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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1999
TRANSITION REPORT UNDER 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
(Name of small business issuer in its charter)
Kentucky 61-1187135
(State of Incorporation) (I.R.S. Employer Identification No.)
12910 Shelbyville Road, Louisville, Kentucky 40243
(Address of principal executive offices)
(502) 244-2420
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Class A
Stock, No Par Value
Check whether the issuer (1) filed all reports required to be filed by
Sections 13 or 15(d) of the Exchange Act during the past 12 months, and (2)
has been subject to such filing requirements for the past 90 days. Yes
X No
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy
information incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year: $36,263,112.
State the aggregate market value of the common equity held by
non-affiliates: $8,990,650 (based on a $12.50 per share quoted bid price on
March 27, 2000).
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 1,762,715 shares of Class A
stock as of March 27, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's Board of Director's Proxy Statement for the Annual
Meeting of Shareholders now scheduled for May 25, 2000 are incorporated into
Part III of this Form 10-KSB.
Transitional Small Business Disclosure Format (Check one): Yes
No X
The date of this Report is March 29, 2000.
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CONTENTS
PART I
Page
ITEM 1. DESCRIPTION OF BUSINESS....................................... 3
ITEM 2. DESCRIPTION OF PROPERTY....................................... 10
ITEM 3. LEGAL PROCEEDINGS............................................. 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS ................................................. 10
PARTII
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS ............................. 10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR
PLAN OF OPERATIONS ...................................... 12
ITEM 7. FINANCIAL STATEMENTS.......................................... 25
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ..................... 46
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT ....... 46
ITEM 10. EXECUTIVE COMPENSATION ........................................ 46
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ................................... 46
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS ............................................ 46
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K .............................. 47
SIGNATURES .............................................................. 48
EXHIBIT INDEX ........................................................... 49
This report contains projections and other forward-looking statements regarding
future events or the future financial performance of the Company. Actual events
and results may differ materially from those in the projections and other
forward-looking statements set forth herein. Among the important factors that
could cause actual events or results to differ materially from those in the
projections and other forward-looking statements are general economic conditions
, including interest rate changes and stock market performance; the Company's
ability to achieve operating effciencies; customer response to marketing efforts
; mortality and morbidity trends; changes in Federal tax law; competition;
regulatory changes; actions of independent rating agencies, and unaticipated
litigation. Readers are referred to the Items 1,6 and 7 in this report and to
the Company Report on Financial Statements in the Company's Annual Report for a
discussion of these and other important risk factors concerning the Company and
its operations.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Citizens Financial Corporation (herein, the "Company" or the "Registrant")
was incorporated in Kentucky in 1990 at the direction of the Board of
Directors of Citizens Security Life Insurance Company ("Citizens Security")
for the ultimate purpose of becoming an insurance holding company. Pursuant
to a merger completed in 1991, Citizens Security became a wholly-owned
subsidiary of the Company. The Company is now a holding company that engages
in the business of life insurance, annuities, and accident and health
insurance through Citizens Security and United Liberty Life Insurance Company
("United Liberty") (herein collectively, the "Life Insurance Subsidiaries").
On October 14, 1999, the Company acquired Kentucky Insurance Company
("Kentucky Insurance"), which is licensed as a property and casualty insurer
in four states. Kentucky Insurance is planning to offer home service fire
and casualty insurance coverage; however, it currently has no business
inforce. The Life Insurance Subsidiaries and Kentucky Insurance are herein
collectively referred to as the "Insurance Subsidiaries".
Citizens Security was incorporated in Kentucky and commenced business in
1965. In 1971, Citizens Security acquired Central Investors Life Insurance
Company by merger. In 1987, it purchased the stock of Old South Life
Insurance Company ("Old South"). In 1992, Old South merged into Citizens
Security. In 1995, the Company and Citizens Security purchased substantially
all of the stock of Integrity National Life Insurance Company ("Integrity")
and merged it into Citizens Security. On May 12, 1998, Citizens Security
purchased all of the outstanding shares of United Liberty. See Item 6.
"Management's Discussion and Analysis or Plan of Operations" and Item 7, Note
2 of the Notes to Consolidated Financial Statements for a description of this
acquisition. The Life Insurance Subsidiaries are currently licensed to
transact the business of life insurance, annuities, and accident and health
insurance. Citizens Security is licensed in twenty states and the District
of Columbia while United Liberty is licensed in twenty-three states.
Insurance Operations
The Company, through its Life Insurance Subsidiaries, operates in five
segments -- 1) home service life insurance, 2) broker-sold life insurance and
annuities, 3) preneed life insurance, 4) dental insurance, and 5) other
health and accident insurance. The home service and preneed life segments
provide individual coverages; the dental segment provides group coverages;
while the broker life and other health segments include individual and group
insurance coverages. The following table presents each business segment's
revenue; pretax income or loss excluding realized investment gains and
interest expense; and ending assets for each of the last three fiscal years.
Additional segment information is contained in Item 6, "Management's
Discussion and Analysis or Plan of Operations" and in Item 7, Note 11 of the
Notes to Consolidated Financial Statements.
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Segment Revenue, Profit or Loss, and Assets:
Year Ended December 31 1999 1998 1997
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Revenue:
Home Service Life $ 8,745,144 $ 8,315,665 $ 8,322,333
Broker Life 6,003,025 5,341,104 4,482,486
Preneed Life 3,614,758 2,099,584 ---
Dental 7,141,409 6,435,680 7,218,575
Other Health 1,383,437 1,409,483 1,485,301
- ----------------------------------------------------------------------------
Segment Totals 26,887,773 23,601,516 21,508,695
Net realized investment gains,
net of expenses 9,375,339 3,675,489 2,193,148
- ----------------------------------------------------------------------------
Total Revenue $36,263,112 $27,277,005 $23,701,843
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Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------------------
Segment Profit (Loss):
Home Service Life $ 312,703 $ 211,713 $ 97,098
Broker Life 150,317 254,189 100,655
Preneed Life (993,560) 15,325 ---
Dental 436,587 295,038 214,495
Other Health (64,524) 90,174 206,591
- ----------------------------------------------------------------------------
Segment Totals (158,477) 866,439 618,839
Net realized investment gains,
net of expenses 9,375,339 3,675,489 2,193,148
Interest expense 553,017 468,268 341,275
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Income before Income Tax $ 8,663,845 $ 4,073,660 $ 2,470,712
- ----------------------------------------------------------------------------
December 31 1999 1998 1997
- ----------------------------------------------------------------------------
Assets:
Home Service Life $ 47,347,032 $43,299,037 $42,944,975
Broker Life 57,958,271 52,783,159 39,165,663
Preneed Life 29,754,353 30,869,962 ---
Dental 913,939 674,728 699,382
Other Health 2,006,435 1,872,237 1,939,822
- ----------------------------------------------------------------------------
Total Assets $137,980,030 $129,499,123 $84,749,842
- ----------------------------------------------------------------------------
Home Service Life. The Home Service Life segment 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. Agents for these products sell primarily small face value
policies (typically from $1,000 to $10,000). These policies are subject to
normal underwriting procedures with the extent of such procedures determined
by the amount of insurance, age of applicant and other pertinent factors.
Broker Life. The Broker Life segment offers traditional whole life
insurance; universal life insurance, which provides policyholders with
permanent life insurance and adjustable rates of return on the cash value
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element of policy premiums, based upon current interest rates; annuities;
group life; accidental death and dismemberment; and dependent life
insurance. The majority of Broker Life sales consist of whole life graded
death benefit and simplified issue policies.
The graded death benefit policy, introduced in the second quarter of 1997,
returns premium plus interest compounded at an annual rate of 10% if the
insured dies of natural causes during the first three years the policy is in
force. After three years, and during the first three years if the insured
dies of an accidental cause, the benefit payable is the face amount of the
policy. The simplified issue product provides full face amount coverage from
date of issue, is more extensively underwritten and carries lower premium
rates than the graded death benefit product. This product was introduced in
the third quarter of 1997. These products are targeted towards the "final
expense market".
Generally, traditional whole life insurance products are more profitable than
universal life policies, in part because investment margins are normally
greater for traditional whole life products than for universal life
policies. Overall profitability on universal life policies may decline as a
result of downward interest crediting rate adjustments to the extent that
policyholders withdraw funds to invest in higher-yielding financial
products. The profitability of traditional whole life products and universal
life policies is also dependent upon the ultimate underwriting experience and
the realization of anticipated unit administrative costs. The Company
believes that the historical claims experience for the traditional whole life
and universal life products issued by the Life Insurance Subsidiaries has
been within expected ranges, in relation to the mortality assumptions used to
price the products.
Substantially all annuity considerations are attributable to sales of
flexible premium deferred annuities, life policy annuity riders, and single
premium deferred annuities. Generally, a flexible premium deferred annuity
or a life policy annuity rider permits premium payments in such amounts as
the policyholder deems appropriate, while a single premium deferred annuity
requires a one-time lump sum payment.
Preneed Life. The Preneed Life segment products are traditional life
policies sold to individuals in connection with prearrangement of their
funeral and include single and multi-pay coverages, generally in amounts of
$10,000 and less. These policies are generally sold to older individuals at
increased premium rates.
The following table provides information concerning the Life Insurance
Subsidiaries' volume of life insurance coverage in force excluding
participation in group underwriting pools for federal employees (FEGLI) and
service personnel (SGLI) for each of the last three fiscal years.
Year Ended December 31
(Dollars in Thousands) 1999 1998 1997
- ----------------------------------------------------------------------------
In force at beginning of period1 $757,571 $680,664 $712,581
Acquired business of United Liberty --- 88,107 ---
New business issued during period:
Individual 84,640 65,860 61,519
Group 7,170 4,026 3,755
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Total $ 91,810 $ 69,886 $ 65,274
- ----------------------------------------------------------------------------
Terminations during period $ 83,941 $ 81,086 $ 97,191
Termination rate2 11.70% 10.80% 13.64%
In force at end of period1:
Individual 605,309 590,467 507,381
Group 160,131 167,104 173,283
- ----------------------------------------------------------------------------
Total $765,440 $757,571 $680,664
- ----------------------------------------------------------------------------
Net reinsurance ceded at end of
period $119,001 $122,993 $115,218
1Before deduction of reinsurance ceded.
2Represents the percentage of individual policies terminated during the
indicated period by lapse, surrender, conversion, maturity, or otherwise.
For 1998, terminations of United Liberty policies have been annualized.
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Dental Insurance. Dental products are indemnity policies sold on a pure
group and voluntary group basis. Voluntary dental groups must meet
prescribed participation limits. All dental products have annual limits on
all covered procedures and lifetime limits on orthodontia procedures. In
addition, orthodontia and major restorative procedures are not covered for
the first six months to one year, depending upon the plan, unless a
no-loss-no-gain provision is attached to the policy.
Other Health Insurance. Other Health products include individual accident
and health insurance policies, which provide coverage for monthly income
during periods of hospitalization, scheduled reimbursement for specific
hospital and surgical expenses and cancer treatments, and lump sum payments
for accidental death or dismemberment. Group health plans are also offered,
providing coverage for short and long-term disability, and income
protection. The Company is not allocating significant marketing resources to
this segment.
Marketing. The Life Insurance Subsidiaries are currently licensed to sell
products in 29 states and the District of Columbia. Citizens Security and
United Liberty are both licensed in the states designated below with a "b"
while only Citizens Security is licensed in the states designated "c" and
only United Liberty in the states designated "u".
b Alabama b Indiana u Nebraska u Oregon
u Arizona u Kansas u Nevada c Pennsylvania
b Arkansas b Kentucky c New Jersey b South Carolina
u Colorado b Louisiana u New Mexico b Tennessee
c Delaware b Maryland c North Carolina b Texas
c District of Columbia b Mississippi u Oklahoma u Utah
b Florida b Missouri b Ohio c Virginia
c Georgia b West Virginia
The Life Insurance Subsidiaries market products through the personal
producing general agent distribution system. Approximately 2,400 sales
representatives are licensed as independent agents for the Life Insurance
Subsidiaries. The majority of these agents also represent other insurers.
Approximately 350 of these agents specialize in the home service market.
That market consists primarily of middle and low-income families and
individuals who desire whole life policies with policy limits typically below
$10,000. Agents usually collect premiums directly at monthly intervals. The
home service market has higher than average policy lapse rates.
Approximately 120 agents specialize in the preneed market. Typically, these
agents are funeral directors or operate from facilities owned by funeral
directors.
The Life Insurance Subsidiaries furnish rate material, brochures,
applications, and other pertinent sales material, at no expense to the
agents. The agents are responsible for complying with state licensing laws
and any related appointment fees. Agents are compensated by commissions.
The Life Insurance Subsidiaries have agent commission arrangements that are
generally intended to provide competitive incentives for agents to increase
their production of new insurance and to promote continued renewals of
in-force insurance. Historically, these incentives have frequently involved
awards, overrides, and compensation scales that escalate according to
achievement levels for newly-issued business and that provide additional
payments for renewal business.
Underwriting. The Life Insurance Subsidiaries follow underwriting procedures
designed to assess and quantify insurance risks before issuing life and
health insurance policies to individuals and members of groups. Such
procedures require medical examinations (including blood tests, where
permitted) of applicants for certain policies of health insurance and for
policies of life insurance in excess of certain policy limits. These
requirements are graduated according to the applicant's age and vary by
policy type. The Life Insurance Subsidiaries also rely 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 Life Insurance
Subsidiaries. Evaluating the impact of future AIDS claims under health and
life insurance policies issued is extremely difficult, in part due to the
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insufficiency and conflicting data regarding the number of persons now
infected with the AIDS virus, uncertainty as to the speed at which the AIDS
virus has and may spread through the general population, and advancements in
medical treatment options. The Life Insurance Subsidiaries have implemented,
where legally permitted, underwriting procedures designed to assist in the
detection of the AIDS virus in applicants.
Investments. The Company derives a substantial portion of its revenue from
investments. The Life Insurance Subsidiaries maintain diversified investment
portfolios that are held primarily to fund future policyholder obligations.
State insurance laws impose certain restrictions on the nature and extent of
investments by insurance companies and, in some states, require divestiture
of assets contravening these restrictions. Within the framework of such
laws, the Life Insurance Subsidiaries follow a general strategy to maximize
total return (current income plus appreciation) without subjecting themselves
to undue risk. Where deemed appropriate, the Life Insurance Subsidiaries
will hold selected non-investment grade bonds that provide higher yields or
are convertible to common stock. The Company considers a bond non-investment
grade if it is unrated or rated less than BBB by Standard & Poor's Rating
Group ("S&P") or BAA by Moody's Investors Service ("Moody's"). The Life
Insurance Subsidiaries' non-investment grade bonds, based on reported fair
values, represented 5.6% of the Company's cash and invested assets as of
December 31, 1999. Citizens Security has maintained substantial investments
in equity securities in order to achieve higher investment earnings than can
usually be achieved through portfolio bonds but at a greater comparative
risk. The Company also maintains an investment portfolio of equity
securities separate from those of the Life Insurance Subsidiaries. Mortgage
loans, federally-insured mortgage-backed securities, collateralized mortgage
obligations and real estate investments, apart from the investment in the
office building described in Item 2. "Description of Property," represented
approximately 3.9% of cash and invested assets as of December 31, 1999.
Neither the Company nor its subsidiaries owned any collateralized
mortgage-backed securities as of December 31, 1999 that would be included in
the high-risk classification.
For additional information concerning investment results, see Item 6,
"Management's Discussion and Analysis or Plan of Operations."
Reinsurance. In keeping with industry practice, the Life Insurance
Subsidiaries reinsure, with unaffiliated insurance companies, portions of the
life and health insurance risks which they underwrite. The Life Insurance
Subsidiaries retain no more than $40,000 of individual life insurance risk
and $15,000 of group life insurance risk for any single life. Graded death
benefit and simplified issue coverages above $4,000 are generally 50%
reinsured, with the Life Insurance Subsidiaries maintaining a maximum $10,000
risk on any one life. Individual and group accidental death coverage is
100% reinsured. At December 31, 1999, approximately $119,001,000 or 16% of
life insurance in force was reinsured under arrangements described in Note 12
to the Consolidated Financial Statements. Under most reinsurance
arrangements described above, new insurance is reinsured automatically rather
than on a basis that would require the reinsurer's prior approval.
Generally, the Life Insurance Subsidiaries enter into indemnity reinsurance
arrangements to assist in diversifying their risks and to limit its maximum
loss on large or unusually hazardous risks. Indemnity reinsurance does not
discharge the ceding insurer's liability to meet policy claims on the
reinsured business. Accordingly, the Life Insurance Subsidiaries remain
responsible for policy claims on the reinsured business to the extent a
reinsurer should fail to pay such claims.
Competition. The insurance industry is highly competitive, with over 1,600
life and health insurance companies in the United States. Many insurers and
insurance holding company systems have substantially greater capital and
surplus, larger and more diversified portfolios of life and health insurance
policies, and larger agency sales operations than those of the Life Insurance
Subsidiaries. Financial and claims-paying ratings assigned to insurers by
A.M. Best Company ("Best") and by nationally-recognized statistical rating
organizations have become more important to policyholders. Citizens
Security's rating was last changed by Best in October, 1999, when it was
upgraded to B (Fair) from B- (Fair). United Liberty's rating at the date of
its acquisition was B- (Fair). According to Best, B and B- ratings are
assigned to companies that have on balance, fair financial strength,
operating performance and market profile when compared to the standards
established by Best. Also according to Best, B and B- companies have an
ability to meet their current obligations to policyholders, but their
financial strength is vulnerable to adverse changes in underwriting or
economic conditions. There are six Best rating categories above the B
category from B+ to A++. The Life Insurance Subsidiaries will continue to
pursue upward revisions in their Best ratings. Kentucky Insurance has no
insurance business inforce and is not rated by Best.
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S&P assigns claims-paying ability ratings to certain U.S. insurers.
Generally, such a rating is S&P's opinion of an insurer's financial capacity
to meet the obligations of its insurance policies in accordance with their
terms. In the case of companies like Citizens Security that have not
requested ratings, S&P's methodology uses statistical tests based on
statutory financial data as filed with the National Association of Insurance
Commissioners ("NAIC"). The rating process does not involve contact between
S&P analysts and the insurer's management. In 1998, S&P changed their rating
methodology and revised Citizens Security's rating from BBQ to BBPI. (The
"q" subscript designated the quantitative method of rating while the "p"
subscript designates the public information method). United Liberty has not
been rated by S&P. According to S&P, BB companies may have adequate
financial security but their capacity to meet policyholder obligations is
vulnerable to adverse economic and underwriting conditions. The BB rating is
the highest of five ratings in the vulnerable range of ratings. 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.
The Life Insurance Subsidiaries compete primarily on the basis of the
experience, size, accessibility and claims response of its customer service
representatives, product design, service and pricing. The Company believes
that the Life Insurance Subsidiaries are generally competitive in the markets
in which they are engaged based upon premium rates and services, have good
relationships with their agents, and have an adequate variety of insurance
and annuity products approved for issuance.
State Insurance Regulation. The Insurance Subsidiaries, in common with other
insurers, are subject to comprehensive regulation in the states in which they
are authorized to conduct business. The laws of such states establish
supervisory agencies with broad administrative powers, among other things, to
grant and revoke licenses for transacting business, regulate the form and
content of policies, establish reserve requirements, prescribe the type and
amount of allowable investments, and review premium rates for fairness and
adequacy. The Insurance Subsidiaries file detailed annual convention
statements with all states in which they are licensed to transact business.
The Kentucky Department of Insurance also periodically examines the business
and accounts of the Insurance Subsidiaries.
The Life Insurance Subsidiaries also can be required, under the solvency or
guaranty laws of most states in which they do business, to pay assessments
(up to prescribed limits) to fund policyholder losses or liabilities of other
insurance companies that become insolvent. These assessments may be deferred
or foregone under most guaranty laws if they would threaten an insurer's
financial strength and, in certain instances, may be offset against future
premium or intangible property taxes. Gross assessments for the Life
Insurance Subsidiaries, net of refunds but before offsets for future premium
or intangible property taxes, were $(13,000), $24,665, and $15,325 in 1999,
1998 and 1997, respectively.
Kentucky, in common with substantially all states, regulates transactions
between or affecting insurance holding companies and their insurance company
subsidiaries, including the Company and the Insurance Subsidiaries.
Generally, under Kentucky insurance holding company statutes, the Kentucky
Department of Insurance must approve in advance the direct or indirect
acquisition of 15% or more of the voting securities of an insurance company
organized under the laws of Kentucky. Such statutes also regulate certain
transactions among affiliates, including the payment of dividends by an
insurance company to its holding company parent. Under the Kentucky
statutes, the Insurance Subsidiaries may not during any year pay dividends on
their common and preferred stock to their parent company in excess of the
lesser of the net gain from operations for the preceding year or 10% of their
capital and surplus at the end of the preceding year, without the consent of
the Kentucky Commissioner of Insurance. For 2000, the maximum amount of
dividends that Citizens Security, United Liberty, and Kentucky Insurance
could pay, without the Commissioner's approval, is $569,000, $236,000, and
$150,000 respectively. It is presently anticipated that the Company will
derive substantially all of its liquidity from income and capital gains
earned on its investment portfolio, management service fees and dividends
paid by the Insurance Subsidiaries, and Citizens Security's repurchase of its
preferred stock owed by the Company.
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During recent years, the National Association of Insurance Commissioners
(NAIC) has taken several steps to address public concerns regarding insurer
solvency. These steps included implementing a state certification program
designed to promote uniformity among the insurance laws of the various states
and developing insurer reporting requirements that focus on asset quality,
capital adequacy, profitability, asset/liability matching, and liquidity.
These requirements include establishment of asset valuation reserves ("AVR")
and interest maintenance reserves ("IMR"), risk-based capital ("RBC") rules
to assess the capital adequacy of an insurer, and a revision to the Standard
Valuation Law ("SVL") that specifies minimum reserve levels and requires cash
flow testing in which projected cash inflows from assets are compared to
projected cash outflows for liabilities to determine reserve adequacy.
The Life Insurance Subsidiaries' AVR, as of December 31, 1999, 1998 and 1997,
is shown in Item 6. "Management's Discussion and Analysis or Plan of
Operations". Cash flow testing and the results of such testing as applied to
the Life Insurance Subsidiaries are also described and discussed in Item 6.
RBC provides a means of establishing the capital standards for insurance
companies to support their overall business operations in light of their size
and risk profile. The four categories of major risk involved in the formula
are [i]asset risk -- the risk with respect to the insurer's assets;
[ii]insurance risk -- the risk of adverse insurance experience with respect
to the insurer's liabilities and obligations; [iii]interest rate risk -- the
interest risk with respect to the insurer's business; and [iv]business risk
- -- all other business risks. A company's RBC is calculated by applying
factors to various asset, premium and reserve items, with higher factors for
those items with greater underlying risk and lower for less risky items. RBC
standards are used by regulators to set in motion appropriate regulatory
actions relating to insurers that show signs of weak or deteriorating
conditions. They also provide an additional standard for minimum capital,
below which companies would be placed in conservatorship. Based on RBC
computations as of December 31, 1999, the Insurance Subsidiaries each have
capital levels which are at least 400% of the minimum requirements.
Action taken by the NAIC in these and other areas may have a significant
impact on the regulation of insurance companies during the next several
years. Given their comparatively small size, it may be expected that the
Life Insurance Subsidiaries 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. The Life Insurance Subsidiaries are taxed under the
life insurance company provisions of the Internal Revenue Code of 1986, as
amended (the "Code"). Under the Code, a life insurance company's taxable
income incorporates all income, including life and health premiums,
investment income, and certain decreases in reserves. The Code currently
establishes a maximum corporate tax rate of 35% and imposes a corporate
alternative minimum tax rate of 20%. See Item 6. "Management's Discussion
and Analysis or Plan of Operations" and Note 9 of the Notes to Consolidated
Financial Statements.
The Code currently requires capitalization and amortization over a five to
ten year period of certain policy acquisition costs incurred in connection
with the sale of certain insurance products. Prior tax laws permitted these
costs to be deducted as incurred. These provisions apply to life, health,
and annuity business. Certain proposals to make additional changes in the
federal income tax laws, including increasing marginal tax rates, and
regulations affecting insurance companies or insurance products, continue to
be considered at various times in the United States Congress and by the
Internal Revenue Service. The Company currently cannot predict whether any
additional changes will be adopted in the foreseeable future or, if adopted,
whether such measures will have a material effect on its operations.
Reserves. In accordance with applicable insurance laws, the Life Insurance
Subsidiaries have established and carry as liabilities actuarial reserves to
meet their policy obligations. Life insurance reserves, when added to
interest thereon at certain assumed rates and premiums to be received on
outstanding policies, are required to be sufficient to meet policy
obligations. The actuarial factors used in determining reserves in the
statutory basis financial statements are based upon statutorily-prescribed
mortality and interest rates. Reserves maintained for health insurance
include the unearned premiums under each policy, reserves for claims that
have been reported but not yet paid, and reserves for claims that have been
incurred but have not been reported. Furthermore, for all health policies
under which renewability is guaranteed, additional reserves are maintained in
recognition of the actuarially-calculated probability that the frequency and
amount of claims will increase as policies persist. The Life Insurance
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Subsidiaries do not continue accumulating reserves on reinsured business
after it is ceded. The Life Insurance Subsidiaries are required to maintain
reserves on reinsured business assumed on a basis essentially comparable to
direct insurance reserves. Reinsurance business assumed is presently
insignificant in amount.
The reserves carried in the financial statements included elsewhere in this
Form 10-KSB are calculated on the basis of accounting principles generally
accepted in the United States and differ from the reserves specified by the
laws of the various statutes and carried in the financial statements of the
Life Insurance Subsidiaries 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 accounting principles generally accepted
in the United States.
Employees. As of March 27, 2000, 77 people, excluding agents, were employed
by the Company. As of that date, the Company had approximately 2,400
independent agents licensed to sell its products.
ITEM 2. DESCRIPTION OF PROPERTY
The Company owns, through Citizens Security, a three-story, 63,000 square
foot office building in suburban Louisville, Kentucky completed in 1988. The
Company and its Subsidiaries occupy about 28% of the building for their
headquarters and home offices. The Company leases the remaining space to
unaffiliated tenants under leases of various duration. Market conditions for
this property are favorable and, in management's opinion, the property is
adequately covered by insurance. Currently, the Company's policy is not to
invest in additional real estate or real estate mortgages, although a change
in such policy would not require a vote of security holders. In addition,
the Company's current bank lending agreement precludes investment in
additional real estate and in mortgages with a loan-to-appraised-value ratio
of more than 75%.
ITEM 3. LEGAL PROCEEDINGS
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 Form 10-KSB to a vote of the Company's security holders, through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
As of March 27, 2000, there were approximately 2,700 holders of record of the
Company's Class A Stock, its only class of common equity.
The Class A Stock is currently eligible for quotation on the National
Association of Securities Dealers, Inc.'s Small-Cap Market ("NASDAQ") under
the trading symbol CNFL. Trading volume in 1999 was about 10% of the average
shares outstanding during the year and trading volume by non-affiliates was
about 23% of the average shares owned by non-affiliates during the year.
10
<PAGE>
The following table summarizes quarterly high and low bid quotations for the
Class A Stock in 1999 and 1998 as reported by NASDAQ. Such quotations
reflect inter-dealer prices and do not include retail markup, markdown, or
commission, and may not represent actual transactions.
Bid Quotations for
Class A Stock
--------------------------
Quarter
Ended High Bid Low Bid
--------------------------
December 31, 1999 $ 12.469 $ 10.750
September 30, 1999 $ 12.500 $ 11.000
June 30, 1999 $ 11.250 $ 9.250
March 31, 1999 $ 11.000 $ 8.438
December 31, 1998 $ 10.250 $ 8.000
September 30, 1998 $ 12.000 $ 10.250
June 30, 1998 $ 15.125 $ 9.000
March 31, 1998 $ 10.000 $ 6.000
The Company has not paid a dividend on the Class A Stock. The Board of
Directors of the Company has not adopted a dividend payment policy; however,
dividends must necessarily depend upon the Company's earnings and financial
condition, applicable legal restrictions, and other factors relevant at the
time the Board of Directors considers a dividend policy. The Company is
subject to a loan agreement covenant that prevents it from paying dividends
on the Class A Stock without the consent of the lender except to the extent
it can meet certain requirements relating to the ratio of its 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, 2000,
the Company could pay dividends in the maximum amount of approximately
$3,025,000 without violating the loan agreement covenant. Cash available for
dividends to shareholders of the Company must initially come from income and
capital gains earned on its investment portfolio, management service fees and
dividends paid by the Insurance Subsidiaries, and Citizens Security's
repurchase of its preferred stock owned by the Company. Provisions of the
Kentucky Insurance Code relating to insurance holding companies subject
transactions between the Company and the Insurance Subsidiaries, including
dividends paid to the Company, to certain standards generally intended to
prevent such transactions from adversely affecting the adequacy of the Life
Insurance Subsidiaries' capital and surplus available to support policyholder
obligations. See Item 1. "Description of Business -- State Insurance
Regulation." In addition, under the Kentucky Business Corporation Act, the
Company may not pay dividends if, after giving effect to a dividend, it would
not be able to pay its debts as they become due in the usual course of
business or if its total liabilities would exceed its total assets.
11
<PAGE>
ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS
OR PLAN OF OPERATIONS
During 1999, earnings per share increased 97% to $3.59 compared to the prior
year while equity per share increased 32% to $15.86. A significant portion
of these record results is attributable to successful management of the
Company's investment portfolio. As detailed below, during the past three
years the Company has maintained an equity portfolio averaging approximately
$15,600,000 (cost basis) which has yielded an average annual pretax total
return in excess of 40%. This cumulative pre-tax total return on equity
positions exceeded $19,500,000 during the past three years.
During 1999, the Company achieved sales increases in all four of its active
product segments, Home Service Life, Broker Life, Preneed Life and Dental.
Pretax segment income for 1999, excluding realized investment gains and
interest expense declined to a loss of $158,000, from a prior year gain of
$866,000. This decline was impacted by the decision to hold increased equity
positions, thus reducing the amount of "non-realized gain" investment income
allocated to operations. If the Company had invested its equities in fixed
maturities yielding 7%, 1999 pre-tax segment income would have been
approximately $922,000 higher, and realized investment gains would have
declined. In addition, 1999 segment income was impacted by additional
marketing expenditures in the recently acquired Preneed Life Insurance
segment and moderate increases in mortality, partially offset by continuing
improvement in Dental sales volume and profit margins.
As described below, on October 14, 1999, the Company completed acquisition of
Kentucky Insurance Company for a total purchase price of approximately
$3,550,000. During 2000, the Company plans to make property and casualty
"fire and contents" insurance available to its Home Service agents in
approximately five states.
Also during 1999, the Company repurchased 35,400 shares of its common stock
during the year at an average price of $11.05 per share.
The Company manages its operations in five business segments, Home Service
Life, Broker Life, Preneed Life, Dental, and Other Health. Products in all
five segments are sold through independent agency operations. Home Service
Life consists primarily of traditional life insurance coverage sold in
amounts of $10,000 and under to middle and lower income individuals. This
distribution channel is characterized by a significant amount of agent
contact with customers throughout the year. Broker Life product sales
consist primarily of simplified issue and graded-benefit policies in amounts
of $10,000 and under. Other products in the Broker Life segment which
comprise a significant portion of existing business include group life,
universal life, annuities and participating life coverages. Preneed Life
products are sold to individuals in connection with prearrangement of their
funeral and include single and multi-pay coverages, generally in amounts of
$10,000 and less. These policies are generally sold to older individuals at
increased premium rates. Dental products are term coverages generally sold to
small and intermediate size employer groups. Other Health products include
various accident and health coverages sold to individuals and employer
groups. Profit or loss for each segment is reported on a pretax basis,
without an allocation of realized investment gains or interest expense.
ACQUISITIONS
Kentucky Insurance Company
On October 14, 1999, the Company acquired 100% of the stock of Kentucky
Insurance from an unaffiliated insurance holding company (the "Kentucky
Insurance Acquisition"). Kentucky Insurance is licensed as a property and
casualty insurance company in four states and has approximately $3.2 million
of statutory capital and surplus; however, it currently has no insurance
operations. The aggregate purchase price for the Kentucky Insurance
Acquisition was approximately $3,550,000 (including net costs associated with
the transaction of approximately $50,000). The acquisition was financed with
available internal funds and $2,500,000 of additional bank borrowings at the
prime rate.
12
<PAGE>
United Liberty Life Insurance Company
On May 12, 1998 the Company and Citizens Security acquired 100% of the common
stock of United Liberty from an unaffiliated insurance holding company (the
"United Acquisition"). The United Acquisition was accounted for as a
purchase and United Liberty's results of operations are included in the
consolidated statements since the date of acquisition. United Liberty's
primary business is traditional life insurance, including a presence in the
preneed funeral funding segment. This acquisition provided the Company with
its Preneed Life business segment, approximately 11% of the premium in its
overall Broker Life segment, and 3% of premium in the Other Health segment.
The aggregate purchase price for the United Acquisition was approximately
$7,076,000 (including net costs associated with the acquisition of
approximately $445,000). In conjunction with the acquisition, the seller
retained approximately $2,100,000 of United Liberty's real estate related and
other assets, which were replaced with cash by Citizens Security.
The United Acquisition was financed with the working capital of Citizens
Security and with approximately $3,400,000 of the $6,710,000 of proceeds
under a Term Loan Agreement dated as of May 8, 1998 between the Company and a
commercial bank (the "Term Loan Agreement"). The remaining borrowing under
the Term Loan Agreement represented refinancing of debt relating to a prior
acquisition.
Integrity National Life Insurance Company
During September, 1995, the Company and Citizens Security acquired the common
stock of Integrity National Life Insurance Company (the "Integrity
Acquisition") from an unaffiliated insurance holding company. The aggregate
purchase price for the Integrity acquisition, as finally adjusted, was
$9,419,000 (including $437,000 of net transaction costs). This acquisition
provided the Company with its Home Service Life segment and approximately
one-third of its Other Health segment. Integrity National was merged into
Citizens Security during 1995.
FINANCIAL POSITION
Assets. At December 31, 1999, the Company's available-for-sale fixed
maturities had a fair value of $69,501,248 and amortized cost of
$68,958,634. 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. The Company's fixed maturities portfolio decreased
approximately 8% in 1999 and increased approximately 80% in 1998, on an
amortized cost basis. The 1999 decrease resulted primarily from
repositioning funds into the favorable equities markets, while the 1998
increase resulted from the United Acquisition. Shown below is a distribution
by rating category of the Company's fixed maturities portfolio as of December
31, 1999.
13
<PAGE>
Standard & Poors
Corporation Rating Amortized Cost1 Fair Value 2
-----------------------------------------------------------
Investment grade:
AAA to A- $51,145,732 $49,990,065
BBB+ to BBB- 11,746,724 12,877,940
-----------------------------------------------------------
Total investment grade 62,892,456 62,868,005
Non-investment grade:
BB+ to BB- 2,381,161 2,430,524
B+ to B- 3,177,000 3,687,711
CCC+ to C 474,922 485,008
CI to not rated 33,095 30,000
-----------------------------------------------------------
-----------------------------------------------------------
Total non-investment grade 6,066,178 6,633,243
-----------------------------------------------------------
Total fixed maturities $68,958,634 $69,501,248
-----------------------------------------------------------
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, 1999 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. Non-investment grade securities
comprised 8.8% and 11.6% of the fixed maturities portfolio, on an amortized
cost basis at December 31, 1999 and 1998, respectively.
Shown below are the Company's four largest holdings in non-investment grade
bonds by a single issuer as of December 31, 1999.
Non-Investment
Grade
December 31, 1999 Book Value Fair Value
------------------------------------------------
Largest $ 905,000 $ 1,029,000
Second largest 500,000 500,000
Third largest 476,000 434,000
Fourth largest 463,000 428,000
------------------------------------------------
Total $2,344,000 $2,391,000
------------------------------------------------
The Company had no guarantee or other type of investment associated with the
issuers represented above.
The Company's investment in equity securities increased $3,495,000 and
$5,733,000 during 1999 on a cost (net of write-downs) and fair value basis,
respectively, after increasing $2,720,000 and $2,266,000 on the same basis in
1998. As of December 31, 1999 there were $4,713,000 of net unrealized gains
in equity securities, as compared with $2,474,000 and $2,929,000 at December
31, 1998 and December 31, 1997, respectively. One security accounted for
$672,000 of such gains at December 31, 1999.
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 $1,122,000 during 1999
($77,000, $110,000, $403,000 and $532,000 for the first through fourth
quarters, respectively). In addition, $450,000 of impairment losses were
recognized on fixed maturities during 1999 ($100,000, $270,000, and $80,000
during the first, second, and fourth quarters, respectively). During 1999,
equity securities and fixed maturities were sold which contained impairment
writedowns of $1,498,000 and $225,000, respectively.
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, 1999. Management
believes these pretax net gains, which total $15,244,000, ($9,375,000,
14
<PAGE>
$3,676,000, and $2,193,000 for 1999, 1998 and 1997, 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 its subsidiaries
maintain their home offices. Approximately 43% of the building is leased to
third-party tenants and 29% is being offered for lease. In early 1999 the
building was essentially fully occupied, however, several leases expired
during 1999. Market conditions for this property are generally favorable and
the Company does not anticipate significant difficulty in leasing available
space. An appraisal obtained during 1996 indicates that the current market
value of the property is approximately $1,700,000 higher than its carrying
value.
The Company has maintained significant cash and short-term balances over the
past several years, principally to hedge against the uncertainty of future
interest rates.
At December 31, 1999, the Company holds a $158,000 mortgage loan from a real
estate limited partnership in which the Company also has a 20% equity
interest. The mortgage loan, maturing March 31, 2000, 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. A comparison of total policy liabilities as of December 31,
1999, 1998 and 1997 is shown below. Approximately 82% of the 1999 total
consists of future policy benefit reserves while policyholder deposit
liabilities represent 16% of the total.
Year Ended December 31 1999 1998 1997
---------------------------------------------------------------------
Home Service Life $ 30,300,225 $ 28,967,749 $ 28,116,965
Broker Life 41,718,948 39,933,144 29,076,701
Preneed Life 21,509,265 23,260,792 ---
Dental 633,751 485,750 502,638
Other Health 3,031,510 2,997,162 1,642,479
---------------------------------------------------------------------
Total $ 97,193,699 $ 95,644,597 $ 59,338,783
---------------------------------------------------------------------
Home Service Life policy liabilities comprise approximately 31% of the
Company total. During the past years, this segment has experienced moderate
growth, after absorbing declines in the initial months after the late 1995
acquisition of Integrity. The Broker Life segment's 1999 net growth is due
to the continued favorable sales of the Company's simplified issue and graded
benefit life products which were redesigned in 1998. The 1998 growth in
Broker Life was due essentially to the United Acquisition. The majority of
this acquired business consists of traditional life participating policies
which are no longer being sold. The Preneed Life business was obtained
primarily in the 1998 United Acquisition. Life claims on this block of
inforce business have outpaced the Company's new sales production. However,
the Company is nearing completion of product redesign and is encouraged about
its growth potential. The Dental segment consists of annual term accident
and health coverages. Accordingly, policy liabilities for this segment are
not significant. Growth during 1998 in the Other Health segment relates
primarily to group medical policies obtained in the United Acquisition.
However, these policies are 100% reinsured to another carrier.
Shown below is a progression of the Company's policyholder deposit activity
for the year ended December 31, 1999.
Year Ended December 31, Universal
1999 Total Annuity Life Other
-------------------------------------------------------------------------
Beginning Balance $16,323,652 $9,556,009 $5,163,856 $1,603,787
Deposits 705,983 200,227 497,586 8,170
Withdrawals (2,080,764) (1,206,294) (777,235) (97,235)
Interest credited 862,615 468,574 321,396 72,645
-------------------------------------------------------------------------
Ending Balance $15,811,486 $9,018,516 $5,205,603 $1,587,367
-------------------------------------------------------------------------
The 1999 total policyholder deposit net reduction of $512,000 is comparable
to the 1998 reduction of $496,000, excluding the impact of deposits acquired
in the 1998 United Acquisition. The Company is not devoting significant
marketing effort toward these products.
16
<PAGE>
CONSOLIDATED RESULTS AND ANALYSIS
Premiums and Other Considerations. The following table details premiums and
other considerations received during the past three fiscal years.
Year Ended December 31 1999 1998 1997
----------------------------------------------------------------
Home Service Life $6,697,932 $6,551,375 $6,548,450
Broker Life 3,447,440 3,040,231 2,579,345
Preneed Life 2,298,013 1,066,069 ---
Dental 7,105,627 6,414,720 7,194,952
Other Health 1,295,816 1,299,233 1,368,130
----------------------------------------------------------------
Total $20,844,828 $ 18,371,628 $ 17,690,877
----------------------------------------------------------------
Home Service Life premium increased 2.2% during 1999 as the Company achieved
its most favorable sales results since the late 1995 acquisition of this
product line. During 1998, the Company introduced redesigned products based
on feedback from its agency force. This redesign included raising premium
rates approximately 15%, increasing the base renewal commission rates by
approximately 5% of premium, simplifying the policy application form, and
streamlining the policy underwriting process for qualifying agents. These
changes were favorably received by the Home Service Life agency force and
production began increasing during the fourth quarter of 1998.
The 13% increase in Broker Life premium during 1999 was attributable to
increased sales of simplified issue and graded benefit life policies as well
as to receiving a full year of premium on participating life policies
obtained in the 1998 United Acquisition. The 18% increase in Broker Life
premium during 1998 includes $340,000 of participating life premium from the
United Acquisition, an approximate $123,000 net increase from simplified
issue and graded benefit life policies partially offset by reductions in
other traditional life plans, $46,000 of additional group life premium, and
$48,000 less universal life premium/policy charges. During late 1997, the
Company instituted a more conservative benefit structure for its
graded-benefit life plans and added a companion simplified issue product
targeted towards the "final expense market". Sales of the graded-benefit
product declined initially due to adoption of the more conservative benefit
structure. However, these sales recovered modestly in 1998 and continued to
improve during 1999. Although the Company is not aggressively marketing its
group life products, enhancements to product design were made during 1998 and
modest sales increases were achieved in 1999 and 1998.
The 1999 growth in Preneed Life premium reflects some increase in the sales
rate and recognition of a full year of premium from policies obtained in the
1998 United Acquisition. The Company is redesigning and repricing the former
United Liberty Preneed products and has expanded its sales staff during
1999. The Company anticipates moderate to strong growth for this product
line during the next several years.
The 11% growth in Dental premium during 1999 reflects a continuing focus on
this market, favorable reaction to the quality of customer service, and a
modest marketing incentive program offered during the year. The 1998
decrease in Dental premium is due to termination of a large association group
which offered dental coverage to a diverse membership. Annual premium volume
for this group totaled approximately $1 million; however their claim ratios
were excessive, therefore coverage was cancelled effective March 1, 1998.
The Company has not been actively marketing Other Health coverages for
several years. However, in response to agent requests, during late 1998 it
began offering a new disability product. Pricing, underwriting, and claims
experience on this product will be closely monitored and it is expected to
provide a competitive advantage in building relationships with effective
agents. The $69,000 decrease in 1998 Other Health premium consists of
$39,000 of additional premium from the United Acquisition offset by a
$108,000 decline in individual supplemental health coverages.
Investments. The Company monitors its available-for-sale fixed maturities
and equity securities to assure they are strategically positioned within the
current market environment. This practice has historically resulted in
equity securities comprising 10% to 20% of the Company's cash and invested
assets, which tends to dampen current income yields in favor of an overall
total return focus.
17
<PAGE>
Investment income yields were 5.1%, 5.3%, and 5.4% for 1999, 1998, and 1997,
respectively. The investment income yield declines in 1999 and 1998 resulted
primarily from higher equity security and short-term investment balances.
As noted above, although increased equity security balances have dampened
investment income yields and segment operating income results, total return
performance for the past three years has been very favorable. As illustrated
below, during the past three years the Company's equity securities have
generated approximately $16,300,000 of additional pre-tax return, above a
hypothetical 7.0% fixed-maturity return. During this period, the Company's
annual net pretax total return on its equity portfolio has averaged 41.9%.
Equity Portfolio - Pretax Total Return
----------------------------------------------------------------------------
Year Ended December Total/Average 1999 1998 1997
----------------------------------------------------------------------------
Average Equities
Cost $15,589,362 $20,650,875 $14,529,633 $11,587,579
----------------------------------------------------------------------------
Realized Gains1 $16,024,139 $ 10,064,022 $ 3,186,308 $ 2,773,809
Change in Unrealized
Gains (Losses) 3,834,309 2,238,293 (454,225) 2,050,241
Dividends 1,264,066 523,520 422,847 317,699
----------------------------------------------------------------------------
Gross Total Return 21,122,514 12,825,835 3,154,930 5,141,749
Direct Expenses (1,521,796) (702,772) (237,094) (581,930)
----------------------------------------------------------------------------
Net Total Return 19,600,718 12,123,063 2,917,836 4,559,819
7.0% Base Return (3,273,765) (1,445,561) (1,017,074) (811,130)
----------------------------------------------------------------------------
Excess Return $16,326,953 $10,677,502 $ 1,900,762 $ 3,748,689
----------------------------------------------------------------------------
Total Return Rate- Gross 45.2% 62.1% 21.7% 44.4%
Total Return Rate- Net 41.9% 58.7% 20.1% 39.4%
1 Excludes adjustments for incentive and guaranty fees incurred by the
Company for investment management services.
These amounts are included separately as "Direct Expenses".
Net realized gains on equity securities were $9,131,389, $2,848,000, and
$2,132,000 for 1999, 1998, and 1997, respectively. These amounts reflect the
direct expenses shown above, as well as reductions for amortization of
deferred policy acquisition costs of $229,861, $139,027, and $59,904 in 1999,
1998, and 1997, respectively. Also included in gross realized losses during
1999, 1998 and 1997 are adjustments to the carrying value of
available-for-sale equity securities of $1,122,000, $1,356,000, and $232,544
respectively, relating to declines in value which were considered by
management to be other than temporary. The equity portfolio had $4,713,000
of net pre-tax unrealized gains as of December 31, 1999 compared to net
pre-tax unrealized gains of $2,474,000 and $2,929,000 at December 31, 1998
and 1997, respectively.
18
<PAGE>
Segment Earnings.
During 1999, pretax income increased by $4,590,000 [113%] to $8,664,000,
while also increasing during 1998 by $1,603,000 [65%] to $4,074,000. Pretax
profits (loss) are shown below for the Company's five business segments,
along with total realized investment gains and interest expense. As
previously indicated, the Company's equity investments have produced very
favorable total returns; however, if these funds had been invested in
fixed-maturities yielding 7.0%, the segment profit totals below would have
increased by an additional $922,000, $594,000, and $493,000 in 1999, 1998,
and 1997 respectively.
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------
Home Service Life $ 312,703 $ 211,713 $ 7,098
Broker Life 150,317 254,189 100,655
Preneed Life (993,560) 15,325 ---
Dental 436,587 295,038 214,495
Other Health (64,524) 90,174 206,591
- -------------------------------------------------------------------------
Segment Profit (Loss) (158,477) 866,439 618,839
Net realized investment gains,
net of expenses 9,375,339 3,675,489 2,193,148
Interest expense 553,017 468,268 341,275
- -------------------------------------------------------------------------
Income before Income Tax $ 8,663,845 $ 4,073,660 $ 2,470,712
- -------------------------------------------------------------------------
The 1999 increase in Home Service Life profit resulted primarily from the
moderate growth of inforce business as described above. The Company expects
continued, gradual improvement in this area due to concentrated marketing
efforts in this line and more structured underwriting practices implemented
upon acquisition of this business in 1995. The 1998 increase in Home Service
profit also resulted primarily improvement in mortality results. The 1999
Broker Life earnings decline resulted primarily from increased mortality on
portions of the acquired United Liberty business offsetting profit growth
from increased sales of simplified issue and graded-benefit life plans. The
1998 Broker Life improvement is due to improved mortality along with volume
growth and a decrease in interest crediting rates for annuity contracts. The
1999 Preneed Life decline is primarily attributable to increased marketing
expenditures and adverse mortality on sale of single-premium products to
older individuals. The Company is redesigning and repricing products,
including implementing a higher degree of underwriting for multi-pay modes.
These changes are expected to generate higher sales volumes and more
favorable profit margins. Information regarding Dental profitability is
included below. The "contribution margin" shown below is a direct margin
without allocable investment income and general expense.
Year Ended December 31 1999 1998 1997
---------------------------------------------------------
Premium $7,105,627 $6,414,720 $7,194,952
Claims and Reserves $4,717,678 $4,370,499 $5,109,221
Contribution Margin $1,432,204 $1,224,470 $1,150,920
Claim Ratio 66.4% 68.1% 71.0%
The significant improvement in Dental profitability during the past two years
resulted from a number of initiatives. These initiatives included
reconfiguring products to provide additional margins for certain more costly
dental procedures, engaging a company to provide expert assistance with
ongoing adjudication of claims, and implementing a program of aggressive
renewal underwriting and re-rating. In addition to the profitability
initiatives, during 1999 the Company launched initiatives aimed at increasing
premium volume, including agent incentive and referral programs for new
business. A large portion of the 1998 improvement was due to termination of
a large association group described above. The Company has not been actively
marketing its Other Health products in recent years, although the inforce
business has historically produced favorable benefit ratios (less than 50%).
However, claims rates began increasing in 1998 and have continued into 1999
on some of the older individual health coverages. The Company is preparing
filings for state approval of premium rate increases.
19
<PAGE>
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 the
Life Insurance Subsidiaries to reduce their 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 the Life Insurance
Subsidiaries' temporary differences. Thus, when a significant increase or
decrease occurs in the Company's net temporary differences, the related
deferred tax is computed using the 34% federal tax rate, whereas tax 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 9 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 the Life Insurance Subsidiaries 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 the Life Insurance Subsidiaries. Due to the impact of the
small life insurance company deduction, the Life Insurance Subsidiaries
record a valuation allowance to reduce deferred tax assets (associated with
temporary differences) to their expected benefit rate of 17%, rather than
34%. The Company's valuation allowance is designed to reduce deferred tax
assets to their estimated ultimate realization value.
Statutory Insurance Information. For insurance regulatory and rating purposes,
the Insurance Subsidiaries report on the basis of statutory accounting
principles ("SAP"). During 1999, A.M. Best Company ("Best") upgraded Citizens
Security's rating to B from B-. United Liberty was rated B- by Best when it was
acquired in 1998, and Kentucky Insurance, due to its lack of insurance
operations, is not rated. Citizens Security reports its investment in United
Liberty on the equity method of accounting for statutory accounting purposes.
Accordingly, the admitted value of Citizens Security's investment in United
Liberty equals United Liberty's statutory capital and surplus total of
$3,070,963 at December 31, 1999. Citizens Security's 1999 statutory net income
includes United Liberty's 1999 statutory net income of $234,853. To provide a
more detailed understanding of Citizens Security's operations, shown below are
SAP basis net income, net operating income, statutory capital and surplus, asset
reserves, and capital ratios for Citizens Security for the five years ended
December 31, 1999.
Net Statutory Asset
Year Ended Net Operating Capitol and Valuation Capital
December 31 Income Income Surplus Reserves1 Ratio2
-------------------------------------------------------------------------
1999 $4,945,708 $ 568,436 $12,942,331 $4,335,111 22.38%
1998 $3,662,188 $1,105,631 $11,227,528 $3,606,655 20.51%
1997 $1,708,884 $ 762,357 $ 9,627,479 $2,753,064 18.22%
19963 $3,062,421 $ 871,089 $ 9,145,830 $1,426,918 16.05%
1995 $ 883,003 $ 494,588 $ 8,406,313 $1,087,020 14.63%
-------------------------------------------------------------------------
1 Asset Valuation Reserves are statutory liabilities that act as
contingency reserves in the event of extraordinary losses on invested
assets and as a buffer for policyholders' surplus to reduce the
impact of realized and unrealized investment losses. The
December 31, 1999 and 1998 amounts also include United Liberty's
reserves.
2 Represents Statutory Capital and Surplus plus Asset Valuation
Reserves divided by invested assets plus cash.
3 Statutory Capital and Surplus amounts and Asset Valuation Reserve
amounts include Integrity beginning in 1995, while Income amounts
include Integrity beginning in 1996.
20
<PAGE>
During 1999, statutory capital and surplus and asset reserves increased by
approximately $2,443,000. This increase resulted primarily from $4,946,000
of statutory net income offset by a $1,200,000 redemption of Citizens
Security's preferred capital stock, and a $1,000,000 shareholder dividend
paid. During 1998, statutory capital and surplus and asset reserves
increased by approximately $2,454,000. This increase resulted primarily from
$3,662,000 of statutory net income offset by a $1,500,000 redemption of
Citizens Security's preferred capital stock, along with unrealized investment
gains. During 1997, statutory capital and surplus and asset reserves
increased by approximately $1,808,000. This increase resulted primarily from
$1,709,000 of statutory net income and $1,130,000 of unrealized investment
gains, partially offset by a $1,050,000 redemption of Citizens Security's
preferred capital stock. During 1996, capital and surplus and asset
reserves increased by approximately $1,079,000. This increase resulted
primarily from statutory net income of $3,062,000 and unrealized investment
losses of $904,000, partially offset by a $1,000,000 redemption of Citizens
Security's preferred capital stock. Net income earned in 1996 includes an
approximate $1,200,000 net gain from an investment transaction between
Citizens Security and an affiliate.
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 the first year of the policy. The Life
Insurance Subsidiaries' first year sales of these type of products have not
been of a magnitude to have a significant impact on statutory surplus.
During 1999, Kentucky Insurance generated approximately $150,000 of net
income, with $21,000 of the total earned after the October 1999 acquisition
by the Company. At December 31, 1999, Kentucky Insurance capital and surplus
totaled approximately $3,285,000.
Year 2000
The Company has experienced no difficulties with its internal systems or with
third-party systems that were identified as year 2000 related. However, the
possibility remains that some of the Company's computer programs could fail
to properly distinguish between dates in the 1900's and 2000's. This could
cause system failures or miscalculations, creating disruption of operations,
including, among other things, a temporary inability to process insurance
transactions, conduct banking activities, or engage in other normal business
activities. Also, some systems and equipment that are not typically thought
of as "computer-related" ("non-IT") contain embedded hardware or software
that may not perform properly in the future.
The Company completed an internal assessment of the year 2000 issue and
implemented updated releases or modified its software so that its computer
systems will function properly with respect to dates in the year 2000 and
thereafter. The Company's primary systems, all of which are considered year
2000 compliant, include vendor supported individual and group administrative
systems, along with internally developed peripheral programs, vendor
supported investment accounting and general ledger systems, and building
equipment control modules at its home office. The total year 2000 project
cost was approximately $100,000, which is primarily internal salary cost for
testing and modifying peripheral programs associated with the Individual and
Group insurance systems. These costs have been expensed. The direct cost of
modifying the vendor supported programs is included in annual maintenance
fees which total approximately $25,000.
The most significant third-parties potentially impacting the Company are
banks, investment brokers, and suppliers of utility and telecommunication
services. Their critical functions include safekeeping and managing
investment portfolios, processing the Company's operating bank accounts, and
supplying utilities. Assurances of year 2000 compliance have been received
from the Company's primary banking service provider and many other key
providers.
The Company has investments in publicly and privately placed securities and
loans. The Company may be exposed to credit risk to the extent that related
borrowers are materially adversely impacted by the year 2000 issue.
Portfolio diversification reduces the overall risk. Although the Company
believes its critical systems are compliant, there is no guarantee future
disruptions will not occur. Specifically, from year 2000 problems, the
Company could experience an interruption in its ability to collect and
process premiums, process claim payments, safeguard and manage its invested
assets and operating cash accounts, accurately maintain policyholder
information, accurately maintain accounting records, issue new policies
21
<PAGE>
and/or perform adequate customer service. While the Company believes the
occurrence of such a situation is unlikely, a possible worst case scenario
might include one or more of the Company's significant insurance systems
being non-compliant. Such an event could result in a material disruption to
the Company's operations. Should the worst case scenario occur, it could,
depending on its duration, have a material impact on the Company's results of
operations and liquidity and ultimately on its financial position. With
respect to contingency plans, if unforeseen problems arise, the Company will
utilize supplemental manual and personal computer-based processing
procedures. Regarding third-party systems, the Company is continuing to
monitor their compliance and has received no formal notification of critical
non-compliant systems.
CASH FLOW AND LIQUIDITY
During 1999, the Company generated $361,000 of positive cash flow from
operations compared to $1,620,000 in 1998 and $2,191,000 in 1997. The 1999
decrease can be attributed primarily to additional spending on Preneed Life
marketing programs and a decline in accounts payable and accrued expenses at
December 31, 1999. The 1998 decrease can be attributed to increased
reinsurance receivable amounts associated with additional graded-benefit life
reinsurance volume.
Cash provided by investment activities during 1999 of $11,200,000 resulted
primarily from a conservative decision to limit reinvestment activity near
year-end, due to increased market volatility. Cash used in investing
activities during 1998 includes payment of approximately $7,076,000 for the
United Acquisition, less $3,288,000 of cash held by United Liberty on the
effective acquisition date, for a net outflow of $3,788,000. Cash used by
financing activities in 1999 includes net policyholder deposit withdrawals
comparable to the 1998 level, a $2,500,000 bank borrowing associated with the
Kentucky Insurance Acquisition, net brokerage advance repayments of
$1,400,000, and common stock repurchases of approximately $390,000. Cash
provided by financing activities in 1998 includes $3,400,000 of additional
bank borrowings, which were used, along with available funds at Citizens
Security, to acquire United Liberty on May 12, 1998. Cash payments on bank
notes during 1997 include $140,000 of prepayments and exclude a $75,000
scheduled installment that was prepaid in late 1996.
The Company is subject to various market risks. However, the most
significant such risks relate to fluctuations in interest rates and in prices
of equity securities. Regarding interest rates, the value of the Company's
fixed-maturity investment portfolio will increase or decrease in an inverse
relationship with fluctuations in interest rates while net investment income
earned on newly-acquired fixed-maturities increases or decreases in direct
relationship with interest rate changes. From an income perspective, the
Company does not believe rising interest rates present a significant risk, as
essentially all of the Company's policy liabilities bear fixed rates.
However, approximately 37% of policy liabilities contain provisions
permitting interest or benefit adjustments at the discretion of the Boards of
Directors of the Life Insurance Subsidiaries. The Company's cash flow
testing (described below) indicates that overall profitability will generally
be enhanced in rising interest rate scenarios. From a liquidity perspective,
the Company's fixed rate policy liabilities have been relatively insensitive
to interest rate fluctuations. Accordingly, the Company believes gradual
increases in interest rates do not present a significant liquidity exposure.
The Company monitors economic conditions on a regular basis and manages this
interest rate risk primarily by adjusting the duration of its fixed-maturity
portfolio. Historically, the Company has maintained conservative durations
in its fixed-maturity portfolio. At December 31, 1999 cash and
fixed-maturity investments with maturities of less than five years equaled
more than sixty percent of total policy liabilities. Notwithstanding the
22
<PAGE>
foregoing, if interest rates rise significantly in a short timeframe, there
can be no assurance that the life insurance industry, including the Company,
would not experience increased levels of surrenders and reduced sales, and
thereby be materially adversely affected.
Interest expense on the Company's commercial bank debt is also subject to
interest rate risk. The rate on this debt is variable and equals 100% of the
bank's prime lending rate. At December 31, 1999, the rate on the Company's
$8,500,000 of bank borrowings was 8.50% and has since increased to 8.75%.
The Company believes its current liquidity position and profitability levels
are adequate to guard against this interest rate risk.
The Company has successfully managed the risk of equity security price
fluctuations during the past several years. The Company and its investment
management firm, SMC Advisors, Inc. devote significant attention to the
equity markets and reposition the Company's portfolio upon detection of
adverse risk trends associated with individual securities or overall
markets. The Company also manages market risks associated with investments
in option securities, as described in Item 7, Note 3 of the Notes to
Consolidated Financial Statements. As noted in the Investments section
above, the average annual total return on the Company's equity securities
during the past three years has exceeded 40%.
In addition to the measures described above, the Life Insurance Subsidiaries
comply with the NAIC promulgated Standard Valuation Law ("SVL") which
specifies minimum reserve levels and prescribes methods for determining them,
with the intent of enhancing solvency. The SVL also requires the Company to
perform annual cash flow testing for its Life Insurance Subsidiaries. This
testing is designed to ensure that statutory reserve levels will maintain
adequate protection in a variety of potential interest rate scenarios. The
Actuarial Standards Board of the American Academy of Actuaries also requires
cash flow testing as a basis for the actuarial opinion on the adequacy of the
reserves which is a required part of the annual statutory reporting process.
Cash flow testing projects cash inflows from assets and cash outflows for
liabilities in various assumed economic and yield curve scenarios. This is a
dynamic process, whereby the performance of the assets and liabilities is
directly related to the scenario assumptions. (An example would involve the
credited interest rate on annuity products and how such rates vary depending
upon projected earnings rates, which are based upon asset performance under a
particular economic scenario.)
The Life Insurance Subsidiaries' most recent cash flow testing, which was
completed in February 2000, 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 Life Insurance Subsidiaries to continue without
exhausting surplus. Again, depending upon severity and frequency, corrective
measures might be needed. Based on results of the testing, no corrective
measures were indicated at the current time. However, such testing is
ongoing and dynamic in nature and future events in the interest and equity
markets or a significant change in the composition of Life Insurance
Subsidiaries' business could negatively impact testing results and require
the initiation of corrective measures.
Any necessary corrective measures could take one or more forms. The duration
of existing assets might not match well with those of the liabilities.
Certain liabilities, such as those associated with indemnity accident and
health, short-term disability and group dental products, are short-term in
nature and are best matched with cash and short-term investments. By
contrast, whole life insurance, which involves lifetime obligations, is
usually best matched by longer duration maturities. In the event there are
insufficient assets of these types, a repositioning of the investment
portfolio might be undertaken.
Initially, balanced durations do not guarantee positive future results.
Asset type, quality, and yield will vary depending upon the economic scenario
tested. Liabilities will be similarly affected. Projected reinvestment
yields may cause overall yields to fall below those required to support
projected liabilities. In that event, portfolio realignment might involve
the type, quality and yield of investments rather than duration.
Alternatively, additional reserve amounts could be allocated to cover any
future shortfalls.
23
<PAGE>
The above discussion centers around asset management. Other possible
corrective measures might involve liability realignment. The Company's
marketing plan could be modified to emphasize certain product types and
reduce others. New business levels could be varied in order to find the
optimum level. Management believes that the Company's current liquidity,
current bond portfolio maturity distribution and 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
and other expenses by:
- Management fees charged to the Life Insurance Subsidiaries
- Redemption of Citizens Security preferred stock as necessary, with
such redemption also requiring approval by the Kentucky Department of
Insurance.
- Dividends from the Life Insurance Subsidiaries, which are limited by
law to the lesser of prior year net operating income or 10% of prior
year-end capital and surplus unless specifically approved by the
Kentucky Department of Insurance.
FORWARD-LOOKING INFORMATION
All statements, trend analyses and other information contained in this report
relative to markets for the Company's products and trends in the Company's
operations or financial results, as well as other statements including words
such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and
other similar expressions, constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors which may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, among
other things: (1) general economic conditions and other factors, including
prevailing interest rate levels and stock market performance, which may
affect the Company's ability to sell its products, the market value of the
Company's investments and the lapse rate and profitability of policies; (2)
the Company's ability to achieve anticipated levels of operating efficiencies
and meet cash requirements based upon projected liquidity sources; (3)
customer response to new products, distribution channels and marketing
initiatives; (4) mortality, morbidity, and other factors which may affect the
profitability of the Company's insurance products; (5) changes in the Federal
income tax laws and regulations which may affect the relative tax advantages
of some of the Company's products; (6) increasing competition in the sale of
insurance; (7) regulatory changes or actions, including those relating to
regulation of insurance products and insurance companies; (8) ratings
assigned to the Company and its subsidiaries by independent rating
organizations which the Company believes are important to the sale of its
products; and (9) unanticipated litigation. There can be no assurance that
other factors not currently anticipated by management will not also
materially and adversely affect the Company's results of operations.
24
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
Financial Statements For Full Fiscal Years Page
Report of Independent Auditors....................................26
Consolidated Statements of Income for the
years ended December 31, 1999, 1998 and 1997 ....................27
Consolidated Statements of Financial Condition at
December 31, 1999 and 1998........................................28
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1999, 1998 and 1997..............30
Consolidated Statements of Cash Flows for the
years ended December 31, 1999, 1998 and 1997......................31
Notes to Consolidated Financial Statements........................32
25
<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 7. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the 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, 1999 and
1998, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Louisville, Kentucky
March 23, 2000
26
<PAGE>
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Income
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------------
Revenues:
Premiums and other considerations $ 21,897,264 $ 19,402,959 $ 18,790,483
Premiums ceded (1,052,436) (1,031,331) (1,099,606)
- -------------------------------------------------------------------------------
Net premiums earned 20,844,828 18,371,628 17,690,877
Net investment income 5,885,312 5,190,322 3,808,938
Net realized investment gains,
net of expenses 9,375,339 3,675,489 2,193,148
Other income 157,633 39,566 8,880
- -------------------------------------------------------------------------------
Total Revenues 36,263,112 27,277,005 23,701,843
Policy Benefits and Expenses:
Policyholder benefits 15,556,565 13,576,645 11,736,457
Policyholder benefits ceded (1,013,424) (1,039,024) (834,426)
- -------------------------------------------------------------------------------
Net benefits 14,543,141 12,537,621 10,902,031
Increase in net benefit reserves 1,632,677 553,673 789,135
Interest credited on
policyholder deposits 862,615 845,608 914,061
Commissions 4,340,262 3,775,530 3,762,482
General expenses 5,385,477 4,430,902 3,902,603
Interest expense 553,017 468,268 341,275
Policy acquisition costs deferred (1,376,309) (1,106,373) (982,333)
Amortization expense:
Deferred policy acquisition
costs 491,221 696,719 736,633
Value of insurance acquired 839,314 696,702 584,993
Goodwill 51,885 35,771 20,962
Depreciation expense 275,967 268,924 259,289
- -------------------------------------------------------------------------------
Total Policy Benefits and Expenses 27,599,267 23,203,345 21,231,131
- -------------------------------------------------------------------------------
Income before Income Tax 8,663,845 4,073,660 2,470,712
Income Tax Expense 2,225,000 774,000 482,500
- -------------------------------------------------------------------------------
Net Income 6,438,845 3,299,660 1,988,212
Dividends on Redeemable Convertible
Preferred Stock --- (279,650) (407,000)
- -------------------------------------------------------------------------------
Net Income Applicable to Common
Stock $ 6,438,845 $ 3,020,010 $ 1,581,212
- -------------------------------------------------------------------------------
Net Income Per Common Share:
Basic $ 3.59 $ 2.31 $ 1.47
Diluted $ 3.59 $ 1.82 $ 1.10
- -------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
27
<PAGE>
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31 1999 1998
- ------------------------------------------------------------------------------
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost of
$68,958,634 and $75,235,199 in 1999 and
1998,respectively) $ 69,501,248 $ 77,582,742
Equity securities (cost of $18,228,519 and
$14,733,876 in 1999 and 1998, respectively) 22,941,274 17,208,338
Investment real estate 3,513,579 3,618,698
Mortgage loans on real estate 158,309 164,757
Policy loans 4,059,801 4,034,152
Short-term investments 580,425 594,805
- ------------------------------------------------------------------------------
Total Investments 100,754,636 103,203,492
Cash and cash equivalents 18,696,401 8,301,999
Accrued investment income 1,145,447 1,263,898
Reinsurance recoverable 3,607,349 3,464,362
Premiums receivable 388,146 407,571
Property and equipment 2,051,414 1,846,768
Deferred policy acquisition costs 4,690,774 4,120,215
Value of insurance acquired 5,295,818 6,135,132
Goodwill 809,809 513,325
Federal income tax receivable 169,502 ---
Other assets 370,734 242,361
- ------------------------------------------------------------------------------
Total Assets $137,980,030 $129,499,123
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
28
<PAGE>
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31 1999 1998
- ------------------------------------------------------------------------------
LIABILITIES
Policy liabilities:
Future policy benefits $ 79,507,902 $ 77,665,183
Policyholder deposits 15,811,486 16,323,652
Policy and contract claims 1,456,030 1,259,459
Unearned premiums 176,779 208,524
Other 241,502 187,779
- ------------------------------------------------------------------------------
Total Policy Liabilities 97,193,699 95,644,597
Notes payable 8,500,000 6,510,000
Accrued expenses and other liabilities 2,270,660 3,627,214
Federal income tax payable --- 667,013
Deferred federal income tax 1,979,214 1,305,018
- ------------------------------------------------------------------------------
Total Liabilities 109,943,573 107,753,842
COMMIMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock, 6,000,000 shares authorized;
1,767,215 and 1,802,615 shares issued and
outstanding in 1999 and 1998, respectively 1,767,215 1,802,615
Additional paid-in capital 7,736,201 8,091,825
Accumulated other comprehensive income 3,322,971 3,079,616
Retained earnings 15,210,070 8,771,225
- ------------------------------------------------------------------------------
Total Shareholders' Equity 28,036,457 21,745,281
- ------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $137,980,030 $129,499,123
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
29
<PAGE>
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Additional Other Comprehensive
Common Paid-in Comprehensive Retained Income
Stock Capital Income Earnings Total
- ------------------------------------------------------------------ ------------
Balance at January 1,
1997 $1,075,615 $4,836,057 $ 428,780 $4,233,003
Net Income $1,988,212 $1,988,212
Net unrealized
appreciation of
available for
sale securities 2,166,218 2,166,218
---------
Comprehensive income $4,154,430
=========
Preferred stock
dividends (407,000)
- ------------------------------------------------------------------
Balance at December
31, 1997 1,075,615 4,836,057 2,594,998 5,814,215
Net Income 3,299,660 $3,299,660
Net unrealized
appreciation of
available for
sale securities 484,618 484,618
---------
Comprehensive income $3,784,278
=========
Preferred stock
dividends (279,650)
Preferred stock
conversion 722,000 3,215,768
Preferred stock
redemption (63,000)
Options exercised 5,000 40,000
- ---------------------------------------------------------------------
Balance at December
31, 1998 1,802,615 8,091,825 3,079,616 8,771,225
Net Income 6,438,845 $6,438,845
Net unrealized
appreciation of
available for
sale securities 243,355 243,355
---------
Comprehensive income $6,682,200
=========
Common stock
repurchases (35,400) (355,624)
- ----------------------------------------------------------------------
Balance at December
31, 1999 $1,767,215 $7,736,201 $3,322,971 $15,210,070
- ----------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
30
<PAGE>
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31 1999 1998 1997
- --------------------------------------------------------------------------------
Cash Flows from Operations:
Net income $ 6,438,845 $ 3,299,660 $ 1,988,212
Adjustments reconciling to cash from
operations:
Increase in benefit reserves 1,806,387 806,183 704,142
(Increase) decrease in claim
liabilities 196,571 (111,746) 9,630
(Increase) decrease in reinsurance
recoverable (142,987) (380,034) 191,602
Interest credited on policyholder
deposits 862,615 845,608 914,061
Provision for amortization and
depreciation,
net of deferrals 308,403 591,743 619,544
Amortization of premium and
accretion of discount on securities
purchased, net 147,566 112,432 (7,438)
Net realized investment gains (9,375,339) (3,675,489) (2,193,148)
Decrease in accrued investment income 79,307 12,304 62,016
Change in other assets and
liabilities 325,992 (269,857) 24,919
Increase (decrease) in deferred
federal income tax liability 550,000 (19,000) 141,000
Increase (decrease) in federal
income taxes payable (836,515) 408,000 (263,500)
- --------------------------------------------------------------------------------
Net Cash provided by Operations 360,845 1,619,804 2,191,040
Cash Flows from Investment Activities:
Securities available-for-sale:
Purchases - fixed maturities (7,956,333) (12,642,382) (3,011,750)
Purchases - equity securities (73,590,880) (33,322,649) (24,800,144)
Sales - fixed maturities 16,523,864 15,160,161 8,498,183
Sales - equity securities 79,476,540 33,432,382 22,570,580
Purchase price paid for subsidiaries
in excess
of cash acquired (3,117,832) (3,787,613) ---
Investment management and brokerage
account fees (292,195) (417,326) (249,841)
Short-term investments sold
(acquired), net 572,192 (22,313) 320,918
Additions to real estate (204,216) (35,270) (77,983)
Additions to property and equipment,
net (197,603) (512,242) (163,430)
(Increase) decrease in net broker
receivable 8,125 245,000 (95,000)
Other investing activities, net (5,776) 159,955 (27,798)
- --------------------------------------------------------------------------------
Net Cash provided by (used in)
Investment Activities 11,215,886 (1,742,297) 2,963,735
Cash Flows from Financing Activities:
Policyholder deposits 705,985 817,372 787,910
Policyholder withdrawals (2,080,766) (2,158,681) (2,093,351)
Proceeds from note payable - bank 2,500,000 3,400,000 ---
Payments on notes payable - bank (510,000) (400,000) (365,000)
Net brokerage account loan proceeds
(repayment) (1,406,524) 989,014 518,394
Common stock repurchase (391,024) --- ---
Preferred stock redemption --- (169,139) ---
Dividends on redeemable convertible
preferred stock --- (279,650) (407,000)
Issuance of common stock --- 45,000 ---
Notes payable and interest - guarantor --- --- (220,869)
- --------------------------------------------------------------------------------
Net Cash provided by (used in)
Financing Activities (1,182,329) 2,243,916 (1,779,916)
- --------------------------------------------------------------------------------
Net Increase in Cash and Cash
Equivalents 10,394,402 2,121,423 3,374,859
Cash and Cash Equivalents at Beginning
of Period 8,301,999 6,180,576 2,805,717
- --------------------------------------------------------------------------------
Cash and Cash Equivalents at End of
Period $ 18,696,401 $ 8,301,999 $ 6,180,576
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
31
<PAGE>
Note 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Presentation. The accompanying consolidated
financial statements include the accounts of Citizens Financial Corporation
and its wholly-owned subsidiaries: Citizens Security Life Insurance Company
("Citizens Security"), United Liberty Life Insurance Company ("United
Liberty"), Kentucky Insurance Company ("Kentucky Insurance"), and Corporate
Realty Service, Inc. ("Corporate Realty"). These entities are collectively
hereinafter referred to as the "Company". United Liberty is also a wholly
owned subsidiary of Citizens Security. All significant intercompany accounts
and transactions are eliminated in consolidation. Certain balances in prior
years have been reclassified to conform to current year classifications.
Nature of Operations. The Company engages primarily in the business of life
insurance, annuities and accident and health insurance through Citizens
Security and United Liberty ("the Life Insurance Subsidiaries"). The Life
Insurance Subsidiaries offer life, fixed-rate annuity and accident and health
insurance products to individuals and groups through independent agents.
Kentucky Insurance was acquired during 1999 (see Note 2) and is licensed as a
property and casualty insurer in four states. The Company is planning to
offer home service fire and casualty insurance coverage; however, Kentucky
Insurance currently has no business inforce. Corporate Realty manages the
Company's real estate along with two other properties affiliated with the
Company's Chairman.
The individual life insurance products currently offered by the Life
Insurance Subsidiaries consist of traditional whole life insurance and
universal life insurance policies. Citizens Security also sells group life
and accidental death and dismemberment policies. The fixed-rate annuity
products offered by Citizens Security consist of flexible premium deferred
annuities, life policy annuity riders, and single premium deferred
annuities. Citizens Security's individual accident and health insurance
products provide coverage for monthly income during periods of
hospitalization, scheduled reimbursement for specific hospital and surgical
expenses and cancer treatments, and lump sum payments for accidental death or
dismemberment, while the group accident and health products provide coverage
for short and long-term disability, income protection and dental procedures.
Citizens Security is licensed to sell products in the District of Columbia
and 20 states primarily located in the South and Southeast. United Liberty
is licensed to sell products in 23 states primarily located in the South,
Midwest, and West. United Liberty's ongoing sales efforts are focused
primarily in nine states where Citizens Security is not licensed.
The Life Insurance Subsidiaries market their portfolio of products through
the personal producing general agent distribution system and presently have
approximately 2,400 sales representatives. Substantially all of these agents
also represent other insurance carriers. Approximately 350 of the agents
specialize in the home service market while approximately 120 are preneed
representatives who market through funeral homes. These markets consist
primarily of individuals who desire whole life policies with policy limits
typically below $10,000.
Use of Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States ("GAAP")
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Investments. The Company classifies fixed maturities and equity securities
as "available-for-sale". Available-for-sale securities are carried at fair
value, with unrealized gains and losses included in accumulated other
comprehensive income, net of applicable deferred taxes and adjustments to
related deferred policy acquisition costs.
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.
32
<PAGE>
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, 1999 was $1,921,544 ($1,645,577 at December 31,
1998).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of
purchase price of purchased subsidiaries, over amounts assigned (based on
estimated fair values at the date of acquisition) to the identifiable net
assets acquired. Goodwill is amortized over 10 to 20 years using the
straight-line method. At December 31, 1999, accumulated amortization was
$238,834 ($186,949 at December 31, 1998).
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, 1999, accumulated amortization was
$3,645,196 ($2,805,882 at December 31, 1998).
Benefit Reserves and Policyholder Deposits. Traditional life and accident
and health insurance products include those contracts with fixed and
guaranteed premiums and benefits and consist principally of whole-life and
term insurance policies, limited-payment life insurance policies and certain
annuities with life contingencies. Reserves on such policies are based on
assumed investment yields which range from 6% to 7%. Reserves on traditional
life and accident and health insurance products are determined using the net
level premium method based on future investment yields, mortality,
withdrawals, and other assumptions, including dividends on participating
policies. Such assumptions are based on past experience and include
provisions for possible unfavorable deviation.
Benefit reserves and policyholder contract deposits on universal life, other
interest-sensitive life products and investment-type products are determined
using the retrospective deposit method and consist of policy account
balances, before deducting surrender charges, which accrue to the benefit of
the policyholder.
Participating insurance business constituted approximately 6%, 7% and 1% of
ordinary life insurance inforce and 5%, 5% and 1% of annualized ordinary life
premium inforce at December 31, 1999, 1998 and 1997, respectively
Participating dividends are determined at the discretion of the Board of
Directors.
Reserves on insurance policies acquired by purchase are based on assumptions
considered appropriate as of the date of purchase. Assumed investment yields
for such acquired policies range from 6.6% to 9.0%.
Premiums, Benefits and Expenses. Premiums for traditional individual life
and accident and health policies are reported as earned when due. Benefit
claims (including an estimated provision for claims incurred but not
reported), benefit reserve changes and expenses (except those deferred) are
charged to expense as incurred. Deferred policy acquisition costs related to
traditional life and accident and health policies are charged to expense over
the life of the policy using methods and assumptions consistent with those
used in estimating liabilities for future policy benefits. In determining
whether a premium deficiency exists on short-duration policies, management
does not give consideration to investment income.
Revenues for universal life and investment-type products consist of
investment income and policy charges for the cost of insurance, policy
initiation, administrative surrender fees and investment income. Expenses
include interest credited to policy account balances, incurred administrative
expenses and benefit payments in excess of policy account balances. Deferred
policy acquisition costs related to universal life and investment-type
products are amortized in relation to the incidence of expected gross profits
over the life of the policies. Expected gross profits are reviewed at each
reporting period, and to the extent actual experience varies from that
previously assumed, the effects of such variances are recorded in the current
period.
33
<PAGE>
Liabilities for Policy Claims. Policy claim liabilities are based on known
liabilities plus estimated future liabilities developed from trends of
historical data applied to current exposures. These liabilities are closely
monitored and adjustments for changes in experience are made in the period
identified.
Federal Income Taxes. The Company uses the liability method of accounting
for income taxes. Deferred income taxes are provided for cumulative
temporary differences between balances of assets and liabilities determined
under GAAP and balances determined for tax reporting purposes.
Earnings Per Share. Basic earnings per share amounts are based on the
weighted average number of common shares outstanding during the year.
Diluted earnings per share amounts assume conversion of all outstanding
Redeemable Convertible Preferred Stock at a conversion price of $5.50 per
share (see notes 7 and 8).
Comprehensive Income. As of January 1, 1998, the Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income or total shareholders'
equity. SFAS No. 130 requires unrealized gains or losses on the Company's
available-for-sale securities to be included in other comprehensive income.
Note 2--ACQUISITIONS
On October 14, 1999, the Company acquired 100% of the stock of Kentucky
Insurance from an unaffiliated insurance holding company (the "Kentucky
Insurance Acquisition"). Kentucky Insurance is licensed as a property and
casualty insurance company in four states and has approximately $3.2 million
of statutory capital and surplus; however, it currently has no insurance
operations. The aggregate purchase price for the Kentucky Insurance
Acquisition was approximately $3,550,000 (including net costs associated with
the acquisition of approximately $50,000). The acquisition was financed with
available internal funds and $2,500,000 of additional bank borrowings at the
prime rate.
On May 12, 1998 the Company acquired 100% of the common stock of United
Liberty from an unaffiliated insurance holding company (the "United
Acquisition"). The aggregate purchase price for the United Acquisition was
approximately $7,076,000 (including net costs associated with the acquisition
of approximately $445,000). In conjunction with the acquisition, the seller
retained approximately $2,100,000 of United Liberty's real estate related and
other assets, which were replaced with cash by Citizens Security. This
acquisition was financed with available internal funds and approximately
$3,400,000 of additional bank borrowings under a Term Loan Agreement. The
Term Loan Agreement represented refinancing of debt relating to a prior
acquisition.
Both acquisitions were accounted for as purchases and the acquired companies'
results of operations are included in the consolidated statements since their
respective dates of acquisition.
Note 3--INVESTMENTS
The cost and fair value of investments in fixed maturities and equity
securities are shown below. The cost amounts are adjusted for amortization
of premium and accretion of discount on fixed maturities and for write-downs
of securities whose decline in value is believed to be other than temporary.
December 31, 1999 Amortized Gross Unrealized Fair Value
Cost Gains Losses (Carrying Value)
- --------------------------------------------------------------------------------
Fixed Maturities:
U.S. Government
obligations $ 8,723,722 $ 640 $ 101,100 $ 8,623,262
Corporate securities 55,714,282 2,222,719 1,569,797 56,367,204
Mortgage-backed 4,520,630 32,000 41,848 4,510,782
securities
- --------------------------------------------------------------------------------
Total $ 68,958,634 $2,255,359 $1,712,745 $ 69,501,248
- --------------------------------------------------------------------------------
Equity Securities $ 18,228,519 $5,080,683 $ 367,928 $ 22,941,274
- --------------------------------------------------------------------------------
34
<PAGE>
December 31, 1998
- --------------------------------------------------------------------------------
Fixed Maturities:
U.S. Government
obligations $ 9,656,117 $ 317,327 $ 30 $ 9,973,414
Corporate securities 59,796,816 2,283,505 465,680 61,614,641
Mortgage-backed 5,782,266 258,330 45,909 5,994,687
securities
- --------------------------------------------------------------------------------
Total $ 75,235,199 $ 2,859,162 $ 511,619 $ 77,582,742
- --------------------------------------------------------------------------------
Equity Securities $ 14,733,876 $ 2,887,926 $ 413,464 $ 17,208,338
- --------------------------------------------------------------------------------
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, 1999, 1998 and 1997, 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 1999 1998 1997
- -------------------------------------------------------------------------
Fixed maturities:
Change in net unrealized
appreciation $(1,804,929) $1,158,586 $ 1,386,925
Net realized gain $ 243,949 $ 827,204 $ 61,173
Equity securities:
Change in net unrealized
appreciation $ 2,238,293 $ (454,225) $ 2,050,241
Net realized gain $ 9,131,390 $2,848,285 $ 2,131,975
The amortized cost and fair value of investments in fixed maturities at
December 31, 1999, 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.
Amortized
December 31, 1999 Cost Fair Value
- ------------------------------------------------------------------
Due in one year or less $ 6,451,902 $ 6,426,135
Due after one year through five
years 35,685,365 36,587,152
Due after five years through ten
years 18,744,915 17,911,916
Due after ten years 3,555,822 4,065,263
- ------------------------------------------------------------------
Subtotal 64,438,004 64,990,466
Mortgage-backed securities 4,520,630 4,510,782
- ------------------------------------------------------------------
Total $ 68,958,634 $ 69,501,248
- ------------------------------------------------------------------
Gross gains of $1,260,650, $1,411,737 and $171,062 and gross losses of
$969,136, $502,680 and $96,073 were realized on the sale of
available-for-sale fixed maturities during 1999, 1998 and 1997,
respectively. Included in gross realized losses during 1999, 1998 and 1997
are net adjustments to the carrying value of available-for-sale fixed
maturities of $55,000, $150,000 and $75,000 respectively, relating to
declines in value which were considered by management to be other than
temporary. Net realized gains from the sale of fixed maturities have been
reduced by $20,021, $38,098 and $3,039 in 1999, 1998 and 1997 respectively,
due to amortization of deferred policy acquisition costs. In addition, net
realized gains from the sale of fixed maturities have been reduced by
$27,544, $43,755 and $10,777 in 1999, 1998 and 1997 respectively, for
incentive fees earned by the portfolio manager.
35
<PAGE>
Gross gains of $16,414,949, $8,165,216 and $3,520,589 and gross losses of
$6,350,927, $4,978,908, and $746,780 were realized on the sale of
available-for-sale equity securities during 1999, 1998 and 1997. Included in
gross realized losses during 1999, 1998 and 1997 are adjustments to the
carrying value of available-for-sale equity securities of $1,017,000,
$1,356,000 and $232,544 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 by $229,861, $100,929
and $59,904 in 1999, 1998 and 1997 respectively, due to amortization of
deferred policy acquisition costs. In addition, net realized gains from the
sale of available-for-sale equity securities have been reduced by $702,771,
$237,094 and $581,930 in 1999, 1998 and 1997, respectively, for incentive and
guaranty fees earned by the portfolio manager and costs associated with
operating a brokerage margin account. Under terms of this brokerage margin
account, Morgan Stanley & Company, Inc. permits 50% of the value of
securities held in the account to be purchased on margin, at a 6.625%
interest rate. At December 31, 1999 and 1998, margin advances of $100,884
and $1,507,408 respectively, were outstanding and are included in the
financial statements with accrued expenses and other liabilities.
Net unrealized appreciation of available-for-sale securities is summarized as
follows:
December 31 1999 1998
- ---------------------------------------------------------------------
Net appreciation (depreciation)on
available-for-sale:
Fixed maturities $ 542,614 $ 2,347,543
Equity securities 4,712,755 2,474,462
Adjustment of deferred policy
acquisition costs (220,566) (155,919)
Deferred income taxes (1,711,832) (1,586,470)
- ---------------------------------------------------------------------
Net unrealized appreciation $ 3,322,971 $ 3,079,616
- ---------------------------------------------------------------------
Investment management services are provided by a firm affiliated with certain
board members and shareholders of the Company - see Related Party Transaction
Note 16.
Major categories of investment income are summarized as follows:
Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------
Fixed maturities $4,655,498 $4,157,891 $3,033,320
Equity securities 523,520 422,847 317,699
Mortgage loans on real 15,406 16,214 16,321
estate
Policy loans 233,844 210,588 174,647
Investment real estate 245,260 406,971 334,044
Short-term investments and 454,102 335,332 148,421
other
- ----------------------------------------------------------------
Subtotal 6,127,630 $5,549,843 $4,024,452
Investment expense (242,318) (359,521) (215,514)
- ----------------------------------------------------------------
Net investment income $5,885,312 $5,190,322 $3,808,938
- ----------------------------------------------------------------
The Company limits credit risk by diversifying its investment portfolio among
government and corporate fixed maturities and common and preferred equity
securities. It further diversifies these investment portfolios within
industry sectors. As a result, management believes that significant
concentrations of credit risk do not exist. The Company's largest investment
in any entity (other than the U.S. Government) was Clear Channel
Communications fixed maturities totaling $4,551,100 and $2,715,500 at
December 31, 1999 and 1998, respectively. At December 31, 1999, the Company
had no investments which had not been income producing for a period of at
least twelve months prior to year end.
36
<PAGE>
The following table is a reconciliation of the net unrealized gain arising
during the period and the change in net unrealized gains as reported on the
accompanying statements of shareholders' equity.
Pretax Tax Net-of-Tax
Year Ended Amount Expense Amount
- -----------------------------------------------------------------------
December 31, 1999:
Unrealized gain arising $ 9,744,056 $ 2,533,084 $ 7,210,972
Less: Reclassification
adjustment for
gains realized in
net income 9,375,339 2,407,722 6,967,617
- -----------------------------------------------------------------------
Change in net unrealized
gain $ 368,717 $ 125,362 $ 243,355
=======================================================================
December 31, 1998:
Unrealized gain arising $ 4,409,760 $ 947,996 $ 3,461,764
Less: Reclassification
adjustment for
gains realized in
net income 3,675,489 698,343 2,977,146
- -----------------------------------------------------------------------
Change in net unrealized
gain $ 734,271 $ 249,653 $ 484,618
=======================================================================
In conjunction with management of its equities portfolio, the Company has
also taken certain option positions, generally on equity securities or
related market indices. Although such positions may be covered by actual
securities owned or offsetting options, hedge accounting is not used.
Accordingly, all such positions are marked to market and changes in value
reported as realized gains or losses. During 1999, options purchases totaled
approximately $4,375,000 and related net realized gains totaled approximately
$1,567,500. At December 31, 1999 net option asset positions outstanding had
a market value of $1,144,750 and a cost of $120,450. There is no significant
off-balance-sheet risk associated with these positions.
Pursuant to requirements of certain state insurance departments, the Company
has investments with a carrying value of $51,099,000, at December 31, 1999,
placed on deposit at various financial institutions which are restricted from
withdrawal without prior regulatory approval.
The Company owns the building and land in which it currently resides. At
December 31, 1999 and 1998, the Company occupied approximately 28% and 25%,
respectively of the building with the remaining space leased or available for
lease to third-party tenants. The accompanying financial statements reflect
the proportionate Company occupied share of the building and related
operating expense as property and equipment and general expense,
respectively. The remaining portion is reflected as investment real estate
and as a reduction of investment income, respectively. Accumulated
depreciation at December 31, 1999 and 1998 on the investment real estate
portion of the building was $843,053 and $772,213, respectively.
The Company leases office space to third-party tenants under noncancellable
lease agreements. Future minimum rental income is $420,280, $379,633,
$326,462, $218,538, $128,269, and $12,640 for years 2000 through 2005,
respectively.
37
<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%. Balances outstanding relate to the purchase of United Liberty and two
additional companies which have been merged into Citizens Security (Integrity
National Life Insurance Company and Old South Life Insurance Company). An
analysis of the value of insurance acquired for the years ended December 31,
1999, 1998 and 1997 is as follows:
Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------
Balance at beginning of
year $6,135,132 $4,496,872 $5,081,865
Purchase of United Liberty --- 2,334,962 ---
Accretion of interest 378,996 372,629 321,166
Amortization (1,218,310) (1,069,331) (906,159)
- ----------------------------------------------------------------
Balance at end of year $5,295,818 $6,135,132 $4,496,872
- ----------------------------------------------------------------
Amortization of the value of insurance acquired (net of interest accretion)
in each of the following five years will be approximately: 2000 - $693,000;
2001 - $623,000; 2002 - $537,000; 2003 - $457,000; and 2004 - $398,000.
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 ($494,616 and $391,311 at December 31, 1999 and 1998, respectively)
and the incurred but not reported portion of accident and health reserves
($2,219,676 and $2,016,205 at December 31, 1999 and 1998, respectively) are
summarized as follows:
Year Ended December 31 1999 1998
- ------------------------------------------------------------------
Balance at January 1 $2,407,516 $1,173,774
Less: reinsurance recoverable 1,597,137 292,327
- ------------------------------------------------------------------
Net balance at January 1 810,379 881,447
United Liberty balance at acquisition --- 33,112
Total incurred - current year 5,496,236 5,027,678
Paid related to:
Current year 4,785,389 4,644,723
Prior years 526,981 487,135
- ------------------------------------------------------------------
Total paid 5,312,370 5,131,858
- ------------------------------------------------------------------
Net balance at December 31 994,245 810,379
Plus reinsurance recoverable 1,720,047 1,597,137
- ------------------------------------------------------------------
Balance at December 31 $2,714,292 $2,407,516
- ------------------------------------------------------------------
Note 6--DEBT
Long term debt consists of the following:
December 31 1999 1998
- ---------------------------------------------------------------------
Commercial bank notes, prime, due 2007 $8,500,000 $6,510,000
Less: Current Portion (500,000) (510,000)
- ---------------------------------------------------------------------
Long Term Portion $8,000,000 $6,000,000
- ---------------------------------------------------------------------
38
<PAGE>
The Company's outstanding borrowings relate primarily to various insurance
company acquisitions. On October 14, 1999, the Company borrowed $2,500,000
in conjunction with the Kentucky Insurance Acquisition and on May 12, 1998
borrowed $3,400,000 in conjunction with the United Acquisition. Interest is
payable quarterly at the bank's prime lending rate. Principal installments
are due as follows: 2000 - $500,000; 2001 - $904,167; 2002 through 2004 -
$1,316,666; 2005 and 2006 - $1,416,666; and 2007 - $312,503. The Company
has pledged the issued and outstanding common and preferred stock of Citizens
Security and Kentucky Insurance as collateral for the commercial bank notes.
The bank notes also contain covenants regarding asset acquisitions,
shareholder dividends and maintenance of certain operating ratios.
Cash paid for interest on debt was $595,939, $524,765 and $367,539 during
1999, 1998 and 1997, respectively; including $84,491, $108,514 and $103,327
in 1999, 1998 and 1997, respectively, related to brokerage account borrowings.
Note 7--REDEEMABLE CONVERTIBLE PREFERRED STOCK
In conjunction with the Integrity Acquisition, during 1995 and 1996, the
Company issued $4,070,000 of redeemable convertible preferred stock with
cumulative quarterly dividends due at an annual rate of 10%. During the
third quarter of 1998, the Company converted approximately 98% of the
preferred stock to common stock and repurchased the remaining 2% for cash.
The conversion resulted in issuance of 722,000 additional common shares and
increased common shareholders' equity by $3,937,768. The remaining preferred
shares were repurchased for $162,000, resulting in a net shareholders' equity
reduction of $63,000.
Note 8--EARNINGS AND DIVIDENDS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share. See Note 7 above for additional disclosures regarding the
outstanding preferred stock.
Year Ended December 31 1999 1998 1997
-------------------------------------------------------------------------------
Numerator:
Diluted: Net income $6,438,845 $3,299,660 $1,988,212
Less: Preferred stock dividends --- 279,650 407,000
-------------------------------------------------------------------------------
Basic: Net income applicable to
common stock $6,438,845 $3,020,010 $1,581,212
-------------------------------------------------------------------------------
Denominator:
Basic: Weighted average common
shares 1,793,554 1,306,894 1,075,615
Plus: Assumed conversion
of preferred stock --- 505,233 740,000
-------------------------------------------------------------------------------
Diluted: Weighted average shares
assuming preferred conversions 1,793,554 1,812,127 1,815,615
-------------------------------------------------------------------------------
Basic earnings per share $3.59 $2.31 $1.47
Diluted earnings per share $3.59 $1.82 $1.10
Options to purchase 5,000 shares of the Company's common stock at $9 per
share were outstanding during 1997 but were not included in the computation
of diluted earnings per share because the options' exercise price was greater
than the average market price of the common shares and, therefore, the effect
would be antidilutive. These options were exercised during 1998. No common
dividends were paid for 1999, 1998, or 1997.
39
<PAGE>
Note 9--INCOME TAXES
Income taxes consist of the following:
Year Ended December 31 1999 1998 1997
- ----------------------------------------------------------------
Current tax expense $1,675,000 $793,000 $341,500
Deferred tax expense
(benefit) 550,000 (19,000) 141,000
- ----------------------------------------------------------------
Income tax expense $2,225,000 $774,000 $482,500
- ----------------------------------------------------------------
Tax expense includes a state and local income tax provision of $225,000 in
1999 and none in 1998 or 1997. Deferred income taxes are provided for
cumulative temporary differences between balances of assets and liabilities
determined under GAAP and balances determined for tax reporting purposes.
Significant components of the Company's deferred tax liabilities and assets
as of December 31, 1999 and 1998 are as follows:
December 31 1999 1998
- ---------------------------------------------------------------------
Deferred Tax Liabilities:
Value of insurance acquired $ 1,800,578 $ 2,085,945
Net unrealized gains on
available-for-sale securities 1,711,832 1,586,470
Other 826,620 223,901
- ---------------------------------------------------------------------
Total deferred tax liabilities 4,339,030 3,896,316
Deferred Tax Assets:
Policy and contract reserves 1,758,494 1,591,595
Deferred policy acquisition costs 78,267 543,132
Fixed maturities and equity securities 377,528 338,474
Real estate 548,668 548,668
Alternative minimum tax credit
carryforwards --- 508,688
Net operating loss carryforwards --- 88,766
Other 430,117 348,377
- ---------------------------------------------------------------------
Total deferred tax assets 3,193,074 3,967,700
Valuation allowance for deferred tax
assets (833,258) (1,376,402)
- ---------------------------------------------------------------------
Net deferred tax assets 2,359,816 2,591,298
- ---------------------------------------------------------------------
Net deferred tax liabilities $ 1,979,214 $ 1,305,018
- ---------------------------------------------------------------------
The following is a reconciliation of the federal statutory income tax rate to
the Company's effective income tax rate:
December 31 1999 1998 1997
- -------------------------------------------------------------------
Statutory rate of income tax 34.00 % 34.00 % 34.00 %
Small life deduction (5.91) (13.90) (18.32)
Alternative minimum tax --- (2.69) 5.28
(credit)
State and local income tax 3.16 0.00 0.00
Surtax exemption and other 0.96 1.01 (3.76)
Dividend exclusion (0.87) (1.52) (1.71)
Change in valuation allowance (5.66) 2.10 4.04
- -------------------------------------------------------------------
Effective rate of income tax 25.68 % 19.00 % 19.53 %
- -------------------------------------------------------------------
40
<PAGE>
Income taxes paid in 1999, 1998 and 1997 were $2,458,515, $385,000 and
$610,000, respectively. The Company utilized $235,567, $430,885 and $508,488
of net operating loss carryforwards in 1999, 1998 and 1997, respectively. The
change in the valuation allowance is due principally to changes in the
alternative minimum tax credit and utilization of net operating loss
carryforwards.
Under the tax law in effect prior to 1984, a portion of income of Citizens
Security was not taxed when earned. It was accumulated in a tax account
known as policyholders' surplus. Under the provisions of the Deficit
Reduction Act of 1984, policyholders' surplus accounts were frozen at their
December 31, 1983 balance of $859,000 for Citizens Security on a merged
basis. Distributions from the policyholders' surplus would be subject to
income tax. At December 31, 1999, Citizens Security could have paid
additional dividends of approximately $19,065,000 before paying tax on any
part of its policyholders' surplus accounts. No provision has been made for
the related deferred income taxes which total $292,000, based on current tax
rates as of December 31, 1999. However, legislation has been proposed which
would tax undistributed policyholder surplus.
Note 10--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDERS' EQUITY
The Insurance Subsidiaries are domiciled in Kentucky and prepare their
statutory-basis financial statements in accordance with statutory accounting
practices ("SAP") prescribed or permitted by the Kentucky Department of
Insurance ("KDI"). Net income and capital and surplus for the Company's
insurance operations, as reported in accordance with SAP, for the three years
ended December 31, 1999 are shown below.
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------
Net Income $ 4,966,948 $ 3,662,188 $ 1,708,884
Capital and Surplus $ 16,227,706 $ 11,227,528 $ 9,627,479
Citizens Security reports its investment in United Liberty on the equity
method of accounting for statutory accounting purposes. Accordingly, the
admitted value of Citizens Security's investment in United Liberty equals
United Liberty's statutory capital and surplus total of $3,070,963 and
$3,302,107 at December 31, 1999 and 1998, respectively. Citizens Security's
net income includes $234,853 and $404,553 of United Liberty statutory
earnings in 1999 and 1998, respectively. The 1999 totals above also include
$21,240 of statutory net income for Kentucky Insurance since its October,
1999 acquisition and $3,285,375 of statutory capital and surplus at December
31, 1999.
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 insurance laws,
regulations, and general administrative rules, as well as a variety of
publications of the National Association of Insurance Commissioners
("NAIC"). "Permitted" statutory accounting practices encompass all
accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. During 1998, the NAIC adopted codified statutory
accounting principles ("Codification"). Codification will likely change, to
some extent, prescribed statutory accounting practices that the Insurance
Subsidiaries use to prepare their statutory-basis financial statements.
Codification will require adoption by the various states before it becomes
the prescribed statutory basis of accounting for insurance companies
domesticated within those states. Accordingly, before Codification becomes
effective for the Insurance Subsidiaries, the KDI must adopt Codification as
the prescribed basis of accounting on which domestic insurers must report
their statutory-basis results to the KDI. At this time it is anticipated
that the KDI will adopt Codification. Based on current draft guidance,
management believes that the impact of Codification will not be material to
the Insurance Subsidiaries' statutory-basis financial statements.
41
<PAGE>
Statutory restrictions limit the amount of dividends which the insurance
companies may pay. Generally, dividends during any year may not be paid,
without prior regulatory approval, in excess of the lesser of (a) 10% of
statutory shareholder's surplus as of the preceding December 31, or (b)
statutory net operating income for the preceding year. During 1999, 1998 and
1997, with appropriate prior regulatory approval, Citizens Security redeemed
$1,200,000. $1,500,000, and $1,050,000 respectively, of its outstanding
preferred stock from the Company. In addition, during 1999, with appropriate
regulatory approval, Citizens Security paid a dividend of $1,000,000 to the
Company. During 1999 and 1998, United Liberty paid dividends of $200,000
and $325,000 respectively, to Citizens Security. The Insurance Subsidiaries
must each maintain $1,250,000 of capital and surplus, the minimum required
for insurance companies domiciled in Kentucky. The KDI imposes minimum
risk-based capital ("RBC") requirements on insurance enterprises that were
developed by the NAIC. The formulas for determining the amount of RBC
specify various weighting factors that are applied to financial balances and
various levels of activity based on the perceived degree of risk. Regulatory
compliance is determined by a ratio (the "Ratio") of the enterprise's
regulatory total adjusted capital, as defined by the NAIC, to its 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. The Insurance Subsidiaries each have a
Ratio that is at least 400% of the minimum RBC requirements; accordingly,
they all meet the RBC requirements.
Under a prior year agreement, an option to purchase 5,000 shares of the
Company's common stock was granted to an officer and was outstanding at the
beginning of 1998. The stock option vested as of June 16, 1995, at an
exercise price of $9 per share, and was scheduled to expire on June 16,
1998. This option was exercised during the second quarter of 1998, resulting
in an increase to shareholders' equity of $45,000. 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 this stock option. No options were exercised during 1999 or 1997. The
effect of applying the fair value method of accounting for the Company's
stock based awards results in net income and earnings per share that are not
materially different from amounts reported.
Note 11--SEGMENT INFORMATION
Effective December 31, 1998, the Company adopted SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
supersedes SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards for the way in which public
business enterprises report information about operating segments. SFAS No.
131 also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The adoption of SFAS No.
131 did not affect results of operations or financial position, but did
affect the disclosure of segment information.
The Company's operations are managed along five principal insurance product
lines: Home Service Life, Broker Life, Preneed Life, Dental, and Other
Health. Products in all five lines are sold through independent agency
operations. Home Service Life consists primarily of traditional life
insurance coverage sold in amounts of $10,000 and under to middle and lower
income individuals. This distribution channel is characterized by a
significant amount of agent contact with customers throughout the year.
Broker Life product sales consist primarily of simplified issue and
graded-benefit policies in amounts of $10,000 and under. Other products in
this segment which are not aggressively marketed include: group life,
universal life, annuities and participating life coverages. Preneed Life
products are sold to individuals in connection with prearrangement of their
funeral and include single premium and multi-pay policies with coverages
generally in amounts of $10,000 and less. These policies are generally sold
to older individuals at increased premium rates. Dental products are term
coverages generally sold to small and intermediate size employer groups.
Other Health products include various accident and health coverages sold to
individuals and employer groups.
42
<PAGE>
Segment information as of December 31, 1999, 1998 and 1997, and for the years
then ended is as follows:
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------
Revenue:
Home Service Life $ 8,745,144 $ 8,315,665 $ 8,322,333
Broker Life 6,003,025 5,341,104 4,482,486
Preneed Life 3,614,758 2,099,584 ---
Dental 7,141,409 6,435,680 7,218,575
Other Health 1,383,437 1,409,483 1,485,301
- -------------------------------------------------------------------------
Segment Totals 26,887,773 23,601,516 21,508,695
Net realized investment
gains, net of expenses 9,375,339 3,675,489 2,193,148
- -------------------------------------------------------------------------
Total Revenue $ 36,263,112 $ 27,277,005 $ 23,701,843
- -------------------------------------------------------------------------
Below are the net investment income amounts which are included in the revenue
totals above.
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------
Net Investment Income:
Home Service Life $ 1,993,810 $ 1,750,942 $ 1,769,757
Broker Life 2,488,921 2,283,466 1,898,714
Preneed Life 1,282,397 1,025,696 ---
Dental 34,848 20,801 23,568
Other Health 85,336 109,417 116,899
- -------------------------------------------------------------------------
Segment Totals $ 5,885,312 $ 5,190,322 $ 3,808,938
- -------------------------------------------------------------------------
The Company evaluates performance based on several factors, of which the
primary financial measure is segment profit. Segment profit represents
pretax earnings, determined in accordance with the accounting policies
described in Note 1, except net realized investment gains and interest
expense are excluded. The majority of the Company's realized investment
gains are generated from investment in equity securities. The equities
portfolio has averaged approximately $15,589,000 (cost basis) during the past
three years. If these funds had been invested in fixed-maturities yielding
7.0%, realized investment gains would have declined and the segment profit
totals below would have increased by an additional $922,000, $594,000, and
$493,000 in 1999, 1998, and 1997 respectively. The decline in Segment
profit in 1999 from 1998 is impacted by additional investments in equity
securities, increased marketing costs in the Preneed segment, and moderate
increases in mortality, partially offset by continuing improvement in Dental
sales volume and profit margins.
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------
Segment Profit (Loss):
Home Service Life $ 312,703 $ 211,713 $ 97,098
Broker Life 150,317 254,189 100,655
Preneed Life (993,560) 15,325 ---
Dental 436,587 295,038 214,495
Other Health (64,524) 90,174 206,591
- -------------------------------------------------------------------------
Segment Totals (158,477) 866,439 618,839
Net realized investment
gains, net of expenses 9,375,339 3,675,489 2,193,148
Interest expense 553,017 468,268 341,275
- -------------------------------------------------------------------------
Income before Income Tax $ 8,663,845 $4,073,660 $2,470,712
- -------------------------------------------------------------------------
43
<PAGE>
Depreciation and amortization amounts below consist of amortization of the
value of insurance acquired, deferred policy acquisition costs and goodwill,
along with depreciation expense.
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Depreciation and Amortization:
Home Service Life $ 583,456 $ 710,150 $ 736,651
Broker Life 601,640 757,154 760,311
Preneed Life 381,354 135,723 ---
Dental 50,276 54,381 59,812
Other Health 41,661 40,708 45,103
- -------------------------------------------------------------------------
Segment Totals $ 1,658,387 $ 1,698,116 $ 1,601,877
- -------------------------------------------------------------------------
Segment asset totals are determined based on policy liabilities outstanding
in each segment.
December 31 1999 1998 1997
- -------------------------------------------------------------------------
Assets:
Home Service Life $ 47,347,032 $43,299,037 $ 42,944,975
Broker Life 57,958,271 52,783,159 39,165,663
Preneed Life 29,754,353 30,869,962 ---
Dental 913,939 674,728 699,382
Other Health 2,006,435 1,872,237 1,939,822
- -------------------------------------------------------------------------
Total Assets $137,980,030 $129,499,123 $ 84,749,842
- -------------------------------------------------------------------------
Note 12--REINSURANCE
The Company currently follows the general practice of reinsuring that portion
of risk on the life of any individual which is in excess of $40,000 for
individual policies (under yearly renewable term and coinsurance agreements)
and $15,000 for group policies (under a group yearly renewable term
agreement). Graded death benefit and simplified issue coverages above $4,000
are generally 50% reinsured, with the Life Insurance Subsidiaries maintaining
a maximum $10,000 risk on any one policyholder. Individual and group
accidental death coverage and major medical accident and health coverages are
100% reinsured. To the extent that reinsuring companies are unable to meet
obligations under reinsurance agreements, the Company would remain liable.
Note 13--CONTINGENCIES
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 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
44
<PAGE>
independent pricing services. Available-for-sale fixed maturities are
carried at fair value in the accompanying statements of financial condition.
At December 31, 1999 and 1998, the fair value of available-for-sale fixed
maturities was $69,501,248 and $77,582,742, 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, 1999 and
1998, the fair value of equity securities was $22,941,274 and $17,208,338,
respectively.
Short-Term Investments: The carrying amount of short-term investments
approximates their fair value. At December 31, 1999 and 1998, the fair value
of short-term investments was $580,425 and $594,805, respectively.
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents
approximates their fair value. At December 31, 1999 and 1998, the fair value
of cash and cash equivalents was $18,696,401 and $8,301,999, respectively.
Mortgage Loans: The carrying amount of mortgage loans approximates their
fair value. At December 31, 1999 and 1998, the fair value of mortgage loans
was $158,309 and $164,757, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair
value. At December 31, 1999 and 1998, the fair value of policy loans was
$4,059,801 and $4,034,152, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity
contracts approximates their fair value. At December 31, 1999 and 1998, the
fair value of investment-type fixed annuity contracts was $8,257,568 and
$8,726,975, respectively.
Notes Payable: The carrying amounts of notes payable approximate their fair
values. At December 31, 1999 and 1998, the fair value of notes payable was
$8,500,000 and $6,510,000, respectively.
Note 15--BENEFIT PLANS
During 1997, the Company adopted a 401(k) savings plan for its full-time
employees. The Company contributes matching contributions at the discretion
its Board of Directors. Company expense associated with this plan totaled
$34,860, $24,337 and $15,238 in 1999, 1998 and 1997, respectively.
Note 16--RELATED PARTY TRANSACTIONS
The Company has various transactions with its President and Chairman of the
Board (the "Chairman") or entities he controls. The Chairman provides investment
portfolio management for the Company and its subsidiaries through SMC Advisors,
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 $48,000 ($39,000 prior to the Kentucky Insurance
Acquisition) and incentive compensation equal to five percent (5%) of the sum of
the net realized and unrealized capital gains in the fixed maturities and equity
securities portfolios of the Company during each contract year. Any excess of
net realized and unrealized capital losses over net realized and unrealized
capital gains at the end of a contract year is not carried forward to the next
contract year. Fixed fees totaled $39,000, $34,500, and $30,000 in 1999, 1998
and 1997, respectively. Incentive fees of $617,524, $196,904 and $306,747 were
incurred and paid for 1999, 1998 and 1997, respectively. Previously, the
Chairman, personally guaranteed a portion of the Company's commercial bank debt
in return for a fee. Effective June 15, 1998 the commercial bank unilaterally
released the Chairman's personal guarantee. Fees earned in connection with the
Chairman's guarantee totaled $169,583 for 1997. No guaranty fees were earned for
1999 or 1998. The Company also maintains a portion of its investments under a
Trust Agreement with a bank controlled by the Chairman. Fees to the bank are
based on assets held. Such fees were $85,396, $46,429 and $26,451 in 1999, 1998,
and 1997, respectively. During 1999, the Company began managing certain
commercial real estate affiliated with its Chairman. The Company charges the
real estate projects management fees at market rates, which totaled $114,628
during 1999.
45
<PAGE>
ITEM 8. 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 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by this Item is set forth under the captions
"Election of Directors", "Executive Officers of the Company", and "Section
16(a) Beneficial Ownership Reporting Compliance" in the Board of Director's
Proxy Statement for the Annual Meeting of Shareholders of the Company now
scheduled for May 25, 2000, and such information is here incorporated by
reference.
ITEM 10. 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 25, 2000,
and such information is here incorporated by reference.
ITEM 11. 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 25, 2000,
and such information is here incorporated by reference.
ITEM 12. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
The information required by this Item is set forth under the captions
"Certain Transactions Involving Directors and Executive Officers" in the
Board of Directors' Proxy Statement for the Annual Meeting of Shareholders of
the Company now scheduled for May 25, 2000, and such information is here
incorporated by reference.
46
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-KSB:
(a) Exhibits.
The exhibits listed in the Index to Exhibits appearing on page 49.
(b) Reports on Form 8-K.
None.
47
<PAGE>
SIGNATURES
In accordance with of Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
CITIZENS FINANCIAL CORPORATION
March 23, 2000 By: /s/ Darrell R. Wells
---------------------------------
Darrell R. Wells
President
In accordance with the requirements of the Exchange Act, this Report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Darrell R. Wells
- ---------------------------
Darrell R. Wells Director and President March 23, 2000
(principal executive
officer)
/s/ Lane A. Hersman
- ---------------------------
Lane A. Hersman Director and Executive March 23, 2000
Vice President
/s/ Brent L. Nemec
- ---------------------------
Brent L. Nemec Vice President, March 23, 2000
Accounting,
Chief Financial Officer,
and Treasurer (principal
financial and accounting officer)
/s/ John H. Harralson, Jr.
- ---------------------------
John H. Harralson, Jr. Director March 23, 2000
/s/ Frank T. Kiley
- ---------------------------
Frank T. Kiley Director March 23, 2000
/s/ Charles A. Mays
- ---------------------------
Charles A. Mays Director March 23, 2000
/s/ Earle V. Powell
- ---------------------------
Earle V. Powell Director March 23, 2000
/s/ Thomas G. Ward
- ---------------------------
Thomas G. Ward Director March 23, 2000
/s/ Margaret A. Wells
- ---------------------------
Margaret A. Wells Director March 23, 2000
48
<PAGE>
INDEX TO EXHIBITS
(Item 13(b))
The documents listed in the following table are filed as Exhibits in response
to Item 13(b). Exhibits listed that are not filed herewith are incorporated
herein by reference.
Exhibit Description
No.
3.1 Restated Articles of Incorporation of the
Company dated August 12, 1996 (filed as
Exhibit 3.1 to the Company's Form 10-KSB
dated March 31, 1999)
3.2 Bylaws of the Company adopted September 12,
1990 as amended March 25, 1994 (filed as
Exhibit 3.2 to the Company's Form 10-K dated
March 28, 1996)
4 Provisions of Articles of Incorporation of
the Company Defining the Rights of Holders
of Class A Stock (filed as Exhibit 4 to the
Company's Form 10 Registration Statement)
10.1 Investment Management Agreements dated July
1, 1994 between Citizens Security and the
Company and SMC Advisors, Incorporated
(filed as Exhibit 10.1 to the Company's Form
10-K dated March 29, 1995)
10.1B Investment Management Agreement dated June
1, 1998 between United Liberty and SMC
Advisors, Incorporated (filed as Exhibit
10.1B to the Company's Form 10-KSB dated
March 31, 1999)
10.1C Investment Management Agreement dated
February 6, 2000 between Kentucky Insurance
and SMC Advisors, Incorporated (filed
herewith)
10.9 Form of Employment Agreement with Certain
Executives of the Company and Schedule of
Data (filed as Exhibit 10.9 to the Company's
Form 10-K dated March 28, 1996)*
10.10 1999 Stock Option Plan (filed as exhibit to
the Company's proxy statement for annual
meeting of shareholders held on May 20,
1999)*
21.1 Subsidiaries of the small business issuer
(filed herewith)
23.2 Consent of Independent Auditors
(filed herewith)
27 Financial Data Schedule (electronic filing
only)
----------------------------------------------------------
* Management contract or compensatory plan or arrangement.
49
<PAGE>
EXHIBIT 10.1C
AMENDED AND RESTATED
INVESTMENT MANAGEMENT AGREEMENT
THIS AGREEMENT is entered into by and between KENTUCKY INSURANCE
COMPANY, a Kentucky insurance company ("Company") and SMC ADVISORS, INC., a
Kentucky corporation ("SMC").
RECITALS:
SMC and its president, Darrell R. Wells, are experienced in investment
decisions, policies and strategies. Company desires to employ SMC to manage
Company's entire bonds and stocks investment portfolio (the "Bonds and Stocks
Portfolio") on a fee basis and SMC is willing to undertake such duties, all
in accordance with the terms set forth herein.
NOW, THEREFORE, the parties agree as follows:
1. Employment of SMC. Company hereby employs SMC and SMC hereby accepts
employment by Company as investment advisor and manager of the Bonds and
Stocks Portfolio.
2. Duties and Responsibilities of SMC. Subject to the overall guidance
of Company, SMC shall administer day-to-day operations of the Bonds and Stock
Portfolio; shall serve as Company's investment advisor and consultant in
connection with policy decisions to be made by Company with respect to the
Bonds and Stocks Portfolio; shall investigate, select, and on behalf of
Company conduct negotiations with brokers, underwriters, investment bankers
and other persons in the securities industry; shall cause investment
transactions with respect to the Bonds and Stocks Portfolio to be executed
through brokers and other authorized persons dealing in Eligible Investments
(as hereinafter defined) and pay appropriate fees to such persons in
connection with investments acquired, sold, or otherwise disposed of or
committed, negotiated, or contemplated to be acquired, sold, or otherwise
disposed of; shall exercise its own sound judgment in doing so; shall, upon
request by Company, invest or reinvest any monies in the Bonds and Stocks
Portfolio; shall perform or assist in performance of such administrative
functions necessary in the management of the Bonds and Stocks Portfolio, as
may be agreed upon by SMC and Company; from time to time, or at any time
requested by Company, shall make reports of its performance of the foregoing
services to Company; and shall be responsible for and shall have
authorization to exchange, invest, reinvest, sell, and purchase assets of
Company that are available for investment in the Bonds and Stocks Portfolio
of Company. SMC shall invest only in such eligible investments as are
permitted to property and casualty insurance companies under the Kentucky
Insurance Code (including Subtitle 7, Chapter 304 of the Kentucky Revised
Statutes) and regulations of the Kentucky Department of Insurance thereunder
("Eligible Investments"). All investment decisions made by SMC shall be in
accordance with such overall policies of Company, if any, as may be disclosed
to SMC from time to time. Notwithstanding any other provision herein, SMC
shall not act as custodian for or hold any securities on behalf of KIC.
<PAGE>
3. Reporting and Disclosure.
A. SMC shall report to the directors or other authorized
officials of Company the results of investment transactions when requested to
do so by Company. SMC shall consult with Company officials and its Board of
Directors from time to time as directed by Company.
B. Likewise, Company shall at all times keep SMC fully informed
with regard to the investments owned by it, its funds available or to become
available for investment, and generally as to the condition of Company's
affairs. Company shall furnish SMC with copies of all available financial
statements and other data necessary for SMC to carry out its duties hereunder.
4. Books. SMC shall maintain appropriate records of all its activities
hereunder.
5. Compensation for Services. As compensation for its services
rendered hereunder:
A. SMC shall receive a monthly base fee of $500 payable in
advance on the first day of each month beginning on the Effective Date of
this Agreement (as hereinafter defined).
B. With respect to each "Accounting Period" (which term shall
mean the Effective Date through December 31, 1999 and then January 1 through
December 31 of each calendar year ending after December 31, 1999 during the
term of this Agreement), SMC shall be entitled to an amount of compensation
equal to 5% of the sum of the Net Unrealized Capital Gains or Net Unrealized
Capital Losses plus the Net Realized Capital Gains or Net Realized Capital
Losses in the Bonds and Stocks Portfolio.
[1] For purposes of this Agreement, the terms "Net Realized
Capital Gain" and "Net Realized Capital Loss" shall mean, with respect to any
Accounting Period, the net difference between the aggregate gains realized in
the Bonds and Stocks Portfolio during such Accounting Period from the
purchase or sale of Eligible Investments and the aggregate losses realized in
the Bonds and Stocks Portfolio during such Accounting Period from the
purchase or sale of Eligible Investments.
[2] The terms "Net Unrealized Capital Gain" and "Net
Unrealized Capital Loss" shall mean, with respect to any Accounting Period,
the increase or decrease during such Accounting Period in the difference
between the aggregate market value and the aggregate statutory book value of
Eligible Investments in the Bonds and Stocks Portfolio.
2
<PAGE>
[3] For purposes of computing Net Realized Capital Gain,
Net Realized Capital Loss, Net Unrealized Capital Gain and Net Unrealized
Capital Loss, gain or loss or increases or decreases in value difference
between shall be determined on the basis of the statutory book value of an
Eligible Investment and the proceeds thereof if disposed of or its closing
value if held at the close on an Accounting Period. The closing value of any
Eligible Investment for any Accounting Period shall be the value of such
Eligible Investment determined in good faith by Company in accordance with
the provisions of paragraph 5.B[4] hereof, as of the end of such Accounting
Period.
[4] Eligible Investments which are listed on a national
securities exchange shall be valued at their last sales price on the date of
determination, or, if no sales occurred on such day, at the median between
the "bid" and "asked" prices on such date. Eligible Investments which are not
so listed shall be valued at their last closing "bid" price. All other
Eligible Investments shall be valued in the manner determined in good faith
by Company to best reflect their fair market value.
C. Payment of incentive compensation shall be made to SMC by
Company not later than 45 days after the end of each Accounting Period.
6. Term of Agreement. This Agreement shall commence on the Effective
Date and shall continue until December 31, 1999. This Agreement shall be
automatically renewed for successive one-year periods unless either party
notifies the other in writing not less than 30 days prior to the end of the
then current period of its intent to terminate this Agreement at the end of
such period.
7. Responsibility of SMC. SMC assumes no responsibility under this
Agreement other than to render all services called for hereunder in good
faith and on an arms-length basis and shall not be responsible for any action
of Company or officers of Company in following or declining to follow the
advice and recommendations of SMC. SMC, its officers, directors, shareholders
and employees will not be liable to Company, Company's shareholders, or
others except by reason of acts constituting bad faith, willful misfeasance,
gross negligence, or reckless disregard of its duties. SMC and Company are
not partners or joint venturers, and nothing herein contained shall be
construed so as to make them partners or joint venturers or impose any
liability as such on either of them.
8. Nonassignability. Neither party may assign its rights under this
Agreement without the written consent of the other party.
9. Termination. This Agreement shall be and become terminated, at the
option of the other party immediately upon the giving of written notice of
termination by such other party, if any of the following events shall occur:
A. If either party shall violate any provision of this Agreement,
and after notice of such violation, shall not cure such default within thirty
(30) days; or
B. If either party shall be adjudged bankrupt or insolvent by a
court or agency of competent jurisdiction, or an order shall be entered by a
court or agency of competent jurisdiction for the appointment of a receiver,
liquidator, or trustee of such party or of all or substantially all of its
property by reason of the foregoing, or approving any petition filed against
such party for its reorganization, and such adjudication or order shall
remain in force or unstayed for a period of thirty (30) days; or
3
<PAGE>
C. If either party shall institute proceedings for voluntary
bankruptcy, or shall file a petition seeking reorganization under the federal
bankruptcy laws, or for relief under any federal or state law for the relief
of debtors, or shall consent to the appointment of a receiver for it or for
all or substantially all of its property, or shall make a general assignment
for the benefit of its creditors, or shall admit in writing its inability to
pay its debts generally as they may become due.
10. Effect of Termination. Upon termination of this Agreement, SMC
shall return to Company all books and records maintained by SMC with respect
to the Bonds and Stocks Portfolio managed hereunder. SMC shall deliver to
Company a full accounting, including a statement showing all payments
collected by and all monies held by it, covering the period following the
date of the last accounting furnished, and deliver to Company all such
property and documents of Company then in the custody of SMC. shall be
entitled to the above-stated compensation through the month of termination.
11. Notices. Any notice, report or other communication required or
permitted to be given hereunder shall be in writing and shall, unless some
other method of giving such notice, report, or other communication is
accepted by the party to whom it is given, be given by being mailed by
certified mail to the following addresses of the parties hereto:
If to SMC: SMC Advisors, Inc.
4350 Brownsboro Road
Suite 310
Louisville, Kentucky 40207
If to Company: Kentucky Insurance Company
The Market Place, Suite 300
12901 Shelbyville Road
Louisville, Kentucky 40243
12. Modification. This Agreement shall not be changed, modified,
terminated, or discharged in whole or in part, except by an instrument in
writing signed by both parties hereto, or their respective successors and
assigns.
13. Binding Effect. This Agreement shall be binding upon and inure to
the benefit of the parties-hereto, their successors and assigns subject to
the provisions of Section 8.
14. Kentucky Governing Law. This Agreement shall be governed by and in
accordance with the laws of the Commonwealth of Kentucky.
IN WITNESS WHEREOF, the parties have executed this
Agreement as of the 6th day of February, 2000.
KENTUCKY INSURANCE COMPANY
By: /s/ Lane A. Hersman
Lane A. Hersman
President
SMC ADVISORS, INC.
By: /s/ Darrell R. Wells
Darrell R. Wells
President
4
<PAGE>
EXHIBIT 21.1
Subsidiaries of the Registrant
Citizens Financial Corporation (Kentucky Corporation)
100% Citizens Security Life Insurance Company (Kentucky Corporation)
100% United Liberty Life Insurance Company (Kentucky Corporation)
100% Kentucky Insurance Company (Kentucky Corporation)
100% Corporate Realty Service, Inc * (Kentucky Corporation
* Previously named Citizens Financial Properties, Inc.
<PAGE>
EXHIBIT 23.2
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-86519) pertaining to the Citizens Financial Corporation 1999 Stock
Option Plan of our report dated March 23, 2000 with respect to the consolidated
financial statements and schedules of Citizens Financial Corporation included in
the Annual Report (Form 10-KSB) for the year ended December 31, 1999.
/s/ Ernst & Young LLP
Louisville, Kentucky
March 23, 2000
<PAGE>
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<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
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