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, 2021
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-16509
CITIZENS, INC.
(Exact name of registrant as specified in its charter)
| Colorado | 84-0755371 | |||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. employer identification no.) | |||||||
11815 Alterra Pkwy, Suite 1500, Austin, TX 78758
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 837-7100
| Securities registered pursuant to Section 12(b) of the Act | ||||||||
| Class A Common Stock | CIA | New York Stock Exchange | ||||||
| (Title of each class) | (Trading symbol(s)) | (Name of each exchange on which registered) | ||||||
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. ☐ Yes ☒ 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. ☐ Yes ☒ 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. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). ☒ Yes ☐ No
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 the 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 | ☐ | Accelerated filer | ☒ | Non-accelerated filer | ☐ | Smaller reporting company | ☐ | Emerging growth company | ☐ | ||||||||||||||||||||||||||||||||||||||
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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
As of June 30, 2021, the aggregate market value of the Class A common stock held by non-affiliates of the registrant was approximately $294,118,656.
Number of shares of common stock outstanding as of March 04, 2022.
Class A: 49,028,634
Class B: —
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 2022 Annual Meeting of Shareholders (the "2022 Proxy Statement"). The 2022 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.
TABLE OF CONTENTS
| Page | ||||||||
| PART I | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 1B. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| PART II | ||||||||
| Item 5. | ||||||||
| Item 6. | ||||||||
| Item 7. | ||||||||
| Item 7A. | ||||||||
| Item 8. | ||||||||
| Item 9. | ||||||||
| Item 9A. | ||||||||
| Item 9B. | ||||||||
| PART III | ||||||||
| Item 10. | ||||||||
| Item 11. | ||||||||
| Item 12. | ||||||||
| Item 13. | ||||||||
| Item 14. | ||||||||
| PART IV | ||||||||
| Item 15. | ||||||||
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (“Form 10-K”) contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Many of the forward-looking statements are located in Part II, Item 7 of this Form 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements include, but are not limited to, statements regarding:
•the Company being positioned to offer stability to our management team, employees and independent sales force in order to move forward with our business and strategic initiatives;
•cross-selling opportunities leading to revenue growth;
•efforts to develop and enhance our products, incentivize our sales force and make process and technology improvements to put the Company on a stronger financial footing and drive sustainable growth;
•competitive advantages over competitors;
•continued premium growth in the Home Service Insurance segment via new products and increased focus on direct sales through our independent agents;
•the attractiveness and competitiveness of our standard commission structure;
•the long-term value of providing agent campaigns and promotions with additional incentives;
•the impact of our retention efforts on the decline in renewal premiums;
•the increasing need for age-related products and increasing demand for living benefit products rather than death benefit products; and
•the impact of the COVID-19 pandemic on our first year premium revenue.
Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A of this Form 10-K under the heading “Risk Factors.” Currently, some of the most significant factors that could cause our actual results to differ significantly from our forward-looking statements include risks related to the ongoing COVID-19 pandemic, such as:
•a higher level of claims due to COVID-19 deaths;
•decreased premium revenue due to disruption to our workforce or distribution channel resulting from required isolation, travel limitations and business restrictions;
•higher surrenders and lapses due to cash needs our policyholders may have due to concerns over COVID-19 economic impacts, particularly in our international business; and
•volatility in our investment portfolio due to market disruptions caused by COVID-19 related concerns such as inflation.
The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. You should be aware that factors not referred to above could affect the accuracy of our forward-looking statements and use caution and common sense when considering our forward-looking statements.
The U.S. Securities and Exchange Commission ("SEC") maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov. We also make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 Reports filed by officers and directors, 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,
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as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the SEC. We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Form 10-K.
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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 provide insurance benefits to residents in 31 U.S. states and more than 70 different countries. We pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We had approximately $1.9 billion of assets at December 31, 2021 and approximately $4.2 billion of insurance in force. We operate in two business segments:
•Life Insurance segment - U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to non-U.S. residents, located principally in Latin America and the Pacific Rim through independent marketing consultants and whole life insurance sold domestically through independent agents; and
•Home Service Insurance segment - final expense life insurance and property insurance policies marketed to middle- and lower-income households, as well as whole life products with higher allowable face values, in Louisiana, Mississippi and Arkansas, and sold through independent agents and through funeral homes.
As an insurance provider, we collect premiums on an ongoing basis from our policyholders and invest the majority of the premiums to pay future benefits, including claims, surrenders and policyholder dividends. Accordingly, the Company derives its revenues principally from: (1) premiums earned for insurance coverage provided to our policyholders; and (2) net investment income. In addition to paying and reserving for insurance benefits that we pay to our policyholders, our expenses consist primarily of the costs of selling our insurance products (e.g., commissions, underwriting, marketing expenses), operating expenses and income taxes.
Because collection of premiums is the primary source of our revenues, our overall financial performance depends primarily upon the pricing of our insurance products and the accuracy of our pricing assumptions. The Company seeks to price our insurance policies such that insurance premiums and future net investment income earned on premiums received will cover the ultimate cost of paying claims on our policies, our expenses and will also yield a profit margin. Pricing adequacy depends on a number of factors, including 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, the ability to obtain regulatory approval for rate changes, expectations about regulatory and legal developments and expense levels.
In order to manage the risks related to pricing, we employ medical underwriting procedures to assess and quantify risks before we issue policies. Insurance applications are reviewed to make two determinations: first, eligibility based on established underwriting guidelines and second, the applicable premium. We periodically review our underwriting requirements and may make changes as needed.
We also seek to manage pricing risk through:
•favorable risk selection and diversification;
•management of claims;
•use of reinsurance;
•careful monitoring of our mortality and morbidity experience; and
•management of our expense ratio.
In addition to insurance premiums, 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. Pursuant to regulatory guidelines, most of the Company’s invested assets are held in available-for-sale ("AFS") fixed maturity securities, primarily in asset classes of corporate bonds, municipal bonds, and government obligation bonds. The interest rate environment has a
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significant impact on the determination of insurance contract liabilities, our investment rates and yields, and our asset/liability management. The profitability of our "spread-based" product features depends largely on the Company’s ability to earn higher returns on invested assets than the interest we credit to policyholders.
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 prudent investment strategy that may vary based on a variety of factors including business needs, regulatory requirements and tax considerations.
IN 2021, WE BECAME A NON-CONTROLLED COMPANY
Throughout most of our history, the Company was led and controlled by our founder Harold E. Riley and his family members. Mr. Riley passed away in 2017 and in 2020, a change-in-control of our Company occurred when the shares held by the Harold E. Riley Trust were transferred to the Harold E. Riley Foundation (the “Foundation”). As a result of this change-in-control:
•On August 5, 2020, Geoffrey Kolander, our Chief Executive Officer and President resigned and Gerald W. Shields, the Vice Chairman of the Board of Directors of the Company, was appointed Interim Chief Executive Officer and President; and
•In February 2021, the Company entered into an agreement with the Foundation to purchase all of the outstanding shares of Class B common stock for a purchase price of $9.1 million (the “B Share Transaction”).
In April 2021, the Company and the Foundation obtained all regulatory approval required to consummate the B Share Transaction. In accordance with Colorado law, the shares of Class B common stock are now classified as authorized, but unissued shares and the Company's Board of Directors (the "Board") has resolved not to vote the shares of Class B common stock as long as they are so classified. Accordingly, since April 2021:
•the Company has only one class of stock outstanding: the Class A common stock, which is registered under the Securities Exchange Act of 1934, as amended, and listed on the New York Stock Exchange (“NYSE”); and
•the Class B Shares do not have any voting rights; and
•the holders of the Class A shares are entitled to elect all of the directors at the Company’s annual meetings; and
•for the first time in over 30 years, we are no longer a “controlled” company as defined under the NYSE rules.
After the consummation of the B Share Transaction, Mr. Shields, then acting as our Interim Chief Executive Officer, began working with the Board and management to create and implement a new strategy for the Company in order to set a course for long-term profitable growth. In December 2021, the Board announced that effective January 1, 2022, Mr. Shields would become the permanent CEO and President.
After the B Share Transaction and the appointment of Mr. Shields as our permanent Chief Executive Officer, the Company believes that it is positioned to offer stability to our management team, employees and independent sales force in order to move forward with our business and strategic initiatives, as described below.
STRATEGIC INITIATIVES
As mentioned above, in 2021, the Company became a non-controlled company for the first time in over 30 years. This change allowed the Board and management to reset and clearly define our priorities to set a course for long-term profitable growth. Our growth strategy consists of focusing on sales growth, improved policy retention, roadmap execution, and financial and expense discipline.
We believe that our roadmap execution is key to achieving sales growth, as it helps us improve sales and service across our three markets (international life, domestic life and home services) by focusing on three specific sales
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levers in each market- products, promotions and processes. Specifically, we implemented a five-quarter roadmap that lays out the following:
•Products. We are focusing on our customer needs by offering new products tailored to our specific markets and enhancing existing products. New products also help our sales force, as they can sell additional products to existing customers and offer a broader portfolio of products to entice prospective customers.
•Promotions. We are focused on implementing sales promotions and campaigns in order to align our sales consultant compensation opportunities with our premium revenue goals, and our growth and retention initiatives.
•Processes. We are implementing process improvements and new technologies in order to get products to our customers faster and improve services for both our policyholders and our agents, as well as helping our employees work more effectively and efficiently.
Status of New and Enhanced Products; Trends in Market Demand
As mentioned above, offering new and enhanced products are key to achieving our strategic goals. In 2021 we:
Introduced New Products in our Home Service Insurance Segment. Over the past 18 months, our Home Service Insurance business has been a focus of transformation to drive sales growth for the Company. Prior to mid-2020, the focus of this segment was collections, i.e. renewal premiums and our sales force had sold the same life insurance product for over 30 years. In 2021, we introduced a higher face value whole life product in this segment, allowing us to expand our target customer. In December 2021, we launched a critical illness product that offers a true living benefit to policyholders by paying a lump sum amount in the event of a covered critical illness to use at the policyholder's discretion. As we continue to expand our product offerings in this market, we believe that cross-selling opportunities (i.e., selling new products to existing customers and offering more than one product to a new customer) will lead to revenue growth.
Reevaluated expansion of Life Insurance Segment into Hispanic US Market. As we previously disclosed, in 2021 we undertook an initiative to expand our Life Insurance segment to the Hispanic market in the U.S. by bringing our infrastructure to complete insurance transactions end-to-end in Spanish to the Florida market. We launched three products in this market in 2021. While we still believe that there is a need for this type of product and service in the U.S., our efforts to recruit agents to sell our products have been slower than we expected and we are re-evaluating our sales distribution approach, initiatives and domestic life insurance offerings in the Florida market in 2022.
Retention
As policy surrenders have increased in our business over the last several years, in 2021, we formed a retention steering team in an effort to curb policy surrenders. This team focused on cultivating and executing on ideas that would increase each of our segments' overall retention, while being beneficial to our policyholders. Both our Life Insurance segment and our Home Service Insurance segment improved policy retention in 2021 due to these efforts.
As we seek to optimize value for the Company's shareholders, customers and distributors, we believe our efforts to develop and enhance our products, incentivize our sales force and make process and technology improvements will continue to put the Company on a stronger financial footing and drive sustainable growth.
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LIFE INSURANCE
Our Life Insurance segment primarily operates through CICA Life Ltd. ("CICA International"), a Bermuda company.
INTERNATIONAL LIFE INSURANCE
Sales
We focus our international sales to residents in Latin America and the Pacific Rim. As of December 31, 2021, we had insurance policies in force in more than 70 foreign countries and receive the majority of our premiums from Colombia, Venezuela, Taiwan, Ecuador and Argentina. International direct premiums comprised approximately 96% of total direct premiums in the Life Insurance segment and 68% of our total direct premiums in 2021.
We believe positive attributes of our international insurance business typically include:
•larger face amount policies issued when compared to our U.S. operations, which results in lower underwriting and administrative costs per dollar of coverage;
•high persistency and low mortality charges due to our customer demographics; and
•premiums paid annually at the beginning of each policy year rather than monthly or quarterly, which reduces our administrative expenses, accelerates cash flow and results in lower policy lapse rates than premium payment options with more frequently scheduled payments.
Our international sales force consists of independent marketing agencies and consultants who specialize in marketing life insurance products and generally have several years of insurance marketing experience. We enter into sales and service contracts with the independent marketing agencies pursuant to which they recruit, train and supervise their managers and associates in the sales and service of our products. These agencies receive commissions for products they sell, as well as commission overrides on the business that their agents produce and, in return for the override, they guarantee any debt their agents owe to us. Their sales agents also contract directly with us as independent consultants and receive commission compensation directly from us. This allows us to develop a relationship with their associates so if an agency contract is terminated for any reason, we may seek to continue the existing independent consultant marketing arrangements with the associates of such agency. Our agreements typically provide that the agencies and their agents are independent consultants responsible for their own operational expenses and are the representative of the prospective insured. Our contracts require the independent marketing agencies and consultants to understand and comply with all laws applicable to sales of our products in their country.
Products
CICA International issues ordinary whole life insurance and endowment products in U.S. dollar-denominated amounts to non-U.S. residents. The whole life insurance products are designed to provide a fixed amount of insurance coverage over the life of the insured and can include rider benefits to provide additional coverage and annuity benefits to enhance accumulations. Our endowment contracts are principally accumulation contracts that incorporate an element of life insurance protection. These products have premium rates that are competitive with most foreign local companies and have been structured to provide the policyowners with:
•U.S. dollar-denominated cash values that accumulate, beginning in the first policy year, throughout a policyholder’s lifetime;
•protection against devaluation of the policyowners' local currency;
•capital investment in a more secure economic environment (i.e., the U.S.); and
•lifetime income guarantees for an insured or for surviving beneficiaries.
Our international products have both living and death benefit features. Most policies contain guaranteed cash values and are participating (i.e., provide for cash dividends as apportioned by CICA International's board of directors). Once a policyowner pays the annual premium and the policy is issued, the owner becomes entitled to policy cash dividends and may elect to receive annual premium benefits. The policyowner has several options with regards to the policy dividends and annual premium benefits, which include, among other things, electing to receive cash, crediting such amounts towards the payment of premiums on the policy, leaving such amounts on deposit with the Company to accumulate at a defined interest rate or assigning them to a third-party. Under the "assigned to a
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third-party" provision, the Company has historically allowed policyowners, 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 Class A common stock, the right to assign policy values outside of the policy to the CISIP, which is administered in the United States by Computershare Trust Company, N.A., our plan administrator and an affiliate of Computershare, Inc., our transfer agent. The CISIP is a direct stock purchase plan available to policyowners, shareholders, our employees and directors, 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 SEC. 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 SEC.
Competition
The life insurance business is highly competitive. Internationally, we compete with a number of life insurance companies, as well as with financial institutions that offer insurance products.
We face competition from other insurance companies that operate in the same markets and manner as we do. Additionally, some of our competitors are local companies formed and operated in the country in which an insured resides, and others are companies foreign to the countries in which their products are sold, but issue insurance policies denominated in the local currency of those countries or issue products approved by regulators of those countries. Some of these companies may have a competitive advantage over us due to their greater financial resources, histories of successful operations and brand recognition, local licensing, partnering with local insurance companies and larger marketing forces.
We believe that we have a competitive advantage over some of our competitors because premiums on our international policies are paid in U.S. dollars, cash value is accumulated in U.S. dollars, and we pay claims and benefits in U.S. dollars. We believe this provides security and stability to our insureds, who are generally individuals in the middle to upper-middle class in their respective countries with significant net worth and earnings. Therefore, our products protect them from the inflationary risks and economic crises that have been common in many of our top-producing foreign countries.
DOMESTIC LIFE INSURANCE
We operate our domestic life insurance business through CICA Life Insurance Company of America ("CICA") and Citizens National Life Insurance Company ("CNLIC"). In 2021, domestic direct life insurance premiums comprised approximately 4% of total direct premiums in the Life Insurance segment and 3% of our consolidated total direct premiums. The majority of our domestic in force business results from renewal premiums from blocks of business of insurance companies we have acquired over the years. CICA and CNLIC issued domestic ordinary whole life and endowment life insurance products prior to 2017, and except for our new domestic initiative described below, continues to sell primarily credit life and accident and health products in Texas.
In 2021, we undertook an initiative to re-start domestic sales in Florida. We believe that our experience in developing and selling products in Latin America will help us expand into the large Hispanic market in the U.S. However, our efforts to recruit agents to sell our product have been slower than we expected and we are re-evaluating our sales distribution approach, initiatives and domestic offerings in the Florida market in 2022.
HOME SERVICE INSURANCE
We operate our domestic Home Service Insurance segment only in the U.S. through our subsidiaries Security Plan Life Insurance Company ("SPLIC"), Magnolia Guaranty Life Insurance Company ("MGLIC") and Security Plan Fire Insurance Company ("SPFIC"). SPLIC and MGLIC focus on final expense life insurance needs of middle- and lower-income markets, primarily in Louisiana, Mississippi and Arkansas. Prior to 2021, all of our Home Service Insurance products issued by SPLIC were sold primarily through employee agents who worked on a debit route system. Starting in late 2020 and continuing throughout 2021, we have been transforming this segment by converting a large portion of our sales force to independent agents, reducing layers of management and introducing
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new products for the first time in almost 35 years. This transformation led to increased sales and decreased operational expenses in 2021.
Policies issued by MGLIC are primarily burial policies which are sold and serviced through funeral homes, who are also typically the beneficiaries of the policies.
SPFIC is a limited liability casualty company that sells small face value property insurance policies covering dwelling and contents, primarily in Louisiana. In 2021, we expanded our product offering to Arkansas in part to mitigate the risk of hurricane-related claims that have impacted our business over the last two years.
In 2021, our Home Service Insurance segment comprised 29% of our total consolidated direct premiums.
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 (e.g. funeral and burial costs). The average life insurance policy face amount issued in 2021 was approximately $7,900 per policy. Due to the lower risk associated with small face amount polices, the underwriting performed on these applications is limited. As part of the Home Services Insurance segment transformation mentioned above, in 2021 we introduced a new product, Security Plan Plus, which has a higher allowed face amount. In December 2021, we also introduced a critical illness product, which pays the insured a lump sum following the diagnosis of an illness covered under the plan. To a much lesser extent, our Home Service Insurance segment sells property insurance policies covering dwellings and content. We provide $30,000 maximum coverage on any one dwelling and contents, while content-only coverage and dwelling-only coverage are both limited to $20,000.
We face competition in Louisiana, Mississippi and Arkansas from other companies specializing in final expense insurance as well as from other property & casualty insurance companies. We seek to compete based upon our emphasis on personal service to our customers. We intend to continue premium growth within this segment via our new products and increased focus on direct sales through our independent agents.
REINSURANCE
We follow the industry practice of reinsuring a portion of our insurance risks with unaffiliated reinsurers. In a reinsurance transaction, a reinsurer agrees to indemnify another insurer for part or all of its liability under a policy or policies it has issued for an agreed upon premium. We participate in reinsurance activities in order to minimize exposure to significant risks, limit losses, and provide additional capacity for future growth. We enter into various agreements with reinsurers that cover individual risks, group risks or defined blocks of business, primarily on a coinsurance, yearly renewable term, excess of loss or catastrophe excess basis.
For the majority of our life insurance business, we retain the first $100,000 of risk on any one life and reinsure the remainder of the risk. Therefore, under the terms of the reinsurance agreements, the reinsurers agree to reimburse us for the ceded amount (i.e., the death benefit amount less our retained risk) in the event a claim is paid. Cessions under reinsurance agreements do not discharge our obligations as the primary insurer. In the event reinsurers do not meet their obligations under the terms of the reinsurance agreements, reinsurance recoverable balances could become uncollectible.
For SPFIC, we obtain catastrophic reinsurance in order to minimize the risks related to payments we owe our insureds due to catastrophic events, such as hurricanes. Upon the occurrence of a catastrophic event, we retain (i.e., pay) the first $500,000 in claims, and then the reinsurer pays the next $10.5 million in claims. Upon the occurrence of a catastrophic event, in order to continue receiving reinsurance, we also have to pay reinstatement premiums in order to be covered for another catastrophic event in the same calendar year.
Our amounts recoverable from reinsurers represent receivables from and/or reserves ceded to reinsurers. The amounts recoverable from reinsurers were $5.5 million as of December 31, 2021.
We focus on obtaining reinsurance from a diverse group of well-established reinsurers. We have restructured our reinsurance relationships as of January 1, 2021 and reinsure our international business with three different
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reinsurers and our domestic business with two reinsurers. We regularly evaluate the financial condition of our reinsurers and monitor concentration risk with our reinsurers.
OTHER NON-INSURANCE ENTERPRISES
Other Non-Insurance Enterprises includes the results of our parent company, Citizens, Inc. and our non-insurance subsidiary, Computing Technology, Inc., which entities primarily provide the Company's information technology and corporate-support functions to the insurance operations.
OPERATIONS AND TECHNOLOGY
Most of our operations are based at our corporate headquarters in Austin, Texas. We also conduct operations for our Home Service Insurance segment from our district offices in Louisiana, Arkansas and Mississippi, as well as our service center in Donaldsonville, Louisiana. At our Bermuda office, we perform underwriting, policy issuance, claims processing, accounting and reporting related to CICA International's policies.
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 and block of business we have acquired has been 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.
REGULATION
The insurance industry is heavily regulated and both Citizens and our insurance subsidiaries are subject to regulation and supervision by the U.S. states in which they do business, by U.S. federal laws, and for CICA International, by Bermuda.
INTERNATIONAL REGULATION
Bermuda
CICA International, our Bermuda domiciled subsidiary, is subject to regulation and supervision by the Bermuda Monetary Authority (the "BMA") and compliance with all applicable Bermuda laws and insurance statutes and regulations, including but not limited to Bermuda’s Insurance Act of 1978 (the "Insurance Act").
CICA International, which is incorporated to conduct long-term business, is registered as a Class E insurer, which is the license class for long-term insurers and reinsurers with total assets of more than $500 million that are not registrable as a single-parent or multi-owner long-term captive insurer or reinsurer. CICA International is not licensed to conduct any business other than life insurance business. The Insurance Act regulates the insurance business of CICA International and provides that no person may conduct any insurance business in or within Bermuda unless registered as an insurer under the Insurance Act by the BMA.
The Insurance Act imposes solvency and liquidity standards as well as auditing and reporting requirements and confers on the BMA powers to supervise, investigate and intervene in the affairs of insurance companies. Certain requirements of the Insurance Act include: the filing of annual statutory financial returns; the filing of annual U.S. GAAP financial statements; the filing of an annual capital and solvency return; the delivery of a declaration of compliance; compliance with minimum enhanced capital requirements; compliance with the BMA’s Insurance Code of Conduct; compliance with minimum solvency margins; limitations on dividends and distributions that CICA International may make to Citizens, its parent company; preparation of an annual Financial Condition Report providing details of measures governing the business operations, corporate governance framework, solvency and financial performance; preparation of an assessment of an insurer's own risk and solvency requirements, referred to as a Commercial Insurer’s Solvency Self-Assessment; the establishment and maintenance of a head and principal office in Bermuda; appointment of an independent auditor; and appointment of an actuary approved by the BMA.
The BMA measures an insurer’s risk and determines appropriate levels of capitalization by using a risk-based capital model called the Bermuda Solvency Capital Requirement (“BSCR”), which CICA International uses to
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calculate its solvency requirements. The BSCR employs a standard mathematical model that correlates the risk underwritten by Bermuda insurers to their capital.
In order to minimize the risk of a shortfall in capital arising from an unexpected adverse deviation or excess risk, the BMA requires Bermuda insurers to maintain available statutory capital and surplus at a level equal to or in excess of the enhanced capital requirement, which requires a threshold capital level (termed the Target Capital Level ("TCL")), of 120% of a company’s enhanced capital requirement. The TCL serves as an early warning tool for the BMA. In addition to being required to meet the TCL, at the request of the BMA, on April 15, 2021, Citizens and CICA International entered into a “Keep Well Agreement.” The Keep Well Agreement requires Citizens to contribute up to $10 million in capital to CICA International as necessary to ensure that it has a minimum capital level of 120%.
Bermuda law distinguishes between those companies that are at least 60% owned and controlled by Bermudians, which are "local companies", and those which are owned and controlled by non-Bermudians, which are "exempted companies". Exempted companies may be resident in Bermuda and conduct business from Bermuda in connection with transactions and activities which are external to Bermuda or with other exempted companies, and exempted companies must obtain a license to conduct business activities within Bermuda from the Minister of Finance of Bermuda. Generally, it is not permitted without a special license granted by the Minister of Finance of Bermuda to ensure Bermuda domestic risks or risks of persons of, in or based in Bermuda and we do not offer insurance products to residents of Bermuda.
In December 2018, the Economic Substance Act (the "ES Act") came into force. The ES Act, as amended, and the regulations promulgated thereunder (collectively, "ES Law"), apply to any "relevant entity" that conducts any "relevant activity" in a "relevant financial period". Under the ES Law, insurance and holding entities are each defined as a "relevant activity" and thus the ES Act applies to CICA International. Under the provisions of the ES Law, a relevant entity that conducts a relevant activity must satisfy the economic substance requirements under the ES Law (the "ES Requirements") in relation to the relevant activity and where a relevant entity is conducting more than one relevant activity, it must meet the ES Requirements with respect to each relevant activity that it conducts. A relevant entity complies with the ES Requirements if: (a) the relevant entity is managed and directed from Bermuda; (b) the core income-generating activities are undertaken in Bermuda with respect to each relevant activity; (c) the relevant entity maintains an adequate physical presence in Bermuda; (d) there are adequate full-time employees in Bermuda with suitable qualifications; and (e) there is adequate operating expenditure incurred in Bermuda in relation to each relevant activity.
CICA International is required to demonstrate compliance with the ES Requirements by filing an annual economic substance declaration with the Registrar of Companies in Bermuda no later than six months after the last day of the relevant financial period. Companies that conduct insurance as a relevant activity are deemed to comply with the ES Requirements, with respect to their insurance business, if they comply with the existing regulatory requirements under the Insurance Act and the corporate governance provisions of the Companies Act 1981. CICA International is in compliance with these requirements as of December 31, 2021.
Other International Regulation
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. Other than Bermuda, we have never qualified to do business in any foreign country or jurisdiction and have never submitted our insurance policies for approval by any foreign or domestic insurance regulatory agency. As described above, we sell our policies to residents of foreign countries through independent marketing agencies and independent consultants located in those countries, and 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 in addressing circumstances similar to ours. Our compliance review has confirmed certain 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.
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U.S. REGULATION
Our domestic insurance subsidiaries are primarily regulated by the insurance departments of the state in which they are domiciled (Colorado, Louisiana, Texas and Mississippi). They are also regulated in each of the 31 states and the District of Columbia in which we conduct insurance business. In supervising and regulating insurance companies, state insurance departments generally aim to protect policyholders and the public rather than investors, and enjoy broad authority and discretion in applying applicable insurance laws and regulation for that purpose. The extent of this regulation varies, but most U.S. 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.
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 underwritten 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.
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.
Because Citizens is a holding company that directly and indirectly owns insurance operating subsidiaries, we are also subject to regulation in our four domiciliary states that require us to furnish the respective insurance regulators with financial and other information concerning the operations of, and the interrelationships and transactions among, the companies within our holding company system that may materially affect the operations, management or financial condition of the insurers within the system. 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. These laws also require that a controlling party obtain the approval of the insurance commissioner of the insurance company's jurisdiction of domicile prior to acquiring or divesting control of the insurer.
The payment of dividends or other distributions to Citizens by our insurance subsidiaries is also regulated by the insurance laws and regulations of their respective state or jurisdiction 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.
In addition to state insurance-specific laws, U.S. laws, such as the USA Patriot Act of 2001, the Foreign Corrupt Practices Act, 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, the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Tax Cuts and Jobs Act, are examples of U.S. laws that affect our business. We are subject to comprehensive regulations under the USA Patriot Act and the U.S. Bank Secrecy Act with respect to money laundering, as well as federal regulations regarding privacy and confidentiality. Our U.S.-based insurance products and thus our businesses also are affected by U.S. federal, state and local tax laws.
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HUMAN CAPITAL RESOURCES
Composition and Demographics
Our human capital is a critical component to our success. Our employees implement and drive our strategic initiatives and contribute to the success of our products (development, underwriting, pricing adequacy, customer service), promotions and processes. Our independent consultants and agents also drive our key goals, as they sell our insurance products and provide local services to our global base of policyholders. We also believe that we derive a great deal of strength from our diverse workforce. Fostering an equitable and inclusive workplace with diverse teams produces more creative solutions and results in more innovative products and services and is crucial to our efforts to attract, develop and retain key talent.
As of December 31, 2021, we had 215 employees. The pie charts below illustrate the gender, racial, ethnicity, and generational make-up of our total employee workforce as of such date.
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We determine race, ethnicity, gender, and generation based on our employees' self-identification or other information compiled to meet requirements of the U.S. government.
None of our employees are subject to a collective bargaining agreement.
We currently do not utilize captive employee agents to distribute our products and thus contract with almost 1,000 actively producing independent consultants internationally and over 500 independent agencies and agents domestically to sell and service our insurance products. Our independent agents generally reflect the demographics of the areas in which they sell their products, i.e., our agents in Latin America are almost all Hispanic or Latino and our agents in Taiwan are almost all Asian.
In order to continue to develop, sell and administer our products, it is crucial that we continue to attract and retain both experienced employees and independent agents.
Compensation and Benefits
Our compensation program is designed to attract and retain talented individuals who possess the skills necessary to support our business objectives, assist in the achievement of our strategic goals and create long-term value for our stockholders. We provide employees with compensation packages that include base salary and annual performance-based bonus opportunities that include cash, and for our executive officers, long-term equity awards currently in the form of restricted stock units ("RSUs"). We believe that a compensation program with both short-term cash awards and long-term equity awards provides fair and competitive compensation and aligns employee and stockholder interests. In addition to cash and equity compensation, we also offer standard employee benefits such as life and health (medical, dental & vision) insurance, HSA contributions, paid parental leave, and a 401(k) plan.
Independent agents work for themselves and may sell insurance policies for a variety of insurers and make most of their money through sales commissions and bonuses. We attract and retain our independent agent sales force through the use of our commission structure and agent campaigns and promotions. We believe that our standard commission structure is attractive and competitive in the market. In our Life Insurance segment, we believe our campaigns and promotions provide an extra incentive to agents that not only promote first year premium growth, but also create improvements within policyholder retention. In our Home Service Insurance segment, we believe our agent campaigns and promotions are critical in attracting and retaining our independent agent sales force. This business contains a large block of existing in force policies. To ensure we maintain this book of business, the agent campaigns and promotions provide an extra incentive to not only grow the business but to collect on the existing policies. We believe that providing agent campaigns and promotions with additional incentives that provide long-term value creates an advantage for Citizens over our competition.
Wellness
We are committed to the health and safety of our work force and compliance with applicable regulatory and legal requirements. In response to the COVID-19 pandemic, in 2021 we implemented operating changes that we determined were in the best interest of the health of our employees, including offering a hybrid work environment where our employees can work part- or full-time from home, depending on their position and circumstances. We also have implemented training programs to assist our independent agents with online sales efforts in order to minimize face-to-face interactions with potential customers and our policyholders.
Item 1A. RISK FACTORS
You should carefully consider the following discussion of risks. If any of these risks develop into actual events, our business, financial condition, results of operations or cash flows could be materially and adversely affected, and, as a result, the trading price of our Class A common stock could decline. These risk factors may also be important to understanding other statements in this Form 10-K. The following information should be read in conjunction with Part I. Item 3. Legal Proceedings, Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and accompanying notes in Part II. Item 8. Financial Statements and Supplementary Data of this report..
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Because of the following factors, as well as other factors affecting the Company’s financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
A SUBSTANTIAL PORTION OF OUR REVENUE IS GENERATED FROM INSURANCE PRODUCTS SOLD OUTSIDE OF THE UNITED STATES. WHILE OUR PRODUCTS ARE PRICED AND PAID FOR IN U.S. DOLLARS, OUR FOREIGN OPERATIONS MAY SUBJECT US TO SEVERAL RISKS.
Our sales to residents of foreign countries expose us to unknown risks related to foreign regulation, foreign currency and tax laws, and political instability. A significant loss of sales in these foreign markets would have a material adverse effect on our results of operations and financial condition.
International Regulatory Risks. A substantial majority of our direct insurance premiums, approximately 68% at December 31, 2021, are from policyholders in foreign countries, primarily those in Latin America and the Pacific Rim. These policies are issued by our Bermuda subsidiary, CICA International, and are sold by independent consultants who are located in the foreign countries in which the policies are sold. Other than Bermuda, we have never registered to do business in these countries, and our products have not been approved by a governmental authority. While 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 laws vary by country and there is a lack of uniform regulation and lack of clarity in certain regulations and thus we face various risks associated with the application of foreign laws to these sales.
Generally, all foreign countries in which we offer insurance products require either CICA International and/or our independent consultants to obtain 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. Other than Bermuda, where CICA International is domiciled, we have never sought to qualify to do business in any foreign country or jurisdiction and have never submitted the insurance policies that we issue to residents of foreign countries for approval by any insurance regulatory agency. Some foreign governments have determined under their existing laws that their residents may not purchase life insurance from us or sell life insurance on our behalf unless we become qualified to do business in that country or unless our policies receive prior approval from their insurance regulators. Others have a "consumption abroad" model where their residents may purchase unregistered products only if they are outside of their country when the purchase is made. There is a risk that foreign governments where we sell our products will 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 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 financially reasonable to comply with those requirements.
We have sought to mitigate the risks described above by, among other things, not locating any of our offices or assets in these foreign countries or jurisdictions, 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 Bermuda, 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 and servicing our insurance products in their respective countries. There is no assurance that these precautionary measures, practices and policies will partially or entirely mitigate the risks associated with the potential application of foreign laws to our sales of insurance policies in our foreign markets. From time to time, insurance regulators in the foreign countries in which we operate have sought to exercise regulatory authority over the Company, including through the imposition of fines and we have chosen not to do business in certain countries, such as Brazil, due to these actions. Although the Company believes that these foreign regulators do not have jurisdiction over the Company and that any actions, including fines, may be unenforceable against the Company, any regulatory action could otherwise absorb Company time and resources away from its business operations or the Company may choose to pay such fines in order to do business in a particular country. Alternatively, the Company may determine that the risks associated with a particular market and its regulatory environment outweigh the benefits of conducting further business in that market and discontinue doing business there.
Any actions by a foreign government to enforce these laws against us could cause disruption to the marketing and sale of our policies in that country or our withdrawal from doing business in that country, which could have a
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material adverse effect on our premium revenue, our costs and expenses and on our results of operations and financial condition.
International Currency and Tax Risks. Currency control laws or other currency exchange restrictions in foreign countries could materially adversely affect our revenues by limiting the ability of our policyholders in such countries to pay premiums in U.S. dollars or to receive U.S. dollar benefits. Additionally, difficulties in transferring funds from or converting currencies to U.S. dollars in certain countries could cause an increase in fees and costs associated with such payments or receipt of benefits and therefore make our products less attractive to such policyholders.
Bermuda participates in the Common Reporting Standard (CRS), which is an information standard for the automatic exchange of information regarding financial accounts on a global level, among tax authorities who participate in CRS. CICA International complies with CRS reporting requirements and therefore we send required account information to certain foreign tax regulators. Taxes imposed upon our policyholders by these foreign countries may cause our products to be less attractive than other products which may be more tax-advantaged. A significant loss of sales or surrenders due to tax reporting could materially impact our business.
International Political Risks. Many of the countries in which we operate have a history of political instability, including regime changes, political uprisings, and anti-democratic or anti-U.S. policies. The ability of people living in these countries to purchase and continue to make premium payments on our insurance policies and our ability to sell our policies in those countries through our independent consultants or otherwise may be adversely affected by political instability. Given the nature of our products, in an economic environment characterized by higher unemployment, lower personal income and reduced consumer spending, new product sales may be adversely affected. During such periods, we may also experience higher claims incidence, longer claims duration, increase in policy lapses and/or increase in surrenders, any of which could have a material adverse effect on our results of operations or financial condition. In addition, the imposition of U.S. sanctions against foreign countries where our policyholders reside could make it difficult for us to continue to issue new policies and receive premiums from policyholders in those countries.
We face significant competition in our international markets. If we are unable to compete effectively in these markets, our business, results of operations and profitability may be adversely affected.
Our international marketing plan focuses on offering U.S. dollar-denominated life insurance products to individuals residing in foreign countries and we depend on the ability of our independent consultants in foreign countries to effectively distribute our products. We experience considerable competition, primarily from the following sources, many of which have substantially greater financial, marketing and other resources than we have:
•Foreign companies with U.S. dollar-denominated policies. We face direct competition from companies that operate in the same manner as we do in our international markets, including from a company recently formed by some of our former employees and independent consultants who we have sued for, among other things, unfair competition (see, Part I. Item 3. Legal Proceedings);
•Foreign companies with locally operated subsidiaries that are registered in those countries and 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 cross-sold with high-need local insurance policies such as health insurance; and
•Locally operated companies with local currency policies. We compete with companies formed and operated in the country in which our foreign insureds reside.
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.
Since we rely on independent consultants for distribution of our products in foreign markets, regulation and licensing requirements imposed upon our Company may impact our ability to attract and retain effective sales representatives, who may choose to distribute products of our competitors.
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.
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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 the U.S. Bank Secrecy Act regulations, the Bermuda Proceeds of Crime Act 1997 and the Proceeds of Crime (Anti-Money Laundering and Anti-Terrorist Financing) Regulations 2008 applicable to insurance companies, we have developed and implemented an anti-money laundering, anti-terrorist financing and sanctions program (“AML/ATF and Sanctions Program”) that includes policies, procedures, controls, independent testing, reporting and recordkeeping requirements for deterring, preventing and detecting potential money laundering, terrorist financing, fraud and other criminal activity in order to comply with U.S. and Bermuda laws. We have an enhanced AML/ATF and Sanctions Program with additional controls, such as watch-list screening beyond sanctions screening required by the U.S. Office of Foreign Assets Control ("OFAC") and the Financial Sanctions Implementation Unit of Bermuda, 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.
BECAUSE MOST OF OUR REVENUE DERIVES FROM COLLECTION OF PREMIUMS ON OUR PRODUCTS, OUR OVERALL FINANCIAL PERFORMANCE DEPENDS PRIMARILY UPON THE PRICING OF OUR INSURANCE PRODUCTS AND THE ACCURACY OF OUR PRICING ASSUMPTIONS. CHANGES IN ACTUAL EXPERIENCE, IMPROPER EVALUATION OF UNDERWRITING RISK AND MISMANAGEMENT OF CLAIMS HANDLING COULD SIGNIFICANTLY INCREASE OUR BENEFIT AND EXPENSE COSTS AND THUS NEGATIVELY AFFECT OUR PROFITABILITY AND FINANCIAL CONDITION.
The Company’s success depends on its ability to accurately underwrite risks and to charge adequate premiums to policyholders.
The Company’s financial condition, liquidity and results of operations largely depend on the Company’s ability to underwrite and set premiums accurately for the risks it faces. Premium rate adequacy is necessary to generate sufficient premiums to cover our cost of sales, costs of operations (including payment of policy benefits) and to earn a profit. In order to price products accurately, the Company must develop and apply appropriate morbidity and mortality estimates, closely monitor and timely recognize changes in trends, and project both severity and frequency of losses with reasonable accuracy to cover these risks. The Company must also review and properly underwrite applications for life insurance in order to charge a sufficient premium to its policyholders. The Company’s ability to undertake these efforts successfully is subject to a number of risks and uncertainties, including, without limitation:
•availability of sufficient reliable data;
•incorrect or incomplete analysis of available data;
•uncertainties inherent in estimates and assumptions;
•selection and application of appropriate rating formulae or other pricing methodologies;
•adoption of successful pricing strategies;
•prediction of policyholder life expectancy and retention;
•unforeseen events that may cause our estimates to be wrong (such as the COVID-19 pandemic);
•unanticipated legislation, regulatory action or court decisions; or
•unexpected changes in interest rates or inflation.
Such risks may result in the Company’s pricing being based on outdated, inadequate, or inaccurate data, or inappropriate analyses, assumptions, or methodologies, and may cause the Company to estimate incorrectly future changes in the frequency or severity of claims. As a result, the Company could underprice risks, which would negatively affect the Company’s margins, or it could overprice risks, which could reduce the Company’s volume and competitiveness. The Company’s ability to accurately underwrite risks in insurance products depends in part on its ability to forecast such changes and trends. If it is not successful in doing so, the Company’s operating results, financial condition, and cash flow could be materially adversely affected.
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Pricing accuracy depends upon our ability to project future losses based on historical loss experience, including policyholder retention. Unanticipated increases in early policyholder withdrawals or surrenders or elections by policyholders to receive lump sum payouts at maturity 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. We also track and manage liabilities and align our investment portfolio in an effort 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, efforts by foreign governments to tax policyholders or increases in surrenders among policies that have been in force for more than fifteen years and are no longer subject to surrender charges.
In addition, 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 aging endowment products that have begun reaching their maturities and policyholder election behavior is not known. It is uncertain how policyholders will react in response to these maturities. If a large number of policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities.
If we experience unanticipated early withdrawal or surrender activity or greater than expected lump sum distributions of endowment maturities and we do not have sufficient cash flow from our insurance operations to support payment of these benefits, we may have to sell our investments in order to meet our cash needs or be forced to obtain third-party financing. The availability of such 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. Therefore, if we are forced to sell our investments on unfavorable terms or obtain financing with unfavorable terms, it could have an adverse effect on our liquidity, results of operations and financial condition.
Our largest expense is payments of claims and surrenders to our policyholders. Mismanagement of claims handling or increased fraudulent claims could negatively impact our costs and financial condition.
Proper claims handling is critical to managing our benefit expenses. Many factors can affect the Company’s ability to pay claims accurately, including the following:
•the training, experience, and skill of the Company’s claims representatives;
•the extent of fraudulent claims and the Company’s ability to recognize and respond to such claims;
•the claims organization’s culture and the effectiveness of its management, and
•the Company’s ability to develop or select and implement appropriate procedures, technologies, and systems to support claims functions.
The Company’s failure to pay claims fairly, accurately, and in a timely manner, or to deploy claims resources appropriately, could result in unanticipated costs, lead to material litigation, undermine customer goodwill and the Company’s reputation in the marketplace, impair its brand image and, as a result, materially and adversely affect its competitiveness, financial results, prospects, and liquidity.
Higher than expected policyholder claims related to unforeseen events may negatively impact our sales, increase our benefits and expense costs and increase our reinsurance costs, thus negatively affecting our financial condition.
Our insurance operations are exposed to the risk of unforeseen events that could cause our pricing assumptions to be wrong. Two of these unforeseen events and the risks they pose to our business are described below:
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The COVID-19 pandemic is negatively impacting certain aspects of our business and, depending on severity and duration, could have a material adverse effect on our financial condition, results of operations and overall business operations.
The prolonged COVID-19 pandemic has caused significant disruption to the global economy and business operations and has resulted in unfavorable impacts to our Company as well as other companies the insurance industry. Due to the unprecedented nature of these events and the uncertainty surrounding the virus and its several variants and their impacts, we cannot fully estimate the duration or full impact of the COVID-19 pandemic on our business. However, we have identified several areas where the COVID-19 pandemic impacted our business during the years ended December 31, 2021 and 2020. Events that we are unable to control, such as the spread of new variants (e.g., Delta, Omicron), spikes in the number of cases of COVID-19, lower than expected vaccination rates in certain areas and the related responses by government authorities and businesses, may continue to present unforeseen risks to our business. We are closely monitoring developments related to the COVID-19 pandemic to assess its impacts on our business.
Some of the most significant risks related to the ongoing COVID-19 pandemic include the following:
•a higher level of claims due to COVID-19 deaths; and
•decreased premium revenue due to disruption to our workforce or distribution channel resulting from required isolation, travel limitations and business restrictions; and
•higher surrenders and lapses due to cash needs our policyholders may have due to concerns over COVID-19 economic impacts, particularly in our international business; and
•volatility in our investment portfolio due to market disruptions caused by COVID-19 related concerns such as inflation.
While we utilize an Enterprise Risk Management framework to manage potential crisis scenarios, we do not know the long-term impact that the COVID-19 pandemic may have on our business. Some potential future risks include (i) the adequacy of our pricing assumptions due to long-term effects of COVID-19, (ii) our ability to adequately underwrite risks related to COVID-19 survivors, and (iii) our ability to ensure the safety of our employees and potential lawsuits related to safety and/or workplace policies. Additionally, the COVID-19 pandemic has led to reliance on digital distribution and development of digital sales and service platforms in order to offset social distancing measures and thus our ability to develop and maintain these platforms and protect them from cyber risk is critical to our ongoing success.
While governmental and non-governmental organizations are continuing to engage in efforts to combat the spread and severity of the COVID-19 pandemic and related public health issues, these measures may not be effective. We cannot predict how legal and regulatory responses to concerns about the COVID-19 pandemic and related public health issues will impact our business. Such events or conditions could result in additional regulation or restrictions affecting the conduct of our business or results of operations in the future.
Climate Change and Impact on Natural Catastrophes
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. SPFIC sells property insurance policies in Louisiana. The vast majority of SPFIC’s claims have arisen out of natural catastrophes such as Hurricane Laura and Hurricane Delta, which both hit Louisiana in 2020, and most recently, Hurricane Ida, a category 4 hurricane that hit the coast of Louisiana in August 2021. Climate change, including rising temperatures and changes in weather patterns, could impact storm frequency and severity in our coverage areas, which could materially impact our financial performance as the volume and severity of claims also continues to rise. Furthermore, since we obtain catastrophic storm reinsurance, storm frequency could cause us to have to obtain additional reinsurance, which negatively impacts our premium revenue. Since we operate in a highly regulated and competitive environment, we may not be able to raise our rates sufficiently to recoup our losses. Additionally, the volume and severity of storms increases the risks of writing property insurance in coastal areas, which could cause us to change our business model, negatively impacting our revenue and earnings.
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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 do not represent an exact calculation of exposure, but instead represent our best estimates using actuarial and statistical procedures. 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 restricts our use of cash to the extent of such increased reserves and increases expenses, negatively affecting our results of operations and financial condition in the periods in which such increases occur.
We may be required to accelerate the amortization of deferred acquisition costs, which would increase our expenses and adversely affect our results of operations and financial condition.
At December 31, 2021, we had $140.4 million of deferred policy acquisition costs, or DAC. DAC represents costs that are directly related to the successful sale and issuance of our insurance policies, which costs 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. Because DAC is amortized over such period, unexpected changes from our assumptions that shorten the premium-paying period, such as increased lapse and surrender rates, or lower persistency in the early years of a policy, would cause us to have to accelerate the amortization of DAC. We regularly review the quality of our DAC to determine if it is 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 regards 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 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.
THE DISTRIBUTION OF OUR PRODUCTS THROUGH INDEPENDENT CONSULTANTS REDUCES OUR CONTROL OVER SALES AND DISTRIBUTION AND THUS SUBJECTS US TO CERTAIN RISKS THAT COULD NEGATIVELY IMPACT OUR REVENUES, OUR IN-FORCE BUSINESS, AND OUR BENEFITS AND EXPENSE COSTS.
Sales of our insurance products could decline if we are unable to establish and maintain relationships with independent marketing agencies and independent consultants and agents.
We depend almost exclusively on the services of independent marketing agencies and independent consultants and agents for the distribution of our products. These agencies, agents and consultants are key to the development and maintenance of our relationships with our policyholders. Significant competition exists among insurers in attracting and maintaining marketers of demonstrated ability. Some of our competitors may offer better compensation packages or commissions or induce agents to sell their products due to their broader product offerings, more distribution resources, better brand recognition, more competitive pricing, lower cost structures or greater financial strength or claims paying ratings than we have. We compete with other insurers for marketing agencies, agents and independent consultants primarily on the basis of our compensation, products 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.
Additionally, as we disclosed in Item 3. Legal Proceedings, we are subject to a risk of our independent consultants leaving our Company to sell products for a competitor and inducing our policyholders to lapse or surrender their policies, or otherwise terminate their relationship with us, in order to purchase products from the independent consultant with our competitor company.
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There may be adverse tax, legal or financial consequences if our sales representatives are determined not to be independent consultants.
Our sales representatives are independent consultants who operate their own businesses. Although we believe that we have properly classified our representatives as independent consultants, 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 classified as employees. The tests governing the determination of whether an individual is considered to be an independent consultant 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 and interpretation.
If there is a change in the manner in which our independent consultants are classified or an adverse determination with respect to some or all of our independent consultants 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.
INSURANCE IS A HIGHLY REGULATED BUSINESS. REGULATIONS VARY FROM JURISDICTION TO JURISDICTION AND MAY CHANGE FROM TIME TO TIME. THESE REGULATIONS AFFECT OUR OPERATIONS AND CHANGES COULD NEGATIVELY IMPACT OUR CASH FLOW, THE RESULTS OF OUR OPERATIONS, OUR LIQUIDITY AND OUR FINANCIAL CONDITION.
LEGAL REGULATION AND RISKS
In addition to the legal risks related to our international operations discussed above in this Item 1A, Risk Factors, we are subject to risks related to the laws and regulations in the jurisdictions where we are domiciled and registered to do business, including Bermuda and various U.S. states. These material risks are described below.
Our insurance subsidiaries are subject to minimum capital and surplus requirements, and any failure to meet these requirements could subject us to regulatory action or other restrictions.
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 jurisdiction of domicile, is considered important by insurance regulatory authorities. Failure to maintain required levels of statutory surplus could result in increased regulatory scrutiny and enforcement action by regulatory authorities.
Our insurance subsidiaries are subject to minimum capital and surplus requirements in both the U.S. and Bermuda, as described below. If we fail to meet these standards and requirements, our various regulators may require specified actions to be taken, including without limitation:
•restricting distributions from our subsidiaries to Citizens; or
•requiring Citizens to contribute additional capital to a subsidiary; or
•requiring Citizens to enter into a guaranty or other agreement to contribute capital to such subsidiary under certain circumstances;
all of which could have a material and adverse impact on the Company’s competitiveness, operational flexibility, financial condition, and results of operations. Additionally, failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny or action by regulatory authorities.
In April 2021, Citizens and CICA International entered into a Keep Well Agreement, as described in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital
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Resources. If CICA International's minimum capital level fell below the minimum required by the BMA, Citizens may have to contribute capital to CICA International, which could negatively impact our capital resources and liquidity.
Citizens is a holding company that has minimal operations of its own and depends on the ability of our insurance subsidiaries to pay dividends or make service payments to us in sufficient amounts to fund our operations. If they cannot make such payments, Citizens may need to sell its investments or seek external capital to cover its operational costs.
As a holding company, our assets consist of the capital stock of our subsidiaries, cash and investments. Accordingly, we rely primarily on statutorily permissible payments from our insurance company subsidiaries, principally through dividends or service agreements we have with our subsidiaries, to meet our working capital needs. As discussed above, the ability of our insurance company subsidiaries to make payments to us is subject to regulation by the states and jurisdictions in which they are domiciled, and in addition to maintaining minimum capital and surplus ratios, these payments depend primarily on regulatory approval of dividend payments and approved service agreements between us and these subsidiaries.
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 other creditors (including us) and shareholders. If any of our subsidiaries becomes insolvent, liquidates or otherwise reorganizes, our policyholders will have a priority to receive the assets of such subsidiary and Citizens may have no rights to receive cash or other assets of such subsidiaries.
If our internal sources of liquidity prove to be insufficient to cover our holding company operations, we may have to sell investments earlier than we want to sell them or in less than favorable market conditions, or we may have to seek external sources of capital. Out of an abundance of caution, in May 2021, we entered into a Credit Facility with Regions Bank. See Part IV, Item 1, Note 7, Commitments and Contingencies in the notes to our consolidated financial statements, herein, for a description of the Credit Facility. To date, we have not utilized the Credit Facility, but if internal sources of capital are not sufficient to meet our operating needs, we may need to utilize the Credit Facility or increase the borrowing availability under the Credit Facility. We may also need to raise capital through issuing our stock. Borrowing money, increasing our borrowing availability under the Credit Facility or obtaining financing for even a small amount of capital could be challenging or expensive in unfavorable market conditions and during periods of economic uncertainty. The availability of financing will depend on a variety of factors such as market conditions, the general availability of credit, the overall availability of credit to the financial services industry, and the possibility that customers or lenders could develop a negative perception of our financial prospects. Raising capital in unfavorable market conditions could increase our interest expense or negatively impact our shareholders through dilution of their common stock ownership of the Company.
Citizens and our insurance subsidiaries are subject to extensive governmental regulation in Bermuda and in the U.S. The rules and regulations to which we are subject may change and impose greater restrictions on our business, which could increase our costs of doing business, restrict the conduct of our business, increase capital requirements for our insurance subsidiaries and negatively impact our results of operations, liquidity and financial condition.
CICA International is registered in Bermuda and is subject to regulation by the Bermuda Monetary Authority ("BMA") and the provisions of the Bermuda Insurance Act and the rules and regulations promulgated thereunder, as well as other laws which apply to Bermuda-based companies, such as compliance with Common Reporting Standards, which are administered by the Bermuda Ministry of Finance ("MOF"). Citizens and our domestic insurance subsidiaries are subject to extensive regulation and supervision in U.S. jurisdictions where we are domiciled and where we do business. These rules and regulations require us to comply with privacy, anti-money laundering, bank secrecy, anti-corruption and foreign asset control laws among others.
In the U.S., we are subject to federal laws, as well as state-level regulation, including a requirement to obtain approval of forms and rates in the states we sell our insurance policies. 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 U.S. 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 claims practices, approving service agreements between a holding company and
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its operating subsidiary, restricting companies' ability to enter and exit markets, and restricting or prohibiting the payment of dividends by our subsidiaries to us.
The BMA and most U.S. 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 regulations and their interpretations, our revenues, results of operations and financial condition and our reputation could be materially adversely affected.
FINANCIAL REGULATION AND RISKS
Changes in accounting standards may adversely affect our reported results of operations and financial condition.
Our consolidated financial statements are subject to the application of GAAP in the U.S. and Bermuda, which is periodically revised and/or expanded. Accordingly, we are required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial Accounting Standards Board ("FASB"), the BMA and the National Association of Insurance Commissioners ("NAIC"). Future accounting standards we adopt, including the FASB’s Accounting Standard Update related to long-duration insurance contracts (known as LDTI), will change current accounting and disclosure requirements applicable to our consolidated financial statements. Such changes may have a material effect on our reported results of operations or financial condition. In addition, the required adoption of new accounting standards may result in significant incremental costs associated with initial implementation and ongoing compliance. See Note 1. Summary of Significant Accounting Policies in the notes to our consolidated financial statements contained herein for additional information regarding accounting updates.
Unexpected losses in future reporting periods may require us to record a valuation allowance against our deferred tax assets.
Under U.S. GAAP, we are required to evaluate our deferred tax assets ("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 and financial condition.
APPROXIMATELY 25% OF OUR TOTAL REVENUES FOR THE YEAR ENDED DECEMBER 31, 2021 CONSISTED OF INVESTMENT INCOME. THE INVESTMENT RETURN, OR YIELD, ON INVESTED ASSETS IS AN IMPORTANT ELEMENT OF OUR EARNINGS SINCE INSURANCE PRODUCTS ARE PRICED WITH THE ASSUMPTION THAT PREMIUMS RECEIVED CAN BE INVESTED FOR A PERIOD OF TIME BEFORE BENEFITS ARE PAID. CHANGES IN THE GLOBAL OR U.S. INVESTMENT ENVIRONMENT, OR MARKET DISRUPTIONS THAT AFFECT INTEREST RATES AND INVESTMENT OPPORTUNITIES, AS WELL AS DECLINES IN THE VALUE OF OUR INVESTMENT PORTFOLIO, MAY ADVERSELY AFFECT OUR RESULTS OF OPERATION AND FINANCIAL CONDITION.
Sustained periods of low interest rates in the long-term investment market may adversely affect our reported net investment income and the discount rates used in reserving for our insurance products, which may adversely affect our results of operations or financial condition.
The low interest rate environment continues to limit increases in profit margins for insurers, including us. We have been impacted by the historically low interest rate environment over the past several years as our fixed maturity investment portfolio, primarily invested in callable securities, has generally been reinvested at lower yields, leading to lower net investment income than assumed in the pricing and reserving for our insurance products. An interest or
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discount rate is used in calculating reserves for our insurance products. We set our reserve discount rate assumptions based on our current and expected future investment yield for assets supporting the reserves, considering current and expected future market conditions. Spread compression and related effects to profitability caused by lower interest rates affect the valuation of in-force business more significantly than the valuation of new business, as new business pricing assumptions reflect the current and anticipated future interest rate environment. Estimates of fair value are inherently uncertain and represent management’s reasonable expectations regarding future developments. If the discount rate assumed in our reserve calculations is higher than our future investment returns, our invested assets will not earn enough investment income to support our future benefit payments. In that case, we may be required to amortize any remaining DAC, record additional liabilities and/or increase our capital contributions to our insurance subsidiaries in the period this occurs, which could have a material adverse effect on our results of operations or financial condition.
Changes in market interest rates may significantly affect our profitability.
We are exposed to significant capital market risk related to changes in interest rates. Our investment performance, including yields and realization of gains and losses, may vary depending on economic and market conditions. Substantial and sustained changes, up or down, in market interest rate levels can materially affect the profitability of our products.
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. We have experienced significant call activity on our fixed maturity portfolio over the years due to the low interest rate environment. Our fixed maturity bond portfolio is exposed to interest rate risk as approximately 52% of the portfolio is callable as of December 31, 2021, with 4% that could be called within the next year. If subject to increased call activity, the Company would have to reinvest the resulting investment portfolio cash proceeds from calls as well as from maturities in lower yielding instruments, further reducing our investment income. 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. As a key component of profitability, a narrowing of our “spread” may have a material adverse effect on our results of operations or financial condition. 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 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).
Our investment portfolio is subject to various risks that may result in investment related 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 investment related 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 credit related allowances. Each of these events may cause us to reduce the carrying value of our investment portfolio.
In particular, at December 31, 2021, fixed maturities represented $1.5 billion or 90.6% of our total investments of $1.6 billion. 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
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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 all 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 98.0% of our fixed maturities were investment grade with 59.5% rated A or above at December 31, 2021, 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.
The determination of valuation and impairments of our investments include estimations and assumptions that are subjective and prone to differing interpretations and could materially impact our results of operations or financial condition.
The Company makes assumptions regarding the fair value and expected performance of its fixed maturity securities and other investments. Valuations may include inputs and assumptions that are less observable or require greater estimation, particularly during periods of market disruption, resulting in values which may be less than the value at which the investments may ultimately be sold. Further, rapidly changing and/or unprecedented credit and equity market conditions could materially impact the valuation of investments as reported in our consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.
The decision of whether to record a credit impairment is determined by our assessment of the financial condition and prospects of a particular issuer, projections of future cash flows and recoverability as well as our ability and intent to hold the securities to recovery or maturity. We evaluate our investment portfolio for impairments. There can be no assurance that we have accurately assessed the level of impairments taken. Additional impairments may need to be taken in the future, and historical trends may not be indicative of future impairments. Any event reducing the value of our securities other than on a temporary basis may have a material adverse effect on our business, results of operations, or financial condition.
FROM TIME TO TIME, WE HAVE EXPANDED OUR BUSINESS BY PURCHASING OTHER INSURANCE COMPANIES OR BLOCKS OF BUSINESS. SUCH ACQUISITIONS SUBJECT US TO POTENTIAL RISKS THAT COULD MATERIALLY NEGATIVELY AFFECT OUR RESULTS OF OPERATIONS OR FINANCIAL CONDITION.
We may be required to accelerate the costs of insurance acquired, which would increase our expenses and adversely affect our results of operations and financial condition.
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 insurance acquired, or COIA, represents the actuarially estimated present value of future cash flows from the acquired policies. At December 31, 2021, we had $10.6 million of COIA.
We amortize the value of this intangible asset in a manner similar to the amortization of DAC; it is subject to acceleration and generally depends upon anticipated profits from investments, surrender and other policy charges, mortality, morbidity, persistency and maintenance expense margins. If actual experience was not as expected when the policies were acquired, 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 COIA to determine if it is 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 regards to expected expenses, investment returns, surrender and other policy charges, mortality, morbidity, lapses or persistency may cause us to increase the amortization of COIA, 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.
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THE COMPANY RELIES ON OUR INFORMATION TECHNOLOGY SYSTEMS, AND THE DATA MAINTAINED WITHIN THOSE SYSTEMS, TO MANAGE MANY ASPECTS OF OUR BUSINESS. CYBERSECURITY RISKS, THE FAILURE OF OUR SYSTEMS TO OPERATE PROPERLY AND/OR THE FAILURE TO MAINTAIN THE CONFIDENTIALITY, INTEGRITY, AND AVAILABILITY OF POLICYHOLDER AND CLAIMS DATA, INCLUDING PERSONAL IDENTIFYING INFORMATION, COULD RESULT IN A MATERIALLY ADVERSE EFFECT ON OUR BUSINESS, REPUTATION, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Our failure to maintain effective information systems could adversely affect our business.
We must maintain and enhance our existing information systems and develop and integrate new information systems to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards and changing customer preferences in a cost-effective manner. If we do not maintain adequate systems, we could experience adverse consequences, including 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. Our failure to maintain effective and efficient information systems, or our failure to consolidate our existing systems could have a material adverse effect on our results of operations and financial condition.
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.
We are continuously evaluating and enhancing systems and creating new systems and processes as our business depends on our ability to maintain and improve our technology. Due to the complexity and interconnectedness of our systems and processes, these changes, as well as changes designed to update and enhance our protective measures to address new threats, increase the risk of a system or process failure or the creation of a gap in our security measures. Any such failure or gap could adversely affect our business operations and results of operations.
A cyber attack or other security breach could disrupt our operations, result in the unauthorized disclosure or loss of confidential data, damage our reputation or relationships, and expose us to significant financial and legal liability, which may adversely affect our business, results of operations, or financial condition.
We store confidential information about our business and our policyholders, independent marketing firms, and independent agents, consultants and others on our information technology systems, including proprietary and personally identifiable information. As part of our normal business operations, we use this information and engage third-party providers, including outsourcing, cloud computing, and other business partners, that store, access, process, and transmit such information on our behalf. We devote significant resources and employ security measures to help protect our information technology systems and confidential information, and we have programs in place to detect, contain, and respond to information security incidents. However, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may be difficult to detect for long periods of time, we and our third-party providers may be unable to anticipate these techniques or implement adequate preventative measures. In addition, hardware, software, or applications we develop or procure from third parties or through open source solutions may contain defects in design or manufacture or other problems that could unexpectedly compromise our information security. Unauthorized parties, whether within or outside our company, may disrupt or gain access to our systems, or those of third parties with whom we do business, through human error, misfeasance, fraud, trickery, or other forms of deceit, including break-ins, use of stolen credentials, social engineering, phishing, or other cyber attacks, computer viruses, malicious codes, and similar means of unauthorized and destructive tampering.
We and our third-party providers experience information security incidents from time to time. There is no assurance that our security systems and measures will be able to prevent, mitigate, or remediate future incidents. A successful penetration or circumvention of the security of our information technology systems, or those of third parties with whom we do business, could cause serious negative consequences for us, including significant disruption of our operations, unauthorized disclosure or loss of confidential information, harm to our brand or reputation, loss of customers and revenues, violations of privacy and other laws, and exposure to litigation, monetary damages,
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regulatory enforcement proceedings, fines, and potentially criminal proceedings and penalties. If we are unaware of the incident for some time after it occurs, our exposure could increase. In addition, the costs to address or remediate systems disruptions or security threats or vulnerabilities, whether before or after an incident, could be significant. As we continue to build our digital capabilities and focus on enhancing the customer experience, the amount of information that we retain and share with third parties is likely to grow, increasing the cost to prevent data security breaches and the cost and potential consequences of such breaches. An information technology systems failure could also interfere with our ability to comply with financial reporting and other regulatory requirements, exposing us to potential disciplinary action by regulators.
Although we have insurance against some cyber risks and attacks, we may be subject to litigation and financial losses that exceed our policy limits, are subject to deductibles or are not covered under any of our current insurance policies.
The failure of our business recovery and incident management processes to resume our business operations in the event of a catastrophe, an epidemic, a cyber attack, or other event could adversely affect our profitability, results of operations, or financial condition.
In the event of a disaster such as a catastrophe, an epidemic, a cyber attack, cyber security breach or other information technology systems failure, a terrorist attack, or war, unanticipated problems with our disaster recovery systems could have a material adverse impact on our ability to conduct business and on our results of operations and financial condition, particularly if those problems affect our information technology systems and destroy valuable data or result in a significant failure of our internal control environment. In addition, in the event that a significant number of our employees were unavailable in the event of a disaster, our ability to effectively conduct business could be severely compromised.
The failure of our information technology and/or disaster recovery systems for any reason could cause significant interruptions or malfunctions in our or our customers’ operations and result in the loss, theft, or failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to our customers. Such a failure could harm our reputation, subject us to regulatory sanctions, legal claims, and increased expenses, and lead to a loss of customers and revenues.
RISKS RELATED TO OUR HOLDING SECURITIES
The number and location of our shareholders may make it difficult to obtain approval of certain corporate actions.
Because we allow our policyholders to use their policy dividends to purchase our Class A common stock through our CISIP, we have over 86,000 shareholders and approximately 40% of our shareholders hold less than 100 shares each. Additionally, many of these shareholders are located in Latin America and the Pacific Rim, where most of our policies are sold, and English may not be their native language. We believe that because of this, we typically have low voter turn-out at our annual meetings and therefore any proposal, such as one related to a merger or an acquisition of our Company, or an amendment to our articles of incorporation, that may require the affirmative vote of a majority of the outstanding shares of our Class A common stock, may be logistically difficult to approve.
Our Class A common stock is not registered in any foreign country.
As mentioned above, a significant portion of our Class A common stock has been purchased under the CISIP by foreign holders of life insurance policies. The Class A common stock sold under the CISIP is registered with the SEC pursuant to a Form S-3 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 was not allowed under applicable laws and regulations of its jurisdiction, such authority may issue or assert a fine, penalty or cease and desist order against our offer and sale of Class A common stock 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.
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Applicable insurance laws in the jurisdictions where our insurance subsidiaries are domiciled may discourage takeovers and business combinations that our shareholders might consider to be in their best interests.
Insurance laws in the jurisdictions in which our insurance subsidiaries are domiciled require regulatory actions for certain transactions, such as a merger or acquisition of our Company, that our shareholders might consider in their best interests. As previously described, the insurance regulators consider the best interests of our policyholders over the best interests of our shareholders. As a result, our shareholders may 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 or such regulatory approval requirement may delay, deter, render more difficult or prevent a takeover attempt or a change in control.
GENERAL RISK FACTORS
Litigation and regulatory actions and investigations are common in our businesses and may result in financial losses and/or harm to our reputation.
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. We are, and in the future may be, parties in various litigation matters. An adverse outcome in one or more of these actions, investigations or litigation matters may, depending on the nature, scope and amount of the ruling, materially and adversely affect our results of operations or financial condition, encourage other litigation, and limit our ability to write new business, particularly if the adverse outcomes negatively impact our reputation.
In the absence of countervailing considerations, we would expect to defend any such actions, investigations or litigation matters 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.
Reinsurance may not be available or affordable, or reinsurers may be unwilling or unable to meet their obligations under our reinsurance contracts, which may adversely affect our results of operations or financial condition.
As part of our overall risk management and capital management strategies, we purchase reinsurance for certain risks underwritten by our various insurance subsidiaries. Market conditions beyond our control determine the availability and cost of reinsurance. Any decrease in the amount of reinsurance will increase our risk of loss and may impact the level of capital requirements for our insurance subsidiaries, and any increase in the cost of reinsurance will, absent a decrease in the amount of reinsurance, reduce our results of operations. Accordingly, we may be forced to incur additional expenses for reinsurance or may be unable to obtain sufficient reinsurance on acceptable terms, which may adversely affect our ability to write future business, result in the assumption of more risk with respect to the policies we issue, and increase our capital requirements. The collectability of our reinsurance recoverable is primarily a function of the solvency of the individual reinsurers. We cannot provide assurance that our reinsurers will pay the reinsurance recoverable owed to us or that they will pay these recoverables on a timely basis. The insolvency of a reinsurer or the inability or unwillingness of a reinsurer to comply with the terms of a reinsurance contract may have an adverse effect on our results of operations or financial condition.
Events that damage our reputation may adversely affect our business, results of operations, or financial condition.
There are many events which may harm our reputation, including, but not limited to, those discussed in this Item 1A regarding regulatory investigations, legal proceedings, cyber or other information security incidents and disputes with our independent agents and consultants.
In addition, as an insurance company, we are paid to accept certain risks. Those who conduct our business, including executive officers and members of management, and to some extent, independent agents and consultants, do so in part by making decisions that involve exposing us to risk. These include decisions such as maintaining effective underwriting and pricing discipline, maintaining effective claim management and customer
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service performance, managing our investment portfolio, delivering effective technology solutions, complying with established sales practices, executing our capital management strategy, exiting a line of business and/or pursuing strategic growth initiatives, and other decisions. Although we have a risk management framework and employ controls and procedures designed to monitor business decisions and prevent us from taking excessive risks or unintentionally failing to comply with internal policies and practices such that errors occur, there can be no assurance that these controls and procedures will be effective. If our employees and independent agents and consultants take excessive risks and/or fail to comply with internal policies and practices, the impact of those events may damage our market position and reputation.
Depending on the severity of the damage to our reputation, we may be unable to effectively compete for new products or retain our existing business, which could adversely affect our results of operations or financial condition. Damage to our reputation may also hinder our ability to raise new capital and/or increase our cost of capital.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
We lease our principal office at the Domain in Austin, Texas to service all business entities and operations. We lease space for our office in Bermuda related to CICA International and in Louisiana, Arkansas and Mississippi related to our Home Service Insurance operations. We also own properties in Louisiana related to our Home Service Insurance operations.
Item 3. LEGAL PROCEEDINGS
The following are material pending legal proceedings in which we or any of our subsidiaries is a party or in which any of our or their property is the subject.
Trade Secret Lawsuit
As previously disclosed, on November 7, 2018, Citizens, CICA International and CICA (defined as "we", "us", "our" or "Plaintiffs" in this Item 3) filed a lawsuit in the District Court of Travis County, Texas (the “District Court”) against (i) Randall Riley (“Riley”), a former Citizens executive and son of Citizens’ founder Harold E. Riley, (ii) CALI, copycat companies formed by Riley and (iii) Alexis Enrique Delgado, Carlos Nalsen Landa, Enrique Pinzon Ruiz, Johan Emilio Mikuski Silva and Esperanza Peralta de Delgado, former independent consultants of Citizens (collectively, the “Los Raudales Defendants,” and together with Riley and CALI, collectively the “Original Defendants”).
On September 10, 2019, we filed an amended complaint and added additional defendants to the lawsuit (with the Original Defendants, collectively, "Defendants"), including (i) Michael P. Buchweitz (a former underwriter for Citizens), Jonathan M. Pollio (a former actuary for Citizens), Jeffrey J. Wood (a former Chief Financial Officer and the current Chief Financial Officer of First Trinity) and Steven A. Rekedal (former marketing officer), (ii) First Trinity Financial Corporation, and Trinity American, Inc. (collectively, “First Trinity”) and International Marketing Group S.A., LLC, entities that have founded a business on the exploitation of Citizens’ trade secrets and goodwill, and (iii) Gregg E. Zahn, the CEO of First Trinity. Our lawsuit claims that:
•Riley and First Trinity tortiously interfered with Citizens’ contracts with its agents and former employees and that they “willfully and intentionally” induced the Los Raudales Defendants and other agents and former employees to breach those contracts by disclosing Citizens’ confidential information;
•The Los Raudales Defendants were properly terminated for cause under their independent consultant contracts and thus not entitled to additional commissions under such contracts;
•Defendants stole Citizens’ information in order to unfairly compete with us;
•Defendants wrongfully secured benefits from Citizens and thus Citizens is entitled to those benefits (unjust enrichment); and
•Defendants conspired to achieve the theft of Citizens’ trade secrets, including by using a confusingly similar name and logo.
December 31, 2021 | 10-K 28
In January 2019, the Original Defendants filed a motion to dismiss certain claims alleged in the suit, which the District Court denied in its entirety. In May 2019, we filed a motion for a preliminary injunction to bar the Original Defendants from continuing to engage in unfair competition and misappropriation of Citizens’ trade secrets and tortious interference with Citizens’ existing contracts with its independent consultants. The District Court denied the application for a temporary injunction and in August 2020, the Third Court of Appeals in Austin, Texas affirmed the District Court’s decision.
In June 2021, the Defendants filed a traditional and no evidence Motion for Partial Summary Judgment (the “Motion”), which was denied in its entirety by the District Court. Defendants’ Motion claimed that we should not be able to proceed with our claims against them for unfair competition, tortious interference with contract, conspiracy and unjust enrichment, because we “have no evidence to support these theories.” By denying Defendants’ Motion in its entirety, we can proceed to trial with all of the claims described above.
In September 2021, the District Court denied the requests of Alexis Enrique Delgado, Enrique Pinzon Ruiz, and Esperanza Peralta de Delgado to be dismissed from the lawsuit and denied Michael Buchweitz’s and Jonathan Pollio’s requests that the claim against each of them for breach of his confidentiality agreement be dismissed. While the District Court allowed the CEO (Zahn) and CFO (Wood) of First Trinity to be dismissed individually from the lawsuit, the ruling does not affect Citizens’ claims against First Trinity described above.
Trial in the lawsuit has been delayed several times due to the COVID-19 pandemic. The trial is currently scheduled to start in May 2022.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
December 31, 2021 | 10-K 29
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. Our Class B common stock is not registered with the SEC nor traded on any exchange. As of December 31, 2021, we held 100% of our Class B common stock in treasury so it is no longer outstanding.
Holders. The number of stockholders of record as of March 4, 2022 was as follows:
| • | Class A Common Stock - | 86,270 | ||||||
| • | Class B Common Stock - | — | ||||||
Dividend Policy. 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, as it is our policy to retain earnings for use in the operation and expansion of our business.
Company Purchases of Equity Securities. We did not repurchase any shares of our Class A common stock during the fourth quarter of 2021.
See Part III. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for equity compensation plan information.
PERFORMANCE COMPARISON
The following graph compares, for the five-year period ended December 31, 2021, the change in the Company’s cumulative total stockholder return on its Class A common stock to that of the NYSE Composite and NASDAQ Insurance indexes. The graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends in each of the Company’s Class A common stock, the NYSE Composite and the NASDAQ Insurance Index. Note that historical stock price performance is not necessarily indicative of future stock price performance.
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | ||||||||||||||||||||||||||||||
| Citizens, Inc. | $ | 100.00 | 74.85 | 76.58 | 68.74 | 58.35 | 54.07 | ||||||||||||||||||||||||||||
| NYSE Composite | $ | 100.00 | 118.73 | 108.10 | 135.68 | 145.16 | 175.18 | ||||||||||||||||||||||||||||
| NASDAQ Insurance | $ | 100.00 | 113.68 | 102.76 | 136.99 | 137.65 | 158.73 | ||||||||||||||||||||||||||||
December 31, 2021 | 10-K 30
Item 6. [RESERVED]
December 31, 2021 | 10-K 31
| Item 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | ||||
This section of this Annual Report on Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 (the "2020 10-K").
OVERVIEW
For over 45 years, we have been fulfilling the needs of our policyholders and their families by providing insurance products that offer both living and death benefits. Citizens conducts insurance related operations through its insurance subsidiaries, which provide benefits to residents in 31 U.S. states and more than 70 different countries. We specialize in offering primarily ordinary whole life insurance, endowment products and final expense insurance in niche markets where we believe we can optimize our competitive position.
As an insurance provider, we collect premiums on an ongoing basis from our policyholders and invest the majority of the premiums to pay future benefits, including claims and surrenders and policyholder dividends. Accordingly, the Company derives its revenues principally from: (1) life insurance premiums earned for insurance coverages provided to insureds in our two operating segments – Life Insurance and Home Services Insurance; and (2) net investment income. In addition to paying and reserving for insurance benefits that we pay to our policyholders, our expenses consist primarily of the costs of selling our insurance products (e.g., commissions, underwriting, marketing expenses), operating expenses and income taxes.
Objective of our Management's Discussion and Analysis
We refer to our Management’s Discussion and Analysis of Financial Condition and Results of Operations as our “MD&A”. The objective of our MD&A is to provide investors with a succinct analysis of the Company's financial performance from management's perspective. We start by discussing the factors that we believe drive our operating results and then we discuss how industry developments and economic circumstances in general (e.g., low interest rates, the COVID-19 pandemic) affected or could affect our financial performance. After telling you about our industry, we discuss our 2021 financial highlights, the impacts of COVID-19 on our business during 2021, and then we break-down our results of operations in detail so an investor understands the various line items of our profit & loss statements from management’s perspective. Since our investments are one of the two principal sources of our revenues, we describe them in detail. Finally, we discuss our capital resources and liquidity so investors will have a better understanding how those resources are utilized and how we are able to meet our cash needs.
Throughout the MD&A, we describe how we view the Company and which matters we believe are reasonably likely to affect future operations. We describe our priorities for the business in Item 1. Business - “Strategic Initiatives” and in the MD&A, we describe how we performed on those initiatives and any known trends or uncertainties that might impact our ability to achieve our goals.
The Factors that Drive our Operating Results
We see the following as the primary factors that drive our operating results:
•Sales
•Our investments
•Death claims and surrenders
•Operating expenses
As premium revenues and investment income are our two primary sources of income, both new sales and "resells" (i.e. retaining the policy) as well as our investments and the interest we receive on such investments, are key to our profitability. Throughout the MD&A and in Item 1 - Business, we describe the actions and initiatives that are taken to increase sales and improve retention, how we performed in 2021, and how we view trends with respect
December 31, 2021 | 10-K 32
to sales and retention. We also discuss our investment performance and what we are doing to improve performance in this extended low-interest rate environment.
Our first-year premiums in 2021 increased by 11.2% compared to 2020. We believe this increase was driven by our focused marketing campaigns, including a campaign intended to recruit new agents, the introduction of new products, and higher sales in 2021 compared to 2020 due to COVID-19 impacts in 2020.
Renewal premiums in our Home Service Insurance increased in 2021 as compared to 2020 due to an increased focus on collection efforts. Renewal premiums in our Life Insurance segment declined due to the decrease in our in-force business over the last several years. The prior-year surrenders negatively impacted the current year renewal premiums even though total surrender benefits paid declined in 2021 compared to 2020 (see below). As we describe in Item 1. Business - Strategic Initiatives, we believe that our retention efforts began to stem the decline of renewal premiums in 2021.
While interest rates continue to remain low, our yield stayed flat, at 4.24% in both 2021 and 2020. Our net investment income increased by $1.3 million from 2020 to 2021 due to a greater asset base.
As part of the ongoing process of managing our portfolio and optimizing performance we have been diversifying our investment portfolio in order to help mitigate the effects of the sustained low interest rate environment, and investment related gains on our investments contributed significantly to our profitability in 2021.
December 31, 2021 | 10-K 33
Payment of policyholder benefits for death claims and surrenders is our largest expense. In 2021, our death claims increased due in large part to COVID-19-related deaths. Our surrenders decreased by $3.2 million in 2021 from 2020, which we believe was in large part due to our retention efforts.
Operating Expenses are our second largest expense and thus drive our operating results. Our general operating expenses decreased by $10.3 million in 2021 as compared to 2020. General operating expenses in 2020 included $10.0 million of severance payments to our former CEO related to the change in control of the Company.
ECONOMIC AND INSURANCE INDUSTRY DEVELOPMENTS
The following significant trends and developments are currently impacting our business and industry:
•Sustained Low Interest Rate Environment. Market interest rates are a key driver of our results. Persistent low interest rates are identified as a major threat for life insurance companies, given their rate-sensitive products and investments. The sustained low interest rate environment continues to limit increases in profit margins for life insurers by:
◦Reducing the spread between guaranteed interest rates credited to policyholders and interest earned on supporting assets;
◦Causing us to reinvest proceeds in lower yielding assets as portions of our fixed maturity investment portfolio, which is primarily invested in callable securities, are called and must be reinvested;
◦Potentially requiring us to increase our reserves or trigger loss recognition events related to policy liabilities, accelerate amortization of DAC and COIA, and potentially impair intangible assets;
◦Making our products less attractive (due to lower credited interest rates), resulting in lower sales; and
◦Changing policyholder behavior, including increasing surrender or withdrawal activity.
We have attempted to mitigate the risk of the low interest rate environment by making new investments in securities of states, municipalities, essential services and corporate issuers as well as identifying investment opportunities in other asset classes, such as limited partnerships, to increase our yields while maintaining a prudent risk profile for our overall portfolio.
•Impact of COVID-19. The COVID-19 pandemic has had and continues to have a significant impact on the life insurance industry. Initially there were hopes for a gradual decline in COVID-19 mortality as the vaccination roll out increased significantly and the pandemic ebbed after more than a year during the summer months of 2021. However, the emergence of the Delta variant resulted in a significant increase in the number of pandemic-related deaths in 2021, and the emergence of the
December 31, 2021 | 10-K 34
Omicron variant has resulted in additional economic distress in early 2022. The global life insurance industry has experienced significantly higher reported claims due to the COVID-19 pandemic.
The long-term nature of life insurance products means premiums are not yet capturing the risk that deaths or long-term illness from COVID-19 will likely remain higher than previously estimated. Additionally, life insurers will need to decide how to underwrite COVID-19 survivors, as the long-term effects of COVID-19 are still unclear.
•Aging population. Many countries in the world are experiencing growth in the number and proportion of older persons in their population. As an increasing percentage of the world population reaches retirement age, we believe there will be a greater need for age-related products and we will benefit from increased demand for living benefit products rather than death benefit products, as customers will require cash accumulation to pay expenses to meet their lifetime income needs. Our ordinary life products are designed to accumulate cash values to provide for living expenses in a policy owner's later years, while continuously providing a death benefit. However, as the population reaches retirement age, policyholders may decide to use their accumulated cash value for cash needed in retirement, thus increasing surrenders of long-term products.
•Availability of Reinsurance. Reinsurance market dynamics including increased pricing, years of accumulating catastrophic losses, investment market losses and the significant losses expected from the fallout of the COVID-19 pandemic have led to a decline in the availability of reinsurance, tighter terms (such as, for example, pandemic exclusions) and/or increased reinsurance prices. While we currently cede a limited amount of our primary insurance business to reinsurers, we may encounter difficulty in obtaining reinsurance in the future, forcing us to resort to a more expensive reinsurance market. If we are unable to obtain affordable reinsurance coverage, this may impact our net exposures and the number of underwriting commitments.
•Technology Adoption. Innovation and digital development strategies continue to evolve and impact all industries, including the insurance industry. The onset of the COVID-19 pandemic in 2020 caused companies to adapt to a more digital operations platform, almost overnight. Therefore, it is critical that we embrace these changes for the benefit of our policyholders, agents, employees and stockholders.
•Climate Change. Rising climate related losses stemming from the frequency and severity of extreme weather-related events have shone a regulatory spotlight on insurance risk and climate change. While the majority of our business is related to life insurance products, which may be less impacted by climate change than our property insurance products, we must understand and access accurate climate data in order to make informed decisions with regard to climate risk.
2021 HIGHLIGHTS
COVID-19 PANDEMIC
The overall impact of COVID-19 and its related economic conditions on the Company's financial results continue to be highly uncertain and unpredictable. While the Company has implemented new strategies and processes to mitigate this impact, the scope, duration and magnitude of the direct and indirect effects of COVID-19 are difficult or impossible to anticipate. As a result, it is not possible to predict its impact on the Company's results in 2022 or beyond. Currently, some of the most significant factors affecting our business that could cause our future results to differ significantly from our prior results or forward-looking statements include:
•a higher level of claims due to COVID-19 deaths;
•decreased premium revenue due to disruption to our workforce or distribution channel resulting from required isolation, travel limitations and business restrictions;
•higher surrenders and lapses due to cash needs our policyholders may have due to concerns over COVID-19 economic impacts, particularly in our international business; and
•volatility in our investment portfolio due to market disruptions caused by COVID-19 related concerns such as inflation.
December 31, 2021 | 10-K 35
We believe that in both 2020 and 2021 we experienced higher than usual death claims due to the impact of COVID-19.
We continue to monitor the impact of the COVID-19 pandemic on our operations.
FINANCIAL HIGHLIGHTS
Federal Income Tax Benefit
The results of operations for the fiscal year ended December 31, 2021 included a significant income tax benefit for the release of most of the uncertain tax position of $43.8 million. The uncertain tax position from previous years is related to the tax treatment of tax reserves pursuant to Internal Revenue Code ("IRC") Section 807, specifically due to ramifications on the determination of those reserves from our product qualification issues in the past. The uncertain tax position released during the fourth quarter of 2021 is due to the expiration of the statute of limitations for the year ended December 31, 2017.
Goodwill Impairment
The release of the liability for the uncertain tax position referenced above, increased the carrying value of our Life Insurance segment. Due to such increase in carrying value and the continued low interest rate environment (which negatively affected the fair value of our net assets by decreasing expected cash flows), we determined that the carrying value of our Life Insurance segment exceeded its implied fair value, resulting in an impairment of goodwill (the excess of the amount paid by us to acquire various life insurance companies over the fair value of their net assets as of the date of acquisition). Accordingly, as of December 31, 2021, we wrote-off the goodwill and recognized an expense of $12.6 million for 2021.
Summary
At December 31, 2021, we had $1.9 billion in total assets, an increase from $1.8 billion at December 31, 2020, and we had $27.3 million in cash. We did not have any debt at December 31, 2021.
During 2021, we reported net income of $36.8 million, compared to a net loss of $11.0 million in 2020. In comparison to 2020, the $47.8 million increase in net income was primarily due to:
↑ $43.8 million tax benefit;
↑ $9.5 million increase in investment related gains; and
↓ $10.3 million of general expenses.
The increase in net income was partially offset by:
↑ $4.2 million in death claim benefits;
↑ $6.5 million in future policy benefit reserves; and
↑ $12.6 million goodwill impairment.
Revenue Highlights
As discussed above, insurance premiums and investment income are our primary sources of revenue.
•Insurance premiums declined 0.3% in 2021 compared to 2020, totaling $174.7 million and $175.3 million, respectively, as growth in first year premiums in both segments was more than offset by a decline in renewal premiums in our Life Insurance segment.
•Net investment income increased 2.2% in 2021 compared to 2020, totaling $61.5 million and $60.2 million, respectively, driven by a growing asset base. The average yield on our consolidated investment portfolio was 4.24% for both 2021 and 2020 as diversification of our investment portfolio into limited partnership investments helped offset a challenging investment environment for fixed maturity securities in 2021.
•Investment related gains increased by $9.5 million.
December 31, 2021 | 10-K 36
Benefits and Expenses Highlights
The primary use of our funds is payment of insurance benefits. Total insurance benefits paid or provided in 2021 increased by 3.6%, from $156.7 million in 2020, to $162.4 million in 2021. This expense consists primarily of the following:
•Claims and surrender benefits decreased 1.2% in 2021 compared to 2020. This decrease was primarily due to a decrease in surrender benefits and endowments benefits in the Life Insurance segment, which more than offset the increase in death claims benefits. The increase in death claim benefits was due primarily to a higher volume of reported claims, including COVID-19 related claims, in addition to an increase in the average death claim amount; and
•Future policy benefit reserves, which increased 21.8% in 2021 compared to 2020 as a result of higher sales production and improved persistency.
The other primary use of our funds are the costs of selling our insurance products and other expenses:
•Commissions increased in 2021 compared to 2020, as they are directly related to premium production, and primarily first year premium production, which increased in 2021;
•General expenses decreased 19.2% in 2021 compared to 2020, driven by the change in control and executive severance expenses in 2020; and
•Goodwill impairment of $12.6 million in 2021.
Our Operating Segments
We manage our business in two operating segments, Life Insurance and Home Service Insurance.
Life Insurance
International. For over 45 years, CICA Life Insurance Company of America ("CICA") and its predecessors have issued U.S. dollar-denominated ordinary whole life insurance and endowment policies to non-U.S. residents. In 2018, we novated of all of the international policies issued by CICA to CICA Life Ltd. ("CICA International"), our Bermuda-based insurer. We distribute our international insurance products through independent marketing organizations and their agents located in the countries in which our policyholders reside. Endowment product sales are the primary driver of sales in this segment.
Domestic. Our domestic operations in our Life Insurance segment primarily consist of the collection of renewal premiums on ordinary whole life and final expense policies issued to middle- and lower-income families and individuals in certain markets in the Mountain West, Midwest and Southern U.S. We also sell credit life and credit accident and health insurance domestically. As we discussed in Item 1. Business - Strategic Initiatives, we introduced our domestic whole life products to the Florida market in 2021. Our efforts to recruit agents to sell our products have been slower than we expected and we are re-evaluating our sales distribution approach, initiatives and domestic life insurance offerings in the Florida market in 2022. The majority of our current domestic revenues are generated by the policies of domestic life insurance companies we have acquired since 1987.
Home Service Insurance
We operate in the Home Service Insurance market through our subsidiaries Security Plan Life Insurance Company ("SPLIC"), Magnolia Guaranty Life Insurance Company ("MGLIC") and Security Plan Fire Insurance Company ("SPFIC"). These companies provide final expense ordinary and industrial life insurance to middle- and lower-income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing independent agents who work on a route system to collect premiums and service policyholders, and through networks of funeral homes that collect premiums and provide personal policyholder service. In 2021, we added a new whole life product to this market that has higher allowable face values and a new critical illness coverage product which we sell through independent agents. To a much lesser extent, our Home Service Insurance segment also sells property insurance policies covering dwellings and content.
December 31, 2021 | 10-K 37
CONSOLIDATED RESULTS OF OPERATIONS
Our insurance operations are the primary focus of the Company, as those operations generate most of our income. The total dollar amount of insurance issued, number of policies issued, and average face amounts of policies issued in 2021 and 2020 are shown below.
| Years Ended December 31, | 2021 | 2020 | |||||||||||||||||||||||||||||||||
| Amount of Insurance Issued | Number of Policies Issued | Average Policy Face Amount Issued | Amount of Insurance Issued | Number of Policies Issued | Average Policy Face Amount Issued | ||||||||||||||||||||||||||||||
| Life Insurance | $ | 233,574,941 | 3,870 | $ | 60,355 | $ | 219,902,799 | 3,419 | $ | 64,318 | |||||||||||||||||||||||||
| Home Service Insurance | 177,754,244 | 22,600 | 7,865 | 134,270,147 | 24,920 | 5,388 | |||||||||||||||||||||||||||||
| Total | $ | 411,329,185 | 26,470 | $ | 354,172,946 | 28,339 | |||||||||||||||||||||||||||||
Total insurance issued increased $57.2 million, or 16.1%, in 2021 compared to 2020 as both the Life Insurance and Home Service Insurance segments experienced growth in amount of insurance issued.
The number of policies issued in the Life Insurance segment increased 13.2% in 2021 compared to 2020. We believe the increase was primarily due to enhancements to our business operations and sales practices to adapt to the COVID-19 pandemic as well as continued sales promotions and campaigns, focused training on virtual selling, and strategically prioritizing selling lower face amount policies due to the COVID-19 pandemic in 2021. In addressing the decreasing first year premiums we have seen in recent years in this segment, we have prioritized recruiting new independent contractors in 2021 and we believe we have seen the impact of these efforts in 2021. We believe that our policies issued and amount of insurance issued in 2020 were negatively impacted by the COVID-19 pandemic.
The number of policies issued in the Home Service Insurance segment decreased 9.3% in 2021 compared to 2020; however, the amount of insurance issued increased by 32.4% due to higher average policy face amounts. The increase in higher average policy face amounts issued is attributable to sales campaigns that focused on increasing the face amount of insurance sold as well as the introduction of our new whole life product in this segment, which has a higher maximum face value. In addition, our Home Service Insurance segment was negatively impacted by the COVID-19 pandemic in 2020 as we had temporary office closures in Louisiana during the second and third quarters of 2020 due to the COVID-19 pandemic and Hurricane Laura, and we also temporarily curtailed the sales of certain product offerings that require extensive person-to-person sales interaction due to the COVID-19 pandemic.
REVENUES
Revenues are primarily generated from insurance premiums and investment income on invested assets.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Revenues: | |||||||||||||||||
| Premiums: | |||||||||||||||||
| Life insurance | $ | 169,801 | 170,328 | 178,351 | |||||||||||||
| Accident and health insurance | 1,250 | 1,019 | 1,383 | ||||||||||||||
| Property insurance | 3,677 | 3,982 | 4,613 | ||||||||||||||
| Net investment income | 61,495 | 60,197 | 59,531 | ||||||||||||||
| Investment related gains (losses) | 10,991 | 1,502 | 5,249 | ||||||||||||||
| Other income | 3,332 | 1,828 | 1,418 | ||||||||||||||
| Total revenues | $ | 250,546 | 238,856 | 250,545 | |||||||||||||
December 31, 2021 | 10-K 38
Renewal premiums consisted of 89.8% and 90.9% of our total premium revenue in 2021 and 2020, respectively.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Premiums: | |||||||||||||||||
| First year | $ | 17,766 | 15,972 | 17,508 | |||||||||||||
| Renewal | 156,962 | 159,357 | 166,839 | ||||||||||||||
| Total premiums | $ | 174,728 | 175,329 | 184,347 | |||||||||||||
As discussed above, despite higher first year premiums in both our segments and higher renewal premiums in our Home Service Insurance segment, total premiums declined due to lower renewal premiums in our Life Insurance segment. A decrease in property insurance premiums resulting from higher catastrophic reinsurance reinstatement premiums in 2021 also contributed to the lower renewal premiums. We believe that our consolidated first year premium revenue was negatively impacted by the COVID-19 pandemic in both 2020 and 2021.
Net Investment Income. Our net investment income and investment performance is summarized as follows:
Years ended December 31, (In thousands, except for %) | 2021 | 2020 | 2019 | ||||||||||||||
| Gross investment income: | |||||||||||||||||
| Fixed maturity securities | $ | 55,579 | 54,653 | 53,860 | |||||||||||||
| Equity securities | 1,024 | 816 | 662 | ||||||||||||||
| Policy loans | 6,420 | 6,605 | 6,451 | ||||||||||||||
| Long-term investments | 809 | 238 | 13 | ||||||||||||||
| Other | 54 | 97 | 374 | ||||||||||||||
| Total investment income | 63,886 | 62,409 | 61,360 | ||||||||||||||
| Less investment expenses | (2,391) | (2,212) | (1,829) | ||||||||||||||
| Net investment income | $ | 61,495 | 60,197 | 59,531 | |||||||||||||
| Average invested assets, at amortized cost | $ | 1,451,701 | 1,445,087 | 1,365,036 | |||||||||||||
| Yield on average invested assets | 4.24 | % | 4.24 | % | 4.36 | % | |||||||||||
Net investment income increased 2.2% to $61.5 million in 2021 compared to $60.2 million in 2020 driven by a growing asset base. Investment income from fixed maturity securities accounted for a majority of our investment income. Long-term investment income continued to increase as our limited partnership asset base grew, in addition to some early distribution income.
The annualized yield remained level in 2021 compared to 2020. The sustained low interest rate environment of the past several years has required us to reinvest a portion of our portfolio at lower interest rates; however, diversification of our investment portfolio into limited partnership investments helped offset a challenging investment environment for fixed maturity securities. As we continue to face a challenging investment environment for fixed maturity assets, which account for the majority of our investment portfolio we have been investing in new asset classes, including limited partnerships; however, insurance regulations limit the amount we can invest in these alternative investments.
December 31, 2021 | 10-K 39
Investment Related Gains (Losses). Investment gains and losses are as follows:
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Investment related gains (losses): | |||||||||||||||||
| Realized investment gains (losses) | $ | 2,977 | (94) | 7,392 | |||||||||||||
| Change in fair value of equity securities | 376 | 1,596 | 962 | ||||||||||||||
| Change in fair value of limited partnerships | 7,452 | — | — | ||||||||||||||
| Change in credit loss allowance | 186 | — | — | ||||||||||||||
| Other-than-temporary impairments ("OTTI") | — | — | (3,105) | ||||||||||||||
| Investment related gains (losses), net | $ | 10,991 | 1,502 | 5,249 | |||||||||||||
Net investment related gains increased by $9.5 million in 2021 from 2020, helping drive our net income improvement in 2021. A significant portion of these gains related to fair value changes in our limited partnership investments. In addition, the Company realized a gain of $1.0 million on the sale of its former training facility near Austin, Texas during 2021 with a gross sale price of $3.8 million. The facility was owned by Citizens and was held in Other Non-Insurance Enterprises. These increases were partially offset by a decrease in fair value on our equity securities.
BENEFITS AND EXPENSES
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Benefits and expenses: | |||||||||||||||||
| Insurance benefits paid or provided: | |||||||||||||||||
| Claims and surrenders | $ | 119,735 | 121,145 | 106,827 | |||||||||||||
| Increase in future policy benefit reserves | 36,444 | 29,923 | 41,712 | ||||||||||||||
| Policyholders' dividends | 6,180 | 5,587 | 6,040 | ||||||||||||||
| Total insurance benefits paid or provided | 162,359 | 156,655 | 154,579 | ||||||||||||||
| Commissions | 35,463 | 32,069 | 34,222 | ||||||||||||||
| Other general expenses | 43,370 | 53,669 | 48,440 | ||||||||||||||
| Capitalization of deferred policy acquisition costs | (22,740) | (20,475) | (22,255) | ||||||||||||||
| Amortization of deferred policy acquisition costs | 24,952 | 27,439 | 28,268 | ||||||||||||||
| Amortization of cost of insurance acquired | 1,206 | 1,816 | 1,546 | ||||||||||||||
| Goodwill impairment | 12,624 | — | — | ||||||||||||||
| Total benefits and expenses | $ | 257,234 | 251,173 | 244,800 | |||||||||||||
December 31, 2021 | 10-K 40
Claims and Surrenders. Payment of death claims and surrender benefits is our primary use of cash. Claims and surrenders decreased 1.2% from $121.1 million in 2020 to $119.7 million in 2021.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Claims and surrenders: | |||||||||||||||||
| Death claim benefits | $ | 31,380 | 27,195 | 25,100 | |||||||||||||
| Surrender benefits | 51,638 | 54,827 | 49,293 | ||||||||||||||
| Endowment benefits | 9,572 | 11,026 | 12,247 | ||||||||||||||
| Matured endowment benefits | 20,304 | 21,580 | 15,147 | ||||||||||||||
| Property claims | 2,112 | 2,807 | 1,563 | ||||||||||||||
| Accident and health benefits | 332 | 219 | 232 | ||||||||||||||
| Other policy benefits | 4,397 | 3,491 | 3,245 | ||||||||||||||
| Total claims and surrenders | $ | 119,735 | 121,145 | 106,827 | |||||||||||||
•Death claim benefits increased 15.4% in 2021 compared to 2020. The increases were due to both a higher volume, including COVID-19 related deaths, and a higher average amount of reported claims. Mortality experience and COVID-19 impacts will continue to be closely monitored by the Company.
•Surrender benefits decreased 5.8% in 2021 compared to 2020. The decrease in surrender benefits is primarily within our Life Insurance segment. Surrender benefits have been high in recent years due to international policies that have been in force for an extended period and have little or no associated surrender charges, but we have focused our efforts on retaining policyholders and believe we have begun to see positive benefits from these efforts starting in the second half of 2021. Surrender benefits represented less than 1.1% of total direct life insurance in force of $4.6 billion as of December 31, 2021.
•Property claim expenses decreased 24.8% in 2021 compared to 2020 due to fewer hurricanes impacting Louisiana in 2021.
Increase in Future Policy Benefit Reserves. Future policy benefit reserves increased 21.8% in 2021 compared to 2020 due to better persistency and higher first year sales in both of our segments.
Policyholder Dividends. Most of our Life Insurance segment's international policies contain guaranteed cash values and are participating (i.e., provide for cash dividends as apportioned by our Board of Directors). Policyholders' dividends increased by 10.6% in 2021 as compared to 2020 due to increased sales in 2021 and improved policyholder retention.
Commissions. Commission expenses are a cost of acquiring business, as commissions are the primary compensation paid to our independent consultants and independent agents for selling our products. First year
December 31, 2021 | 10-K 41
commission rates are higher than renewal commission rates. Commissions fluctuate directly in relation to sales and thus the increase in commissions in 2021 as compared to 2020 was due to higher sales in 2021.
Other General Expenses. Total general expenses decreased $10.3 million, or 19.2%, in 2021 compared to 2020. Other general expenses in 2020 included $10.0 million of non-recurring expenses related to change-in-control severance expenses. We continue to work on improving our controllable operating expenses and in 2021, we had lower audit and long-term incentive compensation expenses compared to 2020.
Capitalization of Deferred Policy Acquisition Costs ("DAC"). We capitalize costs related to successful sales of our insurance products, which include certain commissions, policy issuance costs, and underwriting and agency expenses. These costs vary based upon amounts or premiums received related to new and renewal business. Capitalized DAC was $22.7 million and $20.5 million in 2021 and 2020, respectively. Increases in capitalized amounts are in line with the increases in new sales activity. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business, which has higher commission rates.
Amortization of Deferred Policy Acquisition Costs. Amortization of DAC totaled $25.0 million and $27.4 million in 2021 and 2020, respectively. The decrease in amortization is a result of better persistency and sales. Amortization of DAC is impacted by new business, persistency and the level of surrenders.
Amortization of Cost of Insurance Acquired ("COIA"). Amortization of COIA decreased in 2021 compared to 2020 due primarily to an update in our Home Service Insurance segment's expected earned rate assumptions used within annuity models that resulted in additional amortization of approximately $0.2 million in 2020.
Goodwill Impairment. We recognized a goodwill impairment in our Life Insurance segment of $12.6 million in 2021. The impairment was triggered by increases in our carrying value of the Life Insurance segment due to the release of a $43.8 million uncertain tax position in the fourth quarter of 2021 following the expiration of the statute of limitations for the tax year ended December 31, 2017.
Federal Income Tax. Federal income tax benefits of $43.5 million in 2021 and $1.3 million in 2020 resulted in effective tax rates of 650.0% and 10.8%, respectively. The significant tax benefit in 2021 is comprised of the release of the uncertain tax position of $43.8 million related to the expiration of the statute of limitations for the year ended December 31, 2017. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes. Refer to Note 9. Income Taxes in the notes to our consolidated financial statements for further discussion.
SEGMENT OPERATIONS
As described above, our business is comprised of two operating business segments:
•Life Insurance
•Home Service Insurance
These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income (loss) before federal income taxes for these segments.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Income (loss) before federal income taxes: | |||||||||||||||||
| Segments: | |||||||||||||||||
| Life Insurance | $ | 918 | 9,894 | 11,795 | |||||||||||||
| Home Service Insurance | (2,036) | (3,470) | 1,181 | ||||||||||||||
| Total Segments | (1,118) | 6,424 | 12,976 | ||||||||||||||
| Other Non-Insurance Enterprises | (5,570) | (18,741) | (7,231) | ||||||||||||||
| Total income (loss) before federal income taxes | $ | (6,688) | (12,317) | 5,745 | |||||||||||||
December 31, 2021 | 10-K 42
LIFE INSURANCE
Our Life Insurance segment primarily issues ordinary whole life insurance and endowment policies in U.S. dollar-denominated amounts to non-U.S. residents in more than 70 countries through almost 1,000 active independent marketing consultants as of December 31, 2021.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Revenue: | |||||||||||||||||
| Premiums | |||||||||||||||||
| Life insurance | $ | 125,558 | 128,900 | 136,941 | |||||||||||||
| Accident and health insurance | 500 | 301 | 725 | ||||||||||||||
| Net investment income | 47,216 | 45,885 | 44,779 | ||||||||||||||
| Investment related gains, net | 9,176 | 1,340 | 6,795 | ||||||||||||||
| Other income | 3,362 | 1,806 | 1,412 | ||||||||||||||
| Total revenue | 185,812 | 178,232 | 190,652 | ||||||||||||||
| Benefits and expenses: | |||||||||||||||||
| Insurance benefits paid or provided: | |||||||||||||||||
| Claims and surrenders | 91,390 | 93,813 | 82,964 | ||||||||||||||
| Increase in future policy benefit reserves | 29,407 | 25,825 | 39,873 | ||||||||||||||
| Policyholders' dividends | 6,140 | 5,554 | 6,004 | ||||||||||||||
| Total insurance benefits paid or provided | 126,937 | 125,192 | 128,841 | ||||||||||||||
| Commissions | 18,747 | 17,944 | 20,128 | ||||||||||||||
| Other general expenses | 20,846 | 16,323 | 23,012 | ||||||||||||||
| Capitalization of deferred policy acquisition costs | (16,174) | (15,568) | (17,448) | ||||||||||||||
| Amortization of deferred policy acquisition costs | 21,571 | 23,987 | 23,832 | ||||||||||||||
| Amortization of cost of insurance acquired | 343 | 460 | 492 | ||||||||||||||
| Goodwill impairment | 12,624 | — | — | ||||||||||||||
| Total benefits and expenses | 184,894 | 168,338 | 178,857 | ||||||||||||||
| Income (loss) before federal income taxes | $ | 918 | 9,894 | 11,795 | |||||||||||||
Income before federal income tax expense decreased in 2021 as compared to 2020 due primarily to the goodwill impairment.
Life Insurance Segment premium breakout is detailed below.
| 2021 | 2020 | 2019 | |||||||||||||||
| Premiums: | |||||||||||||||||
| First year | $ | 11,420 | 10,397 | 11,692 | |||||||||||||
| Renewal | 114,638 | 118,805 | 125,974 | ||||||||||||||
| Total premium | $ | 126,058 | 129,202 | 137,666 | |||||||||||||
Over 90% of our Life Insurance premium revenue in both 2021 and 2020 was generated by renewal premiums. While first year premiums increased by 9.8% in 2021 as compared to 2020, overall premium revenue decreased by 2.4% in 2021 compared to 2020 as renewal premiums declined by 3.5%. We believe that the increase in first year premiums is the result of actions we have taken over the past 18 months in executing on our strategic initiatives, including sales promotions and campaigns, focused training on virtual selling, and recruiting new independent contractors in 2021. Renewal premiums have been declining over the last several years, due in part to our
December 31, 2021 | 10-K 43
withdrawal from Brazil and also due to one of our top distributors in Venezuela leaving our Company and as we discussed in Item 3 - Legal Proceedings, we believe is illegally competing with us and stealing our trade secrets and business. We began to stem the decline of renewal premiums in 2021, which we believe is due in part to our retention efforts that we also discuss in Part I. Item 1, Business - Strategic Initiatives.
Endowment sales represent a significant portion of our new business sales internationally and totaled approximately $10.0 million and $8.6 million in 2021 and 2020, respectively, representing approximately 87.2% and 82.7% of total first year premiums in 2021 and 2020, respectively.
International Premiums. The following table sets forth, for our top five producing countries, our direct premiums from our international life insurance business for the periods indicated.
Years ended December 31, (In thousands, except for %) | 2021 | 2020 | 2019 | ||||||||||||||||||||||||||||||||
| Country: | |||||||||||||||||||||||||||||||||||
| Colombia | $ | 24,829 | 20.2 | % | $ | 25,783 | 20.4 | % | $ | 26,768 | 20.1 | % | |||||||||||||||||||||||
| Taiwan | 19,042 | 15.5 | 19,078 | 15.1 | 19,403 | 14.6 | |||||||||||||||||||||||||||||
| Venezuela | 17,788 | 14.5 | 19,956 | 15.8 | 22,353 | 16.8 | |||||||||||||||||||||||||||||
| Ecuador | 13,115 | 10.7 | 13,301 | 10.5 | 14,198 | 10.6 | |||||||||||||||||||||||||||||
| Argentina | 9,160 | 7.5 | 9,175 | 7.3 | 10,069 | 7.6 | |||||||||||||||||||||||||||||
| Other Non-U.S. | 38,871 | 31.6 | 38,992 | 30.9 | 40,562 | 30.3 | |||||||||||||||||||||||||||||
| Total | $ | 122,805 | 100.0 | % | $ | 126,285 | 100.0 | % | $ | 133,353 | 100.0 | % | |||||||||||||||||||||||
The five countries listed above represented the majority of the new and renewal premiums in both 2021 and 2020. All experienced slight declines in 2021 as compared to 2020, which is due to the overall decline in our renewal business. However, premiums from Venezuela continue to decrease more than the other countries and decreased by 10.9% from 2020 to 2021. One of our largest distributors, who is based in Venezuela, has left our Company and based upon discovery conducted in such lawsuit, we believe is illegally competing with us and negatively affecting our business in Venezuela.
Domestic Premiums. Domestic premiums in our Life Insurance segment were $5.0 million in 2021, compared to $5.1 million in 2020. The majority of the premium recorded in 2020 and 2021 is related to renewal business as we discontinued new sales of domestic ordinary whole life and endowment life insurance products within our Life Insurance segment in 2017. In 2021, we introduced new domestic whole life products and distribution to expand our Life Insurance segment to the Hispanic market in Florida. However, our efforts to recruit agents to sell our products have been slower than we expected and we are re-evaluating our sales distribution approach, initiatives and domestic life insurance offerings in the Florida market in 2022.
December 31, 2021 | 10-K 44
Net Investment Income. Net investment income in our Life Insurance segment increased 2.9% in 2021 compared to 2020 due to continued growth in average invested assets. We experienced a decrease in portfolio yield of two basis points in this segment in 2021 compared to 2020 as we continue to face a challenging investment environment for fixed maturity assets, which account for the majority of our investment portfolio.
Years ended December 31, (In thousands, except for %) | 2021 | 2020 | 2019 | ||||||||||||||
| Net investment income | $ | 47,216 | 45,885 | 44,779 | |||||||||||||
| Average invested assets, at amortized cost | 1,109,466 | 1,071,792 | 1,016,055 | ||||||||||||||
| Annualized yield on average invested assets | 4.26 | % | 4.28 | % | 4.41 | % | |||||||||||
Investment Related Gains, Net. The investment related gain for 2021 was primarily due to the appreciation in the value of our limited partnership investments. The investment related gain for 2020 was primarily due to the appreciation in value of a preferred stock exchange traded fund purchased during the first quarter of 2020 as we were able to take advantage of the market dislocation to identify an attractive risk-adjusted investment opportunity.
Claims and Surrenders. A breakout of the primary claims and surrender benefits for the Life Insurance segment is detailed below.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Claims and surrenders: | |||||||||||||||||
| Death claim benefits | $ | 8,160 | 5,990 | 6,710 | |||||||||||||
| Surrender benefits | 49,439 | 52,218 | 46,062 | ||||||||||||||
| Endowment benefits | 9,565 | 11,016 | 12,233 | ||||||||||||||
| Matured endowment benefits | 19,709 | 20,965 | 14,601 | ||||||||||||||
| Accident and health benefits | 135 | 149 | 128 | ||||||||||||||
| Other policy benefits | 4,382 | 3,475 | 3,230 | ||||||||||||||
| Total claims and surrenders | $ | 91,390 | 93,813 | 82,964 | |||||||||||||
75.7% of our claims and surrender benefits in 2021 and 78.0% in 2020 were related to payment of surrender benefits and matured endowment benefits. Policy surrenders decreased 5.3% in 2021 as compared to 2020 and matured endowment benefits decreased by 6.0% in 2021 as compared to 2020. Surrender benefits have been higher than usual the last several years. However, policy surrenders decreased as we have instituted new programs seeking to curb surrenders. Matured endowment benefits had been increasing over the last several years
December 31, 2021 | 10-K 45
but leveled off this year, which is expected, due to endowment products reaching their stated maturities. These charges are within expected levels.
The other key component of claims and surrender benefits is death claim benefits, which increased 36.2% in 2021 compared to 2020 due to both a higher volume, including COVID-19 related deaths, and a higher average amount of reported claims. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
Increase in future policy benefit reserves. The change in future policy benefit reserves increased 13.9% in 2021 compared to 2020 due to better persistency. In addition, the change in future policy reserves for 2021 was lower due to an $0.8 million adjustment for the conversion of a small block of policies to our new actuarial valuation system for our Life Insurance segment during the second quarter of 2021.
HOME SERVICE INSURANCE
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. In June 2021, we added a new whole life product to this market that has higher allowable face values; and in the fourth quarter of 2021, we added a new critical illness insurance product. Our Home Service Insurance segment also sells property insurance policies covering dwellings and contents with maximum coverage of $30,000 per dwelling.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Revenue: | |||||||||||||||||
| Premiums | |||||||||||||||||
| Life insurance | $ | 44,243 | 41,428 | 41,410 | |||||||||||||
| Accident and health insurance | 750 | 718 | 658 | ||||||||||||||
| Property insurance | 3,677 | 3,982 | 4,613 | ||||||||||||||
| Net investment income | 13,224 | 13,051 | 13,058 | ||||||||||||||
| Investment related gains, net | 618 | 223 | 1,470 | ||||||||||||||
| Other income | 7 | 19 | 4 | ||||||||||||||
| Total revenue | 62,519 | 59,421 | 61,213 | ||||||||||||||
| Benefits and expenses: | |||||||||||||||||
| Insurance benefits paid or provided: | |||||||||||||||||
| Claims and surrenders | 28,345 | 27,332 | 23,863 | ||||||||||||||
| Increase in future policy benefit reserves | 7,037 | 4,098 | 1,839 | ||||||||||||||
| Policyholders' dividends | 40 | 33 | 36 | ||||||||||||||
| Total insurance benefits paid or provided | 35,422 | 31,463 | 25,738 | ||||||||||||||
| Commissions | 16,716 | 14,125 | 14,094 | ||||||||||||||
| Other general expenses | 14,739 | 17,402 | 19,517 | ||||||||||||||
| Capitalization of deferred policy acquisition costs | (6,566) | (4,907) | (4,807) | ||||||||||||||
| Amortization of deferred policy acquisition costs | 3,381 | 3,452 | 4,436 | ||||||||||||||
| Amortization of cost of insurance acquired | 863 | 1,356 | 1,054 | ||||||||||||||
| Total benefits and expenses | 64,555 | 62,891 | 60,032 | ||||||||||||||
| Income (loss) before income tax expense | $ | (2,036) | (3,470) | 1,181 | |||||||||||||
Our net loss before income tax expense decreased by $1.4 million in 2021 due primarily to higher first year and renewal life insurance premiums, which drove the total segment revenue increase of 5.2% in 2021 compared to 2020. The increase was partially offset by higher reinstatement premiums for reinsurance coverage from the impact of Hurricane Ida in 2021. First year life premiums increased due mainly to our sales campaigns that focused on increasing the face amount of insurance sold as well as the introduction of our new whole life product in this
December 31, 2021 | 10-K 46
segment, which has a higher maximum face value. Renewal premiums increased during 2021 due to improvements in our collection and payment processes, strong collection efforts by our independent agents and our insureds' increased disposable income due to government stimulus and assistance programs related to the COVID-19 pandemic. Sales during the 2020 period were negatively impacted by the COVID-19 pandemic.
Our benefits and expenses in this segment increased by $1.7 million in 2021 as compared to 2020, primarily due to higher claims and surrenders, as well as an increase in future policy benefit reserves in 2021 due to better persistency and higher first year sales, partially offset by a decrease in other general expenses.
Claims and Surrenders. A breakout of claims and surrender benefits for the Home Service Insurance segment is detailed below.
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Claims and surrenders: | |||||||||||||||||
| Death claim benefits | $ | 23,220 | 21,205 | 18,390 | |||||||||||||
| Surrender benefits | 2,199 | 2,609 | 3,231 | ||||||||||||||
| Endowment benefits | 7 | 10 | 14 | ||||||||||||||
| Matured endowment benefits | 595 | 615 | 546 | ||||||||||||||
| Property claims | 2,112 | 2,807 | 1,563 | ||||||||||||||
| Accident and health benefits | 197 | 70 | 104 | ||||||||||||||
| Other policy benefits | 15 | 16 | 15 | ||||||||||||||
| Total claims and surrenders | $ | 28,345 | 27,332 | 23,863 | |||||||||||||
The majority of claims and surrender benefits in our Home Service Insurance segment relate to death claim benefits. Death claim benefits increased 9.5% in 2021 compared to 2020 due to both a higher volume, including COVID-19 related deaths, and a higher average amount of reported claims. Mortality experience is closely monitored by the Company and can fluctuate based on reported claims as a key performance indicator.
Property claims decreased in 2021 compared to 2020. The Company was impacted by Hurricane Ida in 2021 and by Hurricanes Laura, Delta and Zeta in 2020. We have a reinsurance agreement that covers catastrophic events such as hurricanes. This agreement contains a maximum coverage of $11.0 million per event and a retention level of $0.5 million per event. The decreased hurricane activity in 2021 helped reduce our property claims in 2021 compared to 2020.
Increase in future policy benefit reserves. The change in future policy benefit reserves increased 71.7% in 2021 compared to 2020 due to higher sales and improved retention in 2021.
Other general expenses. Other general expenses decreased in 2021 compared to 2020 as a result of a released tax compliance best estimate liability of $1.8 million and lower expenses due to changes we made to our distribution structure in 2020.
OTHER NON-INSURANCE ENTERPRISES
Years ended December 31, (In thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Income (loss) before federal income tax | $ | (5,570) | (18,741) | (7,231) | |||||||||||||
December 31, 2021 | 10-K 47
This operating unit represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under U.S. GAAP, which typically results in a segment loss. Revenue in this operating unit consists primarily of net investment income and investment related gains or losses, while expenses consist of other general expenses. The loss reported for 2021 declined as other general expenses decreased in 2021 due to the $10.0 million in severance payments paid in 2020 related to our change in control. The Company also sold its former training facility located near Austin, Texas during 2021, resulting in a gain on the sale of $1.0 million.
INVESTMENTS
Our investments play a significant role in the success of our business, as we invest the majority of premiums collected to pay for future benefits and rely on net investment income for our ongoing operations. The administration of our investment portfolio is handled by our management and a third-party investment manager, pursuant to Board-approved investment guidelines. State insurance statutes prescribe the quality and percentage of the various types of investments that may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, mortgage loans and real estate within certain specified percentages. Our investment guidelines comply with the applicable statutes and thus fixed maturity securities comprise a majority of our investment portfolio. The assets are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for our insurance company subsidiaries to meet their respective policyholder obligations and operating expenses.
The following table shows the carrying value of our investments by investment category and cash and the percentage of each to total invested assets.
(1) Includes $158.6 million and $164.0 million of securities guaranteed by third parties at December 31, 2021 and 2020, respectively.
(2) Includes $133.7 million and $139.8 million of U.S. Government agencies and government-sponsored enterprises at December 31, 2021 and 2020, respectively.
During 2021, we continued repositioning our portfolio into more diversified holdings as part of our investment management strategy. As investments matured or were called, the Company increased investments in corporate securities, which now represent 54.0% of our cash and invested assets as of December 31, 2021 as compared to 52.8% at December 31, 2020. The Company has also decreased its exposure to the municipal bond market, which represents 23.3% of the investment portfolio as of December 31, 2021 compared to 24.7% as of December 31, 2020.
December 31, 2021 | 10-K 48
Cash and cash equivalents decreased as of December 31, 2021 compared to December 31, 2020 due to timing of cash inflows and investments of cash into marketable securities.
Real estate and other long-term investments increased to $57.4 million as of December 31, 2021, as compared to $29.9 million as of December 31, 2020, primarily due to investments of $37.9 million in limited partnerships, partially offset by the sale of our former training facility for $2.5 million and the payment of $8.8 million of severance previously held in a Rabbi trust for the benefit of our former chief executive officer.
At December 31, 2021, investments in fixed maturity and equity securities were 90.0% of our total cash and invested assets. All of our fixed maturity securities were classified as available-for-sale at December 31, 2021 and 2020. We had no fixed maturity securities that were classified as trading securities at December 31, 2021 or 2020.
The following table shows annualized investment yields by segment and on a consolidated basis as of December 31 for each year presented.
| Year | Life Insurance | Home Service Insurance | Consolidated | |||||||||||||||||
| 2021 | 4.26 | % | 4.37 | % | 4.24 | % | ||||||||||||||
| 2020 | 4.28 | % | 4.37 | % | 4.24 | % | ||||||||||||||
| 2019 | 4.41 | % | 4.45 | % | 4.36 | % | ||||||||||||||
Yields on investment assets vary between segment operations due to different portfolio mixes and durations in the segments. The consolidated yields include our other non-insurance enterprises. The sustained low interest rate environment of the past several years for fixed maturity assets, which account for the majority of our investment portfolio, has required us to reinvest a portion of our portfolio at lower interest rates; however, diversification of our investment portfolio into limited partnership investments helped offset a challenging investment environment for fixed maturity securities in 2021.
Credit quality is an important feature of our investment guidelines for our fixed maturity securities. Credit ratings reported for the periods indicated are assigned by a Nationally Recognized Statistical Rating Organization ("NRSRO") such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. A credit rating assigned by a NRSRO is a quality-based rating, with AAA representing the highest quality and D the lowest, with BBB and above being considered investment grade. If there is no NRSRO rating, the Company may use credit ratings of the NAIC Securities Valuation Office ("SVO") as assigned. Securities rated by the SVO are grouped in the equivalent NRSRO category as stated by the SVO, and securities that are not rated by a NRSRO are included in the "other" category.
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value.
December 31, (In thousands, except for %) | 2021 | % | 2020 | % | |||||||||||||||||||
| AAA | $ | 29,572 | 2.0 | % | $ | 31,990 | 2.1 | % | |||||||||||||||
| AA | 425,996 | 29.0 | 449,934 | 30.3 | |||||||||||||||||||
| A | 418,465 | 28.5 | 451,488 | 30.3 | |||||||||||||||||||
| BBB | 565,923 | 38.5 | 532,993 | 35.8 | |||||||||||||||||||
| BB and other | 30,661 | 2.0 | 22,978 | 1.5 | |||||||||||||||||||
| Totals | $ | 1,470,617 | 100.0 | % | $ | 1,489,383 | 100.0 | % | |||||||||||||||
The Company made new investments in investment grade bonds during 2021. Non-investment grade securities are the result of downgrades of issuers or securities acquired during acquisitions of other companies, as the Company has not purchased below investment grade securities.
December 31, 2021 | 10-K 49
As of December 31, 2021, the Company held municipal fixed maturity securities that include third-party guarantees. Detailed below is a presentation by credit rating of our municipal holdings by funding type.
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| General Obligation | Special Revenue | Other | Total | % Based on Amortized Cost | |||||||||||||||||||||||||||||||||||||||||||||||||
| (In thousands, except for %) | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | |||||||||||||||||||||||||||||||||||||||||||||
| Municipal fixed maturity securities shown including third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| AAA | $ | 20,655 | 19,588 | 3,315 | 3,078 | — | — | 23,970 | 22,666 | 6.4 | % | ||||||||||||||||||||||||||||||||||||||||||
| AA | 51,780 | 48,158 | 124,926 | 117,665 | 12,010 | 10,824 | 188,716 | 176,647 | 49.5 | ||||||||||||||||||||||||||||||||||||||||||||
| A | 17,497 | 16,116 | 116,115 | 105,646 | 5,008 | 4,412 | 138,620 | 126,174 | 35.4 | ||||||||||||||||||||||||||||||||||||||||||||
| BBB | 3,389 | 3,059 | 13,490 | 12,940 | 1,537 | 1,450 | 18,416 | 17,449 | 4.9 | ||||||||||||||||||||||||||||||||||||||||||||
| BB and other | 4,703 | 4,413 | 9,533 | 9,245 | — | — | 14,236 | 13,658 | 3.8 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 98,024 | 91,334 | 267,379 | 248,574 | 18,555 | 16,686 | 383,958 | 356,594 | 100.0 | % | ||||||||||||||||||||||||||||||||||||||||||
| Municipal fixed maturity securities shown excluding third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| AAA | $ | 2,568 | 2,526 | — | — | — | — | 2,568 | 2,526 | 0.7 | % | ||||||||||||||||||||||||||||||||||||||||||
| AA | 35,200 | 33,377 | 49,088 | 45,885 | 7,380 | 6,526 | 91,668 | 85,788 | 24.1 | ||||||||||||||||||||||||||||||||||||||||||||
| A | 28,849 | 26,902 | 141,759 | 130,001 | 7,941 | 7,141 | 178,549 | 164,044 | 46.0 | ||||||||||||||||||||||||||||||||||||||||||||
| BBB | 6,727 | 6,047 | 35,720 | 33,863 | 57 | 55 | 42,504 | 39,965 | 11.2 | ||||||||||||||||||||||||||||||||||||||||||||
| BB and other | 24,680 | 22,482 | 40,812 | 38,825 | 3,177 | 2,964 | 68,669 | 64,271 | 18.0 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 98,024 | 91,334 | 267,379 | 248,574 | 18,555 | 16,686 | 383,958 | 356,594 | 100.0 | % | ||||||||||||||||||||||||||||||||||||||||||
The table below shows the categories in which the Company held investments in special revenue bonds that were greater than 10% of fair value based upon the Company's portfolio of municipal fixed maturity securities at December 31, 2021.
| (In thousands, except for %) | Fair Value | Amortized Cost | % of Total Fair Value | |||||||||||||||||
| Education | $ | 69,130 | 65,040 | 18.0 | % | |||||||||||||||
| Utilities | 62,545 | 55,958 | 16.3 | % | ||||||||||||||||
| Transportation | 44,210 | 42,569 | 11.5 | % | ||||||||||||||||
The Company's municipal holdings are spread across many states. However, municipal fixed maturity securities from Texas and California comprise the most significant concentration of the total municipal holdings portfolio as of December 31, 2021.
The Company holds 21.6% and 12.9% of its municipal holdings in Texas and California issuers, respectively, as of December 31, 2021. There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2021.
December 31, 2021 | 10-K 50
The table below represents the Company's detailed exposure to municipal bond portfolio by credit rating in Texas at December 31, 2021.
| General Obligation | Special Revenue | Other | Total | ||||||||||||||||||||||||||||||||||||||||||||
| (In thousands) | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | |||||||||||||||||||||||||||||||||||||||
| Texas securities including third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||
| AAA | $ | 20,082 | 19,080 | 3,315 | 3,078 | — | — | 23,397 | 22,158 | ||||||||||||||||||||||||||||||||||||||
| AA | 21,535 | 20,821 | 13,660 | 12,777 | 57 | 55 | 35,252 | 33,653 | |||||||||||||||||||||||||||||||||||||||
| A | — | — | 21,671 | 21,832 | — | — | 21,671 | 21,832 | |||||||||||||||||||||||||||||||||||||||
| BBB | — | — | 1,959 | 1,825 | — | — | 1,959 | 1,825 | |||||||||||||||||||||||||||||||||||||||
| BB and other | — | — | 534 | 505 | — | — | 534 | 505 | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 41,617 | 39,901 | 41,139 | 40,017 | 57 | 55 | 82,813 | 79,973 | ||||||||||||||||||||||||||||||||||||||
| Texas securities excluding third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||
| AAA | $ | 2,568 | 2,526 | — | — | — | — | 2,568 | 2,526 | ||||||||||||||||||||||||||||||||||||||
| AA | 31,801 | 30,439 | 3,216 | 3,032 | — | — | 35,017 | 33,471 | |||||||||||||||||||||||||||||||||||||||
| A | 6,034 | 5,788 | 29,369 | 28,993 | — | — | 35,403 | 34,781 | |||||||||||||||||||||||||||||||||||||||
| BBB | 1,214 | 1,148 | 5,611 | 5,199 | 57 | 55 | 6,882 | 6,402 | |||||||||||||||||||||||||||||||||||||||
| BB and other | — | — | 2,943 | 2,793 | — | — | 2,943 | 2,793 | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 41,617 | 39,901 | 41,139 | 40,017 | 57 | 55 | 82,813 | 79,973 | ||||||||||||||||||||||||||||||||||||||
The table below represents the Company's detailed exposure to municipal bond portfolio by credit rating in California at December 31, 2021.
| General Obligation | Special Revenue | Other | Total | ||||||||||||||||||||||||||||||||||||||||||||
| (In thousands) | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | |||||||||||||||||||||||||||||||||||||||
| California securities including third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||
| AA | $ | — | — | 31,942 | 30,407 | 2,933 | 2,729 | 34,875 | 33,136 | ||||||||||||||||||||||||||||||||||||||
| A | 1,705 | 1,650 | 8,354 | 8,113 | — | — | 10,059 | 9,763 | |||||||||||||||||||||||||||||||||||||||
| BBB | — | — | 4,757 | 4,653 | — | — | 4,757 | 4,653 | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,705 | 1,650 | 45,053 | 43,173 | 2,933 | 2,729 | 49,691 | 47,552 | ||||||||||||||||||||||||||||||||||||||
| California securities excluding third-party guarantees | |||||||||||||||||||||||||||||||||||||||||||||||
| AA | $ | — | — | 3,708 | 3,639 | — | — | 3,708 | 3,639 | ||||||||||||||||||||||||||||||||||||||
| A | 1,705 | 1,650 | 16,076 | 15,463 | 2,933 | 2,729 | 20,714 | 19,842 | |||||||||||||||||||||||||||||||||||||||
| BBB | — | — | 8,315 | 7,847 | — | — | 8,315 | 7,847 | |||||||||||||||||||||||||||||||||||||||
| BB and other | — | — | 16,954 | 16,224 | — | — | 16,954 | 16,224 | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,705 | 1,650 | 45,053 | 43,173 | 2,933 | 2,729 | 49,691 | 47,552 | ||||||||||||||||||||||||||||||||||||||
IMPAIRMENT CONSIDERATIONS RELATED TO INVESTMENTS IN FIXED MATURITY AND EQUITY SECURITIES
Beginning January 1, 2020, in connection with the adoption of a new accounting standard, the Company assesses available-for-sale ("AFS") fixed maturity securities in an unrealized loss position for expected credit losses. See Note 1. Summary of Significant Accounting Policies for a discussion regarding our application of this accounting standard. The Company recorded no credit losses on securities in 2021 or 2020.
December 31, 2021 | 10-K 51
Gross unrealized losses on AFS fixed maturity securities amounted to $3.0 million as of December 31, 2021 and $1.9 million as of December 31, 2020. This increase in gross unrealized losses during 2021 was a result of the increase in average interest rates compared to 2020.
Information on both unrealized and realized gains and losses by category is set forth in Note 2. Investments of the notes to our consolidated financial statements.
REINSURANCE
As is customary among insurance companies, our insurance company subsidiaries reinsure, with other companies, portions of the life insurance risks they underwrite. A primary purpose of reinsurance agreements is to enable an insurance company to reduce the amount of risk by reinsuring the amount exceeding the maximum amount the insurance company is willing to retain. Even though a portion of the risk may be reinsured, our insurance company subsidiaries remain liable to perform all the obligations imposed by the policies issued by them and could be liable if their reinsurers were unable to meet their obligations under the reinsurance agreements.
We believe we have established appropriate reinsurance coverage based upon our net retained insured liabilities compared to our surplus.
The effect of reinsurance on premiums is as follows.
| 2021 | 2020 | 2019 | |||||||||||||||
| Direct premiums | $ | 178,806 | 178,952 | 187,009 | |||||||||||||
| Reinsurance assumed | 84 | 91 | 99 | ||||||||||||||
| Reinsurance ceded | (4,162) | (3,714) | (2,761) | ||||||||||||||
| Net premiums | $ | 174,728 | 175,329 | 184,347 | |||||||||||||
Our insurance subsidiaries monitor the solvency of their reinsurers in seeking to minimize the risk of loss in the event of default by a reinsurer. The primary reinsurers of our insurance subsidiaries are large, well-capitalized entities.
The effect of reinsurance on life insurance in force is as follows.
Years ended December 31, (In millions) | 2021 | 2020 | 2019 | ||||||||||||||
| Direct written life insurance in force | $ | 4,628 | 4,612 | 4,729 | |||||||||||||
| Reinsurance assumed | 4 | 5 | 5 | ||||||||||||||
| Reinsurance ceded | (466) | (475) | (487) | ||||||||||||||
| Net life insurance in force | $ | 4,166 | 4,142 | 4,247 | |||||||||||||
Virtually all of the Company's non-credit accident and health insurance has been reinsured and is administered by Unified Life Insurance Company, an unaffiliated party.
The Company monitors the credit ratings of our life and property reinsurers. The ratings by A.M. Best Company range from B+ (Good) to A+ (Superior).
SPFIC generally carries first and second event catastrophe reinsurance coverage of $10.5 million per event and a retention level of $0.5 million per event. Thus, the first $0.5 million of incurred claims and any claims in excess of $11.0 million per event are SPFIC's responsibility. The reinsurance premium for catastrophe reinsurance was $2.3 million in 2021, $1.4 million in 2020 and $0.8 million in 2019.
December 31, 2021 | 10-K 52
LIQUIDITY AND CAPITAL RESOURCES
Below are our primary capital resources (based on carrying value) at each of December 31, 2021 and 2020.
(In thousands, except for %) | 2021 | 2020 | |||||||||
| Fixed maturity securities | $ | 1,470,617 | 1,489,383 | ||||||||
| Cash and cash equivalents | 27,294 | 34,131 | |||||||||
Liquidity refers to a company's ability to generate sufficient cash flows to meet the needs of its operations. In the year ended December 31, 2021, our operations provided $40.5 million in net cash. We manage our insurance operations as described herein in order to ensure that we have stable and reliable sources of cash flows to meet our obligations. We currently anticipate meeting our short-term and long-term cash needs with cash generated by our insurance operations and from our invested assets. From time-to-time we may raise capital by selling shares in our SIP (as defined below) and we may also access our Credit Facility if needed (both as described below).
PARENT COMPANY LIQUIDITY AND CAPITAL RESOURCES
Citizens is a holding company and has had minimal operations of its own. Our assets consist of the capital stock of our subsidiaries, cash and investments. Our liquidity requirements are met primarily from two sources: cash generated from our operating subsidiaries and our invested assets. Our ability to obtain cash from our insurance subsidiaries depends primarily upon the availability of statutorily permissible payments, including payments Citizens receives from service agreements with our life insurance subsidiaries and dividends from the subsidiaries. The ability to make payments to the holding company is limited by applicable laws and regulations of Bermuda and U.S. states of domicile which subject insurance operations to significant regulatory restrictions. As discussed in Part I, Item 1, Business and Part I. Item 1A. Risk Factors, these laws and regulations require, among other things, that our insurance subsidiaries maintain minimum capital requirements, which limit the amount of dividends that can be paid to the holding company. The regulations also require approval of our service agreements with the applicable regulatory authority in order to prevent insurance subsidiaries from moving large amounts of cash to the unregulated holding company.
In addition to the above-mentioned sources of cash, we offer a Stock Investment Plan ("SIP"), whereby investors, policyholders, independent contractors and agents, employees and directors can directly purchase our stock. At our option, purchases of stock under the SIP can be made from newly issued or treasury stock, rather than in the open market, in which case, we can raise capital by selling our shares.
On May 5, 2021, we entered into a Credit Facility with Regions Bank. See Part IV, Item 1, Note 7, Commitments and Contingencies in the notes to our consolidated financial statements, herein, for a description of the Credit Facility. The Credit Facility provides additional liquidity to the Company for short-term and longer-term needs. As of December 31, 2021, we have not borrowed any money under the Credit Facility and have no immediate plans to do so.
INSURANCE COMPANY SUBSIDIARY LIQUIDITY AND CAPITAL RESOURCES
The liquidity requirements of our insurance operations are primarily met by premium revenues, investment income and investment maturities. Our primary uses of cash are for payments of policy benefits to policyholders, investment purchases, and operating expenses. Historically, cash flow from our operations has been sufficient to meet our cash needs and we have not had to liquidate a material amount of investments to pay our expenses and we did not do so in 2021. Premium revenue was $174.7 million and $175.3 million in the years ended December 31, 2021 and 2020, respectively. See Contractual Obligations and Off-balance Sheet Arrangements below for a discussion of known and estimated cash needs related to payments of future policy benefits and policy claims. Cash flow projections and cash flow tests under various market interest rate scenarios are performed annually to assist in evaluating liquidity needs and adequacy.
Cash from Operations. Cash provided by (used in) operating activities is an important liquidity metric because it reflects, during a given period, the amount of cash generated that is available to pay our operating expenses or
December 31, 2021 | 10-K 53
make strategic acquisitions. Cash provided by operating activities was $40.5 million and $48.8 million for the years ended December 31, 2021 and 2020, respectively. Cash provided by operations was lower in 2021 due to (i) the $8.8 million severance payment to our former CEO, (ii) decreased renewal premiums in our international business; and (iii) increased first year premiums, which have higher costs associated with them than renewal premiums, such as commissions. During the third quarter of 2020, the Company used funds from matured securities to pay $6.0 million to the IRS for the tax compliance matter described in Note 7. Commitments and Contingencies in the notes to our consolidated financial statements. As noted in Note 7. Commitments and Contingencies, the IRS processed these withholding tax returns in 2021, and the Company considers this matter closed.
Cash from/used in Investments. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows, for the most part, are reinvested in fixed income securities and to a lesser extent limited partnerships or other alternative investments. Net cash outflows from investing activities totaled $41.1 million and $61.8 million for the years ended December 31, 2021 and 2020, respectively. The investing activities fluctuate from period to period due to timing of securities activities such as calls and maturities and reinvestment of those funds. Our investments consist of 90.6% of marketable fixed maturity securities classified as available-for-sale and 0.9% of equity securities that could be readily converted to cash for liquidity needs. Over the last several years, a large portion of our fixed maturity security investment portfolio has matured or called, which required us to reinvest in fixed maturity securities with lower interest rates. We are seeking to diversify our portfolio with limited partnership investments in order to earn higher investment income to mitigate the effect of a decrease in our spread between our policy liability crediting rates and our investment earned rates (our gross margin), which could also negatively impact our liquidity. Our investment portfolio (and, specifically, the valuations of investment assets we hold) has also been, and may continue to be, adversely affected as a result of market developments from the COVID-19 pandemic and uncertainty regarding its outcome. Moreover, changes in interest rates, reduced liquidity or a continued slowdown in the U.S. or in global economic conditions may also adversely affect the values and cash flows of these assets.
Cash from/used in Financing Activities. Cash used in financing activities was $6.2 million for the year ended December 31, 2021 due primarily to the purchase of 100% of the outstanding Class B common stock from the Harold E. Riley Foundation for $9.1 million in March 2021. This amount was partially offset by $2.3 million we received from issuing shares under our SIP and $1.1 million net in annuity deposits received higher than annuity withdrawals.
Trends, Demands and Restrictions on our Uses of Cash
Because claims and surrenders are our largest expense, a primary liquidity concern is the risk of either (i) an extraordinary level of early policyholder surrenders, or (ii) higher than expected mortality experience. In order to mitigate the risk of early policyholder surrenders, we include provisions in our insurance policies, such as surrender charges, that help limit and discourage early withdrawals. As previously discussed, surrender benefits have been higher than usual the last several years as many of our policies have reached the age where surrender charges have expired and due to other reasons, like the loss of one of our biggest distributors in Venezuela (see Item 3. Legal Proceedings). However, policy surrenders decreased 5.3% in 2021 when compared to 2020 as we have instituted new programs seeking to curb surrenders. To the extent that early surrenders are higher than expected, our liquidity could be negatively impacted. We continue to monitor surrenders and early withdrawals.
Our whole life and endowment products provide the policyholder with alternatives once the policy matures - they can choose to take a lump sum payout or leave the money on deposit at interest with the Company. As of December 31, 2021, 40% of the Company's total insurance in force was in endowment products. Approximately 15% of the endowments in force will mature in the next five years. Policyholder election behavior is unknown, but if too many policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Meeting these distributions could require the Company to sell securities at inopportune times to pay policyholder withdrawals. Alternatively, if the policyholders were to leave the money on deposit with the Company at interest, our profitability could be impacted if the product guaranteed rate is higher than the market rate we are earning on our investments. We currently anticipate that our available operating cash flow and capital resources will be adequate to meet our needs for funds, but we will monitor closely our policyholder behavior patterns.
December 31, 2021 | 10-K 54
Primarily due to the COVID-19 pandemic, we have experienced increased death claim benefits over the last two years. Because the pandemic was an unforeseen event that was not priced into our product assumptions, to the extent we continue to experience increased claims and the associated death benefit payouts as a result of the COVID-19 pandemic, our liquidity could be negatively impacted. Some of our policies include pandemic exclusions, and we carry reinsurance to offset some of these risks.
As discussed above, we are subject to regulatory capital requirements that could affect the Company’s ability to access capital from our insurance operations or cause the Company to have to put additional cash in our wholly-owned subsidiaries. We experienced substantial increases in property claims in the 2021 and the last half of 2020 due in large part to four hurricanes that hit Louisiana. As a result, SPLIC had to contribute capital to SPFIC in both 2021 and 2020 in order to maintain statutory capital requirements.
Our domestic companies are subject to minimum capital requirements set by the NAIC in the form of risk-based capital ("RBC"). RBC considers the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company's business to develop a minimum level of capital called "Authorized Control Level Risk-Based Capital". This level of capital is then compared to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200% for our domestic companies, a series of remedial actions by the affected company would be required. Additionally, we have a parental guarantee between Citizens and CICA, Citizens' wholly-owned subsidiary domiciled in Colorado, to maintain a RBC level above 350%. At December 31, 2021, our domestic insurance subsidiaries were above the required minimum RBC levels.
CICA International is a Bermuda domiciled company. The BMA requires Bermuda insurers to maintain available statutory economic capital and surplus at a level equal to or in excess of the BMA's Enhanced Capital Requirement, which requires a certain Target Capital Level ("TCL"). As of December 31, 2021, CICA International was above the TCL threshold. At the request of the BMA, on April 15, 2021, Citizens and CICA International entered into a Keep Well Agreement. The Keep Well Agreement requires Citizens to contribute up to $10 million in capital to CICA International as necessary to ensure that CICA International has a minimum capital level of 120%. Since CICA International's capital level currently exceeds 120%, Citizens is not currently required to make a capital contribution. Any capital injection that Citizens is required to make under the parental guarantee with CICA or under the Keep Well Agreement with CICA International could negatively impact the Company's capital resources and liquidity.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
Our material cash requirements from known contractual and other obligations primarily relate to our policy liabilities. Expected timing of those payments are as follows:
As of December 31, 2021 (In thousands) | Total | Less than 1 Year | 1 to 3 Years | 3 to 5 Years | More than 5 Years | |||||||||||||||||||||||||||
| Contractual Obligations: | ||||||||||||||||||||||||||||||||
| Investment commitments | $ | 39,824 | 21,459 | 18,365 | — | — | ||||||||||||||||||||||||||
| Real estate and equipment leases | 10,827 | 1,015 | 2,134 | 2,377 | 5,301 | |||||||||||||||||||||||||||
| Future policy benefit reserves | 1,472,829 | 36,906 | 104,454 | 136,757 | 1,194,712 | |||||||||||||||||||||||||||
| Policy claims payable | 14,590 | 14,590 | — | — | — | |||||||||||||||||||||||||||
| Total contractual obligations | $ | 1,538,070 | ||||||||||||||||||||||||||||||