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. These forward-looking statements are subject to a number of risks, uncertainties and assumptions including those factors discussed in the "Risk Factors" contained in our Annual Report on Form 10-K for the year ended December 31, 2022 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2023 and June 30, 2023, which are incorporated herein by reference. 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 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 For almost 50 years, we have been fulfilling the needs of our policyholders and their families by providing insurance products that offer both living and death benefits. Citizens operates through its insurance subsidiaries located in the United States, including Puerto Rico, and provides benefits to policyholders located throughout the United States and in over 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 optimize our competitive position. 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 Service 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. Objective of our Management's Discussion and Analysis We refer to our Management’s Discussion and Analysis of Financial Condition and Results of Operations as our “MD&A”. The objective of our MD&A is to provide investors with information in order to assess the material changes in our financial condition from December 31, 2022 to September 30, 2023 and the material changes in our results of operations for the three and nine months ended September 30, 2023 as compared to the same periods in 2022. We also discuss in the MD&A any trends that we believe may materially affect our future operations or financial condition. Prior year amounts have been revised to reflect the implementation ASU 2018-12 as noted in Part I, Item September 30, 2023 | 10-Q 43 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS 1, Note 1. Financial Statements - " Significant Accounting Policies " and Note 2. Accounting Pronouncements in the notes to our consolidated financial statements. The Factors that Drive our Operating Results We see the following as the primary factors that drive our operating results: • Sales ( i.e. , premium revenues) • Investments • Claims and surrenders • Operating expenses Premium revenues and investment income are our two primary sources of income and thus key to our profitability. Premium revenues consist of both new sales, which lead to first year premiums, and "resells" ( i.e ., retaining the policy), which lead to renewal premiums. Because we ceased operations in our property insurance business effective June 30, 2023, the premiums charts below only reflect life insurance and accident and health insurance ("A&H") premium results. Our first year life and A&H premiums increased in the three and nine months ended September 30, 2023 by 15% due primarily to new products available for sale in both segments supported by focused marketing campaigns. Our renewal life and A&H premium revenues decreased in the three and nine months ended September 30, 2023 by 3% and 4%, respectively, primarily due to the impact of a higher level of surrenders and matured endowments during the last few years ( i.e ., fewer policies from which to collect renewal premiums). September 30, 2023 | 10-Q 44 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Our net investment income increased for the three and nine months ended September 30, 2023 by 5% and 8%, respectively, compared to the same prior year periods due to a higher average portfolio yield resulting from the higher interest rate environment and investment income from our limited partnership investments. Payment of policyholder benefits for claims and surrenders is our largest expense and thus also key to our profitability. The three main components of this expense are reflected in the graphs above. In the three and nine months ended September 30, 2023 compared to the prior year periods: • Death claim benefits decreased due to a lower number of reported death claims. • Surrenders increased, which we believe is due to the number of our international life policies that are nearing maturity as well as policies that have passed their surrender charge period. • Matured endowments increased as expected due to many of our endowment policies reaching their contractual maturity dates. September 30, 2023 | 10-Q 45 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Operating expenses are our second largest expense and thus also drive our operating results. Our general operating expenses for the three and nine months ended September 30, 2023 increased compared to the prior year periods. The increase was primarily driven by costs related to strategic growth initiatives and costs related to moving our international business from Bermuda to Puerto Rico. The transfer of the international business was completed on August 31, 2023. FINANCIAL HIGHLIGHTS Our net income was $2.7 million and $13.7 million for the three and nine months ended September 30, 2023, respectively, compared to net income of $3.4 million and $12.3 million in the prior year periods, respectively. The increase in net income for the nine months ended September 30, 2023 is primarily driven by the improvements in the fair value of our limited partnership investments, which are recorded as investment related gains (losses) in our financial statements, as well as higher net investment income in the current year period. These improvements were partially offset by lower renewal year premiums in our life insurance business, lower property insurance premiums due to ceasing this line of business on June 30, 2023, higher general operating expenses and higher insurance benefits paid or provided, which as explained above is primarily due to higher surrenders and matured endowments. Net revenue in the three months ended September 30, 2023 improved as compared to the three months ended September 30, 2022 for the same reasons as described above, however, net income in the period was negatively impacted by $1.2 million lower property insurance premiums due to no sales in the quarter versus the prior year quarter. Both current-year periods were negatively impacted by higher policyholder remeasurement losses primarily due to unfavorable surrender experience in the Life Insurance segment. Our basic net income per share of Class A common stock was $0.06 and $0.28 for the three and nine months ended September 30, 2023, respectively, compared to $0.07 and $0.25 in prior year periods. Financial Condition at September 30, 2023 • Total assets of $1.6 billion • Total investments of $1.3 billion; fixed maturity securities comprised 87% of total investments • $4.8 billion of direct insurance in force September 30, 2023 | 10-Q 46 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS • No debt • Fully diluted income per share of Class A common stock of $0.27 • Book value per share of Class A common stock of $3.08. From time-to-time, certain events may affect our business in ways that cause current or future results to differ from past results. In addition to factors described in Part II, Item 1A, "Risk Factors" , the following events may impact our results of operations or financial condition: INFLATION The impact of inflation, which has led to market volatility starting in early 2022, has affected the fair value of our equity securities, leading to investment related losses in 2022 and the three and nine months ended September 30, 2023. Investment related gains and losses can cause significant fluctuations from period to period and are not indicative of our operating results. We believe that investment related gains and losses, whether realized from dispositions or unrealized from changes in market prices of equity securities, have no bearing in understanding our reported results or in evaluating the economic performance of our business. These gains and losses have caused, and we believe will continue to cause, significant volatility in our periodic earnings. We could experience higher surrenders and lapses and fewer sales as our policyholders conserve cash due to concerns over inflation and rising costs, particularly in our Home Service Insurance segment, whose customer base is primarily middle- and lower-income individuals. RISING INTEREST RATES Interest rates began to rise significantly in 2022 after being ultra-low for almost a decade, and have continued to rise in 2023. Higher interest rates typically reduce the market values of fixed income assets, as the interest payments on existing fixed income assets become less competitive relative to newer higher rate fixed income instruments. Because of this, we reported pre-tax net unrealized losses of $238.0 million on our available-for-sale securities at September 30, 2023. This compares to pre-tax net unrealized losses of $201.7 million at December 31, 2022, with the year-over-year change primarily driven by market interest rates. However, because we strive to match our asset duration to our liability duration, as a life insurer, the vast majority of our total investments are invested in longer-term fixed maturity securities and we expect the market values to recover prior to the maturity dates of most of these investments. Another impact rising interest rates may have on our business is that policyholders may surrender their policies in order to utilize the cash values to seek higher crediting rates through other types of investments. CEASING OPERATIONS OF OUR PROPERTY INSURANCE BUSINESS The Company made a strategic decision to exit the property insurance business on June 30, 2023. This business focused on selling limited liability property insurance policies in Louisiana and Arkansas. This decision has negatively impacted our current year premium revenues and financial results. We are contractually obligated to pay the majority of the remaining premiums for our catastrophic reinsurance through the end of 2023. Because we ceased operations at the end of the second quarter, the property insurance premium amounts reflected in our income statements for the nine months ended September 30, 2023 reflect the remaining amount due of $0.7 million under the reinsurance contract for 2023. Additionally, we did not collect premiums in the third quarter of 2023, as we did in the third quarter of 2022. Accordingly, property premium revenue is less for the three and nine months ended September 30, 2023 compared to the prior year periods. The property insurance business operates through SPFIC and represented less than 1% of the Company’s total consolidated assets as of September 30, 2023 and less than 1% of the Company's total consolidated revenues for the nine months ended September 30, 2023. The cessation of this business is not reported as a discontinued September 30, 2023 | 10-Q 47 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS operation because it is immaterial to our total operations. Additionally, there were no material charges incurred in relation to the exit of our property insurance operations. OUR OPERATING SEGMENTS We manage our business in two operating segments: Life Insurance and 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 for ordinary life policies issued during the periods indicated are shown below. Nine Months Ended September 30, 2023 2022 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 Ordinary Life Policies: Life Insurance $ 277,867,815 3,481 $ 79,824 $ 253,040,853 3,022 $ 83,733 Home Service Insurance 226,307,076 17,501 12,931 205,218,816 21,045 9,751 Total $ 504,174,891 20,982 $ 458,259,669 24,067 As we previously disclosed, our strategic initiatives include the introduction of new products tailored to our specific markets. These new products helped drive the 10% increase in total insurance issued in the nine months ended September 30, 2023, from $458.3 million in the first nine months of 2022 to $504.2 million in 2023. Both of our segments experienced an increase in insurance issued with a higher number of policies issued in our Life Insurance segment and higher policy face amounts issued in our Home Service Insurance segment. The growth in our Life Insurance segment is attributable to strong sales from the international whole life product introduced in 2022, which accounted for 68% of total insurance issued in this segment for the nine months ended September 30, 2023. The Life Insurance segment also benefited from our new white label partnerships and final expense products introduced domestically, which accounted for over 18% of the number of policies issued. September 30, 2023 | 10-Q 48 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS CONSOLIDATED RESULTS OF OPERATIONS A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment. REVENUES Our revenues are generated primarily by insurance renewal premiums and investment income from invested assets. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Revenues: Premiums: Life insurance $ 41,794 42,423 118,020 120,930 Accident and health insurance 296 299 1,201 865 Property insurance (64) 1,153 780 3,668 Net investment income 17,372 16,604 51,687 47,983 Investment related gains (losses), net (892) (4,991) (477) (10,589) Other income 884 688 2,620 2,410 Total revenues $ 59,390 56,176 173,831 165,267 Premium Income. Despite higher first year premium revenues in both segments, life insurance premium revenues decreased in the three and nine months ended September 30, 2023 compared to the same periods in 2022 due to lower renewal premiums. Accident and health insurance premiums increased for the nine months ended September 30, 2023 due to sales of our new critical illness products that were launched in late 2022. Property insurance premiums were negatively impacted for the three and nine months ended September 30, 2023 compared to the same periods in 2022 as we stopped accepting renewal premiums at the end of May and ceased our operations on June 30, 2023. September 30, 2023 | 10-Q 49 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Net Investment Income. A summary of our net investment income and annualized net investment income performance are summarized as follows: Three Months Ended Nine Months Ended September 30, September 30, (In thousands, except for %) 2023 2022 2023 2022 Gross investment income: Fixed maturity securities $ 15,005 14,994 44,956 43,136 Equity securities 127 158 451 453 Policy loans 1,478 1,535 4,531 4,641 Long-term investments 1,249 505 3,261 1,604 Other investment income 166 87 430 139 Total investment income 18,025 17,279 53,629 49,973 Investment expenses (653) (675) (1,942) (1,990) Net investment income $ 17,372 16,604 51,687 47,983 Net investment income, annualized $ 68,916 63,977 Average invested assets, at amortized cost $ 1,520,389 1,482,651 Annualized yield on average invested assets 4.53 % 4.30 % Due to insurance regulations, fixed maturity securities constitute the vast majority, or 87%, of our investment portfolio based on fair value and thus provide the vast majority of our investment income. Our total investment income increased by 4% and 7% for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022, primarily due to a higher average portfolio yield on our fixed maturity securities in the current period. Long-term investment income increased as our private equity investment asset base grew. Our yield increased 23 basis points to 4.53% in the nine months of 2023 compared to the prior year period due to investing in the rising interest rate environment. Investment Related Gains (Losses), Net. We recorded investment related losses during the three and nine months ended September 30, 2023 of $0.9 million and $0.5 million compared to losses of $5.0 million and $10.6 million during the same prior year periods. As described above, the gains and losses are primarily related to the fair value change of our limited partnership and equity securities investments, mostly in our Life Insurance segment, due to the volatility in equity markets over the past year. We did not sell these investments; however, the changes in fair values of our equity securities are reflected as investment related gains or losses in our income statement, in addition to executed transactions that result in a gain or loss. Other Income. Other income consists primarily of supplemental contracts issued to policyholders in our Life Insurance segment upon the surrender or maturity of their original policies. September 30, 2023 | 10-Q 50 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS BENEFITS AND EXPENSES Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders $ 37,723 30,729 100,798 86,260 Increase (decrease) in future policy benefit reserves (3,880) 653 (5,802) 4,497 Policyholder liability remeasurement (gain) loss 1,024 396 2,860 1,731 Policyholders' dividends 1,414 1,389 3,783 4,257 Total insurance benefits paid or provided 36,281 33,167 101,639 96,745 Commissions 9,444 9,210 27,340 25,807 Other general expenses 11,949 11,559 35,477 32,989 Capitalization of deferred policy acquisition costs (7,132) (6,372) (20,034) (17,337) Amortization of deferred policy acquisition costs 4,056 3,624 11,544 10,651 Amortization of cost of insurance acquired 151 166 465 446 Total benefits and expenses $ 54,749 51,354 156,431 149,301 Payments of claims and surrenders benefits constitute the majority of our expenses. Total benefits and expenses increased in the three and nine months ended September 30, 2023 as compared to same periods in 2022 driven by higher surrenders and matured endowments. Claims and Surrenders. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Claims and Surrenders: Death claim benefits $ 4,984 6,089 16,002 18,979 Surrender benefits 17,264 12,597 44,570 36,463 Endowment benefits 1,932 2,131 6,117 6,417 Matured endowment benefits 11,080 8,470 28,907 20,737 Property claims 129 326 837 631 A&H and other policy benefits 2,334 1,116 4,365 3,033 Total claims and surrenders $ 37,723 30,729 100,798 86,260 Death claim benefits decreased for the three and nine months ended September 30, 2023 compared to the same periods in 2022 due primarily to a lower volume of reported death claims. Surrender benefits increased for the three and nine months ended September 30, 2023 compared to the same periods in 2022 due to surrenders related to international policies that are nearing maturity as well as policies that have passed their surrender charge period. While we have implemented retention initiatives over the past few years, we believe that the high interest rates are negatively affecting these efforts, as policyholders surrender their policies to re-invest the cash values in higher interest rate products. September 30, 2023 | 10-Q 51 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Matured endowment benefits increased for the three and nine months ended September 30, 2023 compared to the same periods in 2022. We anticipated this increase based upon the contractual maturity dates of the policies. Explanation of other benefits and expenses Increase (Decrease) in Future Policy Benefit Reserves. Future policy benefit reserves reflect the liability established to provide for the payment of policy benefits that we expect to pay in the future and thus generally increase when we have a larger in force block of business due to higher sales and better persistency (i.e., more policies on which we expect to pay future benefits) and decrease when we have lower sales and persistency. In the three and nine months ended September 30, 2023, the change in future policy benefit reserves decreased compared to the same prior year periods despite increases in insurance issued and increases in our in force block of business due to the amount of reserves released in connection with the higher matured endowments and surrenders. Policyholder Liability Remeasurement (Gain) Loss. Most of our products are long-duration contracts that provide a specified, fixed amount of insurance benefit in exchange for a fixed premium. When a policy is initially issued, we establish a "net premium ratio" ("NPR") using assumptions regarding expected premiums and policyholder benefit liabilities. On a quarterly basis, we review actual versus expected experience in such quarter, which is reported as a policyholder liability remeasurement gain (if better performance than assumptions) or loss (if lower performance than assumptions). Additionally, in the third quarter of each year, we update our cash flow assumptions to recalculate the NPR, with the impact on the liability for future policy benefits recognized as a policyholder liability remeasurement on a retrospective catch up basis. 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 and thus commissions fluctuate directly in relation to first year sales. Other General Expenses. General expenses increased in the three and nine months ended September 30, 2023, compared to the same periods in 2022. The increase was primarily driven by costs related to strategic growth initiatives and costs related to moving our international business from Bermuda to Puerto Rico. 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 and thus fluctuate primarily with first year sales. Amortization is on a constant level basis for the grouped contracts over the expected term of the related contracts to approximate straight-line amortization. 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. September 30, 2023 | 10-Q 52 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table sets forth income (loss) before federal income taxes by segment during the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Income (loss) before federal income tax expense: Segments: Life Insurance $ 6,550 5,072 20,395 14,272 Home Service Insurance (443) 950 1,514 5,030 Total segments 6,107 6,022 21,909 19,302 Other Non-Insurance Enterprises (1,466) (1,200) (4,509) (3,336) Total income (loss) before federal income tax expense $ 4,641 4,822 17,400 15,966 LIFE INSURANCE Net income in our Life Insurance segment before federal income tax of $6.6 million and $20.4 million in the three and nine months ended September 30, 2023, respectively, increased from $5.1 million and $14.3 million in the prior year periods, respectively . Detailed results of operations describing the year-over-year net income increases in the Life Insurance segment for the periods indicated are as follows: Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Revenues: Premiums $ 31,148 31,696 86,128 88,461 Net investment income 13,661 12,806 40,470 37,124 Investment related gains (losses), net (424) (4,367) (123) (8,644) Other income 884 682 2,619 2,403 Total revenues 45,269 40,817 129,094 119,344 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 32,419 24,742 83,826 67,768 Increase (decrease) in future policy benefit reserves (5,587) 426 (9,270) 4,808 Policyholder liability remeasurement (gain) loss 840 (445) 2,541 549 Policyholders' dividends 1,405 1,382 3,761 4,241 Total insurance benefits paid or provided 29,077 26,105 80,858 77,366 Commissions 5,406 5,103 14,930 13,701 Other general expenses 6,036 6,016 17,141 17,065 Capitalization of deferred policy acquisition costs (5,141) (4,592) (13,958) (12,205) Amortization of deferred policy acquisition costs 3,313 3,081 9,642 9,051 Amortization of cost of insurance acquired 28 32 86 94 Total benefits and expenses 38,719 35,745 108,699 105,072 Income (loss) before federal income tax $ 6,550 5,072 20,395 14,272 September 30, 2023 | 10-Q 53 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The main drivers of the year-over-year increases in income before federal income tax in the 2023 periods are higher net investment income and lower investment related losses. These increases were partially offset by lower renewal premiums, higher surrenders benefits paid and higher policyholder liability remeasurement losses due to the higher levels of surrenders. Life Insurance segment premium breakout is detailed below. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Premiums: First year $ 3,796 3,135 9,195 7,888 Renewal 27,352 28,561 76,933 80,573 Total premiums $ 31,148 31,696 86,128 88,461 Premiums. First year premiums increased 21% and 17% for three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022, due to sales of new products and expanded domestic distribution. Our total premiums for three and nine months ended September 30, 2023 decreased 2% and 3%, respectively, compared to the same periods in 2022 as renewal premiums declined. We derive most of our premium revenue in the Life Insurance segment from renewal premiums, which decreased 4% and 5%, respectively, in the three and nine months ended September 30, 2023 as compared to the same periods in 2022. As described above, this decline is due to high surrenders and matured endowments over the last several years. International Life Insurance Premiums. Life insurance premiums are generated largely from our international policyholders living in over 75 different countries across the globe. The majority of our international premiums are derived from whole life and endowment products. The following table sets forth our premiums collected from the top five countries of our international life insurance business for the three and nine months ended September 30, 2023 and 2022. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Country: Colombia $ 6,077 5,869 18,415 17,765 Taiwan 3,814 3,862 12,706 12,540 Venezuela 3,804 4,388 11,208 12,343 Ecuador 3,479 3,286 9,882 9,380 Argentina 2,550 2,250 7,130 6,688 Other Non-U.S. 9,866 10,141 28,241 28,711 Total $ 29,590 29,796 87,582 87,427 Domestic Life Insurance Premiums. Our domestic in-force life insurance business consists primarily of closed blocks of business from various insurance companies we have acquired over the years. As discussed, we have recently re-launched our domestic life insurance business through CICA Life Insurance Company of America by expanding our licenses to new states, developing new final expense and living benefit products, entering into new white label and other distribution agreements and obtaining a B+ A.M. Best rating. Because the majority of this business still consists of closed blocks of business, premiums in our domestic Life Insurance segment were lower in the three and nine months ended September 30, 2023 compared to the same prior year periods despite growth in our newly relaunched business. September 30, 2023 | 10-Q 54 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Net Investment Income . Our net investment income increased by 7% and 9% for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022 due to our higher average portfolio yield. The majority of investment income is derived from fixed maturity securities; however, long-term investment income continued to increase as our limited partnership asset base grew. Investment Related Gains (Losses), Net. We recorded investment related losses of $0.4 million and $0.1 million during the three and nine months ended September 30, 2023, respectively, compared to investment related losses of $4.4 million and $8.6 million during the same prior year periods, respectively, resulting from the change in estimated fair market value for our limited partnership investments. Claims and Surrenders. The following table sets forth our primary claims and surrender benefits paid within our Life Insurance segment for the three and nine months ended September 30, 2023 compared to the same periods in 2022. Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Claims and Surrenders: Death claim benefits $ 978 1,370 3,117 3,879 Surrender benefits 16,317 11,817 41,927 34,230 Endowment benefits 1,930 2,128 6,111 6,406 Matured endowment benefits 10,912 8,335 28,447 20,323 A&H and other policy benefits 2,282 1,092 4,224 2,930 Total claims and surrenders $ 32,419 24,742 83,826 67,768 During the three and nine months ended September 30, 2023 and 2022, the majority of our claims and surrender benefits in our Life Insurance segment were related to payment of surrender benefits and matured endowment benefits. Many of our endowment policies are reaching their contractual maturity dates and thus matured endowment benefits are increasing. We expect this trend to continue over the next few years. Surrender benefits increased for the three and nine months ended September 30, 2023 compared to the same periods in 2022, partially due to surrenders related to international policies that are nearing maturity as well as policies that have passed their surrender charge period. Death claims benefits decreased for the three and nine months ended September 30, 2023, respectively, compared to the prior year periods. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels. Increase (Decrease) in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased as a result of reserves released from higher matured endowment and surrender benefits, which was partially offset by increases in insurance issued and normal increases in our in force block of business policy benefit reserves for the three and nine months ended September 30, 2023 compared to the same periods in 2022. September 30, 2023 | 10-Q 55 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS HOME SERVICE INSURANCE Detailed results of operations for the Home Service Insurance segment for the periods indicated are as follows: Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Revenues: Premiums $ 10,878 12,179 33,873 37,002 Net investment income 3,459 3,527 10,379 10,054 Investment related gains (losses), net (370) (462) (283) (1,629) Other income — — 1 1 Total revenues 13,967 15,244 43,970 45,428 Benefits and expenses: Insurance benefits paid or provided: Claims and surrenders 5,304 5,987 16,972 18,492 Increase (decrease) in future policy benefit reserves 1,707 227 3,468 (311) Policyholder liability remeasurement (gain) loss 184 841 319 1,182 Policyholders' dividends 9 7 22 16 Total insurance benefits paid or provided 7,204 7,062 20,781 19,379 Commissions 4,038 4,107 12,410 12,106 Other general expenses 4,293 4,228 13,060 12,093 Capitalization of deferred policy acquisition costs (1,991) (1,780) (6,076) (5,132) Amortization of deferred policy acquisition costs 743 543 1,902 1,600 Amortization of cost of insurance acquired 123 134 379 352 Total benefits and expenses 14,410 14,294 42,456 40,398 Income (loss) before federal income tax $ (443) 950 1,514 5,030 In our Home Service Insurance segment, we reported loss before federal income tax of $0.4 million and income of $1.5 million in the three and nine months ended September 30, 2023, respectively, as compared to income of $1.0 million and $5.0 million in the prior year periods. In both the three and nine month periods ended September 30, 2023, the decreases were primarily driven by lower premiums due to the impact of ceasing our property insurance operations as of June 30, 2023 described above and higher future policy benefit reserves. In the current year nine-month period, the decrease was also driven by higher other general expenses due to higher employee health benefit costs, partially offset by the improvement in investment related losses due to the improvements in the fair value of our equity securities. Premiums. Total premium revenue declined by 11% and 8% in the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022 due primarily to the impact of ceasing our property insurance operations as of June 30, 2023. Our first year premiums increased 6% in the nine months ended September 30, 2023 compared to the same period in 2022. September 30, 2023 | 10-Q 56 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS Claims and Surrenders. Payments of claims and surrender benefits, which are the largest portion of our expenses, are summarized as follows: Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Claims and Surrenders: Death claim benefits $ 4,006 4,719 12,885 15,100 Surrender benefits 947 780 2,643 2,233 Endowment benefits 2 3 6 11 Matured endowment benefits 168 135 460 414 Property claims 129 326 837 631 A&H and other policy benefits 52 24 141 103 Total claims and surrenders $ 5,304 5,987 16,972 18,492 The majority of claims and surrender benefits in our Home Service Insurance segment are death claim benefits. Death claim benefits decreased 15% in the three and nine months ended September 30, 2023 compared to the same three and nine months in 2022 due primarily to a lower volume of reported claims. Mortality experience is closely monitored by the Company as a key performance indicator and fluctuates from quarter-to-quarter based on reported claims. Other General Expenses. General expenses increased in the nine months ended September 30, 2023 compared to the same periods in 2022, primarily due to higher employee health benefit costs. OTHER NON-INSURANCE ENTERPRISES Three Months Ended Nine Months Ended September 30, September 30, (In thousands) 2023 2022 2023 2022 Income (loss) before federal income tax $ (1,466) (1,200) (4,509) (3,336) This operating unit represents the administrative support functions for the insurance operations. Its revenues are primarily intercompany and have been eliminated in consolidation under U.S. GAAP, which typically results in a loss. Revenue in this operating unit consists primarily of net investment income and investment related gains or losses, while expenses consist of other general expenses related to corporate functions. INVESTMENTS Our investments are an integral part of our business success. Our cash and invested assets at September 30, 2023 were $1.3 billion, of which 86% 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. September 30, 2023 | 10-Q 57 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The following table sets forth the carrying value of our investments by investment category and cash, cash equivalents and the percentage of each to total cash and invested assets. Carrying Value September 30, 2023 December 31, 2022 (In thousands, except for %) Amount % Amount % Cash, Cash Equivalents and Invested Assets Fixed maturity securities: U.S. Treasury and U.S. Government-sponsored enterprises $ 9,357 0.7 % $ 13,278 1.0 % Corporate 710,741 53.3 715,645 52.5 States and political subdivisions (1) 283,956 21.3 307,358 22.5 Mortgage-backed (2) 92,686 6.9 99,995 7.3 Asset-backed 54,613 4.1 43,242 3.2 Foreign governments — — 101 — Total fixed maturity securities 1,151,353 86.3 1,179,619 86.5 Short-term investments — — 1,241 0.1 Cash and cash equivalents 16,785 1.3 22,973 1.7 Other investments: Policy loans 75,750 5.7 78,773 5.8 Equity securities 10,555 0.8 11,590 0.8 Other long-term investments 79,798 5.9 69,558 5.1 Total cash, cash equivalents and invested assets $ 1,334,241 100.0 % $ 1,363,754 100.0 % (1) Includes $117.6 million and $133.2 million of securities guaranteed by third parties at September 30, 2023 and December 31, 2022, respectively. (2) Includes $91.6 million and $98.8 million of U.S. Government-sponsored enterprises at September 30, 2023 and December 31, 2022, respectively. The carrying value of the Company’s fixed maturity securities investment portfolio at September 30, 2023 was $1.15 billion compared to $1.18 billion at December 31, 2022. The distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of September 30, 2023 did not materially change from December 31, 2022 – the weighted average was “A” at both dates. Cash and cash equivalents decreased as of September 30, 2023 from December 31, 2022 and fluctuates from period-to-period primarily due to the timing of operating and investing activities. Other long-term investments increased by $10.2 million as of September 30, 2023 from December 31, 2022 due to additional funding of our limited partnership investments. Obligations of States and Political Subdivisions The Company’s fixed maturity securities investment portfolio at September 30, 2023 and December 31, 2022 included $284.0 million and $307.4 million, respectively, of securities that are obligations of states and political subdivisions, including municipalities (collectively referred to as the municipal bond portfolio). September 30, 2023 | 10-Q 58 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The Company's municipal bond portfolio includes 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 September 30, 2023. 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 $ 13,900 13,930 6,307 6,894 — — 20,207 20,824 6.4 % AA 43,135 43,935 108,386 131,470 10,224 11,082 161,745 186,487 57.3 A 3,933 4,461 81,242 94,588 4,327 4,399 89,502 103,448 31.8 BBB 604 654 7,575 9,192 1,328 1,450 9,507 11,296 3.5 BB and other 2,911 3,174 84 85 — — 2,995 3,259 1.0 Total $ 64,483 66,154 203,594 242,229 15,879 16,931 283,956 325,314 100.0 % State and political subdivision fixed maturity securities excluding third-party guarantees AA $ 32,122 32,538 37,457 43,391 6,431 6,496 76,010 82,425 25.3 % A 17,806 18,702 88,677 103,216 5,650 6,130 112,133 128,048 39.4 BBB 1,382 1,415 20,563 24,254 1,469 1,855 23,414 27,524 8.5 BB and other 13,173 13,499 56,897 71,368 2,329 2,450 72,399 87,317 26.8 Total $ 64,483 66,154 203,594 242,229 15,879 16,931 283,956 325,314 100.0 % 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 total municipal bond portfolio at September 30, 2023. (In thousands, except for %) Fair Value Amortized Cost % of Total Fair Value Education $ 47,346 55,750 16.7 % Utilities 42,086 48,115 14.8 Transportation 35,198 44,503 12.4 The Company's municipal bond portfolio is spread across many states, however, municipal bonds from Texas and California comprise the most significant concentration of the total municipal bond portfolio as of September 30, 2023. The Company holds 22% and 14% of its municipal bond portfolio in Texas and California issuers, respectively, as of September 30, 2023. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal bond portfolio as of September 30, 2023. September 30, 2023 | 10-Q 59 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS The table below represents the Company's detailed exposure to municipal bonds in Texas at September 30, 2023. 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 $ 13,405 13,425 2,466 2,639 — — 15,871 16,064 AA 16,430 16,405 13,144 15,820 — — 29,574 32,225 A — — 16,059 21,896 — — 16,059 21,896 Total $ 29,835 29,830 31,669 40,355 — — 61,504 70,185 Texas state and political subdivision fixed maturity securities excluding third-party guarantees AA $ 25,016 24,980 4,827 5,625 — — 29,843 30,605 A 4,819 4,850 15,310 18,093 — — 20,129 22,943 BBB — — 3,037 3,417 — — 3,037 3,417 BB and other — — 8,495 13,220 — — 8,495 13,220 Total $ 29,835 29,830 31,669 40,355 — — 61,504 70,185 The table below represents the Company's detailed exposure to municipal bonds in California at September 30, 2023. 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 AA $ 1,880 2,049 27,278 35,293 2,323 2,732 31,481 40,074 A 1,179 1,650 6,625 7,666 — — 7,804 9,316 BBB — — 570 570 — — 570 570 Total $ 3,059 3,699 34,473 43,529 2,323 2,732 39,855 49,960 California state and political subdivision fixed maturity securities excluding third-party guarantees AA $ 419 445 4,214 5,258 — — 4,633 5,703 A 2,640 3,254 14,016 17,706 2,323 2,732 18,979 23,692 BBB — — 3,143 3,523 — — 3,143 3,523 BB and other — — 13,100 17,042 — — 13,100 17,042 Total $ 3,059 3,699 34,473 43,529 2,323 2,732 39,855 49,960 IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES The Company did not record any credit valuation allowances on fixed maturity securities in either of the three and nine months ended September 30, 2023 or 2022. Information on both unrealized and realized gains and losses by category is set forth in Part I, Item 1, Note 3. Investments of the notes to our consolidated financial statements herein. September 30, 2023 | 10-Q 60 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS LIQUIDITY AND CAPITAL RESOURCES Below are our primary capital resources (based on carrying value of each) as of the periods indicated. (In thousands) September 30, 2023 December 31, 2022 Fixed maturity securities $ 1,151,353 1,179,619 Cash and cash equivalents 16,785 22,973 Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. In the nine months ended September 30, 2023, our operations generated $15.4 million of net cash. We manage our insurance operations as described herein in order to ensure that we have stable and reliable sources of cash flow to meet our obligations. We currently anticipate meeting our short-term and long-term cash needs with cash generated by our insurance operations and from our invested assets. From time-to-time, we may raise capital by selling shares in our SIP (as defined below) and we may also access our Credit Facility if needed (also as described below). PARENT COMPANY LIQUIDITY AND CAPITAL RESOURCES 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 insurance subsidiaries and dividends from the subsidiaries. The ability to make payments to the holding company is limited by applicable laws of the U.S. states of domicile and by the Puerto Rico Office of Commissioner of Insurance, which all subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that our insurance subsidiaries maintain minimum solvency or premium to surplus ratio 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. In addition to the above-mentioned sources of cash, we offer a Stock Investment Plan ("SIP"), whereby investors, policyholders, independent contractors and agents, employees and directors can directly purchase our stock. At our option, purchases of stock under the SIP can be made from newly issued or treasury stock, rather than in the open market, in which case, we can raise capital by selling our shares. In 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. The Credit Facility provides additional liquidity to the Company for short-term and longer-term needs. As of September 30, 2023, we have not borrowed any money under the Credit Facility and have no immediate plans to do so. 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 or sales. Primary cash needs relate to payments of policyholder benefits, investment purchases and operating expenses. Historically, cash flow from our operations has been sufficient to meet our cash needs. We have not had to liquidate a material amount of investments to pay our expenses. 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 and below for a discussion of known and estimated cash needs. Cash flow September 30, 2023 | 10-Q 61 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS projections and cash flow tests under various market interest rate scenarios are performed annually to assist in evaluating liquidity needs and adequacy. Cash from Operating Activities. Cash provided by or used in operating activities is an important liquidity metric because it reflects, during a given period, the amount of cash generated that is available to pay our operating expenses, invest in our business or make strategic acquisitions. In the nine months ended September 30, 2023, our operations provided $15.4 million in net cash. Cash from Investing Activities. 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 limited partnerships or other alternative investments. Net cash outflows from investing activities totaled $18.5 million for the nine months ended September 30, 2023. The investing activities fluctuate from period to period due to timing of security activities such as calls and maturities and reinvestment of those funds. We purchased $50.1 million in fixed maturity securities and we also used $13.3 million to purchase other long-term investments. 86% of our total cash, cash equivalents and investments consist of marketable fixed maturity securities classified as available-for-sale that could be readily converted to cash for liquidity needs. Trends, Demands and Restrictions on our Uses of Cash Because claims and surrenders are our largest expense, a primary liquidity concern is the risk of either (i) an extraordinary level of early policyholder surrenders, or (ii) higher than expected mortality experience. Our death benefit payments have declined in the nine months ended September 30, 2023 and we believe mortality has normalized to pre-pandemic levels. However, as previously discussed, surrender benefits have been higher than usual the last several years and have continued to increase in the first nine months of 2023 despite our retention initiatives. In order to mitigate the risk of early policyholder surrenders, we include provisions in our insurance policies, such as surrender charges, that help limit and discourage early withdrawal, but as many of our policies have reached the age where surrender charges have expired or significantly decreased, we are experiencing higher levels of surrenders. Additionally, we believe that surrenders are increasing due to other reasons, including the loss of one of our biggest distributors in Venezuela, increasing interest rates which may encourage policyholders to seek higher rates of returns in different investment products, post-pandemic beliefs that life insurance may not be as important as it was during the pandemic, and inflationary pressures, which may cause policyholders to want the cash values of their policies due to decreased purchasing power elsewhere. To the extent that early surrenders are higher than expected, our liquidity could be negatively impacted due to benefit payments as well as lower renewal premiums. We continue to monitor surrenders and early withdrawals, as well as mortality experience. Our endowment products have contractual maturity dates and provide the policyholder with alternatives once the policy matures - they can choose to take a lump sum payout or leave the money on deposit at interest with the Company. Approximately 18% of the endowments in force, totaling approximately 6% of our in force business as of September 30, 2023, will mature in the next five years. Policyholder election behavior is unknown, but if too many 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 its investments 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 our available operating cash flow and capital resources will be adequate to meet our needs for funds, but we are closely monitoring our policyholder behavior patterns. 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 September 30, 2023 | 10-Q 62 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS various other aspects of an insurance company's business to develop a minimum level of capital called "Authorized Control Level Risk-Based Capital". This level of capital is then compared to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200% for our domestic companies, a series of remedial actions by the affected company would be required. Additionally, we have a parental guarantee between Citizens and CICA, Citizens' wholly-owned subsidiary domiciled in Colorado, to maintain a RBC level above 350%. At September 30, 2023, our domestic insurance subsidiaries were above the required minimum RBC levels. CICA PR is a Puerto Rico domiciled company. The Insurance Code of Puerto Rico does not specifically set forth minimum capital and surplus standards, but rather requires that an insurer submit a business plan for approval to the OIC that includes proposed minimum capital and surplus. CICA PR is required to maintain a minimum of $750,000 in capital and maintain a premium to surplus ratio of 7 to 1. CICA PR began issuing new business as of January 1, 2023 and received the transfer of all of CICA International's in force insurance business as of August 31, 2023. On that date, Citizens entered into a Keep Well Agreement with CICA PR to replace the Keep Well Agreement that had been in place between Citizens and CICA International (Bermuda). The Keep Well Agreement requires Citizens to contribute up to $10 million in capital to CICA PR as necessary to ensure that CICA PR maintains at least either (i) 112% of its required ratio of premiums to capital and surplus, or (ii) 200% of the minimum capital and surplus requirement, whichever is higher. The initial term of the Keep Well Agreement is 12 months. Since CICA PR's capital exceeds both of the metrics, Citizens is not required to make a capital contribution. Any capital that Citizens is required to contribute could negatively impact the Company's capital resources and liquidity. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS As of September 30, 2023, we have no additional contractual obligations or off-balance sheet arrangements other than those described in Part I. Item 1, Note 7. Commitments and Contingencies in the notes to our consolidated financial statements herein and in Part II, Item 7, Contractual Obligations and Off-Balance Sheet Arrangements in our Form 10-K . 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 except as follows. The following items have changed due to adoption of Accounting Standard Update ("ASU") No. 2018-12, Financial Services-Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. DEFERRED POLICY ACQUISITION COSTS DAC are costs that are incremental and directly related to the successful acquisition of new or renewal insurance contracts. Such costs include the incremental direct costs of contract acquisition, such as sales commissions; the portion of employees’ total compensation and payroll-related fringe benefits related directly to time spent performing acquisition activities, such as underwriting, issuing, and processing policies for contracts that have actually been acquired; and other costs related directly to acquisition activities that would not have been incurred if the contract had not been acquired. Inherent in the capitalization and amortization of DAC are certain management judgements about what acquisition costs are deferred. Approximately 93% of our capitalized DAC are attributed to first year and renewal excess commissions. The remaining 7% are attributed to other costs that vary with and are directly related to the September 30, 2023 | 10-Q 63 Table of Contents CITIZENS, INC. MANAGEMENT'S DISCUSSION & ANALYSIS successful acquisition of new insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business. DAC is amortized on a constant level basis over the expected term of the related contracts to approximate straight-line amortization. For the Life Insurance segment, the constant level basis used is policy count in force. For the Home Service Insurance segment, the constant level basis used is face amount in force. The constant level bases used for amortization are projected using mortality and lapse assumptions that are based on the Company’s experience, industry data, and other factors at the end of each reporting period and are consistent with those used for the liability for future policy benefit life reserves. Annually, the Company completes experience studies to evaluate mortality and lapse. If those assumptions are updated, the DAC amortization basis is recalculated and the impact of the assumption change will be reflected in the cohort level amortization in future periods. COST OF INSURANCE ACQUIRED The Company recognizes an intangible asset that arises in the application of U.S. GAAP purchase accounting as the difference between the reported value and the fair value of insurance contract liabilities, or comparable amounts determined in purchased insurance business combinations. This intangible asset is referred to as the Cost of Insurance Acquired (“COIA”), which is amortized on a basis consistent with DAC, such that it is amortized in proportion to policies in force for the Life Insurance segment and face amount in force for the Home Service Insurance segment to approximate straight-line amortization. Inherent in the amortization of COIA are certain management judgements about the ending asset balance and the annual amortization. The key assumptions 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 three and nine months ended September 30, 2023. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing. POLICY LIABILITIES As premium revenue is recognized, a liability for future policy benefits is accrued. The liability for a future policy benefit is the present value of estimated future policy benefits to be paid to or on behalf of policyholders less the present value of estimated future net premiums to be collected from policyholders. The liability is estimated using current assumptions that include investment yields, discount rate, mortality and lapses and withdrawals. These current assumptions are based on judgements that consider the Company’s historical experience, industry data, and other factors. Annually, the Company completes experience studies to evaluate mortality and lapses. The results of these studies are used to update current year best estimate assumptions used in establishing benefit liabilities and DAC. The current discount rate assumption is a yield curve that equals the yield of an upper-medium grade fixed income instrument, based on an A-quality corporate bond. The current discount rate assumption is updated quarterly and used to remeasure the liability at the reporting date, with the resulting change reflected in other comprehensive income. For liability cash flows that are projected beyond the duration of market-observable A credit-rated fixed-income instruments, the Company uses the last market-observable yield level and uses linear interpolation to determine yield assumptions for durations that do not have market observable yields. The locked-in discount rate for policies issued prior to transition equals the rate set at contract issuance. For current year issues, the locked-in discount rate is the average of the current year quarterly discount rates and will change throughout the year as new discount rates are calculated, with the change reflected in net income. September 30, 2023 | 10-Q 64 Table of Contents CITIZENS, INC. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a smaller reporting company, we have elected to comply with certain scaled disclosure reporting obligations and therefore are not required to provide the information required by this Item.