We own our principal office in Austin, Texas, consisting of an 80,000 square foot office building and approximately one acre of land nearby housing storage facilities. Approximately 50,000 square feet is occupied or reserved for our operations with the remainder of the building being leased to a single tenant under a multi-year lease.
We also own a 6,324 square foot funeral home in Baker, Louisiana with a total cost of $527,000. This facility, acquired in a 1995 acquisition, is owned and operated by FHA.
During 2003, the Company focused its efforts on several key areas.
The Company's book of accident and health business continued to be a source of significant overhead and attention. During the latter part of the year, discussions began with another insurer that culminated in a reinsurance arrangement that was signed in March 2004 whereby all of the in force accident and health business will be ceded to another reinsurer effective January 1, 2004 (See discussion of Accident and Health business below). As a result of this activity management expects to achieve overhead reductions of at least $1 million in 2004.
Management believes that the above acquisitions achieve several objectives: because they were made for shares of our Class A common stock, they provide a source of capital; each of the companies have predominantly sound investments; their books of business are focused on ordinary whole life insurance; and particularly in the case of Mid-American, there are opportunities to expand our USA marketing program.
During 2003, we consolidated certain operating subsidiaries in order to reduce overhead and streamline operations. Lifeline Underwriters Life Insurance Company ("Lifeline"), a Texas-domiciled life insurer acquired in 2002, was merged with and into Combined Underwriters Life Insurance Company ("Combined"), a Texas-domiciled life insurer acquired in the same 2002 transaction. Combined and Lifeline were acquired for approximately 1.1 million shares of our Class A common stock with an aggregate market value of approximately $12.0 million. Additionally, two Illinois-domiciled life insurers were merged: Excalibur Insurance Corporation ("Excalibur") was merged into Central Investors Life Insurance Company of Illinois ("CILIC") and we subsequently changed CILIC's name to Citizens USA Life Insurance Company ("CUSA").
The Company's operations have historically focused on three areas: international life insurance; USA life insurance; and acquisition of other USA life insurance companies. Beginning in 2002 with the acquisition of Combined, a new area was added, that of USA supplemental accident and health business.
Management is pleased with the growth in international production, because several countries from which significant numbers of applications have been received have undergone severe financial crises over the past several years, particularly Argentina and Venezuela. These two countries represent more than 18% of the premium income of the Company. During the late 1980's Argentina became the largest source of new business for CICA, particularly as a new middle class emerged in that country's society. Because of this emerging middle class, CICA (which has historically only focused
The Company's focus historically has been on the international market because of the key advantages described above. However, throughout the Company's history, it has always written U.S. business, and through the acquisition of other U.S. life insurers, has accumulated more than $11.3 million of annual U.S. life premium.
In 2000, management perceived an opportunity for the Company to serve middle-income American families through the sale of an ordinary whole life insurance product containing a no-load annuity benefit. This product was introduced in Texas in 2000. Since that time the Company has sought the marketing management necessary to build a U.S. sales organization from scratch and to begin to write the product in volume. After several attempts to bring in such expertise, in early 2004, senior executives in the Company's home office staff assumed this new management responsibility. We have begun emphasizing the development of a sales force comprised primarily of second career sales associates. Recent acquisitions have created opportunities to increase production. Mid American Century Life Insurance Company, a Missouri-domiciled life insurer acquired in the acquisition of Mid-American Alliance Corporation, is writing approximately $1.5 million of annual life premium. Through this and other acquisitions, marketing operations are being conducted in several states.
Our accident and health book of business acquired in the Combined acquisition has not resulted in the type of operating profits we had sought. Skyrocketing costs of health care in the United States have made it difficult to structure rate increases that are adequate for the unpredictable nature of the associated claims liability. Additionally, reinsurance coverage, which the Company depends on to minimize its exposure to so-called catastrophic claims, has become less available and substantially more expensive in the past year. Also, the administration of accident and health business is burdensome in both costs and manpower. Although virtually all of the major medical business in force for Combined and Lifeline has been non-renewed over the past 24 months, and substantial rate increases imposed on the remaining business, as a whole, the accident and health business has proven to be a strain on profitability.
The following table sets forth the Company's net income for periods indicated:
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", was adopted by us on January 1, 2002 and changed the accounting for goodwill and intangibles, as discussed below. Had SFAS No. 142 been adopted in 2001, pro forma net income would approximate $4,866,000 ($.16 per share) for the year ended December 31, 2001. As further discussed below, increases in amortization of cost of customer relationships acquired, and amortization of intangible assets acquired in the First Alliance acquisition coupled with losses on the accident and health business related to claims and administration costs contributed to the decreased earnings in 2003.
Net investment income increased slightly during 2003 to $14,322,275 from $14,251,907 during 2002. The 2003 increase reflected continued expansion of our asset base that was offset by lower yields available on new investments. The acquisition of First Alliance and Mid-American increased invested assets by $30.6 million and 2003 investment income by $849,217. As interest rates fell, there was a significant amount of call activity on our bond portfolio. During 2003, more than $150 million of bonds were called or matured. Such call activity was expected given the prevailing interest rates and the nature of the bonds in the Company's portfolio.
A majority of new investment activity over the past three years has focused on the acquisition of bonds issued by public agencies that carry the implied full faith and credit of the Federal government, such as FNMA and FHLMC. These bonds typically have stated maturities of 15 years, but will carry a call feature (at par) that varies between three months and two years. All bonds purchased are at par or at a discount, so that the yield to call will be equal to or greater than the yield to maturity. By choosing to invest in these securities, the Company is exposed to reinvestment risk in the event that interest rates fall for an extended period because the securities will typically be called and the likelihood of increases in market value above par is unlikely because the expectation is that the bond will be called. Such events require reinvestment of the proceeds at levels lower than the yields of the called bonds.
During 2003, such a period occurred; however, in many cases, the Company was able to reinvest in bonds at levels at or near those of the called bonds. These recently purchased bonds offer yields of 100 to 200 basis points above the Treasury curve and carry minimal credit risk. Recent scrutiny and concern expressed over the levels of mortgages owned by the various government backed corporations (FNMA and FHLMC) has not resulted in decreases in credit ratings of such entities and management expects to continue to make future investments in these bonds for 2004. The Company does not believe such declines in available yields will have a material adverse effect on its future operating results because of the strong cash flow available to
take advantage of any increases in interest rates. The 2002 results increased 7.2% compared to the $13,296,481 earned in 2001, such increase reflecting growth in invested assets. The acquisition of Combined and Lifeline increased invested assets by $15.2 million and 2002 investment income by $528,021.
Policyholder dividends increased to $3,666,260 in 2003, up 5.4% over 2002 dividends of $3,477,381. The 2002 amounts increased 5.5% compared to $3,294,899 in 2001. Virtually all of CICA's overseas policies are participating. Participating policies represented 47.7% of our business in-force at December 31, 2003, although the percentage of participating business has declined from approximately 91% in 1995 due to acquisitions in recent years.
Claims and surrenders increased 6.1% from $38,107,119 in 2002 to $40,445,007 in 2003. In 2001 claims and surrenders were $29,189,132. The 2003 increase included $3,002,197 related to the operations of First Alliance and Mid-American. Improvements in the persistency of the Company's overseas business coupled with the non-renewal of a majority of the major medical business accounted for the remaining change. The 2002 increase included $6,526,322 related to the acquisitions of Combined and Lifeline.
Underwriting, acquisition and insurance expenses increased 25.9% to $18,966,120 in 2003 compared to $15,064,065 in 2002 and $10,635,639 in 2001. The 2003 increase includes $2,136,416 of expenses related to the acquisitions of First Alliance and Mid-American and approximately $900,000 related to the annual marketing convention for international producers for 2003 and 2004, an expense previously borne by our international marketing manager. In May 2002, in an attempt to more efficiently manage and communicate with our independent marketing consultants, we canceled our contract with an independent international company that had served as the managing general agent for our international marketing activities since early 1997. We no longer pay an overriding commission to this former marketing firm on new business issued internationally but instead directly bear the related costs of all marketing, management and promotional activities. Other factors in the increased expenses relate to the start-up costs of the U.S. marketing program, and approximately $250,000 was spent in attempting to acquire control of First American Capital Corporation, a Kansas insurance holding company, and on other merger and acquisition activities. The 2002 increase was due in part to the acquisition of Combined and Lifeline, which added $1,954,738 in 2002. Additional 2002 expenses related to acquisition activities, costs associated with the listing of our Class A common stock on the New York Stock Exchange and other listing fees related to the acquisitions of Combined and Lifeline. Additionally, as discussed above, the May 2002 cancellation of our contract with an independent international company that served as the managing general agent for our international marketing activities increased 2002 expenses for the eight months of 2002 that the Company incurred those costs. During 2001, we incurred overhead expenses related to acquisition activities combined with expenses incurred to continue to develop the domestic ordinary life sales program.
Amortization of cost of customer relationships acquired, excess of cost over net assets acquired and other intangibles increased from $2,527,996 in 2002 to $7,110,436 in 2003. In 2001, such amortization was $1,908,683. The 2003 increase relates to the amortization of cost of customer relationships acquired with respect to the acquisitions of Combined, Lifeline, First Alliance and Mid-American that amounted to $5,643,769 and $563,055 related to amortization of an intangible asset. The 2002 increase relates to the amortization of cost of customer relationships acquired with respect to the acquisition of Combined and Lifeline that amounted to $1,888,885 in 2002 that more than offset our adoption of the new Financial Accounting Standards Board's (FASB) accounting statement where amortization of goodwill and other intangibles ceased since management determined that these intangibles have an indefinite life. Our analysis of goodwill and other intangibles indicated that there was no impairment as of December 31, 2003 and December 31, 2002. The amortization of goodwill and other intangibles amounted to $902,610 for the year ended December 31, 2001.
During 2003, the Company amended tax returns related to prior years resulting in refunds that reduced 2003 current income tax expense.
Stockholders' equity increased from $101,792,305 at December 31, 2002 to $127,026,722 at December 31, 2003. The increase was attributable to $17,194,513 and $7,223,557, respectively, of Class A common stock issued for the acquisition of First Alliance and Mid-American, net income of $3,126,265 earned in 2003 and unrealized gains, net of tax, decreased by $2,309,918 as of December 31, 2003 compared to December 31, 2002. Decreases in the market value of our bond portfolio caused by lower bond prices resulted in the decrease in unrealized gains.
The Company has benefited from significant cash provided by operations. In 2003, such cash was more than $13.6 million, while in 2002 and 2001, respectively, cash provided by operations was $10.6 million and $14.5 million. This cash flow permits the Company to expand its life insurance activities and to take advantage of investment opportunities as they arise
and fixed maturities available-for-sale which are valued at fair value. Fixed maturities available-for-sale and fixed maturities held-to-maturity were 86.3% and 4.3%, respectively, of invested assets at December 31, 2003. Fixed maturities held to maturity, amounting to $11,699,899 at December 31, 2003, consist of U.S. Treasury and U.S. government agency securities. Management has the intent and believes we have the ability to hold the securities to maturity. (See the discussion of investment income above for further disclosure regarding investment strategy and philosophy.)
Our mortgage loan portfolio, which constituted 0.2% and 0.3% of invested assets at December 31, 2003, and December 31, 2002, respectively, has historically been comprised primarily of seasoned small residential loans in Texas and Colorado. Management established a reserve of $50,000 at December 31, 2003, and December 31, 2002, (approximately 8% to 9% of the mortgage portfolio's balance) to cover potential unforeseen losses in our mortgage portfolio. At December 31, 2003, no loans were past due for more than 90 days.
Our cash balances at our primary depositories were significantly in excess of Federal Deposit Insurance Corporation coverage at December 31, 2003 and 2002. 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 2003, we intend to continue to utilize callable securities issued by Federal agencies as cash management tools to minimize excess cash balances and enhance returns. During 2003, the Company transferred its primary banking relationship from JP Morgan Chase to Regions Bank.
In the wake of recent bankruptcy filings by large corporations, concern has been raised regarding the use of certain off-balance sheet special purpose entities such as partnerships to hedge or conceal losses related to investment activity. We do not utilize special purpose entities as investment vehicles. Nor are there any such entities in which we have an investment that engage in speculative activities of any description, and we do not use such investments to hedge our investment positions.
Our subsidiary, CICA, owned 2,565,894 shares of our Class A common stock at December 31, 2003, and 2,398,031 shares at December 31, 2002. In our consolidated financial statements, the shares owned by CICA are combined with the other treasury shares and the aggregate treasury shares are reported at cost in conformity with U.S. GAAP.
sharing plan had net assets of $1,940,858 as of December 31, 2003, $1,639,619 as of December 31, 2002 and $1,266,197 as of December 31, 2001.
The NAIC has established minimum capital requirements in the form of Risk-Based Capital ("RBC"). Risk-based capital factors the type of business written by an insurance company, the quality of its assets, and various other factors into account 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 actions by the affected company would begin. At December 31, 2003, all of the Company's insurance subsidiaries were above required minimum levels.
During 2003, we engaged in discussions with the investment banking community regarding raising additional equity capital. Should we decide to pursue equity capital, the purpose would be to utilize the proceeds to pursue acquisitions. Management believes the Company has sufficient capital for its long-term operating needs; however, management may pursue additional equity capital to finance larger acquisitions. During early 2004, the Company's shareholders approved amendments to the Articles of Incorporation increasing the number of authorized Class A and Class B shares and authorizing preferred stock that could be issued upon approval of the Board of Directors.
The Company received a commitment from Regions Bank for a $30 million credit facility for use in acquisitions in late 2003. Definitive documents are expected to be signed during March 2004. The Company has historically avoided the incurrence of significant amounts of debt; however, this facility should allow management to pursue larger acquisitions. If a decision is made to utilize the facility in conjunction with a transaction, management intends to view the debt as a bridge facility. Before drawing on the debt, management expects to develop a strategy designed to retire the debt without restricting growth.
The Sarbanes-Oxley Act of 2002 ("the Act") established sweeping new guidelines for corporate governance. Subsequently, the New York Stock Exchange adopted new rules that relate to such matters as the composition of listed companies' Boards of Directors and various committees thereof, the need to adopt specific policies as well as the establishment of a Code of Ethics. The Company's Board of Directors, Compensation Committee and Audit Committee were already configured in such a way as to comply with the Act. Citizens has operated under a "Principles, Purposes, Philosophy and Beliefs" for numerous years that sets forth the manner in which the Company and its officers, directors and employees are expected to function. However, the Board of Directors has implemented a formal Code of Ethics, including an insider trading policy, applicable to all officers, directors and employees.
Additionally, the Act imposes a duty upon public companies to document and test all internal controls and have such audited by independent auditors. The Company has begun the process of documenting all such control procedures and expects to complete the documentation and testing in 2004.
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. Management believes that our policy liabilities and increase in future policy benefit reserves as of and for the years ended December 31, 2003, 2002 and 2001 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.
We utilize the factor method to determine the amount of costs to be capitalized and the ending asset balance. The factor method is based on the ratio of premium revenue recognized for the policies in force at the end of each reporting period compared to the premium revenue recognized for policies in force at the beginning of the reporting period. The factor method ensures that policies that lapsed or surrendered during the reporting period are no longer included in the deferred policy acquisition costs calculation. The
factor method limits the amount of deferred costs to its estimated realizable value, provided actual experience is comparable to that contemplated in the factors.
Additionally, at December 31, 2003, 94.6% of our fixed maturity securities are invested in U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities. All of these securities are backed by or bear the implied full faith and credit of 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. Based upon our emphasis of investing in fixed
The gross unrealized losses on fixed maturities available-for-sale amounted to $2,553,328 as of December 31, 2003. Of the total gross unrealized loss, $41,746 of the fixed maturities available-for-sale have been in a continuous unrealized loss situation for more than 12 months and $2,511,582 have been in a continuous unrealized loss situation for less than 12 months. The fixed maturities available-for-sale in a gross unrealized loss situation for more than 12 months relate to two fixed maturities available-for-sale issued by corporations and two callable instruments issued by U.S. government agencies. These securities are being closely monitored by the Company to determine if the unrealized loss as of December 31, 2003 indicates that there is a loss other-than-temporary. As of December 31, 2003, the Company has determined that there is no need to establish a new cost basis for these two securities since a loss has not occurred.