The Company owns a 110,600 square foot office building in Howell, Michigan, approximately 40 miles outside of Detroit. This building serves as the Company's headquarters and accommodates corporate administration, marketing, information services, claims, and treasury. The Company also owns a 175,000 square foot facility in Howell near its current headquarters which accommodates underwriting, claims, marketing functions, and the Eastern Michigan branch operations.
In addition, the Company leases an aggregate of approximately 55,000 square feet in three Michigan branch offices--in Grand Rapids, Gaylord, and Escanaba--one branch office located in Indianapolis, Indiana--and one branch office located in Columbus, Ohio. The Company also leases space for its claims offices throughout Michigan and Indiana.
Net income in 1995 increased $30.3 million to $74.9 million, compared to $44.6 million in 1994. Excluding realized gains and losses and cumulative effect of changes in accounting, both net of taxes, net income increased $26.5 million to $72.5 million in 1995. The increase in net income is primarily attributable to an increase of $44.1 million in overall underwriting results from a loss of $30.7 million in 1994 to a gain of $13.4 million in 1995. This increase resulted primarily from a return to more normal weather conditions in Michigan and to favorable claims experience on current and prior accident years in the workers' compensation and personal automobile lines. These factors were somewhat offset by an increase in the effective tax rate from virtually zero in 1994 to 22.5% in 1995, resulting from the improvement in underwriting results, increases in realized gains and a decrease in the proportion of pre-tax income attributable to tax-exempt interest.
Net premiums earned increased $55.1 million, or 7.2%, to $817.8 million during 1995, representing increases of $40.1 million, or 8.1%, and $15.0 million, or 5.6%, in the personal and commercial segments, respectively. These increases are attributable to price increases in the homeowners and automobile lines. Continued growth in policies in force in the commercial automobile and commercial multiple peril lines of 12.5% and 11.6%, respectively, also contributed to the increase in net premiums earned. These items were partially offset by a 5.8% decrease in personal automobile policies in force.
Personal segment net premiums earned increased $18.4 million, or 3.4%, to $554.6 million in 1996. This growth is attributable to price increases in the personal automobile and homeowners lines. The growth is partially offset by a 3.0% decrease in policies in force in the personal automobile line, attributable to the Company's selective reduction of writings in Michigan when rates were viewed as inadequate and to continued strong competition in Michigan. While management has taken steps to increase penetration in affinity groups and has initiated other marketing programs, heightened competition may continue to result in reduced growth in the personal segment.
The personal segment underwriting loss in 1996 was $1.3 million compared to $26.6 million in 1995. The improvement in underwriting results reflects favorable claims activity in both current and prior accident years in the personal automobile line attributable to continued improvements in severity. This was partially offset by an increase in catastrophe losses of $6.2 million, to $13.4 million, primarily in the homeowners line. The increase in policy acquisition expenses of $4.4 million, or 4.1%, to $112.5 million in 1996 primarily reflects the growth in net premiums earned. Other underwriting expenses decreased $1.8 million, or 4.4%, to $39.3 million due to reductions in employee related expenses and commissions, partially offset by expenses associated with a policy administration technology project. Management anticipates an increase in its expense levels due to further planned investments.
Commercial segment net premiums earned decreased $0.7 million, or 0.2%, to $280.9 million in 1996. This decrease primarily reflects rate reductions and a 1.4% decrease in policies in force in the workers' compensation line due to continuing competition in this line in Michigan. Rates in the workers' compensation line were decreased 8.5%, 7.0%, and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively. This decrease is partially offset by an increase in policies in force in the commercial multiple peril and commercial automobile lines of 13.2% and 3.7%, respectively. Management believes competitive conditions in Michigan in the workers' compensation line may impact future growth in net premiums earned.
Commercial segment net premiums earned increased $15.0 million, or 5.6%, to $281.6 million in 1995. This increase primarily reflects growth of 8.1% in total commercial policies in force. The overall growth includes increases in policies in force in the commercial automobile and commercial multiple peril lines of 12.5% and 11.6%, respectively, along with a decrease in workers' compensation policies in force of 4.6% and rate decreases of 15.5% in the workers' compensation line during 1995. These decreases in workers' compensation premiums were more than offset by increased workforce exposures due to full employment in Michigan. Price increases in the commercial automobile line also contributed to the increase in net premiums earned.
The commercial segment underwriting profit in 1996 was $2.0 million compared to $40.0 million in 1995. The decline in underwriting profit is primarily attributable to an increase in loss severity and frequency in the commercial multiple peril line. Commercial multiple peril losses and LAE increased $16.9 million, or 42.4%, to $56.8 million in 1996, partially offset by a $5.1 million, or 9.4%, increase to $59.1 million in net premiums earned. Workers' compensation net premiums earned decreased $17.6 million, or 11.9%, to $130.7 million in 1996 while losses and LAE increased $9.6 million, or 15.0%, to $73.4 million in this line, primarily due to reduced favorable development of prior year reserves. Catastrophe losses in this segment were $1.9 million in 1996 compared to $0.8 million during 1995. Policy acquisition expenses remained consistent between years, primarily as a result of flat net earned premiums. Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million due to investments in technology and increased policyholders' dividends, partially offset by reductions in employee related expenses and commissions. Management anticipates an increase in its expense levels due to further planned investments in technology.
The commercial segment underwriting profit in 1995 was $40.0 million compared to $1.6 million in 1994. The improvement in underwriting results in 1995 reflects favorable claims activity in both current and prior accident years in the workers' compensation line attributable to improvements in severity and frequency, and to severe weather and large claims in the first half of 1994 which had an adverse impact on the commercial multiple peril and commercial automobile lines. The increase in policy acquisition expenses of $4.2 million, or 8.9%, to $51.5 million in 1995, primarily reflects the growth in net premiums earned. The decrease in other underwriting expenses reflects the unusually high level of expenses incurred during 1994 resulting from the expansion into Ohio, including the cost of preparing to write multi-state and cross-state commercial line policies, as well as a reduction in 1995 in administration expenses resulting from process improvements in the commercial segment.
Net investment income before taxes was $88.9 million, $78.8 million and $74.8 million in 1996, 1995, and 1994, respectively. The increase in 1996 is primarily the result of an increase in average invested assets, $4.4 million of income from limited partnerships, and the Company's portfolio shift, in 1996, from equity securities to higher yielding debt securities including longer duration and non-investment grade securities. The average pre-tax yields on debt securities were 6.3% in 1996 and 5.9% in both 1995 and 1994. Average invested assets increased $86.5 million, or 6.2%, to $1,490.0 million in 1996 primarily attributable to cash from operations. The increase in 1995 reflects an increase in average invested assets of $74.7 million, or 5.6%, to $1,403.5 million in 1995 from $1,328.8 million in 1994, primarily attributable to unrealized appreciation and to an increase in cash from operations, which was partially offset by the redemption of the $100.0 million Series A Preferred Stock. Net investment income after-tax was $73.4 million in 1996, $64.9 million in 1995, and $64.8 million in 1994. The investment results reflect average pre-tax yields of 6.0% in 1996 and 5.6% in both 1995 and 1994.
The provision for federal income taxes was $21.4 million and $21.7 million in 1996 and 1995, respectively. There was relatively no provision for federal income taxes in 1994. These provisions resulted in consolidated effective federal tax rates of 20.3% and 22.5% in 1996 and 1995, respectively. The effective tax rate was virtually zero in 1994. The decrease in the effective tax rate in 1996 from 1995 resulted from higher tax-exempt interest, partially offset by higher pre-tax income. The increase in the effective tax rate in 1995 from 1994 resulted from the improvement in underwriting results, increases in realized gains and a decrease in the proportion of pre-tax income attributable to tax-exempt interest.
The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company determines the appropriate amount of reinsurance based on evaluation of the risks accepted, analyses prepared by consultants and reinsurers, and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention,
As a condition to the ability to conduct personal automobile business in the state of Michigan, the Company is required under Michigan law to participate in a pooling arrangement with the Michigan Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA for personal protection insurance losses in excess of $0.25 million. At December 31, 1996 the MCCA was the only reinsurer which represented 10% or more of the Company's reinsurance business.
At December 31, 1996, $192.3 million, or 12.0%, of the investment portfolio was invested in equity securities compared to $189.5 million, or 12.7%, at December 31, 1995. Dividend income from equity securities was $4.2 million, or 4.5%, of investment income in 1996, compared to $4.5 million, or 5.3%, in 1995.
Net cash used for investing activities for the Company was $78.3 million and $89.2 million in 1996 and 1995, respectively. Net cash provided by investing activities was $2.1 million in 1994. Net cash used for investing activities has declined in 1996 from 1995 primarily due to the decrease in cash flow from operations. Net cash used for investing activities increased in 1995 from 1994 primarily due to a reduction in the Company's cash and cash equivalents.
Shareholders' equity was $754.5 million, or $21.39 per share, at December 31, 1996, compared to $682.8 million, or $19.04 per share, at December 31, 1995. Shareholders' equity reflects net income for the year, the repurchase of treasury stock and the impact of a net increase of $5.8 million in the fair values of available-for-sale debt and equity securities. Changes in shareholders' equity related to changes in the fair value of the investment portfolio will continue to be volatile as market prices of debt and equity securities fluctuate with changes in interest rates and economic conditions.
of new competitors, and the introduction of new products by new and existing competitors; (iv) adverse state and federal legislation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, and tax treatment of insurance products; (v) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (viii) loss or retirement of key executives; (ix) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (x) termination of provider contracts or renegotiation at less cost- effective rates or terms of payment; (xi) changes in the Company's liquidity due to changes in asset and liability matching; (xii) restrictions on insurance underwriting, based on certain criteria, (xiii) adverse changes in the ratings obtained by independent rating agencies such as Moody's, Standard and Poors and A.M. Best.
The consolidated financial statements include the accounts of Citizens Corporation, a Delaware corporation and non-insurance holding company; Citizens Insurance Company of America (Citizens Insurance), a Michigan corporation; Citizens Insurance Company of the Midwest, an Indiana corporation; and Citizens Insurance Company of Ohio, an Ohio corporation; (collectively Citizens Insurance Operations) and Citizens Management Inc. (collectively, the Company). Approximately 82.5% of the Company is owned by The Hanover Insurance Company (Hanover). Hanover is a wholly-owned subsidiary of Allmerica Property & Casualty Companies, Inc. (APY), a Delaware corporation.
On November 17, 1994, Citizens Insurance Company of Ohio was established and as of January 1, 1995, was admitted to do business in the state of Ohio. Business operations began on February 13, 1995. On September 1, 1994, Citizens Insurance Company of the Midwest was established and as of October 2, 1995 was admitted to do business in the state of Indiana. Business operations began on March 8, 1996.
Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 requires that an enterprise classify debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading. SFAS No. 115 also requires that unrealized holding gains and losses for trading securities be included in earnings, while unrealized gains and losses for available-for-sale securities be excluded from earnings and reported as a separate component of shareholders' equity until realized. The effect of implementing SFAS No. 115, as of January 1, 1994, was an increase in the carrying value of debt securities of $53.9 million and an increase in shareholders' equity of $35.0 million, net of deferred federal income taxes, which resulted from changing the carrying value of the debt securities from amortized cost to fair value. The implementation had no effect on net income.
The Company is included in the consolidated federal tax return of its parent, APY. Current taxes are allocated among all affiliated companies based on a written tax sharing agreement. Under this agreement, allocation is made primarily on a separate return basis with current payment for losses and other tax items utilized in the consolidated return.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). These differences result primarily from loss reserves, policy acquisition expenses, unearned premiums and unrealized appreciation or depreciation on investments.
Earnings per common share are based on the weighted average number of common shares and common share equivalents. The Board of Directors authorized the repurchase of 1.8 million shares or slightly less than five percent of its issued common stock and has purchased a total of 0.8 million shares since the implementation of the repurchase program in 1995. As of December 31, 1996, the Company is holding these shares as treasury stock for the purpose of funding current and future stock option awards and for other purposes.
The cumulative effect of a change in accounting for postemployment benefits was $(0.6) million, net of deferred income taxes, or $(0.02) per share for the year ended December 31, 1994.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which may vary in certain respects from statutory accounting practices followed by the Company that are prescribed or permitted by the Michigan, Ohio and Indiana state insurance regulatory authorities.
The amortized cost and fair value of debt securities, by contractual maturity, are as follows:
The carrying value of debt securities that did not produce income in the preceding twelve months was not significant. The Company had no concentration in an individual issuer that exceeded 10% of shareholders' equity at December 31, 1996.
Provisions for federal income taxes have been calculated in accordance with the provisions of SFAS No. 109. A summary of the federal income tax expense (benefit) in the consolidated statements of income is as follows:
Deferred federal income tax assets and liabilities are comprised of the following:
The provision for federal income tax expense differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate (35%) to income before federal income taxes and cumulative effect of a change in accounting. The sources of the difference and the tax effects of each were as follows:
The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Changes in prior reserve estimates are reflected in results of operations in the year such changes are determined to be needed and recorded.
The following table sets forth the Plan's funded status and amounts recognized in the Company's financial statements.
The Company has agreements under which FAFLIC, APY, and Hanover provide management, space, and other services. Charges for these services are based on full cost including all direct and indirect overhead costs and amounted to $12.5 million, $9.7 million and $3.4 million in 1996, 1995, and 1994, respectively.
The Company has certain operating lease agreements for property and equipment. At December 31, 1996, future minimum rental payments under non- cancelable long-term operating leases were $12.0 million, payable as follows: 1997--$3.1 million; 1998--$2.8 million; 1999--$2.2 million; 2000--$1.6 million; 2001--$1.1 million; and $1.2 million thereafter. All leases expire prior to the year 2005. It is expected that, in the normal course of business, leases that expire will be renewed or replaced by leases on other property and equipment; thus, it is anticipated that future minimum lease commitments will not be less than the amounts shown for 1997. Certain equipment and fixture leases are subject to buy out options. Rent expense, excluding related party charges, was $3.3 million, $3.3 million, and $5.6 million in 1996, 1995, and 1994, respectively.
Michigan limits the payment of dividends and other distributions to shareholders. Under current law, cash dividends may only be paid from earnings and policyholders' surplus. In addition, a Michigan insurer may not pay an "extraordinary" dividend to its stockholders without the prior approval of the Michigan Insurance Commissioner. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of policyholders' surplus as of December 31 of the immediately preceding year or the statutory net income less realized gains, for the immediately preceding calendar year. Based upon the 1996 statutory financial statements of Citizens Insurance, the maximum dividend that may be paid to Citizens Corporation at January 1, 1997, without prior approval from the Michigan Commissioner of Insurance, is $39.9 million.
The Company is engaged primarily in the property and liability insurance business. The Company operates predominately in Michigan, with operations in the adjoining states of Indiana and Ohio. Substantially all of the Company's earnings are generated in the state of Michigan. The Company's insurance operations are segmented into personal and commercial lines of business, based on common underlying risks and customer types for individual products in those segments. The personal segment includes products such as automobile insurance and homeowners insurance. The commercial segment includes products such as automobile insurance, commercial multiple-peril insurance, and workers' compensation insurance.
The following is a review of results by segment. Investments are available for payments of claims and expenses for all products. Investment income, realized gains and total assets have not been identified to specific segments.