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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996
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 0-20148
CITIZENS FINANCIAL CORPORATION
(Exact name of Registrant
as specified in its charter)
Kentucky 61-1187135
(State of Incorporation) (I.R.S. Employer
Identification No.)
The Marketplace, Suite 300, 12910 Shelbyville Road, Louisville, Kentucky 40243
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: 502/244-2420
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Stock,
No Par Value (Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the 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. | |
As of March 14, 1997, the estimated aggregate market value of the shares of the
Registrant's Class A Stock held by non-affiliates of the Registrant was about
$2,500,000 (based upon $5.50 bid per share).
As of March 14, 1997, 1,075,615 shares of the Registrant's Class A Stock were
outstanding.
Portions of the Registrant's Board of Director's Proxy Statement for the Annual
Meeting of Shareholders now scheduled for May 21, 1997 are incorporated into
Part III of this Report.
This Report consists of 57 consecutively numbered pages. An index to
the Exhibits to this Report appears on page .
The date of this Report is March 26, 1997.
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CONTENTS
PART I
Page
ITEM 1. BUSINESS ................................................... 3
ITEM 2. PROPERTIES .................................................. 10
ITEM 3. LEGAL PROCEEDINGS ........................................... 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS .............................................. 10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS .......................... 10
ITEM 6. SELECTED FINANCIAL DATA .................................... 11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS .......................................... 13
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................ 23
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ................. 51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT .......................................... 51
ITEM 11. EXECUTIVE COMPENSATION ..................................... 51
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ............................... 51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS ........................................ 51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K ................................. 52
SIGNATURES .......................................................... 53
EXHIBIT INDEX ....................................................... 54
EXHIBITS............................................................. 56
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PART I
ITEM 1. BUSINESS
General
Citizens Financial Corporation (herein, the "Company" or the "Registrant") was
incorporated in Kentucky in 1990 at the direction of the Board of Directors of
Citizens Security Life Insurance Company ("Citizens Security") for the ultimate
purpose of becoming an insurance holding company. Pursuant to a merger completed
in 1991, Citizens Security became a wholly-owned subsidiary of the Company. The
Company is now a holding company that engages in the business of life insurance
and annuities and accident and health insurance through Citizens Security.
Citizens Security was incorporated in Kentucky and commenced business in 1965.
In 1971, Citizens Security acquired Central Investors Life Insurance Company by
merger. In 1987, it purchased the stock of Old South Life Insurance Company
("Old South"). In 1992, Old South merged into Citizens Security. Effective
August 31, 1995, the Company and Citizens Security purchased substantially all
of the stock of Integrity National Life Insurance Company ("Integrity"). See
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 2 of the Notes to Consolidated Financial Statements for
descriptions of this acquisition and related transactions. On December 31, 1995,
Integrity merged into Citizens Security. Citizens Security is currently licensed
to transact the business of life insurance and annuities and accident and health
insurance in 18 states and the District of Columbia.
In this Form 10-K, the term "Insurance Subsidiaries" is a collective reference
to Citizens Security and Old South prior to their 1992 merger and to Citizens
Security and Integrity from September, 1995 through their December, 1995 merger.
It is otherwise a reference to Citizens Security. References to the business of
Integrity are to those elements of Integrity's business continued by the Company
after the acquisition and therefore excludes other elements that were disposed
of in connection with the acquisition.
Insurance Operations
The Company, through Citizens Security, operates in two segments -- life
insurance and annuities, and accident and health insurance. Both segments
include individual and group insurance. The following table presents information
concerning the revenues and income or loss from operations before federal income
taxes for each segment for each of the last three fiscal years and the
identifiable assets of the two segments as of the end of such years. Additional
information regarding these segments is contained in Note 10 of the Notes to
Consolidated Financial Statements, Schedules III and IV of the Financial
Statement Schedules and in Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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Year Ended December 31, 1996 1995 1994
- --------------------------- ----------------- ------------- --------------
Revenues:
Life insurance and annuities:
Traditional life $11,069,733 $ 6,523,554 $ 1,869,447
Universal life 1,762,019 1,116,724 793,475
Group life 686,467 827,348 867,119
Annuity and other 927,860 1,242,045 609,860
- --------------------------- ------------------ ------------- --------------
Total life insurance and annuities 14,446,080 9,709,671 4,139,901
Accident and health insurance 8,655,980 6,576,906 5,448,053
- --------------------------- ----------------- ------------- ---------------
Total revenues $23,102,060 $16,286,577 $ 9,587,954
- --------------------------- ----------------- ------------- ---------------
Income (loss) from operations before federal income taxes:
Life insurance and annuities $ 1,051,618 $ 417,888 $ (781,027)
Accident and health insurance 284,008 323,343 108,213
- --------------------------- ----------------- -------------- --------------
Total income (loss) $ 1,335,626 $ 741,231 $ (672,814)
- --------------------------- ----------------- -------------- --------------
Assets at end of period:
Life insurance and annuities $76,384,118 $77,504,054 $41,334,707
Accident and health insurance 3,878,590 6,751,207 3,205,155
- --------------------------- ----------------- -------------- --------------
Total assets at end of period $80,262,708 $84,255,261 $44,539,862
- --------------------------- ----------------- -------------- --------------
Life Insurance and Annuities. The individual life insurance products presently
offered by Citizens Security consist of traditional whole life insurance, which
provides policyholders with permanent life insurance and fixed, guaranteed rates
of return on the cash value element of policy premiums, and universal life
insurance, which provides policyholders with permanent life insurance and
adjustable rates of return on the cash value element of policy premiums, based
upon current interest rates. The substantial majority of individual life
insurance products currently sold by Citizens Security are traditional whole
life policies. Citizens Security also issues individual term life insurance
products although sales in recent years have been minimal.
Approximately 83% of 1996 individual life insurance sales were made through
the Company's home service agency force. These agents sell primarily traditional
whole life policies of small face value (typically from $1,000 to $10,000).
These policies are subject to normal underwriting procedures with the extent of
such procedures determined by the amount of insurance, age of applicant and
other pertinent factors. The remaining traditional whole life sales are
primarily attributable to the Company's graded death benefit product. The graded
death benefit policy returns premium plus interest compounded at an annual rate
of 10% if the insured dies of natural causes during the first two years the
policy is in force. After two years, and during the first two years if the
insured dies of an accidental cause, the benefit payable is the face amount of
the policy. During the second quarter of 1997, Citizens Security will withdraw
the current graded death benefit policy and replace it with one whose return of
premium feature operates for a three year, rather than a two year period.
Generally, traditional whole life insurance products are more profitable than
universal life policies, in part because investment margins are normally greater
for traditional whole life products than for universal life policies. Overall
profitability on universal life policies may decline as a result of downward
interest crediting rate adjustments to the extent that policyholders withdraw
funds to invest in higher-yielding financial products. The majority of Citizens
Security's currently outstanding universal life products are subject to
surrender charges. The Company believes that this factor protects it to a great
extent from a decline in profitability due to increased withdrawals over the
next few years. The profitability of traditional whole life products and
universal life policies is also dependent upon the ultimate
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underwriting experience and the realization of anticipated unit administrative
costs. The Company believes that the historical claims experience for the
traditional whole life and universal life products issued by the Insurance
Subsidiaries has been within expected ranges, in relation to the mortality
assumptions used to price the products.
Citizens Security also sells group life, accidental death and dismemberment, and
dependent life insurance. Most policies are written for a one year term and
competitive bids are often sought by the contract holder prior to renewal.
The following table provides information concerning the Insurance Subsidiaries'
volume of life insurance coverage in force excluding participation in group
underwriting pools for federal employees (FEGLI) and service personnel (SGLI)
for each of the last three fiscal years.
Year Ended December 31,
(Dollars in Thousands) 1996 1995 1994
- -------------------------------------------- -------- -------- --------
In force at beginning of period1 $769,471 $423,814 $447,470
Acquired business of Integrity -- 355,077 --
New business issued during period:
Individual 51,477 31,166 8,426
Group 6,787 14,091 15,040
- -------------------------------------------- -------- -------- --------
Total $ 58,264 $ 45,257 $ 23,466
- -------------------------------------------- -------- -------- --------
Terminations during period $115,154 $ 54,677 $ 47,122
Termination rate2 14.97% 10.03% 10.53%
In force at end of period1:
Individual 515,163 555,377 196,369
Group 197,418 214,094 227,445
- -------------------------------------------- -------- -------- --------
Total $712,581 $769,471 $423,814
- -------------------------------------------- -------- -------- --------
Net reinsurance ceded at end of period $129,287 $131,516 $151,209
1Before deduction of reinsurance ceded.
2Represents the percentage of individual policies terminated during the
indicated period by lapse, surrender, conversion, maturity, or otherwise. For
1995, terminations by Integrity policyholders have been annualized to compute
amounts.
Substantially all annuity considerations are attributable to sales of flexible
premium deferred annuities, life policy annuity riders, and single premium
deferred annuities. Generally, a flexible premium deferred annuity or a life
policy annuity rider permits premium payments in such amounts as the
policyholder deems appropriate, while a single premium deferred annuity requires
a one-time lump sum payment.
Accident and Health Insurance. Citizens Security markets individual accident and
health insurance products providing coverage for monthly income during periods
of hospitalization, scheduled reimbursement for specific hospital and surgical
expenses and cancer treatments, and lump sum payments for accidental death or
dismemberment. Citizens Security also markets group health plans providing
coverage for short and long-term disability, income protection, and dental
procedures. The dental products are indemnity policies sold on a pure group and
voluntary group basis. Voluntary dental groups must meet prescribed
participation limits. All dental products have annual limits on all covered
procedures and lifetime limits on orthodontia procedures. In addition,
orthodontia and major restorative procedures are not covered for the first six
months to one year, depending upon the plan, unless a no-loss-no-gain provision
is attached to the policy. Group dental policy premiums have grown substantially
in recent years, making it Citizens Security's largest product based upon
premiums (in 1996, 39% of total premiums and 82% of accident and health
insurance segment premiums).
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Marketing. Citizens Security is currently licensed to sell products in the
District of Columbia and in 18 states as follows:
Alabama Kentucky Ohio
Arkansas Louisiana Pennsylvania
Delaware Maryland South Carolina
Florida Mississippi Tennessee
Georgia Missouri Virginia
Indiana North Carolina West Virginia
Integrity was licensed to sell products in New Jersey and Delaware until its
merger into Citizens Security. Citizens Security was not licensed in those
states at the time of the merger. Its license application for Delaware (which
accounted for about four percent (4%) of Integrity's life insurance premium
income for 1995) was approved in January, 1997 and it has resumed marketing
operations there. Its license application for New Jersey (which accounted for
about 14% of Integrity's life insurance premium income for 1995) has not yet
been approved. It has contracted for reinsurance of new business written by its
agents in New Jersey. The Company may need to make other marketing arrangements
in order to maintain its sales force in New Jersey until its license application
is approved or if it should be denied.
Citizens Security markets its portfolio of products through the personal
producing general agent distribution system. It presently has approximately
1,520 sales representatives, all of whom are independent agents and all or
substantially all of whom also represent other insurers. Approximately 320 of
these agents are former agents of Integrity who specialize in the home service
market. That market consists primarily of low-income families and individuals
who desire whole life policies with policy limits typically below $10,000.
Agents usually collect premiums directly at weekly or monthly intervals. The
home service market has higher than average policy lapse rates.
Citizens Security furnishes rate material, brochures, applications, and other
pertinent sales material, including software, at no expense to the agents. The
agents are responsible for complying with state licensing laws and any related
appointment fees. Agents are compensated by commissions. Citizens Security has
agent commission arrangements that are generally intended to provide competitive
incentives for agents to increase their production of new insurance and to
promote continued renewals of in-force insurance. Historically, these incentives
have frequently involved awards, overrides, and compensation scales that
escalate according to achievement levels for newly-issued business and that
provide additional payments for renewal business.
Underwriting. Citizens Security follows underwriting procedures designed to
assess and quantify insurance risks before issuing life and health insurance
policies to individuals and members of groups. Such procedures require medical
examinations (including blood tests, where permitted) of applicants for certain
policies of health insurance and for policies of life insurance in excess of
certain policy limits. These requirements are graduated according to the
applicant's age and vary by policy type. Citizens Security also relies upon
medical records and upon each applicant's written application for insurance,
which is generally prepared under the supervision of a trained agent. In issuing
health insurance, information from the application and, in some cases,
inspection reports, physician statements, or medical examinations are used to
determine whether a policy should be issued as applied for, issued with reduced
coverage under a health rider, or rejected.
Acquired Immunodeficiency Syndrome ("AIDS") claims identified to date, as a
percentage of total claims, have not been significant for the Insurance
Subsidiaries. Evaluating the impact of future AIDS claims under health and life
insurance policies issued is extremely difficult, in part due to the
insufficiency and conflicting data regarding the number of persons now infected
with the AIDS virus and uncertainty as to the speed at which the AIDS virus has
and may spread through the general population. Citizens Security has
implemented, where legally permitted, underwriting procedures designed to assist
in the detection of the AIDS virus in applicants.
Investments. The Company derives a substantial portion of its income from
investments. Citizens Security maintains a diversified investment portfolio that
is held primarily to fund future policyholder obligations. State insurance laws
impose certain restrictions on the nature and extent of investments by insurance
companies and, in some states, require divestiture of assets contravening these
restrictions. Within the framework of such laws, Citizens Security follows a
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general strategy to maximize total return (current income plus appreciation)
without subjecting itself to undue risk. Where deemed appropriate, Citizens
Security will hold selected non-investment grade bonds that provide higher
yields or are convertible to common stock. The Company considers a bond
non-investment grade if it is unrated or rated less than BBB by Standard &
Poor's Rating Group ("S&P") or BAA by Moody's Investors Service ("Moody's").
Citizens Security's non-investment grade bonds, based on reported fair values,
represented 4.9% of its cash and invested assets as of December 31, 1996.
Citizens Security follows the practice of maintaining substantial investments in
equity securities in order to achieve higher investment earnings than can
usually be achieved through portfolio bonds but at a greater comparative risk.
Mortgage loans, federally-insured mortgage-backed securities, collateralized
mortgage obligations and real estate investments, apart from the investment in
the office building described in Item 2. "Properties," represented approximately
18.2% of cash and invested assets as of December 31, 1996. Citizens Security
owned no collateralized mortgage-backed securities as of December 31, 1996 that
were classified as high risk for purposes of accounting classification.
The Company also maintains an investment portfolio of equity securities separate
from that of Citizens Security. A portion of the portfolio is financed by a
collateral loan from Citizens Security under terms that limit the Company's
investment discretion, primarily by requiring that the Company's investments,
when aggregated with those of Citizens Security, shall not exceed any
categorical or issuer-diversification limitations imposed upon investments by
the Kentucky Insurance Code.
For additional information concerning investment results, see Item 6.
"Selected Financial Data" and Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Reinsurance. In keeping with industry practice, Citizens Security
reinsures, with unaffiliated insurance companies, portions of the life and
health insurance risks which it underwrites. Citizens Security retains no more
than $40,000 of individual life insurance risk and $15,000 of group life
insurance risk for any single life. Individual and group accidental death
coverage is 100% reinsured. At December 31, 1996, approximately $129,287,000 or
18% of life insurance in force was reinsured under arrangements described in
Note 11 to the Consolidated Financial Statements. Under most such reinsurance
arrangements, new insurance is reinsured automatically rather than on a basis
that would require the reinsurer's prior approval. Generally, Citizens Security
enters into indemnity reinsurance arrangements to assist in diversifying its
risks and to limit its maximum loss on large or unusually hazardous risks.
Indemnity reinsurance does not discharge the ceding insurer's liability to meet
policy claims on the reinsured business. Accordingly, Citizens Security remains
responsible for policy claims on the reinsured business to the extent a
reinsurer should fail to pay such claims.
Competition. The insurance industry is highly competitive, with over 1,800
life and health insurance companies in the United States. Many insurers and
insurance holding company systems have substantially greater capital and
surplus, larger and more diversified portfolios of life and health insurance
policies, and larger agency sales operations than those of Citizens Security.
Financial and claims paying ratings assigned to insurers by A.M. Best Company
("Best's") and by nationally-recognized statistical rating organizations have
become more important to policyholders. Citizens Security's rating was last
changed by Best's in May, 1996, when it was moved from C++ (Fair) in financial
size Class IV to B- (Good) in the same size Class. According to Best's, a B-
rating is assigned to companies that, in its opinion, have achieved good overall
performance when compared to the standards established by Best's. Also according
to Best's, B- companies generally have an adequate ability to meet their
policyholder and other contractual obligations, but their financial strength may
be susceptible to unfavorable changes in underwriting or economic conditions.
There are seven Best's rating categories above the B- category from B to A++.
Citizens Security will continue to pursue upward revisions in its Best's rating.
S&P assigns claims-paying ability ratings to certain U.S. insurers. Generally,
such a rating is S&P's opinion of an insurer's financial capacity to meet the
obligations of its insurance policies in accordance with their terms. In the
case of companies like Citizens Security that have not requested ratings, S&P's
methodology uses statistical tests based on statutory financial data as filed
with the National Association of Insurance Commissioners ("NAIC"). The rating
process does not involve contact between S&P analysts and the insurer's
management. Citizens Security's rating was last changed to BBBq effective May,
1996, up from BBq. (The "q" subscript indicates the quantitative method of
rating.)
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According to S&P, BBB companies have adequate financial security but their
capacity to meet policyholder obligations is susceptible to adverse economic and
underwriting conditions. The BBB rating is the lowest of four ratings in the
higher or "secure" range of ratings. The Company was not informed of particular
reasons for the latest change in its rating. A rating is not a recommendation to
buy, sell or hold securities and is subject to revision or withdrawal by the
assigning rating organization. Each rating should be evaluated independently of
any other rating.
Citizens Security competes primarily on the basis of the experience, size,
accessibility and claims response of its agency representatives, product design,
service and pricing. The Company believes that Citizens Security is generally
competitive in the markets in which it is engaged based upon premium rates and
services, has good relationships with its agents, and has an adequate variety of
insurance and annuity products approved for issuance.
State Insurance Regulation. Citizens Security, in common with other insurers, is
subject to comprehensive regulation in the states in which it is authorized to
conduct business. The laws of such states establish supervisory agencies with
broad administrative powers, among other things, to grant and revoke licenses
for transacting business, to regulate the form and content of policies, reserve
requirements, and the type and amount of investments, and to review premium
rates for fairness and adequacy. Citizens Security files detailed annual
convention statements with all states in which it is licensed to transact
business. The Kentucky Department of Insurance also periodically examines the
businesses and accounts of Citizens Security.
Citizens Security also can be required, under the solvency or guaranty laws of
most states in which it does business, to pay assessments (up to prescribed
limits) to fund policyholder losses or liabilities of other insurance companies
that become insolvent. These assessments may be deferred or foregone under most
guaranty laws if they would threaten an insurer's financial strength and, in
certain instances, may be offset against future premium or intangible property
taxes. Gross assessments for Citizens Security, before offsets for future
premium or intangible property taxes were $20,308, $65,182 and $51,706 in 1996,
1995 and 1994, respectively. The amount of any future assessments under these
laws cannot be reasonably estimated.
Kentucky, in common with substantially all states, regulates transactions
between or affecting insurance holding companies and their insurance company
subsidiaries, including the Company and Citizens Security. Generally, under
Kentucky insurance holding company statutes, the Kentucky Department of
Insurance must approve in advance the direct or indirect acquisition of 15% or
more of the voting securities of an insurance company organized under the laws
of Kentucky. Such statutes also regulate certain transactions among affiliates,
including the payment of dividends by an insurance company to its holding
company parent. Under the Kentucky statutes, Citizens Security may not during
any year pay dividends on its common and preferred stock to the Company in
excess of the lesser of the net gain from operations for the preceding year or
10% of Citizens Security's surplus as regards policyholders at the end of the
preceding year, without the consent of the Kentucky Commissioner of Insurance.
For 1997, the maximum amount of dividends that could be paid without the
Commissioner's approval is $871,000. It is presently anticipated that the
Company will derive substantially all of its liquidity from income and capital
gains earned on its investment portfolio, management service fees and dividends
paid by Citizens Security, and Citizens Security's repurchase its preferred
stock owed by the Company.
During the past few years, the National Association of Insurance
Commissioners (NAIC) has taken several steps to address public concerns
regarding insurer solvency. These steps included implementing a state
certification program designed to promote uniformity among the insurance laws of
the various states and, developing insurer reporting requirements that focus on
asset quality, capital adequacy, profitability, asset/liability matching, and
liquidity. These requirements include establishment of asset valuation reserves
("AVR") and interest maintenance reserves ("IMR"); risk-based capital ("RBC")
rules to assess the capital adequacy of an insurer; and a revision to the
Standard Valuation Law ("SVL")that specifies minimum reserve levels and requires
cash flow testing in which cash inflows from assets are compared to cash
outflows for liabilities to determine adequacy.
Citizens Security's AVR, as of December 31, 1996, 1995 and 1994, is shown in
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations," where cash flow testing and the results of such testing as
applied to Citizens Security are also described and discussed.
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RBC provides a means of establishing the capital standards for insurance
companies to support their overall business operations in light of their size
and risk profile. The four categories of major risk involved in the formula are
[i] asset risk -- the risk with respect to the insurer's assets; [ii] insurance
risk -- the risk of adverse insurance experience with respect to the insurer's
liabilities and obligations; [iii] interest rate risk -- the interest risk with
respect to the insurer's business; and [iv] business risk -- all other business
risks. A company's RBC is calculated by applying factors to various asset,
premium and reserve items, with higher factors for those items with greater
underlying risk and lower for less risky items. RBC standards are used by
regulators to set in motion appropriate regulatory actions relating to insurers
that show signs of weak or deteriorating conditions. They also provide an
additional standard for minimum capital, below which companies would be placed
in conservatorship. Based on Citizens Security's RBC computation as of December
31, 1996, its adjusted capital exceeds the point at which any regulatory
inquiries would normally begin by 240%.
Action taken by the NAIC in these and other areas may have a significant impact
on the regulation of insurance companies during the next several years. Given
its comparatively small size, it may be expected that Citizens Security would be
affected by more stringent regulatory policy, both under existing laws and any
new regulatory initiatives. Such effects could include curtailment or
discontinuance of insurance underwriting in one or more states, mandated
increases in capital and surplus, and/or other effects.
Federal Income Taxation. Citizens Security is taxed under the life
insurance company provisions of the Internal Revenue Code of 1986, as amended
(the "Code"). Under the Code, a life insurance company's taxable income
incorporates all income, including life and health premiums, investment income,
and certain decreases in reserves. The Code currently establishes a maximum
corporate tax rate of 35% and imposes a corporate alternative minimum tax rate
of 20%. See Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Note 8 of the Notes to Consolidated Financial
Statements.
Amendments to the Code adopted in 1990 require capitalization and amortization
over a five to ten year period of certain policy acquisition costs incurred in
connection with the sale of certain insurance products. Prior tax laws permitted
these costs to be deducted as incurred. These provisions apply to life, health,
and annuity business. Certain proposals to make additional changes in the
federal income tax laws, including increasing marginal tax rates, and
regulations affecting insurance companies or insurance products, continue to be
considered at various times in the United States Congress and by the Internal
Revenue Service. The Company currently cannot predict whether any additional
changes will be adopted in the foreseeable future or, if adopted, whether such
measures will have a material effect on its operations.
Reserves. In accordance with applicable insurance laws, Citizens Security has
established and carries as liabilities actuarial reserves to meet its policy
obligations. Life insurance reserves, when added to interest thereon at certain
assumed rates and premiums to be received on outstanding policies, are required
to be sufficient to meet policy obligations. The actuarial factors used in
determining reserves in the statutory basis financial statements are based upon
statutorily-prescribed mortality and interest rates. Reserves maintained for
health insurance include the unearned premiums under each policy, reserves for
claims that have been reported but not yet paid, and reserves for claims that
have been incurred but have not been reported. Furthermore, for all health
policies under which renewability is guaranteed, additional reserves are
maintained in recognition of the actuarially-calculated probability that the
frequency and amount of claims will increase as policies persist. Citizens
Security does not continue accumulating reserves on reinsured business after it
is ceded. Citizens Security is required to maintain reserves on reinsured
business assumed on a basis essentially comparable to direct insurance reserves.
Reinsurance business assumed is presently insignificant in amount.
The reserves carried in the financial statements included elsewhere in this
Form 10-K are calculated on the basis of generally accepted accounting
principles and differ from the reserves specified by the laws of the various
statutes and carried in the financial statements of Citizens Security prepared
on the basis of statutory accounting principles. These differences arise from
the use of different mortality and morbidity tables and interest assumptions,
the introduction of lapse assumptions into the reserve calculation, and the use
of the level premium reserve method on all insurance business. See Note 1 of the
Notes to Consolidated Financial Statements for certain additional information
regarding reserve assumptions under generally accepted accounting principles.
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Employees. The total number of persons employed by the Company and its
subsidiaries on March 14, 1997, exclusive of agents, was 58 of whom 57 were full
time. As of that date, the Company had approximately 1,520 independent agents
licensed to sell its products.
ITEM 2. PROPERTIES
The Company owns, through Citizens Security, a three-story, 63,000 square foot
office building in suburban Louisville, Kentucky completed in 1988. The Company
and Citizens Security occupy about 13,200 square feet in the building for their
headquarters and home offices. Another 49,600 square feet of the remaining space
are leased to unaffiliated tenants under leases of various duration.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company or its
subsidiaries or of which any of their property is the subject other than routine
litigation incidental to the business of the Company and its subsidiaries. There
are no material proceedings in which any director, officer, affiliate or
shareholder of the Company, or any of their associates, is a party adverse to
the Company or any of its subsidiaries or has a material interest adverse to the
Company or any of its subsidiaries.
ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by
this Report to a vote of the Company's security holders, through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of March 14, 1997, there were approximately 3,050 holders of record of the
Company's Class A Stock, its only class of common equity.
The Class A Stock is eligible for quotation on the National Association of
Securities Dealers, Inc.'s Nasdaq Small-Cap Market ("NASDAQ") under the trading
symbol CNFL. Trading activity has been limited.
10
<PAGE>
The following table summarizes quarterly high and low bid quotations for the
Class A Stock in 1996 and 1995 as reported by NASDAQ. Such quotations represent
prices between dealers and do not include retail markup, markdown, or
commission, and may not necessarily represent actual transactions.
Bid Quotations for Class A Stock
--------------------------------
Quarter Ended High Bid Low Bid
- ----------------------- ---------------- ---------------
December 31, 1996 $ 6 $ 4 3/4
September 30, 1996 $ 6 $ 5 1/4
June 30, 1996 $ 6 1/2 $ 5 1/4
March 31, 1996 $ 6 $ 5
December 31, 1995 $ 6 $ 4
September 30, 1995 $ 4 $ 3 3/4
June 30, 1995 $ 4 3/4 $ 4
March 31, 1995 $ 4 3/4 $ 4 3/4
The Company has not paid a dividend on the Class A Stock since its
organization in 1991, and no dividend had been paid by its predecessor, Citizens
Security, from 1988 through the date it became a subsidiary of the Company. The
Board of Directors of the Company has not adopted a dividend payment policy;
however, dividends must necessarily depend upon the Company's earnings and
financial condition, applicable legal restrictions, and other factors relevant
at the time the Board of Directors considers a dividend policy. The Company is
subject to a loan agreement covenant that prevents it from paying dividends on
the Class A Stock without the consent of the lender except to the extent it can
meet certain requirements relating to the ratio of its income before interest
and tax expense plus dividends, to its interest expense and dividend payments
for five (5) consecutive quarters and provided that there is no default or
potential default under the loan agreement. As of January, 1997, the Company
could pay dividends in the maximum amount of approximately $200,000 without
violating the loan agreement covenant. Cash available for dividend distributions
to shareholders of the Company must initially come from income and capital gains
earned on its investment portfolio, management service fees and dividends paid
by Citizens Security, and Citizens Security preferred stock repurchase proceeds.
Provisions of the Kentucky Insurance Code relating to insurance holding
companies subject transactions between the Company and Citizens Security,
including dividends paid to the Company, to certain standards generally intended
to prevent such transactions from adversely affecting the adequacy of Citizens
Security's surplus as regards policyholders. See Item 1. "Business -- State
Insurance Regulation." In addition, under the Kentucky Business Corporation Act,
the Company may not pay dividends if, after giving effect to a dividend, it
would not be able to pay its debts as they become due in the usual course of
business or if its total liabilities would exceed its total assets.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial
information for the Company as of December 31, 1996, 1995, 1994, 1993 and 1992
and the years then ended. Such information should be read in conjunction with
the Consolidated Financial Statements of the Company and its subsidiaries, and
the related Notes. Factors affecting the comparability of certain indicated
periods are discussed in Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA (Continued)
<TABLE>
<CAPTION>
Year Ended December 31, 1996 1995 1994 1993 1992
RESULTS OF OPERATIONS
<S> <C> <C> <C> <C> <C>
Premiums and other considerations, net $ 17,947,623 $ 12,071,969 $ 7,961,578 $ 7,898,000 $ 7,626,480
Investment and other income, net 4,187,500 2,680,494 2,025,266 1,785,065 1,951,154
Realized investment gains (losses), net 966,937 1,534,114 (398,890) 2,073,918 1,212,643
Policy benefits, interest, reserve changes 12,707,700 8,338,145 5,885,300 5,826,352 5,383,805
Commission, expense, amortization, net 8,222,534 6,736,307 4,030,181 3,976,370 4,225,775
Interest expense 836,200 470,894 345,287 354,368 360,183
NET INCOME (LOSS) $ 1,109,323 $ 732,231 $ (445,669) 1,369,160 724,514
NET INCOME (LOSS) APPLICABLE
TO COMMON STOCK $ 707,109 $ 732,231 $ (445,669) 1,369,160 724,514
NET INCOME (LOSS) PER SHARE:
Primary $ 0.66 $ 0.67 $ (0.41) $ 1.26 $ 0.67
Fully Diluted $ 0.62 $ 0.67 $ (0.41) $ 1.26 $ 0.67
FINANCIAL POSITION AT END OF PERIOD
Total assets $ 80,262,708 $ 84,255,261 $ 44,539,862 $ 46,922,952 $ 45,324,204
Notes payable $ 4,095,869 9,306,982 4,273,136 4,340,853 4,402,471
Redeemable convertible preferred $ 4,043,907 1,700,907 -- -- --
Shareholders' equity1 $ 10,573,455 $ 11,309,218 $ 8,547,535 9,919,881 8,639,632
Shareholders' equity per share1 $ 9.83 $ 0.51 $ 7.95 $ 9.17 7.97
Shareholders' equity realized2 $ 10,697,171 $ 10,337,976 $ 8,776,480 $ 9,813,102 8,560,555
Shareholders' equity realized per share $ 9.95 $ 9.61 $ 8.16 $ 9.07 7.90
INVESTMENTS
Average cash and invested assets $ 70,958,058 $ 42,844,237 $ 38,301,700 $ 38,693,100 $ 37,696,814
Investment income yield 5.9% 6.1% 5.3% 4.6% 5.2%
Change in unrealized investment gains
(losses), net of tax1 $ (1,442,872) 2,029,452 $ (882,666) $ (80,461) $ 474,722
LIFE INSURANCE DATA
Premiums $ 9,490,351 $ 5,726,770 $ 2,596,469 $ 2,762,793 2,833,241
Insurance in force, net, at end of period $583,294,000 $637,955,000 $272,605,000 $289,971,000 $322,640,000
ACCIDENT AND HEALTH INSURANCE DATA
Premiums $ 8,457,272 $ 6,345,199 $ 5,365,109 $ 5,136,107 4,793,239
Claims ratio 68.7% 63.4% 62.2% 60.5% 60.6%
Expense ratio 30.0% 35.3% 40.3% 40.1% 43.8%
</TABLE>
1 Effective January 1, 1994, the Company adopted SFAS 115, "Accounting for
Certain Investments in Debt and Equity Securities."
2 Excludes from total shareholders' equity the net unrealized gain (loss) on
debt securities and redeemable preferred stocks, net of deferred
acquisition costs and deferred income taxes.
12
<PAGE>
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company makes forward-looking statements from time to time and desires to
take advantage of the "safe harbor" which is afforded such statements under the
Private securities Litigation Reform Act of 1995 when they are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those in the forward-looking
statements.
The statements contained in the following "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and statements contained in
future filings with the Securities and Exchange Commission and publicly
disseminated press releases, and statements which may be made from time to time
in the future by management of the Company in presentations to shareholders,
prospective investors, and others interested in the business and financial
affairs of the Company, which are not historical facts, are forward-looking
statements that involve risks and uncertainties that could cause actual results
to differ materially from those set forth in the forward-looking statements. Any
projections of financial performance or statements concerning expectations as to
future developments should not be construed in any manner as a guarantee such
results or developments will, in fact, occur. There can be no assurance any
forward-looking statement will be realized or actual results will not be
significantly different from that set forth in such forward-looking statement.
In addition to the risks and uncertainties of ordinary business operations, the
forward- looking statements of the Company referred to above are also subject to
risks and uncertainties.
The Company operates in a highly competitive business environment, and its
operations could be negatively affected by matters discussed under the caption,
"Competition," on page 7 of this Form 10-K.
Acquisition
During 1996, the Company successfully completed the full integration of
Integrity National Life Insurance Company (Integrity). In September, 1995, the
Company and Citizens Security Life Insurance Company (Citizens Security)
acquired 98.85% of the common stock of Integrity (the "Acquisition") from
Southwestern Life Corporation, which has since been renamed ICH Corporation
("ICH"). The Acquisition was accounted for as a purchase and the results of
Integrity's operations have been included in the consolidated financial
statements of the Company since the date of acquisition. Citizens Security
acquired the remaining 1.15% of Integrity's common stock in conjunction with the
merger of Integrity into Citizens Security as of December 31, 1995.
The aggregate purchase price for the Acquisition, as finally adjusted, was
$9,419,000 (including $437,000 of net transaction costs associated with the
purchase and, the purchase of minority shareholders' stock as part of the merger
discussed above).
Prior to the closing, Integrity entered into a coinsurance and assumption
reinsurance agreement with Union Bankers Insurance Company ("Union Bankers"),
another affiliate of ICH, covering Integrity's 14,500 individual long-term care
and Medicare Supplement insurance policies with annualized premiums of
approximately $14,800,000, leaving the remaining life and accident and health
insurance business with Integrity. In conjunction with this reinsurance
transaction, Integrity transferred approximately $9,200,000 of reserves to Union
Bankers. Completion of these transactions was a condition to the Company's
obligations in the Acquisition because the reinsured business did not fit into
the Company's business plans. Union Bankers directly assumed the liability for
these policies.
The Acquisition was financed with working capital of Citizens Security and
approximately $6,100,000 of the $6,400,000 proceeds under a Term Loan Agreement
with a commercial bank (the "Term Loan Agreement"). Borrowings under the Term
Loan Agreement are evidenced by a $4,400,000 note that matures on October 1,
2002 (the "2002 Note") and a $2,000,000 note that matures on October 1, 2003
(the "2003 Note"). See Note 6 to the Consolidated Financial Statements.
In order to obtain required approvals from insurance regulatory authorities of
Pennsylvania, the Company issued $1,727,000 of preferred stock in December 1995
and applied $1,500,000 of the proceeds to prepay the first installment
13
<PAGE>
of the 2002 Note. In addition, in January 1996, the Company sold an additional
$2,343,000 of preferred stock. See Notes 7 and 15 to the Consolidated Financial
Statements. Giving effect to payments and prepayments during 1996, the principal
balances of the 2002 Note and the 2003 Note were $2,125,000 and $1,750,000,
respectively, as of December 31, 1996.
Financial Position
Assets. At December 31, 1996, the Company's available-for-sale fixed maturities
had a fair value of $47,041,000 and amortized cost of $47,239,000. The
available-for-sale portfolio consists of fixed maturities and equity securities
that the Company, given the proper market condition, would sell prior to
maturity. This portfolio is reported at fair value with unrealized gains and
losses, net of applicable deferred taxes and adjustments to deferred policy
acquisition costs, reflected as a separate component in shareholders' equity.
Effective December 31, 1995, the Company transferred all of its
"held-to-maturity" fixed maturities to the "available-for-sale" fixed maturities
portfolio. The Company's fixed maturities portfolio increased approximately 4%
and 225% in 1996 and 1995 respectively, on an amortized cost basis.
Substantially all the 1995 increase was due to the Acquisition. Shown below is a
distribution by rating category of the Company's fixed maturities portfolio as
of December 31, 1996.
Standard & Poor's Corporation Rating Amortized Cost 1 Fair Value 2
- ------------------------------------ ------------------ ------------
Investment grade:
AAA to A- $40,537,341 $40,288,318
BBB+ to BBB- 3,436,686 3,548,048
- ------------------------------------ ------------------ -----------
Total investment grade 43,974,027 43,836,366
Non-investment grade:
BB+ to BB- 986,718 977,750
B+ to B- 2,186,082 2,130,975
CCC+ to C --- ---
CI to not rated 91,732 95,500
- ------------------------------------ ------------------ -----------
Total non-investment grade 3,264,532 3,204,225
- ------------------------------------ ------------------ -----------
Total fixed maturities $47,238,559 $47,040,591
- ------------------------------------ ------------------ -----------
1 Net of write-downs on bonds whose decline in value is believed to
be other-than-temporary
2 Fair values as of December 31, 1996 were obtained from the
Company's investment advisor's portfolio review, which used market
prices from Shaw Data Services.
The Company believes it has a well diversified portfolio and has no definitive
plans to decrease its non-investment grade portfolio significantly below its
current level, unless necessary to satisfy requirements of state regulators or
rating agencies. The Company purchases non-investment grade bonds to obtain
higher yields or convertible features and attempts to reduce credit risk by
portfolio diversification. However, publicized failures of significant insurers,
attributed partially or principally to non-investment grade bonds, led the
Company to decrease such bond holdings in most years since 1990.
14
<PAGE>
Shown below are the Company's four largest holdings in non-investment grade
bonds by a single issuer as of December 31, 1996.
Non-Investment Grade
December 31, 1996 Carrying Value Fair Value
- --------------------------- -------------- ----------
Largest $ 750,566 $ 690,000
Second largest 621,272 532,500
Third largest 500,000 500,000
Fourth largest 500,000 494,375
- --------------------------- -------------- ----------
Total $2,371,838 $2,216,875
- --------------------------- -------------- ----------
The Company had no guarantee or other type of investment associated with the
issuers represented above.
The Company's investment in equity securities increased $2,822,000 and
$2,221,000 during 1996 on a cost (net of write-downs) and fair value basis,
respectively, after decreasing $1,881,000 and $530,000 on the same basis in
1995. As of December 31, 1996, there were $878,000 of net unrealized gains in
equity securities, as compared with $1,480,000 and $128,000 at December 31, 1995
and December 31, 1994, respectively. One security represented $481,000 of such
gains at December 31, 1996.
The Company reviews its marketable investments each quarter to determine if
there have been declines in their value that in management's opinion are
other-than-temporary. These reviews resulted in the recognition of impairment
losses on equity securities totaling $900,000 during 1996 ($215,000, $309,000
and $376,000 for the second, third and fourth quarters, respectively). In
addition, equity securities were sold during 1996, which contained impairment
writedowns of $859,000.
As more extensively discussed under Consolidated Results and Analysis, below,
the Company realized significant net capital gains from its marketable
investments over the three-year period ended December 31, 1996. Management
believes these net gains (losses) which total $2,102,000, [$967,000, $1,534,000,
and $(399,00) for 1996, 1995 and 1994, respectively], are greater than would
have been obtained from a more conservative investment strategy involving only
investment grade bonds. The Company's strategy has in some years subjected it to
fluctuations in income and shareholders' equity of a magnitude significantly
larger than would be anticipated under a more conservative investment strategy.
Net capital gains or losses for a given period are not necessarily indicative of
those for future periods.
Citizens Security owns the building in which the Company and Citizens Security
maintain their home offices. Approximately 79% of the building is leased to
third-party tenants. An appraisal obtained during 1996 indicates that the
current market value of the property is approximately $1,600,000 higher than its
carrying value.
The Company maintained relatively high balances in cash and short-term
securities over the past several years through 1995, principally due to the
uncertainty as to future interest rates and anticipation of potential surrenders
and withdrawals. The $9,777,000 balance in cash and short-term securities at
December 31, 1995 was invested in longer term securities during 1996, including
a net increase in equity securities of $2,822,000 (on a cost basis) and
$4,124,000 was used to prepay a mortgage loan.
At December 31, 1996, the Company holds a $156,000 mortgage loan from a real
estate limited partnership in which the Company also has a 20% equity interest.
The mortgage loan, maturing March 31, 1998, permits revolving credit advances,
not to exceed at any time, the lesser of $750,000 or 80% of the collateral fair
value. Stockholders of the partnership's general partner personally guarantee
80% of the loan.
15
<PAGE>
Liabilities. Shown below is a progression of the Company's policyholder
deposit activity for the year ended December 31, 1996.
Year Ended December 31, 1996 Total Annuity Universal Life Other
- ---------------------------- ------------- ----------- ------------ -----------
Beginning Balance $15,925,201 $9,457,887 $5,274,027 $1,193,287
Deposits 818,849 278,675 497,962 42,212
Withdrawals (1,730,273) (807,501) (802,139) (120,633)
Interest credited 916,494 561,024 306,773 48,697
- --------------------------- ------------- ----------- ----------- -----------
Ending Balance $15,930,271 $9,490,085 $5,276,623 $1,163,563
- --------------------------- ------------- ----------- ----------- -----------
Annuity balances increased $32,000 in 1996 after decreasing by $280,000 in 1995.
This improvement resulted primarily from an approximate $400,000 decrease in
surrenders compared to the prior year. The essentially unchanged Universal Life
balance during 1996 compares to a $40,000 decrease during 1995.
A comparison as of December 31, 1996, 1995 and 1994 of contract reserves for
future policy benefits is shown below.
Year Ended December 31, 1996 1995 1994
- ---------------------------- -------------- ------------- --------------
Ordinary Life $39,566,891 $39,515,527 $12,419,309
Accident and Health 1,934,980 1,913,638 1,432,125
- ---------------------------- -------------- ------------- --------------
Total $41,501,871 $41,429,165 $13,851,434
- ---------------------------- -------------- ------------- --------------
The December 31, 1996 ordinary life reserves are net of a $780,000 reduction
associated with refinement of purchase GAAP accounting. Substantially all of the
ordinary life reserve increase in 1995 as compared with 1994 was due to the
Acquisition. The December 31, 1996 accident and health reserves include a
$45,000 increase which is also associated with refinement of purchase GAAP
accounting. The Acquisition also increased accident and health reserves by
$366,000 in 1995.
Consolidated Results and Analysis
Premiums and Other Considerations. The following table presents premiums and
other considerations received during the past three fiscal years.
Year Ended December 31, 1996 1995 1994
- ------------------------- ------------ -------------- ---------------
Traditional life $ 8,256,967 $ 4,420,143 $1,210,920
Universal life 571,831 518,710 515,208
Group life 636,689 758,578 837,844
Annuity 24,864 29,339 32,497
- ------------------------- ------------ -------------- ---------------
Total life and annuity 9,490,351 5,726,770 2,596,469
Accident and health 8,457,272 6,345,199 5,365,109
- ------------------------- ------------ -------------- ---------------
Total accident and health $17,947,623 $12,071,969 $7,961,578
- -------------------- -------------- -------------- ---------------
The Company's net life and annuity premium increased $3,764,000 in 1996,
essentially all of which was attributable to the Integrity acquisition. Although
the Company's other traditional life and graded death benefit gross premiums
have increased; this sales growth, net of reinsurance, is significantly offset
by lapses of older policies with minimal reinsurance. The $3,130,000 increase in
life and annuity premium during 1995 includes $2,996,000 from the Integrity
acquisition, while substantially all of the remaining increase resulted from
sales of the Company's traditional life graded death benefit product.
16
<PAGE>
Although 1996 life and annuity sales increased substantially, the acquired
Integrity annualized premium inforce declined approximately eight percent during
the year. This was primarily due to loss of Integrity's licenses in New Jersey
and Delaware at the Merger date and some disruption of sales momentum during the
merger process. Citizens Security obtained a license to transact business in
Delaware in January, 1997, and a license application is pending in New Jersey.
The Company has also devoted significant attention towards building a solid
relationship with the Integrity agency force, including: hiring a new Senior
Vice President of Agency who has significant experience in the home service
market, developing additional home service products, and ongoing personal visits
with agents in the field and in the home office. Additionally, the Company has
developed several sales initiative programs which management believes will
result in attainment of pre-acquisition production levels within the next year.
The Company experienced a substantial increase (35%) in the sale of its graded
death benefit product during 1996 compared to 1995. The graded death benefit
product, which is sold primarily through the broker market, returns premiums
paid, plus interest compounded at an annual rate of 10% if the insured dies of
natural causes during the first two years the policy is in force. After two
years, and during the first two years if the insured dies of an accidental
cause, the benefit payable is the face amount of the policy. Citizens Security
will be replacing this product during the second quarter of 1997 with a product
that returns premiums paid plus interest, if death occurs during the initial
three years of coverage. In addition, Citizens Security will supplement its
product line with a simplified issue product. Management believes the new graded
death benefit and simplified issue products are complementary, and will permit
significant additional penetration into the "final expense market." Although
management believes that modification of the graded death product may dampen
sales for the next twelve to eighteen months, the impact of any such decline
should be offset by decreased exposure to adverse mortality risk.
Accident and health premiums increased 33.3% during 1996. Approximately
three-quarters of this increase is attributable to a continued emphasis on
aggressively growing the group dental business. The remaining increase is
primarily attributable to the individual accident and health business acquired
from Integrity. During 1995, accident and health premiums increased 18.3%, which
was also due primarily to sales of group and voluntary dental products, offset
to an extent by declines in its individual accident and health products.
The Company's significant growth in dental premium has also increased its loss
ratio over the past two years. As discussed further below, during 1997 the
Company will concentrate its efforts on introducing new designs of its dental
products and other procedures to improve the product's loss ratio to pre-1995
levels. These efforts should significantly enhance product margins, however,
they will likely abate the rate of premium increase experienced during the past
two years.
Investments. The Company monitors its available-for-sale fixed maturities and
equity securities to assure they are strategically positioned within the current
interest rate environment. This practice has historically resulted in equity
securities comprising 10% to 20% of the Company's cash and invested assets,
which tends to dampen current income yields in favor of an overall total return
focus.
Shown below are the investment income and total return yields based on average
cash and invested assets for 1996, 1995 and 1994. The numerator for the total
return yield computation includes investment income and net realized gains and
losses.
Year Ended December 31, 1996 1995 1994
- --------------------- ------------ ----------- -----------
Investment Income Yield 5.9% 6.1% 5.3%
Total Return Yield 7.2% 9.7% 4.2%
The investment income yield decrease in 1996 compared to 1995 resulted primarily
from somewhat higher average cash, short-term, and equity security balances. The
investment income yield increase in 1995 over 1994 is principally attributable
to higher market interest rates, selected movement from lower yielding common
stocks to higher yielding preferred stocks, and the addition of Integrity's
portfolio, which had an annualized yield of 6.7%.
17
<PAGE>
Net realized gains (losses) on equity securities were $749,000, $1,158,000, and
$(129,000) for 1996, 1995, and 1994, respectively. Included in gross realized
losses during 1996, 1995 and 1994 are adjustments to the carrying value of
available-for-sale equity securities of $666,871, $561,135 and $838,610,
respectively, relating to declines in value which were considered by management
to be other than temporary. The equity portfolio had $878,000 of net unrealized
gains as of December 31, 1996 compared to net unrealized gains of $1,480,000 and
$128,000 at December 31, 1995 and 1994, respectively.
Segment Earnings. The $594,000 increase in income from operations before federal
income taxes between 1995 and 1996 resulted from a $567,000 decrease in net
realized capital gains and a $1,161,000 increase in pretax earnings before
realized capital gains. The $1,161,000 increase in 1996 pretax earnings before
capital gains resulted primarily from successful completion of the Integrity
acquisition and a decrease in variable investment management fees. The
$1,414,000 increase in income from operations before federal income taxes in
1995 over 1994 resulted from increased realized capital gains, offset in part by
increased expenses related to the integration of Integrity's operations and
investment management fees, which are paid based upon performance of the
portfolio.
Shown below is segment income (loss) before realized gains on investment
securities and federal income taxes for 1996, 1995, and 1994.
Year Ended December 31 1996 1995 1994
- ---------------------- ----------- ----------- ------------
Life and Annuity $120,956 $(1,036,184) $(402,480)
Accident and Health 247,733 243,301 128,556
- ---------------------- ----------- ----------- ------------
Total $368,689 $ (792,883) $(273,924)
- ---------------------- ----------- ----------- ------------
The $1,157,000 increase in the Life and Annuity segment's income in 1996 as
compared with 1995 was principally attributable to successfully completing the
integration of Integrity's operations in 1996 and certain nonrecurring costs in
1995, including $281,000 of Integrity assimilation costs and $246,000 of
variable investment performance management fees. The $634,000 increase in the
segment's loss between 1994 and 1995 was principally attributable to the
nonrecurring Integrity assimilation costs and variable investment management
fees noted above.
The slight increase in income contributed by the Accident and Health segment
between 1995 and 1996 was primarily attributable to the inclusion of Integrity's
individual health business and improvement in the loss ratios for the Company's
individual cancer products, substantially offset by a $200,000 decline in
margins and modestly increased expense volumes on group dental products. The
improved performance in 1995 over 1994 is attributable to improved loss ratios
in the Company's cancer products in 1995.
Shown below is a comparison of the contribution of each of the group accident
and health products toward profit and overhead (direct premium minus: claims,
change in reserves and commissions) and loss ratios for the years ended December
31, 1996, 1995 and 1994.
Contribution Margin Loss Ratio
------------------------------- --------------------------
Year Ended
December 31, 1996 1995 1994 1996 1995 1994
- ------------------ --------- ---------- ---------- -------- --------- -------
Dental $741,525 $939,857 $943,705 75.6 % 68.6% 64.7%
Short-term disability 73,500 $ 42,885 $ 59,072 9.3 % 52.4% 42.2%
Long-term disability 42,667 $ 18,903 $ 17,893 (30.1)% 18.9% 14.5%
The decline in Dental's contribution is the result of a 29% increase in premium
offset by a 7% increase in the loss ratio. The increase in premiums and the loss
ratio in 1996 are principally attributable to aggressive sales to groups
interested in replacing their previous dental carriers. In order to improve the
profitability of this newly acquired business, the Company is reconfiguring its
products to provide additional margins for certain more costly dental
procedures, engaging a company to provide expert assistance with the ongoing
adjudication of judgmental claims, and implementing a program of aggressive
renewal underwriting and rerating. The short- and long-term disability products
generated only
18
<PAGE>
$148,000 of net premium in 1996. Relatively minor changes in claim and
corresponding reserve levels can significantly impact their relative
contribution margins and loss ratios. Dental's relatively flat contribution in
1995 as compared with 1994 was the result of a 23.7% increase in premium offset
by a 3.9% increase in the loss ratio. The increases in premiums and the loss
ratio during 1995 were also principally attributable to the Company's strategy
of replacing coverage for groups which have previously obtained coverage from
other carriers.
Performance of the Company's individual accident and health line improved in
1996 over 1995 due to approximately $100,000 of additional margins from the
acquired Integrity business and $50,000 of additional margins from the cancer
product's performance. The cancer product's loss ratio has steadily improved
over the past three years (30.5%, 36.4%, and 51.7% in 1996, 1995, and 1994
respectively).
Federal Income Taxes. The Company has a relatively low effective federal income
tax rate, which can fluctuate significantly due to the application of Statement
of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes." The most significant provision under SFAS No. 109 affecting the Company
is the disallowance of the small life insurance company deduction when computing
deferred taxes. The small life insurance deduction allows Citizens Security to
reduce its taxable income by 60% before computing its current provision for
regular or alternative minimum tax. By disallowing this deduction in the
computation of deferred taxes, SFAS No. 109 significantly increases the deferred
taxes on Citizens Security's temporary differences. Thus, when a significant
increase or decrease occurs in the Company's net temporary differences, the
related deferred tax is computed using the 34% federal tax rate, whereas tax
will actually be paid on these net liabilities (when realized) at a 17% rate
(the alternative minimum tax rate after application of the allowable small life
insurance company deduction). The Company's gross deferred federal income tax
liabilities and assets are more fully discussed in Note 8 to the Consolidated
Financial Statements. All operating deferred tax assets of the Company are
realizable by offset against existing deferred tax liabilities. Capital deferred
tax assets of Citizens Security can be realized through the carry back of such
assets to recapture prior years' taxes paid on capital assets. Capital deferred
tax assets of the Company must be offset against future capital gains. The
Company believes such gains will materialize and the deferred tax assets will be
realized. The deferred tax assets are offset, to some extent, by valuation
allowances related to the Company and to Citizens Security. Due to the impact of
the small life insurance company deduction, Citizens Security records a
valuation allowance to reduce deferred tax assets (associated with temporary
differences) to their expected benefit rate of 17%, rather than 34%. The
Company's valuation allowance is designed to reduce deferred tax assets to their
estimated ultimate realization value.
Statutory Insurance Information. During 1996, A.M. Best Company upgraded
Citizens Security's rating from C++ to B-, based upon statutory financial and
statistical information through December 31, 1995. To provide a more detailed
understanding of Citizens Security's statutory operations, shown below are the
net income, net operating income, statutory capital and surplus, asset reserves,
and capital ratios for Citizens Security for the five years ended December 31,
1996.
19
<PAGE>
Net
Operating Statutory Asset
Year Ended Net Income Capital and Valuation Capital
December 31 Income (Loss) Surplus Reserves1 Ratio2
- --------------- --------- ----------- ----------- ----------- ---------
1996 $3,062,421 $871,089 $9,145,830 $1,426,918 16.05%
1995(3) $ 883,003 $494,588 $8,406,313 $1,087,020 14.63%
1994 $ 591,998 $296,809 $5,651,136 $ 768,664 18.46%
1993 $1,381,537 $126,887 $5,690,048 $1,648,343 20.08%
1992(4) $1,101,725 $319,802 $4,309,785 $2,322,379 19.06%
1 Asset valuation reserves are statutory liabilities that act as
contingency reserves in the event of extraordinary losses on invested
assets and as a buffer for policyholders' surplus to reduce the impact
of realized and unrealized investment losses.
2 Represents Statutory Capital and Surplus plus Asset Valuation Reserves
divided by invested assets plus cash.
3 Statutory Capital and Surplus and Asset Valuation Reserve amounts include
Integrity beginning in 1995, while Income amounts include Integrity
beginning in 1996.
4 Statutory net income of Old South was included in Citizens Security's
net income on the equity basis from the date of its acquisition in 1987
to the date of its merger, September 30, 1992.
The increase in statutory capital and surplus and asset reserves in 1996 from
1995 resulted primarily from approximately $3,000,000 of statutory net income,
partially offset by redemption of $1,000,000 of Citizens Security's preferred
capital stock and $900,000 of unrealized investment losses. The $3,000,000 of
statutory income includes an approximate $1,200,000 net gain from an investment
transaction between Citizens Security and an affiliate.
The merger of Integrity into Citizens Security resulted in $1,832,000 of the
increase in statutory capital and surplus in 1995 as compared with 1994. The
remaining $924,000 increase was the result of operating income and unrealized
investment gains offset, to an extent, by $945,000 of dividends paid to the
Company.
The decrease in statutory capital and surplus and asset reserves in 1994 as
compared with 1993 was due to unrealized losses in the equity portfolio offset
to an extent by increased operating income.
The increase in statutory capital and surplus and asset reserves in 1993 from
1992 resulted from income produced from operations and capital gains.
Statutory capital and surplus, specifically the component called surplus, is
used to fund the expansion of an insurance company's first year individual
life and accident and health sales. The first year commission and underwriting
expenses on such sales will normally consume a very high percentage of, if not
exceed, first year premiums. Accordingly, a statutory loss often occurs on these
sales during the first year of the policy. Citizens Security's first year sales
of these type of products have not been of a magnitude to have a significant
impact on statutory surplus.
Cash Flow and Liquidity
During 1996, the Company generated $1,272,000 of positive cash flow from
operations compared to $2,664,000 in 1995 and $327,000 in 1994. The decrease in
1996 resulted from a significant reduction in accrued expenses that were
outstanding at December 31, 1995 related to the Integrity acquisition, partially
offset by a $377,000 increase in net income. The increase in 1995 compared to
1994 resulted from a $1,178,000 increase in net income and the additional
Integrity acquisition accruals noted above.
During 1996, $2,343,000 of cash was generated from the sale of additional
redeemable convertible preferred stock. These additional funds were obtained to
provide flexibility for pursuing potential acquisition/growth opportunities. In
addition, to enhance net investment spreads, the Company elected to repay an
outstanding $4,202,000, 8% mortgage
20
<PAGE>
loan, the majority of which was due in 1998. Principal repayments totaling
$1,025,000 were also made on outstanding bank debt, including $200,000 of
scheduled payments and $825,000 of prepayments.
The NAIC promulgated Standard Valuation Law ("SVL") specifies minimum reserve
levels and prescribes methods for determining them, with the intent of enhancing
solvency. Some of the states in which Citizens Security is licensed have enacted
this law. The primary method required by the SVL for verifying reserve adequacy
is cash flow testing, in which projected cash inflows from assets are matched
with cash outflows for liabilities. Various future economic and yield curve
scenarios are assumed. This is a dynamic process, whereby the performance of the
assets and liabilities is directly related to the scenario assumptions. (An
example would involve the credited interest rate on annuity products and how
such rates vary depending upon projected earnings rates, which are based upon
asset performance under a particular economic scenario.)
In addition to the SVL, the Actuarial Standards Board of the American Academy of
Actuaries has produced a Standard of Practice that prescribes cash flow testing
as a basis for the actuarial opinion on the adequacy of the reserves required as
part of the annual statutory reporting process of insurance companies.
Citizens Security's most recent testing process, which was completed in March,
1997, involved a review of two basic measures. The first was the value of free
market surplus, which is defined as the difference between the projected market
value of assets and liabilities at the end of the analysis period (typically
10-20 years). Deficits could indicate the need for corrective action depending
upon the severity and the number of scenarios in which a deficit appeared. A
second measure involved distributable earnings. Negative earnings for extended
durations might impair the ability of Citizens Security to continue without
exhausting surplus. Again, depending upon severity and frequency, corrective
measures might be needed. Based on results of the testing completed in March of
1997, no corrective measures were indicated at the current time. However, such
testing is ongoing and dynamic in nature and future events in the interest and
equity markets or a significant change in the composition of Citizens Security's
business could negatively impact testing results and require the initiation of
corrective measures.
Any necessary corrective measures could take one or more forms. The duration of
existing assets might not match well with those of the liabilities. Certain
liabilities, such as those associated with indemnity accident and health,
short-term disability and group dental products, are short-term in nature and
are best matched with cash and short-term investments. By contrast, whole life
insurance, which involves lifetime obligations, is usually best matched by
longer duration maturities. In the event there are insufficient assets of these
types, a repositioning of the investment portfolio might be undertaken.
Initially balanced durations do not guarantee positive future results. Asset
type, quality, and yield will vary depending upon the economic scenario tested.
Liabilities will be similarly affected. Projected reinvestment yields may cause
overall yields to fall below those required to support projected liabilities. In
that event, portfolio realignment might involve the type, quality and yield of
investments rather than duration. Alternatively, additional reserve amounts
could be allocated to cover any future shortfalls.
The above discussion centers around asset management. Other possible corrective
measures might involve liability realignment. The Company's marketing plan could
be modified to emphasize certain product types and reduce others. New business
levels could be varied in order to find the optimum level.
21
<PAGE>
Management believes that the Company's current liquidity, current bond portfolio
maturity distribution and positive cash flow from operations give it substantial
resources to administer its existing business and fund growth generated by
direct sales. The Company will service debt, dividends, redemption of preferred
stock, and other expenses by:
- Management fees charged to Citizens Security.
- Dividends from Citizens Security, which are limited by law to the lesser
of prior year net operating income or 10% of prior year-end capital and
surplus unless specifically approved by the Kentucky Department of
Insurance.
- Redemption of Citizens Security preferred stock as necessary, with such
redemption also requiring approval by the Kentucky Department of
Insurance.
22
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
Financial Statements For Full Fiscal Years Page
Report of Independent Auditors.................................... 24
Consolidated Statements of Operations for the
years ended December 31, 1996, 1995 and 1994 .................... 25
Consolidated Statements of Financial Condition at
December 31, 1996 and 1995....................................... 26
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1996, 1995 and 1994............. 28
Consolidated Statements of Cash Flows for the
years ended December 31, 1996, 1995 and 1994..................... 29
Notes to Consolidated Financial Statements........................ 30
Financial Statement Schedules
Schedule I -- Summary of investments--other than
investments in related parties.................... 44
Schedule II -- Condensed financial information of registrant..... 45
Schedule III -- Supplementary insurance information............... 49
Schedule IV -- Reinsurance....................................... 50
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted or the
information is presented in the consolidated financial statements or related
notes.
23
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Shareholders and Board of Directors
Citizens Financial Corporation
We have audited the consolidated financial statements of Citizens Financial
Corporation and subsidiaries listed in the accompanying index to financial
statements at Item 8. Our audit also included the financial statement schedules
listed in the index at Item 8. These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 consolidated financial position of
Citizens Financial Corporation and subsidiaries at December 31, 1996 and 1995,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, the financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
/s/ Ernst & Young, LLP
- ----------------------
Louisville, Kentucky
March 21, 1997
24
<PAGE>
<TABLE>
<CAPTION>
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31 1996 1995 1994
- -------------------------------------------------------------- ------------ ------------
Revenues:
<S> <C> <C> <C>
Premiums and other considerations $18,810,551 $12,925,088 $ 8,987,190
Premiums ceded (862,928) (853,119) (1,025,612)
- -------------------------------------------------------------- ------------ ------------
Net premiums earned 17,947,623 12,071,969 7,961,578
Net investment income 4,158,282 2,607,306 2,019,926
Net realized investment gains (losses) 966,937 1,534,114 (398,890)
Other income 29,218 73,188 5,340
- -------------------------------------------------------------- ------------ ------------
Total Revenues 23,102,060 16,286,577 9,587,954
Benefits and Expenses:
Policyholder benefits 11,845,025 7,685,979 5,836,219
Policyholder benefits ceded (734,082) (649,116) (813,902)
- -------------------------------------------------------------- ----------- ------------
Net benefits 11,110,943 7,036,863 5,022,317
Increase (decrease) in net benefit reserves 680,263 405,035 (40,344)
Interest credited on policyholder deposits 916,494 896,247 903,327
Commissions 3,956,075 2,887,398 1,205,891
General expenses 3,899,708 3,342,096 2,558,659
Interest expense 836,200 470,894 345,287
Policy acquisition costs deferred (1,189,993) (932,746) (473,179)
Amortization expense:
Deferred policy acquisition costs 911,543 790,140 446,290
Value of insurance acquired 390,688 419,516 70,780
Goodwill 20,962 20,962 20,962
Depreciation expense 233,551 208,941 200,778
- -------------------------------------------------------------- ----------- ------------
Total Benefits and Expenses 21,766,434 15,545,346 10,260,768
Income (Loss) before Federal Income Tax 1,335,626 741,231 (672,814)
Federal Income Tax (Expense) (226,303) (9,000) 227,145
- -------------------------------------------------------------- ------------ ------------
Net Income (Loss) 1,109,323 732,231 (445,669)
Dividends on Redeemable Convertible Preferred Stock (402,214) -- --
- -------------------------------------------------------------- ------------ ------------
Net Income (Loss) Applicable to Common Stock $ 707,109 $ 732,231 $ (445,669)
- -------------------------------------------------------------- ------------ ------------
Net Income (Loss) Per Common Share:
Primary $ 0.66 $ 0.67 $ (0.41)
Fully diluted $ 0.62 $ 0.67 $ (0.41)
- -------------------------------------------------------------- ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
25
<PAGE>
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31 1996 1995
- ---------------------------------------------------- ------------- -------------
ASSETS
INVESTMENTS:
SECURITIES AVAILABLE FOR SALE, AT FAIR VALUE:
FIXED MATURITIES (AMORTIZED COST OF $47,238,559
AND $45,369,804 IN 1996 AND 1995, RESPECTIVELY) $47,040,591 $46,917,198
EQUITY SECURITIES (COST OF $7,085,104
AND $4,263,273 IN 1996 AND 1995, RESPECTIVELY) 7,963,550 5,742,914
INVESTMENT REAL ESTATE 3,938,806 4,095,094
MORTGAGE LOANS ON REAL ESTATE 176,636 183,935
POLICY LOANS 2,852,670 2,720,396
SHORT-TERM INVESTMENTS 893,410 821,271
- ------------------------------------------------------------------ -------------
TOTAL INVESTMENTS 62,865,663 60,480,808
CASH AND CASH EQUIVALENTS 2,805,717 9,776,964
ACCRUED INVESTMENT INCOME 772,689 636,758
REINSURANCE RECOVERABLE:
PAID BENEFITS AND LOSSES 231,648 91,773
UNPAID BENEFITS, LOSSES AND IBNR 1,579,926 1,468,413
PREMIUMS RECEIVABLE 491,330 485,585
PROPERTY AND EQUIPMENT 1,265,948 1,133,315
DEFERRED POLICY ACQUISITION COSTS 3,791,939 3,477,377
VALUE OF INSURANCE ACQUIRED 5,081,865 6,059,095
GOODWILL 125,766 146,738
OTHER ASSETS 502,204 498,435
DEFERRED FEDERAL INCOME TAX 748,013 ---
- ------------------------------------------------------------------ -------------
TOTAL ASSETS $80,262,708 $84,255,261
- ------------------------------------------------------------------ -------------
See Notes to Consolidated Financial Statements.
26
<PAGE>
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31 1996 1995
- -------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
POLICY LIABILITIES:
FUTURE POLICY BENEFITS $41,501,871 $41,429,165
POLICYHOLDER DEPOSITS 15,930,271 15,925,201
POLICY AND CONTRACT CLAIMS 1,210,393 1,139,777
UNEARNED PREMIUMS 183,613 201,772
OTHER 214,305 163,100
- -------------------------------------------------------------------------------
TOTAL POLICY LIABILITIES 59,040,453 58,859,015
NOTES PAYABLE 4,095,869 9,306,982
ACCRUED EXPENSES AND OTHER LIABILITIES 1,982,024 2,725,510
FEDERAL INCOME TAX PAYABLE 527,000 20,163
DEFERRED FEDERAL INCOME TAX --- 333,466
- -------------------------------------------------------------------------------
TOTAL LIABILITIES 65,645,346 71,245,136
COMMITMENTS AND CONTINGENCIES
REDEEMABLE CONVERTIBLE PREFERRED STOCK;
370 AND 157 SHARES ISSUED AND OUTSTANDING
IN 1996 AND 1995, RESPECTIVELY 4,043,907 1,700,907
SHAREHOLDERS' EQUITY:
COMMON STOCK, 6,000,000 SHARES AUTHORIZED;
1,275,724 SHARES ISSUED AND OUTSTANDING 1,275,724 1,275,724
ADDITIONAL PAID-IN CAPITAL 5,198,250 5,198,250
UNREALIZED APPRECIATION OF INVESTMENTS 428,780 1,871,652
RETAINED EARNINGS 4,233,003 3,525,894
COMMON STOCK HELD IN TREASURY-AT COST (200,109 SHARES) (562,302) (562,302)
- -------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 10,573,455 11,309,218
- -------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $80,262,708 $84,255,261
- -------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
27
<PAGE>
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
NET UNREALIZED
APPRECIATION COMMON STOCK
ADDITIONAL (DEPRECIATION) OWNED BY
COMMON PAID-IN OF AVAILABLE-FOR- RETAINED WHOLLY-OWNED
STOCK CAPITAL SALE SECURITIES EARNINGS SUBSIDIARY
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994 $ 1,275,724 $5,198,250 $ 724,866 $3,239,332 $(518,291)
Adjustment to beginning balance
for change in accounting method -- -- (53,132) -- --
Net loss -- -- -- (445,669) --
Net unrealized depreciation of
available-for-sale securities -- -- (829,534) -- --
Purchase of shares by wholly-
owned subsidiary -- -- -- -- (44,011)
Balance at December 31, 1994 1,275,724 5,198,250 (157,800) 2,793,663 (562,302)
Net income -- -- -- 732,231 --
Net unrealized appreciation of
available-for-sale securities -- -- 2,029,452 -- --
Balance at December 31, 1995 1,275,724 5,198,250 1,871,652 3,525,894 (562,302)
Net income -- -- -- 1,109,323 --
Net unrealized depreciation of
available-for-sale securities -- -- -- (1,442,872) --
Preferred stock dividends -- -- -- (402,214) --
Balance at December 31, 1996 $ 1,275,724 $5,198,250 $ 428,780 $4,233,003 $(562,302)
</TABLE>
See Notes to Consolidated Financial Statements.
28
<PAGE>
<TABLE>
<CAPTION>
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 1996 1995 1994
CASH FLOWS FROM OPERATIONS:
<S> <C> <C> <C>
Net income (loss) $1,109,323 $ 732,231 $ (445,669)
Adjustments to reconcile net
income (loss) to net cash flows from operations:
Increase in benefit reserves 791,089 706,719 135,822
Increase (decrease) in claims liabilities 70,616 179,910 (143,572)
(Increase) decrease in reinsurance recoverable:
Paid benefits (139,875) 63,896 (69,148)
Unpaid benefits (111,513) (238,738) (149,228)
Interest credited on policyholder deposits 916,494 896,247 903,327
Provision for amortization and depreciation,
net of deferrals 366,751 506,813 265,631
Amortization of premium and accretion of discount
on securities purchased, net (16,822) (51,785) (35,942)
Net realized investment (gains) losses (966,937) (1,534,114) 398,890
Decrease (increase) in accrued investment income (135,931) 192,806 (129,804)
Change in other assets and other liabilities (844,461) 1,340,608 (159,249)
Deferred federal income taxes (273,175) (151,000) (244,000)
Federal income taxes payable 506,837 20,163 ---
Net Cash Flows provided by Operations 1,272,396 2,663,756 327,058
CASH FLOWS FROM INVESTMENT ACTIVITIES:
Securities available-for-sale:
Purchases - fixed maturities (24,651,316) (6,663,541) (5,662,433)
Sales - fixed maturities 23,033,577 2,018,858 3,901,562
Purchases - equity securities (20,301,373)(12,431,696) (8,140,773)
Sales - equity securities 18,316,750 15,480,434 9,358,444
Securities held-to-maturity:
Purchases --- (1,228,594) (3,551,038)
Maturities --- 4,731,524 2,602,816
Short-term investments sold (acquired), net (72,139) 2,670,671 (2,979,406)
Repayments of mortgage loans 7,299 286,038 150,603
Purchase of investment real estate (24,396) (65,583) (91,161)
Additions to property and equipment, net (185,501) (110,998) (30,638)
(Increase) decrease in net broker receivable (154,269) (44,775) (465,884)
Other investing activities, net (132,274) 56,280 167,837
Purchase price of Integrity National Life
Insurance Companyin excess of cash and
cash equivalents acquired --- (3,679,184) ---
Net Cash Provided by (Used In)
Investment Activities (4,163,642) 1,019,434 (4,740,071)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of redeemable convertible preferred stock 2,343,000 1,700,907 ---
Policyholder deposits 818,849 931,477 1,429,491
Policyholder withdrawals (1,730,273) (2,242,256) (2,515,574)
Proceeds from bank borrowing --- 6,400,000 ---
Notes payable and accrued interest-Guarantor 15,543 205,326 ---
Payments on notes payable (5,226,656) (1,571,480) (67,717)
Purchase of shares by wholly-owned subsidiary --- --- (44,011)
Dividends on nonredeemable convertible preferred stock (300,464) --- ---
Other --- (251,485) ---
Net Cash Flows provided by (Used In)
Financing Activities (4,080,001) 5,172,489 (1,197,811)
Net Increase (Decrease) in Cash and Cash Equivalents (6,971,247) 8,855,679 (5,610,824)
Cash and Cash Equivalents at Beginning of Year 9,776,964 921,285 6,532,109
Cash and Cash Equivalents at End of Year $ 2,805,717 $ 9,776,964 $ 921,285
</TABLE>
See Notes to Consolidated Financial Statements.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Citizens Financial Corporation is a holding company that
engages in the business of life insurance and annuities and accident and health
insurance through its wholly-owned subsidiary, Citizens Security Life Insurance
Company ("Citizens Security"). Citizens Security offers life, fixed-rate annuity
and accident and health insurance products to individuals and groups through
independent agents.
The individual life insurance products currently offered by Citizens Security
consist of traditional whole life insurance and universal life insurance
policies. Citizens Security also sells group life and accidental death and
dismemberment policies. The fixed-rate annuity products offered by Citizens
Security consist of flexible premium deferred annuities, life policy annuity
riders, and single premium deferred annuities. Citizens Security's individual
accident and health insurance products provide coverage for monthly income
during periods of hospitalization, scheduled reimbursement for specific hospital
and surgical expenses and cancer treatments, and lump sum payments for
accidental death or dismemberment, while the group accident and health products
provide coverage for short and long-term disability, income protection and
dental procedures.
Citizens Security is licensed to sell products in the District of Columbia and
18 states primarily located in the south and southeast. Citizens Security
markets its portfolio of products through the personal producing general agent
distribution system and presently has approximately 1,520 sales representatives,
all of whom are independent agents and all, or substantially all, of whom also
represent other insurers. Approximately 320 of these agents are former agents of
Integrity Life Insurance Company ("Integrity") who specialize in the home
service market. That market consists primarily of individuals who desire whole
life policies with policy limits typically below $10,000.
Principles of Consolidation and Presentation. The accompanying consolidated
financial statements include the accounts of Citizens Financial Corporation, its
wholly-owned subsidiaries, Citizens Financial Properties, Inc., Citizens
Security, and Integrity since the date of its acquisition, September 22, 1995
(see Note 2), and a wholly-owned partnership, Marketplace I Limited Partnership
(collectively hereinafter referred to as the "Company"). Effective December 31,
1995, Integrity was merged into Citizens Security. All significant intercompany
accounts and transactions are eliminated in consolidation. Certain balances in
prior years have been reclassified to conform to current year classifications.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Investments. Effective January 1, 1994, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under SFAS No. 115, the Company
classifies fixed maturities and equity securities as "available-for-sale" if
they are not bought and held principally for the purpose of selling them in the
near term (e.g. "trading securities") or, if fixed maturities are not intended
to be "held to maturity." Available-for-sale securities are carried at fair
value, with unrealized gains and losses included in shareholders' equity, net of
applicable deferred taxes and adjustments to related deferred policy acquisition
costs. Fixed maturities are classified as "held-to-maturity" when the Company
has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are carried at cost adjusted for amortization of
premium or accretion of discount. The effect of the adoption, which represented
adjustments to related deferred policy acquisition costs, was to decrease
shareholders' equity by $53,132, net of deferred taxes of $27,370, at January 1,
1994. There was no effect on net income. Effective December 31, 1995, the
Company adopted the Financial Accounting Standards Board's Implementation Guide
on SFAS No. 115 ("Implementation Guide"). In accordance with the Implementation
Guide, the Company reassessed the classification of its fixed maturities and
equity securities and, accordingly, transferred all of its "held-to-maturity"
fixed maturities to "available-for-sale." The fair value and amortized cost of
the fixed maturities transferred on December 31, 1995, were $13,085,928 and
$12,524,060, respectively. The effect of this transfer was to increase
shareholders' equity by $370,833, net of deferred taxes of $191,035, at December
31, 1995. There was no effect on net income. In addition, upon acquisition of
Integrity, the Company classified all of Integrity's fixed maturities and equity
securities as "available-for-sale." Prior to the Company's acquisition of
Integrity, Integrity did not prepare its financial statements in accordance with
generally accepted accounting principals ("GAAP").
30
<PAGE>
NOTE 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fixed maturities and equity securities having a decline in value considered by
management to be other than temporary are adjusted to an amount which, in
management's judgment, reflects such declines. Such amounts are included in net
realized investment gains and losses. For purposes of computing realized gains
and losses on fixed maturities and equity securities sold, the carrying value is
determined using the specific-identification method. Mortgage loans and policy
loans are carried at unpaid balances. Investment real estate is carried at
depreciated cost. Short-term investments, which consist of certificates of
deposit and treasury bills, are carried at cost which approximates fair value.
Cash and cash equivalents consist of highly liquid investments with maturities
of three months or less at the date of purchase and are also carried at cost
which approximates fair value.
Deferred Policy Acquisition Costs. Commissions and other policy acquisition
costs which vary with, and are primarily related to, the production of new
insurance contracts are deferred, to the extent recoverable from future policy
revenues and gross profits, and amortized over the life of the related
contracts. See Premiums, Benefits and Expenses regarding amortization methods.
Property and Equipment. Property and equipment, including the home office
building, are carried at cost less accumulated depreciation, using principally
the straight-line method of depreciation. Accumulated depreciation at December
31, 1996, was $1,117,364 ($883,813 at December 31, 1995).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of the
purchase price of a former wholly-owned subsidiary, which was merged into
Citizens Security effective September 30, 1992, over amounts assigned (based on
estimated fair values at the date of acquisition) to the identifiable net assets
acquired. Goodwill is amortized over 15 years using the straight-line method. At
December 31, 1996, accumulated amortization was $130,216 ($109,254 at December
31, 1995).
Value of insurance acquired is recorded for the estimated value assigned to the
insurance in force of the purchased subsidiaries at the dates of acquisition.
The assigned value is amortized over the expected remaining life of the
insurance in force using methods consistent with that used for amortization of
policy acquisition costs (as described under Premiums, Benefits and Expenses).
At December 31, 1996, accumulated amortization was $1,524,187 ($1,133,499 at
December 31, 1995).
Benefit Reserves and Policyholder Deposits. Traditional life and accident and
health insurance products include those contracts with fixed and guaranteed
premiums and benefits and consist principally of whole-life and term insurance
policies, limited-payment life insurance policies and certain annuities with
life contingencies. Reserves on such policies are based on assumed investment
yields which range from 6% to 7%. Reserves on traditional life and accident and
health insurance products are determined using the net level premium method
based on future investment yields, mortality, withdrawals and other assumptions,
including dividends on participating policies. Such assumptions are based on
past experience and include provisions for possible unfavorable deviation.
Benefit reserves and policyholder contract deposits on universal life, other
interest-sensitive life products and investment-type products are determined
using the retrospective deposit method and consist of policy account balances,
before deducting surrender charges, which accrue to the benefit of the
policyholder.
Participating insurance business at December 31, 1996 and 1995, constituted
approximately 1% of ordinary life insurance in force (7% at December 31, 1994)
and less than 1% of annualized ordinary life premium inforce (1% at December 31,
1994). Participating dividends are determined at the discretion of the Board of
Directors.
Reserves on insurance policies acquired by purchase are based on assumptions
considered appropriate as of the date of purchase. Assumed investment yields for
such acquired policies range from 6.6% to 9.0%.
Premiums, Benefits and Expenses. Premiums for traditional individual life and
accident and health policies are reported as earned when due. Benefit claims
(including an estimated provision for claims incurred but not reported), benefit
reserve changes and expenses (except those deferred) are charged to expense as
incurred. Deferred policy acquisition costs related to traditional life and
accident and health policies are charged to expense over the life of the policy
using methods and assumptions consistent with those used in estimating
liabilities for future policy benefits. In determining whether a premium
deficiency exists on short-duration policies, management does not give
consideration to investment income.
31
<PAGE>
NOTE 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenues for universal life and investment-type products consist of investment
income and policy charges for the cost of insurance, policy initiation,
administrative surrender fees and investment income. Expenses include interest
credited to policy account balances, incurred administrative expenses and
benefit payments in excess of policy account balances.
Deferred policy acquisition costs related to universal life and investment-type
products are amortized in relation to the incidence of expected gross profits
over the life of the policies. Expected gross profits are reviewed at each
reporting period, and to the extent actual experience varies from that
previously assumed, the effects of such variances are recorded in the current
period.
Liabilities for Policy Claims. Policy claim liabilities are based on known
liabilities plus estimated future liabilities developed from trends of
historical data applied to current exposures. These liabilities are closely
monitored and adjustments for changes in experience are made in the period
identified.
Federal Income Taxes. The Company uses the liability method of accounting for
income taxes. Deferred income taxes are provided for cumulative temporary
differences between balances of assets and liabilities determined under
generally accepted accounting principles and balances determined for tax
reporting purposes.
Earnings Per Share. Primary earnings per share amounts are based on the weighted
average number of common and common equivalent shares outstanding during the
year (1,075,615 in 1996 and 1995, and 1,078,369 in 1994). Fully diluted earnings
per share amounts assume conversion of all outstanding Class B Convertible
Preferred Stock at a conversion price of $5.50 per share. The weighted average
number of common shares outstanding, on a fully diluted basis is 1,793,148;
1,089,379; and 1,078,369 in 1996, 1995, and 1994 respectively.
NOTE 2--ACQUISITION
On September 22, 1995, the Company acquired 98.85% of the common stock of
Integrity from Southwestern Life Corporation ("Southwestern"), a Dallas-based
insurance holding company (the "Acquisition"). The Acquisition was accounted for
as a purchase with the results of Integrity's operations being included in the
consolidated statements since the date of acquisition. Citizens Security
acquired the remaining 1.15% of the common stock of Integrity in conjunction
with the merger of Integrity into Citizens Security.
The aggregate purchase price for the Acquisition, was $9,419,000 (including net
cost associated with the purchase of $437,000 and the purchase of minority
shareholders stock as part of the merger discussed above). No goodwill was
recorded relating to the acquisition.
Prior to the closing, Integrity entered into a coinsurance and assumption
reinsurance agreement with Union Bankers Insurance Company ("Union Bankers"),
another affiliate of Southwestern, covering Integrity's 14,500 individual
long-term care and Medicare supplement insurance policies with annualized
premiums of approximately $14,800,000, leaving the remaining life and accident
and health insurance business with Integrity. In conjunction with this
reinsurance transaction, Integrity transferred approximately $9,200,000 in
reserves to Union Bankers. Completion of these transactions was a condition to
the Company's obligations under the Stock Purchase Agreement with Southwestern
because the reinsured business did not fit into the Company's current business
plans. Under the agreement, Union Bankers directly assumed the liability for
these policies.
The Acquisition was financed with the working capital of Citizens Security and
with approximately $6,100,000 of the $6,400,000 of proceeds under a Term Loan
Agreement dated as of September 22, 1995 between the Company and a commercial
bank (the "Term Loan Agreement"). The Term Loan Agreement provides for a
$4,400,000 note payable that matures on October 1, 2002 (the "2002 Note") and a
$2,000,000 note payable that matures on October 1, 2003 (the "2003 Note") ( see
Note 6). In order to obtain required approvals from insurance regulatory
authorities of the state of Pennsylvania, [i] the Company agreed to authorize a
private placement of preferred stock to accredited investors, [ii] the Principal
Shareholder of the Company provided a personal guarantee that at least
$1,500,000 of the aforementioned preferred stock would be sold, and [iii] the
Company agreed that at least $1,500,000 of the proceeds of such sale would be
used to pay down the principal amount of the 2002 Note. The Company sold
$1,727,000 of the preferred stock on December 15, 1995, and applied $1,500,000
of the proceeds to prepay the first installment of the 2002 Note (see Notes 6
and 7).
32
<PAGE>
NOTE 3--INVESTMENTS
The cost and fair value of investments in fixed maturities and equity securities
are shown below. The cost amounts are adjusted for amortization of premium and
accretion of discount on fixed maturities and for write-downs of securities
whose decline in value is believed to be other than temporary. Treasury bills
having a carrying value of $342,219 and $4,032,592 as of December 31, 1996 and
1995, respectively are included below but reported as short-term investments and
cash equivalents in the accompanying financial statements.
Fair Value
DECEMBER 31, 1996 Amortized Gross Unrealized (Carrying
Cost Gains Losses Value)
----------- ---------- -------- -----------
Fixed Maturities:
U. S. government obligations $10,132,155 $ 35,502 $210,194 $ 9,957,463
Corporate securities 25,663,794 308,374 312,780 25,659,388
Mortgage-backed securities 11,784,829 120,605 139,475 11,765,959
- --------------------------------- ----------- ---------- -------- -----------
Total $47,580,778 $ 464,481 $662,449 $47,382,810
- --------------------------------- ----------- ---------- -------- -----------
Equity securities $ 7,085,104 $1,291,042 $412,596 $ 7,963,550
- --------------------------------- ----------- ---------- -------- -----------
DECEMBER 31, 1995
Fixed Maturities:
U. S. government obligations $ 9,859,074 $ 133,685 $ 58 $ 9,992,701
Corporate securities 26,700,021 1,148,050 93,320 27,754,751
Mortgage-backed securities 12,843,301 426,971 67,934 13,202,338
----------- ---------- -------- -----------
Total $49,402,396 $1,708,706 $161,312 $50,949,790
----------- ---------- -------- -----------
Equity securities $ 4,263,273 $1,549,368 $ 69,727 $ 5,742,914
----------- ---------- -------- -----------
The fair values for investments in fixed maturities and equity securities are
based on quoted market prices, where available. For investments in fixed
maturities and equity securities not actively traded, fair values are estimated
using values obtained from independent pricing services.
The annual change in net unrealized investment appreciation or depreciation, at
December 31, 1996, 1995 and 1994, and the amount of net realized investment gain
or loss included in net income for the respective years then ended are as
follows:
Year Ended December 31 1996 1995 1994
- -------------------------------------------------------- ------------ ----------
FIXED MATURITIES:
Available-For-Sale:
Change in net unrealized appreciation
(depreciation) $(1,745,362) $1,930,776 $(545,167)
Net realized gain (loss) $ 218,188 $ 357,997 $(276,204)
Held-To-Maturity:
Change in net unrealized appreciation
(depreciation) $ -- $ 612,060 $(895,565)
Net realized gain $ -- $ 17,951 $ 31,079
EQUITY SECURITIES:
Change in net unrealized appreciation
(depreciation) (601,195) $1,351,641 $(808,496)
Net realized gain (loss) $ 748,749 $1,158,166 $(128,765)
33
<PAGE>
NOTE 3--INVESTMENTS (CONTINUED)
The amortized cost and fair value of investments in fixed maturities at December
31, 1996, by contractual maturity are shown below. Expected maturities for
investments in fixed maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations, sometimes without
prepayment penalties.
December 31, 1996 Amortized Cost Fair Value
- ------------------------------ ------------- ------------
Due in one year or less $ 2,488,374 $ 2,500,832
Due after one year through five years 10,442,500 10,478,608
Due after five years through ten years 19,372,180 19,312,757
Due after ten years 3,492,895 3,324,654
- ------------------------------ ------------- -------------
Subtotal 35,795,949 35,616,851
Mortgage-backed securities 11,784,829 11,765,959
- ------------------------------ ------------- -------------
Total $47,580,778 $47,382,810
- ------------------------------ ------------- -------------
Gross gains of $551,881, $376,889 and $135,280 and gross losses of $317,685,
$18,892, and $411,484 were realized on the sale of available-for-sale fixed
maturities during 1996, 1995 and 1994, respectively. Included in gross realized
losses during 1994 is a net adjustment to the carrying value of
available-for-sale fixed maturities of $91,000, relating to declines in value
which were considered by management to be other than temporary. Net realized
gains from the sale of fixed maturities have been reduced in 1996 by $16,008
associated with the amortization deferred policy acquisition costs.
Gross gains of $2,481,688, $2,372,076 and $1,150,212 and gross losses of
$1,689,679, $1,213,910 and $1,278,977 were realized on the sale of
available-for-sale equity securities during 1996, 1995 and 1994. Included in
gross realized losses during 1996, 1995 and 1994 are adjustments to the carrying
value of available-for-sale equity securities of $666,871, $561,135 and
$838,610, respectively, relating to declines in value which were considered by
management to be other than temporary. Net realized gains from the sale of
equity securities have been reduced in 1996 by $43,260 associated with the
amortization deferred policy acquisition costs.
Net unrealized appreciation (depreciation) of available-for-sale securities is
summarized as follows:
December 31, 1996 1995
- --------------------------------------- ------------- ------------
Net appreciation (depreciation) on available-for-sale:
Fixed maturities $(197,968) $1,547,394
Equity maturities 878,446 1,479,641
Adjustment of deferred policy acquisition cost (30,811) (126,191)
Deferred income taxes (220,887) (1,029,192)
- --------------------------------------- ------------- ------------
Net Unrealized Appreciation $ 428,780 $1,871,652
- --------------------------------------- ------------- ------------
Investment management services are provided by a firm affiliated with certain
board members and shareholders of the Company. Fees for these services were
$30,000, $275,578 and $30,000 in 1996, 1995 and 1994, respectively.
34
<PAGE>
NOTE 3--INVESTMENTS (CONTINUED)
Major categories of investment income are summarized as follows:
Year Ended December 31 1996 1995 1994
- ------------------------------ -------------------------------------
Fixed maturities $3,361,210 $2,088,980 $1,241,705
Equity securities 152,025 248,796 187,492
Mortgage loans on real estate 18,298 18,975 44,938
Policy loans 154,845 114,191 113,743
Investment real estate 323,498 288,259 323,662
Short-term investments and other 367,324 206,596 280,517
- ------------------------------ -------------------------------------
Subtotal $4,377,200 $2,965,797 $2,192,057
Investment expenses (218,918) (358,491) (172,131)
- ----------------------------- --------------------------------------
Net Investment Income $4,158,282 $2,607,306 $2,019,926
- ----------------------------- --------------------------------------
The Company limits credit risk by diversifying its investment portfolio among
government and corporate fixed maturities and common and preferred equity
securities. It further diversifies these investment portfolios within industry
sectors. As a result, management believes that significant concentrations of
credit risk do not exist.
At December 31, 1996, the Company held in its available-for-sale fixed maturity
portfolio an investment in Walt Disney Company amounting to $1,494,350.
At December 31, 1996, the Company had no investments which had not been income
producing for a period of at least twelve months prior to year end.
Pursuant to requirements of certain state insurance departments, the Company has
investments with a carrying value of $22,425,130 at December 31, 1996, placed on
deposit at various financial institutions which are restricted from withdrawal
without prior regulatory approval.
The Company owns the building and land in which it currently resides and
occupies approximately 21% of the building with the majority of the remaining
space being leased to tenants. The accompanying financial statements reflect 21%
of the building and its operating expense as property and equipment and general
expense, respectively, with the remaining 79% as investment real estate and as a
reduction of investment income, respectively. Accumulated depreciation at
December 31, 1996 and 1995 on the investment real estate portion of the building
was $588,097 and $474,840, respectively.
The Company leases office space to third party tenants under noncancellable
lease agreements. Future minimum rental income is $721,816, $651,913, $178,941,
and $7,400 for years 1997 through 2000, respectively.
35
<PAGE>
NOTE 4--VALUE OF INSURANCE ACQUIRED
The value of insurance acquired is an asset which represents the present value
of future profits on business acquired, using interest rates of 6.6% to 9%. An
analysis of the value of insurance acquired for the years ended December 31,
1996, 1995 and 1994 is as follows:
Year ended December 31 1996 1995 1994
- ---------------------- -------------- ------------ ------------
Balance at beginning of year $6,059,095 $ 442,046 $ 512,826
Purchase of Integrity (586,542) 6,036,565 ---
Accretion of interest 354,312 394,337 39,184
Amortization (745,000) (813,853) (109,964)
- ---------------------- -------------- ------------ ------------
Balance at end of year $5,081,865 $6,059,095 $ 442,046
- ---------------------- -------------- ------------ ------------
During the first twelve months after the September 22, 1995 acquisition of
Integrity, the assumptions used to establish the value of insurance acquired
were reconfirmed. Based on this review, the value of net assets acquired was
increased by $586,542. This revision relates primarily to a reduction in the
amount of assumed future policy benefits associated with certain individual life
insurance policies that cover multiple family members, partially offset by an
increase in direct costs required to complete the acquisition.
Amortization of the value of insurance acquired (net of interest accretion) in
each of the following five years will be approximately: 1997 - $480,000; 1998 -
$423,000; 1999 - $383,000; 2000 - $372,000; and 2001 - $371,000.
NOTE 5--LIABILITY FOR ACCIDENT AND HEALTH UNPAID CLAIMS AND INCURRED, BUT
NOT REPORTED CLAIMS PORTION OF RESERVES
Activity in the accident and health liability portion of policy and contract
claims ($425,095 and $346,902 at December 31, 1996 and 1995, respectively) and
the incurred but not reported portion of accident and health reserves
($1,195,361 and $1,316,799 at December 31, 1996 and 1995, respectively) are
summarized as follows:
Year Ended December 31, 1996 1995
- ----------------------------------- ----------------------------
Balance at January 1 $1,663,701 $1,147,942
Less reinsurance recoverable 735,100 527,133
- ----------------------------------- ----------------------------
Net balance at January 1 928,601 620,809
Integrity balance at acquisition --- 245,688
Incurred related to:
Current year 5,848,067 4,227,868
Prior years --- 1,654
- ----------------------------------- ----------------------------
Total incurred 5,848,067 4,229,522
Paid related to:
Current year 5,243,068 3,605,337
Prior years 489,189 562,081
- ----------------------------------- ----------------------------
Total paid 5,732,227 4,167,418
Net balance at December 31 1,044,441 928,601
Plus reinsurance recoverable 576,015 735,100
- ----------------------------------- ----------------------------
Balance at December 31 $1,620,456 $1,663,701
- ----------------------------------- ----------------------------
36
<PAGE>
NOTE 6--DEBT
Long term debt consisted of the following:
December 31 1996 1995
- ----------------------------------- ------------ ------------
Commercial bank note, prime plus 1/2%, due 2002 $2,125,000 $2,900,000
Commercial bank note, prime, due 2003 1,750,000 2,000,000
Subordinated guaranty note, prime, due 2003 220,869 205,326
Mortgage note, 8%, due 1998 --- 4,201,656
- ----------------------------------- ------------ ------------
Total 4,095,869 9,306,982
Less: Current Portion (225,000) (277,539)
- ----------------------------------- ------------ ------------
Long Term Portion $3,870,869 $9,029,443
- ----------------------------------- ------------ ------------
The two commercial bank notes were issued in 1995, to finance the Integrity
acquisition. The notes were both originally issued at the bank's prime lending
rate plus 1%, with interest payable quarterly. The 2002 Note and the 2003 Note
had original note amounts of $4,400,000 and $2,000,000, respectfully, and have
outstanding balances at December 31, 1996 of $2,125,000 and $1,750,000,
respectively. Remaining principal installments due in each succeeding year for
the 2002 Note are $225,000, $400,000, and $500,000 thereafter through the year
of maturity, 2002. The 2003 Note is to be repaid in three (3) consecutive
quarterly installments of $500,000 each beginning on January 1, 2003, with the
final installment of $250,000 due on October 1, 2003. During 1996, the interest
rate on the 2002 Note was reduced by 1/2% to prime plus 1/2%, while the interest
rate on the 2003 Note was reduced by 1% to prime. No prepayments are permitted
on the 2003 Note until the 2002 Note has been paid in full, except from proceeds
of equity security offerings or other subordinated indebtedness. During 1996,
the Company elected to prepay $500,000 and $250,000 of principal on 2002 and
2003 Notes, respectively, utilizing net proceeds deemed available from issuance
of redeemable convertible preferred stock (see Note 7). Additional payments made
during 1996 on the 2002 Note included $200,000 of scheduled installments and
prepayment of a $75,000 installment due January 1, 1997. The Company has pledged
all of the issued and outstanding common and preferred stock of Citizens
Security as collateral for the commercial bank notes. In addition, the Company's
principal shareholder (the "Principal Shareholder"), who is also its Chairman
and President, has personally guaranteed the 2003 Note.
In consideration of the personal guarantee noted above, the Company entered into
a Guarantor's Compensation Agreement (the "Guarantor's Compensation Agreement"),
dated September 22, 1995, with its Principal Shareholder whereby the Company
will pay an annual guaranty fee based on an applicable percentage of the
outstanding principal balance of the 2003 Note on its date of issuance and each
anniversary thereof. The applicable percentage ranged from 10% in the first two
years and thereafter decreased in stages to 0.5% on the last anniversary before
maturity, for an average of 4.21% over the term of the 2003 Note. However, the
Guarantor's Compensation Agreement was amended effective September 22, 1996 to
replace the 10% fee due on September 22, 1996 with an Interim Fee equal to 15%
of the net realized and unrealized investment gains and losses earned on the
parent company's (nonconsolidated) investment portfolio during the period from
October 1, 1996 to September 30, 1997. This 15% fee is reduced in proportion to
average principal repayments on the 2003 Note. During the three months ended
December 31, 1996, no net realized and unrealized gains were earned on this
portfolio (which totaled $2,359,238 at December 31, 1996); therefore, no
guaranty fee has been earned for such period.
Annual guaranty fees will be paid in the form of non-negotiable promissory notes
of the Company (the "Guaranty Notes"), except that the Interim Fee noted above
is payable in cash by November 15, 1997, unless the Company is unable to obtain
any required consent from the holder of the commercial bank notes. The Guaranty
Notes bear interest at the prime rate charged by a commercial bank, they are
subordinated to the commercial bank notes, and they are payable at maturity of
the 2003 Note. The Guarantor's Compensation Agreement also provides that the
Company and the Principal Shareholder may agree to exchange the Guaranty Notes
for securities of the Company on terms to be determined by a majority of the
members of the Company's Board of Directors who are not affiliated with the
Principal Shareholder. Effective September 22, 1995, the Company issued a
Guaranty Note in the amount of $200,000 to the Principal Shareholder. At
December 31, 1996 and 1995, the outstanding balance of the Guaranty Note,
including accrued interest, was $220,869 and $205,326, respectively.
37
<PAGE>
NOTE 6--DEBT (CONTINUED)
The 8% mortgage note outstanding at December 31, 1995 was repaid in advance, on
December 31, 1996, at its then outstanding balance of $4,124,117. This note was
secured by Company real estate which had a depreciated cost at December 31,
1996, of $4,976,051.
Cash paid for interest on debt was $ 835,426, $517,855, and $349,623 during
1996, 1995, and 1994, respectively.
NOTE 7--REDEEMABLE CONVERTIBLE PREFERRED STOCK
On January 19, 1996 and December 15, 1995, the Company issued 213 and 157
shares, respectively of 1995 Class B redeemable convertible preferred stock
("Preferred Stock"), for cash in the amount of $11,000 per share ($4,070,000 in
the aggregate). Holders of the Preferred Stock are entitled to cumulative
quarterly dividends, currently at the rate of $275 per share ($1,100 per annum).
The Preferred Stock currently has a liquidation preference of $4,070,000 in the
aggregate. The Preferred Stock is mandatorily redeemable in 12 equal quarterly
installments beginning January 1, 2003. At the option of any holder, the Company
must redeem any or all of such holder's Preferred Stock not later than January
1, 2002. The Company may call any or all of the Preferred Stock for redemption,
at any time after January 1, 1999, and may also call any or all of the Preferred
Stock for redemption at any time after January 1, 1998, if the market price for
the Company's Class A Stock exceeds $8.25 per share for at least 20 out of 30
consecutive trading days. In each case, the redemption price is currently
$11,000 per share. Until five (5) days prior to any redemption date, each share
of the Preferred Stock is convertible into a specified number of shares of the
Company's Class A Stock (currently 2,000). Holders of the Preferred Stock have
the right to elect two (2) members of the Company's Board of Directors at any
time that, and for as long as, the Company has failed to complete a required
redemption or to pay dividends on the Preferred Stock for six (6) quarterly
periods. The dividend rate, redemption price and conversion ratio are all
subject to adjustment for any stock dividends, combinations, splits or similar
changes affecting the Preferred Stock in the future.
NOTE 8--FEDERAL INCOME TAXES
Federal income taxes consist of the following:
Year Ended December 31, 1996 1995 1994
- --------------------------- ------------- ------------ ------------
Deferred tax benefit $ 252,730 $151,000 $ 244,000
Current tax expense (479,033) (160,000) (16,855)
- --------------------------- ------------- ------------ ------------
Federal Income Tax (Expense) Benefit $(226,303) $ (9,000) $227,145
- --------------------------- ------------- ------------ ------------
38
<PAGE>
NOTE 8--FEDERAL INCOME TAXES (CONTINUED)
Deferred income taxes are provided for cumulative temporary differences between
balances of assets and liabilities determined under generally accepted
accounting principles and balances determined for tax reporting purposes.
Significant components of the Company's deferred tax liabilities and assets as
of December 31, 1996 and 1995 are as follows:
December 31, 1996 1995
- -------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Value of insurance acquired $1,727,834 $2,060,092
Net unrealized gains on available-for-sale securities 220,887 1,029,192
Other 179,543 217,074
- -------------------------------------------------------------------------------
Total deferred tax liabilities 2,128,264 3,306,358
DEFERRED TAX ASSETS:
Policy and contract reserves 1,808,358 2,200,490
Deferred policy acquisition costs 438,105 502,531
Fixed maturities and equity securities 192,075 151,386
Real estate 531,709 ---
Alternative minimum tax credit carry forwards 317,165 241,415
Net operating loss carry forwards 464,146 424,029
Other 118,170 122,030
- -------------------------------------------------------------------------------
Total deferred tax assets 3,869,728 3,641,881
Valuation allowance for deferred tax assets (993,451) (668,989)
- -------------------------------------------------------------------------------
Net deferred tax assets 2,876,277 2,972,892
- -------------------------------------------------------------------------------
NET DEFERRED TAX LIABILITIES (ASSETS) $ (748,013) $ 333,466
- -------------------------------------------------------------------------------
The following is a reconciliation of the federal statutory income tax rate to
the Company's effective income tax rate:
Year Ended December 31, 1996 1995 1994
- -------------------------------- ------------ ------------ ------------
Statutory rate of income tax (benefit) 34.00 % 34.00 % (34.00)%
Dividend exclusion (1.65)% (3.70)% (3.10)%
Alternative minimum tax 9.00 % --- 2.70 %
Small life insurance deduction (39.48)% (23.10)% (8.20)%
Surtax exemption and other 1.17 % 3.30 % (5.30)%
Increase in valuation allowance 13.96 % 15.80 % 14.10 %
Deferred benefit from merger --- (26.20)% ---
- -------------------------------- ------------ ------------ ------------
Effective rate of income tax (benefit) 17.00 % 0.10 % (33.80)%
- -------------------------------- ------------ ------------ ------------
Federal income taxes paid in 1996, 1995 and 1994 were $91,766, $55,000, and
$230,000, respectively. The Company utilized $1,180,000 and $176,621 of net
operating loss carry forwards in 1996 and 1994 respectively. The Company has
$1,365,134 of net operating loss carry forwards which will expire between 2007
and 2011.
Under the tax law in effect prior to 1984, a portion of income of Citizens
Security was not taxed when earned. It was accumulated in a tax account known as
policyholders' surplus. Under the provisions of the Deficit Reduction Act of
1984, policyholders' surplus accounts were frozen at their December 31, 1983,
balance of $859,000 for Citizens Security on a merged basis. Distributions from
39
<PAGE>
NOTE 8--FEDERAL INCOME TAXES (CONTINUED)
the policyholders' surplus would be subject to income tax. At December 31, 1996,
Citizens Security could have paid additional dividends of approximately
$7,875,000 before paying tax on any part of its policyholders' surplus accounts.
Since the Company believes that tax will not be paid on any part of the
policyholders' surplus accounts in the foreseeable future, no provision has been
made for the related deferred income taxes which total $292,000, based on
current tax rates.
NOTE 9--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDERS' EQUITY
Citizens Security is domiciled in Kentucky and prepares its statutory-basis
financial statements in accordance with statutory accounting practices ("SAP")
prescribed or permitted by the Kentucky Department of Insurance ("KDI"). Net
income for 1996 and capital and surplus for the Company's insurance operations
as reported in accordance with SAP for the three years ended December 31, 1996
are shown below.
Year Ended December 31, 1996 1995 1994
- -------------------------------- ------------ ------------ ------------
Net Income $3,062,421 $883,003 $591,998
Capital and Surplus $9,145,830 $8,406,313 $5,651,136
Principal differences between SAP and GAAP include: a) costs of acquiring
new policies are deferred and amortized for GAAP; b) value of insurance inforce
acquired is established as an asset for GAAP; c) benefit reserves are calculated
using more realistic investment, mortality and withdrawal assumptions for GAAP;
d) deferred income taxes are provided for GAAP; e) assets and liabilities of
acquired companies are adjusted to their fair values at acquisition with the
excess purchase price over such fair values recorded as goodwill under GAAP; f)
available-for-sale fixed maturity investments are reported at fair value with
unrealized gain and losses reported as a separate component of shareholders'
equity for GAAP; and g) statutory asset valuation reserves and interest
maintenance reserves are not required for GAAP.
"Prescribed" statutory accounting practices include state laws, regulations, and
general administrative rules, as well as a variety of publications of the
National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory
accounting practices encompass all accounting practices that are not prescribed;
such practices may differ from state to state, may differ from company to
company within a state, and may change in the future. The NAIC currently is in
the process of codifying statutory accounting practices, the result of which is
expected to constitute the only source of "prescribed" statutory accounting
practices. Accordingly, that project, which is expected to be completed in 1998,
will likely change, to some extent, prescribed statutory accounting practices,
and may result in changes to the accounting practices that insurance enterprises
use to prepare their statutory-basis financial statements.
Statutory restrictions limit the amount of dividends which may be paid by
Citizens Security to the Company. Generally, dividends during any year may not
be paid, without prior regulatory approval, in excess of the lesser of (a) 10%
of statutory shareholder's surplus as of the preceding December 31, or (b)
statutory net operating income for the preceding year. During 1996, with
appropriate prior regulatory approval, Citizens Security redeemed $1,000,000 of
its outstanding preferred stock and paid a $750,000 extraordinary dividend to
the Company. In addition, Citizens Security must maintain the minimum capital
and surplus, $1,250,000, required for life insurance companies domiciled in
Kentucky.
The KDI imposes minimum risk-based capital ("RBC") requirements on insurance
enterprises that were developed by the NAIC. The formulas for determining the
amount of RBC specify various weighting factors that are applied to financial
balances and various levels of activity based on the perceived degree of risk.
Regulatory compliance is determined by a ratio (the "Ratio") of the enterprise's
regulatory total adjusted capital, as defined by the NAIC, to its authorized
control level RBC, as defined by the NAIC. Enterprises below specific trigger
points or ratios are classified within certain levels, each of which requires
specified corrective action. Citizens Security has a Ratio that is at least 400%
of the minimum RBC requirements; accordingly, Citizens Security meets the RBC
requirements.
40
<PAGE>
NOTE 9--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDERS' EQUITY (CONTINUED)
During 1996, the number of authorized shares of the Company's common stock was
increased from 2,000,000 to 6,000,000 shares. Under a stock option
agreement, 5,000 options on the Company's common stock have been granted to an
officer. The stock options vested as of June 16, 1995, at an exercise price of
$9 per share. The Company accounts for its stock option grants in accordance
with APB Opinion No. 25, "Accounting for Stock Issued to Employees." No
compensation expense has been recognized for these stock options since the
exercise price exceeds market value. No options were exercised during 1996, 1995
or 1994. The effect of applying the fair value method of accounting for the
Company's stock based awards (as described in SFAS 123, "Accounting and
Disclosure of Stock-Based Compensation") results in net income and earnings per
share that are not materially different from amounts reported.
NOTE 10--SEGMENT INFORMATION
The Company essentially operates in two segments as shown in the following
tables. Both segments include individual and group insurance. Identifiable
revenues, expenses and assets are assigned directly to the applicable segment.
Net investment income and invested assets are allocated to the operating
segments generally in proportion to policy liabilities.
Segment information as of December 31, 1996, 1995 and 1994, and for the years
then ended is as follows:
Year Ended December 31, 1996 1995 1994
- ------------------------------- ------------- ------------- -------------
REVENUES:
Life and Annuities $14,446,080 $ 9,709,671 $ 4,139,901
Accident and Health 8,655,980 6,576,906 5,448,053
- ------------------------------- ------------- ------------- -------------
Total $23,102,060 $16,286,577 $ 9,587,954
INCOME (LOSS) FROM OPERATIONS BEFORE FEDERAL INCOME TAXES:
Life and Annuities $ 1,051,618 $ 417,888 $ (781,027)
Accident and Health 284,008 323,343 108,213
- ------------------------------- ------------- ------------- -------------
Total $ 1,335,626 $ 741,231 $ (672,814)
ASSETS:
Life and Annuities $76,384,118 $77,504,054 $41,334,707
Accident and Health 3,878,590 6,751,207 3,205,155
- ------------------------------- ------------- ------------- -------------
Total $80,262,708 $84,255,261 $44,539,862
DEPRECIATION AND AMORTIZATION EXPENSE:
Life and Annuities $ 1,462,051 $ 1,315,897 $ 620,071
Accident and Health 94,693 123,662 118,739
- ------------------------------- ------------- ------------- -------------
Total $ 1,556,744 $ 1,439,559 $ 738,810
The increase in income from operations before federal income taxes for Life
and Annuities from a gain of $417,888 in 1995 to a gain of $1,051,618 in 1996
results from an approximate $1,100,000 increase in segment earnings before
realized capital gains and a decrease of approximately $500,000 in realized
capital gains. The $1,100,000 segment earnings improvement resulted primarily
from successfully completing the integration of Integrity's operations during
1996 and certain nonrecurring costs in 1995, including $281,000 of Integrity
assimilation/integration costs and $246,000 of variable investment portfolio
management fees. The increase in income from operations before federal income
taxes for Life and Annuities from a loss of $781,027 in 1994 to a gain of
$417,888 in 1995 results primarily from an increase in realized gains and
investment income allocable to this segment, partially offset by the
nonrecurring items noted above.
41
<PAGE>
NOTE 10--SEGMENT INFORMATION (CONTINUED)
The decrease in income from operations before federal income taxes for Accident
and Health from $323,343 in 1995 to $284,008 in 1996 resulted primarily from a
decrease in realized capital gains allocated to the segment of approximately
$40,000. The increase in income from operations before federal income taxes for
Accident and Health from $108,213 in 1994 to $323,343 in 1995 resulted
principally from an increase in realized gains allocated to the segment and a
reduction of maintenance expenses.
NOTE 11--REINSURANCE
The Company currently follows the general practice of reinsuring that portion of
risk on the life of any individual which is in excess of $40,000 for individual
policies (under yearly renewable term and coinsurance agreements) and $15,000
for group policies (under a group yearly renewable term agreement). To the
extent that reinsuring companies are unable to meet obligations under
reinsurance agreements, the Company would remain liable.
As discussed in Note 2, on September 22, 1995, Integrity entered into a
coinsurance and assumption reinsurance agreement with Union Bankers covering
Integrity's long term care and Medicare supplement business. Under the
agreement, Union Bankers directly assumed these liabilities.
NOTE 12--CONTINGENCIES
In the normal course of business, the Company is party to a number of lawsuits.
Management believes recorded claims liabilities are adequate to ensure these
suits will be resolved without material financial impact to the Company.
NOTE 13--LEASE COMMITMENTS
The Company leases various equipment. Presented below is a schedule by year of
future minimum rental payments required under those leases:
Year Rental
----- -----------
1997 $ 43,693
1998 39,353
1999 25,754
----- -----------
Total $ 108,800
----- -----------
The Company incurred rental expense of $59,783, $105,922 and $108,624 in
1996, 1995 and 1994, respectively.
NOTE 14--FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments, and the methods and assumptions used
in estimating their fair values, are as follows:
Fixed Maturities: The fair values for fixed maturities are based on quoted
market prices, where available. For those fixed maturities which are not
actively traded, fair values are estimated using values obtained from
independent pricing services. Available-for-sale fixed maturities are carried at
fair value in the accompanying statements of financial condition. At December
31, 1996 and 1995, the fair value of available-for-sale fixed maturities was
$47,040,591 and $46,917,198, respectively.
Equity Securities: The fair values for equity securities are based on quoted
market prices. Equity securities are carried at fair value in the accompanying
statements of financial condition. At December 31, 1996 and 1995, the fair value
of equity securities was $7,963,550 and $5,742,914, respectively.
Short-Term Investments: The carrying amount of short-term investments
approximates their fair value. At December 31, 1996 and 1995, the fair value of
short-term investments was $893,410 and $821,721, respectively.
42
<PAGE>
NOTE 14--FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents
approximates their fair value. At December 31, 1996 and 1995, the fair value of
cash and cash equivalents was $2,805,717 and $9,776,964, respectively.
Mortgage Loans: The carrying amount of mortgage loans approximates their fair
value. At December 31, 1996 and 1995, the fair value of mortgage loans was
$176,636 and $183,935, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair value.
At December 31, 1996 and 1995, the fair value of policy loans was $2,852,670 and
$2,720,396, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity
contracts approximates their fair value. At December 31, 1996 and 1995, the fair
value of investment-type fixed annuity contracts was $9,490,085 and $9,457,887,
respectively.
Notes Payable: The carrying amounts of notes payable approximate their fair
values. At December 31, 1996 and 1995, the fair value of notes payable was
$4,095,869 and $9,306,982, respectively.
NOTE 15--RELATED PARTY TRANSACTIONS
The Company has various transactions with its President and Chairman of the
Board (the "Chairman") or entities he controls. The Chairman provides investment
portfolio management for the Company and Citizens Security, through SMC
Advisors, Incorporated (of which the Chairman is the principal officer, a
director, and the sole shareholder). The investment portfolio management
contracts provide for total annual fixed fees of $30,000 and incentive
compensation equal to five percent (5%) of the sum of the net realized and
unrealized capital gains in the fixed maturities and equity securities
portfolios of the Company and Citizens Security during each contract year. No
incentive fees were earned for 1996 or 1994. An incentive fee of $245,578 was
earned and paid for 1995. Any excess of net realized and unrealized capital
losses over net realized and unrealized capital gains at the end of a contract
year is not carried forward to the next contract year. The Company also
maintains a portion of its investments under a Trust Agreement with a bank
controlled by its Chairman. Fees to the bank are based on assets held. In 1996
and 1995, such fees were $17,316 and $11,121, respectively. No such fees were
paid during 1994. In addition, the Chairman guarantees certain debt of the
Company for which he is compensated as described in Note 6.
43
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED
PARTIES
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
At December 31, 1996
- -------------------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D
- ----------------------------------------- -------------- ------------- --------------
Cost or Amount at
Amortized Which Shown in
Type of Investment Cost Fair Value Balance Sheet
- ----------------------------------------- -------------- ------------- --------------
<S> <C> <C> <C>
Available-for-sale:
United States Government and government
agencies and authorities $10,132,155 $ 9,957,463 $ 9,957,463
Public utilities 3,530,715 3,511,465 3,511,465
Convertible bonds and bonds with
warrants attached 3,050,812 3,057,573 3,057,573
All other corporate 30,524,877 30,514,090 30,514,090
- ----------------------------------------- -------------- ------------- --------------
Total fixed maturities available-for-sale $47,238,559 $47,040,591 $47,040,591
- ----------------------------------------- -------------- ------------- --------------
Equity securities available-for-sale 1:
Non-redeemable preferred stocks $ 2,039,867 $ 2,017,338 $ 2,017,338
Common stocks:
Banks, trust and insurance companies 685,712 931,438 931,438
Industrial, miscellaneous and all other 4,359,525 5,014,774 5,014,774
- ----------------------------------------- -------------- ------------- --------------
Total equity securities available-for-sale $ 7,085,104 $ 7,963,550 $ 7,963,550
- ----------------------------------------- -------------- ------------- --------------
Investment real estate $ 3,938,806 --- $ 3,938,806
Mortgage loans on real estate 176,636 --- 176,636
Policy loans 2,852,670 --- 2,852,670
Short-term investments 893,410 --- 893,410
- ----------------------------------------- -------------- ------------- --------------
Total Investments $62,185,185 --- $62,865,663
- ----------------------------------------- -------------- ------------- --------------
</TABLE>
1Cost for equity securities is original purchase price, adjusted for declines in
value believed to be other than temporary totaling $825,400.
44
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CITIZENS FINANCIAL CORPORATION
Condensed Balance Sheet
December 31, 1996 1995
- ------------------------------------------------- --------------- -------------
ASSETS
Cash and cash equivalents $ 356,402 $ 523,370
Fixed maturities available-for-sale, at fair
value (amortized cost of $731,429) --- 652,500
Equity securities available-for-sale, at fair
value (cost of $2,266,772 and $2,201,112 in 1996
and 1995, respectively 2,359,238 2,431,950
Short-term investments 342,219 ---
Investment in subsidiaries* 16,225,196 17,984,581
Current and deferred tax asset 550,045 406,371
Other assets 89,654 251,485
- ------------------------------------------------- -------------- -------------
Total Assets $19,922,754 $22,250,257
- ------------------------------------------------- -------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable to insurance subsidiary* $ 781,441 $ 3,498,798
Note payable to bank 3,875,000 4,900,000
Note payable to guarantor 220,869 205,326
Other liabilities 326,332 636,008
Dividends payable - redeemable convertible
preferred stock 101,750 ---
- ------------------------------------------------- -------------- -------------
Total Liabilities $ 5,305,392 $ 9,240,132
Redeemable Convertible Preferred Stock $ 4,043,907 $ 1,700,907
Common stock $ 1,275,724 $ 1,275,724
Additional paid-in capital 4,945,487 4,945,487
Net unrealized appreciation of available-
for-sale securities 61,027 100,260
Equity in net unrealized investment gains
of subsidiaries* 590,454 1,994,093
Retained earnings 3,753,224 3,046,115
- ------------------------------------------------- -------------- -------------
$10,625,916 $11,361,679
Less: 1,300 shares owned by wholly-owned
subsidiary (52,461) (52,461)
- ------------------------------------------------- -------------- -------------
Total Stockholders' Equity $10,573,455 $11,309,218
- ------------------------------------------------- -------------- -------------
Total Liabilities and Stockholders' Equity $19,922,754 $22,250,257
- ------------------------------------------------- -------------- -------------
This condensed financial statement should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of Citizens Financial
Corporation and Subsidiaries. Balances referenced with an asterisk (*) are
eliminated in the Consolidated Financial Statements of Citizens Financial
Corporation and Subsidiaries.
45
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CITIZENS FINANCIAL CORPORATION
Condensed Statement of Income
Year ended December 31, 1996 1995 1994
- ------------------------------------ ---------------- ------------- ------------
REVENUES (LOSSES)
Net realized investment gains (losses) $ (89,158) $ 174,642 $(216,879)
Dividend from subsidiary* 750,000 945,000 125,000
Service fee from subsidiary* 891,527 --- ---
Interest and dividend income 144,660 32,517 51,946
- ------------------------------------ ---------------- ------------- ------------
Total Revenues (Losses) 1,697,029 1,152,159 (39,933)
EXPENSES
Administrative and general expenses 984,792 432,721 409,265
Interest expense paid to subsidiary* 280,975 242,033 211,441
Interest expense other 497,454 175,107 ---
- ------------------------------------ ---------------- ------------- ------------
Total Expenses 1,763,221 849,861 620,706
- ------------------------------------ ---------------- ------------- ------------
Income (loss) before income taxes and
equity in undistributed earnings (66,192) 302,298 (660,639)
Income tax benefit 149,697 194,000 202,020
- ------------------------------------ ---------------- ------------- ------------
Income (loss) before equity in
undistributed earnings of subsidiaries 83,505 496,298 (458,619)
Equity in undistributed earnings of
subsidiaries 1,025,818 235,933 12,950
- ------------------------------------ ---------------- ------------- ------------
Net Income (Loss) $1,109,323 $732,231 $(445,669)
- ------------------------------------ ---------------- ------------- ------------
This condensed financial statement should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of Citizens Financial
Corporation and Subsidiaries. Balances referenced with an asterisk (*) are
eliminated in the Consolidated Financial Statements of Citizens Financial
Corporation and Subsidiaries.
46
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CITIZENS FINANCIAL CORPORATION
Condensed Statement of Cash Flows
Year ended December 31, 1996 1995 1994
- ------------------------------------------ -------------- ------------- ------------
<S> <C> <C> <C>
Cash from operations $ 236,155 $ 634,965 $ (297,928)
Cash flows from investing activities:
Purchases of available-for-sale securities (12,356,456) (8,060,845) (1,452,458)
Sales of available-for-sale securities 12,979,830 6,452,213 3,319,096
Redemption of affiliated preferred stock* 1,000,000 --- ---
Purchase of Integrity Life Insurance Company --- (7,098,801) ---
Change in short term investments, other (342,219) (44,775) (256,170)
- ------------------------------------------ -------------- ------------- ------------
Net cash provided by (used in) investing
activities 1,281,155 (8,752,208) 1,610,468
Cash flow from financing activities:
Issuance of redeemable convertible preferred
stock 2,343,000 1,700,907 ---
Note payable to bank --- 6,400,000 ---
Note payable to guarantor 15,543 205,326 ---
Payments on note payable to bank (1,025,000) (1,500,000) ---
Change in loan from insurance subsidiary* (2,717,357) 1,568,130 (1,197,457)
Dividends paid on redeemable convertible
preferred stock (300,464) --- ---
Other --- (251,485) ---
- ------------------------------------------ -------------- ------------- ------------
Net cash provided by (used in) financing
activities (1,684,278) 8,122,878 (1,197,457)
- ------------------------------------------ -------------- ------------- ------------
Net increase in cash and cash equivalents (166,968) 5,635 115,083
Cash and cash equivalents at beginning of year 523,370 517,735 402,652
- ------------------------------------------ -------------- ------------- ------------
Cash and cash equivalents at end of year $ 356,402 $ 523,370 $ 517,735
- ------------------------------------------ -------------- ------------- ------------
</TABLE>
This condensed financial statement should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of Citizens Financial
Corporation and Subsidiaries. Balances referenced with an asterisk (*) are
eliminated in the Consolidated Financial Statements of Citizens Financial
Corporation and Subsidiaries.
47
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CITIZENS FINANCIAL CORPORATION
Notes to Condensed Financial Statements
Note A - Basis of Presentation
The Registrant's investment in the Insurance Subsidiaries is stated at the
Insurance Subsidiaries' equity at the date of reorganization (cost for
non-insurance subsidiaries) plus equity in undistributed earnings and net
unrealized appreciation (depreciation) of securities since date of
reorganization or organization if later.
Note B - Note Payable to Insurance Subsidiary
The loan payable to insurance subsidiary is a $3,500,000 revolving credit
facility maturing December 31, 2003. The loan pays interest at prime plus 2% and
is collateralized by securities having a market value of $392,259 at December
31, 1996.
48
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
CITIZENS FINANCIAL CORPORATION
For the Years Ended December 31, 1996, 1995 and 1994
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J
Amortization
of Deferred
Policy
Future Acquisition
Policy Premium Costs
Deferred Benefits Other Policy Income Net and Present
Policy and Claims and and Investment Value of Other
Acquisition Policyholder Unearned Benefits Other and Other Benefits and Acquired Operating
Segment Costs Deposits Premiums Payable Considerations Income 1 Claims2 Business3 Costs4
- ------------------ ----------- ------------ ------------ ---------- ------------ ----------- ------------ ----------- ------------
Year Ended
December 31, 1996:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Life and Annuities $3,667,503 $55,497,162 $ 7,394 $ 918,999 $ 9,490,351 $3,995,006 $ 6,215,099 $1,291,149 $5,506,057
Accident and Health 124,436 1,934,980 176,219 505,699 8,457,272 192,494 5,812,338 11,082 2,489,940
- ------------------ ----------- ------------ ------------ ---------- ------------ ----------- ------------ ----------- ------------
$3,791,939 $57,432,142 $ 183,613 $1,424,698 $17,947,623 $4,187,500 $12,027,437 $1,302,231 $7,995,997
Year Ended
December 31, 1995:
Life and Annuities $3,355,484 $55,440,728 $ 8,108 $ 874,424 $ 5,726,770 $2,569,722 $ 3,731,622 $1,195,504 $4,199,127
Accident and Health 121,893 1,913,638 193,664 428,453 6,345,199 110,772 4,201,488 14,152 2,239,308
- ------------------ ----------- ------------ ------------ ---------- ------------ ----------- ------------ ----------- ------------
$3,477,377 $57,354,366 $201,772 $1,302,877 $12,071,969 $2,680,494 $ 7,933,110 $1,209,656 $6,438,435
Year Ended
December 31, 1994:
Life and Annuities $3,349,312 $28,759,042 $ 10,633 $ 286,526 $ 2,596,469 $1,921,978 $ 2,591,210 $ 503,561 $1,802,355
Accident and Health 122,400 1,432,125 193,845 274,447 5,365,109 103,288 3,334,434 13,509 2,162,973
- ------------------ ----------- ------------ ------------ ---------- ------------ ----------- ------------ ----------- ------------
$3,471,712 $30,191,167 $ 204,478 $ 560,973 $ 7,961,578 $2,025,266 $ 5,925,644 $ 517,070 $3,965,328
- ------------------ ----------- ------------ ------------ ---------- ------------ ----------- ------------ ----------- ------------
</TABLE>
1Net investment income is allocated based upon average policy reserves and
deposits.
2Includes interest on policyholder deposits and dividends credited to
participating policyholders.
1996 1995 1994
----------- ----------- ------------
3Amortization of deferred acquisition costs $911,543 $790,140 $446,290
Amortization of present value of acquired 390,688 419,516 70,780
----------- ----------- ------------
$1,302,231 $1,209,656 $517,070
----------- ----------- ------------
4Includes commissions, salaries and wages, general expense and depreciation
expense.
49
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE IV - REINSURANCE
CITIZENS FINANCIAL CORPORATION
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- --------------------------------------------------- --------------- ------------ --------------- ------------
Percentage
Ceded to Assumed of Amount
Gross other from other Net Assumed to
Amount Companies Companies Amount Net Amount
- --------------------------------------------------- --------------- ------------ --------------- ------------
YEAR ENDED DECEMBER 31, 1996:
<S> <C> <C> <C> <C>
Life insurance in force (1) $712,581,000 $129,287,000 $583,294,000
- --------------------------------------------------- --------------- ------------ --------------- ------------
Premiums and other considerations:
Life insurance 10,287,617 (797,266) 9,490,351
Accident and Health insurance 8,522,934 (65,662) 8,457,272
- --------------------------------------------------- --------------- ------------ --------------- ------------
Total premiums $ 18,810,551 $ (862,928) $ 17,947,623
- --------------------------------------------------- --------------- ------------ --------------- ------------
YEAR ENDED DECEMBER 31, 1995:
Life insurance in force (1) $769,471,000 $131,516,000 $637,955,000
- --------------------------------------------------- --------------- ------------ --------------- ------------
Premiums and other considerations:
Life insurance $ 6,435,749 $ 708,979 $ 5,726,770
Accident and Health insurance 6,489,339 144,140 6,345,199
- --------------------------------------------------- --------------- ------------ --------------- ------------
Total premiums $ 12,925,088 $ 853,119 $ 12,071,969
- --------------------------------------------------- --------------- ------------ --------------- ------------
YEAR ENDED DECEMBER 31, 1994:
Life insurance in force (1) $423,814,000 $151,209,000 $272,605,000
- --------------------------------------------------- --------------- ------------ --------------- ------------
Premiums and other considerations:
Life insurance $ 3,500,358 $ 903,889 $ 2,596,469
Accident and Health insurance 5,486,832 121,723 5,365,109
- --------------------------------------------------- --------------- ------------ --------------- ------------
Total premiums $ 8,987,190 $ 1,025,612 $ 7,961,578
- --------------------------------------------------- --------------- ------------ --------------- ------------
</TABLE>
(1) Excludes FEGLI and SGLI
50
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no change in accountants nor have there been any disagreements on
accounting and financial disclosure requiring disclosure pursuant to the
Instructions to this Item.
PART III
ITEM 10. DIRECTORS AND
EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning directors and executive officers of the Company
required by this Item is set forth under the captions "Election of Directors"
and "Executive Officers of the Company" in the Board of Director's Proxy
Statement for the Annual Meeting of Shareholders of the Company now scheduled
for May 21, 1997, and such information is here incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the caption "Executive
Compensation" in the Board of Directors' Proxy Statement for the Annual Meeting
of Shareholders of the Company now scheduled for May 21, 1997, and such
information is here incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The information required by this Item is set forth under the captions "Security
Ownership of Certain Beneficial Owners and Management" and "Election of
Directors" in the Board of Directors' Proxy Statement for the Annual Meeting of
Shareholders of the Company now scheduled for May 21, 1997, and such information
is here incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
The information required by this Item is set forth under the captions "Certain
Transactions" and "Certain Transactions Relating to Acquisition of Integrity
Life Insurance Company" in the Board of Directors' Proxy Statement for the
Annual Meeting of Shareholders of the Company now scheduled for May 21, 1997,
and such information is here incorporated by reference.
51
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-K:
(a)Financial Statements and Financial Statement Schedules.
The audited Consolidated Financial Statements of the Company and its
subsidiaries, the Financial Statement Schedules, and the related Report of
Independent Auditors listed in the Index to Financial Statements and
Financial Statement Schedule appearing under Item 8 of this Form 10-K.
(b)Reports on Form 8-K.
None.
(c)Exhibits.
The exhibits listed in the Index to Exhibits appearing on page .
Pursuant to paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company
agrees to furnish to the Commission upon request copies of instruments defining
the rights of holders of the Company's long term debt.
52
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CITIZENS FINANCIAL CORPORATION
March 26, 1997 By /s/ Darrell R. Wells
--------------------
Darrell R. Wells
President
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 Company and in
the capacities and on the dates indicated.
/s/ Darrell R. Wells Director and President March 26, 1997
- --------------------------
Darrell R. Wells (principal executive officer)
/s/ Brent L. Nemec Vice President, Accounting, March 26, 1997
- --------------------------
Brent L. Nemec Chief Financial Officer, and
Treasurer (principal financial
and accounting officer)
/s/ Lane A. Hersman Director and Executive March 26, 1997
- --------------------------
Lane A. Hersman Vice President
/s/ John H. Harralson, Jr. Director March 26, 1997
- --------------------------
John H. Harralson, Jr.
/s/ Frank T. Kiley Director March 26, 1997
- --------------------------
Frank T. Kiley
/s/ Charles A. Mays Director March 26, 1997
- --------------------------
Charles A. Mays
/s/ Earle V. Powell Director March 26, 1997
- --------------------------
Earle V. Powell
/s/ Thomas G. Ward Director March 26, 1997
- --------------------------
Thomas G. Ward
/s/ Margaret A. Wells Director March 26, 1997
- --------------------------
Margaret A. Wells
53
<PAGE>
INDEX TO EXHIBITS
(Item 14(c))
The documents listed in the following table are filed as Exhibits in response to
Item 14(c). Exhibits listed that are not filed herewith are incorporated herein
by reference.
Exhibit Sequential
No. Description Page No.
- -------------- ---------------------------------------------- -----------------
2.1 Stock Purchase Agreement dated March 24, 1995
between Southwestern Life Corporation and the
Company (Exhibit B omitted)(filed as Exhibit
2.1 to the Company's Form 8-K dated September
22, 1995)
2.2 Amendment to Stock Purchase Agreement dated
September 22, 1995 between Southwestern Life
Corporation and the Company (Exhibits omitted)
(filed as Exhibit 2.2 to the Company's Form 8-K
dated September 22, 1995)
3.1 Articles of Incorporation of the Company dated
September 11, 1990 as amended December 14, 1995
and June 5, 1996) (filed as Exhibit 3.1 to the
Company's Form 10-Q for the quarter ended June 30,
1996)
3.2 Bylaws of the Company adopted September 12, 1990
as amended March 25, 1994 (filed as Exhibit 3.2
to the Company's Form 10-K dated March 28, 1996)
4 Provisions of Articles of Incorporation of the
Company Defining the Rights of Holders of Class A
Stock (filed as Exhibit 4 to the Company's Form 10
Registration Statement)
10.1 Investment Management Agreements dated July 1, 1994
between Citizens Security and the Company and SMC
Advisors, Incorporated (filed as Exhibit 10.1 to
the Company's Form 10-K dated March 29, 1995)
10.2 Resolution of Board of Directors of the Company
adopted February 4, 1992 granting stock options to
Lane A. Hersman (filed as Exhibit 10.2 to the
Company's Form 10 Registration Statement)
10.6 Quota Share Coinsurance and Assumption Reinsurance
Agreement dated September 21, 1995 between Integrity
Life Insurance Company and Union Bankers Insurance
Company (Exhibits omitted) (filed as Exhibit 10.6
to the Company's Form 8-K dated September 22, 1995)
54
<PAGE>
Exhibit Sequential
No. Description Page No.
- -------------- ---------------------------------------------- -----------------
10.8 Guarantor's Compensation Agreement dated as of
September 22, 1995 between the Company and
Darrell R. Wells (including Exhibit C,
form of Guaranty Note)(Other exhibits omitted)
(filed as Exhibit 10.8 to the Company's Form
8-K dated Septem ber 22, 1995)
10.8A First Amendment to Guarantor's Compensation
Agreement dated September 21, 1996 between
the Company and Darrell R. Wells (filed as
Exhibit 10.8A to the Company's Form 10-Q for
the quarter ended September 30, 1996)
10.9 Form of Employment Agreement with Certain
Executives of the Company and Schedule of
Data (filed as Exhibit 10.9 to the
Company's Form 10-K dated March 28, 1996)
11 Statement Re: Computation of Per Share Earnings 56
(filed herewith)
21.1 Subsidiaries of the Registrant (filed herewith) 57
27 Financial Data Schedule (electronic filing only)
The Company agrees to furnish supplementally to the Commission upon request a
copy of the omitted schedules to Exhibits Nos. 2.1 and 2.2 as contemplated by
Rule 601(b)(2). The Company further agrees to furnish to the Commission on
request a copy of instruments defining the rights of holders of long-term debt
required to be filed by Rule 601(b)(4) but for the exception in Rule
601(b)(4)(iii).
55
<PAGE>
EXHIBIT 11
Re: Computation of per Share Earnings
Year Ended December 31, 1996 1995 1994
- ------------------------------------------------------ ------------ -----------
PRIMARY EARNINGS PER COMMON SHARE:
Net income $1,109,323 $ 732,231 $ (445,669)
Convertible preferred stock dividends 402,214 --- ---
- ------------------------------------------------------ ------------ -----------
Net Income applicable to common stock $ 707,109 $ 732,231 $ (445,669)
Average common shares outstanding 1,075,615 1,075,615 1,078,369
- ------------------------------------------------------ ------------ -----------
Primary earnings per common share $ 0.66 $ 0.67 $ (0.41)
- ------------------------------------------------------ ------------ -----------
FULLY DILUTED EARNINGS PER COMMON SHARE:
Net income $1,109,323 $ 732,231 $ (445,669)
Average number of shares for computation
of fully diluted
earnings per common share 1,793,148 1,089,379 1,078,369
- ------------------------------------------------------- ------------ -----------
Fully diluted earnings per common share $ 0.62 $ 0.67 $ (0.41)
- ------------------------------------------ ------------ ------------ -----------
56
<PAGE>
EXHIBIT 21.1
Subsidiaries of the Registrant
Citizens Financial Corporation
(Kentucky corporation)
100% 100%
------------------------------------------------
Citizens Security Life Citizens Financial
Insurance Company Properties, Inc.
(Kentucky corporation) (Kentucky corporation)
Citizens Financial Properties, Inc. is presently inactive and has no
material assets or liabilities.
57
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
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<DEBT-CARRYING-VALUE> 0
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<REAL-ESTATE> 3,939
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<CASH> 2,806
<RECOVER-REINSURE> 232
<DEFERRED-ACQUISITION> 3,792
<TOTAL-ASSETS> 80,263
<POLICY-LOSSES> 41,502
<UNEARNED-PREMIUMS> 214
<POLICY-OTHER> 1,210
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4,044
0
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17,948
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<UNDERWRITING-OTHER> 8,110
<INCOME-PRETAX> 1,336
<INCOME-TAX> 226
<INCOME-CONTINUING> 1,109
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<EPS-PRIMARY> 0.66
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