23 / 188
Defaults, downgrades, widening credit spreads or other events impairing the value of the fixed maturity
securities, perpetual securities and loan receivables in our investment portfolio may reduce our earnings and
capital position.
We are subject to the risk that the issuers and/or guarantors of fixed maturity securities, perpetual securities and loan
receivables we own may default on principal or interest. A significant portion of our portfolio represents an unsecured
obligation of the issuer, including some that are subordinated to other debt in the issuer’s capital structure. In these cases,
many factors can influence the overall creditworthiness of the issuer and ultimately its ability to service and repay our
holdings. This can include changes in the global economy, the company's assets, strategy, or management, shifts in the
dynamics of the industries in which they compete, their access to additional funding, and the overall health of the credit
markets. Factors unique to our securities including contractual protections such as financial covenants or relative position
in the issuer's capital structure also influence the value of our holdings.
Most of our investments carry a rating by one or more of the NRSROs. Any change in the rating agencies' approach
to evaluating credit and assigning an opinion could negatively impact the fair value of our portfolio. We employ a team of
credit analysts to monitor the creditworthiness of the issuers in our portfolio. Any credit-related declines in the fair value of
positions held in our portfolio we believe are not temporary in nature will negatively impact our net income and capital
position through impairment and other credit related losses. These losses would also affect our solvency ratios in the
United States and Japan. Aflac Japan has certain regulatory accounting requirements for realizing impairments that could
be triggered by credit-related losses, which may be different from U.S. GAAP and statutory requirements. These
impairment losses could negatively impact Aflac Japan's earnings, and the corresponding repatriation and capital
deployment.
We are also subject to the risk that any collateral providing credit enhancement to our positions could deteriorate.
These instruments may include senior secured first lien loans, such as commercial mortgage loans, bank loans, middle
market loans, and loan-backed securities where the underlying loan or collateral notes may default on principal, interest,
or other payments, causing an adverse change in cash flows to the positions held in our investment portfolio.
Our portfolio includes holdings of perpetual securities. Most of these are issued by global banks and financial
institutions. Following the financial crisis, rating agencies reviewed and, in most cases, modified the rating criteria for
financial institutions. This has caused multiple downgrades of many bank and financial issuers, but perpetual securities
have been more negatively impacted as their lower position in the capital structure represents relatively more risk than
other more senior obligations of the issuer. Further downgrades or default of issuers of securities we own will have a
negative impact on our portfolio and could reduce our earnings and capital.
We are exposed to sovereign credit risk through instruments issued directly by governments and government entities
as well as banks and other institutions that rely in part on the strength of the underlying government for their credit quality.
In addition to the United States and Japan, many governments, especially in Europe, have been subject to rating
downgrades due to the need for fiscal and budgetary remediation and structural reforms, reduced economic activity, and
investment needed to support banks or other systemically important entities. Additional downgrades or default of our
sovereign issuers will have a negative impact on our portfolio and could reduce our earnings and capital.
In addition to our exposure to the underlying fundamental credit strength of the issuers of our fixed maturity and
perpetual securities and the underlying risk of default, we are also exposed to the general movement in credit market
spreads. A widening of credit spreads could reduce the value of our existing portfolio, create unrealized losses on our
investment portfolio, and reduce our adjusted capital position which is used in determining the SMR in Japan. This
widening of credit spreads could, however, increase the net investment income on new credit investments. Conversely, a
tightening of credit spreads could increase the value of our existing portfolio and create unrealized gains on our
investment portfolio. This tightening of credit spreads could also reduce the net investment income available to us on new
credit investments. Increased market volatility also makes it difficult to value certain of our investment holdings (see the
Critical Accounting Estimates section in Item 7, Management's Discussion and Analysis, of this Form 10-K).
As a result of the large decline in oil prices in early 2016 and subsequent price volatility, there has been heightened
attention to certain investments in the various energy sectors. Our portfolio includes holdings diversified across multiple
sub-sectors of the oil and gas industry, spread among multiple geographies.
21