CITIZENS, INC. 10-K

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section of this Annual Report on Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019. OVERVIEW For over 45 years, we have been meeting the needs of our policyholders and their families by providing insurance products that provide both living and death benefits. Citizens conducts operations through its insurance subsidiaries, who provide benefits to residents in 31 U.S. states and more than 75 different countries. We specialize in offering primarily ordinary whole life insurance, endowment products and final expense insurance in niche markets where we believe we can achieve competitive advantages. Beginning in 2017, we endeavored to transform Citizens, setting the course for a sustainable future. We took clear and decisive actions to improve internal controls, remediate weaknesses in our financial and operational structures and redefine our culture. We assessed the strength of our people, products and operations. Based on clearly defined values and priorities, we made the hard decisions to recruit new talent, exit unprofitable or undesirable markets, realign our distributors and improve the profitability of our product offerings. As an insurance provider, we collect premiums on an ongoing basis from our policyholders and invest the majority of the premiums to pay future benefits, including claims and surrenders and policyholder dividends. Accordingly, the Company derives its revenues principally from: (1) life insurance premiums earned for insurance coverages provided to insureds in our two operating segments – Life Insurance and Home Services Insurance; and (2) net investment income. In addition to paying and reserving for insurance benefits that we pay to our policyholders, our expenses consist primarily of the costs of selling our insurance products (e.g., commissions, underwriting, marketing expenses), operating expenses and income taxes. 2020 Highlights 2020 was a challenging year. As the COVID-19 pandemic spread across the world and changed behavior and economic patterns, as described in Part I, Item 1. Business under “Strategic Initiatives”, we focused on pivoting our business to a more virtual model while executing on our growth initiatives that build on our expertise. We did this while navigating through significant internal and external disruptions, uncertainties and challenges including a change in control, the resignation of our former chief executive officer and appointment of an interim chief executive officer, litigation in Colorado brought by the Foundation, as our former controlling shareholder, against the Company and our Board of Directors following the change in control, and the global pandemic. These topics are discussed in more detail under Part I. Item 1. Business and Part I, Item 3. Legal Proceedings of this Annual Report on Form 10-K. During 2020, we reported a net loss of $11.0 million, compared to a net loss of $1.4 million in 2019. The increase in net loss in 2020 was primarily driven by $10.0 million of general expenses related to executive severance costs and professional fees incurred in connection with the change in control of the Company. Expenses related to the change in control in 2020 include (i) a severance 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”), and (ii) $1.2 million of expenses related to the accelerated vesting of Mr. Kolander’s Restricted Stock Units following his resignation upon the change in control pursuant to his employment agreement and Separation and Consulting Agreement. Legal fees related to the litigation brought by the Foundation against the Company and its Board of Directors in Colorado also contributed to increased general expenses during 2020. December 31, 2020 | 10-K 37 Table of Contents CITIZENS, INC. While our first-year premiums in the fourth quarter of 2020 in our Life Insurance segment were 75% higher than first year premiums in the third quarter of 2020 and 15% higher than first year premiums in the fourth quarter of 2019, premiums decreased by $9.0 million during 2020 as compared to 2019. We believe that our overall sales in the Life Insurance segment for 2020 were negatively impacted by the COVID-19 pandemic. First year premiums in our Home Service Insurance segment were also negatively impacted by the COVID-19 pandemic as we stopped our door-to-door selling for two months while we pivoted to more virtual selling methods. Our renewal premiums in the Life Insurance segment were negatively impacted by higher levels of surrenders, which we believe was due to not only an aging block of business (i.e., maturities and surrenders of products where the surrender charges are close to expiring or have expired) and our decision to cease issuing new policies in Brazil in 2017 (where we see many policies lapsing), but also by economic circumstances in Latin America. At December 31, 2020, we had $1.8 billion in total assets, an increase from $1.7 billion at December 31, 2019, and we had $34.1 million in cash. We did not have any debt at December 31, 2020. Revenue Highlights As discussed above, insurance premiums and investment income are our primary sources of revenue. • Insurance premiums declined 4.9% in 2020 compared to 2019, totaling $175.3 million and $184.3 million, respectively, driven by lower first year and renewal premiums in our Life Insurance segment. • Net investment income increased 1.1% in 2020 compared to 2019, totaling $60.2 million and $59.5 million, respectively, driven by a growing asset base derived from cash flows from our insurance operations, which was partially offset by higher investment expenses from diversification of our investment portfolio into private equity investments. The average yield on our consolidated investment portfolio was 4.24% (annualized rate) for 2020 compared to 4.36% (annualized rate) for 2019, a decline of twelve basis points, as we faced a challenging investment environment for fixed maturity securities in 2020. • Lower realized investment gains in 2020 were primarily a function of a recorded net gain in 2019 of $2.4 million net of real estate sales and impairment losses and $2.0 million of realized gains in 2019 related to tender offers for fixed maturity securities. Benefits and Expenses Highlights The primary use of our funds is payment of insurance benefits. Total insurance benefits paid or provided in 2020 increased by 1.3%, from $154.6 million in 2019, to $156.7 million in 2020. This expense consists primarily of the following: • Claims and surrender benefits, which increased 13.4% in 2020 compared to 2019. This increase was primarily due to an increase in surrender benefits and matured endowments in the Life Insurance segment, due primarily to the aging block of business and other economic circumstances. • Increase in future policy benefit reserves, which decreased 28.3% in 2020 compared to 2019. Future policy benefit reserves decreased due to the lower in force block of business. The other primary use of funds are the costs of selling our insurance products (e.g., commissions, underwriting, marketing expenses) and general expenses. These costs increased in 2020 primarily due to an increase in general expenses, which rose 10.8% in 2020 compared to 2019, driven by the change in control and executive severance expenses as described above. Our general expenses in 2020 benefited from a $2.2 million reduction in our 7702 tax compliance best estimate liability from the estimate at year end 2019. The increase in general expenses was also offset by a reduction in costs directly related to the selling of our insurance products, including commissions and capitalization of deferred policy acquisition costs, which decreased in 2020 compared to 2019, as they are directly related to premium production, and primarily first year premium production, which declined in 2020. ECONOMIC AND INSURANCE INDUSTRY DEVELOPMENTS While it is difficult to quantify the full impact that the COVID-19 pandemic has had on our business and industry in 2020, as we have previously disclosed, our results of operations for the year ended December 31, 2020 were negatively impacted by the COVID-19 pandemic in the U.S. and other countries where we do business. The December 31, 2020 | 10-K 38 Table of Contents CITIZENS, INC. COVID-19 pandemic primarily negatively impacted our product sales (and thus first year premium revenue), and our claims and surrender benefits. We describe throughout this discussion in more detail areas of our results in which we believe our business may have been impacted by the COVID-19 pandemic. As described above, 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, and because of slower-than-expected implementation of COVID-19 vaccines and treatment therapies, we continue to foresee some adverse impact to near-term sales activity and premiums, especially in Latin America, as well as potential continued impact to claims, policy benefits, invested assets and regulatory capital. 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 I, Item 1A – Risk Factors , in this Annual Report on Form 10-K. Additionally, we continue to be impacted by the following significant economic issues and other developments impacting our business and industry, including the following: • Sustained Low Interest Rate Environment. Market interest rates are a key driver of our results. Persistent low interest rates are identified as a major threat for life insurance companies, given their rate-sensitive products and investments. The sustained low interest rate environment continues to limit increases in profit margins for life insurers by: ◦ Reducing the spread between guaranteed interest rates credited to policyholders and interest earned on supporting assets; ◦ Causing us to reinvest proceeds in lower yielding assets as our fixed maturity investment portfolio, which is primarily invested in callable securities, are called and must be reinvested; ◦ Potentially requiring us to increase our reserves or trigger loss recognition events related to policy liabilities, accelerate amortization of DAC and COIA, and potentially impair intangible assets; ◦ Making our products less attractive (due to lower credited interest rates), resulting in lower sales; or ◦ Changing policyholder behavior, including increasing surrender or withdrawal activity. Although our investment strategy has not changed, the Company has attempted to mitigate the risk of the low interest rate environment by making new investments in securities of states, municipalities, essential services and corporate issuers as well as identifying investment opportunities in other asset classes such as private equity to increase our yields while maintaining a prudent risk profile for our overall portfolio. • Aging population. According to data from the United Nations, "World Population Prospects: the 2019 Revision", virtually every country in the world is experiencing growth in the number and proportion of older persons in their population. As an increasing percentage of the world population reaches retirement age, we believe there will be a greater need for age-related products and we will benefit from increased demand for living benefit products rather than death benefit products, as customers will require cash accumulation to pay expenses to meet their lifetime income needs. Our ordinary life products are designed to accumulate cash values to provide for living expenses in a policy owner's later years, while continuously providing a death benefit. However, as the population reaches retirement age, policyholders may decide to use their accumulated cash value for cash needed in retirement, thus increasing surrenders of long-term products. • Availability of Reinsurance. Reinsurance market dynamics including increased pricing, years of accumulating catastrophic losses, investment market losses and the significant losses expected from the fallout of the COVID-19 pandemic have led to a decline in the availability of reinsurance, tighter terms (such as, for example, pandemic exclusions) and/or increased reinsurance prices. While we currently cede a limited amount of our primary insurance business to reinsurers, we may find it difficult to obtain reinsurance in the future, forcing us to seek reinsurers who are more expensive to us. If we cannot obtain affordable reinsurance coverage, either our net exposures will increase or we will have to reduce our underwriting commitments. December 31, 2020 | 10-K 39 Table of Contents CITIZENS, INC. • Technology Adoption. Innovation and digital development strategies continue to evolve and impact all industries, including the insurance industry. The COVID-19 pandemic has forced companies to virtualize their operations, almost overnight. It is critical that we embrace these changes for the benefit of our policyholders, agents, employees and stockholders. • Global Operations. While our management has extensive experience in writing life insurance policies for foreign residents, changes to foreign laws and regulations and their related application and increased enforcement efforts by foreign governments, along with currency controls affecting our foreign resident insureds, could adversely impact our revenues, results of operations and financial condition. Our Operating Segments Life Insurance. For over 45 years, CICA Life Insurance Company of America ("CICA") and its predecessors have issued U.S. dollar-denominated ordinary whole life insurance and endowment policies to non-U.S. residents. We completed a novation of all of the international policies issued by CICA to CICA Life Ltd. ("CICA Ltd."), our Bermuda-based insurer, effective July 1, 2018. We distribute our international insurance products through independent marketing organizations and their agents located in the countries in which our policyholders reside. Endowment product sales are the primary driver of sales in this segment. The twenty-year endowment is our top selling product, followed by an endowment product that matures at age sixty-five. Through the domestic market of our Life Insurance segment, we collect renewal premiums on ordinary whole life, credit life insurance, and final expense policies issued to middle- and lower-income families and individuals in certain markets in the Mountain West, Midwest and Southern U.S. As we discussed in I tem 1. Business - Strateg ic Initiatives , we will introduce, beginning in Florida, our domestic products and distribution in early 2021. The majority of our current domestic revenues are generated by the policies of domestic life insurance companies we have acquired since 1987. Home Service Insurance. We provide final expense ordinary and industrial life insurance to middle- and lower-income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing independent agents who work on a route system to collect premiums and service policyholders, and through networks of funeral homes that collect premiums and provide personal policyholder service. To a much lesser extent, our Home Service Insurance segment also sells limited liability named-peril property policies covering dwellings and content. December 31, 2020 | 10-K 40 Table of Contents CITIZENS, INC. CONSOLIDATED RESULTS OF OPERATIONS A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment. Our insurance operations are the primary focus of the Company, as those operations generate most of our income. The total dollar amount of insurance issued, number of policies issued, and average face amounts of policies issued in 2020 and 2019 are shown below. Years Ended December 31, 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 $ 219,902,799 3,419 $ 64,318 $ 233,503,780 3,456 $ 67,565 Home Service Insurance 134,270,147 24,920 5,388 158,758,921 22,148 7,168 Total $ 354,172,946 28,339 $ 392,262,701 25,604 We issued $354.2 million in insurance face amounts in 2020 as compared to $392.3 million in 2019. As discussed above, our first-year sales were impacted by the COVID-19 pandemic. We issued 28,339 new policies in 2020, as compared to 25,604 new policies in 2019. The increase was driven by policies issued by our Home Service Insurance segment, which have a significantly lower face value than policies issued in our Life Insurance segment. The number of policies issued in the Life Insurance segment decreased 1.1% in 2020 compared to 2019. While the total number of new business applications for our Life Insurance segment decreased during 2020 compared to 2019, the number of applications progressively increased during the second half of the year. In the third quarter, new policies issued increased 53% from the second quarter while fourth quarter policies issued increased 36% from the third quarter. The increase in applications 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 the COVID-19 pandemic. Although applications increased during the third and fourth quarters, due to these enhancements, average policy face amount declined by 4.8% and the amount of insurance issued declined by 5.8% during 2020 compared to 2019 for the Life Insurance segment. The number of policies issued in the Home Service Insurance segment increased 12.5% in 2020 compared to 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 24.8% decline in average policy face values and a 15.4% decline in amount of insurance issued as compared to 2019. Despite the increase in policies issued in 2020, our Home Service Insurance segment continued to be negatively impacted by the COVID-19 pandemic. We had temporary office closures in Louisiana during the second and third quarters due to the COVID-19 pandemic and Hurricane Laura, and we also curtailed the sales of certain product offerings that require extensive person-to-person sales interaction due to the COVID-19 pandemic. December 31, 2020 | 10-K 41 Table of Contents CITIZENS, INC. REVENUES Revenues are primarily generated from insurance premium revenues and investment income on invested assets. Years ended December 31, (In thousands) 2020 2019 2018 Revenues: Premiums: Life insurance $ 170,328 178,351 181,825 Accident and health insurance 1,019 1,383 1,218 Property insurance 3,982 4,613 4,817 Net investment income 60,197 59,531 54,205 Realized investment gains 1,502 5,249 108 Other income 1,828 1,418 1,833 Total revenues $ 238,856 250,545 244,006 Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased 4.9% during 2020 compared to 2019. The decrease in 2020 was driven primarily by a decline in renewal and first year premiums in our Life insurance segment as discussed in "2020 Highlights". Years ended December 31, (In thousands) 2020 2019 2018 Premiums: First year $ 15,972 17,508 17,639 Renewal 159,357 166,839 170,221 Total premiums $ 175,329 184,347 187,860 As discussed in “2020 Highlights”, we believe that our consolidated first year premium revenue was negatively impacted by the COVID-19 pandemic. The decrease in renewal premiums in our Life Insurance segment resulted from a decline in our in force business in this segment over the past few years, which is due in part to changes we made to our products and distribution. Renewal premiums in our Home Services segment were strong but were negatively impacted by catastrophic reinsurance premiums paid in the second half of 2020, as described below. Net Investment Income. Net investment income increased 1.1% to $60.2 million in 2020 compared to $59.5 million in 2019 driven by a growing asset base derived from cash flows from our insurance operations. The annualized yield decreased by twelve basis points in 2020 compared to 2019 as we continue to face a challenging investment environment for fixed maturity assets, which account for the majority of our investment portfolio. Net investment income performance is summarized as follows. Years ended December 31, (In thousands, except for %) 2020 2019 2018 Net investment income $ 60,197 59,531 54,205 Average invested assets, at amortized cost 1,420,129 1,365,036 1,300,755 Yield on average invested assets 4.24 % 4.36 % 4.17 % The sustained low interest rate environment of the past several years has required us to reinvest a portion of our portfolio at lower interest rates, which led to a lower portfolio yield in 2020. As part of the ongoing process of managing our portfolio and optimizing performance, we are continuing to identify and invest in new asset classes, including private equity. December 31, 2020 | 10-K 42 Table of Contents CITIZENS, INC. Investment income from fixed maturity securities accounted for approximately 87.6% of total investment income for the year ended December 31, 2020 and 87.8% for 2019. Years ended December 31, (In thousands) 2020 2019 2018 Gross investment income: Fixed maturity securities $ 54,653 53,860 49,126 Equity securities 816 662 722 Policy loans 6,605 6,451 6,210 Long-term investments 238 13 15 Other 97 374 409 Total investment income 62,409 61,360 56,482 Less investment expenses (2,212) (1,829) (2,277) Net investment income $ 60,197 59,531 54,205 Investment income from fixed maturity securities increased 1.5% in 2020 compared to 2019. We have strategically increased our exposure to both private and public equity this year to improve our overall investment performance, endeavoring to increase our portfolio yields in a prudent manner. In addition, the increase in the policy loans asset balance, which represents policyholders utilizing their accumulated policy cash value to pay for premiums, contributed to the increase in investment income for 2020. Realized Gains (Losses) on Investments. Realized investment gains and losses are as follows: Years ended December 31, (In thousands) 2020 2019 2018 Realized investment gains (losses): Sales, calls and maturities: Fixed maturity securities $ (112) 1,927 1,792 Real estate — 5,513 — Property and equipment 9 (48) (80) Other long-term investments 9 — — Realized investment gains (losses) (94) 7,392 1,712 Change in fair value of equity securities 1,596 962 (828) Other-than-temporary impairments ("OTTI"): Fixed maturity securities — — (776) Real estate held for sale — (3,105) — Realized losses on OTTI — (3,105) (776) Net realized investment gains $ 1,502 5,249 108 In 2020, we recorded realized gains of $1.6 million primarily related to fair value changes in a preferred stock exchange traded fund investment owned at December 31, 2020. In 2019, we recognized a gain of $1.9 million related to the redemption of two fixed maturity securities. We also recorded a net realized gain of $2.4 million from Citizens-owned real estate transactions in 2019. December 31, 2020 | 10-K 43 Table of Contents CITIZENS, INC. BENEFITS AND EXPENSES Years ended December 31, (In thousands) 2020 2019 2018 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders $ 121,145 106,827 91,103 Increase in future policy benefit reserves 29,923 41,712 47,947 Policyholders' dividends 5,587 6,040 6,362 Total insurance benefits paid or provided 156,655 154,579 145,412 Commissions 32,069 34,222 34,962 Other general expenses 53,669 48,440 47,632 Capitalization of deferred policy acquisition costs (20,475) (22,255) (22,695) Amortization of deferred policy acquisition costs 27,439 28,268 34,235 Amortization of cost of insurance acquired 1,816 1,546 2,458 Total benefits and expenses $ 251,173 244,800 242,004 Claims and Surrenders. Death claim and surrender benefits are our primary use of cash. As noted in the table below, claims and surrenders increased 13.4% from $106.8 million in 2019 to $121.1 million in 2020. December 31, 2020 | 10-K 44 Table of Contents CITIZENS, INC. Years ended December 31, (In thousands) 2020 2019 2018 Claims and surrenders: Death claim benefits $ 27,195 25,100 22,598 Surrender benefits 54,827 49,293 41,176 Endowment benefits 11,026 12,247 13,341 Matured endowment benefits 21,580 15,147 9,088 Property claims 2,807 1,563 1,648 Accident and health benefits 219 232 260 Other policy benefits 3,491 3,245 2,992 Total claims and surrenders $ 121,145 106,827 91,103 • Death claim benefits increased 8.3% in 2020. The increase in 2020 was concentrated in our Home Service Insurance segment and we believe likely reflected increased mortality due to the COVID-19 pandemic in our customer base in this segment. Mortality experience and COVID-19 impacts will continue to be closely monitored by the Company. • Surrender benefits increased 11.2% in 2020. Surrender benefits represented less than 1.2% of total direct life insurance in force of $4.6 billion as of December 31, 2020. The increase in surrender benefits is primarily within our Life Insurance segment. A significant portion of surrender benefits relates to policies that have been in force and have little or no associated surrender charges. • Matured endowment benefits increased 42.5% in 2020 compared to 2019. These increases were anticipated based upon the dates when our policy endowment contracts were sold and their expected maturities as set forth in their contracts. • Property claim expenses increased 79.6% in 2020 compared to 2019 due to the three hurricanes that hit Louisiana in the second half of 2020. Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 28.3% in 2020 compared to 2019. Future policy benefit reserves decrease as our block of in force business decreases and thus the decline was driven largely by lower policyholder retention. In 2019, changes in actuarial valuation estimates associated with the conversion to a new actuarial valuation system also contributed $2.4 million to the decline. Policyholder Dividends. Most of our Life Insurance segment's international policies contain guaranteed cash values and are participating (i.e., provide for cash dividends as apportioned by our Board of Directors). The policyowner has several options with regards 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 which would allow for participation in the CISIP, as described in Item 1 - Business - International Products. Policyholders' dividends decreased by 7.5% in 2020 as compared to 2019 due to a lower in force block of business and actions taken by the Company to reduce discretionary dividends on existing international policies in response to the sustained low interest rate environment. Commissions. Commission expenses are a cost of acquiring business, as commissions are the primary compensation paid to our independent consultants and independent agents for selling our products. First year commission rates are higher than renewal commission rates. Commissions fluctuate directly in relation to sales and thus the decrease in commissions in 2020 as compared to 2019 was due to lower sales in 2020. Other General Expenses. Total general expenses increased 10.8% in 2020 compared to 2019 due primarily to change in control and severance expenses as described above, partially offset by a $2.2 million reduction in our 7702 compliance best estimate liability and decreases in audit and long-term incentive compensation expenses. December 31, 2020 | 10-K 45 Table of Contents CITIZENS, INC. We perform an expense study on an annual basis, utilizing an enterprise-wide time study, and we adjust cost allocations among entities as needed based upon this review. Any allocation changes are reflected in the segment operations, but do not impact consolidated expenses. Capitalization of DAC. Capitalized DAC was $20.5 million and $22.3 million in 2020 and 2019, respectively. Decreases in capitalized amounts are in line with the decreases noted in sales activity. These costs will vary based upon successful efforts related to newly issued policies and renewal business. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business which has higher commission rates. Amortization of DAC. Amortization of DAC totaled $27.4 million and $28.3 million in 2020 and 2019, respectively. Amortization of DAC is impacted by new business, persistency and the level of surrenders. Additionally, 2019 included $1.4 million of amortization associated with the conversion to a new actuarial valuation system. Amortization of Cost of Insurance Acquired ("COIA"). Amortization of COIA increased in 2020 compared to 2019 due primarily to an update in our Home Service Insurance segment's expected earned rate assumptions used within annuity models that resulted in additional amortization of approximately $0.2 million in 2020. Federal Income Tax. Federal income tax benefit of $1.3 million in 2020 and federal income tax expense of $7.1 million in 2019 resulted in effective tax rates of 10.8% and 126.0%, respectively. Subsequent to the novation of all of the international policies issued by CICA to CICA Ltd., the earnings of CICA Ltd. are subject to Subpart F of the IRC and, therefore, are included in Citizens' taxable income. The Subpart F income inclusion generated $2.2 million of federal income tax expense in 2020, as compared to $5.9 million in 2019. The decrease in tax from Subpart F income was partially offset in 2019 and 2020 by foreign income tax rate differential of $1.6 million and $1.8 million, respectively. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes. Refer to Note 9. Income Taxes in the notes to our consolidated financial statements for further discussion. SEGMENT OPERATIONS Our business is comprised of two operating business segments, as detailed below. • Life Insurance • Home Service Insurance December 31, 2020 | 10-K 46 Table of Contents CITIZENS, INC. These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income (loss) before federal income taxes for these segments. Years ended December 31, (In thousands) 2020 2019 2018 Income (loss) before federal income taxes: Segments: Life Insurance $ 9,894 11,795 12,085 Home Service Insurance (3,470) 1,181 (2,496) Total Segments 6,424 12,976 9,589 Other Non-Insurance Enterprises (18,741) (7,231) (7,587) Total income (loss) before federal income taxes $ (12,317) 5,745 2,002 LIFE INSURANCE Our Life Insurance segment primarily issues ordinary whole life insurance and endowment policies in U.S. dollar-denominated amounts to non-U.S. residents in more than 75 countries through almost 1,000 independent marketing consultants as of December 31, 2020. Years ended December 31, (In thousands) 2020 2019 2018 Revenue: Premiums $ 129,202 137,666 141,146 Net investment income 45,885 44,779 39,985 Realized investment gains, net 1,340 6,795 358 Other income 1,806 1,412 1,833 Total revenue 178,233 190,652 183,322 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 93,813 82,964 69,149 Increase in future policy benefit reserves 25,825 39,873 43,671 Policyholders' dividends 5,554 6,004 6,316 Total insurance benefits paid or provided 125,192 128,841 119,136 Commissions 17,944 20,128 20,079 Other general expenses 16,323 23,012 18,718 Capitalization of deferred policy acquisition costs (15,568) (17,448) (17,194) Amortization of deferred policy acquisition costs 23,987 23,832 29,915 Amortization of cost of insurance acquired 460 492 583 Total benefits and expenses 168,338 178,857 171,237 Income before income tax expense $ 9,895 11,795 12,085 Premiums. Premium revenues decreased by 6.1% in 2020 compared to 2019 as first year premiums decreased by 11.1%, while renewal premiums declined by 5.7%. While first year premiums declined sharply in 2020 due to the COVID-19 pandemic, we experienced progressive improvement in our new business production for our international business during the second half of the year as described above and in the fourth quarter we experienced the highest level of first year sales over the last three years due to executing on our strategic initiatives. December 31, 2020 | 10-K 47 Table of Contents CITIZENS, INC. Life Insurance premium breakout is detailed below. Years ended December 31, (In thousands) 2020 2019 2018 Premiums: First year $ 10,397 11,692 11,451 Renewal 118,805 125,974 129,695 Total premium $ 129,202 137,666 141,146 92% of our Life Insurance premium revenue in each of the past three years was generated by renewal premiums. The Company has taken actions over the past few years to pursue long-term growth and stability, including reducing discretionary dividends on existing international policies in response to the sustained low interest environment and making changes to our distribution, which has negatively impacted sales levels. These changes also included the discontinuance of new business in Brazil in April 2018, following the review of our international business model and regulatory risks. Brazil had been one of our top premium-producing countries in our international life insurance business for the prior several years. Finally, Venezuela, which has historically been one of our top premium-producing countries, has experienced prolonged economic and political turmoil, which has negatively impacted our sales in the country, decreasing approximately 10% in each of 2020 and 2019. As discussed in Part I. Item 1, Business - Strategic Initiatives, we are beginning to implement on our growth strategies in the Life Insurance segment, by expanding our product offerings to the U.S. market. Endowment sales represent a significant portion of our new business sales internationally and totaled approximately $8.6 million and $9.3 million, representing approximately 82.7% and 79.5% of total first year premiums in 2020 and 2019, respectively. Most of our life insurance policies contain a policy loan provision, which allows the policyholder to use the accumulated cash value of a policy to pay premiums. These accumulated cash values can also be taken as a cash loan from the policy at the request of the policyholder and are secured by the policy values. The policy loan asset balance increased 2.0% from 2019 to 2020 and remains at the same approximate ratio to life reserves as noted in prior years. International Premiums. The following table sets forth, for our top five producing countries, our direct premiums from our international life insurance business for the periods indicated. December 31, 2020 | 10-K 48 Table of Contents CITIZENS, INC. Years ended December 31, (In thousands, except for %) 2020 2019 2018 Country: Colombia $ 25,783 20.4 % $ 26,768 20.1 % $ 27,605 20.0 % Venezuela 19,956 15.8 22,353 16.8 24,783 18.0 Taiwan 19,078 15.1 19,403 14.6 18,888 13.7 Ecuador 13,301 10.5 14,198 10.6 15,187 11.0 Argentina 9,175 7.3 10,069 7.6 9,953 7.2 Other Non-U.S. 38,992 30.9 40,562 30.3 41,309 30.1 Total $ 126,285 100.0 % $ 133,353 100.0 % $ 137,725 100.0 % Sales from Colombia, Venezuela and Taiwan represented the majority of the new and renewal business premiums in 2020 and 2019. Overall, all of our top five countries listed above experienced a decline in premium levels from 2019 to 2020, with the biggest decrease occurring in Venezuela. As we discussed above, 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 the pace of new policies issued lagging the number of policies terminated from death, surrender or lapse. We believe the economic uncertainty in Venezuela contributed to the larger decline in that country. Domestic Premiums. Domestic premiums in our Life Insurance segment were $5.1 million in 2020, down from $6.2 million in 2019. We discontinued new sales of domestic ordinary whole life and endowment life insurance products within our Life Insurance segment in 2017; therefore, the majority of the premium recorded in 2018, 2019 and 2020 is related to renewal business. 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 as detailed above under Item 1 - Business - Strategic Initiatives. Net Investment Income. Net investment income in our Life Insurance segment increased 2.5% in 2020 compared to 2019 due to continued growth in average invested assets. We experienced a decrease in portfolio yield of 13 basis points in this segment in 2020 compared to 2019 as we continue to face a challenging investment environment for fixed maturity assets, which account for the majority of our investment portfolio. See the Investments section below for more detailed information on our investments. Years ended December 31, (In thousands, except for %) 2020 2019 2018 Net investment income $ 45,885 44,779 39,985 Average invested assets, at amortized cost 1,071,792 1,016,055 958,135 Annualized yield on average invested assets 4.28 % 4.41 % 4.17 % Realized Investment Gains, Net. T he realized gain for 2020 was primarily due to the appreciation in the value of a preferred stock exchange traded fund purchased during the first quarter as we were able to take advantage of the market dislocation to identify an attractive risk-adjusted investment opportunity. Realized gains for 2019 were primarily due to 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 and $1.3 million gain on fixed maturity redemptions above par. December 31, 2020 | 10-K 49 Table of Contents CITIZENS, INC. Claims and Surrenders. A breakout of death claim and surrender benefits for the Life Insurance segment is detailed below. Years ended December 31, (In thousands) 2020 2019 2018 Claims and surrenders: Death claim benefits $ 5,990 6,710 5,880 Surrender benefits 52,218 46,062 38,187 Endowment benefits 11,016 12,233 13,329 Matured endowment benefits 20,965 14,601 8,548 Accident and health benefits 149 128 229 Other policy benefits 3,475 3,230 2,976 Total claims and surrenders $ 93,813 82,964 69,149 78% of our claims and surrender benefits in 2020 and 73% in 2019 were related to payment of surrender benefits and matured endowment benefits. Policy surrenders increased 13.4% in 2020 as compared to 2019 and matured endowment benefits increased by 43.6% in 2020. These expenses have been increasing over the last several years, which is expected, due to the aging of this block of business - a significant portion of surrenders relates to policies that have been in force and have little to no associated surrender charges and endowment products reaching their stated maturities. These charges are within expected levels. The other key component of claims and surrender benefits is death claim benefits, which decreased 10.7% in 2020 compared to 2019. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels. HOME SERVICE INSURANCE We operate in the Home Service Insurance market through our subsidiaries Security Plan Life Insurance Company ("SPLIC"), Magnolia Guaranty Life Insurance Company ("MGLIC") and Security Plan Fire Insurance Company ("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 415 independent agents who work on a debit route system and through funeral homes that sell policies, collect premiums and service policyholders. 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 December 31, 2020 | 10-K 50 Table of Contents CITIZENS, INC. 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. Years ended December 31, (In thousands) 2020 2019 2018 Revenue: Premiums $ 46,128 46,681 46,714 Net investment income 13,051 13,058 13,125 Realized investment gains (losses), net 223 1,470 (46) Other income (loss) 19 4 (1) Total revenue 59,421 61,213 59,792 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 27,332 23,863 21,954 Increase in future policy benefit reserves 4,098 1,839 4,276 Policyholders' dividends 33 36 46 Total insurance benefits paid or provided 31,463 25,738 26,276 Commissions 14,125 14,094 14,883 Other general expenses 17,402 19,517 20,435 Capitalization of deferred policy acquisition costs (4,907) (4,807) (5,501) Amortization of deferred policy acquisition costs 3,452 4,436 4,320 Amortization of cost of insurance acquired 1,356 1,054 1,875 Total benefits and expenses 62,891 60,032 62,288 Income (loss) before income tax expense $ (3,470) 1,181 (2,496) Premiums. First year premiums in this segment were negatively impacted by the COVID-19 pandemic and thus declined slightly in 2020 as compared to 2019. We had temporary office closures in Louisiana during the second and third quarters due to the COVID-19 pandemic and we have also had to curtail the sales of certain product offerings that require extensive person-to-person sales interaction. Premiums were also negatively affected due to three hurricanes in Louisiana during 2020 that increased reinsurance premiums paid to our reinsurers, which we net against premium revenue. The following table sets forth our direct premiums by state for the periods indicated. Years ended December 31, (In thousands, except for %) 2020 2019 2018 State Louisiana $ 42,950 90.2 % $ 42,867 90.2 % $ 42,898 90.2 % Mississippi 1,955 4.1 2,037 4.3 2,105 4.4 Arkansas 1,690 3.6 1,660 3.5 1,675 3.5 Other states 995 2.1 938 2.0 857 1.9 Total premiums $ 47,590 100.0 % $ 47,502 100.0 % $ 47,535 100.0 % December 31, 2020 | 10-K 51 Table of Contents CITIZENS, INC. Claims and Surrenders. A breakout of death claim and surrender benefits for the Home Service Insurance segment is detailed below. Years ended December 31, (In thousands) 2020 2019 2018 Claims and surrenders: Death claim benefits $ 21,205 18,390 16,718 Surrender benefits 2,609 3,231 2,988 Endowment benefits 10 14 12 Matured endowment benefits 615 546 541 Property claims 2,807 1,563 1,648 Accident and health benefits 70 104 31 Other policy benefits 16 15 16 Total claims and surrenders $ 27,332 23,863 21,954 The majority of claims and surrender benefits in our Home Service Insurance segment relate to death claim benefits. Death claim benefits increased 15.3% in 2020 compared to 2019 due primarily to the COVID-19 pandemic and the average dollar amount of claims incurred. Mortality experience is closely monitored by the Company and can fluctuate based on reported claims as a key performance indicator. The other primary claims and surrender benefits were: • Surrender benefits decreased in 2020 compared to 2019 but were within anticipated ranges based on management expectations. • Property claims increased materially in 2020 compared to 2019. During the third quarter of 2020, SPFIC was impacted by Hurricane Laura, a Category 4 hurricane that caused significant damage in Louisiana. During the fourth quarter of 2020 SPFIC was also impacted by Hurricanes Delta and Zeta, both of which were Category 2 storms that also hit Louisiana. The Company has a reinsurance agreement that covers catastrophic events such as a hurricane. 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 each of Hurricane Laura and Delta 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. Hurricane Zeta has been a less significant storm and at this point, we do not expect the impact of this storm to have a material effect on our consolidated financial statements. OTHER NON-INSURANCE ENTERPRISES Years ended December 31, (In thousands) 2020 2019 2018 Income (loss) before income tax expense (18,741) (7,231) (7,587) This operating unit represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under U.S. GAAP, which typically results in a segment loss. Revenue in this operating unit consists primarily of net investment income and realized investment gains or losses, while expenses consist of other general expenses. The loss reported for 2020 was negatively impacted by the change in control costs described above, which contributed to the $19.9 million of other general expenses. The loss in 2019 was impacted by an impairment loss of $3.1 million in connection with reclassifying our Citizens Academy training facility located near Austin, Texas as real estate held for sale. This facility is no longer being used by the Company and is for sale. December 31, 2020 | 10-K 52 Table of Contents CITIZENS, INC. INVESTMENTS Our investments are an integral part of our business success, as we invest the majority of premiums collected to pay for future benefits and rely on net investment income for our ongoing operations. The administration of our investment portfolio 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. State insurance statutes prescribe the quality and percentage of the various types of investments that may be made by insurance companies and generally permit investment 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. Our investment guidelines comply with the applicable statutes and require that fixed maturity securities, both government and corporate, are investment grade and comprise a majority of the investment portfolio. The assets are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for our insurance company subsidiaries to meet their respective policyholder obligations and operating expenses. The following table shows the carrying value of our investments by investment category and cash and the percentage of each to total invested assets. Years ended December 31, (In thousands, except for %) 2020 % 2019 % Cash and invested assets: Fixed maturity securities: U.S. Treasury and U.S. Government-sponsored enterprises $ 16,117 1.0 % $ 15,878 1.0 % Corporate 877,208 52.8 650,088 42.6 Municipal bonds (1) 409,665 24.7 536,284 35.1 Mortgage-backed (2) 140,184 8.5 131,387 8.6 Asset-backed 46,091 2.8 44,203 2.9 Foreign governments 118 — 119 — Total fixed maturity securities 1,489,383 89.8 1,377,959 90.2 Short-term investments — — 1,301 0.1 Cash and cash equivalents 34,131 2.1 46,205 3.0 Other investments: Policy loans 83,318 5.0 82,005 5.4 Equity securities 22,102 1.3 16,033 1.1 Real estate and other long-term investments 29,865 1.8 2,956 0.2 Total cash and invested assets $ 1,658,799 100.0 % $ 1,526,459 100.0 % (1) Includes $164.0 million and $188.1 million of securities guaranteed by third parties for the years ended December 31, 2020 and 2019, respectively. (2) Includes $139.8 million and $130.1 million of U.S. Government agencies and government-sponsored enterprises for the years ended December 31, 2020 and 2019, respectively. During 2020, we continued repositioning our portfolio into more diversified holdings as part of our investment management strategy. As investments matured or were called, the Company increased investments in corporate securities, which now represent 52.8% of our cash and invested assets as of December 31, 2020 as compared to 42.6% at December 31, 2019. The Company has also decreased its exposure to the municipal bond market, which now represents 24.7% of the investment portfolio in 2020 compared to 35.1% in 2019. Cash and cash equivalents decreased as of December 31, 2020 compared to December 31, 2019 due to timing of cash inflows and investments of cash into marketable securities. December 31, 2020 | 10-K 53 Table of Contents CITIZENS, INC. Real estate and other long-term investments increased to $29.9 million as of December 31, 2020 as compared to $3 million as of December 31, 2019 primarily due to investments of $18.1 million in private equity funds and other alternative investments and 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 and Chief Executive Officer Separation of Service and Consulting Agreement in connection with his resignation following the change in control. At December 31, 2020, investments in fixed maturity and equity securities were 91.1% of our total cash and invested assets. All of our fixed maturity securities were classified as available-for-sale at December 31, 2020 and 2019. We had no fixed maturity securities that were classified as trading securities at December 31, 2020 or 2019. The following table shows annualized investment yields by segment operations as of December 31 for each year presented. Year Life Insurance Home Service Insurance Consolidated 2020 4.28 % 4.37 % 4.24 % 2019 4.41 % 4.45 % 4.36 % 2018 4.17 % 4.52 % 4.17 % Yields on investment assets vary between segment operations due to different portfolio mixes and durations in the segments. Our annualized yield on average invested assets on the consolidated level decreased twelve basis points in 2020 compared to 2019, primarily driven by the Life Insurance segment. Credit quality is an important feature of our investment guidelines for our fixed maturity securities. 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 and Fitch Ratings. A credit rating assigned by a NRSRO is a quality-based rating, with AAA representing the highest quality and D the lowest, with BBB and above being considered investment grade. If there is no NRSRO rating, the Company may use credit ratings of the NAIC Securities Valuation Office ("SVO") as assigned. Securities rated by the SVO are grouped in the equivalent NRSRO category as stated by the SVO, and securities that are not rated by a NRSRO are included in the "other" category. The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value. December 31, (In thousands, except for %) 2020 % 2019 % AAA $ 31,990 2.1 % $ 56,977 4.1 % AA 449,934 30.3 513,190 37.2 A 451,488 30.3 385,345 28.0 BBB 532,993 35.8 406,515 29.5 BB and other 22,978 1.5 15,932 1.2 Totals $ 1,489,383 100.0 % $ 1,377,959 100.0 % The Company made new investments in investment grade bonds during 2020. Non-investment grade securities are the result of downgrades of issuers or securities acquired during acquisitions of companies, as the Company has not purchased below investment grade securities. December 31, 2020 | 10-K 54 Table of Contents CITIZENS, INC. As of December 31, 2020, the Company held municipal fixed maturity securities that include third-party guarantees. Detailed below is a presentation by credit rating of our municipal holdings by funding type. December 31, 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 $ 22,785 22,066 3,334 3,096 — — 26,119 25,162 6.7 % AA 66,897 62,227 129,071 120,231 12,479 10,787 208,447 193,245 51.2 A 16,909 15,221 130,463 117,694 5,184 4,419 152,556 137,334 36.4 BBB 4,273 4,169 11,491 11,062 1,592 1,450 17,356 16,681 4.4 BB and other 4,509 4,432 678 608 — — 5,187 5,040 1.3 Total $ 115,373 108,115 275,037 252,691 19,255 16,656 409,665 377,462 100.0 % Municipal fixed maturity securities shown excluding third-party guarantees AAA $ 4,530 4,419 — — — — 4,530 4,419 1.2 % AA 45,779 44,235 46,048 42,602 7,839 6,542 99,666 93,379 24.7 A 30,432 28,169 164,915 149,742 8,156 7,146 203,503 185,057 49.0 BBB 9,232 8,642 34,177 32,316 — — 43,409 40,958 10.9 BB and other 25,400 22,650 29,897 28,031 3,260 2,968 58,557 53,649 14.2 Total $ 115,373 108,115 275,037 252,691 19,255 16,656 409,665 377,462 100.0 % 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 fixed maturity securities at December 31, 2020. (In thousands, except for %) Fair Value Amortized Cost % of Total Fair Value Utilities $ 69,190 60,895 16.9 % Education 71,766 66,174 17.5 % 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 December 31, 2020. December 31, 2020 | 10-K 55 Table of Contents CITIZENS, INC. The Company holds 21.4% of its municipal holdings in Texas issuers as of December 31, 2020. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2020. General Obligation Special Revenue Total (In thousands) Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Texas securities including third-party guarantees AAA $ 22,176 21,557 3,334 3,096 25,510 24,653 AA 23,009 22,554 14,092 13,067 37,101 35,621 A — — 22,334 21,855 22,334 21,855 BBB — — 1,977 1,828 1,977 1,828 BB and other — — 559 508 559 508 Total $ 45,185 44,111 42,296 40,354 87,481 84,465 Texas securities excluding third-party guarantees AAA $ 4,530 4,419 — — 4,530 4,419 AA 33,368 32,710 3,612 3,316 36,980 36,026 A 6,063 5,830 30,117 29,028 36,180 34,858 BBB 1,224 1,152 5,547 5,209 6,771 6,361 BB and other — — 3,020 2,801 3,020 2,801 Total $ 45,185 44,111 42,296 40,354 87,481 84,465 IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES Beginning January 1, 2020, in connection with the adoption of a new accounting standard, the Company assesses available-for-sale ("AFS") fixed maturity securities in an unrealized loss position for expected credit losses. See Note 1. Summary of Significant Accounting Policies for a discussion regarding our application of this accounting standard in 2020. The Company recorded no credit losses on securities in 2020 or other-than-temporary impairments ("OTTI") on securities in 2019. Gross unrealized losses on AFS fixed maturity securities amounted to $1.9 million as of December 31, 2020 and $1.6 million as of December 31, 2019. This increase in gross unrealized losses during 2020 was a result of the market disruption caused by the COVID-19 pandemic. Information on both unrealized and realized gains and losses by category is set forth in Note 2. Investments of the notes to our consolidated financial statements. REINSURANCE As is customary among insurance companies, our insurance company subsidiaries reinsure, with other companies, portions of the life insurance risks they underwrite. A primary purpose of reinsurance agreements is to enable an insurance company to reduce the amount of risk by reinsuring the amount exceeding the maximum amount the insurance company is willing to retain. Even though a portion of the risk may be reinsured, our insurance company subsidiaries remain liable to perform all the obligations imposed by the policies issued by them and could be liable if their reinsurers were unable to meet their obligations under the reinsurance agreements. We believe we have established appropriate reinsurance coverage based upon our net retained insured liabilities compared to our surplus. December 31, 2020 | 10-K 56 Table of Contents CITIZENS, INC. The effect of reinsurance on premiums is as follows. Years ended December 31, (In thousands) 2020 2019 2018 Direct premiums $ 178,952 187,009 191,561 Reinsurance assumed 91 99 99 Reinsurance ceded (3,714) (2,761) (3,800) Net premiums $ 175,329 184,347 187,860 Our insurance subsidiaries monitor the solvency of their reinsurers in seeking to minimize the risk of loss in the event of default by a reinsurer. The primary reinsurers of our insurance subsidiaries are large, well-capitalized entities. The effect of reinsurance on life insurance in force is as follows. Years ended December 31, (In millions) 2020 2019 2018 Direct written life insurance in force $ 4,612 4,729 4,836 Reinsurance assumed 5 5 5 Reinsurance ceded (475) (487) (490) Net life insurance in force $ 4,142 4,247 4,351 Virtually all of the Company's non-credit accident and health insurance has been reinsured and is administered by Unified Life Insurance Company, an unaffiliated party. The Company monitors the credit ratings of our life and property reinsurers. The ratings by A.M. Best Company range from B+ (Good) to A+ (Superior). SPFIC generally carries first and second event catastrophe reinsurance coverage of $10.0 million per event and a retention level of $0.5 million per event. Thus, the first $0.5 million of incurred claims and any claims in excess of $10.0 million per event are SPFIC's responsibility. The reinsurance premium for catastrophe reinsurance was $1.4 million in 2020 and $0.8 million in 2019 and 2018, respectively. LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. In the year ended December 31, 2020, our operations provided $48.8 million in net cash. 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. Since the Company does not have any debt, the Company could seek a line of credit in order to provide additional liquidity at the holding company level if needed to provide for longer-term or emergency cash needs. PARENT COMPANY LIQUIDITY AND CAPITAL RESOURCES Liquidity is the ability to generate amounts of cash adequate to meet our cash needs. 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 December 31, 2020 | 10-K 57 Table of Contents CITIZENS, INC. subject insurance operations to significant regulatory restrictions. As discussed in Part I, Item 1, Business and Part I. Item 1A. Risk Factors , these laws and 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 "2020 Highlights", Citizens had significant expenses in 2020 related to executive severance costs due to severance payable to our former Chief Executive Officer 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 and Chief Executive Officer Separation of Service and Consulting 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. The $8.8 million payment was paid to Mr. Kolander on February 8, 2021. We also incurred significant one-time expenses related to the build-out of our new headquarters in Austin, Texas and for the purchase of furniture and fixtures for the leased space. Additionally, as discussed in Part I. Item 1. Business , on March 5, 2021, the Company paid $9.1 million to the Foundation to hold in escrow in order to purchase, upon obtaining final regulatory approval, 100% of the outstanding Class B common stock. See Contractual Obligations and Off-balance Sheet Arrangements below for a discussion of real estate lease payments to be made under our new long-term contract for our headquarters in Austin, Texas. We have been 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 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, the liquidity of our insurance subsidiaries would be negatively impacted, inhibiting their ability to make dividends to the Company, 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 revenues, investment income and investment maturities. Primary cash needs are for payments of policy benefits to policyholders, investment purchases, and operating expenses. Historically, we have not had to liquidate investments to provide cash flow for our insurance operations and we did not do so in 2020. We believe that we have adequate capital resources to support the liquidity requirements of our insurance operations if the cash flow from our insurance operations is insufficient to meet our cash needs. As discussed above, premium revenue was $175.3 million and $184.3 million in the years ended December 31, 2020 and 2019, respectively. See Contractual Obligations and Off-balance Sheet Arrangements below for a discussion of known and estimated cash needs related to payments of future policy benefits and policy claims. Cash flows from operating activities were $48.8 million, $72.2 million and $84.6 million for the years ended December 31, 2020, 2019 and 2018, 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 and to a lesser extent private equity funds or other alternative investments. However, during the third quarter of 2020, the Company used funds from matured securities to pay $6.0 million to the IRS for the tax compliance matter described in Note 7. Commitments and Contingencies in the notes to our consolidated financial statements. As noted in Note 7 . 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. Net cash outflows from investing activities totaled $61.8 million and $69.3 million for the years ended December 31, 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. December 31, 2020 | 10-K 58 Table of Contents CITIZENS, INC. Our investments consist of 91.7% of marketable fixed maturity securities classified as available-for-sale and 1.4% of equity securities that could be readily converted to cash for liquidity needs. Over the last several years, a large portion of our fixed maturity security investment portfolio has matured, which required us to reinvest in fixed maturity securities with lower interest rates. We are seeking to diversify our portfolio with private equity investments in order to earn higher interest rates to mitigate the effect of a decrease in our spread between our policy liability crediting rates and our investment earned rates (our gross margin), 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. Because claims and surrenders are our largest expense, a primary liquidity concern is the risk of an extraordinary level of early policyholder surrenders. 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, our associated cash outflows for claims and surrender benefits historically have not had an adverse impact on our overall liquidity. Although we experienced an increase in surrenders in the Life Insurance segment during 2020 compared to 2019, we believe that such surrenders were not materially impacted by the COVID-19 pandemic. 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. 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 December 31, 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, our capital resources and future cash flows will be adequate to meet our needs for funds, but we will monitor closely our policyholder behavior patterns. For reasons previously discussed, we have experienced increased death claim benefits in our Home Service Insurance segment in 2020 compared to 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. 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", we experienced substantial increases in property claims in the last half of 2020 due in large part to three hurricanes that hit Louisiana. As a result, Citizens had to contribute additional capital to SPFIC in order to maintain statutory capital requirements. 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 December 31, 2020 | 10-K 59 Table of Contents CITIZENS, INC. 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 December 31, 2020, our domestic insurance subsidiaries were above the required minimum RBC levels. CICA Ltd. is a Bermuda domiciled company. The BMA requires Bermuda insurers to maintain available statutory economic capital and surplus at a level equal to or in excess of the BMA's Enhanced Capital Requirement, which requires a certain Target Capital Level ("TCL"). As of December 31, 2020, CICA Ltd. was above the TCL threshold. However, as discussed in Part I. Item 1. Business – International Regulation – Bermuda, due to the Prudential Review, the BMA is requiring Citizens and CICA Ltd. to enter into a “Keepwell Agreement”, which would encumber certain assets of the Company. The Keepwell Agreement will include a specific target solvency level at which the Company would be required to make a capital injection into CICA Ltd. Both the Keepwell Agreement and any capital injection could negatively impact the Company’s capital resources and liquidity. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS We have committed to the following contractual obligations as of December 31, 2020, with the payments due by the period indicated below: (In thousands) Total Less than 1 Year 1 to 3 Years 3 to 5 Years More than 5 Years Contractual Obligations: Investment commitments $ 68,571 30,000 38,571 — — Real estate and equipment leases 11,973 1,145 2,053 2,253 6,522 Future policy benefit reserves: Life insurance 1,246,423 22,561 77,937 128,601 1,017,324 Annuities 78,304 — 7 4 78,293 Accident and health 761 107 396 8 250 Dividend accumulations 33,336 — — — 33,336 Premiums paid in advance 40,605 930 3,239 5,383 31,053 Other policyholder funds 22,447 — — — 22,447 Total policy liabilities 1,421,876 23,598 81,579 133,996 1,182,703 Policy claims payable: Life insurance 12,314 12,314 — — — Accident and health 149 149 — — — Casualty 743 743 — — — Total policy claims payable 13,206 13,206 — — — Total purchase obligations 9,592 9,592 — — — Total contractual obligations $ 1,525,218 77,541 122,203 136,249 1,189,225 Future Policy Benefit Reserves and Policy Claims Payable. The payments related to the future policy benefits and policy claims payable reflected in the table above have been projected utilizing assumptions based upon our historical experience and anticipated future experience. Payments of amounts related to annuity, dividend and other policyholder funds left on deposit are projected based on assumptions of policyholder withdrawal activity. Because the exact timing and amount of the ultimate policyholder fund obligation is subject to significant uncertainty, we have reflected the obligation at the amount of the liability presented on the consolidated balance sheet in the more than five-year category. December 31, 2020 | 10-K 60 Table of Contents CITIZENS, INC. Real Estate and Equipment Leases. The Company entered into a long-term lease agreement with an unrelated party for its new home office in Austin, Texas and moved into its new home office in the first week of November 2020. Payments under this new long-term lease agreement average approximately $112,340 per month. Total Purchase Obligations. Total purchase obligations in the table above reflect primarily the $8.8 million held in the Rabbi Trust at December 31, 2020 for the severance payment made to Mr. Kolander in February 2021. The Company does not have off-balance sheet arrangements at December 31, 2020 and does not expect any future effects on the Company's financial condition related to any such arrangements. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engages in speculative activities of any nature, and we do not use such investments to hedge our investment positions. CRITICAL ACCOUNTING POLICIES The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: (1) it requires assumptions to be made that were uncertain at the time the estimate was made; and (2) changes in the estimate, or different estimates that could have been selected, could have a material effect on our consolidated results of operations or financial condition. While we believe that our estimates, assumptions and judgments are reasonable, they are based on information presently available. Changes in our assumptions, estimates or assessments as a result of unforeseen events or otherwise could have a material impact on our financial position or results of operations. Management has discussed the development and selection of its critical accounting estimates with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the disclosure presented below relating to them. See Note 1. Summary of Significant Accounting Policies in the notes to our consolidated financial statements for further information on our critical accounting policies. VALUATION OF INVESTMENTS IN FIXED MATURITY SECURITIES Based upon current accounting guidance, investment securities must be classified as held-to-maturity, available-for-sale ("AFS") or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Fixed maturity securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as AFS and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized. The Company currently does not hold any fixed maturity securities classified as held-to-maturity. The Company monitors all fixed maturity securities on an on-going basis relative to changes in credit ratings, market prices, earnings trends and financial performance, in addition to specific region or industry reviews. The Company evaluates whether a credit impairment exists for fixed maturity securities by considering primarily the following factors: (a) changes in the financial condition of the security's underlying collateral; (b) whether the issuer is current on contractually obligated interest and principal payments; (c) changes in the financial condition, credit rating and near-term prospects of the issuer; and (d) the payment structure of the security. The Company's best estimate of expected future cash flows used to determine the credit loss amount is a quantitative and qualitative process. Quantitative review includes information received from third-party sources such as financial statements, pricing and rating changes, liquidity and other statistical information. Qualitative factors include judgments related to business strategies, economic impacts on the issuer, overall judgment related to estimates and industry factors as well as the Company's intent to sell the security, or if it is more likely than not that the Company would be required to sell a security before recovery of its amortized cost. The Company's best estimate of future cash flows involves assumptions including, but not limited to, various performance indicators, such as historical and projected default and recovery rates, credit ratings, and current delinquency rates. These assumptions require the use of significant management judgment and include the December 31, 2020 | 10-K 61 Table of Contents CITIZENS, INC. probability of issuer default and estimates regarding timing and amount of expected recoveries, which may include estimating the underlying collateral value. In addition, projections of expected future fixed maturity security cash flows may change based upon new information regarding the performance of the issuer. Any credit losses are presented as an allowance rather than as a write-down of AFS fixed maturity securities. DEFERRED POLICY ACQUISITION COSTS Acquisition costs, consisting of commissions and policy issuance, underwriting and agent convention expenses that are directly related to and vary with the successful production of new business are deferred. These deferred amounts, referred to as deferred policy acquisition costs ("DAC"), are recorded as an asset on the consolidated balance sheets and amortized to income in a systematic manner, based on related contract revenues or gross profits as appropriate. Traditional life insurance and accident and health insurance acquisition costs are amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing future policy benefit liabilities. For universal life type contracts and investment contracts that include significant surrender charges or that yield significant revenues from sources other than the investment contract holders' funds, the deferred contract acquisition cost amortization is matched to the recognition of gross profit. The effect on the DAC asset that would result from realization of unrealized gains or losses is recognized with an offset to accumulated other comprehensive income in consolidated stockholders' equity. If an internal replacement of insurance or investment contract modification substantially changes a contract as defined in current accounting guidance, then the DAC is written off immediately through income and any new deferrable costs associated with the new replacement are deferred. If a contract modification does not substantially change the contract, the DAC amortization on the original contract will continue and any acquisition costs associated with the related modification are immediately expensed. The ending DAC asset balance is calculated at a seriatim level for policies in force at the end of each reporting period based on the remaining unamortized asset. The assumptions used to calculate DAC are set when a policy is issued and do not change with changes in actual experience, unless a loss recognition event occurs. The seriatim method ensures that policies lapsed or surrendered during the reporting period are no longer included in the DAC calculation. This method limits the amount of deferred costs to its estimated realizable value, provided actual experience is comparable to that contemplated in the locked-in assumptions. Inherent in the capitalization and amortization of DAC are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 93.3% of our capitalized DAC are attributed to first year and renewal excess commissions. The remaining 6.7% are attributed to other costs that vary with and are directly related to the successful acquisition of new insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business. DAC is subject to recoverability testing at the time of policy issuance and loss recognition testing on an annual basis, or when an event occurs that might require loss recognition testing. If loss recognition or impairment is necessary, DAC would be written off to the extent that anticipated future premiums and investment income is insufficient to cover expected future policy benefits and expenses. Loss recognition testing considers, among other things, actual experience and projected future experience and calculates the available premium (gross premium less the benefit and expense portion of premium) for the next 50 years. DAC is evaluated for recoverability using best estimate assumptions related to interest rates, mortality and lapses. Based on the results of DAC recoverability and loss recognition testing, management believes that our DAC for the years ended December 31, 2020, 2019 and 2018 is recorded at its estimated realizable value. However, if expenses or mortality increase by 5% from our underlying assumptions or interest rates continue to decline, a loss recognition event could occur in our Home Service Insurance segment. For DAC related to long-duration traditional insurance contracts, if the assets supporting the liabilities are in a net unrealized gain position at the balance sheet date, loss recognition testing assumptions are updated to exclude such gains from future cash flows by reflecting the impact of reinvestment rates on future yields. If a future loss is anticipated under this basis, any additional shortfall indicated by loss recognition tests is recognized as a reduction in accumulated other comprehensive income (shadow loss recognition). Similar to other loss recognition on long-duration insurance contracts, such shortfall is first reflected as a reduction in DAC and secondly as an increase in December 31, 2020 | 10-K 62 Table of Contents CITIZENS, INC. liabilities for future policy benefits. The change in these adjustments, net of tax, is included with the change in net unrealized appreciation of investments that is credited or charged directly to other comprehensive income. COST OF INSURANCE ACQUIRED Cost of Insurance Acquired ("COIA") is established when we purchase a block of insurance. COIA is amortized over the emerging profit of the related policies using the same assumptions as were used in computing liabilities for future policy benefits. Inherent in the amortization of COIA are certain management judgments about the ending asset balance and the annual amortization. The key assumptions used are based upon interest, mortality and lapses at the time of purchase. A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests are based initially on an estimate of the available premium (gross premium less the benefit and expense portion of premium) for the next 50 years using best estimate assumptions related to interest rates, mortality and lapses. Management believes that our COIA is recoverable for the years ended December 31, 2020 and 2019. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing. GOODWILL Current accounting guidance requires that goodwill balances be reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate a triggering event has occurred. A reporting unit is defined as an operating segment or one level below an operating segment. The Company's reporting units, for which goodwill has been allocated, are equivalent to the Company's operating segment, as there is no discrete financial information reviewed and analyzed by management for the separate components of the segment or all of the components of the segment have similar economic characteristics. Goodwill is tested for impairment on an annual basis or more frequently if indicators of potential impairment exist. The goodwill testing requires us to compare the estimated fair value of a reporting unit to its carrying value. If the carrying value of the reporting unit is lower than its estimated fair value, no further evaluation is required. If the carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded for that excess, limited to the total amount of goodwill allocated to that reporting unit. We have the option of performing an assessment of certain qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value or proceeding directly to a quantitative impairment test. Management’s determination of the fair value of each reporting unit under the accounting guidance incorporates multiple inputs including discounted cash flow calculations based on assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, discount rates and earnings projections. Spread compression and related effects to profitability caused by lower interest rates affect the valuation of in force business more significantly than the valuation of new business, as new business pricing assumptions reflect the current and anticipated future interest rate environment. Estimates of fair value are inherently uncertain and represent management's reasonable expectations regarding future developments. We performed our annual goodwill impairment test and the fair value was in excess of the segment's carrying value for the years ended 2020, 2019 or 2018. As of December 31, 2020, the Company had $12.6 million of goodwill allocated to the Life Insurance segment and the segment's fair value exceeded the carrying value by approximately 8%. We apply significant judgment when determining the estimated fair value of our reporting unit. These judgements incorporate multiple inputs including discounted cash flow calculations based on assumptions that market participants would make in valuing the reporting unit, levels of economic capital, production levels and profitability of new business, pricing changes, spread compression, value of in force and earnings projections. Estimates of fair value are inherently uncertain and represent management’s reasonable expectations regarding future developments. Unfavorable changes to assumptions or factors that decrease the fair value and could result in future impairment include, but are not limited to, lower expectations for future sales, higher maintenance expenses, unfavorable mortality, higher discount rates and market-based inputs. Increases in the carrying value of the segment caused by recognition of uncertain tax benefits could also result in future impairment. December 31, 2020 | 10-K 63 Table of Contents CITIZENS, INC. POLICY LIABILITIES Future policy benefit reserves have been computed using the net level premium method with assumptions as to investment yields, dividends on participating business, mortality, lapses and withdrawals based upon our experience. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of policy liabilities and the increase in future policy benefit reserves. Management's judgments and estimates for future policy benefit reserves provide for possible adverse deviation. We continue to use the original assumptions (including a provision for the risk of adverse deviation) in subsequent periods to determine the changes in the liability for future policy benefits (the "lock-in concept”) unless a premium deficiency exists. Management monitors these assumptions and has determined that a premium deficiency did not exist as of December 31, 2020. Management believes that our policy liabilities and increase in future policy benefit reserves as of the years ended December 31, 2020, 2019 and 2018 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision. Annually, the Company completes experience studies with respect to mortality, lapse, interest and expenses. The results of these studies are used for current year reserve adequacy testing, which includes loss recognition, goodwill, and establishing benefit liabilities and DAC for the following year's new issues. CONTINGENCIES An estimated loss from a contingency is accrued and charged to results of operations only if both of the following conditions are met: 1. Information available prior to the issuance of the financial statements indicates that it is probable (virtual certainty is not required) that an asset has been impaired or a liability incurred as of the date of the financial statements; and 2. The amount of the loss can be reasonably estimated. Reasonable estimation of a possible loss does not require estimating a single amount of the loss. It requires that a loss be accrued if it can be estimated within a range. If an amount within the range is a better estimate than any other amount within the range, that amount is accrued. If no amount within the range is a better estimate than any other amount, the minimum amount in the range is accrued. A gain contingency is an uncertain situation that will be resolved in the future, possibly resulting in a gain. We do not allow the recognition of a gain contingency prior to settlement of the underlying event. If we were to have a gain contingency, we would disclose it in the notes to our consolidated financial statements. TAX ACCOUNTING Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in net income in the period in which the change is enacted. CICA Ltd., a wholly-owned subsidiary of Citizens, is considered a controlled foreign corporation for federal tax purposes. As a result, the insurance activity of CICA Ltd. is subject to Subpart F of the IRC and is included in Citizens taxable income on its US federal income tax return and due to the 0% enacted tax rate in Bermuda there are no deferred taxes recorded for CICA Ltd.'s temporary differences. RECENT ACCOUNTING PRONOUNCEMENTS See Item 8. Financial Statements and Supplementary Data and "Accounting Pronouncements" in Note 1. Accounting Pronouncements in the notes to our consolidated financial statements. December 31, 2020 | 10-K 64 Table of Contents CITIZENS, INC.