Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
Item 14 of This Report Incorporates By Reference The Information in The Section Entitled "Audit Matters" in Our Proxy Statement.
Item 15. Exhibits, Financial Statement Schedules
Note 1: Summary of Significant Accounting Policies
Note 2: Investments
Note 3: Fair Value Measurements
Note 4: Policy Liabilities and Short Duration Contracts
Note 5: Reinsurance
Note 6: Stockholders' Equity and Restrictions
Note 7: Commitments and Contingencies
Note 8: Segment and Other Operating Information
Note 9: Income Taxes
Note 10: Other Comprehensive Income (Loss)
Note 11: Stock Compensation
Note 12: Benefit Plans
Note 13: Related Party Transactions
Note 14: Quarterly Financial Information (Unaudited)
Note 15: Subsequent Event
Citizens Earnings 2018-12-31
CIA 10K Annual Report
10-K 1 cia-20181231x10k.htm 10-K Document
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
Commission File Number: 000-16509
(Exact Name of Registrant as Specified in Its Charter)
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
2900 Esperanza Crossing, 2nd Floor, Austin, TX
(Address of principal executive offices)
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Class A Common Stock
New York Stock Exchange
(Title of Each Class)
(Name of Each Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes ý No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes ý No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes o No
Indicate by check mark whether the registrant has submitted electronically 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). ý Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K). o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer ý Non-accelerated filer o Smaller reporting company o Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes ý No
As of June 30, 2018, the aggregate market value of the Class A common stock held by non-affiliates of the registrant was approximately $381,928,058.
Number of shares of common stock outstanding as of March 4, 2019.
Class A: 49,227,795
Class B: 1,001,714
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Report incorporates by reference certain portions of the definitive proxy materials to be delivered to stockholders in connection with the 2019 Annual Meeting of Shareholders.
Certain statements contained in this Annual Report on Form 10-K are not statements of historical fact and constitute forward-looking statements within the meaning of the federal securities laws, including, without limitation, statements specifically identified as forward-looking statements within this document. Many of these statements contain risk factors as well. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by us or with the approval of the Company, which are not statements of historical fact, constitute forward-looking statements. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as "believes," "anticipates," "assumes," "estimates," "plans," "projects," "could," "expects," "intends," "targeted," "may," "will" and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.
Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that could cause the Company's future results to differ materially from expected results include, but are not limited to:
Changes in the application, interpretation or enforcement of foreign insurance laws that impact our business, which derives the substantial majority of its revenues from residents of foreign countries;
Potential changes in amounts reserved for in connection with intended proposals for settlement with the IRS related to tax withholding and product compliance matters;
The transition of our international business to a new Bermuda-based entity, the regulatory oversight of our international business by the Bermuda Monetary Authority and potential shifts in policyholder behavior arising from these changes;
Changes in foreign and U.S. general economic, market, and political conditions, including the performance of financial markets and interest rates;
Changes in consumer behavior or regulatory oversight, which may affect our ability to sell our products and retain business;
The timely development of and acceptance of our new products and the perceived overall value of these products and services by existing and potential customers;
Fluctuations in experience regarding current mortality, morbidity, persistency and interest rates relative to expected amounts used in pricing our products;
The performance of our investment portfolio, which may be adversely affected by changes in interest rates, adverse developments and ratings of issuers whose debt securities we may hold, and other adverse macroeconomic events;
Results of litigation we may be involved in;
Changes in assumptions related to deferred acquisition costs and the value of any businesses we may acquire;
Regulatory, accounting or tax changes that may affect the cost of, or the demand for, our products or services;
Our concentration of business from persons residing in Latin America and the Pacific Rim;
Changes in tax laws;
Effects of acquisitions and restructuring, including possible difficulties in integrating and realizing the projected results of acquisitions;
Changes in statutory or U.S. Generally Accepted Accounting Principles ("U.S. GAAP"), policies or practices;
Changes in leadership among our board and senior management team;
Our success at managing risks involved in the foregoing; and
The risk factors discussed in "Part 1. Item 1A- Risk Factors" of this report.
Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.
The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at http://www.sec.gov. We also make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 Reports filed by officers and directors, news releases, and, if applicable, amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the Securities and Exchange Commission. We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K.
Citizens, Inc. ("Citizens" or the "Company") is an insurance holding company incorporated in Colorado serving the life insurance needs of individuals in the United States since 1969 and internationally since 1975. Through our insurance subsidiaries, we pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We had approximately $1.6 billion of assets at December 31, 2018 and approximately $4.4 billion of insurance in force. Our core insurance operations include:
U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to foreign residents, located principally in Latin America and the Pacific Rim, through independent marketing consultants;
ordinary whole life insurance policies to middle income households concentrated in the Midwest, Mountain West and southern United States through independent marketing consultants; and
final expense and limited liability property policies to middle and lower income households in Louisiana, Mississippi and Arkansas through employee and independent agents in our home service distribution channel and funeral homes.
During the last five years, except for 2018, our business, revenues and assets have continued to grow, driven primarily by continued new and renewal sales and increased investment income. From 2014 through 2018, revenues rose 6% from $230.2 million in 2014 to $244.0 million in 2018, but declined approximately 3% in 2018 compared to 2017. During that same period, our assets grew 14% from $1.4 billion to $1.6 billion, and our net income was impacted by non-recurring tax items in the last two years and declined 85% from net loss of $6.0 million in 2014 to a net loss of $11.1 million in 2018. Net income before federal income taxes was $(2.0) million in 2014 and $2.0 million in 2018. See Item 6. "Selected Financial Data" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report.
The Company's Board of Directors (the "Board") and executive management team are continuing their assessment of the Company's international and domestic business models and strategies with the assistance and support of external consultants and advisors. Our strategic realignment of the Company's international business model is ongoing under the leadership of our President and Chief Executive Officer, Chief Legal Officer and Chief Marketing Officer. Specifically, we are focused on (1) introducing new products in the international market and increasing our profitability in both international and domestic markets for our Life segment and our Home Service segment; (2) a potential restructuring of our international business and operations that may include withdrawals from certain markets; (3) a strategic modernization and upgrade from our legacy technology systems and IT operations with a focus on digitization, our future business needs and cyber risk; (4) effectively operating our international life insurance business offshore in Bermuda through CICA Life Ltd.; and (5) assessing and optimizing our investment portfolio strategy.
We completed a novation of all of the international policies issued by CICA Life Insurance Company of America, a Colorado corporation ("CICA") to CICA Life Ltd., a newly established Bermuda entity ("CICA Ltd."), effective July 1, 2018. Both CICA and CICA Ltd. are wholly owned subsidiaries of the Company. As previously disclosed, Bermuda was chosen for its strong insurance regulatory environment and suitability with the Company's priorities to protect our customers. We expect to operate our international business exclusively from this entity going forward. For more information on the impact of the novation, see the discussion in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report and Note 1 - "Summary of Significant Accounting Policies" and Note 9 - "Income Taxes" in the notes to our consolidated financial statements. As the Company continues its strategic review, it may make further changes to its business model in the future.
We announced in April 2018 a decision to discontinue accepting life insurance applications from Brazilian residents or citizens. We recorded premiums from the Brazilian portion of our business of $10.0 million or 7.2% of total international premiums as of December 31, 2018 compared to $11.1 million or 7.6% as of December 31, 2017. The Company is continuing to assess the financial impacts of this change, but based upon the information to date, we do not anticipate that it will be material to our financial results of operations. The Company intends to continue fulfilling commitments under existing policies and to refocus its resources on other more attractive potential markets, products and opportunities.
In coordination with our business model changes we are actively monitoring quantitative changes in sales patterns as well as qualitative feedback from our independent sales consultants and policyholders to identify and analyze long term business trends, while simultaneously exploring opportunities to mitigate any negative impacts and put the Company on a path toward sustainable profits and growth.
As a result of the Company’s strategic review of its technology systems, the Company implemented technology upgrades in 2018 to support its ongoing operations and initiatives. During the third quarter of 2018, the Company completed the implementation of a new Oracle Enterprise Resource Planning ("ERP") application, which replaced several of the Company's back-office legacy systems, such as the general ledger, accounts payable, cash management, and fixed asset systems. The introduction of this new ERP application and the related workflow changes resulted in changes to the Company’s financial reporting controls and procedures. These system changes were undertaken to standardize accounting systems, improve management reporting and consolidate accounting functions for the Company and its subsidiaries. In addition, the Company also implemented a new actuarial valuation and modeling system, GGY AXIS, as of July 1, 2018 for CICA and CICA Ltd. actuarial reporting to provide enhanced modeling capabilities. The impact of this system conversion resulted in changes in estimates due to refinements reflected as a decrease in reserves of $10.2 million and a decrease in DAC of $4.3 million, before tax. This implementation also resulted in changes to our financial reporting controls and procedures during the third and fourth quarters of 2018.
The low interest rate environment has required us to reduce the policy-related benefits and policyholder dividends for most of our policies offered internationally in reaction to the compressed spreads. Prior to 2017, our policies provided significantly higher guarantees and policyholder dividends that were not sustainable within the then-current financial markets and our return from our then-current investments. As a result, the Company reduced discretionary dividends on existing international policies in 2016, which lowered our dividend expense from $10.7 million in 2015 to $6.8 million, $6.2 million and $6.3 million for the years ended 2016, 2017 and 2018, respectively. In addition, in 2017, the Company repriced products sold internationally to better align with the current low interest rate environment we faced. Sales have been depressed on these new products compared to the previously higher guaranteed products they replaced. We expect to issue some newly enhanced products in 2019 that we believe will be more desirable to our international clients.
The Company hired a third-party investment manager in May 2018 to manage, supervise and direct the Company's investment accounts and enhance our portfolio and investment strategies. We routinely monitor the portfolio's rate of return as compared to the product features in our insurance policies and strive to maximize returns on our investment portfolio within our conservative investment guidelines. Our primary objective is to grow bottom-line returns for our shareholders. We monitor the risk that changes to our products will result in lower demand for our new policies, or that the financial markets will make our investment strategy more difficult to maintain a rate of return.
The following pages describe the operations of our two business segments: Life Insurance and Home Service Insurance. CICA, CICA Ltd. and Citizens National Life Insurance Company ("CNLIC") constitute the Life segment, and Security Plan Life Insurance Company ("SPLIC"), Security Plan Fire Insurance Company ("SPFIC") and Magnolia Guaranty Life Insurance Company ("MGLIC") constitute the Home Service segment. In addition to the Life Insurance and Home Service business, the Company also has other non-insurance operations ("Other Non-Insurance Enterprises") which primarily include the Company's IT and Corporate-support functions.
Revenues derived from any single customer did not exceed 10% of consolidated revenues in any of the last three years. For more information about the financial performance of our business segments, see Note 8 - "Segment and Other Operating Information" of the notes to our consolidated financial statements.
Our Life Insurance segment issues U.S. Dollar-denominated endowment contracts internationally which are principally accumulation contracts that incorporate an element of life insurance protection and ordinary whole life insurance U.S. Dollar-denominated amounts sold to foreign residents. These contracts are designed to provide a fixed amount of insurance coverage over the life of the insured and may utilize rider benefits to provide additional increasing or decreasing coverage and annuity benefits to enhance accumulations. For the majority of our business, we retain the first $100,000 of risk on any one life, reinsuring the remainder of the risk. Historically we have operated this segment through our CICA and CNLIC insurance subsidiaries. Since, July 1, 2018, we have operated the novated international business in this segment through CICA Ltd. We operate our domestic business in this segment through CICA and CNLIC.
We focus our sales of U.S. Dollar-denominated ordinary whole life insurance and endowment policies to residents in Latin America and the Pacific Rim. We have participated in the foreign marketplace since 1975. We believe positive attributes of our international insurance business include:
larger face amount policies typically issued when compared to our U.S. operations, which results in lower underwriting and administrative costs per unit of coverage;
premiums typically paid annually rather than monthly or quarterly, which reduces our administrative expenses, accelerates cash flow and results in lower policy lapse rates than premiums with more frequently scheduled payments; and
persistency experience and mortality rates that are comparable to U.S. policies.
As of December 31, 2018, we had insurance policies in force in more than 20 countries, including Colombia, Venezuela, Taiwan, Ecuador and Brazil as our top producing countries. As discussed above, we decided in 2018 to discontinue accepting new life insurance applications from Brazilian residents or citizens. In 2018, international direct premiums comprised approximately 96% of total direct premiums in the Life segment and 72% of our total direct premiums.
Our independent marketing firms and consultants specialize in marketing life insurance products and generally have several years of insurance marketing experience. We maintain contracts with the independent marketing firms pursuant to which they provide recruitment, training and supervision of their managers and associates in the service and placement of our products. However, all associates of these firms also contract directly with us as independent contractors and receive their compensation directly from us. Accordingly, should an arrangement between any independent marketing firm and us be terminated for any reason, we expect we would seek to continue the existing marketing arrangements with the associates of these firms. Our agreements with independent marketing firms and consultants typically provide that they are independent contractors responsible for their own operational expenses and are the representative of the prospective insured. In addition, the marketing firms guarantee any debts of their associates to us. The marketing firms receive commissions on all new and renewal policies serviced or placed by them or their associates. All of these contracts provide that the independent marketing firms and consultants are aware of and responsible for compliance with local laws.
We offer several ordinary whole life insurance and endowment products designed to meet the needs of our non-U.S. policyowners. These policies have been structured to provide:
U.S. Dollar-denominated cash values that accumulate, beginning in the first policy year, to a policyholder during his or her lifetime;
premium rates that are competitive with most foreign local companies;
a hedge against local currency inflation;
protection against devaluation of foreign 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 living benefit features. Most policies contain guaranteed cash values and are participating (i.e., provide for cash dividends as apportioned by the Board). Once a policyowner pays the annual premium and the policy is issued, the owner becomes entitled to policy cash dividends as well as annual premium benefits if the annual premium benefit was elected. According to the policy language, the policyowner has several options with regard to the policy dividends and annual premium benefits. Any annual policy cash dividend may, at the option of the policyowner and provided the value of a dividend is not encumbered by a policy loan, be applied under one of the following options: (1) paid in cash to the policy owner; (2) credited toward payment of premiums on the policy; (3) left with the Company to accumulate at a defined interest rate; (4) applied to increase the amount of insurance benefit by purchase of paid-up additions to the policy; or (5) be assigned to a third-party. If the policy is encumbered by a loan, only option (3) will apply to secure the outstanding loan. Similarly, all annual premium benefits credited to the policy may at the option of the policyowner, and provided the policy is not encumbered by a policy loan, be applied under one of the following options: (1) paid in cash to the policy owner; (2) credited toward payment of premiums on the policy; (3) left with the Company to accumulate at an annually company declared interest rate; or (4) be assigned to a third-party. Likewise,
if the policy is encumbered by a loan, only option (3) will apply to secure the outstanding loan. Under the "assigned to a third-party" provision, the Company has historically allowed policyowners, 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 Securities and Exchange Commission. Computershare administers the CISIP in accordance with the terms and conditions of the CISIP, which is available on the Computershare website and as part of the Company’s registration statement on file with the Securities and Exchange Commission.
The life insurance business is highly competitive. We compete with a number of stock and mutual life insurance companies internationally and domestically, as well as with financial institutions that offer insurance products. There are more than 700 life insurance companies in the United States, some of which also provide insurance to foreign residents.
We face competition primarily from companies formed and operated in the country in which the insureds reside, from companies that operate in the same manner as we do and from companies that are foreign to the countries in which policies are sold, but issue insurance policies denominated in the local currency of those countries. A substantial number of companies may be deemed to have a competitive advantage over us due to their significantly greater financial resources, histories of successful operations and larger marketing forces.
Because premiums on our international policies are paid in U.S. dollars, and we pay claims and benefits in U.S. dollars, we provide a product that is different from the products offered by foreign-domiciled companies. We believe our international policies are usually acquired by individuals in the upper middle class in their respective countries and those with significant net worth and earnings that place them in the upper income brackets of their respective countries. The policies sold by our foreign competitors are generally offered broadly and are priced using the mortality of the entire population of the geographic region. Our mortality charges are typically lower due to our customer demographics, which provides a competitive advantage. Additionally, the assets backing the reserves for our foreign competitors' policies must be substantially invested in their respective countries and, therefore, are exposed to the inflationary risks and social or economic crises that have been more common in these foreign countries.
In 2018, domestic direct premiums comprised approximately 4% of total direct premiums in the Life segment and 3% of our total direct premiums. The majority of our domestic inforce business results from blocks of business of insurance companies we have acquired over the past 20 years. We discontinued new sales of our non-Home Service domestic products beginning January 1, 2017. Under the direction of our President and Chief Executive Officer and Chief Marketing Officer, we are reviewing our domestic strategy.
Domestic Life Insurance Products
Our domestic life insurance products have historically focused primarily on living needs and provided benefits focused toward accumulating financial benefits for the policyowner. The features of our domestic life insurance products include:
cash accumulation/living benefits;
tax-deferred interest earnings;
guaranteed lifetime income options;
monthly income for surviving family members;
accidental death benefit coverage options; and
an option to waive premium payments in the event of disability.
Our life insurance products have historically been designed to address the insured's concern about outliving his or her monthly income, while at the same time providing death benefits. The primary purpose of our product portfolio is to help the insured create capital for needs such as retirement income, children's higher education funds, business opportunities, emergencies and health care needs.
Our domestic Home Service segment operates through our subsidiaries SPLIC, MGLIC and SPFIC, and focuses on the life insurance needs of the middle and lower income markets, primarily in Louisiana, Mississippi and Arkansas. Our policies are sold and serviced through a home service marketing distribution system of approximately 311 employee-agents who work on a route system and through over 350 funeral homes and independent agents who sell policies, collect premiums and service policyholders. To a lesser extent, our Home Service segment sells limited liability, named peril property policies covering dwelling and contents. In 2018, our Home Service segment comprised 25%, or $47.5 million of our total direct premiums.
Home Service Products and Competition
Our Home Service insurance products consist primarily of small face amount ordinary whole life and pre-need policies, which are designed to fund final expenses for the insured, primarily consisting of funeral and burial costs. The average life insurance policy face amount issued was approximately $7,000 in 2018. Due to the lower risk associated with small face amount polices, the underwriting performed on these applications is limited. Our property coverages are limited to $30,000 maximum coverage on any one dwelling and contents, while content-only coverage and dwelling-only coverage is limited to $20,000. We face competition in Louisiana, Mississippi and Arkansas from other companies specializing in home service distribution of insurance. We seek to compete based upon our emphasis on personal service to our customers. We intend to continue premium growth within this segment via direct sales.
Other Non-Insurance Enterprises
Other Non-Insurance Enterprises includes the results of the parent company, Citizens, Inc., and Computing Technology, Inc., which provides data processing services to the Company. As of December 31, 2018, Insurance Investors, Inc., which previously provided aviation transportation to the Company, was dissolved into its parent, CICA.
Operations and Technology
Our administrative operations principally serve our Life Insurance segment and are conducted primarily at our executive offices in Austin, Texas through approximately 120 administrative, operating and underwriting personnel. Our home service operations are conducted to a large degree from our district offices in Louisiana, Arkansas and Mississippi, as well as our service center in Donaldsonville, Louisiana. At our executive offices, we also perform policy design, marketing oversight, underwriting, accounting and reporting, actuarial, customer service, claims processing, administrative and investing activities. We added three personnel to our office location in Bermuda related to CICA Ltd. operations in 2018. We perform underwriting, policy issuance and claims processing relating to our international policies from our Bermuda location.
We have a single integrated information technology system for our entire Company, which is a centrally-controlled, mainframe-based administrative system. Functions of our policy administrative system include policy set-up, administration, billing and collections, commission calculation, valuation, automated data edits, storage backup, image management and other related functions. Each company we acquire 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.
We are currently reviewing technology options to transition from our legacy administration system to an upgraded, modernized technology platform that will service our policy administration needs into the future. For our current block of insurance contracts under administration and accounting, we have outsourced the operations and maintenance of our legacy system to a third-party provider.
The Company has an enterprise risk management function ("ERM") that analyzes the Company’s risks on an individual and aggregated basis and is responsible for ensuring that the Company’s risks remain within its risk appetite and tolerances as determined by management with oversight from the Audit Committee. The Company's focus on ERM strengthens its risk management culture and discipline. The mission of ERM is to support the Company in achieving its strategic priorities by:
Providing a comprehensive view of the risks facing the Company, including risk concentrations and correlations;
Helping management define the Company’s overall capacity and appetite for risk by evaluating the risk return profile of the business relative to the Company’s strategic intent and financial underpinning;
Assisting management in setting specific risk tolerances and limits that are measurable, actionable, and comply with the Company’s overall risk philosophy;
Communicating and monitoring the Company’s risk exposures relative to set limits and recommending, or implementing as appropriate, mitigating strategies; and
Providing insight to assist in growing the businesses and achieving optimal risk-adjusted returns within established guidelines.
Enterprise Risk Management Structure and Governance
Effective risk oversight is an important priority for the Company’s Board and senior management team. While it is the job of the President and Chief Executive Officer and senior management to assess and manage the Company’s risk exposure through ERM, in accordance with New York Stock Exchange ("NYSE") requirements, the Audit Committee of the Board is charged with discussing guidelines and policies to govern the process by which ERM is handled. The Audit Committee periodically discusses the Company’s major financial risk exposures and the steps management has taken to monitor and control such exposures.
The five broad categories of risk exposures assessed and managed by senior management include, but are not limited to:
Strategic risk, including international business risks;
Insurance risk, including those arising out of catastrophes and acts of terrorism;
Financial risk, including market, credit and liquidity risks;
Operational risk, including cybersecurity risk and legal and regulatory compliance risks; and
Any other risk that poses a material threat to the operational and/or strategic viability of the Company.
In addition to the Audit Committee, the Compensation Committee considers the risks and rewards that may be implicated by our executive compensation philosophy and programs, and the Nominating and Corporate Governance Committee oversees the Company’s governance practices, director succession and committee composition and leadership to manage risks associated with corporate governance. Although risk oversight is conducted primarily through committees of the Board, the full Board has retained responsibility for general oversight of risks. The Board satisfies this responsibility through full reports by each committee chair regarding the committees’ considerations and actions, as well as through regular reports directly from officers responsible for oversight of particular risks within the Company.
Our insurance subsidiaries are subject to regulation and supervision by the U.S. states and Bermuda.
Our U.S. insurance operations are subject to a wide variety of laws and regulations. State insurance laws establish supervisory agencies with broad regulatory authority to regulate most aspects of our U.S. insurance businesses, and our insurance subsidiaries are regulated by the insurance departments of each state in which they are licensed. In addition, U.S. laws, such as the USA Patriot Act of 2001, the Foreign Corrupt Practices Act ("FCPA"), the Gramm-Leach-Bliley Act of 1999, the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, the Sarbanes-Oxley Act of 2002, and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and the Tax Cuts and Jobs Act, are examples of U.S. regulations that affect our business. We are subject to comprehensive regulations under the USA Patriot Act and the Bank Secrecy Act with respect to money laundering, as well as federal regulations regarding privacy and confidentiality. Our insurance products and thus our businesses also are affected by U.S. federal, state and local tax laws. The Dodd-Frank Act focuses on financial reform and
has resulted in changes to the regulation of institutions operating in the financial services industry, including the Company. Its requirements include streamlining the state-based regulation of reinsurance and non-admitted insurance (also known as surplus lines insurance, which is property or casualty insurance written by a company that is not licensed to sell policies of insurance in a given state) and establishing a new Federal Insurance Office ("FIO") within the U.S. Department of the Treasury with powers over all lines of insurance except health insurance, certain long-term care insurance and crop insurance. The FIO is authorized to, among other things, gather data and information to monitor aspects of the insurance industry, identify issues in the regulation of insurers about insurance matters and preempt state insurance measures under certain circumstances. However, the FIO’s limited monitoring abilities posed minimal risk to the insurance industry and the Dodd-Frank Act has had no significant impact on our business, results of operations, liquidity and capital resources. The rulemaking process going forward may change with the current presidential administration.
The purpose of the laws and regulations that affect our insurance business is primarily to protect our insureds and not our stockholders. Many of the laws and regulations to which we are subject are regularly re-examined, and existing or future laws and regulations may become more restrictive or otherwise adversely affect our operations. In addition, insurance regulatory authorities (including state law enforcement agencies and attorneys general) periodically make inquiries and regularly conduct examinations regarding compliance by us and our subsidiaries with insurance, and other laws and regulations regarding the conduct of our insurance businesses. It is our practice to fully and consistently cooperate with such inquiries and examinations and take corrective action when warranted.
Our U.S. insurance subsidiaries are collectively licensed to transact business in 31 states and in the District of Columbia. We have insurance subsidiaries domiciled in the states of Colorado, Louisiana, Mississippi, Texas and in Bermuda. Our U.S. insurance subsidiaries are licensed and regulated in all U.S. jurisdictions in which they conduct insurance business. The extent of this regulation varies, but most jurisdictions have laws and regulations based upon the National Association of Insurance Commissioners ("NAIC") model rules governing the financial condition of insurers, including standards of solvency, types and concentration of investments, establishment and maintenance of reserves, credit for reinsurance and requirements of capital adequacy, and the business conduct of insurers, including marketing and sales practices and claims handling. In addition, statutes and regulations usually require the licensing of insurers and their agents, the approval of policy forms and related materials and the approval of rates for certain types of insurance products.
All U.S. jurisdictions in which our U.S. insurance subsidiaries conduct insurance business have enacted legislation that requires each U.S. insurance company in a holding company system, except captive insurance companies, to register with the insurance regulatory authority of its jurisdiction of domicile and to furnish that regulatory authority with financial and other information concerning the operations of, and the interrelationships and transactions among, companies within its holding company system that may materially affect the operations, management or financial condition of the insurers within the system. These laws and regulations also regulate transactions between insurance companies and their parents and affiliates. Generally, these laws and regulations require that all transactions within a holding company system between an insurer and its affiliates be fair and reasonable and that the insurer's statutory capital and surplus following any transaction with an affiliate be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. For certain types of agreements and transactions between an insurer and its affiliates, these laws and regulations require prior notification to, and non-disapproval or approval by, the insurance regulatory authority of the insurer's jurisdiction of domicile.
The payment of dividends or other distributions to us by our insurance subsidiaries is regulated by the insurance laws and regulations of their respective state or 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.
The laws and regulations of the jurisdictions in which our U.S. insurance subsidiaries are domiciled require that a controlling party obtain the approval of the insurance commissioner of the insurance company's jurisdiction of domicile prior to acquiring control of the insurer and may delay, deter or prevent a transaction our shareholders might consider desirable.
Risk-based capital ("RBC") requirements are imposed on life and property and casualty insurance companies. The NAIC has established minimum capital requirements in the form of RBC. RBC requirements weight the type of business 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.
CICA Ltd., our Bermuda domiciled subsidiary, is subject to regulation and supervision by the Bermuda Monetary Authority (the "BMA") and compliance with all applicable Bermuda law and Bermuda insurance statutes and regulations, including but not limited to Bermuda’s Insurance Act 1978 (the "Insurance Act").
CICA Ltd., which is incorporated to carry on 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 Ltd. is not licensed to conduct general business. The Insurance Act regulates the insurance business of CICA Ltd. and provides that no person may carry on any insurance business in or from 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 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 Ltd. may make to Citizens, Inc., 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 (with certain officers, a principal representative and a director to reside in Bermuda); appointment of an independent auditor; appointment of an actuary approved by the BMA; and compliance with restrictions on certain changes in control of regulated insurers.
Bermuda’s regulatory regime provides a risk-based capital model, termed the Bermuda Solvency Capital Requirement (“BSCR”), as a tool to assist the BMA both in measuring risk and in determining appropriate levels of capitalization. The BSCR employs a standard mathematical model that correlates the risk underwritten by Bermuda insurers to their capital. The BSCR framework applies a standard measurement format to the risk associated with an insurer's assets, liabilities and premiums, including a formula to take into account catastrophe risk exposure. The BMA established risk-based regulatory capital adequacy and solvency margin requirements for Bermuda insurers that mandate that a Bermuda domiciled subsidiary’s Enhanced Capital Requirement ("ECR") be calculated by either (a) BSCR, or (b) an internal capital model which the BMA has approved for use for this purpose. CICA Ltd. uses the BSCR in calculating its solvency requirements. The Economic Balance Sheet (“EBS") framework is embedded as part of the BSCR and forms the basis of our ECR.
In order to minimize the risk of a shortfall in capital arising from an unexpected adverse deviation and in moving towards the implementation of a risk-based capital approach, the BMA has established a threshold capital level (termed the Target Capital Level ("TCL")), set at 120 percent of ECR, that serves as an early warning tool for the BMA. Failure to maintain statutory capital at least equal to the TCL would likely result in increased BMA regulatory oversight.
All Bermuda “exempted companies” are exempt from certain Bermuda laws restricting the percentage of share capital that may be held by non-Bermudians. However, exempted companies may not participate in certain enumerated business transactions, including the carrying on of business of any kind in Bermuda not in furtherance of the business carried on outside Bermuda or under license granted by the Bermuda Minister of Finance. Generally, it is not permitted without a special license granted by the Bermuda Minister of Finance to insure Bermuda domestic risks or risks of persons of, in or based in Bermuda.
In December 2018, the Economic Substance Act 2018 (the “ESA”) came into effect in Bermuda. Under the provisions of the ESA, every Bermuda registered entity engaged in a “relevant activity” must satisfy economic substance requirements by maintaining a substantial economic presence in Bermuda. Under the ESA, insurance or holding entity activities (both as defined in the ESA and Economic Substance Regulations 2018) are relevant activities. To the extent that the ESA applies to CICA Ltd., we will be required to demonstrate compliance with economic substance requirements by filing an annual economic substance declaration with the Registrar of Companies in Bermuda. Companies that carry on insurance as a relevant activity are deemed to comply with the economic substance requirements, with respect to their insurance business, if they comply with existing regulatory requirements under the Insurance Act and the applicable provisions of Bermuda's Companies Act 1981.
Generally, all foreign countries in which we offer insurance products require a license or other authority to conduct insurance business in that country. Some of these countries also require that local regulatory authorities approve the terms of any insurance product sold to residents of that country. We have never qualified to do business in any foreign country or jurisdiction, except with respect to Bermuda, where CICA Ltd. is domiciled, and have never submitted our insurance policies issued to residents of foreign countries for approval by any foreign or domestic insurance regulatory agency. We sell our policies to residents of foreign countries using foreign independent marketing firms and independent consultants, and we rely on our independent consultants to comply with laws applicable to them in marketing our insurance products in their respective countries. We have undertaken a comprehensive compliance review of risks associated with the potential application of foreign laws to our sales of insurance policies in foreign countries. The application of foreign laws to our sales of insurance policies in foreign countries varies by country. There is a lack of uniform regulation, lack of clarity in certain regulations and lack of legal precedent in addressing circumstances similar to ours. Our compliance review has confirmed the previously disclosed risks related to foreign insurance laws associated with our current business model, at least in certain jurisdictions, as described in detail in "Item 1A - Risk Factors - Risks Relating to our Business." We are exploring alternatives to our current business model in one or more jurisdictions.
Item 1A. RISK FACTORS
Investing in our Company involves certain risks. Set forth below are certain risks with respect to our Company. Readers should carefully review these risks, together with the other information contained in this report. The risks and uncertainties we have described in this report are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently deem not material, may also adversely affect our business. Any of the risks discussed in this report or that are presently unknown or not material, if they were to actually occur, could result in a significant adverse impact on our business, operating results, prospects or financial condition. References in the risk factors below to "we," "us," "our," "Citizens" and like terms relate to Citizens, Inc. and its subsidiaries on a U.S. GAAP consolidated financial statement basis, unless specifically identified otherwise. We operate our subsidiaries as separate and distinct entities with respect to corporate formalities.
Risks Relating to Our Business
A substantial majority of our sales derives from residents of foreign countries and is subject to risks associated with political instability, poor infrastructure and the application of currency control laws and foreign insurance laws. A significant loss of sales in these foreign markets could have a material adverse effect on our results of operations and financial condition.
A substantial majority of our direct premiums, approximately 72% in 2018, are from foreign countries, primarily those in Latin America and the Pacific Rim. These sales are made through independent consultants who are located in these foreign countries. Many of these countries have a history of political instability, including regime changes, political uprisings, currency fluctuations and anti-democratic or anti-U.S. policies. 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. We may also be affected by poor utility infrastructure in some of these countries which can impair the ability of our current or prospective policyholders to make payments of any kind. Continued wide spread power outages or any other issues with infrastructure could affect our ability to receive insurance policy applications and premiums from Venezuela, and issue insurance policies to, policyholders in Venezuela. 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.
Our Company’s future sales and financial results also depend upon avoiding significant regulatory restraints on receiving insurance policy applications and premiums from, and issuing insurance policies to, policyholders outside of the United States. Currency control laws, other currency exchange restrictions or tax laws in foreign countries could materially adversely affect our revenues by imposing restrictions or additional fees, costs or taxes on asset transfers outside of a country where our policyowners reside. Difficulties in transferring funds from or converting currencies to U.S. dollars in certain countries or any increase in fees, costs or taxes associated therewith could prevent our policyowners in those countries from purchasing or paying premiums on our policies and/or make our products less attractive to such policyowners. As such, existing or future laws and regulations, and the manner in which they are interpreted or applied, may become more restrictive or otherwise adversely affect our operations.
We also face risks associated with the application of foreign laws to our sales of insurance policies to residents in foreign countries. Generally, all foreign countries in which we offer insurance products require a license or other authority to conduct insurance business in that country. Some of these countries also require that local regulatory authorities approve the terms of any insurance product sold to residents of that country. We have never sought to qualify to do business in any foreign country or jurisdiction, except Bermuda, in which CICA Ltd. is domiciled, and have never submitted the insurance policies that we issue to residents of foreign countries for approval by any foreign or domestic insurance regulatory agency. Traditionally, we have sought to mitigate risks associated with the potential application of foreign laws to our sales of insurance policies in our foreign markets by, among other things, not locating any of our offices or assets in foreign countries, selling policies only through independent consultants rather than our own employees, requiring that all applications for insurance be submitted to and accepted only in our offices in the U.S. or, following the novation of our international policies to CICA Ltd. in Bermuda effective July 1, 2018, 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 our insurance products in their respective countries. There is no assurance that the precautionary measures, practices and policies mentioned above will partially or entirely mitigate the risk associated with the potential application of foreign laws to our sales of insurance policies in our foreign markets. 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.
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 and lack of clarity in certain regulations. Our compliance review has confirmed the previously disclosed risks related to foreign insurance laws associated with our current business model, at least in certain foreign countries. As a result of this evaluation, the Company announced on April 25, 2018 its decision to discontinue accepting life insurance applications from Brazilian residents or citizens. While the Company intends to continue fulfilling commitments under existing policies, it is unclear whether Brazilian regulations or regulators will allow us to continue to do so.
There are risks that a foreign government could determine under its existing laws that its residents may not purchase life insurance from us unless we become qualified to do business in that country or unless our policies purchased by its residents receive prior approval from its insurance regulators. There also is a risk that a foreign government will enact additional legislation that may render our existing insurance products either illegal or less attractive to potential customers. There is the further risk that regulators may become more aggressive in enforcing any perceived violations of their laws and seek to impose monetary fines, criminal penalties, and/or order us to cease our sales in that jurisdiction. There is no assurance that, if a foreign country were to deem our sales of policies in that country to require that we qualify to do business in that country or submit our policies for approval by that country’s regulatory authorities, we would be able to, or would conclude that it is advisable to, comply with those requirements. Any determination by a foreign country that we or our policy sales are subject to regulation under their laws, or any actions by a foreign country to enforce such laws more aggressively, could therefore have a material adverse effect on our ability to sell policies in that country and, in turn, on our results of operations and financial condition. We are exploring alternatives to our current business model in one or more jurisdictions.
Effective July 1, 2018, the Company novated all of the international policies issued by CICA to CICA Ltd. The novation may result in adverse consequences that are difficult to anticipate. We could be required to allocate considerable time and resources to comply with any new or additional regulatory requirements in Bermuda, and any such requirements could impact the operations of CICA Ltd., result in increased costs for us and impact our financial condition. In addition, how existing policyholders will react to their insurance policies being held by a Bermuda domiciled company, rather than a U.S. domiciled company, is uncertain. If policyholders were to view policies of a Bermuda company as less attractive for any reason, this may result in reduced sales of new policies, fewer renewals and/or a higher level of surrenders of existing policies which may, in the aggregate, have a material adverse effect on the Company’s financial performance.
Any disruption to the marketing and sale of our policies to residents of foreign countries, resulting from the actions of foreign regulatory authorities, the withdrawal from Brazil or other markets, the implementation of new Bermuda regulatory obligations or otherwise, could have a material adverse effect on our business, results of operations and financial condition.
Our operating results and financial condition may be affected if the liabilities actually incurred differ, or if our estimates of those liabilities change, from the amounts we have reserved for in connection with missed tax reporting or noncompliance of some of our products with the Internal Revenue Code.
We have previously reported that a portion of the life insurance policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Section 7702 of the Internal Revenue Code ("IRC") of 1986. Further, we have determined that the structure of our policies sold to non-U.S. citizens, which were novated to our Bermuda affiliate effective July 1, 2018, may have inadvertently generated U.S. source income for policyholders over time. Based upon a review of the options available to address these issues, we intend to remediate domestic life and annuity policies sold to U.S. citizens to comply with the IRC. For instance, we expect to settle with the IRS any past liabilities related to the novated policies sold to non-U.S. citizens. The Company has continued to refine its calculation of the exposure and expenses related to these tax issues, as described below for the current reporting period.
We have established a best estimate liability of $10.0 million as of December 31, 2018 for probable liabilities and expenses. The range of financial estimates relative to this issue is $6.0 million to $52.5 million. This estimated range includes projected settlement amounts payable to the IRS, as well as any other costs attributed to remediation of non-compliant domestic life insurance. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life and annuity insurance policies we will be required to remediate, the methodology applicable to the calculation of tax liabilities for policies and the amount of time and resources we will require from external advisors who are assisting us with resolving these issues. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and could exceed the high end of our estimated range of liabilities and expenses. To the extent the amount reserved is insufficient to meet the actual amount of our liabilities and expenses, or if our estimates of those liabilities and expenses change in the future, our financial condition and results of operations may be materially adversely affected.
On May 17, 2017, we submitted an offer to enter into Closing Agreements with the IRS covering the CICA and CNLIC domestic life insurance business. The toll charges calculated and enumerated in the Closing Agreements totaled $124,000 and $4,000 for the CICA and CNLIC domestic life insurance businesses, respectively. We have not yet received any correspondence from the IRS related to our submissions.
We have initiated discussions with the IRS to address potential liabilities regarding the CICA international business and our annuity business.
CICA Ltd. is subject to extensive government regulation by the Bermuda Monetary Authority ("BMA"), which is a new regulatory regime for the Company. Failure to comply with regulation by the BMA may increase our costs of doing business, restrict the conduct of our business and negatively impact our financial position or results of operations.
For over 40 years, the Company’s life insurance subsidiaries have been regulated in the U.S. by the state insurance departments of their states of domicile. CICA Ltd. was registered in Bermuda under the Bermuda Insurance Act 1978 (the “Insurance Act”) as a Class E insurer in February 2018 and is now subject to the provisions of the Insurance Act and the rules and regulations promulgated thereunder. We have no prior experience operating in a foreign jurisdiction and have limited experience with regulation by the BMA. Failure to comply with laws and regulations in Bermuda could subject us to monetary penalties imposed by the BMA, increased regulatory supervision, unanticipated costs associated with remedying such failure or other claims, harm to our reputation and interruption of our operations, which may have a material adverse impact on our financial position or results of operations.
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.
Declines in interest rates and/or the continuance of the current level of low interest rates and yields on fixed income investments may cause the rates of return on our investment portfolio to decrease more than expected, leading to lower net investment income than assumed in the pricing and reserving for our insurance products. An interest, or 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. 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 claim payments. In that case, the reserves may eventually be insufficient, resulting in the need to increase
our reserves and/or increase our capital contributions to our insurance subsidiaries, either of which could have a material adverse effect on our results of operations or financial condition.
We face financial, liquidity and capital market risks in our operations.
As an insurance holding company with significant investment exposure, we face material financial and capital markets risk in our operations. Due to the sustained low interest rate environment in recent years, we experienced significant call activity on our fixed income portfolio that decreased our investment yields compared to prior years. A large portion of our debt security investment portfolio will mature in the next seven years and could be called sooner as we were subject to significant call activity beginning in 2009 due to the declining interest rate environment and we reinvested into shorter durations that are now approaching maturity. We will need to reinvest these maturing funds in the current interest rate environment. Our profitability could be negatively impacted depending on the market rates at the time of reinvestment. This could result in a decrease in our spread between our policy liability crediting rates and our investment earned rates. This could also negatively impact our liquidity.
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. As of December 31, 2018, the Company has a significant amount of endowment products representing approximately 46.0% of total insurance in force with older contracts sold historically that will begin reaching their maturities over the next several years. It is uncertain how policyholders will react in response to these maturities. If policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Meeting these distributions could require the Company to sell securities at inopportune times to pay policyholder withdrawals. Alternatively, if the policyholder were to leave the money on deposit with the Company at interest, our profitability could be negatively impacted if the product guaranteed rate is higher than the current market rate we can earn on our investments.
Changes in market interest rates may significantly affect our profitability.
Some of our products, principally traditional whole life insurance with annuity riders, expose us to the risk that changes in interest rates will reduce our "spread," or the difference between the amounts we are required to pay under our contracts to policyholders and the rate of return we are able to earn on our investments intended to support obligations under the contracts. Our spread is an integral component of our net income.
If interest rates decrease or remain at low levels, we may be forced to reinvest proceeds from investments that have matured, prepaid, been sold, or called at lower yields, reducing our investment margin. Our fixed income bond portfolio is exposed to interest rate risk as approximately 56% of the portfolio is callable as of December 31, 2018. 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). This risk is discussed further in the two risk factors below.
Our investment portfolio is subject to various risks that may result in realized investment losses. In particular, decreases in the fair value of fixed maturities may significantly reduce the value of our investments, and as a result, our financial condition may suffer.
We are subject to credit risk in our investment portfolio. Defaults by third parties in the payment or performance of their obligations under these securities could reduce our investment income and realized investment gains or result in the recognition of investment losses. The value of our investments may be materially adversely affected by increases in interest rates, downgrades in the bonds included in our portfolio and by other factors that may result in the recognition of other-than-temporary impairments. Each of these events may cause us to reduce the carrying value of our investment portfolio.
In particular, at December 31, 2018, fixed maturities represented $1.2 billion or 91.7% of our total investments of $1.3 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 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 at December 31, 2018, approximately 98.1% of our fixed maturities were investment grade with 75.5% rated A or above, all of our fixed maturities are subject to credit risk. If any of the issuers of our fixed maturities suffer financial setbacks, the ratings on the fixed maturities could be downgraded (with a concurrent decrease in fair value) and, in a worst-case scenario, the issuer could default on its financial obligations. If the issuer defaults, we could have realized losses associated with the impairment of the securities.
Valuation of our investments and the determination of whether a decline in the fair value of our invested assets is other-than-temporary are based on estimates that may prove to be incorrect.
U.S. GAAP requires that when the fair value of any of our invested assets declines and the decline is deemed to be other-than-temporary, we recognize a loss in either other comprehensive income or in our statement of income based on certain criteria in the period for which the determination is made. The determination of the fair value of certain invested assets, particularly those that do not trade on a regular basis, requires an assessment of available data and the use of assumptions and estimates. Once it is determined that the fair value of an asset is below its carrying value, we must determine whether the decline in fair value is other-than-temporary, which is based on subjective factors and involves a variety of assumptions and estimates.
There are risks and uncertainties associated with determining whether declines in market value are other-than-temporary. These include significant changes in general economic conditions and business markets, trends in certain industry segments, interest rate fluctuations, rating agency actions, changes in significant accounting estimates and assumptions and legislative actions. In the case of mortgage- and asset-backed securities, there is added uncertainty as to the performance of the underlying collateral assets. To the extent that we are incorrect in our determination of the fair value of our investment securities or our determination that a decline in their value is other-than-temporary, we may realize losses that never actually materialize or may fail to recognize losses within the appropriate reporting period.
Gross unrealized losses on available-for-sale fixed maturity securities may be realized or result in future impairments, resulting in a reduction in our net income.
Fixed maturity securities classified as available-for-sale are reported at fair value. Unrealized gains and losses on available-for-sale securities are recognized as a component of other comprehensive income (loss) and are, therefore, excluded from our net income. Our total gross unrealized losses on our available-for-sale securities portfolio at December 31, 2018 were $11.3 million. The accumulated change in estimated fair value of these securities is recognized in net income when the gain or loss is realized upon sale of the security or in the event that the decline in estimated fair value is determined to be other-than-temporary and an impairment charge to earnings is taken. Realized losses or impairments may have a material adverse effect on our net income in a particular quarterly or annual period.
Our actual claims losses may exceed our reserves for claims, and we may be required to establish additional reserves, which in turn may adversely impact our results of operations and financial condition.
We maintain reserves to cover our estimated exposure for claims relating to our issued insurance policies. Reserves, whether calculated under U.S. GAAP or statutory accounting practices prescribed by various state insurance regulators, do not represent an exact calculation of exposure, but instead represent our best estimates, generally involving actuarial projections, of what we expect claims will be based on mortality assumptions that are determined by various regulatory authorities. Many reserve assumptions are not directly quantifiable, particularly on a prospective basis. In addition, when we acquire other domestic life insurance companies, our assessment of the adequacy of acquired policy liabilities is subject to our estimates and assumptions. Reserve estimates are refined as experience develops, and adjustments to reserves are reflected in our statements of operations for the period in which such estimates are updated. Because establishing reserves is an inherently uncertain process involving estimates of future losses, future developments may require us to increase policy benefit reserves, which may have a material adverse effect on our results of operations and financial condition in the periods in which such increases occur.
Unanticipated increases in early policyholder withdrawals or surrenders or elections by policyholders to deposit distributions at maturity in guaranteed interest contracts could negatively impact liquidity.
A primary liquidity concern is the risk of unanticipated or extraordinary early policyholder withdrawals or surrenders. Our insurance policies include provisions, such as surrender charges, that help limit and discourage early withdrawals, and we track and manage liabilities and attempt to align our investment portfolio to maintain sufficient liquidity to support anticipated withdrawal demands. However, early withdrawal and surrender levels may differ from anticipated levels for a variety of reasons, including changes in economic conditions, changes in policyholder behavior or financial needs, changes in relationships with our independent consultants, changes in our claims-paying ability, or increases in surrenders among policies that have been inforce for more than fifteen years and are no longer subject to surrender charges. In addition, our whole life and endowment products provide the policyholder with alternatives once the policy matures. The policyholder can choose to take a lump sum payout or leave the money on deposit at interest with the Company. The Company has a significant amount of endowment products, with older contracts sold historically that will begin reaching their maturities over the next several years and policyholder election behavior is not known. If policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Any of these occurrences could adversely affect our liquidity, profitability and financial condition.
While we own a significant amount of liquid assets, a certain portion of investment assets are relatively illiquid. If we experience unanticipated early withdrawal or surrender activity, we could exhaust all other sources of liquidity and be forced to obtain additional financing or liquidate assets, perhaps on unfavorable terms. The availability of additional financing will depend on a variety of factors, such as market conditions, the availability of credit in general or more specifically in the insurance industry, the strength or weakness of the capital markets, the volume of trading activities, our credit capacity, and the perception of our long- or short-term financial prospects if we incur large realized or unrealized investment losses or if the level of business activity declines due to a market downturn. If we are forced to dispose of assets on unfavorable terms, it could have an adverse effect on our liquidity, results of operations and financial condition.
Catastrophes may adversely impact liabilities for policyholder claims and reinsurance availability.
Our insurance operations are exposed to the risk of catastrophic events. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes, earthquakes, tsunamis and man-made catastrophes may produce significant damage or loss of life in larger areas, especially those that are heavily populated. Claims resulting from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. In addition, catastrophic events could harm the financial condition of issuers of obligations we hold in our investment portfolio, resulting in impairments to these obligations, and the financial condition of our reinsurers, thereby increasing the probability of default on reinsurance recoveries. Large-scale catastrophes may also reduce the overall level of economic activity in affected countries, which could hurt our business and the value of our investments or our ability to sell new policies.
Our life insurance operations are exposed to the risk of catastrophic mortality, such as a pandemic or other event that causes a large number of deaths, especially if concentrated in our top foreign markets. A significant pandemic could have a major impact on the global economy or the economies of particular countries or regions, including travel, trade, tourism, the health system, food supply, consumption, overall economic output and, eventually, on the financial markets. In addition, a pandemic that affected our employees, our policyholders, our independent consultants or other companies with which we do business could disrupt our
business operations. The effectiveness of external parties, including governmental and non-governmental organizations, in combating the spread and severity of such a pandemic could have a material impact on the losses experienced by us. These events could cause a material adverse effect on our results of operations in any period and, depending on their severity, could also materially and adversely affect our financial condition.
We may be required to accelerate the amortization of deferred acquisition costs and the costs of customer relationships acquired, which would increase our expenses and adversely affect our results of operations and financial condition.
At December 31, 2018, we had $155.7 million of deferred policy acquisition costs, or DAC. DAC represents costs that vary with and are directly related to the successful sale and issuance of our insurance policies and are deferred and amortized over the estimated life of the related insurance policies. These costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material costs and some support costs, such as underwriting and contract and policy issuance expenses. Under U.S. GAAP for our type of insurance products, DAC is amortized over the premium-paying period of the policies.
In addition, when we acquire a block of insurance policies, we assign a portion of the purchase price to the right to receive future net cash flows from existing insurance and investment contracts and policies. This intangible asset, called the cost of customer relationships acquired, or CCRA, represents the actuarially estimated present value of future cash flows from the acquired policies. At December 31, 2018, we had $15.2 million of CCRA. We amortize the value of this intangible asset in a manner similar to the amortization of DAC.
The amortization of DAC and CCRA is subject to acceleration and generally depends upon anticipated profits from investments, surrender and other policy charges, mortality, morbidity, persistency and maintenance expense margins. For example, if our insurance policy lapse and surrender rates were to exceed the assumptions upon which we priced our insurance policies, or if actual persistency proves to be less than our persistency assumptions, especially in the early years of a policy, we might be required to accelerate the amortization of expenses we deferred in connection with the acquisition of the policy. We regularly review the quality of our DAC and CCRA to determine if they are recoverable from future income. If these costs are not recoverable, the amount that is not recoverable is charged to expenses in the financial period in which we make this determination.
Unfavorable experience with regard to expected expenses, investment returns, surrender and other policy charges, mortality, morbidity, lapses or persistency may cause us to increase the amortization of DAC or CCRA, or both, or to record a current period expense to increase benefit reserves, any of which could have a material adverse effect on our results of operations and financial condition.
We may be required to recognize an impairment on the value of our goodwill, which would increase our expenses and materially adversely affect our results of operations and financial condition.
Goodwill represents the excess of the amount paid by us to acquire various life insurance companies over the fair value of their net assets at the date of the acquisition. Under U.S. GAAP, we test the carrying value of goodwill for impairment at least annually at the "reporting unit" level, which is either an operating segment or a business that is one level below the operating segment. Goodwill is impaired if its carrying value exceeds its implied fair value. This may occur for various reasons, including changes in actual or expected earnings or cash flows of a reporting unit, generation of earnings by a reporting unit at a lower rate than similar businesses or declines in market prices for publicly traded businesses similar to our reporting units. If any portion of our goodwill becomes impaired, we would be required to recognize the amount of the impairment as a current-period expense, which could have a material adverse effect on our results of operations and financial condition. In 2017, we recognized a goodwill impairment of $4.6 million on our Home Service segment. Goodwill in our consolidated financial statements related to our Life segment was $12.6 million as of December 31, 2018.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including qualitative and quantitative factors such as discounted cash flow calculations based on assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections and trends.
Our conversion to a new actuarial valuation system is not yet complete and contains known uncertainties that could result in identification of additional errors in our financial reporting.
The Company is in the process of converting its actuarial valuation from a third-party service provider to an actuarial valuation modeling software system purchased from a vendor. In connection with our ongoing actuarial valuation conversion, certain legacy
system immaterial errors were discovered in 2018, 2017 and 2016. As we complete this validation and conversion, we could identify additional differences that will be evaluated for financial reporting purposes. The conversion to the new system has been completed for some of our individual company valuations but is on-going for others and is expected to be completed in the next one to two years.
We are a defendant in lawsuits, which may adversely affect our financial condition and detract from the time our management is able to devote to our business, and we are subject to risks related to litigation and regulatory matters.
From time to time we are, and have been, subject to a variety of legal and regulatory actions and investigations relating to our business operations, including, but not limited to:
disputes over insurance coverage or claims adjudication;
regulatory compliance with state laws, including insurance and securities regulations;
regulatory compliance with U.S. federal securities laws, tax, anti-money laundering, bank secrecy, anti-bribery, anti-corruption and foreign asset control laws, among others;
disputes with our independent marketing firms, independent consultants and employee-agents over compensation, termination of contracts, noncompliance with applicable laws and regulations and related claims;
disputes regarding our tax liabilities;
disputes relating to reinsurance and coinsurance agreements; and
disputes relating to businesses acquired and operated by us.
In the absence of countervailing considerations, we would expect to defend any such claims vigorously. However, in doing so, we could incur significant defense costs, including 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.
Reinsurers with which we do business could increase their premium rates and may not honor their obligations, leaving us liable for the reinsured coverage.
We reinsure certain risks underwritten by our various insurance subsidiaries. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase. The high cost of reinsurance or lack of affordable coverage could adversely affect our results of operations and financial condition.
Our reinsurance facilities are generally subject to annual renewal. We may not be able to maintain our current reinsurance facilities and, even if highly desirable or necessary, we may not be able to obtain replacement reinsurance facilities in adequate amounts or at rates economically attractive to us. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling or unable to bear an increase in net exposures, we may have to reduce the level of our underwriting commitments. In addition, our reinsurance facilities may be canceled for new business, pursuant to their terms, upon the occurrence of certain specified events, including a change of control of our Company (generally defined as the acquisition of 10% or more of our voting equity securities) or the failure of our insurance company subsidiaries to maintain the minimum required levels of statutory surplus. Any of these potential developments could materially adversely affect our revenues, results of operations and financial condition.
In 2018, we reinsured $490.3 million of the face amount of our life insurance policies. Amounts reinsured in 2018 represented 10.1% of the face amount of direct life insurance in force in that year. Although the cost of reinsurance is, in some cases, reflected in premium rates, under certain reinsurance agreements, the reinsurer may increase the rate it charges us for reinsurance. If our cost of reinsurance were to increase, we might not be able to recover these increased costs, and our results of operations and financial condition could be materially adversely affected. See Note 5 - "Reinsurance" in the notes to our Company's consolidated financial statements.
Our international markets face significant competition. If we are unable to compete effectively in our markets, our business, results of operations and profitability may be adversely affected.
Our international marketing plan focuses on making available U.S. dollar-denominated life insurance products to individuals residing in foreign countries. New competition could increase the supply of available insurance, which could adversely affect our ability to price our products at attractive profitable rates and thereby adversely affect our revenues, results of operations and financial condition. Existing barriers to entry in the foreign markets we serve may not be sufficient to impede potential competitors
from entering such markets. In connection with our business with foreign nationals, we experience competition primarily from the following sources, many of which have substantially greater financial, marketing and other resources than we have:
Foreign operated companies with U.S. dollar-denominated policies. We face direct competition from companies that operate in the same manner as we operate in our international markets, including from a company recently formed by some of our former employees and independent consultants.
Foreign operated companies with locally operated subsidiaries that offer both local jurisdiction regulated products in local currency and off-shore U.S. dollar-denominated policies. This arrangement creates competition in that the U.S. dollar-denominated policies are offered in conjunction with high-need local insurance policies such as health insurance.
Local currency policies. These policies provide the benefit of assets located in the country of foreign residents, but entail risks of uncertainty due to local currency fluctuations, as well as the perceived instability and weakness of local currencies.
Locally operated companies with local currency policies. We compete with companies formed and operated in the country in which our foreign insureds reside. Generally, these companies are subject to risks of currency fluctuations, and they primarily use mortality tables based on experience of the local population as a whole. These mortality tables are typically based on significantly shorter life spans than those we use. As a result, the cost of insurance from these companies tends to be higher than ours. Although these companies typically market their policies to a broader section of the population than do our independent marketing firms and independent consultants, there can be no assurance that these companies will not endeavor to place a greater emphasis on our target market and compete more directly with us.
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.
There can be no assurance that we will be able to compete effectively in any of our markets. If we do not, our business, results of operations and financial condition will be materially adversely affected.
Sales of our insurance products could decline if we are unable to (i) establish and maintain commercial relationships with independent marketing firms and independent consultants, (ii) attract and retain employee agents or (iii) develop and maintain our distribution sources.
We distribute our insurance products through several distribution channels, including independent marketing firms, independent consultants and our employee agents. These relationships are significant for both our revenues and our profits. In our Life Insurance segment, we depend almost exclusively on the services of independent marketing firms and independent consultants. In our Home Service segment, we depend on employee agents whose role in our distribution process is integral to developing and maintaining relationships with policyholders. Significant competition exists among insurers in attracting and maintaining marketers of demonstrated ability. Some of our competitors may offer better compensation packages for marketing firms, independent consultants and agents and broader arrays of products and have a greater diversity of distribution resources, better brand recognition, more competitive pricing, lower cost structures and greater financial strength or claims paying ratings than we do. We compete with other insurers for marketing firms, independent consultants and employee agents primarily on the basis of our compensation, 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. Modifications in our international business model including, without limitation, our novation to our Bermuda-based entity, CICA Ltd., and our withdrawal from certain markets may have an adverse impact on our ability to attract and retain effective sales representatives.
There may be adverse tax, legal or financial consequences if our sales representatives are determined not to be independent contractors.
Our international sales representatives are independent contractors who operate their own businesses. Although we believe that we have properly classified our representatives as independent contractors, there is nevertheless a risk that the IRS, a foreign agency, a court or other authority will take the different view that our sales representatives should be treated like employees. Furthermore, the tests governing the determination of whether an individual is considered to be an independent contractor or an employee are typically fact-sensitive and vary from jurisdiction to jurisdiction. Laws and regulations that govern the status and misclassification of independent sales representatives are subject to change or interpretation.
If there is a change in the manner in which our independent contractors are classified or an adverse determination with respect to some or all of our independent contractors by a court or governmental agency, we could incur significant costs in complying with such laws and regulations, including in respect of tax withholding, social security payments, government and private pension plan contributions and recordkeeping, or we may be required to modify our business model, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, there is the risk that we may be subject to significant monetary liabilities arising from fines or judgments as a result of any such actual or alleged non-compliance with applicable federal, state, local or foreign laws.
We and our insurance subsidiaries are subject to extensive governmental regulation in the United States, which is subject to change and may increase our costs of doing business, restrict the conduct of our business, increase capital requirements for our insurance subsidiaries and negatively impact our results of operations, liquidity and financial condition.
We and our subsidiaries are subject to extensive regulation and supervision in U.S. jurisdictions where we do business, including state insurance regulations and U.S. federal securities, tax, financial services, privacy, anti-money laundering, bank secrecy, anti-corruption and foreign asset control laws. Insurance company regulation is generally designed to protect the interests of policyholders, with substantially lesser protections to shareholders of the regulated insurance companies. To that end, all the states in which we do business have insurance regulatory agencies with broad legal powers with respect to licensing companies to transact business; mandating capital and surplus requirements; regulating trade and claims practices; approving policy forms; restricting companies' ability to enter and exit markets; and restricting or prohibiting the payment of dividends by our subsidiaries to us.
The capacity for an insurance company's growth in premiums is partially a function of its required statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by statutory accounting practices prescribed or permitted by a company's state of domicile, is considered important by all state insurance regulatory authorities. Failure to maintain required levels of statutory surplus could result in increased regulatory scrutiny and enforcement action by regulatory authorities.
Most insurance regulatory authorities have broad discretion to grant, renew, suspend and revoke licenses and approvals, and could preclude or temporarily suspend us from carrying on some or all of our activities, including acquisitions of other insurance companies, require us to add capital to our insurance company subsidiaries, or fine us. If we are unable to maintain all required licenses and approvals, or if our insurance business is determined not to comply fully with the wide variety of applicable laws and regulations and their interpretations, including the USA Patriot Act, our revenues, results of operations and financial condition could be materially adversely affected.
Our failure to maintain effective information systems could adversely affect our business.
We must maintain and enhance our existing information systems and develop 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 products acquired through acquisition, inadequate information on which to base pricing, underwriting and reserve decisions, regulatory problems, failure to meet prompt payment obligations, increases in administrative expenses and loss of customers. We must also effectively consolidate our information systems to eliminate redundant or obsolete applications. 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.
Our success depends on our ability to successfully implement new or upgraded systems and technology. For example, during the third quarter of 2018, we completed the implementation of a new Oracle Enterprise Resource Planning application, which has replaced several of our back office legacy systems, such as the general ledger, accounts payable, cash management, and fixed asset systems. We also implemented a new actuarial valuation and modeling system, GGY AXIS, related to CICA and CICA Ltd. actuarial valuations. There are inherent risks associated with the modifications and transition to our new general ledger system and actuarial valuation system, including the potential for inaccurately capturing data as well as system disruptions. Either of these problems, if not anticipated and appropriately mitigated, could have a negative impact on our ability to provide timely and accurate financial reporting and have a material adverse effect on our results of operations and financial condition.
Failures of disclosure controls and procedures and internal control over financial reporting could materially and adversely affect our business, financial condition and results of operations, impair our ability to timely file reports with the SEC and subject us to litigation and/or regulatory scrutiny and penalties.
We maintain disclosure controls and procedures designed to ensure that we timely report information as specified in SEC rules and regulations. We also maintain a system of internal control over financial reporting. However, these controls may not achieve, and in some cases have not achieved, their intended objectives. Control processes that involve human diligence and oversight, such as our disclosure controls and procedures and internal control over financial reporting, are subject to human error. Controls that rely on models may be subject to inadequate design or inaccurate assumptions or estimates. Controls also can be circumvented by improper management override of such controls. Because of such limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected, and that information may not be reported on a timely basis. The failure of our controls to be effective could have a material adverse effect on our business, financial condition, results of operations and the market for our common stock, and could subject us to litigation, regulatory scrutiny and/or penalties.
As disclosed in Part II, Item 9A of this Annual Report on Form 10-K, we have identified a deficiency in our internal control over financial reporting that constitutes a material weakness and for which remediation is still in process as of December 31, 2018. If we fail to design effective controls, fail to remediate control deficiencies or fail to otherwise maintain effective internal control over financial reporting in the future, such failures could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors to lose confidence in our financial statements, have a negative effect on the trading price of our common stock, limit our ability to obtain financing if needed or increase the cost of any financing we may obtain. In addition, these failures may negatively impact our business, financial condition and results of operations, impair our ability to timely file our periodic reports with the SEC, subject us to litigation and regulatory scrutiny and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.
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, independent consultants and employee-agents 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 may 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, 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.
The failure of our business recovery and incident management processes to resume our business operations in the event of a catastrophe, 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.
We depend on the ability of our insurance subsidiaries to make payments to us in sufficient amounts for us to conduct our operations. Our insurance subsidiaries are restricted by applicable laws and regulations in the amounts of payments they may make to us and their ability to transfer funds to us may be impaired by adverse financial results or a change in capital requirements. Accordingly, internal sources of capital and liquidity may not always be sufficient. If we need to seek external capital, adverse market conditions may affect our access to capital or our cost of capital.
As a holding company, our principal asset is the stock of our subsidiaries. We rely primarily on statutorily permissible payments from our insurance company subsidiaries, principally through service agreements we have with our subsidiaries, to meet our working capital and other corporate expenses. The ability of our insurance company subsidiaries to make payments to us is subject to regulation by the states in which they are domiciled, and these payments depend primarily on approved service agreements between us and these subsidiaries and, to a lesser extent, the statutory surplus (which is the excess of assets over liabilities as determined under statutory accounting practices prescribed by an insurance company's state of domicile), future statutory earnings (which are earnings as determined in accordance with statutory accounting practices) and regulatory restrictions. Generally, the net assets of our insurance company subsidiaries available for dividends are limited to either the lesser or greater (depending on the state of domicile) of the subsidiary's net gain from operations during the preceding year or 10% of the subsidiary's net statutory surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed by insurance regulatory authorities.
Except to the extent that we are a creditor with recognized claims against our subsidiaries, claims of our subsidiaries' creditors, including policyholders, have priority with respect to the assets and earnings of the subsidiaries over the claims of our creditors and shareholders. If any of our subsidiaries becomes insolvent, liquidates or otherwise reorganizes, our creditors and shareholders will have no right to proceed in their own right against the assets of that subsidiary or to cause the liquidation, bankruptcy or winding-up of the subsidiary under applicable liquidation, bankruptcy or winding-up laws.
Additionally, any change in demand for our insurance subsidiaries’ products or an increase in the incidence of new claims or the duration of existing claims could negatively impact their cash flows from operations. Deterioration in the credit market, which could delay our and our insurance subsidiaries’ ability to sell positions in certain of fixed maturity securities in a timely manner, could also negatively impact our and our insurance subsidiaries’ cash flows. Regulatory changes such as those discussed herein
in this Item 1A may impose higher capital or reserve requirements on our insurance subsidiaries and/or implement other requirements which could unfavorably affect our liquidity. Without sufficient liquidity, our ability to maintain and grow our operations would be limited. If our internal sources of liquidity prove to be insufficient, we may be unable to successfully obtain additional financing and capital on favorable terms, or at all, which may adversely affect us.
If our financial results are unfavorable, we may need to increase our capital in order to satisfy regulatory requirements. Maintaining appropriate levels of statutory surplus is considered important not only by us but by insurance regulatory authorities in the U.S. and Bermuda. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny or action by regulatory authorities. Need for additional capital may limit a subsidiary's ability to distribute funds to our holding companies.
Obtaining financing for even a small amount of capital could be challenging in unfavorable market conditions and during periods of economic uncertainty. The markets may exert downward pressure on availability of liquidity and credit capacity for certain issuers. 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. Similarly, our access to funds may be impaired if regulatory authorities take negative actions against us. Raising capital in unfavorable market conditions could increase our interest expense or negatively impact our shareholders through increased dilution of their common stock in the Company.
Unexpected losses in future reporting periods may require us to record a valuation allowance against our deferred tax assets.
We evaluate our deferred tax asset ("DTA") quarterly for recoverability based on available evidence. This process involves management's judgment about assumptions, which are subject to change from period to period due to tax rate changes or variances between our projected operating performance and our actual results. Ultimately, future adjustments to the DTA valuation allowance, if any, will be determined based upon changes in the expected realization of the net deferred tax assets. The realization of the deferred tax assets depends on the existence of sufficient taxable income in either the carry back or carry forward periods under applicable tax law. Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we may be required to record a valuation allowance in future reporting periods. Such an adjustment could have a material adverse effect on our results of operation, financial condition and capital position.
We face a greater risk of money laundering activity associated with sales derived from residents of certain foreign countries.
Some of our top international markets are in countries identified by the U.S. Department of State as jurisdictions of high risk for money laundering. As required by Bank Secrecy Act ("BSA") regulations applicable to insurance companies, we have developed and implemented an anti-money laundering program that includes policies and procedures for complying with our applicable BSA program, auditing, reporting and recordkeeping requirements and for deterring, preventing and detecting potential money laundering, fraud and other criminal activity ("BSA Program"). We have an enhanced BSA Program with additional controls, such as watch-list screening software beyond sanctions screening required by the Office of Foreign Assets Control ("OFAC"), enhanced payment due diligence and transaction controls. However, there can be no assurance that these enhanced controls will entirely mitigate money laundering risk associated with these jurisdictions.
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 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 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 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 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 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.
Risks Relating to Our Capital Stock
If our foreign policyholders reduced or ceased participation in our Citizens's Inc. Stock Investment Plan (the "CISIP") or if a securities regulatory authority were to deem the CISIP's operation contrary to securities laws, the volume of Class A common stock purchased on the open market through the CISIP, and the price of our Class A common stock, could fall.
More than 95% of the shares of Class A common stock purchased under the CISIP in 2018 were purchased by foreign holders of life insurance policies (or related brokers); the remaining 5% of the shares of Class A common stock purchased under the CISIP in 2018 were purchased by approximately 1,723 participants residing in the United States. The CISIP is registered with the SEC pursuant to a registration statement under the Securities Act of 1933, but is not registered under the laws of any foreign jurisdiction. If a foreign securities regulatory authority were to determine the offer and sale of our Class A common stock under the CISIP were contrary to applicable laws and regulations of its jurisdiction, such authority may issue or assert a fine, penalty or cease and desist order against us in that foreign jurisdiction. There is a risk our Class A common stock price could be negatively impacted by a decrease in participation in the CISIP. If fewer policyholders elect to participate in the Plan, or our international premium collections were to decrease as a result of regulatory, economic, or marketing impediments, the trading volume of our Class A common stock may decline from its present levels, the demand for our Class A common stock could be negatively impacted and the price of our Class A common stock could fall.
Due to required regulatory approval for acquisition of control of a regulated U.S. domestic insurance company, control of our Company, through the ownership of our Class B common stock, has not yet transferred from our founder's trust to a 501(c)(3) charitable foundation established by our founder, and we cannot determine whether or when any change in our management, operations, or operating strategies will occur.
Harold E. Riley, our founder, was the beneficial owner of 100% of our Class B common stock, which was held in the name of the Harold E. Riley Trust ("Trust"), of which he had served as Trustee until his death in September 2017. Our Class A and Class B common stock are identical in all respects, except the Class B common stock elects a simple majority of the Board and receives one-half of any cash dividends paid, on a per share basis, to the Class A common stock. The Class A common stock elects the remainder of the Board. The Trust documents provided that upon Mr. Riley's death, the Class B common stock will transfer from the Trust to the Harold E. Riley Foundation, a charitable organization established under 501(c)(3) of the Internal Revenue Code (the "Foundation").
To date, the estate process related to the Class B common stock is not complete and the required state insurance regulatory approvals for change of control to occur have not been received. Therefore, the Trust, of which Mr. Riley's estate is the trustee, currently remains the holder of record of the Class B common stock. The Foundation and the Estate of Harold E. Riley are proceeding independent of the Company to obtain regulatory approval from the Colorado Division of Insurance, the Texas Department of Insurance, the Louisiana Department of Insurance and the Mississippi Department of Insurance through the requisite Form A approval process. The Company does not know if or when regulatory approvals of the transfer ultimately will be granted. If such approvals are obtained from the states' department of insurances listed above, the Company will record the transfer of the controlling Class B common stock from the Trust to the Foundation in the Company's shareholder records.
The Foundation is organized as a public support charity for the benefit of its charitable beneficiaries, Baylor University and Southwestern Baptist Theological Seminary. The Foundation is governed by a board of trustees appointed by Harold Riley prior to his death, Baylor University and Southwestern Baptist Theological Seminary. It is unclear what, if any, change may occur to our Board, management, or corporate operating strategies as a result of ownership of our Class B common stock by the Foundation.
If and when the Foundation becomes the record holder of the Class B common stock, the first of two prongs of certain "change in control" provisions in the employment agreement of our President and Chief Executive Officer, Geoffrey Kolander, dated January 23, 2019 will be triggered. Under Mr. Kolander's new employment agreement effective January 1, 2019, a "change in control" includes, among other things (1) the regulatory approval of the transfer of the Class B common stock from the Trust to any individual, entity or group, other than regulatory approval of a transaction wherein the Company is the first to repurchase the Class B common stock directly from the Trust or the Foundation and (2) the exercise of a power of attorney granted by Harold E. Riley over the Company's Class B common stock by the Trust or the Foundation. If his employment is terminated by Mr. Kolander or
by the Company without cause, in each case, within eighteen (18) months of a change in control, Mr. Kolander would be entitled to receive certain cash payments and benefits.
The price of our Class A common stock may be volatile and may be affected by market conditions beyond our control.
Our Class A common stock price has historically fluctuated and is likely to fluctuate in the future and could decline materially because of the volatility of the stock market in general, decreased participation in the CISIP referred to above or a variety of other factors, many of which are beyond our control, including: quarterly or annual variations in actual or anticipated results of our operations; interest rate fluctuations; changes in financial estimates by securities analysts; competition and other factors affecting the life insurance business generally; and conditions in the U.S. and world economies.
Our international markets, and the specific manner in which we conduct our business in those jurisdictions, may be subject to negative publicity in social media or other channels, which may negatively impact the market price of our Class A common stock.
We interface with and distribute our products to residents of foreign countries that may be subject to the risks disclosed in our Item 1A. Risk Factor under the heading, "A substantial majority of our sales derives from residents of foreign countries and is subject to risks associated with widespread political instability, currency control laws and foreign insurance laws. A significant loss of sales in these foreign markets could have a material adverse effect on our results of operations and financial condition". Venezuela is one such example. Accordingly, from time to time, bloggers or other social media outlets relevant to investors may focus attention on our exposure to these countries and the negative circumstances surrounding their governments, thereby subjecting us to periodic negative publicity. Negative publicity on investor blogs or through other media channels could impact trading in our stock especially due to aggressive and coordinated efforts between anonymous bloggers and short sellers which may ultimately cause the market price of our Class A common stock to fall.
Our articles of incorporation and bylaws, as well as applicable state insurance laws, may discourage takeovers and business combinations that our shareholders might consider to be in their best interests.
Our articles of incorporation and bylaws, as well as various state insurance laws, may delay, deter, render more difficult or prevent a takeover attempt our shareholders might consider in their best interests. As a result, our shareholders will be prevented from receiving the benefit from any premium to the market price of our Class A common stock that may be offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our Class A common stock if they are viewed as discouraging takeover attempts in the future.
The following provisions in our articles of incorporation and bylaws make it difficult for our Class A shareholders to replace or remove our directors and have other anti-takeover effects that may delay, deter or prevent a takeover attempt:
holders of shares of our Class B common stock elect a simple majority of our Board, and all of these shares are held by the Harold E. Riley Trust until such time that the Harold E. Riley Foundation receives regulatory approval for acquisition of the Class B common stock and becomes holder of record; and
our Board may issue one or more series of preferred stock without the approval of our shareholders.
State insurance laws generally require prior approval of a change in control of an insurance company. Generally, such laws provide that control over an insurer is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing 10% or more of the voting securities of the insurer. In considering an application to acquire control of an insurer, an insurance commissioner generally will consider such factors as the experience, competence and financial strength of the proposed acquirer, the integrity of the proposed acquirer's board of directors and executive officers, the proposed acquirer's plans for the management and operation of the insurer, and any anti-competitive results that may arise from the acquisition. In addition, a person seeking to acquire control of an insurance company is required in some states to make filings prior to completing an acquisition if the acquirer and the target insurance company and their affiliates have sufficiently large market shares in particular lines of insurance in those states. These state insurance requirements may delay, deter or prevent our ability to complete an acquisition.
We have never paid any cash dividends on our Class A common stock and do not anticipate doing so in the foreseeable future.
We have never paid cash dividends on our Class A common stock, as it is our policy to retain earnings for use in the operation and expansion of our business. We do not expect to pay cash dividends on our Class A common stock for the foreseeable future.
We lease our principal office in Austin, Texas to service all business entities and operations. We also lease space for our office in Bermuda related to CICA Ltd. In 2018, we owned properties in Austin and Buchanan Dam, Texas used for our general business operations and properties in Louisiana related to our Home Service segment and business operations. On February 15, 2019, we sold an owned building located at 400 East Anderson Lane and a nearby property in Austin to a third-party. Following the sales, we no longer own any property in Austin.
Item 3. LEGAL PROCEEDINGS
As disclosed in prior periods, the legal and regulatory actions facing the Company include those relating to compliance with U.S. federal securities laws. Specifically, the Company has been the subject of an investigation by the Securities and Exchange Commission ("SEC"), which was focused on the Company’s internal control over financial reporting and disclosure controls and procedures in light of the Company’s determination in 2015 that a portion of the life insurance and annuity policies issued by its subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code of 1986, (the "Investigation"). On August 22, 2018, the Company received a notice from the SEC (the "Notice") stating that the SEC has concluded the Investigation and, based on the information that the SEC had as of the date of the Notice, the SEC has decided to not recommend an enforcement action against the Company relating to the Investigation. The Notice was provided under the guidelines set forth in the final paragraph of Securities Act Release No. 5310.
There are no 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. From time to time we are subject to legal and regulatory actions relating to our business. We defend all claims vigorously. As a result, we incur defense costs, including attorneys' fees, other direct litigation costs and the expenditure of management time that otherwise would be devoted to our business. If we suffer an adverse judgment as a result of litigation claims, it could have a material adverse effect on our business, results of operations and financial condition.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Class A common stock is traded on the New York Stock Exchange ("NYSE") under the symbol CIA. All of our Class B common stock is owned by the Trust; therefore, there is no public trading market for our Class B common stock.
The number of stockholders on record on March 4, 2019 was as follows:
Class A Common Stock - 94,048
Class B Common Stock - 1
We have never paid cash dividends on our Class A or B common stock and do not expect to pay cash dividends in the foreseeable future, as it is our policy to retain earnings for use in the operation and expansion of our business.
We did not purchase any of our equity securities during 2016, 2017 or 2018.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information regarding securities authorized for issuance under our equity compensation plan, the Citizens Inc. Omnibus Incentive Plan as of December 31, 2018. See Note 11 - "Stock Compensation" in the notes to our consolidated financial statements for additional information regarding our Omnibus Incentive Plan.
Number of securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of securities remaining for future issuance under equity compensation plans
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
The following graph compares the change in the Company’s cumulative total stockholder return on its common stock over a five-year period. The following graph assumes a $100 investment on December 31, 2013, and reinvestment of all dividends in each of the Company’s common shares, the New York Stock Exchange ("NYSE") Composite and the Hemscott Group Index, a peer group of major U.S.-based insurance companies.
The peer group index weights individual company returns for stock market capitalization. The companies included in the peer group index are shown in the following table.
The following table presents selected financial data of the Company. This should be read in conjunction with Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8. "Financial Statements and Supplementary Data" of this Form 10-K.
Years ended December 31,
(In thousands, except per share data)
Net investment income
Realized investment gains (losses)
Net income (loss) before federal income taxes
Net income (loss)
Balance sheet data
Total stockholders' equity
Life insurance in force
Per share data
Book value per share
Basic and diluted earnings (losses) per Class A share
See Item 1. "Business" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," for information that may affect the comparability of the financial data contained in the above table.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of the consolidated financial condition and consolidated results of operations of the Company. It is intended to be a discussion of certain key financial information regarding the Company and should be read in conjunction with the consolidated financial statements and related Notes to this Annual Report on Form 10-K.
We conduct operations as an insurance holding company emphasizing ordinary life insurance and endowment products in niche markets where we believe we can achieve competitive advantages. As an insurance provider, we collect premiums on an ongoing basis to pay future benefits to our policy and contract holders. Our core operations include issuing:
whole life insurance;
final expense; and
limited liability property policies.
The Company derives its revenues principally from 1) premiums earned for insurance coverages provided to insureds; 2) net investment income; and 3) net realized capital gains and losses.
Profitability of our insurance operations depends heavily upon the Company’s underwriting discipline, as we seek to manage exposure to loss through:
favorable risk selection and diversification;
management of claims;
use of reinsurance;
sizing of our in force block;
careful monitoring of our mortality and morbidity experience; and
management of our expense ratio, which we accomplish through economies of scale and management of acquisition costs and other underwriting expenses.
Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future losses based on historical loss experience adjusted for known trends, the Company’s response to competitors, and expectations about regulatory and legal developments and expense levels. The Company seeks to price our insurance policies such that insurance premiums and future net investment income earned on premiums received will cover underwriting expenses and the ultimate cost of paying claims reported on the policies and provide for a profit margin. The Company has the ability to adjust dividend scales and interest crediting rates at its discretion based on economic and other factors. The profitability of fixed annuities, riders and other "spread-based" product features depends largely on the Company’s ability to earn target spreads between earned investment rates on assets and interest credited to policyholders.
The investment return, or yield, on invested assets is an important element of the Company’s earnings since insurance products are priced with the assumption that premiums received can be invested for a period of time before benefits are paid. The majority of the Company’s invested assets have been held in fixed maturities available-for-sale securities, primarily in asset classes of corporate bonds, municipal bonds, and government obligation bonds. The interest rate environment has a significant impact on the determination of insurance contract liabilities, our investment rates and yields and our asset/liability management.
The primary investment objective for the Company is to maximize economic value, consistent with acceptable risk parameters, including the management of credit risk and interest rate sensitivity of invested assets, while generating sufficient after-tax income to meet policyholder and corporate obligations. The Company maintains a conservative investment strategy that may vary based on a variety of factors including business needs, regulatory requirements and tax considerations.
We previously announced that we determined that a portion of the life and annuity insurance policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code ("IRC") of 1986. Further, we have determined that the structure of our policies sold to non-U.S. citizens, which were novated to CICA Life Ltd. ("CICA Ltd."), our Bermuda affiliate effective July 1, 2018, may have inadvertently
generated US source income over time. We have incurred significant costs in the evaluation process of this issue as we have engaged legal, tax and actuarial consultants to assist us in this review and remediation. We have established a best estimate reserve of $10.0 million, net of tax as of December 31, 2018 for probable liabilities and expenses and the probability weighted range of financial estimates relative to this issue is $6.0 million to $52.5 million, net of tax. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, the methodology applicable to the calculation of taxable benefits under non-compliant policies and the amount of time and resources we will require from external advisors who are assisting us with resolving these issues. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and also could exceed the high end of our estimated range of liabilities and expenses.
On May 17, 2017, we submitted an offer to enter into Closing Agreements with the IRS covering the CICA and CNLIC domestic life insurance business. The toll charges calculated and enumerated in the Closing Agreements totaled $124,000 and $4,000 for the CICA and CNLIC domestic life insurance businesses, respectively. We have not yet received any correspondence from the IRS related to our submissions.
Our on-going strategic initiatives as defined by our executive team and Board of Directors (the "Board") require that we commit resources as necessary. See a discussion of our strategic initiatives in Part 1, Item 1. Business.
Current Financial Highlights
Our 2018 financial results are driven by our historical business management model and traditional life insurance product sales. Although interest rates have risen recently, the historically low interest rate environment continues to impact our results and our industry as investment yields are an integral component of our business operations.
Our assets decreased $29 million from 2017 to 2018 and totaled $1.6 billion as of December 31, 2018.
Total stockholders' equity decreased from $223.5 million at December 31, 2017, to $187.7 million at December 31, 2018 due to the impact of subpart F income on the novation of all of the international policies issued by our subsidiary, CICA Life Insurance Company of America ("CICA"), to CICA Ltd. effective July 1, 2018 and the Tax Cuts and Jobs Act of 2017 (the "New Tax Act"), which resulted in tax expense for the current period of $13.1 million in 2018. In addition, we recorded a change in unrealized losses on available-for-sale securities of $38.8 million in 2018 due to market interest rates rising from 2017 levels, which reduced the net unrealized gains from $46.0 million down to $7.2 million.
Insurance premiums decreased 5.0% in 2018 and 0.1% in 2017, respectively, primarily from our Life Insurance segment, which decreased $9.6 million from 2017.
Net investment income increased 2.0% and 9.4% for 2018 and 2017, respectively, primarily due to an increase in the investment asset balances in 2018 compared to the prior year. The average yield on the consolidated investment portfolio has changed from a yield of 4.31% in 2017 down to 4.17% in 2018, as investment rates available have remained low in the sustained low interest rate environment.
Other-than-temporary impairments ("OTTI") items recorded totaled $0.8 million and $0.2 million in 2018 and 2017, respectively, and are reported as realized losses. Realized net investment gains in 2017 resulted from a gain on the sale of a real estate holding totaling $1.1 million offset by OTTI on investment securities.
During 2018, claims and surrenders expense increased 9.9% from 2017, primarily due to an increase in surrender benefits and matured endowments in the Life segment compared to the 2017 levels.
The change in future policy benefit reserves decreased 36.9% in 2018 compared to 2017 primarily due to changes in actuarial valuation estimates associated with the conversion to the new actuarial valuation system, AXIS, in 2018 that resulted in a decrease in reserves of $11.9 million when compared to 2017.
Policyholders' dividends increased 1.5% in 2018 compared to 2017, primarily due to the aging of the participating policies in our Life segment.
General expenses increased 2.7% in 2018, due primarily to additional audit fees related to the 2017 audit, higher legal and consulting fees and higher permanent executive salaries and temporary salaries, offset by a decrease in our tax compliance best estimate liability. In 2017, we recognized a $4.6 million impairment of our Home Service goodwill, reducing it down to zero.
Amortization of deferred policy acquisition expenses increased from $29.7 million at December 31, 2017 to $34.2 million at December 31, 2018 primarily due to the AXIS actuarial system conversion impacting amortization by $3.7 million in 2018 and higher surrender activity.
Life Insurance. For almost forty years, CICA and its predecessors had accepted policy applications from foreign nationals for U.S. dollar-denominated ordinary whole life insurance and endowment policies. We completed a novation of all of the international policies issued by CICA to CICA Ltd., effective July 1, 2018. We make our insurance products available using third-party marketing organizations and independent marketing consultants.
Endowment product sales have been the primary driver of sales in this segment. The Company has noted that the twenty year endowment is our top selling product, followed by an endowment product that matures at age sixty-five. The Company repriced its top six selling international products as of the beginning of 2017 and introduced minimum guaranteed rates and current crediting rates in these products to allow for adjustment relative to market interest rates as needed.
Through the domestic market of our Life Insurance segment, we collect renewal premiums on ordinary whole life, credit life insurance, 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 stopped issuing new domestic life policies in 2017. The majority of our domestic revenues are generated by the policies of domestic life insurance companies we have acquired since 1987.
Home Service Insurance. We provide final expense ordinary and industrial life insurance to middle and lower income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders, and through networks of funeral homes that collect premiums and provide personal policyholder service.
Premiums in this segment decreased slightly in 2018 compared to 2017, as renewal premiums and first year premiums decreased. We noted slight increases in 2017 compared to 2016 which were driven by renewal premiums.
Economic and Insurance Industry Developments
Significant economic issues impacting our business and industry currently and into the future are discussed below.
Slow increases in the interest rate environment will limit increases in profit margins for insurers. We have been impacted by the historically low interest rate environment over the past several years as our fixed income investment portfolio, primarily invested in callable securities, has been reinvested at lower yields. The Company’s conservative investment strategy has not changed, but we have focused new investments into securities of state, municipalities, essential services and corporate issuers compared to our historical investment in U.S. government holdings. Our investment earnings also impact the reserve and deferred policy acquisition costs ("DAC") balances, as assumptions are used in the development of the balances. Due to the recent decline in investment yields on our portfolio, our projection of long-term investment returns has declined. This has resulted in increasing the reserves on policies issued in the current year, as well as reducing the DAC asset.
As an increasing percentage of the world population reaches retirement age, we believe we will benefit from increased demand for living benefit products rather than death benefit products, as customers will require cash accumulation to pay expenses to meet their lifetime income needs. Our ordinary life products are designed to accumulate cash values to provide for living expenses in a policy owner's later years, while continuously providing a death benefit.
There has been a trend toward consolidation of domestic life insurance companies, due to significant losses incurred by the life insurance industry as a result of the low interest rate environment and related economic pressures, as well as increasing costs of regulatory compliance for domestic life insurance companies.
Many of the events and trends affecting the life insurance industry have had an impact on the life reinsurance industry. These events have led to a decline in the availability of reinsurance. While we currently cede a limited amount
of our primary insurance business to reinsurers, we may find it difficult to obtain reinsurance in the future, forcing us to seek reinsurers who are more expensive to us. If we cannot obtain affordable reinsurance coverage, either our net exposures will increase or we will have to reduce our underwriting commitments.
Innovation and digital development strategies will be implemented in various industries including the insurance industry in the coming years which could significantly impact our business. It will be critical that we embrace these changes to the benefit of our policyholders, agents and stockholders.
While our management has extensive experience in writing life insurance policies for foreign residents, changes to foreign laws and regulations and their related application and enforcement, along with currency controls affecting our foreign resident insureds could adversely impact our revenues, results of operations and financial condition.
Consolidated Results of Operations
A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment.
Insurance revenues are primarily generated from premium revenues and investment income. In addition, realized gains and losses on investment holdings can significantly impact revenues from year to year.
Years Ended December 31,
Accident and health insurance
Net investment income
Realized investment gains (losses)
Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased 5.0% during 2018 compared to 2017 and remained relatively flat during 2017 compared to 2016. Life insurance premiums reflected a decrease primarily resulting from decreased first year and renewal premiums in our Life segment. See details on the distribution of premiums below and further discussion within Segment Operations.
Years Ended December 31,
Endowment sales represent a significant portion of new business sales internationally with the 20-year endowment and endowment to age 65 as our top products. In addition, most of our life insurance policies contain a policy loan provision, which allows the
policyholder to use cash value within a policy to pay premiums. The policy loan asset balance increased 9.6% and 10.6% in 2018 and 2017, year over year, and remains in line with historical levels when compared to policy benefit liabilities.
Net Investment Income. Net investment income increased to $54.2 million in 2018 compared to $53.1 million in 2017, as we experienced higher average invested assets in 2018 as a result of our investment of incoming premium revenue. Our yield on average invested assets decreased fourteen basis points from 2017 to 2018 primarily due to higher coupon investments sales, maturities and calls being replaced with lower current market coupon rate investments.
Net investment income performance is summarized as follows.
Years Ended December 31,
(In thousands, except for %)
Net investment income
Average invested assets, at amortized cost
Yield on average invested assets
We have traditionally invested in fixed maturity securities with a large percentage held in callable issues. In the later part of 2018, we began a process of repositioning our portfolio into more diversified holdings and maturities as part of our investment management strategy. The sustained low interest rate environment of the past several years has required us to manage a challenging balance of continuing to invest in quality issuers, with durations that consider the lower yielding environment and our investment guidelines and liability maturities. While U.S. Treasury interest rates have risen recently they are still considered to be historically low. The interest rate direction is uncertain but as market interest rates begin to rise, our call risk will diminish, resulting in our fixed securities maturing at the stated maturity dates and our portfolio yield will rise more slowly over time, as new money investments would be made at higher rates.
The annualized yield also decreased during 2018 compared to 2017 due to the decrease in investment income as make-whole calls elected by issuers of the bond instruments held by us declined compared to prior years. These calls resulted in $655,000 of additional net income in 2017 compared to $141,000 in 2018. A make-whole call provision in the bond instruments allows the borrower to pay off the debt early and, in doing so, incur make-whole premiums. This option was elected by borrowers on some of our bond issues as noted.
Investment income from fixed maturity securities accounted for approximately 87.0% of total investment income for the year ended December 31, 2018. We have increased our investment purchases of AA rated mortgage backed securities in the later part of 2018 as we reposition our distribution in various investment sectors and decrease our municipal holdings. In addition, we currently have $14.7 million invested in equity securities related to bond and stock mutual funds.
Investment income from fixed maturity investments increased in 2018 due to an increase in the portfolio size from new money investment purchases that we made in the later part of 2018 as noted above relative to the fixed maturity portfolio. In addition, the increase in the policy loans asset balance, which represents policyholders utilizing their accumulated policy cash value to pay for premiums, contributed to the increase to investment income for 2018. Investment income from equity securities has declined as we have reduced our holdings as discussed above.
Realized Gains (Losses) on Investments.
Years Ended December 31,
Realized investment gains (losses):
Sales, calls and maturities
Property and equipment
Realized investment gains
Change in fair value of equity securities
Other-than-temporary impairments ("OTTI"):
Realized losses on OTTI
Net realized investment gains (losses)
In 2018, we recognized gains of $1.8 million primarily from sales of bonds that had been previously impaired. Net realized investment losses recorded from OTTI on fixed maturities in 2018 resulted from recording losses on securities that we do not intend to hold until recovery in value and due to credit concerns totaling $0.8 million. In 2017 and 2016, we recorded OTTI on fixed maturities and equity securities of $0.2 million and $4.3 million, respectively. Net realized gains in 2017 resulted primarily from a gain of $1.1 million recognized on the sale of a real estate holding reduced by impairments. The OTTI in 2016 was somewhat offset by realized investment gains on sales of fixed maturity securities in our available-for-sale portfolio and sales of equity securities. We also have realized losses in 2018 on equity securities adjustments to fair value with the adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities of $0.8 million.
The Company monitors death claims based upon expectations. These values may routinely fluctuate from year to year.
Policy surrenders increased 10.7% in 2018 and 10.4% in 2017, or 0.9% and 0.7% of direct ordinary whole life insurance in force for 2018 and 2017, respectively. The increase in surrender expense is primarily related to our international business. A significant portion of surrenders relates to policies that have been in force over fifteen years and no longer have a surrender charge associated with them. Total direct insurance in force reported in 2018 was $4.8 billion, which was consistent with 2017 and 2016.
Endowment benefits decreased 11.8% in 2018 compared to 2017 amounts. We have a series of international policies that carry an immediate endowment benefit of an amount selected by the policy owner. These benefits have been popular in the Pacific Rim and Latin America, where the Company has experienced increased interest in our guaranteed products. Annual guaranteed endowments are factored into the premium, and, as such, the increase or decrease is expected to have little impact on expected profitability.
Matured endowments increased 215.3% in the 2018 after decreasing in 2017. This increase has been anticipated based upon the date of when our policy endowment contracts were sold and the expected endowment maturities as set forth in the contracts.
Property claims decreased 5.5% to approximately $1.6 million in 2018 compared with the amount reported for 2017 due to a decrease in weather-related claims.
Other policy benefits resulted primarily from interest paid on premium deposits and policy benefit accumulations and increased as these policy liabilities also increased.
Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 36.9% in 2018 compared to 2017 and increased 0.2% in 2017 compared to 2016. The 2018 decrease was primarily due to changes in actuarial valuation estimates associated with the conversion to the new actuarial valuation system, AXIS, in 2018 that resulted in a decrease in reserves of $11.9 million when compared to 2017. The remaining changes in future policy benefit reserves are largely driven by policyholder activity (e.g. premiums, surrenders, etc). See Note 1 - "Summary of Accounting Policies" in the notes to our consolidated financial statements for a discussion of the conversion to our new actuarial system and the impact on our reserves.
Policyholder Dividends. The Company issues long duration participating policies in our Life segment to foreign residents that are expected to pay dividends to policyholders based upon actual experience. Initially, policyholder dividend scales are factored into the guaranteed premiums at the time the product is developed, based on expected future experience and desired profit goals. As actual and expected experience develops over time, it can become necessary to adjust dividends, as we did at the end of 2015 when our expense to policyholders was $10.7 million, in order to maintain long term product profitability. Policyholders' dividends have remained relatively consistent at $6.4 million, $6.3 million and $6.8 million in 2018, 2017, and 2016, respectively.
Commissions. Commission expense fluctuates in a direct relationship to new and renewal insurance premiums and has decreased 15.4% in 2018 compared to 2017 as first year premium revenues, on which higher commission rates are paid, declined in the Life segment and renewal premiums were also down 2.7%.
Other General Expenses. Total general expenses increased 2.7% on a consolidated basis in 2018 compared to 2017 due primarily to increased consulting and audit fees of $2.1 million related to the 2017 audit costs incurred in 2018, as well as higher employee salaries and bonuses of $2.3 million, including related employee benefits paid to top executives. We also noted an increase in rent of approximately $1.0 million in 2018 compared to 2017. General expenses increased 39.1% on a consolidated basis from 2016 to 2017 due primarily to the tax compliance liability estimate adjustment we first reported in 2014 and a write-off of $4.6 million of our Home Service goodwill in 2017.
We perform an expense study on an annual basis, utilizing an enterprise-wide time study, and we adjust cost allocations among entities as needed based upon this review. Any allocation changes are reflected in the segment operations, but do not impact total expenses.
Capitalization of Deferred Policy Acquisition Costs. Capitalized DAC were $22.7 million, $29.1 million and $32.7 million in 2018, 2017 and 2016. Decreases in capitalized amounts are in line with the decreases noted in sales activity. These costs will vary based upon successful efforts related to newly issued policies and renewal business. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business which has higher commission rates.
Amortization of Deferred Policy Acquisition Costs. Amortization of DAC totaled $34.2 million, $29.7 million and $28.5 million in 2018, 2017 and 2016, respectively, which primarily resulted from the AXIS actuarial system conversion impacting amortization by $3.7 million in 2018 and due to the higher surrender activity, including early duration elections to convert existing policies to reduced paid up ("RPU") or extended term insurance ("ETI") status in 2018 and 2017. There are higher deferred acquisition costs associated with early duration conversions to RPU or ETI, which, when converted, increases amortization expense. Amortization of deferred policy acquisition costs is impacted by persistency and the higher level of surrenders is impacting our amortization.
Amortization of Cost of Customer Relationships Acquired ("COIA"). Amortization of COIA increased in 2018 due to an update in our Home Service segment assumptions that resulted in a true up adjustment of approximately $663,000.
Federal Income Tax. Federal income tax expense was $13.1 million, $35.1 million and $3.5 million in 2018, 2017 and 2016, respectively, resulting in effective tax rates of 652.6%, (1,176.9)% and 64.1%, respectively. Subsequent to the novation, the insurance activity of CICA Ltd. is subject to Subpart F of the IRC and, therefore, is included in Citizens’s taxable income. The Subpart F income inclusion generated $18.4 million of federal income tax expense in 2018, which was largely driven by the impact of the novation transaction. The significant changes in effective tax rates noted in 2017 are the result of the New Tax Act enacted at the end of 2017 and the tax compliance issue we identified in 2014, which impacted our effective tax rates in each year as these costs are not deductible for tax purposes. Additionally, the Company recorded a tax expense in each year for an uncertain tax position that is affecting the tax rates. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes. Refer to Note 9 - "Income Taxes" in the notes to our consolidated financial statements for further discussion.
Our business is comprised of two operating business segments and Other Non-Insurance Operations as detailed below.
Our insurance operations are the primary focus of the Company, as those segments generate the most of our income. The amount of insurance, number of policies, and average face amounts of policies issued during the periods indicated are shown below.
Years Ended December 31,
The number of policies issued decreased 28.5% and 9.2% for the Life and Home Service segments in 2018 and 2017, respectively. We believe that the decline in new business applications in our Life segment was driven by several factors but primarily the political instability in Venezuela, uncertainty around the novation to Bermuda, ceasing sales in Brazil, and slower acceptance of the new product set that we repriced and submitted to the market beginning in 2017. While the number of policies issued declined during 2018, the average face amount issued increased, which results in overall premium income not declining at the same rate as policy issuances.
These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income before federal income taxes.
Our Life Insurance segment primarily issues ordinary whole life insurance and endowment policies in U.S. dollar-denominated amounts to foreign residents in more than 20 countries through approximately 1,110 independent marketing consultants, and domestically through over 50 independent marketing firms and consultants throughout the United States.
Years Ended December 31,
Net investment income
Realized investment gains (losses), net
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders
Increase in future policy benefit reserves
Total insurance benefits paid or provided
Other general expenses
Capitalization of deferred policy acquisition costs
Amortization of deferred policy acquisition costs
Amortization of cost of customer relationships acquired
Total benefits and expenses
Income before income tax expense
Premiums. Premium revenues decreased in 2018 compared to 2017 as first year premiums decreased 34.2% and 18.8% in 2018 and 2017, respectively. Our renewal premiums for 2018 were comparable to 2016 levels but down from 2017 by 2.7%.
Life Insurance premium breakout is detailed below.
Years Ended December 31,
The Company has taken actions over the past few years that may be negatively impacting our current sales levels. In 2016, the Company reduced discretionary dividends on existing international policies in response to the sustained low interest rate environment. This was the first time in the Company's history that it had adjusted this policy benefit. In 2017, the Company introduced a set of repriced products in response to the continued low interest rate environment in order to increase profits in our international markets. These measures resulted in more expensive policies for our customers and likely negatively impacted our new sales. In April 2018, in connection with our review of our international business model, we discontinued accepting new life
insurance applications from Brazilian citizens or residents. Brazil had been one of our top premium-producing countries in our international life insurance business for the past several years. In addition, Venezuela, which has historically been one of our top markets, has experienced prolonged economic and social turmoil, which has negatively impacted our sales in the country, decreasing approximately 10% from each of 2016 to 2017 and 2017 to 2018.
Endowment sales represent a significant portion of our new business sales internationally and totaled approximately $10.4 million, $13.3 million and $16.5 million, representing approximately 90.8%, 76.4% and 77.0% of total first year premiums in 2018, 2017, and 2016, respectively.
Most of our life insurance policies contain a policy loan provision, which allows the policyholder to use their accumulated cash value of a policy to pay premiums. These accumulated cash values can also be taken as a cash loan from the policy at the request of the policyholder and are secured by the policy values. The policy loan asset balance increased 9.6% year over year and remains at the same approximate ratio to life reserves as noted in prior years.
The following table sets forth, by country, our direct premiums from our international life insurance business for the periods indicated.
Years ended December 31,
(In thousands, except for %)
Sales from Colombia, Venezuela and Ecuador represented the majority of the new business premiums in 2018, 2017 and 2016. Overall our top five countries listed above reflected a decrease in premium levels from 2017 to 2018 with Venezuela leading the decline. Our international business is dependent on our clients having access to U.S. dollars. Our international business and premium collections could be impacted by our inability to comply with current or future foreign laws or regulations applicable to the Company or our independent consultants in the countries from which we accept applications as well as by marketing or operational changes made by the Company to comply with those laws or regulations. Our international business may also be affected by our ongoing strategic review of our business model and by economic or other events in foreign countries in which our
policies are marketed. Venezuela, for example, is continuing to experience civil unrest due to local demonstrations against crime, corruption and soaring inflation. See "Item 1A. Risk Factors" for additional information.
The following table sets forth our direct premiums by state from our domestic business for the periods indicated.
Years ended December 31,
(In thousands, except for %)
We discontinued new sales of our non-Home Service domestic products in 2017 while we reevaluate our domestic life strategy; therefore, the majority of the premium recorded in 2017 and all of the premium in 2018 are related to renewal business.
Net Investment Income. Net investment income has increased due to continued growth in average invested assets even though the annual yield has decreased sixteen basis points in this segment from 2017. We also noted that current securities sales, calls and maturities had an average coupon of 5.84% and new securities that we are currently purchasing have an average coupon of 3.66%. A portion of this decrease in yield is also related to repositioning our portfolio into more diversified holdings and maturities as part of our investment management strategy. See the Investment section below for more detailed information.
For the Years Ended December 31,
(In thousands, except for %)
Net investment income
Average invested assets, at amortized cost
Annualized yield on average invested assets
Realized Investment Losses, Net. In 2018, 2017 and 2016, this segment recognized losses on other-than-temporary impairments totaling $0.5 million, $13.5 thousand and $2.3 million, respectively, related to bond and mutual fund holdings.
Claims and Surrenders. A breakout of claims and surrender benefits is detailed below.
For the Years Ended December 31,
Accident and health benefits
Other policy benefits
Total claims and surrenders
Death claims expense increased 6.3% in 2018 compared to 2017 and decreased 6.0% in 2017 compared to 2016. No unusual trends have been noted in our claims experience. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
We noted increases in surrender expense over the last several years, which is primarily related to activity in Colombia and Venezuela and is expected to increase over time due to the aging of this block of business and the larger distribution of in force business in these two top countries, as well as the overall aging of the business in general. Most of policy surrender benefits paid is attributable to our international business and historically was related to policies that have been in force over fifteen years, when surrender charges are no longer applicable.
Endowment benefit expense results from the election by policyholders of a product feature that provides an annual benefit. This is a fixed benefit over the life of the contract, and this expense will increase with new sales and improved persistency.
Matured endowments increased 261.6% in 2018 after decreasing 19.5% in 2017. We expect this increasing trend to continue as this block of business increases, persists and policies begin to reach maturity.
Other policy benefits resulted primarily from interest paid on premium deposits and policy benefit accumulations that increased as these policy liabilities also increased.
Increase in Future Policy Benefit Reserves. Policy benefit reserves in 2018 decreased compared to the same period in 2017, primarily due to changes in actuarial valuation estimates associated with the conversion to the new actuarial valuation system, AXIS, in 2018 that resulted in a decrease in reserves of $11.9 million when compared to 2017.
Policyholder Dividends. Policyholders' dividends increased 1.4% and decreased 8.1%, respectively in 2018 and 2017, due to the dividend rate actions taken by us at the end of 2016 to improve our product profitability which lowered our expense 36.7% from $10.7 million in 2015 to $6.8 million, $6.2 million and $6.3 million for the years ended 2016, 2017 and 2018, respectively. The Company issues long duration participating policies to foreign residents that are expected to pay dividends to policyholders based upon actual experience. The life company boards approve any dividends on an annual basis and may change the dividend rates as needed for business purposes. Policyholder dividends are factored into the premiums at the time the product is developed and therefore have no impact on expected profitability.
Commissions. Commission expenses decreased 22.1% from 2017 to 2018 in line with the reduction in premiums. Commission expense increases or decreases are directly related to increases or decreases in premiums. First year policy premiums pay a higher commission rate than renewal policy premiums.
Other General Expenses. Expenses increased 0.7% to $18.7 million in 2018 compared to 2017 and 30.2% to $18.6 million in 2017 compared to 2016. The increase expense levels in both 2018 and 2017 were due primarily to increased consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. The expenses are allocated by segment, based upon an annual expense study performed by the Company.
Capitalization and Amortization of Deferred Policy Acquisition Costs. Capitalized costs fluctuate in direct relation to commissions. Capitalized costs decreased as commission-related costs decreased in 2018 compared to 2017 and 2016 based upon lower first year and renewal sales levels. Amortization of DAC increased in 2018 by 18.3% from 2017, which primarily resulted from the AXIS actuarial system conversion changes in estimates due to refinements impacting amortization by $3.7 million in 2018, and as we experienced increased surrender activity in 2018, including early duration elections to convert to reduced paid-up policies or extended term insurance as compared to 2017 and 2016. There are higher deferred acquisition costs associated with early duration conversions to reduced paid-up policies or extended term insurance, which, when converted, increases amortization expense.
Our Home Service Insurance segment provides pre-need and final expense ordinary life insurance and annuities to middle and lower income individuals primarily in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through funeral homes and a home service marketing distribution system utilizing over 650 employees and independent agents.
Years Ended December 31,
Net investment income
Realized investment gains (losses), net
Other income (loss)
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders
Increase in future policy benefit reserves
Total insurance benefits paid or provided
Other general expenses
Capitalization of deferred policy acquisition costs
Amortization of deferred policy acquisition costs
Amortization of cost of customer relationships acquired
Total benefits and expenses
Income (loss) before income tax expense
Premiums. The premiums in this segment remained relatively flat in 2018 compared to 2017 and 2016, as the Company did not experience real growth in new business. The slight decline in 2018 is related to our Mississippi business where we have mainly funeral home agents. We initiated training with the funeral agents to promote consistent processing and collection procedures which contributed to lower collections in 2018 compared to 2017.
The following table sets forth our direct premiums by state for the periods indicated.
Years ended December 31,
(In thousands, except for %)
Net Investment Income. Net investment income decreased in 2018 and 2017 as our average invested assets decreased due to our higher expenses over the past several years, as discussed below.
Net investment income yield for our Home Service Insurance segment is summarized as follows:
For the Years Ended December 31,
(In thousands, except for %)
Net investment income
Average invested assets, at amortized cost
Annualized yield on average invested assets
Realized Investment Gains (Losses), Net. This segment recognized losses on other-than-temporary impairments totaling $0.2 million in 2018 and 2017 and $2.0 million in 2016, related to bond and mutual fund holdings. A gain of $1.1 million was recognized on the sale of real estate property in 2017.
Claims and Surrenders. A breakout of claims and surrender benefits is detailed below.
For the Years Ended December 31,
Accident and health benefits
Other policy benefits
Total claims and surrenders
Death claims expense decreased 3.0% in 2018 compared to 2017 after remaining relatively flat in 2017 compared to 2016. Death claims can fluctuate from year to year. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
Surrender expenses are consistent with actuarial expectations and remained relatively consistent.
Property claims decreased in 2018 compared to 2017 due to higher reported weather claims experienced in 2017. Property claims decreased in 2017 compared to 2016, which was primarily due to tornado activity in Louisiana and high winds that accompanied the severe flooding in Louisiana during 2016.
Increase in Future Policy Benefit Reserves. The change in reserves decrease is related to the decrease in current year sales.
Commissions. Commission expense decreased in 2018, which was in line with the premium levels and was comparable for all three periods presented based upon fluctuations in premiums collected.
Other General Expenses. Expenses decreased 12.7% in 2018 and increased 53.4% in 2017 compared to prior periods. The increase in 2017 was related to the write-off of our Home Service goodwill value of $4.6 million. Expenses are higher for both 2018 and 2017 due primarily to increased consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. Expenses are allocated by segment based upon an annual expense study performed by the Company.
Capitalization and Amortization of Deferred Policy Acquisition Costs. DAC capitalization is directly correlated to fluctuations in first year commissions. Amortization of DAC was relatively flat from 2017 to 2018 (only decreasing by 1.7%) and increased by 7.5% from 2016 to 2017. The increase in 2016 was primarily due to an increase in surrenders, although both 2016 and 2017 increases reflect the impact of updates in our assumptions as well.
Amortization of Cost of Customer Relationships Acquired. Amortization of COIA increased in 2018 compared to 2017 due to an update in our assumptions that resulted in a true up adjustment of approximately $663,000.
Other Non-Insurance Operations
This operating unit represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under U.S. GAAP, which typically results in a segment loss. The 2018 increase in expenses is related to executive compensation, equity compensation costs and increased audit fees as discussed in the segment analysis.
The administration of our investment portfolios is handled by our management and, since May 2018, a third-party investment manager, pursuant to Board-approved investment guidelines, with all trading activity approved by each board of Citizens and its insurance subsidiaries. The guidelines used require that fixed maturities, both government and corporate, are investment grade and comprise a majority of the investment portfolio. State insurance statutes prescribe the quality and percentage of the various types of investments that may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, mortgage loans and real estate within certain specified percentages. The assets are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for our insurance company subsidiaries to meet their respective policyholder obligations.
The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets.
December 31, 2018
December 31, 2017
% of Total
% of Total
(In thousands, except for %)
Fixed maturity securities:
U.S. Treasury and U.S. Government-sponsored enterprises