##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 30, 2006
 or
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from  to
 Commission File Number: 1-13004
 CITIZENS, INC.
 (Exact name of registrant as specified in its charter)
 Colorado
    
    84-0755371(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)400 East Anderson Lane, Austin, Texas
    
    78752(Address of principal executive offices)
    
    (Zip Code)
  
   
   þ o
  o þ o
  o þ




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##### 



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 INDEX
 PageNumberPart I.
    
    Financial InformationItem 1.
    
    Financial StatementsConsolidated Statements of Financial Position,
September 30, 2006 (Unaudited) and December 31, 2005
    
    
    2Consolidated Statements of Operations, Three Months
Ended September 30, 2006 and 2005 (Unaudited)
    
    
    4Consolidated Statements of Operations, Nine Months
Ended September 30, 2006 and 2005 (Unaudited)
    
    
    5Consolidated Statements of Cash Flows, Nine Months
Ended September 30, 2006 and 2005 (Unaudited)
    
    
    6Notes to Consolidated Financial Statements
    
    
    8Item 2.
    
    Managements Discussion and Analysis
of Financial Condition and Results
of Operations
    
    
    18Item 3.
    
    Quantitative and Qualitative
Disclosures about Market Risk
    
    
    36Item 4.
    
    Controls and Procedures
    
    
    37Part II.
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    39Item 1. A
    
    Risk Factors
    
    
    40Item 2.
    
    Unregistered Sales of Equity Securities and Use of
Proceeds
    
    
    40Item 3.
    
    Defaults Upon Senior Securities
    
    
    40Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    40Item 5.
    
    Other Information
    
    
    40Item 6.
    
    Exhibits
    
    
    41Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
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##### Table of Contents



PART I
FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
 (Unaudited)September 30,
    
    
    December 31,2006
    
    
    2005AssetsInvestments:Fixed maturities held-to-maturity, at
amortized cost (fair value $6,282,000
in 2006 and $9,143,212 in 2005)
    
    $
    5,496,645
    
    
    
    7,639,505Fixed maturities available-for-sale, at
fair value (amortized cost $484,863,578
in 2006 and $457,386,343 in 2005)
    
    
    476,390,904
    
    
    
    449,931,167Equity securities, available-for-sale,
at fair value (cost $344,521 in 2006
and $429,176 in 2005)
    
    
    450,636
    
    
    
    609,760Mortgage loans on real estate (net of
allowance of $50,000 in 2006 and 2005)
    
    
    514,140
    
    
    
    833,464Policy loans
    
    
    24,160,448
    
    
    
    23,918,241Other long-term investments
    
    
    1,840,174
    
    
    
    1,878,886Total investments
    
    
    508,852,947
    
    
    
    484,811,023Cash and cash equivalents
    
    
    24,434,044
    
    
    
    18,311,105Accrued investment income
    
    
    6,134,993
    
    
    
    6,477,499Reinsurance recoverable
    
    
    15,653,893
    
    
    
    19,118,009Federal income tax recoverable
    
    
    402,718
    
    
    
    Deferred policy acquisition costs
    
    
    81,592,694
    
    
    
    70,410,334Other intangible assets
    
    
    1,695,125
    
    
    
    2,095,125Cost of customer relationships acquired
    
    
    37,178,033
    
    
    
    39,259,276Excess of cost over net assets acquired
    
    
    12,401,990
    
    
    
    12,401,990Property and equipment
    
    
    7,627,942
    
    
    
    7,736,623Other assets
    
    
    5,453,658
    
    
    
    1,267,827Total assets
    
    $
    701,428,037
    
    
    
    661,888,811
 See accompanying notes to consolidated financial statements.
    
    (Continued)
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION, CONTINUED
 (Unaudited)September 30,
    
    
    December 31,Liabilities and Stockholders Equity
    
    2006
    
    
    2005Liabilities:Future policy benefit reserves:Life insurance
    
    $
    463,856,363
    
    
    
    436,716,912Annuities
    
    
    20,615,121
    
    
    
    19,440,486Accident and health
    
    
    10,818,742
    
    
    
    11,579,870Dividend accumulations
    
    
    5,033,630
    
    
    
    5,066,828Premium deposits
    
    
    11,469,891
    
    
    
    9,942,096Policy claims payable
    
    
    8,079,643
    
    
    
    11,226,907Other policyholders funds
    
    
    5,664,531
    
    
    
    5,473,358Total policy liabilities
    
    
    525,537,921
    
    
    
    499,446,457Commissions payable
    
    
    2,318,029
    
    
    
    2,666,764Federal income tax payable
    
    
    
    
    
    
    447,829Deferred Federal income tax
    
    
    1,862,198
    
    
    
    1,620,839Payable for securities in the process of settlement
    
    
    6,936,097
    
    
    
    Warrants outstanding
    
    
    1,513,542
    
    
    
    1,587,151Other liabilities
    
    
    9,881,242
    
    
    
    7,611,138Total liabilities
    
    
    548,049,029
    
    
    
    513,380,178Cumulative convertible preferred stock
Series A-1 - $500 stated value per share, 25,000 shares authorized,
issued and outstanding in 2006 and 2005; Series A-2 - $935 stated
value per share, 5,000 shares authorized, 4,014 issued and outstanding
in 2006
    
    
    12,548,135
    
    
    
    11,545,543Stockholders Equity:Common stock:Class A, no par value, 100,000,000 shares
authorized, 43,400,186 shares issued
in 2006 and 43,300,934 shares issued
in 2005, including shares in treasury of
3,135,738 in 2006 and 2,930,596 in 2005
    
    
    214,827,268
    
    
    
    214,307,665Class B, no par value, 2,000,000 shares
authorized, 1,001,714 shares issued and outstanding in
2006 and 936,181 shares issued and outstanding in 2005
    
    
    3,184,350
    
    
    
    3,184,350Retained deficit
    
    
    (60,648,210
    )
    
    
    (64,717,088
    )Accumulated other comprehensive loss:Unrealized losses on securities, net of tax
    
    
    (5,521,929
    )
    
    
    (4,801,231
    )151,841,477
    
    
    
    147,973,696Treasury stock, at cost
    
    
    (11,010,606
    )
    
    
    (11,010,606
    )Total stockholders equity
    
    
    140,830,872
    
    
    
    136,963,090Total liabilities and stockholders equity
    
    $
    701,428,037
    
    
    
    661,888,811
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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended September 30, 2006 and 2005
 (Unaudited)
 2006
    
    
    2005Revenues:Premiums
    
    $
    31,525,397
    
    
    
    29,422,007Net investment income
    
    
    7,039,926
    
    
    
    6,155,959Realized gains (losses)
    
    
    (139,756
    )
    
    
    61,642Increase in fair value of options and warrants
    
    
    (291,348
    )
    
    
    (129,187
    )Other income
    
    
    350,840
    
    
    
    336,075Total revenues
    
    
    38,485,059
    
    
    
    35,846,496Benefits and expenses:Insurance benefits paid or provided:Claims and surrenders
    
    
    13,336,093
    
    
    
    12,119,097Increase in future policy benefit reserves
    
    
    7,444,137
    
    
    
    6,684,117Policyholders dividends
    
    
    1,493,184
    
    
    
    1,317,811Total insurance benefits paid or provided
    
    
    22,273,414
    
    
    
    20,121,025Commissions
    
    
    8,189,946
    
    
    
    8,269,384Other underwriting, acquisition and insurance expenses
    
    
    6,090,168
    
    
    
    5,903,568Capitalization of deferred policy acquisition costs
    
    
    (6,112,745
    )
    
    
    (6,180,211
    )Amortization of deferred policy acquisition costs
    
    
    3,239,901
    
    
    
    2,772,603Amortization of cost of customer relationships acquired
and other intangible assets
    
    
    841,644
    
    
    
    2,714,252Total benefits and expenses
    
    
    34,522,328
    
    
    
    33,600,621Income before Federal income tax
    
    
    3,962,731
    
    
    
    2,245,875Federal income tax expense
    
    
    1,374,506
    
    
    
    759,000Net income
    
    $
    2,588,225
    
    
    
    1,486,875Net income applicable to common stockholders
    
    $
    2,079,724
    
    
    
    999,762Per Share Amounts:Basic income per share of common stock
    
    $
    0.05
    
    
    
    0.02Diluted income per share of common stock
    
    $
    0.05
    
    
    
    0.02Weighted average shares outstanding  basic
    
    
    41,236,144
    
    
    
    41,104,264Weighted average shares outstanding  diluted
    
    
    44,237,801
    
    
    
    41,104,264
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Nine Months Ended September 30, 2006 and 2005
 (Unaudited)
 2006
    
    
    2005Revenues:Premiums
    
    $
    92,440,027
    
    
    
    84,851,258Net investment income
    
    
    20,034,063
    
    
    
    17,635,157Realized gains
    
    
    1,173,542
    
    
    
    677,317Decrease (increase) in fair value of options and warrants
    
    
    73,609
    
    
    
    (186,399
    )Other income
    
    
    1,067,971
    
    
    
    717,875Total revenues
    
    
    114,789,212
    
    
    
    103,695,208Benefits and expenses:Insurance benefits paid or provided:Claims and surrenders
    
    
    41,313,779
    
    
    
    37,282,328Increase in future policy benefit reserves
    
    
    21,953,156
    
    
    
    18,155,375Policyholders dividends
    
    
    3,821,723
    
    
    
    3,394,911Total insurance benefits paid or provided
    
    
    67,088,658
    
    
    
    58,832,614Commissions
    
    
    25,820,569
    
    
    
    23,759,477Other underwriting, acquisition and insurance expenses
    
    
    21,393,947
    
    
    
    19,349,462Capitalization of deferred policy acquisition costs
    
    
    (19,126,248
    )
    
    
    (17,176,193
    )Amortization of deferred policy acquisition costs
    
    
    8,913,888
    
    
    
    7,396,979Amortization of cost of customer relationships acquired
and other intangibles
    
    
    2,481,243
    
    
    
    5,210,183Total benefits and expenses
    
    
    106,572,057
    
    
    
    97,372,522Income before Federal income tax
    
    
    8,217,155
    
    
    
    6,322,686Federal income tax expense
    
    
    2,626,083
    
    
    
    2,114,000Net income
    
    $
    5,591,072
    
    
    
    4,208,686Net income applicable to common stockholders
    
    $
    4,068,878
    
    
    
    2,730,469Per Share Amounts:Basic income per share of common stock
    
    $
    0.10
    
    
    
    0.07Diluted income per share of common stock
    
    $
    0.09
    
    
    
    0.07Weighted average shares outstanding  basic
    
    
    41,201,962
    
    
    
    41,080,370Weighted average shares outstanding  diluted
    
    
    43,203,066
    
    
    
    41,080,370
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months Ended September 30, 2006 and 2005
 (Unaudited)
 2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    5,591,072
    
    
    
    4,208,686Adjustments to reconcile net income to net cash
provided by operating activities:Realized gains on sale of
investments and other assets
    
    
    (1,173,542
    )
    
    
    (677,317
    )Net deferred policy acquisition costs
    
    
    (10,212,360
    )
    
    
    (9,779,214
    )Increase (decrease) on fair value of
options and warrants
    
    
    (73,609
    )
    
    
    186,399Amortization of cost of customer
relationships acquired and other
intangibles
    
    
    2,481,243
    
    
    
    5,210,183Amortization of net premiums on
fixed maturities
    
    
    1,047,939
    
    
    
    1,122,725Depreciation
    
    
    957,393
    
    
    
    758,767Deferred Federal income tax expense
    
    
    612,631
    
    
    
    1,777,042Change in:Accrued investment income
    
    
    342,506
    
    
    
    1,024,461Reinsurance recoverable
    
    
    3,464,116
    
    
    
    (5,689,625
    )Future policy benefit reserves
    
    
    25,715,156
    
    
    
    18,159,445Other policy liabilities
    
    
    (1,461,495
    )
    
    
    7,449,466Federal income tax
    
    
    (850,547
    )
    
    
    (2,113,032
    )Commissions payable and other
liabilities
    
    
    3,341,503
    
    
    
    (2,512,748
    )Change in other receivables
    
    
    (4,185,831
    )
    
    
    1,115,554Other, net
    
    
    (1,358,650
    )
    
    
    (783,282
    )Net cash provided by operating
activities
    
    
    24,237,525
    
    
    
    19,457,510Cash flows from investing activities:Sale of fixed maturities, available-for-sale
    
    
    16,378,125
    
    
    
    14,762,475Sale of equity securities, available-for-sale
    
    
    176,756
    
    
    
    Maturity of fixed maturities, available-for-sale
    
    
    24,506,210
    
    
    
    85,187,799Purchase of fixed maturities, available-for-sale
    
    
    (59,159,113
    )
    
    
    (99,794,782
    )Principal payments on mortgage loans
    
    
    92,738
    
    
    
    38,561Sale of other long-term investments and property
and equipment
    
    
    90,176
    
    
    
    989,898Decrease (increase) in policy loans
    
    
    (242,207
    )
    
    
    231,700Principal payments on notes receivable
    
    
    474,884
    
    
    
    Purchase of other long-term investments and
property and equipment
    
    
    (849,825
    )
    
    
    (242,917
    )Net cash provided by (used in)
investing activities
    
    
    (18,532,256
    )
    
    
    1,172,734
 See accompanying notes to consolidated financial statements.
    
    (Continued)
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Nine Months Ended September 30, 2006 and 2005
 (Unaudited)
 2006
    
    
    2005Cash flows from financing activities:Annuity and universal life deposits
    
    
    1,837,802
    
    
    
    2,135,975Annuity and universal life withdrawals
    
    
    (1,420,132
    )
    
    
    (1,108,543
    )Payoff of notes payable
    
    
    
    
    
    
    (30,000,000
    )Payment of convertible preferred stock
issuance cost
    
    
    
    
    
    
    (87,533
    )Proceeds from issuance of convertible
preferred stock
    
    
    
    
    
    
    2,500,936Net cash provided by (used in)
financing activities
    
    
    417,670
    
    
    
    (26,559,165
    )Net increase (decrease) in cash and cash
equivalents
    
    
    6,122,939
    
    
    
    (5,928,921
    )Cash and cash equivalents at beginning of period
    
    
    18,311,105
    
    
    
    31,720,787Cash and cash equivalents at end of period
    
    $
    24,434,044
    
    
    
    25,791,866Supplemental Disclosure of Operating Activities:Cash paid during the period for income taxes
    
    $
    2,864,001
    
    
    
    2,449,990Cash paid during the period for interest
    
    $
    
    
    
    
    695,408
 Supplemental Disclosure of Non-Cash Investing and Financing Activities:
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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 September 30, 2006
 (Unaudited)
 (1)
    
    Financial StatementsThe interim consolidated financial statements include the accounts and operations of
Citizens, Inc. (Citizens), incorporated in the state of Colorado on November 8, 1977, and
its wholly-owned subsidiaries, CICA LIFE Insurance Company of America (CICA) (fka
Citizens Insurance Company of America), Computing Technology, Inc., Funeral Homes of
America, Inc., Insurance Investors, Inc., Citizens National Life Insurance Company
(CNLIC), KYWIDE Insurance Management, Inc., Security Alliance Insurance Company, Security
Plan Life Insurance Company (Security Plan or SPLIC), Security Plan Fire Insurance
Company (SPFIC), and Mid-American Associates Agency, Inc. (MAAAI). Citizens and its
consolidated subsidiaries are collectively referred to as the Company, we, or our.On March 15, 2006, MAAAI was dissolved. In addition, Citizens USA Life Insurance Company
was merged into CICA effective March 31, 2006.The consolidated statement of financial position for September 30, 2006, the consolidated
statements of operations for the three-month and nine-month periods ended September 30,
2006 and 2005, and the consolidated statements of cash flows for the nine-month periods
then ended have been prepared by the Company without audit. In the opinion of
management, all adjustments and reclassifications to present fairly the financial
position, results of operations and changes in cash flows at September 30, 2006, and for
comparative periods presented have been made.Certain 2005 amounts have been reclassified to conform to current year presentation.
Specifically, $2,135,975 of annuity and universal life considerations, net of $1,108,543
of annuity and universal life payments, have been netted against an equal amount included
in insurance benefits paid or provided. Also, $283,517 of expense included in the
increase in future policy benefit reserves has been reclassified to premium revenue. In
addition, effective with the three-month period ended March 31, 2006, the Company began
accruing premium revenue based on the gross amount due from policyholders, rather than
just a portion of that amount. As a result, premium revenue for the first quarter of
2006 was increased $954,951. When considered together with other corrections recorded in
the first quarter of 2006, which were individually immaterial, the net effect is also not
material.During the second quarter of 2006, assumptions were revised for SPLIC 2006 policy issues.
Specifically, commissions capitalized as deferred acquisition costs were increased,
effective January 1, by $466,817 to reflect the higher commission SPLIC is paying for new
business.The Company wrote off $400,000 of other intangible assets in the first quarter of 2006,
as the subsidiaries to which the intangibles relate no longer exist.
This impairment occurred during 2005.
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The Securities and Exchange Commission (SEC) has recently issued guidance, Staff
Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements,(SAB 108), on the
process of quantifying and reporting financial statement misstatements. Through its SAB
No. 99, Materiality,and SAB 108 analysis, the Company has determined it will record an
adjustment to the January 1, 2006, beginning balance sheet during the fourth quarter of
2006. The Company anticipates that assets will be decreased by approximately $1.6
million (primarily non-invested assets and policy loans) and liabilities (primarily other
liabilities) will be increased by approximately $1.9 million, and beginning retained
deficit will be increased approximately $3.5 million. These
amounts are exclusive of approximately $700,000 of other pre-tax
prior year misstatements, which have already been corrected in the
2006 financial statements. The primary components of this $700,000
are disclosed above. The Company is currently evaluating whether such
corrections can be moved and added into the January 1, 2006
beginning balance sheet adjustment that will be made as part of its
adoption of SAB 108.Certain information and footnote disclosures normally included in financial statements
prepared in accordance with United States of America (U.S.) generally accepted accounting
principles (U.S. GAAP) have been omitted. It is suggested that these financial
statements be read in conjunction with the financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended December 31,
2005, filed with the SEC. The results of operations for the period ended September 30,
2006, are not necessarily indicative of the operating results for the full year.(2)
    
    Sale of CNLICA formal contract was signed with a third party in the first quarter of 2006 to sell our
primary accident and health insurance subsidiary, CNLIC, but was subject to regulatory
approval before closing. CNLIC represents approximately 60% of our accident and health
business. The remaining 40% of the accident and health business will continue to be
ceded under an existing coinsurance agreement with the acquirer of CNLIC. During the
third quarter of 2006, the buyer was advised that such regulatory approval would not be
granted at that time due to operating losses experienced by the buyer; however,
reconsideration would be given once profitability was restored. The Company has agreed
to extend the purchase agreement so that the buyer can rectify its deficiency. Closing
is now expected in 2007.(3)
    
    Revolving Line of CreditThe Company has entered into a $75 million line of credit with Regions Bank that
terminates in November 2006. The line of credit provides for a maximum of $5,000,000 for
general corporate purposes not related to the acquisition of insurance companies.
Although the line of credit was increased from an original level of $30 million,
additional borrowing above the $30 million amount will require the prior written approval
of the holders of the Companys preferred stock. No amount was outstanding on this line
at September 30, 2006.
 9




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##### Table of Contents



(4)
    
    Segment InformationThe Company has four reportable segments: International Life Business, Home Service
Business, Domestic Life Business and Domestic Health Business. The accounting policies
of the segments are in accordance with U.S. GAAP and are the same as those described in
the summary of significant accounting policies in the Companys Annual Report on Form
10-K for the year ended December 31, 2005. The Company evaluates profit and loss
performance based on U.S. GAAP net income before federal income taxes for its four
reportable segments.International Life Business, consisting of ordinary whole-life policies, is sold
primarily throughout Central and South America and Taiwan. The Company has no assets,
offices or employees outside of the U.S. and requires that all transactions be in U.S.
Dollars paid in the U.S.The Companys Home Service business segment focuses on writing final expense ordinary
life insurance utilizing the home service marketing distribution method, whereby
approximately 350 employee-agents work on a route system to collect premiums and service
policyholders. The Company also uses the home service method to write small casualty
policies on Louisiana residents.The Domestic Life Business, consisting of traditional ordinary life, credit life and
final expense policies, is marketed in the Midwest and southern U.S. A majority of
revenue in this segment is also comprised of blocks of business acquired in acquisitions.
At June 30, 2006, the Company assumed a 50% share of a block of domestic policies with a
face value of $22 million from an unaffiliated insurer.Prior to 2004, the Company actively operated the fourth segment, Domestic Health. The
Company transferred a majority of this business to a third party in 2004 under a
coinsurance agreement effective January 1, 2004. The Company continues to have an
insignificant amount of revenue in this segment.Geographic Areas- The following summary represents quarterly financial data of the
Companys continuing operations based on their location:
 Three Months Ended September 30,2006
    
    
    2005Revenues:U.S.
    
    $
    14,805,564
    
    
    
    15,287,873Non-U.S
    
    
    23,679,495
    
    
    
    20,558,623Total revenues
    
    $
    38,485,059
    
    
    
    35,846,496
  10




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##### Table of Contents



Three Months Ended September 30,2006
    
    
    2005Profit (Loss) MeasurementIncome (loss) before Federal income tax:International Life
    
    $
    1,865,627
    
    
    
    1,743,227Home Service Business
    
    
    1,317,309
    
    
    
    113,089Domestic Life
    
    
    764,415
    
    
    
    431,839Domestic Health
    
    
    15,380
    
    
    
    (42,280
    )Total consolidated income before
Federal income tax
    
    $
    3,962,731
    
    
    
    2,245,875Selected Components of Profit MeasurementRevenue:International Life
    
    $
    23,679,494
    
    
    
    20,558,623Home Service Business
    
    
    12,722,185
    
    
    
    12,207,922Domestic Life
    
    
    1,898,642
    
    
    
    2,880,644Domestic Health
    
    
    184,738
    
    
    
    199,307Total consolidated revenue
    
    $
    38,485,059
    
    
    
    35,846,496Premiums:International Life
    
    $
    20,236,363
    
    
    
    18,202,616Home Service Business
    
    
    9,501,202
    
    
    
    9,135,330Domestic Life
    
    
    1,603,094
    
    
    
    1,884,754Domestic Health
    
    
    184,738
    
    
    
    199,307Total consolidated premiums
    
    $
    31,525,397
    
    
    
    29,422,007Net investment income:International Life
    
    $
    3,504,888
    
    
    
    2,622,293Home Service Business
    
    
    3,218,835
    
    
    
    3,078,736Domestic Life
    
    
    316,203
    
    
    
    454,930Domestic Health
    
    
    
    
    
    
    Total consolidated net investment income
    
    $
    7,039,926
    
    
    
    6,155,959Amortization expense:International Life
    
    $
    2,677,094
    
    
    
    2,220,268Home Service Business
    
    
    1,096,198
    
    
    
    2,507,056Domestic Life
    
    
    308,253
    
    
    
    759,531Domestic Health
    
    
    
    
    
    
    Total consolidated amortization expense
    
    $
    4,081,545
    
    
    
    5,486,855Realized gains (losses) on sale of
investments and other assets:International Life
    
    $
    (124,779
    )
    
    
    56,311Home Service Business
    
    
    1,374
    
    
    
    (4,153
    )Domestic Life
    
    
    (16,351
    )
    
    
    9,484Domestic Health
    
    
    
    
    
    
    -- Total consolidated realized gains
(losses) on sale of investments and
other assets
    
    $
    (139,756
    )
    
    
    61,642
 11




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##### Table of Contents



Three Months Ended September 30,2006
    
    
    2005Ordinary Life
    
    $
    30,102,996
    
    
    
    28,147,494Group Life
    
    
    148,814
    
    
    
    166,062Accident and Health
    
    
    348,258
    
    
    
    353,623Casualty
    
    
    925,329
    
    
    
    754,828Total premiums
    
    $
    31,525,397
    
    
    
    29,422,007
 Geographic Areas
 Nine Months Ended September 30,2006
    
    
    2005Revenues:U.S.
    
    $
    46,506,071
    
    
    
    45,897,879Non-U.S
    
    
    68,283,141
    
    
    
    57,797,329Total Revenues
    
    $
    114,789,212
    
    
    
    103,695,208
  Nine Months Ended September 30,2006
    
    
    2005Profit (Loss) MeasurementIncome (loss) before Federal income tax:International Life
    
    $
    6,799,313
    
    
    
    4,585,191Home Service Business
    
    
    2,207,865
    
    
    
    2,149,490Domestic Life
    
    
    (798,924
    )
    
    
    (511,563
    )Domestic Health
    
    
    8,901
    
    
    
    99,568Total consolidated income before Federal
income tax
    
    $
    8,217,155
    
    
    
    6,322,686Selected Components of Profit MeasurementRevenues:International Life
    
    $
    68,283,141
    
    
    
    57,797,329Home Service Business
    
    
    38,625,407
    
    
    
    37,803,528Domestic Life
    
    
    7,323,261
    
    
    
    7,443,850Domestic Health
    
    
    557,403
    
    
    
    650,501Total consolidated revenues
    
    $
    114,789,212
    
    
    
    103,695,208Premiums:International Life
    
    $
    57,498,628
    
    
    
    49,850,072Home Service Business
    
    
    28,532,140
    
    
    
    28,830,449Domestic Life
    
    
    5,851,856
    
    
    
    5,520,236Domestic Health
    
    
    557,403
    
    
    
    650,501Total consolidated premiums
    
    $
    92,440,027
    
    
    
    84,851,258
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##### Table of Contents



Nine Months Ended September 30,2006
    
    
    2005Net investment income:International Life
    
    $
    9,829,882
    
    
    
    7,473,702Home Service Business
    
    
    9,108,463
    
    
    
    8,852,271Domestic Life
    
    
    1,095,718
    
    
    
    1,309,184Domestic Health
    
    
    
    
    
    
    Total consolidated net investment income
    
    $
    20,034,063
    
    
    
    17,635,157Amortization expense:International Life
    
    $
    7,993,090
    
    
    
    6,142,067Home Service Business
    
    
    2,118,738
    
    
    
    4,234,103Domestic Life
    
    
    1,283,303
    
    
    
    2,230,992Domestic Health
    
    
    
    
    
    
    Total consolidated amortization expense
    
    $
    11,395,131
    
    
    
    12,607,162Realized gains (losses) on sale of
investments and other assets:International Life
    
    $
    (70,535
    )
    
    
    473,555Home Service Business
    
    
    982,663
    
    
    
    120,808Domestic Life
    
    
    261,414
    
    
    
    82,954Domestic Health
    
    
    
    
    
    
    -- Total consolidated realized gains on sale of
investments and other assets
    
    $
    1,173,542
    
    
    
    677,317
  Nine Months Ended September 30,2006
    
    
    2005Ordinary Life
    
    $
    88,237,050
    
    
    
    80,332,431Group Life
    
    
    432,546
    
    
    
    484,242Accident and Health
    
    
    1,080,516
    
    
    
    1,135,562Casualty
    
    
    2,689,915
    
    
    
    2,899,023Total premiums
    
    $
    92,440,027
    
    
    
    84,851,258
  September 30,
    
    
    December 31,2006
    
    
    2005Assets:International Life
    
    $
    262,263,214
    
    
    
    233,529,849Home Service Business
    
    
    304,660,693
    
    
    
    300,946,232Domestic Life
    
    
    123,174,684
    
    
    
    115,320,962Domestic Health
    
    
    11,329,446
    
    
    
    12,091,768Total
    
    $
    701,428,037
    
    
    
    661,888,811
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##### Table of Contents



(5)
    
    Total Comprehensive Income and (Loss)
 Three Months Ended September 30,2006
    
    
    2005Net income
    
    $
    2,588,225
    
    
    
    1,486,875Other comprehensive income (loss) net of
tax:Unrealized net gains (losses) on
investments in fixed maturities available
for sale and equity securities
    
    
    9,822,332
    
    
    
    (5,352,757
    )Total comprehensive income (loss)
    
    $
    12,410,557
    
    
    
    (3,865,882
    )
 Nine Months Ended September 30,2006
    
    
    2005Net income
    
    $
    5,591,072
    
    
    
    4,208,686Other comprehensive loss net of
tax:Unrealized net losses on
investments in fixed maturities
available for sale and equity
securities
    
    
    (720,698
    )
    
    
    (1,243,194
    )Total comprehensive income
    
    $
    4,870,374
    
    
    
    2,965,492
 (6)
    
    Earnings Per ShareBasic and diluted earnings per share have been computed using the weighted average
number of shares of Class A and Class B common stock outstanding during each period.
The basic weighted average shares outstanding for the three and nine months ended
September 30, 2006, were 41,236,144 and 41,201,962, respectively. The diluted weighted
average shares outstanding for the three and nine months outstanding ended September 30,
2006 were 44,237,801 and 43,203,066, respectively. The weighted average shares
outstanding for both the three and nine months ended September 30, 2005, were 41,104,264
and 41,080,370, respectively. The per share amounts have been adjusted retroactively
for all periods presented to reflect the change in capital structure resulting from a 7%
stock dividend paid in 2005. The 2005 stock dividend resulted in the issuance of
2,840,821 Class A common shares (including 205,142 shares in treasury) and 65,533 Class
B common shares.
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##### Table of Contents



The following table sets forth the computation of basic and dilutive earnings per share:
 Three Months Ended September 30,2006
    
    
    2005Basic and diluted income per share:Numerator:Net income
    
    $
    2,588,225
    
    
    
    1,486,875Less: Preferred stock dividend
    
    
    (174,405
    )
    
    
    (130,506
    )Accretion of deferred issuance
costs and discounts on preferred
stock
    
    
    (334,096
    )
    
    
    (356,607
    )Net income to common stockholders
    
    $
    2,079,724
    
    
    
    999,762Basic income per share
    
    $
    0.05
    
    
    
    0.02Diluted income per share
    
    $
    0.05
    
    
    
    0.02Denominator:Weighted average shares outstanding  basic
    
    
    41,236,144
    
    
    
    41,104,264Weighted average shares outstanding  diluted
    
    
    44,237,801
    
    
    
    41,104,264
 Nine Months Ended September 30,2006
    
    
    2005Basic and diluted income per share:Numerator:Net income
    
    $
    5,591,072
    
    
    
    4,208,686Less: Preferred stock dividend
    
    
    (519,603
    )
    
    
    (393,809
    )Accretion of deferred issuance
costs and discounts on preferred
stock
    
    
    (1,002,591
    )
    
    
    (1,084,408
    )Net income to common stockholders
    
    $
    4,068,878
    
    
    
    2,730,469Basic income per share
    
    $
    0.10
    
    
    
    0.07Diluted income per share
    
    $
    0.09
    
    
    
    0.07Denominator:Weighted average shares outstanding  basic
    
    
    41,201,962
    
    
    
    41,080,370Weighted average shares outstanding  diluted
    
    
    43,203,066
    
    
    
    41,080,370
 The effects of Series A Convertible Preferred Stock are dilutive because the holders of
the Companys Series A Preferred Stock have redemption rights. The warrants are
antidilutive because the exercise price is in excess of the average Class A common stock
market price for the three and nine months ended September 30, 2006.(5)
    
    New Accounting PronouncementsIn May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154,
Accounting Changes and Error Corrections, and FASB Statement No. 3 (SFAS 154). The
statement requires retrospective application to prior period financial statements for a
voluntary change in accounting principle unless it is deemed impracticable. It also
requires that a change in the method of depreciation, amortization, or depletion for
long-lived, non-financial assets be accounted for as a
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##### Table of Contents



change in accounting estimate
rather than a change in accounting principle. SFAS 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December 15,
2005. SFAS 154 did not have any material impact on the Companys consolidated financial
statements.In September 2005, the American Institute of Certified Public Accountants (AICPA) issued
Statement of Position (SOP) 05-1, Accounting by Insurance Enterprises for Deferred
Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts
(SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for
deferred acquisition costs on internal replacements of insurance and investment
contracts other than those specifically described in Statement of Financial Accounting
Standard (SFAS) No. 97, Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and For Realized Gains and Losses from the Sale of Investments.
SOP 05-1 defines an internal replacement as a modification in product benefits,
features, rights, or coverages that occurs by the exchange of a contract for a new
contract, or by amendment, endorsement, or rider to a contract, or by the election of a
feature or coverage within a contract. Under SOP 05-1, modifications that result in a
substantially unchanged contract will be accounted for as a continuation of the replaced
contract. A replacement contract that is substantially changed will be accounted for as
an extinguishment of the replaced contract resulting in a release of unamortized
deferred acquisition costs and unearned inducements associated with the replaced
contract. The guidance in SOP 05-1 will be applied prospectively and is effective for
internal replacements occurring in fiscal years beginning after December 15, 2006. The
Company is currently evaluating the impact of SOP 05-1 and does not expect that the
pronouncement will have a material impact on the Companys consolidated financial
statements.In June 2006, the FASB issued FASB Interpretation 48 (FIN 48), Accounting for
Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprises financial statements in accordance with SFAS 109,
Accounting for Income Taxes. This Interpretation defines the minimum recognition
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The
Company is currently evaluating the effect that the adoption of FIN 48 will have on its
financial position and results of operations.In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement
defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and requires additional disclosures about fair value
measurements. This Statement does not require any new fair value measurements, but the
application of this Statement could change current practices in determining fair value.
The Company plans to adopt this guidance effective January 1, 2008. The Company is
currently assessing the impact of SFAS No. 157 on the Companys consolidated financial
position and results of operations.In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB
No. 108 addresses quantifying the financial statement effects of misstatements,
specifically, how the effects of prior year uncorrected errors must be
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##### Table of Contents



considered in
quantifying misstatements in the current year financial statements. SAB No. 108 does
not change the SEC staffs previous positions in SAB No. 99, Materiality, regarding
qualitative consideration in assessing the materiality of misstatements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. SAB No. 108 offers special
transition provisions only for circumstances where
its application would have altered previous materiality conclusions. In those
circumstances, the SEC staff will not object if a registrant does not restate its prior
period financial statements. Instead, such a registrant may reflect the cumulative
effect of applying SAB No. 108 as an adjustment to retained earnings as of the beginning
of the first fiscal year ending after November 15, 2006, with disclosure of the nature
and amount of each individual error being corrected in the cumulative adjustment,
including when and how each error being corrected arose. The Company anticipates
adopting SAB No. 108 in the fourth quarter of 2006, recording a cumulative opening
January 1, 2006 adjustment to increase its retained deficit by approximately $3.5
million, decrease assets by approximately $1.6 million and increase liabilities by
approximately $1.9 million.(6)
    
    Legal ProceedingsCause Number 03-0505; Citizens Insurance Company of America, Citizens, Inc., Harold E.
Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in the
Supreme Court of Texas.This lawsuit has been certified as a class action by the Texas District Court, Austin,
Texas, and affirmed by the Court of Appeals for the Third District of Texas, relating to
the original action filed in 1999. The Company appealed the grant of class status to
the Texas Supreme Court, with oral arguments occurring on October 21, 2004. The Company
has not yet received a decision from the Texas Supreme Court.The suit names as a class all non-U.S. residents who purchased insurance policies or
made premium payments since August 1996 and assigned policy dividends to two non-U.S.
trusts for the purchase of the Companys class A common stock. It alleges that the life
insurance policies the Company made available to these non-U.S. residents, when combined
with a policy feature which allows policy dividends to be assigned to the trusts for the
purpose of accumulating ownership of the Companys Class A common stock, along with
allowing the policyholders to make additional contributions to the trusts, were actually
offers and sales of securities that occurred in Texas by unregistered dealers in
violation of Texas securities laws. The remedy sought is rescission and return of the
insurance premium payments.The Company asserts that, among other things, U.S. law, including Texas law, does not
apply to the operations of the trusts, and therefore, no securities registration
provisions apply, nor do laws relating to broker-dealer registration apply. Further, it
is the Companys position that the Plaintiffs securities claims, based on Texas
securities laws, are not valid, that no broker registration is required by the Company
or its marketing consultants, and the class as defined is not appropriate for class
certification because it does not meet the legal requirements for class treatment under
Texas law. To date, no hearing on the merits of the case have been scheduled.
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##### Table of Contents



The Company intends to vigorously defend against the class certification, as well as
against the other securities related claims in this case. However, it is unable to
determine the potential financial magnitude of the claims in the event of a final class
certification and the plaintiffs prevailing on the substantive action, although the
Company would expect a significant adverse financial impact from an adverse class action
judgment.The Company is also a party to various legal proceedings incidental to its
business. The Company has been named as a defendant in various legal actions, including
one class action lawsuit filed in Louisiana federal district court, seeking payments for
claims denied by the Company and other declaratory relief relevant to Hurricanes Katrina
and Rita. The Company asserts, among other things, that the SPFIC policies flood
exclusion language should apply. The Company intends to vigorously defend the
applicable flood exclusion language and defend against the class certification. In the
opinion of management, the ultimate liability, if any, resulting from any contingent
liabilities that might arise from this litigation is not considered material in relation
to the financial position or results of operations of the Company. Reserves for claims
payable are based on the expected claim amount to be paid after a case-by-case review of
the facts and circumstances relating to each claim. A contingency exists with regard to
these reserves until the claims are adjudicated and paid.
 
 ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 FORWARD-LOOKING STATEMENTS
 Certain statements contained in this report are not statements of historical fact and constitute
forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the
Act), including, without limitation, the italicized statements and the 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
or with the approval of the Company which are not statements of historical fact constitute
forward-looking statements within the meaning of the Act. Examples of forward-looking statements,
include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per
share, the payment or non-payment of dividends, capital structure, and other financial items, (ii)
statements of our plans and objectives or 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,
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 involve risks and uncertainties, which may cause actual results to
differ materially from those in such statements. Factors that could cause actual results to differ
from those discussed in the forward-looking statements include, but are not limited to: (i) the
strength of foreign and U.S. economies in general and the strength of the local economies where our
policyholders reside; (ii) the effects of and changes in trade, monetary and fiscal policies
 18




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##### Table of Contents



and
laws; (iii) inflation, interest rates, stock market and monetary fluctuations and volatility;
(iv) the timely development of and acceptance of new insurance products and services and perceived
overall value of these products and services by existing and potential customers; (v)
changes in consumer spending, borrowing and saving habits; (vi) a concentration of our insurance
business from persons residing in Latin and South America and the Pacific Rim; (vii) uncertainties
in assimilating acquisitions; (viii) the persistency of existing and future insurance policies
sold by the Company and its subsidiaries; (ix) the dependence of the Company on its Chairman of
the Board; (x) the ability to control expenses; (xi) the effect of changes in laws and
regulations (including laws and regulations concerning insurance) with which the Company and its
subsidiaries must comply, (xii) the effect of changes in accounting policies and practices, as may
be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xiii)
changes in the Companys organization and compensation plans; (xiv) the costs and effects of
litigation and of unexpected or adverse outcomes in such litigation; and (xv) the success of the
Company at managing the risks involved in the foregoing.
 Our forward-looking statements speak only as of the date on which such statements are made, and we
undertake no obligation to update any forward-looking statement to reflect events or circumstances
after the date on which any such statement is made to reflect the occurrence of unanticipated
events.
 We make available, free of charge, through our Internet website ( http://www.citizensinc.com ), our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16
reports filed by officers and directors, news releases, and, if applicable, amendments to those
reports filed or furnished pursuant to 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 report.
 Overview
  
    
    the issuance of ordinary life insurance in U.S. Dollar-denominated amounts to
foreign nationals with significant net worth; and
    
    offering final expense ordinary life insurance through the home service distribution
channel in Louisiana.
  19




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##### Table of Contents



International Life.
   Home Service Life.
   20




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##### Table of Contents



Domestic Life.
  21




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##### Table of Contents



Marketplace Conditions and Trends
  
    
    As an increasing percentage of the world population reaches retirement age, we believe
we will benefit from increased demand for living products rather than death products, as
aging baby boomers will require cash accumulation to provide expenses to meet their
lifetime needs. Our ordinary life products are designed for our policyowners to accumulate
cash values to provide for living expenses in the insureds later years while continuously
providing a death benefit.
    
    The volatility in the equity markets over the past few years has posed a number of
problems for some companies in the life insurance industry. Even though the capital
markets have recovered, not all companies have participated evenly in the recovery. We
historically have had minimal equity exposure, including less than 1% of total invested
assets as of September 30, 2006 and December 31, 2005, and we plan to continue to have
minimal assets in equity investments in the future.
    
    Corporate bond defaults and credit downgrades, which have resulted in other-than-
temporary impairment in the value of many securities, have had a material impact on life
insurers in the past few years. We have not incurred significant losses from bond defaults
for many years. The majority of our investment portfolio is held in debt instruments
carrying the full faith and credit of the U.S. Government, or U.S. Government-sponsored
enterprises. As interest rates rise, we may elect to diversify beyond such instruments;
however, we do not expect to make significant changes to the risk profile of the portfolio.
    
    Some life insurance companies have recently suffered significant reductions in capital
due to losses, and will have to improve their capital adequacy ratios to support their
business or divest a portion of their business. We have not experienced any capital
reductions in our life subsidiaries and do not anticipate this trend will affect us. We
did reduce capital on a regulatory basis by approximately $20 million when we acquired
Security Plan; however, we maintain more than adequate levels of capital, and with the
earnings of Security Plan on a regulatory basis, expect to replenish regulatory capital
from our life insurance subsidiaries profitability.
    
    Some property/casualty insurance companies, including SPFIC, have recently suffered
significant reductions in capital due to weather-related losses, specifically Hurricanes
Katrina and Rita. These reductions are expected to continue as a result of Louisianas
current regulatory and judicial environment. In accordance with Louisiana Legislative
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##### Table of Contents



Acts
739 and 802, all property and casualty insurers were required to extend the prescriptive
period an additional one year for filing claims and lawsuits related to Hurricanes Katrina
and Rita. The Louisiana Supreme Court upheld the constitutionality of this legislatively
mandated extension. We have compensated for SPFICs current and potential losses through
an additional capital contribution from Security Plan and through
increased catastrophic reinsurance coverage, as well as an increase in rates. SPFICs
operations are not part of the Companys core business, and represent only 2.9% of overall
premium income.
    
    Because of the trends described above coupled with increasing costs of regulatory
compliance such as the Sarbanes-Oxley Act of 2002, we believe there is a trend towards
consolidation of domestic life insurance companies. We believe this should be a benefit to
our acquisition strategy because there should be more complementary acquisition candidates
available for us to consider acquiring.
    
    Many of the events and trends affecting the life insurance industry have had an impact
on the life reinsurance industry. These events 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 would have to reduce our
underwriting commitments.
 Recent Transactions
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##### Table of Contents



Quarter Ended September 30, 2006 Compared to the Quarter Ended September 30, 2005
 Overview
    Consolidated Results
  Net IncomeQuarter
    
    
    
    
    
    Per Class A and BEnded
    
    Net Income
    
    Common ShareSeptember 30
    
    (In thousands)
    
    Basic and Diluted2006
    
    $
    2,588
    
    
    $
    0.052005
    
    
    1,487
    
    
    
    0.02
 Premium Income
 Net Investment Income
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##### Table of Contents



Claims and Surrenders
 Three Months Ended September 30,2006
    
    
    2005(In thousands)Death claims
    
    $
    4,553
    
    
    
    4,290Surrender benefits
    
    
    4,382
    
    
    
    4,101Endowments
    
    
    2,585
    
    
    
    2,366Casualty claims
    
    
    1,418
    
    
    
    1,046Other policy benefits
    
    
    277
    
    
    
    226Accident and health benefits
    
    
    121
    
    
    
    90Total claims and surrenders
    
    $
    13,336
    
    
    
    12,119
 Reserves
 Policyholder Dividends
 Commissions
 Underwriting, Acquisition and Insurance Expense
 Deferred Policy Acquisition Costs
 25




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##### Table of Contents



Amortization of Cost of Customer Relationships Acquired and Other Intangibles.
 Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
 Overview
 
  Consolidated Results
  Net Income
    
    Net IncomeNine Months
    
    
    
    
    
    Per Class A and B
    
    Per Class A and BEnded
    
    Net Income
    
    Common Share
    
    Common ShareSeptember 30
    
    (In thousands)
    
    Basic
    
    Diluted2006
    
    $
    5,591
    
    
    $
    0.10
    
    
    $
    0.092005
    
    
    4,209
    
    
    
    0.07
    
    
    
    0.07
  Premium Income
 26




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##### Table of Contents



Net Investment Income
 Claims and Surrenders
 Nine Months Ended September 30,2006
    
    
    2005(In thousands)Death claims
    
    $
    16,016
    
    
    
    16,432Surrender benefits
    
    
    12,681
    
    
    
    11,485Endowments
    
    
    7,532
    
    
    
    6,413Casualty claims
    
    
    3,990
    
    
    
    2,033Other policy benefits
    
    
    687
    
    
    
    583Accident and health benefits
    
    
    408
    
    
    
    336Total claims and surrenders
    
    $
    41,314
    
    
    
    37,282
    27




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##### Table of Contents



Reserves
 Policyholder Dividends
 Commissions
 Underwriting, Acquisition and Insurance Expense
 Deferred Policy Acquisition Costs
 Amortization of Cost of Customer Relationships Acquired and Other Intangibles
 Liquidity and Capital Resources
  28
    Table of Contents          29




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##### Table of Contents



30




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##### Table of Contents



Contractual
    
    
    
    
    
    Less than
    
    
    1 to 3
    
    
    3 to 5
    
    
    More thanObligation
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 years(In Thousands)Operating leases
    
    $
    766
    
    
    
    291
    
    
    
    333
    
    
    
    142
    
    
    
    Other
    
    
    86
    
    
    
    42
    
    
    
    44
    
    
    
    
    
    
    
    Total operating
leases and other
    
    
    852
    
    
    
    333
    
    
    
    377
    
    
    
    142
    
    
    
    Future policy benefit reserves:Life insurance
    
    
    463,856
    
    
    
    171
    
    
    
    961
    
    
    
    9,022
    
    
    
    453,784Annuities
    
    
    20,615
    
    
    
    8,205
    
    
    
    5,668
    
    
    
    3,670
    
    
    
    2,990Accident and health
    
    
    10,819
    
    
    
    10,819
    
    
    
    
    
    
    
    
    
    
    
    Total future policy
benefit reserves
    
    
    495,290
    
    
    
    19,195
    
    
    
    6,629
    
    
    
    12,692
    
    
    
    456,774Policy claims payable:Life insurance
    
    
    5,583
    
    
    
    5,583
    
    
    
    
    
    
    
    
    
    
    
    Accident and health
    
    
    1,260
    
    
    
    1,260
    
    
    
    
    
    
    
    
    
    
    
    Casualty
    
    
    1,237
    
    
    
    1,237
    
    
    
    
    
    
    
    
    
    
    
    Total policy
claims payable
    
    
    8,080
    
    
    
    8,080
    
    
    
    
    
    
    
    
    
    
    
    Series A-1 and A-2
preferred stock
    
    
    16,251
    
    
    
    
    
    
    
    
    
    
    
    16,251
    
    
    
    Total contractual obligations
    
    $
    520,473
    
    
    
    27,608
    
    
    
    7,006
    
    
    
    29,085
    
    
    
    456,774
  Parent Company Liquidity and Capital Resources
  31




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##### Table of Contents



Critical Accounting Policies
  Policy Liabilities
   Deferred Policy Acquisition Costs and Cost of Customer Relationships
    32




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##### Table of Contents



Excess of Cost Over Net Assets Acquired and Other Intangible Assets
 Goodwill and Other Intangible Assets
  33




---



##### Table of Contents



Valuation of Investments in Fixed Maturity and Equity Securities
     Premium Revenue and Related Expenses
   34




---



##### Table of Contents



New Accounting Pronouncements
 Accounting by Insurance Enterprises for Deferred Acquisition Costs in
Connection with Modifications or Exchanges of Insurance Contracts Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and For Realized Gains and Losses from the Sale of
Investments
 Accounting for Uncertainty in Income Taxes Accounting for Income Taxes
 Fair Value
Measurements 35
    Table of Contents    Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements Materiality
 
 ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
 General
  Market Risk Related to Interest Rates
  36
    Table of Contents    September 30, 2006
 (In thousands)
 Decreases in Interest Rates
    
    
    Increases in Interest Rates300 Basis
    
    200 Basis
    
    
    100 Basis
    
    
    100 Basis
    
    
    200 Basis
    
    
    300 BasisPoints
    
    Points
    
    
    Points
    
    
    Points
    
    
    Points
    
    
    Points$45,185
    
    $
    29,375
    
    
    $
    18,217
    
    
    $
    (35,307
    )
    
    $
    (54,886
    )
    
    $
    (86,762
    )
 December 31, 2005
 (In thousands)
 Decreases in Interest Rates
    
    
    Increases in Interest Rates300 Basis
    
    200 Basis
    
    
    100 Basis
    
    
    100 Basis
    
    
    200 Basis
    
    
    300 BasisPoints
    
    Points
    
    
    Points
    
    
    Points
    
    
    Points
    
    
    Points$65,930
    
    $
    42,730
    
    
    $
    23,279
    
    
    $
    (42,198
    )
    
    $
    (73,921
    )
    
    $
    (102,269
    )
   Market Risk Related to Equity Prices
  
 ITEM 4. CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
  37




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##### Table of Contents



Change in Internal Control over Financial Reporting
  38




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##### Table of Contents



PART II
OTHER INFORMATION
 
 Item 1. Legal Proceedings
 Cause Number 03-0505; Citizens Insurance Company of America, Citizens, Inc., Harold E.
Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in the
Supreme Court of Texas.This lawsuit has been certified as a class action by the Texas District Court, Austin,
Texas, and affirmed by the Court of Appeals for the Third District of Texas, relating to
the original action filed in 1999. We appealed the grant of class status to the Texas
Supreme Court, with oral arguments occurring on October 21, 2004. We have not yet
received a decision from the Texas Supreme Court.The suit names as a class all non-U.S. residents who purchased insurance policies or
made premium payments since August 1996 and assigned policy dividends to two non-U.S.
trusts for the purchase of our class A common stock. It alleges that our life insurance
policies made available to these non-U.S. residents, when combined with a policy feature
that allows policy dividends to be assigned to the trusts for the purpose of
accumulating ownership of the our Class A common stock, along with allowing the
policyholders to make additional contributions to the trusts, were actually offers and
sales of securities that occurred in Texas by unregistered dealers in violation of Texas
securities laws. The remedy sought is rescission and return of the insurance premium
payments.We assert that, among other things, U.S. law, including Texas law, does not apply to the
operations of the trusts, and therefore, no securities registration provisions apply,
nor do laws relating to broker-dealer registration apply. Further, it is our position
that the plaintiffs securities claims, based on Texas securities laws, are not valid,
that no broker registration is required by us or our marketing consultants, and the
class as defined is not appropriate for class certification because it does not meet the
legal requirements for class treatment under Texas law. To date, no hearing on the
merits of the case has been scheduled.We intend to vigorously defend against the class certification, as well as against the
other securities related claims in this case. However, we are unable to determine the
potential financial magnitude of the claims in the event of a final class certification
and the plaintiffs prevailing on the substantive action, although we would expect a
significant adverse financial impact from an adverse class action judgment.
 39




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##### Table of Contents



We are also a party to various legal proceedings incidental to our business. We have
been named as a defendant in various legal actions, including one class action lawsuit
filed in Louisiana federal district court, seeking payments for claims denied by us and
other declaratory relief relevant to Hurricanes Katrina and Rita. We assert, among
other things, that the SPFIC policies flood exclusion language should apply. We
intend to vigorously defend the applicable flood exclusion language and defend against
the class certification. In the opinion of management, the ultimate liability, if any,
resulting from any contingent liabilities that might arise from this litigation is not
considered material in relation to our financial position or results of operations.
Reserves for claims payable are based on the expected claim amount to be paid after a
case-by-case review of the facts and circumstances relating to each claim. A
contingency exists with regard to these reserves until the claims are adjudicated and
paid.
 
 Item 1. A Risk Factors
 No change.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 None.
 
 Item 3. Defaults upon Senior Securities
 None.
 
 Item 4. Submission of Matters to a Vote of Security Holders
 None
 
 Item 5. Other Information
 None.
 40




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##### Table of Contents



Item 6. Exhibits
 3.1
    
    Restated and Amended Articles of Incorporation (a)3.2
    
    Bylaws (b)4.1
    
    Amendment to State Series A-1 and A-2 Senior Convertible Preferred Stock (j)10.1
    
    Self-Administered Automatic Reinsurance Agreement  Citizens Insurance
Company of America and Riunione Adriatica di Sicurta, S.p.A. (c)10.2
    
    Bulk Accidental Death Benefit Reinsurance Agreement between Connecticut
General Life Insurance Company and Citizens Insurance Company of America, as
amended (d)10.3
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement,
Administrative Services Agreement dated March 9, 2004, between Citizens
Insurance Company of America and Texas International Life Insurance Company,
Reinsurance Trust Agreement dated March 9, 2004, by and among Citizens
Insurance Company of America, Texas International Life Insurance Company and
Wells Fargo Bank, N.A. (e)10.4
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement,
Administrative Services Agreement dated March 9, 2004, between Combined
Underwriters Life Insurance Company and Texas International Life Insurance
Company, Reinsurance Trust Agreement dated March 9, 2004, by and among
Combined Underwriters Life Insurance Company, Texas International Life
Insurance Company and Wells Fargo Bank, N.A. (f)10.5
    
    Loan Agreement, Security Agreement and Note dated March 22,2004 between
Citizens, Inc. and Regions Bank (h)10.5(a)
    
    Second Amendment to Loan Agreement between Citizens, Inc. and Regions Bank
dated October 1, 2004 (j)10.5(b)
    
    Security Agreement between Citizens Insurance Company of America and Regions
Bank dated October 1, 2004 (j)10.5(c)
    
    Subordinated Debenture dated October 1, 2004, issued by Citizens Insurance
Company of America to Citizens, Inc. (o)10.6(a)
    
    Securities Purchase Agreement dated July 12, 2004 among Citizens, Inc.,
Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and
Opportunity Fund, and Smithfield Fiduciary LLC (h)10.6(b)
    
    Registration Rights Agreement dated July 12, 2004 among Citizens, Inc.,
Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and
Opportunity Fund, and Smithfield Fiduciary LLC (h)10.6(c)
    
    Unit Warrant dated July 12, 2004, to Mainfield Enterprises, Inc. (h)10.6(d)
    
    Unit Warrant dated July 12, 2004, to Steelhead Investments Ltd. (h)10.6(e)
    
    Unit Warrant dated July 12, 2004, to Portside Growth and Opportunity Fund (h)10.6(f)
    
    Unit Warrant dated July 12, 2004, to Smithfield Fiduciary LLC (h)10.6(g)
    
    Warrant to Purchase Class A Common Stock to Mainfield Enterprises, Inc. (h)10.6(h)
    
    Warrant to Purchase Class A Common Stock to Steelhead Investments Ltd. (h)10.6(i)
    
    Warrant to Purchase Class A Common Stock to Portside Growth and Opportunity
Fund (h)10.6(j)
    
    Warrant to Purchase Class A Common Stock to Smithfield Fiduciary LLC (h)10.6(k)
    
    Subordination Agreement among Regions Bank, the Purchasers and Citizens,
Inc. dated July 12, 2004 (h)10.6(l)
    
    Non-Exclusive Finders Agreement dated September 29, 2003, between Citizens,
Inc. and the Shemano Group, Inc. (h)10.7
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance
Company of America and Converium Reinsurance (Germany) Ltd. (l)10.8
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance
Company of America and Scottish Re Worldwide (England) (m)10.9
    
    First Amended and Restated Loan Agreement  Regions Bank, dated December 5,
2005 (n)11.0
    
    Statement re: Computation of per share earnings (i)31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act*31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act*32.1
    
    Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act*32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act*
 
 *
    
    Filed herewith.Table of Contents(a)
    
    Filed with the Registrants Annual Report on Form 10-K for the year ended December 31,
2003.(b)
    
    Filed with the Registrants Registration Statement on Form S-4, Registration No.
33-59039, filed with the Commission on May 2, 1995, and incorporated herein by reference.(c)
    
    Filed as Exhibit 10.8 with the Registration Statement on Form S-4, SEC File No.
333-16163, filed on or about November 4, 1996, and incorporated herein by reference.(d)
    
    Filed as Exhibit 10.9 with the Registrants Annual Report on Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.(e)
    
    Filed on March 22, 2004 as Exhibit 10.8 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(f)
    
    Filed on March 22, 2004 as Exhibit 10.9 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(g)
    
    See Note 6 to the Notes to Consolidated Financial Statements included in Item 1 of Part
1 of this Form 10-Q.(h)
    
    Filed with the Registrants Periodic Report on Form 8-K on July 15, 2004 and
incorporated herein by reference.(i)
    
    Filed on March 26, 2004 as Exhibit 10.10 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(j)
    
    Filed on October 1, 2004 as Exhibit 10.11 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(k)
    
    Filed on October 1, 2004 as Exhibit 10.11 with the Registrants current Report on Form
8-K and incorporated herein by reference.(l)
    
    Filed on March 31, 2005, as Exhibit 10.10(m) with the Registrants Annual Report on
Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.(m)
    
    Filed on March 31, 2005 as Exhibit 10.10(n) with the Registrants Annual Report on
Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.(n)
    
    Filed on March 16, 2006 with the Registrants Annual Report on Form 10-K for the year
ended December 31, 2005, as Exhibit 10.10(o), and incorporated herein by reference. 41




---



##### Table of Contents



SIGNATURES
  CITIZENS, INC.By:
    /s/ Harold E. RileyHarold E. RileyChief Executive Officer and ChairmanBy:
    /s/ Larry E. CarsonLarry E. CarsonVice President, Chief Financial Officer and Treasurer  42




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##### Table of Contents



Exhibit Index
 Description3.1
    
    Restated and Amended Articles of Incorporation (a)3.2
    
    Bylaws (b)4.1
    
    Amendment to State Series A-1 and A-2 Senior Convertible Preferred Stock (j)10.1
    
    Self-Administered Automatic Reinsurance Agreement  Citizens Insurance
Company of America and Riunione Adriatica di Sicurta, S.p.A. (c)10.2
    
    Bulk Accidental Death Benefit Reinsurance Agreement between Connecticut
General Life Insurance Company and Citizens Insurance Company of America, as
amended (d)10.3
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement,
Administrative Services Agreement dated March 9, 2004, between Citizens
Insurance Company of America and Texas International Life Insurance Company,
Reinsurance Trust Agreement dated March 9, 2004, by and among Citizens
Insurance Company of America, Texas International Life Insurance Company and
Wells Fargo Bank, N.A. (e)10.4
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement,
Administrative Services Agreement dated March 9, 2004, between Combined
Underwriters Life Insurance Company and Texas International Life Insurance
Company, Reinsurance Trust Agreement dated March 9, 2004, by and among
Combined Underwriters Life Insurance Company, Texas International Life
Insurance Company and Wells Fargo Bank, N.A. (f)10.5
    
    Loan Agreement, Security Agreement and Note dated March 22,2004 between
Citizens, Inc. and Regions Bank (h)10.5(a)
    
    Second Amendment to Loan Agreement between Citizens, Inc. and Regions Bank
dated October 1, 2004 (j)10.5(b)
    
    Security Agreement between Citizens Insurance Company of America and Regions
Bank dated October 1, 2004 (j)10.5(c)
    
    Subordinated Debenture dated October 1, 2004, issued by Citizens Insurance
Company of America to Citizens, Inc. (o)10.6(a)
    
    Securities Purchase Agreement dated July 12, 2004 among Citizens, Inc.,
Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and
Opportunity Fund, and Smithfield Fiduciary LLC (h)10.6(b)
    
    Registration Rights Agreement dated July 12, 2004 among Citizens, Inc.,
Mainfield Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and
Opportunity Fund, and Smithfield Fiduciary LLC (h)10.6(c)
    
    Unit Warrant dated July 12, 2004, to Mainfield Enterprises, Inc. (h)10.6(d)
    
    Unit Warrant dated July 12, 2004, to Steelhead Investments Ltd. (h)10.6(e)
    
    Unit Warrant dated July 12, 2004, to Portside Growth and Opportunity Fund (h)10.6(f)
    
    Unit Warrant dated July 12, 2004, to Smithfield Fiduciary LLC (h)10.6(g)
    
    Warrant to Purchase Class A Common Stock to Mainfield Enterprises, Inc. (h)10.6(h)
    
    Warrant to Purchase Class A Common Stock to Steelhead Investments Ltd. (h)10.6(i)
    
    Warrant to Purchase Class A Common Stock to Portside Growth and Opportunity
Fund (h)10.6(j)
    
    Warrant to Purchase Class A Common Stock to Smithfield Fiduciary LLC (h)10.6(k)
    
    Subordination Agreement among Regions Bank, the Purchasers and Citizens,
Inc. dated July 12, 2004 (h)10.6(l)
    
    Non-Exclusive Finders Agreement dated September 29, 2003, between Citizens,
Inc. and the Shemano Group, Inc. (h)10.7
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance
Company of America and Converium Reinsurance (Germany) Ltd. (l)10.8
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance
Company of America and Scottish Re Worldwide (England) (m)10.9
    
    First Amended and Restated Loan Agreement  Regions Bank, dated December 5,
2005 (n)11.0
    
    Statement re: Computation of per share earnings (i)31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act*31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act*32.1
    
    Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act*32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act*
 
 *
    
    Filed herewith.Table of Contents(a)
    
    Filed with the Registrants Annual Report on Form 10-K for the year ended December 31,
2003.(b)
    
    Filed with the Registrants Registration Statement on Form S-4, Registration No.
33-59039, filed with the Commission on May 2, 1995, and incorporated herein by reference.(c)
    
    Filed as Exhibit 10.8 with the Registration Statement on Form S-4, SEC File No.
333-16163, filed on or about November 4, 1996, and incorporated herein by reference.(d)
    
    Filed as Exhibit 10.9 with the Registrants Annual Report on Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.(e)
    
    Filed on March 22, 2004 as Exhibit 10.8 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(f)
    
    Filed on March 22, 2004 as Exhibit 10.9 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(g)
    
    See Note 6 to the Notes to Consolidated Financial Statements included in Item 1 of Part
1 of this Form 10-Q.(h)
    
    Filed with the Registrants Periodic Report on Form 8-K on July 15, 2004 and
incorporated herein by reference.(i)
    
    Filed on March 26, 2004 as Exhibit 10.10 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(j)
    
    Filed on October 1, 2004 as Exhibit 10.11 with the Registrants Current Report on Form
8-K and incorporated herein by reference.(k)
    
    Filed on October 1, 2004 as Exhibit 10.11 with the Registrants current Report on Form
8-K and incorporated herein by reference.(l)
    
    Filed on March 31, 2005, as Exhibit 10.10(m) with the Registrants Annual Report on
Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.(m)
    
    Filed on March 31, 2005 as Exhibit 10.10(n) with the Registrants Annual Report on
Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.(n)
    
    Filed on March 16, 2006 with the Registrants Annual Report on Form 10-K for the year
ended December 31, 2005, as Exhibit 10.10(o), and incorporated herein by reference. 43