Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2010
or
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 000-16509
CITIZENS, INC.
(Exact name of registrant as specified in its charter)
     
Colorado   84-0755371
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
400 East Anderson Lane, Austin, Texas   78752
     
(Address of principal executive offices)   (Zip Code)
(512) 837-7100
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
As of November 4, 2010, the Registrant had 48,686,759 shares of Class A common stock, no par value, outstanding and 1,001,714 shares of Class B common stock outstanding.
 
 

 

 


 

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 Exhibit 21
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 Exhibit 99.1

 

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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Financial Position
(In thousands)
                 
    September 30,     December 31,  
Assets   2010     2009  
    (Unaudited)          
Investments:
               
Fixed maturities available-for-sale, at fair value
(cost: $501,649 and $389,195 in 2010 and 2009, respectively)
  $ 519,132       385,579  
Fixed maturities held-to-maturity, at amortized cost
(fair value: $128,865 and $199,676 in 2010 and 2009, respectively)
    127,674       206,909  
Equity securities available-for-sale, at fair value
(cost: $25,619 and $25,899 in 2010 and 2009, respectively)
    33,986       33,477  
Mortgage loans on real estate
    1,501       1,533  
Policy loans
    34,970       32,096  
Real estate held for sale
    2,805       2,825  
Real estate held for investment (less $445 and $374 accumulated depreciation in 2010 and 2009, respectively)
    6,522       6,305  
Other long-term investments
    49       86  
Short-term investments
          2,510  
 
           
Total investments
    726,639       671,320  
 
               
Cash and cash equivalents
    65,366       48,625  
Accrued investment income
    8,406       7,455  
Reinsurance recoverable
    10,411       11,587  
Deferred policy acquisition costs
    121,540       115,570  
Cost of customer relationships acquired
    32,097       34,728  
Goodwill
    17,160       17,160  
Other intangible assets
    1,026       1,046  
Federal income tax receivable
    1,903       4,023  
Property and equipment, net
    6,772       6,018  
Due premiums, net (less $1,341 and $1,644 allowance for doubtful accounts in 2010 and 2009, respectively)
    7,224       8,960  
Prepaid expenses
    1,378       288  
Other assets
    477       546  
 
           
Total assets
  $ 1,000,399       927,326  
 
           
     
See accompanying notes to consolidated financial statements.   (Continued)

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Financial Position, Continued
(In thousands, except share amounts)
                 
    September 30,     December 31,  
Liabilities and Stockholders’ Equity   2010     2009  
    (Unaudited)          
Liabilities:
               
Policy liabilities:
               
Future policy benefit reserves:
               
Life insurance
  $ 621,841       592,358  
Annuities
    40,692       37,882  
Accident and health
    5,966       6,399  
Dividend accumulations
    9,188       5,621  
Premiums paid in advance
    22,140       20,373  
Policy claims payable
    10,810       10,222  
Other policyholders’ funds
    8,080       8,105  
 
           
Total policy liabilities
    718,717       680,960  
Commissions payable
    2,078       2,434  
Deferred federal income tax
    15,127       8,052  
Payable for securities in process of settlement
    18,500       6,000  
Warrants outstanding
    1,439       1,819  
Other liabilities
    7,588       11,986  
 
           
Total liabilities
    763,449       711,251  
 
           
Commitments and contingencies (Note 8)
               
Stockholders’ equity:
               
Common stock:
               
Class A, no par value, 100,000,000 shares authorized, 51,822,497 shares issued in 2010 and 2009, including shares in treasury of 3,135,738 in 2010 and 2009
    256,703       256,703  
Class B, no par value, 2,000,000 shares authorized, 1,001,714 shares issued and outstanding in 2010 and 2009
    3,184       3,184  
Retained deficit
    (31,636 )     (38,092 )
Accumulated other comprehensive income:
               
Unrealized gains on securities, net of tax
    19,710       5,291  
 
           
 
    247,961       227,086  
Treasury stock, at cost
    (11,011 )     (11,011 )
 
           
Total stockholders’ equity
    236,950       216,075  
 
           
Total liabilities and stockholders’ equity
  $ 1,000,399       927,326  
 
           
See accompanying notes to consolidated financial statements.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Operations
Three Months Ended September 30,
(In thousands, except per share amounts)
(Unaudited)
                 
    2010     2009  
Revenues:
               
Premiums:
               
Life insurance
  $ 36,433       34,589  
Accident and health insurance
    392       371  
Property insurance
    1,230       1,192  
Net investment income
    7,272       7,413  
Realized gains (losses), net
    (103 )     1,006  
Decrease in fair value of warrants
    128        
Other income
    103       273  
 
           
Total revenues
    45,455       44,844  
 
           
 
               
Benefits and expenses:
               
Insurance benefits paid or provided:
               
Claims and surrenders
    15,739       14,494  
Increase in future policy benefit reserves
    11,398       10,305  
Policyholders’ dividends
    1,977       1,827  
 
           
Total insurance benefits paid or provided
    29,114       26,626  
Commissions
    9,229       8,435  
Other underwriting, acquisition and insurance expenses
    6,580       6,772  
Capitalization of deferred policy acquisition costs
    (6,148 )     (5,306 )
Amortization of deferred policy acquisition costs
    2,975       4,303  
Amortization of cost of customer relationships acquired and other intangibles
    726       946  
 
           
Total benefits and expenses
    42,476       41,776  
 
           
Income before federal income tax
    2,979       3,068  
Federal income tax expense
    1,313       1,033  
 
           
Net income
  $ 1,666       2,035  
 
           
Net income applicable to common stockholders
  $ 1,666       1,878  
 
           
 
               
Per Share Amounts:
               
Basic and diluted earnings per share of Class A common stock
  $ 0.03       0.04  
 
           
Basic and diluted earnings per share of Class B common stock
  $ 0.02       0.02  
 
           
See accompanying notes to consolidated financial statements.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Operations
Nine Months Ended September 30,
(In thousands, except per share amounts)
(Unaudited)
                 
    2010     2009  
Revenues:
               
Premiums:
               
Life insurance
  $ 105,114       101,858  
Accident and health insurance
    1,215       1,135  
Property insurance
    3,592       3,501  
Net investment income
    23,896       21,733  
Realized gains, net
    648       2,827  
Decrease in fair value of warrants
    380       3,081  
Other income
    602       796  
 
           
Total revenues
    135,447       134,931  
 
           
 
               
Benefits and expenses:
               
Insurance benefits paid or provided:
               
Claims and surrenders
    46,410       44,254  
Increase in future policy benefit reserves
    30,726       28,021  
Policyholders’ dividends
    5,324       4,742  
 
           
Total insurance benefits paid or provided
    82,460       77,017  
Commissions
    26,385       25,462  
Other underwriting, acquisition and insurance expenses
    20,541       21,889  
Capitalization of deferred policy acquisition costs
    (17,406 )     (16,257 )
Amortization of deferred policy acquisition costs
    11,422       11,715  
Amortization of cost of customer relationships acquired and other intangibles
    2,332       2,630  
 
           
Total benefits and expenses
    125,734       122,456  
 
           
Income before federal income tax
    9,713       12,475  
Federal income tax expense
    3,257       2,762  
 
           
Net income
  $ 6,456       9,713  
 
           
Net income applicable to common stockholders
  $ 6,456       7,208  
 
           
 
               
Per Share Amounts:
               
Basic earnings per share of Class A common stock
  $ 0.13       0.15  
 
           
Basic earnings per share of Class B common stock
  $ 0.07       0.08  
 
           
Diluted earnings per share of Class A common stock
  $ 0.13       0.10  
 
           
Diluted earnings per share of Class B common stock
  $ 0.07       0.05  
 
           
See accompanying notes to consolidated financial statements.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended September 30,
(In thousands)
(Unaudited)
                 
    2010     2009  
Cash flows from operating activities:
               
Net income
  $ 6,456       9,713  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Net realized gains on sale of investments and other assets
    (648 )     (2,827 )
Net deferred policy acquisition costs
    (5,984 )     (4,542 )
Amortization of cost of customer relationships acquired and other intangibles
    2,332       2,630  
Decrease in fair value of warrants
    (380 )     (3,081 )
Depreciation
    787       908  
Amortization of premiums and discounts on fixed maturities and short-term investments
    2,548       1,466  
Deferred federal income tax benefit
    (61 )     (1,191 )
Change in:
               
Accrued investment income
    (951 )     434  
Reinsurance recoverable
    1,176       1,258  
Due premiums and other receivables
    1,736       856  
Future policy benefit reserves
    30,223       27,171  
Other policyholders’ liabilities
    5,897       1,187  
Federal income tax receivable
    2,120       2,827  
Commissions payable and other liabilities
    (4,754 )     58  
Other, net
    (1,021 )     (583 )
 
           
Net cash provided by operating activities
    39,476       36,284  
 
           
Cash flows from investing activities:
               
Purchase of fixed maturities, held-to-maturity
    (71,452 )     (202,286 )
Calls of fixed maturities, held-to-maturity
    150,350        
Sale of fixed maturities, available-for-sale
    7,074       72,148  
Maturity and calls of fixed maturities, available-for-sale
    137,506       276,058  
Purchase of fixed maturities, available-for-sale
    (246,238 )     (174,931 )
Sale of equity securities, available-for-sale
    591       1,184  
Calls of equity securities, available-for-sale
    100        
Purchase of equity securities, available-for-sale
    (205 )     (476 )
Principal payments on mortgage loans
    33       24  
Mortgage loans funded
          (170 )
Increase in policy loans
    (2,874 )     (2,905 )
Sale of other long-term investments and property and equipment
    42       406  
Purchase of other long-term investments and property and equipment
    (1,799 )     (2,172 )
Maturity of short-term investments
    2,500       2,250  
Purchase of short-term investments
          (2,604 )
Cash acquired in acquisition
          9,770  
 
           
Net cash used in investing activities
    (24,372 )     (23,704 )
 
           
     
See accompanying notes to consolidated financial statements.   (Continued)

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Nine Months Ended September 30,
(In thousands)
(Unaudited)
                 
    2010     2009  
Cash flows from financing activities:
               
Warrants exercised
  $       69  
Annuity deposits
    4,041       3,990  
Annuity withdrawals
    (2,404 )     (2,515 )
 
           
Net cash provided by financing activities
    1,637       1,544  
 
           
Net increase in cash and cash equivalents
    16,741       14,124  
Cash and cash equivalents at beginning of year
    48,625       63,792  
 
           
Cash and cash equivalents at end of period
  $ 65,366       77,916  
 
           
 
               
Supplemental disclosures of operating activities:
               
Cash paid during the period for income taxes
  $ 1,200       1,125  
 
           
Supplemental Disclosures of Non-Cash Investing Activities:
On February 27, 2009, the Company acquired Integrity Capital Corporation (ICC) for 1,294,000 shares of Class A common stock with a fair value of $8.4 million. CICA Life Insurance Company of America held a 13% interest in ICC prior to the acquisition with a carrying value of $551,000, making the total non-cash acquisition price approximately $9.0 million.
In 2010, the Company sold a parcel of real estate and issued a mortgage loan for $102,000.
In 2010, the Company foreclosed on a mortgage loan and transferred the real estate to real estate held for sale in the amount of $101,000.
Supplemental Disclosures of Non-Cash Financing Activities:
Dividends on the Company’s Series A-1 Convertible Preferred Stock, issued in 2004, and Series A-2 Convertible Preferred Stock, issued in 2005, were paid by the Company through the issuance of Class A common stock to the preferred shareholders in the amount of $216,000 in the first nine months of 2009. Accretion of deferred issuance costs and discounts on the Convertible Preferred Stock recorded as a deduction to Class A common stock during the first nine months of 2009 was $2.3 million.
See accompanying notes to consolidated financial statements.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2010
(Unaudited)
(1)  
Financial Statements
Basis of Presentation and Consolidation
   
The accompanying consolidated financial statements of the Company and its wholly owned subsidiaries have been prepared in conformity with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”).
   
The consolidated financial statements include the accounts and operations of Citizens, Inc. (“Citizens”), a Colorado corporation, and its wholly-owned subsidiaries, CICA Life Insurance Company of America (“CICA”), Computing Technology, Inc. (“CTI”), Funeral Homes of America, Inc. (“FHA”), Insurance Investors, Inc. (“III”), Citizens National Life Insurance Company (“CNLIC”), Integrity Capital Corporation (“ICC”), Integrity Capital Insurance Company (“ICIC”), Security Plan Life Insurance Company (“SPLIC”) and Security Plan Fire Insurance Company (“SPFIC”). All significant inter-company accounts and transactions have been eliminated. Citizens and its wholly owned consolidated subsidiaries are collectively referred to as “the Company,” “we,” or “our.”
   
The consolidated statements of financial position for September 30, 2010, the consolidated statements of operations for the three and nine-month periods ended September 30, 2010 and 2009, and the consolidated statements of cash flows for the nine-month period then ended have been prepared by the Company without audit. In the opinion of management, all adjustments to present fairly the financial position, results of operations, and changes in cash flows at September 30, 2010 and for comparative periods have been made.
   
The Company completed its acquisition of ICC in exchange for 1,294,000 shares of its Class A common stock in the first quarter of 2009. ICC is the parent of ICIC, an Indiana life insurance company. The transaction was valued at $9.0 million on the closing date of February 27, 2009. On October 30, 2009, FHA completed the sale of its business assets valued at approximately $600,000, consisting primarily of funeral home assets.
   
We provide life and health insurance policies through four of our subsidiaries — CICA, SPLIC, CNLIC and ICIC. CICA, CNLIC and ICIC issue ordinary whole-life policies, burial insurance, pre-need policies, and accident and health related policies, throughout the midwest and southern United States. CICA also issues ordinary whole-life policies to non-U.S. residents. SPLIC offers final expense and home service life insurance in Louisiana, Arkansas and Mississippi and SPFIC, a wholly owned subsidiary of SPLIC, writes a limited amount of property insurance in Louisiana.
   
CTI provides data processing systems and services as well as furniture and equipment to the Company. III provides aviation transportation to the Company. FHA was a funeral home operator before the sale of its assets in 2009.
   
The Company corrected two valuation database discrepancies in the current quarter that resulted in a decrease to reserves of $559,000. There was a value per unit error related to fully paid up policies under one plan in duration twenty-one resulting in a reserve overstatement amounting to $508,000, with approximately $475,000 related to prior years, and another plan where surrender charges were not properly recorded, which also overstated reserves by $51,000.
   
Reserving assumptions are reviewed to ensure that our original assumptions at the time of policy issuance related to interest, mortality, withdrawals, and settlement expenses are based upon management’s best judgment. The Company modified these assumptions during the current year with respect to new policies issued, which resulted in an increase to reserves of $456,000.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
Use of Estimates
   
The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
   
The most significant estimates include those used in the evaluation of other-than-temporary impairments on debt securities and valuation allowances on investments, goodwill impairment, valuation allowance on deferred tax assets, and contingencies relating to litigation and regulatory matters. Certain of these estimates are particularly sensitive to market conditions, and deterioration and/or volatility in the worldwide debt or equity markets could have a material impact on the Consolidated Financial Statements.
Significant Accounting Policies
   
For a description of significant accounting policies, see Note 1 of the Notes to Consolidated Financial Statements included in our 2009 Form 10-K Annual Report, which should be read in conjunction with these accompanying Consolidated Financial Statements.
(2)  
Accounting Pronouncements
Accounting Standards Recently Adopted
   
In January 2010, the Financial Accounting Standards Board (“FASB”) updated Accounting Standards Codification (“ASC”) Topic 820, requiring additional disclosures about fair value measurements regarding transfers between fair value categories as well as purchases, sales, issuances and settlements related to fair value measurements of financial instruments with non-observable inputs. This update was effective for interim and annual periods beginning after December 15, 2009 except for disclosures about purchases, sales, issuances and settlements of financial instruments with non-observable inputs, which are effective for years beginning after December 15, 2010. The additional disclosures required by this update are included in the note on fair value measurements upon adoption. The additional disclosures did not have a material impact on our financial condition or results of operations.
   
On September 29, 2010, the FASB ratified the Emerging Issues Task Force’s (“EITF”) final consensus on EITF Issue No. 09-G, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“Issue 09-G”). Issue 09-G clarifies what costs should be deferred by insurance companies when issuing or renewing insurance contracts. The EITF concluded that only costs incurred in the acquisition of new and renewal contracts that are 1) incremental direct costs of a successful contract acquisition, 2) portions of employees’ salaries and benefits directly related to time spent performing specified acquisition activities for a contract that has actually been acquired, 3) other costs directly related to the specified acquisition activities that would not have occurred otherwise, and 4) advertising costs that meet the capitalization criteria in other issued accounting guidance would be capitalizable as deferred acquisition costs. This Issue 09-G will be effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2011. The Company is currently reviewing this guidance and our current deferral policies to determine what impact this consensus may have on our consolidated financial statements and what information gathering changes may need to be implemented.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
(3)  
Segment Information
   
The Company has three reportable segments: Life Insurance, Home Service Insurance, and Other Non-Insurance Enterprises. The accounting policies of the segments are in accordance with U.S. GAAP and are the same as those used in the preparation of the consolidated financial statements. The Company evaluates profit and loss performance based on U.S. GAAP income before federal income taxes for its three reportable segments.
   
The Company has no reportable differences between segments and consolidated operations.
                                 
    Three Months Ended September 30, 2010  
            Home     Other        
    Life     Service     Non-Insurance        
    Insurance     Insurance     Enterprises     Consolidated  
    (In thousands)  
Revenues:
                               
Premiums
  $ 27,514       10,541             38,055  
Net investment income
    3,893       3,244       135       7,272  
Realized gains (losses), net
    1       (96 )     (8 )     (103 )
Decrease in fair value of warrants
                128       128  
Other income
    78       10       15       103  
 
                       
Total revenue
    31,486       13,699       270       45,455  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    10,498       5,241             15,739  
Increase in future policy benefit reserves
    10,688       710             11,398  
Policyholders’ dividends
    1,965       12             1,977  
 
                       
Total insurance benefits paid or provided
    23,151       5,963             29,114  
 
                               
Commissions
    5,572       3,657             9,229  
Other underwriting, acquisition and insurance expenses
    2,596       3,529       455       6,580  
Capitalization of deferred policy acquisition costs
    (4,579 )     (1,569 )           (6,148 )
Amortization of deferred policy acquisition costs
    2,613       362             2,975  
Amortization of cost of customer relationships acquired and other intangibles
    239       487             726  
 
                       
Total benefits and expenses
    29,592       12,429       455       42,476  
 
                       
 
                               
Income (loss) before income tax expense
  $ 1,894       1,270       (185 )     2,979  
 
                       

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
                                 
    Nine Months Ended September 30, 2010  
            Home     Other        
    Life     Service     Non-Insurance        
    Insurance     Insurance     Enterprises     Consolidated  
    (In thousands)  
Revenues:
                               
Premiums
  $ 78,364       31,557             109,921  
Net investment income
    13,239       10,251       406       23,896  
Realized gains (losses), net
    116       585       (53 )     648  
Decrease in fair value of warrants
                380       380  
Other income
    487       63       52       602  
 
                       
Total revenue
    92,206       42,456       785       135,447  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    30,644       15,766             46,410  
Increase in future policy benefit reserves
    28,123       2,603             30,726  
Policyholders’ dividends
    5,267       57             5,324  
 
                       
Total insurance benefits paid or provided
    64,034       18,426             82,460  
 
                               
Commissions
    15,316       11,069             26,385  
Other underwriting, acquisition and insurance expenses
    8,213       10,964       1,364       20,541  
Capitalization of deferred policy acquisition costs
    (12,741 )     (4,665 )           (17,406 )
Amortization of deferred policy acquisition costs
    10,752       670             11,422  
Amortization of cost of customer relationships acquired and other intangibles
    858       1,474             2,332  
 
                       
Total benefits and expenses
    86,432       37,938       1,364       125,734  
 
                       
 
                               
Income (loss) before income tax expense
  $ 5,774       4,518       (579 )     9,713  
 
                       

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
                                 
    Three Months Ended September 30, 2009  
            Home     Other        
    Life     Service     Non-Insurance        
    Insurance     Insurance     Enterprises     Consolidated  
    (In thousands)  
Revenues:
                               
Premiums
  $ 25,795       10,357             36,152  
Net investment income
    4,232       3,126       55       7,413  
Realized gains, net
    650       356             1,006  
Other income
    108       20       145       273  
 
                       
Total revenue
    30,785       13,859       200       44,844  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    10,035       4,459             14,494  
Increase in future policy benefit reserves
    8,850       1,455             10,305  
Policyholders’ dividends
    1,809       18             1,827  
 
                       
Total insurance benefits paid or provided
    20,694       5,932             26,626  
Commissions
    4,827       3,608             8,435  
Other underwriting, acquisition and insurance expenses
    2,563       3,588       621       6,772  
Capitalization of deferred policy acquisition costs
    (3,975 )     (1,331 )           (5,306 )
Amortization of deferred policy acquisition costs
    3,757       546             4,303  
Amortization of cost of customer relationships acquired and other intangibles
    397       549             946  
 
                       
Total benefits and expenses
    28,263       12,892       621       41,776  
 
                       
 
                               
Income (loss) before income tax expense
  $ 2,522       967       (421 )     3,068  
 
                       

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
                                 
    Nine Months Ended September 30, 2009  
            Home     Other        
    Life     Service     Non-Insurance        
    Insurance     Insurance     Enterprises     Consolidated  
    (In thousands)  
Revenues:
                               
Premiums
  $ 75,570       30,924             106,494  
Net investment income
    12,196       9,396       141       21,733  
Realized gains, net
    1,068       1,682       77       2,827  
Decrease in fair value of warrants
                3,081       3,081  
Other income
    267       84       445       796  
 
                       
Total revenue
    89,101       42,086       3,744       134,931  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    30,259       13,995             44,254  
Increase in future policy benefit reserves
    24,258       3,763             28,021  
Policyholders’ dividends
    4,687       55             4,742  
 
                       
Total insurance benefits paid or provided
    59,204       17,813             77,017  
 
                               
Commissions
    14,531       10,931             25,462  
Other underwriting, acquisition and insurance expenses
    7,873       11,577       2,439       21,889  
Capitalization of deferred policy acquisition costs
    (12,227 )     (4,030 )           (16,257 )
Amortization of deferred policy acquisition costs
    10,677       1,038             11,715  
Amortization of cost of customer relationships acquired and other intangibles
    1,105       1,525             2,630  
 
                       
Total benefits and expenses
    81,163       38,854       2,439       122,456  
 
                       
 
                               
Income before income tax expense
  $ 7,938       3,232       1,305       12,475  
 
                       
(4)  
Total Comprehensive Income
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
 
 
Net income
  $ 1,666       2,035       6,456       9,713  
 
                               
Other comprehensive income net of effects of deferred acquisition costs and taxes:
                               
Unrealized gains on available-for-sale securities
    11,288       16,963       21,554       22,614  
Tax expense
    (2,700 )     (3,678 )     (7,135 )     (4,233 )
 
                       
Other comprehensive income
    8,588       13,285       14,419       18,381  
 
                       
Total comprehensive income
  $ 10,254       15,320       20,875       28,094  
 
                       

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
(5)  
Earnings per Share
   
The following table sets forth the computation of basic and diluted earnings per share for the period indicated.
                 
    Three Months Ended September 30,  
    2010     2009  
    (In thousands, except per share amounts)  
Basic and diluted earnings per share:
               
Numerator:
               
Net income
  $ 1,666       2,035  
Less: Preferred stock dividend
          (13 )
Accretion of deferred issuance costs and discounts on preferred stock
          (144 )
 
           
Net income available to common stockholders
  $ 1,666       1,878  
 
           
Net income allocated to Class A common stock
  $ 1,649       1,859  
Net income allocated to Class B common stock
    17       19  
 
           
Net income available to common stockholders
  $ 1,666       1,878  
 
           
Denominator:
               
Weighted average shares of Class A outstanding — basic and diluted
    48,687       48,441  
Weighted average shares of Class B outstanding — basic and diluted
    1,002       1,002  
 
           
Total weighted average shares outstanding — basic and diluted
    49,689       49,443  
 
           
Basic and diluted earnings per share of Class A common stock
  $ 0.03       0.04  
 
           
Basic and diluted earnings per share of Class B common stock
  $ 0.02       0.02  
 
           

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The following table sets forth the computation of basic and diluted earnings per share for the period indicated.
                 
    Nine Months Ended September 30,  
    2010     2009  
    (In thousands, except per share amounts)  
Basic and diluted earnings per share:
               
Numerator:
               
Net income
  $ 6,456       9,713  
Less: Preferred stock dividend
          (216 )
Accretion of deferred issuance costs and discounts on preferred stock
          (2,289 )
 
           
Net income available to common stockholders
  $ 6,456       7,208  
 
           
Net income allocated to Class A common stock
  $ 6,390       7,132  
Net income allocated to Class B common stock
    66       76  
 
           
Net income available to common stockholders
  $ 6,456       7,208  
 
           
Denominator:
               
Weighted average shares of Class A outstanding — basic
    48,687       47,177  
Weighted average shares of Class B outstanding — basic
    1,002       1,002  
 
           
Total weighted average shares outstanding — basic
    49,689       48,179  
 
           
Basic earnings per share of Class A common stock
  $ 0.13       0.15  
 
           
Basic earnings per share of Class B common stock
  $ 0.07       0.08  
 
           
Diluted earnings per share of Class A common stock
  $ 0.13       0.10  
 
           
Diluted earnings per share of Class B common stock
  $ 0.07       0.05  
 
           
   
For the three and nine months ended September 30, 2010, the warrants associated with the Convertible Preferred Stock portfolio were anti-dilutive. As such, the diluted weighted average shares of Class A common stock outstanding for the period was 48,687,000.
   
For the nine months ended September 30, 2009, certain warrants relative to the Convertible Preferred Stock became dilutive. As such, the diluted weighted average shares of Class A common stock for the period was 47,204,000. Total diluted weighted average shares was 48,206,000.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
(6)  
Investments
   
Financial stability and the prevention of capital erosion are important investment considerations for the Company. A primary investment goal is the conservation of assets due to the long-term nature of a significant portion of our insurance liabilities. The Company invests primarily in fixed maturity securities, which totaled 81.7% of total investments and cash and cash equivalents at September 30, 2010.
                                 
    September 30, 2010     December 31, 2009  
    Carrying     % of Total     Carrying     % of Total  
    Value     Carrying Value     Value     Carrying Value  
    (In thousands)             (In thousands)        
Fixed maturity securities
  $ 646,806       81.7 %   $ 592,488       82.3 %
Equity securities
    33,986       4.3       33,477       4.6  
Mortgage loans
    1,501       0.2       1,533       0.2  
Policy loans
    34,970       4.4       32,096       4.5  
Real estate and other long-term investments
    9,376       1.2       9,216       1.3  
Short-term investments
                2,510       0.3  
Cash and cash equivalents
    65,366       8.2       48,625       6.8  
 
                       
Total cash, cash equivalents and investments
  $ 792,005       100.0 %   $ 719,945       100.0 %
 
                       
   
Cash balances increased in 2010 compared to December 31, 2009 due to call activity related to fixed maturity securities. The balances held in cash are expected to be reinvested into fixed maturity securities in the next few months. Significant call activity may continue if our investment income returns remain low.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The following tables represent gross unrealized gains and losses for fixed maturities and equity securities as of the periods indicated.
                                 
    September 30, 2010  
    Cost or     Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (In thousands)  
Fixed maturities available-for-sale:
                               
U.S. Treasury securities
  $ 10,921       2,936             13,857  
U.S. Government-sponsored enterprises
    253,536       2,539       442       255,633  
States of the United States and political subdivisions of the states
    62,229       1,865       1,969       62,125  
Foreign governments
    105       35             140  
Corporate
    159,610       11,899       429       171,080  
Securities not due at a single maturity date
    15,248       1,079       30       16,297  
 
                       
Total fixed maturities available-for-sale
    501,649       20,353       2,870       519,132  
Fixed maturities held-to-maturity:
                               
U.S. Government-sponsored enterprises
    127,674       1,231       40       128,865  
 
                       
Total fixed maturities
  $ 629,323       21,584       2,910       647,997  
 
                       
Total equity securities
  $ 25,619       8,376       9       33,986  
 
                       
                                 
    December 31, 2009  
    Cost or     Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (In thousands)  
Fixed maturities available-for-sale:
                               
U.S. Treasury securities
  $ 11,110       1,324             12,434  
U.S. Government-sponsored enterprises
    184,797       96       4,610       180,283  
States of the United States and political subdivisions of the states
    60,070       321       3,199       57,192  
Foreign governments
    105       15             120  
Corporate
    114,175       3,726       1,803       116,098  
Securities not due at a single maturity date
    18,938       556       42       19,452  
 
                       
Total fixed maturities available-for-sale
    389,195       6,038       9,654       385,579  
Fixed maturities held-to-maturity:
                               
U.S. Government-sponsored enterprises
    206,909       18       7,251       199,676  
 
                       
Total fixed maturities
  $ 596,104       6,056       16,905       585,255  
 
                       
Total equity securities
  $ 25,899       7,578             33,477  
 
                       
   
Almost 90% of the Company’s mortgage-backed securities are residential. Mortgage-backed securities are also referred to as securities not due at a single maturity date throughout this report. The majority of the Company’s equity securities are held within diversified mutual funds.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
Valuation of Investments in Fixed Maturity and Equity Securities
   
The Company monitors all debt and equity securities on an on-going basis relative to changes in credit ratings, market prices, earnings trends and financial performance, in addition to specific region or industry reviews. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. The Company determines other-than-temporary impairment by reviewing all relevant evidence related to the specific security issuer as well as the Company’s intent to sell the security, or if it is more likely than not that the Company would be required to sell a security before recovery of its amortized cost.
   
When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment is separated into the following: a) the amount representing the credit loss, and b) the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings becomes the new amortized cost basis of the investment. The new amortized cost basis is not adjusted for subsequent recoveries in fair value.
   
The Company evaluates whether a credit impairment exists for debt securities by considering primarily the following factors: (a) changes in the financial condition of the security’s underlying collateral, (b) whether the issuer is current on contractually obligated interest and principal payments, (c) changes in the financial condition, credit rating and near-term prospects of the issuer, (d) the extent to which the fair value has been less than the amortized cost of the security and (e) the payment structure of the security. The Company’s best estimate of expected future cash flows used to determine the credit loss amount is a quantitative and qualitative process. Quantitative review includes information received from third party sources such as financial statements, pricing and rating changes, liquidity and other statistical information. Qualitative factors include judgments related to business strategies, economic impacts on the issuers and overall judgment related to estimates and industry factors. The Company’s best estimate of future cash flows involves assumptions including, but not limited to, various performance indicators, such as historical and projected default and recovery rates, credit ratings, and current delinquency rates. These assumptions require the use of significant management judgment and include the probability of issuer default and estimates regarding timing and amount of expected recoveries, which may include estimating the underlying collateral value. In addition, projections of expected future debt security cash flows may change based upon new information regarding the performance of the issuer.
   
The primary factors considered in evaluating whether an impairment exists for an equity security include, but are not limited to: (a) the length of time and the extent to which the fair value has been less than the cost of the security, (b) changes in the financial condition, credit rating and near-term prospects of the issuer, (c) whether the issuer is current on contractually obligated payments, and (d) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery.
   
The Company recognized $27,000 of other-than-temporary impairments (“OTTI”) in the three months ended September 30, 2010. OTTI items were recognized in the first quarter of 2009 relating to credit losses totaling $111,000.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The tables below present the fair values and gross unrealized losses of fixed maturities and equity securities that have remained in a continuous unrealized loss position for the periods indicated.
                                                                         
    September 30, 2010  
    Less than 12 months     Greater than 12 months     Total  
    Fair     Unrealized     # of     Fair     Unrealized     # of     Fair     Unrealized     # of  
    Value     Losses     Securities     Value     Losses     Securities     Value     Losses     Securities  
    (In thousands, except for # of securities)  
Available-for-sale securities:
                                                                       
U.S. Government-sponsored enterprises
  $ 61,870       442       42                         61,870       442       42  
Securities issued by states and political subdivisions
                      10,782       1,969       9       10,782       1,969       9  
Corporate
    8,655       290       7       4,599       139       9       13,254       429       16  
Securities not due at a single maturity date
    1,403       11       3       206       19       5       1,609       30       8  
 
                                                     
Total available-for-sale
    71,928       743       52       15,587       2,127       23       87,515       2,870       75  
Held-to-maturity securities:
                                                                       
U.S. Government-sponsored enterprises
    5,357       40       3                         5,357       40       3  
 
                                                     
Total fixed maturities
  $ 77,285       783       55       15,587       2,127       23       92,872       2,910       78  
 
                                                     
Total equity securities
  $ 30       9       2                         30       9       2  
 
                                                     
                                                                         
    December 31, 2009  
    Less than 12 months     Greater than 12 months     Total  
    Fair     Unrealized     # of     Fair     Unrealized     # of     Fair     Unrealized     # of  
    Value     Losses     Securities     Value     Losses     Securities     Value     Losses     Securities  
    (In thousands, except for # of securities)  
Available-for-sale securities:
                                                                       
U.S. Government-sponsored enterprises
  $ 169,514       4,610       213                         169,514       4,610       213  
Securities issued by states and political subdivisions
    19,055       343       19       14,995       2,856       15       34,050       3,199       34  
Corporate
    36,342       541       21       12,857       1,261       12       49,199       1,802       33  
Securities not due at a single maturity date
    179       1       1       637       42       8       816       43       9  
 
                                                     
Total available-for-sale
    225,090       5,495       254       28,489       4,159       35       253,579       9,654       289  
Held-to-maturity securities:
                                                                       
U.S. Government-sponsored enterprises
    185,659       7,251       81                         185,659       7,251       81  
 
                                                     
Total fixed maturities
  $ 410,749       12,746       335       28,489       4,159       35       439,238       16,905       370  
 
                                                     
   
As of September 30, 2010, the Company had 23 available-for-sale securities in an unrealized loss position for greater than 12 months, which were municipal, corporate and mortgage-backed securities. The Company has reviewed these securities and determined that no other-than-temporary impairment exists based on our evaluations of the credit worthiness of the issuers and due to the fact that we do not intend to sell the investments, nor is it likely that we would be required to sell these investments before recovery of their amortized cost bases, which may be maturity.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The amortized cost and fair value of fixed maturity securities at September 30, 2010 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The Company has experienced significant issuer calls over the past two years as a result of the declining interest rate environment.
                 
    September 30, 2010  
    Amortized     Fair  
    Cost     Value  
    (In thousands)  
Available-for-sale securities:
               
Due in one year or less
  $ 13,463       13,575  
Due after one year through five years
    32,387       34,264  
Due after five years through ten years
    185,486       192,650  
Due after ten years
    255,065       262,346  
 
           
Total available-for-sale securities
    486,401       502,835  
Held-to-maturity securities:
               
Due after ten years
    127,674       128,865  
Securities not due at a single maturity date
    15,248       16,297  
 
           
Total fixed maturities
  $ 629,323       647,997  
 
           
   
The securities not due at a single maturity date are primarily mortgage-backed obligations of U.S. Government-sponsored enterprises and corporate securities.
   
The Company uses the specific identification method to determine the cost basis used in the calculation of realized gains and losses related to security sales. Proceeds and gross realized gains from sales of securities for the three and nine months ended September 30, 2010 and 2009 are summarized as follows:
                                                                 
    Fixed Maturities Available-for-Sale     Equity Securities  
    Three Months     Nine Months     Three Months     Nine Months  
    Ended September 30,     Ended September 30,     Ended September 30,     Ended September 30,  
    2010     2009     2010     2009     2010     2009     2010     2009  
    (In thousands)     (In thousands)  
 
                                                               
Proceeds
  $ 208       33,478       7,074       72,148     $       9       591       1,184  
 
                                               
Gross realized gains
  $ 69       1,167       811       2,720     $             166       219  
 
                                               
   
No securities were sold for realized losses for the periods reported and there were no securities sold from the held-to-maturity portfolio during the three and nine months ended September 30, 2010.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
(7)  
Fair Value Measurements
   
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We hold available-for-sale fixed maturity securities and equity securities, which are carried at fair value.
   
Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. All assets and liabilities carried at fair value are required to be classified and disclosed in one of the following three categories:
   
Level 1 — Quoted prices for identical instruments in active markets.
   
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs or whose significant value drivers are observable.
   
Level 3 — Instruments whose significant value drivers are unobservable.
   
Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as U.S. Treasury securities and actively traded stock and mutual fund investments.
   
Level 2 includes those financial instruments that are valued by independent pricing services or broker quotes. These models are primarily industry-standard models that consider various inputs, such as interest rates, credit spreads and foreign exchange rates for the underlying financial instruments. All significant inputs are observable, or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include corporate fixed maturity securities, U.S. Government-sponsored enterprise securities, municipal securities and certain mortgage and asset-backed securities.
   
Level 3 is comprised of financial instruments whose fair value is estimated based on non-binding broker prices utilizing significant inputs not based on or corroborated by readily available market information. This category consists of two private placement mortgage-backed securities where we cannot corroborate the significant valuation inputs with market observable data.
   
The following table sets forth our assets and liabilities that are measured at fair value on a recurring basis as of the date indicated.
                                 
    Fair Value Measurements  
    September 30, 2010  
                            Total  
    Level 1     Level 2     Level 3     Fair Value  
    (In thousands)  
Financial assets:
                               
Fixed maturities available-for-sale:
                               
U.S. Treasury and U.S. Government- sponsored enterprises
  $ 13,749       255,741             269,490  
Corporate
          171,080             171,080  
Municipal bonds
          62,125             62,125  
Mortgage-backed
          15,759       538       16,297  
Foreign governments
          140             140  
 
                       
Total fixed maturities, available-for-sale
    13,749       504,845       538       519,132  
Total equity securities, available-for-sale
    33,986                   33,986  
 
                       
Total financial assets
  $ 47,735       504,845       538       553,118  
 
                       
Financial liabilities:
                               
Warrants outstanding
  $       1,439             1,439  
 
                       

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The following table sets forth our assets and liabilities that are measured at fair value on a recurring basis as of the date indicated.
                                 
    Fair Value Measurements  
    December 31, 2009  
                            Total  
    Level 1     Level 2     Level 3     Fair Value  
    (In thousands)  
Financial assets:
                               
Fixed maturities available-for-sale:
                               
U.S. Treasury and U.S. Government- sponsored enterprises
  $ 12,434       180,283             192,717  
Corporate
          116,098             116,098  
Municipal bonds
          57,192             57,192  
Mortgage-backed
          18,875       577       19,452  
Foreign governments
          120             120  
Short term investments
          2,510             2,510  
 
                       
Total fixed maturities, available-for-sale
    12,434       375,078       577       388,089  
Total equity securities, available-for-sale
    33,477                   33,477  
 
                       
Total financial assets
  $ 45,911       375,078       577       421,566  
 
                       
Financial liabilities:
                               
Warrants outstanding
  $       1,819             1,819  
 
                       
Financial Instruments Valuation
   
Fixed maturity securities, available-for-sale. At September 30, 2010, the fixed maturities, valued using a third-party pricing source, totaled $504.8 million for Level 2 assets and comprised 97.2% of total reported fair value. Fair values for Level 3 assets are based upon unadjusted broker quotes that are non-binding. The valuations are reviewed and validated quarterly through random testing by comparisons to separate pricing models, other third party pricing services, and back tested to recent trades. For the nine months ended September 30, 2010, there were no material changes to the valuation methods or assumptions used to determine fair values, and no broker or third party prices were changed from the values received.
   
Equity securities, available-for-sale. Fair values of these securities are based upon quoted market price and are classified as Level 1 assets.
   
Short-term investments. The fair values for short-term investments are determined using a third-party pricing source. These assets are classified as Level 2.
   
Warrants outstanding. Fair value of our warrants are based upon industry standard models that consider various observable inputs and are classified as Level 2.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
The following table presents additional information about fixed maturity securities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value:
         
    September 30, 2010  
    (In thousands)  
Beginning balance at December 31, 2009
  $ 577  
Total realized and unrealized losses:
       
Included in net income
     
Included in other comprehensive income
    3  
Principal paydowns
    (42 )
Transfer in and (out) of Level 3
     
 
     
Ending balance at September 30, 2010
  $ 538  
 
     
   
We review the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets. Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.
Financial Instruments not Carried at Fair Value
   
Estimates of fair values are made at a specific point in time, based on relevant market prices and information about the financial instruments. The estimated fair values of financial instruments presented below are not necessarily indicative of the amounts the Company might realize in actual market transactions.
   
The carrying amount and fair value for the financial assets and liabilities on the consolidated balance sheets for the periods indicated are as follows:
                                 
    September 30, 2010     December 31, 2009  
    Carrying     Fair     Carrying     Fair  
    Value     Value     Value     Value  
    (In thousands)  
Financial assets:
                               
Fixed maturities, held-to-maturity
  $ 127,674       128,865       206,909       199,676  
Mortgage loans
    1,501       1,447       1,533       1,484  
Policy loans
    34,970       34,970       32,096       32,096  
Short-term investments
                2,510       2,512  
Cash and cash equivalents
    65,366       65,366       48,625       48,625  
 
                               
Financial liabilities:
                               
Annuities
    40,692       40,742       37,882       33,980  
   
Fair values for fixed income securities are based on an independent pricing source.
   
Mortgage loans are secured principally by residential properties and commercial properties. Weighted average interest rates for these loans were approximately 6.7% per year as of September 30, 2010 and December 31, 2009, with maturities ranging from one to thirty years. Management estimated the fair value using an annual interest rate of 6.25% at September 30, 2010 and December 31, 2009.
   
Policy loans have a weighted average annual interest rate of 7.7% and 7.6% as of September 30, 2010 and December 31, 2009, respectively, and have no specified maturity dates. The aggregate fair value of policy loans approximates the carrying value reflected on the consolidated balance sheet. These loans typically carry an interest rate that is tied to the crediting rate applied to the related policy and contract reserves. Policy loans are an integral part of the life insurance policies that we have in force and cannot be valued separately and are not marketable; therefore, the fair value of policy loans approximates the carrying value.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
   
For cash and cash equivalents, accrued investment income, reinsurance recoverable, other assets, federal income tax payable and receivable, dividend accumulations, commissions payable, amounts held on deposit, and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.
   
The fair value of the Company’s liabilities under annuity contract policies was estimated at September 30, 2010 using December 31, 2009 discounted cash flows using a risk free rate plus a component for non-performance risk and interest rate risk. The fair value of liabilities under all insurance contracts are taken into consideration in the overall management of interest rate risk, which seeks to minimize exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
(8)  
Legal Proceedings
   
We are a defendant in a lawsuit filed on August 6, 1999 in the Texas District Court, Austin, Texas, now styled Citizens Insurance Company of America, Citizens, Inc., Harold E. Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in which a class was originally certified by the trial court and reversed by the Texas Supreme Court in 2007 with an order to the trial court to conduct further proceedings consistent with its ruling. The underlying lawsuit alleged that certain life insurance policies CICA made available to non-U.S. residents, when combined with a policy feature that allowed certain cash benefits to be assigned to two non-U.S. trusts for the purpose of accumulating ownership of our Class A common stock, along with allowing the policyholders to make additional contributions to the trusts, were actually offers and sales of securities that occurred in Texas by unregistered dealers in violation of the Texas securities laws. The remedy sought was rescission and return of the insurance premium payments. On December 9, 2009, the trial court denied the recertification of the class after conducting additional proceedings in accordance with the Texas Supreme Court’s ruling. The remaining plaintiffs must now proceed individually, and not as a class, if they intend to pursue their cases against us. We intend to maintain a vigorous defense in any remaining proceedings.
   
In addition to the legal proceeding described above, we may from time to time be subject to a variety of legal and regulatory actions relating to our future, current and past business operations, including, but not limited to:
   
disputes over insurance coverage or claims adjudication;
   
regulatory compliance with insurance and securities laws in the United States and in foreign countries;
   
disputes with our marketing firms, consultants and employee agents over compensation and termination of contracts and related claims;
   
disputes regarding our tax liabilities;
   
disputes relative to reinsurance and coinsurance agreements; and
   
disputes relating to businesses acquired and operated by us.
   
In the absence of countervailing considerations, we would expect to defend any such claims vigorously. However, in doing so, we could incur significant defense costs, including not only attorneys’ fees and other direct litigation costs, but also the expenditure of substantial amounts of management time that otherwise would be devoted to our business. If we suffer an adverse judgment as a result of any claim, it could have a material adverse effect on our business, results of operations and financial condition.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 2010
(Unaudited)
(9)  
Convertible Preferred Stock
   
In July 2004, the Company completed a private placement of Series A-1 Convertible Preferred Stock (“Series A-1 Preferred”) to four unaffiliated institutional investors. We also issued to the investors warrants to purchase shares of our Class A common stock at various exercise prices that range from $6.72 to $7.93, with most of them striking at $6.95. The conversion, exercise and redemption prices, along with the number of shares and warrants, were adjusted for stock dividends paid on December 31, 2004 and 2005.
   
On July 13, 2009, the Company converted all of its outstanding Series A-1 and Series A-2 Convertible Preferred Stock into Class A common shares in accordance with the mandatory redemption provision of the preferred shareholder agreement dated July 12, 2004. The total amount of Class A common shares issued as part of the conversion was 1,706,682, inclusive of pro rata dividends due through the conversion date. Warrants to purchase shares of Class A common stock are still outstanding until July 2011 and 2012.
(10)  
Income Taxes
   
The effective tax rate was 44% and 34% for the third quarter of 2010 and 2009, respectively, and 34% and 22% for the nine months ended September 30, 2010 and 2009, respectively. The 2010 and 2009 rates were lower than the statutory rate of 35%, except for the third quarter of 2010, primarily due to gains from the change in fair value of outstanding warrants for purchase of Class A common stock of $128,000 and a minimal amount that was not taxable for the three months ended September 30, 2010 and 2009, respectively. The revenue increased from the decrease in fair value of outstanding warrants were $380,000 and $3.1 million for the nine months ended September 30, 2010 and 2009, respectively. Also causing a reduction in the effective tax rate are tax benefits from the release of tax valuation allowances. The increase above the statutory tax rate in the current quarter of 2010 relates to Citizens’ redemption of its stock that was held by subsidiaries, generating taxable transactions resulting in $0.9 million and $1.4 million of tax expense during the three and nine months ended September 30, 2010. This tax increased the effective tax rate as the gain was eliminated in consolidation.
   
The table below details the changes in the Company’s tax valuation allowance.
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Tax benefit (expense) in tax provision
  $ 554       (213 )     1,225       236  
Tax benefit in other comprehensive income
    1,250       2,258       408       3,681  
Adjustment to goodwill
                      (254 )
 
                       
Decrease in valuation allowance
  $ 1,804       2,045       1,633       3,663  
 
                       
(11)  
Related Party Transactions
   
Citizens Inc. purchased Class A common shares during 2010 that were held by subsidiaries at market value as of the transaction dates, which approximated $4.3 million. These transactions were eliminated for financial reporting purposes in accordance with consolidation accounting, but generated a tax expense in the three months ended September 30, 2010 totaling approximately $1.4 million.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the Act), including, without limitation, statements specifically identified as forward-looking statements within this document. Many of these statements contain risk factors as well. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by us or with the approval of the Company, which are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements, include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of our plans and objectives by our management or Board of Directors including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as believes,” “anticipates, “assumes,” “estimates,” “plans,” “projects,” “could,” expects,” “intends,” “targeted,” “may,” “willand similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that could cause the Company’s future results to differ materially from expected results include, but are not limited to:
 
Changes in foreign and U.S. general economic, market, and political conditions, including the performance of financial markets and interest rates, particularly in light of the severe economic conditions and the severe stress experienced by the global financial markets in recent years;
 
Changes in consumer behavior, which may affect the Company’s ability to sell its products and retain business;
 
The timely development of and acceptance of new products of the Company and perceived overall value of these products and services by existing potential customers;
 
Fluctuations in experience regarding current mortality, morbidity, persistency and interest rates relative to expected amounts used in pricing the Company’s products;
 
The performance of our investment portfolio, which may be adversely affected by changes in interest rates, adverse developments and ratings of issuers whose debt securities we may hold, and other adverse macroeconomic events;
 
Results of litigation we may be involved in;
 
Changes in assumptions related to deferred acquisition costs and the value of any businesses we may acquire;
 
Regulatory, accounting or tax changes that may affect the cost of, or the demand for, the Company’s products or services;
 
Our concentration of business from persons residing in Latin America and the Pacific Rim;
 
Our success at managing risks involved in the foregoing;
 
Changes in tax laws;
 
Effects of acquisitions and restructuring, including possible difficulties in integrating and realizing the projected results of acquisitions; and
 
Changes in statutory or U.S. GAAP accounting principles, policies or practices.
Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events.
We 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 Securities and Exchange Commission. We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Overview
We conduct operations as an insurance holding company emphasizing ordinary life insurance products in niche markets where we believe we can achieve competitive advantages. As an insurance provider, we collect premiums in the current period to pay future benefits to our policy and contract holders. Our core operations include issuing and servicing:
   
U.S. Dollar-denominated ordinary whole life insurance and endowment policies predominantly to high net worth, high income foreign residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants;
   
ordinary whole life insurance policies to middle income households in the midwest and the southern United States through independent marketing consultants; and
   
final expense and limited liability property policies to middle and lower income households in Louisiana, Mississippi and Arkansas through employee and independent agents in our home service distribution channel.
Life Insurance. For over the past 30 years, CICA and its predecessors have accepted policy applications from foreign nationals for U.S. Dollar-denominated ordinary whole life insurance and endowment policies. Traditionally, this market has been concentrated in the top 3-5% of the population of a country in terms of income and net worth. In recent years, however, there has been a shift to encompass a broader spectrum of the population, as upper middle classes develop in Latin America and the Pacific Rim. We make our insurance products available using third-party marketing organizations and independent marketing consultants. Historically, the majority of our international business has come from Latin America; however, the Pacific Rim has represented a meaningful source of new business for several years.
Through the domestic market of our Life Insurance segment, we provide ordinary whole life, credit life insurance, and final expense policies to middle income families and individuals in certain markets in the midwest and southern U.S. The majority of our revenues from this market are the result of acquisitions of domestic life insurance companies since 1987.
Home Service Insurance. We provide final expense ordinary life insurance to middle and lower income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders and through networks of funeral homes who collect premiums and provide personal policyholder service.
The Company has been striving to reach a goal set by our founder and CEO, Harold E. Riley, approximately ten years ago to reach $1.0 billion in assets by 2010. This quarter ended September 30, 2010, with positive earnings and market value increases on our invested assets, the Company has moved over the one billion dollar mark to reach its goal. With steady operations under our founder’s leadership, we have grown from total assets of $267.8 million at December 31, 2000 to slightly over $1.0 billion today.
The Company has traditionally grown through domestic acquisitions and we continue to search for opportunities that will enhance our strategic objectives and add value for our shareholders.
Acquisition
In the first quarter of 2009, the Company completed its acquisition of Integrity Capital Corporation (“ICC”) in exchange for 1,294,000 shares of Citizens, Inc. Class A common stock. ICC is the parent of Integrity Capital Insurance Company (“ICIC”), an Indiana life insurance company that is included in the Life Insurance segment. The transaction was valued at $9.0 million when the transaction closed on February 27, 2009.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Consolidated Results of Operations
Note: All discussion below compares or states 2010 results for the three and nine months ended September 30, 2010 compared to 2009 results.
Revenues
Revenues are generated primarily by insurance premiums and investment income on invested asset holdings.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Revenues:
                               
Premiums:
                               
Life insurance
  $ 36,433       34,589       105,114       101,858  
Accident and health insurance
    392       371       1,215       1,135  
Property insurance
    1,230       1,192       3,592       3,501  
Net investment income
    7,272       7,413       23,896       21,733  
Realized gains (losses), net
    (103 )     1,006       648       2,827  
Decrease in fair value of warrants
    128             380       3,081  
Other income
    103       273       602       796  
 
                       
Total revenues
    45,455       44,844       135,447       134,931  
Exclude decrease in fair value of warrants
    (128 )           (380 )     (3,081 )
 
                       
Total revenues, excluding fair value adjustments
  $ 45,327       44,844       135,067       131,850  
 
                       
Premium Income. All premium revenue lines grew from 2009 levels comparing quarter to quarter and year to year. Life insurance premium income increased during the three and nine months ended September 30, 2010 compared to the same periods in 2009, primarily related to renewal premiums indicating favorable persistency.
Net Investment Income. Net investment income increased for the nine months ended September 30, 2010 compared to the same period in 2009. The increase was due to higher invested assets held in the current year compared to 2009 as a result of investing new premium income, and income earned on the Company’s portfolio. Net investment income for the three months ended September 30, 2010 was lower, partially because of large call volumes on the fixed maturity portfolio, which began in the second quarter of this year, and due to overall decline in portfolio yield. Investment portfolio yield decreased approximately sixteen basis points at September 30, 2010 compared to the same period in 2009.
Net investment income performance is summarized as follows.
                         
    Nine Months Ended     Year Ended     Nine Months Ended  
    September 30,     December 31,     September 30,  
    2010     2009     2009  
    (In thousands, except for %)  
 
Net investment income
  $ 23,896       29,602       21,733  
Average invested assets, at amortized cost
  $ 684,074       622,699       601,802  
Annualized yield on average invested assets
    4.66 %     4.75 %     4.82 %
The Company has traditionally invested in fixed maturity securities with a large percent held in callable issues. The Company experienced significant call activity related to fixed maturity security holdings due to the historically low interest rate environment over the past few years. This call activity was significant in 2009 and 2010, and the proceeds from these calls were invested in lower yielding securities.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Investment income from debt securities accounted for approximately 84.2% of total investment income for the nine months ended September 30, 2010. We continue to invest primarily in bonds of U.S. Government-sponsored enterprises, such as FNMA and FHLMC, which comprised 64.5% of the total fixed maturity portfolio based on amortized cost at September 30, 2010.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Gross investment income:
                               
Fixed maturity securities
  $ 6,325       6,461       20,974       18,591  
Equity securities
    162       254       494       803  
Mortgage loans
    17       5       53       18  
Policy loans
    683       628       1,996       1,813  
Real estate investments
    252       357       832       1,071  
Other investment income
    173       120       550       641  
 
                       
Total investment income
    7,612       7,825       24,899       22,937  
Investment expenses
    (340 )     (412 )     (1,003 )     (1,204 )
 
                       
Net investment income
  $ 7,272       7,413       23,896       21,733  
 
                       
The decrease in investment income in 2010 from equity securities resulted from the disposal of securities throughout 2009, primarily related to an acquired portfolio with a book value of $1.3 million and the disposal of certain of SPLIC’s mutual funds totaling $16.1 million in the fourth quarter of 2009. Policy loans have increased primarily from policyholders using the cash value accumulated on their policies to pay premiums and continue their insurance coverage. The increase in the asset balance of policy loans has resulted in a correlating increase in investment income. Other investment income for the nine months ended September 30, 2009 resulted from a legal settlement of $0.2 million in 2009 in connection with a defaulted bond investment.
Realized Gains (Losses), Net. The Company recorded net realized losses of $0.1 million, related to bond holdings in the third quarter of 2010. The net realized gains of $0.6 million during the nine months of 2010 were primarily the result of sales of several available-for-sale debt and equity securities, including some securities that had previously been impaired. The Company recorded a valuation allowance of $45,000 during the first quarter of 2010 on a non-performing mortgage loan. The net realized gains in 2009 were primarily due to sales of fixed maturity securities for the three and nine months ended September 30, 2009. An other-than-temporary impairment of $27,000 was recorded during the current quarter of 2010 related to one bond in default. In the first quarter of 2009, the Company recorded realized losses of $111,000 relating to other-than-temporary impairments.
Change in Fair Value of Warrants. The Company adjusts the liability related to its outstanding warrants to purchase shares of Class A common stock at each reporting date to reflect the current fair value of warrants computed based upon the Class A common stock value calculated using the Black-Scholes option pricing model. As the stock value increases and decreases, the change in the warrant liability also increases and decreases in inverse order. The adjustment to fair value is recorded as an increase or decrease in fair value of warrants on the consolidated statement of operations.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Benefits and Expenses
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
  $ 15,739       14,494       46,410       44,254  
Increase in future policy benefit reserves
    11,398       10,305       30,726       28,021  
Policyholders’ dividends
    1,977       1,827       5,324       4,742  
 
                       
Total insurance benefits paid or provided
    29,114       26,626       82,460       77,017  
 
 
Commissions
    9,229       8,435       26,385       25,462  
Other underwriting, acquisition and insurance expense
    6,580       6,772       20,541       21,889  
Capitalization of deferred policy acquisition costs
    (6,148 )     (5,306 )     (17,406 )     (16,257 )
Amortization of deferred policy acquisition costs
    2,975       4,303       11,422       11,715  
Amortization of cost of customer relationships acquired and other intangibles
    726       946       2,332       2,630  
 
                       
Total benefits and expenses
  $ 42,476       41,776       125,734       122,456  
 
                       
Claims and Surrenders.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
 
                               
Death claims
  $ 5,977       5,454       17,912       17,236  
Surrender benefits
    5,126       4,530       14,863       14,158  
Endowment benefits
    3,616       3,455       10,446       10,049  
Property claims
    469       514       1,340       1,264  
Accident and health benefits
    98       113       485       323  
Other policy benefits
    453       428       1,364       1,224  
 
                       
Total claims and surrenders
  $ 15,739       14,494       46,410       44,254  
 
                       
   
Death claims remained consistent for the three and nine months ended September 30, 2010 compared to the same periods in 2009. These amounts will vary from period to period but were within Company expectation for all periods presented in this report.
   
Surrender benefits represent payments to contract holders upon termination of a contract. The Company monitors surrenders on an ongoing basis. Surrenders as a percent of ordinary whole life insurance in force were unchanged at 0.4% in the first nine months of 2010 and 2009.
   
Endowment benefit expense has increased as this product has become more popular with policyholders, and will likely continue to increase.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Increase in Future Policy Benefit Reserves. Reserving assumptions are reviewed to ensure that our original assumptions at the time of policy issuance related to interest, mortality, withdrawals, and settlement expenses are based upon management’s best judgment. The Company modified these assumptions during the current year with respect to new policies issued, which resulted in an increase to reserves of $0.5 million. In addition, the Company recognized adjustments to reserves related to two valuation database discrepancies that resulted in a decrease to reserves of $0.6 million. There was a value per unit error related to fully paid up policies under one plan in duration twenty-one and another plan where surrender charges were not properly recorded. The net impact of these reserve items during the quarter ended September 30, 2010 was a reduction in reserves of $0.1 million.
Policyholder Dividends. Policyholder dividends increased during the three and nine months ended September 30, 2010 compared to the same periods in 2009, due to continued sales and persistency of participating ordinary whole life products in the international market. All of our international policies are participating, and the dividends are factored into the premiums and therefore do not impact profitability. As dividend rates increase each year that a policy is in force, dividend expense is expected to increase as this block of insurance becomes more seasoned.
Commissions. Commission expense is directly related to new and renewal insurance premium fluctuations and production levels by agents and associates. Commission expense was consistent with prior year amounts as premium revenues stayed relatively consistent.
Other Underwriting, Acquisition and Insurance Expenses. The decrease in these expenses was due to a decrease of $0.2 million in legal fees, which were associated with the 2009 acquisition of ICC. Additionally, auditing fees were lower by $0.3 million in the current year, reflecting efficiencies in the financial reporting process area.
Amortization of Deferred Policy Acquisition Costs. Amortization decreased for the three and nine months ended September 30, 2010 to $3.0 million and $11.4 million compared to the same periods in 2009 as our persistency has improved. Persistency was impacted in 2009 by one newly-recruited consultant, which resulted in higher amortization expense in 2009 as policies sold by this former consultant lapsed.
Federal Income Tax. The effective tax rate for the three and nine months ended September 30, 2010 was 44.1% and 33.5% versus 33.7% and 22.1% for the same periods in 2009. Tax differences impact the enacted tax rate when they result in differences between taxable income and expense that do not affect both the financial reporting and tax bases of accounting. The rate variance from the statutory rate of 35% occurred because changes in fair value of our Class A common stock warrants are not taxable items. In addition, intercompany transactions related to CIA shares held by subsidiaries that were redeemed by Citizens, Inc. during the current year were eliminated under current consolidation rules for financial reporting purposes, but result in taxable transactions and increased the current year effective tax rate. The additional tax expense related to these transactions totaled $0.9 million and $1.4 million for the three and nine months ended September 30, 2010, respectively.
Segment Operations
The Company has three reportable segments: Life Insurance, Home Service Insurance and Other Non-Insurance Enterprises. These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income before income taxes.
                                 
            Home     Other        
    Life     Service     Non-Insurance        
    Insurance     Insurance     Enterprises     Total  
    (In thousands)  
Income (loss) before income tax expense:
                               
Three months ended:
                               
September 30, 2010
  $ 1,894       1,270       (185 )     2,979  
September 30, 2009
    2,522       967       (421 )     3,068  
 
 
Nine months ended:
                               
September 30, 2010
    5,774       4,518       (579 )     9,713  
September 30, 2009
    7,938       3,232       1,305       12,475  

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Life Insurance
Our Life Insurance segment consists of issuing primarily ordinary whole life insurance and endowments in U.S. Dollar-denominated amounts to foreign residents, and domestically through independent marketing firms and consultants.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Revenue:
                               
Premiums
  $ 27,514       25,795       78,364       75,570  
Net investment income
    3,893       4,232       13,239       12,196  
Realized gains, net
    1       650       116       1,068  
Other income
    78       108       487       267  
 
                       
Total revenue
    31,486       30,785       92,206       89,101  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    10,498       10,035       30,644       30,259  
Increase in future policy benefit reserves
    10,688       8,850       28,123       24,258  
Policyholders’ dividends
    1,965       1,809       5,267       4,687  
 
                       
Total insurance benefits paid or provided
    23,151       20,694       64,034       59,204  
Commissions
    5,572       4,827       15,316       14,531  
Other underwriting, acquisition and insurance expenses
    2,596       2,563       8,213       7,873  
Capitalization of deferred policy acquisition costs
    (4,579 )     (3,975 )     (12,741 )     (12,227 )
Amortization of deferred policy acquisition costs
    2,613       3,757       10,752       10,677  
Amortization of cost of customer relationships acquired and other intangibles
    239       397       858       1,105  
 
                       
Total benefits and expenses
    29,592       28,263       86,432       81,163  
 
                       
Income before income tax expense
  $ 1,894       2,522       5,774       7,938  
 
                       
Premiums. Premium revenues increased for the three and nine months ended September 30, 2010 compared to the same three and nine months in 2009 due primarily to international renewal business, which experienced strong persistency as this block of insurance matures. Renewals accounted for approximately 85% of total premium for the nine months ended in 2009 and 2010.
Life Insurance premium breakout is detailed below.
                                                                 
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2010     2009     2010     2009  
    (In thousands, except for %)  
Premiums:
                                                               
First year
  $ 4,172       15.2 %     3,667       14.2 %     11,396       14.5 %     10,821       14.3 %
Renewal
    23,342       84.8 %     22,128       85.8 %     66,968       85.5 %     64,749       85.7 %
 
                                               
Total premiums
  $ 27,514       100.0 %     25,795       100.0 %     78,364       100.0 %     75,570       100.0 %
 
                                               
Net Investment Income. Net investment income increased comparing the nine months ended September 30, 2010 to the same period of 2009. The increase in the current year resulted from increased income on bonds as our investment portfolio grew due to new investments added from premium growth. Due to the declining interest rate environment, the Company experienced significant call activity related to fixed income debt securities during 2009 and beginning in the latter part of the second quarter in 2010. This activity has resulted in lower yields due to a lag in reinvesting proceeds and reinvestment into lower yielding investments related to these calls. The current quarter of 2010 reflects this yield decline compared to the 2009 portfolio yield, which was approximately 40 basis points higher.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Claims and Surrenders. Claims and surrenders increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009. These amounts fluctuate from period to period but were within anticipated ranges based upon management’s expectations.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
Death claims
  $ 1,987       2,115       5,771       6,269  
Surrender benefits
    4,477       4,062       13,083       12,811  
Endowment benefits
    3,611       3,446       10,427       10,030  
Accident and health benefits
    65       77       348       193  
Other policy benefits
    358       335       1,015       956  
 
                       
Total claims and surrenders
  $ 10,498       10,035       30,644       30,259  
 
                       
   
Death claims were favorable in the three and nine months for September 30, 2010 compared to the same periods in 2009, with a decrease of approximately 6.0% and 8.0%, respectively.
   
Surrender benefits increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009. The majority of policy surrender benefits paid is attributable to our international business and related to policies that have been in force over fifteen years, and no longer have surrender charges associated with them.
   
Endowment benefit expense has increased as this product has become more popular with policyholders, and will likely continue to increase.
Increase in Future Policy Benefit Reserves. Policy benefit reserves increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009, primarily due to increased sales of endowment products, which build up reserve balances more quickly compared to other life product sales. Endowment sales have become more popular relative to our international sales in the past few years, representing approximately 57%, 60% and 48% of total in force of new policies issued for 2010 (through nine months), 2009 and 2008, respectively.
Reserving assumptions are reviewed to ensure that our original assumptions at the time of policy issuance related to interest, mortality, withdrawals, and settlement expenses are based upon management’s best judgment. The Company modified these assumptions during the current year with respect to new policies issued, which resulted in an increase to reserves of $0.5 million. In addition, the Company recognized adjustments to reserves related to system database issues that were discovered, which resulted in a decrease to reserves of $0.6 million. The net impact of these reserve items during the quarter ended September 30, 2010 was a reduction in reserves of $0.1 million.
Commissions. Commission expense increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009, as premium revenues increased between periods. This expense fluctuates directly with premium revenues.
Amortization of Deferred Policy Acquisition Costs (“DAC”). Amortization costs decreased in 2010 for the three months ended September 30, 2010 compared to 2009 resulting from improved persistency. The Company canceled its contract with a newly-recruited consultant in the second quarter of 2009, due to poor experience. Policies sold by this consultant lapsed at high rates during the first and second quarter of 2010, which resulted in higher DAC amortization in those periods compared to the third quarter of 2010, which was not impacted by similar lapses. DAC amortization increased due to the higher percentage of endowment product sales, which have a shorter amortization period than a whole life policy. As mentioned relative to the increase in reserves, the Company’s sales of endowment products have increased over the past few years.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Home Service Insurance
We provide final expense ordinary life insurance to middle and lower income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing employee-agents.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
        (In thousands)  
Revenue:
                               
Premiums
  $ 10,541       10,357       31,557       30,924  
Net investment income
    3,244       3,126       10,251       9,396  
Realized gains (losses), net
    (96 )     356       585       1,682  
Other income
    10       20       63       84  
 
                       
Total revenue
    13,699       13,859       42,456       42,086  
 
                       
 
                               
Benefits and expenses:
                               
Insurance benefits paid or provided:
                               
Claims and surrenders
    5,241       4,459       15,766       13,995  
Increase in future policy benefit reserves
    710       1,455       2,603       3,763  
Policyholders’ dividends
    12       18       57       55  
 
                       
Total insurance benefits paid or provided
    5,963       5,932       18,426       17,813  
 
                               
Commissions
    3,657       3,608       11,069       10,931  
Other underwriting, acquisition and insurance expenses
    3,529       3,588       10,964       11,577  
Capitalization of deferred policy acquisition costs
    (1,569 )     (1,331 )     (4,665 )     (4,030 )
Amortization of deferred policy acquisition costs
    362       546       670       1,038  
Amortization of cost of customer relationships acquired and other intangibles
    487       549       1,474       1,525  
 
                       
Total benefits and expenses
    12,429       12,892       37,938       38,854  
 
                       
Income before income tax expense
  $ 1,270       967       4,518       3,232  
 
                       
Premiums. The premium increases were due to enhanced marketing efforts to promote the Home Service segment, as well as a SPFIC rate increase that was effective in the latter part of 2009. The Company has received approval for a rate increase of approximately 5.7% that will be effective January 1, 2011.
Net Investment Income. Net investment income increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009. The current year increase was due to an increased size of the asset portfolio from new business sales and income earned on the portfolio. The Company experienced significant call activity in the second quarter of 2009, which depressed our investment income for that period and lowered portfolio yields. Call activity was again significant in the latter part of the second quarter of 2010, which continues to result in lower investment income. The 2009 results included a one-time positive adjustment from a legal settlement of $240,000 related to a defaulted bond.
Realized Gains, Net. The net realized losses of $0.1 million in the third quarter of 2010 were primarily related to bonds that were purchased at a premium. Net realized gains of $0.6 million for the nine months ended September 30, 2010 were mostly due to sales of several available-for-sale debt and equity securities, some of which were previously impaired. Net realized gains for the nine months ended September 2009 were due primarily to bond sales.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Claims and Surrenders. Claims and surrenders increased for the three and nine month periods ended September 30, 2010 compared to the same periods in 2009.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    (In thousands)  
 
 
Death claims
  $ 3,990       3,339     $ 12,141       10,967  
Surrender benefits
    649       468       1,780       1,347  
Endowment benefits
    5       9       19       19  
Property claims
    469       514       1,340       1,264  
Accident and health benefits
    33       36       137       130  
Other policy benefits
    95       93       349       268  
 
                       
Total claims and surrenders
  $ 5,241       4,459     $ 15,766       13,995  
 
                       
   
Death claims increased 19.5% and 10.7% for the three and nine months ended September 30, 2010 compared to the same periods in 2009. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
   
Surrender benefits have increased in the three and nine months ended for the current year compared to the same periods in 2009, which is believed to be the result of negative economic issues impacting policyholders.
Other Underwriting, Acquisition and Insurance Expenses. Other underwriting, acquisition and insurance expenses decreased for the three and nine months ended at September 30, 2010 compared to the same periods in 2009, due to a decrease in accounting and consulting fees in the current year.
Other Non-Insurance Enterprises
Overall, other non-insurance operations are relatively immaterial to the consolidated results, except for the fair value adjustment related to the Company’s warrants to purchase Class A common stock. These amounts fluctuate due to the movement in the stock price and fair value calculation using the Black-Scholes valuation model.
Investments
The administration of our investment portfolios is handled by our management, pursuant to board-approved investment guidelines, with all trading activity approved by a committee of the respective boards of directors of our insurance company subsidiaries. The guidelines used require that fixed maturities, both government and corporate, are of high quality and comprise a majority of the investment portfolio. State insurance statutes prescribe the quality and percentage of the various types of investments that may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, mortgage loans and real estate within certain specified percentages. The assets are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for our insurance company subsidiaries to meet their respective policyholder obligations.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets.
                                 
    September 30, 2010     December 31, 2009  
    Carrying     % of Total     Carrying     % of Total  
    Value     Carrying Value     Value     Carrying Value  
    (In thousands)           (In thousands)        
Fixed maturity securities:
                               
U.S. Treasury and U.S. Government-sponsored enterprises
  $ 397,164       50.2 %   $ 399,626       55.6 %
Corporate
    171,080       21.6       116,098       16.1  
Municipal bonds
    62,125       7.8       57,192       7.9  
Mortgage-backed (1)
    16,297       2.1       19,452       2.7  
Foreign governments
    140             120        
 
                       
Total fixed maturity securities
    646,806       81.7       592,488       82.3  
Cash and cash equivalents
    65,366       8.2       48,625       6.8  
Short-term investments
                2,510       0.3  
Policy loans
    34,970       4.4       32,096       4.5  
Equity securities
    33,986       4.3       33,477       4.6  
Mortgage loans
    1,501       0.2       1,533       0.2  
Real estate and other long-term investments
    9,376       1.2       9,216       1.3  
 
                       
Total cash, cash equivalents and investments
  $ 792,005       100.0 %   $ 719,945       100.0 %
 
                       
     
(1)  
Includes $14.5 million and $16.2 million of U.S. Government-sponsored enterprises at September 30, 2010 and December 31, 2009, respectively.
The Company increased holdings in corporate securities during the first nine months of 2010, investing in shorter duration investment grade securities. Cash and cash equivalents increased as of September 30, 2010 due to issuer call activity related to fixed maturity securities that occurred toward the end of the second quarter and continued throughout the third quarter. Short-term investments held at December 31, 2009 matured in the first quarter and those funds were reinvested into fixed maturity securities.
The held-to-maturity portfolio as of September 30, 2010 represented 19.7% of the total fixed maturity securities owned based upon carrying values, with the remaining 80.3% classified as available-for-sale. Held-to-maturity securities are reported in the financial statements at amortized cost and available-for-sale securities are reported at fair value.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
The following table sets forth the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of September 30, 2010 and December 31, 2009.
                                 
    September 30, 2010     December 31, 2009  
    Carrying Value     %     Carrying Value     %  
    (In thousands)             (In thousands)          
AAA and U.S. Government
  $ 481,307       74.4 %   $ 442,160       74.6 %
AA
    24,627       3.8       26,613       4.5  
A
    70,671       10.9       69,934       11.8  
BBB
    55,324       8.6       48,311       8.2  
BB and other
    14,877       2.3       5,470       0.9  
 
                       
Totals
  $ 646,806       100.0 %   $ 592,488       100.0 %
 
                       
The increase in fixed maturities with credit ratings of BBB as of September 30, 2010 compared to December 31, 2009 is a result of new investments in corporate bonds, primarily public utility issuers, with an average maturity of seven years. The increase in non-investment grade securities was due to down-grades of issuers in the current period, as the Company does not purchase below investment grade securities.
Valuation of Investments
We evaluate the carrying value of our fixed maturity and equity securities at least quarterly. The Company monitors all debt and equity securities on an on-going basis relative to changes in credit ratings, market prices, earnings trends and financial performance, in addition to specific region or industry reviews. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. The Company determines other-than-temporary impairment by reviewing all relevant evidence related to the specific security issuer as well as the Company’s intent to sell the security, or if it is more likely than not that the Company would be required to sell a security before recovery of its amortized cost.
When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment is separated into the following: a) the amount representing the credit loss; and b) the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings becomes the new amortized cost basis of the investment. The new amortized cost basis is not adjusted for subsequent recoveries in fair value.
The Company recognized $27,000 of other-than-temporary impairments related to one fixed maturity security recorded in the third quarter of 2010. The Company recognized a valuation allowance on one mortgage loan totaling $45,000 during the first quarter of 2010. Impairments recorded during the first nine months of 2009 totaled $111,000.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Liquidity and Capital Resources
Liquidity refers to a company’s ability to generate sufficient cash flows to meet the needs of its operations. Liquidity is managed on insurance operations and seeks to ensure stable and reliable sources of cash flows to meet obligations provided by a variety of sources. Liquidity requirements of Citizens are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds, while investment purchases, policy benefits, and operating expenses are the primary uses of funds. We historically have not had to liquidate investments to provide cash flow and did not do so during the first nine months of 2010. Our investments as of September 30, 2010 consist of 71.4% of marketable debt securities classified as available-for-sale that could be readily converted to cash for liquidity needs.
A primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our insurance policies, such as surrender charges, that help limit and discourage early withdrawals. Since these contractual withdrawals, as well as the level of surrenders experienced, were largely consistent with our assumptions in asset liability management, our associated cash outflows have, to date, not had an adverse impact on our overall liquidity. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. Cash flow projections and cash flow tests under various market interest rate scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds.
Cash flows from our insurance operations have been sufficient to meet current needs. Cash flows from operating activities were $39.5 million and $36.3 million for the nine months ended September 30, 2010 and 2009, respectively. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows, for the most part, are reinvested in fixed income securities. Net cash outflows from investment activity totaled $24.4 million and $23.7 million for the nine months ended September 30, 2010 and 2009, respectively.
The National Association of Insurance Commissioners (“NAIC”) has established minimum capital requirements in the form of Risk-Based Capital (“RBC”). Risk-based capital factors 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” and compares this level to 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 risk-based capital fall below 200%, a series of actions by the affected company would begin.
Two of our subsidiaries fell below the minimum RBC threshold at December 31, 2008. A capital contribution of $1.0 million was made to SPFIC during the first quarter of 2009. An additional $1.0 million capital contribution was made to SPFIC in the third quarter of 2009. A capital contribution of $1.0 million was also made to Ozark National Life Insurance Company (“ONLIC”) during the first quarter of 2009 due to its RBC ratio falling below 200% at December 31, 2008. The decline in SPFIC’s capital balance mainly resulted from hurricane losses in 2008 and an increase in operating expenses. The reduction in ONLIC’s capital balance resulted from declines in asset values of preferred and common stock holdings. These capital contributions increased the RBC ratios and RBC action plans were submitted to the relevant insurance departments. The capital balance of ONLIC was determined to be at company action level at March 31, 2009 due to continued declines relative to its investment holdings. The capital contributions made in 2009 increased the ratios as anticipated in action plans submitted to the appropriate state insurance departments. The Company received approval from the respective state insurance departments to merge ONLIC into SPLIC as of October 1, 2009. The capital contributions did not impact the overall consolidated financial position or results of operations of the Company. All insurance subsidiaries were above the RBC minimums at September 30, 2010.
Due to a decline in statutory surplus, CNLIC no longer met minimum capital and surplus requirements as of June 30, 2010 in two states it is licensed in, Florida, deficient by approximately $0.4 million, and Mississippi, deficient by approximately $0.5 million. CNLIC currently maintains its Certificate of Authority, but voluntarily suspended sales in these states and its licenses were suspended. Life premiums collected in 2009 were $2,000 and $9,800 relating exclusively to policy renewals in Florida and Mississippi, respectively.
Effective September 1, 2010, CICA contributed 150,000 shares of Citizens, Inc. Class A common stock to CNLIC as a capital contribution. The shares had a fair market contributed value of $1,032,000. These shares were subsequently purchased by Citizens, Inc., the ultimate parent, on September 13, 2010 for $1,041,000 cash. The transaction has been eliminated under consolidation accounting rules. Management is currently evaluating CNLIC’s operations and strategy for the future, but does not anticipate any material change relative to the consolidated financial condition of the Company.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Contractual Obligations and Off-balance Sheet Arrangements
There have been no material changes in contractual obligations from those reported at December 31, 2009 in the Company’s Form 10-K. The Company does not have off-balance sheet arrangements at September 30, 2010 and does not expect any future effects on the Company’s financial condition related to any such arrangements. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engages in speculative activities of any nature, and we do not use such investments to hedge our investment positions.
Parent Company Liquidity and Capital Resources
We are a holding company and have had minimal operations of our own. Our assets consist primarily of the capital stock of our subsidiaries. Accordingly, our cash flows depend upon the availability of statutorily permissible payments, primarily payments under management agreements from our two primary life insurance subsidiaries, CICA and SPLIC. The ability to make payments is limited by applicable laws and regulations of Colorado, CICA’s state of domicile, and Louisiana, SPLIC’s state of domicile, which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that these insurance subsidiaries maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. We historically have not relied upon dividends from subsidiaries for our cash flow needs.
Critical Accounting Policies
Our critical accounting policies are as follows:
Policy Liabilities
Future policy benefit reserves have been computed by the net level premium method with assumptions as to investment yields, dividends on participating business, mortality and withdrawals based upon our experience. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of policy liabilities and the increase in future policy benefit reserves. Management’s judgments and estimates for future policy benefit reserves provide for possible unfavorable deviation.
We continue to use the original assumptions (including a provision for the risk of adverse deviation) in subsequent periods to determine the changes in the liability for future policy benefits (the “lock-in concept”) unless a premium deficiency exists. Management monitors these assumptions and has determined that a premium deficiency did not exist as of September 30, 2010. Management believes that our policy liabilities and increase in future policy benefit reserves as of the nine months ended September 30, 2010 and 2009 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision.
Reserving assumptions are reviewed to ensure that our original assumptions at the time of policy issuance related to interest, mortality, withdrawals, and settlement expenses are based upon management’s best judgment. The Company modified these assumptions during the current year with respect to new policies issued, which resulted in an increase to reserves of $0.5 million, due primarily from a decrease in interest rate assumptions on investments.
Deferred Policy Acquisition Costs
Acquisition costs, consisting of commissions and policy issuance, underwriting and agency expenses that relate to and vary with the production of new business, are deferred. These deferred policy acquisition costs are amortized primarily over the estimated premium paying period of the related policies in proportion to the ratio of the annual premium recognized to the total premium revenue anticipated, using the same assumptions as were used in computing liabilities for future policy benefits.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
We utilize the factor method to determine the amount of costs to be capitalized and the ending asset balance. The factor method is based on the ratio of premium revenue recognized for the policies in force at the end of each reporting period compared to the premium revenue recognized for policies in force at the beginning of the reporting period. The factor method ensures that policies that lapsed or surrendered during the reporting period are no longer included in the deferred policy acquisition costs calculation. The factor method limits the amount of deferred costs to its estimated realizable value, provided actual experience is comparable to that contemplated in the factors.
Inherent in the capitalization and amortization of deferred policy acquisition costs are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 80% of our capitalized deferred acquisition costs are attributed to first year excess commissions. The remaining 20% are attributed to costs that vary with and are directly related to the acquisition of new insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then evaluated over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Management believes that our deferred policy acquisition costs and related amortization for the nine months ended September 30, 2010 and 2009 limits the amount of deferred costs to its estimated realizable value. This belief is based upon the analysis performed on capitalized expenses that vary with and are primarily related to the acquisition of new and renewal insurance business, utilization of the factor method and annual recoverability testing.
Cost of Customer Relationships Acquired
Cost of Customer Relationships Acquired (“CCRA”) is established when we purchase a block of insurance. CCRA is amortized primarily over the emerging profit of the related policies using the same assumptions as were used in computing liabilities for future policy benefits. We utilize various methods to determine the amount of the ending asset balance, including a static model and a dynamic model. Inherent in the amortization of CCRA are certain management judgments about the ending asset balance and the annual amortization. The assumptions used are based upon interest, mortality and lapses at the time of purchase.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next thirty years. The CCRA is then evaluated utilizing reasonable assumptions. Management believes that our CCRA and related amortization is recoverable for the nine months ended September 30, 2010 and 2009. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
Goodwill
Current accounting guidance requires that goodwill balances be reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event has occurred. A reporting unit is defined as an operating segment on one level below an operating segment. Most of the Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segment, as there is no discrete financial information available for the separate components of the segment or all of the components of the segment have similar economic characteristics.
The goodwill impairment test follows a two step process as defined under current accounting guidance. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations, peer company price to earnings multiples, the level of the Company’s Class A common stock price and assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Valuation of Investments in Fixed Maturity and Equity Securities
The evaluation of securities for impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period.
Based upon current accounting guidance, investment securities must be classified as held-to-maturity, available-for-sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Fixed maturity securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.
The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an OTTI exists pursuant to the accounting guidelines. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the Federal government or its agencies, by government-sponsored agencies, or whether downgrades by bond rating agencies have occurred, and reviews of the issuer’s financial condition.
If management determines that an investment experienced an OTTI, management must then determine the amount of OTTI to be recognized in earnings. If management does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment. If management intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The new amortized cost basis is not adjusted for subsequent recoveries in fair value.
The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.
Premium Revenue and Related Expenses
Premiums on life and accident and health policies are reported as earned when due or, for short duration contracts, over the contract period on a pro rata basis. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the estimated life of the contracts. This matching is accomplished by means of provisions for future benefits and the capitalization and amortization of deferred policy acquisition costs.
Annuities are accounted for in a manner consistent with accounting for interest bearing financial instruments. Our primary annuity products do not include fees or other such charges.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Tax Accounting
A deferred tax asset or deferred tax liability is recorded only if a determination is made that is more likely than not that the tax treatment on which the deferred tax item depends will be sustained in the event of an audit. These determinations inherently involve management’s judgment. In addition, the Company must record a tax valuation allowance with respect to deferred tax assets if it is more likely than not that the tax benefit will not be realized. This valuation allowance is in essence a contra account to the deferred tax asset. Management must determine the portion of the deferred tax asset and resulting tax benefit that may not be realized based upon judgment of expected outcomes. Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in future reporting periods. Such a charge could have a material adverse effect on our results of operations, financial condition and capital position.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General
The nature of our business exposes us to investment market risk. Market risk is the risk of loss that may occur when changes in interest rates and public equity prices adversely affect the value of our invested assets. Interest rate risk is our primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the fair value of our investments. The fair value of our fixed maturity portfolio generally increases when interest rates decrease and decreases when interest rates increase.
The following table summarizes net unrealized gains and losses for the periods indicated.
                                                 
    September 30, 2010     December 31, 2009  
                    Net                     Net  
                    Unrealized                     Unrealized  
    Amortized     Fair     Gains     Amortized     Fair     Gains  
    Cost     Value     (Losses)     Cost     Value     (Losses)  
    (In thousands)  
 
                                               
Fixed maturities, available-for-sale
  $ 501,649       519,132       17,483       389,195       385,579       (3,616 )
Fixed maturities, held-to-maturity
    127,674       128,865       1,191       206,909       199,676       (7,233 )
 
                                   
Total fixed maturities
  $ 629,323       647,997       18,674       596,104       585,255       (10,849 )
 
                                   
Total equity securities
  $ 25,619       33,986       8,367       25,899       33,477       7,578  
 
                                   
Market Risk Related to Interest Rates
Our exposure to interest rate changes results from our significant holdings of fixed maturity investments, which comprised 89% of our investment portfolio as of September 30, 2010. These investments are mainly exposed to changes in U.S. Treasury rates. Our fixed maturities investments include U.S. Government-sponsored enterprises, U.S. Government bonds, securities issued by government agencies, and corporate bonds. Approximately 63.6% of the fixed maturities at fair value as of September 30, 2010 were invested in U.S. Government-sponsored enterprises, or were backed by U.S. Government agencies.
To manage interest rate risk, we perform periodic projections of asset and liability cash flows to evaluate the potential sensitivity of our investments and liabilities. We assess interest rate sensitivity with respect to our available-for-sale fixed maturities investments using hypothetical test scenarios that assume either upward or downward 100 basis point shifts in the prevailing interest rates. We performed a sensitivity analysis as of December 31, 2009 for our interest rate sensitive assets. The change in fair values of our debt and equity securities as of September 30, 2010 were within the expected range of this analysis.
Changes in interest rates typically have a sizable effect on the fair values of our debt and equity securities. The interest rate of the ten-year U.S. Treasury bond decreased significantly to 2.5% during the quarter ended September 30, 2010 from 3.8% at December 31, 2009. Net unrealized gains on fixed maturity securities totaled $18.7 million at September 30, 2010 compared to losses of $10.8 million at December 31, 2009.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
The fixed maturity portfolio is exposed to call risk as a significant portion of the current bond holdings are callable. A decreasing interest rate environment can result in increased call activity.
There are no fixed maturities or other investments that we classify as trading instruments. Approximately 80.1% of fixed maturities were held in available-for-sale and 19.9% in held-to-maturity based upon fair value at September 30, 2010. At September 30, 2010 and December 31, 2009, we had no investments in derivative instruments, nor did we have any subprime or collateralized debt obligation risk.
Market Risk Related to Equity Prices
Changes in the level or volatility of equity prices affect the value of equity securities we hold as investments. Our equity investments portfolio represented 4.7% of our total investments at September 30, 2010. We believe that significant decreases in the equity markets would not have a material adverse impact on our total investment portfolio.
Item 4. CONTROLS AND PROCEDURES
We have established disclosure controls and procedures to ensure, among other things, that material information relating to our Company, including its consolidated subsidiaries, is made known to our officers who certify our financial reports and to the other members of our senior management and the Board of Directors.
Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon an evaluation at the end of the period, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
During the quarter ended September 30, 2010, there were no changes in the Company’s internal controls over financial reporting that materially affect or are reasonably likely to affect the Company’s internal controls over financial reporting (as defined in rules 13a-15(f) and 15d-15(f) under the Exchange Act).
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
We are a defendant in a lawsuit filed on August 6, 1999 in the Texas District Court, Austin, Texas, now styled Citizens Insurance Company of America, Citizens, Inc., Harold E. Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in which a class was originally certified by the trial court and reversed by the Texas Supreme Court in 2007 with an order to the trial court to conduct further proceedings consistent with its ruling. The underlying lawsuit alleged that certain life insurance policies CICA made available to non-U.S. residents, when combined with a policy feature that allowed certain cash benefits to be assigned to two non-U.S. trusts for the purpose of accumulating ownership of our Class A common stock, along with allowing the policyholders to make additional contributions to the trusts, were actually offers and sales of securities that occurred in Texas by unregistered dealers in violation of the Texas securities laws. The remedy sought was rescission and return of the insurance premium payments. On December 9, 2009, the trial court denied the recertification of the class after conducting additional proceedings in accordance with the Texas Supreme Court’s ruling. The remaining plaintiffs must now proceed individually, and not as a class, if they intend to pursue their cases against us. We intend to maintain a vigorous defense in any remaining proceedings.
In addition to the legal proceeding described above, we may from time to time be subject to a variety of legal and regulatory actions relating to our future, current and past business operations, including, but not limited to:
   
disputes over insurance coverage or claims adjudication;
   
regulatory compliance with insurance and securities laws in the United States and in foreign countries;
   
disputes with our marketing firms, consultants and employee agents over compensation and termination of contracts and related claims;
   
disputes regarding our tax liabilities;
   
disputes relative to reinsurance and coinsurance agreements; and
   
disputes relating to businesses acquired and operated by us.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
In the absence of countervailing considerations, we would expect to defend any such claims vigorously. However, in doing so, we could incur significant defense costs, including not only attorneys’ fees and other direct litigation costs, but also the expenditure of substantial amounts of management time that otherwise would be devoted to our business. If we suffer an adverse judgment as a result of any claim, it could have a material adverse effect on our business, results of operations and financial condition.
Item 1A. RISK FACTORS
There are no updates to our risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, except as noted below.
Control of our Company, through the ownership of our Class B Common Stock, may one day be held by a 501(c)(3) charitable foundation and we cannot determine whether any change in our management or operations will occur as a result of the ownership change.
Harold E. Riley, our Founder, Chairman and CEO, is deemed by the New York Stock Exchange to be our ultimate controlling party. Mr. Riley owns 100% of Citizens Class B Common Stock through the Harold E. Riley Trust (“Trust”). Citizens’ Class A and Class B Common Stock are identical in all respects, except the Class B Common Stock elects a simple majority of the Board and receives one-half of the cash dividends paid on a per share basis as the Class A shares. The Class A Common Stock elects the remainder of the Board. Upon Mr. Riley’s death, the Class B Common Stock will be transferred from the Trust to the Harold E. Riley Foundation, a charitable organization established under 501(c)(3) of the Internal Revenue Code (“Foundation”). However, it is unclear what, if any changes, would occur to our board or management structure as a result of different ownership of the control position of our Company. Mr. Riley may at any time prior to his death deem it appropriate to transfer the Class B Common Stock, currently held by the Trust, to the Foundation.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. (RESERVED)
Item 5. OTHER INFORMATION
On November 5, 2010, the Company issued a news release (the “Release”) reporting, among other things, results for its third quarter 2010 earnings. A copy of the Release is furnished as Exhibit 99.1 to this Quarterly Report on Form 10-Q. Citizens also announced that it would hold a conference call to discuss its financial results at 10:00 a.m. Central Standard Time on Monday, November 8, 2010.

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
Item 6. EXHIBITS
         
Exhibit Number   The following exhibits are filed herewith:
       
 
  3.1    
Restated and Amended Articles of Incorporation (a)
       
 
  3.2    
Bylaws (b)
       
 
  4.1    
Amendment to State Series A-1 and A-2 Senior Convertible Preferred Stock (c)
       
 
  10.1    
Self-Administered Automatic Reinsurance Agreement — Citizens Insurance Company of America and Riunione Adriatica di Sicurta, S.p.A. (d)
       
 
  10.2    
Bulk Accidental Death Benefit Reinsurance Agreement between Connecticut General Life Insurance Company and Citizens Insurance Company of America, as amended (e)
       
 
  10.3    
Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement, Administrative Services Agreement dated March 9, 2004, between Citizens Insurance Company of America and Texas International Life Insurance Company, Reinsurance Trust Agreement dated March 9, 2004, by and among Citizens Insurance Company of America, Texas International Life Insurance Company and Wells Fargo Bank, N.A. (f)
       
 
  10.4    
Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement, Administrative Services Agreement dated March 9, 2004, between Combined Underwriters Life Insurance Company and Texas International Life Insurance Company, Reinsurance Trust Agreement dated March 9, 2004, by and among Combined Underwriters Life Insurance Company, Texas International Life Insurance Company and Wells Fargo Bank, N.A. (g)
       
 
  10.5 (a)  
Securities Purchase Agreement dated July 12, 2004 among Citizens, Inc., Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and Opportunity Fund, and Smithfield Fiduciary LLC (h)
       
 
  10.5 (b)  
Registration Rights Agreement dated July 12, 2004 among Citizens, Inc., Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and Opportunity Fund, and Smithfield Fiduciary LLC (h)
       
 
  10.5 (c)  
Unit Warrant dated July 12, 2004, to Mainfield Enterprises, Inc. (h)
       
 
  10.5 (d)  
Unit Warrant dated July 12, 2004, to Steelhead Investments Ltd. (h)
       
 
  10.5 (e)  
Unit Warrant dated July 12, 2004, to Portside Growth and Opportunity Fund (h)
       
 
  10.5 (f)  
Unit Warrant dated July 12, 2004, to Smithfield Fiduciary LLC (h)
       
 
  10.5 (g)  
Warrant to Purchase Class A Common Stock to Mainfield Enterprises, Inc. (h)
       
 
  10.5 (h)  
Warrant to Purchase Class A Common Stock to Steelhead Investments Ltd. (h)
       
 
  10.5 (i)  
Warrant to Purchase Class A Common Stock to Portside Growth and Opportunity Fund (h)
       
 
  10.5 (j)  
Warrant to Purchase Class A Common Stock to Smithfield Fiduciary LLC (h)
       
 
  10.5 (k)  
Subordination Agreement among Regions Bank, the Purchasers and Citizens, Inc. dated July 12, 2004 (h)
       
 
  10.5 (l)  
Non-Exclusive Finder’s Agreement dated September 29, 2003, between Citizens, Inc. and the Shemano Group, Inc. (h)
       
 
  10.6    
Self-Administered Automatic Reinsurance Agreement between Citizens Insurance Company of America and Converium Reinsurance (Germany) Ltd. (i)
       
 
  10.7    
Self-Administered Automatic Reinsurance Agreement between Citizens Insurance Company of America and Scottish Re Worldwide (England) (j)
       
 
  10.8    
Self-Administered Automatic Reinsurance Agreement — CICA Life Insurance Company of America and Scor Global Life U.S. Re Insurance Company (k)

 

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
September 30, 2010
         
Exhibit Number   The following exhibits are filed herewith:
       
 
  10.9    
Self-Administered Automatic Reinsurance Agreement — CICA Life Insurance Company of America and Mapfre Re Compania de Reaseguros, S.A. (l)
       
 
  11    
Statement re: Computation of per share earnings (see financial statements)
       
 
  21    
Subsidiaries of the Registrant*
       
 
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act*
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act*
       
 
  32.1    
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act*
       
 
  32.2    
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act*
       
 
  99.1    
News Release reporting third quarter results issued on November 5, 2010 (furnished herewith).
 
     
*  
Filed herewith.
 
(a)  
Filed on March 15, 2004 with the Registrant’s Annual Report on Form 10-K for the Year Ended December 31, 2003 as Exhibit 3.1, and incorporated herein by reference.
 
(b)  
Filed on March 31, 1999 with the Registrant’s Annual Report on Form 10-K for the Year Ended December 31, 1998, as Exhibit 3.2, and incorporated herein by reference.
 
(c)  
Filed on July 15, 2004, with the Registrant’s Current Report on Form 8-K as Exhibit 4.1, and incorporated herein by reference.
 
(d)  
Filed as Exhibit 10.8 with the Registration Statement on Form S-4, SEC File No. 333-16163, on November 14, 1996 and incorporated herein by reference.
 
(e)  
Filed on April 9, 1997 as Exhibit 10.9 with the Registrant’s Annual Report on Form 10-K for the Year Ended December 31, 1996, Amendment No. 1, and incorporated herein by reference.
 
(f)  
Filed on March 22, 2004 as Exhibit 10.8 of the Registrant’s Current Report on Form 8-K, and incorporated herein by reference.
 
(g)  
Filed on March 22, 2004 as Exhibit 10.9 of the Registrant’s Current Report on Form 8-K, and incorporated herein by reference.
 
(h)  
Filed on July 15, 2004 as part of Exhibit 10.12 with the Registrant’s Current Report on Form 8-K, and incorporated herein by reference.
 
(i)  
Filed on March 31, 2005, with the Registrant’s Annual Report on Form 10-K for the Year Ended December 31, 2004, as Exhibit 10.10(m), and incorporated herein by reference.
 
(j)  
Filed on March 31, 2005, with the Registrant’s Annual Report on Form 10-K for the Year Ended December 31, 2004, as Exhibit 10.10(n), and incorporated herein by reference.
 
(k)  
Filed on November 6, 2009, with the Registrant’s Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2009, as Exhibit 10.8(k), and incorporated herein by reference.
 
(l)  
Filed on November 6, 2009, with the Registrant’s Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2009, as Exhibit 10.9(l), and incorporated herein by reference.

 

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SIGNATURES
   
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  CITIZENS, INC.
 
 
  By:   /s/ Harold E. Riley    
    Harold E. Riley   
    Chairman and Chief Executive Officer   
     
  By:   /s/ Kay E. Osbourn    
    Kay E. Osbourn   
    Executive Vice President, Chief Financial Officer and Treasurer   
Date: November 5, 2010

 

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