We conduct operations as an insurance holding company emphasizing ordinary life insurance products in niche markets where we believe we can achieve competitive advantages. As an insurance provider, we collect premiums in the current period to pay future benefits to our policy and contract holders. Our core operations include issuing:
final expense and limited liability property policies to middle and lower income households in Louisiana, Mississippi and Arkansas through approximately 625 employee and independent agents in our home service distribution segment.
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 to accumulate cash values to provide for living expenses in a policy owner’s later years, while continuously providing a death benefit.
We believe there is a trend toward consolidation of domestic life insurance companies, due to significant losses incurred by the life insurance industry as a result of the credit crisis and recession of 2008-2009, as well as increasing costs of regulatory compliance for domestic life insurance companies. We believe this trend should be a benefit to our acquisition strategy as more complementary acquisition candidates may become available for us to consider.
In the fourth quarter of 2008, the Company completed its acquisition of ONLIC, included in the Home Service segment, for $8.0 million and had additional acquisition related expenses of $900,000. In the first quarter of 2009, the Company completed its acquisition of Integrity Capital Corporation (“ICC”) in exchange for 1,292,000 shares of Citizens, Inc. Class A common stock. ICC is the parent of Integrity Capital Insurance Company (“ICIC”), an Indiana life insurance company that is included in the Life Insurance segment. The transaction was valued at $8.4 million when the transaction closed on February 27, 2009.
Realized Gains (Losses) on Investments. The investment markets were very volatile at the end of 2008 and throughout 2009 due to the credit crisis and economic downturn. In 2009, the Company sold equity mutual funds, which were previously impaired, for a realized gain of $4.9 million. The Company also sold a number of fixed maturity investments in 2009, resulting in a total gain of $8.0 million. The Company recorded $0.3 million in realized losses during 2009 related to other-than-temporary impairments due to market declines and issuer credit deterioration, which are netted against the gains recorded. In 2008, the Company recognized other-than-temporary impairment write-downs of $23.5 million on its holdings of equity mutual funds. In addition, we also impaired two bonds due to credit quality, recognizing a realized loss of $0.3 million.
Decrease (Increase) in Fair Value of Warrants. Because the market value of our Class A common stock decreased during 2009, we recognized a gain on the decrease in fair value of warrants of $3.2 million in 2009, compared to a loss of $2.7 million in 2008 and a gain of $0.8 million in 2007. The gain in 2009 was directly related to the decrease in the price of our Class A common stock. The warrant liability is calculated using the Black-Scholes option pricing model, which projects the future value of the warrants when they expire in July 2011 and 2012. Current accounting standards require the change in the value of the warrant liability be recorded as a component of revenues. When the liability increases we incur a loss, and when the liability decreases we recognized income. The warrant liability is not anticipated to have an effect on the Company’s cash flows, as the Company expects the warrants will either be converted into our Class A common stock in July 2012, or sooner, at the election of the warrant holders, or expire.
The Company monitors death claims to determine if they are within levels meeting expectations. The claim experience in 2009 improved relative to 2008. In addition in 2008, there was a $650,000 decrease in 2007 to correct an overstatement of the prior year’s claim liability.
Policy surrenders increased 29.2% in 2009 to $19.7 million from $15.2 million in 2008, up from $13.8 million in 2007. The increase in surrender expense is primarily related to our international business and is expected to increase over time due to the maturity of this block of business. A significant portion of surrenders relates to policies that have been in force over fifteen years and no longer have a surrender charge associated with them. In addition, the Company believes a significant portion of the increase resulted from the global recession and policyholder uncertainty about the economy. Total direct insurance inforce reported in 2009 was $4.4 billion compared to $4.3 billion in 2008 and $4.2 billion in 2007.
Property claims decreased 40.2% in 2009, from $2.7 million in 2008 to $1.6 million in 2009, and were $1.1 million in 2007. In 2008, Hurricanes Gustav and Ike swept through Louisiana resulting in an increase in property claims of $1.6 million over 2007. In 2007, the Company released claim liabilities of $711,000 that were no longer required due to the expiration of the statute of limitations, which had been related to Hurricane Katrina in 2005 and impacted several years thereafter.
Reserves. The change in future policy benefit reserves increased from $37.1 million in 2008 to $40.8 million in 2009. Sales of certain endowment products have gained popularity is our international markets, which build reserves at a much higher rate, and have contributed to the increasing reserves over the past several years. Endowment sales totaled approximately $8.5 million, $7.4 million and $6.6 million in 2009, 2008 and 2007, respectively.
Commissions. Commissions decreased slightly during 2009 to $35.5 million from $36.0 million in 2008 and $35.6 million in 2007. Commissions were essentially flat all three years, even though premium income was up due to the increase of renewal premiums, which pay a lower commission rate than the rate paid on first year business.
Cost of Customer Relationships Acquired and Other Intangibles. Amortization of cost of customer relationships acquired and other intangibles increased from $2.9 million in 2008, to $3.5 million in 2009, and was $3.2 million in 2007. The 2009 increase related to the ICC acquisition and faster amortization due to the increase in lapses on this new business block, in addition to a full year of amortization related to ONLIC in the current year compared to two months in 2008.
The Company has three reportable segments: Life Insurance, Home Service Insurance and Other Non-Insurance Enterprises. These segments are reported in accordance with U.S. GAAP. The Company evaluates profit and loss performance based on net income before Federal income taxes.
Premiums. Premium revenues increased 3.9% to $106.0 million for 2009 compared to $102.0 million for 2008. First year premiums have declined in this segment due primarily to lower international new sales. However, total segment premiums reflect an increase due to higher renewal premiums, which have been trending higher as this block of insurance matures.
Net Investment Income. Net investment income decreased to $16.7 million in 2009 compared to $17.0 million and $16.9 million in 2008 and 2007. The decrease related to lower investment rates available in 2009, as well as the significant call activity the Company experienced in the current year. Approximately $215.0 million in bonds was called by the U.S. Government and Government agencies in 2009 on a total life segment portfolio of $289.6 million. This money was reinvested in lower yielding securities.
Claims and Surrenders. Claims and surrenders increased to $41.3 million in 2009 compared to $36.2 million and $34.3 million in 2008 and 2007.
Death claim amounts fluctuate from period to period, and are monitored by the Company. The amounts are within anticipated ranges based upon management’s expectations.
Other Underwriting, Acquisition and Insurance Expenses. The operating expenses have declined over the past several years due to lower expenses related to staffing reductions, accountants and other consultants. In addition, an expense allocation adjustment was made in 2008 to more realistically weight the Home Service segment overhead due to its higher administrative overhead than our other operations. The Company monitors all operating expenses and continues to seek efficiencies in our operations.
Net Investment Income. The increase in 2009 was due to the overall increase in the investment portfolio holdings with the addition of ONLIC. In addition, SPLIC received $240,000 from a lawsuit settlement related to a bond in default. The overall investment yield on investment securities resulted in lower investment income in 2009 due to significant call activity that resulted in approximately 21% of the bond portfolio being reinvested into lower yielding securities.
Claims and Surrenders. Claims and surrenders decreased with $18.7 million incurred in 2009 compared to $20.0 million and $16.3 million in 2008 and 2007. The decrease from 2008 to 2009 was due primarily to a decrease in death benefits for SPLIC and a decrease in casualty claims for SPFIC in 2009 compared to the same period in 2008. The results in 2008 included incurred claims from Hurricanes Ike and Gustav totaling $0.8 million.
Other Underwriting, Acquisition and Insurance Expenses. Expenses increased to $14.8 million in 2009 compared to $14.5 million and $10.0 million in 2008 and 2007. The current year increase was due primarily to the additional allocation of expenses in this segment due to the labor intensive nature of the high volume and lower face amount products.
Deferred Policy Acquisition Costs (“DAC”). Capitalized expenses increased to $5.8 million in 2009 compared to $4.9 million and $5.6 million in 2008 and 2007. This increase was directly related to the increase in premiums collected and agent production. Amortization totaled $2.4 million, $2.3 million and $1.7 million in 2009, 2008 and 2007, respectively. Amortization was impacted by lapse rates relative to the block of business. Higher lapse rates resulted in higher DAC amortization.
Includes $16.2 million and $46.4 of U.S. Government agencies and government-sponsored enterprises in 2009 and 2008, respectively.
The Company experienced a significant amount of maturities and call activity relative to the fixed income portfolio, with $292.7 million reported in 2009 compared to $162.3 million and $75.9 million in 2008 and 2007. As interest rates declined over the past two years, issuers called those holdings and the Company reinvested into lower yielding securities. The gross investment yield on the fixed maturity securities portfolio dropped approximately 50 basis points from year end 2008 compared to the same period in 2009.
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 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.
When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or more like than not will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary impairment shall be separated into the following: a) the amount representing the credit loss; and b) the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss shall be recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall become the new amortized cost basis of the investment. That new amortized cost basis shall not be adjusted for subsequent recoveries in fair value.
With the exception of Security Plan, virtually all of our subsidiaries fixed maturity investments are in U.S. Government or U.S. Government-sponsored enterprises or U.S. Government instruments. Security Plan has significant investments in corporate and municipal bonds. In 2009, the Company impaired three bonds for $0.1 million and a number of common stocks totaling $0.2 million. These 2009 impairments resulted from declines due to credit quality of the issuers and have been reflected as a realized loss in the accompanying income statement. The Company impaired two bonds totaling $0.3 million during 2008, because the Company did not expect these securities to recover in value in the near term. The Company’s equity securities consist of mutual funds acquired in 2007 and 2008. The Company recorded an other-than-temporary impairment charges on its equity securities in 2008 in the amount of $23.5 million. Based upon our emphasis on investing in fixed maturity securities primarily composed of obligations of U.S. Government-sponsored corporations and our analysis of whether declines in fair value below cost are temporary or other-than-temporary, management believes that our investments in fixed maturity investments at December 31, 2009 were not impaired, and no additional other-than-temporary losses need to be recorded.
Gross unrealized losses on fixed maturities available-for-sale amounted to $9.7 million as of December 31, 2009 and $16.0 million as of December 31, 2008. This increase was primarily due to a lower interest rate environment, which put downward pricing pressure on the fair values of our U.S. Government and agency bonds. There were no gross unrealized losses on equity securities as of December 31, 2009, as all of these securities were deemed impaired in 2008 and were written down to their fair value as of December 31, 2008. In 2009, the Company sold the equity mutual fund holdings from the Home Service segment and recorded realized gains of $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.”
Virtually all of the Company’s non-credit accident and health insurance has been assigned and is administered by Texas International Life Insurance Company (“TILIC”), an unaffiliated party. The reinsurance recoverables under this agreement are collateralized by assets held in a trust for the benefit of the reinsured policies.
SPFIC elected to increase the amount of first and second event catastrophe reinsurance to $10.0 million per event from $7.1 million and raise the retention level to $500,000 per event from $250,000, after the negative effects from Hurricane Katrina in 2005. Thus, the first $500,000 of incurred claims and any claims in excess of $10.0 million were SPLIC’s responsibility. The same reinsurance levels were in place for 2007 and 2008. The reinsurance premium for first event catastrophe reinsurance was $750,000 in 2008, and $840,000 in 2007. In 2008, SPFIC also paid reinsurance premiums in the amount of $478,000 for second and third event coverage due to Hurricanes Gustav and Ike.
Cash flows from our insurance operations historically have been sufficient to meet current needs. Cash flows from operating activities were $52.1 million, $46.4 million and $37.9 million for the years ended December 31, 2009, 2008 and 2007, respectively. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments, which totaled $292.7 million, $162.3 million and $75.9 million in 2009, 2008 and 2007. These cash flows, for the most part, are reinvested in fixed income securities. Net cash outflows from investment activity totaled $68.8 million, $14.3 million and $58.8 million for the years ended December 31, 2009, 2008 and 2007, respectively. The outflows from investing activities for the year ended December 31, 2009, primarily related to the investment of excess cash and cash equivalents generated from operations during 2009. The Company’s cash flows from financing activities were $1.5 million in 2009, $10.6 million in 2008 and $17.5 million in 2007. In 2008, the Company received $9.4 million from capital contributions relating to our Series A-1 preferred stock. In 2007, the Company sold approximately 2.7 million shares of Class A common stock in a registered direct public offering. The sale resulted in gross proceeds of $18.8 million and net proceeds of $17.1 million after broker commissions and offering related expenses.
Stockholders’ equity at December 31, 2009 was $216.1 million compared to $171.5 million at December 31, 2008. The 2009 increase was largely due to income earned during the period and conversion of the Company’s preferred stock to Class A common stock.
Investments increased to $671.3 million at December 31, 2009 from $569.3 million at December 31, 2008. Invested assets increased 17.9% during 2009, due to the increase in fixed income holdings in the Company’s portfolio resulting from new premium and cash amounts being invested, as cash balances decreased by $15.2 million from 2008 to 2009, and the inclusion of ICC. Fixed maturities are categorized as fixed maturities available-for-sale, which are carried in our consolidated financial statements at fair value and held-to-maturity, which are carried at amortized cost. Fixed maturities available-for-sale were 57.4% of investments at December 31, 2009, and fixed maturities held-to-maturity were 30.8% of investments at December 31, 2009.
Two of our subsidiaries were below the minimum threshold at December 31, 2008. A capital contribution of $1.0 million was made to SPFIC by its parent SPLIC during the first quarter of 2009 because the ratio fell below 200%. An additional $1.0 million contribution was made to SPFIC by its parent SPLIC in the third quarter of 2009. Adjustments have been made relative to SPFIC product profitability, which had a positive impact on operations through the remainder of 2009 and are expected to benefit future years. A capital contribution of $1.0 million was also made to ONLIC by its parent CICA during the first quarter of 2009 when its ratio fell below 200%. The decline in SPFIC’s capital balance mainly resulted from hurricane losses in 2008 and an increase in operating expenses. The reduction in ONLIC’s capital balance resulted from declines in asset values of preferred and common stock holdings. The capital contributions made in 2009 increased the ratios as anticipated in action plans submitted to the appropriate state insurance departments. The Company received approval from the respective state insurance departments to merge ONLIC into SPLIC as of October 1, 2009. The capital contributions did not impact the overall consolidated financial position or results of operations of the Company.
We are a holding company and have had minimal operations of our own. Our assets primarily consist of the capital stock of our subsidiaries. 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, Security Plan’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 and we do not intend to do so in the future.
Cost of Customer Relationships Acquired (“CCRA”) is established when we purchase a block of insurance. CCRA is amortized primarily over the emerging profit of the related policies using the same assumptions as were used in computing liabilities for future policy benefits. We utilize various methods to determine the amount of the ending asset balance, including a static model and a dynamic model. Inherent in the amortization of CCRA are certain management judgments about the ending asset balance and the annual amortization. The assumptions used are based upon interest, mortality and lapses at the time of purchase.
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 that our CCRA and related amortization is recoverable for the years ended December 31, 2009, 2008 and 2007. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations, peer company price to earnings multiples, the level of the Company’s Class A common stock price and assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections.
A deferred tax asset or deferred tax liability is recorded only if a determination is made that is more-likely-than-not that the tax treatment on which the deferred tax item depends will be sustained in the event of an audit. These determinations inherently involves management’s judgment. In addition, the Company must record a tax valuation allowance with respect to deferred tax assets if it is more-likely-than-not that the tax benefit will not be realized. This valuation allowance is in essence a contra account to the deferred tax asset. Management must determine the portion of the deferred tax asset and resulting tax benefit that may not be realized based upon judgment of expected outcomes. Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in future reporting periods. Such a charge could have a material adverse effect on our results of operations, financial condition and capital position.