Citizens, Inc. — Q1 2017 Form 10-Q
Business context and period. The unaudited filing covers the three months ended March 31, 2017, with balance-sheet comparisons to December 31, 2016. Citizens is an insurance holding company focused primarily on life insurance, including policies sold to customers in the U.S. and international markets, notably Latin America and the Pacific Rim. It reported approximately $1.6 billion in assets and $5.0 billion of insurance in force.
Financial performance and position
- Revenue: $59.6 million, up 9.3% from $54.5 million. Insurance premiums were $45.4 million, up 2.1%; net investment income was $12.7 million, up 8.6%.
- Profit: Net income was $2.1 million, compared with a $2.4 million net loss in Q1 2016. Pretax income was $0.9 million versus a $1.3 million pretax loss. Class A basic and diluted EPS were $0.04, versus a $0.05 loss. The reported income tax benefit was $1.1 million.
- Unusual revenue item: Net realized investment gains were $1.3 million, including approximately $1.1 million from the sale of the Markham building in Little Rock. Q1 2016 included $1.9 million of other-than-temporary impairments.
- Claims and expenses: Claims and surrenders increased 14.3% to $21.7 million, principally reflecting higher life surrender benefits. Total benefits and expenses rose to $58.6 million from $55.8 million; general expenses increased to $10.2 million from $9.2 million.
- Cash flow: Operating cash flow was $21.6 million, compared with $21.0 million. Investing activities used $17.3 million, versus $59.1 million; financing provided $1.3 million. Cash and cash equivalents increased to $41.2 million from $35.5 million.
- Assets and liquidity: Total assets were $1.610 billion, up from $1.584 billion at year-end. Total investments were $1.242 billion; available-for-sale fixed maturities were $907.2 million at fair value. Management said available liquidity and future cash flows were expected to meet funding needs, and that it had not needed to liquidate investments in Q1.
- Capital and liabilities: Stockholders’ equity was $254.4 million, up from $249.1 million. Total policy liabilities were $1.236 billion, primarily future life policy benefit reserves. No borrowing balance is shown as a separate line in the balance sheet; the filing does not clearly state a total debt figure. All insurance subsidiaries were above applicable RBC minimums, without ratios provided here.
- Investment yield and portfolio: The annualized yield on average invested assets was 4.22%, down from 4.29% in Q1 2016. Fixed maturities represented about 89.7% of cash, cash equivalents and investments; approximately 97.1% of fixed maturities were investment grade. Net unrealized gains on fixed maturities were $33.0 million at quarter-end.
Material changes versus Q1 2016
- Premium growth and higher investment income, together with a reversal from investment impairment losses to realized gains, accompanied a return to quarterly profitability.
- Life Insurance pretax income improved to $1.7 million from a $0.4 million loss; Home Service Insurance improved to $0.3 million from a $0.4 million loss. Other Non-Insurance Enterprises reported a $1.0 million loss, compared with a $0.5 million loss.
- Life surrender benefits rose 26% in the segment, and total surrender benefits increased 23.8%. Management attributed the trend largely to a maturing book of business and policies entering later durations with reduced or expired surrender charges.
- New ordinary life insurance production increased: issued face amount and policy counts rose in both Life and Home Service. Domestic life products that did not comply with IRC Section 7702 were discontinued effective January 1, 2017.
- Cash used in investing activities was substantially lower than in Q1 2016, primarily reflecting differences in investment purchases and maturities.
Outlook, risks, contingencies and other notable matters
- Strategy: The board and new executive team were reviewing domestic and international business models, products and profitability, potential international restructuring, technology and cyber-risk needs, and management staffing. No specific financial guidance was provided.
- IRC tax-compliance exposure: The company estimated a $12.8 million after-tax liability for policies that may not qualify under IRC Sections 7702 and 72(s), within an estimated after-tax range of $7.4 million to $38.8 million. It recorded $0.5 million of additional general expenses in Q1 and estimated another $1.0 million to $2.0 million of 2017 costs, while cautioning these costs could exceed the estimate. The company expected to submit required IRS filings in 2017, subject to uncertainty.
- International and product risks: Management identified foreign insurance regulation, political instability, currency restrictions and customer access to U.S. dollars as risks to international sales and premium collection. The company expected 2017 domestic sales to decline because noncompliant products had been withdrawn and compliant replacements were still being developed.
- Other contingencies: State audits of unclaimed-property practices were underway in Louisiana, Arkansas and Texas. Possible payments, penalties and interest could not be estimated; Louisiana exposure could be substantial depending on the state’s position. A putative securities class action filed in March 2017 seeks unspecified damages; the company said it would defend the case and could not estimate the outcome.
- Governance and controls: The filing noted recent executive and board appointments and ongoing remediation of material weaknesses disclosed in the 2016 Form 10-K. Management concluded disclosure controls were effective at quarter-end; it reported no Q1 changes in internal controls that materially affected, or were reasonably likely to materially affect, those controls.
- Market and operating risks: Interest-rate changes, callable bonds, credit downgrades, higher surrenders, reserve assumptions, foreign-market concentration, regulatory developments and potential investment impairments could affect results, liquidity or equity. Management also noted the actuarial-system conversion was expected to be completed in 2017 and could identify additional differences.
Important facts for investors to verify
- How the $12.8 million tax-compliance reserve and $7.4 million–$38.8 million estimated range evolve as IRS filings and policy remediation proceed.
- Whether higher surrender activity persists and affects cash flows, acquisition-cost amortization or policy reserves.
- Progress on replacement domestic products and the strategic review of international operations, including any changes to foreign-market access.
- Results and potential financial exposure from the securities lawsuit and unclaimed-property audits, particularly in Louisiana.
- Remediation of the previously identified material weaknesses and completion of the actuarial-system conversion.
- Investment portfolio credit quality, municipal concentration, interest-rate sensitivity and the effect of realized gains or impairments on recurring earnings.