Citizens Financial 10K 2005 Annual report

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

X	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
	EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file number 0-20148

CITIZENS FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Kentucky	61-1187135
(State of Incorporation)	(I.R.S. Employer Identification No.)

12910 Shelbyville Road, Louisville, Kentucky 40243

(Address of principal executive offices)

(502) 244-2420

(Registrant’s telephone number)

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

Securities registered pursuant to Section 12(g) of the Act: Class A Stock, No Par Value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes

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, and (2) has been subject to such filing requirements for the past 90 days. Yes X No

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. [ X]

Indicate by check mark whether the registrant is an accelerated filer (as determined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes No X

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Act. (Check one):

Large accelerated filer

Accelerated filer

Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes

State the aggregate market value of the common equity held by non-affiliates of the registrant: $3,981,228 (based on an $6.35per share average of bid and asked prices on March 22, 2006).

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 1,671,628 shares of Class A Stock as of March 22, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the issuer’s Board of Director’s Proxy Statement for the Annual Meeting of Shareholders now scheduled for June 15, 2006 are incorporated into Part III of this Form 10-K. The date of this Report is March 24, 2006.

CONTENTS

PART I

Page

ITEM	1	BUSINESS		3
ITEM	1A	RISK FACTORS	10
ITEM	1B	UNRESOLVED STAFF COMMENTS	13
ITEM	2	PROPERTIES	13
ITEM	3	LEGAL PROCEEDINGS	13
ITEM	4	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	14

PART II

ITEM

MARKET FOR REGISTRANT’S

COMMON EQUITY RELATED STOCKHOLDER MATTER AND ISSUER

PURCHASES OF EQUITY SECURITIES

ITEM

SELECTED FINANCAL DATA

ITEM

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATION

ITEM

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT

MARKET RISK

ITEM

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM

CHANGES IN AND DISAGREEMENTS

WITH ACCOUNTANTS ON ACCOUNTING AND

FINANCIAL DISCLOSURE

ITEM

CONTROLS AND PROCEDURES

ITEM

OTHER INFORMATION

PART III

ITEM 10	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT			59
ITEM 11	EXECUTIVE COMPENSATION			59
ITEM 12	SECURITY OWNERSHIP OF CERTAIN
		BENEFICIAL OWNERS AND MANAGEMENT AND
		RELATED STOCKHOLDER MATTERS	59
ITEM 13	CERTAIN RELATIONSHIPS
		AND RELATED TRANSACTIONS	59
ITEM 14	PRINCIPAL ACCOUNTANT FEES AND SERVICES			59

PART IV

ITEM 15	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	60
SIGNATURES		61
EXHIBIT INDEX		62
EXHIBITS		63

This report contains projections and other forward-looking statements regarding future events or the future financial performance of the Company. Actual events and results may differ materially from those in the projections and other forward-looking statements set forth herein. Among the important factors that could cause actual events or results to differ materially from those in the projections and other forward-looking statements are: changes in the market value of the Company’s investments, including stock market performance and interest rate changes; customer response to marketing efforts; mortality and morbidity trends; regulatory changes; actions of independent rating agencies; general economic conditions and increased competition; the Company’s ability to achieve operating efficiencies; unanticipated adverse litigation; and changes in Federal tax law. Readers are referred to the Items 1, 7, 7a and 8 in this report and to the Company Report on Financial Statements in the Company’s Annual Report to Shareholders for the year ended December 31, 2005 for a discussion of these and other important risk factors concerning the Company and its operations.

PART I

ITEM 1. BUSINESS

General

Citizens Financial Corporation (herein, the “Company” or the “Registrant”) was incorporated in Kentucky in 1990 at the direction of the Board of Directors of Citizens Security Life Insurance Company (“Citizens Security”) for the ultimate purpose of becoming an insurance holding company. Pursuant to a merger completed in 1991, Citizens Security became a wholly owned subsidiary of the Company. The Company is now a holding company that engages in the business of life insurance, annuities, and accident and health insurance through Citizens Security and United Liberty Life Insurance Company (“United Liberty”), a wholly owned subsidiary of Citizens Security (herein collectively, the “Life Insurance Subsidiaries”). Citizens Security also owns Citizens Insurance Company (“Citizens Insurance”), which is licensed as a property and casualty insurer but currently has no business in force. The Life Insurance Subsidiaries and Citizens Insurance are herein collectively referred to as the “Insurance Subsidiaries.”

Insurance Operations

The Company, through its Life Insurance Subsidiaries, operates in five business segments -- 1) home service life insurance (“Home Service Life” or “Home Service”), 2) broker-sold life insurance and annuities (“Broker Life”), 3) preneed life insurance (“Preneed Life” or “Preneed”), 4) dental insurance (“Dental”), and 5) other health and accident insurance (“Other Health”). The Home Service and Preneed Life segments provide individual coverages; the Dental segment provides group coverages; while the Broker Life and Other Health segments include individual and group insurance coverages. The following table presents each business segment’s revenue; pretax segment profit (loss) excluding realized investment gains (losses) and interest expense; and ending assets for each of the last three fiscal years. Additional segment information is contained in Item 7 and in Note 8 of the Notes to Consolidated Financial Statements.

Segment Revenue, Profit ( Loss) and Assets:

Home Service Life. The Home Service Life segment consists primarily of traditional whole life insurance, which provides policyholders with permanent life insurance and fixed, guaranteed rates of return on the cash value element of policy premiums. Agents for these products sell primarily small face value policies (typically from $1,000 to $10,000). These policies are subject to normal underwriting procedures with the extent of such procedures determined by the amount of insurance, age of applicant and other pertinent factors.

Broker Life. The Broker Life segment offers traditional whole life insurance; universal life insurance, which provides policyholders with permanent life insurance and adjustable rates of return on the cash value element of policy premiums, based upon current interest rates; annuities; group life; accidental death and dismemberment; and dependent life insurance. The majority of Broker Life sales consists of whole life graded death benefit and simplified issue policies.

The graded death benefit policy returns premium plus interest compounded at an annual rate of 10% if the insured dies of natural causes during the first three years the policy is in force. If the insured dies of an accidental cause, the benefit payable is the face amount of the policy. The simplified issue product provides full face amount coverage from date of issue, is more extensively underwritten and carries lower premium rates than the graded death benefit product. These products are targeted towards the “final expense market.”

Generally, traditional whole life insurance products are more profitable than universal life policies, in part because investment margins are normally greater for traditional whole life products than for universal life policies. Overall profitability on universal life policies may decline as a result of downward interest crediting rate adjustments to the extent that policyholders withdraw funds to invest in higher-yielding financial products. The profitability of traditional whole life products and universal life policies is also dependent upon the ultimate underwriting experience and the realization of anticipated unit administrative costs. The Company believes that the historical claims experience for the traditional whole life and universal life products issued by the Life Insurance Subsidiaries has been within expected ranges, in relation to the mortality assumptions used to price the products.

Substantially all annuity considerations are attributable to sales of flexible premium deferred annuities, life policy annuity riders, and single premium deferred annuities. Generally, a flexible premium deferred annuity or a life policy annuity rider permits premium payments in such amounts as the policyholder deems appropriate, while a single premium deferred annuity requires a one-time lump sum payment.

Preneed Life. The Preneed Life segment products are traditional whole life policies sold to individuals in connection with prearrangement of their funeral and include single and multi-pay coverages, generally in amounts of $10,000 and less. These policies are generally sold to middle-aged to elderly individuals.

Coverage in Force.

The following table provides information concerning the Life Insurance Subsidiaries' volume of life insurance coverage in force.

¹Before deduction of reinsurance ceded.

²Represents the percentage of individual policies terminated during the indicated period by lapse, surrender, conversion,

maturity, or otherwise.

The downward trend in Net In-force amounts is primarily the result of the reduced new premium (as part of the Company’s strategy) and continued benefit payments in the Preneed segment.

Dental Insurance. Dental products are indemnity policies sold on a pure group and voluntary group basis. Voluntary dental groups must meet prescribed participation limits. All dental products have annual limits on all covered procedures and lifetime limits on orthodontia procedures. In addition, orthodontia and major restorative procedures are not covered for the first six months to one year, depending upon the plan, unless a no-loss-no-gain provision is attached to the policy.

Other Health Insurance. Other Health products include individual accident and health insurance policies, which provide coverage for monthly income during periods of hospitalization, scheduled reimbursement for specific hospital and surgical expenses and cancer treatments, and lump sum payments for accidental death or dismemberment. Group health plans are also offered, providing coverage for short-term disability, and income protection. The Company is not allocating significant marketing resources to this segment.

Marketing. The Life Insurance Subsidiaries are currently licensed to sell products in 29 states and the District of Columbia. Citizens Security and United Liberty are both licensed in the states designated below with a “b” while only Citizens Security is licensed in the states designated “c” and only United Liberty in the states designated “u”.

The Life Insurance Subsidiaries market products through the personal producing general agent distribution system. Approximately 3,100 sales representatives are licensed as independent agents for the Life Insurance Subsidiaries. Nearly all of these agents also represent other insurers. Approximately 900 of these agents specialize in the home service market. That market consists primarily of middle and low-income families and individuals who desire whole life policies with policy limits typically below $10,000. Agents usually collect premiums directly at monthly intervals. The home service market has higher than average policy lapse rates. Approximately 700 agents specialize in the Preneed market. Typically, these agents are funeral directors or operate from facilities owned by funeral directors.

The Life Insurance Subsidiaries furnish rate material, brochures, applications, and other pertinent sales material, at no expense to the agents. The agents are responsible for complying with state licensing laws and any related appointment fees. Agents are compensated by commissions. The Life Insurance Subsidiaries have agent commission arrangements that are generally intended to provide competitive incentives for agents to increase their production of new insurance and to promote continued renewals of in-force insurance. Historically, these incentives have frequently involved awards, overrides, and compensation scales that escalate according to achievement levels for newly-issued business and that provide additional payments for renewal business.

Underwriting. The Life Insurance Subsidiaries follow underwriting procedures designed to assess and quantify insurance risks before issuing life and health insurance policies to individuals and members of groups. Such procedures require medical examinations (including blood tests, where permitted) of applicants for certain policies of health insurance and for policies of life insurance in excess of certain policy limits. These requirements are graduated according to the applicant's age and vary by policy type. In addition, certain types of life insurance policies are offered with higher premium rates and less stringent underwriting requirements. The Life Insurance Subsidiaries also rely upon each applicant's written application for insurance, which is generally prepared under the supervision of a trained agent. In issuing health insurance, information from the application and, in some cases, inspection reports, physician statements, or medical examinations are used to determine whether a policy should be issued as applied for, issued with reduced coverage under a health rider, or rejected.

Acquired Immunodeficiency Syndrome (“AIDS”) claims identified to date, as a percentage of total claims, have not been significant for the Life Insurance Subsidiaries. Evaluating the impact of future AIDS claims under health and life insurance policies issued is extremely difficult, in part due to the insufficiency and conflicting data regarding the number of persons now infected with the AIDS virus, uncertainty as to the speed at which the AIDS virus has and

may spread through the general population, and advancements in medical treatment options. The Life Insurance Subsidiaries have implemented, where legally permitted, underwriting procedures designed to assist in the detection of the AIDS virus in applicants.

Investments. The Company derives a substantial portion of its revenue from investments. The Life Insurance Subsidiaries maintain diversified investment portfolios that are held primarily to fund future policyholder obligations. State insurance laws impose certain restrictions on the nature and extent of investments by insurance companies and, in some states, require divestiture of assets contravening these restrictions. Within the framework of such laws, the Life Insurance Subsidiaries follow a general strategy to maximize total return (current income plus appreciation) without subjecting themselves to undue risk. Where deemed appropriate, the Life Insurance Subsidiaries will hold selected non-investment grade bonds that provide higher yields or are convertible to common stock. The Company considers a bond non-investment grade if it is unrated or rated less than BBB by Standard & Poor's Rating Group (“S&P”) or BAA by Moody's Investors Service (“Moody's”). The Company’s non-investment grade bonds, based on reported fair values, represented 3.3% of the Company’s cash and invested assets as of December 31, 2005. Citizens Security has maintained substantial investments in equity securities in an effort to achieve higher investment earnings than can usually be achieved through portfolio bonds but at a greater comparative risk. The Company also maintains an investment portfolio of equity securities separate from those of the Insurance Subsidiaries. Federally-insured mortgage-backed securities, collateralized mortgage obligations and real estate investments, apart from the investment in the office building described in Item 2., “Description of Property,” represented approximately 2.2% of cash and invested assets as of December 31, 2005. Neither the Company nor its subsidiaries owned any collateralized mortgage-backed securities as of December 31, 2005 that would be included in the high-risk classification.

For additional information concerning investment results, see Item 7.

Reinsurance. In keeping with industry practice, the Life Insurance Subsidiaries reinsure, with unaffiliated insurance companies, portions of the life and health insurance risks which they underwrite. The Life Insurance Subsidiaries retain no more than $40,000 of individual life insurance risk and $15,000 of group life insurance risk for any single life. Graded death benefit and simplified issue coverages above $4,000 are generally 50% reinsured, with the Life Insurance Subsidiaries maintaining a maximum $10,000 risk on any one life. Individual and group accidental death coverage is 100% reinsured. At December 31, 2005, approximately $83,173,000 or 12% of life insurance in force was reinsured under arrangements described in Note 10 of the Notes to the Consolidated Financial Statements. Under most reinsurance arrangements described above, new insurance is reinsured automatically rather than on a basis that would require the reinsurer's prior approval. Generally, the Life Insurance Subsidiaries enter into indemnity reinsurance arrangements to assist in diversifying their risks and to limit their maximum loss on large or unusually hazardous risks. Indemnity reinsurance does not discharge the ceding insurer's liability to meet policy claims on the reinsured business. Accordingly, the Life Insurance Subsidiaries remain responsible for policy claims on the reinsured business to the extent a reinsurer should fail to pay such claims.

Competition. The insurance industry is highly competitive, with approximately 1,500 life and health insurance companies in the United States. Many insurers and insurance holding company systems have substantially greater capital and surplus, larger and more diversified portfolios of life and health insurance policies, and larger agency sales operations than those of the Life Insurance Subsidiaries. Financial and claims-paying ratings assigned to insurers by A.M. Best Company (“Best”) and by nationally recognized statistical rating organizations have become more important to policyholders. Citizens Security's rating was last changed by Best in October 2001, when it was downgraded to B- (Fair) from B (Fair). The B- rating was reaffirmed in December 2005. United Liberty’s rating has remained at B- (Fair) since its 1998 acquisition. According to Best, B- ratings are assigned to companies that have on balance, fair financial strength, operating performance and market profile when compared to the standards established by Best. Also according to Best, B- companies have an ability to meet their current obligations to policyholders, but their financial strength is vulnerable to adverse changes in underwriting or economic conditions. There are seven Best rating categories above the B- category from B to A++. The Life Insurance Subsidiaries will continue to pursue upward revisions in their Best ratings. Citizens Insurance has no insurance business in force and is not rated by Best.

A rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.

The Life Insurance Subsidiaries compete primarily on the basis of the experience, size, accessibility and claims response of their customer service representatives, product design, service and pricing. The Company believes that the Life Insurance Subsidiaries are generally competitive in the markets in which they are engaged based upon premium rates and services, have good relationships with their agents, and have an adequate variety of insurance and annuity products approved for issuance.

State Insurance Regulation. The Insurance Subsidiaries are subject to comprehensive regulation in the states in which they are authorized to conduct business. The laws of such states establish supervisory agencies with broad administrative powers, among other things, to grant and revoke licenses for transacting business, regulate the form and content of policies, establish reserve requirements, prescribe the type and amount of allowable investments, and review premium rates for fairness and adequacy. The Insurance Subsidiaries file detailed annual statements with the National Association of Insurance Commissioners (“NAIC”) and with many states in which they are licensed to transact business. The KOI also periodically examines the business and accounts of the Insurance Subsidiaries.

The Life Insurance Subsidiaries also can be required, under the solvency or guaranty laws of most states in which they do business, to pay assessments (up to prescribed limits) to fund policyholder losses or liabilities of other insurance companies that become insolvent. These assessments may be deferred or foregone under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium or intangible property taxes. Gross assessments for the Life Insurance Subsidiaries, net of refunds but before offsets for future premium or intangible property taxes, were $5,544, $5,178, and $6,945 in 2005, 2004, and 2003, respectively.

Kentucky, in common with substantially all states, regulates transactions between or affecting insurance holding companies and their insurance company subsidiaries, including the Company and the Insurance Subsidiaries. Generally, under Kentucky insurance holding company statutes, the Kentucky Office of Insurance must approve in advance the direct or indirect acquisition of 15% or more of the voting securities of an insurance company organized under the laws of Kentucky. Such statutes also regulate certain transactions among affiliates, including the payment of dividends by an insurance company to its holding company parent. Under the Kentucky statutes, the Insurance Subsidiaries may not during any year pay dividends on their common and preferred stock to their parent company in excess of the lesser of the net gain from operations for the preceding year or 10% of their capital and surplus at the end of the preceding year, without the consent of the Executive Director of the KOI. For 2006, the maximum amount of dividends that Citizens Security, United Liberty and Citizens Insurance could pay, without the Executive Director's approval, is $479,000, $100,000 and $26,500. The Company provides substantially all management, operating and employee services for the Insurance Subsidiaries and is reimbursed at actual cost plus 15%. This management fee totaled $5,034,000 for 2005. The Company currently has resources which management believes will be adequate to service debt obligations through 2006. In addition, the Company’s Chairman has expressed potential willingness to lend up to $1,000,000 of additional funds to the Company if necessary. Accordingly, the Company is not relying upon affiliate dividends for near-term debt service.

During recent years, the NAIC has taken several steps to address public concerns regarding insurer solvency. These steps included implementing a state certification program designed to promote uniformity among the insurance laws of the various states and developing insurer reporting requirements that focus on asset quality, capital adequacy, profitability, asset/liability matching, and liquidity. These requirements include establishment of asset valuation reserves (“AVR”) and interest maintenance reserves (“IMR”), risk-based capital (“RBC”) rules to assess the capital adequacy of an insurer, and a revision to the Standard Valuation Law (“SVL”) that specifies minimum reserve levels and requires cash flow testing in which projected cash inflows from assets are compared to projected cash outflows for liabilities to determine reserve adequacy.

The Life Insurance Subsidiaries’ AVR, as of December 31, 2005, 2004 and 2003, is shown in Item 7. Cash flow testing and the results of such testing as applied to the Life Insurance Subsidiaries are also described and discussed in Item 7.

RBC provides a means of establishing the capital standards for insurance companies to support their overall business operations in light of their size and risk profile. The four categories of major risk involved in the formula are [i] asset risk -- the risk with respect to the insurer's assets; [ii] insurance risk -- the risk of adverse insurance experience with respect to the insurer's liabilities and obligations; [iii] interest rate risk -- the interest risk with respect to the insurer's business; and [iv] business risk -- all other business risks. A company's RBC is calculated by applying factors to various asset, premium and reserve items, with higher factors for those items with greater underlying risk and lower for less risky items. RBC standards are used by regulators to set in motion appropriate

regulatory actions relating to insurers that show signs of weak or deteriorating conditions. They also provide an additional standard for minimum capital, below which companies would be placed in conservatorship.

Based on RBC computations as of December 31, 2005, the Insurance Subsidiaries each have capital that is in excess of minimum regulatory requirements.

Action taken by the NAIC in these and other areas may have a significant impact on the regulation of insurance companies during the next several years. In addition, various proposals are being considered for permitting insurers to elect Federal regulation. Given their comparatively small size, it may be expected that the Life Insurance Subsidiaries would be affected by more stringent regulatory policy, both under existing laws and any new regulatory initiatives. Such effects could include curtailment or discontinuance of insurance underwriting in one or more states, mandated increases in capital and surplus, and/or other effects.

Income Taxation. The Life Insurance Subsidiaries are taxed under the life insurance company provisions of the Internal Revenue Code of 1986, as amended (the “Code”). Under the Code, a life insurance company's taxable income incorporates all income, including life and health premiums, investment income, and certain decreases in reserves. The Code currently establishes a maximum corporate tax rate of 34% and imposes a corporate alternative minimum tax rate of 20%. See Item 7 and Note 6 of the Notes to Consolidated Financial Statements.

The Code currently requires capitalization and amortization over a five to ten year period of certain policy acquisition costs incurred in connection with the sale of certain insurance products. Prior tax laws permitted these costs to be deducted as incurred. These provisions apply to life, health, and annuity business. Certain proposals to make additional changes in the federal income tax laws, including increasing marginal tax rates, and regulations affecting insurance companies or insurance products, continue to be considered at various times in the United States Congress and by the Internal Revenue Service. The Company currently cannot predict whether any additional changes will be adopted in the foreseeable future or, if adopted, whether such measures will have a material effect on its operations.

Reserves. In accordance with applicable insurance laws, the Life Insurance Subsidiaries have established and carry as liabilities actuarially determined reserves to meet their policy obligations. Life insurance reserves, when added to interest thereon at certain assumed rates and premiums to be received on outstanding policies, are required to be sufficient to meet policy obligations. Reserves maintained for health insurance include the unearned premiums under each policy, reserves for claims that have been reported but not yet paid, and reserves for claims that have been incurred but have not been reported. Furthermore, for all health policies under which renewability is guaranteed, additional reserves are maintained in recognition of the actuarially calculated probability that the frequency and amount of claims will increase as policies persist. The Life Insurance Subsidiaries are required to maintain reserves on reinsured business assumed on a basis essentially comparable to direct insurance reserves. Reinsurance business assumed is presently insignificant in amount.

The reserves carried in the financial statements included in this Form 10-K are calculated on the basis of accounting principles generally accepted in the United States and differ from the reserves specified by laws of the various states, which govern preparation of financial statements on the statutory basis of accounting for the Life Insurance Subsidiaries. These differences arise from the use of different mortality and morbidity tables and interest assumptions, the introduction of lapse assumptions into the reserve calculation, and the use of the level premium reserve method on all insurance business. See Note 1 of the Notes to Consolidated Financial Statements, for certain additional information regarding reserve assumptions under accounting principles generally accepted in the United States.

Employees. As of March 1, 2006, the Company employed 68 people, excluding agents. As of that date, the Company had approximately 3,100 independent agents licensed to sell its products.

ITEM 1A. RISK FACTORS

The following list describes several of the more significant risk factors unique to our company. Additional risks to which we are subject include, but are not limited to, the factors discussed under “Forward-Looking Statements” and elsewhere in this Form 10-K:

Market fluctuations and general economic conditions may adversely impact our operating results and financial position.

Our investment income and the values of our investment holdings are sensitive to stock, real estate and interest rate market fluctuations and general economic conditions and these fluctuations could adversely affect our investment returns, realized and unrealized investment gains and losses and the value of our invested assets. A prolonged period of high inflation could cause a negative change in consumer sentiment adversely affecting the sales and persistency of our products. Market conditions also determine the availability and cost of reinsurance we employ to limit our risks.

Losses due to defaults by others could adversely impact the value of our investments and our operating results.

Issuers and borrowers whose securities we hold and reinsurers may default on their obligations to us due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons, having an adverse impact on our operating results and financial position.

The life insurance industry is becoming increasingly competitive. If we are not able to effectively compete it would adversely impact our operating results and financial position.

We face significant competition, including from companies with significantly greater resources. Product life cycles have shortened in many product segments, creating intense competition regarding product features. Larger companies with greater resources are able to allocate more resources to brand identity, product development and risk management, as well as distribution capability and information technology needed to offer the superior customer service demanded by an increasingly sophisticated marketplace (both policyholder and agent base).

Differences between actual claims experience and underwriting and reserving assumptions might adversely impact our operating results and financial position.

We set prices for our insurance products based upon expected claims, using assumptions for mortality and morbidity rates of our policyholders and expected persistency of our products. Significant deviations in actual experience from our pricing assumptions could adversely affect our profitability.

If our reserves for future policyholder benefits are inadequate, an increase in our reserves in the future would adversely impact our operating results and financial position.

We establish reserves to pay future policyholder benefits based upon actuarial or statistical estimates, using many assumptions and projections which involve the exercise of significant judgment, including as to the levels of and timing of receipt or payment of premiums, benefits, claims, expenses, interest credits, investment results, surrenders, mortality, morbidity and persistency. If we conclude that our reserves are inadequate, we would be required to increase our reserves and incur operating statement charges for the period in which we make the determination, adversely impacting our operating results and financial position.

Reinsurance may not be available, affordable or adequate to protect us against losses.

While life reinsurance generally binds the reinsurer for the life of the business reinsured at generally fixed pricing, market conditions determine the availability and cost of reinsurance protection for new business. As a result of consolidation of the life reinsurance market and other market factors, capacity in the life reinsurance market has decreased. Further, life reinsurance is currently available at higher prices and less favorable terms than those prevailing between 1997 and 2003. Further consolidation, regulatory developments, catastrophic events or other significant developments affecting the pricing and availability of reinsurance could materially harm the reinsurance market and our ability to enter into reinsurance agreements. An increase in the cost of reinsurance or our inability to protect us against large losses would adversely impact our operating results and financial position.

We may be unable to attract and retain sales representatives for our products which would adversely impact our operating results and financial position.

We use an independent agent distribution channel to sell our products. Our independent agents generally sell competing products offered by a number of different insurance companies. Strong competition exists among insurance companies for agents with demonstrated ability. The companies represented by independent agents compete on the basis of financial position, support services, compensation, product features and other factors. If we are unsuccessful in attracting and retaining high quality, producing agents our profitability could be significantly adversely affected.

We may not be able to raise capital, if necessary, at an affordable cost which could adversely impact our operating results.

Due to our relative small size, the relatively thin market for shares of our stock and our lack of a stable history of income, we may not be able to raise additional capital or borrowings, if needed, with acceptable terms. This could force us to forgo opportunities to grow or force us to raise capital with unfavorable terms, which could adversely impact our operating results and financial position.

The loss and replacement of a key employee or director could disrupt our operations and adversely impact our operating results.

Due to the relative size and the limited resources of our business we are forced to operate with a limited number of key management employees. The loss of one or more of our key employees or directors could be disruptive to our operations, and filling a vacancy could be expensive and difficult because we compete with larger companies having greater resources for qualified management employees and directors. Such a loss could adversely impact our operating results.

We may be required to accelerate the amortization of deferred policy acquisition costs (“DAC”), or value of insurance acquired (“VIF”), or recognize impairment in the value of our goodwill that would adversely impact our operating results and financial position.

Deferred acquisition costs represent the costs that vary with and are related primarily to the acquisition of new and renewal insurance contracts. We amortize these costs over the expected lives of the related insurance contracts. Valuation of business acquired represents the present value of future profits embedded in acquired business and is amortized over the expected lives of the acquired contracts. Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other business over the fair value at the date of acquisition of the net assets acquired. Management continuously tests the DAC and VIF to determine if the recorded amounts are recoverable under current assumptions. We also regularly review the estimates and assumptions underlying DAC and VIF for those products for which we amortize DAC and VIF in proportion to gross profits. Management reviews goodwill for impairment at least annually based upon estimates of the fair value of the reporting unit to which the goodwill relates. Given changes in facts and circumstances, these tests and reviews could lead to reductions in goodwill, DAC or VIF that could have an adverse impact on our operating results and financial position.

A downgrade or potential downgrade in our claims paying rating could limit our ability to market products and/or increase the number or value of policies being surrendered.

Claims paying ratings represent the opinions of rating agencies regarding the financial ability of an insurance company to meet its obligations under an insurance policy, and are important factors affecting public confidence in an insurer and its competitive position in marketing products.

Our operating insurance subsidiaries are heavily regulated and changes in regulation could reduce our profitability and limit our growth.

Our insurance subsidiaries are regulated by the Kentucky Office of Insurance and other states in which they are licensed to do business. We are also subject to the rules and regulations of the SEC and NASDAQ relative to reporting and disclosure, security trading, accounting and financial reporting and corporate governance matters. The Sarbanes-Oxley Act of 2002 and the rules and regulations adopted in furtherance of that Act have substantially increased the requirements in these and other areas for public companies. Compliance with applicable laws and regulations is time consuming and staff intensive. Changes in these laws and regulations may materially increase our direct and indirect compliance costs, adversely impacting our operating results and financial position.

Legal actions are inherent in our insurance business and could adversely impact our operating results and financial position.

We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of business, including the risk of class action lawsuits. Any adverse judgment against us, and the legal costs of defending our company in potentially lengthy legal battles would have an adverse impact on our operating results and financial position, as well as threaten our ability to continue operating.

Catastrophes may adversely impact our operating results and financial position.

Our insurance operations are exposed to the risk of catastrophic mortality, such as a pandemic or other natural or man caused event that causes a large number of deaths. The occurrence of any such catastrophic event could materially adversely impact our operating results and financial position due to a potentially large number of death claims and surrenders.

Our risk management policies and procedures may leave us exposed to unidentified or unanticipated risk which could adversely impact our operating results and financial position.

Our policies and procedures to monitor risks may not be fully effective and may leave us exposed to unidentified and unanticipated risks. Past or future employee or agent misconduct could result in violations of law by us, regulatory sanctions, serious financial harm or harm to our reputation, and the precautions we take to prevent and detect such activity may not be effective in all cases. A failure of our computer systems or a compromise of their security could subject us to regulatory sanctions or other claims, harm our reputation, interrupt our operations and adversely impact our business, operating results, or financial position.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company owns, through Citizens Security, a three-story, 63,000 square foot office building in suburban Louisville, Kentucky completed in 1988. The Company and its Subsidiaries occupy about 32% of the building for their headquarters and home offices. The remaining 68% of the building space is available for lease to tenants under leases of various durations. Market conditions for this property are generally favorable and, in management’s opinion, the property is adequately covered by insurance. Currently, the Company’s policy is not to invest in additional real estate or real estate mortgages, although a change in such policy would not require a vote of security holders. In addition, the Company’s current bank lending agreement precludes investment in additional real estate and in mortgages with a loan-to-appraised-value ratio of more than 75%.

ITEM 3. LEGAL PROCEEDINGS

United Liberty, which the Company acquired in 1998, defended an action in an Ohio state court brought by two policyholders in 2000. The Complaint referred to a class of life insurance policies, including related certificates of participation, that United Liberty issued over a period of years ended around 1971 (known as “Five Star Policies”). It alleged that United Liberty’s dividend payments on these policies from 1993 through 1999 were less than the amounts required by the certificates of participation. It did not specify the amount of the alleged underpayment but implied a maximum of about $850,000. The plaintiffs also alleged that United Liberty was liable to pay punitive damages, also in an unspecified amount, for breach of an implied covenant of good faith and fair dealing to the plaintiffs in relation to the dividends. The action was certified as a class action on behalf of all policyholders who were Ohio residents and whose policies were still in force in 1993. United Liberty denied the material allegations of the Complaint and defended the action vigorously.

As a result of a provisional settlement agreement dated October 8, 2004, which applied to all holders of the Five Star Policies wherever they reside, United Liberty recorded as of December 31, 2004 an obligation for future payments to the policyholders and their attorneys totaling $825,000. The terms of the settlement agreement were subject to the approval of the court in which the action was pending. On October 21, 2005, the Court entered a Final Order and Judgment. The Final Order and Judgment approved the provisional Settlement Agreement dated October 8, 2004, and became final and effective on November 20, 2005.

The $825,000 obligation for future payments included in the consolidated financial statements as of December 31, 2005 and 2004, consists of [i] up to $500,000 payable to all persons who owned Five Star Policies that were still in force in 1993, [ii] $315,000 in attorneys’ fees payable to counsel for the class and [iii] a $10,000 incentive award payable to the lead plaintiffs for the class. The $500,000 portion is payable in respect of dividend obligations on the Five Star Policies from 1993 through 2000 and is to be paid in a lump sum to those policy holders whose policies are no longer in force and in three annual installments to those policy holders whose policies are still in force at their anniversary date. United Liberty made the first payments dated January 12, 2006 to those whose policies were no longer in force, which totaled $278,698. The attorneys’ fees and incentive award were also paid on that date (prior to the “Initial Payment Date” set as sixty days subsequent to the end of the appeal period).

In addition, the Company is party to other lawsuits in the normal course of business. Based on information available at very early stages, management believes that currently pending lawsuits will be resolved without material financial impact to the Company.

ITEM 4. SUBMISSION OF

MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted during the fourth quarter of the fiscal year covered by this Form 10-K to a vote of the Company's security holders, through the solicitation of proxies or otherwise.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY,

RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

As of March 22, 2006, there were approximately 2,350 holders of record of the Company's Class A Stock, its only class of common equity. The Class A Stock is currently eligible for quotation on the National Association of Securities Dealers, Inc.'s Small-Cap Market (“NASDAQ”) under the trading symbol CNFL. Trading volume in 2005 was 13.3% of the average shares outstanding during the year and trading volume by non-affiliates was about 35.3% of the average shares owned by non-affiliates during the year.

The following table summarizes quarterly high and low bid quotations for the Class A Stock in 2005 and 2004 as reported by NASDAQ. Such quotations reflect inter-dealer prices and do not include retail markup, markdown, or commission, and may not necessarily represent actual transactions.

The Company has not paid a dividend on the Class A Stock. The Board of Directors of the Company has not adopted a dividend payment policy; however, dividends must necessarily depend upon the Company's earnings and financial condition, applicable legal restrictions, and other factors relevant at the time the Board of Directors considers a dividend policy. The Company is subject to a loan agreement covenant that prevents it from paying dividends on the Class A Stock without the consent of the lender except to the extent it can meet certain requirements relating to the ratio of its outstanding borrowings compared to dividends and income before interest expense, amortization, depreciation and income tax expense for (5) consecutive quarters and provided that there is no default or potential default under the loan agreement. As of January 2006, the bank loan covenant precludes the Company from paying any dividends. Cash available for dividends to shareholders of the Company must initially come from income and capital gains earned on its investment portfolio, management service fees and dividends paid by the Insurance Subsidiaries, and Citizens Security’s repurchase of its preferred stock owned by the Company. Provisions of the Kentucky Insurance Code subject transactions between the Insurance Subsidiaries and their respective parents, including dividend payments, to certain standards generally intended to prevent such transactions from adversely affecting the adequacy of the Insurance Subsidiaries’ capital and surplus available to support policyholder obligations. See Item 1. “Description of Business -- State Insurance Regulation.” In addition, under the Kentucky Business Corporation Act, the Company may not pay dividends if, after giving effect to a dividend, it would not be able to pay its debts as they become due in the usual course of business or if its total liabilities would exceed its total assets.

Equity Compensation Plan Information

Issuer Purchases of Equity Securities

(a)	No shares were purchased during 2005.
(b)		The average price paid per share of stock repurchased under the stock repurchase program includes any commissions paid to the brokers.
(c)		Information in this column relates to the stock repurchase program publicly announced on August 12, 1998 our Board of Directors authorized the repurchase of up to an aggregate of $1,200,000 of our common stock and amended such plan on November 12, 2002 to authorize the repurchase of an additional $250,000. Under the repurchase program, we may repurchase outstanding shares of our common stock from time to time in the open market and through privately negotiated transactions. Unless terminated earlier by resolution of our Board of Directors, the repurchase program will expire when we have repurchased all shares authorized for repurchase under the repurchase program.

ITEM 6. SELECTED FINANCIAL DATA

Note:	See Item 7 for additional information relevant to the above data.
(a)	Results from the adoption of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”.
(b)	Net income per share and shareholders’ equity per share are based upon the weighted average common shares outstanding in 2005, 2004, 2003, 2002 and 2001 of 1,671,628, 1,671,628, 1,685,390, 1,711,627,and 1,740,360, respectively.
(c)	Net investment income reported in the consolidated financial statements as a percent of average cash and invested assets.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATION

EXECUTIVE SUMMARY

The Company’s management continuously monitors the performance of and outlook for the Company by analyzing several indicators that they judge to be critical. The key indicators of particular interest to management are (a) the general economic environment relative to outlook, (b) trend of premium volume, (c) lapse rates, (d) mortality and morbidity rates (e) trend of general expense levels, (f) asset and capital and surplus growth, (g) general interest rate movements, (h) investment yields, (i) diversity (e.g. by industry) and mix (e.g. between fixed income securities and equity securities) of our investment portfolios and (j) segment performance and trends.

The Company’s management has identified the following as major financial, operational and marketing accomplishments during 2005:

• The Company has continued to restructure its investment portfolio to consist of a greater percentage of investment grade fixed maturity securities and less investment in equities. This action reduces the risks inherent in the equities market, improves investment income yields and is looked upon favorably by regulators and rating agencies.

• The Company earned a profit for the third straight year despite experiencing reduced premiums and reduced net realized investment gains.

• The Company reached a final settlement of a long-standing class action lawsuit involving United Liberty, one of its insurance subsidiaries.

• The Company completed the installation of a new group administration system to create a platform for Group Dental growth.

• The Company introduced a new Final Expense product and distribution channel to create an opportunity for growth, with adequate first year performance.

• The Company reduced costs and expenses associated with the Preneed line of business, realizing segment profit in that line for the first time since 1998.

Management sees the following as its key challenges for 2006:

• Financial
	(1)	earning an operating profit for all segments (see page 27 of this Management Discussion and Analysis of Financial Condition and Results of Operation and Note 7 to the Consolidated Financial Statements for a discussion of statutory accounting)

(2)	continuing to solidify the ratings from A.M. Best and setting the stage for a rating upgrade after 2006 (see the section titles “Competition” In Item 1 for a discussion of the Company’s rating)

(3)	using a portion of profits to fund higher sales growth in 2006 and beyond without straining capital and surplus

(4)	evaluating plans to reduce compliance costs in 2007 and beyond

• Operational

(1)	controlling operating expenses

(2)	updating hardware and software technology

• Product line

(1)	for Group Dental: creating a plan to offer Preferred Provider networks and Third Party Administration products in 2006, building on the Company’s strength of providing high quality service and exploring plans to sell other products through the Dental marketing channel

(2)	for Final Expense: performing a controlled growth path through select Managing General Agents who focus on this type of product

(3)	for Home Service: improving 13-month persistency, strengthening controls over field premium collection, recruiting satisfactory agents and controlling expenses

(4)	for Preneed: maintaining current distribution relationships and controlling costs and expenses

The following discussion is presented to provide the reader with a clearer understanding of some of the operational elements impacting the financial position and results as reported in the accompanying consolidated balance sheets and related consolidated statements of operations, shareholders’ equity and cash flows.

Segment Profit (Loss)

The Company manages its operations in five business segments, Home Service Life, Broker Life, Preneed Life, Dental, and Other Health. Products in all five segments are sold through independent agency operations. Home Service Life consists primarily of traditional life insurance coverage sold in amounts of $10,000 and under to middle and lower income individuals. This distribution channel is characterized by a significant amount of agent contact with customers throughout the year. Broker Life product sales consist primarily of simplified issue and graded-benefit policies in amounts of $10,000 and under. Other products in the Broker Life segment that comprise a significant portion of existing business include group life, universal life, annuities and participating life policies. Preneed Life products are sold to individuals in connection with prearrangement of their funeral and include single and multi-pay policies, generally in amounts of $10,000 and less. These policies are generally sold to middle aged and elderly individuals. Dental products are term policies generally sold to small and intermediate size employer groups. Other Health products include various accident and health policies sold to individuals and employer groups. Profit or loss for each segment is reported on a pretax basis, without an allocation of realized investment gains or interest expense.

The Company’s 2005 segment loss was $(76,000) compared to losses of $(2,307,000) in 2004 and $(973,000) in 2003. The segment loss in 2004, excluding nonrecurring items described below, was $(481,000).

The nonrecurring items in 2004 include costs of $1,190,000 (settlement and legal costs) incurred in 2004 associated with the legal proceedings described in Item 3, and additional one time consulting expenses of $636,000 related to redesign and other organizational restructuring begun in 2003, as well as severance agreements.

The decrease of $2,231,000 in segment loss from $(2,307,000) in 2004 to $(76,000) in 2005 results primarily from: (a) a decrease in premiums and other considerations of $2,317,000 (Preneed decreased $1,937,000, Dental decreased $545,000, Home Service decreased $135,000, Other Health decreased $150,000, while Broker Life increased $450,000 (including new final expense premiums of $324,000)); (b) an increase in investment and other income of $577,000; (c) a decrease in policyholder benefits and commissions of $2,934,000; (d) a decrease in general expenses and depreciation of $864,000; and (e) a decrease in amortization of deferred policy acquisition costs and value of insurance acquired of $236,000, offset by a decrease in amortization of acquisition costs deferred of $63,000.

See pages 26 through 28 of Management’s Discussion and Analysis for a more extensive analysis of factors impacting the individual segment operating results between years.

Net Income

The Company’s 2005 net income is $324,000 compared to a net income of $256,000 and $712,000 in 2004 and 2003, respectively. These results reflect the segment losses described above (including nonrecurring items) and net realized gains of $780,000, $2,868,000 and $1,978,000 in 2005, 2004 and 2003, respectively. The Company realized significant increases in realized capital gains in both 2004 and 2003 due to restructuring the investment portfolio to include a greater proportion of fixed maturity investments and fewer equity investments while taking advantage of an upturn in the equities market. After the restructuring, our equities portfolio did not present opportunities for similar levels of realized gains in 2005.

Comprehensive Income (Loss) Comprehensive Income (Loss) (which combine net income (loss) and net unrealized gains and losses) were ($2,318,000), ($977,000), and $3,084,000 for 2005, 2004, and 2003, respectively. During 2005, the Company continued to be adversely affected by relatively low yields on its fixed income investment portfolio. The increase of $1,341,000 in comprehensive loss in 2005 is attributable to the increase in net income of $68,000 described above offset by the change in unrealized losses of ($1,409,000). Late in the second quarter of 2005, interest yields on fixed maturity investments began to rise. Although this adversely impacts the market value of the Company’s bond portfolio, the opportunity to invest new money at higher yields has a positive impact on the Company’s operating earnings. The 2005 environment continues to generate a relatively high level of qualitative investment risk, as discussed in the Cash Flow and Liquidity section. The majority of the 2004 declines in net income and the comprehensive losses were attributable to adverse securities markets, including the effects of declines in the airlines, telecommunications and technology sectors and general economic sluggishness.

The Company did not repurchase any shares of its common stock during 2005. The Company repurchased 13,600 and 1,600 shares of its common stock during 2004 and 2003 respectively, at average prices of $7.50 and $4.79 per share, respectively.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s discussion and analysis of its financial condition and results of operations are based on its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to investments, agent receivables, intangible assets, policy liabilities, income taxes, regulatory requirements and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following accounting policies, judgments and estimates, which have been discussed with the Audit Committee of the Board of Directors, critically impact preparation of its consolidated financial statements.

Investment in Debt and Equity Securities. The Company holds debt and equity interests in a variety of companies, many of which are seeking to exploit recent technology advancements. The majority of these are publicly traded and many have experienced volatile market prices. Company management periodically evaluates whether the declines in fair value of investments are other-than-temporary. These evaluations involve significant judgment. The evaluations consist of a review of qualitative and quantitative factors, including analysis of the Company’s competitive position in its markets, deterioration in the financial condition of the issuer, downgrades of the security by a rating agency, and other publicly available issuer-specific news or general market conditions. Declines in fair values of securities deemed to be temporary and which the Company has the ability and intent to hold until full recovery are included as an unrealized loss in shareholders’ equity. Declines in fair values of securities deemed to be other-than-temporary are included in net income as realized investment losses. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the current carrying value of the investments, thereby possibly requiring an impairment charge in the future.

Deferred Acquisition Costs (“DAC”). The Company is required to defer certain policy acquisition costs and amortize them over future periods. These costs include commissions and certain other expenses that vary with and are primarily associated with acquiring new business. The deferred costs are recorded as an asset commonly referred to as deferred policy acquisition costs (“DAC”). The DAC asset balance is subsequently charged to income over the lives of the underlying contracts in relation to the anticipated emergence of revenue or profits. Actual revenue or profits can vary from Company estimates, resulting in an increase or decrease in the rate of amortization. The Company regularly evaluates its DAC balances to determine if actual experience or other evidence suggests that earlier estimates should be revised. Assumptions considered significant include surrender and lapse rates, mortality, expense levels, investment performance, and estimated interest spread. Should actual experience dictate that the Company change its assumptions regarding the emergence of future revenues or profits (commonly referred to as “unlocking”), the Company would record a charge or credit to bring its DAC balance to the level it would have been if using the new assumptions from the inception date of each policy.

DAC is also subject to periodic recoverability and loss recognition testing. These tests ensure that the present value of future contract-related cash flows will support the capitalized DAC balance to be amortized in the future. The present value of these cash flows, less the benefit reserve, is compared with the unamortized DAC balance and if the DAC balance is greater, the deficiency is charged to expense as a component of amortization and the asset balance is reduced to the recoverable amount. For more information about accounting for DAC see Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.

Goodwill and Intangible Impairment. The balance of the Company’s goodwill and value of insurance acquired (VIF) was $3 million at December 31, 2005. The recovery of these assets is dependent on the fair value of the business to which they relate. Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, goodwill is subject to annual impairment tests based on the estimated fair value of the respective assets. There are numerous assumptions and estimates underlying the determination of the estimated fair value of these assets. Different valuation methods and assumptions can produce significantly different results that could affect the amount of any potential impairment charge that might be required to be recognized. During both 2005 and 2004, the Company concluded that no impairment adjustment was necessary for its goodwill or VIF.

Policy Liabilities. Establishing policy liabilities for the Company’s long-duration insurance contracts requires making many assumptions, including policyholder persistency, mortality rates, investment yields, discretionary benefit increases, new business pricing, and operating expense levels. The Company evaluates historical experience for these factors when assessing the need for changing current assumptions. However, since many of these factors are interdependent and subject to short-term volatility during the long-duration contract period, substantial estimates and judgment are required. Accordingly, if actual experience emerges differently from that assumed, any such difference would be recognized in the current year’s Consolidated Statement of Operations.

Deferred Income Taxes. The Company records a valuation allowance to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized. In assessing the need for the valuation allowance, the Company has not assumed future taxable income. In the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to deferred tax assets would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to deferred tax assets would be charged to income in the period such determination was made.

FINANCIAL POSITION

Assets. At December 31, 2005, the Company's available-for-sale fixed maturities had a fair value of $112,924,772 and amortized cost of $112,087,958. The Company’s fixed maturities portfolio increased approximately 1% during 2005 and 6% during 2004, on an amortized cost basis. Shown below is a distribution by rating category of the Company's fixed maturities portfolio as of December 31, 2005.

¹Net of write-downs on bonds whose decline in value is believed to be other-than-temporary

²Fair values as of December 31, 2005 were obtained primarily from Interactive Data Corporation.

The Company believes it has a well-diversified portfolio and has no plans to adjust its non-investment grade portfolio significantly, unless necessary to satisfy requirements of state regulators or rating agencies. The Company purchases non-investment grade bonds to obtain higher yields or convertible features and attempts to reduce credit risk by portfolio diversification. Non-investment grade securities comprised 3.8% and 5.7% of the fixed maturities portfolio, on an amortized cost basis, at December 31, 2005 and 2004, respectively. During 2005, the Company did not recognize any impairment losses on fixed maturities. The Company reviews its fixed maturity portfolio quarterly for impairment losses which might be other than temporary losses and recognizes all such losses in the quarter they are deemed other than temporary.

Realized investment losses included $807,000 of pretax impairment losses for the year ended December 31, 2004. The impairments recorded were the result of the continued credit deterioration of specific issuers in the bond and equity markets, especially in the airline and telecommunications industries.

Shown below are the Company's four largest holdings in non-investment grade bonds by a single issuer as of December 31, 2005.

The Company had no guarantee or other type of enhancement associated with the issuers represented above.

During 2005, the Company's investment in equity securities increased $1,001,000 on a cost basis, and decreased $363,000 on a fair value basis, after decreasing $771,000 and $2,394,000 on a cost and fair value basis, respectively, during 2004. As of December 31, 2005, 2004 and 2003, there were $288,000, $1,652,000 and $3,275,000 respectively, of unrealized gains on equity securities.

The Company reviews its marketable investments each quarter to determine if there have been declines in their value that in management’s opinion are other-than-temporary. These reviews can involve qualitative and quantitative information relating to an individual company or industry and general factors impacting the economy. However, due to wide market fluctuations occurring during the past two years, determining whether declines are temporary has become much more complex and judgmental. These reviews resulted in the recognition of impairment losses on equity securities totaling $473,000 during 2004 ($101,000, $319,000 and $53,000 for the first, third and fourth quarters, respectively). In addition, $334,000 of impairment losses were recognized on fixed maturities during 2004, all in the third quarter. During 2005, equity securities were sold which contained impairment write-downs of $358,000 and no fixed maturities were sold which contained impairment write downs.

Citizens Security owns the building in which the Company and its subsidiaries maintain their home offices. They occupy approximately 32% of the building with the balance available for lease to third-party tenants. Market conditions for this property are generally favorable. An updated appraisal obtained during 2002 indicates the market value of the property is approximately $2,725,000 higher than its carrying amounts.

At December 31, 2005 the Company has recorded $756,000 of goodwill and $12,511,000 of deferred policy acquisition costs and value of insurance acquired. As noted in the above discussion of critical accounting policies and estimates, these intangibles, and the recorded value of policy liabilities, are based on many assumptions that require substantial estimates and judgment. At December 31, 2005 and December 31, 2004 the Company reassessed the assumptions supporting these values in accordance with SFAS No. 142. Although no impairment was considered necessary, management will continue to monitor the appropriateness of the recorded values of these intangibles and will make adjustments to such values in the future as management deems necessary.

Liabilities. A comparison of total policy liabilities as of December 31, 2005, 2004 and 2003 is shown below. Approximately 89% of the 2005 total consist of insurance policy benefit reserves while policyholder deposit liabilities represent 11% of the total.

Home Service Life sales have decreased only moderately in recent years (Home Service Life revenue, including net investment and other income, increased by 1.5% in 2005 from 2004) with net growth in policy liabilities of 2.2% and 3.0% in 2005 and 2004, respectively, through a combination of attracting new producers and continuing to focus on meeting the needs of existing customers and agents. Broker Life sales increased 12.8% in 2005 (9.2% from sales of the new final expense product). Only a modest change was experienced in 2004. Preneed Life premiums are lower, due in part to the Company’s decision to emphasize the lower annual premium “multi-pay” policies rather than “single-pay” policies and some loss of volume attributable to reducing commission levels and the rate of annual growth credited to policies. The Company is not currently focusing any marketing effort to this segment because of the adverse effects of the low interest rate environment of recent years. During 2005, Dental premiums were unfavorably impacted by the non-renewal of a large group with unsatisfactory claims experience and more aggressive renewal underwriting for all groups. The Other Health segment products are not being actively marketed.

Shown below is a progression of the Company's policyholder deposit activity for the year ended December 31, 2005.

As indicated above, total policyholder deposits decreased by a net $565,000 during 2005. The Company is not devoting significant marketing effort toward Annuity, Universal Life and other deposit products and has elected not to aggressively compete in crediting excess interest on such products.

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not participate in any off-balance sheet arrangements.

CONSOLIDATED RESULTS AND ANALYSIS

Premiums and Other Considerations. The following table details premiums and other considerations received during the past three years.

Home Service Life premium decreased modestly in both 2005 and 2004. New sales began to decline in the fourth quarter of 2005 and have continued to decline in 2006 as a result of producer response to the Company’s introduction of a variable first year commission program designed to improve persistency in this segment. The Company also lost our regional representative for the Florida and Georgia region, as well as several producers in that region early in 2005. The Company continues its efforts to attract successful, experienced Home Service agents. In the fourth quarter of 2004, the Company began to geographically expand the Home Service market, hiring two new regional representatives to recruit new agents in Ohio and Pennsylvania. Company management considers it a challenge to increase new sales even modestly, while providing incentive to keep business in force for longer periods than we have historically experienced (i.e. improve our persistency rate) in this segment.

The increase in Broker Life premium during 2005 resulted primarily from the introduction of the new final expense product early in the year in an effort to strengthen the growth of this segment by better meeting the desires of our policyholders and agents.

The 27.9% and 47.1% decrease in Preneed Life premium during 2005 and 2004, respectively, resulted from the Company’s modification of certain policy benefits and commissions (which resulted in a loss in the number of producers) and an intentional refocusing of marketing efforts toward segments that the Company believes offer more positive potential in the current environment.

The 6.0% decrease in Dental premium during 2005 resulted primarily from the non-renewal of a large group with an unsatisfactory claims loss ratio, and introducing more aggressive renewal underwriting. The result, as expected, was a decrease in premium and a decrease in the overall claims loss ratio from 72.2% in 2004 to 69.7 % in 2005. During recent years, new business production has become increasingly competitive as larger providers expand their marketing initiatives. However, the Company has historically maintained strong customer and agent loyalty by continuing to improve customer service, including sales and administrative support functions. In January 2005 the Company began expanding its capacity to administer more Dental business without increasing administration costs by replacing our group administration system with a current state of the art system. The new system was placed in service in January 2006 and the Company plans to add additional functionality features throughout 2006 (including a group website, preferred provider network, third party administration capability and auto adjudication of claims). The Company also employed a senior marketing executive and a regional sales representative to focus marketing efforts on the Dental segment.

The Company has not been actively marketing Other Health policies for several years. However, in response to agent requests, certain cancer and disability protection products have been updated and promoted. Pricing, underwriting, and claims experience on these products are closely monitored. Due to unsatisfactory financial results in this product line, the Company discontinued selling new disability policies in October 2004, and received approval to increase premium rates by 35% effective February 1, 2006 in the state of New Jersey, where the majority of such policies have been issued.

Investments. The Company monitors its available-for-sale fixed maturities and equity securities to assure they are strategically positioned within the current market environment. This practice has historically resulted in holding significant equity security positions, which tend to dampen current income yields in favor of an overall total return

focus. The Company’s equity securities comprised 7.1% and 7.2% of its total investment portfolios at December 31, 2005 and 2004, respectively. The Company’s investment income yields were 5.1%, 4.7%, and 4.5% for 2005, 2004, and 2003, respectively. The 2005 yield increase resulted primarily from increasing interest rates on new investments, as well as improved short-term yields during the year. Although the Company’s total return on investments has historically been favorable, returns in recent years have been severely impacted by declines in the airline, automobile, telecommunications and technology sectors, declines in the fixed maturities market (due to increasing rates), a general economic recession and the effect of terrorist events on the securities markets.

As detailed in the following table, net realized and unrealized investment gains (losses) totaled approximately ($3,400,000) and $982,000 for the years ended December 31, 2005 and 2004, respectively. The Company does not anticipate severe deterioration in the securities markets as experienced during the years 2000 through 2002 although there is still some volatility in the equities markets. At December 31, 2005 and 2004, the Company’s investment portfolios contained net unrealized gains outstanding of $1,124,000 and $5,261,000, respectively. Below is an approximate calculation of investment income yields and “total return” (defined as yields including net

investment income, net realized investment gains or losses and net change in the excess or deficit of market values

over book values of the investment portfolios or unrealized gains (losses)) yields for the five years ended December

31, 2005.

The Company realized significant gains on the sales of equity securities and high yield, below investment grade bonds during 2004 and 2003 as we repositioned our portfolio to include a greater proportion of investment grade bonds. As bond interest rates began to increase in 2005 we experienced significant unrealized losses on our fixed maturity portfolio (due to lower than market yields on our portfolio). Company management continues to monitor the equities and fixed maturity markets, and to reposition the portfolios as considered appropriate.

Segment Earnings. Pretax profit is shown below for the Company’s five business segments, along with total net realized investment gains and interest expense.

The 2005 increase in pretax income of $118,000 results from the negative effects of: (a) a decrease in premiums and other considerations of $2,317,000, or 8.3% (Preneed decreased $1,937,000, Dental decreased $545,000, Home Service decreased $135,000, Other Health decreased $150,000, while Broker Life increased $450,000 (including new final expense premiums of $324,000)), (b) a decrease in net realized investment gains of $2,088,000, and (c) an increase in interest expense of $25,000 offset by the positive effects of: (d) an increase in investment and other income of $577,000, (e) a decrease in policyholder benefits and commissions of $2,934,000, (f) a decrease in general expenses and depreciation of $864,000, and (g) a decrease in amortization of deferred policy acquisition costs and value of insurance acquired of $236,000, offset by a decrease in acquisition costs deferred of $63,000.

The 2004 decline in pretax income of $435,000 was attributable to the negative effects of: (a) a decrease in premiums and other considerations of $5,600,000, or 16.7% (Preneed premium decreased $6,200,000, or 47.1% while Dental premium increased $900,000, or 11.2% and premium for other segments experienced modest decreases), (b) costs of $1,200,000 (settlement and legal costs) associated with the legal proceedings described in Item 3, (c) a decrease in net deferral of policy acquisition costs and amortization of value of insurance in force of $648,000, and (d) additional one time expenses related to consulting and severance of $139,000, offset by the positive effects of: (e) a decrease in policyholder benefits and commissions totaling $5,800,000, (f) an increase of $357,000 in investment and other income (g) an increase of $891,000 in net realized investment gains (h) a decrease in interest expense of $9,100, and (e) a decrease other recurring general expenses of $95,000

Home Service Life

In 2005 the Home Service Life segment benefited by $272,000 of higher investment and other income and by $382,000 of decreased expenses (including net deferral of policy acquisition costs), associated primarily with one-time consulting costs, severance and legal costs, resulting in a decrease in the segment loss of $604,000.

Broker Life

The $932,000 decrease in the loss in the Broker Life segment is primarily the result of an increase in premium of $450,000 (primarily from our new final expense product), a decrease of $205,000 in policyholder benefits and an increase in investment and other income of $275,000.

Preneed Life

The $740,000 change from a loss of $275,000 in 2004 to a profit of $464,000 in 2005 in the Preneed life segment is primarily the result of a decrease of $643,000 in expenses (including net deferral of policy acquisition costs), associated primarily with one-time consulting costs, severance and legal costs a decrease in commissions of $344,000 and a decrease of $1,674,000 in policyholder benefits offsetting the decrease of $1,936,000 in premiums resulting from the reduced level of business. During 2002, the Company accepted a significant amount of single-premium business, which generally has higher than average mortality rates. At that time, significant management and marketing resources were devoted to this business. To improve profitability, annual benefit growth rates were reduced in early 2003 and again in September 2004. Also, twice during 2002, certain commission rates were reduced and agent contracts revised to encourage production of the more profitable multi-pay products.

Dental

Information regarding Dental profitability is included below. The “contribution margin” shown below is a direct margin without allocable investment income and general expense.

The contribution margin increased in 2005 by $213,000 due primarily to the Company’s aggressive renewal underwriting and re-rating and not renewing a large group with a particularly high morbidity rate in December 2004. Although premiums decreased $545,000 in 2005, benefits decreased $615,000, and commissions decreased $142,000. Expenses for the Dental segment increased $261,000 due to the increased marketing resources allocated to this segment (the Company employed a senior marketing executive for this segment in August of 2005, and employed a regional representative in the fourth quarter of 2005).

The contribution margin decreased in 2004 by $217,000 from 2003 due to adverse morbidity (especially related to one large group) and inadequate premium for groups renewing. Also, the Company has encountered more competition as additional insurers continue to expand in the Dental market and Dental providers continue to provide higher levels of care to patients. The Company is continuing its ongoing efforts to maintain profitability in this line by reconfiguring products to provide adequate margins for the various dental procedures, utilizing a third-party company to provide expert assistance with ongoing adjudication of claims, and continuing its program of aggressive renewal underwriting and re-rating.

Other Health

The Company has not devoted significant marketing effort toward its Other Health products in recent years. However, during 2002 through 2004, a significant increase in disability claims occurred, with a concentration in New Jersey. The Company received approval for a 35% rate increase on its disability products in New Jersey effective in early 2006, and discontinued accepting applications for this policy in New Jersey in the fall of 2004.

Income Taxes. Historically, the Company has experienced a relatively low effective current income tax rate, due primarily to the small life insurance company deduction, along with operating loss carryforwards and capital loss carryforwards. The effective expense (benefit) rate is approximately 0.0% and (23)% in 2005 and 2004, respectively.

The small life insurance company deduction allows the Life Insurance Subsidiaries to reduce their taxable income by 60% before computing their current provisions for regular or alternative minimum tax. However, for purposes of computing deferred income tax liabilities under the provisions of SFAS No. 109, “Accounting for Income Taxes”, the Company is precluded from assuming the small life insurance company deduction will be available in the future. Accordingly, by disallowing this deduction, SFAS No. 109 significantly increases the deferred taxes on the Life Insurance Subsidiaries’ temporary differences. Thus, when a significant increase or decrease occurs in the Company’s net temporary differences, the related deferred tax is computed using the 34% federal tax rate, whereas tax may actually be paid on these net liabilities (when realized) at a rate potentially as low as 17% (the alternative minimum tax rate after application of the allowable small life insurance company deduction). The Company’s gross deferred federal income tax liabilities and assets are more fully discussed in Note 6 of the Notes to Consolidated Financial Statements. The gross deferred tax assets are offset, to some extent, by valuation allowances related to the Company and to the Life Insurance Subsidiaries and then offset against existing deferred tax liabilities. The Company’s valuation allowance is designed to reduce deferred tax assets to their estimated ultimate realization value.

Statutory Insurance Information. For insurance regulatory and rating purposes, the Insurance Subsidiaries report on the basis of statutory accounting principles (“SAP”). In recent years, various state insurance departments and the NAIC have expressed concern, essentially about the “rate of return” earned by holders of small face amount life policies, potentially including Preneed policies. Although the Company does not believe calculating a simple “rate of return” or premium “pay-back” measure is meaningful for traditional life insurance products, certain state insurance regulators are considering actions that could alter the profitability of existing contracts or eliminate small face amount policies as a viable product offering.

During December 2002, Citizens Financial strengthened the statutory capital position of Citizens Security by acquiring $2,000,000 of Citizens Security redeemable preferred stock. During January 2001, Citizens Financial contributed 100% of the capital stock of Citizens Insurance to Citizens Security. The statutory value of this contribution was $3,540,555. Citizens Security has reported its investments in United Liberty and Citizens Insurance on the equity method of accounting, since their acquisitions in 1998 and 2001, respectively. However, beginning in 2001, new rules changed the statutory equity method of accounting to preclude a parent insurer from recording as income, its share of undistributed subsidiary earnings. For 2005, 2004, and 2003, Citizens Security reported as income the $250,000, $1,174,090 and $116,400 respectively, of dividend distributions that it received from United Liberty and Citizens Insurance. At December 31, 2005, Citizens Security reported its investments in United Liberty and Citizens Insurance at their statutory equity values of $2,096,243 and $2,431,907 respectively. To provide a more detailed understanding of Citizens Security's operations, shown below are SAP basis net income (loss), pretax net operating income (loss), statutory capital and surplus, asset valuation reserves, and capital ratios for Citizens Security for the five years ended December 31, 2005.

¹Asset Valuation Reserves are statutory liabilities that act as contingency reserves in the event of extraordinary losses on invested assets and as a buffer for policyholders’ surplus to reduce the impact of realized and unrealized investment losses. The 2001 through 2005 amounts also include United Liberty’s asset valuation reserves. Citizens Insurance does not have an Asset Valuation Reserve.

² Represents Statutory Capital and Surplus plus Asset Valuation Reserves divided by invested assets plus cash.

The following table shows the changes to Citizens Security’s statutory capital and surplus for the five years ended December 31, 2005.

In addition to the statutory totals shown above, Citizens Insurance generated statutory net income of approximately $63,000, $76,000, and $93,000 during, 2002, 2001, and 2000, respectively without remitting any dividends to its parent. Citizens Insurance generated statutory net income of $22,000 and $56,000 and paid dividends of $250,000 and $1,174,000 to Citizens Security in 2005 and 2004, respectively. United Liberty generated statutory net income (loss) of approximately $117,000, ($692,000), $536,000, ($328,000), and ($48,000), during 2005, 2004, 2003, 2002 and 2001, respectively and remitted dividends to its parent of $54,000 and $214,000 in 2003 and 2002, respectively.

Statutory capital and surplus, specifically the component called surplus, is used to fund the expansion of an insurance company’s first year individual life and accident and health sales. The first year commission and underwriting expenses on such sales will often exceed first year premiums. Accordingly, a statutory loss (surplus strain) often occurs on these sales during the first policy year. Historically, the Company’s level of life insurance sales has not significantly impacted statutory surplus.

The Company completed a strategic review of its products and operations, resulting in the mitigation of the significant losses incurred in the Preneed Life business segment in prior years and strengthening the potential for future profitability in the Broker Life, Home Service Life and Dental segments by increasing premiums, strengthening underwriting policies, modifying commissions, and where possible, lowering interest crediting or policy growth rates.

CASH FLOW AND LIQUIDITY

Due to losses in 2001 and 2002 and the adverse impact of the low interest rate environment on operating results, during 2002 the Company borrowed $2,000,000 from its Chairman to strengthen the statutory capital position of Citizens Security. The Company borrowed an additional $1,000,000 from its Chairman in 2003 and an additional $1,000,000 in 2005 for general operating capital, including bank debt service. The borrowings from the Company’s Chairman are considered current debt as a result of a 90-day call provision in the loan agreement. The Company also has $1,375,003 of commercial bank debt outstanding, with scheduled repayments due through April 2007. During 2004, 2003 and 2002 the Company did not comply with a loan covenant (debt to earnings ratio) on this debt and received a series of waivers of such violation through December 31, 2004. In return for the waivers the Company��s Chairman agreed to personally guarantee the outstanding bank debt. The Company was in compliance with the debt covenant for the last two quarters of 2005. Regarding the currently scheduled debt repayments, the Company believes its available funds will be adequate to service 2006 debt obligations. In addition, the Company’s Chairman has expressed potential willingness to loan the Company an additional $1,000,000 if necessary, which could service debt obligations through 2006. Additional information regarding debt obligations is included in Note 4 of the Notes to Consolidated Financial Statements.

A summary of all known commitments of the Company as of December 31, 2005, including the aforementioned borrowings, and an estimate (based on reasonable assumptions and anticipated trends) of payments to be made for future policy benefits and contract claims, is as follows:

(a) Anticipated cash benefit payments not including any future earnings or additional premium

Management is not aware of any other commitments or unusual events that could materially affect the Company’s capital resources.

The Company generated approximately $138,000, $913,000 and $6,069,000 of cash flow from operations during 2005, 2004 and 2003, respectively. The fluctuations are principally attributable to growth of Preneed Life premiums in 2003 and a decrease in Preneed Life premiums in 2004 and 2005.

Cash provided by (used in) investment activities of $316,000, $(2,464,000), and $(2,618,000) during 2005, 2004, and 2003 respectively, relates primarily to investing additional Preneed Life premiums in fixed maturity securities in 2004 and 2003. The net cash provided by investments in 2005 results primarily from the sale of short-term investments for $612,000, less approximately $300,000 used to acquire new equipment.

Cash used in financing activities during 2005 of $1,592,000 includes $1,416,000 of debt repayments and $1,176,000 of net withdrawals of policyholder deposits, offset by additional borrowings of $1,000,000 from the Company’s Chairman. The $2,346,000 of cash used by financing activities during 2004 includes $1,342,000 of debt repayments and $902,000 of net withdrawals of policyholder deposits, and $102,000 used to repurchase the Company’s common stock.

The Company is subject to various market risks. However, the most significant such risks relate to fluctuations in prices of equity securities and interest rates. Historically, total returns on the Company’s equity portfolio have been favorable and the Company has successfully managed the risk of equity security price fluctuations over many years. The Company devotes significant attention to the equity markets and repositions the Company’s portfolio upon detection of adverse risk trends associated with individual securities or overall markets. The Company also manages market risks associated with investments in option securities, as described in Note 2 of the Notes to Consolidated Financial Statements. The fair value of the Company’s equity portfolio was approximately $8,580,000 and $8,943,000 at December 31, 2005 and 2004, respectively. Accordingly, a 10% decline in equity prices would have reduced the fair value of the Company’s equity portfolio by $858,000 and $894,000 at December 31, 2005 and 2004, respectively. The average cost value of the Company’s equity portfolio was $7,559,000 and $11,133,000 during 2005 and 2004, respectively.

Regarding interest rate risk, the value of the Company’s fixed-maturity investment portfolio will increase or decrease in an inverse relationship with fluctuations in interest rates while net investment income earned on newly-acquired fixed-maturities increases or decreases in direct relationship with interest rate changes. Management estimates that a 100 basis point increase in interest rates (“rate shock”) would have decreased the fair value of its $112.9 million fixed maturity portfolio by approximately 6.3% or $7.1 million at December 31, 2005 and 6.3% or $7.3 million at December 31, 2004. From an income perspective, the Company does not believe rising interest rates present a significant risk, as essentially all of the Company’s policy liabilities bear fixed rates. However, approximately 39% of policy liabilities contain provisions permitting interest or benefit adjustments at the discretion of the Boards of Directors of the Insurance Subsidiaries. The Company’s cash flow testing (described below) indicates that overall profitability will generally be enhanced in rising interest rate scenarios. From a liquidity perspective, the Company’s fixed rate policy liabilities have been relatively insensitive to interest rate fluctuations. Accordingly, the Company believes gradual increases in interest rates do not present a significant liquidity exposure. The Company monitors economic conditions on a regular basis and manages this interest rate risk primarily by adjusting the duration of its fixed-maturity portfolio. Historically, the Company has maintained conservative durations in its fixed-maturity portfolio. During 2005 and 2004, the Company increased durations of the fixed maturity portfolio. At December 31, 2005 cash and fixed-maturity investments with maturities of less than five years equaled approximately 19% of total policy liabilities compared to approximately 26% at December 31, 2004. Notwithstanding the foregoing, if interest rates rise significantly in a short timeframe, there can be no assurance that the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales, and thereby be materially adversely affected.

Interest expense on the Company’s debt varies quarterly and is therefore also subject to interest rate risk. For its commercial bank debt, the Company elects the lower of the prime lending rate or the one-month LIBOR rate plus 2.75%. For its related party debt, the interest rate is the higher of 6% or the commercial bank prime lending rate plus 1%. At December 31, 2005, the weighted average rate on the Company’s $5,375,003 of borrowings was 8.09%. The Company believes its current liquidity position and profitability levels are adequate to guard against this interest rate risk.

In addition to the measures described above, the Life Insurance Subsidiaries comply with the NAIC promulgated Standard Valuation Law (“SVL”) which specifies minimum reserve levels and prescribes methods for determining them, with the intent of enhancing solvency. The SVL also requires the Company to perform annual cash flow testing for its Life Insurance Subsidiaries. This testing is designed to ensure that statutory reserve levels will maintain adequate protection in a variety of potential interest rate scenarios. The Actuarial Standards Board of the American Academy of Actuaries also requires cash flow testing as a basis for the actuarial opinion on the adequacy of the reserves which is a required part of the annual statutory reporting process.

Cash flow testing projects cash inflows from assets and cash outflows for liabilities in various assumed economic and yield curve scenarios. This is a dynamic process, whereby the performance of the assets and liabilities is directly related to the scenario assumptions. (An example would involve the credited interest rate on annuity products and how such rates vary depending upon projected earnings rates, which are based upon asset performance under a particular economic scenario.)

The Life Insurance Subsidiaries’ most recent cash flow testing, which was completed in February 2006, involved a review of two basic measures. The first was the value of free market surplus, which is defined as the difference between the projected market value of assets and liabilities at the end of the analysis period (typically 10-30 years). Deficits could indicate the need for corrective action depending upon the severity and the number of scenarios in which a deficit appeared. A second measure involved distributable earnings. Negative earnings for extended durations might impair the ability of the Life Insurance Subsidiaries to continue without exhausting surplus. Again, depending upon severity and frequency, corrective measures might be needed. Based on results of the testing, no corrective measures were indicated at the current time. However, such testing is ongoing and dynamic in nature and future events in the interest and equity markets or a significant change in the composition of Life Insurance Subsidiaries’ business could negatively impact testing results and require the initiation of corrective measures.

Any necessary corrective measures could take one or more forms. The duration of existing assets might not match well with those of the liabilities. Certain liabilities, such as those associated with indemnity accident and health, short-term disability and group dental products, are short-term in nature and are best matched with cash and short-term investments. By contrast, whole life insurance, which involves lifetime obligations, is usually best matched by longer duration maturities. In the event there are insufficient assets of these types, a repositioning of the investment portfolio might be undertaken.

Initially balanced durations do not guarantee positive future results. Asset type, quality, and yield will vary depending upon the economic scenario tested. Liabilities will be similarly affected. Projected reinvestment yields may cause overall yields to fall below those required to support projected liabilities. In that event, portfolio realignment might involve the type, quality and yield of investments rather than duration. Alternatively, additional reserve amounts could be allocated to cover any future shortfalls.

The above discussion centers on asset management. Other possible corrective measures might involve liability realignment. The Company’s marketing plan could be modified to emphasize certain product types and reduce others. New business levels could be varied in order to find the optimum level. Management believes that the Company's current liquidity, current bond portfolio maturity distribution and cash flow from operations give it substantial resources to administer its existing business and fund growth generated by direct sales.

FORWARD-LOOKING INFORMATION

All statements, trend analyses and other information contained in this report relative to markets for the Company’s products and trends in the Company’s operations or financial results, as well as other statements including words such as “anticipate”, “believe”, “plan”, “estimate”, “expect”, “intend”, and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things:

•	the market value of the Company’s investments, including stock market performance and prevailing interest rate levels (see the Cash Flow and Liquidity section of this Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations);
•	customer and agent response to new products, distribution channels and marketing initiatives, including exposure to unrecoverable advanced commissions;
•	mortality, morbidity, lapse rates, and other factors which may affect the profitability of the Company’s insurance products;
•	regulatory changes or actions, including those relating to regulation of insurance products and insurance companies (see the State Insurance Regulation section of Item 1 - Business);
•	ratings assigned to the Company and its subsidiaries by independent rating organizations which the Company believes are important to the sale of its products;
•	general economic conditions and increasing competition which may affect the Company’s ability to sell its products;
•	the Company’s ability to achieve anticipated levels of operating efficiencies and meet cash requirements based upon projected liquidity sources;
•		unanticipated adverse litigation outcomes (see Item 3 – Legal Proceedings); and
•	changes in the Federal income tax laws and regulations, which may affect the relative tax advantages of some of the Company’s products.

There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect the Company’s results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative and qualitative disclosures about market risk are described in the Cash Flow and Liquidity section of Item 7 - Management’s Discussion and Analysis.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES

Financial Statements For Full Fiscal Years

Page

Report of Independent Registered Public Accounting Firm

Consolidated Statements of Operations for the

years ended December 31, 2005, 2004 and 2003

Consolidated Balance Sheets at

December 31, 2005 and 2004

Consolidated Statements of Shareholders' Equity

for the years ended December 31, 2005, 2004 and 2003

Consolidated Statements of Cash Flows for the

years ended December 31, 2005, 2004 and 2003

Notes to Consolidated Financial Statements

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH

ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There has been no change in accountants nor have there been any disagreements on accounting and financial disclosure requiring disclosure pursuant to the Instructions to this Item.

ITEM 9A. CONTROLS AND PROCEDURES

The Company’s chief executive officer and chief financial officer, with the participation of management, have evaluated the Company’s disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rule 13a-15(e)) as of December 31, 2005. Based on the evaluation, they concluded that the controls and procedures are effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

ITEM 9B. OTHER INFORMATION

There is no other information requiring disclosure pursuant to the Instructions to this Item.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Shareholders and Board of Directors

Citizens Financial Corporation

We have audited the accompanying consolidated balance sheets of Citizens Financial Corporation and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens Financial Corporation and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

Louisville, Kentucky

March 17, 2006