UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended December 31, 2004

or

     For the transition period from                                         to                                        

Commission file number 1-13004

CITIZENS, INC.

Registrant’s telephone number, including area code: (512) 837-7100

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes þ No o.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ___

As of the Registrant’s last business day of its most recently completed second fiscal quarter (June 30, 2004), the aggregate market value of the Class A voting stock held by non-affiliates of the Registrant was approximately $290,340,827.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Report incorporates certain portions of the definitive proxy material of the Registrant in respect of Annual Meeting of Shareholders.

Number of shares of common stock outstanding as of March 1, 2005:

Class A: 37,433,736
Class B: 936,181

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Table of Contents

PART I

Item 1. Business

	(a)	General development of business
		Citizens, Inc. (Citizens) operates primarily as an insurance holding company. We were incorporated in Colorado in 1977. We are a parent company that directly or indirectly owns 100% of 15 operating subsidiaries that are listed in the table below. Collectively, Citizens and its subsidiaries are referred to herein as the “Company”, “we” or “us.” Information concerning our subsidiaries follows.

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Historically, our business has focused primarily on issuing ordinary whole life insurance products to overseas residents, and most of our revenues continue to be generated from this area. In addition, our U.S. operations consist of the sale of ordinary whole life insurance and limited amount of benefit accident and health insurance products to middle and lower income Americans, as well as managing books of life insurance from insurance subsidiaries acquired over the past several years.

We actively review acquisition opportunities for other U.S. life insurers, and we consider a variety of criteria when evaluating potential acquisition candidates, including:

	•	the asset base and growth opportunities;
	•	insurance policy composition as well as persistency and profitability of the policies;
	•	the market location and demographics of the policyholder base;
	•	opportunities to achieve economies of scale;
	•	the effect of the acquisition on book value and earnings per share;
	•	resources required to integrate the operations; and
	•	the investment required for, and opportunity costs of, the acquisition.

Our strategy in integrating acquisitions is to achieve revenue growth while continuously reviewing and streamlining the operations of the acquired entities. The following are our acquisitions in the last five years.

On March 19, 2002, we issued approximately 753,000 shares of our Class A common stock to acquire Combined, and approximately 305,000 shares of our Class A common stock to acquire Lifeline Underwriters Life Insurance Company (“Lifeline”). The aggregate market value of the consideration was approximately $12.0 million.

On February 18, 2003, we issued approximately 2.6 million shares of our Class A common stock to acquire First Alliance Corporation, the then owner of FAIC. The aggregate market value of the consideration was approximately $17.2 million.

On November 18, 2003, we issued approximately 775,000 shares of our Class A common stock to acquire Mid-American. The aggregate market value of the consideration was approximately $7.2 million.

On October 1, 2004, we acquired SPLIC and its subsidiary, SPFIC, for $85 million, which was funded from cash on hand and a $30 million term loan from Regions Bank.

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Certain statements contained in this Annual Report on Form 10-K are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the “Act”), including, without limitation, the italicized statements and the statements specifically identified as forward-looking statements within this document. Many of these statements contain risk factors as well. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements, include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of plans and objectives of the Company or its management or Board of Directors including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “may”, “will” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) the strength of foreign and U.S. economies in general and the strength of the local economies where our policyholders reside; (ii) the effects of and changes in trade, monetary and fiscal policies and laws; (iii) inflation, interest rates, market and monetary fluctuations and volatility; (iv) the timely development of and acceptance of new products and services and perceived overall value of these products and services by existing and potential customers; (v) changes in consumer spending, borrowing and saving habits; (vi) a concentration of business from persons residing in third world countries; (vii) uncertainties in assimilating acquisitions; (viii) the persistency of existing and future insurance policies sold by the Company and its subsidiaries; (ix) the dependence of the Company on its Chairman of the Board; (x) the ability to control expenses; (xi) the effect of changes in laws and regulations (including laws and regulations concerning insurance) with which the Company and its subsidiaries must comply, (xii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xiii) changes in the Company’s organization and compensation plans; (xiv) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (xv) the success of the Company at managing the risks involved in the foregoing.

Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events.

We make available, free of charge, through our Internet website (http://www.citizensinc.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Section 16 reports filed by officers and directors, news releases, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the Securities and Exchange Commission. We are not including the

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          information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K.

(b)	Financial information regarding the insurance business
	Through several of our subsidiaries, we operate principally in four business segments: offering selected lines of individual life insurance policies in the United States, selected U.S. individual accident and health policies, the issuance of ordinary whole life insurance policies in the United States utilizing the home service distribution method, and the acceptance of applications from foreign nationals and overseas residents for the consideration of the issuance of individual ordinary whole life insurance around the world. Except for certain insignificant operations, we do not, and have no present intention to, engage in any non-insurance related business. The following tables set forth certain statistical information on the basis of accounting principles generally accepted in the United States of America (U.S. GAAP) concerning our operations for each of the five years ended December 31, 2004.

Table I

The following table sets forth (i) life insurance in force and (ii) mean life insurance in force.

Improved persistency in 2001 combined with increased sale of new policies in 2000 and 2001 contributed to the growth in insurance in force during 2000 and 2001. Increased surrender activity during 2002 related to the uncertain economic climate in several Latin American countries contributed to the decline in insurance in force. Increased issuance of new policies coupled with acquisitions contributed to the growth in insurance in force in 2003. The acquisition of SPLIC in October, 2004 added approximately $982 million to the life insurance in force.

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Table II

The following table sets forth (i) the ratio of lapses and surrenders to mean life insurance in force and (ii) life reinsurance ceded.

Lapsation and surrender activity attributed to policyholders of FAIC and MACLIC, two companies we acquired in 2003, contributed approximately $39,627,000 to the increase in 2003 lapses and surrenders. As described above, the uncertain economic climate in several Latin American countries contributed to the increased lapsation and surrender activity in 2002. The decline in ceded premium in 2001 and 2002 related to an increase in our retention from $75,000 to $100,000. The decline in ceded premium in 2003 was related to the termination of a substantial portion of the major medical business acquired with the acquisitions of CNLIC, while the significant increase in 2004 ceded premium related to the 100% cession of the in-force accident and health premiums to another carrier.

Table III

The following table sets forth information with respect to total insurance premiums.

The non-renewal of certain major medical policies affected total premium income for 2000 and 2001. The 2002 increase in accident and health premiums is attributable to the acquisition of CNLIC. The 2003 premium increase was related to increased new life revenues and the acquisitions of FAIC and MACLIC. In 2004, the decline in accident and health premium as a result of the cession of the business to another carrier, was offset by increases in CICA’s international business and the acquisition of SPLIC in 2004. The casualty premiums in 2004 resulted from the acquisition of SPFIC.

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Table IV

The following table sets forth information relating to the ratio of underwriting and other expenses to insurance revenues.

During 2000, accident and health premiums and claims decreased as discussed above due to the cancellation of major portions of our group dental and major medical business; however, due to the costs associated with the creation of a U.S. ordinary life sales program and the administrative costs of managing the run-off of the cancelled accident and health business, the ratio of expenses to premiums increased. During 2001, a decrease in lapses and surrenders combined with a decrease in accident and health claims offset increased commissions and administration expenses, resulting in a decrease in the ratio of benefits to premiums and an increase in the ratio of expenses to premiums. During 2002, increased new life revenues and increased accident and health premiums attributable to the acquisition of CNLIC resulted in decreases in the ratio of benefits to premiums; however, the expenses associated with conversion efforts and the administration of the accident and health business increased the ratio of expenses to premiums. During 2003, increased new life revenues from new business and the acquisitions of FAIC and MACLIC resulted in decreases in the ratio of benefits; however, the expenses of these two acquisitions resulted in increases in the ratios of expenses to premiums. In 2004, expense reductions resulted in improvement in the ratio of expenses to premiums; however, the claims incurred by SPLIC caused the overall expense and benefit ratio to increase slightly. Because of the nature of SPLIC’s business, a high benefit ratio is not unusual.

Table V

The following table sets forth changes in the face amount of new life insurance business produced between participating and non-participating policies.

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During 2000 and 2001, the percentage of participating new business grew due to the mix of products issued. During 2003, the acquisitions of FAIC and MACLIC contributed to the increase in non-participating new business, and the 2004 purchase of SPLIC further increased the percentage of non-participating business.

Table VI

The following table sets forth changes in the face amount of new life insurance business issued according to policy types.

In 2000, new life business, measured in paid annualized premiums, increased 21.4%. In 2001, new life business increased 14.9%. In 2002, such business increased 17.7% due to acquisitions and internal growth, while in 2003 the increase was 2.9%. The 2003 growth was slowed by the economic downturn in several Latin American countries. In 2004, the addition of SPLIC, which contributed three months results, coupled with growth in CICA’s overseas business, increased the percentage of whole life insurance in force.

Table VII

     The following table sets forth deferred policy acquisition costs capitalized and amortized compared to new life insurance business issued.

Amortization expense in 2002 and 2003 increased due to higher surrender activity while the decreases in 2001 and 2000 were due to improved persistency. The increase in capitalized costs since 2000 is related to the increase in new business issued. In 2004, persistency on CICA’s international business improved, contributing to lower amortization, as well as no amortization for the accident and health business that was ceded in 2004.

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Table VIII

The following table sets forth the mean amount of our invested assets and net investment income from our investment portfolio.

During 2000, we terminated our outside investment manager and changed the mix of new investments, resulting in improved performance for the year. During 2001, the significant decrease in yields in the bond market caused the return on invested assets to drop slightly. During 2002 we were able to maintain our investment yield by continuing to place less emphasis on government guaranteed pass-through instruments and more emphasis on investments in callable instruments issued by U.S. government agencies. During 2003, the low interest rates available on newly invested money relative to prior years and the significant call activity on the bonds owned negatively impacted our net investment income compared to prior years. In 2004, only SPLIC’s investment income for the fourth quarter was included, leading to a further decline in percentage return. Had the entire year’s results for SPLIC been included, the ratio above would have been 5.6%.

(c)

Narrative description of business

	(i)	Business of Citizens
		Our principal business is that of a life insurance holding company. Additionally, we provide management services to our subsidiaries and other companies who contract with us for our services, under management services agreements. At December 31, 2004, we had approximately 600 full time equivalent employees, including approximately 390 full-time agents. All inter-company fees and expenses have been eliminated in the consolidated financial statements.
	(ii)	Business of CICA
		CICA has historically been our primary insurance subsidiary and 74% of our 2004 revenues were derived from its operations. Historically, CICA’s revenues have been from life insurance premiums and investment income. CICA is a Colorado-domiciled life insurance company that makes available ordinary whole life products to high net worth foreign nationals through contracts with overseas marketing organizations. Additionally, it offers credit life insurance policies, as well as ordinary whole life insurance products, to middle income U.S. residents. All intercompany fees and expenses have been eliminated in the consolidated financial statements.

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		During the year ended December 31, 2004, 97.7% of CICA’s premium income was attributable to life, endowment and term insurance, 1.4% to accident and health insurance, and 0.9% to individual annuities. Of the life policies in force at December 31, 2004 and 2003, 32.6% and 45.8%, respectively, were non-participating and 67.4% and 54.2%, respectively, were participating.
		CICA has begun a United States marketing program focused on the sale of ordinary whole life products to middle income families. Sales to date have been insignificant. We intend to expand sales efforts to other states in which CICA is licensed and believe that our recent acquisitions should augment this program.
		CICA’s underwriting policy requires a medical examination of applicants for ordinary insurance in excess of certain prescribed limits. These limits are graduated according to the age of the applicant and the amount of insurance. Generally, the maximum amount of ordinary life insurance issued domestically without a medical examination is $200,000 for ages 0 through 35; $100,000 for ages 36 through 45; $50,000 for ages 46 through 50; $15,000 for ages 51 through 55; and $10,000 for ages 56 and over. In addition, HIV testing is performed on all applicants for amounts over $75,000. Non-United States applicants through age 39 can obtain up to $150,000 of insurance without a medical examination. Medical examinations are required of all non-United States applicants aged 40 and over. The supplemental accident and health policies sold in the United States have only minimal field underwriting.
		On life policies, CICA’s maximum coverage on any one life is not limited. However, CICA reinsures the amount of coverage, which is in excess of its retention policy. See “Business of CICA — Reinsurance.” CICA does not accept substandard risks above Table 6 (generally policyholders who cannot qualify for standard ordinary insurance because of past medical history).
		At December 31, 2004, CICA had $30.4 million of insurance in force on individuals that are classified as substandard risks, the majority of such business having been acquired in the purchase of other companies. Management believes the exposure to loss as a result of insuring these individuals is minimal, since the premiums are higher than standard policies to cover the nature of the risk, additional reserves are established, and the amount of this insurance represents approximately 1.0% of the total insurance in force.
		Geographical distribution of business
		CICA makes available ordinary whole-life insurance products to residents of foreign countries worldwide. Premium income from non-U.S. residents accounted for approximately 87.4%, 86.2% and 84.5% of total CICA premiums for the years ended December 31, 2004, 2003 and 2002, respectively.
		Areas representing more than 5% of CICA’s total premiums for the years ended December 31, 2004, 2003 and 2002 were: Argentina – 12.5%, 15.3% and 19.43%; Colombia – 26.9%, 26.3% and 25.1%; Ecuador – 5.4%, 4.3%, 3.5%; Taiwan – 5.5%, 3.4%, 1.3%; Venezuela – 9.5%, 8.9%, 10.4% and Uruguay – 5.1%, 6.8% and 8.0%, respectively.
		The following table sets forth the composition of CICA’s total yearly premium income by geographic area for the years indicated.

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The policies issued by CICA on residents of foreign countries have an average face amount of approximately $58,000 and are issued primarily to individuals in the top 5% of the population in terms of household income. CICA has neither offices nor employees overseas. It accepts applications for international insurance policies submitted by several outside marketing firms and consultants in these markets with whom CICA has non-exclusive contracts. These firms and consultants specialize in marketing life insurance products to citizens of foreign countries and have many years of experience marketing life insurance products. The outside firms provide recruitment, training and supervision of their managers and associates in the placement of dollar-denominated life insurance products; however, all associates of these firms contract directly with CICA and receive their compensation directly from CICA. Accordingly, should the arrangement between any outside marketing firm and CICA be canceled for any reason, CICA believes it could continue suitable marketing arrangements with the associates of these outside firms without appreciable loss of present and future sales, as CICA has done in the past. There is, however, always a risk that sales could decrease.

CICA’s standard agreement with individual consultants provides that the consultant is the representative of the prospective insured. CICA’s standard contract with outside marketing firms provides that the firm has the responsibility for recruiting and training its associates. These firms guarantee any debts of their marketers and their associates to CICA. In consideration for the services rendered, the marketing firms receive a fee on all new policies placed by them or their associates. See “Business of CICA — Commissions.” CICA’s contracts with both outside marketing firms and consultants provide that any party may terminate the contracts for various causes at any time or upon 30 days’ notice.

At present, CICA is dependent on the non-U.S. markets for a large percentage of its new life insurance business. As a result of these foreign markets, CICA is subjected to potential risks with regard to the continued ability to write such business should adverse events occur in the countries from which CICA receives applications. These potential risks include lapses of policies if funds that flow out of such countries were to become restricted. Based on more than 35 years experience in the marketplace in which CICA competes, management believes such risks are not material. CICA maintains no assets outside the U.S. and requires all premiums to be paid in the U.S. with U.S. dollars via drafts drawn on banks in the U.S.; therefore, it is not subject to currency devaluation or foreign appropriation. Management believes that many of the inherent risks in foreign countries, such as political instability, hyperinflation and economic disruptions, tend to improve rather than hurt CICA’s business over the long term because they encourage individuals to convert assets out of local currencies to the more stable U.S. dollar.

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Marketing operations

CICA holds licenses to do business in 16 states and accepts applications for consideration from any foreign country. CICA’s marketing operations are conducted by outside consultants, with 3,263 active representatives contracted at December 31, 2004, 3,778 individuals contracted at December 31, 2003 and 2,445 at December 31, 2002.

Commissions

CICA’s marketing associates are independent contractors, responsible for their respective expenses, and are compensated based on a percentage of premiums. Percentage amounts paid to insurance associates on individual term, annuity and accident and health insurance are substantially less than the levels paid for individual ordinary life insurance. With respect to CICA’s contracts with outside marketing consultants, these firms receive overriding first year and renewal commissions on business written by associates under their supervision, and all marketing expenses related thereto, except conventions, are borne by these consultants.

Reserves

CICA has established liabilities for policyholders’ account balances and future policy benefits to meet obligations on various policies and contracts. Reserves for policyholders’ account balances for investment-type policies are equal to cumulative account balances consisting of deposits plus credited interest, less expense and mortality charges and withdrawals. Future policy benefits for traditional products are computed on the net level premium method, which utilizes assumed investment yields, mortality, persistency, morbidity and expenses (including a margin for adverse deviation). These reserves are established at the time of issuance of a policy and generally vary by product, year of issue and policy duration. CICA periodically reviews both reserve assumptions and policyholder liabilities.

Reinsurance

As is customary among insurance companies, CICA reinsures with other companies portions of the life and accident and health insurance risks it will underwrite. The primary purpose of reinsurance agreements is to enable an insurance company to reduce the amount of risk on any particular policy and, by reinsuring the amount exceeding the maximum amount the insurance company is willing to retain, to write policies in amounts larger than it could without such agreements. Even though a portion of the risk may be reinsured, CICA remains liable to perform all the obligations imposed by the policies issued by it and could be liable if its reinsurers were unable to meet their obligations under the reinsurance agreements.

(1)

Insurance ceded

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CICA retains up to $100,000 of risk on any one person. As of December 31, 2004, the aggregate amount of life insurance ceded was $171,283,000 or 5.3% of total direct and assumed life insurance in force, and at December 31, 2003 was $171,992,000 or 5.6% of direct insurance in force. CICA is contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations reinsured.

As of December 31, 2004, CICA had in effect automatic reinsurance agreements with reinsurers that provide for cessions of ordinary insurance from CICA. These treaties provide for both automatic and facultative reinsurance of standard and substandard risks ceded to them by CICA for life, accident and health and supplemental benefits above CICA’s retention limit on a yearly renewable term, or coinsurance basis. Automatic cession means that so long as the risk is within the limits of the reinsurance agreement the reinsurer must assume the risk. Facultative cases are subject to specific underwriting approval of the reinsurer.

Historically, treaties with Employers Reassurance (ERC), American United Life Insurance Company (AUL) and Businessmen’s Assurance (BMA), all unaffiliated parties, were used by CICA for its international business. The treaties were structured in such a way as to allow CICA to “self administer” the cessions on a reduced cost basis.

The ERC and BMA agreements provided that for risks reinsured in specified countries, 70% of each risk in excess of CICA’s retention would be ceded to ERC and 30% to BMA. The AUL agreement provided that on risks reinsured in specified countries, 100% of the risk in excess of CICA’s retention was ceded to AUL. CICA paid premiums to ERC, BMA and AUL on an annual basis.

The cessions were on a yearly renewable term basis and were automatic over CICA’s retention up to $280,000 for ERC, $120,000 for BMA and $400,000 for AUL, after which the reinsurance is subject to a facultative review by the reinsurers. At December 31, 2004, CICA had ceded $57,909,000 in face amount of insurance to ERC, $23,794,000 to Riunione Adriatica di Sicurta of Italy, a predecessor to AUL, $16,320,000 to BMA and $24,632,000 to AUL under these agreements.

In late 2002, AUL notified CICA that it would no longer be accepting new reinsurance business effective January 1, 2003, as a result of being purchased by ERC, which was owned by General Electric. Subsequently, ERC indicated a desire to withdraw from the international reinsurance market because of a decision on the part of its new parent.

Consequently, a pool of two reinsurers was created in early 2003 to replace BMA, ERC and AUL for new business. Worldwide Reassurance of England (Worldwide) received 55% of the reinsurance pool of all countries. Converium, of Germany, was given 45% of the reinsurance pool. At December 31, 2004, CICA had ceded $27,729,000 in face amount to Worldwide and $16,532,000 to Converium. The former reinsurers retain their risk on business previously ceded.

Worldwide and Converium are unauthorized reinsurers in the state of Colorado. However, they have each agreed to provide a letter of credit issued by a U.S. Bank in the amount of any liabilities they may incur under the reinsurance

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agreements with CICA in the event that a reinsurance credit is significant. There were no such significant credits as of December 31, 2004.

In addition, a reinsurance treaty with Swiss Re Life & Health America, Inc. (Swiss Re) covers all of CICA’s accidental death insurance supplementing its life insurance policies. These cessions are on a yearly renewable term basis and occur automatically if total accidental death benefits known to CICA are less than $250,000 or otherwise on a facultative review basis. At December 31, 2004, CICA had ceded $1.4 billion of supplemental life insurance benefits to Swiss Re under this treaty.

Effective January 1, 2004, CICA entered into a coinsurance agreement with Texas International Life Insurance Company (TILIC), an unaffiliated party, whereby TILIC assumed all of CICA’s non-credit accident and health business. CICA shares in the profits of the business, on a graduated scale, over a ten-year period.

CICA monitors the solvency of its reinsurers in seeking to minimize the risk of loss in the event of a failure by a reinsurer. The primary reinsurers of CICA are large, well capitalized entities.

(2)

Insurance assumed

At December 31, 2004, CICA had in-force reinsurance assumed as follows:

The reinsurance agreement with Prudential provides for CICA to assume a portion of the insurance under a group insurance policy issued by Prudential to the Administrator of Veterans’ Affairs. CICA’s portion of the total insurance under the policy is allocated to CICA in accordance with the criteria established by the Administrator.

CICA has also entered into a Serviceman’s Group Life Insurance Conversion Pool Agreement with Prudential, under the above-described agreement, whereby CICA assumed a portion of the risk of Prudential under the group policy due to excess mortality under the conversion pool agreement. This was for risks resulting from issuing conversion policies as prescribed for membership in the conversion pool.

Investments

State insurance statutes prescribe the quality and percentage of the various types of investments which may be made by insurance companies and generally permit investment in qualified state, municipal, federal and foreign government obligations, high quality corporate bonds, preferred and common stock, real estate and mortgage loans within certain specified percentages. CICA’s invested assets at December 31, 2004 were distributed as follows: 83.4% in fixed maturities, 0.2% in mortgage loans, 10.9% in policy loans, 0.1% in other long-term

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investments, and 5.4% in short-term investments. CICA foreclosed on one small mortgage in 2004 for a profit. The investment policy of CICA is consistent with the provisions of the Colorado Insurance Code.

At December 31, 2004, 98.6% of CICA’s investments in fixed maturities were comprised of U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities, compared to 97.4% at December 31, 2003. Of these mortgage-backed securities, all were guaranteed by U.S. government agencies or corporations that are backed by the full faith and credit of the U.S. government or that bear the implied full faith and credit of the U.S. government.

Regulation

Our insurance company subsidiaries are subject to regulation and supervision by the insurance department of each state or other jurisdiction in which they are licensed to do business. These departments have broad administrative powers relating to the granting and revocation of licenses to transact business, the licensing of marketing persons, the approval of policy forms, the advertising and solicitation of insurance, the form and content of mandatory financial statements, the reserve requirements, and the type of investments which may be made. Our insurance subsidiaries are required to file detailed annual reports with each such insurance department, and their books and records are subject to examination at any time. In accordance with state laws and the rules and practices of the National Association of Insurance Commissioners (NAIC), our insurance subsidiaries are examined periodically by examiners of their domiciliary states and by representatives (on an “association” or “zone” basis) of the other states in which they are licensed to do business. An examination of CICA was concluded in 2003 for the five years ended December 31, 2001, by a statutory examination accounting firm under contract with and supervision by the Colorado Division of Insurance. The examination noted no substantive findings, but made suggestions on a few minor housekeeping matters. An independent public accounting firm audits CICA annually.

Various states, including Colorado, have enacted “Insurance Holding Company” legislation, which requires the registration and periodic reporting by insurance companies that control, or are controlled by, other corporations or persons. Under most of such legislation, control is presumed to exist with the ownership of ten percent or more of an insurance company’s voting securities. We are subject to such regulation and have registered under such statutes as a member of an “insurance holding company system.” The legislation typically requires periodic disclosure concerning the transactions between the registered insurer, the ultimate controlling party, and all affiliates and subsidiaries of the ultimate controlling party, and in many instances requires prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system.

Since we do not physically conduct business in countries outside the U.S. but rather accept applications for consideration from overseas marketers, we are not subject to regulation in countries where most of our insureds are residents. We view the prospect of such regulation as unlikely because obtaining insurance

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through application by mail outside of one’s country is a common practice in many foreign countries, particularly those where CICA’s insureds reside.

Competition

The life insurance business is highly competitive, and we compete with a large number of stock and mutual life companies both internationally and domestically as well as from financial institutions which offer insurance products. We compete with 1,500 to 2,000 other life insurance companies in the United States, some of which we also compete with internationally. We believe that our premium rates and policies are generally competitive with those of other life insurance companies selling similar types of ordinary whole-life insurance, many of which are larger than we are.

A large percentage of our first year and renewal life insurance premium income comes from the international market. See “Business of CICA — Geographical Distribution of Business.” Given the significance of our international business, the variety of markets in which we make ordinary whole-life insurance available and the impact that economic changes have on these foreign markets, it is not possible to ascertain our competitive position. We face offshore competition from several American life insurance companies that also sell U.S. dollar denominated policies to non-U.S. citizens, with no one company being dominant in the market. Some companies may be deemed to have a competitive advantage due to histories of successful operations and large agency forces. Management believes that its experience, combined with the special features of CICA’s unique policies, allows CICA to compete effectively in pursuing new business.

Our marketing plan stresses making available dollar-denominated whole life, cash value build-up, insurance products to high net worth individuals residing in foreign countries. It also focuses on the sale of individual, cash value whole life and supplemental accident and health products to United States residents.

We compete indirectly with non-U.S. companies, particularly Latin American companies. However, because our premiums must be paid in U.S. dollars drawn on U.S. banks, and we pay claims in U.S. dollars, we have a different clientele and product than foreign-domiciled companies. Our products are usually acquired by persons in the top 5% of income of their respective countries. The policies sold by foreign companies are offered broadly and are priced based on the mortality of the entire populace of the respective geographic region. Because of the predominance of lower incomes in most of these countries, the mortality experience tends to be very high on the average, causing mortality charges that are considered unreasonable based on the life mortality experience of the upper 5% of income of the population.

Additionally, the assets that back up the policies issued by foreign companies are substantially invested in the respective countries, and thus, are exposed to the inflationary risks and economic crises that historically have impacted many foreign countries. Another reason that we experience an advantage is that many of our policyholders desire to transfer capital out of their countries due to the perceived financial strength and security of the United States.

(iii)

Business of SPLIC

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SPLIC was acquired in October 2004 for $85 million. Historically, SPLIC has focused on the needs of the lower income market. Its policies, which are predominantly ordinary whole life products, provide a means of taking care of individuals’ final expenses, primarily consisting of funeral and cemetery costs. The policies are sold and serviced through the home service (or debit) marketing distribution system utilizing employee-agents who work on a route system to collect premiums and service policyholders. Virtually all business has been written in Louisiana, where SPLIC is one of the leading writers of life insurance in the home service business. In addition, SPLIC has a small block ($830,000 of annual premium) of accidental health insurance in force. SPLIC’s premium writings have been supplemented by the acquisition of life insurance policies from over 100 companies in its history.

Because of the type of business SPLIC writes, the average life insurance policy face amount in force is relatively small—approximately $1,400 per policy in 2004. The underwriting performed on these applications is limited due to the small average face amount.

Marketing operations

SPLIC holds licenses to do business in two states—Louisiana and Mississippi. Its marketing activities were conducted by approximately 390 employee/agents as of December 31, 2004.

Reserves

SPLIC has established liabilities for policyholders’ account balances and future policy benefits to meet obligations on various policies and contracts. Reserves for policyholders’ account balances for investment-type policies are equal to cumulative account balances consisting of deposits plus credited interest, less expense and mortality charges and withdrawals. Future policy benefits for traditional products are computed on the net level premium method, which utilizes assumed investment yields, mortality, persistency, morbidity and expenses (including a margin for adverse deviation). These reserves are established at the time of issuance of a policy and generally vary by product, year of issue and policy duration. SPLIC periodically reviews both reserve assumptions and policyholder liabilities.

Reinsurance

Consistent with the general practice in the life insurance industry, SPLIC has reinsured portions of the coverage provided by its insurance products with other non-affiliated insurance companies. Insurance is ceded principally to reduce net liability on individual risks, to provide protection against large losses and to obtain a greater diversification of risk. Although reinsurance does not legally discharge the ceding insurer from its primary liability for the full amount of policies reinsured, it does make the reinsurers liable to the insurer to the fullest extent of the reinsurance ceded.

SPLIC seeks to enter into reinsurance treaties with highly rated and capitalized insurers. Its policy is to use reinsurers who have received an A.M. Best rating of

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“A-(Excellent)” or better and who, in the opinion of management have significant levels of capital and surplus. We believe that we have established appropriate reinsurance coverage based upon our net retained insured liabilities compared to our surplus. Based on a review of our reinsurers’ financial positions and reputations in the reinsurance marketplace, we believe that our reinsurers are financially sound.

In addition, SPLIC maintains a coinsurance agreement with the former parent of SPLIC on a closed block of business that represents less than 1% of total business in force.

Investments

Prior to its acquisition by CICA, SPLIC utilized outside investment managers to oversee its portfolio. CICA terminated the outside managers, preferring its own in-house style.

The portfolio of SPLIC has a significant investment in corporate bonds. Corporate bonds make up approximately 48% of the overall bond portfolio. Additionally, because of certain provisions of Louisiana law that permit reductions in certain taxes based upon investment in that state, tax-exempt municipal bonds make up more than 12% of the bond portfolio. The remaining bonds are comprised of those issued by the U.S. government, or agencies. SPLIC does not have any equity investments.

(iv)

Business of CNLIC (formerly Combined)

CNLIC is a Texas-domiciled life and accident and health insurer offering products primarily to residents of the southern United States. CNLIC was acquired by the Company in 2002. At the same time, an affiliated company of Combined, Lifeline Underwriters Life Insurance Company (Lifeline) was also acquired. Lifeline was merged into Combined in 2003. During 2004, Combined was renamed Citizens National Life Insurance Company (CNLIC). CNLIC is licensed in the states of Alabama, Arizona, Arkansas, Florida, Louisiana, Mississippi, Missouri, New Mexico, Oklahoma, Texas and Virginia. The majority of CNLIC’s business is concentrated in Texas (66.2%), Oklahoma (21.6%) and Louisiana (5.4%). At December 31, 2004, CNLIC had assets of $22.7 million and 2004 revenues of $4.9 million. All intercompany fees and expenses have been eliminated in the consolidated financial statements.

As of December 31, 2004, CNLIC had $73,885,000 of life insurance in force, of which $5,205,000 was reinsured. The maximum retention on any one life is $35,000. All of its accidental death benefit coverage is reinsured. As of December 31, 2004, CNLIC also had $9,526,000 (in premiums) of accident and health insurance in force (including $495,000 of group business), all of which was ceded to another carrier.

CNLIC operates as a stipulated premium company under Texas law. Life, accident and health policies are primarily sold by licensed independent general agents. In addition, individuals may also be issued licenses to act as agents and sell only life insurance not to exceed $15,000 on any one life after receiving certification from CNLIC that the individual has completed a course of study and

18

passed a written examination. None of these agents or individuals licensed to act as agents have underwriting authority. Management believes that commissions paid by CNLIC are competitive with commissions paid by other life and accident and health insurance companies in the states in which CNLIC is licensed to operate. CNLIC is aware that there is considerable competition for obtaining qualified agents and that it competes with well-established insurance companies for agents to sell its policies. CNLIC also recruits and trains agents from among persons who are not now engaged in the selling of life and accident and health insurance.

Investments

CNLIC’s investments are limited as to type and amount by Texas insurance laws designed to insure prudent investment policies. The investment of capital, paid-in and operating surplus and other funds of insurers organized under the laws of the State of Texas is governed by the Texas Insurance Code. These statutes include general and specific limitations on investments, records of investments and other matters. The Texas insurance law regulating investments and other aspects of the management of insurance companies is designed primarily for the protection of policyholders rather than investors.

The administration of CNLIC’s investment portfolio is handled by management, with all trades approved by a committee of its Board of Directors. The investment guidelines require that bonds, both government and corporate, are of high quality and comprise a majority of the investment portfolio. The assets selected are intended to mature in accordance with the average maturity of the insurance products and to provide cash flow for CNLIC to meet its policyholder obligations. The type, quality and mix of investments are designed to allow CNLIC to compete in the life and accident and health insurance marketplace and to provide appropriate interest margins.

Of CNLIC’s investments at December 31, 2004, 74.1% were in bonds and 25.7% in short-term investments, with the remaining .2% invested in equity securities. With respect to the invested bonds, 98.9% were invested in U.S. Treasury securities and obligations of U.S. government corporations and agencies, or in corporations that bear the implied full faith and credit of the U.S. government, with the remaining 1.1% invested in corporate securities.

Reinsurance

CNLIC’s life insurance is being ceded through reinsurance agreements with Generali USA Reinsurance Company (Generali), Kansas City, Missouri and Optimum Re, Dallas, Texas. At December 31, 2004, CNLIC had ceded $1,020,000 in face amount to Generali and $4,185,000 to Optimum Re. Additionally, during 2004 CNLIC entered into a coinsurance agreement with Texas International Life Insurance Co. (TILIC) whereby TILIC assumed 100% of CNLIC’s accident and health business in force. None of CNLIC’s reinsurers are affiliated with the Company.

Reserves

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CNLIC has established liabilities for policyholders’ account balances and future policy benefits to meet obligations on various policies and contracts. Reserves for policyholders’ account balances for investment-type policies are equal to cumulative account balances consisting of deposits plus credited interest, less expense and mortality charges and withdrawals. Future policy benefits for traditional products are computed on the net level premium method, which utilizes assumed investment yields, mortality, persistency, morbidity and expenses (including a margin for adverse deviation). These reserves are established at the time of issuance of a policy and generally vary by product, year of issue and policy duration. CNLIC periodically reviews both reserve assumptions and policyholder liabilities.

(v)

Business of CUSA, FAIC, MACLIC and SAIC

In addition to the domestic life business of CICA, SPLIC and SPFIC, the remaining domestic life operations of the Company originate from CUSA, FAIC, MACLIC and SAIC.

CUSA is an Illinois domiciled life insurer admitted to do business in four states. During 2003, Excalibur Insurance Corporation was merged into Central Investors Life Insurance Company of Illinois and the merged company was renamed Citizens USA Life Insurance Company (CUSA). At December 31, 2004, CUSA had assets of $6.7 million and annual revenues of $430,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements. As of December 31, 2004, CUSA had $4,482,000 in life insurance in force, of which $1,038,000 was reinsured.

FAIC is a Kentucky domiciled life insurer admitted to do business in six states. It was acquired in connection with the Company’s February 18, 2003 acquisition of First Alliance. At December 31, 2004, FAIC had assets of $34 million and revenues of $4.9 million. All intercompany fees and expenses have been eliminated in the consolidated financial statements. As of December 31, 2004, FAIC had $128,894,000 of life insurance in force, of which $49,028,000 was reinsured. FAIC was merged into CICA effective January 1, 2005, following regulatory approval.

MACLIC is a Missouri domiciled life insurer admitted to do business in two states. It was acquired in connection with the Company’s November 18, 2003 acquisition of Mid-American. At December 31, 2004, MACLIC had assets of $9 million and revenues of approximately $2.9 million. MACLIC offers ordinary whole life insurance policies with annuity riders to residents of Missouri. During 2004, approximately $1.0 million of new life insurance premiums were submitted. All intercompany fees and expenses have been eliminated in the consolidated financial statements. As of December 31, 2004, MACLIC had $77,354,000 of life insurance in force, of which $30,784,000 was reinsured.

SAIC is a dormant Arkansas domiciled life insurer admitted to do business in Arkansas. It was also acquired in connection with the Company’s November 18, 2003 acquisition of Mid-American. At December 31, 2004, SAIC had assets of approximately $362,000 and revenues of $17,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements. As of December 31, 2004, SAIC had $941,000 of life insurance in force, of which

20

$574,000 was reinsured.

CUSA, FAIC, MACLIC and SAIC all operate as life insurance companies under the laws of their respective states of domicile. SAIC is dormant, and the remaining companies offer ordinary whole life insurance policies sold by licensed general agents. No agent has underwriting authority. The commissions paid are believed by management to be competitive with commissions paid by other life insurance companies in the states in which CUSA, FAIC, MACLIC and SAIC are licensed to operate. There is considerable competition for obtaining qualified agents and these companies compete with other well-established insurance companies for agents to sell their policies.

Investments

CUSA, FAIC, MACLIC and SAIC invest and reinvest certain of their reserves and other funds. The investments of these companies are limited as to type and amount by the insurance laws of their state of domicile, which are designed to insure prudent investment policies.

The investment of capital, paid-in and operating surplus and other funds of insurers organized under the laws of the state of domicile of CUSA, FAIC, MACLIC and SAIC is specified by the insurance laws of those states. These statutes generally include general and specific limitations on investments, records of investments and other matters. The insurance law of these states regulating investments and other aspects of the management of insurance companies is designed primarily for the protection of the policyholders rather than investors.

The administration of the investment portfolios of CUSA, FAIC, MACLIC and SAIC is handled by management, with all trades approved by a committee of their respective Boards of Directors. The guidelines used require that bonds, both government and corporate, are of high quality and comprise a majority of the investment portfolio. The assets selected are intended to mature in accordance with the average maturity of the insurance products and to provide the cash flow for CUSA, FAIC, MACLIC and SAIC to meet their respective policyholder obligations. Of CUSA’s investments at December 31, 2004, 92% were in bonds and 7.2% were in short-term investments, with the remaining .8% invested in equity securities. With respect to the invested bonds, 96.4% were invested in U.S Treasury securities and obligations of U.S. government corporations and agencies, or in corporations that bear the implied full faith and credit of the U.S. government, with the remaining 3.6% invested in corporate securities.

Of FAIC’s investments at December 31, 2004, 94.6% were in bonds, with the remaining 5.4% invested in common stocks. With respect to the invested bonds, 96.5% were invested in U.S. Treasury securities and obligations of U.S. government corporations and agencies, or in corporations that bear the implied full faith and credit of the U.S. government, with the remaining 3.5% invested in corporate securities.

Of MACLIC’s investments at December 31, 2004, 88% were in bonds and 12% in short-term investments. With respect to the invested bonds, 63.3% were invested in U.S. Treasury securities and obligations

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of U.S. government corporations and agencies, or in corporations that bear the implied full faith and credit of the U.S. government, with the remaining 39.7% invested in corporate securities.

The invested assets of SAIC at December 31, 2004 were invested in bonds.

Reinsurance

As is customary among insurance companies, CUSA, FAIC, MACLIC and SAIC reinsure with other companies portions of the life insurance risks they underwrite. Even though a portion of the risk may be reinsured, the issuing company remains liable to perform all the obligations imposed by the policies issued by it and is liable if the reinsurer should be unable to meet its obligation under the reinsurance agreements.

Reserves

CUSA, FAIC, MACLIC and SAIC have established liabilities for policyholders’ account balances and future policy benefits to meet obligations on various policies and contracts. Reserves for policyholders’ account balances for investment-type policies are equal to cumulative account balances consisting of deposits plus credited interest, less expense and mortality charges and withdrawals. Future policy benefits for traditional products are computed on the net level premium method, which utilizes assumed investment yields, mortality, persistency, morbidity and expenses (including a margin for adverse deviation). These reserves are established at the time of issuance of a policy and generally vary by product, year of issue and policy duration. We periodically review both reserve assumptions and policyholder liabilities.

(vi)

Business of SPFIC

SPFIC, a wholly owned subsidiary of SPLIC, provides property and casualty coverages to lower income residents of Louisiana. SPFIC utilizes the same employees/agents as SPLIC. The maximum coverage on any one dwelling is $20,000 and content coverage is limited to $10,000.

At December 31, 2004, SPFIC had total assets of approximately $6 million and annual revenues of $4.7 million.

(vii)

Business of CTI

CTI is a wholly owned subsidiary of CICA and engages in the business of providing data processing services and acquisition and leasing of furniture and equipment for its parent as well as data processing services and software to other companies. Pursuant to an Information Systems Management and Services Contract dated October 1, 1991, and subsequently amended, CTI provides data processing services to the Company for a fixed fee of $85,000 per month. As of and for the year ended December 31, 2004, CTI’s total assets were approximately $1.1 million and revenues were $1.1 million. All intercompany fees and expenses have been eliminated in the consolidated financial statements.

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(viii)

Business of III

III is a wholly owned subsidiary of CICA and engages in the business of providing aviation transportation for the Company. As of and for the year ended December 31, 2004, III’s total assets were $3.3 million and revenues were $30,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements.

(ix)

Business of FHA

FHA owns and operates a funeral home in Baker, Louisiana. At December 31, 2004, FHA had total assets of $575,000 and total annual revenues of $369,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements.

(x)

Business of KYWIDE, MAAAI and MAAIA

In connection with the acquisitions of First Alliance and Mid-American, Citizens acquired four operating insurance agencies. These insurance agencies market life and property and casualty insurance products of various insurance companies to individuals and companies. During 2004, a dormant subsidiary, AIM, was liquidated. At January 28, 2005, a contract to sell MAAIA was pending. At December 31, 2004, these insurance agencies had total assets of approximately $187,000 and total revenues of approximately $213,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements.

(xi)

Business of First Alliance and Mid-American

First Alliance was the parent of FAIC. It was liquidated in 2004.

Mid-American also operates as an insurance holding company through its directly or indirectly wholly owned subsidiaries MACLIC, SAIC, MAAAI and MAAIA. Mid-American is incorporated in Missouri. At December 31, 2004, Mid-American had total assets of approximately $6.2 million and total revenues of $136,000. All inter-company fees and expenses have been eliminated in the consolidated financial statements.

Item 2. Description of 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 contains housing storage facilities.

Approximately 50,000 square feet is occupied or reserved for our operations with the remainder of the building being leased to a single tenant under a multi-year lease.

We also own a 6,324 square foot funeral home in Baker, Louisiana acquired at a total cost of $527,000. This facility, acquired in a 1995 acquisition, is owned and

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operated by FHA.

In addition, we own other properties in Texas and Louisiana that are incidental to our operations.

Item 3. Legal Proceedings

On April 24, 2003, the Court of Appeals for the Third District of Texas affirmed in part and modified in part, a July 31, 2002, class action certification granted by a Travis County, Texas district court judge to the plaintiffs in a lawsuit filed in 1999 styled Delia Bolanos Andrade, et al v. Citizens Insurance Company of America, Citizens, Inc., Negocios Savoy, S.A., Harold E. Riley, and Mark A. Oliver, Case Number 99-09099. The suit alleges that life insurance policies offered or sold to certain non-U.S. residents by CICA are actually “securities” that were offered or sold in Texas by unregistered dealers in violation of the registration provisions of the Texas securities laws. The suit seeks class action status naming as a class all non-U.S. residents who purchased insurance policies or made premium payments since August 1996 and assigned policy dividends to an overseas trust for the purchase of the Company’s Class A common stock. The remedy sought is rescission of the insurance premium payments. The Supreme Court of Texas granted the Company’s Petition for Review and heard oral arguments on the case on October 21, 2004. The Company believes the Plaintiffs’ claim under the Texas Securities Act is not valid and the class defined is not appropriate for class certification and does not meet the legal requirements for class action treatment under Texas law.

Recent decisions from the Texas Supreme Court indicate a more defense-oriented approach to class certification cases, especially in class action cases encompassing claimants from more than one state or jurisdiction. Although a decision is not expected until sometime in 2005, the Company expects the Supreme Court of Texas will ultimately rule in the Company’s favor, decertify the class and remand the matter to district court for further action. During the time of the Company’s appeal to the Texas Supreme Court, there are no further district court proceedings in the case. The Company is unable to determine the potential magnitude of the claims in the event of a final class certification and the plaintiffs prevailing on the substantive action, although the Company would expect a significant adverse financial impact from any final class action judgment.

The Company is a party to various legal proceedings incidental to its business. The Company has been named as a defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of management, the ultimate liability, if any, resulting from any contingent liabilities that might arise from litigation are not considered material in relation to the financial position or results of operations of the Company. Reserves for claims payable are based on the expected claim amount to be paid after a case-by-case review of the facts and circumstances relating to each claim. A contingency exists with regard to these reserves until the claims are adjudicated and paid.

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

No matters were submitted to our shareholders during the fourth calendar quarter of 2004.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

Our Class A common stock is traded on the New York Stock Exchange (NYSE), under the symbol CIA. The quarterly high and low prices per share as reported by the NYSE are shown below. These prices have been adjusted to reflect 7% stock dividends paid in 2003 and 2004.

As of December 31, 2004, the approximate number of record owners of our Class A common stock was 22,000. Management estimates the number of beneficial owners to be approximately 90,000.

On December 31, 2003, we paid a 7% stock dividend to holders of record as of December 1, 2003. The dividend resulted in the issuance of 2,476,420 Class A shares (including 179,181 shares in treasury) and 57,239 Class B shares.

On December 31, 2004, we paid a 7% stock dividend to holders of record as of December 1, 2004. The dividend resulted in the issuance of 2,690,039 Class A shares (including 191,722 shares in treasury) and 61,246 Class B shares.

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

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 cash warrants issued in conjunction with the convertible preferred stock issued in 2004. (See Note 8 of the “Notes to Consolidated Financial Statements.”)

Item 6. Selected Financial Data

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

     See Item I — 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 Operations

Overview

In 2004, new avenues to growth were added and existing sources of revenues were expanded, leading to improved revenue and profitability for the year.

Our international life business continued to grow at a double-digit pace. New annualized submitted premiums from the international market increased by more than 17% during 2004 compared to 2003. The development of new markets in the Pacific Rim and the expansion of existing markets in Latin America contributed to the growth in international revenues.

Our book of accident and health business, a source of continuing operating losses over the past five years, was transferred to another carrier under a reinsurance agreement that permits us to share in any profits developed over a graduated scale for a period of ten years. Although this action decreased revenues by approximately $13 million in 2004, management believes the reduced overhead and potential for profit will benefit shareholders for the long term.

The development of a United States marketing operation continued during the year. Marketing was active in Missouri, Illinois, Texas and Oklahoma during 2004, and the addition of SPLIC in October 2004 brings an established presence in Louisiana with an experienced core of home service marketing representatives.

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Management believes that the marketing activities of SPLIC can be expanded beyond its current levels.

The acquisition of SPLIC was, at $85 million, the largest made by the Company in its history, and it provides a profitable source of revenue and a solid asset base. We used our $30 million line of credit negotiated in March 2004 from Regions Bank to supplement available cash in completing the transaction. Although the acquisition added $30 million of debt to our balance sheet, management expects to repay the debt by the end of April 2005. Management continues to seek other candidates for acquisition.

Additionally, during 2004 we successfully completed a $12.5 million private placement of convertible preferred stock to a group of four institutional investors. The offering can be increased to $25 million under certain conditions. The preferred stock carries a 4% dividend and is mandatorily redeemable in five years if not converted prior to the redemption date. The dividends and redemptions are payable in shares of the Company’s Class A common stock. Management believes that this placement marks a significant step in the Company’s evolution as it brings institutional investors into the Company.

We continued our plan to consolidate certain operating subsidiaries in order to reduce overhead and streamline operations during 2004. First Alliance was liquidated during the year, and during the first quarter of 2005, FAIC was merged into CICA. Additionally, we entered into an agreement with a third party to sell MAAIA. That transaction is expected to close in the second quarter of 2005. Management plans to continue to make such consolidations in order to achieve better economies of scale by reducing the number of operating subsidiaries.

Results of Operations

The Company operates in four primary segments—international life insurance, U.S. life insurance operations, U.S. accident and health operations and, with the acquisition of SPLIC and SPFIC, U.S. home service insurance operations. Prior to 2004, another segment—U.S. accident and health operations—existed, but that segment was exited in 2004 with the transfer of virtually all of such business to a third party carrier through a coinsurance arrangement.

International Operations

The acceptance of applications for U.S. dollar denominated ordinary whole life insurance from high net worth foreign nationals is the foundation upon which the Company was built. For the past 35 years, we have participated in the foreign marketplace. Positive attributes of the foreign insurance market include:

	•	policies are typically larger face amounts than in the U.S.;
	•	the premiums are paid annually;
	•	persistency is higher compared to U.S. policies;
	•	the mortality is as good as or better than that experienced in the U.S.;

27

	•	the marketers from whom applications are received are more professional than that typically seen in the U.S.; and
	•	commissions are not advanced.

The Company has no assets, offices or employees outside of the U.S. We expect to continue to expand our international operations. The number of our producing independent contractors has expanded over the past few years and the number of countries from where applications are received is expanding. Historically, the majority of such business has come from Central and South America; however, in 2004 the Pacific Rim began to represent a meaningful and growing source of new business, amounting to $2.4 million of submitted annualized premium. Overall, foreign business made up more than 71.1% of total premium revenues in 2004.

Beginning in 2002, expansion began into the Pacific Rim, particularly Taiwan. CICA has established relationships with a number of marketing organizations in the Pacific Rim, and during 2004, received approximately $2.4 million of annualized new submitted premium from that region. Additionally, Brazil, which has never been a country from which large volumes of premiums were received, began to develop adding $650,000 of new premiums. Overall, submitted annualized premiums for 2004 from the international markets totaled $16.7 million, compared to $13.5 million in 2003 and $13.2 million in 2002.

Management is pleased with the continued growth and expansion of the Company’s international production, particularly in light of the significant financial problems experienced by several South American countries in recent years. Argentina and Venezuela, in particular, experienced severe economic declines. These two countries represented more than 18% of the premium income of the Company in 2003. Argentina was historically a large source of new business for CICA, particularly as a new middle class emerged in that country’s society. During the late 1980’s, CICA (which had historically only focused on the upper income groups) began offering a plan in Argentina that was designed for this group that was popularly received. When the economic crises occurred, the middle class was severely impacted and CICA experienced a decrease in new business and an increase in lapsation from that market. Since that time, management has refocused its Argentine marketing organization on the high net worth individuals that have historically been the core group of insureds. During 2003 and 2004 surrenders declined. In 2004, production from that area amounted to more than $1.1 million and management has successfully motivated numerous marketers who had ceased production to return to recruiting new marketing representatives and writing applications. We are optimistic that as the economy improves, the volume of new business written in Argentina should increase to previous levels.

Total premium income from the international market amounted to $59.2 million in 2004, compared to $51.9 million in 2003 and $48.6 million in 2002. (See Note 11 of the “Notes to Consolidated Financial Statements” for an analysis of the results of the International Life segment.)

U.S. Life Operations

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The Company’s focus historically has been on the international market because of the key advantages described above. However, throughout the Company’s history, it has always written U.S. business and through the acquisition of other U.S. life insurers, accumulated more than $13.6 million of annual U.S. life insurance premium in 2004 (excluding home service).

In 2000, management perceived an opportunity for the Company to serve middle-income American families through the sale of an ordinary whole life insurance product containing a no-load annuity benefit. Since its introduction, the Company has sought the marketing management necessary to build a U.S. sales organization from scratch and to begin to write the product in volume. After several attempts to bring in such expertise, in early 2004 senior executives in the Company’s home office staff assumed this management responsibility. We have begun emphasizing the development of a sales force comprised primarily of second career sales associates. Recent acquisitions have created opportunities to increase production. MACLIC, acquired in 2003, wrote approximately $1 million of new annual life premium, and associates of CNLIC generated another $250,000.

When the Company acquired Combined Underwriters (now called Citizens National Life or CNLIC) in 2002, management hoped to take advantage of a unique charter structure called a “Stipulated Premium” charter that permitted CNLIC to recruit and license marketing associates in Texas without the standard testing requirements. Management now believes that while this charter structure offers advantages, they are outweighed by the costs and inefficiencies associated with maintaining CNLIC as a separate operating entity. In early 2005, plans are being finalized to merge CNLIC into CICA.

Additionally, the Company has a block of credit life and disability business written through furniture stores in Texas, Louisiana and Arkansas. This business is typically single premium and amounted to $1.1 million in 2004 and $851,000 in 2003. Total U.S. life premium income for 2004 (excluding home service) amounted to $13.6 million, compared to $11.2 million in 2003 and $6.2 million in 2002. Management intends to broaden the portfolio of U.S. products to include the same products as are offered to overseas clients.

Home Service Business

The acquisition of SPLIC and SPFIC created a new segment for the Company. SPLIC has focused on writing ordinary whole life insurance utilizing the home service marketing distribution method, whereby employee/agents working “routes” make regular collections of premiums from clients. SPFIC also uses the home service method to write small fire policies on Louisiana residents. This marketing method dates back to the creation of the life insurance industry in the United States and SPLIC utilizes approximately 390 agents (307 of whom also represent SPFIC) to write and collect premiums. Because SPLIC and SPFIC were acquired on October 1, 2004, only the fourth quarter of their activities are included in 2004 results from operations.

Under the management of its previous owner, SPLIC had focused on limiting the amount of new business sold in order to maximize profits under regulatory accounting. As such, its book of premium revenues has decreased each year for the past five years. Management is optimistic that a new emphasis on sales can

29

halt the shrinkage in the premium income and serve as a base from which to expand the home service or debit business. SPLIC is made up of books of business from more than 100 small life insurance carriers that it had acquired during its history. For the last quarter of 2004, Home Service premium revenues amounted to $9.6 million, of which $8.5 million was life and $1.1 million was casualty.

Accident and Health Business

We have historically maintained a small block of U.S. accident and health business, primarily through acquisitions in the mid-1990’s that brought other books of accident and health business, including some major medical business. However, the acquisition of CNLIC in 2002 substantially increased both the amount of accident and health business in force, as well as the volume of new business. Most of the accident and health business we acquired was unprofitable when we acquired it. Significant rate increases coupled with the non-renewal of the major medical business, would improve the performance of these acquired blocks over time.

Management determined in late 2003 to seek a buyer for the block of accident and health business due to increased costs, regulatory limits on rate increases, a reduced reinsurance market and high administration costs relating to this segment. In early 2004, they agreed to transfer most of the in-force accident and health business to a Texas-domiciled reinsurer effective January 1, 2004. The consideration for the transfer, which was initially accomplished through a 100% coinsurance arrangement until the various state insurance departments can approve an assumption reinsurance agreement, will be a participation in any future profits on the book of business over a 10-year period.

For 2004, accident and health premium decreased by $14 million, compared to the same period in 2003. Upon closing of the transaction, CICA ceded reserves of $8,101,000, and CNLIC ceded reserves of $6,859,000 to the assuming carrier. A loss of $634,000 was recorded on the transfer, which was offset by the amortization of the deferred gain of $72,000. Administrative cost savings of $1,462,000 were achieved in 2004 as a result of the transfer of this business.

Consolidated Results

The following table sets forth the Company’s net income for periods indicated:

Reductions in operating expenses, coupled with the transfer of the Company’s accident and health business to another carrier and the acquisition of SPLIC, contributed to the significant improvement in 2004. In 2003, increases in the

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amortization of cost of customer relationships acquired and other intangible assets acquired in the FAIC acquisition, combined with losses on the accident and health business, caused the earnings decrease.

The Company entered into coinsurance agreements, effective January 1, 2004, and ceded approximately $14 million of its annual accident and health premium and corresponding benefits and claims. In consideration for these cessions, the Company made a closing settlement payment of $10,440,000 to the reinsurer in June 2004. Due to this cession, the Company also reduced its January 1, 2004 deferred policy acquisition costs, cost of customer relationships acquired and policy benefit reserves by $2,197,000, $2,886,000 and $14,960,000, respectively. The Company recorded an initial amount payable to the reinsurer of $10,440,000, resulting in a first quarter 2004 charge of $634,000 and a deferred gain of $72,000, which was amortized during 2004. The coinsurance agreements provide that this ceded business will revert to the reinsurer when parallel assumption reinsurance agreements are approved by the various state insurance departments holding jurisdiction. Such approval is anticipated during 2005. The Company also participates in future profits on the accident and health business subject to the coinsurance agreements over a 10-year period. During 2004, the Company recognized approximately $809,000 as profit under the agreements.

Total revenues for 2004 were $102,826,000 compared to $95,103,000 in 2003 and $83,004,000 in 2002. The growth in CICA’s premium income fueled by the increase in new business, coupled with SPLIC’s acquisition, which contributed only to the last quarter of the year, offset the ceding of approximately $14 million of accident and health premium. The acquisitions of FAIC and MACLIC increased 2003 revenues by $6,128,000. The acquisition of CNLIC in 2002 increased revenues for that year by $11,270,000. The 2004 increase in revenues was due to increases in life insurance premiums, plus the acquisition of SPLIC and SPFIC. The 2003 increase in revenues was primarily due to a 5.7% increase in new life premiums, a 17.1% increase in renewal life premiums and a 9.7% increase in accident and health premiums. The 2002 increase in revenues was due to a 17.1% increase in new life premiums, a 4.5% increase in renewal life premiums, a 166.3% increase in accident and health premiums and a 7.2% increase in net investment income.

Premium income increased by 6.6% to $83,168,000 in 2004, from $78,027,000 in 2003. The increase in 2004 was driven by a 6.4% increase in premiums from CICA, as well as the inclusion of SPLIC and SPFIC, which added $9,587,000 since their acquisition in October 2004, which offset the loss of approximately $14 million of accident and health premium ceded to TILIC. Premium income increased by 14.4% from $68,211,000 in 2002 to $78,027,000 in 2003. The 2003 increase was comprised of an $8,506,000 increase in life premiums and annuity and universal life considerations, and a $1,311,000 increase in accident and health premiums. The February 2003 acquisition of FAIC and the November 2003 acquisition of MACLIC increased life premiums by $4,345,000. Production of new life insurance premiums by CICA increased 5.7% from 2002 to 2003.

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Significant increases are anticipated in 2005 when the full year of results will be included for SPLIC.

Net investment income increased 18.7% to $17,005,000 from $14,322,000 in 2003 and $14,252,000 in 2002. The increase reflects the acquisition of SPLIC and SPFIC in October 2004. SPLIC and SPFIC contributed $2,875,000 to 2004 investment results, in the form of additional interest on bonds. The remaining companies’ investment income declined slightly during 2004 as a result of lower available interest rates and the sale of a significant amount of bonds during the third quarter to fund the acquisition of SPLIC and to provide the funds to transfer the accident and health business. During the second and third quarters of 2004, approximately $50 million of bonds were sold or matured to provide cash for the SPLIC acquisition. In addition, approximately $10 million of bonds were sold or matured so that cash in an amount equal to the accident and health reserves and claims payable could be transferred under the coinsurance agreement.

A majority of our new investment activity over the past three years has focused on the acquisition of bonds issued by public corporations that carry the implied full faith and credit of the Federal government, such as FNMA and FHLMC. These bonds carry call features that limit the potential for capital gains in a falling interest rate environment, but generate yields that are typically 150 basis points higher than that available in the Treasury market and generally 50 basis points higher than AAA and AA rated corporate securities. By choosing to invest in these securities, the Company is exposed to reinvestment risk in the event that interest rates fall for an extended period, because the securities will typically be called, and the likelihood of increases in market value above par is unlikely because the expectation is that the bond will be called. Such events require reinvestment of the proceeds at levels lower than the yields of the called bonds. During the fourth quarter of 2004, approximately $20 million of tax-exempt municipal bonds were purchased for SPLIC in order to meet the requirements of the Louisiana Insurance Code for a reduction in premium taxes.

A period of falling interest rates occurred during 2003, and a significant number of bonds were called; however, in many cases, the Company was able to reinvest in bonds at levels at or near those of the called bonds. In 2004, a large number of bonds were also called. The Company does not believe such declines in available yields will have a material adverse effect on its future operating results because of strong cash flow available to take advantage of any increases in interest rates.

The change in future policy benefit reserves increased from $7,904,000 in 2003 to $18,627,000 in 2004. CICA’s life reserves increased $16.7 million in 2004 compared to an increase of $10.6 million in 2003 predominantly due to increased persistency on the Company’s business and the increase in new business.

Due to the cession of the majority of the accident and health business, CICA experienced a minimal change in accident and health reserves for 2004. The change in future policy benefit reserves increased from $6,052,000 in 2002 to $7,904,000 in 2003. CICA’s life reserves increased $10.6 million in 2003, which offset decreases in accident and health reserves. This was due to an increase in persistency on the Company’s overseas business. These persistency improvements have led to an increase in policy reserves at an accelerated rate compared to the past. CICA’s accident and health reserves decreased

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approximately $200,000 because of expected lapsation and non-renewal as the Company continued to implement significant rate increases.

SPLIC’s reserves increased $233,000 between its October 1, 2004 acquisition and year-end.

CNLIC’s life reserves increased approximately $199,000 in 2004, compared to a decrease of approximately $258,000 in 2003, due primarily to sales of newly developed whole life products that carry increased reserves contrasted with the existing life business that was in force at the acquisition date. Due to the cession of all of its accident and health business, CNLIC had no change in associated reserves for 2004. In 2003, accident and health policy reserves for CNLIC decreased by approximately $3.0 million. The non-renewal of the major medical block of business accounted for $1.3 million of the decrease. In addition, CNLIC experienced high lapsation on new accident and health policies issued during 2003. Including the policies terminated from the non-renewal of the major medical business, the policy count for CNLIC accident and health policies decreased by approximately 33% during 2003 compared to 2002, resulting in associated policy reserves decreasing by approximately $1.7 million.

The remaining change in future policy benefit reserves was primarily due to a decrease of $1.1 million in FAIC life reserves between 2003 and 2004 and a $1.1 million increase in MACLIC’s reserves in 2004. The MACLIC increase was primarily related to the sales production and persistency of its life insurance block. FAIC, purchased on February 18, 2003, had an increase in policy benefit reserves of approximately $580,000 during 2003. Approximately $380,000 of the increase related to annuities and approximately $200,000 related to life insurance.

Policyholder dividends increased 12.9% during 2004 to $4,142,000 from 2003 dividends of $3,666,000 due to improved persistency and the continued sale of participating ordinary whole life products. Virtually all of CICA’s overseas policies are participating, and participating policies represent approximately 59% of our business in force. Policyholder dividends are factored into the premium and as such the increase should have no adverse impact on profitability.

As noted in the table below, claims and surrenders decreased 8.9% from $40,445,000 for 2003 to $36,831,000 for 2004. The 2004 decrease primarily related to the cession of most of our accident and health business as discussed above, which offset the inclusion of SPLIC’s results for the fourth quarter of the year.

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Death benefits increased 59.8% from $6,399,000 in 2003 to $10,224,000 in 2004. Death claims in 2002 were $6,600,000. The acquisition of SPLIC increased 2004 death benefits by $3,688,000. The experience of the other companies in the group was generally favorable. As discussed above, CICA has historically adhered to an underwriting policy that requires thorough medical examinations on all applicants who are foreign residents. The 2002 claims were impacted by the acquisition of CNLIC, which increased such expense by $712,000.

Accident and health benefits decreased from $9,110,000 in 2003 to $(60,000) in 2004, due to the cession of most of the Company’s accident and health business pursuant to coinsurance agreements effective January 1, 2004. In 2002, such benefits totaled $8,615,000. The 2003 increase was directly related to the acquisition of CNLIC, which saw continued increases in claims incurred. During 2003, we did not renew approximately $2.3 million of major medical premiums on the CNLIC book of accident and health business and, in addition, implemented significant rate increases on the accident and health business remaining in force.

Endowment benefits increased 17.0% from $6,416,000 in 2003 to $7,509,000 in 2004. Endowments totaled $5,730,000 in 2002. CICA has a series of international policies that carry an immediate endowment benefit of an amount elected by the policyowner. This endowment is factored into the premium of the policy and is paid annually. Like policy dividends, endowments are factored into the premium and as such the increase should have no adverse impact on profitability.

Policy surrenders increased 2.3% from $17,986,000 in 2003 to $18,406,000 in 2004. The 2003 results represented a 7.2% increase over 2002 when surrenders amounted to $16,777,000. The 2004 increase was primarily due to the acquisitions of FAIC and MACLIC, discussed above, which generated $3,427,000 in additional surrenders, plus the inclusion of SPLIC which added $432,000. FAIC has experienced significantly higher surrender activity since its acquisition in 2003 due to the actions of former marketing associates placing numerous policies with other companies (see Table III). FAIC filed legal action against the individual primarily responsible for such replacements in the fourth quarter of 2004 and saw a sharp drop in replacement activity. The 2003 increase was directly related to the acquisitions of FAIC and MACLIC, discussed above, which generated $2,669,000 in surrenders. Surrenders for CICA declined 5.4% in 2003. The uncertain economic climate in several Latin American countries was the primary reason for the increased 2002 surrender activity. The economies in Argentina and Venezuela in particular were in near-depression during 2002. However, management is optimistic about the long-term prospects for these countries.

During 2004, commissions increased 16.7% to $21,274,000 from $18,228,000 in 2003 primarily due to the increase in the production of new life premiums during 2004 discussed above. Accident and health commissions on the business that was ceded in 2004 were approximately $2,608,000. In addition, the acquisitions of FAIC and MACLIC contributed an additional $1,324,000 of commissions to the 2004 increase, while SPLIC’s commissions during the fourth quarter of 2004 were $2,211,000. During 2003, commissions increased 11.6% to $18,228,000 from $16,339,000 in 2002. The 2003 increase was attributable to the acquisition of FAIC and MACLIC, whose 2003 commissions were $1,064,000. The

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remainder of the 2003 increase was due to the 5.7% increase in production of new life insurance premiums.

Underwriting, acquisition and insurance expenses decreased 8.3% to $17,391,000 in 2004, compared to $18,966,000 in 2003, due primarily to economies of scale being achieved in administration of the business of FAIC, MACLIC and CNLIC. The 2004 results include three months of expense for SPLIC amounting to $1,949,000. Management believes expense reductions will be achieved in SPLIC during 2005 through certain economies of scale. In addition, 2003 included severance related expenses from the acquisitions of FAIC and CNLIC. Administration costs on the ceded accident and health business in 2004 reduced expenses by $1,145,000. Underwriting, acquisition and insurance expenses increased 25.9% to $18,966,000 in 2003 compared to $15,064,000 in 2002. The 2003 increase includes $2,136,000 of expenses related to the acquisitions of FAIC and MACLIC and approximately $900,000 related to the annual marketing convention for international producers for 2003 and 2004, an expense previously borne by our international marketing manager. In May 2002, in an attempt to more efficiently manage and communicate with our independent marketing consultants, we canceled our contract with an independent international company that had served as the managing general agent for our international marketing activities since early 1997. We no longer pay an overriding commission to this former marketing firm on new business issued internationally but instead directly bear the related costs of all marketing, management and promotional activities. Other factors in the increased expenses relate to the start-up costs of the U.S. marketing program, and approximately $250,000 was spent in attempting to acquire control of First American Capital Corporation, a Kansas insurance holding company, and on other merger and acquisition activities.

Capitalized deferred policy acquisition costs increased 4.1% from $16,558,000 in 2003 to $17,241,000 in 2004 primarily due to the increase in new life production discussed above. These costs were $14,423,000 in 2002. Amortization of these costs was $8,438,000, $11,807,000, and $10,039,000 in 2004, 2003 and 2002, respectively. With most of the accident and health business ceded effective January 1, 2004, amortization of these costs was minimal in 2004. The 2003 increase related to the 5.7% increase in new life production. The 2002 increase included $1,518,000 of deferred policy acquisition costs that have been capitalized by CNLIC. The remainder of the increase related to the increase in new life production. Most of the 2002 increase related to the increased surrender activity caused by the uncertain economic climate in several Latin American countries.

Amortization of cost of customer relationships acquired and other intangibles decreased from $7,110,000 in 2003 to $4,136,000 in 2004. With most of the accident and health business ceded effective January 1, 2004, amortization of these costs was minimal in 2004. The acquisitions of FAIC and MACLIC contributed an additional $1,651,000 of amortization of these costs in 2004, while SPLIC added $849,000. Amortization of other intangibles was $1,100,000 during 2004. Included in such amortization was $668,000 related to other intangible assets that were deemed to be impaired in 2004. Amortization of cost of customer relationships acquired, excess of cost over net assets acquired and other intangibles increased from $2,528,000 in 2002 to $7,110,000 in 2003. The 2003 increase relates to the amortization of cost of customer relationships acquired

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with respect to the acquisitions of CNLIC, FAIC and MACLIC that amounted to $5,644,000 and $563,000 related to amortization of an intangible asset. The 2002 increase relates to the amortization of cost of customer relationships acquired with respect to the acquisition of CNLIC that amounted to $1,889,000 in 2002 that more than offset our adoption of the new Financial Accounting Standards Board’s (FASB) accounting statement where amortization of goodwill and other intangibles ceased since management determined that these intangibles have an indefinite life. Our analysis of goodwill and other intangibles indicated that there was no impairment as of December 31, 2004 and December 31, 2003.

For 2004, the Company’s expected tax rate increased to 33.9% from the 28.4% effective tax rate of the comparable 2003 period due to the Company no longer being eligible for the small life insurance company deduction available under the Internal Revenue Code due to the October 1, 2004 acquisition of SPLIC discussed above. The Company’s policy is to make its best estimate of the effective tax rate it expects to be applicable for the full year in its provision for income taxes on an interim basis. The acquisition of SPLIC will result in the life insurance company assets of the Company’s life insurance controlled group exceeding $500 million, making it ineligible for the small life insurance company deduction going forward.

The effective tax rate is low in 2004 due to the change in valuation allowance being decreased by approximately $1,319,000 in 2004 and the correction of prior year taxes.

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 all obligations and is provided by a variety of sources.

Liquidity requirements 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. Although the Company historically has not had to liquidate invested assets to provide cash flow, its investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs.

A primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. The Company includes provisions within its annuity and universal life 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 consistent with the Company’s assumptions in asset liability management, the associated cash outflows did not have an adverse impact on 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 and cash flow tests under various market interest rate scenarios are also performed to assist in evaluating liquidity needs and adequacy. The Company currently anticipates

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that available liquidity sources and future cash flows to be adequate to meet the demand for funds.

In the past, cash flows from the Company’s insurance operations have been sufficient to meet current needs. Cash flows from operating activities were $9.5 million and $13.6 million for 2004 and 2003, respectively. The Company also has traditionally had significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. Net cash outflows from investment activity totaled $34.1 million and $17.8 million for the years ended December 31, 2004 and 2003, respectively. In 2004 the outflow resulted from the $85 million expended to acquire SPLIC. The cash outflow for investment activities for the year ended December 31, 2003 primarily related to the investment of excess cash and cash equivalents generated from operations during 2003.

Stockholders’ equity increased from $127,027,000 at December 31, 2003 to $135,131,000 at December 31, 2004 primarily due to income earned during the period and recognition of a $2,394,000 beneficial conversion feature, net of accretion, in excess of unrealized losses, net of tax, of $(2,021,000) for 2004. Decreases in the market value of our bond portfolio caused by lower bond prices resulted in the increase in unrealized losses since December 31, 2003.

Invested assets increased 72.9% to $475,802,000 at December 31, 2004 from $275,188,000 at December 31, 2003. The increase relates to the assets of SPLIC, acquired in 2004. The increase in cash on hand at December 31, 2004 ($31.7 million versus $15 million at December 31, 2003) resulted from the call of fixed maturities during December 2004. Fixed maturities are categorized into two classifications: fixed maturities held-to-maturity, which are valued at amortized cost, and fixed maturities available-for-sale, which are valued at fair value. Fixed maturities available-for-sale and fixed maturities held-to-maturity were 92.5% and 1.6%, respectively, of invested assets at December 31, 2004. Fixed maturities held to maturity, amounting to $7,514,000 at December 31, 2004, consist of corporate bonds which are backed by the implied full faith and credit of the U.S. government, U.S. Treasury and U.S. government agency securities. Management has the intent and believes we have the ability to hold the held-to-maturity securities to maturity.

During 2004, fixed maturities available for sale grew to $440,053,000 from $237,506,000 at December 31, 2003. Included in this growth were more than $31 million of bonds issued by states and approximately $113 million of corporate bonds. The overall growth, as well as the change in mix, is directly related to the acquisition of SPLIC and SPFIC during 2004. During 2004, we disposed of approximately $50 million in bonds to finance the purchase of SPLIC and the reserve transfer on the TILIC reinsurance transaction.

Policy loans comprised 5.1% of invested assets at December 31, 2004 compared to 7.9% at December 31, 2003. The decrease relates to the acquisition of SPLIC, in which policy loans represented less than 1.5% of invested assets. These loans, which are secured by the underlying policy values, have annual yields ranging from 5% to 10% percent 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.

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Our cash balances at our primary depositories were significantly in excess of Federal Deposit Insurance Corporation coverage at December 31, 2004 and December 31, 2003. 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 2005, we intend to utilize high-grade commercial paper as a cash management tool to minimize excess cash balances and enhance returns. During 2003, the Company transferred its primary banking relationship from JP Morgan Chase to Regions Bank.

We do not utilize special purpose entities as investment vehicles. Nor do we invest in any such entities that engage in speculative activities of any description, and we do not use such investments to hedge our investment positions.

The NAIC has established minimum capital requirements in the form of Risk-Based Capital (“RBC”), which factors the type of business written by an insurance company, the quality of its assets, and various other factors into account 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 RBC fall below 200%, a series of actions by the affected company would begin. At December 31, 2004 and December 31, 2003, all of the Company’s insurance subsidiaries were above required minimum levels.

Effective January 1, 2001, the NAIC implemented codified rules for statutory accounting. These rules were approved and implemented by each state in which all of our insurance subsidiaries operations are domiciled. CICA is domiciled in Colorado, CNLIC is domiciled in Texas, FAIC in Kentucky, MACLIC in Missouri, SAIC in Arkansas and CUSA in Illinois. CICA follows certain Colorado state laws that differ from NAIC’s codified rules. The primary difference between the Colorado statutes and the codified rules involve the establishment of a liability for future policy dividends payable. Under NAIC codified rules, such reserve is mandated; however, Colorado has an exception if the difference between the premium charged and the mortality factor included in the premium on participating policies exceeds the reserve that would be established. Such is the case for CICA. As a result, as provided under Colorado law, CICA did not establish a reserve of approximately $3 million in its statutory financial statements as of and for the years ended December 31, 2004 and 2003. Texas, Illinois, Kentucky, Missouri, Louisiana and Arkansas codified rules must be followed unless the Commissioner of Insurance permits specific practices that differ from codified rules. None of our insurance subsidiaries has requested any permission from any state insurance regulatory authority to deviate from NAIC codified rules.

During March 2004, the Company’s shareholders approved amendments to the Articles of Incorporation increasing the number of authorized Class A and Class B shares and authorizing preferred stock that could be issued upon approval of the Board of Directors.

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On July 12, 2004, the Company completed a private placement of $12.5 million of Series A-1 Senior Convertible Preferred Stock to four unaffiliated institutional investors. The terms and conditions of the Series A-1 Senior Convertible Preferred Stock are discussed in Note 8 to our consolidated financial statements. The initial recognition of the beneficial conversion feature and discounts on fair values of options and warrants issued in connection with the private placement resulted in $3,073,000 of additional paid-in capital for the Class A common stock and $2,994,000 of liabilities for options and warrants. Changes in the fair value of options and warrants are recognized in the statement of operations with a corresponding change in the liabilities for options and warrants. For the period ended December 31, 2004, there was a decrease in fair value of options and warrants of $256,000 and corresponding decrease in the related liabilities.

On September 30, 2004, and December 31, 2004 the Company declared and paid quarterly dividends relating to the Series A-1 Senior Convertible Preferred Stock shareholders (4% per year). The Company paid the dividend by issuing 19,396 shares of its Class A common stock valued at $116,000 at September 30, and 20,948 shares of Class A common stock valued at $133,000 at December 31.

The Company signed a revolving line of credit agreement from Regions Bank for a $30 million credit facility for use in acquisitions in March 2004. On October 1, 2004, the Company entered into a Second Amendment to the Loan Agreement that converted into a term loan its $30 million advance against the line of credit made in connection with the acquisition of SPLIC. Under the term loan, the Company is obligated to repay the principal portion of the loan in ten semi-annual installments of $3,000,000 beginning on May 1, 2005, with the final installment of principal and any accrued and unpaid interest on November 1, 2009. Interest on the unpaid principal balance of the loan is required to be paid on the fifth day of each month following the end of each fiscal quarter of the Company. The interest rate is equal to a 30-day LIBOR (London InterBank Offered Rate) plus 1.8% per year (approximately 4.3% annually as of December 31, 2004).

Because the maximum borrowing authorized on the Company’s line of credit is $30 million, the line has been drawn down to zero. Under the Amended Loan Agreement, upon any prepayment or repayment of the term loan described above, the line of credit is to be reinstated to an aggregate amount equal to the difference between (a) $30 million minus (b) the aggregate outstanding principal amount under the term loan. Management expects to repay the loan in full during the first quarter of 2005 using proceeds from bond calls and maturities.

In connection with the SPLIC acquisition, funds borrowed by the Company were re-loaned to CICA. CICA has issued to the Company a Subordinated Debenture in the principal amount of $30 million plus interest equal to 30-day LIBOR plus 1.8% per year. Because CICA is an insurance company formed under the laws of Colorado, any principal and accrued interest on the subordinated debenture is not a legal liability of CICA until repayment of interest or principal has received the prior written approval of the Commissioner of Insurance for the State of Colorado. CICA has filed with the Commissioner of Insurance requesting permission to retire the debenture in full.

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The Sarbanes-Oxley Act of 2002 (the “Act”) established significant new guidelines for corporate governance. Subsequently, the New York Stock Exchange adopted new rules relating to such matters as the composition of listed companies’ Boards of Directors and various committees thereof, the need to adopt specific policies and the establishment of a Code of Ethics. The Company’s Board of Directors, Compensation Committee and Audit Committee were already configured in such a way as to comply with the Act. Citizens has operated under a “Principles, Purposes, Philosophy and Beliefs” for numerous years that sets forth the manner in which the Company and its officers, directors and employees are expected to function. However, the Board of Directors has implemented a formal Code of Ethics applicable to all officers, directors and employees.

Additionally, the Act imposes a duty upon public companies to document and test all internal controls and have such controls audited by independent auditors.

The Company has committed to the following contractual obligations as of December 31, 2004 with the payments due by the period indicated below:

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The payments related to the future policy benefits and claim liabilities reflected in the table above have been projected utilizing assumptions based upon the Company’s historical experience and anticipated future experience.

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 industry 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.

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. Management believes that our policy liabilities and increase in future policy benefit reserves as of and for the years ended December 31, 2004, 2003 and 2002 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.

In Table II in Item 1, the ratio of lapses and surrenders to mean life insurance in force has varied between 4.9% and 8.2% over the past five years. The year 2003 was adversely impacted by the acquisition of FAIC. The 2002 ratio of 7.3% relates to surrenders caused by adverse economic conditions in several Latin American countries. In addition, the 2003 ratio of 8.2% includes FAIC surrenders and lapses of approximately $32.2 million of life insurance in force (approximately 1.2% of the total). In 2004, the ratio improved to 7.2%, the lowest amount since 2001. Improved persistency on CICA’s international business was the primary reason for the improvement.

Table IV in Item 1 above, illustrates that during the past five years the ratio of commissions, underwriting and operating expenses to insurance premiums has ranged from 42.2% to 47.7% and the ratio of commissions, underwriting and operating expenses, policy reserves increases, policyholder benefits and dividends to policyholders to insurance premiums has ranged from 114.7% to 119.2%. Table VIII also shows that the ratio of net investment income to mean amount of invested assets has varied from 4.5% to 6.8% from 2000 through 2004. The 2003 5.7% and 2004 4.5% represents the impact of the low interest environment and the liquidation of bonds to fund the acquisition of SPLIC. Additionally, the 4.5% is negatively impacted by the October acquisition of SPLIC. As set forth above in Management’s Discussion and Analysis of Financial Condition and Results of Operations, death benefits for the years ended December 31, 2004, 2003 and 2002

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were $10,224,000, $6,399,000 and $6,600,000, respectively. The acquisition of SPLIC increased 2004 benefits by $3,688,000, while $712,000 of the 2002 increase in death benefits related to the acquisitions of CNLIC and $320,000 of the 2003 increase in death benefits related to the acquisitions of FAIC and MACLIC.

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. Over 85% of our capitalized deferred acquisition costs are attributed to first year excess commissions. The remaining 15% 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. Use of the factor method, as discussed above, limits the amount of unamortized deferred policy acquisition costs to its estimated realizable value provided actual experience is comparable to that contemplated in the factors and results in amortization amounts such that policies that lapse or surrender during the period are no longer included in the ending deferred policy acquisition cost balance.

A recoverability test that considers among other things, actual experience and projected future experience, is performed at least annually by third party actuarial consultants. 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 amortized 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

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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, 2004, 2003 and 2002 limits the amount of deferred costs to its estimated realizable value.

Valuation of Investments in Fixed Maturity and Equity Securities

At December 31, 2004, investments in fixed maturity and equity securities were 94.1% and 0.2%, respectively, of total investments. Approximately 98.3% of our fixed maturities were classified as available-for-sale securities at December 31, 2004, with the remaining 1.7% classified as held-to-maturity securities based upon our intent and ability to hold these securities to maturity. All equity securities at December 31, 2004 are classified as available-for-sale securities. We have no fixed maturity or equity securities that are classified as trading securities at December 31, 2004.

Additionally, at December 31, 2004, 70.8% of our fixed maturity securities were invested in corporations backed by the implied full faith and credit of the U.S. government, U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities. All of these securities are backed by or bear the implied full faith and credit of 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 SPLIC, virtually all subsidiaries’ investments are in corporate bonds that carry the implied full faith and credit of the U.S. government, Treasuries or agencies of the U.S. government. SPLIC has significant investments in corporate and municipality bonds. Based upon our emphasis on investing in fixed maturity securities primarily composed of obligations of U.S. government sponsored corporation, U.S. Treasury securities and obligations of the U.S. government and agencies, including U.S. government guaranteed mortgage-backed securities and callable instruments issued by U.S. government agencies and our analysis whether declines in fair value below cost are temporary or other than temporary, management believes that our investments in fixed maturity and equity securities at December 31, 2004 are not impaired, and no “other than temporary losses” need to be recorded.

Gross unrealized losses on fixed maturities available-for-sale amounted to $3,857,000 as of December 2004 and $2,553,000 as of December 2003. Of this 2004 total gross unrealized loss, $2,018,000 have been in a continuous loss situation for more than 12 months and $1,839,000 have been in a continuous loss situation for less than 12 months.

The fixed maturities available-for-sale in a gross unrealized loss situation for more than 12 months are primarily investments in callable instruments issued by corporations backed by the implied full faith and credit of the U.S. government and U.S. government agencies. It is remote that unrealized losses on these instruments will result in realized losses, since the Company has the intent and believes it has the ability to hold these securities to the call date or maturity date.

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These securities are being closely monitored by the Company to determine if the unrealized loss as of December 31, 2004 indicates that there is a loss which is other-than-temporary. As of December 31, 2004, the Company has determined that there is no need to establish a new cost basis for these securities.

The majority of the fixed maturities available-for-sale that have been in a continuous loss situation for less than 12 months are from investments owned by SPLIC. The losses are due to the coupon interest rate being less than the prevailing market interest rates at December 31, 2004. The Company has determined that there is no need to establish a new cost basis for these securities.

Gross unrealized losses on equity securities available-for-sale were $3,000 as of December 31, 2004 and were $3,200 as of December 31, 2003. The entire $3,000 at December 31, 2004 have been in a continuous loss situation for more than 12 months. As of December 31, 2004, the Company has determined that there is no need to establish a new cost basis for these securities. See also Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”

Accounting Pronouncements

On January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets.” Under the guidelines of SFAS No. 142, excess of cost over net assets acquired (goodwill) amounting to $12,402,000 and $12,939,000 and other intangible assets amounting to $2,331,000 and $3,086,000 as of December 31, 2004, and December 31, 2003, respectively, were determined to have an indefinite useful life and will no longer be amortized. Instead goodwill and other intangible assets will be subjected to annual impairment analyses under the provisions of SFAS No. 142 and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” respectively.

In October 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 superseded and amended SFAS No. 121 and relevant portions of SFAS No. 30. SFAS No. 144 was adopted on January 1, 2002. SFAS No. 144 did not have a material effect on the financial position, results of operation or liquidity of the Company.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 affected income statement classification of gains and losses from extinguishment of debt and made certain other technical corrections. SFAS No. 145 was adopted on January 1, 2003. SFAS No. 145 did not have a material effect on the financial position, results of operations or liquidity of the Company.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 spread out the reporting of expenses related to restructurings initiated after 2002. Commitment to a plan to exit an activity or dispose of long-lived assets will no longer be enough evidence

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to record a charge for most anticipated exit or disposal activities. Companies will instead record exit or disposal costs when they are “incurred” and can be measured by fair value and the recorded liability will subsequently be adjusted for changes in estimated cash flows. SFAS No. 146 also revised accounting for specified employee and contract terminations that are part of restructuring activities. The Company adopted SFAS No. 146 on January 1, 2003. SFAS No. 146 did not have a material effect on the financial position, results of operations or liquidity of the Company.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an Interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34.” This Interpretation elaborated on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued and also clarified that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The Company adopted FASB Interpretation No. 45 on January 1, 2003. FASB Interpretation No. 45 did not have a material effect on the financial position, results of operations or liquidity of the Company.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB No. 123.” This statement amends SFAS No. 123, “Accounting for Stock Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ended after December 31, 2002. The Company currently offers no stock-based employee compensation. The Company adopted SFAS No. 148 on January 1, 2003. SFAS No. 148 did not have a material effect on the financial position, results of operations or liquidity of the Company.

In December 2003 the FASB issued a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” that was originally issued in January 2003. This interpretation as revised addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. This interpretation requires certain disclosures in financial statements issued after January 31, 2003. The Company adopted FASB Interpretation No. 46 as revised on December 31, 2003. FASB Interpretation 46 as revised did not have a material effect on the financial position, results of operations or liquidity of the Company.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. This statement is generally effective for contracts entered into or modified after September 30, 2003, and all provisions should be applied prospectively. The

45

Company adopted SFAS No. 149 on September 30, 2003. SFAS No. 149 did not have a material effect on the financial position, results of operations or liquidity of the Company.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equities.” This statement established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument within its scope as a liability (or an asset in some circumstances). Many of the instruments within the scope of SFAS No. 150 were previously classified as equity. Based on current operations, the Company does not anticipate that SFAS No. 150 will have a material effect on the financial position, results of operations or liquidity of the Company.

In December 2003, the FASB issued a revision to SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This statement requires that companies provide more details about their plan assets, benefit obligations, cash flows, benefit costs and other relevant information. This statement is effective for fiscal years ending after December 15, 2003. The Company adopted the revision to SFAS No. 132 on December 31, 2003. SFAS No. 132, as revised, did not have a material effect on the financial position, results of operations or liquidity of the Company.

In 2004, the FASB issued a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance and establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” nor does it

46

address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” SFAS 123 as amended is effective for interim reporting periods beginning after June 30, 2005. The Company does not anticipate the revision of SFAS No. 123 will have a material effect on the financial position, results of operations or liquidity of the Company.

In July 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This statement provides guidance on separate account presentation and valuation, the accounting for sales inducements and the classification and valuation of long-duration contract liabilities. The Company adopted this statement on January 1, 2004. The adoption of SOP 03-1 did not have a material effect on the financial position, results of operations or liquidity of the Company.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

General

The nature of our business exposes us to 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 market value of our investments. The market value of our fixed maturity, mortgage loan portfolio and policy loans 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 almost 99% of our investment portfolio as of December 31, 2004. These investments are mainly exposed to changes in treasury rates. Our fixed maturities investments include U.S. government bonds, securities issued by government agencies, and corporate bonds. Approximately 70.8% of the fixed maturities we owned at December 31, 2004 are instruments of private corporations carrying the implied full faith and credit backing of the U.S. government, 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:

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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, 2004 and 2003, we had no investments in derivative instruments.

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 1% of our total investments at December 31, 2004. 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.

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Item 8. Financial Statements and Supplementary Data

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Index to Consolidated Financial Statements and
Financial Statement Schedules

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 changed accountants, nor have we reported on Form 8-K any disagreements between our independent accountants and us.

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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 the Company, including its consolidated subsidiaries, is made known to the officers who certify our financial reports and to the other members of senior management and the Board of Directors.

Our Chief Executive Officer (CEO) and our President and Chief Financial Officer (CFO) are responsible for establishing and maintaining disclosure controls and procedures for the Company (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)). Based upon our evaluation at the end of the period, the Chief Executive Officer and the President and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of the end of the period covered by this annual report because of the material weakness discussed below.

(b) Management Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed the Company’s 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, and considering the material weakness discussed below, management concluded the Company did not maintain effective internal control over financial reporting as of December 31, 2004.

A “material weakness” in internal control over financial reporting is defined by the Public Company Accounting Oversight Board’s (“PCAOB”) Auditing Standard No. 2 as a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The material weakness relates to the inadequate and ineffective management oversight and review of the Company’s financial reporting process. Specifically, the Company did not revise its management oversight and review protocols to address changes in the qualifications of personnel performing financial reporting functions, and did not provide for effective cross-training of personnel performing financial reporting functions. As a result, numerous material errors were identified in the Company’s financial statement footnotes. These errors were corrected prior to issuance of the Company’s 2004 consolidated financial statements.

The aforementioned material weakness in internal control over financial reporting resulted in more than a remote likelihood that the Company’s financial statements could have been materially misstated.

The Company acquired Security Plan Life Insurance Company and its subsidiary Security Plan Fire Insurance Company (SPLIC) on October 1, 2004. Management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, SPLIC’s internal control over financial reporting associated with total assets of $298,396,000, representing 45.1% of the Company’s consolidated total assets, and total revenues of $12,346,000,

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representing 12.0% of the Company’s consolidated revenue, included in the consolidated financial statements of Citizens, Inc. and subsidiaries as of and for the year ended December 31, 2004.

The Company’s independent registered public accounting firm, KPMG LLP, has issued an audit report on management’s assessment of the Company’s internal control over financial reporting. Their report is included in item 9A(d).

(c) Change in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended December, 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

However, we are in the process of completing remediation efforts relating to the material weakness, which are set forth in detail below, which primarily include hiring additional personnel who will be competent to address U.S. GAAP relating to our operations, additional training for our accounting staff, particularly relating to U.S. GAAP, and enhanced management review procedures.

In order to address the findings of our internal control assessment, we are implementing the following improvements to our internal controls and procedures in the financial accounting area which we believe will improve our internal control over financial reporting in future periods:

	•	Hiring a new Vice President, Financial Reporting and Tax, with significant experience in U.S. GAAP and SEC reporting who will be responsible for the preparation and supervision of the Company’s financial statements. This individual will report directly to the Chief Financial Officer. In addition, we plan on assuring that at least one other person is fully trained and experienced to step in and perform the duties of the Vice President, Financial Reporting and Tax if he should, for any reason, be unable to do so.
	•	Hiring new personnel to work with the Vice President, Financial Reporting and Tax to develop additional expertise in U.S. GAAP and SEC reporting and to insure that adequate depth is developed in the Company’s financial reporting area.
	•	Strengthening the process of workpaper review by senior members of management to ensure the completeness and accuracy of supporting workpapers and schedules, including formalized sign-off processes.
	•	Additional training of accounting department personnel in U.S. GAAP and SEC reporting.
	•	Adopt procedures to seek a more thorough and timely review process by senior management of the financial statement process.

We believe these efforts will address the material weakness identified by management during its assessment of internal control over financial reporting as of December 31, 2004.

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(d) Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Citizens, Inc.

We have audited management’s assessment, included in the accompanying Management Report on Internal Control over Financial Reporting (Item 9A(b), that Citizens, Inc. and subsidiaries (the Company) did not maintain effective internal control over financial reporting as of December 31, 2004, because of the effect of a material weakness identified in management’s assessment related to inadequate internal control over the Company’s financial reporting process, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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.

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A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment as of December 31, 2004: The Company’s policies and procedures did not provide for adequate and effective management oversight and review of the Company’s financial reporting process. Specifically, the Company did not revise its management oversight and review protocols to address changes in the qualifications of personnel performing financial reporting functions, and did not provide for effective cross-training of personnel performing financial reporting functions. As a result, numerous material errors were identified in the Company’s financial statement footnotes.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated statements of financial position of Citizens, Inc. and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2004, and the related financial statement schedules. The aforementioned material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 consolidated financial statements and the financial statement schedules, and this report does not affect our report dated March 30, 2005, which expressed an unqualified opinion on those consolidated financial statements and the financial statement schedules.

In our opinion, management’s assessment that the Citizens, Inc. and subsidiaries did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

The Company acquired Security Plan Life Insurance Company and its subsidiary Security Plan Fire Insurance Company (SPLIC) on October 1, 2004. Management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, SPLIC’s internal control over financial reporting associated with total assets of $298,396,000, representing 45.1% of the Company’s consolidated total assets, and total revenues of $12,346,000, representing 12.0% of the Company’s consolidated revenue, included in the consolidated financial statements of Citizens, Inc. and subsidiaries as of and for the year ended December 31, 2004. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of SPLIC.

/s/ KPMG LLP

Dallas, Texas
March 30, 2005

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, 2004.

PART IV

Item 15. Exhibits, Financial Statement Schedules

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

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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

CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Index to Consolidated Financial Statements and
Financial Statement Schedules

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.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Citizens, Inc.

We have audited the accompanying consolidated statements of financial position of Citizens, Inc. and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2004. In connection with our audits of the consolidated financial statements, we also have audited the 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 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, 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 consolidated financial statements taken as a whole, present fairly in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Citizens, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 30, 2005 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Dallas, Texas
March 30, 2005

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Consolidated Statements of Financial Position

December 31, 2004 and 2003

(Continued)

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES
Consolidated Statements of Financial Position, Continued
December 31, 2004 and 2003

See accompanying notes to consolidated financial statements.

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Consolidated Statements of Operations

Years ended December 31, 2004, 2003 and 2002

(Continued)

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Consolidated Statements of Operations, Continued

Years ended December 31, 2004, 2003 and 2002

See accompanying notes to consolidated financial statements.

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CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income

Years ended December 31, 2004, 2003 and 2002