Citizens, Inc. — Q2 2015 Form 10-Q
Business context and period: Citizens is an insurance holding company focused primarily on life insurance, with domestic and international operations, including substantial sales to policyholders in Latin America and the Pacific Rim. This unaudited filing covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are to December 31, 2014. Amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $60.1 | $56.5 | $115.9 | $109.5 |
| Income (loss) before tax | $(0.8) | $1.5 | $(0.5) | $3.2 |
| Net income (loss) | $(1.9) | $1.2 | $(1.5) | $2.3 |
| Class A diluted EPS | $(0.04) | $0.03 | $(0.03) | $0.05 |
- Revenue and margins: Revenue rose 6.3% in Q2 and 5.8% year to date. Net margin was approximately (3.2)% for Q2 and (1.3)% year to date, versus approximately 2.0% and 2.1% in the comparable 2014 periods.
- Drivers: Insurance premiums increased 4.6% in Q2 and 4.1% year to date, primarily from life insurance first-year and renewal business. Net investment income increased 11.1% and 11.4%, respectively. Claims and surrenders rose 15.4% in Q2 and 16.7% year to date; other general expenses increased to $10.4 million in Q2 and $18.0 million year to date, including costs associated with tax-compliance matters.
- Cash flow: Six-month operating cash flow was $39.8 million, compared with $43.4 million in 2014. Investing activities used $54.1 million versus $40.6 million; financing provided $1.4 million versus effectively nil. Cash declined to $37.8 million from $50.7 million at year-end, which management attributed mainly to timing of cash inflows and investment purchases.
- Balance sheet and liquidity: At June 30, assets were $1.450 billion, liabilities $1.201 billion and stockholders’ equity $249.2 million. Investments totaled $1.102 billion; policy liabilities were $1.098 billion. No separate conventional debt balance is presented in the supplied financial statements. Management said operating cash flows and available liquidity were expected to meet needs; 66.3% of investments were marketable available-for-sale debt securities.
- Investment and comprehensive income: Fixed maturities were $966.7 million, or 87.7% of investments; 96.9% were investment grade. Net unrealized gains on fixed maturities fell to $33.4 million from $47.2 million at year-end. Six-month other comprehensive loss was $7.6 million, contributing to comprehensive loss of $9.1 million.
Material changes and management commentary
- Life Insurance reported a pretax loss of $0.8 million for the first half, versus income of $1.1 million a year earlier. Home Service Insurance pretax income fell to $0.9 million from $2.9 million. Management cited higher claims, surrender activity and compliance-related expenses; the 2015 Home Service comparison also includes six months of MGLIC, versus four months in 2014.
- Life-segment surrenders increased 41.7% year to date, primarily in older international policies after surrender charges expired. Management said mortality experience remained within expected levels, though year-to-date claims experience was unfavorable.
- There is no specific earnings or revenue guidance in the filing. Management noted that interim results are not necessarily indicative of full-year results and said yields were rising modestly as investments were reinvested. The consolidated portfolio’s annualized yield was 4.25%, versus 4.21% in the comparable 2014 period.
Risks, contingencies and unusual items
- Insurance-product tax compliance: The company identified life policies that may not qualify for favorable treatment under IRC Sections 7702 and 7702A; it also identified annuity contracts lacking qualifying Section 72(s) language in July 2015. The filing reports an estimated range of $13.9 million to $46.6 million, net of tax, for probable expenses and liabilities and says the company recorded the low end. The life-policy matter included $11.4 million recorded as of December 31, 2014; the annuity matter resulted in $2.5 million of pretax expense recorded as of June 30, 2015. Further remediation and consulting costs were possible, and actual costs could exceed the estimate. Some affected international products will not be remediated; policyholder tax consequences and possible surrenders remain risks.
- Other compliance and contingency exposure: The company identified potential deficiencies in its Bank Secrecy Act program and could not estimate any related loss. State-authorized unclaimed-property audits are underway; possible Louisiana exposure could be substantial, but no amount was estimable. Routine legal and regulatory matters were described as immaterial to the financial statements.
- Capital, markets and controls: All insurance subsidiaries were above minimum risk-based capital requirements at June 30. Interest-rate movements affect investment values and equity; unrealized losses could become realized or require impairment. The filing says no other-than-temporary impairments were recognized. Disclosure controls were judged effective, while the company continued remediation of a material weakness in the actuarial function identified at year-end 2014.
Important facts for investors to verify
- Updated estimates, reserves, remediation plans and policyholder impacts for the IRC 7702/7702A and 72(s) matters, including whether costs exceed the recorded low-end estimate.
- Progress and potential financial exposure from the Bank Secrecy Act review and state unclaimed-property audits, particularly in Louisiana.
- Subsequent trends in life-policy surrenders, claims experience, premium growth and segment profitability.
- Investment portfolio credit quality, interest-rate sensitivity, unrealized losses and available liquidity as cash is reinvested.
- Status of the actuarial control remediation and any effect on reserves, statutory capital or reported results.