25       35       26       37  

Cancer

     24          23          21          23     

Ordinary life:

        

Child endowment

     17          19          20          17     

WAYS

     19          7          18          7     

Other ordinary life

     11          12          11          13     

Other

     4          4          4          3     

Total

     100       100       100       100  
   

The medical insurance product was the leading contributor to total sales for the second quarter of 2011. Medical insurance sales decreased 26.2% during the three-month period ended June 30, 2011, compared with the same period a year ago, reflecting a difficult comparison to prior year sales, which had benefited from the favorable consumer response to our revised EVER medical product. Despite the comparative sales decrease, we maintained our position as the number one seller of medical insurance policies in Japan. With continued cost pressure on Japan’s health care system, we expect the need for medical products will continue to rise in the future, and we remain encouraged about the outlook for the medical insurance market.

Cancer insurance sales were up 12.4% during the second quarter of 2011, compared with the same period a year ago. The increase primarily reflected the introduction of the new base cancer policy, DAYS, which was introduced at the end of March. The enhancements to this new base policy are a response to the changes in cancer treatment as well as our commitment to being the number one provider of cancer insurance in Japan. Sales of cancer insurance accounted for 24.4% of new annualized premium sales for the quarter. We are convinced that the affordable cancer products Aflac Japan provides will continue to be an important part of our product portfolio.

The bank channel generated new annualized premium sales of 7.6 billion yen in the second quarter of 2011, an increase of 95.6% over the second quarter of 2010. As the bank channel has become a larger contributor to sales, Aflac Japan has enhanced its product portfolio to better meet the needs of banks. These products include our child endowment product and WAYS, a product that we first introduced in 2006 and introduced to the bank channel in 2009. Sales of WAYS were 6.7 billion yen during the second quarter of 2011, an increase of 190.7%, compared with the same period a year ago. Our profit margin on WAYS is significantly enhanced when policyholders elect to pay premiums upfront using the “discounted advance premium” option. Approximately 90% of customers at banks choose this payment option. As the banking channel becomes a greater contributor to our sales growth, we expect sales of this product to grow significantly in 2011.

Sales of our child endowment product were 6.2 billion yen during the second quarter of 2011, a decrease of 1.4% compared with the same period a year ago. We are shifting our focus from selling child endowment toward selling WAYS and our new cancer product DAYS. In addition, having sold the child endowment product for two years, we have already made a first attempt at selling this product to the eligible target market of families with young children. Remaining growth will primarily come from newborns, however the Japan birth rate is low. Finally, the government child subsidy that initially

 

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helped fuel demand for this product is being re-evaluated for possible reduction or elimination. As a result, we expect child endowment sales to decline significantly for the remainder of the year.

In the second quarter of 2011, the bank channel generated 21.1% of new annualized premium sales for Aflac Japan, compared with 11.5% during the same period a year ago. At June 30, 2011, we had agreements to sell our products with 367 banks, or more than 90% of the total number of banks in Japan. While many banks have agreed to sell our products, it takes time to facilitate training of employees at more than 20,000 branches representing the 367 banks. We are seeing sales steadily improving at many of these bank branches as training takes place and as many banks expand their offerings of Aflac products. We believe we have significantly more banks selling our third sector insurance products than any other insurer operating in Japan. We believe our long-standing and strong relationships within the Japanese banking sector, along with our strategic preparations, have proven to be an advantage as this channel opened up for our types of products.

We also remain committed to selling through our traditional channels, which allows us to reach consumers through affiliated corporate agencies, independent corporate agencies and individual agencies. In the second quarter of 2011, we recruited more than 1,500 new sales agencies, an increase of 16.1% over the same period a year ago. At June 30, 2011, Aflac Japan was represented by approximately 20,000 sales agencies and more than 117,700 licensed sales associates employed by those agencies.

Overall, Aflac Japan performed well in the second quarter of 2011. We believe that there is still a continued need for our products in Japan. Following strong sales growth in 2010, our objective for 2011 was for new annualized premium sales to be in the range of down 2% to up 3% in Japan. However, with the better-than-expected sales results in the first six months of 2011, we have upwardly revised Aflac Japan’s annual sales target to achieving a flat to 5% sales increase in 2011.

Aflac Japan Investments

Growth of investment income in yen is affected by available cash flow from operations, the timing of investing the cash flow, yields on new investments, and the effect of yen/dollar exchange rates on dollar-denominated investment income. Aflac Japan has invested in privately issued securities to secure higher yields than those available on Japanese government or other public corporate bonds, while still adhering to prudent standards for credit quality. All of our privately issued securities are rated investment grade at the time of purchase. These securities are generally issued with documentation consistent with standard medium-term note programs. In addition, many of these investments have protective covenants appropriate to the specific issuer, industry and country. These covenants often require the issuer to adhere to specific financial ratios and give priority to repayment of our investment under certain circumstances.

The following table presents the results of Aflac Japan’s investment yields for the periods ended June 30.

 

      Three Months     Six Months  
        2011       2010       2011       2010    

New money yield - yen only

     2.16       2.55       2.24       2.51  

New money yield - blended

     2.67          2.77          2.88          2.72     

Return on average invested assets, net of investment expenses

     3.15          3.55          3.23          3.55     
   

The decrease in the Aflac Japan yen only new money yield reflects the low level of interest rates and tightening credit spreads. At June 30, 2011, the yield on Aflac Japan’s investment portfolio, including dollar-denominated investments, was 3.51%, compared with 3.71% a year ago. In order to address our challenge of investing in Japan’s low-interest-rate environment, in 2010 and continuing into the first six months of 2011, we started increasing the amount Aflac Japan invests in higher-yielding dollar-denominated securities. See Notes 3 and 5 of the Notes to the Consolidated Financial Statements and the Analysis of Financial Condition section of this MD&A for additional information on our investments.

Japanese Economy

Japan’s economy had experienced downward pressure due to the effects of the earthquake and tsunami that occurred on March 11, 2011, however The Bank of Japan’s July 2011 Monthly Report of Recent Economic and Financial Developments stated that Japan’s economic activity is improving. After declining sharply following the earthquake, production has recently shown signs of increased activity with the easing of supply-side constraints and an increase in exports. Domestic private demand has also begun to increase, with some improvement in household and business sentiment. Financial conditions have generally continued to ease, while weakness has been observed in the financial positions of some firms, mainly small ones.

 

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Prior to the earthquake and tsunami, Japan’s economic conditions had been showing signs of improvement. Japan’s economy is still expected to return to a moderate recovery path, following the effects of the natural disaster earlier this year. For additional information, see the Japanese Economy subsection of MD&A in our annual report to shareholders for the year ended December 31, 2010.

Japanese Regulatory Environment

Japan’s Financial Services Agency (FSA) maintains a solvency standard, which is used by Japanese regulators to monitor the financial strength of insurance companies. The FSA will apply a revised method of calculating the solvency margin ratio for life insurance companies as of the fiscal year-end 2011 (March 31, 2012) and has encouraged the disclosure of the ratio as reference information as of fiscal year-end 2010 (March 31, 2011). The FSA had commented that the revision would generally reduce life insurance companies’ solvency margin ratios to approximately half the level of those reported under the current calculation method. As of March 31, 2011, Aflac Japan’s solvency margin ratio calculated using the current method was 919.3%, and the solvency margin ratio under the new standards, disclosed as reference information, was 512.2%. As expected, based on the results of the calculation of the solvency margin ratio under the new standards, Aflac Japan’s relative position within the industry did not materially change.

In 2005, legislation aimed at privatizing Japan’s postal system (Japan Post) was enacted into law. The privatization laws split Japan Post into four entities that began operating in October 2007. In 2007, one of these entities selected Aflac Japan as its provider of cancer insurance to be sold through post offices, and, in 2008, we began selling cancer insurance through these post offices. Japan Post has historically been a popular place for consumers to purchase insurance products. Currently, our products are being offered in approximately 1,000 post offices.

Japan Post reform legislation was introduced in the 2010 Japanese ordinary Diet session, but the session ended before the legislation could be passed. The legislation again failed to pass in the 2010 fall Diet session and is scheduled to be taken up in the 2011 ordinary Diet session, which opened on January 24, 2011. Given that the ruling coalition no longer controls a majority in the Diet’s upper house following its defeat in the July 2010 election, it is unclear whether the postal reform legislation will be passed in the 2011 ordinary Diet session. Regardless, we believe that the Diet debate on postal reform is unlikely to change Aflac Japan’s relationship with the post office company.

 

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AFLAC U.S. SEGMENT

Aflac U.S. Pretax Operating Earnings

Changes in Aflac U.S. pretax operating earnings and profit margins are primarily affected by morbidity, mortality, expenses, persistency and investment yields. The following table presents a summary of operating results for Aflac U.S.

Aflac U.S. Summary of Operating Results

     

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
(In millions)    2011     2010     2011     2010  

Premium income

   $ 1,186      $ 1,147      $ 2,356      $ 2,289   

Net investment income

     148        135        291        267   

Other income

     3        3        6        5   

Total operating revenues

     1,337        1,285        2,653        2,561   

Benefits and claims

     676        655        1,319        1,235   

Operating expenses:

        

Amortization of deferred policy acquisition costs

     97        90        213        228   

Insurance commissions

     138        134        271        266   

Insurance and other expenses

     180        179        351        361   

   Total operating expenses

     415        403        835        855   

Total benefits and expenses

     1,091        1,058        2,154        2,090   

Pretax operating earnings(1)

   $ 246      $ 227      $ 499      $ 471   
   

Percentage change over previous period:

        

  Premium income

     3.4  %      4.9  %      2.9  %      4.2  % 

  Net investment income

     9.7        6.1        9.2        5.9   

  Total operating revenues

     4.0        5.1        3.6        4.4   

  Pretax operating earnings(1)

     8.3        15.0        5.9        17.3   
   

 

(1) 

See the Insurance Operations section of this MD&A for our definition of segment operating earnings.

Annualized premiums in force increased 3.1% in the first six months of 2011 and 2010. Annualized premiums in force at June 30, 2011, were $5.0 billion, compared with $4.9 billion a year ago.

The following table presents a summary of operating ratios for Aflac U.S.

 

      Three Months Ended
June 30,
     Six Months Ended
June 30,
 
Ratios to total revenues:    2011           2010           2011           2010       

Benefits and claims

     50.6  %         51.0  %         49.7  %         48.2  %   

Operating expenses:

           

  Amortization of deferred policy acquisition costs

     7.2              7.0              8.0              8.9        

  Insurance commissions

     10.3              10.4              10.2              10.4        

  Insurance and other expenses

     13.5              13.9              13.3              14.1        

Total operating expenses

     31.0              31.3              31.5              33.4        

Pretax operating earnings(1)

     18.4              17.7              18.8              18.4        
   

 

(1) 

See the Insurance Operations section of this MD&A for our definition of segment operating earnings.

In the second quarter of 2011, the pretax operating profit margin expanded, compared with the same period a year ago due to the improvement of the benefit and expense ratios. In the first quarter of 2010, we experienced the loss of a large payroll account which resulted in the release of the future policy benefit reserves and amortization of the deferred policy acquisition costs for policies associated with this account; the net result had a positive impact on the profit margin in the first six months of 2010. In the first six months of 2011, as expected, our benefit ratio increased, compared with the same period of 2010, however it is still somewhat below normal levels. We believe we have benefited from the overall low level of healthcare utilization that is currently being experienced in the United States. The expense ratio decreased in the first six months of 2011, resulting in a slightly improved pretax operating profit margin, compared with that experienced in

 

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2010. For the remainder of 2011, we expect the benefit ratio to increase somewhat as healthcare utilization returns to a more normal level. We also expect the expense ratio to be higher in the remainder of the year as we invest in marketing and other areas in preparation for 2012.

Aflac U.S. Sales

For the second consecutive quarter in 2011, Aflac U.S. generated positive sales growth. We believe this sales improvement reflects our intense focus on supporting our field force with enhanced products, including group products, and better resources and training that help our sales force approach selling in the current economic environment more effectively. The following table presents Aflac’s U.S. new annualized premium sales for the periods ended June 30.

 

      Three Months           Six Months       
(In millions)    2011           2010           2011           2010       

New annualized premium sales

     $353              $333               $689              $649         

Increase (decrease) over comparable period in prior year

     5.9  %         (2.4)  %         6.1  %         (6.3)  %   
   

The following table details the contributions to new annualized premium sales by major insurance product category for the periods ended June 30.

 

      Three Months           Six Months       
      2011           2010           2011           2010       

Income-loss protection:

           

  Short-term disability

     17  %         17  %         17  %         17  %   

  Life

     6              6              6              6        

Asset-loss protection:

           

  Accident

     31              32              31              31        

  Critical care(1)

     23              22              23              22        

Supplemental medical:

           

  Hospital indemnity

     16              17              16              18        

  Dental/vision

     7              6              7              6        

Total

     100  %         100  %         100  %         100  %   
   

 

(1) 

Includes cancer, critical illness, and hospital intensive care products

New annualized premium sales for accident insurance, our leading product category, increased 3%, short-term disability sales increased 3%, critical care insurance sales (including cancer insurance) increased 13%, and hospital indemnity insurance sales decreased 3% in the second quarter of 2011, compared with the same period a year ago.

We are pursuing sales through “Smart Launches,” which are product specific coordinated sales marketing efforts. Our first “Smart Launch” was in the first quarter of 2011, and it focused our sales force on selling our dental product. Continuing the success of that effort from the first quarter, the results were very positive with our dental category generating a 44.1% sales increase in the second quarter of 2011, compared with the same period a year ago. Our second “Smart Launch” promotes our new Critical Care and Recovery product, which was previously known as our Specified Health Event product. This “Smart Launch” began in the middle of the second quarter of 2011. Therefore, it is too early to quantify its full impact. However, we are encouraged with how our sales force has embraced both the product itself and the “Smart Launch.”

As part of our U.S. sales strategy, we continue to focus on growing and enhancing the effectiveness of our U.S. sales force. Field force recruiting continued to benefit from targeted national advertising campaigns that we began in January 2011. These campaigns contributed significantly to our 10.2% increase in recruits for the second quarter of 2011, compared with the same period a year ago. We recruited more than 6,400 new sales associates in the second quarter of 2011, resulting in approximately 72,700 licensed sales associates as of June 30, 2011.

In addition to expanding the size and capabilities of our traditional sales force, we are encouraged about the opportunities to broaden our distribution by pursuing and strengthening relationships with insurance brokers. Insurance brokers have been a historically underleveraged sales channel for Aflac, so we have been developing relationships that complement our traditional distribution system with the Aflac for BrokersSM initiative that we launched in 2009. We have a management team experienced in broker sales, and we are supporting this initiative with streamlined products, targeted broker-specific advertising campaigns, customized enrollment technology, and competitive compensation.

 

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Our group products sold through CAIC, now branded as Aflac Group Insurance, have enhanced sales opportunities not only for brokers but also for our traditional sales force of individual associates, especially when they pursue larger payroll accounts. For the three-month period ended June 30, 2011, sales from Aflac Group Insurance increased to $35 million, or 9.8% of new annualized premium sales for Aflac U.S. For the six-month period ended June 30, 2011, sales from Aflac Group Insurance increased to $70 million, or 10.2% of new annualized premium sales for Aflac U.S.

Although we remain somewhat cautious in our short-term sales outlook for Aflac U.S., our longer-term view has not changed. We believe the need for our products we sell remains strong, and that the United States provides a vast and accessible market for our products. We are taking measures to better reach potential customers through our product and distribution strategy, which includes broadening our product portfolio to include group products in addition to our traditional individually issued products. The addition of the group product platform and our growing broker initiative only serve to enhance our ability to leverage the Aflac brand to reach more companies, large and small, across the United States. Following the passage of health care reform in 2010, we believe employers and consumers will increasingly come to understand the need for the products we offer, just as they have in Japan. We believe that our objective for Aflac U.S. new annualized premium sales growth for 2011 to be flat to up 5% is reasonable.

Aflac U.S. Investments

The following table presents the results of Aflac’s U.S. investment yields for the periods ended June 30.

 

      Three Months           Six Months       
      2011           2010           2011           2010       

New money yield

     5.72  %         6.11  %         5.74  %         6.01  %   

Return on average invested assets, net of investment expenses

     6.41              6.24              6.42              6.36        
   

The decrease in the U.S. new money yield reflects a low level of interest rates and tightening credit spreads. At June 30, 2011, the portfolio yield on Aflac’s U.S. portfolio was 6.76%, compared with 7.04% a year ago. See Notes 3 and 5 of the Notes to the Consolidated Financial Statements and the Analysis of Financial Condition section of this MD&A for additional information on our investments.

U.S. Economy

Operating in the U.S. economy continues to be challenging. Ongoing low confidence levels from consumers and small businesses coupled with fewer employees at the worksite continue to pose challenges to our U.S. sales growth. Most of our business continues to revolve around small business owners and accounts with fewer than 100 employees. Small businesses, in particular, have proven to be especially vulnerable to ongoing economic weakness, and both small-business owners and their workers are anxious about the future. Workers at small businesses are holding back on increasing their spending for voluntary insurance products. Although we believe that the weakened U.S. economy has been a contributing factor to slower sales growth, we also believe our products remain affordable to the average American consumer. We believe that consumers’ underlying need for our U.S. product line remains strong, and that the United States remains a sizeable and attractive market for our products.

U.S. Regulatory Environment

In March 2010, President Barack Obama signed the Patient Protection and Affordable Care Act (PPACA) to give Americans of all ages and income levels access to comprehensive major medical health insurance. The primary subject of the new legislation is major medical insurance, therefore, the PPACA, as enacted, does not directly affect the design of our insurance products or our sales model. Our experience with Japan’s national healthcare environment leads us to believe that the need for our products will only increase over the coming years.

In July 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Dodd-Frank Act, which, among other things, created a Financial Stability and Oversight Council. The Council may designate by a two-thirds vote whether certain insurance companies and insurance holding companies pose a grave threat to the financial stability of the United States, in which case such nonbank financial companies would become subject to prudential regulation by the Board of Governors of the U.S. Federal Reserve, including capital requirements, leverage limits, liquidity requirements and examinations. The Board may limit such company’s ability to enter into merger transactions, restrict its ability to offer financial products, require it to terminate one or more activities, or impose conditions on the manner in which it conducts activities. The Dodd-Frank Act also established a Federal Insurance Office under the U.S. Treasury Department to monitor all aspects of the insurance industry and of lines of business other than certain health insurance, certain long-term care insurance and crop insurance. Traditionally, U.S. insurance companies have been regulated primarily by state insurance departments. The Dodd-Frank Act requires extensive rule-making and other

 

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future regulatory action, which in some cases will take a period of years to implement. Despite the lack of regulations to implement this law, we believe that Aflac would not likely be considered a company that would pose a systemic risk to the financial stability of the United States. However, at the current time, it is not possible to predict with any degree of certainty what impact, if any, the Dodd-Frank Act will have on our U.S. business, financial condition, or results of operations.

ANALYSIS OF FINANCIAL CONDITION

Our financial condition has remained strong in the functional currencies of our operations. The yen/dollar exchange rate at the end of each period is used to translate yen-denominated balance sheet items to U.S. dollars for reporting purposes.

The following table demonstrates the effect of the change in the yen/dollar exchange rate by comparing select balance sheet items as reported at June 30, 2011, with the amounts that would have been reported had the exchange rate remained unchanged from December 31, 2010.

 

Impact of Foreign Exchange on Balance Sheet Items       
(In millions)   

  As  

Reported

         Exchange             
    Effect            
     Net of        
Exchange Effect         
      

Yen/dollar exchange rate(1)

     80.73                             81.49                

Investments and cash

     $              92,984                    $            675                     $ 92,309              

Deferred policy acquisition costs

     10,028                    67                       9,961              

Total assets

     106,232                    758                       105,474              

Policy liabilities

     86,366                    733                       85,633              

Total liabilities

     94,251                    776                       93,475              
                                
(1) 

The exchange rate at June 30, 2011, was 80.73 yen to one dollar, or .9% stronger than the December 31, 2010, exchange rate of 81.49.

Market Risks of Financial Instruments

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 fixed income securities markets.

The following table details investment securities by segment.

 

Investment Securities by Segment  
      Aflac Japan           Aflac U.S.  
(In millions)    June 30,
2011    
     December 31,
2010        
          June 30,
2011    
    December 31,
2010        
 

Securities available for sale, at fair value:

            

Fixed maturities

     $      43,292               $      39,485                $       9,095  (1)      $       8,750  (1)     

Perpetual securities

     6,925         7,233                178             279        

Equity securities

     23         23                  0             0        

Total available for sale

     50,240         46,741                  9,273             9,029        

Securities held to maturity, at amortized cost:

            

Fixed maturities

     31,908         30,084                  0             0        

Total held to maturity

     31,908         30,084                  0             0        

Total investment securities

     $      82,148               $      76,825                $      9,273             $      9,029        
   
(1) 

Excludes investment-grade, available-for-sale fixed-maturity securities held by the Parent Company of $119 in 2011 and $120 in 2010.

 

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Because we invest in fixed-income securities, our financial instruments are exposed primarily to three types of market risks: currency risk, interest rate risk, and credit risk.

Currency Risk

The functional currency of Aflac Japan’s insurance operations is the Japanese yen. All of Aflac Japan’s premiums, claims and commissions are received or paid in yen, as are most of its investment income and other expenses. While we have been investing a portion of our yen cash flow in dollar-denominated securities, most of Aflac Japan’s investments, cash and liabilities are yen-denominated. When yen-denominated securities mature or are sold, the proceeds are generally reinvested in yen-denominated securities. Aflac Japan holds these yen-denominated assets to fund its yen-denominated policy obligations. In addition, Aflac Incorporated has yen-denominated debt obligations.

Although we generally do not convert yen into dollars, we do translate financial statement amounts from yen into dollars for financial reporting purposes. Therefore, reported amounts are affected by foreign currency fluctuations. We report unrealized foreign currency translation gains and losses in accumulated other comprehensive income.

Aflac Japan maintains a portfolio of reverse-dual currency securities (yen-denominated debt securities with dollar coupon payments), which exposes Aflac to changes in foreign exchange rates. This foreign currency effect is accounted for as a component of unrealized gains or losses on available-for-sale securities in accumulated other comprehensive income. When the yen strengthens against the dollar, shareholders’ equity is negatively impacted and, conversely, when the yen weakens against the dollar, shareholders’ equity is positively impacted. Aflac Japan invests a portion of its assets in reverse-dual currency securities to provide a higher yield than those available on Japanese government or other public corporate bonds, while still adhering to prudent standards of credit quality. The yen/dollar exchange rate would have to strengthen to approximately 50 before the yield on these instruments would equal that of a comparable yen-denominated instrument.

On a consolidated basis, we attempt to minimize the exposure of shareholders’ equity to foreign currency translation fluctuations. We accomplish this by investing a portion of Aflac Japan’s investment portfolio in dollar-denominated securities and by the Parent Company’s issuance of yen-denominated debt (for additional information, see the discussion under the Hedging Activities subsection of MD&A). As a result, the effect of currency fluctuations on our net assets is reduced.

The following table demonstrates the effect of foreign currency fluctuations by presenting the dollar values of our yen-denominated assets and liabilities, and our consolidated yen-denominated net asset exposure at selected exchange rates.

 

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Dollar Value of Yen-Denominated Assets and Liabilities

at Selected Exchange Rates

 
(In millions)    June 30, 2011     December 31, 2010  

Yen/dollar exchange rates

     65.73        80.73 (1)      95.73        66.49        81.49 (1)      96.49      

Yen-denominated financial instruments:

            

Assets:

            

  Securities available for sale:

            

Fixed maturities

   $ 37,550      $ 30,573      $ 25,782      $ 35,905      $ 29,296      $ 24,742      

Fixed maturities - consolidated variable interest entities

     3,348        2,726        2,299        3,637        2,968        2,506      

Perpetual securities

     6,538        5,323        4,489        6,911        5,638        4,762      

Perpetual securities - consolidated variable interest entities

     1,756        1,430        1,206        1,745        1,424        1,203      

Equity securities

     23        19        16        23        19        16      

  Securities held to maturity:

            

Fixed maturities

     38,429        31,289        26,386        36,119        29,470        24,889      

Fixed maturities - consolidated variable interest entities

     761        619        522        752        614        518      

  Cash and cash equivalents

     310        253        213        939        766        647      

  Other financial instruments

     163        133        112        153        125        105      

Subtotal

     88,878        72,365        61,025        86,184        70,320        59,388      

Liabilities:

            

  Notes payable

     1,295        1,054        889        1,280        1,044        882      

  Japanese policyholder protection corporation

     110        89        75        132        108        91      

Subtotal

     1,405        1,143        964        1,412        1,152        973      

Net yen-denominated financial instruments

     87,473        71,222        60,061        84,772        69,168        58,415      

Other yen-denominated assets

     10,937        8,905        7,509        10,338        8,435        7,124      

Other yen-denominated liabilities

     100,755        82,037        69,180        95,441        77,873        65,767      

Consolidated yen-denominated net assets (liabilities) subject to foreign currency fluctuation

   $ (2,345   $ (1,910   $ (1,610   $ (331   $ (270   $ (228)     
                                                  

 

(1)

Actual period-end exchange rate

Effective January 1, 2010, we were required to consolidate certain variable interest entities (VIEs) upon the adoption of new accounting guidance. Prior to the adoption of this new accounting guidance, our beneficial interest in certain VIEs was a yen-denominated available-for-sale fixed maturity security. Upon consolidation on January 1, 2010, the original yen-denominated investment was derecognized and the underlying U.S. dollar-denominated fixed-maturity or perpetual securities and cross-currency swaps were recognized. While the combination of a U.S. dollar-denominated investment and cross-currency swap economically creates a yen-denominated investment, these investments will create foreign currency fluctuations but have no impact on our net investment hedge position. For additional information, see the Hedging Activities subsection of MD&A.

Some of the consolidated VIEs in our Aflac Japan portfolio use foreign currency swaps to convert foreign denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations. Foreign currency swaps exchange an initial principal amount in two currencies, agreeing to re-exchange the currencies at a future date, at an agreed upon exchange rate. There may also be periodic exchanges of payments at specified intervals based on the agreed upon rates and notional amounts.

We are exposed to economic currency risk only when yen funds are actually converted into dollars. This primarily occurs when we repatriate funds from Aflac Japan to Aflac U.S., which is generally done annually. The exchange rates prevailing at the time of repatriation will differ from the exchange rates prevailing at the time the yen profits were earned. A portion of the repatriation may be used to service Aflac Incorporated’s yen-denominated notes payable with the remainder converted into dollars.

 

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Interest Rate Risk

Our primary interest rate exposure is to the impact of changes in interest rates on the fair value of our investments in debt and perpetual securities. We estimate that the reduction in the fair value of debt and perpetual securities we own resulting from a 100 basis point increase in market interest rates, based on our portfolios at June 30, 2011, and December 31, 2010, would be as follows:

 

      June 30,           December 31,       
(In millions)    2011           2010       

Effect on yen-denominated debt and perpetual securities

   $ (8,157      $ (7,833  

Effect on dollar-denominated debt and perpetual securities

     (1,871          (1,366    

Effect on total debt and perpetual securities

   $ (10,028      $ (9,199  
                           

There are various factors that affect the fair value of our investment in debt and perpetual securities. Included in those factors are changes in the prevailing interest rate environment, which directly affect the balance of unrealized gains or losses for a given period in relation to a prior period. Decreases in market yields generally improve the fair value of debt and perpetual securities while increases in market yields generally have a negative impact on the fair value of our debt and perpetual securities. However, we do not expect to realize a majority of any unrealized gains or losses because we generally have the intent and ability to hold such securities until a recovery of value, which may be maturity. For additional information on unrealized losses on debt and perpetual 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. Currently, when debt and perpetual 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. However, adding riders to our older policies has helped offset negative investment spreads on these policies. Overall, adequate profit margins exist in Aflac Japan’s aggregate block of business because of changes in the mix of business and favorable experience from mortality, morbidity and expenses.

We entered into interest rate swap agreements related to our 20 billion yen variable interest rate Uridashi notes that will mature in September 2011 and our 5.5 billion yen variable interest rate Samurai notes that we issued subsequent to the end of the second quarter in July 2011. These agreements effectively convert the variable interest rate notes to fixed rate notes to eliminate the volatility in our interest expense. We also have interest rate swaps related to some of our consolidated VIEs. These interest rate swaps are primarily used to convert interest receipts on floating-rate fixed-maturity securities contracts to fixed rates. For further information, see Note 4 of the accompanying Notes to the Consolidated Financial Statements and Note 8 of the Notes to the Consolidated Financial Statements and the Interest Rate Risk subsection of MD&A in our annual report to shareholders for the year ended December 31, 2010.

Credit Risk

Our investment activities expose us to credit risk, which is a consequence of extending credit and/or carrying investment positions. However, we continue to adhere to prudent standards for credit quality. We accomplish this by considering our product needs and overall corporate objectives, in addition to credit risk. In evaluating the initial rating, we look at the overall senior issuer rating, the explicit rating for the actual issue or the rating for the security class, and, where applicable, the appropriate designation from the Securities Valuation Office (SVO) of the National Association of Insurance Commissioners (NAIC). All of our securities have ratings from either a nationally recognized statistical rating organization or the SVO of the NAIC. In addition, we perform extensive internal credit reviews to ensure that we are consistent in applying rating criteria for all of our securities.

We use specific criteria to judge the credit quality of both existing and prospective investments. Furthermore, we use several methods to monitor these criteria, including credit rating services and internal credit analysis. The distributions by credit rating of our purchases of debt securities, based on acquisition cost, were as follows:

 

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Composition of Purchases by Credit Rating

 

    

Six Months Ended

June 30, 2011

       

Twelve Months Ended

December 31, 2010

  

Six Months Ended

June 30, 2010

         

 

  AAA

          21.2  %                   1.0  %            .7  %         

  AA

          53.0                   60.7                62.0           

  A

          13.2                   24.5                30.7           

  BBB

          11.7                   13.8                  6.6           

  BB or lower

        .9                 .0              .0           

 

Total

        100.0  %               100.0  %            100.0  %         

 

Purchases of securities from period to period are determined based on diversification objectives, relative value and availability of investment opportunities, while meeting our investment policy guidelines for liquidity, safety, and quality. We did not purchase any perpetual securities during the periods presented in the table above. The increase in purchases of AAA rated securities during the first six months of 2011 was due to an increase in purchases of U.S. Treasury securities. The purchases of BB or lower rated securities during the first six months of 2011 was due to a limited program that we initiated in May 2011 to invest in senior secured bank loans to U.S. and Canadian corporate borrowers, most of which have below-investment-grade ratings. The program is managed externally by a third party firm specializing in this asset class. Its mandate requires an average credit quality of BB-/Ba3, no loans rated below B/B2, and no exposure to any individual credit greater than 3% of the program’s assets. The objectives of this program include enhancing the yield on invested assets, achieving further diversification of credit risk, and mitigating the risk of rising interest rates through the acquisition of floating rate assets.

The distributions of debt and perpetual securities we own, by credit rating, were as follows:

Composition of Portfolio by Credit Rating

 

     June 30, 2011    December 31, 2010       

 

         Amortized
    Cost
            Fair    
  Value    
              Amortized
    Cost
            Fair    
  Value    
      

 

 AAA

         4.8 %                  5.0 %                  3.3 %              3.6 %        

 AA

       37.5                    37.9                    35.7                  36.5            

 A

       32.9                    33.2                    36.0                  36.6            

 BBB

       19.4                    19.1                    18.8                  18.7            

 BB or lower

         5.4                      4.8                      6.2                  4.6            

Total

     100.0 %                100.0 %                100.0 %                100.0 %          
 

As of June 30, 2011, our direct and indirect exposure to securities in our investment portfolio that were guaranteed by third parties was immaterial both individually and in the aggregate.

Subordination Distribution

The majority of our total investments in debt and perpetual securities was senior debt at June 30, 2011, and December 31, 2010. We also maintained investments in subordinated financial instruments that primarily consisted of Lower Tier II, Upper Tier II, and Tier I securities, listed in order of seniority. The Lower Tier II (LTII) securities are debt instruments with fixed maturities. Our Upper Tier II (UTII) and Tier I investments consisted of debt instruments with fixed maturities and perpetual securities, which have an economic maturity as opposed to a stated maturity.

 

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The following table shows the subordination distribution of our debt and perpetual securities.

 

Subordination Distribution of Debt and Perpetual Securities  
      June 30, 2011      December 31, 2010    
(In millions)   

Amortized

Cost

    

Percentage

of Total

    

Amortized

Cost

    

Percentage  

of Total

 

Senior notes

       $   75,427         83.4  %           $   68,407         79.5  %     

Subordinated securities:

           

Fixed maturities (stated maturity date):

           

Lower Tier II

     6,734         7.4              8,679         10.1          

Upper Tier II

     0         .0              15         .0          

Tier I(1)

     543         .6              613         .7          

Surplus notes

     335         .4              335         .4          

Trust preferred - non-banks

     85         .1              85         .1          

Other subordinated - non-banks

     52         .1              52         .1          

Total fixed maturities

     7,749         8.6              9,779         11.4          

Perpetual securities (economic maturity date):

           

Upper Tier II

     4,758         5.3              5,285         6.1          

Tier I

     2,501         2.7              2,542         3.0          

Total perpetual securities

     7,259         8.0              7,827         9.1          

Total debt and perpetual securities

       $   90,435         100.0  %           $   86,013         100.0  %     
   

 

(1)

Includes trust preferred securities

As indicated in the table above, the percentage of our investment portfolio comprising subordinated fixed maturities and perpetual securities investments has declined due primarily to sales and impairments resulting from an implemented plan to reduce the risk exposure in our investment portfolio. See the Investment Concentrations section below for more information on these derisking activities.

Portfolio Composition

For information regarding the amortized cost for our investments in debt and perpetual securities, the cost for equity securities and the fair values of these investments, refer to Note 3 of the Notes to the Consolidated Financial Statements.

Investment Concentrations

As of June 30, 2011, our largest investment industry sector concentration was banks and financial institutions. Throughout 2008 and during the first half of 2009, concerns related to troubled residential mortgages in the United States, United Kingdom and Europe spread to structured investment securities. As a result, banks and financial institutions suffered significant write-downs of asset values, which pressured banks and financial institutions to seek capital and liquidity support. National governments responded with various forms of support, ranging from guarantees on new and existing debt to significant injections of capital. In the second half of 2009, asset valuations generally improved, and banks and other institutions continued to use exchanges and tender offers to enhance their core capital. However, 2010 brought new concerns about the fiscal integrity of peripheral European sovereign nations. As a result, Greece, Ireland, and most recently Portugal were forced to accept external funding aid in various forms to meet their financial obligations, as public markets were not accessible. The financial institutions of these countries have faced both liquidity and asset valuation pressures. Nationalization and/or recapitalization, along with loss-sharing among bondholders, all remain distinct risks for financial institutions in these countries and others facing similar fiscal pressures. While European politicians have become increasingly hesitant to put taxpayers at risk, with few exceptions, we believe nationalizations and burden-sharing among debt holders remain options of last resort.

See Note 3 of the Notes to the Consolidated Financial Statements for a discussion of our investment discipline, further discussion of our largest investment industry sector concentration (banks and financial institutions), and disclosure on our investment exposure to certain Eurozone countries (Greece, Ireland, Italy, Portugal and Spain).

 

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Our largest global investment exposures as of June 30, 2011, were as follows:

 

Largest Global Investment Positions
     Amortized      % of         Ratings
(In millions)    Cost      Total         Seniority          Moody’s    S&P      Fitch

Japan National Government(1)

   $ 20,037         22.2        Senior    Aa2    AA-    AA-

United States Treasury

     1,806         2.0           Senior    Aaa    AAA    AAA

Israel Electric Corp.

     908         1.0           Senior    Baa2    BB+    -

Republic of Tunisia(2)

     810         0.9           Senior    Baa3    BBB-    BBB-

Republic of South Africa

     757         0.8           Senior    A3    BBB+    BBB+

HSBC Holdings PLC

     740         0.8                   

HSBC Finance Corporation (formerly Household Finance)

     620         0.7           Senior    A3    A    AA-

HSBC Bank PLC (RAV Int’l. Ltd.)

     40         0.0           Upper Tier II    A3    A    A+

The Hongkong & Shanghai Banking Corporation Ltd.

     80         0.1           Upper Tier II    Aa3    -    -

Commerzbank AG (includes Dresdner Bank)

     625         0.7                   

Commerzbank AG

     434         0.5           Lower Tier II    Baa3    BBB-    A

Dresdner Bank AG (Dresdner Funding Trust IV)

     191         0.2           Lower Tier II    Baa3    BBB-    A

UniCredit SpA

     622         0.7                   

UniCredit Bank Austria

     11         0.0           Lower Tier II    Aa3    AA+    -

UniCredit Bank AG (Hypovereinsbank)

     248         0.3           Lower Tier II    Baa2    BBB+    A

UniCredit Bank AG (HVB Funding Trust I, III & VI)

     363         0.4           Tier I    Baa3    BBB    BBB

Mizuho Financial Group Inc.

     581         0.6                   

Mizuho Bank, Mizuho Finance Cayman & Aruba

     581         0.6           Upper Tier II    A2    A-    -

Bank of Tokyo-Mitsubishi UFJ Ltd.

     557         0.6                   

Bank of Tokyo-Mitsubishi UFJ Ltd. (BTMU Curacao Holdings NV)

     557         0.6           Lower Tier II    Aa3    A    A-

Bank of America Corp. (includes Merrill Lynch)

     557         0.6                   

Merrill Lynch & Co. Inc.

     309         0.3           Senior    A2    A    A+

Bank of America Corp.

     248         0.3           Lower Tier II    A3    A-    A

BNP Paribas (includes Fortis)

     557         0.6                   

BNP Paribas

     124         0.2           Senior    Aa2    AA    AA-

Fortis Bank SA-NV

     309         0.3           Upper Tier II    A3    A    A-

Fortis Luxembourg Finance SA

     124         0.1           Upper Tier II    Baa2    A    A-

Erste Group Bank AG

     532         0.6                   

Erste Group Bank

     124         0.1           Lower Tier II    A2    A-    A-

Erste Group Bank (Erste Finance Jersey Ltd 3 & 5)

     408         0.5           Tier I    Ba1    -    BBB-

Investcorp SA

     508         0.6                   

Investcorp Capital Limited

     508         0.6           Senior    Ba2    -    BB+

National Grid PLC

     496         0.6                   

National Grid Gas PLC

     248         0.3           Senior    A3    A-    A

National Grid Electricity Transmission PLC

     248         0.3           Senior    A3    A-    A

Sumitomo Mitsui Financial Group Inc.

     496         0.6                   

Sumitomo Mitsui Banking Corporation

     124         0.2           Lower Tier II    Aa3    A    A-

Sumitomo Mitsui Banking Corporation (SMBC International Finance)

     372         0.4           Upper Tier II    A1    A-    -

Telecom Italia SpA

     495         0.6                   

Telecom Italia Finance SA

     495         0.6           Senior    Baa2    BBB    BBB

Citigroup Inc.

     489         0.5                   

Citigroup Inc (includes Citigroup Global Markets Holdings Inc., Associates Corp.)

     488         0.5           Senior    A3    A    A+

Citigroup Inc. (Citicorp)

     1         0.0           Lower Tier II    Baa1    A-    A

JP Morgan Chase & Co. (including Bear Stearns)

     488         0.5                   

JPMorgan Chase & Co (including Bear Stearns Companies Inc.)

     434         0.5           Senior    Aa3    A+    AA-

JPMorgan Chase & Co (FNBC)

     26         0.0           Senior    Aa1    AA-    -

JPMorgan Chase & Co (Bank One Corp.)

     17         0.0           Lower Tier II    A1    A    A+

JPMorgan Chase & Co (NBD Bank)

     11         0.0           Lower Tier II    Aa2    A+    A+

Commonwealth Bank of Australia

     483         0.5                   

Commonwealth Bank of Australia

     124         0.1           Lower Tier II    Aa3    AA-    AA-

Commonwealth Bank of Australia

     248         0.3           Upper Tier II    -    A+    -

Bankwest

     111         0.1           Upper Tier II    Aa3    AA-    -

Total

   $ 32,544         36.0                        
 

Total debt and perpetual securities

   $ 90,435         100.0                
 

 

(1) 

JGBs or JGB-backed securities

(2) 

Deemed by the Company to be below investment grade

As previously disclosed, we own long-dated debt instruments in support of our long-dated policyholder obligations. Included in our largest global investment holdings are legacy issues that date back many years. Additionally, the concentration of certain of our holdings of individual credit exposures has grown over time through merger and consolidation activity. Beginning in 2005, we have generally limited our investment exposures to issuers to no more than 5% of total adjusted capital (TAC) on a statutory accounting basis, with the exception of obligations of the Japanese and U.S. governments. However, existing investment exposures that exceeded 5% of TAC at the time this guidance was adopted, or exposures that may exceed this threshold from time to time through merger and consolidation activity, are not automatically reduced through sales of the issuers’ securities but rather are reduced over time consistent with our investment policy.

 

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During the three- and six-month periods ended June 30, 2011, we pursued strategic investment activities to lower the risk profile of our investment portfolio. Our primary focus was on reducing our exposure to peripheral Eurozone investments, perpetual securities, and investments in certain banks/financial institutions. Our primary derisking activities are summarized as follows:

 

Investment Derisking Activities

 

 
     Three Months Ended June 30, 2011  
     Balance,     Realized Investment     Balance,  
    Beginning of Period     Gains (Losses)     End of Period  
            Amortized     Sales and                   Amortized  
(in millions)   Par Value     Cost     Redemptions     Impairments     Par Value     Cost  

Peripheral Eurozone banks/financial institutions, by country:

                                               

Ireland(1)

  $ 956      $ 621      $ (74   $ 0      $ 525      $ 525   

Greece

    770        372        (45     0        0        0   

Portugal

    842        842        (99     (275     558        282   
                                                 

Perpetual securities:

           

Dexia SA (includes Dexia Bank Belgium & Dexia Overseas)

  $ 541      $ 439      $ 0      $ (184   $ 557      $ 268   

Royal Bank of Scotland Group PLC

    58        19        28        0        0        0   

Lloyds Banking Group PLC (2)

    33        7        18        0        0        0   

Swedbank

    349        293        2        0        235        178   
                                                 

(1)  Includes Irish Life and Permanent PLC perpetual securities

(2)   Remainder of exposure to this issuer does not consist of perpetual securities

 

     

      

     Six Months Ended June 30, 2011  
     Balance,     Realized Investment     Balance,  
    Beginning of Period     Gains (Losses)     End of Period  
            Amortized     Sales and                   Amortized  
(in millions)   Par Value     Cost     Redemptions     Impairments     Par Value     Cost  

Peripheral Eurozone banks/financial institutions, by country:

                                               

Ireland(1)

  $ 1,220      $ 710      $ (72   $ 0      $ 525      $ 525   

Greece

    1,154        1,152        (222     (397     0        0   

Portugal

    859        859        (99     (275     558        282   
                                                 

Perpetual securities:

           

Dexia SA (includes Dexia Bank Belgium & Dexia Overseas)

  $ 552      $ 448      $ 0      $ (184   $ 557      $ 268   

Royal Bank of Scotland Group PLC

    58        19        28        0        0        0   

Lloyds Banking Group PLC(2)

    33        7        18        0        0        0   

Swedbank

    356        299        2        0        235        178   

HSBC Holdings PLC

    166        155        4        0        136        120   
                                                 

 

(1) 

Includes Irish Life and Permanent PLC perpetual securities

(2) 

Remainder of exposure to this issuer does not consist of perpetual securities

 

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As a result of our primary derisking activities, we have experienced significant reductions in peripheral Eurozone, perpetual, and financial exposures on an amortized cost basis. At the start of 2008, sovereign and financial investments in peripheral Eurozone countries comprised 5.9% of total investments and cash, declining to 2.8% by the end of the second quarter of 2011. At the start of 2008, investments in perpetual securities comprised 14.7% of total investments and cash, declining to 7.9% by the end of the second quarter of 2011. At the start of 2008, investments in financial securities comprised 41.9% of total investments and cash, declining to 30.1% by the end of the second quarter of 2011. As a result of these derisking activities, we have no direct investment exposure to Greece, only senior indebtedness in Ireland, and materially lower exposure to Portuguese investments.

As a result of derisking activities to reduce our exposure to large concentrated positions that exceed 10% of total adjusted capital (TAC) on a statutory accounting basis, in the first six months of 2011 we reduced our exposure to Israel Electric by $89 million, the Republic of Tunisia by $104 million, HSBC by $100 million, Commerzbank by $94 million, and Bank of America Corp. by $104 million, on an amortized cost basis, resulting in a pretax net loss of $3 million ($2 million after-tax) for the three-month period and a pretax net gain of $6 million ($4 million after-tax) for the six-month period ended June 30, 2011.

As of the end of the second quarter of 2011, we believe we have substantially completed our investment derisking activities from a realized investment loss perspective. See the Investment Concentrations section of Note 3 of the Notes to the Consolidated Financial Statements for additional information.

We have investments in both publicly and privately issued securities. The outstanding amount of a particular issuance, as well as the level of activity in a particular issuance and market conditions, including credit events and the interest rate environment, affect liquidity regardless of whether it is publicly or privately issued.

The following table details investment securities by type of issuance.

 

Investment Securities by Type of Issuance  
      June 30, 2011            December 31, 2010  
(In millions)   

Amortized

Cost

    

Fair   

Value   

          

Amortized

Cost

    

Fair  

Value  

 

Publicly issued securities:

              

Fixed maturities

       $   37,409             $  38,971                   $  31,098           $  32,457       

Perpetual securities

     216               214                 235             256       

Equity securities

     12               14                   13             14       

Total publicly issued

     37,637               39,199                   31,346             32,727       

Privately issued securities:

              

Fixed maturities

     45,767               45,517                 47,088             46,367       

Perpetual securities

     7,043               6,889                 7,592             7,256       

Equity securities

     9               9                   9             9       

Total privately issued

     52,819               52,415                   54,689             53,632       

Total investment securities

       $   90,456             $  91,614                     $  86,035           $  86,359       
   

The following table details our privately issued investment securities.

 

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Privately Issued Securities  
(Amortized cost, in millions)   

June 30,

2011

   

December 31,            

2010            

 

Privately issued securities as a percentage of total debt and perpetual securities

     58.4       63.6  %              

Privately issued securities held by Aflac Japan

   $         50,052        $     51,702                   

Privately issued securities held by Aflac Japan as a percentage of total debt and perpetual securities

     55.3       60.1  %              
   
Reverse-Dual Currency Securities (1)   
(Amortized cost, in millions)   

June 30,

2011

   

December 31,            

2010            

 

Privately issued reverse-dual currency securities

   $         12,729        $     12,790                   

Publicly issued collateral structured as reverse-dual currency securities

     2,858          2,844                   

Total reverse-dual currency securities

   $         15,587        $     15,634                   
   

Reverse-dual currency securities as a percentage of total debt and perpetual securities

     17.2       18.2  %              
   
(1) 

Principal payments in yen and interest payments in dollars

The decrease in privately issued securities as a percentage of total debt and perpetual securities was due primarily to sales and impairments of investments and the reallocation of funds to investments in Japanese Government Bonds (JGBs) and U.S. Treasury securities in the first six months of 2011.

Aflac Japan has invested in privately issued securities to better match liability characteristics and secure higher yields than those available on Japanese government or other public corporate bonds. Aflac Japan’s investments in yen-denominated privately issued securities consist primarily of non-Japanese issuers and have longer maturities, thereby allowing us to improve our asset/liability matching and our overall investment returns. Most of our privately issued securities are issued under medium-term note programs and have standard documentation commensurate with credit ratings of the issuer, except when internal credit analysis indicates that additional protective and/or event-risk covenants are required.

Below-Investment-Grade and Split-Rated Securities

Below-investment-grade debt and perpetual securities represented 5.3% of total debt and perpetual securities at June 30, 2011, compared with 6.2% of total debt and perpetual securities at December 31, 2010, at amortized cost. Debt and perpetual securities classified as below investment grade at June 30, 2011 and December 31, 2010, were generally reported as available for sale and carried at fair value.

The below-investment-grade securities shown in the following table were investment grade at the time of purchase and were subsequently downgraded.

 

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Below-Investment-Grade Securities (3)  
      June 30, 2011     December 31, 2010  
(In millions)   

Par

Value

    

Amortized

Cost

    

Fair

Value

    

Unrealized

Gain/Loss

   

Par

Value

    

Amortized

Cost

    

Fair

Value

    

Unrealized      

Gain/Loss      

 

Republic of Tunisia(4)

   $ 810       $ 810       $ 893       $ 83      $ *       $ *       $ *       $ *        

Dexia SA (includes Dexia Bank Belgium & Dexia Overseas) (1)

     557         268         268         0        368         264         186         (78)       

Investcorp Capital Limited

     508         508         355         (153     504         504         337         (167)       

Lloyds Banking Group PLC (5)

     408         358         376         18        440         364         387         23        

UPM-Kymmene

     384         384         293         (91     380         380         290         (90)       

Ford Motor Credit Company

     372         372         377         5        368         368         374         6        

Banco Espirito Santo SA

     372         209         209         0        *         *         *         *        

CSAV (Tollo Shipping Co. S.A.)

     297         297         149         (148     295         295         161         (134)       

Bank of Ireland

     248         248         139         (109     *         *         *         *        

KBL European Private Bankers S.A (Part of KBC Group NV) (1)

     248         138         143         5        245         137         144         7        

Tokyo Electric Power Co., Inc.

     223         227         217         (10     *         *         *         *        

Caixa Geral de Depositos SA

     186         73         73         0        *         *         *         *        

BAWAG Capital Finance Jersey (1)

     173         122         104         (18     172         120         116         (4)       

IKB Deutsche Industriebank AG

     161         107         107         0        160         160         104         (56)       

Hypo Vorarlberg Capital Finance (1)

     136         109         97         (12     135         108         97         (11)       

Finance For Danish Industry (FIH)

     124         124         102         (22     123         123         104         (19)       

Aiful Corporation

     124         37         37         0        184         67         67         0        

Irish Life and Permanent PLC (1)

     0         0         0         0        454         112         112         0        

EFG Eurobank Ergasias

     0         0         0         0        417         416         131         (285)       

NBG (National Bank of Greece)

     0         0         0         0        368         368         146         (222)       

Alpha Bank

     0         0         0         0        368         368         115         (253)       

Swedbank (1)

     *         *         *         *        356         299         314         15        

Hella KG Hueck & Co.

     *         *         *         *        270         269         224         (45)       

Allied Irish Banks PLC

     0         0         0         0        245         77         77         0        

Royal Bank of Scotland Group PLC (1)

     0         0         0         0        58         19         42         23        

Commerzbank AG (formerly Dresdner Bank AG) (Tier 1 only)

     0         0         0         0        53         55         46         (9)       

Macy’s Inc.

     *         *         *         *        53         58         58         0        

Various Other Issuers (below $50 million in par value) (2)

     409         378         360         (18     386         366         326         (40)       

Total

   $ 5,740       $ 4,769       $ 4,299       $ (470   $ 6,402       $ 5,297       $ 3,958       $ (1,339)       
                                                                        

* Investment grade at respective reporting date

(1) Perpetual security

(2) Includes 21 different issuers in 2011 and 19 different issuers in 2010

(3) Does not include an externally managed portfolio of senior secured bank loans

(4) Deemed by the Company to be below investment grade

(5) Includes perpetual securities only at December 31, 2010

 

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In May 2011, we initiated a limited program to invest in senior secured bank loans to U.S. and Canadian corporate borrowers, most of which have below-investment-grade ratings. The program is managed externally by a third party firm specializing in this asset class. Its mandate requires an average credit quality of BB-/Ba3, no loans rated below B/B2, and no exposure to any individual credit greater than 3% of the program’s assets. The objectives of this program include enhancing the yield on invested assets, achieving further diversification of credit risk, and mitigating the risk of rising interest rates through the acquisition of floating rate assets. As of June 30, 2011, our investments in this program totaled $72 million at amortized cost.

Occasionally, a debt or perpetual security will be split rated. This occurs when one rating agency rates the security as investment grade while another rating agency rates the same security as below investment grade. Our policy is to review each issue on a case-by-case basis to determine if a split-rated security should be classified as investment grade or below investment grade. Our review includes evaluating the issuer’s credit position as well as current market pricing and other factors, such as the issuer’s or security’s inclusion on a credit rating downgrade watch list. Split-rated securities totaled $2.9 billion as of June 30, 2011, and $2.4 billion as of December 31, 2010, and represented 3% of total debt and perpetual securities, at amortized cost, at each period. The 10 largest split-rated securities as of June 30, 2011, were as follows:

 

Split-Rated Securities
(In millions)   

Amortized

Cost

     Investment-Grade Status

Israel Electric Corp.

   $ 908       Investment Grade    

Erste Group Bank (Erste Finance Jersey Ltd 3 & 5)(1)

     408       Investment Grade    

SLM Corp.

     402       Investment Grade    

Bank of Ireland

     248       Below Investment Grade    

Banco Espirito Santo SA

     209       Below Investment Grade    

Swedbank(1)

     134       Investment Grade    

Dexia Overseas SA(1)

     94       Below Investment Grade    

Caixa Geral De Depositos SA

     73       Below Investment Grade    

Sparebanken Vest(1)

     60       Investment Grade    

Macy’s Inc.

     58       Investment Grade    
 

(1) Perpetual security

Other-than-temporary Impairment

See Note 3 of the Notes to the Consolidated Financial Statements for a discussion of our impairment policy.

Unrealized Investment Gains and Losses

The following table provides details on amortized cost, fair value and unrealized gains and losses for our investments in debt and perpetual securities by investment-grade status as of June 30, 2011.

 

(In millions)   

Total

Amortized

Cost

    

Total

Fair

Value

    

Percentage

of Total Fair

Value

   

Gross

Unrealized

Gains

    

Gross        

Unrealized        

Losses        

 

Available-for-sale securities:

             

Investment-grade securities

   $   53,686       $   55,238         60.3     $   2,583       $   1,031           

Below-investment-grade securities

     4,841         4,371         4.8          125         595           

Held-to-maturity securities:

             

Investment-grade securities

     31,908         31,982         34.9          976         902           

Total

   $ 90,435       $ 91,591         100.0     $ 3,684       $ 2,528           
   

 

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The following table presents an aging of debt and perpetual securities in an unrealized loss position as of June 30, 2011.

 

Aging of Unrealized Losses  
     Total      Total      Less than Six Months     

Six Months to Less

than 12 Months

    

12 Months

or Longer

 
(In millions)   

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

 

Available-for-sale securities:

                       

Investment-grade securities

   $   14,756       $   1,031       $   2,284       $   34       $   3,052       $   91       $   9,420       $   906   

Below-investment-grade securities

     2,301         595         465         28         5         1         1,831         566   

Held-to-maturity securities:

                       

Investment-grade securities

     15,367         902         2,775         43         2,138         80         10,454         779   

Total

   $   32,424       $   2,528       $   5,524       $   105       $   5,195       $   172       $   21,705       $   2,251   
                                                                         

The following table presents a distribution of unrealized losses on debt and perpetual securities by magnitude as of June 30, 2011.

 

Percentage Decline From Amortized Cost  
     Total      Total      Less than 20%      20% to 50%      Greater than 50%  
(In millions)   

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

    

Amortized

Cost

    

Unrealized

Loss

 

Available-for-sale securities:

                       

Investment-grade securities

   $   14,756       $   1,031       $   14,383       $   937       $   373       $   94       $         0       $   0   

Below-investment-grade securities

     2,301         595         1,007         102         1,294         493         0         0   

Held-to-maturity securities:

                       

Investment-grade securities

     15,367         902         15,118         846         249         56         0         0   

Total

   $   32,424       $   2,528       $   30,508       $   1,885       $   1,916       $   643       $   0       $   0   
                                                                         

 

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The following table presents the 10 largest unrealized loss positions in our portfolio as of June 30, 2011.

 

(In millions)    Credit
Rating
   Amortized
Cost
   Fair
Value
   Unrealized    
Loss    
 

Investcorp Capital Limited

   BB    $ 508    $ 355      $ (153)           

CSAV (Tollo Shipping Co. S.A.)

   B       297       149      (148)           

Bank of Ireland

   BB       248       139      (109)           

UPM-Kymmene

   BB       384       293      (91)           

SLM Corp.

   BBB       402       320      (82)           

Bank of Tokyo-Mitsubishi UFJ LTD

   AA       557       506      (51)           

Svenska Handelsbanken(1)

   A       218       168      (50)           

Bank of America Corp. (Includes Merrill Lynch)

   A       557       510      (47)           

Republic of Poland

   A       254       209      (45)           

Union Fenosa Finance B.V.

   BBB       458       413      (45)           
                         

(1) Perpetual security

Declines in fair value noted above were impacted by changes in interest rates and credit spreads, yen/dollar exchange rates, and issuer credit status. However, we believe it would be inappropriate to recognize impairment charges because we believe the changes in fair value are temporary. See the Investment Concentrations and Unrealized Investment Gains and Losses sections in Note 3 of the Notes to the Consolidated Financial Statements for further discussions of unrealized losses related to Ireland, financial institutions including perpetual securities, and other corporate investments.

Investment Valuation and Cash

We estimate the fair values of our securities available for sale on a monthly basis. We monitor the estimated fair values obtained from our custodian and pricing brokers and those derived from our discounted cash flow pricing model for consistency from month to month, while considering current market conditions. We also periodically discuss with our custodian and pricing brokers the pricing techniques they use to monitor the consistency of their approach and periodically assess the appropriateness of the valuation level assigned to the values obtained from them. See Note 5 of the Notes to the Consolidated Financial Statements for the fair value hierarchy classification of our securities available for sale as of June 30, 2011.

Cash and cash equivalents totaled $1.3 billion, or 1.4% of total investments and cash, as of June 30, 2011, compared with $2.1 billion, or 2.4%, at December 31, 2010. For a discussion of the factors affecting our cash balance, see the Operating Activities, Investing Activities and Financing Activities subsections of this MD&A.

For additional information concerning our investments, see Notes 3, 4, and 5 of the Notes to the Consolidated Financial Statements.

Deferred Policy Acquisition Costs

The following table presents deferred policy acquisition costs by segment.

 

(In millions)    June 30, 2011    December 31, 2010    % Change          

Aflac Japan

   $      7,213    $    6,964        3.6 %  (1)   

Aflac U.S.

           2,815          2,770       1.6            

Total

   $    10,028    $    9,734       3.0 %      
                     

(1) Aflac Japan’s deferred policy acquisition costs increased 2.6% in yen during the six months ended June 30, 2011.

The increase in Aflac Japan’s deferred policy acquisition costs was primarily driven by new annualized premium sales.

 

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Policy Liabilities

The following table presents policy liabilities by segment.

 

(In millions)    June 30, 2011    December 31, 2010    % Change      

Aflac Japan

   $    78,565     $    74,872           4.9 %  (1)

Aflac U.S.

          7,799           7,581        2.9      

Other

                 2                  3            .0        

Total

   $    86,366     $    82,456           4.7 %    
 

(1) Aflac Japan’s policy liabilities increased 4.0% in yen during the six months ended June 30, 2011.

The increase in Aflac Japan’s policy liabilities was primarily the result of the growth and aging of our in-force business.

Notes Payable

Notes payable totaled $3.0 billion at June 30, 2011 and December 31, 2010. The ratio of debt to total capitalization (debt plus shareholders’ equity, excluding the unrealized gains and losses on investment securities and derivatives) was 21.4% as of June 30, 2011, compared with 21.7% as of December 31, 2010. See Note 6 of the accompanying Notes to the Consolidated Financial Statements for additional information on our notes payable.

Benefit Plans

Aflac Japan and Aflac U.S. have various benefit plans. For additional information on our Japanese and U.S. plans, see Note 9 of the accompanying Notes to the Consolidated Financial Statements and Note 13 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.

Policyholder Protection Corporation

The Japanese insurance industry has a policyholder protection system that provides funds for the policyholders of insolvent insurers. On December 12, 2008, legislation was enacted extending the framework of the Life Insurance Policyholder Protection Corporation (LIPPC), which included government fiscal measures supporting the LIPPC through March 2012.

See the Policyholder Protection Corporation subsection of MD&A in our annual report to shareholders for the year ended December 31, 2010, for additional information.

Hedging Activities

Net Investment Hedge

Our primary exposure to be hedged is our investment in Aflac Japan, which is affected by changes in the yen/dollar exchange rate. To mitigate this exposure, we have taken the following courses of action. First, Aflac Japan maintains a portfolio of dollar-denominated securities, which serve as an economic currency hedge of a portion of our investment in Aflac Japan. The foreign exchange gains and losses related to this portfolio are taxable in Japan and the U.S. when the securities mature or are sold. Until maturity or sale, deferred tax expense or benefit associated with the foreign exchange gains or losses are recognized in other comprehensive income. Second, we have designated the Parent Company’s yen-denominated liabilities (Samurai and Uridashi notes and yen-denominated loans) as a hedge of our investment in Aflac Japan. At the beginning of each quarter, we make our net investment hedge designation. If the total of our designated yen-denominated liabilities is equal to or less than our net investment in Aflac Japan, the hedge is deemed to be effective and the related exchange effect is reported in the unrealized foreign currency component of other comprehensive income. Should these designated yen-denominated liabilities exceed our investment in Aflac Japan, the foreign exchange effect on the portion of the liabilities that exceeds our investment in Aflac Japan would be recognized in net earnings. We estimate that if our yen-denominated liabilities exceeded our investment in Aflac Japan by 10 billion yen, we would report a foreign exchange gain/loss of approximately $1 million for every 1% yen weakening/strengthening in the end-of-period yen/dollar exchange rate. For hedge designation purposes, Aflac Japan yen-denominated net assets exceeded the Parent Company’s designated yen-denominated liabilities as of April 1, 2011, the date of hedge designation for the second quarter of 2011. As a result, our net investment hedge was effective during the six-month period ended June 30, 2011. Our net investment hedge was also effective during the six-month period ended June 30, 2010.

 

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Effective January 1, 2010, the yen net asset figure calculated for hedging purposes differs from the yen-denominated net asset position as discussed in the Currency Risk subsection of MD&A. As disclosed in that subsection, the consolidation of the underlying assets in certain VIEs on January 1, 2010, required that we derecognize our yen-denominated investment in the VIE and recognize the underlying U.S. dollar-denominated fixed-maturity or perpetual securities and cross-currency swaps. While these U.S. dollar investments will create foreign currency fluctuations, the combination of the U.S. dollar-denominated investment and the cross-currency swap economically creates a yen-denominated investment that qualifies for inclusion as a component of our investment in Aflac Japan.

The dollar values of our yen-denominated net assets, including certain VIEs as yen-denominated investments for net investment hedging purposes as discussed above, are summarized as follows (translated at end-of-period exchange rates):

 

(In millions)    June 30,
2011
           December 31,
    2010    
 

Aflac Japan yen-denominated net assets

   $         1,830                $         3,282              

Parent Company yen-denominated net liabilities

     (1,053)                   (1,041)             

Consolidated yen-denominated net assets (liabilities) subject to foreign currency translation fluctuations

   $ 777                  $ 2,241              
                        

The decline in yen-denominated net assets subject to foreign currency fluctuation is primarily due to an increase in the amount of investment in dollar-denominated investments during the first six months of 2011.

Cash Flow Hedges

Effective January 1, 2010, as a result of the adoption of new accounting guidance and the corresponding consolidation of additional VIEs, we have freestanding derivative instruments that are reported in the consolidated balance sheet at fair value and are reported in other assets and other liabilities. Several of these freestanding derivatives qualify for hedge accounting, including interest rate and foreign currency swaps. Interest rate and foreign currency swaps are used within VIEs to hedge the risk arising from changes in interest rates and foreign currency exchange rates, respectively. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income. Any hedge ineffectiveness is recorded immediately in current period earnings as net realized investment gains and losses. This hedging relationship was effective during the six-month periods ending June 30, 2011 and 2010. See Note 4 of the Notes to the Consolidated Financial Statements for additional information.

We have interest rate swap agreements related to our 20 billion yen variable interest rate Uridashi notes that will mature in September 2011 and our 5.5 billion yen variable interest rate Samurai notes that we issued in July 2011. By entering into these contracts, we swapped the variable interest rates to a fixed interest rate of 1.52% for the Uridashi notes and 1.475% for the Samurai notes. We have designated these interest rate swaps as a hedge of the variability in our interest cash flows associated with the respective variable interest rate notes. The notional amounts and terms of the swaps match the principal amount and terms of the variable interest rate notes, and the swaps had no value at inception. GAAP requires that the change in the fair value of the swap contracts be recorded in other comprehensive income so long as the hedge is deemed effective. Any ineffectiveness is recognized in net earnings. The hedge for the Uridashi notes was effective during the six-month periods ended June 30, 2011 and 2010; therefore, there was no impact on net earnings during those periods. See Note 4 of the Notes to the Consolidated Financial Statements for additional information.

Off-Balance Sheet Arrangements

As of June 30, 2011, we had no material letters of credit, standby letters of credit, guarantees or standby repurchase obligations. See Note 14 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010, for information on material unconditional purchase obligations that are not recorded on our balance sheet.

 

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CAPITAL RESOURCES AND LIQUIDITY

Aflac provides the primary sources of liquidity to the Parent Company through dividends and management fees. The following table presents the amounts provided for the six-month periods ending June 30:

 

Liquidity Provided by Aflac to Parent Company  
(In millions)    2011                  2010            

Dividends declared or paid by Aflac

   $         282                $         230             

Management fees paid by Aflac

     115                    95             
                        

The primary uses of cash by the Parent Company are shareholder dividends, the repurchase of its common stock and interest on its outstanding indebtedness. The Parent Company’s sources and uses of cash are reasonably predictable and are not expected to change materially in the future. For additional information, see the Financing Activities subsection of this MD&A.

The Parent Company also accesses debt security markets to provide additional sources of capital. In March 2009, we filed a shelf registration statement with the SEC that allows us to issue an indefinite amount of senior and subordinated debt, in one or more series, from time to time through May 2012. As of June 30, 2011, we have issued $2.0 billion of senior notes under this registration statement. In November 2009, we filed an additional shelf registration statement with Japanese regulatory authorities that allows us to issue up to 100 billion yen of yen-denominated Samurai notes in Japan through November 2011. In July 2011, the Parent Company issued 50 billion yen of yen-denominated Samurai notes under this registration statement. If issued, the remaining 50 billion yen (approximately $619 million using the June 30, 2011, exchange rate) of yen-denominated Samurai notes will not be available to U.S. persons. We believe outside sources for additional debt and equity capital, if needed, will continue to be available. For additional information, see Note 6 of the Notes to the Consolidated Financial Statements.

The principal sources of cash for our insurance operations are premiums and investment income. The primary uses of cash by our insurance operations are policy claims, commissions, operating expenses, income taxes and payments to the Parent Company for management fees and dividends. Both the sources and uses of cash are reasonably predictable.

When making an investment decision, our first consideration is based on product needs. Our investment objectives provide for liquidity through the purchase of investment-grade debt securities. These objectives also take into account duration matching, and because of the long-term nature of our business, we have adequate time to react to changing cash flow needs.

As a result of policyholder aging, claims payments are expected to gradually increase over the life of a policy. Therefore, future policy benefit reserves are accumulated in the early years of a policy and are designed to help fund future claims payments. We expect our future cash flows from premiums and our investment portfolio to be sufficient to meet our cash needs for benefits and expenses.

Our financial statements adequately convey our financing arrangements during the periods presented. We have not engaged in material intra-period short-term financings during the periods presented that are not otherwise reported in our balance sheet. We do not have any restrictive financial covenants related to our notes payable, and we were in compliance with all of the covenants of our notes payable at June 30, 2011. We have not entered into transactions involving the transfer of financial assets with an obligation to repurchase financial assets that have been accounted for as a sale under applicable accounting standards, including securities lending transactions. See Note 3 of the Notes to the Consolidated Financial Statements and Note 1 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010, for more information on our securities lending activity. We do not have a known trend, demand, commitment, event or uncertainty that would reasonably result in our liquidity increasing or decreasing by a material amount. Our cash and cash equivalents include unrestricted cash on hand, money market instruments, and other debt instruments with a maturity of 90 days or less when purchased, all of which has minimal market, settlement or other risk exposure.

Consolidated Cash Flows

We translate cash flows for Aflac Japan’s yen-denominated items into U.S. dollars using weighted-average exchange rates. In periods when the yen weakens, translating yen into dollars causes fewer dollars to be reported. When the yen strengthens, translating yen into dollars causes more dollars to be reported.

 

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The following table summarizes consolidated cash flows by activity for the six-month periods ended June 30.

 

(In millions)    2011                2010          

Operating activities

   $ 4,378                 $ 3,023           

Investing activities

     (5,034)                  (3,176)          

Financing activities

     (175)                  (7)          

Exchange effect on cash and cash equivalents

     1                   21           

Net change in cash and cash equivalents

   $         (830)                $          (139)          
                   

Operating Activities

The following table summarizes operating cash flows by source for the six-month periods ended June 30.

 

(In millions)    2011                  2010          

Aflac Japan

   $         4,067                $         2,665           

Aflac U.S. and other operations

     311                    358           

Total

   $ 4,378                  $ 3,023           
                        

Investing Activities

Operating cash flow is primarily used to purchase debt securities to meet future policy obligations. The following table summarizes investing cash flows by source for the six-month periods ended June 30.

 

(In millions)    2011           2010          

Aflac Japan

   $     (4,835)           $         (2,499)          

Aflac U.S. and other operations

     (199)             (677)          

Total

   $ (5,034)           $ (3,176)          
                   

Prudent portfolio management dictates that we attempt to match the duration of our assets with the duration of our liabilities. Currently, when our debt and perpetual securities mature, the proceeds may be reinvested at a yield below that required for the accretion of policy benefit liabilities on policies issued in earlier years. However, the long-term nature of our business and our strong cash flows provide us with the ability to minimize the effect of mismatched durations and/or yields identified by various asset adequacy analyses. When market opportunities arise, we dispose of selected debt and perpetual securities that are available for sale to improve the duration matching of our assets and liabilities, improve future investment yields, and/or rebalance our portfolio. As a result, dispositions before maturity can vary significantly from year to year. Dispositions before maturity were approximately 3% of the year-to-date average investment portfolio of debt and perpetual securities available for sale during the six-month periods ended June 30, 2011, and 2010.

Financing Activities

Consolidated cash used by financing activities was $175 million in the first six months of 2011, compared with $7 million for the same period of 2010. Cash returned to shareholders through dividends and treasury stock purchases was $482 million during the six-month period ended June 30, 2011, compared with $262 million through dividends during the six-month period ended June 30, 2010.

In July 2011, the Parent Company issued 50 billion yen of yen-denominated Samurai notes (approximately $619 million using the June 30, 2011, exchange rate). See Note 6 of the Notes to the Consolidated Financial Statements for further information on this debt issuance. In September 2011, 35 billion yen (approximately $434 million using the June 30, 2011, exchange rate) of our Uridashi notes will mature. We plan to use existing cash to redeem these notes.

We have no restrictive financial covenants related to our notes payable. We were in compliance with all of the covenants of our notes payable at June 30, 2011.

 

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The following tables present a summary of treasury stock activity during the six-month periods ended June 30.

 

Treasury Stock Purchased  
(In millions of dollars and thousands of shares)      2011          2010            

Treasury stock purchases

   $ 222       $ 5           
                   

Number of shares purchased:

     

Open market

     4,100         0           

Other

     155         95           

Total shares purchased

     4,255         95           
                   
Treasury Stock Issued  
(In millions of dollars and thousands of shares)      2011          2010            

Stock issued from treasury

   $ 26       $ 36           
                   

Number of shares issued

     909         1,624           
                   

During the first six months of 2011, we purchased 4.1 million shares of our common stock in the open market. As of June 30, 2011, a remaining balance of 26.3 million shares of our common stock was available for purchase under a share repurchase authorization by our board of directors in 2008. We anticipate ending up at the low end of our six to 12 million share repurchase target in 2011.

Cash dividends paid to shareholders were $.30 per share in the second quarter of 2011, compared with $.28 per share in the second quarter of 2010. The following table presents the dividend activity for the six-month periods ended June 30.

 

(In millions)      2011          2010            

Dividends paid in cash

   $ 260       $ 262           

Dividends through issuance of treasury shares

     21         0           

Total dividends to shareholders

   $ 281       $ 262           
                   

In July 2011, the board of directors declared the third quarter cash dividend of $.30 per share. The dividend is payable on September 1, 2011, to shareholders of record at the close of business on August 17, 2011.

Regulatory Restrictions

Aflac is domiciled in Nebraska and is subject to its regulations. A life insurance company’s statutory capital and surplus is determined according to rules prescribed by the NAIC, as modified by the insurance department in the insurance company’s state of domicile. Statutory accounting rules are different from GAAP and are intended to emphasize policyholder protection and company solvency. The continued long-term growth of our business may require increases in the statutory capital and surplus of our insurance operations. Aflac’s insurance operations may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Parent Company from funds generated through debt or equity offerings. The NAIC’s risk-based capital (RBC) formula is used by insurance regulators to help identify inadequately capitalized insurance companies. The RBC formula quantifies insurance risk, business risk, asset risk and interest rate risk by weighing the types and mixtures of risks inherent in the insurer’s operations. Aflac’s company action level RBC ratio was estimated to be within the range of 480% and 520% as of June 30, 2011. Aflac’s RBC ratio remains high and reflects a strong capital and surplus position.

In addition to limitations and restrictions imposed by U.S. insurance regulators, Japan’s FSA may not allow profit repatriations from Aflac Japan if the transfers would cause Aflac Japan to lack sufficient financial strength for the protection of policyholders. The FSA maintains its own solvency standard. See the Japanese Regulatory Environment subsection of this MD&A for a discussion of changes to the calculation of the solvency margin ratio. As of March 31, 2011, Aflac Japan’s solvency margin ratio calculated using the current method was 919.3%, which significantly exceeded regulatory minimums, and the solvency margin ratio under the new standards, disclosed as reference information, was 512.2%. As expected, based on the results of the calculation of the solvency margin ratio under the new standards, our relative position within the industry did not materially change.

Payments are made from Aflac Japan to the Parent Company for management fees and to Aflac U.S. for allocated expenses and remittances of earnings. The following details Aflac Japan remittances for the six-month periods ended June 30.

 

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Aflac Japan Remittances  
(In millions of dollars and billions of yen)    2011      2010      

Aflac Japan management fees paid to Parent Company

   $     13       $     16       

Expenses allocated to Aflac Japan

     20         16       

Aflac Japan profit remittances to Aflac U.S. in dollars

     0         317       
                   

Aflac Japan profit remittances to Aflac U.S. in yen

     0         28.7       
                   

We anticipate that Aflac Japan will remit profits of 11.0 billion yen in the third quarter of 2011. We anticipate that 2011 profit remittances will total 11.0 billion yen, compared with full-year remittances of 28.7 billion yen in 2010.

For additional information on regulatory restrictions on dividends, profit repatriations and other transfers, see Note 12 of the Notes to the Consolidated Financial Statements and the Regulatory Restrictions subsection of MD&A, both in our annual report to shareholders for the year ended December 31, 2010.

Other

For information regarding commitments and contingent liabilities, see Note 10 of the Notes to the Consolidated Financial Statements.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

The information required by Item 3 is incorporated by reference from the Market Risks of Financial Instruments subsection of MD&A in Part I, Item 2 of this report.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second fiscal quarter of 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1A. Risk Factors

The following should be read in conjunction with and supplements and amends the risk factors that may affect the Company’s business or operations described under “Risk Factors” in Part I, Item 1A. of our 2010 annual report on Form 10-K for the year ended December 31, 2010.

The concentration of our investment portfolios in any particular single-issuer or sector of the economy may have an adverse effect on our financial position or results of operations.

The concentration of our investment portfolios in any particular single-issuer, industry, group of related industries or geographic sector could have an adverse effect on our investment portfolios and, consequently, on our results of operations and financial position. Events or developments that have a negative impact on any particular single-issuer industry, group of related industries or geographic sector may have a greater adverse effect on the investment portfolios to the extent that the portfolios are concentrated rather than diversified. At June 30, 2011, approximately 30% of our total portfolio of debt and perpetual securities, on an amortized cost basis, was in the bank and financial institution sector. In addition, at June 30, 2011, with the exception of investments in Japanese government bonds (JGBs) and U.S. Treasury securities, we had four legacy single-issuer investments that exceeded the upper bound of our investment risk exposure limits, which is considered to be 10% of total adjusted capital (TAC) on a statutory accounting basis.

The impact of the earthquake and tsunami natural disaster in March 2011 and related events at the nuclear plant in Japan and their aftermath could adversely affect our financial condition and results of operations.

Aflac Japan’s first quarter 2011 financial results reflected a provision of 3.0 billion yen, or $37 million, for claims related to the earthquake and tsunami that struck Japan on March 11, 2011. These claims were offset by reserve releases and reinsurance of 2.0 billion yen, or $25 million, resulting in a net income statement impact of 1.0 billion yen, or $12 million, for benefits expense in the first quarter. Our financial results in the first quarter of 2011 also reflected .7 billion yen, or $8 million, of operating expenses resulting from the earthquake and tsunami. Our initial claims estimates were based on judgments that considered assumptions and projections which are subject to change to reflect future information. Although the current impact of the natural disaster and its related events has not had a material impact on our financial position or results of operations, actual claims may vary from our estimates and may further negatively impact our financial results.

Our business operations in Japan have continued to be fully functional in the aftermath of the natural disaster. However, the recent events in Japan could impair the recovery of the Japanese economy, which could have an adverse effect on our results of operations and financial condition. The policy response from the Japanese government to the disaster could involve the issuance of JGBs. Increased borrowing to finance reconstruction of the affected areas coupled with the fiscal challenges already facing Japan could reduce the creditworthiness of JGBs, which account for a significant portion of our investment portfolio. Although questions remain with regard to Japan’s electricity supply as a result of the problems caused by the nuclear plant which was damaged by the natural disaster, we do not expect Aflac’s operations in Japan to be materially impacted.

We will continue to monitor the business and economic conditions in Japan in light of the recent events and will continue to update our assessment of the natural disaster impact on our results of operations.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

During the second quarter of 2011, we repurchased shares of Aflac common stock as follows:

 

                     Total          
                  Number      Maximum      
                  of Shares      Number of      
                  Purchased      Shares that      
                  as Part of      May Yet Be      
     Total            Publicly      Purchased      
     Number of     Average      Announced      Under the      
     Shares     Price Paid      Plans or      Plans or      
Period    Purchased     Per Share      Programs      Programs      

April 1 - April 30

     228      $ 54.26         0         27,270,254   

May 1 - May 31

     380,274        48.74         380,000         26,890,254   

June 1 - June 30

     622,069        45.53         620,000         26,270,254   

Total

     1,002,571    (2)    $ 46.75         1,000,000         26,270,254    (1)     
                                    
  (1) 

The total remaining shares available for purchase at June 30, 2011, consisted of 26,270,254 shares related to a 30,000,000 share repurchase authorization by the board of directors announced in January 2008.

  (2) 

During the second quarter of 2011, 2,571 shares were purchased in connection with income tax withholding obligations related to the vesting of restricted-share-based awards during the period.

 

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Item 6. Exhibits

 

(a) EXHIBIT INDEX:
3.0     -      Articles of Incorporation, as amended – incorporated by reference from Form 10-Q for June 30, 2008, Exhibit 3.0 (File No. 001-07434).
3.1     -      Bylaws of the Corporation, as amended – incorporated by reference from Form 10-Q for March 31, 2010, Exhibit 3.1 (File No. 001-07434).
4.0     -      There are no instruments with respect to long-term debt not being registered in which the total amount of securities authorized exceeds 10% of the total assets of Aflac Incorporated and its subsidiaries on a consolidated basis. We agree to furnish a copy of any long-term debt instrument to the Securities and Exchange Commission upon request.
4.1     -      Indenture, dated as of May 21, 2009, between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee – incorporated by reference from Form 8-K dated May 21, 2009, Exhibit 4.1 (File No. 001-07434).
4.2     -      First Supplemental Indenture, dated as of May 21, 2009, between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including form of 8.500% Senior Note due 2019) – incorporated by reference from Form 8-K dated May 21, 2009, Exhibit 4.2 (File No. 001-07434).
4.3     -      Second Supplemental Indenture, dated as of December 17, 2009, between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including form of 6.900% Senior Note due 2039) – incorporated by reference from Form 8-K dated December 14, 2009, Exhibit 4.1 (File No. 001-07434).
4.4     -      Third Supplemental Indenture, dated as of August 9, 2010, between Aflac Incorporated and The Bank of New York Mellon Trust Company, N.A., as trustee (including form of 6.45% Senior Note due 2040) - incorporated by reference from Form 8-K dated August 4, 2010, Exhibit 4.1 (File No. 001-07434).
4.5     -      Fourth Supplemental Indenture, dated as of August 9, 2010, between Aflac Incorporated and The Bank of New York and Mellon Trust Company, N.A., as trustee (including form of 3.45% Senior Note due 2015) – incorporated by reference from Form 8-K dated August 4, 2010, Exhibit 4.2 (File No. 001-07434).
10.0*    -      American Family Corporation Retirement Plan for Senior Officers, as amended and restated October 1, 1989 – incorporated by reference from 1993 Form 10-K, Exhibit 10.2 (File No. 001- 07434).
10.1*    -      Amendment to American Family Corporation Retirement Plan for Senior Officers, dated December 8, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.1 (File No. 001-07434).
10.2*    -      Aflac Incorporated Supplemental Executive Retirement Plan, as amended and restated January 1, 2009 – incorporated by reference from 2008 Form 10-K, Exhibit 10.5 (File No. 001- 07434).
10.3*    -      Aflac Incorporated Executive Deferred Compensation Plan, as amended and restated, effective January 1, 2009 – incorporated by reference from 2008 Form 10-K, Exhibit 10.9 (File No. 001-07434).
10.4*    -      First Amendment to the Aflac Incorporated Executive Deferred Compensation Plan dated June 1, 2009 – incorporated by reference from Form 10-Q for June 30, 2009, Exhibit 10.4 (File No. 001-07434).
10.5*    -      Aflac Incorporated Amended and Restated 2009 Management Incentive Plan – incorporated by reference from the 2008 Shareholders’ Proxy Statement, Appendix B (File No. 001-07434).
10.6*    -      First Amendment to the Aflac Incorporated Amended and Restated 2009 Management Incentive Plan, dated December 19, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.11 (File No. 001-07434).
10.7*    -      Aflac Incorporated Sales Incentive Plan – incorporated by reference from 2007 Form 10-K, Exhibit 10.8 (File No. 001-07434).
10.8*    -      1999 Aflac Associate Stock Bonus Plan, as amended, dated February 11, 2003 – incorporated by reference from 2002 Form 10-K, Exhibit 99.2 (File No. 001-07434).

 

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10.9*    -      Aflac Incorporated 1997 Stock Option Plan – incorporated by reference from the 1997 Shareholders’ Proxy Statement, Appendix B (File No. 001-07434).
10.10*    -      Form of Officer Stock Option Agreement (Non-Qualifying Stock Option) under the Aflac Incorporated 1997 Stock Option Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.5 (File No. 001-07434).
10.11*    -      Form of Officer Stock Option Agreement (Incentive Stock Option) under the Aflac Incorporated 1997 Stock Option Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.6 (File No. 001-07434).
10.12*    -      Notice of grant of stock options and stock option agreement to officers under the Aflac Incorporated 1997 Stock Option Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.7 (File No. 001-07434).
10.13*    -      2004 Aflac Incorporated Long-Term Incentive Plan, dated May 3, 2004 – incorporated by reference from the 2004 Notice and Proxy Statement, Exhibit B (File No. 001-07434).
10.14*    -      First Amendment to the 2004 Aflac Incorporated Long-Term Incentive Plan, dated May 2, 2005 – incorporated by reference from Form 10-Q for March 31, 2005, Exhibit 10.1 (File No. 001- 07434).
10.15*    -      Second Amendment to the 2004 Aflac Incorporated Long-Term Incentive Plan, dated February 14, 2006 – incorporated by reference from Form 10-Q for March 31, 2006, Exhibit 10.32 (File No. 001-07434).
10.16*    -      Third Amendment to the 2004 Aflac Incorporated Long-Term Incentive Plan, dated December 19, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.21 (File No. 001-07434).
10.17*    -      Form of Non-Employee Director Stock Option Agreement (NQSO) under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.1 (File No. 001-07434).
10.18*    -      Notice of grant of stock options to non-employee director under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.2 (File No. 001-07434).
10.19*    -      Form of Non-Employee Director Restricted Stock Award Agreement under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.3 (File No. 001-07434).
10.20*    -      Notice of restricted stock award to non-employee director under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated January 28, 2005, Exhibit 10.4 (File No. 001-07434).
10.21*    -      Form of Officer Restricted Stock Award Agreement under the 2004 Aflac Incorporated Long- Term Incentive Plan – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.1 (File No. 001-07434).
10.22*    -      Notice of restricted stock award to officers under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.2 (File No. 001-07434).
10.23*    -      Form of Officer Stock Option Agreement (Non-Qualifying Stock Option) under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.3 (File No. 001-07434).
10.24*    -      Form of Officer Stock Option Agreement (Incentive Stock Option) under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.4 (File No. 001-07434).
10.25*    -      Notice of grant of stock options to officers under the 2004 Aflac Incorporated Long-Term Incentive Plan – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.5 (File No. 001-07434).
10.26*    -      Aflac Incorporated Retirement Plan for Directors Emeritus, as amended and restated, dated February 9, 2010 – incorporated by reference from 2009 Form 10-K, Exhibit 10.26 (File No. 001-07434).

 

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10.27*    -      Amendment to Aflac Incorporated Retirement Plan for Directors Emeritus, as amended and restated, dated August 10, 2010 – incorporated by reference from Form 10-Q for September 30, 2010, Exhibit 10.27 (File No. 001-07434).
10.28*    -      Aflac Incorporated Employment Agreement with Daniel P. Amos, dated August 1, 1993 – incorporated by reference from 1993 Form 10-K, Exhibit 10.4 (File No. 001-07434).
10.29*    -      Amendment to Aflac Incorporated Employment Agreement with Daniel P. Amos, dated December 8, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.32 (File No. 001-07434).
10.30*    -      Aflac Incorporated Employment Agreement with Kriss Cloninger III, dated February 14, 1992, and as amended November 12, 1993 – incorporated by reference from 1993 Form 10-K, Exhibit 10.6 (File No. 001-07434).
10.31*    -      Amendment to Aflac Incorporated Employment Agreement with Kriss Cloninger III, dated November 3, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.34 (File No. 001-07434).
10.32*    -      Amendment to Aflac Incorporated Employment Agreement with Kriss Cloninger III, dated December 19, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.35 (File No. 001-07434).
10.33*    -      Amendment to Aflac Incorporated Employment Agreement with Kriss Cloninger III, dated March 15, 2011 – incorporated by reference from Form 10-Q for March 31, 2011, Exhibit 10.33 (File No. 001-07434).
10.34*    -      Aflac Incorporated Employment Agreement with Paul S. Amos II, dated January 1, 2005 – incorporated by reference from Form 8-K dated February 7, 2005, Exhibit 10.2 (File No. 001- 07434).
10.35*    -      Amendment to Aflac Incorporated Employment Agreement with Paul S. Amos II, dated December 19, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.39 (File No. 001-07434).
10.36*    -      Aflac Incorporated Employment Agreement with Joey Loudermilk, dated September 12, 1994 and as amended December 10, 2008 – incorporated by reference from 2008 Form 10-K, Exhibit 10.40 (File No. 001-07434).
10.37*    -      Aflac Incorporated Employment Agreement with Tohru Tonoike, effective February 1, 2007 – incorporated by reference from 2008 Form 10-K, Exhibit 10.41 (File No. 001-07434).
10.38*    -      Amendment to Aflac Incorporated Employment Agreement with Tohru Tonoike, dated February 9, 2010 – incorporated by reference from 2009 Form 10-K, Exhibit 10.36 (File No. 001-07434).
10.39*    -      Aflac Retirement Agreement with E. Stephen Purdom, dated February 15, 2000 – incorporated by reference from 2000 Form 10-K, Exhibit 10.13 (File No. 001-07434).
11    -      Statement regarding the computation of per-share earnings for the Registrant.
12    -      Statement regarding the computation of ratio of earnings to fixed charges for the Registrant.
15    -      Letter from KPMG LLP regarding unaudited interim financial information.
31.1    -      Certification of CEO dated August 5, 2011, required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
31.2    -      Certification of CFO dated August 5, 2011, required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
32    -      Certification of CEO and CFO dated August 5, 2011, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    -      XBRL Instance Document.(1)
101.SCH    -      XBRL Taxonomy Extension Schema.
101.CAL    -      XBRL Taxonomy Extension Calculation Linkbase.
101.DEF    -      XBRL Taxonomy Extension Definition Linkbase.
101.LAB    -      XBRL Taxonomy Extension Label Linkbase.
101.PRE    -      XBRL Taxonomy Extension Presentation Linkbase.

 

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(1)    Includes the following materials contained in this Quarterly Report on Form 10-Q for the period ended June 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Earnings, (ii) Consolidated Balance Sheets, (iii) Consolidated Statements of Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Comprehensive Income (Loss), (vi) Notes to the Consolidated Financial Statements
*    Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 6 of this report

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Aflac Incorporated

  August 5, 2011

   

/s/ Kriss Cloninger III

    (Kriss Cloninger III)
   

President, Chief Financial Officer,

Treasurer and Director

  August 5, 2011

   

/s/ June Howard

   

(June Howard)

Senior Vice President, Financial Services; Chief Accounting Officer

 

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