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, 2000
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 Boulevard, Building I
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.
- 1 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2000 and December 31, 1999..............................3
Consolidated Statements of Income
For the three and nine month periods ended
September 30, 2000 and September 30, 1999.............................5
Consolidated Statements of Cash Flows
For the three and nine month periods ended
September 30, 2000 and September 30, 1999 . . . .. . . . . . . . . . .9
Notes to Consolidated Financial Statements....................................13
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations.......................15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ................................................20
Part II
Other Information............................................................22
Signature Page...............................................................24
- 2 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2000 1999
(unaudited)
ASSETS
Investments other than investments in affiliate:
Fixed maturities available for sale
at market value (amortized cost of $78,667
and $78,252 at September 30, 2000 and
December 31, 1999, respectively ) $ 78,840 $ 77,515
Equity securities at market (cost
approximates $11 at September 30, 2000
and December 31, 1999) 4 4
Policy loans 3,676 3,595
Short-term investments 17,370 24,839
Total investments 99,890 105,953
Cash 1,613 692
Investment in affiliate 75,681 70,013
Accrued investment income 1,182 1,180
Agency advances and other receivables 6,534 6,885
Reinsurance receivables 16,781 14,848
Due and deferred premiums 12,541 12,392
Property and equipment, net 1,318 1,355
Deferred policy acquisition costs 55,447 52,490
Present value of future profits of
acquired businesses 20,125 23,109
Other assets 4,778 4,758
Separate account assets 0 379
Total Assets $ 295,890 $ 294,054
The accompanying notes are an integral part of these
consolidated financial statements
- 3 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2000 1999
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract
holder deposit funds:
Future policy benefits $ 61,735 $ 59,783
Contract holder deposit funds 43,515 44,681
Unearned premiums 0 14
Other policy claims and
benefits payable 3,111 4,282
108,361 108,760
Subordinated notes payable to affiliate 36,886 41,497
Deferred federal income taxes 23,200 23,222
Other liabilities 4,031 4,079
Separate account liabilities 0 ___ 379
Total Liabilities 172,478 177,937
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 2000 and 1999 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income (838) (2,454)
Retained earnings 123,231 117,552
130,787 123,492
Common treasury stock, at cost, 790,639
at 2000 and 1999. (7,375) (7,375)
Total Shareholders" Equity 123,412 116,117
Total Liabilities and
Shareholders' Equity $ 295,890 $ 294,054
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended Sept. 30,
2000 1999
(unaudited)
Revenues:
Premiums $ 8,503 $ 8,516
Net investment income 1,780 1,733
Earned insurance charges 824 1,148
Other 3 324
11,110 11,721
Benefits and expenses:
Policyholder benefits and expenses 3,528 3,557
Interest expense on contract holders
deposit funds 496 345
Amortization of present value of future
profits of acquired businesses 1,112 1,334
Amortization of deferred policy
acquisition costs 1,417 1,354
Operating expenses 2,674 2,728
Interest expense 501 532
9,728 9,850
Income before federal income tax and
equity in net earnings of affiliates 1,382 1,871
Provision for federal income taxes 256 181
Income before equity in net earnings
of affiliates 1,126 1,690
Equity in net earnings of affiliate,
net of taxes 1,041 786
Net Income $ 2,167 $ 2,476
The accompanying notes are an integral part of these
consolidated statements.
- 5 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended Sept. 30,
2000 1999
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,055
Basic earnings per share $ 0.43 $ 0.49
Diluted:
Common stock and common stock equivalents 5,160 5,203
Diluted earnings per share $ 0.42 $ 0.48
The accompanying notes are an integral part of these
consolidated financial statements.
- 6 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Nine Months Ended Sept. 30,
2000 1999
(unaudited)
Revenues:
Premiums $ 25,347 $ 26,198
Net investment income 5,220 5,187
Earned insurance charges 3,196 3,733
Other 6 1,026
33,769 36,144
Benefits and expenses:
Policyholder benefits and expenses 10,749 11,490
Interest expense on contract holders
deposit funds 1,555 1,317
Amortization of present value of future
profits of acquired businesses 2,984 3,946
Amortization of deferred policy
acquisition costs 3,860 3,737
Operating expenses 8,612 8,450
Interest expense 1,513 1,782
Total 29,273 30,722
Income before federal income tax and
equity in net earnings of affiliates 4,496 5,422
Provision for federal income taxes 834 954
Income before equity in net earnings
of affiliates 3,662 4,468
Equity in net earnings of affiliate,
net of tax 2,924 2,077
Net Income $ 6,586 $ 6,545
The accompanying notes are an integral part of
these consolidated statements.
- 7 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Nine Months Ended Sept. 30,
2000 1999
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,055
Basic earnings per share $ 1.30 $ 1.29
Diluted:
Common stock and common stock equivalents 5,163 5,202
Diluted earnings per share $ 1.28 $ 1.26
The accompanying notes are an integral part of these
consolidated financial statements.
- 8 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended Sept. 30,
2000 1999
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 2,167 $ 2,476
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 1,112 1,334
Amortization of deferred policy
acquisition costs 1,417 1,354
Equity in undistributed earnings
of affiliate (1,534) (1,389)
Changes in assets and liabilities:
(Increase) decrease in accrued
investment income 62 64
Increase in agent advances and other
receivables (73) (456)
(Increase) decrease in due and
deferred premiums (26) 288
Increase in deferred policy acquisition
costs (2,624) (2,555)
Decrease in other assets 13 518
(Increase) decrease in policy liabilities
and accruals (308) 928
Increase in other liabilities 281 456
Increase (decrease) in deferred federal
income taxes 102 (122)
Other, net (246) 1,155
Net cash (used in) provided by operating
activities $ 343 $ 4,051
The accompanying notes are an integral part of these
consolidated financial statements.
- 9 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Three Months Ended Sept. 30,
2000 1999
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (500) $ (8,561)
Proceeds from sales and maturities of
fixed maturities 3,279 4,623
Increase in policy loans (73) (218)
Net change in short-term investments (1,080) 2,837
Purchase & retirement of property
and equipment 0 0
Net cash provided by (used in)
investing activities 1,626 (1,319)
CASH FLOW FROM FINANCING
ACTIVITIES
Dividends paid 0 0
Repayment of subordinated notes payable (1,537) (1,536)
Net cash used in financing activities (1,537) (1,536)
Net increase in cash 432 1,196
Cash, beginning of period 1,181 1,002
Cash, end of period $ 1,613 $ 2,198
The accompanying notes are an integral part of these
consolidated financial statements.
- 10 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended Sept. 30,
2000 1999
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 6,586 $ 6,545
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 2,984 3,946
Amortization of deferred policy
acquisition costs 3,860 3,737
Equity in undistributed earnings of affiliate (4,565) (3,867)
Changes in assets and liabilities:
(Increase) decrease in accrued
investment income (2) 106
Increase in agent advances and
other receivables (1,582) (1,283)
(Increase) decrease in due and deferred premiums (149) 27
Increase in deferred policy acquisition costs (6,817) (7,063)
(Increase) decrease in other assets (20) 1,039
(Decrease) increase in policy liabilities
and accruals (399) 83
Decrease in other liabilities (48) (957)
Decrease in deferred federal income taxes (22) (282)
Other, net 59 1,084
Net cash (used in) provided by
operating activities $ (115) $ 3,115
The accompanying notes are an integral part of these
consolidated financial statements.
- 11 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Nine Months Ended Sept. 30,
2000 1999
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (10,788) $ (18,557)
Proceeds from sales and maturities of
fixed maturities 9,917 17,878
Increase in policy loans (81) (340)
Net change in short-term investments 7,469 2,111
Purchase & retirement of property
and equipment 37 0
Net cash provided by investing activities 6,554 1,092
CASH FLOW FROM FINANCING
ACTIVITIES
Dividends paid (907) 0
Repayment of subordinated notes payable (4,611) (4,610)
Net cash used in financing activities (5,518) (4,610)
Net increase (decrease) in cash 921 (403)
Cash, beginning of year 692 2,601
Cash, end of period $ 1,613 $ 2,198
The accompanying notes are an integral part of these
consolidated financial statements.
- 12 -
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, 1999, 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
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, 1999 to September 30, 2000 (in thousands):
Net Total
Net unrealized gain appreciation accumulated
(loss) on investments (depreciation) other
in fixed maturities of equity comprehensive
available for sale securities income
Balance at
December 31, 1999 $ (2,454) $ (0) $ (2,454)
Current Period Change 1,618 (2) 1,616
Balance at
September 30, 2000 $ (836) $ (2) $ (838)
Accumulated other comprehensive income of FIC includes approximately $943,000 of
net unrealized losses from FIC"s affiliate, ILCO.
- 13 -
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 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 No. 133 is
not anticipated to have a material impact on the Company's results of
operations, liquidity or financial position.
Dividends Declared
On January 17, 2000, FIC's Board of Directors approved a cash dividend in the
amount of $.18 per common share. The dividend was paid on April 12, 2000 to
shareholders of record on April 5, 2000.
- 14 -
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation
The following discussion addresses the results of operations of Financial
Industries Corporation ("FIC") for the nine months ended September 30, 2000
compared with the same nine-month period last year, and the financial condition
of as of September 30, 2000, compared with December 31, 1999.
For the nine-month period ended September 30, 2000, FIC's net income was
$6,586,000 (basic earnings of $1.30 per common share, or diluted earnings of
$1.28 per common share) as compared to $6,545,000 (basic earnings of $1.29 per
common share, or diluted earnings of $1.26 per common share) in the first nine
months of 1999. 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.
Results of Operations
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, 2000, was $4,496,000 (on revenues of
$33,769,000), as compared to $5,422,000 (on revenues of $36,144,000) in the
first nine months of 1999.
Premiums for the first nine months of 2000, net of reinsurance ceded, were $25.3
million, as compared to $26.2 million in the first nine months of 1999.
Policyholder benefits and expenses were $10.7 million in the third quarter of
2000, as compared to $11.5 million in the first nine months of 1999.
As of September 30, 2000, the market value of the fixed maturities available for
sale segment was $78.84 million as compared to an amortized cost of $78.67
million, or an unrealized gain of $.17 million. The increase reflects unrealized
gains on such investments related to changes in interest rates subsequent to the
purchase of such investments. The net of tax effect of this increase ($.11
million at September 30, 2000) has been recorded as an increase in shareholders'
equity.
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.
- 15 -
Equity in Net Income of InterContinental Life Corporation
General
For the nine-month period ended September 30, 2000, the Company's equity in the
net earnings of InterContinental Life Corporation ("ILCO"), net of federal
income tax, was $2,924,000, as compared to $2,077,000 for the first nine months
of 1999.
As of September 30, 2000, FIC owned 3,590,292 shares of ILCO's common stock. In
addition, FIC's wholly-owned life insurance subsidiary, Family Life Insurance
Company ('Family Life"), owned 342,400 shares of ILCO common stock. As a result,
as of September 30, 2000, FIC owned, directly and indirectly through Family
Life, 3,932,692 shares (approximately 48.4 %) of ILCO's common stock.
As of September 30, 2000, the market value of ILCO's fixed maturities available
for sale segment was $445.61 million as compared to an amortized cost of $448.89
million, or an unrealized loss of $3.28 million. The decrease reflects
unrealized losses on such investments related to changes in interest rates
subsequent to the purchase of such investments. Since FIC owns approximately 48
% of the common stock of ILCO, the net of tax effect of this decrease
(approximately $1.0 million at September 30, 2000) is included in "Accumulated
other comprehensive loss" on the Consolidated Balance Sheets and has been
recorded as a decrease in shareholders' equity.
Liquidity and Capital Resources of ILCO
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"). Prior
to June 30, 2000, ILCO's primary source of funds consisted of payments under the
surplus debentures from Investors-NA.
Prior to June 30, 2000, ILCO's principal source of liquidity consisted of the
periodic payment of principal and interest to it by Investors-NA, pursuant to
the terms of two surplus debentures (the "Surplus Debentures"). 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, ILCOs available source of liquidity
would be from dividends paid to it from its subsidiaries, Investors-NA and
Investors-IN. Applicable state insurance laws may limit the ability of such
subsidiaries to pay dividends to ILCO. Investors-NA is domiciled in the State of
Washington. The Washington insurance law includes the "greater of" standard for
payment of dividends to shareholders, but has a requirement that prior
notification of a proposed dividend be given to the Washington Insurance
- 16 -
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, 2000,
Investors-NA had earned surplus of $ 52.9 million.
Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance
law, 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 $20.86 million at September 30, 2000. In
June, 1999, Investors- IN paid a dividend in the amount of $3 million to its
sole shareholder, Investors-NA. The amount of the dividend was less than the net
gain from operations for the prior fiscal year; accordingly, no prior approval
was required for the payment of the dividend. Advance notice of the payment was
provided to the Indiana Department of Insurance, in accordance with the
provisions of the Indiana Insurance Code.
The Form 10-Qs of ILCO for the nine-month periods ended September 30, 2000 and
September 30,1999, 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.
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
consists of cash flow from operations of its subsidiaries.
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 September 30, 2000, the outstanding balance of such indebtedness was
$36.9 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 September 30,
2000, the statutory capital and surplus of Family Life was $24.1 million, an
- 17 -
amount substantially in excess of the surplus floor. As of September 30, 2000,
the principal balance of the Surplus Debenture was $7.88 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 Family Life will have any difficulty in making principal and
interest payments on the Surplus Debenture in the amounts necessary to enable
Family Life Corporation to service its indebtedness for the foreseeable future.
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.
FIC's net cash flow provided by operating activities was $(0.115 million in the
first nine months of 2000, as compared to $3.1 million in the first nine months
of 1999. Net cash flow used in financing activities was $5.5 million in the
first nine months of 2000, as compared to $4.6 million in the first nine months
of 1999.
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 September 30, 2000, the Company's investment assets totaled $99.9 million,
as compared to $105.95 million as of December 31, 1999.
- 18 -
The level of short-term investments at September 30, 2000 was $17.4 million, as
compared to $24.8 million as of December 31, 1999. The fixed maturities
available for sale portion represents $78.84 million of investment assets as of
September 30, 2000, as compared to $77.5 million at December 31, 1999. The
amortized cost of fixed maturities available for sale as of September 30, 2000
was $78.67 million representing a net unrealized gain of $.17 million. This
unrealized gain principally reflects changes in interest rates from the date the
respective investments were purchased. To reduce the exposure to interest rate
changes, portfolio investments are selected so that diversity, maturity and
liquidity factors approximate the duration of associated policyholder
liabilities.
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 September 30, 2000,
consisted solely of fixed maturities investments 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 a "1" (highest quality).
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $22.0 million and $176.2 million, respectively, and mortgage-backed
pass-through securities of $28.8 million and $44.4 million, respectively, at
September 30, 2000. Mortgage-backed pass-through securities, sequential CMO's
and support bonds, which comprised approximately 50.3 % of the book value of
FIC's mortgage-backed securities and 55.5 % of the book value of ILCO's
mortgage-backed securities at September 30, 2000, 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 September 30, 2000, PAC and TAC
instruments and scheduled bonds represented approximately 49.7% of the book
value of FIC's mortgage-backed securities and approximately 44.5 % of the book
value of ILCO's mortgage-backed securities. Sequential and support classes
represented approximately 21.5 % of the book value of FIC's mortgage-backed
securities and approximately 35.3 % of the book value of ILCO's mortgage-backed
securities at September 30, 2000. 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 September 30, 2000. The
prepayment risk that certain mortgage-backed securities are subject to is
prevalent in periods of declining interest rates, when mortgages may be repaid
- 19 -
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. Neither FIC nor ILCO made additional investments in CMOs
during 1999. For the year 2000, 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, provide
security to its policyholders and to credit relatively consistent rates of
return to its policyholders.
Cautionary Statements for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act of 1995
Except for historical factual information set forth in this Management's
Discussion and Analysis, certain statements made in this report are forward
looking and contain information about financial results, economic conditions and
other risks and known uncertainties. The Company cautions the reader that actual
results could differ materially from those anticipated by the Company, depending
upon the eventual outcome of certain factors, including: (1) heightened
competition for new business, (2) significant changes in interest rates and (3)
adverse regulatory changes affecting the business of insurance.
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 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
No. 133 is not anticipated to have a material impact on the Company's results of
operations, liquidity or financial position.
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.
- 20 -
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 own approximately 48.4 % 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.
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 $ 3.2 million at September 30, 2000 and $9.7 million
at December 31, 1999. 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 $ 96.2 million at September 30, 2000 and $102.4
million at December 31, 1999.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was
$30.9 million at September 30, 2000 and $ 27.3 million at December 31,
1999. 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 $ 1.3 million at
September 30, 2000 and $ 1.9 million at December 31, 1999.
(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 $6.5 million at September 30, 2000 and $6.3 million at
December 31, 1999.
- 21 -
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.
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. 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.
In August, 1997, another individual filed a similar action in Travis County,
Texas against the corporate entities identified above. The lawsuit involved the
same type of policy and includes allegations which are substantially identical
to the allegations in the first action. In July, 2000, the court, on its own
motion, moved to dismiss the action for failure on the part of the plaintiff to
prosecute the matter. The plaintiff did not file a motion to retain the case and
the matter has been removed from the court's docket.
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
- 22 -
Item 5. Other Information
a. As previously reported in a press release dated October 13, 2000,
the Board of Directors of the Company has established a Special
Committee of outside directors of the Board to explore a merger with
InterContinental Life Corporation ("ILCO"). FIC owns approximately 48%
of the common stock of ILCO. The Board and the Special Committee have
received a report on an actuarial evaluation of the Company and ILCO,
which was performed by an independent actuarial consulting firm. The
Special Committee will review the actuarial evaluation and other
pertinent information and furnish a recommendation on the merger
proposal to the Board. As of the date of this report on Form 10-Q, no
date has been set for the next meeting of the Board of Directors of
the Company.
b. On October, 10, 2000, Charles K. Chacosky submitted his resignation
as a director and officer of the Company and its life insurance
company subsidiaries. Mr. Chacosky advised the Board that his
resignation was for personal reasons.
c. On October 5, 2000, Dale E. Mitte submitted his resignation as a
director of the Company, since his health condition does not permit
him to actively participate in the work of the Board.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Form 10-K Annual Report of Registrant for the year ended
December 31, 1999 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K
None.
- 23 -
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/ James M. Grace
James M. Grace, Treasurer
Date: November 14, 2000
- 24 -