Aflac - Q3 2023
November 2, 2023
Transcript
Operator (participant)
Good morning, and welcome to the Aflac Incorporated third quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the call over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead.
David Young (VP of Capital Markets)
Good morning, and welcome. This morning, we will be hearing remarks about the third quarter related to our operations in Japan and the United States from Dan Amos, Chairman and CEO of Aflac Incorporated, and Fred Crawford, President and COO of Aflac Incorporated. Max Brodén, Executive Vice President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity, which can also be found with the materials that we posted, along with our earnings release and financial supplement on investors.aflac.com. We also posted under Financials on the same site, updated slides of investment details related to our commercial real estate and middle market loans. In addition, Max provided his quarterly video update, which you will find there also.
Other members of our executive management team who are joining us for Q&A include Virgil Miller, President of Aflac U.S., Charles Lake, Chairman and Representative Director, President of Aflac International, Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan, Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures.
I'll now hand the call over to Dan. Dan?
Daniel Amos (Chairman and CEO)
Thank you, David. Good morning. We're glad you joined us. Reflecting on the third quarter of 2023, our management team, employees, and sales distribution have continued to work tirelessly as dedicated stewards of our business. This has allowed us to be there for the policyholders when they need us most, just as we promised. Aflac Incorporated delivered very strong earnings for both the quarter and for the first nine months. Beginning with Japan, I am pleased with our 12.4% year-over-year increase in sales, which was largely driven by a nearly 23% increase in cancer insurance sales, with a significant contribution from Japan Post Company and Japan Post Insurance. I am also pleased to see continued improvements in cancer insurance sales through our other alliances, Dai-ichi Life and Daido Life.
These alliance partners, along with agencies and banks, combine to form our extensive distribution channels that are so important to being where the customer wants to buy insurance and providing them with financial protection. We continue to work hard to support each channel. We also introduced our new medical insurance product on September the 19th. The product design is simple to appeal to younger policyholders with basic needs and older or existing policyholders who desire additional or updated coverage. While it's too early to evaluate the success of this product launch, early indications show that it's being well-received. We continue to gain new customers through WAYS and Child Endowment, while also increasing opportunities to sell our Third Sector products.
Since the launch of our refreshed WAYS product, approximately 80% of our sales are to younger customers below the age of 50, and the level of concurrent Third Sector sales remains approximately 50%. Thus far, our product strategy in Japan has served us well, and I'm encouraged by our progress so far. Turning to the U.S., I'm encouraged by our sales increase of 7.5% in the quarter. This reflects continued productivity improvements and the contribution from our growth initiatives of Group Life and Disability, Consumer Markets, Network Dental, and Vision. We remain focused on driving scale, stabilizing new platforms, and leveraging our ability to bundle essential product lines as we work with brokers on larger groups. Agents and brokers contributed to the growth of our individual business. Our group platform benefited significantly from the sales of Group Life and Disability.
I am very excited about our new Cancer Protection Assurance policy, which provides enhanced benefits at no additional cost. We know that when people experience the value of our products, it increases persistency, which benefits our policyholders and lowers our expenses. I believe that the need for our products and solutions we offer is strong... are stronger than ever before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers, particularly given that our products are sold, not bought. As we communicate the value of our products, we know that a strong brand alone is not enough. We must paint a better picture of how our products help address the gap that people face when they get medical treatments, even though they may have major medical insurance.
Knowing our products help lift people up when they need it most, is something that makes all of us at Aflac very proud and propels us to do more and achieve more. We continue to reinforce our leading position and build on that momentum. As always, we are committed to prudent liquidity and capital management. We continue to generate strong investment results while remaining in a defensive position as we monitor evolving economic conditions. In addition, we have taken proactive steps in recent years to defend our cash flow and deployable capital against the weakening Japanese yen. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders. At the same time, we're listening to our shareholders and understanding the importance of prudent liquidity and capital management.
We remain committed to maintaining strong capital ratios on behalf of the policyholder and balance this financial strength with tactical capital deployment. I am very pleased with the board's declaration of the fourth quarter dividend, and declaring this dividend of 2023 marks the 41st consecutive year of dividend increases, a record that we treasure. I am even more pleased with the board's action to increase the first quarter of 2024 dividend by 19% to $0.50 per share. We also remain in the market, purchasing shares at a historically high level of $700 million, as seen in the first two quarters of this year. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows, which support both our dividend track record and tactical share repurchase.
Overall, I think we can say that it has been a very strong quarter, especially when a vast number of factors are in our favor. Aflac Japan had a strong quarter for sales as we executed product and distribution strategy. Aflac U.S. continued to build on its momentum as it nears pre-pandemic levels. Pre-tax profit margins remain strong in both Japan at 32.8% and the U.S. at 28.8%. Plus, our capital ratios remain very strong, and our quarterly share repurchase was, like last quarter, one of the largest in the company's history. Before I hand it over to Fred, I want to address an announcement of his retirement. I've enjoyed working closely with Fred over the last eight years and certainly understand his desire to retire and spend more time with the family and personal interests.
Fred, you will be missed, and I look forward to working with you and Aflac's executive team to ensure a smooth transition until your official retirement day. I wish you many happy years. As for me and the company, we have some outstanding candidates who are capable of running Aflac. It is my responsibility to continue to train and watch the progress of these potential heir apparents, while the board oversees the process. To be prepared for any unknowns, we have always had an interim CEO ready, should something abruptly happen to me, as well as a strong process within the board's corporate governance committee. I recently had a physical at Emory University and received an excellent report, so I plan on being around to prepare our leaders for the future and drive shareholder value. With that, I'll now turn the program over to Fred. Fred?
Frederick Crawford (Retired)
Thank you, Dan. As announced last night, I plan to retire in September of next year to spend more time with my family and pursue other interests. It's a personal decision, but also a recognition of the very capable leadership team surrounding Dan and the company being in a very strong position. While I believe this is the best for me and my family, I also believe it is in the best interest of Aflac. I've enjoyed 25 years as an executive in the insurance industry and feel blessed to have worked with talented professionals and leaders throughout. However, the highlight has clearly been my time here working for Dan and for Aflac. Over the next year, I will be focused on transition and helping on select initiatives where I can add value. I'll now hand the call back over to Max. Max?
Max Brodén (SEVP and CFO)
Thank you, Fred. For the third quarter, adjusted earnings per diluted share increased 27.8% year-over-year to $1.84, with a negative $0.06 impact from FX in the quarter. With this being the third quarter under the new LDTI accounting regime, we evaluate our reserve assumptions for morbidity, persistency and mortality at least annually to see if an update is needed. If necessary, these assumptions will be unlocked on a prospective basis as they were in this quarter, leading to remeasurement gains of $205 million. Variable investment income ran $13 million, or $0.02 per share, below our long-term return expectations. We also wrote down certain software intangibles in our U.S. segment, impacting our results by $0.04 per share.
Adjusted book value per share, including foreign currency translation gains and losses, increased 10.3%, and the adjusted ROE was 15.6%, a significant spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premium for the quarter declined 2.8%, reflecting the impact of paid-up policies, our January first reinsurance transaction, and deferred profit liability. Lapses were somewhat elevated, but within our expectations. However, if adjusting for all these factors, the earned premium declined an estimated 1.7%. Japan's total benefit ratio came in at 65.1% for the quarter, down 170 basis points year-over-year, and the third sector benefit ratio was 54.8%, down approximately 460 basis points year-over-year.
We continue to experience favorable actual to expected on our well-priced, large, and mature in-force block. We estimate the impact from remeasurement gains to be 260 basis points favorable to the benefit ratio in Q3. Long-term experience trends as it relates to treatments of cancer and hospitalization continue to be in place, leading to favorable underwriting experience. Persistency remains solid, with a rate of 93.5%, but was down 80 basis points year over year. With product refreshments, we tend to experience some elevation in lapses as customers update and refresh their coverage, which was the case with the recently refreshed cancer and First Sector products. Our expense ratio in Japan was 19%, down 100 basis points year over year, driven primarily by good expense control and to some extent by expense allowance from reinsurance transactions and a DAC commission true-up.
For the full year, we would expect to end up towards the low end of our expense ratio range of 20%-22%. Adjusted net investment income in yen terms was up 7.2%, as we experienced higher yields on our U.S. dollar-denominated investments and related favorable FX, and a return on our alternatives portfolio more in line with our long-term return expectations. This was offset by transfer of assets due to reinsurance. In the quarter, we reduced our FX forwards and increased FX put options notional, leading to lower run rate hedge costs and a more efficient use of our investment risk capital. The pre-tax margin for Japan in the quarter was 32.8%, up 350 basis points year-over-year, a very good result for the quarter. Turning to U.S. results, net earned premium was up 3.2%.
Persistency increased 80 basis points year-over-year to 78.7%. This is a function of poor persistency quarters falling out of the metric and stabilization across numerous product categories, especially group voluntary benefits. Our total benefit ratio came in lower than expected at 35.9%, a full 890 basis points lower than Q3 2022. We estimate that the remeasurement gains impacted the benefit ratio by 12.1 percentage points in the quarter. Claims utilization remains subdued, and as we incorporate more recent experience into our reserve models, we have released some reserves. For the full year, we now estimate our benefit ratio to be materially below our outlook range of 47%-50%. Excluding remeasurement gains, however, we are tracking well within the 47%-50% outlook range.
Our expense ratio in the U.S. was 40.6%, up 70 basis points year-over-year. This includes a 190 basis points impact from a software intangibles write-down. Adjusting for this write-down, we are trending in the right direction. Our growth initiatives, Group Life and Disability, Network Dental and Vision, and Direct to Consumer, increased our total expense ratio by 330 basis points. We would expect this impact to decrease over time as these businesses grow to scale and improve their profitability. For the full year, we now expect our expense ratio to come in slightly above our outlook range of 37%-40%.
Adjusted net investment income in the U.S. was up 13%, mainly driven by higher yields on both our fixed and floating rate portfolios, and variable investment income in the quarter more in line with long-term return expectations. Profitability in the U.S. segment was solid, with a pre-tax margin of 28.8%, driven primarily by the remeasurement gains from unlocking. As you know, the commercial real estate markets are going through the worst cycle in decades, especially in the office subsector. We're seeing most property values quoted down 25%-40%, but some distressed situations are driving market values down as much as 60%, far exceeding the 35%-40% declines of the financial crisis. Our total commercial real estate watch list remains approximately $1 billion, with around two-thirds of these in active foreclosure proceedings.
As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $34 million this quarter. We also moved two properties into real estate owned, which resulted in a $53 million write-down. We do not believe the current distressed market is indicative of the true intrinsic economic value of the underlying properties currently undergoing a foreclosure process. We continue to believe our ability to take ownership of these quality buildings and manage them through this cycle will allow us to maximize our recoveries. In our corporate segment, we recorded a pre-tax loss of $49 million, which is somewhat smaller than a year ago, primarily due to our reinsurance transaction. Adjusted net investment income was $8 million lower than last year due to an increased volume of tax credit investments.
Higher rates began to earn in, and amortized hedge income increased. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $64 million, with an associated credit to the tax line. The net impact to our bottom line was a positive $3.8 million in the quarter. To date, these investments are performing well and in line with expectations. We are continuing to build out our reinsurance platform, and I'm pleased with the outcome and performance. In Q4, we intend to execute another tranche with similar structure and economics to our first transaction from January this year. Our capital position remains strong, and we ended the quarter with an SMR above 1,000% in Japan. Our combined RBC, while not finalized, we estimate to be greater than 650%.
Unencumbered holding company liquidity stood at $3.3 billion, $1.6 billion above our minimum balance. These are strong capital ratios, which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. U.S. stat impairments were $4 million, and Japan FSA impairments, JPY 2.9 billion, or roughly $20 million. This is well within our expectations and with limited impact to both earnings and capital. Leverage remains at a comfortable 18.8%, just below our leverage corridor of 20%-25%. The decline in the quarter is primarily driven by the weakening yen. As we hold approximately two-thirds of our debt denominated in yen, our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in U.S. dollar terms.
We repurchased $700 million of our own stock and paid dividends of $248 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now hand the call back to David to begin the Q&A.
David Young (VP of Capital Markets)
Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you are welcome to rejoin the queue to ask an additional question. We will now take the first question.
Operator (participant)
We will now begin the question and answer session. To ask a question, press star, then one. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. Our first question will come from Tom Gallagher with Evercore ISI. You may now go ahead.
Thomas Gallagher (Senior Managing Director)
Good morning. Dan, wanted to start with your comment about succession planning and having several strong candidates. Should we take that to mean you won't be looking to do an outside search to replace Fred? And are you looking to replace Fred in the COO role? A little bit of color on what you're thinking overall there. Thanks.
Daniel Amos (Chairman and CEO)
Sure. First, I would say that you have to understand that one of the reasons that we created the Chief Operating Officer and also for Fred to go to Japan, part of it was due to the COVID period of time, and that we had a situation where with COVID, we wanted more interaction with Japan, and so Fred was willing to go over there and do that. And that was very helpful to us, and we continued to rotate people over to Japan and from Japan to the United States. And it's for example, Steve Beaver, who you probably know has been around a long time, will be working with them. As far as how and what will involve, these decisions ultimately come from the Board.
I think there's always two ways to look at transition, and what would take place would be an abruptness of something happening and then, well, it was structured. So we work with the concept that this will be planned over a long period of time... and we've had internal candidates. It's always been my preference that it be internal candidates because of the Japanese operation and the uniqueness that we have there. Saying that, I would say the board would, the corporate governance committee specifically, and then the full board would be reviewing every aspect to make sure you have the best person for the job. And so we would also take that into consideration, as we're moving forward. As I said in my comments, I'm enjoying life, I'm enjoying working with the company and want to continue to do so.
At the same time, these adjustments of people retiring and moving on happens, and I've been around to see a lot of them, but I think there's a little element of pride that keeps me around because of the family, and frankly, I just enjoy doing it. So I look forward to working with these people. There are several that are on the horizon. We continue to add new people that have potential. So, I'm encouraged about that, and I think we're in a strong position, and I think this quarter sent a signal of how strong we are managerially wise, and we'll continue to do that.
Thomas Gallagher (Senior Managing Director)
Gotcha. Thanks. Thanks for that, Dan. Just an operational question for my follow-up. Max B, can you comment on what's behind the bigger reserve release in the U.S., and if there's a go-forward earnings impact associated with that? I would have thought there might have been a bigger benefit coming from Japan, just given how strong this and this efficiency of margins there are. Any, maybe any color comparing and contrasting how the actuarial review stacked up U.S. versus Japan? Thanks.
Max Brodén (SEVP and CFO)
Thank you. Thank you, Tom. So obviously, this is the first year we're running on an LDTI basis, and the third quarter is when we do the unlockings, including prospective unlockings. When you think about it, if you go back and look at the last couple of years, and you see the morbidity trends, and also trends in hospitalization and outpatient treatments, and you compare and contrast Japan and the United States, in the U.S., we shut down a lot more than what you ended up doing in Japan as it relates to how people went to the hospital and how people changed their behavior. And that is coming through in our morbidity experience. So we did see, for example, accident, hospitalizations, et cetera, drop a lot more in the United States than what you saw in Japan.
And that was simply a factor of the COVID virus, had a much more significant spread in the U.S. than what it did have in Japan. In Japan, you really had a big spike in the third quarter of 2022, but outside of that, it was a significantly lower spread than what you had in the U.S. And that is why you're now seeing that having a much more pronounced impact on the morbidity experience that is feeding into our actuarial models, that is then leading to the outcome that you saw this quarter.
Thomas Gallagher (Senior Managing Director)
Okay, thanks.
Operator (participant)
Our next question will come from Jimmy Bhullar with JP Morgan. You may now go ahead.
Jimmy Bhullar (Managing Director)
Hey, good. Hi, good morning. So Fred, I'm sure we'll be dealing with you a little bit more over the next year, but, good luck in the future. I had first a question on just the, any updates you have on the potential Tri-Agency Rule, and in sort of a worst-case scenario, what are the products that are in scope, and what could be the impact in, on your business, assuming that the industry does not get any concessions from, the rule as it's initially written?
Virgil Miller (President)
Good morning. This is Virgil Miller from the U.S. I'll take that question for you. So we continue to advocate on behalf of our policyholders to provide them the protection when they need it most. The comment period is closed, but you can see and review our comments out there as well as others. I'll just say that we saw no impact in the third quarter to our sales. If you think about it, our hospital indemnity product could be one that's impacted. We had relatively flat sales in the third quarter, but you've heard Dan mention in his comments about our cancer insurance protection plan. We saw our cancer sales up in the third quarter. I would say this also, that remember, one of the considerations as part of the proposal is around pre-tax implications.
Aflac has been selling. We were selling our policies without those pre-tax benefits long before it actually occurred years ago. So I think we'll be positioned well, even if the rule were to pass.
Daniel Amos (Chairman and CEO)
Let me make one other comment. I was in Washington for three days about three weeks ago, and met with probably 18 senators and congressmen to just see their positions on it. I wanna go back to the pre-tax situation that Virgil was talking about because it was an anomaly. What actually happened was it ended up being passed, and we, as a company, back 20-something years ago, we didn't sell pre-tax for the first 2 years because the Congress said it was a mistake, and it was never really meant to happen. And so...
Once it was in the bill, then when they tried to take it out, thought about taking it out, it looked like it was a free tax, and if they took it out, it became a tax on the average American. And, you know, take, for example, a schoolteacher that is come down with cancer, to all of a sudden say you're gonna tax their benefits, will not sit well with their contingent, the contingency of people that they deal with. And so we were able to talk to a lot of people about it, and we had no feedback that thought that it should be the opposite.
Now, saying that, we know that this has been submitted by the branch outside Congress through the executive branch, and we've got to handle it, and we plan on talking to them. But it is, it will absolutely be a direct tax. But we sold in that environment. I'm one of the ones, one thing about me being around a long time is I remember a lot of things. And we sold in a pre-tax environment. I was around when we sold in a pre-tax environment. In fact, I was in the sales force for 10 years and saw it. And so it's a matter of adjustment, no matter what happens. And what I've always says is, with change comes opportunity. And so no matter what happens, we're gonna find a way to do well in that environment.
Jimmy Bhullar (Managing Director)
Okay. If I could ask just one more. Your comments on CRE seem fairly negative, and the environment's pretty challenging as well. But how do you square the watch list of over $1 billion, around $1 billion with your CECL reserve, which it seems pretty modest at around $34 million?
Bradley Dyslin (EVP, Global Chief Investment Officer and President, Aflac Global Investments)
Yeah. Good morning, Jimmy. This is, this is Brad Dyslin, I'll take that. There's a couple of things behind the relatively modest reserving that you've seen so far compared to that $1 billion watch list. One is the average LTV of the portfolio and the price declines we've seen. What happens when we go through the foreclosure process is we have to mark that asset to the lower of the principal balance of the loan or the value of the asset. So when you're starting at a 60% LTV, you've got a fair amount of cushion before you start to realize losses on that mark. The second dynamic at play here is we are still in process on about half of that $1 billion watch list, which means we are in workout negotiations with the borrower.
Those can be very long-lasting, very intense, and they can ebb and flow a lot of different directions. Once we get certainty that we expect to foreclose, we have to order a third-party appraisal. Those take time to come in, and as they come in, that's when we end up remarketing our assets. So it's a combination of our relatively conservative LTVs and the fact that we've still got about half that portfolio subject to appraisal.
Jimmy Bhullar (Managing Director)
Thank you.
Operator (participant)
Our next question will come from Ryan Krueger with KBW. You may now go ahead.
Ryan Krueger (SVP of Investor Relations)
Hey, thanks. Good morning. My first question was on the changes you made to the FX hedging program. I just wanted to confirm, you had a pretty major decline in the hedge costs in the third quarter versus the last couple of quarters. Just wanted to confirm that that's a reasonable expectation on the hedge costs going forward for the foreseeable future.
Max Brodén (SEVP and CFO)
Yeah. Thank you, Ryan. Yes, I think, you know, what you saw in terms of hedge costs for the third quarter, it's a blend of us rolling into our new structure. So it's a mix between the old structure and the new structure. In terms of run rate hedge costs going forward, I do think that the third quarter hedge costs that you saw, it's certainly not gonna be higher. It will probably gonna, on a run rate basis going forward, be at this level or slightly lower going forward in terms of actual hedge costs. That is obviously subject to capital markets inputs, and everything that impacts the cost of a put option, and also to some extent, if we decide to increase our forward exposure in the future as well.
So things like the FX volatility, interest rates, et cetera, will come into play here. But in the near future, I would expect our hedge costs to be similar to the third quarter level or slightly lower.
Ryan Krueger (SVP of Investor Relations)
There's no offset anywhere else, right? That would drop to the bottom line.
Max Brodén (SEVP and CFO)
Sorry, Ryan, I didn't quite catch that. Can you repeat?
Ryan Krueger (SVP of Investor Relations)
There's no offset.
Max Brodén (SEVP and CFO)
Um-
Ryan Krueger (SVP of Investor Relations)
I just wanted to... There's no offset anywhere else-
Max Brodén (SEVP and CFO)
Yeah. Oh, I understand. I understand.
Ryan Krueger (SVP of Investor Relations)
That would drop to the bottom line.
Max Brodén (SEVP and CFO)
The way to think about this, in terms of the P&L, this will drop to the bottom line. When you think about the P&L here, what we have done when we moved gradually from using forwards to put options, what happens is that we are now increasing the volatility for small moves in the yen-dollar as it relates to our capital ratios in Japan, i.e., the SMR and ESR. So for a strengthening yen or a weakening yen, you're gonna see slightly higher volatility in that ratio for small moves. But what the put options give us is that we have dramatically reduced the tails. So any dramatic moves or shock moves in the yen-dollar, we have reduced our risk exposure to those kind of events... and we feel that this is a very good risk-reward for us.
Ryan Krueger (SVP of Investor Relations)
Thanks. And then on the reinsurance transaction, the transaction you did, last year, I think, freed up $900 million of capital, but then, I think around half of it or so was available for redeployment into shareholders. On this next transaction, would you expect closer to all of it to be available to return to shareholders?
Max Brodén (SEVP and CFO)
We will deploy the capital appropriately in the respective business units. If we have good opportunities to deploy the capital there, we will do so. If we feel that we have significant surplus capital, it will be moved up to the holding company, and the holding company will deploy it in the different sort of capital distributions that the holding company generally does, i.e., dividends, buybacks, etc.
Ryan Krueger (SVP of Investor Relations)
Thank you.
Operator (participant)
Our next question will come from Suneet Kamath with Jefferies. You may now go ahead.
Suneet Kamath (Managing Director and Senior Equity Analyst)
Thanks. Good morning. I just wanted to follow up to Tom's question on the U.S. reserve releases. It sounded like some of the benefit here was lower hospitalizations in the U.S. due to COVID. And I'm just want to understand, is are you assuming that kind of that lower level of hospitalization sort of persists going forward? Or are you assuming some sort of reversion to historical trend?
Max Brodén (SEVP and CFO)
Let me kick off on that question, and I would ask Al Ruggieri to fill in any blanks and add his color as well. But the fact of the matter is that we have seen lower levels, generally speaking, in terms of hospitalizations, come through. And we've also seen changes in the way treatments are being done, i.e., more outpatient treatments, as well. So we believe that we have seen a shift in both the way hospitals are operating and also the way individuals are going for their treatments. And we have factored that in to some extent.
Albert Riggieri (SVP, Global Chief Risk Officer and Chief Actuary)
Yes, this is Al Ruggieri. Just to add in a little bit on that. Remember, the COVID period dropped all hospital utilization, treatment patterns. Many of that during COVID would have some ups and downs during the period as hospitals had more capacity and people would return and get like elective surgeries and all of that. What we did this year was begin to recognize that 2022 was the first year in the United States where you would say that the pandemic was kind of in the rearview mirror. So we brought in the experience of 2022. We did still remove the experience, very low experience during COVID period.
We brought in the post-COVID period, we called it, for 2022, and as Max was saying, continued to see, even in that period in 2022, that we did have lower experience. So we built that into the experience base for updating the assumptions.
Suneet Kamath (Managing Director and Senior Equity Analyst)
I, and I think, Max, you said you've factored some of that into your reserve. Is it, does that mean that if things sort of persist the way they are, that there would be the potential for some more reserve releases down the road?
Max Brodén (SEVP and CFO)
We believe that we have adequately reflected, sort of, the new paradigm or, the new experience that we're seeing now into our models. Now, please remember, these are obviously models. So what that means is that if these trends were to improve further, than what we have experienced to date, there is the potential for further unlockings, favorable or negative. It can go the other way as well. We believe that we have reflected it to the best, the best way we can, given the data that we see. And it's important that we do reflect it, to the best way we can. But I also want to make sure that you understand that these are estimates, and they can go both ways.
Suneet Kamath (Managing Director and Senior Equity Analyst)
Yeah. No, that, that makes sense. My, my other one was on Japan and the earned premium drop of 1.7%, sort of adjusted. I would have thought at some point the impact of the paid-up policies would sort of have run its course, and I know some of those policies were very long-dated, but I believe that they were sold quite a bit ago. So are we getting closer to the point where that impact is expected to fall off?
Max Brodén (SEVP and CFO)
So, when we look forward into the paid up schedules, you, you are going to see a little bit of a drop in 2014, sorry, 2024, and then a further drop in 2025. And, that's where I would say that I would expect us to run more on a, on a normalized basis for paid up. Keep in mind that the big sales, that we had of the WAYS product, they really occurred in the 2012 through 2014 time period, and there was 5-year pay, and there were 10-year pay. So when you roll that forward, that's when you see that, you get a little bit of a drop-off in 2024 and then a further in 2025.
That being said, paid up is something that we generally build into our products, both First Sector and Third Sector. But I wanted to mention 2024 and 2025 because that's when we move into a more normal schedule, and you're not necessarily going to see these more significant year-over-year deviations.
Suneet Kamath (Managing Director and Senior Equity Analyst)
Okay, thanks.
Operator (participant)
Our next question will come from Alex Scott with Goldman Sachs. You may now go ahead.
Speaker 18
Morning, it's Marley on for Alex. I was hoping you could provide a little more color on the Japan Post sales and partnership. It looks like it's been progressing, so I was hoping to hear a little more on this versus the longer-term sales guide.
Koichiro Yoshizumi (EVP and Director of Sales and Marketing and Alliance Strategy)
Hey, this is Yoshizumi. I oversee the entire sales in Japan. The sales of our cancer insurance, new cancer insurance Wings, and also Lump Sum Serious Disease Benefit Rider continues to be very strong. We will continue to aim at growth in cancer insurance sales by providing sales support to the sales offices and post offices of Japan Post Company and Japan Post Insurance nationwide, including sales process management and the sharing of good practices. We are also actively working on the training and also developing of the sales agents, agents across all the branches nationwide by sharing good practices and best practices. We are expecting to have growth in sales even more by having all these activities done in a solid manner. That's all for me.
Daniel Amos (Chairman and CEO)
Yeah, I want to make one other comment. We've been waiting for Japan Post to come back for several years now, and we had assurances that they would do that, and I'm happy to see it take place. You know, they are our largest shareholder, and so what is good for us is good for them, and vice versa. I believe this is a strong alliance and will continue to be strong as we move forward.
Speaker 18
Thank you. And then just as a follow-up, if we could turn to capital a little bit. Would you mind providing an update on what you view as near-term versus longer-term capital management priorities or capital deployment?
Max Brodén (SEVP and CFO)
So, obviously, the capital ratios in our subsidiaries, they are strong, and that's obviously priority number one, to make sure that we have adequate and strong capital in our operating subsidiaries. And then we want to move operating cash flow up to the holding company and then deploy it from there. You did see that in the quarter, we bought back $700 million of our own stock. I view that as quite a strong capital deployment, and we also increased the dividend by 19% starting in the first quarter of next year. So, overall, the company is generating significant cash flow, and we are deploying significant cash flow as well.
Speaker 18
Thank you.
Operator (participant)
Our next question will come from John B. Barnidge with Piper Sandler. You may now go ahead.
John Barnidge (Managing Director, Senior Research Analyst)
Good morning. Thanks for the opportunity. Fred, congrats on the retirement. Question is around Japan and the expense reduction efforts. I know there was a paperless effort and other expense efficiencies. Have you already completed any required software installations, or do you have any planned upcoming? Thank you.
Frederick Crawford (Retired)
You know, why don't I just make a couple comments on that, and then Koide-san can comment. But what we are focused on in Japan, from an efficiency perspective, is digitizing the platform. That's the major thrust of what we're looking at, which is a long-term plan of investment followed by returns. And that is a plan to digitize or increase the usage of digital applications, away from paper applications, the use of digital self-service, where policyholders go online and serve themselves through technology as opposed to inundating our call center, and then claims payments or digital claims. We've been making steady progress on both the digital application front and on the customer self-service, but we are engaged currently in updating those tools. Think of it as no different than your iPhone 1 to iPhone 11.
We are updating those tools to modernize them and improve the customer experience. We have been in a proof of concept over the last year and, in fact, have moved those digital adoption rates up, and so with that will come natural efficiencies over time, but it will take time. So it's a long-term progress of moving customer and agent experience to digital and away from paper, but that will yield benefits. The claims side of it is more stubborn. The reason for that has nothing to do with Aflac. It's because the Japanese healthcare system is a paper-based healthcare system that requires the exchange of paper forms when one goes to the doctor. That's really requiring a modernization of the healthcare system in Japan, and interestingly, they actually do have an effort underway to attempt to modernize or digitize the healthcare system.
But until that takes place, our ability to process claims digitally will be somewhat contained. Over time, we expect to improve. What you should expect as investors is that over the long time, we will be increasing that digital adoption. It will yield a lower per policy expense outcome from an administrative standpoint, but it will be over multiple years of slow and steady progress, because this is about adoption, it's not about installing software. Okay?
John Barnidge (Managing Director, Senior Research Analyst)
Very helpful. Thank you very much. Then on the investment portfolio, those properties you took keys, can you maybe talk about the occupancy rates in those versus the ones that remain on the watch list? Thanks a lot.
Bradley Dyslin (EVP, Global Chief Investment Officer and President, Aflac Global Investments)
Sure. Thank you. The 2 properties that we took back, the current occupancy levels are in the low to mid-50s, which has been pretty stable since we first got involved with and did the loan. The occupancy across the portfolio, it does range a fair amount. We've got a few that are below 50%, given the nature of the asset class, the nature of transitional real estate. But for the most part, our averages are right around the 55%-65%.
John Barnidge (Managing Director, Senior Research Analyst)
Thank you very much.
Operator (participant)
Our next question will come from Wilma Burdis with Raymond James. You may now go ahead. Pardon me, Wilma, your line is open for question.
Wilma Burdis (Director)
Oh, hey, good morning. Is it fair to think that Aflac can rewrite its hospital indemnity policies to comply with the potential DOL HHS rule without compromising the attractiveness of the product? And, has Aflac started work on this? If so, and does the burden appear manageable?
Virgil Miller (President)
This is Virgil from the US. We absolutely are taking precautions to make sure that we're prepared, just in case the proposal does go through. We are confident that we can do that. You know, we've been continuing to enhance our benefits while current policies are out there. I think, Dan, we've stated earlier, we were clear that we've sold before in an environment without some of the pre-tax benefits that currently exist, and we're confident we'll be able to do that again. We have a random process here that we're always looking to innovate and reinvent our products and enhance our benefits. We demonstrated that this past year with our cancer enhancements we did, that really had no additional cost to our policyholders. You can expect more of the same related to that.
Wilma Burdis (Director)
Okay, thank you. And then I just want to confirm, I know, I know you guys sort of said it, but I just want to make sure that I understand. In the reinsurance deal that you just recently completed, you freed up around $900 million of capital, and it sounds like, you know, that could either be used to reinvest or maybe ultimately for shareholder returns.
Frederick Crawford (Retired)
Yeah, obviously, our priorities with all the capital that we have is always to deploy it into writing new business and use it in our operating entities. That is where we get the, generally, the best IRR on that capital. If we cannot deploy it in our operating entities, then it will flow up to the holding company.
Wilma Burdis (Director)
Mm-hmm. But it was, it was around $900 million is what, is what you freed up for that?
Frederick Crawford (Retired)
Yeah, that, that is our estimate, yes.
Wilma Burdis (Director)
Okay, thank you.
Operator (participant)
Our next question will come from Josh Shanker with Bank of America. You may now go ahead.
Josh Shanker (Managing Director)
Yes, thank you. When I think about the commercial loan portfolio, are the properties most at risk those that have been more recently loaned to, or the ones that have a longer vintage in terms of when they were established? Along those lines, when did you cool the deployment of new investment flows into commercial loans?
Bradley Dyslin (EVP, Global Chief Investment Officer and President, Aflac Global Investments)
Sure. Thank you, Josh. The loans that we're dealing with now that are on the watch list are those that were made a couple of years ago. The transitional real estate book is our biggest focus area, and that differs from a more traditional CML book in that the maturities are much shorter. They tend to be 3-year fixed maturities with options to extend up to 5, in some cases, up to 7 years, based on certain thresholds and operating metrics being met. So what we're dealing with now are those maturities, predominantly in 2023 and a few in 2024, as obviously, the maturity is coming up, and when those loans need to be addressed, either being repaid or, if that is not an option, then we get into the workout discussions.
We have really substantially reduced our deployment into the asset class this year. Part of that is the market. Well, not part of it. It is, it is frankly driven by the market. The very, very much a lack of activity. We're seeing a large bid-ask between buyers and sellers.... The increase in rates has really put valuations upside down. Buyers are trying to get, take, take advantage of the current levels. Sellers are trying to get yesterday's prices, and we're just not seeing a lot of good, solid transactions, and there's a lack of liquidity in the market. So that's, that's really limited our opportunities.
Of course, we always adjust our underwriting standards to the current experience, to the current market, so we're being a little bit more difficult in our terms and conditions as well.
Josh Shanker (Managing Director)
And then related, is there any way you can frame the capital consumption or rating agency charge for those two properties? What was it before they were converted into wholly owned properties, and what is it now?
Max Brodén (SEVP and CFO)
Yeah. So when they moved from being a CML to Real Estate Owned, there is a significant uptick in terms of the capital charge associated with that. For us, it's still very small. So if you think about RBC points, it's very. I would estimate it to be low single digits. And as it relates to SMR, the same applies.
Josh Shanker (Managing Director)
Okay, thank you very much.
Max Brodén (SEVP and CFO)
When you then think about the distribution on what balance sheet or capital base that they go into, as follow it the same way the size of the investment portfolio is between the two segments, i.e., roughly 85% falls into Japan and 15% falls into the U.S.
Josh Shanker (Managing Director)
Okay, thank you very much. Bye-bye.
Operator (participant)
Our next question will come from Wes Carmichael with Wells Fargo. You may now go ahead.
Wes Carmichael (Executive Director and Equity Research Analyst)
Hey, good morning. Just wanted to follow up on capital a bit. You know, Max, I know you said that your first priority is to deploy that within the subs on organic, but to the extent that, you know, there's not that opportunity, I just wanted to get your thoughts around potential M&A, and you know, given that you've got pretty significant excess at the Holdco in the subs.
Max Brodén (SEVP and CFO)
Yeah, we, if you think about what our track record, you have seen what we have done historically, Aflac has not been an acquisitive company. This is a company that is built selling one policy at a time. We've done a number of, I would call it tuck-in acquisitions in the United States to broaden our product portfolio. And we do feel that we're in a good spot in terms of the products that we have to offer in our go-to-market strategy. So at this point, I don't see that we have any holes that needs to be filled using M&A.
Wes Carmichael (Executive Director and Equity Research Analyst)
Got it. Thanks. And then maybe just to follow up on the middle market loan book, away from, you know, commercial real estate. It seems like, you know, that's the book yield now is near 11%. So just wondering if you're seeing any terms in any collateral deterioration? And if, you know, interest rates remain high, you know, for a year or so, like, do you expect defaults within that portfolio?
Bradley Dyslin (EVP, Global Chief Investment Officer and President, Aflac Global Investments)
Yeah, thank you. So far, we have been extremely pleased with the performance of the middle market loan portfolio. It is, frankly, performing better than we expected, given where we are at this point in the cycle. There are several reasons for that, and it ultimately, it boils down to fundamentals, underwriting, and then how we've chosen to build the portfolio. We have a very small average loan size. We have maintained a discipline around only first lien secured structures. We've kept leverage at a very modest level. We have maintained our use of strong covenants. And then ultimately, it's about good businesses, good companies with sound business plans that are seeing good top-line growth and have the margins and cash flow, avoiding cyclical companies, and that's really played out.
We have built this as our primary below investment-grade portfolio, so we do expect to incur some losses. But relative to the outsized yields we've received, they're really quite modest. And as I said, it is doing better than we expected at this point in the cycle. Going forward, we're gonna have to wait and see just how the macro environment does. It does look like we've got the possibility of a soft or at least a soft-ish landing. And then how quickly rates turn around is something that we're gonna watch very closely.
Wes Carmichael (Executive Director and Equity Research Analyst)
Thank you.
Operator (participant)
Our next question will come from Joel Hurwitz with Dowling and Partners. You may now go ahead.
Joel Hurwitz (Lead Analyst, Life Insurance & Retirement Services Research)
Hey, good morning. RBC is strong at over 600, 650%, well above your 400% target. Can you just talk about plans in managing that down towards the target?
Max Brodén (SEVP and CFO)
So, obviously, in the U.S., we are seeing some growth, and we're seeing some growth in the lines of business that are all driving a little bit more new business strain. And that's why we have, in the pandemic, we wanted to run with a little bit more capital, and then coming out of the pandemic, we see a little bit higher strain associated with that growth that we are starting to see and expect to see coming through. That has led us to run with a little bit higher RBC than what, than the 400%. But, we are at a point in time now where I would expect us, over the next couple of years to really get down to that 400% level long term.
Joel Hurwitz (Lead Analyst, Life Insurance & Retirement Services Research)
Okay. And do you expect that to be driven by the needs for growth, or do you expect to actually draw that down with outsized dividends to the hold co?
Max Brodén (SEVP and CFO)
The preferred option would be to drive it by growth because that's where we're getting the best returns on our capital by just writing more policies. At the same time, even though we have some lines of business that are consuming a little bit more capital, overall, we're a relatively capital-light business. So I, given that we're operating at a 650% RBC right now, I don't see that growth alone will necessarily drive us all the way down to 400%. In order to do so, we probably would, over time, need to address our capital base through special dividends, et cetera.
Joel Hurwitz (Lead Analyst, Life Insurance & Retirement Services Research)
Okay, thank you.
Operator (participant)
This concludes our question and answer session. I would like to turn the conference back over to David Young for any closing remarks.
David Young (VP of Capital Markets)
Thank you, Anthony, and thank you all for joining us this morning. While we're not hosting our financial analyst briefing this year, we will be in 2024, but we will also be giving an outlook for 2024 on our fourth quarter 2023 earnings call. In the interim, please reach out to the investor and rating agency relations team if you have any questions, and we look forward to speaking to you then. Everyone, have a great day. Thank you.