The selected financial data of the Company as of December 31, 1990 through 1995 and for the years then ended are derived from the consolidated financial statements of Citizens Security Group Inc. and subsidiaries, which financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. The consolidated financial statements for 1995, 1994 and 1993 and KPMG Peat Marwick LLP's report thereon are included in Part II, Item 8, "Financial Statements and Supplementary Data."
- ------------------- * All per common share information for 1995 and 1994 reflects the March 1994 stock exchange transaction and the deduction of preferred stock dividends.
Property and casualty insurance policies are priced before costs are known as premiums are determined before losses are reported. The profitability of insurers is affected by many factors, including the severity and frequency of claims, natural disasters, interest rates, crime rates, general business conditions, regulatory measures, and court decisions that define and expand the extent of coverage and amount of compensation due for injuries or losses.
Net investment income increased 11.8 percent in 1995 over 1994, primarily as a result of an increase in invested assets. Realized gains on investments were $76,880 in 1995 compared to a realized loss of $7,422 in 1994. The Company continued to shorten the duration of the investment portfolios in order to decrease exposure to interest rate volatility.
The Company's loss ratio was 62.0 percent in 1995 compared to 59.3 percent in 1994. The Company experienced a 12.7 percent decrease in the number of claims in 1995 compared to 1994; however, this decrease was offset by an increase in severe claims during 1995. The Company experienced an increase in the severity of claims mainly in the homeowners line of business as a result of catastrophe hailstorms in Iowa, North Dakota and South Dakota and in the personal automobile line due to major accidents. The increase in severity was partially offset by favorable development of prior years' workers' compensation losses in 1995.
In evaluating its financial performance, the Company focuses on after-tax operating results before consideration of realized investment gains or losses. Management believes operating results are a better indicator of the Company's financial performance because it eliminates the variability associated with such gains or losses. After-tax operating income, excluding realized gains and losses, was $1,389,643 in 1995 compared to $1,386,961 in 1994. This resulted in operating earnings per common share of $.61 in 1995 (after deduction of Preferred Stock dividends) compared to $.57 in 1994. The MWCRA refund, in addition to accrued interest income associated with such refund, accounted for net income of approximately $410,000, or $.25 per common share, in the first quarter of 1995.
Net premiums written in 1994 rose 16.3 percent over the comparable amount in 1993 mainly as the result of the increase in direct premiums written. The Company's net premiums written also increased by $592,398 due to a refund of excess ceded premiums from the MWCRA. Net written premiums and unearned premiums as of December 31, 1994 were increased by this amount. Net premiums earned in 1994 increased 11.7 percent over 1993.
Net investment income was $2,194,372 for 1994 compared to $1,952,529 for 1993. This increase over 1993 results was primarily from an increase in invested assets. The Company experienced realized losses on investments of $7,422 in 1994 compared to realized gains of $606,031 in 1993. During the first quarter of 1993, the Company took advantage of favorable conditions in the bond market and repositioned a portion of its investment portfolio to reduce its exposure to fixed maturities being called before maturity.
As a result of the expense reallocation, the Company's expense ratio for 1994 increased nearly one percentage point as compared to the expense ratio for 1993.
After-tax operating income, excluding realized gains and losses, increased 30 percent to $1,386,961 in 1994 from $1,062,887 in 1993. This increase resulted in operating earnings per common share of $.57 in 1994 (after effect of the March 1994 stock exchange of Common Stock for Preferred Stock by Citizens Mutual and the deduction of Preferred Stock dividends) compared to $.37 in 1993.
Net income was $1,381,538, or $.57 per common share, in 1994 compared to net income of $1,501,918, or $.52 per common share, in 1993.
The primary sources of liquidity for the Company's subsidiaries are funds generated from insurance premiums and net investment income. The principal outflows of cash are payments of claims, taxes and operating expenses. The amount of cash provided from operating activities was $2,557,371 in 1995 and $3,826,575 in 1994. The Company's subsidiaries generate sufficient cash to meet their operating requirements.
In 1995, the Company's subsidiaries' investment portfolios were effected by a change in economic conditions which led to a decrease in interest rates. The Company experienced an after-tax increase of approximately $2.1 million from December 31, 1994 to December 31, 1995 in the market value of its investments in fixed maturities and equity securities. The entire investment portfolio is classified as "available-for-sale," and, therefore, these investments are reported at estimated market value, with unrealized gains and losses, net of deferred taxes, recorded in shareholders' equity. Citizens Fund's and ICO's investment portfolios consist almost entirely of fixed maturity bonds, of which 97% are rated "A" or higher by investment rating agencies. The Company does not own real estate, junk bonds or high-risk derivative products.
At December 31, 1995, the Company, Citizens Fund and ICO held cash and short- term investments of $2,753,621. Management believes these funds provide adequate liquidity for the payment of claims and other short-term cash needs.
On March 31, 1994, Citizens Mutual exchanged 1,250,000 shares of Common Stock for 1,250,000 shares of Preferred Stock issued by the Company. Annual cumulative dividends totaling $347,813 ($.27825 per share) are payable with respect to the Preferred Stock.
As a holding company, the Company depends on cash dividends from its subsidiaries and fees payable under a capital access fee agreement to make principal and interest payments due under the loan agreement and provide funds for preferred stock dividends and other expenses. Citizens Fund and ICO are restricted under state insurance laws as to the amount of dividends that may be paid without the approval of such regulatory authorities. See Note 14 of Notes to Consolidated Financial Statements included in Part II, Item 8, "Financial Statements and Supplementary Data."
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Citizens Security Group Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS Citizens Security Group Inc. and Subsidiaries
Citizens Security Group Inc. (the "Company") was incorporated on September 12, 1986 and is currently 54.5 percent owned by Citizens Security Mutual Insurance Company ("Citizens Mutual"). Citizens Fund Insurance Company ("Citizens Fund"), a wholly-owned subsidiary of the Company, was incorporated on September 15, 1986. Insurance Company of Ohio ("ICO"), a wholly-owned subsidiary of the Company, was acquired by the Company effective as of October 20, 1989. As used herein, "Subsidiaries" refers to Citizens Fund and ICO. The consolidated financial statements include the accounts of the Company and Subsidiaries. All significant intercompany balances have been eliminated in consolidation.
The Subsidiaries and Citizens Mutual provide personal and commercial insurance products throughout the states of Iowa, Minnesota, Missouri, North Dakota, Ohio, South Dakota, and Wisconsin.
Under the terms of a management services agreement, Citizens Mutual provides the Company and Subsidiaries with facilities, employees and substantially all services required to conduct its business. In return, the Subsidiaries pay 75 percent of the related expenses of Citizens Mutual, which consist primarily of salaries, employee benefits, rent and depreciation of equipment. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company.
INVESTMENTS The Company implemented Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" as of December 31, 1993. The Company classified its entire fixed maturity and equity investment portfolios as "available-for-sale." Accordingly, these investments are reported at estimated market value with unrealized gains and losses, net of deferred taxes, recorded in shareholders' equity. Classifying these portfolios as "available-for-sale" does not impact net income. Estimated market value is based on quoted market prices where available. Where quoted market prices are not available, market value is estimated using values obtained from independent pricing services.
PREMIUMS Premiums are recognized as revenue on a pro rata basis over the terms of the respective policies. Unearned premiums are calculated on the daily pro rata basis.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The Company provides reserves for losses based upon aggregate case basis estimates for losses reported and estimates of unreported losses, less reductions for estimated amounts recoverable for salvage and subrogation. The estimated amounts recoverable for salvage and subrogation were $685,000 and $695,000 at December 31, 1995 and 1994, respectively. The Company provides reserves for loss adjustment expenses by estimating expenses to be incurred in settlement of the claims. Estimated losses and loss adjustment expenses recoverable from reinsurers are reflected as assets.
The reserves for losses and loss adjustment expenses are considered adequate to cover the ultimate net cost of losses and loss adjustment expenses. Since the reserves are necessarily based on estimates, the ultimate liability may be more or less than such reserves. Any adjustments made to reserves are reflected in the operating results of the year during which the adjustments are made.
EARNINGS PER COMMON SHARE Earnings per common share are calculated based on the weighted average number of common and common equivalent shares outstanding and after net income is reduced by dividends on the Company's Series A preferred stock. Declared preferred stock dividends were $347,812 and $260,859 in 1995 and 1994, respectively.
EXCESS OF COST OVER NET ASSETS ACQUIRED The excess of cost over net assets acquired of $1,184,550, less accumulated amortization of $875,253 and $733,033 as of December 31, 1995 and 1994, respectively, represents the unamortized excess of cost over underlying net tangible assets of ICO at the date of acquisition. The original amount is being amortized on a straight-line basis over an average life of approximately nine years. The Company monitors the value of goodwill and would reduce the carrying value against expenses if it was determined that goodwill had been impaired.
reported financial statement balances as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
Similar to most companies with property and casualty insurance operations, the Company's gross and net reserves for losses and loss adjustment expenses and deferred acquisition costs, although supported by actuarial projections and other data, are ultimately based on management's reasoned expectations of future events. It is reasonably possible that the expectations associated with these accounts could change in the near term (i.e., within one year) and that the effect of such changes could be material to the consolidated financial statements.
The amortized cost, gross unrealized appreciation, gross unrealized depreciation and estimated market value of investments in fixed maturities available for sale as of December 31, 1995 and 1994 are as follows:
At December 31, 1995 and 1994, bonds carried at $705,671 and $602,064 respectively, were pledged to the Commerce Department of the State of Minnesota. At December 31, 1995 and 1994, bonds carried at $259,140 and $237,577, respectively, were pledged to the Insurance Department of the State of Ohio.
The components of income tax expense related to income before cumulative effect of accounting change are as follows:
The Company has determined it is not necessary to establish a valuation allowance for the deferred tax asset as it is more likely than not the deferred tax asset will be realized principally through future reversal of existing taxable temporary differences, future taxable income and tax planning strategies related to its investment portfolios.
Income tax payments in 1995, 1994 and 1993 were $695,617, $678,710 and $700,491, respectively.
In 1991, the Company adopted a non-employee director stock option plan. The Company has reserved a maximum of 50,000 shares of common stock for issuance under such plan. As of December 31, 1995 and 1994, options to purchase 50,000 and 40,000 shares, respectively, had been granted at exercise prices ranging from $3.13 to $4.00. No options have been exercised under this plan.
In October 1992, Citizens Mutual established an Employee Stock Ownership Plan ("ESOP"). The ESOP borrowed $1,200,000 from Citizens Mutual. The loan will be repaid in monthly principal payments of $20,000. The current interest rate is 9.5 percent, but the rate is variable and is tied to the prime rate. On October 30, 1992, the ESOP purchased 349,090 shares of the Company's authorized but previously unissued shares of Common Stock for approximately $1,200,000. The stock held by the ESOP is released for allocation to the participants' accounts over the term of the loan as the Company and Citizens Mutual make contributions. The Company has reflected the principal portion of the loan it expects to repay as an unearned compensation liability and a corresponding reduction in shareholders' equity. These amounts will be reduced as the ESOP loan is repaid. The amount of the annual contribution is discretionary, except that it must be sufficient to enable the ESOP to meet its current obligations. The Company's portion of contribution expense related to the ESOP amounted to $221,988, $229,699 and $235,131 in 1995, 1994 and 1993, respectively, of which $41,988, $49,700 and $55,125, respectively, was payment of interest.
The Company is subject to claims and lawsuits that arise in the ordinary course of business. In the opinion of management, the ultimate resolution of such litigation will not have a material adverse effect on the Company's financial position.
The loan is secured by a pledge of the stock of the Subsidiaries. Additionally, the Company agreed to certain restrictive covenants which limit the amount of subsequent indebtedness, dividends payable to shareholders, capital expenditures and business acquisitions. The covenants also restrict any changes to the pooling agreement.
In 1994, the Company received refunds of $592,388 of excess ceded reinsurance premiums from the Minnesota Workers' Compensation Reinsurance Association ("WCRA"). These refunds were required to be distributed to certain workers' compensation policyholders under legislation passed by the State of Minnesota in 1992. This legislation was challenged by a group of insurers and on January 31, 1995 the U.S. Court of Appeals for the Eighth Circuit upheld a lower court ruling that found the legislation to be unconstitutional. At December 31, 1994 the Company recorded the refund as a reduction of ceded written premium and ceded unearned premium, with no effect on earned premium. The Company recorded these refunds as premiums earned in 1995.
In 1995, the majority of the decrease in estimated losses and LAE for claims occurring in prior years is the result of favorable development primarily in the workers' compensation line.
The Subsidiaries are required to file statutory financial statements with state regulatory authorities. The Subsidiaries follow prescribed statutory accounting policies in all material respects. The accounting practices used to prepare statutory financial statements differ from generally accepted accounting principles ("GAAP").
A reconciliation of net income and shareholders' equity, as determined in accordance with GAAP on a consolidated basis, to statutory amounts reported to regulatory authorities by the Subsidiaries on an unconsolidated basis, is as follows:
On March 31, 1994, the Company's affiliate, Citizens Mutual, exchanged 1,250,000 shares of common stock for 1,250,000 shares of 7.95% Series A Preferred Stock ("Preferred Stock"). The Preferred Stock, which has an annual cumulative dividend of $.27825 per share and a liquidation preference of $3.50 per share, ranks senior to the Company's common stock as to payment of dividends and also as to the distribution of assets should there be a liquidation or dissolution of the Company. The Preferred Stock has one vote per share voting together with the Company's common stock on all matters submitted to a shareholders' vote. The Preferred Stock is not convertible by Citizens Mutual and is not subject to redemption at the option of the Company or the holder thereof.
The Preferred Stock was recorded at the liquidation preference of $3.50 per share which approximated the market of the common stock retired at the time of the exchange. Common stock and additional paid-in capital were decreased $4,524,814 for the common stock retired (including $149,814 of transaction costs).
As a holding company, the Company depends on dividends from the Subsidiaries to make principal and interest payments with respect to its bank loan and to meet its other expenses. As members of an insurance holding company system, the Subsidiaries are restricted by law as to the amount of dividends they may pay to the Company without the approval of state regulatory authorities.
Generally, restrictions on Citizens Fund limit the amount of dividends paid during a twelve month period to an amount which does not exceed the greater of (i) 10 percent of Citizens Fund's statutory surplus at the end of the prior year or (ii) the statutory net income, not including realized gains, of Citizens Fund for the prior year. In addition, ordinary dividends may only be paid from the earned surplus of Citizens Fund, also known as unassigned funds, determined in accordance with the accounting procedures and practices used in the preparation of its statutory annual statement, minus 25 percent of earned surplus attributable to unrealized capital gains. As of December 31, 1995, Citizens Fund's unassigned surplus was $305,020. Citizens Fund's ordinary dividends are restricted to a maximum of $832,883 for 1996. Citizens Fund paid dividends of $789,000 in 1995.
We have audited the consolidated balance sheets of Citizens Security Group Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in equity and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.