CITIZENS, INC. 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This section and other parts of this Quarterly Report on Form 10-Q ("Form 10-Q") contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A . of this Form 10-Q and in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Risk Factors,” which are incorporated herein by reference. Additionally, the effects of the COVID-19 pandemic could cause our actual results to differ significantly for reasons such as: • Securities market disruption or volatility and related effects such as decreased economic activity that affect our investment portfolio; • Decreased premium revenue and cash flow from disruption to our distribution channel of independent agents, customer self-isolation, travel limitations, business restrictions and decreased economic activity; • An unusually high level of claims, lapses or surrenders in our insurance operations, which could affect our liquidity and cash flow; and • Inability of our workforce to perform necessary business functions. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part I, Item 1 of this Form 10-Q. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. The U.S. Securities and Exchange Commission ("SEC") maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov. We also make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 Reports filed by officers and directors, news releases, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the SEC. We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Form 10-Q. OVERVIEW Citizens, Inc. ("Citizens" or the "Company") is an insurance holding company incorporated in Colorado serving the life insurance needs of individuals in the United States since 1969 and internationally since 1975. Through our insurance subsidiaries, we pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We had approximately $1.8 billion of assets at June 30, 2020 and approximately $4.6 billion of direct insurance in force. Our core insurance operations include: • Life Insurance segment - U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to foreign residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants; and • Home Service Insurance segment - final expense and limited liability property policies sold to middle and lower income households in Louisiana, Mississippi and Arkansas, through independent agents in our home service insurance distribution channel and through funeral homes. June 30, 2020 | 10-Q 31 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS As part of the continued strategic review of our operations, effective August 2020, we began to operate our Home Service Insurance segment through independent agents, rather than employee agents, which involved converting employee agents to independent agents. For an additional discussion of the potential impacts on the business from the conversion, see Part II, Item 1A – Risk Factors . STRATEGIC INITIATIVES The Company remains committed to cultivating enduring value for its key stakeholders through the execution of a customer-centric growth strategy. In 2017, the Company's executive management team, in cooperation with its Board of Directors, began a strategic realignment of its Life and Home Service Insurance segments in order to set a course for long-term profitable growth. During 2020, we are focused on the following clearly defined priorities: • continuing to build operational excellence, as our high impact and values-based culture takes root, • growth initiatives within the markets in which we operate, as we set targets for growing premium revenues and implementing growth strategies, and • building new capabilities that will create business opportunities aligned with our essential purpose. As we seek to optimize value for the Company, its customers and its collaborators, we believe our efforts will continue to put the Company on a stronger financial footing and drive sustainable growth. CURRENT FINANCIAL HIGHLIGHTS Our results of operations for the three months ended June 30, 2020 were negatively impacted by the acceleration in intensity of the COVID-19 pandemic in the U.S. and other countries where we do business. While it is difficult to quantify the full impact that the COVID-19 pandemic had on our business in the second quarter, we believe that the COVID-19 pandemic primarily negatively impacted our product sales (and thus first year premium revenue), claims in our Home Service Insurance segment and net investment income. In the three months ended March 31, 2020, our first year premiums in the Life Insurance segment had increased 19% over the same prior year period. We believe these increases were primarily due to our strategic initiatives to make changes in our products and distribution, including investments made in our sales and marketing activities and increased sales of higher average premium policies. First year premiums in our Life Insurance segment declined 40.5% in the three months ended June 30, 2020 from the same period in 2019. We believe this was due primarily to the disruption in our sales processes and challenging economic conditions during the COVID-19 pandemic. Prior to the second quarter of 2020, claims experience in our Home Service Insurance segment had fluctuated from period to period but were within the range of expected levels. We believe that because of the demographics of our policyholders in our Home Service Insurance segment and their reduced ability to sequester and avoid an airborne contagion, the COVID-19 pandemic had a negative impact on claims in that segment, driving the 32% increase in claims for the second quarter of 2020 compared to the same period in 2019. The COVID-19 pandemic also negatively impacted our net investment income during the second quarter. Continued economic turmoil due to the COVID-19 pandemic has led to historically low treasury yields. Although we have begun to diversify into other asset classes, our investment portfolio is weighted heavily towards fixed maturity assets. While the stabilization in equity and fixed maturity markets from March 31, 2020 to June 30, 2020 resulted in a marked improvement in our shareholders' equity in the same period, the low treasury yields made identifying and executing on attractive risk-adjusted purchases for our fixed maturity portfolio more difficult. Thus while we recorded $80.3 million in unrealized investment gains and $1.4 million in realized investment gains during the second quarter, contributing to a 34.3% increase in our shareholders’ equity from March 31, 2020, our net June 30, 2020 | 10-Q 32 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS investment income and portfolio yield declined from recent quarters. See Note 5. Investments in the notes to our consolidated financial statements for a discussion of these unrealized gains. We continued to see quarantines, “stay-at-home” orders and similar mandates for many individuals and businesses requiring them to substantially restrict daily activities and to curtail or cease normal operations, in both Texas and Louisiana, where our home offices are located, and globally where we do business. In response, we began accelerating operational changes and sales practices in order to account for the impact of the COVID-19 pandemic and to ensure business continuity while adhering to federal and local government work guidelines. These changes included the following. • implemented virtual sales training for international agents • prioritized sales of lower face amount policies with reduced underwriting requirements • discontinued and replaced certain products that no longer fall within acceptable levels of risk • adopted new practices to virtually serve customers • implemented new payment methods ◦ announced our international policyholders can now pay U.S. Dollar-denominated premiums in their local currencies, along with a transaction fee to minimize currency fluctuations and our exchange rate risks ◦ expanded digital payment options to policyholders in our Home Service Insurance segment • revised resource structure to improve virtual collection efforts in historical door-to-door collection model • continued remote working arrangements We describe below in more detail areas of our results in which we believe our business may have been impacted by the COVID-19 pandemic during the quarter. We do foresee some adverse impact to near-term sales activity, premiums, claims, policy benefits, invested assets and regulatory capital as a result of the COVID-19 pandemic. Although the extent to which the COVID-19 pandemic may impact our future financial results and business remains uncertain as of the date of this Form 10-Q, we are closely monitoring developments related to the COVID-19 pandemic to assess its impact on our future results and business. For an additional discussion of the potential impacts on our business from the COVID-19 pandemic, see Part II, Item 1A – Risk Factors . We had net loss of $1.0 million and $4.6 million in the three and six months ended June 30, 2020, respectively, compared to a net loss of $4.6 million and $8.4 million in the respective prior year periods, leading to a $0.07 and $0.08 per share improvement, respectively. Our total revenues of $58.3 million for the three months ended June 30, 2020 increased 2.6% from $56.9 million in the prior year period, and decreased by 4.4%, from $119.3 million in the first six months of 2019 to $114.1 million in the six months ended June 30, 2020. The decrease in the six month period was primarily due to lower premiums, which were affected by the COVID-19 pandemic as discussed above. In the three month period, the lower premiums were offset by realized investment gains in the current period versus a one-time realized loss related to a real estate transaction in the prior year period, as described below. Our total cost for benefits and expenses continued to decrease despite the higher claims, due in part to our strategic efforts to lower general expenses. This resulted in overall better net income in the three and six months ended June 30, 2020 compared to the prior periods. June 30, 2020 | 10-Q 33 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Financial highlights for the three and six months ended June 30, 2020 compared to the same periods in 2019 were: REVENUE HIGHLIGHTS • For the three months ended June 30, 2020, insurance premiums declined 5.3% to $41.5 million from $43.8 million for the same period in 2019. The decline was driven primarily by lower first year and renewal premiums in our Life Insurance segment. First year premiums in our Life Insurance segment declined 40.6% from the second quarter of 2019 as our sales processes were materially disrupted by the COVID-19 pandemic. The decrease in renewal premiums primarily reflects the changes we have made to our products and distribution, primarily: (1) in 2017, we repriced certain products in response to a prolonged low interest rate environment and (2) we terminated agreements with independent producers who did not align with our vision, values and culture, both of which decreased persistency. • For the six months ended June 30, 2020, insurance premiums declined 4.0% to $82.8 million from $86.3 million for the same period in 2019. The decline was driven by lower renewal premiums in our Life Insurance segment for the six months and lower first year premiums for the second quarter of 2020. • Net investment income declined 2.6% for the second quarter ended June 30, 2020 compared to the same period of 2019, totaling $14.9 million and $15.3 million, respectively. The COVID-19 pandemic negatively impacted our second quarter performance as explained above. • We recorded realized gains of $1.4 million during the second quarter of 2020 related to fair value changes in our equity securities owned on June 30, 2020, as equity markets rebounded sharply during the period as compared to March 31, 2020. An impairment loss of $3.1 million was recorded during the second quarter of 2019 in our Other Non-Insurance enterprises related to our Citizens Academy training facility located near Austin, Texas. BENEFITS AND EXPENSES HIGHLIGHTS • Claims and surrenders expense increased 2.7% for the second quarter of 2020 and 8.3% for the six months ended June 30, 2020 compared to the same periods in 2019. The increase was driven primarily by an increase in matured endowments in the Life Insurance segment during the six months, which were within expected levels, and higher COVID-19 related claims in the second quarter in our Home Service Insurance segment. We are closely monitoring claim volumes to evaluate whether there is a delay in reporting or filing for benefits as a result of the COVID-19 pandemic in both of our segments. • Future policy benefit reserves decreased 13.0% for the second quarter of 2020 and 18.7% for the six months ended June 30, 2020 compared to the same periods in 2019, driven primarily by the release of reserves resulting from increased matured endowments in the Life Insurance segment and increased claims in the Home Service Insurance segment during the period. • As a result of lower product sales in the second quarter primarily due to the impact of the COVID-19 pandemic, capitalization of deferred policy acquisition costs decreased, as these costs are directly related to first year premium production. • General expenses decreased 6.8% for the second quarter of 2020 and 13.3% for the six months ended June 30, 2020, compared to the same periods in 2019. The reduction for both periods was driven primarily by reduced audit and consulting expenses, while first half expenses were also positively impacted by reduced stock compensation expenses during the first quarter. After addressing prior deficiencies in our internal control environment, we are benefiting from reductions in external audit fees and outside consulting expenses. June 30, 2020 | 10-Q 34 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS OUR OPERATING SEGMENTS Our business is comprised of two operating business segments, as detailed below. • Life Insurance • Home Service Insurance Our insurance operations are the primary focus of the Company, as those operations generate most of our income. See the discussion under Segment Operations below for detailed analysis. The amount of insurance, number of policies, and average face amounts of ordinary life policies issued during the periods indicated are shown below. Six Months Ended June 30, 2020 2019 Amount of Insurance Issued Number of Policies Issued Average Policy Face Amount Issued Amount of Insurance Issued Number of Policies Issued Average Policy Face Amount Issued Life Insurance $ 84,017,811 1,315 $ 63,892 $ 100,095,500 1,481 $ 67,586 Home Service Insurance 65,239,577 9,230 7,068 84,521,648 11,674 7,240 The number of policies issued decreased 11.2% and 20.9%, respectively, for the Life Insurance and Home Service Insurance segments for the six months ended June 30, 2020 compared to the same period in 2019. The decrease in new business applications in both our Life Insurance and Home Service Insurance segments was driven primarily by disruptions in our sales practices caused by the COVID-19 pandemic. The number of new business applications for our Life Insurance segment declined during April and May of this year and increased in June of this year as compared to the number of new business applications in the same months in 2019. The increase in June of this year, compared to April and May, was primarily due to adjustments to our business operations and sales practices to account for the impact of the COVID-19 pandemic, such as focused training on virtual selling and strategically prioritizing selling lower face amount policies as many of our markets remain in lockdown. Lower face amount policies typically have less underwriting requirements and, in some cases, may not require the completion of medical tests, which would otherwise be difficult to obtain during the COVID-19 pandemic. Due to these adjustments, average policy face amount declined by 5.5% during the six months ended June 30, 2020 compared to the same period in 2019 for the Life Insurance segment. Home Service Insurance segment production for the first six months of 2020 was negatively affected by the impact of the COVID-19 pandemic, as a couple of our offices in Louisiana were forced to temporarily close during the month of March and because we discontinued and replaced certain products that no longer fall within acceptable levels of risk and rolled out new policies offering value to the policyholder without disproportionate exposure to the Company. Additionally, certain product offerings that require extensive person to person sales interaction were temporarily ceased during the second quarter. Other changes to our Home Service Insurance operations and collection processes were made, including limiting or reducing face to face interactions between our agents and our policyholders and emphasizing to our policyholders the availability of payment options such as debit/credit cards and traditional mail that obviate such personal interaction. We continue to monitor the impact of the COVID-19 pandemic on our business and may have to implement additional operational changes. June 30, 2020 | 10-Q 35 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS CONSOLIDATED RESULTS OF OPERATIONS A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment. REVENUES Revenues are generated primarily by insurance premiums and investment income on invested assets. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Revenues: Premiums: Life insurance $ 40,185 42,313 80,131 83,293 Accident and health insurance 248 345 509 668 Property insurance 1,063 1,146 2,173 2,307 Net investment income 14,915 15,315 30,084 29,111 Realized investment gains, net 1,448 (2,869) 142 3,092 Other income 482 616 1,024 801 Total revenues $ 58,341 56,866 114,063 119,272 Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased 5.3% and 4.0% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. The overall decrease in premium income was driven primarily by a decline throughout the first six month of 2020 in renewal premiums for the reasons described above in “Current Financial Highlights” and a COVID-19-related decline in first year premiums during the second quarter, in our Life Insurance segment. See the detail distribution of premiums within Segment Operations discussed below. Net Investment Income. Net investment income performance is summarized as follows. June 30, December 31, June 30, (In thousands, except for %) 2020 2019 2019 Net investment income, annualized $ 60,168 59,531 58,222 Average invested assets, at amortized cost 1,403,295 1,365,036 1,355,408 Annualized yield on average invested assets 4.29 % 4.36 % 4.30 % The annualized yield slightly decreased during the first six months of 2020 compared to the same period in 2019, as overall market yields for fixed maturity securities declined to historic lows during the first six months of 2020. As a substantial proportion of our fixed maturity investments continue to be called or mature, we faced challenges in the second quarter in finding investments with comparable yields in the continued low interest rate environment. In addition, concerns about potential negative COVID-19-related impacts on our liquidity, while not ultimately realized, resulted in us holding more cash than usual during the first half of 2020, which negatively impacted yields. As part of the ongoing process of managing our portfolio and optimizing performance, we are continuing to identify, consider, and invest in new asset classes. June 30, 2020 | 10-Q 36 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Investment income from fixed maturity securities accounted for approximately 88.0% of total investment income for the six months ended June 30, 2020. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Gross investment income: Fixed maturity securities $ 13,512 13,747 27,380 26,261 Equity securities 199 168 379 325 Policy loans 1,629 1,600 3,252 3,201 Long-term investments 18 — 19 1 Other investment income 16 162 84 189 Total investment income 15,374 15,677 31,114 29,977 Investment expenses (459) (362) (1,030) (866) Net investment income $ 14,915 15,315 30,084 29,111 Fixed maturity securities income decreased 1.7% for the second quarter of 2020 and increased 4.3% for the six months ended June 30, 2020, compared to the same periods in 2019. We continue to adjust our investment management strategy to increase our investment yields while maintaining a prudent risk profile. Equity securities income increased as we were able to take advantage of market dislocations and identify and execute on some attractive equities purchases during the first quarter of 2020. In addition, the increase in policy loans, which represents policyholders utilizing their accumulated policy cash value to pay for premiums, contributed to the increase in investment income. Realized Investment Gains (Losses), Net. We recorded realized gains of $1.3 million during the second quarter of 2020 related to fair value changes in our equity securities owned at June 30, 2020, as equity markets rebounded sharply during the second quarter as compared to the first quarter. An impairment loss of $3.1 million was recorded for the second quarter of 2019 in connection with classifying the Citizens Academy training facility near Austin, Texas as real estate held-for-sale. BENEFITS AND EXPENSES Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders $ 27,754 27,024 54,203 50,057 Increase in future policy benefit reserves 8,237 9,472 17,708 21,771 Policyholders' dividends 1,328 1,423 2,561 2,605 Total insurance benefits paid or provided 37,319 37,919 74,472 74,433 Commissions 6,714 8,384 14,567 16,268 Other general expenses 11,139 11,949 22,612 26,081 Capitalization of deferred policy acquisition costs (3,731) (5,412) (8,740) (10,240) Amortization of deferred policy acquisition costs 6,061 6,931 12,180 13,208 Amortization of cost of insurance acquired 401 418 769 837 Total benefits and expenses $ 57,903 60,189 115,860 120,587 June 30, 2020 | 10-Q 37 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Claims and Surrenders. A detail of claims and surrender benefits is provided below. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Claims and Surrenders: Death claims $ 7,046 5,943 13,635 12,430 Surrender benefits 10,675 13,426 22,730 23,165 Endowments 2,619 2,991 5,358 6,067 Matured endowments 6,148 3,684 9,901 6,365 Property claims 316 272 803 490 Accident and health benefits 61 58 114 116 Other policy benefits 889 650 1,662 1,424 Total claims and surrenders $ 27,754 27,024 54,203 50,057 • Death claims increased 18.6% and 9.7% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. The increase was concentrated in our Home Service Insurance segment and primarily reflected differing socioeconomic levels and related ability to mitigate exposure to COVID-19 for policyholders in this segment. Mortality experience and the COVID-19 impacts will continue to be closely monitored by the Company. • Surrenders decreased 20.5% and 1.9% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. Surrenders represented less than 2% of total direct ordinary whole life insurance in force of $4.6 billion as of June 30, 2020. The decrease in surrender expense is primarily related to our international business, and reflects changes in the relative maturities of our policies and resulting tendency to surrender in the second quarter of 2020 compared to recent quarters. In addition, we saw an unusually high percentage of policyholders in our Life Insurance segment select the reduced paid up insurance ("RPU") option instead of surrendering their policies in the second quarter of 2020. • Matured endowments increased 66.9% and 55.6% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. We anticipated this increase based upon the dates of when our endowment contracts were sold and their expected maturities as set forth in the contracts. Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 13.0% and 18.7% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019 as a result of changes in maturity activity between periods. Commissions. Commission expense for the second quarter and six months ended June 30, 2020 was slightly lower compared to the same periods in 2019 and primarily reflects the impact of the COVID-19 pandemic on our new sales generation, especially in the second quarter of 2020. Commission expense fluctuates directly with changes in first year and renewal premiums. Other General Expenses. Expenses for the second quarter and six months ended June 30, 2020 decreased 6.8% and 13.3% compared to the same periods in 2019, driven primarily by lower audit, consulting and employee-related expenses. We continue to execute on our strategic cost savings initiatives. Capitalization and Amortization of Deferred Policy Acquisition Costs. Costs capitalized include certain commissions, policy issuance costs, and underwriting and agency expenses that relate to successful sales efforts for insurance June 30, 2020 | 10-Q 38 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS contracts. Capitalized costs decreased during the second quarter and the six months ended June 30, 2020 compared to the same periods in 2019 as we experienced a decrease in first year premium production as previously noted. Amortization of deferred policy acquisition costs was lower during the second quarter and the six months ended June 30, 2020 compared to the same periods last year. Amortization is impacted by persistency, surrenders, and new sales production and thus they may fluctuate from quarter to quarter. Federal Income Tax. Tax expense decreased for the six months ended June 30, 2020 compared to the same period in 2019 resulting in effective tax rates of (156.7)% and (536.3)%, respectively. For the six months ended June 30, 2019, the Company's federal income tax expense was impacted by the gain realized on the sale of our former corporate headquarters. The Company's tax rate was impacted by differences between our effective tax rate and the statutory tax rate resulting from income and expense items that are treated differently for financial reporting and tax purposes. In addition, CICA Ltd., a wholly-owned subsidiary of Citizens, is considered a controlled foreign corporation for federal tax purposes and CICA Ltd.'s activity gives rise to taxable income in the U.S. as Subpart F Income, which is treated as a permanent tax difference and therefore included in the Company's effective tax rate calculation. See Note 8. Income Taxes in the notes to our consolidated financial statements. SEGMENT OPERATIONS The Company has two reportable segments: Life Insurance and Home Service Insurance. These segments are reported in accordance with U.S. GAAP. The Company also operates other non-insurance portions of the Company, which primarily include the Company's IT and corporate-support functions, which are included in the table presented below to properly reconcile the segment information with the consolidated financial statements of the Company. The Company evaluates profit and loss performance of its segments based on income (loss) before federal income taxes. The following table shows income (loss) before federal income taxes by segments during the periods indicated. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Segments: Life Insurance $ 2,119 (119) 4,205 4,518 Home Service Insurance (26) (335) (2,171) (669) Total segments 2,093 (454) 2,034 3,849 Other Non-Insurance enterprises (1,655) (2,869) (3,831) (5,164) Income (loss) before federal income tax expense $ 438 (3,323) (1,797) (1,315) LIFE INSURANCE Our Life Insurance segment issues ordinary whole life insurance in the U.S. and in U.S. Dollar-denominated amounts to non-U.S. residents. These contracts are designed to provide a fixed amount of insurance coverage over the life of the insured and can include rider benefits to provide additional increasing or decreasing coverage and annuity benefits to enhance accumulations. Additionally, the Company issues endowment contracts, which are principally accumulation contracts that incorporate an element of life insurance protection. For the majority of our business, we retain the first $0.1 million of risk on any one life and reinsure the remainder of the risk. We operate this segment internationally through CICA Ltd. and domestically through our CICA and CNLIC insurance subsidiaries. June 30, 2020 | 10-Q 39 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS INTERNATIONAL SALES We focus our sales of U.S. Dollar-denominated ordinary whole life insurance and endowment policies to residents in Latin America and the Pacific Rim. We have participated in the foreign marketplace since 1975. We believe positive attributes of our international insurance business typically include: • larger face amount policies issued when compared to our U.S. operations, which results in lower underwriting and administrative costs per unit of coverage; • premiums paid annually at the beginning of each policy year rather than monthly or quarterly, which reduces our administrative expenses, accelerates cash flow and results in lower policy lapse rates than premium payment options with more frequently scheduled payments; and • persistency experience and mortality rates that are comparable to U.S. policies. INTERNATIONAL PRODUCTS We offer several ordinary whole life insurance and endowment products designed to meet the needs of our non-U.S. policyowners. These policies have been structured to provide the policyowners with: • U.S. Dollar-denominated cash values that accumulate, beginning in the first policy year, to a policyholder during his or her lifetime; • premium rates that are competitive with most foreign local companies; • a hedge against policyowners' local currency inflation; • protection against devaluation of the policyowners' local currency; • capital investment in a more secure economic environment (i.e., the U.S.); and • lifetime income guarantees for an insured or for surviving beneficiaries. Our international products have both living and death benefit features. Most policies contain guaranteed cash values and are participating (i.e., provide for cash dividends as apportioned by the Board). Once a policyowner pays the annual premium and the policy is issued, the owner becomes entitled to policy cash dividends as well as annual premium benefits if the annual premium benefit was elected. The policyowner has several options with regard to the policy dividends and annual premium benefits, which include, among other things, electing to receive cash crediting such amounts towards the payment of premiums on the policy, leaving such amounts on deposit with the Company to accumulate at a defined interest rate or assigning them to a third-party. Under the "assigned to a third-party" provision, the Company has historically allowed policyowners, after receiving a copy of the Citizens, Inc. Stock Investment Plan (the "CISIP") prospectus and acknowledging their understanding of the risks of investing in Citizens Class A common stock, the right to assign policy values outside of the policy to the CISIP, which is administered in the United States by Computershare Trust Company, N.A., our plan administrator and an affiliate of Computershare, Inc., our transfer agent. The CISIP is a direct stock purchase plan available to policyowners, shareholders, our employees and directors, independent consultants, and other potential investors through the Computershare website. The Company has registered the shares of Class A common stock issuable to participants under the CISIP on a registration statement under the Securities Act of 1933, as amended (the "Securities Act") that is on file with the SEC. Computershare administers the CISIP in accordance with the terms and conditions of the CISIP, which is available on the Computershare website and as part of the Company’s registration statement on file with the SEC. June 30, 2020 | 10-Q 40 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table sets forth, by country, our direct premiums from the top five premium producing countries in our international life insurance business for the six months ended June 30, 2020 and 2019 as indicated below. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Country: Colombia $ 5,981 6,142 11,869 12,102 Venezuela 4,937 5,426 9,890 10,731 Taiwan 3,882 4,346 8,856 9,111 Ecuador 3,227 3,575 6,338 6,813 Argentina 2,433 2,679 4,256 4,660 Other Non-U.S. 9,347 9,698 17,548 18,175 Total $ 29,807 31,866 58,757 61,592 We reported declines in premiums during the second quarter and the six months ended June 30, 2020 compared to the same periods in 2019 due primarily to a decrease in first year premiums in the second quarter as previously noted, and lower renewal premiums throughout the first half of 2020. We continue to monitor key indicators in these markets including COVID-19 pandemic impacts. All of our top five countries listed above experienced a decline in premium levels during the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. Renewal premiums declined for the reasons described above in "Current Financial Highlights". DOMESTIC SALES Most of our domestic inforce business results from blocks of business of insurance companies we have acquired over the years. We discontinued new sales of domestic ordinary whole life and endowment life insurance products within our Life Insurance segment in 2017 while we evaluate our domestic life strategy; therefore, the majority of the premium recorded is related to renewal business. June 30, 2020 | 10-Q 41 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The results of operations for the Life Insurance segment for the periods indicated are as follows: Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Revenue: Premiums $ 30,062 32,140 59,881 63,054 Net investment income 11,345 11,612 22,825 21,781 Realized investment gains, net 391 68 1,126 5,525 Other income 482 614 1,006 797 Total revenue 42,280 44,434 84,838 91,157 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 20,888 21,316 41,048 38,478 Increase in future policy benefit reserves 7,384 8,519 15,530 19,832 Policyholders' dividends 1,319 1,413 2,544 2,585 Total insurance benefits paid or provided 29,591 31,248 59,122 60,895 Commissions 3,294 4,676 7,772 9,049 Other general expenses 4,446 6,458 9,394 12,663 Capitalization of deferred policy acquisition costs (2,716) (4,020) (6,637) (7,722) Amortization of deferred policy acquisition costs 5,419 6,053 10,737 11,494 Amortization of cost of insurance acquired 127 138 245 260 Total benefits and expenses 40,161 44,553 80,633 86,639 Income (loss) before federal income tax expense $ 2,119 (119) 4,205 4,518 Premiums. Premium revenues declined 6.5% and 5.0% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019 due to a decrease in renewal business throughout the first half of 2020 and a decline in first year premiums during the second quarter primarily related to the impact of the COVID-19 pandemic. We have taken and will continue to take countermeasures to reduce the impact of the COVID-19 pandemic on our premiums, including emphasizing virtual selling and tailoring our sales efforts to products whose sales processes are less impacted by the pandemic. Life insurance premium breakout is detailed below. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Premiums: First year $ 1,588 2,673 4,303 4,947 Renewal 28,474 29,467 55,578 58,107 Total premiums $ 30,062 32,140 59,881 63,054 Net Investment Income . Net investment income declined in the second quarter of 2020 compared to the same period in 2019 primarily due to the impact of the COVID-19 pandemic and the resulting historically low market yields June 30, 2020 | 10-Q 42 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS available to us for reinvestment, and the need to hold more cash than usual. Net investment income increased during the first half of 2020 compared to the same period in 2019 primarily due to the growth in average invested assets and a strategic focus on increasing yields in a prudent manner. June 30, December 31, June 30, (In thousands, except for %) 2020 2019 2019 Net investment income, annualized $ 45,714 44,779 43,562 Average invested assets, at amortized cost 1,052,500 1,016,055 1,008,256 Annualized yield on average invested assets 4.34 % 4.41 % 4.32 % The annualized yield in the first six months of 2020 increased slightly compared to the same period in 2019. We are continually adjusting our investment management strategy to identify opportunities to improve our yields while maintaining a prudent risk profile. This continues to be a challenge in the current low interest rate environment. The annualized yield in the first six months of 2020 declined compared to the three months ended December 31, 2019 as we faced a particularly challenging investment environment this year. Realized Investment Gains (Losses), Net. The realized gain for the second quarter and first six months ended June 30, 2020 were primarily due to the appreciation in the value of a preferred stock exchange traded fund purchase we made during the first quarter as we were able to take advantage of the market dislocation to identify an attractive risk-adjusted opportunity. We recorded a realized gain of $5.5 million during the first quarter of 2019 related to the sale of our former corporate headquarters in Austin, Texas. Claims and Surrenders. These amounts fluctuate from period to period but were within anticipated ranges based upon management's expectations. Neither death claims nor surrenders were materially impacted by the COVID-19 pandemic. The decline in surrender benefits in the second quarter reflects changes in the relative maturities of our policies as previously noted. The following table shows the claims and surrenders incurred within the Life Insurance segment for the six months ended June 30, 2020 compared to the same period in 2019. June 30, 2020 | 10-Q 43 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Claims and Surrenders: Death claims $ 1,243 1,502 2,968 3,350 Surrender benefits 10,132 12,612 21,435 21,487 Endowment benefits 2,617 2,988 5,353 6,062 Matured endowments 5,969 3,529 9,569 6,087 Accident and health benefits 41 38 68 76 Other policy benefits 886 647 1,655 1,416 Total claims and surrenders $ 20,888 21,316 41,048 38,478 • Death claims expense was favorable for the second quarter and six months ended June 30, 2020 compared with the same periods in 2019. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels. We are closely monitoring claim volumes to evaluate whether there is a delay in reporting or filing for benefits as a result of the COVID-19 pandemic. • Surrenders decreased 19.7% and 0.2% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019, reflecting changes in the relative maturities of our policies as noted above and more policyholders selecting the RPU option. • Endowment benefits primarily result from the election by policyholders of a product feature providing an annual guaranteed benefit. This is a fixed benefit over the life of the contract, thus this expense will vary with new sales and persistency of the business. • Matured endowments increased 69.1% and 57.2% for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019, as a large number of our endowment contracts reached maturity in the current period. We anticipate this trend will continue as endowment products sold reach their stated maturities. Increase in Future Policy Benefit Reserves. The lower increase in policy benefit reserves for the second quarter and six months ended June 30, 2020 compared to the same periods last year was due primarily to increases in maturity activity in the current period as described above. Policyholders' Dividends. Policyholders' dividends were slightly lower for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. The decrease was due to changes in persistency and production. Commissions. Commission expense decreased substantially during the second quarter and six months ended June 30, 2020 as we experienced lower first year premiums compared to the same periods in 2019. Commission expense is driven primarily, but not exclusively, by new business as commission rates paid are higher on first year premium sales. Other General Expenses. Expenses are allocated by segment based upon an annual expense study performed by the Company. Expenses decreased for the second quarter and six months ended June 30, 2020 due to lower audit, consulting and employee-related expenses compared to the same periods in 2019. Capitalization of Deferred Policy Acquisition Costs. Capitalized costs fluctuate in direct relation to commissions, decreasing for the second quarter and six months ended June 30, 2020, based upon first year and renewal premiums and commissions paid compared to the same periods in 2019. June 30, 2020 | 10-Q 44 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Amortization of Deferred Policy Acquisition Costs. Amortization costs fluctuate with changes in first year premium activity, surrenders, and persistency in general. As previously noted, persistency is monitored closely by the Company. HOME SERVICE INSURANCE We operate in the Home Service Insurance market through our subsidiaries SPLIC, MGLIC and SPFIC, and focus on the life insurance needs of the middle and lower income markets, primarily in Louisiana, Mississippi and Arkansas. Our policies are sold and serviced through a home service insurance marketing distribution system of agents who work on a debit route system and through funeral homes that sell policies, collect premiums and service policyholders. The following table sets forth our direct premiums by state for the periods indicated. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 State: Louisiana $ 10,482 10,666 20,988 21,309 Mississippi 513 532 1,009 1,038 Arkansas 403 437 866 824 Other States 238 232 484 459 Total $ 11,636 11,867 23,347 23,630 HOME SERVICE INSURANCE PRODUCTS Our Home Service Insurance products consist primarily of small face amount ordinary whole life and pre-need policies, which are designed to fund final expenses for the insured, primarily consisting of funeral and burial costs. To a much lesser extent, our Home Service Insurance segment sells limited-liability, named-peril property policies covering dwellings and contents. We provide $30,000 maximum coverage on any one dwelling and contents, while content only coverage and dwelling only coverage is limited to $20,000, respectively. We provide final expense ordinary life insurance and annuity products primarily to middle and lower income individuals and families in Louisiana, Mississippi and Arkansas, a demographic that has been disproportionally impacted by the COVID-19 pandemic. June 30, 2020 | 10-Q 45 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The results of operations for the Home Service Insurance segment for the periods indicated are as follows: Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Revenue: Premiums $ 11,434 11,664 22,932 23,214 Net investment income 3,256 3,325 6,588 6,411 Realized investment gains (losses), net 924 152 (793) 636 Other income — 1 18 2 Total revenue 15,614 15,142 28,745 30,263 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 6,866 5,708 13,155 11,579 Increase in future policy benefit reserves 853 953 2,178 1,939 Policyholders' dividends 9 10 17 20 Total insurance benefits paid or provided 7,728 6,671 15,350 13,538 Commissions 3,420 3,708 6,795 7,219 Other general expenses 4,591 5,332 8,907 10,402 Capitalization of deferred policy acquisition costs (1,015) (1,392) (2,103) (2,518) Amortization of deferred policy acquisition costs 642 878 1,443 1,714 Amortization of cost of insurance acquired 274 280 524 577 Total benefits and expenses 15,640 15,477 30,916 30,932 Loss before federal income tax expense $ (26) (335) (2,171) (669) Premiums. Premiums declined for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019 as sales of new policies and in-person premium collections were negatively impacted by COVID-19-related temporary office closures and social distancing requirements, as noted in our “Current Financial Highlights” above and in our Risk Factors discussed in Part II, Item 1A herein. Net Investment Income. Net investment income for the six months ended June 30, 2020 increased compared to the same period in 2019 as average invested assets rose from the previous period. Annualized yield on invested assets declined during the six months ended June 30, 2020 compared to the same period in 2019 as we faced challenges in locating attractive risk-adjusted opportunities in the current low interest rate environment. Net investment income yield for our Home Service Insurance segment is summarized below. Six Months Ended Year Ended Six Months Ended June 30, December 31, June 30, (In thousands, except for %) 2020 2019 2019 Net investment income, annualized $ 13,113 13,058 13,027 Average invested assets, at amortized cost 297,979 293,497 292,042 Annualized yield on average invested assets 4.40 % 4.45 % 4.46 % June 30, 2020 | 10-Q 46 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Realized Investment Gains (Losses), Net. Realized net losses for the six months ended June 30, 2020 were primarily related to equity securities fair value adjustments of $0.8 million during the period, as we faced an historically challenging equities market in the first quarter of 2020. Claims and Surrenders. As discussed above, the overall increase in claims and surrenders during the three and six months ended June 30, 2020 compared to the same periods in 2019 was due primarily to the increase in death claims due to the COVID-19 pandemic. Claims and surrenders expense is summarized as follows: Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2020 2019 2020 2019 Claims and Surrenders: Death claims $ 5,803 4,441 10,667 9,080 Surrender benefits 543 814 1,295 1,678 Endowment benefits 2 2 5 4 Matured endowments 179 155 332 278 Property claims 316 272 803 490 Accident and health benefits 20 20 46 40 Other policy benefits 3 4 7 9 Total claims and surrenders $ 6,866 5,708 13,155 11,579 • Death claims expense fluctuates based upon reported claims. We experienced an increase in reported claims and the average dollar amount of claims in the second quarter and six months ended June 30, 2020 compared to the same periods in 2019, due in part to the COVID-19 pandemic as indicated above. Mortality experience is closely monitored by the Company as a key performance indicator and amounts were within the range of expected levels. • Surrender benefits decreased for the second quarter and six months ended June 30, 2020 but were within anticipated ranges based on management expectations. • Property claims increased in the second quarter and six months ended June 30, 2020 as we experienced higher average claim payouts and more claim activity compared to the same periods last year. Commissions. Commission expense decreased for the second quarter and six months ended June 30, 2020 compared to the same period in 2019, consistent with premium collection levels. Other General Expenses. Expenses are allocated by segment based upon an annual expense study performed by the Company. Expenses decreased for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019 due primarily to lower audit and employee-related expenses. Capitalization of Deferred Policy Acquisition Costs ("DAC"). Capitalized costs decreased for the second quarter and six months ended June 30, 2020 compared to the same periods in 2019. DAC capitalization is directly correlated to fluctuations in new business and commissions. OTHER NON-INSURANCE ENTERPRISES This represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under GAAP, which typically results in a loss. Losses reported for the second quarter and six months ended June 30, 2020 and 2019, respectively, are also impacted by general expenses. June 30, 2020 | 10-Q 47 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS INVESTMENTS The administration of our investment portfolios is handled by our management and a third-party investment manager pursuant to board-approved investment guidelines, with all trading activity approved by each board of Citizens and its insurance subsidiaries. The guidelines used require that fixed maturities, both government and corporate, are investment grade and comprise a majority of the investment portfolio. State insurance statutes prescribe the quality and percentage of the various types of investments that may be made by insurance companies and generally permit investments in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, mortgage loans and real estate within certain specified percentages. The invested assets are intended to mature in accordance with the average maturity of our insurance products and provide the cash flow for our insurance company subsidiaries to meet their respective policyholder obligations. The following table shows the carrying value of each invested asset and the percentage to total cash and invested assets. Carrying Value June 30, 2020 December 31, 2019 (In thousands, except for %) Amount % Amount % Cash and Invested Assets Fixed maturity securities: U.S. Treasury and U.S. Government-sponsored enterprises $ 16,521 1.0 % $ 15,878 1.0 % States and political subdivisions (1) 455,819 28.7 % 536,284 35.1 % Corporate 755,884 47.6 % 650,088 42.6 % Mortgage-backed (2) 141,988 8.9 % 131,387 8.6 % Asset-backed 46,984 3.0 % 44,203 2.9 % Foreign governments 121 — % 119 — % Total fixed maturity securities 1,417,317 89.2 % 1,377,959 90.2 % Short-term investments — — % 1,301 0.1 % Cash and cash equivalents 52,375 3.4 % 46,205 3.0 % Other investments: Policy loans 84,171 5.3 % 82,005 5.4 % Equity securities 20,698 1.3 % 16,033 1.1 % Real estate and other long-term investments 12,023 0.8 % 2,956 0.2 % Total cash and invested assets $ 1,586,584 100.0 % $ 1,526,459 100.0 % (1) Includes $168.7 million and $188.1 million of securities guaranteed by third parties at June 30, 2020 and December 31, 2019, respectively. (2) Includes $141.6 million and $130.1 million of U.S. Government-sponsored enterprises at June 30, 2020 and December 31, 2019, respectively. Cash and cash equivalents increased as of June 30, 2020 compared to December 31, 2019 due to timing of cash inflows and investments of cash into marketable securities. At June 30, 2020, investments in fixed maturity and equity securities were 90.6% of our total invested assets. All of our fixed maturities were classified as available-for-sale securities at June 30, 2020 and December 31, 2019. We had no fixed maturity or equity securities that were classified as trading securities at June 30, 2020 or December 31, 2019. June 30, 2020 | 10-Q 48 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of June 30, 2020 and December 31, 2019. Carrying Value June 30, 2020 December 31, 2019 (In thousands, except for %) Amount % Amount % AAA $ 47,496 3.4 % $ 56,977 4.1 % AA 480,005 33.9 % 513,190 37.2 % A 403,774 28.5 % 385,345 28.0 % BBB 459,370 32.4 % 406,515 29.5 % BB and other 26,672 1.8 % 15,932 1.2 % Totals $ 1,417,317 100.0 % $ 1,377,959 100.0 % Credit ratings reported for the periods indicated are assigned by a Nationally Recognized Statistical Rating Organization ("NRSRO") such as Moody’s Investors Service, Standard & Poor’s or Fitch Ratings. A credit rating assigned by an NRSRO is a quality-based rating, with AAA representing the highest quality and D the lowest, with BBB and above being considered investment grade. In addition, the Company may use credit ratings of the National Association of Insurance Commissioners ("NAIC") Securities Valuation Office ("SVO") as assigned, if there is no NRSRO rating. Securities rated by the SVO are grouped in the equivalent NRSRO category as stated by the SVO and securities that are not rated by an NRSRO are included in the "other" category. Non-investment grade securities are the result of downgrades of issuers or securities acquired during acquisitions of companies, as the Company does not purchase below investment grade securities. We are closely monitoring credit ratings for potential downgrades due to the COVID-19 pandemic. The Company has no direct sovereign European debt exposure as of June 30, 2020. June 30, 2020 | 10-Q 49 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS As of June 30, 2020, the Company held municipal fixed maturity securities that include third-party guarantees. Detailed below is a presentation by NRSRO rating of our municipal holdings by funding type as of June 30, 2020. General Obligation Special Revenue Other Total % Based on Amortized Cost (In thousands, except for %) Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Municipal fixed maturity securities shown including third-party guarantees AAA $ 26,335 25,498 12,210 11,916 — — 38,545 37,414 8.8 % AA 93,699 89,182 137,279 130,136 12,282 10,795 243,260 230,113 53.7 % A 18,248 16,780 122,259 110,815 7,664 7,039 148,171 134,634 31.5 % BBB 4,711 4,789 9,833 9,393 1,548 1,450 16,092 15,632 3.7 % BB and other 4,676 4,738 5,075 4,998 — — 9,751 9,736 2.3 % Total $ 147,669 140,987 286,656 267,258 21,494 19,284 455,819 427,529 100.0 % Municipal fixed maturity securities shown excluding third-party guarantees AAA $ 5,021 4,872 512 507 — — 5,533 5,379 1.3 % AA 71,840 70,115 76,517 73,494 7,719 6,550 156,076 150,159 35.1 % A 32,898 30,873 148,155 134,988 10,604 9,766 191,657 175,627 41.1 % BBB 10,038 9,631 27,786 26,437 — — 37,824 36,068 8.4 % BB and other 27,872 25,496 33,686 31,832 3,171 2,968 64,729 60,296 14.1 % Total $ 147,669 140,987 286,656 267,258 21,494 19,284 455,819 427,529 100.0 % The table below shows the categories in which the Company held investments in special revenue bonds that were greater than 10% of fair value based upon the Company's portfolio of municipal fixed maturity securities at June 30, 2020. (In thousands) Fair Value Amortized Cost % of Total Fair Value Utilities $ 95,914 87,695 21.0 % Education 68,861 63,619 15.1 % The Company's municipal holdings are spread across many states, however, municipal fixed maturity securities from Texas comprise the most significant concentration of the total municipal holdings portfolio as of June 30, 2020. The Company holds 17.1% of its municipal holdings in Texas issuers as of June 30, 2020. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of June 30, 2020. June 30, 2020 | 10-Q 50 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The table below represents the Company's detailed exposure to municipal holdings in Texas at June 30, 2020. June 30, 2020 General Obligation Special Revenue Other Total (In thousands) Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Texas municipal fixed maturity securities shown including third-party guarantees AAA $ 25,333 24,577 9,350 9,062 — — 34,683 33,639 AA 23,795 23,299 12,290 11,480 — — 36,085 34,779 A — — 6,485 5,951 — — 6,485 5,951 BBB — — — — — — — — BB and other — — 825 775 — — 825 775 Total $ 49,128 47,876 28,950 27,268 — — 78,078 75,144 Texas municipal fixed maturity securities shown excluding third-party guarantees AAA $ 4,610 4,461 — — — — 4,610 4,461 AA 36,194 35,407 12,084 11,760 — — 48,278 47,167 A 6,084 5,854 12,662 11,606 — — 18,746 17,460 BBB 1,235 1,154 558 528 — — 1,793 1,682 BB and other 1,005 1,000 3,646 3,374 — — 4,651 4,374 Total $ 49,128 47,876 28,950 27,268 — — 78,078 75,144 IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES For the three and six months ended June 30, 2020, the Company recorded no credit valuation losses on fixed maturity securities and recognized no fixed maturity investment impairments for the three and six months ended June 30, 2019. Information on both unrealized and realized gains and losses by category is set forth in Note 5. Investments of the notes to our consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. We manage our insurance operations as described herein in order to ensure that we have stable and reliable sources of cash flows to meet our obligations. We expect to meet our cash needs for the next 12 months with cash generated by our insurance operations and from our invested assets. PARENT COMPANY LIQUIDITY AND CAPITAL RESOURCES Citizens is a holding company and has had minimal operations of its own. Our assets consist of the capital stock of our subsidiaries, cash and investments. Our liquidity requirements are met primarily from two sources: cash generated from our operating subsidiaries and our invested assets. Our ability to obtain cash from our insurance subsidiaries depends primarily upon the availability of statutorily permissible payments, including payments Citizens receives from service agreements with our life insurance subsidiaries and dividends from the subsidiaries. The ability to make payments to the holding company is limited by applicable laws and regulations of Bermuda and U.S. states of domicile which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that our insurance subsidiaries maintain minimum solvency requirements, June 30, 2020 | 10-Q 51 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS which limit the amount of dividends that can be paid to the holding company. The regulations also require approval of our service agreements with the applicable regulatory authority in order to prevent insurance subsidiaries from moving large amounts of cash to the unregulated holding company. As we discussed in Note 11. Subsequent Events , upon the regulatory approval of the transfer of the Citizens, Inc. Class B common stock from the Harold E. Riley Trust to the Harold E. Riley Foundation, the "Change in Control" clause in the Employment Agreement by and between the Company and Geoffrey M. Kolander, our Chief Executive Officer and President, was triggered. Following the change in control, Mr. Kolander announced his intention to resign as Chief Executive Officer and President and a member of the Board of Directors, effective no later than August 10, 2020. Pursuant to the terms of the Employment Agreement, Mr. Kolander is entitled to the cash severance amount totaling $8.8 million. Additionally, Citizens entered into a new lease for its headquarters space in Austin, Texas, and expects to spend cash for build-out costs primarily during the third quarter of 2020. We believe we have the appropriate liquidity to meet such cash commitments. We are closely monitoring the impact that the COVID-19 pandemic may have on our liquidity and capital resources. To the extent that we continue to experience significant decreases in sales and collections of premiums, decreases in our investment income and/or increases in claim payments as a result of the COVID-19 pandemic, our liquidity would be negatively impacted and would likely result in the sale of our investments to meet operational cash flow requirements. INSURANCE COMPANY SUBSIDIARY LIQUIDITY AND CAPITAL RESOURCES The liquidity requirements of our insurance operations are primarily met by premium deposits and revenues, investment income and investment maturities. Primary uses of these funds are investment purchases, payments of policy benefits to policyholders, and operating expenses. Historically, we have not had to liquidate investments to provide cash flow, and there were no liquidity issues during the six months ended June 30, 2020. Cash flows from operating activities were $28.6 million and $31.4 million for the six months ended June 30, 2020 and 2019, respectively. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows, for the most part, are reinvested in fixed income securities. Net cash outflows from investing activities totaled $22.8 million and $41.4 million for the six months ended June 30, 2020 and 2019, respectively. The investing activities fluctuate from period to period due to timing of securities activities such as calls and maturities and reinvestment of those funds. The Company's net cash inflow and outflow from financing activities were $0.4 million and $1.0 million for the six months ended June 30, 2020 and 2019, respectively. Our investments consist of 92.4% of marketable fixed maturity securities classified as available-for-sale and 1.3% of equity securities that could be readily converted to cash for liquidity needs. A large portion of our fixed maturity security investment portfolio will mature in the next several years and could be called sooner. Over the years, we have been subject to significant call activity due to the declining interest rate environment, which required us to reinvest in fixed maturity securities with shorter durations that are now approaching maturity. We will need to reinvest these maturing funds in the current low interest rate environment. Our profitability could be negatively impacted depending on the market rates at the time of reinvestment. This could result in a decrease in our spread between our policy liability crediting rates and our investment earned rates which could also negatively impact our liquidity. Our investment portfolio (and, specifically, the valuations of investment assets we hold) has also been, and may continue to be, adversely affected as a result of market developments from the COVID-19 pandemic and uncertainty regarding its outcome. Moreover, changes in interest rates, reduced liquidity or a continued slowdown in the U.S. or in global economic conditions may also adversely affect the values and cash flows of these assets. A primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions in our insurance policies, such as surrender charges, that help limit and discourage early withdrawals. Since these contractual withdrawals, as well as the level of surrenders experienced, have been largely consistent with our assumptions in asset liability management, our associated cash outflows historically have not June 30, 2020 | 10-Q 52 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS had an adverse impact on our overall liquidity. We have not experienced any measurable increases in surrenders due to the COVID-19 pandemic, however we continue to monitor surrenders and early withdrawals. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. For reasons described above, we have experienced increased claims in our Home Service Insurance segment in the second quarter of 2020. Additionally, we are closely monitoring claim volumes to evaluate whether there is a delay in reporting or filing for benefits as a result of the COVID-19 pandemic in our Home Service Insurance segment and Life Insurance segment. To the extent we continue to experience increased claims and the associated death benefit payouts in our Home Service Insurance segment and, possibly our Life Insurance segment, as a result of the COVID-19 pandemic, our liquidity could be negatively impacted. Some of our policies include pandemic exclusions and we carry reinsurance to offset some of these risks. While our mortality experience is closely monitored by the Company and the activity has historically been within expected levels, we cannot predict whether we will see increased death benefit payouts above expected levels due to the COVID-19 pandemic. We have had to place a moratorium on policy cancellations or non-renewals for nonpayments of premium and forbearance on premium collections in our Home Service Insurance segment due to state mandates which could negatively affect our liquidity due to lower premium collections and increased death claims due to policies being kept in force that would have otherwise lapsed. Cash flow projections and cash flow tests under various market interest rate scenarios are performed annually to assist in evaluating liquidity needs and adequacy. Our whole life and endowment products provide the policyholder with alternatives once the policy matures. The policyholder can choose to take a lump sum payout or leave the money on deposit at interest with the Company. As of June 30, 2020, 41% of the Company's total insurance in force was in endowment products. Approximately 12% of the endowments in force will mature in the next five years. Policyholder election behavior is unknown, but if policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Meeting these distributions could require the Company to sell securities at inopportune times to pay policyholder withdrawals. Alternatively, if the policyholders were to leave the money on deposit with the Company at interest, our profitability could be impacted if the product guaranteed rate is higher than the market rate we are earning on our investments. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds, but we will monitor closely our policyholder behavior patterns. We have established a liability of $ 10.0 million, net of tax, as of June 30, 2020 for probable liabilities and expenses associated with a tax compliance matter as described in Note 7. Commitments and Contingencies in the notes to our consolidated financial statements, which represents management’s estimate of this contingent liability. This estimate and range include projected settlement amounts payable to the IRS, as well as estimated increased payout obligations to current and former holders of non-compliant domestic life insurance policies expected to result from remediation of those policies. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, and the methodology applicable to the calculation of the tax liabilities for policies. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and exceed the high end of our estimated range of liabilities and expenses. As discussed above, we are subject to regulatory capital requirements that could affect the Company’s ability to access capital from our insurance operations or cause the Company to have to put additional cash in our wholly-owned subsidiaries. Our domestic companies are subject to minimum capital requirements set by the NAIC in the form of risk-based capital ("RBC"). RBC considers the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company's business to develop a minimum level of capital called "Authorized Control Level Risk-Based Capital". This level of capital is then compared to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment June 30, 2020 | 10-Q 53 Table of Contents DRAFT 6 CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200% for our domestic companies, a series of remedial actions by the affected company would be required. Additionally, we have a parental guarantee between Citizens and CICA, Citizens' wholly-owned subsidiary domiciled in Colorado, to maintain a RBC level above 350%. At June 30, 2020, our domestic insurance subsidiaries were above the required minimum RBC levels. CICA Ltd. is a Bermuda domiciled company. The Bermuda Monetary Authority ("BMA") requires Bermuda insurers to maintain available statutory economic capital and surplus at a level equal to or in excess of its enhanced capital requirement (“ECR”). As described in Note 4. Stockholders' Equity and Restrictions , because of the disruption that the COVID-19 pandemic had on the worldwide economy in March 2020, the fair value of our assets had decreased and interest rates also had decreased which increased the fair value of our statutory economic insurance liabilities. As a result, CICA Ltd.’s statutory economic capital and surplus at March 31, 2020 was below the Target Capital Level ("TCL") by $8.9 million. Pursuant to the insurance laws in Bermuda, CICA Ltd. notified the BMA of this shortfall and filed a written report containing details of the circumstances leading to the shortfall. The fair value of our assets has increased significantly since March 31, 2020 and CICA Ltd. has rectified the failure as of June 30, 2020. Although we continue to hold discussions with the BMA, there have been no capital or management actions required. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS There have been no material changes in contractual obligations from those reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. The Company does not have off-balance sheet arrangements at June 30, 2020. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engage in speculative activities of any nature, and we do not use such investments to hedge our investment positions. CRITICAL ACCOUNTING POLICIES We believe that the accounting policies set forth Note 1. Financial Statements of our consolidated financial statements and "Critical Accounting Policies" in the Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2019 continue to describe the significant judgments and estimates used in the preparation of our consolidated financial statements.