The Company owns a 110,600 square foot office building in Howell, Michigan, approximately 40 miles outside of Detroit. This building serves as the Company's headquarters and accommodates corporate administration, marketing, information services, and treasury. The Company also owns a 175,000 square foot facility in Howell near its current headquarters which accommodates underwriting, claims, marketing functions, and the Eastern Michigan branch operations.
- -------- (1) Industry data is from A.M. Best. (2) All earnings per share amounts for all years have been presented to conform with Statement of Financial Accounting Standards No. 128, Earnings Per Share. The adoption of the aforementioned standard had no effect on previously reported earnings per share. For further discussion of Statement No. 128, see Note 1 on page 29 of the Notes to Consolidated Financial Statements included in Financial Statements.
Net premiums earned increased $17.7 million, or 2.2%, to $835.5 million during 1996, representing increases of $18.4 million, or 3.4% in the personal segment, partially offset by decreases of $0.7 million, or 0.2%, in the commercial segment. This overall growth is due to increases in net premiums earned of $11.4 million, or 22.5%, to $62.1 million in Ohio and Indiana resulting from expansion in these states. Rate increases contributed to net premium growth in all major lines except the workers' compensation line where rate reductions and competitive conditions continue in Michigan. Continued growth in policies in force in the commercial multiple peril and commercial automobile lines of 13.2% and 3.7%, respectively, were offset by decreases in personal automobile and workers' compensation policies in force of 3.0% and 1.4% respectively.
Personal segment net premiums earned increased $28.7 million, or 5.2%, to $583.3 million in 1997. This growth is attributable to rate increases in the personal automobile and homeowners lines and a 2.8% increase in policies in force in the homeowners line. The growth is partially offset by a 0.6% decrease in policies in force in the personal automobile line, attributable to the Company's selective reduction of writings in Michigan when rates were viewed as inadequate, and to continued strong competition in Michigan. While management has taken steps to increase penetration in affinity groups and has initiated other marketing programs, heightened competition may result in reduced growth in the personal segment.
The personal segment underwriting loss in 1997 was $8.8 million compared to $1.3 million in 1996. The decline in underwriting results reflects a decrease in prior year favorable development in the personal automobile line of $10.5 million and an increase in catastrophe losses of $0.9 million, to $14.3 million, primarily in the homeowners line. The decrease in policy acquisition expenses of $0.4 million, or 0.4%, to $112.1 million in 1997 primarily reflects lower commission rates for 1997 partially offset by higher earned premiums. Other underwriting expenses increased $0.6 million, or 1.5%, to $39.9 million due to an increase in net premiums earned offset by reductions in employee related expenses.
The personal segment underwriting loss in 1996 was $1.3 million compared to $26.6 million in 1995. The improvement in underwriting results reflects favorable claims activity in both current and prior accident years in the personal automobile line attributable to improvements in severity. This was partially offset by an increase in catastrophe losses of $6.2 million, to $13.4 million, primarily in the homeowners line. The increase in policy acquisition expenses of $4.4 million, or 4.1%, to $112.5 million in 1996 primarily reflects the growth in net premiums earned. Other underwriting expenses decreased $1.8 million, or 4.4%, to $39.3 million due to reductions in employee related expenses and commissions, partially offset by expenses associated with a policy administration technology project.
The commercial segment underwriting profit in 1996 was $2.0 million compared to $40.0 million in 1995. The decline in underwriting profit is primarily attributable to an increase in loss severity and frequency in the commercial multiple peril line, lower net premiums earned in the workers' compensation line, less favorable development of prior year reserves in the workers' compensation line, an increase in catastrophe losses of $0.8 million, partially offset by an increase in net premiums earned in the commercial multiple peril line. Policy acquisition expenses remained consistent between years, primarily as a result of flat net earned premiums. Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million due to investments in technology and increased policyholders' dividends, partially offset by reductions in employee related expenses and commissions.
Net investment income before taxes was $101.8 million, $88.9 million and $78.8 million in 1997, 1996, and 1995, respectively. The increase of $12.9 million in 1997 is due to an increase in average invested assets and the company's portfolio shift from equity securities to higher yielding debt securities, including longer duration and non-investment grade securities, partially offset by a $1.2 million decrease in investment income from limited partnership investments. The average pre-tax yields on debt securities were 6.7% in 1997, 6.3% in 1996 and 5.9% in 1995. Average invested assets increased $111.8 million, or 7.3%, to $1,648.1 million in 1997 primarily attributable to cash from operations and market value appreciation. The increase in 1996 is primarily the result of an increase in average invested assets, $4.4 million of income from limited partnerships, and the aforementioned portfolio shift. Net investment income after taxes was $83.8 million in 1997, $73.4 million in 1996 and $64.9 million in 1995.
Net realized gains on investments before taxes were $28.8 million, $15.0 million, and $3.8 million, in 1997, 1996, and 1995, respectively. Net realized gains in 1997 and 1996 primarily resulted from sales of appreciated equity securities due to the Company's strategy of shifting to a higher level of debt securities. Net realized gains in 1995 were primarily the result of the sales of equity securities impacted by the overall rise in the market.
Citizens favorable development in 1997 primarily reflects a modest shift over the past few years of the workers' compensation business to Western and Northern Michigan, which have demonstrated more favorable loss experience than Eastern Michigan. The favorable development in 1996 and 1995 primarily reflects the initiatives taken by the Company to manage medical costs in both the automobile and workers' compensation lines, as well as the impact of the Michigan Supreme Court ruling on workers' compensation indemnity payments in 1995, which decreases the maximum amount to be paid for indemnity cases on all existing and future claims.
notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate and the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves.
The Company maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes pro-rata, excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. The Company determines the appropriate amount of reinsurance based on the Company's evaluation of the risks accepted and analyses prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. The Company has reinsurance for casualty business.
The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound.
The reserve for losses and LAE at December 31, 1997 and 1996, is shown gross of reinsurance recoverable on unpaid losses of $458.6 million and $466.4 million, respectively. Losses and LAE ceded were $97.4 million, $51.4 million and $134.1 million in 1997, 1996, and 1995, respectively. Ceded premiums earned were $181.3 million, $201.1 million and $206.3 million in 1997, 1996, and 1995, respectively.
The Company's investment policy is structured with emphasis on maximizing after tax income while providing liquidity and preserving asset quality. The portfolio is dominated by fixed income securities. The fixed income portfolio maintains a laddered maturity structure with a duration of 5.0 years. During 1997, average durations shortened as interest rates fell and bonds began pricing at their call dates rather than maturity. The Company continually evaluates credit quality throughout the investment holding period. The Company's investment portfolio increased $116.4 million to $1,721.6 million at December 31, 1997, from $1,605.2 million at December 31, 1996, primarily attributable to the investment of cash provided by operations of $48.6 million and total invested asset market appreciation of $47.8 million. Approximately 88.4% of the portfolio was invested in debt securities at December 31, 1997, compared to 87.1% at December 31, 1996.
Net cash used for investing activities for the Company was $31.3 million, $78.3 million, and $89.2 million in 1997, 1996, and 1995, respectively. Net cash used for investing activities has declined in 1997 from 1996 and in 1996 from 1995 primarily due to the decrease in cash flow from operations.
Net cash used for financing activities was $6.9 million, $18.2 million and $113.1 million in 1997, 1996, and 1995, respectively. Net cash used in 1997 reflects dividends paid to shareholders of $7.1 million partially offset by the reissuance of 7,800 shares of treasury stock, or $0.2 million, upon employees' exercising stock options. Net cash used in 1996 reflects the purchase of $11.1 million of treasury stock and dividends paid to shareholders of $7.1 million.
Shareholders' equity was $872.9 million, or $24.75 per share, at December 31, 1997, compared to $754.5 million, or $21.39 per share, at December 31, 1996. Shareholders' equity reflects net income for the year, the reissuance of treasury stock and the impact of a net increase of $31.1 million in the fair values of available-for-sale debt and equity securities. Changes in shareholders' equity related to changes in the fair value of the investment portfolio will continue to be volatile as market prices of debt and equity securities fluctuate with changes in interest rates and economic conditions.
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it will be required to modify or replace significant portions of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue can be resolved. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company.
The Company has initiated formal communications with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 Issue. The Company's total Year 2000 project cost and estimates to complete the project include the estimated costs and time associated with the impact of a third party's Year 2000 Issue, and are based on presently
In our opinion, the consolidated financial statements and financial statement schedules listed in the accompanying index present fairly, in all material respects, the financial position of Citizens Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
The management of Citizens Corporation has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and include amounts based on management's informed estimates and judgments. We believe that these statements present fairly the Company's financial position and results of operations and that the other information contained in the annual report is accurate and consistent with the financial statements.
In November 1995, the Financial Accounting Standards Board (FASB) issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, which permitted companies to reclassify securities, where appropriate, based on the new guidance. As a result, the Company transferred all of the held-to-maturity category securities, with amortized cost and fair value of $35.0 million and $36.5 million, respectively, to the available-for-sale category, which resulted in a net increase in shareholders' equity of $1.0 million in 1995.
Realized investment gains and losses are reported as a component of revenues based upon the specific-identification basis, using amortized cost for fixed maturities and cost for equity securities. Fixed maturities and equity securities with other than temporary declines in fair value are written down to estimated fair value resulting in the recognition of realized losses.
Fair values for debt and equity securities are based on quoted market prices. For securities not actively traded, fair values are estimated using values obtained from independent pricing services.
In the normal course of business, the Company enters into transactions involving various types of financial instruments, including investments in debt and equity securities. These instruments involve credit risk and also may be subject to risk of loss due to currency and interest rate fluctuations. Financial instruments which are subject to fair value disclosure requirements are carried in the financial statements at amounts which approximate fair value, unless otherwise indicated in the notes to the consolidated financial statements.
Although realization of deferred policy acquisition costs is not assured, management believes that all these costs will be realized. The amount of deferred policy acquisition costs considered realizable, however, could be reduced in the near term if the estimates of investment income discussed above are reduced, and this would impact the amortization of deferred policy acquisition costs.
The reserve for losses and loss adjustment expenses (LAE) represents the accumulation of individual case estimates for reported losses and actuarial estimates for incurred but not reported losses and LAE. Assumed reserves are recorded as reported by the ceding organization. The reserve for losses and LAE is intended to cover the ultimate net cost of all losses and LAE incurred through the balance sheet date. The reserve is stated net of anticipated salvage and subrogation and gross of reinsurance ceded. Reinsurance recoverable on paid and unpaid losses is shown as a separate line of the balance sheet. The reserve estimates are continually reviewed and updated. The ultimate liability may be more or less than the current estimate. The effects of changes in the estimated reserve are included in the results of operations in the period in which the estimates are revised.
The Company periodically purchases annuity contracts from various non- affiliated life insurance companies to settle claims currently. The present value of such annuities, where the Company remains primarily liable, is recorded in the accounts of the Company as both an other asset and other liability and amounted to $16.6 million and $16.8 million at December 31, 1997 and 1996, respectively.
The Company and its subsidiaries are included in the consolidated federal income tax return of its ultimate parent Allmerica Financial Corporation. Current federal income taxes are allocated among all affiliated companies based upon a written tax sharing agreement. This agreement requires the consolidated group to allocate tax to each member of the group on a separate return basis. Any tax losses or credits utilized by a profit member of the group shall be reimbursed to a loss member of the group when such loss member, on a separate return basis, could utilize the loss or credits incurred in a prior year.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement No. 109). These differences result primarily from loss reserves, policy acquisition expenses, unearned premiums and unrealized appreciation or depreciation on investments.
In 1997, the FASB issued Statement of Financial Accounting Standards No. 128, Earnings Per Share (Statement No. 128) which supersedes Accounting Principles Board Opinion No. 15, Earnings Per Share. This standard replaces the primary and fully diluted earnings per share with a basic and diluted earnings per share computation, and requires a dual presentation of basic and diluted earnings per share for those companies with complex capital structures. All earnings per share amounts for all periods have been presented to conform to the Statement No. 128 requirements. The adoption of the aforementioned standard had no effect on the Company's previously reported earnings per share.
In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement No. 130), which establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. All items that are required to be recognized under accounting standards as components of comprehensive income are to be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement stipulates that comprehensive income reflect the change in equity of an enterprise during a period from transactions and other events and circumstances from non-owner sources. This statement is effective for fiscal years beginning after December 15, 1997. The Company anticipates that the adoption of Statement No. 130 will result primarily in reporting unrealized gains and losses on investments in debt and equity securities in comprehensive income.
In June 1997, the FASB also issued Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (Statement No. 131). Statement No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that selected information about those operating segments be reported in interim financial statements. This statement supersedes Statement of Financial Accounting Standards No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 requires that all public enterprises report financial and
descriptive information about their reportable operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that it is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This statement is effective for fiscal years beginning after December 15, 1997. The Company has determined that the adoption of Statement No. 131 will not significantly change the Company's reportable segments.
In December 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments (Statement No. 97-3). Statement No. 97-3 provides guidance on when a liability should be recognized for guaranty fund and other assessments and on how to measure the liability. This statement allows for the discounting of the liability if the amount and timing of the cash payments are fixed and determinable. In addition, it provides criteria for when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges.
This statement is effective for fiscal years beginning after December 15, 1998. The Company believes that the adoption of this statement will not have a material effect on the results of operations or financial position.
Certain reclassifications have been made to the 1996 and 1995 consolidated financial statements in order to conform to the 1997 presentation.
Debt securities with an amortized cost of $8.5 million were on deposit with various states or government authorities as of December 31, 1997. There were no contractual fixed maturity investment commitments at December 31, 1997 and 1996, respectively.
Mortgage-backed securities are included above in the category representing their ultimate maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from voluntary sales of debt securities in 1997, 1996, and 1995 were $306.1 million, $470.4 million and $511.3 million, respectively. Gross gains in 1997, 1996, and 1995 of $3.9 million, $3.2 million and $6.3 million were realized on those sales, respectively. Gross losses in 1997, 1996, and 1995 of $2.9 million, $5.6 million and $8.0 million were realized on those sales, respectively. Proceeds from voluntary sales of equity securities in 1997, 1996, and 1995 were $69.3 million, $70.6 million and $45.8 million, respectively. Gross gains in 1997, 1996, and 1995 of $27.5 million, $17.8 million, and $7.7 million were realized on these sales, respectively. Gross losses in 1997, 1996, and 1995 of $0.2 million, $0.4 million, and $2.2 million were realized on those sales, respectively.
Provisions for federal income taxes have been calculated in accordance with the provisions of Statement No. 109. A summary of the federal income tax expense in the consolidated statements of income is as follows:
Management believes, based on the Company's recent earnings history and its future expectations, that the Company's taxable income in future years will be sufficient to realize all deferred tax assets. In determining the adequacy of future income, management considered the future reversal of its existing temporary differences and available tax planning strategies, including the sale of investment assets, that could be implemented, if necessary.
The Company maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes pro-rata, excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. Most reinsurance treaties are negotiated by the Company's parent through a broker and provide coverage for all of the subsidiaries of Allmerica Property & Casualty Companies, Inc., including the Company. The Company remains contingently liable in the event that a reinsurer is unable to meet the obligations assumed under the reinsurance agreements.
Citizens Insurance cedes 100% of business written in specific states to Hanover. Citizens Insurance also assumes certain business from Hanover which was written by Hanover on behalf of Citizens Insurance. Premiums receivable at December 31, 1997 and 1996, include $0.9 million and $1.6 million, respectively, of premiums due to Citizens Insurance from Hanover on assumed business. In addition, other liabilities at December 31, 1997 and 1996, include $1.8 million and $2.7 million, respectively, of claim payments due from Citizens Insurance to Hanover on
The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company determines the appropriate amount of reinsurance based on evaluation of the risks accepted, analyses prepared by consultants and reinsurers, and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound.
Company annually provides an allocation to each eligible employee as a percentage of that employee's salary, similar to a defined contribution plan arrangement. The 1997, 1996, and 1995 allocations were based on 7.0% of each employee's salary. The Company's policy for the Plan is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974.
The Company also has a 401(k) Matched Savings Plan, a defined contribution plan. Effective with the 1995 plan year, the Company began matching employee elective 401(k) contributions, up to a maximum percentage determined annually by the Board of Directors. During 1997, 1996, and 1995, the Company matched 50% of employees' contributions up to 6% of eligible compensation. The total expenses related to these plans were $0.3 million, $1.8 million and $1.4 million, in 1997, 1996, and 1995, respectively.
In addition to the Company's pension plans, the Company provides postretirement medical and death benefits to certain full-time employees and dependents. Generally, employees become eligible at age 55 with at least 15 years of service.
Spousal coverage is generally provided for up to two years after death of retiree. Benefits include hospital, major medical, and a payment at death equal to retirees' final compensation up to certain limits. Effective January 1, 1996, the Company revised these benefits so as to establish limits on future benefit payments, restrict eligibility for current employees and eliminate eligibility for new employees. The medical plans have varying co- payments and deductibles, depending on the plan. Participation in the medical plan requires some retiree contributions, which are defined in the plan. The life insurance plan is a non-contributory plan. These plans are unfunded.
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7% as of December 31, 1997 and 1996. The assumed rate of future annual salary increases range was 5.5% at both valuation dates.
As described in Note 8, the liabilities related to the Company's plan, net of the deferred tax asset, will be transferred to FAFLIC, effective January 1, 1998.
The Company provides data processing, claims adjusting, underwriting, and bond operation services to Hanover on business assumed from Hanover. These items are treated as assumed expenses by the Company.
In October 1995 the FASB issued Statement of Financial Accounting Standards No. 123 Accounting for Stock-Based Compensation (Statement No. 123). The standard is effective for fiscal years beginning after December 15, 1995, and requires the Company either to apply a fair value measure to any stock-based compensation granted by the Company after December 31, 1994, or continue to apply the valuation provisions of existing accounting standards, but with pro- forma net income and earnings per share disclosures using a fair value methodology to value the stock-based compensation. Beginning the year ended December 31, 1996, the Company has elected to continue to apply the valuation provisions of existing accounting standards (APB 25) in accounting for its stock options and, accordingly, no compensation cost has been recognized for stock options in the financial statements. The pro-forma effect of applying Statement No. 123 is not material.
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Although the Company does not believe that there is a material contingency associated with the Year 2000 project, there can be no assurance that exposure for material contingencies will not arise.