The primary investment objective for the Company is to maximize economic value, consistent with acceptable risk parameters, including the management of credit risk and interest rate sensitivity of invested assets, while generating sufficient after-tax income to meet policyholder and corporate obligations. The Company maintains a conservative investment strategy that may vary based on a variety of factors including business needs, regulatory requirements and tax considerations.
We previously announced that we determined that a portion of the life and annuity insurance policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code ("IRC") of 1986. To the extent that these policies had unreported income build-up, we may be liable
to the IRS for failure to withhold taxes or to notify policyholders of their obligation to pay taxes directly to the IRS. We have undertaken an analysis of our potential liability to the IRS arising from this matter, as well as other expenses we may incur to remediate (i.e., conform to the requirements of the IRS) certain previously issued domestic life insurance and annuity policies and to address any missed reporting for policies issued to non-U.S. citizens and have established a best estimate reserve of $12.3 million, net of tax as of December 31, 2017 for probable liabilities and expenses. The probability weighted range of financial estimates relative to this issue is $5.9 million to $48.2 million, net of tax. This estimated range includes projected toll charges and fees payable to the IRS, as well as estimated increased payout obligations to current and former holders of non-compliant domestic life insurance policies expected to result from remediation of those policies. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, the methodology applicable to the calculation of taxable benefits under non-compliant policies and the amount of time and resources we will require from external advisors who are assisting us with resolving these issues. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and also could exceed the high end of our estimated range of liabilities and expenses. To the extent the amount reserved is insufficient to meet the actual amount of our liabilities and expenses, or if our estimates of those liabilities and expenses change in the future, our financial condition and results of operations may be materially adversely affected.
Our 2017 financial results are driven by our historical business management model and traditional life insurance product sales. Although interest rates have risen recently, the historically low interest rate environment continues to impact our results and our industry as investment yields are an integral component of our business operations.
Our assets grew $61 million in 2017 and totaled $1.6 billion as of December 31, 2017.
Net investment income increased 9.4% and 6.1% for 2017 and 2016, respectively, primarily due to an increase in the investment asset balances in 2017 compared to the prior year. The average yield on the consolidated investment portfolio has changed from a yield of 4.38% in 2015 down to 4.28% in 2016 and rising to a yield of 4.31% in 2017, as investment rates available have remained low in the sustained low interest rate environment.
During 2017, claims and surrenders expense increased 1.9% from the comparable period in 2016, primarily due to an increase in surrender benefits and matured endowments in the life segment compared to the 2016 levels.
tax compliance best estimate liability. In addition, we impaired our Home Service goodwill value by $4.6 million, down to zero.
Through the domestic market of our Life Insurance segment, we provide ordinary whole life, credit life insurance, and final expense policies to middle and lower income families and individuals in certain markets in the mountain west, midwest and southern U.S. The majority of our domestic revenues are generated by the policies of domestic life insurance companies we have acquired since 1987.
Investment income from fixed maturity investments increased in 2017 due to an increase in the portfolio from new money investment purchases as noted above relative to the fixed maturity portfolio. In addition, the increase in the policy loans asset balance, which represents policyholders utilizing their accumulated policy cash value, contributed to the increase to investment income. Investment income from equity securities has declined as we have reduced our holdings as discussed above.
The Company monitors death claims based upon expectations. These values may routinely fluctuate from year to year.
Matured endowments decreased in the current year after increasing in 2016 and 2015. We expect this increasing trend to continue as this block of business increases, persists and policies begin to reach maturity.
Policyholder Dividends. The Company issues long duration participating policies in our life segment to foreign residents that are expected to pay dividends to policyholders based upon actual experience. Initially, policyholder dividend scales are factored into the guaranteed premiums at the time the product is developed, based on expected future experience and desired profit goals. As actual and expected experience develops over time, it can become necessary to adjust dividends, as we did at the end of 2016, in order to maintain our original expected level of long term product profitability. Policyholders' dividends decreased 8.3% in 2017 compared to 2016, and 36.4% in 2016 compared to 2015 or $0.6 million and $3.9 million, respectively, due to the dividend rate actions that we took at the end of 2016.
Commissions. Commission expense fluctuates in a direct relationship to new and renewal insurance premiums and has decreased 7.4% in 2017 compared to 2016 as first year premium revenues, on which higher commission rates are paid, declined in the life segment while renewal premiums were up 2.7%.
Other General Expenses. Total general expenses increased 39.1% on a consolidated basis in 2017 due primarily to increased legal, consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. We also have $4.6 million of expense in the current year due to the write-off of our home service goodwill. Total general expenses increased 0.2% on a consolidated basis in 2016 due primarily to the tax compliance issue we recognized in 2014. In 2015, we recorded an additional $3.4 million of expense related to this tax compliance issue.
Deferred Policy Acquisition Costs. Capitalized DAC were $29.1 million, $32.7 million and $31.1 million in 2017, 2016 and 2015. These costs will vary based upon successful efforts related to newly issued policies and renewal business. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business which have higher commission rates. In addition, the prolonged low interest rate environment impacted the assumptions used in the development of the DAC asset for new policies issued.
Amortization of DAC totaled $29.7 million, $28.5 million and $23.4 million in 2017, 2016 and 2015 primarily due to the higher surrender activity, including early duration elections to convert existing policies to reduced paid up ("RPU") or extended term insurance ("ETI") status in 2017 and 2016. There are higher deferred acquisition costs associated with early duration conversions to RPU or ETI, which, when converted, increases amortization expense. Amortization of deferred policy acquisition costs is impacted by persistency and the higher level of surrenders is impacting our amortization.
Federal Income Tax. Federal income tax expense was $35.1 million, $3.5 million and $1.2 million in 2017, 2016 and 2015, respectively, resulting in effective tax rates of (1,176.9)%, 64.1% and (61.8)%, respectively. The significant changes in rates noted are the result of the New Tax Act enacted at the end of 2017 and the tax compliance issue we identified in 2014 which impacted our effective tax rates in each year as these costs are not deductible for tax purposes. Additionally, the Company recorded a tax expense in each year for an uncertain tax position that is affecting the tax rates. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes.
Our business is comprised of two operating business segments and Other Non-insurance Operations
Our insurance operations are the primary focus of the Company, as those segments generate the majority of our income. The amount of insurance, number of policies, and average face amounts of policies issued during the periods indicated are shown below.
Premiums. Premium revenues decreased in 2017 compared to 2016 as first year premiums decreased 18.8% and 0.5% in 2017 and 2016, respectively. Premium revenues increased in 2016 compared to 2015, due primarily to higher international renewal premiums, which have experienced strong persistency as this block of insurance ages. In 2016, we cut dividend rates to make our products more profitable. In 2017, to increase profitability, we introduced a set of repriced products in our international markets
Endowment sales represent a significant portion of new business sales internationally. In addition, most of our life insurance policies contain a policy loan provision, which allows the policyholder to use their accumulated cash value of a policy to pay premiums. These accumulated cash values can also be taken as a cash loan from the policy at the request of the policyholder and are secured by the policy values. The policy loan asset balance increased 10.6% year over year and remains at the same approximate ratio to life reserves as noted in prior years.
Endowment sales totaled approximately $13.3 million, $16.5 million and $16.4 million, representing approximately 76.4%, 77.0% and 76.1% of total new first year premiums in 2017, 2016, and 2015, respectively.
We continue to report strong first year and renewal premiums in our top producing countries (other than Venezuela) as noted above; however, this business is dependent on our clients having access to U.S. dollars. Our international business and premium collections could be impacted by our inability to comply with current or future foreign laws or regulations applicable to the Company or our independent consultants in the countries from which we accept applications as well as by marketing or operational changes made by the Company to comply with those laws or regulations. Our international business may also be affected by economic or other events in foreign countries in which our policies are marketed. Venezuela, for example, is continuing to experience civil unrest due to local demonstrations against crime, corruption and soaring inflation. See "Item 1A. Risk Factors" for additional information.
The following table sets forth our direct premiums by state from our domestic business for the periods indicated.
We discontinued sales of the majority of our domestic products in 2017 while we reevaluate our domestic life strategy and therefore the majority of the premium recorded in 2017 is related to renewal business.
Net Investment Income. Net investment income has increased due to continued growth in average invested assets even though the annual yield has increased 5 basis points in this segment from 2016, as discussed in the Consolidated Results of Operations above.
Death claims expense decreased 6.0% in 2017 compared to 2016 and decreased 14.0% in 2016 compared to 2015. No unusual trends have been noted in our claims experience. Mortality experience is closely monitored by the Company as a key performance indicator and these amounts were within expected levels.
Commissions. Commission expense increases or decreases are directly related to increases or decreases in premiums. First year policy premiums pay a higher commission rate than renewal policy premiums.
Premiums. The premiums in this segment increased in 2017 compared to 2016, as renewal premiums and first year premiums increased. There was no real growth in new business in 2016 compared to 2015.
Realized Investment Gains (Losses), Net. A gain of $1.1 million was recognized on the sale of real estate property in the current year. In 2017, 2016 and 2015, this segment recognized losses on other-than-temporary impairments totaling $0.2 million, $2.0 million and $1.6 million, respectively, related to bond and mutual fund holdings.
Increase in Future Policy Benefit Reserves. The change in reserves increase is related to the increase in current year sales.
Commissions. Commission expense was comparable for all three periods presented based upon fluctuations in premiums collected.
Other General Expenses. Expenses increased 53.4% due primarily to increased company-allocated expenses based upon our annual time study and related to legal, consulting and audit fees, as well as higher salaries, bonuses and related employee benefits paid to top executives. Expenses are allocated by segment based upon an annual expense study performed by the Company. We recorded expenses in 2017 related to the write-off of our Home Service goodwill value of $4.6 million. The 2017 expenses related to the IRC tax compliance issue for life and annuity insurance remediation expense remained flat compared to the 2016 expense, while in 2016 the expense decreased $1.7 million due to further refinement of our estimates.
2016 was primarily due to an increase in surrenders, although both 2016 and 2017 increases reflect the impact of updated annual U.S. GAAP assumptions as well. We monitor lapse rates as a key component of our insurance operations.
The Company has increased investments in corporate fixed maturity securities as municipal fixed maturity securities matured in the current year.
The following table shows investment yields by segment operations as of December 31 for each year presented.
As of December 31, 2017, the Company held municipal fixed maturity securities that include third party guarantees. Detailed below is a presentation by NRSRO rating of our municipal holdings by funding type.
The tables below represent the Company’s detailed exposure to municipal holdings in Louisiana, Texas and Florida, which comprise the most significant state concentrations of the total municipal fixed maturity portfolio as of December 31, 2017.
The Company also holds 22.8% of its municipal holdings in Texas issuers.
The Company also holds 12.0% of its municipal holdings in Florida issuers.
There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2017.
Gross unrealized losses on fixed maturities available-for-sale amounted to $3.1 million as of December 31, 2017 and $9.2 million as of December 31, 2016. This decrease in gross unrealized losses during 2017 was a result of a decrease in the interest rate environment in the fourth quarter of 2016. Gross unrealized losses on equity securities were $6,000 as of December 31, 2017 and $0.1 million as of December 31, 2016. Information on unrealized gains and losses by category is set forth in our consolidated financial statements, Note 2 - "Investments."
SPFIC has first and second event catastrophe reinsurance coverage of $10.0 million per event and a retention level of $500,000 per event. Thus, the first $500,000 of incurred claims and any claims in excess of $10.0 million are SPFIC's responsibility. The reinsurance premium for first event catastrophe reinsurance was $781,000, $828,000 and $873,000 in 2017, 2016 and 2015, respectively.
Our liquidity requirements 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 there were no liquidity issues in 2017 or 2016. Our investments consist of 74.6% of marketable debt securities and 1.2% of equity securities classified as available-for-sale that could be readily converted to cash for liquidity needs.
Our whole life and endowment products provide the policyholder with alternatives once the policy matures. The policyholder can choose to take a lump sum payout or leave the money on deposit at interest with the Company. The Company has a significant amount of endowment products representing approximately 45-49% of total inforce with older contracts sold historically that will begin reaching their maturities over the next several years and policyholder election behavior is not known. If policyholders elect lump sum distributions, the Company could be exposed to liquidity risk in years of high maturities. Meeting these distributions could require the Company to sell securities at inopportune times to pay policyholder withdrawals. Alternatively, if the policyholder were to leave the money on deposit with the Company at interest, our profitability could be impacted if the product guaranteed rate is higher than the current market rate we can earn on our investments. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds, but we will monitor closely our policyholder behavior patterns.
In 2015, we determined that a portion of the life insurance and annuity policies issued by our subsidiary insurance companies failed to qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 72(s) of the Internal Revenue Code ("IRC") of 1986. As a result, we have established a liability reserve of $12.3 million, net of tax for probable liabilities and expenses associated with this tax compliance matter, which represents management’s best estimate and we have disclosed an estimated range related to probable liabilities and expenses of $5.9 million to $48.2 million, net of tax. This estimate and range includes projected toll charges and fees payable to the IRS, as well as estimated increased payout obligations to current and former holders of non-compliant domestic life insurance policies expected to result from remediation of those policies. The amount of our liabilities and expenses depends on a number of uncertainties, including the number of prior tax years for which we may be liable to the IRS, the number of domestic life insurance policies we will be required to remediate, and the methodology applicable to the calculation of the toll charge for non-compliant policies. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and also could exceed the high end of our estimated range of liabilities and expenses.
This tax compliance issue impacts our policyholders and their tax liabilities relative to these products that fail 7702 and 72(s) for those that will not be remediated. The exposure related to future sales or products in force is unknown at this time. Policyholders could decide to surrender their policies due to this issue which would subsequently result in higher cash outflows due to an increase in surrender activity.
The NAIC has established minimum capital requirements in the form of RBC. RBC considers the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company's business to develop a minimum level of capital called "Authorized Control Level Risk-based Capital" and compares this level to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk-based capital fall below 200%, a series of remedial actions by the affected company would be required.
At December 31, 2017, all of our insurance subsidiaries were above the required minimum RBC levels.
In 2017, Citizens made a $5.0 million capital contribution to CICA Life. In the third quarter of 2017, Citizens contributed $250,000 to CICA Life Ltd. to capitalize a newly formed Bermuda entity, SPLIC contributed $250,000 in capital to MGLIC, and SPLIC declared a dividend payable to CICA of $395,000 which will be paid in 2018.
We have committed to the following contractual obligations as of December 31, 2017, with the payments due by the period indicated below:
Citizens is a holding company and has had minimal operations of its own. Our assets consist of the capital stock of our subsidiaries, cash, fixed income securities, mutual funds and investment real estate. Our cash flows depend primarily upon the availability of statutorily permissible payments, primarily payments under management agreements from our two primary life insurance subsidiaries, CICA and SPLIC. The ability to make payments is limited by applicable laws and regulations of Colorado, CICA's state of domicile, and Louisiana, SPLIC's state of domicile, which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that these insurance subsidiaries maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. We historically have not relied upon dividends from subsidiaries for our cash flow needs. However, CICA and SPLIC both dividend available funds from time to time in relation to business strategies.
As of December 31, 2017, Citizens had fixed maturities available for sale of $39.5 million and cash of $23.9 million, which represents additional liquidity for future acquisitions, liquidity support for the life insurance companies and for general corporate purposes.
Management has discussed the development and selection of its critical accounting estimates with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the disclosure presented below relating to them. See Note 1 - “Summary of Significant Accounting Policies” of the Company's consolidated financial statements for further information on our critical accounting policies.
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 did not exist as of December 31, 2017. Management believes that our policy liabilities and increase in future policy benefit reserves as of the years ended December 31, 2017, 2016 and 2015 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision.
Acquisition costs, consisting of commissions and policy issuance, underwriting and agency expenses that relate to and vary with the successful production of new business, are deferred. These deferred policy acquisition costs are amortized primarily over the premium-paying period of the policies, using the same assumptions as were used in computing liabilities for future policy benefits.
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 50 years. The CCRA is then evaluated for recoverability utilizing best estimate assumptions. Management believes our CCRA and related amortization is recoverable for the years ended December 31, 2017, 2016 and 2015. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
Based upon current accounting guidance, investment securities must be classified as held-to-maturity, available-for-sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Fixed maturity securities are classified as
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in net income in the period in which the change is enacted. Given the enactment of the New Tax Act on December 22, 2017, we have re-measured our deferred tax assets and deferred tax liabilities to the new corporate tax rate of 21% which resulted in a $35.7 million tax expense.
Information available prior to the issuance of the financial statements indicates that it is probable (virtual certainty is not required) that an asset has been impaired or a liability incurred as of the date of the financial statements; and
See Item 8. "Financial Statements and Supplementary Data," and Note 1 - "Accounting Pronouncements" to the Company's Consolidated Financial Statements.