The following table presents selected financial data of the Company. The information presented below is not necessarily indicative of results of future operations and should be read in conjunction with
This section and other parts of this Annual Report on Form 10-K (“Form 10-K”) contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A of this Form 10-K under the heading “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Annual Report on Form 10-K. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.
of fixed annuities, riders and other "spread-based" product features depends largely on the Company’s ability to earn target spreads between earned investment rates on assets and interest credited to policyholders.
We have previously reported that a portion of the life 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. Further, we have determined that the structure of our policies sold to non-U.S. persons, which were novated to CICA Ltd. effective July 1, 2018, may have inadvertently generated U.S. source income over time, which caused tax withholding and information reporting requirements for the Company under Chapters 3 and 4 of the IRC. We have incurred significant costs in the evaluation process of this issue as we have engaged legal, tax and actuarial consultants to assist us in this review and remediation. In December 2019, the Company submitted corrected withholding tax returns to the IRS in order to establish the tax liability amount for failing to withhold tax and report the U.S. source income generated by the novated policies. With the continued uncertainty that remains, including the acceptance of the submitted withholding tax returns, IRS review of our submission, and future negotiations, our estimated liability as of December 31, 2019 was approximately $10.0 million, after tax, related to projected agreement with the IRS. The probability weighted range of financial estimates relative to this issue is $7.4 million to $52.5 million, net of tax. 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.
On May 17, 2017, we submitted an offer to enter into Closing Agreements with the IRS covering certain CICA and CNLIC domestic life insurance policies (the "Closing Agreements"), which was accepted by the IRS on June 7, 2019. Pursuant to the Closing Agreements, CICA and CNLIC agreed to pay the IRS $123,779 and $4,118, respectively, by August 6, 2019, and follow the corrective steps for the policies outlined in the Closing Agreements by September 5, 2019. These payments were made to the IRS on July 12, 2019.
See Note 7. Commitments and Contingencies in the notes to our consolidated financial statements for more information.
Our total assets grew 8.0%, or $129 million, from 2018 to 2019 and totaled $1.7 billion as of December 31, 2019.
to 2018. Insurance premiums declined 6.3% in 2018 compared to 2017, driven by fewer renewal and first year premiums in our Life Insurance segment.
A realized gain of $2.0 million was recorded during 2019 related to the redemption of two fixed maturity securities by the issuers at a price above par. An impairment loss of $3.1 million was recorded during the second quarter of 2019 in our Other Non-Insurance Enterprises segment related to our Citizens Academy training facility located near Austin, Texas. This investment was reclassified from real estate held for investment to held for sale. Additionally, a realized gain of $5.5 million was recorded in the first quarter of 2019 related to the sale of our former corporate headquarters in Austin, Texas.
Claims and surrenders expense increased 17.3% for 2019 compared to 2018 and increased 9.9% for 2018 compared to 2017. For both periods, these increases were primarily due to an increase in surrender benefits and matured endowments in the Life Insurance segment, which were within expected levels.
Capitalization of deferred policy acquisition costs decreased 1.9% in 2019 compared to 2018 and 22.1% in 2018 compared to 2017. These capitalized costs are directly related to first year premium production and we experienced declines in first year premiums of 0.7% in 2019 and 25.7% in 2018. Amortization of deferred policy acquisition costs decreased 17.4% in 2019 compared to 2018 and increased 15.3% in 2018 compared to 2017. The conversion to a new actuarial valuation system increased amortization costs in 2018 by $3.7 million.
Life Insurance. For almost forty years, CICA and its predecessors had accepted policy applications from foreign nationals for U.S. dollar-denominated ordinary whole life insurance and endowment policies. We completed a novation of all of the international policies issued by CICA to CICA Ltd., effective July 1, 2018. We make our insurance products available using third-party marketing organizations and independent marketing consultants.
Premium Income. Premium income derived from life, accident and health, and property insurance sales decreased 1.9% during 2019 compared to 2018 and decreased 5.0% during 2018 compared to 2017. The decrease in 2019 was driven primarily by a decline in renewal premiums in our Life insurance segment and was partially offset by an increase in first year premiums in that segment. The decrease in 2018 was primarily due to a decline in first year and renewal premiums in our Life insurance segment. See details on the distribution of premiums below and further discussion within Segment Operations.
Net Investment Income. Net investment income increased 9.8% to $59.5 million in 2019 compared to $54.2 million in 2018, despite a decline in overall market yields. The annualized yield increased by nineteen basis points in 2019 compared to 2018. We have been successful in achieving higher yields while maintaining a prudent risk profile for our portfolio in 2019 despite facing an increasingly challenging investment environment. During the fourth quarter of 2018, we repositioned our portfolio into more diversified holdings and maturities as part of our investment management strategy to improve our portfolio credit quality. In doing so, we increased our purchases of investment grade securities while reducing our municipal holdings. While these purchases improved the overall credit rating of our portfolio, these securities generally have lower yields. In addition, net investment income and the annualized yield on our portfolio were lower during 2018 due to the need to maintain sufficient cash balances to fund our Bermuda novation as previously noted.
We have traditionally invested in fixed maturity securities with a large percentage held in callable issues. In the latter part of 2018, we began a process of repositioning our portfolio into more diversified holdings and maturities as part of our investment management strategy. The sustained low interest rate environment of the past several years has required that we manage a challenging balance of continuing to invest in quality issuers, while attempting to increase our portfolio yield. As part of the ongoing process of managing our portfolio and optimizing performance, we are continuing to identify and consider new asset classes.
In 2019, we recognized a gain of $1.9 million related to the redemption of two fixed maturity securities. We also recorded a realized gain of $5.5 million relating to the sale of our former corporate headquarters. In addition, we recorded realized gains of $1.0 million during 2019 related to fair value changes in our equity securities owned at December 31, 2019. Finally, an impairment loss of $3.1 million was recorded in connection with classifying our Citizens Academy training facility located near Austin, Texas as real estate held for sale. In 2018, realized gains of $1.8 million and realized losses of $0.8 million were recorded related to our fixed maturity and equity portfolios, respectively, along with investment losses recorded from OTTI of $0.8 million relating to fixed maturity securities that we did not intend to hold until recovery in value.
Increase in Future Policy Benefit Reserves. The change in future policy benefit reserves decreased 13.0% in 2019 and 36.9% in 2018. For both years, the decline was due in part to changes in actuarial valuation estimates associated with the conversion to the new actuarial valuation system. These changes resulted in a decrease in reserves of $2.4 million in 2019 and $11.9 million in 2018. The remaining changes in future policy benefit reserves were largely driven by policyholder activity (e.g. premiums, surrenders, etc.). See Note 1. Summary of Accounting Policies in the notes
Policyholder Dividends. The Company issues long duration participating policies in our Life Insurance segment to foreign residents that are expected to pay dividends 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 in order to maintain long term product profitability. Policyholders' dividends have remained relatively stable at $6.0 million, $6.4 million and $6.3 million in 2019, 2018, and 2017, respectively.
Commissions. Commission expense for 2019 and 2018 fluctuated directly in relation to the decrease in first year and renewal premiums in both years.
Capitalization of DAC. Capitalized DAC was $22.3 million, $22.7 million and $29.1 million in 2019, 2018 and 2017, respectively. Decreases in capitalized amounts are in line with the decreases noted in sales activity. 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 has higher commission rates.
Amortization of Cost of Insurance Acquired ("COIA"). Amortization of COIA decreased in 2019 compared to 2018 due primarily to an update in our Home Service Insurance segment expected earned rate assumptions used within annuity models that resulted in a write-down of approximately $0.7 million in 2018.
The number of policies issued decreased 8.7% and 8.9% for the Life Insurance and Home Service Insurance segments in 2019 and 2018, respectively. The decline in the number of new business applications in our Life Insurance segment is driven by ceasing sales in Brazil and terminating agreements with several independent consultants in Latin America who did not align with our vision, values and culture. Excluding these two factors, the number of policies issued by our international business increased during 2018 and 2019 as we invested heavily in our sales and marketing activities and achieved better alignment with our independent consultants on vision, value and strategy. While the number of policies issued has declined in the Life Insurance and Home Service Insurance segments during 2019, the average face amount issued has increased, resulting in overall premium income not declining at the same rate as policy issuances.
Our Life Insurance segment primarily issues ordinary whole life insurance and endowment policies in U.S. dollar-denominated amounts to foreign residents in more than 20 countries through approximately 1,000 independent marketing consultants.
Premiums. Premium revenues decreased by 2.5% in 2019 compared to 2018 as first year premiums increased 2.1%, while renewal premiums declined by 2.9%. We have invested heavily in our sales and marketing activities in 2019 and achieved better alignment with our independent consultants on vision, value, and strategy. The increase in first year premiums is also partly due to the Company's focus on selling higher average premium policies. Since the first quarter of 2019, we have experienced progressive improvement in our new business production for our international business. For 2018, premiums decreased 6.3% as we experienced declines in both first year and renewal premiums.
Endowment sales represent a significant portion of our new business sales internationally and totaled approximately $9.3 million, $10.4 million and $13.3 million, representing approximately 79.5%, 90.8% and 76.4% of total first year premiums in 2019, 2018, and 2017, respectively.
We discontinued new sales of domestic ordinary whole life and endowment life insurance products within our Life Insurance segment in 2017 while we evaluate our domestic life strategy; therefore, the majority of the premium recorded in 2017, 2018 and 2019 is related to renewal business. The increase in premiums in Texas from 2019 to 2018 is due to increased accident and health sales.
Net Investment Income. Net investment income increased 12.0% in 2019 compared to 2018 due to continued growth in average invested assets, improvements in cash management, and a strategic focus on increasing portfolio yields in a prudent manner. Despite facing a difficult investment environment in 2019, our strong focus on the execution of our investment strategy to increase yield drove an increase in portfolio yield of 24 basis points in this segment compared to 2018. Both net investment income and portfolio yield were negatively impacted in 2018 by the need to maintain sufficient cash balances to fund our Bermuda novation, as noted previously. See the Investments section below for more detailed information on our investments.
Realized Investment Losses, Net. The realized gains for 2019 were primarily due to a $5.5 million realized gain from the sale of our former corporate headquarters in Austin, Texas. We also recorded a $1.3 million gain on fixed maturity redemptions above par. In 2018, we recognized losses on other-than-temporary impairments totaling $0.5 million in our fixed maturity portfolio for this segment.
Increase in Future Policy Benefit Reserves. Changes in policy benefit reserves were lower in 2019 compared to 2018 due to the impact of increased surrender and maturity activity and lower premiums compared to 2018. The conversion to a new actuarial valuation system resulted in a decrease in reserves of $11.9 million in 2018 compared to 2017. The conversion to a new actuarial valuation system in 2018 helped offset the impact of increased surrender and maturity activity and lower premiums compared to 2017.
Commissions. Commission expenses increased 0.2% from 2018 to 2019 in line with the increase in first year premiums. 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.
Other General Expenses. Expenses increased 22.9% to $23.0 million in 2019 compared to 2018 and 0.7% to $18.7 million in 2018 compared to 2017. The increase in expense in 2019 was due in part to the reduction in the 7702 tax compliance estimated costs recorded in 2018, which resulted in lower expenses during 2018. We also had lower audit fees which were offset by additional costs related to salaries, bonuses and other compensation in 2019. Expenses are allocated by segment, based upon an annual expense study performed by the Company.
Capitalization and Amortization of DAC. Capitalized costs fluctuate in direct relation to commissions. Capitalized costs increased in 2019 compared to 2018 as commission-related costs increased due to higher first year sales levels. Amortization of DAC decreased by 20.3% in 2019 compared to 2018, as amortization costs in 2018 were increased by $3.7 million due to the impact of the conversion to a new actuarial valuation system. Amortization costs fluctuate with changes in first year premium activity, surrenders, and persistency. As previously described, persistency is closely monitored by the Company. We have experienced increased surrender activity in 2019 and 2018, including early duration elections to convert to reduced paid-up policies or extended term insurance as compared to 2017. There is higher DAC associated with early duration conversions to reduced paid-up policies or extended term insurance, which, when converted, increases amortization expense.
Net Investment Income. Net investment income decreased slightly in 2019 as a fall in yields and an increase in investment expenses offset a slight increase in average invested assets. As previously described, it has been challenging to find attractive yields in the current low interest rate environment. See Investments below for more detailed information on our investments.
Realized Investment Gains (Losses), Net. Realized net gains for 2019 were primarily related to equity securities fair value adjustments of $0.8 million, as financial markets generally performed well during 2019. In addition, we recognized a gain of $0.7 million in 2019 related to fixed maturity redemptions above par value.
Surrender expenses increased in 2019, but were within anticipated ranges based on management expectations.
Increase in Future Policy Benefit Reserves. The decrease in change in reserves is primarily due to changes in actuarial valuation estimates associated with the conversion to the new actuarial valuation system in 2019 that resulted in a decrease in reserves of $2.4 million compared to 2018.
Commissions. Commission expense decreased in 2019 and 2018, which was in line with the premium levels and was consistent for all three periods presented based upon fluctuations in premiums collected.
Capitalization and Amortization of DAC. DAC capitalization declined in 2019 as it is directly correlated to fluctuations in first year commissions. Amortization of DAC was relatively flat in 2019 and 2018.
Amortization of Cost of Insurance Acquired. Amortization decreased in 2019 mainly due to an annual review and true up performed in the first quarter of 2019. Amortization increased in 2018 compared to 2017 due to an update in our assumptions that resulted in an adjustment of approximately $0.7 million.
(1) Includes $188.1 million and $220.6 million of securities guaranteed by third parties for the years ended December 31, 2019 and 2018, respectively.
The Company significantly increased investments in mortgage-backed securities in the latter part of 2018, which now represent 8.6% of our cash, cash equivalents, and investment portfolio as of December 31, 2019. We also began a process of repositioning our portfolio into more diversified holdings and maturities as part of our investment management strategy in the latter part of 2018. The Company has also decreased its exposure to the municipal bond market, which now represents 35.1% of the investment portfolio in 2019 compared to 52.0% in 2018.
At December 31, 2019, investments in fixed maturity and equity securities were 91.3% of our total cash, cash equivalents and investments. All of our fixed maturities were classified as available-for-sale securities at December 31, 2019 and 2018. We had no fixed maturity or equity securities that were classified as trading securities at December 31, 2019 or 2018.
The Company made new investments in investment grade bonds during 2019. Non-investment grade securities are the result of downgrades of issuers or securities acquired during acquisitions of companies, as the Company does not purchase below investment grade securities.
As of December 31, 2019, 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 Company holds 19.4% of its municipal holdings in Texas issuers as of December 31, 2019.
There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2019.
When an OTTI has occurred, the amount of the OTTI recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis, an OTTI is recognized in earnings equal to the entire difference between the investment's cost and its fair value at the consolidated financial statement date. If the Company does not intend to sell the security and it is not more likely than not that the Company is required to sell the security before recovery of its amortized cost basis, the OTTI will be separated into the following: (a) the amount representing the credit loss; and (b) the amount related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The new amortized cost is not adjusted for subsequent recoveries in fair value.
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. As of December 31, 2019, the Company has a significant amount of endowment products representing approximately 41.0% of total insurance in force. Approximately 10% of the endowments in force will mature in the next five years. Policyholder election behavior is unknown, but 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.
Our fixed maturity bond portfolio is exposed to interest rate risk as approximately 51% of the portfolio is callable as of December 31, 2019, with 17% that could be called within the next year. If subject to increased call activity, the Company would have to reinvest the resulting investment portfolio cash proceeds from calls as well as from maturities in lower yielding instruments, further reducing our investment income. Our profitability could be negatively impacted depending on the market rates at the time of reinvestment. This could result in a decrease in the spread between our policy liability crediting rates and our investment earned rates. This could also negatively impact our liquidity.
We have established a liability of $10.0 million, net of tax, for probable liabilities and expenses associated with a tax compliance matter as of December 31, 2019 as described in Note 7. Commitments and Contingencies in the notes to our consolidated financial statements, which represents management’s best estimate. We have disclosed an estimated range related to probable liabilities and expenses of $7.4 million to $52.5 million, net of tax. This estimate and range include projected settlement amounts 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 tax liabilities for policies. Given the range of potential outcomes and the significant variables assumed in establishing our estimates, actual amounts incurred may exceed our reserve and exceed the high end of our estimated range of liabilities and expenses.
The Company’s principal executive office is temporarily located at 14231 Tandem Boulevard, Second Floor, Austin, Texas. In January 2019, the Company entered into a long-term lease agreement with an unrelated party for our new principal executive office. The building in which we have leased office space is under construction and is expected to be completed in 2020. The long-term lease will commence after construction of the building is complete and has a 121-month term. Payments under the new long-term lease agreement will average approximately $112,340 per month.
As of December 31, 2019, Citizens had fixed maturities available-for-sale of $50.5 million and cash of $10.8 million, which represents additional liquidity for future acquisitions, liquidity support for the life insurance companies and for general corporate purposes.
Additionally, a substantial portion of our international policyholders invest their policy cash dividends and benefits in our Class A common stock through our Citizens, Inc. Stock Investment Plan (the "CISIP"). Once a policyholder elects to participate in the CISIP, their policy benefits can be used to purchase Citizens Class A common stock through the CISIP in the open market, or, at our option, directly from us from newly issued or treasury shares. In addition, our existing holders of Class A common stock, employees, directors and independent consultants are eligible to participate in the CISIP. If fewer policyholders elect to participate in the CISIP, or if our international premium collections were to decrease as a result of regulatory or marketing impediments, the trading volume of our Class A common stock may decline from its present levels.
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 held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized. The Company currently does not hold any fixed maturity securities classified as held-to-maturity.
Acquisition costs, consisting of commissions and policy issuance, underwriting and agent convention expenses that are directly related to and vary with the successful production of new business are deferred. These deferred amounts, referred to as deferred policy acquisition costs ("DAC"), are recorded as an asset on the consolidated balance sheets and amortized to income in a systematic manner, based on related contract revenues or gross profits as appropriate.
Inherent in the capitalization and amortization of DAC are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 93.6% of our capitalized DAC are attributed to first year and renewal excess commissions. The remaining 6.4% are attributed to other costs that vary with and are directly related to the successful acquisition of new insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests are based initially on an estimate of the available premium (gross premium less the benefit and expense portion of premium) for the next 50 years. Management believes that our COIA is recoverable for the years ended December 31, 2019 and 2018. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations based on assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections.
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 Tax Act on December 22, 2017, we 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 in 2017. CICA Ltd., a wholly-owned subsidiary of Citizens, is considered a controlled foreign corporation for federal tax purposes. As a result, the insurance activity of CICA Ltd.
is subject to Subpart F of the IRC and is included in Citizens taxable income on its US federal income tax return and due to the 0% enacted tax rate in Bermuda there are no deferred taxes recorded for CICA Ltd.'s temporary differences.
See Item 8. Financial Statements and Supplementary Data and "Accounting Pronouncements" in Note 1. Accounting Pronouncements in the notes to our consolidated financial statements.