18 / 188
support yen-denominated policy liabilities. These and other yen-denominated financial statement items are, however,
translated into dollars for financial reporting purposes. Accordingly, fluctuations in the yen/dollar exchange rate can have a
significant effect on our reported financial position and results of operations. 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. Any unrealized foreign currency translation adjustments are reported in accumulated other
comprehensive income. As a result, yen weakening has the effect of suppressing current year results in relation to the
prior year, while yen strengthening has the effect of magnifying current year results in relation to the prior year. In addition,
the weakening of the yen relative to the dollar will generally adversely affect the value of our yen-denominated
investments in dollar terms. Foreign currency translation also impacts the computation of our risk-based capital ratio
because Aflac Japan is consolidated in our U.S. statutory filings due to its status as a branch. Our required capital, as
determined by the application of risk factors to our assets and liabilities, is proportionately more sensitive to changes in
the exchange rate than our total adjusted capital. As a result, when the yen strengthens relative to the dollar, our RBC and
SMR is suppressed. We engage in certain foreign currency hedging activities for the purpose of hedging the yen exposure
to our net investment in our branch operations in Japan. These hedging activities are limited in scope and we cannot
provide assurance that these activities will be effective.
Aflac Japan is exposed to further foreign exchange risk through its investment in unhedged U.S. dollar-denominated
securities. When the yen strengthens, the unhedged U.S. dollar-denominated investments will experience unrealized
foreign exchange losses, negatively impacting SMR. For regulatory accounting purposes for Aflac Japan, there are certain
requirements for realizing impairments that could be triggered by changes in the yen/dollar exchange rate and could
negatively impact Aflac Japan's earnings and the corresponding repatriation and capital deployment.
Additionally, we are exposed to economic currency risk when yen cash flows are converted into dollars, resulting in an
increase or decrease in our earnings when exchange gains or losses are realized. This primarily occurs when we
repatriate funds from Aflac Japan to Aflac U.S., but it also has an impact when yen cash is converted to U.S. dollars for
investment into U.S. dollar-denominated assets (as described above). The exchange rates prevailing at the time of
repatriation may differ from the exchange rates prevailing at the time the yen profits were earned. We engage in foreign
currency hedging activities to mitigate the exposure to this foreign exchange risk.
For more information regarding foreign currency risk, see the Currency Risk subsection within the Market Risks of
Financial Instruments section of MD&A in this report.
Failure to execute or implement the conversion of the Japan branch to a legal subsidiary could adversely affect
our business, results of operations, or financial position.
The implementation of the Japan Branch conversion to a legal subsidiary is a complex undertaking and involves a
number of risks, including additional costs, information technology-related delays and problems, personnel loss,
regulatory law changes, legal and regulatory requirements, changes to our operations, and management distraction.
Many aspects of these transactions are subject to regulatory approvals from a number of different jurisdictions. We may
not obtain needed regulatory approvals in the timeframe anticipated or at all, which could delay or prevent us from
realizing the anticipated benefits of this transaction. Changes to regulatory laws before the completion of the transaction
could result in significant costs or reduction in capital. The transaction or the related regulatory approvals may entail
modifications of certain aspects of our operations, which could result in additional costs or reduce net earnings. Any of
these risks, if realized, could result in a material adverse effect on our business, results of operations or financial
condition.
Lack of availability of acceptable yen-denominated investments could adversely affect our results of operations,
financial position or liquidity.
We attempt to match both the duration and currency of our assets with our liabilities. This is very difficult for Aflac
Japan due to the lack of available long-dated yen-denominated fixed income instruments.
Prior to the financial crisis of 2008, the Company was focused on investing cash flows in JGBs, which had relatively
low yields, and utilizing private placement and perpetual securities to gain additional yield, extend the duration of the
investment portfolio, and maintain yen exposure. Given call activity, with respect to certain of the Company's legacy
private placement investments, the Company has recently added a modest amount of yen-denominated private
placements to its investment portfolio. The investment in private placements and legacy perpetual securities carries risk
associated with illiquidity, which is managed and monitored by the Company.
16