ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Citizens, Inc. ("Citizens") operates primarily as an insurance holding company. It was incorporated in 1977. Citizens is the parent holding company that directly or indirectly owns 100% of Citizens Insurance Company of America ("CICA"), Computing Technology, Inc. ("CTI"), Insurance Investors, Inc. ("III"), Funeral Homes of America ("FHA") (formerly Funeral Homes of Louisiana), Central Investors Life Insurance Company of Illinois ("CILIC"), United Security Life Insurance Co. ("USLIC") and National Security Life and Accident Insurance Company ("NSLIC"). Collectively, Citizens and its subsidiaries are referred to herein as the "Company." Pertinent information relating to Citizens' subsidiary companies is set forth below:
On October 28, 1996, CICA announced that it had signed a definitive written agreement for the acquisition of American Investment Network, Inc. (AIN), a life insurance holding company headquartered in Jackson, Mississippi with $7.5 million in assets, $3.4 million of stockholders' equity, revenues of $3.2 million and $67 million of life insurance in-force. Following the acquisition by CICA, AIN shareholders received 1 share of Citizens, Inc. Class A Common Stock for each 7.2 shares of AIN Common Stock owned. The transaction closed on June 19, 1997. Citizens issued approximately 700,000 Class A shares in connection with the transaction, which was accounted for as a purchase.
On October 31, 1996, CICA, CICA Acquisition, Inc. (a subsidiary organized for purposes of the transaction) and First American Investment Corporation ("FAIC"), a holding company entered into a merger agreement for the merger of CICA Acquisition, Inc. into FAIC. Prior thereto, Citizens had indirectly owned approximately 94.5% of FAIC. As part of this merger, CICA acquired the approximately 5.5% of FAIC shares owned by minority investors at an exchange rate of 0.1111 shares of Class A Common Stock for each 1 share of FAIC owned by minority investors. The merger became effective March 7, 1997, and Citizens issued
approximately 134,000 shares of Class A Common Stock in this transaction which was accounted for as a purchase. Subsequently, FAIC was liquidated.
To streamline its corporate structure, Citizens and American Liberty Financial Corporation ("ALFC"), a wholly-owned subsidiary holding company, entered into a merger agreement dated November 22, 1996 for the merger of ALFC into Citizens. No shares of Citizens were issued in the merger which became effective in January 1997. Also on November 22, 1996, CICA and American Liberty Life Insurance Company ("ALLIC"), a subsidiary of ALFC, entered into a merger agreement for the merger of ALLIC into CICA. These agreements closed in June, 1997.
Pursuant to a Stock Purchase Agreement, Citizens purchased from Jansen Enterprises, Inc., a Texas corporation, 100% of the issued and outstanding shares of National Security Life and Accident Insurance Company (NSLIC) for $1,700,000, consisting of $1,000,000 cash and restricted shares of Citizen's Class A Common Stock valued at $700,000 in a transaction that closed on November 20, 1997. NSLIC is a Texas-domiciled life and accident and health insurer with assets of approximately $5 million and revenues of approximately $5 million.
On September 10, 1998, Citizens entered into an agreement with First Investors Group, Inc. (Investors) of Springfield, Illinois to acquire 100% of the outstanding preferred and common shares of Investors for shares of Citizens' Class A Common stock. Investors is the parent of Excalibur Insurance Corporation, also of Springfield, Illinois. Pursuant to the agreement which closed on January 26, 1999, Citizens issued approximately 610,000 shares to holders of Investors preferred and common stock.
Certain statements contained in this Annual Report on Form 10-K are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the "Act"), including, without limitation, the italicized statements and the statements specifically identified as forward-looking statements within this document. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements, include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of plans and objectives of the Company or its management or Board of Directors including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted", "may", "will" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from those in such statements. Factors that could cause
actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) the strength of foreign and U.S. economies in general and the strength of the local economies in which operations are conducted; (ii) the effects of and changes in trade, monetary and fiscal policies and laws; (iii) inflation, interest rates, market and monetary fluctuations and volatility; (iv) the timely development of and acceptance of new products and services and perceived overall value of these products and services by existing and potential customers; (v) changes in consumer spending, borrowing and saving habits; (vi) concentrations of business from persons residing in third world countries; (vii) acquisitions; (viii) the persistency of existing and future insurance policies sold by the Company and its subsidiaries; (ix) the dependence of the Company on its Chairman of the Board; (x) the ability to control expenses; (xi) the effect of changes in laws and regulations (including laws and regulations concerning insurance) with which the Company and its subsidiaries must comply, (xii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xiii) changes in the Company's organization and compensation plans; (xiv) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (xv) the success of the Company at managing the risks involved in the foregoing.
Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events.
(b) FINANCIAL INFORMATION REGARDING THE INSURANCE BUSINESS
Citizens, through CICA, USLIC, NSLIC and CILIC, operates principally in two business segments, that of selling selected lines of individual life and accident and health ("A&H") insurance policies in domestic and international markets. Except for certain insignificant operations, Citizens has no present intention to engage in any non-insurance related business. The following tables set forth certain statistical information concerning the operations of the Company for each of the five years ended December 31, 1998 The information is presented in accordance with generally accepted accounting principles.
TABLE I
The following table sets forth (i) life insurance in-force and (ii) mean life insurance in-force.
- --------------------------------- (a) In thousands (000s) (b) Before ceding reinsurance to reinsurers.
The increases in insurance in-force as shown above reflect the volumes of new business written by the Company over the past five years. Approximately $40,243,000 of the 1995 increase relates to the acquisition of ALLIC in 1995, while $96,803,000 of the 1997 increases resulted from the acquisitions of USLIC and NSLIC.
TABLE II
The following table sets forth (i) the ratio of lapses and surrenders to mean life insurance in-force and (ii) life reinsurance ceded.
- --------------------------------- (a) In thousands (000s) (b) Approximately 95% of the reinsurance is yearly renewable term insurance, with the remainder being coinsurance. Premiums reflect both life and accident and health business.
The increased lapsation during 1996 reflects the inclusion of the ALLIC insurance business. The increase in ceded premium in 1998 is due to the cession of a substantial portion of the major medical accident and health business of NSLIC.
TABLE III
The following table sets forth information with respect to total insurance premiums.
- --------------------- (a) After deduction for reinsurance ceded.
Premium income has grown substantially due to the volume of new business written each year, as well as the acquisitions. However, new sales of life insurance decreased in 1995, and remained at similar levels in 1996 and 1997; therefore, the overall increase since 1995 is less than for previous years. The acquisition of ALLIC mitigated the total decline in new life insurance sales, although only three months of ALLIC's premiums are reflected in the above table for 1995. Much of the 1998 increase relates to the acquisition of USLIC and NSLIC.
TABLE IV
The following table sets forth information relating to the ratio of underwriting and other expenses to insurance revenues.
- ------------------------- (a) After premiums ceded to reinsurers.
Prior to 1996, the ratios of expenses to premiums had declined each year since 1989. These declines are the result of three factors: 1) underwriting and operating expenses have generally not increased at the same rate as premium income due to the Company's efficient method of operation; 2) sales commissions as a percentage of total premium income are declining annually as the business enters renewal stages and commissions are paid at a lower rate than the first year; and 3) the amount of new insurance written annually represents a smaller percentage of the Company's total premium income. However, in 1996, with the addition of ALLIC and the
considerable expense associated with its marketing operation start-up, the ratio reached its highest level since 1993. Following the merger of ALLIC in 1997, significant reductions in operating expenses were realized. The 1997 acquisitions and their related conversion expenses as well as increases in accident and health benefits were the primary reasons for the 1998 increase.
TABLE V
The following table sets forth changes in new life insurance business produced between participating and nonparticipating policies.
- ----------------------------- (a) In thousands (000s)
The percentage of the new business produced that was participating prior to 1995 increased steadily due to the fact that the Ultra Expansion products were all participating and represented the majority of new business throughout the mid 1990's. The decline in new business during 1995 was caused in part by disruptions in the international market. The decrease in non-participating business in 1997 results from sales by USLIC and NSLIC, which sell only non-participating policies. The significant change in 1998 is due to the volume of credit life business produced by NSLIC that is non-participating. See Management's Discussion and Analysis.
TABLE VI
The following table sets forth changes in new business issued according to policy types.
- ----------------------------- (a) In thousands (000s)
This table illustrates that most of the new business written prior to 1997 is whole life. The 1995 results reflect a decrease in new life business during the year, as does 1997. Most of the 1998 increase is due to the credit life business sold by NSLIC.
TABLE VII
The following table sets forth deferred policy acquisition costs capitalized and amortized compared to new business issued.
In 1994, the rate of capitalization was affected by an adjustment due to the lower interest environment. The amortization of these costs has grown as the aggregate deferred acquisition cost asset has increased. In 1996, this amortization increased due to the increase in surrender activity. The decrease in costs capitalized for 1995 and 1997 reflects the reduction in the amount of new business produced and lower commission expenses incurred as a result thereof. In 1996, new business increased; however, the increase in capitalized costs was not as high due to changes in the commission structure of the Company. The decrease in the 1998 figures is a result of the shift in the business mixture to more A&H as well as lower new production in life business compared to previous years.
TABLE VIII
The following table sets forth investment results.
- --------------------- (a) The year 1996 includes assets acquired from CILIC on March 12, 1996. The year 1997 includes assets acquired from NSLIC and USLIC. The year 1995 includes assets acquired from ALLIC on September 14, 1995. (b) Does not include realized and unrealized gains and losses on investments.
Available yields began to increase in mid-1994 and the Company was able to obtain a slight growth in the return on invested assets. This growth continued throughout most of 1995, and continued through 1996. The Company hired an investment advisor in 1995, and this action contributed to the increased yield in 1996. Significant decreases in yields in the bond market caused the return on invested assets to drop slightly in 1997 and continued throughout 1998.
(c) NARRATIVE DESCRIPTION OF BUSINESS
(i) BUSINESS OF CITIZENS
Citizens' principal business is ownership of CICA and NSLIC and their affiliates. Additionally, it provides management services to these companies under management services agreements. At December 31, 1998, Citizens had approximately 85 full and part-time employees.
(ii)BUSINESS OF CICA
Historically, CICA's revenues have been derived from insurance premiums and revenues from investments. CICA is a Colorado-domiciled life insurance company marketing primarily ordinary whole-life products on an international basis through marketing companies. Additionally, it offers specialty life and individual accident and health policies to United States residents. During the fiscal year ended December 31, 1998, 93.2% of CICA's premium income was attributable to life, endowment and term insurance, 0.4% to individual annuities, and 6.4% to accident and health insurance. During the fiscal year ended December 31, 1997, 92.5% of CICA's premium income was attributable to life, endowment and term insurance; 0.5% to individual annuities; and 7.1% to accident and health insurance. Of the life policies in force at December 31, 1998 and 1997, 39.6% and 34.4%, were nonparticipating and 60.4% and 65.6%, respectively were participating. The change in participating policies as a percentage of total results from the ALLIC merger in 1997.
From 1987 to 1997, CICA offered its Ultra Expansion products, a series of participating whole life policies targeted for international markets. All of the Ultra products were participating with dividends ranging from 2% of the premium in the first year to 123% in the 20th year. Beginning January 1, 1998, CICA introduced its Millennia 2000 series of policies as a replacement for the Ultra Expansion plans. The ten plans that make up the Millennia Series are, like the Ultra Expansion plans, designed for the international market and maintain many of the features of the Ultra series, with several new enhancements. These enhancements include terminal illness protection as well as dismemberment provisions.
Additionally, following the merger with ALLIC, CICA began offering specialty individual accident and health products as well as ordinary whole life policies to residents of the United States. The sale of these products is focused in Oklahoma, Louisiana and Mississippi.
The CICA underwriting policy requires a medical examination of applicants for ordinary insurance in excess of certain prescribed limits. These limits are graduated according to the age of the applicant and the amount of insurance. Generally, the maximum amount of ordinary life insurance issued domestically
without a medical examination is $200,000 for ages 0 through 35; $100,000 for ages 36 through 45; $50,000 for ages 46 through 50; $15,000 for ages 51 through 55; and $10,000 for ages 56 and over. Limits for insuring non-United States applicants without a medical examination are: $150,000 for ages 0 through 39; $50,000 for ages 40 through 65; and all amounts over age 65. The accident and health policies sold in the U.S. have only minimal, field underwriting.
On life policies, CICA's maximum coverage on any one life is not limited by company policy. However, CICA reinsures the amount of coverage which is in excess of its retention policy. See "Business of CICA - Reinsurance." CICA does not accept substandard risks above Table 6 (generally policyholders who cannot qualify for standard ordinary insurance because of past medical history) in exchange for which CICA would charge higher premiums.
CICA has $24.5 million of insurance in-force on individuals that are classified as substandard risks, the majority of such business having been acquired in the purchase of other companies. Management believes the exposure to loss as a result of insuring these individuals is minimal, since the premiums are increased to cover the nature of the risk, additional reserves are established, and the amount of insurance represents less than 1.0% of the total insurance in-force.
GEOGRAPHICAL DISTRIBUTION OF BUSINESS
For the year ended December 31, 1998, insurance policies held by residents of Oklahoma accounted for 5.5% of CICA's total premium income from direct business, policies held by residents of the Texas accounted for 3.2% of premium income from direct business, policies held by residents of Louisiana accounted for 1.2% of premium income from direct business for the same period. All other states of the United States totaled 6.3% of the premium income from direct business with no single state, except as set forth above, accounting for as much as 1% of premium income. Business on foreign residents accounted for 83.3% of premium revenue in 1998. For the year ended December 31, 1997, residents of Oklahoma accounted for 6.2% of CICA's total premium income, residents of Texas accounted for 2.7%, Louisiana, 1.5% and Colorado, 1%. No other state in the U.S. amounted to 1% of total premium income during the period. Business on foreign citizens represented 82.9% of 1997 premium income. For the year ended December 31, 1996, residents of Oklahoma accounted for 7.0% of CICA's total premium income, residents of Texas accounted for 3.0%, Mississippi, 2.3%, Louisiana, 1.6% and Georgia, 1.1%. No other state in the U.S. amounted to 1% of total premium income during the period. Business on foreign citizens represented 81.0% of 1996 premium income. The increase in domestic business as a percentage of total premium income in 1997 results from the above-described merger of ALLIC into CICA during the year.
The participating whole life policies accepted by CICA on high net worth residents of foreign countries have an average face amount of approximately
$70,000 and are marketed primarily to the top 5% of the population in terms of household income.
CICA accepts applications for international insurance policies marketed by several independent international firms with whom CICA has nonexclusive consulting contracts. These firms market life insurance products to citizens of foreign countries. Such life products are specially designed by CICA to be compatible with marketing methods and commission requirements.
The international firms have many years' experience marketing life insurance products for CICA. The contract with the consultants provides that they have the responsibility for recruiting and training salesmen. They are responsible for all of their overhead costs and bear the expense of awards. These firms guarantee any debits of marketers and their associates. In consideration for the services rendered, the marketing consultants receive a fee on all new policies placed by them or their associates. See "Business of CICA Commissions." The marketing contracts may be terminated for various causes, at any time by mutual consent of the parties or upon 30 days' notice by either party.
These firms provide recruitment, training and supervision of their managers and associates in the placement of dollar-denominated life insurance products; however, all consultants and associates contract directly with CICA and receive their compensation from CICA. Accordingly, should the consulting arrangement between any firm and CICA be canceled for any reason, CICA believes it could continue suitable marketing arrangements with the individuals of the consulting firms without appreciable loss of present and future sales, as it has done in the past. There is, however, always a risk that sales could decrease.
At present, CICA is dependent on the non-U.S. markets for a large percentage of its new life insurance business. This subjects CICA to potential risks with regard to the continued ability to write such business should adverse events occur in the countries from which CICA receives applications. These potential risks include lapses of policies if funds that flow out of such countries were to become restricted. Based on more than 30 years experience in the marketplace in which CICA competes, management believes such risks are not material. CICA maintains no assets outside the U.S. and requires all premiums to be paid in the U.S. with U.S. dollars via drafts drawn on banks in the U.S.; therefore, it could lose no funds from currency devaluation or foreign appropriation. Many of the inherent risks in foreign countries, such as political instability, hyper-inflation and economic disruptions tend to improve rather than hurt CICA's business because it encourages individuals to convert assets out of local currencies to the more stable U.S. dollar.
MARKETING OPERATIONS
CICA holds licenses to do business in 15 states and accepts applications from numerous foreign countries. Additionally, CICA has applications for admission pending in two states. CICA's operations are conducted on the independent contractor basis, with a sales force at December 31, 1998 of 615 individuals, 777 individuals at December 31, 1997 and 1,319 individuals at December 31, 1996. The decrease in marketing consultants in 1997 reflects the termination of all individuals who had not produced in the last twelve months, a practice that had not been enforced in several years. The further decline in 1998 reflects the loss of former ALLIC sales representatives described below.
COMMISSIONS
CICA's marketing managers are independent contractors, responsible for their respective expenses, and are compensated on a percentage of premium basis. Percentage amounts paid to salesmen on individual term, annuity and accident and health insurance are substantially less than the levels paid for individual ordinary life insurance. The marketing managers receive overriding first year and renewal commissions on business written by individuals under their supervision and all marketing expenses related thereto are included in the above percentages.
RESERVES
CICA establishes actuarial reserves as liabilities to meet obligations on all outstanding policies. Reserves and deferred acquisition costs are prepared in conformity with the American Academy of Actuaries Committee on Financial Reporting Principles and generally accepted accounting principles. In determining such reserves CICA used the 1955 to 1960, 1965 to 1970, and 1975 to 1980 Select and Ultimate Mortality Tables with interest rates at 4% or in a range graded from 9% to 5% with recent issues reserved at 7% graded to 6 1/2%. Withdrawal assumptions are based primarily on actual historical experience. Statutory reserves are used for paid-up life business. Claims reserves include an amount equal to the expected benefit to be paid on reported claims in addition to an estimate of claims that are incurred but not reported, based on actual historical experience. CICA receives an independent actuarial certification of its reserves prepared in accordance with both Generally Accepted Accounting Principles and Statutory Accounting Principles. The certifications have noted no deficiencies for the years presented herein.
` REINSURANCE
CICA assumes and cedes insurance with other insurers, reinsurers and members of various reinsurance pools. Reinsurance arrangements are utilized to provide greater diversification of risk and minimize exposure on larger risks.
(a) INSURANCE CEDED
CICA generally retains $75,000 of risk on any one person. As of December 31, 1998, the aggregate amount of life insurance ceded amounted to $278,277,000 or 9.7% of total direct and assumed life insurance in force, and $281,400,000 or 13.1% in 1997. CICA is contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations reinsured.
As of December 31, 1998, CICA had in effect automatic reinsurance agreements that provide for cessions of ordinary insurance from CICA. Additionally, CICA has reinsurance treaties in force with several reinsurers of life and accident and health insurance. These treaties provide for both automatic and facultative reinsurance of standard and substandard risks ceded to them by CICA for life, accident and health and supplemental benefits above CICA's retention limit on a yearly renewable term, coinsurance or modified coinsurance basis.
Treaties with Employers Reassurance (ERC) and Businessmen's Assurance ("BMA") historically have been the primary vehicles utilized by CICA for its international business. The treaties are structured in such a way as to allow CICA to "self administer" the cessions on a reduced cost basis. During 1995, a third carrier was added as a principal reinsurer, Riunione Adriatica di Sicurta, of Italy (RAS).
The ERC and BMA agreements provide that for risks reinsured in specified countries, 70% of each risk in excess of CICA's retention will be ceded to ERC and 30% to BMA. The RAS agreement provides that on risks reinsured in specified countries, 100% of the risk in excess of CICA's retention will be ceded to RAS. CICA pays premiums to ERC, BMA and RAS on an annual basis and is responsible for the production of the reporting monthly and annually to ERC, BMA and RAS to allow proper accounting for the treaties.
The cessions are on a yearly renewable term basis and are automatic up to $333,333 for ERC, $500,000 for RAS and $166,667 for BMA at which point the reinsurance is subject to a facultative review by the reinsurers. At December 31, 1998, CICA had ceded $168,365,000 in face amount of insurance to ERC, $26,178,000 to BMA and $75,343,000 to RAS under these agreements.
RAS is an unauthorized reinsurer in the state of Colorado; however, RAS has agreed to comply with Colorado statutes regarding such companies. Under these statutes, RAS will provide a letter of credit, issued by a U.S. bank meeting the Colorado requirements, equal to any liabilities it incurs under this agreement.
A reinsurance treaty with Connecticut General Life Insurance Company (CG) covers all of CICA's accidental death insurance supplementing its life insurance policies. These cessions are on a yearly renewable term basis and occur automatically if total accidental death benefits known to CICA are less than $250,000 or otherwise on a facultative review basis. At December 31, 1998,
CICA had ceded $1,273,000,000 in face amount of business to CG under this treaty.
CICA monitors the solvency of its reinsurers to minimize the risk of loss in the event of a failure by one of the parties. The primary reinsurers of CICA are large, well capitalized entities which have no current or prior history of financial difficulty.
(b) INSURANCE ASSUMED. At December 31, 1998, CICA had in-force reinsurance assumed as follows:
The reinsurance agreement with Prudential provides for CICA to assume a portion of the insurance under a group insurance policy issued by Prudential to the Administrator of Veterans' Affairs. CICA's portion of the total insurance under the policy is allocated to CICA in accordance with the criteria established by the Administrator. The agreement continues in full force and effect at December 31, 1998.
CICA has also entered into a Serviceman's Group Life Insurance Conversion Pool Agreement with Prudential, under the above described agreement, whereby CICA assumed a portion of the risk of Prudential under the group policy due to excess mortality under the conversion pool agreement resulting from issuing conversion policies as prescribed for membership in the conversion pool.
INVESTMENTS
State insurance statutes prescribe the quality and percentage of the various types of investments which may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, real estate and mortgage loans by certain specified percentages. CICA's invested assets at December 31, 1998 were distributed as follows: fixed maturities - 86.3%, equity securities - 0%, mortgage loans - 0.9%, policy loans - 12.7%, government insured student loans - 0%, short-term investments - 0% and other long-term investments - 0.1% (see Note 2 of the "Notes to Consolidated Financial Statements"). CICA did not foreclose on any mortgage loans in 1998. All mortgage loans are supported by independently appraised real estate. The investment policy of CICA with regard to mortgage loans is consistent with the provisions of the Colorado Insurance Code.
At December 31, 1998, 85.1% of CICA's investments in fixed maturities were comprised of U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities, compared to 85.7% at December 31, 1997. Of these mortgage-backed securities, all were guaranteed by U.S. government agencies or corporations that are backed by the full faith and credit of the U.S. government or that bear the implied full faith and credit of the U.S. government.
REGULATION
CICA is subject to regulation and supervision by the insurance department of each state or other jurisdiction in which it is licensed to do business. These departments have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of marketing persons, the approval of policy forms, the advertising and solicitation of insurance, the form and content of mandatory financial statements, the reserve requirements, and the type of investments which may be made. CICA is required to file detailed annual reports with each such insurance department, and its books and records are subject to examination at any time. In accordance with state laws and the rules and practices of the National Association of Insurance Commissioners, CICA is examined periodically by examiners of its domiciliary state and by representatives (on an "association" or "zone" basis) of the other states in which it is licensed to do business. An examination began in late 1997 and concluded in 1998 for the five years ended December 31, 1996, by a public accounting firm under contract with and supervision by the Colorado Division of Insurance. CICA is audited annually by an independent public accounting firm.
Various states, including Colorado, have enacted "Insurance Holding Company" legislation which requires the registration and periodic reporting by insurance
companies which control, or are controlled by, other corporations or persons. Under most of such legislation, control is presumed to exist with the ownership of 10% or more of an insurance company's voting securities. CICA is subject to such regulation and has registered under such statutes as a member of an "insurance holding company system." The legislation typically requires periodic disclosure concerning the transactions between the registered insurer, the ultimate controlling party, and all affiliates and subsidiaries of the ultimate controlling party, and in many instances requires prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system.
Since CICA does not physically conduct business in countries outside the U.S. but rather accepts applications from overseas marketers, it is not subject to regulation in countries where most of its insureds are residents. The prospect of such regulation is viewed as remote by management of CICA because obtaining insurance through application by mail outside of one's country is a common practice in many foreign countries, particularly those where CICA's insureds reside.
COMPETITION
The life insurance business is highly competitive, and CICA competes with a large number of stock and mutual companies. CICA believes that its premium rates and its policies are generally competitive with those of other life insurance companies, many of which are larger than CICA, selling similar types of insurance.
CICA's marketing plan stresses making available dollar-denominated life insurance products available to high net worth individuals residing in foreign countries and the sale of individual, whole life and supplemental accident and health products to United States residents. A large percentage of CICA's first year and renewal life insurance premium income during 1997 and 1998 came from the international market. See "Business of CICA - Geographical Distribution of Business." Management believes CICA to be a significant competitor in the international market and attributes its success in penetrating that market to the expertise of management, the uniqueness of its life insurance products and competitiveness of its pricing methods.
CICA faces offshore competition from numerous American life insurance companies that also sell U.S. dollar denominated policies to non-U.S. citizens, with no one company being dominant in the market. Some companies may be deemed to have a competitive advantage due to histories of successful operations and large agency forces. Management believes that its experience, combined with the special features of its unique policies, allows CICA to compete effectively in pursuing new business.
Management believes that CICA competes indirectly with non-U.S. companies, particularly with respect to Latin American companies. CICA, as a U.S. domestic insurer paying claims in U.S. dollars in the U.S., has a different clientele and product than foreign-domiciled companies. CICA's product is usually acquired by persons in the top 5% of income of their respective countries. The policies sold by foreign companies are sold broadly and are priced based on the mortality of the entire populace of the respective geographic region. Because of the predominance of lower incomes in most of these countries, the mortality experience tends to be very high on the average, causing mortality charges which are considered unreasonable based on the life mortality experience of the upper five percent of income of the population.
Additionally, the assets that back up the policies issued by foreign companies are invested in the respective countries, and thus, are exposed to the inflationary risks and economic crises that historically have impacted many foreign countries. Another reason that CICA experiences an advantage is that many of its policyholders desire to transfer capital out of their countries due to the perceived financial strength and security of the United States by foreigners. Also, CICA competes indirectly with other U.S. and European insurers in countries where CICA's insureds reside. CICA's experience has been that its market niche is in attracting insureds who want the safety and security of a U.S. domestic insurer. Management of CICA considers it to be difficult and speculative to estimate the potential of the foreign market for U.S. insurers. However, based upon the volume of new premium generated by CICA that originates from many countries in Latin America, management believes that CICA receives a substantial share of such business. However, CICA does not have market share data to confirm management's belief.
In CICA's block of accident and health insurance (6.5% of total premium income), it is in competition with many insurance companies as well as with voluntary and government-sponsored plans for meeting hospitalization and medical expenses such as Blue Cross/Blue Shield, "Medicare" and "Medicaid." Future expansion of such programs or the establishment of additional government health programs could adversely affect the future of accident and health insurance on CICA's books, most of which has been acquired in the acquisition of other companies.
FEDERAL INCOME TAXATION
CICA is a "small company" as that term is defined in the Internal Revenue Code (the "Code"), section 806. As such, CICA qualified for a special small company deduction (presently equal to 60% of "tentative life insurance company taxable income") which serves to decrease significantly the amount of tax which might otherwise have to be paid.
The Omnibus Reconciliation Act of 1993 (the "1993 Act") was signed into law on August 10, 1993. Among its provisions was an increase to corporate tax rates to 35% on taxable income between $10,000,000 and $15,000,000 and to 38% on taxable income between $15,000,000 and $18,300,000. This legislation had no material impact on the financial position of the Company.
The Revenue Reconciliation Act of 1990 revised the method in which insurance companies claim deductions for policy acquisition costs. Previously, insurance companies were allowed to deduct actual policy acquisition costs as they were incurred. Beginning in 1990, policy acquisition costs are determined as a percentage of annual net premiums and are then deductible on a straight-line basis over a ten-year period rather than treated as an immediate deduction. This change in treatment for acquisition costs has had a significant impact on CICA's taxable income due to the relatively large amounts of such deferrals caused by the increases in new business.
CICA files a consolidated Federal income tax return with Citizens and its subsidiaries.
(iii) BUSINESS OF CTI
CTI is a wholly-owned subsidiary of CICA and engages in the business of providing data processing services and acquisition and leasing of furniture and equipment for its parent as well as data processing services and software to other companies. Pursuant to an Information Systems Management and Services Contract dated October 1, 1991, CTI provides data processing services to the Company for a fixed fee of $53,000 per month. In August, 1997, this fee was increased to $85,000 per month to reflect the growth in the Company's business. As of and for the year ended December 31, 1998, CTI's total assets were $933,000 and revenues were $1,057,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements.
(iv) BUSINESS OF III
In August, 1993, Citizens sold the stock of III to CICA for its book value. CICA subsequently contributed debit balances receivable of approximately $169,000 to III. III collected such receivables and, as additional consideration, received an airplane which it operates for Citizens and CICA. As of and for the year ended December 31, 1998, III's total assets were $1,250,000 and revenues were $770,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements.
(v) BUSINESS OF USLIC
USLIC is a Mississippi-domiciled life and accident and health insurer offering whole life products and specialty accident and health products to residents of the
Southeastern United States. USLIC is licensed in the states of Alabama, Arizona, Arkansas, Georgia, Indiana, Louisiana, Mississippi, New Mexico, Oklahoma, Tennessee and Texas.
As of December 31, 1998, USLIC had $34,243,000 of life insurance in force, of which $21,319,000 was reinsured and $12,924,000 retained. The maximum retention by USLIC on any one life for life insurance policies is $20,000. All of the accidental death benefit coverage is reinsured.
USLIC historically offered customary forms of life insurance, including non-participating whole life, decreasing term, level term policies, supplementary health policies and a participating whole life policy. Its leading life policy in the past has been the "Lifetime Accumulator," a participating whole life insurance policy. This policy differs from the usual offering of life insurance in that the premium is uniform but the amount of insurance varies by the age of the proposed insured. The product was sold, therefore, in premium units rather than in face amount units. While this policy was written only on persons at ages 0 - 40, other life insurance products were offered at ages 0 - 70.
Since 1994, USLIC has developed several new supplementary health insurance products, i.e., cancer, hospital indemnity, mental illness, outpatient sickness, catastrophic illness, emergency accident, intensive care and disability income and Medicare supplement. Premiums are employer paid or paid through payroll deduction. USLIC can issue life insurance on a rated premium substandard basis up through Table 16 (400% extra mortality), but in so doing it will reinsure all of the risk. USLIC only issues through Table 4 (100% extra mortality) on its Lifetime Accumulator policy to improve the mortality and potential profitability on that product line. The substandard risks are those that by reason of health, occupation or avocation fall outside the normal anticipated mortality levels of the general population as developed by the actuarial sciences. It reinsures all of its accidental death risk. USLIC also has a reinsurance agreement on its cancer policy which limits its claim risk to $25,000 in any calendar year on any one claim. It also reinsures various amounts on several other health products.
USLIC's selling efforts are not usually concentrated on any one economic, occupational, hazard or age group. The marketing territory is Alabama, Arkansas, Louisiana, Mississippi, Oklahoma, Tennessee and Texas. USLIC's products are generally competitive with those of other insurers in those states.
USLIC's policies are being sold by direct licensed representatives and licensed general agents. None of these agents has underwriting authority. The commissions paid are believed by management to be competitive with commissions paid by other life insurance companies in the states in which USLIC is licensed to operate. USLIC is aware that there is considerable competition for obtaining qualified agents and that it will be competing with well-established life insurance companies for agents to sell its policies. USLIC will also recruit agents
from among persons who are not now engaged in the selling of life and accident and health insurance, and USLIC expects to train such agents. USLIC presently has approximately 300 licensed agents. The agents recruited and licensed by USLIC hold licenses with other companies and possibly could sell other companies' policies that are similar in some respects to USLIC's policies. This arrangement is quite common with companies that recruit and license general agents.
Through 1993, USLIC had written primarily the Lifetime Accumulator, which accounted for approximately 98% of premium income. From late 1993 through 1996, USLIC shifted its marketing thrust to non-participating ordinary life products and supplementary accident and health and group dental products. In 1997 and 1998, virtually all sales were supplemental accident and health or group dental products. For 1998, 12.5% of premium income was from life policies and 87.5% was from accident and health policies, and in 1997, 22.8% of premium income was from life products, and 77.2% from accident and health.
INVESTMENTS
USLIC invests and reinvests certain of its reserves and other funds. The investments of USLIC are limited as to type and amount by the Mississippi insurance laws which are designed to insure prudent investment policies.
The investment of capital, paid-in and operating surplus and other funds of insurers organized under the laws of the State of Mississippi is specified by the Mississippi Insurance Code. This statute includes general and specific limitations on investments, records of investments and other matters. The Mississippi insurance law regulating investments and other aspects of the management of insurance companies is designed primarily for the protection of policyholders rather than investors.
The administration of USLIC's investment portfolio is handled by the same outside investment manager as CICA's, with all trades approved by a committee of the Board of Directors. The guidelines used require that bonds, both government and corporate, are of high quality and comprise a majority of the investment portfolio. The assets selected are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for USLIC to meet its policyholder obligations. The type, quality and mix will enable USLIC to compete in the life insurance marketplace and to provide appropriate interest margins.
USLIC has classified all its investments as securities available-for-sale which are carried at fair value.
REINSURANCE
As is customary among insurance companies, USLIC will reinsure with other companies' portions of the life insurance risks it will underwrite. The primary purpose of reinsurance agreements is to enable the company to reduce the amount of its risk on any particular policy and, by reinsuring the amount exceeding the maximum amount the insurance company is willing to retain, to write policies in amounts larger than it could without such agreements. Even though a portion of the risk may be reinsured, USLIC will remain liable to perform all obligations imposed by the policies issued by it and is liable if its reinsurer should be unable to meet its obligation under the reinsurance agreements. USLIC's general policy is to reinsure business with insurance companies with an A.M. Best and Company rating of "A" or better.
USLIC's life reinsurance is being ceded through automatic and facultative treaties with two unaffiliated insurance companies, Businessmen's Assurance Company, Kansas City, Missouri, and Optimum Re Insurance Company, Dallas, Texas. At December 31, 1998, USLIC had ceded to BMA, $9,992,000 in face amount, and $11,327,000 to Optimum Re. It is the practice of USLIC to reinsure all accidental death benefit risks that are written. USLIC has a reinsurance agreement with Reliastar Financial Corporation, Minneapolis, Minnesota, providing coverage of claims in excess of various amounts on several of USLIC's accident and health policies. Approximately $336,000 in premiums were ceded under this treaty in 1998.
RESERVES
USLIC has set up actuarially computed reserves as liabilities to meet the obligations on the policies it writes. These reserves are the amounts which, with additions from premiums to be received and with interest in such reserves, compounded annually at certain assumed rates, are calculated to be sufficient according to accepted actuarial principles to meet policy obligations as they mature. The various actuarial factors are determined from mortality tables and interest rates in effect when the policies are issued. The reserves to be included in statutory filings will be valued on a basis that meets the requirements of law in Mississippi. USLIC receives an independent actuarial certification of its reserves prepared in accordance with both GAAP and statutory practices.
REGULATION
Mississippi insurance laws and regulations generally govern the accounting practices and prescribe the procedures and forms for financial reports of insurance companies prepared on a statutory accounting basis and filed with the Insurance Department. Reports prepared in accordance with the prescribed or permitted statutory accounting practices are primarily intended to insure the ability of an insurance company to meet its obligations to policyholders and do not necessarily reflect going concern value. Balance sheets prepared in accordance with statutory accounting practices are designed primarily to reflect the financial position of
insurance companies from the standpoint of solvency. Certain of the prescribed or permitted accounting practices differ in some respects from generally accepted accounting principles followed by other business enterprises in determining financial position and results of operations.
The insurance laws of Mississippi also provide that a life insurance company will be assessed a lower premium tax if up to 25% of the life company's investments are in Mississippi securities. The management of USLIC has invested its assets in a manner to incur the lower tax rate.
In common with other insurance companies operating in Mississippi, USLIC is subject to the regulation and supervision of the Mississippi Insurance Commissioner. After making application for admission and receiving proper license, USLIC may operate in other states and, at that time, will be subject to regulation and supervision in any other state where it may be permitted to transact business. Such regulation is primarily for the benefit and protection of insurance policyholders. Broad administrative powers are possessed by the Mississippi Department of Insurance and other supervising agencies. Although the powers differ from state to state, in general they include authority to grant and revoke licenses to transact business, to be an agent, to supervise premium rates, to approve the form of insurance contracts, to supervise the form of financial statements filed with such agency, to regulate capital requirements, to regulate insurable interest on one life and to require the filing of detailed annual reports. USLIC's business and accounts are subject to examination by the Mississippi Department of Insurance, which conducted an examination of the three years ended December 31, 1996 during 1997. Such regulation includes the filing of financial statements by USLIC, periodic reporting and examination by the insurance regulatory authorities, and review of transactions between members of the holding company group.
At December 31, 1998, USLIC's capital and surplus, while above the minimum levels required by law, was below that required by several states to continue to write new business. Additionally, its Risk-Based Capital Ratio fell below 200%, the minimum action level. Immediately upon realization of this circumstance, management caused a $600,000 capital contribution to be made to USLIC to increase its capital and surplus to an amount greater than that required by every state in which it is licensed to do business. Additionally, USLIC has subsequently determined that the claim reserves used in its 1998 Annual Statement filed with regulatory authorities was approximately $250,000 overstated, and expects to file amended financial statements which will further strengthen USLIC's statutory position.
(vi) BUSINESS OF FHA
Formed in 1989, FHA, formerly Funeral Homes of Louisiana, owns and operates a funeral home in Baker, Louisiana. Constructed in 1992, the Baker Funeral
Home constitutes the primary business function of FHA. At December 31, 1998, FHL had total assets of $565,000 and total annual revenues of $349,000.
(vii) BUSINESS OF CILIC
CILIC is an Illinois domiciled life insurer admitted to do business in four states. Dormant for several years, the Company services a closed block of life insurance policies. At December 31, 1998, CILIC had assets of $3.1 million and annual revenues of $200,000.
(viii) BUSINESS OF NSLIC
NSLIC was acquired in November, 1997 by Citizens. Domiciled in Arlington, Texas, NSLIC's revenues have historically been derived from revenues generated by the sale of ordinary whole life insurance, individual supplemental and major medical health insurance and credit insurance and investment income. During the year ended December 31, 1998, 7.4% of premium revenue was attributable to life, endowment and term insurance; 18.1% to credit insurance; and 74.5% to accident and health insurance. All of the life insurance in force is non-participating.
In recent years, NSLIC's sales efforts have centered on a major medical supplemental hospitalization policy and its credit business. The claims incurred on the accident and health policy to date are below the level anticipated in the development and pricing of the product. The credit business is sold primarily through a chain of furniture stores in Texas. As a result, the average contract size is relatively small, and the average duration is approximately three years. Beginning in 1998, sale of the major medical products was discontinued.
During 1998, management discontinued selling the limited major medical products that NSLIC's prior management had begun to introduce in 1997. Management believes that the level of surplus and asset size of NSLIC are not sufficient to support the potential volatility that is inherent in such types of business. As such, NSLIC's marketing efforts are focused solely on the expansion of existing credit life and credit accident and health business.
GEOGRAPHICAL DISTRIBUTION OF BUSINESS
For the year ended December 31, 1998, 97.3% of NSLIC's total premium income was derived from residents of Texas and 2.6% from Louisiana residents. For 1997, 96.6% of total premium income was derived from residents of Texas; and 3.3% from Louisiana residents.
MARKETING OPERATIONS
NSLIC holds licenses to do business in three states - Texas, Oklahoma and Louisiana. NSLIC's operations are conducted through independent contractors,
with a sales force of 142 representatives at December 31, 1998 and 218 at December 31, 1997.
RESERVES
NSLIC establishes actuarial reserves as liabilities to meet obligations on all outstanding policies. Reserves and deferred acquisition costs are prepared in conformity with the American Academy of Actuaries Committee on Financial Reporting Principles and generally accepted accounting principles. Claims reserves include an amount equal to the expected benefit to be paid on reported claims in addition to an estimate of claims that are incurred but not reported, based on actual historical experience. NSLIC receives an independent actuarial certification of its reserves. The certifications have noted no deficiencies for the years presented herein.
REINSURANCE
NSLIC cedes insurance with other insurers, reinsurers and members of various reinsurance pools. Reinsurance arrangements are utilized to provide greater diversification of risk and minimize exposure on larger risks.
(a) INSURANCE CEDED
NSLIC generally retains $20,000 of risk on any one person. As of December 31, 1998, the aggregate amount of life insurance ceded amounted to $5,276,000 or 10.6% of total direct life insurance in force. Additionally, NSLIC ceded $1,169,000 of accident and health premium (approximately 32.9% of NSLIC's total A&H premium). NSLIC is contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations reinsured.
As of December 31, 1998, NSLIC had in effect automatic reinsurance agreements that provide for cessions of ordinary insurance from NSLIC. Additionally, NSLIC has reinsurance treaties in force with several reinsurers of life and accident and health insurance. These treaties provide for both automatic and facultative reinsurance of standard and substandard risks ceded to them by NSLIC for life, accident and health and supplemental benefits above NSLIC's retention limit on a yearly renewable term basis.
A treaty with Employers Reassurance (ERC) has historically been the primary vehicle utilized by NSLIC for its life business. A reinsurance treaty with Continental Assurance Company covers virtually all of NSLIC's accident and health business.
NSLIC closely monitors the solvency of its reinsurers to minimize the risk of loss in the event of a failure by one of the parties. The primary reinsurers are large,
well capitalized entities which have no current or prior history of financial difficulty.
INVESTMENTS
State insurance statutes prescribe the quality and percentage of the various types of investments which may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, real estate and mortgage loans by certain specified percentages. NSLIC's invested assets at December 31, 1998 were distributed as follows: fixed maturities - 99.8%, equity securities - 0%, mortgage loans - 0%, policy loans - 0.2%, short-term investments - 0%.
REGULATION
NSLIC is subject to regulation and supervision by the insurance department of each state or other jurisdiction in which it is licensed to do business. These departments have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of marketing persons, the approval of policy forms, the advertising and solicitation of insurance, the form and content of mandatory financial statements, the reserve requirements, and the type of investments which may be made. NSLIC is required to file detailed annual reports with each such insurance department, and its books and records are subject to examination at any time. In accordance with state laws and the rules and practices of the National Association of Insurance Commissioners, NSLIC is examined periodically by examiners of its domiciliary state and by representatives (on an "association" or "zone" basis) of the other states in which it is licensed to do business. NSLIC's most recent examination which was completed during 1998, was for the three years ended December 31, 1997, by the Texas Department of Insurance. NSLIC is audited annually by an independent public accounting firm.
Various states, including Texas, have enacted "Insurance Holding Company" legislation which requires the registration and periodic reporting by insurance companies which control, or are controlled by, other corporations or persons. Under most of such legislation, control is presumed to exist with the ownership of ten percent or more of an insurance company's voting securities. NSLIC is subject to such regulation and has registered under such statutes as a member of an "insurance holding company system." The legislation typically requires periodic disclosure concerning the transactions between the registered insurer, the ultimate controlling party, and all affiliates and subsidiaries of the ultimate controlling party, and in many instances requires prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system.
At December 31, 1998, NSLIC's capital was impaired by approximately $131,000. Additionally, its Risk-Based Capital Ratio fell below 200%, the minimum action level. Immediately upon realization of this circumstance, management caused a $500,000 capital contribution to be made to NSLIC to increase its capital and surplus to an amount greater than that required by every state in which it is licensed to do business. Additionally, NSLIC has subsequently determined that the claim reserves used in its 1998 Annual Statement filed with regulatory authorities was approximately $1,000,000 overstated, and expects to file amended financial statements which will further strengthen its statutory position.
COMPETITION
The life insurance business is highly competitive, and NSLIC competes with a large number of stock and mutual companies. NSLIC believes that its premium rates and its policies are generally competitive with those of other life insurance companies, many of which are larger than NSLIC, selling similar types of insurance.
In NSLIC's block of accident and health insurance, it is in competition with many life insurance companies as well as with voluntary and government-sponsored plans for meeting hospitalization and medical expenses such as Blue Cross/Blue Shield, "Medicare" and "Medicaid." Future expansion of such programs or the establishment of additional government health programs could adversely affect the future of accident and health insurance on NSLIC's books.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTIES
CICA owns its principal office in Austin, Texas, consisting of an 80,000 square foot office building. Approximately 33,000 square feet is occupied by CICA and its affiliates with the remainder of the building being leased. At December 31, 1998, the occupancy rate of the property was 100%.
CICA also owned 1.10 acres of land with a 13,000 square foot office building which previously served as the Company's executive offices. The property, with a book value of $104,000, was sold for cash in 1998 for $850,000.
During 1995, CICA acquired through foreclosure, a 7,500 square foot office property in Wheatridge, Colorado for $116,000. Subsequently, the Company renovated the property, bringing its investment to $230,000. The property was sold for $275,000 in 1998, with the Company retaining a $240,000 first lien.
Through the acquisition of American Liberty Financial Corporation described above, the Company also owns a 6,324 square foot funeral home in Baker,
Louisiana with a total cost of $473,000. This facility is owned and operated by a subsidiary, FHA.
AIN owned a 13,000 square foot building in a suburb of Jackson, Mississippi. In March, 1998, this building was sold for $537,000, a gain of approximately $50,000 with CICA making a $430,000 mortgage loan.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On September 22, 1997, Citizens was notified that class action certification was granted September 15, 1997 to plaintiffs in a lawsuit (Dwain Kirkham et al. v. American Liberty Life Insurance Company et al., No. 25,954, 2nd Judicial District, Jackson Parish, Louisiana) filed against American Liberty Life Insurance Company ("ALLIC") on August 19, 1996 and against Citizens, Inc. on December 20, 1996 (collectively "Defendants"). In the same ruling, Defendants' motion for summary judgment and exception of prescription (statute of limitations) were denied. Defendants believed that these rulings are significantly in error and filed a motion for appeal. On August 19, 1998, the Louisiana Second Circuit Court of Appeals vacated the class action certification by the trial court, and the case was remanded for further proceedings consistent with the decision of the Court of Appeals.
The lawsuit was filed by four individuals who purchased from ALLIC, prior to August 1, 1986, life insurance policies on their children and grandchildren. In the complaint, plaintiffs alleged that the insurance policies were fraudulently misrepresented to be "retirement" and "insured savings" plans in which, after six or seven years, additional premiums would be unnecessary and monthly retirement income would be generated for plaintiffs. Plaintiffs also alleged other causes of action including breach of contract and are seeking rescission, unspecified damages, interest and attorneys' fees. Prior to the class certification ruling, rescission of the insurance policies purchased by the four plaintiffs would have resulted in a total payment of $31,000 (including 33% for contingent attorneys' fees). The activities described in plaintiffs' complaint allegedly occurred over 10 years ago with respect to certain types of insurance policies sold by an independent general agent. Prior to its recent merger into Citizens' principal subsidiary, CICA, ALLIC was a separate subsidiary of Citizens since its acquisition in September 1995. In October, all claims were settled for $75,000.
In March 1999, the Company was served with a summons regarding an action entitled Berdeaux Living Trust v. First Investors Group, Inc., Donald L. Dennis, H. Marie Dennis, Winona Drewes and Citizens, Inc. in U.S. District Court, Southern District of Illinois. The complaint alleges that the defendants defrauded the plaintiffs and other persons who were preferred shareholders of First Investors Group, Inc. in connection with an acquisition of First Investors completed by the Company in early 1999. In the acquisition, the Company issued approximately
610,000 shares of its Class A Common Stock to shareholders of First Investors pursuant to a registration statement declared effective by the Securities and Exchange Commission in December 1998. The plaintiffs are seeking class action certification on behalf of the approximately 1,860 persons who where preferred shareholders of First Investors. Damages are alleged based upon alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and the Illinois securities laws as well as under Illinois common law fraud and against the defendants other than the Company, for breach of fiduciary duty. The Company is preparing an answer which vigorously denies the allegations, and it believes the case is without merit.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to shareholders of Citizens during the fourth calendar quarter of 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Citizens' Class A common stock is traded on the American Stock Exchange (AMEX) under the symbol CIA. The high and low prices per share as supplied by the Amex Monthly Statistical Report are as follows.
As of December 31, 1998, the approximate number of record owners of Citizens' Class A common stock was 19,000. Management estimates the number of beneficial owners to be approximately 57,000.
Citizens has not paid dividends in any of the past four years and does not intend to pay cash dividends in the immediate future. For restrictions on the present and future ability to pay dividends, see Note 7 of the "Notes to Consolidated Financial Statements."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The table below sets forth, in summary form, selective data of the Company. This data, which is not covered in the report of the independent auditors, should be read in conjunction with the consolidated financial statements and notes which are included elsewhere herein (amounts in thousands except per share amounts).
See Part I (b) - Financial information regarding the insurance business and Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
On October 28, 1996, Citizens announced that it had signed definitive written agreements for the acquisition of American Investment Network, Inc. ("American"), a Jackson, Mississippi, based life insurance holding company and parent of United Security Life Insurance Company ("USLIC") with $7.5 million in assets, $3.4 million of stockholders' equity, revenues of $3.2 million and $67 million of life insurance in force. Approximately 700,000 Citizens' Class A common shares were issued in connection with the transaction, which was accounted for as a purchase. The transaction closed on June 19, 1997.
On August 13, 1997, Citizens signed a definitive agreement to acquire 100% of the outstanding shares of National Security Life and Accident Insurance Company ("NSLIC") of Arlington, Texas for $1.7 million in cash and restricted stock. The transaction closed in November, 1997.
On September 15, 1998 Citizens and First Investors Group, Inc. ("Investors") of Springfield, Illinois reached an agreement wherein Citizens would acquire 100% of the outstanding preferred and common shares of Investors for shares of Citizens' Class A Common stock. Investors is the parent of Excalibur Insurance Corporation, also of Springfield, Illinois ("Excalibur"), and has consolidated assets of approximately $3.2 million, annual revenues of $201,000 and capital of
$3.1 million. Pursuant to the terms of the Agreement, which was approved by the Illinois Department of Insurance on October 13, 1998 and the shareholders of Investors on January 26, 1999, Citizens issued one share of Citizens Class A Common stock for each 6.6836 shares of Investors common and preferred stock issued and outstanding. Citizens issued approximately 610,000 shares of its Class A Common stock to consummate the transaction.
RESULTS OF OPERATIONS
A net loss of $6,720,693, or $0.31 per share was incurred during 1998, compared to net income of $3,425,523 or $.16 per share in 1997 and net income of $2,213,726 or $.11 per share in 1996.
A non-recurring charge to goodwill of $9.5 million recorded in the third quarter of 1998 caused the 1998 loss. The writedown was related to goodwill recorded in the 1995 acquisition of American Liberty Financial Corporation. The writedown was caused by a decline in new production from insurance agents formerly associated with American Liberty. Subsequent to the 1995 acquisition, management implemented a 45% reduction in commissions paid to these agents in order to preserve profitability of the accident and health business which was negatively impacted by (i) changes in state laws that established minimum claims ratios, and (ii) a mandated change in interest rates used to compute reserves. In addition, as a result of a merger of American Liberty into CICA during 1997, new policy sales were delayed because CICA had to resubmit policies formerly sold by American Liberty for approval in each of the states in which the policies were sold by American Liberty. Accordingly, the Company experienced what was believed to be a temporary decline in new production of American Liberty. The Company continued to monitor production associated with these products, for which the primary marketing efforts occur during the months of June to September, due to the nature of the policies sold. As a result of obtaining the necessary policy approval and increased sales efforts during 1998, management was successful in reviving production from some of the largest producers of American Liberty. However, management's estimate of future production was reevaluated during the quarter ended September 30, 1998 based upon the sales activity of the products sold during that quarter, the size of the active agency force, and the anticipated future production to be achieved in subsequent years. As a result of this evaluation, the writedown was recognized.
Management continues to monitor production associated with these products. As a result of obtaining the necessary policy approvals by CICA in 1997 and increased sales efforts during 1998, management was successful in reviving production from some of the largest producers of American Liberty. Estimates of future production will continue to be reevaluated based upon the sales activity of the products sold, the size of the active agency force, and the anticipated future production. Management has been successful in returning the largest producing marketing organization of American Liberty to production and anticipates continuing increases in new production in 1999, compared to amounts seen in 1997 and 1998.
Total revenues for the year ended December 31, 1998 were $72,684,915 compared to $65,027,298 in 1997 , an increase of 11.8%. In 1996 revenues were $63,822,160. The inclusion of the revenues from USLIC and NSLIC for the entire year was the primary reason for the increase during 1998. Decreased writing of new business by CICA in the international market and by ALLIC domestically was offset by the premium revenues of USLIC and NSLIC, which contributed to the increase in revenue in 1997. Additionally, only six months of revenues of USLIC and only one month of NSLIC's revenues are included in the 1997 results. However, economies of scale created by the combination of companies contributed to the increase in 1997 income.
Premium income reached $59,154,329 in 1998, a 6.8% increase over the $55,362,616 in 1997. The 1997 amounts were a 1.9% increase over the previous year when premium income totaled $54,303,445. Declines in the production of international premium by CICA and domestically by ALLIC's former marketing operations during 1997 resulted in a nominal increase in 1997 compared to 1996. Additionally, as stated above, the results for USLIC and NSLIC were not included for the entire year 1997. In January, 1998, CICA introduced a new line of international products known as the Millennia 2000 series. Management believes that these products will be well received in the marketplace; however, in 1998, CICA's international sales were hampered due to the contraction of several Latin American economies as well as increased competition from new local insurance companies who are subsidiaries of large U.S. insurers.
It is management's belief that CICA, utilizing the marketing representatives who previously represented ALLIC, is better served to continue to exploit its niche selling specialty accident and health life products through existing distribution channels. The acquisition of USLIC also brings capable sales forces that have historically sold similar products; therefore, management believes that the ability to "cross-sell" products between companies is high.
During 1998, management discontinued selling the limited major medical products that NSLIC's prior management had begun to introduce in 1997. Management believes that the level of surplus and asset size of NSLIC are not sufficient to support the potential volatility that is inherent in such types of business. As such, NSLIC's marketing efforts are focused solely on the expansion of existing credit life and credit accident and health business.
Net investment income increased 12.4% during 1998 to $11,279,125 from $10,038,736 during 1997. The 1997 results were up 9.29% compared to the $9,185,506 earned in 1996. The 1998 and 1997 results reflect the continuing expansion of the Company's asset base as well as the actions taken in previous years to change the mix and duration of the Company's invested assets. Overall, the duration was increased to approximately 5.19 years from 4 years.
The low yields available in the bond market during the Company's growth period have made it difficult to increase the return on the Company's invested assets without exposing the portfolio to undue risk.. Management hired the investment advisory firm of Asset Allocation and Management, Inc. of Chicago ("AAM"), Illinois in late 1995 to manage the Company's fixed maturity portfolio. During 1996, a nominal reconfiguration was begun. In lieu of purchasing U.S. Treasury instruments, the Company began to purchase U.S. Government guaranteed mortgage pass-through securities. This program continued throughout 1998. Management expects to continue this strategy throughout 1999 as opportunities present themselves.
Overall policyholder dividends increased to $3,025,746 in 1998, up 8.7% over 1997 when such benefits were $2,782,215. The 1997 amounts represented an increase of 18% compared to $2,363,201 in 1996. The 1997 growth is primarily due to the acquisition of USLIC, which increased the current year results by approximately $397,000. Virtually all CICA's policies that have been sold since 1989 are participating. However, sales of credit life by NSLIC are non-participating and have had the effect of lowering the overall growth in dividends. Participating policies represent a large majority (71%) of the Company's business in-force, although the percentage of participating business has declined from approximately 91% due to the acquisitions in recent years. Additionally, due to the disruption in the Argentine market mentioned above and the lower than usual persistency in that market, the growth in overall dividends has been slowed as policies lapse before the dividend amount can grow. Management expects continued growth in this item due to the fact that CICA will continue to focus on participating products internationally, subject to factors such as persistency and future sales, although dividends are factored into the policies, although dividends are factored into the policies.
Claims and surrenders increased to $31,592,740 in 1998, an increase of 13.4% over 1997 when such benefits were $27,852,907. In 1996 claims and surrenders were $25,919,054. The increase in benefits can be attributed to the inclusion of NSLIC and USLIC for an entire year in 1998, as well as increases in accident and health benefits attributable to the respective blocks of business of these companies. Death benefits increased to $5,150,647 in 1998, up from $4,475,083 in 1997, and $3,667,159 in 1996. The 1998 increase can be traced directly to the inclusion of NSLIC and USLIC for an entire year. During 1998, claims on NSLIC were $421,801, while claims from USLIC were $35,570. The increase in such claims in 1997 does not appear to be due to any trend. Rather, it is the result of the growing block of business written by the Company. Additionally, the pre-need and burial policies formerly sold by ALLIC were marketed to an older clientele and as such, higher claims are anticipated and factored into the product. The Company has historically adhered to a strict underwriting policy which requires complete medical examinations on all applicants who are foreign residents, except children, regardless of age or face amount of the policy applied for. For 1996 and future years, management initiated a change to more selective
medical examinations in conjunction with dry spot blood tests and extensive medical questions on the application in order to lower the cost of new business without sacrificing necessary information for the underwriter. Additionally, X-rays and electrocardiograms are required depending on age and face amount of the policy. On all policies of $150,000 or more, inspection reports are required which detail the background resources and lifestyle of the applicant. The Company has developed numerous contacts throughout Latin America with which its underwriters can validate information contained in the application, medical or inspection report.
Accident and health benefits grew to $6,160,966 in 1998 from $2,963,636 in 1997. Such claims were $1,719,244 in 1996. The increase reflects the growing block of accident and health premium on the Company's books, and more specifically the inclusion of NSLIC and USLIC for the entire year. Claims on USLIC's A&H benefits were $2,513,680, while NSLIC's were $1,653,367. In 1997, the addition of USLIC and NSLIC contributed approximately $740,000 to the benefit amounts. In 1996, the acquisition of ALLIC caused such benefits to increase sharply because of the volume of A&H premium on ALLIC's books compared to the amount on CICA's books. During the second half of 1998, the Company experienced a significant increase in the volume of claims which resulted in a backlog. During the fourth quarter of 1998, management increased the number of individuals processing claims from approximately 13 to 30. Management believes the Company will be current on its claims processing in the second quarter of 1999. In the meantime, significant effort has been made to ensure that the pending claims reserve and provisions for incurred but not reported claims are conservative and reasonable.
Endowment expense grew to $5,258,881 in 1997 from $5,192,607 in 1996. In 1998, such expenses declined to $5,027,937. Beginning in late 1990, Citizens introduced a new series of plans called "Ultra Expansion Plus" which carried an immediate endowment benefit of an amount elected by the policyowner. This endowment is factored into the premium of the policy and is paid annually. The relatively small increase from 1996 to 1997 and the decline in 1998 reflects the decline in production of this policy over the last three years.
In 1998, policy surrenders remained flat at $14,481,335. Policy surrenders were $14,322,593 in 1997, compared to $14,421,683 in 1996. The decrease in 1997 and relative stability in 1998 is, in the opinion of management, the result of a campaign begun in mid-1997 to inform policyowners about the benefits of their policies.
Other claim expenses amounted to $1,020,410 in 1998, $848,093 in 1997 and $918,361 in 1996. These expenses are comprised of supplemental contract benefits, interest on policy funds and assorted other miscellaneous policy benefits.
During 1998, commissions increased to $12,501,426 from $11,918,192. In 1996, commission expense was $12,447,664. The majority of such amounts paid relates to first year commissions which were $8,169,835, $8,120,748, and $8,677,297 in 1998, 1997, and 1996, respectively. The 1996 increases relate to improved sales activity in CICA and approximately $1.5 million associated with ALLIC. The decline in first year commissions reflected in 1998 and 1997 compared to 1996 relates to the slowdown in new sales discussed earlier. Additionally, the increase in new sales of accident and health and credit business contributed to the decline. These products typically carry lower commissions than do ordinary life products.
Underwriting, acquisition and insurance expenses increased to $11,079,065 compared to $6,992,402 in 1997 and $9,500,973 in 1996. Approximately $2.5 million of the increase in 1998 relates to the inclusion of NSLIC and USLIC for the entire year. Additionally, because of the increased claims volume mentioned above, management was forced to significantly increase staff size and thus overhead on a temporary basis. Due to the consolidation of ALLIC's operations with CICA, management was able to achieve significant reductions in expenses through economies of scale which were reflected in the 1997 results.
In order to convert a majority of CICA's marketing overhead from fixed to variable, management contracted in early 1997 with an independent international marketing company to serve as managing agent for the Company's international marketing activities. This firm receives an overriding commission on all new business sold internationally in exchange for the absorption of all marketing management and promotion activities. Management has utilized firms such as this in previous periods with great success at obtaining increases in sales and expense reductions.
Capitalized deferred policy acquisition costs were $7,941,829 in 1998, $9,804,022 in 1997, and $10,531,222 in 1996. The large drop in 1998 reflects the sale of accident and health products described above which carry lower levels of commission and thus capitalization. The decline in amounts in 1997 reflects the lower level of new sales experienced during the year, as well as the lower interest rate environment. Amortization of these costs was $7,789,513, $9,630,705 and $10,221,917, respectively in 1998, 1997 and 1996.
Amortization of cost of insurance acquired and excess of cost over net assets acquired declined in 1998 to $2,100,433 from $2,305,127 in 1997. In 1996, such amortization was $1,398,859 in 1996. The increase in 1997 was attributable to the goodwill and cost of insurance recorded on the acquisitions of USLIC, NSLIC, ALLIC and IIH. As discussed above, management wrote off $9.5 million of the goodwill associated with the acquisition of American Liberty during the third quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Stockholders' equity decreased to $74,903,679 at December 31, 1998 from $79,581,698 in 1997. The loss from operations caused by the non-recurring charge offset improvement in the market value of the Company's fixed maturity portfolio and caused the decline in equity.
Invested assets grew to $176,572,123 in 1998 from $162,651,692 in 1997, an increase of 8.6%. The growth is attributable to the internal growth achieved by the Company. At December 31, 1998 and 1997, fixed maturities have been categorized into two classifications: Fixed maturities held to maturity, which are valued at amortized cost, and fixed maturities available for sale which are valued at market. The Company does not have a plan to make material dispositions of fixed maturities during 1999; however, because of continued uncertainty regarding long-term interest rates, management cannot rule out sales during 1999. Fixed maturities held to maturity, amounting to $5,606,374 at December 31, 1998 consist of U.S. Treasury securities. Management has the intent and believes the Company has the ability to hold the securities to maturity.
In order to monitor the market risk associated with the Company's investment policy, management measures the sensitivity of the portfolio to instantaneous interest rate changes. At December 31, 1998, decreases in interest rates of 100, 200 and 300 basis points, respectively, would result in increases in market values of approximately $12,402,000, $19,666,000 and $23,588,000, respectively. Conversely, increases in rates of 100, 200 and 300 basis points would generate losses of $1,041,000, $7,484,000 and $13,738,000, respectively. Under either interest rate scenario the portfolio carries positive convexity.
The Company's mortgage loan portfolio, which constitutes 0.9% of invested assets at December 31, 1998 and 1997, has historically been composed of small residential loans in Texas. At December 31, 1998 and 1997, one mortgage loan with a principal balance of approximately $38,400 was in default. Management has established a reserve of $50,000 at December 31, 1998 and 1997 (approximately 3% of the mortgage portfolio's balance) to cover potential unforeseen losses in the Company's mortgage portfolio. During the first quarter of 1999 while foreclosure on the above-referenced loan was in progress, the Company was notified that the property had been sold and a payoff of its lien was forthcoming.
Policy loans comprise 11.9% of invested assets at December 31, 1998 compared to 12.6% at December 31, 1997. These loans, which are secured by the underlying policy values, have yields ranging from 5% to 10% percent and maturities that are related to the maturity or termination of the applicable policies. Management believes that the Company maintains more than adequate liquidity despite the uncertain maturities of these loans.
Cash balances of the Company in its primary depository, Chase Bank of Texas, Austin, Texas, were significantly in excess of Federal Deposit Insurance
Corporation coverage at December 31, 1998 and 1997. Management monitors the solvency of all financial institutions in which it has funds to minimize the exposure for loss. Management does not believe the Company is at risk for such a loss. During 1999, the Company intends to utilize highly-rated commercial paper as a cash management tool to minimize excess cash balances and enhance return.
In February 1992, the Company paid cash for an 80,000 square foot office building in Austin, Texas to serve as its primary office. Renovation and remodeling of the property began in the third quarter of 1992 and the Company relocated to the building in September 1993. The Company occupies approximately 33,000 square feet of space in the building. The Company's former office property, consisting of approximately 13,000 square feet in Austin, with a carrying value of $104,000 was sold during 1998 for $850,000.
CICA owned 1,821,332 shares of Citizens Class A common stock at December 31, 1998 and 1997. Statutory accounting practices prescribed by Colorado require that the Company carry its investment at market value reduced by the percentage ownership of Citizens by CICA, limited to 2% of admitted assets. As of December 31, 1997 and 1998, the Company valued the shares in accordance with prescribed statutory accounting practices. In the Citizens' consolidated financial statements, this stock is shown as treasury stock.
CICA had outstanding at December 31, 1998, a $333,333 surplus debenture payable to Citizens. For statutory accounting purposes, this debenture is a component of surplus, while for GAAP it is eliminated in consolidation. Citizens has recognized a liability for its related obligation to a bank in a like amount.
The NAIC has established minimum capital requirements in the form of Risk-Based Capital ("RBC"). Risk-based capital factors the type of business written by a company, the quality of its assets, and various other factors into account to develop a minimum level of capital called "authorized control level risk-based capital" and compares this level to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting practices, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk-based capital fall below 200%, a series of actions by the Company would begin. At December 31, 1997, CICA, and CILIC were well above required minimum levels. NSLIC and USLIC fell below the 200% level as reported on their December 31, 1998 Annual Statement to insurance regulatory authorities. Management immediately made capital contributions to both companies to raise them above the minimum levels. Additionally, during the 1998 annual audit, it was discovered that the provisions for pending claims in both companies were overstated. Management expects to amend the 1998 statutory financial statements of USLIC and NSLIC to increase surplus by approximately $250,000 and $1,000,000, respectively as a result of the overstatement, bringing both companies further above the 200% level of RBC.
INFORMATION SYSTEMS AND THE YEAR 2000
Company management has been actively involved in life and health insurance software development since the 1960's. The Company continues to develop and maintain its core information systems with a professional staff of program designers, analysts and programmers through its wholly-owned subsidiary Computing Technology, Inc.
During the past 15 years, the Company has undertaken numerous major systems projects, including but not limited to, development of interactive, simulated-real-time transaction collection and user inquiry programs, conversion from CSC/Continuum's Life/70 to in-house developed core processing systems, transition from a Harris minicomputer to a Wang VS, transition from an IBM plug-compatible mainframe to a Wang VS and conversion of at least seven life and health insurance company operations to its systems. During 1998, Company personnel have successfully completed conversion of two insurance company operations, namely United Security Life Insurance Company and National Security Life and Accident Insurance Company, from non-compliant UNIX and IBM systems to systems designed and operated by Citizens. The Company's electronic systems department ("ESD") staff believes year 2000 issues will continue to be addressed as a top priority until the Company can certify its systems are Year 2000 compliant. The effort needed to complete the task is expected to be effected with existing staff by June 30, 1999, thus leaving ample time to assess and resolve any significant remaining issues.
Company personnel have been actively planning, identifying and resolving year 2000 issues for more than a year. These activities are expected to continue through the early part of 1999 with parallel testing and final remediation actions concluding within the second half of 1999.
In the late 1980's, the Company began developing software to routinely audit its data bases and its source code. These internal audit tools run daily and provide perpetual balancing of the Company's policy and agency master files to its general ledger. The source code audit tool has been an instrumental key to identifying system code that may need year 2000 remediation. By using this automated "bloodhound" combined with visual review of record and screen layouts/documentation, the Company's ESD staff have identified the "worst case" scenario for a year 2000 impact. Under this scenario, the Company does not expect material costs, because the remaining functions that could be non-compliant can be handled manually.
The overall expenditure for addressing year 2000 issues is minimal because all planning, remediation and testing have been, and will continue to be, performed with existing staff during normal business hours.
The Company utilizes a Wang VS 7160 for providing core processing and on-line support in conjunction with a local-area-network (LAN) based upon CISCO 5500 and 2900 intelligent switching components. The Company's Mitel telephone system was replaced during 1998 with a Mitel 2000 Light, nodal, fiber-optic system which is year 2000 compliant.
Wang has certified the 7.53.00 operating system to be year 2000 compliant and the Company successfully completed installation and testing of this system in July, 1998. The Company uses Microsoft's WFW 3.11 and NT Server 3.51 (SP5), for its LAN, both of which are certified by Microsoft to be year 2000 compliant. The Company uses Word 6.0, EXCEL 5.0, and Notes 3.3 as applications on the LAN which are certified to be compliant except for the Notes product which is not compliant, but is reported to have no loss of data or functionality. However, only the Wang system is mission-critical with the in-house developed code for Host Daily Cycle systems being considered a part thereof.
As for electronic data exchanges, the Company interacts with Chase Bank, Rudd and Wisdom, Dataplex, PCS Health Systems and certain reinsurance companies. The Chase Bank relationship is the only third-party interface that could be considered mission-critical and it can be circumvented (in less than one man-hour) by using paper drafts instead of electronic transactions should the Company find such to be desirable. Other vendor interfaces can be circumvented with hard-copy reporting should an electronic interface become untenable for some reason.
The Company believes it has addressed its Year 2000 concerns. The Company has developed contingency and recovery plans aimed at ensuring the continuity of critical business functions before, on and after December 31, 1999. The contingency and recovery planning is substantially complete. The Year 2000 contingency plans will be reviewed periodically throughout 1999 and revised as needed. The Company believes its Year 2000 contingency plan, coupled with existing "disaster recovery" and "business resumption" plans, minimize the impact Year 2000 issues may have on the organization
FINANCIAL ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement 128 "Earnings per Share" ("Statement 128"). Statement 128 establishes the standards for computing and presenting earnings per share ("EPS"). This statement replaces the presentation of primary EPS with a presentation of basic EPS and requires dual presentation of basic and diluted EPS. Statement 128 is effective for fiscal years ending after December 15, 1997. Implementation did not have a material impact on the Company's earnings per share.
In June 1997, the FASB issued Statement 130 "Reporting Comprehensive Income" ("Statement 130"). Statement 130 establishes the standards for reporting
and display of comprehensive income and its components in a full set of general-purpose financial statements. Statement 130 is effective for fiscal periods beginning after December 15, 1997. Implementation has not had a material impact on the Company.
Also in June, 1997, Statement 131, "Disclosures about Segments of an Enterprise and Related Information," was issued by the Financial Accounting Standards Board. This Statement requires that companies disclose segment data on the basis that is used internally by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. The Company's current definition of its business segments, significant lines of business (life and health products), will be expanded to significant lines of business by geographic location of policyholder (international and domestic).
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is set forth in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
CITIZENS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
All other schedules have been omitted as the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
During the 24 months preceding the date of the audited financial statements of Citizens included herein, there has been no change of accountants made by Citizens, nor has it reported on Form 8-K any disagreements between the Company and its independent accountants.
PART III
Items 10, 11, 12, and 13 of this Report incorporate by reference the information in the Company's definitive proxy material under the headings "Stock and Principal Stockholders," "Control of the Company," "Election of Directors," "Executive Officers," "Executive Officer and Director Compensation" and "Certain Reports" to be filed with the Securities and Exchange Commission within 120 days after December 31, 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 AND 2
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The financial statements and schedules listed on the following index to financial statements and financial statement schedules are filed as part of this Form 10-K.
(a) 3 EXHIBITS
- ---------------------------------- (a) Filed as a part of the Amendment No. 1 to Registration Statement on Form S-4, SEC File No. 33--4753, filed on or about June 19, 1992. (b) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference. (c) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference. (d) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. (e) Filed with or referenced in the Registrant's Current Report on Form 8-K dated December 9, 1994 and incorporated herein by reference. (f) Filed as a part of the Registration Statement on Form S-4, SEC File No. 33--59039, filed on or about May 2, 1995. (g) Filed as a part of the Registration Statement on Form S-4, SEC File No. 33--63275, filed on or about October 6, 1995. (h) Filed as a part of the Registration Statement on Form S-4, SEC File No. 333--16163, filed on or about November 14, 1996. (i) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. (j) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. (k) Filed as a part of the Registration Statement on Form S-4, SEC File No. 333--67091, on or about November 10, 1998.
(b) REPORTS ON FORM 8-K
No Reports on Form 8-K were filed by Citizens during the fourth quarter of 1998.
CITIZENS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
All other schedules have been omitted as the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Citizens, Inc.:
We have audited the consolidated financial statements of Citizens, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG LLP
Dallas, Texas March 18, 1999
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 1998 AND 1997
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION, CONTINUED
DECEMBER 31, 1998 AND 1997
See accompanying notes to consolidated financial statements.
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS, CONTINUED
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
See accompanying notes to consolidated financial statements.
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
See accompanying notes to consolidated financial statements.
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
CITIZENS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Supplemental disclosures of non-cash investing and financing activities:
The Company issued Class A stock and cash to purchase all of the capital stock of AIN, NSLIC, and the minority ownership in FAIC in 1997 and IIH in 1996. In conjunction with the acquisitions, liabilities were assumed as follows:
See accompanying notes to consolidated financial statements.
CITIZENS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) NATURE OF BUSINESS
The consolidated financial statements include the accounts and operations of Citizens, Inc. (Citizens), incorporated in the state of Colorado on November 8, 1977 and its wholly-owned subsidiaries, Citizens Insurance Company of America (CICA), Computing Technology, Inc. (CTI), Funeral Homes of America, Inc. (FHA), Insurance Investors, Inc. (III), National Security Life and Accident Insurance Company (NSLIC), United Security Life Insurance Company (USLIC) and Central Investors Life Insurance Company of Illinois (CILIC). Citizens and its subsidiaries are collectively referred to as "the Company."
American Liberty Financial Corporation (ALFC) and its subsidiaries, American Liberty Life Insurance Company (ALLIC), First American Investment Corp. (FAIC), and American Liberty Exploration Company (ALEC) were acquired by Citizens in September 1995. Effective January 1, 1997, ALFC was merged into Citizens and ALLIC was merged into CICA. American Investment Network (AIN), which was acquired in June 1997, owned USLIC. During 1998, AIN was liquidated into CICA. Insurance Investors and Holding Company (IIH), which was acquired in March 1996 owned CILIC. During 1998, IIH was liquidated and merged into CICA.
Citizens provides life and health insurance policies through four of its subsidiaries - CICA, USLIC, NSLIC and CILIC. CICA sells ordinary whole-life policies internationally, burial insurance, pre-need policies, accident and health specified disease, hospital indemnity, and accidental death policies, throughout the southern United States and USLIC and NSLIC sell participating whole-life policies and specialty individual accident and health policies.
CILIC does not actively market insurance policies, but does administer an in-force block of life insurance.
III provides aviation transportation to the Company. CTI provides data processing systems and services to the Company. FHA is a funeral home operator.
(b) BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company and its wholly-owned subsidiaries have been prepared in conformity with generally accepted accounting principles (GAAP). All significant intercompany accounts and transaction have been eliminated.
(C) INVESTMENTS, OTHER THAN AFFILIATES
Investments are shown on the following basis:
1. Fixed maturities, primarily consisting of bonds which the Company has the ability and intent to hold to maturity are carried at amortized cost. Fixed maturities which may be sold prior to maturity to support the Company's investment strategies are considered held as available-for-sale and carried at fair value as of the balance sheet date. Unrealized appreciation (depreciation) of equity securities and fixed maturities held as available-for-sale are shown as a separate component of stockholders' equity, net of tax, and is not included in the determination of net income. The unrealized holding gains or losses included in the separate component of equity for securities transferred from available-for-sale to held-to-maturity are maintained and amortized into earnings over the remaining life of the security as an adjustment to yield in a manner consistent with the amortization or accretion of premium or discount on the associated security.
2. Equity securities include non-redeemable preferred stock and are reported at fair value.
3. Mortgage loans on real estate, policy loans, and guaranteed student loans are reported at unpaid principal balances less an allowance for uncollectible amounts. Mortgage loans have an allowance for uncollectible amounts of $50,000 at December 31, 1998 and 1997. Guaranteed student loans had an allowance for uncollectible amounts of $10,000 at December 31, 1997.
4. Other long-term investments consist primarily of real estate which is recorded at the lower of fair value, minus estimated costs to sell, or cost. If the fair value of the real estate minus estimated costs to sell is less than cost, a valuation allowance is provided for the deficiency. Increases in the valuation allowance are charged to income.
5. Short-term investments consist of treasury bills and commercial paper with maturities of greater than ninety days but less than one year, or commercial paper, and are carried at cost, which approximates fair market value.
A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.
Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available-for-sale and held-to-maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
Policy loans and other investments are primarily reported at cost.
The Company has assets with a fair value of $8,745,400 at December 31, 1998, and $10,652,298 at December 31, 1997, on deposit with various state regulatory authorities to fulfill statutory requirements.
The Company holds no derivative investments.
(d) PREMIUM REVENUE AND RELATED EXPENSES
Premiums on life and accident and health policies are reported as earned when due or, for short duration contracts, over the contract periods. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the estimated life of the contracts. This matching is accomplished by means of provisions for future benefits and the capitalization and amortization of deferred policy acquisition costs.
Annuities are accounted for in a manner consistent with accounting for interest bearing financial instruments. Premium receipts are not reported as revenues but rather as deposit liabilities to annuity contracts.
(e) DEFERRED POLICY ACQUISITION COSTS AND COST OF INSURANCE ACQUIRED
Acquisition costs, consisting of commissions and policy issuance, underwriting and agency expenses which relate to and vary with the production of new business, are deferred. These deferred policy acquisition costs are amortized primarily over the estimated premium paying period of the related policies in proportion to the ratio of the annual premium recognized to the total premium revenue anticipated using the same assumptions as were used in computing liabilities for future policy benefits.
The Company uses the factor method to determine the amount of costs to be capitalized and the ending asset balance. This method limits the amount of deferred cost to their estimated realizable value.
The value of insurance acquired in the Company's various acquisitions, which is included in cost of insurance acquired in the accompanying consolidated financial statements, was determined based on the present value of future profits discounted at a risk rate of return. The cost of insurance acquired is being amortized over the anticipated premium paying period of the related policies.
(f) POLICY LIABILITIES AND ACCRUALS
Future policy benefit reserves have been computed by the net level premium method with assumptions as to investment yields, dividends on participating business, mortality and withdrawals based upon the Company's and industry experience, which provide for possible unfavorable deviation (see Note 4).
Annuity benefits are carried at accumulated contract values based on premiums paid by participants, annuity rates of return ranging from 3.0% to 7.0% (primarily at 4.0% to 5.5%) and annuity withdrawals.
Premium deposits accrue interest at rates ranging from 3.5% to 8.25% per annum. Cost of insurance is included in premium when collected and interest is credited annually to the deposit account.
Policy and contract claims are based on case-basis estimates for reported claims, and on estimates, based on experience, for incurred but unreported claims and loss expenses.
(g) EXCESS OF COST OVER NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS
The excess of cost over the fair value of net assets acquired in mergers and acquisitions is amortized on a straight-line basis ranging from 5 to 20 years.
Other intangible assets, primarily the value of state licenses, are amortized on a straight-line basis over 10 years.
The Company continually monitors long-lived assets and certain intangible assets, such as excess of cost over net assets acquired and cost of insurance acquired, for impairment. An impairment loss is recorded in the period in which the carrying value of the assets exceeds the fair value or expected future cash flows. Any amounts deemed to be impaired are charged, in the period in which such impairment was determined, as an expense against earnings.
(h) PARTICIPATING POLICIES
At December 31, 1998 and 1997, participating business approximated 59% and 82%, respectively, of life insurance in-force and premium income. The amount of dividends to be paid is determined annually by the Board of Directors.
(i) EARNINGS PER SHARE
Basic and diluted earnings per share have been computed using the weighted average number of shares of common stock outstanding during each period. The weighted average shares outstanding for the years ended December 31, 1998, 1997 and 1996 were 21,386,137, 20,868,921, and 20,236,469, respectively.
(j) INCOME TAXES
For the years ended December 31, 1998 and 1997 the Company files six separate tax returns as follows: 1) Citizens, Inc., CICA and all direct non-life subsidiaries, excluding FAIC and AIN, 2) FAIC and its subsidiaries, 3) AIN, 4) USLIC, 5) NSLIC and 6) CILIC.
For the year ended December 31, 1996 the Company filed three separate tax returns as follows: 1) Citizens, Inc., CICA, and all direct non-life subsidiaries, excluding FAIC, 2) CILIC, and 3) FAIC and its subsidiaries.
Deferred tax asset and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(k) ACCOUNTING PRONOUNCEMENTS
In 1998, the Company adopted and implemented the provisions of SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." This Statement established standards for reporting information about a Company's operating segments. The adoption of SFAS No. 131 resulted in revised and additional disclosures but had no effect on the financial position, results of operations or liquidity of the Company.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which is effective January 1, 2000. SFAS No. 133 will not impact the Company since they intend to not invest in derivatives.
On January 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income" and restated prior years' financial statements to conform to the reporting standard. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income includes all changes in equity during a period except those resulting from investments by shareholders and distributions to
shareholders. The adoption of SFAS No. 130 resulted in revised and additional disclosures, but had no effect on the financial position, results of operations or liquidity of the Company.
In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share". SFAS No. 128 establishes the standards for computing and presenting earnings per share ("EPS"). This statement replaces the presentation of primary EPS with a presentation of basic EPS and requires dual presentation of basic and diluted EPS. SFAS No. 128 is effective for fiscal years ending after December 15, 1997. Implementation did not have a material impact on the Company's earnings per share.
In December 1997, the AICPA issued Statement of Position ("SOP") 97-3. SOP 97-3 provides (1) guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, (2) guidance on how to measure the liability, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not anticipate implementation of SOP 97-3 to have a material impact on the Company's financial statements.
In March 1998, the AICPA issued SOP 98-1. "Accounting for the Costs of Computer Software Development or Obtained for Internal Use." This SOP provides guidance for determining whether costs of software developed or obtained for internal use should be capitalized or expensed as incurred. In the past, the Company has expensed such costs as they were incurred. This SOP is also effective for fiscal years beginning December 15, 1998. The Company is currently completing its evaluation of the financial impact as well as the changes to its related disclosures.
(l) CASH EQUIVALENTS
The Company considers as cash equivalents all securities whose duration does not exceed ninety days at the date of acquisition.
(m) DEPRECIATION
Depreciation is calculated on a straight line basis using estimated useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated over the estimated life of 30 years.
(n) USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
(o) RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1996 amounts to conform with the 1998 presentation.
(2) INVESTMENTS
The cost, gross unrealized gains and losses and fair value of investments of fixed maturities and equity securities available-for-sale, as of December 31, 1998 and 1997, are as follows:
The amortized cost and fair value of fixed maturities at December 31, 1998, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
FIXED MATURITIES HELD-TO-MATURITY
FIXED MATURITIES AVAILABLE-FOR-SALE
The Company had no investments in any one entity which exceeded 10% of stockholders' equity at December 31, 1998 other than investments guaranteed by the U.S. Government.
The Company's investment in mortgage loans is concentrated 30% in Colorado, 41% in Texas, 28% in Mississippi and 1% in other states as of December 31, 1998.
Major categories of net investment income are summarized as follows:
Equity securities of $58,874 as of December 31, 1998, did not produce income during the preceding 12 months.
Proceeds and gross realized gains (losses) from sales and maturities of fixed maturities available-for-sale for 1998, 1997 and 1996 are summarized as follows:
Proceeds and gross realized gains (losses) from sales of equity securities available-for-sale for 1998, 1997 and 1996 are summarized as follows:
Realized gains (losses) are as follows:
(3) COST OF INSURANCE ACQUIRED AND EXCESS OF COST OVER NET ASSETS ACQUIRED
Cost of insurance acquired is summarized as follows:
Accretion of interest on cost of insurance acquired is calculated based on the rates of interest used in setting the related policy reserves. These rates range from 6.5% to 8.5%.
Estimated amortization in each of the next five years is as follows. These amounts are greater than the carrying value due to interest accretion. Actual future amortization will differ from these estimates due to variances from estimated future withdrawal assumptions.
Excess of cost over net assets acquired is summarized as follows:
During 1998, the Company recognized an impairment loss in the amount of $9,500,000 relating to the goodwill recorded in the 1995 acquisition of ALLIC. The impairment loss was the result of a decline in production from agents formerly associated with ALLIC.
The acquisition of NSLIC was consummated on November 20,1997, therefore the balance of cost of insurance acquired as of December 31, 1997 was management's estimate based on the information available as of December 31, 1997. The Company revised its estimate related to this acquisition in 1998, which resulted in a reallocation of the purchase price.
(4) POLICY LIABILITIES
Various assumptions used to determine the future policy benefit reserves include the following: a) valuation interest rates from 4 to 9%, b) mortality assumptions are from the 1955 to 1960, 1965 to 1970, and 1975 to 1980 Select and Ultimate mortality tables and c) withdrawals are based primarily on actual historical termination rates.
The following table presents information on changes in the liability for accident and health policy and contract claims for the years ended December 31,1998 and 1997.
In 1998 and 1997, as a result of changes in estimates of insured events in prior years, the liability for policy and contract claims decreased.
(5) REINSURANCE
In the normal course of business, the Company reinsures portions of certain policies that it underwrites to limit disproportionate risks. The Company retains varying amounts of individual insurance up to a maximum retention of $75,000 on any life and $35,000 on health policies. Amounts not retained are ceded to other insurance enterprises or reinsurers, through yearly renewable term insurance or coinsurance contracts. Risks are reinsured with other companies to permit the recovery of a portion of any direct losses. The Company remains contingently liable to the extent that the reinsuring companies cannot meet their obligations under these reinsurance treaties.
Assumed and ceded reinsurance activity for 1998 and 1997 is summarized as follows:
Premiums and claims and surrenders assumed and ceded for the years ended December 31, 1998, 1997 and 1996:
Amounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. The cost of reinsurance related to long duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
(6) NOTES PAYABLE
Notes payable as of December 31, 1998 and 1997 consist of:
Note A is secured by proceeds from the surplus debenture between CICA and the Company.
Note B was collateralized by property. The property was disposed of in 1998 and the proceeds were applied to the note.
(7) STOCKHOLDERS' EQUITY AND RESTRICTIONS
The two classes of stock of Citizens are equal in all respects, except (a) the Class B common stock elects a simple majority of the Board of Directors of Citizens and the Class A common stock elects the remaining directors; and (b) each Class A share receives twice the cash dividends paid on a per share basis to the Class B common stock.
Generally, the net assets of the insurance subsidiaries available for transfer to the Company are limited to the greater of the subsidiary net gain from operations during the preceding year or 10% of the subsidiary net statutory surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. Payments of dividends in excess of such amounts would generally require approval by the regulatory authorities. Based upon statutory net gain from operation and surplus of the individual insurance companies as of and for the year ended December 31, 1998 approximately $5,489,797 of dividends could be paid to the Company without prior regulatory approval.
CICA, USLIC, NSLIC, and CILIC have calculated their risk based capital (RBC) in accordance with the National Association of Insurance Commissioners' Model Rule and the RBC rules as adopted by their respective state of domicile. The RBC as calculated for CICA and CILIC exceeded levels requiring company or regulatory action.
The RBC as calculated for USLIC and NSLIC at December 31, 1998, failed to maintain the minimum policyholder surplus equivalent under the RBC calculation. In 1999, CICA contributed $600,000 and $500,000 in capital to USLIC and NSLIC, respectively. USLIC and NSLIC expect to revise their 1998 statutory annual statements filed with regulatory authorities based upon an error in the calculation of claim reserves at December 31, 1998. The anticipated reduction in claim reserves and the additional capital contributions made during 1999 will be sufficient for USLIC and NSLIC to exceed the RBC levels as required by the National Association of Insurance Commissioners.
(8) STOCK OPTIONS
During 1989, the Company entered into an agreement granting, a financial public relations consultant providing services to the Company, the right and option to purchase 100,000 shares of Class A no par common stock of the Company at $2.50 per share, the fair market value of the common stock at the date of the agreement. The option which would have expired on February 8, 1994 was extended for an additional 36 months during 1993. During 1996, options to purchase 41,500 shares were exercised. During 1997, 52,200 shares were issued in conjunction with the exercise of this option. The remaining options expired in 1997. The outstanding options had no impact on diluted earnings per share for the years ended December 31, 1996.
(9) MERGER AND ACQUISITIONS
During March 1997, the Company acquired the 5.52% minority interest in FAIC, a 94.8% subsidiary of ALFC. The Company issued 134,125 shares of the Company's Class A stock to consummate this transaction. The excess of cost over net assets acquired amounted to $1,065,696 of which $399,353 was written off concurrent with the acquisition. Effective January 1, 1997, AFLC was merged into Citizens and FAIC was merged into CICA.
On October 28, 1996, CICA announced that it had signed definitive written agreements for the acquisition of AIN, a Jackson, Mississippi, based life insurance holding company and
its wholly-owned subsidiary USLIC with $7.5 million in assets, $3.4 million of stockholders' equity, revenues of $3.2 million and $67 million of life insurance in-force.
The AIN agreement provided that following the acquisition by CICA, AIN shareholders will receive 1 share of Citizens, Inc. Class A Common Stock for each 7.2 shares of AIN Common Stock owned. The Company issued approximately 700,000 Class A common shares in connection with the transaction, which was accounted for as a purchase. The transaction was consummated on June 19, 1997. During 1998, AIN was liquidated and USLIC was merged into CICA.
On August 13, 1997, Citizens signed a definitive agreement to acquire 100% of the outstanding shares of NSLIC of Arlington, Texas for $1.7 million in cash and restricted stock. The transaction, which was accounted for as a purchase, was consummated on November 20, 1997.
In conjunction with the acquisition the Company and two executives of NSLIC executed employment agreements which require the executives to provide services to the Company for 42 months. The employees will be compensated $8,333 a month for the first twelve months escalating to $12,500 a month for the remaining thirty months.
The pro-forma unaudited results of operations for the years ended December 31, 1997 and 1996, assuming the purchase of AIN, NSLIC and the minority ownership in FAIC, had been consummated at the beginning of fiscal 1996, are presented below. Adjustments have been made for amortization of amounts assigned to the fair value of historical assets. It is assumed in the pro-forma basic earnings per share calculations that the shares issued in connection with the acquisitions were outstanding from the beginning of the period presented (stated in thousands other than per share amounts).
The IIH agreement closed on March 12, 1996 and provided that Investors' shareholders would receive one share of Citizens' Class A Common Stock for each eight shares of Investors Common Stock owned. Additionally, Citizens acquired all shares of CILIC (a 94% owned subsidiary of Investors) not already owned by Investors, based upon an exchange ratio of one share of Citizens' Class A common stock for each four shares of Central Investors owned. The acquisition of these two companies involved the issuance of approximately 171,000 of Citizens' Class A shares which was accounted for as a purchase. During 1998, IIH was liquidated and CILIC was merged into CICA.
On September 15, 1998, Citizens announced that a definitive agreement had been reached between Citizens and First Investors Group, Inc. (Investors) of Springfield, Illinois wherein Citizens would acquire 100% of the outstanding shares of Investors for approximately 610,000 shares of Citizens Class A Common stock. Investors is the parent of Excalibur
Insurance Corporation (Excalibur), also of Springfield, Illinois. This transaction closed on January 26, 1999.
Pursuant to the terms of the Agreement, which was approved by Investors' shareholders and regulatory authorities, Citizens issued one share of Citizens Class A Common stock for each 6.6836 shares of Investors common and preferred stock issued and outstanding. Citizens issued approximately 610,000 shares of its Class A Common stock to consummate the transaction.
(10) CONTINGENCIES
The Company is a party to various legal proceedings incidental to its business. Contingent liabilities that might arise from litigation are not considered material in relation to the financial position of the Company.
Reserves for claims payable are based on the expected claim amount to be paid after a case by case review of the facts and circumstances relating to each claim. A contingency exists with regard to these reserves until such time as the claims are adjudicated and paid.
(11) SEGMENT INFORMATION
The Company has two reportable segments identified by geographic area: International Business and Domestic Business. International Business consists of ordinary whole-life business. International sales are throughout Latin America with policies sold to residents of Central and South America. The Company has no assets, offices or employees outside of the United States of America (U.S.) and requires that all transactions be in U.S. dollars paid in the U.S. Domestic Business consisting of traditional life and burial insurance, pre-need policies, accident and health specified disease, hospital indemnity and accidental death policies are sold throughout the Southern U.S.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on GAAP net income (loss) before federal income taxes for its two reportable segments.
Geographic Areas - The following summary represents financial data of the Company's continuing operations based on their location.
The following summary represents revenues and pretax income from continuing operations and identifiable assets for the Company's reportable segments as of and for the years ended December 31, 1998, 1997 and 1996, is as follows:
(12) INCOME TAXES
A reconciliation of federal income tax expense computed by applying the federal income tax rate of 34% to income before federal income tax expense are as follows:
Income tax expense (benefit) for the years ended December 31, 1998, 1997 and 1996 consists of:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below.
During 1998 the Company released the valuation allowance associated with ALFC net operating losses as these losses can be utilized by Citizens, Inc. as a result of the merger of these two entities.
The Company has established a valuation allowance for net operating losses of IIH and other entities which may not be used prior to their expiration. The Company and its subsidiaries have net operating losses at December 31, 1998 available to offset future taxable income of approximately $1,733,000 for Federal income tax which expire through 2008. The net operating loss carryforward is subject to limitations under Section 382 of the Internal Revenue Code.
At December 31, 1998, the Company had accumulated approximately $3,291,000 in its "policyholders' surplus account." This is a special memorandum tax account into which certain amounts not previously taxed, under prior tax laws, were accumulated. No new additions will be made to this account. Federal income taxes will become payable thereon at the then current tax rate (a) when and if distributions to the shareholder, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income; or (b) when a company ceases to be a life insurance company as defined by the Internal Revenue Code and such termination is not due to another life insurance company acquiring its assets in a nontaxable transaction. The Company does not anticipate any transactions that would cause any part of this amount to become taxable. However, should the balance at December 31, 1998 become taxable, the tax computed at present rates would be approximately $1,119,000.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimates of fair values are made at a specific point in time, based on relevant market prices and information about the financial instrument. The estimated fair values of financial instruments presented below are not necessarily indicative of the amounts the Company might realize in actual market transactions. The carrying amount and fair value for the financial assets and liabilities on the consolidated balance sheets at each year-end were:
Fair values for fixed income securities and equity securities are based on quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other assumptions, including the discount rate and estimates of future cash flows.
Mortgage loans are secured principally by residential properties. Weighted average interest rate for these loans as of December 31, 1998, was approximately 8.7% with maturities ranging from one to fifteen years. Management believes that reported amounts approximate fair value.
Student loans are guaranteed by the government. Weighted average interest rate for these loans as of December 31, 1998, was approximately 7.44%. Management believes that the reported amounts approximate fair value as these loans are sold as soon as possible.
The carrying value of the note payable approximates fair value as the interest rate charged on the note payable is indexed with the prime rate.
The carrying value and fair values for the Company's liabilities under annuity contract policies are the same as the interest rates credited to these products and are periodically
adjusted by the Company to reflect market conditions. The fair values of liabilities under all insurance contracts are taken into consideration in the overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
Policy loans have a weighted average interest rate of 7.15% as of December 31, 1998 and 1997 and have no specified maturity dates. The aggregate fair value of policy loans approximates the carrying value reflected on the consolidated balance sheet. These loans typically carry an interest rate that is tied to the crediting rate applied to the related policy and contract reserves. Policy loans are an integral part of the life insurance policies which the Company has in force and cannot be valued separately.
For cash, and short-term investments, accrued investment income, amounts recoverable from reinsurers, other assets, federal income tax payable and receivable, dividend accumulations, commissions payable, amounts held on deposit, and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.
(14) OTHER COMPREHENSIVE INCOME (LOSS)
The changes in the components of other comprehensive income (loss) are reported net of income taxes of 34% for the periods indicated as follows:
(15) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table contains selected unaudited consolidated financial data for each quarter.
(16) YEAR 2000 ISSUES (UNAUDITED)
The Company has investigated the potential impact of the Year 2000 on its systems, procedures, customers and business processes. The Year 2000 assessment provided information used to determine what system components must be changed or replaced to minimize the impact of the calendar change from 1999 to 2000.
The Company continues to use internal resources to modify, replace and test the Year 2000 modifications. Management estimates 90% of the identified modifications to mission critical systems and 60% of the identified modifications to other systems have been completed for its Year 2000 project. The project completion is scheduled to occur prior to any anticipated impact on the Company operations. The total cost for the project is negligible as it is being performed with existing staff, with costs being expensed as incurred until completion.
The Company faces the risk that one or more of its critical suppliers or customers (external relationships) will not be able to interact with the Company due to the third party's inability to resolve their own Year 2000 issues. The Company has identified its external relationships and has determined the overall Year 2000 readiness of its external relationships. The Company has received information as to those parties' Year 2000 plans and state of readiness. The Company has determined that all mission critical systems are either Year 2000 compliant or can be circumvented (at minimal cost and time) by using non-electronic transactions. In addition, any other systems that were deemed to not be Year 2000 compliant, have been reported to have no loss of data or functionality.
The Company believes it has addressed its Year 2000 concerns. The Company has begun to develop contingency and recovery plans aimed at ensuring the continuity of critical business functions before, on and after December 31, 1999. The contingency and recovery planning is substantially complete. The Year 2000 contingency plans will be reviewed periodically throughout 1999 and revised as needed. The Company believes its Year 2000 contingency plan, coupled with existing "disaster recovery" and "business resumption" plans, minimize the impact Year 2000 issues may have on the organization.
SCHEDULE II
CITIZENS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CITIZENS, INC. (PARENT COMPANY)
STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 1998 AND 1997
(1) Eliminated in consolidation.
See accompanying independent auditors' report.
SCHEDULE II, CONTINUED
CITIZENS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CITIZENS, INC. (PARENT COMPANY)
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 1998 AND 1997 AND 1996
(1) Eliminated in consolidation.
See accompanying independent auditors' report.
SCHEDULE II, CONTINUED
CITIZENS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CITIZENS, INC. (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
See accompanying independent auditors' report.
SCHEDULE IV
CITIZENS, INC. AND SUBSIDIARIES
REINSURANCE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
See accompanying independent auditors' report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
CITIZENS, INC.
Date: March 30, 1999 By: /s/ Mark A. Oliver ----------------------------------------- Mark A. Oliver, President
By: /s/ Jeffrey J. Wood ----------------------------------------- Jeffrey J. Wood, Executive Vice President, Chief Financial Officer and Secretary/ Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Each individual whose signature appears below hereby designates and appoints Harold E. Riley and Mark A. Oliver, and each of them, as such person's true and lawful attorney's-in-fact and agents (the "Attorneys-in-Fact") with full power of substitution and resubstitution, for each person and in such person's name, place, and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K, which amendments may make such changes in this Annual Report on Form 10-K as either Attorney-in-Fact deems appropriate and to file therewith, with the Securities and Exchange Commission, granting unto such Attorneys-in-Fact and each of them, full power and authority to do and perform each and every act and think requisite and necessary to be done in and about the premises, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that such Attorneys-in-Fact or either of them, in their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
INDEX TO EXHIBITS