The table below sets forth, in summary form, selected data of the Company. This data, which is not covered in the reports of our independent registered public accounting firms, should be read in conjunction with our consolidated financial statements and notes, which are included elsewhere herein. The net income per share amounts have been adjusted retroactively for all periods presented to reflect the 7% common stock dividends paid on December 31, 2005, 2004, and 2003.
U.S. Dollar-denominated ordinary whole life insurance policies predominantly to high net worth, high income foreign residents, located principally in Latin America and the Pacific Rim, through approximately 2,600 independent marketing consultants;
Life Insurance. For the past 30 years, CICA and its predecessors have participated in the foreign marketplace through the issuance of U.S. Dollar-denominated ordinary whole life insurance to foreign nationals. Traditionally, this market has focused on the top 3-5% of the population of a country in terms of income and net worth. In recent years, however, there has been a shift to encompass a broader spectrum of the population, as upper middle classes develop in Latin America and the Pacific Rim. We make our insurance products available using third-party marketing organizations and independent marketing consultants. The number of our producing independent consultants has expanded over the years in this segment to
In 2007, our Life Insurance segment generated revenue of $119.0 million, which accounted for 68.5% of our total revenue. For the year ended December 31, 2006, this segment produced revenue of $105.7 million or 66.9% of our total revenue, compared to 2005 when it produced approximately $90.6 million or 63.8% of total revenue. Our strategy in operating our Life Insurance segment is to increase new business written through our existing marketers as well as expand the number of countries from which we receive policy applications. The development of new markets in the Pacific Rim, particularly Taiwan, and the expansion of existing markets in Latin America were the primary contributors to the growth in this segment.
In 2008, CICA plans introduction of a new set of international products. The Company anticipates the new products will be very well accepted in the international market.
Home Service Insurance. Through a subsidiary, SPLIC, we provide final expense ordinary life insurance to middle to lower income individuals in Louisiana. Our policies in this segment are sold and serviced through the home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders.
SPLIC’s property insurance subsidiary, SPFIC, was negatively impacted by Hurricanes Katrina and Rita. Commencing in 2005 and through December 31, 2007, total incurred losses not covered by reinsurance amounted to $4.0 million, resulting in SPLIC infusing $4 million of additional capital into SPFIC. Legislative and judicial decrees had further extended the period for filing claims, for one year, beyond that provided for under the contracts. Due to this extended claims filing period, an incurred but not reported
As 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 for our policyowners to accumulate cash values to provide for living expenses in a policy owner’s later years, while continuously providing a death benefit.
The volatility in the equity markets over the past few years has posed a number of problems for some companies in the life insurance industry. We historically have had minimal equity holdings, constituting less than 7% of total invested assets as of December 31, 2007 and less than 1% at December 31, 2006.
In late 2007, the Company completed an $18.8 million registered direct offering of its Class A common stock, selling approximately 2.7 million shares at a price of $7.00 per share. The net proceeds of the offering were $17.1 million, after underwriter commissions and other offering related expenses. The anticipated use of proceeds from the offering is for general corporate purposes, which could include acquisitions of other insurance companies.
As further discussed below, increases in premium income, fueled by the writing of new life insurance premiums and improved persistency, as well as an increase in investment income and lower property claims development, contributed to a 90.8% increase in earnings for 2007.
Policy surrenders increased 4.6% in 2007 to $18.0 million from $17.2 million in 2006, up from $15.4 million in 2005. The increase in surrender expense is in line with management expectations, considering the inforce business has increased over the last three years. Surrenders as a percent of inforce business were 0.4% in 2007, 2006 and 2005.
Endowment benefits increased 19.0% from $10.8 million in 2006 to $12.8 million in 2007. Endowments totaled $9.0 million in 2005. We have a series of international policies that carry an immediate endowment benefit of an amount elected by the policy owner. This endowment is factored into the premium of the policy and is paid annually. These benefits have been particularly popular in the Pacific Rim, where the Company has experienced increased business in recent years. Like policy dividends, endowments are factored into the premium and, as such, the increase should have no adverse impact on profitability.
Deferred Policy Acquisition Costs. Capitalized deferred policy acquisition costs (“DAC”) decreased 2.9% from $27.0 million in 2006 to $26.2 million in 2007. These costs were $24.4 million in 2005. The 2007 decrease from 2006 was primarily related to flat new life production discussed above, and tracked consistently with the slight decrease in commissions. Amortization of these costs was $12.5 million, $11.4 million and $10.3 million in 2007, 2006 and 2005, respectively. The write-off of DAC on internal replacements under The American Institute of Certified Public Accountants (AICPA) Statement of Position, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1), added $917,000 to amortization in 2007.
Federal Income Tax. Federal income tax expense was $4.5 million, $4.7 million and $6.9 million in 2005, 2006 and 2007, respectively. This represents effective tax rates of 38.1%, 35.0% and 29.5%, respectively. In 2005, a valuation allowance in the amount of $1.1 million was established, which added 9.3% to our effective tax rate. The 2005 allowance was due to the anticipated sale of CNLIC, which had a $1.1 million net deferred tax asset at December 31, 2005, primarily related to net operating losses that would not be available in future years as CNLIC would no longer be part of the Company’s consolidated group. The 2006 tax rate was higher due to a write-off of $1.0 million of goodwill, which has no tax effect. In 2007, the valuation allowance was released in the amount of $1.1 million as the CNLIC sale agreement was terminated and the Company’s plan is to now consolidate CNLIC in the Company’s life-nonlife tax return in 2008. CICA should have sufficient life income to absorb the CNLIC net operating losses. This release of the valuation allowance reduced our effective tax rate by 4.7%. (See Note 10 of the “Notes to Consolidated Financial Statements” for additional information on Federal income tax.)
Liquidity requirements of Citizens are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds, while investment purchases, policy benefits, and operating expenses are the primary uses of funds. We historically have not had to liquidate investments to provide cash flow and did not do so in 2007. During the fourth quarter of 2005 and the first six months of 2006, however, SPFIC sold approximately $3.1 million of bonds in order to meet the cash outflow related to claims from Hurricanes Katrina and Rita. Such sales were not needed in the second half of 2006. Additionally, in early 2005, management chose to pay off the $30 million in debt incurred in the Security Plan transaction. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. See Note 8 of the “Notes to Consolidated Financial Statements” for a table disclosing our contractual obligations.
and cash flow tests under various market interest rate scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds.
In the past, cash flows from our insurance operations have been sufficient to meet current needs. Cash flows from operating activities were $37.9 million, $39.1 million and $34.5 million for the years ended December 31, 2007, 2006, and 2005, respectively. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows, for the most part, are reinvested in fixed income securities. Net cash outflows from investment activity totaled $58.8 million, $33.6 million and $22.6 million for the years ended December 31, 2007, 2006 and
2005, respectively. The outflows from investing activities for the year ended December 31, 2007, primarily related to the investment of excess cash and cash equivalents generated from operations during 2007 and the investment of proceeds from our registered direct offering of $18.8 million of Class A common stock completed in late 2007.
Our cash balances at our primary depositories were significantly in excess of Federal Deposit Insurance Corporation coverage at December 31, 2007 and December 31, 2006. Management monitors the solvency of all financial institutions in which we have funds to minimize the exposure for loss. Management does not believe we are at significant risk for such a loss. During 2008, we intend to continue to utilize high grade commercial paper as a cash management tool to minimize excess cash balances and enhance returns.
We continue to use the original assumptions (including a provision for the risk of adverse deviation) in subsequent periods to determine the changes in the liability for future policy benefits (the “lock-in concept”) unless a premium deficiency exists. Management monitors these assumptions and has determined that a premium deficiency does not exist at December 31, 2007. Management believes that our policy liabilities and increase in future policy benefit reserves as of and for the years ended December 31, 2007 and 2006 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision. The relative stability of these assumptions and management’s analysis is discussed below.
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 net premium less percent of premium expense) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then evaluated over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Based upon the analysis performed to only capitalize expenses that vary with and are directly related to the acquisition of new and renewal insurance business, utilization of the factor method and annual recoverability testing, management believes that our deferred policy acquisition costs and related amortization as of and for the years ended December 31, 2007, 2006 and 2005 limits the amount of deferred costs to its estimated realizable value.
At December 31, 2007, 68.3% of our fixed maturity securities were invested in U.S. Government-sponsored enterprises or securities backed by the U.S. Government. We evaluate the carrying value of our fixed maturity and equity securities at least quarterly. A decline in the fair value of any fixed maturity or equity security below cost that is deemed other-than-temporary is charged to earnings resulting in the establishment of a new cost basis for the security. The new cost basis is not changed for subsequent recoveries in the fair value of the fixed maturity or equity security. With the exception of Security Plan, virtually all of our subsidiaries’ fixed maturity investments are in U.S. Government-sponsored enterprises or U.S. Government instruments. Security Plan has significant investments in corporate and municipal bonds. Based upon our emphasis on investing in fixed maturity securities primarily composed of obligations of U.S. Government-sponsored corporations, our intent and ability to hold temporarily impaired fixed maturities until recovery, 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 at December 31, 2007 were not impaired, and no other-than-temporary losses needed to be recorded. The Company’s equity securities consist of mutual funds acquired in 2007, and thus any declines in value have recently arisen. The Company will continue to monitor these investments. At December 31, 2007, there were no other-than-temporary impairments.