UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
December 31, 2017
Commission File Number:
000-16509
CITIZENS, INC.
(
Exact Name of Registrant as Specified in Its Charter
)
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Colorado
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84-0755371
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.)
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2900 Esperanza Crossing, Austin, TX
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78758
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(Address of principal executive offices)
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(Zip Code)
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(512) 837-7100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Class A Common Stock
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New York Stock Exchange
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(Title of Each Class)
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(Name of Each Exchange on Which Registered)
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Securities registered pursuant to Section 12(g) of the Act:
None
(Title of class)
Indicate
by
check
mark if the
registrant
is
a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o
Yes
ý
No
Indicate
by
check
mark if the
registrant is
not
required
to
file reports pursuant to Section 13 or
Section
15(d)
of the Act.
o
Yes
ý
No
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.
ý
Yes
o
No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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).
ý
Yes
o
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K).
ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
ý
Non-accelerated filer
o
Smaller reporting company
o
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o
Yes
ý
No
As of
June 30, 2017
, the aggregate market value of the Class A common stock held by non-affiliates of the registrant was approximately
$340,350,072
.
Number of shares of common stock outstanding as of
March 5, 2018
.
Class A:
49,080,114
Class B:
1,001,714
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Report incorporates by reference certain portions of the definitive proxy materials to be delivered to stockholders in connection with the
2018
Annual Meeting of Shareholders.
THIS PAGE INTENTIONALLY LEFT BLANK
TABLE OF CONTENTS
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PART I
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Page
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Item 1.
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Item 1A.
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Item 1B.
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Item 2.
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Item 3.
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Item 4.
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PART II
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Item 5.
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Item 6.
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Item 7.
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Item 7A.
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Item 8.
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Item 9.
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Item 9A.
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Item 9B.
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PART III
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Item 10.
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Item 11.
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Item 12.
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Item 13.
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Item 14.
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PART IV
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Item 15.
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FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K are not statements of historical fact and constitute forward-looking statements within the meaning of the federal securities laws, 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. 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," "will" and 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:
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Changes in the application, interpretation or enforcement of foreign insurance laws that impact our business, which derives the majority of its revenues from residents of foreign countries;
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Potential changes in amounts reserved for in connection with the noncompliance of a portion of our insurance policies with Sections 7702 under the Internal Revenue Code, the failure of certain annuity contracts to qualify under Section 72(s) of the Internal Revenue Code and the anticipated timing of finalization of our proposed closing agreements with the IRS to address these matters;
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The anticipated transition of our international business to a new Bermuda-based entity, the adoption of our international business to regulatory oversight by the Bermuda Monetary Authority and potential shifts in policyholder behavior arising from these changes;
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Changes in foreign and U.S. general economic, market, and political conditions, including the performance of financial markets and interest rates;
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Changes in consumer behavior or regulatory oversight, which may affect the Company's ability to sell its products and retain business;
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The timely development of and acceptance of new products of the Company and perceived overall value of these products and services by existing and potential customers;
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Fluctuations in experience regarding current mortality, morbidity, persistency and interest rates relative to expected amounts used in pricing the Company's products;
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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;
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Results of litigation we may be involved in;
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Changes in assumptions related to deferred acquisition costs and the value of any businesses we may acquire;
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Regulatory, accounting or tax changes that may affect the cost of, or the demand for, the Company's products or services;
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Our concentration of business from persons residing in Latin America and the Pacific Rim;
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Changes in tax laws;
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Effects of acquisitions and restructuring, including possible difficulties in integrating and realizing the projected results of acquisitions;
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Changes in statutory or U.S. Generally Accepted Accounting Principles ("U.S. GAAP"), policies or practices;
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Changes in leadership among our board and senior management team.
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Our success at managing risks involved in the foregoing; and
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The risk factors discussed in "Part 1.-Item 1A- Risk Factors" of this report.
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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.
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
1
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 Annual Report on Form 10-K.
2
PART I
Item 1
. BUSINESS
Overview
Citizens, Inc. (“Citizens” or the "Company") is an insurance holding company incorporated in Colorado serving the life insurance needs of individuals in the United States since 1969 and internationally since 1975. Through our insurance subsidiaries, we pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We had approximately
$1.6 billion
of assets at December 31,
2017
and approximately
$4.5 billion
of insurance in force. Our core insurance operations include:
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U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to foreign residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants;
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ordinary whole life insurance policies to middle income households concentrated in the Midwest, Mountain West and southern United States through independent marketing consultants; and
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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 and funeral homes.
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During the last five years, our business, revenues and assets have continued to grow, driven primarily by continued new and renewal sales and increased investment income. From
2013
through
2017
, revenues rose
18%
from
$213.6 million
in
2013
to
$252.6 million
in
2017
. During that same period, our assets grew
36%
, from
$1.2 billion
to
$1.6 billion
. Our net income declined
822%
, from net income of
$5.3 million
in 2013 to a net loss of
$38.1 million
. 2017 is impacted as a result of the newly enacted Tax Cuts and Jobs Act signed into law on December 22, 2017 (the “New Tax Act”), resulting in re-measurement of deferred tax balances that decreased income in the current year by $35.7 million. In addition, we recorded a goodwill impairment of $4.6 million in
2017
and we recorded higher auditing, consulting and legal costs. See Item 6. "Selected Financial Data" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report.
Recent Board of Directors and Officer Changes
On February 1, 2017, the Company announced the appointment of Terry Festervand, as Chief Operating Officer. Ms. Festervand joins Citizens with over 18 years of insurance experience at American International Group, Inc. (“AIG”) in various capacities. During the last five years, she served at AIG Life and Retirement, first as Senior Vice President and Treasurer and later as Senior Vice President, Accounting Operations. Earlier in her career at AIG she was the Director of Global Sarbanes Oxley (“SOX”) Compliance (AIG Corporate, New York) and led the development and implementation of a SOX compliance program throughout AIG’s worldwide operations. Ms. Festervand brings Citizens’ team expertise in coordinating publicly traded company responsibilities with insurance operations, having been an Executive Vice President, Chief Financial Officer at AIG (Advisor Group, Atlanta).
On February 22, 2017, the Company announced the appointment of Gerald W. Shields to fill the open seat on our Board of Directors ("the Board") vacated by former Chairman and Chief Executive Officer Rick D. Riley. Mr. Shields joins the Board with over 37 years of technology experience, including significant life insurance experience as the Senior Vice President and Chief Information Officer of AFLAC, Inc., a leading provider of supplemental insurance. During the last five years, Mr. Shields has served as Director of the IT practice at RE Nolan, a management-consulting firm that caters to the insurance, health care, technology, and banking industries. He also currently serves as the Chief Information Officer of FirstCare Health Plans, a provider of comprehensive health care services to health maintenance organization ("HMO") subscribers that also owns Southwest Life & Health Insurance Company which offers the FirstCare PPO and life insurance products. Mr. Shields brings to the Board expertise in technology, cybersecurity and insurance operating systems, having significant experience directing these areas throughout his career.
On February 27, 2017, the Company announced the appointment of Frank Keating as a director. Governor Keating is a partner at the law firm of Holland & Knight, LLP. Governor Keating has held significant leadership positions in both the public and private sectors. In addition to serving as Governor of Oklahoma, his career included serving as CEO of the American Bankers Association and prior to that President and CEO of the American Council of Life Insurers, the trade association for the life insurance and retirement security industry. He also has served as Assistant Secretary of the Treasury and Associate Attorney General under President Ronald Reagan. He was later General Counsel and Acting Deputy Secretary for the Department of Housing and Urban Development ("HUD") under President George H.W. Bush. During his tenure at the Treasury Department and HUD, he worked
3
on significant issues affecting the banking, insurance and the financial services industries. His law enforcement career included serving as the U.S. Attorney for the Northern District of Oklahoma and as a Federal Bureau of Investigation ("FBI") agent.
On May 15, 2017, the Company announced it added a new C-level officer role to its executive team by creating a Chief Accounting Officer position at the Company and hiring Jeff Conklin, for the role. Mr. Conklin was most recently Vice President of Special Projects at American International Group, Inc. (“AIG”), Life & Retirement, Houston, and prior to that Director and then Vice President of Financial Reporting at AIG. His career at AIG spanned 13 years. Mr. Conklin joins Citizens with over 25 years of life insurance and financial reporting experience, having worked at Zurich Life and Jackson National Life prior to joining AIG. In addition to financial reporting, Mr. Conklin brings Citizens expertise in budgeting, financial analysis and implementing strategic accounting initiatives.
On June 9, 2017, the Company announced the addition of Christopher (“Chris”) W. Claus and J.D. (“Chip”) Davis, Jr. to its Board of Directors.
Mr. Claus, had a 20 year career as an executive at USAA of San Antonio, Texas. From 2013 - 2014, Mr. Claus served as Executive Vice President of USAA’s Enterprise Advice Group. Prior to that, Mr. Claus served as President of USAA’s Financial Advice and Solutions Group from 2007 to 2013. From 2001 to 2006, Mr. Claus served as President of USAA’s Insurance Management Company. Mr. Claus serves on Citizens’ Executive Committee. He also concurrently serves as Lead Director and on the Audit Committee of TrueCar (NASDAQ:TRUE), a digital automotive marketplace.
Mr. Davis, had a 40-year insurance career with National Farm Life Insurance Company (“NFLIC”) of Ft. Worth, Texas. During his career, Mr. Davis served as President, CEO and Chairman of NFLIC’s board of directors. Mr. Davis serves on Citizens’ Compensation Committee and Executive Committee.
On June 19, 2017, the Company hired Greg Broer as Vice President and Chief Actuary. Mr. Broer joins us from AIG, where he served in multiple roles over 23 years. Greg is a Fellow of the Society of Actuaries, Member of the American Academy of Actuaries, Certified Public Accountant, and Chartered Financial Analyst.
On July 16, 2017, the Company hired Robert Mauldin as Chief Marketing Officer. Mr. Mauldin is responsible for managing all aspects of marketing, distribution, customer analytics and innovation. Prior to joining Citizens, Mr. Mauldin served over 20 years in marketing with Bank of America, most recently as Senior Vice President of Product Management for the insurance division, where his work was focused on innovation and business transformation. In other roles, Mr. Mauldin served as Operations Leader for USI Inc.’s life insurance division and management roles with the American Bankers Association and American International Group.
On September 12, 2017, the Company announced the appointment of David S. Jorgensen as General Manager for International Operations of our subsidiary, CICA Life, Ltd. (Bermuda). Mr. Jorgensen has more than 30 years of experience in the life insurance industry, particularly in oversight of international insurance operations in his most recent role as Chief Financial Officer and Treasurer of Citizens. Prior to joining the Company, Mr. Jorgensen was SVP and Controller of AIG’s Life and Retirement Division, which included the additional role of Chief Financial Officer of AIG Life of Bermuda from 2014 to 2015, where he gained experience in Bermuda Solvency Capital Requirements (“BSCR”), corporate governance, risk assessment and risk management under the BSCR. In his new role, he will be responsible for leading CICA Life, Ltd. operations, expanding the Company’s international footprint globally and implementing strategic changes to the Company’s current international business model.
Mr. Jorgensen was succeeded at the Chief Financial Officer ("CFO") position by Kay E. Osbourn, who serves as Citizens’ Executive Vice President, Chief Financial Officer and Chief Investment Officer. Ms. Osbourn was most recently the Company’s President. Since joining the Company in 2008, Ms. Osbourn has served in a number of management roles including Vice President, Internal Audit, Treasurer, Chief Financial Officer, President and Interim Chief Executive Officer. Ms. Osbourn has extensive experience in the insurance industry and with the Company.
Geoffrey M. Kolander, Citizens’ current Chief Executive Officer, succeeded Ms. Osbourn as President and now serves in both the role of President and Chief Executive Officer ("CEO") of Citizens, Inc.
On October 23, 2017, the Company hired Darin Moore as Interim Chief Information Officer ("CIO"). Mr. Moore comes to Citizens with 30 years of technology experience, including life insurance experience at Chubb Life America, Union Central Life, and AFLAC, Inc. During the last six years, he has served in interim leadership positions at various health insurance companies including interim CIO for Anthem’s Government Programs Division, supporting all of Anthem’s Medicaid, Medicare, and Federal Employee
4
Program business. Mr. Moore also served as Vice President of Consulting for Clearwater Compliance, a company focused on HIPAA compliance and cybersecurity. Mr. Moore brings Citizens’ expertise in technology, high volume call center operations, claims payment operations, cybersecurity, project leadership, and software implementation, having extensive experience directing these areas throughout his career.
On January 22, 2018, the Company announced its intention to pursue Board diversity. It further announced that Steve Shelton, age 62, independent director and member of the Nominating and Corporate Governance Committee, notified the Company of his intention not to stand for re-election as a director at the completion of his current one-year term, which will expire at the Company’s 2018 Annual Meeting of Shareholders. Mr. Shelton will continue to serve on the Company’s Board of Directors and the Nominating and Corporate Governance Committee until that time.
On February 12, 2018, the Company hired Jim Eliasberg as Vice President, Chief Legal Officer and Corporate Secretary. After graduating from the University of Chicago Law School in 1984, Jim has practiced in the business, transactional and corporate areas, dividing his career between private and in-house practice. Jim has extensive general counsel experience, having served in that role with Taco Cabana, WSNet and, most recently, with Golfsmith.
Strategic Initiatives
In 2015, we began a process to evaluate the expansion of our international footprint and initiated a strategic analysis of our current international business model. As a result of these strategic initiatives, on May 22, 2017, we incorporated CICA Life Ltd. in Bermuda, as a direct and wholly-owned subsidiary of the Company. On February 23, 2018, CICA Life Ltd. received its Class E, long term insurance license from the Bermuda Monetary Authority (“BMA”) and we capitalized the entity. Bermuda was chosen for its strong regulatory environment and suitability with the Company's priorities to protect our customers. We expect to operate our international business from this entity beginning in 2018 related to current and new business.
The Company's Board of Directors and new executive management team are continuing their assessment of the Company's domestic and international business models and business strategies with the assistance and support of external consultants and advisors. Specifically, our evaluation of the Company's international business model is ongoing under the leadership of our new Chief Marketing Officer and CEO. We are focused on (1) new products and our profitability in both the domestic and international markets of our Life Segment as well as our Homes Service Segment; (2) a potential restructuring of our international business and operations; (3) a strategic modernization and upgrade from our legacy technology systems and IT operations with a focus on digitization, our future business needs and cyber risk; (4) effectively operating our international life insurance business offshore in Bermuda through CICA Life, Ltd. (Bermuda); and (5) investment portfolio strategy assessment.
A prolonged low interest rate period has required us to reduce the benefits and dividends included under many policies offered internationally. In many cases, our policies provided significantly higher guarantees and dividends than the financial markets might otherwise offer. As such, the Company reduced discretionary dividends on existing international policies in 2016. In 2017, the Company created new repriced products sold internationally to better reflect the prolonged low interest rate environment that we face.
The Company reviews its investment strategies routinely to monitor the rate of return. By combining more conservative interest rate features in our insurance policies with a more diversified investment strategy to improve returns on our investment portfolio, we intend to grow bottom line returns to shareholders. There is risk that these changes will result in lower demand for new policies, or that the financial markets will make our investment strategy more difficult. Despite the risks, the Company believes that such strategies are in the best interest of our shareholders.
The following pages describe the operations of our two business segments: Life Insurance and Home Service Insurance. CICA Life Insurance Company of America ("CICA"), Citizens National Life Insurance Company ("CNLIC"), constitute the Life segment and Security Plan Life Insurance Company ("SPLIC"), Security Plan Fire Insurance Company ("SPFIC"), Magnolia Guaranty Life Insurance Company ("MGLIC"), comprise the Home Service segment. Revenues derived from any single customer did not exceed 10% of consolidated revenues in any of the last three years. For more information about the financial performance of our business segments, see “Note 8 - Segment and Other Operating Information” of the notes to consolidated financial statements.
5
Life Insurance
Our Life Insurance segment has historically marketed and issued ordinary whole life insurance in the United States and in U.S. dollar-denominated amounts to foreign residents. These contracts are designed to provide a fixed amount of insurance coverage over the life of the insured and can utilize rider benefits to provide additional increasing or decreasing coverage and annuity benefits to enhance accumulations. Additionally, endowment contracts are issued by the Company, which are principally accumulation contracts that incorporate an element of life insurance protection. For the majority of our business, we retain the first $100,000 of risk on any one life, reinsuring the remainder of the risk. We operate this segment through our subsidiaries: CICA Life Insurance Company of America ("CICA") and Citizens National Life Insurance Company ("CNLIC").
International Sales
We focus our sales of U.S. dollar-denominated ordinary whole life insurance and endowment policies to residents in Latin America and the Pacific Rim. As of
December 31, 2017
, we had insurance policies in force in more than
30
countries, including Colombia, Venezuela, Taiwan, Ecuador and Brazil as our top producing countries. Venezuela one of our top markets, has experienced significant economic and social turmoil recently that has negatively impacted our business in that region. New sales premiums decreased 48.6% from 2016 to 2017. However, renewals by existing policyholders in Venezuela were impacted less significantly with renewal premiums only declining 2.7% from 2016 to 2017. The country's ongoing economic struggles also have resulted in considerable population migration. The migrating population includes many current and prospective customers in our target market demographic profile and we do not anticipate these trends improving in the near term.
In
2017
, international direct premiums comprised approximately
95%
of total direct premiums in the life segment and
73%
of our total direct premiums, and exceeded
10%
of our premiums for each of the last three years. We have participated in the foreign marketplace since 1975. We believe positive attributes of our international insurance business include:
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larger face amount policies typically issued when compared to our U.S. operations, which results in lower administrative costs per unit of coverage;
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premiums typically paid annually rather than monthly or quarterly, which limits our administrative expenses, accelerates cash flow and results in lower policy lapse rates than premiums with more frequently scheduled payments; and
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persistency experience and mortality rates that are comparable to our U.S. policies.
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We have implemented several policies and procedures to limit the risks of asset and premium loss relating to our international business. Approvals for policy issuance are made in our Austin, Texas office and policies are issued and delivered to the independent consultants, who deliver the policies to the insureds. We have no offices, employees or assets outside of the United States other than the initial capital contribution of CICA Life Ltd. in Bermuda. Insurance policy applications and premium payments are submitted by the independent consultants or customers to us, and we review the applications in our home offices in Austin, Texas. Premiums are paid in U.S. dollars by check, wire or credit card. The policies we issue contain limitations on benefits for certain causes of death, such as homicide in certain high risk international countries. We have also developed disciplined underwriting criteria, which include medical reviews of applicants as well as background and reference checks. In addition, we have a claims policy that requires investigation of substantially all death claims. Furthermore, we perform background reviews and reference checks of prospective independent marketing firms and consultants.
Our independent marketing firms and consultants specialize in marketing life insurance products and generally have several years of insurance marketing experience. We maintain contracts with the independent marketing firms pursuant to which they provide recruitment, training and supervision of their managers and associates in the service and placement of our products. However, all associates of these firms also contract directly with us as independent contractors and receive their compensation directly from us. Accordingly, should an arrangement between any independent marketing firm and us be terminated for any reason, we expect that we would seek to continue the existing marketing arrangements with the associates of these firms. Our agreements with independent marketing firms and consultants typically provide that they are independent contractors responsible for their own operational expenses and are the representative of the prospective insured. In addition, the marketing firms guarantee any debts of their associates to us. The marketing firms receive commissions on all new and renewal policies serviced or placed by them or their associates. All of these contracts provide that the independent marketing firms and consultants are aware of and responsible for compliance with local laws.
6
International Products
We offer several ordinary whole life insurance and endowment products designed to meet the needs of our non-U.S. policyowners. These policies have been structured to provide:
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U.S. dollar-denominated cash values that accumulate to a policyholder during his or her lifetime;
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premium rates that are competitive with or better than most foreign local companies;
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a hedge against local currency inflation;
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protection against devaluation of foreign currency;
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capital investment in a more secure economic environment (i.e., the United States); and
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lifetime income guarantees for an insured or for surviving beneficiaries.
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Our international products have living benefit features. Every policy contains guaranteed cash values and is participating (i.e., provides for cash dividends as apportioned by the board of directors). Once a policyowner pays the annual premium and the policy is issued, the owner becomes entitled to policy cash dividends as well as annual premium benefits, if the annual premium benefit was elected. According to the policy language, the policyowner has several options with regard to the policy dividends and annual premium benefits. Any annual policy cash dividend may, at the option of the policyowner and provided the value of a dividend is not encumbered by a policy loan, be applied under one of the following options: (1) paid in cash to the policy owner; (2) credited toward payment of premiums on the policy; (3) left with the Company to accumulate at a defined interest rate; (4) applied to increase the amount of insurance benefit by purchase of paid-up additions to the policy; or (5) be assigned to a third party. If the policy is encumbered by a loan, only option 3 will apply to secure the outstanding loan. Similarly, all annual premium benefits credited to the policy may at the option of the policyowner, and provided the policy is not encumbered by a policy loan, be applied under one of the following options: (1) paid in cash to the policy owner; (2) credited toward payment of premiums on the policy; (3) left with the Company to accumulate at an annually company declared interest rate; or (4) be assigned to a third party. Likewise, if the policy is encumbered by a loan, only option (3) will apply to secure the outstanding loan. Under the “assigned to a third party” provision, the Company has historically allowed policyowners, only after receiving a copy of the Citizens, Inc. Stock Investment Plan (the “CISIP”) prospectus and acknowledging their understanding of the risks of investing in Citizens stock, the right to assign policy values outside of the policy to the CISIP, which is administered in the United States by Computershare, our plan administrator and transfer agent. The CISIP is a direct stock purchase plan available to our policyowners, our shareholders, our employees, our independent consultants, and other potential investors through the Computershare website. The Company has registered the shares of Class A common stock issuable to participants under the CISIP on a registration statement under the Securities Act of 1933, as amended (the "Securities Act") that is on file with the Securities and Exchange Commission. Computershare administers the CISIP in accordance with the terms and conditions of the CISIP, which is available on the Computershare website and as part of the Company’s registration statement on file with the Securities and Exchange Commission.
International Competition
The life insurance business is highly competitive. We compete with a large number of stock and mutual life insurance companies internationally and domestically, as well as with financial institutions that offer insurance products. There are more than 800 life insurance companies in the United States, some of which also provide insurance to foreign residents.
We face competition primarily from companies formed and operated in the country in which the insureds reside, from companies that operate in the same manner as we do and from companies that are foreign to the countries in which policies are sold, but issue insurance policies denominated in the local currency of those countries. A substantial number of companies may be deemed to have a competitive advantage over us due to their significantly greater financial resources, histories of successful operations and larger marketing forces.
Because premiums on our international policies are paid in U.S. dollars, and we pay claims and benefits in U.S. dollars, we provide a product that is different from the products offered by foreign-domiciled companies. We believe our international policies are usually acquired by individuals in the upper middle class in their respective countries and those with significant net worth and earnings that place them in the upper income brackets of their respective countries. The policies sold by our foreign competitors are generally offered broadly and are priced using the mortality of the entire population of the geographic region. Our mortality charges are typically lower due to our customer demographics, which provides a competitive advantage. Additionally, the assets backing the reserves for our foreign competitors' policies must be substantially invested in their respective countries and, therefore, are exposed to the inflationary risks and social or economic crises that have been more common in these foreign countries.
7
Domestic Sales
In
2017
, domestic direct premiums comprised approximately
5%
of total direct premiums in the life segment and
3%
of our total direct premiums. The majority of our domestic inforce business results from blocks of business of insurance companies we have acquired over the past
19
years. We discontinued new sales of our non-home service domestic products beginning January 1, 2017. These sales represented approximately 1% of total new business in 2016 for the life segment and is considered immaterial to our business. Under the direction of our new CMO, we are reviewing our domestic strategy.
Domestic Life Insurance Products
Our domestic life insurance products have historically focused primarily on living needs and provided benefits focused toward accumulating financial benefits for the policyowner. The features of our domestic life insurance products include:
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cash accumulation/living benefits;
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•
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tax-deferred interest earnings;
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•
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guaranteed lifetime income options;
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•
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monthly income for surviving family members;
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•
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accidental death benefit coverage options; and
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•
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an option to waive premium payments in the event of disability.
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Our life insurance products have historically been designed to address the insured's concern about outliving his or her monthly income, while at the same time providing death benefits. The primary purpose of our product portfolio is to help the insured create capital for needs such as retirement income, children's higher education funds, business opportunities, emergencies and health care needs.
Domestic Home Service Insurance
Our domestic Home Service segment operates through our subsidiaries Security Plan Life Insurance Company ("SPLIC"), Magnolia Guaranty Life Insurance Company ("MGLIC") and Security Plan Fire Insurance Company ("SPFIC"), and focuses on the life insurance needs of the middle and lower income markets, primarily in Louisiana, Mississippi and Arkansas. Our policies are sold and serviced through a home service marketing distribution system of approximately
307
employee-agents who work on a route system and through over
350
funeral homes and independent agents to sell policies, collect premiums and service policyholders. To a lesser extent, our Home Service segment sells limited liability, named peril property policies covering dwelling and contents. In
2017
, our Home Service segment comprised
24%
, or
$47.8 million
of our total direct premiums.
Home Service Products and Competition
Our home service insurance products consist primarily of small face amount ordinary whole life and pre-need policies, which are designed to fund final expenses for the insured, primarily consisting of funeral and burial costs. The average life insurance policy face amount issued was approximately
$6,800
in
2017
. Due to the lower risk associated with small face amount polices, the underwriting performed on these applications is limited. Our property coverages are limited to
$30,000
maximum coverage on any one dwelling and contents, while content-only coverage and dwelling-only coverage is limited to
$20,000
. We face competition in Louisiana, Mississippi and Arkansas from other companies specializing in home service distribution of insurance. We seek to compete based upon our emphasis on personal service to our customers. We intend to continue premium growth within this segment via direct sales and acquisitions.
Other Non-Insurance Operations
Other Non-insurance Operations includes Computing Technology, Inc., which provides data processing services to the Company, and Insurance Investors, Inc., which provided aviation transportation to the Company until the company-owned airplane was sold during 2017. This operating unit includes the results of Citizens, Inc., the parent Company.
Operations and Technology
Our administrative operations principally serve our life insurance segment and are conducted primarily at our executive offices in Austin, Texas through approximately
136
administrative, operating and underwriting personnel. Our Home Service operations are conducted to a large degree from our district offices in Louisiana, Arkansas and Mississippi, as well as our service center in
8
Donaldsonville, Louisiana. At our executive offices, we also perform policy design, marketing oversight, underwriting, accounting and reporting, actuarial, customer service, claims processing, administrative and investing activities.
We have a single integrated information technology system for our entire Company, which is a centrally-controlled, mainframe-based administrative system. Functions of our policy administrative system include policy set up, administration, billing and collections, commission calculation, valuation, automated data edits, storage backup, image management and other related functions. Each company we acquire is ultimately converted onto our administrative system. This system has been in place for more than 30 years and has been updated on an ongoing basis as technology has evolved.
We are currently reviewing technology options to transition from our legacy administration system to an upgraded, modernized technology platform that will service our needs into the future. On February 1, 2017, we went live with a modernized claims system. We are also currently converting our actuarial valuation from a third party service provider to an actuarial valuation modeling software system purchased from a vendor.
Enterprise Risk Management
The Company has an enterprise risk management function (“ERM”) that analyzes the Company’s risks on an individual and aggregated basis and is responsible for ensuring that the Company’s risks remain within its risk appetite and tolerances as determined by management with oversight from the Audit Committee. The Company's focus on ERM strengthens its risk management culture and discipline. The mission of ERM is to support the Company in achieving its strategic priorities by:
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Providing a comprehensive view of the risks facing the Company, including risk concentrations and correlations;
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•
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Helping management define the Company’s overall capacity and appetite for risk by evaluating the risk return profile of the business relative to the Company’s strategic intent and financial underpinning;
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•
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Assisting management in setting specific risk tolerances and limits that are measurable, actionable, and comply with the Company’s overall risk philosophy;
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•
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Communicating and monitoring the Company’s risk exposures relative to set limits and recommending, or implementing as appropriate, mitigating strategies; and
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•
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Providing insight to assist in growing the businesses and achieving optimal risk-adjusted returns within established guidelines.
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Enterprise Risk Management Structure and Governance
Effective risk oversight is an important priority for the Company’s Board of Directors and senior management team. While it is the job of the CEO and senior management to assess and manage the Company’s risk exposure through ERM, in accordance with NYSE requirements, the Audit Committee of the Board of Directors is charged with discussing guidelines and policies to govern the process by which ERM is handled. The Audit Committee periodically discusses the Company’s major financial risk exposures and the steps management has taken to monitor and control such exposures.
The five broad categories of risk exposures assessed and managed by senior management include, but are not limited to:
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Strategic risk, including international business risks;
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•
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Insurance risk, including those arising out of catastrophes and acts of terrorism;
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•
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Financial risk, including market, credit and liquidity risks;
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•
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Operational risk, including cybersecurity risk and legal and regulatory compliance risks; and
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•
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Any other risk that poses a material threat to the operational and/or strategic viability of the Company.
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In addition to the Audit Committee, the Compensation Committee considers the risks and rewards that may be implicated by our executive compensation philosophy and programs, and the Nominating and Corporate Governance Committee oversees the Company’s governance practices, director succession and committee composition and leadership to manage risks associated with corporate governance. Although risk oversight is conducted primarily through committees of the Board, the full Board has retained responsibility for general oversight of risks. The Board satisfies this responsibility through full reports by each committee chair regarding the committees’ considerations and actions, as well as through regular reports directly from officers responsible for oversight of particular risks within the Company.
9
Regulation
Our U.S. insurance operations are subject to a wide variety of laws and regulations. State insurance laws establish supervisory agencies with broad regulatory authority to regulate most aspects of our U.S. insurance businesses, and our insurance subsidiaries are regulated by the insurance departments of each state in which they are licensed. In addition, U.S. laws, such as the USA Patriot Act of 2001, the Foreign Corrupt Practices Act (“FCPA”), the Gramm-Leach-Bliley Act of 1999, the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Dodd-Frank Act") and the Tax Cuts and Jobs Act, are examples of U.S. regulations that affect our business. We are subject to comprehensive regulations under the USA Patriot Act and the Bank Secrecy Act with respect to money laundering, as well as federal regulations regarding privacy and confidentiality. Our insurance products and thus our businesses also are affected by U.S. federal, state and local tax laws. The Dodd-Frank Act focuses on financial reform and has resulted in changes to the regulation of institutions operating in the financial services industry, including the Company. Its requirements include streamlining the state-based regulation of reinsurance and non-admitted insurance (also known as surplus lines insurance, which is property or casualty insurance written by a company that is not licensed to sell policies of insurance in a given state) and establishing a new Federal Insurance Office ("FIO") within the U.S. Department of the Treasury with powers over all lines of insurance except health insurance, certain long-term care insurance and crop insurance. The FIO is authorized to, among other things, gather data and information to monitor aspects of the insurance industry, identify issues in the regulation of insurers about insurance matters and preempt state insurance measures under certain circumstances. However, the FIO’s limited monitoring abilities posed minimal risk to the insurance industry and the Dodd-Frank Act has had no significant impact on our business, results of operations, liquidity and capital resources. The rulemaking process going forward may change with the current presidential administration.
The purpose of the laws and regulations that affect our insurance business is primarily to protect our insureds and not our stockholders. Many of the laws and regulations to which we are subject are regularly re-examined, and existing or future laws and regulations may become more restrictive or otherwise adversely affect our operations. In addition, insurance regulatory authorities (including state law enforcement agencies and attorneys general) periodically make inquiries and regularly conduct examinations regarding compliance by us and our subsidiaries with insurance, and other laws and regulations regarding the conduct of our insurance businesses. It is our practice to fully and consistently cooperate with such inquiries and examinations and take corrective action when warranted.
Our insurance subsidiaries are collectively licensed to transact business in
32
states. We have insurance subsidiaries domiciled in the states of Colorado, Louisiana, Mississippi and Texas. Our U.S. insurance subsidiaries are licensed and regulated in all U.S. jurisdictions in which they conduct insurance business. The extent of this regulation varies, but most jurisdictions have laws and regulations based upon the National Association of Insurance Commissioners (“NAIC”) model rules governing the financial condition of insurers, including standards of solvency, types and concentration of investments, establishment and maintenance of reserves, credit for reinsurance and requirements of capital adequacy, and the business conduct of insurers, including marketing and sales practices and claims handling. In addition, statutes and regulations usually require the licensing of insurers and their agents, the approval of policy forms and related materials and the approval of rates for certain types of insurance products.
All U.S. jurisdictions in which our U.S. insurance subsidiaries conduct insurance business have enacted legislation that requires each U.S. insurance company in a holding company system, except captive insurance companies, to register with the insurance regulatory authority of its jurisdiction of domicile and to furnish that regulatory authority with financial and other information concerning the operations of, and the interrelationships and transactions among, companies within its holding company system that may materially affect the operations, management or financial condition of the insurers within the system. These laws and regulations also regulate transactions between insurance companies and their parents and affiliates. Generally, these laws and regulations require that all transactions within a holding company system between an insurer and its affiliates be fair and reasonable and that the insurer's statutory capital and surplus following any transaction with an affiliate be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. For certain types of agreements and transactions between an insurer and its affiliates, these laws and regulations require prior notification to, and non-disapproval or approval by, the insurance regulatory authority of the insurer's jurisdiction of domicile.
Generally, all foreign countries in which we offer insurance products require a license or other authority to conduct insurance business in that country. Some of these countries also require that local regulatory authorities approve the terms of any insurance product sold to residents of that country. We have never qualified to do business in any foreign country and have never submitted our insurance policies issued to residents of foreign countries for approval by any foreign or domestic insurance regulatory agency. We sell our policies to residents of foreign countries using foreign independent marketing firms and independent consultants, and we rely on our independent consultants to comply with laws applicable to them in marketing our insurance products in their
10
respective countries. We have undertaken a comprehensive compliance review of risks associated with the potential application of foreign laws to our sales of insurance policies in foreign countries. The application of foreign laws to our sales of insurance policies in foreign countries varies by country. There is a lack of uniform regulation, lack of clarity in certain regulations and lack of legal precedent in addressing circumstances similar to ours. Our compliance review has confirmed the previously disclosed risks related to foreign insurance laws associated with our current business model, at least in certain jurisdictions, as described in detail in “Item 1A - Risk Factors - Risks Relating to our Business.” We are exploring alternatives to our current business model in one or more jurisdictions, including withdrawing from particular markets. We cannot assure you that any of these laws, regulations, or application of them by foreign regulatory authorities, or any change in our business model, will not have a material adverse effect on our ability to market our products through our independent marketing consultants and, in turn, on our results of operations and financial condition.
The payment of dividends or other distributions to us by our insurance subsidiaries is regulated by the insurance laws and regulations of their respective state or country of domicile. The laws and regulations of some of these jurisdictions also prohibit an insurer from declaring or paying a dividend except out of its earned surplus or require the insurer to obtain regulatory approval before it may do so. In addition, insurance regulators may prohibit the payment of ordinary dividends or other payments by our insurance subsidiaries to us (such as a payment under a tax sharing agreement or for employee or other services) if they determine such payment could be adverse to policyholders or insurance contract holders of the subsidiary.
The laws and regulations of the jurisdictions in which our U.S. insurance subsidiaries are domiciled require that a controlling party obtain the approval of the insurance commissioner of the insurance company's jurisdiction of domicile prior to acquiring control of the insurer and may delay, deter or prevent a transaction our shareholders might consider desirable.
Risk-based capital ("RBC") requirements are imposed on life and property and casualty insurance companies. The NAIC has established minimum capital requirements in the form of RBC. RBC requirements weight 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 would be required by the affected company, including submitting a capital plan to the Department of Insurance in the insurance company's state of domicile.
Item 1A.
RISK FACTORS
Investing in our Company involves certain risks.
Set forth below are certain risks with respect to our Company. Readers should carefully review these risks, together with the other information contained in this report. The risks and uncertainties we have described in this report are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently deem not material, may also adversely affect our business. Any of the risks discussed in this report or that are presently unknown or not material, if they were to actually occur, could result in a significant adverse impact on our business, operating results, prospects or financial condition. References in the risk factors below to "we," "us," "our," "Citizens" and like terms relate to Citizens, Inc. and its subsidiaries on a U.S. GAAP consolidated financial statement basis, unless specifically identified otherwise. We operate our subsidiaries as separate and distinct entities with respect to corporate formalities.
Risks Relating to Our Business
The majority of our sales derive from residents of foreign countries and is subject to risks associated with political instability, currency control laws and foreign insurance laws. A significant loss of sales in these foreign markets could have a material adverse effect on our results of operations and financial condition.
The majority of our direct premiums, approximately
73%
in
2017
, are from foreign countries, primarily those in Latin America and the Pacific Rim. These sales are made through independent consultants who are located in these foreign countries. Many of these countries have a history of political instability, including regime changes, political uprisings, currency fluctuations and anti-democratic or anti-U.S. policies. There is a risk that political instability in these countries could have a material adverse effect on the ability of people living in these countries to purchase our insurance policies or our ability to sell our policies in those countries through our independent consultants or otherwise. Our Company’s future sales and financial results depend upon avoiding significant regulatory restraints on receiving insurance policy applications and premiums from, and issuing insurance policies to, residents outside of the United States.
11
Currency control laws or other currency exchange restrictions in foreign countries could materially adversely affect our revenues by imposing restrictions on asset transfers outside of a country where our insureds reside. Difficulties in transferring funds from or converting currencies to U.S. dollars in certain countries could prevent our insureds in those countries from purchasing or paying premiums on our policies. There can be no assurance that such restrictions will not be imposed and that our revenues, results of operations and financial condition will not be materially adversely affected if they do occur.
We also face risks associated with the application of foreign laws to our sales of policies to residents in foreign countries. Generally, all foreign countries in which we offer insurance products require a license or other authority to conduct insurance business in that country. Some of these countries also require that local regulatory authorities approve the terms of any insurance product sold to residents of that country. We have never sought to qualify to do business in any foreign country and have never submitted the insurance policies that we issue to residents of foreign countries for approval by any foreign or domestic insurance regulatory agency. Traditionally, we have sought to address risks associated with the potential application of foreign laws to our sales of insurance policies in our foreign markets by, among other things, not locating any of our offices or assets in foreign countries, selling policies only through independent consultants rather than our own employees, requiring that all applications for insurance be submitted to and accepted only in our offices in the U.S., and requiring that policy premiums be paid to us only in U.S. Dollars. We rely on our independent consultants to comply with laws applicable to them in marketing our insurance products in their respective countries.
We have undertaken a comprehensive compliance review of risks associated with the potential application of foreign laws to our sales of insurance policies in foreign countries. The application of foreign laws to our sales of insurance policies in foreign countries varies by country. There is a lack of uniform regulation, lack of clarity in certain regulations and lack of legal precedent addressing circumstances similar to ours. Our compliance review has confirmed the previously disclosed risks related to foreign insurance laws associated with our current business model, at least in certain foreign countries. There are risks that a foreign government could determine under its existing laws that its residents may not purchase life insurance from us unless we become qualified to do business in that country or unless our policies purchased by its residents receive prior approval from its insurance regulators. There also is a risk that foreign regulators may become more aggressive in enforcing any perceived violations of their laws and seek to impose monetary fines, criminal penalties, and/or order us to cease our sales in that jurisdiction. There is no assurance that, if a foreign country were to deem our sales of policies in that country to require that we qualify to do business in that country or submit our policies for approval by that country’s regulatory authorities, we would be able to, or would conclude that it is advisable to, comply with those requirements. Any determination by a foreign country that we or our policy sales are subject to regulation under their laws, or any actions by a foreign country to enforce such laws more aggressively, could therefore have a material adverse effect on our ability to sell policies in that country and, in turn, on our results of operations and financial condition. We are exploring alternatives to our current business model in one or more jurisdictions, including withdrawing from particular markets.
Any disruption to the marketing and sale of our policies to residents of a foreign country, resulting from the action of foreign regulatory authorities or otherwise, could have a material adverse effect on our results of operations and financial condition.
Our operating results and financial condition may be affected if the liabilities actually incurred differ, or if our estimates of those liabilities change, from the amounts we have reserved for in connection with the noncompliance of a portion of our life insurance policies with Section 7702 of the Internal Revenue Code and the failure of certain annuity contracts to qualify under Section 72(s) of the Internal Revenue Code.
We previously announced that we determined that a portion of the life and annuity insurance policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code ("IRC") of 1986. We may be liable to the IRS for failure to withhold taxes or to tax report on IRS information returns and payee statements. We have undertaken an analysis of our potential liability to the IRS arising from this matter, as well as other expenses we may incur to remediate (i.e., conform to the requirements of the IRS) certain previously issued domestic life insurance and annuity policies and to address any missed reporting and withholding for policies issued to non-U.S. citizens and have established a best estimate reserve of $
12.3
million, net of tax as of
December 31, 2017
for probable liabilities and expenses. The probability weighted range of financial estimates relative to this issue is
$5.9 million
to
$48.2 million
, net of tax. This estimated range includes projected toll charges and fees payable to the IRS, as well as estimated increased payout obligations to current holders of non-compliant domestic life insurance policies expected to result from remediation of those policies. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, the methodology applicable to the calculation of toll charges for non-compliant policies and the amount of time and resources we will require from external advisors who are assisting us with resolving these issues. Given the range of potential outcomes and the
12
significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and also could exceed the high end of our estimated range of liabilities and expenses. To the extent the amount reserved is insufficient to meet the actual amount of our liabilities and expenses, or if our estimates of those liabilities and expenses change in the future, our financial condition and results of operations may be materially adversely affected.
On May 17, 2017, we submitted an offer to enter into Closing Agreements with the IRS covering the CICA and CNLIC domestic life insurance business. The toll charges calculated and enumerated in the Closing Agreements totaled $124,000 and $4,000 for the CICA and CNLIC domestic life insurance businesses, respectively.
We expect to submit offers to enter into Closing Agreements with the IRS for the SPLIC and MGLIC life insurance business and for the CICA international business and our annuity business in 2018.
The new CICA Life Ltd. (Bermuda) will be subject to extensive government regulation by the Bermuda Monetary Authority (“BMA”), which is a new regulatory regime for the Company. Regulation by the BMA, is subject to change and may increase our costs of doing business, restrict the conduct of our business and negatively impact our results of operations, liquidity and financial condition.
For over 40 years, the Company’s life insurance subsidiaries have been regulated in the U.S. by the state insurance departments of their states of domicile. In 2018, CICA Life Ltd. will be subject to extensive regulation and supervision by the BMA in jurisdictions where we do business, including global insurance regulations, tax, financial services, privacy, anti-money laundering, bank secrecy, anti-corruption and foreign asset control laws. Bermuda insurance company regulation is generally designed to protect the interests of policyholders, with substantially lesser protections to shareholders of the regulated insurance companies. To that end, the BMA has broad powers to regulate business activities of CICA Life Ltd, mandate capital and surplus requirements, regulate trade and claims practices and require strong enterprise risk management and corporate governance activities. The Company has no prior experience operating in a foreign jurisdiction and limited experience with regulation by the BMA.
We face financial, liquidity and capital market risks in our operations.
As an insurance holding company with significant investment exposure, we face material financial and capital markets risk in our operations. Due to the low interest rate environment in recent years, we experienced significant call activity on our fixed income portfolio that decreased our investment yields compared to prior years. We also have recorded other-than-temporary impairments in the past several years due to credit related market declines and equity market volatility.
We face potential liquidity risks if policyholders with mature policies elect to receive lump sum distributions at greater levels than anticipated. Our whole life and endowment products provide the policyholder with alternatives once the policy matures. The policyholder can choose to take a lump sum payout or leave the money on deposit at interest with the Company. The Company has a significant amount of endowment products representing approximately
45.9%
of total inforce with older contracts sold historically that will begin reaching their maturities over the next several years and policyholder election behavior is not known. If policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Meeting these distributions could require the Company to sell securities at inopportune times to pay policyholder withdrawals. Alternatively, if the policyholder were to leave the money on deposit with the Company at interest, our profitability could be negatively impacted if the product guaranteed rate is higher than the current market rate we can earn on our investments.
A large portion of our debt security investment portfolio will mature in the next seven years and could be called sooner as we were subject to significant call activity beginning in 2009 due to the declining interest rate environment and we reinvested into shorter durations that are now approaching maturity. We will need to reinvest these maturing funds in the current interest rate environment. Our profitability could be negatively impacted depending on the market rates at the time of reinvestment. This could result in a decrease in our spread between our policy liability crediting rates and our investment earned rates. This could also negatively impact our liquidity.
Changes in market interest rates may significantly affect our profitability.
Some of our products, principally traditional whole life insurance with annuity riders, expose us to the risk that changes in interest rates will reduce our "spread," or the difference between the amounts we are required to pay under our contracts to policyholders and the rate of return we are able to earn on our investments intended to support obligations under the contracts. Our spread is an integral component of our net income.
13
If interest rates decrease or remain at low levels, we may be forced to reinvest proceeds from investments that have matured, prepaid, been sold, or called at lower yields, reducing our investment margin. Our fixed income bond portfolio is exposed to interest rate risk as approximately 55% of the portfolio is callable. Lowering our interest crediting rates can help offset decreases in investment margins on some of our products. However, our ability to lower these rates could be limited by competition or contractually guaranteed minimum rates, and may not match the timing or magnitude of changes in asset yields.
An increase in interest rates will decrease the net unrealized gain position of our investment portfolio and may subject us to disintermediation risk. Disintermediation risk is the risk that in a change from a low interest rate period to a significantly higher and increasing interest rate period, policyholders may surrender their policies or make early withdrawals in order to increase their returns, requiring us to liquidate investments in an unrealized loss position (i.e. the market value less the carrying value of the investments). This risk is discussed further in the two risk factors below.
Our investment portfolio is subject to various risks that may result in realized investment losses. In particular, decreases in the fair value of fixed maturities may significantly reduce the value of our investments, and as a result, our financial condition may suffer.
We are subject to credit risk in our investment portfolio. Defaults by third parties in the payment or performance of their obligations under these securities could reduce our investment income and realized investment gains or result in the recognition of investment losses. The value of our investments may be materially adversely affected by increases in interest rates, downgrades in the bonds included in our portfolio and by other factors that may result in the recognition of other-than-temporary impairments. Each of these events may cause us to reduce the carrying value of our investment portfolio.
In particular, at
December 31, 2017
, fixed maturities represented
$1,208.6 million
or
92.5%
of our total investments of
$1,306.1 million
. The fair value of fixed maturities and the related investment income fluctuates depending on general economic and market conditions. The fair value of these investments generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us will generally increase or decrease in line with changes in market interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate fluctuations. An investment has prepayment risk when there is a risk that the timing of cash flows resulting from the repayment of principal might occur earlier than anticipated because of declining interest rates or later than anticipated because of rising interest rates. The impact of value fluctuations affects our consolidated financial statements, as a large portion of our fixed maturities are classified as available-for- sale, with changes in fair value reflected in our stockholders' equity (accumulated other comprehensive income or loss). No similar adjustment is made for liabilities to reflect a change in interest rates. Therefore, interest rate fluctuations and economic conditions could adversely affect our stockholders' equity, total comprehensive income and/or cash flows. Although at
December 31, 2017
, approximately
97.2%
of our fixed maturities were investment grade with
75.2%
rated A or above, all of our fixed maturities are subject to credit risk. If any of the issuers of our fixed maturities suffer financial setbacks, the ratings on the fixed maturities could be downgraded (with a concurrent decrease in fair value) and, in a worst-case scenario, the issuer could default on its financial obligations. If the issuer defaults, we could have realized losses associated with the impairment of the securities.
Valuation of our investments and the determination of whether a decline in the fair value of our invested assets is other-than-temporary are based on estimates that may prove to be incorrect.
U.S. GAAP requires that when the fair value of any of our invested assets declines and the decline is deemed to be other-than-temporary, we recognize a loss in either other comprehensive income or in our statement of income based on certain criteria in the period for which the determination is made. The determination of the fair value of certain invested assets, particularly those that do not trade on a regular basis, requires an assessment of available data and the use of assumptions and estimates. Once it is determined that the fair value of an asset is below its carrying value, we must determine whether the decline in fair value is other-than-temporary, which is based on subjective factors and involves a variety of assumptions and estimates.
There are risks and uncertainties associated with determining whether declines in market value are other-than-temporary. These include significant changes in general economic conditions and business markets, trends in certain industry segments, interest rate fluctuations, rating agency actions, changes in significant accounting estimates and assumptions and legislative actions. In the case of mortgage- and asset-backed securities, there is added uncertainty as to the performance of the underlying collateral assets. To the extent that we are incorrect in our determination of the fair value of our investment securities or our determination that a decline in their value is other-than-temporary, we may realize losses that never actually materialize or may fail to recognize losses within the appropriate reporting period.
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Gross unrealized losses on fixed maturity and equity securities may be realized or result in future impairments, resulting in a reduction in our net income.
Fixed maturity and equity securities classified as available-for-sale are reported at fair value. Unrealized gains and losses on available-for-sale securities are recognized as a component of other comprehensive income (loss) and are, therefore, excluded from our net income. Our total gross unrealized losses on our available-for-sale securities portfolio at
December 31, 2017
were $
3.1 million
. The accumulated change in estimated fair value of these securities is recognized in net income when the gain or loss is realized upon sale of the security or in the event that the decline in estimated fair value is determined to be other-than-temporary and an impairment charge to earnings is taken. Realized losses or impairments may have a material adverse effect on our net income in a particular quarterly or annual period.
Our actual claims losses may exceed our reserves for claims, and we may be required to establish additional reserves, which in turn may adversely impact our results of operations and financial condition.
We maintain reserves to cover our estimated exposure for claims relating to our issued insurance policies. Reserves, whether calculated under U.S. GAAP or statutory accounting practices prescribed by various state insurance regulators, do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections, of what we expect claims will be based on mortality assumptions that are determined by various regulatory authorities. Many reserve assumptions are not directly quantifiable, particularly on a prospective basis. In addition, when we acquire other domestic life insurance companies, our assessment of the adequacy of acquired policy liabilities is subject to our estimates and assumptions. Reserve estimates are refined as experience develops, and adjustments to reserves are reflected in our statements of operations for the period in which such estimates are updated. Because establishing reserves is an inherently uncertain process involving estimates of future losses, future developments may require us to increase policy benefit reserves, which may have a material adverse effect on our results of operations and financial condition in the periods in which such increases occur.
Unanticipated increases in early policyholder withdrawals or surrenders could negatively impact liquidity.
A primary liquidity concern is the risk of unanticipated or extraordinary early policyholder withdrawals or surrenders. Our insurance policies include provisions, such as surrender charges, that help limit and discourage early withdrawals, and we track and manage liabilities and attempt to align our investment portfolio to maintain sufficient liquidity to support anticipated withdrawal demands. However, early withdrawal and surrender levels may differ from anticipated levels for a variety of reasons, including changes in economic conditions, changes in policyholder behavior or financial needs, changes in relationships with our independent consultants, changes in our claims-paying ability, or increases in surrenders among policies that have been in force for more than fifteen years and are no longer subject to surrender charges. Any of these occurrences could adversely affect our liquidity, profitability and financial condition.
While we own a significant amount of liquid assets, a certain portion of investment assets are relatively illiquid. If we experience unanticipated early withdrawal or surrender activity, we could exhaust all other sources of liquidity and be forced to obtain additional financing or liquidate assets, perhaps on unfavorable terms. The availability of additional financing will depend on a variety of factors, such as market conditions, the availability of credit in general or more specifically in the insurance industry, the strength or weakness of the capital markets, the volume of trading activities, our credit capacity, and the perception of our long- or short-term financial prospects if we incur large realized or unrealized investment losses or if the level of business activity declines due to a market downturn. If we are forced to dispose of assets on unfavorable terms, it could have an adverse effect on our liquidity, results of operations and financial condition.
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Catastrophes may adversely impact liabilities for policyholder claims and reinsurance availability.
Our insurance operations are exposed to the risk of catastrophic events. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes, earthquakes, tsunamis and man-made catastrophes may produce significant damage or loss of life in larger areas, especially those that are heavily populated. Claims resulting from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. In addition, catastrophic events could harm the financial condition of issuers of obligations we hold in our investment portfolio, resulting in impairments to these obligations, and the financial condition of our reinsurers, thereby increasing the probability of default on reinsurance recoveries. Large-scale catastrophes may also reduce the overall level of economic activity in affected countries, which could hurt our business and the value of our investments or our ability to sell new policies.
Our life insurance operations are exposed to the risk of catastrophic mortality, such as a pandemic or other event that causes a large number of deaths, especially if concentrated in our top foreign markets. A significant pandemic could have a major impact on the global economy or the economies of particular countries or regions, including travel, trade, tourism, the health system, food supply, consumption, overall economic output and, eventually, on the financial markets. In addition, a pandemic that affected our employees, our policyholders, our independent consultants or other companies with which we do business could disrupt our business operations. The effectiveness of external parties, including governmental and non-governmental organizations, in combating the spread and severity of such a pandemic could have a material impact on the losses experienced by us. These events could cause a material adverse effect on our results of operations in any period and, depending on their severity, could also materially and adversely affect our financial condition.
We may be required to accelerate the amortization of deferred acquisition costs and the costs of customer relationships acquired, which would increase our expenses and adversely affect our results of operations and financial condition.
At
December 31, 2017
, we had
$167.1 million
of deferred policy acquisition costs, or DAC. DAC represents costs that vary with and are directly related to the successful sale and issuance of our insurance policies and are deferred and amortized over the estimated life of the related insurance policies. These costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material costs and some support costs, such as underwriting and contract and policy issuance expenses. Under U.S. GAAP for our type of insurance products, DAC is amortized over the premium-paying period of the policies.
In addition, when we acquire a block of insurance policies, we assign a portion of the purchase price to the right to receive future net cash flows from existing insurance and investment contracts and policies. This intangible asset, called the cost of customer relationships acquired, or CCRA, represents the actuarially estimated present value of future cash flows from the acquired policies. At
December 31, 2017
, we had
$17.5 million
of CCRA. We amortize the value of this intangible asset in a manner similar to the amortization of DAC.
The amortization of DAC and CCRA is subject to acceleration and generally depends upon anticipated profits from investments, surrender and other policy charges, mortality, morbidity, persistency and maintenance expense margins. For example, if our insurance policy lapse and surrender rates were to exceed the assumptions upon which we priced our insurance policies, or if actual persistency proves to be less than our persistency assumptions, especially in the early years of a policy, we might be required to accelerate the amortization of expenses we deferred in connection with the acquisition of the policy. We regularly review the quality of our DAC and CCRA to determine if they are recoverable from future income. If these costs are not recoverable, the amount that is not recoverable is charged to expenses in the financial period in which we make this determination.
Unfavorable experience with regard to expected expenses, investment returns, surrender and other policy charges, mortality, morbidity, lapses or persistency may cause us to increase the amortization of DAC or CCRA, or both, or to record a current period expense to increase benefit reserves, any of which could have a material adverse effect on our results of operations and financial condition.
We may be required to recognize an impairment on the value of our goodwill, which would increase our expenses and materially adversely affect our results of operations and financial condition.
Goodwill represents the excess of the amount paid by us to acquire various life insurance companies over the fair value of their net assets at the date of the acquisition. Under U.S. GAAP, we test the carrying value of goodwill for impairment at least annually at the "reporting unit" level, which is either an operating segment or a business that is one level below the operating
16
segment. Goodwill is impaired if its carrying value exceeds its implied fair value. This may occur for various reasons, including changes in actual or expected earnings or cash flows of a reporting unit, generation of earnings by a reporting unit at a lower rate than similar businesses or declines in market prices for publicly traded businesses similar to our reporting units. If any portion of our goodwill becomes impaired, we would be required to recognize the amount of the impairment as a current-period expense, which could have a material adverse effect on our results of operations and financial condition. In 2017, we recognized a goodwill impairment of $4.6 million on our Home Service Segment. Goodwill in our consolidated financial statements was
$12.6 million
as of
December 31, 2017
.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations based on assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections.
Our conversion to a new actuarial valuation system is not yet complete and contains known uncertainties that could result in identification of additional errors in our financial reporting.
The Company is in the process of converting its actuarial valuation from a third party service provider to an actuarial valuation modeling software system purchased from a vendor. In connection with our ongoing actuarial valuation conversion, certain legacy system immaterial errors were discovered in both 2017 and 2016. As we complete this validation and conversion, we could identify additional differences that will be evaluated for financial reporting purposes. The conversion to the new system is expected to be completed in 2018.
We are a defendant in lawsuits, which may adversely affect our financial condition and detract from the time our management is able to devote to our business, and we are subject to risks related to litigation and regulatory matters.
From time to time we are, and have been, subject to a variety of legal and regulatory actions and investigations relating to our business operations, including, but not limited to:
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disputes over insurance coverage or claims adjudication;
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regulatory compliance with state laws, including insurance and securities regulations;
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regulatory compliance with U.S. federal securities laws, tax, anti-money laundering, bank secrecy, anti-bribery, anti-corruption and foreign asset control laws, among others;
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disputes with our independent marketing firms, independent consultants and employee-agents over compensation, termination of contracts, noncompliance with applicable laws and regulations and related claims;
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disputes regarding our tax liabilities;
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disputes relating to reinsurance and coinsurance agreements; and
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disputes relating to businesses acquired and operated by us.
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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 attorneys' fees, other direct litigation costs and the expenditure of substantial amounts of management time that otherwise would be devoted to our business. Further, 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.
As noted above, and as disclosed in prior periods, the legal and regulatory actions facing the Company include those relating to compliance with U.S. federal securities laws. Specifically, the Company has been the subject of an investigation by the Securities and Exchange Commission (“SEC”), which appears to be focused on the Company’s internal control over financial reporting and disclosure controls and procedures in light of the Company’s determination in 2015 that a portion of the life insurance and annuity policies issued by its subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code of 1986. There have been no allegations of fraud presented by the SEC. We have cooperated fully with the investigation and expect that the matter will be resolved soon, although we cannot predict the timing of a resolution or the ultimate outcome of the investigation.
17
Reinsurers with which we do business could increase their premium rates and may not honor their obligations, leaving us liable for the reinsured coverage.
We reinsure certain risks underwritten by our various insurance subsidiaries. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase. The high cost of reinsurance or lack of affordable coverage could adversely affect our results of operations and financial condition.
Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and, even if highly desirable or necessary, we may not be able to obtain replacement reinsurance facilities in adequate amounts or at rates economic to us. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling or unable to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. In addition, our reinsurance facilities may be canceled for new business, pursuant to their terms, upon the occurrence of certain specified events, including a change of control of our Company (generally defined as the acquisition of 10% or more of our voting equity securities) or the failure of our insurance company subsidiaries to maintain the minimum required levels of statutory surplus. Any of these potential developments could materially adversely affect our revenues, results of operations and financial condition.
In
2017
, we reinsured
$503.7 million
of the face amount of our life insurance policies. Amounts reinsured in
2017
represented
10.1%
of the face amount of direct life insurance in force in that year. Although the cost of reinsurance is, in some cases, reflected in premium rates, under certain reinsurance agreements, the reinsurer may increase the rate it charges us for reinsurance. If our cost of reinsurance were to increase, we might not be able to recover these increased costs, and our results of operations and financial condition could be materially adversely affected. See Note 5 to the Company's consolidated financial statements.
Our international markets face significant competition. If we are unable to compete effectively in our markets, our business, results of operations and profitability may be adversely affected.
Our international marketing plan focuses on making available U.S. dollar-denominated life insurance products to individuals residing in more than
30
countries. New competition could increase the supply of available insurance, which could adversely affect our ability to price our products at attractive profitable rates and thereby adversely affect our revenues, results of operations and financial condition. Existing barriers to entry in the foreign markets we serve may not be sufficient to impede potential competitors from entering such markets. In connection with our business with foreign nationals, we experience competition primarily from the following sources, many of which have substantially greater financial, marketing and other resources than we have:
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Foreign operated companies with U.S. dollar-denominated policies. We face direct competition from companies that operate in the same manner as we operate in our international markets.
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Another group of our competitors in the international marketplace consists of foreign operated companies that have locally operated subsidiaries that offer both local jurisdiction regulated products in local currency and off-shore U.S. dollar-denominated policies. This arrangement creates competition in that the U.S. dollar-denominated policies are offered in conjunction with high-need local insurance policies such as health insurance.
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Local currency policies provide the benefit of assets located in the country of foreign residents, but entail risks of uncertainty due to local currency fluctuations, as well as the perceived instability and weakness of local currencies.
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Locally operated companies with local currency policies. We compete with companies formed and operated in the country in which our foreign insureds reside. Generally, these companies are subject to risks of currency fluctuations, and they primarily use mortality tables based on experience of the local population as a whole. These mortality tables are typically based on significantly shorter life spans than those we use. As a result, the cost of insurance from these companies tends to be higher than ours. Although these companies typically market their policies to a broader section of the population than do our independent marketing firms and independent consultants, there can be no assurance that these companies will not endeavor to place a greater emphasis on our target market and compete more directly with us.
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In addition, from time to time, companies enter and exit the markets in which we operate, thereby increasing competition at times when there are new entrants. We may lose business to competitors offering competitive products at lower prices, or for other reasons.
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There can be no assurance that we will be able to compete effectively in any of our markets. If we do not, our business, results of operations and financial condition will be materially adversely affected.
Sales of our insurance products could decline if we are unable to (i) establish and maintain commercial relationships with independent marketing firms and independent consultants, (ii) attract and retain employee agents or (iii) develop and maintain our distribution sources.
We distribute our insurance products through several distribution channels, including independent marketing firms, independent consultants and our employee agents. These relationships are significant for both our revenues and our profits. In our life insurance segment, we depend almost exclusively on the services of independent marketing firms and independent consultants. In our home service insurance segment, we depend on employee agents whose role in our distribution process is integral to developing and maintaining relationships with policyholders. Significant competition exists among insurers in attracting and maintaining marketers of demonstrated ability. Some of our competitors may offer better compensation packages for marketing firms, independent consultants and agents and broader arrays of products and have a greater diversity of distribution resources, better brand recognition, more competitive pricing, lower cost structures and greater financial strength or claims paying ratings than we do. We compete with other insurers for marketing firms, independent consultants and employee agents primarily on the basis of our compensation and support services. Any reduction in our ability to attract and retain effective sales representatives could materially adversely affect our revenues, results of operations and financial condition.
There may be adverse tax, legal or financial consequences if our sales representatives are determined not to be independent contractors.
Our international sales representatives are independent contractors who operate their own businesses. Although we believe that we have properly classified our representatives as independent contractors, there is nevertheless a risk that the IRS, a foreign agency, a court or other authority will take the different view that our sales representatives should be treated like employees. Furthermore, the tests governing the determination of whether an individual is considered to be an independent contractor or an employee are typically fact-sensitive and vary from jurisdiction to jurisdiction. Laws and regulations that govern the status and misclassification of independent sales representatives are subject to change or interpretation.
If there is a change in the manner in which our independent contractors are classified or an adverse determination with respect to some or all of our independent contractors by a court or governmental agency, we could incur significant costs in complying with such laws and regulations, including in respect of tax withholding, social security payments, government and private pension plan contributions and recordkeeping, or we may be required to modify our business model, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, there is the risk that we may be subject to significant monetary liabilities arising from fines or judgments as a result of any such actual or alleged non-compliance with applicable federal, state, local or foreign laws.
We are subject to extensive governmental regulation in the United States, which is subject to change and may increase our costs of doing business, restrict the conduct of our business and negatively impact our results of operations, liquidity and financial condition.
We are subject to extensive regulation and supervision in U.S. jurisdictions where we do business, including state insurance regulations and U.S. federal securities, tax, financial services, privacy, anti-money laundering, bank secrecy, anti-corruption and foreign asset control laws. Insurance company regulation is generally designed to protect the interests of policyholders, with substantially lesser protections to shareholders of the regulated insurance companies. To that end, all the states in which we do business have insurance regulatory agencies with broad legal powers with respect to licensing companies to transact business; mandating capital and surplus requirements; regulating trade and claims practices; approving policy forms; and restricting companies' ability to enter and exit markets.
The capacity for an insurance company's growth in premiums is partially a function of its required statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by statutory accounting practices prescribed or permitted by a company's state of domicile, is considered important by all state insurance regulatory authorities. Failure to maintain required levels of statutory surplus could result in increased regulatory scrutiny and enforcement action by regulatory authorities.
Most insurance regulatory authorities have broad discretion to grant, renew, suspend and revoke licenses and approvals, and could preclude or temporarily suspend us from carrying on some or all of our activities, including acquisitions of other insurance companies, require us to add capital to our insurance company subsidiaries, or fine us. If we are unable to maintain all required licenses and approvals, or if our insurance business is determined not to comply fully with the wide variety of applicable laws and
19
regulations and their interpretations, including the USA Patriot Act, our revenues, results of operations and financial condition could be materially adversely affected.
Our failure to maintain effective information systems could adversely affect our business.
We must maintain and enhance our existing information systems and develop new information systems in order to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards and changing customer preferences. If we do not maintain adequate systems, we could experience adverse consequences, including products acquired through acquisition, inadequate information on which to base pricing, underwriting and reserve decisions, regulatory problems, failure to meet prompt payment obligations, increases in administrative expenses and loss of customers.
Some of our information technology systems and software are mainframe-based, legacy-type systems that require an ongoing commitment of resources to maintain current standards. Our systems utilize proprietary code requiring highly skilled personnel. Due to the unique nature of our proprietary operating environment, we could have difficulty finding personnel with the skills required to provide ongoing system maintenance and development as we seek to keep pace with changes in our products and business models, information processing technology, evolving industry and regulatory standards and policyholder needs. Our success is dependent upon, among other things, maintaining and enhancing the effectiveness of existing systems, as well as continuing to integrate, develop and enhance our information systems to support business processes in a cost-effective manner.
Our failure to maintain effective and efficient information systems, or our failure to efficiently and effectively consolidate our information systems to eliminate redundant or obsolete applications, could have a material adverse effect on our results of operations and financial condition.
Failures of disclosure controls and procedures and internal control over financial reporting could materially and adversely affect our business, financial condition and results of operations, impair our ability to timely file reports with the SEC and subject us to litigation and/or regulatory scrutiny and penalties.
We maintain disclosure controls and procedures designed to ensure that we timely report information as specified in SEC rules and regulations. We also maintain a system of internal control over financial reporting. However, these controls may not achieve, and in some cases have not achieved, their intended objectives. Control processes that involve human diligence and oversight, such as our disclosure controls and procedures and internal control over financial reporting, are subject to human error. Controls that rely on models may be subject to inadequate design or inaccurate assumptions or estimates. Controls also can be circumvented by improper management override of such controls. Because of such limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected, and that information may not be reported on a timely basis. The failure of our controls to be effective could have a material adverse effect on our business, financial condition, results of operations and the market for our common stock, and could subject us to litigation, regulatory scrutiny and/or penalties.
As disclosed in Part II, Item 9A of this Annual Report on Form 10-K, we have identified control deficiencies in our disclosure controls and financial reporting process that constitute material weaknesses and for which remediation is still in process as of December 31, 2017. If we fail to design effective controls, fail to remediate control deficiencies or fail to otherwise maintain effective internal controls over financial reporting in the future, such failures could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors to lose confidence in our financial statements, have a negative effect on the trading price of our common stock, limit our ability to obtain financing if needed or increase the cost of any financing we may obtain. In addition, these failures may negatively impact our business, financial condition and results of operations, impair our ability to timely file our periodic reports with the SEC, subject us to litigation and regulatory scrutiny and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.
Our failure to protect confidential information and privacy could result in the unauthorized disclosure of sensitive or confidential corporate or customer information, damage to our reputation, loss of customers, fines, penalties and adverse effects on our results of operations and financial condition.
Our insurance subsidiaries are subject to privacy regulations. The actions we take to protect confidential information include among other things: monitoring our record retention plans and policies and any changes in state or federal privacy and compliance requirements; maintaining secure storage facilities for tangible records; and limiting access to electronic information in order to safeguard certain information.
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We have a written information security program with appropriate administrative, technical and physical safeguards to protect such confidential information. Cyber security attacks are on the rise throughout the world and while we believe we have taken reasonable steps to secure our customer information we could experience a breach of data. We closely monitor cyber attack attempts on our system, and we are not aware of any material breach of our cybersecurity, administrative, technical and physical safeguards or client data. Nevertheless, it is possible a cyber attack could go undetected and that preventative actions we take to reduce this risk of cyber-incidents and protect our information may be insufficient to prevent cyber attacks or other security breaches.
If we do not comply with privacy regulations and protect confidential information, we could experience adverse consequences, including regulatory sanctions, loss of reputation, litigation exposure, disruptions to our operations or significant technical, legal and operating expenses, any of which could have a material adverse effect on our business, results of operations and financial condition.
Our insurance subsidiaries are restricted by applicable laws and regulations in the amounts of fees, dividends and other distributions they may make to us. The inability of our subsidiaries to make payments to us in sufficient amounts for us to conduct our operations could adversely affect our ability to meet our obligations or expand our business.
As a holding company, our principal asset is the stock of our subsidiaries. We rely primarily on statutorily permissible payments from our insurance company subsidiaries, principally through service agreements we have with our subsidiaries, to meet our working capital and other corporate expenses. The ability of our insurance company subsidiaries to make payments to us is subject to regulation by the states in which they are domiciled, and these payments depend primarily on approved service agreements between us and these subsidiaries and, to a lesser extent, the statutory surplus (which is the excess of assets over liabilities as determined under statutory accounting practices prescribed by an insurance company's state of domicile), future statutory earnings (which are earnings as determined in accordance with statutory accounting practices) and regulatory restrictions.
Generally, the net assets of our insurance company subsidiaries available for dividends are limited to either the lesser or greater (depending on the state of domicile) of the subsidiary's net gain from operations during the preceding year and 10% of the subsidiary's net statutory surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed by insurance regulatory authorities.
Except to the extent that we are a creditor with recognized claims against our subsidiaries, claims of our subsidiaries' creditors, including policyholders, have priority with respect to the assets and earnings of the subsidiaries over the claims of our creditors and shareholders. If any of our subsidiaries becomes insolvent, liquidates or otherwise reorganizes, our creditors and shareholders will have no right to proceed in their own right against the assets of that subsidiary or to cause the liquidation, bankruptcy or winding-up of the subsidiary under applicable liquidation, bankruptcy or winding-up laws.
Unexpected losses in future reporting periods may require us to adjust the valuation allowance against our deferred tax assets.
We evaluate our deferred tax asset (“DTA”) quarterly for recoverability based on available evidence. This process involves management's judgment about assumptions, which are subject to change from period to period due to tax rate changes or variances between our projected operating performance and our actual results. Ultimately, future adjustments to the DTA valuation allowance, if any, will be determined based upon changes in the expected realization of the net deferred tax assets. The realization of the deferred tax assets depends on the existence of sufficient taxable income in either the carry back or carry forward periods under applicable tax law. 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 may be required to record a valuation allowance in future reporting periods. Such an adjustment could have a material adverse effect on our results of operation, financial condition and capital position.
We face a greater risk of money laundering activity associated with sales derived from residents of certain foreign countries.
Some of our top international markets are in countries identified by the U.S. Department of State as jurisdictions of high risk for money laundering. As required by Bank Secrecy Act ("BSA”) regulations applicable to insurance companies, we have developed and implemented an anti-money laundering program that includes policies and procedures for complying with our applicable BSA program, auditing, reporting and recordkeeping requirements and for deterring, preventing and detecting potential money laundering, fraud and other criminal activity (“BSA Program”). We have an enhanced BSA Program with additional controls, such as list screening software beyond sanctions screening required by the Office of Foreign Assets Control (“OFAC”), enhanced payment due diligence and transaction controls. However, there can be no assurance that these enhanced controls will entirely mitigate money laundering risk associated with these jurisdictions.
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Risks Relating to Our Capital Stock
If our foreign policyholders reduced or ceased participation in our Stock Investment Plan (the “Plan”) or if a securities regulatory authority were to deem the CISIP's operation contrary to securities laws, the volume of Class A common stock purchased on the open market through the CISIP, and the price of our Class A common stock, could fall.
More than 96% of the shares of Class A common stock purchased under the CISIP in
2017
were purchased by foreign holders of life insurance policies (or related brokers); the remaining 4% of the shares of Class A common stock purchased under the CISIP in
2017
were purchased by approximately 1,864 participants resident in the United States. The CISIP is registered with the SEC pursuant to a registration statement under the Securities Act of 1933, but is not registered under the laws of any foreign jurisdiction. If a foreign securities regulatory authority were to determine the offer and sale of our Class A common stock under the CISIP were contrary to applicable laws and regulations of its jurisdiction, such authority may issue or assert a fine, penalty or cease and desist order against us in that foreign jurisdiction. There is a risk our Class A common stock price could be negatively impacted by a decrease in participation in the CISIP. If fewer policyholders elect to participate in the Plan, or our international premium collections were to decrease as a result of regulatory, economic, or marketing impediments, the trading volume of our Class A common stock may decline from its present levels, the demand for our Class A common stock could be negatively impacted and the price of our Class A common stock could fall.
Control of our Company, through the ownership of our Class B Common Stock, has transferred from our founder to a 501(c)(3) charitable foundation established by our founder, and we cannot determine whether any change in our management, operations, or operating strategies will occur as a result of this ownership change.
Harold E. Riley, our founder, was the beneficial owner of 100% of our Class B common stock, which was held in the name of the Harold E. Riley Trust ("Trust"), of which he had served as Trustee until his death in September 2017. Our 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 any cash dividends paid, on a per share basis, to the Class A shares. The Class A common stock elects the remainder of the Board. The Trust documents provided that upon Mr. Riley's death, the Class B common stock was transferred from the Trust to the Harold E. Riley Foundation, a charitable organization established under 501(c)(3) of the Internal Revenue Code (the "Foundation"). Therefore, the Foundation controls our Company. The Foundation is organized as a public support charity for the benefit of its charitable beneficiaries, Baylor University and Southwestern Baptist Theological Seminary. The Foundation is governed by 11 trustees, five of which were appointed by Harold Riley prior to his death, three of which were appointed by Baylor University and three of which were appointed by Southwestern Baptist Theological Seminary. It is unclear what, if any, change will occur to our board, management, or corporate operating strategies as a result of different ownership of our Class B common stock. The transfer of our Class B common stock from the Trust has triggered the first of two prongs of certain “change in control” provisions in the employment agreements of our top two executives Chief Executive Officer Geoff Kolander and Chief Financial Officer Kay Osbourn. Under each employment agreement, a "change in control" includes, among other things (1) the transfer of a majority of the Company's Class B common stock from the Trust to an individual other than Harold E. Riley, an entity not beneficially owned by Harold E. Riley, or a trust not controlled by Harold E. Riley and (2) the exercise of a power of attorney granted by Harold E. Riley over the Company's Class B common stock. Upon a termination of the executive by Citizens without cause or the executive’s voluntary termination with Good Reason, in each case other than within the ninety (90) day period prior to the consummation of a change in control or within one (1) year following a change in control, the executive would be entitled to certain cash payments and benefits.
There are a substantial number of our shares of Class A common stock issued to our executive officers and directors which are eligible for future sale in the public market. The sale of these shares could cause the market price of our Class A common stock to fall.
There were
49,080,114
shares of our Class A common stock issued and outstanding as of
December 31, 2017
. Our executive officers and directors owned approximately
54,436
shares of our Class A common stock as of
December 31, 2017
, representing approximately
0.1%
of our then outstanding Class A common stock. Almost all of these shares have been registered for public resale and generally may be sold freely. In the event of a sale of some or all of these shares or the perceived sale of these shares, the market price of our Class A common stock could fall substantially.
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The price of our Class A common stock may be volatile and may be affected by market conditions beyond our control.
Our Class A common stock price has historically fluctuated and is likely to fluctuate in the future and could decline materially because of the volatility of the stock market in general, decreased participation in the CISIP referred to above or a variety of other factors, many of which are beyond our control, including: quarterly or annual variations in actual or anticipated results of our operations; interest rate fluctuations; changes in financial estimates by securities analysts; competition and other factors affecting the life insurance business generally; and conditions in the U.S. and world economies.
Our international markets, and the specific manner in which we conduct our business in those jurisdictions, may be subject to negative publicity in social media or other channels, which may negatively impact the market price of our Class A common stock.
We interface with and distribute our products to residents of foreign countries that may be subject to the risks disclosed in our Item 1A. Risk Factor under the heading, “
The majority of our sales derive from residents of foreign countries and are subject to risks associated with widespread political instability, currency control laws and foreign insurance laws. A significant loss of sales in these foreign markets could have a material adverse effect on our results of operations and financial condition".
Venezuela is one such example. Accordingly, from time to time, bloggers or other social media outlets relevant to investors may focus attention on our exposure to these countries and the negative circumstances surrounding their governments, thereby subjecting us to periodic negative publicity. Negative publicity on investor blogs or through other media channels could impact trading in our stock especially due to aggressive and coordinated efforts between anonymous bloggers and short sellers which ultimately cause the market price of our Class A common stock to fall.
Our articles of incorporation and bylaws, as well as applicable state insurance laws, may discourage takeovers and business combinations that our shareholders might consider to be in their best interests.
Our articles of incorporation and bylaws, as well as various state insurance laws, may delay, deter, render more difficult or prevent a takeover attempt our shareholders might consider in their best interests. As a result, our shareholders will be prevented from receiving the benefit from any premium to the market price of our Class A common stock that may be offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our Class A common stock if they are viewed as discouraging takeover attempts in the future.
The following provisions in our articles of incorporation and bylaws make it difficult for our Class A shareholders to replace or remove our directors and have other anti-takeover effects that may delay, deter or prevent a takeover attempt:
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holders of shares of our Class B common stock elect a simple majority of our board of directors, and all of these shares are owned by the Harold E. Riley Foundation; and
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our board of directors may issue one or more series of preferred stock without the approval of our shareholders.
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State insurance laws generally require prior approval of a change in control of an insurance company. Generally, such laws provide that control over an insurer is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing 10% or more of the voting securities of the insurer. In considering an application to acquire control of an insurer, an insurance commissioner generally will consider such factors as the experience, competence and financial strength of the proposed acquirer, the integrity of the proposed acquirer's board of directors and executive officers, the proposed acquirer's plans for the management and operation of the insurer, and any anti-competitive results that may arise from the acquisition. In addition, a person seeking to acquire control of an insurance company is required in some states to make filings prior to completing an acquisition if the acquirer and the target insurance company and their affiliates have sufficiently large market shares in particular lines of insurance in those states. These state insurance requirements may delay, deter or prevent our ability to complete an acquisition.
We have never paid any cash dividends on our Class A common stock and do not anticipate doing so in the foreseeable future.
We have never paid cash dividends on our Class A common stock, as it is our policy to retain earnings for use in the operation and expansion of our business. We do not expect to pay cash dividends on our Class A common stock for the foreseeable future.
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Item 1B.
UNRESOLVED STAFF COMMENTS
None.
Item 2.
PROPERTIES
We lease our principal office in Austin, Texas to service all business entities and operations. We also own properties in Austin and Buchanan Dam, Texas used for our general business operations and Louisiana related to our Home Service segment and business operations.
Item 3.
LEGAL PROCEEDINGS
On or about March 16, 2017, Juan Gamboa filed a putative class action lawsuit against the Company and five of its current and former directors and executive officers in the United States District Court, Western District of Texas. The lawsuit alleges the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making false and/or misleading statements, as well as failing to disclose material adverse facts about the Company’s business, operations and prospects. On May 25, 2017, the court appointed lead plaintiffs, and on July 31, 2017, the lead plaintiffs filed an amended complaint. The amended complaint seeks an award of damages in an unspecified amount on behalf of a putative class consisting of persons who purchased the Company’s common stock between March 11, 2015 and March 8, 2017, inclusive. On September 28, 2017, we filed a motion to dismiss, which remains pending before the court. The Company believes that the lawsuit is without merit, and it intends to vigorously defend against all claims asserted. At this time, the Company is unable to reasonably estimate the outcome of this litigation.
In the normal course of business, the Company is subject to various legal and regulatory actions which are immaterial to the Company's financial statements. For more information about the risks related to litigation and regulatory actions, please see the risk factor titled “We are a defendant in lawsuits, which may adversely affect our financial condition and detract from the time our management is able to devote to our business, and we are subject to risks related to litigation and regulatory matters.” in Item 1A. Risk Factors.
As disclosed in prior periods, the legal and regulatory actions facing the Company include those relating to compliance with U.S. federal securities laws. Specifically, the Company has been the subject of an investigation by the Securities and Exchange Commission (“SEC”), which appears to be focused on the Company’s internal control over financial reporting and disclosure controls and procedures in light of the Company’s determination in 2015 that a portion of the life insurance and annuity policies issued by its subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code of 1986. There have been no allegations of fraud presented by the SEC. We have cooperated fully with the investigation and expect that the matter will be resolved soon, although we cannot predict the timing of a resolution or the ultimate outcome of the investigation.
Item 4.
MINE SAFETY DISCLOSURES
Not applicable.
24
PART II
|
Item 5.
|
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|
Market Information
Our Class A common stock is traded on the New York Stock Exchange ("NYSE") under the symbol CIA.
Quarterly high and low closing prices per share of our Class A common stock as reported by the NYSE are shown below.
|
|
2017
|
|
2016
|
|||||||||
|
Quarter Ended
|
High
|
|
Low
|
|
High
|
|
Low
|
|||||
|
March 31
|
$
|
10.53
|
|
|
6.87
|
|
|
7.82
|
|
|
6.16
|
|
|
June 30
|
7.38
|
|
|
5.95
|
|
|
8.41
|
|
|
7.07
|
|
|
|
September 30
|
8.35
|
|
|
6.74
|
|
|
10.92
|
|
|
7.41
|
|
|
|
December 31
|
8.65
|
|
|
7.11
|
|
|
11.69
|
|
|
7.51
|
|
|
Equity Security Holders
The number of stockholders on record on
March 5, 2018
was as follows:
|
•
|
Class A Common Stock -
99,226
|
|
•
|
Class B Common Stock -
1
|
We have never paid cash dividends on our Class A or B common stock and do not expect to pay cash dividends in the foreseeable future. For restrictions on our present and future ability to pay dividends, see Note 6 of the Company's consolidated financial statements.
We did not purchase any of our equity securities during any quarter in
2015
,
2016
or
2017
.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information regarding securities authorized for issuance under our equity compensation plan, the Citizens Inc. Omnibus Incentive Plan as of December 31, 2017. (See Note 14 - "Subsequent Events" of the accompanying consolidated financial statements for additional information regarding our Omnibus Incentive Plan).
|
Plan Category
|
|
Number of securities to be issued upon exercise of outstanding options, warrants and rights
|
|
Weighted-average exercise price of outstanding options, warrants and rights
|
|
Number of securities remaining for future issuance under equity compensation plans
|
||||
|
|
|
|
|
|
|
|
||||
|
Equity compensation plans approved by security holders
|
|
—
|
|
|
$
|
—
|
|
|
3,000,000
|
|
|
|
|
|
|
|
|
|
||||
|
Equity compensation plans not approved by security holders
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total
|
|
—
|
|
|
$
|
—
|
|
|
3,000,000
|
|
25
Performance Comparison
The following graph compares the change in the Company’s cumulative total stockholder return on its common stock over a five-year period. The following graph assumes a $100 investment on December 31,
2012
, and reinvestment of all dividends in each of the Company’s common shares, the New York Stock Exchange (“NYSE”) Composite and the Hemscott Group Index, a peer group of major U.S.-based insurance companies.
|
|
2012
|
|
2013
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|||||||
|
Citizens, Inc.
|
$
|
100.00
|
|
|
79.19
|
|
|
68.78
|
|
|
67.24
|
|
|
88.87
|
|
|
66.52
|
|
|
NYSE Composite
|
$
|
100.00
|
|
|
126.28
|
|
|
134.81
|
|
|
129.29
|
|
|
144.73
|
|
|
171.83
|
|
|
Peer Group
|
$
|
100.00
|
|
|
154.43
|
|
|
162.04
|
|
|
151.01
|
|
|
162.31
|
|
|
192.51
|
|
The peer group index weights individual company returns for stock market capitalization. The companies included in the peer group index are shown in the following table.
|
American Equity Investment Life Holding Co
|
|
Independence Holding Co
|
|
Primerica, Inc
|
|
Atlantic American Corp
|
|
Investors Heritage Capital Corp
|
|
Prudential Financial, Inc
|
|
Aviva Plc
|
|
Kansas City Life Insurance Co
|
|
Prudential Plc
|
|
China Life Insurance Co Ltd
|
|
Lincoln National Corp
|
|
Reinsurance Group Of America, Inc
|
|
Citizens, Inc
|
|
Metlife Inc
|
|
Torchmark Corp
|
|
Genworth Financial, Inc
|
|
National Western Life Group Inc
|
|
Utg, Inc
|
26
Item 6.
SELECTED FINANCIAL DATA
The following table presents selected financial data of the Company. This should be read in conjunction with Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8. "Financial Statements and Supplementary Data" of this Form 10-K.
|
|
Years ended December 31,
|
||||||||||||||
|
|
2017
|
|
2016
|
|
2015
|
|
2014
|
|
2013
|
||||||
|
|
(In thousands, except per share data)
|
||||||||||||||
|
Operating items
|
|
|
|
|
|
|
|
|
|
||||||
|
Insurance premiums
|
$
|
197,720
|
|
|
197,876
|
|
|
194,480
|
|
|
188,532
|
|
|
176,158
|
|
|
Net investment income
|
53,146
|
|
|
48,560
|
|
|
45,782
|
|
|
41,062
|
|
|
36,597
|
|
|
|
Realized investment gains (losses)
|
518
|
|
|
(1,985
|
)
|
|
(5,459
|
)
|
|
(19
|
)
|
|
(247
|
)
|
|
|
Total revenues
|
252,627
|
|
|
245,406
|
|
|
236,268
|
|
|
230,225
|
|
|
213,636
|
|
|
|
Net income (loss)
|
(38,127
|
)
|
|
1,969
|
|
|
(3,143
|
)
|
|
(5,970
|
)
|
|
5,279
|
|
|
|
Balance sheet data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
1,644,453
|
|
|
1,583,668
|
|
|
1,480,751
|
|
|
1,413,798
|
|
|
1,212,837
|
|
|
|
Total liabilities
|
1,420,940
|
|
|
1,334,568
|
|
|
1,233,825
|
|
|
1,151,466
|
|
|
963,591
|
|
|
|
Total stockholders' equity
|
223,513
|
|
|
249,100
|
|
|
246,926
|
|
|
262,332
|
|
|
249,246
|
|
|
|
Life insurance in force
|
4,469,735
|
|
|
4,497,735
|
|
|
4,478,202
|
|
|
4,662,660
|
|
|
4,616,128
|
|
|
|
Per share data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Book value per share
|
4.46
|
|
|
4.97
|
|
|
4.93
|
|
|
5.24
|
|
|
4.98
|
|
|
|
Basic and diluted earnings (losses) per Class A share
|
(0.77
|
)
|
|
0.04
|
|
|
(0.06
|
)
|
|
(0.12
|
)
|
|
0.11
|
|
|
See Item 1. "Business" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," for information that may affect the comparability of the financial data contained in the above table.
27
|
Item 7.
|
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
The following is management's discussion and analysis of the consolidated financial condition and consolidated results of operations of the Company. It is intended to be a discussion of certain key financial information regarding the Company and should be read in conjunction with the consolidated financial statements and related Notes to this Annual Report on Form 10-K.
Overview
We conduct operations as an insurance holding company emphasizing ordinary life insurance and endowment products in niche markets where we believe we can achieve competitive advantages. As an insurance provider, we collect premiums on an ongoing basis to pay future benefits to our policy and contract holders. Our core operations include issuing:
|
•
|
whole life insurance;
|
|
•
|
endowments;
|
|
•
|
final expense; and
|
|
•
|
limited liability property policies.
|
The Company derives its revenues principally from 1) premiums earned for insurance coverages provided to insureds; 2) net investment income; and 3) net realized capital gains and losses.
Profitability of our insurance operations depends heavily upon the Company’s underwriting discipline, as we seek to manage exposure to loss through:
|
•
|
favorable risk selection and diversification;
|
|
•
|
management of claims;
|
|
•
|
use of reinsurance;
|
|
•
|
sizing of our in force block;
|
|
•
|
careful monitoring of our mortality and morbidity experience; and
|
|
•
|
management of our expense ratio, which we accomplish through economies of scale and management of acquisition costs and other underwriting expenses.
|
Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future losses based on historical loss experience adjusted for known trends, the Company’s response to competitors, and expectations about regulatory and legal developments and expense levels. The Company seeks to price our insurance policies such that insurance premiums and future net investment income earned on premiums received will cover underwriting expenses and the ultimate cost of paying claims reported on the policies and provide for a profit margin. The Company has the ability to adjust dividend scales and interest crediting rates at its discretion based on economic and other factors. The profitability of fixed annuities, riders and other “spread-based” product features depends largely on the Company’s ability to earn target spreads between earned investment rates on assets and interest credited to policyholders.
The investment return, or yield, on invested assets is an important element of the Company’s earnings since insurance products are priced with the assumption that premiums received can be invested for a period of time before benefits are paid. The majority of the Company’s invested assets have been held in fixed maturities available-for-sale and held-to-maturity securities, primarily in asset classes of corporate bonds, municipal bonds, and government obligation bonds. The interest rate environment has a significant impact on the determination of insurance contract liabilities, our investment rates and yields and our asset/liability management.
The primary investment objective for the Company is to maximize economic value, consistent with acceptable risk parameters, including the management of credit risk and interest rate sensitivity of invested assets, while generating sufficient after-tax income to meet policyholder and corporate obligations. The Company maintains a conservative investment strategy that may vary based on a variety of factors including business needs, regulatory requirements and tax considerations.
We previously announced that we determined that a portion of the life and annuity insurance policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code ("IRC") of 1986. To the extent that these policies had unreported income build-up, we may be liable
28
to the IRS for failure to withhold taxes or to notify policyholders of their obligation to pay taxes directly to the IRS. We have undertaken an analysis of our potential liability to the IRS arising from this matter, as well as other expenses we may incur to remediate (i.e., conform to the requirements of the IRS) certain previously issued domestic life insurance and annuity policies and to address any missed reporting for policies issued to non-U.S. citizens and have established a best estimate reserve of $
12.3
million, net of tax as of
December 31, 2017
for probable liabilities and expenses. The probability weighted range of financial estimates relative to this issue is
$5.9 million
to
$48.2 million
, net of tax. This estimated range includes projected toll charges and fees payable to the IRS, as well as estimated increased payout obligations to current and former holders of non-compliant domestic life insurance policies expected to result from remediation of those policies. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, the methodology applicable to the calculation of taxable benefits under non-compliant policies and the amount of time and resources we will require from external advisors who are assisting us with resolving these issues. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and also could exceed the high end of our estimated range of liabilities and expenses. To the extent the amount reserved is insufficient to meet the actual amount of our liabilities and expenses, or if our estimates of those liabilities and expenses change in the future, our financial condition and results of operations may be materially adversely affected.
In May 2017, we submitted an offer to enter into closing agreements with the IRS covering the CICA and CNLIC domestic life insurance business. The toll charges calculated and enumerated in the closing agreements totaled $124,000 and $4,000 for the CICA and CNLIC domestic life insurance businesses, respectively. We expect to file closing agreements with the IRS for the SPLIC and MGLIC life insurance business as well as for the CICA international business and our annuity business in 2018.
Current Financial Highlights
Our
2017
financial results are driven by our historical business management model and traditional life insurance product sales. Although interest rates have risen recently, the historically low interest rate environment continues to impact our results and our industry as investment yields are an integral component of our business operations.
|
•
|
Our assets grew
$61 million
in
2017
and totaled
$1.6 billion
as of
December 31, 2017
.
|
|
•
|
Total stockholders' equity
decreased
from
$249.1 million
at
December 31, 2016
, to
$223.5 million
at
December 31, 2017
due to the New Tax Act enacted on December 22, 2017, which resulted in tax expense for the current period of
$35.1 million
in
2017
.
|
|
•
|
Insurance premiums decreased
0.1%
in
2017
and rose
1.7%
in
2016
, respectively, primarily from our life insurance segment, which decreased
$0.5 million
from
2016
.
|
|
•
|
Net investment income increased
9.4%
and
6.1%
for
2017
and
2016
, respectively, primarily due to an increase in the investment asset balances in
2017
compared to the prior year. The average yield on the consolidated investment portfolio has changed from a yield of
4.38%
in
2015
down to
4.28%
in
2016
and rising to a yield of
4.31%
in
2017
, as investment rates available have remained low in the sustained low interest rate environment.
|
|
•
|
Realized net investment gains in the current year resulted from a gain on the sale of a real estate holding totaling $1.1 million offset by other-than-temporary impairments ("OTTI") on investment securities. OTTI items recorded totaled
$0.2 million
and
$4.3 million
in
2017
and
2016
, respectively, and are reported as realized losses. The OTTI in 2016 was somewhat offset by realized investment gains on sales of fixed maturity securities in our available-for-sale portfolio and sales of equity securities.
|
|
•
|
During
2017
, claims and surrenders expense increased
1.9%
from the comparable period in
2016
, primarily due to an increase in surrender benefits and matured endowments in the life segment compared to the
2016
levels.
|
|
•
|
Policyholders' dividends decreased
8.3%
in
2017
compared to
2016
, due to the dividend rate actions taken by us at the end of
2016
to improve our product profitability.
|
|
•
|
General expenses increased
39.1%
in
2017
, due primarily to additional audit fees related to the
2016
audit, higher legal and consulting fees and higher permanent executive salaries and temporary salaries, offset by a decrease in our 7702/72(s)
|
29
tax compliance best estimate liability. In addition, we impaired our Home Service goodwill value by $4.6 million, down to zero.
|
•
|
Amortization of deferred policy acquisition expenses increased from
$28.5 million
at
December 31, 2016
to
$29.7 million
at
December 31, 2017
primarily due to the higher surrender activity.
|
Life Insurance
. For over thirty-seven years, CICA and its predecessors have accepted policy applications from foreign nationals for U.S. dollar-denominated ordinary whole life insurance and endowment policies. We make our insurance products available using third-party marketing organizations and independent marketing consultants.
Endowment product sales have been the primary driver of sales in this segment. The Company currently offers a fifteen and twenty year endowment and our top selling endowment is a product that matures at age sixty-five. The Company repriced its top six selling international products at the end of 2016 to increase profitability.
Through the domestic market of our Life Insurance segment, we provide ordinary whole life, credit life insurance, and final expense policies to middle and lower income families and individuals in certain markets in the mountain west, midwest and southern U.S. The majority of our domestic revenues are generated by the policies of domestic life insurance companies we have acquired since 1987.
Home Service Insurance
. We provide final expense ordinary and industrial life insurance to middle and lower income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders, and through networks of funeral homes that collect premiums and provide personal policyholder service.
Premiums in this segment increased slightly in
2017
compared to
2016
, as renewal premiums and first year premiums increased. We noted slight increases in
2016
compared to
2015
which were driven by renewal premiums.
Economic and Insurance Industry Developments
Significant economic issues impacting our business and industry currently and into the future are discussed below.
|
•
|
Slow increases in the interest rate environment will limit increases in profit margins for insurers. We have been impacted by the historically low interest rate environment over the past several years as our fixed income investment portfolio, primarily invested in callable securities, has been reinvested at lower yields. The Company’s conservative investment strategy has not changed but we have focused new investments into securities of state, municipalities, essential services and corporate issuers compared to our historical investment in U.S. government holdings. Our investment earnings also impact the reserve and DAC balances, as assumptions are used in the development of the balances. Due to the recent decline in investment yields on our portfolio, our projection of long-term investment returns has declined. This has resulted in increasing the reserves on policies issued in the current year, as well as reducing the DAC asset.
|
|
•
|
As an increasing percentage of the world population reaches retirement age, we believe we will benefit from increased demand for living benefit products rather than death benefit products, as customers will require cash accumulation to pay expenses to meet their lifetime income needs. Our ordinary life products are designed to accumulate cash values to provide for living expenses in a policy owner's later years, while continuously providing a death benefit.
|
|
•
|
There has been a trend toward consolidation of domestic life insurance companies, due to significant losses incurred by the life insurance industry as a result of the credit crisis and related economic pressures, as well as increasing costs of regulatory compliance for domestic life insurance companies.
|
|
•
|
Many of the events and trends affecting the life insurance industry have had an impact on the life reinsurance industry. These events have led to a decline in the availability of reinsurance. While we currently cede a limited amount of our primary insurance business to reinsurers, we may find it difficult to obtain reinsurance in the future, forcing us to seek reinsurers who are more expensive to us. If we cannot obtain affordable reinsurance coverage, either our net exposures will increase or we will have to reduce our underwriting commitments.
|
30
|
•
|
Innovation and digital development strategies will be implemented in various industries including the insurance industry in the coming years which could significantly impact our business. It will be critical that we embrace these changes to the benefit of our policyholders, agents and stockholders.
|
|
•
|
While our management has extensive experience in writing life insurance policies for foreign residents, changes to foreign laws and regulations and their related application and enforcement, along with currency controls affecting our foreign resident insureds could adversely impact our revenues, results of operations and financial condition.
|
Consolidated Results of Operations
A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment.
Revenues
Insurance revenues are primarily generated from premium revenues and investment income. In addition, realized gains and losses on investment holdings can significantly impact revenues from year to year.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Revenues:
|
|
|
|
|
|
||||
|
Premiums:
|
|
|
|
|
|
||||
|
Life insurance
|
$
|
191,342
|
|
|
191,254
|
|
|
187,686
|
|
|
Accident and health insurance
|
1,392
|
|
|
1,546
|
|
|
1,599
|
|
|
|
Property insurance
|
4,986
|
|
|
5,076
|
|
|
5,195
|
|
|
|
Net investment income
|
53,146
|
|
|
48,560
|
|
|
45,782
|
|
|
|
Realized investment gains (losses), net
|
518
|
|
|
(1,985
|
)
|
|
(5,459
|
)
|
|
|
Other income
|
1,243
|
|
|
955
|
|
|
1,465
|
|
|
|
Total revenues
|
$
|
252,627
|
|
|
245,406
|
|
|
236,268
|
|
Premium Income
. Premium income derived from life, accident and health, and property insurance sales remained relatively flat during
2017
compared to
2016
, and increased
1.7%
during
2016
compared to
2015
. Life insurance reflected an increase resulting primarily from renewal premiums, which increased
2.2%
in
2017
and
2.4%
in
2016
and totaled
$171.9 million
,
$168.3 million
and
$164.4 million
on the consolidated level in
2017
,
2016
and
2015
, respectively. New sales, reflected as first year premiums, decreased
18.8%
and
0.5%
, and
2.7%
in the life segment in
2017
,
2016
and
2015
, respectively. In 2017, to increase productivity, we introduced a set of repriced products in our international markets that are more expensive policies for our customers and likely negatively impacted our new sales. In addition, Venezuela, which has historically been one of our top markets, has experienced economic and social turmoil, which has negatively impacted our sales in the country, decreasing 10% year over year based upon total premiums from
2016
to
2017
.
Endowment sales represent a significant portion of new business sales internationally with the 20-year endowment and endowment to age 65 as our top products. In addition, most of our life insurance policies contain a policy loan provision, which allows the policyholder to use cash value within a policy to pay premiums. The policy loan asset balance
increased
10.6%
and
10.8%
in
2017
and
2016
, year over year and remains in line with historical levels when compared to policy benefit liabilities.
Net Investment Income
. Net investment income increased to
$53.1 million
in
2017
compared to
$48.6 million
in
2016
, as we experienced higher average invested assets as a result of our investment of incoming premium revenue. Our yield on average invested assets increased three basis points from
2016
to
2017
as rates stayed similar on investments.
31
Net investment income performance is summarized as follows.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands, except for %)
|
||||||||
|
Net investment income
|
$
|
53,146
|
|
|
48,560
|
|
|
45,782
|
|
|
Average invested assets, at amortized cost
|
1,233,580
|
|
|
1,133,705
|
|
|
1,045,736
|
|
|
|
Yield on average invested assets
|
4.31
|
%
|
|
4.28
|
%
|
|
4.38
|
%
|
|
We have traditionally invested in fixed maturity securities with a large percentage held in callable issues. The sustained low interest rate environment of the past several years is holding down yields. While U.S. Treasury interest rates have risen recently after a fairly significant decline during 2016, yields on high quality corporate and municipal securities have been slower to rise. The interest rate direction is uncertain but as market interest rates begin to rise, our call risk will diminish, resulting in our fixed securities maturing at the stated maturity dates and our portfolio yield will rise more slowly over time, as new money investments would be made at higher rates.
Investment income from fixed maturity securities accounted for approximately
88.0%
of total investment income for the year ended
December 31, 2017
. We have increased our investment purchases of corporate and municipal securities over the past several years, with no focus on any particular industry sectors in these security categories, but rather a focus on higher yielding, investment quality securities. In addition, we currently have
$15.6 million
invested in equity securities related to bond and stock mutual funds as these securities offer a competitive yield with a shorter duration. However, we have reduced our holdings over the last several years due to higher earnings volatility and RBC charges.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Gross investment income:
|
|
|
|
|
|
||||
|
Fixed maturity securities
|
$
|
48,164
|
|
|
43,637
|
|
|
39,570
|
|
|
Equity securities
|
708
|
|
|
851
|
|
|
2,909
|
|
|
|
Mortgage loans
|
11
|
|
|
24
|
|
|
36
|
|
|
|
Policy loans
|
5,735
|
|
|
5,277
|
|
|
4,614
|
|
|
|
Long-term investments
|
76
|
|
|
305
|
|
|
247
|
|
|
|
Other
|
68
|
|
|
89
|
|
|
53
|
|
|
|
Total investment income
|
54,762
|
|
|
50,183
|
|
|
47,429
|
|
|
|
Less investment expenses
|
(1,616
|
)
|
|
(1,623
|
)
|
|
(1,647
|
)
|
|
|
Net investment income
|
$
|
53,146
|
|
|
48,560
|
|
|
45,782
|
|
Investment income from fixed maturity investments increased in
2017
due to an increase in the portfolio from new money investment purchases as noted above relative to the fixed maturity portfolio. In addition, the increase in the policy loans asset balance, which represents policyholders utilizing their accumulated policy cash value, contributed to the increase to investment income. Investment income from equity securities has declined as we have reduced our holdings as discussed above.
Realized Losses on Investments
. Net realized gains in
2017
resulted primarily from a gain of $1.1 million recognized on the sale of a real estate holding reduced by impairments. Net realized investment losses recorded from OTTI on both fixed maturity and equity securities totaling
$0.2 million
and
$4.3 million
, in
2017
and
2016
. The OTTI in 2016 was somewhat offset by realized investment gains on sales of fixed maturity securities in our available-for-sale portfolio and sales of equity securities.
32
Realized investment gains (losses) are as follows.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Realized investment gains (losses):
|
|
|
|
|
|
||||
|
Sales, calls and maturities
|
|
|
|
|
|
||||
|
Fixed maturities
|
$
|
(506
|
)
|
|
2,024
|
|
|
(111
|
)
|
|
Equity securities
|
121
|
|
|
303
|
|
|
37
|
|
|
|
Real estate
|
1,110
|
|
|
—
|
|
|
—
|
|
|
|
Net realized investment gains (losses)
|
725
|
|
|
2,327
|
|
|
(74
|
)
|
|
|
Other-than-temporary impairments ("OTTI"):
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
—
|
|
|
(3,970
|
)
|
|
(2,998
|
)
|
|
|
Equity securities
|
(207
|
)
|
|
(342
|
)
|
|
(2,387
|
)
|
|
|
Realized losses on OTTI
|
(207
|
)
|
|
(4,312
|
)
|
|
(5,385
|
)
|
|
|
Net realized investment gains (losses)
|
$
|
518
|
|
|
(1,985
|
)
|
|
(5,459
|
)
|
Benefits and Expenses
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Benefits and expenses:
|
|
|
|
|
|
||||
|
Insurance benefits paid or provided:
|
|
|
|
|
|
||||
|
Claims and surrenders
|
$
|
82,905
|
|
|
81,367
|
|
|
78,879
|
|
|
Increase in future policy benefit reserves
|
76,029
|
|
|
75,881
|
|
|
77,060
|
|
|
|
Policyholders' dividends
|
6,268
|
|
|
6,832
|
|
|
10,747
|
|
|
|
Total insurance benefits paid or provided
|
165,202
|
|
|
164,080
|
|
|
166,686
|
|
|
|
Commissions
|
41,324
|
|
|
44,641
|
|
|
43,625
|
|
|
|
Other general expenses
|
46,388
|
|
|
33,356
|
|
|
33,287
|
|
|
|
Capitalization of deferred policy acquisition costs
|
(29,120
|
)
|
|
(32,732
|
)
|
|
(31,104
|
)
|
|
|
Amortization of deferred policy acquisition costs
|
29,690
|
|
|
28,515
|
|
|
23,400
|
|
|
|
Amortization of cost of customer relationships acquired
|
2,129
|
|
|
2,063
|
|
|
2,317
|
|
|
|
Total benefits and expenses
|
$
|
255,613
|
|
|
239,923
|
|
|
238,211
|
|
33
Claims and Surrenders.
As noted in the table below, claims, benefits and surrenders
increased
from
$81.4 million
in
2016
to
$82.9 million
in
2017
.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Death claims
|
$
|
22,773
|
|
|
23,104
|
|
|
24,638
|
|
|
Surrender expenses
|
37,192
|
|
|
33,686
|
|
|
31,682
|
|
|
|
Endowment benefits
|
15,134
|
|
|
16,173
|
|
|
16,273
|
|
|
|
Matured endowments
|
2,882
|
|
|
3,392
|
|
|
1,773
|
|
|
|
Property claims
|
1,744
|
|
|
1,941
|
|
|
1,689
|
|
|
|
Accident and health benefits
|
310
|
|
|
462
|
|
|
388
|
|
|
|
Other policy benefits
|
2,870
|
|
|
2,609
|
|
|
2,436
|
|
|
|
Total claims and surrenders
|
$
|
82,905
|
|
|
81,367
|
|
|
78,879
|
|
|
•
|
The Company monitors death claims based upon expectations. These values may routinely fluctuate from year to year.
|
|
•
|
Policy surrenders increased
10.4%
in
2017
from
2016
and
6.3%
from
2015
to
2016
, or
0.8%
and
0.7%
of direct ordinary whole life insurance in force for
2017
and
2016
, respectively. The increase in surrender expense is primarily related to our international business and is expected to increase over time due to the aging of this block of business. Our premium persistency rates have remained consistent for
2017
and
2016
. A significant portion of surrenders relates to policies that have been in force over fifteen years and no longer have a surrender charge associated with them. Total direct insurance in force reported in
2017
was
$5.0 billion
and was consistent with
2016
and
2015
.
|
|
•
|
Endowment benefits decreased slightly in
2017
compared to
2016
amounts. We have a series of international policies that carry an immediate endowment benefit of an amount selected by the policy owner. These benefits have been popular in the Pacific Rim and Latin America, where the Company has experienced increased interest in our guaranteed products in recent years. Annual guaranteed endowments are factored into the premium, and, as such, the increase or decrease is expected to have little impact on expected profitability.
|
|
•
|
Matured endowments decreased in the current year after increasing in
2016
and
2015
. We expect this increasing trend to continue as this block of business increases, persists and policies begin to reach maturity.
|
|
•
|
Property claims
decreased
10%
to approximately
$1.7 million
in
2017
compared with the amount reported for
2016
due to a decrease in weather-related claims.
|
|
•
|
Other policy benefits resulted primarily from interest paid on premium deposits and policy benefit accumulations and increased as these policy liabilities also increased.
|
Increase in Future Policy Benefit Reserves
. The change in future policy benefit reserves has
increased
in
2017
by
0.2%
and decrease in
2016
by
1.5%
. The 2016 decrease was mainly due to higher surrender activity recorded when compared to the prior year. Changes in future policy benefit reserves are largely driven by policyholder activity (e.g. premiums, surrenders, etc.)
Policyholder Dividends
. The Company issues long duration participating policies in our life segment to foreign residents that are expected to pay dividends to policyholders based upon actual experience. Initially, policyholder dividend scales are factored into the guaranteed premiums at the time the product is developed, based on expected future experience and desired profit goals. As actual and expected experience develops over time, it can become necessary to adjust dividends, as we did at the end of
2016
, in order to maintain our original expected level of long term product profitability. Policyholders' dividends decreased
8.3%
in
2017
compared to
2016
, and 36.4% in
2016
compared to
2015
or $0.6 million and $3.9 million, respectively, due to the dividend rate actions that we took at the end of
2016
.
34
Commissions
. Commission expense fluctuates in a direct relationship to new and renewal insurance premiums and has
decreased
7.4%
in
2017
compared to
2016
as first year premium revenues, on which higher commission rates are paid, declined in the life segment while renewal premiums were up
2.7%
.
Other General Expenses
. Total general expenses
increased
39.1%
on a consolidated basis in
2017
due primarily to increased legal, consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. We also have $4.6 million of expense in the current year due to the write-off of our home service goodwill. Total general expenses
increased
0.2%
on a consolidated basis in
2016
due primarily to the tax compliance issue we recognized in 2014. In 2015, we recorded an additional $3.4 million of expense related to this tax compliance issue.
We perform an expense study on an annual basis, utilizing an enterprise-wide time study, and we adjust cost allocations among entities as needed based upon this review. Any allocation changes are reflected in the segment operations, but do not impact total expenses.
Deferred Policy Acquisition Costs
. Capitalized DAC were
$29.1 million
,
$32.7 million
and
$31.1 million
in
2017
,
2016
and
2015
. These costs will vary based upon successful efforts related to newly issued policies and renewal business. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business which have higher commission rates. In addition, the prolonged low interest rate environment impacted the assumptions used in the development of the DAC asset for new policies issued.
Amortization of DAC totaled
$29.7 million
,
$28.5 million
and
$23.4 million
in
2017
,
2016
and
2015
primarily due to the higher surrender activity, including early duration elections to convert existing policies to reduced paid up ("RPU") or extended term insurance ("ETI") status in
2017
and
2016
. There are higher deferred acquisition costs associated with early duration conversions to RPU or ETI, which, when converted, increases amortization expense. Amortization of deferred policy acquisition costs is impacted by persistency and the higher level of surrenders is impacting our amortization.
Federal Income Tax
. Federal income tax expense was
$35.1 million
,
$3.5 million
and
$1.2 million
in
2017
,
2016
and
2015
, respectively, resulting in effective tax rates of
(1,176.9)%
,
64.1%
and
(61.8)%
, respectively. The significant changes in rates noted are the result of the New Tax Act enacted at the end of
2017
and the tax compliance issue we identified in 2014 which impacted our effective tax rates in each year as these costs are not deductible for tax purposes. Additionally, the Company recorded a tax expense in each year for an uncertain tax position that is affecting the tax rates. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes.
Segment Operations
Our business is comprised of two operating business segments and Other Non-insurance Operations
as detailed below.
|
•
|
Life Insurance
|
|
•
|
Home Service Insurance
|
Our insurance operations are the primary focus of the Company, as those segments generate the majority of our income. The amount of insurance, number of policies, and average face amounts of policies issued during the periods indicated are shown below.
|
|
Years Ended December 31,
|
||||||||||||||||||||
|
|
2017
|
|
2016
|
||||||||||||||||||
|
|
Amount of
Insurance
Issued
|
|
Number of
Policies
Issued
|
|
Average Policy
Face Amount
Issued
|
|
Amount of
Insurance
Issued
|
|
Number of
Policies
Issued
|
|
Average Policy
Face Amount
Issued
|
||||||||||
|
Life
|
$
|
302,571,460
|
|
|
5,296
|
|
|
$
|
57,132
|
|
|
$
|
389,125,834
|
|
|
6,632
|
|
|
$
|
58,674
|
|
|
Home Service
|
182,144,245
|
|
|
26,762
|
|
|
6,806
|
|
|
178,485,493
|
|
|
26,847
|
|
|
6,648
|
|
||||
35
These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income before federal income taxes.
|
|
Income (Loss) Before Federal Income Taxes
|
||||||||
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Segments:
|
|
|
|
|
|
||||
|
Life Insurance
|
$
|
5,394
|
|
|
5,391
|
|
|
(4,772
|
)
|
|
Home Service Insurance
|
(5,599
|
)
|
|
2,339
|
|
|
4,538
|
|
|
|
Total Segments
|
(205
|
)
|
|
7,730
|
|
|
(234
|
)
|
|
|
Other Non-Insurance Operations
|
(2,781
|
)
|
|
(2,247
|
)
|
|
(1,709
|
)
|
|
|
Total
|
$
|
(2,986
|
)
|
|
5,483
|
|
|
(1,943
|
)
|
Life Insurance
Our Life Insurance segment primarily issues ordinary whole life insurance and endowment policies in U.S. dollar-denominated amounts to foreign residents in more than
30
countries through approximately
1,244
independent marketing consultants, and domestically through over
36
independent marketing firms and consultants throughout the United States.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Revenue:
|
|
|
|
|
|
||||
|
Premiums
|
$
|
150,708
|
|
|
151,195
|
|
|
147,832
|
|
|
Net investment income
|
38,578
|
|
|
33,350
|
|
|
30,206
|
|
|
|
Realized investment losses, net
|
(461
|
)
|
|
(1,685
|
)
|
|
(3,873
|
)
|
|
|
Other income
|
1,061
|
|
|
882
|
|
|
1,008
|
|
|
|
Total revenue
|
189,886
|
|
|
183,742
|
|
|
175,173
|
|
|
|
Benefits and expenses:
|
|
|
|
|
|
|
|
|
|
|
Insurance benefits paid or provided:
|
|
|
|
|
|
|
|
|
|
|
Claims and surrenders
|
60,393
|
|
|
58,440
|
|
|
55,912
|
|
|
|
Increase in future policy benefit reserves
|
70,783
|
|
|
71,373
|
|
|
73,259
|
|
|
|
Policyholders' dividends
|
6,226
|
|
|
6,774
|
|
|
10,695
|
|
|
|
Total insurance benefits paid or provided
|
137,402
|
|
|
136,587
|
|
|
139,866
|
|
|
|
Commissions
|
25,760
|
|
|
29,235
|
|
|
28,336
|
|
|
|
Other general expenses
|
18,597
|
|
|
14,284
|
|
|
16,345
|
|
|
|
Capitalization of deferred policy acquisition costs
|
(23,157
|
)
|
|
(26,742
|
)
|
|
(25,268
|
)
|
|
|
Amortization of deferred policy acquisition costs
|
25,295
|
|
|
24,428
|
|
|
20,025
|
|
|
|
Amortization of cost of customer relationships acquired
|
595
|
|
|
559
|
|
|
641
|
|
|
|
Total benefits and expenses
|
184,492
|
|
|
178,351
|
|
|
179,945
|
|
|
|
Income (loss) before federal income tax expense
|
$
|
5,394
|
|
|
5,391
|
|
|
(4,772
|
)
|
Premiums
. Premium revenues decreased in
2017
compared to
2016
as first year premiums decreased
18.8%
and
0.5%
in
2017
and
2016
, respectively. Premium revenues increased in
2016
compared to
2015
, due primarily to higher international renewal premiums, which have experienced strong persistency as this block of insurance ages. In
2016
, we cut dividend rates to make our products more profitable. In 2017, to increase profitability, we introduced a set of repriced products in our international markets
36
that are more expensive policies for our customers and likely negatively impacted our new sales. In addition, Venezuela, which has historically been one of our top markets, has experienced economic and social turmoil, which has negatively impacted our sales in the country, decreasing 10% from
2016
to
2017
. Sales from Colombia, Taiwan and Ecuador represented the majority of the new business premium increases.
Life Insurance premium breakout is detailed below.
Endowment sales represent a significant portion of new business sales internationally. In addition, most of our life insurance policies contain a policy loan provision, which allows the policyholder to use their accumulated cash value of a policy to pay premiums. These accumulated cash values can also be taken as a cash loan from the policy at the request of the policyholder and are secured by the policy values. The policy loan asset balance increased
10.6%
year over year and remains at the same approximate ratio to life reserves as noted in prior years.
Endowment sales totaled approximately
$13.3 million
,
$16.5 million
and
$16.4 million
, representing approximately
76.4%
,
77.0%
and
76.1%
of total new first year premiums in
2017
,
2016
, and
2015
, respectively.
The following table sets forth, by country, our direct premiums from our international life insurance business for the periods indicated. Our international business and premium collections could be impacted by future changes relative to laws, regulations or economic events in the countries from which we accept applications.
|
|
Years ended December 31,
|
|||||||||||||||||||
|
|
2017
|
|
2016
|
|
2015
|
|||||||||||||||
|
|
(In thousands, except for %)
|
|||||||||||||||||||
|
Country
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
Colombia
|
$
|
29,200
|
|
|
20.0
|
%
|
|
$
|
29,643
|
|
|
20.2
|
%
|
|
$
|
27,589
|
|
|
19.3
|
%
|
|
Venezuela
|
27,997
|
|
|
19.2
|
|
|
31,107
|
|
|
21.2
|
|
|
31,948
|
|
|
22.4
|
|
|||
|
Taiwan
|
19,535
|
|
|
13.4
|
|
|
18,590
|
|
|
12.7
|
|
|
18,031
|
|
|
12.6
|
|
|||
|
Ecuador
|
16,440
|
|
|
11.3
|
|
|
15,456
|
|
|
10.5
|
|
|
15,527
|
|
|
10.9
|
|
|||
|
Brazil
|
11,088
|
|
|
7.6
|
|
|
9,856
|
|
|
6.7
|
|
|
8,960
|
|
|
6.3
|
|
|||
|
Other Non-U.S.
|
41,714
|
|
|
28.5
|
|
|
41,992
|
|
|
28.7
|
|
|
40,529
|
|
|
28.5
|
|
|||
|
Total
|
$
|
145,974
|
|
|
100.0
|
%
|
|
$
|
146,644
|
|
|
100.0
|
%
|
|
$
|
142,584
|
|
|
100.0
|
%
|
We continue to report strong first year and renewal premiums in our top producing countries (other than Venezuela) as noted above; however, this business is dependent on our clients having access to U.S. dollars. Our international business and premium collections could be impacted by our inability to comply with current or future foreign laws or regulations applicable to the Company or our independent consultants in the countries from which we accept applications as well as by marketing or operational changes made by the Company to comply with those laws or regulations. Our international business may also be affected by economic or other events in foreign countries in which our policies are marketed. Venezuela, for example, is continuing to experience civil unrest due to local demonstrations against crime, corruption and soaring inflation. See "Item 1A. Risk Factors" for additional information.
37
The following table sets forth our direct premiums by state from our domestic business for the periods indicated.
|
|
Years ended December 31,
|
|||||||||||||||||||
|
|
2017
|
|
2016
|
|
2015
|
|||||||||||||||
|
|
(In thousands, except for %)
|
|||||||||||||||||||
|
State
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
Texas
|
$
|
2,096
|
|
|
30.3
|
%
|
|
$
|
2,236
|
|
|
32.5
|
%
|
|
$
|
2,460
|
|
|
34.2
|
%
|
|
Indiana
|
1,198
|
|
|
17.3
|
|
|
1,211
|
|
|
17.6
|
|
|
1,372
|
|
|
19.1
|
|
|||
|
Florida
|
802
|
|
|
11.6
|
|
|
708
|
|
|
10.3
|
|
|
685
|
|
|
9.5
|
|
|||
|
Missouri
|
444
|
|
|
6.4
|
|
|
457
|
|
|
6.6
|
|
|
452
|
|
|
6.3
|
|
|||
|
Kentucky
|
308
|
|
|
4.5
|
|
|
391
|
|
|
5.7
|
|
|
443
|
|
|
6.2
|
|
|||
|
Other States
|
2,061
|
|
|
29.9
|
|
|
1,887
|
|
|
27.3
|
|
|
1,783
|
|
|
24.7
|
|
|||
|
Total
|
$
|
6,909
|
|
|
100.0
|
%
|
|
$
|
6,890
|
|
|
100.0
|
%
|
|
$
|
7,195
|
|
|
100.0
|
%
|
We discontinued sales of the majority of our domestic products in 2017 while we reevaluate our domestic life strategy and therefore the majority of the premium recorded in 2017 is related to renewal business.
Net Investment Income
. Net investment income has increased due to continued growth in average invested assets even though the annual yield has
increase
d 5 basis points in this segment from
2016
, as discussed in the Consolidated Results of Operations above.
|
|
For the Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands, except for %)
|
||||||||
|
Net investment income
|
$
|
38,578
|
|
|
33,350
|
|
|
30,206
|
|
|
Average invested assets, at amortized cost
|
890,705
|
|
|
779,592
|
|
|
684,590
|
|
|
|
Annualized yield on average invested assets
|
4.33
|
%
|
|
4.28
|
%
|
|
4.41
|
%
|
|
Realized Investment Losses, Net
. In
2017
,
2016
and
2015
, this segment recognized losses on other-than-temporary impairments totaling $13,500, $2.3 million and $3.8 million, respectively, related to bond and mutual fund holdings.
Claims and Surrenders
. A breakout of claims and surrender benefits is detailed below.
|
|
For the Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Death claims
|
$
|
5,530
|
|
|
5,886
|
|
|
6,843
|
|
|
Surrender expenses
|
34,275
|
|
|
30,502
|
|
|
28,767
|
|
|
|
Endowment benefits
|
15,117
|
|
|
16,160
|
|
|
16,256
|
|
|
|
Matured endowments
|
2,364
|
|
|
2,937
|
|
|
1,304
|
|
|
|
Accident and health benefits
|
253
|
|
|
365
|
|
|
325
|
|
|
|
Other policy benefits
|
2,854
|
|
|
2,590
|
|
|
2,417
|
|
|
|
Total claims and surrenders
|
$
|
60,393
|
|
|
58,440
|
|
|
55,912
|
|
|
•
|
Death claims expense decreased 6.0% in
2017
compared to
2016
and decreased 14.0% in
2016
compared to
2015
. No unusual trends have been noted in our claims experience. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
|
38
|
•
|
We noted increases in surrender expense over the last several years which is primarily related to our international business and is expected to increase over time due to the aging of this block of business. The majority of policy surrender benefits paid is attributable to our international business and historically was related to policies that have been in force over fifteen years, when surrender charges are no longer applicable. However, in 2017 and 2016, the increased surrender activity is also in the earlier durations (years 1-15), which still have surrender charges. We are seeing various reasons for individuals surrendering their policies, including the sustained slow world-wide economy, individuals simply needing their money and former independent consultants moving business to other insurance carriers.
|
|
•
|
Endowment benefit expense results from the election by policyholders of a product feature that provides an annual benefit. This is a fixed benefit over the life of the contract, and this expense will increase with new sales and improved persistency.
|
|
•
|
Matured endowments decreased in the current year after increasing in
2016
and
2015
. We expect this increasing trend to continue as this block of business increases, persists and policies begin to reach maturity.
|
|
•
|
Other policy benefits resulted primarily from interest paid on premium deposits and policy benefit accumulations and increased as these policy liabilities also increased.
|
Increase in Future Policy Benefit Reserves
. Policy benefit reserves in
2017
decreased compared to the same period in
2016
, primarily as a result of the higher surrenders and the lower new sales as noted above.
Policyholder Dividends
. Policyholders' dividends decreased 8.1% and 36.7% or $0.5 million and $3.9 million respectively in
2017
and
2016
, due to the dividend rate actions taken by us at the end of
2016
to improve our product profitability. The Company issues long duration participating policies to foreign residents that are expected to pay dividends to policyholders based upon actual experience. The life company boards approve any dividends on an annual basis and may change the dividend rates as needed for business purposes. Policyholder dividends are factored into the premiums at the time the product is developed and therefore have no impact on expected profitability.
Capitalization and Amortization of Deferred Policy Acquisition Costs
. Capitalized costs decreased, as commission-related costs have decreased in the current year compared to
2016
based upon first year and renewal sales levels. Amortization of DAC
increased
in the current year by
3.5%
from
2016
as we experienced increased surrender activity in the current year, including early duration elections to convert to reduced paid up ("RPU") or extended term insurance ("ETI") in 2017 and 2016. There are higher deferred acquisition costs associated with early duration conversions to RPU or ETI, which, when converted, increases amortization expense. Amortization of deferred policy acquisition costs is impacted by persistency and the higher level of surrenders is impacting our amortization.
Commissions
. Commission expense increases or decreases are directly related to increases or decreases in premiums. First year policy premiums pay a higher commission rate than renewal policy premiums.
Other General Expenses
. Expenses increased in the current year
30.2%
to
$18.6 million
in
2017
compared to
$14.3 million
in
2016
, due primarily to increased legal, consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. The expenses are allocated by segment, based upon an annual expense study performed by the Company.
39
Home Service Insurance
Our Home Service Insurance segment provides pre-need and final expense ordinary life insurance and annuities to middle and lower income individuals primarily in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through funeral homes and a home service marketing distribution system utilizing over
650
employees and independent agents.
|
|
Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Revenue:
|
|
|
|
|
|
||||
|
Premiums
|
$
|
47,012
|
|
|
46,681
|
|
|
46,648
|
|
|
Net investment income
|
13,132
|
|
|
13,705
|
|
|
14,063
|
|
|
|
Realized investment gains (losses), net
|
979
|
|
|
(300
|
)
|
|
(1,586
|
)
|
|
|
Other income
|
3
|
|
|
5
|
|
|
86
|
|
|
|
Total revenue
|
61,126
|
|
|
60,091
|
|
|
59,211
|
|
|
|
Benefits and expenses:
|
|
|
|
|
|
|
|
|
|
|
Insurance benefits paid or provided:
|
|
|
|
|
|
|
|
||
|
Claims and surrenders
|
22,512
|
|
|
22,927
|
|
|
22,967
|
|
|
|
Increase in future policy benefit reserves
|
5,246
|
|
|
4,508
|
|
|
3,801
|
|
|
|
Policyholders' dividends
|
42
|
|
|
58
|
|
|
52
|
|
|
|
Total insurance benefits paid or provided
|
27,800
|
|
|
27,493
|
|
|
26,820
|
|
|
|
Commissions
|
15,564
|
|
|
15,406
|
|
|
15,289
|
|
|
|
Other general expenses
|
23,395
|
|
|
15,252
|
|
|
13,349
|
|
|
|
Capitalization of deferred policy acquisition costs
|
(5,963
|
)
|
|
(5,990
|
)
|
|
(5,836
|
)
|
|
|
Amortization of deferred policy acquisition costs
|
4,395
|
|
|
4,087
|
|
|
3,375
|
|
|
|
Amortization of cost of customer relationships acquired
|
1,534
|
|
|
1,504
|
|
|
1,676
|
|
|
|
Total benefits and expenses
|
66,725
|
|
|
57,752
|
|
|
54,673
|
|
|
|
Income (loss) before federal income tax expense
|
$
|
(5,599
|
)
|
|
2,339
|
|
|
4,538
|
|
Premiums
. The premiums in this segment increased in
2017
compared to
2016
, as renewal premiums and first year premiums increased. There was no real growth in new business in
2016
compared to
2015
.
The following table sets forth our direct premiums by state for the periods indicated.
|
|
Years ended December 31,
|
|||||||||||||||||||
|
|
2017
|
|
2016
|
|
2015
|
|||||||||||||||
|
|
(In thousands, except for %)
|
|||||||||||||||||||
|
State
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
|
Louisiana
|
$
|
42,837
|
|
|
89.6
|
%
|
|
$
|
42,605
|
|
|
89.6
|
%
|
|
$
|
42,537
|
|
|
89.4
|
%
|
|
Mississippi
|
2,369
|
|
|
5.0
|
|
|
2,450
|
|
|
5.2
|
|
|
2,564
|
|
|
5.4
|
|
|||
|
Arkansas
|
1,716
|
|
|
3.6
|
|
|
1,602
|
|
|
3.4
|
|
|
1,585
|
|
|
3.3
|
|
|||
|
Other States
|
906
|
|
|
1.8
|
|
|
883
|
|
|
1.8
|
|
|
871
|
|
|
1.9
|
|
|||
|
Total
|
$
|
47,828
|
|
|
100.0
|
%
|
|
$
|
47,540
|
|
|
100.0
|
%
|
|
$
|
47,557
|
|
|
100.0
|
%
|
Net Investment Income
. Net investment income decreased in
2017
as our average invested assets decreased as did the overall portfolio yield by 13 basis points from
2016
as higher yielding securities matured and lower rate securities are purchased in the current interest rate environment.
40
Net investment income for our home service insurance segment is summarized as follows:
|
|
For the Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands, except for %)
|
||||||||
|
Net investment income
|
$
|
13,132
|
|
|
13,705
|
|
|
14,063
|
|
|
Average invested assets, at amortized cost
|
289,634
|
|
|
294,132
|
|
|
300,174
|
|
|
|
Annualized yield on average invested assets
|
4.53
|
%
|
|
4.66
|
%
|
|
4.68
|
%
|
|
Realized Investment Gains (Losses), Net
. A gain of $1.1 million was recognized on the sale of real estate property in the current year. In
2017
,
2016
and
2015
, this segment recognized losses on other-than-temporary impairments totaling $0.2 million, $2.0 million and $1.6 million, respectively, related to bond and mutual fund holdings.
Claims and Surrenders
. A breakout of claims and surrender benefits is detailed below.
|
|
For the Years Ended December 31,
|
||||||||
|
|
2017
|
|
2016
|
|
2015
|
||||
|
|
(In thousands)
|
||||||||
|
Death claims
|
$
|
17,243
|
|
|
17,218
|
|
|
17,794
|
|
|
Surrender expenses
|
2,917
|
|
|
3,184
|
|
|
2,915
|
|
|
|
Endowment benefits
|
17
|
|
|
13
|
|
|
17
|
|
|
|
Matured endowments
|
518
|
|
|
455
|
|
|
469
|
|
|
|
Property claims
|
1,744
|
|
|
1,941
|
|
|
1,689
|
|
|
|
Accident and health benefits
|
56
|
|
|
98
|
|
|
63
|
|
|
|
Other policy benefits
|
17
|
|
|
18
|
|
|
20
|
|
|
|
Total claims and surrenders
|
$
|
22,512
|
|
|
22,927
|
|
|
22,967
|
|
|
•
|
Death claims expense was relatively flat in
2017
compared to
2016
, after decreasing in
2016
from
2015
. Death claims can fluctuate from year to year. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
|
|
•
|
Surrender expenses are consistent with actuarial expectations.
|
|
•
|
Property claims
decreased
in
2017
compared to
2016
related to reported weather claims. The large increase in 2016 was primarily due to tornado activity in Louisiana earlier in the year and high winds that accompanied the severe flooding in Louisiana.
|
Increase in Future Policy Benefit Reserves
. The change in reserves increase is related to the increase in current year sales.
Commissions
. Commission expense was comparable for all three periods presented based upon fluctuations in premiums collected.
Other General Expenses
. Expenses increased 53.4% due primarily to increased company-allocated expenses based upon our annual time study and related to legal, consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. Expenses are allocated by segment based upon an annual expense study performed by the Company. We recorded expenses in
2017
related to the write-off of our Home Service goodwill value of $4.6 million. The
2017
expenses related to the IRC tax compliance issue for life and annuity insurance remediation expense remained flat compared to the
2016
expense, while in
2016
the expense decreased $1.7 million due to further refinement of our estimates.
Capitalization and Amortization of DAC
. DAC capitalization is directly correlated to fluctuations in first year commissions. Amortization of DAC increased from
2016
to
2017
by
7.5%
and by
21.1%
from
2015
to
2016
. This increase in
41
2016
was primarily due to an increase in surrenders, although both
2016
and
2017
increases reflect the impact of updated annual U.S. GAAP assumptions as well. We monitor lapse rates as a key component of our insurance operations.
Other Non-Insurance Operations
This operating unit represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under U.S. GAAP, which typically results in a segment loss.
Investments
Financial stability and capital preservation 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 liabilities. The administration of our investment portfolios is handled internally, pursuant to board-approved investment guidelines, with all trading activity approved by a committee of each entity’s respective board of directors. The guidelines used require that securities are of high quality and investment grade. 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 selected are generally 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. Due to the prolonged low interest rate environment, we have intentionally shortened the duration of our asset portfolio to capitalize on new investment purchases as interest rates rise. As rates rise, we plan to extend assets durations and increase investment yields.
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.
|
|
December 31, 2017
|
|
December 31, 2016
|
||||||||||
|
|
Carrying
Value
|
|
% of Total
Carrying Value
|
|
Carrying
Value
|
|
% of Total
Carrying Value
|
||||||
|
|
(In thousands, except for %)
|
||||||||||||
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
||||||
|
U.S. Treasury and U.S. Government-sponsored enterprises
|
$
|
16,304
|
|
|
1.2
|
%
|
|
$
|
22,695
|
|
|
1.8
|
%
|
|
Corporate
|
409,610
|
|
|
30.3
|
|
|
306,134
|
|
|
24.3
|
|
||
|
Municipal bonds (1)
|
780,557
|
|
|
57.7
|
|
|
797,240
|
|
|
63.4
|
|
||
|
Mortgage-backed (2)
|
1,978
|
|
|
0.1
|
|
|
2,477
|
|
|
0.2
|
|
||
|
Foreign governments
|
121
|
|
|
—
|
|
|
126
|
|
|
—
|
|
||
|
Total fixed maturity securities
|
1,208,570
|
|
|
89.3
|
|
|
1,128,672
|
|
|
89.7
|
|
||
|
Short-term investments
|
—
|
|
|
—
|
|
|
508
|
|
|
—
|
|
||
|
Cash and cash equivalents
|
46,064
|
|
|
3.4
|
|
|
35,510
|
|
|
2.8
|
|
||
|
Other investments:
|
|
|
|
|
|
|
|
|
|
||||
|
Policy loans
|
73,735
|
|
|
5.5
|
|
|
66,672
|
|
|
5.3
|
|
||
|
Equity securities
|
16,164
|
|
|
1.2
|
|
|
18,159
|
|
|
1.5
|
|
||
|
Mortgage loans
|
195
|
|
|
—
|
|
|
232
|
|
|
—
|
|
||
|
Real estate and other long-term investments
|
7,452
|
|
|
0.6
|
| ||||||||