The following is management's discussion and analysis of the consolidated financial condition and consolidated results of operations of the Company. It is intended to be a discussion of certain key financial information regarding the Company and should be read in conjunction with the Consolidated Financial Statements and related Notes to this report on Form 10-K.
Net investment income increased 2.9% for 2011 and was flat in 2010 and 2009. The average yield on the consolidated investment portfolio has declined significantly the last three years from a yield of 4.75% in 2009 down to 4.32% in 2010 and to 4.03% in 2011. The increase in the investment asset balances due to premium revenue growth was sufficient to offset the lower yield in the declining rate environment and resulted in an increase in net investment income.
Life Insurance. For over thirty years, CICA and its predecessors have accepted policy applications from foreign nationals for U.S. Dollar-denominated ordinary whole life insurance and endowment policies. We make our insurance products available using third-party marketing organizations and independent marketing consultants.
Endowment product sales have been on the rise and represented approximately 80% of new sales. The Company offers a ten, fifteen and twenty year endowment and our top selling endowment is a product that matures at age sixty-five. We also introduced a new product in the current year that is an endowment at age eighteen with a payout over four or five years. We have had limited sales to date, but we anticipate this product will be well received in our international markets.
Through the domestic market of our Life Insurance segment, we provide ordinary whole life, credit life insurance, and final expense policies to middle and lower income families and individuals in certain markets in the mid-west and southern U.S. The majority of our domestic revenues are the result of acquisitions of domestic life insurance companies since 1987.
Home Service Insurance. We provide final expense ordinary life insurance to middle and lower income individuals in Louisiana, Mississippi and Arkansas. Our policies in this segment are sold and serviced through a home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders, and through networks of funeral homes that collect premiums and provide personal policyholder service.
It is predicted that the interest rate environment will remain low for the foreseeable future, which translates into lower profit margins for insurers. We have been impacted by the historically low interest rate environment over the past several years as our fixed income investment portfolio, primarily invested in callable securities, has been reinvested at lower yields during this declining interest rate environment. The Company’s conservative investment strategy has not changed, but it has been a challenging investment time, as large amounts of calls resulted in significant cash balances to be reinvested. The Company experienced some delays in reinvesting the funds as suitable bonds meeting our target characteristics of investment grade and yield parameters were identified. Our investment earnings also impact the reserve and Deferred Acquisition Costs (“DAC”) balances, as assumptions are used in the development of the balances. Due to the recent decline in investment yields on our portfolio, our projection of long-term investment returns has declined. This has resulted in increasing the reserves on policies issued in the current year, as well as reducing the DAC asset.
Yields on invested assets vary between segment operations due to different portfolio mixes in the segments. The life segment invests more in U.S. government securities while the home service segment has a larger concentration in the corporate and municipal sectors.
Realized Gains (Losses) on Investments. In 2011, 2010 and 2009, the Company sold equity mutual funds, which were previously impaired, and realized gains of $1.3 million, $6.4 million and $4.9 million, respectively.
The Company monitors death claims based upon expectations. The claims experience was favorable in 2011, decreasing by 7.4% from 2010 recorded amounts and remained relatively consistent over the prior two years. Additionally, 2011 results include a $0.8 million incurred but not reported release of liability related to our claim expense calculation. These values may routinely fluctuate from year to year.
Property claims increased 26% to approximately $2.0 million in 2011 compared with the amount reported for 2010 and 2009, as the prior two years reflected claims reported that were lower than historical experience.
Reserves. The change in future policy benefit reserves has increased over the past several years, primarily because of the sale of endowment products, which build reserves at a much higher rate. Endowment sales totaled approximately $12.3 million, $9.4 million and $8.5 million in 2011, 2010 and 2009, respectively. In addition, the low interest rate environment is impacting assumptions used in the development of reserve balances on current year issued policies, which results in an increase of reserves.
Endowment sales represent a significant portion of new business sales internationally, as these products have gained in popularity over the past several years. In addition, most of our life insurance policies contain a policy loan provision, which allows the policyholder to use cash value of a policy to pay premiums. The policy loan asset balance increased 10.5% year over year.
The following table sets forth premiums from our international life insurance business for the periods indicated.
Realized Investment Gains, Net. Realized gains of $1.3 million and $6.6 were recognized in 2011 and 2010, due primarily to disposals of previously impaired equity mutual funds. Realized gains totaled $1.1 million in 2009 resulting from sales of available-for-sale fixed income securities, as discussed in the Consolidated Results of Operations above.
Capitalization and Amortization of Deferred Policy Acquisition Costs. Capitalized costs increased, as commission related costs have increased in the current year compared to 2010. Amortization of DAC decreased in the current year by 2.9% from 2010 as the Company experienced improved persistency in this segment.
Premiums. The premium increases were due to enhanced marketing efforts to promote the Home Service segment, as well as a SPFIC rate increase of approximately 5.8% that became effective January 1, 2011.
Realized Investment Gains (Losses), Net. Net realized losses of $0.6 million in 2011 are due primarily from an OTTI on one American Airlines debt security that totaled $70,000 due to the issuer filing bankruptcy, and a write-down of approximately $0.5 million related to investment real estate for an office building in Arkansas. We obtained an appraisal in 2011 that reflected a loss in fair value. Gains of $1.5 million in 2010 related primarily to sales of below investment grade securities that were added to the portfolio as part of an acquisition and had been previously impaired. Gains reported in 2009 totaled $6.6 million, which related primarily to sales of equity mutual funds that had been previously impaired. Impairments of $0.3 million were recorded in 2009 due to further declines in fair values relating to credit issues.
Property claims increased in 2011 compared to 2010 and 2009, as previous years reported claims were lower than historical experience.
Capitalization and Amortization of Deferred Policy Acquisition Costs ("DAC"). DAC capitalization is directly correlated to fluctuations in first year commissions. Amortization in 2011 increased compared to 2010 primarily because we experienced a higher lapse rate in the current year in this segment. We monitor lapse rates as a key component of our insurance operations. We are not aware of any information that would indicate this higher lapse rate will continue. Amortization in 2011 includes an adjustment that resulted in an increase of $0.3 million due to a refinement in an estimate using system generated information related to SPLIC assumptions. Amortization reported in 2010 is impacted by an adjustment that decreased amortization by $0.3 million in that reporting period.
Overall, other non-insurance operations are relatively immaterial to the consolidated results, except for the fair value adjustment related to the Company's warrants to purchase Class A common stock. These amounts fluctuate due to the movement in our Class A common stock price and fair value calculation using the Black-Scholes valuation model.
At December 31, 2011, investments in fixed maturity and equity securities were 90.3% of our total cash, and cash equivalents and investments. All of our fixed maturities were classified as either available-for-sale or held-to-maturity securities at December 31, 2011 and 2010. We had no fixed maturity or equity securities that were classified as trading securities at December 31, 2011 or 2010.
In addition, the Company made new investments in the AA credit category of taxable municipals and corporate bonds, primarily public utility issuers with an average maturity of seven years. The increase in non-investment grade securities was due to downgrades of issuers in the current period, as the Company does not purchase below investment grade securities.
The Company invests in municipal securities of issuers in the state of Louisiana and receives a credit that reduces its premium tax liability in that state. At December 31, 2011, total holdings of municipal securities in Louisiana represented 25.1% of all municipal holdings based upon fair value. The Company also holds 21.3% of its municipal holdings in Texas issuers.
There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2011.
Impairment Considerations Related to Investments in Fixed Maturity and Equity Securities
We evaluate the carrying value of our fixed maturity and equity securities at least quarterly. The Company monitors all debt and equity securities on an on-going basis relative to changes in credit ratings, market prices, earnings trends and financial performance, in addition to specific region or industry reviews. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. The Company determines other-than-temporary impairment (“OTTI”) by reviewing all relevant evidence related to the specific security issuer as well as the Company's intent to sell the security, or if it is more likely than not that the Company would be required to sell a security before recovery of its amortized cost.
Gross unrealized losses on fixed maturities available-for-sale amounted to $3.0 million as of December 31, 2011 and $13.7 million as of December 31, 2010. This decrease in gross unrealized losses was due to an increase in the interest rate environment. There were $0.5 million of gross unrealized losses on equity securities as of December 31, 2011. In 2011, 2010 and 2009, the Company sold equity mutual fund holdings from the Life and Home Service segments and recorded realized gains of $1.3 million, $6.4 million and $4.9 million due to market recovery since impairment at December 31, 2008. Information on unrealized gains and losses by category is set forth in our consolidated financial statements, Note 2 - Investments, in the "Notes to the Consolidated Financial Statements."
SPFIC has first and second event catastrophe reinsurance coverage of $10.0 million per event and a retention level of $500,000 per event. Thus, the first $500,000 of incurred claims and any claims in excess of $10.0 million are SPFIC's responsibility. The reinsurance premium for first event catastrophe reinsurance was $1,128,000, $1,130,000 and $1,075,000 in 2011, 2010 and 2009, respectively.
In 2011 and 2010, CICA contributed 150,000 shares of Citizens, Inc. Class A common stock to CNLIC as a capital contribution due to minimum capital and surplus considerations. The contributed shares had a fair market contributed value of $1.1 million and $1.0 million. These shares were subsequently purchased by Citizens, Inc., the ultimate parent, for $1.2 million and $1.0 million cash in 2011 and 2010, respectively. These transactions have been eliminated under consolidation accounting rules.
We have committed to the following contractual obligations as of December 31, 2011 with the payments due by the period indicated below:
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.
Citizens is a holding company and has had minimal operations of its own. Our assets consist of the capital stock of our subsidiaries, cash, fixed income securities, mutual funds and investment real estate. Accordingly, our cash flows depend upon the availability of statutorily permissible payments, primarily payments under management agreements from our two primary life insurance subsidiaries, CICA and SPLIC. The ability to make payments is limited by applicable laws and regulations of Colorado, CICA's state of domicile, and Louisiana, SPLIC's state of domicile, which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that these insurance subsidiaries maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. We historically have not relied upon dividends from subsidiaries for our cash flow needs. However, CICA and SPLIC both dividend available funds from time to time in relation to new acquisition target strategies. CICA has contributed amounts in the form of dividends to Citizens totaling $6.8 million, $9.3 million and $10.5 million in 2011, 2010 and 2009, respectively.
Inherent in the capitalization and amortization of deferred policy acquisition costs are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 90% of our capitalized deferred acquisition costs are attributed to first year excess commissions. The remaining 10% are attributed to costs that vary with and are directly related to the acquisition of new insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then evaluated over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Management believes that our deferred policy acquisition costs and related amortization for the years ended December 31, 2011, 2010 and 2009 limits the amount of deferred costs to its estimated realizable value. This belief is based upon the analysis performed on capitalized expenses that vary with and are primarily related to the acquisition of new and renewal insurance business, utilization of the factor method and annual recoverability testing.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next thirty years. The CCRA is then evaluated utilizing reasonable assumptions. Management believes our CCRA and related amortization is recoverable for the years ended December 31, 2011, 2010 and 2009. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
The goodwill impairment test follows a two step process as defined under current accounting guidance. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess.
Reference is made to the financial statements, the notes thereto, and the report of our independent registered public accounting firm, as listed on the table of contents.