##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON D.C. 20549
 FORM 10-K
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2006
 Commission file number 1-13004
 CITIZENS, INC.
 (Exact name of registrant as specified in its charter)
 Colorado
    
    84-0755371(State of incorporation)
    
    (IRS Employer Identification No.)400 East Anderson Lane, Austin, Texas
    
    78752(Address of principal executive offices)
    
    (Zip Code)
 
 Title of each classClass A Common Stock
    
    Name of each exchange on which registeredNew York Stock Exchange
 None
 o þ
 o þ
 o
 þ
  o þ o
 o þ
   
 DOCUMENTS INCORPORATED BY REFERENCE




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 TABLE OF CONTENTS
 PagePART IItem 1. Business
    
    
    3Item 1A. Risk Factors
    
    
    34Item 1B. Unresolved Staff Comments
    
    
    57Item 2. Properties
    
    
    57Item 3. Legal Proceedings
    
    
    57Item 4. Submission of Matters to a Vote of Security Holders
    
    
    58PART IIItem 5. Market for Registrants Common Equity, Related
Stockholder Matters and Issuer Purchase of Equity
Securities
    
    
    58Item 6. Selected Financial Data
    
    
    59Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operation
    
    
    60Item 7A. Quantitative and Qualitative Disclosures about Market Risk
    
    
    75Item 8. Financial Statements and Supplementary Data
    
    
    77Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
    
    
    77Item 9A. Controls and Procedures
    
    
    77Item 9B. Other information
    
    
    81PART IIIItem 10. Directors, Executive Officers and Corporate Governance
    
    
    81Item 11. Executive Compensation
    
    
    81Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
    
    
    81Item 13. Certain Relationships and Related Transactions, and
Director Independence
    
    
    81Item 14. Principal Accounting Fees and Services
    
    
    81PART IVItem 15. Exhibits, Financial Statement Schedules
    
    
    81First Amendment to First Amended and Restated Loan AgreementSubsidiariesConsent of KPMG LLPConsent of Ernst & Young LLPCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  1




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 FORWARD-LOOKING STATEMENTS
 Certain statements contained in this Annual Report on Form 10-K are not statements of historical
fact and constitute forward-looking statements within the meaning of the Private Securities
Litigation Reform Act (the Act), including, without limitation, statements specifically
identified as forward-looking statements within this document. Many of these statements contain
risk factors as well. In addition, certain statements in future filings by the Company with the
Securities and Exchange Commission, in press releases, and in oral and written statements made by
or with the approval of the Company which are not statements of historical fact constitute
forward-looking statements within the meaning of the Act. Examples of forward-looking statements,
include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per
share, the payment or non-payment of dividends, capital structure, and other financial items, (ii)
statements of our plans and objectives by our management or Board of Directors including those
relating to products or services, (iii) statements of future economic performance and (iv)
statements of assumptions underlying such statements. Words such as believes, anticipates,
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 and
laws; (iii) inflation, interest rates, market and monetary fluctuations and volatility; (iv) the
timely development of and acceptance of new 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 business from persons residing in Latin
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.
 Such forward-looking statements speak only as of the date on which such statements are made, and
the Company undertakes no obligation to update any forward-looking statement to reflect events or
circumstances after the date on which such statement is made to reflect the occurrence of
unanticipated events.
 2




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 We make available, free of charge, through our Internet website ( http://www.citizensinc.com ), our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16
reports filed by officers and directors, news releases, and, if applicable, amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as soon as reasonably practicable after we electronically file such reports with, or furnish
such reports to, the Securities and Exchange Commission. We are not including any of the
information contained on our website as part of, or incorporating it by reference into, this Annual
Report on Form 10-K.
 
 PART I
 
 ITEM 1. Business
 Overview
  
    
    the issuance of ordinary life insurance in U.S. Dollar-denominated amounts to
foreign nationals through outside marketing consultants, principally in Latin America
and the Pacific Rim; and
    
    offering final expense ordinary life insurance through our home service
distribution channel.
   
    
    building assets through the issuance of cash accumulation and final expense
ordinary life insurance products;
    
    strategic acquisitions of domestic life insurance companies; and
    
    expanding our distribution channels of ordinary life insurance.
  3




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
     For the Year Ended December 31,2006
    
    2005(In thousands)Segment
    
    
    
    
    
    SegmentOperating Business
    
    
    
    
    
    Income
    
    
    
    
    
    IncomeSegment and
    
    
    
    
    
    (Loss)
    
    
    
    
    
    (Loss)Principal Distribution
    
    Total
    
    Before
    
    Total
    
    BeforeChannel
    
    Revenue
    
    Income Tax
    
    Revenue
    
    Income TaxLife Insurance -
Approximately 2,150
marketing consultants
around the world and
525 domestic
representatives
    
    $
    105,747
    
    
    $
    10,803
    
    
    $
    90,649
    
    
    $
    4,715Home Service
Insurance -
Approximately 320
employee agents
    
    
    51,235
    
    
    
    3,531
    
    
    
    49,655
    
    
    
    5,902Other Non-Insurance
Enterprises
    
    
    1,077
    
    
    
    (992
    )
    
    
    1,809
    
    
    
    1,179
  4




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Our Operating Segments
  
    
    Life Insurance;
 
    
    Home Service Insurance (which we acquired on October 1, 2004, and as such, all
income statement amounts in 2004 are for the last fiscal quarter only); and
 
    
    Other Non-insurance Enterprises.
  Year Ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)RevenueLife Insurance
    
    $
    105,747
    
    
    
    90,649
    
    
    
    86,468Home Service Insurance
    
    
    51,235
    
    
    
    49,655
    
    
    
    12,556Other Non-Insurance Enterprises
    
    
    1,077
    
    
    
    1,809
    
    
    
    835Total consolidated revenue
    
    $
    158,059
    
    
    
    142,113
    
    
    
    99,859Premium incomeLife Insurance
    
    $
    90,479
    
    
    
    78,592
    
    
    
    70,117Home Service Insurance
    
    
    38,017
    
    
    
    37,682
    
    
    
    9,797Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    Total consolidated premium income
    
    $
    128,496
    
    
    
    116,274
    
    
    
    79,914Net investment incomeLife Insurance
    
    $
    14,243
    
    
    
    11,780
    
    
    
    13,950Home Service Insurance
    
    
    12,232
    
    
    
    11,573
    
    
    
    2,876Other Non-Insurance Enterprises
    
    
    500
    
    
    
    215
    
    
    
    179Total consolidated net investment income
    
    $
    26,975
    
    
    
    23,568
    
    
    
    17,005Income (loss) before federal income tax:Life Insurance
    
    $
    10,803
    
    
    
    4,715
    
    
    
    5,842Home Service Insurance
    
    
    3,531
    
    
    
    5,902
    
    
    
    2,609Other Non-Insurance Enterprises
    
    
    (992
    )
    
    
    1,179
    
    
    
    (363
    )Total consolidated income before federal
income tax
    
    $
    13,342
    
    
    
    11,796
    
    
    
    8,088
 5




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 December 31,2006
    
    
    2005(In thousands)Assets:Life Insurance
    
    $
    395,297
    
    
    
    346,313Home Service Insurance
    
    
    300,368
    
    
    
    300,693Other Non-Insurance Enterprises
    
    
    15,519
    
    
    
    14,883Total consolidated assets
    
    $
    711,184
    
    
    
    661,889
 Life Insurance
  
    
    policies are typically larger face amounts than in our U.S operations. resulting in
lower underwriting and administrative costs per policy;
 
    
    the premiums are paid annually rather than monthly or quarterly, which saves us
administrative expenses and accelerates our cash flow;
 
    
    persistency is higher than U.S. policies;
 
    
    the mortality is as good or better than that experienced in the U.S. because our
insureds are in the top income brackets in their countries;
 
    
    the marketing consultants from whom applications are received are highly
professional;
 
    
    we do not advance any commissions relating to this business, so we do not have
financial exposure in the event monies are advanced and insurance revenues do not cover
the advances; and
 
    
    the profit margins are higher for us than for our typical U.S. policies.
  6




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   Country
    
    2006
    
    
    2005
    
    
    2004(Dollars in thousands)Colombia
    
    $
    22,879
    
    
    
    28.0
    %
    
    $
    20,572
    
    
    
    30.1
    %
    
    $
    18,487
    
    
    
    31.2
    %Taiwan
    
    
    10,077
    
    
    
    12.3
    
    
    
    7,008
    
    
    
    10.2
    
    
    
    3,748
    
    
    
    6.3Argentina
    
    
    8,975
    
    
    
    11.0
    
    
    
    8,419
    
    
    
    12.3
    
    
    
    8,592
    
    
    
    14.5Venezuela
    
    
    8,907
    
    
    
    10.9
    
    
    
    7,178
    
    
    
    10.5
    
    
    
    6,557
    
    
    
    11.1Uruguay
    
    
    3,092
    
    
    
    3.8
    
    
    
    3,202
    
    
    
    4.7
    
    
    
    3,527
    
    
    
    6.0Other Non-U.S.
    
    
    27,818
    
    
    
    34.0
    
    
    
    22,065
    
    
    
    32.2
    
    
    
    18,303
    
    
    
    30.9Total
    
    $
    81,748
    
    
    
    100.0
    %
    
    $
    68,444
    
    
    
    100.0
    %
    
    $
    59,214
    
    
    
    100.0
    %
  7




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
       8




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    State
    
    2006
    
    
    2005
    
    
    2004(Dollars in thousands)Texas
    
    $
    7,962
    
    
    
    39.6
    %
    
    $
    9,172
    
    
    
    38.6
    %
    
    $
    10,212
    
    
    
    36.9
    %Kentucky
    
    
    2,436
    
    
    
    12.1
    
    
    
    2,936
    
    
    
    12.3
    
    
    
    4,377
    
    
    
    15.8Oklahoma
    
    
    2,363
    
    
    
    11.8
    
    
    
    3,481
    
    
    
    14.6
    
    
    
    4,262
    
    
    
    15.4Mississippi
    
    
    1,520
    
    
    
    7.6
    
    
    
    1,658
    
    
    
    7.0
    
    
    
    1,811
    
    
    
    6.5Other States
    
    
    5,828
    
    
    
    28.9
    
    
    
    6,545
    
    
    
    27.5
    
    
    
    7,029
    
    
    
    25.4Total
    
    $
    20,109
    
    
    
    100.0
    %
    
    $
    23,792
    
    
    
    100.0
    %
    
    $
    27,691
    
    
    
    100.0
    %
 Home Service Insurance
     9




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Our Products
 Life Insurance
  
    
    U.S. Dollar-denominated living cash values;
    
    rates that are competitive with or better than most foreign local companies;
    
    a hedge against local currency inflation;
    
    protection against devaluation of foreign currency;
    
    capital transference to a safe haven (U.S.);
    
    lifetime income;
    
    tax-free earnings on cash build-up; and
    
    cash values beginning in the first policy year.
   
    
    cash accumulation/living benefits;
 
    
    tax-deferred interest earnings;
 10




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 
    
    guaranteed lifetime income at age 65;
    
    monthly income for surviving family members;
    
    significant accidental death benefits; and
    
    payment waiver in the event of disability.
  Home Service
  Operations and Technology
   11




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Information Regarding Our Insurance Businesses
   New
    
    Claims,In Force,
    
    Business
    
    Lapses,Beginning of
    
    Issued
    
    Surrenders
    
    Acquisitions
    
    In Force,Year
    
    During Year
    
    During Year
    
    During Year
    
    End of Year(In millions)2006
    
    $
    4,280
    
    
    
    727
    
    
    
    (366
    )
    
    
    
    
    
    
    4,6412005
    
    
    4,001
    
    
    
    725
    
    
    
    (446
    )
    
    
    
    
    
    
    4,2802004
    
    
    2,921
    
    
    
    570
    
    
    
    (472
    )
    
    
    982
    
    
    
    4,0012003
    
    
    2,408
    
    
    
    434
    
    
    
    (193
    )
    
    
    272
    
    
    
    2,9212002
    
    
    2,417
    
    
    
    410
    
    
    
    (497
    )
    
    
    78
    
    
    
    2,408
  In Force
    
    
    
    
    
    Mean LifeBeginning of
    
    In Force
    
    Insurance InYear
    
    End of Year
    
    Force(a)
    
    (a)
    
    (a)(In millions)2006
    
    $
    4,280
    
    
    
    4,641
    
    
    
    4,4612005
    
    
    4,001
    
    
    
    4,280
    
    
    
    4,1412004
    
    
    2,921
    
    
    
    4,001
    
    
    
    3,4612003
    
    
    2,408
    
    
    
    2,921
    
    
    
    2,6652002
    
    
    2,417
    
    
    
    2,408
    
    
    
    2,413
 
 (a)
    
    Before ceding amounts to reinsurers.  12




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Reinsurance CededInforce
    
    Premium(In thousands)2006
    
    $
    258,756
    
    
    $
    1,8442005
    
    
    221,793
    
    
    
    1,9072004
    
    
    265,001
    
    
    
    1,0012003
    
    
    301,366
    
    
    
    1,3822002
    
    
    152,103
    
    
    
    1,321
   Ordinary
    
    
    
    
    
    
    
    
    
    Accident &Life (a)
    
    Casualty (a)
    
    Group Life
    
    Health (a)
    
    Total(In thousands)2006
    
    $
    122,277
    
    
    
    3,777
    
    
    
    981
    
    
    
    1,461
    
    
    
    128,4962005
    
    
    110,519
    
    
    
    3,627
    
    
    
    568
    
    
    
    1,560
    
    
    
    116,2742004
    
    
    77,377
    
    
    
    1,113
    
    
    
    636
    
    
    
    788
    
    
    
    79,9142003
    
    
    60,395
    
    
    
    
    
    
    
    463
    
    
    
    14,785
    
    
    
    75,6432002
    
    
    54,033
    
    
    
    
    
    
    
    421
    
    
    
    13,474
    
    
    
    67,928
 
 (a)
    
    After deduction for reinsurance ceded.  13




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Commissions, Underwriting andOperating Expenses, PolicyCommissions,
    
    Reserve Increases, PolicyholderUnderwriting and
    
    Benefits and Dividends toOperating Expenses
    
    PolicyholdersInsurance
    
    
    
    
    
    Ratio toPremiums
    
    Amount
    
    Insurance
    
    Amount
    
    Ratio to Insurance(a)
    
    (a)
    
    Premiums
    
    (a)
    
    Premiums(In thousands)2006
    
    $
    128,496
    
    
    $
    63,298
    
    
    
    49.3
    %
    
    $
    155,662
    
    
    
    121.1
    %2005
    
    
    116,274
    
    
    
    58,414
    
    
    
    50.2
    
    
    
    138,511
    
    
    
    119.12004
    
    
    79,914
    
    
    
    38,665
    
    
    
    48.4
    
    
    
    95,874
    
    
    
    120.02003
    
    
    75,643
    
    
    
    37,194
    
    
    
    49.2
    
    
    
    89,455
    
    
    
    118.32002
    
    
    67,928
    
    
    
    31,411
    
    
    
    46.2
    
    
    
    79,320
    
    
    
    116.8
 
 (a)
    
    After premiums ceded to reinsurers.   Total New
    
    Participating
    
    Non-participatingBusiness
    
    Amount
    
    Percent
    
    Amount
    
    Percent(In thousands)2006
    
    $
    727,134
    
    
    $
    429,382
    
    
    
    59.1
    %
    
    $
    297,752
    
    
    
    40.9
    %2005
    
    
    725,199
    
    
    
    399,008
    
    
    
    55.0
    
    
    
    326,191
    
    
    
    45.02004
    
    
    570,462
    
    
    
    339,008
    
    
    
    59.4
    
    
    
    231,454
    
    
    
    40.62003
    
    
    433,697
    
    
    
    266,303
    
    
    
    61.4
    
    
    
    167,394
    
    
    
    38.62002
    
    
    410,352
    
    
    
    265,476
    
    
    
    64.7
    
    
    
    144,876
    
    
    
    35.3
  14




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Total FaceAmount
    
    Whole Life andNew
    
    Endowment
    
    Term
    
    CreditBusiness
    
    Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    Percent(In thousands)2006
    
    $
    727,134
    
    
    $
    600,755
    
    
    
    82.6
    %
    
    $
    79,460
    
    
    
    10.9
    %
    
    $
    46,919
    
    
    
    6.5
    %2005
    
    
    725,199
    
    
    
    569,933
    
    
    
    78.6
    
    
    
    79,025
    
    
    
    10.9
    
    
    
    76,241
    
    
    
    10.52004
    
    
    570,462
    
    
    
    406,075
    
    
    
    71.2
    
    
    
    82,839
    
    
    
    14.5
    
    
    
    81,548
    
    
    
    14.32003
    
    
    433,697
    
    
    
    297,280
    
    
    
    68.5
    
    
    
    76,637
    
    
    
    17.7
    
    
    
    59,780
    
    
    
    13.82002
    
    
    410,352
    
    
    
    289,976
    
    
    
    70.7
    
    
    
    80,342
    
    
    
    19.5
    
    
    
    40,034
    
    
    
    9.8
   Deferred Policy AcquisitionCostsCapitalized
    
    Amortized(In thousands)2006
    
    $
    26,986
    
    
    $
    11,3912005
    
    
    24,388
    
    
    
    10,3132004
    
    
    17,241
    
    
    
    8,4392003
    
    
    16,558
    
    
    
    11,8072002
    
    
    14,423
    
    
    
    10,039
  15




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Investments
   Valuation of Investments in Fixed Maturity and Equity Securities
    16




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  December 31, 2006Carrying Value
    
    
    Percent of Total(In thousands)Fixed maturity securities:U.S. Government and Government agencies (1)
    
    $
    275,390
    
    
    
    51.1
    %Mortgage-backed (1)
    
    
    52,843
    
    
    
    9.8Corporate
    
    
    98,353
    
    
    
    18.2Municipal bonds
    
    
    61,732
    
    
    
    11.4Total fixed maturity securities
    
    
    488,318
    
    
    
    90.5Cash and cash equivalents
    
    
    24,521
    
    
    
    4.5Other investments:Policy loans
    
    
    23,542
    
    
    
    4.4Equity securities
    
    
    312
    
    
    
    0.1Mortgage Loans
    
    
    456
    
    
    
    0.1Real estate and other invested assets
    
    
    2,427
    
    
    
    0.4Total
    
    $
    539,576
    
    
    
    100.0
    %
 
 (1)
    
    U.S. Government and government agencies include U.S. Treasury
securities ($14,637) and U.S. government-sponsored enterprises
($313,566).  Fixed Maturities Available-For-Sale(In thousands)Amortized cost
    
    
    Fair valueDue in one year or less
    
    $
    11,208
    
    
    
    11,171Due after one year through five years
    
    
    41,774
    
    
    
    40,615Due after five years through ten years
    
    
    21,937
    
    
    
    21,437Due after ten years
    
    
    368,660
    
    
    
    362,252443,579
    
    
    
    435,475Securities not due at a single maturity date
    
    
    54,360
    
    
    
    52,843Totals
    
    $
    497,939
    
    
    
    488,318
   17




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Ratio of NetInvestment Income toYear Ended
    
    Mean Amount of
    
    Net Investment
    
    Mean Amount ofDecember 31
    
    Invested Assets
    
    Income (a)
    
    Invested Assets (a)(In thousands)2006
    
    $
    499,933
    
    
    $
    26,975
    
    
    
    5.4
    %2005
    
    
    480,306
    
    
    
    23,568
    
    
    
    4.92004
    
    
    375,495
    
    
    
    17,005
    
    
    
    4.52003
    
    
    250,598
    
    
    
    14,322
    
    
    
    5.72002
    
    
    216,352
    
    
    
    14,252
    
    
    
    6.6
 
 (a)
    
    Does not include realized and unrealized gains and losses on investments.  Reserves
  Reinsurance
   18




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Insurance Ceded
       19




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    nd st
 20




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Insurance Assumed
  Type of
    
    Amount inBusiness
    
    Force at EndName of Company
    
    Assumed
    
    of Year(In thousands)Prudential Insurance Company
(Prudential)
    
    Group Life
    
    $
    659,066Landmark Life Insurance
Company (Landmark)
    
    Ordinary Life
    
    $
    10,721
   Competition
  International Market
 Locally Operated Companies with Local Currency Policies.
  21




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   U.S. Companies Issuing U.S. Dollar Policies.
  Foreign Operated Companies with Local Currency Policies.
  Domestic Market
 22




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Home Service
 Employees
  Other Operations
  REGULATION
 General
    23




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   U.S. Insurance Regulation
   Insurance holding company regulation
  Policy forms
  24




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Dividend limitations
  
    
    10% of the insurers statutory surplus as of the immediately prior year end; or
 
    
    the statutory net gain from the insurers operations (if a life insurer) or the
statutory net income (if not a life insurer) during the prior calendar year.
  Market conduct regulation
  Financial examinations
  25




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Guaranty funds or associations
   Change of control
  Policy and contract reserve sufficiency analysis
  26




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Surplus and capital requirements
  Statutory accounting principles
   Insurance Regulatory Information System
  27




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   Risk-Based Capital (RBC) Requirements
   28




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Regulation of investments
  Federal initiatives
  Changes in tax laws
  29




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Other Laws and Regulations
 USA Patriot Act
  The International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001
  30




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The Bank Secrecy Act of 1970
  The Money Laundering Control Act of 1986
  Privacy of consumer information
  31




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The Terrorism Risk Insurance Act
     32




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 OFAC
   Gramm-Leach-Bliley Act
 
 33




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Environmental considerations
  Legislative Developments
    
 Item 1A. Risk Factors
  A substantial amount of our revenue comes from foreign nationals. This involves risks associated
with business in other countries, such as might result from political or economic instability or
the application of laws or regulations to our business.
  34




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  We may not be able to continue our past strategy of acquiring other U.S. life insurance companies,
and we may not realize improvements to our financial results due to past and future acquisitions.
    35




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
    
    inaccurate assessment of undisclosed liabilities and policyholder reserves;
    
    difficulties in realizing projected efficiencies, synergies and cost savings;
    
    failure to achieve anticipated revenues, earnings or cash flow;
    
    an increase in indebtedness and a limitation in our ability to access additional
capital when needed; and
    
    adverse changes in the economies of geographic regions in which the businesses of our
acquisitions are concentrated, due to natural disasters, changing population demographics,
governmental actions and other causes.
  Sales of our products may be reduced if we are unable to attract and retain marketing
representatives or develop and maintain distribution sources.
   Policy lapses in excess of those actuarially anticipated would have a negative impact on our
financial performance.
  36




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 .
 Our actual claims losses may exceed our reserves for claims that may require us to establish
additional reserves, which in turn may materially reduce our earnings, profitability and capital.
  Our investment portfolio is subject to several risks that may diminish the value of our invested
assets and negatively affect profitability.
 Our investment portfolio may suffer reduced returns or losses that could reduce our profitability.
  37




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The performance of our investment portfolio is subject to fluctuations due to changes in interest
rates and market conditions.
      Our investment portfolio is subject to credit risk.
  38




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  We may be required to accelerate the amortization of deferred acquisition costs and the cost of
customer relationships acquired, which would increase our expenses and reduce profitability.
    39




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  We may be required to recognize impairment in the value of our excess of cost over net assets
acquired that would increase our expenses and reduce our profitability.
  Loss of the services of our senior management team would likely hinder development of our operating
and marketing programs and our strategy for expanding our business.
  We are a defendant in lawsuits, which may adversely affect our financial condition and detract from
our managements time.
 Citizens Insurance Company of America, Citizens, Inc., Harold E. Riley
and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach
 40




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Abadie,
et al v. Aegis Security Insurance Co., et al
  Our business is subject to risks related to litigation and regulatory actions
  
    
    other possible disputes relating to the overseas trusts that hold our Class A
common stock on behalf of CICA policyholders. We also could face claims in foreign
countries relating to noncompliance with their securities laws in connection with
policyholders who participate in a non-U.S. trust and who beneficially own our Class A
common stock. We cannot, for example, ensure that our foreign sales associates are in
compliance with foreign securities and
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 insurance laws, as we do not have oversight
over such persons. The estimation of any liabilities from any possible claims would
be difficult to determine;
 
    
    disputes over insurance coverage or claims adjudication;
 
    
    disputes regarding sales practices, disclosures or absence of disclosures in
connection with the offer and sale of our insurance policies and the option available
to policyholders to assign dividends to a non-U.S. trust for the purpose of
accumulating our Class A common stock;
 
    
    regulatory compliance with insurance and securities laws in the United States and
in foreign countries;
 
    
    disputes with our consultants or employee agents over compensation and termination
of contracts and related claims;
    
    disputes regarding our tax liabilities; and
    
    disputes relating to businesses acquired by us.
   We operate in a highly competitive, mature industry within the U.S., which could limit our ability
to increase our domestic insurance operations.
  42




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    Our international operations face competition from several sources.
  
    
    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 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. Also, as a
result of the foregoing factors, the statistical cost of insurance for these companies
tends to be higher than ours. However, they hold their assets in local currencies,
which may be preferable to some potential customers.
 
    
    Companies foreign to the countries in which policies are sold but that issue local
currency policies.Another group of our competitors consists of
 43




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 companies that are
foreign to the countries in which the policies are sold but use the local currencies
of those countries. Local currency policies provide the benefit of assets located in
the country of foreign residents but entail risks of uncertainty due to local currency
fluctuations as well as the perceived instability and weakness of local currencies.
We have observed that local currency policies, whether issued by foreign or locally
operated companies, tend to focus on universal life insurance and annuities instead of
whole life insurance as we do.
 
    
    Foreign operated companies with U.S. Dollar policies.We also face direct
competition from companies that operate in the same manner as we do. We compete using
our history of performance and our products.Competitors in our international markets include National Western Life Insurance
Company, Best Meridian Insurance Company and to a lesser extent, Pan American Life
Insurance Company and American International Group. There can be no assurances that
competition from the above companies will not adversely affect our business.Our ability to compete is dependent upon, among other things, our ability:
 
    
    to attract marketing organizations and individuals who will market our products;
    
    to market our insurance products;
    
    to develop competitive and profitable products; and
    
    to maintain our underwriting and claims handling criteria.
 We are subject to extensive governmental regulation in the U.S., which increases our costs and
could restrict the conduct of our business.
  
    
    licensing companies to transact business;
    
    authorizing lines of business;
    
    mandating capital and surplus requirements;
    
    imposing dividend limitations;
 44




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
    
    regulating changes in control;
    
    licensing agents and distributors of insurance products;
    
    placing limitations on the minimum size of life insurance contracts;
    
    restricting companies ability to enter and exit markets;
    
    admitting statutory assets;
    
    mandating certain insurance benefits;
    
    restricting companies ability to terminate or cancel coverage;
    
    requiring companies to provide certain types of coverage;
    
    regulating premium rates, including the ability to increase premium rates;
    
    approving policy forms;
    
    regulating trade and claims practices;
    
    imposing privacy requirements;
    
    establishing reserve requirements and solvency standards;
    
    restricting certain transactions between affiliates;
    
    regulating the content of disclosures to debtors in the credit insurance area;
    
    mandating assessments or other surcharges for guaranty funds;
 
    
    regulating market conduct and sales practices of insurers and their marketers; and
 
    
    restricting contact with consumers, such as the recently created national do not
call list, and imposing consumer protection measures.
   45




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  We are unable to quantify the effect of foreign regulation of our insurance business if regulation
were to be imposed on us, but we believe we could expend substantial amounts of time and incur
substantial expense in complying with any foreign regulation, and we may decide to withdraw from
the particular market where the regulation was imposed.
  Changes in U.S. regulation may reduce our profitability and limit our prospective growth.
   46




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
     Reinsurers with which we do business with may not honor their obligations, leaving us liable for
the reinsured coverage, and our reinsurers could increase their premium rates.
    47




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   The failure to effectively maintain and modernize our information systems could adversely affect
our business.
   
    
    inadequate information on which to base pricing, underwriting and reserve
decisions;
    
    the loss of existing customers;
    
    difficulty in attracting new customers;
    
    customer and marketer disputes;
    
    regulatory problems, such as failure to meet prompt payment obligations;
    
    litigation exposure; or
 48




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
    
    increases in administrative expenses.
  To the extent that we fail to maintain our current system of internal controls to an effective
level with regard to material weaknesses we may identify, there is a risk that we may not be able
to report our financial results accurately. As a result, our business could be harmed, and current
and potential investors could lose confidence in our financial reporting, which could have a
negative effect on the trading price of our securities.
     49




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   Failure to protect confidential information and privacy could result in the loss of customers,
reduction to our profitability and subject us to fines and penalties.
  
    
    monitoring our record retention plans and any changes in state or federal privacy
and compliance requirements;
    
    drafting appropriate contractual provisions into any contract that raises
proprietary and confidentiality issues;
    
    maintaining secure storage facilities for tangible records; and
    
    limiting access to electronic information in order to safeguard certain current
information.
   50




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 The insurance business in which we operate may be subject to periodic negative publicity, which
may negatively impact our financial results
  General economic, financial market and political conditions may adversely affect our results of
operations and financial condition.
  
    
    insurance industry cycles;
    
    levels of employment;
    
    levels of consumer spending;
    
    levels of inflation; and
    
    movements of the financial markets.
  The inability of our subsidiaries to make payments to us in sufficient amounts for us to conduct
operations could harm our ability to meet our obligations.
  51




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The price of our Class A common stock may be volatile and may be affected by market conditions
beyond our control.
  
    
    quarterly variations in actual or anticipated results of our operations including for
individual products;
    
    interest rate fluctuations;
    
    changes in financial estimates by securities analysts;
    
    our failure to meet the expectations of securities analysts and investors; and
    
    actions or announcements by our competitors.
 Class A common stockholders will always be minority holders who will not control us, will have a
limited ability to influence our business policies and corporate actions, and will not by
themselves be able to elect any directors.
  Our articles of incorporation, bylaws and insurance laws may discourage takeovers and business
combinations that our stockholders might consider in their best interests.
  52




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    
    
    provide that our Class B common stock elects a simple majority of our board of
directors; all of such stock is beneficially owned by Harold E. Riley; and
    
    permit our board of directors to issue one or more series of preferred stock.
  You should not anticipate receiving cash dividends on your Citizens Class A common stock, because
we have not paid any cash dividends and do not anticipate doing so in the foreseeable future.
  There are a substantial number of shares of our Class A common stock eligible for future sale in
the public market. The sale of a large number of these shares could cause the market price of our
Class A common stock to fall.
 53




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
         54




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    Provisions of our Series A Preferred Stock may prevent or make it more difficult for us to raise
funds or take certain other actions.
  Holders of our Series A Preferred Stock may obtain the right to require us to redeem their Series
A Preferred Stock and we will be required to redeem any shares of Series A Preferred Stock that
remain outstanding on the fifth anniversary of their issuance
  55




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    
    
    the average closing price of our Class A common stock is $3.50 per share or above;
    
    we have sufficient number of shares of Class A common stock available for
issuance;
    
    our Class A common stock is listed on NYSE or other eligible market;
    
    the shares of Class A common stock to be issued are registered under an effective
registration statement;
    
    the shares to be issued can be issued without violating the rules of the NYSE or
any applicable trading market or a provision of our agreement with the holders;
    
    we have not filed for protection under applicable bankruptcy laws; and
    
    certain other enumerated conditions.
   56




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   
 Item 1B. Unresolved Staff Comments
  
 Item 2. Properties
   
 Item 3. Legal Proceedings
 Citizens Insurance Company of America, Citizens, Inc., Harold E. Riley
and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach
 57




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Abadie, et al v. Aegis Security Insurance Co., et al
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 PART II
 
 Item 5.
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
  58




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 2006
    
    2005Quarter Ended
    
    High
    
    Low
    
    High
    
    LowMarch 31
    
    $
    5.60
    
    
    
    4.78
    
    
    
    5.80
    
    
    
    5.01June 30
    
    
    5.54
    
    
    
    4.57
    
    
    
    5.79
    
    
    
    4.79September 30
    
    
    6.04
    
    
    
    4.88
    
    
    
    6.93
    
    
    
    5.70December 31
    
    
    6.97
    
    
    
    5.60
    
    
    
    6.05
    
    
    
    4.92
     
 Securities Authorized for Issuance Under Equity Compensation Plans
  
 Item 6. Selected Financial Data
  59




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Year Ended December 31,(In thousands except per share data)2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Total Revenues
    
    $
    158,059
    
    
    
    142,113
    
    
    
    99,859
    
    
    
    92,060
    
    
    
    82,901Net Income
    
    
    8,677
    
    
    
    7,302
    
    
    
    7,732
    
    
    
    3,126
    
    
    
    4,254Basic Earnings Per Share
    
    
    0.16
    
    
    
    0.13
    
    
    
    0.17
    
    
    
    0.08
    
    
    
    0.12Total Assets at December 31
    
    
    711,184
    
    
    
    661,889
    
    
    
    661,212
    
    
    
    390,093
    
    
    
    326,291Long-term Debt
    
    
    
    
    
    
    
    
    
    
    30,000
    
    
    
    
    
    
    
    Total Liabilities
    
    
    558,690
    
    
    
    513,380
    
    
    
    520,179
    
    
    
    263,066
    
    
    
    224,499Total Stockholders Equity
    
    
    139,611
    
    
    
    136,963
    
    
    
    135,131
    
    
    
    127,027
    
    
    
    101,792Book Value Per Share
    
    
    3.38
    
    
    
    3.33
    
    
    
    3.29
    
    
    
    3.10
    
    
    
    2.76
  
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 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.
  Life Insurance.
 60




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    Home Service Insurance.
   61




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   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 an 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 holdings, constituting
less than 1% of total invested assets as of December 31, 2006 and December 31, 2005.
    
    Corporate bond defaults and credit downgrades, which have resulted in
other-than-temporary impairments in the value of some 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
in U.S. Government-sponsored enterprises. Most of the municipal bonds we own are
privately insured. We intend to manage our investment portfolio conservatively in the
future in these type of debt instruments.
    
    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.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
    
    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.
 Significant Transactions
 Cessation of Accident and Health Business
  Acquisition of Security Plan
   63




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Results
  Net Income perYear Ended
    
    Net Income
    
    Class A & B
    
    Change fromDecember 31,
    
    (In Thousands)
    
    Share
    
    Previous Year2006
    
    $
    8,677
    
    
    $
    0.16
    
    
    
    18.8
    %2005
    
    
    7,302
    
    
    
    0.13
    
    
    
    (5.6
    )2004
    
    
    7,732
    
    
    
    0.17
    
    
    
    147.3
   Premium Income
 Net Investment Income
 Reserves
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Policy Dividends
 Claims and Surrenders
  Year ended December 31,(In thousands)2006
    
    
    2005
    
    
    2004Death claims
    
    $
    21,686
    
    
    
    22,404
    
    
    
    10,224Surrender expenses
    
    
    17,205
    
    
    
    15,369
    
    
    
    15,960Endowments
    
    
    10,786
    
    
    
    9,021
    
    
    
    7,509Casualty claims
    
    
    5,194
    
    
    
    3,685
    
    
    
    562Other policy benefits
    
    
    849
    
    
    
    780
    
    
    
    752Accident and health benefits
    
    
    541
    
    
    
    446
    
    
    
    (60
    )Total claims and surrenders
    
    $
    56,261
    
    
    
    51,705
    
    
    
    34,947
    65




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   Commissions
 Underwriting, Acquisition and Insurance Expense
 Deferred Policy Acquisition Costs
 Cost of Customer Relationships Acquired and Other Intangibles
 66




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  Federal Income Tax
 Liquidity and Capital Resources
    67




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    Less than 1
    
    
    
    
    
    
    
    
    
    
    More than 5Contractual Obligation
    
    Total
    
    
    Year
    
    
    1 to 3 Years
    
    
    3 to 5 Years
    
    
    Years(In Thousands)Operating leases
    
    $
    683
    
    
    
    267
    
    
    
    297
    
    
    
    119
    
    
    
    Other
    
    
    2,336
    
    
    
    2,292
    
    
    
    44
    
    
    
    
    
    
    
    Total operating and other leases
    
    $
    3,019
    
    
    
    2,559
    
    
    
    341
    
    
    
    119
    
    
    
    Future policy benefit reserves:Life insurance
    
    $
    473,355
    
    
    
    176
    
    
    
    987
    
    
    
    9,258
    
    
    
    462,934Annuities
    
    
    20,761
    
    
    
    8,263
    
    
    
    5,708
    
    
    
    3,696
    
    
    
    3,094Accident and health
    
    
    10,604
    
    
    
    10,604
    
    
    
    
    
    
    
    
    
    
    
    Total future policy benefit reserves
    
    $
    504,720
    
    
    
    19,043
    
    
    
    6,695
    
    
    
    12,954
    
    
    
    466,028Policy claims payable:Life insurance
    
    $
    6,189
    
    
    
    6,189
    
    
    
    
    
    
    
    
    
    
    
    Accident and health
    
    
    1,423
    
    
    
    1,423
    
    
    
    
    
    
    
    
    
    
    
    Casualty
    
    
    1,836
    
    
    
    1,836
    
    
    
    
    
    
    
    
    
    
    
    Total policy claims payable
    
    $
    9,448
    
    
    
    9,448
    
    
    
    
    
    
    
    
    
    
    
    Convertible Preferred Stock
    
    $
    16,251
    
    
    
    
    
    
    
    
    
    
    
    16,251
    
    
    
    Total contractual obligations$
    533,438
    
    
    $
    31,050
    
    
    $
    7,036
    
    
    $
    29,324
    
    
    $
    466,028
  69




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Parent Company Liquidity and Capital Resources
   Critical Accounting Policies
  Policy Liabilities
   Deferred Policy Acquisition Costs
  70




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
     Valuation of Investments in Fixed Maturity and Equity Securities
   71




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  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
 Income Tax Consequences of Issuing Convertible
Debt with a Beneficial Conversion Feature Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios Application of Issue No. 98-5
to Certain Convertible Instruments
 72




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments Accounting for Certain Investments in
Debt and Equity The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments
 Determining Whether a General Partner,
or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the
Limited Partners Have Certain Rights
 Accounting Changes and Error Corrections, a replacement
of APB Opinion No. 2 and FASB Statement No. 3
 73




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Accounting Issues Related to Certain features of Contingently Convertible Debt and the Effect on
Diluted Earnings per Share
 Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements
   Fair Value Measurements Accounting for Derivative Instruments and Hedging
Activities
 74




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
  The Fair Value Option for Financial Assets and
Financial Liabilities
 Accounting for Uncertainty in Income
Taxes  an interpretation of FASB Statement No.-10
 
 Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
 General
  Market Risk Related to Interest Rates
  75




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   Change in Interest Rates
Decreases in Interest Rates(In thousands)
 100 Basis
    
    
    200 Basis
    
    
    300 BasisDecember 31,
    
    Points
    
    
    Points
    
    
    Points2006
    
    $
    20,429
    
    
    
    36,129
    
    
    
    55,3122005
    
    $
    23,279
    
    
    
    42,730
    
    
    
    65,930
 Increases in Interest Rates(In thousands)
 100 Basis
    
    
    200 Basis
    
    
    300 BasisDecember 31,
    
    Points
    
    
    Points
    
    
    Points2006
    
    $
    (32,305
    )
    
    
    (59,302
    )
    
    
    (92,949
    )2005
    
    $
    (42,198
    )
    
    
    (73,921
    )
    
    
    (102,269
    )
   Market Risk Related to Equity Prices
  76




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 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
 (a) Disclosure Controls and Procedures
   (b) Management Report on Internal Control over Financial Reporting
 Internal Control  Integrated Framework
  77




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
   
    
    Stockholders equity as of January 1, 2006 was reduced by $3.1 million as a result
of the Companys adoption of SAB 108.
    
    Pre-tax income was reduced by $1.7 million due to an impairment of goodwill (excess
cost over net assets acquired) of approximately $1.0 million and additional
amortization of intangible assets (cost of customer relationships acquired) of
approximately $0.7 million for the year ended December 31, 2006.
  (c) Change in Internal Control over Financial Reporting
 Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements
   78




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
    
    Hired a new Vice President of Accounting, with significant statutory accounting and
U.S. GAAP experience during the fourth quarter of 2006;
    
    Hired a new Chief Actuary with a background in U.S. GAAP financial reporting during
the third quarter of 2006;
    
    Are committed to implementing an automated U.S. GAAP ledger during 2007; and
    
    Are strengthening the process of workpaper review by senior members of management
to ensure the completeness and accuracy of supporting workpapers and schedules,
including formalized sign-off processes.
 (d) Report of Independent Registered Public Accounting Firm on Internal Control over Financial
Reporting
 Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
  Internal
Control-Integrated Framework
   79




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
    
    
    Stockholders equity as of January 1, 2006 was reduced by $3.1 million as a result
of the Companys adoption of SAB 108.
    
    Pre-tax income was reduced by $1.7 million due to an impairment of goodwill (excess
cost over net assets acquired) of approximately $1.0 million and
additional amortization of intangible assets (cost of customer
relationships acquired) of approximately $0.7 million for the
year ended December 31, 2006.
    /s/ Ernst & Young LLPAustin, TexasMarch 30, 2007
 80




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Item 9B.
Other Information
  
 PART III
 10, 11, 12, 13 14
 
 PART IV
 
 Item 15.
Exhibits, Financial Statement Schedules
 (a)
    
    (1) and (2) Filings as Part of this ReportThe financial statements and schedules listed on the following index to financial
statements and financial statement schedules are filed under Item 8 as part of this
Form 10-K.(b)
    
    (3) Exhibits  See the Exhibit Index
 81




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Index to Consolidated Financial Statements and
Financial Statement Schedules
 PageReferenceReports of independent registered public accounting firms
    
    
    83Consolidated statements of financial position at December 31,
2006 and 2005
    
    
    85Consolidated statements of operations
- years ended December 31, 2006, 2005 and 2004
    
    
    87Consolidated statements of stockholders equity and comprehensive
income  years ended December 31, 2006, 2005 and 2004
    
    
    89Consolidated statements of cash flows
- years ended December 31, 2006, 2005 and 2004
    
    
    91Notes to consolidated financial statements
    
    
    94Schedules at December 31, 2006 and 2005:Schedule II  Condensed Financial
Information of Registrant
    
    
    140Schedules for each of the years in the three-year
period ended December 31, 2006:Schedule III  Supplementary Insurance Information
    
    
    143Schedule IV  Reinsurance
    
    
    145
  82




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Report of Independent Registered Public Accounting Firm
     Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current
Year Financial Statements
 Internal Control-Integrated
Framework
 /s/ Ernst & Young LLPAustin, TexasMarch 30, 2007
 83




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Report of Independent Registered Public Accounting Firm
 
    /s/ KPMG LLPDallas, TexasMarch 16, 2006
 84




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Consolidated Statements of Financial Position
December 31, 2006 and
2005 
(In thousands)
 2006
    
    
    2005AssetsInvestments:Fixed maturities held-to-maturity, at amortized cost
(fair value $0 and $9,144 in 2006 and 2005, respectively)
    
    $
    
    
    
    
    7,640Fixed maturities available-for-sale, at fair value
(cost: $497,939 and $457,387 in 2006 and 2005, respectively)
    
    
    488,318
    
    
    
    449,931Equity securities available-for-sale, at fair value
(cost: $279 and $429 in 2006 and 2005, respectively)
    
    
    312
    
    
    
    610Mortgage loans on real estate, net
(less $0 and $50 allowance for loan losses in 2006 and
and 2005, respectivley)
    
    
    456
    
    
    
    833Policy loans
    
    
    23,542
    
    
    
    23,918Real estate and other long-term investments
(less $206 and $172 accumulated depreciation in 2006
and 2005, respectively)
    
    
    2,427
    
    
    
    1,879Total investments
    
    
    515,055
    
    
    
    484,811Cash and cash equivalents
    
    
    24,521
    
    
    
    18,311Accrued investment income
    
    
    7,107
    
    
    
    6,478Reinsurance recoverable
    
    
    16,044
    
    
    
    19,118Deferred policy acquisition costs
    
    
    86,975
    
    
    
    70,410Other intangible assets
    
    
    1,093
    
    
    
    2,095Cost of customer relationships acquired
    
    
    34,812
    
    
    
    39,259Excess of cost over net assets acquired
    
    
    11,386
    
    
    
    12,402Property and equipment, net
    
    
    7,350
    
    
    
    7,737Due premium, net
(less $1,440 and $0 allowance for doubtful accounts in 2006
and 2005, respectively)
    
    
    6,078
    
    
    
    28Other assets
    
    
    763
    
    
    
    1,240Total assets
    
    $
    711,184
    
    
    
    661,889
  85




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Statements of Financial Position, Continued
December 31, 2006 and 2005
(In thousands)
 2006
    
    
    2005Liabilities and Stockholders EquityLiabilities:Future policy benefit reserves:Life insurance
    
    $
    473,355
    
    
    
    436,717Annuities
    
    
    20,761
    
    
    
    19,440Accident and health
    
    
    10,604
    
    
    
    11,580Dividend accumulations
    
    
    5,027
    
    
    
    5,067Premium deposits
    
    
    11,897
    
    
    
    9,942Policy claims payable
    
    
    9,448
    
    
    
    11,227Unearned premium
    
    
    1,812
    
    
    
    1,684Other policyholders funds
    
    
    3,771
    
    
    
    3,789Total policy liabilities
    
    
    536,675
    
    
    
    499,446Commissions payable
    
    
    2,581
    
    
    
    2,667Federal income tax payable
    
    
    2,031
    
    
    
    448Deferred Federal income tax
    
    
    1,498
    
    
    
    1,621Warrants outstanding
    
    
    1,831
    
    
    
    1,587Funds held in trust and other liabilities
    
    
    14,074
    
    
    
    7,611Total liabilities
    
    
    558,690
    
    
    
    513,380Commitments and contingencies (Note 10)Cumulative convertible preferred stock  Series A(Series A-1-$500 stated valueper share,25,000 shares issued, authorized and
outstanding in 2006 and 2005; Series A-2 - $935 stated value per share, 5,000
shares authorized, 4,014 shares issued and outstanding in 2006 and 2005)
    
    
    12,883
    
    
    
    11,546Stockholders equity:Common stock:Class A, no par value, 100,000,000 shares authorized,
43,425,524 shares issued in 2006 and 43,300,934 shares issued in
2005, including shares in treasury of 3,135,738 in 2006 and 2005
    
    
    210,066
    
    
    
    211,403Class B, no par value, 2,000,000 shares authorized,
1,001,714 shares issued and outstanding in 2006 and 2005
    
    
    3,184
    
    
    
    3,184Retained deficit
    
    
    (56,282
    )
    
    
    (61,812
    )Accumulated other comprehensive loss:Unrealized losses on securities, net of tax
    
    
    (6,346
    )
    
    
    (4,801
    )150,622
    
    
    
    147,974Treasury stock, at cost
    
    
    (11,011
    )
    
    
    (11,011
    )Total stockholders equity
    
    
    139,611
    
    
    
    136,963Total liabilities and stockholders equity
    
    $
    711,184
    
    
    
    661,889
  86




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Consolidated Statements of Operations 
Years ended December 31, 2006, 2005 and 2004 (In thousands)
 2006
    
    
    2005
    
    
    2004Revenues:Premiums:Life insurance
    
    $
    123,258
    
    
    
    111,087
    
    
    
    78,013Accident and health
    
    
    1,461
    
    
    
    1,560
    
    
    
    788Property
    
    
    3,777
    
    
    
    3,627
    
    
    
    1,113Net investment income
    
    
    26,975
    
    
    
    23,568
    
    
    
    17,005Realized gains, net
    
    
    1,286
    
    
    
    419
    
    
    
    389Decrease (increase) in fair value of warrants
    
    
    (244
    )
    
    
    489
    
    
    
    256Other income
    
    
    1,546
    
    
    
    1,363
    
    
    
    2,295Total revenues
    
    
    158,059
    
    
    
    142,113
    
    
    
    99,859Benefits and expenses:Insurance benefits paid or provided:Claims and surrenders
    
    
    56,261
    
    
    
    51,705
    
    
    
    34,947Increase in future policy benefit reserves
    
    
    30,719
    
    
    
    23,603
    
    
    
    18,120Policyholders dividends
    
    
    5,384
    
    
    
    4,789
    
    
    
    4,142Total insurance benefits paid or provided
    
    
    92,364
    
    
    
    80,097
    
    
    
    57,209Commissions
    
    
    35,691
    
    
    
    32,985
    
    
    
    21,274Other underwriting, acquisition and insurance
expenses
    
    
    27,607
    
    
    
    25,429
    
    
    
    17,391Capitalization of deferred policy acquisition costs
    
    
    (26,986
    )
    
    
    (24,388
    )
    
    
    (17,241
    )Amortization of deferred policy acquisition costs
    
    
    11,391
    
    
    
    10,313
    
    
    
    8,439Amortization of cost of customer relationships
acquired and other intangibles
    
    
    4,650
    
    
    
    5,881
    
    
    
    4,136Loss on coinsurance agreement
    
    
    
    
    
    
    
    
    
    
    563Total benefits and expenses
    
    
    144,717
    
    
    
    130,317
    
    
    
    91,771
 87




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Statements of Operations, Continued 
Years ended December 31, 2006, 2005 and 2004
(In thousands)
 2006
    
    
    2005
    
    
    2004Income before Federal income tax
    
    $
    13,342
    
    
    
    11,796
    
    
    
    8,088Federal income tax expense
    
    
    4,665
    
    
    
    4,494
    
    
    
    356Net income
    
    $
    8,677
    
    
    
    7,302
    
    
    
    7,732Net income applicable to common stockholders
    
    $
    6,654
    
    
    
    5,326
    
    
    
    6,803Per Share AmountsBasic and diluted earnings per share of common
stock
    
    $
    0.16
    
    
    
    0.13
    
    
    
    0.17Weighted average shares outstanding  basic
and diluted
    
    
    41,218
    
    
    
    41,105
    
    
    
    41,017
 88




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Consolidated
Statements of Stockholders Equity and Comprehensive Income
 Years ended December 31, 2006, 2005 and 2004
(In thousands)
 Accumulatedother
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Retained
    
    
    comprehensive
    
    
    Treasury
    
    
    StockholdersClass A
    
    
    Class B
    
    
    deficit
    
    
    income (loss)
    
    
    stock
    
    
    equityBalance at December 31, 2003
    
    $
    178,066
    
    
    
    2,437
    
    
    
    (46,077
    )
    
    
    1,272
    
    
    
    (8,672
    )
    
    
    127,026Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    7,732
    
    
    
    
    
    
    
    
    
    
    
    7,732Unrealized investment losses, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,021
    )
    
    
    
    
    
    
    (2,021
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    7,732
    
    
    
    (2,021
    )
    
    
    
    
    
    
    5,711Beneficial conversion feature on preferred
stock
    
    
    3,073
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,073Accretion of deferred issuance costs and
discounts on preferred stock
    
    
    (679
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (679
    )Stock dividend
    
    
    16,878
    
    
    
    390
    
    
    
    (16,047
    )
    
    
    
    
    
    
    (1,221
    )
    
    
    Balance at December 31, 2004
    
    
    197,338
    
    
    
    2,827
    
    
    
    (54,392
    )
    
    
    (749
    )
    
    
    (9,893
    )
    
    
    135,131Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    7,302
    
    
    
    
    
    
    
    
    
    
    
    7,302Unrealized investment losses, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,052
    )
    
    
    
    
    
    
    (4,052
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    7,302
    
    
    
    (4,052
    )
    
    
    
    
    
    
    3,250Accretion of deferred issuance costs and
discounts on preferred stock
    
    
    (1,418
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,418
    )Stock dividend
    
    
    15,483
    
    
    
    357
    
    
    
    (14,722
    )
    
    
    
    
    
    
    (1,118
    )
    
    
    Balance at December 31, 2005
    
    
    211,403
    
    
    
    3,184
    
    
    
    (61,812
    )
    
    
    (4,801
    )
    
    
    (11,011
    )
    
    
    136,963Cummulative effect of adopting SEC StaffAccounting Bulletin No. 108
    
    
    
    
    
    
    
    
    
    
    (3,147
    )
    
    
    
    
    
    
    
    
    
    
    (3,147
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    8,677
    
    
    
    
    
    
    
    
    
    
    
    8,677Unrealized investment losses, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,545
    )
    
    
    
    
    
    
    (1,545
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    8,677
    
    
    
    (1,545
    )
    
    
    
    
    
    
    7,132Accretion of deferred issuance costs and
discounts on preferred stock
    
    
    (1,337
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,337
    )Balance at December 31, 2006
    
    $
    210,066
    
    
    
    3,184
    
    
    
    (56,282
    )
    
    
    (6,346
    )
    
    
    (11,011
    )
    
    
    139,611
  89




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Statements of Stockholders Equity, continued 
Years ended December 31, 2006, 2005 and 2004
(In thousands)
  Common Stock
    
    
    TreasuryClass A
    
    
    Class B
    
    
    StockBalance at December 31, 2003
    
    
    37,674
    
    
    
    875
    
    
    
    (2,739
    )Stock dividends
    
    
    2,690
    
    
    
    61
    
    
    
    (192
    )Balance at December 31, 2004
    
    
    40,364
    
    
    
    936
    
    
    
    (2,931
    )Stock dividends
    
    
    2,937
    
    
    
    66
    
    
    
    (205
    )Balance at December 31, 2005
    
    
    43,301
    
    
    
    1,002
    
    
    
    (3,136
    )Stock dividends
    
    
    125
    
    
    
    
    
    
    
    Balance at December 31, 2006
    
    
    43,426
    
    
    
    1,002
    
    
    
    (3,136
    )
  90




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Consolidated Statements of Cash Flows 
Years ended December 31, 2006, 2005 and 2004
(In thousands)
 2006
    
    
    2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    8,677
    
    
    
    7,302
    
    
    
    7,732Adjustments to reconcile net income to net cash
provided by operating activities, net of
assets acquired:Realized gains on sale of investments and other
assets
    
    
    (1,286
    )
    
    
    (419
    )
    
    
    (389
    )Net deferred policy acquisition costs
    
    
    (16,565
    )
    
    
    (14,075
    )
    
    
    (8,802
    )Amortization of cost of customer relationships
acquired, and other intangibles
    
    
    4,650
    
    
    
    5,881
    
    
    
    4,136Loss on coinsurance agreements
    
    
    
    
    
    
    
    
    
    
    563Increase (decrease) in fair value of options and
warrants
    
    
    244
    
    
    
    (489
    )
    
    
    (256
    )Depreciation
    
    
    1,297
    
    
    
    897
    
    
    
    878Amortization of premiums and discounts on fixed
fixed maturities
    
    
    1,467
    
    
    
    1,154
    
    
    
    448Deferred federal income tax expense (benefit)
    
    
    829
    
    
    
    2,903
    
    
    
    (1,118
    )Change in:Accrued investment income
    
    
    (644
    )
    
    
    (364
    )
    
    
    (130
    )Reinsurance recoverable
    
    
    3,452
    
    
    
    (1,311
    )
    
    
    (10,381
    )Other receivables
    
    
    (1,089
    )
    
    
    
    
    
    
    Future policy benefit reserves
    
    
    31,741
    
    
    
    23,003
    
    
    
    16,835Other policy liabilities
    
    
    (46
    )
    
    
    4,867
    
    
    
    795Federal income tax
    
    
    1,330
    
    
    
    (859
    )
    
    
    344Commissions payable and other liabilities
    
    
    4,854
    
    
    
    2,469
    
    
    
    (778
    )Other, net
    
    
    166
    
    
    
    3,547
    
    
    
    (1,189
    )Net cash provided by operating activities
    
    
    39,077
    
    
    
    34,506
    
    
    
    8,688Cash flows from investing activities:Sale of fixed maturities, held-to-maturity
    
    
    2,472
    
    
    
    
    
    
    
    Sale of fixed maturities, available-for-sale
    
    
    14,006
    
    
    
    14,569
    
    
    
    42,824Maturity of fixed maturities, available-for-sale
    
    
    57,473
    
    
    
    93,746
    
    
    
    89,615Purchase of fixed maturities, available-for-sale
    
    
    (107,080
    )
    
    
    (132,557
    )
    
    
    (82,634
    )Sale of equity securities, available-for-sale
    
    
    334
    
    
    
    616
    
    
    
    63Principal payments on mortgage loans
    
    
    201
    
    
    
    89
    
    
    
    272Mortgage loans funded
    
    
    
    
    
    
    (100
    )
    
    
    (194
    )Sale of other long-term investments and property
and equipment
    
    
    264
    
    
    
    686
    
    
    
    490Principal payments on note receivable
    
    
    475
    
    
    
    396
    
    
    
    
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Statements of Cash Flows, Continued 
Years ended December 31, 2006, 2005 and 2004
(In thousands)
 2006
    
    
    2005
    
    
    2004(Increase) decrease in policy loans, net
    
    
    (428
    )
    
    
    398
    
    
    
    1,228Purchase of other long-term investments and property
and equipment
    
    
    (1,277
    )
    
    
    (432
    )
    
    
    (3,485
    )Cash paid for acquisition, net
    
    
    
    
    
    
    
    
    
    
    (82,232
    )Net cash used in investing activities
    
    
    (33,560
    )
    
    
    (22,589
    )
    
    
    (34,053
    )Cash flows from financing activities:Proceeds from issuance of convertible preferred stock
    
    
    
    
    
    
    3,751
    
    
    
    12,500Payment of convertible preferred stock issuance costs
    
    
    
    
    
    
    (187
    )
    
    
    (1,211
    )Proceeds from note payable
    
    
    
    
    
    
    
    
    
    
    30,000Payoff of note payable
    
    
    
    
    
    
    (30,000
    )
    
    
    Annuity and universal life deposits
    
    
    2,520
    
    
    
    3,021
    
    
    
    3,520Annuity and universal life withdrawals
    
    
    (1,827
    )
    
    
    (1,912
    )
    
    
    (2,739
    )Net cash provided by (used in) financing
activities
    
    
    693
    
    
    
    (25,327
    )
    
    
    42,070Net increase (decrease) in cash and cash equivalents
    
    
    6,210
    
    
    
    (13,410
    )
    
    
    16,705Cash and cash equivalents at beginning of year
    
    
    18,311
    
    
    
    31,721
    
    
    
    15,016Cash and cash equivalents at end of year
    
    $
    24,521
    
    
    
    18,311
    
    
    
    31,721Supplemental Disclosure of Operating ActivitiesCash paid during the year for:Interest
    
    $
    
    
    
    
    695
    
    
    
    Income taxes
    
    $
    2,506
    
    
    
    2,450
    
    
    
    779
 Supplemental disclosures of non-cash investing and financing activities:
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 Consolidated Statements of Cash Flows, Continued 
Years ended December 31, 2006, 2005 and 2004
(In thousands)
  2004Fair value of tangible assets acquired excluding cash
and cash equivalents of $3,781
    
    $
    (255,361
    )Fair value of intangible assets acquired
    
    
    (34,012
    )Liabilities assumed
    
    
    207,141Cash and cash equivalents used in mergers and acquisitions
    
    $
    (82,232
    )
    93




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
 
 Notes to Consolidated Financial Statements
 December 31, 2006, 2005 and 2004
 (1) Summary of Significant Accounting Policies
 (a)
    
    Principles of ConsolidationThe 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), Computing
Technology, Inc. (CTI), Funeral Homes of America, Inc. (FHA), Insurance Investors, Inc.
(III), Citizens National Life Insurance Company (CNLIC), Security Plan Life Insurance
Company (SPLIC), and Security Plan Fire Insurance Company, (SPFIC). All significant
inter-company accounts and transactions have been eliminated. Citizens and its wholly
owned consolidated subsidiaries are collectively referred to as the Company, we, or
our.On March 15, 2006, Mid-American Associates Agency was dissolved. In addition, Citizens
USA Life Insurance Company was merged into CICA effective March 31, 2006, and Security
Alliance Insurance Company was merged into CICA effective October 1, 2006.Citizens provides life and health insurance policies through three of its subsidiaries
  CICA, SPLIC and CNLIC. CICA issues ordinary whole-life policies internationally and
domestically, and burial insurance, pre-need policies, and accident and health related
policies, throughout the Midwestern and southern United States. SPLIC offers home
service life insurance in Louisiana and Mississippi, and SPFIC, a wholly owned
subsidiary of SPLIC, writes a limited amount of property insurance in Louisiana.A formal contract was signed with a third party in the first quarter of 2006 to sell
CNLIC, but was subject to regulatory approval before closing. Closing is now expected
in 2007.III provides aviation transportation to the Company. CTI provides data processing
systems and services as well as furniture and equipment to the Company. FHA is a
funeral home operator.(b)
    
    Basis of PresentationThe accompanying consolidated financial statements of the Company and its wholly owned
subsidiaries have been prepared in conformity with U.S. Generally Accepted Accounting
Principles (U.S. GAAP).(c)
    
    InvestmentsFixed maturities consist primarily of bonds. Fixed maturities that the Company has the
ability and intent to hold to maturity are carried at amortized cost. Fixed
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 maturities that may be sold prior to maturity to support the Companys investment
strategies are considered held as available-for-sale and carried at fair value. Equity
securities (including non-redeemable preferred stock) are considered available-for-sale
and are reported at fair value. The Company uses the specific identification method in
computing realized gains and losses from the sale of securities.Unrealized appreciation (depreciation) of equity securities and fixed maturities held
as available-for-sale is shown as a separate component of stockholders equity, net of
tax, and is a separate component of comprehensive income.A decline in the fair value of any available-for-sale or held-to-maturity security
below cost that is deemed other than temporary is charged to earnings resulting in the
establishment of a new cost basis for the security.Mortgage loans on real estate and policy loans are reported at unpaid principal
balances.Real estate and other long-term investments consist primarily of land and buildings
that are recorded at the lower of fair value, minus estimated costs to sell, or
depreciated cost. If the fair value of the real estate is less than the carrying
value, an impairment loss is recognized and charged to earnings.Premiums and discounts are amortized or accreted over the life of the related security
as an adjustment to yield using the effective interest method. Dividend and interest
income is recognized when earned. Realized gains and losses for securities classified
as available-for-sale and held-to-maturity are included in earnings and are derived
using the specific identification method for determining the cost of securities sold.The Company had assets with a fair value of $6,571,000 and $11,558,000 at December 31,
2006 and 2005, respectively, on deposit with various state regulatory authorities to
fulfill statutory requirements.(d)
    
    Premium Revenue and Related ExpensesBeginning the first quarter of 2006, the Company began accruing premium revenue based
on the gross amount due rather than just a portion of that amount, in accordance with
Statement of Financial Accounting Standard (SFAS) 60Accounting and Reporting by Insurance Enterprises.The initial implementation of this
accounting treatment, in the amount of $955,000 of income, was recorded in the SAB 108
adjustment discussed in Note 1(q) below.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Premiums on life policies are recognized as earned when due. Due premium on the balance
sheet are net of premium allowances of $1,440,000 in 2006 and $0 in
2005. Accident and Health policies are recognized as revenue over the contract period
on a pro rata basis. Benefits and expenses are associated with earned premiums so as
to result in the recognition of profits over the estimated lives of the contracts.
This matching is accomplished by means of a provision for future policy benefits and
the capitalization and amortization of deferred policy acquisition costs.Annuity policies, primarily flexible premium fixed annuity products, are accounted for
in a manner consistent with accounting for interest bearing financial instruments.
Premium receipts are not reported as revenue, rather as deposit liabilities to annuity
contracts. The annuity products issued do not included fees or other such charges.(e)
    
    Deferred Policy Acquisition Costs and Cost of Customer Relationships AcquiredAcquisition costs, consisting of commissions and policy issuance, underwriting and
agency expenses that relate to and vary with the production of new business, are
deferred. These deferred policy acquisition costs are amortized primarily over the
estimated premium paying period of the related policies in proportion to the ratio of
the annual premium recognized to the total premium revenue anticipated using the same
assumptions as were used in computing liabilities for future policy benefits.A new GAAP era was created in 2006 for CICA new issues to reflect the better mortality
and persistency being experienced in the last few years. This new era resulted in a
decrease in DAC amortization by $800,000 in 2006.The Company utilizes the factor method to determine the amount of costs to be
capitalized and the ending asset balance. The factor method ensures that policies that
lapsed or surrendered during the reporting period are no longer included in the
deferred policy acquisition costs or the cost of customer relationships acquired (CCRA)
calculation. The factor method limits the amount of deferred costs to its estimated
realizable value, provided actual experience is comparable to that contemplated in the
factors. A recoverability test that considers among other things, actual experience
and projected future experience, is performed at least annually.Deferred policy acquisition costs on universal life contracts are capitalized and
amortized over the life of the contract at a constant rate based on the present value
of the estimated gross profit amounts expected to be earned over the life of the
universal life contracts.The value of CCRA in the Companys various acquisitions, which is included in cost of
customer relationships acquired in the accompanying consolidated financial statements,
was determined based on the present value of future profits
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 discounted at rates ranging from 5% to 8.5%. In 2005 the Company recorded additional
amortization of $2.3 million related to the Louisiana hurricanes. In conjunction with
this loss recognition, management revised the Companys amortization methodology to (a)
reduce its projection of future collected premiums by approximately 4% and (b) to
amortize the acquired paid up block over in force balances, which resulted in a
$400,000 decrease in amortization expense in 2006. As a result, for premium-paying
policies, the CCRA is being amortized over the anticipated premium paying period of the
related policies. For paid-up policies, amortization is based on the change in
in-force balances. Prior to 2006, amortization for premium paying and paid-up policies
was amortized over the anticipated premium paying period.(f)
    
    Policy Liabilities and AccrualsFuture policy benefit reserves for life insurance have been computed by the net level
premium method with assumptions as to investment yields, dividends on participating
business, mortality and withdrawals based upon the Companys and industry experience,
which provide for possible unfavorable deviation. A new GAAP era was created in 2006
for CICA new issues to better reflect mortality and persistency. This new era lowered
reserves by $400,000 in 2006.Annuity benefits are carried at accumulated contract values based on consideration paid
by participants, annuity rates of return ranging from 3.0% to 8.0% and annuity
withdrawals.Accident and health reserves are carried based on case-basis estimates for reported
claims.The Companys casualty business by its nature requires contingencies for loss reserves
and claim costs resulting from specific uncertainties that are not considered to be
recurring or normal due to their significance or nature. In 2005, Hurricane Katrina
devastated the Gulf Coast. The Company suffered losses of $4.1 million in excess of
its reinsurance coverage related to this storm. At the end of 2006, the Company was
still receiving claims related to Katrina. As a result, loss reserves were increased
by $500,000 in anticipation of newly reported or adjusted claims.Premium deposits accrue interest at rates ranging from 4.0% to 8.25% per annum. The
cost of insurance is included in premium when collected and interest is credited
annually to the deposit account.Policyholder dividends are determined based on the discretion of the Companys Board of
Directors. The Company utilizes contractual life insurance dividend scales as shown in
published dividend illustrations at the date the insurance contracts are issued
(unrelated to the Companys net income)
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 in determining
policyholder dividends. Policyholder dividends are accrued over the premium paying
periods of the insurance contracts.Policy and contract claims are based on case-basis estimates for reported claims, and
on estimates, based on experience, for incurred but unreported claims and loss
expenses.(g)
    
    Excess of Cost Over Net Assets Acquired and Other Intangible AssetsThe excess of cost over net assets acquired (goodwill) is the difference between the
purchase price in a business combination and the fair value of assets and liabilities
acquired. Other intangible assets include various state insurance licenses, which have
been determined to have an indefinite useful lives. Therefore, amounts are not
amortized. Instead, such assets are subjected to annual impairment analyses, while
intangibles with definitive lives are amortized over the life of the respective asset.
The Company performed assessments of whether there was an indication that goodwill and
intangible assets were impaired on December 31, 2006 and wrote off $1.0 million of
goodwill in 2006. No impairments were identified in 2005 and 2004.(h)
    
    Participating PoliciesAt December 31, 2006 and 2005, participating business approximated 48.2% and 47.2%,
respectively, of life insurance in force.Future policy benefits on participating policies are estimated based on net level
premium reserves for death and endowment policy benefits ranging from 3% to 8%, and the
cash surrender values described in such contract. The average rate of investment
yields used in the determination of expected gross margin was 6% in 2006 and 6% in
2005. Earnings and dividends on participating policies are allocated based on
policies in force.(i)
    
    Earnings Per ShareBasic earnings per share is computed by dividing income available to common
stockholders by the weighted average number of shares of common stock outstanding
during each period. Diluted earnings per share is computed under the if-converted
method giving effect to all potential dilutive common stock, including options,
warrants and convertible/redeemable preferred stock. The basic and diluted weighted
average shares outstanding for the year ended December 31, 2006 were 41,218,000,
compared to 41,105,000 for 2005 and 41,017,000 for 2004. The per share amounts have
been adjusted retroactively for all periods presented to reflect the change in capital
structure resulting from 7% stock dividends paid in 2005 and 2004.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The 2005 stock dividend resulted in the issuance of 2,841,000 Class A shares (including
205,000 treasury shares) and 66,000 Class B shares. The 2004 stock dividend resulted
in the issuance of 2,650,000 Class A shares (including 192,000 treasury shares) and
61,000 Class B shares.The following table sets forth the computation of basic and diluted earnings per share:
 Year endedDecember-312006
    
    
    2005
    
    
    2004(In thousands except per shareamounts)Basic and diluted earnings per share:Numerator:Net income
    
    $
    8,677
    
    
    
    7,302
    
    
    
    7,732Less: Preferred stock dividend
    
    
    (686
    )
    
    
    (558
    )
    
    
    (250
    )Accretion of deferred issuance costs and
discounts on preferred stock
    
    
    (1,337
    )
    
    
    (1,418
    )
    
    
    (679
    )Net income to common stockholders
    
    $
    6,654
    
    
    
    5,326
    
    
    
    6,803Basic and diluted earnings per share of
common stock
    
    $
    0.16
    
    
    
    0.13
    
    
    
    0.17Denominator:Weighted average shares outstanding-basic
and diluted
    
    
    41,218
    
    
    
    41,105
    
    
    
    41,017
 The effects of Series A-1 Convertible Preferred Stock and warrants, along with the
Series A-2 Convertible Preferred Stock and warrants, are dilutive for 2006. The
preferred stock is dilutive because the amount of the dividend and accretion of
deferred issuance costs and discounts for the year ended December 31, 2006, 2005 and
2004 in relation to the Class A common stock obtainable on conversion lowers basic
income per share. The warrants issued with the preferred stock are anti-dilutive
because the exercise price is in excess of the average Class A common stock market
price for the year ended December 31, 2006, 2005 and 2004.(j)
    
    Income TaxesDeferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates in effect for the year
in which those temporary differences are expected to be recovered.
Valuation allowances are recorded as needed to reduce deferred tax assets to the
amounts the Company expects to realize.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (k)
    
    Property and EquipmentProperty and equipment, including leasehold improvements, are carried at cost less
accumulated depreciation. Depreciation of property and equipment is computed using the
straight-line method over the useful lives of the assets, ranging from three to 30
years. We amortize leasehold improvements over the shorter of the related lease term
or the estimated life of the improvements. The Company has no capital leases.Following is a summary of property and equipment:
 December 31,2006
    
    
    2005(In thousands)Property and equipmentHome office land and buildings
    
    $
    6,754
    
    
    
    6,832Furniture and equipment
    
    
    1,773
    
    
    
    1,750Electronic data processing equipment
    
    
    4,036
    
    
    
    3,320Automobiles and marine assets
    
    
    394
    
    
    
    394Airplane
    
    
    3,166
    
    
    
    2,971Total property and equipment
    
    
    16,123
    
    
    
    15,267Accumulated depreciation
    
    
    (8,773
    )
    
    
    (7,530
    )Net property and equipment
    
    $
    7,350
    
    
    
    7,737
 (l)
    
    Reinsurance RecoverableReinsurance recoverable includes expected reimbursements for policyholder claim amounts
in excess of the Companys retention, as well as profit sharing and experience refund
accruals. Reinsurance recoverable is reduced for estimated uncollectible amounts, if
any.Reinsurance premiums, losses and adjustment expenses are accounted for on a basis
consistent with those used in accounting for the original policies issued and the terms
of the reinsurance contracts. The cost of reinsurance related to long duration
contracts is accounted for over the life of the underlying reinsured policies using
assumptions consistent with those used to account for the underlying policies. The
cost of reinsurance related to short duration contracts is accounted for over the
coverage period. Profit-sharing and similar adjustable provisions are accrued based on
the experience of the underlying policies.(m)
    
    Cash EquivalentsThe Company considers as cash equivalents all securities whose duration does not exceed
90 days at the date of acquisition.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (n)
    
    DepreciationDepreciation is calculated on a straight-line basis using estimated useful lives
ranging from three to 10 years. Building improvements are depreciated over the
estimated lives of 30 years.(o)
    
    Use of EstimatesThe preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.(p)
    
    ReclassificationsThe following reclassifications have been made to 2005 and 2004 amounts to conform to
the 2006 presentation:
 
    
    $2,905,000 consisting of accretion of preferred stock deferred issuance
costs and discounts and of preferred stock dividends in 2005 have been
reclassified from retained deficit to Class A common stock.
    
    $2,830,000 and $3,233,000 of annuity considerations have been reclassified
out of revenues, with an equal amount reclassified out of increase in future
policy benefit reserves in 2005 and 2004, respectively. $1,583,000 and
$2,460,000 of annuity benefits have been reclassified out of claims and
surrenders and netted out of the increase in future policy benefit reserves in
2005 and 2004, respectively.
    
    $628,000 and $266,000 related to due premiums have been reclassified into
life insurance premiums, and an equal amount has been reclassified into
increase in future policy reserves in 2005 and 2004, respectively.
    
    $191,000 and $286,000 of universal life considerations have been
reclassified between annuity and universal life considerations into other
income in 2005 and 2004, respectively.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (q)
    
    Accounting PronouncementsIn 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 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 does not expect that the
implementation of SOP 05-01 will have a material impact on its consolidated financial
statements.In June 2005, the FASB completed its review of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments(EITF 03-1).
EITF 03-1 provides accounting guidance regarding the determination of when an impairment of debt and marketable equity securities and
investments accounted for under the cost method should be considered
other-than-temporary and recognized in income. EITF 03-1 also requires certain
quantitative and qualitative disclosures for debt and marketable equity securities
classified as available-for-sale or held-to-maturity under SFAS No. 115, Accounting for
Certain Investments in Debt and EquitySecurities (SFAS 115), that are impaired at the
balance sheet date, but for which an other-than-temporary impairment has not been
recognized. The FASB decided not to provide additional guidance on the meaning of
other-than-temporary impairment, but has issued FASB Staff Position (FSP) 115-1, The
Meaning of Other-Than-Temporary Impairment and its Application to CertainInvestments
(FSP 115-1), which nullifies the accounting guidance on the determination of whether an
investment is other-than-temporarily impaired as set forth in EITF 03-1. FSP 115-1 was
effective on a prospective basis for other-than-temporary impairments on certain
investments in periods beginning after December 15, 2005. The Company has no
investments that are impaired under EITF Issue No. 03-1 and adoption of FSP 115-1 did
not have a material impact on our consolidated financial statements.In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 2 and FASB Statement No. 3
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (SFAS 154).
The Statement requires retrospective application to prior periods 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 change in accounting
estimate rather than a change in accounting principle. SFAS 154 was effective for
accounting changes and corrections of errors made in fiscal years beginning after
December 15, 2005. SFAS 154 did not have any impact on the Companys consolidated
financial statements.At the September 2004 meeting, the EITF reached a consensus with respect to Issue
No.-04-8, Accounting Issues Related to Certain features of Contingently Convertible
Debt and the Effect on Diluted Earnings per Share. This Issue addresses when the
dilutive effect of contingently convertible debt with a market price trigger should be
included in diluted earnings per share (EPS). The adoption of Issue No. 04-8 in the
first quarter 2005 did not affect the Companys EPS.In September 2006, the FASB issued FAS-No.-157, Fair Value Measurements(FAS-157).
FAS-157 defines fair value, establishes a framework for measuring fair value in GAAP
and requires enhanced disclosures about fair value measurements. However, FAS-157 does
not require new fair value measurements. The guidance in FAS-157 will be applied
prospectively with the exception of certain financial and hybrid instruments measured
at initial recognition under FAS-No.-133, Accounting for Derivative Instruments and
Hedging Activities,and for block discounts of financial instruments. Additionally,
FAS-157 will increase the disclosures required. The pronouncement is effective for
fiscal years beginning after November-15, 2007. The Company is currently evaluating
the impact of FAS-157 on the Companys financial instruments and its consolidated
financial statements.In February 2007, the FASB issued FAS-No.-159, The Fair Value Option for Financial
Assets and Financial Liabilities(FAS-159). FAS-159 permits the option to measure most
financial instruments and certain other items at fair value at specified election
dates. The change in value represents the unrealized gains and losses that will be
included in earnings. The fair value option will generally be applied on an
instrument-by-instrument basis and is generally an irrevocable election. FAS-159 is
effective for fiscal years beginning after November 15, 2007. The Company is
evaluating its assets and liabilities to determine which financial instruments, if any,
are eligible to account for at fair value under FAS-159 and the related impact on the
Companys consolidated financial statements.On July 13, 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No.-10
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (FIN-48), which clarifies the accounting for uncertainty in income tax positions.
FIN-48 prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of an income tax position taken or expected to be
taken in a tax return. FIN-48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, and additional disclosures. The
effective date of this implementation guidance was January 1, 2007, with the cumulative
effect of the change in accounting principles recorded as an adjustment to opening
retained earnings. The implementation of FIN-48 will not be material to the Companys
consolidated financial condition.On September 13, 2006, the SEC released SAB No. 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.
The issuance provides interpretive guidance on how the effects of the carryover or
reversal of prior year misstatements should be considered in quantifying a current year
misstatement. There are two common approaches used to quantify such errors. Under the
first approach, the rollover approach, the error(s) are quantified as the amount by
which the current year income statement is misstated. The second approach, the iron
curtain approach, quantifies the error as the cumulative amount by which the current
year balance sheet is misstated. Exclusive reliance on either approach can produce
results that are still misleading. This is possible by either accumulating errors on
the balance sheet that may not have been material to any individual income statement,
but which nonetheless may misstate one or more balance sheet accounts or by
disregarding the effects of errors in the current year income statement that result
from the correction of an error existing in previously issued financial statements.SAB 108 requires companies to quantify the impact of correcting all misstatements,
including both the carryover and reversing effects of prior year misstatements, on the
current year financial statements. This quantification is performed using both a
balance sheet and an income statement approach, and errors are to be evaluated under
each approach. Thus, a registrants financial statements would require adjustment when
either approach results in quantifying a material misstatement after considering all
relevant quantitative and qualitative factors.The Company adopted SAB 108 effective January 1, 2006. As such, the Company has
evaluated the balance sheet and prior period income statements to determine if any
material misstatements had occurred. The Company identified misstatements in several
balance sheet accounts, but determined that no errors were material to any prior year;
therefore, prior year financial statements will not require amendment. The Companys
SAB 108 adjustment increased the retained deficit by $3.1 million at January 1, 2006.
 104




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The adoption was done through a cumulative adjustment comprised of several error
corrections, as shown below:
 AMOUNT
    
    
    NOTE(In thousands)Errors corrected in 1-1-2006 cumulative adjustmentStatutory to GAAP accounting technique misstatements
    
    $
    (2,633
    )
    
    
    ADue premium
    
    
    955
    
    
    
    BSPLIC purchase accounting
    
    
    (266
    )
    
    
    CSPLIC negative reserves
    
    
    (544
    )
    
    
    COther intangibles
    
    
    (952
    )
    
    
    DReinsurance recoverables
    
    
    378
    
    
    
    EPending life claim liability
    
    
    (225
    )
    
    
    FMiscellaneous liability
    
    
    184
    
    
    
    GIntercompany payable elimination
    
    
    162
    
    
    
    HProperty and equipment depreciation
    
    
    (120
    )
    
    
    IAccident and health excess mortality reserve
    
    
    (67
    )
    
    
    JMortgage loan allowance reversal
    
    
    50
    
    
    
    KNet adjustments other than income taxes
    
    
    (3,078
    )Deferred income tax effect
    
    
    1,047
    
    
    
    MAdjustments net of tax
    
    
    (2,031
    )Correction of current taxes payable
    
    
    (253
    )
    
    
    LDeferred taxes
    
    
    (863
    )
    
    
    MNet adjustment to beginning retained deficit
as of January 1, 2006
    
    $
    (3,147
    )
 105




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The table below reconciles the balance sheet at December 31, 2005 with the SAB 108
adjustments to the adjusted balance at January 1, 2006.
 12/31/2005
    
    
    Correction
    
    
    Note
    
    
    1/1/2006AssetsInvestments:Fixed maturities and equity securities
    
    $
    458,181
    
    
    
    
    
    
    
    
    
    
    
    458,181Mortgage loans on real estate
    
    
    833
    
    
    
    50
    
    
    
    K
    
    
    
    883Policy loans
    
    
    23,918
    
    
    
    (804
    )
    
    
    A
    
    
    
    23,114Real estate and other long-term
investments
    
    
    1,879
    
    
    
    972
    
    
    
    A
    
    
    
    2,851Cash and cash equivalents
    
    
    18,311
    
    
    
    
    
    
    
    
    
    
    
    18,311Accrued investment income
    
    
    6,478
    
    
    
    (14
    )
    
    
    A
    
    
    
    6,464Reinsurance recoverable
    
    
    19,118
    
    
    
    378
    
    
    
    E
    
    
    
    19,496DAC and CCRA
    
    
    109,669
    
    
    
    (863
    )
    
    
    C
    
    
    
    108,806Other intangible assets
    
    
    2,095
    
    
    
    (952
    )
    
    
    D
    
    
    
    1,143Excess of cost over net assets acquired
    
    
    12,402
    
    
    
    
    
    
    
    
    
    
    
    12,402Property and equipment
    
    
    7,737
    
    
    
    (120
    )
    
    
    I
    
    
    
    7,617Due premium, net
    
    
    28
    
    
    
    4,955
    
    
    
    B
    
    
    
    4,983Other assets
    
    
    1,240
    
    
    
    (306
    )
    
    
    A
    
    
    
    934Total assets
    
    $
    661,889
    
    
    
    3,296
    
    
    
    
    
    
    
    665,185Liabilities and Stockholders EquityLiabilities:Future policy benefit reserves:Life insurance
    
    $
    436,717
    
    
    
    4,544
    
    
    
    B,C
    
    
    
    441,261Annuities
    
    
    19,440
    
    
    
    
    
    
    
    
    
    
    
    19,440Accident and health
    
    
    11,580
    
    
    
    5
    
    
    
    A
    
    
    
    11,585Policyholder deposits, accumulations,
claims payable and other funds
    
    
    31,709
    
    
    
    292
    
    
    
    F,J
    
    
    
    32,001Commissions payable
    
    
    2,667
    
    
    
    (541
    )
    
    
    A
    
    
    
    2,126Federal income tax payable
    
    
    448
    
    
    
    253
    
    
    
    L
    
    
    
    701Deferred Federal income tax
    
    
    1,621
    
    
    
    (184
    )
    
    
    M
    
    
    
    1,437Warrants outstanding
    
    
    1,587
    
    
    
    
    
    
    
    
    
    
    
    1,587Funds held in trust and other liabilities
    
    
    7,611
    
    
    
    2,074
    
    
    
    A,C,G,H
    
    
    
    9,685Total liabilities
    
    
    513,380
    
    
    
    6,443
    
    
    
    
    
    
    
    519,823Convertible preferred stock
    
    
    11,546
    
    
    
    
    
    
    
    
    
    
    
    11,546Total stockholders equity
    
    
    136,963
    
    
    
    (3,147
    )
    
    
    
    
    
    
    133,816Total liabilities and stockholders
equity
    
    $
    661,889
    
    
    
    3,296
    
    
    
    
    
    
    
    665,185
 A.
    
    The Company has historically used a manual technique for converting its
statutory insurance accounting trial balances to a GAAP basis. Due to the
nature of this method, certain detail supporting various balance sheet account
adjustments was lost through the years. During the process of
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 performing
account reconciliations during the third and fourth quarters of
2006, misstatements of these balance sheet accounts were identified. The
analysis indicated that these errors occurred prior to 2006. The accounts
affected and their net effect included in the beginning SAB 108 adjustment are as
follows:
 Decrease (Increase)to Retained Deficit(In thousands)Other liabilities understated
    
    $
    (3,017
    )Other long-term investments understated
    
    
    972Policy loans overstated
    
    
    (804
    )Other assets overstated
    
    
    (656
    )Commissions payable overstated
    
    
    541Agent accounts receivable understated
    
    
    350Accrued investment income overstated
    
    
    (14
    )Accident and health reserve understated
    
    
    (5
    )Net increase in retained deficit
    
    $
    (2,633
    )
 B.
    
    Prior to 2006, the Company recognized premium revenue on its
traditional SFAS 60 life insurance policies when received, rather than when due.
Also, the future policy benefit reserves were reduced by the net due premium,
rather than presented at their gross amount. As of December 31, 2005, there was
$4,955,000 of unrecorded gross due premiums receivable, and $4,000,000 of net due
premiums netted against future policy benefit reserves. The net effect of
correcting this accounting was an increase in pre-tax income of $955,000.
Although previously corrected in our first quarter 2006 financial statements, this
amount has now been reversed out of 2006 income and is included in the SAB 108
adjustment.C.
    
    When the Company acquired SPLIC in 2004, as part of the beginning
purchase accounting balance sheet, the Company initially set up a liability for
future payments on operating leases for district offices, which were
inappropriately capitalized. This liability had a balance of $497,000 at December
31, 2005. A liability was also initially set up in the beginning purchase
accounting balance sheet in the amount of $100,000 for general contingencies,
which ultimately was not supportable. These liabilities have been eliminated
through the SAB 108 adjustment. The correction of these liabilities would have
resulted in additional negative goodwill at the time of acquisition, which was
recorded as a reduction of the initial CCRA. As a result, CCRA was also reduced
by $863,000 as of December 31, 2005 and has been recorded as a part of the SAB 108
adjustment. The net of these items is an increase in the retained deficit of
$266,000.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The Company also determined that certain plans of insurance of SPLIC had negative
future policy benefit reserves. Accordingly, an adjustment has been recorded in
the amount of $544,000.D.
    
    While preparing the first quarter of 2006 financial statements, the
Company determined that there was $350,000 of other intangible assets related to
state insurance licenses of acquired companies which had been merged into CICA in
prior years. These intangible assets should have been written off when the
companies were merged and were written off in the first quarter of 2006. While
preparing the year-end 2006 financial statements, the Company determined that an
additional $602,000 of intangible assets of a previously merged company and
intangibles with definite lives should have also been written off. The combined
$952,000 reduction of other intangibles was included in the SAB 108 adjustment,
$350,000 of which was reversed out of 2006 income.E.
    
    During the preparation of quarterly financial statements in 2006, the
Company determined that it had certain adjustable reinsurance contract provisions
that had been recorded when settled, rather than when earned. CICAs accidental
death benefit reinsurance contract had a favorable experience refund of $216,000
for the 2005 contract year, which should have been accrued at December 31, 2005.
SPFICs catastrophe reinsurance contract had a premium refund of $162,000, which
should have been accrued at December 31, 2005. Although previously included in
our 2006 quarterly financial statements, the total reinsurance receivable of
$378,000 has now been reversed out of 2006 income and is a part of the SAB 108
adjustment.F.
    
    A life claim liability in the amount of $225,000 was erroneously
eliminated in 2005 while the Company converted its statutory trial balances to
GAAP. This adjustment has been corrected through the SAB 108 adjustment.G.
    
    During its 2006 account reconciliations, the Company identified
$75,000 of expense accruals, $60,000 of state tax accruals and $49,000 of
miscellaneous payables that were general reserves established in prior years and
not based on known specifics; as such, they were not supportable. The $184,000
total for these items is included in the SAB 108 adjustment.H.
    
    While preparing the year-end 2006 financial statements, it was
determined that a prior year $162,000 intercompany payable from the insurance
company subsidiaries to Citizens was not eliminated. This amount is included in
the SAB 108 adjustment.
 108




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 I.
    
    During its 2006 account reconciliations, a prior year entry to
reverse excess statutory accounting depreciation was discovered. This entry was
not supportable and is included in the SAB 108 adjustment in the amount of
$120,000.J.
    
    During its 2006 account reconciliations, the Company identified
$67,000 of accident and health morbidity reserves that were general reserves
established in a prior year and not based on known specifics; as such, they were
not supportable and are included in the SAB 108 adjustment.K.
    
    An allowance for losses on mortgage loans for $50,000, which was not
related to a specific loan, and has existed for many years, was reversed and
included in the beginning SAB 108 adjustment.L.
    
    As part of its 2006 account reconciliations, current income taxes
payable were analyzed and increased by $253,000. This adjustment was to adjust
the December 31, 2005 liability to the 2005 tax returns as filed, and is included
in the SAB 108 adjustment.M.
    
    Prior to 2006, the Company used the roll forward method to calculate
deferred income taxes. During 2006, the Company began using the tax basis balance
sheet method, which identified errors that resulted in an increase to deferred
taxes payable at December 31, 2005 of $863,000.
 109




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 2)
    
    InvestmentsThe cost, gross unrealized gains and losses and fair value of investments of fixed maturities
and equity securities, as of December 31, 2006 and 2005, are as follows:
 December 31, 2006(In thousands)Gross
    
    
    Grossunrealized
    
    
    unrealizedCost
    
    
    gains
    
    
    (losses)
    
    
    Fair valueFixed Maturities Available-for-Sale:U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies
    
    $
    13,862
    
    
    
    809
    
    
    
    (4
    )
    
    
    14,667U.S. Government-sponsored enterprises
    
    
    266,554
    
    
    
    102
    
    
    
    (5,933
    )
    
    
    260,723Public utilities
    
    
    2,016
    
    
    
    
    
    
    
    (33
    )
    
    
    1,983Debt securities issued by states of the
United States and political subdivisions
of the states
    
    
    59,950
    
    
    
    237
    
    
    
    (438
    )
    
    
    59,749Corporate debt securities
    
    
    101,197
    
    
    
    85
    
    
    
    (2,929
    )
    
    
    98,353Securities not due at a single maturity date
    
    
    54,360
    
    
    
    26
    
    
    
    (1,543
    )
    
    
    52,843Total fixed maturities
available-for-sale
    
    $
    497,939
    
    
    
    1,259
    
    
    
    (10,880
    )
    
    
    488,318Total Equity Securities:
    
    $
    279
    
    
    
    40
    
    
    
    (7
    )
    
    
    312
 110




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 December 31, 2005
(In thousands)
 Gross
    
    
    Grossunrealized
    
    
    unrealizedCost
    
    
    gains
    
    
    (losses)
    
    
    Fair valueFixed maturities held-to-maturity:U.S. Treasury securities
    
    $
    5,510
    
    
    
    958
    
    
    
    
    
    
    
    6,468U.S. Government-sponsored enterprises
    
    
    2,130
    
    
    
    546
    
    
    
    
    
    
    
    2,676Total fixed maturities held-to-maturity
    
    $
    7,640
    
    
    
    1,504
    
    
    
    
    
    
    
    9,144Fixed maturities available-for-sale:U.S. Treasury securities and obligations of
U.S. Government corporations and
agencies
    
    $
    14,662
    
    
    
    298
    
    
    
    (49
    )
    
    
    14,911U.S. Government-sponsored enterprises
    
    
    221,677
    
    
    
    1,595
    
    
    
    (4,712
    )
    
    
    218,560Public utilities
    
    
    2,939
    
    
    
    41
    
    
    
    (12
    )
    
    
    2,968Debt securities issued by states of the
United States and political subdivisions
of the states
    
    
    53,504
    
    
    
    279
    
    
    
    (491
    )
    
    
    53,292Corporate debt securities
    
    
    110,253
    
    
    
    756
    
    
    
    (2,387
    )
    
    
    108,622Securities not due at a single maturity date
    
    
    54,352
    
    
    
    35
    
    
    
    (2,809
    )
    
    
    51,578Total fixed maturities
available-for-sale
    
    $
    457,387
    
    
    
    3,004
    
    
    
    (10,460
    )
    
    
    449,931Total Equity Securities:
    
    $
    429
    
    
    
    202
    
    
    
    (21
    )
    
    
    610
 111




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 For investments of available-for-sale fixed maturities and equity securities that have
unrealized losses as of December 31, 2006, the cost, gross unrealized losses that have been in
a continuous unrealized loss position for less than 12 months, gross unrealized losses that
have been in a continuous unrealized loss position for 12 months or longer and fair value are
as follows:
 Gross
    
    
    Grossunrealized
    
    
    unrealized(losses) less
    
    
    (losses)then 12
    
    
    more thenCost
    
    
    months
    
    
    12 months
    
    
    Fair valueFixed maturities available-for-sale:U.S. Treasury securities and obligations of
U.S. Government corporations and agencies
    
    $
    201
    
    
    
    (1
    )
    
    
    
    
    
    
    200U.S. Treasury securities and obligations of
U.S. Government corporations and agencies
    
    
    206
    
    
    
    
    
    
    
    (3
    )
    
    
    203U.S. Government-sponsored enterprises
    
    
    67,471
    
    
    
    (530
    )
    
    
    
    
    
    
    66,941U.S. Government-sponsored enterprises
    
    
    194,893
    
    
    
    
    
    
    
    (5,403
    )
    
    
    189,490Public utilities
    
    
    2,016
    
    
    
    (33
    )
    
    
    
    
    
    
    1,983Debt securities issued by states of the
United States and political subdivisions
of the states
    
    
    17,690
    
    
    
    (248
    )
    
    
    
    
    
    
    17,442Debt securities issued by states of the
United States and political subdivisions
of the states
    
    
    18,291
    
    
    
    
    
    
    
    (190
    )
    
    
    18,101Corporate debt securities
    
    
    27,081
    
    
    
    (627
    )
    
    
    
    
    
    
    26,454Corporate debt securities
    
    
    65,970
    
    
    
    
    
    
    
    (2,302
    )
    
    
    63,668Securities not due at a single maturity date
    
    
    405
    
    
    
    (8
    )
    
    
    
    
    
    
    397Securities not due at a single maturity date
    
    
    48,998
    
    
    
    
    
    
    
    (1,535
    )
    
    
    47,463Total fixed maturities
available-for-sale
    
    $
    443,222
    
    
    
    (1,447
    )
    
    
    (9,433
    )
    
    
    432,342Total Equity Securities:
    
    $
    79
    
    
    
    
    
    
    
    (7
    )
    
    
    72
 The fixed maturities available-for-sale in a gross unrealized loss situation for more than 12
months are primarily investments in callable instruments issued by U.S. Government agencies
and the current loss position primarily relates to changes in the current interest rate
environment. It is remote that unrealized losses on these instruments will result in realized
losses, because the Company has the intent and believes it has the ability to hold these
securities to full recovery. The Company has determined that none of these losses are other
than temporary.The amortized cost and fair value of fixed maturities at December 31, 2006 by contractual
maturity are shown below. Actual maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties.
 112




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Fixed maturities available-for-sale  (In thousands)
 Amortized Cost
    
    
    Fair ValueDue in one year or less
    
    $
    11,208
    
    
    
    11,171Due after one year through five years
    
    
    41,774
    
    
    
    40,615Due after five years through ten years
    
    
    21,937
    
    
    
    21,437Due after ten years
    
    
    368,660
    
    
    
    362,252443,579
    
    
    
    435,475Securities not due at a single maturity date
    
    
    54,360
    
    
    
    52,843Totals
    
    $
    497,939
    
    
    
    488,318
 The securities not due at a single maturity date are mortgage-backed obligations of U.S.
Government corporations and agencies.
 The Company had no investments in any one entity that exceeded 10% of stockholders equity at
December 31, 2006.
 The Companys investment in mortgage loans is concentrated 49% in Texas and 51% in Louisiana
as of December 31, 2006.
 Major categories of net investment income are summarized as follows:
 Year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Investment income on:Fixed maturities
    
    $
    25,386
    
    
    
    21,572
    
    
    
    15,443Equity securities
    
    
    6
    
    
    
    16
    
    
    
    36Mortgage loans on real estate
    
    
    46
    
    
    
    330
    
    
    
    36Policy loans
    
    
    1,219
    
    
    
    1,494
    
    
    
    1,392Long-term investments
    
    
    479
    
    
    
    468
    
    
    
    447Other
    
    
    255
    
    
    
    579
    
    
    
    29327,391
    
    
    
    24,459
    
    
    
    17,647Investment expenses
    
    
    (416
    )
    
    
    (891
    )
    
    
    (642
    )Net investment income
    
    $
    26,975
    
    
    
    23,568
    
    
    
    17,005
 Proceeds and gross realized gains (losses) from sales of fixed maturities available-for-sale
for 2006, 2005 and 2004 are summarized as follows:
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Proceeds
    
    $
    14,006
    
    
    
    14,569
    
    
    
    42,824Gross realized gains
    
    $
    1,090
    
    
    
    324
    
    
    
    1,715Gross realized (losses)
    
    $
    (122
    )
    
    
    (121
    )
    
    
    (1,351
    )
 During 2006, the Company sold the remaining three zero coupon fixed maturity securities
in its portfolio, as they did not meet the Companys investment criteria. One of the
securities was in the held-to-maturity portfolio. The amortized cost of this security was
$2,189,000, with a $283,000 realized gain. After this sale, the one security remaining in the
held-to-maturity portfolio was transferred to the available-for-sale portfolio as of December
31, 2006, which resulted in an unrealized gain of $484,000, net of tax, and is included in
other comprehensive income.
 Proceeds and gross realized gains (losses) from sales of equity securities for 2006, 2005 and
2004 are summarized as follows:
 Year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Proceeds
    
    $
    334
    
    
    
    616
    
    
    
    63Gross realized gains
    
    $
    183
    
    
    
    322
    
    
    
    Gross realized (losses)
    
    $
    
    
    
    
    
    
    
    
    
 Realized gains (losses) are as follows:
 Year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Realized gains (losses):Fixed maturities
    
    $
    1,251
    
    
    
    203
    
    
    
    364Equity securities
    
    
    183
    
    
    
    322
    
    
    
    Gain from the sale of property and
equipment
    
    
    
    
    
    
    505
    
    
    
    45Loss on other invested assets
    
    
    (148
    )
    
    
    (611
    )
    
    
    (20
    )Net realized gains
    
    $
    1,286
    
    
    
    419
    
    
    
    389
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (3)
    
    Cost of Customer Relationships Acquired and Excess of Cost Over Net Assets AcquiredCost of customer relationships acquired is summarized as follows:
 Year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Balance at beginning of period
    
    $
    39,259
    
    
    
    44,904
    
    
    
    16,884SAB 108 adjustment
    
    
    (863
    )
    
    
    
    
    
    
    Adjusted balance at beginning of period
    
    
    38,396
    
    
    
    44,904
    
    
    
    16,884Increase (decrease) related to:Acquisitions
    
    
    
    
    
    
    
    
    
    
    33,942Amortization
    
    
    (3,584
    )
    
    
    (5,645
    )
    
    
    (5,922
    )Balance at end of period
    
    $
    34,812
    
    
    
    39,259
    
    
    
    44,904
 Estimated amortization of cost of customer relationships acquired in each of the next
five years is as follows. Actual future amortization will differ from these estimates due to
variances from estimated future withdrawal assumptions.
 (In thousands)
 Year
    
    Amount2007
    
    $
    3,5752008
    
    
    3,0382009
    
    
    2,7502010
    
    
    2,4872011
    
    
    2,279Thereafter
    
    
    20,683
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Excess of cost over net assets acquired is summarized as follows:
 AccumulatedGross
    
    
    amortization
    
    
    Net(In thousands)Balance at January 1, 2004
    
    $
    18,007
    
    
    
    (5,068
    )
    
    
    12,939Adjustment of purchase accounting
accounting on acquisition
    
    
    (537
    )
    
    
    
    
    
    
    (537
    )Balance at December 31, 2004
and 2005
    
    
    17,470
    
    
    
    (5,068
    )
    
    
    12,402Impairment of Goodwill
    
    
    (1,016
    )
    
    
    
    
    
    
    (1,016
    )Balance at December 31, 2006
    
    $
    16,454
    
    
    
    (5,068
    )
    
    
    11,386
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (4)
    
    Policy LiabilitiesVarious assumptions used to determine the future policy benefit reserves of life insurance
include the following: a) valuation interest rates from 4 to 9%, b) mortality assumptions are
from the 1955 to 1960, 1965 to 1970, 1975 to 1980 and 2001 Select and Ultimate mortality
tables and c) withdrawals are based primarily on actual historical termination rates.The following table presents information on changes in the liability for life and accident and
health policy and contract claims for the years ended December 31, 2006, 2005 and 2004.
 2006
    
    
    2005
    
    
    2004(In thousands)Policy and contract claims payable at January 1
    
    $
    11,227
    
    
    
    8,282
    
    
    
    5,648Less: reinsurance recoverable
    
    
    4,337
    
    
    
    2,714
    
    
    
    1,144Net balance at January 1
    
    
    6,890
    
    
    
    5,568
    
    
    
    4,504SAB 108 adjustment (see note1(q))
    
    
    292
    
    
    
    
    
    
    
    Adjusted balance at January 1
    
    
    7,182
    
    
    
    5,568
    
    
    
    4,504Acquisitions of Security Plan
    
    
    
    
    
    
    
    
    
    
    3,715Less: reinsurance recoverable
    
    
    
    
    
    
    
    
    
    
    Net acquired balance
    
    
    
    
    
    
    
    
    
    
    3,715Add: claims incurred, related to:Current year
    
    
    24,760
    
    
    
    27,928
    
    
    
    12,744Prior years
    
    
    2,838
    
    
    
    (1,212
    )
    
    
    (1,833
    )27,598
    
    
    
    26,716
    
    
    
    10,911Deduct: claims paid, related to:Current year
    
    
    18,731
    
    
    
    21,037
    
    
    
    11,514Prior years
    
    
    8,670
    
    
    
    4,357
    
    
    
    2,04827,401
    
    
    
    25,394
    
    
    
    13,562Net balance December 31
    
    
    7,379
    
    
    
    6,890
    
    
    
    5,568Plus: reinsurance recoverable
    
    
    2,069
    
    
    
    4,337
    
    
    
    2,714Policy and contract claims payable, December 31
    
    $
    9,448
    
    
    
    11,227
    
    
    
    8,282
 The favorable development of prior year claim reserves in 2005 and 2004 reflects claims
settling at amounts less than actuarial estimates. These settlements, predominantly on
accident and health policies, can vary significantly from the actuarially computed expected
experience, particularly on a closed block of business, where policies may lapse resulting
in a lower incurred claim amount than would otherwise be expected. The adverse development in
2006 occurred because SPFIC was negatively impacted by the 2005 hurricanes in Louisiana.
Through December 31, 2006, losses in excess of reinsurance amounted to more than $4.1 million,
resulting in Security Plan infusing $4.0 million of additional capital into SPFIC.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (5)
    
    ReinsuranceIn the normal course of business, the Company reinsures portions of certain policies that it
underwrites to limit disproportionate risks. During 2006 and 2005, the Company retained
varying amounts of individual insurance up to a maximum retention of $100,000 on any life.
The Company also reinsures 100% of its accidental death benefit rider coverage. Catastrophe
reinsurance is in place for our property policies. In 2006, this reinsurance provided
$10,000,000 of coverage above $500,000. In 2005, this reinsurance provided $7,100,000 of
coverage above $250,000 for the first event and the same coverage for the second event upon
payment of a reinstatement premium. Our health insurance policies are substantially all
reinsured on a 100% coinsurance basis. The Company remains contingently liable to the extent
that the reinsuring companies cannot meet their obligations under these reinsurance treaties.Our amounts recoverable from reinsurers represent receivables from and reserves ceded to
reinsurers. We obtain reinsurance from multiple reinsurers, and we monitor concentration as
well as financial strength ratings of our principal reinsurers. As we are not relieved of our
liability to the ceding companies for reinsured business, the liabilities and obligations
associated with the reinsured contracts remain on our consolidated balance sheets with a
corresponding reinsurance receivable from the business sold. To support and protect our
position we have established and funded a trust to support our liabilities related to accident
and health reinsurance ceded to Texas International Life Insurance Company.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Assumed and ceded life reinsurance activity as of December 31, 2006, 2005 and 2004 is
summarized as follows:
 2006
    
    
    2005
    
    
    2004(In thousands)Aggregate assumed life insurance in force
    
    $
    669,787
    
    
    
    592,636
    
    
    
    488,312Aggregate ceded life insurance in force
    
    $
    (258,756
    )
    
    
    (221,793
    )
    
    
    (265,001
    )Net life insurance in force
    
    $
    4,382,530
    
    
    
    4,058,072
    
    
    
    3,736,355
 The Companys net reinsurance recoveries on ceded reinsurance less assumed reinsurance
were $9.4 million in 2006, $19.9 million in 2005, and $11.6 million in 2004. Premiums and
claims and surrenders assumed and ceded for all lines of business for these years are
summarized as follows:
 2006
    
    
    2005
    
    
    2004(In thousands)Premiums assumed
    
    $
    1,126
    
    
    
    571
    
    
    
    636Premiums ceded
    
    $
    (11,811
    )
    
    
    (13,867
    )
    
    
    (15,389
    )Claims and surrenders assumed
    
    $
    1,056
    
    
    
    561
    
    
    
    627Claims and surrenders ceded
    
    $
    (10,448
    )
    
    
    (20,433
    )
    
    
    (12,217
    )
 SPFIC had reinsurance agreements in place to protect it from catastrophic events such as
Hurricanes Katrina and Rita that struck Louisiana in 2005. The agreements in place during
2005 provided that SPFIC bore responsibility for the first $250,000 of incurred claims.
Reinsurers indemnified SPFIC for losses in excess of $250,000 up to $7.1 million per event.
Any amount over $7.1 million was SPFICs responsibility. The Company incurred claims of
approximately $750,000 in excess of $7.1 million on Hurricane Katrina. Once the maximum
coverage was met, SPFIC had an opportunity to pay for 2nd event coverage, upon
payment of approximately $400,000 in premium. SPFIC elected to do so and the claims for
Hurricane Rita were covered under this second event reinsurance. Through December 31, 2005,
claims related to Hurricane Rita were approximately $3.7 million and were 100% reinsured. For
calendar year 2006, SPFIC elected to increase the amount of 1st event catastrophe
reinsurance to $10 million and increase the retention to $500,000 by paying an annual premium
of $798,750.(6)
    
    Stockholders Equity and RestrictionsThe two classes of common stock of the Company are equal in all respects, except (a) each
Class A share receives twice the cash dividends paid on a per share basis to the Class B
common stock; and (b) the Class B common stock elects a simple majority of the Board of
Directors of Citizens and the Class A common stock elects the remaining directors.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The table below shows the insurance subsidiaries stockholders equity and net income (loss)
for life insurance operations and property insurance operations.
 2006
    
    
    2005(In thousands)Statutory Stockholders EquityLife insurance operations
    
    $
    99,693
    
    
    
    102,463Property insurance operations
    
    
    3,393
    
    
    
    1,438Total statutory stockholders equity
    
    $
    103,086
    
    
    
    103,901
 2006
    
    
    2005
    
    
    2004(In thousands)Statutory Net Income (Loss)Life insurance operations
    
    $
    9,104
    
    
    
    7,747
    
    
    
    11,847Property insurance operations
    
    
    (3,783
    )
    
    
    (3,812
    )
    
    
    327Total statutory net income
    
    $
    5,321
    
    
    
    3,935
    
    
    
    12,174
 Generally, the net assets of the insurance subsidiaries available for transfer to the
Company are limited to the greater of the subsidiary net gain from operations (net income for
SPFIC) during the preceding year or 10% of the subsidiary net statutory surplus as of the end
of the preceding year as determined in accordance with accounting practices prescribed or
permitted by insurance regulatory authorities. Under these practices, total capital and
surplus at December 31, 2006 was $103,086,000. Payments of dividends in excess of such
amounts would generally require approval by the regulatory authorities. Based upon statutory
net gain from operations (net income for SPFIC) and surplus of the individual insurance
companies as of and for the year ended December 31, 2006, approximately $10,277,000 of
dividends could be paid to the Company without prior regulatory approval in 2007.CICA, CNLIC and SPLIC have calculated their risk based capital (RBC) in accordance with the
National Association of Insurance Commissioners Model Rule and the RBC rules as adopted by
their respective state of domicile. The RBC as calculated for CICA, CNLIC and SPLIC as of
December 31, 2006 exceeded levels requiring company or regulatory action.(7)
    
    Revolving Line of Credit and Term LoanOn March 22, 2004, the Company entered into a revolving loan agreement with Regions Bank
establishing a commitment for a line of credit of $30,000,000 that matured on March 22, 2005.
It was extended at maturity until September 21, 2005.On October 1, 2004, the Company entered into a Second Amendment to the Loan Agreement that
converted a $30 million advance against the line of credit made for the purpose of acquiring
SPLIC into a term loan. Under the term loan, the Company was required to repay the principal
portion of the loan in ten semi-annual installments of $3,000,000 beginning on May 1, 2005.
In April 2005, the term loan was paid off.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Documents to renew the line of credit through October 2007, and to increase the borrowing
capacity to $75 million were executed 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, additional borrowing above
$30 million will require the prior written approval of the holders of the Companys preferred
stock. No amount was outstanding on this line at December 31, 2006.(8)
    
    Convertible Preferred StockOn July 12, 2004, the Company completed a private placement of $12.5 million of Series A-1
Convertible Preferred Stock (Series A-1 Preferred) to four unaffiliated institutional
investors. The Company used the net proceeds from the sale of the Series A-1 Preferred as
part of the purchase price for the acquisition of SPLIC (See Notes 7 and 9). Along with the
Series A-1 Preferred, the Company also issued warrants to purchase 544,000 shares of Class A
common stock, at an exercise price of $6.95 per share, and unit warrants to purchase Series
A-2 Convertible Preferred Stock (Series A-2 Preferred).The conversion, exercise and redemption prices set forth in this Note 8, along with the
numbers of shares and warrants (except for the 25,000 Series A-1 Preferred shares referenced
below), have been adjusted for the respective stock dividends paid December 31, 2004 and
December 30, 2005.The 25,000 shares of Series A-1 Preferred carry a 4% per annum dividend, payable in cash or,
if certain conditions are met, shares of the Companys Class A common stock. The Company has
paid all of the preferred dividends through December 31, 2006 with Class A common stock.The Company may, at its option, subject to certain conditions, increase the issued Series A-1
Preferred by $12.5 million to $25 million by requiring the investors to make additional
payments for their shares of Series A-1 Preferred. To the extent the Company increases the
issue from $12.5 million, the number of Class A common shares that may be purchased pursuant
to the seven-year warrants would increase proportionately.The Series A-1 Preferred and Series A-2 Preferred are convertible at the option of the
investors at any time into shares of Class A common stock at a
conversion price of $6.33 per share and a range from $6.11 to $7.26 per share, respectively and each with a mandatory redemption in five
years after their issuance if not converted prior to the redemption date. The Series A-1
Preferred can be converted into an aggregate of 1,975,000 Class A common shares. The Series
A-2 Preferred can be converted into an aggregate number of shares based on a variable defined
price.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The Series A-1 and A-2 Preferred stock is mandatorily redeemable in 2009. Both may also
become redeemable at the option of the holder if certain conditions exist, as described below.
Under either scenario the shares may be redeemed in cash or shares of Class A common stock depending on the
circumstances. If redeemed in stock, the redemption price is based on a defined formula.The provisions of the Series A Preferred Stock require that if (i) at any time after the
original issue date of the stock, the closing price of our
Class A common stock for any 42 trading days, including a period not less than 5 consecutive trading days, is less than $4.80, or (ii)
we issue Class A common stock or common stock equivalents
for less than $6.11 per share, then the holders of the Series A Preferred Stock may require us
to redeem their shares of Series A Preferred Stock at a price equal to the amount of the
original holders original investment, plus all accrued but unpaid dividends thereon to the
date of payment and any applicable penalties. The preferred holders right to require a
redemption has not been triggered under clause (i) or clause (ii) above. If the right were to
be triggered, that right would terminate if the price per share of Class A common stock
exceeds certain defined amounts for certain specified periods of time.We will be required to redeem any shares of the Series A Preferred Stock that remain
outstanding on the fifth anniversary after their issuance at a price equal to the amount of
the original holders original investment, plus all accrued but unpaid dividends thereon to
the date of such payment. If the average price is less than $3.50 per common share, the
redemption must be in cash.Another provision of the Series A Preferred Stock allows the preferred holders to require the
Company to repurchase in cash (1) any shares of Series A Preferred Stock still held by the
preferred shareholders and (2) any shares of Class A common stock still held by the preferred
shareholders pursuant to the provisions of the Preferred Stock if certain defined Events or
other conditions occur and are not cured within specified time periods. Those Events or
conditions generally relate to the preferred holders ability to resell their Class A common shares.
 The unit warrants, which were also issued on July 12, 2004, entitled the investors to purchase
from the Company up to $5 million of Series A-2 Preferred. Three of the four investors
exercised their unit warrants, for an exercise price of approximately $3.75 million, before
the unit warrants expired in October 2005. The three issuances of Series A-2 Preferred are
convertible into Class A common stock at conversion prices equal to 110% of the average market
closing prices of the Class A common stock for the 30 trading days before the respective dates
of issuance of the Series A-2 Preferred to the three investors. The redemption period for the
Series A-2 Preferred expires on July 12, 2009.On July 7, 2005, the first of the three investors to do so exercised its unit warrant and
purchased 1,338 shares of Series A-2 Preferred for $1,250,000, convertible into Class A common
stock at $6.11 per common share, and seven year warrants to purchase 56,000 shares of Class A
common stock at an exercise price of $6.72 per share.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 On September 30, 2005, the second investor exercised its unit warrant, purchasing 1,338 shares
of Series A-2 Preferred for $1,250,000, convertible into Class A common stock at $7.26 per
common share, and seven year warrants to purchase 47,000 shares of Class A common stock at an
exercise price of $7.99 per share.In early October 2005, the third investor exercised its unit warrant, purchasing 1,338 shares
of Series A-2 Preferred for $1,250,000, convertible into Class A common stock at $7.20 per
common share, and seven year warrants to purchase 48,000 shares of Class A common stock at an
exercise price of $7.92 per share.In October 2005, the remaining series A-2 Preferred Stock and associated warrants expired
without the fourth investor exercising its option. In connection with the issuance of Series
A-1 Preferred and associated warrants in July 2004, the finders with respect to these
transactions received, as part of the finders compensation, warrants to purchase 99,000
shares of Series A common stock at an exercise price of $6.95 per share. In connection with
the issuances of Series A-2 Preferred and associated warrants in 2005, the finders received,
as part of the finders compensation, warrants to purchase 28,000 shares of Class A common
stock at exercise prices ranging from $6.72 to $7.99.At July 12, 2004, the Company initially recognized deferred issuance costs of $1,486,000, a
discount on the beneficial conversion feature of $3,073,000 and discounts on fair values of
options and warrants of $2,719,000, respectively, as offsets against the $12.5 million
issuance of the Series A-1 Preferred. The beneficial conversion feature represents the
difference at July 12, 2004 between the fair value of the Citizens stock and the effective
conversion price, taking into account embedded warrants and options based upon the number of shares to be converted at inception. This intrinsic value of the beneficial conversion
feature at July 12, 2004 reduced the carrying value of the Series A-1 Preferred on the
statement of financial position with an equal amount credited to the Class A common stock. In
2004 and 2005, these deferred issuance costs and discounts were amortized to the retained
deficit over the period until redemption using the effective interest method. On July 7,
2005, September 30, 2005 and October 6, 2005, three of the four unaffiliated investors
exercised their right to purchase the Series A-2 Convertible Preferred Stock. The Company
recognized deferred issuance costs of $247,000 and a premium of $721,000 related to the
liability for the option recorded at the date of the respective exercises.At December 31, 2006 and 2005, there was $942,000 and $1,301,000 in unaccreted deferred
issuance costs and $2,427,000 and $3,405,000 in unaccreted net discount costs, respectively.
The redemption value of the series A-2 convertible stock was $16,251,000 at December 31, 2006.The initial July 12, 2004 recognition of the beneficial conversion feature and discounts on
fair values of options and warrants resulted in $3,073,000 of additional paid-in capital for
the Class A common stock and $2,944,000 of liabilities for options and warrants. Changes in
the fair value of options and warrants are recognized in the statement of operations with a
corresponding change in the liabilities for options and warrants.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 On September 30, 2004, the Company declared its initial 4% dividend to the Series A-1
Preferred shareholders. The Company paid the dividend by issuing 19,000 shares of its Class A
common stock valued at $116,000. On December 31, 2004, the Company declared the second
quarterly dividend, consisting of 21,000 shares of its Class A common Stock valued at
$133,000. On March 31, 2005, the Company paid the third quarterly dividend, consisting of
24,000 shares of its Class A common stock valued at $131,000. On June 30, 2005, the Company
paid the fourth quarterly dividend, consisting of 22,000 shares of its Class A common stock
valued at $132,000. On September 30, 2005, the Company paid the fifth quarterly dividend,
consisting of 20,000 shares of its Class A common stock valued
at $131,000. Of this, 2,000 shares of Class A common stock valued at $11,000 were paid because of the unit warrant
exercise and issuance of Series A-2 Preferred on July 7, 2005. On December 31, 2005, the
Company paid the sixth quarterly dividend resulting in the issuance of 30,000 shares of its
Class A common stock valued at $164,000. Of this, 7,000 shares of Class A common stock valued
at $37,000 were paid to holders of the Series A-2 Preferred. On March 31, 2006, the Company
paid our seventh quarterly dividend, resulting in the issuance of 33,000 shares of its Class A
common stock valued at $172,000. Of this, 8,000 shares of the Class A common stock, valued at
$40,000, were paid to the holders of the Series A-2 Preferred. On June 30, 2006, the Company
paid our eighth quarterly dividend, resulting in the issuance of 35,000 shares of its Class A
common stock valued at $173,000. Of this, 8,000 shares of the Class A common stock, valued at
$40,000, were paid to the holders of the Series A-2 Preferred. On September 30, 2006, the
Company paid our ninth quarterly dividend, resulting in the issuance of
30,000 shares of its Class A common stock valued at $174,000. Of this, 7,000 shares of the
Class A common stock, valued at $40,000, were paid to the holders of the Series A-2 Preferred.
On December 31, 2006, the Company paid our tenth quarterly dividend, resulting in the
issuance of 25,000 shares of its Class A common stock valued at $167,000. Of this, 6,000
shares of the Class A common stock, valued at $39,000, were paid to the holders of the Series
A-2 Preferred.(9)
    
    Mergers and AcquisitionsOn October 1, 2004, CICA acquired 100% of the outstanding common stock of SPLIC. The results
of SPLIC (and its subsidiary, SPFIC) have been included in the consolidated financial
statements since that date. SPLIC is a provider of home service life insurance products,
primarily in Louisiana.The aggregate purchase price was $85 million of cash, plus $1,013,000 of related expenses. To
fund the acquisition, Citizens borrowed $30 million from Regions Bank under a line of credit
the Company had established earlier in 2004, and loaned the money to CICA in exchange for a
surplus debenture. In addition, the Company made an $11 million capital contribution to CICA.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The following table summarizes the estimated fair value of the assets acquired and liabilities
assumed at the date of acquisition.
 At October 31,2004(In thousands)Investments
    
    $
    251,721Cash and cash equivalents
    
    
    3,781Accrued investment income
    
    
    2,642Other intangible assets
    
    
    70Cost of customer relationships acquired
    
    
    33,942Federal income tax recoverable
    
    
    22Property and equipment
    
    
    613Other assets
    
    
    363Total assets acquired
    
    
    293,154Future policy benefit reserves
    
    
    192,445Policy claims payable
    
    
    3,714Other policyholders funds
    
    
    1,475Commissions payable
    
    
    510Deferred federal income taxes
    
    
    4,851Other liabilities
    
    
    4,146Total liabilities assumed
    
    
    207,141Net assets acquired
    
    $
    86,013
 Of the acquired intangible assets, $70,000 was assigned to state insurance department
licenses that are not subject to amortization and $33,942,000 was assigned to CCRA that will
be amortized over the anticipated premium paying period of the related policies. No goodwill
was recognized.The unaudited pro forma results from operations for the year ended December 31, 2004, as if
SPLIC had been owned since January 1, 2004 are shown below.
 As Reported
    
    Pro Forma(In thousands)Revenue
    
    $
    99,859
    
    
    
    141,287Net Income
    
    
    7,732
    
    
    
    12,552Net Income Per Share
    
    
    0.17
    
    
    
    0.28
 The per share amounts presented above have been adjusted retroactively for all periods
presented to reflect the change in capital structure resulting from the 7% stock dividends
paid in 2004.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (10)
    
    Commitments and ContingenciesWe have committed to the following contractual obligations as of December 31, 2006 with the
payments due by the period indicated below:
 Less than 1
    
    
    
    
    
    
    
    
    
    
    More than 5Contractual Obligation
    
    Total
    
    
    Year
    
    
    1 to 3 Years
    
    
    3 to 5 Years
    
    
    Years(In Thousands)Operating leases
    
    $
    683
    
    
    
    267
    
    
    
    297
    
    
    
    119
    
    
    
    Other
    
    
    2,336
    
    
    
    2,292
    
    
    
    44
    
    
    
    
    
    
    
    Total operating and other leases
    
    $
    3,019
    
    
    
    2,559
    
    
    
    341
    
    
    
    119
    
    
    
    Future policy benefit reserves:Life insurance
    
    $
    473,355
    
    
    
    176
    
    
    
    987
    
    
    
    9,258
    
    
    
    462,934Annuities
    
    
    20,761
    
    
    
    8,263
    
    
    
    5,708
    
    
    
    3,696
    
    
    
    3,094Accident and health
    
    
    10,604
    
    
    
    10,604
    
    
    
    
    
    
    
    
    
    
    
    Total future policy benefit reserves
    
    $
    504,720
    
    
    
    19,043
    
    
    
    6,695
    
    
    
    12,954
    
    
    
    466,028Policy claims payable:Life insurance
    
    $
    6,189
    
    
    
    6,189
    
    
    
    
    
    
    
    
    
    
    
    Accident and health
    
    
    1,423
    
    
    
    1,423
    
    
    
    
    
    
    
    
    
    
    
    Casualty
    
    
    1,836
    
    
    
    1,836
    
    
    
    
    
    
    
    
    
    
    
    Total policy claims payable
    
    $
    9,448
    
    
    
    9,448
    
    
    
    
    
    
    
    
    
    
    
    Convertible Preferred Stock
    
    $
    16,251
    
    
    
    
    
    
    
    
    
    
    
    16,251
    
    
    
    Total contractual obligations$
    533,438
    
    
    $
    31,050
    
    
    $
    7,036
    
    
    $
    29,324
    
    
    $
    466,028
 The payments related to the future policy benefits and policy claims payable reflected in the
table above have been projected utilizing assumptions based upon our historical experience and
anticipated future experience.We are a defendant in a lawsuit originally filed on August 6, 1999 in the Texas District
Court, Austin, Texas, now styled Citizens Insurance Company of America, Citizens, Inc., Harold
E. Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in which a
class was originally certified by the trial court, and affirmed by the Court of Appeals for
the Third District of Texas. We appealed the grant of class status to the Texas Supreme
Court, and oral arguments occurred on October 21, 2004. On March 2, 2007, the Texas Supreme
Court reversed the Court of Appeals affirmation of the trial courts class certification
order, decertified the class and remanded the case to the trial court for further proceedings
consistent with the Texas Supreme Courts opinion. The suit alleges that certain life
insurance policies that we made available by our primary life insurance subsidiary to non-U.S.
residents, when combined with a policy feature that allows policy dividends to be assigned to
two non-U.S. trusts for the purpose of accumulating ownership of our Class A common stock,
along with allowing the policyholders to make additional contributions to the trusts, were
actually offers and sales of securities that occurred in Texas by unregistered dealers in
violation of the registration provisions of the Texas securities laws. The remedy sought was
rescission and return of the insurance premium payments. We intend to continue to pursue a
vigorous defense in any remaining proceeding. However, we expect financial exposure to us, if
any, would be significantly less than had the purported class not been decertified.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 lawsuit pursuing class
certification filed in the United States District Court, Eastern District of Louisiana, on
August 28, 2006, styled Abadie, et al v. Aegis Security Insurance Co., et al, seeking payments
for claims denied by Security Plan Fire Insurance Company (SPFIC) and other declaratory
relief relevant to Hurricane Katrina. All property and casualty insurers in Louisiana were
named in this lawsuit.
On November 27, 2006, the trial court judge concluded that the flood exclusions contained in
most, if not all, of the property and casualty insurance policies were ambiguous whether the
exclusions pertained to flooding resulting from the negligence of third parties. As a
result, the trial court judge concluded that the policies will provide coverage for all
flooding resulting from the negligence of third parties. The trial court judge immediately
certified his opinion for appeal. It is presently unknown whether the U.S. Court of Appeals
for the Fifth Circuit will accept the appeal and, if so, what the briefing schedule will be
for a resolution of this appeal. However, 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 proposed class certification. In
the event of an adverse outcome, especially with regard to (a) whether the flooding is covered
by the SPFIC policies and (b) whether this litigation is appropriate for class certification,
the potential exposure to SPFIC, while not at this time quantifiable, could be substantial.
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.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Litigation, such as the matters described above, also can require significant amounts of time
of our management that would otherwise be devoted to our business.In early 2007, Citizens, Inc. acquired approximately 17 acres of real estate adjacent to
property already owned at Lake Buchanan, Texas, for $2.25 million.(11)
    
    Segment and Other Operating InformationOperating Segment InformationThe Company has three reportable segments: Life Insurance, Home Service Insurance, and Other
Non-Insurance Enterprises. The accounting policies of the segments are in accordance with
U.S. GAAP and are the same as those described in the summary of significant accounting
policies. The Company evaluates profit and loss performance based on U.S. GAAP net income
before federal income taxes for its three reportable segments.The Life Insurance segment, consisting of ordinary whole-life policies, is sold primarily
throughout Central and South America and Taiwan. Traditional ordinary life, credit life and
final expense policies, are also marketed in the Midwest and southern U.S. The life insurance
segment is aggregated from CICA and CNLIC. 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. 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 Insurance 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 property policies on Louisiana
residents.The measurement of segment profit and loss and segment assets do not include material
transactions between segments. The Company has no reportable differences between segments and
consolidated operations.Prior to 2006, the Company operated separate segments for domestic and international life
insurance. The Company has determined these segments should be combined as the operations
have become less diversified, the marketing philosophies are similar and operations are under
common management control. Additionally, internal analysis and reporting is based on total
life insurance operations. Prior to 2004, the Company actively operated a fourth segment,
Domestic Health. The
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 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 from this business.The following summary presents the Companys profit (loss) measurement from continuing
operations for each reportable segment, along with certain components of that profit (loss)
measurement, for the periods indicated.
 2006
    
    
    2005
    
    
    2004Year Ended December 31
    
    (In thousands)Profit (Loss) MeasurementIncome (loss) before federal income tax:Life Insurance
    
    $
    10,803
    
    
    
    4,715
    
    
    
    5,842Home Service Insurance
    
    
    3,531
    
    
    
    5,902
    
    
    
    2,609Other Non-Insurance Enterprises
    
    
    (992
    )
    
    
    1,179
    
    
    
    (363
    )Total consolidated income before Federal
income taxes
    
    $
    13,342
    
    
    
    11,796
    
    
    
    8,088
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Year Ended December 31
    
    2006
    
    
    2005
    
    
    2004(In thousands)Selected Components of Profit MeasurementTotal revenue:Life Insurance
    
    $
    105,747
    
    
    
    90,649
    
    
    
    86,468Home Service Insurance
    
    
    51,235
    
    
    
    49,655
    
    
    
    12,556Other Non-Insurance Enterprises
    
    
    1,077
    
    
    
    1,809
    
    
    
    835Total consolidated revenue
    
    $
    158,059
    
    
    
    142,113
    
    
    
    99,859Premium income:Life Insurance
    
    $
    90,479
    
    
    
    78,592
    
    
    
    70,117Home Service Insurance
    
    
    38,017
    
    
    
    37,682
    
    
    
    9,797Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    Total consolidated premium income
    
    $
    128,496
    
    
    
    116,274
    
    
    
    79,914Net investment income:Life Insurance
    
    $
    14,243
    
    
    
    11,780
    
    
    
    13,950Home Service Insurance
    
    
    12,232
    
    
    
    11,573
    
    
    
    2,876Other Non-Insurance Enterprises
    
    
    500
    
    
    
    215
    
    
    
    179Total consolidated net investment income
    
    $
    26,975
    
    
    
    23,568
    
    
    
    17,005Amortization expense:Life Insurance
    
    $
    12,102
    
    
    
    11,424
    
    
    
    11,726Home Service Insurance
    
    
    3,939
    
    
    
    4,770
    
    
    
    849Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    Total consolidated amortization expense
    
    $
    16,041
    
    
    
    16,194
    
    
    
    12,575Realized gains (losses):Life Insurance
    
    $
    321
    
    
    
    (105
    )
    
    
    788Home Service Insurance
    
    
    983
    
    
    
    305
    
    
    
    (398
    )Other Non-Insurance Enterprises
    
    
    (18
    )
    
    
    219
    
    
    
    (1
    )Total consolidated realized gains (losses)
    
    $
    1,286
    
    
    
    419
    
    
    
    389
 Assets as of December 31:
    
    2006
    
    
    2005(In thousands)Life Insurance
    
    $
    395,297
    
    
    
    346,313Home Service Insurance
    
    
    300,368
    
    
    
    300,693Other Non-Insurance Enterprises
    
    
    15,519
    
    
    
    14,883Total
    
    $
    711,184
    
    
    
    661,889
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
  Year Ended December 31:
    
    2006
    
    
    2005
    
    
    2004(In thousands)Premium income:Ordinary life
    
    $
    122,277
    
    
    
    110,519
    
    
    
    77,377Group life
    
    
    981
    
    
    
    568
    
    
    
    636Accident and health
    
    
    1,461
    
    
    
    1,560
    
    
    
    788Casualty
    
    
    3,777
    
    
    
    3,627
    
    
    
    1,113Total premium income
    
    $
    128,496
    
    
    
    116,274
    
    
    
    79,914
 Geographic InformationThe following table sets forth the Companys total yearly earned premium by
geographic area for the years indicated:
 Years Ended December 31,Area
    
    2006
    
    
    2005
    
    
    2004(In thousands)United States
    
    $
    56,717
    
    
    
    59,562
    
    
    
    35,376Columbia
    
    
    23,088
    
    
    
    20,699
    
    
    
    18,263Taiwan
    
    
    10,173
    
    
    
    7,057
    
    
    
    3,705Argentina
    
    
    9,060
    
    
    
    8,476
    
    
    
    8,490Venezuela
    
    
    8,995
    
    
    
    7,228
    
    
    
    6,482Ecuador
    
    
    7,482
    
    
    
    5,296
    
    
    
    3,665Other foreign countries
    
    
    23,666
    
    
    
    21,252
    
    
    
    18,686Reinsurance
    
    
    (10,685
    )
    
    
    (13,296
    )
    
    
    (14,753
    )Total
    
    $
    128,496
    
    
    
    116,274
    
    
    
    79,914
 (12) Income Taxes
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 A reconciliation of Federal income tax expense computed by applying the Federal income tax
rate of 34% to income before Federal income tax expense is as follows:
 2006
    
    
    2005
    
    
    2004(In thousands)Expected tax expense
    
    $
    4,536
    
    
    
    4,011
    
    
    
    2,750Change in valuation allowance
    
    
    41
    
    
    
    1,102
    
    
    
    (1,319
    )Tax-exempt interest
    
    
    (281
    )
    
    
    (230
    )
    
    
    (10
    )Goodwill impairment loss
    
    
    345
    
    
    
    
    
    
    
    Change in fair value of options and
warrants
    
    
    83
    
    
    
    (166
    )
    
    
    (87
    )Small life insurance company deduction
    
    
    
    
    
    
    
    
    
    
    (103
    )Adjustment of prior year taxes
    
    
    (33
    )
    
    
    (144
    )
    
    
    (591
    )Basis difference in investments
    
    
    
    
    
    
    
    
    
    
    (314
    )Other
    
    
    (26
    )
    
    
    (79
    )
    
    
    30Federal income tax expense
    
    $
    4,665
    
    
    
    4,494
    
    
    
    356
 Income tax expense (benefit) for the years ended December 31, 2006, 2005 and 2004
consists of:
 2006
    
    
    2005
    
    
    2004(In thousands)Current
    
    $
    3,836
    
    
    
    1,591
    
    
    
    1,474Deferred
    
    
    829
    
    
    
    2,903
    
    
    
    (1,118
    )$
    4,665
    
    
    
    4,494
    
    
    
    356
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 are presented
below:
 2006
    
    
    2005(In thousands)Deferred tax assets:Future policy benefit reserves
    
    $
    21,309
    
    
    $
    21,126Net operating loss carryforwards
    
    
    6,768
    
    
    
    5,022Due and accrued dividends and expenses
    
    
    935
    
    
    
    562Investments available-for-sale
    
    
    3,259
    
    
    
    2,473Other
    
    
    915
    
    
    
    1,209Total gross deferred tax assets
    
    
    33,186
    
    
    
    30,392Valuation allowance
    
    
    (1,177
    )
    
    
    (1,102
    )Total gross deferred tax assets net of valuation
allowance
    
    
    32,009
    
    
    
    29,290Deferred tax liabilities:Deferred policy acquisition costs, cost of customer
relationships acquired and intangible assets
    
    
    (31,064
    )
    
    
    (28,127
    )Investments amortization
    
    
    (1,956
    )
    
    
    (2,770
    )Other
    
    
    (487
    )
    
    
    (14
    )Total gross deferred tax liabilities
    
    
    (33,507
    )
    
    
    (30,911
    )Net deferred tax liability
    
    $
    (1,498
    )
    
    
    (1,621
    )
 A summary of the changes in the components of deferred federal income taxes
for 2006 and 2005 is as follows:
 2006
    
    
    2005(In thousands)Deferred tax assets (liabilities):Balance January 1
    
    $
    (1,621
    )
    
    
    (805
    )SAB 108 adjustment (see note 1(q))
    
    
    184
    
    
    
    Adjusted balance at January 1
    
    
    (1,437
    )
    
    
    (805
    )Deferred tax expense
    
    
    (829
    )
    
    
    (2,903
    )Investments available-for-sale
    
    
    768
    
    
    
    2,087Balance December 31
    
    $
    (1,498
    )
    
    
    (1,621
    )
 The Company and its subsidiaries had net operating losses at December 31, 2006 available
to offset future taxable income of approximately $19.9 million for Federal income tax
expiring at various times through 2026. A portion of the net operating loss carry forward is
subject to limitations under Section 382 of the Internal Revenue Code. At December 31, 2006
and 2005, the Company determined that as a result of the Companys income, projected future
income, tax planning strategies, and the nature of the items from which its deferred tax
assets are derived, it is more likely than not that its deferred tax assets, net of the
established valuation allowance, would
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 be realized. The Company established a valuation allowance for the net deferred tax asset,
in the amount of $1.2 million, related to CNLIC as a result of the proposed sale of that
company.At December 31, 2006, the Company had accumulated approximately $3,291,000 in its
policyholders surplus account. This is a special memorandum tax account into which
certain amounts not previously taxed, under prior tax laws, were accumulated. No new
additions will be made to this account. Federal income taxes will become payable thereon at
the then current tax rate (a) when and if distributions to the shareholder, other than stock
dividends and other limited exceptions, are made in excess of the accumulated previously
taxed income; or (b) when a company ceases to be a life insurance company as defined by the
Internal Revenue Code and such termination is not due to another life insurance company
acquiring its assets in a nontaxable transaction. The Company does not anticipate any
transactions that would cause any part of this amount to become taxable. However, should the
balance at December 31, 2006 become taxable, the tax computed at present rates would be
approximately $1,119,000 .The Company implemented SAB 108 as of January 1, 2006 and increased federal income taxes
payable by $253,000, from $448,000 to $701,000 as of that date.(13)
    
    Fair Value of Financial InstrumentsEstimates of fair values are made at a specific point in time, based on relevant market
prices and information about the financial instrument. The estimated fair values of
financial instruments presented below are not necessarily indicative of the amounts the
Company might realize in actual market transactions. The carrying amount and fair value for
the financial assets and liabilities on the consolidated balance
sheets at each year-end
were as follows:
 2006
    
    2005Carrying
    
    
    
    
    
    Carryingamount
    
    Fair value
    
    amount
    
    Fair value(In thousands)Financial assets:Fixed maturities
    
    $
    488,318
    
    
    
    488,318
    
    
    
    457,571
    
    
    
    459,075Equity securities
    
    
    312
    
    
    
    312
    
    
    
    610
    
    
    
    610Cash and cash equivalents
    
    
    24,521
    
    
    
    24,521
    
    
    
    18,311
    
    
    
    18,311Mortgage loans
    
    
    456
    
    
    
    469
    
    
    
    833
    
    
    
    929Financial liabilities:Annuities
    
    
    20,761
    
    
    
    20,761
    
    
    
    19,440
    
    
    
    19,440
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Fair values for fixed income securities and equity securities are based on quoted market
prices. In cases where quoted market prices are not available, fair values are based on
estimates using present value or other assumptions, including the discount rate and estimates
of future cash flows.Mortgage loans are secured principally by residential properties. Weighted average interest
rates for these loans as of December 31, 2006 and 2005, were approximately 8.4% and 8.9%,
respectively, with maturities ranging from one to fifteen years. Management estimated the
fair value using an interest rate of 6.25% at December 31, 2006 and 2005.The carrying value and fair values for the Companys liabilities under annuity contract
policies are the same as the interest rates credited to these products and are periodically
adjusted by the Company to reflect market conditions. The fair value of liabilities under
all insurance contracts are taken into consideration in the overall management of interest
rate risk, which minimizes exposure to changing interest rates through the matching of
investment maturities with amounts due under insurance contracts.Policy loans have a weighted average interest rate of 7.5% as of December 31, 2006 and 2005,
and have no specified maturity dates. The aggregate fair value of policy loans approximates
the carrying value reflected on the consolidated balance sheet. These loans typically carry
an interest rate that is tied to the crediting rate applied to the related policy and
contract reserves. Policy loans are an integral part of the life insurance policies that the
Company has in force and cannot be valued separately.For cash and cash equivalents, accrued investment income, amounts recoverable from
reinsurers, other assets, federal income tax payable and receivable, dividend accumulations,
commissions payable, amounts held on deposit, and other liabilities, the carrying amounts
approximate fair value because of the short maturity of such financial instruments.
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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (14)
    
    Other Comprehensive LossThe changes in the components of other comprehensive loss are reported net of income taxes of
34% for the periods indicated as follows:
 (In Thousands)Pre-tax
    
    
    Tax
    
    
    NetAmount
    
    
    Effect
    
    
    AmountYear ended December 31, 2006Unrealized loss on securities:Unrealized holding loss arising
during the period
    
    $
    (1,613
    )
    
    
    548
    
    
    
    (1,065
    )Add: reclassification adjustment for
gains included in net income
    
    
    (1,434
    )
    
    
    488
    
    
    
    (946
    )Unrealized gains on securities
transferred during the period
from held-to-maturity to
available-for-sale
    
    
    734
    
    
    
    (250
    )
    
    
    484Change in tax valuation allowance
    
    
    
    
    
    
    (18
    )
    
    
    (18
    )Other comprehensive loss
    
    $
    (2,313
    )
    
    
    768
    
    
    
    (1,545
    )Year ended December 31, 2005Unrealized loss on securities:Unrealized holding loss arising
during the period
    
    $
    (5,614
    )
    
    
    1,909
    
    
    
    (3,705
    )Add: reclassification adjustment for
gains included in net income
    
    
    (525
    )
    
    
    178
    
    
    
    (347
    )Other comprehensive loss
    
    $
    (6,139
    )
    
    
    2,087
    
    
    
    (4,052
    )Year ended December 31, 2004Unrealized loss on securities:Unrealized holding loss arising
during the period
    
    $
    (2,699
    )
    
    
    918
    
    
    
    (1,781
    )Add: reclassification adjustment for
gains included in net income
    
    
    (364
    )
    
    
    124
    
    
    
    (240
    )Other comprehensive loss
    
    $
    (3,063
    )
    
    
    1,042
    
    
    
    (2,021
    )
 (15)
    
    Profit-Sharing PlanThe Company sponsors a defined contribution profit-sharing plan. Employees with one year of
service can participate. Contributions are made at the Companys discretion and are subject
to graded vesting. Employer contributions to the plan were $750,000, $500,000 and $300,000
in 2006, 2005 and 2004, respectively. The plan does not permit employee contributions.
 135




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (16)
    
    Related Party TransactionsThe Company sponsors the Citizens, Inc. Stock Investment Plan (the Plan), which is
administered by an independent third party. The Plan is a means for new and existing
investors in Citizens, Inc. Class A Common Stock to purchase and sell shares at market
prices. Each share purchased through the Plan is registered in the name of the investing
shareholder, and dividends can be automatically reinvested. The Company offers the Plan to
the Companys policyholders for automatic investment of policy benefits, including
policyholder dividends. The Company does not have possession of, or control over, any
amounts invested through the Plan.
 136




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 (17) Quarterly Financial Information (Unaudited)
  SAB 108As Reported
    
    Adjustments
    
    Interperiod
    
    As2006
    
    on Form 10-Q
    
    (See Note 1(q))
    
    Adjustments
    
    Adjusted(In thousands)Fourth Quarter:Revenues
    
    
    43,270
    
    
    
    955
    
    A162
    
    B216
    
    C
    
    
    
    
    
    44,603Benefits and expenses
    
    
    38,145
    
    
    
    350
    
    D
    
    (589
    )
    E65
    
    F
    
    37,971Federal income tax expense
    
    
    2,039
    
    
    
    334
    
    
    
    178
    
    
    
    2,551Net income
    
    
    3,086
    
    
    
    649
    
    
    
    346
    
    
    
    4,081Net income available to common shareholders
    
    
    2,585
    
    
    
    649
    
    
    
    346
    
    
    
    3,580Basic and diluted earnings per share
    
    
    0.06
    
    
    
    0.02
    
    
    
    0.00
    
    
    
    0.08Third Quarter:Revenues
    
    
    38,485
    
    
    
    (65
    )
    C
    
    180
    
    G
    
    38,600Benefits and expenses
    
    
    34,522
    
    
    
    
    
    
    
    65
    
    F48
    
    E(225
    )
    H(135
    )
    I
    
    34,275Federal income tax expense
    
    
    1,375
    
    
    
    (22
    )
    
    
    145
    
    
    
    1,498Net income
    
    
    2,588
    
    
    
    (43
    )
    
    
    282
    
    
    
    2,827Net income available to common shareholders
    
    
    2,080
    
    
    
    (43
    )
    
    
    282
    
    
    
    2,319Basic and diluted earnings per share
    
    
    0.05
    
    
    
    (0.00
    )
    
    
    0.01
    
    
    
    0.06Second Quarter:Revenues
    
    
    38,196
    
    
    
    (151
    )
    C
    
    
    
    
    
    38,045Benefits and expenses
    
    
    37,000
    
    
    
    
    
    
    
    65
    
    F75
    
    H38
    
    I(17
    )
    E
    
    37,161Federal income tax expense
    
    
    242
    
    
    
    (51
    )
    
    
    (55
    )
    
    
    136Net income
    
    
    954
    
    
    
    (100
    )
    
    
    (106
    )
    
    
    748Net income available to common shareholders
    
    
    446
    
    
    
    (100
    )
    
    
    (106
    )
    
    
    240Basic and diluted earnings per share
    
    
    0.01
    
    
    
    (0.00
    )
    
    
    (0.00
    )
    
    
    0.01First Quarter:Revenues
    
    
    38,108
    
    
    
    (955
    )
    A
    
    (180
    )
    G(162
    )
    B
    
    
    
    
    
    36,811Benefits and expenses
    
    
    35,050
    
    
    
    (350
    )
    D
    
    (195
    )
    F150
    
    H97
    
    I558
    
    E
    
    35,310Federal income tax expense
    
    
    1,009
    
    
    
    (261
    )
    
    
    (268
    )
    
    
    480Net income
    
    
    2,049
    
    
    
    (506
    )
    
    
    (522
    )
    
    
    1,021Net income available to common shareholders
    
    
    1,543
    
    
    
    (506
    )
    
    
    (522
    )
    
    
    515Basic and diluted earnings per share
    
    
    0.04
    
    
    
    (0.01
    )
    
    
    (0.02
    )
    
    
    0.01
 137




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 The differences above between the amounts as reported on Form 10-Q and the amounts as adjusted
consist of (1) corrections of prior year errors initially recorded during 2006 but subsequently
moved to the beginning-of-year cumulative retained deficit adjustment pursuant to SAB 108 and (2)
current year items initially recorded during 2006 in a quarter other than the quarter(s) in which
they arose. These differences consist of the following:
 A.
    
    Accrual of $955,000 due premium originally recorded in the first quarter, and then
transferred to the SAB 108 adjustment in the fourth quarter. See note 1(q) B.B.
    
    Accrual of $162,000 catastrophe reinsurance premium refund originally recorded in the
first quarter, and then transferred to the SAB 108 adjustment in the fourth quarter. See
note 1 (q) E.C.
    
    Accrual of $216,000 in reinsurance recoverables originally recorded in the second and
third quarters, and then transferred to the SAB 108 adjustment in the fourth quarter. See
note 1 (q) E.D.
    
    Impairment of $350,000 of intangibles originally recorded in the first quarter, and
then transferred to the SAB 108 adjustment in the fourth quarter. See note 1 (q) D.E.
    
    Additional $589,000 amortization of cost of customer relationships recorded in the
fourth quarter, but pertaining to the first, second, and third quarters.F.
    
    $195,000 workers compensation insurance premium expensed in the first quarter, but
pertaining to the second, third, and fourth quarters.G.
    
    $180,000 impairment of an other long-term investment recorded in the third quarter,
but pertaining to the first quarter.H.
    
    Accrual of $225,000 interest expense on policyholder dividends recorded in the third
quarter, but pertaining to the first and second quarters.I.
    
    Correction of purchased lease accounting recorded in the third quarter, but
pertaining to errors originating in the first and second quarters. See note 1 (q) B.
 All adjustments have been tax effected at 34%.
 138




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
December 31, 2006, 2005 and 2004
 Fourth
    
    Third
    
    Second
    
    First2005
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter(In Thousands)Revenues
    
    $
    38,418
    
    
    
    35,847
    
    
    
    33,864
    
    
    
    33,984Benefits and expenses
    
    
    32,944
    
    
    
    33,601
    
    
    
    33,140
    
    
    
    30,632Federal income tax expense
    
    
    2,380
    
    
    
    759
    
    
    
    362
    
    
    
    993Net income
    
    
    3,094
    
    
    
    1,487
    
    
    
    362
    
    
    
    2,359Net income (loss) available to
common shareholders
    
    
    2,596
    
    
    
    999
    
    
    
    (134
    )
    
    
    1,865Basic and diluted earnings per
share
    
    
    0.06
    
    
    
    0.02
    
    
    
    
    
    
    
    0.05
 139




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
December 31, 2006, 2005 and 2004
 
 Schedule II
 CITIZENS, INC. (Parent Company)
Balance Sheet
December 31, 2006 and 2005
 2006
    
    
    2005(In Thousands)AssetsInvestment in subsidiaries (1)
    
    $
    142,108
    
    
    
    140,165Fixed maturities available-for-sale, at fair value
    
    
    8,297
    
    
    
    7,337Mortgage loans
    
    
    24
    
    
    
    305Accrued investment income
    
    
    107
    
    
    
    107Real estate
    
    
    1,111
    
    
    
    748Cash
    
    
    1,360
    
    
    
    1,227Other assets
    
    
    1,989
    
    
    
    1,985Total assets
    
    $
    154,996
    
    
    
    151,874Liabilities and Stockholders EquityLiabilities:Accrued expense and other liabilities
    
    $
    671
    
    
    
    1,778Liabilities for options and warrants
    
    
    1,831
    
    
    
    1,587Total Liabilities
    
    
    2,502
    
    
    
    3,365Cumulative convertible preferred stock
    
    
    12,883
    
    
    
    11,546Stockholders equity:Common stock:Class A
    
    
    210,066
    
    
    
    211,403Class B
    
    
    3,184
    
    
    
    3,184Retained deficit
    
    
    (56,282
    )
    
    
    (61,812
    )Unrealized investment losses on securities held by
parent and subsidiaries, net of tax
    
    
    (6,346
    )
    
    
    (4,801
    )Treasury stock
    
    
    (11,011
    )
    
    
    (11,011
    )Total stockholders equity
    
    
    139,611
    
    
    
    136,963Total liabilities and stockholders equity
    
    $
    154,996
    
    
    
    151,874
 
 (1)
    
    Eliminates in consolidation.  140




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ended December 31, 2006, 2005 and 2004
 Schedule II, Continued
Condensed Financial Information of Registrant
CITIZENS, INC. (Parent Company)
Statements of Operations
 2006
    
    
    2005
    
    
    2004(In Thousands)Revenues:Management service fees (1)
    
    $
    28,076
    
    
    
    27,372
    
    
    
    17,931Investment income
    
    
    471
    
    
    
    187
    
    
    
    168Decrease (increase) in fair value of option and warrants
    
    
    (244
    )
    
    
    489
    
    
    
    256Other
    
    
    65
    
    
    
    7
    
    
    
    2Realized gains (losses)
    
    
    (18
    )
    
    
    59
    
    
    
    (1
    )Total revenues
    
    
    28,350
    
    
    
    28,114
    
    
    
    18,356Expenses:General
    
    
    26,497
    
    
    
    25,323
    
    
    
    17,327Taxes
    
    
    1,387
    
    
    
    1,472
    
    
    
    889Total expenses
    
    
    27,884
    
    
    
    26,795
    
    
    
    18,216Income before equity in income of unconsolidated
subsidiaries
    
    
    466
    
    
    
    1,319
    
    
    
    140Equity in income of consolidated subsidiaries
    
    
    8,211
    
    
    
    5,983
    
    
    
    7,592Net income
    
    $
    8,677
    
    
    
    7,302
    
    
    
    7,732
 
 (1)
    
    Eliminates in consolidation.  141




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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ended December 31, 2006, 2005 and 2004
 Schedule II, Continued
Condensed Financial Information of Registrant
CITIZENS, INC. (Parent Company)
Statements of Cash Flows
 2006
    
    
    2005
    
    
    2004(In Thousands)Cash flows provided by (used in) operating activities:Net income
    
    $
    8,677
    
    
    
    7,302
    
    
    
    7,732Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Realized losses (gains)
    
    
    18
    
    
    
    (59
    )
    
    
    1Equity in net income of unconsolidated subsidiaries
    
    
    (8,211
    )
    
    
    (5,983
    )
    
    
    (7,592
    )Increase (decrease) in fair value of options and
warrants
    
    
    244
    
    
    
    (489
    )
    
    
    (256
    )Accrued expenses and other liabilities
    
    
    (64
    )
    
    
    329
    
    
    
    489Depreciation
    
    
    82
    
    
    
    79
    
    
    
    73Change in accrued investment income
    
    
    (15
    )
    
    
    (54
    )
    
    
    8Other
    
    
    534
    
    
    
    395
    
    
    
    (599
    )Net cash provided by (used in) operating activities
    
    
    1,265
    
    
    
    1,520
    
    
    
    (144
    )Cash flows from investing activities:Purchase of fixed maturities, available-for-sale
    
    
    (2,999
    )
    
    
    (5,500
    )
    
    
    (450
    )Maturities of fixed maturities, available-for-sale
    
    
    2,000
    
    
    
    950
    
    
    
    700Payoff of note receivable
    
    
    
    
    
    
    30,000
    
    
    
    Capital contribution to subsidiaries
    
    
    
    
    
    
    
    
    
    
    (11,000
    )Sale of real estate and other long-term investments
    
    
    58
    
    
    
    213
    
    
    
    3Issuance of note receivable
    
    
    
    
    
    
    
    
    
    
    (30,000
    )Payoff of collateral loan
    
    
    
    
    
    
    100
    
    
    
    Purchase of real estate and other long-term investments
    
    
    (191
    )
    
    
    (22
    )
    
    
    (114
    )Net cash used in investing activities
    
    
    (1,132
    )
    
    
    25,741
    
    
    
    (40,861
    )Cash flows from financing activities:Proceeds/payoff of note payable
    
    
    
    
    
    
    (30,000
    )
    
    
    30,000Proceeds from issuance of convertible preferred stock
    
    
    
    
    
    
    3,751
    
    
    
    12,500Payment of convertible preferred stock issuance costs
    
    
    
    
    
    
    (187
    )
    
    
    (1,211
    )Net cash provided by (used in) financing activities
    
    
    
    
    
    
    (26,436
    )
    
    
    41,289Net increase in cash
    
    
    133
    
    
    
    825
    
    
    
    284Cash at beginning of year
    
    
    1,227
    
    
    
    402
    
    
    
    118Cash at end of year
    
    $
    1,360
    
    
    
    1,227
    
    
    
    402
  142




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ended December 31, 2006, 2005 and 2004
 
 Schedule III
 Supplementary Insurance Information
 2006
    
    
    2005(In Thousands)Deferred policy acquisition cost:Life Insurance
    
    $
    80,482
    
    
    
    68,014Home Service Insurance
    
    
    6,493
    
    
    
    2,396Other Non-Insurance Enterprises
    
    
    
    
    
    
    Total consolidated deferred policy acquisition costs:
    
    $
    86,975
    
    
    
    70,410Future policy benefit reserves and policy
claims payable:Life Insurance
    
    $
    310,592
    
    
    
    277,362Home Service Insurance
    
    
    203,576
    
    
    
    201,602Other Non-Insurance Enterprises
    
    
    
    
    
    
    Total consolidated future policy benefits, reserves
and policy claims payable
    
    $
    514,168
    
    
    
    478,964Unearned premiums:Life Insurance
    
    $
    632
    
    
    
    583Home Service Insurance
    
    
    1,180
    
    
    
    1,101Other Non-Insurance Enterprises
    
    
    
    
    
    
    Total consolidated unearned premiums
    
    $
    1,812
    
    
    
    1,684Other policy claims and benefits payable:Life Insurance
    
    $
    20,361
    
    
    
    18,476Home Service Insurance
    
    
    334
    
    
    
    322Other Non-Insurance Enterprises
    
    
    
    
    
    
    Total consolidated other policy claims and benefits
payable
    
    $
    20,695
    
    
    
    18,798
  143




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ended December 31, 2006, 2005 and 2004
 Schedule III, continued
 Supplementary Insurance Information, continued
 2006
    
    
    2005
    
    
    2004(In Thousands)Premiums:Life Insurance
    
    $
    90,479
    
    
    
    78,592
    
    
    
    70,117Home Service Insurance (1)
    
    
    38,017
    
    
    
    37,682
    
    
    
    9,797Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    Total consolidated premium revenue
    
    $
    128,496
    
    
    
    116,274
    
    
    
    79,914Net investment income:Life Insurance
    
    $
    14,243
    
    
    
    11,780
    
    
    
    13,950Home Service Insurance
    
    
    12,232
    
    
    
    11,573
    
    
    
    2,876Other Non-Insurance Enterprises
    
    
    500
    
    
    
    215
    
    
    
    179Total consolidated net investment income
    
    $
    26,975
    
    
    
    23,568
    
    
    
    17,005Benefits, claims, losses and settlement expenses:Life Insurance
    
    $
    66,939
    
    
    
    59,334
    
    
    
    52,104Home Service Insurance
    
    
    25,425
    
    
    
    20,763
    
    
    
    5,105Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    Total consolidated benefits, claims, losses and
settlement expenses
    
    $
    92,364
    
    
    
    80,097
    
    
    
    57,209Amortization of deferred policy acquisition costs:Life Insurance
    
    $
    9,786
    
    
    
    9,354
    
    
    
    7,136Home Service Insurance
    
    
    1,605
    
    
    
    959
    
    
    
    Other Non-Insurance Enterprises
    
    
    
    
    
    
    
    
    
    
    1,302Total consolidated amortization of deferred policy
acquisition costs
    
    $
    11,391
    
    
    
    10,313
    
    
    
    8,438Other operating expenses:Life Insurance
    
    $
    15,245
    
    
    
    15,261
    
    
    
    14,774Home Service Insurance
    
    
    10,292
    
    
    
    9,571
    
    
    
    1,949Other Non-Insurance Enterprises
    
    
    2,070
    
    
    
    597
    
    
    
    668Total consolidated other operating expenses
    
    $
    27,607
    
    
    
    25,429
    
    
    
    17,391
 
 (1)
    
    Premiums written for property insurance approximates premiums earned.  144




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ended December 31, 2006, 2005 and 2004
  
 Schedule IV
 Reinsurance
 Assumed
    
    
    
    
    
    
    % ofCeded to
    
    
    From
    
    
    
    
    
    
    AmountDirect
    
    
    Other
    
    
    Other
    
    
    Net
    
    
    Assumed(In thousands)
    
    Amount
    
    
    Companies
    
    
    Companies
    
    
    Amount
    
    
    to NetYear ended December 31, 2006Life insurance in force
    
    $
    3,971,499
    
    
    
    258,756
    
    
    
    669,787
    
    
    
    4,382,530
    
    
    
    15.3
    %Premiums:Life insurance
    
    
    123,976
    
    
    
    1,844
    
    
    
    1,126
    
    
    
    123,258
    
    
    
    0.9Accident and health insurance
    
    
    10,403
    
    
    
    8,942
    
    
    
    
    
    
    
    1,461
    
    
    
    Property
    
    
    4,802
    
    
    
    1,025
    
    
    
    
    
    
    
    3,777
    
    
    
    Total premiums
    
    $
    139,181
    
    
    
    11,811
    
    
    
    1,126
    
    
    
    128,496
    
    
    
    0.9
    %Year ended December 31, 2005Life insurance in force
    
    $
    3,687,229
    
    
    
    221,793
    
    
    
    592,636
    
    
    
    4,058,072
    
    
    
    14.6
    %Premiums:Life insurance
    
    
    112,423
    
    
    
    1,907
    
    
    
    571
    
    
    
    111,087
    
    
    
    0.5Accident and health insurance
    
    
    12,389
    
    
    
    10,829
    
    
    
    
    
    
    
    1,560
    
    
    
    Property
    
    
    4,758
    
    
    
    1,131
    
    
    
    
    
    
    
    3,627
    
    
    
    Total premiums
    
    $
    129,570
    
    
    
    13,867
    
    
    
    571
    
    
    
    116,274
    
    
    
    0.5
    %Year ended December 31, 2004Life insurance in force
    
    $
    3,513,044
    
    
    
    265,001
    
    
    
    488,312
    
    
    
    3,736,355
    
    
    
    13.1
    %Premiums:Life insurance
    
    
    78,378
    
    
    
    1,001
    
    
    
    636
    
    
    
    78,013
    
    
    
    0.8Accident and health insurance
    
    
    15,086
    
    
    
    14,298
    
    
    
    
    
    
    
    788
    
    
    
    Property
    
    
    1,203
    
    
    
    90
    
    
    
    
    
    
    
    1,113
    
    
    
    Total premiums
    
    $
    94,667
    
    
    
    15,389
    
    
    
    636
    
    
    
    79,914
    
    
    
    0.8
    %
  145




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##### Table of Contents



Signatures
  CITIZENS, INC.Date:  March 30, 2007
    By:
    /s/ Harold E. RileyHarold E. RileyChief Executive Officer and ChairmanBy:
    /s/ Larry E. CarsonLarry E. CarsonVice President, Chief Financial Officer and
Treasurer    /s/ Mark A. Oliver

Mark A. Oliver, Director
    
    /s/ Harold E. Riley

Harold E. Riley, Chairman of
the Board and Director/s/ Richard C. Scott

Dr. Richard C. Scott, Director
    
    /s/ Timothy T. Timmerman

Timothy T. Timmerman, Director/s/ Rick D. Riley

Rick D. Riley, Director
    
    /s/ Steven F. Shelton

Steven F. Shelton, Director/s/ E. Dean Gage

Dr. E. Dean Gage, Director
    
    /s/ Grant G. Teaff

Grant G. Teaff, Director
 146




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##### Table of Contents



EXHIBITS
 Exhibit Number
    
    The following exhibits are filed herewith:3.1
    
    Restated and Amended Articles of Incorporation (a)3.2
    
    Bylaws (b)4.1
    
    Amendment to State Series A-1 and A-2 Senior Convertible Preferred Stock (c)10.1
    
    Self-Administered Automatic Reinsurance Agreement  Citizens Insurance Company of America and
Riunione Adriatica di Sicurta, S.p.A. (d)10.2
    
    Bulk Accidental Death Benefit Reinsurance Agreement between Connecticut General Life
Insurance Company and Citizens Insurance Company of America, as amended (e)10.3
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement, Administrative Services
Agreement dated March 9, 2004, between Citizens Insurance Company of America and Texas
International Life Insurance Company, Reinsurance Trust Agreement dated March 9, 2004, by and
among Citizens Insurance Company of America, Texas International Life Insurance Company and
Wells Fargo Bank, N.A. (f)10.4
    
    Coinsurance Reinsurance Agreement, Assumption Reinsurance Agreement, Administrative Services
Agreement dated March 9, 2004, between Combined Underwriters Life Insurance Company and Texas
International Life Insurance Company, Reinsurance Trust Agreement dated March 9, 2004, by and
among Combined Underwriters Life Insurance Company, Texas International Life Insurance Company
and Wells Fargo Bank, N.A. (g)10.5(a)
    
    Securities Purchase Agreement dated July 12, 2004 among Citizens, Inc., Mainfield
Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and Opportunity Fund, and
Smithfield Fiduciary LLC (h)10.5(b)
    
    Registration Rights Agreement dated July 12, 2004 among Citizens, Inc., Mainfield
Enterprises, Inc., Steelhead Investments Ltd., Portside Growth and Opportunity Fund, and
Smithfield Fiduciary LLC (h)10.5(c)
    
    Unit Warrant dated July 12, 2004, to Mainfield Enterprises, Inc. (h)10.5(d)
    
    Unit Warrant dated July 12, 2004, to Steelhead Investments Ltd. (h)10.5(e)
    
    Unit Warrant dated July 12, 2004, to Portside Growth and Opportunity Fund (h)10.5(f)
    
    Unit Warrant dated July 12, 2004, to Smithfield Fiduciary LLC (h)




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ending December 31, 2006, 2005 and 2004
 Exhibit Number
    
    The following exhibits are filed herewith:10.5(g)
    
    Warrant to Purchase Class A Common Stock to Mainfield Enterprises, Inc. (h)10.5(h)
    
    Warrant to Purchase Class A Common Stock to Steelhead Investments Ltd. (h)10.5(i)
    
    Warrant to Purchase Class A Common Stock to Portside Growth and Opportunity Fund (h)10.5(j)
    
    Warrant to Purchase Class A Common Stock to Smithfield Fiduciary LLC (h)10.5(k)
    
    Subordination Agreement among Regions Bank, the Purchasers and Citizens, Inc. dated July
12, 2004 (h)10.5(l)
    
    Non-Exclusive Finders Agreement dated September 29, 2003, between Citizens, Inc. and the
Shemano Group, Inc. (h)10.6
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance Company of
America and Converium Reinsurance (Germany) Ltd.(i)10.7
    
    Self-Administered Automatic Reinsurance Agreement between Citizens Insurance Company of
America and Scottish Re Worldwide (England) (j)10.8
    
    First Amended and Restated Loan Agreement  Regions Bank, dated December 5, 2005(k)10.9
    
    First Amendment to First Amended and Restated Loan Agreement  Regions Bank, dated December
8, 2006*11
    
    Statement re: Computation of per share earnings (see financial
statements)21
    
    Subsidiaries of Registrant*23(a)
    
    Consent of Independent Registered Public Accounting Firm   KPMG
LLP*23(b)
    
    Consent of Independent Registered Public Accounting Firm  Ernst &
Young LLP*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




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##### Table of Contents



CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Financial Schedules
For the Years Ending December 31, 2006, 2005 and 2004
 Exhibit Number
    
    The following exhibits are filed herewith:Sarbanes-Oxley Act*32.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act*
 
 *
    
    Filed herewith.(a)
    
    Filed on March 15, 2004 with the Registrants Annual Report on Form 10-K for the Year Ended
December 31, 2003 as Exhibit 3.1, and incorporated herein by reference.(b)
    
    Filed with the Registrants Annual Report on Form 10-K for the Year Ended December 31, 1998,
as Exhibit 3.2,, and incorporated herein by reference.(c)
    
    Filed on July 15, 2004, with the Registrants Current Report on Form 8-K as Exhibit 4.1, and
incorporated herein by reference.(d)
    
    Filed as Exhibit 10.8 with the Registration Statement on Form S-4, SEC File No. 333-16163, on
November 14, 1996 and incorporated herein by reference.(e)
    
    Filed on April 9, 1997 as Exhibit 10.9 with the Registrants Annual Report on Form 10-K for
the Year Ended December 31, 1996, Amendment No. I, and incorporated herein by reference.(f)
    
    Filed on March 22, 2004 as Exhibit 10.8 of the Registrants Current Report on Form 8-K, and
incorporated herein by reference.(g)
    
    Filed on March 22, 2004 as Exhibit 10.9 of the Registrants Current Report on Form 8-K, and
incorporated herein by reference.(h)
    
    Filed on July 15, 2004 as part of Exhibit 10.12 with the Registrants Current Report on Form
8-K, and incorporated herein by reference.(i)
    
    Filed on March 31, 2005, with the Registrants Annual Report on Form 10-K for the Year Ended
December 31, 2004, as Exhibit 10.10(m), and incorporated herein by reference.(j)
    
    Filed on March 31, 2005, with the Registrants Annual Report on Form 10-K for the Year Ended
December 31, 2004, as Exhibit 10.10(n), and incorporated herein by reference.(k)
    
    Filed on or about 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.