-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Df54mq1PWDtMJiG/dBot430Bbzopbsrb9adzlIA5n/WOQbz1J366qZnMFLToV2rc dOD580JdC9Zm7Jdbx983JA== 0000927016-98-001214.txt : 19980330 0000927016-98-001214.hdr.sgml : 19980330 ACCESSION NUMBER: 0000927016-98-001214 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITIZENS CORP /DE/ CENTRAL INDEX KEY: 0000895469 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 043178765 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-11714 FILM NUMBER: 98576969 BUSINESS ADDRESS: STREET 1: 440 LINCOLN ST CITY: WORCESTER STATE: MA ZIP: 01653 BUSINESS PHONE: 5088551000 MAIL ADDRESS: STREET 1: 440 LINCOLN STREET CITY: WORCESTER STATE: MA ZIP: 01653 10-K 1 FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM: TO 1-11714 (COMMISSION FILE NUMBER) ---------------- CITIZENS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 04-3178765 (STATE OR OTHER JURISDICTION, (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 440 LINCOLN STREET, WORCESTER, 01653 MASSACHUSETTS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (508) 855-1000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT: COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE (TITLE OF EACH CLASS OF STOCK) (NAME OF EXCHANGE ON WHICH REGISTERED) SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: NONE ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[_] Based on the closing sales price of March 13, 1998 the aggregate market value of the voting stock held by nonaffiliates of the registrant was $205,296,705. The number of shares outstanding of the registrant's common stock, $0.01 par value, was 35,275,100 shares outstanding as of March 13, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of Citizens Corporation's Proxy Statement for Annual Meeting of Shareholders to be held May 12, 1998 (the Proxy Statement) are incorporated by reference in Part III. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS ORGANIZATION Citizens Corporation is a Delaware Corporation and non-insurance holding company with wholly-owned subsidiaries: Citizens Insurance Company of America (Citizens Insurance), a Michigan corporation; Citizens Insurance Company of the Midwest, an Indiana corporation; and Citizens Insurance Company of Ohio, an Ohio corporation; (collectively Citizens Insurance Group) and Citizens Management Inc. (CMI). Citizens Corporation and its subsidiaries are hereinafter collectively referred to as "the Company." Approximately 82.5% of the Company is owned by The Hanover Insurance Company (Hanover). Hanover is an indirect wholly-owned subsidiary of Allmerica Financial Corporation (AFC), a Delaware corporation. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS The Company's insurance operations are segmented into personal and commercial lines based on common underlying risks and customer types for individual products in those lines. Information with respect to each of the Company's segments is included in "Segment Results" on pages 14 and 15 in Management's Discussion & Analysis of Results of Operations and Financial Condition and in Note 14 on page 47 of the Notes to the Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K. GENERAL The Company, through Citizens Insurance, is one of the largest underwriters of personal and commercial property and casualty insurance, in terms of market share, in Michigan. The Company has a historically strong regional focus and it places heavy emphasis on underwriting profitability and loss reserve adequacy. Through an independent agency force, the Company underwrites personal and commercial segments of insurance including: personal automobile, homeowners, workers' compensation, commercial automobile and commercial multiple peril. The Company maintains a clear focus on the core disciplines of underwriting, pricing, claims adjusting, marketing and sales. In particular, the Company seeks to achieve and maintain underwriting profitability in each of its five major product lines. The Company's overall strategy is to improve profitability through operating efficiencies and to pursue measured growth in existing markets and, as opportunities arise, in new markets which offer long- term growth potential. In addition, by focusing on its established major segment product lines, the Company typically does not pursue the development of new products with relatively unpredictable risk profiles. Citizens Insurance's average premium growth rate was 7.0% for the ten year period ended December 31, 1997 and its average statutory combined ratio for the same period was 100.6. The industry average premium growth rate was 3.7% for the ten year period ended December 31, 1997 and the industry average statutory combined ratio for the same period was 107.8. (Industry estimates are based on data published by A.M. Best.) The property and casualty insurance industry is highly cyclical. The industry's profitability can be affected significantly by price competition, volatile and unpredictable developments such as extreme weather conditions and natural disasters, legal developments affecting insurer liability and the size of jury awards, fluctuations in interest rates and other factors that affect investment returns, and other general economic conditions and trends, such as inflationary pressures, that may affect the adequacy of reserves. In 1996, the Company began the process of consolidating certain operations which are intended to achieve process improvements and efficiencies of operations. These operations include the claims, finance, policy processing and administrative functions. In 1997, the Company upgraded its claims processing automation and consolidated many of its Michigan claims offices into a regional claims center based in Howell. Additionally, 2 the Company increased claim draft authority for its agents and implemented a network of auto repair facilities to streamline damage appraisal and repair. The Company also began reengineering its processing of commercial lines business, redefining underwriting roles and providing more authority to agents to price and bind standard accounts. SEGMENT PRODUCT LINES Citizens underwrites personal and commercial property and casualty insurance coverage. The personal segment principally includes personal automobile and homeowners coverage. The commercial segment principally includes workers' compensation, commercial automobile and commercial multiple peril coverage. Personal automobile coverage insures individuals against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle, and property damage to other vehicles and other property. Homeowners coverage insures individuals against losses to their residences and personal property, such as those caused by fire, wind, hail, water damage (except for flooding), theft, and vandalism, and against third party liability claims. Workers' compensation coverage insures employers against employee medical and indemnity claims resulting from injuries related to work. Workers' compensation policies are often written in conjunction with other commercial policies. Commercial automobile coverage insures businesses against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle and property damage to other vehicles and other property. Commercial multiple peril coverage insures businesses against third-party liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold. It also insures business property for damage, such as that caused by fire, wind, hail, water damage (except for flooding), theft and vandalism. The Company also offers a variety of other products, such as inland marine, umbrella, fire, other liability and surety insurance. The Company provides self-insurance administration services for individual risks and groups, and writes excess reinsurance coverage for the self-insurance programs it administers through its wholly-owned subsidiary, CMI. CUSTOMERS, MARKETING AND DISTRIBUTION The Company seeks to maintain long-term pricing and underwriting integrity in order to remain a stable market for its independent agents. In order to complement the Company's property and casualty focus and increase customer contact, agents will seek to market employer benefit programs, including group medical and life, dental, and asset management. The Company also seeks to increase operating efficiencies through centralized strategic planning, marketing, and administrative support functions and increased use of sophisticated risk selection and operational technologies. The Company's insurance products are marketed in Michigan through approximately 3,600 licensed independent insurance agents, who are paid on a commission basis, associated with approximately 530 insurance agencies. The Company also markets its products in Indiana and Ohio through approximately 1,800 licensed independent insurance agents associated with approximately 220 insurance agencies. In 1997, each agency representing the Company wrote an average of approximately $1.6 million in Michigan, $0.5 million in Indiana, and $0.3 million in Ohio of Company premiums. In 1997, 287 agencies wrote Company premiums in excess of $1.0 million, 126 agencies wrote over $2.0 million, 62 agencies wrote over $3.0 million and 27 wrote over $4.0 million. The three largest agencies wrote approximately $20.3 million, $16.9 million, and $16.1 million of Company premiums, respectively. 3 The Company seeks to pursue profitable growth in existing markets by establishing long-term relationships with larger, well-established agencies. To solidify its relationship with higher quality agents, the Company offers enhanced profit sharing agreements, recognition awards, and maintains local presence through five branch offices and four claims offices in Michigan, Indiana and Ohio. In 1997, the Company completed the process of consolidating certain operations with Hanover to achieve process improvements and efficiencies in operations including claims, finance, policy processing and administrative functions. Additionally, during 1997 the Company relocated many of its claims functions to a regional office in Michigan to provide for better client service and gain operational efficiencies. The Company has been successful in developing and marketing groups in both personal and commercial segments that are tailored for members of associations, financial institutions and employers in Michigan, Indiana and Ohio. The organizations may choose to make the Company's programs available to their members or employees based on an evaluation of the Company's rates, service, and regulation, but each risk is individually underwritten and each customer is issued a separate policy. Associations and organizations receive no payment for making Citizens' franchise programs available to their members or employees. As of December 31, 1997, the Company had approximately 144 group programs in-force, 114 of which were in personal segments and 30 of which were in commercial segments. Revenue from personal and commercial lines groups accounts for nearly 50 percent of the Company's total premium volume. Citizens continues its use of agency-company interface ("ACI") technology, which enables agents to electronically submit personal lines policies for review and rating. In addition, agents are authorized to bind the Company on risks. The agents are guided by the Company's written underwriting rules and practices. These rules and practices set forth eligibility rules for various policies and coverages, unacceptable risks, and maximum and minimum limits of liability. Violation of these rules and practices is grounds for termination of the agency's contract to represent the Company. The Company is not dependent upon a single customer or any few customers for which the loss of any one or more would have a material adverse effect upon the Company's operations. MICHIGAN CATASTROPHIC CLAIMS ASSOCIATION As a condition to the ability to conduct personal automobile business in the state of Michigan, the Company is required under Michigan law to participate in a pooling arrangement with the Michigan Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA for personal protection insurance losses in excess of $0.25 million. Participation is required for all Michigan-licensed automobile and motorcycle insurers. The MCCA assesses its member companies an annual premium on each of such member company's policies covering automobile and motorcycles written in Michigan. The assessment is passed on directly to policyholders. The Company cedes a significant portion of its private passenger automobile premiums to the MCCA. Ceded premiums earned to MCCA in 1997, 1996, and 1995 were $9.8 million, $50.5 million and $66.8 million, respectively. The decrease in ceded premiums earned to MCCA reflects a reduction in premiums charged per policyholder by MCCA. Losses and LAE ceded to MCCA in 1997, 1996, and 1995 were ($0.8) million, ($52.9) million and $62.9 million, respectively. In 1997 and 1996, the MCCA's favorable development on prior year reserves exceeded the losses and LAE incurred during the year. At December 31, 1997 and 1996, the Company had reinsurance recoverable from the MCCA on paid and unpaid losses of $280.2 million and $292.0 million, respectively. The amount recoverable from the MCCA is a current estimate of future payments to be made to the Company by the MCCA for reimbursements of amounts for currently pending personal protection insurance (PIP) claims and PIP claims incurred but not yet reported. The Company bills the MCCA on a quarterly basis and all amounts have been paid when due. Because PIP claims whose payments will be reimbursed by the MCCA involve amounts to be paid over many years, actual amounts to be owed to the Company by the MCCA in the future are subject to change based on claims paid. The Company bills the MCCA based upon amounts actually paid by the Company to policyholders, however, there 4 can be no assurance that the Company will recover the full amount of reinsurance payments owed to it by the MCCA. As of June 30, 1997, 1996 and 1995, the MCCA had estimated surplus of $2.5 billion, $1.7 billion and $666.2 million, respectively. Management believes that in the current regulatory climate, the Company is unlikely to incur any material loss or become unable to pay claims as a result of nonpayment of amounts owed to it by the MCCA because (i) the MCCA is currently in a surplus position, (ii) the payment obligations of the MCCA are extended over many years, resulting in relatively small current payment obligations in terms of MCCA total assets, (iii) all amounts owed to the Company by the MCCA have been paid when due, and (iv) the MCCA is supported by assessments permitted by statute. COMPETITION The property and casualty industry is highly competitive among national agency companies, direct writers, and regional and local insurers on the basis of both price and service. Many of these companies are larger and have greater financial and technical resources than Citizens. National agency companies sell insurance through independent agents and usually concentrate on commercial lines of property and casualty insurance. Direct writers, including those with exclusive agent representation, dominate the personal lines of property and casualty insurance and operate on a national, regional, or single state basis. Regional and local companies sell through independent agents in one or several states in the same region and usually compete in both personal and commercial lines. In addition, because the Company markets exclusively through independent agents, Citizens competes with other independent agency companies for business in each of the agencies representing it. In Michigan, the Company competes in personal lines with a number of direct writers and regional and local companies, several of which are larger than the Company. Citizens Insurance is the largest writer of property and casualty insurance in Michigan through independent agents. The Company's principal competition in the Michigan homeowners line is from direct writers, including State Farm Group. The Company also faces competition from the two largest direct writers in Michigan, Auto Club Michigan Group and State Farm Group, in the personal automobile line. In February 1996, an amendment to the Essential Insurance Act became effective in Michigan. This amendment eliminates personal automobile and homeowners insurance territorial rating restrictions and limits merit ratings for automobile policies. This new legislation has removed barriers to entrance into the market for national agency companies, which have not been significant competitive forces in Michigan in the personal lines of property and casualty insurance in previous years. This was, in part, due to Michigan's prior insurance regulatory environment which required such companies to develop and implement special incentive programs designed to encourage agents to identify and sell insurance to individuals with lower risk profiles consistent with the constraints of Michigan law. Although the Company believes that this new legislation will encourage national companies to return or enter into the state, they do not believe that the impact of this law is yet measurable. The Company faces commercial lines competition principally from national agency companies, and regional and local companies, many of which have financial resources substantially greater than those of the Company. The Company is the second leading writer in Michigan in its three primary commercial lines combined: commercial automobile, workers' compensation, and commercial multiple peril. The commercial lines industry has been in a downturn over the past several years due primarily to price competition. Premium rate levels are related to the availability of insurance coverage, which varies according to the level of excess capacity in the industry. The current commercial lines market is extremely competitive due to a continuing soft market in which capacity is high and prices are low. In Michigan, Citizens workers' compensation line is the largest commercial line in terms of premiums written. Over the past few years, competition has caused Citizens to reduce workers' compensation insurance rates four times; 8.5%, 7.0%, 6.4% and 8.7% effective May 1, 1995, December 1, 1995, June 1, 1996 and March 1, 1997, respectively. In March 1997, the Company introduced workers' compensation product and pricing alternatives, written through Citizens Insurance Company of Ohio and Citizens Insurance Company of the Midwest. These vehicles enable greater pricing flexibility, particularly for writing preferred risks in medium and large workers' compensation accounts. By the end of 1997, rate filings effective January 1, 1998 by companies indicated either small decreases for selected classes of business or even some rate increases. 5 Consistent with industry response to high loss ratios in the homeowners insurance market, Citizens increased rates in this line of business in November 1997. Because many of the Company's national and regional competitors took similar rate increases, it is difficult to determine at present the impact of this increase. Beginning in 1995, Citizens Insurance Group experienced an increase in competition in affinity franchise group sales as a result of the January 1995 order by the Michigan Insurance Commissioner which allowed competitors to offer similar products. While management has taken steps to increase penetration in affinity franchise groups and initiated other marketing programs, the Company believes that competition for affinity group business and for other premiums in the property and casualty insurance market will continue and may have an adverse impact on rates and profitability. UNDERWRITING Pricing Citizens Insurance Group seeks to apply profit-driven underwriting and pricing practices in both hard and soft markets, expand its quality agency relationships and maintain a consistent presence in the markets for its five core product lines. This strategy seeks to achieve measured growth and consistent profitability on a continuous basis. The Company's position as one of the largest insurers in terms of net premiums written in Michigan allows it to use its own loss experience in determining premium rates. The Company's rates for personal and commercial automobile and homeowners insurance in Michigan are based on its own experience. In Michigan, and in Indiana, the Company develops rates for commercial lines of general liability and property by using loss cost data from the Insurance Service Office (ISO), an independent organization providing industry-wide loss experience in all major product lines. To this cost data, the Company adds its own experience in these lines. In the workers' compensation line in Michigan, the Company uses its own experience to determine rates for its largest classifications, and uses industry-wide experience to help set rates for smaller classifications. In Ohio, the Company has not yet developed enough loss experience on which to make rate calculations, and uses loss cost information from the ISO, along with market comparisons. Claims The Company employs experienced claims adjusters, appraisers, medical specialists, and attorneys in order to manage its claims. The Company has field claims staff strategically located throughout its operating territories, as well as a central customer service center in Howell, Michigan where claims are reported and most first party losses are quickly resolved. All claims staff members work closely with the agents to settle claims rapidly and cost- effectively. Claims office adjusting staff are supported by general adjusters on large property losses, automobile and heavy equipment damage appraisers on automobile material damage losses and medical specialists whose principal concentration is in workers' compensation and no-fault automobile injury cases. In addition, the claims offices are supported by staff attorneys who specialize in litigation defense and claim settlements. The Company also has a special unit which investigates suspected insurance fraud and abuse. Citizens Insurance has instituted a program under which participating agents have settlement authority for many property loss claims. Based upon the program experience, the Company believes that this program contributes to lower experience and to its higher customer satisfaction ratings by permitting the early and direct settlement of such claims. Approximately 30.1% and 26.6% of the number of total paid claims reported to Citizens Insurance in the years ended December 31, 1997 and 1996, respectively, were settled under this program. 6 Citizens Insurance has increased usage of the managed care expertise of the AFC's Corporate Risk Management Services segment in the analysis of medical services and pricing in the management of workers' compensation and medical claims on its automobile policies. The Company's use of this capability has demonstrated reduced costs and serves its customers more efficiently. Citizens Insurance has introduced Citizens/Care, which is a network of Preferred Provider Agreements which focuses on managing medical cost claims and serving customers more efficiently. Property and casualty insurers are subject to claims arising out of catastrophes which may have a significant impact on their results of operations and financial condition. The Company may experience catastrophe losses in the future which could have a material adverse impact on the Company. Catastrophes can be caused by various events including hurricanes, earthquakes, tornadoes, wind, hail, fires, and explosions, and the incidence and severity of catastrophes are inherently unpredictable. Although catastrophes can cause losses in a variety of property and casualty lines, homeowners and business property insurance have in the past generated the vast majority of catastrophe related claims. RESERVES FOR UNPAID LOSSES AND LAE See "Reserve for Losses and Loss Adjustment Expenses" on pages 16-18 of Management's Discussion & Analysis of Results of Operations and Financial Condition of this Form 10-K which are incorporated into this item by reference. The Company's actuaries review the reserves each quarter and certify the reserves annually as required for the Company's statutory filings. The Company does not use discounting techniques in establishing reserves for losses and LAE, nor has it participated in any loss portfolio transfers or other similar transactions. The Company regularly reviews its reserving techniques, its overall reserve position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to estimated reserves could have a material impact on the results of operations. Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to the Company, and the Company's payment of that loss. To recognize liabilities for unpaid losses, the Company establishes reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and LAE. 7 ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSES RESERVE DEVELOPMENT The following table sets forth the development of net reserves for unpaid losses and LAE from 1987 through 1997 for the Company.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- (IN MILLIONS) Net reserve for losses and LAE(1)............ $ 747.5 $ 772.1 $ 772.7 $ 739.9 $ 673.7 $ 598.8 $ 534.9 $ 429.6 $ 387.8 $ 329.8 $ 265.2 Cumulative amount paid as of(2): One year later........ -- 280.4 239.1 223.4 204.5 195.3 196.2 160.2 152.4 130.8 108.5 Two years later....... -- -- 368.2 333.4 309.0 295.0 295.4 255.4 227.9 202.7 167.6 Three years later..... -- -- -- 397.5 363.3 351.4 349.2 306.8 281.4 240.7 203.8 Four years later...... -- -- -- -- 394.9 378.3 380.0 334.7 310.8 269.7 220.9 Five years later...... -- -- -- -- -- 396.4 393.4 351.0 325.1 287.8 237.0 Six years later....... -- -- -- -- -- -- 405.6 360.1 335.9 296.5 246.9 Seven years later..... -- -- -- -- -- -- -- 370.2 343.0 303.7 254.0 Eight years later..... -- -- -- -- -- -- -- -- 351.5 308.9 259.4 Nine years later...... -- -- -- -- -- -- -- -- -- 315.7 263.4 Ten years later....... -- -- -- -- -- -- -- -- -- -- 268.3 Net reserve re- estimated as of(3): End of year............ 747.5 772.1 772.7 739.9 673.7 598.8 534.9 429.6 387.8 329.8 265.2 One year later........ -- 702.6 714.3 692.9 661.3 592.4 530.3 436.2 376.8 330.7 275.2 Two years later....... -- -- 646.7 634.0 609.3 578.4 530.5 451.0 388.1 326.9 272.9 Three years later..... -- -- -- 588.4 562.6 543.9 518.6 457.9 404.5 329.3 266.1 Four years later...... -- -- -- -- 533.7 518.4 507.7 454.4 415.2 353.5 277.4 Five years later...... -- -- -- -- -- 504.7 496.4 443.9 413.3 361.4 293.7 Six years later....... -- -- -- -- -- -- 491.4 437.8 407.0 361.4 300.8 Seven years later..... -- -- -- -- -- -- -- 437.9 405.0 359.2 302.5 Eight years later..... -- -- -- -- -- -- -- -- 407.2 359.2 300.7 Nine years later...... -- -- -- -- -- -- -- -- -- 362.1 303.9 Ten years later....... -- -- -- -- -- -- -- -- -- -- 309.3 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Cumulative Redundancy (Deficiency)(4)....... $ -- $ 69.5 $ 126.0 $ 151.5 $ 140.0 $ 94.1 $ 43.5 $ (8.3) $ (19.4) $ (32.3) $ (44.1) ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- -------- (1) Sets forth the net estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years; represents the net estimated amount of losses and LAE for claims arising in the current and all prior years that are unpaid at the balance sheet date, including incurred but not reported ("IBNR") reserves. (2) Cumulative loss and LAE payments made in succeeding years for losses incurred prior to the balance sheet date. (3) Re-estimated amount of the previously recorded liability based on experience for each succeeding year; increased or decreased as payments are made and more information becomes known about the severity of the remaining unpaid claims. (4) Cumulative deficiency or redundancy at December 31, 1997 of the net reserve amounts shown on the top line of the corresponding column. A redundancy in reserves means the reserves established in prior years exceeded actual losses and LAE or were reevaluated at more than the original reserved amount. A deficiency in reserves means the reserves established in prior years were less than actual losses and LAE or were reevaluated at more than the original reserved amount. 8 (5) The following table sets forth the development of gross reserve for unpaid losses and LAE from 1992 through 1997 for the Company:
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- ------- (IN MILLIONS) Reserve for losses and LAE: Gross Liability.......... $1,206.1 $1,238.5 $1,291.6 $1,196.6 $1,076.7 $ 867.8 Reinsurance recoverable.. 458.6 466.4 518.9 456.7 403.0 269.0 -------- -------- -------- -------- -------- ------- Net liability............ $ 747.5 $ 772.1 $ 772.7 $ 739.9 $ 673.7 $ 598.8 ======== ======== ======== ======== ======== ======= One year later: Gross re-estimated liability............... $1,110.1 $1,111.0 $1,063.8 $1,004.6 $ 898.2 Re-estimated recoverable. 407.5 396.7 370.9 343.3 305.8 -------- -------- -------- -------- ------- Net re-estimated liability............... $ 702.6 $ 714.3 $ 692.9 $ 661.3 $ 592.4 ======== ======== ======== ======== ======= Two years later: Gross re-estimated liability............... $1,003.6 $ 986.5 $ 896.9 $ 853.0 Re-estimated recoverable. 356.9 352.5 287.6 274.6 -------- -------- -------- ------- Net re-estimated liability............... $ 646.7 $ 634.0 $ 609.3 $ 578.4 ======== ======== ======== ======= Three years later: Gross re-estimated liability............... $ 910.5 $ 862.0 $ 785.4 Re-estimated recoverable. 322.1 299.4 241.5 -------- -------- ------- Net re-estimated liability............... $ 588.4 $ 562.6 $ 543.9 ======== ======== ======= Four years later: Gross re-estimated liability............... $ 809.0 $ 780.9 Re-estimated recoverable. 275.3 262.5 -------- ------- Net re-estimated liability............... $ 533.7 $ 518.4 ======== ======= Five years later: Gross re-estimated liability............... $ 750.3 Re-estimated recoverable. 245.6 ------- Net re-estimated liability............... $ 504.7 =======
RATING AGENCIES From 1970 to 1996, Citizens Insurance had been rated "A+ (Superior)" by A.M. Best. This was the second highest rating out of fifteen rating levels established by A.M. Best for the insurance industry. Ratings range from "A++ (Superior)" to "F (In Liquidation)." In 1997, A.M. Best decided to no longer rate Citizens independently from its majority parent, The Hanover Insurance Company, but instead rated the two separate companies as a group. Consequently, Citizens was assigned Best's "A (Excellent)" rating. According to A.M. Best, the objective of this rating is to evaluate factors that effect the overall performance of an insurance company. A.M. Best uses this information to provide an opinion of a company's operating performance, financial strength and ability to meet the obligations to policy holders. The quantitative and qualitative evaluations are used to determine financial condition and operating performance. The quantitative evaluations are based on an analysis of each company's reported financial performance for at least the previous five fiscal years. EMPLOYEES At December 31, 1997, the Company had approximately 1,387 employees, none of whom were represented by a labor union. Management believes that its relations with employees are good. REINSURANCE See "Reinsurance" on pages 18 and 19 of Management's Discussion and Analysis of Results of Operations and Financial Condition and Note 6 on pages 38, 39 and 40, respectively, of the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K which are incorporated into this item by reference. See also "Michigan Catastrophic Claims Association" on page 4 of this Form 10-K which is incorporated into this item by reference. 9 INVESTMENT OPERATIONS See "Investment Portfolio" on page 19 of Management's Discussion and Analysis of Results of Operations and Financial Condition and Note 3 on pages 34-36 of the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K which are incorporated into this item by reference. ITEM 2. PROPERTIES The Company owns a 110,600 square foot office building in Howell, Michigan, approximately 40 miles outside of Detroit. This building serves as the Company's headquarters and accommodates corporate administration, marketing, information services, and treasury. The Company also owns a 175,000 square foot facility in Howell near its current headquarters which accommodates underwriting, claims, marketing functions, and the Eastern Michigan branch operations. In addition, the Company leases an aggregate of approximately 55,000 square feet in three Michigan branch offices--in Grand Rapids, Gaylord, and Escanaba--one branch office located in Indianapolis, Indiana--and one branch office located in Columbus, Ohio. The Company also leases space for its claims offices throughout Michigan and Indiana. Management believes that the Company's owned and leased office space is adequate for its current needs. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this Form 10-K. 10 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS COMMON STOCK AND SHAREHOLDER OWNERSHIP The common stock of Citizens Corporation is traded on the New York Stock Exchange under the symbol "CZC." On March 13, 1998, the Company had 166 shareholders of record and 35.3 million shares outstanding. On the same date, the trading price of the Company's common stock was $33 1/4 per share. COMMON STOCK PRICES AND DIVIDENDS
HIGH LOW DIVIDENDS ---- ---- --------- 1997 First Quarter....................................... $25 1/8 $22 $0.05 Second Quarter...................................... $28 $23 3/4 $0.05 Third Quarter....................................... $30 3/8 $27 3/8 $0.05 Fourth Quarter...................................... $31 1/2 $27 3/4 $0.05 1996 First Quarter....................................... $20 1/4 $18 1/2 $0.05 Second Quarter...................................... $19 5/8 $17 5/8 $0.05 Third Quarter....................................... $22 3/8 $18 3/8 $0.05 Fourth Quarter...................................... $22 3/4 $20 1/8 $0.05
1998 DIVIDEND SCHEDULE Citizens Corporation declared a cash dividend of $0.05 on December 16, 1997, which is payable on February 16, 1998. The record date for such dividend is February 2, 1998. Dividends by the Company are funded from dividends paid to the Company from Citizens Insurance, which are subject to restrictions imposed by state insurance laws and regulations with respect to dividends paid to the Company. See "Liquidity and Capital Resources" on pages 19 and 20 of Management's Discussion & Analysis of Results of Operations and Financial Condition and Note 13 on page 46 of the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K which are incorporated into this item by reference. The payment of any future dividends will be a business decision to be made by the Board of Directors from time to time based upon the results of operations and financial condition of the Company and such other factors as the Board of Directors consider to be relevant. 11 ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) Net premiums written.................... $ 864 $ 838 $ 834 $ 779 $ 743 REVENUE: Net premiums earned.................... 855 836 818 763 713 Net investment income.................. 102 89 79 75 74 Net realized gain (loss) on investments........................... 29 15 4 (1) 31 Total revenues......................... 992 946 907 842 819 Statutory underwriting (loss) gain..... (12) (3) 7 (39) 0 GAAP underwriting gain (loss).......... (11) 1 13 (31) 10 STATUTORY COMBINED RATIO(1): Losses and loss adjustment expenses.... 74.6 72.3 71.0 76.2 71.2 Underwriting expenses.................. 25.7 27.2 26.8 27.6 27.0 Dividends to policyholders............. 0.8 0.9 0.8 0.7 0.7 Combined ratio......................... 101.1 100.4 98.6 104.5 98.9 Industry combined ratio................ 101.8 105.8 106.5 108.5 106.9 Income before cumulative effect of changes in accounting................. 94 84 75 45 88 Net income............................. 94 84 75 45 83 PER COMMON SHARE DATA (BASIC AND DILUTED)(2): Income before realized gain (loss) on investments, net of federal income taxes................................. 2.14 2.10 1.95 1.16 1.82 Realized gain (loss) on investments, net of federal income taxes........... 0.53 0.27 0.07 (0.01) 0.57 Cumulative effect of changes in accounting............................ -- -- -- (0.02) (0.14) Net income............................. 2.67 2.37 2.02 1.13 2.25 Dividends declared to common shareholders.......................... 0.20 0.20 0.20 0.20 0.20 Book value per share................... 24.75 21.39 19.04 15.13 14.96 Market value per share................. 28.75 22.50 18.63 17.00 19.63 AT YEAR END: Total assets........................... 2,605 2,503 2,471 2,334 2,153 Total shareholders' equity............. 873 755 683 646 640 Total statutory surplus................ 726 624 504 539 532 RESERVES: Losses and loss adjustment expenses.... 1,206 1,239 1,292 1,197 1,077 Unearned premiums...................... 379 362 351 332 310
- -------- (1) Industry data is from A.M. Best. (2) All earnings per share amounts for all years have been presented to conform with Statement of Financial Accounting Standards No. 128, Earnings Per Share. The adoption of the aforementioned standard had no effect on previously reported earnings per share. For further discussion of Statement No. 128, see Note 1 on page 29 of the Notes to Consolidated Financial Statements included in Financial Statements. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION INTRODUCTION The results of operations for Citizens Corporation and subsidiaries ("the Company") include the accounts of Citizens Corporation ("Citizens"), a non- insurance holding company, Citizens Insurance Company of America ("Citizens Insurance"), Citizens Insurance Company of Ohio, Citizens Insurance Company of the Midwest, and Citizens Management Inc. RESULTS OF OPERATIONS Consolidated Overview 1997 COMPARED TO 1996 Net income in 1997 increased $10.1 million to $94.2 million, compared to $84.1 million in 1996. Excluding net realized gains of $18.7 million and claims office restructuring charges of $1.4 million, both net of taxes, net income increased $1.8 million to $76.9 million in 1997. The increase in net income is primarily attributable to an increase in investment income and realized gains of $12.9 million and $13.8 million, respectively, partially offset by a decrease in underwriting profit of $11.9 million. The increases in investment income and realized gains were primarily the result of the company's portfolio shift from equity securities to higher yielding debt securities, begun in 1996 and substantially completed in the first quarter of 1997. The decrease in underwriting profit primarily reflects an increase in claims activity in the commercial multiple peril and homeowners lines and an increase in catastrophes. Catastrophe losses were $17.8 million in 1997 compared to $15.3 million in 1996. The increases in catastrophes and claims activity were partially offset by favorable claims experience on current and prior accident years in the personal automobile and workers' compensation lines. Federal income tax expense increased $3.2 million to $24.6 million, while the effective tax rate increased from 20.3% in 1996 to 20.7% in 1997. Net premiums earned increased $19.8 million, or 2.4%, to $855.3 million during 1997, representing increases of $28.7 million, or 5.2% in the personal segment, partially offset by decreases of $8.9 million, or 3.2%, in the commercial segment. This overall growth is due to increases in net premiums earned of $16.8 million, or 27.1%, to $78.9 million in Ohio and Indiana resulting from expansion in these states. Rate increases contributed to net premium growth in all major lines except the workers' compensation line where rate reductions and competitive conditions continue in Michigan. Continued growth in policies in force in the commercial multiple peril, homeowners, and commercial automobile lines of 16.6%, 2.8%, and 2.7%, respectively, were offset by a 0.6% decrease in personal automobile policies in force. 1996 COMPARED TO 1995 Net income in 1996 increased $9.2 million to $84.1 million, compared to $74.9 million in 1995. Excluding net realized gains of $9.7 million and severance charges of $0.7 million, both net of taxes, net income increased $2.6 million to $75.1 million in 1996. The increase in net income is primarily attributable to an increase in investment income and realized gains of $10.1 million and $11.2 million, respectively, partially offset by a decrease in underwriting profit of $12.7 million. The increase in investment income and realized gains was primarily the result of the Company's portfolio shift, in 1996, from equity securities to higher yielding debt securities. The decrease in underwriting profit primarily reflects an increase in catastrophes and an increase in claims activity in the commercial multiple peril and homeowners lines. Catastrophe losses were $15.3 million in 1996 compared to $8.0 million in 1995. The increases in catastrophes and claims activity were partially offset by favorable claims experience on current and prior accident years in the personal automobile line. Federal income tax expense decreased $0.3 million to $21.4 million, while the effective tax rate decreased from 22.5% in 1995 to 20.3% in 1996. 13 Net premiums earned increased $17.7 million, or 2.2%, to $835.5 million during 1996, representing increases of $18.4 million, or 3.4% in the personal segment, partially offset by decreases of $0.7 million, or 0.2%, in the commercial segment. This overall growth is due to increases in net premiums earned of $11.4 million, or 22.5%, to $62.1 million in Ohio and Indiana resulting from expansion in these states. Rate increases contributed to net premium growth in all major lines except the workers' compensation line where rate reductions and competitive conditions continue in Michigan. Continued growth in policies in force in the commercial multiple peril and commercial automobile lines of 13.2% and 3.7%, respectively, were offset by decreases in personal automobile and workers' compensation policies in force of 3.0% and 1.4% respectively. SEGMENT RESULTS Personal Segment Personal segment premiums represented 68.2%, 66.4% and 65.6% of total net premiums earned in 1997, 1996 and 1995, respectively.
FOR THE YEARS ENDED DECEMBER 31, ----------------------- 1997 1996 1995 ------ ------ ------- (IN MILLIONS) Net premiums earned.................................... $583.3 $554.6 $ 536.2 Losses and loss adjustment expenses (LAE) incurred..... 440.1 404.1 413.6 Policy acquisition expenses............................ 112.1 112.5 108.1 Other underwriting expenses............................ 39.9 39.3 41.1 ------ ------ ------- Underwriting loss...................................... $ (8.8) $ (1.3) $ (26.6) ====== ====== =======
Personal segment net premiums earned increased $28.7 million, or 5.2%, to $583.3 million in 1997. This growth is attributable to rate increases in the personal automobile and homeowners lines and a 2.8% increase in policies in force in the homeowners line. The growth is partially offset by a 0.6% decrease in policies in force in the personal automobile line, attributable to the Company's selective reduction of writings in Michigan when rates were viewed as inadequate, and to continued strong competition in Michigan. While management has taken steps to increase penetration in affinity groups and has initiated other marketing programs, heightened competition may result in reduced growth in the personal segment. Personal segment net premiums earned increased $18.4 million, or 3.4%, to $554.6 million in 1996. This growth is attributable to rate increases in the personal automobile and homeowners lines. The growth is partially offset by a 3.0% decrease in policies in force in the personal automobile line, attributable to the aforementioned competitive factors in Michigan. The personal segment underwriting loss in 1997 was $8.8 million compared to $1.3 million in 1996. The decline in underwriting results reflects a decrease in prior year favorable development in the personal automobile line of $10.5 million and an increase in catastrophe losses of $0.9 million, to $14.3 million, primarily in the homeowners line. The decrease in policy acquisition expenses of $0.4 million, or 0.4%, to $112.1 million in 1997 primarily reflects lower commission rates for 1997 partially offset by higher earned premiums. Other underwriting expenses increased $0.6 million, or 1.5%, to $39.9 million due to an increase in net premiums earned offset by reductions in employee related expenses. The personal segment underwriting loss in 1996 was $1.3 million compared to $26.6 million in 1995. The improvement in underwriting results reflects favorable claims activity in both current and prior accident years in the personal automobile line attributable to improvements in severity. This was partially offset by an increase in catastrophe losses of $6.2 million, to $13.4 million, primarily in the homeowners line. The increase in policy acquisition expenses of $4.4 million, or 4.1%, to $112.5 million in 1996 primarily reflects the growth in net premiums earned. Other underwriting expenses decreased $1.8 million, or 4.4%, to $39.3 million due to reductions in employee related expenses and commissions, partially offset by expenses associated with a policy administration technology project. 14 Commercial Segment Commercial segment premiums represented 31.8%, 33.6% and 34.4% of total net premiums earned in 1997, 1996 and 1995, respectively.
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN MILLIONS) Net premiums earned.......................... $ 272.0 $ 280.9 $ 281.6 Losses and LAE incurred...................... 197.0 200.3 164.7 Policy acquisition expenses.................. 52.8 51.6 51.5 Other underwriting expenses(1)............... 24.6 27.0 25.4 ---------- ---------- ---------- Underwriting (loss) profit................... $ (2.4) $ 2.0 $ 40.0 ========== ========== ==========
- -------- (1) Includes policyholders' dividends Commercial segment net premiums earned decreased $8.9 million, or 3.2%, to $272.0 million in 1997. This decrease primarily reflects rate reductions in the workers' compensation line. Rates in the workers' compensation line were decreased 8.5%, 7.0%, 6.4% and 8.7% effective May 1, 1995, December 1, 1995, June 1, 1996 and March 1, 1997, respectively. This decrease is partially offset by an increase in policies in force in the commercial multiple peril and commercial automobile lines of 16.6% and 2.7%, respectively. Management believes competitive conditions in Michigan in the workers' compensation line may impact future growth in net premiums earned. Commercial segment net premiums earned decreased $0.7 million, or 0.2%, to $280.9 million in 1996. This decrease primarily reflects the aforementioned rate reductions and a 1.4% decrease in policies in force in the workers' compensation line due to continuing competition in this line in Michigan. This decrease is partially offset by an increase in policies in force in the commercial multiple peril and commercial automobile lines of 13.2% and 3.7%, respectively. The commercial segment underwriting loss in 1997 was $2.4 million compared to a $2.0 million profit in 1996. The decline in underwriting profit is primarily attributable to lower net premiums earned in the workers' compensation line, an increase in current year severity and frequency in the commercial multiple peril line, less favorable development of prior year reserves in the commercial automobile line, and an increase in catastrophe losses of $1.6 million. These decreases were offset by a $13.9 million increase in favorable development of prior year claims in the workers' compensation line. Policy acquisition expenses increased $1.2 million, or 2.3%, primarily as a result of higher commission rates, offset by a decrease in net premiums earned. Other underwriting expenses decreased $2.4 million, or 8.9%, to $24.6 million due to reductions in employee related expenses. The commercial segment underwriting profit in 1996 was $2.0 million compared to $40.0 million in 1995. The decline in underwriting profit is primarily attributable to an increase in loss severity and frequency in the commercial multiple peril line, lower net premiums earned in the workers' compensation line, less favorable development of prior year reserves in the workers' compensation line, an increase in catastrophe losses of $0.8 million, partially offset by an increase in net premiums earned in the commercial multiple peril line. Policy acquisition expenses remained consistent between years, primarily as a result of flat net earned premiums. Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million due to investments in technology and increased policyholders' dividends, partially offset by reductions in employee related expenses and commissions. 15 INVESTMENT RESULTS Net investment income before taxes was $101.8 million, $88.9 million and $78.8 million in 1997, 1996, and 1995, respectively. The increase of $12.9 million in 1997 is due to an increase in average invested assets and the company's portfolio shift from equity securities to higher yielding debt securities, including longer duration and non-investment grade securities, partially offset by a $1.2 million decrease in investment income from limited partnership investments. The average pre-tax yields on debt securities were 6.7% in 1997, 6.3% in 1996 and 5.9% in 1995. Average invested assets increased $111.8 million, or 7.3%, to $1,648.1 million in 1997 primarily attributable to cash from operations and market value appreciation. The increase in 1996 is primarily the result of an increase in average invested assets, $4.4 million of income from limited partnerships, and the aforementioned portfolio shift. Net investment income after taxes was $83.8 million in 1997, $73.4 million in 1996 and $64.9 million in 1995. Net realized gains on investments before taxes were $28.8 million, $15.0 million, and $3.8 million, in 1997, 1996, and 1995, respectively. Net realized gains in 1997 and 1996 primarily resulted from sales of appreciated equity securities due to the Company's strategy of shifting to a higher level of debt securities. Net realized gains in 1995 were primarily the result of the sales of equity securities impacted by the overall rise in the market. FEDERAL INCOME TAXES The provision for federal income taxes was $24.6 million, $21.4 million, and 21.7 million in 1997, 1996, and 1995, respectively. These provisions resulted in consolidated effective federal tax rates of 20.7%, 20.3%, and 22.5% in 1997, 1996, and 1995, respectively. The increase in the effective tax rate in 1997 from 1996 resulted from higher capital gains partially offset by higher tax-exempt interest. The decrease in the effective tax rate in 1996 from 1995 resulted from higher tax-exempt interest, partially offset by higher pre-tax income. FINANCIAL CONDITION Reserve for Losses and Loss Adjustment Expenses The Company maintains reserves to provide for its estimated ultimate liability for losses and LAE with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation, where a longer period may elapse before a definitive determination of ultimate liability may be made, and liability lines, where the technological, judicial, and political climates involving these types of claims are changing. The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Changes in prior reserve estimates are reflected in results of operations in the year such changes are determined to be needed and recorded. 16 The table below provides a reconciliation of the beginning and ending reserve for unpaid losses and LAE for the years ended December 31:
1997 1996 1995 -------- -------- -------- (IN MILLIONS) Reserve for losses and LAE, beginning of year.... $1,238.5 $1,291.6 $1,196.6 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year.... 708.2 662.8 625.3 Decrease in provision for insured events of prior years.................................... (69.5) (58.4) (47.0) -------- -------- -------- Total incurred losses and LAE.................... 638.7 604.4 578.3 ======== ======== ======== Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year................................... 382.9 365.9 322.1 Losses and LAE attributable to insured events of prior years.................................... 280.4 239.1 223.4 -------- -------- -------- Total payments................................... 663.3 605.0 545.5 -------- -------- -------- Change in reinsurance recoverable on unpaid losses.......................................... (7.8) (52.5) 62.2 -------- -------- -------- Reserve for losses and LAE, end of year.......... $1,206.1 $1,238.5 $1,291.6 ======== ======== ========
As part of an ongoing process, the reserves, net of reinsurance, have been re-estimated for all prior accident years and were decreased by $69.5 million, $58.4 million and $47.0 million in 1997, 1996, and 1995, respectively. The increase in favorable development of $11.1 million in 1997 reflects improved severity in the workers' compensation line where favorable development increased $13.9 million to $35.7 million and in the commercial multiple peril line where favorable development increased $7.0 million to $4.3 million, partially offset by less favorable development in the personal automobile line, where favorable development decreased $10.5 million to $22.5 million in 1997. The increase in favorable development of $11.4 million in 1996 reflects improved severity in the personal automobile line, where favorable development increased $28.6 million to $33.0 million in 1996, partially offset by less favorable development in the workers' compensation line of $10.9 million. Citizens favorable development in 1997 primarily reflects a modest shift over the past few years of the workers' compensation business to Western and Northern Michigan, which have demonstrated more favorable loss experience than Eastern Michigan. The favorable development in 1996 and 1995 primarily reflects the initiatives taken by the Company to manage medical costs in both the automobile and workers' compensation lines, as well as the impact of the Michigan Supreme Court ruling on workers' compensation indemnity payments in 1995, which decreases the maximum amount to be paid for indemnity cases on all existing and future claims. This favorable development reflects the Company's reserving philosophy consistently applied over these periods. Conditions and trends that have affected development of the loss and LAE reserves in the past may not necessarily occur in the future. Due to the nature of business written by the Company, the exposure to environmental liabilities is relatively small. Losses and LAE reserves related to environmental damage and toxic tort liability, included in the total reserve for losses and LAE were $19.0 million and $20.6 million at the end of 1997 and 1996, respectively, both net of reinsurance of $7.0 and $3.5 million, respectively. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company has been required to defend such claims. Due to their unusual nature and absence of historical claims data, reserves for these claims are not determined using historical experience to project future losses. The Company estimated its ultimate liability for these claims based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these claims are not material, their existence gives rise to uncertainty and is discussed because of the possibility, however remote, that they may become material. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. Management believes that, 17 notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate and the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves. Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation on the Company varies by product. Property and casualty insurance premiums are established before the amount of losses and LAE, and the extent to which inflation may affect such expenses, are known. Consequently, the Company attempts, in establishing rates, to anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserve position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions; (ii) review of per claim information; (iii) historical loss experience of the Company and the industry; (iv) the relatively short-term nature of most policies; and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. REINSURANCE The Company maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes pro-rata, excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. The Company determines the appropriate amount of reinsurance based on the Company's evaluation of the risks accepted and analyses prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. The Company has reinsurance for casualty business. Under the 1997 casualty reinsurance program, the reinsurers are responsible for 100% of the amount of each loss in excess of $0.5 million per occurrence up to $30.5 million for general liability and workers' compensation. Additionally, this reinsurance covers workers' compensation losses in excess of $30.5 million to $60.5 million per occurrence. Amounts in excess of $60.5 million are retained 100% by the Company. Under the Company's 1997 catastrophe reinsurance program, the Company retains 5% of losses in excess of $10.0 million, up to $25.0 million. For losses in excess of $25.0 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. In 1996, the Company had additional catastrophe coverage which reinsured 90% of $5.0 million for aggregated catastrophe losses in excess of $5.0 million which individually exceed $1.0 million. In 1997 and 1996, the Company recovered $1.2 million and $4.6 million on its catastrophe coverage, respectively. In 1995, the Company did not exceed the minimum catastrophe levels. Effective January 1, 1998, the Company modified its catastrophe reinsurance program to include a higher retention. Under the Company's 1998 catastrophe reinsurance program, the Company retains the first $45 million. For losses in excess of $45 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound. 18 As a condition to the ability to conduct personal automobile business in the state of Michigan, the Company is required under Michigan law to participate in a pooling arrangement with the Michigan Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA for personal protection insurance losses in excess of $0.25 million. The Company cedes a portion of its private passenger automobile premiums to the MCCA. Ceded premiums earned to MCCA in 1997, 1996 and 1995 were $9.8 million, $50.5 million and $66.8 million, respectively. The decrease in ceded premiums earned to MCCA reflects a reduction in premiums charged per policyholder by MCCA. Losses and LAE ceded to MCCA in 1997, 1996 and 1995 were ($0.8) million, ($52.9) million and $62.9 million, respectively. In 1997 and 1996, the MCCA's favorable development on prior year reserves exceeded the losses and LAE incurred during the current year. At December 31, 1997 and 1996, the Company had reinsurance recoverable from the MCCA on paid and unpaid losses of $280.2 million and $292.0 million, respectively. Because MCCA is supported by assessments permitted by statute and all amounts billed by the Company to MCCA have been paid when due, the Company believes that it has no significant exposure to uncollectible reinsurance balances. The reserve for losses and LAE at December 31, 1997 and 1996, is shown gross of reinsurance recoverable on unpaid losses of $458.6 million and $466.4 million, respectively. Losses and LAE ceded were $97.4 million, $51.4 million and $134.1 million in 1997, 1996, and 1995, respectively. Ceded premiums earned were $181.3 million, $201.1 million and $206.3 million in 1997, 1996, and 1995, respectively. INVESTMENT PORTFOLIO The Company's investment policy is structured with emphasis on maximizing after tax income while providing liquidity and preserving asset quality. The portfolio is dominated by fixed income securities. The fixed income portfolio maintains a laddered maturity structure with a duration of 5.0 years. During 1997, average durations shortened as interest rates fell and bonds began pricing at their call dates rather than maturity. The Company continually evaluates credit quality throughout the investment holding period. The Company's investment portfolio increased $116.4 million to $1,721.6 million at December 31, 1997, from $1,605.2 million at December 31, 1996, primarily attributable to the investment of cash provided by operations of $48.6 million and total invested asset market appreciation of $47.8 million. Approximately 88.4% of the portfolio was invested in debt securities at December 31, 1997, compared to 87.1% at December 31, 1996. At December 31, 1997, $1,311.7 million, or 86.2%, of debt securities held by the Company were rated by the National Association of Insurance Commissioners ("NAIC") as investment grade (1 or 2 by the NAIC). The remaining $210.7 million were rated non-investment grade. At December 31, 1996, $1,233.5 million, or 88.2%, of the debt securities were rated investment grade. At December 31, 1997, 66.1% of debt securities were tax-exempt investments, compared to 69.9% at December 31, 1996. The Company may make modest extensions in portfolio incremental credit risk and adjustments to its taxable and tax- exempt positions in the future to seek to maximize after tax income. At December 31, 1997, $182.7 million, or 10.6%, of the investment portfolio was invested in equity securities compared to $192.3 million, or 12.0%, at December 31, 1996. Dividend income from equity securities was $4.3 million, or 4.0%, of total investment income in 1997, compared to $4.2 million, or 4.5%, and $4.5 million, or 5.3%, in 1996 and 1995, respectively. LIQUIDITY AND CAPITAL RESOURCES Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, Citizens' primary source of cash for payment of dividends to its shareholders is dividends from its insurance subsidiaries, which are subject to limitations imposed by state regulators. Such limitations require that dividends be paid only out of statutory earned surplus (unassigned funds) and impose a restriction on the payment of "extraordinary" dividends without prior approval of the state authorities. The maximum dividend that may be paid to Citizens Corporation at January 1, 1998, without prior approval from the Michigan Commissioner of Insurance, is $86.9 million. 19 Sources of cash for the Company's insurance subsidiaries are from premiums collected, investment income and maturing investments. Primary cash outflows are paid losses and LAE, policy acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to claim losses and LAE can be variable because of uncertainties regarding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. Accordingly, the Company's strategy is to monitor available cash and short-term investment balances in relation to projected cash needs by matching maturities of its investments with expected payments of current and longer term liabilities. The Company periodically adjusts its investment policy to respond to changes in short-term and long- term cash requirements. Net cash provided by operating activities for the Company was $48.6 million, $73.5 million and $120.0 million in 1997, 1996, and 1995, respectively. The decrease in cash provided by operating activities in all periods is attributable primarily to the increase in payments for losses and LAE of $58.3 million to $663.3 million in 1997 and $59.5 million to $605.0 million in 1996 compared to $545.5 million in 1995. Net cash used for investing activities for the Company was $31.3 million, $78.3 million, and $89.2 million in 1997, 1996, and 1995, respectively. Net cash used for investing activities has declined in 1997 from 1996 and in 1996 from 1995 primarily due to the decrease in cash flow from operations. Net cash used for financing activities was $6.9 million, $18.2 million and $113.1 million in 1997, 1996, and 1995, respectively. Net cash used in 1997 reflects dividends paid to shareholders of $7.1 million partially offset by the reissuance of 7,800 shares of treasury stock, or $0.2 million, upon employees' exercising stock options. Net cash used in 1996 reflects the purchase of $11.1 million of treasury stock and dividends paid to shareholders of $7.1 million. Shareholders' equity was $872.9 million, or $24.75 per share, at December 31, 1997, compared to $754.5 million, or $21.39 per share, at December 31, 1996. Shareholders' equity reflects net income for the year, the reissuance of treasury stock and the impact of a net increase of $31.1 million in the fair values of available-for-sale debt and equity securities. Changes in shareholders' equity related to changes in the fair value of the investment portfolio will continue to be volatile as market prices of debt and equity securities fluctuate with changes in interest rates and economic conditions. The Company expects to continue to pay dividends in the foreseeable future. However, payment of future dividends is subject to the Board of Directors' approval and dependent upon earnings and the financial condition of the Company. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Based on a recent assessment, the Company determined that it will be required to modify or replace significant portions of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue can be resolved. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. The Company has initiated formal communications with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 Issue. The Company's total Year 2000 project cost and estimates to complete the project include the estimated costs and time associated with the impact of a third party's Year 2000 Issue, and are based on presently 20 available information. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have material adverse effect on the Company. The Company does not believe that it has material exposure to contingencies related to the Year 2000 Issue for the products it has sold. Although the Company does not believe that there is a material contingency associated with the Year 2000 project, there can be no assurance that exposure for material contingencies will not arise. The Company will utilize both internal and external resources to reprogram, or replace, and test the software for Year 2000 modifications. The Company plans to complete the mission critical elements of the Year 2000 project by December 31, 1998. The cost of the Year 2000 project will be expensed as incurred over the next two years, and is being funded through a reallocation of resources from discretionary projects. Therefore, the Year 2000 project is not expected to result in significant incremental technology costs or to have material effect on the results of operations. Through December 31, 1997, the Company has incurred and expensed approximately $6.3 million related to the assessment of, and preliminary efforts in connection with, the project and the development of a remediation plan. The total remaining cost of the Year 2000 project is estimated at $16.1 million. The costs of the project and the date on which the Company plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. FORWARD-LOOKING STATEMENTS The Company wishes to caution readers that the following important factors, among others, in some cases have affected and in the future could affect, the Company's actual results and could cause the Company's actual results for 1998 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes," "anticipated," "expects" and similar expressions are intended to identify forward-looking statements. See "Important Factors Regarding Forward-Looking Statements" filed herewith as Exhibit 99.1 and incorporated herein by reference. Factors that may cause actual results to differ materially from those contemplated or projected, forecasted, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) adverse catastrophe experience and severe weather; (ii) adverse loss development for events the Company insured in prior years; (iii) heightened competition, including the intensification of price competition, the entry of new competitors, and the introduction of new products by new and existing competitors; (iv) adverse state and federal legislation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, and tax treatment of insurance products; (v) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (viii) loss or retirement of key executives; (ix) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (x) termination of provider contracts or renegotiation at less cost- effective rates or terms of payment; (xi) changes in the Company's liquidity due to changes in asset and liability matching; (xii) restrictions on insurance underwriting, based on certain criteria; (xiii) adverse changes in the ratings obtained by independent rating agencies such as Moody's, Standard and Poors and A.M. Best; and (xiv) uncertainty related to the Year 2000 Issue. 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE(S) ------- Report of Independent Accountants...................................... 23 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995................................................... 25 Consolidated Balance Sheets as of December 31, 1997 and 1996........... 26 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995...................................... 27 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995................................................... 28 Notes to Consolidated Financial Statements............................. 29-48
INDEX TO FINANCIAL STATEMENT SCHEDULES Schedule I--Summary of Investments--Other than Investments in Related Parties................................................................. 56 Schedule II--Condensed Financial Information of the Registrant........... 57-59 Schedule III--Supplementary Insurance Information........................ 60-62 Schedule IV--Reinsurance................................................. 63 Schedule V--Valuation and Qualifying Accounts............................ 64 Schedule VI--Supplemental Information Concerning Property/Casualty Insurance Operations.................................................... 65
22 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholdersof Citizens Corporation In our opinion, the consolidated financial statements and financial statement schedules listed in the accompanying index present fairly, in all material respects, the financial position of Citizens Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse LLP Boston, Massachusetts February 3, 1998 23 CITIZENS CORPORATION MANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING The management of Citizens Corporation has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and include amounts based on management's informed estimates and judgments. We believe that these statements present fairly the Company's financial position and results of operations and that the other information contained in the annual report is accurate and consistent with the financial statements. Citizens Corporation's Board of Directors annually appoints independent accountants to perform an audit of its consolidated financial statements. The financial statements have been audited by Price Waterhouse LLP, independent accountants, in accordance with generally accepted auditing standards. Their audit included consideration of the Company's system of internal control in order to determine the audit procedures required to express their opinion on the consolidated financial statements. Management of Citizens Corporation has established and maintains a system of internal control that provides reasonable assurance that assets are safeguarded and that transactions are properly authorized and recorded. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management continually monitors the system of internal control for compliance. Citizens Corporation and its subsidiaries maintain a strong internal audit program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. Management recognizes the inherent limitations in all internal control systems and believes that our system of internal control provides an appropriate balance between the costs and benefits desired. Management believes that the Company's system of internal control provides reasonable assurance that errors or irregularities that would be material to the financial statements are prevented or detected in the normal course of business. The Audit Committee of the Board of Directors, composed solely of outside directors, oversees management's discharge of its financial reporting responsibilities. The committee meets periodically with management, our internal auditors and independent accountants, Price Waterhouse LLP. Both our internal auditors and Price Waterhouse LLP have direct access to the Audit Committee. Management recognizes its responsibility for fostering a strong ethical climate. This responsibility is reflected in the Company's policies which address, among other things, potential conflicts of interest; compliance with all domestic and foreign laws including those relating to financial disclosure and the confidentiality of proprietary information. Citizens Corporation maintains a systematic program to assess compliance with these policies. /s/John F. O'Brien /s/Edward J. Parry, III - ------------------------------------- ------------------------------------- JOHN F. O'BRIEN EDWARD J. PARRY, III President and Chief Executive Officer Vice President, Chief Financial Accounting Officer Officer, Treasurer and Principal 24 CITIZENS CORPORATION CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 --------- --------- --------- (IN MILLIONS, EXCEPT PER COMMON SHARE DATA) Revenues Net premiums written.......................... $ 863.7 $ 838.2 $ 833.7 Change in unearned premiums, net of prepaid reinsurance premiums......................... 8.4 2.7 15.9 --------- --------- --------- Net premiums earned........................... 855.3 835.5 817.8 Net investment income......................... 101.8 88.9 78.8 Net realized gains on investments............. 28.8 15.0 3.8 Other income.................................. 6.5 6.2 6.1 --------- --------- --------- Total revenues.............................. 992.4 945.6 906.5 --------- --------- --------- Expenses Losses and loss adjustment expenses........... 638.7 604.4 578.3 Policy acquisition expenses................... 164.9 164.1 159.6 Other operating expenses...................... 63.4 64.4 65.4 Policyholders' dividends...................... 6.6 7.2 6.6 --------- --------- --------- Total expenses.............................. 873.6 840.1 809.9 --------- --------- --------- Income before federal income taxes.............. 118.8 105.5 96.6 Federal income tax expense Current.............. Current....................................... 19.6 20.3 17.6 Deferred...................................... 5.0 1.1 4.1 --------- --------- --------- Total federal income tax expense............ 24.6 21.4 21.7 --------- --------- --------- Net income...................................... 94.2 84.1 74.9 Dividends on Series A preferred stock........... -- -- (2.0) --------- --------- --------- Net income available to common shareholders..... $ 94.2 $ 84.1 $ 72.9 ========= ========= ========= Per common share data (basic and diluted) Net income available to common shareholders... $ 2.67 $ 2.37 $ 2.02 ========= ========= ========= Weighted average common shares outstanding (basic and diluted)............................ 35.3 35.5 36.1 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 25 CITIZENS CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ---------------------- 1997 1996 ---------- ---------- (IN MILLIONS, EXCEPT PER SHARE DATA) ASSETS Investments: Debt securities available-for-sale, at fair value (amortized cost of $1,453.1 and $1,366.9)........... $ 1,522.4 $ 1,398.3 Equity securities available-for-sale, at fair value (cost of $110.2 and $132.3)......................... 182.7 192.3 Other investments, at fair value (cost of $17.7 and $13.2).............................................. 16.5 14.6 ---------- ---------- Total investments.................................. 1,721.6 1,605.2 Cash and cash equivalents............................ 46.5 36.1 Accrued investment income............................ 26.5 25.3 Premiums and notes receivable (less allowance for doubtful accounts of $0.9).......................... 139.4 140.3 Reinsurance recoverable on paid and unpaid losses.... 474.3 476.8 Prepaid reinsurance premiums......................... 70.4 62.8 Deferred policy acquisition expenses................. 54.8 54.3 Deferred federal income taxes........................ 3.7 25.4 Other assets......................................... 68.1 76.8 ---------- ---------- Total assets....................................... $ 2,605.3 $ 2,503.0 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Reserve for losses and loss adjustment expenses...... $ 1,206.1 $ 1,238.5 Unearned premiums.................................... 378.5 362.3 Other liabilities.................................... 147.8 147.7 ---------- ---------- Total liabilities.................................. 1,732.4 1,748.5 ---------- ---------- Commitments and contingencies (Note 12) Shareholders' equity: Series A preferred stock, $0.01 par value per share; authorized 10.0 million shares; none issued or outstanding in 1997 and 1996........................ -- -- Common stock, $0.01 par value per share; authorized 100.0 million shares; 36.1 million shares issued.... 0.4 0.4 Additional paid-in capital........................... 156.1 156.1 Retained earnings.................................... 639.6 552.5 Unrealized appreciation on investments, net of deferred federal income taxes....................... 91.6 60.5 Treasury stock, at cost (0.8 million shares)......... (14.8) (15.0) ---------- ---------- Total shareholders' equity......................... 872.9 754.5 ---------- ---------- Total liabilities and shareholders' equity......... $ 2,605.3 $ 2,503.0 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 26 CITIZENS CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) PREFERRED STOCK Balance at beginning of year......................... -- -- $100.0 Redemption of preferred stock........................ -- -- (100.0) ------ ------ ------ Balance at end of year............................... -- -- -- ------ ------ ------ COMMON STOCK Balance at beginning and end of year................. $ 0.4 $ 0.4 $ 0.4 ------ ------ ------ ADDITIONAL PAID-IN CAPITAL Balance at beginning and end of year................. 156.1 156.1 156.1 ------ ------ ------ RETAINED EARNINGS Balance at beginning of year......................... 552.5 475.5 409.8 Net income........................................... 94.2 84.1 74.9 Dividends declared to shareholders................... (7.1) (7.1) (9.2) ------ ------ ------ Balance at end of year............................... 639.6 552.5 475.5 UNREALIZED APPRECIATION (DEPRECIATION) ON INVESTMENTS, NET OF DEFERRED FEDERAL INCOME TAXES Balance at beginning of year......................... 60.5 54.7 (20.4) Effect of transfer of securities from held-to-matu- rity to available-for- sale: Net appreciation on available-for-sale debt securi- ties............................................... -- -- 1.5 Provision for deferred federal income taxes........ -- -- (0.5) ------ ------ ------ Total................................................ -- -- 1.0 ------ ------ ------ Appreciation on investments during the year: Net appreciation on available-for-sale securities.. 47.8 9.0 114.1 Provision for deferred federal income taxes........ (16.7) (3.2) (40.0) ------ ------ ------ Total................................................ 31.1 5.8 74.1 ------ ------ ------ Balance at end of year............................... 91.6 60.5 54.7 ------ ------ ------ TREASURY STOCK Balance at beginning of year......................... (15.0) (3.9) -- Shares purchased at cost............................. -- (11.1) (3.9) Shares reissued...................................... 0.2 -- -- ------ ------ ------ Balance at end of year............................... (14.8) (15.0) (3.9) ------ ------ ------ Total shareholders' equity............................. $872.9 $754.5 $682.8 ====== ====== ======
The accompanying notes are an integral part of these consolidated financial statements. 27 CITIZENS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................. $ 94.2 $ 84.1 $ 74.9 Adjustments to reconcile net income to net cash provided by operating activities: Net realized gains on investments.................... (28.8) (15.0) (3.8) Deferred federal income tax provision................ 5.0 1.1 4.1 Changes in assets and liabilities: Deferred policy acquisition expenses............... (0.5) (2.1) (2.9) Premiums and notes receivable, net of reinsurance payable........................................... 0.6 5.4 (23.1) Unearned premiums, net of prepaid reinsurance pre- miums............................................. 8.6 2.6 15.9 Reserve for losses and loss adjustment expenses, net of reinsurance recoverable.................... (29.9) (8.1) 35.3 Other, net......................................... (0.6) 5.5 19.6 ------ ------ ------ Net cash provided by operating activities............ 48.6 73.5 120.0 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of available-for-sale debt securi- ties.................................................. 306.1 470.4 511.3 Proceeds from available-for-sale debt securities ma- tured or called....................................... 95.4 148.3 95.2 Proceeds from held-to-maturity debt securities matured or called............................................. -- -- 10.6 Proceeds from sale of available-for-sale equity securities and other investments...................... 76.3 73.7 47.8 Purchases of available-for-sale debt securities........ (487.0) (741.4) (637.2) Purchases of available-for-sale equity securities and other investments..................................... (31.3) (42.5) (93.9) Change in net receivable from security transactions not settled............................................... 12.1 16.1 (19.2) Other investing activities, net........................ (2.9) (2.9) (3.8) ------ ------ ------ Net cash used for investing activities............... (31.3) (78.3) (89.2) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid to shareholders......................... (7.1) (7.1) (9.2) Treasury stock purchased, at cost...................... -- (11.1) (3.9) Treasury shares reissued............................... 0.2 -- -- Redemption of Series A preferred stock................. -- -- (100.0) ------ ------ ------ Net cash used for financing activities............... (6.9) (18.2) (113.1) ------ ------ ------ Net increase (decrease) in cash and cash equivalents... 10.4 (23.0) (82.3) Cash and cash equivalents at beginning of year......... 36.1 59.1 141.4 ------ ------ ------ Cash and cash equivalents at end of year............... $ 46.5 $ 36.1 $ 59.1 ====== ====== ====== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year: Federal income taxes................................. $ 15.1 $ 17.3 $ 20.8
The accompanying notes are an integral part of these consolidated financial statements. 28 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of Citizens Corporation, a Delaware corporation and non-insurance holding company; Citizens Insurance Company of America (Citizens Insurance), a Michigan corporation; Citizens Insurance Company of the Midwest, an Indiana corporation; and Citizens Insurance Company of Ohio, an Ohio corporation; (collectively, Citizens Insurance Operations) and Citizens Management Inc. (collectively, the Company). Approximately 82.5% of the Company is owned by The Hanover Insurance Company (Hanover). Hanover is an indirect wholly-owned subsidiary of Allmerica Financial Corporation (AFC), a Delaware corporation. The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles and the general practices within the insurance industry. All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. B. PREMIUM REVENUE Premiums are recognized as earned using the daily pro rata method over the terms of the policies. Unearned premiums represent the portion of premiums written that relate to the unexpired term of the policies in force. C. INVESTMENTS In accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (Statement No. 115), the Company is required to classify its investments into one of three categories: held-to-maturity, available-for-sale or trading. Statement No. 115 also requires that unrealized holding gains and losses for trading securities be included in earnings, while unrealized gains and losses for available-for-sale securities be excluded from earnings and reported as a separate component of shareholders' equity until realized. In November 1995, the Financial Accounting Standards Board (FASB) issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, which permitted companies to reclassify securities, where appropriate, based on the new guidance. As a result, the Company transferred all of the held-to-maturity category securities, with amortized cost and fair value of $35.0 million and $36.5 million, respectively, to the available-for-sale category, which resulted in a net increase in shareholders' equity of $1.0 million in 1995. Realized investment gains and losses are reported as a component of revenues based upon the specific-identification basis, using amortized cost for fixed maturities and cost for equity securities. Fixed maturities and equity securities with other than temporary declines in fair value are written down to estimated fair value resulting in the recognition of realized losses. Fair values for debt and equity securities are based on quoted market prices. For securities not actively traded, fair values are estimated using values obtained from independent pricing services. 29 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Fixed maturities that are delinquent are placed on non-accrual status, and thereafter interest income is recognized only when cash payments are received. D. FINANCIAL INSTRUMENTS In the normal course of business, the Company enters into transactions involving various types of financial instruments, including investments in debt and equity securities. These instruments involve credit risk and also may be subject to risk of loss due to currency and interest rate fluctuations. Financial instruments which are subject to fair value disclosure requirements are carried in the financial statements at amounts which approximate fair value, unless otherwise indicated in the notes to the consolidated financial statements. E. CASH AND CASH EQUIVALENTS Cash and cash equivalents includes cash on hand, amounts due from banks and highly liquid short-term investments. The Company considers all short-term investments with an original maturity of three months or less to be cash equivalents. F. DEFERRED POLICY ACQUISITION EXPENSES Deferred policy acquisition expenses consist of commissions, premium taxes and other costs that vary with and are primarily related to the production of new and renewal business. The deferral is subject to ultimate recoverability and is charged to expense over the period in which the related premiums are earned. Deferred policy acquisition expenses are reviewed for each segment to determine that they do not exceed recoverable amounts, after considering anticipated investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. Although realization of deferred policy acquisition costs is not assured, management believes that all these costs will be realized. The amount of deferred policy acquisition costs considered realizable, however, could be reduced in the near term if the estimates of investment income discussed above are reduced, and this would impact the amortization of deferred policy acquisition costs. G. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The reserve for losses and loss adjustment expenses (LAE) represents the accumulation of individual case estimates for reported losses and actuarial estimates for incurred but not reported losses and LAE. Assumed reserves are recorded as reported by the ceding organization. The reserve for losses and LAE is intended to cover the ultimate net cost of all losses and LAE incurred through the balance sheet date. The reserve is stated net of anticipated salvage and subrogation and gross of reinsurance ceded. Reinsurance recoverable on paid and unpaid losses is shown as a separate line of the balance sheet. The reserve estimates are continually reviewed and updated. The ultimate liability may be more or less than the current estimate. The effects of changes in the estimated reserve are included in the results of operations in the period in which the estimates are revised. The Company periodically purchases annuity contracts from various non- affiliated life insurance companies to settle claims currently. The present value of such annuities, where the Company remains primarily liable, is recorded in the accounts of the Company as both an other asset and other liability and amounted to $16.6 million and $16.8 million at December 31, 1997 and 1996, respectively. 30 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) H. FEDERAL INCOME TAXES The Company and its subsidiaries are included in the consolidated federal income tax return of its ultimate parent Allmerica Financial Corporation. Current federal income taxes are allocated among all affiliated companies based upon a written tax sharing agreement. This agreement requires the consolidated group to allocate tax to each member of the group on a separate return basis. Any tax losses or credits utilized by a profit member of the group shall be reimbursed to a loss member of the group when such loss member, on a separate return basis, could utilize the loss or credits incurred in a prior year. Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement No. 109). These differences result primarily from loss reserves, policy acquisition expenses, unearned premiums and unrealized appreciation or depreciation on investments. I. EARNINGS PER COMMON SHARE Earnings per common share are based on the weighted average number of common shares and common share equivalents. The Board of Directors authorized the repurchase of 1.8 million shares or slightly less than five percent of its issued common stock and has purchased a total of 0.8 million shares since the implementation of the repurchase program in 1995. As of December 31, 1997, the Company is holding these shares as treasury stock for the purpose of funding current and future stock option awards and for other purposes. In 1997, the FASB issued Statement of Financial Accounting Standards No. 128, Earnings Per Share (Statement No. 128) which supersedes Accounting Principles Board Opinion No. 15, Earnings Per Share. This standard replaces the primary and fully diluted earnings per share with a basic and diluted earnings per share computation, and requires a dual presentation of basic and diluted earnings per share for those companies with complex capital structures. All earnings per share amounts for all periods have been presented to conform to the Statement No. 128 requirements. The adoption of the aforementioned standard had no effect on the Company's previously reported earnings per share. J. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement No. 130), which establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. All items that are required to be recognized under accounting standards as components of comprehensive income are to be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement stipulates that comprehensive income reflect the change in equity of an enterprise during a period from transactions and other events and circumstances from non-owner sources. This statement is effective for fiscal years beginning after December 15, 1997. The Company anticipates that the adoption of Statement No. 130 will result primarily in reporting unrealized gains and losses on investments in debt and equity securities in comprehensive income. In June 1997, the FASB also issued Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (Statement No. 131). Statement No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that selected information about those operating segments be reported in interim financial statements. This statement supersedes Statement of Financial Accounting Standards No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 requires that all public enterprises report financial and 31 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) descriptive information about their reportable operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that it is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This statement is effective for fiscal years beginning after December 15, 1997. The Company has determined that the adoption of Statement No. 131 will not significantly change the Company's reportable segments. In December 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments (Statement No. 97-3). Statement No. 97-3 provides guidance on when a liability should be recognized for guaranty fund and other assessments and on how to measure the liability. This statement allows for the discounting of the liability if the amount and timing of the cash payments are fixed and determinable. In addition, it provides criteria for when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges. This statement is effective for fiscal years beginning after December 15, 1998. The Company believes that the adoption of this statement will not have a material effect on the results of operations or financial position. K. RECLASSIFICATIONS Certain reclassifications have been made to the 1996 and 1995 consolidated financial statements in order to conform to the 1997 presentation. 32 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 2. BASIS OF PRESENTATION The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which may vary in certain respects from statutory accounting practices followed by the Company that are prescribed or permitted by the Michigan, Ohio and Indiana state insurance regulatory authorities. A reconciliation of the Company's statutory net income and surplus to GAAP net income and shareholders' equity is as follows:
FOR THE YEARS ENDED OR AS OF DECEMBER 31, ------------------------- 1997 1996 1995 ------- ------- ------- (IN MILLIONS) NET INCOME Statutory net income................................ $ 102.2 $ 84.7 $ 71.2 Holding company net loss............................ (0.5) (0.8) (0.7) Deferred policy acquisition expenses................ 0.5 2.1 2.9 Deferred federal income tax provision............... (5.0) (1.1) (4.1) Postretirement benefits............................. 1.0 1.6 0.5 Other, net.......................................... (4.0) (2.4) 5.1 ------- ------- ------- GAAP net income..................................... $ 94.2 $ 84.1 $ 74.9 ======= ======= ======= SHAREHOLDERS' EQUITY Statutory surplus................................... $ 724.1 $ 611.0 $ 496.2 Holding company investments......................... 1.5 13.3 7.3 Deferred policy acquisition expenses................ 54.8 54.3 52.2 Non-admitted assets and statutory reserves.......... 22.5 22.4 54.7 Deferred federal income taxes....................... 3.7 25.4 29.7 Postretirement benefit obligation................... (6.5) (7.5) (9.1) Fair value of available-for-sale debt securities in excess of statutory carrying value........................... 69.3 31.4 42.0 Other, net.......................................... 3.5 4.2 9.8 ------- ------- ------- GAAP shareholders' equity........................... $ 872.9 $ 754.5 $ 682.8 ======= ======= =======
33 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 3. INVESTMENTS Summary of Investments The Company accounts for its investments, all of which are classified as available-for-sale, in accordance with the provisions of Statement No. 115. The amortized cost and fair value of available-for-sale investments are as follows:
DECEMBER 31, 1997 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE --------- ------------ ------------ --------- (IN MILLIONS) U.S. government obligations...... $ 18.3 $ 1.1 $ -- $ 19.4 States and political subdivi- sions........................... 955.2 45.2 (0.2) 1,000.2 Foreign government............... 5.2 0.7 -- 5.9 Corporate debt securities........ 427.5 22.9 (1.3) 449.1 Mortgage-backed securities....... 46.9 1.0 (0.1) 47.8 --------- ------ ------ --------- Total debt securities avail- able-for-sale................. $ 1,453.1 $ 70.9 $ (1.6) $ 1,522.4 ========= ====== ====== ========= Equity securities................ $ 110.2 $ 73.8 $ (1.3) $ 182.7 ========= ====== ====== ========= DECEMBER 31, 1996 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE --------- ------------ ------------ --------- (IN MILLIONS) U.S. government obligations...... $ 18.4 $ 1.2 $ -- $ 19.6 States and political subdivi- sions........................... 955.0 19.2 (2.8) 971.4 Foreign government............... 4.2 0.7 -- 4.9 Corporate debt securities........ 334.6 13.4 (0.7) 347.3 Mortgage-backed securities....... 54.7 0.6 (0.2) 55.1 --------- ------ ------ --------- Total debt securities avail- able-for-sale................. $ 1,366.9 $ 35.1 $ (3.7) $ 1,398.3 ========= ====== ====== ========= Equity securities................ $ 132.3 $ 60.1 $ (0.1) $ 192.3 ========= ====== ====== =========
Debt securities with an amortized cost of $8.5 million were on deposit with various states or government authorities as of December 31, 1997. There were no contractual fixed maturity investment commitments at December 31, 1997 and 1996, respectively. Unrealized gains and losses on available-for-sale securities are summarized as follows:
FOR THE YEAR ENDED DECEMBER 31, 1997 ---------------------------------------- DEBT EQUITY OTHER SECURITIES SECURITIES INVESTMENTS TOTAL ---------- ---------- ----------- ------ (IN MILLIONS) Net appreciation, beginning of year.. $ 20.5 $ 39.0 $ 1.0 $ 60.5 Net appreciation (depreciation) on available-for-sale securities..... 37.9 12.5 (2.6) 47.8 (Provision) benefit for deferred federal income taxes.............. (13.3) (4.4) 1.0 (16.7) ------ ------ ------ ------ Net appreciation (depreciation), end of year............................. $ 45.1 $ 47.1 $ (0.6) $ 91.6 ====== ====== ====== ======
34 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1996 ----------------------------------------- DEBT EQUITY OTHER SECURITIES SECURITIES INVESTMENTS TOTAL ---------- ---------- ----------- ------- (IN MILLIONS) Net appreciation, beginning of year.............................. $ 27.2 $ 26.0 $ 1.5 $ 54.7 Net (depreciation) appreciation on available-for-sale securities...................... (10.4) 20.1 (0.7) 9.0 Provision (benefit) for deferred federal income taxes............ 3.7 (7.1) 0.2 (3.2) ------- ------ ----- ------- Net appreciation, end of year...... $ 20.5 $ 39.0 $ 1.0 $ 60.5 ======= ====== ===== ======= FOR THE YEAR ENDED DECEMBER 31, 1995 ----------------------------------------- DEBT EQUITY OTHER SECURITIES SECURITIES INVESTMENTS TOTAL ---------- ---------- ----------- ------- (IN MILLIONS) Net (depreciation) appreciation, beginning of year................. $ (25.3) $ 4.7 $ 0.2 $ (20.4) Effect of transfers of securities from held-to-maturity to avail- able-for-sale: Net appreciation on available- for-sale securities............. 1.5 -- -- 1.5 Provision for deferred federal income taxes.................... (0.5) -- -- (0.5) ------- ------ ----- ------- 1.0 -- -- 1.0 Net unrealized appreciation during the year, net of deferred federal income taxes: Net appreciation................. 79.3 32.8 2.0 114.1 Provision for deferred federal income taxes.................... (27.8) (11.5) (0.7) (40.0) ------- ------ ----- ------- 51.5 21.3 1.3 74.1 ------- ------ ----- ------- Net appreciation, end of year...... $ 27.2 $ 26.0 $ 1.5 $ 54.7 ======= ====== ===== =======
Expected Maturities of Debt Securities The amortized cost and fair value of debt securities, by contractual maturity, are as follows:
DECEMBER 31, 1997 --------------------------- AMORTIZED FAIR COST VALUE --------- --------- (IN MILLIONS) Due in one year or less............................. $ 58.2 $ 58.6 Due after one year through five years............... 383.3 403.4 Due after five years through ten years.............. 298.4 311.0 Due after ten years................................. 713.2 749.4 --------- --------- $ 1,453.1 $ 1,522.4 ========= =========
Mortgage-backed securities are included above in the category representing their ultimate maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 35 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Net Investment Income The following is a summary of the sources of net investment income:
FOR THE YEARS ENDED DECEMBER 31, ----------------------- 1997 1996 1995 ------- ------ ------ (IN MILLIONS) Debt securities........................................ $ 95.7 $ 82.6 $ 73.1 Equity securities...................................... 4.3 4.2 4.5 Other investments...................................... 4.0 5.6 2.4 Cash and cash equivalents.............................. 2.2 1.8 4.4 ------- ------ ------ Total investment income.............................. 106.2 94.2 84.4 Investment expenses.................................... (4.4) (5.3) (5.6) ------- ------ ------ Net investment income................................ $ 101.8 $ 88.9 $ 78.8 ======= ====== ======
Included in income from other investments was income from limited partnerships of $3.2 million and $4.4 million for the years ended December 31, 1997 and 1996, respectively. The Company had no income from limited partnerships for the year ended December 31, 1995. There were no debt securities that were non-income producing for the twelve months ended December 31, 1997. The Company had no concentration in an individual issuer that exceeded 10% of shareholders' equity at December 31, 1997. Net Realized Gains and Losses Realized gains (losses) were as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Debt securities.......................................... $ 1.5 $ (2.4) $ (1.7) Equity securities........................................ 27.3 17.4 5.5 ------ ------ ------ $ 28.8 $ 15.0 $ 3.8 ====== ====== ======
Voluntary Sales and Related Gross Gains and Gross Losses on Available-for- Sale Securities Proceeds from voluntary sales of debt securities in 1997, 1996, and 1995 were $306.1 million, $470.4 million and $511.3 million, respectively. Gross gains in 1997, 1996, and 1995 of $3.9 million, $3.2 million and $6.3 million were realized on those sales, respectively. Gross losses in 1997, 1996, and 1995 of $2.9 million, $5.6 million and $8.0 million were realized on those sales, respectively. Proceeds from voluntary sales of equity securities in 1997, 1996, and 1995 were $69.3 million, $70.6 million and $45.8 million, respectively. Gross gains in 1997, 1996, and 1995 of $27.5 million, $17.8 million, and $7.7 million were realized on these sales, respectively. Gross losses in 1997, 1996, and 1995 of $0.2 million, $0.4 million, and $2.2 million were realized on those sales, respectively. 36 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 4. DEFERRED POLICY ACQUISITION EXPENSES The following reflects the amounts of policy acquisition expenses deferred and amortized:
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (IN MILLIONS) Balance, beginning of year........................ $ 54.3 $ 52.2 $ 49.3 Policy acquisition expenses deferred.............. 165.4 166.2 162.5 Amortization expense.............................. (164.9) (164.1) (159.6) -------- -------- -------- Balance, end of year.............................. $ 54.8 $ 54.3 $ 52.2 ======== ======== ========
5. FEDERAL INCOME TAXES Provisions for federal income taxes have been calculated in accordance with the provisions of Statement No. 109. A summary of the federal income tax expense in the consolidated statements of income is as follows:
FOR THE YEARS ENDED DECEMBER 31, -------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Current.................................................... $ 19.6 $ 20.3 $ 17.6 Deferred................................................... 5.0 1.1 4.1 ------ ------ ------ Total.................................................... $ 24.6 $ 21.4 $ 21.7 ====== ====== ======
Deferred federal income tax assets and liabilities are comprised of the following:
DECEMBER 31, ------------- 1997 1996 ------ ------ (IN MILLIONS) DEFERRED FEDERAL INCOME TAX ASSETS Discount of reserve for losses and loss adjustment expenses....... $ 43.0 $ 46.1 Unearned premiums................................................. 21.5 21.0 Postretirement benefits........................................... 5.5 5.5 Pension benefits.................................................. 3.7 2.9 Alternative minimum tax carry forward............................. 0.4 1.2 Other............................................................. 2.6 5.6 ------ ------ Total deferred federal income tax assets........................ 76.7 82.3 ====== ====== Deferred federal income tax liabilities Deferred policy acquisition expenses.............................. 19.2 19.0 Unrealized appreciation on available-for-sale securities.......... 49.1 32.5 Other............................................................. 4.7 5.4 ------ ------ Total deferred federal income tax liabilities................... 73.0 56.9 ------ ------ Net deferred federal income tax asset............................. $ 3.7 $ 25.4 ====== ======
Management believes, based on the Company's recent earnings history and its future expectations, that the Company's taxable income in future years will be sufficient to realize all deferred tax assets. In determining the adequacy of future income, management considered the future reversal of its existing temporary differences and available tax planning strategies, including the sale of investment assets, that could be implemented, if necessary. 37 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The provision for federal income tax expense differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate (35%) to income before federal income taxes and cumulative effect of a change in accounting. The sources of the difference and the tax effects of each were as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Tax provision at statutory rate......................... $ 41.6 $ 36.9 $ 33.8 Tax-exempt interest..................................... (16.2) (15.0) (13.0) Dividends received deduction............................ (1.5) (0.6) (0.7) Other, net.............................................. 0.7 0.1 1.6 ------ ------ ------ Federal income tax expense.............................. $ 24.6 $ 21.4 $ 21.7 ------ ------ ------ Effective tax rate...................................... 20.7% 20.3% 22.5% ====== ====== ======
The Company's federal income tax returns are routinely audited by the IRS, and provisions are made in the financial statements in anticipation of the results of these audits. In management's opinion, adequate tax liabilities have been established for all years. However, the amount of these tax liabilities could be revised in the near term if estimates of the Company's ultimate liability are revised. 6. REINSURANCE The Company maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes pro-rata, excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. Most reinsurance treaties are negotiated by the Company's parent through a broker and provide coverage for all of the subsidiaries of Allmerica Property & Casualty Companies, Inc., including the Company. The Company remains contingently liable in the event that a reinsurer is unable to meet the obligations assumed under the reinsurance agreements. Under the 1997 casualty reinsurance program, the reinsurers are responsible for 100% of the amount of each loss in excess of $0.5 million per occurrence up to $30.5 million for general liability and workers' compensation. Additionally, this reinsurance covers workers' compensation losses in excess of $30.5 million to $60.5 million per occurrence. Amounts in excess of $60.5 million are retained 100% by the Company. Under the Company's 1997 catastrophe reinsurance program, the Company retains 5% of losses in excess of $10.0 million, up to $25.0 million. For losses in excess of $25.0 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. In 1996, the Company had additional catastrophe coverage which reinsured 90% of $5.0 million for aggregated catastrophe losses in excess of $5.0 million which individually exceed $1.0 million. In 1997 and 1996, the Company recovered $1.2 million and $4.6 million on its catastrophe coverage, respectively. In 1995, the Company did not exceed the minimum catastrophe levels. Effective January 1, 1998, the Company modified its catastrophe reinsurance program to include a higher retention. Under the Company's 1998 catastrophe reinsurance program, the Company retains the first $45 million. For losses in excess of $45 million and up to $180.0 million, the Company retains 10% of the loss. Amounts in excess of $180.0 million are retained 100% by the Company. Citizens Insurance cedes 100% of business written in specific states to Hanover. Citizens Insurance also assumes certain business from Hanover which was written by Hanover on behalf of Citizens Insurance. Premiums receivable at December 31, 1997 and 1996, include $0.9 million and $1.6 million, respectively, of premiums due to Citizens Insurance from Hanover on assumed business. In addition, other liabilities at December 31, 1997 and 1996, include $1.8 million and $2.7 million, respectively, of claim payments due from Citizens Insurance to Hanover on 38 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) business assumed. Unearned premiums at December 31, 1997 and 1996, include $5.0 million and $4.1 million, respectively, and reserve for losses and LAE at December 31, 1997 and 1996, include $24.5 million and $22.9 million, respectively, from Hanover assumed business. The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company determines the appropriate amount of reinsurance based on evaluation of the risks accepted, analyses prepared by consultants and reinsurers, and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound. The Company is subject to concentration of risk with respect to reinsurance ceded through a pooling arrangement. As a condition to the ability to conduct personal automobile business in the state of Michigan, the Company is required under Michigan law to participate in a pooling arrangement with the Michigan Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA for personal protection insurance losses in excess of $0.25 million. The Company cedes a significant portion of its private passenger automobile premiums to the MCCA. Ceded premiums earned to MCCA in 1997, 1996, and 1995 were $9.8 million, $50.5 million and $66.8 million, respectively. The decrease in ceded premiums earned to MCCA reflects a reduction in premiums charged per policyholder by MCCA. Losses and LAE ceded to MCCA in 1997, 1996, and 1995 were ($0.8) million, ($52.9) million and $62.9 million, respectively. In 1997 and 1996, the MCCA's favorable development on prior year reserves exceeded the losses and LAE incurred during the year. Net written and earned premiums and losses and LAE incurred included reinsurance activity as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN MILLIONS) Net premiums written Direct....................................... $ 1,038.4 $ 1,030.0 $ 1,024.3 Assumed...................................... 14.2 17.4 19.5 Ceded: Hanover.................................... 143.5 124.2 112.3 Nonaffiliates.............................. 45.4 85.0 97.8 ---------- ---------- ---------- Net premiums written..................... $ 863.7 $ 838.2 $ 833.7 ========== ========== ========== Net premiums earned Direct....................................... $ 1,022.6 $ 1,019.6 $ 1,003.7 Assumed...................................... 14.0 17.0 20.4 Ceded: Hanover.................................... 134.7 117.8 107.2 Nonaffiliates.............................. 46.6 83.3 99.1 ---------- ---------- ---------- Net premiums earned...................... $ 855.3 $ 835.5 $ 817.8 ========== ========== ========== Losses and LAE incurred Direct....................................... $ 710.8 $ 645.5 $ 695.6 Assumed...................................... 25.3 10.3 16.8 Ceded: Hanover.................................... 81.6 85.1 63.5 Nonaffiliates.............................. 15.8 (33.7) 70.6 ---------- ---------- ---------- Losses and LAE incurred.................. $ 638.7 $ 604.4 $ 578.3 ========== ========== ==========
39 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Reinsurance recoverables on paid and unpaid losses and ceded prepaid premiums were as follows:
DECEMBER 31, --------------- 1997 1996 ------- ------- (IN MILLIONS) Reinsurance recoverable on paid and unpaid losses Hanover...................................................... $ 123.4 $ 115.7 MCCA......................................................... 280.2 292.0 Nonaffiliates................................................ 70.7 69.1 ------- ------- $ 474.3 $ 476.8 ======= ======= Prepaid premiums Hanover...................................................... $ 65.6 $ 56.8 Nonaffiliates................................................ 4.8 6.0 ------- ------- $ 70.4 $ 62.8 ======= =======
7. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Changes in prior reserve estimates are reflected in results of operations in the year such changes are determined to be needed and recorded. The table below provides a reconciliation of the beginning and ending reserve for unpaid losses and LAE for the years ended December 31:
1997 1996 1995 -------- -------- -------- (IN MILLIONS) Reserve for losses and LAE, beginning of year.... $1,238.5 $1,291.6 $1,196.6 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year... 708.2 662.8 625.3 Decrease in provision for insured events of prior years................................... (69.5) (58.4) (47.0) -------- -------- -------- Total incurred losses and LAE.................... 638.7 604.4 578.3 -------- -------- -------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year............................... 382.9 365.9 322.1 Losses and LAE attributable to insured events of prior years................................ 280.4 239.1 223.4 -------- -------- -------- Total payments................................... 663.3 605.0 545.5 -------- -------- -------- Change in reinsurance recoverable on unpaid losses.......................................... (7.8) (52.5) 62.2 -------- -------- -------- Reserve for losses and LAE, end of year.......... $1,206.1 $1,238.5 $1,291.6 ======== ======== ========
Loss Development As part of an ongoing process, the reserves, net of reinsurance, have been re-estimated for all prior accident years and were decreased by $69.5 million, $58.4 million and $47.0 million in 1997, 1996, and 1995, respectively. The increase in favorable development of $11.1 million in 1997 reflects improved severity in the workers' compensation line where favorable development increased $13.9 million to $35.7 million and in the commercial multiple peril line where favorable development increased $7.0 million to $4.3 million, partially offset by less favorable development in the personal automobile line, where favorable development decreased $10.5 million to $22.5 million in 1997. The increase in favorable development of $11.4 million in 1996 reflects improved severity in the personal automobile line, where favorable development increased $28.6 million to $33.0 million in 1996, partially offset by less favorable development in the workers' compensation line of $10.9 million. 40 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Citizens favorable development in 1997 primarily reflects a modest shift over the past few years of the workers' compensation business to Western and Northern Michigan, which have demonstrated more favorable loss experience than Eastern Michigan. The favorable development in 1996 and 1995 primarily reflects the initiatives taken by the Company to manage medical costs in both the automobile and workers' compensation lines, as well as the impact of the Michigan Supreme Court ruling on workers' compensation indemnity payments in 1995, which decreases the maximum amount to be paid for indemnity cases on all existing and future claims. This favorable development reflects the Company's reserving philosophy consistently applied over these periods. Conditions and trends that have affected development of the loss and LAE reserves in the past may not necessarily occur in the future. Due to the nature of business written by the Company, the exposure to environmental liabilities is relatively small. Losses and LAE reserves related to environmental damage and toxic tort liability, included in the total reserve for losses and LAE were $19.0 million and $20.6 million at the end of 1997 and 1996, respectively, net of reinsurance of $7.0 million and $3.5 million, respectively. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company has been required to defend such claims. Due to their unusual nature and absence of historical claims data, reserves for these claims are not determined using historical experience to project future losses. The Company estimated its ultimate liability for these claims based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these claims are not material, their existence gives rise to uncertainty and is discussed because of the possibility, however remote, that they may become material. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. Management believes that, notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate and the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves. Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation on the Company varies by product. Property and casualty insurance premiums are established before the amount of losses and LAE, and the extent to which inflation may affect such expenses, are known. Consequently, the Company attempts, in establishing rates, to anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserve position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions; (ii) review of per claim information; (iii) historical loss experience of the Company and the industry; (iv) the relatively short-term nature of most policies; and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. 8. PENSION PLANS The Company provides retirement benefits to substantially all of its employees, under a defined benefit pension plan (the "Plan"). Benefits under this defined benefit formula were frozen for most employees effective December 31, 1994. In its place, the Company adopted a defined benefit cash balance formula, under which the 41 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Company annually provides an allocation to each eligible employee as a percentage of that employee's salary, similar to a defined contribution plan arrangement. The 1997, 1996, and 1995 allocations were based on 7.0% of each employee's salary. The Company's policy for the Plan is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Net pension expense included the following components:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Service cost--benefits earned........................... $ 4.0 $ 3.8 $ 4.0 Interest cost on projected benefit obligation........... 2.8 2.5 1.8 Actual return on Plan assets............................ (3.8) (1.3) (9.3) Net amortization and deferral........................... -- (2.3) 6.4 ------ ------ ------ Net pension expense................................... $ 3.0 $ 2.7 $ 2.9 ====== ====== ======
The following table sets forth the Plan's funded status and amounts recognized in the Company's financial statements.
DECEMBER 31, -------------- 1997 1996 ------ ------ (IN MILLIONS) Actuarial present value of benefit obligations Vested benefit obligation.................................... $ 40.7 $ 36.0 Unvested benefit obligation.................................. 1.4 1.3 ------ ------ Accumulated benefit obligation............................. $ 42.1 $ 37.3 ====== ====== Pension liability included in consolidated balance sheets Projected benefit obligation................................. $ 46.5 $ 41.2 Plan assets at fair value.................................... 36.4 34.1 ------ ------ Plan assets less than projected benefit obligation......... (10.1) (7.1) Unrecognized net loss from past experience................... 4.4 5.0 Unrecognized prior service benefit........................... (5.4) (6.0) Unamortized transition asset................................. (1.6) (1.9) ------ ------ Net pension liability...................................... $(12.7) $(10.0) ====== ======
Determination of the projected benefit obligation was based on a weighted average discount rate of 7% at December 31, 1997 and 1996. The assumed long- term rate of return on plan assets was 9% for both years. The actuarial present value of the projected benefit obligation was determined using assumed rates of increase in future compensation levels ranging from 5% to 5.5%. Plan assets are invested primarily in various separate accounts and the general account of First Allmerica Financial Life Insurance Company (FAFLIC), an affiliate of the Company. The Plan also holds stock of Allmerica Financial Corporation, the ultimate parent of the Company. The Company also has a 401(k) Matched Savings Plan, a defined contribution plan. Effective with the 1995 plan year, the Company began matching employee elective 401(k) contributions, up to a maximum percentage determined annually by the Board of Directors. During 1997, 1996, and 1995, the Company matched 50% of employees' contributions up to 6% of eligible compensation. The total expenses related to these plans were $0.3 million, $1.8 million and $1.4 million, in 1997, 1996, and 1995, respectively. 42 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On January 1, 1998, all of the employees of the Company will be transferred to FAFLIC. In addition, the Company's benefit plans will be merged with the existing benefit plans of FAFLIC. Accordingly, the assets and liabilities related to the Company's plans will be transferred to FAFLIC. Beginning in 1998, the Company will be charged actual salaries and benefit costs for services provided to the Company by FAFLIC employees. The transfer of employees and benefit plans to FAFLIC will not have a material impact on the results of operations or financial position of the Company. 9. POSTRETIREMENT BENEFIT PLANS In addition to the Company's pension plans, the Company provides postretirement medical and death benefits to certain full-time employees and dependents. Generally, employees become eligible at age 55 with at least 15 years of service. Spousal coverage is generally provided for up to two years after death of retiree. Benefits include hospital, major medical, and a payment at death equal to retirees' final compensation up to certain limits. Effective January 1, 1996, the Company revised these benefits so as to establish limits on future benefit payments, restrict eligibility for current employees and eliminate eligibility for new employees. The medical plans have varying co- payments and deductibles, depending on the plan. Participation in the medical plan requires some retiree contributions, which are defined in the plan. The life insurance plan is a non-contributory plan. These plans are unfunded. The plan changes effective January 1, 1996 resulted in an unrecognized negative prior service cost (change in eligibility and medical benefits) of $8.1 million and a curtailment (no future increases in life insurance) of $1.2 million. The negative prior service cost will be amortized over the average number of years to full eligibility (approximately 9 years or $0.9 million per year). The curtailment gain has been deducted from unrecognized loss. The components of net periodic postretirement benefit expense were as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Service cost............................................ $ 0.4 $ 0.6 $ 1.2 Interest cost........................................... 0.7 0.7 1.3 Net amortization........................................ -- 0.1 0.1 Prior service cost...................................... (0.9) (0.9) -- ------ ------ ------ Net postretirement benefit expense...................... $ 0.2 $ 0.5 $ 2.6 ====== ====== ======
The plans' status and the amounts recognized in the Company's consolidated balance sheets were as follows:
DECEMBER 31, ---------------- 1997 1996 ------- ------- ( IN MILLIONS) Accumulated postretirement benefit obligation: Retirees.................................................... $ 5.8 $ 6.4 Other fully eligible plan participants...................... 1.0 1.2 Other active plan participants.............................. 3.5 4.0 ------- ------- Accumulated postretirement benefit obligation................. 10.3 11.6 Unrecognized prior service cost............................... 6.3 7.2 Unrecognized loss............................................. (1.1) (3.1) ------- ------- Accrued postretirement benefit cost........................... $ 15.5 $ 15.7 ======= =======
43 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) For purposes of measuring the accumulated postretirement benefit obligation at December 31, 1997, health care costs were assumed to decrease to 8.0% in 1998, declining thereafter until the ultimate rate of 5.5% is reached in 2001 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1% in each year would increase the medical accumulated postretirement benefit obligation as of December 31, 1997 by $0.6 million, or 8.5%, and the aggregate of the service and interest cost components of annual net periodic postretirement benefit expense by $0.1 million, or 8.6%. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7% as of December 31, 1997 and 1996. The assumed rate of future annual salary increases range was 5.5% at both valuation dates. As described in Note 8, the liabilities related to the Company's plan, net of the deferred tax asset, will be transferred to FAFLIC, effective January 1, 1998. 10. RELATED PARTY TRANSACTIONS The Company declared dividends to Hanover as follows:
FOR THE YEARS ENDED DECEMBER 31, -------------------- 1997 1996 1995 ------ ------ ------ (IN MILLIONS) Common stock dividends.................................... $ 5.8 $ 5.8 $ 5.8 Preferred stock dividends................................. -- -- 2.0 ------ ------ ------ Total declared dividends to Hanover..................... $ 5.8 $ 5.8 $ 7.8 ====== ====== ======
The Company is a party to a consolidated service agreement along with all other affiliates under which FAFLIC and Hanover provide management, space, technology and other services. Charges for these services are based on full cost including all direct and indirect overhead costs and amounted to $20.5 million, $13.3 million and $9.7 million in 1997, 1996, and 1995, respectively. Also under the consolidated service agreement, Citizens provided technology services to Hanover. Charges for these services amounted to $6.4 million and $0.7 million in 1997 and 1996, respectively. Charges in 1995 were insignificant. The Company provides data processing, claims adjusting, underwriting, and bond operation services to Hanover on business assumed from Hanover. These items are treated as assumed expenses by the Company. 11. STOCK OPTIONS In October 1995 the FASB issued Statement of Financial Accounting Standards No. 123 Accounting for Stock-Based Compensation (Statement No. 123). The standard is effective for fiscal years beginning after December 15, 1995, and requires the Company either to apply a fair value measure to any stock-based compensation granted by the Company after December 31, 1994, or continue to apply the valuation provisions of existing accounting standards, but with pro- forma net income and earnings per share disclosures using a fair value methodology to value the stock-based compensation. Beginning the year ended December 31, 1996, the Company has elected to continue to apply the valuation provisions of existing accounting standards (APB 25) in accounting for its stock options and, accordingly, no compensation cost has been recognized for stock options in the financial statements. The pro-forma effect of applying Statement No. 123 is not material. 44 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Effective March 9, 1994, the Company adopted a Long Term Stock Incentive Plan (the "Plan"). Key employees of the Company and Citizens Insurance are eligible for awards pursuant to the Plan administered by the Compensation Committee of the Board of Directors (the "Committee") of the Company. Under the terms of the Plan, options may be granted to eligible employees at a price not less than the market price of the Company's common stock on the date of grant. Option shares may be exercised subject to the terms prescribed by the Committee at the time of grant, otherwise options vest at the rate of 20% annually for five consecutive years and must be exercised not later than ten years from the date of grant. Information regarding the Company's stock option plan is summarized below:
1997 1996 1995 ---------------- ---------------- ---------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------- -------- ------- -------- ------- -------- Outstanding at beginning of year....................... 100,500 $17.38 70,500 $16.46 33,500 $15.25 Granted..................... -- -- 52,000 18.36 56,500 16.84 Exercised................... 7,800 17.14 1,500 15.79 -- -- Forfeited................... 16,900 17.52 20,500 16.83 19,500 15.46 ------- ------ ------- ------ ------ ------ Outstanding at end of year.. 75,800 $17.37 100,500 $17.38 70,500 $16.46 ------- ------ ------- ------ ------ ------ Options exercisable at end of year.................... 22,900 $16.89 12,700 $16.28 3,300 $15.25 ======= ====== ======= ====== ====== ======
No options expired during 1997, 1996, and 1995. Exercise prices for options outstanding as of December 31, 1997 ranged from $15.25 to $18.875. The weighted average remaining contractual life of these options is 7.8 years. At December 31, 1997, there were 58,000 option shares available for future grant. The fair value of each option is estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values of options granted in 1996 and 1995 were $7.98 and $9.22, respectively. There were no options granted during 1997. Principal assumptions used in applying the Black-Scholes model were as follows:
1997 1996 1995 ------ -------- -------- Risk-free interest rate................................ -- 5.3-6.3% 6.4-7.9% Expected life, in years................................ -- 2.5-7 2.5-7 Expected volatility.................................... -- 18.8% 22.0% Expected dividend yield................................ -- 1.1% 1.1-1.2%
12. COMMITMENTS AND CONTINGENCIES The Company has certain operating lease agreements for property and equipment. At December 31, 1997, future minimum rental payments under non- cancelable long-term operating leases were $9.9 million, payable as follows: 1998--$2.7 million; 1999--$2.3 million; 2000--$1.7 million; 2001--$1.1 million; 2002--$0.9 million; and $1.2 million thereafter. All leases expire prior to the year 2005. It is expected that, in the normal course of business, leases that expire will be renewed or replaced by leases on other property and equipment; thus, it is anticipated that future minimum lease commitments will not be less than the amounts shown for 1998. Certain equipment and fixture leases are subject to buy out options. Rent expense, excluding related party charges, was $3.3 million, $3.3 million, and $3.3 million in 1997, 1996, and 1995, respectively. Litigation The Company has been named a defendant in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these 45 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) proceedings will not have a material effect on the consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised. Year 2000 The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Although the Company does not believe that there is a material contingency associated with the Year 2000 project, there can be no assurance that exposure for material contingencies will not arise. 13. DIVIDEND RESTRICTION AND REGULATORY MATTERS Michigan limits the payment of dividends and other distributions to shareholders. Under current law, cash dividends may only be paid from earnings and policyholders' surplus. In addition, a Michigan insurer may not pay an "extraordinary" dividend to its stockholders without the prior approval of the Michigan Commissioner. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of policyholders' surplus as of December 31 of the immediately preceding year or the statutory net income less realized gains, for the immediately preceding calendar year. Based upon the 1997 statutory financial statements of Citizens Insurance, the maximum dividend that may be paid to Citizens Corporation at January 1, 1998, without prior approval from the Michigan Commissioner of Insurance, is $86.9 million. 46 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. SEGMENT INFORMATION The Company is engaged primarily in the property and liability insurance business. The Company operates predominately in Michigan, with operations in the adjoining states of Indiana and Ohio. Substantially all of the Company's earnings are generated in the state of Michigan. The Company's insurance operations are segmented into personal and commercial lines of business, based on common underlying risks and customer types for individual products in those segments. The personal segment includes products such as automobile insurance and homeowners insurance. The commercial segment includes products such as automobile insurance, commercial multiple-peril insurance, and workers' compensation insurance. The following is a review of segment results. Investments are available for payments of claims and expenses for all products. Investment income, realized gains and total assets have not been identified to specific segments.
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------------------------- INCOME BEFORE NET FEDERAL NET PREMIUMS INVESTMENT REALIZED UNDERWRITING INCOME TOTAL EARNED INCOME GAIN PROFIT (LOSS) TAXES ASSETS ------------ ---------- -------- ------------- ------- --------- (IN MILLIONS) 1997 Personal.... $ 583.3 $ (8.8) Commercial.. 272.0 (2.4) ------- ------- ------ ------- ------- --------- Total..... $ 855.3 $ 101.8 $ 28.8 $ (11.2) $ 118.8 $ 2,605.3 ======= ======= ====== ======= ======= ========= 1996 Personal.... $ 554.6 $ (1.3) Commercial.. 280.9 2.0 ------- ------- ------ ------- ------- --------- Total..... $ 835.5 $ 88.9 $ 15.0 $ 0.7 $ 105.5 $ 2,503.0 ======= ======= ====== ======= ======= ========= 1995 Personal.... $ 536.2 $ (26.6) Commercial.. 281.6 40.0 ------- ------- ------ ------- ------- --------- Total..... $ 817.8 $ 78.8 $ 3.8 $ 13.4 $ 96.6 $ 2,470.8 ======= ======= ====== ======= ======= =========
47 CITIZENS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 15. QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED, 1997 --------------------------------------------- MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ----------- ---------- ----------- ---------- (IN MILLIONS, EXCEPT COMMON SHARE DATA) Total revenues................... $ 254.7 $ 237.1 $ 249.7 $ 250.9 Net income....................... $ 28.4 $ 16.6 $ 17.3 $ 31.9 Net income available to common shareholders' per share (basic and diluted).................... $ 0.80 $ 0.47 $ 0.50 $ 0.90 Dividends declared per common share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05 FOR THE THREE MONTHS ENDED, 1996 --------------------------------------------- MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ----------- ---------- ----------- ---------- (IN MILLIONS, EXCEPT PER COMMON SHARE DATA) Total revenues................... $ 240.4 $ 234.4 $ 234.8 $ 236.0 Net income....................... $ 22.5 $ 12.1 $ 27.1 $ 22.4 Net income available to common shareholders' per share (basic and diluted).................... $ 0.63 $ 0.34 $ 0.77 $ 0.63 Dividends declared per common share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05 FOR THE THREE MONTHS ENDED, 1995 --------------------------------------------- MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ----------- ---------- ----------- ---------- (IN MILLIONS, EXCEPT PER COMMON SHARE DATA) Total revenues................... $ 216.2 $ 226.0 $ 234.0 $ 230.3 Net income....................... $ 11.6 $ 24.0 $ 20.9 $ 18.4 Net income available to common shareholders' per share (basic and diluted).................... $ 0.29 $ 0.64 $ 0.58 $ 0.51 Dividends declared per common share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05
48 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT A description of the directors, including those nominated for election as directors at the Annual Meeting of Shareholders of the Registrant, is incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below is biographical information concerning the executive officers of the Company. Officers of the Company hold office until the first meeting of the Board of Directors following the next annual meeting of the shareholders and until their respective successor is chosen and qualified unless a shorter period is specified by the terms of their election or appointment. JOHN F. O'BRIEN, 54 Chairman of the Board and Chief Executive Officer of the Company since 1992 President of the Company since 1994 John F. O'Brien has been a Director of Citizens Insurance since March 1992 and Citizens, for which he also serves as President and Chief Executive Officer, since December 1992. Mr. O'Brien has also served as Director, President and Chief Executive Officer of Allmerica Property & Casualty since August 1992, and has also been a Director of Hanover since September 1989. In addition, Mr. O'Brien has served as a Director, Chief Executive Officer and President of Allmerica Financial Corporation ("AFC") since February 1995 and of First Allmerica Financial Life Insurance Company ("FAFLIC") since August 1989. Mr. O'Brien is also a trustee or director and executive officer of Allmerica Investment Trust, Allmerica Securities Trust, and Allmerica Funds. Additionally, Mr. O'Brien is a director and/or holds offices at various other non-public FAFLIC affiliates including SMA Financial Corp. and Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"). Mr. O'Brien also currently serves as a Director of The TJX Companies, Inc., an off-price family apparel retailer, ABIOMED, Inc., a medical device company, Cabot Corporation, a diversified specialty chemicals and materials and energy company, and The Life Insurance Association of Massachusetts, and serves as a member on the Steering Committee on Financial Services of The American Council of Life Insurance. He also currently serves as a member of the executive committee of the Massachusetts Capital Resource Company, a Massachusetts investment partnership. Prior to joining FAFLIC, Mr. O'Brien served as an officer of FMR Corp., the parent company of various financial services companies in the Fidelity Group, and a director and/or an executive officer at various other of FMR Corp.'s affiliates. BRUCE C. ANDERSON, 53 Vice President of the Company since 1997 Bruce C. Anderson has been Vice President of Citizens and APY since March 1997 and of AFC since February 1995. Mr. Anderson has been employed by FAFLIC since 1967 and has been Vice President and Director of FAFLIC since October 1984 and April 1996, respectively. In addition, Mr. Anderson is a director and/or executive officer at various other non-public affiliates. ROBERT E. BRUCE, 47 Vice President of the Company since 1997 Robert E. Bruce has been Vice President of Citizens and AFC since July 1997 and Vice President and Director of Citizens and Hanover since August 1997. In addition, Mr. Bruce has served as Vice President and 49 Director of FAFLIC since May 1995 and August 1997, respectively, and Chief Information Officer of FAFLIC since February 1997. Mr. Bruce is also a director and/or executive officer at various other non-public affiliates. Prior to joining FAFLIC in May 1995, Mr. Bruce was Corporate Manager at Digital Equipment Corporation, a computer manufacturer, from May 1979 to March 1995. JOHN P. KAVANAUGH, 43 Vice President and Chief Investment Officer of the Company since 1996 John P. Kavanaugh has been Vice President and Chief Investment Officer of Citizens, AFC and APY since September 1996. Mr. Kavanaugh has been employed by FAFLIC since 1983, and has been Vice President of FAFLIC since December 1991 and Vice President of AFLIAC since January 1992. Mr. Kavanaugh has also served as Director and Chief Investment Officer of FAFLIC, Hanover, Citizens Insurance and AFLIAC since August 1996. Mr. Kavanaugh is also a director and/or executive officer at various other non-public affiliates. JOHN F. KELLY, 59 Vice President, General Counsel and Assistant Secretary of the Company since 1993 John F. Kelly has been Assistant Secretary of Citizens since December 1992, Vice President and General Counsel of Citizens since September 1993, Vice President and General Counsel of APY since August 1992, and Assistant Secretary of APY since May 1995. Mr. Kelly has been Vice President, Assistant Secretary and General Counsel of AFC since February 1995, has been employed by FAFLIC since July 1968, and has been Senior Vice President and General Counsel of FAFLIC since February 1986 and a Director of FAFLIC since April 1996. Mr. Kelly also served as Secretary of APY from August 1992 to May 1995. In addition to his positions with AFC and FAFLIC, Mr. Kelly has been a Director of AFLIAC since October 1982 and is a director and/or executive officer at various other non-public affiliates. J. BARRY MAY, 50 Vice President of the Company since 1997 Director of the Company since 1996 J. Barry May has been Vice President and Director of Citizens since March 1997 and September 1996, respectively, and has served as President and Director of Hanover since September 1996. Mr. May has also been Vice President of APY since September 1996 and Vice President of AFC since February 1997. Mr. May served as Vice President of Hanover from May 1995 to September 1996, as Regional Vice President from February 1993 to May 1995 and as a General Manager of Hanover from June 1989 to May 1995. Mr. May has been employed by Hanover since 1985. In addition, Mr. May is a director and/or executive officer at various other non-public affiliates. JAMES R. MCAULIFFE, 53 Vice President and Director of the Company since 1992 James R. McAuliffe has been a Director and Vice President of Citizens since December 1992, President of Citizens Insurance since December 1994 and Vice President of APY since August 1992. Mr. McAuliffe has been employed by FAFLIC since 1968, and served as Vice President and Chief Investment Officer of FAFLIC from November 1986 through December 1994. Mr. McAuliffe was Vice President of AFC from February 1995 to December 1995 and since February 1997. Mr. McAuliffe was also a Director, Vice President and Chief Investment Officer of APY from August 1992 through December 1994, and a Director of AFLIAC from April 1987 through May 1995 and since May 1996. Mr. McAuliffe also served as Vice President and Chief Investment Officer of AFLIAC from December 1986 through May 1995. Additionally, Mr. McAuliffe is a director and/or executive officer at various other non-public affiliates. 50 EDWARD J. PARRY, III, 38 Chief Financial Officer of the Company since 1996 Vice President of the Company since 1993 Treasurer of the Company since 1992 Edward J. Parry, III has been Chief Financial Officer of Citizens and Citizens Insurance since December 1996 and Vice President and Treasurer of Citizens since September 1993 and December 1992, respectively. He has served as Chief Financial Officer of APY, AFC, FAFLIC, AFLIAC and Hanover since December 1996 and has been Vice President and Treasurer of APY, FAFLIC, AFLIAC and Hanover since February 1993 and of AFC since February 1995. Mr. Parry is also director and/or executive officer at various other non-public affiliates. RICHARD M. REILLY, 59 Vice President of the Company since 1997 Richard M. Reilly has been Vice President of Citizens and APY since March 1997 and Vice President of AFC and FAFLIC since February 1997 and November 1990, respectively. He has also been a Director and Vice President of AFLIAC since November 1990 and President and Chief Executive Officer of AFLIAC since August 1995. Mr. Reilly was Vice President of AFC from February 1995 through December 1995. Additionally, Mr. Reilly has been the President of Allmerica Investment Trust, Allmerica Funds, and Allmerica Securities Trust, each a registered investment company, since February 1991, April 1991 and February 1991, respectively. Mr. Reilly is also a director and/or holds an executive office at various other non-public affiliates. ERIC A. SIMONSEN, 52 Vice President and Director of the Company since 1992 Eric A. Simonsen has been a Director and Vice President of Citizens since December 1992, of AFLIAC since September 1990 and a Vice President of AFC since February 1995. Mr. Simonsen was a Director of APY from August 1992 to July 1997. In addition, Mr. Simonsen has been Vice President and Director of FAFLIC since September 1990 and April 1996, respectively. Mr. Simonsen has been President of Allmerica Services Corporation since December 1996. Mr. Simonsen was Chief Financial Officer of AFC from February 1995 to December 1996, of FAFLIC and AFLIAC from September 1990 to December 1996, of APY from August 1992 to December 1996 and of Citizens from December 1992 to December 1996. Mr. Simonsen is also a director and/or executive officer at various other non-public affiliates. PHILLIP E. SOULE, 48 Vice President of the Company since 1997 Phillip E. Soule has been Vice President of Citizens, APY and FAFLIC since March 1997, September 1996 and February 1987, respectively, and of AFC since February 1997. He was a Vice President of AFC from February 1995 through December 1995. Mr. Soule has been employed by FAFLIC since 1972 in various capacities. ITEM 11. EXECUTIVE COMPENSATION Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND MANAGEMENT Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. 51 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS AND INDEX: The consolidated financial statements of Citizens Corporation are listed under Item 8 of this Form 10-K. (a)(2) FINANCIAL STATEMENT SCHEDULES AND INDEX:
PAGE NO. IN SCHEDULE THIS REPORT -------- ----------- Summary of Investments--Other than Investments in Re- I lated Parties......................................... 56 II Condensed Financial Information of the Registrant..... 57-59 III Supplementary Insurance Information................... 60-62 IV Reinsurance........................................... 63 V Valuation and Qualifying Accounts..................... 64 Supplemental Information Concerning Property/Casualty VI Insurance Operations.................................. 65
Schedules other than those listed above are omitted as they are not required, not applicable, or the required information is disclosed elsewhere in the financial statements and related notes. (a)(3) EXHIBITS: Exhibits filed as part of this Form 10-K are as follows: (3.1) Amended Articles of Incorporation* (3.2) By-Laws of the Registrant* (4) Form of Common Stock Certificate* (10) Material Contracts* (10.1) The Hanover Insurance Company/Citizens Insurance Company of America Excess Benefit Retirement Plan* (10.2) Citizens Insurance Company of America Supplemental Employee Retirement Plan.* Amended November 15, 1994. (10.3) The Citizens Insurance Company of America Management Reward Plan.* Amended November 15, 1994. Further amended September 6, 1995. (10.4) Consolidated Income Tax Agreement dated December 31, 1997. (10.5) Citizens-Hanover Service Agreement dated December 18, 1979.* (10.7) Intercompany Reinsurance Agreement between Hanover and Citizens Insurance dated December 13, 1983, together with addenda.* (10.8) Intercompany Reinsurance Agreement between Citizens Insurance and Hanover dated September 16, 1992, together with addenda.* Further amended January 1, 1995.
52 (10.10) Lease between Citizens Insurance and Bavarian Group Partnership dated August 19, 1989 related to leased premises in Gaylord, Michigan.* (10.11) Lease between Citizens Insurance and Upper Peninsula Commission for Area Progress, Inc. dated January 26, 1995 related to leased premises in Escanaba, Michigan,* with addendum dated March 9, 1995. *** (10.12) Addendum to the lease between Citizens Insurance and The Precedent dated May 4, 1992 related to leased premises in Indianapolis, Indiana.** (10.13) Loan Agreement between Citizens Insurance and The Economic Development Corporation of the County of Livingston ("EDC") dated August 1, 1986.* (10.14) Indenture between EOL and the First National Bank of Howell dated August 1, 1986.* (10.15) Consolidated Service Agreement between State Mutual Life Assurance Company of America and their subsidiaries dated September 30, 1993.* (10.16) Lease between Citizens Insurance and CICOA, L.L.C., entered into November 7, 1994, related to leased premises in construction in Grand Rapids, Michigan. ** (10.17) Citizens Insurance Company of America Stock Option Plan dated June 3, 1994. ** (10.18) Lease between Citizens Insurance and Eastrich No. 152 Corporation, effective March 1, 1995, related to leased premises in Columbus, Ohio.*** (10.19) Intercompany Reinsurance Agreement between Citizens Insurance Company of America and Citizens Insurance Company of Ohio dated January 1, 1995.*** (10.20) Citizens Insurance Company of America Employees' 401(k) Matched Savings Plan.***** (10.21) Allmerica Financial Cash Balance Pension Plan.***** (10.22) Intercompany Reinsurance Agreement between Citizens Insurance Company of America and Citizens Insurance Company of the Midwest dated January 1, 1995. (10.23) Consolidated Service Agreement dated January 1, 1998.
(11) Statement regarding computation of per share earnings (21) Subsidiaries of the Registrant (23) Consent of Independent Accountants in reference to the Registration Statement on Form S-8 (No. 33-97066) (24) Power of Attorney (99.1) Important factors regarding forward-looking statements - -------- * Incorporated by reference to the similarly numbered exhibit in the Company's Registration Statement on Form S-1, No. 33-56240, filed March 18, 1993. ** Incorporated by reference to the similarly numbered exhibit in the Company's Annual Report for the year ended December 31, 1994 on Form 10- K, filed March 29, 1995. 53 *** Incorporated by reference to the similarly numbered exhibit in the Company's Quarterly Report for the period ended March 31, 1995 on Form 10-K, filed May 11, 1995 **** Incorporated by reference to the similarly numbered exhibit in the Company's Quarterly Report for the period ended June 30, 1995 on Form 10-K, filed August 10, 1995. ***** Incorporated by reference to the similarly numbered exhibit in the Company's Quarterly Report for the period ended September 30, 1995 on Form 10-K, filed November 10, 1995. (b) REPORTS ON FORM 8-K FILED IN THE FOURTH QUARTER OF 1997: None. 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Citizens Corporation Registrant Dated March 18, 1998 /s/ John F. O'Brien By___________________________________ JOHN F. O'BRIEN PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Dated March 18, 1998 /s/ John F. O'Brien --------------------------------------- JOHN F. O'BRIEN PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD Dated March 18, 1998 /s/ Edward J. Parry, III --------------------------------------- EDWARD J. PARRY, III VICE PRESIDENT, CHIEF FINANCIAL OFFICER, TREASURER AND PRINCIPAL ACCOUNTING OFFICER Dated March 18, 1998 * --------------------------------------- JAMES A. COTTER, JR. DIRECTOR Dated March 18, 1998 * --------------------------------------- NEAL J. CURTIN DIRECTOR Dated March 18, 1998 * --------------------------------------- DONA SCOTT LASKEY DIRECTOR Dated March 18, 1998 * --------------------------------------- J. BARRY MAY VICE PRESIDENT AND DIRECTOR Dated March 18, 1998 * --------------------------------------- JAMES R. MCAULIFFE VICE PRESIDENT AND DIRECTOR Dated March 18, 1998 * --------------------------------------- ERIC A. SIMONSEN VICE PRESIDENT AND DIRECTOR *By:/s/ John F. O'Brien ------------------------------------ JOHN F. O'BRIEN, ATTORNEY-IN-FACT 55 SCHEDULE I CITIZENS CORPORATION SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997
AMOUNT AT WHICH SHOWN IN THE FAIR CONSOLIDATED TYPE OF INVESTMENT COST(1) VALUE(1) BALANCE SHEET ------------------ -------- -------- --------------- (IN MILLIONS) Fixed Maturities: Bonds: U.S. government obligations................ $ 20.4 $ 21.5 $ 21.5 States and political subdivisions.......... 955.2 1,000.2 1,000.2 Foreign governments........................ 5.2 5.9 5.9 Public utilities........................... 27.0 28.4 28.4 Convertibles and bonds with warrants....... -- -- -- All other corporate bonds.................. 336.2 351.2 351.2 Redeemable preferred stock.................. 109.1 115.2 115.2 -------- -------- -------- Total fixed maturities................... 1,453.1 1,522.4 1,522.4 -------- -------- -------- Equity securities: Common stocks: Public utilities........................... 1.5 2.1 2.1 Banks, trusts and insurance companies...... 15.3 29.7 29.7 Industrial, miscellaneous and all other.... 88.4 145.5 145.5 Nonredeemable preferred stocks.............. 5.0 5.4 5.4 -------- -------- -------- Total equity securities.................. 110.2 182.7 182.7 ======== ======== ======== Other investments............................ 17.7 16.5 16.5 -------- -------- -------- Total investments..................... $1,581.0 $1,721.6 $1,721.6 ======== ======== ========
- -------- (1) Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums and accretion of discounts. 56 SCHEDULE II CITIZENS CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT COMPANY ONLY CONDENSED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ----- ----- ----- (IN MILLIONS) Revenues Net investment income.................................... $ 0.2 $ 0.2 $ 0.6 ----- ----- ----- Total revenues.......................................... 0.2 0.2 0.6 ----- ----- ----- Expenses Miscellaneous expenses................................... 1.1 1.2 1.7 ----- ----- ----- Total expenses.......................................... 1.1 1.2 1.7 ----- ----- ----- Loss before federal income taxes and equity in net operat- ing results of subsidiaries.............................. (0.9) (1.0) (1.1) Federal income tax benefit................................ 0.5 0.2 0.4 Equity in net operating results of subsidiaries........... 94.6 84.9 75.6 ----- ----- ----- Net income................................................ $94.2 $84.1 $74.9 ===== ===== =====
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto in this Form 10-K. 57 SCHEDULE II (CONTINUED) CITIZENS CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT COMPANY ONLY CONDENSED BALANCE SHEET
DECEMBER 31, ---------------------- 1997 1996 ---------- ---------- (IN MILLIONS, EXCEPT PER SHARE DATA) ASSETS Cash and cash equivalents............................ $ 3.0 $ 5.1 Investment in subsidiaries........................... 871.4 741.2 Other assets......................................... 0.3 10.0 ---------- ---------- Total assets....................................... $ 874.7 $ 756.3 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Total liabilities.................................. $ 1.8 $ 1.8 ---------- ---------- SHAREHOLDERS' EQUITY Common stock, $0.01 par value per share; authorized 100.0 million shares; 36.1 million shares issued; 35.9 million shares outstanding..................... 0.4 0.4 Additional paid-in capital........................... 156.1 156.1 Retained earnings.................................... 639.6 552.5 Unrealized appreciation on investments, net of de- ferred federal income taxes......................... 91.6 60.5 Treasury stock, at cost (0.8 million shares)......... (14.8) (15.0) ---------- ---------- Total shareholders' equity......................... 872.9 754.5 ---------- ---------- Total liabilities and shareholders' equity......... $ 874.7 $ 756.3 ========== ==========
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto in this Form 10-K. 58 SCHEDULE II (CONTINUED) CITIZENS CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT COMPANY ONLY CONDENSED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ----- ----- ------ (IN MILLIONS) CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................. $94.2 $84.1 $ 74.9 Adjustments to reconcile net income to net cash provided by operating activities: Increase in undistributed net income of subsidiaries.. (94.2) (54.9) (64.1) Change in liabilities................................. -- (0.4) 0.5 Change in other assets................................ 9.7 (10.0) 4.0 ----- ----- ------ Net cash provided by operating activities............ 9.7 18.8 15.3 ----- ----- ------ CASH FLOWS FROM INVESTING ACTIVITIES Investment in subsidiaries............................. (4.5) (5.0) (7.0) Sale of available-for-sale debt securities............. -- 0.2 1.2 Purchases of available-for-sale debt securities........ (0.4) -- (0.2) Proceeds from subsidiary redemption of Series A pre- ferred stock.......................................... -- -- 100.0 ----- ----- ------ Net cash (used for) provided by investing activities. (4.9) (4.8) 94.0 ----- ----- ------ CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid to shareholders......................... (7.1) (7.1) (9.2) Treasury stock purchased, at cost...................... -- (11.1) (3.9) Treasury shares reissued............................... 0.2 -- -- Redemption of Series A preferred stock................. -- -- (100.0) ----- ----- ------ Net cash used for financing activities............... (6.9) (18.2) (113.1) ----- ----- ------ Net decrease in cash and cash equivalents.............. (2.1) (4.2) (3.8) Cash and cash equivalents at beginning of the period... 5.1 9.3 13.1 ----- ----- ------ Cash and cash equivalents at end of the period......... $ 3.0 $ 5.1 $ 9.3 ===== ===== ======
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto in this Form 10-K. 59 SCHEDULE III CITIZENS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEAR ENDED DECEMBER 31, 1997
RESERVE FOR DEFERRED LOSSES AND POLICY LOSS NET NET ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2) ----------- ----------- ----------- -------- ---------- (IN MILLIONS) Private passenger auto- mobile................. $20.0 $ 652.8 $178.4 $454.5 Homeowners.............. 12.1 38.6 67.2 113.8 Other personal lines.... 1.4 3.1 9.2 15.0 ----- -------- ------ ------ ------ Total personal lines.. 33.5 694.5 254.8 583.3 ----- -------- ------ ------ ------ Commercial automobile... 6.5 92.9 34.7 75.3 Commercial multiple per- il..................... 7.9 127.1 35.2 69.2 Workers' compensation... 4.5 260.1 36.5 104.5 Other commercial lines.. 2.4 31.5 17.3 23.0 ----- -------- ------ ------ ------ Total commercial lines................ 21.3 511.6 123.7 272.0 ----- -------- ------ ------ ------ Totals.............. $54.8 $1,206.1 $378.5 $855.3 $101.8 ===== ======== ====== ====== ====== ===
LOSSES AND LOSS POLICY OTHER NET ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS EXPENSES EXPENSES EXPENSES(3) WRITTEN --------------- ----------- ------------ -------- Private passenger automobile......... $328.8 $ 86.2 $33.7 $453.7 Homeowners.......... 104.6 23.1 8.4 120.0 Other personal lines.............. 7.8 2.8 1.1 15.5 ------ ------ ----- ------ Total personal lines............ 441.2 112.1 43.2 589.2 ------ ------ ----- ------ Commercial automo- bile............... 63.1 16.4 5.6 76.5 Commercial multiple peril.............. 71.4 17.8 5.1 74.6 Workers' compensa- tion............... 47.7 14.0 7.7 98.5 Other commercial lines.............. 15.3 4.6 1.8 24.9 ------ ------ ----- ------ Total commercial lines............ 197.5 52.8 20.2 274.5 ------ ------ ----- ------ Totals.......... $638.7 $164.9 $63.4 $863.7 ====== ====== ===== ======
- -------- (1) As of December 31, 1997 (2) Total invested assets which generate investment income are not recorded or allocated by line of business; therefore, net investment income is stated in total. (3) Excludes policyholders' dividends of $6.6. 60 SCHEDULE III (CONTINUED) CITIZENS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEAR ENDED DECEMBER 31, 1996
RESERVE FOR DEFERRED LOSSES AND POLICY LOSS NET NET ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2) ----------- ----------- ----------- -------- ---------- (IN MILLIONS) Private passenger auto- mobile................. $ 19.8 $ 582.7 $ 170.3 $ 436.1 Homeowners.............. 11.4 53.6 60.9 104.4 Other personal lines.... 1.3 2.3 8.5 14.1 ------ --------- ------- ------- ------ Total personal lines.. 32.5 638.6 239.7 554.6 ------ --------- ------- ------- ------ Commercial automobile... 6.8 106.5 33.7 67.6 Commercial multiple per- il..................... 7.3 143.7 31.5 59.1 Workers' compensation... 5.3 320.4 42.7 130.7 Other commercial lines.. 2.4 29.3 14.7 23.5 ------ --------- ------- ------- ------ Total commercial lines................ 21.8 599.9 122.6 280.9 ------ --------- ------- ------- ------ Totals.............. $ 54.3 $ 1,238.5 $ 362.3 $ 835.5 $ 88.9 ====== ========= ======= ======= ======
LOSSES AND LOSS POLICY OTHER NET ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS EXPENSES EXPENSES EXPENSES(3) WRITTEN --------------- ----------- ------------ -------- Private passenger automo- bile....................... $299.0 $ 87.5 $33.1 $433.8 Homeowners.................. 97.3 22.2 8.0 107.7 Other personal lines........ 7.8 2.8 1.7 14.5 ------ ------ ----- ------ Total personal lines...... 404.1 112.5 42.8 556.0 ------ ------ ----- ------ Commercial automobile....... 53.8 14.6 4.9 70.4 Commercial multiple peril... 56.8 14.3 7.4 63.3 Workers' compensation....... 73.4 17.4 7.1 125.0 Other commercial lines...... 16.3 5.3 2.2 23.5 ------ ------ ----- ------ Total commercial lines.... 200.3 51.6 21.6 282.2 ------ ------ ----- ------ Totals.................. $604.4 $164.1 $64.4 $838.2 ====== ====== ===== ======
- -------- (1) As of December 31, 1996. (2) Total invested assets which generate investment income are not recorded or allocated by line of business; therefore, net investment income is stated in total. (3) Excludes policyholders' dividends of $7.2. 61 SCHEDULE III (CONTINUED) CITIZENS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEAR ENDED DECEMBER 31, 1995
RESERVE FOR DEFERRED LOSSES AND POLICY LOSS NET NET ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2) ----------- ----------- ----------- -------- ---------- (IN MILLIONS) Private passenger auto- mobile................. $20.5 $ 653.9 $128.5 $424.4 Homeowners.............. 10.9 50.2 73.8 98.7 Other personal lines.... 1.3 3.5 9.4 13.1 ----- -------- ------ ------ ------ Total personal lines.. 32.7 707.6 211.7 536.2 ----- -------- ------ ------ ------ Commercial automobile... 5.7 121.1 35.6 59.8 Commercial multiple per- il..................... 5.6 119.1 34.6 54.0 Workers' compensation... 5.9 323.6 56.4 148.3 Other commercial lines.. 2.3 20.2 13.1 19.5 ----- -------- ------ ------ ------ Total commercial lines................ 19.5 584.0 139.7 281.6 ----- -------- ------ ------ ------ Totals.............. $52.2 $1,291.6 $351.4 $817.8 $ 78.8 ===== ======== ====== ====== ======
LOSSES AND LOSS POLICY OTHER NET ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS EXPENSES EXPENSES EXPENSES(3) WRITTEN --------------- ----------- ------------ -------- Private passenger automo- bile....................... $326.1 $ 86.8 $30.7 $425.5 Homeowners.................. 80.0 18.8 8.8 102.2 Other personal lines........ 7.5 2.5 1.6 13.8 ------ ------ ----- ------ Total personal lines...... 413.6 108.1 41.1 541.5 ------ ------ ----- ------ Commercial automobile....... 51.3 13.1 4.7 64.0 Commercial multiple peril... 39.9 10.9 8.3 58.4 Workers' compensation....... 63.8 23.7 2.8 147.2 Other commercial lines...... 9.7 3.8 3.0 22.6 ------ ------ ----- ------ Total commercial lines.... 164.7 51.5 18.8 292.2 ------ ------ ----- ------ Totals.................. $578.3 $159.6 $59.9 $833.7 ====== ====== ===== ======
- -------- (1) As of December 31, 1995. (2) Total invested assets which generate investment income are not recorded or allocated by line of business; therefore, net investment income is stated in total. (3) Excludes policyholders' dividends of $6.6. 62 SCHEDULE IV CITIZENS CORPORATION REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
PERCENTAGE CEDED TO ASSUMED OF AMOUNT DIRECT OTHER FROM OTHER NET ASSUMED AMOUNT COMPANIES COMPANIES AMOUNT TO NET -------- --------- ---------- ------ ---------- (IN MILLIONS) 1997: Property and liability insur- ance premiums earned......... $1,022.6 $ 181.3 $ 14.0 $855.3 1.6% ======== ======= ====== ====== === 1996: Property and liability insur- ance premiums earned......... $1,019.6 $ 201.1 $ 17.0 $835.5 2.0% ======== ======= ====== ====== === 1995: Property and liability insur- ance premiums earned......... $1,003.7 $ 206.3 $ 20.4 $817.8 2.5% ======== ======= ====== ====== ===
63 SCHEDULE V CITIZENS CORPORATION VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
DEDUCTIONS FROM ADDITIONS PREMIUM BALANCE AT CHARGED TO BALANCES TO BALANCE AT BEGINNING OF COSTS AND ALLOWANCE END OF PERIOD EXPENSES ACCOUNT PERIOD ------------ ---------- ----------- ---------- (IN MILLIONS) 1997: Allowance for doubtful ac- counts........................ $0.9 $1.2 $1.2 $0.9 ==== ==== ==== ==== 1996: Allowance for doubtful ac- counts........................ $0.8 $1.8 $1.7 $0.9 ==== ==== ==== ==== 1995: Allowance for doubtful ac- counts........................ $0.7 $1.9 $1.8 $0.8 ==== ==== ==== ====
64 SCHEDULE VI CITIZENS CORPORATION SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
DISCOUNT, IF ANY, DEFERRED DEDUCTED POLICY RESERVE FOR FROM NET NET ACQUISITION LOSSES AND PREVIOUS UNEARNED PREMIUMS INVESTMENT AFFILIATION WITH REGISTRANT EXPENSES LAE(2) COLUMN(1) PREMIUMS EARNED INCOME - --------------------------- ----------- ----------- --------- -------- -------- ---------- (IN MILLIONS) 1997 Citizens Insurance Group.................. $54.8 $1,206.1 $ -- $378.5 $855.3 $101.8 ===== ======== ===== ====== ====== ====== 1996 Citizens Insurance Group.................. $54.3 $1,238.5 $ -- $362.3 $835.5 $ 88.9 ===== ======== ===== ====== ====== ====== 1995 Citizens Insurance Group.................. $52.2 $1,291.6 $ -- $351.4 $817.8 $ 77.7 ===== ======== ===== ====== ====== ======
AMORTIZATION LOSSES AND LAE OF DEFERRED ----------------- POLICY PAID NET CURRENT PRIOR ACQUISITION LOSSES PREMIUMS YEAR YEAR.... EXPENSES AND LAE WRITTEN -------- -------- ------------ ------- -------- 1997 Citizens Insurance Group...... $ 708.2 $ (69.5) $164.9 $663.3 $863.7 ======== ======== ====== ====== ====== 1996 Citizens Insurance Group...... $ 662.8 $ (58.4) $164.1 $605.0 838.2 ======== ======== ====== ====== ====== 1995 Citizens Insurance Group...... $ 625.3 $ (47.0) $159.6 $545.5 $833.7 ======== ======== ====== ====== ======
- -------- (1) The Company does not employ any discounting techniques. (2) Reserves for losses and LAE are shown gross of $458.6 million, $466.4 million and $518.9 million of reinsurance recoverable on unpaid losses in 1997, 1996 and 1995, respectively. Unearned premiums are shown gross of prepaid premiums of $70.4 million, $62.8 million and $54.5 million in 1997, 1996 and 1995, respectively. 65 EX-10.4 2 CONSOLIDATED INCOME TAX AGREEMENT DATED 12/31/1997 EXHIBIT 10.4 CITIZENS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME TAX AGREEMENT This agreement is entered into effective for the tax year ending December 31, 1997 between Allmerica Financial Corporation (the "Parent"), Allmerica, Inc., Allmerica Funding Corp., First Allmerica Financial Life Insurance Company, Allmerica Services Corporation, Logan Wells Water Company, Inc., SMA Financial Corp., Allmerica Property & Casualty Companies, Inc., Sterling Risk Management Services, Inc., Allmerica Trust Company, N.A., Somerset Square, Inc., Allmerica Financial Life Insurance and Annuity Company, Allmerica Institutional Services, Inc., Allmerica Investments, Inc., Allmerica Asset Management, Inc., Allmerica Financial Services Insurance Agency, Inc., Linder Skokie Real Estate Corporation, Allmerica Investment Management Company, Inc., Allmerica Benefits, Inc., APC Funding Corp., The Hanover Insurance Company, Allmerica Financial Insurance Brokers, Inc., Citizens Insurance Company of Illinois, Allmerica Financial Benefit Insurance Company, Allmerica Plus Insurance Agency, Inc., The Hanover American Insurance Company, Hanover Texas Insurance Management Company, Inc., Hanover Lloyd's Insurance Company, Citizens Corporation, Massachusetts Bay Insurance Company, Allmerica Financial Alliance Insurance Company, AMGRO, Inc., Citizens Insurance Company of Ohio, Citizens Insurance Company of America, Citizens Insurance Company of Midwest, Lloyds Credit Corporation and Citizens Management Inc. WHEREAS, as of the date of this agreement, the parties hereto are members of an affiliated group ("Affiliated Group") as defined in Section 1504(a) of the Internal Revenue Code, and WHEREAS, such Affiliated Group is required to file consolidated federal income tax returns, and WHEREAS, it is the intent and desire of the parties hereto that a method be established for allocating the consolidated tax liability for the Affiliated Group among its members, for reimbursing the Parent for payment of such liability, and for compensating any party for use of its losses or credits. NOW, THEREFORE, in consideration of the mutual covenants herein contained the parties agree as follows: (1) A U.S. consolidated income tax return shall be filed by the Parent for each taxable period in respect of which the Affiliated Group is required or permitted to file a consolidated tax return. (2) (a) The consolidated tax liability shall be allocated among the members of the Affiliated Group in the ratio that each member's regular separate return tax liability for the year bears to the sum of the regular separate return tax liabilities of all the members. (b) For each taxable period, each member of the Affiliated Group shall compute its separate tax liability in a manner consistent with the provisions of Regulation Section 1.1552-1(a)(2)(ii). (c) If, in any consolidated return year, there is an excess of consolidated tentative minimum tax over consolidated regular tax liability, each member whose separate return tentative minimum tax exceeds its separate return regular tax shall pay the share of such consolidated excess that its separate return excess of tentative minimum tax over regular tax bears to the total of such excesses of all the members which have such excesses. (3) For each tax year during which a Subsidiary is included in a consolidated federal income tax return with the Parent, the Subsidiary will pay to the Parent an amount equal to the federal income tax at the current year's statutory rate applied to the Subsidiary's separate taxable income, adjusted for all tax credits. Such tax shall be determined without regard to separate company limitations. If the amount of the consolidated tax is greater than the sum of the individual Subsidiary's tax amounts, the difference will be allocated to the Parent. 68 Any tax losses or credits utilized by the profit member(s) of the Affiliated Group shall be reimbursed to a loss member(s) of the Affiliated Group when such loss member(s) on a separate return basis could use the loss or credits incurred in a prior year. (4) If for any taxable period whereby a profit member of the Affiliated Group becomes a loss member in the subsequent tax period, and that loss cannot be absorbed in the current tax period, and which could on a separate return basis have been carried back to offset taxable income in a prior year, then those loss members which received a benefit pursuant to paragraph (3) from that profit member shall refund to that member the applicable portion of the tax payment. (5) Payment of the consolidated tax liability for the taxable period shall include the payment of estimated tax installments due for each taxable period, and each subsidiary shall pay to the Parent its share of each payment within a reasonable time of receiving notice of such payment from the Parent or, to the extent required by Regulatory authorities, within 30 days after filing the consolidated tax return. Any overpayment of estimated tax should be refunded to the Subsidiary within a reasonable time following the filing of the consolidated return. All settlements shall be made in cash or securities eligible as investments pursuant to the insurance code of the Subsidiary's state of domicile. (6) If the consolidated tax liability is adjusted for any taxable period whether by means of an amended return, claim for refund or after a tax audit by the Internal Revenue Service, the liability of each member shall be recomputed to give effect to such adjustments. In the case of a refund the Parent shall make payment to each member for its share of the refund plus interest, determined in the same manner as above, within a reasonable period after the refund is received by the Parent or, to the extent required by Regulatory authorities, within 30 days after receipt of the refund. In the case of an increase in tax liability, each member shall pay to the Parent its allocable share of such increased tax liability plus interest. It is agreed that the Parent is hereby authorized in its sole discretion to make final settlement of any proposed underpayment or overpayment of tax with representatives of the United States Government on the basis that the Parent deems most beneficial to the Affiliated Group. (7) Nothing in this agreement shall authorize any practice by the Parent or by any Subsidiary which is in conflict with regulations promulgated by the Internal Revenue Service; further, nothing in this agreement shall affect any elections which have been made under those regulations, or which might be made in the future. (8) It is agreed that if any Subsidiary should for any reason cease to be included as a member of the Affiliated Group, final settlement of accounts between that Subsidiary and the Affiliated Group shall be made according to this agreement within a reasonable time following the filing of the consolidated return for the last year the Subsidiary was a member of the Affiliated Group except for adjustments pursuant to paragraph (6) above. Except as may be required by law, to the extent there is any loss or credit attributable to such Subsidiary which is unutilized by such Subsidiary, such Subsidiary hereby waives any right to be compensated for such unused loss or credit to the extent such loss or credit remains after such Subsidiary has left the Affiliated Group. To the extent such Subsidiary generates any loss or credit after leaving the Affiliated Group, which loss or credit can be carried back and utilized by the Affiliated Group, such Subsidiary hereby waives any right to be compensated for such loss or credit. (9) The parties hereto specifically recognize that from time to time other companies may become members of the Parent Affiliated Group and hereby agree that such new members must become parties to this agreement. Such new members should execute the master copy of this agreement (or a counterpart thereto, which shall be deemed to be the original agreement) and it will not be necessary for all the other members to sign the agreement, but it will be effective as if the old members had signed the agreement. (10) The Parent shall be liable for, and indemnify and hold each member harmless (subject to set off for any unpaid amounts due Parent from such member, net of any unpaid amounts Parent owes such member, under this agreement) against, any and all federal income tax for periods in which it is included in the consolidated federal income tax return with Parent, including any amounts for which such members may be held severally liable under Section 1.150 2-6 of the Treasury Regulations. 69 (11) Miscellaneous ------------- (a) Injunctions. The parties acknowledge that irreparable damage would ----------- occur in the event that any of the provisions of this agreement were not performed in accordance with its specific terms or were otherwise breached. The parties hereto shall be entitled to an injunction or injunctions to prevent breaches of the provisions of this agreement and to enforce specifically the terms and provisions hereof in any court having jurisdiction, such remedy being in addition to any other remedy to which they may be entitled at law or equity. (b) Assignment. Except by operation of law or in connection with the sale ---------- of all or substantially all the assets of a party hereto, this agreement shall not be assignable, in whole or in part, directly or indirectly, by any party hereto without the written consent of the other parties; and any attempt to assign any rights or obligations arising under this agreement without such consent shall be void; provided, however, that the provisions of this agreement -------- ------- shall be binding upon, inure to the benefit of and be enforceable by the parties hereto and their respective successors and permitted assigns, but no assignment shall relieve any party's obligations hereunder without the written consent of the other parties. (c) Further Assurances. Subject to the provisions hereof, the parties ------------------ hereto shall make, execute, acknowledge and deliver such other instruments and documents, and take all such other actions, as may be reasonably required in order to effectuate the purposes of this agreement and to consummate the transactions contemplated hereby. Subject to the provisions hereof, each of the parties shall, in connection with entering into this agreement, performing its obligations hereunder and taking any and all actions relating hereto, comply with all applicable laws, regulations, order and decrees obtain all required consents and approvals and make all required filings with any governmental agency, other regulatory or administrative agency, commission or similar authority and promptly provide the other parties with all such information as they may reasonably request in order to be able to comply with the provisions of this paragraph. (d) Parties in Interest. Except as herein otherwise specifically provided, ------------------- nothing in this agreement expressed or implied is intended to confer any right or benefit upon any person, firm or corporation other than the parties and their respective successors and permitted assigns. (e) Waivers, Etc. No failure or delay on the part of the parties in ------------ exercising any power or right hereunder shall operate as a waiver hereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. No modification or waiver of any provision of this agreement nor consent to any departure by the parties therefrom shall in any event be effective unless the same shall be in writing, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. (f) Set off. All payments to be made by any party under this agreement ------- shall, except to the extent otherwise specifically provided herein, be made without set off, counterclaim or withholding, all of which are expressly waived. (g) Change of Law. Any alteration, modification, addition, deletion, or ------------- other change in the consolidated income tax return provisions of the Code or the Treasury Regulations shall automatically be applicable to this agreement. If, due to any change in applicable law or regulations interpretation hereof by any court of law or other governing body having jurisdiction subsequent to the date of this agreement, performance of any provision of this agreement or any transaction contemplated thereby shall become impracticable or impossible, the parties hereto shall use their best efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such provision. 70 (h) Prior Tax-Sharing Agreements: Amendment of this Agreement. This --------------------------------------------------------- Agreement constitutes the entire agreement between the parties and shall supersede any other tax-sharing or tax-allocation agreement or arrangement (whether written or oral) in effect between the parties hereto prior to the effective date hereof with respect to the matters expressly dealt with herein, but shall not affect the currently outstanding intercompany accounts, if any, in respect of taxes between the members. This agreement may not be altered, changed, modified, or terminated orally; any modifications or revision of this agreement shall be accomplished only through a writing clearly denominated as an amendment to this agreement signed by the parties hereto. (I) Confidentiality. Subject to any contrary requirement of law or --------------- regulations and the right of each party to enforce its rights hereunder in any legal action, each party agrees that it shall keep strictly confidential, and shall cause its employees and agents to keep strictly confidential any information which it or any of its agents or employees may acquire pursuant to, or in the course of performing its obligations under, any provision of this agreement; provided, however, that such obligation to maintain confidentiality -------- ------- shall not apply to information which (1) at the time of disclosure was in the public domain not as a result of acts by the receiving party or (2) was in the possession of the receiving party at the time of disclosure. (j) Headings. Descriptive headings are for convenience only and shall not -------- control or affect the meaning or construction of any provision of this agreement. (k) Counterparts. For the convenience of the parties, any number of ------------ counterparts of this agreement may be executed by the parties hereto, and each such executed counterpart shall be, and shall be deemed to be, an original instrument. (l) Governing Law. This agreement shall be governed by and construed and ------------- enforced in accordance with the laws of the Commonwealth of Massachusetts applicable to contracts made and to be performed therein. (m) Records and Workpapers. Each party will retain all returns, schedules ---------------------- and workpapers, and all material records and other documents relating thereto, until (I) parent notifies such party that such returns and other documents may be destroyed after such returns and other documents are offered to Parent, and (ii) the expiration of the statute of limitations (including extensions) of the taxable years to which such returns and other documents relate or there has been a Final Determination of all tax for such years, and (iii) there has been a final settlement of all payments which may be required under this agreement for such years. IN WITNESS WHEREOF, the parties hereto have executed this Agreement effective for the tax year ending December 31, 1997 by their duly authorized officers this 28th day of February, 1998. 71 EX-10.22 3 INTERCOMPANY REINSURANCE AGREEMENT EXHIBIT 10.22 CITIZENS CORPORATION AND SUBSIDIARIES INTERCOMPANY REINSURANCE AGREEMENT (HEREINAFTER REFERRED TO AS THE "AGREEMENT") BETWEEN CITIZENS INSURANCE COMPANY OF AMERICA (HEREINAFTER REFERRED TO AS THE "REINSURER") AND CITIZENS INSURANCE COMPANY OF THE MIDWEST (HEREINAFTER REFERRED TO AS THE "REINSURED") ARTICLE I COMMENCEMENT AND CANCELLATION - ------------ --- ------------ This Agreement shall be effective at 12:01 a.m., standard time at the address of the Reinsured, on January 1, 1995, with respect to losses occurring on or after that date, and remain inforce for an indefinite period but may be terminated by either party by giving ninety (90) days written notice. Upon cancellation of this Agreement and unless otherwise mutually agreed, the liability of the Reinsurer with respect to policies in effect at the time and date of cancellation, shall continue until the expiration or cancellation or next anniversary date of each such policy of the Reinsured, whichever comes first. ARTICLE II BUSINESS COVERED - -------- ------- This Agreement applies to new and renewal insurance contracts (Covered Contracts) issued by the Reinsured, which are effective on and after the commencement date of this Agreement. ARTICLE III RETENTION AND LIMITS - -------------------- The Reinsured hereby obligates itself to cede to the Reinsurer and the Reinsurer obligates itself to accept cessions of reinsurance of 80% of the Reinsured's Net Retained Liability for Covered Contracts inforce at the effective date hereof or renewed on or after that date. The Reinsured shall retain net for its own account the remaining 20% of its Net Retained Liability. For the purposes of this Agreement, Net Retained Liability is defined as the insurance liabilities exceeding recoveries from any other reinsurance contract. ARTICLE IV LIABILITY OF THE REINSURER - -------------------------- The liability of the Reinsurer with respect to each session hereunder shall commence simultaneuosly with that of the Reinsured subject to the terms, conditions and limitations hereinafter set forth. 72 ARTICLE V LOSS AND LOSS ADJUSTMENT EXPENSE - -------------------------------- The Reinsured at its full, sole discretion shall adjust, settle or compromise all claims or losses. Any loss settlement made by the Reinsured, whether under the strict conditions of the policy or by way of compromise, shall be unconditionally binding upon the Reinsurer in proportion to its participation hereunder. The Reinsurer shall bear its proportionate share of all expenses incurred by the Reinsured in the investigation, adjustment, appraisal or defense of all claims under policies reinsured hereunder and shall receive its proportionate share of any recoveries of such expenses. If there are any recoveries, salvages or reimbursements subsequent to a loss settlement, and if the expenses incurred in obtaining salvage or other recoveries are less than the amount recovered, the amount recovered shall first be applied to the reimbursement of the expense of recovery, and the remaining expense shall be borne by the Reinsured and the Reinsurer in proportion to the liability of each party for the loss before such recovery has been obtained. All salvages, recoveries and payments recovered or received subsequent to a loss settlement under this Agreement shall be applied as if recovered and received prior to the said settlement; and all necessary adjustments shall be made by the parties hereto. ARTICLE VI OTHER EXPENSES - -------------- The Reinsurer shall bear its proportionate share of all acquisition, underwriting, investment and general expenses of the Reinsured. ARTICLE VII COMMISSIONS - ----------- The Reinsurer shall receive, from the Reinsured, its proportionate share of ceding commissions or contingent commissions from any other reinsurance contracts covering the insurance policies issued by the Reinsured. ARTICLE VIII ORIGINAL CONDITIONS - ------------------- All amounts ceded hereunder shall be subject to the same rates, clauses, conditions, waivers, and to the same modifications and alterations as the respective policies of the Reinsured. The Reinsurer shall be receive from the Reinsured its proportionate share of gross premiums less commission expense hereon received by the Reinsured, prior to disbursement of any dividends, but after deduction of premiums, if any, ceded by the Reinsured for any other reinsurance contract. ARTICLE IX INSOLVENCY - ---------- In the event of the insolvency of the Reinsured, this reinsurance shall be payable directly to the Reinsured, or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of the Reinsured without diminution because of the insolvency or because the liquidator, receiver, conservator or statutory successor has failed to pay all or a portion of any claim. However, as a condition precedent to any such payment the liquidator, receiver, conservator or statutory successor shall give written notice to the Reinsurer of the pendency of a claim against the Reinsured indicating the covered contract reinsured which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation of liquidation proceeding 73 or in the receivership, and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense that it may deem available to the Reinsured or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable subject to the approval of the court against the Reinsured as part of the expense of conservation or liquidation to the extent of a prorata share of the benefit which may accrue to the Reinsured solely as a result of the defense undertaken by the Reinsurer. ARTICLE X ARBITRATION - ----------- Any controversy of claim arising out of or relating to this Agreement, or breach thereof, shall be settled by arbitration in accordance with the Rules of the American Arbitration Association, and judgement upon the award may be entered in any court having jurisdiction thereof. ARTICLE XI TAXES - ----- The Reinsured shall be liable for all taxes on premium ceded to the Reinsurer under this agreement. If the Reinsurer is obligated to pay any taxes on such premium, the Reinsured shall reimburse the Reinsurer; however, the Reinsured shall not be required to pay taxes twice on the same premium. ARTICLE XII ERRORS AND OMISSIONS - -------------------- Any inadvertant error or omission shall not invalidate the liability of the Reinsurer, provided that the error or omission is rectified promptly upon discovery. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by the duly authorized officers. In Howell, Michigan, this 18th day of April, 1995 CITIZENS INSURANCE COMPANY OF AMERICA Name /s/ Joseph O. Marker Title Assistant Vice President In Indianapolis, Indiana this 20th day of April, 1995 CITIZENS INSURANCE COMPANY OF THE MIDWEST Name /s/ William Schramm Title Vice President 74 EX-10.23 4 CONSOLIDATED SERVICE AGREEMENT DATED 01/01/1998 EXHIBIT 10.23 CITIZENS CORPORATION AND SUBSIDIARIES CONSOLIDATED SERVICE AGREEMENT AGREEMENT effective January 1, 1998, between ALLMERICA FINANCIAL CORPORATION ("Parent") and AAM GROWTH & INCOME FUND L.L.C., AAM HIGH YIELD FUND, L.L.C., AAM EQUITY FUND, AFC CAPITAL TRUST I, ALLMERICA ASSET MANAGEMENT, INC., ALLMERICA BENEFITS, INC., ALLMERICA EQUITY INDEX POOL, ALLMERICA FINANCIAL ALLIANCE INSURANCE COMPANY, ALLMERICA FINANCIAL BENEFIT INSURANCE COMPANY, ALLMERICA FINANCIAL INSURANCE BROKERS, INC., ALLMERICA FINANCIAL LIFE INSURANCE AND ANNUITY COMPANY, ALLMERICA FINANCIAL SERVICES INSURANCE AGENCY, INC., ALLMERICA FUNDING CORP., ALLMERICA FUNDS, ALLMERICA, INC., ALLMERICA INSTITUTIONAL SERVICES, INC., ALLMERICA INVESTMENT MANAGEMENT COMPANY, INC., ALLMERICA INVESTMENTS, INC., ALLMERICA INVESTMENT TRUST, ALLMERICA PLUS INSURANCE AGENCY, INC., ALLMERICA PROPERTY & CASUALTY COMPANIES, INC., ALLMERICA SECURITIES TRUST, ALLMERICA SERVICES CORPORATION, ALLMERICA TRUST COMPANY, N.A., AMGRO, INC., APC FUNDING CORP., CITIZENS CORPORATION, CITIZENS INSURANCE COMPANY OF AMERICA, CITIZENS INSURANCE COMPANY OF ILLINOIS, CITIZENS INSURANCE COMPANY OF THE MIDWEST, CITIZENS INSURANCE COMPANY OF OHIO, CITIZENS MANAGEMENT INC., FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY, GREENDALE SPECIAL PLACEMENTS FUND, THE HANOVER AMERICAN INSURANCE COMPANY, THE HANOVER INSURANCE COMPANY, HANOVER TEXAS INSURANCE MANAGEMENT COMPANY, INC., HANOVER LLOYD'S INSURANCE COMPANY, LOGAN WELLS WATER COMPANY, INC., LLOYDS CREDIT CORP., MASSACHUSETTS BAY INSURANCE COMPANY, SMA FINANCIAL CORP., SOMERSET SQUARE, INC., STERLING RISK MANAGEMENT SERVICES, INC. The above listed companies known collectively as "Affiliated Group". WHEREAS, the Cost Distribution Policy adopted by the Affiliated Group on June 15, 1993 and amended as of October 21, 1997, for implementation in calendar year 1998 ("Policy"), and as supplemented by the Cost Distribution Policy Implementation Manual, as may be created or amended by Parent's management from time to time to conform to State or Federal law, regulation or requirement or for other sound reason "Implementation Manual") has been determined to be an appropriate method of achieving fair distribution of servicing costs between the Affiliated Group. NOW, THEREFORE, the Affiliated Group hereby agree as follows: 1. Each Company hereby agrees to provide any other Company in the Affiliated Group with such services as it may require for its operations. The Policy and Implementation Manual shall be the basis for allocating cost for various services between each Company. The Policy and Implementation Manual will become a part of this Agreement. 2. The servicing company agrees to provide each serviced company with a quarterly report covering the items of service performed on behalf of serviced company. 3. This Agreement may be canceled in whole upon 60 days written notice by any party delivered to the other members of the Affiliated Group, or in part by any party giving the other 60 days written notice that certain services will no longer be performed by the servicing company or will no longer be purchased by the serviced company. This Agreement will automatically be canceled with respect to a company that leaves the Affiliated Group. 4. The parties to the Agreement acknowledge that First Allmerica Financial Life Insurance Company ("FAFLIC") shall be the single employer within the Affiliated Group and that all employment costs shall be 75 paid by FAFLIC. Each member of the Affiliated Group shall then be charged by FAFLIC for services performed by employees of FAFLIC on behalf of such affiliate. Employees of FAFLIC shall not be directly compensated by an affiliate under this Agreement. 5. The parties hereto specifically recognize that from time to time other companies may become members of the Affiliated Group and hereby agree that such new members must become parties to this Agreement. Such new members should execute the master copy of this Agreement (or a counterpart thereto, which shall be deemed to be the original agreement) and it will not be necessary for all the other members to sign the agreement, but it will be effective as if the old members had signed the agreement. 6. For the convenience of the parties, any number of counterparts of this Agreement may be executed by the parties hereto, and each such executed counterpart shall be, and shall be deemed to be, an original instrument. 7. This Agreement supersedes all previous agreements or understandings of any nature whatsoever regarding the subject matter of this Agreement. 8. This Agreement shall be governed by and construed and enforced in accordance with the laws of the Commonwealth of Massachusetts. IN WITNESS WHEREOF, the parties hereto have executed this Agreement by their duly authorized officers as of the 1st day of January, 1998. ALLMERICA FINANCIAL CORPORATION By: /s/ Richard J. Baker ---------------------- Richard J. Baker Secretary AAM GROWTH & INCOME FUND L.L.C. By: Allmerica Asset Management, Investment Manager By: /s/ Henry L. Ferguson III ------------------------- Henry L. Ferguson III Clerk AAM HIGH YIELD FUND, L.L.C. By: First Allmerica Financial Life Insurance Company, Member By: Citizens Insurance Company of America, Member By: The Hanover Insurance Company, Member By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Assistant Secretary/Secretary/Clerk AAM EQUITY FUND By: Allmerica Asset Management, Inc., Trustee By: /s/ Henry L. Ferguson III -------------------------- Henry L. Ferguson III Clerk 76 AFC CAPITAL TRUST I By: /s/ John P. Kavanaugh ---------------------- John P. Kavanaugh Administrative Trustee ALLMERICA ASSET MANAGEMENT, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA BENEFITS, INC. By: /s/ Abigail M. Armstrong ------------------------ Abigail M. Armstrong Secretary ALLMERICA EQUITY INDEX POOL By: Allmerica Asset Management, Inc. Trustee By: /s/ Henry L. Ferguson III ------------------------- Henry L. Ferguson III Clerk ALLMERICA FINANCIAL ALLIANCE INSURANCE COMPANY By: /s/ William J. Cahill, Jr. -------------------------- William J. Cahill, Jr. Secretary ALLMERICA FINANCIAL BENEFIT INSURANCE COMPANY By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary ALLMERICA FINANCIAL INSURANCE BROKERS, INC. By: /s/ William J. Cahill, Jr. -------------------------- William J. Cahill, Jr. Clerk ALLMERICA FINANCIAL LIFE INSURANCE AND ANNUITY COMPANY By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary 77 ALLMERICA FINANCIAL SERVICES INSURANCE AGENCY, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA FUNDING CORP. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA FUNDS By: /s/ George M. Boyd ------------------ George M. Boyd Secretary ALLMERICA, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA INSTITUTIONAL SERVICES, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA INVESTMENT MANAGEMENT COMPANY, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA INVESTMENTS, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA INVESTMENT TRUST By: /s/ George M. Boyd ------------------- George M. Boyd Secretary 78 ALLMERICA PLUS INSURANCE AGENCY, INC. By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Clerk ALLMERICA PROPERTY & CASUALTY COMPANIES, INC. By: /s/ Richard J. Baker --------------------- Richard J. Baker Secretary ALLMERICA SECURITIES TRUST By: /s/ George M. Boyd ------------------- George M. Boyd Secretary ALLMERICA SERVICES CORPORATION By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk ALLMERICA TRUST COMPANY, N.A. By: /s/ Charles F. Cronin ---------------------- Charles F. Cronin Secretary AMGRO, INC. By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Clerk APC FUNDING CORP. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk CITIZENS CORPORATION By: /s/ Richard J. Baker --------------------- Richard J. Baker Secretary 79 CITIZENS INSURANCE COMPANY OF AMERICA By: /s/ Karen Livingston-Wilson ---------------------------- Karen E. Livingston-Wilson Secretary CITIZENS INSURANCE COMPANY OF ILLINOIS By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary CITIZENS INSURANCE COMPANY OF THE MIDWEST By: /s/ Karen E. Livingston-Wilson ------------------------------ Karen E. Livingston-Wilson Secretary CITIZENS INSURANCE COMPANY OF OHIO By: /s/ Karen E. Livingston-Wilson ------------------------------- Karen E. Livingston-Wilson Secretary CITIZENS MANAGEMENT INC. By: /s/ Karen E. Livingston-Wilson ------------------------------- Karen E. Livingston-Wilson Secretary FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary GREENDALE SPECIAL PLACEMENTS FUND By: Allmerica Asset Management, Inc., Trustee By: /s/ Henry L. Ferguson III -------------------------- Henry L. Ferguson III Clerk 80 THE HANOVER AMERICAN INSURANCE COMPANY By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary THE HANOVER INSURANCE COMPANY By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary HANOVER TEXAS INSURANCE MANAGEMENT COMPANY, INC. By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary HANOVER TEXAS INSURANCE MANAGEMENT COMPANY, INC. ATTORNEY-IN-FACT FOR HANOVER LLOYD'S INSURANCE COMPANY By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary LOGAN WELLS WATER COMPANY, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk LLOYDS CREDIT CORP. By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Clerk MASSACHUSETTS BAY INSURANCE COMPANY By: /s/ William J. Cahill, Jr. --------------------------- William J. Cahill, Jr. Secretary SMA FINANCIAL CORP. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary/Clerk 81 SOMERSET SQUARE, INC. By: /s/ Henry L. Ferguson III -------------------------- Henry L. Ferguson III Secretary/Clerk STERLING RISK MANAGEMENT SERVICES, INC. By: /s/ Abigail M. Armstrong ------------------------- Abigail M. Armstrong Secretary 82 Allmerica Financial Corporation ("Parent") AAM Growth & Income Fund L.L.C. AAM High Yield Fund, L.L.C. AAM Equity Fund AFC CAPITAL TRUST I Allmerica Asset Management, Inc. Allmerica Benefits, Inc. Allmerica Equity Index Pool Allmerica Financial Alliance Insurance Company Allmerica Financial Benefit Insurance Company Allmerica Financial Insurance Brokers, Inc. Allmerica Financial Life Insurance and Annuity Company Allmerica Financial Services Insurance Agency, Inc. Allmerica Funding Corp. Allmerica Funds Allmerica, Inc. Allmerica Institutional Services, Inc. Allmerica Investment Management Company, Inc. Allmerica Investments, Inc. Allmerica Investment Trust Allmerica Plus Insurance Agency, Inc. Allmerica Property & Casualty Companies, Inc. Allmerica Securities Trust Allmerica Services Corporation Allmerica Trust Company, N.A. AMGRO, Inc. APC Funding Corp. Citizens Corporation Citizens Insurance Company of America Citizens Insurance Company of Illinois Citizens Insurance Company of the Midwest Citizens Insurance Company of Ohio Citizens Management Inc. First Allmerica Financial Life Insurance Company Greendale Special Placements Fund The Hanover American Insurance Company The Hanover Insurance Company Hanover Texas Insurance Management Company, Inc. Hanover Lloyd's Insurance Company Logan Wells Water Company, Inc. Lloyds Credit Corp. Massachusetts Bay Insurance Company SMA Financial Corp. Somerset Square, Inc. Sterling Risk Management Services, Inc. 83 EX-11 5 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE EXHIBIT 11 CITIZENS CORPORATION AND SUBSIDIARIES STATEMENT RE COMPUTATION OF PER COMMON SHARE EARNINGS FOR THE PERIODS ENDED DECEMBER 31, 1997 AND 1996 (IN MILLIONS, EXCEPT PER SHARE DATA)
QUARTER ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, -------------- ------------- 1997 1996 1997 1996 ----- ----- ----- ----- Basic: Average shares outstanding...................................................... 35.3 35.3 35.3 35.3 ===== ===== ===== ===== Net income available to common shareholders..................................... $31.9 $22.4 $94.2 $84.1 ===== ===== ===== ===== Per share amount................................................................ $0.90 $0.63 $2.67 $2.37 Diluted: Average shares outstanding...................................................... 35.3 35.3 35.3 35.3 Net effect of dilutive stock options based on the treasury stock method using average market price.................................................... _ _ _ _ ----- ----- ----- ----- Totals...................................................................... 35.3 35.3 35.3 35.5 ===== ===== ===== ===== Net income available to common shareholders....................................... $31.9 $22.4 $94.2 $84.1 ===== ===== ===== ===== Per share amount.................................................................. $0.90 $0.63 $2.67 $2.37
84 EX-21 6 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 CITIZENS CORPORATION SUBSIDIARIES OF REGISTRANT Citizens Insurance Company of America (Michigan) Citizens Management Inc. (Michigan) Citizens Insurance Company of Ohio (Ohio) Citizens Insurance Company of the Midwest (Indiana) 85 EX-23 7 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CITIZENS CORPORATION CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-97066) of Citizens Corporation of our report dated February 3, 1998, which appears in this Annual Report on Form 10-K. /s/ PRICE WATERHOUSE LLP ------------------------------- Price Waterhouse LLP Boston, Massachusetts March 24, 1998 86 EX-24 8 POWER OF ATTORNEY EXHIBIT 24 CITIZENS CORPORATION POWER OF ATTORNEY We, the undersigned, hereby severally constitute and appoint John F. O'Brien, John F. Kelly, and Edward J. Parry III , and each of them singly, our true and lawful attorneys, with full power in each of them, sign for and in our names and in any and all capacities, Form 10-K of Citizens Corporation (the ''Company'') and any other filings made on behalf of said Company pursuant to the requirements of the Securities Exchange Act of 1934, and to file the same with all exhibits and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys and each of them, acting alone, full power and authority to do and perform each and every act and thing requisite or necessary to be done, hereby ratifying and confirming all that said attorneys or any of them may lawfully do or cause to be done by virtue hereof. Witness our hands and common seal on the date set forth below. Dated January 29, 1998 By: /s/ John F. O'Brien ---------------------------------- John F. O'Brien DIRECTOR, CHAIRMAN OF THE BOARD, CEO and President Dated January 29, 1998 /s/ Edward J. Parry, III ----------------------------------- EDWARD J. PARRY, III Vice President, Chief Financial Officer, TREASURER AND PRINCIPAL ACCOUNTING OFFICER Dated January 29, 1998 /s/ James A. Cotter, Jr. -------------------------------- JAMES A. COTTER, JR. Director Dated January 29, 1998 /s/ Neal J. Curtin ------------------------------ NEAL J. CURTIN Director Dated January 29, 1998 /s/ Donna Scott Laskey ------------------------------ DONNA SCOTT LASKEY Director Dated January 29, 1998 /s/ J. Barry May ----------------------------- J. BARRY MAY Vice President and Director Dated January 29, 1998 /s/ James R. McAuliffe ------------------------------ JAMES R. MCAULIFFE VICE PRESIDENT AND DIRECTOR Dated January 29, 1998 /s/ Eric A. Simonsen ------------------------------ ERIC A. SIMONSEN Vice President and Director 87 EX-27 9 FINANCIAL DATA SCHEDULE
7 1,000,000 12-MOS DEC-31-1997 DEC-31-1997 1522 1453 1522 183 0 0 1722 47 16 55 2605 1206 379 2 5 0 0 0 0 873 2605 855 102 29 7 639 151 84 119 25 94 0 0 0 94 2.67 2.67 1239 708 (70) 383 280 1206 (70)
EX-99.1 10 IMPORTANT FACTORS REGARDING STATEMENTS EXHIBIT 99.1 IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS The Company wishes to caution readers that the following important factors, among others, in some cases have affected the Company's results and in the future could cause actual results and needs of the Company to vary materially from forward-looking statements made from time to time by the Company on the basis of management's then-current expectations. The businesses in which the Company is engaged are in rapidly changing and competitive markets and involve a high degree of risk, and accuracy with respect to forward-looking projections is difficult. GEOGRAPHIC CONCENTRATION IN THE PROPERTY AND CASUALTY INSURANCE BUSINESS Substantially all of the Company's net premiums written and earnings are generated in Michigan. The revenues and profitability of the Company are therefore subject to prevailing economic, regulatory, demographic and other conditions, including adverse weather, in Michigan. CYCLICALITY IN THE PROPERTY AND CASUALTY INSURANCE INDUSTRY Historically, the property and casualty insurance industry has been highly cyclical. The property and casualty industry's profitability can be affected significantly by price competition, volatile and unpredictable developments such as extreme weather conditions and natural disasters, legal developments affecting insurer liability and the size of jury awards, fluctuations in interest rates and other factors that affect investment returns and other general economic conditions and trends that may affect the adequacy of reserves. Over the past several years, the property and casualty insurance industry as a whole has been in a soft market. Competition for premiums in the property and casualty insurance markets may continue to have an adverse impact on the Company's rates and profitability. CATASTROPHES AND SEVERE WEATHER LOSSES IN THE PROPERTY AND CASUALTY INSURANCE INDUSTRY Property and casualty insurers are subject to claims arising out of catastrophes, and other severe weather-related losses, which may have a significant impact on their results of operations and financial condition. The Company may experience catastrophes and other severe weather-related losses in the future which could have a material adverse impact on the Company. Catastrophes and severe weather-related losses can be caused by various events including hurricanes, earthquakes, tornadoes, wind, hail, fires, severe winter weather and explosions, and the frequency and severity of catastrophes are inherently unpredictable. The extent of losses from catastrophes and severe weather is a function of two factors: the total amount of insured exposure in the area affected by the event and the severity of the event. Although catastrophes and severe weather can cause losses in a variety of property and casualty lines, homeowners and commercial property insurance have in the past generated the vast majority of the Company's catastrophe-related claims. The Company purchases catastrophe reinsurance as protection against catastrophe losses. The Company believes, based upon its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, that the financial condition of its reinsurers is sound. However, there can be no assurance that reinsurance will be adequate to protect the Company against such losses or that such reinsurance will continue to be available to the Company in the future at commercially reasonable rates. UNCERTAINTY REGARDING ADEQUACY OF PROPERTY AND CASUALTY LOSS RESERVES The Company maintains reserves to cover its estimated ultimate liability for losses and loss adjustment expenses ("LAE") with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given time, of what the Company expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and judicial theories of liability, legislative activity and other factors. The inherent uncertainties of estimating reserves are greater for certain types of property and casualty insurance lines, particularly workers' compensation, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, and environmental liability, where the technological, judicial and political climates involving these types of claims are changing. The Company regularly reviews reserving techniques, reinsurance and overall reserve adequacy. Based upon (I) review of historical data, legislative enactments, judicial decisions, legal developments in imposition of damages, changes in political attitudes and trends in general economic conditions; (ii) review of per claim information; (iii) historical loss experience of the Company and the industry; and (iv) the relatively short-term nature of most of its property and casualty insurance policies, management believes that adequate provision has been made for reserves. However, establishment of appropriate reserves is an inherently uncertain process involving estimates of future losses and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. The Company's reserves are annually certified as required by insurance regulatory authorities. REGULATORY, SURPLUS, CAPITAL, RATING AGENCY AND RELATED MATTERS Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate to numerous aspects of an insurance company's business and financial condition, including limitations on the authorization of lines of business, underwriting limitations, the setting of premium rates, the establishment of standards of solvency, the licensing of insurers and agents, concentration of investments, levels of reserves, the payment of dividends, transactions with affiliates, changes of control and the approval of policy forms. Such regulation is concerned primarily with the protection of policyholders. State regulatory oversight and various proposals at the federal level (including the proposed adoption of a federal regulatory framework for insurance companies) may, in the future, adversely affect the Company's ability to sustain adequate returns in certain lines of business. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems. Further, the National Association of Insurance Commissioner ("NAIC") and state insurance regulators are reexamining existing laws and regulations, and, as a condition to accreditation, have required the adoption of certain model laws which specifically focus on insurance company investments, issues relating to the solvency of insurance companies, risk-based capital ("RBC") guidelines, interpretations of existing laws, the development of new laws, and the definition of extraordinary dividends. The capacity for an insurance company's growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by state insurance regulators, is considered important by state insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by the private rating agencies. 2 The NAIC has created a new system for assessing the adequacy of statutory capital for property and casualty insurers. The new system, known as risk-based capital, is in addition to the states' fixed dollar minimum capital and other requirements. The new system is based on risk-based formulas (separately defined for property and casualty insurers) that apply prescribed factors to the various risk elements in an insurer's business to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. In 1997, A.M. Best decided to no longer rate Citizens independently from its majority parent, The Hanover Insurance Company, but instead rated the two separate companies as a group. Consequently, Citizens was assigned Best's "A (Excellent)" rating. Management believes that its strong ratings are important factors in marketing the products of its insurance companies to its agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Insurance company ratings are assigned to an insurer based upon factors relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. Further downgrades may have a material adverse effect on the Company's business and prospects. STATE GUARANTY FUNDS, SHARED MARKETS MECHANISMS AND POOLING ARRANGEMENTS All fifty states of the United Sates have insurance guaranty fund laws requiring all property and casualty insurance companies doing business within the state to participate in guaranty associations, which are organized to pay contractual obligations under insurance policies issued by impaired or insolvent insurance companies. These associations levy assessments (up to prescribed limits) on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired or insolvent insurer is engaged. Mandatory assessments by state guaranty funds are used to cover losses to policyholders of insolvent or rehabilitated companies and can be partially recovered through a reduction in future premium taxes in many states. These assessments may increase in the future depending upon the rate of insolvencies of insurance companies. In addition, as a condition to the ability to conduct business in various states, the Company is required to participate in mandatory property and casualty shared market mechanisms or pooling arrangements, which provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage voluntarily provided by private insurers. The Company cannot predict whether its participation in these shared market mechanisms or pooling arrangements will provide underwriting profits or losses to the Company. COMPETITION The property and casualty insurance industry, in general, is highly competitive. Many of the Company's competitors are larger and have greater financial, technical, and operating resources than those of the Company. RETENTION OF KEY EXECUTIVES The future success of the Company will be affected by its continued ability to attract and retain qualified executives. The Company's success is dependent in large part on John F. O'Brien, the loss of whom could adversely affect the Company's business. The Company does not have an employment agreement with Mr. O'Brien. 3 IMPACT OF THE YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Based on a recent assessment, the Company determined that it will be required to modify or replace significant portions of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue can be resolved. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. The Company has initiated formal communications with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 Issue. The Company's total Year 2000 project cost and estimates to complete the project include the estimated costs and time associated with the impact of a third party's Year 2000 Issue, and are based on presently available information. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have material adverse effect on the Company. The Company does not believe that it has material exposure to contingencies related to the Year 2000 Issue for the products it has sold. Although the Company does not believe that there is a material contingency associated with the Year 2000 project, there can be no assurance that exposure for material contingencies will not arise. The Company will utilize both internal and external resources to reprogram, or replace, and test the software for Year 2000 modifications. The Company plans to complete the mission critical elements of the Year 2000 project by December 31, 1998. The cost of the Year 2000 project will be expensed as incurred over the next two years, and is being funded through a reallocation of resources from discretionary projects. Therefore, the Year 2000 project is not expected to result in significant incremental technology costs or to have material effect on the results of operations. The costs of the project and the date on which the Company plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. 4 -----END PRIVACY-ENHANCED MESSAGE-----