The investment return, or yield, on invested assets is an important element of the Company’s earnings since insurance products are priced with the assumption that premiums received can be invested for a period of time before benefits are paid. The majority of the Company’s invested assets have been held in available-for-sale and held-to-maturity securities, primarily in asset classes of corporate bonds, municipal bonds, and government obligation bonds. The current and projected low interest rate environment is having a significant impact on the determination of insurance contract liabilities and assets regarding reserves and deferred acquisition costs.
In the first quarter of 2015, we announced that we identified that a substantial 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 7702A of the Internal Revenue Code ("IRC") of 1986. As a result, we have established a reserve of $11.4 million for probable expenses and liabilities associated with this tax compliance matter, which amount represents the low end of management’s estimated range of those probable expenses and liabilities of $11.4 million to $40.0 million net of tax. This estimated range includes projected toll charges and fees as well as increased claims liability for past claims, reserves increases to bring policies into compliance and other probable liabilities resulting from this tax compliance matter. Our estimated range reflects the uncertainties with respect to the required course of action and other matters unknown at this time. Currently, management believes there is not a specific
The 2014 financial results are driven by our conservative business management and traditional life product sales. The interest rate environment continues to impact our results and our industry as investment yields are an integral component of our business operations.
Our assets grew $201 million in 2014 and totaled $1.4 billion as of December 31, 2014.
Net investment income increased 12.2% and 15.4% for 2014 and 2013, respectively, as rates have risen in 2014 compared to the prior two years. The average yield on the consolidated investment portfolio has changed from a yield of 3.81% in 2012 up to 4.11% in 2013 and increasing to a yield of 4.21% in 2014 as rates have risen slightly and our new investments have been focused on municipals and corporates. The increase in the investment asset balances due to premium revenue growth has also contributed to the increase in net investment income.
Endowment product sales have been on the rise and represented approximately 76.1% of new sales. The Company offers a ten, fifteen and twenty year endowment and our top selling endowment is a product that matures at age sixty-five. We also introduced a new product in 2012 that is an endowment at age eighteen with a payout over four or five years.
Net Investment Income. Net investment income increased to $41.1 million in 2014 compared to $36.6 million in 2013, due to an increase in yields from new investments primarily in municipal and corporate issues and as we experienced higher average invested assets as a result of investment of new premium revenue.
We have traditionally invested in fixed maturity securities with a large percent held in callable issues. In recent years, we have experienced significant call activity related to fixed maturity security holdings due to the historically low interest rate environment. The low yield rates have leveled off and are now beginning to rise as noted in the table above. If market interest rates begin to rise, our call risk will diminish and our portfolio yield will rise more slowly over time, as new money investments would be made at higher rates.
Realized Gains (Losses) on Investments. In 2014, investment gains on fixed maturities of $0.4 million were recorded due to calls by issuers and several sales and net gains on equity securities of $49,000 was related to the sale of several mutual funds in the current year. In 2013, we sold two equity bond funds which resulted in a realized loss of $0.4 million. The Company sold equity mutual funds in 2012, which were previously impaired, and realized gains of $0.6 million.
Policy surrenders increased in 2014, 2013 and 2012, but remained at a level that represents approximately 0.6% of direct ordinary whole life insurance inforce. The increase in surrender expense is primarily related to our international business and is expected to increase over time due to the aging of this block of business. A significant portion of surrenders relates to policies that have been in force over fifteen years and no longer have a surrender charge associated with them. Total direct insurance inforce reported in 2014 was $4.9 billion compared to $4.7 billion in 2013 and $4.6 billion 2012.
Commissions. Commission expense fluctuates in a direct relationship to new and renewal insurance premiums and has increased 8.8% in 2014 compared to 2013 as premium revenues have increased.
Other General Expenses. Total general expenses have increased significantly on a consolidated basis in 2014 due to the tax compliance issue we identified in 2015, which resulted in a $10.2 million expense for future liabilities recorded in the current year. In 2013, claims cost increased compared to 2012, related to our self insurance health plan for our employees resulting in approximately $0.5 million increase to our overall benefit expenses. We also had an increase in temporary labor staffing costs of
Amortization of deferred policy acquisition costs is impacted by persistency and may fluctuate from year to year. Amortization in 2014 increased as we experienced lower persistency in the life segment. Amortization costs increased in 2013 compared to 2012 as persistency began to decline from previous levels primarily in the life segment. In addition, the prolonged low interest rate environment impacted the assumptions used in the development of the DAC asset for new policies issued.
Premiums. Premium revenues increased for 2014 compared to 2013 and 2012, due to higher international renewal premiums, which have experienced strong persistency as this block of insurance ages. First year premiums increased in the current year, reflecting improved new business production in all products internationally. Sales from Colombia, Ecuador, Taiwan and Venezuela represented the majority of the first year premium increase.
Net Investment Income. Net investment income has increased as the annual yield has increased 19 basis points in this segment from 2013, as discussed in the Consolidated Results of Operations above.
Other policy benefits increased in the current year due primarily to premium deposits and dividend accumulations policyholder liability accounts which have increased as these amounts credit a 4% interest rate, making them an attractive deposit in this low interest rate environment.
In addition, reserves have risen year over year for all periods presented due to the increased sales of endowment products, which build up reserve balances more quickly compared to other life product sales. Endowment sales totaled approximately $16.9 million, $14.3 million and $14.3 million, representing approximately 76.1%, 73.0% and 76.0% of total new first year premium in 2014, 2013, and 2012, respectively.
The following table sets forth our direct premiums by state for the periods indicated.
Surrender expenses have increased as the Home Service block grows, and is consistent with expectations for the current economic conditions.
Increase in Future Policy Benefit Reserves. The current year change in reserves was minimal, excluding MGLIC additional reserves, as premiums were relatively flat and lapse experience was comparable for all three periods presented.
Policyholders' dividends. The increase in 2012 compared to subsequent years resulted from a manual adjustment that was properly set up in 2012 in the policy administration system to appropriately reflect increasing policy values from annual paid up additions. This one time increase in dividends paid and single premium revenue of approximately $180,000 had no impact on the overall
Capitalization and Amortization of Deferred Policy Acquisition Costs ("DAC"). DAC capitalization is directly correlated to fluctuations in first year commissions. Amortization was relatively level, excluding MGLIC, as we experienced comparable lapse rates in the three years presented in this segment. We monitor lapse rates as a key component of our insurance operations.
This segment represents the administrative support entities to the insurance operations whose revenues are primarily intercompany and have been eliminated in consolidation under GAAP, which typically results in a segment loss. In 2012 the fair value adjustment related to the Company's warrants to purchase Class A common stock were recorded which resulted in a gain of $0.5 million. These amounts fluctuated due to the movement in our Class A common stock price and fair value calculation for warrants using the Black-Scholes valuation model. There were no warrants outstanding during 2014 or 2013.
(1) Includes $3.2 million and $3.8 million of U.S. Government agencies and government-sponsored enterprise for the years ended December 31, 2014 and 2013, respectively.
(2) Includes $272.0 million and $226.6 million of securities guaranteed by third parties for the years ended December 31, 2014 and 2013, respectively.
The tables below represent the Company’s detailed exposure of municipal holdings in Louisiana and Texas, which comprise the most significant state concentrations of the total municipal portfolio as of December 31, 2014.
There were no other states or individual issuer holdings that represented or exceeded 10% of the total municipal portfolio as of December 31, 2014.
This tax compliance issue impacts our policyholders and their tax liabilities relative to these products that fail 7702 qualifications and will not be remediated. The exposure related to future sales or products in force is unknown at this time. Policyholders could
decide to surrender their policies due to this issue which would subsequently result in higher cash outflows due to an increase in surrender activity.
At December 31, 2014, all of our insurance subsidiaries were above the required minimum RBC levels.
In 2013, CICA contributed 50,000 shares of Citizens, Inc. Class A common stock to CNLIC as a capital contribution due to minimum capital and surplus considerations. The contributed shares had a fair market contributed value of and $0.4 million. These shares were subsequently purchased by Citizens, Inc., the ultimate parent, for $0.4 million cash in 2013. Citizens, Inc. also purchased Class A Common shares in 2012 from CTI with an approximate fair value of $0.5 million. These transactions have been eliminated under consolidation accounting rules.
We have committed to the following contractual obligations as of December 31, 2014, with the payments due by the period indicated below:
The Company does not have off-balance sheet arrangements at December 31, 2014 and, therefore, does not expect any future effects on the Company's financial condition related to any such arrangements. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engages in speculative activities of any nature, and we do not use such investments to hedge our investment positions.
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: (1) it requires assumptions to be made that were uncertain at the time the estimate was made; and (2) changes in the estimate, or different estimates that could have been selected, could have a material effect on our consolidated results of operations or financial condition. While we believe that our estimates, assumptions, and judgments are reasonable, they are based on information presently available. Actual results may differ significantly. Additionally, changes in our assumptions, estimates or assessments as a result of unforeseen events or otherwise could have a material impact on our financial position or results of operations.
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 did not exist as of December 31, 2014. Management believes that our policy liabilities and increase in future policy benefit reserves as of the years ended December 31, 2014, 2013 and 2012 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision.
Inherent in the capitalization and amortization of deferred policy acquisition costs are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 93.0% of our capitalized deferred acquisition costs are attributed to first year excess commissions. The remaining 7.0% are attributed to 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 initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then evaluated over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Management believes that our deferred policy acquisition costs and related amortization for the years ended December 31, 2014, 2013 and 2012 limits the amount of deferred costs to its estimated realizable value. This belief is based upon the analysis performed on capitalized expenses that vary with and are primarily related to the acquisition of new and renewal insurance business, utilization of the factor method and annual recoverability testing.
A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit and expense portion of premium) for the next thirty years. The CCRA is then evaluated utilizing reasonable assumptions. Management believes our CCRA and related amortization is recoverable for the years ended December 31, 2014, 2013 and 2012. This belief is based upon the analysis performed on estimated future results of the block and our annual recoverability testing.
carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess.
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.