Citizens, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited, consolidated U.S. GAAP results. Citizens is an insurance holding company focused primarily on life insurance, including policies sold to foreign residents, and home-service insurance in the southern United States.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 or comparison |
|---|---|---|
| Total revenue | $54.5 million | $55.9 million; down 2.4% |
| Insurance premiums | $44.4 million | $44.6 million; down 0.3% |
| Net investment income | $11.7 million | $11.1 million; up 6.0% |
| Realized investment losses, net | $1.8 million | $0.1 million |
| Benefits and expenses | $56.3 million | $55.5 million |
| Pre-tax loss | $1.8 million | Pre-tax income of $0.4 million |
| Net loss | $1.9 million | Net income of $0.4 million |
| Basic and diluted EPS | Class A: $(0.04); Class B: $(0.02) | Class A: $0.01; Class B: less than $0.01 |
| Operating cash flow | $21.0 million | $17.0 million |
The net loss equaled approximately 3.6% of revenue, versus a net margin of approximately 0.8% in Q1 2015. Other comprehensive income was $8.5 million, primarily reflecting unrealized gains on available-for-sale securities; comprehensive income was $6.6 million.
- Balance sheet at March 31, 2016: Assets of $1.501 billion, liabilities of $1.252 billion, and stockholders’ equity of $249.1 million. Equity was $242.5 million at year-end 2015.
- Investments and liquidity: Investments totaled $1.153 billion; cash and cash equivalents were $45.4 million, down from $82.8 million at year-end. The company attributed the cash decline mainly to investing excess year-end cash in securities. Cash, cash equivalents, and investments totaled $1.199 billion.
- Cash flows: Investing activities used $59.1 million, versus $26.8 million in Q1 2015, largely reflecting higher fixed-maturity purchases. Financing activities provided $0.6 million. Cash decreased $37.5 million during the quarter.
- Insurance liabilities: Policy liabilities were $1.158 billion, including $1.011 billion of life insurance future benefit reserves. The filing does not list a conventional borrowings balance; annuity investment-contract liabilities were $47.9 million.
- Portfolio and yield: Fixed maturities represented 88.3% of cash, cash equivalents, and investments. The annualized consolidated portfolio yield was 4.29%, compared with 4.26% a year earlier and 4.38% at year-end 2015. Net unrealized gains on fixed maturities were $44.3 million, up from $26.5 million at year-end.
Material changes and operating drivers
- Premiums were nearly flat, with lower first-year life premiums partly offset by renewal premiums. First-year life premiums fell to $4.0 million from $4.4 million; renewal premiums increased to $28.9 million from $28.6 million.
- Claims and surrenders declined to $19.0 million from $19.4 million. Death claims fell, but life-segment surrender benefits rose 12.6%, mainly involving older policies beyond their surrender-charge periods.
- Policyholder dividends declined to $1.5 million from $2.3 million, reflecting reduced discretionary dividend scales on certain international policies.
- Other general expenses rose to $9.3 million from $7.6 million. Management cited tax-compliance consulting costs and additional audit costs; the filing identifies $0.5 million of consulting and $0.7 million of additional audit-related costs.
- Life Insurance reported a pre-tax loss of $0.8 million, versus a $0.2 million loss. Home Service Insurance shifted to a $0.3 million pre-tax loss from $0.7 million of income. Other Non-Insurance Enterprises reported a $0.6 million loss versus $0.2 million.
- The company recognized approximately $1.9 million of other-than-temporary investment impairments, relating to one available-for-sale fixed-maturity security; none were recognized in Q1 2015.
Outlook, risks, and unusual items
- Outlook and strategy: No specific financial guidance was provided. Management said it was reviewing products and profitability, the international business and operations, technology and cyber-risk needs, and management structure. It is adjusting international policy dividends and product design for the prolonged low-rate environment, while revisiting investment strategies. Management cautioned these changes could reduce demand or make investment objectives harder to achieve.
- Tax qualification contingency: Some policies may not qualify under IRC Sections 7702 and 72(s). The company recorded an estimated liability of $14.6 million after tax and disclosed a range of $9.0 million to $45.5 million after tax. The estimate includes projected IRS toll charges and fees and potential policyholder obligations; actual costs could exceed the reserve and the disclosed range. Management estimated additional 2016 costs could be $1.5 million to $2.0 million but could not reliably estimate ultimate costs.
- Other compliance matters: The company is enhancing its Bank Secrecy Act/anti-money-laundering program after identifying deficiencies in an internal review; it could not determine the potential loss. State audits of unclaimed-property compliance are underway. Potential Louisiana exposure could be substantial, but the amount was not estimable.
- Capital and liquidity: Management said available liquidity and projected cash flows should meet funding needs, and all insurance subsidiaries exceeded RBC minimums at quarter-end. Early policy surrenders, including possible surrenders connected with the tax-compliance issue, could increase cash demands. The company said it would expect the holding company to fund life subsidiaries as needed to maintain required capital.
- Market and business risks: The portfolio is exposed to interest-rate, credit, call and market-value risk; approximately 97.7% of fixed maturities were investment grade. Foreign-market regulatory, political and currency risks are significant; about 72% of 2015 direct premiums came from foreign countries. The filing also cites litigation and regulatory risk, competition, policyholder behavior, and technology and cyber risks.
- Controls: Management concluded disclosure controls were effective at quarter-end. The company was still remediating a previously identified material weakness involving management review of complex external tax documentation.
Important facts for investors to verify
- How the IRC 7702/72(s) review develops, including any IRS assessment, remediation requirements, policyholder response, and changes to the $14.6 million reserve and $9.0–$45.5 million estimated range.
- Whether the company’s increased surrenders persist and how they affect liquidity, policy persistency, and deferred acquisition cost amortization.
- Whether the investment impairment was isolated and how interest rates, issuer credit quality, callable securities, and unrealized losses affect earnings and equity.
- Developments in foreign-market compliance reviews and the Louisiana, Arkansas, and Texas unclaimed-property audits, especially the currently unquantified Louisiana exposure.
- Progress remediating the tax-review control weakness and strengthening the BSA/AML program.