Item 2. Management’s Discussion and Analysis
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 as well as 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 September 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 non-U.S. residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants; and
• Home Service Insurance segment - final expense life insurance and limited liability property insurance policies sold to middle and lower income households in Louisiana, Mississippi and
September 30, 2020 | 10-Q 33
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
Arkansas, through independent agents in our home service distribution channel and through funeral homes.
STRATEGIC INITIATIVES
The Company remains committed to cultivating enduring value for its key stakeholders through the execution of a customer-centric growth strategy.
As we have previously stated, we entered 2020 with clearly defined priorities in order to set a course for long-term profitable growth.
• We are focused on continuing to build operational excellence, as our high impact and values-based culture takes root.
• We are focused on growth initiatives within the markets in which we operate, as we set targets for growing premium revenues and implementing growth strategies.
• We are focused on building new capabilities that will create business opportunities aligned with our essential purpose.
We are focused on growth primarily through expanding and/or refining our products to tailor them to our markets, creating sales promotions and campaigns to incentivize the agents in our distribution channels, developing training and guidelines that promote safe, yet effective sales practices, and implementing process and technology improvements to remove friction in the sales cycles.
During the third quarter of 2020, we continued to execute on our strategic initiatives and focus on growth initiatives that build on our expertise, all while navigating through significant internal and external disruptions, uncertainties and challenges including a change in control, the resignation of our chief executive officer and appointment of an interim chief executive officer, litigation involving our Board of Directors and controlling shareholder arising from the change in control, and a global pandemic. These topics are discussed in more detail under Part II, Item 1 – Legal Proceedings and Part II, Item 1A – Risk Factors of this Form 10-Q.
Despite these challenges, we made progress on many of our strategic initiatives during the third quarter of 2020, including the following:
Planned for Expansion of Life Insurance Segment into Hispanic US Market in 2021. Because we have developed the ability to complete insurance transactions end-to-end in Spanish and Portuguese and understand the needs of the Hispanic market due to over 50 years of doing business in Latin America, we plan to expand our Life Insurance segment to the Hispanic market in the U.S and expect to begin selling in this market during 2021.
Reorganized our Home Service Insurance Distribution System. In our Home Service Insurance segment, as part of the continued strategic review of our operations, effective August 2020, we began to operate our distribution system 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 Factor s .
Launched New Marketing Campaigns in our Life Insurance and our Home Service Insurance segments. In our Life Insurance segment, we created an enticing sales campaign that helped lead to 39% higher premiums in the third quarter as compared to the second quarter of 2020. In the Home Service Insurance segment, we launched a sales campaign that resulted in an increase in the amount of in-force insurance for our current customer base. See below in "Our Operating Segments" for more detail on these campaigns and their impact on our business during the third quarter.
Implemented Operational Improvements. We updated our underwriting processes to remove barriers to sales with a more frictionless process for agents and applicants and to reduce underwriting expense. We also focused on
September 30, 2020 | 10-Q 34
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
continued training for virtual sales and collections in both our Life Insurance and our Home Service Insurance segments and expanded our alternative payment methods for our Home Service Insurance segment to accept credit cards and debit card payments.
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
In the three months ended September 30, 2020, we had a net loss of $7.9 million compared to net income of $2.0 million in the prior year period. In the nine months ended September 30, 2020, we had a net loss of $12.5 million compared to a net loss of $6.3 million in the prior year period. Accordingly, our earnings (losses) per share declined by $0.20 and $0.12 in the three and nine months ended September 30, 2020, respectively, compared to prior year periods.
The $10.0 million decrease in net income in the three months ended September 30, 2020 compared to the prior year period was primarily driven by a $7.9 million increase in our general expenses related to executive severance costs and professional fees in connection with a change in control of the Company. As we previously announced on July 29, 2020, a change in control of the Company occurred when the Harold E. Riley Foundation became the beneficial owner of 100% of the Company’s Class B common stock (the “Change in Control”). Holders of the Company's Class B common stock have the right to nominate a simple majority of our Board of Directors. The Change in Control, and its trigger of related payments to our former Chief Executive Officer upon his resignation under his employment agreement, materially impacted our general expenses for the three and nine months ended September 30, 2020. Expenses related to the Change in Control for the third quarter include (i) payment of $8.8 million to a Rabbi Trust for the benefit of our former Chief Executive Officer, Geoffrey Kolander, following his resignation pursuant to the terms of his employment agreement and the Chief Executive Officer Separation of Service and Consulting Agreement dated July 29, 2020 (the “Separation and Consulting Agreement”), (ii) $1.2 million of expense related to the accelerated vesting of Mr. Kolander’s Restricted Stock Units following his resignation upon a change in control pursuant to his employment agreement, and (iii) legal fees related to Change in Control, including defense costs for the litigation brought by the Foundation against the Company and its Board, as described in Part II, Item 1. Legal Proceedings of this Quarterly Report on Form 10-Q. The increase in general expenses due to the Change in Control was partially offset by previous quarter strategic efforts to lower general expenses. In addition to the higher general expenses, a $1.9 million decrease in premium revenue and a $4.2 million increase in claims and surrenders expense also contributed to the decrease in net income for the third quarter of 2020. See below in “Revenue Highlights” and in “Benefits and Expenses Highlights” for an explanation of these changes.
The $6.2 million increase in net loss in the nine months ended September 30, 2020 as compared to the same period in 2019 primarily reflects:
• a $5.4 million decrease in premium revenue for the reasons explained in “Revenue Highlights” below;
• a $2.5 million decrease in realized investment gains primarily due to a realized gain of $5.5 million in the first quarter of 2019 related to the sale of our former corporate headquarters in Austin, Texas;
• an $8.4 million increase in claims and surrenders for the reasons discussed in “Benefits and Expenses Highlights” below; and
• a $4.4 million increase in general expenses, driven by our former Chief Executive Officer's severance package and the Change in Control, partially offset by previous strategic efforts to lower general expenses.
These decreases to revenues and increases to benefits and expenses in the nine months ended September 30, 2020 as compared to the same period in 2019 were partially offset by:
• a $6.3 million decrease in future policy benefit reserves driven primarily by the release of reserves resulting from the decreases in our in force business;
September 30, 2020 | 10-Q 35
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
• a $2.9 million decrease in commissions paid which primarily reflect lower sales of new policies, which have significantly higher commission rates than renewals;
• lower capitalization and amortization of deferred policy acquisition costs, which also reflect lower sales of new policies; and
• a $4.6 million lower federal income tax expense.
While it is difficult to quantify the full impact that the COVID-19 pandemic has had on our business in the three and nine months ended September 30, 2020, as we have previously disclosed, our results of operations for the three and nine months ended September 30, 2020 were negatively impacted by the COVID-19 pandemic in the U.S. and other countries where we do business. The COVID-19 pandemic primarily negatively impacted our product sales (and thus first year premium revenue), and our claims and surrenders expenses. 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. While we have implemented operational changes and sales practices to mitigate the impact of the COVID-19 pandemic on our business, because the COVID-19 pandemic continues to cause 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 globally where we do business, we continue to 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 and we continue to closely monitor 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 , in this Quarterly Report on Form 10-Q.
Financial highlights for the three and nine months ended September 30, 2020 compared to the same periods in 2019 were:
REVENUE HIGHLIGHTS
• For the three months ended September 30, 2020, insurance premiums declined 4.1% to $44.1 million from $46.0 million for the same period in 2019. The decline was driven primarily by lower first year premiums in our Life Insurance segment, which, while increasing from the previous quarter, declined 34.1% to $2.2 million from $3.4 million in the third quarter of 2019 as our new policy sales continue to be negatively impacted by the COVID-19 pandemic. Renewal premiums in our Life Insurance segment also contributed to the overall decrease, declining 3.1% to $30.1 million in the third quarter of 2020 from $31.0 million in the same period in 2019. The decrease in renewal premiums resulted from a decline in our in force business in this segment over the year, which is due in part to changes we made to our products and distribution over the last few years.
• For the nine months ended September 30, 2020, insurance premiums declined 4.0% to $126.9 million from $132.3 million for the same period in 2019. The decline was driven by our Life Insurance segment as renewal premiums for the nine months ended September 30, 2020 and first year premiums for the second and third quarters of 2020 fell compared to the comparable periods in 2019.
• Net investment income was $15.0 million for both the three months ended September 30, 2020 and 2019, and slightly increased to $45.1 million from $44.2 million in the nine months ended September 30, 2020 from the same period in 2019.
BENEFITS AND EXPENSES HIGHLIGHTS
• Claims and surrenders expense increased 14.6% and 10.6% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The increases were driven primarily by an increase in surrendered policies in the Life Insurance segment during the third quarter primarily as a result of policies nearing their maturities. The increases were also due to higher claims in the second and third quarters in our Home Service Insurance segment due primarily to COVID-19 deaths. Additionally, we incurred unusually large property claims in our
September 30, 2020 | 10-Q 36
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
Home Service Insurance segment in the third quarter of 2020 due to the impacts of Hurricane Laura, a Category 4 hurricane which caused significant damage in Louisiana.
• Future policy benefit reserves decreased 35.1% and 22.4% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The declines were driven primarily by the release of reserves resulting from the decreases in our in force business.
• General expenses increased 68.2% and 11.7% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The increase for both periods was driven primarily by the Change in Control as described above in "Current Financial Highlights". Excluding the effects of the executive severance charges incurred in connection with the Change in Control, our general expenses decreased for the three and nine month periods in 2020, reflecting reductions in external audit fees and outside consulting expenses as well as a $2.3 million decrease due to a reduction of our tax compliance liability under Sections 7702 and 72(s) of the Internal Revenue Code for our Life Insurance segment, as discussed in Note 8. Commitments and Contingencies of the notes to our consolidated financial statements.
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 these 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.
Nine Months Ended September 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 $ 142,390,980 2,214 $ 64,314 $ 166,580,870 2,519 $ 66,130
Home Service Insurance 103,456,413 20,261 5,106 124,529,689 17,288 7,203
The number of policies issued in the nine months ended September 30, 2020 decreased 12.1% in the Life Insurance segment. We believe that the decrease in new business applications in our Life Insurance segment was driven primarily by disruptions in our sales practices that began in the second quarter of 2020 due to the COVID-19 pandemic. While the number of new business applications for our Life Insurance segment decreased during the nine months ended September 30, 2020 compared to the same period in 2019, third quarter new business applications increased 23% and 56% from the first and second quarters of 2020, respectively, despite the continuation of strict quarantine protocols in many of the markets in which we operate. The increase in applications in the third quarter was primarily due to enhancements to our business operations and sales practices to account for the impact of the COVID-19 pandemic, including sales promotions and campaigns, focused training on virtual selling and strategically prioritizing selling lower face amount policies, which typically have less stringent underwriting requirements and, in some cases, may not require the completion of medical tests, as many of our markets remain in lockdown due to COVID-19 pandemic. Although applications increased in the third quarter from the second quarter, due to these enhancements, average policy face amount declined by 2.7% and the amount of insurance issued declined by 14.5% during the nine months ended September 30, 2020 compared to the same period in 2019 for the Life Insurance segment.
September 30, 2020 | 10-Q 37
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
The number of policies issued in the nine months ended September 30, 2020 increased 17.2% in the Home Service Insurance segment compared to the same period in 2019. The increase in new business applications in our Home Service segment was driven primarily by the introduction of a new sales campaign targeted at existing policyholders in the third quarter that emphasized higher volume selling at lower average face amounts. In doing so, we focused on sales of additional benefits for our existing policyholders, which have lower face values, thus leading to a 29.1% decline in average policy face values and a 16.9% decline in amount of insurance issued as compared to the same period in 2020.
Despite the increase in policies issued in the third quarter of 2020 compared to the second quarter, our Home Service Insurance segment has continued to be negatively impacted by the COVID-19 pandemic. We continued to have temporary office closures in Louisiana during the third quarter due to the COVID-19 pandemic and Hurricane Laura, and we have also had to curtail the sales of certain product offerings that require extensive person-to-person sales interaction due to the COVID-19 pandemic.
We continue to monitor the impact of the COVID-19 pandemic on our business and may have to implement additional operational changes.
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 renewal premiums and investment income on invested assets.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Revenues:
Premiums:
Life insurance $ 42,732 44,502 122,863 127,795
Accident and health insurance 236 350 745 1,018
Property insurance 1,140 1,157 3,313 3,464
Net investment income 14,997 15,039 45,081 44,150
Realized investment gains, net 527 72 669 3,164
Other income 193 347 1,217 1,148
Total revenues $ 59,825 61,467 173,888 180,739
Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased 4.1% and 4.0% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The overall decrease in premium income was driven primarily by a decline throughout the first nine months of 2020 in renewal premiums for the reasons described above in “Revenue Highlights” and a decline in first year premiums during the second and third quarters, in our Life Insurance segment, which is attributable in large part to the COVID-19 pandemic. See the detail distribution of premiums within Segment Operations discussed below.
September 30, 2020 | 10-Q 38
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
Net Investment Income. Net investment income performance is summarized as follows.
September 30, December 31, September 30,
(In thousands, except for %) 2020 2019 2019
Net investment income, annualized $ 60,108 59,531 58,867
Average invested assets, at amortized cost 1,409,993 1,365,036 1,357,720
Annualized yield on average invested assets 4.26 % 4.36 % 4.34 %
The annualized yield decreased during the first nine months of 2020 compared to the same period in 2019, due in part to a decline in overall market yields for fixed maturity securities this year. As a substantial proportion of our fixed maturity investments continue to be called or mature, we have faced challenges 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 nine months of 2020, which also 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.
Investment income from fixed maturity securities accounted for approximately 87.4% and 87.8% of total investment income for the three and nine months ended September 30, 2020, respectively.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Gross investment income:
Fixed maturity securities $ 13,593 13,637 40,973 39,898
Equity securities 214 154 593 479
Policy loans 1,666 1,619 4,918 4,820
Long-term investments 72 — 91 1
Other investment income 3 98 87 287
Total investment income 15,548 15,508 46,662 45,485
Investment expenses (551) (469) (1,581) (1,335)
Net investment income $ 14,997 15,039 45,081 44,150
Fixed maturity securities income decreased 0.3% for the third quarter of 2020 and increased 2.7% for the nine months ended September 30, 2020, compared to the same periods in 2019. Equity securities income increased for the nine month period as we were able to take advantage of market dislocations and identify and execute on 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 in both the three and nine months ended September 30, 2020.
Realized Investment Gains (Losses), Net. We recorded realized gains of $0.5 million during the third quarter of 2020 related to fair value changes in our equity securities owned at September 30, 2020. An impairment loss of $3.1 million was recorded for the first nine months of 2019 in connection with classifying the Citizens Academy training facility near Austin, Texas as real estate held-for-sale. In addition, we recorded a realized gain of $5.5 million in the first quarter of 2019 relating to the sale of our former corporate headquarters.
September 30, 2020 | 10-Q 39
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
BENEFITS AND EXPENSES
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders $ 32,958 28,751 87,161 78,808
Increase in future policy benefit reserves 4,158 6,409 21,866 28,180
Policyholders' dividends 1,450 1,560 4,011 4,165
Total insurance benefits paid or provided 38,566 36,720 113,038 111,153
Commissions 7,712 8,879 22,279 25,147
Other general expenses 19,391 11,530 42,003 37,611
Capitalization of deferred policy acquisition costs (4,892) (5,984) (13,632) (16,224)
Amortization of deferred policy acquisition costs 6,760 7,835 18,940 21,043
Amortization of cost of insurance acquired 459 355 1,228 1,192
Total benefits and expenses $ 67,996 59,335 183,856 179,922
Claims and Surrenders. A detail of claims and surrender benefits is provided below.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Claims and Surrenders:
Death claims $ 7,724 5,797 21,359 18,227
Surrender benefits 16,131 13,959 38,861 37,124
Endowments 2,706 3,012 8,064 9,079
Matured endowments 4,475 4,232 14,376 10,597
Property claims 966 625 1,769 1,115
Accident and health benefits 33 92 147 208
Other policy benefits 923 1,034 2,585 2,458
Total claims and surrenders $ 32,958 28,751 87,161 78,808
• Death claims increased 33.2% and 17.2% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The increase was concentrated in our Home Service Insurance segment and reflected increased mortality due to COVID-19 in our customer base in this segment. Mortality experience and COVID-19 impacts will continue to be closely monitored by the Company.
• Surrenders increased 15.6% and 4.7% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. Surrenders represented 0.8% of total direct ordinary whole life insurance in force of $4.6 billion as of September 30, 2020. The increase in surrender benefit expense is primarily related to our international business, and partly reflects policies nearing their maturities. Surrender activity will continue to be closely monitored by the Company.
September 30, 2020 | 10-Q 40
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
• Matured endowments increased 5.7% and 35.7% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. We anticipated this increase based upon the dates when our endowment contracts were sold and the maturity dates in the contracts.
Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 35.1% and 22.4% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019 driven primarily by the release of reserves resulting from the decrease in our in force business.
Commissions. Commission expense for the three and nine months ended September 30, 2020 decreased 13.1% and 11.4%, respectively, compared to the same periods in 2019, which reflects lower new product sales in the 2020 periods. Commission expense fluctuates directly with changes in premiums and is more heavily weighted towards first year premiums, which pay higher commission levels than renewal premiums.
Other General Expenses. Expenses for the three and nine months ended September 30, 2020 increased 68.2% and 11.7%, respectively, compared to the same periods in 2019, driven primarily by expenses related to the Change in Control of the Company as described in "Current Financial Highlights" above.
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 contracts. Capitalized costs decreased during the three and nine months ended September 30, 2020 compared to the same periods in 2019 as we experienced a decrease in first year premium production as previously discussed. Amortization of deferred policy acquisition costs was lower during the three and the nine months ended September 30, 2020 compared to the same periods in the prior year. Amortization is impacted by persistency, surrenders, and new sales production and thus it may fluctuate from quarter to quarter.
Federal Income Tax. Tax expense decreased for the nine months ended September 30, 2020 compared to the same period in 2019 resulting in effective tax rates of (25.8)% and 873.7%, respectively. For the nine months ended September 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 Bermuda 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 9. 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's other non-insurance enterprises include non-insurance operations such as 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
September 30, 2020 | 10-Q 41
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
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 Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Segments:
Life Insurance $ 5,508 2,310 9,713 6,828
Home Service Insurance (1,026) 927 (3,197) 258
Total segments 4,482 3,237 6,516 7,086
Other Non-Insurance enterprises (12,653) (1,105) (16,484) (6,269)
Income (loss) before federal income tax expense $ (8,171) 2,132 (9,968) 817
LIFE INSURANCE
Our Life Insurance segment issues ordinary whole life insurance 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. (a Bermuda company) and domestically through our CICA and CNLIC insurance subsidiaries.
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 dollar 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.
September 30, 2020 | 10-Q 42
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
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.
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 nine months ended September 30, 2020 and 2019 as indicated below.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Country:
Colombia $ 5,858 6,465 17,727 18,567
Venezuela 5,000 5,740 14,890 16,471
Taiwan 4,157 4,393 13,013 13,504
Ecuador 3,443 3,641 9,781 10,454
Argentina 2,466 2,539 6,722 7,199
Other Non-U.S. 10,346 10,485 27,894 28,660
Total $ 31,270 33,263 90,027 94,855
September 30, 2020 | 10-Q 43
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
We reported declines in premiums during the three and nine months ended September 30, 2020 compared to the same periods in 2019 due primarily to decreases in first year premiums in the second and third quarters as previously discussed, and lower renewal premiums throughout the year. We continue to monitor key indicators in these markets including the COVID-19 pandemic and other economic impacts. All of our top five countries listed above experienced a decline in premium levels during the three and nine months ended September 30, 2020 compared to the same periods in 2019. Renewal premiums declined for the reasons described above in "Revenue Highlights".
DOMESTIC SALES
Our domestic in force 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 evaluated our domestic life strategy; therefore, the majority of the premium recorded is related to renewal business. As discussed above in "Strategic Initiatives", we intend to begin selling again in the U.S. in 2021.
The results of operations for the Life Insurance segment for the periods indicated are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Revenues:
Premiums $ 32,265 34,385 92,146 97,439
Net investment income 11,507 11,340 34,332 33,121
Realized investment gains, net 133 61 1,259 5,586
Other income 189 349 1,195 1,146
Total revenues 44,094 46,135 128,932 137,292
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders 25,023 22,533 66,071 61,011
Increase in future policy benefit reserves 3,274 7,667 18,804 27,499
Policyholders' dividends 1,443 1,551 3,987 4,136
Total insurance benefits paid or provided 29,740 31,751 88,862 92,646
Commissions 4,140 5,386 11,912 14,435
Other general expenses 1,915 5,358 11,309 18,021
Capitalization of deferred policy acquisition costs (3,512) (4,743) (10,149) (12,465)
Amortization of deferred policy acquisition costs 6,190 5,960 16,927 17,454
Amortization of cost of insurance acquired 113 113 358 373
Total benefits and expenses 38,586 43,825 119,219 130,464
Income before federal income tax expense $ 5,508 2,310 9,713 6,828
Premiums. We derive most of our premium revenue in the Life Insurance segment from renewal premiums. Premium revenues declined 6.2% and 5.4% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. These declines were due in large part to decreases in renewal premiums throughout the year. We experienced decreases in renewal premium as a result of a decline in our in force business. Our in force business, in terms of policy counts and amount of in force insurance, has been declining for several years due to changes we made to our products and distribution over the last few years, which resulted in
September 30, 2020 | 10-Q 44
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
the pace of new policies issued lagging the number of policies terminated from death, surrender or lapse. A decline in first year premiums during the second and third quarters also contributed to the overall decrease. The declines in first year premiums were 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 holding sales promotions and campaigns, emphasizing virtual selling and tailoring our sales efforts to products whose sales processes are less impacted by the pandemic.
Life Insurance segment premium breakout is detailed below.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Premiums:
First year $ 2,214 3,361 6,517 8,308
Renewal 30,051 31,024 85,629 89,131
Total premiums $ 32,265 34,385 92,146 97,439
Net Investment Income . Net investment income increased in the nine months ended September 30, 2020 compared to the same period in 2019 and the twelve months ended December 31, 2020.
September 30, December 31, September 30,
(In thousands, except for %) 2020 2019 2019
Net investment income, annualized $ 45,776 44,779 44,163
Average invested assets, at amortized cost 1,062,751 1,016,055 1,010,578
Annualized yield on average invested assets 4.31 % 4.41 % 4.37 %
The annualized yield in the first nine months of 2020 decreased compared to the same period in 2019 and from December 31, 2019. As a substantial proportion of our fixed maturity investments continue to be called or mature, we have faced challenges in finding investments with comparable yields in the continued low interest rate environment.
Realized Investment Gains (Losses), Net. The realized gains for the three and nine months ended September 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.
September 30, 2020 | 10-Q 45
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
The following table shows the claims and surrenders incurred within the Life Insurance segment for the nine months ended September 30, 2020 compared to the same period in 2019.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Claims and Surrenders:
Death claims $ 1,595 1,249 4,563 4,599
Surrender benefits 15,449 13,104 36,884 34,591
Endowment benefits 2,703 3,008 8,056 9,070
Matured endowments 4,324 4,103 13,893 10,190
Accident and health benefits 34 41 102 117
Other policy benefits 918 1,028 2,573 2,444
Total claims and surrenders $ 25,023 22,533 66,071 61,011
• Death claims expense was unfavorable for the three months ended September 30, 2020 increasing 27.7% from the same period in 2019, while remaining flat for the nine months ended September 30, 2020 compared with the same period 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 increased 17.9% and 6.6% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019, primarily as a result of policies nearing their maturities, as noted above, and fell within anticipated range. Surrender activity will continue to be closely monitored by the Company.
• Matured endowments increased 5.4% and 36.3% for the three and nine months ended September 30, 2020, respectively, 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.
September 30, 2020 | 10-Q 46
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
Increase in Future Policy Benefit Reserves. The lower increase in policy benefit reserves for the three and nine months ended September 30, 2020 compared to the same periods in 2019 was primarily due to premium decreases and benefit increases as discussed above.
Commissions. Commission expense decreased substantially during the three and nine months ended September 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 three and nine months ended September 30, 2020 due to lower audit, consulting and employee-related expenses compared to the same periods in 2019 and the release of the tax compliance liability under Sections 7702 and 72(s) of the Internal Revenue Code as described above.
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 independent 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 Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
State:
Louisiana $ 10,967 10,688 31,955 31,997
Mississippi 488 508 1,497 1,546
Arkansas 424 398 1,290 1,222
Other States 260 235 744 694
Total $ 12,139 11,829 35,486 35,459
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 are both limited to $20,000.
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.
September 30, 2020 | 10-Q 47
Table of Contents
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 Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Revenues:
Premiums $ 11,843 11,624 34,775 34,838
Net investment income 3,200 3,309 9,788 9,720
Realized investment gains (losses), net 388 3 (405) 639
Other income (loss) 1 (2) 19 —
Total revenues 15,432 14,934 44,177 45,197
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders 7,935 6,218 21,090 17,797
Increase in future policy benefit reserves 884 (1,258) 3,062 681
Policyholders' dividends 7 9 24 29
Total insurance benefits paid or provided 8,826 4,969 24,176 18,507
Commissions 3,572 3,493 10,367 10,712
Other general expenses 4,524 4,669 13,431 15,071
Capitalization of deferred policy acquisition costs (1,380) (1,241) (3,483) (3,759)
Amortization of deferred policy acquisition costs 570 1,875 2,013 3,589
Amortization of cost of insurance acquired 346 242 870 819
Total benefits and expenses 16,458 14,007 47,374 44,939
Income (loss) before federal income tax expense $ (1,026) 927 (3,197) 258
Premiums. Premiums increased slightly in the three months and were flat for the nine months ended September 30, 2020 compared to the same periods in 2019, despite the COVID-19 pandemic. Third quarter premiums increased compared to the prior period due to increases in renewal premiums, which was attributable to changes we made in our Home Service Insurance operations and collection processes, leading to increased use of alternative payment methods, such as debit and credit cards, which assisted with the agents’ collection levels. While first year premiums increased in the three months and decreased slightly in the nine months ended September 30, 2020, the introduction of a new sales campaign in the third quarter targeted at existing policyholders boosted first year premium revenue.
September 30, 2020 | 10-Q 48
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
Net Investment Income. Net investment income for the nine months ended September 30, 2020 increased slightly compared to the same period in 2019 due to an increase in average invested assets. Net investment income yield for our Home Service Insurance segment is summarized below.
Nine Months Ended Year Ended Nine Months Ended
September 30, December 31, September 30,
(In thousands, except for %) 2020 2019 2019
Net investment income, annualized $ 13,051 13,058 13,098
Average invested assets, at amortized cost 298,344 293,497 291,712
Annualized yield on average invested assets 4.37 % 4.45 % 4.49 %
Realized Investment Gains (Losses), Net. Changes in realized gains/losses were primarily due to overall market fluctuations and the related fair value adjustments on equity securities.
Claims and Surrenders. Claims and surrenders expense is summarized as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2020 2019 2020 2019
Claims and Surrenders:
Death claims $ 6,129 4,548 16,796 13,628
Surrender benefits 682 855 1,977 2,533
Endowment benefits 3 6 8 10
Matured endowments 151 129 483 407
Property claims 966 625 1,769 1,115
Accident and health benefits (1) 52 45 92
Other policy benefits 5 3 12 12
Total claims and surrenders $ 7,935 6,218 21,090 17,797
• Death claims expense fluctuates based upon reported claims. We experienced an increase in reported claims and the average dollar amount of claims in the three and nine months ended September 30, 2020 compared to the same periods in 2019, due primarily 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.
• Property claims increased in the three and nine months ended September 30, 2020 compared to the same periods in 2019 for the reasons described below.
During the third quarter of 2020, SPFIC was impacted by Hurricane Laura, a Category 4 hurricane that caused significant damage in Louisiana. The Company has a reinsurance agreement that covers catastrophic events such as Hurricane Laura. The reinsurance agreement specifies a maximum coverage per event of $11.0 million and a retention level of $0.5 million per event. We have paid the $0.5 million retention in claim amounts for this storm and do not believe we will exceed the maximum coverage; however, any claims in excess of $11.0 million would have to be paid by SPFIC.
September 30, 2020 | 10-Q 49
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
After the third quarter of 2020, SPFIC was impacted by Hurricanes Delta and Zeta, both of which were Category 2 storms that also hit Louisiana. Hurricane Delta is expected to be a less significant event and we are still evaluating the impact of Hurricane Zeta. At this point, we do not expect the impact of either storm to have a material effect on our consolidated financial statements.
Our catastrophic event reinsurance agreement only allows coverage on a maximum of two catastrophic events per calendar year per reinsurance layer. If Hurricane Delta turns out to be a more significant event than we anticipate and claims exceed our retention amount so that we need to use our reinsurance to cover for losses arising from Hurricane Delta, our current reinsurance will not cover all of an additional catastrophic event in 2020. Thus, if any additional catastrophic events occur in the fourth quarter of 2020, SPFIC may have to absorb more of the cost of the claims arising from such events or incur additional catastrophe reinsurance premiums for coverage, either of which could adversely affect the Company’s results of operations.
Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves for the three and nine months ended September 30, 2019 was lower due primarily to the impact of our actuarial valuation system conversion which resulted in a decrease in reserves of $2.3 million in the prior year.
Other General Expenses. Expenses are allocated by segment based upon an annual expense study performed by the Company. Expenses decreased for the three and nine months ended September 30, 2020 compared to the same periods in 2019 due primarily to lower audit and employee-related expenses.
Amortization of DAC. Amortization decreased for the three and nine months ended September 30, 2020 compared to the same period in 2019 due primarily to the impact of the conversion to a new actuarial valuation system in our Home Service Insurance segment in the third quarter of 2019 which increased amortization by $0.9 million in the prior year.
OTHER NON-INSURANCE ENTERPRISES
As described above in “Segment Operations”, Other Non-Insurance Enterprises consists of the Company's non-insurance operations, which primarily include the Company's IT and Corporate-support functions who provide services to the insurance operations. In the three and nine months ended September 30, 2020, the Other Non-Insurance Enterprises had revenues of $0.3 million and $0.8 million, respectively, which is primarily intercompany and is eliminated in consolidation under GAAP. Losses reported for the three and nine months ended September 30, 2020 were $12.7 million and $16.5 million, respectively, and were driven primarily by the expenses related to the Change in Control, as described above in “Current Financial Highlights.”
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.
September 30, 2020 | 10-Q 50
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
The following table shows the carrying value of each invested asset and the percentage to total cash and invested assets.
Carrying Value September 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 $ 16,364 1.0 % $ 15,878 1.0 %
States and political subdivisions (1)
432,719 26.8 % 536,284 35.1 %
Corporate 807,925 50.1 % 650,088 42.6 %
Mortgage-backed (2)
142,008 8.8 % 131,387 8.6 %
Asset-backed 45,444 2.8 % 44,203 2.9 %
Foreign governments 119 — % 119 — %
Total fixed maturity securities 1,444,579 89.5 % 1,377,959 90.2 %
Short-term investments — — % 1,301 0.1 %
Cash and cash equivalents 42,261 2.6 % 46,205 3.0 %
Other investments:
Policy loans 83,962 5.2 % 82,005 5.4 %
Equity securities 21,151 1.3 % 16,033 1.1 %
Real estate and other long-term investments 22,239 1.4 % 2,956 0.2 %
Total cash and invested assets $ 1,614,192 100.0 % $ 1,526,459 100.0 %
(1) Includes $167.8 million and $188.1 million of securities guaranteed by third parties at September 30, 2020 and December 31, 2019, respectively.
(2) Includes $141.6 million and $130.1 million of U.S. Government-sponsored enterprises at September 30, 2020 and December 31, 2019, respectively.
Cash and cash equivalents decreased as of September 30, 2020 compared to December 31, 2019 due to timing of cash inflows and investments of cash into marketable securities.
See Note 5. Investments in the notes to our consolidated financial statements for a discussion of the increase in real estate and other long-term investments.
At September 30, 2020, investments in fixed maturity and equity securities were 90.8% of our total invested assets. All of our fixed maturities were classified as available-for-sale securities at September 30, 2020 and December 31, 2019. We had no fixed maturity or equity securities that were classified as trading securities at September 30, 2020 or December 31, 2019.
September 30, 2020 | 10-Q 51
Table of Contents
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 September 30, 2020 and December 31, 2019.
Carrying Value September 30, 2020 December 31, 2019
(In thousands, except for %) Amount % Amount %
AAA $ 36,249 2.5 % $ 56,977 4.1 %
AA 473,027 32.7 % 513,190 37.2 %
A 424,938 29.4 % 385,345 28.0 %
BBB 489,990 33.9 % 406,515 29.5 %
BB and other 20,375 1.5 % 15,932 1.2 %
Totals $ 1,444,579 100.0 % $ 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 September 30, 2020.
September 30, 2020 | 10-Q 52
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
As of September 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 September 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 $ 23,528 22,659 6,199 5,943 — — 29,727 28,602 7.1 %
AA 78,340 73,628 140,715 132,599 12,470 10,791 231,525 217,018 54.0 %
A 18,107 16,259 120,072 107,771 5,051 4,420 143,230 128,450 32.0 %
BBB 4,149 4,174 17,107 16,846 1,598 1,450 22,854 22,470 5.6 %
BB and other 4,437 4,438 946 874 — — 5,383 5,312 1.3 %
Total $ 128,561 121,158 285,039 264,033 19,119 16,661 432,719 401,852 100.0 %
Municipal fixed maturity securities shown excluding third-party guarantees
AAA $ 4,572 4,437 505 503 — — 5,077 4,940 1.2 %
AA 57,532 55,812 66,350 62,902 7,867 6,546 131,749 125,260 31.3 %
A 31,665 29,222 156,146 141,322 8,027 7,147 195,838 177,691 44.2 %
BBB 9,492 9,014 39,011 37,368 — — 48,503 46,382 11.5 %
BB and other 25,300 22,673 23,027 21,938 3,225 2,968 51,552 47,579 11.8 %
Total $ 128,561 121,158 285,039 264,033 19,119 16,661 432,719 401,852 100.0 %
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 September 30, 2020.
(In thousands) Fair
Value Amortized
Cost % of Total
Fair Value
Utilities $ 90,604 81,956 20.9 %
Education 70,227 64,901 16.2 %
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 September 30, 2020. The Company holds 19.2% of its municipal holdings in Texas issuers as of September 30, 2020. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of September 30, 2020.
September 30, 2020 | 10-Q 53
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
The table below represents the Company's detailed exposure to municipal holdings in Texas at September 30, 2020.
September 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 $ 22,919 22,150 3,354 3,100 — — 26,273 25,250
AA 23,113 22,591 12,425 11,460 — — 35,538 34,051
A — — 18,483 18,385 — — 18,483 18,385
BBB — — 1,971 1,829 — — 1,971 1,829
BB and other — — 830 774 — — 830 774
Total $ 46,032 44,741 37,063 35,548 — — 83,095 80,289
Texas municipal fixed maturity securities shown excluding third-party guarantees
AAA $ 4,572 4,437 — — — — 4,572 4,437
AA 34,130 33,309 6,105 5,785 — — 40,235 39,094
A 6,098 5,842 24,783 24,037 — — 30,881 29,879
BBB 1,232 1,153 4,687 4,350 — — 5,919 5,503
BB and other — — 1,488 1,376 — — 1,488 1,376
Total $ 46,032 44,741 37,063 35,548 — — 83,095 80,289
IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES
For the three and nine months ended September 30, 2020, the Company recorded no credit valuation losses on fixed maturity securities and recognized no fixed maturity investment impairments for the three and nine months ended September 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
September 30, 2020 | 10-Q 54
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
regulations require, among other things, that our insurance subsidiaries maintain minimum solvency requirements, 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 "Current Financial Highlights", Citizens had significant expenses in the third quarter of 2020 related to executive severance costs due to our former Chief Executive Officer under his employment agreement upon his resignation in August 2020 following the Change in Control. These expenses included payment of $8.8 million to a Rabbi Trust for the benefit of Mr. Kolander representing the severance payments due to him under his employment agreement in connection with his resignation following a change in control. During the third quarter of 2020, Citizens sold approximately $5.7 million of fixed maturity securities held in our investment portfolio in order to fund a portion of the $8.8 million severance payment to the Rabbi Trust for the benefit of Mr. Kolander.
We are closely monitoring the impact that the COVID-19 pandemic may have on our liquidity and capital resources. To the extent that we experience decreases in sales or collections of renewal premiums, increases in surrenders, 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 we may have to sell some 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 for our insurance operations, and there were no liquidity issues during the nine months ended September 30, 2020.
Cash flows from operating activities were $34.0 million and $50.9 million for the nine months ended September 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. However, during the third quarter of 2020, the Company paid $6.0 million to the IRS for the tax compliance matter described in Note 8. Commitments and Contingencies in the notes to our consolidated financial statements. As noted in Note 8. Commitments and Contingencies , our payment does not represent closure of the matter or IRS acceptance of the tax liability shown on the submitted withholding tax returns, and the IRS reserves the right to revise our total tax liability for the covered period. In addition, the Company invested in private equity funds and other alternate investments in 2020 as detailed in Note 5. Investments of the notes to our consolidated financial statements. Net cash outflows from investing activities totaled $39.2 million and $48.1 million for the nine months ended September 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 inflows and outflows from financing activities were $1.3 million and $1.1 million for the nine months ended September 30, 2020 and 2019, respectively.
Our investments consist of 91.9% 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
September 30, 2020 | 10-Q 55
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
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 had an adverse impact on our overall liquidity. Although we experienced an increase in surrenders in the Life Insurance segment during the third quarter of 2020 compared to the same period in 2019, we believe that such surrenders were not materially impacted by the COVID-19 pandemic. However, policyholders' surrender behavior is unknown and may change in unexpected ways in response to a prolonged COVID-19 pandemic and related economic uncertainty. To the extent that we continue to experience an increase in surrenders in our Life Insurance segment, whether due to the COVID-19 pandemic or otherwise, our liquidity could be negatively impacted. 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 previously discussed, we have experienced increased death claims in our Home Service Insurance segment in the third quarter of 2020 compared to the same period in 2019. 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.
As described above in "Home Service Insurance", in the third quarter of 2020, we experienced substantial increases in property claims due in large part to the impact of Hurricane Laura. While we do not believe that SPFIC will reach its maximum reinsurance levels for Hurricane Laura under its catastrophe reinsurance policy, any claims in excess of the maximum coverage would have to be paid by SPFIC. Additionally, higher-than-expected claims from Hurricane Delta or additional catastrophic events that hit in the fourth quarter of 2020 may cause us to pay out-of-pocket on claims arising from such catastrophic events or obtain additional catastrophe reinsurance. We believe we have the appropriate liquidity to meet such potential cash commitments, although we may need to provide a capital contribution to SPFIC.
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 September 30, 2020, 41% of the Company's total insurance in force was in endowment products. Approximately 13% 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.
September 30, 2020 | 10-Q 56
Table of Contents
CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS
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 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 September 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, which requires a certain Target Capital Level ("TCL"). As of September 30, 2020, CICA Ltd. was above the TCL threshold.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2020, the Company is committed to fund investments up to $95 million related to private equity funds and other investments. The Company is also committed to pay $8.8 million to our former Chief Executive Officer, Geoffrey Kolander, in February 2021 representing the severance payments due to him under the terms of his employment agreement in connection with his resignation following a change in control of the Company. There have been no other 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 September 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.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.