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Changes in interest rates have a direct impact on the fair values of fixed securities in our investment portfolio;
however, they do not have a direct impact on the related valuation of the corresponding liabilities. Prolonged periods of
low interest rates, as have been experienced in recent years, heighten the risk of future increases in interest rates
because an increasing proportion of our investment portfolio includes investments that bear lower rates of return than the
embedded book yield of the investment portfolio. A rise in interest rates could decrease the fair value of our debt and
perpetual securities. Some of the insurance products that Aflac sells in the United States and Japan provide cash
surrender values. A rise in interest rates could trigger significant policy lapsation which might require the Company to sell
investment assets and recognize unrealized losses. This situation is commonly referred to as disintermediation risk. We
generally invest our assets to match the duration and cash flow characteristics of our policy liabilities, and therefore would
not expect to realize most of these gains or losses, however, our risk is that unforeseen events or economic conditions,
such as changes in interest rates resulting from governmental monetary policies, domestic and international economic
and political conditions, and other factors beyond our control will reduce the effectiveness of this strategy. These events or
economic conditions could either cause us to dispose of some or all of these investments prior to their maturity, or
increase the risk that the issuers of these securities may default or may require impairment, which could result in our
having to recognize such gains or losses.
Rising interest rates also negatively impact the SMR since unrealized losses on the available-for-sale investment
portfolio factor into the ratio. For regulatory accounting purposes for Aflac Japan, there are certain requirements for
realizing impairments that could be triggered by rising interest rates, negatively impacting Aflac Japan's earnings and
corresponding repatriation and capital deployment.
Further, interest rate risk is still an inherent portfolio, business and capital risk for us, and significant changes in
interest rates could have a material adverse effect on our consolidated results of operations, financial condition or cash
flows through realized losses, impairments, changes in unrealized positions, and liquidity.
For more information regarding interest rate risk, see the Interest Rate Risk subsection within the Market Risks of
Financial Instruments section of MD&A in this report.
Our concentration of business in Japan poses risks to our operations.
Our operations in Japan, including realized gains and losses on Aflac Japan's investment portfolio, accounted for 71%
of our total revenues for 2016, compared with 70% in 2015 and 72% in 2014. The Japanese operations accounted for
83% of our total assets at both December 31, 2016 and 2015.
Further, because of the concentration of our business in Japan and our need for long-dated yen-denominated assets,
we have a substantial concentration of JGBs in our investment portfolio. As such we have material exposure to the
Japanese economy, geo-political climate, political regime, and other factors that generally determine a country's
creditworthiness. Specifically, the nationally recognized statistical rating organizations
(
NRSROs, or "rating agencies"),
credit rating agencies registered with the SEC, have placed increased scrutiny on JGBs, which are a significant
component of the Company’s overall investment portfolio, resulting in downgrades as discussed later in this Risk Factors
section. The NAIC is also considering changes to investment risk factors. Any negative developments by the NRSROs or
NAIC in these areas could result in increased capital requirements for the Company.
We seek to match the investment currency and interest rate risk to our yen liabilities. The low level of interest rates
available on yen-denominated securities has a negative effect on our overall net investment income. A large portion of the
cash available for reinvestment each year is deployed in yen-denominated instruments and subject to the low level of yen
interest rates.
Any potential deterioration in Japan
'
s credit quality, market access, the overall economy of Japan, or Japanese market
volatility could adversely impact the business of Aflac in general and specifically Aflac Japan and our related results of
operations and financial condition.
We are exposed to foreign currency fluctuations in the yen/dollar exchange rate.
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 financial position and results of operations. Aflac Japan's
premiums and approximately half of its investment income are received in yen. Claims and most expenses are paid in
yen, and we purchase yen-denominated assets and U.S. dollar-denominated assets, which may be hedged to yen, to
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