## CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES 

Commissions. Commission expense fluctuates in a direct relationship to new and renewal insurance premiums and has decreased 15.4% in 2018 compared to 2017 as first year premium revenues, on which higher commission rates are paid, declined in the Life segment and renewal premiums were also down 2.7%. 

Other General Expenses. Total general expenses increased 2.7% on a consolidated basis in 2018 compared to 2017 due primarily to increased consulting and audit fees of $2.1 million related to the 2017 audit costs incurred in 2018, as well as higher employee salaries and bonuses of $2.3 million, including related employee benefits paid to top executives. We also noted an increase in rent of approximately $1.0 million in 2018 compared to 2017. General expenses increased 39.1% on a consolidated basis from 2016 to 2017 due primarily to the tax compliance liability estimate adjustment we first reported in 2014 and a write-off of $4.6 million of our Home Service goodwill in 2017. 

We perform an expense study on an annual basis, utilizing an enterprise-wide time study, and we adjust cost allocations among entities as needed based upon this review. Any allocation changes are reflected in the segment operations, but do not impact total expenses. 

Capitalization of Deferred Policy Acquisition Costs. Capitalized DAC were $22.7 million, $29.1 million and $32.7 million in 2018, 2017 and 2016. Decreases in capitalized amounts are in line with the decreases noted in sales activity. These costs will vary based upon successful efforts related to newly issued policies and renewal business. Significantly lower amounts are capitalized related to renewal business in correlation with the lower commissions paid on that business compared to first year business which has higher commission rates. 

Amortization of Deferred Policy Acquisition Costs. Amortization of DAC totaled $34.2 million, $29.7 million and $28.5 million in 2018, 2017 and 2016, respectively, which primarily resulted from the AXIS actuarial system conversion impacting amortization by $3.7 million in 2018 and due to the higher surrender activity, including early duration elections to convert existing policies to reduced paid up ("RPU") or extended term insurance ("ETI") status in 2018 and 2017. There are higher deferred acquisition costs associated with early duration conversions to RPU or ETI, which, when converted, increases amortization expense. Amortization of deferred policy acquisition costs is impacted by persistency and the higher level of surrenders is impacting our amortization. 

Amortization of Cost of Customer Relationships Acquired ("COIA"). Amortization of COIA increased in 2018 due to an update in our Home Service segment assumptions that resulted in a true up adjustment of approximately $663,000. 

Federal Income Tax. Federal income tax expense was $13.1 million, $35.1 million and $3.5 million in 2018, 2017 and 2016, respectively, resulting in effective tax rates of 652.6%, (1,176.9)% and 64.1%, respectively. Subsequent to the novation, the insurance activity of CICA Ltd. is subject to Subpart F of the IRC and, therefore, is included in Citizens’s taxable income. The Subpart F income inclusion generated $18.4 million of federal income tax expense in 2018, which was largely driven by the impact of the novation transaction. The significant changes in effective tax rates noted in 2017 are the result of the New Tax Act enacted at the end of 2017 and the tax compliance issue we identified in 2014, which impacted our effective tax rates in each year as these costs are not deductible for tax purposes. Additionally, the Company recorded a tax expense in each year for an uncertain tax position that is affecting the tax rates. Differences between our effective tax rate and the statutory tax rate result from income and expense items that are treated differently for financial reporting and tax purposes. Refer to Note 9 - "Income Taxes" in the notes to our consolidated financial statements for further discussion. 

## Segment Operations 

Our business is comprised of two operating business segments and Other Non-Insurance Operations as detailed below. 

• Life Insurance 

• Home Service Insurance 

