Year Ended December 31 2000 1999 1998 1997 1996 - --------------------------------------------------------------------------------
FINANCIAL POSITION - -------------------------------------------------------------------------------- Total assets $135,538,006 $137,980,030 $129,499,123 $84,749,842 $80,262,708 Notes payable 8,000,000 $8,500,000 $6,510,000 $3,510,000 $4,095,869 Redeemable convertible preferred stock --- --- --- $4,043,907 $4,043,907 Shareholders' equity $23,274,109 $28,036,457 $21,745,281 $14,320,885 $10,573,455 Shareholders' equity per share - Basic $13.24 $15.86 $12.06 $13.31 $9.83 Shareholders' equity per share - Diluted $13.24 $15.86 $12.06 $10.11 $8.05
INVESTMENTS - -------------------------------------------------------------------------------- Average cash and invested assets $121,807,002 $115,045,517 $98,436,023 $70,294,955 $70,958,058 Average equity portfolio (cost basis) $20,017,915 $20,650,875 $14,529,633 $11,587,579 $7,125,001 Investment income yield 4.9% 5.1% 5.3% 5.4% 5.9% Change in unrealized investment gains (losses) net of tax $(4,896,265) $243,355 $484,618 $2,166,218 $(1,442,872)
LIFE INSURANCE DATA - -------------------------------------------------------------------------------- Premiums $14,553,493 $12,443,385 $10,657,675 $9,127,795 $9,490,351 Insurance in force, net at end of period $706,044,000 $646,439,000 $634,578,000 $565,446,000 $583,294,000
ACCIDENT AND HEALTH INSURANCE DATA - -------------------------------------------------------------------------------- Premiums $9,268,931 $8,401,443 $7,713,953 $8,563,082 $8,457,272 Claims ratio 66.0% 64.5% 65.2% 68.0% 68.7%
Note: Above amounts include results from acquisitions: National Affiliated Investors Life Insurance Company (reinsurance assumption), Kentucky Insurance Company and United Liberty Life Insurance Company from the dates of their acquisition in 2000, 1999 and 1998, respectively.
During 2000, the Company's net income applicable to common shares totaled $238,000 compared to $6,439,000 in 1999 and $3,020,000 in 1998. In addition, the comprehensive loss (including net unrealized losses) for 2000 was $4,658,000 compared to comprehensive gains of $6,682,000 and $3,784,000 in 1999 and 1998, repectively. Accordingly, although the Company's total book value has declined from the end of 1999, it remains more than $1.5 million or 7% above the level at January 1, 1999. The majority of the 2000 decline in net income and comprehensive income is attributable to the downturn in the securities markets during the last half of the year. Obviously we cannot forecast movement in securities markets during the coming year; however, we do intend to participate in these markets. Although certainly not without risk, our strategies during the past ten (10) years have produced an after-tax compound annual growth rate in book value per share of 9.7% and a 10 year annual growth rate for total equity of 14.3%. In addition, as detailed below, during the past three years the Company has maintained an equity portfolio averaging approximately $18,399,000 (cost basis) which has yielded an average annual pretax total return in excess of 17%.
During 2000, the Company achieved premium increases in four of its five product segments, Home Service Life, Preneed Life, Dental, and Other Health. Pretax segment income for 2000, excluding realized investment gains and interest expense, increased to $36,000 from a prior year loss of $158,000. This improvement was impacted by an overall 14% premium increase and improving margins in a majority of the product segments. This improvement was realized while maintaining the Company's total-return investment strategy which dampens operating income yields and while making continued investment in the growing Preneed Life segment.
As described below, during the year the Company purchased a small block of life insurance business for a net purchase price of approximately $355,000. In addition, the Company repurchased 9,000 and 35,400 shares of its common stock during 2000 and 1999, respectively, at average prices of $11.58 and $11.05 per share, respectively.
transaction of approximately $50,000). The acquisition was financed with available internal funds and $2,500,000 of additional bank borrowings at the prime rate.
On May 12, 1998 the Company and Citizens Security acquired 100% of the common stock of United Liberty from an unaffiliated insurance holding company (the "United Acquisition"). The United Acquisition was accounted for as a purchase and United Liberty's results of operations are included in the consolidated statements since the date of acquisition.
The United Acquisition was financed with the working capital of Citizens Security and with approximately $3,400,000 of the $6,710,000 of proceeds under a Term Loan Agreement dated as of May 8, 1998 between the Company and a commercial bank (the "Term Loan Agreement"). The remaining borrowing under the Term Loan Agreement represented refinancing of debt relating to a prior acquisition.
1 Net of write-downs on bonds whose decline in value is believed to be other-than-temporary 2 Fair values as of December 31, 2000 were obtained from the Company's investment advisor's portfolio review, which used market prices from Shaw Data Services
Shown below are the Company's four largest holdings in non-investment grade bonds by a single issuer as of December 31, 2000.
Non-Investment Grade Amortized December 31, 2000 Cost Fair Value ------------------------------------------------ Largest $500,000 $445,625 Second largest 488,155 521,850 Third largest 476,227 402,900 Fourth largest 401,025 479,350 ------------------------------------------------ Total $1,865,407 $1,849,725 ------------------------------------------------
The Company's investment in equity securities decreased $4,551,000 and $10,363,000 during 2000 on a cost (net of write-downs) and fair value basis, respectively, after increasing $3,495,000 and $5,733,000 on the same basis in 1999. As of December 31, 2000 there were $1,099,000 of unrealized losses on equity securities, as compared with $4,713,000 and $2,474,000 of unrealized gains at December 31, 1999 and December 31, 1998, respectively. One security accounted for $672,000 of the unrealized losses at December 31, 2000.
Citizens Security owns the building in which the Company and its subsidiaries maintain their home offices. The Company occupies approximately 28% of the building with 62% leased to third-party tenants and 10% being offered for lease. Market conditions for this property are generally favorable and the Company does not anticipate significant difficulty in leasing available space. An appraisal obtained during 1996 indicates that the current market value of the property is approximately $1,700,000 higher than its carrying value.
The Company has maintained significant cash and short-term balances over the past several years, principally to hedge against the uncertainty of future interest rates.
not to exceed at any time, the lesser of $750,000 or 80% of the collateral fair value. Stockholders of the partnership's general partner personally guarantee 80% of the loan.
Year Ended December 31, Universal 2000 Total Annuity Life Other --------------------------------------------------------------------- Beginning Balance $15,811,486 $9,346,749 $5,205,603 $1,259,134 Acquired Business $1,600,158 309,794 1,193,240 97,124 Deposits 866,778 308,685 550,802 7,291 Withdrawals (2,785,603)(1,818,106) (892,359) (75,138) Interest credited 888,428 507,285 319,430 61,713 --------------------------------------------------------------------- Ending Balance $16,381,247 $8,654,407 $6,376,716 $1,350,124 ---------------------------------------------------------------------
The 2000 increase in total policyholder deposits of approximately $570,000 is primarily attributable to the NAIL acquisition. Without the acquisition, deposits would have declined approximately $1,080,000 compared to a 1999 net reduction of $512,000. The Company is not devoting significant marketing effort toward these products and has elected not to aggressively compete in crediting excess interest.
Home Service Life premium increased 3.1% during 2000 as the Company achieved its most favorable sales results since the late 1995 acquisition of this product line. The Company has continued to attract a number of successful, experienced Home Service agents without subsidizing inexperienced agents. In addition, a 1999 pilot program to automate and streamline agent field accounting was expanded during 2000 and continues to be favorably received by the agency force. During 1998, the Company introduced redesigned products which raised premium rates approximately 15%, increased base renewal commission rates by approximately 5% of premium, simplified the policy application form, and streamlined the policy underwriting process for qualifying agents. These changes were favorably received by the Home Service Life agency force and production began increasing during the fourth quarter of 1998.
The 84% increase in Preneed Life premium during 2000 resulted from intensified marketing efforts aimed at introducing the Company as a committed participant in this market, successfully negotiating various competitive third-party marketing agreements, and redesigning the former United Liberty Preneed products. The Company anticipates accelerating growth in this segment along with increased statutory surplus strain associated with advance commission arrangements typical in the industry. The premium growth in 1999 reflects the resumption of sales efforts and recognition of a full year of premium from policies obtained in the 1998 United Acquisition.
Net realized gains on equity securities were $119,790, $9,131,389, and $2,848,000 for 2000, 1999, and 1998, respectively. These amounts reflect the direct expenses shown below, as well as increases (reductions) for amortization of deferred policy acquisition costs of $201,179, $(229,861), and $(139,027) in 2000, 1999, and 1998, respectively. Also included in gross realized losses
during 2000, 1999 and 1998 are reductions in the carrying value of available-for-sale equity securities of $5,733,000, 1,122,000, and $1,356,000 respectively, relating to declines in value which were considered by management to be other than temporary. The equity portfolio had $1,099,000 of net pre-tax unrealized losses as of December 31, 2000 compared to net pre-tax unrealized gains of $4,713,000 and $2,474,000 at December 31, 1999 and 1998, respectively. As previously indicated, much of the 2000 decline in realized and unrealized investment gains is attributable to the decline in the equity markets during the second half of the year. Many of the 1999 gains arose from technology related securities, which experienced significant declines during 2000.
As noted above, although increased cash and equity security balances have dampened investment income yields and segment operating income results, total return performance for the past three years has been favorable. As illustrated below, during the past three years the Company's equity securities have generated approximately $5,600,000 of additional pre-tax total return, above a hypothetical 7.0% fixed-maturity return. During this period, the Company's annual net pretax total return on its equity portfolio has averaged 17%.
Total Return Rate - Gross 19.2% (26.9)% 62.1% 21.7% Total Return Rate - Net 17.1% (28.0)% 58.7% 20.1%
1 Excludes adjustments for incentive and guaranty fees incurred by the Company for investment management services. These amounts are included separately as "Direct Expenses".
Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------------- Home Service Life $ 200,479 $ 312,703 $ 211,713 Broker Life 299,777 150,317 254,189 Preneed Life (827,265) (993,560) 15,325 Dental 331,206 436,587 295,038 Other Health 32,186 (64,524) 90,174 - ------------------------------------------------------------------------- Segment Profit (Loss) 36,383 (158,477) 866,439 Net realized investment gains, 1,180,879 9,375,339 3,675,489 net of expenses Interest expense 769,132 553,017 468,268 - ------------------------------------------------------------------------- Income before Income Tax $ 448,130 $ 8,663,845 $ 4,073,660 - -------------------------------------------------------------------------
The 2000 decline in Home Service Life profit resulted primarily from the moderate growth of inforce business as described above, offset by a slight increase in mortality. The 1999 increase in Home Service profit resulted from moderate volume growth and some mortality improvement. The 2000 Broker Life earnings increase resulted primarily from improved mortality on simplified issue and graded benefit life plans. During 1999, increased mortality on the acquired United Liberty business offset improvements in simplified issue and graded benefit life mortality. The 2000 Preneed Life improvement is primarily attributable to improving mortality on business obtained in the 1998 United Acquisition and efficiencies associated with growing levels of new business. As indicated above, the Company has intensified marketing efforts in the Preneed segment and expects continued revenue growth and improving segment results along with increased statutory surplus strain associated with higher new business volumes. Information regarding Dental profitability is included below. The "contribution margin" shown below is a direct margin without allocable investment income and general expense.
Year Ended December 31 2000 1999 1998 --------------------------------------------------------- Premium $7,892,356 $7,105,627 $6,414,720 Claims and Reserves $5,369,742 $4,717,678 $4,370,499 Contribution Margin $1,516,948 $1,432,204 $1,224,470 Claim Ratio 68.0% 66.4% 68.1%
The overall Dental contribution margin continued to improve during 2000 as a result of an 11% increase in premium volume, however the claim ratio also increased somewhat during the year. After two years of strong premium growth, management will again reassess renewal underwriting criteria in order to maintain expected profit margins. The significant improvement in profitability during 1999 resulted from a number of initiatives. These initiatives included reconfiguring products to provide additional margins for certain more costly dental procedures, engaging a company to provide expert assistance with ongoing adjudication of claims, and implementing a program of aggressive renewal underwriting and re-rating. In addition to the profitability initiatives, during 1999 the Company launched initiatives aimed at increasing premium volume, including agent incentive and referral programs for new business. The Company has not been actively marketing its Other Health products in recent years. However, the Company is closely monitoring recent sales activity increases for certain cancer and disability coverages. In addition, state filings for significant rate increases on certain older blocks of Other Health business have been approved and will be implemented, beginning in the second quarter of 2001.
Income Taxes. Historically, the Company has experienced a relatively low effective income tax rate, due primarily to the small life insurance company deduction. However, during 2000, the effective rate was substantially increased by state and local income taxes on the parent company's investment gains (which are not eligible for offset by Insurance Subsidiary investment losses), and the effect of an increased valuation allowance on deferred tax assets as discussed below.
The small life insurance company deduction allows the Life Insurance Subsidiaries to reduce their taxable income by 60% before computing its current provision for regular or alternative minimum tax. However, for purposes of computing deferred income tax liabilities under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", the Company is precluded from assuming the small life insurance company deduction will be available in the future. Accordingly, by disallowing this deduction, SFAS No. 109 significantly increases the deferred taxes on the Life Insurance Subsidiaries' temporary differences. Thus, when a significant increase or decrease occurs in the Company's net temporary differences, the related deferred tax is computed using the 34% federal tax rate, whereas tax may actually be paid on these net liabilities (when realized) at a rate potentially as low as 17% (the alternative minimum tax rate after application of the allowable small life insurance company deduction). The Company's gross deferred federal income tax liabilities and assets are more fully discussed in Note 9 to the Consolidated Financial Statements. All deferred tax assets of the Company are realizable by offset against existing deferred tax liabilities or by carryback to recapture prior years' taxes paid on operating income and capital gains. The deferred tax assets are offset, to some extent, by valuation allowances related to the Company and to the Life Insurance Subsidiaries. Due to the impact of the small life insurance company deduction, the Life Insurance Subsidiaries record a valuation allowance to reduce deferred tax assets (associated with temporary differences) to their expected benefit rate of approximately 19%, rather than 34%. The Company's valuation allowance is designed to reduce deferred tax assets to their estimated ultimate realization value.
Statutory Net Capital Asset Year Ended Net Operating and Valuation Capital December 31 Income Income Surplus Reserves1 Ratio2 -------------------------------------------------------------------------- 2000 $1,868,575 $ 715,250 $8,315,902 $1,548,271 13.7% 1999 $4,945,708 $ 568,436 $12,942,331 $4,335,111 22.4% 1998 $3,662,188 $1,105,631 $11,227,528 $3,606,655 20.5% 1997 $1,708,884 $ 762,357 $9,627,479 $2,753,064 18.2% 1996 $3,062,421 $ 871,089 $9,145,830 $1,426,918 16.1% --------------------------------------------------------------------------
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 December 31, 2000, 1999 and 1998 amounts also include United Liberty's reserves. 2 Represents Statutory Capital and Surplus plus Asset Valuation Reserves divided by invested assets plus cash.
During 2000, statutory capital and surplus and asset reserves decreased by approximately $7,413,000. This decrease resulted primarily from $1,869,000 of statutory net income offset by $7,875,000 of unrealized losses and a $1,200,000 redemption of Citizens Security's preferred capital stock. The significant decline during 2000 has been partially offset during 2001 by the contribution of KIC's stock to Citizens Security in January, 2001. During 1999, statutory capital and surplus and asset reserves increased by approximately $2,443,000. This increase resulted primarily from $4,946,000 of statutory net income offset by a $1,200,000 redemption of preferred capital stock, and a $1,000,000 shareholder dividend paid. During 1998, statutory capital and surplus and asset reserves increased by approximately $2,454,000. This increase resulted primarily from $3,662,000 of statutory net income offset by a $1,500,000 redemption of preferred capital stock, along with unrealized investment gains. During 1997, statutory capital and surplus and asset reserves increased by approximately $1,808,000. This increase resulted primarily from $1,709,000 of statutory net income and $1,130,000 of unrealized investment gains, partially offset by a $1,050,000 redemption of preferred capital stock.
Statutory capital and surplus, specifically the component called surplus, is used to fund the expansion of an insurance company's first year individual life and accident and health sales. The first year commission and underwriting expenses on such sales will normally consume a very high percentage of, if not exceed, first year premiums. Accordingly, a statutory loss (surplus strain) often occurs on these sales during the first policy year. Historically, the Company's level of life insurance sales has not significantly impacted statutory surplus. However, as Preneed Life sales increase, the Company anticipates incurring surplus strain.
During 2000, the Company used approximately $467,000 of cash flow in operations while generating $361,000 and $1,620,000 of cash flow during 1999 and 1998, respectively. The 2000 decrease is principally attributable to Federal Income Tax deposits required early in the year, which are being refunded. The 1999 decrease is attributable primarily to additional spending on Preneed Life marketing programs and a decline in accounts payable and accrued expenses at December 31, 1999.
risks associated with investments in option securities, as described in Item 8, Note 3 of the Notes to Consolidated Financial Statements. At December 31, 2000 the fair value of the Company's equity portfolio was approximately $12,578,000 compared to an adjusted cost basis of $13,677,000. Accordingly, a 10% decline in equity prices would reduce the fair value of the Company's equity portfolio by $1,257,800.
Regarding interest rate risk, the value of the Company's fixed-maturity investment portfolio will increase or decrease in an inverse relationship with fluctuations in interest rates while net investment income earned on newly-acquired fixed-maturities increases or decreases in direct relationship with interest rate changes. Management estimates that a 100 basis point increase in interest rates ("rate shock") would decrease the fair value of its $71.4 million fixed maturity portfolio by approximately 2.8% or $2 million. From an income perspective, the Company does not believe rising interest rates present a significant risk, as essentially all of the Company's policy liabilities bear fixed rates. However, approximately 37% of policy liabilities contain provisions permitting interest or benefit adjustments at the discretion of the Boards of Directors of the Insurance Subsidiaries. The Company's cash flow testing (described below) indicates that overall profitability will generally be enhanced in rising interest rate scenarios. From a liquidity perspective, the Company's fixed rate policy liabilities have been relatively insensitive to interest rate fluctuations. Accordingly, the Company believes gradual increases in interest rates do not present a significant liquidity exposure. The Company monitors economic conditions on a regular basis and manages this interest rate risk primarily by adjusting the duration of its fixed-maturity portfolio. Historically, the Company has maintained conservative durations in its fixed-maturity portfolio. At December 31, 2000 cash and fixed-maturity investments with maturities of less than five years equaled more than 75% of total policy liabilities. Notwithstanding the foregoing, if interest rates rise significantly in a short timeframe, there can be no assurance that the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales, and thereby be materially adversely affected.
The Life Insurance Subsidiaries' most recent cash flow testing, which was completed in February 2001, involved a review of two basic measures. The first was the value of free market surplus, which is defined as the difference between the projected market value of assets and liabilities at the end of the analysis period (typically 10-20 years). Deficits could indicate the need for corrective action depending upon the severity and the number of scenarios in which a deficit appeared. A second measure involved distributable earnings. Negative earnings for extended durations might impair the ability of the Life Insurance Subsidiaries to continue without exhausting surplus. Again, depending upon severity and frequency, corrective measures might be needed. Based on results of the testing, no corrective measures were indicated at the current time. However, such testing is ongoing and dynamic in nature and future events in the interest and equity markets or a significant change in the composition of Life Insurance Subsidiaries' business could negatively impact testing results and require the initiation of corrective measures.
Any necessary corrective measures could take one or more forms. The duration of existing assets might not match well with those of the liabilities. Certain liabilities, such as those associated with indemnity accident and health, short-term disability and group dental products, are short-term in nature and are best matched with cash and short-term investments. By contrast, whole life
The above discussion centers around asset management. Other possible corrective measures might involve liability realignment. The Company's marketing plan could be modified to emphasize certain product types and reduce others. New business levels could be varied in order to find the optimum level. Management believes that the Company's current liquidity, current bond portfolio maturity distribution and cash flow from operations give it substantial resources to administer its existing business and fund growth generated by direct sales. The Company will service debt and other expenses by:
mortality, morbidity, lapse rates, and other factors which may affect the profitability of the Company's insurance products;
Consolidated Statements of Financial Condition at December 31, 2000 and 1999............................................28
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998..........................31
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens Financial Corporation and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------------------- Revenues: Premiums and other considerations $ 24,834,809 $ 21,897,264 $ 19,402,959 Premiums ceded (1,012,385) (1,052,436) (1,031,331) - ------------------------------------------------------------------------------- Net premiums earned 23,822,424 20,844,828 18,371,628 Net investment income 5,993,362 5,885,312 5,190,322 Net realized investment gains, net of expenses 1,180,879 9,375,339 3,675,489 Other income 297,947 157,633 39,566 - ------------------------------------------------------------------------------- Total Revenues 31,294,612 36,263,112 27,277,005
Policy Benefits and Expenses: Policyholder benefits 16,881,624 15,556,565 13,576,645 Policyholder benefits ceded (1,074,788) (1,013,424) (1,039,024) - ------------------------------------------------------------------------------- Net benefits 15,806,836 14,543,141 12,537,621 Increase in net benefit reserves 2,705,133 1,632,677 553,673 Interest credited on policyholder deposits 888,428 862,615 845,608 Commissions 5,047,274 4,340,262 3,775,530 General expenses 5,775,093 5,385,477 4,430,902 Interest expense 769,132 553,017 468,268 Policy acquisition costs deferred (1,832,617) (1,376,309) (1,106,373) Amortization expense: Deferred policy acquisition costs 539,062 491,221 696,719 Value of insurance acquired 766,498 839,314 696,702 Goodwill 78,014 51,885 35,771 Depreciation expense 303,629 275,967 268,924 - ------------------------------------------------------------------------------- Total Policy Benefits and Expenses 30,846,482 27,599,267 23,203,345 - ------------------------------------------------------------------------------- Income before Income Tax 448,130 8,663,845 4,073,660 Income Tax Expense 210,000 2,225,000 774,000 - ------------------------------------------------------------------------------- Net Income 238,130 6,438,845 3,299,660 Dividends on Redeemable Convertible Preferred Stock --- --- (279,650) - ------------------------------------------------------------------------------- Net Income Applicable to Common Stock $ 238,130 $ 6,438,845 $ 3,020,010 - -------------------------------------------------------------------------------
Net Income Per Common Share: Basic $ 0.14 $ 3.59 $ 2.31 Diluted $ 0.14 $ 3.59 $ 1.82 - -------------------------------------------------------------------------------
Policy liabilities: Future policy benefits $ 83,403,780 $ 79,507,902 Policyholder deposits 16,381,247 15,811,486 Policy and contract claims 1,816,947 1,456,030 Unearned premiums 217,670 176,779 Other 203,600 241,502 - ------------------------------------------------------------------------------ Total Policy Liabilities 102,023,244 97,193,699
Notes payable 8,000,000 8,500,000 Accrued expenses and other liabilities 2,240,653 2,270,660 Deferred federal income tax --- 1,979,214 - ------------------------------------------------------------------------------ Total Liabilities 112,263,897 109,943,573
- ------------------------------------------------------------------- Balance at December 31, 1998 1,802,615 8,091,825 3,079,616 8,771,225
Net unrealized appreciation of available for sale securities 243,355 243,355 ----------- Comprehensive income $6,682,200 =========== Common stock repurchases (35,400) (355,624)
- ------------------------------------------------------------------- Balance at December 31, 2000 1,758,215 7,640,988 (1,573,294) 15,448,200 ===================================================================
Cash Flows from Investment Activities: Securities available-for-sale: Purchases - fixed maturities (14,302,398) (7,956,333) (12,642,382) Purchases - equity securities (77,517,925) (73,590,880) (33,322,649) Sales - fixed maturities 14,362,095 16,523,864 15,160,161 Sales - equity securities 81,928,028 79,476,540 33,432,382 Net cash received (paid) for insurance business and subsidiary acquisitions 1,976,855 (3,117,832) (3,787,613) Investment management and brokerage account fees (680,654) (292,195) (417,326) Short-term investments sold (acquired), net (29,954) 572,192 (22,313) Additions to real estate (139,232) (204,216) (35,270) Additions to property and equipment, net (1,065,533) (197,603) (512,242) Decrease in net broker receivable --- 8,125 245,000 Other investing activities, net (43,476) (5,776) 159,955 - -------------------------------------------------------------------------------- Net Cash provided by (used in) Investment Activities 4,487,806 11,215,886 (1,742,297)
Cash Flows from Financing Activities: Policyholder deposits 866,778 705,985 817,372 Policyholder withdrawals (2,785,603) (2,080,766) (2,158,681) Proceeds from note payable - bank --- 2,500,000 3,400,000 Payments on notes payable - bank (500,000) (510,000) (400,000) Net brokerage account loan proceeds (repayment) (100,884) (1,406,524) 989,014 Common stock repurchase (104,213) (391,024) --- Preferred stock redemption --- --- (169,139) Dividends on redeemable convertible preferred stock --- --- (279,650) Issuance of common stock --- --- 45,000 - -------------------------------------------------------------------------------- Net Cash provided by (used in) Financing Activities (2,623,922) (1,182,329) 2,243,916
- -------------------------------------------------------------------------------- Net Increase in Cash and Cash Equivalents 1,397,373 10,394,402 2,121,423 Cash and Cash Equivalents at Beginning of Period 18,696,401 8,301,999 6,180,576 - -------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Period $ 20,093,774 $ 18,696,401 $ 8,301,999 - --------------------------------------------------------------------------------
Principles of Consolidation and Presentation. The accompanying consolidated financial statements include the accounts of Citizens Financial Corporation and its wholly-owned subsidiaries: Citizens Security Life Insurance Company ("Citizens Security"), United Liberty Life Insurance Company ("United Liberty"), Kentucky Insurance Company ("Kentucky Insurance"), and Corporate Realty Service, Inc. ("Corporate Realty"). These entities are collectively hereinafter referred to as the "Company". United Liberty, and (effective January 31, 2001) KIC, are also wholly owned subsidiaries of Citizens Security. All significant intercompany accounts and transactions are eliminated in consolidation. Certain balances in prior years have been reclassified to conform to current year classifications.
Fixed maturities and equity securities having a decline in value considered by management to be other than temporary are adjusted to an amount which, in management's judgment, reflects such declines. Such amounts are included in net realized investment gains and losses. For purposes of computing realized gains and losses on fixed maturities and equity securities sold, the carrying value is determined using the specific-identification method. Mortgage loans and policy loans are carried at unpaid balances. Investment real estate is carried at depreciated cost. Short-term investments, which consist of certificates of deposit and treasury bills, are carried at cost which approximates fair value.
Participating insurance business constituted approximately 6%, 6% and 7% of ordinary life insurance inforce and 4%, 5% and 5% of annualized ordinary life premium inforce at December 31, 2000, 1999 and 1998, respectively. Participating dividends are determined at the discretion of the Board of Directors.
Revenues for universal life and investment-type products consist of investment income and policy charges for the cost of insurance, policy initiation, administrative surrender fees and investment income. Expenses include interest credited to policy account balances, incurred administrative expenses and benefit payments in excess of policy account balances. Deferred policy acquisition costs related to universal life and investment-type products are amortized in relation to the incidence of expected gross profits over the life of the policies. Expected gross profits are reviewed at each reporting period, and to the extent actual experience varies from that previously assumed, the effects of such variances are recorded in the current period.
Earnings Per Share. Basic earnings per share amounts are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share amounts assume conversion of all outstanding Redeemable Convertible Preferred Stock at a conversion price of $5.50 per share (see notes 7 and 8).
On July 7, 2000, the Company acquired, through an assumption reinsurance agreement, 100% of the inforce business of National Affiliated Investors Life Insurance Company ("NAIL") for a net cash purchase price of approximately $355,000. The acquisition was coordinated through the National Organization of Life and Health Guaranty Associations. The acquired business consists primarily of individual life insurance with policy reserves and annual premium of approximately $3,500,000 and $300,000, respectively.
On October 14, 1999, the Company acquired 100% of the stock of Kentucky Insurance from an unaffiliated insurance holding company (the "Kentucky Insurance Acquisition"). Kentucky Insurance is licensed as a property and casualty insurance company in four states and has approximately $3.4 million of statutory capital and surplus; however, it currently has no insurance operations. The aggregate purchase price for the Kentucky Insurance Acquisition was approximately $3,550,000 (including net costs associated with the acquisition of approximately $50,000). The acquisition was financed with available internal funds and $2,500,000 of additional bank borrowings at the prime rate.
These acquisitions were accounted for as purchases and the acquired companies' results of operations are included in the consolidated statements since their respective dates of acquisition.
Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------------- Fixed maturities: Change in net unrealized $(1,655,112)$(1,804,929) $1,158,586 appreciation Net realized gain $ 1,061,089 $ 243,949 $ 827,204 Equity securities: Change in net unrealized $(5,812,184)$ 2,238,293 $ (454,225) appreciation Net realized gain $ 119,790 $ 9,131,390 $2,848,285
The amortized cost and fair value of investments in fixed maturities at December 31, 2000, by contractual maturity are shown below. Expected maturities for investments in fixed maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations, sometimes without prepayment penalties.
December 31 2000 1999 - -------------------------------------------------------------------------------- Net appreciation depreciation) on available-for-sale: Fixed maturities $(1,112,498) $ 542,614 Equity securities (1,099,429) 4,712,755 Adjustment of deferred policy acquisition costs 84,590 (220,566) Deferred income tax benefit (expense) 554,043 (1,711,832) - -------------------------------------------------------------------------------- Net unrealized appreciation (depreciation) $(1,573,294) $ 3,322,971 - --------------------------------------------------------------------------------
Year Ended December 31 2000 1999 1998 - ---------------------------------------------------------------------- Fixed maturities $4,410,640 $4,655,498 $4,157,891 Equity securities 397,552 523,520 422,847 Mortgage loans on real estate 14,887 15,406 16,214 Policy loans 239,199 233,844 210,588 Investment real estate 107,969 245,260 406,971 Short-term investments and other 1,138,318 454,102 335,332 - ---------------------------------------------------------------------- Subtotal 6,308,565 6,127,630 $5,549,843 Investment expense (315,203) (242,318) (359,521) - ---------------------------------------------------------------------- Net investment income $5,993,362 $5,885,312 $5,190,322 - ----------------------------------------------------------------------
The Company limits credit risk by diversifying its investment portfolio among government and corporate fixed maturities and common and preferred equity securities. It further diversifies these investment portfolios within industry sectors. As a result, management believes that significant concentrations of credit risk do not exist. The Company's largest investment in any entity (other than the U.S. Government) was Clear Channel Communications, a fixed maturity totaling $3,123,220 and $4,551,100 at December 31, 2000 and 1999, respectively. At December 31, 2000, the Company had no investments which had not been income producing for a period of at least twelve months prior to year-end.
In conjunction with management of its equities portfolio, the Company has also taken certain option positions, generally on equity securities or related market indices. Although such positions may be covered by actual securities owned or offsetting options, hedge accounting is not used. Accordingly, all such positions are marked to market and changes in value reported as realized gains or losses. During 2000, options purchases totaled approximately $1,789,000 and related net realized gains totaled approximately $1,033,000. At December 31, 2000 net option asset positions outstanding had a market value of $14,375 and a cost of $60,150. There is no significant off-balance-sheet risk associated with these positions.
Pursuant to requirements of certain state insurance departments, the Company has investments with a carrying value of $51,098,000, at December 31, 2000, placed on deposit at various financial institutions which are restricted from withdrawal without prior regulatory approval.
The Company owns the building and land in which it currently resides. At December 31, 2000 and 1999, the Company occupied approximately 28% of the building with the remaining space leased or available for lease to third-party tenants. The accompanying financial statements reflect the proportionate Company occupied share of the building and related operating expense as property and equipment and general expense, respectively. The remaining portion is reflected as investment real estate and as a reduction of investment income, respectively. Accumulated depreciation at December 31, 2000 and 1999 on the investment real estate portion of the building was $950,962 and $843,053, respectively.
The value of insurance acquired is an asset which represents the present value of future profits on business acquired, using interest rates of 6.6% to 9%. Balances outstanding relate primarily to the purchase of United Liberty and two additional companies which have been merged into Citizens Security (Integrity National Life Insurance Company and Old South Life Insurance Company) along with the NAIL total of $355,360 added during 2000. An analysis of the value of insurance acquired for the years ended December 31, 2000, 1999 and 1998 is as follows:
Year Ended December 31 2000 1999 1998 - ------------------------------------------------------------------ Balance at beginning of year $5,295,818 $6,135,132 $4,496,872 Business Acquired 355,360 --- 2,334,962 Accretion of interest 312,002 378,996 372,629 Amortization (1,078,500) (1,218,310) (1,069,331) - ------------------------------------------------------------------ Balance at end of year $4,884,680 $5,295,818 $6,135,132 - ------------------------------------------------------------------
Activity in the accident and health liability portion of policy and contract claims ($414,454 and $494,616 at December 31, 2000 and 1999, respectively) and the incurred but not reported portion of accident and health reserves ($1,188,515 and $2,219,676 at December 31, 2000 and 1999, respectively) is summarized as follows:
Year Ended December 31 2000 1999 - ------------------------------------------------------------------ Balance at January 1 $2,714,292 $2,407,516 Less: reinsurance recoverable 1,720,047 1,597,137 - ------------------------------------------------------------------ Net balance at January 1 994,245 810,379 Total incurred - current year 6,151,422 5,496,236 Paid related to: Current year 5,450,648 4,785,389 Prior years 693,776 526,981 - ------------------------------------------------------------------ Total paid 6,144,424 5,312,370 - ------------------------------------------------------------------ Net balance at December 31 1,001,243 994,245 Plus reinsurance recoverable 601,726 1,720,047 - ------------------------------------------------------------------ Balance at December 31 $1,602,969 $2,714,292 - ------------------------------------------------------------------
December 31 2000 1999 - --------------------------------------------------------------------- Commercial bank notes, prime, due 2007 $8,000,000 $8,500,000 Less: Current Portion (904,167) (500,000) - --------------------------------------------------------------------- Long Term Portion $7,095,833 $8,000,000 - ---------------------------------------------------------------------
In conjunction with the a 1995 acquisition, during 1995 and 1996, the Company issued $4,070,000 of redeemable convertible preferred stock with cumulative quarterly dividends due at an annual rate of 10%. During the third quarter of 1998, the Company converted approximately 98% of the preferred stock to common stock and repurchased the remaining 2% for cash. The conversion resulted in issuance of 722,000 additional common shares and increased common shareholders' equity by $3,937,768. The remaining preferred shares were repurchased for $162,000, resulting in a net shareholders' equity reduction of $63,000.
Diluted: Net income $238,130 $6,438,845 $3,299,660 Less: Preferred stock dividends --- --- 279,650 - -------------------------------------------------------------------------------- Basic: Net income applicable to common stock $238,130 $6,438,845 $3,020,010 - -------------------------------------------------------------------------------- Denominator: Basic: Weighted average common shares 1,761,882 1,793,554 1,306,894 Plus: Assumed conversion of preferred stock --- --- 505,233 - -------------------------------------------------------------------------------- Diluted: Weighted average shares assuming preferred conversions 1,761,882 1,793,554 1,812,127 - --------------------------------------------------------------------------------
Options to purchase 5,000 shares of the Company's common stock at $9 per share were outstanding during 1997 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. These options were exercised during 1998. No common dividends were paid for 2000, 1999, or 1998.
Significant components of the Company's deferred tax liabilities and assets as of December 31, 2000 and 1999 are as follows:
December 31 2000 1999 - --------------------------------------------------------------------- Deferred Tax Liabilities: Value of insurance acquired $ 1,660,791 $ 1,800,578 Deferred policy acquisition costs 639,946 --- Net unrealized gains on available-for-sale securities --- 1,711,832 Other 506,113 826,620 - --------------------------------------------------------------------- Total deferred tax liabilities 2,806,850 4,339,030
Deferred Tax Assets: Policy and contract reserves 2,254,166 1,758,494 Fixed maturities and equity securities 2,270,748 377,528 Real estate 548,668 548,668 Unrealized losses 554,043 --- Deferred policy acquisition costs --- 78,267 Other 309,994 430,117 - --------------------------------------------------------------------- Total deferred tax assets 5,937,619 3,193,074 Valuation allowance for deferred tax assets (1,419,108) (833,258) - --------------------------------------------------------------------- Net deferred tax assets 4,518,511 2,359,816 - --------------------------------------------------------------------- Net deferred tax assets (liabilities) $ 1,711,661 $(1,979,214) - ---------------------------------------------------------------------
December 31 2000 1999 1998 - -------------------------------------------------------------------- Tax at the statutory rate $ 152,400 $ 2,945,700 $ 1,385,000 Change in valuation allowance 585,800 (490,400) 85,700 Small life deduction (276,300) (511,900) (566,300) State and local income tax 233,600 273,500 --- Surtax exemption and other (446,100) 83,800 40,900 Dividend exclusion (39,400) (75,700) (61,900) Alternative minimum tax (credit) --- --- (109,400) - -------------------------------------------------------------------- Tax at the effective rate $ 210,000 $ 2,225,000 $ 774,000 - --------------------------------------------------------------------
Income taxes paid in 2000, 1999 and 1998 were $3,100,000, $2,458,515, and $385,000, respectively. The Company utilized $235,567, and $430,885 of net operating loss carryforwards in 1999 and 1998, respectively. The change in the valuation allowance is due principally to the limitation in the recovery of prior year taxes at the full statutory rate.
Under the tax law in effect prior to 1984, a portion of income of Citizens Security was not taxed when earned. It was accumulated in a tax account known as policyholders' surplus. Under the provisions of the Deficit Reduction Act of 1984, policyholders' surplus accounts were frozen at their December 31, 1983 balance of $859,000 for Citizens Security on a merged basis. Distributions from the policyholders' surplus would be subject to income tax. At December 31, 2000, Citizens Security could have paid additional dividends of approximately
$21,800,000 before paying tax on any part of its policyholders' surplus accounts. No provision has been made for the related deferred income taxes which total $292,000, based on current tax rates as of December 31, 2000.
Year Ended December 31 2000 1999 1998 - -------------------------------------------------------------------- Net Income $ 1,961,792 $ 4,966,948 $ 3,662,188 Capital and Surplus $ 11,694,494 $ 16,227,706 $ 11,227,528
Citizens Security reports its investment in United Liberty on the equity method of accounting for statutory accounting purposes. Accordingly, the admitted value of Citizens Security's investment in United Liberty equals United Liberty's statutory capital and surplus total of $3,112,690, $3,070,963, and $3,302,107 at December 31, 2000, 1999, and 1998, respectively. Citizens Security's net income includes $289,489, $234,853 and $404,553 of United Liberty statutory earnings in 2000, 1999 and 1998, respectively. The 2000 and 1999 totals above also include Kentucky Insurance net income of $93,217 and $21,240, respectively and capital and surplus of $3,378,592 and $3,285,375, respectively.
Net Investment Income: Home Service Life $ 2,028,680 $ 1,993,810 $ 1,750,942 Broker Life 2,538,610 2,488,921 2,283,466 Preneed Life 1,298,434 1,282,397 1,025,696 Dental 39,289 34,848 20,801 Other Health 88,349 85,336 109,417 - --------------------------------------------------------------------------- Segment Totals $ 5,993,362 $ 5,885,312 $ 5,190,322 - ---------------------------------------------------------------------------
The Company evaluates performance based on several factors, of which the primary financial measure is segment profit. Segment profit represents pretax earnings, determined in accordance with the accounting policies described in Note 1, except net realized investment gains and interest expense are excluded. The majority of the Company's realized investment gains are generated from investment in equity securities. The equities portfolio has averaged approximately $18,399,000 (cost basis) during the past three years. If these funds had been invested in fixed-maturities yielding 7.0%, realized investment gains would have declined and the segment profit totals below would have increased by an additional $1,004,000, $922,000, and $594,000 in 2000, 1999, and 1998, respectively.
Segment Profit (Loss): Home Service Life $ 200,479 $ 312,703 $ 211,713 Broker Life 299,777 150,317 254,189 Preneed Life (827,265) (993,560) 15,325 Dental 331,206 436,587 295,038 Other Health 32,186 (64,524) 90,174 - -------------------------------------------------------------------------- Segment Totals 36,383 (158,477) 866,439 Net realized investment gains, net of expenses 1,180,879 9,375,339 3,675,489 Interest expense 769,132 553,017 468,268 - -------------------------------------------------------------------------- Income before Income Tax $ 448,130 $ 8,663,845 $ 4,073,660 - --------------------------------------------------------------------------
Below is selected consolidated quarterly financial data for each of the two years in the period ended December 31, 2000.
Segment Profit (Loss) $ (18) $ (67,654) $ (191,938) $ 295,993 Investment gains (losses), net 4,793,958 1,530,931 (1,664,106) (3,479,904) Interest expense 185,222 194,085 196,435 193,390 Income tax expense (benefit) 1,700,000 440,000 (868,000) (1,062,000)
- -------------------------------------------------------------------------------- Net Income (Loss) $ 2,908,718 $ 829,192 $(1,184,479) $(2,315,301) - --------------------------------------------------------------------------------
During June 2000, the Company was informed of an action filed against its United Liberty subsidiary, by two policyholders. The complaint in the action refers to a particular class of life insurance policies that United Liberty issued over a period of years ending around 1971. The complaint alleges that United Liberty's dividend payments on these policies from 1993 through 1999 were less than the required amount. The complaint does not specify the amount of the alleged underpayment but implies a maximum of about $1 million. The plaintiffs also
Equity Securities: The fair values for equity securities are based on quoted market prices. Equity securities are carried at fair value in the accompanying statements of financial condition. At December 31, 2000 and 1999, the fair value of equity securities was $12,577,874 and $22,941,274, respectively.
Mortgage Loans: The carrying amount of mortgage loans approximates their fair value. At December 31, 2000 and 1999, the fair value of mortgage loans was $156,000 and $158,309, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity contracts approximates their fair value. At December 31, 2000 and 1999, the fair value of investment-type fixed annuity contracts was $7,865,030 and $8,257,568, respectively.
The Company has various transactions with its President and Chairman of the Board (the "Chairman") or entities he controls. The Chairman provides investment portfolio management for the Company and its subsidiaries through SMC Advisors, Incorporated (of which the Chairman is the principal officer, a director, and the sole shareholder). The investment portfolio management contracts provide for total annual fixed fees of $48,000 and incentive compensation equal to five percent (5%) of the sum of the net realized and unrealized capital gains in the fixed maturities and equity securities portfolios of the Company during each contract year. Any excess of net realized and unrealized capital losses over net realized and unrealized capital gains at the end of a contract year is not carried forward to the next contract year. Fixed fees totaled $48,000, $39,000, and $34,500 in 2000, 1999 and 1998, respectively. Incentive fees of $207,369, $617,524, and $196,904 were incurred and paid for 2000, 1999 and 1998, respectively. The Company also maintains a portion of its investments under a Trust Agreement with a bank controlled by the Chairman. Fees to the bank are based on assets held. Such fees were $94,660, $85,396, and $46,429 in 2000, 1999, and 1998, respectively. During 1999, the Company began managing certain commercial real estate affiliated with its Chairman. The Company charges the real estate projects management and leasing fees at market rates, which totaled $150,672 and $114,628 during 2000 and 1999.
Effective January 1, 2001, the Company adopted Financial Accounting Standards Board Statement (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 137 and 138. This statement requires that all derivatives be recognized as either assets or liabilities in the balance sheet at their fair value, and sets forth the manner in which gains or losses thereon are to be recorded. The treatment of such gains or losses is dependent upon the type of exposure, if any, for which the derivative is designated as a hedge. Currently, the Company has not designated any derivatives as hedges. Management anticipates that adoption of SFAS No. 133 will result in a January 1, 2001 transition adjustment which will reduce net income and increase accumulated other comprehensive income by approximately $390,000.
Equity securities available-for-sale: Commons stocks: Banks, trusts and insurance companies $ 457,425 $ 530,080 $ 530,080 Industrial, miscellaneous and all other 9,627,024 8,499,994 8,499,994 Nonredeemable preferred stocks 3,592,854 3,547,800 3,547,800 - ------------------------------------------------------------------------------- Total $13,677,303 $12,577,874 $12,577,874
1 Adjusted for declines in value believed to be other than temporary, totaling $1,347,067 for fixed maturity securities and $5,948,193 for equity securities and, as to fixed maturities, reduced by repayments and adjusted for amortization of premium and accrual of discounts.
Schedule II - Condensed Financial Information of Registrant Citizens Financial Corporation (Parent Company Only) Condensed Balance Sheets
- ------------------------------------------------------------------------------ Total Liabilities and Shareholders' Equity $ 32,127,169 $ 38,612,390 - ------------------------------------------------------------------------------
Schedule II - Condensed Financial Information of Registrant Citizens Financial Corporation (Parent Company Only) Condensed Statements of Income
Expenses: Administrative and general expenses 4,323,967 4,006,129 1,925,693 Interest expense 769,132 553,017 495,390 - ------------------------------------------------------------------------------- Total Expenses 5,093,099 4,559,146 2,421,083
These consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and accompanying footnotes of Citizens Financial Corporation and Subsidiaries.
Cash flow from investing activities: Purchases of available-for-sale securities (20,401,917) (37,514,433) (20,991,407) Sales of available-for-sale securities 28,718,945 40,458,637 21,017,433 Purchase of affiliated preferred stock* --- --- (3,400,000) Redemption of affiliated preferred stock* 1,200,000 2,200,000 1,500,000 Purchase of subsidiaries* --- (3,556,469) (400,000) Investment management fees (201,179) (150,022) (203,591) Additions to property and equipment, net (1,065,533) (197,603) (433,075) Change in investments, other 13,425 13,425 40,396 - ------------------------------------------------------------------------------ Net cash provided by (used in) investing activities 8,263,741 1,253,535 (2,870,244)
Cash flow from financing activities: Proceeds from note payable - bank --- 2,500,000 3,400,000 Payments on notes payable - bank (500,000) (510,000) (400,000) Repurchase of capital stock (104,213) (391,024) (169,139) Net brokerage account loan proceeds (repayment) (100,884) (1,406,524) 989,014 Repayment of intercompany note --- --- (471,441) Dividends on redeemable convertible preferred stock --- --- (279,650) Issuance of common stock --- --- 45,000 - ------------------------------------------------------------------------------ Net cash provided by (used in ) financing activities (705,097) 192,452 3,113,784
- ------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents 5,826,137 29,690 (265,897) Cash and cash equivalents at beginning of year 17,812 (11,878) 254,019 - ------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 5,843,949 $ 17,812 $ (11,878) - ------------------------------------------------------------------------------
Schedule IV - Reinsurance Citizens Financial Corporation For the Years Ended December 31, 2000, 1999, and 1998
Premiums: Life insurance .... $ 15,458,588 $ 940,202 $ 35,107 $ 14,553,493 0.2% Accident & health insurance 9,341,114 72,183 --- 9,268,931 0.0% - -------------------------------------------------------------------------------- Total ....... $ 24,799,702 $ 1,012,385 $ 35,107 $ 23,822,424 0.1% - --------------------------------------------------------------------------------