Citizens, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. Citizens is an insurance holding company focused on life insurance, including U.S.-dollar policies sold to foreign residents, and home service insurance. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless stated otherwise. The company reported approximately $1.6 billion of assets and $4.4 billion of insurance in force.
Financial results and position
| Metric | Q3 2018 | Nine months 2018 | Comparable 2017 |
|---|---|---|---|
| Total revenue | $61.2 million, down 4.9% | $178.4 million, down 3.4% | $64.3 million; $184.8 million |
| Net income (loss) | $(14.8) million | $(17.3) million | $3.4 million; $6.1 million |
| Income before tax | $5.6 million | $4.0 million | $3.1 million; $6.1 million |
| Net investment income | $13.6 million, down 1.7% | $41.2 million, up 3.9% | $13.8 million; $39.6 million |
| Operating cash flow | Not presented quarterly | $65.2 million | $68.9 million |
Calculated pretax margin was approximately 9.1% for Q3 and 2.3% for the nine-month period; net margin was approximately (24.1)% and (9.7)%, respectively, chiefly reflecting the unusually high tax expense. Class A EPS was $(0.30) for Q3 and $(0.35) year to date, versus $0.07 and $0.12 in 2017.
At September 30, total assets were $1.602 billion, total liabilities $1.421 billion, and stockholders’ equity $180.7 million, down from $223.5 million at year-end 2017. Cash and equivalents were $68.8 million, up from $46.1 million. Fixed maturities were $1.200 billion at fair value; all fixed maturities were classified available-for-sale at period end. Policy liabilities totaled $1.336 billion. The filing reports no conventional borrowings; it does report $56.1 million of annuity investment-contract liabilities.
For the nine months, investing activities used $42.4 million and financing activities used $0.2 million. Net cash increased $22.7 million. The portfolio’s annualized yield on average invested assets was 4.29%, versus 4.31% for the comparable 2017 period. Net unrealized gains on fixed maturities fell to $6.9 million from $46.0 million at year-end, largely amid higher interest rates.
Material changes and management commentary
- Premiums declined 5.6% in Q3 and 4.0% year to date, mainly from lower first-year and renewal life premiums. Life segment pretax income improved to $7.0 million in Q3 and $11.6 million year to date; Home Service reported pretax losses of $0.4 million and $3.1 million, respectively.
- Claims and surrenders rose 16.9% in Q3 and 7.6% year to date, with matured endowment benefits a major contributor. Management expects maturities to continue as older endowment policies reach their contractual dates. Surrenders also increased, including in Colombia and Taiwan.
- On July 1, the company novated its international CICA policies to its new Bermuda subsidiary, CICA Ltd. The transition, Brazil sales exit, political instability in Venezuela, and slower acceptance of repriced products are disrupting international sales; the duration and ultimate impact remain uncertain. Brazil represented less than 6% of premiums and less than 1% of in-force policies at December 31, 2017.
- The new AXIS actuarial system conversion affected reserves and deferred acquisition costs. The note’s quantified impact shows a $10.2 million reduction in life reserves and a $4.3 million reduction in deferred acquisition costs, increasing pretax income by $5.9 million. Management’s discussion elsewhere cites a $11.9 million reserve reduction; investors should reconcile the disclosures. The conversion also increased DAC amortization.
- Federal income tax expense was $21.3 million for the nine months, despite pretax income of $4.0 million. Management attributed $18.7 million of tax expense to Subpart F income associated largely with the novation. The resulting effective tax rate was 528.7%.
- Operating expenses increased, reflecting audit costs, executive compensation, technology work, and tax-compliance matters. Investment losses included $0.8 million of other-than-temporary impairments year to date. Make-whole bond calls also contributed less investment income than in 2017.
Outlook, risks and contingencies
No quantified earnings or revenue guidance is provided. Management is reviewing product profitability, international markets and operations, technology modernization, Bermuda operations, and investment strategy. It says available liquidity and future cash flows are currently expected to meet needs, while monitoring policyholder behavior and maturing endowments.
- The estimated liability for policies that may not qualify under IRC Sections 7702 and 72(s) is $8.9 million, within a disclosed estimated range of $4.5 million to $52.5 million. The IRS has not responded to the company’s 2017 offer for closing agreements; actual costs could exceed the estimate or disclosed range. Additional 2018 costs of $0.5 million to $1.5 million were anticipated.
- Potential Louisiana unclaimed-property exposure cannot be reasonably estimated and could be substantial for SPLIC. The filing also identifies ordinary-course litigation and regulatory risks.
- All insurance subsidiaries were above RBC minimums at September 30. The company has agreed to provide capital to CICA if needed to keep its risk-based capital above 350% at future year ends; Bermuda regulatory capital requirements may also require funding.
- Liquidity risks include lump-sum payments on maturing endowments, increased surrenders, and reinvestment of bonds at lower yields. About 50% of in-force policies were endowment products, and policyholder election behavior is uncertain.
- Disclosure controls were assessed as ineffective because previously identified material weaknesses in internal control over financial reporting remained unremediated. New Oracle ERP and AXIS systems also changed reporting processes; management began testing remediation controls in Q3.
- The SEC notified the company in August 2018 that it had concluded its investigation and would not recommend enforcement action based on information then available.
Important facts for investors to verify
- How the IRS resolves the 7702/72(s) matters, including whether the $8.9 million reserve is adequate relative to the disclosed range.
- Whether Bermuda novation and international-market changes stabilize new business, renewals, and surrender experience—particularly in Venezuela and after the Brazil exit.
- The reconciled financial impact of the AXIS conversion and whether further system-conversion adjustments will be required.
- Progress in remediating material weaknesses and the effectiveness of controls over the new ERP and actuarial systems.
- Policyholder choices at endowment maturity, liquidity needs, investment yields, and the effect of declining unrealized gains or further impairments on equity.