CITIZENS, INC. quarterly report, Q3 FY2016

Full document

Citizens, Inc. — Q3 2016 Form 10-Q

Business context and period. Citizens is an insurance holding company focused primarily on life insurance, with domestic home-service and international businesses. This unaudited report covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are to December 31, 2015. Unless noted otherwise, amounts below are in millions.

Financial results and position

  • Third quarter: Revenue was $61.7 million, up 6.2% from $58.1 million. Net income was $2.5 million versus $0.1 million; diluted EPS was $0.05 for Class A and $0.03 for Class B, compared with approximately zero for both classes in Q3 2015. Pretax margin was approximately 6.9%, versus a small pretax loss in the prior-year quarter.
  • First nine months: Revenue was $177.5 million, up 2.0% from $174.1 million. Net income was $1.9 million, compared with a $1.4 million loss; diluted EPS was $0.04 for Class A and $0.02 for Class B, versus losses of $0.03 and $0.02, respectively. Pretax margin was approximately 2.7%, versus a pretax loss in 2015.
  • Revenue drivers: Insurance premiums rose 0.5% in both periods: $49.2 million for Q3 and $142.6 million year to date. Net investment income increased 8.8% in Q3 and 7.3% year to date, to $12.3 million and $36.1 million, respectively. The annualized portfolio yield for the first nine months was 4.29%, compared with 4.24% in 2015.
  • Benefits and expenses: Year-to-date claims and surrenders increased 4.8% to $61.0 million, while total insurance benefits declined 2.6% to $118.9 million, mainly reflecting lower reserve increases and policyholder dividends. Other general expenses declined 8.0% to $23.0 million; the comparison was affected by changes in estimates and prior-year tax-compliance expenses. Year-to-date realized investment losses were $1.8 million, including $2.3 million of other-than-temporary impairments; no such impairments were recorded in Q3 2016.
  • Cash flow: Operating activities provided $69.2 million for the first nine months, versus $62.7 million in 2015. Investing activities used $121.5 million, versus $72.7 million, primarily reflecting purchases of fixed maturities. Financing activities provided $1.8 million. Cash and cash equivalents declined $50.5 million to $32.3 million; management attributed the decrease largely to investing excess year-end 2015 cash in securities.
  • Balance sheet and liquidity: Total assets were $1.566 billion, including $1.224 billion of investments. Total liabilities were $1.304 billion, including $1.197 billion of policy liabilities; stockholders’ equity was $262.8 million. Available-for-sale fixed maturities had $48.9 million of net unrealized gains at September 30. Management said available liquidity and projected cash flows were expected to meet needs; it reported no investment liquidations to fund cash flow during the first nine months. All insurance subsidiaries were above RBC minimums.
  • Debt: The filing does not provide a clear conventional borrowings or debt balance. It reports $49.6 million of annuity investment-contract liabilities, which are insurance-related obligations rather than identified borrowings.

Material changes and management commentary

  • Improved earnings reflected higher investment income, lower policyholder dividends and lower general expenses, partly offset by higher claims and surrender costs and increased amortization of deferred acquisition costs.
  • Life premiums benefited from renewal business, while first-year life premiums fell year over year. New life policies issued and insurance amounts issued also declined. Management attributed weaker Q3 international new sales partly to a new business process that required associate training and expected Q4 sales to be in line with prior-year levels after training was completed.
  • Management reduced discretionary dividends on existing international policies and revised new-product structures in response to prolonged low interest rates. It is also reviewing products, international operations, technology and cyber-risk needs, and management structure. It cautioned that product changes could reduce demand and investment results could make its investment strategy more difficult.
  • International business is significant: approximately 72% of direct premiums for the first nine months came from foreign countries. The company cited political and economic turmoil in Latin America and regulatory uncertainty in foreign markets.

Risks, contingencies and unusual items

  • Tax qualification matter: Certain policies may not qualify under Internal Revenue Code Sections 7702 and 72(s). The company recorded an estimated liability of $12.8 million, net of tax, within a probability-weighted estimated range of $6.1 million to $40.5 million, net of tax. Management warned actual costs could exceed the reserve and even the high end of the range. It expected $0.5 million to $1.0 million of additional costs in the remainder of 2016.
  • Uncertain tax positions: The company reported $82.9 million of tax liabilities for uncertain tax positions at September 30 and $1.8 million of related tax expense for the first nine months. The IRS accepted amended 2011 and 2012 returns; the company expected to release $0.6 million of related liability in Q4 2016.
  • Unclaimed property audits: Louisiana, Arkansas and Texas authorized an audit. Potential beneficiary payments, escheatment, penalties and interest could not be estimated.
  • Investment and surrender risks: The portfolio is heavily weighted toward fixed maturities, and interest-rate movements can affect fair value, investment income and equity. Early policy surrenders increased, particularly in the life segment; a sharp increase could pressure liquidity and profitability.
  • Capital and subsequent event: On November 1, 2016, subsidiary SPLIC paid a $20.0 million extraordinary dividend to CICA, with no consolidated financial-statement impact; SPLIC remained above minimum capital requirements after payment.
  • Controls: Management concluded disclosure controls were effective at quarter-end. The company was still remediating a previously identified material weakness involving management review of external tax experts’ complex documentation.
  • No formal earnings guidance was provided. Interim results are not necessarily indicative of full-year or future results.

Important facts for investors to verify

  • Whether the $12.8 million tax-compliance reserve adequately reflects the uncertain $6.1 million–$40.5 million net-of-tax exposure, and whether further costs or policyholder surrenders emerge.
  • Whether international new-business sales recover as management expected, given lower first-year premiums, foreign-market risks and recent process changes.
  • Whether higher surrenders persist and affect policy reserves, deferred acquisition cost amortization, cash needs or earnings.
  • The credit quality and concentration of the investment portfolio, including municipal holdings, and sensitivity of unrealized gains to interest-rate changes.
  • Progress on the material-weakness remediation, the unclaimed-property audits and the company’s assessment of foreign regulatory compliance.
  • How the $20.0 million subsidiary dividend affects statutory capital and the parent’s available resources, notwithstanding management’s statement that the subsidiary remained above minimum requirements.