CITIZENS, INC. 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This section and other parts of this Quarterly Report on Form 10-Q ("Form 10-Q") contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A of this Form 10-Q as well as in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020 under the heading “Risk Factors,” which are incorporated herein by reference. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. The impacts of COVID-19 and related economic conditions on the Company's financial results, which began to affect the Company late in the first quarter of 2020, continue to be highly uncertain and outside the Company’s control. The scope, duration and magnitude of the direct and indirect effects of COVID-19 are difficult or impossible to anticipate. As a result, it is not possible to predict its impact on the Company's results for the remainder of 2021. Currently, some of the most significant factors that could cause our actual results to differ significantly from our forward-looking statements are those relating to the adverse effects of the COVID-19 pandemic, including: • Decreased premium revenue and cash flow from disruption to our distribution channel of independent agents, customer self-isolation, travel limitations, business restrictions and decreased economic activity; and • An unusually high level of claims, lapses or surrenders in our insurance operations, which could affect our liquidity and cash flow. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part I, Item 1 of this Form 10-Q. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. The U.S. Securities and Exchange Commission ("SEC") maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov. We also make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 Reports filed by officers and directors, news releases, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the SEC. We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Form 10-Q. OVERVIEW Citizens, Inc. ("Citizens" or the "Company") is an insurance holding company incorporated in Colorado serving the life insurance needs of individuals in the United States since 1969 and internationally since 1975. Through our insurance subsidiaries, we provide insurance benefits to residents in 31 U.S. states and more than 75 different countries. We pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We operate in two business segments: • Life Insurance segment - U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to non-U.S. residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants; and March 31, 2021 | 10-Q 27 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS • Home Service Insurance segment - final expense life insurance and limited liability property insurance policies marketed to middle- and lower-income households in Louisiana, Mississippi and Arkansas, sold through independent agents and through funeral homes. CURRENT FINANCIAL HIGHLIGHTS In both the three months ended March 31, 2021 and 2020, we had a net loss of $3.6 million; however, our net loss before federal income tax increased by $0.5 million in the three months ended March 31, 2021 compared to prior year period. The increase in the pre-tax net loss in the 2021 period was driven by a $4.1 million increase in claims and surrender benefits, which was higher in both our Life Insurance and our Home Service Insurance segments. The higher claim expense was a result of a higher volume of reported claims, including those COVID-19 related, in addition to an increase in the average death claim amount in both segments. We also continued to experience an increase in surrender benefits and matured endowments in the Life Insurance segment, which we believe is due primarily to the aging block of business and other economic circumstances. Our realized investment gains improved by $1.6 million in the three months ended March 31, 2021, to $0.3 million, from a $1.3 million loss in the prior year period. As discussed in Part I, Item 1, Note 5 . Investments , changes in realized gains reflect the changes in fair values of our equity securities. In the three months ended March 31, 2020, we recorded realized losses of $1.1 million, which were primarily the result of the sudden stock market decline resulting from the onset of the COVID-19 pandemic. Our other general expenses continued to be negatively impacted in the three months ended March 31, 2021 by the expenses related to professional fees incurred in connection with the change in control of the Company. A detailed description of the change in control of the Company and expenses related thereto are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 ("Form 10-K"). The settlement of all legal issues related to the change in control occurred in the first quarter of 2021 and thus, we do not expect any additional expenses related to this matter. See Part I, Item 1, Business – "Change in Control; Agreement to Purchase the Class B Shares; Anticipated Divestiture of Control” in our Form 10-K and Part I, Item 1, Note. 11 Subsequent Events in the notes to our consolidated financial statements herein for a further discussion of the change in control. Despite the change in control costs, our other general expenses decreased slightly for the three months ended March 31, 2021 compared to the same period in 2020. The change in control costs were offset by lower salary and benefit expenses resulting from converting our Home Service Insurance sales agents to independent agents and lower audit and consulting fees. Consolidated Revenue Highlights Insurance premiums and investment income are our primary sources of revenue. In the three months ended March 31, 2021 as compared to the same period in 2020: • Insurance premiums declined by $2.3 million, or 5.5%, to $39.0 million from $41.3 million in the same period in 2020. The decline was driven by our Life Insurance segment as renewal premiums declined 9.3% to $24.6 million in the first quarter of 2021 from $27.1 million in the same period in 2020. The decrease in renewal premiums resulted primarily from a decline in our in force business in this segment, which is due in part to changes we made to our products and distribution over the last few years. • Net investment income was $15.2 million in both periods. Additionally, realized investment gains increased by $1.6 million primarily for the reason discussed above. Other income increased 68.8% to $0.9 million from $0.5 million for the same period in 2020. Other income consists primarily of policyholders selecting supplemental contracts upon maturity of their original policies, which has been increasing over the past few quarters. March 31, 2021 | 10-Q 28 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Consolidated Benefits and Expenses Highlights The primary use of our funds is payment of insurance benefits. As discussed above, our claims and surrender benefits increased by $4.1 million in the three months ended March 31, 2021 as compared to the same period in prior year; however, total insurance benefits paid or provided was essentially flat year-over-year, as the increase in claims and surrender benefits was offset by a decrease in future policy benefit reserves. 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. Costs incurred related to selling our insurance products remained flat in the three months ended March 31, 2021 as compared to the same period in prior year and as discussed above, general expenses slightly decreased for the period. 2021 First Quarter Financial Condition • Total investments of $1.5 billion; fixed maturity securities comprised 91.9% of total investments. • Total assets of $1.8 billion. • $4.6 billion of direct insurance in force. • No debt. OUR OPERATING SEGMENTS Our business is comprised of two operating business segments, as detailed below. • Life Insurance • Home Service Insurance Our insurance operations are the primary focus of the Company, as these operations generate most of our income. See the discussion under Segment Operations below for detailed analysis. The amount of insurance, number of policies, and average face amounts of ordinary life policies issued during the periods indicated are shown below. Three Months Ended March 31, 2021 2020 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 $ 50,330,540 863 $ 58,320 $ 49,611,100 728 $ 68,147 Home Service Insurance 44,658,259 6,361 7,021 36,117,767 5,174 6,981 Total $ 94,988,799 7,224 $ 85,728,867 5,902 We issued $95.0 million of insurance in the three months ended March 31, 2021 as compared to $85.7 million in 2020, as both our Life Insurance and Home Service Insurance segments experienced growth. We issued 7,224 new policies in 2021, as compared to 5,902 new policies in 2020. The number of policies issued in the three months ended March 31, 2021 increased 18.5% in the Life Insurance segment. The increase in applications in the first quarter was primarily due to enhancements to our business operations and sales practices to account for the impact of the COVID-19 pandemic, including sales promotions and campaigns, focused training on virtual selling and strategically prioritizing selling lower face amount policies, which typically have less stringent underwriting requirements and, in some cases, may not require the completion of medical tests, as many of our top international markets remain in quarantine due to the COVID-19 pandemic. In March 31, 2021 | 10-Q 29 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS addition, in order to address the decreasing first year premiums we have seen in recent years in this segment, we prioritized recruiting new independent contractors in the first quarter of 2021, and we began to see the impact of these efforts in March. Although applications increased during the first quarter of 2021 compared to the same period last year due to these enhancements, average policy face amount declined by almost $10,000 per policy, as we continued to emphasize the selling of lower face amount policies, as noted above. The number of policies issued in the three months ended March 31, 2021 increased 22.9% in the Home Service Insurance segment compared to the same period in 2020. The increase in new business applications in our Home Service Insurance segment was driven by the broadening of a sales campaign introduced during the third quarter of last year targeted at existing policyholders that emphasizes increased coverage as well as lower applications received in the prior year period as the onset of the COVID-19 pandemic and stay-at-home orders negatively impacted our business. During the first quarter of 2021, as part of the campaign, we increased the target face amount of insurance. As a result, the overall average face amount of policies issued for the Home Service Insurance segment increased slightly compared to the first quarter of 2020. CONSOLIDATED RESULTS OF OPERATIONS A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment. REVENUES Our revenues are generated primarily by insurance renewal premiums and investment income on invested assets. Three Months Ended March 31, (In thousands) 2021 2020 Revenues: Premiums: Life insurance $ 37,642 39,946 Accident and health insurance 343 261 Property insurance 1,047 1,110 Net investment income 15,244 15,169 Realized investment gains (losses), net 292 (1,306) Other income 915 542 Total revenues $ 55,483 55,722 Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased $2.3 million, or 5.5% for the three months ended March 31, 2021 compared to the same period in 2020. The overall decrease in premium income was driven primarily by a $2.5 million decline throughout the first three months of 2021 in renewal premiums in our Life Insurance segment. The decrease in renewal premiums in the Life Insurance segment continues to result 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 and surrenders outpacing new sales. Premium revenues continue to be negatively impacted by high levels of surrenders, which we believe are due not only to 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 due to economic circumstances in Latin America. See the detailed distribution of premiums within Segment Operations discussed below. March 31, 2021 | 10-Q 30 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Net Investment Income. Our annualized net investment income performance is summarized as follows. March 31, December 31, March 31, (In thousands, except for %) 2021 2020 2020 Net investment income, annualized $ 60,976 60,197 60,676 Average invested assets, at amortized cost 1,449,518 1,420,129 1,408,688 Annualized yield on average invested assets 4.21 % 4.24 % 4.31 % Annualized net investment income increased slightly in the three months ended March 31, 2021 as compared to the same annualized performance in the 2020 period as an increase in average invested assets derived from cash flows from our insurance operations and a one-time benefit described below offset a lower portfolio yield. The annualized yield decreased by ten basis points during the first quarter of 2021 compared to the same period in 2020, as we continue to face a challenging investment environment for fixed maturity assets, which account for the majority of our investment portfolio. 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 equities. Investment income from fixed maturity securities accounted for approximately 87.9% of total investment income for the three months ended March 31, 2021. Three Months Ended March 31, (In thousands) 2021 2020 Gross investment income: Fixed maturity securities $ 14,100 13,868 Equity securities 207 180 Policy loans 1,644 1,623 Long-term investments 73 1 Other investment income 15 68 Total investment income 16,039 15,740 Investment expenses (795) (571) Net investment income $ 15,244 15,169 Income from fixed maturity securities income increased 1.7% for the three months ended March 31, 2021, compared to the same period in 2020 and our total investment income increased by 1.9% in the same period due to the recognition of accelerated interest payments resulting from a “make-whole” call redemption, whereby the borrower was required to pay a lump sum based on the net present value of interest payments foregone due to the call. Investment expenses were slightly higher due to our increased investments in private equity, which often include start-up fees. Realized Investment Gains (Losses), Net. We recorded realized gains of $0.3 million during the first quarter of 2021 related to fair value changes in our equity securities owned at March 31, 2021. The fair value of our equity securities owned at March 31, 2020 was negatively impacted by the onset of the COVID-19 pandemic as discussed above. March 31, 2021 | 10-Q 31 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS BENEFITS AND EXPENSES Three Months Ended March 31, (In thousands) 2021 2020 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders $ 30,589 26,449 Increase in future policy benefit reserves 5,232 9,471 Policyholders' dividends 1,306 1,233 Total insurance benefits paid or provided 37,127 37,153 Commissions 8,157 7,853 Other general expenses 11,382 11,473 Capitalization of deferred policy acquisition costs (4,985) (5,009) Amortization of deferred policy acquisition costs 6,183 6,119 Amortization of cost of insurance acquired 367 368 Total benefits and expenses $ 58,231 57,957 Claims and Surrenders. Death claim and surrender benefits are our primary use of cash. As reflected in the table below, claims and surrender benefits increased 16.6%, from $18.6 million in the three months ended March 31, 2020, to $21.7 million in the three months ended March 31, 2021. Three Months Ended March 31, (In thousands) 2021 2020 Claims and Surrenders: Death claim benefits $ 8,940 6,589 Surrender benefits 12,807 12,055 Endowment benefits 2,401 2,739 Matured endowment benefits 5,122 3,753 Property claims 321 487 Accident and health benefits 59 53 Other policy benefits 939 773 Total claims and surrenders $ 30,589 26,449 • Death claim benefits increased 35.7% for the three months ended March 31, 2021, compared to the same period in 2020 - Life Insurance segment claims increased 55.6% and Home Service Insurance segment claims increased 28.6%. As discussed above in "Current Financial Highlights", the increase was due to increases in reported claims, including COVID-19 related deaths, and the average dollar amount of claims incurred. • Surrender benefits increased 6.2% for the three months ended March 31, 2021, compared to the same period in 2020. Surrender benefits represented less than 0.3% of total direct ordinary whole life insurance in force of $4.6 billion as of March 31, 2021. A significant portion of surrender benefits relates to international policies that have been in force and have little or no associated surrender charges. March 31, 2021 | 10-Q 32 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS • Matured endowment benefits increased 36.5% for the three months ended March 31, 2021, compared to the same period in 2020. We anticipated this increase based upon the dates when our endowment contracts were sold and the maturity dates set forth in the contracts. Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 44.8% for the three months ended March 31, 2021, compared to the same period in 2020. Future policy benefit reserves decreased as our block of in force business decreased. 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 were higher in the three months ended March 31, 2021 due to the increase in first year sales in our Home Service Insurance segment. Other General Expenses. As mentioned above, general expenses decreased slightly in the three months ended March 31, 2021 compared to the same period in 2020, driven primarily by lower incentive compensation costs, and lower audit and consulting costs. Capitalization and Amortization of Deferred Policy Acquisition Costs. Costs capitalized include certain commissions, policy issuance costs, and underwriting and agency expenses that relate to successful sales efforts for insurance contracts. Capitalized costs decreased slightly during the three months ended March 31, 2021 compared to the same period in 2020 as we experienced a decrease in first year premium production in our Life Insurance segment as previously discussed. Amortization of deferred policy acquisition costs was slightly higher during the three months ended March 31, 2021 compared to the same period in the prior year. Amortization is impacted by persistency, surrenders, and new sales production and thus it may fluctuate from quarter to quarter. Federal Income Tax. Tax expense decreased for the three months ended March 31, 2021 compared to the same period in 2020 resulting in effective tax rates of (30.0)% and (60.3)%, respectively. For the three months ended March 31, 2020, the Company's federal income tax expense was impacted by the gain realized on the sale of our former corporate headquarters. The Company's tax rate was impacted by differences between our effective tax rate and the statutory tax rate resulting from income and expense items that are treated differently for financial reporting and tax purposes. In addition, CICA Ltd., a wholly-owned Bermuda subsidiary of Citizens, is considered a controlled foreign corporation for federal tax purposes and CICA Ltd.'s activity gives rise to taxable income in the U.S. as Subpart F Income, which is treated as a permanent tax difference and therefore included in the Company's effective tax rate calculation. See Part I, Item 1, Note 8. Income Taxes in the notes to our consolidated financial statements herein. SEGMENT OPERATIONS Our business is comprised of two operating business segments, as detailed below. • Life Insurance • Home Service Insurance These segments are reported in accordance with U.S. GAAP. The Company's Other Non-Insurance enterprises include non-insurance operations such as IT and corporate-support functions, which are included in the table presented below to properly reconcile the segment information with the consolidated financial statements of the Company. March 31, 2021 | 10-Q 33 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table shows income (loss) before federal income taxes by segments during the periods indicated. Three Months Ended March 31, (In thousands) 2021 2020 Income (loss) before federal income tax expense: Segments: Life Insurance $ (106) 2,086 Home Service Insurance (758) (2,145) Total segments (864) (59) Other Non-Insurance enterprises (1,884) (2,176) Total loss before federal income tax expense $ (2,748) (2,235) LIFE INSURANCE Our Life Insurance segment primarily operates through CICA Ltd. (a Bermuda company), which 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 independent marketing consultants. The whole life products are designed to provide a fixed amount of insurance coverage over the life of the insured and can include rider benefits to provide additional coverage and annuity benefits to enhance accumulations. The endowment contracts are principally accumulation contracts that incorporate an element of life insurance protection. For the majority of our business, we retain the first $0.1 million on any one life and reinsure the remainder of the risk. We operate the Life Insurance segment internationally through CICA Ltd. and domestically through our CICA and CNLIC insurance subsidiaries. March 31, 2021 | 10-Q 34 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The results of operations for the Life Insurance segment for the periods indicated are as follows: Three Months Ended March 31, (In thousands) 2021 2020 Revenues: Premiums $ 27,063 29,819 Net investment income 11,598 11,480 Realized investment gains (losses), net (108) 735 Other income 913 524 Total revenues 39,466 42,558 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 23,270 20,160 Increase in future policy benefit reserves 3,658 8,146 Policyholders' dividends 1,296 1,225 Total insurance benefits paid or provided 28,224 29,531 Commissions 4,231 4,478 Other general expenses 5,226 4,948 Capitalization of deferred policy acquisition costs (3,561) (3,921) Amortization of deferred policy acquisition costs 5,348 5,318 Amortization of cost of insurance acquired 104 118 Total benefits and expenses 39,572 40,472 Income (loss) before federal income tax expense $ (106) 2,086 Life Insurance segment premium breakout is detailed below. Three Months Ended March 31, (In thousands) 2021 2020 Premiums: First year $ 2,479 2,715 Renewal 24,584 27,104 Total premiums $ 27,063 29,819 Premiums. We derive most of our premium revenue in the Life Insurance segment from renewal premiums. Total premium revenues declined 9.2% for the three months ended March 31, 2021 compared to the same period in 2020 and renewal premiums declined by 9.3%. See “Consolidated Results of Operations” above for a discussion regarding the decline in renewal premiums in this segment. As previously mentioned, first year policies issued increased in the three months ended March 31, 2021, but lower issued face amounts led to the decline in first year premium revenue. Endowment sales totaled approximately $2.2 million of first year premiums in the three months ended March 31, 2021, as compared to $2.0 million in the prior year period. March 31, 2021 | 10-Q 35 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table sets forth, for our top five producing countries, our direct premiums from our international life insurance business for the three months ended March 31, 2021 and 2020. Three Months Ended March 31, (In thousands) 2021 2020 Country: Colombia $ 5,244 5,888 Taiwan 4,484 4,974 Venezuela 4,368 4,953 Ecuador 2,921 3,111 Argentina 1,828 1,823 Other Non-U.S. 8,105 8,201 Total $ 26,950 28,950 Sales from Colombia, Taiwan and Venezuela continued to represent the majority of the new and renewal business premiums in our international business in the three months ended March 31, 2021. Overall, four of our top five countries listed above experienced a decline in premium levels in the current year period due primarily to decreases in renewal premiums. 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. DOMESTIC SALES Domestic premiums in our Life Insurance segment were $1.2 million in the three months ended March 31, 2021, down from $1.3 million in the prior year period. Our domestic in force business results from blocks of business of insurance companies we have acquired over the years. We discontinued new sales of domestic ordinary whole life and endowment life insurance products within our Life Insurance segment in 2017 while we evaluated our domestic life strategy; therefore, the majority of the premium recorded is related to renewal business. We began marketing our products again domestically in early 2021, beginning in Florida. We believe that our experience in developing and selling products in Latin America will help us expand into the large Hispanic market in the U.S. March 31, 2021 | 10-Q 36 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Net Investment Income . Annualized net investment income in our Life Insurance segment was as follows: March 31, December 31, March 31, (In thousands, except for %) 2021 2020 2020 Net investment income, annualized $ 46,393 45,885 45,920 Average invested assets, at amortized cost 1,107,540 1,071,792 1,057,428 Annualized yield on average invested assets 4.19 % 4.28 % 4.34 % Annualized net investment income in our Life Insurance segment increased in the three months ended March 31, 2021 compared to the same period annualized in 2020 and the twelve months ended December 31, 2020, due to continued growth in average invested assets. The annualized yield in the first three months of 2021 decreased compared to the same period in 2020 and from December 31, 2020 as a substantial portion of our fixed maturity investments were called or matured during the past year and we face challenges in finding investments with comparable yields in the continued low interest rate environment. See the Investments section below for more detailed information on our investments. Realized Investment Gains (Losses), Net. The realized loss for the three months ended March 31, 2021 and the realized gain for the prior year period were primarily due to changes in the market value of a preferred stock exchange traded fund purchased during the first quarter of 2020. Claims and Surrenders. The following table shows the claims and surrender benefits paid within the Life Insurance segment for the three months ended March 31, 2021 compared to the same period in 2020. March 31, 2021 | 10-Q 37 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Three Months Ended March 31, (In thousands) 2021 2020 Claims and Surrenders: Death claim benefits $ 2,684 1,725 Surrender benefits 12,251 11,303 Endowment benefits 2,399 2,736 Matured endowment benefits 4,980 3,600 Accident and health benefits 21 27 Other policy benefits 935 769 Total claims and surrenders $ 23,270 20,160 The majority of our claims and surrender benefits in our Life Insurance segment are related to payment of surrender benefits and matured endowment benefits. Policy surrenders increased 8.4% in the three months ended March 31, 2021 as compared to the prior year period and matured endowment benefits increased by 38.3% in the current year. 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 expenses are within expected levels. The other key component of claims and surrender benefits is death claim benefits, which increased 55.6% in the three months ended March 31, 2021 as compared to the prior year period due to the reasons discussed above in “Current Financial Highlights”. HOME SERVICE INSURANCE We operate in the Home Service Insurance market through our subsidiaries SPLIC, MGLIC and SPFIC, and focus on the life insurance needs of the middle- and lower-income markets, primarily in Louisiana, Mississippi and Arkansas. Premium revenue of 89.4% and 89.7% in the three months ended March 31, 2021 and March 31, 2020, respectively, were from policyholders in Louisiana. Our policies are sold and serviced through a home service insurance marketing distribution system of independent agents who work on a debit route system and through funeral homes that sell policies, collect premiums and service policyholders. March 31, 2021 | 10-Q 38 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The results of operations for the Home Service Insurance segment for the periods indicated are as follows: Three Months Ended March 31, (In thousands) 2021 2020 Revenues: Premiums $ 11,969 11,498 Net investment income 3,345 3,332 Realized investment gains (losses), net 223 (1,717) Other income 2 18 Total revenues 15,539 13,131 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 7,319 6,289 Increase in future policy benefit reserves 1,574 1,325 Policyholders' dividends 10 8 Total insurance benefits paid or provided 8,903 7,622 Commissions 3,926 3,375 Other general expenses 3,794 4,316 Capitalization of deferred policy acquisition costs (1,424) (1,088) Amortization of deferred policy acquisition costs 835 801 Amortization of cost of insurance acquired 263 250 Total benefits and expenses 16,297 15,276 Loss before federal income tax expense $ (758) (2,145) Premiums. Premiums increased by 4.1% in the three months ended March 31, 2021 compared to the same period in 2020, with increases in both first year premiums and renewal premiums despite the continuing effects of the COVID-19 pandemic in the states in which this segment operates. First year premiums increased due to an automatic issue product we offered to existing policyholders, which resulted in a higher number of policies issued as well as lower premiums in the prior year period due to the onset of the COVID-19 pandemic and stay-at-home orders, which negatively impacted our business. Renewal premiums increased based on continued strong collections by our independent agents. Net Investment Income. Net investment income for the three months ended March 31, 2021 increased slightly compared to the same period in 2020 due to an increase in average invested assets and a one-time benefit from a “make-whole” call redemption offsetting a decline in portfolio yield. Realized Investment Gains (Losses), Net. Changes in realized gains/losses, which reflect changes in fair values of our equity securities, were primarily due to the sudden stock market decline at the quarter ended March 31, 2020 due to the onset of the COVID-19 pandemic. March 31, 2021 | 10-Q 39 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Claims and Surrenders. Claims and surrender benefits for the Home Service Insurance segment is summarized as follows: Three Months Ended March 31, (In thousands) 2021 2020 Claims and Surrenders: Death claim benefits $ 6,256 4,864 Surrender benefits 556 752 Endowment benefits 2 3 Matured endowment benefits 142 153 Property claims 321 487 Accident and health benefits 38 26 Other policy benefits 4 4 Total claims and surrenders $ 7,319 6,289 The vast majority of claims and surrender benefits in our Home Service Insurance segment relate to death claim benefits. Death claim benefits increased 28.6% in the three months ended March 31, 2021 compared to the 2020 period due to the reasons discussed above in “Current Financial Highlights”. Mortality experience is closely monitored by the Company as a key performance indicator and can fluctuate based on reported claims. OTHER NON-INSURANCE ENTERPRISES Three Months Ended March 31, (In thousands) 2021 2020 Income (loss) before income tax expense $ (1,884) (2,176) 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. In the three months ended March 31, 2021, the Other Non-Insurance Enterprises had a loss of $1.9 million compared to a loss of $2.2 million for the three months ended 2020 as realized investment gains improved. 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. Our cash and invested assets at March 31, 2021 were $1.6 billion, of which 90.8% was invested in fixed maturity securities, all of which are classified as available-for-sale. We closely monitor the duration of our fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy our insurance obligations. March 31, 2021 | 10-Q 40 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table shows the carrying value of our investments by investment category and cash and the percentage of each to total cash and invested assets. Carrying Value March 31, 2021 December 31, 2020 (In thousands, except for %) Amount % Amount % Cash and Invested Assets Fixed maturity securities: U.S. Treasury and U.S. Government-sponsored enterprises $ 15,538 1.0 % $ 16,117 1.0 % Corporate 834,790 53.4 % 877,208 52.8 % States and political subdivisions (1) 393,859 25.2 % 409,665 24.7 % Mortgage-backed (2) 132,146 8.4 % 140,184 8.5 % Asset-backed 44,138 2.8 % 46,091 2.8 % Foreign governments 116 — % 118 — % Total fixed maturity securities 1,420,587 90.8 % 1,489,383 89.8 % Cash and cash equivalents 19,493 1.2 % 34,131 2.1 % Other investments: Policy loans 82,674 5.3 % 83,318 5.0 % Equity securities 22,366 1.4 % 22,102 1.3 % Real estate and other long-term investments 19,918 1.3 % 29,865 1.8 % Total cash and invested assets $ 1,565,038 100.0 % $ 1,658,799 100.0 % (1) Includes $161.8 million and $164.0 million of securities guaranteed by third parties at March 31, 2021 and December 31, 2020, respectively. (2) Includes $132.0 million and $139.8 million of U.S. Government-sponsored enterprises at March 31, 2021 and December 31, 2020, respectively. The carrying value of the Company’s fixed maturity securities investment portfolio at March 31, 2021 was $1.4 billion. The distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of March 31, 2021 did not materially change from December 31, 2020 – the weighted average was “A” at both dates. Cash and cash equivalents decreased as of March 31, 2021 compared to December 31, 2020 due primarily to the purchase of 100% of the Company’s Class B common stock from the Foundation for $9.1 million. Real estate and other long-term investments decreased to $19.9 million as of March 31, 2021 as compared to $29.9 million as of December 31, 2020 primarily due a $8.8 million payment from a Rabbi Trust (which was considered a long-term investment) to our former Chief Executive Officer, Geoffrey Kolander, representing the severance payments due to him in connection with his resignation following the change in control. Obligations of States and Political Subdivisions The Company’s fixed maturity securities investment portfolio at March 31, 2021 and December 31, 2020 included $393.9 million and $409.7 million, respectively, of securities that are obligations of states and political subdivisions, including municipalities (collectively referred to as the municipal bond portfolio). March 31, 2021 | 10-Q 41 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS As of March 31, 2021, the Company's municipal bond portfolio included third-party guarantees. Detailed below is a presentation by the Nationally Recognized Statistical Rating Organization ("NRSRO") rating of these holdings by funding type as of March 31, 2021. 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 State and political subdivision fixed maturity securities including third-party guarantees AAA $ 21,343 20,768 3,307 3,091 — — 24,650 23,859 6.4 % AA 63,196 59,413 123,848 118,507 12,191 10,838 199,235 188,758 50.9 % A 14,779 13,429 125,958 117,391 5,017 4,417 145,754 135,237 36.5 % BBB 3,952 3,669 13,330 12,987 1,511 1,450 18,793 18,106 4.9 % BB and other 4,758 4,428 669 607 — — 5,427 5,035 1.3 % Total $ 108,028 101,707 267,112 252,583 18,719 16,705 393,859 370,995 100.0 % State and political subdivision fixed maturity securities excluding third-party guarantees AAA $ 3,248 3,156 — — — — 3,248 3,156 0.9 % AA 43,591 42,435 43,473 41,198 7,633 6,538 94,697 90,171 24.3 % A 28,833 26,827 159,425 149,410 7,914 7,145 196,172 183,382 49.4 % BBB 7,250 6,662 35,561 34,211 56 55 42,867 40,928 11.0 % BB and other 25,106 22,627 28,653 27,764 3,116 2,967 56,875 53,358 14.4 % Total $ 108,028 101,707 267,112 252,583 18,719 16,705 393,859 370,995 100.0 % 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 municipal bond portfolio at March 31, 2021. (In thousands) Fair Value Amortized Cost % of Total Fair Value Education $ 70,289 66,134 17.9 % Utilities 65,579 59,591 16.7 % Transportation 39,432 38,709 10.0 % The Company's municipal bond portfolio are spread across many states, however, municipal bonds from Texas and California comprise the most significant concentration of the total municipal bond portfolio as of March 31, 2021. The Company holds 21.1% and 10.0% of its municipal bond portfolio in Texas and California issuers, respectively, as of March 31, 2021. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal bond portfolio as of March 31, 2021. March 31, 2021 | 10-Q 42 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The table below represents the Company's detailed exposure to municipal bond portfolio in Texas at March 31, 2021. March 31, 2021 General Obligation Special Revenue Other Total (In thousands) Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Texas state and political subdivision fixed maturity securities including third-party guarantees AAA $ 20,757 20,259 3,307 3,091 — — 24,064 23,350 AA 21,754 21,407 13,426 12,811 56 55 35,236 34,273 A — — 21,385 21,849 — — 21,385 21,849 BBB — — 1,905 1,827 — — 1,905 1,827 BB and other — — 554 508 — — 554 508 Total $ 42,511 41,666 40,577 40,086 56 55 83,144 81,807 Texas state and political subdivision fixed maturity securities excluding third-party guarantees AAA $ 3,248 3,156 — — — — 3,248 3,156 AA 32,080 31,541 3,299 3,061 — — 35,379 34,602 A 5,985 5,818 28,939 29,020 — — 34,924 34,838 BBB 1,198 1,151 5,483 5,207 56 55 6,737 6,413 BB and other — — 2,856 2,798 — — 2,856 2,798 Total $ 42,511 41,666 40,577 40,086 56 55 83,144 81,807 The table below represents the Company's detailed exposure to municipal bond portfolio in California at March 31, 2021. March 31, 2021 General Obligation Special Revenue Other Total (In thousands) Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost California state and political subdivision fixed maturity securities including third-party guarantees AAA $ — — — — — — — — AA 1,681 1,650 25,068 24,333 2,898 2,728 29,647 28,711 A — — 4,682 4,726 — — 4,682 4,726 BBB — — 4,888 4,669 — — 4,888 4,669 BB and other — — — — — — — — Total $ 1,681 1,650 34,638 33,728 2,898 2,728 39,217 38,106 California state and political subdivision fixed maturity securities excluding third-party guarantees AAA $ — — — — — — — — AA 1,681 1,650 2,664 2,632 — — 4,345 4,282 A — — 10,496 10,294 2,898 2,728 13,394 13,022 BBB — — 8,521 7,970 — — 8,521 7,970 BB and other — — 12,957 12,832 — — 12,957 12,832 Total $ 1,681 1,650 34,638 33,728 2,898 2,728 39,217 38,106 March 31, 2021 | 10-Q 43 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES For the three months ended March 31, 2021 and 2020, the Company recorded no credit valuation losses on fixed maturity securities. Information on both unrealized and realized gains and losses by category is set forth in Part I, Item 1, Note 5. Investments of the notes to our consolidated financial statements herein. LIQUIDITY AND CAPITAL RESOURCES Although the Company experienced increased death claim benefits in the first three months of 2021, we do not believe that the Company's liquidity and capital resources were materially impacted by COVID-19 in the period. For further discussion regarding the potential future impacts of COVID-19 and related economic conditions on the Company's liquidity and capital resources, see Part I, Item 1A, Risk Factors in the Company's Form 10-K . Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. We manage our insurance operations as described herein in order to ensure that we have stable and reliable sources of cash flows to meet our obligations. We expect to meet our cash needs for the next 12 months with cash generated by our insurance operations and from our invested assets. At March 31, 2021, we had $19.5 million in cash and cash equivalents and $1.5 billion in invested assets. 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 minimal operations of its own. Our assets consist of the capital stock of our subsidiaries, cash and investments. Our liquidity requirements are met primarily from two sources: cash generated from our operating subsidiaries and our invested assets. Our ability to obtain cash from our insurance subsidiaries depends primarily upon the availability of statutorily permissible payments, including payments Citizens receives from service agreements with our life insurance subsidiaries and dividends from the subsidiaries. The ability to make payments to the holding company is limited by applicable laws and regulations of Bermuda and U.S. states of domicile which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that our insurance subsidiaries maintain minimum solvency requirements, 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. Our cash and cash equivalents decreased from $34.1 million at December 31, 2020 to $19.5 million at March 31, 2021. In the three months ended March 31, 2021, uses of cash included: • $8.8 million severance payment to 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 (See Part I, Item 1, Note 6 . Fair Value Measurements – "Other Long-Term Investments”, herein, and our Form 10-K for additional discussion about the severance payment to Mr. Kolander); and • $9.1 million payment to the Harold E. Riley Foundation ("Foundation") for the purchase of 100% of the outstanding Class B common stock. See Part I, Item 1, Note 11. Subsequent Events in the notes to our consolidated financial statements herein. On May 5, 2021, we entered into a Credit Facility with Regions Bank. See Part I, Item 1, Note 7 . Commitments and Contingencies in the notes to our consolidated financial statements, herein, for a description of the Credit Facility. March 31, 2021 | 10-Q 44 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The Credit Facility provides additional liquidity to the Company for short-term and longer-term needs. As of May 5, 2021, we had not borrowed any money under the Credit Facility and do not expect to do so immediately. 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 relate to payments of policy benefits to policyholders, investment purchases and operating expenses. Historically, we have not had to liquidate a material amount of investments to provide cash flow for our insurance operations and we did not do so in the three months ended March 31, 2021. 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. See Contractual Obligations and Off-balance Sheet Arrangements in our Form 10-K for a discussion of known and estimated cash needs. In the three months ended March 31, 2021, our operations provided $1.8 million in net cash as compared to $14.1 million provided by operations in the same period in 2020. As mentioned above, we used $8.8 million in cash in the quarter to pay Mr. Kolander’s severance. Cash provided by operations was also lower, as surrenders and lower renewal premiums in our international business are not being replaced by new sales. We have traditionally also had significant cash flows from investing activities due to 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 and other alternative investments. Net cash used in investing activities totaled $7.4 million for the three months ended March 31, 2021 as opposed to $26.2 million used in investing activities for the three months ended March 31, 2020. The investing activities fluctuate from period to period due to timing of securities activities such as calls and maturities and reinvestment of those funds. Cash used in financing activities was $9.1 million in the three months ended March 31, 2021, due to the purchase of the Class B common stock from the Foundation. Because claims and surrender benefits are our largest expense, a primary liquidity concern is the risk of an extraordinary level of early policyholder surrenders. While these expenses increased in the three months ended March 31, 2021 and have been increasing over the last several years, the increases are within expected levels 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. For reasons previously discussed, death claim benefits in our Home Service Insurance segment increased in the first quarter of 2021. We continue to closely monitor claim volumes to evaluate whether there is a delay in reporting or filing for benefits as a result of the COVID-19 pandemic. As discussed above, we are subject to regulatory capital requirements that could affect the Company’s ability to access capital from our insurance operations or cause the Company to have to put additional cash in our wholly-owned subsidiaries. Our domestic companies are subject to minimum capital requirements set by the NAIC in the form of risk-based capital ("RBC"). RBC considers the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company's business to develop a minimum level of capital called "Authorized Control Level Risk-Based Capital". This level of capital is then compared to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200% for our domestic companies, a series of remedial actions by the affected company would be required. Additionally, we have a parental guarantee between Citizens and CICA, Citizens' wholly-owned subsidiary domiciled in Colorado, to maintain a RBC level above 350%. At March 31, 2021, 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 March 31, 2021 | 10-Q 45 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS requires a certain Target Capital Level ("TCL"). As of March 31, 2021, CICA Ltd. was above the TCL threshold. At the request of the BMA, on April 15, 2021, Citizens and CICA Ltd. entered into a Keep Well Agreement. The Keep Well Agreement requires Citizens to contribute up to $10 million in capital to CICA Ltd. as necessary to ensure that CICA Ltd. has a minimum capital level of 120%. Since CICA Ltd.’s capital level currently exceeds 120%, Citizens is not currently required to make a capital contribution. Any capital injection that Citizens is required to make under the parental guarantee with CICA or under the Keep Well Agreement with CICA Ltd. could negatively impact the Company’s capital resources and liquidity. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS As of March 31, 2021, the Company is committed to fund investments up to $68.5 million related to private equity funds and other investments. There have been no other material changes in contractual obligations from those described in Part II, Item 7, Contractual Obligations and Off-Balance Sheet Arrangements in our Form 10-K . The Company does not have off-balance sheet arrangements at March 31, 2021. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engage in speculative activities of any nature, and we do not use such investments to hedge our investment positions. CRITICAL ACCOUNTING POLICIES We believe that the accounting policies set forth in Part I, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations - "Critical Accounting Policies" and Part IV, Item 15, Note 1. Summary of Significant Accounting Policies of our consolidated financial statements in our Form 10-K continue to describe the significant judgments and estimates used in the preparation of our consolidated financial statements. Table of Contents CITIZENS, INC.