Citizens, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. Citizens is an insurance holding company focused on life insurance, with additional home-service insurance operations and non-insurance support entities. This unaudited filing covers the quarter and six months ended June 30, 2017; comparative income and cash-flow figures are for 2016. Most direct premiums come from international markets, particularly Latin America and the Pacific Rim.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $60.9 million | $61.2 million | $120.4 million | $115.8 million |
| Income before tax | $2.1 million | $2.6 million | $3.0 million | $1.3 million |
| Net income (loss) | $0.6 million | $1.5 million | $2.6 million | $(0.9) million |
| Class A EPS, basic and diluted | $0.01 | $0.03 | $0.05 | $(0.02) |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $43.4 million | $43.0 million |
Revenue and profitability. Q2 revenue declined about 0.6% year over year, while six-month revenue rose about 4.0%. Six-month premiums were down 0.3% to $93.1 million; net investment income increased 8.8% to $25.8 million. The six-month realized investment result improved to a $1.1 million gain from a $1.8 million loss, including a gain on the sale of the Markham building. Six-month net margin was approximately 2.2%, versus a loss in the prior-year period; Q2 net margin was approximately 0.9%, compared with 2.4%.
Six-month benefits and expenses increased to $117.4 million from $114.5 million. Other general expenses rose 10.0%, chiefly due to audit, legal and consulting fees and higher salaries. The six-month effective tax rate was 13.5%; Q2’s was 72.7%, reflecting tax-compliance matters and other items.
Balance sheet and liquidity. At June 30, total assets were $1.624 billion, up from $1.584 billion at year-end 2016. Investments totaled $1.267 billion and cash and cash equivalents were $33.7 million, compared with $35.5 million at year-end. Total liabilities were $1.366 billion, including $1.254 billion of policy liabilities; stockholders’ equity was $258.0 million. The filing does not present a conventional corporate debt balance or leverage measure. It reports no off-balance-sheet arrangements. Six-month investing cash outflow was $46.5 million and financing cash inflow was $1.3 million. Management said liquidity sources and projected cash flows are expected to meet needs; available-for-sale debt securities provide a further liquidity source.
Fixed maturities were 90.4% of cash, cash equivalents and investments. The annualized yield on average invested assets was 4.24%, down from 4.31% in the prior-year period. Approximately 97.5% of fixed maturities were investment grade, according to the filing.
Material changes and management commentary
- Citizens and CNLIC stopped selling noncompliant domestic life products on January 1, 2017. The company is developing Section 7702-compliant products and says domestic sales will resume after regulatory approval; it expects 2017 sales to decline because of the product gap.
- International premiums remain exposed to foreign regulation, political and economic conditions, and customers’ access to U.S. dollars. The company specifically warned that worsening conditions in Venezuela may further reduce sales and collections there.
- Management and the Board are reviewing domestic and international business models, products, profitability, technology and potential restructuring. Management also described plans to extend asset duration and seek higher yields if market returns rise, while acknowledging that repricing and product changes could reduce demand.
- The company made progress adding senior leaders and directors and is recruiting a Chief Information Officer. It is working to remediate material weaknesses and other control deficiencies identified in its 2016 Form 10-K. Disclosure controls were concluded to be effective at quarter-end, but remediation remains ongoing.
- EY notified the company on June 30, 2017 that it would resign as independent auditor; EY completed its review of this quarter’s interim statements.
- Management attributed lower Q2 claims and surrenders partly to lower death claims, but six-month surrenders increased, particularly in the maturing life-insurance book. Louisiana property claims were affected by tornadoes during Q1.
Risks, contingencies and unusual items
- IRC tax-compliance exposure: Certain policies do not qualify under IRC Sections 7702 or 72(s). The estimated liability was $12.3 million after tax, with an estimated range of $7.1 million to $37.7 million after tax; actual exposure could exceed the range. The company recorded $1.0 million of related general expenses in the first half and anticipated additional 2017 costs, which it could not reliably estimate. It submitted IRS closing-agreement offers for certain domestic business and expected additional offers for other blocks.
- Unclaimed property audits: Louisiana, Arkansas and Texas authorized audits. Possible payments, escheatment, penalties and interest are not estimable; the company cautioned that Louisiana exposure could be substantial depending on the state’s approach.
- Litigation: A putative securities class action filed in March 2017 alleges misleading statements and seeks unspecified damages. The company intends to defend the case and cannot reasonably estimate its outcome.
- Market and investment risks: Interest rates, calls and prepayments, credit deterioration, unrealized losses and the ability to reinvest at adequate yields may affect earnings, equity and liquidity. Net unrealized gains on fixed maturities were $37.8 million at June 30.
- Other exposure: Foreign regulatory and political risks, money-laundering compliance, policyholder surrenders, claims reserves, reinsurance availability, legacy actuarial-system conversion and potential goodwill impairment are identified risks. Management noted no material cyber breach known to it.
Most important facts for investors to verify
- Progress and final cost of resolving the IRC 7702/72(s) issues, including IRS agreements, policyholder remediation and whether exposure remains within or exceeds the $7.1–$37.7 million after-tax range.
- Timing, regulatory approval and expected economics of compliant domestic products, and the resulting effect on new business and distribution.
- Developments in foreign-market compliance and political/economic conditions, particularly premium collection and sales trends in Venezuela.
- Results of the unclaimed-property audits and the securities class action, neither of which had a quantifiable outcome in this filing.
- Auditor transition, remediation of previously identified material weaknesses, actuarial-system conversion and any resulting financial-statement corrections.
- Investment portfolio credit quality, interest-rate and call exposure, surrender experience, and capital adequacy of insurance subsidiaries; the filing states all subsidiaries exceeded RBC minimums at June 30, 2017.