S&P Downgrades Aflac (AFL) to 'A+'; Following Lowering of Japan's L-T Sovereign Credit

Standard & Poor's Ratings Services said that it lowered its long-term counterparty credit and financial strength ratings on Aflac Inc.'s (NYSE: AFL) core operating companies (American Family Life Assurance Co. of Columbus, American Family Life Assurance Co. - Japan Branch, and American Family Life Assurance Co. of NY [collectively, Aflac]) to 'A+' from 'AA-'. At the same time, we lowered our counterparty credit rating on the holding company, Aflac Inc., to 'A-' from 'A'. We also lowered our rating on the company's senior debt to 'A-' from 'A' and on its junior subordinated debt to 'BBB' from 'BBB+'. The outlook is stable.

The downgrade of Aflac follows our lowering of the long-term sovereign credit rating on Japan to 'A+' from 'AA-' (see Japan Ratings Lowered To 'A+/A-1'; Outlook Is Stable , published Sept. 16, 2015, on RatingsDirect). "We believe the likelihood of an economic recovery in Japan that is strong enough to restore economic support for sovereign creditworthiness commensurate with our previous assessment has diminished," said Standard & Poor's credit analyst Deep Banerjee. During 2011-2014, average per-capita income in Japan slipped to $36,000 from close to $47,000. Apart from a sharp depreciation in the exchange rate between the yen and the U.S. dollar, this also reflected weak average economic growth during the period and persistently weak price trends. Despite showing initial promise, we believe that the government's economic revival strategy--dubbed "Abenomics"--will not be able to reverse this deterioration in the next two to three years.

We rarely rate insurance companies above the sovereign long-term rating because, during sovereign stress, the sovereign's regulatory and supervisory powers may restrict an insurer's or financial system's flexibility, and because insurers are affected by many of the same economic factors that cause sovereign stress. We conducted a hypothetical stress test to see the impact on capital and liquidity of Aflac in a sovereign default scenario. Aflac passed our hypothetical liquidity stress test because very few of its products have surrender values associated with them. But, Aflac fails our capital stress test primarily due to the severe nature of the market value declines (e.g., 60% haircut on sovereign securities) assumed in our hypothetical default scenario test.

It is important note that our view of Aflac's fundamental credit characteristics has not changed. We view the company as having a very strong business risk profile and very strong financial risk profile that support its stand-alone credit profile of 'aa-'. This rating action reflects our view of an appreciable likelihood that companies with significant concentrations in a sovereign would default under a scenario where the sovereign defaults on its obligations. Currently, close to 70% of Aflac's consolidated premiums are derived from its Japan operations. The company has taken steps to diversify its asset base, but 37% of its invested assets (as of June 30, 2015) remain in Japanese national government bonds.

The outlook on Aflac is stable based on its fundamental credit profiles and our stable outlook on Japan. On a stand-alone basis, we expect Aflac to continue generating above-industry-average operating earnings (EBIT return on revenue of 18%-20%, maintain its leading market position), and to retain capitalization at least at the 'AA' level per our capital model.

Although unlikely, we could lower the ratings on Aflac if we were to further lower the rating on Japan or if Aflac's group capital adequacy declined significantly such that it was no longer redundant at the 'A' level as per our capital model.

Our ratings on companies are usually no higher than our ratings on the sovereign where these firms have a majority of operations or significant amount of invested assets. Because Aflac is currently rated at the same level as we rate the Japanese sovereign, there is limited likelihood of us upgrading Aflac unless we upgrade the Japanese sovereign first.

The only potential rating upside will be based on either Aflac's ability to diversify its assets and operations significantly outside of Japan, or if Aflac's board of directors approves a risk-mitigation plan that we find to be adequate to alleviate the impact of a sovereign default on Aflac's Japanese operations.

You May Also Be Interested In

• Growth isn't weak enough to truly undercut inflation pressures - BMO
• Parke Bancorp (PKBK) Reports Q1 EPS of $0.51
• Prysmian SpA (PRY:IM) (PRYMY) PT Raised to EUR53 at HSBC