the right to receive, or the power to direct the receipt of, dividends from, or the proceeds from the sale of, such securities. The filing further states that no such client is known to have such right or power with respect to more than five percent of the common stock of the Company.
(6) Based on information reported on a Schedule 13G filed by Financial & Investment Management Group, Ltd on February 9, 2006. According to the 13G filing, Financial & Investment Management Group, Ltd is a registered investment advisor managing individual client accounts. All shares represented in the 13G are held in accounts owned by the clients of Financial & Investment Management Group, Ltd and Financial & Investment Management Group, Ltd disclaims beneficial ownership of the shares.
The following table sets forth certain information regarding the beneficial ownership of Common Stock as of May 15, 2006, by (i) each director, (ii) the current executive officers of the Company, (iii) other persons named in the Summary Compensation Table below, and (iv) all such persons as a group:
* Less than 1%.
The business address of each officer and director is c/o Financial Industries Corporation, 6500 River Place Blvd., Building I, Austin, Texas 78730.
(of which Otter Creek Management, Inc. serves as general partner); Otter Creek International, Ltd, an investment corporation; and HHMI XIII, a limited liability company. The shares in the table include 232,741 shares owned by Otter Creek International, Ltd Corporation and 136,778 shares owned by Otter Creek Partners I, LP Partnership. Mr. Long disclaims beneficial ownership of these shares for purposes of Section 16 of the Securities Exchange Act of 1934 or for any other purpose.
(3)) | Owned in 401(k) plan account, subject to vesting, as a result of employer matching contribution program. |
(4) | Does not include 385,000 shares owned by American Physicians Service Group, Inc., of which Mr. Shifrin is CEO and Chairman. Mr. Shifrin disclaims beneficial ownership of such shares. |
(5) Includes shares issued under the Stock Plan, effective September 30, 2005. For additional information, see the section entitled “Compensation of Directors.”;
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
New Era Transactions
In June 2003, a subsidiary of FIC acquired three companies: Total Compensation Group Consulting Inc., a consulting firm and registered investment advisor; Paragon, a group of three companies providing employee benefits products and services; and JNT Group Inc., an independent fee-based third-party administrator (collectively, the “New Era Marketing Companies”). The acquisitions were facilitated for FIC by representatives of American Physicians Service Group Inc. (“APS”) and Equita Financial and Insurance Services of Texas, Inc. Kenneth S. Shifrin, a director of FIC, is the chairman and chief executive officer of APS.
Pursuant to Option Agreements dated as of June 5, 2003 (the “Option Agreements”), in consideration for their facilitation of the acquisition of the New Era Marketing Companies and the Marketing Agreement described below, APS and Equita were granted options to purchase 323,000 and 169,000 shares of Common Stock, respectively, at $16.42 per share (120% of the average closing price of Common Stock for the 15 trading days ended June 3, 2003). Such options are exercisable only if a marketing subsidiary, FIC Financial Services Inc., produced over $200,000,000 in qualifying premiums between July 1, 2003, and December 31, 2005. Equita was also granted an option to purchase up to 158,000 shares of Common Stock at $16.42 per share, exercisable at the rate of 10,000 shares for each $10,000,000 increment by which qualifying premiums generated by products marketed by Equita exceeded $200,000,000 between July 1, 2003 and December 31, 2005. As of June 1, 2005, there have been no “qualifying premiums”, as described in “Part I, Item 1-Description of the Business-Agency Operations-Marketing Agreement with Equita.”;
In accordance with the terms of the Option Agreements, the Company appointed Mr. Shifrin and Eugene J. Woznicki, designees of APS and Equita, respectively, to the Board to fill the two vacancies created by the resignation of Roy Mitte and his son, Scott Mitte in 2003. See “Settlement of Litigation with Mitte Family”, below. In addition, the Company agreed, with respect to the 2003 Annual Meeting and its 2004 Annual Meeting, to propose Messrs. Shifrin and Woznicki as nominees for election to the Board, include their names in the Company’s proxy materials, and recommend and solicit proxies for their election. Under that agreement, in the event that the Company’s designated proxies cumulated votes for any director nominees, such proxies were obligated to cumulate votes in favor of Mr. Shifrin if such cumulative voting would result in the election of at least four directors and in favor of Mr. Woznicki if such cumulative voting would result in the election of at least eight directors. Such cumulative voting in favor of Mr. Shifrin occurred with respect to the 2003 Annual Meeting.
Pursuant to Stock Purchase Agreements dated as of June 5, 2003, APS and an affiliate of Equita acquired 312,484 and 204,918 shares of Common Stock, respectively, from the Mitte Foundation. In addition, APS acquired an additional 27,395 shares of Common Stock from FIC for a cash purchase price of $14.64 per share on June 5, 2003. Pursuant to a Registration Rights Agreement dated as of June 5, 2003, the Company granted registration rights to APS and Equita for all shares of Common Stock held by them on June 5, 2003, and any shares of Common Stock acquired pursuant to the Option Agreements.
In June 2005, Equita commenced litigation against FIC pertaining to matters arising out of the option agreement. See Item 3-Legal Proceedings-Litigation with Equita Financial and Insurance Services of Texas, Inc. and M&W Insurance Services, Inc.
Sale of Actuarial Risk Consultants, Inc. and Amendment to Employment Agreement of George Wise
On December 31, 2003, FIC sold Actuarial Risk Consultants, Inc. (“ARC”), an actuarial consulting subsidiary which it had established in December, 2002. The sale of ARC was to George M. Wise, III, who was Vice President and Chief Financial Officer of FIC until March 2004. The consideration for the transaction was $10,000. Prior to the closing, all intercompany payables owed by ARC to FIC or its affiliates were satisfied in full, and certain tangible and intangible assets used by ARC in
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connection with the operation of its business were assigned to ARC. The cost to the Company of its investment in ARC at the time of the sale was $146,000.
In connection with the sale, Mr. Wise and FIC entered into an amendment to Mr. Wise’s employment agreement, as described under “Compensation of Executive Officers and Directors–Employment Agreements and Change In Control Arrangements”. The amendment released FIC from any claims Mr. Wise may have had relating to his employment with FIC, including claims which Mr. Wise had asserted related to his entitlement to a bonus payment of approximately $70,000.
Also, in connection with the sale of ARC to Mr. Wise, FIC entered into a consulting agreement with ARC. Under the terms of the agreement, FIC and its insurance subsidiaries may (but are not obligated to) obtain up to 2,000 hours of actuarial consulting services from ARC during the period from January 1, 2004 to December 31, 2005. During 2004 and 2005, the Company paid fees of approximately $1.16 million and $0.84 million, respectively to ARC in connection with the provision of actuarial consulting services, including services related to the Company’s review of deferred policy acquisition costs and present value of future profits of acquired businesses.
Settlement of Litigation with Mitte Family
In October 2002, a Special Committee of the Company’s Board of Directors voted to terminate the employment agreement of Roy F. Mitte, the Company’s Chairman and Chief Executive Officer, by reason of Mr. Mitte’s physical or mental disability extending over a period of six consecutive months or more. The Special Committee further voted to terminate Mr. Mitte’s employment agreement on the alternative basis that the actions of Mr. Mitte, as described in the Report of the Audit Committee of the Board of Directors Concerning Payment of Personal Expenses of the Chairman, dated September 17, 2002 (the “Audit Committee Report”), constituted breaches of such agreement that excused further performance thereof by FIC.
The Audit Committee, which at the time consisted of John D. Barnett, David G. Caldwell, W. Lewis Gilcrease and Frank Parker, found that over the course of almost ten years, the Company had paid, or reimbursed Mr. Mitte for, approximately $550,000 in expenses that were personal in nature. The Audit Committee further noted that in January 2002, Mr. Mitte caused the transfer of $1,000,000 from the Company to the Roy F. and Joann Cole Mitte Foundation (the “Mitte Foundation”), a charitable foundation controlled by Mr. Mitte, in contravention of his earlier statement to the Compensation Committee of the Board that no donation would be made from FIC to the Mitte Foundation during 2002, and without the prior approval of the Board.
On January 23, 2003, the Company commenced litigation against Mr. Mitte, the Mitte Foundation, and Joann Cole Mitte which sought repayment of the personal expenses and donation and to delay a special shareholders meeting previously requested by the Mitte Foundation, alleging, among other things, Mr. Mitte’s violation of certain provisions of the securities laws. On March 19, 2003, Mr. Mitte filed a counterclaim against the Company alleging breach of contract with respect to the Company’s failure to pay Mr. Mitte severance benefits and compensation that Mr. Mitte claimed he was entitled to receive under his employment agreement with the Company. Mr. Mitte sought actual damages, interest and attorney’s fees and costs. He claimed the actual damages were incurred with respect to the Company’s termination of his employment agreement, which provided a minimum level of compensation of $503,500 per year through February 25, 2007, and an annual bonus through February 25, 2007, in the discretion of the Board, of $2.5 million which would be automatically payable in the event of a change of control of the Company.
On May 15, 2003, the Company entered into a Settlement Agreement with the Mitte Family. Under the terms of the Settlement Agreement, the Mitte Family released the Company from any past, present or future claims which they may have against the Company, including any claims which Roy Mitte may assert under the employment agreement. In addition, the Company agreed to release the Mitte Family from any past, present or future claims which the Company may have against the Mitte Family.
The Settlement Agreement provided for payments by the Company to Roy Mitte of $1 million on each of June 1, 2003, June 1, 2004 and June 1, 2005, which would be subject to acceleration in the event of specified changes in control of the Company. Pursuant to the Settlement Agreement, the Company also agreed to:
| • | use its commercially reasonable efforts to locate a purchaser or purchasers of specified installments over a two year period of the 1,552,206 shares of Company common stock owned by the Mitte Foundation as of the date of the Settlement Agreement during future periods set forth in the Settlement Agreement, at a price of $14.64 per share; |
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| • | purchase (or, alternatively, locate a purchaser) on or before June 1, 2003, of the 39,820 shares of Common Stock owned by Roy Mitte and the 35,520 shares of Common Stock held in the ESOP account of Roy Mitte, in each case as of the date of the Settlement Agreement, at a price of $14.64 per share; and |
| • | cancel options to purchase 6,600 shares of Common Stock held by Roy Mitte in exchange for a cash payment equal to $42,636 (the difference between $14.64 per share and the exercise price per share). |
Pursuant to the Settlement Agreement, the Mitte Family granted an irrevocable proxy for any shares of Common Stock owned by the Mitte Foundation to the persons named as proxies by the Company. With respect to the 2003 and later Annual Meetings of the Company, the proxy may be voted “for” all nominees of the Board named in the Company’s proxy statements, “against” any proposal by a person other than the Company for the removal of any members of the Board, “withheld” as to nominees for the Board proposed by any person other than the Company, “against” any proposal by any person other than the Company to amend the bylaws or articles of the Company, and in accordance with the recommendation of the Board or at their discretion as permitted by applicable law with respect to any shareholder proposal submitted pursuant to Rule 14a-8 under the Exchange Act. The proxy also extended to certain matters which may be proposed by the Company at its 2004 annual meeting of shareholders, or any later annual or special meeting, regarding changes in the ownership percentage required in order for a shareholder to call a special meeting of shareholders and the elimination of cumulative voting. The Company agreed not to propose at the 2003 Annual Meeting any amendment to the Company’s articles of incorporation or bylaws that would increase the ownership threshold for a shareholder’s ability to call a special meeting of shareholders. The proxy did not extend to any other matters that may be proposed by FIC at any annual or special meeting during which the proxy is in effect, including, without limitation, any other amendment to the articles of incorporation or bylaws of the Company, any action relative to a merger of FIC, the sale of all or substantially all of the assets of FIC or the issuance or sale by FIC of any of its equity securities.
The survival of the proxy was generally conditioned upon the performance of the scheduled purchases of the shares of Common Stock owned by the Mitte Foundation and payments required under the Settlement Agreement. The Settlement Agreement provided that, unless earlier terminated, the proxy would expire on May 15, 2005. Accordingly, the proxy granted under the terms of the Settlement Agreement has expired by its own terms.
As described under “New Era Transactions”, above, APS and a subsidiary of Equita acquired 312,484 and 204,918 shares of Common Stock, respectively, from the Mitte Foundation in June 2003. Prior to the 2003 Annual Meeting, at the request of APS and the Equita subsidiary, FIC released the proxy with respect to the shares of Common Stock of FIC acquired from the Foundation. Accordingly, APS and the Equita subsidiary each voted their respective shares directly at the 2003 Annual Meeting.
In May 2003, the Company purchased from Mr. Mitte the 39,820 shares of FIC common stock owned by him and the 35,520 shares of common stock held in Mr. Mitte’s ESOP account, as provided under the terms of the Settlement Agreement, at a price of $14.64 per share. Subsequently, in July 2003, the Company’s Nonqualified Deferred Compensation Plan f/b/o Eugene E. Payne purchased, at the request of Dr. Payne, 13,600 of these shares, at a price of $14.64 per share. The benefits available to Dr. Payne under the plan are based on the value of these shares, as well as the value of other assets held in the plan.
The Settlement Agreement also includes provisions related to the continuation of health insurance of Roy Mitte and Joann Mitte for five years. In accordance with the Settlement Agreement, Roy Mitte and Scott Mitte resigned from the Board effective as of June 2, 2003. The Company recognized a charge of $2.9 million (before tax) in the first quarter of 2003 for amounts to be paid under the Settlement Agreement.
Litigation with Otter Creek Partnership I, L.P.
On June 13, 2003, Otter Creek Partnership I, L.P. filed a civil lawsuit against FIC in the District Court in Travis County, Texas, Cause No. GN302872. In its lawsuit, Otter Creek sought an injunction against FIC to compel it to schedule and hold the 2003 annual meeting of shareholders. In addition, the lawsuit sought to compel FIC either not to exercise the proxy that it acquired from the Mitte Family (as described above) or to vote such shares in the same proportion as the other outstanding shares of the Company are voted. Otter Creek and FIC completed a settlement with respect to the lawsuit in December 2003. Under the settlement agreement, (1) the Company reimbursed Otter Creek for $250,000 in proxy expenses, and (2) an additional $475,000 of proxy and litigation expenses will be submitted to the Company’s shareholders for approval at the next Annual Meeting. The Board of Directors agreed to recommend that shareholders approve the reimbursement. The settlement also included mutual releases between the Company and Otter Creek and its affiliates in favor of each of them and their respective employees, directors, officers, agents, and representatives. The Chairman of the Board of Directors of the Company, R. Keith Long, is the President and owner of the General Partner of Otter Creek Partners I, L.P.
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Consulting Arrangement with William P. Tedrow
William P. Tedrow, who served as a vice president of the Company from June 2003 to March 2004, provided consulting services to the Company during the period from January 2003 to May 2003. These services related to the development of the business plan that led, in June 2003, to the purchase of the New Era companies and the marketing arrangement with Equita. In connection with such consulting services, Mr. Tedrow received fees of $94,361 and reimbursement of expenses in the amount of $8,925.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the dollar amount of the fees incurred through September 30, 2006 to the Company by PricewaterhouseCoopers LLP (“PwC”) for audit and other services for the years 2003 and 2004 and by Deloitte & Touche LLP (“Deloitte”) for audit and other services for the year 2004:
| For the Audit of |
| Year Ended December 31, |
| 2004 | | 2003 |
| Deloitte | | PwC | | PwC |
| | | | | |
Audit fees | $3,244,019 | | $ 47,464 | | $5,204,672 |
Audit-related fees | 317,195 | | 68,054 | | 256,122 |
Tax fees | - | | - | | 234,117 |
All other fees | - | | - | | - |
| | | | | |
Total fees billed | $3,561,214 | | $ 115,518 | | $5,694,911 |
| | | | | |
Audit fees represent fees for services provided in connection with the audit of the Company’s consolidated statements, review of interim financial statements, statutory audits, and SEC registration statement reviews.
Audit-related fees consist primarily of fees for audits of employee benefit plans and services that are reasonably related to the performance of the audit or review of the Company’s consolidated financial statements. This category includes fees related to audit and attest services not required by statute or regulations, and consultations concerning financial accounting and reporting standards.
Tax fees consist of fees for professional services for tax compliance, tax advice, tax planning and tax audits. These services include assistance regarding federal and state tax compliance, return preparation, claims for refunds and tax audits.
The Audit Committee considers and, if it deems appropriate, approves, on a case by case basis, any audit or permitted non-audit service to be performed by the independent auditor at the time that the independent auditor is to be engaged to perform such service. These services may include audit services, audit-related services, tax services and other services. Since the Audit Committee specifically pre-approves each of the services to be rendered by the independent auditor in advance of performance, the Audit Committee currently does not have a pre-approval policy. In connection with the approval of audit and non-audit services, the Audit Committee must consider whether the provision of such permitted non-audit services is consistent with maintaining the independent auditor’s status as our independent auditors. Since May 6, 2003, the date on which SEC rules relating to approval of services by independent auditors became effective, all services for which the Audit Committee engaged the independent auditor were pre-approved by the Audit Committee.
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PART IV
ITEM 15. EXHIBITS, FINANICAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) | The following documents have been filed as part of this report: |
| 1. | Financial Statements (See Item 8) |
The following consolidated financial statements of Financial Industries Corporation and subsidiaries are included in Item 8:
Reports of Independent Registered Public Accounting Firms.
Consolidated Balance Sheets, December 31, 2004 and 2003 (Restated).
Consolidated Statements of Operations, for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).
Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).
Consolidated Statements of Cash Flows, for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).
Notes to Consolidated Financial Statements (Restated).
| 2. | The following consolidated financial statement schedules of Financial Industries Corporation and subsidiaries are included: |
Schedule I - Summary of Investments Other Than Investments in Related Parties.
Schedule II - Condensed Financial Statements of Registrant (Restated).
Schedule III – Supplementary Insurance Information (Restated).
Schedule IV – Reinsurance (Restated).
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore, have been omitted.
| 3. | Exhibits filed with this report or incorporated herein by reference are as listed in the Index to Exhibits beginning on Page 71. |
Registrant filed the following reports on Form 8-K during the fourth quarter of 2004:
(i) On October 13, 2004, the Registrant filed a Current Report on Form 8-K. The current report referred to a press release issued October 13, 2004 by the Company, which announced the resignation of Charles B. Cooper as Chief Operating Officer effective December 31, 2004. The report also announced that the Company would begin an immediate search of a replacement for Mr. Cooper.
| (ii) | On November 4, 2004, the Registrant filed a Current Report on Form 8-K. The current report disclosed that Charles B. Cooper has submitted his resignation as Chief Operating Officer effective November 1, 2004, based on a request by the Board of Directors. Mr. Cooper had previously submitted his resignation to be effective December 31, 2004. |
The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are listed in the Exhibit Index of this Annual Report on Form 10-K.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Financial Industries Corporation
(Registrant)
By: /s/ Michael P. Hydanus | By: /s/ Vincent L. Kasch |
Michael P. Hydanus, Interim President and | Vincent L. Kasch, Chief Financial Officer, |
Chief Executive Officer | (Principal Accounting and Financial Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on October 27, 2006.
_/s/ R. Keith Long___________ | __/s/ Richard H. Gudeman________ |
R. KEITH LONG, CHAIRMAN | RICHARD H. GUDEMAN, DIRECTOR |
__/s/ John Barnett_______________________ | __/s/ Kenneth Shifrin____________________ |
JOHN BARNETT, DIRECTOR | KENNETH SHIFRIN, DIRECTOR |
__/s/ Robert A. Nikels __________________ | __/s/ Lonnie Steffen_____________________ |
ROBERT A. NIKELS, DIRECTOR | LONNIE STEFFEN, DIRECTOR |
__/s/ Eugene Woznicki____________ |
EUGENE WOZNICKI, DIRECTOR
__/s/ Patrick E. Falconio_______________ |
PATRICK E. FALCONIO, DIRECTOR
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EXHIBIT INDEX
Exhibit
No. |
Description of Exhibit
|
2.1 | Agreement and Plan of Merger dated as of January 18, 2001, by and among FIC, InterContinental Life and ILCO Acquisition Corp. (1) |
3.1 | Articles of Incorporation of FIC (2) |
3.2 | Certificate of Amendment to the Articles of Incorporation of FIC, dated November 12, 1996 (3) |
3.3 | Bylaws of FIC (2) |
3.4 | Amendment to Bylaws of FIC dated February 29, 1992 (8) |
3.5 | Amendment to Bylaws of FIC dated June 16, 1992 (8) |
3.6 | Amendment to Articles of Incorporation of FIC dated May 18, 2001 (10) |
4.1 | Indenture Agreement between FIC and Wilmington Trust Company, as trustee, pertaining to the issuance by FIC of the Floating Rate Senior Debt Securities due 2033 (15) |
10.01 | Option Agreement, dated as of June 12, 1991, among FIC, Investors Life Insurance Company of North America and Investors Life Insurance Company of California (4) |
10.02 | Note, dated July 30, 1993, in the original principal amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America (5) |
10.03 | Note, dated July 30, 1993, in the original principal amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America (5) |
10.04 | Amendment No. 1, dated December 12, 1996, effective June 12, 1996, to the note dated July 30, 1993 in the original principal amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America (6) |
10.05 | Amendment No. 1, dated December 12, 1996, effective June 12, 1996, to the note dated July 30, 1993 in the original principal amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America (6) |
10.06 | Amendment Agreement, dated December 12, 1996, amending the Option Agreement among FIC, Investors Life Insurance Company of North America and Investors Life Insurance Company of California (6) |
10.07 | Assignment Agreement, dated December 23, 1998, between Family Life Insurance Investment Company and FIC (7) |
10.08 | Amendment dated as of April 4, 2001 to Employment Agreement between the Registrant and Roy F. Mitte (9) |
10.09 | Amended and Restated Stock Option Grant Agreement (10) |
10.10 | Employment Agreement between Registrant and Jeffrey H. Demgen dated as of May 1, 2002 and ratified by the Board of Directors on August 17, 2002, as amended on August 19, 2002 (11) |
10.11 | Employment Agreement between Registrant and Thomas C. Richmond dated as of May 1, 2002 and ratified by the Board of Directors on August 17, 2002 (11) |
10.12 | Employment Agreement between Registrant and Theodore A. Fleron dated as of March 22, 2002 and ratified by the Board of Directors on August 17, 2002 (11) |
10.13 | Employment Agreement between Registrant and Dr. Eugene E. Payne dated as of November 4, 2002 and ratified by the Board of Directors on November 4, 2002 (12) |
10.14 | Financial Industries Corporation Equity Incentive Plan, dated November 4, 2002 (12) |
10.15 | Employment Agreement between Registrant and George M. Wise, III dated as of December 13, 2002 and ratified by the Board of Directors on December 13, 2002 (13) |
10.16 | Employment Agreement between Registrant and Theodore A. Fleron dated as of December 13, 2002 and ratified by the Board of Directors on December 13, 2002, superceding Exhibit 10.12 (13) |
10.17 | Employment Agreement between Registrant and Thomas C. Richmond dated as of December 13, 2002 and ratified by the Board of Directors on December 13, 2002, superceding Exhibit 10.11 (13) |
10.18 | Compromise Settlement Agreement and Mutual Release in the litigation entitled Financial Industries Corporation v. The Roy F. and Joann Cole Mitte Foundation, Roy F. Mitte, and Joann Cole Mitte, Civil Action No. A03 CA 033 SS, in the United States District Court for the Western District of Texas, Austin Division (14) |
10.19 | Stock Purchase Agreement, by and among Total Compensation Group Consulting, Inc., John Pesce, Mike Cochran, Arthur A. Howard, Geoffrey Calaway, W.M. Hartman, Edward F. Harman, III, M.B. Donaldson, Teri Hoyt, Alycia Andrews, Charles Francis, Tom Cook, David Allen, and Marcus Smith and Financial Industries Corporation, and FIC Financial Services, Inc. (15) |
10.20 | Stock Purchase Agreement by and among JNT Group, Inc., Earl W. Johnson and Total Compensation Group Consulting, Inc., FIC, and FIC Financial Services, Inc. (15) |
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10.21 | Stock Purchase Agreement by and among Paragon Benefits, Inc., The Paragon Group, Inc., Paragon National, Inc., Scott A. Bell, Wayne C. Desselle, and Chris Murphy and FIC, and FIC Financial Services, Inc.(15) |
10.22 | Marketing Agreement by and among Investors Life Insurance Company of North America, Family Life Insurance Company and Equita Financial and Insurance Services of Texas, Inc. (15) |
10.23 | Stock Purchase and Option Agreement by and between FIC and American Physicians Service Group, Inc. (15) |
10.24 | Stock Option Agreement by and among FIC, Equita Financial and Insurance Services of Texas, Inc., and, solely for purposes of Section 4.5 of the agreement, M&W Insurance Services, Inc. (15) |
10.25 | Registration Rights Agreement by and among FIC, American Physicians Service Group, Inc., M&W Insurance Services, Inc., Equita Financial and Insurance Services of Texas, Inc. (15) |
10.26 | Stock Option Agreement between FIC and William P. Tedrow (15) |
10.27 | Senior Notes Subscription Agreement between FIC and InCapS Funding I, Ltd. (15) |
10.28 | Placement Agreement with Sandler O’Neill & Partners, L.P., as agent of FIC, with respect to the issue and sale by FIC and the placement by Sandler O’Neill & Partners, L.P. of $15,000,000 aggregate principal amount of Floating Rate Senior Notes of FIC (15) |
10.29 | Amendment No. 1 to Employment Agreement of Eugene E. Payne, dated as of October 9, 2003 (16) |
10.30 | Stock Purchase Agreement dated December 31, 2003, by and between BCDP Holdings, LLP, Financial Industries Corporation and FIC Financial Services, Inc. (17) |
10.31 | Acquisition Agreement dated December 31, 2003, by and between InterContinental Life Corporation and George M. Wise, III (17) |
10.32 | Agreement and Release dated December 31, 2003, by and between Scott A. Bell, FIC Financial Services, Inc., and Financial Industries Corporation (17) |
10.33 | Agreement and Release dated December 31, 2003, by and between Mike Cochran, FIC Financial Services, Inc., and Financial Industries Corporation (17) |
10.34 | Agreement and Release dated December 31, 2003, by and between Wayne C. Desselle, FIC Financial Services, Inc., and Financial Industries Corporation (17) |
10.35 | Agreement and Release dated December 31, 2003, by and between Chris Murphy, FIC Financial Services, Inc., and Financial Industries Corporation (17) |
10.36 | Agreement and Release dated December 31, 2003, by and between John Pesce, FIC Financial Services, Inc., and Financial Industries Corporation (17) |
10.37 | Amendment No. 1 dated December 31, 2003, to Employment Agreement between George Wise and Financial Industries Corporation (17) |
10.38 | Consulting Agreement between Actuarial Risk Consultants, Inc. and Financial Industries Corporation (17) |
10.39 | Employment Agreement dated January 7, 2004 by and between Bruce Boisture and Financial Industries Corporation (18) |
10.40 | Amendment No. 1 to Employment Agreement between Financial Industries Corporation and Thomas C. Richmond dated as of February 13, 2004 (19) |
10.41 | Non-Qualified Deferred Compensation Plan (21) |
10.42 | Investment Management Agreement dated as of October 20, 2003 by and between, Investors Life Insurance Company of North America and Conning Asset Management Company (21) |
10.43 | Investment Management Agreement dated as of October 20, 2003 by and between Family Life Insurance Company and Conning Asset Management Company (21) |
10.44 | Mutual Release dated as of July 30, 2004 between Eugene E. Payne and the Registrant. (21) |
10.45 | Letter Agreement dated as of April 5, 2004 between Jeffrey H. Demgen and the Registrant with respect to the termination of Mr. Demgen’s active employment. (21) |
10.46 | Settlement Agreement in the litigation entitled Otter Creek Partnership I, L.P.v. Financial Industries Corporation, Civil Action No. GN302872 in the District Court, Travis County, Texas. (21) |
10.47 | Amendment No. 2, dated June 10, 2004, effective as of March 18, 2004, to the note dated July 30, 1993 in the original principal amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America (21) |
10.48 | Amendment No. 2, dated June 10, 2003, effective as of March 18, 2004, to the note dated July 30, 1993, in the original principal amount of $4.5 million made by FIC in favor of Investors Life Insurance Company of North America (21) |
10.49 | Agreement of Sale and Purchase dated as of March 17, 2005, between Investors Life Insurance Company of North America and Aspen Growth Properties, Inc. (21) |
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10.50 | First Amendment to Agreement of Sale and Purchase dated as of June 1, 2005, between Investors Life Insurance Company of North America and Aspen Growth Properties, Inc. (21) |
10.51 | Lease Agreement dated as of June 1, 2005, between Investors Life Insurance Company of North America and River Place Pointe, L.P. (21) |
10.52 | Employment Letter dated February 17, 2004 provided to Vincent L. Kasch (22) |
10.53 | Employment Letter dated April 19, 2005 provided to Michael P. Hydanus regarding position of Chief Operating Officer (20) |
10.54 | Employment Agreement dated January 7, 2004 by and between Bruce Boisture and Financial Industries Corporation (23) |
10.55 | Severance Agreement dated September 27, 2005 by and between Bruce Boisture and Financial Industries Corporation (24) |
10.56 | Letter of Agreement effective January 12, 2006 by and between Vincent L. Kasch and Financial Industries Corporation regarding change of control (25) |
10.57 | Employment Letter dated January 1, 2006 provided to Michael P. Hydanus regarding position of Interim Chief Executive Officer (26) |
10.58 | Amendment No. 3, dated March 9, 2006, to the note dated July 30, 1993 in the original principal amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America* |
10.59 | Amendment No. 3, dated March 9, 2006, to the note dated July 30, 1993, in the original principal amount of $4.5 million made by FIC in favor of Investors Life Insurance Company of North America* |
10.60 | Consulting Agreement effective January 5, 2006 by and between Theodore A. Fleron and Financial Industries Corporation (27) |
10.61 | Form 8-K dated April 18, 2006 regarding non-reliance on previously issued financial statements (28) |
10.62 | Form 8-K dated June 9, 2006 regarding retainer of Keefe, Bruyette & Woods, Inc. effective June 9, 2006 (29) |
10.63 | Form 8-K dated July 18, 2005 regarding resignation of Sal Diaz-Verson as Director (30) |
10.64 | Form 8-K dated October 5, 2005 regarding appointment of Robert Nikels as Director (31) |
10.65 | FIC Stock Fee Plan for Non-Employee Directors, effective as of September 30, 2005 (33) |
10.66 | Defined Contribution SERP Plan effective January 1, 2005* |
10.67 | InterContinental Life Corporation Pension Restoration Plan For Rule Of 68 HCE’s, effective January 1, 2005* |
10.68 | Resolution to Terminate the InterContinental Life Corporation Defined Contribution Supplemental Executive Retirement Plan, dated December 20, 2005* |
10.69 | Resolution to Terminate the InterContinental Life Corporation Supplemental Executive Retirement Plan, also known as the Pension Restoration Plan For Rule Of 68 HCE’s, dated December 20, 2005* |
14.1 | Code of Ethics for Senior Executives and Financial Officers (21) |
14.2 | Business Ethics and Practices Policy (21) |
16.1 | Form 8-K dated September 14, 2005 regarding change of independent accountant (32) |
21.1 | Subsidiaries of the Registrant * |
23.1 | Consent of Independent Registered Public Accounting Firm * |
23.2 | Consent of Independent Registered Public Accounting Firm * |
31.1 | Chief Executive Officer’s Certification Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 * |
31.2 | Chief Financial Officer’s Certification Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 * |
32.1 | Chief Executive Officer’s Certification Pursuant to 18 U.S.C. Section 1350 * |
32.2 | Chief Financial Officer’s Certification Pursuant to 18 U.S.C. Section 1350 * |
99.1 | Form 8-K dated June 9, 2006 regarding the exploration of strategic alternatives (34) |
| (1) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated January 22, 2001. |
| (2) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for 1985. |
| (3) | Incorporated by reference to the Exhibits filed with FIC’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. |
| (4) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated June 25, 1991. |
| (5) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for 1993. |
| (6) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for 1996. |
87
| (7) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for 1998. |
| (8) | Incorporated by reference to the Exhibits filed with FIC’s S-4 filed on February 1, 2001. |
| (9) | Incorporated by reference to the Exhibits filed with FIC’s 10K/A filed on April 5, 2001. |
| (10) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for the year ended December 31, 2001. |
| (11) | Incorporated by reference to the Exhibits filed with FIC’s Quarterly Report on Form 10-Q filed on August 26, 2002, for the six-month period ended June 30, 2002. |
| (12) | Incorporated by reference to the Exhibits filed with FIC’s Quarterly Report on Form 10-Q filed on November 14, 2002, for the nine-month period ended September 30, 2002. |
| (13) | Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for the year ended December 31, 2002. |
| (14) | Incorporated by reference to the Exhibits filed with FIC’s Quarterly Report on Form 10-Q /A filed on May 16, 2003 for the three-month period ended March 31, 2003. |
| (15)) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated June 10, 2003. |
| (16) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated October 29, 2003. |
| (17) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated January 6, 2004. |
| (18) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated February 8, 2004. |
| (19) | Incorporated by reference to the Exhibits filed with FIC’s Current Report on Form 8-K dated February 16, 2004. |
| (20) | Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated May 6, 2004. |
(21) Incorporated by reference to the Exhibits filed with FIC’s Annual Report on Form 10-K for the year ended December 31, 2003.
(22) Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated May 4, 2004.
(23) Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated January 8, 2004.
(24) Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated October 3, 2005.
(25) Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated January 18, 2006.
(26) Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated January 13, 2006.
(27)Incorporated by reference to the Exhibit filed with FIC’s Current Report on Form 8-K dated January 6, 2006.
(28) Incorporated by reference to the Current Report on Form 8-K dated April 18, 2006.
(29) Incorporated by reference to the Current Report on Form 8-K dated June 9, 2006.
(30) Incorporated by reference to the Current Report on Form 8-K dated July 18, 2005.
(31) Incorporated by reference to the Current Report on Form 8-K dated October 5, 2005.
(32) Incorporated by reference to the Current Report on Form 8-K dated September 14, 2005.
(33) Incorporated by reference to the Current Report on Form 8-K dated September 30, 2005.
(34) Incorporated by reference to the Current Report on Form 8-K dated June 9, 2006.
88
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
FORM 10-K—ITEM 15(a) (1) and (2)
LIST OF FINANCIAL STATEMENTS
TABLE OF CONTENTS
(1) The following consolidated financial statements of Financial Industries Corporation and Subsidiaries are included in Item 8: |
Reports of Independent Registered Public Accounting Firms | F-2 |
Consolidated Balance Sheets, December 31, 2004 and 2003 (Restated) | F-4 |
Consolidated Statements of Operations
for the years ended December 31, 2004, 2003 (Restated), 2002 (Restated) | F-6 |
Consolidated Statements of Changes in Shareholders’ Equity
for the years ended December 31, 2004, 2003 (Restated), 2002 (Restated) | F-8 |
Consolidated Statements of Cash Flows
for the years ended December 31, 2004, 2003 (Restated), 2002 (Restated) | F-11 |
Notes to Consolidated Financial Statements (Restated) | F-13 |
(2) The following consolidated financial statement schedules of Financial Industries Corporation and Subsidiaries are included: |
Schedule I – Summary of Investments – Other Than Investments in Related Parties | F-62 |
Schedule II – Condensed Financial Information of Registrant (Restated) | F-63 |
Schedule III – Supplementary Insurance Information (Restated) | F-66 |
Schedule IV – Reinsurance (Restated) | F-67 |
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore, have been omitted.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Financial Industries Corporation
Austin, Texas
We have audited the accompanying consolidated balance sheet of Financial Industries Corporation and subsidiaries (the “Company”) as of December 31, 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year ended December 31, 2004. Our audit also included the 2004 financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Financial Industries Corporation and subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 2004 financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We were engaged to audit, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, and our report dated October 27, 2006 disclaimed an opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting because of a scope limitation and expressed an adverse opinion on the effectiveness of the Company's internal control over financial reporting because of material weaknesses and the effects of a scope limitation.
DELOITTE & TOUCHE LLP
Dallas, Texas
October 27, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Financial Industries Corporation:
In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Financial Industries Corporation and its subsidiaries at December 31, 2003, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the 2003 and 2002 financial statement schedules listed in the accompanying index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.
As discussed in Note 1, during 2002, the Company adopted Statement of Financial Accounting Standards No. 141, “Business Combinations.”
As discussed in Note 2, the Company has restated its previously issued consolidated financial statements and financial statement schedules for the years ended December 31, 2003 and 2002.
PricewaterhouseCoopers LLP
Dallas, Texas
July 29, 2005, except for the current period restatement described in
Note 2 as to which the date is October 19, 2006
F-3
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| | | | December 31, |
| | | | | | 2003 |
| | | | 2004 | | Restated (1) |
| | | | (In thousands) |
ASSETS | | | |
| | | | | | |
Investments: | | | |
| Fixed maturity securities held to maturity, at amortized cost (fair value of $19 | | | |
| | at December 31, 2003) | $ - | | $ 17 |
| Fixed maturity securities available for sale, at fair value (amortized cost of | | | |
| | $500,701 and $557,285 at December 31, 2004 and 2003) | 499,155 | | 555,801 |
| Fixed maturity securities held for trading, at fair value | 1,057 | | 4,873 |
| Equity securities, at fair value (cost of $6,311 and $6,393 at December 31, | | | |
| | 2004 and 2003) | 8,502 | | 7,941 |
| Policy loans | 39,855 | | 42,452 |
| Investment real estate | 76,580 | | 76,712 |
| Real estate held for sale | 589 | | 968 |
| Short-term investments | 62,514 | | - |
Total investments | 688,252 | | 688,764 |
| | | | | | |
Cash and cash equivalents | 52,044 | | 82,436 |
Deferred policy acquisition costs | 50,640 | | 54,819 |
Present value of future profits of acquired business | 17,905 | | 21,096 |
Agency advances and other receivables, net of allowance for doubtful | | | |
| accounts of $3,334 and $3,011 at December 31, 2004 and 2003 | 10,539 | | 10,241 |
Reinsurance receivables | 36,912 | | 39,978 |
Real estate held for use | 13,559 | | 13,870 |
Accrued investment income | 5,652 | | 6,695 |
Due premiums | 2,045 | | 2,362 |
Property and equipment, net | 1,244 | | 1,454 |
Other assets | 2,089 | | 6,058 |
Separate account assets | 359,876 | | 358,271 |
| | | | | | |
Total assets | $ 1,240,757 | | $ 1,286,044 |
| | | | | | |
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements
F-4
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
| | | | December 31, |
| | | | | | 2003 |
| | | | 2004 | | Restated (1) |
| | | | (In thousands) |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | |
| | | | | | |
Liabilities: | | | |
Policy liabilities and contractholder deposit funds: | | | |
| Contractholder deposit funds | $ 572,090 | | $ 593,881 |
| Future policy benefits | 160,175 | | 169,244 |
| Other policy claims and benefits payable | 12,939 | | 13,693 |
Notes payable | 15,000 | | 15,000 |
Deferred federal income taxes | 3,549 | | 6,333 |
Other liabilities | 29,585 | | 25,313 |
Separate account liabilities | 359,876 | | 358,271 |
Total liabilities | 1,153,214 | | 1,181,735 |
| | | | | | |
Commitments and contingencies (Notes 12 and 14) | | | |
| | | | | | |
Shareholders’ equity: | | | |
Common stock, $.20 par value; 25,000,000 shares authorized in 2004 and 2003; | | | |
| 12,516,841 shares issued in 2004 and 2003; 9,804,009 | | | |
| and 9,791,024 shares outstanding in 2004 and 2003 | 2,504 | | 2,504 |
Additional paid-in capital | 70,398 | | 70,391 |
Accumulated other comprehensive income (loss) | (4,667) | | (2,121) |
Retained earnings | 42,650 | | 56,988 |
Common treasury stock, at cost; 2,712,832 and 2,725,817 shares in 2004 and 2003 | (23,342) | | (23,453) |
Total shareholders’ equity | 87,543 | | 104,309 |
| | | | | | |
Total liabilities and shareholders’ equity | $ 1,240,757 | | $ 1,286,044 |
| | | | | | |
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements.
F-5
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated (1) | | Restated (1) |
| | | | (In thousands) |
| | | | | | | | |
Revenues: | | | | | |
| Premiums, net | $ 23,283 | | $ 31,057 | | $ 38,672 |
| Earned insurance charges | 41,809 | | 40,316 | | 41,859 |
| Net investment income | 30,703 | | 35,346 | | 38,168 |
| Real estate income, net | 1,808 | | 2,367 | | 2,870 |
| Net realized gains (losses) on investments | 2,783 | | (403) | | (2,805) |
| Other | 2,226 | | 2,714 | | 2,272 |
Total revenues | 102,612 | | 111,397 | | 121,036 |
| | | | | | | | |
Benefits and expenses: | | | | | |
| Policyholder benefits and expenses | 47,510 | | 47,414 | | 53,463 |
| Interest expense on contractholder deposit funds | 23,156 | | 25,814 | | 30,267 |
| Amortization of deferred policy acquisition costs | 10,479 | | 9,774 | | 11,013 |
| Amortization of present value of future profits of acquired business | 3,198 | | 4,464 | | 4,246 |
| Operating expenses | 34,176 | | 41,492 | | 34,573 |
| Litigation settlement (Note 14) | - | | 2,915 | | - |
| Interest expense | 864 | | 485 | | - |
Total benefits and expenses | 119,383 | | 132,358 | | 133,562 |
Loss from continuing operations before federal income taxes, | | | | | |
| discontinued operations, and cumulative effect of change in | | | | | |
| accounting principle | (16,771) | | (20,961) | | (12,526) |
| | | | | | | | |
Federal income tax benefit: | | | | | |
| Current | (943) | | (1,613) | | (59) |
| Deferred | (1,261) | | (1,898) | | (3,462) |
Loss from continuing operations before discontinued operations | | | | | |
| and cumulative effect of change in accounting principle | (14,567) | | (17,450) | | (9,005) |
| | | | | | | | |
Discontinued operations | - | | (6,133) | | - |
Loss before cumulative effect | | | | | |
| of change in accounting principle | (14,567) | | (23,583) | | (9,005) |
| | | | | | | | |
Cumulative effect of change in accounting principle, net of taxes | 229 | | - | | 4,140 |
| | | | | | | | |
Net loss | $ (14,338) | | $ (23,583) | | $ (4,865) |
| | | | | | | | |
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements.
F-6
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS, continued
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated (1) | | Restated (1) |
| | | | (In thousands, except per share data) |
| | | | | | | | |
Net loss per share: | | | | | |
| | | | | | | | |
Basic: | | | | | | |
| Average weighted shares outstanding | 9,796 | | 9,667 | | 9,555 |
| Basic earnings per share: | | | | | |
| Loss from continuing operations before discontinued operations | | | | | |
| | and cumulative effective of change in accounting principle | $ (1.48) | | $ (1.81) | | $ (0.94) |
| | | | | | | | |
| Discontinued operations | - | | (0.63) | | - |
| Loss before cumulative effect | | | | | |
| | of change in accounting principle | (1.48) | | (2.44) | | (0.94) |
| | | | | | | | |
| Cumulative effect of change in accounting principle | 0.02 | | - | | 0.43 |
| | | | | | | | |
| Net loss per share | $ (1.46) | | $ (2.44) | | $ (0.51) |
| | | | | | | | |
Diluted: | | | | | |
| | | | | | | | |
| Common stock and common stock equivalents | 9,796 | | 9,667 | | 9,555 |
| | | | | | | | |
| Diluted earnings per share: | | | | | |
| Loss from continuing operations before discontinued operations | | | | | |
| | and cumulative effect of change in accounting principle | $ (1.48) | | $ (1.81) | | $ (0.94) |
| | | | | | | | |
| Discontinued operations | - | | (0.63) | | - |
| Loss before cumulative effect | | | | | |
| | of change in accounting principle | (1.48) | | (2.44) | | (0.94) |
| | | | | | | | |
| Cumulative effect of change in accounting principle | 0.02 | | - | | 0.43 |
| | | | | | | | |
| Net loss per share | $ (1.46) | | $ (2.44) | | $ (0.51) |
| | | | | | | | |
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements.
F-7
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
| | | | Common Stock | | Additional Paid-in |
| | | | Shares | | Amount | | Capital |
| | | | (In thousands, except per share data) |
| | | | | | | | |
Balance at January 1, 2002, as previously reported | 11,736 | | $ 2,348 | | $ 65,790 |
| Prior period adjustments | - | | - | | - |
| | | | | | | | |
Balance at January 1, 2002, as restated (1) | 11,736 | | 2,348 | | 65,790 |
Comprehensive income (loss): | | | | | |
| Net loss, as restated (1) | | | | | |
| Other comprehensive income (loss): | | | | | |
| Change in net unrealized gain on investments in | | | | | |
| | fixed maturities available for sale, net of taxes | | | | | |
| Change in net unrealized appreciation of | | | | | |
| | equity securities, net of taxes | | | | | |
| Minimum pension liability, net of taxes, as restated (1) | | | | | |
Total comprehensive income (loss), as restated (1) | - | | - | | - |
Stock options exercised | 120 | | 24 | | 1,244 |
Treasury stock purchased, as restated (1) | | | | | |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | | 2 |
Stock based compensation | | | | | |
Cash dividends to shareholders ($0.28 per share) | | | | | |
| | | | | | | | |
Balance at December 31, 2002, as restated (1) | 11,856 | | 2,372 | | 67,036 |
Comprehensive income (loss): | | | | | |
| Net loss, as restated (1) | | | | | |
| Other comprehensive income (loss): | | | | | |
| Change in net unrealized loss on investments in | | | | | |
| | fixed maturities available for sale, net of taxes, as restated (1) | | | | | |
| Change in net unrealized appreciation of | | | | | |
| | equity securities, net of taxes | | | | | |
| Minimum pension liability, net of taxes, as restated (1) | | | | | |
Total comprehensive income (loss), as restated (1) | - | | - | | - |
Stock options exercised | 661 | | 132 | | 2,833 |
Treasury stock purchased, net of sales, as restated (1) | | | | | 269 |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | | 15 |
Treasury stock distributed (Note 17), as restated (1) | | | | | 238 |
| | | | | | | | |
Balance at December 31, 2003, as restated (1) | 12,517 | | 2,504 | | 70,391 |
Comprehensive income (loss): | | | | | |
| Net loss | | | | | |
| Other comprehensive income (loss): | | | | | |
| Change in net unrealized loss on investments in | | | | | |
| | fixed maturities available for sale, net of taxes | | | | | |
| Change in net unrealized appreciation of | | | | | |
| | equity securities, net of taxes | | | | | |
| Minimum pension liability, net of taxes | | | | | |
Total comprehensive income (loss) | - | | - | | - |
Treasury stock contributed to Company 401(k) Plan | | | | | 7 |
| | | | | | | | |
Balance at December 31, 2004 | 12,517 | | $ 2,504 | | $ 70,398 |
(1) See Note 2 | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
F-8
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY, continued
| | | | Net Unrealized Appreciation (Depreciation) of Equity Securities | | Net Unrealized Gain (Loss) on Fixed Maturities Available for Sale | | Other | | Total Accumulated Other Comprehensive Income (Loss) |
| | | | (In thousands, except per share data) |
Balance at January 1, 2002, as previously reported | $ (373) | | $ 3,850 | | $ (1,235) | | $ 2,242 |
| Prior period adjustments | - | | - | | - | | - |
Balance at January 1, 2002, as restated (1) | (373) | | 3,850 | | (1,235) | | 2,242 |
Comprehensive income (loss): | | | | | | | |
| Net loss, as restated (1) | | | | | | | |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized gain on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes | | | 5,421 | | | | 5,421 |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | 353 | | | | | | 353 |
| Minimum pension liability, net of taxes, as restated (1) | | | | | (397) | | (397) |
Total comprehensive income (loss), as restated (1) | 353 | | 5,421 | | (397) | | 5,377 |
Stock options exercised | | | | | | | |
Treasury stock purchased, as restated (1) | | | | | | | |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | | | |
Stock based compensation | | | | | | | |
Cash dividends to shareholders ($0.28 per share) | | | | | | | |
| | | | | | | | | | |
Balance at December 31, 2002, as restated (1) | (20) | | 9,271 | | (1,632) | | 7,619 |
Comprehensive income (loss): | | | | | | | |
| Net loss, as restated (1) | | | | | | | |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized loss on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes, as restated (1) | | (10,524) | | | | (10,524) |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | 1,043 | | | | | | 1,043 |
| Minimum pension liability, net of taxes, as restated (1) | | | | | (259) | | (259) |
Total comprehensive income (loss), as restated (1) | 1,043 | | (10,524) | | (259) | | (9,740) |
Stock options exercised | | | | | | | |
Treasury stock purchased, net of sales, as restated (1) | | | | | | | |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | | | |
Treasury stock distributed (Note 17), as restated (1) | | | | | | | |
Balance at December 31, 2003, as restated (1) | 1,023 | | (1,253) | | (1,891) | | (2,121) |
Comprehensive income (loss): | | | | | | | |
| Net loss | | | | | | | |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized loss on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes | | | 236 | | | | 236 |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | 423 | | | | | | 423 |
| Minimum pension liability, net of taxes | | | | | (3,205) | | (3,205) |
Total comprehensive income (loss) | 423 | | 236 | | (3,205) | | (2,546) |
Treasury stock contributed to Company 401(k) Plan | | | | | | | |
Balance at December 31, 2004 | $ 1,446 | | $ (1,017) | | $ (5,096) | | $ (4,667) |
(1) See Note 2
The accompanying notes are an integral part of these consolidated financial statements.
F-9
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY, continued
| | | | Deferred Compensation | | Retained Earnings | | Treasury Stock | | Total Shareholders’ Equity |
| | | | (In thousands, except per share data) |
Balance at January 1, 2002, as previously reported | $ (292) | | $ 90,165 | | $(21,842) | | $ 138,411 |
| Prior period adjustments | - | | (2,138) | | - | | (2,138) |
Balance at January 1, 2002, as restated (1) | (292) | | 88,027 | | (21,842) | | 136,273 |
Comprehensive income (loss): | | | | | | | |
| Net loss, as restated (1) | | | (4,865) | | | | (4,865) |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized gain on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes | | | | | | | 5,421 |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | | | | | | | 353 |
| Minimum pension liability, net of taxes, as restated (1) | | | | | | | (397) |
Total comprehensive income (loss), as restated (1) | - | | (4,865) | | - | | 512 |
Stock options exercised | | | | | | | 1,268 |
Treasury stock purchased, as restated (1) | | | | | (461) | | (461) |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | 96 | | 98 |
Stock based compensation | 292 | | | | | | 292 |
Cash dividends to shareholders ($0.28 per share) | | | (2,591) | | | | (2,591) |
| | | | | | | | | | |
Balance at December 31, 2002, as restated (1) | - | | 80,571 | | (22,207) | | 135,391 |
Comprehensive income (loss): | | | | | | | |
| Net loss, as restated (1) | | | (23,583) | | | | (23,583) |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized loss on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes, as restated (1) | | | | | | (10,524) |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | | | | | | | 1,043 |
| Minimum pension liability, net of taxes, as restated (1) | | | | | | | (259) |
Total comprehensive income (loss), as restated (1) | - | | (23,583) | | - | | (33,323) |
Stock options exercised | | | | | | | 2,965 |
Treasury stock purchased, net of sales, as restated (1) | | | | | (1,768) | | (1,499) |
Treasury stock contributed to Company 401(k) Plan, as restated (1) | | | | 113 | | 128 |
Treasury stock distributed (Note 17), as restated (1) | | | | | 409 | | 647 |
| | | | | | | | | | |
Balance at December 31, 2003, as restated (1) | - | | 56,988 | | (23,453) | | 104,309 |
Comprehensive income (loss): | | | | | | | |
| Net loss | | | (14,338) | | | | (14,338) |
| Other comprehensive income (loss): | | | | | | | |
| Change in net unrealized loss on investments in | | | | | | | |
| | fixed maturities available for sale, net of taxes | | | | | | | 236 |
| Change in net unrealized appreciation of | | | | | | | |
| | equity securities, net of taxes | | | | | | | 423 |
| Minimum pension liability, net of taxes | | | | | | | (3,205) |
Total comprehensive income (loss) | - | | (14,338) | | - | | (16,884) |
Treasury stock contributed to Company 401(k) Plan | | | | | 111 | | 118 |
| | | | | | | | | | |
Balance at December 31, 2004 | $ - | | $ 42,650 | | $(23,342) | | $ 87,543 |
(1) See Note 2 | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
F-10
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated (1) | | Restated (1) |
| | | | (In thousands) |
| | | | | | | | |
Cash flows from operating activities: | | | | | |
| Net loss | $(14,338) | | $(23,583) | | $(4,865) |
| Adjustments to reconcile net loss to net cash provided by | | | | | |
| | operating activities: | | | | | |
| Amortization of deferred policy acquisition costs | 10,479 | | 9,774 | | 11,013 |
| Amortization of present value of future profits of acquired business | 3,198 | | 4,464 | | 4,246 |
| Realized (gain) loss on investments | (2,783) | | 403 | | 2,805 |
| Depreciation | 3,148 | | 3,363 | | 2,882 |
| Cumulative effect of change in accounting principle | (229) | | - | | (4,140) |
| Loss on sale of discontinued operations | - | | 4,935 | | - |
| Changes in assets and liabilities: | | | | | |
| | Decrease in accrued investment income | 1,043 | | 138 | | 94 |
| | Decrease (increase) in agency advances and other receivables | (298) | | 4,106 | | (1,487) |
| | Decrease in reinsurance receivables | 3,066 | | 2,005 | | 5,355 |
| | Decrease in due premiums | 317 | | 518 | | 829 |
| | Increase in deferred policy acquisition costs | (6,372) | | (8,255) | | (10,372) |
| | Decrease (increase) in other assets | 3,969 | | 6,489 | | (432) |
| | Increase (decrease) in policy liabilities and accruals | (216) | | 4,070 | | 7,896 |
| | Increase (decrease) in other liabilities | 4,272 | | 2,654 | | (3,178) |
| | Decrease in deferred federal income taxes | (1,146) | | (2,229) | | (1,763) |
| | Net activity from trading securities | 3,815 | | (4,873) | | - |
| | Other | (2,397) | | 1,806 | | 1,630 |
Net cash provided by operating activities | 5,528 | | 5,785 | | 10,513 |
| | | | | | | | |
Cash flows from investing activities: | | | | | |
| Fixed maturities purchased | (151,074) | | (511,596) | | (214,747) |
| Real estate capital expenditures | (2,210) | | (1,281) | | (13,673) |
| Proceeds from sales and maturities of fixed maturities | 206,860 | | 417,628 | | 243,356 |
| Proceeds from sales of invested real estate | 2,022 | | - | | - |
| Proceeds from payments received on mortgage loans | - | | 17 | | 3,743 |
| Net (increase) decrease in short-term investments | (62,520) | | 126 | | 47,682 |
| Net decrease in policy loans | 2,597 | | 2,557 | | 3,436 |
| Acquisition of subsidiary companies, net of cash acquired | - | | (4,124) | | - |
| Purchase of property and equipment | (426) | | (480) | | (1,128) |
Net cash (used in) provided by investing activities | (4,751) | | (97,153) | | 68,669 |
| | | | | | | | |
(continued)
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements.
F-11
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated (1) | | Restated (1) |
| | | | (In thousands) |
| | | | | | | | |
Cash flows from financing activities: | | | | | |
| Cash dividends to shareholders | $ - | | $ (480) | | $ (2,021) |
| Issuance of capital stock | - | | 1,383 | | 1,007 |
| Contractholder fund deposits | 39,292 | | 57,458 | | 55,341 |
| Contractholder fund withdrawals | (70,461) | | (62,163) | | (67,677) |
| Proceeds from bank borrowings | - | | 15,000 | | - |
| Purchase of treasury stock | - | | (1,103) | | (460) |
| Sales of treasury stock | - | | 656 | | - |
Net cash provided by (used in) financing activities | (31,169) | | 10,751 | | (13,810) |
| | | | | | | | |
Net increase (decrease) in cash | (30,392) | | (80,617) | | 65,372 |
| | | | | | | | |
Cash and cash equivalents, beginning of year | 82,436 | | 163,053 | | 97,681 |
| | | | | | | | |
Cash and cash equivalents, end of year | $ 52,044 | | $ 82,436 | | $ 163,053 |
| | | | | | | | |
Supplemental Cash Flow Disclosures: | | | | | |
| Income taxes (refunded) paid, net | $ (1,668) | | $ (5,623) | | $ 3,335 |
| | | | | | | | |
| Interest paid | $ 846 | | $ 417 | | $ - |
| | | | | | | | |
Supplemental Schedule of Non-Cash Investing Activities:
In June 2003, the Company purchased all of the capital stock of the New Era companies (as described in Note 17) for $4.2 million in cash and consideration in the form of restricted FIC common stock of $646,000. In conjunction with the acquisition, assets were acquired and liabilities were assumed as follows:
Estimated fair value of assets acquired $5.1 million.
Estimated fair value of liabilities assumed $0.2 million.
Dividends of $570,000 were declared but not paid in 2002.
(1) See Note 2.
The accompanying notes are an integral part of these consolidated financial statements.
F-12
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. | Organization and Summary of Significant Accounting Policies |
Organization and Nature of Business
Financial Industries Corporation (“FIC” or the “Company”) is principally engaged in marketing and underwriting individual life insurance and annuity products through its two life insurance subsidiaries. Family Life Insurance Company (“Family Life”) is licensed to sell annuity and life insurance products in 49 states and the District of Columbia as of December 31, 2004. Investors Life Insurance Company of North America (“Investors Life”) is licensed to sell individual life insurance and annuity products in 49 states, the District of Columbia, and the U.S. Virgin Islands as of December 31, 2004. Such products are marketed through both captive and independent agency systems. The Company also acquires and administers existing portfolios of individual life insurance and annuity products.
Other significant subsidiaries are: Family Life Corporation (“FLC”), FIC Realty Services, Inc. (“FIC Realty”), FIC Property Management, Inc. (“FIC Property”), FIC Financial Services, Inc., InterContinental Life Corporation (“ILCO”), Investors Life Insurance Company of Indiana (“Investors-IN”), ILG Securities Corporation, and ILG Sales Corporation.
ILCO, and its subsidiaries, including Investors Life, Investors-IN and ILG Sales Corporation, became wholly owned by the Company on May 18, 2001. Prior to that date, the Company’s investment in ILCO was reported using the equity method of accounting. On February 18, 2002, Investors-IN was merged into Investors Life with Investors Life as the surviving entity.
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which differ from statutory accounting principles required by regulatory authorities for the Company’s insurance subsidiaries. The consolidated financial statements include the accounts of FIC and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated. The following accounting policies describe the accounting principles used in the preparation of the consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Significant estimates in the accompanying consolidated financial statements include (1) liabilities for policy benefits and claims, (2) valuation allowances for deferred tax assets, (3) valuation allowances for agency advances, (4) recoverability of deferred policy acquisition costs (“DAC”) and present value of future profits of acquired businesses (“PVFP”), and (5) impairment losses on fixed maturity securities and invested real estate.
Investments
Although the Company did experience significant turnover in fixed maturities in 2003 partially due to a portfolio restructure associated with a transition to a new investment manager, the Company’s general investment philosophy is to hold fixed maturities for long-term investment. However, fixed maturities may be sold prior to their maturity dates in response to changing market conditions, duration of liabilities, liquidity factors, interest rate movements and other investment factors. Accordingly, substantially all the Company’s fixed-maturity investments are classified as available for sale and are carried at fair value. Unrealized gains and losses on fixed maturities available for sale are not recognized in the consolidated statement of operations but are reported as a separate component of shareholders’ equity in accumulated other comprehensive income, net of effects on DAC and PVFP and related income taxes. However, if a decline in fair value is deemed to be other than temporary, the investment is reduced to its net realizable value and a realized loss is recorded in the consolidated statement of operations.
Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. For mortgage-backed and asset-backed securities, the effective interest method is used based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied at the time of acquisition. This adjustment is reflected
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in net investment income.
Equity securities are classified as available for sale and are carried at fair value. Equity securities include investments in the Company’s own separate accounts, which are carried at estimated fair value. Unrealized gains and losses on equity securities are not recognized in the consolidated statement of operations but are reported as a separate component of shareholders’ equity in accumulated other comprehensive income, net of effects on other balance sheet accounts and related income taxes. If a decline in fair value is deemed to be other than temporary, the investment is reduced to its net realizable value and a realized loss is recorded in the consolidated statement of operations.
Fixed maturity securities held for trading are carried at fair value. Unrealized gains and losses on trading securities are recorded in the consolidated statement of operations.
Policy loans are recorded at unpaid balances, net of allowances for uncollectible accounts.
Short-term investments are carried at cost, which approximates fair value, and generally consist of those fixed maturities and other investments with maturities of less than one year from the date of purchase.
The Company monitors the performance of its real estate properties on an ongoing basis and identifies properties it intends to hold for investment and properties it intends to sell. Properties held for investment are classified as investment real estate and are stated at cost less accumulated depreciation. Depreciation is provided using straight-line methods over estimated useful lives of 5 to 40 years, or for leasehold improvements the minimum lease term if shorter. Real estate income is reported net of expenses incurred to operate the properties and depreciation expenses. The Company reviews its investment real estate properties on an on-going basis for impairment using a probability-weighted estimation of the expected net undiscounted future cash flows. If the expected net undiscounted future cash flows are less than the net book value of the property, the excess of the net book value over the Company’s estimate of fair value of the asset is recognized as a realized loss in the consolidated statement of operations and the new cost basis is depreciated over the property’s remaining life. Based on the application of the above policy, the Company has determined that no impairment is considered to exist with respect to its real estate held for investment as of December 31, 2004, and 2003.
Properties that are identified for sale and actively marketed by the Company are classified as real estate held for sale and are stated at the lower of cost less accumulated depreciation or net realizable value. No depreciation is recorded while the property is classified as held for sale. Net realizable value is determined by the Company based on the estimated selling price less direct costs of the sale.
Realized gains and losses on disposal of investments are included in the consolidated statement of operations. The cost of investments sold is determined on the specific identification basis, except for stocks, for which the first-in, first-out method is employed.
Cash and Cash Equivalents
Generally, cash includes cash on hand and on deposit in non-interest bearing accounts. Short term investments with maturities of three months or less at the time of purchase are reported as cash equivalents.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method over estimated useful lives of 3 to 8 years. Maintenance and repairs are charged to expense when incurred. Accumulated depreciation on property and equipment was $1,988,000 and $1,477,000 as of December 31, 2004 and 2003, respectively.
Deferred Policy Acquisition Costs
The cost of acquiring new business, principally first-year commissions and certain expenses of the policy issuance and underwriting departments, which vary with and are primarily related to the production of new business, have been deferred to the extent recoverable. Acquisition costs related to traditional life insurance products are deferred and amortized to expense using actuarial methods that include the same assumptions used to estimate future policy benefits. Acquisition costs related to interest-sensitive products are deferred and amortized in proportion to the estimated annual gross profits over the expected lives of the contracts. Loss recognition analysis with respect to deferred acquisition costs is evaluated periodically on an aggregate basis that combines deferred acquisition costs with the present value of future profits on acquired business.
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Present Value of Future Profits on Acquired Business
The present value of future profits of acquired traditional life business is amortized over the premium-paying period of the related policies in proportion to the estimated annual premium revenue applicable to such policies. Interest on the unamortized balance is accreted at rates from 4.4% to 11.0%.
For interest-sensitive products, these costs are amortized in relation to the expected gross profits of the policies. Retrospective adjustments of these amounts for interest sensitive products are made periodically along with a revision to the estimates of current or future gross profits to be realized from an acquired group of policies.
Loss recognition analysis with respect to present value of future profits is evaluated periodically on an aggregate basis that combines deferred acquisition costs with the present value of future profits on acquired business.
Real Estate Held for Use
Real estate held for use represents real estate occupied by the Company and is carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over estimated useful lives of 40 years. Accumulated depreciation on real estate occupied by the Company was $1,440,000 and $1,082,000 as of December 31, 2004 and 2003, respectively.
Other Assets
Other assets include the excess of cost over net assets acquired, or goodwill, totaling $752,000 at December 31, 2003. Such goodwill was recognized by ILCO in connection with its acquisitions, including Investors Life, and represents the Company���s carryforward interest using the equity method of accounting prior to the acquisition of ILCO on May 18, 2001.
Pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company performs an annual test for impairment of the carrying value of goodwill. As a result of this analysis for 2004, goodwill was determined to be impaired as the carrying value of this asset exceeded its fair value. Accordingly, goodwill totaling $752,000 was written off in 2004 and recorded in operating expenses in the consolidated statement of operations.
Separate Accounts
Separate account assets and liabilities, carried at market value, represent policyholder funds maintained in accounts having specific investment objectives. The net investment income, gains, and losses of these accounts, less applicable contract charges, generally accrue directly to the policyholders and are not included in the Company’s consolidated statement of operations with the exception of the investment income attributed to the Company’s seed money in the separate accounts, which are included in net investment income. The Company’s seed money in the separate accounts is reported as equity securities in the accompanying consolidated balance sheets.
Solvency Laws Assessments
The solvency or guaranty laws of most states in which the Company’s insurance subsidiaries do business may require the Company’s insurance subsidiaries to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer’s financial strength, and in certain instances, may be offset against future premium taxes. The Company records the effect for guaranty fund assessments in the period such amounts are probable and can be reasonably estimated.
Policy Liabilities and Contractholder Deposit Funds
Liabilities for future policy benefits related to traditional life products are accrued as premium revenue is recognized. The liabilities are computed using the net level premium method, or an equivalent actuarial method. The investment yield assumption varies by calendar year and is based on Company experience and expectations. Expense assumptions and assumptions for withdrawals vary by product, issue age, and policy duration, and are based on Company experience and expectations. Assumptions for mortality are based upon industry experience as modified to reflect Company experience. Assumptions also reflect a provision for adverse deviation.
Contractholder deposit funds represent liabilities for universal life and annuity products. These liabilities consist of deposits received from customers and are accumulated at actual credited interest rates on their fund balances less universal life charges for expenses and mortality.
F-15
Excess of Net Assets Acquired Over Cost
The excess of net assets acquired over cost, or negative goodwill, was recognized in connection with the acquisition of ILCO. Prior to January 1, 2002, the excess of net assets acquired over cost was amortized in accordance with expected revenues of the related policies. During the first quarter of 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” SFAS No. 141 eliminates the practice of deferring and amortizing excess of fair value of net assets acquired over cost and requires unallocated negative goodwill to be recognized immediately. In accordance with SFAS No. 141, the unamortized negative goodwill balance of $4.1 million at January 1, 2002 resulting from the acquisition of ILCO was recognized as a cumulative effect of a change in accounting principle in the consolidated statement of operations.
Other Policy Claims and Benefits Payable
The liability for other policy claims and benefits payable represents management’s estimate of ultimate unpaid losses on claims and other miscellaneous liabilities to policyholders. Estimated unpaid losses on claims are comprised of losses on claims that have been reported but not yet paid and claims that have been incurred but not reported. Policy claims are based on case-basis estimates for reported claims, and on estimates, based on experience, for incurred but unreported claims and loss expenses.
The liability for other policy claims and benefits payable is subject to the impact of changes in claim severity, frequency and other factors. Although there is considerable variability inherent in such estimates, management believes that the liability recorded is adequate.
Federal Income Taxes
The Company computes deferred income taxes utilizing the asset and liability method. Under this method, balance sheet amounts for deferred income taxes are computed based on the tax effect of the differences between the financial reporting and federal income tax bases of assets and liabilities using the tax rates which are expected to be in effect when these differences are anticipated to reverse.
The Company establishes a valuation allowance when management believes, based on the weight of the available evidence, that it is more likely than not that some portion of the deferred tax asset will not be realized. Realization of deferred tax assets is dependent upon the Company’s generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods.
Revenue Recognition
Premiums on traditional life and health products are recognized as revenue when due. Benefits and expenses are associated with earned premiums, so as to result in recognition of net profits over the lives of the contracts.
Proceeds from annuity and universal life products are recorded as liabilities when received. Revenues for annuity and universal life products consist of net investment income, mortality charges, administration charges, and surrender charges.
Segment Information
Financial Accounting Standards Board (“FASB”) Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), requires disclosure of certain operating and financial data with respect to separate business activities within an enterprise. The Company’s primary business is the sale of individual life insurance and annuity products. The Company does not distinguish or group its consolidated operations by product type or geography. Management decisions regarding the allocation of resources and the assessment of performance are made on a number of different operational perspectives. The Company derives all significant revenues from a single reportable operating segment of the business, sales and administration of individual life insurance and annuity products. Accordingly, the Company does not report more than one segment.
Stock Option Plans and Other Equity Incentive Plans
The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and related Interpretations in accounting for its stock option plans, which are described more fully in Note 11. No compensation cost has been recognized by the Company in the accompanying consolidated statements of operations for its stock option plans, with the exception of the amortization of deferred compensation costs related to the acquisition of ILCO. During 2002, the
F-16
remaining deferred compensation costs were amortized as the related stock options became fully vested in accordance with their original contractual terms.
The Company follows the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock Based Compensation – Transition and Disclosure.” SFAS No. 123 allows companies to follow existing accounting rules (APB 25) provided that pro forma disclosures are made of what net income and earnings per share would have been had the Company recognized expense for stock-based awards based on their fair value at date of grant. The fair value disclosure assumes that fair value of option grants were calculated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
| | | | Options Granted in Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | | | | | |
Expected dividend yield | – | | – | | 1.00% |
Expected volatility | – | | – | | 0.37 |
Risk-free interest rate | – | | – | | 2.23-2.72% |
Expected holding period – years | – | | – | | 1 |
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. Pro forma income information is detailed below:
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated | | Restated |
| | | | (In thousands, except per share data) |
| | | | | | | | |
Net loss – as reported | $ (14,338) | | $ (23,583) | | $ (4,865) |
Pro forma compensation expense, net of tax benefits | - | | - | | (560) |
| | | | | | | | |
Net loss – pro forma | $ (14,338) | | $ (23,583) | | $ (5,425) |
Net loss per share: | | | | | |
| Basic – as reported | $ (1.46) | | $ (2.44) | | $ (0.51) |
| Diluted – as reported | $ (1.46) | | $ (2.44) | | $ (0.51) |
| | | | | | | | |
| Basic – pro forma | $ (1.46) | | $ (2.44) | | $ (0.57) |
| Diluted – pro forma | $ (1.46) | | $ (2.44) | | $ (0.57) |
When stock appreciation rights are granted, the Company recognizes compensation expense equal to the amount by which the quoted market price of the Company’s common stock exceeds the exercise price at the measurement date. Compensation expense is accrued as a charge to expense over the period or periods the employee performs the related services. Compensation accrued during the service period is adjusted in subsequent periods up to the measurement date for changes, either increases or decreases, in the quoted market value of the shares of the enterprise’s stock covered by the grant, but shall not be adjusted below zero. The offsetting adjustment is made to compensation expense of the period in which changes in the market value occur.
Net Income (Loss) Per Share
Net income (loss) per share is calculated based on two methods: basic earnings (loss) per share and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The computation of diluted earnings (loss) per share does not assume conversion, exercise or contingent issuance of securities that would result in an increase in earnings per share amounts or a decrease in loss per share amounts (antidilution). Both methods are presented on the face of the accompanying consolidated statements of operations.
New Accounting Pronouncements
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In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” which was originally issued by the FASB in 1995. As originally issued, SFAS 123 provided companies with the option to either record expense for share-based payments under a fair value model, or to simply disclose the impact of the expense. SFAS 123(R) requires companies to measure the cost of share-based payments to employees using a fair value model, and to recognize that cost over the relevant service period. In addition, SFAS 123(R) requires that an estimate of future award forfeitures be made at the grant date, while SFAS 123 permitted recognition of forfeitures on an as incurred basis. This statement is effective for all awards granted, modified, repurchased, or cancelled after June 15, 2005, and, as a result, the Company will adopt SFAS 123(R) beginning January 1, 2006. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities, an interpretation of ARB 51” (“FIN 46”). The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This new model for consolidation applies to an entity which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures.
In December 2003, the FASB issued Revised Interpretation No. 46, (“FIN 46R”). FIN 46R clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN 46R clarifies how to identify a VIE and how to determine when a business enterprise should include the assets, liabilities, non-controlling interests, and results of activities of a VIE in its consolidated financial statements. FIN 46R also requires disclosure of certain information where the reporting company is the primary beneficiary or holds a significant variable interest in a VIE (but is not the primary beneficiary). FIN 46R was effective for public companies that have interests in VIEs or potential VIEs that are special-purpose entities for periods ending after December 15, 2003. Application by public companies for all other types of entities is required for periods ending after March 15, 2004. The adoption of FIN 46R did not affect FIC’s consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” for decisions made (1) as part of the FASB’s Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (2) in connection with other FASB projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not affect FIC’s consolidated financial statements.
In April 2003, the FASB issued SFAS No. 133 Implementation Issue No. B36, “Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor Under Those Instruments.” Implementation Issue No. B36 indicates that a modified coinsurance arrangement (“modco”), in which funds are withheld by the ceding insurer and a return on those withheld funds is paid based on the ceding company’s return on certain of its investments, generally contains an embedded derivative feature that is not clearly and closely related to the host contract and should be bifurcated in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”
The effective date of Implementation Issue No. B36 is the first day of the first fiscal quarter beginning after September 15, 2003. Beginning in the fourth quarter of 2003, FIC implemented the guidance prospectively for existing contracts and all future transactions. As permitted by SFAS No. 133, all contracts entered into prior to January 1, 1998, were grandfathered and are exempt from provisions of SFAS No. 133 that relate to embedded derivatives. Based upon FIC’s current modco reinsurance, the application of Implementation Issue No. B36 did not materially affect FIC’s consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of a non-public entity. For financial instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of the interim period of adoption, transition is achieved by reporting the cumulative effect of a change in an accounting principle by initially measuring the financial instruments at fair value or other measurement attribute
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required by SFAS No. 150. As a result of further discussion by the FASB on October 8, 2003, the FASB clarified that minority interests in consolidated partnerships with specified finite lives should be reclassified as liabilities and presented at fair market value unless the interests are convertible into the equity of the parent. Fair market value adjustments occurring subsequent to July 1, 2003 would be recorded as a component of interest expense. At their October 29, 2003 meeting, the FASB agreed to indefinitely defer the implementation of a portion of SFAS No. 150 regarding the accounting treatment for minority interests in finite life partnerships. The provisions of SFAS No. 150, which FIC adopted in 2003, did not have a material impact on the Company’s consolidated financial statements.
In July 2003, the Accounting Standards Executive Committee (“AcSEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts.” AcSEC developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” and SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” and the need for interpretive guidance to be developed in three areas: separate account presentation and valuation; the accounting recognition given sales inducements (bonus interest, bonus credits, persistency bonuses); and the classification and valuation of certain long-duration contract liabilities.
The Company adopted the provisions of SOP 03-01 at January 1, 2004, resulting in an increase to income as a cumulative effect of a change in accounting principle totaling $229,000, net of taxes, as reflected in the accompanying 2004 consolidated statement of operations. The Company has certain universal life insurance products that are credited with bonus interest after applicable qualifying periods. The adoption of the new accounting principle changed the pattern of recognition of the bonus interest expense.
In June 2004, the FASB issued FASB Staff Position (“FSP”) No. 97-1, “Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, Permit or Require Accrual of an Unearned Revenue Liability.” FSP 97-1 clarifies the accounting for unearned revenue liabilities of certain universal-life type contracts under SOP 03-01. The Company’s adoption of FSP 97-1 did not have a material impact on the Company’s consolidated financial statements.
In March 2004, the EITF of the FASB reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.” This Issue establishes impairment models for determining whether to record impairment losses associated with investments in certain equity and debt securities. It also requires income to be accrued on a level-yield basis following an impairment of debt securities, where reasonable estimates of the timing and amount of future cash flows can be made. In September 2004, the FASB issued 03-1-1, which defers the effective date of a substantial portion of EITF 03-1, from the third quarter of 2004, as originally required by the EITF, until such time as FASB issues further implementation guidance. In November 2005, the FASB issued FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP addresses the determination as to when an impairment in equity securities (including costs method investments) and debt securities that can contractually be prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost should be deemed other-than-temporary. This FSP nullifies certain requirements of EITF 03-1 and carries forward certain requirements and disclosures. The provisions of this FSP are to be applied to reporting periods beginning after December 15, 2005. Compliance with this FSP is not expected to have a material impact on the Company’s consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections – A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable.
This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB Opinion 20 for reporting the correction of an error in previously issued financial
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statements and a change in accounting estimate. This statement is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005, with earlier adoption permitted. As a result, and due to the restatement included within the accompanying 2003 and 2002 consolidated financial statements, the Company adopted SFAS No. 154 for the correction of errors reported after December 31, 2005.
In September 2005, the American Institute of Certified Public Accountants (“AICPA”), issued Statement of Position (“SOP”) 05-01, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts.” The SOP 05-01 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”) 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and For Realized Gains and Losses from the Sale of Investments.” The SOP 05-01 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The SOP 05-01 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. The Company has not completed an assessment of the estimated impact of SOP 05-01 on its consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments.” This statement amends SFAS No. 133 and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The provisions of SFAS No. 155 (1) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (2) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, (3) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (4) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (5) amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 will be applied prospectively by the Company and is effective for all financial instruments acquired or issued for fiscal years beginning after September 15, 2006. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140” (“SFAS 156”). Among other requirements, SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations. SFAS 156 will be applied prospectively and is effective for fiscal years beginning after September 15, 2006. SFAS 156 is not expected to have a material impact on the Company's consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, treatment of interest and penalties, and disclosure of such positions. FIN 48 will be applied prospectively and will be effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48 and does not expect adoption to have a material impact on the Company's consolidated financial statements.
In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 will be applied prospectively and is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. SFAS 157 is not expected to have a material impact on the Company’s consolidated financial statements.
In September, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). Under this new standard, companies must recognize a net liability or asset to report the funded status of their defined benefit pension and other postretirement benefit plans on their balance sheets. The effective date of the recognition and disclosure provisions for calendar-year public companies is for calendar years ending after December 15, 2006. The Company is currently evaluating the impact of this new standard but it is not expected to have a significant effect on the consolidated financial statements for the year ending December 31, 2006.
2. | Restatement of Previously Issued Financial Statements |
In the course of the Company’s work on its insurance company subsidiaries’ 2004 statutory financial statements, the Company
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identified significant adjustments relating to 2003 and other prior periods. The Company determined that the accounting errors also affected its consolidated financial statements prepared in accordance with GAAP as included in its previously filed 2003 Form 10-K. Subsequent to this determination, the Company continued to work on the completion of its consolidated financial statements for 2004. This work resulted in the identification of additional adjustments affecting 2003 and prior years.
As a result, the Company has restated the accompanying consolidated financial statements for 2003 and 2002. The January 1, 2002 beginning retained earnings was also restated to correct errors occurring in the years prior to 2002. The restatement adjustments also affected previously reported unaudited quarterly financial data as presented in Note 19. These adjustments have been classified into the following areas:
Policy liabilities and Contractholder Deposit Funds – Following the filing of its 2003 Form 10-K, the Company engaged a new actuarial consulting firm to assist with the Company’s actuarial functions and the actuarial processes affecting financial statement preparation. The Company, along with the new firm, performed various reviews of the actuarial policy reserving process. Through this review, errors in the Company’s 2003 and prior year consolidated financial statements were identified relating to policy liabilities and contractholder deposit funds as described below.
The most significant of the errors related to a unique block of life insurance policies. This block of policies consisted of several different policy types including hybrid fixed premium universal life policies and fixed premium interest sensitive whole life policies. These are relatively complex products that were not properly administered in some cases and, therefore, reserves were not recorded to cover all of the policy options. This block also required manual policy reserve calculations in many instances. Upon additional review of this block of business, errors in the reserving calculations were identified along with the determination that a significant number of policies had not been included in the reserving process.
Another significant adjustment related to contractholder deposit funds for annuity policies. Several annuity policies were misidentified in prior years as variable annuities and excluded from policy liabilities. Upon additional review, these policies have been appropriately identified as general account policies and included in the Company’s contractholder deposit fund liabilities.
As a result, corrected calculations and reserving processes for these policies were performed and the liability balances were increased for these corrections totaling $6.5 million, specifically, contractholder deposit funds totaling $4.8 million and future policy benefits totaling $1.7 million.
The Company also determined that there were errors in its process for calculating the liability for premiums received in advance related to policies processed on one of its policy administration systems. As a result, the Company developed a new program to correct the advance premium calculation process resulting in an increase to this liability of $365,000.
Various other errors were identified resulting in corrections primarily related to paid-up insurance coverages, manual policy processing, and accumulation of GAAP policy reserves and related reinsurance reserve credits. These resulted in an increase to reinsurance receivables of $291,000, with a reduction in future policy benefits of $17,000.
Reinsurance – As a result of the findings by a significant reinsurer and issues identified by the Company, the Company completed a comprehensive review of its reinsurance administrative systems. These systems generally rely on manual interface with the Company’s policy administration systems and general ledger. This manual interface, along with changes in retention policies which are based on covered individuals, resulted in errors in premiums ceded. As a result, restatement adjustments totaling $668,000 were made to appropriately cede premiums and reduce reinsurance receivables in accordance with the reinsurance agreements with various reinsurers.
Present Value of Future Profits of Acquired Businesses (PVFP) – The Company recorded a restatement adjustment totaling $56,000 for the amortization of PVFP in 2003 related to the correction of certain policy in-force data.
Excess of Net Assets Acquired Over Cost – In connection with the 2001 acquisition of ILCO, the Company allocated the purchase price to the fair value of the assets acquired and liabilities assumed in accordance with the purchase method of accounting resulting in the recognition of an excess of net assets acquired over cost, also referred to as negative goodwill. Prior to its acquisition of ILCO’s remaining outstanding common shares on May 18, 2001, the Company accounted for ILCO under the equity method of accounting. The Company owned approximately 48% of ILCO’s common shares prior to May 18, 2001. The restatement adjustments to the Company’s equity in earnings of affiliate are therefore equal to approximately 48% of the related adjustments to ILCO’s retained earnings and total shareholders’ equity prior to May 18, 2001. Certain restatement adjustments as described in this Note, therefore, affected the fair value of the net assets acquired from ILCO and
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the cost of the investment in ILCO resulting in a decrease of $2.7 million in the remaining unamortized negative goodwill, which was recognized as a cumulative effect of a change in accounting principle in 2002 in accordance with SFAS No. 141 “Business Combinations”.
Income Taxes - - Current and deferred Federal income tax provisions were recalculated to include the impact of the restatement adjustments as described herein, and to reflect the amount of taxes receivable from the IRS and the amount of deferred Federal income tax liability resulting from the utilization of the asset and liability method after consideration of the portion of the deferred tax asset that may not be realized pursuant to the requirements of SFAS No. 109,"Accounting for Income Taxes." The Company also determined that deferred taxes had not been established related to ILCO's pension assets. Adjustments made to decrease the income tax receivable and reduce the deferred tax liability totaled $1.9 million, including an increase in accumulated other comprehensive income of $280,000 primarily as a result of changes to the deferred tax valuation allowance applied to other comprehensive income and the recalculation of deferred income taxes applied to the Company's minimum pension liability.
Other Miscellaneous – The Company recorded the following additional restatement adjustments:
| • | Correct agent advances for calculation errors in amounts collected by the Company, increasing accounts receivable $33,000 |
| • | Correct the accounting of certain manually administered policy loans, decreasing policy loans $163,000 |
| • | Establish sales tax accrual on actuarial consulting fees, increasing other liabilities $79,000 |
| • | Adjustment of duplicate claims checks included in escheat liability and vacation benefits liability, reducing other liabilities by $95,000 |
| • | Reduction of accrued interest on bond for which interest received was held in suspense totaling $52,000 |
| • | Increase in a tax withholding liability totaling $54,000 |
| • | Increase in agency receivables of $183,000 |
| • | Reduction of accounts receivable for straight-line treatment of rental income totaling $86,000 |
| • | Correction of agent commission liability of $255,000 and allowance for agents’ balances of $157,000 due to errors in programming of the Company’s commission rate structure totaling $98,000 |
| • | Correction of treasury stock, increasing additional paid-in capital by $524,000 and common treasury stock by $122,000 and reducing other liabilities by $646,000, as a result of treasury shares distributed in 2003 in conjunction with the acquisition of the New Era companies. See Note 17 for additional details regarding the acquisition and subsequent sale of the New Era companies. |
| • | Establishment of cash account and liability for a unrecorded premium depository account totaling $249,000 |
| • | Reclassifications of certain balance sheet and statement of operations items which were improperly classified, including amortization of DAC and PVFP of $121,000, premium revenue and policyholder benefits and expenses of $202,000, accrued investment income and accounts receivable of $395,000, reinsurance receivables and contractholder deposit funds of $303,000, and policyholder benefits and expenses and interest on contractholder deposit funds totaling $1.5 million. |
In addition to the above restatements, the statement of cash flows for the year ended December 31, 2003 was also affected by the following items:
| • | Loss from discontinued operations of the New Era companies was shown as a separate line item, with offsetting reductions in change in agency advances ($273,000), change in other assets ($4,780,000), other ($442,000), and an increase in other liabilities of $560,000. |
| • | Acquisition of subsidiary companies was adjusted to eliminate the net effects of changes in other assets and liabilities. Acquisition of subsidiary companies increased by $941,000, offset by reductions in other of $1,587,000, issuance of treasury stock of $646,000, and increases in change in other assets of $647,000 and change in other liabilities of $2,527,000. |
| • | Adjustment to issuance of treasury stock of $127,000 due to issuance of treasury stock to 401(k) participants, reclassifying change to other. |
| • | Adjustment of proceeds from sales or maturities of fixed maturities of $458,000, with offset to other, for accretion and amortization of bond discount and premium, respectively, previously included. |
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In the aggregate, the correction of these errors impacted the consolidated balance sheet as of December 31, 2003, and consolidated statements of operations for the years ended December 31, 2003 and 2002, respectively, as follows (in thousands):
As of December 31, 2003 | Policy Liabilities and Contract- holder Deposits | | Reinsurance | | Present Value of Future Profits | | Other Miscellaneous and Reclassifications | | Income Taxes | | Total |
| | | | | | | | | | | |
Investments: | | | | | | | | | | | |
Policy loans | $ - | | $ - | | $ - | | $ (163) | | $ - | | $ (163) |
Total investments | - | | - | | - | | (163) | | - | | (163) |
Cash and cash equivalents | - | | - | | - | | 249 | | - | | 249 |
Deferred policy acquisition costs | - | | - | | - | | (121) | | - | | (121) |
Present value of future profits of acquired businesses | - | | - | | 56 | | 121 | | - | | 177 |
Agency advances and other receivables | - | | - | | - | | 427 | | (117) | | 310 |
Reinsurance receivables | 291 | | (650) | | - | | 303 | | - | | (56) |
Accrued investment income | - | | - | | - | | (447) | | - | | (447) |
Total assets | $ 291 | | $ (650) | | $ 56 | | $ 369 | | $ (117) | | $ (51) |
| | | | | | | | | | | |
Policy liabilities and contractholder deposit funds: | | | | | | | | | | | |
Contractholder deposit funds | $ 4,768 | | $ - | | $ - | | $ 303 | | $ - | | $ 5,071 |
Future policy benefits | 2,063 | | - | | - | | - | | - | | 2,063 |
Deferred federal income taxes | - | | - | | - | | - | | (2,036) | | (2,036) |
Other liabilities | - | | 18 | | - | | (360) | | - | | (342) |
Total liabilities | 6,831 | | 18 | | - | | (57) | | (2,036) | | 4,756 |
Shareholders’ equity: | | | | | | | | | | | |
Additional paid-in capital | - | | - | | - | | 524 | | - | | 524 |
Accumulated other comprehensive income | - | | - | | - | | - | | 280 | | 280 |
Retained earnings | (6,540) | | (668) | | 56 | | (220) | | 1,639 | | (5,733) |
Common treasury stock, at cost | - | | - | | - | | 122 | | - | | 122 |
Total shareholders’ equity | (6,540) | | (668) | | 56 | | 426 | | 1,919 | | (4,807) |
Total liabilities and shareholders’ equity | $ 291 | | $ (650) | | $ 56 | | $ 369 | | $ (117) | | $ (51) |
| | | | | | | | | | | |
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For the year ended December 31, 2003 | Policy Liabilities and Contract- holder Deposits | | Reinsurance | | Present Value of Future Profits | | Other Miscellaneous and Reclassifications | | Income Taxes | | Total |
| | | | | | | | | | | |
Revenues: | | | | | | | | | | | |
Premiums, net | $ 43 | | $ (3) | | $ - | | $ (208) | | $ - | | $ (168) |
Net investment income | - | | - | | - | | (82) | | - | | (82) |
Real estate income, net | - | | - | | - | | (20) | | - | | (20) |
Total revenues | 43 | | (3) | | - | | (310) | | - | | (270) |
Benefits and expenses: | | | | | | | | | | | |
Policyholder benefits and expenses | 772 | | 251 | | - | | 1,305 | | - | | 2,328 |
Interest expense on contractholder deposit funds | 958 | | - | | - | | (1,506) | | - | | (548) |
Amortization of deferred policy acquisition costs | - | | - | | | | 121 | | - | | 121 |
Amortization of present value of future profits | | | | | | | | | | | |
of acquired business | - | | - | | (56) | | (121) | | - | | (177) |
Operating expenses | - | | - | | | | (277) | | - | | (277) |
Total benefits and expenses | 1,730 | | 251 | | (56) | | (478) | | - | | 1,447 |
(Loss) income from continuing operations before | | | | | | | | | | | |
federal income taxes, discontinued operations, | | | | | | | | | | | |
and cumulative effect of change in | | | | | | | | | | | |
accounting principle | (1,687) | | (254) | | 56 | | 168 | | - | | (1,717) |
Federal income tax benefit: | | | | | | | | | | | |
Current | - | | - | | - | | - | | (131) | | (131) |
Deferred | - | | - | | - | | - | | (501) | | (501) |
(Loss) income from continuing operations before | | | | | | | | | | | |
discontinued operations and cumulative effect of | | | | | | | | | | | |
change in accounting principle | (1,687) | | (254) | | 56 | | 168 | | 632 | | (1,085) |
(Loss) income before cumulative effect | | | | | | | | | | | |
of change in accounting principle | (1,687) | | (254) | | 56 | | 168 | | 632 | | (1,085) |
Cumulative effect of change in accounting principle | - | | - | | - | | - | | - | | - |
Net (loss) income | $ (1,687) | | $ (254) | | $ 56 | | $ 168 | | $ 632 | | $ (1,085) |
| | | | | | | | | | | |
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For the year ended December 31, 2002 | Policy Liabilities and Contract- holder Deposits | | Reinsurance | | Excess of Net Assets Acquired Over Cost | | Other Miscellaneous and Reclassifications | | Income Taxes | | Total |
| | | | | | | | | | | |
Revenues: | | | | | | | | | | | |
Premiums, net | $ 22 | | $ (3) | | $ - | | $ (213) | | $ - | | $ (194) |
Net investment income | - | | - | | - | | 89 | | - | | 89 |
Real estate income, net | - | | - | | - | | (34) | | - | | (34) |
Total revenues | 22 | | (3) | | - | | (158) | | - | | (139) |
Benefits and expenses: | | | | | | | | | | | |
Policyholder benefits and expenses | (132) | | 50 | | - | | (165) | | - | | (247) |
Interest expense on contractholder deposit funds | 575 | | - | | - | | - | | - | | 575 |
Amortization of deferred policy acquisition costs | - | | - | | - | | - | | - | | - |
Amortization of present value of future profits | | | | | | | | | | | |
of acquired business | - | | - | | - | | - | | - | | - |
Operating expenses | - | | - | | - | | (55) | | - | | (55) |
Total benefits and expenses | 443 | | 50 | | - | | (220) | | - | | 273 |
(Loss) income from continuing operations before | | | | | | | | | | | |
federal income taxes, discontinued operations, | | | | | | | | | | | |
and cumulative effect of change | | | | | | | | | | | |
in accounting principle | (421) | | (53) | | - | | 62 | | - | | (412) |
Federal income tax benefit: | | | | | | | | | | | |
Current | - | | - | | - | | - | | (38) | | (38) |
Deferred | - | | - | | - | | - | | (514) | | (514) |
(Loss) income from continuing operations before | | | | | | | | | | | |
discontinued operations and cumulative effect of | | | | | | | | | | | |
change in accounting principle | (421) | | (53) | | - | | 62 | | 552 | | 140 |
(Loss) income before cumulative effect | | | | | | | | | | | |
of change in accounting principle | (421) | | (53) | | - | | 62 | | 552 | | 140 |
Cumulative effect of change in accounting principle | - | | - | | (2,650) | | - | | - | | (2,650) |
Net (loss) income | $ (421) | | $ (53) | | $ (2,650) | | $ 62 | | $ 552 | | $ (2,510) |
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The effect of the above restatement adjustments on the results of operations and cash flows for the years ended December 31, 2003 and 2002, respectively, and financial position as of December 31, 2003, are as follows (in thousands):
| 2003 |
| As Previously | | |
| Reported | | As Restated |
Consolidated Balance Sheet as of December 31, 2003: | | | |
Investments: | | | |
Policy loans | $ 42,615 | | $ 42,452 |
Total investments | 688,927 | | 688,764 |
Cash and cash equivalents | 82,187 | | 82,436 |
Deferred policy acquisition costs | 54,940 | | 54,819 |
Present value of future profits of acquired businesses | 20,919 | | 21,096 |
Agency advances and other receivables | 9,931 | | 10,241 |
Reinsurance receivables | 40,034 | | 39,978 |
Accrued investment income | 7,142 | | 6,695 |
Total assets | $ 1,286,095 | | $ 1,286,044 |
| | | |
Policy liabilities and contractholder deposit funds: | | | |
Contractholder deposit funds | $ 588,810 | | $ 593,881 |
Future policy benefits | 167,181 | | 169,244 |
Deferred federal income taxes | 8,369 | | 6,333 |
Other liabilities | 25,655 | | 25,313 |
Total liabilities | 1,176,979 | | 1,181,735 |
Shareholders’ equity: | | | |
Additional paid-in capital | 69,867 | | 70,391 |
Accumulated other comprehensive income | (2,401) | | (2,121) |
Retained earnings | 62,721 | | 56,988 |
Common treasury stock, at cost | (23,575) | | (23,453) |
Total shareholders’ equity | 109,116 | | 104,309 |
Total liabilities and shareholders’ equity | $ 1,286,095 | | $ 1,286,044 |
F-26
| 2003 | | 2002 |
| As Previously | | | | As Previously | | |
| Reported | | As Restated | | Reported | | As Restated |
Consolidated Statements of Operations for the years ended | | | | | | | |
December 31, 2003 and 2002: | | | | | | | |
Revenues: | | | | | | | |
Premiums, net | $ 31,225 | | $ 31,057 | | $ 38,866 | | $ 38,672 |
Net investment income | 35,428 | | 35,346 | | 38,079 | | 38,168 |
Real estate income, net | 2,387 | | 2,367 | | 2,904 | | 2,870 |
Total revenues | 111,667 | | 111,397 | | 121,175 | | 121,036 |
Benefits and expenses: | | | | | | | |
Policyholder benefits and expenses | 45,086 | | 47,414 | | 53,710 | | 53,463 |
Interest expense on contractholder deposit funds | 26,362 | | 25,814 | | 29,692 | | 30,267 |
Amortization of deferred policy acquisition costs | 9,653 | | 9,774 | | 11,013 | | 11,013 |
Amortization of present value of future profits of acquired business | 4,641 | | 4,464 | | 4,246 | | 4,246 |
Operating expenses | 41,769 | | 41,492 | | 34,628 | | 34,573 |
Total benefits and expenses | 130,911 | | 132,358 | | 133,289 | | 133,562 |
Loss from continuing operations before federal income | | | | | | | |
taxes, discontinued operations, and cumulative effect of | | | | | | | |
change in accounting principle | (19,244) | | (20,961) | | (12,114) | | (12,526) |
Federal income tax benefit: | | | | | | | |
Current | (1,482) | | (1,613) | | (21) | | (59) |
Deferred | (1,397) | | (1,898) | | (2,948) | | (3,462) |
Loss from continuing operations before discontinued | | | | | | | |
operations and cumulative effect of change in accounting principle | (16,365) | | (17,450) | | (9,145) | | (9,005) |
Loss before cumulative effect of change in accounting principle | (22,498) | | (23,583) | | (9,145) | | (9,005) |
Cumulative effect of change in accounting principle | - | | - | | 6,790 | | 4,140 |
Net loss | $ (22,498) | | $ (23,583) | | $ (2,355) | | $ (4,865) |
Net loss per share (basic and diluted) | $ (2.34) | | $ (2.44) | | $ (0.25) | | $ (0.51) |
F-27
| 2003 | | 2002 |
| As Previously | | | | As Previously | | |
| Reported | | As Restated | | Reported | | As Restated |
Consolidated Statements of Cash Flows for the years | | | | | | | |
ended December 31, 2003 and 2002: | | | | | | | |
| | | | | | | |
Cash flows from operating activities: | | | | | | | |
Net loss | $ (22,498) | | $ (23,583) | | $ (2,355) | | $ (4,865) |
Adjustments to reconcile net loss to net cash provided | | | | | | | |
by operating activities: | | | | | | | |
Amortization of deferred policy acquisition costs | 9,653 | | 9,774 | | 11,013 | | 11,013 |
Amortization of present value of future profits of acquired business | 4,641 | | 4,464 | | 4,246 | | 4,246 |
Depreciation | 2,545 | | 3,363 | | 2,864 | | 2,882 |
Cumulative effect of change in accounting principle | - | | - | | (6,790) | | (4,140) |
Loss on sale of discontinued operations | - | | 4,935 | | - | | - |
Changes in assets and liabilities: | | | | | | | |
Decrease (increase) in accrued investment income | (283) | | 138 | | 125 | | 94 |
Decrease (increase) in agency advances and other receivables | 5,628 | | 4,106 | | (1,423) | | (1,487) |
Decrease in reinsurance receivables | 2,348 | | 2,005 | | 4,882 | | 5,355 |
Decrease (increase) in other assets | 10,623 | | 6,489 | | (10) | | (432) |
Increase in policy liabilities and accruals | 1,789 | | 4,070 | | 3,856 | | 7,896 |
Increase (decrease) in other liabilities | 547 | | 2,654 | | (2,576) | | (3,178) |
Decrease in deferred federal income taxes | (1,828) | | (2,229) | | (1,259) | | (1,763) |
Other | 1,461 | | 1,806 | | (623) | | 1,630 |
Net cash provided by operating activities | 2,419 | | 5,785 | | 5,212 | | 10,513 |
Cash flows from investing activities: | | | | | | | |
Real estate capital expenditures | (1,087) | | (1,281) | | (13,556) | | (13,673) |
Proceeds from sales and maturities of fixed maturities | 418,971 | | 417,628 | | 244,910 | | 243,356 |
Net decrease in short-term investments | 125 | | 126 | | 47,683 | | 47,682 |
Net decrease in policy loans | 2,578 | | 2,557 | | 3,399 | | 3,436 |
Acquisition of subsidiary companies, net of cash acquired | (3,183) | | (4,124) | | - | | - |
Purchase of property and equipment | (247) | | (480) | | (1,064) | | (1,128) |
Net cash (used in) provided by investing activities | (94,422) | | (97,153) | | 70,368 | | 68,669 |
Cash flow from financing activities: | | | | | | | |
Cash dividends to shareholders | (483) | | (480) | | (2,134) | | (2,021) |
Issuance of capital stock | 1,895 | | 1,383 | | 1,007 | | 1,007 |
Contractholder fund deposits | 57,458 | | 57,458 | | 55,368 | | 55,341 |
Contractholder fund withdrawals | (62,163) | | (62,163) | | (64,085) | | (67,677) |
Purchase of treasury stock | (320) | | (1,103) | | (362) | | (460) |
Sales of treasury stock | - | | 656 | | - | | - |
Net cash provided by (used in) financing activities | 11,387 | | 10,751 | | (10,206) | | (13,810) |
Net increase (decrease) in cash | $ (80,616) | | $ (80,617) | | $ 65,374 | | $ 65,372 |
F-28
Additionally, the effect of the above restatement adjustments decreased retained earnings as of January 1, 2002 in the following categories (in thousands):
Policy liabilities and contractholder deposit funds | | | $ 4,432 |
Reinsurance | | | 360 |
Excess of net assets acquired over cost | | | (2,650) |
Other miscellaneous | | | 451 |
Income taxes | | | (455) |
| | | $ 2,138 |
| | | |
Fixed Maturities and Equity Securities
Investments in fixed maturities and equity securities and related unrealized gains and losses are detailed as follows:
| | | | December 31, 2004 |
| | | | | | Gross | | Gross | | |
| | | | Amortized | | Unrealized | | Unrealized | | Fair |
| | | | Cost | | Gains | | Losses | | Value |
| | | | (In thousands) |
| | | | | | | | | | |
Fixed maturities available for sale: | | | | | | | |
U.S. Treasury securities and obligations of U.S. | | | | | | | |
| government agencies and corporations | $ 39,085 | | $ 482 | | $ 74 | | $ 39,493 |
States, municipalities and political subdivisions | 16,720 | | 228 | | 363 | | 16,585 |
Corporate | 252,449 | | 5,296 | | 1,166 | | 256,579 |
Mortgage-backed and asset-backed | 192,447 | | 983 | | 6,932 | | 186,498 |
| | | | | | | | | | |
Total fixed maturities | $ 500,701 | | $ 6,989 | | $ 8,535 | | $ 499,155 |
| | | | | | | | | | |
Equity securities available for sale | $ 6,311 | | $ 2,214 | | $ 23 | | $ 8,502 |
| | | | | | | | | | |
| | | | December 31, 2003 |
| | | | | | Gross | | Gross | | |
| | | | Amortized | | Unrealized | | Unrealized | | Fair |
| | | | Cost | | Gains | | Losses | | Value |
| | | | (In thousands) |
| | | | | | | | | | |
Fixed maturities available for sale: | | | | | | | |
U.S. Treasury securities and obligations of U.S. | | | | | | | |
| government agencies and corporations | $ 50,974 | | $ 1,858 | | $ 2 | | $ 52,830 |
States, municipalities and political subdivisions | 16,824 | | 258 | | 951 | | 16,131 |
Corporate | 183,054 | | 5,996 | | 1,111 | | 187,939 |
Mortgage-backed and asset-backed | 306,433 | | 1,943 | | 9,475 | | 298,901 |
Total fixed maturities available for sale | 557,285 | | 10,055 | | 11,539 | | 555,801 |
| | | | | | | | | | |
Fixed maturities held to maturity: | | | | | | | |
Corporate | 17 | | 2 | | - | | 19 |
| | | | | | | | | | |
Total fixed maturities | $ 557,302 | | $ 10,057 | | $ 11,539 | | $ 555,820 |
| | | | | | | | | | |
Equity securities available for sale | $ 6,393 | | $ 1,589 | | $ 41 | | $ 7,941 |
F-29
The Company’s insurance subsidiaries are required to maintain assets on deposit with state regulatory authorities. Such assets are included in fixed maturities and have an aggregate fair value of $13.9 million and $11.8 million at December 31, 2004 and 2003, respectively.
For investments of fixed maturities that have unrealized losses at December 31, 2004, the fair value, gross unrealized losses, and length of time that individual securities have been in a continuous unrealized loss position are as follows:
| | 2004 |
| | Less than 12 months | | 12 months or more | | Total |
| | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized |
| | Value | | Losses | | Value | | Losses | | Value | | Losses |
| | (In thousands) |
| | | | | | | | | | | | |
U.S. Treasury and other U.S. government | | | | | | | | | | | |
| agencies and corporations | $ 26,624 | | $ 74 | | $ - | | $ - | | $ 26,624 | | $ 74 |
States, municipalities, and | | | | | | | | | | | |
| political subdivisions | 994 | | 6 | | 12,496 | | 357 | | 13,490 | | 363 |
Corporate | 81,032 | | 544 | | 23,077 | | 622 | | 104,109 | | 1,166 |
Mortgage-backed and asset-backed | 45,398 | | 362 | | 64,963 | | 6,570 | | 110,361 | | 6,932 |
| | | | | | | | | | | | |
Fixed maturities available for sale | $154,048 | | $ 986 | | $100,536 | | $ 7,549 | | $254,584 | | $ 8,535 |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | 2003 |
| | Less than 12 months | | 12 months or more | | Total |
| | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized |
| | Value | | Losses | | Value | | Losses | | Value | | Losses |
| | (In thousands) |
| | | | | | | | | | | | |
U.S. Treasury and other U.S. government | | | | | | | | | | | |
| agencies and corporations | $ 11,989 | | $ 2 | | $ - | | $ - | | $ 11,989 | | $ 2 |
States, municipalities, and | | | | | | | | | | | |
| political subdivisions | 13,342 | | 951 | | - | | - | | 13,342 | | 951 |
Corporate | 53,198 | | 1,111 | | - | | - | | 53,198 | | 1,111 |
Mortgage-backed and asset-backed | 175,184 | | 9,199 | | 21,087 | | 276 | | 196,271 | | 9,475 |
| | | | | | | | | | | | |
Fixed maturities available for sale | $253,713 | | $ 11,263 | | $ 21,087 | | $ 276 | | $274,800 | | $11,539 |
| | | | | | | | | | | | |
At December 31, 2004, the Company held five U.S. Treasury securities with unrealized losses caused by interest rate increases. At December 31, 2003, the Company held two U.S. Treasury securities with unrealized losses caused by interest rate increases.
At December 31, 2004, the Company held three investments in debt securities issued by states, municipalities, and political subdivisions with unrealized losses caused primarily by market interest rate increases. The average unrealized loss on these securities was 3% of carrying value. The three securities are rated by a credit agency and had an investment grade rating of A- or higher. At December 31, 2003, the Company held four investments in debt securities issued by states, municipalities, and political
F-30
subdivisions with unrealized losses caused primarily by market interest rate increases. The average unrealized loss on these securities was 6.7% of carrying value. Three of these securities are rated by a credit agency and had an investment grade rating of AAA.
At December 31, 2004, the Company held twenty-two investments in debt securities issued by corporations with unrealized losses caused by interest rate increases. The average unrealized loss on these securities was 1% of carrying value. Twenty-one of these investments had investment grade ratings by a ratings agency. At December 31, 2003, the Company held seventeen investments in debt securities issued by corporations with unrealized losses caused by interest rate increases. The average unrealized loss on these securities was 2% of carrying value. Sixteen of these investments had investment grade ratings by a ratings agency.
At December 31, 2004, the Company held thirty-six investments in mortgage-backed or asset-backed securities with unrealized losses caused by interest rate increases. The average unrealized loss on these securities was 6% of carrying value. At December 31, 2003, the Company held forty investments in mortgage-backed or asset-backed securities with unrealized losses caused by interest rate increases. The average unrealized loss on these securities was 4.6% of carrying value.
Because of the high ratings of these investments and the Company’s ability and intent to hold these investments until recovery of fair value, which may be maturity or earlier if called, the Company does not consider these unrealized losses to be other than temporary.
There were no impairments in the value of investments in 2004 which were considered other than temporary. During 2003, the Company identified eight securities which were considered impaired and reduced their carrying value by $5.2 million. All eight fixed-maturity securities were sold during the fourth quarter of 2003. At December 31, 2003, the Company identified six additional securities which were considered impaired and reduced their carrying value by $1.6 million. All six of these fixed-maturity securities were sold in 2004. The Company also identified one security at December 31, 2002, that was considered to be impaired and reduced its carrying value by $463,000. Additionally at December 31, 2002, the Company determined that its investments in its separate accounts, which are classified as equity securities, were impaired and reduced the carrying values by $2.5 million.
As part of the Company’s ongoing investment review, the Company has reviewed its fixed maturities and equity securities investment portfolio and concluded that there were no additional other-than-temporary impairments as of December 31, 2004 or 2003. Due to the issuers’ continued satisfaction of the investment obligations in accordance with their contractual terms and management’s expectation that they will continue to do so, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that unrealized losses on these investments at December 31, 2004, and 2003 were temporary.
In evaluating whether a decline in value is other than temporary, the Company considers several factors including, but not limited to, the following; (1) whether the decline is substantial; (2) the duration; (3) the reasons for the decline in value (credit event, interest related, or market fluctuations); (4) the Company’s ability and intent to hold the investments for a period of time to allow for a recovery of value; and (5) the financial condition of and near term prospects of the issuer. The evaluation for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates.
The amortized values and market values of fixed maturities at December 31, 2004, are shown below by contractual maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | Amortized | | Fair |
| | | | Value | | Value |
| | | | (In thousands) |
Due in one year or less | $ 8,171 | | $ 8,343 |
Due after one year through five years | 117,871 | | 119,398 |
Due after five years through ten years | 104,359 | | 106,448 |
Due after ten years | 77,853 | | 78,468 |
Mortgage-backed and asset-backed securities | 192,447 | | 186,498 |
| | | | | | |
Total fixed maturities | $ 500,701 | | $ 499,155 |
F-31
The net change in unrealized gains (losses) on fixed maturities available for sale and equity securities represent a component of accumulated other comprehensive income for the years ended December 31, 2004, 2003, and 2002. The following is a summary of the change in unrealized gains (losses), net of the effects on DAC and PVFP and related deferred income taxes, that are reflected in accumulated other comprehensive income for the periods presented.
| | | | Year Ended December 31, |
| | | | | | 2003 | | |
| | | | 2004 | | Restated | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Fixed maturities | $ (65) | | $ (21,100) | | $ 11,776 |
Equity securities | 643 | | 1,578 | | 543 |
Gross unrealized gains (losses) | 578 | | (19,522) | | 12,319 |
Effect on other balance sheet accounts | (65) | | 5,426 | | (3,537) |
Deferred federal income taxes | 146 | | 4,615 | | (3,008) |
| | | | | | | | |
Net change in unrealized gains (losses) on investments | $ 659 | | $ (9,481) | | $ 5,774 |
| | | | | | | | |
The following table sets forth unrealized holding gains (losses) on investments arising during the year and the reclassification adjustments required for the years ended December 31, 2004, 2003, and 2002:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Reclassification adjustments: | | | | | |
Unrealized holding gains (losses) on investments arising | | | | | |
| during the period, net of taxes | $ (74) | | $ (9,215) | | $ 7,597 |
Reclassification adjustments for (gains) losses included | | | | | |
| in net income, net of taxes | 733 | | (266) | | (1,823) |
Unrealized gains (losses) on investments, net of reclassification | | | | | |
| adjustment, net of taxes | $ 659 | | $ (9,481) | | $ 5,774 |
| | | | | | | | |
Mortgage Loans
In 2002 the Company agreed to a proposed $3.6 million payoff of two mortgage loans on properties located in the state of New York, Champlain Centre Mall and Salmon Run Mall, with a total balance due of $4.6 million by the borrower. As a result, the Company recorded a realized loss of $955,000 in 2002 from this discounted payoff which is included in realized losses on investments in the consolidated statement of operations.
Investment Real Estate
Investors Life completed development of the River Place Pointe office complex in 2002. River Place Pointe consists of seven office buildings, with rentable space of approximately 584,000 square feet, and associated parking, drives, and related improvements on 48 acres of land in Austin, Texas. At December 31, 2004, the Company occupied Building One, consisting of approximately 76,000 square feet and approximately 4,000 square feet in Building Four. Approximately 333,310 square feet of the remaining 370,228 square feet in Buildings Two, Three, Four and Six were leased to third parties. The remaining two buildings (Buildings Five and Seven) were not leased at December 31, 2004. The office building (Building One) occupied by the Company,
F-32
which is reflected in the accompanying consolidated financial statements as real estate held for use, was $13.6 million and $13.9 million at December 31, 2004 and 2003, respectively. Investment real estate, which is comprised of the other six buildings in the River Place Pointe office complex, was $76.6 million and $76.7 million at December 31, 2004 and 2003, respectively. In 2005, the Company sold all seven buildings in the River Place Pointe office complex. See Note 18 for additional details regarding the sale of River Place Pointe.
River Place Pointe and properties held for sale are leased under agreements classified as operating leases. The Company is generally responsible for the payment of property taxes, insurance and maintenance costs related to the real estate properties. Future minimum lease payments receivable for River Place Pointe and other properties (excluding rental income related to the Company’s occupancy of Building One of River Place Pointe) under noncancelable leasing arrangements as of December 31, 2004, are as follows (in thousands):
For the years ending December 31: |
| 2005 | $ 7,039 |
| 2006 | 6,066 |
| 2007 | 5,404 |
| 2008 | 1,768 |
| 2009 | 590 |
| Thereafter | 229 |
| | $ 21,096 |
Accumulated depreciation on investment real estate totaled $9.0 million and $6.5 million as of December 31, 2004 and 2003, respectively.
Real Estate Held for Sale
The Company determined in 2003 to sell all of its investment real estate, excluding River Place Pointe. Accordingly, the carrying value of seven properties aggregating $968,000 was evaluated and reclassified as real estate held for sale in the accompanying consolidated balance sheet at December 31, 2003. During 2004, the Company sold two properties held for sale generating gross proceeds of $2.0 million and realized gains aggregating $1.7 million. At December 31, 2004, the remaining five properties classified as real estate held for sale had a carrying value of $589,000. See Note 18 for additional details regarding the sale of properties subsequent to December 31, 2004. Accumulated depreciation on real estate held for sale totaled $2.7 million and $3.4 million as of December 31, 2004 and 2003, respectively.
Non-Income Producing Investments
The carrying values of investments at December 31, 2004 and 2003 that were non-income producing, for the preceding 12 months, were as follows:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | (In thousands) |
| | | | | | |
Investment real estate: | | | |
| River Place Pointe non-leased buildings | $ 21,421 | | $ 32,401 |
| Others | 81 | | 81 |
| | | | | | |
| | | | $ 21,502 | | $ 32,482 |
| | | | | | |
Net Investment Income
The components of net investment income are summarized as follows:
F-33
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated | | Restated |
| | | | (In thousands) |
| | | | | | | | |
Fixed maturities | $ 27,386 | | $ 31,846 | | $ 30,783 |
Other, including short-term investments and policy loans | 4,036 | | 4,177 | | 7,487 |
Gross investment income | 31,422 | | 36,023 | | 38,270 |
Investment expenses | (719) | | (677) | | (102) |
| | | | | | | | |
Net investment income | $ 30,703 | | $ 35,346 | | $ 38,168 |
| | | | | | | | |
Net Realized Investment Gains
Proceeds and gross realized gains (losses) from sales of fixed maturities available for sale are summarized as follows:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Proceeds | $ 155,786 | | $ 282,115 | | $ 61,800 |
| | | | | | | | |
Gross realized gains | $ 1,810 | | $ 6,685 | | $ 1,171 |
Gross realized losses | (702) | | (5,513) | | (57) |
| | | | | | | | |
Net realized investment gains | $ 1,108 | | $ 1,172 | | $ 1,114 |
| | | | | | | | |
F-34
4. Fair Values of Financial Instruments
The carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2004 and 2003 are as follows:
| | | | 2004 | | 2003 |
| | | | Carrying | | Fair | | Carrying | | Fair |
| | | | Value | | Value | | Value | | Value |
| | | | (In thousands) | | (In thousands) |
| | | | | | | | | | |
Financial assets: | | | | | | | |
| Fixed maturity securities held to maturity | $ - | | $ - | | $ 17 | | $ 19 |
| Fixed maturity securities available for sale | 499,155 | | 499,155 | | 555,801 | | 555,801 |
| Fixed maturity securities held for trading | 1,057 | | 1,057 | | 4,873 | | 4,873 |
| Equity securities | 8,502 | | 8,502 | | 7,941 | | 7,941 |
| Policy loans | 39,855 | | 49,343 | | 42,452 | | 42,452 |
| Short-term investments | 62,514 | | 62,514 | | - | | - |
| Cash and cash equivalents | 52,044 | | 52,044 | | 82,436 | | 82,436 |
| Separate account assets | 359,876 | | 359,876 | | 358,271 | | 358,271 |
| | | | | | | | | | |
Financial liabilities: | | | | | | | |
| Separate account liabilities | $ 359,876 | | $ 359,876 | | $ 358,271 | | $ 358,271 |
| Deferred annuities | 145,010 | | 139,825 | | 150,691 | | 145,490 |
| Notes payable | 15,000 | | 15,000 | | 15,000 | | 15,000 |
| Supplemental contracts | 10,965 | | 10,965 | | 12,729 | | 12,418 |
| | | | | | | | | | |
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Fixed Maturities, Trading Securities, and Equity Securities
Fair values are based on quoted market prices or dealer quotes.
Policy Loans
Fair values of policy loans are estimated using discounted cash flow analysis, using interest rates offered for similar loans to borrowers with similar credit ratings. Policy loans with similar characteristics are aggregated for purposes of the calculation.
Separate Account Assets and Liabilities
Separate account assets and liabilities represent the market value of policyholder funds maintained in accounts having specific investment objectives.
Cash, Cash Equivalents, and Short-term Investments
The carrying value of these instruments approximates fair value due to the short-term nature of these items.
Deferred Annuities and Supplemental Contracts
The fair values of deferred annuities are estimated using cash surrender values. Fair values for supplemental contracts are estimated using a discounted cash flow analysis, based on interest rates currently offered on similar products.
Notes Payable
The carrying value of notes payable approximates the fair value as the interest rate is variable.
F-35
5. Deferred Policy Acquisition Costs
An analysis of deferred policy acquisition costs follows:
| | | | Year Ended December 31, |
| | | | | | 2003 | | |
| | | | 2004 | | Restated | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Deferred policy acquisition costs, beginning of year | $ 54,819 | | $ 51,213 | | $ 55,223 |
Policy acquisition costs deferred | 6,372 | | 8,255 | | 10,372 |
Amortization, net of interest accretion | (10,479) | | (9,774) | | (11,013) |
Adjustments for unrealized gains/losses on investment securities | (72) | | 5,125 | | (3,369) |
| | | | | | | | |
Deferred policy acquisition costs, end of year | $ 50,640 | | $ 54,819 | | $ 51,213 |
| | | | | | | | |
6. | Present Value of Future Profits of Acquired Businesses |
An analysis of the present value of future profits of acquired businesses follows:
| | | | Year Ended December 31, |
| | | | | | 2003 | | |
| | | | 2004 | | Restated | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Present value of future profits, beginning of year | $ 21,096 | | $ 25,259 | | $ 29,673 |
Accretion of interest | 1,735 | | 1,841 | | 2,157 |
Amortization | (4,933) | | (6,305) | | (6,403) |
Adjustments for unrealized gains/losses on investment securities | 7 | | 301 | | (168) |
| | | | | | | | |
Present value of future profits, end of year | $ 17,905 | | $ 21,096 | | $ 25,259 |
| | | | | | | | |
Anticipated amortization of the present value of future profits net of interest accretion for each of the next five years is as follows (in thousands):
2005 | $ 2,746 |
2006 | $ 2,310 |
2007 | $ 2,037 |
2008 | $ 1,719 |
2009 | $ 1,470 |
In May, 2003, the Company issued $15 million aggregate principal amount of Floating Rate Senior Notes due 2033 (the “Senior Notes”) and entered into a Senior Notes Subscription Agreement (“Subscription Agreement”) with InCapS Funding I, Ltd. (“InCapS”), wherein InCapS agreed to purchase the Senior Notes. The Senior Notes were issued on May 22, 2003, pursuant to an indenture between FIC and Wilmington Trust Company, as Trustee.
The principal amount of the Senior Notes is to be paid on May 23, 2033, and interest is to be paid quarterly, beginning on August 23, 2003, at the rate of 4.20% over LIBOR (rate is recalculated quarterly and may not exceed 12.5% prior to May 2008). FIC may redeem the Senior Notes at any time on or after May 23, 2008, by payment of 100% of the principal amount of the Senior Notes being redeemed plus unpaid interest. Proceeds from the Senior Notes were used to fund the acquisition of the New Era companies (See Note 17) and to reduce intercompany payable balances.
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8. Income Taxes
The Company files a consolidated federal income tax return with its subsidiaries, except for Investors Life and ILG Securities, which file separate returns.
Total income taxes were allocated as follows:
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated | | Restated |
| | | | (In thousands) | |
| | | | | | | | |
Tax provision (benefit) on income or loss from: | | | | | |
| Continuing operations | $ (2,204) | | $ (3,511) | | $ (3,521) |
| Discontinued operations | - | | - | | - |
| Cumulative effect of change in accounting principle | 118 | | - | | - |
Total tax provision (benefit) on income or loss | (2,086) | | (3,511) | | (3,521) |
| | | | | | | | |
Tax provision (benefit) on components of shareholders’ equity: | | | | | |
| Net unrealized gains/losses on: | | | | | |
| | Fixed maturities available for sale | (364) | | (5,153) | | 2,818 |
| | Equity securities | 218 | | 538 | | 190 |
| Additional paid in capital - stock option tax (benefit) | - | | (329) | | (261) |
| Minimum pension liability | (1,495) | | (95) | | (214) |
Total tax provision (benefit) on shareholders’ equity | (1,641) | | (5,039) | | 2,533 |
| | | | | | | | |
Total provision (benefit) for income taxes | $ (3,727) | | $ (8,550) | | $ (988) |
| | | | | | | | |
The provision for income taxes is less than the amount of income taxes determined by applying the U.S. statutory income tax rate of 34% to pre-tax income from continuing operations (before cumulative effect of change in accounting principle), as a result of the following differences:
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated | | Restated |
| | | | (In thousands) |
| | | | | | | | |
Income taxes at the statutory rate | $ (5,703) | | $ (7,127) | | $ (4,259) |
Increase (decrease) in taxes resulting from: | | | | | |
| Dividends received deduction | (21) | | (27) | | (83) |
| Tax-exempt interest | - | | (2) | | (5) |
| Nondeductible goodwill | 256 | | - | | - |
| Valuation allowance | 3,264 | | 3,582 | | 767 |
| Other items, net | - | | 63 | | 59 |
| | | | | | | | |
Total provision (benefit) for income taxes on continuing operations | $ (2,204) | | $ (3,511) | | $ (3,521) |
| | | | | | | | |
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The provision (benefit) for income taxes differs from the income taxes determined by applying the U.S. statutory income tax rate of 34% to pre-tax loss from discontinued operations for the year ended December 31, 2003, as detailed below (in thousands):
Income taxes at the statutory rate | $ (2,085) |
Valuation allowance | 2,085 |
| | | | |
Total provision (benefit) for income taxes on discontinued operations | $ - |
| | | | |
Provision has not been made for state and foreign income tax expense since this expense is minimal. Premium taxes are paid to various states where premium revenue is earned. Premium taxes are included in the statements of operations as operating expenses.
Current federal income taxes receivable totaled $5.3 million and $6.0 million at December 31, 2004 and 2003, respectively.
Deferred taxes are recorded for temporary differences between the financial reporting bases and the federal income tax bases of the Company’s assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows:
| | | | December 31, |
| | | | | | 2003 |
| | | | 2004 | | Restated |
| | | | (In thousands) |
| | | | | | |
Deferred tax liabilities: | | | |
Deferred intercompany gain | $ 339 | | $ 518 |
Deferred policy acquisition costs | 11,334 | | 12,150 |
Present value of future profits of acquired business | 6,070 | | 7,157 |
Deferred and uncollected premium | 695 | | 803 |
Reinsurance receivables | 3,051 | | 3,635 |
Unrealized (depreciation) appreciation on securities | 221 | | 46 |
Prepaid expenses | 1,360 | | 1,588 |
Other taxable temporary differences | 824 | | 282 |
| Total deferred tax liabilities | 23,894 | | 26,179 |
| | | | | | |
Deferred tax assets: | | | |
Policy reserves | 8,106 | | 9,448 |
Net operating loss carry forward | 15,479 | | 10,880 |
Fixed maturity securities | - | | 472 |
Agency advances | 187 | | 249 |
Other receivables | 293 | | 293 |
Pension liability | 2,572 | | 974 |
Other deductible temporary differences | 3,509 | | 4,284 |
| Total deferred tax assets | 30,146 | | 26,600 |
| Valuation allowance | (9,801) | | (6,754) |
| Net deferred tax assets | 20,345 | | 19,846 |
| | | | | | |
Net deferred tax liabilities | $ 3,549 | | $ 6,333 |
| | | | | | |
Under the provisions of pre-1984 life insurance company income tax regulations, a portion of “gain from operations” of Investors Life was not subject to current taxation but was accumulated, for tax purposes, in special tax memorandum accounts designated as “policyholders’ surplus accounts.” Subject to certain limitations, “policyholders’ surplus” is not taxed until distributed or the insurance company no longer qualifies to be taxed as a life insurance company. The accumulation in this account for Investors Life at December 31, 2004, was $12.6 million. Federal income tax of which $4.4 million would be due if the entire balance is distributed at a tax rate of 35%.
The Company does not anticipate any transactions that would cause any part of the policyholders’ surplus accounts to become taxable and, accordingly, deferred taxes have not been provided on such amounts. At December 31, 2004, Investors Life has
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approximately $165.6 million in the aggregate in its shareholders’ surplus account from which distributions could be made without incurring any federal tax liability.
FIC and its subsidiaries have no taxes paid in prior years that can be recovered in the event of future operating losses.
At December 31, 2004, the Company and its non-life insurance wholly owned subsidiaries have net operating loss carry forwards of approximately $34.6 million, which will begin to expire in 2008. Approximately $31.3 million of these loss carry forwards are not scheduled to expire until years 2018 through 2024 and are available to offset taxable income of members of the FIC group excluding Investors Life. The Company’s life insurance subsidiaries have operating loss deduction carryforwards of approximately $11.7 million that will begin to expire in 2018.
The Company has a valuation allowance of approximately $9.8 million as of December 31, 2004 and $6.8 million as of December 31, 2003 and an increase in the valuation allowance of $3.0 million in 2004 and $6.0 million in 2003.
The Company establishes a valuation allowance when management believes, based on the weight of the available evidence, that it is more likely than not that some portion of the deferred tax asset will not be realized. Realization of deferred tax assets is dependent upon the Company's generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods. Management has established a valuation allowance of $9.8 million and $6.8 million as of December 31, 2004 and 2003, respectively, against the portion of the deferred tax asset that has expiration dates prior to which those deferred assets must be utilized. These deferred tax assets are primarily comprised of the nonlife net operating losses described above. The Company has determined primarily due to the Company’s cumulative loss position over the past three years that the deferred tax asset will more likely than not be realized through reductions of future taxes, except as otherwise provided.
Family Life and Investors Life reinsure portions of certain policies they write, thereby providing greater diversification of risk and minimizing exposure on larger policies. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of benefit payments. The Company’s retention on any one individual ranges up to $250,000 depending on the risk.
Policy liabilities and contractholder deposit funds are reported in the consolidated financial statements before considering the effect of reinsurance ceded. The insurance subsidiaries remain liable to the extent the reinsurance companies are unable to meet their obligations under the reinsurance agreements.
The components of reinsurance receivables as presented in the consolidated financial statements are as follows:
| | | | December 31, |
| | | | | | 2003 |
| | | | 2004 | | Restated |
| | | | (In thousands) |
| | | | | | |
Receivable related to modified coinsurance agreement | $ 25,665 | | $ 27,526 |
Future policy benefits ceded | 5,210 | | 5,436 |
Other reinsurance recoverables | 3,718 | | 5,191 |
Other policy claims and benefits | 2,319 | | 1,825 |
| | | | | | |
Total reinsurance receivables | $ 36,912 | | $ 39,978 |
| | | | | | |
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The amounts in the consolidated statements of operations have been reduced by reinsurance ceded as follows:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 Restated | | 2002 Restated |
| | | | (In thousands) |
| | | | | | | | |
Premiums | $ 4,163 | | $ 4,014 | | $ 2,822 |
| | | | | | | | |
Policyholder benefits and expenses | $ 2,491 | | $ 1,970 | | $ 3,967 |
| | | | | | | | |
Estimated amounts recoverable from reinsurers on paid claims are $1.2 million and $1.7 million in 2004 and 2003, respectively. These amounts are included in reinsurance receivables in the consolidated financial statements at December 31, 2004 and 2003.
Dividend Restrictions
The Company’s ability to pay dividends to its shareholders is affected, in part, by receipt of dividends from Family Life and Investors Life. Family Life and Investors Life were domiciled in the State of Washington as of December 31, 2003. On March 18, 2004, both companies were redomesticated to the State of Texas. Accordingly, the ability to pay dividends by these insurance companies is regulated by the Texas Department of Insurance. Under current Texas law, any proposed payment of an “extraordinary dividend” requires a 30-day prior notice to the Texas Insurance Commissioner, during which period the Commissioner can approve the dividend, disapprove the dividend, or fail to comment on the notice, in which case the dividend is deemed approved at the end of the 30-day period. An “extraordinary dividend” is a distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) the statutory net gain from operations for the preceding calendar year. Payment of a regular dividend requires that the insurer's earned surplus after dividends or distributions must be reasonable in relation to the insurer’s outstanding liabilities and adequate to its financial needs. No dividends were paid to the Company by either insurance subsidiary in 2004 or 2003.
The Company’s ability to pay dividends to shareholders is also affected by the obligations of FIC and FLC to make principal and interest payments pursuant to their subordinated notes payable to Investors Life. With the approval of the Texas Department of Insurance, these loans were restructured as of March 18, 2004. As amended, the loans provide for a reduction in the interest rate from 9% to 5% for the balance of the term of the loans, no required principal payments for the period from June 12, 2004, to December 12, 2005, a resumption of principal payments on March 12, 2006, and ten equal quarterly principal payments until the maturity date of June 12, 2008. However, these subordinated notes were again restructured subsequent to December 31, 2004, as described in Note 18. The aggregate unpaid balance of the subordinated notes was $15.4 million and $16.9 million at December 31, 2004 and 2003, respectively.
Regulatory Capital Requirements of Insurance Companies
The Texas Department of Insurance imposes minimum risk-based capital requirements on insurance companies that were developed by the National Association of Insurance Commissioners (“NAIC”). The formulas for determining the amount of risk-based capital (“RBC”) specify various weighting factors that are applied to statutory financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of a company’s regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The RBC solvency margins for Family Life and Investors Life at December 31, 2004 and 2003 were in excess of NAIC minimum standards.
NAIC IRIS Ratios
The NAIC Regulatory Information System (“IRIS”) ratios cover 12 categories of financial data with defined “usual” ranges for each such category. The ratios are intended to provide insurance regulators with “early warnings” as to when a given company might warrant special attention. An insurance company may fall outside of the usual range for one or more ratios, and such variances may result from specific transactions that are, by themselves, immaterial or eliminated at the consolidation level. In certain states, insurers with more than three IRIS ratios outside of the NAIC usual ranges may be subject to increased regulatory oversight. For 2004, each of the Company’s insurance subsidiaries had six IRIS ratios outside of the usual ranges. For Family Life,
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the ratios outside the usual ranges were primarily related to changes in capital and surplus, net income, investment income, and non-admitted assets. For Investors Life, the ratios outside the usual ranges were primarily related to investment income and changes in premium. Both Family Life and Investors Life continue to maintain capital and surplus positions which significantly exceed risk-based capital (“RBC”) and other regulatory requirements.
Capital and Surplus of Insurance Companies
Capital and surplus of Family Life as determined in accordance with statutory accounting practices prescribed or permitted by the State of Texas at December 31, 2004 and 2003, was $18.9 million and $25.4 million, respectively. Statutory net income (loss) was $(2.2 million), $2.3 million, and $4.1 million for the years ended December 31, 2004, 2003, and 2002, respectively.
Capital and surplus of Investors Life as determined in accordance with statutory accounting practices prescribed or permitted by the State of Texas at December 31, 2004 and 2003, was $25.7 million and $34.4 million, respectively. Statutory net income (loss) was $(3.0 million), $(3.3 million), and $903,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
The Company’s insurance subsidiaries, Family Life and Investors Life, prepare their statutory financial statements in conformity with accounting practices prescribed or permitted by the State of Texas for 2004 and 2003 and by the State of Washington for 2002. The prescribed or permitted accounting practices for Texas and Washington differ in certain instances from the NAIC Accounting Practices and Procedures Manual (“NAIC SAP”) as described in more detail below.
Family Life and Investors Life are reporting their investment in FIC common stock under a prescribed practice pursuant to the Texas Department of Insurance (“TDI”).
A residential real estate property owned by Investors Life was non-admitted pursuant to accounting practices prescribed by the TDI.
Fixed assets such as furniture and equipment must be non-admitted under NAIC SAP. However, pursuant to accounting practices prescribed by the TDI, Investors Life has admitted certain qualifying furniture and equipment in 2004 and 2003.
In 2004, policy reserves for flexible premium universal life insurance policies were reported in accordance with accounting practices required by NAIC SAP and TDI. In 2003, the companies employed practices prescribed by the State of Washington.
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A reconciliation of the capital and surplus at December 31, 2004 and 2003 between NAIC SAP and practices prescribed and permitted by the State of Texas is shown below:
| | | | | | | December 31, |
| | | | | | | 2004 | | 2003 |
Family Life: | | | | (In thousands) |
| | | | | | | | | |
Capital and surplus as reported in audited statutory financial statements | $ 18,914 | | $ 25,373 |
| | | | | | | | | |
State prescribed practices: | | | | |
Investment in FIC common stock | | (3,893) | | (5,933) |
| | | | | | | | | |
State permitted practices: | | | | |
Aggregate reserves for life insurance policies | - | | 2,872 |
| | | | | | | | | |
Capital and surplus per NAIC SAP | | $ 15,021 | | $ 22,312 |
| | | | | | | | | | |
| | | | | | | | | December 31, |
| | | | | | | | | 2004 | | 2003 |
Investors Life: | | | (In thousands) |
| | | | | | | | | | | |
Capital and surplus as reported in audited statutory financial statements | $ 25,711 | | $ 34,415 |
| | | | | |
State prescribed practices: | | | | | |
Investment in FIC common stock | | | (7,737) | | (8,094) |
Investment in real estate | | | 211 | | 211 |
Furniture and equipment | | | (266) | | (873) |
| | | | | | | | | | | |
State permitted practices: | | | | | |
Aggregate reserves for life insurance policies | | | - | | 681 |
Capital and surplus per NAIC SAP | | | $ 17,919 | | $ 26,340 |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
11. | Retirement Plans and Employee Stock Plans |
Retirement Plans
A. Family Life
Family Life has a non-contributory defined benefit pension plan (“Family Life Pension Plan”), which covers employees who have completed one year or more of service. Under the Family Life Pension Plan, benefits are payable upon retirement based on earnings and years of credited service.
| a. | The Normal Retirement Date for all employees is the first day of the month coinciding with or next following the later of attainment of age 65 or the fifth anniversary of employment. |
| b. | The Normal Retirement Benefit is the actuarial equivalent of a life annuity, payable monthly, with the first payment commencing on the Normal Retirement Date. The life annuity is equal to the sum of (1) plus (2): |
| (1) | Annual Past Service Benefit: 1.17% of the first $10,000 of Average Final Earnings plus 1 1/2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant’s Credited Past Service. For these purposes, “credited past service” is service prior to April 1, 1967, with respect to employees who were plan participants on December 31, 1975. |
| (2) | Annual Future Service Benefit: 1.5578% of the first $10,000 of Average Final Earnings plus 2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant’s Credited Future Service. |
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| c. | Effective April 1, 1997, the Family Life Pension Plan was amended to provide that the accrual rate for future service is 1.57% of Final Average Earnings multiplied by Credited Service after March 31, 1997, less 0.65% of Final Average Earnings up to Covered Compensation. With respect to service prior to April 1, 1997, the accrual rate described in paragraph (b), above, is applicable, with Average Final Earnings taking into account a participant’s earnings subsequent to April 1, 1997. |
| d. | Effective March 31, 2004, all employees covered under the plan were terminated. No new employees are permitted to enter or re-enter the plan. Thus, as of December 31, 2005, the plan only consists of retirees currently receiving pensions and vested terminated employees entitled to future benefits upon attaining normal or early retirement age. |
Average Final Earnings are the highest average Considered Earnings during any five consecutive years while an active participant. Total Credited Past Service plus Credited Future Service is limited to 30 years. A detail of plan disclosures, based on a measurement date of December 31 for each year, is provided below.
A curtailment occurred on January 1, 2004 when the decision was made to terminate the employment of all active participants in the plan as discussed in item (d) above. Because the plan’s unrecognized losses exceeded the decrease in PBO caused by the curtailment as of January 1, 2004, the SFAS No. 88 curtailment charge recognized in the 2004 expense was zero. (The plan was subsequently amended to prevent any new or rehired employee from entering or reentering the plan in the future. Thus, the plan is now frozen.)
A settlement occurred on December 31, 2004 due to the settlement of several former employees’ plan obligations through the payment of lump sums. A settlement occurs whenever the lump sums paid during the year exceed the sum of the plans Service Cost and Interest Cost components of expense for that year. The settlement resulted in the recognition of a $399,000 charge to expense for 2004.
The pension costs for the Family Life Pension Plan include the following components:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Service cost for benefits earned during the year | $ - | | $ 66 | | $ 66 |
Interest cost on projected benefit obligation | 508 | | 546 | | 541 |
Expected return on plan assets | (432) | | (314) | | (512) |
Amortization of unrecognized prior service cost | - | | - | | - |
Amortization of unrecognized (gains)/losses | 77 | | 180 | | 191 |
Recognition of net loss due to settlement | 399 | | - | | - |
| | | | | | | | |
Net periodic benefit cost | $ 552 | | $ 478 | | $ 286 |
| | | | | | | | |
Weighted-average assumptions used to determine net periodic benefit cost:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | |
Discount rate | 6.25% | | 6.75% | | 7.25% |
Expected long-term return on plan assets | 7.25% | | 4.75% | | 8.00% |
Rate of compensation increase | N/A | | 5.00% | | 5.00% |
| | | | | | | | |
The Plan Sponsor employs a building block approach in determining the expected long-term rate of return on plan assets. Historical markets are studied and long-term historical relationships between equities and fixed-income are preserved consistent with the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors such as inflation and interest rates are evaluated before long-term market assumptions are determined. The long-term portfolio return is established via a building block approach with proper consideration of diversification and rebalancing. Peer data and historical returns are reviewed to check for reasonability and appropriateness.
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The following summarizes the obligations and funded status of the Family Life Pension Plan:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | (In thousands) |
| | | | | | |
Change in benefit obligation: | | | |
| Benefit obligation at beginning of year | $ 8,661 | | $ 8,454 |
| | Service cost | - | | 66 |
| | Interest cost | 508 | | 546 |
| | Benefits paid | (145) | | (518) |
| | Liability actuarial loss | 1,421 | | 113 |
| | Curtailments | (414) | | - |
| | Annual lump sum distribution or other expected settlements | (868) | | - |
| Benefit obligation at end of year | 9,163 | | 8,661 |
| | | | | | |
Change in plan assets: | | | |
| Fair value of plan assets at beginning of year | 6,341 | | 6,625 |
| | Actual return on plan assets | 177 | | 58 |
| | Employer contributions | 389 | | 176 |
| | Benefits paid | (145) | | (518) |
| | Annual lump sum distribution or other expected settlements | (868) | | - |
| Fair value of plan assets at end of year | 5,894 | | 6,341 |
| | | | | | |
Funded status: | | | |
| Funded status at end of year | (3,269) | | (2,320) |
| | Unrecognized prior service cost | - | | - |
| | Unrecognized actuarial net loss | 4,207 | | 3,421 |
| | | | | | |
| Net amount recognized | $ 938 | | $ 1,101 |
| | | | | | |
Amounts recognized in the consolidated balance sheets consist of: | | | |
| Prepaid benefit cost | $ - | | $ - |
| Accrued benefit cost | (3,269) | | (1,763) |
| Intangible asset | - | | - |
| Accumulated other comprehensive income | 4,207 | | 2,864 |
| | | | | | |
| Net amount recognized | $ 938 | | $ 1,101 |
| | | | | | |
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | (In thousands) |
| | | | | | |
Projected benefit obligation | $ 9,163 | | $ 8,661 |
Accumulated benefit obligation | $ 9,163 | | $ 8,104 |
Fair value of plan assets | $ 5,894 | | $ 6,341 |
| | | | | | |
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Weighted average assumptions used to determine benefit obligations:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | | | |
Discount rate | 5.25% | | 6.25% |
Rate of compensation increase | N/A | | 4.00% |
| | | | | | |
The increase in the additional minimum liability before taxes included in accumulated other comprehensive income totalled $1,343,000 and $352,000 for the years ended December 31, 2004, and 2003, respectively.
The plan’s asset allocations are as follows:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | | | |
Equity securities | 47% | | -% |
Debt securities | 10 | | 53 |
Group annuity contract | - | | 46 |
Short-term investments | 42 | | - |
Other | | 1 | | 1 |
| | | | | | |
Total | | 100% | | 100% |
| | | | | | |
The plan’s investment strategy is to obtain a reasonable long-term return consistent with the level of risk assumed and to ensure that sufficient cash is on hand to meet the emerging benefit liabilities. During 2004, the Company changed the plan’s asset allocation targets to the following investment mix: equities – 50%; debt securities – 45%; and cash and equivalents – 5%. The reallocation of plan assets to achieve the new targets was completed in 2005.
The total estimated contribution to the plan for 2005 was $518,000.
The following table illustrates the estimated pension benefit payments, which reflect expected future service, as appropriate, that are projected to be paid:
Year | | Estimated Benefit Payments |
| | (In thousands) |
| | |
2005 | | $ 1,328 |
2006 | | $ 1,315 |
2007 | | $ 973 |
2008 | | $ 705 |
2009 | | $ 1,155 |
Years 2010 through 2014 | | $ 2,665 |
B. ILCO
ILCO maintains a retirement plan (“ILCO Pension Plan”) covering substantially all employees of the Company and its subsidiaries. The ILCO Pension Plan is a non-contributory, defined benefit pension plan, which covers each eligible employee who has attained 21 years of age and has completed one year or more of service. Each participating subsidiary company contributes an amount necessary (as actuarially determined) to fund the benefits provided for its participating employees.
The ILCO Pension Plan’s basic retirement income benefit at normal retirement age is 1.57% of the participant’s average annual earnings less 0.65% of the participant’s final average earnings up to covered compensation multiplied by the number of his/her
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years of credited service. For participants who previously participated in the ILCO Pension Plan maintained by ILCO for the benefit of former employees of the IIP Division of CIGNA Corporation (the IIP Plan), the benefit formula described above applies to service subsequent to May 31, 1996. With respect to service prior to that date, the benefit formula provided by the IIP Plan is applicable, with certain exceptions applicable to former IIP employees who are classified as highly compensated employees.
Former eligible IIP employees commenced participation automatically. The ILCO Pension Plan also provides for early retirement, postponed retirement, and disability benefits to eligible employees. Participant benefits become fully vested upon completion of five years of service, as defined, or attainment of normal retirement age, if earlier. A detail of plan disclosures, based on a measurement date of December 31 for each year, is provided below.
A curtailment occurred on December 31, 2004 when the plan was amended to freeze accrued benefits for all participants except for Rule of 68 Non-Highly Compensated Employees (NHCEs). (A Rule of 68 Participant is a Participant who was an Employee on December 31, 2004 and for whom the sum of the Participant’s age in years and fractions thereof and service in years and fractions thereof was greater than or equal to 68 years as of December 31, 2004. A Rule of 68 NHCE is a Rule of 68 Participant who was not a Highly Compensated Employee, as defined under IRC Section 414(q), as of December 31, 2004.) Because the plan’s unrecognized losses exceeded the decrease in PBO caused by the curtailment as of December 31, 2004, the SFAS No. 88 curtailment charge recognized in the 2004 expense was zero.
The pension costs for the ILCO Pension Plan include the following components:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | (In thousands) |
| | | | | | | | |
Service cost for benefits earned during the period | $ 582 | | $ 512 | | $ 544 |
Interest cost on projected benefit obligation | 1,134 | | 1,100 | | 1,023 |
Expected return on plan assets | (1,368) | | (828) | | (1,360) |
Amortization of unrecognized (gains)/losses | 175 | | 110 | | 93 |
Amortization of unrecognized prior service cost | - | | - | | - |
| | | | | | | | |
Net periodic benefit cost | $ 523 | | $ 894 | | $ 300 |
| | | | | | | | |
Weighted-average assumptions used to determine net periodic benefit cost:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 | | 2002 |
| | | | | | | | |
Discount rate | 6.25% | | 6.75% | | 7.25% |
Expected long-term return on plan assets | 8.00% | | 4.75% | | 8.00% |
Rate of compensation increase | 4.00% | | 5.00% | | 5.00% |
| | | | | | | | |
The Plan Sponsor employs a building block approach in determining the expected long-term rate of return on plan assets. Historical markets are studied and long-term historical relationships between equities and fixed-income are preserved consistent with the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors such as inflation and interest rates are evaluated before long-term market assumptions are determined. The long-term portfolio return is established via a building block approach with proper consideration of diversification and rebalancing. Peer data and historical returns are reviewed to check for reasonability and appropriateness.
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The following summarizes the obligations and funded status of the ILCO Pension Plan:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | (In thousands) |
| | | | | | |
Change in benefit obligation: | | | |
| Benefit obligation at beginning of period | $ 18,128 | | $ 16,372 |
| | Service cost | 582 | | 512 |
| | Interest cost | 1,134 | | 1,100 |
| | Benefits paid | (673) | | (627) |
| | (Gain)/loss due to experience | 1,419 | | 771 |
| | Curtailments | (2,429) | | - |
| Benefit obligation at end of year | 18,161 | | 18,128 |
| | | | | | |
Change in plan assets: | | | |
| Fair value of plan assets at beginning of year | 17,490 | | 17,814 |
| | Actual return on plan assets | 778 | | 303 |
| | Employer contributions | - | | - |
| | Benefits paid | (673) | | (627) |
| Fair value of plan assets at end of year | 17,595 | | 17,490 |
| | | | | | |
Funded status: | | | |
| Funded status at end of year | (566) | | (638) |
| | Unrecognized prior service cost | - | | - |
| | Unrecognized actuarial net loss | 3,621 | | 4,215 |
| | | | | | |
| Prepaid benefit cost at end of year | $ 3,055 | | $ 3,577 |
| | | | | | |
Amounts recognized in the consolidated balance sheets consist of: | | | |
| Prepaid benefit cost | $ - | | $ 3,577 |
| Accrued benefit cost | (303) | | - |
| Intangible asset | - | | - |
| Accumulated other comprehensive income | 3,358 | | - |
| | | | | | |
| Net amount recognized | $ 3,055 | | $ 3,577 |
| | | | | | |
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | (In thousands) |
| | | | | | |
Projected benefit obligation | $ 18,161 | | $ 18,128 |
Accumulated benefit obligation | $ 17,898 | | $ 15,917 |
Fair value of plan assets | $ 17,595 | | $ 17,490 |
Weighted average assumptions used to determine benefit obligations:
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 |
| | | | | | |
Discount rate | 5.75% | | 6.25% |
Rate of compensation increase | 3.75% | | 4.00% |
| | | | | | |
The increase in the additional minimum liability before taxes included in accumulated other comprehensive income totalled $3,358,000 for the year ended December 31, 2004. No additional minimum liability was required for 2003.
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The plan’s asset allocations are as follows:
| | | | December 31, |
| | | | 2004 | | 2003 |
| | | | | | |
Equity securities | 35% | | -% |
Debt securities | 27 | | 27 |
Group annuity contract | - | | 36 |
Short-term investments | 38 | | 36 |
Other | | - | | 1 |
Total | | 100% | | 100% |
| | | | | | |
The plan’s investment strategy is to obtain a reasonable long-term return consistent with the level of risk assumed and to ensure that sufficient cash is on hand to meet the emerging benefit liabilities. During 2004, the Company changed the plan’s asset allocation targets to the following investment mix: equities – 65%; debt securities – 30%; and cash and equivalents – 5%. The reallocation of plan assets to achieve the new targets was completed in 2005.
The total estimated contribution to the plan for 2005 was zero.
The following table illustrates the estimated pension benefit payments, which reflect expected future service, as appropriate, that are projected to be paid:
Year | | Estimated Benefit Payments |
| | (in thousands) |
| | |
2005 | | $ 1,009 |
2006 | | $ 1,032 |
2007 | | $ 1,122 |
2008 | | $ 1,275 |
2009 | | $ 1,313 |
Years 2010 through 2014 | | $ 6,637 |
| | |
Savings and Investment Plan
ILCO maintains a savings and investment plan (“401(k) Plan”) that allows eligible employees who have met a one-year service requirement to make contributions to the 401(k) Plan on a tax-deferred basis. A 401(k) Plan participant may elect to contribute up to 16% of eligible earnings on a tax deferred basis, subject to certain limitations applicable to “highly compensated employees” as defined in the Internal Revenue Code. 401(k) Plan participants may allocate contributions, and earnings thereon, between investment options selected by participants. The Account Balance of each Participant attributable to employee contributions is 100% vested at all times.
The 401(k) Plan allows for a matching contribution. The match, which was in the form of shares of ILCO common stock, prior to the acquisition of the remaining outstanding common stock of ILCO by FIC on May 18, 2001, and is in the form of FIC common stock thereafter, is equal to 100% of an eligible participant’s elective deferral contributions, as defined in the 401(k) Plan, not to exceed a maximum percentage of the participant’s plan compensation. The maximum percentage is 2%. Allocations are made on a quarterly basis to the account of participants who have at least 250 hours of service in that quarter. The costs recognized by the Company relating to the 401(k) Plan totalled $118,000, $147,000, and $122,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
Effective January 1, 2005, the 401(k) Plan was amended to add a provision whereby the Employer will contribute each year an amount equal to 3.5% of eligible participants’ compensation for the plan year. These contributions are not conditioned on any requirement other than that the employee be eligible to make elective deferrals under the plan for any part of the year. Participants
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will always be 100% vested in these contributions. For the plan year beginning January 1, 2006, the employer contribution will be made on a discretionary basis. Further, employer matching contributions will be made in the form of cash instead of FIC common stock. The employer matching contribution will continue to be equal to 100% of participants’ contributions to the 401(k) Plan up to 2% of the participants’ total compensation.
ILCO maintained an Employee Stock Ownership Plan (“ESOP Plan”) and a related trust for the benefit of its employees and Family Life employees. The ESOP Plan generally covered employees who had attained the age of 21 and had completed one year of service. Vesting of benefits to employees was based on number of years of service. Effective May 1, 1998, the 401(k) Plan was amended to provide for the merger of the ESOP Plan into the 401(k) Plan. In connection with the merger, certain features under the ESOP Plan were preserved for the benefit of employees previously participating in the ESOP Plan with regard to all benefits accrued under the ESOP Plan through the date of merger. The merger was effected on December 26, 2001. At December 31, 2004, the 401(k) Plan had a total of 346,555 shares of FIC stock, which are allocated to participants.
401(k) Plan shares are treated as issued and outstanding in calculating the Company’s earnings per share. Dividends to shareholders in the 401(k) Plan are treated by the Company as dividends to outside shareholders and are a direct charge to retained earnings.
Stock Option Plans
A. ILCO Stock Option Plan
Under ILCO’s 1999 Non-qualified Stock Option Plan (the “ILCO Stock Option Plan”) options to purchase shares of ILCO’s common stock were granted to certain employees of ILCO, its subsidiaries, and affiliates. The ILCO Stock Option Plan became effective on May 18, 1999 (the “Effective Date”). The exercise price of the options is equal to 100% of the fair market value on the date of grant, but in no case less than $7.50 per share ($6.818 per share as adjusted for the exchange ratio in the merger). A portion of the options become exercisable on the next anniversary of the Effective Date following the date of grant. No options may be exercised after the sixth anniversary of the Effective Date. All options must be exercised in one year from the date the options become exercisable. The number of options that become exercisable on each anniversary of the Effective Date, prior to the sixth anniversary, is equal to 100% of the total options granted divided by the number of years between the next anniversary of the Effective Date following the date of grant and the sixth anniversary of the Effective Date.
Subsequent to May 18, 2001, each share of ILCO common stock issuable pursuant to outstanding options was assumed by the Company and became an option to acquire FIC common stock. The number of shares and the exercise price were adjusted for the exchange ratio in the merger . The related charge was included in equity as deferred compensation. In 2002, 33,000 options were granted at prices ranging from $13.42 to $14.00, 42,350 were cancelled and 119,650 were exercised. In 2003, no options were granted, 48,616 were cancelled and 160,234 were exercised. As of December 31, 2004 and 2003, there are no options outstanding and no options available to be granted.
The following table summarizes activity under ILCO’s Stock Option Plan for the years ended December 31, 2004 and 2003:
| | | | | | Weighted | | | | Weighted | | | | Weighted |
| | | | | | Average | | | | Average | | | | Average |
| | | | 2004 | | Exercise | | 2003 | | Exercise | | 2002 | | Exercise |
| | | | Options | | Price | | Options | | Price | | Options | | Price |
| | | | (In thousands, except option prices/values) | | | | |
| | | | | | | | | | | | | | |
Outstanding at beginning of year | - | | $ - | | 209 | | $ 9.51 | | 338 | | $ 8.76 |
Granted | - | | - | | - | | - | | 33 | | 13.74 |
Exercised | - | | - | | (160) | | 8.64 | | (120) | | 8.56 |
Cancelled | - | | - | | (49) | | 12.39 | | (42) | | 9.52 |
Outstanding at end of year | - | | $ - | | - | | $ - | | 209 | | $ 9.51 |
| | | | | | | | | | | | | | |
Options exercisable at end of year | - | | $ - | | - | | $ - | | 209 | | $ 9.51 |
| | | | | | | | | | | | | | |
Weighted average fair value of options | | | | | | | | | | | |
| granted during the year | | | $ - | | | | $ - | | | | $ 2.09 |
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B. FIC Stock Option Plan
The Company has a qualified stock option plan for officers and key employees. The aggregate amount of the common shares on which options may be granted is limited to 200,000 shares. The option price will not be less than 100% of the fair market price of the optioned shares on the date the option is granted. As of December 31, 2004, no options had been granted under the FIC Stock Option Plan.
C. Stock Appreciation Rights Granted in 2002
On November 4, 2002, FIC adopted an Equity Incentive Plan (the “Plan”). The purpose of the Plan is to provide motivation to key employees of the Company and its subsidiaries to put forth maximum efforts toward the continued growth, profitability, and success of the Company and its subsidiaries by providing incentives to such key employees through performance-related incentives, including, but not limited to, the performance of the common stock of the Company. Toward this objective, stock appreciation rights or performance units may be granted to key employees of the Company and its subsidiaries on the terms and subject to the conditions set forth in the Plan. On November 4, 2002, the Company granted stock appreciation rights (“SARs”) with respect to 30,000 shares of the common stock of the Company, pursuant to terms and provisions of the Plan. The exercise price of each unit is $14.11, which was 100% of the fair market value of the common stock of the Company on the date of such grant. All 30,000 SARs were exercised in 2003.
D. Stock Options Granted During 2003
In consideration of the role that American Physicians Service Group, Inc. (“APS”) served in having brought the opportunity to acquire the New Era companies (see Note 17) to FIC and APS’s intention to actively assist in promoting FIC’s business plan, FIC granted to APS an option to acquire up to 323,000 shares of common stock at a per share exercise price equal to $16.42 per share, but only if “Qualifying Premiums” for the “Determination Period” exceed $200 million. The Qualifying Premiums requirement refers, with certain exceptions, to the amount of premiums for life insurance and annuity products marketed through FICFS, the newly-established subsidiary of FIC that purchased the New Era companies and includes premiums received by FIC’s life insurance subsidiaries in connection with the Equita Marketing Agreement. The Determination Period means the period beginning on July 1, 2003, and ending on December 31, 2005. Unless earlier exercised, the option expires on December 31, 2006. The fair value of the options at the date the Qualifying Premium targets, if met, are achieved, will be recognized as expense at that date in accordance with SFAS No. 123, and Emerging Issues Task Force Issue No. 96-18 (“EITF 96-18”), “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”
In consideration of the role that Equita served in having brought the opportunity to acquire the New Era companies to FIC and Equita’s intention to assist FIC in the implementation of its business plan, FIC granted to Equita an option to acquire up to 169,000 shares of common stock at a per share exercise price equal to $16.42 per share, but only if “Qualifying Premiums” for the “Determination Period” exceed $200 million. The definitions of Qualifying Premiums and Determination Period are the same as those for the option granted to APS with respect to the base option only. In addition, FIC granted to Equita an additional option to purchase up to 158,000 shares of common stock at a per share exercise price equal to $16.42 per share, but only at the rate of 10,000 shares for each $10 million increment by which Qualifying Premiums for the Determination Period exceed $200 million. Unless earlier exercised, the options granted to Equita expire on December 31, 2006. The fair value of the options at the date the Qualifying Premium targets, if met, are achieved will be recognized as expense at that date in accordance with SFAS No. 123 and EITF 96-18.
FIC granted to William P. Tedrow an option to purchase up to 150,000 shares of common stock at a per share exercise price of $13.07, but only if “Qualifying Premiums” for the “Determination Period” exceed $200 million. The definitions of Qualifying Premiums and Determination Period are the same as those for the option granted to APS described above. Unless earlier exercised, the options expire on December 31, 2006, or earlier in the event of the termination of Mr. Tedrow’s employment for cause or if he terminates his employment without good cause. The options granted to Mr. Tedrow are being accounted for in accordance with APB Opinion No. 25 and Financial Accounting Standards Board (“FASB”) Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15 and 25.” No expense related to the options granted to Mr. Tedrow was recognized for the year ended December 31, 2003. These options were cancelled upon the termination of Mr. Tedrow’s employment in March 2004.
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E. Stock Options Granted During 2004
No stock options were granted during 2004.
12. Lease Commitments
The Company and its subsidiaries have entered into lease agreements for office space and equipment which expire at various dates through March 2008. Certain office space leases may be renewed at the option of the Company.
In 1985, the Company entered into a sale/leaseback transaction with a third party for an office building. The leaseback term expires in December 2005, and requires an annual base rent of $798,000 effective January 1, 2004. In addition, the Company is required to pay maintenance, taxes, insurance, and utilities, and subleases this office space to various third parties. As of December 31, 2003, the Company accrued a $2.0 million estimated net loss from the operation of this building representing the annual base rental amount plus estimated operating expenses through December 2005, reduced by estimated sublease income. The estimated future losses were accrued in 2003 as management determined that there were no prospects for significant additional subleasing of the building and future losses would not be avoidable.
At December 31, 2004 and 2003, the remaining deferred gain on the sale of the building was $151,000 and $302,000, respectively, which is being amortized through December 2005.
The Company recorded rent expense of $368,000 in 2004. Rent expense was $955,000 (in addition to the loss described above) and $1.4 million in 2003 and 2002, respectively. As of December 31, 2004, minimum annual rentals under noncancellable leases are as follows (in thousands):
| 2005 | $ 1,038 |
| 2006 | 120 |
| 2007 | 34 |
| 2008 | 2 |
| 2009 | - |
| Thereafter | - |
| Total | $ 1,194 |
| | |
The Company occupies approximately 81,000 square feet in the River Place Pointe office complex. As described more fully in Note 18, the Company sold River Place Pointe subsequent to December 31, 2004, and also entered into a lease agreement for one of the buildings in the office complex.
13. | Related-Party Transactions |
Mitte Foundation
In January 2002 the Company donated $1 million to the Roy F. and Joann Cole Mitte Foundation (the “Foundation”). The Foundation is a charitable entity exempt from federal income tax under section 501(a) of the Code as an organization described in section 501(c)(3) of the Code, and owns 9.84% of the outstanding shares of FIC’s common stock as of December 31, 2004. The sole members of the Foundation are Roy F. Mitte, former Chairman, President and Chief Executive Officer of the Company, and his wife, Joann Cole Mitte.
Sale of Actuarial Risk Consultants, Inc.
On December 31, 2003, FIC through ILCO sold Actuarial Risk Consultants, Inc. (“ARC”), an actuarial consulting subsidiary which it had established in December 2002. The sale of ARC was to George M. Wise, III, who was Vice President and Chief Financial Officer of FIC. The consideration for the transaction was $10,000. Prior to the closing, all intercompany payables owed by ARC to the Company were satisfied in full, and certain tangible and intangible assets used by ARC in connection with the operation of its business were assigned to ARC.
On December 31, 2003, Mr. Wise and FIC entered into an amendment to Mr. Wise’s employment agreement. The amendment provided that the term of the agreement would end on March 31, 2004, instead of December 31, 2005. Mr. Wise agreed to continue as Chief Financial Officer of FIC until March 31, 2004. As mutually agreed, Mr. Wise actually served as Chief Financial Officer until April 26, 2004. Under the amendment, Mr. Wise received a severance payment of $310,000, one-half of which was
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paid in January 2004, and the balance on March 31, 2004. In connection with the amendment, Mr. Wise released FIC from certain claims he may have, including claims related to matters arising out of his employment agreement or his employment relationship with FIC.
Also, in connection with the sale of ARC to Mr. Wise, FIC entered into a consulting agreement with ARC. Under the terms of the agreement, FIC and its insurance subsidiaries could (but were not obligated to) obtain up to 2,000 hours of actuarial consulting services from ARC during the period from January 1, 2004, to December 31, 2005. During 2004 and 2005, the Company paid fees of approximately $1.16 million and $0.84 million, respectively, to ARC in connection with the provision of actuarial consulting services for the specified hours at the discounted rate stated in the agreement, including services related to the Company’s review of deferred policy acquisition costs and present value of future profits of acquired businesses.
Consulting Arrangement with William P. Tedrow
William P. Tedrow, who served as a vice president of the Company from June 2003 to March 2004, provided consulting services to the Company during the period from January 2003 to May 2003. These services related to the development of the business plan that led, in June 2003, to the purchase of the New Era companies and the marketing arrangement with Equita. In connection with such consulting services, Mr. Tedrow received fees of $94,361 and reimbursement of expenses in the amount of $8,925.
14. | Commitments and Contingencies |
Mitte Settlement
In 2002, the Company filed a lawsuit against Roy F. Mitte (“Mitte”), The Roy F. and Joann Cole Mitte Foundation (the “Foundation”), and Joann Mitte (collectively referred to as the “Defendants”). Mitte was the Chairman, President and Chief Executive Officer of FIC until he was placed on administrative leave in August, 2002. The administrative leave, and the subsequent action by the Board of Directors in October, 2002, to terminate the employment agreement between the Company and Mitte, resulted from an investigation conducted by the FIC Audit Committee. Subsequent to the filing of the lawsuit, Mitte filed a counterclaim against the Company alleging that the Company breached the employment agreement between the Company and Mr. Mitte by refusing to pay Mitte the severance benefits and compensation provided for under the employment agreement and amended thereto.
On May 15, 2003, the Company entered into a settlement agreement with the Defendants and Scott Mitte (a director of the Company and the son of Roy Mitte) (the “Mitte Parties”). Under the terms of the agreement the Mitte Parties released the Company from any past, present or future claims which they may have against the Company, including any claims which Roy Mitte may assert under his employment agreement. In addition, the Company agreed to release the Mitte Parties from any past, present or future claims which the Company may have against the Mitte Parties.
The settlement provides for payments aggregating $3 million by the Company to Roy Mitte in equal installments of $1 million on June 1, 2003, June 1, 2004 and June 1, 2005, with a provision for acceleration of payments in the event of a change in control. The settlement agreement also includes provisions whereby, the Company agrees (i) to use reasonable efforts to locate purchasers over a two-year period for 1,552,206 shares of FIC common stock owned by the Foundation at a price of $14.64 per share, (ii) to purchase (or, alternatively, locate a purchaser) on or before June 1, 2003 for 39,820 shares of FIC common stock owned by Roy Mitte and 35,520 shares of common stock held in the ESOP account of Roy Mitte, at a price of $14.64 per share. The agreement also includes provisions related to the continuation of health insurance of Roy and Joann Mitte and payment for the cancellation of options held by Roy Mitte to purchase 6,600 shares of FIC common stock. The Company has recognized a charge of $2.9 million in 2003 for the discounted amounts to be paid under the settlement agreement, which is reflected in the consolidated statement of operations as litigation settlement.
As a condition of the obligations of the Company under the settlement agreement, the Mitte Parties agreed to grant a limited proxy to the persons named as proxies by FIC in any proxy statement filed by FIC with the SEC. With respect to the future shareholders meetings, the proxy may be voted “for” all nominees for the Board of Directors named on FIC’s proxy statement, “against” any proposal by a person other than FIC for the removal of any members of the Board of Directors, “withheld” as to nominees for the Board of Directors proposed by any person other than FIC and “against” any proposal by any person other than FIC to amend the bylaws or articles of FIC. The proxy also extends to certain matters which may be proposed by FIC at the 2004 annual meeting of shareholders, or any later annual or special meeting, regarding changes in the ownership percentage required in order for a shareholder to call a special meeting of shareholders and the elimination of cumulative voting. The granting of the proxy is generally conditioned upon the performance of the scheduled purchases of the shares of FIC common stock owned by the Foundation.
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T. David Porter v. Financial Industries Corporation
On May 31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis County, Texas District Court (the “Court”), against the Company. The suit alleges that the Company refuses to hold a shareholder meeting because FIC is currently unable to comply with Rule 14a-3 of the Securities Exchange Act of 1934. The Company claims that because FIC is not currently in a position to solicit proxies in connection with an annual meeting, or to provide an annual report to its shareholders, FIC does not believe it is currently able to hold an annual shareholders’ meeting at which its shareholders will be fully informed or represented. The suit is brought under Article 2.24(B) of the Texas Business Corporation Act, which states that if an annual meeting of shareholders is not held within any 13-month period and a written consent of shareholders has not been executed instead of a meeting, any court of competent jurisdiction in the county in which the principal office of the corporation is located may, on the application of any shareholder, summarily order a meeting to be held. Mr. Porter is asking the Court to compel the Company to have a shareholder meeting; order FIC to send notice of the meeting to the Company’s shareholders at its expense; order the Company to provide Mr. Porter with a list of shareholders as of the record date for the meeting, and costs and attorney’s fees. The Company filed its answer on June 30, 2006. On July 18, 2006, plaintiffs filed a motion to compel an annual shareholders meeting. On August 7, 2006, the Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual Shareholders Meeting (the “Order”) and agreed to (1) hold an annual shareholders meeting for the election of directors on December 6, 2006, even if the Company has not filed all relevant financial statements with the SEC or whether management is able to solicit proxies for the meeting; (2) the record date for the annual shareholders meeting shall be October 24, 2006 (the “Record Date”); (3) on or before October 27, 2006, the Company shall service Mr. Porter with a complete list of shareholders as of the Record Date and (4) in the event that the Board of Directors of FIC, between the date of the Order and the December 6, 2006 annual meeting, votes to sell either or both of FIC’s life insurance subsidiaries without first obtaining approval of FIC’s shareholders, FIC will announce such impending transaction to the public through a Form 8-K filed with the SEC, and will agree to allow Mr. Porter a reasonable amount of expedited discovery prior to the closing of such transaction(s) so that Mr. Porter may determine whether or not to seek a restraining order or temporary injunctive relief preventing the closing of such transaction(s). In such event, Mr. Porter will also appear for deposition by the Company’s counsel, at a mutually agreeable time and place prior to any hearing on an application for restraining order or temporary injunctive relief.
Litigation with Otter Creek Partnership I, L.P.
During 2003, Otter Creek Management Inc., (“Otter Creek Management”), solicited proxies for the Company’s 2003 Annual Meeting of Stockholders (the “2003 Annual Meeting”) held on July 31, 2003, seeking the election of seven nominees to the Board of Directors of the Company in opposition to the ten candidates selected by the then incumbent Board of Directors. Otter Creek Management is an investment advisory firm that manages three investment funds that are shareholders of the Company: Otter Creek Partners I, LP (“Otter Creek Partners”), Otter Creek International Ltd. and HHMI XIII, LLC (together with Otter Creek Management and Otter Creek Partners, “Otter Creek”).
In connection with this solicitation of proxies, on June 13, 2003, Otter Creek Partners commenced a lawsuit in the District Court in Travis County, Texas, Cause No. GN302872 (the “Litigation”) seeking, among other things, to compel the Company to hold the previously delayed 2003 Annual Meeting. Otter Creek also sought in the Litigation to neutralize the effect of a proxy obtained by the Company from the Mitte Family (the “Mitte Proxy”) the preceding month whereby the incumbent board was able to vote 1,627,610 shares in favor of its nominees.
Following the initiation of this litigation and a hearing before the court, the court ordered the Company not to amend its bylaws in a manner that would adversely affect voting or other matters relating to the Annual Meeting and election of directors and not to reschedule such Annual Meeting scheduled for July 31, 2003, or the record date of the Annual Meeting.
At the meeting, six of the seven Otter Creek nominees were elected to the Board: R. Keith Long, J. Bruce Boisture, Salvador Diaz-Verson Jr., Patrick E. Falconio, Richard H. Gudeman and Lonnie L. Steffen. The shares covered by the Mitte Proxy were all voted in favor of the incumbent nominees at the 2003 Annual Meeting. Had Otter Creek been successful in neutralizing the effect of the Mitte Proxy, all seven of the Otter Creek nominees would have been elected.
Following the 2003 Annual Meeting, Otter Creek and FIC completed a settlement with respect to the lawsuit in December 2003. Under the settlement agreement, the Company reimbursed Otter Creek for $250,000 in proxy expenses in 2003. An additional $475,000 of proxy and litigation expenses will be submitted to the Company’s shareholders for approval at the next Annual Meeting of Shareholders. If payment of the additional $475,000 is so approved, the amount will be expensed by the Company in the year of approval. The Board of Directors will recommend that shareholders approve the reimbursement. The settlement also included mutual releases between the Company and Otter Creek and its affiliates. The Chairman of the Board of Directors of the Company, R. Keith Long, is the President and owner of the General Partner of Otter Creek Partners I, L.P.
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Litigation with Former Employee of Subsidiary
In October 2003, the Company placed Earl Johnson, the then-president of JNT Group, Inc. (“JNT”), a subsidiary of FIC that was later sold in December 2003 in the sale of the New Era companies, on administrative leave pending an investigation of matters related to (1) Johnson’s alleged termination of an employee in response to her request for information regarding her workers’ compensation rights arising out of an injury and (2) his co-mingled and disorganized bookkeeping of JNT’s client accounts with those of a personal business owned by Mr. Johnson and run by him at the same office (using the Company’s employees to do so). Soon after being interviewed in the course of that investigation, Mr. Johnson resigned, alleging good reason under his employment agreement with a subsidiary of FIC, on the ground that the change in the composition of the Board of Directors of FIC following the 2003 Annual Meeting of Shareholders resulted in a “change of control” under the provisions of his employment agreement. The employment agreement provided that if Mr. Johnson were to voluntarily terminate his employment for good reason, he would receive compensation and benefits for the remainder of the three-year term of the agreement and would become fully vested in 17,899 restricted shares of FIC stock. The Company notified Mr. Johnson that his resignation was not for “good reason” pursuant to his employment agreement. Under that agreement, termination without good reason results in forfeiture of future salary and benefits, as well as forfeiture of the restricted shares of FIC common stock.
In November 2003, Mr. Johnson and his wife, Carol Johnson, filed suit in Harris County, Texas District Court against the Company, FIC Financial Services, Inc. (“FICFS”) and an employee of the Company. The suit, which sought an unspecified amount of damages and injunctive relief, alleges that the defendants interfered with the non-JNT contract and business relationships of the plaintiffs, made slanderous statements regarding the plaintiffs, and accessed computer files at the JNT offices relating to the non-JNT business relationships of the plaintiffs, without the consent of the plaintiffs. The suit also alleged conspiracy, conversion, and various other torts, all related to the defendants’ investigation of plaintiff’s business practices at JNT.
Subsequently, Mr. Johnson filed a demand for arbitration under his employment agreement, which has a mandatory arbitration clause. In the arbitration, Mr. Johnson sought damages for breach of contract and various other benefits relating to the termination of his employment contract, totaling $913,133.40. In connection with the arbitration, FIC submitted a counter-claim, alleging that Mr. Johnson committed multiple breaches of his employment agreement, and that he breached his fiduciary duty to FIC as a result of his actions in conducting the business of JNT, thereby entitling FIC to a dismissal of plaintiff’s claims. Prior to the hearing on the arbitration, the Harris County Court ordered that the matters raised in that lawsuit by Mr. Johnson (though not Carol Johnson) be combined with the arbitration.
An arbitration hearing on Johnson’s contract claims was conducted in April 2005. On July 21, 2005, the Arbitrator issued an interim award in which he denied all of Johnson’s claims for breach of contract, as well as Johnson’s claims with respect to the restricted shares of FIC stock. In denying Johnson’s claims, the Arbitrator concluded that:
| (1) | Johnson had committed multiple and material breaches of his employment agreement by operating a personal tax and accounting business out of office space and using employees, utilities and other items, all paid for by FICFS; by engaging in a self-dealing transaction involving the payment to himself of $25,000 out of funds held by JNT in a suspense account, an account to which JNT owed fiduciary duties to its customers and clients; and by firing an employee of JNT on the same day that the employee inquired about possible workers compensation benefits in connection with an on-the-job injury, |
| (2) | Johnson’s breaches of his employment agreement occurred prior to the time that he was placed on administrative leave, thereby precluding him from maintaining a breach of contract suit against FIC and FICFS, and |
| (3) | the change in the majority of the Board of Directors of FIC resulting from the 2003 Annual Meeting of FIC’s shareholders did not constitute a “change of control” under Johnson’s employment agreement, thereby denying Johnson’s claim that he was entitled to a “good reason” termination of his employment agreement. |
In addition, the Arbitrator awarded FICFS $28,000, plus interest at the rate of 6% per annum from July 21, 2005, to the date of payment, with respect to Johnson’s unauthorized conversion of funds held in the JNT suspense account. The order confirming the arbitration award was signed on February 27, 2006, by the Harris County district judge and the Company is currently pursuing collection of the judgment. No amounts have been recorded in the Company’s consolidated financial statements for such judgment.
With respect to the matters raised by Mr. Johnson in the Harris County lawsuit, which were referred by the Court to the arbitration, following his loss in the arbitration of the employment agreement, Mr. Johnson notified the Arbitrator that he would not pursue arbitration of his other claims. In addition, in May 2006, Mrs. Johnson filed a notice of non-suit with respect to the claims made by her in the Harris County lawsuit. Accordingly, this matter is now closed.
F-54
Litigation with Equita Financial and Insurance Services of Texas, Inc. and M&W Insurance Services, Inc.
On June 2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil suit in Travis County, Texas District Court against the Company. The suit alleges that, in entering into certain agreements with the plaintiffs, the Company made certain misrepresentations and omissions as to its business and financial condition. The agreements referenced in the suit consist of (a) an option agreement entered into in June 2003 between Equita and the Company, granting Equita the right to purchase shares of FIC’s common stock at $16.42 per share, if certain sales goals were achieved under an exclusive marketing agreement between Equita and a subsidiary of the Company (the “Option Agreement”), (b) a stock purchase agreement entered into in June 2003 between M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the purchase of 204,918 shares of FIC’s common stock (the Stock Purchase Agreement”), and (c) a registration rights agreement entered into in June 2003 among the plaintiffs and the Company, whereby the Company agreed to file and maintain a shelf registration statement which respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation or which may be acquired in the future by Equita under the option agreement (the “Registration Rights Agreement,” and, collectively, the “Agreements”).
The suit alleges that the Company breached the provisions of the Option Agreement by refusing to indemnify the plaintiffs for losses relating to the alleged breach of certain representations and warranties included in the Option Agreement. The plaintiffs also allege that the Company required M&W to purchased 204,918 shares of FIC common stock from the Mitte Foundation as a condition of Equita’s obtaining, in June 2003, an exclusive marketing agreement with a subsidiary of the Company pertaining to the distribution of insurance products in the “senior market” (the “Marketing Agreement”), and that such requirement was motivated by the desire of the Company’s management to obtain certain proxy rights obtained under a settlement agreement with the Mitte Foundation and the Mitte family. The plaintiffs further allege that the Company breached the provisions of the Registration Rights Agreement by failing to file a shelf registration with the SEC with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation and the shares which may be acquired in the future by Equita under the provisions of the Option Agreement. The plaintiffs seek rescission of the Agreements; damages in an amount equal to the $3 million that M&W paid to acquire FIC shares from the Mitte Foundation, together with interest and attorney’s fees and unspecified expenses; and an unspecified amount of exemplary damages.
At a hearing on December 20, 2005, the Company was successful in the intervention of Family Life and Investors Life, which allows the companies to introduce evidence in the case. The parties are currently undergoing the discovery phase of the litigation.
The Company believes that the allegations in this lawsuit are entirely without merit. The Company further believes that Equita has breached its obligations under the provisions of the Marketing Agreement pertaining to the distribution of insurance products of the Company’s insurance subsidiary, thereby causing damages to the Company and forfeiting Equita’s entitlement to the option rights under the Option Agreement.
The Company intends to vigorously oppose the lawsuit and is weighing all of its options including, but not limited to, asserting counterclaims against the plaintiffs.
Shareholder Claim
The Company received a demand letter in April 2004 from a law firm representing an individual shareholder (Mr. Cook) who owns 530 shares of the Company’s common stock, which letter set forth certain allegations and notified the Registrant that the shareholder intended to file a shareholder derivative lawsuit (the “Demand Letter”). In May 2004, FIC, by and through its Special Litigation Committee, filed a petition in the 250th District Court of Travis County, Texas (the “Court”), seeking to have the Court appoint a panel of independent and disinterested persons pursuant to Section H (3) of Article 5.14 of the Texas Business Corporation Act to investigate the allegations, and stay any shareholder derivative actions. Subsequently, on June 1, 2004, the Court issued an Order appointing Eugene Woznicki, Kenneth S. Shifrin, John D. Barnett and F. Gary Valdez as a panel of independent and disinterested persons (the “Panel”) to make determinations contemplated by Section F of Article 5.14 of the Texas Business Corporation Act in connection with the Demand Letter and staying any shareholder derivative actions relating to the letter until the Panel’s review was completed and a determination was made by the panel as to what, if any, further action was to be taken. Messrs. Woznicki, Shifrin and Barnett are independent directors of FIC. Mr. Valdez is neither a director nor an employee of FIC. Mr. Valdez is the founder and president of Focus Strategies, L.L.C. and is active in various community and civic organizations in the Austin, Texas area.
Following an extensive review of the claims made by the individual shareholder, the Panel, in January 2005, filed with the court a Petition for Declaratory Judgment pursuant to the Texas Declaratory Judgments Act and Article 5.14 of the Texas Business Corporations Act (the “Petition”). The Petition describes the process used by the Panel and its counsel in considering the matters raised in the Demand Letter and the submittal provided by counsel for the shareholder. The Petition advised the Court that, after consideration of the evidence obtained through its inquiry, the Panel had unanimously made a good faith determination that the continuation of the Committee's derivative proceeding and the
F-55
commencement of any further derivative proceedings based on the allegations made by the individual shareholder was not in the best interests of FIC.
On October 10, 2005, the 250th District Court of Travis County, Texas, heard for trial on the merits the matters raised by the Panel in the Petition (Financial Industries Corporation v. Tom Cook (Cause No. GN 401513). After consideration of the pleadings, evidence and authorities submitted by counsel for the Company, the Court issued a Final Judgment on October 10, 2005, in which it ruled that the determinations made by the Panel, as reflected in a report submitted to the Court by a Special Litigation Committee appointed by the Registrant’s Board of Directors, were made: (1) in good faith, (2) after the Panel conducted a reasonable inquiry, and (3) based on the factors deemed appropriate under the circumstances by the Panel. The Court’s ruling otherwise dismissed with prejudice the derivative proceedings involved in this matter. The Final Judgment was approved as to form and substance by counsel for the Registrant and by counsel for the defendant.
Other Litigation
FIC and its insurance subsidiaries are regularly involved in litigation, both as a defendant and as a plaintiff. The litigation naming the insurance subsidiaries as defendant ordinarily involves our activities as a provider of insurance products. Management does not believe that any of this other litigation, either individually or in the aggregate, will have a material adverse effect on the Company’s business or financial condition.
In the opinion of the Company’s management, it is not currently possible to estimate the impact, if any, that the ultimate resolution of these legal proceedings previously disclosed will have on the Company’s results of operations, financial position, or cash flows.
The following table reflects the calculation of basic and diluted earnings per share:
| | | | Year Ended December 31, |
| | | | | | 2003 | | 2002 |
| | | | 2004 | | Restated | | Restated |
| | | | (In thousands, except per share amounts) |
Numerator: | | | | | |
Loss from continuing operations before discontinued operations | | | | | |
| and cumulative effect of change in accounting principle | $ (14,567) | | $ (17,450) | | $ (9,005) |
| | | | | | | | |
Denominator: | | | | | |
| Weighted average common shares outstanding: | | | | | |
| | Basic | 9,796 | | 9,667 | | 9,555 |
| | Common stock options | - | | - | | - |
| | Repurchase of treasury stock | - | | - | | - |
| | | | | | | | |
| | Diluted | 9,796 | | 9,667 | | 9,555 |
| | | | | | | | |
Per share: | | | | | |
| | Basic | $ (1.48) | | $ (1.81) | | $ (0.94) |
| | Diluted | $ (1.48) | | $ (1.81) | | $ (0.94) |
Options to purchase 650,000 shares of common stock at a price of $16.42 were outstanding at December 31, 2004, but were not included in the computation of diluted earnings per share because the inclusion would result in an anti-dilutive effect in periods in which a loss from continuing operations was incurred. Options to purchase 800,000 shares of common stock at prices ranging from $13.07 to $16.42 were outstanding at December 31, 2003, but were not included in the computation of diluted earnings per share because the inclusion would result in an anti-dilutive effect in periods in which a loss from continuing operations was incurred. Options to purchase 208,850 shares of common stock at prices ranging from $8.18 to $14.30 were outstanding at December 31, 2002, but were not included in the computation of diluted earnings per share because the inclusion would result in an anti-dilutive effect in periods in which a loss from continuing operations was incurred.
F-56
16. | Business Concentration |
One of the Company’s insurance subsidiaries, Family Life, provides mortgage protection life, disability, and accidental death insurance to mortgage borrowers of financial institutions. For marketing purposes, a significant number of these financial institutions provide Family Life with customer lists. In 2004, premium income from these products was derived from 49 states and the District of Columbia with concentrations of approximately 21% and 30% in California and Texas, respectively. In 2003, these amounts were 23% and 29%, respectively.
The Company’s other insurance subsidiary, Investors Life, also markets individual traditional life, universal life, and annuity products in 49 states, the District of Columbia, and the U.S. Virgin Islands with concentrations of approximately 13%, 8% and 8% in Pennsylvania, California, and Ohio, respectively, for 2004. For 2003, these concentrations were 14%, 8% and 8% for Pennsylvania, California, and Ohio.
17. | Discontinued Operations |
The Company acquired Paragon Benefits, Inc., The Paragon Group, Inc., Paragon National, Inc., Total Consulting Group, Inc., and JNT Group, Inc. (collectively the “New Era companies”) in June, 2003, for approximately $4.2 million in cash and 47,395 shares of FIC common stock with a fair market value of $646,000. The New Era companies consulted in the design of planned benefit programs for secondary school systems, provided administrative services for the related plans, insurance brokerage services to plan participants, and investment advisory services for such plans and other clients. In connection with the acquisition, the six principals of the New Era companies entered into three-year and five-year employment agreements under which they would receive FIC stock, with a market value of approximately $2.4 million on the date of the agreements, during the term of their employment. The purchase price of the New Era companies and the grants of stock pursuant to the employment contracts were not tied to the future performance of the New Era companies.
The purchase price paid for the New Era companies (including transaction fees and excluding contingent consideration amounts accounted for as compensation as described above) was $4.9 million. The acquisition of the New Era companies was accounted for in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”). This statement required that FIC estimate the fair value of assets acquired and liabilities assumed as of the date of the acquisition and allocate the purchase price to those assets and liabilities. The purchase price was allocated as follows: $116,000 to cash, $158,000 to agency advances and other receivables, $288,000 to property, plant and equipment, $28,000 to other assets, $182,000 to other liabilities, and $4.5 million to goodwill and other intangibles (included in other assets).
The performance of the New Era companies after the acquisition was substantially below expectations and after reviewing their long-term prospects the Company determined to sell them. On December 31, 2003, the New Era companies were sold to five of the original principals for nominal consideration and the cancellation of their employment agreements. (The employment contract of the sixth principal was terminated earlier in 2003.) In connection with these cancellations, the five principals each received a payment of $10,000 from the Company and the FIC common stock granted pursuant to those agreements, with a market value of approximately $2.1 million at December 31, 2003, reverted to the Company.
The loss from operations of the New Era companies for the period from acquisition through December 31, 2003, was $1.2 million. The Company also incurred a loss of $4.9 million on the sale of the New Era companies. These losses and the aggregate $50,000 in cancellation payments to the principals totalled $6.1 million, which is recorded as a loss from discontinued operations in the accompanying consolidated statement of operations.
Sale of Real Estate
On June 1, 2005, the Company sold the River Place Pointe office complex to a non-affiliated party in an all-cash transaction for a gross purchase price of $103 million. The office complex is located in Austin, Texas, as more fully described in Note 3. Under the terms of the sale agreement, the Company entered into a lease with the purchaser with respect to all of the space in Building One for a five-year term at a rate of $28.00 per square foot, which was the prevailing rental rate at the time that FIC and its subsidiaries occupied the building in July 2000. The lease provides the Company with a right of cancellation of the lease at March 31, 2008. The Company will realize a gain of $10.1 million on the sale, which includes both a current 2005 realized gain of $8.0 million and a deferred gain of $2.1 million to be recognized over the period from the sale date through March 31, 2008.
At December 31, 2004, the Company had $589,000 of real estate available for sale, consisting of six properties. Three of these properties were sold in 2005 and the remaining three properties were sold in early 2006. Realized gains on the sales totaled $761,000 and $517,000 in 2005
and 2006, respectively.
F-57
Amendment of Subordinated Loans
As previously described in Note 10, FIC and FLC have subordinated notes payable to Investors Life with an unpaid balance of $15.4 million at December 31, 2004. With the approval of the Texas Department of Insurance, the loans were restructured as of March 9, 2006. As amended, the loans provide for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009. These notes have been eliminated in the consolidated financial statements.
19. | Quarterly Financial Data (Unaudited) |
Previously reported unaudited quarterly financial data has been restated for the effects of the adjustments described in Note 2 to the extent applicable, as follows:
| | | | | | Three Months Ended |
| | | | | | March 31, |
| | | | | | | | | 2003 |
| | | | | | | 2004 | | As Previously Reported | | As Restated |
| | | | | | | (In thousands, except per share data) |
| | | | | | | | | | | |
Total revenues | | | | $ 28,872 | | $ 30,268 | | $ 30,019 |
| | | | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | |
| and cumulative effect of change in accounting principle | | $ (2,500) | | $ (2,637) | | $ (2,766) |
Discontinued operations | | | | - | | - | | - |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (2,500) | | (2,637) | | (2,766) |
Cumulative effect of change in accounting principle | | | | 229 | | - | | - |
Net loss | | | | $ (2,271) | | $ (2,637) | | $ (2,766) |
| | | | | | | | | | | |
Basic earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.25) | | $ (0.27) | | $ (0.29) |
Discontinued operations | | | | - | | - | | - |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.25) | | (0.27) | | (0.29) |
Cumulative effect of change in accounting principle | | | | 0.02 | | - | | - |
Net loss | | | | $ (0.23) | | $ (0.27) | | $ (0.29) |
| | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.25) | | $ (0.27) | | $ (0.29) |
Discontinued operations | | | | - | | - | | - |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.25) | | (0.27) | | (0.29) |
Cumulative effect of change in accounting principle | | | | 0.02 | | - | | - |
Net loss | | | | $ (0.23) | | $ (0.27) | | $ (0.29) |
| | | | | | | | | | | |
F-58
| | | | | | | Three Months Ended |
| | | | | | | June 30, |
| | | | | | | | | 2003 |
| | | | | | | 2004 | | As Previously Reported | | As Restated |
| | | | | | | (In thousands, except per share data) |
| | | | | | | | | | | |
Total revenues | | | | $ 24,924 | | $ 29,740 | | $ 29,432 |
| | | | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (3,796) | | $ (2,542) | | $ (2,517) |
Discontinued operations | | | | - | | - | | (130) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (3,796) | | (2,542) | | (2,647) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (3,796) | | $ (2,542) | | $ (2,647) |
| | | | | | | | | | | |
Basic earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.38) | | $ (0.26) | | $ (0.26) |
Discontinued operations | | | | - | | - | | (0.01) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.38) | | (0.26) | | (0.27) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.38) | | $ (0.26) | | $ (0.27) |
| | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.38) | | $ (0.26) | | $ (0.26) |
Discontinued operations | | | | - | | - | | (0.01) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.38) | | (0.26) | | (0.27) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.38) | | $ (0.26) | | $ (0.27) |
| | | | | | | | | | | |
F-59
| | | | | | | Three Months Ended |
| | | | | | | September 30, |
| | | | | | | | | 2003 |
| | | | | | | 2004 | | As Previously Reported | | As Restated |
| | | | | | | (In thousands, except per share data) |
| | | | | | | | | | | |
Total revenues | | | | $ 24,643 | | $ 27,766 | | $ 26,692 |
| | | | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (4,845) | | $ (5,753) | | $ (6,398) |
Discontinued operations | | | | - | | - | | 29 |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (4,845) | | (5,753) | | (6,369) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (4,845) | | $ (5,753) | | $ (6,369) |
| | | | | | | | | | | |
Basic earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.49) | | $ (0.60) | | $ (0.66) |
Discontinued operations | | | | - | | - | | - |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.49) | | (0.60) | | (0.66) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.49) | | $ (0.60) | | $ (0.66) |
| | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | | | |
| and cumulative effect of change in accounting principle | | $ (0.49) | | $ (0.60) | | $ (0.66) |
Discontinued operations | | | | - | | - | | - |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.49) | | (0.60) | | (0.66) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.49) | | $ (0.60) | | $ (0.66) |
| | | | | | | | | | | |
F-60
| | | | | | | Three Months Ended December 31, |
| | | | | | | | | 2003 |
| | | | | | | 2004 | | As Previously Reported | | As Restated |
| | | | | | | (In thousands, except per share data) |
| | | | | | | | | | | |
Total revenues | | | | $ 24,173 | | $ 23,893 | | $ 25,254 |
| | | | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | |
| and cumulative effect of change in accounting principle | | $ (3,426) | | $ (5,433) | | $ (5,769) |
Discontinued operations | | | | - | | (6,133) | | (6,032) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (3,426) | | (11,566) | | (11,801) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (3,426) | | $ (11,566) | | $ (11,801) |
| | | | | | | | | | | |
Basic earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | |
| and cumulative effect of change in accounting principle | | $ (0.35) | | $ (0.56) | | $ (0.59) |
Discontinued operations | | | | - | | (0.63) | | (0.62) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.35) | | (1.19) | | (1.21) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.35) | | $ (1.19) | | $ (1.21) |
| | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | |
Loss from continuing operations before discontinued operations | | | | |
| and cumulative effect of change in accounting principle | | $ (0.35) | | $ (0.56) | | $ (0.59) |
Discontinued operations | | | | - | | (0.63) | | (0.62) |
Loss before cumulative effect of | | | | | | | | |
| change in accounting principle | | | | (0.35) | | (1.19) | | (1.21) |
Cumulative effect of change in accounting principle | | | | - | | - | | - |
Net loss | | | | $ (0.35) | | $ (1.19) | | $ (1.21) |
| | | | | | | | | | | |
F-61
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE I – SUMMARY OF INVESTMENTS – OTHER THAN
INVESTMENTS IN RELATED PARTIES
| | | | December 31, 2004 |
| | | | | | | | Amount |
| | | | Amortized | | Fair | | Shown on the |
| | | | Cost | | Value | | Balance Sheet |
| | | | (In thousands) |
| | | | | | | | |
Type of Investment: | | | | | |
Fixed maturity securities: | | | | | |
| United States Government and government | | | | | |
| | agencies and authorities | $ 39,085 | | $ 39,493 | | $ 39,493 |
| States, municipalities and political subdivisions | 16,720 | | 16,585 | | 16,585 |
| Corporate | 252,449 | | 256,579 | | 256,579 |
| Mortgage-backed and asset-backed | 192,447 | | 186,498 | | 186,498 |
| Total fixed maturity securities available for sale | 500,701 | | 499,155 | | 499,155 |
| Fixed maturity securities held for trading | 1,057 | | 1,057 | | 1,057 |
Total fixed maturity securities | 501,758 | | 500,212 | | 500,212 |
| | | | | | | | |
Equity securities | 6,311 | | 8,502 | | 8,502 |
Policy loans | 39,855 | | 49,343 | | 39,855 |
Invested real estate | 76,580 | | N/A | | 76,580 |
Real estate held for sale | 589 | | N/A | | 589 |
Short-term investments | 62,514 | | 62,514 | | 62,514 |
| | | | | | | | |
Total investments | $ 687,607 | | | | $ 688,252 |
| | | | | | | | |
F-62
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
| | | | | | December 31, |
| | | | | | 2004 | | 2003 Restated |
| | | | | | (In thousands) |
| | | | | | | | |
ASSETS | | | | | |
| | | | | | | | |
Cash and cash equivalents | | | $ 167 | | $ 1,696 |
Short-term investments | | | 707 | | - |
Investments in subsidiaries* | | | 119,981 | | 136,035 |
Intercompany receivables* | | | 7,945 | | 7,430 |
Accounts receivable | | | 1 | | 368 |
Other assets | | | 542 | | 766 |
| | | | | | | | |
Total assets | | | $ 129,343 | | $ 146,295 |
| | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | |
| | | | | | | | |
Liabilities: | | | | | |
Subordinated notes payable* | | | 2,005 | | 2,205 |
Notes payable | | | 15,000 | | 15,000 |
Intercompany payables* | | | - | | - |
Other liabilities | | | 3,235 | | 3,194 |
Total liabilities | | | 20,240 | | 20,399 |
| | | | | | | | |
Shareholders’ equity: | | | | | |
Common stock, $.20 par value, 25,000,000 shares authorized in 2004 and 2003; | | | | |
| 12,516,841 shares issued in 2004 and 2003; 9,804,009 | | | | | |
| and 9,791,024 shares outstanding in 2004 and 2003 | | | 2,504 | | 2,504 |
Additional paid-in capital | | | 70,398 | | 70,391 |
Accumulated other comprehensive income (loss) | | | (4,667) | | (2,121) |
Retained earnings (including $108,341 and $119,418 of undistributed | | | | | |
| earnings of subsidiaries at December 31, 2004 and 2003) | | | 42,650 | | 56,988 |
Total shareholders’ equity before treasury stock | | | 110,885 | | 127,762 |
| | | | | | | | |
Common treasury stock, at cost, 409,233 and 422,218 shares in 2004 and 2003** | | (1,782) | | (1,866) |
Total shareholders’ equity | | | 109,103 | | 125,896 |
| | | | | | | | |
Total liabilities and shareholders’ equity | | | $ 129,343 | | $ 146,295 |
| | | | | | | | |
* | Eliminated in consolidation in 2004 and 2003. |
** | Excludes $21.6 million of FIC stock owned by subsidiaries at December 31, 2004 and 2003. |
F-63
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 Restated | | 2002 Restated |
| | | | (In thousands) |
| | | | | | | | |
Income | | $ 8 | | $ 176 | | $ 12 |
Expenses: | | | | | |
| Operating expenses | 2,650 | | 4,456 | | 2,000 |
| Interest expense | 990 | | 733 | | 312 |
Total expenses | 3,640 | | 5,189 | | 2,312 |
| | | | | | | | |
Loss from operations | (3,632) | | (5,013) | | (2,300) |
| | | | | | | | |
Equity in undistributed earnings (loss) from subsidiaries | (10,706) | | (18,570) | | (2,565) |
| | | | | | | | |
Net loss | $ (14,338) | | $ (23,583) | | $ (4,865) |
| | | | | | | | |
F-64
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
| | | | Year Ended December 31, |
| | | | 2004 | | 2003 Restated | | 2002 Restated |
| | | | (In thousands) |
| | | | | | | | |
Cash flows from operating activities: | | | | | |
| Net loss | $ (14,338) | | $ (23,583) | | $ (4,865) |
| Adjustments to reconcile net loss to net cash (used in) | | | | | |
| | provided by operating activities: | | | | | |
| Decrease (increase) in accounts receivables | 367 | | (81) | | (240) |
| Decrease in investment in subsidiaries* | 13,508 | | 26,643 | | 2,470 |
| Decrease (increase) in other assets | 224 | | (765) | | (1) |
| Increase (decrease) in intercompany receivables/payables * | (515) | | (21,171) | | 3,271 |
| Increase (decrease) in other liabilities | 41 | | 387 | | (273) |
| Other | - | | 25 | | (93) |
Net cash provided by (used in) operating activities | (713) | | (18,545) | | 269 |
| | | | | | | | |
Cash flows from investing activities: | | | | | |
| Decrease (increase) in short-term investments | (707) | | - | | 1,300 |
Net cash (used in) provided by investing activities | (707) | | - | | 1,300 |
| | | | | | | | |
Cash flows from financing activities: | | | | | |
| Principal repayments on subordinated notes payable to Investors Life | (200) | | (802) | | (802) |
| Proceeds from bank borrowings | - | | 15,000 | | - |
| Cash dividend to shareholders | - | | - | | (2,206) |
| Issuance (purchase) of treasury stock | 91 | | 2,713 | | (362) |
| Issuance of capital stock | - | | 2,946 | | 1,500 |
| Net cash provided by (used in) financing activities | (109) | | 19,857 | | (1,870) |
| | | | | | | | |
| Net increase (decrease) in cash | (1,529) | | 1,312 | | (301) |
| | | | | | | | |
| Cash and cash equivalents, beginning of year | 1,696 | | 384 | | 685 |
| | | | | | | | |
| Cash and cash equivalents, end of year | $ 167 | | $ 1,696 | | $ 384 |
| | | | | | | | |
* Eliminated in consolidation
F-65
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE III – SUPPLEMENTARY INSURANCE INFORMATION
| | Year Ended December 31, 2004, 2003, and 2002 |
| | | | Future Policy | | | | |
| | Deferred Policy | | Benefits, Losses, | | Other Policy | | |
| | Acquisition | | Claims and Loss | | Claims and | | Premium |
| | Costs | | Expenses (1) | | Benefits Payable | | Revenue |
| | (In thousands) |
| | | | | | | | |
2004 | | $ 50,640 | | $ 732,265 | | $ 12,939 | | $ 23,283 |
2003, as restated | | $ 54,819 | | $ 763,125 | | $ 13,693 | | $ 31,057 |
2002, as restated | | $ 51,213 | | $ 761,611 | | $ 15,842 | | $ 38,672 |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | Year Ended December 31, 2004, 2003, and 2002 |
| | | | Benefits, Claims, | | Amortization of | | |
| | Net | | Losses, and | | Deferred Policy | | Other |
| | Investment | | Settlement | | Acquisition | | Operating |
| | Income | | Expenses (2) | | Costs | | Expenses |
| | (In thousands) |
| | | | | | | | |
2004 | | $ 30,703 | | $ 70,666 | | $ 10,479 | | $ 34,176 |
2003, as restated | | $ 35,346 | | $ 73,228 | | $ 9,774 | | $ 41,492 |
2002, as restated | | $ 38,168 | | $ 83,730 | | $ 11,013 | | $ 34,573 |
| | | | | | | | |
(1) Includes contractholder funds
(2) Includes interest expense on contractholder funds
F-66
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE IV – REINSURANCE
| Year Ended December 31, 2004, 2003, and 2002 |
| | | | | | | | | Percentage |
| | | Ceded to | | Assumed | | | | of Amount |
| Gross Direct | | Other | | from Other | | Net | | Assumed |
| Amount | | Companies | | Companies | | Amount | | to Net |
| (In thousands) |
2004 | | | | | | | | | |
Life insurance in-force | $ 9,223,922 | | $ 854,124 | | $ - | | $ 8,369,798 | | 0% |
Premium: | | | | | | | | | |
Life insurance | $ 27,165 | | $ 4,080 | | $ - | | $ 23,085 | | 0% |
Accident and health insurance | $ 281 | | $ 83 | | $ - | | $ 198 | | 0% |
Total premium | $ 27,446 | | $ 4,163 | | $ - | | $ 23,283 | | 0% |
| | | | | | | | | |
| | | | | | | | | |
2003, as restated | | | | | | | | | |
Life insurance in-force | $ 10,077,749 | | $ 1,153,916 | | $ - | | $ 8,923,833 | | 0% |
Premium: | | | | | | | | | |
Life insurance | $ 34,675 | | $ 3,673 | | $ - | | $ 31,002 | | 0% |
Accident and health insurance | $ 396 | | $ 341 | | $ - | | $ 55 | | 0% |
Total premium | $ 35,071 | | $ 4,014 | | $ - | | $ 31,057 | | 0% |
| | | | | | | | | |
2002, as restated | | | | | | | | | |
Life insurance in-force | $ 10,736,157 | | $ 1,274,843 | | $ - | | $ 9,461,314 | | 0% |
Premium: | | | | | | | | | |
Life insurance | $ 40,995 | | $ 2,372 | | $ - | | $ 38,623 | | 0% |
Accident and health insurance | $ 499 | | $ 450 | | $ - | | $ 49 | | 0% |
Total premium | $ 41,494 | | $ 2,822 | | $ - | | $ 38,672 | | 0% |
| | | | | | | | | |
F-67
