CITIZENS, INC. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This section and other parts of this Quarterly Report on Form 10-Q ("Form 10-Q")
contain forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995, that involve risks and uncertainties.
Forward-looking statements provide current expectations of future events based
on certain assumptions and include any statement that does not directly relate
to any historical or current fact. Forward-looking statements can also be
identified by words such as "future," "anticipates," "believes," "estimates,"
"expects," "intends," "plans," "predicts," "will," "would," "could," "can,"
"may," and similar terms. Forward-looking statements are not guarantees of
future performance and the Company's actual results may differ significantly
from the results discussed in the forward-looking statements. Factors that might
cause such differences include, but are not limited to, those discussed in
Part II, Item 1A . of this Form 10-Q as well as in Part I, Item 1A of our
Annual Report on Form 10-K for the year ended December 31, 2019 under the
heading "Risk Factors," which are incorporated herein by reference.
Additionally, the effects of the COVID-19 pandemic could cause our actual
results to differ significantly for reasons such as:
•Securities market disruption or volatility and related effects such as decreased economic activity that affect our investment portfolio; •Decreased premium revenue and cash flow from disruption to our distribution channel of independent agents, customer self-isolation, travel limitations, business restrictions and decreased economic activity; •An unusually high level of claims, lapses or surrenders in our insurance operations, which could affect our liquidity and cash flow; and •Inability of our workforce to perform necessary business functions.
The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part I, Item 1 of this Form 10-Q. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. TheU.S. Securities and Exchange Commission ("SEC") maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with theSEC . The public can obtain any documents that the Company files with theSEC at http://www.sec.gov. We also make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 Reports filed by officers and directors, news releases, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, theSEC . We are not including any of the information contained on our website as part of, or incorporating it by reference into, this Form 10-Q.
OVERVIEW
Citizens, Inc. ("Citizens" or the "Company") is an insurance holding company incorporated inColorado serving the life insurance needs of individuals inthe United States since 1969 and internationally since 1975. Through our insurance subsidiaries, we pursue a strategy of offering traditional insurance products in niche markets where we believe we are able to achieve competitive advantages. We had approximately$1.8 billion of assets atSeptember 30, 2020 and approximately$4.6 billion of direct insurance in force. Our core insurance operations include: •Life Insurance segment -U.S. dollar-denominated ordinary whole life insurance and endowment policies predominantly sold to non-U.S. residents, located principally inLatin America and thePacific Rim , through independent marketing consultants; and •Home Service Insurance segment - final expense life insurance and limited liability property insurance policies sold to middle and lower income households inLouisiana ,Mississippi andSeptember 30, 2020 | 10-Q 33
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STRATEGIC INITIATIVES
The Company remains committed to cultivating enduring value for its key stakeholders through the execution of a customer-centric growth strategy.
As we have previously stated, we entered 2020 with clearly defined priorities in order to set a course for long-term profitable growth. •We are focused on continuing to build operational excellence, as our high impact and values-based culture takes root. •We are focused on growth initiatives within the markets in which we operate, as we set targets for growing premium revenues and implementing growth strategies. •We are focused on building new capabilities that will create business opportunities aligned with our essential purpose. We are focused on growth primarily through expanding and/or refining our products to tailor them to our markets, creating sales promotions and campaigns to incentivize the agents in our distribution channels, developing training and guidelines that promote safe, yet effective sales practices, and implementing process and technology improvements to remove friction in the sales cycles. During the third quarter of 2020, we continued to execute on our strategic initiatives and focus on growth initiatives that build on our expertise, all while navigating through significant internal and external disruptions, uncertainties and challenges including a change in control, the resignation of our chief executive officer and appointment of an interim chief executive officer, litigation involving our Board of Directors and controlling shareholder arising from the change in control, and a global pandemic. These topics are discussed in more detail under Part II, Item 1 - Legal Proceedings and
Part II, Item 1A - Risk Factors of this Form 10-Q.
Despite these challenges, we made progress on many of our strategic initiatives during the third quarter of 2020, including the following:
Planned for Expansion of Life Insurance Segment into Hispanic US Market in 2021. Because we have developed the ability to complete insurance transactions end-to-end in Spanish and Portuguese and understand the needs of the Hispanic market due to over 50 years of doing business inLatin America , we plan to expand our Life Insurance segment to the Hispanic market in theU.S and expect to begin selling in this market during 2021. Reorganized our Home Service Insurance Distribution System. In ourHome Service Insurance segment, as part of the continued strategic review of our operations, effectiveAugust 2020 , we began to operate our distribution system through independent agents, rather than employee agents, which involved converting employee agents to independent agents. For an additional discussion of the potential impacts on the business from the conversion, see Part II, Item 1A - Risk Factor s . Launched New Marketing Campaigns in our Life Insurance and ourHome Service Insurance segments. In our Life Insurance segment, we created an enticing sales campaign that helped lead to 39% higher premiums in the third quarter as compared to the second quarter of 2020. In theHome Service Insurance segment, we launched a sales campaign that resulted in an increase in the amount of in-force insurance for our current customer base. See below in "Our Operating Segments" for more detail on these campaigns and their impact on our business during the third quarter.
Implemented Operational Improvements. We updated our underwriting processes to remove barriers to sales with a more frictionless process for agents and applicants and to reduce underwriting expense. We also focused on
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continued training for virtual sales and collections in both our Life Insurance
and our Home Service Insurance segments and expanded our alternative payment
methods for our Home Service Insurance segment to accept credit cards and debit
card payments.
As we seek to optimize value for the Company, its customers and its collaborators, we believe our efforts will continue to put the Company on a stronger financial footing and drive sustainable growth.
CURRENT FINANCIAL HIGHLIGHTS
In the three months endedSeptember 30, 2020 , we had a net loss of$7.9 million compared to net income of$2.0 million in the prior year period. In the nine months endedSeptember 30, 2020 , we had a net loss of$12.5 million compared to a net loss of$6.3 million in the prior year period. Accordingly, our earnings (losses) per share declined by$0.20 and$0.12 in the three and nine months endedSeptember 30, 2020 , respectively, compared to prior year periods. The$10.0 million decrease in net income in the three months endedSeptember 30, 2020 compared to the prior year period was primarily driven by a$7.9 million increase in our general expenses related to executive severance costs and professional fees in connection with a change in control of the Company. As we previously announced onJuly 29, 2020 , a change in control of the Company occurred when theHarold E. Riley Foundation became the beneficial owner of 100% of the Company's Class B common stock (the "Change in Control"). Holders of the Company's Class B common stock have the right to nominate a simple majority of our Board of Directors. The Change in Control, and its trigger of related payments to our former Chief Executive Officer upon his resignation under his employment agreement, materially impacted our general expenses for the three and nine months endedSeptember 30, 2020 . Expenses related to the Change in Control for the third quarter include (i) payment of$8.8 million to a Rabbi Trust for the benefit of our former Chief Executive Officer,Geoffrey Kolander , following his resignation pursuant to the terms of his employment agreement and the Chief Executive Officer Separation of Service and Consulting Agreement datedJuly 29, 2020 (the "Separation and Consulting Agreement"), (ii)$1.2 million of expense related to the accelerated vesting ofMr. Kolander's Restricted Stock Units following his resignation upon a change in control pursuant to his employment agreement, and (iii) legal fees related to Change in Control, including defense costs for the litigation brought by the Foundation against the Company and its Board, as described in Part II, Item 1. Legal Proceedings of this Quarterly Report on Form 10-Q. The increase in general expenses due to the Change in Control was partially offset by previous quarter strategic efforts to lower general expenses. In addition to the higher general expenses, a$1.9 million decrease in premium revenue and a$4.2 million increase in claims and surrenders expense also contributed to the decrease in net income for the third quarter of 2020. See below in "Revenue Highlights" and in "Benefits and Expenses Highlights" for an explanation of these changes. The$6.2 million increase in net loss in the nine months endedSeptember 30, 2020 as compared to the same period in 2019 primarily reflects: •a$5.4 million decrease in premium revenue for the reasons explained in "Revenue Highlights" below; •a$2.5 million decrease in realized investment gains primarily due to a realized gain of$5.5 million in the first quarter of 2019 related to the sale of our former corporate headquarters inAustin, Texas ; •an$8.4 million increase in claims and surrenders for the reasons discussed in "Benefits and Expenses Highlights" below; and •a$4.4 million increase in general expenses, driven by our former Chief Executive Officer's severance package and the Change in Control, partially offset by previous strategic efforts to lower general expenses. These decreases to revenues and increases to benefits and expenses in the nine months endedSeptember 30, 2020 as compared to the same period in 2019 were partially offset by: •a$6.3 million decrease in future policy benefit reserves driven primarily by the release of reserves resulting from the decreases in our in force business; September 30, 2020 | 10-Q 35
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•a $2.9 million decrease in commissions paid which primarily reflect lower sales
of new policies, which have significantly higher commission rates than renewals;
•lower capitalization and amortization of deferred policy acquisition costs,
which also reflect lower sales of new policies; and
•a $4.6 million lower federal income tax expense.
While it is difficult to quantify the full impact that the COVID-19 pandemic has
had on our business in the three and nine months ended September 30, 2020 , as we
have previously disclosed, our results of operations for the three and nine
months ended September 30, 2020 were negatively impacted by the COVID-19
pandemic in the U.S. and other countries where we do business. The COVID-19
pandemic primarily negatively impacted our product sales (and thus first year
premium revenue), and our claims and surrenders expenses. We describe below in
more detail areas of our results in which we believe our business may have been
impacted by the COVID-19 pandemic. While we have implemented operational changes
and sales practices to mitigate the impact of the COVID-19 pandemic on our
business, because the COVID-19 pandemic continues to cause quarantines,
"stay-at-home" orders and similar mandates for many individuals and businesses
requiring them to substantially restrict daily activities and to curtail or
cease normal operations globally where we do business, we continue to foresee
some adverse impact to near-term sales activity, premiums, claims, policy
benefits, invested assets and regulatory capital as a result of the COVID-19
pandemic and we continue to closely monitor developments related to the COVID-19
pandemic to assess its impact on our future results and business. For an
additional discussion of the potential impacts on our business from the COVID-19
pandemic, see Part II, Item 1A - Risk Factors , in this Quarterly Report on
Form 10-Q.
Financial highlights for the three and nine months ended
REVENUE HIGHLIGHTS
•For the three months endedSeptember 30, 2020 , insurance premiums declined 4.1% to$44.1 million from$46.0 million for the same period in 2019. The decline was driven primarily by lower first year premiums in our Life Insurance segment, which, while increasing from the previous quarter, declined 34.1% to$2.2 million from$3.4 million in the third quarter of 2019 as our new policy sales continue to be negatively impacted by the COVID-19 pandemic. Renewal premiums in our Life Insurance segment also contributed to the overall decrease, declining 3.1% to$30.1 million in the third quarter of 2020 from$31.0 million in the same period in 2019. The decrease in renewal premiums resulted from a decline in our in force business in this segment over the year, which is due in part to changes we made to our products and distribution over the last few years. •For the nine months endedSeptember 30, 2020 , insurance premiums declined 4.0% to$126.9 million from$132.3 million for the same period in 2019. The decline was driven by our Life Insurance segment as renewal premiums for the nine months endedSeptember 30, 2020 and first year premiums for the second and third quarters of 2020 fell compared to the comparable periods in 2019. •Net investment income was$15.0 million for both the three months endedSeptember 30, 2020 and 2019, and slightly increased to$45.1 million from$44.2 million in the nine months endedSeptember 30, 2020 from the same period in 2019.
BENEFITS AND EXPENSES HIGHLIGHTS
•Claims and surrenders expense increased 14.6% and 10.6% for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019. The increases were driven primarily by an increase in surrendered policies in the Life Insurance segment during the third quarter primarily as a result of policies nearing their maturities. The increases were also due to higher claims in the second and third quarters in ourHome Service Insurance segment due primarily to COVID-19 deaths. Additionally, we incurred unusually large property claims in ourSeptember 30, 2020 | 10-Q 36
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Home Service Insurance segment in the third quarter of 2020 due to the impacts
of Hurricane Laura, a Category 4 hurricane which caused significant damage in
Louisiana .
•Future policy benefit reserves decreased 35.1% and 22.4% for the three and nine
months ended September 30, 2020 , respectively, compared to the same periods in
2019. The declines were driven primarily by the release of reserves resulting
from the decreases in our in force business.
•General expenses increased 68.2% and 11.7% for the three and nine months ended
September 30, 2020 , respectively, compared to the same periods in 2019. The
increase for both periods was driven primarily by the Change in Control as
described above in "Current Financial Highlights". Excluding the effects of the
executive severance charges incurred in connection with the Change in Control,
our general expenses decreased for the three and nine month periods in 2020,
reflecting reductions in external audit fees and outside consulting expenses as
well as a $2.3 million decrease due to a reduction of our tax compliance
liability under Sections 7702 and 72(s) of the Internal Revenue Code for our
Life Insurance segment, as discussed in Note 8. Commitments and
Contingencies of the notes to our consolidated financial statements.
OUR OPERATING SEGMENTS
Our business is comprised of two operating business segments, as detailed below.
•Life Insurance
•Home Service Insurance
Our insurance operations are the primary focus of the Company, as these
operations generate most of our income. See the discussion under Segment
Operations below for detailed analysis. The amount of insurance, number of
policies, and average face amounts of ordinary life policies issued during the
periods indicated are shown below.
Nine Months Ended September
30, 2020 2019
Average Average
Amount of Number of Policy Amount of Number of Policy
Insurance Policies Face Amount Insurance Policies Face Amount
Issued Issued Issued Issued Issued Issued
Life Insurance $ 142,390,980 2,214 $ 64,314 $ 166,580,870 2,519 $ 66,130
Home Service Insurance 103,456,413 20,261 5,106 124,529,689 17,288 7,203
The number of policies issued in the nine months ended September 30, 2020
decreased 12.1% in the Life Insurance segment. We believe that the decrease in
new business applications in our Life Insurance segment was driven primarily by
disruptions in our sales practices that began in the second quarter of 2020 due
to the COVID-19 pandemic. While the number of new business applications for our
Life Insurance segment decreased during the nine months ended September 30, 2020
compared to the same period in 2019, third quarter new business applications
increased 23% and 56% from the first and second quarters of 2020, respectively,
despite the continuation of strict quarantine protocols in many of the markets
in which we operate. The increase in applications in the third quarter was
primarily due to enhancements to our business operations and sales practices to
account for the impact of the COVID-19 pandemic, including sales promotions and
campaigns, focused training on virtual selling and strategically prioritizing
selling lower face amount policies, which typically have less stringent
underwriting requirements and, in some cases, may not require the completion of
medical tests, as many of our markets remain in lockdown due to COVID-19
pandemic. Although applications increased in the third quarter from the second
quarter, due to these enhancements, average policy face amount declined by 2.7%
and the amount of insurance issued declined by 14.5% during the nine months
ended September 30, 2020 compared to the same period in 2019 for the Life
Insurance segment.
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The number of policies issued in the nine months ended September 30, 2020
increased 17.2% in the Home Service Insurance segment compared to the same
period in 2019. The increase in new business applications in our Home Service
segment was driven primarily by the introduction of a new sales campaign
targeted at existing policyholders in the third quarter that emphasized higher
volume selling at lower average face amounts. In doing so, we focused on sales
of additional benefits for our existing policyholders, which have lower face
values, thus leading to a 29.1% decline in average policy face values and a
16.9% decline in amount of insurance issued as compared to the same period in
2020.
Despite the increase in policies issued in the third quarter of 2020 compared to
the second quarter, our Home Service Insurance segment has continued to be
negatively impacted by the COVID-19 pandemic. We continued to have temporary
office closures in Louisiana during the third quarter due to the COVID-19
pandemic and Hurricane Laura, and we have also had to curtail the sales of
certain product offerings that require extensive person-to-person sales
interaction due to the COVID-19 pandemic.
We continue to monitor the impact of the COVID-19 pandemic on our business and may have to implement additional operational changes.
CONSOLIDATED RESULTS OF OPERATIONS
A discussion of consolidated results is presented below, followed by a discussion of segment operations and financial results by segment.
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