1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] 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 1-13004 CITIZENS, INC. ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) <TABLE> <S> <C> Colorado 84-0755371 ------------------------ --------------------------------- (State of incorporation) (IRS Employer Identification No.) 400 East Anderson Lane, Austin, Texas 78752 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) </TABLE> Registrant's telephone number, including area code: (512) 837-7100 Securities registered pursuant to Section 12(b) of the Act: <TABLE> <S> <C> Title of each class Name of each exchange on which registered Class A Common Stock American Stock Exchange - -------------------- ----------------------- </TABLE> Securities registered pursuant to Section 12(g) of the Act: None 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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirement 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 or any amendment to this Form 10-K. X --- As of March 1, 2001, aggregate market value of the Class A voting stock held by non-affiliates of the Registrant was approximately $129,960,000. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Report incorporates certain portions of the definitive proxy material of the Registrant in respect of its 2001 Annual Meeting of Shareholders. Number of shares of common stock outstanding as of March 1, 2001 Class A: 24,396,564 Class B: 711,040
2 PART I ITEM 1. BUSINESS (a) GENERAL DEVELOPMENT OF BUSINESS Citizens, Inc. (Citizens) operates primarily as an insurance holding company. It was incorporated in Colorado in 1977. Citizens is the parent company that directly or indirectly owns 100% of Citizens Insurance Company of America (CICA), Computing Technology, Inc. (CTI), Insurance Investors, Inc. (III), Funeral Homes of America (FHA), Central Investors Life Insurance Company of Illinois (CILIC), First Investors Group, Inc. (Investors) and Excalibur Insurance Corporation (Excalibur). Collectively, Citizens and its subsidiaries are referred to herein as the "Company." Pertinent information relating to Citizens' subsidiary companies is set forth below: <TABLE> <CAPTION> YEAR STATE OF BUSINESS SUBSIDIARY INCORPORATED INCORPORATION ACTIVITY - ---------- ------------ ------------- -------- <S> <C> <C> <C> CICA 1968 Colorado Life insurance CILIC 1965 Illinois Life insurance Investors 1996 Illinois Holding company Excalibur 1996 Illinois Life insurance CTI 1986 Colorado Data processing III 1965 Texas Aircraft transportation FHA 1989 Louisiana Funeral home </TABLE> In June, 1997, CICA acquired American Investment Network, Inc. (AIN), a life insurance holding company and United Security Life Insurance Company (USLIC), its wholly-owned subsidiary, headquartered in Jackson, Mississippi with $7.5 million in assets, $3.4 million of stockholders' equity, annual revenues of $3.2 million and $67 million of life insurance in-force. Subsequently, AIN was liquidated. USLIC was merged into CICA in October, 2000. To streamline corporate structure, in June, 1997, American Liberty Financial Corporation (ALFC), a wholly owned subsidiary, was merged into Citizens. American Liberty Life Insurance Company (ALLIC), a subsidiary of ALFC, was also merged into CICA. In November, 1997, Citizens purchased 100% of the issued and outstanding shares of National Security Life and Accident Insurance Company (NSLIC). NSLIC was a Texas-domiciled life and accident and health insurer with assets of approximately $5 million and revenues of approximately $5 million. It was merged into CICA in June, 2000. In January, 1999, Citizens acquired Investors, the parent of Excalibur.
3 Certain statements contained in this Annual Report on Form 10-K are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the "Act"), including, without limitation, the italicized statements and the statements specifically identified as forward-looking statements within this document. Many of these statements contain risk factors as well. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements, include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of plans and objectives of the Company or its management or Board of Directors including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted", "may", "will" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) the strength of foreign and U.S. economies in general and the strength of the local economies in which operations are conducted; (ii) the effects of and changes in trade, monetary and fiscal policies and laws; (iii) inflation, interest rates, market and monetary fluctuations and volatility; (iv) the timely development of and acceptance of new products and services and perceived overall value of these products and services by existing and potential customers; (v) changes in consumer spending, borrowing and saving habits; (vi) concentrations of business from persons residing in third world countries; (vii) acquisitions; (viii) the persistency of existing and future insurance policies sold by the Company and its subsidiaries; (ix) the dependence of the Company on its Chairman of the Board; (x) the ability to control expenses; (xi) the effect of changes in laws and regulations (including laws and regulations concerning insurance) with which the Company and its subsidiaries must comply, (xii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xiii) changes in the Company's organization and compensation plans; (xiv) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (xv) the success of the Company at managing the risks involved in the foregoing. Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. 3
4 (b) FINANCIAL INFORMATION REGARDING THE INSURANCE BUSINESS Citizens, through CICA, CILIC, and Excalibur, operates principally in two business segments: selling selected lines of individual life and accident and health (A&H) insurance policies in domestic markets and individual ordinary life insurance in international markets. Except for certain insignificant operations, Citizens has no present intention to engage in any non-insurance related business. The following tables set forth certain statistical information on the basis of accounting principles generally accepted in the United States of America (U.S. GAAP) concerning the operations of the Company for each of the five years ended December 31, 2000. TABLE I The following table sets forth (i) life insurance in-force and (ii) mean life insurance in-force. <TABLE> <CAPTION> IN-FORCE MEAN LIFE BEGINNING IN-FORCE INSURANCE OF YEAR END OF YEAR IN-FORCE (a) (b) (a) (b) (a) (b) ------- ------- ------- <S> <C> <C> <C> 2000 $2,197,844 $2,240,523 $2,219,184 1999 2,340,744 2,197,844 2,269,294 1998 2,250,197 2,340,744 2,295,471 1997 2,231,017 2,250,197 2,240,607 1996 2,151,955 2,231,017 2,191,486 </TABLE> (a) In thousands (000s) (b) Before ceding reinsurance to reinsurers The increases in insurance in-force prior to 1999 reflect the volumes of new business written by the Company as well as the impact of acquisitions. Economic and other market disruptions in the Company's international markets had a negative impact on the Company's persistency in 1999, contributing to the decline in insurance in-force. Improved persistency in 2000 combined with increased sale of new policies contributed to the growth in insurance in-force during 2000. Approximately $96,803,000 of the 1997 numbers resulted from the acquisitions of USLIC and NSLIC. 4
5 TABLE II The following table sets forth (i) the ratio of lapses and surrenders to mean life insurance in-force and (ii) life reinsurance ceded. <TABLE> <CAPTION> RATIO OF REINSURANCE CEDED LAPSES AND ------------------------------------ SURRENDERS AMOUNT REINSURANCE LAPSES AND TO MEAN OF PREMIUM SURRENDERS (a) IN-FORCE REINSURANCE (a) CEDED (b) -------------- -------- --------------- ----------- <S> <C> <C> <C> <C> 2000 $112,676 5.1% $272,150 $2,494,798 1999 115,018 5.1 278,689 2,539,155 1998 100,906 4.4 306,070 3,368,690 1997 95,684 4.3 318,630 2,257,556 1996 101,860 4.6 296,378 2,511,318 </TABLE> (a) In thousands (000s) (b) Approximately 95 percent of the reinsurance is yearly renewable term insurance, with the remainder being coinsurance. Premiums reflect both life and accident and health business. As described above, the disruption in certain international markets contributed to the increased lapsation and surrender activity in 1999. The decline in ceded premium in 1999 and 2000 was related to the termination of a substantial portion of NSLIC's major medical business, much of which had been ceded. The increase in ceded premium in 1998 was due to the cession of a substantial portion of the major medical accident and health business of NSLIC. TABLE III The following table sets forth information with respect to total insurance premiums. <TABLE> <CAPTION> ORDINARY ANNUITY & ACCIDENT LIFE (a) UNIVERSAL LIFE GROUP LIFE & HEALTH (a) TOTAL -------- -------------- ---------- ------------ ----- <S> <C> <C> <C> <C> <C> 2000 $45,892,621 $228,479 $ 95,068 $ 7,235,685 $53,451,853 1999 47,687,414 261,880 484,746 10,886,317 59,320,357 1998 48,801,081 263,994 231,410 9,857,844 59,154,329 1997 49,412,066 366,135 284,632 5,299,783 55,362,616 1996 49,563,720 389,084 309,953 4,040,688 54,303,445 </TABLE> (a) After deduction for reinsurance ceded. New sales of life insurance remained relatively flat from 1996 to 1999. In 2000, new life sales increased, but overall life premium declined due to the lower level of sales in previous years coupled with the surrender activity shown in Table II above. Much of the 1998 increase in accident and health premiums related to the acquisition of USLIC and NSLIC. Additionally, much of the 2000 decline in accident and health premiums related to management's decision to cancel a large portion of USLIC's group dental business and NSLIC's major medical business during the third quarter of 1999 in order to curtail both claims and operating expenses. 5
6 TABLE IV The following table sets forth information relating to the ratio of underwriting and other expenses to insurance revenues. <TABLE> <CAPTION> COMMISSIONS, UNDERWRITING AND OPERATING EXPENSES, POLICY RESERVE INCREASES, COMMISSIONS, UNDERWRITING POLICYHOLDER BENEFITS AND AND OPERATING EXPENSES DIVIDENDS TO POLICYHOLDERS ---------------------- -------------------------- RATIO TO RATIO TO INSURANCE INSURANCE INSURANCE PREMIUMS (a) AMOUNT PREMIUMS AMOUNT PREMIUMS ------------ ------ -------- ------ -------- <S> <C> <C> <C> <C> <C> 2000 $53,451,853 $22,550,592 42.2% $63,693,030 119.2% 1999 59,320,357 22,563,049 38.0 68,043,243 114.7 1998 59,154,329 23,580,491 39.9 66,914,063 113.1 1997 55,362,616 18,910,594 34.2 58,865,744 106.3 1996 54,303,445 21,948,637 40.4 59,113,575 108.9 </TABLE> (a) After premiums ceded to reinsurers. Following the merger of ALLIC in 1997, significant reductions in operating expenses were realized. The 1997 acquisitions of NSLIC and USLIC and their related conversion expenses as well as increases in accident and health benefits were the primary reasons for the 1998 and 1999 increase in policyholder benefits and the 1998 increase in commission, underwriting and operating expenses. During 2000, accident and health premiums and claims decreased as discussed above due to the cancellation of major portions of the group dental and major medical business; however, due to the development of a domestic ordinary life sales program and the administrative costs of managing the run-off of the cancelled accident and health business, the ratio of expenses to premium increased. TABLE V The following table sets forth changes in new life insurance business produced between participating and nonparticipating policies. <TABLE> <CAPTION> PARTICIPATING NONPARTICIPATING TOTAL NEW ------------- ---------------- BUSINESS (a) AMOUNT (a) PERCENT AMOUNT (a) PERCENT ------------ ---------- ------- ---------- ------- <S> <C> <C> <C> <C> <C> 2000 $327,753 $217,303 66.3% $110,450 33.7% 1999 287,238 180,800 62.9 106,438 37.1 1998 311,331 222,496 71.5 88,835 28.5 1997 286,698 245,547 85.6 41,151 14.4 1996 337,051 294,408 87.3 42,643 12.7 </TABLE> (a) In thousands (000s) Non-participating business increased beginning in 1996 because USLIC and NSLIC sold only non-participating policies and a change was made in benefits in the Company's international business, as new or ordinary life products shifted away from participating to non-participating. 6
7 The significant changes in 1998 and 1999 were due to the volume of credit life business produced by NSLIC that is non-participating. During 2000 the percentage of participating new business increased due to the cancellation of USLIC's and NSLIC's group dental and individual major medical non-participating policies and due to an increase in new life sales. TABLE VI The following table sets forth changes in new life insurance business issued according to policy types. <TABLE> <CAPTION> WHOLE LIFE AND ENDOWMENT TERM CREDIT TOTAL NEW --------------------- ---------------------- ---------------------- BUSINESS (a) AMOUNT (a) PERCENT AMOUNT (a) PERCENT AMOUNT (a) PERCENT ------------ ---------- ------- ---------- ------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> <C> 2000 $327,753 $220,691 67.3% $56,747 17.3% $50,315 15.4% 1999 287,238 183,726 63.9 43,607 15.2 59,905 20.9 1998 311,331 224,918 72.2 51,531 16.6 34,882 11.2 1997 286,698 245,637 85.7 41,061 14.3 0 -- 1996 337,051 296,985 88.1 40,066 11.9 0 -- </TABLE> (a) In thousands (000s) This table illustrates that virtually all of the new business written prior to 1997 was whole life. The 1997 results reflect a decrease in new life business during the year, which continued through 1999. Most of the 1998 and 1999 increases were due to the credit life business sold by NSLIC. The decline in 1998 and 1999 whole life production related to the disruption in the Company's international market. In 2000, new life sales measured in paid annualized premiums increased 21.4%. TABLE VII The following table sets forth deferred policy acquisition costs capitalized and amortized compared to new business life insurance issued. <TABLE> <CAPTION> DEFERRED POLICY TOTAL NEW ACQUISITION COSTS BUSINESS ----------------- ISSUED CAPITALIZED AMORTIZED ------ ----------- --------- <S> <C> <C> <C> 2000 $327,753,000 $10,056,287 $ 8,521,972 1999 287,238,000 9,287,457 10,028,806 1998 311,331,000 7,941,829 7,789,513 1997 286,698,000 9,804,022 9,630,705 1996 337,051,000 10,531,222 10,221,917 </TABLE> The decrease in costs capitalized for 1997 and 1998 reflected the reduction in the amount of new business produced and lower commission expenses incurred as a result thereof. Amortization in 1999 was high due to increased surrender activity. The increase in 2000 capitalized costs related to the increase in new business issued, while the decrease in amortized costs was due to improved persistency during the year. 7
8 TABLE VIII The following table sets forth investment results. <TABLE> <CAPTION> RATIO OF NET INVESTMENT INCOME MEAN AMOUNT OF NET INVESTMENT TO MEAN AMOUNT INVESTED ASSETS (a) INCOME (b) OF INVESTED ASSETS (a) ------------------- ---------- ---------------------- <S> <C> <C> <C> 2000 $184,270,944 $12,550,754 6.8% 1999 175,305,342 11,636,940 6.6 1998 169,461,908 11,279,125 6.7 1997 150,481,414 10,038,736 6.7 1996 134,167,938 9,185,506 6.8 </TABLE> (a) The year 1997 includes assets acquired from NSLIC and USLIC. The year 1996 includes assets acquired from CILIC on March 12, 1996. (b) Does not include realized and unrealized gains and losses on investments. Significant decreases in yields in the bond market caused the return on invested assets to drop slightly in 1997, which continued throughout 1998 and 1999. During 2000, the Company terminated its outside investment manager and changed the mix of new investments, resulting in improved performance for the year. (c) NARRATIVE DESCRIPTION OF BUSINESS (i) BUSINESS OF CITIZENS Citizens' principal business is ownership of CICA, Investors and their affiliates. Additionally, it provides management services to these companies under management services agreements. At December 31, 2000, Citizens had approximately 90 full and part-time employees. All intercompany fees and expenses have been eliminated in the consolidated financial statements. (ii)BUSINESS OF CICA Historically, CICA's revenues have been derived from life insurance premiums and revenues from investments. CICA is a Colorado-domiciled life insurance company marketing primarily ordinary whole-life products on an international basis through marketing companies. Additionally, it offers specialty individual accident and health policies to United States residents, and following the merger of NSLIC in 2000, credit life insurance policies to U.S. residents. All intercompany fees and expenses have been eliminated in the consolidated financial statements. During the year ended December 31, 2000, 89.7% of CICA's premium income was attributable to life, endowment and term insurance, .4% to individual annuities and 13.6% to accident and health insurance. During the year ended December 31, 1999, 93.1% of CICA's premium income was attributable to life, endowment and term insurance, 0.5% to individual annuities, and 6.4% to 8
9 accident and health insurance. Of the life policies in force at December 31, 2000 and 1999, 43.1% and 39.9%, were nonparticipating and 56.9% and 59.1%, respectively were participating. The increase in accident and health premiums between years resulted from the merger of NSLIC and USLIC during 2000. From 1987 to 1997, CICA offered a series of participating whole life policies designed for international markets. Beginning January 1, 1998, CICA introduced a new series of policies to replace the policies then offered. Ten plans make up this series and, like those previously sold, are designed for the international market. These plans maintain many of the features of the previous series and incorporate several new enhancements, such as terminal illness protection as well as dismemberment provisions. Additionally, following the merger with ALLIC, CICA began offering specialty individual accident and health products as well as ordinary whole life policies to residents of the United States. The sale of these products is focused in Oklahoma, Louisiana and Mississippi. In 1999 management began developing a domestic ordinary life sales program and received regulatory approval of the product and related sales material in Texas during April of 2000. Management began recruiting efforts for associates in the State of Texas for the new product in mid-2000 and sales began late during second quarter 2000. This program, targeting rural areas of the United States, is expected to provide a new entree into the domestic life market for the Company. The Company intends to expand sales efforts beyond Texas to other states in which CICA is licensed. Because sales efforts have recently begun, management is unable to predict the success of this new program. The CICA underwriting policy requires a medical examination of applicants for ordinary insurance in excess of certain prescribed limits. These limits are graduated according to the age of the applicant and the amount of insurance. Generally, the maximum amount of ordinary life insurance issued domestically without a medical examination is $200,000 for ages 0 through 35; $100,000 for ages 36 through 45; $50,000 for ages 46 through 50; $15,000 for ages 51 through 55; and $10,000 for ages 56 and over. Limits for insuring non-United States applicants without a medical examination are: $150,000 for ages 0 through 39 and $50,000 for ages 40 through 65; and all amounts over age 40. The accident and health policies sold in the U.S. have only minimal, field underwriting. On life policies, CICA's maximum coverage on any one life is not limited by Company policy. However, CICA reinsures the amount of coverage, which is in excess of its retention policy. See "Business of CICA - Reinsurance." CICA does not accept substandard risks above Table 6 (generally policyholders who cannot qualify for standard ordinary insurance because of past medical history). CICA has $27.5 million of insurance in-force on individuals that are classified as substandard risks, the majority of such business having been acquired in the 9
10 purchase of other companies. Management believes the exposure to loss as a result of insuring these individuals is minimal, since the premiums are increased to cover the nature of the risk, additional reserves are established, and the amount of this insurance represents approximately 1.0% of the total insurance in-force. GEOGRAPHICAL DISTRIBUTION OF BUSINESS The following table sets forth CICA's total yearly premium income by geographic area for the years indicated. <TABLE> <CAPTION> AREA 2000 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> Oklahoma 5.2% 5.4% 5.5% Texas 4.4% 2.3% 3.2% Louisiana 1.1% 1.2% 1.2% All Other States 6.6% 5.6% 6.8% Foreign 82.7% 85.5% 83.3% </TABLE> The participating whole life policies accepted by CICA on high net worth residents of foreign countries have an average face amount of approximately $70,000 and are marketed primarily to the top 5% of the population in terms of household income. CICA has neither offices nor employees overseas. It accepts applications for international insurance policies submitted by several independent firms in these markets with whom CICA has non-exclusive consulting contracts. These firms specialize in marketing life insurance products to citizens of foreign countries and have many years of experience marketing life insurance products. They provide recruitment, training and supervision of their managers and associates in the placement of dollar-denominated life insurance products; however, all consultants and associates contract directly with CICA and receive their compensation from CICA. Accordingly, should the consulting arrangement between any firm and CICA be canceled for any reason, CICA believes it could continue suitable marketing arrangements with the individuals of the consulting firms without appreciable loss of present and future sales, as it has done in the past. There is, however, always a risk that sales could decrease. The contract with the consultants provides that they are the representative of the prospective insured, have the responsibility for recruiting and training their sales associates and are responsible for all of their overhead costs including the expense of contests and awards. These firms guarantee any debts of marketers and their associates. In consideration for the services rendered, the marketing consultants receive a fee on all new policies placed by them or their associates. See "Business of CICA - Commissions." Either party may terminate the marketing contracts for various causes at any time by mutual consent of the parties or upon 30 days' notice. At present, CICA is dependent on the non-U.S. markets for a large percentage of its new life insurance business. This subjects CICA to potential risks with regard to the continued ability to write such business should adverse events occur in the 10
11 countries from which CICA receives applications. These potential risks include lapses of policies if funds that flow out of such countries were to become restricted. Based on more than 35 years experience in the marketplace in which CICA competes, management believes such risks are not material. The Company maintains no assets outside the U.S. and requires all premiums to be paid in the U.S. with U.S. dollars via drafts drawn on banks in the U.S.; therefore, it could lose no funds from currency devaluation or foreign appropriation. Many of the inherent risks in foreign countries, such as political instability, hyper-inflation and economic disruptions tend to improve rather than hurt CICA's business because it encourages individuals to convert assets out of local currencies to the more stable U.S. dollar. MARKETING OPERATIONS CICA holds licenses to do business in 15 states and accepts applications for consideration from any foreign country. CICA's operations are conducted on the independent contractor basis, with 1,302 individuals contracted at December 31, 2000 and 1,415 at December 31, 1999 and 615 individuals at December 31, 1998. COMMISSIONS CICA's marketing managers are independent contractors, responsible for their respective expenses, and are compensated on a percentage of premium basis. Percentage amounts paid to contractors on individual term, annuity and accident and health insurance are substantially less than the levels paid for individual ordinary life insurance. The marketing managers receive overriding first year and renewal commissions on business written by individuals under their supervision and all marketing expenses related thereto are included in the above percentages. RESERVES CICA establishes actuarial reserves as liabilities to meet obligations on all outstanding policies. Reserves and deferred acquisition costs are prepared in conformity with the American Academy of Actuaries Committee on Financial Reporting Principles and accounting principles generally accepted in the United States of America. In determining such reserves CICA used the 1955 to 1960, 1965 to 1970, and 1975 to 1980 Select and Ultimate Mortality Tables with interest rates at 4% or in a range graded from 9% to 5% with recent issues reserved at 7% graded to 6 1/2%. Withdrawal assumptions are based primarily on actual historical experience. Statutory reserves are used for paid-up life business. Claims reserves include an amount equal to the expected benefit to be paid on reported claims in addition to an estimate of claims that are incurred but not reported based on actual historical experience. CICA receives an independent actuarial certification of its reserves prepared in accordance with both Generally Accepted Accounting Principles and Statutory Accounting Practices. The certifications have noted no deficiencies for the years presented herein. 11
12 REINSURANCE CICA assumes and cedes insurance with other insurers, reinsurers and members of various reinsurance pools. Reinsurance arrangements are utilized to provide greater diversification of risk and minimize exposure on larger risks. (a) INSURANCE CEDED CICA has historically retained $75,000 of risk on any one person. Effective January 1, 2001, this amount was increased to $100,000 based upon CICA's capital growth. The increase in retention is based upon the relative size and financial strength of CICA. As of December 31, 2000, the aggregate amount of life insurance ceded amounted to $270,515,000 or 10.6% of total direct and assumed life insurance in-force, and was $259,060,000 or 10.8% in 1999. CICA is contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations reinsured. As of December 31, 2000, CICA had in effect automatic reinsurance agreements with reinsurers that provide for cessions of ordinary insurance from CICA. Additionally, CICA has reinsurance treaties in force with several reinsurers of life and accident and health insurance. These treaties provide for both automatic and facultative reinsurance of standard and substandard risks ceded to them by CICA for life, accident and health and supplemental benefits above CICA's retention limit on a yearly renewable term, coinsurance or modified coinsurance basis. Treaties with Employers Reassurance (ERC) and Businessmen's Assurance (BMA) historically have been the primary vehicles utilized by CICA for its international business. The treaties are structured in such a way as to allow CICA to "self administer" the cessions on a reduced cost basis. During 1995, a third carrier was added as a principal reinsurer, Riunione Adriatica di Sicurta, of Italy (RAS). American United Life Insurance Company (AUL) replaced RAS in 2000. The ERC and BMA agreements provide that for risks reinsured in specified countries, 70% of each risk in excess of CICA's retention will be ceded to ERC and 30% to BMA. The RAS agreement provided that on risks reinsured in specified countries, 100% of the risk in excess of CICA's retention was ceded to RAS. AUL's treaty provides for the same share of business that RAS previously reinsured. CICA pays premiums to ERC, BMA and AUL on an annual basis and is responsible for the production of the reporting monthly and annually to ERC and BMA to allow proper accounting for the treaties. The RAS agreement contained similar terms. The cessions are on a yearly renewable term basis and are automatic over the Company's retention up to $350,000 for ERC, $150,000 for BMA and $500,000 for AUL, after which the reinsurance is subject to a facultative review by the reinsurers. At December 31, 2000, CICA had ceded $147,791,000 in face amount 12
13 of insurance to ERC, $29,864,000 to BMA, $65,087,000 to RAS and $17,610,000 to AUL under these agreements. RAS is an unauthorized reinsurer in the state of Colorado; however, RAS has agreed to comply with Colorado statutes regarding such companies. Under these statutes, RAS will provide a letter of credit, issued by a U.S. bank meeting the Colorado requirements, equal to any liabilities it incurs under this agreement. RAS notified CICA in late 1999 that it was withdrawing from the reinsurance market effective January 1, 2000 and AUL replaced it. A reinsurance treaty with Connecticut General Life Insurance Company (CG) covers all of CICA's accidental death insurance supplementing its life insurance policies. These cessions are on a yearly renewable term basis and occur automatically if total accidental death benefits known to CICA are less than $250,000 or otherwise on a facultative review basis. At December 31, 2000, CICA had ceded $1.2 billion in face amount of business to CG under this treaty. CICA monitors the solvency of its reinsurers to minimize the risk of loss in the event of a failure by one of the parties. The primary reinsurers of CICA are large, well capitalized entities which have no current or prior history of financial difficulty. (b) INSURANCE ASSUMED At December 31, 2000, CICA had in-force reinsurance assumed as follows: <TABLE> <CAPTION> TYPE OF AMOUNT BUSINESS IN-FORCE AT NAME OF COMPANY LOCATION ASSUMED END OF YEAR --------------- -------- ------- ----------- <S> <C> <C> <C> Prudential Insurance Newark, Ordinary Company (Prudential) New Jersey Group Life $326,267,000 </TABLE> The reinsurance agreement with Prudential provides for CICA to assume a portion of the insurance under a group insurance policy issued by Prudential to the Administrator of Veterans' Affairs. CICA's portion of the total insurance under the policy is allocated to CICA in accordance with the criteria established by the Administrator. The agreement continues in full force and effect at December 31, 2000. CICA has also entered into a Serviceman's Group Life Insurance Conversion Pool Agreement with Prudential, under the above described agreement, whereby CICA assumed a portion of the risk of Prudential under the group policy due to excess mortality under the conversion pool agreement resulting from issuing conversion policies as prescribed for membership in the conversion pool. 13
14 INVESTMENTS State insurance statutes prescribe the quality and percentage of the various types of investments which may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, real estate and mortgage loans within certain specified percentages. CICA's invested assets at December 31, 2000 were distributed as follows: fixed maturities - 87.7%, mortgage loans - .6%, policy loans - 11.3% and other long-term investments - .4%. CICA did not foreclose on any mortgage loans in 2000. All mortgage loans are supported by independently appraised real estate. The investment policy of CICA is consistent with the provisions of the Colorado Insurance Code. At December 31, 2000, 86.4% of CICA's investments in fixed maturities were comprised of U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities, compared to 81.3% at December 31, 1999. Of these mortgage-backed securities, all were guaranteed by U.S. government agencies or corporations that are backed by the full faith and credit of the U.S. government or that bear the implied full faith and credit of the U.S. government. REGULATION CICA is subject to regulation and supervision by the insurance department of each state or other jurisdiction in which it is licensed to do business. These departments have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of marketing persons, the approval of policy forms, the advertising and solicitation of insurance, the form and content of mandatory financial statements, the reserve requirements, and the type of investments which may be made. CICA is required to file detailed annual reports with each such insurance department, and its books and records are subject to examination at any time. In accordance with state laws and the rules and practices of the National Association of Insurance Commissioners, CICA is examined periodically by examiners of its domiciliary state and by representatives (on an "association" or "zone" basis) of the other states in which it is licensed to do business. An examination was concluded in 1998 for the five years ended December 31, 1996, by a public accounting firm under contract with and supervision by the Colorado Division of Insurance. CICA is audited annually by an independent public accounting firm. Various states, including Colorado, have enacted "Insurance Holding Company" legislation, which requires the registration and periodic reporting by insurance companies which control, or are controlled by, other corporations or persons. Under most of such legislation, control is presumed to exist with the ownership of ten percent or more of an insurance company's voting securities. The Company is subject to such regulation and has registered under such statutes as a member of an "insurance holding company system." The legislation typically requires 14
15 periodic disclosure concerning the transactions between the registered insurer, the ultimate controlling party, and all affiliates and subsidiaries of the ultimate controlling party, and in many instances requires prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system. Since CICA does not physically conduct business in countries outside the U.S. but rather accepts applications for consideration from overseas marketers, it is not subject to regulation in countries where most of its insureds are residents. The prospect of such regulation is viewed as remote by management of CICA because obtaining insurance through application by mail outside of one's country is a common practice in many foreign countries, particularly those where CICA's insureds reside. COMPETITION The life insurance business is highly competitive, and CICA competes with a large number of stock and mutual companies. CICA believes that its premium rates and its policies are generally competitive with those of other life insurance companies, many of which are larger than CICA, selling similar types of insurance. CICA's international marketing plan stresses making available dollar-denominated life insurance products available to high net worth individuals residing in foreign countries and the sale of individual, whole life and supplemental accident and health products to United States residents. A large percentage of CICA's first year and renewal life insurance premium income during the last five years came from the international market. See "Business of CICA - Geographical Distribution of Business." Management believes CICA to be a significant competitor in the international market and attributes its market position to the expertise of management, the uniqueness of its life insurance products and competitiveness of its pricing methods. CICA faces offshore competition from numerous American life insurance companies that also sell U.S. dollar denominated policies to non-U.S. citizens, with no one company being dominant in the market. Some companies may be deemed to have a competitive advantage due to histories of successful operations and large agency forces. Management believes that its experience, combined with the special features of CICA's unique policies, allows CICA to compete effectively in pursuing new business. Management believes that CICA competes indirectly with non-U.S. companies, particularly with respect to Latin American companies. CICA, as a U.S. domestic insurer paying claims in U.S. dollars in the U.S., has a different clientele and product than foreign-domiciled companies. CICA's product is usually acquired by persons in the top 5% of income of their respective countries. The policies sold by foreign companies are sold broadly and are priced based on the mortality 15
16 of the entire populace of the respective geographic region. Because of the predominance of lower incomes in most of these countries, the mortality experience tends to be very high on the average, causing mortality charges which are considered unreasonable based on the life mortality experience of the upper five percent of income of the population. Additionally, the assets that back up the policies issued by foreign companies are invested in the respective countries, and thus, are exposed to the inflationary risks and economic crises that historically have impacted many foreign countries. Another reason that CICA experiences an advantage is that many of its policyholders desire to transfer capital out of their countries due to the perceived financial strength and security of the United States by foreigners. Also, CICA competes indirectly with other U.S. and European insurers in countries where CICA's insureds reside. CICA's experience has been that its market niche is in attracting insureds who want the safety and security of a U.S. domestic insurer. Management of CICA considers it to be difficult and speculative to estimate the potential of the foreign market for U.S. insurers. However, based upon the volume of new premium generated by CICA that originates from many countries in Latin America, management believes that CICA receives a substantial share of such business. However, CICA does not have market share data to confirm management's belief. CICA initiated a new domestic marketing program during 2000 focusing on the sale of individual ordinary life insurance products to residents of rural communities. This program is being initiated through one state at a time, and began in Texas. Management believes this market is overlooked by the majority of U.S. insurers. Competition from many U.S. companies is significantly greater in the domestic market, particularly as banking institutions enter the insurance market due to the passage of the Graham Leach Bliley Act in 1999. In CICA's block of accident and health insurance (13.6% of total premium income), it is in competition with many insurance companies as well as with voluntary and government-sponsored plans for meeting hospitalization and medical expenses such as Blue Cross/Blue Shield, "Medicare" and "Medicaid." Future expansion of such programs or the establishment of additional government health programs could adversely affect the future of accident and health insurance on CICA's books, most of which has been acquired in the acquisition of other companies. FEDERAL INCOME TAXATION CICA is a "small company" as that term is defined in Section 806 of the Internal Revenue Code (the "Code"). As such, CICA qualifies for a special small company deduction (presently equal to 60% of "tentative life insurance company taxable income") which serves to decrease significantly the amount of tax, which might otherwise have to be paid. 16
17 The Revenue Reconciliation Act of 1990 revised the method by which insurance companies claim deductions for policy acquisition costs. Previously, insurance companies were allowed to deduct actual policy acquisition costs as they were incurred. Beginning in 1990, policy acquisition costs are determined as a percentage of annual net premiums and are then deductible on a straight-line basis over a ten-year period rather than treated as an immediate deduction. This change in treatment for acquisition costs has had a significant impact on CICA's taxable income due to the relatively large amounts of such deferrals caused by the increases in new business. CICA files a consolidated Federal income tax return with Citizens and its subsidiaries. (iii) BUSINESS OF CILIC CILIC is an Illinois domiciled life insurer admitted to do business in four states. Dormant for several years, CILIC services a closed block of life insurance policies. At December 31, 2000, CILIC had assets of $2.9 million and annual revenues of $187,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements. (iv) BUSINESS OF INVESTORS Investors is an Illinois holding company that owns Excalibur. Management expects to consolidate Investors with Citizens during 2001 to eliminate unnecessary expenses. All intercompany fees and expenses have been eliminated in the consolidated financial statements. (v) BUSINESS OF EXCALIBUR Excalibur is an Illinois-domiciled life insurer. It services a small block of ordinary life insurance. Excalibur is 100% owned by Investors. At December 31, 2000, Excalibur had assets of $3.0 million and annual revenues of $196,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements. (vi) BUSINESS OF CTI CTI is a wholly owned subsidiary of CICA and engages in the business of providing data processing services and acquisition and leasing of furniture and equipment for its parent as well as data processing services and software to other companies. Pursuant to an Information Systems Management and Services Contract dated October 1, 1991, and subsequently amended, CTI provides data processing services to the Company for a fixed fee of $85,000 per month. As of and for the year ended December 31, 2000, CTI's total assets were approximately $570,000 and revenues were $1.1 million. All intercompany fees and expenses have been eliminated in the consolidated financial statements. 17
18 (vii) BUSINESS OF III As of and for the year ended December 31, 2000, III's total assets were $1.2 million and revenues were $237,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements. (viii) BUSINESS OF FHA FHA owns and operates a funeral home in Baker, Louisiana. At December 31, 2000, FHA had total assets of $542,000 and total annual revenues of $553,000. All intercompany fees and expenses have been eliminated in the consolidated financial statements. ITEM 2. DESCRIPTION OF PROPERTIES CICA owns its principal office in Austin, Texas, consisting of an 80,000 square foot office building. Approximately 45,000 square feet is occupied or reserved for occupancy by CICA and its affiliates with the remainder of the building being leased. The Company also owns a 6,324 square foot funeral home in Baker, Louisiana with a total cost of $527,000. This facility, acquired as a result of a 1995 acquisition, is owned and operated by a subsidiary, FHA. ITEM 3. LEGAL PROCEEDINGS The Company from time to time may be a party to various legal proceedings incidental to its business. Management does not expect the ultimate resolution of these legal proceedings to have a material adverse impact on the results of operations or the financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to shareholders of Citizens during the fourth calendar quarter of 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Citizens' Class A common stock is traded on the American Stock Exchange (AMEX) under the symbol CIA. The high and low prices per share as supplied by the Amex Monthly Statistical Report are as follows. These prices have been adjusted to reflect 7% stock dividends paid in 1999 and 2000. 18
19 <TABLE> <CAPTION> 2000 1999 ---- ---- QUARTER ENDED HIGH LOW HIGH LOW ------------- ---- --- ---- --- <S> <C> <C> <C> <C> March 31 $6.72 $6.13 $5.08 $2.40 June 30 6.31 5.02 5.29 2.62 September 30 6.31 5.89 5.24 4.69 December 31 7.00 5.72 6.66 4.69 </TABLE> As of December 31, 2000, the approximate number of record owners of Citizens' Class A common stock was 15,600. Management estimates the number of beneficial owners to be approximately 60,000. On November 2, 1999, the Company's Board of Directors declared a 7% stock dividend, payable on December 31, 1999 to holders of record as of December 1, 1999. The dividend resulted in the issuance of 1,763,805 Class A shares (including 136,091 shares in treasury) and 43,474 Class B shares. On October 31, 2000, the Board declared a 7% stock dividend payable on December 31, 2000 to holders of record as of December 1, 2000. The dividend resulted in the issuance of 1,887,265 Class A shares (including 145,613 shares in treasury) and 46,517 Class B shares. Citizens has not paid cash dividends in any of the past five years and does not expect to pay such in the immediate future. For restrictions on the present and future ability to pay dividends, see Note 6 of the "Notes to Consolidated Financial Statements." ITEM 6. SELECTED FINANCIAL DATA The table below sets forth, in summary form, selective data of the Company. This data, which is not covered in the report of the independent auditors, should be read in conjunction with the consolidated financial statements and notes which are included elsewhere herein (amounts in thousands except per share amounts). The per share amounts have been adjusted retroactively for all periods presented to reflect the change in capital structure resulting from 7% common stock dividends paid on December 31, 1999 and December 31, 2000, respectively. 19
20 <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (IN THOUSANDS EXCEPT PER SHARE DATA) ------------------------------------ 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> NET OPERATING REVENUES $ 66,678 $ 71,877 $ 72,685 $ 65,027 $ 63,822 NET INCOME (LOSS) $ 2,053 $ 1,271 $ (6,721) $ 3,426 $ 2,214 NET INCOME (LOSS) PER SHARE $ .08 $ .05 $ (.27) $ .14 $ .10 TOTAL ASSETS $ 267,842 $ 255,485 $ 253,384 $ 249,519 $ 218,277 NOTES PAYABLE $ - $ - $ 333 $ 937 $ 489 TOTAL LIABILITIES $ 190,529 $ 183,218 $ 178,480 $ 169,939 $ 151,394 TOTAL STOCKHOLDERS' EQUITY $ 77,313 $ 72,267 $ 74,904 $ 79,582 $ 66,883 BOOK VALUE PER SHARE $ 3.08 $ 2.88 $ 3.06 $ 3.33 $ 2.89 </TABLE> See Part I (b) - Financial information regarding the insurance business and Item 7 - Management's Discussion and Analysis. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Net income of $2,052,741 or $.08 per share was earned during 2000, compared to net income of $1,271,072 or $.05 per share for the year ended December 31, 1999 and a net loss of $6,720,693 or $.27 per share in 1998. Improved claims experience and persistency, coupled with reductions in expenses contributed to the increased earnings in 2000. A charge of $9.5 million recorded in the third quarter of 1998 related to the non-recoverability of a portion of the excess of cost over net assets acquired ("goodwill") on the Company's books caused the 1998 loss. The writedown was related to the goodwill recorded in the 1995 acquisition of American Liberty Financial Corporation (ALFC) and was caused by a decline in new production from insurance agents formerly associated with American Liberty. Subsequent to the acquisition, management implemented a 50% reduction in the amount of commission paid to these agents. The commission reductions were necessary to preserve the profitability of the accident and health business which was negatively impacted by changes in state laws that established minimum claims ratios that severely limited profit margins, as well as mandated change in interest rates used to compute reserves on this business. In order to ascertain the recoverability of the goodwill balance, the Company performed an analysis of the relevant cash flows based upon estimated production, net of policy acquisition costs, policyholder benefits and other general expenses. As a result of this analysis, it was determined that the production of future business did not support goodwill of $9.5 million that was charged to earnings during third quarter 1998. Management's estimate of future production was re-evaluated based upon sales activity, the size of the active agency force, and the anticipated future production 20
21 to be achieved in subsequent years. Management has continued to monitor production associated with these products. During 1998, management was successful in reviving production from some of the largest producers of American Liberty. During 1999 and 2000, the assumed production levels were met. Should production fall below such estimates, additional write-offs could be necessary. Approximately $2.8 million of goodwill related to ALFC remains at December 31, 2000. Total revenues for the year ended December 31, 2000 were $66,678,116 compared to $71,877,058 in 1999, a decrease of 7.2%. In 1998 revenues were $72,684,915. The decrease in 2000 revenues was related to a 33.5% decrease in accident and health premiums (a decline from $10,886,317 in 1999 to $7,235,685 in 2000) as a result of the termination of the Company's book of individual major medical and group dental business as well as decreased renewal life premiums resulting from the lower persistency experienced in 1998 and 1999. The decrease in 1999 revenues was related to an 80.7% decrease in realized gains which were $310,890 for 1999 compared to $1,614,388 in 1998. Premium income decreased by 9.9% from $59,320,357 in 1999 to $53,451,853 in 2000. The 1999 amounts were a 0.3% increase over the previous year when premium income totaled $59,154,329. The 2000 decrease is primarily attributable to a $3,650,632 decrease in accident and health premiums that were $7,235,685 for 2000 compared to $10,886,317 for 1999. During the second half of 1998, the Company began to experience a significant increase in the volume of accident and health claims created by high early utilization by holders of USLIC's group dental certificates. As a result of the substantial increase in the volume of claims plus an increase in the accident and health loss ratio, management moved to cancel a large portion of the existing block of USLIC's group dental business and NSLIC's individual major medical business during the third quarter of 1999 in order to curtail both claims and operating expenses. This action contributed to the $3,650,632 decrease in accident and health premiums in 2000. An additional decrease of approximately $1.5 million of annual accident and health premium income in 2001 is expected as policies terminate; however, due to the claims experience as well as the overhead necessary to administer such, management believes this change will enhance near and long-term profitability. Because of the increase in the loss ratio, management implemented significant rate increases beginning April 2000 on several of the supplemental accident and health products that are non-cancelable. These increases became effective on policy anniversaries, many of which were late in 2000. In January, 1998, CICA introduced a new line of international products known as the Millennia 2000 series; however, in 1998 and 1999, CICA's international sales were hampered due to the contraction of several Latin American economies, as well as competition from new local companies, many of whom are subsidiaries of 21
22 large U.S. insurers. As a result, there was a decrease in the Company's core book of ordinary life business. Production of new life insurance premiums by the associates of CICA measured in issued paid annualized premiums increased 21.4% from 1999 to 2000. In addition, management began developing a domestic ordinary life sales program during 1999 for which it received regulatory approval in April of 2000. Recruiting efforts for associates began in the State of Texas for the new product in mid-2000 and sales began late in the second quarter 2000. This program, targeting rural areas of the United States, is expected to provide a new entree into the domestic life market for the Company in future years. The Company intends to expand sales efforts beyond Texas to other states in which CICA is licensed. Because sales efforts have just begun, management is unable to predict the success of this new program. Net investment income increased 7.9% during 2000 to $12,550,754 from $11,636,940 during 1999. The 1999 results were up 3.2% compared to the $11,279,125 earned in 1998. The 2000 and 1999 results reflect the continuing expansion of the Company's asset base, investment in higher yielding instruments and the actions taken in previous years to change the mix and duration of the Company's invested assets. Management terminated the Company's outside investment advisor effective March 31, 2000. The Company feels it can more effectively achieve its investment objectives by overseeing the investment activities in-house. The increased returns in 2000 relate to more aggressive management of the Company's excess cash balances and a shift in the mix of the portfolio to place less emphasis on government guaranteed mortgage pass-through instruments and more investments in callable instruments issued by U.S. government agencies. Policyholder dividends increased to $3,037,343 in 2000, up 6.8% over 1999 results of $2,843,681. The 1999 amounts represented a decrease of 6.0% compared to $3,025,746 in 1998. Virtually all CICA's policies that have been sold since 1989 are participating. Participating policies represent a large majority (56.9%) of the Company's business in-force, although the percentage of participating business has declined from approximately 91% in 1995 due to acquisitions in recent years. Additionally, due to the disruption in the Latin American markets mentioned above and the lower than usual persistency in that market, the growth in overall dividends has been slowed as policies lapse before the dividend amount can grow. Management expects continued growth in this item due to the fact that CICA will continue to focus on participating products internationally, subject to persistency and future sales. Claims and surrenders decreased 12.6% from $34,747,480 in 1999, to $30,370,996 in 2000. In 1998 claims and surrenders were $31,592,740. Increases in accident and health benefits attributable to the respective blocks of business of National Security Life and Accident (NSLIC) and United Security Life (USLIC) were responsible for the 1999 increase. The decline in claims on these blocks as a 22
23 result of the termination in 1999 and 2000 contributed to the improvement during the year. Death benefits increased 2.8% from $5,135,808 in 1999, to $5,277,284 in 2000. Death benefits were $5,150,647 in 1998. The Company has historically adhered to a strict underwriting policy which requires complete medical examinations on all applicants who are foreign residents, except children, regardless of age or face amount of the policy applied for. Beginning in 1996, management initiated a change to more selective medical examinations in conjunction with dry spot blood tests and extensive medical questions on the application in order to lower the cost of new business without sacrificing necessary information for the underwriter. Additionally, X-rays and electrocardiograms are required depending on age and face amount of the policy. On all policies of $150,000 or more, inspection reports are required which detail the background resources and lifestyle of the applicant. The Company has developed numerous contacts throughout Latin America with which its underwriters can validate information contained in the application, medical or inspection report. Accident and Health benefits decreased 39.1% from $8,686,218 in 1999 to $5,158,623 in 2000. Such claims were $5,912,411 in 1998. The 1999 increase reflected the volume of Accident and Health business written in previous years. During the second half of 1998, the Company began to experience a significant increase in the volume accident and health claims created by the high early utilization by holders of USLIC's group dental certificates. As a result of the substantial increase in the volume of claims plus an increase in the accident and health loss ratio, management moved to cancel a large portion of the existing blocks of USLIC's group dental and NSLIC's individual major medical business during the third quarter of 1999 in order to curtail both claims and operating expenses. Most of the terminations were effective prior to January 1, 2000. This action contributed to the decrease of $3,650,632 in accident and health premiums and the $3,309,171 decrease in accident and health claims in 2000. It is anticipated an additional decrease of $1.5 million of annual premium income will occur in 2001; however, due to the claims experience as well as the overhead necessary to administer such, management believes this action will enhance near and long-term profitability. Endowment benefits decreased 3.0% from $5,048,973 in 1999 to $4,895,492 in 2000. In 1998, such expenses were $5,027,937. Beginning in late 1990, CICA introduced a new series of international policies that carried an immediate endowment benefit of an amount elected by the policyowner. This endowment is factored into the premium of the policy and is paid annually. Policy surrenders decreased 5.3% from $14,920,985 in 1999 to $14,124,514 in 2000. Surrenders were $14,481,335 in 1998. The relative stability in 2000, 1999 and 1998 is, in the opinion of management, the result of a campaign begun in mid-1997 to inform policyowners about the benefits of their policies. 23
24 Other claim expenses amounted to $915,083 in 2000, $955,496 in 1999 and, $1,020,410 in 1998. These expenses are comprised of supplemental contract benefits, interest on policy funds and assorted other miscellaneous policy benefits. During 2000, commissions increased slightly to $12,411,053 from $12,234,053 in 1999. In 1998, commission expense was $12,501,426. The increase in 2000 occurred because the issuance of new life policies increased and offset the reduction in accident and health commissions due to the terminations discussed above. Underwriting, acquisition and insurance expenses decreased slightly to $10,139,539 in 2000 compared to $10,328,996 in 1999 and $11,079,065 in 1998. Because of the increased claims volume mentioned above, management was forced to significantly increase staff size in 1998 and 1999 and thus overhead on a temporary basis. During 2000, overhead expenses were incurred to develop the domestic ordinary life sales program which offset reductions achieved following the termination of the accident and health business described above and the consolidation of NSLIC and USLIC. Due to the consolidation of USLIC's and NSLIC's operations with CICA, management anticipates continued reductions in expenses through economies of scale. In order to convert a majority of CICA's marketing overhead from fixed to variable, management contracted in early 1997 with an independent international marketing company to serve as managing agent for the Company's international marketing activities. This firm receives an overriding commission on all new business issued internationally in exchange for the absorption of all marketing, management and promotion activities. By taking such actions, management believes a significant amount of fixed overhead has been converted to a variable expense. Management has utilized firms such as this in previous periods with success in obtaining increases in new business and expense reductions. Capitalized deferred policy acquisition costs increased 8.3% from $9,287,457 in 1999 to $10,056,287 in 2000. These costs were $7,941,829 in 1998. The increase in 2000 reflects increased fourth quarter sales of traditional whole life policies internationally. The 1999 increase reflects increased fourth quarter sales activity. Amortization of these costs was $8,521,972, $10,028,806 and $7,789,513, respectively in 2000, 1999 and 1998. Amortization of cost of insurance acquired, excess of cost over net assets acquired and other intangibles decreased from $2,120,017 in 1999 to $1,995,660 in 2000. In 1998, such amortization was $2,100,433. As discussed above, management wrote off $9.5 million of the goodwill associated with the acquisition of American Liberty during the third quarter of 1998. Should production by the former agents of American Liberty, now representing CICA, not meet expected amounts due to the rate increases described above, additional write-offs could result. There remains approximately $2.8 million of goodwill related to American Liberty. New accounting rules regarding amortization of goodwill were proposed by 24
25 the FASB during 2000. If implemented, annual amortization of such amounts would cease, and a change would occur only if goodwill on the balance sheet became unrecoverable. The Company has approximately $7.4 million of goodwill recorded at December 31, 2000. During 2000, $658,390 was amortized. LIQUIDITY AND CAPITAL RESOURCES Stockholders' equity increased from $72,266,969 at December 31, 1999 to $77,313,031 at December 31, 2000. The increase was attributable to net income of $2,052,741 earned in 2000 and unrealized losses, net of tax decreasing by $2,993,321 during 2000. Increases in the market value of the Company's bond portfolio caused by higher bond prices resulted in the change in unrealized losses. The Company paid a 7% stock dividend on December 31, 2000 to holders of record as of December 1, 2000. A similar 7% dividend was paid on December 31, 1999 to record holders on December 1, 1999. Both dividends were paid using Class A and B shares that were previously authorized but unissued. The dividends had the effect of transferring $11,497,886 and $10,649,736 respectively in 2000 and 1999 from retained earnings to Common Stock and Treasury Stock. Invested assets increased to $194,203,327 in 2000 from $174,338,561 in 1999, an increase of 11.4%. A 14.4% increase in fixed maturities available-for-sale more than offset a 3.1% decrease in policy loans. At December 31, 2000 and 1999, fixed maturities have been categorized into two classifications: fixed maturities held-to-maturity, which are valued at amortized cost, and fixed maturities available-for-sale which are valued at fair market. The Company disposed of a number of bonds as it changed the mix of securities following the termination of its outside investment advisor. Fixed maturities held to maturity, amounting to $5,582,802 at December 31, 2000 consist of U.S. Treasury securities. Management has the intent and believes the Company has the ability to hold the securities to maturity. At December 31, 2000, decreases in interest rates of 100, 200 and 300 basis points, respectively, would result in increases in market values of investments in fixed maturities of approximately $2,505,000, $5,865,000 and $9,515,000, respectively. Conversely, increases in rates of 100, 200 and 300 basis points would generate losses of $6,502,000, $12,330,000 and $18,141,000, respectively. At December 31, 1999, decreases in interest rates of 100, 200 and 300 basis points, respectively, would result in increases in market values of approximately $385,000, $6,646,000 and $13,800,000, respectively. Increases in rates of 100, 200 and 300 basis points would generate decreases in market values of $10,981,000, $20,232,000 and $26,096,000, respectively. Policy loans comprise 10.8% of invested assets at December 31, 2000 compared to 12.4% at December 31, 1999. These loans, which are secured by the underlying policy values, have yields ranging from 5% to 10% percent and maturities that are related to the maturity or termination of the applicable policies. 25
26 Management believes that the Company maintains more than adequate liquidity despite the uncertain maturities of these loans. Cash balances of the Company in its primary depository, Chase Bank, were significantly in excess of Federal Deposit Insurance Corporation (FDIC) coverage at December 31, 2000 and 1999. Management monitors the solvency of all financial institutions in which it has funds to minimize the exposure for loss. At December 31, 2000, management does not believe the Company is at significant risk for such a loss. During 2001, the Company intends to utilize callable securities issued by Federal agencies as cash management tools to minimize excess cash balances and enhance return. CICA owned 2,085,244 shares (1,948,718 in 1999) of Citizens Class A common stock at December 31, 2000. Statutory accounting practices prescribed by the National Association of Insurance Commissioners (NAIC) and the State of Colorado require that the Company carry its investment at market value reduced by the percentage ownership of Citizens by CICA, limited to 2% of admitted assets. As of December 31, 2000 and 1999, the Company valued the shares in accordance with prescribed Statutory Accounting Practices. In the Citizens' consolidated financial statements, this stock is shown as treasury stock. The NAIC has established minimum capital requirements in the form of Risk-Based Capital ("RBC"). Risk-based capital factors the type of business written by a company, the quality of its assets, and various other factors into account to develop a minimum level of capital called "authorized control level risk-based capital" and compares this level to an adjusted statutory capital that includes capital and surplus as reported under Statutory Accounting Principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk-based capital fall below 200%, a series of actions by the Company would begin. At December 31, 2000, CICA, CILIC and Excalibur were above required minimum levels. Effective January 1, 2001, the NAIC has implemented codified rules for statutory accounting. These rules are subject to approval and implementation by each state. Colorado has notified CICA that it has adopted the codified accounting rules; however, certain state laws that differ from these rules should be followed. The primary difference between the Colorado statutes and the codified rules involve the establishment of a liability for future policy dividends payable. Under codification such reserve is mandated; however, Colorado has an exception if the difference between the premium charged and the maturity factor included in the premium on participating policies exceeds the reserve that would be established. Such is the case for CICA. As a result, CICA will not establish the reserve of approximately $3 million in its statutory financial statements. Overall, the implementation of codification is expected to reduce the Company's surplus on a statutory accounting basis by approximately 3%. 26
27 INFORMATION SYSTEMS AND THE YEAR 2000 The Company successfully addressed the impact of the Year 2000 on its systems, procedures, customers and business processes. There was no adverse impact on any Company operations for the calendar change from 1999 to 2000. The Company used internal resources to modify, replace and test the Year 2000 modifications. The total cost for the project was negligible. The work was performed with existing staff and the associated costs were expensed as incurred until completion. All critical suppliers or customers (external relationships) resolved their own third party Year 2000 issues and were able to interact with the Company. The Company encountered no loss of data or functionality related to the Year 2000. FINANCIAL ACCOUNTING STANDARDS In December 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 97-3 "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides: 1) guidance for determining when an entity should recognize a liability for guaranty fund and other insurance-related assessments, 2) guidance on how to measure a liability, 3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges and 4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company adopted SOP 97-3 during 1999. Implementation did not have a material impact on the Company's financial statements. In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance for determining whether costs of software developed or obtained for internal use should be capitalized or expensed when incurred. In the past, the Company has expensed such costs as they were incurred. This SOP is also effective for fiscal years beginning after December 15, 1998. The Company adopted SOP 98-1 during 1999. Implementation did not have a material impact on the Company's financial statements. Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, is effective January 1, 2001. Management does not believe that SFAS No. 133, as amended, will have a significant effect on the financial position, results of operations or liquidity of the Company. SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement of FASB Statement 125" revises 27
28 the rules to be followed when determining whether a special purpose entity (SPE) is a qualifying SPE (QSPE). SFAS No. 140 requires that a QSPE have at least 10% of its beneficial interests held by parties unrelated to the transferor and limits the amount and type of derivative instruments that a QSPE can hold. SFAS No. 140 requires that for a transfer to a QSPE to be accounted for as a sale, the transferor must not retain effective control over the transferred assets through a removal-of-accounts provision that allows the transferor to unilaterally reclaim specific transferred assets. SFAS No. 140 requires extensive disclosures about securitizations entered into during the period and retained interests in securitized financial assets at the balance sheet date, accounting policies, sensitivity information related to retained interests and cash flows distributed to the transferor. It is effective for transfers occurring after March 31, 2001. However, the expanded disclosures about securitizations and collateral are effective for fiscal years ending after December 15, 2000. Management does not believe that SFAS No. 140 will have a significant effect on the financial position, results of operations or liquidity of the Company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The unrealized gains (losses) that could be caused by decreases and increases in the interest rates of 100, 200 and 300 basis points, respectively, on the Company's available-for-sale fixed maturities is as follows at December 31, 2000 and 1999: <TABLE> <CAPTION> Decreases in Interest Rates Increases in Interest Rates --------------------------- --------------------------- 300 BASIS 200 BASIS 100 BASIS 100 BASIS 200 BASIS 300 BASIS POINTS POINTS POINTS POINTS POINTS POINTS ------ ------ ------ ------ ------ ------ <S> <C> <C> <C> <C> <C> <C> December 31, 2000 $ 9,515,000 $5,865,000 $2,505,000 $ (6,502,000) $(12,330,000) $(18,141,000) =========== ========== ========== ============= ============= ============= December 31, 1999 $13,800,000 $6,646,000 $ 385,000 $(10,981,000) $(20,232,000) $(10,981,000) =========== ========== ========== ============= ============= ============= </TABLE> There are no fixed maturities or other investments that the Company classifies as trading instruments. At December 31,2000 and 1999, there were no investments in derivative instruments. The Company has minimal investment in equity securities. The overall credit rating of the fixed maturity portfolio is Agency. Approximately 73.4% of the fixed maturities owned by the Company at December 31, 2000 are instruments of the United States government or are backed by U.S. government agencies or private corporations carrying the implied full faith and credit backing of the U.S. government. See also Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 28
29 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES <TABLE> <CAPTION> PAGE REFERENCE --------- <S> <C> Independent auditors' report 34 Consolidated statements of financial position at December 31, 2000 and 1999 35-36 Consolidated statements of operations - years ended December 31, 2000, 1999 and 1998 37-38 Consolidated statements of stockholders' equity and comprehensive Income (loss)- years ended December 31, 2000, 1999 and 1998 39 Consolidated statements of cash flows - years ended December 31, 2000, 1999 and 1998 40-41 Notes to consolidated financial statements 42-61 Schedules at December 31, 2000 and 1999: Schedule II - Condensed Financial Information of Registrant 62-64 Schedules for each of the years in the three-year Period ended December 31, 2000: Schedule IV - Reinsurance 65 </TABLE> All other schedules have been omitted as the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE During the 24 months preceding the date of the audited financial statements of Citizens included herein, there has been no change of accountants made by Citizens, nor has it reported on Form 8-K any disagreements between the Company and its independent accountants. PART III Items 10, 11, 12, and 13 of this Report incorporate by reference the information in the Company's definitive proxy material under the headings "Stock and Principal Stockholders," "Control of the Company," "Election of Directors," "Executive Officers," "Executive Officer and Director Compensation" and "Certain Reports" to be filed with the Securities and Exchange Commission within 120 days after December 31, 2000. 29
30 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1 AND 2 FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The financial statements and schedules listed on the following index to financial statements and financial statement schedules are filed as part of this Form 10-K. (a) 3 EXHIBITS The following exhibits are incorporated by reference herein or filed herewith as indicated. <TABLE> <CAPTION> EXHIBIT EXHIBIT NO. DESCRIPTION PAGE NO. ----------- ----------- -------- <S> <C> <C> (1) Underwriting Agreement N/A (2) Plan of acquisition, reorganization, arrangement, liquidation or succession (e) (3) 3.1 Articles of Incorporation; as amended (d) 3.2 Bylaws N/A (4) Instruments defining the rights of security holders, including indentures N/A (5) Opinion re: Legality N/A (6) (Removed and Reserved) N/A (7) (Removed and Reserved) N/A (8) Opinion re: Tax Matters N/A (9) Voting Trust Agreement N/A (10) Material Contracts 10.1 Automatic Yearly Renewable term (NR) Life Reinsurance Agreement between Citizens Insurance Company of America and The Centennial Life Insurance Company dated March 1, 1982 (a) 10.2 Stock Purchase Agreement between Citizens Insurance Company of America and Citizens, Inc. (a) 10.3 Plan and Agreement of Merger and Exchange by and among Insurance Investors & Holding Co., Central Investors Life Insurance Company of Illinois, Citizens, Inc. and Citizens Acquisition, Inc. (g) </TABLE> 30
31 <TABLE> <CAPTION> EXHIBIT EXHIBIT NO. DESCRIPTION PAGE NO. ----------- ----------- -------- <S> <C> <C> 10.4 Self-Administered Automatic Reinsurance Agreement - Citizens Insurance Company of America and Riunione Adriatica di Sicurta, S.p.A. (h) 10.5 Plan and Agreement of Exchange dated October 28, 1996 between Citizens, Inc. and American Investment Network, Inc. (h) 10.6 Agreement and Plan of Merger dated October 31, 1996 between Citizens Insurance Company of America, CICA Acquisition, Inc., and First American Investment Corporation (h) 10.7 Plan and Agreement of Merger dated November 22, 1996 between Citizens, Inc. and American Liberty Financial Corporation, as amended (i) 10.8 Plan and Agreement of Merger dated November 22, 1996 between Citizens Insurance Company of America and American Liberty Life Insurance Company, as amended (i) 10.9 Bulk Accidental Death Benefit Reinsurance Agreement between Connecticut General Life Insurance Company and Citizens Insurance Company of America, as amended (i) 10.10 Plan and Agreement of Exchange dated October 28, 1996 between American Investment Network, Inc., United Security Life Insurance Co., Inc. and Citizens Insurance Company of America (j) 10.11 Stock Purchase Agreement dated November 20, 1997 between Jansen Enterprises, Inc. and Citizens, Inc. (j) 10.12 Plan and Agreement of Merger dated September 10, 1998 between First Investors Group, Inc., Citizens, Inc., and Excalibur Acquisition, Inc. (k) (11) Statement re: Computation of per share earnings N/A (12) Statement re: Computation of ratios N/A (13) Annual report to security holders, Form 10-Q or quarterly report to N/A security holders (14) (Removed and Reserved) N/A (15) Letter re: Unaudited interim financial statements N/A (16) Letter re: Change in certifying accountant N/A (17) Letter re: Director resignation N/A (18) Letter re: Change in accounting principles N/A (19) Report furnished to security holders N/A (20) Other documents or statements to security holders N/A (21) Subsidiaries of the registrant Filed Herewith </TABLE> 31
32 <TABLE> <CAPTION> EXHIBIT EXHIBIT NO. DESCRIPTION PAGE NO. ----------- ----------- -------- <S> <C> <C> (22) Published report regarding matters submitted to a vote of security holders N/A (23) Consents of expert and counsel Filed Herewith (24) Power of Attorney See signature page (25) Statement of eligibility of trustee N/A (26) Invitations for competitive bids N/A (27) (Removed and Reserved) N/A (99) Additional Exhibits N/A </TABLE> - ---------------------------- (a) Filed as a part of the Amendment No. 1 to Registration Statement on Form S-4, SEC File No. 33--4753, filed on or about June 19, 1992. (b) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference. (c) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference. (d) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. (e) Filed with or referenced in the Registrant's Current Report on Form 8-K dated December 9, 1994 and incorporated herein by reference. (f) Filed as a part of the Registration Statement on Form S-4, SEC File No. 33--59039, filed on or about May 2, 1995. (g) Filed as a part of the Registration Statement on Form S-4, SEC File No. 33--63275, filed on or about October 6, 1995. (h) Filed as a part of the Registration Statement on Form S-4, SEC File No. 333--16163, filed on or about November 14, 1996. (i) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. (j) Filed with or referenced in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. (k) Filed as a part of the Registration Statement on Form S-4, SEC File No. 333--67091, on or about November 10, 1998 and incorporated herein by reference. (b) REPORTS ON FORM 8-K A Report on Form 8-K was filed by Citizens on November 3, 2000 regarding the promotion of Rick D. Riley to Chief Executive Officer. 32
33 CITIZENS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES <TABLE> <CAPTION> PAGE REFERENCE <S> <C> Independent auditors' report 34 Consolidated statements of financial position at December 31, 2000 and 1999 35-36 Consolidated statements of operations - years ended December 31, 2000, 1999 and 1998 37-38 Consolidated statements of stockholders' equity and comprehensive income (loss)- years ended December 31, 2000, 1999 and 1998 39 Consolidated statements of cash flows - years ended December 31, 2000, 1999 and 1998 40-41 Notes to consolidated financial statements 42-61 Schedules at December 31, 2000 and 1999: Schedule II - Condensed Financial Information of Registrant 62-64 Schedules for each of the years in the three-year period ended December 31, 2000: Schedule IV - Reinsurance 65 </TABLE> All other schedules have been omitted as the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein. 33
34 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Citizens, Inc.: We have audited the consolidated financial statements of Citizens, Inc. and consolidated subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG LLP Dallas, Texas March 9, 2001 34
35 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION DECEMBER 31, 2000 AND 1999 <TABLE> <CAPTION> ASSETS 2000 1999 ------ ------------ ------------ <S> <C> <C> Investments: Fixed maturities held-to-maturity, at amortized cost $ 5,582,802 $ 5,594,745 Fixed maturities available-for-sale, at fair value 164,945,698 144,214,555 Equity securities available-for-sale, at fair value 675,726 717,812 Mortgage loans on real estate 1,178,668 1,374,204 Policy loans 20,884,136 21,556,344 Other long-term investments 936,297 880,901 ------------ ------------ Total investments 194,203,327 174,338,561 Cash and cash equivalents 4,064,035 11,149,084 Accrued investment income 2,222,583 1,761,071 Reinsurance recoverable 2,662,724 2,183,729 Deferred policy acquisition costs 38,052,352 36,518,037 Other intangible assets 1,675,325 1,982,525 Federal income tax recoverable 174,978 -- Deferred federal income tax 4,628,750 6,182,764 Cost of insurance acquired 6,156,424 7,186,494 Excess of cost over net assets acquired 7,362,654 8,021,044 Property, plant and equipment 5,469,583 5,071,735 Other assets 1,169,629 1,089,742 ------------ ------------ Total assets $267,842,364 $255,484,786 ============ ============ </TABLE> (Continued) 35
36 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION, CONTINUED DECEMBER 31, 2000 AND 1999 <TABLE> <CAPTION> LIABILITIES AND STOCKHOLDERS' EQUITY 2000 1999 ------------------------------------ ------------- ------------- <S> <C> <C> Liabilities: Future policy benefit reserves: Life insurance $ 161,869,267 $ 154,352,032 Annuities 4,170,884 4,023,827 Accident and health 9,229,156 9,037,337 Dividend accumulations 4,749,321 4,854,835 Premium deposits 3,033,514 2,725,016 Policy claims payable 2,866,110 3,591,289 Other policyholders' funds 2,245,947 2,070,950 ------------- ------------- Total policy liabilities 188,164,199 180,655,286 Other liabilities 1,355,718 901,636 Commissions payable 1,009,416 530,928 Federal income tax payable 1,129,967 ------------- ------------- Total liabilities 190,529,333 183,217,817 ------------- ------------- Stockholders' equity: Common stock: Class A, no par value, 50,000,000 shares authorized, 26,622,383 shares issued in 2000 and 24,880,731 in 1999, including shares in treasury of 2,225,819 in 2000 and 2,080,206 in 1999 79,701,590 67,510,026 Class B, no par value, 1,000,000 shares authorized, 711,040 shares issued and outstanding in 2000 and 664,523 in 1999 910,482 584,863 Retained earnings 1,311,655 10,756,800 Accumulated other comprehensive loss: Unrealized investment loss, net of tax (718,135) (3,711,456) ------------- ------------- 81,205,592 75,140,233 Treasury stock, at cost (3,892,561) (2,873,264) ------------- ------------- Total stockholders' equity 77,313,031 72,266,969 ------------- ------------- $ 267,842,364 $ 255,484,786 ============= ============= </TABLE> See accompanying notes to consolidated financial statements. 36
37 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Revenues: Premiums: Life insurance $ 45,987,689 $ 48,172,160 $ 49,032,491 Accident and health 7,235,685 10,886,317 9,857,844 Annuity and universal life considerations 228,479 261,880 263,994 Net investment income 12,550,754 11,636,940 11,279,125 Realized gains 86,569 310,890 1,614,388 Other income 588,940 667,320 664,084 Interest expense -- (58,449) (27,011) ------------ ------------ ------------ Total revenues 66,678,116 71,877,058 72,684,915 ------------ ------------ ------------ Benefits and expenses: Insurance benefits paid or provided: Increase in future policy benefit reserves 7,265,347 7,371,214 8,279,056 Policyholders' dividends 3,037,343 2,843,681 3,025,746 Claims and surrenders 30,370,996 34,747,480 31,592,740 Annuity expenses 468,752 517,819 436,030 ------------ ------------ ------------ Total insurance benefits paid or provided 41,142,438 45,480,194 43,333,572 Commissions 12,411,053 12,234,053 12,501,426 Other underwriting, acquisition and insurance expenses 10,139,539 10,328,996 11,079,065 Capitalization of deferred policy acquisition costs (10,056,287) (9,287,457) (7,941,829) Amortization of deferred policy acquisition costs 8,521,972 10,028,806 7,789,513 Amortization of cost of insurance acquired, excess of cost over net assets acquired and other intangibles 1,995,660 2,120,017 11,600,433 ------------ ------------ ------------ Total benefits and expenses 64,154,375 70,904,609 78,362,180 ------------ ------------ ------------ </TABLE> (Continued) 37
38 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS, CONTINUED YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ---------- ---------- ----------- <S> <C> <C> <C> Income (loss) before Federal income tax $2,523,741 $ 972,449 $(5,677,265) Federal income tax expense (benefit) 471,000 (298,623) 1,043,428 ---------- ---------- ----------- Net income (loss) $2,052,741 $1,271,072 $(6,720,693) ========== ========== =========== Basic and diluted earnings (loss) per share of common stock $ .08 $ .05 $ (.27) ========== ========== =========== </TABLE> See accompanying notes to consolidated financial statements. 38
39 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> ACCUMULATED OTHER COMMON STOCK COMPREHENSIVE TOTAL ---------------------------- RETAINED INCOME TREASURY STOCKHOLDERS' CLASS A CLASS B EARNINGS (LOSS) STOCK EQUITY ------------ ------------ ------------ ------------- ------------ ------------- <S> <C> <C> <C> <C> <C> <C> BALANCE AT DECEMBER 31, 1997 $ 52,790,643 $ 283,262 $ 26,856,157 $ 1,580,790 $ (1,929,154) $ 79,581,698 ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive loss: Net loss (6,720,693) (6,720,693) Unrealized investment gains, net -- -- -- 2,042,674 -- 2,042,674 ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive loss -- -- (6,720,693) 2,042,674 (4,678,019) ------------ ------------ ------------ ------------ ------------ ------------ BALANCE AT DECEMBER 31, 1998 $ 52,790,643 $ 283,262 $ 20,135,464 $ 3,623,464 $ (1,929,154) $ 74,903,679 ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive loss: Net income -- -- 1,271,072 -- -- 1,271,072 Unrealized investment losses, net -- -- -- (7,334,920) -- (7,334,920) ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive loss -- -- 1,271,072 (7,334,920) -- (6,063,848) ------------ ------------ ------------ ------------ ------------ ------------ Acquisition of Investors 3,427,138 -- -- -- 3,427,138 Stock dividend 11,292,245 301,601 (10,649,736) -- (944,110) -- ------------ ------------ ------------ ------------ ------------ ------------ BALANCE AT DECEMBER 31, 1999 $ 67,510,026 $ 584,863 $ 10,756,800 $ (3,711,456) $ (2,873,264) $ 72,266,969 ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive income: Net income -- -- 2,052,741 -- -- 2,052,741 Unrealized investment gains, net -- 2,993,321 2,993,321 ------------ ------------ ------------ ------------ ------------ ------------ Comprehensive income -- -- 2,052,741 2,993,321 -- 5,046,062 Stock dividend 12,191,564 325,619 (11,497,886) -- (1,019,297) -- ------------ ------------ ------------ ------------ ------------ ------------ BALANCE AT DECEMBER 31, 2000 $ 79,701,590 $ 910,482 $ 1,311,655 $ (718,135) $ (3,892,561) $ 77,313,031 ============ ============ ============ ============ ============ ============ </TABLE> See accompanying notes to consolidated financial statements. 39
40 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Cash flows from operating activities: Net income (loss) $ 2,052,741 $ 1,271,072 $ (6,720,693) Adjustments to reconcile net income to net cash provided by operating activities, net of assets acquired: Realized gains (86,569) (310,890) (1,614,388) Accrued investment income (461,512) 79,319 204,447 Net deferred policy acquisition costs (1,534,315) 741,349 (152,316) Amortization of cost of insurance acquired, excess cost over net assets acquired and other intangibles 1,995,660 2,120,017 11,600,433 Depreciation 608,533 510,755 493,691 Change in: Reinsurance recoverable (478,995) (427,811) 313,862 Future policy benefit reserves 7,856,111 7,169,153 8,057,287 Other policy liabilities (347,198) (25,336) 1,105,031 Deferred federal income tax 12,000 (1,704,321) (1,477,949) Federal income tax (1,304,945) (404,302) 771,277 Commissions payable and other liabilities 932,570 (1,763,567) (682,884) Other, net 157,828 376,787 1,237,829 ------------ ------------ ------------ Net cash provided by operating activities 9,401,909 7,632,225 13,135,627 ------------ ------------ ------------ Cash flows from investing activities: Sale of fixed maturities, available-for-sale 10,325,965 1,630,775 28,476,347 Maturity of fixed maturities, available-for-sale 30,559,981 10,260,075 688,037 Purchase of fixed maturities, available-for-sale (57,178,261) (18,742,695) (39,392,056) Sale of equity securities, available-for-sale 88 92,500 151,923 Principal payments on mortgage loans 195,536 186,553 391,538 Mortgage loans funded -- -- (665,000) Guaranteed student loans funded -- (6,287) (32,338) Guaranteed student loans sold -- 10,960 119,346 Sale of other long-term investments and property, plant and equipment 10,949 13,799 2,702,877 </TABLE> (Continued) 40
41 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Cash and cash equivalents provided by mergers and acquisitions $ -- $ 1,512,255 $ -- Increase (decrease) in policy loans, net 672,208 (559,425) (530,735) Purchase of other long-term investments and property, plant and equipment (1,073,424) (717,046) (1,027,697) ------------ ------------ ------------ Net cash used by investing activities (16,486,958) (6,318,536) (9,117,758) ------------ ------------ ------------ Cash flows used by financing activities: Payments on notes payable -- (333,333) (604,097) ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (7,085,049) 980,356 3,413,772 ------------ ------------ ------------ Cash and cash equivalents at beginning of year 11,149,084 10,168,728 6,754,956 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 4,064,035 $ 11,149,084 $ 10,168,728 ============ ============ ============ </TABLE> Supplemental: <TABLE> <CAPTION> 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Cash paid during the year for: Interest $ -- $ 43,810 $ 41,650 ============ ============ ============ Income taxes $ 1,763,945 $ 1,810,000 $ 1,750,100 ============ ============ ============ </TABLE> Supplemental disclosures of non-cash investing and financing activities: The Company issued Class A common stock and cash to purchase all of the capital stock of Investors in 1999. In conjunction with the acquisition, cash and cash equivalents were provided as follows: <TABLE> <CAPTION> 1999 ----------- <S> <C> Fair value of capital stock issued $ 3,427,138 Fair value of tangible assets acquired excluding cash and cash equivalents (1,658,547) Fair value of intangible assets acquired (353,703) Liabilities assumed 97,367 ----------- Cash and cash equivalents provided by mergers and acquisitions $ 1,512,255 =========== Issuance of 609,269 Class A shares $ 3,427,138 =========== </TABLE> See accompanying notes to consolidated financial statements. 41
42 CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) NATURE OF BUSINESS The consolidated financial statements include the accounts and operations of Citizens, Inc. (Citizens), incorporated in the state of Colorado on November 8, 1977 and its wholly-owned subsidiaries, Citizens Insurance Company of America (CICA), Computing Technology, Inc. (CTI), Funeral Homes of America, Inc. (FHA), Insurance Investors, Inc. (III), Central Investors Life Insurance Company of Illinois (CILIC), First Investors Group, Inc. (Investors) and Excalibur Insurance Corporation (Excalibur). Citizens and its consolidated subsidiaries are collectively referred to as "the Company." American Liberty Financial Corporation (ALFC) and its subsidiaries, American Liberty Life Insurance Company (ALLIC), First American Investment Corp. (FAIC) and American Liberty Exploration Company (ALEC) were acquired by Citizens in September 1995. Effective January 1, 1997, ALFC was merged into Citizens and ALLIC was merged into CICA. American Investment Network (AIN), which was acquired in June 1997, owned United Security Life Insurance Company (USLIC). During 1998, AIN was liquidated into CICA. Insurance Investors and Holding Company (IIH), which was acquired in March 1996, owned CILIC. During 1998, IIH was liquidated and merged into CICA. National Security Life and Accident Insurance Company (NSLIC) was merged into CICA effective January 1, 2000 and USLIC was merged into CICA effective October 1, 2000. Citizens provides life and health insurance policies through three of its subsidiaries - CICA, CILIC and Excalibur. CICA sells ordinary whole-life policies internationally and burial insurance, pre-need policies, accident and health specified disease, hospital indemnity and accidental death policies, throughout the southern United States. Excalibur sells life insurance business throughout the State of Illinois. CILIC does not actively market insurance policies, but does administer an in-force block of life insurance. III provides aviation transportation to the Company. CTI provides data processing systems and services to the Company. FHA is a funeral home operator. 42
43 (b) BASIS OF PRESENTATION The accompanying consolidated financial statements of the Company and its wholly owned subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). All significant intercompany accounts and transactions have been eliminated. (c) INVESTMENTS, OTHER THAN AFFILIATES Fixed maturities consist primarily of bonds, which the Company has the ability and intent to hold to maturity, and are carried at amortized cost. Fixed maturities, which may be sold prior to maturity to support the Company's investment strategies, are considered held as available-for-sale and carried at fair value as of the balance sheet date. Equity securities include non-redeemable preferred stock and are reported at fair value. Unrealized appreciation (depreciation) of equity securities and fixed maturities held as available-for-sale is shown as a separate component of stockholders' equity, net of tax, and is a separate component of comprehensive income. Mortgage loans on real estate, policy loans, and guaranteed student loans are reported at unpaid principal balances less an allowance for uncollectible amounts. Mortgage loans have an allowance for uncollectible amounts of $50,000 at December 31, 2000 and 1999 which was estimated by the Company based upon historical amounts that proved uncollectible. Other long-term investments consist primarily of real estate that is recorded at the lower of fair value, minus estimated costs to sell, or cost. If the fair value of the real estate minus estimated costs to sell is less than cost, a valuation allowance is provided for the deficiency. Increases in the valuation allowance are charged to income. A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income is recognized when earned. Realized gains and losses for securities classified as available-for-sale and held-to-maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Policy loans and other investments are primarily reported at cost. The Company has assets with a fair value of $9,420,063 at December 31, 2000 and $9,261,668 at December 31, 1999 on deposit with various state regulatory authorities to fulfill statutory requirements. 43
44 (d) PREMIUM REVENUE AND RELATED EXPENSES Premiums on life and accident and health policies are reported as earned when due or, for short duration contracts, over the contract periods. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the estimated life of the contracts. This matching is accomplished by means of provisions for future benefits and the capitalization and amortization of deferred policy acquisition costs. Annuities are accounted for in a manner consistent with accounting for interest bearing financial instruments. Premium receipts are not reported as revenues but rather as deposit liabilities to annuity contracts. (e) DEFERRED POLICY ACQUISITION COSTS AND COST OF INSURANCE ACQUIRED Acquisition costs, consisting of commissions and policy issuance, underwriting and agency expenses that relate to and vary with the production of new business, are deferred. These deferred policy acquisition costs are amortized primarily over the estimated premium paying period of the related policies in proportion to the ratio of the annual premium recognized to the total premium revenue anticipated using the same assumptions as were used in computing liabilities for future policy benefits. The Company uses the factor method to determine the amount of costs to be capitalized and the ending asset balance. This method limits the amount of deferred cost to their estimated realizable value. The value of insurance acquired in the Company's various acquisitions, which is included in cost of insurance acquired in the accompanying consolidated financial statements, was determined based on the present value of future profits discounted at a risk rate of return. The cost of insurance acquired is being amortized over the anticipated premium paying period of the related policies. (f) POLICY LIABILITIES AND ACCRUALS Future policy benefit reserves have been computed by the net level premium method with assumptions as to investment yields, dividends on participating business, mortality and withdrawals based upon the Company's and industry experience, which provide for possible unfavorable deviation. Annuity benefits are carried at accumulated contract values based on premiums paid by participants, annuity rates of return ranging from 3.0% to 7.0% (primarily at 4.0% to 5.5%) and annuity withdrawals. Premium deposits accrue interest at rates ranging from 3.5% to 8.25% per annum. Cost of insurance is included in premium when collected and interest is credited annually to the deposit account. 44
45 Policy and contract claims are based on case-basis estimates for reported claims, and on estimates, based on experience, for incurred but unreported claims and loss expenses. (g) EXCESS OF COST OVER NET ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS The excess of cost over the fair value of net assets acquired in mergers and acquisitions is amortized on a straight-line basis ranging from 5 to 20 years. Other intangible assets, primarily the value of state licenses, are amortized on a straight-line basis ranging from 10 to 20 years. The Company continually monitors long-lived assets and certain intangible assets, such as excess of cost over net assets acquired and cost of insurance acquired, for impairment. An impairment loss is recorded in the period in which the carrying value of the assets exceeds the fair value or expected future cash flows. Any amounts deemed to be impaired are charged, in the period in which such impairment was determined, as an expense against earnings. (h) PARTICIPATING POLICIES At December 31, 2000 and 1999, participating business approximated 57% and 59%, respectively, of life insurance in-force and premium income. The amount of dividends to be paid is determined annually by the Board of Directors. (i) EARNINGS PER SHARE Basic and diluted earnings per share have been computed using the weighted average number of shares of common stock outstanding during each period. The weighted average shares outstanding for the years ended December 31, 2000, 1999 and 1998 were 25,107,604, 25,057,913 and 24,484,989, respectively. The per share amounts have been adjusted retroactively for all periods presented to reflect the change in capital structure resulting from a 7% stock dividend declared on October 31, 2000, payable on December 31, 2000 to holders of record as of December 1, 2000 and a 7% stock dividend declared on November 2, 1999, payable on December 31, 1999 to holders of record as of December 1, 1999. The 2000 stock dividend resulted in the issuance of 1,887,265 Class A shares (including 145,613 shares in treasury) and 46,517 Class B shares and the 1999 stock dividend resulted in the issuance of 1,763,805 Class A shares (including 136,091 shares in treasury) and 43,474 Class B shares. (j) INCOME TAXES For the year ended December 31, 2000, the Company plans to file three separate tax returns as follows: 1) Citizens, Inc., CICA and all direct non-life subsidiaries, 2) Excalibur and 3) CILIC. 45
46 For the year ended December 31, 1999, the Company filed five separate tax returns as follows: 1) Citizens, Inc., CICA and all direct non-life subsidiaries, 2) Excalibur, 3) USLIC, 4) NSLIC and 5) CILIC. For the year ended December 31, 1998, the Company filed six separate tax returns as follows: 1) Citizens, Inc., CICA, and all direct non-life subsidiaries, 2) Investors, 3) Excalibur, 4)USLIC, 5) NSLIC, and 6) CILIC. Deferred tax asset and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (k) ACCOUNTING PRONOUNCEMENTS In December 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 97-3 "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides: 1) guidance for determining when an entity should recognize a liability for guaranty fund and other insurance-related assessments, 2) guidance on how to measure a liability, 3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges and 4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company adopted SOP 97-3 during 1999. Implementation did not have a material impact on the Company's financial statements. In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance for determining whether costs of software developed or obtained for internal use should be capitalized or expensed when incurred. In the past, the Company has expensed such costs as they were incurred. This SOP is also effective for fiscal years beginning after December 15, 1998. The Company adopted SOP 98-1 during 1999. Implementation did not have a material impact on the Company's financial statements. Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, is effective January 1, 2001. Management does not believe SFAS No. 133, as amended, will have a significant effect on the financial position, results of operations or liquidity of the Company. SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement of FASB Statement 125" revises the 46
47 rules to be followed when determining whether a special purpose entity (SPE) is a qualifying SPE (QSPE). SFAS No. 140 requires that a QSPE have at least 10% of its beneficial interests held by parties unrelated to the transferor and limits the amount and type of derivative instruments that a QSPE can hold. SFAS No. 140 requires that for a transfer to a QSPE to be accounted for as a sale, the transferor must not retain effective control over the transferred assets through a removal-of-accounts provision that allows the transferor to unilaterally reclaim specific transferred assets. SFAS No. 140 requires extensive disclosures about securitizations entered into during the period and retained interests in securitized financial assets at the balance sheet date, accounting policies, sensitivity information related to retained interests and cash flows distributed to the transferor. It is effective for transfers occurring after March 31, 2001. However, the expanded disclosures about securitizations and collateral are effective for fiscal years ending after December 15, 2000. Management does not believe that SFAS No. 140 will have a significant effect on the financial position, results of operations or liquidity of the Company. (l) CASH EQUIVALENTS The Company considers as cash equivalents all securities whose duration does not exceed ninety days at the date of acquisition. (m) DEPRECIATION Depreciation is calculated on a straight-line basis using estimated useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated over the estimated life of 30 years. (n) USE OF ESTIMATES The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. (o) RECLASSIFICATIONS Certain reclassifications have been made to the 1999 and 1998 amounts to conform to the 2000 presentation. (2) INVESTMENTS The cost, gross unrealized gains and losses and fair value of investments of fixed maturities and equity securities available-for-sale, as of December 31, 2000 and 1999, are as follows: 47
48 <TABLE> <CAPTION> 2000 ------------------------------------------------------------------------ GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Fixed maturities held-to-maturity: US Treasury securities $ 5,582,802 $ 6,198 $ -- $ 5,589,000 ============ ============ ============ ============ Fixed maturities available-for-sale: US Treasury securities and obligations of US government corporations and agencies 36,355,133 467,241 422,705 36,399,669 Public utilities 2,327,073 793 141,665 2,186,201 Debt securities issued by States of the United States and political Subdivisions of the States 3,583,666 17,216 28,583 3,572,299 Corporate securities 17,235,989 135,458 869,857 16,501,590 Mortgage-backed securities 106,494,411 946,837 1,155,309 106,285,939 ------------ ------------ ------------ ------------ Total fixed maturities available-for-sale $165,996,272 $ 1,567,545 $ 2,618,119 $164,945,698 ============ ============ ============ ============ Total equity securities available-for-sale $ 713,235 $ 15,872 $ 53,381 $ 675,726 ============ ============ ============ ============ </TABLE> <TABLE> <CAPTION> 1999 ------------------------------------------------------------------------ GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Fixed maturities held-to-maturity: US Treasury securities $ 5,594,745 $ -- $ 388,495 $ 5,206,250 ============ ============ ============ ============ Fixed maturities available-for-sale: US Treasury securities and obligations of US government corporations and agencies 43,573,934 139,888 1,435,222 42,278,600 Public utilities 2,258,495 745 182,048 2,077,192 Debt securities issued by States of the United States and political Subdivisions of the States 5,847,282 35,582 129,039 5,753,825 Corporate securities 22,243,158 228,217 551,430 21,919,945 Mortgage-backed securities 75,916,624 62,503 3,794,134 72,184,993 ------------ ------------ ------------ ------------ Total fixed maturities available-for-sale $149,839,493 $ 466,935 $ 6,091,873 $144,214,555 ============ ============ ============ ============ Total equity securities available-for-sale $ 716,293 $ 50,994 $ 49,475 $ 717,812 ============ ============ ============ ============ </TABLE> 48
49 The amortized cost and fair value of fixed maturities at December 31, 2000 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. FIXED MATURITIES HELD-TO-MATURITY <TABLE> <CAPTION> AMORTIZED COST FAIR VALUE <S> <C> <C> Due after ten years $5,582,802 $5,589,000 ========== ========== </TABLE> FIXED MATURITIES AVAILABLE-FOR-SALE <TABLE> <CAPTION> AMORTIZED COST FAIR VALUE ------------ ------------ <S> <C> <C> Due in one year or less $ 1,431,065 $ 1,434,993 Due after one year through five years 9,650,824 9,555,249 Due after five years through ten years 22,997,012 22,757,793 Due after ten years 25,422,960 24,911,724 ------------ ------------ 59,501,861 58,659,759 Mortgage-backed securities 106,494,411 106,285,939 ------------ ------------ Totals $165,996,272 $164,945,698 ============ ============ </TABLE> The Company had no investments in any one entity that exceeded 10% of stockholders' equity at December 31, 2000 other than investments guaranteed by the U.S. Government. The Company's investment in mortgage loans is concentrated 28% in Colorado, 41% in Texas and 31% in Mississippi as of December 31, 2000. Major categories of net investment income are summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Investment income on: Fixed maturities $ 10,885,567 $ 9,795,297 $ 9,070,636 Equity securities 51,401 52,252 61,623 Mortgage loans on real estate 124,092 121,818 145,325 Policy loans 1,532,238 1,571,863 1,492,733 Long-term investments 852,117 829,599 900,276 Other 191,354 451,411 616,958 ------------ ------------ ------------ 13,636,739 12,822,240 12,287,551 Investment expenses (1,086,015) (1,185,300) (1,008,426) ------------ ------------ ------------ Net investment income $ 12,550,754 $ 11,636,940 $ 11,279,125 ============ ============ ============ </TABLE> Equity securities of $23,328 as of December 31, 2000, did not produce income during the preceding 12 months. 49
50 Proceeds and gross realized gains (losses) from sales and maturities of fixed maturities available-for-sale for 2000, 1999 and 1998 are summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------------------------------- 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Proceeds $ 40,885,946 $ 11,890,850 $ 29,164,384 ============ ============ ============ Gross realized gains $ 284,038 $ 344,002 $ 452,105 ============ ============ ============ Gross realized (losses) $ (193,801) $ (36,325) $ (45,268) ============ ============ ============ </TABLE> Proceeds and gross realized gains (losses) from sales of equity securities available-for-sale for 2000, 1999 and 1998 are summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------------------- 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> Proceeds $ 88 $ 92,500 $151,923 ======== ======== ======== Gross realized gains $ -- $ -- $ -- ======== ======== ======== Gross realized (losses) $ (2,970) $ (6,477) $(16,319) ======== ======== ======== </TABLE> Realized gains (losses) are as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------- 2000 1999 1998 ----------- ----------- ----------- <S> <C> <C> <C> Realized gains (losses): Fixed maturities $ 90,237 $ 307,677 $ 406,837 Equity securities (2,970) (6,477) (16,319) Other (698) 9,690 1,223,870 ----------- ----------- ----------- Net realized gains $ 86,569 $ 310,890 $ 1,614,388 =========== =========== =========== </TABLE> (3) COST OF INSURANCE ACQUIRED AND EXCESS OF COST OVER NET ASSETS ACQUIRED Cost of insurance acquired is summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------------------- 2000 1999 1998 ------------ ------------ ------------ <S> <C> <C> <C> Balance at beginning of period $ 7,186,494 $ 8,290,853 $ 10,639,667 Increase (decrease) related to Acquisitions -- 50,000 (877,904) Interest 538,988 625,251 797,975 Amortization (1,569,058) (1,779,610) (2,268,885) ------------ ------------ ------------ Balance at end of period $ 6,156,424 $ 7,186,494 $ 8,290,853 ============ ============ ============ </TABLE> 50
51 Accretion of interest on cost of insurance acquired is calculated based on the rates of interest used in setting the related policy reserves. These rates range from 6.5% to 8.5%. Estimated amortization in each of the next five years is as follows. These amounts are equal to the carrying value due and exclude interest accretion at rates ranging from 6.5% to 8.5%. Actual future amortization will differ from these estimates due to variances from estimated future withdrawal assumptions. <TABLE> <CAPTION> YEAR AMOUNT ---- ---------- <S> <C> 2001 $1,254,416 2002 917,660 2003 811,552 2004 718,515 2005 664,301 Thereafter 1,789,980 </TABLE> Excess of cost over net assets acquired is summarized as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------ ACCUMULATED GROSS AMORTIZATION NET ------------ ------------ ------------ <S> <C> <C> <C> Balance at December 31, 1997 $ 20,179,342 $ (2,713,219) $ 17,466,123 Increase related to acquisitions 852,498 -- 852,498 Impairment loss (9,500,000) -- (9,500,000) Amortization -- (442,822) (442,822) ------------ ------------ ------------ Balance at December 31, 1998 11,531,840 (3,156,041) 8,375,799 Increase related to acquisitions 303,703 -- 303,703 Amortization -- (658,458) (658,458) ------------ ------------ ------------ Balance at December 31, 1999 $ 11,835,543 $ (3,814,499) $ 8,021,044 Amortization -- (658,390) (658,390) ------------ ------------ ------------ Balance at December 31, 2000 $ 11,835,543 $ (4,472,889) $ 7,362,654 ============ ============ ============ </TABLE> During 1998, the Company recognized an impairment loss in the amount of $9,500,000 relating to the goodwill recorded in the 1995 acquisition of ALLIC. The impairment loss was the result of a decline in production from agents formerly associated with ALLIC. (4) POLICY LIABILITIES Various assumptions used to determine the future policy benefit reserves include the following: a) valuation interest rates from 4 to 9%, b) mortality assumptions are from the 1955 to 1960, 1965 to 1970, and 1975 to 1980 Select and Ultimate mortality tables and c) withdrawals are based primarily on actual historical termination rates. 51
52 The following table presents information on changes in the liability for accident and health policy and contract claims for the years ended December 31, 2000 and 1999. <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> Policy and contract claims payable at January 1 $ 2,009,144 $2,390,618 Add claims incurred, related to: Current year 5,176,481 8,673,369 Prior years (17,858) 12,849 ----------- ---------- 5,158,623 8,686,218 Deduct claims paid, related to: Current year 4,080,331 5,450,160 Prior years 1,717,017 3,617,532 ----------- ---------- 5,797,348 9,067,692 ----------- ---------- Policy and contract claims payable, December 31 $ 1,370,419 $2,009,144 =========== ========== </TABLE> The development of prior year claim reserves reflects normal changes in actuarial estimates. (5) REINSURANCE In the normal course of business, the Company reinsures portions of certain policies that it underwrites to limit disproportionate risks. During 2000, the Company retained varying amounts of individual insurance up to a maximum retention of $75,000 on any life. On health policies there are varying retention limits ranging from $25,000 to $35,000 depending on the product with some of the supplemental hospital and surgical policies reinsured on a quota share basis. The Company's share of risk on the quota share reinsurance ranges from 25% to 50%. The Company remains contingently liable to the extent that the reinsuring companies cannot meet their obligations under these reinsurance treaties. Assumed and ceded reinsurance activity for 2000 and 1999 is summarized as follows: <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> Aggregate assumed life insurance in-force $ 326,267,000 $ 273,146,000 =============== =============== Aggregate ceded life insurance in-force $ (272,150,000) $ (278,689,000) =============== =============== Total life insurance in-force $ 2,294,640,000 $ 2,192,301,000 =============== =============== </TABLE> Premiums and claims and surrenders assumed and ceded for the years ended December 31, 2000, 1999 and 1998: <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Premiums assumed $ 95,068 $ 484,746 $ 231,410 =========== =========== =========== Premiums ceded $(2,494,798) $(2,539,155) $(3,368,690) =========== =========== =========== Claims and surrenders assumed $ 87,025 $ 481,899 $ 234,037 =========== =========== =========== Claims and surrenders ceded $(1,710,160) $(1,762,195) $(1,690,643) =========== =========== =========== </TABLE> 52
53 Amounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. The cost of reinsurance related to long duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. (6) STOCKHOLDERS' EQUITY AND RESTRICTIONS The two classes of stock of Citizens are equal in all respects, except (a) each Class A share receives twice the cash dividends paid on a per share basis to the Class B common stock; and (b) the Class B common stock elects a simple majority of the Board of Directors of Citizens and the Class A common stock elects the remaining directors. Generally, the net assets of the insurance subsidiaries available for transfer to Citizens are limited to the greater of the subsidiary net gain from operations during the preceding year or 10% of the subsidiary net statutory surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. Payments of dividends in excess of such amounts would generally require approval by the regulatory authorities. Based upon statutory net gain from operations and surplus of the individual insurance companies as of and for the year ended December 31, 2000 approximately $3,400,000 of dividends could be paid to Citizens without prior regulatory approval. CICA, CILIC and Excalibur have calculated their risk based capital (RBC) in accordance with the National Association of Insurance Commissioners' Model Rule and the RBC rules as adopted by their respective state of domicile. The RBC as calculated for CICA, CILIC and Excalibur exceeded levels requiring company or regulatory action. (7) MERGERS AND ACQUISITIONS In March 1997, the Company acquired the remaining 5.2% minority interest in FAIC, a 94.8% subsidiary of ALFC. The Company issued 134,125 shares of the Company's Class A stock to consummate this transaction. The excess of cost over net assets acquired amounted to $1,065,696 (of which $399,353 was written off concurrent with the acquisition) and is being amortized over 10 years. Effective January 1, 1997, AFLC was merged into Citizens and FAIC was merged into CICA. On October 28, 1996, CICA announced that it had signed definitive written agreements for the acquisition of AIN, a Jackson, Mississippi, based life insurance holding company and its wholly-owned subsidiary USLIC with $7.5 million in assets, $3.4 million of stockholders' equity, revenues of $3.2 million and $67 million of life insurance in-force. The AIN agreement provided that following the acquisition by CICA, AIN shareholders would receive 1 share of Citizens, Inc. Class A Common Stock for each 7.2 shares of AIN Common Stock owned. The Company issued approximately 700,000 Class A shares in connection with the transaction, which was accounted for as a purchase and was consummated on June 19, 1997. The excess of cost over net assets acquired amounted to 53
54 $875,000 and is being amortized over 20 years. During 1998, AIN was liquidated and USLIC became a wholly-owned subsidiary of CICA. On August 13, 1997, Citizens signed a definitive agreement to acquire 100% of the outstanding shares of NSLIC of Arlington, Texas for $1.7 million in cash and restricted stock. The transaction, which was accounted for as a purchase, was consummated on November 20, 1997. The excess of cost over net assets acquired amounted to $625,567 and is being amortized over 10 years. In conjunction with the acquisition, the Company and two executives of NSLIC executed employment agreements that require the executives to provide services to the Company for 42 months. The employees will be compensated $8,333 a month for the first twelve months escalating to $12,500 a month for the remaining thirty months. The IIH agreement closed on March 12, 1996 and provided that Investors' shareholders would receive one share of Citizens' Class A Common Stock for each eight shares of Central Investors Common Stock owned. Additionally, Citizens acquired all shares of CILIC (a 94% owned subsidiary of Investors) not already owned by Investors, based upon an exchange ratio of one share of Citizens' Class A common stock for each four shares of Central Investors owned. The acquisition of these two companies involved the issuance of approximately 171,000 of Citizens' Class A shares which was accounted for as a purchase. The excess of cost over net assets acquired amounted to $419,878 and is being amortized over 5 years. During 1998, IIH was liquidated and CILIC became a wholly-owned subsidiary of CICA. On September 15, 1998, Citizens announced that a definitive agreement had been reached between Citizens and Investors of Springfield, Illinois whereby Citizens would acquire 100% of the outstanding shares of Investors for shares of Citizens Class A Common stock. Investors is the parent of Excalibur, also of Springfield, Illinois. Pursuant to the terms of the Agreement, which was approved by Investors' shareholders and regulatory authorities, Citizens issued one share of Citizens Class A Common stock for each 6.6836 shares of Investors common and preferred stock issued and outstanding. The transaction closed on January 26, 1999. Citizens issued 609,269 shares of its Class A Common stock to consummate the transaction, which was accounted for as a purchase. The excess of cost over net assets acquired amounted to $303,703 and is being amortized over 10 years. Effective January 1, 2000, NSLIC was merged with and into CICA. Additionally, effective October 1, 2000, USLIC was merged with and into CICA. (8) CONTINGENCIES The Company is a party to various legal proceedings incidental to its business. The Company has been named as a defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of management and its legal counsel, the ultimate liability, if any, resulting from any contingent liabilities that might arise from litigation are not considered material in relation to the financial position or results of operations of the Company. 54
55 Reserves for claims payable are based on the expected claim amount to be paid after a case by case review of the facts and circumstances relating to each claim. A contingency exists with regard to these reserves until such time as the claims are adjudicated and paid. (9) SEGMENT INFORMATION The Company has two reportable segments identified by geographic area: International Business and Domestic Business. International Business consisting of ordinary whole-life business is sold throughout Central and South America. The Company has no assets, offices or employees outside of the United States of America (U.S.) and requires that all transactions be in U.S. dollars paid in the U.S. Domestic Business consisting of traditional life and burial insurance, pre-need policies, accident and health specified disease, hospital indemnity and accidental death policies are sold throughout the southern U.S. The accounting policies of the segments are in accordance with U.S. GAAP and are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on U.S. GAAP net income (loss) before federal income taxes for its two reportable segments. Geographic Areas - The following summary represents financial data of the Company's continuing operations based on their location. <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- REVENUES <S> <C> <C> <C> U.S $14,340,251 $19,844,710 $20,674,694 Non-U.S 52,337,865 52,032,348 52,010,221 ----------- ----------- ----------- Total Revenues $66,678,116 $71,877,058 $72,684,915 =========== =========== =========== </TABLE> The following summary, representing revenues and pre-tax income from continuing operations and identifiable assets for the Company's reportable segments as of and for the years ended December 31, 2000, 1999 and 1998, is as follows: <TABLE> <CAPTION> YEARS ENDED DECEMBER 31 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Revenue, excluding net investment income and realized gains Domestic $11,622,382 $16,546,005 $17,007,228 International 42,418,411 43,383,223 42,784,174 ----------- ----------- ----------- Total consolidated revenue $54,040,793 $59,929,228 $59,791,402 =========== =========== =========== Net investment income: Domestic $ 2,699,251 $ 3,212,871 $ 3,208,265 International 9,851,503 8,424,069 8,070,860 ----------- ----------- ----------- Total consolidated net investment income $12,550,754 $11,636,940 $11,279,125 =========== =========== =========== </TABLE> 55
56 <TABLE> <S> <C> <C> <C> Amortization expense: Domestic $ 1,922,308 $ 1,766,439 $ 12,177,194 International 8,595,324 10,382,384 7,212,752 ----------- ----------- ------------ Total consolidated amortization expense $10,517,632 $12,148,823 $ 19,389,946 =========== =========== ============ Realized gains Domestic $ 18,618 $ 85,834 $ 459,201 International 67,951 225,056 1,155,187 ----------- ----------- ------------ Total consolidated realized gains $ 86,569 $ 310,890 $ 1,614,388 =========== =========== ============ Income (loss) before federal Income tax: Domestic $ 290,577 $ 67,571 $ (7,767,586) International 2,233,164 904,878 2,090,321 ----------- ----------- ------------ Total consolidated net income (loss) before federal income taxes $ 2,523,741 $ 972,449 $ (5,677,265) =========== =========== ============ </TABLE> <TABLE> <CAPTION> December 31 2000 1999 ---- ---- <S> <C> <C> Assets: Domestic $ 93,476,985 $ 94,273,886 International 174,365,379 161,210,900 ------------ ------------ Total $267,842,364 $255,484,786 ============ ============ </TABLE> (10) INCOME TAXES A reconciliation of Federal income tax expense computed by applying the Federal income tax rate of 34% to income before Federal income tax expense is as follows: <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Computed normal tax expense (benefit) $ 858,072 $ 330,633 $(1,930,270) Small life insurance company deduction (573,000) (597,755) (447,690) Change in valuation allowance -- (173,350) (24,479) Amortization of excess of costs over net assets acquired 224,000 223,876 3,444,038 Other (38,072) (82,027) 1,829 --------- --------- ----------- Federal income tax expense (benefit) $ 471,000 $(298,623) $ 1,043,428 ========= ========= =========== </TABLE> 56
57 Income tax expense (benefit) for the years ended December 31, 2000, 1999 and 1998 consists of: <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Current $ 459,000 $ 1,405,698 $ 2,521,377 Deferred 12,000 (1,704,321) (1,477,949) --------- ----------- ----------- $ 471,000 $ (298,623) $ 1,043,428 ========= =========== =========== </TABLE> The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999 are presented below. <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> Deferred tax assets: Future policy benefit reserves $15,472,000 $15,182,304 Net operating loss carryforwards 760,000 904,717 Investments available for sale 369,948 1,911,962 Other 836,802 715,649 ----------- ----------- Total gross deferred tax assets 17,438,750 18,714,632 Less valuation allowance -- -- ----------- ----------- Net deferred tax assets $17,438,750 $18,714,632 ----------- ----------- Deferred tax liabilities: Deferred policy acquisition costs and cost of insurance acquired $11,847,000 $11,526,363 Other 963,000 1,005,505 ----------- ----------- Total gross deferred tax liabilities 12,810,000 12,531,868 ----------- ----------- Net deferred tax asset $ 4,628,750 $ 6,182,764 =========== =========== </TABLE> During 1999 and 1998, the Company released the valuation allowance associated with NSLIC and ALFC net operating losses, respectively, as these losses can be utilized in the future by the Company and CICA. The Company and its subsidiaries have net operating losses at December 31, 2000 available to offset future taxable income of approximately $760,000 for Federal income tax substantially all of which expire through 2020. A portion of the net operating loss carryforward is subject to limitations under Section 382 of the Internal Revenue Code. At December 31, 2000, the Company had accumulated approximately $3,291,000 in its "policyholders' surplus account." This is a special memorandum tax account into which certain amounts not previously taxed, under prior tax laws, were accumulated. No new additions will be made to this account. Federal income taxes will become payable thereon at the then current tax rate (a) when and if distributions to the shareholder, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income; or (b) when a company ceases to be a life insurance 57
58 company as defined by the Internal Revenue Code and such termination is not due to another life insurance company acquiring its assets in a nontaxable transaction. The Company does not anticipate any transactions that would cause any part of this amount to become taxable. However, should the balance at December 31, 2000 become taxable, the tax computed at present rates would be approximately $1,119,000. (11) FAIR VALUE OF FINANCIAL INSTRUMENTS Estimates of fair values are made at a specific point in time, based on relevant market prices and information about the financial instrument. The estimated fair values of financial instruments presented below are not necessarily indicative of the amounts the Company might realize in actual market transactions. The carrying amount and fair value for the financial assets and liabilities on the consolidated balance sheets at each year-end were. <TABLE> <CAPTION> 2000 1999 ---- ---- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ------ ----- ------ ----- <S> <C> <C> <C> <C> Financial assets: Fixed maturities $170,528,500 $170,534,698 $149,809,300 $149,420,805 Equity securities 675,726 675,726 717,812 717,812 Cash and cash equivalents 4,064,035 4,064,035 11,149,084 11,149,084 Mortgage Loans 1,178,668 1,178,668 1,374,204 1,374,204 Financial Liabilities: Annuities 4,170,884 4,170,884 4,023,827 4,023,827 </TABLE> Fair values for fixed income securities and equity securities are based on quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other assumptions, including the discount rate and estimates of future cash flows. Mortgage loans are secured principally by residential properties. Weighted average interest rate for these loans as of December 31, 2000 and 1999, were approximately 8.6% and 8.7% respectively, with maturities ranging from one to fifteen years. Management believes that reported amounts approximate fair value. The carrying value and fair values for the Company's liabilities under annuity contract policies are the same as the interest rates credited to these products and are periodically adjusted by the Company to reflect market conditions. The fair value of liabilities under all insurance contracts are taken into consideration in the overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts. 58
59 Policy loans have a weighted average interest rate of 7.5% and 7.2% as of December 31, 2000 and 1999, respectively, and have no specified maturity dates. The aggregate fair value of policy loans approximates the carrying value reflected on the consolidated balance sheet. These loans typically carry an interest rate that is tied to the crediting rate applied to the related policy and contract reserves. Policy loans are an integral part of the life insurance policies which the Company has in-force and cannot be valued separately. For cash, accrued investment income, amounts recoverable from reinsurers, other assets, federal income tax payable and receivable, dividend accumulations, commissions payable, amounts held on deposit, and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments. (12) OTHER COMPREHENSIVE INCOME (LOSS) The changes in the components of other comprehensive income (loss) are reported net of income taxes of 34% for the periods indicated as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 ---------------------------- PRE-TAX TAX NET AMOUNT EFFECT AMOUNT ------ ------ ------ <S> <C> <C> <C> Unrealized gain on securities: Unrealized holding gain arising during the period $ 4,622,602 $(1,571,685) $3,050,917 Less: reclassification adjustment for gains included in net income (87,267) 29,671 (57,596) ----------- ----------- ---------- Other comprehensive income $ 4,535,335 $(1,542,014) $2,993,321 =========== =========== ========== </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 1999 ---------------------------- PRE-TAX TAX NET AMOUNT EFFECT AMOUNT ------ ------ ------ <S> <C> <C> <C> Unrealized loss on securities: Unrealized holding loss arising during the period $(10,812,316) $3,676,186 $(7,136,130) Add: reclassification adjustment for gains included in net income (301,200) 102,410 (198,790) ------------ ---------- ----------- Other comprehensive loss $(11,113,516) $3,778,596 $(7,334,920) ============ ========== =========== </TABLE> 59
60 <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 1998 ---------------------------- PRE-TAX TAX NET AMOUNT EFFECT AMOUNT ------ ------ ------ <S> <C> <C> <C> Unrealized gain on securities: Unrealized holding gain arising during the period $ 3,485,479 $(1,185,063) $ 2,300,416 Less: reclassification adjustment for gains included in net income (390,518) 132,776 (257,742) ----------- ----------- ----------- Other comprehensive income $ 3,094,961 $(1,052,287) $ 2,042,674 =========== =========== =========== </TABLE> (13) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following table contains selected unaudited consolidated financial data for each calendar quarter. <TABLE> <CAPTION> 2000 ---- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- <S> <C> <C> <C> <C> Revenues $ 17,621,342 $ 17,010,084 $ 16,468,250 $ 15,578,440 Expenses 15,224,838 17,631,964 15,298,624 15,998,949 Federal income tax expense (benefit) 705,398 (335,073) 220,512 (119,837) Net income (loss) 1,691,106 (286,807) 949,114 (300,672) Basic and diluted earnings (loss) per share .07 (.01) .03 (.01) </TABLE> <TABLE> <CAPTION> 1999 ---- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- <S> <C> <C> <C> <C> Revenues $ 18,883,005 $ 17,946,816 $ 18,229,167 $16,818,070 Expenses 19,150,093 16,816,910 18,455,771 16,481,835 Federal income tax expense (benefit) (481,050) 239,427 (115,484) 58,484 Net income (loss) 213,962 890,479 (111,120) 277,751 Basic and diluted earnings (loss) per share .01 .04 (.01) .01 </TABLE> 60
61 <TABLE> <CAPTION> 1998 ---- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- <S> <C> <C> <C> <C> Revenues $ 19,013,057 $ 19,049,196 $18,162,381 $16,460,281 Expenses 16,673,560 27,487,836 17,890,009 16,310,775 Federal income tax expense 733,120 200,870 72,516 36,922 Net income (loss) 1,606,377 (8,639,510) 199,856 112,584 Basic and diluted earnings (loss) per share .07 (.35) .01 .01 </TABLE> (14) YEAR 2000 ISSUES (UNAUDITED) The Company successfully addressed the impact of the Year 2000 on its systems, procedures, customers and business processes. There was no adverse impact on any Company operations for the calendar change from 1999 to 2000. The Company used internal resources to modify, replace and test the Year 2000 modifications. The total cost for the project was negligible, was performed with existing staff and the associated costs were expensed as incurred. All critical suppliers or customers (external relationships) resolved their own third party Year 2000 issues and were able to interact with the Company. The Company encountered no loss of data or functionality related to the Year 2000. 61
62 SCHEDULE II CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CITIZENS, INC. (PARENT COMPANY) STATEMENTS OF FINANCIAL POSITION DECEMBER 31, 2000 AND 1999 <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> Assets Investment in subsidiaries (1) $ 72,435,637 $ 68,043,909 Fixed maturities available-for-sale, at fair value 2,583,419 -- Accrued investment income 44,683 14,410 Real estate 800,114 741,834 Cash 220,273 1,667,050 Notes receivable (1) 200,000 266,667 Other assets 1,449,198 1,701,898 ------------ ------------ $ 77,733,324 $ 72,435,768 ============ ============ Liabilities and Stockholders' Equity Liabilities - Accrued expense and other $ 420,293 $ 168,799 ------------ ------------ Stockholders' equity: Common stock: Class A 79,701,590 67,510,026 Class B 910,482 584,863 Retained earnings 1,311,655 10,756,800 Accumulated other comprehensive income: Unrealized investment gain (loss) of securities held by subsidiaries, net of tax (718,135) (3,711,456) Treasury stock (3,892,561) (2,873,264) ------------ ------------ 77,313,031 72,266,969 ------------ ------------ $ 77,733,324 $ 72,435,768 ============ ============ </TABLE> (1) Eliminated in consolidation. See accompanying independent auditors' report. 62
63 SCHEDULE II, CONTINUED CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CITIZENS, INC. (PARENT COMPANY) STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000 AND 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Revenues: Management service fees (1) $12,252,079 $ 13,333,733 $ 13,033,492 Investment income 129,515 79,872 79,882 Other 35,174 6,437 4,425 Realized loss -- (7,281) ----------- ------------ ------------ 12,416,768 13,412,761 13,117,799 ----------- ------------ ------------ Expenses: General 11,047,326 12,126,181 12,019,676 Interest -- 18,537 27,011 Taxes 806,657 812,896 533,098 ----------- ------------ ------------ 11,853,983 12,957,614 12,579,785 ----------- ------------ ------------ Income before equity in income of unconsolidated subsidiaries 562,785 455,147 538,014 Equity in income (loss) of unconsolidated subsidiaries 1,489,956 815,925 (7,258,707) ----------- ------------ ------------ Net income (loss) $ 2,052,741 $ 1,271,072 $ (6,720,693) =========== ============ ============ </TABLE> - ---------- (1) Eliminated in consolidation. See accompanying independent auditors' report. 63
64 SCHEDULE II, CONTINUED CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CITIZENS, INC. (PARENT COMPANY) STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Cash flows from operating activities: Net income (loss) $ 2,052,741 $ 1,271,072 $(6,720,693) Adjustments to reconcile net income (loss) to net cash used by operating activities: Realized losses on sales -- 7,281 -- Equity in net (income) loss of unconsolidated subsidiaries (1,489,956) (815,925) 7,258,707 Accrued expenses and other liabilities 251,494 104,018 (11,777) Accrued investment income (30,273) -- 2,844 Other 300,896 (138,184) 536,295 ----------- ----------- ----------- Net cash provided by operating activities 1,084,902 428,262 1,065,376 ----------- ----------- ----------- Cash flows from investing activities: Purchase of fixed maturities, available-for-sale (2,540,066) -- -- Payments on notes receivable 66,667 66,666 66,667 Investment in real estate (58,280) (284,153) (28,675) ----------- ----------- ----------- Net cash provided (used) by investing activities (2,531,679) (217,487) 37,992 ----------- ----------- ----------- Cash flows from financing activities: Payment on notes payable -- (333,333) (66,667) ----------- ----------- ----------- Net cash used by financing activities -- (333,333) (66,667) ----------- ----------- ----------- Net increase (decrease) in cash 1,446,777 (122,558) 1,036,701 Cash at beginning of year 1,667,050 1,789,608 752,907 ----------- ----------- ----------- Cash at end of year $ 220,273 $ 1,667,050 $ 1,789,608 =========== =========== =========== </TABLE> See accompanying independent auditors' report. 64
65 SCHEDULE IV CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES REINSURANCE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 <TABLE> <CAPTION> CEDED ASSUMED PERCENTAGE GROSS TO OTHER FROM OTHER NET OF AMOUNT AMOUNT COMPANIES COMPANIES AMOUNT ASSUMED TO NET ------ --------- --------- ------ -------------- <S> <C> <C> <C> <C> <C> Year ended December 31, 2000: Life insurance in-force $2,240,523,000 $272,150,000 $326,267,000 $2,294,640,000 14.2% ============== ============ ============ ============== ==== Premiums: Life insurance 48,046,655 2,154,034 95,068 45,987,689 .2% Accident and health insurance 7,576,449 340,764 -- 7,235,685 -- -------------- ------------ ------------ -------------- ---- Total premiums $ 55,623,104 $ 2,494,798 $ 95,068 $ 53,223,374 .2% ============== ============ ============ ============== ==== Year ended December 31, 1999 Life insurance in-force $2,197,844,000 $278,689,000 $273,146,000 $2,192,301,000 12.5% ============== ============ ============ ============== ==== Premiums: Life insurance 49,654,207 1,966,793 484,746 48,172,160 1.0% Accident and health insurance 11,458,679 572,362 -- 10,886,317 -- -------------- ------------ ------------ -------------- ---- Total premiums $ 61,112,886 $ 2,539,155 $ 484,746 $ 59,058,477 .8% ============== ============ ============ ============== ==== Year ended December 31, 1998 Life insurance in-force $2,340,744,000 $306,070,000 $333,719,000 $2,368,393,000 14.1% ============== ============ ============ ============== ==== Premiums: Life insurance 50,569,111 1,768,030 231,410 49,032,491 .5% Accident and health insurance 11,458,504 1,600,660 -- 9,857,844 -- -------------- ------------ ------------ -------------- ---- Total premiums $ 62,027,615 $ 3,368,690 $ 231,410 $ 58,890,335 .4% ============== ============ ============ ============== ==== </TABLE> See accompanying independent auditors' report. 65
66 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized. <TABLE> <S> <C> CITIZENS, INC. Date: March 27, 2001 By: /s/ Mark A. Oliver ------------------------------------------------ Mark A. Oliver, President By: /s/ Jeffrey J. Wood ------------------------------------------------ Jeffrey J. Wood, Executive Vice President, Chief Financial Officer and Secretary / Treasurer </TABLE> Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Each individual whose signature appears below hereby designates and appoints Harold E. Riley and Mark A. Oliver, and each of them, as such person's true and lawful attorney's-in-fact and agents (the "Attorneys-in-Fact") with full power of substitution and resubstitution, for each person and in such person's name, place, and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K, which amendments may make such changes in this Annual Report on Form 10-K as either Attorney-in-Fact deems appropriate and to file therewith, with the Securities and Exchange Commission, granting unto such Attorneys-in-Fact and each of them, full power and authority to do and perform each and every act and think requisite and necessary to be done in and about the premises, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that such Attorneys-in-Fact or either of them, in their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. <TABLE> <S> <C> <C> <C> /s/ Mark A. Oliver March 27, 2001 /s/ Harold E. Riley March 27, 2001 - ------------------------------ -------------------------------- Mark A. Oliver, Director Harold E. Riley, Chairman of the Board and Director /s/ Ralph M. Smith March 27, 2001 /s/ Joe R. Reneau March 27, 2001 - ------------------------------ -------------------------------- Ralph M. Smith, Director Joe R. Reneau, Director /s/ Dr. Richard C. Scott March 27, 2001 /s/ Timothy T. Timmerman March 27, 2001 - ------------------------------ -------------------------------- Dr. Richard C. Scott, Director Timothy T. Timmerman, Director /s/ Rick D. Riley March 27, 2001 /s/ Steve Shelton March 27, 2001 - ------------------------------ -------------------------------- Rick D. Riley, Director Steve Shelton, Director /s/ Dr. E. Dean Gage March 27, 2001 - ------------------------------ Dr. E. Dean Gage, Director </TABLE> 66
67 INDEX TO EXHIBITS <TABLE> <CAPTION> EXHIBIT PAGE ------- ---- <S> <C> Exhibit 21 68 Exhibit 23 69 </TABLE> 67