Citizens is an insurance company that operates in an illegal activity, has numerous red-flags, trades at an absurd valuation and now has a potential catalyst for increased regulatory scrutinty. We think CIA is worth between zero and $2 per share compared to its current $6.45 price. There has been some commentary about CIA on the NWLI thread recently so I thought I would post this since the recent 8K has introduced a timely catalyst.
1. CIA’s core international life insurance business is based on illegal activity in Latin America
2. Their business is tailored to exploit people to invest in their stock and inflate its value through the quirks of their policyholder dividends
3. There is potential regulatory scrutiny in Brazil and other markets
4. There could be potential liability from a Texas class-action lawsuit
5. The company trades at 55x earnings, 1.5x stated tangible book value and 10x adjusted tangible book value (excluding AOCI and DAC)
6. Most importantly, the recent 8K disclosure about non-compliance with IRS requirements could be a significant financial liability for the company and increase additional scrutinty on the company’s operations - from the SEC to state insurance commissions
1. Core business:
Citizens sells US dollar-denominated life insurance in international markets, predominantly Latin America, without any local presence, offices or branches. This business is illegal since it violates most local insurance regulations that require insurance companies to register with local insurance commissions. The company’s risk factors disclose the dubious nature of its operations.
2. Citizens’ policies are very odd in that they pay cash policyholder dividends, which are then re-invested in the parent company’s stock. We are not aware of any stock or mutual insurance company with such an unusual arrangement. It seems very odd that an insurance company would allow its policyholders to buy its common stock through their policy at all, but it is even more absurd when the stock trades at over 50x earnings and well above book value. CEO Harold Riley tried to explain the logic behind this practice in this clip (see 6:10 mark):
“Now we have these trusts that invest back in what? Into Citizens’ stock. Are they gambling? No. They are simply taking an opportunity to get a market gain because the market has no ceiling.”
It’s very difficult to know how much stock the policyholders actually own now since the purchases were done through a Panamanian trust and the disclosure has been changed from time to time. It is possible that a large portion of the company’s shares are (perhaps unknowingly) held by policyholders, all while the Riley family has been slowly selling their holdings.
3. As mentioned on the recent NWLI thread, the Brazilian insurance regulator fined NWLI (with a $900 million market cap) an amount equal to $6 billion (with a B) for operating as an insurance company in Brazil without due authorization. While it is nearly impossible to enforce that fine since NWLI or CIA have no assets in the country, we think that this illustrates the questionable business practices that both companies follow. I should note that NWLI, which has a part of their business that does the same thing as Citizens, but to a less nefarious degree, was where CIA CEO Riley began his career.
4. There has been a Texas lawsuit that has sought class-action status and has been pursued for many years against Citizens, essentially arguing that the company violated US securities regulations by selling these insurance policies. The case was scheduled trial in late 2014 but has been delayed to the best of my knowledge and I have no view on the timing given how long it has dragged on.
The risks and red-flags go on and one, as evidenced by the increasing risk factors in the company’s 10K:
5. The company trades at nonsensical valuation metrics for a life-insurance company, largely because there is artificial demand for its shares from the policyholder dividends that buy stock in the open market. If CIA were to valued similar to NWLI, its stock would be down between 40% and 80%.
6. Most importantly, last Wednesday the company put out an 8K that stated:
As part of an internal operation review of the life insurance products issued by our subsidiary insurance companies, the Company’s management determined during the first quarter of 2015 that a substantial portion of its endowment policies and whole life insurance policies do not qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 7702A of the Internal Revenue Code of 1986. The policies at issue were primarily sold to non-U.S. citizens residing abroad. The failure of these policies to qualify under Sections 7702 and 7702A is expected to result in charges to the Company’s consolidated financial statements for the fiscal year ended December 31, 2014. At present, the Company is unable to quantify with reasonable certainty the magnitude of the charge expected to result from this tax compliance issue, but it is expected to be material to the Company’s financial condition and 2014 results of operations.
While we are not tax experts, we believe that there could be substantial financial penalties levied on the company or its policyholders (who would likely seek reimbursement from the company). The implications could be significant as many policyholders are also shareholders of the company, often with policyholders loans that the company itself provided. It is not inconceivable to see a run-on-the-bank based on the liabilities involved.
Also, we think (hope) that an IRS investigation into the company’s business practices could lead to additional scrutiny, from the SEC or the Texas state insurance commission. We believe that the vast majority of this company’s operations are illegal.