The statements contained in the following "Management's Discussion and Analysis of Financial Condition and Results of Operations," and statements contained in future filings with the Securities and Exchange Commission and publicly disseminated press releases, and statements which may be made from time to time in the future by management of the Company in presentations to shareholders, prospective investors, and others interested in the business and financial affairs of the Company, which are not historical facts, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. Any projections of financial performance or statements concerning expectations as to future developments should not be construed in any manner as a guarantee such results or developments will, in fact, occur. There can be no assurance any forward-looking statement will be realized or actual results will not be significantly different from that set forth in such forward-looking statement. In addition to the risks and uncertainties of ordinary business operations, the forward- looking statements of the Company referred to above are also subject to risks and uncertainties.
The Company operates in a highly competitive business environment, and its operations could be negatively affected by matters discussed under the caption, "Competition," on page 7 of this Form 10-K.
During 1996, the Company successfully completed the full integration of Integrity National Life Insurance Company (Integrity). In September, 1995, the Company and Citizens Security Life Insurance Company (Citizens Security) acquired 98.85% of the common stock of Integrity (the "Acquisition") from Southwestern Life Corporation, which has since been renamed ICH Corporation ("ICH"). The Acquisition was accounted for as a purchase and the results of Integrity's operations have been included in the consolidated financial statements of the Company since the date of acquisition. Citizens Security acquired the remaining 1.15% of Integrity's common stock in conjunction with the merger of Integrity into Citizens Security as of December 31, 1995.
of the 2002 Note. In addition, in January 1996, the Company sold an additional $2,343,000 of preferred stock. See Notes 7 and 15 to the Consolidated Financial Statements. Giving effect to payments and prepayments during 1996, the principal balances of the 2002 Note and the 2003 Note were $2,125,000 and $1,750,000, respectively, as of December 31, 1996.
Assets. At December 31, 1996, the Company's available-for-sale fixed maturities had a fair value of $47,041,000 and amortized cost of $47,239,000. The available-for-sale portfolio consists of fixed maturities and equity securities that the Company, given the proper market condition, would sell prior to maturity. This portfolio is reported at fair value with unrealized gains and losses, net of applicable deferred taxes and adjustments to deferred policy acquisition costs, reflected as a separate component in shareholders' equity. Effective December 31, 1995, the Company transferred all of its "held-to-maturity" fixed maturities to the "available-for-sale" fixed maturities portfolio. The Company's fixed maturities portfolio increased approximately 4% and 225% in 1996 and 1995 respectively, on an amortized cost basis. Substantially all the 1995 increase was due to the Acquisition. Shown below is a distribution by rating category of the Company's fixed maturities portfolio as of December 31, 1996.
Standard & Poor's Corporation Rating Amortized Cost 1 Fair Value 2 - ------------------------------------ ------------------ ------------ Investment grade: AAA to A- $40,537,341 $40,288,318 BBB+ to BBB- 3,436,686 3,548,048 - ------------------------------------ ------------------ ----------- Total investment grade 43,974,027 43,836,366 Non-investment grade: BB+ to BB- 986,718 977,750 B+ to B- 2,186,082 2,130,975 CCC+ to C --- --- CI to not rated 91,732 95,500 - ------------------------------------ ------------------ ----------- Total non-investment grade 3,264,532 3,204,225 - ------------------------------------ ------------------ ----------- Total fixed maturities $47,238,559 $47,040,591 - ------------------------------------ ------------------ -----------
Shown below are the Company's four largest holdings in non-investment grade bonds by a single issuer as of December 31, 1996.
The Company's investment in equity securities increased $2,822,000 and $2,221,000 during 1996 on a cost (net of write-downs) and fair value basis, respectively, after decreasing $1,881,000 and $530,000 on the same basis in 1995. As of December 31, 1996, there were $878,000 of net unrealized gains in equity securities, as compared with $1,480,000 and $128,000 at December 31, 1995 and December 31, 1994, respectively. One security represented $481,000 of such gains at December 31, 1996.
The Company reviews its marketable investments each quarter to determine if there have been declines in their value that in management's opinion are other-than-temporary. These reviews resulted in the recognition of impairment losses on equity securities totaling $900,000 during 1996 ($215,000, $309,000 and $376,000 for the second, third and fourth quarters, respectively). In addition, equity securities were sold during 1996, which contained impairment writedowns of $859,000.
Annuity balances increased $32,000 in 1996 after decreasing by $280,000 in 1995. This improvement resulted primarily from an approximate $400,000 decrease in surrenders compared to the prior year. The essentially unchanged Universal Life balance during 1996 compares to a $40,000 decrease during 1995.
A comparison as of December 31, 1996, 1995 and 1994 of contract reserves for future policy benefits is shown below.
The December 31, 1996 ordinary life reserves are net of a $780,000 reduction associated with refinement of purchase GAAP accounting. Substantially all of the ordinary life reserve increase in 1995 as compared with 1994 was due to the Acquisition. The December 31, 1996 accident and health reserves include a $45,000 increase which is also associated with refinement of purchase GAAP accounting. The Acquisition also increased accident and health reserves by $366,000 in 1995.
The Company experienced a substantial increase (35%) in the sale of its graded death benefit product during 1996 compared to 1995. The graded death benefit product, which is sold primarily through the broker market, returns premiums paid, plus interest compounded at an annual rate of 10% if the insured dies of natural causes during the first two years the policy is in force. After two years, and during the first two years if the insured dies of an accidental cause, the benefit payable is the face amount of the policy. Citizens Security will be replacing this product during the second quarter of 1997 with a product that returns premiums paid plus interest, if death occurs during the initial three years of coverage. In addition, Citizens Security will supplement its product line with a simplified issue product. Management believes the new graded death benefit and simplified issue products are complementary, and will permit significant additional penetration into the "final expense market." Although management believes that modification of the graded death product may dampen sales for the next twelve to eighteen months, the impact of any such decline should be offset by decreased exposure to adverse mortality risk.
The investment income yield decrease in 1996 compared to 1995 resulted primarily from somewhat higher average cash, short-term, and equity security balances. The investment income yield increase in 1995 over 1994 is principally attributable to higher market interest rates, selected movement from lower yielding common stocks to higher yielding preferred stocks, and the addition of Integrity's portfolio, which had an annualized yield of 6.7%.
The slight increase in income contributed by the Accident and Health segment between 1995 and 1996 was primarily attributable to the inclusion of Integrity's individual health business and improvement in the loss ratios for the Company's individual cancer products, substantially offset by a $200,000 decline in margins and modestly increased expense volumes on group dental products. The improved performance in 1995 over 1994 is attributable to improved loss ratios in the Company's cancer products in 1995.
The decline in Dental's contribution is the result of a 29% increase in premium offset by a 7% increase in the loss ratio. The increase in premiums and the loss ratio in 1996 are principally attributable to aggressive sales to groups interested in replacing their previous dental carriers. In order to improve the profitability of this newly acquired business, the Company is reconfiguring its products to provide additional margins for certain more costly dental procedures, engaging a company to provide expert assistance with the ongoing adjudication of judgmental claims, and implementing a program of aggressive renewal underwriting and rerating. The short- and long-term disability products generated only
Statutory Insurance Information. During 1996, A.M. Best Company upgraded Citizens Security's rating from C++ to B-, based upon statutory financial and statistical information through December 31, 1995. To provide a more detailed understanding of Citizens Security's statutory operations, shown below are the net income, net operating income, statutory capital and surplus, asset reserves, and capital ratios for Citizens Security for the five years ended December 31, 1996.
1 Asset valuation reserves are statutory liabilities that act as contingency reserves in the event of extraordinary losses on invested assets and as a buffer for policyholders' surplus to reduce the impact of realized and unrealized investment losses. 2 Represents Statutory Capital and Surplus plus Asset Valuation Reserves divided by invested assets plus cash. 3 Statutory Capital and Surplus and Asset Valuation Reserve amounts include Integrity beginning in 1995, while Income amounts include Integrity beginning in 1996. 4 Statutory net income of Old South was included in Citizens Security's net income on the equity basis from the date of its acquisition in 1987 to the date of its merger, September 30, 1992.
The increase in statutory capital and surplus and asset reserves in 1996 from 1995 resulted primarily from approximately $3,000,000 of statutory net income, partially offset by redemption of $1,000,000 of Citizens Security's preferred capital stock and $900,000 of unrealized investment losses. The $3,000,000 of statutory income includes an approximate $1,200,000 net gain from an investment transaction between Citizens Security and an affiliate.
The merger of Integrity into Citizens Security resulted in $1,832,000 of the increase in statutory capital and surplus in 1995 as compared with 1994. The remaining $924,000 increase was the result of operating income and unrealized investment gains offset, to an extent, by $945,000 of dividends paid to the Company.
The increase in statutory capital and surplus and asset reserves in 1993 from 1992 resulted from income produced from operations and capital gains.
During 1996, the Company generated $1,272,000 of positive cash flow from operations compared to $2,664,000 in 1995 and $327,000 in 1994. The decrease in 1996 resulted from a significant reduction in accrued expenses that were outstanding at December 31, 1995 related to the Integrity acquisition, partially offset by a $377,000 increase in net income. The increase in 1995 compared to 1994 resulted from a $1,178,000 increase in net income and the additional Integrity acquisition accruals noted above.
During 1996, $2,343,000 of cash was generated from the sale of additional redeemable convertible preferred stock. These additional funds were obtained to provide flexibility for pursuing potential acquisition/growth opportunities. In addition, to enhance net investment spreads, the Company elected to repay an outstanding $4,202,000, 8% mortgage
In addition to the SVL, the Actuarial Standards Board of the American Academy of Actuaries has produced a Standard of Practice that prescribes cash flow testing as a basis for the actuarial opinion on the adequacy of the reserves required as part of the annual statutory reporting process of insurance companies.
Citizens Security's most recent testing process, which was completed in March, 1997, involved a review of two basic measures. The first was the value of free market surplus, which is defined as the difference between the projected market value of assets and liabilities at the end of the analysis period (typically 10-20 years). Deficits could indicate the need for corrective action depending upon the severity and the number of scenarios in which a deficit appeared. A second measure involved distributable earnings. Negative earnings for extended durations might impair the ability of Citizens Security to continue without exhausting surplus. Again, depending upon severity and frequency, corrective measures might be needed. Based on results of the testing completed in March of 1997, no corrective measures were indicated at the current time. However, such testing is ongoing and dynamic in nature and future events in the interest and equity markets or a significant change in the composition of Citizens Security's business could negatively impact testing results and require the initiation of corrective measures.
- Dividends from Citizens Security, which are limited by law to the lesser of prior year net operating income or 10% of prior year-end capital and surplus unless specifically approved by the Kentucky Department of Insurance.
Consolidated Statements of Financial Condition at December 31, 1996 and 1995....................................... 26
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994............. 28
Schedule I -- Summary of investments--other than investments in related parties.................... 44
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens Financial Corporation and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
INVESTMENTS: SECURITIES AVAILABLE FOR SALE, AT FAIR VALUE: FIXED MATURITIES (AMORTIZED COST OF $47,238,559 AND $45,369,804 IN 1996 AND 1995, RESPECTIVELY) $47,040,591 $46,917,198 EQUITY SECURITIES (COST OF $7,085,104 AND $4,263,273 IN 1996 AND 1995, RESPECTIVELY) 7,963,550 5,742,914 INVESTMENT REAL ESTATE 3,938,806 4,095,094 MORTGAGE LOANS ON REAL ESTATE 176,636 183,935 POLICY LOANS 2,852,670 2,720,396 SHORT-TERM INVESTMENTS 893,410 821,271 - ------------------------------------------------------------------ ------------- TOTAL INVESTMENTS 62,865,663 60,480,808
CASH AND CASH EQUIVALENTS 2,805,717 9,776,964 ACCRUED INVESTMENT INCOME 772,689 636,758 REINSURANCE RECOVERABLE: PAID BENEFITS AND LOSSES 231,648 91,773 UNPAID BENEFITS, LOSSES AND IBNR 1,579,926 1,468,413 PREMIUMS RECEIVABLE 491,330 485,585 PROPERTY AND EQUIPMENT 1,265,948 1,133,315 DEFERRED POLICY ACQUISITION COSTS 3,791,939 3,477,377 VALUE OF INSURANCE ACQUIRED 5,081,865 6,059,095 GOODWILL 125,766 146,738 OTHER ASSETS 502,204 498,435 DEFERRED FEDERAL INCOME TAX 748,013 --- - ------------------------------------------------------------------ ------------- TOTAL ASSETS $80,262,708 $84,255,261 - ------------------------------------------------------------------ ------------- See Notes to Consolidated Financial Statements.
NOTES PAYABLE 4,095,869 9,306,982 ACCRUED EXPENSES AND OTHER LIABILITIES 1,982,024 2,725,510 FEDERAL INCOME TAX PAYABLE 527,000 20,163 DEFERRED FEDERAL INCOME TAX --- 333,466 - ------------------------------------------------------------------------------- TOTAL LIABILITIES 65,645,346 71,245,136
Nature of Operations. Citizens Financial Corporation is a holding company that engages in the business of life insurance and annuities and accident and health insurance through its wholly-owned subsidiary, Citizens Security Life Insurance Company ("Citizens Security"). Citizens Security offers life, fixed-rate annuity and accident and health insurance products to individuals and groups through independent agents.
The individual life insurance products currently offered by Citizens Security consist of traditional whole life insurance and universal life insurance policies. Citizens Security also sells group life and accidental death and dismemberment policies. The fixed-rate annuity products offered by Citizens Security consist of flexible premium deferred annuities, life policy annuity riders, and single premium deferred annuities. Citizens Security's individual accident and health insurance products provide coverage for monthly income during periods of hospitalization, scheduled reimbursement for specific hospital and surgical expenses and cancer treatments, and lump sum payments for accidental death or dismemberment, while the group accident and health products provide coverage for short and long-term disability, income protection and dental procedures.
Investments. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under SFAS No. 115, the Company classifies fixed maturities and equity securities as "available-for-sale" if they are not bought and held principally for the purpose of selling them in the near term (e.g. "trading securities") or, if fixed maturities are not intended to be "held to maturity." Available-for-sale securities are carried at fair value, with unrealized gains and losses included in shareholders' equity, net of applicable deferred taxes and adjustments to related deferred policy acquisition costs. Fixed maturities are classified as "held-to-maturity" when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are carried at cost adjusted for amortization of premium or accretion of discount. The effect of the adoption, which represented adjustments to related deferred policy acquisition costs, was to decrease shareholders' equity by $53,132, net of deferred taxes of $27,370, at January 1, 1994. There was no effect on net income. Effective December 31, 1995, the Company adopted the Financial Accounting Standards Board's Implementation Guide on SFAS No. 115 ("Implementation Guide"). In accordance with the Implementation Guide, the Company reassessed the classification of its fixed maturities and equity securities and, accordingly, transferred all of its "held-to-maturity" fixed maturities to "available-for-sale." The fair value and amortized cost of the fixed maturities transferred on December 31, 1995, were $13,085,928 and $12,524,060, respectively. The effect of this transfer was to increase shareholders' equity by $370,833, net of deferred taxes of $191,035, at December 31, 1995. There was no effect on net income. In addition, upon acquisition of Integrity, the Company classified all of Integrity's fixed maturities and equity securities as "available-for-sale." Prior to the Company's acquisition of Integrity, Integrity did not prepare its financial statements in accordance with generally accepted accounting principals ("GAAP").
Fixed maturities and equity securities having a decline in value considered by management to be other than temporary are adjusted to an amount which, in management's judgment, reflects such declines. Such amounts are included in net realized investment gains and losses. For purposes of computing realized gains and losses on fixed maturities and equity securities sold, the carrying value is determined using the specific-identification method. Mortgage loans and policy loans are carried at unpaid balances. Investment real estate is carried at depreciated cost. Short-term investments, which consist of certificates of deposit and treasury bills, are carried at cost which approximates fair value. Cash and cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase and are also carried at cost which approximates fair value.
Property and Equipment. Property and equipment, including the home office building, are carried at cost less accumulated depreciation, using principally the straight-line method of depreciation. Accumulated depreciation at December 31, 1996, was $1,117,364 ($883,813 at December 31, 1995).
Value of insurance acquired is recorded for the estimated value assigned to the insurance in force of the purchased subsidiaries at the dates of acquisition. The assigned value is amortized over the expected remaining life of the insurance in force using methods consistent with that used for amortization of policy acquisition costs (as described under Premiums, Benefits and Expenses). At December 31, 1996, accumulated amortization was $1,524,187 ($1,133,499 at December 31, 1995).
Revenues for universal life and investment-type products consist of investment income and policy charges for the cost of insurance, policy initiation, administrative surrender fees and investment income. Expenses include interest credited to policy account balances, incurred administrative expenses and benefit payments in excess of policy account balances.
Earnings Per Share. Primary earnings per share amounts are based on the weighted average number of common and common equivalent shares outstanding during the year (1,075,615 in 1996 and 1995, and 1,078,369 in 1994). Fully diluted earnings per share amounts assume conversion of all outstanding Class B Convertible Preferred Stock at a conversion price of $5.50 per share. The weighted average number of common shares outstanding, on a fully diluted basis is 1,793,148; 1,089,379; and 1,078,369 in 1996, 1995, and 1994 respectively.
On September 22, 1995, the Company acquired 98.85% of the common stock of Integrity from Southwestern Life Corporation ("Southwestern"), a Dallas-based insurance holding company (the "Acquisition"). The Acquisition was accounted for as a purchase with the results of Integrity's operations being included in the consolidated statements since the date of acquisition. Citizens Security acquired the remaining 1.15% of the common stock of Integrity in conjunction with the merger of Integrity into Citizens Security.
The Acquisition was financed with the working capital of Citizens Security and with approximately $6,100,000 of the $6,400,000 of proceeds under a Term Loan Agreement dated as of September 22, 1995 between the Company and a commercial bank (the "Term Loan Agreement"). The Term Loan Agreement provides for a $4,400,000 note payable that matures on October 1, 2002 (the "2002 Note") and a $2,000,000 note payable that matures on October 1, 2003 (the "2003 Note") ( see Note 6). In order to obtain required approvals from insurance regulatory authorities of the state of Pennsylvania, [i] the Company agreed to authorize a private placement of preferred stock to accredited investors, [ii] the Principal Shareholder of the Company provided a personal guarantee that at least $1,500,000 of the aforementioned preferred stock would be sold, and [iii] the Company agreed that at least $1,500,000 of the proceeds of such sale would be used to pay down the principal amount of the 2002 Note. The Company sold $1,727,000 of the preferred stock on December 15, 1995, and applied $1,500,000 of the proceeds to prepay the first installment of the 2002 Note (see Notes 6 and 7).
The cost and fair value of investments in fixed maturities and equity securities are shown below. The cost amounts are adjusted for amortization of premium and accretion of discount on fixed maturities and for write-downs of securities whose decline in value is believed to be other than temporary. Treasury bills having a carrying value of $342,219 and $4,032,592 as of December 31, 1996 and 1995, respectively are included below but reported as short-term investments and cash equivalents in the accompanying financial statements.
Fixed Maturities: U. S. government obligations $ 9,859,074 $ 133,685 $ 58 $ 9,992,701 Corporate securities 26,700,021 1,148,050 93,320 27,754,751 Mortgage-backed securities 12,843,301 426,971 67,934 13,202,338 ----------- ---------- -------- ----------- Total $49,402,396 $1,708,706 $161,312 $50,949,790
The annual change in net unrealized investment appreciation or depreciation, at December 31, 1996, 1995 and 1994, and the amount of net realized investment gain or loss included in net income for the respective years then ended are as follows:
Year Ended December 31 1996 1995 1994 - -------------------------------------------------------- ------------ ---------- FIXED MATURITIES: Available-For-Sale: Change in net unrealized appreciation (depreciation) $(1,745,362) $1,930,776 $(545,167) Net realized gain (loss) $ 218,188 $ 357,997 $(276,204) Held-To-Maturity: Change in net unrealized appreciation (depreciation) $ -- $ 612,060 $(895,565) Net realized gain $ -- $ 17,951 $ 31,079 EQUITY SECURITIES: Change in net unrealized appreciation (depreciation) (601,195) $1,351,641 $(808,496) Net realized gain (loss) $ 748,749 $1,158,166 $(128,765)
Gross gains of $2,481,688, $2,372,076 and $1,150,212 and gross losses of $1,689,679, $1,213,910 and $1,278,977 were realized on the sale of available-for-sale equity securities during 1996, 1995 and 1994. Included in gross realized losses during 1996, 1995 and 1994 are adjustments to the carrying value of available-for-sale equity securities of $666,871, $561,135 and $838,610, respectively, relating to declines in value which were considered by management to be other than temporary. Net realized gains from the sale of equity securities have been reduced in 1996 by $43,260 associated with the amortization deferred policy acquisition costs.
December 31, 1996 1995 - --------------------------------------- ------------- ------------ Net appreciation (depreciation) on available-for-sale: Fixed maturities $(197,968) $1,547,394 Equity maturities 878,446 1,479,641 Adjustment of deferred policy acquisition cost (30,811) (126,191) Deferred income taxes (220,887) (1,029,192) - --------------------------------------- ------------- ------------ Net Unrealized Appreciation $ 428,780 $1,871,652 - --------------------------------------- ------------- ------------
The Company limits credit risk by diversifying its investment portfolio among government and corporate fixed maturities and common and preferred equity securities. It further diversifies these investment portfolios within industry sectors. As a result, management believes that significant concentrations of credit risk do not exist.
At December 31, 1996, the Company held in its available-for-sale fixed maturity portfolio an investment in Walt Disney Company amounting to $1,494,350.
At December 31, 1996, the Company had no investments which had not been income producing for a period of at least twelve months prior to year end.
Year ended December 31 1996 1995 1994 - ---------------------- -------------- ------------ ------------ Balance at beginning of year $6,059,095 $ 442,046 $ 512,826 Purchase of Integrity (586,542) 6,036,565 --- Accretion of interest 354,312 394,337 39,184
Amortization (745,000) (813,853) (109,964) - ---------------------- -------------- ------------ ------------ Balance at end of year $5,081,865 $6,059,095 $ 442,046 - ---------------------- -------------- ------------ ------------
Amortization of the value of insurance acquired (net of interest accretion) in each of the following five years will be approximately: 1997 - $480,000; 1998 - $423,000; 1999 - $383,000; 2000 - $372,000; and 2001 - $371,000.
Annual guaranty fees will be paid in the form of non-negotiable promissory notes of the Company (the "Guaranty Notes"), except that the Interim Fee noted above is payable in cash by November 15, 1997, unless the Company is unable to obtain any required consent from the holder of the commercial bank notes. The Guaranty Notes bear interest at the prime rate charged by a commercial bank, they are subordinated to the commercial bank notes, and they are payable at maturity of the 2003 Note. The Guarantor's Compensation Agreement also provides that the Company and the Principal Shareholder may agree to exchange the Guaranty Notes for securities of the Company on terms to be determined by a majority of the members of the Company's Board of Directors who are not affiliated with the Principal Shareholder. Effective September 22, 1995, the Company issued a Guaranty Note in the amount of $200,000 to the Principal Shareholder. At December 31, 1996 and 1995, the outstanding balance of the Guaranty Note, including accrued interest, was $220,869 and $205,326, respectively.
The 8% mortgage note outstanding at December 31, 1995 was repaid in advance, on December 31, 1996, at its then outstanding balance of $4,124,117. This note was secured by Company real estate which had a depreciated cost at December 31, 1996, of $4,976,051.
On January 19, 1996 and December 15, 1995, the Company issued 213 and 157 shares, respectively of 1995 Class B redeemable convertible preferred stock ("Preferred Stock"), for cash in the amount of $11,000 per share ($4,070,000 in the aggregate). Holders of the Preferred Stock are entitled to cumulative quarterly dividends, currently at the rate of $275 per share ($1,100 per annum). The Preferred Stock currently has a liquidation preference of $4,070,000 in the aggregate. The Preferred Stock is mandatorily redeemable in 12 equal quarterly installments beginning January 1, 2003. At the option of any holder, the Company must redeem any or all of such holder's Preferred Stock not later than January 1, 2002. The Company may call any or all of the Preferred Stock for redemption, at any time after January 1, 1999, and may also call any or all of the Preferred Stock for redemption at any time after January 1, 1998, if the market price for the Company's Class A Stock exceeds $8.25 per share for at least 20 out of 30 consecutive trading days. In each case, the redemption price is currently $11,000 per share. Until five (5) days prior to any redemption date, each share of the Preferred Stock is convertible into a specified number of shares of the Company's Class A Stock (currently 2,000). Holders of the Preferred Stock have the right to elect two (2) members of the Company's Board of Directors at any time that, and for as long as, the Company has failed to complete a required redemption or to pay dividends on the Preferred Stock for six (6) quarterly periods. The dividend rate, redemption price and conversion ratio are all subject to adjustment for any stock dividends, combinations, splits or similar changes affecting the Preferred Stock in the future.
Year Ended December 31, 1996 1995 1994 - --------------------------- ------------- ------------ ------------ Deferred tax benefit $ 252,730 $151,000 $ 244,000 Current tax expense (479,033) (160,000) (16,855) - --------------------------- ------------- ------------ ------------ Federal Income Tax (Expense) Benefit $(226,303) $ (9,000) $227,145 - --------------------------- ------------- ------------ ------------
Deferred income taxes are provided for cumulative temporary differences between balances of assets and liabilities determined under generally accepted accounting principles and balances determined for tax reporting purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1996 and 1995 are as follows:
- ------------------------------------------------------------------------------- NET DEFERRED TAX LIABILITIES (ASSETS) $ (748,013) $ 333,466 - -------------------------------------------------------------------------------
Year Ended December 31, 1996 1995 1994 - -------------------------------- ------------ ------------ ------------ Statutory rate of income tax (benefit) 34.00 % 34.00 % (34.00)% Dividend exclusion (1.65)% (3.70)% (3.10)% Alternative minimum tax 9.00 % --- 2.70 % Small life insurance deduction (39.48)% (23.10)% (8.20)% Surtax exemption and other 1.17 % 3.30 % (5.30)% Increase in valuation allowance 13.96 % 15.80 % 14.10 % Deferred benefit from merger --- (26.20)% --- - -------------------------------- ------------ ------------ ------------ Effective rate of income tax (benefit) 17.00 % 0.10 % (33.80)% - -------------------------------- ------------ ------------ ------------
Year Ended December 31, 1996 1995 1994 - -------------------------------- ------------ ------------ ------------ Net Income $3,062,421 $883,003 $591,998 Capital and Surplus $9,145,830 $8,406,313 $5,651,136
"Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1998, will likely change, to some extent, prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory-basis financial statements.
Statutory restrictions limit the amount of dividends which may be paid by Citizens Security to the Company. Generally, dividends during any year may not be paid, without prior regulatory approval, in excess of the lesser of (a) 10% of statutory shareholder's surplus as of the preceding December 31, or (b) statutory net operating income for the preceding year. During 1996, with appropriate prior regulatory approval, Citizens Security redeemed $1,000,000 of its outstanding preferred stock and paid a $750,000 extraordinary dividend to the Company. In addition, Citizens Security must maintain the minimum capital and surplus, $1,250,000, required for life insurance companies domiciled in Kentucky.
During 1996, the number of authorized shares of the Company's common stock was increased from 2,000,000 to 6,000,000 shares. Under a stock option agreement, 5,000 options on the Company's common stock have been granted to an officer. The stock options vested as of June 16, 1995, at an exercise price of $9 per share. The Company accounts for its stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees." No compensation expense has been recognized for these stock options since the exercise price exceeds market value. No options were exercised during 1996, 1995 or 1994. The effect of applying the fair value method of accounting for the Company's stock based awards (as described in SFAS 123, "Accounting and Disclosure of Stock-Based Compensation") results in net income and earnings per share that are not materially different from amounts reported.
Life and Annuities $ 1,051,618 $ 417,888 $ (781,027) Accident and Health 284,008 323,343 108,213 - ------------------------------- ------------- ------------- ------------- Total $ 1,335,626 $ 741,231 $ (672,814)
The increase in income from operations before federal income taxes for Life and Annuities from a gain of $417,888 in 1995 to a gain of $1,051,618 in 1996 results from an approximate $1,100,000 increase in segment earnings before realized capital gains and a decrease of approximately $500,000 in realized capital gains. The $1,100,000 segment earnings improvement resulted primarily from successfully completing the integration of Integrity's operations during 1996 and certain nonrecurring costs in 1995, including $281,000 of Integrity assimilation/integration costs and $246,000 of variable investment portfolio management fees. The increase in income from operations before federal income taxes for Life and Annuities from a loss of $781,027 in 1994 to a gain of $417,888 in 1995 results primarily from an increase in realized gains and investment income allocable to this segment, partially offset by the nonrecurring items noted above.
The decrease in income from operations before federal income taxes for Accident and Health from $323,343 in 1995 to $284,008 in 1996 resulted primarily from a decrease in realized capital gains allocated to the segment of approximately $40,000. The increase in income from operations before federal income taxes for Accident and Health from $108,213 in 1994 to $323,343 in 1995 resulted principally from an increase in realized gains allocated to the segment and a reduction of maintenance expenses.
In the normal course of business, the Company is party to a number of lawsuits. Management believes recorded claims liabilities are adequate to ensure these suits will be resolved without material financial impact to the Company.
Year Rental ----- ----------- 1997 $ 43,693 1998 39,353 1999 25,754 ----- ----------- Total $ 108,800 ----- -----------
The Company incurred rental expense of $59,783, $105,922 and $108,624 in 1996, 1995 and 1994, respectively.
The fair values of financial instruments, and the methods and assumptions used in estimating their fair values, are as follows:
Mortgage Loans: The carrying amount of mortgage loans approximates their fair value. At December 31, 1996 and 1995, the fair value of mortgage loans was $176,636 and $183,935, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair value. At December 31, 1996 and 1995, the fair value of policy loans was $2,852,670 and $2,720,396, respectively.
1Cost for equity securities is original purchase price, adjusted for declines in value believed to be other than temporary totaling $825,400.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CITIZENS FINANCIAL CORPORATION Condensed Balance Sheet
ASSETS Cash and cash equivalents $ 356,402 $ 523,370 Fixed maturities available-for-sale, at fair value (amortized cost of $731,429) --- 652,500 Equity securities available-for-sale, at fair value (cost of $2,266,772 and $2,201,112 in 1996 and 1995, respectively 2,359,238 2,431,950 Short-term investments 342,219 --- Investment in subsidiaries* 16,225,196 17,984,581 Current and deferred tax asset 550,045 406,371 Other assets 89,654 251,485 - ------------------------------------------------- -------------- ------------- Total Assets $19,922,754 $22,250,257 - ------------------------------------------------- -------------- -------------
Common stock $ 1,275,724 $ 1,275,724 Additional paid-in capital 4,945,487 4,945,487 Net unrealized appreciation of available- for-sale securities 61,027 100,260 Equity in net unrealized investment gains of subsidiaries* 590,454 1,994,093 Retained earnings 3,753,224 3,046,115 - ------------------------------------------------- -------------- ------------- $10,625,916 $11,361,679 Less: 1,300 shares owned by wholly-owned subsidiary (52,461) (52,461) - ------------------------------------------------- -------------- ------------- Total Stockholders' Equity $10,573,455 $11,309,218 - ------------------------------------------------- -------------- ------------- Total Liabilities and Stockholders' Equity $19,922,754 $22,250,257 - ------------------------------------------------- -------------- -------------
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) CITIZENS FINANCIAL CORPORATION Condensed Statement of Income
REVENUES (LOSSES) Net realized investment gains (losses) $ (89,158) $ 174,642 $(216,879) Dividend from subsidiary* 750,000 945,000 125,000 Service fee from subsidiary* 891,527 --- --- Interest and dividend income 144,660 32,517 51,946 - ------------------------------------ ---------------- ------------- ------------ Total Revenues (Losses) 1,697,029 1,152,159 (39,933)
EXPENSES Administrative and general expenses 984,792 432,721 409,265 Interest expense paid to subsidiary* 280,975 242,033 211,441 Interest expense other 497,454 175,107 --- - ------------------------------------ ---------------- ------------- ------------ Total Expenses 1,763,221 849,861 620,706
This condensed financial statement should be read in conjunction with the Consolidated Financial Statements and Notes thereto of Citizens Financial Corporation and Subsidiaries. Balances referenced with an asterisk (*) are eliminated in the Consolidated Financial Statements of Citizens Financial Corporation and Subsidiaries.