================================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2001
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-20148
CITIZENS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Kentucky 61-1187135
(State of Incorporation) (I.R.S. Employer Identification No.)
12910 Shelbyville Road, Louisville, Kentucky 40243
(Address of principal executive offices)
(502) 244-2420
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Stock, No
Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes ~~X~~ No ~~~~~
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [~X~]
State the aggregate market value of the common equity held by non-affiliates of
the registrant: $5,646,077 (based on an $8.40 per share average of bid and ask
prices on March 25, 2002).
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 1,716,815 shares of Class A
Stock as of March 25, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's Board of Director's Proxy Statement for the Annual
Meeting of Shareholders now scheduled for May 23, 2002 are incorporated into
Part III of this Form 10-K. The date of this Report is March 28, 2002.
================================================================================
CONTENTS
PART I
Page
ITEM 1. BUSINESS .................................................. 3
ITEM 2. PROPERTIES ................................................. 10
ITEM 3. LEGAL PROCEEDINGS .......................................... 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS ........................................... 10
PART~II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS ....................... 11
ITEM 6. SELECTED FINANCAL DATA ..................................... 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS........................ 13
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.. 24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ............... 53
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ......... 53
ITEM 11. EXECUTIVE COMPENSATION ..................................... 53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS ........ 53
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS ...................................... 53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K ..................... 54
SIGNATURES .............................................................. 55
EXHIBIT INDEX ........................................................... 56
EXHIBITS................................................................. 57
This report contains projections and other forward-looking statements regarding
future events or the future financial performance of the Company. Actual events
and results may differ materially from those in the projections and other
forward-looking statements set forth herein. Among the important factors that
could cause actual events or results to differ materially from those in the
projections and other forward-looking statements are: changes in the market
value of the Company's investments, including stock market performance and
interest rate changes; customer response to marketing efforts; mortality and
morbidity trends; regulatory changes; actions of independent rating agencies;
general economic conditions and increased competition; the Company's ability to
achieve operating efficiencies; unanticipated adverse litigation; and changes in
Federal tax law. Readers are referred to the Items 1, 7, 7a and 8 in this report
and to the Company Report on Financial Statements in the Company's Annual Report
for a discussion of these and other important risk factors concerning the
Company and its operations.
PART I
ITEM 1. BUSINESS
General
Citizens Financial Corporation (herein, the "Company" or the "Registrant") was
incorporated in Kentucky in 1990 at the direction of the Board of Directors of
Citizens Security Life Insurance Company ("Citizens Security") for the ultimate
purpose of becoming an insurance holding company. Pursuant to a merger completed
in 1991, Citizens Security became a wholly owned subsidiary of the Company. The
Company is now a holding company that engages in the business of life insurance,
annuities, and accident and health insurance through Citizens Security and
United Liberty Life Insurance Company ("United Liberty") (herein collectively,
the "Life Insurance Subsidiaries"). During October 1999, the Company acquired
Citizens Insurance Company ("Citizens Insurance"), which is licensed as a
property and casualty insurer in four states. Citizens Insurance is planning to
offer home service fire and casualty insurance coverage; however, it currently
has no business inforce. In January 2001, the Company contributed the stock of
Citizens Insurance to Citizens Security. The Life Insurance Subsidiaries and
Citizens Insurance are herein collectively referred to as the "Insurance
Subsidiaries".
Citizens Security was incorporated in Kentucky and commenced business in 1965.
In 1971, Citizens Security acquired Central Investors Life Insurance Company by
merger. In 1987, it purchased the stock of Old South Life Insurance Company
("Old South"). In 1992, Old South merged into Citizens Security. In 1995, the
Company and Citizens Security purchased all of the stock of Integrity National
Life Insurance Company ("Integrity") and merged it into Citizens Security.
During May 1998, Citizens Security purchased all of the outstanding shares of
United Liberty. As stated above, in October 1999, the Company acquired Citizens
Insurance. See Item 7. "Management's Discussion and Analysis" and Item 8, Note 2
of the Notes to Consolidated Financial Statements for descriptions of certain of
these acquisitions. The Life Insurance Subsidiaries are currently licensed to
transact the business of life insurance, annuities, and accident and health
insurance. Citizens Security is licensed in twenty states and the District of
Columbia while United Liberty is licensed in twenty-three states.
Insurance Operations
The Company, through its Life Insurance Subsidiaries, operates in five segments
-- 1) home service life insurance, 2) broker-sold life insurance and annuities,
3) preneed life insurance, 4) dental insurance, and 5) other health and accident
insurance. The home service and preneed life segments provide individual
coverages; the dental segment provides group coverages; while the broker life
and other health segments include individual and group insurance coverages. The
following table presents each business segment's revenue; pretax income or loss
excluding realized investment gains and interest expense; and ending assets for
each of the last three fiscal years. Additional segment information is contained
in Item 7, "Management's Discussion and Analysis" and in Item 8, Note 10 of the
Notes to Consolidated Financial Statements.
Segment Revenue, Profit or Loss, and Assets:
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Revenue:
Home Service Life $ 9,290,120 $ 9,036,005 $ 8,745,144
Broker Life 6,497,286 6,328,884 6,003,025
Preneed Life 9,974,405 5,345,930 3,614,758
Dental 8,025,375 7,933,598 7,141,409
Other Health 1,487,562 1,469,316 1,383,437
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals 35,274,748 30,113,733 26,887,773
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
------------------------------------------------------ ----------------- ---------------- -----------------
Total Revenue $ 27,362,919 $ 31,294,612 $ 36,263,112
------------------------------------------------------ ----------------- ---------------- -----------------
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Profit (Loss):
Home Service Life $ 382,723 $ 200,479 $ 312,703
Broker Life 74,960 299,777 150,317
Preneed Life (264,488) (827,265) (993,560)
Dental 256,385 331,206 436,587
Other Health 10,847 32,186 (64,524)
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals 460,427 36,383 (158,477)
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
Interest expense 532,962 769,132 553,017
------------------------------------------------------ ----------------- ---------------- -----------------
Income (Loss) before income tax and cumulative $ (7,984,364) $ 448,130 $ 8,663,845
effect of a change in accounting principle
------------------------------------------------------ ----------------- ---------------- -----------------
December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Assets:
Home Service Life $ 44,818,038 $ 45,577,255 $ 47,347,032
Broker Life 54,954,194 57,721,008 57,958,271
Preneed Life 34,138,535 29,421,677 29,754,353
Dental 726,728 799,496 913,939
Other Health 1,959,588 2,018,570 2,006,435
------------------------------------------------------ ----------------- ---------------- -----------------
Total Assets $136,597,083 $135,538,006 $137,980,030
------------------------------------------------------ ----------------- ---------------- -----------------
Home Service Life. The Home Service Life segment consists of traditional whole
life insurance, which provides policyholders with permanent life insurance and
fixed, guaranteed rates of return on the cash value element of policy premiums.
Agents for these products sell primarily small face value policies (typically
from $1,000 to $10,000). These policies are subject to normal underwriting
procedures with the extent of such procedures determined by the amount of
insurance, age of applicant and other pertinent factors.
Broker Life. The Broker Life segment offers traditional whole life insurance;
universal life insurance, which provides policyholders with permanent life
insurance and adjustable rates of return on the cash value element of policy
premiums, based upon current interest rates; annuities; group life; accidental
death and dismemberment; and dependent life insurance. The majority of Broker
Life sales consist of whole life graded death benefit and simplified issue
policies.
The graded death benefit policy returns premium plus interest compounded at an
annual rate of 10% if the insured dies of natural causes during the first three
years the policy is in force. If the insured dies of an accidental cause, the
benefit payable is the face amount of the policy. The simplified issue product
provides full face amount coverage from date of issue, is more extensively
underwritten and carries lower premium rates than the graded death benefit
product. These products are targeted towards the "final expense market".
Generally, traditional whole life insurance products are more profitable than
universal life policies, in part because investment margins are normally greater
for traditional whole life products than for universal life policies. Overall
profitability on universal life policies may decline as a result of downward
interest crediting rate adjustments to the extent that policyholders withdraw
funds to invest in higher-yielding financial products. The profitability of
traditional whole life products and universal life policies is also dependent
upon the ultimate underwriting experience and the realization of anticipated
unit administrative costs. The Company believes that the historical claims
experience for the traditional whole life and universal life products issued by
the Life Insurance Subsidiaries has been within expected ranges, in relation to
the mortality assumptions used to price the products.
Substantially all annuity considerations are attributable to sales of flexible
premium deferred annuities, life policy annuity riders, and single premium
deferred annuities. Generally, a flexible premium deferred annuity or a life
policy annuity rider permits premium payments in such amounts as the
policyholder deems appropriate, while a single premium deferred annuity requires
a one-time lump sum payment.
Preneed Life. The Preneed Life segment products are traditional life policies
sold to individuals in connection with prearrangement of their funeral and
include single and multi-pay coverages, generally in amounts of $10,000 and
less. These policies are generally sold to older individuals at increased
premium rates.
The following table provides information concerning the Life Insurance
Subsidiaries' volume of life insurance coverage in force excluding participation
in group underwriting pools for federal employees (FEGLI) and service personnel
(SGLI) for each of the last three fiscal years.
Year Ended December 31 (Dollars in Thousands) 2001 2000 1999
-------------------------------------------------- --------------------- -------------------- ---------------------
Gross In-force at beginning of period1 $809,045 $765,440 $757,571
Business purchased --- 43,940 ---
New business issued during period:
Individual $ 113,119 $ 91,182 $ 84,640
Group 7,632 2,001 7,170
-------------------------------------------------- --------------------- -------------------- ---------------------
New business total $ 120,751 $ 93,183 $ 91,810
Terminations during period $ 117,281 $ 93,518 $ 83,941
Termination rate2 14.5% 11.9% 11.7%
Gross In-force at end of period1:
Individual $668,565 $658,800 $605,309
Group 143,950 150,245 160,131
-------------------------------------------------- --------------------- -------------------- ---------------------
Gross In-force total $812,515 $809,045 $765,440
-------------------------------------------------- --------------------- -------------------- ---------------------
Reinsurance ceded at end of period 109,227 103,001 119,001
-------------------------------------------------- --------------------- -------------------- ---------------------
Net In-force at end of period $703,288 $706,044 $646,439
-------------------------------------------------- --------------------- -------------------- ---------------------
1Before deduction of reinsurance ceded.
2Represents the percentage of individual policies terminated during the indicated period by lapse, surrender, conversion,
maturity, or otherwise.
Dental Insurance. Dental products are indemnity policies sold on a pure group
and voluntary group basis. Voluntary dental groups must meet prescribed
participation limits. All dental products have annual limits on all covered
procedures and lifetime limits on orthodontia procedures. In addition,
orthodontia and major restorative procedures are not covered for the first six
months to one year, depending upon the plan, unless a no-loss-no-gain provision
is attached to the policy.
Other Health Insurance. Other Health products include individual accident and
health insurance policies, which provide coverage for monthly income during
periods of hospitalization, scheduled reimbursement for specific hospital and
surgical expenses and cancer treatments, and lump sum payments for accidental
death or dismemberment. Group health plans are also offered, providing coverage
for short-term disability, and income protection. The Company is not allocating
significant marketing resources to this segment.
Marketing. The Life Insurance Subsidiaries are currently licensed to sell
products in 29 states and the District of Columbia. Citizens Security and United
Liberty are both licensed in the states designated below with a "b" while only
Citizens Security is licensed in the states designated "c" and only United
Liberty in the states designated "u".
b Alabama b Indiana u Nebraska u Oregon
u Arizona u Kansas u Nevada c Pennsylvania
b Arkansas b Kentucky c New Jersey b South Carolina
u Colorado b Louisiana u New Mexico b Tennessee
c Delaware b Maryland c North Carolina b Texas
c District of b Mississippi u Oklahoma u Utah
Columbia
b Florida b Missouri b Ohio c Virginia
c Georgia b West Virginia
The Life Insurance Subsidiaries market products through the personal producing
general agent distribution system. Approximately 3,000 sales representatives are
licensed as independent agents for the Life Insurance Subsidiaries. The majority
of these agents also represent other insurers. Approximately 450 of these agents
specialize in the home service market. That market consists primarily of middle
and low-income families and individuals who desire whole life policies with
policy limits typically below $10,000. Agents usually collect premiums directly
at monthly intervals. The home service market has higher than average policy
lapse rates. Approximately 500 agents specialize in the preneed market.
Typically, these agents are funeral directors or operate from facilities owned
by funeral directors.
The Life Insurance Subsidiaries furnish rate material, brochures, applications,
and other pertinent sales material, at no expense to the agents. The agents are
responsible for complying with state licensing laws and any related appointment
fees. Agents are compensated by commissions. The Life Insurance Subsidiaries
have agent commission arrangements that are generally intended to provide
competitive incentives for agents to increase their production of new insurance
and to promote continued renewals of in-force insurance. Historically, these
incentives have frequently involved awards, overrides, and compensation scales
that escalate according to achievement levels for newly-issued business and that
provide additional payments for renewal business.
Underwriting. The Life Insurance Subsidiaries follow underwriting procedures
designed to assess and quantify insurance risks before issuing life and health
insurance policies to individuals and members of groups. Such procedures require
medical examinations (including blood tests, where permitted) of applicants for
certain policies of health insurance and for policies of life insurance in
excess of certain policy limits. These requirements are graduated according to
the applicant's age and vary by policy type. In addition, certain types of life
insurance policies are offered with higher premium rates and less stringent
underwriting requirements. The Life Insurance Subsidiaries also rely upon each
applicant's written application for insurance, which is generally prepared under
the supervision of a trained agent. In issuing health insurance, information
from the application and, in some cases, inspection reports, physician
statements, or medical examinations are used to determine whether a policy
should be issued as applied for, issued with reduced coverage under a health
rider, or rejected.
Acquired Immunodeficiency Syndrome ("AIDS") claims identified to date, as a
percentage of total claims, have not been significant for the Life Insurance
Subsidiaries. Evaluating the impact of future AIDS claims under health and life
insurance policies issued is extremely difficult, in part due to the
insufficiency and conflicting data regarding the number of persons now infected
with the AIDS virus, uncertainty as to the speed at which the AIDS virus has and
may spread through the general population, and advancements in medical treatment
options. The Life Insurance Subsidiaries have implemented, where legally
permitted, underwriting procedures designed to assist in the detection of the
AIDS virus in applicants.
Investments. The Company derives a substantial portion of its revenue from
investments. The Life Insurance Subsidiaries maintain diversified investment
portfolios that are held primarily to fund future policyholder obligations.
State insurance laws impose certain restrictions on the nature and extent of
investments by insurance companies and, in some states, require divestiture of
assets contravening these restrictions. Within the framework of such laws, the
Life Insurance Subsidiaries follow a general strategy to maximize total return
(current income plus appreciation) without subjecting themselves to undue risk.
Where deemed appropriate, the Life Insurance Subsidiaries will hold selected
non-investment grade bonds that provide higher yields or are convertible to
common stock. The Company considers a bond non-investment grade if it is unrated
or rated less than BBB by Standard & Poor's Rating Group ("S&P") or BAA by
Moody's Investors Service ("Moody's"). The Company's non-investment grade bonds,
based on reported fair values, represented 4.4% of the Company's cash and
invested assets as of December 31, 2001. Citizens Security has maintained
substantial investments in equity securities in order to achieve higher
investment earnings than can usually be achieved through portfolio bonds but at
a greater comparative risk. The Company also maintains an investment portfolio
of equity securities separate from those of the Insurance Subsidiaries. Mortgage
loans, federally-insured mortgage-backed securities, collateralized mortgage
obligations and real estate investments, apart from the investment in the office
building described in Item 2. "Description of Property," represented
approximately 2.4% of cash and invested assets as of December 31, 2001. Neither
the Company nor its subsidiaries owned any collateralized mortgage-backed
securities as of December 31, 2001 that would be included in the high-risk
classification.
For additional information concerning investment results, see Item 7,
"Management's Discussion and Analysis."
Reinsurance. In keeping with industry practice, the Life Insurance Subsidiaries
reinsure, with unaffiliated insurance companies, portions of the life and health
insurance risks which they underwrite. The Life Insurance Subsidiaries retain no
more than $40,000 of individual life insurance risk and $15,000 of group life
insurance risk for any single life. Graded death benefit and simplified issue
coverages above $4,000 are generally 50% reinsured, with the Life Insurance
Subsidiaries maintaining a maximum $10,000 risk on any one life. Individual and
group accidental death coverage is 100% reinsured. At December 31, 2001,
approximately $109,227,000 or 13.5% of life insurance in force was reinsured
under arrangements described in Note 12 to the Consolidated Financial
Statements. Under most reinsurance arrangements described above, new insurance
is reinsured automatically rather than on a basis that would require the
reinsurer's prior approval. Generally, the Life Insurance Subsidiaries enter
into indemnity reinsurance arrangements to assist in diversifying their risks
and to limit its maximum loss on large or unusually hazardous risks. Indemnity
reinsurance does not discharge the ceding insurer's liability to meet policy
claims on the reinsured business. Accordingly, the Life Insurance Subsidiaries
remain responsible for policy claims on the reinsured business to the extent a
reinsurer should fail to pay such claims.
Competition. The insurance industry is highly competitive, with approximately
1,500 life and health insurance companies in the United States. Many insurers
and insurance holding company systems have substantially greater capital and
surplus, larger and more diversified portfolios of life and health insurance
policies, and larger agency sales operations than those of the Life Insurance
Subsidiaries. Financial and claims-paying ratings assigned to insurers by A.M.
Best Company ("Best") and by nationally-recognized statistical rating
organizations have become more important to policyholders. Citizens Security's
rating was last changed by Best in October, 2001, when it was downgraded to B-
(Fair) from B (Fair). United Liberty's rating has remained at B- (Fair) since
its 1998 acquisition. According to Best, B- ratings are assigned to companies
that have on balance, fair financial strength, operating performance and market
profile when compared to the standards established by Best. Also according to
Best, B- companies have an ability to meet their current obligations to
policyholders, but their financial strength is vulnerable to adverse changes in
underwriting or economic conditions. There are seven Best rating categories
above the B- category from B to A++. The Life Insurance Subsidiaries will
continue to pursue upward revisions in their Best ratings. Citizens Insurance
has no insurance business inforce and is not rated by Best.
S&P assigns claims-paying ability ratings to certain U.S. insurers. Generally,
such a rating is S&P's opinion of an insurer's financial capacity to meet the
obligations of its insurance policies in accordance with their terms. In the
case of companies like Citizens Security that have not requested ratings, S&P's
methodology uses statistical tests based on statutory financial data as filed
with the National Association of Insurance Commissioners ("NAIC"). The rating
process does not involve contact between S&P analysts and the insurer's
management. In 1998, S&P changed its rating methodology and revised Citizens
Security's rating from BBq to BBpi. (The "q" subscript designated the
quantitative method of rating while the "pi" subscript designates the public
information method). United Liberty has not been rated by S&P. According to S&P,
BB companies may have adequate financial security but their capacity to meet
policyholder obligations is vulnerable to adverse economic and underwriting
conditions. The BB rating is the highest of five ratings in the vulnerable range
of ratings.
A rating is not a recommendation to buy, sell or hold securities and is subject
to revision or withdrawal by the assigning rating organization. Each rating
should be evaluated independently of any other rating.
The Life Insurance Subsidiaries compete primarily on the basis of the
experience, size, accessibility and claims response of its customer service
representatives, product design, service and pricing. The Company believes that
the Life Insurance Subsidiaries are generally competitive in the markets in
which they are engaged based upon premium rates and services, have good
relationships with their agents, and have an adequate variety of insurance and
annuity products approved for issuance.
State Insurance Regulation. The Insurance Subsidiaries, in common with other
insurers, are subject to comprehensive regulation in the states in which they
are authorized to conduct business. The laws of such states establish
supervisory agencies with broad administrative powers, among other things, to
grant and revoke licenses for transacting business, regulate the form and
content of policies, establish reserve requirements, prescribe the type and
amount of allowable investments, and review premium rates for fairness and
adequacy. The Insurance Subsidiaries file detailed annual convention statements
with all states in which they are licensed to transact business. The Kentucky
Department of Insurance also periodically examines the business and accounts of
the Insurance Subsidiaries. In recent years, various state insurance departments
and the NAIC have expressed concern, essentially about the "rate of return"
earned by holders of small face amount life policies, potentially including
Preneed policies. Although the Company does not believe calculating a simple
"rate of return" is meaningful for traditional life insurance products, state
insurance regulators could take steps that would alter the profitability of
existing contracts and/or eliminate small face amount policies as a viable
product offering.
The Life Insurance Subsidiaries also can be required, under the solvency or
guaranty laws of most states in which they do business, to pay assessments (up
to prescribed limits) to fund policyholder losses or liabilities of other
insurance companies that become insolvent. These assessments may be deferred or
foregone under most guaranty laws if they would threaten an insurer's financial
strength and, in certain instances, may be offset against future premium or
intangible property taxes. Gross assessments for the Life Insurance
Subsidiaries, net of (refunds) but before offsets for future premium or
intangible property taxes, were $(1,000), $(11,000), and $(13,000) in 2001,
2000, and 1999, respectively.
Kentucky, in common with substantially all states, regulates transactions
between or affecting insurance holding companies and their insurance company
subsidiaries, including the Company and the Insurance Subsidiaries. Generally,
under Kentucky insurance holding company statutes, the Kentucky Department of
Insurance must approve in advance the direct or indirect acquisition of 15% or
more of the voting securities of an insurance company organized under the laws
of Kentucky. Such statutes also regulate certain transactions among affiliates,
including the payment of dividends by an insurance company to its holding
company parent. Under the Kentucky statutes, the Insurance Subsidiaries may not
during any year pay dividends on their common and preferred stock to their
parent company in excess of the lesser of the net gain from operations for the
preceding year or 10% of their capital and surplus at the end of the preceding
year, without the consent of the Kentucky Commissioner of Insurance. For 2002,
the maximum amount of dividends that Citizens Security, United Liberty, and
Citizens Insurance could pay, without the Commissioner's approval, is $339,000,
$214,000, and $75,000 respectively. It is presently anticipated that the Company
will derive substantially all of its liquidity from income and capital gains
earned on its investment portfolio, management service fees and dividends paid
by the Insurance Subsidiaries, and Citizens Security's repurchase of its
preferred stock owed by the Company. The Company provides substantially all
management, operating and employee services for the Insurance Subsidiaries and
is reimbursed at actual cost plus fifteen percent. This management fee totaled
$4,705,000 for 2001.
During recent years, the National Association of Insurance Commissioners (NAIC)
has taken several steps to address public concerns regarding insurer solvency.
These steps included implementing a state certification program designed to
promote uniformity among the insurance laws of the various states and developing
insurer reporting requirements that focus on asset quality, capital adequacy,
profitability, asset/liability matching, and liquidity. These requirements
include establishment of asset valuation reserves ("AVR") and interest
maintenance reserves ("IMR"), risk-based capital ("RBC") rules to assess the
capital adequacy of an insurer, and a revision to the Standard Valuation Law
("SVL") that specifies minimum reserve levels and requires cash flow testing in
which projected cash inflows from assets are compared to projected cash outflows
for liabilities to determine reserve adequacy.
The Life Insurance Subsidiaries' AVR, as of December 31, 2001, 2000 and 1999, is
shown in Item 7. "Management's Discussion and Analysis". Cash flow testing and
the results of such testing as applied to the Life Insurance Subsidiaries are
also described and discussed in Item 7.
RBC provides a means of establishing the capital standards for insurance
companies to support their overall business operations in light of their size
and risk profile. The four categories of major risk involved in the formula are
[i]~asset risk -- the risk with respect to the insurer's assets; [ii]~insurance
risk -- the risk of adverse insurance experience with respect to the insurer's
liabilities and obligations; [iii]~interest rate risk -- the interest risk with
respect to the insurer's business; and [iv]~business risk -- all other business
risks. A company's RBC is calculated by applying factors to various asset,
premium and reserve items, with higher factors for those items with greater
underlying risk and lower for less risky items. RBC standards are used by
regulators to set in motion appropriate regulatory actions relating to insurers
that show signs of weak or deteriorating conditions. They also provide an
additional standard for minimum capital, below which companies would be placed
in conservatorship. Based on RBC computations as of December 31, 2001, the
Insurance Subsidiaries each have capital which is well in excess minimum
regulatory requirements.
Action taken by the NAIC in these and other areas may have a significant impact
on the regulation of insurance companies during the next several years. In
addition, various proposals are being considered for permitting insurers to
elect Federal regulation. Given their comparatively small size, the Life
Insurance Subsidiaries could be adversely affected by more stringent regulatory
policy, both under existing laws and any new regulatory initiatives. Such
effects could include curtailment or discontinuance of insurance underwriting in
one or more states, mandated increases in capital and surplus, and/or other
effects.
Income Taxation. The Life Insurance Subsidiaries are taxed under the life
insurance company provisions of the Internal Revenue Code of 1986, as amended
(the "Code"). Under the Code, a life insurance company's taxable income
incorporates all income, including life and health premiums, investment income,
and certain decreases in reserves. The Code currently establishes a maximum
corporate tax rate of 35% and imposes a corporate alternative minimum tax rate
of 20%. See Item 7. "Management's Discussion and Analysis" and Note 8 of the
Notes to Consolidated Financial Statements.
The Code currently requires capitalization and amortization over a five to ten
year period of certain policy acquisition costs incurred in connection with the
sale of certain insurance products. Prior tax laws permitted these costs to be
deducted as incurred. These provisions apply to life, health, and annuity
business. Certain proposals to make additional changes in the federal income tax
laws, including increasing marginal tax rates, and regulations affecting
insurance companies or insurance products, continue to be considered at various
times in the United States Congress and by the Internal Revenue Service. The
Company currently cannot predict whether any additional changes will be adopted
in the foreseeable future or, if adopted, whether such measures will have a
material effect on its operations.
Reserves. In accordance with applicable insurance laws, the Life Insurance
Subsidiaries have established and carry as liabilities actuarially determined
reserves to meet their policy obligations. Life insurance reserves, when added
to interest thereon at certain assumed rates and premiums to be received on
outstanding policies, are required to be sufficient to meet policy obligations.
The actuarial factors used in determining reserves in the statutory basis
financial statements are based upon statutorily-prescribed mortality and
interest rates. Reserves maintained for health insurance include the unearned
premiums under each policy, reserves for claims that have been reported but not
yet paid, and reserves for claims that have been incurred but have not been
reported. Furthermore, for all health policies under which renewability is
guaranteed, additional reserves are maintained in recognition of the
actuarially-calculated probability that the frequency and amount of claims will
increase as policies persist. The Life Insurance Subsidiaries do not continue
accumulating reserves on reinsured business after it is ceded. The Life
Insurance Subsidiaries are required to maintain reserves on reinsured business
assumed on a basis essentially comparable to direct insurance reserves.
Reinsurance business assumed is presently insignificant in amount.
The reserves carried in the financial statements included in this Form 10-K are
calculated on the basis of accounting principles generally accepted in the
United States and differ from the reserves specified by laws of the various
states, which govern preparation of financial statements on the statutory basis
of accounting for the Life Insurance Subsidiaries. These differences arise from
the use of different mortality and morbidity tables and interest assumptions,
the introduction of lapse assumptions into the reserve calculation, and the use
of the level premium reserve method on all insurance business. See Note 1 of the
Notes to Consolidated Financial Statements for certain additional information
regarding reserve assumptions under accounting principles generally accepted in
the United States.
Employees. As of March 25, 2002, 74 people, excluding agents, were employed by
the Company. As of that date, the Company had approximately 3,000 independent
agents licensed to sell its products.
ITEM 2. PROPERTIES
The Company owns, through Citizens Security, a three-story, 63,000 square foot
office building in suburban Louisville, Kentucky completed in 1988. The Company
and its Subsidiaries occupy about 29% of the building for their headquarters and
home offices. The Company leases the remaining space to tenants under leases of
various duration. Market conditions for this property are generally favorable
and, in management's opinion, the property is adequately covered by insurance.
Currently, the Company's policy is not to invest in additional real estate or
real estate mortgages, although a change in such policy would not require a vote
of security holders. In addition, the Company's current bank lending agreement
precludes investment in additional real estate and in mortgages with a
loan-to-appraised-value ratio of more than 75%.
ITEM 3. LEGAL PROCEEDINGS
An action was filed against United Liberty in the Court of Common Pleas for
Butler County, Ohio by two policyholders in June 2000. The Complaint refers to a
particular class of life insurance policies that United Liberty issued over a
period of years ending around 1971. It alleges that United Liberty's dividend
payments on these policies from 1993 through 1999 were less than the required
amount. It does not specify the amount of the alleged underpayment but implies a
maximum of about $850,000. The plaintiffs also allege that United Liberty is
liable to pay punitive damages, also in an unspecified amount, for breach of an
implied covenant of good faith and fair dealing to the plaintiffs in relation to
the dividends. The action has been certified as a class action on behalf of all
policyholders whose policies were issued in Ohio and were still in force in
1993. United Liberty has denied the material allegations of the Complaint and is
defending the action vigorously. Pre-trial discovery is continuing. United
Liberty has filed a motion for summary judgment to which the plaintiffs have not
yet responded. Although United Liberty has requested mediation of the action,
the plaintiffs would not agree to the request for mediation until United Liberty
made an offer to settle the case. Consequently, United Liberty has offered to
settle the matter for payments over time, which would include attorneys' fees,
and which would be contingent upon an exchange or reformation of the insurance
policies currently owned by the members of the class for policies with an
increased premium and a set dividend. At this stage of the litigation, the
Company is unable to determine whether an unfavorable outcome of the action is
likely to occur or, alternatively, whether the chance of such an outcome is
remote. Therefore, at this time, management has no basis for estimating
potential losses, if any. There are no other material legal proceedings pending
against the Company or its subsidiaries or of which any of their property is the
subject other than routine litigation incidental to the business of the Company
and its subsidiaries. There are no material proceedings in which any director,
officer, affiliate or shareholder of the Company, or any of their associates, is
a party adverse to the Company or any of its subsidiaries or has a material
interest adverse to the Company or any of its subsidiaries.
ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by
this Form 10-K to a vote of the Company's security holders, through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
As of March 25, 2002, there were approximately 2,780 holders of record of the
Company's Class A Stock, its only class of common equity.
The Class A Stock is currently eligible for quotation on the National
Association of Securities Dealers, Inc.'s Small-Cap Market ("NASDAQ") under the
trading symbol CNFL. Trading volume in 2001 was about 8% of the average shares
outstanding during the year and trading volume by non-affiliates was about 20%
of the average shares owned by non-affiliates during the year.
The following table summarizes quarterly high and low bid quotations for the
Class A Stock in 2001 and 2000 as reported by NASDAQ. Such quotations reflect
inter-dealer prices and do not include retail markup, markdown, or commission,
and may not represent actual transactions.
Bid Quotations for Class A Stock
-------------------------------------
Quarter Ended High Bid Low Bid
---------------- -----------------
December 31, 2001 $ 9.750 $ 8.100
September 30, 2001 $ 10.000 $ 8.600
June 30, 2001 $ 10.875 $ 9.350
March 31, 2001 $ 11.500 $ 10.375
December 31, 2000 $ 12.750 $ 10.000
September 30, 2000 $ 16.313 $ 11.500
June 30, 2000 $ 13.875 $ 10.625
March 31, 2000 $ 12.750 $ 11.000
The Company has not paid a dividend on the Class A Stock. The Board of Directors
of the Company has not adopted a dividend payment policy; however, dividends
must necessarily depend upon the Company's earnings and financial condition,
applicable legal restrictions, and other factors relevant at the time the Board
of Directors considers a dividend policy. The Company is subject to a loan
agreement covenant that prevents it from paying dividends on the Class A Stock
without the consent of the lender except to the extent it can meet certain
requirements relating to the ratio of its outstanding borrowings compared to
dividends and income before interest expense, amortization, depreciation and
income tax expense for (5) consecutive quarters and provided that there is no
default or potential default under the loan agreement. As of January 2002, the
bank loan covenant precludes the Company from paying any dividends. Cash
available for dividends to shareholders of the Company must initially come from
income and capital gains earned on its investment portfolio, management service
fees and dividends paid by the Insurance Subsidiaries, and Citizens Security's
repurchase of its preferred stock owned by the Company. Provisions of the
Kentucky Insurance Code subject transactions between the Insurance Subsidiaries
and their respective parents, including dividend payments, to certain standards
generally intended to prevent such transactions from adversely affecting the
adequacy of the Insurance Subsidiaries' capital and surplus available to support
policyholder obligations. See Item 1. "Description of Business -- State
Insurance Regulation." In addition, under the Kentucky Business Corporation Act,
the Company may not pay dividends if, after giving effect to a dividend, it
would not be able to pay its debts as they become due in the usual course of
business or if its total liabilities would exceed its total assets.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31 2001 2000 1999 1998 1997
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
RESULTS OF OPERATIONS
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
Premiums and other considerations $28,744,376 $23,822,424 $20,844,828 $18,371,628 $17,690,877
Investment and other income, net 6,530,372 6,291,309 6,042,945 5,229,888 3,817,818
Policy benefits and reserve change 22,989,732 19,400,397 17,038,433 13,936,902 12,605,227
Commissions, expense, amortization, net 11,824,589 10,676,953 10,007,817 8,798,175 8,284,629
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
Segment profit (loss) 460,427 36,383 (158,477) 866,439 618,839
Realized investment gains (losses), net (7,911,829) 1,180,879 9,375,339 3,675,489 2,193,148
Interest expense 532,962 769,132 553,017 468,268 341,275
Cumulative effect - accounting change (311,211) --- --- --- ---
Income tax expense (benefit) (2,090,000) 210,000 2,225,000 774,000 482,500
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
NET INCOME (LOSS) $(6,205,575) $ 238,130 $ 6,438,845 $ 3,299,660 $ 1,988,212
NET INCOME (LOSS) APPLICABLE
TO COMMON STOCK $(6,205,575) $ 238,130 $ 6,438,845 $ 3,020,010 $ 1,581,212
NET INCOME (LOSS) PER SHARE:
Before accounting change $(3.39) $0.14 $3.59 $2.31 $1.47
Basic $(3.57) $0.14 $3.59 $2.31 $1.47
Diluted $(3.57) $0.14 $3.59 $1.82 $1.10
FINANCIAL POSITION
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
Total assets $136,597,083 $135,538,006 $137,980,030 $129,499,123 $ 84,749,842
Notes payable $ 7,095,834 $ 8,000,000 $ 8,500,000 $ 6,510,000 $ 3,510,000
Redeemable convertible preferred stock --- --- --- --- $ 4,043,907
Shareholders' equity $ 20,002,483 $ 23,274,109 $ 28,036,457 $ 21,745,281 $ 14,320,885
Shareholders' equity per share - Basic $11.65 $13.24 $15.86 $12.06 $13.31
Shareholders' equity per share - Diluted $11.65 $13.24 $15.86 $12.06 $10.11
INVESTMENTS
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
Average cash and invested assets $112,982,243 $121,807,002 $115,045,517 $ 98,436,023 $ 70,294,955
Average equity portfolio (cost basis) $ 9,736,625 $ 20,017,915 $ 20,650,875 $ 14,529,633 $ 11,587,579
Investment income yield 5.6% 4.9% 5.1% 5.3% 5.4%
Change in unrealized investment gains
(losses), net of tax $ 3,019,188 $ (4,896,265) $ 243,355 $ 484,618 $ 2,166,218
LIFE INSURANCE DATA
----------------------------------------- --------------- --------------- --------------- -------------- ---------------
Premiums $ 19,362,994 $ 14,553,493 $ 12,443,385 $ 10,657,675 $ 9,127,795
Insurance in force, net at end of period $ 703,288,000 $ 706,044,000 $ 646,439,000 $ 634,578,000 $ 565,446,000
ACCIDENT AND HEALTH INSURANCE DATA
------------------------------------------------------------------------------------------------------------------------
Premiums $ 9,381,382 $ 9,268,931 $ 8,401,443 $ 7,713,953 $ 8,563,082
Benefit ratio 67.9% 66.7% 65.2% 65.4% 66.4%
Note: See Item 7 for additional information relevant to the above data. The above amounts include results from acquisitions:
National Affiliated Investors Life Insurance Company (reinsurance assumption), Citizens Insurance Company and United Liberty
Life Insurance Company from the dates of their acquisition in 2000, 1999 and 1998, respectively.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS
The Company's 2001 net loss was $6,206,000 compared to net income of $238,000
and $6,439,000 in 2000 and 1999, respectively. In addition, the comprehensive
loss (including net unrealized losses) for 2001 was $2,875,000 compared to a
comprehensive loss of $4,658,000 in 2000 and a comprehensive gain of $6,682,000
in 1999. The majority of the 2001 and 2000 declines in net income and the
comprehensive losses in 2001 and 2000 are attributable adverse securities
markets during those years, including the effects of declines in the
telecommunications and technology sectors, a general economic recession and
terrorist events.
During 2001, the Company achieved a 21% or $4,922,000 increase in premiums. The
majority of the increase was in the Preneed Life segment, although increases
were also achieved in the other four segments. Pretax segment earnings,
excluding realized investment gains and losses and interest expense, were
$460,000 and $36,000 for 2001 and 2000 respectively. This improvement is
primarily attributable to increased Preneed Life production.
The Company repurchased 41,400 and 9,000 shares of its common stock during 2001
and 2000 respectively, at average prices of $9.58 and $11.58 per share,
respectively.
The Company manages its operations in five business segments, Home Service Life,
Broker Life, Preneed Life, Dental, and Other Health. Products in all five
segments are sold through independent agency operations. Home Service Life
consists primarily of traditional life insurance coverage sold in amounts of
$10,000 and under to middle and lower income individuals. This distribution
channel is characterized by a significant amount of agent contact with customers
throughout the year. Broker Life product sales consist primarily of simplified
issue and graded-benefit policies in amounts of $10,000 and under. Other
products in the Broker Life segment which comprise a significant portion of
existing business include group life, universal life, annuities and
participating life coverages. Preneed Life products are sold to individuals in
connection with prearrangement of their funeral and include single and multi-pay
coverages, generally in amounts of $10,000 and less. These policies are
generally sold to older individuals at increased premium rates. Dental products
are term coverages generally sold to small and intermediate size employer
groups. Other Health products include various accident and health coverages sold
to individuals and employer groups. Profit or loss for each segment is reported
on a pretax basis, without an allocation of realized investment gains or
interest expense.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based on its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. Preparation of these financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, the Company evaluates its estimates,
including those related to investments, agent receivables, intangible assets,
policy liabilities, income taxes, regulatory requirements, contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following accounting
policies, judgments and estimates critically impact preparation of its
consolidated financial statements.
Investment in Debt and Equity Securities. The Company holds debt and equity
interests in a variety of companies, many of which are seeking to exploit recent
technology advancements. The majority of these are publicly traded and many have
experienced volatile market prices. The Company records an investment impairment
charge when it believes an investment has experienced a decline in value that is
other than temporary. Future adverse changes in market conditions or poor
operating results of underlying investments could result in losses or an
inability to recover the current carrying value of the investments, thereby
possibly requiring an impairment charge in the future.
Goodwill and Intangible Impairment. Assessing recoverability of the Company's
goodwill and other intangibles (including deferred policy acquisition costs and
value of insurance acquired) requires assumptions regarding estimated future
cash flows and other factors (see Policy Liabilities below) to determine the
fair value of the respective assets. If these estimates or their related
assumptions change in the future, the Company may be required to record
impairment charges for these assets not previously recorded. On January 1, 2002
the Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," and will be required to expand its
analysis of goodwill for impairment issues during the first six months of 2002,
and then on a periodic basis thereafter. The Company has not yet determined what
the effect of the new standard will be on its earnings and financial position.
During the year ended December 31, 2001, the Company did not record any
impairment losses related to goodwill and other intangible assets.
Policy Liabilities. Establishing liabilities (and related intangible assets) for
the Company's long-duration insurance contracts requires making many
assumptions, including policyholder persistency, mortality rates, investment
yields, discretionary benefit increases, new business pricing, and operating
expense levels. The Company evaluates historical experience for these factors
when assessing the need for changing current assumptions. However, since many of
these factors are interdependent and subject to short-term volatility during the
long-duration contract period, substantial estimates and judgment are required.
Accordingly, if actual experience emerges differently from that assumed,
material financial statement adjustments could be required. Deferred Taxes. The
Company records a valuation allowance to reduce its deferred tax assets to the
amount that it believes is more likely than not to be realized. In assessing the
need for the valuation allowance, the Company has considered ongoing prudent and
feasible tax planning strategies but has not assumed future taxable income. In
the event the Company were to determine that it would be able to realize its
deferred tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax asset would increase income in the period such
determination was made. Likewise, should the Company determine that it would not
be able to realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made.
ACQUISITIONS
National Affiliated Investors Life
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 "NAIL Acquisition"). The acquisition was coordinated through the
National Organization of Life and Health Guaranty Associations. The acquired
business consists primarily of individual life insurance business with policy
reserves and annual premium of approximately $3,500,000 and $300,000,
respectively.
Citizens Insurance Company
On October 14, 1999, the Company acquired 100% of the stock of Citizens
Insurance (formerly Kentucky Insurance Company) from an unaffiliated insurance
holding company (the "Citizens Insurance Acquisition"). Citizens Insurance is
licensed as a property and casualty insurance company in four states and has
approximately $3.6 million of statutory capital and surplus; however, it
currently has no insurance operations. The aggregate purchase price for the
Citizens Insurance Acquisition was approximately $3,550,000 (including net costs
associated with the transaction of approximately $50,000). The acquisition was
financed with available internal funds and $2,500,000 of additional bank
borrowings.
United Liberty Life Insurance Company
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 aggregate purchase price for the
United Acquisition was approximately $7,076,000 (including net costs associated
with the acquisition of approximately $445,000). In conjunction with the
acquisition, the seller retained approximately $2,100,000 of United Liberty's
real estate related and other assets, which were replaced with cash by Citizens
Security. The United Acquisition was financed with working capital of Citizens
Security and approximately $3,400,000 of additional bank borrowings.
Integrity National Life Insurance Company
During September 1995, the Company and Citizens Security acquired the common
stock of Integrity National Life Insurance Company from an unaffiliated
insurance holding company. The aggregate purchase price for the Integrity
acquisition, as finally adjusted, was $9,419,000 (including $437,000 of net
transaction costs). Integrity National was merged into Citizens Security during
1995.
FINANCIAL POSITION
Assets. At December 31, 2001, the Company's available-for-sale fixed maturities
had a fair value of $77,534,516 and amortized cost of $75,872,277. The Company's
fixed maturities portfolio increased approximately 5% during both 2001 and 2000,
on an amortized cost basis. The 2001 increase is primarily attributable to
Preneed Life sales growth, while the 2000 increase resulted primarily from the
NAIL acquisition. Shown below is a distribution by rating category of the
Company's fixed maturities portfolio as of December 31, 2001.
Standard & Poor's Corporation Rating Amortized Cost1 Fair Value 2
-------------------------------------- ----------------------- ---------------
Investment grade:
AAA to A- $58,409,236 $60,088,109
BBB+ to BBB- 12,368,821 12,455,710
-------------------------------------- ------------------------ ---------------
Total investment grade 70,778,057 72,543,819
Non-investment grade:
BB+ to BB- 1,599,610 1,580,809
B+ to B- 2,726,890 2,641,241
CCC+ to C 767,720 768,647
-------------------------------------- ------------------------ ---------------
Total non-investment grade 5,094,220 4,990,697
-------------------------------------- ------------------------ ---------------
Total fixed maturities $75,872,277 $77,534,516
-------------------------------------- ------------------------ ---------------
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, 2001 were obtained from the Company's
investment advisor's portfolio review, which used market prices from Shaw
Data Services
The Company believes it has a well diversified portfolio and has no plans to
decrease its non-investment grade portfolio significantly below its current
level, unless necessary to satisfy requirements of state regulators or rating
agencies. The Company purchases non-investment grade bonds to obtain higher
yields or convertible features and attempts to reduce credit risk by portfolio
diversification. Non-investment grade securities comprised 6.7% and 8.3% of the
fixed maturities portfolio, on an amortized cost basis at December 31, 2001 and
2000, respectively.
Shown below are the Company's four largest holdings in non-investment grade
bonds by a single issuer as of December 31, 2001.
Non-Investment Grade
December 31, 2001 Amortized Cost Fair Value
------------------------------- ------------------- ------------------
Largest $904,604 $902,371
Second largest 573,477 374,000
Third largest 535,029 398,750
Fourth largest 500,000 507,500
------------------------------- ------------------- ------------------
Total $2,513,110 $2,182,621
------------------------------- ------------------- ------------------
The Company had no guarantee or other type of enhancement associated with the
issuers represented above.
The Company's investment in equity securities decreased $6,622,000 and
$4,460,916 during 2001 on a cost (net of write-downs) and fair value basis,
respectively, after decreasing $4,551,000 and $10,363,000 on the same basis in
2000. As of December 31, 2001 there were $1,062,000 of unrealized gains
on equity securities, as compared with $1,099,000 of unrealized losses at
December 31, 2000 and $4,713,000 of unrealized gains at December 31, 1999,
respectively.
The Company reviews its marketable investments each quarter to determine if
there have been declines in their value that in management's opinion are
other-than-temporary. These reviews can involve qualitative and quantitative
information relating to an individual company or industry and general factors
impacting the economy. However, due to wide market fluctuations occurring during
the past two years, determining whether declines are temporary has become much
more complex and judgmental. These reviews resulted in the recognition of
impairment losses on equity securities totaling $1,533,000 during 2001
($332,000, $1,123,000, and $78,000 for the second through fourth quarters,
respectively). In addition, $739,000 of impairment losses were recognized on
fixed maturities during 2001 ($7,000, $4,000, and $728,000 during the first,
second, and fourth quarters, respectively). During 2001, equity securities and
fixed maturities were sold which contained impairment writedowns of $5,160,000
and $940,000, respectively.
Citizens Security owns the building in which the Company and its subsidiaries
maintain their home offices. The Company occupies approximately 29% of the
building with the balance leased to third-party tenants. Market conditions for
this property are generally favorable. An updated appraisal obtained during 2001
indicates the market value of the property is approximately $2,500,000 higher
than its carrying value.
At December 31, 2001, the Company holds a $156,000 mortgage loan from a real
estate limited partnership. The mortgage loan, maturing March 31, 2002, permits
revolving credit advances, not to exceed at any time, the lesser of $750,000 or
80% of the collateral fair value. A stockholder of the partnership's general
partner personally guarantees 80% of the loan.
At December 31, 2001 the Company has recorded $756,000 of goodwill and
$12,757,000 of other intangible assets for deferred policy acquisition costs and
value of insurance acquired. As noted in the above discussion of critical
accounting policies and estimates, these intangibles, and the recorded value of
policy liabilities, are based on many assumptions that require substantial
estimates and judgment. In connection with adoption of SFAS No. 142, the Company
will be perform a detailed reassessment of the assumptions supporting these
values.
Liabilities. A comparison of total policy liabilities as of December 31, 2001,
2000 and 1999 is shown below. Approximately 83% of the 2001 total consists of
future policy benefit reserves while policyholder deposit liabilities represent
15% of the total.
Year Ended December 31 2001 2000 1999
------------------------------------------ ------------------- ------------------ -------------------
Home Service Life $ 32,609,959 $ 31,543,557 $ 30,300,225
Broker Life 44,414,974 44,631,499 41,718,948
Preneed Life 27,512,646 23,094,830 21,509,265
Dental 565,119 610,111 633,751
Other Health 2,137,079 2,143,247 3,031,510
------------------------------------------ ------------------- ------------------ -------------------
Total $107,239,777 $102,023,244 $ 97,193,699
------------------------------------------ ------------------- ------------------ -------------------
Home Service Life sales have been favorable in recent years, with net growth in
policy liabilities of 3.4% and 4.1% in 2001 and 2000, respectively. During
recent years, this segment has experienced moderate growth through a combination
of attracting new producers and continuing to focus on meeting the needs of
existing customers and agents. The Broker Life segment's 2001 policy liability
net decline of $217,000 includes $464,000 of declines in policyholder deposits
as detailed below, partially offset by normal aging of remaining reserves.
Approximately half of the net policyholder deposit decline relates to expiration
of a withdrawal waiting period for the NAIL business acquired during 2000. Most
of the 2000 Broker Life net growth was attributable to the NAIL acquisition.
During 2001, the Company increased Preneed Life production through arrangements
with several third party marketing groups. Although the Company terminated some
of its more competitive arrangements during the year, it has attracted
additional marketing groups that have continued to grow net production
throughout the year. The 2000 growth was achieved in the Company's second full
year in the Preneed market, after completing the United Acquisition in 1998.
However, United Liberty began offering Preneed Life insurance in 1991. The
Company's Dental products are annual term coverages; accordingly, policy
liabilities for this segment are not significant. The Other Health segment
business in not a significant marketing focus. The 2000 policy liability
decrease for this segment relates primarily to the settlement of a reinsurance
obligation with no impact on overall retention.
Shown below is a progression of the Company's policyholder deposit activity for
the year ended December 31, 2001.
Year Ended December 31, 2001 Total Annuity and Universal
Other Life
-------------------------------- --------------- --------------- ---------------
Beginning Balance $16,381,247 $ 10,004,531 $ 6,376,716
Deposits 1,006,892 426,098 580,794
Withdrawals (2,205,095) (951,457) (1,253,638)
Interest Credited 734,687 428,769 305,918
-------------------------------- --------------- --------------- ---------------
Ending Balance $15,917,731 $ 9,907,941 $ 6,009,790
-------------------------------- --------------- --------------- ---------------
As indicated above, total policyholder deposits decreased $464,000 during 2001,
with approximately $250,000 of the decrease attributable to withdrawals of NAIL
business acquired during 2000. The terms of the NAIL Acquisition precluded
policyholder withdrawals and surrenders for the initial six months after the
acquisition. This limitation expired during early 2001. The Company is not
devoting significant marketing effort towards Annuity, Universal Life and other
deposit products and has elected not to aggressively compete in crediting excess
interest on such products.
CONSOLIDATED RESULTS AND ANALYSIS
Premiums and Other Considerations. The following table details premiums and
other considerations received during the past three fiscal years.
Year Ended December 31 2001 2000 1999
----------------------------- -------------------- -------------------- --------------------
Home Service Life $7,152,242 $6,906,473 $6,697,932
Broker Life 3,812,841 3,664,072 3,447,440
Preneed Life 8,397,911 3,982,948 2,298,013
Dental 7,988,620 7,892,356 7,105,627
Other Health 1,392,762 1,376,575 1,295,816
----------------------------- -------------------- -------------------- --------------------
Total $ 28,744,376 $ 23,822,424 $ 20,844,828
----------------------------- -------------------- -------------------- --------------------
Home Service Life premium increased 3.6% during 2001 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, the
Company's program to automate and streamline agent field accounting continues to
expand with favorable reaction among the agency force. During 2001 the Company
also began a Home Service marketing joint venture in two southern states with a
much larger property and casualty insurance carrier.
The 4.1% Broker Life premium increase during 2001 is primarily attributable to
receiving a full year of premium on the NAIL business compared to receiving six
months of additional premium during 2000. In addition, during the past two
years, the Company experienced some softening in sales growth for simplified
issue and graded benefit life policies.
The 111% increase in Preneed Life premium during 2001 and the 73% increase
during 2000 resulted from intensified marketing efforts aimed at defining the
Company as a committed participant in this market, successfully negotiating
competitive third-party marketing agreements, implementing various product
enhancements, and positive referrals from customers who comment favorably on the
Company's organization and customer service.
The 1% growth in Dental premium during 2001 resulted from normal inflationary
rate increases, partially offset by the loss of a large group case. The 11%
increase during 2000 included inflationary increases and net new production.
During 2001 new business production has become increasingly competitive as
larger providers expand their marketing initiatives. However, the Company has
historically maintained strong customer and agent loyalty by continuing to
improve customer service, including sales and administrative support functions.
The Company has not been actively marketing Other Health coverages for several
years. However, in response to agent requests, certain cancer and disability
protection products have been updated and promoted. Pricing, underwriting, and
claims experience on these products are closely monitored.
Investments. The Company monitors its available-for-sale fixed maturities and
equity securities to assure they are strategically positioned within the current
market environment. This practice has historically resulted in equity securities
comprising 10% to 20% of the Company's cash and invested assets, which tends to
dampen current income yields in favor of an overall total return focus.
Investment income yields were 5.6%, 4.9%, and 5.1% for 2001, 2000, and 1999,
respectively. The 2001 yield increase resulted primarily from carrying
significantly lower levels of equity securities and higher levels of fixed
maturity investments. The 2000 yield decrease resulted primarily from higher
short-term investment balances along with a temporary increase in real estate
vacancy rates. Although the Company's total return on investments has generally
been very favorable, returns for 2001 and 2000 were severely impacted by
declines in the telecommunications and technology sectors, a general economic
recession and the effect of terrorist events on the securities markets. As
detailed below, net realized and unrealized investment losses totaled
approximately $(10,200,000) for the two years ended December 31, 2001,while net
realized and unrealized gains totaled approximately $14,200,000 for the two
years ended December 31, 1999. The Company does not anticipate continued severe
deterioration in the securities markets. At December 31, 2001, the Company's
investment portfolios are positioned more conservatively compared to the prior
two years, and they contain a net unrealized gain of $2,316,000. Below is an
approximate calculation of investment income yields and total return rates for
the four years ending December 31, 2001.
Year Ended December 31, 2001 2000 1999 1998
------------------------------------- --------------- --------------- --------------- ---------------
Investment Income $6,274,143 $5,993,362 $5,885,312 $5,190,322
Gains and Losses:
Fixed Maturities:
Realized gains (losses) (1,260,092) 1,061,089 243,949 827,204
Unrealized gains (losses) 2,303,205 (1,655,112) (1,804,929) 1,158,586
------------------------------------- --------------- --------------- --------------- ---------------
Net Fixed Maturities 1,043,113 (594,023) (1,560,980) 1,985,790
Equity Securities:
Realized gains (losses) (7,123,269) 119,790 9,131,390 2,848,285
Unrealized gains (losses) 2,160,985 (5,812,184) 2,238,293 (454,225)
------------------------------------- --------------- --------------- --------------- ---------------
Net Equity Securities (4,962,284) (5,692,394) 11,369,683 2,394,060
------------------------------------- --------------- --------------- --------------- ---------------
Total Gains and Losses (3,919,171) (6,286,417) 9,808,703 4,379,850
------------------------------------- --------------- --------------- --------------- ---------------
Total Return $2,354,972 $(293,055) $ 15,694,015 $9,570,172
------------------------------------- --------------- --------------- --------------- ---------------
Average Cash and Investments $112,980,000 $121,810,000 $115,050,000 $98,436,000
Yield - Income 5.6% 4.9 % 5.1% 5.3%
Yield - Total Return 2.1% (0.2)% 13.6% 9.7%
Segment Earnings.
The 2001 loss before income tax and the cumulative effect of a change in
accounting principle was $7,984,000 compared to income of $448,000 and
$8,664,000 in 2000 and 1999, respectively. Pretax profit (loss) is shown below
for the Company's five business segments, along with total realized investment
gains and interest expense.
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Home Service Life $ 382,723 $ 200,479 $ 312,703
Broker Life 74,960 299,777 150,317
Preneed Life (264,488) (827,265) (993,560)
Dental 256,385 331,206 436,587
Other Health 10,847 32,186 (64,524)
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Profit (Loss) 460,427 36,383 (158,477)
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
Interest expense 532,962 769,132 553,017
------------------------------------------------------ ----------------- ---------------- -----------------
Income (Loss) before income tax and cumulative $ (7,984,364) $ 448,130 $ 8,663,845
effect of a change in accounting principle
------------------------------------------------------ ----------------- ---------------- -----------------
The 2001 increase in Home Service Life profit resulted primarily from continuing
sales growth and improved mortality results, while the 2000 decline resulted
primarily from the moderate business growth, offset by a slight increase in
mortality. The 2001 Broker Life earnings decrease resulted primarily from
increased mortality and expenses while the 2000 earnings increase resulted
primarily from improved mortality on simplified issue and graded benefit life
plans. The 2001 Preneed Life loss improved approximately $563,000 from the prior
year while premium increased approximately 111%. This volume growth leverages
the Company's fixed costs and has improved per-policy profitability.
Additionally, the Company has revised certain product benefits and agent
incentives to further improve profitability. The 2000 Preneed Life loss
improvement was 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. However, interest rate declines
during 2001 and 2000 have adversely impacted the Company's investment income
earnings on recent Preneed Life sales. Although the Company is optimistic about
improving growth and profitability in this highly competitive market, if adverse
profitability trends develop, several options are available. These options,
including lowering discretionary annual benefit increases and adjusting premiums
and commissions on new business, would likely adversely impact the Company's
ability to compete for new business.
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 2001 2000 1999
--------------------------- ----------------- --------------- -----------------
Premium $7,988,620 $7,892,356 $7,105,627
Claims and Reserves $5,551,624 $5,369,742 $4,717,678
Contribution Margin $1,465,017 $1,516,948 $1,432,204
Claim Ratio 69.5% 68.0% 66.4%
The overall Dental contribution margin declined slightly during 2001 due to
increased claim levels. The 2000 contribution margin increase resulted from an
11% increase in premium volume that more than offset the higher claim ratio.
During 2001 the Company encountered more competition as additional insurers are
expanding in the Dental market and Dental providers are continuing to provide
higher levels of care to patients. The Company is continuing its ongoing efforts
to maintain profitability in this line by reconfiguring products to provide
adequate margins for the various dental procedures, utilizing a third-party
company to provide expert assistance with ongoing adjudication of claims, and
continuing its program of aggressive renewal underwriting and re-rating. 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, during 2001
the Company began implementing significant rate increases on certain older
blocks of Other Health business.
Income Taxes. Historically, the Company has experienced a relatively low
effective income tax rate, due primarily to the small life insurance company
deduction. The effective rate was approximately 26% in 2001 and 1999. 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 8 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 17%, rather than 34%. The Company's valuation allowance is
designed to reduce deferred tax assets to their estimated ultimate realization
value.
Statutory Insurance Information. For insurance regulatory and rating purposes,
the Insurance Subsidiaries report on the basis of statutory accounting
principles ("SAP"). As described in Note 9 to the Consolidated Financial
Statements, effective January 1, 2001 portions of SAP were revised by
"Codification". In recent years, various state insurance departments and the
NAIC have expressed concern, essentially about the "rate of return" earned by
holders of small face amount life policies, potentially including Preneed
policies. Although the Company does not believe calculating a simple "rate of
return" or premium "pay-back" measure is meaningful for traditional life
insurance products, certain state insurance regulators are considering actions
that could alter the profitability of existing contracts or eliminate small face
amount policies as a viable product offering. During 2001, A.M. Best Company
("Best") downgraded Citizens Security's rating to B- from B. United Liberty's
rating has remained at B- by Best since it was acquired in 1998, and Citizens
Insurance, due to its lack of insurance operations, is not rated.
Effective January 31, 2001, Citizens Financial contributed 100% of the capital
stock of Citizens Insurance to Citizens Security. The statutory value of this
contribution was $3,540,555. Citizens Security reports its investment in United
Liberty and Citizens Insurance on the equity method of accounting, since their
acquisition in 1998 and 2001, respectively. However, beginning in 2001,
Codification changed the statutory equity method of accounting to preclude a
parent insurer from recording as income, its share of undistributed subsidiary
earnings. Accordingly, from 1998 through 2000, Citizens Security's net income
includes the net earnings of United Liberty, $404,553, $234,853, and $289,489,
in 1998, 1999, and 2000, respectively. For 2001, Citizens Security reported as
income the $292,000 of dividend distributions which it received from United
Liberty. At December 31, 2001, Citizens Security reported its investments in
United Liberty and Citizens Insurance at their statutory equity value of
$2,695,333 and $3,601,560, respectively. To provide a more detailed
understanding of Citizens Security's operations, shown below are SAP basis net
income, net operating income, statutory capital and surplus, asset reserves, and
capital ratios for Citizens Security for the five years ended December 31, 2001.
Net Statutory Asset
Year Ended Net Operating Capital and Valuation Capital
December 31 Income (Loss) Income Surplus Reserves1 Ratio2
----------------------- --------------- --------------- --------------- --------------- ------------
2001 $(3,497,701) $ 361,863 $ 9,687,289 $ 978,418 13.6%
2000 $ 1,868,575 $ 715,250 $ 8,315,902 $1,589,735 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%
----------------------- --------------- --------------- --------------- --------------- ------------
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 1998 through 2001 amounts also include United Liberty's reserves.
2 Represents Statutory Capital and Surplus plus Asset Valuation Reserves divided by invested assets plus cash.
During 2001, statutory capital and surplus and asset reserves increased
approximately, $760,000. This increase resulted primarily from the Citizens
Insurance capital contribution noted above, plus $1,082,000 of unrealized gains
offsetting the $3,498,000 net loss and a $572,000 increase in nonadmitted
assets. 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. 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.
In addition to the statutory totals shown above, Citizens Insurance generated
statutory net income of approximately $76,000, $93,000, and $21,000 during,
2001, 2000, and 1999, respectively.
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 that
surplus strain will dampen statutory earnings.
CASH FLOW AND LIQUIDITY
During 2001, the Company generated approximately $6,394,000 of cash flow from
operations, while using $467,000 in 2000, and generating $361,000 in 1999. The
2001 increase is principally attributable to growth of Preneed Life premium
collections and refunding of Federal income tax deposits made during the prior
year. The 2000 decrease is principally attributable to Federal income tax
deposits required early in the year.
Cash used by investment activities during 2001 of $5,555,000 resulted primarily
from investing additional Preneed Life premiums in fixed maturity securities.
Cash provided by investment activities during 2000 of $4,488,000 resulted
primarily from a reduction in equity portfolio positions and net cash received
from acquisition of the NAIL business, partially offset by additional property
and equipment expenditures, including a fractional aircraft ownership share.
Cash provided by investment activities during 1999 of $11,200,000 resulted
primarily from a decision to limit reinvestment activity near year-end, due to
increased market volatility. Cash used by financing activities during 2001
includes net withdrawals of policyholder deposits totaling approximately
$1,200,000, debt repayments of $904,000 and common stock repurchases of
$396,000. The policyholder withdrawals are principally due to the Company's
decision not to aggressively compete in crediting higher interest returns on
such funds. However, net policyholder withdrawals decreased in 2001 compared to
a total of $1,900,000 in 2000 and $1,400,000 in 1999. Cash from financing
activities in 1999 also includes proceeds from a $2,500,000 bank borrowing
associated with the Citizens Insurance Acquisition, net brokerage advance
repayments of $1,400,000, and common stock repurchases of approximately
$390,000.
The Company is subject to various market risks. However, the most significant
such risks relate to fluctuations in prices of equity securities and interest
rates. Although the Company experienced negative total returns on its equity
portfolio in 2001 and 2000, historically these returns have been very favorable
and the Company has successfully managed the risk of equity security price
fluctuations over many years. As described above, the Company does not
anticipate that investment markets will continue to deteriorate at the rate
encountered during 2001 and 2000. The Company and its investment advisory firm,
SMC Advisors, Inc. devote significant attention to the equity markets and
reposition the Company's portfolio upon detection of adverse risk trends
associated with individual securities or overall markets. SMC Advisors, Inc.
also manages market risks associated with investments in option securities, as
described in Item 8, Note 3 of the Notes to Consolidated Financial Statements.
The fair value of the Company's equity portfolio was approximately $8,117,000
and $12,578,000 at December 31, 2001 and 2000, respectively. Accordingly, a 10%
decline in equity prices would have reduced the fair value of the Company's
equity portfolio by $811,700 and $1,257,800 at December 31, 2001 and 2000,
respectively.
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 have decreased the fair value of its
$77.5 million fixed maturity portfolio by approximately 2.8% or $2.2 million at
December 31. 2001 and 2.8% or $2.0 million at December 31, 2000. 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 40% 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, 2001 cash and fixed-maturity
investments with maturities of less than five years equaled more than 48% 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.
Interest expense on the Company's commercial bank debt is also subject to
interest rate risk. The rate on this debt is variable and quarterly, the Company
elects the lower of the prime lending rate or the one-month LIBOR rate plus
2.75%. At December 31, 2001, the rate on the Company's $7,095,834 of bank
borrowings was 4.68%. The Company believes its current liquidity position and
profitability levels are adequate to guard against this interest rate risk.
In addition to the measures described above, the Life Insurance Subsidiaries
comply with the NAIC promulgated Standard Valuation Law ("SVL") which specifies
minimum reserve levels and prescribes methods for determining them, with the
intent of enhancing solvency. The SVL also requires the Company to perform
annual cash flow testing for its Life Insurance Subsidiaries. This testing is
designed to ensure that statutory reserve levels will maintain adequate
protection in a variety of potential interest rate scenarios. The Actuarial
Standards Board of the American Academy of Actuaries also requires cash flow
testing as a basis for the actuarial opinion on the adequacy of the reserves
which is a required part of the annual statutory reporting process.
Cash flow testing projects cash inflows from assets and cash outflows for
liabilities in various assumed economic and yield curve scenarios. This is a
dynamic process, whereby the performance of the assets and liabilities is
directly related to the scenario assumptions. (An example would involve the
credited interest rate on annuity products and how such rates vary depending
upon projected earnings rates, which are based upon asset performance under a
particular economic scenario.)
The Life Insurance Subsidiaries' most recent cash flow testing, which was
completed in February 2002, 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
insurance, which involves lifetime obligations, is usually best matched by
longer duration maturities. In the event there are insufficient assets of these
types, a repositioning of the investment portfolio might be undertaken.
Initially balanced durations do not guarantee positive future results. Asset
type, quality, and yield will vary depending upon the economic scenario tested.
Liabilities will be similarly affected. Projected reinvestment yields may cause
overall yields to fall below those required to support projected liabilities. In
that event, portfolio realignment might involve the type, quality and yield of
investments rather than duration. Alternatively, additional reserve amounts
could be allocated to cover any future shortfalls.
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.
However, due to securities losses incurred during 2001 and 2000, the Company has
negotiated less stringent debt covenants. Although the Company anticipates being
able to meet these covenants, further significant deterioration of the
securities markets could jeopardize this situation. The Company expects to
service debt and other expenses by:
|X| Management fees charged to the Insurance Subsidiaries
|X| Redemption of Citizens Security preferred stock as necessary, with
such redemption also requiring approval by the Kentucky Department of
Insurance
|X| Dividends from the Insurance Subsidiaries, which are limited by law to
the lesser of prior year net operating income or 10% of prior year-end
capital and surplus unless specifically approved by the Kentucky
Department of Insurance
FORWARD-LOOKING INFORMATION
All statements, trend analyses and other information contained in this report
relative to markets for the Company's products and trends in the Company's
operations or financial results, as well as other statements including words
such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and
other similar expressions, constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors which may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, among
other things:
|X| the market value of the Company's investments, including stock market
performance and prevailing interest rate levels (see the Cash Flow and
Liquidity section of Item 7);
|X| customer and agent response to new products, distribution channels and
marketing initiatives, including exposure to unrecoverable advanced
commissions;
|X| mortality, morbidity, lapse rates, and other factors which may affect
the profitability of the Company's insurance products;
|X| regulatory changes or actions, including those relating to regulation
of insurance products and insurance companies (see the State Insurance
Regulation section of Item 1);
|X| ratings assigned to the Company and its subsidiaries by independent
rating organizations which the Company believes are important to the
sale of its products;
|X| general economic conditions and increasing competition which may affect
the Company's ability to sell its products;
|X| the Company's ability to achieve anticipated levels of operating
efficiencies and meet cash requirements based upon projected liquidity
sources;
|X| unanticipated adverse litigation outcomes (see Item 3); and
|X| changes in the Federal income tax laws and regulations which may affect
the relative tax advantages of some of the Company's products.
There can be no assurance that other factors not currently anticipated by
management will not also materially and adversely affect the Company's results
of operations.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about market risk are described in the
Cash Flow and Liquidity section of Item 7 - Management's Discussion and
Analysis.
ITEM 8. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
Financial Statements For Full Fiscal Years Page
Report of Independent Auditors...........................................26
Consolidated Statements of Operations for the
years ended December 31, 2001, 2000 and 1999.............................27
Consolidated Statements of Financial Condition at
December 31, 2001 and 2000...............................................28
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 2001, 2000 and 1999.....................30
Consolidated Statements of Cash Flows for the
years ended December 31, 2001, 2000 and 1999.............................31
Notes to Consolidated Financial Statements...............................32
Financial Statement Schedules
Schedule I - Summary of Investments - Other than Investments
In Related Parties..........................47
Schedule II - Condensed Financial Information of Registrant...........48
Schedule III - Supplementary Insurance Information.....................51
Schedule IV - Reinsurance..............................................52
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted or the
information is presented in the consolidated financial statements or related
notes.
REPORT OF INDEPENDENT AUDITORS
The Shareholders and Board of Directors
Citizens Financial Corporation
We have audited the accompanying consolidated balance sheets of Citizens
Financial Corporation and subsidiaries at December 31, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2001. Our
audits also included the financial statement schedules listed in the index at
Item 14(a). These financial statements and schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards 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. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Citizens Financial
Corporation and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, 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.
/s/ Ernst & Young LLP
Louisville, Kentucky
March 25, 2002
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Operations
Year Ended December 31 2001 2000 1999
---------------------------------------------------- -------------------- -------------------- --------------------
Revenues:
Premiums and other considerations $ 29,969,756 $ 24,834,809 $ 21,897,264
Premiums ceded (1,225,380) (1,012,385) (1,052,436)
---------------------------------------------------- -------------------- -------------------- --------------------
Net premiums earned 28,744,376 23,822,424 20,844,828
Net investment income 6,274,143 5,993,362 5,885,312
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
Other income 256,229 297,947 157,633
---------------------------------------------------- -------------------- -------------------- --------------------
Total Revenues 27,362,919 31,294,612 36,263,112
Policy Benefits and Expenses:
Policyholder benefits 17,537,817 16,881,624 15,556,565
Policyholder benefits ceded (1,129,446) (1,074,788) (1,013,424)
---------------------------------------------------- -------------------- -------------------- --------------------
Net benefits 16,408,371 15,806,836 14,543,141
Increase in net benefit reserves 5,846,674 2,705,133 1,632,677
Interest credited on policyholder deposits 734,687 888,428 862,615
Commissions 6,414,289 5,047,274 4,340,262
General expenses 6,145,361 5,775,093 5,385,477
Interest expense 532,962 769,132 553,017
Policy acquisition costs deferred (3,177,040) (1,832,617) (1,376,309)
Amortization expense:
Deferred policy acquisition costs 1,279,485 539,062 491,221
Value of insurance acquired 706,773 766,498 839,314
Goodwill 96,013 78,014 51,885
Depreciation expense 359,708 303,629 275,967
---------------------------------------------------- -------------------- -------------------- --------------------
Total Policy Benefits and Expenses 35,347,283 30,846,482 27,599,267
---------------------------------------------------- -------------------- -------------------- --------------------
Income (Loss) before income tax and cumulative (7,984,364) 448,130 8,663,845
effect of a change in accounting principle
Income Tax Expense (Benefit) (2,090,000) 210,000 2,225,000
---------------------------------------------------- -------------------- -------------------- --------------------
Income (Loss) before cumulative effect of a (5,894,364) 238,130 6,438,845
change in accounting principle
Cumulative effect - prior years (since January 1,
1999) accounting for embedded options (311,211) --- ---
---------------------------------------------------- -------------------- -------------------- --------------------
Net Income (Loss) $(6,205,575) $ 238,130 $ 6,438,845
---------------------------------------------------- -------------------- -------------------- --------------------
Per Share Amounts:
Income (Loss) before cumulative effect of a
change in accounting principle $(3.39) $ 0.14 $ 3.59
Cumulative effect - prior years (since January 1,
1999) accounting for embedded options (0.18) --- ---
---------------------------------------------------- -------------------- -------------------- --------------------
Net Income (Loss) $(3.57) $ 0.14 $ 3.59
---------------------------------------------------- -------------------- -------------------- --------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31
2001 2000
------------------------------------------------------------------------ -------------------- --------------------
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost of $75,872,277
and $72,516,172 in 2001 and 2000, respectively) $ 77,534,516 $ 71,403,674
Equity securities (cost of $7,055,402 and
$13,677,303 in 2001 and 2000, respectively) 8,116,958 12,577,874
Investment real estate 3,438,345 3,506,386
Mortgage loans on real estate 156,000 156,000
Policy loans 4,136,649 4,270,588
Short-term investments 652,192 610,379
------------------------------------------------------------------------ -------------------- --------------------
Total Investments 94,034,660 92,524,901
Cash and cash equivalents 18,433,626 20,093,774
Accrued investment income 1,390,550 1,328,491
Reinsurance recoverable 2,755,680 2,686,747
Premiums receivable 215,520 212,089
Property and equipment 2,862,727 2,959,744
Deferred policy acquisition costs 8,579,423 6,511,948
Value of insurance acquired 4,177,907 4,884,680
Goodwill 755,782 851,795
Federal income tax receivable 2,854,933 1,364,502
Deferred federal income tax --- 1,711,661
Other assets 536,275 407,674
------------------------------------------------------------------------ -------------------- --------------------
Total Assets $ 136,597,083 $ 135,538,006
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31
2001 2000
------------------------------------------------------------------------ -------------------- --------------------
LIABILITIES
Policy liabilities:
Future policy benefits $ 89,337,560 $ 83,403,780
Policyholder deposits 15,917,731 16,381,247
Policy and contract claims 1,442,356 1,816,947
Unearned premiums 252,730 217,670
Other 289,400 203,600
------------------------------------------------------------------------ -------------------- --------------------
Total Policy Liabilities 107,239,777 102,023,244
Notes payable 7,095,834 8,000,000
Accrued expenses and other liabilities 1,748,753 2,240,653
Deferred federal income tax 510,236 ---
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities 116,594,600 112,263,897
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock, 6,000,000 shares authorized;
1,716,815 and 1,758,215 shares issued and
outstanding in 2001 and 2000, respectively 1,716,815 1,758,215
Additional paid-in capital 7,285,938 7,640,988
Accumulated other comprehensive income (loss) 1,757,105 (1,573,294)
Retained earnings 9,242,625 15,448,200
------------------------------------------------------------------------ -------------------- --------------------
Total Shareholders' Equity 20,002,483 23,274,109
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities and Shareholders' Equity $ 136,597,083 $ 135,538,006
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Additional Other Comprehensive
Common Paid-in Comprehensive Retained Income (Loss)
Stock Capital Income (Loss) Earnings Total
----------------------------------- ----------------- --------------- -------------- ------------- --------------
Balance at January 1, 1999 1,802,615 8,091,825 3,079,616 8,771,225
Net Income 6,438,845 $ 6,438,845
Net unrealized appreciation of 243,355 243,355
available for sale securities
--------------
Comprehensive income $ 6,682,200
==============
Common stock repurchases (35,400) (355,624)
----------------------------------- ----------------- --------------- -------------- -------------
Balance at December 31, 1999 $ 1,767,215 $ 7,736,201 $ 3,322,971 $ 15,210,070
Net Income 238,130 $ 238,130
Net unrealized depreciation of (4,896,265) (4,896,265)
available for sale securities
--------------
Comprehensive loss $ (4,658,135)
==============
Common stock repurchases (9,000) (95,213)
----------------------------------- ----------------- --------------- -------------- -------------
Balance at December 31, 2000 $1,758,215 $ 7,640,988 $(1,573,294) $ 15,448,200
Net Loss before cumulative
effect of a change in (5,894,364) $ (5,894,364)
accounting principle
Cumulative effect - prior years
accounting for embedded 311,211 (311,211) ---
options
Net unrealized appreciation of 3,019,188 3,019,188
available for sale securities
--------------
Comprehensive loss $(2,875,176)
==============
Common stock repurchases (41,400) (355,050)
----------------------------------- ----------------- ---------------- -------------- -------------
Balance at December 31, 2001 $1,716,815 $7,285,938 $1,757,105 $ 9,242,625
=================================== ================= ================ ============== =============
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31 2001 2000 1999
---------------------------------------------------------- --------------------- ------------------- ------------------
Cash Flows from Operations:
Net income (loss) $ (6,205,575) $ 238,130 $ 6,438,845
Adjustments reconciling to cash from operations:
Increase in benefit reserves 5,979,218 1,810,331 1,806,387
Increase (decrease) in claim liabilities (374,591) 305,543 196,571
(Increase) decrease in reinsurance recoverable (68,933) 920,602 (142,987)
Interest credited on policyholder deposits 734,687 888,428 862,615
Provision for amortization and depreciation,
net of deferrals (735,061) (145,414) 308,403
Amortization of premium and accretion
of discount on securities purchased, net (138,180) 54,094 147,566
Net realized investment (gains) losses 7,911,829 (1,180,879) (9,375,339)
(Increase) decrease in accrued investment income (62,060) (183,044) 79,307
Change in other assets and liabilities (391,533) (434,302) 325,992
Deferred income tax expense (benefit) 923,000 (1,545,000) 550,000
Increase in federal income taxes receivable (1,490,431) (1,195,000) (836,515)
Cumulative effect - change in accounting principle 311,211 --- ---
---------------------------------------------------------- --------------------- ------------------- ------------------
Net Cash provided by (used in) Operations 6,393,581 (466,511) 360,845
Cash Flows from Investment Activities:
Securities available-for-sale:
Purchases - fixed maturities (18,440,196) (14,302,398) (7,956,333)
Purchases - equity securities (13,909,021) (77,517,925) (73,590,880)
Sales - fixed maturities 13,210,562 14,362,095 16,523,864
Sales - equity securities 13,829,235 81,928,028 79,476,540
Investment management and brokerage account fees (177,786) (680,654) (292,195)
Short-term investments sold (acquired), net (41,813) (29,954) 572,192
Additions to real estate (154,262) (139,232) (204,216)
Additions to property and equipment, net (40,392) (1,065,533) (197,603)
Net cash received (paid) for insurance business and
subsidiary acquisitions --- 1,976,855 (3,117,832)
Other investing activities, net 168,763 (43,476) 2,349
---------------------------------------------------------- --------------------- ------------------- ------------------
Net Cash provided by (used in) Investment Activities (5,554,910) 4,487,806 11,215,886
Cash Flows from Financing Activities:
Policyholder deposits 1,006,892 866,778 705,985
Policyholder withdrawals (2,205,095) (2,785,603) (2,080,766)
Payments on notes payable - bank (904,166) (500,000) (510,000)
Repurchase of common stock (396,450) (104,213) (391,024)
Repayment of brokerage advances --- (100,884) (1,406,524)
Proceeds from bank borrowings --- --- 2,500,000
---------------------------------------------------------- --------------------- ------------------- ------------------
Net Cash used in Financing Activities (2,498,819) (2,623,922) (1,182,329)
---------------------------------------------------------- --------------------- ------------------- ------------------
Net Increase (Decrease) in Cash and Cash Equivalents (1,660,148) 1,397,373 10,394,402
Cash and Cash Equivalents at Beginning of Period 20,093,774 18,696,401 8,301,999
---------------------------------------------------------- --------------------- ------------------- ------------------
Cash and Cash Equivalents at End of Period $ 18,433,626 $ 20,093,774 $ 18,696,401
---------------------------------------------------------- --------------------- ------------------- ------------------
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
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"),
Citizens Insurance Company ("Citizens 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) Citizens
Insurance, 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.
Nature of Operations. The Company engages primarily in the business of life
insurance, annuities and accident and health insurance through Citizens Security
and United Liberty ("the Life Insurance Subsidiaries"). The Life Insurance
Subsidiaries offer life, fixed-rate annuity and accident and health insurance
products to individuals and groups through independent agents. Citizens
Insurance was acquired during 1999 (see Note 2) and is licensed as a property
and casualty insurer in four states. The Company is planning to offer home
service fire and casualty insurance coverage; however, Citizens Insurance
currently has no business inforce. Corporate Realty manages the Company's real
estate along with two other properties affiliated with the Company's Chairman.
The individual life insurance products currently offered by the Life Insurance
Subsidiaries consist of traditional whole life insurance and universal life
insurance policies. Citizens Security also sells group life and accidental death
and dismemberment policies. The fixed-rate annuity products offered by Citizens
Security consist of flexible premium deferred annuities, life policy annuity
riders, and single premium deferred annuities. Citizens Security's individual
accident and health insurance products provide coverage for monthly income
during periods of hospitalization, scheduled reimbursement for specific hospital
and surgical expenses and cancer treatments, and lump sum payments for
accidental death or dismemberment, while the group accident and health products
provide coverage for short and long-term disability, income protection and
dental procedures.
Citizens Security is licensed to sell products in the District of Columbia and
20 states primarily located in the South and Southeast. United Liberty is
licensed to sell products in 23 states primarily located in the South, Midwest,
and West. United Liberty's ongoing sales efforts are focused primarily in nine
states where Citizens Security is not licensed.
The Life Insurance Subsidiaries market their portfolio of products through the
personal producing general agent distribution system and presently have
approximately 3,000 sales representatives. Many of these agents also represent
other insurance carriers. Approximately 450 of the agents specialize in the home
service market while approximately 500 are preneed representatives who market
through funeral homes. These markets consist primarily of individuals who desire
whole life policies with policy limits typically below $10,000.
Use of Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States ("GAAP") requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Investments. The Company classifies fixed maturities and equity securities as
"available-for-sale". Available-for-sale securities are carried at fair value,
with unrealized gains and losses included in accumulated other comprehensive
income (loss), net of applicable deferred taxes and adjustments to related
deferred policy acquisition costs. Mark-to-market accounting is used for equity
options embedded in convertible bonds and all other derivatives. Changes in the
fair value of derivatives are reported currently as realized gains or losses.
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.
Cash and cash equivalents consist of highly liquid investments with maturities
of three months or less at the date of purchase and are also carried at cost
which approximates fair value.
Deferred Policy Acquisition Costs. Commissions and other policy acquisition
costs which vary with, and are primarily related to, the production of new
insurance contracts are deferred, to the extent recoverable from future policy
revenues and gross profits, and amortized over the life of the related
contracts. See Premiums, Benefits and Expenses regarding amortization methods.
Property and Equipment. Property and equipment, including the home office
building, are carried at cost less accumulated depreciation, using principally
the straight-line method of depreciation. Accumulated depreciation at December
31, 2001 was $2,333,330 ($1,977,438 at December 31, 2000).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of
purchase price of purchased subsidiaries, over amounts assigned (based on
estimated fair values at the date of acquisition) to the identifiable net assets
acquired. Goodwill is amortized over 10 to 20 years using the straight-line
method. At December 31, 2001, accumulated amortization was $412,861 ($316,848 at
December 31, 2000).
Value of insurance acquired is recorded for the estimated value assigned to the
insurance in force of the purchased subsidiaries at the dates of acquisition.
The assigned value is amortized over the expected remaining life of the
insurance in force using methods consistent with that used for amortization of
policy acquisition costs (as described under Premiums, Benefits and Expenses).
At December 31, 2001, accumulated amortization was $5,118,467 ($4,411,694 at
December 31, 2000).
Benefit Reserves and Policyholder Deposits. Traditional life and accident and
health insurance products include those contracts with fixed and guaranteed
premiums and benefits and consist principally of whole-life and term insurance
policies, limited-payment life insurance policies and certain annuities with
life contingencies. Reserves on such policies are based on assumed investment
yields which range from 6% to 7%. Reserves on traditional life and accident and
health insurance products are determined using the net level premium method
based on future investment yields, mortality, withdrawals, and other
assumptions, including dividends on participating policies. Such assumptions are
based on past experience and include provisions for possible unfavorable
deviation.
Benefit reserves and policyholder contract deposits on universal life, other
interest-sensitive life products and investment-type products are determined
using the retrospective deposit method and consist of policy account balances,
before deducting surrender charges, which accrue to the benefit of the
policyholder.
Participating insurance business constituted approximately 6% of ordinary life
insurance inforce at December 31, 2001, 2000, and 1999, and 4%, 4%, and 5% of
annualized ordinary life premium inforce at December 31, 2001, 2000, and 1999,
respectively. Participating dividends are determined at the discretion of the
Board of Directors.
Reserves on insurance policies acquired by purchase are based on assumptions
considered appropriate as of the date of purchase. Assumed investment yields for
such acquired policies range from 6.6% to 9.0%.
Premiums, Benefits and Expenses. Premiums for traditional individual life
(including Preneed life) and accident and health policies are reported as earned
when due. Benefit claims (including an estimated provision for claims incurred
but not reported), benefit reserve changes and expenses (except those deferred)
are charged to expense as incurred. Deferred policy acquisition costs related to
traditional life and accident and health policies are charged to expense over
the life of the policy using methods and assumptions consistent with those used
in estimating liabilities for future policy benefits. In determining whether a
premium deficiency exists on short-duration policies, management does not give
consideration to investment income.
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.
Liabilities for Policy Claims. Policy claim liabilities are based on known
liabilities plus estimated future liabilities developed from trends of
historical data applied to current exposures. These liabilities are closely
monitored and adjustments for changes in experience are made in the period
identified.
Federal Income Taxes. The Company uses the liability method of accounting for
income taxes. Deferred income taxes are provided for cumulative temporary
differences between balances of assets and liabilities determined under GAAP and
balances determined for tax reporting purposes.
Earnings Per Share. Basic earnings per share amounts are based on the weighted
average number of common shares outstanding during the year.
Note 2--ACQUISITIONS
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 Citizens
Insurance (formerly Kentucky Insurance Company) from an unaffiliated insurance
holding company (the "Citizens Insurance Acquisition"). Citizens Insurance is
licensed as a property and casualty insurance company in four states and has
approximately $3.6 million of statutory capital and surplus; however, it
currently has no insurance operations. The aggregate purchase price for the
Citizens 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. The acquisition was accounted for as a purchase and Citizens
Insurance results of operations are included in the consolidated statements
since its date of acquisition.
Note 3--INVESTMENTS
The cost and fair value of investments in fixed maturities and equity securities
are shown below. The cost amounts are adjusted for amortization of premium and
accretion of discount on fixed maturities and for write-downs of securities
whose decline in value is believed to be other than temporary.
Amortized Unrealized Gross Fair Value
December 31, 2001 Cost Gains Losses (Carrying Value)
---------------------------------------- ----------------- ---------------------------------- ----------------
Fixed Maturities:
U.S. Government obligations $ 26,038,744 $ 637,535 $ 95,265 $ 26,581,014
Corporate securities 47,435,636 1,341,524 366,107 48,411,053
Mortgage-backed securities 2,397,897 144,637 85 2,542,449
---------------------------------------- ----------------- ---------------- ----------------- ----------------
Total $ 75,872,277 $ 2,123,696 $ 461,457 $ 77,534,516
---------------------------------------- ----------------- ---------------- ----------------- ----------------
Equity Securities $ 7,055,402 $ 1,243,333 $ 181,777 $ 8,116,958
---------------------------------------- ----------------- ---------------- ----------------- ----------------
December 31, 2000
---------------------------------------- ----------------- ---------------- ----------------- ----------------
Fixed Maturities:
U.S. Government obligations $ 10,951,802 $ 224,631 $ 4,976 $ 11,171,457
Corporate securities 57,984,195 389,866 1,834,171 56,539,890
Mortgage-backed securities 3,580,175 119,075 6,923 3,692,327
---------------------------------------- ----------------- ---------------- ----------------- ----------------
Total $ 72,516,172 $ 733,572 $ 1,846,070 $ 71,403,674
---------------------------------------- ----------------- ---------------- ----------------- ----------------
Equity Securities $ 13,677,303 $ 832,565 $ 1,931,994 $ 12,577,874
---------------------------------------- ----------------- ---------------- ----------------- ----------------
The fair values for investments in fixed maturities and equity securities are
based on quoted market prices, where available. For investments in fixed
maturities and equity securities not actively traded, fair values are estimated
using values obtained from independent pricing services.
The annual change in net unrealized investment appreciation or depreciation, at
December 31, 2001, 2000 and 1999, and the amount of net realized investment gain
or loss included in net income for the respective years then ended are shown
below. The 2001 change in net unrealized appreciation for fixed maturities shown
below is after recognizing the January 1, 2001 pretax transition adjustment of
approximately $471,532, as described in Note 17.
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Fixed maturities:
Change in net unrealized appreciation $2,303,205 $(1,655,112) $(1,804,929)
Net realized gain (loss) $(1,260,092) $ 1,061,089 $ 243,949
Equity securities:
Change in net unrealized appreciation $2,160,985 $(5,812,184) $ 2,238,293
Net realized gain $(6,651,737) $ 119,790 $ 9,131,390
The amortized cost and fair value of investments in fixed maturities at December
31, 2001, 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, 2001 Amortized Cost Fair Value
------------------------------------------------------ -------------------- --------------------
Due in one year or less $12,641,634 $12,876,214
Due after one year through five years 40,696,578 42,020,968
Due after five years through ten years 11,880,472 11,874,468
Due after ten years 8,255,696 8,220,417
------------------------------------------------------ -------------------- --------------------
Subtotal 73,474,380 74,992,067
Mortgage-backed securities 2,397,897 2,542,449
------------------------------------------------------ -------------------- --------------------
Total $75,872,277 $77,534,516
------------------------------------------------------ -------------------- --------------------
Gross gains of $463,679, $2,268,554, and $1,260,650 and gross losses of
$1,778,519, $1,127,299, and $969,136 were realized on the sale of
available-for-sale fixed maturities during 2001, 2000, and 1999, respectively.
Included in gross realized losses during 2001, 2000, and 1999 are net
adjustments to the carrying value of available-for-sale fixed maturities of
$739,000, $912,000, and $55,000 respectively, relating to declines in value
which were considered by management to be other than temporary. Net realized
gains from the sale of fixed maturities have been increased (decreased) by
$63,492, $(80,166), and $(20,021) in 2001, 2000, and 1999 respectively, due to
amortization of deferred policy acquisition costs. In addition, net realized
gains from the sale of fixed maturities have been reduced by $8,744 and $27,544
in 2001 and 1999 respectively, for incentive fees earned by the portfolio
manager.
Gross gains of $1,378,585, $16,764,844, and $16,414,949 and gross losses of
$8,245,943, $16,740,314, and $6,350,927, were realized on the sale of
available-for-sale equity securities during 2001, 2000 and 1999. Included in
gross realized losses during 2001, 2000, and 1999 are adjustments to the
carrying value of available-for-sale equity securities of $1,533,000,
$5,733,000, and $1,017,000 respectively, relating to declines in value which
were considered by management to be other than temporary. Net realized gains
from the sale of equity securities have been increased (decreased) by $252,534,
$302,629, and $(229,861) in 2001, 2000, and 1999 respectively, due to
amortization of deferred policy acquisition costs. In addition, net realized
gains from the sale of available-for-sale equity securities have been reduced by
$36,913, $207,369, and $702,771 in 2001, 2000, and 1999, respectively, for
incentive and management fees earned by the portfolio manager and costs
associated with operating a brokerage margin account. Under terms of this
brokerage margin account, Morgan Stanley & Company, Inc. permits 50% of the
value of securities held in the account to be purchased on margin. At December
31, 1999, margin advances of $100,884 were outstanding and included in the
financial statements with accrued expenses and other liabilities.
Net unrealized appreciation (depreciation) of available-for-sale securities is
summarized as follows:
December 31 2001 2000
------------------------------------------------------------- ------------------- ------------------
Net appreciation (depreciation) on available-for-sale:
Fixed maturities $1,662,239 $(1,112,498)
Equity securities 1,061,556 (1,099,429)
Adjustment of deferred policy acquisition costs (61,515) 84,590
Deferred income taxes (905,175) 554,043
------------------------------------------------------------- ------------------- ------------------
Net unrealized appreciation (depreciation) $1,757,105 $(1,573,294)
------------------------------------------------------------- ------------------- ------------------
Investment management services are provided by a firm affiliated with certain
board members and shareholders of the Company - see Note 16 - Related Party
Transactions.
Major categories of investment income are summarized as follows:
Year Ended December 31 2001 2000 1999
---------------------------------------- ----------------- ---------------- -----------------
Fixed maturities $4,785,712 $4,410,640 $4,655,498
Equity securities 284,922 397,552 523,520
Investment real estate 239,762 107,969 245,260
Mortgage loans on real estate 14,033 14,887 15,406
Policy loans 258,135 239,199 233,844
Short-term investments and other 1,014,971 1,138,318 454,102
---------------------------------------- ----------------- ---------------- -----------------
Subtotal 6,597,535 6,308,565 6,127,630
Investment expense (323,392) (315,203) (242,318)
---------------------------------------- ----------------- ---------------- -----------------
Net investment income $6,274,143 $5,993,362 $5,885,312
---------------------------------------- ----------------- ---------------- -----------------
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 following are the only investments (other than the
U.S. Governments) comprising more than ten percent of shareholders' equity at
December 31, 2001: Clear Channel Communications ($3,153,875), Ford Motor Credit
($2,168,504) and Preferred Term Securities III, Ltd. ($1,988,311). At December
31, 2001, the Company had no investments which had not been income producing for
a period of at least twelve months prior to year-end.
The following table is a reconciliation of the net unrealized gain (loss)
arising during the period and the change in net unrealized gains (losses) as
reported on the accompanying statements of shareholders' equity.
Pretax Tax Net-of-Tax
Year Ended Amount Expense Amount
---------------------------------------- -------------------- -------------------- --------------------
December 31, 2001:
Unrealized loss $(3,593,744) $(1,391,125) $(2,202,619)
Less: Reclassification adjustment
for losses realized in net income (7,911,829) (2,690,022) (5,221,807)
---------------------------------------- -------------------- -------------------- --------------------
Change in net unrealized gain $4,318,085 $1,298,897 $3,019,188
======================================== ==================== ==================== ====================
December 31, 2000:
Unrealized loss $(5,981,261) $(1,864,376) $(4,116,885)
Less: Reclassification adjustment
for gains realized in net income 1,180,879 401,499 779,380
---------------------------------------- -------------------- -------------------- --------------------
Change in net unrealized loss $(7,162,140) $(2,265,875) $(4,896,265)
======================================== ==================== ==================== ====================
As an income generation strategy, the Company takes certain option positions,
generally on equity securities or related market indices and on equity options
embedded in convertible bonds. 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 2001, option purchases totaled
approximately $2,605,000 and related net realized gains totaled approximately
$971,410, along with the SFAS No. 133 transition adjustment described in Note
17. At December 31, 2001 net option positions outstanding had a market value of
$254,000 with an associated realized loss recorded of $203,000. Approximately
$90,000 of these positions contain market risk of loss beyond the recorded
value.
Pursuant to requirements of certain state insurance departments, the Company has
investments with a carrying value of $52,020,396, at December 31, 2001, 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, 2001 and 2000, the Company occupied approximately 29% 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, 2001 and 2000 on the investment real
estate portion of the building was $1,041,432 and $950,962, respectively.
The Company leases office space to third-party tenants under noncancellable
lease agreements. Future minimum rental income is $622,000, $473,000, $341,000,
$202,000 and $43,000 for years 2002 through 2006, respectively.
Note 4--VALUE OF INSURANCE ACQUIRED
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, 2001, 2000 and 1999 is as
follows:
Year Ended December 31 2001 2000 1999
---------------------------------------- ----------------- ---------------- -----------------
Balance at beginning of year $4,884,680 $5,295,818 $6,135,132
Business acquired --- 355,360 ---
Accretion of interest 296,964 312,002 378,996
Amortization (1,003,737) (1,078,500) (1,218,310)
---------------------------------------- ----------------- ---------------- -----------------
Balance at end of year $4,177,907 $4,884,680 $5,295,818
---------------------------------------- ----------------- ---------------- -----------------
Amortization of the value of insurance acquired (net of interest accretion) in
each of the following five years will be approximately: 2002 - $557,000; 2003 -
$480,000; 2004 - $423,000; 2005 - $382,000, and 2006 - $338,000.
Note 5--LIABILITY FOR ACCIDENT AND HEALTH UNPAID CLAIMS AND INCURRED, BUT NOT
REPORTED CLAIMS PORTION OF RESERVES
Activity in the accident and health liability portion of policy and contract
claims ($415,601 and $414,454 at December 31, 2001 and 2000, respectively) and
the incurred but not reported portion of accident and health reserves
($1,141,089 and $1,188,515 at December 31, 2001 and 2000, respectively) is
summarized as follows:
Year Ended December 31 2001 2000
---------------------------------------------------------- ------------------ ------------------
Balance at January 1 $1,602,969 $2,714,292
Less: reinsurance recoverable 601,725 1,720,047
---------------------------------------------------------- ------------------ ------------------
Net balance at January 1 1,001,244 994,245
Total incurred - current year 6,385,452 6,151,422
Paid related to:
Current year 5,981,009 5,450,648
Prior years 592,340 693,776
---------------------------------------------------------- ------------------ ------------------
Total paid 6,573,349 6,144,424
---------------------------------------------------------- ------------------ ------------------
Net balance at December 31 813,347 1,001,243
Plus: reinsurance recoverable 743,343 601,726
---------------------------------------------------------- ------------------ ------------------
Balance at December 31 $1,556,690 $1,602,969
---------------------------------------------------------- ------------------ ------------------
Note 6--DEBT
Long term debt consists of the following:
December 31 2001 2000
------------------------------------------------------------- ------------------- ------------------
Commercial bank notes, prime, due 2007 $7,095,834 $8,000,000
Less: Current Portion (1,316,667) (904,167)
------------------------------------------------------------- ------------------- ------------------
Long Term Portion $5,779,167 $7,095,833
------------------------------------------------------------- ------------------- ------------------
The Company's outstanding borrowings relate primarily to various insurance
company acquisitions. On October 14, 1999, the Company borrowed $2,500,000 in
conjunction with the Citizens Insurance Acquisition and on May 12, 1998 borrowed
$3,400,000 in conjunction with the United Acquisition. Interest is payable
quarterly at the lower of the bank's prime lending rate or the one month LIBOR
rate plus 2.75%. Principal installments are due as follows: 2002 through 2004 -
$1,316,666; 2005 and 2006 - $1,416,666; and 2007 - $312,503. The Company has
pledged the issued and outstanding common and preferred stock of Citizens
Security as collateral for the commercial bank notes. The bank notes also
contain covenants regarding asset acquisitions, shareholder dividends and
maintenance of certain earnings ratios. Due to losses incurred during 2001, the
Company did not meet covenants relating to a particular earnings ratio and a
specified capital amount. Accordingly, in a letter dated March 25, 2002, the
lender agreed to waive its right to call the debt as a result of these
violations through December 31, 2001. In addition, effective January 1, 2002 the
bank has revised the financial covenants governing the debt. Based on these
revised terms, the Company believes it is probable that violations will not
recur.
Cash paid for interest on debt was $635,594, $771,095 and $595,939 during 2001,
2000 and 1999, respectively; including $21,447 and $84,491 in 2000 and 1999,
respectively, related to brokerage account borrowings.
Note 7--EARNINGS AND DIVIDENDS PER SHARE
The following table sets forth the computation of basic and diluted earnings
(losses) per share. No dividends were paid or accrued for 2001, 2000, or 1999.
Year Ended December 31 2001 2000 1999
------------------------------------------------------------------ ---------------- ---------------- ---------------
Numerators:
Income (Loss) before cumulative effect of a change in $(5,894,364) $238,130 $6,438,845
accounting principle
Cumulative effect of a change in accounting principle (311,211) --- ---
------------------------------------------------------------------ ---------------- ---------------- ---------------
Net Income (Loss) $(6,205,575) $238,130 $6,438,845
------------------------------------------------------------------ ---------------- ---------------- ---------------
Denominator:
Weighted average common shares 1,740,360 1,761,882 1,793,554
Earnings (Loss) Per Share:
Income (Loss) before cumulative effect of a change in $(3.39) $0.14 $3.59
accounting principle
Cumulative effect of a change in accounting principle $(0.18) --- ---
------------------------------------------------------------------ ---------------- ---------------- ---------------
Net Income (Loss) $(3.57) $0.14 $3.59
------------------------------------------------------------------ ---------------- ---------------- ---------------
Note 8--INCOME TAXES
Income taxes consist of the following:
Year Ended December 31 2001 2000 1999
---------------------------------------- ----------------- ---------------- -----------------
Current tax expense (benefit) $(3,013,000) $1,755,000 $1,675,000
Deferred tax expense (benefit) 923,000 (1,545,000) 550,000
---------------------------------------- ----------------- ---------------- -----------------
Income tax expense (benefit) $(2,090,000) $ 210,000 $2,225,000
---------------------------------------- ----------------- ---------------- -----------------
Tax expense includes a current state and local income tax provision (benefit) of
$(230,000), $350,000, and $225,000 in 2001, 2000, and 1999, respectively.
Deferred income taxes are provided for cumulative temporary differences between
balances of assets and liabilities determined under GAAP and balances determined
for tax reporting purposes.
Significant components of the Company's deferred tax liabilities and assets as
of December 31, 2001 and 2000 are as follows:
December 31 2001 2000
------------------------------------------------------------- ------------------- ------------------
Deferred Tax Liabilities:
Value of insurance acquired $ 1,420,488 $ 1,660,791
Deferred policy acquisition costs 1,487,291 639,946
Net unrealized gains on available-for-sale securities 905,175 ---
Other 550,565 506,113
------------------------------------------------------------- ------------------- ------------------
Total deferred tax liabilities 4,363,519 2,806,850
Deferred Tax Assets:
Policy and contract reserves 2,676,602 2,254,166
Fixed maturities and equity securities 1,161,536 2,270,748
Real estate 548,668 548,668
Alternative minimum tax credit carryforwards 196,761 ---
Net operating loss carryforwards 82,420 ---
Net unrealized losses on available-for-sale securities --- 554,043
Other 248,035 309,994
------------------------------------------------------------- ------------------- ------------------
Total deferred tax assets 4,914,022 5,937,619
Valuation allowance for deferred tax assets (1,060,739) (1,419,108)
------------------------------------------------------------- ------------------- ------------------
Net deferred tax assets 3,853,283 4,518,511
------------------------------------------------------------- ------------------- ------------------
Net deferred tax assets (liabilities) $ (510,236) $ 1,711,661
------------------------------------------------------------- ------------------- ------------------
The following is a reconciliation of income tax expense at the federal statutory
rate, to the tax at the Company's effective income tax rate:
December 31 2001 2000 1999
------------------------------------ -------------- --------------- ---------------
Tax at the statutory rate $ (2,714,700) $ 152,400 $ 2,945,700
Change in valuation allowance (358,500) 585,800 (490,400)
Small life deduction 1,141,100 (276,300) (511,900)
State and local income tax (165,200) 233,600 273,500
Surtax exemption and other 24,000 (446,100) 83,800
Dividend exclusion (16,700) (39,400) (75,700)
------------------------------------ -------------- --------------- ---------------
Tax at the effective rate $ (2,090,000) $ 210,000 $ 2,225,000
------------------------------------ -------------- --------------- ---------------
Income taxes paid (refunded) in 2001, 2000 and 1999 were $(1,293,000),
$3,100,000, and $2,459,000, respectively. The Company utilized $236,000 of net
operating loss carryforwards in 1999 and has $240,000 of net operating loss
carryforwards which expire in 2016. 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, 2001,
Citizens Security could have paid additional dividends of approximately
$12,000,000 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, 2001.
Note 9--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDERS' EQUITY
The Insurance Subsidiaries are domiciled in Kentucky and prepare their
statutory-basis financial statements in accordance with statutory accounting
practices ("SAP") prescribed or permitted by the Kentucky Department of
Insurance ("KDI"). "Prescribed" statutory accounting practices include state
insurance laws, regulations, and general administrative rules, as well as a
variety of publications of the National Association of Insurance Commissioners
("NAIC"). "Permitted" statutory accounting practices encompass all accounting
practices that are not prescribed; such practices may differ from state to
state, may differ from company to company within a state, and may change in the
future. Effective January 1, 2001, the NAIC revised its Accounting Practices and
Procedures Manual in a process referred to as Codification. The KDI has adopted
the revised manual, which has changed, to some extent, prescribed statutory
accounting practices which the Insurance Subsidiaries use to prepare their
statutory-basis financial statements. The primary statutory changes affecting
the Insurance Subsidiaries are, establishment of deferred income taxes,
recognizing as realized losses securities impairments considered other than
temporary, recording an allocable share of the Company's accrued employee
benefit obligations, and revision of the statutory equity method of accounting
which now precludes a parent insurer from recording as income, its share of
undistributed subsidiary earnings. Effective January 1, 2001, the Insurance
Subsidiaries recorded a net deferred tax benefit from Codification of
$1,750,000, partially offset by approximately $228,000 of accrued employee
benefit obligations.
Statutory-basis net income and capital and surplus for the Company's combined
insurance operations, for the three years ended December 31, 2001 are shown
below. These amounts are combined totals for Citizens Security, United Liberty,
and Citizens Insurance, with adjustments to eliminate intercompany holdings and
activity.
Year Ended December 31 2001 2000 1999
--------------------------- ----------------- ---------------- -----------------
Net Income (Loss) $ (3,762,603) $ 1,961,792 $ 4,966,948
Capital and Surplus $ 9,687,289 $ 11,694,494 $ 16,227,706
Principal differences between SAP and GAAP include: a) costs of acquiring new
policies are generally deferred and amortized for GAAP; b) value of insurance
inforce acquired is established as an asset for GAAP; c) benefit reserves are
calculated using more realistic investment, mortality and withdrawal assumptions
for GAAP; d) the change in SAP deferred income taxes associated with timing
differences is recorded directly to equity rather than as a component of net
income as required for GAAP; e) assets and liabilities of acquired companies are
adjusted to their fair values at acquisition with the excess purchase price over
such fair values recorded as goodwill under GAAP; f) available-for-sale fixed
maturity investments are reported at fair value with unrealized gain and losses
reported as a separate component of shareholders' equity for GAAP; and g)
statutory asset valuation reserves and interest maintenance reserves are not
required for GAAP.
Statutory restrictions limit the amount of dividends which the insurance
companies may pay. Generally, dividends during any year may not be paid, without
prior regulatory approval, in excess of the lesser of (a) 10% of statutory
shareholder's surplus as of the preceding December 31, or (b) statutory net
operating income for the preceding year. During 2001, the Company contributed
the stock of Citizens Insurance and $150,000 to Citizens Security. The statutory
value of the contributed Citizens Insurance stock was $3,540,555. Citizens
Security contributed the $150,000 received from the Company to Citizens
Insurance. During both 2000 and 1999, with appropriate prior regulatory
approval, Citizens Security redeemed $1,200,000 of its outstanding preferred
stock from the Company. In addition, during 1999, with appropriate regulatory
approval, Citizens Security paid a dividend of $1,000,000 to the Company. During
2001 and 2000, United Liberty paid dividends to Citizens Security of $292,000
and $200,000, respectively. The Insurance Subsidiaries must each maintain
$1,250,000 of capital and surplus, the minimum required for insurance companies
domiciled in Kentucky. The KDI imposes minimum risk-based capital ("RBC")
requirements on insurance enterprises that were developed by the NAIC. The
formulas for determining the amount of RBC specify various weighting factors
that are applied to financial balances and various levels of activity based on
the perceived degree of risk. Regulatory compliance is determined by a ratio
(the "Ratio") of the enterprise's regulatory total adjusted capital, as defined
by the NAIC, to its required authorized control level RBC, as defined by the
NAIC. Enterprises below specific trigger points or ratios are classified within
certain levels, each of which requires specified corrective action. Based on RBC
computations as of December 31, 2001, the Insurance Subsidiaries each have
statutory capital which is well in excess minimum regulatory requirements.
Note 10--SEGMENT INFORMATION
The Company's operations are managed along five principal insurance product
lines: Home Service Life, Broker Life, Preneed Life, Dental, and Other Health.
Products in all five lines are sold through independent agency operations. Home
Service Life consists primarily of traditional life insurance coverage sold in
amounts of $10,000 and under to middle and lower income individuals. This
distribution channel is characterized by a significant amount of agent contact
with customers throughout the year. Broker Life product sales consist primarily
of simplified issue and graded-benefit policies in amounts of $10,000 and under.
Other products in this segment which are not aggressively marketed include:
group life, universal life, annuities and participating life coverages. Preneed
Life products are sold to individuals in connection with prearrangement of their
funeral and include single premium and multi-pay policies with coverages
generally in amounts of $10,000 and less. These policies are generally sold to
older individuals at increased premium rates. Dental products are term coverages
generally sold to small and intermediate size employer groups. Other Health
products include various accident and health coverages sold to individuals and
employer groups.
Segment information as of December 31, 2001, 2000 and 1999, and for the years
then ended is as follows:
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Revenue:
Home Service Life $ 9,290,120 $ 9,036,005 $ 8,745,144
Broker Life 6,497,286 6,328,884 6,003,025
Preneed Life 9,974,405 5,345,930 3,614,758
Dental 8,025,375 7,933,598 7,141,409
Other Health 1,487,562 1,469,316 1,383,437
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals 35,274,748 30,113,733 26,887,773
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
------------------------------------------------------ ----------------- ---------------- -----------------
Total Revenue $ 27,362,919 $ 31,294,612 $ 36,263,112
------------------------------------------------------ ----------------- ---------------- -----------------
Below are the net investment income amounts which are included in the revenue
totals above.
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Net Investment Income:
Home Service Life $ 2,053,995 $ 2,028,680 $ 1,993,810
Broker Life 2,579,117 2,538,610 2,488,921
Preneed Life 1,514,638 1,298,434 1,282,397
Dental 35,312 39,289 34,848
Other Health 91,081 88,349 85,336
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals $ 6,274,143 $ 5,993,362 $ 5,885,312
------------------------------------------------------ ----------------- ---------------- -----------------
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. A
significant portion of the Company's realized investment gains and losses are
generated from investments in equity securities.
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Profit (Loss):
Home Service Life $ 382,723 $ 200,479 $ 312,703
Broker Life 74,960 299,777 150,317
Preneed Life (264,488) (827,265) (993,560)
Dental 256,385 331,206 436,587
Other Health 10,847 32,186 (64,524)
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals 460,427 36,383 (158,477)
Net realized investment gains (losses) (7,911,829) 1,180,879 9,375,339
Interest expense 532,962 769,132 553,017
------------------------------------------------------ ----------------- ---------------- -----------------
Income (Loss) before income tax and cumulative $ (7,984,364) $ 448,130 $ 8,663,845
effect of a change in accounting principle
------------------------------------------------------ ----------------- ---------------- -----------------
Depreciation and amortization amounts below consist of amortization of the value
of insurance acquired, deferred policy acquisition costs and goodwill, along
with depreciation expense.
Year Ended December 31 2001 2000 1998
------------------------------------------------------ ----------------- ---------------- -----------------
Depreciation and Amortization:
Home Service Life $ 873,529 $ 723,255 $ 583,456
Broker Life 678,446 506,016 601,640
Preneed Life 779,199 350,758 381,354
Dental 68,866 61,286 50,276
Other Health 41,939 45,888 41,661
------------------------------------------------------ ----------------- ---------------- -----------------
Segment Totals $ 2,441,979 $ 1,687,203 $ 1,658,387
------------------------------------------------------ ----------------- ---------------- -----------------
Segment asset totals are determined based on policy liabilities outstanding in
each segment.
December 31 2001 2000 1999
------------------------------------------------------ ----------------- ---------------- -----------------
Assets:
Home Service Life $ 44,818,038 $ 45,577,255 $ 47,347,032
Broker Life 54,954,194 57,721,008 57,958,271
Preneed Life 34,138,535 29,421,677 29,754,353
Dental 726,728 799,496 913,939
Other Health 1,959,588 2,018,570 2,006,435
------------------------------------------------------ ----------------- ---------------- -----------------
Total Assets $136,597,083 $135,538,006 $137,980,030
------------------------------------------------------ ----------------- ---------------- -----------------
Note 11--QUARTERLY FINANCIAL DATA (Unaudited)
Below is selected consolidated quarterly financial data for each of the two
years in the period ended December 31, 2001.
Year 2001 _ Quarter: 1* 2* 3* 4
---------------------------------------- --------------- --------------- --------------- --------------
Segment Revenue $ 8,453,433 $ 8,935,430 $ 9,039,850 $ 8,846,035
Investment gains (losses), net 171,896 (3,469,996) (3,100,898) (1,512,831)
---------------------------------------- --------------- --------------- --------------- --------------
Total Revenue $ 8,625,329 $ 5,465,434 $ 5,938,952 $ 7,333,204
---------------------------------------- --------------- --------------- --------------- --------------
Segment Profit (Loss) $ 328,901 $ (99,095) $ 132,237 $ 98,384
Investment gains (losses), net 171,896 (3,469,996) (3,100,898) (1,512,831)
Interest expense 171,651 143,050 127,504 90,757
Income tax expense (benefit) 86,000 (972,000) (810,000) (394,000)
---------------------------------------- --------------- --------------- --------------- --------------
Net Income (Loss) before cumulative 243,146 (2,740,141) (2,286,165) (1,111,204)
effect of change in accounting
Cumulative effect from prior years of (311,211) --- --- ---
accounting for embedded options
---------------------------------------- --------------- --------------- --------------- --------------
Net Loss $ (68,065) $(2,740,141) $(2,286,165) $(1,111,204)
---------------------------------------- --------------- --------------- --------------- --------------
Net Loss Per Share $(0.04) $(1.57) $(1.32) $(0.64)
---------------------------------------- --------------- --------------- --------------- --------------
* Net Loss for the quarters ended March 31, June 30, and September 30, 2001 has
been restated from amounts previously reported in the Company's Form 10-Qs. The
restated amounts reflect correction of policy benefit reserves and related
deferred acquisition costs for the Preneed Life segment. In addition,
corresponding income taxes have been revised for the Preneed Life change and to
reflect the actual effective tax rate applicable for the year. The effect of the
restatement for the first three quarters of 2001 was to increase earnings and
per share amounts (e.g. decrease Net Loss) as follows:
Pretax Income Net Earnings
2001 Revisions Income Tax Benefit Income per Share
-------------------- ------------- ------------- ------------- -----------------
First quarter $ 137,701 $ 2,000 $ 139,701 $ 0.08
Second quarter $ 180,022 $ 27,000 $ 207,022 $ 0.11
Third quarter $ 159,011 $ 24,000 $ 183,011 $ 0.10
Year 2000 - Quarter: 1 2 3 4
---------------------------------------- --------------- --------------- --------------- --------------
Segment Revenue $ 7,191,817 $ 7,168,160 $ 7,802,964 $ 7,950,792
Investment gains (losses), net 4,793,958 1,530,931 (1,664,106) (3,479,904)
---------------------------------------- --------------- --------------- --------------- --------------
Total Revenue $ 11,985,775 $ 8,699,091 $ 6,138,858 $ 4,470,888
---------------------------------------- --------------- --------------- --------------- --------------
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)
---------------------------------------- --------------- --------------- --------------- --------------
Net Income (Loss) Per Share $1.65 $0.47 $(0.67) $(1.31)
---------------------------------------- --------------- --------------- --------------- --------------
Note 12--REINSURANCE
The Company currently follows the general practice of reinsuring that portion of
risk on the life of any individual which is in excess of $40,000 for individual
policies (under yearly renewable term and coinsurance agreements) and $15,000
for group policies (under a group yearly renewable term agreement). Graded death
benefit and simplified issue coverages above $4,000 are generally 50% reinsured,
with the Life Insurance Subsidiaries maintaining a maximum $10,000 risk on any
one policyholder. Individual and group accidental death coverage and major
medical accident and health coverages are 100% reinsured. To the extent that
reinsuring companies are unable to meet obligations under reinsurance
agreements, the Company would remain liable.
Note 13--CONTINGENCIES
United Liberty, which the Company acquired in 1998, is defending an action in an
Ohio state court brought by two policyholders. The Complaint refers to a
particular class of life insurance policies that United Liberty issued over a
period of years ending around 1971. It alleges that United Liberty's dividend
payments on these policies from 1993 through 1999 were less than the required
amount. It does not specify the amount of the alleged underpayment but implies a
maximum of about $850,000. The plaintiffs also allege that United Liberty is
liable to pay punitive damages, also in an unspecified amount, for breach of an
implied covenant of good faith and fair dealing to the plaintiffs in relation to
the dividends. The action has been certified as a class action on behalf of all
policyholders whose policies were issued in Ohio and were still in force in
1993. United Liberty has denied the material allegations of the Complaint and is
defending the action vigorously. Pre-trial discovery is continuing. United
Liberty has filed a motion for summary judgment to which the plaintiffs have not
yet responded. Although United Liberty has requested mediation of the action,
the plaintiffs would not agree to the request for mediation until United Liberty
made an offer to settle the case. Consequently, United Liberty has offered to
settle the matter for payments over time, which would include attorneys' fees,
and which would be contingent upon an exchange or reformation of the insurance
policies currently owned by the members of the class for policies with an
increased premium and a set dividend. At this stage of the litigation, the
Company is unable to determine whether an unfavorable outcome of the action is
likely to occur or, alternatively, whether the chance of such an outcome is
remote. Therefore, at this time, management has no basis for estimating
potential losses, if any. In addition, the Company is party to other lawsuits in
the normal course of business. Management believes recorded claims liabilities
are adequate to ensure these other suits will be resolved without material
financial impact to the Company.
Note 14--FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments, and the methods used in estimating
these values, are as follows:
Fixed Maturities: The fair values for fixed maturities are based on quoted
market prices, where available. For those fixed maturities which are not
actively traded, fair values are estimated using values obtained from
independent pricing services. Available-for-sale fixed maturities are carried at
fair value in the accompanying statements of financial condition. At December
31, 2001 and 2000, the fair value of available-for-sale fixed maturities was
$77,534,516 and $71,403,674, respectively.
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, 2001 and 2000, the fair value
of equity securities was $8,116,958 and $12,577,874, respectively.
Short-Term Investments: The carrying amount of short-term investments
approximates their fair value. At December 31, 2001 and 2000, the fair value of
short-term investments was $652,192 and $610,379, respectively.
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents
approximates their fair value. At December 31, 2001 and 2000, the fair value of
cash and cash equivalents was $18,433,626 and $20,093,774 respectively.
Mortgage Loans: The carrying amount of mortgage loans approximates their fair
value. At December 31, 2001 and 2000, the fair value of mortgage loans was
$156,000.
Policy Loans: The carrying amount of policy loans approximates their fair value.
At December 31, 2001 and 2000, the fair value of policy loans was $4,136,649 and
$4,270,588, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity
contracts approximates their fair value. At December 31, 2001 and 2000, the fair
value of investment-type fixed annuity contracts was $7,468,172 and $7,865,030,
respectively.
Notes Payable: The carrying amounts of notes payable approximate their fair
values. At December 31, 2001 and 2000, the fair value of notes payable was
$7,095,834 and $8,000,000, respectively.
Note 15--BENEFIT PLANS
During 1997, the Company adopted a 401(k) savings plan for its full-time
employees. The Company contributes matching contributions at the discretion of
its Board of Directors. Company expense associated with this plan totaled
$57,532, $46,353, and $34,860 in 2001, 2000 and 1999, respectively.
Note 16--RELATED PARTY TRANSACTIONS
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,
Inc. (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 $45,000 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 $45,000, $48,000, and
$39,000 in 2001, 2000, and 1999, respectively. Incentive fees of $48,168,
$207,369, and $617,524 were incurred and paid for 2001, 2000, and 1999,
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 $94,199, $94,660, and $85,396 in 2001,
2000, and 1999, 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
$174,746, $150,672, and $114,628 during 2001, 2000, and 1999, respectively.
Note 17 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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. Adoption of SFAS No. 133 resulted in a January 1, 2001 transition
adjustment that reduced net income and increased accumulated other comprehensive
income by approximately $311,000. This adjustment consists of a pretax total of
$471,000 less a $160,000 tax benefit.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, "Business Combinations", and No. 142,
"Goodwill and Other Intangible Assets", effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill will no longer be
amortized but will be subject to annual impairment tests in accordance with the
Statements. Other intangible assets will continue to be amortized over their
useful lives. The Company will apply the new rules on accounting for goodwill
and other intangible assets beginning in the first quarter of 2002. Application
of the nonamortization provisions of the Statement is expected to result in an
increase in net income of $90,000 ($0.05 per share) per year. During 2002, the
Company will perform the first of the required impairment tests of goodwill as
of January 1, 2002 and has not yet determined what the effect of these tests
will be on the earnings and financial position of the Company.
Schedule I - Summary of Investments - Other than Investments in Related Parties
Citizens Financial Corporation and Subsidiaries
At December 31, 2001
Type of Investment Cost or Fair Value Amount at
Which Shown
Amortized Cost1 Balance Sheet
---------------------------------------------------- -------------------- -------------------- --------------------
Fixed maturity securities available-for-sale:
US Government and government agencies
and authorities $26,038,744 $26,581,014 $26,581,014
Public utilities 4,028,346 4,096,921 4,096,921
Convertibles and bonds with warrants 2,708,813 2,268,875 2,268,875
All other corporate bonds 43,096,374 44,587,706 44,587,706
---------------------------------------------------- -------------------- -------------------- --------------------
Total $75,872,277 $77,534,516 $77,534,516
Equity securities available-for-sale:
Commons stocks:
Banks, trusts and insurance companies $ 186,025 $ 208,100 $ 208,100
Industrial, miscellaneous and all other 4,400,792 5,196,788 5,196,788
Nonredeemable preferred stocks 2,468,585 2,712,070 2,712,070
---------------------------------------------------- -------------------- -------------------- --------------------
Total $ 7,055,402 $ 8,116,958 $ 8,116,958
Investment real estate 3,438,345 3,438,345 3,438,345
Mortgage loans on real estate 156,000 156,000 156,000
Policy loans 4,136,649 4,136,649 4,136,649
Short-term investments 652,192 652,192 652,192
---------------------------------------------------- -------------------- -------------------- --------------------
Total Investments $91,310,865 $94,034,660 $94,034,660
---------------------------------------------------- -------------------- -------------------- --------------------
1 Adjusted for declines in value believed to be other than temporary, totaling $1,068,000 for fixed maturity securities and
$2,321,158 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
December 31
2001 2000
------------------------------------------------------------------------ -------------------- --------------------
Assets:
Cash and cash equivalents $ 2,094,329 $ 5,843,949
Equity securities available-for-sale (cost of $1,275,702 and
$2,423,152 in 2001 and 2000, respectively) 1,474,719 2,290,923
Fixed maturity securities available-for-sale (cost of
$194,500 in 2001) 194,500 ---
Net option positions --- 14,375
Investments in subsidiaries* 20,638,410 22,243,083
Furniture and equipment 1,400,954 1,507,164
Intercompany receivable* 606,764 ---
Current and deferred federal income tax 863,851 98,851
Other assets 252,023 128,824
------------------------------------------------------------------------ -------------------- --------------------
Total Assets $ 27,525,550 $ 32,127,169
------------------------------------------------------------------------ -------------------- --------------------
Liabilities:
Note payable to bank $ 7,095,834 $ 8,000,000
Intercompany payable* --- 137,382
Current and deferred federal income tax 337,183 169,559
Net option positions 90,050 ---
Other liabilities --- 546,119
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities 7,523,067 8,853,060
Shareholders' Equity:
Common stock 1,716,815 1,758,215
Additional paid-in capital 7,285,938 7,640,988
Accumulated other comprehensive income (loss) 131,351 (87,271)
Equity (deficit) in accumulated other comprehensive
Income (loss) of subsidiaries* 1,625,754 (1,486,023)
Retained earnings 9,242,625 15,448,200
------------------------------------------------------------------------ -------------------- --------------------
Total Shareholders' Equity 20,002,483 23,274,109
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities and Shareholders' Equity $ 27,525,550 $ 32,127,169
------------------------------------------------------------------------ -------------------- --------------------
* Eliminated in consolidation.
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and accompanying footnotes of Citizens
Financial Corporation and Subsidiaries.
Schedule II - Condensed Financial Information of Registrant
Citizens Financial Corporation
(Parent Company Only)
Condensed Statements of Operations
Year Ended December 31 2001 2000 1999
---------------------------------------------------- -------------------- -------------------- --------------------
Revenues:
Net realized investment gains (losses) $(1,953,848) $ 4,282,893 $ 4,115,408
Service fees from subsidiaries 4,705,087 4,497,590 4,198,106
Interest and dividend income 206,940 159,124 20,143
Other income 38,816 47,018 83,329
---------------------------------------------------- -------------------- -------------------- --------------------
Total Revenues 2,996,995 8,986,625 8,416,986
Expenses:
Administrative and general expenses 4,743,159 4,323,967 4,006,129
Interest expense 532,962 769,132 553,017
---------------------------------------------------- -------------------- -------------------- --------------------
Total Expenses 5,276,121 5,093,099 4,559,146
---------------------------------------------------- -------------------- -------------------- --------------------
Income (loss) before income taxes and (2,279,126) 3,893,526 3,857,840
undistributed earnings of subsidiaries
Income tax expense (benefit) (940,000) 1,435,000 1,525,000
---------------------------------------------------- -------------------- -------------------- --------------------
Income (loss) before equity in undistributed (1,339,126) 2,458,526 2,332,840
earnings of subsidiaries
Equity in undistributed earnings (loss)
of subsidiaries (4,866,449) (2,220,396) 4,106,005
---------------------------------------------------- -------------------- -------------------- --------------------
Net Income (Loss) $(6,205,575) $ 238,130 $ 6,438,845
---------------------------------------------------- -------------------- -------------------- --------------------
* Eliminated in consolidation.
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and accompanying footnotes of Citizens
Financial Corporation and Subsidiaries.
Schedule II - Condensed Financial Information of Registrant
Citizens Financial Corporation
(Parent Company Only)
Condensed Statements of Cash Flows
Year Ended December 31 2001 2000 1999
------------------------------------------------------ ------------------- ------------------ ------------------
Cash from operations $(1,423,335) $ (1,732,507) $ (1,416,297)
Cash flow from investing activities:
Purchases of available-for-sale securities (6,211,339) (20,401,917) (37,514,433)
Sales of available-for-sale securities 5,338,727 28,718,945 40,458,637
Redemption of affiliated preferred stock* 1,200,000 2,200,000
Purchase of, or contribution to subsidiaries* (150,000) --- (3,556,469)
Investment management fees --- (201,179) (150,022)
Additions to property and equipment, net (40,392) (1,065,533) (197,603)
Change in investments, other 37,335 13,425 13,425
------------------------------------------------------ ------------------- ------------------ ------------------
Net cash provided by (used in) investing activities (1,025,669) 8,263,741 1,253,535
Cash flow from financing activities:
Payments on notes payable - bank (904,166) (500,000) (510,000)
Repurchase of capital stock (396,450) (104,213) (391,024)
Proceeds from note payable - bank --- --- 2,500,000
Net brokerage account loan proceeds
(repayment) --- (100,884) (1,406,524)
------------------------------------------------------ ------------------- ------------------ ------------------
Net cash provided by (used in ) financing activities (1,300,616) (705,097) 192,452
------------------------------------------------------ ------------------- ------------------ ------------------
Net increase (decrease) in cash (3,749,620) 5,826,137 29,690
and cash equivalents
Cash and cash equivalents at beginning of year 5,843,949 17,812 (11,878)
------------------------------------------------------ ------------------- ------------------ ------------------
Cash and cash equivalents at end of year $ 2,094,329 $ 5,843,949 $ 17,812
------------------------------------------------------ ------------------- ------------------ ------------------
* Eliminated in consolidation.
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and accompanying footnotes of Citizens
Financial Corporation and Subsidiaries.
Schedule III - Supplementary Insurance Information
Citizens Financial Corporation
For the Years Ended December 31, 2001, 2000, and 1999
Year Ended December 31 / Other Policy Net
Deferred Policy and Claims and Investment Policy Amortization Other
Acquisition Claim Unearned Benefits Premium and Other Benefits of Operating
Segment Costs Reserves Premiums Payable Revenue Income1 and Claims2 Policy Costs3 Costs4
-------------------- ------------ ------------ --------- ------------ ----------- ---------- ----------- ------------- -------------
Column: A B C D E F G H I J
2001:
Home Service Life $3,297,247 $ 32,093,694 $ --- $ 516,265 $ 7,152,242 $2,137,878 $ 4,474,816 $ 714,743 $3,717,838
Broker Life 3,451,936 44,067,779 3,147 344,048 3,812,841 2,684,445 3,920,434 538,374 1,963,518
Preneed Life 1,665,278 27,239,439 --- 273,207 8,397,911 1,576,494 8,223,074 711,300 1,304,519
Dental --- 264,235 5,540 295,344 7,988,620 36,754 5,551,624 --- 2,217,365
Other Health 164,962 1,590,144 244,043 302,892 1,392,762 94,801 819,784 21,841 635,091
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
Total $8,579,423 $105,255,291 $252,730 $1,731,756 $28,744,376 $6,530,372 $22,989,732 $1,986,258 $9,838,331
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
2000:
Home Service Life $2,739,204 $ 30,865,491 $ --- $ 678,066 $ 6,906,473 $2,129,532 $ 4,697,315 $ 585,396 $3,552,815
Broker Life 3,184,922 44,046,164 3,577 581,758 3,664,072 2,664,812 3,842,619 474,982 1,711,506
Preneed Life 425,320 22,902,433 --- 192,397 3,982,948 1,362,982 4,676,422 220,525 1,276,248
Dental --- 303,550 7,680 298,881 7,892,356 41,242 5,369,742 --- 2,232,650
Other Health 162,502 1,667,389 206,413 269,445 1,376,575 92,741 814,299 24,657 598,174
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
Total $6,511,948 $ 99,785,027 $217,670 $2,020,547 $23,822,424 $6,291,309 $19,400,397 $1,305,560 $9,371,393
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
1999:
Home Service Life $2,178,003 $ 29,690,250 $ --- $ 609,975 $ 6,697,932 $2,047,212 $ 4,553,823 $ 476,814 $3,401,804
Broker Life 2,379,344 41,202,757 4,404 511,787 3,447,440 2,555,585 3,768,763 515,582 1,568,363
Preneed Life 10,336 21,427,254 --- 82,011 2,298,013 1,316,745 3,237,316 318,841 1,052,161
Dental --- 316,914 7,433 309,404 7,105,627 35,781 4,717,677 --- 1,987,144
Other Health 123,091 2,682,213 164,942 184,355 1,295,816 87,622 760,854 19,298 667,810
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
Total $4,690,774 $ 95,319,388 $176,779 $1,697,532 $20,844,828 $6,042,945 $17,038,433 $1,330,535 $8,677,282
------------------- ------------ ------------ ---------- ------------ ----------- ---------- ------------ ------------- ------------
1Amounts are allocated based on average policy reserves and deposits.
2Includes interest on policyholder deposits and dividends credited to participating policyholders.
3Amortization of Policy Costs: 2001 2000 1999
----------------- ---------------- -----------------
Deferred acquisition costs $ 1,279,485 $ 539,062 $ 491,221
Present value of insurance acquired 706,773 766,498 839,314
----------------- ---------------- -----------------
$1,986,258 $1,305,560 $1,330,535
================= ================ =================
4Includes commissions, general expense, goodwill amortization, and depreciation expense.
Schedule IV - Reinsurance
Citizens Financial Corporation
For the Years Ended December 31, 2001, 2000, and 1999
Year Ended December 31 Percentage
Ceded to Assumed of Amount
Gross To Other From Other Net Assumed
Amount Companies Companies Amount To Net
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
2001:
Life insurance in force: $812,515,000 $109,227,000 $6,768,604 $710,056,604 1.0%
Premiums:
Life insurance $20,387,653 $ 1,051,574 $ 26,915 $19,362,994 0.1%
Accident & health insurance 9,555,188 173,806 --- 9,381,382 0.0%
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
Total $29,942,841 $ 1,225,380 $ 26,915 $28,744,376 0.1%
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
2000:
Life insurance in force: $799,576,000 $100,829,000 $7,297,000 $706,044,000 1.0%
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%
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
1999:
Life insurance in force: $757,391,000 $119,001,000 $8,049,000 $646,439,000 1.2%
Premiums:
Life insurance $13,300,690 $ 914,541 $ 57,236 $12,443,385 0.5%
Accident & health insurance 8,539,338 137,895 --- 8,401,443 0.0%
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
Total $21,840,028 $ 1,052,436 $ 57,236 $20,844,828 0.3%
------------------------------------- ---------------- ----------------- ---------------- ----------------- ----------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no change in accountants nor have there been any disagreements on
accounting and financial disclosure requiring disclosure pursuant to the
Instructions to this Item.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
OF THE REGISTRANT
The information required by this Item is set forth under the captions: "Election
of Directors", "Executive Officers of the Company", and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Board of Director's Proxy
Statement for the Annual Meeting of Shareholders of the Company now scheduled
for May 23, 2002, and such information is here incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the captions:
"Executive Compensation", "Board of Directors Report on Executive Compensation",
"Performance Graph" and "Compensation Committee Interlocks and Insider
Participation" of the Board of Directors' Proxy Statement for the Annual Meeting
of Shareholders of the Company now scheduled for May 23, 2002, and such
information is here incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is set forth under the caption: "Security
Ownership of Certain Beneficial Owners and Management" in the Board of
Directors' Proxy Statement for the Annual Meeting of Shareholders of the Company
now scheduled for May 23, 2002, and such information is here incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
The information required by this Item is set forth under the caption: "Certain
Transactions Involving Directors and Executive Officers" in the Board of
Directors' Proxy Statement for the Annual Meeting of Shareholders of the Company
now scheduled for May 23, 2002, and such information is here incorporated by
reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-K:
(a) Financial Statements and Financial Statement Schedules.
The audited Consolidated Financial Statements of the Company and its
subsidiaries, the Financial Statements Schedules (including: Schedule I -
Summary of Investments - Other than Investments In Related Parties,
Schedule II - Condensed Financial Information of Registrant, Schedule III -
Supplementary Insurance Information, and Schedule IV - Reinsurance), and
the related Report of Independent Auditors listed in the Index to Financial
Statements and Financial Statement Schedules appearing under Item 8 of this
Form 10-K.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
The exhibits listed in the Index to Exhibits appearing on page 56.
Pursuant to paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company
agrees to furnish to the Commission upon request copies of instruments defining
the rights of holders of the Company's long term debt.
SIGNATURES
In accordance with of Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CITIZENS FINANCIAL CORPORATION
March 21, 2002 By: /s/ Darrell R. Wells
-----------------------------------------------
Darrell R. Wells
President
In accordance with the requirements of the Exchange Act, this Report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Darrell R. Wells
-----------------------------
Darrell R. Wells Director and President March 21, 2002
(principal executive officer)
/s/ Lane A. Hersman
-----------------------------
Lane A. Hersman Director and Executive March 21, 2002
Vice President
/s/ Brent L. Nemec
-----------------------------
Brent L. Nemec Vice President, Accounting, March 21, 2002
Chief Financial Officer, and
Treasurer (principal financial
/s/ John H. Harralson, Jr. and accounting officer)
-----------------------------
John H. Harralson, Jr. Director March 21, 2002
/s/ Frank T. Kiley
-----------------------------
Frank T. Kiley Director March 21, 2002
/s/ Earle V. Powell
-----------------------------
Earle V. Powell Director March 21, 2002
/s/ Thomas G. Ward
-----------------------------
Thomas G. Ward Director March 21, 2002
/s/ Margaret A. Wells
-----------------------------
Margaret A. Wells Director March 21, 2002
INDEX TO EXHIBITS
(Item 14(c))
The documents listed in the following table are filed as Exhibits in response to
Item 14(c). Exhibits listed that are not filed herewith are incorporated herein
by reference.
Exhibit No. Description
3.1 Restated Articles of Incorporation of the Company dated
August 12, 1996 (filed as Exhibit 3.1 to the Company's
Form 10-KSB dated March 31, 1999)
3.2 Bylaws of the Company adopted September 12, 1990 as
amended March 25, 1994 (filed as Exhibit 3.2 to the
Company's Form 10-K dated March 28, 1996)
4 Provisions of Articles of Incorporation of the Company
Defining the Rights of Holders of Class A Stock (filed
as Exhibit 4 to the Company's Form 10 Registration
Statement)
10.1 Investment Management Agreements dated July 1, 1994
between Citizens Security and the Company and SMC
Advisors, Inc. (filed as Exhibit 10.1 to the Company's
Form 10-K dated March 29, 1995)
10.1B Investment Management Agreement dated June 1, 1998
between United Liberty and SMC Advisors, Inc. (filed
as Exhibit 10.1B to the Company's Form 10-KSB dated
March 31, 1999)
10.1C Investment Management Agreement dated February 6, 2000
between Citizens Insurance and SMC Advisors, Inc. (filed
as Exhibit 10.1C to the Company's Form 10-KSB dated
March 29, 2000)
10.9 Form of Employment Agreement with Certain Executives of
the Company and Schedule of Data (filed as Exhibit 10.9
to the Company's Form 10-K dated March 28, 1996)*
10.10 1999 Stock Option Plan (filed as exhibit to the Company's
proxy statement for annual meeting of shareholders held
on May 20, 1999)*
21.2 Subsidiaries of the registrant (filed herewith)
23.3 Consent of Independent Auditors (filed herewith)
* Management contract or compensatory plan or arrangement.
EXHIBIT 21.2
Subsidiaries of the Registrant
--------------------------------------------
Citizens Financial Corporation
(Kentucky Corporation)
--------------------------------------------
100% 100%
--------------------------------- ---------------------------------
Citizens Security Life Corporate Realty Service, Inc.
Insurance Company (Kentucky Corporation)
(Kentucky Corporation)
--------------------------------- ---------------------------------
100% 100%
------------------------- -------------------------
United Liberty Life Citizens Insurance
Insurance Company Company
(Kentucky Corporation) (Kentucky Corporation)
------------------------- -------------------------
EXHIBIT 23.3
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-86519) pertaining to the Citizens Financial Corporation 1999 Stock
Option Plan of our report dated March 25, 2002 with respect to the consolidated
financial statements and schedules of Citizens Financial Corporation included in
the Annual Report (Form 10-K) for the year ended December 31, 2001.
/s/ Ernst & Young LLP
March 25, 2002
Louisville, Kentucky