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A Lesson in Hedging

merchandise aflac

A Lesson in Hedging

Who doesn’t love that Aflac duck? In the insurance world, the Aflac duck is on an island (or a marshland, perhaps) of its own. The Michael Jordan of mascots, the American Pekin duck has been a staple with the Georgia insurance firm for over 20 years. While Aflac and its feathery companion appear as American as apple pie, a little-known fact about the insurer is it generates nearly 70% of annual income not in the States, but in Japan. 

One of the most difficult jobs of running a multinational is currency hedging. International business typically involves more than one currency, and to mitigate the impact of foreign exchange risk, Chief Financial Officers (CFOs) engage in hedging. Aflac is no different, and while the yen is currently sitting at a two-decade low against the dollar, the company’s hedging program has implemented some novel strategies that are garnering attention outside of just insurance. 

The Aflac strategy is grounded in three areas. The first is a dollar-denominated portfolio that is part of the fully owned Japanese subsidiary. This investment portfolio held approximately $26 billion in assets as of April 2022. The second is yen-denominated debt – roughly $4.5 billion to be exact. This debt is held by the US holding company and represents nearly 60% of Aflac’s total debt. The debt is marketed to Japanese investors and when the yen declines, the dollar also loses value. Aflac’s leverage decreases whenever the yen depreciates, but when this occurs Aflac can take on additional debt to invest back into the company over time. 

Third, Aflac has structured $5 billion in forward contracts. This gives them the room to convert yen to dollars on specific dates at specific rates. The contracts are designed to be long on the dollar and short on the yen. When the yen depreciates the value of the forwards increase. Disbursed over a 2-year period (24 months), once existing contracts expire they immediately open new ones. Moreover, there are also forward contracts flowing in the opposite direction – converting dollars into yen at present rates. Yet, the cost of this hedge (dollar to yen) has gone up principally due to interest rate differences in Japan and the US. 

Aflac registered $5.3 billion in revenue and net earnings of $1.03 billion during the first quarter of 2022. The average exchange rate between the yen and dollar was 8.9% weaker than in 2021. Sales volumes are down compared to pre-pandemic, but this is a reality across most industries. The currency exchange certainly reduced first-quarter earnings, but on a macro level, the company is considered to be very well hedged. 

A significant number of Aflac’s investors are US based. As such, converting their Japanese earnings to dollars is a reality. Aflac’s CFO does not rule out expanding on its 3-point strategy. Currency fluctuations are impossible to predict. At the end of the day, smoothing volatility is the name of the game.