CITIZENS, INC. - Annual Report: 2007 (Form 10-K)

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control involving us, including through transactions, and in particular unsolicited transactions, that some or most of our stockholders might consider to be desirable and in which our stockholders may receive a premium.

We have never paid any cash dividends on our class A common stock and do not anticipate doing so in the foreseeable future.

We have never paid cash dividends on our class A common stock, as it is our policy to retain earnings for use in the operation and expansion of our business.

There are a substantial number of shares of our class A common stock eligible for future sale in the public market. The sale of a large number of these shares could cause the market price of our class A common stock to fall.

There were 43,070,092 shares of our class A common stock outstanding as of December 31, 2007. Members of our management and other affiliates owned approximately 5,800,000 shares of our class A common stock as of this date, representing approximately 13.5% of our outstanding class A common stock. These shares have been registered for public resale and may be sold freely.

In addition, a total of 3,347,039 shares of our class A common stock are issuable upon the conversion of our series A-1 and series A-2 preferred stock and the exercise of warrants granted in connection therewith. We have a registration statement currently in effect that allows the public resale of all such shares of class A common stock.

If our preferred and common stockholders sell a large number of shares of our class A common stock, the market price of shares of our class A common stock could decline significantly. Moreover, the perception in the public market that our stockholders might sell shares of our class A common stock could depress the market price of our class A common stock.

Holders of our series A preferred stock may obtain the right to require us to redeem their series A preferred stock and we will be required to redeem any shares of series A preferred stock that remain outstanding on July 12, 2009.

We will be required to redeem any shares of our series A preferred stock that remain outstanding on July 12, 2009 at the original investment price, plus all accrued but unpaid dividends.

We can elect to pay the redemption price in shares of our class A common stock if:

	•		the average closing price of the stock is in excess of $3.50 per share for a period of ten consecutive trading days prior to (but not including) the date that is three trading days prior to the date of redemption;
	•		the stock is listed on NYSE or other eligible market; and
	•		the stock to be issued is registered under a registration statement effective with the SEC.

We intend to pay the redemption price of our series A preferred stock in shares of our class A common stock to the extent the conditions described above are satisfied and we are permitted to do so. The number of shares of our class A common stock that we issue to redeem these shares of series A preferred stock could have a dilutive effect on the book value of the shares of class A common stock held by existing holders. However, provisions of our series A preferred stock could require us to pay part or all of the redemption price in cash, rather than in shares of our class A common stock, under certain circumstances, including failure to meet the conditions described above.

The provisions of our series A preferred stock require that if (i) the closing price of our class A common stock for any 42 trading days, including a period not less than five consecutive trading days, is less than $4.80, or (ii) we issue class A common stock or common stock equivalents for less than $6.11 per share, then the holders of our series A preferred stock may require us to redeem their shares of series A preferred stock at a price equal to the amount of the original holder’s original investment, plus all accrued but unpaid

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

dividends thereon to the date of payment. If we are required, or elect, to redeem shares of our series A preferred stock for cash, we may have to curtail our growth and acquisition plans.

Provisions applicable to our series A preferred stock may make it more difficult or prevent us from raising funds or taking certain other actions.

Provisions applicable to the outstanding shares of our series A preferred stock trigger rights of first refusal or payment provisions and require us to obtain the approval of the holders of such shares to (i) incur debt or allow liens on our property, other than certain permitted debt and liens, (ii) amend our articles of incorporation so as to affect adversely any rights of the preferred shareholders, (iii) authorize or create a new class of stock that will be senior or equal to our series A preferred stock in terms of dividends, redemption or distribution of assets or (iv) take other specified actions. These provisions may make it more difficult for us to take certain corporate actions and could delay, deter or prevent future financings.

In all other offerings of our shares of class A common stock, such as a private placement of shares, unless certain limited exceptions apply, the holders of our series A preferred stock will generally be entitled to purchase up to 50% of the number of shares of our class A common stock offered by us. These preemptive rights could delay, deter or prevent future equity financings.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

We own our principal office in Austin, Texas, consisting of an 80,000 square foot office building and approximately one acre of land nearby that house storage facilities. Approximately 50,000 square feet is occupied or reserved for our operations. We also own a training facility at Lake Buchanan, Texas. In addition, we own other properties in Texas and Louisiana that are incidental to our operations.

Item 3. Legal Proceedings

We are a defendant in a lawsuit originally filed on August 6, 1999 in the Texas District Court, Austin, Texas, now styled Citizens Insurance Company of America, Citizens, Inc., Harold E. Riley and Mark A. Oliver, Petitioners v. Fernando Hakim Daccach, Respondent, in which a class was originally certified by the trial court and affirmed by the Court of Appeals for the Third District of Texas. We appealed the grant of class status to the Texas Supreme Court which, on March 2, 2007, reversed the Court of Appeal’s affirmation of the trial court’s class certification order, decertified the class and remanded the case to the trial court for further proceedings consistent with the Texas Supreme Court’s opinion. As a result, no class action is presently certified, and plaintiffs’ counsel is seeking to recertify the class. In order to recertify the class, the lead plaintiff must establish that he is qualified to represent the purported class and that the res judicata effect of a class action will not have a deleterious effect on the putative class members. The underlying lawsuit alleges that certain life insurance policies that we made available to non-U.S. residents, when combined with a policy feature that allowed certain cash benefits to be assigned to two non-U.S. trusts for the purpose of accumulating ownership of our class A common stock, along with allowing the policyholders to make additional contributions to the trusts, were actually offers and sales of securities that occurred in Texas by unregistered dealers in violation of the Texas securities laws. The remedy sought was rescission and return of the insurance premium payments. We believe the lawsuit is without merit and intend to continue a vigorous defense in any remaining proceedings, including any class recertification. If the class is recertified, we could be exposed to costly and time consuming litigation, and an adverse judgment could have a material adverse effect on our results of operations and financial condition. The case is now back before the District judge for her performance of an analysis of the evidence presented to see if it warrants recertification of a class.

Our wholly-owned Louisiana property insurer, SPFIC, has been named as a defendant in a lawsuit filed in the United States District Court, Eastern District of Louisiana, in which plaintiff originally asserted allegations on behalf of a purported class. All class allegations were subsequently dismissed. The suit was

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

filed on August 28, 2006, and was initially styled Connie Abadie, et al v. Aegis Security Insurance Co., et al., or Connie Abadie. Most of the property and casualty insurers in Louisiana were also named in this lawsuit. The suit sought payments for claims denied by SPFIC and other declaratory relief related to Hurricane Katrina. It was unclear from the petition how many plaintiffs were insureds of SPFIC. In order to expedite the handling of all the litigation related to Hurricane Katrina, the court consolidated Connie Abadie into an action styled In Re: Katrina Canal Breaches Consolidated Litigation, or the Katrina Consolidated Litigation. On March 15, 2007, a Master Class Action Insurance Complaint was filed in the Katrina Consolidated Litigation. On March 27, 2007, the Katrina Consolidated Litigation was administratively closed by the court and superseded by the Master Class Action Insurance Complaint. Presently, the Master Class Action Insurance Complaint is stayed by order of the court.

One of the defenses that certain defendants in the Master Class Action Insurance Complaint have asserted is that their insurance policies excluded claims for flood damage, even though the floods resulting from Hurricane Katrina may have been caused by negligence. On August 2, 2007, the U.S. Court of Appeals for the Fifth Circuit ruled in the Master Class Action Insurance Complaint that the flood exclusion language in certain property insurance policies was effective to preclude claims for flood damage by policyholders whose policies include such an exclusion. Although SPFIC was not a party to that lawsuit, its policies do exclude flood damage claims. On September 30, 2007, the judge presiding over the Master Class Action Insurance Complaint issued a ruling holding that specific named peril policies that do not list flooding as one of the named perils do not provide coverage for flooding. SPFIC’s policies are named peril policies that do not list flooding as one of the named perils. SPFIC intends to continue to vigorously defend any claims resulting from flood damage on the grounds, among others, that its policies do not cover such damage. The deadline for filing claims against insurers arising out of property damage from Hurricane Katrina was August 29, 2007.

SPFIC is also a defendant in a suit styled The State of Louisiana v. AAA Insurance, or Road Home Litigation, which was filed in the Civil District Court for the Parish of Orleans on August 23, 2007 by the state of Louisiana as subrogee/assignee of the insureds of more than 200 different insurance companies. The suit was filed to recover money that the state of Louisiana paid to certain insureds under the Louisiana Road Home Program for damages resulting from Hurricanes Katrina and Rita. The suit was removed to the United States District Court for the Eastern District of Louisiana on September 11, 2007 and the removal was appealed by the Plaintiff. Responsive pleadings have not yet been filed on behalf of any of the defendant insurers in this case, nor has any discovery been conducted to date.

SPFIC was also named as a defendant in a lawsuit filed in the Civil District Court for the Parish of Orleans on behalf of Karen Cheneau in August 2006. The Cheneau suit stems from damages Ms. Cheneau sustained during Hurricane Katrina. In November 2007, plaintiff filed a Motion for Leave to File First Amended Petition to Assert Class Allegations Against SPFIC. The purported class consists of Louisiana citizens who purchased homeowner’s insurance coverage and/or contents insurance coverage from SPFIC, whose homes and/or property covered by said policies were damaged as a result of Hurricane Katrina and who timely submitted claims to SPFIC for their losses, and who either received no recovery or received less than the proper value of their valued policies as a result of their claims. SPFIC has responded to the Amended Petition by filing Exceptions of No Cause of Action, No Right of Action, Vagueness, Prescription and Failure to Meet Class Action Requirements.

The exceptions have not yet been set for hearing. SPFIC intends to vigorously defend this lawsuit. The Master Class Action Insurance Complaint, the Road Home Litigation and Cheneau are in the early stages of litigation, and no discovery has yet occurred. Therefore, it is not possible to evaluate how many claims in those cases relate to SPFIC, or the potential exposure to SPFIC. However, in the event of an adverse outcome, the potential exposure to SPFIC could be significant

On November 8, 2005, SPLIC was named as a defendant in a suit filed by Lilac Todd, who alleges that SPLIC failed to pay her claim for medical expenses arising out of the amputation of one of her limbs. On December 20, 2007, a Supplemental and Amended Petition for Damages was filed pursuant to which plaintiff has asserted class action allegations pursuant to La. C.C.P. art. 591. The purported class is defined as all Louisiana insureds of SPLIC, whose policies contained an incontestability provision identical or similar to Ms. Todd’s policy, and whose claims were denied within 10 years of the petition filing on the basis of

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

illnesses, injuries or diseases diagnosed or which occurred at any time preceding the incontestability. SPLIC has responded by filing Exceptions of Vagueness and of Improper Use of the Class Action Procedure, as well as an Answer to the Supplemental and Amended Petition for Damages. The Exceptions have not yet been set for hearing. The Lilac Todd matter is in the early stages of litigation relative to the class allegations and no discovery has yet occurred. Therefore, it is not possible to know how many claims in this case relate to SPLIC, or the potential exposure to SPLIC. SPLIC intends to aggressively defend this action. However, in the event of an adverse outcome, the potential exposure to SPLIC could be significant.

In addition to the legal proceedings described above, we may from time to time be subject to a variety of legal and regulatory actions relating to our future, current and past business operations, including, but not limited to:

	•		disputes over insurance coverage or claims adjudication;
	•		regulatory compliance with insurance and securities laws in the United States and in foreign countries;
	•		disputes with our marketing firms, consultants and employee agents over compensation and termination of contracts and related claims;
	•		disputes regarding our tax liabilities;
	•		disputes relative to reinsurance and coinsurance agreements; and
	•		disputes relating to businesses acquired and operated by us.

In the absence of countervailing considerations, we would expect to defend any such claims vigorously. However, in doing so, we could incur significant defense costs, including not only attorneys’ fees and other direct litigation costs, but also the expenditure of substantial amounts of management time that otherwise would be devoted to our business. If we suffer an adverse judgment as a result of any claim, it could have a material adverse effect on our business, results of operations and financial condition. We have not established any reserve account on our consolidated financial statements for the adverse financial impact of any of our litigation matters.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of our security holders during the fourth quarter of the fiscal year covered by this report.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

Our Class A common stock is traded on the New York Stock Exchange (NYSE) under the symbol CIA.
As of December 31, 2007, the approximate number of record owners of our Class A common stock was 71,000. Management estimates the number of beneficial owners to be approximately 125,000.

We have not paid cash dividends in any of the past five years and do not expect to pay such in the foreseeable future. For restrictions on our present and future ability to pay dividends, see Note 6 of the “Notes to Consolidated Financial Statements.”

We did not purchase any of our equity securities during any quarter in 2005, 2006 or 2007.

Securities Authorized for Issuance Under Equity Compensation Plans

We do not maintain any equity compensation plans or arrangements. Thus, we do not have any securities authorized for issuance under these types of plans, nor have we issued any options, warrants or similar instruments to purchase any of our equity securities, except for warrants issued in conjunction with the convertible preferred stock issued in 2005. (See Note 7 of the “Notes to Consolidated Financial Statements.”)

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Item 6. Selected Financial Data

The table below sets forth, in summary form, selected data of the Company. This data, which is not covered in the reports of our independent registered public accounting firms, should be read in conjunction with our consolidated financial statements and notes, which are included elsewhere herein. The net income per share amounts have been adjusted retroactively for all periods presented to reflect the 7% common stock dividends paid on December 31, 2005, 2004, and 2003.

		Years ended December 31,
		2007				2006				2005				2004				2003
		(In thousands, except per share data)
Total Revenues		$	173,794				158,059				142,113				99,859				92,060
Net Income			16,557				8,677				7,302				7,732				3,126
Basic and Diluted Earnings Per Class A Share			0.35				0.16				0.13				0.17				0.08
Total Assets at December 31			787,909				711,184				661,889				661,212				390,093
Long-term Debt			—				—				—				30,000				—
Total Liabilities			597,532				558,690				513,380				520,179				263,066
Total Stockholders’ Equity			176,157				139,611				136,963				135,131				127,027
Book Value Per Share			4.00				3.38				3.33				3.29				3.10

See Item 1 — Business (A) and (B), and Item 7 — Management’s Discussion and Analysis, for information that may affect the comparability of the financial data contained in the above table.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Overview

We conduct operations as an insurance holding company emphasizing ordinary life insurance products in niche markets where we believe we can achieve competitive advantages. Our core operations include issuing:

	•		U.S. Dollar-denominated ordinary whole life insurance policies predominantly to high net worth, high income foreign residents, located principally in Latin America and the Pacific Rim, through approximately 2,600 independent marketing consultants;
	•		ordinary whole life insurance policies to middle income households in the Midwest and the southern United States through approximately 600 independent marketing consultants; and
	•		final expense and limited liability property policies to middle to lower income households in Louisiana through approximately 300 employee agents in our home service distribution channel.

We operate through two segments as follows:

Life Insurance. For the past 30 years, CICA and its predecessors have participated in the foreign marketplace through the issuance of U.S. Dollar-denominated ordinary whole life insurance to foreign nationals. Traditionally, this market has focused on the top 3-5% of the population of a country in terms of income and net worth. In recent years, however, there has been a shift to encompass a broader spectrum of the population, as upper middle classes develop in Latin America and the Pacific Rim. We make our insurance products available using third-party marketing organizations and independent marketing consultants. The number of our producing independent consultants has expanded over the years in this segment to

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

approximately 2,600, and we presently receive applications from more than 35 countries outside of the U.S. Historically, the majority of our international business has come from Latin America. However, in 2004 the Pacific Rim began to represent a meaningful and growing source of new business, and in 2007 was one of the leading sources of new premium income.

In 2007, our Life Insurance segment generated revenue of $119.0 million, which accounted for 68.5% of our total revenue. For the year ended December 31, 2006, this segment produced revenue of $105.7 million or 66.9% of our total revenue, compared to 2005 when it produced approximately $90.6 million or 63.8% of total revenue. Our strategy in operating our Life Insurance segment is to increase new business written through our existing marketers as well as expand the number of countries from which we receive policy applications. The development of new markets in the Pacific Rim, particularly Taiwan, and the expansion of existing markets in Latin America were the primary contributors to the growth in this segment.

In 2008, CICA plans introduction of a new set of international products. The Company anticipates the new products will be very well accepted in the international market.

Through the domestic market of our Life Insurance segment, we provide ordinary whole life, credit life insurance, and final expense policies to middle income families or individuals in certain markets in the Midwest and southern U.S. The majority of our revenues in this regard are the result of acquisitions of domestic life insurance companies since 1987.

Citizens National Life Insurance Company (“CNLIC”), one of our subsidiaries that markets our domestic products, was previously for sale under a contract entered into in 2005. During 2007, the sales contract was terminated.

We also realize revenues from our investment portfolio. Life insurance companies earn profits on the investment float, which reflects the investment income earned on the premiums paid to the insurer between the time of receipt and the time benefits are paid out under policies. Changes in interest rates, changes in economic conditions and volatility in the capital markets can all impact the amount of earnings that we realize from our investment portfolio.

Home Service Insurance. Through a subsidiary, SPLIC, we provide final expense ordinary life insurance to middle to lower income individuals in Louisiana. Our policies in this segment are sold and serviced through the home service marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders.

During 2007, revenue from this segment was $52.9 million, which accounted for 30.4% of our total revenue. For the year ended December 31, 2006, revenue from this segment was $51.2 million or 32.4% of our total revenue compared to $49.7 million or 34.9% of our total revenue in 2005. Our business strategy in this segment is to continue to serve existing customers in Louisiana as well as expand the business through new marketing management that we put in place in early 2005.

In August and September 2005, Hurricanes Katrina and Rita struck the Louisiana coast, causing significant damage and disruption to the New Orleans area. Management estimates that one-third of SPLIC’s premium income was located in the affected area. SPLIC was not significantly impacted by death claims related to the storms (approximately $660,000); however, because of uncertainty regarding the collectibility of future premiums from the area, we wrote down approximately $2.3 million of cost of customer relationships acquired in the SPLIC acquisition during the third quarter of 2005 because of the decrease in collected premiums during the quarter. Ultimately, SPLIC closed the year with only a 4.5% decline in premium income compared to 2004. In 2006, premium income surpassed the 2005 level, reaching $38.0 million, and was $39.5 million in 2007.

SPLIC’s property insurance subsidiary, SPFIC, was negatively impacted by Hurricanes Katrina and Rita. Commencing in 2005 and through December 31, 2007, total incurred losses not covered by reinsurance amounted to $4.0 million, resulting in SPLIC infusing $4 million of additional capital into SPFIC. Legislative and judicial decrees had further extended the period for filing claims, for one year, beyond that provided for under the contracts. Due to this extended claims filing period, an incurred but not reported

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

claim and loss adjustment expense (LAE) liability of $500,000 was recorded at December 31, 2006 to cover any claims filed in 2007. When the extended deadline for filing of claims expired in the third quarter of 2007, SPFIC released approximately $425,000 of liabilities, which SPFIC determined were not payable under the contracts.

Marketplace Conditions and Trends

Described below are some of the significant recent events and trends affecting the life insurance industry and the possible effects they may have on our future operations.

	•		As an increasing percentage of the world population reaches retirement age, we believe we will benefit from increased demand for living products rather than death products, as aging baby boomers will require cash accumulation to provide expenses to meet their lifetime needs. Our ordinary life products are designed for our policyowners to accumulate cash values to provide for living expenses in a policy owner’s later years, while continuously providing a death benefit.
	•		We are exposed to a variety of risks, including the current market conditions as well as the credit crisis and corresponding potential changes in the fair value of our investments. In the normal course of business, we employ established policies and procedures to manage our exposure to fluctuations in the current market and changes in the fair value of our investments. We have not experienced any impairments in the value of our securities due to the current credit crisis in world financial markets. We have no subprime or collateralized debt investments.
	•		The volatility in the equity markets over the past few years has posed a number of problems for some companies in the life insurance industry. We historically have had minimal equity holdings, constituting less than 7% of total invested assets as of December 31, 2007 and less than 1% at December 31, 2006.
	•		Corporate bond defaults and credit downgrades, which have resulted in other-than-temporary impairments in the value of some securities, have had a material impact on life insurers in the past few years. We have not incurred significant losses from bond defaults for many years. The majority of our investment portfolio is held in debt instruments carrying the full faith and credit of the U.S. Government, or in U.S. Government-sponsored enterprises. Most of the municipal bonds we own are privately insured. We intend to manage our investment portfolio conservatively in the future in these type of debt instruments.
	•		Because of the trends described above coupled with increasing costs of regulatory compliance such as the Sarbanes-Oxley Act of 2002, we believe there is a trend towards consolidation of domestic life insurance companies. We believe this should be a benefit to our acquisition strategy because there should be more complementary acquisition candidates available for us to consider.
	•		Many of the events and trends affecting the life insurance industry have had an impact on the life reinsurance industry. These events led to a decline in the availability of reinsurance. While we currently cede a limited amount of our primary insurance business to reinsurers, we may find it difficult to obtain reinsurance in the future, forcing us to seek reinsurers who are more expensive to us. If we cannot obtain affordable reinsurance coverage, either our net exposures will increase or we would have to reduce our underwriting commitments.

Significant Transactions

In late 2007, the Company completed an $18.8 million registered direct offering of its Class A common stock, selling approximately 2.7 million shares at a price of $7.00 per share. The net proceeds of the offering were $17.1 million, after underwriter commissions and other offering related expenses. The anticipated use of proceeds from the offering is for general corporate purposes, which could include acquisitions of other insurance companies.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Consolidated Results of Operations

The following table sets forth our net income for the periods indicated:

Years ended		Net Income				Net Income per				Increase (decrease)
December 31,		(In thousands)				Class A Share				from Previous Year
2007		$	16,557			$	0.35				90.8	%
2006			8,677				0.16				18.8
2005			7,302				0.13				(5.6	)

As further discussed below, increases in premium income, fueled by the writing of new life insurance premiums and improved persistency, as well as an increase in investment income and lower property claims development, contributed to a 90.8% increase in earnings for 2007.

Total revenues for 2007 were $173.8 million, a 10.0% increase over 2006 revenues of $158.1 million. Total revenues for 2005 were $142.1 million. Total revenues from Home Service were $52.9 million in 2007 and $51.2 million in 2006, compared to $49.7 million in 2005. Total revenues from our Life Insurance segment amounted to $119.0 million during 2007, compared to $105.7 million for 2006 and $90.6 million for 2005, reflecting continued growth in new business.

Premium Income. Premium income during 2007 increased to $140.9 million from $128.5 in 2006, or 9.6%, and $116.3 million in 2005. The 2007 increase was attributable to the new international business written in 2006 and 2007 in the Life Insurance segment, which had $101.4 million of premium income during the year. Additionally, we continue to experience improved persistency in our international life business, which contributed largely to the increase. First year premium in the Life Insurance segment was unchanged from its 2006 level. Additionally, property insurance premiums were up $1.1 million in 2007 over 2006, or 30.4%, as rate increases implemented in the fourth quarter of 2006 and third quarter 2007 materialized.

Net Investment Income. Net investment income increased 14.0% during 2007 to $30.7 million, compared to $27.0 million during 2006 and $23.6 million in 2005. The increase was due primarily to the growth in the investment portfolio during 2007. Additionally, during 2007 the Company invested $36.7 million in equity mutual funds, which added $2.1 million to net investment income from fund distributions. The Company expects to increase this number to 10% of invested assets during 2008. We continue to invest primarily in bonds of U.S. Government-sponsored enterprises, such as FNMA and FHLMC.

Reserves. The change in future policy benefit reserves increased from $30.7 million in 2006 to $36.4 million in 2007, predominantly due to an improvement in persistency on our international life business, as well as a change in product mix, which resulted in larger first year reserves. During 2007 and 2006, a shift in products sold occurred with the addition of sales in the Pacific Rim, which resulted in a more rapid rise in reserves. The change in future policy benefit reserves increased from $23.6 million in 2005 to $30.7 million in 2006, due predominantly to increased persistency on our business and an increase and change in product mix in new business. Sales of certain endowment products in the Taiwanese market, which build reserves at a much higher rate, contributed to the increase.

Policyholder Dividends. Policyholder dividends increased 18.9% during 2007 to $6.4 million from $5.4 million in 2006 and $4.8 million in 2005, due to improved persistency and the continued sale of participating ordinary whole life products in the international market. All of our international policies are participating, and the improvement in persistency and increase in new business on our international business have contributed to the growth in dividends. The dividends are factored into the premiums and have no impact on profitability.

Claims and Surrenders. As noted in the table below, claims and surrenders decreased 2.7% from $56.3 million in 2006 to $54.7 million in 2007. The 2007 decrease primarily related to a decline in claims from Hurricane Katrina in 2007, which were a negative $711,000 because of a release of liabilities related to the expiration of the extended claims filing deadline. Hurricane related claims were $3.0 million in 2006 and $1.6 million in 2005.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

		Years ended December 31,
		2007				2006				2005
		(In thousands)
Death claims		$	20,720				21,686				22,404
Surrender expenses			17,989				17,205				15,369
Endowments			12,835				10,786				9,021
Property claims			1,090				5,194				3,685
Other policy benefits			1,783				849				780
Accident and health benefits			311				541				446
Total claims and surrenders		$	54,728				56,261				51,705

Death benefits declined in 2007 compared to 2006, despite the growth in our business written, because of more restrictive underwriting rules, as well as strict claims adjudication procedures that the Company has developed over its history. Death benefits also decreased in 2006 compared to 2005.

Policy surrenders increased 4.6% in 2007 to $18.0 million from $17.2 million in 2006, up from $15.4 million in 2005. The increase in surrender expense is in line with management expectations, considering the inforce business has increased over the last three years. Surrenders as a percent of inforce business were 0.4% in 2007, 2006 and 2005.

Endowment benefits increased 19.0% from $10.8 million in 2006 to $12.8 million in 2007. Endowments totaled $9.0 million in 2005. We have a series of international policies that carry an immediate endowment benefit of an amount elected by the policy owner. This endowment is factored into the premium of the policy and is paid annually. These benefits have been particularly popular in the Pacific Rim, where the Company has experienced increased business in recent years. Like policy dividends, endowments are factored into the premium and, as such, the increase should have no adverse impact on profitability.

Property claims decreased 79.0% in 2007, from $5.2 million in 2006 to $1.1 million in 2007, and were $3.7 million in 2005. In 2007, the Company began to experience a dramatic decline in property claims that adversely affected the business in 2006 and 2005. Hurricane claims in 2007 were a negative $711,000. Of the 2006 property claims, $3.0 million were due to Hurricane Katrina, while in 2005, $1.6 million were due to Hurricanes Katrina and Rita.

Commissions. Commissions decreased slightly during 2007 to $35.6 million from $35.7 million in 2006 and $33.0 million in 2005, primarily due to the new business issued during the period. Commissions were flat in 2007 compared to 2006, even though premiums were up 10.0%, due to the increased amount of renewal premiums, which pay a lower commission.

Underwriting, Acquisition and Insurance Expense. Underwriting, acquisition and insurance expenses were unchanged in 2007 from 2006 at $27.6 million. The 2006 increase to $27.6 million from $25.4 million in 2005 was largely attributable to higher cost of employee benefits, higher accounting fees related to financial statement and Sarbanes-Oxley compliance, and an increased contribution to the Company’s profit sharing plan.

Deferred Policy Acquisition Costs. Capitalized deferred policy acquisition costs (“DAC”) decreased 2.9% from $27.0 million in 2006 to $26.2 million in 2007. These costs were $24.4 million in 2005. The 2007 decrease from 2006 was primarily related to flat new life production discussed above, and tracked consistently with the slight decrease in commissions. Amortization of these costs was $12.5 million, $11.4 million and $10.3 million in 2007, 2006 and 2005, respectively. The write-off of DAC on internal replacements under The American Institute of Certified Public Accountants (AICPA) Statement of Position, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1), added $917,000 to amortization in 2007.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

At our lead Life Insurance segment subsidiary, CICA, deferred acquisition cost assumptions had not been revised in several years. A new GAAP era was created for new issues beginning in 2006 to reflect the better mortality and persistency being experienced in the last few years.

Cost of Customer Relationships Acquired and Other Intangibles. Amortization of cost of customer relationships acquired and other intangibles decreased from $5.9 million in 2005, to $4.7 million in 2006 and $3.2 million in 2007. Amortization of these items related to Security Plan was $3.8 million in 2005, $2.3 million in 2006 and $2.0 million in 2007. The decrease resulted from an increase in amortization of $2.3 million in 2005 related to the Louisiana hurricanes. In conjunction with this loss recognition, we revised our amortization methodology to (i) reduce projections of future collected premiums by approximately 4.0% and (ii) to amortize the acquired paid-up block over inforce balances, which resulted in a $400,000 decrease in amortization expense in 2006. This change also reduced 2007 amortization.

The goodwill of CNLIC, a reporting unit within the Life Insurance segment, showed that it was impaired at December 31, 2006. Due to significant declines in new business issued by CNLIC, the fair value of this reporting unit was below its carrying value. As a result, an impairment loss of $1,016,000 was recognized in the fourth quarter of 2006. The fair value of that reporting unit was estimated using the present value of estimated future cash flows. The remaining goodwill is associated with CICA. At December 31, 2007, there was no impairment of this goodwill.

Federal Income Tax. Federal income tax expense was $4.5 million, $4.7 million and $6.9 million in 2005, 2006 and 2007, respectively. This represents effective tax rates of 38.1%, 35.0% and 29.5%, respectively. In 2005, a valuation allowance in the amount of $1.1 million was established, which added 9.3% to our effective tax rate. The 2005 allowance was due to the anticipated sale of CNLIC, which had a $1.1 million net deferred tax asset at December 31, 2005, primarily related to net operating losses that would not be available in future years as CNLIC would no longer be part of the Company’s consolidated group. The 2006 tax rate was higher due to a write-off of $1.0 million of goodwill, which has no tax effect. In 2007, the valuation allowance was released in the amount of $1.1 million as the CNLIC sale agreement was terminated and the Company’s plan is to now consolidate CNLIC in the Company’s life-nonlife tax return in 2008. CICA should have sufficient life income to absorb the CNLIC net operating losses. This release of the valuation allowance reduced our effective tax rate by 4.7%. (See Note 10 of the “Notes to Consolidated Financial Statements” for additional information on Federal income tax.)

Liquidity and Capital Resources

Liquidity refers to a company’s ability to generate sufficient cash flows to meet the needs of its operations. Liquidity is managed on insurance operations to ensure stable and reliable sources of cash flows to meet obligations and is provided by a variety of sources.

Liquidity requirements of Citizens are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds, while investment purchases, policy benefits, and operating expenses are the primary uses of funds. We historically have not had to liquidate investments to provide cash flow and did not do so in 2007. During the fourth quarter of 2005 and the first six months of 2006, however, SPFIC sold approximately $3.1 million of bonds in order to meet the cash outflow related to claims from Hurricanes Katrina and Rita. Such sales were not needed in the second half of 2006. Additionally, in early 2005, management chose to pay off the $30 million in debt incurred in the Security Plan transaction. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. See Note 8 of the “Notes to Consolidated Financial Statements” for a table disclosing our contractual obligations.

A primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our insurance policies, such as surrender charges, that help limit and discourage early withdrawals. Since these contractual withdrawals, as well as the level of surrenders experienced, were largely consistent with our assumptions in asset liability management, our associated cash outflows have, to date, not had an adverse impact on our overall liquidity. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. Cash flow projections

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

and cash flow tests under various market interest rate scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds.

In the past, cash flows from our insurance operations have been sufficient to meet current needs. Cash flows from operating activities were $37.9 million, $39.1 million and $34.5 million for the years ended December 31, 2007, 2006, and 2005, respectively. We have traditionally also had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows, for the most part, are reinvested in fixed income securities. Net cash outflows from investment activity totaled $58.8 million, $33.6 million and $22.6 million for the years ended December 31, 2007, 2006 and

2005, respectively. The outflows from investing activities for the year ended December 31, 2007, primarily related to the investment of excess cash and cash equivalents generated from operations during 2007 and the investment of proceeds from our registered direct offering of $18.8 million of Class A common stock completed in late 2007.

Stockholders’ equity at December 31, 2007 was $176.2 million compared to $139.6 million at December 31, 2006. The 2007 increase was largely due to income earned during the period, a decrease in unrealized investment gains of $4.2 million, and the accretion of deferred issuance costs and discounts on preferred stock of $1.3 million. Also, in the fourth quarter of 2007, the Company completed a registered direct offering of approximately 2.7 million shares of its Class A common stock, netting proceeds of $17.1 million.

Investments increased to $585.3 million at December 31, 2007 from $515.1 million at December 31, 2006. Invested assets grew by 13.6% during 2007. Fixed maturities are categorized into fixed maturities available-for-sale, which are carried in our consolidated financial statements at fair value. Fixed maturities available-for-sale were 85.5% of investments at December 31, 2007.

Policy loans comprised 4.4% of invested assets at December 31, 2007 compared to 4.6% at December 31, 2006. These loans, which are secured by the underlying policy values, have yields ranging from 5% to 12% and maturities that are related to the maturity or termination of the applicable policies. Management believes that we maintain adequate liquidity despite the uncertain maturities of these loans.

Our cash balances at our primary depositories were significantly in excess of Federal Deposit Insurance Corporation coverage at December 31, 2007 and December 31, 2006. Management monitors the solvency of all financial institutions in which we have funds to minimize the exposure for loss. Management does not believe we are at significant risk for such a loss. During 2008, we intend to continue to utilize high grade commercial paper as a cash management tool to minimize excess cash balances and enhance returns.

In the wake of bankruptcy filings by large corporations several years ago, concern was raised regarding the use of certain off-balance sheet special purpose entities such as partnerships to hedge or conceal losses related to investment activity. We do not utilize special purpose entities as investment vehicles, nor are there any such entities in which we have an investment that engage in speculative activities of any nature, and we do not use such investments to hedge our investment positions. The Company has no subprime or collateralized debt obligations.

The NAIC has established minimum capital requirements in the form of Risk-Based Capital (“RBC”). Risk-based capital factors the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company’s business to develop a minimum level of capital called “authorized control level risk-based capital” and compares this level to an adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk-based capital fall below 200%, a series of actions by the affected company would begin. At December 31, 2007 and 2006, all of our insurance subsidiaries were above required minimum levels.

In late 2007, the Company did not renew its $75 million line of credit. Management believes that if such borrowing capacity is needed in the future, the Company will be able to secure another line of credit.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Parent Company Liquidity and Capital Resources

We are a holding company and have had minimal operations of our own. Our assets consist of the capital stock of our subsidiaries. Accordingly, our cash flows depend upon the availability of statutorily permissible payments, primarily payments under management agreements from our two primary life insurance subsidiaries, CICA and SPLIC. The ability to make payments is limited by applicable laws and regulations of Colorado, CICA’s state of domicile, and Louisiana, Security Plan’s state of domicile, which subject insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that these insurance subsidiaries maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. We historically have not relied upon dividends from subsidiaries for our cash flow needs and we do not intend to do so in the future.

Critical Accounting Policies

Our critical accounting policies are as follows:

Policy Liabilities

Future policy benefit reserves have been computed by the net level premium method with assumptions as to investment yields, dividends on participating business, mortality and withdrawals based upon our experience. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of policy liabilities and the increase in future policy benefit reserves. Management’s judgments and estimates for future policy benefit reserves provide for possible unfavorable deviation.

At December 31, 2007, Security Plan’s paid-up policies did not convert to our new policy administration system. Because of this, reserves related to these policies were estimated based on the ratio of statutory reserves at December 31, 2007 compared to September 30, 2007, multiplied by the GAAP reserves at September 30, 2007.

We continue to use the original assumptions (including a provision for the risk of adverse deviation) in subsequent periods to determine the changes in the liability for future policy benefits (the “lock-in concept”) unless a premium deficiency exists. Management monitors these assumptions and has determined that a premium deficiency does not exist at December 31, 2007. Management believes that our policy liabilities and increase in future policy benefit reserves as of and for the years ended December 31, 2007 and 2006 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision. The relative stability of these assumptions and management’s analysis is discussed below.

Deferred Policy Acquisition Costs

Acquisition costs, consisting of commissions and policy issuance, underwriting and agency expenses that relate to and vary with the production of new business, are deferred. These deferred policy acquisition costs are amortized primarily over the estimated premium paying period of the related policies in proportion to the ratio of the annual premium recognized to the total premium revenue anticipated, using the same assumptions as were used in computing liabilities for future policy benefits.

We utilize the factor method to determine the amount of costs to be capitalized and the ending asset balance. The factor method is based on the ratio of premium revenue recognized for the policies in force at the end of each reporting period compared to the premium revenue recognized for policies in force at the beginning of the reporting period. The factor method ensures that policies that lapsed or surrendered during the reporting period are no longer included in the deferred policy acquisition costs calculation. The factor method limits the amount of deferred costs to its estimated realizable value, provided actual experience is comparable to that contemplated in the factors.

Inherent in the capitalization and amortization of deferred policy acquisition costs are certain management judgments about what acquisition costs are deferred, the ending asset balance and the annual amortization. Approximately 80% of our capitalized deferred acquisition costs are attributed to first year excess commissions. The remaining 20% are attributed to costs that vary with and are directly related to the acquisition of new and renewal insurance business. Those costs generally include costs related to the production, underwriting and issuance of new business.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

A recoverability test that considers, among other things, actual experience and projected future experience is performed at least annually. These annual recoverability tests initially calculate the available premium (gross premium less benefit net premium less percent of premium expense) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then evaluated over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Based upon the analysis performed to only capitalize expenses that vary with and are directly related to the acquisition of new and renewal insurance business, utilization of the factor method and annual recoverability testing, management believes that our deferred policy acquisition costs and related amortization as of and for the years ended December 31, 2007, 2006 and 2005 limits the amount of deferred costs to its estimated realizable value.

The American Institute of Certified Public Accountants (AICPA)  issued Statement of Position (SOP) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1), which defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Under SOP 05-1, modifications that result in a substantially unchanged contract will be accounted for as a continuation of the replaced contract. A replacement contract that is substantially changed will be accounted for as an extinguishment of the replaced contract resulting in a release of unamortized deferred acquisition costs and unearned inducements associated with the replaced contract. Also under SOP 05-1, the unamortized deferred acquisition cost is written off when a policy is reinstated that had previously lapsed. We implemented SOP 05-1 in the first quarter of 2007, and as a result, the Company wrote off $917,000 of DAC on reinstated policies during the year ended December 31, 2007.

Valuation of Investments in Fixed Maturity and Equity Securities

Our fixed maturities consist primarily of bonds. Prior to December 31, 2006, fixed maturities that the Company had the ability and intent to hold to maturity were carried at amortized cost. Fixed maturities that may be sold prior to maturity to support the Company’s investment strategies are considered held as available-for-sale and carried at fair value as of the balance sheet date. Equity securities (including non-redeemable preferred stock) are considered available-for-sale and are reported at fair value.

At December 31, 2007, 68.3% of our fixed maturity securities were invested in U.S. Government-sponsored enterprises or securities backed by the U.S. Government. We evaluate the carrying value of our fixed maturity and equity securities at least quarterly. A decline in the fair value of any fixed maturity or equity security below cost that is deemed other-than-temporary is charged to earnings resulting in the establishment of a new cost basis for the security. The new cost basis is not changed for subsequent recoveries in the fair value of the fixed maturity or equity security. With the exception of Security Plan, virtually all of our subsidiaries’ fixed maturity investments are in U.S. Government-sponsored enterprises or U.S. Government instruments. Security Plan has significant investments in corporate and municipal bonds. Based upon our emphasis on investing in fixed maturity securities primarily composed of obligations of U.S. Government-sponsored corporations, our intent and ability to hold temporarily impaired fixed maturities until recovery, and our analysis of whether declines in fair value below cost are temporary or other-than-temporary, management believes that our investments in fixed maturity at December 31, 2007 were not impaired, and no other-than-temporary losses needed to be recorded. The Company’s equity securities consist of mutual funds acquired in 2007, and thus any declines in value have recently arisen. The Company will continue to monitor these investments. At December 31, 2007, there were no other-than-temporary impairments.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

General

The nature of our business exposes us to investment market risk. Market risk is the risk of loss that may occur when changes in interest rates and public equity prices adversely affect the value of our invested assets. Interest rate risk is our primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the fair value of our investments. The fair value of our fixed maturity portfolio generally increases when interest rates decrease, and decreases when interest rates increase.

Market Risk Related to Interest Rates

Our exposure to interest rate changes results from our significant holdings of fixed maturity investments, policy loans and mortgage loans on real estate, all of which comprised over 87% of our cash and investment portfolio as of December 31, 2007. These investments are mainly exposed to changes in U.S. Treasury rates. Our fixed maturities investments include U.S. Government-sponsored corporations, U.S. Government bonds, securities issued by government agencies, and corporate bonds. Approximately 68.3% of the fixed maturities we owned at December 31, 2007 are instruments of U.S. Government-sponsored enterprises, or are backed by U.S. Government agencies.

To manage interest rate risk, we perform periodic projections of asset and liability cash flows to evaluate the potential sensitivity of our investments and liabilities. We assess interest rate sensitivity with respect to our available-for-sale fixed maturities investments using hypothetical test scenarios that assume either upward or downward 100 basis point shifts in the prevailing interest rates.

The following tables set forth the potential amount of unrealized gains (losses) that could be caused by 100 basis point upward and downward shifts on our available-for-sale fixed maturities investments as of the dates indicated.

		Decreases in Interest Rates
		(In thousands)
		100 Basis Points				200 Basis Points				300 Basis Points
December 31,
2007		$	18,594				29,582				42,812
2006		$	20,429				36,129				55,312

		Increases in Interest Rates
		(In thousands)
		100 Basis Points				200 Basis Points				300 Basis Points
December 31,
2007		$	(22,821	)			(51,006	)			(79,768	)
2006		$	(32,305	)			(59,302	)			(92,949	)

While the test scenario is for illustrative purposes only and does not reflect our expectations regarding future interest rates or the performance of fixed-income markets, it is a near-term change that illustrates the potential impact of such events. Due to the composition of our book of insurance business, we believe it is unlikely that we would encounter large surrender activity due an interest rate increase that would force us to dispose of our fixed maturities at a loss.

There are no fixed maturities or other investments that we classify as trading instruments. At December 31, 2007 and 2006, we had no investments in derivative instruments, nor does the Company have any subprime or CDO (collateralized debt obligation) risk.

Market Risk Related to Equity Prices

Changes in the level or volatility of equity prices affect the value of equity securities we hold as investments. However, our equity investments portfolio was less than 7% of our total investments at December 31, 2007. Thus, we believe that significant decreases in the equity markets would have an immaterial impact on our total investment portfolio. (See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Item 8. Financial Statements and Supplementary Data

Reference is made to the financial statements, the notes thereto, and the report of our independent registered public accounting firm and predecessor independent registered public accounting firm, as listed on the table of contents.

All other schedules have been omitted as the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

During the 24 months preceding the date of the audited financial statements included herein, we have not reported on Form 8-K any disagreements between our independent registered accounting firms and us. On March 23, 2006, we reported the termination of KPMG LLP as our principal independent registered public accounting firm and the engagement of Ernst & Young LLP as our successor independent registered public accounting firm.

Item 9A. Controls and Procedures

(a) Disclosure Controls and Procedures

We have established disclosure controls and procedures to ensure, among other things, that material information relating to our Company, including its consolidated subsidiaries, is made known to our officers who certify our financial reports and to the other members of our senior management and the Board of Directors.

Our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”) are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon an evaluation at the end of the period, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.

(b) Management Report on Internal Control over Financial Reporting

Management of our Company is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed our internal control over financial reporting based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that we maintained effective internal control over financial reporting as of December 31, 2007.

Our independent registered public accounting firm, Ernst & Young LLP has issued an attestation report on management’s assessment of our internal control over financial reporting. The report is included in item 9A(d) of this annual report.

(c) Change in Internal Control over Financial Reporting

As of December 31, 2007, we have implemented certain changes in internal control that remediated the material weakness in our financial statement close process that we reported at December 31, 2006. Such changes included:

•

Hired a new Vice President of Accounting, with significant statutory accounting and U.S. GAAP experience;

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

	•		Hired a new Chief Actuary with a background in U.S. GAAP financial reporting;
	•		Ensured that all of our financial statement closing process journal entries for each of our subsidiaries have been recorded in their general ledgers (previously, many such entries were in Excel only);
	•		Created the position of Vice President of Financial Reporting, committing resources to enable the timely review of supporting work papers for prior and current accounting periods and to prevent and detect misapplications of U.S. GAAP;
	•		Strengthened accounting work paper review by senior members of management, including our VP Financial Reporting and CFO, to ensure completeness and accuracy of supporting work papers and schedules, including formalized sign-off processes;
	•		Implemented additional layers of review at greater levels of precision over our financial statement close process; and
	•		Strengthened our preparation and review of annual accounting and year-end disclose analysis.

These corrective actions have remediated the December 31, 2006 material weakness.

(d) Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

The Board of Directors and Shareholders of Citizens, Inc.:

We have audited Citizens, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Citizens, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting under Item 9A of the Index. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Citizens, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2007 of Citizens, Inc. and subsidiaries and our report dated March 14, 2008 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Austin, Texas
March 14, 2008

Item 9B. Other Information

None.

PART III

Items 10, 11, 12, 13 and 14 of this Report incorporate by reference the information in our definitive proxy material under the headings “Election of Directors,” “Executive Officers,” “Executive Officer and Director Compensation,” “Stock and Principal Stockholders,” “Control of the Company,” and “Principal Accounting Fees and Services,” to be filed with the Securities and Exchange Commission within 120 days after December 31, 2007.

PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)

(1) and (2) Filings as Part of this Report

The financial statements and schedules listed on the following index to financial statements and financial statement schedules are filed under Item 8 as part of this Form 10-K.

(b)

(3) Exhibits – See the Exhibit Index

Index to Consolidated Financial Statements and Financial Statement Schedules

		Page
		Reference
Reports of independent registered public accounting firms			40
Consolidated statements of financial position at December 31, 2007 and 2006			42
Consolidated statements of operations - years ended December 31, 2007, 2006 and 2005			44
Consolidated statements of stockholders’ equity and comprehensive income – years ended December 31, 2007, 2006 and 2005			45
Consolidated statements of cash flows - years ended December 31, 2007, 2006 and 2005			47
Notes to consolidated financial statements			49
Schedules at December 31, 2007 and 2006:
Schedule II – Condensed Financial			82
Information of Registrant
Schedules for each of the years in the three-year period ended December 31, 2007:
Schedule III – Supplementary Insurance Information			85
Schedule IV – Reinsurance			87

All other schedules have been omitted because the required information is inapplicable or the information required is presented in the financial statements or the notes thereto filed elsewhere herein.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Citizens, Inc.:

We have audited the accompanying consolidated statements of financial position of Citizens, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2007. Our audit also included the financial statement schedules II, III, and IV under Item 15 of the Index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens, Inc. and subsidiaries at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As described in Note 1(p) to the consolidated financial statements, in 2007 the Company adopted American Institute of Certified Public Accountants Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modification or Exchanges of Insurance Contracts. Also, as described in Note 1(p) to the consolidated financial statements, during the fourth quarter of 2006, the Company adopted Securities and Exchange Commission Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements (“SAB No. 108”). In accordance with the transition provisions of SAB No. 108, the Company recorded an adjustment to retained deficit effective January 1, 2006 for the correction of prior period misstatements.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Citizens, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2008 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Austin, Texas
March 14, 2008

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Citizens, Inc.:

We have audited the accompanying consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows of Citizens, Inc. and subsidiaries (the Company) for the year ended December 31, 2005. In connection with our audit of the consolidated financial statements, we also have audited the amounts related to the year ended December 31, 2005 in financial statement schedules II to IV. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and the cash flows of Citizens, Inc. and subsidiaries for the year ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the amounts related to the year ended December 31, 2005 in the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Dallas, Texas
March 14, 2008

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

		2007				2006
Assets
Investments:
Fixed maturities available-for-sale, at fair value (cost: $502, 635 and $497,939 in 2007 and 2006, respectively)		$	500,426				488,318
Equity securities available-for-sale, at fair value (cost: $36,696 and $279 in 2007 and 2006, respectively)			35,669				312
Mortgage loans on real estate			291				456
Policy loans			25,490				23,542
Real estate held for investment (less $249 and $206 accumulated depreciation in 2007 and 2006, respectively			5,152				1,341
Other long-term investments			618				1,086
Short-term investments			17,650				—
Total investments			585,296				515,055
Cash and cash equivalents			21,123				24,521
Accrued investment income			7,115				7,107
Reinsurance recoverable			13,492				16,044
Deferred policy acquisition costs			100,655				86,975
Cost of customer relationships acquired			31,636				34,812
Goodwill			11,386				11,386
Other intangible assets			1,066				1,093
Federal income tax receivable			715				—
Property and equipment, net			6,795				7,350
Due premiums, net (less $1,780 and $1,440 allowance for doubtful accounts in 2007 and 2006, respectively)			7,656				6,078
Other assets			974				763
Total assets		$	787,909				711,184

(Continued)

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Financial Position, Continued
December 31, 2007 and 2006
(In thousands)

		2007				2006
Liabilities and Stockholders’ Equity
Liabilities:
Future policy benefit reserves:
Life insurance		$	508,209				473,355
Annuities			22,792				20,761
Accident and health			8,293				10,604
Dividend accumulations			4,825				5,027
Premium deposits			14,148				11,897
Policy claims payable			6,908				9,448
Unearned premiums			1,992				1,812
Other policyholders’ funds			4,357				3,771
Total policy liabilities			571,524				536,675
Commissions payable			2,385				2,581
Federal income tax payable			—				2,031
Deferred Federal and state income taxes			4,810				1,498
Payable for securities in process of settlement			7,000				—
Warrants outstanding			1,003				1,831
Other liabilities and funds held for others			10,810				14,074
Total liabilities			597,532				558,690
Commitments and contingencies (Notes 5 and 8)
Cumulative convertible preferred stock – Series A
(Series A-1 - $500 stated value per share, 25,000 shares issued, authorized and outstanding in 2007 and 2006; Series A-2 - $935 stated value per share, 5,000 shares authorized, 4,014 shares issued and outstanding in 2007 and 2006)			14,220				12,883
Stockholders’ equity:
Common stock:
Class A, no par value, 100,000,000 shares authorized, 46,205,830 shares issued in 2007 and 43,425,524 shares issued in 2006, including shares in treasury of 3,135,738 in 2007 and 2006			225,812				210,066
Class B, no par value, 2,000,000 shares authorized, 1,001,714 shares issued and outstanding in 2007 and 2006			3,184				3,184
Retained deficit			(39,725	)			(56,282	)
Accumulated other comprehensive loss:
Unrealized losses on securities, net of tax			(2,103	)			(6,346	)
			187,168				150,622
Treasury stock, at cost			(11,011	)			(11,011	)
Total stockholders’ equity			176,157				139,611
Total liabilities and stockholders’ equity		$	787,909				711,184

See accompanying notes to consolidated financial statements

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

		2007				2006				2005
Revenues:
Premiums:
Life insurance		$	134,422				123,258				111,087
Accident and health insurance			1,558				1,461				1,560
Property insurance			4,925				3,777				3,627
Net investment income			30,743				26,975				23,568
Realized gains (losses), net			(94	)			1,286				419
Decrease (increase) in fair value of warrants			828				(244	)			489
Other income			1,412				1,546				1,363
Total revenues			173,794				158,059				142,113
Benefits and expenses:
Insurance benefits paid or provided:
Claims and surrenders			54,728				56,261				51,705
Increase in future policy benefit reserves			36,420				30,719				23,603
Policyholders’ dividends			6,401				5,384				4,789
Total insurance benefits paid or provided			97,549				92,364				80,097
Commissions			35,641				35,691				32,985
Other underwriting, acquisition and insurance expenses			27,583				27,607				25,429
Capitalization of deferred policy acquisition costs			(26,210	)			(26,986	)			(24,388	)
Amortization of deferred policy acquisition costs			12,530				11,391				10,313
Amortization of cost of customer relationships acquired and other intangibles			3,203				4,650				5,881
Total benefits and expenses			150,296				144,717				130,317
Income before income tax expense			23,498				13,342				11,796
Income tax expense			6,941				4,665				4,494
Net income		$	16,557				8,677				7,302
Net income applicable to common stockholders		$	14,555				6,654				5,326
Per Share Amounts
Basic and diluted earnings per share of Class A common stock		$	0.35				0.16				0.13
Basic and diluted earnings per share of Class B common stock		$	0.18				0.08				0.07

See accompanying notes to consolidated financial statements.

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

														Accumulated
														other								Total
		Common Stock								Retained				comprehensive				Treasury				Stockholders’
		Class A				Class B				deficit				loss				stock				equity
Balance at December 31, 2004		$	197,338				2,827				(54,392	)			(749	)			(9,893	)			135,131
Comprehensive income:
Net income			—				—				7,302				—				—				7,302
Unrealized investment losses, net			—				—				—				(4,052	)			—				(4,052	)
Total comprehensive income			—				—				7,302				(4,052	)			—				3,250
Accretion of deferred issuance costs and discounts on preferred stock			(1,418	)			—				—				—				—				(1,418	)
Stock dividend			15,483				357				(14,722	)			—				(1,118	)			—
Balance at December 31, 2005			211,403				3,184				(61,812	)			(4,801	)			(11,011	)			136,963
Cummulative effect of adopting SEC Staff
Accounting Bulletin No. 108			—				—				(3,147	)			—				—				(3,147	)
Comprehensive income:
Net income			—				—				8,677				—				—				8,677
Unrealized investment losses, net			—				—				—				(1,545	)			—				(1,545	)
Total comprehensive income			—				—				8,677				(1,545	)			—				7,132
Accretion of deferred issuance costs and discounts on preferred stock			(1,337	)			—				—				—				—				(1,337	)
Common stock dividend on preferred stock			—				—				—				—				—				—
Balance at December 31, 2006			210,066				3,184				(56,282	)			(6,346	)			(11,011	)			139,611
Comprehensive income:
Net income			—				—				16,557				—				—				16,557
Unrealized investment gains, net			—				—				—				4,243				—				4,243
Total comprehensive income			—				—				16,557				4,243				—				20,800
Accretion of deferred issuance costs and discounts on preferred stock			(1,337	)			—				—				—				—				(1,337	)
Sale of Class A common stock			17,083				—				—				—				—				17,083
Balance at December 31, 2007		$	225,812				3,184				(39,725	)			(2,103	)			(11,011	)			176,157

(Continued)

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income,
Continued
Years ended December 31, 2007, 2006 and 2005
(In thousands)

A summary of the number of shares of common stock of Class A, Class B and treasury stock issued is as follows:

		Common Stock								Treasury
		Class A				Class B				Stock
Balance at December 31, 2004			40,364				936				(2,931	)
Stock dividends			2,937				66				(205	)
Balance at December 31, 2005			43,301				1,002				(3,136	)
Stock dividends			125				—				—
Balance at December 31, 2006			43,426				1,002				(3,136	)
Stock dividends			97				—				—
Stock sale			2,683				—				—
Total stock issued			2,780				—				—
Balance at December 31, 2007			46,206				1,002				(3,136	)

See accompanying notes to consolidated financial statements

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2007, 2006 and 2005
(In thousands)

		2007				2006				2005
Cash flows from operating activities:
Net income		$	16,557				8,677				7,302
Adjustments to reconcile net income to net cash provided by operating activities:
Realized losses (gains) on sale of investments and other assets			94				(1,286	)			(419	)
Net deferred policy acquisition costs			(13,680	)			(16,565	)			(14,075	)
Amortization of cost of customer relationships acquired and other intangibles			3,203				4,650				5,881
Increase (decrease) in fair value of warrants			(828	)			244				(489	)
Depreciation			1,076				1,297				897
Amortization of premiums and discounts on fixed maturities			1,243				1,467				1,154
Deferred federal income tax expense			1,202				829				2,903
Change in:
Accrued investment income			(8	)			(644	)			(364	)
Reinsurance recoverable			2,552				3,452				(1,311	)
Due premiums and other receivables			(1,702	)			(1,089	)			—
Future policy benefit reserves			34,132				31,741				23,003
Other policy liabilities			275				(46	)			4,867
Federal income tax			(2,746	)			1,330				(859	)
Commissions payable and other liabilities			(3,367	)			4,854				2,469
Other, net			(86	)			166				3,547
Net cash provided by operating activities			37,917				39,077				34,506
Cash flows from investing activities:
Sale of fixed maturities, held-to-maturity			—				2,472				—
Sale of fixed maturities, available-for-sale			3,844				14,006				14,569
Maturity of fixed maturities, available-for-sale			75,939				57,473				93,746
Purchase of fixed maturities, available-for-sale			(78,845	)			(107,080	)			(132,557	)
Sale of equity securities, available-for-sale			248				334				616
Purchase of equity securities available-for-sale			(36,666	)			—				—
Principal payments on mortgage loans			165				201				89
Mortgage loans funded			—				—				(100	)
Sale of other long-term investments and property and equipment			428				264				686
Principal payments on note receivable			2				475				396