Citizens, Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. Citizens is a life insurance holding company with Life Insurance, Home Service Insurance, and Other Non-Insurance Enterprises segments. It reported approximately $4.5 billion of net insurance in force and $1.6 billion of assets at year-end. The filing was signed April 27, 2017.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $245.4 million | $236.3 million |
| Insurance premiums | $197.9 million | $194.5 million |
| Net investment income | $48.6 million | $45.8 million |
| Net realized investment losses | $2.0 million | $5.5 million |
| Income (loss) before tax | $5.5 million | $(1.9) million |
| Net income (loss) | $2.0 million | $(3.1) million |
| Class A earnings (loss) per share | $0.04 | $(0.06) |
| Operating cash flow | $102.3 million | $87.2 million |
| Total assets | $1,583.7 million | $1,480.8 million |
| Total liabilities | $1,334.6 million | $1,233.8 million |
| Stockholders’ equity | $249.1 million | $246.9 million |
Net investment portfolio yield was 4.28%, down from 4.38%. Fixed maturities were $1,128.7 million, or 89.7% of cash, cash equivalents, and investments; 97.2% of fixed maturities were investment grade, with 78.2% rated A or higher. Gross unrealized losses on available-for-sale securities were $9.4 million. The filing reports no off-balance-sheet arrangements and does not report conventional borrowings; total liabilities are principally insurance and policyholder obligations.
Cash and cash equivalents were $35.5 million, compared with $82.8 million a year earlier. The company reported no liquidity issues in 2016 and expected available liquidity and future cash flows to meet needs. Cash used in investing activities was $152.1 million, mainly reflecting investment of operating cash and prior-year excess cash. Insurance subsidiaries exceeded minimum risk-based capital requirements. Citizens had $14.7 million of parent-company cash and $51.4 million of available-for-sale fixed maturities.
Fourth-quarter 2016 revenue was $67.9 million and net income was $116,000, versus a $2.2 million net loss in fourth-quarter 2015.
Material changes versus prior periods
- Revenue rose 3.9% and premiums rose 1.7% year over year; net income returned to profit after losses in 2014 and 2015.
- Life Insurance segment pre-tax income improved to $5.4 million from a $4.8 million loss. Home Service pre-tax income fell to $2.3 million from $4.5 million; Other Non-Insurance Enterprises reported a $2.2 million pre-tax loss.
- Claims and surrenders increased to $81.4 million from $78.9 million, driven notably by surrender benefits and matured endowments. DAC amortization increased to $28.5 million from $23.4 million, primarily due to higher surrender activity.
- Policyholder dividends declined 36.4% following dividend-scale reductions. OTTI losses decreased to $4.3 million from $5.4 million, but remained a drag on earnings.
- Assets increased by $102.9 million, while cash declined by $47.3 million. The company’s five-year overview reports that 2012–2016 revenue grew 21%, while net income fell 61%.
Outlook, risks, contingencies, and unusual items
- Tax compliance exposure: Some life policies did not qualify under IRC Section 7702, and certain annuity contracts did not qualify under Section 72(s). The company recorded a $14.4 million after-tax reserve; its probability-weighted estimated range was $7.5 million to $44.8 million after tax. Management expected to submit IRS filings in 2017, but outcomes and timing remained uncertain. Additional 2017 costs were estimated at $1.0 million to $2.0 million, with actual costs potentially higher.
- International regulatory and political exposure: Approximately 73% of 2016 direct premiums came from foreign residents, principally in Latin America and the Pacific Rim. The company had not qualified to do business or obtained policy approvals in foreign countries and relied on independent consultants to comply with local laws. Its compliance review confirmed risks in at least some jurisdictions; possible responses include changing the business model or withdrawing from markets. Venezuela-related instability and currency-access risks are also relevant.
- Product and sales outlook: Citizens repriced its six top-selling international products at year-end to improve profitability and cut discretionary dividends. Management said lower customer returns could reduce demand. Domestic life products that did not comply with Section 7702 were discontinued effective January 1, 2017; compliant replacements were in development, and management expected 2017 sales to decline while products were unavailable.
- Interest rates and investments: Low rates, callable bonds, reinvestment yields, credit deterioration, and higher rates that reduce bond fair values could affect earnings, equity, and liquidity. A modeled 100-basis-point rate increase would reduce fixed-maturity fair value by approximately $56.9 million. The portfolio is concentrated in municipal bonds, including exposure to Texas, Florida, and Louisiana.
- Controls and restatement: Management and Ernst & Young concluded that internal control over financial reporting was ineffective at year-end due to material weaknesses in data validation and review, oversight of third-party service providers, and staff expertise in actuarial and tax work. Remediation was ongoing. Prior-year financial statements were restated for errors involving DAC and policy benefit reserves; the company characterized the errors as immaterial to those prior periods. The financial-statement audit opinion was unqualified, but the auditor issued an adverse opinion on internal control.
- Legal and other contingencies: A putative securities class action filed in March 2017 seeks unspecified damages; the company intended to defend it and could not estimate the outcome. State audits of unclaimed-property practices could lead to payments, penalties, or interest; Louisiana exposure could be substantial but was not estimable. No cash dividends were paid or expected in the foreseeable future.
- Other items: The Home Service goodwill unit failed the first step of its impairment test but passed step two, leaving its $4.6 million goodwill unimpaired in 2016. A Little Rock building was sold in February 2017 for $3.25 million, generating a reported $1.0 million gain.
Most important facts for investors to verify
- Progress, final cost, and IRS resolution of the Section 7702 and 72(s) matters, including whether the $14.4 million reserve is adequate.
- Foreign-market compliance conclusions, regulatory actions, and any resulting changes to distribution or market access, particularly in key premium-producing countries.
- Remediation and independent testing of the material weaknesses, and whether the actuarial-system conversion identifies further reporting differences.
- Trends in international policy surrenders, persistency, new sales after repricing, and domestic sales while compliant products are developed.
- Investment portfolio credit quality, municipal and geographic concentrations, realized impairments, and the effect of interest-rate changes on capital and liquidity.
- Developments in the securities lawsuit and state unclaimed-property audits, as well as subsidiary statutory capital and dividend capacity.