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 32% of the building for their headquarters and home offices. The Company leases the remaining space to tenants under leases of various
• The Company stabilized the legal environment with the settlement of lawsuits and the implementation of controls.
for Group Dental; creating plan to offer Preferred Provider networks and Third Party Administration products in 2006, building on the Company’s strength of providing high quality service and exploring plans to sell other products through the Dental marketing channel
for Final Expense; performing a controlled introduction through select Managing General Agents who focus on this type of product
The following discussion is presented as a means of providing the reader with a more clear understanding of some of the operational elements impacting the financial position and results as reported in the accompanying consolidated balance sheets and related consolidated statements of operations, shareholders’ equity and cash flows.
See pages 20 through 24 of Management Discussion and Analysis for a more extensive analysis of factors impacting the individual segment operating results between years.
Comprehensive Gains and (Losses) Comprehensive Gains and (Losses) (which combine net gains and losses and net unrealized gains and losses) were ($977,000), $3,084,000, and ($2,105,000) for 2004, 2003, and 2002, respectively. During 2004, the Company continued to be adversely affected by relatively low yields on its fixed income investment portfolio.Comprehensive losses were attributable to the decrease in net income of $456,000 described above and a change in unrealized gains (losses) of ($3,600,000). Late in the second quarter of 2004, interest yields
The Company repurchased 13,600, 1,600 and 29,987 shares of its common stock during 2004, 2003 and 2002 respectively, at average prices of $7.50, $4.79 and $4.65 per share, respectively.
The Company’s discussion and analysis of its financial condition and results of operations are based on its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to investments, agent receivables, intangible assets, policy liabilities, income taxes, regulatory requirements, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following accounting policies, judgments and estimates, which have been discussed with the Audit Committee of the Board of Directors, critically impact preparation of its consolidated financial statements.
reduced to the recoverable amount. For more information about accounting for DAC see Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.
Goodwill and Intangible Impairment. The balance of the Company’s goodwill and value of insurance acquired (VIF) was $3.4 million at December 31, 2004. The recovery of these assets is dependent on the fair value of the business to which they relate. Pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets”, (“SFAS No. 142”), goodwill is subject to annual impairment tests based on the estimated fair value of the respective assets. There are numerous assumptions and estimates underlying the determination of the estimated fair value of these assets. Different valuation methods and assumptions can produce significantly different results that could affect the amount of any potential impairment charge that might be required to be recognized. During both 2004 and 2003, the Company concluded that no impairment adjustment was necessary for its goodwill or VIF.
Policy Liabilities and Policy Intangible Assets. Establishing policy liabilities for the Company’s long-duration insurance contracts requires making many assumptions, including policyholder persistency, mortality rates, investment yields, discretionary benefit increases, new business pricing, and operating expense levels. The Company evaluates historical experience for these factors when assessing the need for changing current assumptions. However, since many of these factors are interdependent and subject to short-term volatility during the long-duration contract period, substantial estimates and judgment are required. Accordingly, if actual experience emerges differently from that assumed, any such difference would be recognized in the current year’s Consolidated Statement of Operations.
Litigation. As further described in Item 3 and Note 11 of the Notes to Consolidated Financial Statements, United Liberty has been a party to an outstanding lawsuit concerning payment of policyholder dividends. The parties have reached a provisional settlement agreement dated October 8, 2004. As described in Item 3 and Note 11, the Company has recorded the financial impact of the agreement as of December 31, 2004.
Assets. At December 31, 2004, the Company's available-for-sale fixed maturities had a fair value of $115,080,380 and amortized cost of $111,471,499. The Company’s fixed maturities portfolio increased approximately 6% during 2004 and 4% during 2003, on an amortized cost basis. Shown below is a distribution by rating category of the Company's fixed maturities portfolio as of December 31, 2004.
Liabilities. A comparison of total policy liabilities as of December 31, 2004, 2003 and 2002 is shown below. Approximately 88% of the 2004 total consist of insurance policy benefit reserves while policyholder deposit liabilities represent 12% of the total.
Shown below is a progression of the Company's policyholder deposit activity for the year ended December 31, 2004.
The modest decreases in Broker Life premium during 2004 and 2003 resulted from reduction of business provided by certain larger brokers during 2003 and continuing pressure from the overall economic slowdown on middle and lower-income consumers. The Company is evaluating opportunities for revising its product design and commission rates to counteract the softening in demand for its simplified issue and graded benefit life policies. The Company introduced a new final expense policy in January 2005 in an effort to strengthen the growth of this segment by better meeting the desires of our policyholders and agents.
The 47.1% and 27.2% decrease in Preneed Life premium during 2004 and 2003, respectively, resulted from the Company’s modification of certain policy benefits and commissions (which resulted in a loss in the number of producers) and an intentional refocusing of marketing efforts toward segments that the Company believes offer more positive potential in the current environment.
The 11.2% and 2.5% growth in Dental premium during 2004 and 2003, respectively, resulted primarily from a renewed effort to expand the Company’s presence in the Dental marketplace. During the past two years, new business production has become increasingly competitive as larger providers expand their marketing initiatives. However, the Company has historically maintained strong customer and agent loyalty by continuing to improve customer service, including sales and administrative support functions. Beginning in January 2005 the Company is expanding its capacity to administer more Dental business without increasing administration costs by replacing our group administration system with a current state of the art system.
As detailed in the following table, net realized and unrealized investment gains totaled approximately $7,315,000 for the two years ended December 31, 2004, while net realized and unrealized losses totaled approximately $11,953,000 for the three years ended December 31, 2002. The Company does not anticipate severe deterioration in the securities markets as experienced during the years 2000 through 2002 although there is still some volatility in the equities markets. At December 31, 2004, the Company’s investment portfolios contain a net unrealized gain outstanding of $5,261,000. Below is an approximate calculation of investment income yields and “total return” (defined as yields including net investment income, net realized investment gains or losses and net change in the excess or deficit of market values over book values of the investment portfolios or unrealized gains (losses)) yields for the five years ending December 31, 2004.
Segment Earnings. Pretax profit (loss) is shown below for the Company’s five business segments, along with total net realized investment gains (losses) and interest expense.
The decline in pretax segment profit in 2003 was primarily attributable to decreased Preneed Life premium and adverse mortality.
The reduced loss of $680,000 in 2004 compared to 2003 is the result of the efforts described below along with higher investment yields and lower expenses resulting from the reduced level of new business. Although the Company is optimistic about improving profitability in this highly competitive market, if adverse profitability trends continue, several options are available. These options, including further lowering discretionary annual benefit increases and adjusting premiums and commissions on new business, could further adversely impact the Company’s ability to compete for new business. The 2003 Preneed Life increased loss compared to 2002 resulted from lower investment yields, unfavorable mortality, and increased expenses. During 2002, the Company accepted a significant amount of single-premium business, which generally has higher than average mortality rates. In addition, significant management and marketing resources were devoted to this business. To improve profitability, annual benefit growth rates were reduced in early 2003 and again in September 2004. Also, twice during 2002, certain commission rates were reduced and agent contracts revised to encourage production of the more profitable multi-pay products.
The overall Dental contribution margin decreased in 2004 by $380,000 due to adverse morbidity (especially related to one large group) and inadequate premium for groups renewing, after increasing slightly during 2003 due to improved claim levels. Also, the Company has encountered more competition as additional insurers continue to expand in the Dental market and Dental providers continue to provide higher levels of care to patients. The Company is continuing its ongoing efforts to maintain profitability in this line by reconfiguring products to provide adequate margins for the various dental procedures, utilizing a third-party company to provide expert assistance with ongoing adjudication of claims, and continuing its program of aggressive renewal underwriting and re-rating. A large group with a particularly high morbidity rate was not renewed in December 2004.
During December 2002, Citizens Financial strengthened the statutory capital position of Citizens Security by acquiring $2,000,000 of Citizens Security redeemable preferred stock. During January 2001, Citizens Financial contributed 100% of the capital stock of Citizens Insurance to Citizens Security. The statutory value of this
contribution was $3,540,555. Citizens Security has reported its investments in United Liberty and Citizens Insurance on the equity method of accounting, since their acquisition in 1998 and 2001, respectively. However, beginning in 2001, new rules changed the statutory equity method of accounting to preclude a parent insurer from recording as income, its share of undistributed subsidiary earnings. For 2004, 2003, and 2002, Citizens Security reported as income the $1,174,090, $116,400 and $214,000 respectively, of dividend distributions that it received from United Liberty and Citizens Insurance. At December 31, 2004, Citizens Security reported its investments in United Liberty and Citizens Insurance at their statutory equity values of $1,932,627 and $2,660,021 respectively. To provide a more detailed understanding of Citizens Security's operations, shown below are SAP basis net income (loss), net operating income (loss), statutory capital and surplus, asset valuation reserves, and capital ratios for Citizens Security for the five years ended December 31, 2004.
1 Asset Valuation Reserves are statutory liabilities that act as contingency reserves in the event of extraordinary losses on invested assets and as a buffer for policyholders’ surplus to reduce the impact of realized and unrealized investment losses. The 2000 through 2004 amounts also include United Liberty’s asset valuation reserves. Citizens Insurance does not have an Asset Valuation Reserve.
The following table shows the changes to Citizens Security’s capital and surplus for the five years ended December 31, 2004.
In addition to the statutory totals shown above, Citizens Insurance generated statutory net income of approximately $63,000, $76,000, and $93,000 during, 2002, 2001, and 2000, respectively without remitting any dividends to its parent. Citizens Insurance generated statutory net income in both 2004 and 2003 of $56,000 and paid dividends of $1,174,000 and $62,400 to Citizens Security in 2004 and 2003, respectively. United Liberty generated statutory net income (loss) of approximately ($692,000), $536,000, ($328,000), ($48,000), and $289,000 during 2004, 2003, 2002, 2001 and 2000, respectively and remitted dividends to its parent of $54,000 and $214,000 in 2003 and 2002 , respectively.
A summary of all known commitments of the Company as of December 31, 2004, including the aforementioned borrowings, is as follows:
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. Historically, total returns on the Company’s equity portfolio have been very favorable and the Company has successfully managed the risk of equity security price fluctuations over many years. The Company devotes significant attention to the equity markets and repositions the Company’s portfolio upon detection of adverse risk trends associated with individual securities or overall markets. The Company also manages market risks associated with investments in option securities, as described in Note 2 of the Notes to Consolidated Financial Statements. The fair value of the Company’s equity portfolio was approximately $8,943,000 and $11,337,000 at December 31, 2004 and 2003, respectively. Accordingly, a 10% decline in equity prices would have reduced the fair value of the Company’s equity portfolio by $894,000 and $1,113,000 at December 31, 2004 and 2003, respectively. The average cost value of the Company’s equity portfolio was $11,133,000 and $10,031,000 during 2004 and 2003, respectively.
Cash flow testing projects cash inflows from assets and cash outflows for liabilities in various assumed economic and yield curve scenarios. This is a dynamic process, whereby the performance of the assets and liabilities is directly related to the scenario assumptions. (An example would involve the credited interest rate on annuity