The Company owns, through Citizens Security, a three-story, 63,000 square foot office building in suburban Louisville, Kentucky completed in 1988. The Company and its Subsidiaries occupy about 28% of the building for their headquarters and home offices. The Company leases the remaining space to tenants under leases of various duration. Market conditions for this property are favorable and, in management's opinion, the property is adequately covered by insurance. Currently, the Company's policy is not to invest in additional real estate or real estate mortgages, although a change in such policy would not require a vote of security holders. In addition, the Company's current bank lending agreement precludes investment in additional real estate and in mortgages with a loan-to-appraised-value ratio of more than 75%.
RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Premiums and other considerations $23,822,424 $20,844,828 $18,371,628 $17,690,877 $17,947,623 Investment and other income, net 6,291,309 6,042,945 5,229,888 3,817,818 4,187,500
Policy benefits and reserve change 19,400,397 17,038,433 13,936,902 12,605,227 12,707,700 Commissions, expense, amortization, net 10,676,953 10,007,817 8,798,175 8,284,629 8,222,534
Segment profit (loss) 36,383 (158,477) 866,439 618,839 1,204,889 Realized investment gains, net 1,180,879 9,375,339 3,675,489 2,193,148 915,062 Interest expense 769,132 553,017 468,268 341,275 784,325 Pretax profit 448,130 8,663,845 4,073,660 2,470,712 1,335,626
NET INCOME $238,130 $6,438,845 $3,299,660 $1,988,212 $1,109,323 NET INCOME APPLICABLE TO COMMON STOCK $238,130 $6,438,845 $3,020,010 $1,581,212 $ 707,109
NET INCOME PER SHARE: Basic $0.14 $3.59 $2.31 $1.47 $0.66 Diluted $0.14 $3.59 $1.82 $1.10 $0.62
On July 7, 2000, the Company acquired, through an assumption reinsurance agreement, 100% of the inforce business of National Affiliated Investors Life Insurance Company ("NAIL") for a net cash purchase price of approximately $355,000. The acquisition was coordinated through the National Organization of Life and Health Guaranty Associations. The acquired business consists primarily of individual life insurance business with policy reserves and annual premium of approximately $3,500,000 and $300,000, respectively.
On October 14, 1999, the Company acquired 100% of the stock of Kentucky Insurance from an unaffiliated insurance holding company (the "Kentucky Insurance Acquisition"). Kentucky Insurance is licensed as a property and casualty insurance company in four states and has approximately $3.4 million of statutory capital and surplus; however, it currently has no insurance operations. The aggregate purchase price for the Kentucky Insurance Acquisition was approximately $3,550,000 (including net costs associated with the
During September 1995, the Company and Citizens Security acquired the common stock of Integrity National Life Insurance Company (the "Integrity Acquisition") from an unaffiliated insurance holding company. The aggregate purchase price for the Integrity acquisition, as finally adjusted, was $9,419,000 (including $437,000 of net transaction costs). Integrity National was merged into Citizens Security during 1995.
Assets. At December 31, 2000, the Company's available-for-sale fixed maturities had a fair value of $71,403,674 and amortized cost of $72,516,172. The Company's fixed maturities portfolio increased approximately 5% in 2000 and decreased approximately 8% in 1999, on an amortized cost basis. The 2000 increase resulted primarily from the NAIL acquisition, while the 1999 decrease resulted from repositioning funds to cash and the equity market. Shown below is a distribution by rating category of the Company's fixed maturities portfolio as of December 31, 2000.
Standard & Poor's Fair Corporation Rating Amortized Cost 1 Value 2 --------------------------------------------------------- Investment grade: AAA to A- $56,143,683 $56,251,789 BBB+ to BBB- 10,322,495 10,033,747 --------------------------------------------------------- Total investment grade 66,466,178 66,285,536
Non-investment grade: BB+ to BB- 1,611,931 1,494,807 B+ to B- 3,589,098 2,741,731 CCC+ to C 827,715 860,350 CI to not rated 21,250 21,250 --------------------------------------------------------- --------------------------------------------------------- Total non-investment grade 6,049,994 5,118,138 --------------------------------------------------------- Total fixed maturities $72,516,172 $71,403,674 ---------------------------------------------------------
The Company believes it has a well diversified portfolio and has no definitive plans to decrease its non-investment grade portfolio significantly below its current level, unless necessary to satisfy requirements of state regulators or
rating agencies. The Company purchases non-investment grade bonds to obtain higher yields or convertible features and attempts to reduce credit risk by portfolio diversification. Non-investment grade securities comprised 8.3% and 8.8% of the fixed maturities portfolio, on an amortized cost basis at December 31, 2000 and 1999, respectively.
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 can involve qualitative and quantitative information relating to an individual company or industry and general factors impacting the economy. In addition, market performance subsequent to the balance sheet date has historically been a key factor. However, due to wide market fluctuations occurring prior and subsequent to December 31, 2000, post balance sheet price movements have become less useful for assessing permanent impairment. Accordingly, determining whether declines are temporary, has become much more complex and judgmental. These reviews resulted in the recognition of impairment losses on equity securities totaling $5,733,000 during 2000 ($1,035,000, $865,000, $838,000 and $2,995,000 for the first through fourth quarters, respectively). In addition, $912,000 of impairment losses were recognized on fixed maturities during 2000 ($513,000, $5,000, $387,000 and $7,000 during the first through fourth quarters, respectively). During 2000, equity securities and fixed maturities were sold which contained impairment writedowns of $1,108,000 and $15,000, respectively.
As more extensively discussed under Consolidated Results and Analysis, below, the Company realized significant net capital gains from its marketable investments over the three-year period ended December 31, 2000. Management believes these pretax net gains, which total $14,232,000 ($1,181,000, $9,375,000, and $3,676,000 for 2000, 1999 and 1998, respectively), are greater than would have been obtained from a more conservative investment strategy involving only investment grade bonds. The Company's strategy has in some years subjected it to fluctuations in income and shareholders' equity of a magnitude significantly larger than would be anticipated under a more conservative investment strategy. Net capital gains or losses for a given period are not necessarily indicative of those for future periods. In addition, the net realized gains (and unrealized losses) reported for 2000 are significantly impacted by the judgmental determination of securities impairments discussed above.
Liabilities. A comparison of total policy liabilities as of December 31, 2000, 1999 and 1998 is shown below. Approximately 82% of the 2000 total consists of future policy benefit reserves while policyholder deposit liabilities represent 16% of the total.
Year Ended December 31 2000 1999 1998 --------------------------------------------------------------------- Home Service Life $ 31,543,557 $ 30,300,225 $ 28,967,749 Broker Life 44,631,499 41,718,948 39,933,144 Preneed Life 23,094,830 21,509,265 23,260,792 Dental 610,111 633,751 485,750 Other Health 2,143,247 3,031,510 2,997,162 --------------------------------------------------------------------- Total $102,023,244 $ 97,193,699 $ 95,644,597 ---------------------------------------------------------------------
Home Service Life policy liabilities comprise approximately 31% of the Company total. During recent years, this segment has experienced moderate growth through a combination of attracting new producers and continuing to focus on meeting the needs of existing customers and agents. The Broker Life segment's 2000 net growth is due primarily to the NAIL acquisition, while the 1999 growth resulted from favorable sales of the Company's simplified issue and graded benefit life products which were redesigned in late 1997. The Company initially entered the Preneed Life business in 1998 after completing the United Acquisition. During 2000, Preneed Life product offerings were redesigned and the Company attracted a number of new producers who have reacted favorably to the new products and level of service provided. During the initial full year of Preneed production in 1999, claims on the inforce business outpaced the Company's new sales production. The Company's Dental products are annual term coverages; accordingly, policy liabilities for this segment are not significant. The Other Health segment change in 2000 relates primarily to the settlement of a reinsurance obligation with no impact on overall retention.
Shown below is a progression of the Company's policyholder deposit activity for the year ended December 31, 2000.
Year Ended December 31 2000 1999 1998 ---------------------------------------------------------------- Home Service Life $6,906,473 $6,697,932 $6,551,375 Broker Life 3,425,795 3,447,440 3,040,231 Preneed Life 4,221,225 2,298,013 1,066,069 Dental 7,892,356 7,105,627 6,414,720 Other Health 1,376,575 1,295,816 1,299,233 ---------------------------------------------------------------- Total $ 23,822,424 $ 20,844,828 $ 18,371,628 ----------------------------------------------------------------
The less than 1% decline in Broker Life premium during 2000 was primarily attributable reductions in group life premium and lapses on a closed block of business obtained in the United Acquisition. In addition, the Company experienced some softening in sales of simplified issue and graded benefit life policies, partially offset by additional premium from the NAIL acquisition. The 13% increase in Broker Life premium during 1999 was attributable to increased sales of simplified issue and graded benefit life policies as well as to receiving a full year of premium on participating life policies obtained in the 1998 United Acquisition.
The 11% growth rates for Dental premium during 2000 and 1999 reflect a continuing focus on this market, favorable reaction to the quality of customer service, and a modest marketing incentive program. The Company constantly strives to build strong customer and agent loyalty by continuing to improve sales and administrative support functions.
Investments. The Company monitors its available-for-sale fixed maturities and equity securities to assure they are strategically positioned within the current market environment. This practice has historically resulted in equity securities comprising 10% to 20% of the Company's cash and invested assets, which tends to dampen current income yields in favor of an overall total return focus. Investment income yields were 4.9%, 5.1%, and 5.3% for 2000, 1999, and 1998, respectively. The investment income yield declines in 2000 and 1999 resulted primarily from higher equity security and short-term investment average balances.
Equity Portfolio - Pretax Total Return ------------------------------------------------------------------------------ Year Ended December 31, Total/Average 2000 1999 1998 ------------------------------------------------------------------------------ Average Equities Cost $18,399,474 $20,017,915 $20,650,875 $14,529,633 ------------------------------------------------------------------------------ Realized Gains 1 $13,274,860 $ 24,530 $10,064,022 $ 3,186,308 Change in Unrealized Gains (Losses) (4,028,116) (5,812,184) 2,238,293 (454,225) Dividends 1,343,919 397,552 523,520 422,847 ------------------------------------------------------------------------------ Gross Total Return 10,590,663 (5,390,102) 12,825,835 3,154,930
Direct Expenses (1,147,235) (207,369) (702,772) (237,094) ------------------------------------------------------------------------------ Net Total Return 9,443,428 (5,597,471) 12,123,063 2,917,836 7.0% Base Return (3,863,889) (1,401,254) (1,445,561) (1,017,074) ------------------------------------------------------------------------------ Excess Return $ 5,579,539 $ (6,998,725) $10,677,502 $ 1,900,762 ------------------------------------------------------------------------------
Pretax income for 2000 totaled approximately $448,000 compared to $8,664,000 in 1999 and $4,074,000 in 1998. Pretax profit (loss) is shown below for the Company's five business segments, along with total realized investment gains and interest expense. As previously indicated, the Company's equity investments have historically produced very favorable total returns; however, if these funds had been invested in fixed-maturities yielding 7.0%, the segment profit totals below would have increased by an additional $1,004,000, $922,000, and $594,000 in 2000, 1999, and 1998 respectively.
Statutory Insurance Information. For insurance regulatory and rating purposes, the Insurance Subsidiaries report on the basis of statutory accounting principles ("SAP"). During 1999, A.M. Best Company ("Best") upgraded Citizens Security's rating to B from B-. United Liberty's rating has remained at B- by Best since it was acquired in 1998, and Kentucky Insurance, due to its lack of insurance operations, is not rated. Citizens Security reports its investment in United Liberty on the equity method of accounting for statutory accounting purposes. Accordingly, the admitted value of Citizens Security's investment in United Liberty equals United Liberty's statutory capital and surplus total of $3,112,690 at December 31, 2000. Citizens Security's 2000 statutory net income includes United Liberty's 2000 statutory net income of $289,489. To provide a more detailed understanding of Citizens Security's operations, shown below are SAP basis net income, net operating income, statutory capital and surplus, asset reserves, and capital ratios for Citizens Security for the five years ended December 31, 2000.
In addition to the statutory totals shown above, Kentucky Insurance generated approximately $93,000 of net income, during 2000 and $150,000 during 1999, with $21,000 of the 1999 total earned after Kentucky Insurance was acquired by the Company. At December 31, 2000, Kentucky Insurance capital and surplus totaled approximately $3,379,000. Effective January 31, 2001, 100% of the capital stock of Kentucky Insurance was contributed by Citizens Financial into Citizens Security.
Cash provided by investment activities during 2000 of $4,488,000 resulted primarily from a reduction in equity portfolio positions and net cash received in the acquisition of the NAIL business, partially offset by additional property and equipment expenditures, including a fractional aircraft ownership share. Cash provided by investment activities during 1999 of $11,200,000 resulted primarily from a conservative decision to limit reinvestment activity near year-end, due to increased market volatility. Cash used in investing activities during 1998 includes payment of approximately $7,076,000 for the United Acquisition, less $3,288,000 of cash held by United Liberty on the effective acquisition date, for a net outflow of $3,788,000. Cash used by financing activities during 2000 includes higher levels of policyholder deposit withdrawals, principally due to the Company's decision not to aggressively compete in crediting higher interest returns on such funds. Cash used by financing activities in 1999 includes net policyholder deposit withdrawals comparable to the 1998 level, a $2,500,000 bank borrowing associated with the Kentucky Insurance Acquisition, net brokerage advance repayments of $1,400,000, and common stock repurchases of approximately $390,000. Cash provided by financing activities in 1998 includes $3,400,000 of additional bank borrowings, which were used, along with available funds at Citizens Security, to acquire United Liberty on May 12, 1998.
The Company is subject to various market risks. However, the most significant such risks relate to fluctuations in prices of equity securities and interest rates. Although the company's total return on equity securities during 2000 was a loss of approximately $5,600,000, the Company has successfully managed the risk of equity security price fluctuations during the past several years. For the three years ended December 31, 2000, the total pretax return on equity securities has exceeded $9,400,000, for an average annual return of approximately 17.1%. The Company and its investment advisory firm, SMC Advisors, Inc. devote significant attention to the equity markets and reposition the Company's portfolio upon detection of adverse risk trends associated with individual securities or overall markets. SMC Advisors, Inc. also manages market
Interest expense on the Company's commercial bank debt is also subject to interest rate risk. The rate on this debt is variable and equals 100% of the bank's prime lending rate. At December 31, 2000, the rate on the Company's $8,000,000 of bank borrowings was 9.50% and has since decreased to 8.00% at March 21, 2001. The Company believes its current liquidity position and profitability levels are adequate to guard against this interest rate risk.
In addition to the measures described above, the Life Insurance Subsidiaries comply with the NAIC promulgated Standard Valuation Law ("SVL") which specifies minimum reserve levels and prescribes methods for determining them, with the intent of enhancing solvency. The SVL also requires the Company to perform annual cash flow testing for its Life Insurance Subsidiaries. This testing is designed to ensure that statutory reserve levels will maintain adequate protection in a variety of potential interest rate scenarios. The Actuarial Standards Board of the American Academy of Actuaries also requires cash flow testing as a basis for the actuarial opinion on the adequacy of the reserves which is a required part of the annual statutory reporting process.
insurance, which involves lifetime obligations, is usually best matched by longer duration maturities. In the event there are insufficient assets of these types, a repositioning of the investment portfolio might be undertaken.
Dividends from the Insurance Subsidiaries, 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
regulatory changes or actions, including those relating to regulation of insurance products and insurance companies (see the State Insurance Regulation section of Item 1);
general economic conditions and increasing competition which may affect the Company's ability to sell its products;
the Company's ability to achieve anticipated levels of operating efficiencies and meet cash requirements based upon projected liquidity sources;
Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998 ........................27
Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998..................30
Schedule I - Summary of Investments - Other than Investments In Related Parties.......................48
We have audited the consolidated financial statements of Citizens Financial Corporation and subsidiaries listed in the accompanying index to financial statements at Item 8. Our audit also included the financial statement schedules listed in the index at Item 14. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Investments: Securities available-for-sale, at fair value: Fixed maturities (amortized cost of $72,516,172 and $68,958,634 in 2000 and 1999, respectively) $ 71,403,674 $ 69,501,248 Equity securities (cost of $13,677,303 and $18,228,519 in 2000 and 1999, respectively) 12,577,874 22,941,274 Investment real estate 3,506,386 3,513,579 Mortgage loans on real estate 156,000 158,309 Policy loans 4,270,588 4,059,801 Short-term investments 610,379 580,425 - ------------------------------------------------------------------------------ Total Investments 92,524,901 100,754,636
Cash and cash equivalents 20,093,774 18,696,401 Accrued investment income 1,328,491 1,145,447 Reinsurance recoverable 2,686,747 3,607,349 Premiums receivable 212,089 388,146 Property and equipment 2,959,744 2,051,414 Deferred policy acquisition costs 6,511,948 4,690,774 Value of insurance acquired 4,884,680 5,295,818 Goodwill 851,795 809,809 Federal income tax receivable 1,364,502 169,502 Deferred federal income tax 1,711,661 --- Other assets 407,674 370,734 - ------------------------------------------------------------------------------ Total Assets $135,538,006 $137,980,030 - ------------------------------------------------------------------------------
Common stock, 6,000,000 shares authorized; 1,758,215 and 1,767,215 shares issued and outstanding in 2000 and 1999, respectively 1,758,215 1,767,215 Additional paid-in capital 7,640,988 7,736,201 Accumulated other comprehensive income (loss) (1,573,294) 3,322,971 Retained earnings 15,448,200 15,210,070 - ------------------------------------------------------------------------------ Total Shareholders' Equity 23,274,109 28,036,457 - ------------------------------------------------------------------------------ Total Liabilities and Shareholders' Equity $135,538,006 $137,980,030 - ------------------------------------------------------------------------------
Accumulated Other Comprehensive Additional Comprehensive Income Common Paid-in Income Retained (Loss) Stock Capital (Loss) Earnings Total - ------------------------------------------------------------------------------
- ------------------------------------------------------------------- Balance at December 31, 1999 1,767,215 7,736,201 3,322,971 15,210,070
Net unrealized depreciation of available for sale securities (4,896,265) (4,896,265) ----------- Comprehensive loss $(4,658,135) =========== Common stock repurchases (9,000) (95,213)
Cash Flows from Operations: Net income $ 238,130 $ 6,438,845 $ 3,299,660 Adjustments reconciling to cash from operations: Increase in benefit reserves 1,810,331 1,806,387 806,183 Increase (decrease) in claim liabilities 305,543 196,571 (111,746) (Increase) decrease in reinsurance recoverable 920,602 (142,987) (380,034) Interest credited on policyholder deposits 888,428 862,615 845,608 Provision for amortization and depreciation, net of deferrals (145,414) 308,403 591,743 Amortization of premium and accretion of discount on securities purchased, net 54,094 147,566 112,432 Net realized investment gains (1,180,879) (9,375,339) (3,675,489) (Increase) decrease in accrued investment income (183,044) 79,307 12,304 Change in other assets and liabilities (434,302) 325,992 (269,857) Deferred income tax expense (benefit) (1,545,000) 550,000 (19,000) Increase (decrease) in federal income taxes payable (1,195,000) (836,515) 408,000 - -------------------------------------------------------------------------------- Net Cash provided by (used in) Operations (466,511) 360,845 1,619,804
The Life Insurance Subsidiaries market their portfolio of products through the personal producing general agent distribution system and presently have approximately 2,600 sales representatives. Many of these agents also represent other insurance carriers. Approximately 400 of the agents specialize in the home service market while approximately 300 are preneed representatives who market through funeral homes. These markets consist primarily of individuals who desire whole life policies with policy limits typically below $10,000.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
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, 2000 was $1,977,438 ($1,718,359 at December 31, 1999).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of purchase price of purchased subsidiaries, over amounts assigned (based on estimated fair values at the date of acquisition) to the identifiable net assets acquired. Goodwill is amortized over 10 to 20 years using the straight-line method. At December 31, 2000, accumulated amortization was $316,848 ($238,834 at December 31, 1999).
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, 2000, accumulated amortization was $4,411,694 ($3,645,196 at December 31, 1999).
Liabilities for Policy Claims. Policy claim liabilities are based on known liabilities plus estimated future liabilities developed from trends of historical data applied to current exposures. These liabilities are closely monitored and adjustments for changes in experience are made in the period identified.
Fair Value Amortized Gross Unrealized (Carrying December 31, 2000 Cost Gains Losses Value) - -------------------------------------------------------------------------------- Fixed Maturities: U.S. Government obligations $ 10,951,802 $ 224,631 $ 4,976 $ 11,171,457 Corporate securities 57,984,195 389,866 1,834,171 56,539,890 Mortgage-backed 3,580,175 119,075 6,923 3,692,327 securities - -------------------------------------------------------------------------------- Total $ 72,516,172 $ 733,572 $ 1,846,070 $ 71,403,674 - -------------------------------------------------------------------------------- Equity Securities $ 13,677,303 $ 832,565 $ 1,931,994 $ 12,577,874 - --------------------------------------------------------------------------------
December 31, 1999 - -------------------------------------------------------------------------------- Fixed Maturities: U.S. Government obligations $ 8,723,722 $ 640 $ 101,100 $ 8,623,262 Corporate securities 55,714,282 2,222,719 1,569,797 56,367,204 Mortgage-backed 4,520,630 32,000 41,848 4,510,782 securities - -------------------------------------------------------------------------------- Total $ 68,958,634 $ 2,255,359 $ 1,712,745 $ 69,501,248 - -------------------------------------------------------------------------------- Equity Securities $ 18,228,519 $ 5,080,683 $ 367,928 $ 22,941,274 - --------------------------------------------------------------------------------
The annual change in net unrealized investment appreciation or depreciation, at December 31, 2000, 1999 and 1998, and the amount of net realized investment gain or loss included in net income for the respective years then ended are as follows:
December 31, 2000 Amortized Cost Fair Value - ------------------------------------------------------------------- Due in one year or less $ 6,409,858 $ 6,486,205 Due after one year through five years 52,157,598 51,440,761 Due after five years through ten years 8,123,240 7,719,552 Due after ten years 2,245,301 2,064,829 - ------------------------------------------------------------------- Subtotal 68,935,997 67,711,347 Mortgage-backed securities 3,580,175 3,692,327 - ------------------------------------------------------------------- Total $72,516,172 $71,403,674 - -------------------------------------------------------------------
Gross gains of $2,268,554, $1,260,650, and $1,411,737 and gross losses of $1,127,299, $969,136, and $502,680 were realized on the sale of available-for-sale fixed maturities during 2000, 1999 and 1998, respectively. Included in gross realized losses during 2000, 1999 and 1998 are net adjustments to the carrying value of available-for-sale fixed maturities of $912,000, $55,000, and $150,000 respectively, relating to declines in value which were considered by management to be other than temporary. Net realized gains from the sale of fixed maturities have been reduced by $80,166, $20,021, and $38,098 in 2000, 1999 and 1998 respectively, due to amortization of deferred policy acquisition costs. In addition, net realized gains from the sale of fixed maturities have been reduced by $27,544, and $43,755 in 1999 and 1998 respectively, for incentive fees earned by the portfolio manager.
Gross gains of $16,764,844, $16,414,949, and $8,165,216 and gross losses of $16,740,314, $6,350,927, and $4,978,908, were realized on the sale of available-for-sale equity securities during 2000, 1999 and 1998. Included in gross realized losses during 2000, 1999 and 1998 are adjustments to the carrying value of available-for-sale equity securities of $5,733,000 $1,017,000, and $1,356,000 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 increased by $302,629, $(229,861), and $(100,929) in 2000, 1999 and 1998 respectively, due to amortization of deferred policy acquisition costs. In addition, net realized gains from the sale of available-for-sale equity securities have been reduced by $207,369, $702,771, and $237,094 in 2000, 1999 and 1998, respectively, for incentive and guaranty fees earned by the portfolio manager and costs associated with operating a brokerage margin account. Under terms of this brokerage margin account, Morgan Stanley & Company, Inc. permits 50% of the value of securities held in the account to be purchased on margin. At December 31, 1999, margin advances of $100,884 were outstanding and included in the financial statements with accrued expenses and other liabilities.
Investment management services are provided by a firm affiliated with certain board members and shareholders of the Company - see Related Party Transaction Note 17.
December 31, 2000: Unrealized loss arising $(5,981,261) $(1,864,376) $(4,116,885) Less: Reclassification adjustment for gains realized in net income 1,180,879 401,499 779,380 - -------------------------------------------------------------------------------- Change in net unrealized loss $(7,162,140) $(2,265,875) $(4,896,265) ================================================================================
December 31, 1999: Unrealized gain arising $ 9,744,056 $ 2,533,084 $ 7,210,972 Less: Reclassification adjustment For gains realized in net income 9,375,339 2,407,722 6,967,617 - -------------------------------------------------------------------------------- Change in net unrealized gain $ 368,717 $ 125,362 $ 243,355 ================================================================================
The Company leases office space to third-party tenants under noncancellable lease agreements. Future minimum rental income is $598,000, $570,000, $442,000, $316,000 and $140,000 for years 2001 through 2005, respectively.
Amortization of the value of insurance acquired (net of interest accretion) in each of the following five years will be approximately: 2001 - $648,000; 2002 - $564,000; 2003 - $486,000; 2004 - $428,000; and 2005 - $387,000.
Note 5--LIABILITY FOR ACCIDENT AND HEALTH UNPAID CLAIMS AND INCURRED, BUT NOT REPORTED CLAIMS PORTION OF RESERVES
The Company's outstanding borrowings relate primarily to various insurance company acquisitions. On October 14, 1999, the Company borrowed $2,500,000 in conjunction with the Kentucky Insurance Acquisition and on May 12, 1998 borrowed $3,400,000 in conjunction with the United Acquisition. Interest is payable quarterly at the bank's prime lending rate. Principal installments are due as follows: 2001 - $904,167; 2002 through 2004 - $1,316,666; 2005 and 2006 - $1,416,666; and 2007 - $312,503. The Company has pledged the issued and outstanding common and preferred stock of Citizens Security and Kentucky Insurance as collateral for the commercial bank notes. The bank notes also contain covenants regarding asset acquisitions, shareholder dividends and maintenance of certain operating ratios.
Cash paid for interest on debt was $771,095, $595,939 and $524,765 during 2000, 1999 and 1998, respectively; including $21,447, $84,491, and $108,514 in 2000, 1999 and 1998, respectively, related to brokerage account borrowings.
The following table sets forth the computation of basic and diluted earnings per share. See Note 7 for additional disclosures regarding the outstanding preferred stock.
Basic earnings per share $0.14 $3.59 $2.31 Diluted earnings per share $0.14 $3.59 $1.82
Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------------- Current tax expense $1,755,000 $1,675,000 $793,000 Deferred tax expense (benefit) (1,545,000) 550,000 (19,000) - ------------------------------------------------------------------------- Income tax expense $ 210,000 $2,225,000 $774,000 - -------------------------------------------------------------------------
Tax expense includes a current state and local income tax provision of $350,000 and $225,000 in 2000 and 1999, respectively and none in 1998. Deferred income taxes are provided for cumulative temporary differences between balances of assets and liabilities determined under GAAP and balances determined for tax reporting purposes.
The Insurance Subsidiaries are domiciled in Kentucky and prepare their statutory-basis financial statements in accordance with statutory accounting practices ("SAP") prescribed or permitted by the Kentucky Department of Insurance ("KDI"). Net income and capital and surplus for the Company's insurance operations, as reported in accordance with SAP, for the three years ended December 31, 2000 are shown below.
"Prescribed" statutory accounting practices include state insurance 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. Effective January 1, 2001, the NAIC revised its Accounting Practices and Procedures Manual in a process referred to as Codification. The KDI has adopted the provisions in the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices that will result in changes to the accounting practices which the Insurance Subsidiaries use to prepare their statutory-basis financial statements. Management believes the impact of these changes will not be material to the Insurance Subsidiaries' statutory-basis capital and surplus as of January 1, 2001.
Statutory restrictions limit the amount of dividends which the insurance companies may pay. 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 2000, 1999 and 1998, with appropriate prior regulatory approval, Citizens Security redeemed $1,200,000, $1,200,000, and $1,500,000, respectively, of its outstanding preferred stock from the Company. In addition, during 1999, with appropriate regulatory approval, Citizens Security paid a dividend of $1,000,000 to the Company. During 1999 and 1998, United Liberty paid dividends to Citizens Security of $200,000 and $325,000 respectively. The Insurance Subsidiaries must each maintain $1,250,000 of capital and surplus, the minimum required for insurance companies domiciled in Kentucky. The KDI imposes minimum risk-based capital ("RBC") requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances and various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio (the "Ratio") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The
Insurance Subsidiaries each have a Ratio that is at least 250% of the minimum RBC requirements; accordingly, they all meet the RBC requirements.
Under a prior year agreement, an option to purchase 5,000 shares of the Company's common stock was granted to an officer and was outstanding at the beginning of 1998. The stock option vested as of June 16, 1995, at an exercise price of $9 per share, and was scheduled to expire on June 16, 1998. This option was exercised during the second quarter of 1998, resulting in an increase to shareholders' equity of $45,000. 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 this stock option. No options were exercised during 2000 or 1999. The effect of applying the fair value method of accounting for the Company's stock based awards results in net income and earnings per share that are not materially different from amounts reported.
The Company's operations are managed along five principal insurance product lines: Home Service Life, Broker Life, Preneed Life, Dental, and Other Health. Products in all five lines are sold through independent agency operations. Home Service Life consists primarily of traditional life insurance coverage sold in amounts of $10,000 and under to middle and lower income individuals. This distribution channel is characterized by a significant amount of agent contact with customers throughout the year. Broker Life product sales consist primarily of simplified issue and graded-benefit policies in amounts of $10,000 and under. Other products in this segment which are not aggressively marketed include: group life, universal life, annuities and participating life coverages. Preneed Life products are sold to individuals in connection with prearrangement of their funeral and include single premium and multi-pay policies with coverages generally in amounts of $10,000 and less. These policies are generally sold to older individuals at increased premium rates. Dental products are term coverages generally sold to small and intermediate size employer groups. Other Health products include various accident and health coverages sold to individuals and employer groups.
Segment information as of December 31, 2000, 1999 and 1998, and for the years then ended is as follows:
Depreciation and Amortization: Home Service Life $ 723,255 $ 583,456 $ 710,150 Broker Life 506,016 601,640 757,154 Preneed Life 350,758 381,354 135,723 Dental 61,286 50,276 54,381 Other Health 45,888 41,661 40,708 - ------------------------------------------------------------------------- Segment Totals $1,687,203 $1,658,387 $1,698,116 - -------------------------------------------------------------------------
Assets: Home Service Life $ 45,577,255 $ 47,347,032 $ 43,299,037 Broker Life 57,721,008 57,958,271 52,783,159 Preneed Life 29,421,677 29,754,353 30,869,962 Dental 799,496 913,939 674,728 Other Health 2,018,570 2,006,435 1,872,237 - ------------------------------------------------------------------------------ Total Assets $135,538,006 $137,980,030 $129,499,123 - ------------------------------------------------------------------------------
Segment Revenue $ 7,191,817 $ 7,168,160 $ 7,802,964 $ 7,950,792 Investment gains (losses), net 4,793,958 1,530,931 (1,664,106) (3,479,904) - -------------------------------------------------------------------------------- Total Revenue $11,985,775 $ 8,699,091 $ 6,138,858 $ 4,470,888 - --------------------------------------------------------------------------------
Segment Revenue $ 6,468,039 $ 6,905,918 $ 6,638,010 $ 6,875,806 Investment gains, net 1,541,836 2,412,242 1,712,277 3,708,984 - -------------------------------------------------------------------------------- Total Revenue $ 8,009,875 $ 9,318,160 $ 8,350,287 $10,584,790 - --------------------------------------------------------------------------------
Segment Profit (Loss) $ 172,819 $ (81,263) $ (131,892) $ (118,141) Investment gains, net 1,541,836 2,412,242 1,712,277 3,708,984 Interest expense 127,099 124,575 127,438 173,905 Income tax expense (benefit) 425,000 670,000 305,000 825,000 - -------------------------------------------------------------------------------- Net Income $ 1,162,556 $ 1,536,404 $ 1,147,947 $ 2,591,938 - --------------------------------------------------------------------------------
allege that United Liberty is liable to pay punitive damages, also in an unspecified amount, for breach of an implied covenant of good faith and fair dealing to the plaintiffs in relation to the dividends. The plaintiffs are seeking to have the action certified as a class action on behalf of all other policyholders whose policies were still in force in 1993. United Liberty has filed its answer denying the material allegations of the complaint and intends to defend the action vigorously. The Company has engaged in pre-trial discovery proceedings, in relation both to the plaintiffs' underlying allegations and their request for class action certification. At this early stage of the litigation, the Company is unable to determine whether an unfavorable outcome of the action is likely to occur or, alternatively, whether the chance of such an outcome is remote. Therefore, at this time, management has no basis for estimating potential losses, if any. In addition, the Company is party to other lawsuits in the normal course of business. Management believes recorded claims liabilities are adequate to ensure these other suits will be resolved without material financial impact to the Company.
Fixed Maturities: The fair values for fixed maturities are based on quoted market prices, where available. For those fixed maturities which are not actively traded, fair values are estimated using values obtained from independent pricing services. Available-for-sale fixed maturities are carried at fair value in the accompanying statements of financial condition. At December 31, 2000 and 1999, the fair value of available-for-sale fixed maturities was $71,403,674 and $69,501,248, respectively.
Short-Term Investments: The carrying amount of short-term investments approximates their fair value. At December 31, 2000 and 1999, the fair value of short-term investments was $610,379 and $580,425, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair value. At December 31, 2000 and 1999, the fair value of policy loans was $4,270,588 and $4,059,801, respectively.
Notes Payable: The carrying amounts of notes payable approximate their fair values. At December 31, 2000 and 1999, the fair value of notes payable was $8,000,000 and $8,500,000, respectively.
Schedule I - Summary of Investments - Other than Investments in Related Parties Citizens Financial Corporation and Subsidiaries At December 31, 2000
Amount at Cost or Which Shown Type of Investment Amortized Cost1 Fair Value Balance Sheet - -------------------------------------------------------------------------------
Fixed maturity securities available-for-sale: US Government and government agencies and authorities $16,943,524 $17,257,929 $17,257,929 Public utilities 4,531,145 4,459,150 4,459,150 Convertibles and bonds with warrants 9,354,074 7,274,752 7,274,752 All other corporate bonds 41,687,429 42,411,843 42,411,843 - ------------------------------------------------------------------------------- Total $72,516,172 $71,403,674 $71,403,674
Investment real estate 3,506,386 3,506,386 3,506,386 Mortgage loans on real estate 156,000 156,000 156,000 Policy loans 4,270,588 4,270,588 4,270,588 Short-term investments 610,379 610,379 610,379
Assets: Cash and cash equivalents $ 5,843,949 $ 17,812 Equity securities available-for-sale (cost of $2,423,152 and $5,125,733 in 2000 and 1999, respectively) 2,290,923 6,811,919 Net option positions 14,375 1,144,750 Investments in subsidiaries* 22,243,083 29,359,590 Furniture and equipment 1,507,164 554,225 Intercompany receivable* --- 302,221 Current and deferred federal income tax 98,851 248,851 Other assets 128,824 173,022 - ------------------------------------------------------------------------------ Total Assets $ 32,127,169 $ 38,612,390 - ------------------------------------------------------------------------------
Shareholders' Equity: Common stock 1,758,215 1,767,215 Additional paid-in capital 7,640,988 7,736,201 Accumulated other comprehensive income (loss) (87,271) 1,112,883 Equity (deficit) in accumulated other comprehensive income (loss) of subsidiaries* (1,486,023) 2,210,088 Retained earnings 15,448,200 15,210,070 - ------------------------------------------------------------------------------ Total Shareholders' Equity 23,274,109 28,036,457
Revenues: Net realized investment gains $ 4,282,893 $ 4,115,408 $ 690,778 Service fees from subsidiaries 4,497,590 4,198,106 2,011,024 Interest and dividend income 159,124 20,143 20,569 Other income 47,018 83,329 41,911 - ------------------------------------------------------------------------------- Total Revenues 8,986,625 8,416,986 2,764,282
- ------------------------------------------------------------------------------- Income before income taxes and undistributed earnings of subsidiaries 3,893,526 3,857,840 343,199 Income taxes 1,435,000 1,525,000 85,000 - ------------------------------------------------------------------------------- Income before equity in undistributed earnings of subsidiaries 2,458,526 2,332,840 258,199 Equity in undistributed earnings (loss) of subsidiaries (2,220,396) 4,106,005 3,041,461 - ------------------------------------------------------------------------------- Net Income 238,130 6,438,845 3,299,660 Dividends on redeemable convertible preferred stock --- --- 279,650 - ------------------------------------------------------------------------------- Net Income Applicable to Common Stock $ 238,130 $ 6,438,845 $ 3,020,010 - -------------------------------------------------------------------------------
Percentage Ceded to Assumed of Amount Year Ended Gross To Other From Other Net Assumed December 31 Amount Companies Companies Amount To Net - --------------------------------------------------------------------------------
Premiums: Life insurance ......$ 11,489,782 $ 911,968 $ 78,785 $ 10,656,599 0.7% Accident & health insurance 7,834,392 119,363 --- 7,715,029 0.0% - -------------------------------------------------------------------------------- Total ..........$ 19,324,174 $ 1,031,331 $ 78,785 $ 18,371,628 0.4% - --------------------------------------------------------------------------------