SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the Quarterly Period Ended March 31, 2001
Commission File Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact Name of Registrant as specified in its charter)
Texas 74-2126975
(State of Incorporation) (I.R.S. Employer Identification Number)
6500 River Place Blvd., Building One
Austin, Texas 78730
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 404-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Number of common shares outstanding ($.20 par value) at end of period:
5,054,661.
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Forward-Looking Statements
Except for historical factual information set forth in this Form 10-Q, the
statements, analyses, and other information contained in this report relating to
trends in the Company's operations and financial results, the markets for the
Company's products, the future development of the Company's business, and the
contingencies and uncertainties to which the Company may be subject, as well as
other statements including words such as "anticipate," "believe," "path,"
"estimate," "expect," "intend" and other similar expressions constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. Such statements are made based upon management's current expectations and
beliefs concerning the financial results, economic conditions and are subject to
known and unknown risks, uncertainties and other factors contemplated by the
forward-looking statements. Such factors include, among other things: (1)
general economic conditions and other factors, including prevailing interest
rate levels and stock market performance, which may affect the ability of FIC to
sell its products, the market value of FIC's investments and the lapse rate and
profitability of policies; (2) FIC's ability to achieve anticipated levels of
operational efficiencies and cost-saving initiatives; (3) customer response to
new products, distribution channels and marketing initiatives; (4) mortality,
morbidity and other factors which may affect the profitability of FIC's
insurance products; (5) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of FIC's products; (6)
increasing competition in the sale of insurance and annuities; (7) regulatory
changes or actions, including those relating to regulation of insurance products
and insurance companies; (8) ratings assigned to FIC's insurance subsidiaries by
independent rating organizations such as A.M. Best Company, which FIC believes
are particularly important to the sale of annuity and other accumulation
products; and (9) unanticipated litigation. There can be no assurance that other
factors not currently anticipated by management will not also materially and
adversely affect FIC.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
March 31, 2001 and December 31, 2000.......................... 4
Consolidated Statements of Income
For the three month period ended
March 31, 2001 and March 31, 2000............................. 6
Consolidated Statements of Cash Flows
For the three month period ended
March 31, 2001 and March 31, 2000............................. 8
Notes to Consolidated Financial Statements.............................10
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations................12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ............................................21
Part II
Other Information.....................................................22
Signature Page........................................................25
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2001 2000
(unaudited)
ASSETS
Investments other than investments in affiliate:
Fixed maturities available for sale at market value
(amortized cost of $74,946 and $78,249 at March 31,
2001 and December 31, 2000, respectively) $ 77,340 $ 79,786
Equity securities at market (cost approximates $11
at March 31, 2001 and December 31, 2000) 4 4
Policy loans 3,746 3,699
Short-term investments 14,862 15,624
Total investments 95,952 99,113
Cash and cash equivalents 3,855 2,733
Investment in affiliate 79,559 79,105
Accrued investment income 1,348 1,172
Agency advances and other receivables 9,854 7,604
Reinsurance receivables 18,136 17,466
Due and deferred premiums 12,863 12,537
Property and equipment, net 1,318 1,318
Deferred policy acquisition costs 56,695 56,161
Present value of future profits of acquired business 18,602 19,440
Other assets 4,453 4,117
Total Assets $ 302,635 $ 300,766
The accompanying notes are an integral part of these
consolidated financial statements
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2001 2000
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract holder deposit funds:
Future policy benefits $ 62,584 $ 62,462
Contract holder deposit funds 43,055 43,301
Unearned premiums -0- -0-
Other policy claims and benefits payable 3,303 2,931
108,942 108,694
Subordinated notes payable to affiliate 33,812 35,349
Deferred federal income taxes 24,473 24,437
Other liabilities 5,491 3,734
Total Liabilities 172,718 172,214
Commitments and Contingencies
Shareholders' equity:
Common stock, $.20 par value, 10,000,000
shares authorized; 5,845,300 shares issued, 5,054,661
outstanding in 2001 and 2000 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income 3,320 2,107
Retained earnings 125,578 125,426
137,292 135,927
Common treasury stock, at cost, 790,639 shares in 2001 (7,375) (7,375)
and 2000
Total Shareholders' Equity 129,917 128,552
Total Liabilities and Shareholders' Equity $ 302,635 $ 300,766
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended March 31,
2000 2001
(unaudited)
Revenues:
Premiums $ 8,038 $ 8,401
Net investment income 1,631 1,740
Earned insurance charges 934 1,147
10,603 11,288
Benefits and expenses:
Policyholder benefits and expenses 2,591 3,351
Interest expense on contract holders
deposit funds 570 590
Amortization of present value of future
profits of acquired businesses 838 1,016
Amortization of deferred policy
acquisition costs 1,439 1,349
Operating expenses 3,140 2,947
Interest expense 427 528
9,005 9,781
Income before federal income tax and
equity in net earnings of affiliates 1,598 1,507
Provision for federal income taxes 360 259
Income before equity in net earnings
of affiliates 1,238 1,248
Equity in net earnings of affiliate,
net of tax 845 966
Net Income $ 2,083 $ 2,214
The accompanying notes are an integral part of these
consolidated statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended March 31,
2001 2000
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,055
Basic earnings per share $ 0.41 $ 0.44
Diluted:
Common stock and common stock equivalents 5,183 5,167
Diluted earnings per share $ 0.40 $ 0.43
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
2001 2000
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 2,083 $ 2,214
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Amortization of present value of future
profits of acquired business 838 1,016
Amortization of deferred policy
acquisition costs 1,439 1,349
Equity in undistributed earnings of affiliate (1,361) (1,526)
Changes in assets and liabilities:
(Increase) decrease in accrued investment income (176) 49
Increase in agent advances and
other receivables (2,920) (257)
(Increase) decrease in due premiums (326) 137
Increase in deferred policy acquisition costs (1,973) (1,971)
(Increase) decrease in other assets (336) 100
Increase (decrease) in policy liabilities and accruals 248 (220)
Increase (decrease) in other liabilities 1,757 (465)
(Decrease) increase in deferred federal income taxes 36 (47)
Other, net (661) (140)
Net cash (used in) provided by operating activities $ (1,352) $ 239
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Three Months Ended March 31,
2001 2000
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (5,200) $ (1,462)
Increase in policy loans (47) (3)
Proceeds from calls and maturities of
fixed maturities 8,496 232
Net increase (decrease) in short-term investments 762 2,712
Net cash provided by investing activities 4,011 1,479
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (1,537) (1,537)
Net cash used in financing activities (1,537) (1,537)
Net increase in cash 1,122 181
Cash and cash equivalents, beginning of year 2,733 692
Cash and cash equivalents, end of period $ 3,855 $ 873
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The financial statements included herein have been presented to conform to the
requirements of Form 10-Q. This presentation includes year end balance sheet
data which was derived from audited financial statements. The notes to the
financial statements do not necessarily include all disclosures required by
generally accepted accounting principles (GAAP). The reader should refer to Form
10-K for the year ended December 31, 2000 previously filed with the Securities
and Exchange Commission for financial statements prepared in accordance with
GAAP. Management believes the financial statements reflect all adjustments
necessary to present a fair statement of interim results. Certain prior year
amounts have been reclassified to conform with current year presentation.
The consolidated financial statements include the accounts of Financial
Industries Corporation ("FIC") and its wholly-owned subsidiaries. The investment
of FIC in InterContinental Life Corporation ("ILCO") is presented using the
equity method. All significant intercompany items and transactions have been
eliminated.
Other Comprehensive Income
The following is a reconciliation of accumulated other comprehensive income
from December 31, 2000 to March 31, 2001 (in thousands):
Net unrealized Total
gain on Net accumulated
investments appreciation other
in fixed maturities of equity comprehensive
available for sale securities income
Balance at December 31, 2000 $ 2,107 $ 0 $ 2,107
Current Period Change 1,213 0 1,213
Balance at March 31, 2001 $ 3,320 $ 0 $ 3,320
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dividends Declared
In March, 2001 FIC announced that its board approved the payment of an annual
cash dividend in the amount of $0.41 per share. The dividend has been accrued in
other liabilities on the consolidated balance sheet and was paid on April 12,
2001, to shareholders of record as of the close of business on March 19, 2001.
New Accounting Pronouncements
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133, as amended by FAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - An Amendment of
FASB Statement No. 133", is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 2000 as amended by FAS No 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FAS No 133". As the Company does not have significant
investments in derivative financial instruments, the adoption of FAS 133 did not
have a material impact on the Company's results of operations, liquidity or
financial position.
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Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation
Results of Operations - Three Months Ended March 31, 2001 and 2000
For the three-month period ended March 31, 2001, Financial Industries
Corporation's ("FIC") net income was $2,083,000 (basic earnings of $0.41 per
common share, or diluted earnings of $0.40 per common share) as compared to
$2,214,000 (basic earnings of $0.44 per common share, or diluted earnings of
$0.43 per common share) in the first three months of 2000. Earnings per share
are stated in accordance with the requirements of FAS No. 128, which establishes
two measures of earnings per share: basic earnings per share and diluted
earnings per share. Basic earnings per share is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflect the potential
dilution that would occur if securities or other contracts to issue common stock
were converted or exercised.
FIC's income from operations - as determined before federal income tax and
equity in net earnings of its affiliate, InterContinental Life Corporation - for
the three-month period ended March 31, 2001, was $1,598,000 (on revenues of
$10,603,000), as compared to $1,507,000 (on revenues of $11,288,000), in the
first three months of 2000.
The operating strategy of the Company's management emphasizes several key
objectives: expense management; marketing of competitively priced insurance
products which are designed to generate an acceptable level of profitability;
maintenance of a high quality portfolio of investment grade securities; and the
provision of quality customer service.
Revenues.
Premiums for the first three months of 2001, net of reinsurance ceded, were $8.0
million, as compared to $8.4 million in the first three months of 2000. This
source of revenues is related to Family Life's traditional life insurance book
of business, primarily Family Life's term life insurance business. The decrease
from March 31, 2000 to March 31, 2001 is attributable to the decrease in the
traditional life insurance book of business from $5.76 billion at March 31, 2000
to $5.51 billion at March 31, 2001.
The net investment income for the first three months of 2001 was $1.63 million
as compared to $1.74 million in the same period of 2000. The net investment
income decreased as compared to the same quarter for 2000 because there was a
decline in the average interest rate earned on the investment portfolio of the
Company.
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Earned insurance charges for the first three months of 2001 were $0.93 million,
as compared to $1.15 million in the same period of 2000. This source of revenue
is related to Family Life's universal life insurance and annuity book of
business. The decline in the level of earned insurance charges is attributable
to a decrease in Family Life's universal life and annuity business. The face
amount of in force universal life policies was $908 million at March 31, 2000 as
compared to $897 million at March 31, 2001.
Benefits and Expenses.
Policyholder benefits and expenses were $2.6 million in the first quarter of
2001, as compared to $3.4 million in the first quarter of 2000. The change
between the two periods is attributable to a decline in the amount of benefits
paid during the first quarter of 2001 of $0.87 million.
Interest expense on contract holders deposit funds was $0.57 million in the
first quarter of 2001, as compared to $0.59 million in the same period of the
year 2000. This expense's slight decrease is related to the small decrease in
the level of contract holder deposit funds, which declined from $43.3 million at
December 31, 2000 to $43.1 million at March 31, 2001.
In the first three months of 2001, the amortization of present value of future
profits of acquired business was $0.84 million as compared to $1.02 million in
the first three months of 2000. These decreases in amortization were expected
and should continue to decrease as the underlying asset, present value of future
profits, decreases.
The amortization of deferred policy acquisition costs was $1.44 million in the
first three months of 2001, as compared to $1.35 million in the first three
months of 2000. The increase in amortization is attributable to the
capitalization of expenses incurred in connection with the writing of new
business.
The operating expenses for the first three months of 2001 were $3.14 million, as
compared to $2.95 million in the first three months of 2000. The increase was
due to a higher level of expenses over the current period versus the prior
period's expenses.
Interest expense for the first three months of 2001 was $0.43 million, as
compared to $0.53 million in the first three months of 2000. The decrease in the
amount of interest expenses from the first quarter of 2000 to the first quarter
of 2001 is attributable to the scheduled reduction in the amount of outstanding
indebtedness.
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The provision for federal income taxes was $0.36 million in the first three
months of 2001 as compared to $0.26 million in the first three months of 2000.
The increase is due to the increase in income from operations.
Equity in Net Income of InterContinental Life Corporation
General
For the three-month period ended March 31, 2001, the Company's equity in the net
earnings of InterContinental Life Corporation ("ILCO"), net of federal income
tax, was $845,000, as compared to $966,000 for the first three months of 2000.
The decrease is attributable to the lower level of ILCO's earnings.
FIC currently owns 3,591,534 shares of ILCO's common stock. In addition, Family
Life currently owns 342,400 shares of ILCO common stock. As a result, FIC
currently owns, directly and indirectly through Family Life, 3,933,934 shares
(approximately 48.1%) of ILCO's common stock.
FIC carries its investment in ILCO using the equity method of accounting. At
March 31, 2001, FIC's investment in affiliate was valued at $79.56 million. The
book value of ILCO's common stock at March 31, 2001 was $20.55 per share, which
is substantially above the market value ($12.00) of ILCO's common stock on that
same date. The applicable accounting standards permit FIC to carry its
investment in ILCO on the equity method of accounting, without any adjustment to
reflect the difference between book value and market value. Under certain
circumstances, Accounting Principles Board Opinion 18 ("APB 18") and Staff
Accounting Bulletin Topic 5.M ("SAB 5.M") require an adjustment to earnings
where the value of an investment is deemed to have decreased on an other than a
temporary basis. Application of the "other than temporary" provisions of APB 18
and SAB 5.M to FIC's investment in ILCO would potentially result in a charge to
earnings in some future period. The amount of such charge would be based
primarily upon the market price of ILCO's common stock, which ranged from $9.313
per share to $17.99 per share during the period from January 1, 2001 to May 14,
2001. Based on that range of market prices, the range of possible impairment
charges which might result would be from $8.16 million to $39.76 million, net of
tax.
However, management believes that an adjustment to earnings is neither required
nor appropriate under the provisions of APB 18 and SAB 5.M. In addition,
management notes that FIC and ILCO are currently parties to an Agreement and
Plan of Merger whereby ILCO would become a wholly-owned subsidiary of FIC. FIC
believes that it is probable that the merger will be consummated. After the
merger, FIC will include ILCO in its consolidated financial statements. FIC
expects to recover the cost of its investment in ILCO from the realization of
ILCO's net assets through consolidation.
As of March 31, 2001, the market value of the fixed maturities available for
sale segment was $427.36 million as compared to an amortized cost of $418.02
million, or an unrealized gain of $9.34 million. The increase reflects
unrealized gains on such investments related to changes in interest rates
subsequent to the purchase of such investments. Since FIC owns approximately
48.1% of the common stock of ILCO, such unrealized gains, net of tax, are
reflected in FIC's investment in affiliate and accumulated other comprehensive
income, and had the effect of increasing the reported value of such equity
interest by approximately $1.9 million. The net of tax effect of this increase
($1.8 million at March 31, 2001) is included in "Accumulated other comprehensive
income" on the Consolidated Balance Sheets and has been recorded as an increase
in shareholders' equity. As required under the provisions of FAS No. 130, the
determination of "Accumulated other comprehensive income" includes separate
identification of the change in values which occurred during the current period.
As of December 31, 2000, the market value of the fixed maturities available for
sale segment was $440.7 million as compared to an amortized cost of $437.0
million, or an unrealized gain of $3.7 million.
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Liquidity and Capital Resources of ILCO.
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. ILCO is a holding company
whose principal assets consist of the common stock of Investors Life Insurance
Company of North America ("Investors-NA") and its subsidiary - Investors Life
Insurance Company of Indiana ("Investors-IN"). Historically, ILCO's principal
cash flow sources have been from periodic payment of principal and interest by
Investors-NA, pursuant to the terms of the Surplus Debentures. In addition to
the need for cash flow to meet operating expenses, ILCO'S liquidity requirements
relate principally to the liabilities associated with ILCO'S various life
insurance and annuity products. ILCO'S product liabilities include the payment
of benefits under life insurance and annuity products, as well as the payment of
policy surrenders, withdrawals and policy loans.
The Surplus Debentures were originally issued by Standard Life Insurance Company
and their terms were previously approved by the Mississippi Insurance
Commissioner. In connection with the 1993 merger of Standard Life into
Investors-NA, the obligations of the Surplus Debentures were assumed by
Investors-NA. As of June 30, 2000, the outstanding principal balance of the
Surplus Debentures was completely paid off. For periods subsequent to June 30,
2000, ILCO's available source of liquidity is dividends paid to it from its
subsidiaries. Applicable state insurance laws generally restrict the ability of
insurance companies to pay cash dividends in excess of prescribed limitations
without prior approval. The ability of Investors-NA to pay shareholder dividends
is and will continue to be subject to restrictions set forth in the insurance
laws and regulations of Washington, its domiciliary state. The Washington
insurance law limits how and when Investors-NA can pay shareholder dividends by
including the "greater of" standard for payment of dividends to shareholders,
and requiring that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash dividends may be paid only from
earned surplus. Under the "greater of" standard, an insurer may pay a dividend
in an amount equal to the greater of (i) 10% of the policyholder surplus or (ii)
the insurer's net gain from operations for the previous year. As of March 31,
2001, Investors-NA had earned surplus of $60.7 million.
Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance
code, a domestic insurer may make dividend distributions upon proper notice to
the Department of Insurance, as long as the distribution is reasonable in
relation to adequate levels of policyholder surplus and quality of earnings.
Under Indiana law the dividend must be paid from earned surplus. Extraordinary
dividend approval would be required where a dividend exceeds the greater of 10%
of surplus or the net gain from operations for the prior fiscal year.
Investors-IN had earned surplus of $23.4 million at March 31, 2001.
The Form 10-Qs of ILCO for the three-month periods ended March 31, 2001 and
March 31, 2000, set forth the business operations and financial results of ILCO
and its life insurance subsidiaries. Such 10-Q reports of ILCO, including the
discussion by ILCO's management under the caption "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" are incorporated
herein by reference.
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Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the common stock of
Family Life and its equity ownership in ILCO. FIC's primary sources of capital
consist of cash flow from operations of its subsidiaries and the proceeds from
bank and institutional borrowings.
The cash requirements of FIC and its subsidiaries consist primarily of its
service of the indebtedness created in connection with its ownership of Family
Life. As of March 31, 2001, the outstanding balance of such indebtedness was
$33.8 million on the Subordinated Notes granted by Investors-NA.
The principal source of liquidity for FIC's subsidiaries consists of the
periodic payment of principal and interest by Family Life pursuant to the terms
of a Surplus Debenture. The terms of the Surplus Debenture were previously
approved by the Washington Insurance Commissioner. Under the provisions of the
Surplus Debenture and current law, no prior approval of the Washington Insurance
Department is required for Family Life to pay interest or principal on the
Surplus Debenture; provided that, after giving effect to such payments, the
statutory surplus of Family Life is in excess of 6% of assets (the "surplus
floor"). However, Family Life has voluntarily agreed with the Washington
Insurance Commissioner that it will provide at least five days advance notice of
payments which it will make under the surplus debenture. As of March 31, 2001,
the statutory capital and surplus of Family Life was $26.1 million, an amount
substantially in excess of the surplus floor. As of March 31, 2001, the
principal balance of the Surplus Debenture was $3.9 million. The funds required
by Family Life to meet its obligations under the terms of the Surplus Debenture
are generated primarily from premium payments from policyholders, investment
income and the proceeds from the sale and redemption of portfolio investments.
Washington's insurance code includes the "greater of" standard for dividends but
has requirements that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash dividends may be paid only from
earned surplus. Family Life does not presently have earned surplus as defined by
the regulations adopted by the Washington Insurance Commissioner and, therefore,
is not permitted to pay cash dividends. However, since the new law applies only
to dividend payments, the ability of Family Life to make principal and interest
payments under the Surplus Debenture is not affected. The Company does not
anticipate that, for the foreseeable future, Family Life will have any
difficulty in making payments to Family Life Corporation in amounts sufficient
to enable Family Life Corporation to service indebtedness, either by payments of
principal and interest by Family Life on the Surplus Debenture or partial
redemptions by Family Life of its redeemable preferred stock.
The sources of funds for Family Life consist of premium payments from
policyholders, investment income and the proceeds from the sale and redemption
of portfolio investments. These funds are applied primarily to provide for the
payment of claims under insurance and annuity policies, operating expenses,
taxes, investments in portfolio securities, shareholder dividends and payments
under the provisions of the Surplus Debenture.
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FIC's net cash flow (used in) provided by operating activities was $(1.35)
million in the first three months of 2001, as compared to $0.24 million in the
first three months of 2000. Net cash flow used in financing activities was $1.54
million in the first three months of 2001, as compared to $1.54 million in the
first three months of 2000. The decrease in cash flow provided by operating
activities for the quarter ended March 31, 2001 was affected by an increase in
agency advances and other receivables as well as an increase in other
liabilities related to the dividend payable to FIC shareholders.
Net cash flow provided by investing activities was $4.01 million for the three
months ended March 31, 2001, as compared to $1.48 million for the same period in
2000. The increase in cash flow from investing activities was primarily
attributable to cash received from the redemption or maturity of investments
which cash was used in operations and financing activities.
The guaranty commitments of FIC under the loans incurred in connection with the
acquisition of Family Life (after taking into account the repayments and new
loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued
by Family Life Corporation to Investors Life Insurance Company of North America
and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term investments
are sufficient to meet the needs of its business and to satisfy debt service.
There are no trends, commitments or capital asset requirements that are expected
to have an adverse effect on the liquidity of FIC.
Investments.
As of March 31, 2001, the Company's investment assets totaled $95.95 million, as
compared to $99.11 million as of December 31, 2000. The decrease was primarily
attributable to cash received from the redemption or maturity of investments
which cash was used in operations and financing activities.
As of March 31, 2001, the market value of the fixed maturities available for
sale segment was $77.34 as compared to an amortized value of $74.95 million or
an unrealized gain of $2.39 million. The increase reflects unrealized gains on
such investments related to changes in interest rates subsequent to the purchase
of such investments. The net of tax effect of this increase ($1.55 million at
March 31, 2001) has been recorded as an increase in shareholders' equity. As
required under the provisions of FAS No. 130, the determination of "Accumulated
other comprehensive income" includes separate identification of the change in
values which occurred during the current period.
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The level of short-term investments at March 31, 2001 was $14.86 million, as
compared to $15.62 as of December 31, 2000. The slight decrease is within the
expected levels of short-term investments.
The assets held by Family Life must comply with applicable state insurance laws
and regulations. In selecting investments for the portfolios of its life
insurance subsidiaries, the Company's emphasis is to obtain targeted profit
margins, while minimizing the exposure to changing interest rates. This
objective is implemented by selecting primarily short- to medium-term,
investment grade fixed income securities. In making such portfolio selections,
the Company generally does not select new investments which are commonly
referred to as "high yield" or "non-investment grade".
The fixed maturities portfolio of Family Life, as of March 31, 2001, consisted
solely of fixed maturities investments which, in the annual statement of the
company, as filed with state insurance departments, were designated under the
National Association of Insurance Commissioners ("NAIC") rating system as a "1"
(highest quality).
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $19 million and $173 million, respectively, and mortgage-backed pass-through
securities of $8 million and $39.4 million, respectively, at March 31, 2001.
Mortgage-backed pass-through securities, sequential CMO's and support bonds,
which comprised approximately 54.4% of the book value of FIC's mortgage-backed
securities and 56.2% of the book value of ILCO's mortgage-backed securities at
March 31, 2001, are sensitive to prepayment and extension risks. ILCO and FIC
have reduced the risk of prepayment associated with mortgage- backed securities
by investing in planned amortization class ("PAC"), target amortization class
("TAC") instruments and scheduled bonds. These investments are designed to
amortize in a predictable manner by shifting the risk of prepayment of the
underlying collateral to other investors in other tranches ("support classes")
of the CMO. At March 31, 2001, PAC and TAC instruments and scheduled bonds
represented approximately 45.6% of the book value of FIC's mortgage-backed
securities and approximately 43.8% of the book value of ILCO's mortgage-backed
securities. Sequential and support classes represented approximately 24.8% of
the book value of FIC's mortgage-backed securities and approximately 37.7% of
the book value of ILCO's mortgage-backed securities at March 31, 2001. In
addition, FIC and ILCO limit the risk of prepayment of CMOs by not paying a
premium for any CMOs. ILCO and FIC do not invest in mortgage-backed securities
with increased prepayment risk, such as interest-only stripped pass-through
securities and inverse floater bonds. Neither FIC nor ILCO had any z-accrual
bonds as of March 31, 2001. The prepayment risk that certain mortgage-backed
securities are subject to is prevalent in periods of declining interest rates,
when mortgages may be repaid more rapidly than scheduled as individuals
refinance higher rate mortgages to take advantage of the lower current rates. As
a result, holders of mortgage-backed securities may receive large prepayments on
their investments which cannot be reinvested at an interest rate comparable to
the rate on the prepaying mortgages. For the year 2001, the investment
objectives of FIC and ILCO include the making of selected investments in CMOs.
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of its life insurance
subsidiary enhances the ability of the Company to service its debt, to provide
security to its policyholders and to credit relatively consistent rates of
return to its policyholders.
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Accounting Developments
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133, as amended by FAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - An Amendment of
FASB Statement No. 133", is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 2000 as amended by FAS No 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FAS No 133". As the Company does not have significant
investments in derivative financial instruments, the adoption of FAS 133 did not
have a material impact on the Company's results of operations, liquidity or
financial position.
Other Developments
Agreement and Plan of Merger.
On January 17, 2001, FIC entered into an Agreement and Plan of Merger (the
"Agreement") with ILCO and ILCO Acquisition Company ("ILCO Acquisition"), a
Texas corporation and wholly-owned subsidiary of FIC. In general, the Agreement
provides that, following the approval of the Agreement by the shareholders of
ILCO and the approval of the issuance of shares of FIC common stock and
amendment to FIC's articles of incorporation by the shareholders of FIC and the
satisfaction or waiver of the other conditions to the merger: (1) ILCO
Acquisition will merge with and into ILCO; and (2) ILCO Acquisition will cease
to exist and ILCO will continue as the surviving corporation and as a
wholly-owned subsidiary of FIC following the merger.
Upon the consummation of the merger: (1) each share of ILCO common stock issued
and outstanding immediately prior to the merger, other than shares of ILCO
common stock held as treasury shares by ILCO (but excluding shares of ILCO
common stock held by any of ILCO's subsidiaries, whether or not treated as
treasury shares of ILCO on a consolidated basis under generally accepted
accounting principles) or shares of ILCO common stock held by FIC, will be
converted into the right to receive 1.1 shares of FIC common stock. However, in
the event of any change in FIC common stock and/or ILCO common stock prior to
the merger, such as a stock split, stock dividend, subdivision,
reclassification, recapitalization, combination, exchange of shares or the like,
the number and class of shares of FIC common stock to be issued and delivered in
the merger in exchange for each outstanding share of ILCO common stock will be
adjusted so as to maintain the relative proportionate interests of the holders
of ILCO common stock and FIC common stock; (2) each share of ILCO common stock,
series A preferred stock and series B preferred stock of ILCO, in each case
which is held as treasury shares by ILCO prior to the merger (excluding shares
of ILCO common stock held by any of ILCO's subsidiaries, whether or not treated
as treasury shares of ILCO on a consolidated basis under generally accepted
accounting principles), and each share of ILCO common stock which is held by FIC
(excluding any shares of ILCO common stock owned by any of FIC's subsidiaries)
prior to the merger, will be cancelled and retired; (3) each share of common
stock of ILCO Acquisition issued and outstanding immediately prior to the merger
will be converted into one share of common stock of ILCO and such shares will
represent all of the issued and outstanding capital stock of ILCO following the
merger; and (4) shares of FIC common stock outstanding immediately prior to the
merger (including shares of FIC common stock held by any subsidiary of FIC or
ILCO) will remain outstanding and will be unaffected by the merger. No
fractional shares of FIC common stock will be issued in the merger. A holder of
ILCO common stock who would otherwise be entitled to receive fractional shares
of FIC common stock as a result of the merger will receive, in lieu of
fractional shares, cash in an amount equal to the average closing price per
share of FIC common stock for the 30 trading days immediately prior to the
merger multiplied by the fraction to which the holder would otherwise be
entitled. FIC will make available to First Union National Bank, as exchange
agent, from time to time sufficient cash amounts to satisfy payment for
fractional shares and First Union will distribute such proceeds, without
interest, to the holders of the fractional interests.
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The consummation of the merger remains subject to regulatory approval, as well
as to the various conditions precedent set forth in the Agreement, including the
approval of certain matters by the shareholders of FIC and ILCO. A Special
Meeting of the shareholders of each of FIC and ILCO is scheduled for May 18,
2001. For a more detailed description of the Agreement, see the complete copy of
the Agreement, attached as an annex to the S-4 filed by FIC with the Securities
and Exchange Commission on February 1, 2001, as amended by the S-4/A filed on
March 13, 2001 and the S-4/A filed on April 3, 2001.
NASDAQ Listing
On January 24, 2001, FIC submitted an application to have its common stock
traded on the NASDAQ National Market under the symbol FNIN. Previously, the
common stock of FIC was traded on the NASDAQ Small-Cap Market. The application
was approved and the common stock of FIC commenced trading on the NASDAQ
National Market on April 9, 2001.
Unsolicited Verbal Inquiries Concerning Possible Purchase of Post-Merger Company
On March 8, 2001, FIC announced that it has received unsolicited verbal
indications of interest from a few companies that may be interested in acquiring
FIC after completion of the merger with ILCO. The press release did not state
any price ranges or other material terms. In conjunction with such indications
of interest, FIC has retained Philo Smith Capital Corporation as its financial
advisor to explore the possibility of a post-merger sale of FIC with these
companies and to further solicit indications of interest from other companies
that may have similar interests. As indicated on the Form 424B3 filed with the
Securities and Exchange Commission on May 9, 2001, FIC has received one
indication of interest that it intends to pursue through further discussions
with the third party submitting such indication of interest. However, FIC has
still not determined whether it will sell the company, and no price or material
terms on which it would agree to sell the company have been determined by the
board of directors of FIC or agreed upon with any third party.
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Dividends Declared
In March, 2001 FIC announced that its board approved the payment of an annual
cash dividend in the amount of $0.41 per share. The dividend has been accrued in
other liabilities on the consolidated balance sheet and was paid on April 12,
2001, to shareholders of record as of the close of business on March 19, 2001.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General.
FIC's principal assets are financial instruments, which are subject to market
risks. Market risk is the risk of loss arising from adverse changes in market
rates, principally interest rates on fixed rate investments. For a discussion of
the Company's investment portfolio and the management of that portfolio to
reflect the nature of the underlying insurance obligations of the Company's
insurance subsidiaries, please refer to the information set forth in Item 2
"Management's Discussion and Analysis of Financial Conditions and Results of
Operation - Investments" of this report.
The following is a discussion of the Company's primary market risk sensitive
instruments. It should be noted that this discussion has been developed using
estimates and assumptions. Actual results may differ materially from those
described below. Further, the following discussion does not take into account
actions which could be taken by management in response to the assumed changes in
market rates. In addition, the discussion does not take into account other types
of risks which may be involved in the business operations of the Company, such
as the reinsurance recoveries on reinsurance treaties with third party insurers.
The primary market risk to the Company's investment portfolio is interest rate
risk. Since the Company owns approximately 48.1% of the common stock of ILCO,
the interest rate risk of ILCO's fixed income portfolio has an effect on the
value of FIC's 'investment in affiliate'. The Company does not use derivative
financial instruments.
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Interest Rate Risk.
(a) FIC's Fixed Income Investments
Assuming an immediate increase of 100 basis points in interest rates,
the net hypothetical loss in fair market value related to the
financial instruments segment of the Company's balance sheet is
estimated to be $2.6 million at March 31, 2001 and $3.4 million at
December 31, 2000. For purposes of the foregoing estimate, the
following categories of the Company's fixed income investments were
taken into account: (i) fixed maturities, including fixed maturities
available for sale and (ii) short-term investments. The market value
of such assets was $92.2 million at March 31, 2001 and $95.4 million
at December 31, 2000.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was
$27.9 million at March 31, 2001 and $28.1 million at December 31,
2000. Assuming an immediate increase of 100 basis points in interest
rates, the net hypothetical loss in the fair market value related to
such mortgage-backed securities is estimated to be $0.9 million at
March 31, 2001 and $1.5 million at December 31, 2000.
(b) FIC's Investment in Affiliate
The value of FIC's investment in affiliate is affected by the amount
of unrealized gains and losses, net of tax, in the investment
portfolio of its affiliate, ILCO. Assuming an immediate increase of
100 basis points in interest rates, the net hypothetical loss in
value, net of tax, related to the Company's investment in affiliate is
estimated to be $5.6 million at March 31, 2001 and $6.2 million at
December 31, 2000.
The hypothetical effect of the interest rate risk on fair values was estimated
by applying a commonly used model. The model projects the impact of interest
rate changes on a range of factors, including duration and potential prepayment.
Part II. Other Information
Item 1. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact upon the
financial statements.
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Universal Life Litigation:
ILCO and Investors-NA are defendants in a lawsuit which was filed in October,
1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also
a named defendant in the lawsuit. The named plaintiffs in the suit (a husband
and wife), allege that the universal life insurance policies sold to them by INA
Life Insurance Company (a company which was merged into Investors-NA in 1992)
utilized unfair sales practices. The named plaintiffs seek reformation of the
life insurance contracts and an unspecified amount of damages. The named
plaintiffs also seek a class action as to similarly situated individuals. In
April, 2001, the named plaintiffs filed an amended complaint, so as to include
various post-sale allegations, including allegations related to the manner in
which increases in the cost of insurance were applied, the allocation of
portfolio yields to the universal life policies and changes in the spread
between the earned rate and the credited rate. The Company filed a motion to
strike the amended Complaint, which motion was denied by the Court. No
certification of a class has been granted as of the date hereof. The Company
believes that the suit is without merit and intends to vigorously defend this
matter.
Litigation Relating to the FIC/ ILCO Merger:
On the day that FIC and ILCO each publicly announced the formation of a special
committee to evaluate a potential merger, two class action lawsuits were filed
against ILCO, FIC and the officers and directors of ILCO. The actions allege
that a cash consideration in the proposed merger is unfair to the shareholders
of ILCO, that it would prevent the ILCO shareholders from realizing the true
value of ILCO, and that FIC and the named officers and directors had material
conflicts of interest in approving the transaction.
In their initial pleadings, the plaintiffs sought certification of the cases as
class actions and the named plaintiffs as class representatives, and among other
relief, requested that the merger be enjoined (or, if consummated, rescinded and
set aside) and that the defendants account to the class members for their
damages.
Recently, the plaintiffs initiated discovery in this matter. The defendants
believe that the lawsuits are without merit and intend to vigorously contest the
lawsuits. Management is unable to determine the impact, if any, that the
lawsuits may have on the results of operations of the Company.
Other Litigation:
Additionally, FIC and its subsidiaries are regularly involved in litigation,
both as a defendant and as plaintiff. The litigation naming the insurance
subsidiaries as defendant ordinarily involves our activities as a provider of
insurance protection products. We do not believe that such litigation, either
individually or in the aggregate, will have a material adverse effect on the
Company's business, financial condition or results of operations.
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Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Form 10-K Annual Report of Registrant for the year ended
December 31, 2000 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K
On January 22, 2001, the Registrant filed a report on Form
8-K. The report pertained to the announcement by the
Registrant that it had entered into a definitive agreement
whereby it would acquire the remaining common shares
(approximately 52%) of InterContinental Life Corporation
("ILCO") which it does not currently own. The terms and
provisions of the transaction are set forth in an Agreement
and Plan of Merger dated as of January 17, 2001, among the
Registrant, ILCO and ILCO Acquisition Company. A copy of the
Agreement and Plan of Merger is attached to the Report of
Form 8-K.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SUBSIDIARIES
SIGNATURE
Pursuant to the requirements 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
/s/ James M. Grace
James M. Grace, Treasurer
Date: May 15, 2001
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