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 September 30, 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:
9,487,516.
- 1 -
<page>
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.
- 2 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2001 and December 31, 2000...........................4
Consolidated Statements of Income
For the three and nine month periods ended
September 30, 2001 and September 30, 2000..........................7
Consolidated Statements of Cash Flows
For the three and nine month periods ended
September 30, 2001 and September 30, 2000.........................11
Notes to Consolidated Financial Statements.................................15
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations....................18
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ................................................28
Part II
Other Information.........................................................29
Signature Page............................................................32
- 3 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<table>
<s> <c> <c>
September 30, December 31,
2001 2000
(unaudited)
ASSETS
Investments other than investments in affiliate:
Fixed maturities available for sale at market value
(amortized cost of $454,491 and $78,249 at September
30, 2001 and December 31, 2000, respectively) $ 470,067 $ 79,786
Fixed maturities at amortized cost (market approximates
$1,450 at September 30, 2001) 1,450 0
Equity securities at market (cost approximates $40 at
September 30, 2001 and $11 at December 31, 2000) 46 4
Policy loans 49,828 3,699
Mortgage loans and other investments 4,758 0
Invested real estate and other invested assets 56,113 0
Short-term investments 179,840 15,624
Total investments 762,102 99,113
Cash 12,922 2,733
Investment in affiliate 0 79,105
Accrued investment income 9,487 1,172
Agency advances and other receivables 23,112 7,604
Reinsurance receivables 34,588 17,466
Due and deferred premiums 18,707 12,537
Real estate occupied by the Company 20,135 0
Property and equipment, net 3,805 1,318
Deferred policy acquisition costs 77,252 56,161
Present value of future profits of acquired businesses 33,002 19,440
Other assets 15,976 4,117
Separate account assets 389,432 0
Total Assets $ 1,400,520 $ 300,766
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<table>
<s> <c> <c>
September 30, December 31,
2001 2000
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract holder deposit funds:
Future policy benefits $ 194,668 $ 62,462
Contract holder deposit funds 559,122 43,301
Unearned premiums 0 0
Other policy claims and benefits payable 15,849 2,931
769,639 108,694
Subordinated notes payable to affiliate 0 35,349
Deferred federal income taxes 36,989 24,437
Excess of net assets acquired over cost 13,381 0
Other liabilities 12,335 3,734
Separate account liabilities 381,998 0
Total Liabilities 1,214,342 172,214
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 5 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, Continued
(in thousands)
<table>
<s> <c> <c>
September 30, December 31,
2001 2000
(unaudited)
Commitments and Contingencies
Shareholders' equity:
Common stock, $.20 par value, 25,000,000 shares
authorized; 11,727,860 and 5,845,300 shares issued,
9,487,516 and 5,054,661 shares outstanding in 2001 and
2000, respectively. 2,345 1,169
Additional paid-in capital 68,025 7,225
Accumulated other comprehensive income 8,174 2,107
Retained earnings 130,100 125,426
208,644 135,927
Common treasury stock, at cost, 2,240,344 at 2001 and
790,639 at 2000. (22,466) (7,375)
Total Shareholders' Equity 186,178 128,552
Total Liabilities and Shareholders' Equity $ 1,400,520 $ 300,766
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 6 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<table>
<s> <c> <c>
Three Months Ended September 30,
2001 2000
(unaudited)
Revenues:
Premiums $ 10,225 $ 8,503
Net investment income 12,694 1,780
Earned insurance charges 10,361 824
Other 685 3
33,965 11,110
Benefits and expenses:
Policyholder benefits and expenses 10,321 3,528
Interest expense on contract holders
deposit funds 7,439 496
Amortization of present value of future
profits of acquired businesses 875 1,112
Amortization of deferred policy
acquisition costs 1,745 1,417
Operating expenses 8,042 2,674
Interest expense 0 501
28,422 9,728
Income before federal income tax and
equity in net earnings of affiliates 5,543 1,382
Provision for federal income taxes 1,737 256
Income before equity in net earnings of affiliates 3,806 1,126
Equity in net earnings of affiliate, net of tax 0 1,041
Net Income $ 3,806 $ 2,167
</table>
The accompanying notes are an integral part of these
consolidated statements.
- 7 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<table>
<s> <c> <c>
Three Months Ended September 30,
2001 2000
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 9,483 5,055
Basic earnings per share $ 0.40 $ 0.43
Diluted:
Common stock and common stock equivalents 9,536 5,160
Diluted earnings per share $ 0.40 $ 0.42
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 8 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<table>
<s> <c> <c>
Nine Months Ended September 30,
2001 2000
(unaudited)
Revenues:
Premiums $ 27,324 $ 25,347
Net investment income 21,466 5,220
Earned insurance charges 16,953 3,196
Other 939 6
66,682 33,769
Benefits and expenses:
Policyholder benefits and expenses 19,615 10,749
Interest expense on contract holders
deposit funds 12,135 1,555
Amortization of present value of future
profits of acquired businesses 2,651 2,984
Amortization of deferred policy
acquisition costs 4,678 3,860
Operating expenses 16,558 8,612
Interest expense 616 1,513
Total 56,253 29,273
Income before federal income tax and
equity in net earnings of affiliates 10,429 4,496
Provision for federal income taxes 3,091 834
Income before equity in net earnings
of affiliates 7,338 3,662
Equity in net earnings of affiliate,
net of tax 1,317 2,924
Net Income $ 8,655 $ 6,586
</table>
The accompanying notes are an integral part of
these consolidated statements.
- 9 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<table>
<s> <c> <c>
Nine Months Ended September 30,
2001 2000
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 7,261 5,055
Basic earnings per share $ 1.19 $ 1.30
Diluted:
Common stock and common stock equivalents 7,292 5,163
Diluted earnings per share $ 1.18 $ 1.28
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 10 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<table>
<s> <c> <c>
Three Months Ended September 30,
2001 2000
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 3,806 $ 2,167
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 875 1,112
Amortization of deferred policy
acquisition costs 1,745 1,417
Equity in undistributed earnings of affiliate 0 (1,534)
Changes in assets and liabilities:
Decrease in accrued investment income 1 62
Decrease (Increase) in agent advances and
other receivables 3,006 (73)
Decrease (Increase) in due and deferred premiums 3,494 (26)
Increase in deferred policy acquisition costs (3,324) (2,624)
Decrease in other assets 184 13
Decrease in policy liabilities and accruals (4,503) (308)
(Decrease) Increase in other liabilities (937) 281
Increase in deferred federal income taxes 162 102
Other, net 1,484 (246)
Net cash provided by operating activities $ 5,993 $ 343
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 11 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
<table>
<s> <c> <c>
Three Months Ended September 30,
2001 2000
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (6,063) $ (500)
Proceeds from sales and maturities of
fixed maturities 27,841 3,279
Real estate development (10,861) 0
Decrease (Increase) in policy loans 1,933 (73)
Net change in short-term investments (16,234) (1,080)
Purchase of property
and equipment (43) 0
Net cash (used in) provided by investing activities $ (3,427) $ 1,626
CASH FLOW FROM FINANCING ACTIVITIES
Dividends Paid (2,051) 0
Issuance of common capital stock 271 0
Issuance of treasury stock 57 0
Repayment of subordinated notes payable 0 (1,537)
Net cash used in financing activities (1,723) (1,537)
Net Increase (Decrease) in cash 843 432
Cash, beginning of period 12,079 1,181
Cash, end of period $ 12,922 $ 1,613
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 12 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<table>
<s> <c> <c>
Nine Months Ended September 30,
2001 2000
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 8,655 $ 6,586
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 2,931 2,984
Amortization of deferred policy
acquisition costs 4,662 3,860
Equity in undistributed earnings of affiliate (2,137) (4,565)
Changes in assets and liabilities:
Increase in accrued investment income (103) (2)
Decrease (Increase) in agent advances and
other receivables 3,003 (1,582)
Decrease (Increase) in due and deferred premiums 3,067 (149)
Increase in deferred policy acquisition costs (7,864) (6,817)
Decrease (Increase) in other assets 229 (20)
Decrease in policy liabilities and accruals (5,208) (399)
Decrease in other liabilities (800) (48)
Increase (Decrease) in deferred federal income taxes 12 (22)
Other, net 2,212 59
Net cash provided by (used in) operating activities $ 8,659 $ (115)
</table>
The accompanying notes are an integral part of these
consolidated statements.
- 13 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
<table>
<s> <c> <c>
Nine Months Ended September 30,
2001 2000
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (37,253) $ (10,788)
Proceeds from sales and maturities of
fixed maturities 70,406 9,917
Real estate development (13,656) 0
Decrease (Increase) in policy loans 1,825 (81)
Net change in short-term investments (19,229) 7,469
Purchase & retirement of property
and equipment (53) 37
Net cash provided by investing activities 2,040 6,554
CASH FLOW FROM FINANCING ACTIVITIES
Dividends Paid (3,982) (907)
Issuance of common capital stock 271 0
Purchase of insurance holding company 6,979 0
Purchase of treasury stock (2,241) 0
Repayment of subordinated notes payable (1,537) (4,611)
Net cash used in financing activities $ (510) $ (5,518)
Net Increase (Decrease) in cash 10,189 921
Cash, beginning of year 2,733 692
Cash, end of period $ 12,922 $ 1,613
</table>
The accompanying notes are an integral part of these
consolidated financial statements.
- 14 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The financial statements included herein reflect all adjustments which are, in
the opinion of management, necessary to present a fair statement of the interim
results. The statements have been prepared to conform to the requirements of
Form 10-Q and 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 Commission for
financial statements prepared in accordance with GAAP. 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
which FIC held in InterContinental Life Corporation ("ILCO") prior to the May
18, 2001 merger of ILCO with a subsidiary of FIC (see Acquisition of
InterContinental Life Corporation, below), 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 September 30, 2001 (in thousands):
<table>
<s> <c> <c> <c>
Net Total
Net unrealized appreciation accumulated
gain on investments (depreciation) 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 6,063 4 6,067
Balance at September 30, 2001 $ 8,170 $ 4 $ 8,174
</table>
Acquisition of InterContinental Life Corporation
On May 18, 2001, Financial Industries Corporation ("FIC") completed the merger
of a subsidiary of FIC with and into ILCO, with ILCO surviving the merger as a
wholly-owned subsidiary of FIC. In connection with the transaction, FIC issued
1.1 shares of its common stock for each share of ILCO common stock outstanding
at the time of the merger and not held directly by FIC or ILCO. In addition,
each option to purchase ILCO common stock was assumed by FIC and became an
option to purchase FIC common stock with the number of shares and the exercise
price adjusted for the exchange ratio in the merger. The consideration for the
transaction was $50.536 million represented by the issuance of 4.7 million
shares of FIC stock, at $10 per share, to ILCO shareholders. The $10 per share
price was calculated based on the average price of FIC common stock on the two
days immediately preceding and following the date of the merger agreement
between FIC and ILCO. Prior to the merger, FIC owned approximately 48.1% of
ILCO's common stock. The acquisition of ILCO was accounted for as a purchase;
accordingly, the results of ILCO's operations are included in the consolidated
result of operations from the date of the acquisition to June 30, 2001. The
allocation of the purchase price to the net assets acquired resulted in excess
of net assets acquired which have been estimated to be approximately $14.1
million. This estimate is based on an analysis, as of May 18, 2001, of the
acquired book of business, which estimate is subject to adjustment based on
actuarial and other analysis of the assets and liabilities acquired. For the
period from January 1, 2001 to May 17, 2001, and for the first nine months of
2000, FIC;s net income includes its equity interest in the net income of ILCO,
with such equity interest being based on FIC's percentage ownership of ILCO. -
-15 -
<page>
The pro forma unaudited results of operations for the nine months ended
September 30, 2001 and 2000, assuming the ILCO acquisition had been consummated
as of the beginning of the respective periods, are as follows:
Nine Months Ended
September 30
(In thousands, except per share data)
2001 2000
Total Revenues $104,337 $109,366
Net Income $ 10,959 $ 13,079
Net Income per share:
Basic $ 1.14 $ 1.34
Diluted $ 1.13 $ 1.32
New Accounting Pronouncements
In June 1998, the Financial Accounting Standard Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 (FAS 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 133 is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 2000, as amended by FAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FAS 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.
- 16 -
<page>
During 2001, the FASB issued Statement of Financial Accounting Standards No. 141
(FAS 141), "Business Combinations," which supersedes Accounting Principles Board
Opinion No. 16 (APB 16), "Business Combinations," and establishes guidelines to
account for business combinations under one method, the purchase method. The
most significant changes made by FAS 141 are: (1) requiring that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001, (2) establishing specific criteria for the recognition of intangible
assets separately from goodwill, and (3) requiring unallocated negative goodwill
to be written off immediately as an extraordinary gain (instead of being
deferred and amortized).
As of the earlier of the first day of the fiscal year beginning after December
15, 2001, or the date Financial Accounting Standards Statement No. 142 (FAS 142)
is initially applied in its entirety, the amount of any unamortized deferred
credit related to an excess of net assets acquired over cost arising from (a) a
business combination for which the acquisition date was before July 1, 2001, or
(b) an investment accounted for by the equity method acquired before July 1,
2001, shall be written off and recognized as the effect of a change in
accounting principle. The effect of the accounting change and related income tax
effects shall be presented in the income statement between the captions
extraordinary items and net income. The per-share information presented in the
income statement shall include the per-share effect of the accounting change.
Upon adoption of FAS 141 in the first quarter of 2002, FIC will allocate the
unamortized balance of excess of net assets acquired over cost to net income.
This amount will be recorded as a change in accounting principle.
During 2001, the FASB issued Financial Accounting Standards No. 142 (FAS 142),
"Goodwill and Other Intangible Assets," which supersedes Accounting Principles
Board Opinion No. 17 (APB 17), "Intangible Assets," and which addresses
financial accounting and reporting for acquired goodwill and other intangible
assets upon and subsequent to their acquisition. The provisions of FAS 142 will
be effective for fiscal years beginning after December 15, 2001. The most
significant changes made by FAS 142 are: (1) goodwill and indefinite lived
intangible assets will no longer be amortized, (2) goodwill will be tested for
impairment at least annually at the reporting unit level, (3) intangible assets
deemed to have an indefinite life will be tested for impairment at least
annually, and (4) the amortization period of intangible assets with finite lives
will no longer be limited to forty years. The adoption of FAS 142 is not
expected to materially affect FIC's financial position.
During 2001, the FASB issued Statement of Financial Accounting Standard No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS 144
supersedes Statement of Financial Accounting Standard No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(FAS 121) and amends Accounting Principles Bulletin Opinion No. 30, "Reporting
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" (APB 30) and Accounting Research Bulletin No. 51 (ARB 51)
"Consolidated Financial Statements". The adoption of FAS 144 did not materially
affect FIC's financial position.
During 2001, the FASB issued Statement of Financial Accounting Standards No. 143
(FAS 143), "Accounting for Asset Retirement Obligations", which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. FAS 143 is effective for financial statements issued for fiscal years
beginning after June 15, 2002, the adoption of which is not expected to
materially affect FIC's financial position.
Dividend Paid
In May, 2001, FIC announced that its Board of Directors has approved the payment
of a semi-annual cash dividend in the amount of $.25 per common share. The
dividend was paid on July 2, 2001, to record holders as of the close of business
on June 18, 2001.
- 17 -
<page>
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation
Results of Operations - Nine Months Ended September 30, 2001 and 2000
For the nine-month period ended September 30, 2001, Financial Industries
Corporation's ("FIC") net income was $8,655,000 (basic earnings of $1.19 per
common share, or diluted earnings of $1.18 per common share) as compared to
$6,586,000 (basic earnings of $1.30 per common share, or diluted earnings of
$1.28 per common share) in the first nine 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.
Earnings per share for the nine months ended September 30, 2001, were affected
by the increase in the number of FIC's common shares outstanding. The increase
is attributable to the shares issued to InterContinental Life Corporation
("ILCO") shareholders in connection with the merger described in the following
paragraph. As of September 30, 2001, the number of FIC's common shares
outstanding was 9,487,516, as compared to 5,054,661 as of September 30, 2000.
On May 18, 2001, FIC completed the merger of a subsidiary of FIC with and into
ILCO. In connection with the merger, FIC issued 1.1 shares of its common stock
for each share of ILCO common stock outstanding at the time of the merger and
not held directly by FIC or ILCO. As a result of the merger, ILCO became a
wholly-owned subsidiary of FIC. Prior to the merger, FIC owned approximately
48.1% of ILCO's common stock. Since ILCO was a wholly-owned subsidiary of FIC
for the period from May 18, 2001 to September 30, 2001, the operations of ILCO
are reported on a consolidated basis with FIC. For the period from January 1,
2001 to May 17, 2001, and for the first nine months of 2000, FIC's net income
included its equity interest in the net income of ILCO, with such equity
interest being based on FIC's percentage ownership of ILCO.
FIC's income from operations - as determined before federal income tax and
equity in net earnings of its affiliate, InterContinental Life Corporation - for
the nine-month period ended September 30, 2001, was $10,429,000 (on revenues of
$66,682,000), as compared to $4,496,000 (on revenues of $33,769,000), in the
first nine months of 2000. The consolidation of ILCO's operations for the period
from May 18, 2001 to September 30, 2001 contributed approximately $5,509,000 to
income from operations and approximately $35,935,000 to revenues for the
nine-month period ended September 30, 2001.
- 18 -
<page>
Revenues
Premium income for the first nine months of 2001, net of reinsurance ceded, was
$27.32 million, as compared to $25.35 million in the first nine months of 2000.
This source of revenues is related to the traditional life insurance book of
business of FIC's insurance subsidiaries. The consolidation of ILCO's operations
following the May 18th merger contributed approximately $3.4 million to premium
income for the nine-month period ended September 30, 2001.
Net investment income for the first nine months of 2001 was $21.47 million as
compared to $5.22 million in the same period of 2000. The consolidation of
ILCO's operations for the period from May 18, 2001 to September 30, 2001
contributed approximately $17.4 million to net investment income for the
nine-month period ended September 30, 2001. The level of investment income
contributed by the investment portfolio of Family Life Insurance Company (which
has been a subsidiary of FIC for both of the nine-month periods covered by this
report) during the current period was adversely affected by the decline in the
level of interest income received from fixed income and short-term investments.
This decline is attributable to lower interest rates during the period.
Earned insurance charges for the first nine months of 2001 were $16.95 million,
as compared to $3.20 million in the same period of 2000. This source of revenue
is related to the universal life insurance and annuity book of business of FIC's
insurance subsidiaries. The consolidation of ILCO's operations following the May
18th merger contributed approximately $14.1 million to earned insurance charges
for the nine-month period ended September 30, 2001. At Family Life, earned
insurance charges declined from $3.2 million in the 2000 period to $2.6 million
in the 2001 period. This change is attributable to a decrease in Family Life's
universal life and annuity business. The face amount of in force universal life
policies was $859.1 million at September 30, 2000 as compared to $737.6 million
at September 30, 2001.
Benefits and Expenses
Policyholder benefits and expenses were $19.62 million in the first nine months
of 2001, as compared to $10.75 million in the first nine months of 2000. The
consolidation of ILCO's operations for the period from May 18, 2001 to September
30, 2001 contributed approximately $10.6 million to policyholder benefits and
expenses for the nine-month period ended September 30, 2001. At Family Life, the
level of policyholder benefits and expenses decreased from $10.7 million for the
first nine months of 2000 to $8.8 million for the same period in 2001, which
decrease is attributable to a decrease in death benefit claims.
Interest expense on contract holders deposit funds was $12.14 million in the
first nine months of 2001, as compared to $1.56 million in the same period of
the year 2000. This increase is primarily attributable to $10.2 million of
interest expense on contract holders deposit funds resulting from the
consolidation of ILCO's operations following the May 18th merger transaction.
- 19 -
<page>
In the first nine months of 2001, the amortization of present value of future
profits of acquired business was $2.65 million as compared to $2.98 million in
the first nine months of 2000. The decreases in amortization was expected and
should continue to decrease as the underlying asset, present value of future
profits, decreases.
The amortization of deferred policy acquisition costs was $4.68 million in the
first nine months of 2001, as compared to $3.86 million in the first nine months
of 2000. The increase in amortization is attributable to the capitalization of
expenses incurred in connection with the writing of new business. The
amortization of deferred policy acquisition costs for the current period
includes costs associated with Investors-NA and Investors-IN only for the period
from May 18, 2001 to September 30, 2001, in the amount of $0.47 million.
The operating expenses for the first nine months of 2001 were $16.56 million, as
compared to $8.61 million in the first nine months of 2000. The consolidation of
ILCO's operations for the period from May 18, 2001 to September 30, 2001
contributed approximately $7.53 million to operating expenses for the nine-month
period ended September 30, 2001.
Interest expense for the first nine months of 2001 was $0.62 million, as
compared to $1.51 million in the first nine months of 2000. The decrease in the
amount of interest expenses from the first nine months of 2000 to the first nine
months of 2001 is attributable to the scheduled reduction in the amount of
outstanding indebtedness. This interest expense is related to the indebtedness
owed to Investors- NA by Family Life Corporation and FIC and includes the amount
of interest for the period from January 1, 2001 to May 18, 2001. The
consolidation of ILCO's operations with those of FIC for periods following the
May 18th merger results in the elimination of this interest expense in the
income statements of FIC and thus the interest expense amount for the three
month period ended September 20, 2001 is $0.
The provision for federal income taxes was $3.09 million in the first nine
months of 2001 as compared to $0.83 million in the first nine months of 2000.
The inclusion of ILCO's results for the period from May 18, 2001 to September
30, 2001 contributed approximately $1.67 million to the level of federal income
taxes.
Results of Operations - Three Months Ended September 30, 2001
as compared to the Three Months Ended September 30, 2000
For the three-month period ended September 30, 2001, FIC's net income was $3.81
million (basic and diluted earnings of $0.40 per common share) on revenues of
$33.97 million as compared to net income of $2.17 million (basic earnings of
$0.43 per common share and diluted earnings of $0.42 per common share) on total
revenues of $11.11 million in the same three month period of 2000. The increase
in net income and total revenues from 2000 to 2001 is primarily attributable to
the consolidation of ILCO's operations into FIC's Statements of Income for the
third quarter of 2001.
- 20 -
<page>
Equity in Net Income of InterContinental Life Corporation
For the period from January 1, 2001 to May 17, 2001, FIC's equity in the net
earnings of InterContinental Life Corporation ("ILCO"), net of federal income
tax, was $1.32 million, as compared to $2.92 million for the first nine months
of 2000. Following the merger of ILCO with FIC on May 18, 2001, the results of
ILCO were consolidated with those of FIC. Accordingly, the equity in net
earnings of affiliate results for the 2001 period are not fully comparable with
the 2000 period. Prior to the merger with ILCO, FIC owned 3,591,534 shares of
ILCO's common stock. In addition, Family Life owned 342,400 shares of ILCO
common stock. As a result, FIC owned, directly and indirectly through Family
Life, 3,933,934 shares (approximately 48.1%) of ILCO's common stock. Upon
completion of the merger, ILCO became a wholly-owned subsidiary of FIC.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. FIC is a holding company
whose principal assets currently consists of the common stock of its insurance
subsidiaries - Investors Life Insurance Company of North America
("Investors-NA"), Investors Life Insurance Company of Indiana ("Investors-IN")
and Family Life Insurance Company ("Family Life"). Prior to the merger of FIC
and ILCO on May 18, 2001, the principal assets of FIC consisted of the common
stock of its insurance subsidiary, Family Life - and its equity ownership in
ILCO. FIC's primary source of capital consists of dividends from its
subsidiaries.
Prior to the May 18th merger of ILCO with FIC, the principal source of liquidity
for FIC's subsidiaries consisted of the periodic payment of principal and
interest by Family Life pursuant to the terms of a Surplus Debenture. In June,
2001, the outstanding principal balance of the Surplus Debenture was completely
paid off. For future periods, FIC's available source of liquidity will be
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 September 30, 2001,
Investors-NA had earned surplus of $77.8 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 $28.0 million at September 30, 2001.
- 21 -
<page>
Family Life is domiciled in the State of Washington and its ability to pay
dividends to FIC is subject to the insurance regulatory requirements described
above. 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.
The sources of funds for the insurance subsidiaries of FIC consist of premium
payments from policyholders, earned insurance charges, 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
and shareholder dividends.
FIC's net cash flow provided by (used in) operating activities was $8.66 million
in the first nine months of 2001, as compared to $(0.12) million in the first
nine months of 2000. Net cash used in financing activities was $(0.51) million
in the first nine months of 2001, as compared to $(5.52) million in the first
nine months of 2000. Net cash flow provided by investing activities was $2.04
million for the nine months ended September 30, 2001, as compared to $6.55
million for the same period in 2000.
The cash requirements of FIC, and its subsidiary, Family Life Corporation
("FLC"), consist primarily of its service of the indebtedness created in
connection with FIC's ownership of Family Life. As of September 30, 2001, the
outstanding balance of such indebtedness was $30.74 million on the Subordinated
Notes granted by Investors-NA. FIC believes that the resources available to it
within the holding company group are sufficient to provide for FLC's service of
its indebtedness to Investors- NA.
The guaranty commitments of FIC under the loans incurred in connection with the
acquisition of Family Life relate to the $34.5 million loaned by Investors-NA to
a subsidiary of FIC. Prior to September 12, 2001, FIC's guaranty commitments
also consisted of a $22.5 million note issued by Family Life Corporation to
Investors Life Insurance Company of North America. That loan was fully paid off
as of September 12, 2001.
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.
- 22 -
<page>
Investments
As of September 30, 2001, FIC's investment assets totaled $762.10 million, as
compared to $99.11 million as of December 31, 2000. The increase is primarily
attributable to the inclusion of the assets of ILCO in the consolidated
financial statements of FIC.
As of September 30, 2001, the market value of the fixed maturities available for
sale segment was $470.07 million as compared to an amortized cost of $454.49
million or an unrealized gain of $15.58 million. The increase reflects
unrealized gains on such investments related to changes in interest rates
subsequent to the purchase of such investments. A portion ($1.96 million) of the
unrealized gain has been recorded as a decrease in deferred policy acquisition
costs on the consolidated balance sheet. The net of tax effect of the remainder
of this increase ($8.17 million) has been recorded as an increase in
shareholders' equity.
The level of short-term investments at September 30, 2001 was $179.84 million,
as compared to $15.62 million as of December 31, 2000. This increase is also
primarily attributable to the inclusion of the assets of ILCO in the
consolidated financial statements of FIC.
Invested real estate and other invested assets at September 30, 2001 were $56.11
million. At December 31, 2000, FIC did not have any assets invested in real
estate. The change is attributable to the consolidation of ILCO's financial
results with FIC following the May 18th merger of the two companies. The real
estate investment is related to the development of the River Place Pointe
project ("River Place Pointe") by Investors-NA, a subsidiary of ILCO. In
October, 1998, Investors-NA purchased River Place Pointe, two adjoining tracts
of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase
price for these tracts was $8.1 million. Prior to the closing of the
transaction, Investors-NA obtained a Site Development Permit for the tracts from
the City of Austin. The Site Development Permit allows for the construction of
seven office buildings totaling 600,000 square feet, with associated parking,
drives and related improvements. Construction on the first section of the
Project, which consists of four office buildings, an associated parking garage,
and related infrastructure was completed in the second quarter of 2001.
Construction on the second section continued during the third quarter of 2001,
including work on buildings six and seven.
The assets held by the life insurance subsidiaries of FIC 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".
- 23 -
<page>
The Company's fixed maturities portfolio (including short-term investments), as
of September 30, 2001, included a non-material amount (0.3% of total fixed
maturities and short-term investments) of debt securities which, in the annual
statements of the companies as filed with state insurance departments, were
designated under the National Association of Insurance Commissioners ("NAIC")
rating system as "3" (medium quality) or below. This number is primarily
attributable to mortgage bonds which one of the Company's insurance subsidiaries
owns in California utilities, which have been downgraded to a "6" (lowest
quality) rating by the NAIC. As of September 30, 2001, Investors-NA owned
mortgage bonds in Pacific Gas & Electric which were purchased for $515,000 and
had a market value as of September 30, 2001 of $450,000 and Investors-NA and
Investors-IN owned bonds in Southern California Edison which were purchased for
$1.47 million and had a market value as of September 30, 2001 of $1.30 million.
The investment objective of the Company's insurance subsidiaries emphasizes the
selection of short to medium term high quality fixed income securities, rated
Baa-3 (investment grade) or better by Moody's Investors Service, Inc. As of
September 30, 2001, only 5.8% of the Company's total assets were invested in
mortgage loans or real estate. Non-affiliated corporate debt securities that
were non-investment grade represented only 0.1% of the Company's total assets at
September 30, 2001.
The investments of FIC's insurance subsidiaries in mortgage-backed securities
included collateralized mortgage obligations ("CMOs") of $182.0 million, and
mortgage-backed pass-through securities of $34.6 million, at September 30, 2001.
Mortgage-backed pass-through securities, sequential CMO's and support bonds,
which comprised approximately 51.5% of the book value of FIC's mortgage- backed
securities at September 30, 2001, are sensitive to prepayment and extension
risks. FIC's insurance subsidiaries 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 September 30, 2001, PAC and
TAC instruments and scheduled bonds represented approximately 48.5% of the book
value of FIC's mortgage-backed securities. Sequential and support classes
represented approximately 35.5% of the book value of FIC's mortgage-backed
securities at September 30, 2001. In addition, FIC's insurance subsidiaries
limit the risk of prepayment of CMOs by not paying a premium for any CMOs. FIC's
insurance subsidiaries do not invest in mortgage- backed securities with
increased prepayment risk, such as interest-only stripped pass-through
securities and inverse floater bonds. FIC's insurance subsidiaries did not have
any z-accrual bonds as of September 30, 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's insurance subsidiaries include the making of
selected investments in CMOs.
- 24 -
<page>
FIC's insurance subsidiaries do not make new mortgage loans on commercial
properties. Substantially all of the Company's mortgage loans were made by its
subsidiaries prior to their acquisition by the Company. At September 30, 2001,
none of the mortgage loans held by the subsidiaries had defaulted as to
principal or interest for more than 90 days, and none of the Company's mortgage
loans were in foreclosure.
Another key element of the Company's investment strategy is to avoid large
exposure in other investment categories which the Company believes carry higher
credit or liquidity risks, including private placements, partnerships and bank
participations. These categories accounted for approximately 0.2% of the
Company's invested assets at September 30, 2001.
The investment portfolio of Investors-NA includes $30.74 million of notes ,
represented by (i) a loan of $30 million by Investors-NA to Family Life
Corporation made in July, 1993, in connection with the prepayment by the FIC
subsidiaries of indebtedness which had been previously issued to Merrill Lynch
as part of the 1991 acquisition of Family Life Insurance Company by a
wholly-owned subsidiary of FIC and (ii) a loan of $4.5 million by Investors-NA
to Family Life Insurance Investment Company made in July, 1993, in connection
with the same transaction described above. Prior to September 12, 2001, the
investment portfolio also included a $22.5 million loan from Investors-NA to
Family Life Corporation and a $2.5 million loan from Investors-CA to Financial
Industries Corporation (which is now owned by Investors-NA as a result of the
merger of Investors-CA into Investors-NA) and $2.0 million of additions to the
$2.5 million note made in accordance with the terms of such note. These loans
were fully paid on September 12, 2001.
As of June 12, 1996, the provisions of the notes from Investors-NA to FLC and
FLIIC were modified as follows: (a) the $30 million note was amended to provide
for forty quarterly principal payments, in the amount of $163,540 each for the
period December 12, 1996 to September 12, 2001; beginning with the principal
payment due on December 12, 2001, the amount of the principal payment increases
to $1,336,458; the final quarterly principal payment is due on September 12,
2006; the interest rate on the note remains at 9%, and (b) the $4.5 million note
was amended to provide for forty quarterly principal payments, in the amount of
$24,531 each for the period December 12, 1996 to September 12, 2001; beginning
with the principal payment due on December 12, 2001, the amount of the principal
payment increases to $200,469; the final quarterly principal payment is due on
September 12, 2006; the interest rate on the note remains at 9%.
In December, 1998, FLIIC was dissolved. In connection with the dissolution, all
of the assets and liabilities of FLIIC became the obligations of FLIIC's sole
shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5
million note described above are now the obligations of FIC.
The NAIC continued its rating of "3" to the "Notes receivable from affiliates",
as amended. These loans have not been included in the preceding description of
NAIC rating percentages.
- 25 -
<page>
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.
Accounting Developments
In June 1998, the Financial Accounting Standard Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 (FAS 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 133 is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 2000, as amended by FAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FAS 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.
During 2001, the FASB issued Statement of Financial Accounting Standards No. 141
(FAS 141), "Business Combinations," which supersedes Accounting Principles Board
Opinion No. 16 (APB 16), "Business Combinations," and establishes guidelines to
account for business combinations under one method, the purchase method. The
most significant changes made by FAS 141 are: (1) requiring that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001, (2) establishing specific criteria for the recognition of intangible
assets separately from goodwill, and (3) requiring unallocated negative goodwill
to be written off immediately as an extraordinary gain (instead of being
deferred and amortized).
As of the earlier of the first day of the fiscal year beginning after December
15, 2001, or the date Financial Accounting Standards Statement No. 142 (FAS 142)
is initially applied in its entirety, the amount of any unamortized deferred
credit related to an excess of net assets acquired over cost arising from (a) a
business combination for which the acquisition date was before July 1, 2001, or
(b) an investment accounted for by the equity method acquired before July 1,
2001, shall be written off and recognized as the effect of a change in
accounting principle. The effect of the accounting change and related income tax
effects shall be presented in the income statement between the captions
extraordinary items and net income. The per-share information presented in the
income statement shall include the per-share effect of the accounting change.
Upon adoption of FAS 141 in the first quarter of 2002, FIC will allocate the
unamortized balance of excess of net assets acquired over cost to net income.
This amount will be recorded as a change in accounting principle.
- 26 -
<page>
During 2001, the FASB issued Financial Accounting Standards No. 142 (FAS 142),
"Goodwill and Other Intangible Assets," which supersedes Accounting Principles
Board Opinion No. 17 (APB 17), "Intangible Assets," and which addresses
financial accounting and reporting for acquired goodwill and other intangible
assets upon and subsequent to their acquisition. The provisions of FAS 142 will
be effective for fiscal years beginning after December 15, 2001. The most
significant changes made by FAS 142 are: (1) goodwill and indefinite lived
intangible assets will no longer be amortized, (2) goodwill will be tested for
impairment at least annually at the reporting unit level, (3) intangible assets
deemed to have an indefinite life will be tested for impairment at least
annually, and (4) the amortization period of intangible assets with finite lives
will no longer be limited to forty years. The adoption of FAS 142 is not
expected to materially affect FIC's financial position.
During 2001, the FASB issued Statement of Financial Accounting Standard No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS 144
supersedes Statement of Financial Accounting Standard No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(FAS 121) and amends Accounting Principles Bulletin Opinion No. 30, "Reporting
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" (APB 30) and Accounting Research Bulletin No. 51 (ARB 51)
"Consolidated Financial Statements". The adoption of FAS 144 did not materially
affect FIC's financial position.
During 2001, the FASB issued Statement of Financial Accounting Standards No. 143
(FAS 143), "Accounting for Asset Retirement Obligations", which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. FAS 143 is effective for financial statements issued for fiscal years
beginning after June 15, 2002, the adoption of which is not expected to
materially affect FIC's financial position.
Other Developments
Dividend Paid
In May, 2001, FIC announced that its Board of Directors has approved the payment
of a semi-annual cash dividend in the amount of $.25 per common share. The
dividend was paid on July 2, 2001, to record holders as of the close of business
on June 18, 2001.
Events of September 11, 2001
As of the date of this report, FIC's subsidiaries have only received one claim
arising from the events of September 11, 2001. As a result, claims resulting
from September 11th did not have a material effect on results of operations,
liquidity or financial condition during the third quarter.
- 27 -
<page>
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. The Company does not use derivative financial instruments.
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 $16.1 million at
September 30, 2001 and $22.0 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 $646.7 million at September 30, 2001 and $702.7 million at
December 31, 2000.
The fixed income investments of the Company include certain mortgage-backed
securities. The market value of such securities was $228.0 million at September
30, 2001 and $251.0 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 $4.2
million at September 30, 2001 and $12.6 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.
- 28 -
<page>
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.
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 has filed a Motion
for Summary Judgment to dismiss the lawsuit, which will be heard by the court on
November 20, 2001. The plaintiffs have filed a motion with the court for
certification, which motion will be heard by the court in December, 2001. 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.
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.
- 29 -
<page>
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.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of the Shareholders was held on August 24, 2001. The
only matter submitted at the meeting to a vote of the Shareholders was the
election of directors. All of the nominees had previously served as directors of
the Company, and all were reelected as directors.
The voting tabulation as to each nominee was as follows:
Name In Favor Withheld
John D. Barnett 6,214,861 602,493
S. Tim Casey 6,194,199 623,155
Joseph F. Crowe 6,214,911 602,443
Jeffrey H. Demgen 6,194,434 622,920
Theodore A. Fleron 6,194,549 622,805
W. Lewis Gilcrease 6,199,161 618,193
James M. Grace 6,194,844 622,510
Roy F. Mitte 6,201,044 616,310
M. Scott Mitte 6,220,261 597,093
Elizabeth T. Nash 6,193,256 624,098
Frank Parker 6,217,511 599,843
Thomas C. Richmond 6,214,461 602,893
Steven P. Schmitt 6,194,974 622,380
- 30 -
<page>
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:
None
- 31 -
<page>
FINANCIAL INDUSTRIES CORPORATION AND 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/ Jeffrey Demgen
Jeffrey Demgen
Vice-President
/s/ David Hopkins
David Hopkins
Chief Accounting Officer
Date: November 14, 2001
- 32 -