CIA - NYSE

Welcome to Citizen’s Inc. 2012 Second Quarter Conference Call. [Operator Instructions] I would like to now turn the call over to Ms. Osbourn. You may begin.

Thank you, Cara. Good morning. Welcome to our earnings conference call. I’m Kay Osbourn, Citizen’s Chief Financial Officer. Joining me on the call today are Rick Riley, our Vice Chairman and President; Geoff Kolander, our Executive Vice President, Corporate Secretary and General Counsel; Larry Carson, Financial Reporting and Tax; and Jonathan Pollio, Vice President and Chief Actuary. Before I turn the call over to Rick for our opening remarks. Let me get a few formalities out of the way. First, yesterday, we issued our earnings release and filed our second quarter 2012 10-Q. Both documents are available on our website at citizensinc.com. During today’s call, we will discuss the expected performance of Citizen’s, Inc. which will constitute forward-looking information within the meaning of the Private Securities Litigation Act. Actual results may differ materially from any forward-looking information provided in this call. Such information involves significant risks and uncertainties. A complete Safe Harbor disclaimer is included in the Citizens, Inc. Press Release, dated August 6, 2012, and is incorporated by reference into this call. We are not responsible for transcripts of this call made by third-parties. And finally, we do have a reconciliation of non-GAAP information, as required by Regulation G which has been provided with the release and is also available on our web site. Rick?

Thank you, Kay. Welcome everyone, and we thank you for the opportunity to provide you with this quarter’s update. The quarter for Citizens was rather unique quarter. We saw a coincidental convergence of a variety events, which Kay and I will attempt to cover as we work through the call here. The most important takeaway out of the quarter we think is the fact that we continue to see our underlying strength as a business and we continue to see growth in our operations, and we believe we have excellent opportunities for expansion. Our book value increased, and we have the financial strength to undertake acquisition transactions when we find appropriate ones to engage with. First, let me look with you at the insurance operations in the Life Insurance segment particularly, that accounted for about $30.6 million of the second quarter premiums, and that represented 93% of the overall growth in premium for -- as of the end of the 6 month period. We expect -- the international sales volumes are actually off a little bit comparatively between years, although we can point to our annual incentive [ph] award trip that we conducted during the month of April which will have impacted -- kept people out of the field during that particular quarter. And so we know that, that’s one of the influences, that it always -- it annually -- it does influence the quarter that it falls in each year when we have it, so that's the most significant thing we can point to for the deviation. We do anticipate that as we go through the year we’ll get back on track for a continuing, I guess, we're expecting, what we'll do through the rest of the year to be more standard and conventional with our yearly progress and yearly development. In the international business, we've been serving residents around the world for more than 36 years. Our policyholders remain focused on accumulation rather than face amount. We have a predominant presence in the Latin American market with an extension also over into the Pacific Rim. And we understand that these economies and these environments also affect what we do and how things manifest themselves in our results. We're not particularly aware of anything in the Latin American economies that are contributing adversely to anything that we’re doing, and that we continue to see good steady production coming out of that particular area. We also see steady production coming out of the Pacific Rim and continuing to grow and develop in that environment as well. You may recall that the Asian market has been shrinking over the last couple of years, but we’re seeing at least some improvement there during this particular calendar year. I guess probably the most significant, or one of the more significant observations, about the quarter was the -- and we've talked about it just about every quarter and that’s persistency, our persistency continues to remain exceptionally strong, so it's a part of those factors that affect what's happened in this quarter, because as those persistency assumptions are better than what's anticipated and expected or provisioned in the product we see an impact in what's going on in our results. Because we've designed and built product towards long-term returns and not short-term oriented aspects of the business, we're confident and expect that the long-term indicators and the long-term design of the product will make sure that we get our earnings back into a more positive vain, as we move into the future with the positive persistency that we’re seeing. The other dimension of our environment and one that kind of plays in a couple of different dynamics is the policy loan provision or policies. We do see utilization of that from quarter-to-quarter. I don't think that it’s anything abnormal or extraordinary, although it’s a continuing contributor to what we see as we go through each quarter. That provision provides that policyholders can pay their premiums if for some reason they have an interruption or a disruption in their ability to bring the dollars to the states and get us the dollars to pay the premium that the policy loan provision will be provided there as a bridging mechanism in their policies to help to facilitate the timing of those premiums coming in. As you probably are aware, those premiums are predominantly annual premiums and so we'll see the impact of those annual premium loans being made and then subsequently, we see a fairly consistent reduction in those or payoff of those loans as those premiums get collected over time. At the same time, while we see the loan balance increasing through this period or from period-to-period as some of those -- obviously some of those loans don't get repaid but and we have an increasing loan balance as a result. The interest earnings on those loan balances are generally in the 7% to 8% range and so they contribute very effectively to the overall investment income. So it kind of has a positive effect to both policyholders and shareholders as you look at how that particular provision works. We continue to see endowment products representing about 80% of our first year premium in the international market, both of our whole life and endowment products are priced for long-term returns as we mentioned earlier and therefore the short-term aspects of what we see are not particularly alarming at this point. In the U.S. domestic market, just as reminder, the bulk of the U.S. Life premiums come from renewals, out of books of business that we’ve been acquired over a period of approximately 20 years or so. But at the same time, we got sales development efforts taking place here in the U.S. and we're seeing in -- most of that taking place in Southern and Midwestern U.S. states for the most part, but we're seeing continuing growth year-over-year in that particular marketing division. Just from a comparative standpoint to the international market, they both are focused upon sales of accumulation-oriented products, although in the U.S. market we’ll see more whole life sales than we will endowment sales. It’s just not material enough or significant enough to offset the significant growth in endowments that we see that come out of the international, because it's so much more dominating relative to overall production. We do continue to focus our sales in both environments on selling and income that you can't outlive. That's really our predominant focus when we’re out selling product in either the international or the U.S. market. Kay, I'll let you add some color now relative to the financial numbers.

All right. We're experiencing and reporting a loss relative to the Life segment for the 3 months and the 6 months ended June 30. This is primarily driven by reserve increases. Premiums were up 5.5% and 5.8% for the 3 and 6 months in 2012, compared to 2011 due to renewal premium growth in this segment, which increased $1.9 million and $4.3 million over 2011 earned premium amounts for the same periods. We do have the accounting for long duration contracts results and actuarial assumptions related to mortality, interest lapses and expenses, which are established at the time of policy issuance and remain unchanged. Thus the differences in the actual experience is recorded in the current period, which is what we’re experiencing this quarter and this year. We’ve noted improved persistency, as Rick indicated earlier, as well as the lower interest rate that has continued, those are impacting our current results and also impacting the increase we’re seeing in the reserves. We also have the endowment products, as Rick indicated, which have been a primary seller for us, those also impact reserves by having an establishment of higher reserves compared to a whole life product that has a longer-term nature, as opposed to the endowment maturity basis. We have seen mortality and surrender trends that are within expected levels. The ordinary surrenders have remained at 0.05% for the past several years. And we’re also experiencing lower commissions relative to this segment just due by the driver of how premiums were coming; we’ve got more renewal premiums in the current quarter, compared to first year premiums which have a higher commission rate. So those were the key drivers of results in the Life segment, and I’ll turn it back it to Rick for an overview of the Home Service segment.

Well, just one -- before I jump to the Home Service -- one thought occurred to me as Kay was describing the commissions and the commission expense factor. One of the things of particular note is it as we were talking earlier about the policy loan provision. If those policy loans were being made out of restricted cash values that are limited for withdrawal purposes, then we actually don’t pay commissions on those premiums when those are paid through the premium loan provision. So that also contributes back towards some of that lower commission expense factor that she was describing and I thought that might be a point worth noting as we go. Let’s turn to the Home Service segment here and the fact that it contributed about $11 million in premium for the quarter, representing 7% of that overall growth that we see through the second quarter. We’ve had a very positive year-over-year comparison in the first half of the year because of the acquisition of an additional book of business that was acquired in the latter part of 2011, but not included in the 2012 first 6 months results, so you see a positive impact there as a result of those additional premiums coming from that acquired business. Again, it’s not overly significant or particularly significant to the whole, but it does have an impact on those numbers. The rate increases on the Fire business continue to provide positive impact on the P&C segment, again, that’s a small overall component of our overall consolidated results, but we are in the process of evaluating and making determination regarding appropriate 2013 rate increases, it may be necessary, so that’s under review at the present time. Of course, we’re also entering the hurricane season that is -- typically has an impact on our P&C business, but thus far this year, we’ve not seen or aware of anything that’s going to directly affect the operation of that Fire business for 2012. The continuing economic challenges that are pressing our nation as a whole continue to have an impact on our lower income clientele. We’ve seen increased surrenders during the second quarter, while surrenders are offset by reserve releases and the impact on the bottom-line and that segment is not particularly significant as a result of it, we do see the churning and the turnover of the business as a result of the challenging times that we’re facing. I just returned from visiting a couple of the districts out in the Home Service operations this past week and just wanted to pass on, I am encouraged by their optimism and expectations for what they will be doing in the balance of 2012. Kay, I let you now give a little more color to the financial details.

All right. The Home Service segment is really consistent overall relative to the results year-over-year. We did have an expectation of higher lapses in the second quarter which is a normal occurrence for us due to first quarter sales trends which tend to be higher, and then we have projected lapse rates which were higher in the second quarter. So that’s impacting results as well as the fact that we had increase in death claims; for the quarter we have 3.9 million in 2012 for the 3 months compared to 3 million in 2011, and 7.7 million in death claims for the 6 months of the current year compared to 7.3 million in 2011. And those are within expected levels, but those are really the 2 main drivers and then we will get into the investment discussion which is obviously key to all segments. So I’ll turn it back to Rick.

Our investment income continues to grow despite the low rate environment where that’s predominantly driven by the growth in the invested asset base that we have through the steady continuing growth of our overall book of business. Again, persistency contributes into that particular element. We continue to see yields decline again in the second quarter, we continue to seek bottom although the declines that we saw were less significant in this particular period than they have been in previous quarters. As the Fed and the Treasury continue to seek new record lows as far as the interest rate levels, we're continuing to work through that period and ride through that period with our portfolio, not really changing a lot of what we're doing, other than having to focus more probably on municipal type investments than we have in the U.S. government-sponsored enterprises, although we still continue to utilize both as we move forward in time. It's just that the yields in the U.S. government marketplace for the long-term commitments are just not as attractive and desirable as what we are able to do over in the municipal markets and that's why we focused more and actually done more purchasing in that particular market as we move forward, but we still do balance purchases in both areas, as we reinvest the calls and that type of activity. And relative to calls we've had a heavy call activity during the -- We had a lot in the first quarter and had again continuing call activity during the second quarter. We've seen it continue into the third into July, although we are not anticipating as much activity as we get on into August. We are expecting that to slow somewhat. The unrealized gains on a portfolio over the year have actually been very positive for us and continue to enhance our overall book value, increase that book value component as a result of the strength of that portfolio and the conservatism of the investment that we have in these government-oriented instruments that we are focused in utilizing. The investment activity continues to be essentially the same as it has been for the better part of the year. Again, we buy cushion U.S. government sponsored enterprise, Fannie Mae or Freddie debt. We will pick up longer-term items if we can get the yield in the secondary market where we need it. For the most part, if we’re making investments in a 15 to 20 year span of time, we’re getting 4.5% to 5.5% on those investments. On those that are in the shorter-term periods, it will range depending on how short you’re dealing with. If you’re dealing with less in a year, you'll be at -- I think the lowest that we’ve seen is 0.5% for 60 days to 90 days and then upwards of 75 --0.75% through 6 to 9 months and we get out beyond a year we’re usually at or above 1%, but we are expecting to continue to see activity in terms of calls and turning over the portfolio as we live through and work through the low interest rate environment that we’re experiencing. Our reinvestment spread has continued to compress, but again with less overall significance. We don’t expect that will change materially, it may actually be improved as we move forward unless rates continue to track down, which would be hard to imagine that they could go much lower than where we are and where we’ve been. We have found that utilization of some tax-free investments over in our non-life entities has proven to be an effective strategy for countering some of the yield compression and the only challenge we have there is we have limited capacity for those -- making those types of investments, but where we can do that and where we’ve been able to utilize that strategy we have done so as aggressively there as we can with tax-free munis. The interest rates continue to be concentrated in U.S. government, government sponsored entities and U.S. municipalities. We do not have much global or European exposure. If we have -- what little bit we have would be through equity mutual funds and those are very nominal limited exposure in that regard. As far as a longer-term view, it’s hard to envision anything but an upward trend as for our investment yields because we're as -- unless we’re going to start paying the government for making investments then I’m not sure how it’s going to change anything but upward as we move forward in time. So, we’re hopeful and expectant that we’ll see some improvement in the investment arena as we go forward, but that’s essentially the overview of what we've got in investment activity for this particular point. Kay, I’ll let you wrap up.

All right. I just want to highlight a few things that Rick really discussed, but give you some numbers. We did see some rating category changes where we have had a decline from our ‘AA’ rating category. At year-end we held 65.1% of the fixed maturity portfolio in the ‘AA’ category, where now we hold 51.1% and we’ve increased our ‘A’ rating and ‘BBB’ holdings relative to the investment categories that Rick mentioned previously. We’ve also seen investments in tax exempt state and local bonds in our non-life insurance company over the past several months and this has resulted in actually lowering our effective tax rate, as we can realize the full tax benefit on those investments. And as Rick indicated, the yields on the portfolios have continued to decline in the current low interest rate environment. We did experience approximately 220 million worth of calls on our fixed maturity portfolio in the 6 months ended June 30. So those monies as well as new premium money is being reinvested in the current market, thus compressing the yield that we’re seeing. And we do primarily invest in callable fixed maturity investments. A couple of other highlights I wanted to make relative to the financials is that we did see 56,219 of the warrants that were outstanding at June 30, were exercised in July. That represented 35% of the balance outstanding. We anticipate or it will be that the remainder of those warrants either will expire or be exercised in 2012. So those warrants will no longer be impacting the comparability of results and the fair market value accounting after this year We also do on an annual and quarterly basis and really ongoing a review of the portfolio relative to other than temporary impairments. We did not identify any other than temporary impairments in the 3 or 6 months ended 2012 or 2011, and our realized gains and losses were really insignificant in both periods presented. The balance sheet remains strong. We recorded an increase in book value of 2.9% driven by gains in the market value of securities held as available for sale, which were carried at fair value each reporting period. And there have been no significant changes in the RBC ratios of the life insurance companies that we reported for year-end. So I’ll turn it back to Rick for closing comments.

Again, we appreciate the opportunity to share the information on the quarter with you and look forward to addressing any questions you may have. We are optimistic again about what our future holds and the fact that we are a very healthy and strong business, it is a unique business, our insurance operations are our strength, particularly in the niche markets that we target, investment markets hopefully will improve as we go forward, but clearly, we’re dependent upon political, global, whether it would be European oriented or otherwise conditions around the world as well as our own U.S. economic conditions, as they improve will certainly have an impact in the investment marketplace as we move forward in time We continue to look forward to opportunities to grow the company and acquire additional business components that will contribute to our bottom-line and we stay poised and ready to do that with a capacity to actually do transactions when we see those that fit our particular scenario. Kay, at this point I believe we’re open and ready to take questions.

[Operator Instructions] And our first question comes from Ed Shields from Sandler O'Neill.

So, I’m going to start off with the investments. Kay, can you actually quantify how much call activity happened in the second quarter? I know you said $200 million for the first half, but just the second quarter, if you could?

Let’s see, Ed. I don’t know if I have got those numbers in front of me here.

Okay, I can back into it. Because I think I’ve got last quarter’s. Do you have the effective yield of the bonds that have been called in the first half of the year compared to what you’re reinvesting at new money rates? Can you compare that -- those 2 items?

You want to know effective yield on the bonds relative to new investment?

Right. That gives the investment spread compression there a little bit.

Yes, I think we’ll need to get into an analytical, Ed, to provide you the specifics on it because we didn’t bring anything of that in with us for this particular call.

All right, fair enough. The cash balance is pretty high at the end of the quarter on the balance sheet, roughly $70 million on the balance sheet there. Is that largely due to the call activity and reinvestment not [indiscernible]

It absolutely is. It's a timing -- it’s the timing and every time I get through the call, what happens to us is we get a fairly concentrated set of calls coming in different -- in any given month, because again, as you are aware, we have been churning through this now for a couple of years and so we’re seeing a fairly strong activity, but we’re not having any real trouble finding the opportunity to put it back out, it’s just a timing issue of when we do see those calls. So what you saw -- as of year-end for example, we had worked through a large -- end of 2011, we'd worked through a large number of calls last year and even timing in the last quarter and yet when we closed the year, we had our cash balances down as low as I think we'd closed any quarter at the end of the year. As we ended the first quarter and the second quarter this year, we ended up with timing of calls that put large cash balances on the reports for the quarters, but there it’s a see-saw kind of an effect, because it does come in and bulk up and then we work our way back through it over the coming days or weeks as we get the money back out working again, so it’s usually more of a just what time do the calls occur, if it's early in the month, we’ll get them eliminated. If it's coming towards the end of the month, then it’s probably more likely what you’re going to be seeing when you see the large cash balances as a result of that timing.

Kind of related with that, what’s your expectation for calls in the third quarter or the second half of the year? Is it going to be at the same level, or is it going to diminish?

Well, I've looked out ahead. July was heavy again, but I’ve looked out through August and we don’t expect much activity, I think there was a small mid-month call that we’re anticipating in the middle of August, but it did not take it on into September, so I can’t really speak to what it’s going to look like through the end of September. But, as a point of color, September last year was where we took a good bit of the available funds that we had and went into bond mutual funds, which has proven to be a very stable and even a positive impact on us on our overall value to the portfolio, but also on the yield, because we’ve gotten good strong consistent yields out of those particular investments. So given the timing of a lot of those September investments that we made, my expectation would be that we should see low calls, but again, as we’re picking up secondary pieces through the year, we may well have some September call activity that I’m not particularly cognizant of as we’re talking today.

Okay. Fair enough. Let’s put on our thinking caps and think if we remain in a kind of a flat yield environment right now like the 1.4%, 1.5% on the 10-year treasury for let’s say 2 to 3 years, kind of a 2-part question, how will that affect your sales product whether you make product design changes in say, commission rates, crediting rates or try to pivot the sales force to sell different products, rather than the endowment product and/or the impact on your investment portfolio [indiscernible]. Any thoughts there?

Absolutely. No, we actually have an expectation to do some deeper dives into product designs, product planning for future sales as a result of the potential that we may see on even more extended lower rate environment. We want to be certain that what we have in play is not going to be problematic to us in any way. We’re encouraged by what we’ve seen, and just a cursory review initially of what we understand, particularly, in this particular quarter which had some unusual events, we’re hopeful that and expectant that what we have seen is, the profitability of the products is not really a major issue, but we are not going to just assume, we are going to do some deeper digging and make sure that we -- and testing of those existing products. And if we find that it’s necessary to make adjustments and take some additional steps in terms of pricing to mitigate an extended long term/short-term -- or an extended short term, low rate environment that we need to take steps to improve that profitability. Certainly, we will be taking the steps that need to be done down that line. We’re, at this point, like I said, based upon the cursory reviews we're comfortable with what we’re seeing and what we’re experiencing is really more of an aberration and a combination of events occurring all at once kind of quarter impact. Again, there’re interesting dynamics that are in play and we just want to be certain that what we’re seeing and what we’re experiencing are not indicative of some kind of a trend or even a problem in terms of pricing, but we don’t believe there is at this point.

All right. Kind of the ubiquitous, what are you seeing in the M&A environment?

We've actually got 2 or 3 things that we know are there and available. We've got an NDA out on one situation. It’s a little premature to tell whether or not it’s something that we’ll engage and do, but certainly, the book of business and the environment, the nature of the entity is compatible with our operation and one that we believe would be complementary, whether or not we can advance that initiative is yet to be seen, but we certainly are in the middle of at least exploring that opportunity. Again, as we are -- at almost any time, we got something that we're looking at, but there's nothing to really talk about, certainly nothing publicly to announce relative to any immediate acquisition or transaction. But there are, like I say, at least 3 different scenarios that we're engaged in looking at and contemplating how we might [indiscernible] it's a two-way street, both that we’re contemplating as well as the other side of the equation is contemplating, whether they want engagement or pursue the activity further, so that's kind of where we are.

So, on a general sense, are you seeing more activity of books of business being chopped [ph] or is it about the same, consistent not really being impacted by the time?

Yes, it's been slow most of the year, but I would say we are seeing moderately enhanced activity, but it's not anything of any robust nature certainly.

Okay and one last one here and I'll let others ask questions. Any developments on the litigation front? It's been kind a quiet for while so I thought I’d ask the question.

I don’t think there’s anything particularly significant. I mean, we’ve updated the disclosure in the publicly filed documents relative to the Road Home Litigation, which is probably the most significant remaining thing that's out there, but even then it's not particularly significant, because it’s not major at this point, and we don't anticipate frankly that, that’s going to rise to any level of huge significance to us. So, we do have some exposure there, we have a number of identified individual policy records that are under the radar there as far as that particular litigation is concerned, but again, when we look at it in the nature of that particular fire company exposure, those are such small limited contract types that we don't expect that to grow into anything of any materiality so. And otherwise, on the other front, there’ve been really no other activity on any other litigation so.

[Operator Instructions] And there appear to be no further questions. Rick, the floor is yours.

Thank you very much. We appreciate again the opportunity to share the quarter results with you and look forward to meeting again or sharing again in November when we get those third quarter results put together. Thank you and good day.