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, 1999
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)
The Austin Centre, 701 Brazos, 12th Floor
Austin, Texas 78701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 404-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Number of common shares outstanding ($.20 par value) at end of period: 5,054,661
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998............................ 3
Consolidated Statements of Income
For the three and nine month periods ended
September 30, 1999 and 1998......................................... 5
Consolidated Statements of Cash Flows
For the three and nine month periods ended
September 30, 1999 and 1998......................................... 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 ...............................................24
PART II
Other Information...........................................................26
Signature Page..............................................................28
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
1999 1998
(unaudited)
ASSETS
Investments other than investments
in affiliate:
Fixed maturities available for sale
at market value (amortized cost of
$77,464 and $76,727 at September 30,
1999 and December 31, 1998, respectively) $ 77,820 $ 79,402
Equity securities at market (cost
approximates $11 at September 30,
1999 and December 31, 1998) 4 4
Policy loans 3,495 3,155
Short-term investments 25,478 27,589
--------------- -------------
Total investments 106,797 110,150
Cash 2,198 2,601
Investment in affiliate 70,164 70,950
Accrued investment income 1,103 1,209
Agency advances and other receivables 6,519 7,759
Reinsurance receivables 14,949 12,426
Due and deferred premiums 12,154 12,181
Property and equipment, net 1,758 1,758
Deferred policy acquisition costs 51,836 48,510
Present value of future profits of
acquired businesses 24,348 28,294
Other assets 4,353 5,392
Separate account assets 324 508
--------------- -------------
Total Assets $ 296,503 $ 301,738
================ ==============
The accompanying notes are an integral part of these
consolidated financial statements
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
1999 1998
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract holder
deposit funds:
Future policy benefits $ 60,913 $ 60,069
Contract holder deposit funds 44,681 45,128
Unearned premiums 14 28
Other policy claims and benefits payable 4,282 4,582
----------------- --------------
109,890 109,807
Subordinated notes payable to affiliate 43,035 47,645
Deferred federal income taxes 23,709 23,984
Other liabilities 3,516 4,474
Separate account liabilities 324 508
----------------- --------------
Total Liabilities 180,474 186,418
----------------- --------------
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 1999
and 1998 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income 62 5,898
Retained earnings 114,948 108,403
----------------- --------------
123,404 122,695
Common treasury stock, at cost, 790,639
at 1999 and 1998. (7,375) (7,375)
----------------- --------------
Total Shareholders' Equity 116,029 115,320
----------------- --------------
Total Liabilities and Shareholders' Equity $ 296,503 $ 301,738
================= ==============
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended
September 30,
1999 1998
(unaudited)
Revenues:
Premiums $ 8,516 $ 9,629
Net investment income 1,733 1,949
Earned insurance charges 1,148 1,533
Other 324 350
---------------- ----------------
11,721 13,461
Benefits and expenses:
Policyholder benefits and expenses 3,557 4,480
Interest expense on contract holders
deposit funds 345 577
Amortization of present value of future
profits of acquired businesses 1,334 1,541
Amortization of deferred policy
acquisition costs 1,354 1,272
Operating expenses 2,728 2,954
Interest expense 532 809
---------------- ----------------
9,850 11,633
---------------- ----------------
Income before federal income tax and
equity in net earnings of affiliates 1,871 1,828
Provision for federal income taxes 181 419
---------------- ----------------
Income before equity in net earnings
of affiliates 1,690 1,409
Equity in net earnings of affiliate,
net of tax 786 744
---------------- ----------------
Net income $ 2,476 $ 2,153
================ ================
The accompanying notes are an integral
part of these consolidated
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended
September 30,
1999 1998
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,428
================== ==================
Basic earnings per share $ 0.49 $ 0.40
================== ==================
Diluted:
Common stock and common stock equivalents 5,203 5,602
================== ==================
Diluted earnings per share $ 0.48 $ 0.38
================== ==================
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Nine Months Ended
September 30,
1999 1998
(unaudited)
Revenues:
Premiums $ 26,198 $ 29,350
Net investment income 5,187 5,870
Earned insurance charges 3,733 4,698
Other 1,026 1,047
---------------- -----------------
36,144 40,965
Benefits and expenses:
Policyholder benefits and expenses 11,490 12,384
Interest expense on contract holders
deposit funds 1,317 1,783
Amortization of present value of future
profits of acquired businesses 3,946 4,810
Amortization of deferred policy
acquisition costs 3,737 3,538
Operating expenses 8,450 9,553
Interest expense 1,782 2,210
---------------- -----------------
TOTAL 30,722 34,278
---------------- -----------------
Income before federal income tax and
equity in net earnings of affiliates 5,422 6,687
Provision for federal income taxes 954 1,552
---------------- -----------------
Income before equity in net earnings
of affiliates 4,468 5,135
Equity in net earnings of affiliate,
net of tax 2,077 1,844
---------------- -----------------
Net income $ 6,545 $ 6,979
================ =================
The accompanying notes are an integral part
of these consolidated statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Nine Months Ended
September 30,
1999 1998
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,428
================= =================
Basic earnings per share $ 1.29 $ 1.29
================= =================
Diluted:
Common stock and common stock equivalents 5,202 5,604
================= =================
Diluted earnings per share $ 1.26 $ 1.25
================= ================
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended
September 30,
1999 1998
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 2,476 $ 2,153
Adjustments to reconcile net income
to net cash provided by operating
activities:
Amortization of present value of future
profits of acquired business 1,334 1,541
Amortization of deferred policy
acquisition costs 1,354 1,272
Equity in undistributed earnings of
affiliate (1,389) (1,260)
Changes in assets and liabilities:
Decrease in accrued
investment income 64 334
Increase in agent advances and other
receivables (456) (1,357)
Decrease (increase) in due and
deferred premiums 288 (437)
Increase in deferred policy acquisition
costs (2,555) (2,115)
Decrease (increase) in other assets 518 (75)
Increase in policy liabilities and accruals 928 23
Increase in other liabilities 456 417
(Decrease) increase in deferred federal
income taxes (122) 870
Other, net 1,155 (195)
----------------- ------------------
Net cash provided by operating activities $ 4,051 $ 1,171
----------------- ------------------
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Three Months Ended
September 30,
1999 1998
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (8,561) $ -0-
Proceeds from sales and maturities of
fixed maturities 4,623 2,377
Increase in policy loans (218) (78)
Net change in short-term investments 2,837 (1,886)
--------------- --------------
Net cash (used in) provided by investing activities (1,319) 413
--------------- --------------
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (1,536) (1,537)
--------------- --------------
Net cash used in financing activities (1,536) (1,537)
--------------- --------------
Net increase in cash 1,196 47
Cash, beginning of period 1,002 1,210
--------------- --------------
Cash, end of period $ 2,198 $ 1,257
=============== ==============
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
1999 1998
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 6,545 $ 6,979
Adjustments to reconcile net income
to net cash provided by operating
activities:
Amortization of present value of future
profits of acquired business 3,946 4,810
Amortization of deferred policy
acquisition costs 3,737 3,538
Equity in undistributed earnings of
affiliate (3,867) (3,733)
Changes in assets and liabilities:
Decrease in accrued
investment income 106 266
Increase in agent advances and
other receivables (1,283) (2,623)
Decrease (increase) in due and deferred
premiums 27 (683)
Increase in deferred policy acquisition costs (7,063) (6,185)
Decrease in other assets 1,039 933
Increase in policy liabilities
and accruals 83 144
Decrease in other liabilities (957) (777)
(Decrease) increase in deferred federal
income taxes (282) 2,128
Other, net 1,084 (404)
---------------- ------------------
Net cash provided by operating activities $ 3,115 $ 4,393
---------------- ------------------
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Nine Months Ended
September 30,
1999 1998
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (18,557) $ (9,082)
Proceeds from sales and maturities of
fixed maturities 17,878 8,749
Increase in policy loans (340) (291)
Net change in short-term investments 2,111 1,624
Purchase & retirement of property
and equipment 0 (34)
------------- -------------
Net cash provided by investing activities 1,092 966
------------- -------------
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (4,610) (4,610)
------------- -------------
Net cash used in financing activities (4,610) (4,610)
------------ -------------
Net (decrease) increase in cash (403) 749
Cash, beginning of year 2,601 508
------------- -------------
Cash, end of period $ 2,198 $ 1,257
============= =============
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 1998, 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.
NEW ACCOUNTING PRONOUNCEMENTS
Comprehensive Income
Total comprehensive income for the nine months ended September 30, 1999 and
September 30, 1998 is $.71 million and $8.65 million, respectively.
The following is a reconciliation of accumulated other comprehensive income from
December 31, 1998 to September 30, 1999 (in thousands):
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, 1998 $ 5,900 $ (2) $ 5,898
Current Period Change (5,836) 0 (5,836)
-------- ------ --------
Balance at September 30, 1999 $ 64 $ (2) $ 62
======== ====== ========
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NEW ACCOUNTING PRONOUNCEMENTS
In December 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments," which provides guidance on accounting for
insurance-related assessments. The Company adopted SOP 97-3 effective January 1,
1999. The adoption of SOP 97-3 did not have a material impact on the Company's
results of operations, liquidity or financial position.
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 FASB Statements No. 133. The operations of the Company are not
affected by the provisions of FAS No. 133.
- 14 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATION:
For the nine-month period ended September 30, 1999, Financial Industries
Corporation's ("FIC") net income was $6,545,000 (basic earnings of $1.29 per
common share, or diluted earnings of $1.26 per common share) as compared to
$6,979,000 (basic earnings of $1.29 per common share, or diluted earnings of
$1.25 per common share) in the first nine months of 1998. 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, 1999, was $5,422,000 (on revenues of
$36,144,000), as compared to $6,687,000 (on revenues of $40,965,000) in the
first nine months of 1998.
Earnings per share (basic and diluted) for the nine-month period ended September
30, 1999 include $.03 per share due to the decrease in the number of common
shares outstanding resulting from (i) FIC's purchase on November 17, 1998 of
101,304 shares of FIC's common stock from the Roy F. and Joann Cole Mitte
Foundation (the "Foundation"), a Texas non-profit corporation which is
controlled by Mr. Mitte and his wife, at a price of $18.625 per share (or a
total purchase price of $1,886,787) and (ii) Family Life Insurance Company's
purchase on November 17, 1998 of 272,000 shares of FIC's common stock from the
Foundation at a price of $18.625 per share (or a total purchase price of
$5,066,000).
Premiums for the first nine months of 1999, net of reinsurance ceded, were $26.2
million, as compared to $29.4 million in the first nine months of 1998.
Policyholder benefits and expenses were $11.5 million in the 1999 period, as
compared to $12.4 million in the first nine months of 1998.
As of September 30, 1999, the market value of the fixed maturities available for
sale segment was $77.8 million as compared to an amortized value of $77.5
million, or an unrealized gain of $0.3 million. The increase reflects unrealized
gains on such investments related to changes in interest rates subsequent to the
purchase of such investments. There is no assurance that this gain will be
realized in the future. The net of tax effect of this increase ($0.2 million at
September 30, 1999) has been recorded as an increase in shareholders' equity. As
required under the provisions of FAS No. 130, the determination of "Accumulated
other comprehensive
- 15 -
income" includes separate identification of the change in values which occurred
during the current period.
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.
Equity in Net Income of InterContinental Life Corporation
General:
For the nine-month period ended September 30, 1999, the Company's equity in the
net earnings of InterContinental Life Corporation ("ILCO"), net of federal
income tax, was $2,077,000 , as compared to $1,844,000 for the first nine months
of 1998.
On March 17, 1999, ILCO paid a stock dividend (one share of common stock for
each outstanding share of common stock). FIC currently owns 3,590,292 shares of
ILCO's common stock. In addition, Family Life currently owns 342,400 shares of
ILCO common stock. As a result, FIC currently owns, directly and indirectly
through Family Life, 3,932,692 shares (approximately 45%) of ILCO's common
stock.
Prior to September 30, 1998, FIC held options to acquire (on a pre-dividend
basis) an additional 1,702,155 shares. The options were granted under an option
agreement between FIC and ILCO which was entered into in March, 1986 ("Option
Agreement"). The Option Agreement provided that it continued in effect as long
as FIC guaranteed indebtedness of ILCO. Since the Senior Loan of ILCO was fully
repaid on September 30, 1998, FIC's rights under the Option Agreement expired on
September 30, 1998.
As of September 30, 1999, the market value of ILCO's fixed maturities available
for sale segment was $409.4 million as compared to an amortized cost of $410.04
million, or an unrealized loss of $0.64 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 45%
of the common stock of ILCO, the net of tax effect of this decrease ($0.2
million at September 30, 1999) is included in "Accumulated other comprehensive
income" on the Consolidated Balance Sheets and has been recorded as an 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 (formerly
InterContinental Life Insurance Company). ILCO's primary source of funds
consists of payments under the surplus debentures from Investors-NA.
- 16 -
Prior to September 30, 1998, the cash requirements of ILCO consisted primarily
of its service of the indebtedness created in connection with the 1988
acquisition of the Investors Life Companies and the 1995 acquisition of Meridian
Life Insurance Company (which company was subsequently merged into another life
insurance subsidiary of ILCO). As of December 31, 1997, the outstanding
principal balance of ILCO's senior loan obligations was $11.0 million, which
reflected the prepayment by ILCO of the payment originally scheduled for January
1, 1998. A regular payment in the amount of $3.7 million was made on April 1,
1998, and a prepayment of the July 1, 1998 installment, in the amount of $3.7
million, was made on June 30, 1998. The outstanding principal balance of ILCO's
senior loan obligations was $3.6 million at June 30, 1998. The final installment
on the senior loan obligation scheduled for October 1, 1998, was prepaid on
September 30, 1998. As a result, the senior loan obligation of ILCO was fully
discharged effective September 30, 1998.
ILCO's principal source of liquidity consists of the periodic payment of
principal and interest to it by Investors-NA, pursuant to the terms of the two
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 September 30, 1999, the outstanding principal
balances of the surplus debentures were $1.5 million and $6.9 million,
respectively. The terms of the latter of the two Surplus Debentures required
final payment of the remaining principal balance on September 30, 1999.
Effective September 28, 1999, the ILCO and Investors-NA amended the payment
schedule to provide payment of the remaining balance in four installments, with
the final installment being due July 1, 2000. Since Investors-NA is domiciled in
the State of Washington, the Washington insurance law applies to the
administration of the terms of the surplus debentures. Under the provisions of
the surplus debentures and current law, no prior approval of the Washington
Insurance Commissioner is required for Investors-NA to pay interest or principal
on the surplus debentures; provided that, after giving effect to such payments,
the statutory surplus of Investors- NA is in excess of $10 million (the "surplus
floor"). However, Investors-NA 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,
1999, the statutory capital and surplus of Investors-NA was $70.2 million, an
amount substantially in excess of the surplus floor. The funds required by
Investors-NA to meet its obligations to ILCO under the terms of the surplus
debentures are generated from operating income generated from insurance and
investment operations.
In addition to the payments under the terms of the Surplus Debentures, ILCO has
received dividends from its subsidiaries. Washington's insurance code 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 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 policyholder surplus or (ii) the
insurer's net gain from operations for the previous year. As of September 30,
1999, Investors-NA had earned surplus of $46.0 million.
- 17 -
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 $17.6 million at September 30, 1999. 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, 1999 and
September 30, 1998, 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, 1999, the outstanding balance of such indebtedness was
$43.0 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,
1999, the statutory capital and surplus of Family Life was $27.6 million, an
amount substantially in excess of the surplus floor. As of September 30, 1999,
the principal balance of the Surplus Debenture was $16.1 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.
- 18 -
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 $3.1 million in the
first nine months of 1999, as compared to $4.4 million in the first nine months
of 1998. Net cash flow used in financing activities was $4.6 million in the
first nine months of 1999, as compared to $4.6 million in the first nine months
of 1998.
In connection with the purchase of the Investors Life Companies by ILCO and the
purchase of Family Life by a wholly-owned subsidiary of FIC, FIC guaranteed the
payment of the indebtedness created in connection with such acquisitions. After
giving effect to the refinancing of the ILCO Senior Loan and the repayment of
the ILCO Subordinated Loans, the guaranty commitments of FIC with respect to the
debt obligations of ILCO related to the ILCO Senior Loan. The outstanding
principal balance of ILCO's senior loan obligations was $3.6 million at June 30,
1998. The final installment on the Senior Loan obligation scheduled for October
1, 1998, was prepaid on September 30, 1998. As a result, the Senior Loan
obligation of ILCO was fully discharged effective September 30, 1998, relieving
FIC of the guaranty commitments with respect to the debt obligations of ILCO.
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.
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Investments
As of September 30, 1999, the Company's investment assets totaled $106.8
million, as compared to $110.2 million as of December 31, 1998.
The level of short-term investments at September 30, 1999 was $25.5 million, as
compared to $27.6 million as of December 31, 1998. The fixed maturities
available for sale portion represents $77.8 million of investment assets as of
September 30, 1999, as compared to $79.4 million at December 31, 1998. The
amortized cost of fixed maturities available for sale as of September 30, 1999
was $77.5 million representing a net unrealized gain of $0.3 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, 1999,
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 $22.1 million and $182.1 million, respectively, and mortgage-backed
pass-through securities of $5.6 million and $30.7 million, respectively, at
September 30, 1999. Mortgage-backed pass-through securities, sequential CMO's
and support bonds, which comprised approximately 44.1% of the book value of
FIC's mortgage-backed securities and 52.0% of the book value of ILCO's
mortgage-backed securities at September 30, 1999, 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, 1999, PAC and TAC
instruments and scheduled bonds represented approximately 55.9% of the book
value of FIC's mortgage-backed securities and approximately 48.0% of the book
value of ILCO's mortgage-backed securities. Sequential and support classes
represented approximately 24.0% of the book value of FIC's mortgage-backed
securities and approximately 37.6% of the book value of ILCO's mortgage-backed
securities at September 30, 1999. 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
- 20 -
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, 1999. 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. Neither FIC nor ILCO made additional
investments in CMOs during 1998 and the first three quarters of 1999. The
current investment objectives of both FIC and ILCO do not contemplate additions
to the portfolio of CMO investments during the remainder of 1999.
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.
Y2K Compliance
The Company and its subsidiaries utilize a centralized computer system to
process policyholder records and financial information. In addition, the Company
uses non-centralized computer terminals in connection with its operations. The
software programs used in connection with these systems will be affected by what
is referred to as the "Y2K date problem". This refers to the limitations of the
programming code in certain existing software programs to recognize date
sensitive information as the year 2000 approaches. Unless modified prior to the
year 2000, such systems may not properly recognize such information and could
generate erroneous data or cause a system to fail to operate properly.
The Company has evaluated its centralized computer systems and has developed a
plan to reach Y2K compliance. A central feature of the plan is to convert most
of the centralized systems to a common system which is already in compliance
with Y2K requirements. The Company has completed this system conversion, except
as it relates to the conversion of approximately 560 active policies and
additional testing of previously completed conversions. The Company has
increased the budget for the implementation and completion of the Plan from the
prior years estimate. As of December 31, 1997, the Company had budgeted
approximately $330,000 for implementing the Plan. Based on its current analysis,
the Company expects that the cost of implementing and completing the Plan will
result in an after-tax expense of approximately $898,000 for the three-year
(1997 - 1999) conversion period. For the three month period ended September 30,
1999, the Company has incurred an after tax expense of approximately $34,400 in
connection with the completion of the Plan. Between January 1, 1997 and
September 30, 1999, the Company has expended approximately 84% of the three-year
expected after-tax cost discussed above.
The Plan called for an upgrade of the Family Life's administrative systems by
changing individual lines of computer code in order to modify current operating
software such that it will become Y2K compliant. This process included
approximately 29 sub-systems which provide data input to the main systems. The
administrative systems which were not modified were
- 21 -
converted onto the Company's CK/4 System, a system designed to be Y2K compliant
according to the representations of the vendor.
The systems which administer a substantial number of Family Life policies will
be modified rather than converted. The modification of the PMS system
(administering approximately 100,880 policies for Family Life) was completed in
March, 1998. The conversion of the Cypros AP system (administering approximately
22,210 active policies for Family Life) was completed in October of 1999.
A small number of Family Life policies are administered by systems which also
administer policies for ILCO and its subsidiaries. With regard to ILCO and its
subsidiaries, the ALIS system (administering approximately 42,000 active
policies for Investors-NA at the time of conversion) was converted to CK/4 in
January of 1998. The conversion of the Life 70 system (administering
approximately 15,300 active policies for Investors-IN) was completed in May of
1999. The modification of the Lifecomm-B system which is responsible for the
administration of approximately 16,900 active policies assumed after ILCO's
acquisition of State Auto Life was also completed. As of June 30, 1999, the
Lifecomm-A system administered approximately 57,140 active policies for
Investors-NA and 2000 active policies for Family Life. As of September 30, 1999,
the conversion of all but approximately 6,130 active policies for Investors- NA
and 560 active policies for Family Life had been completed. The majority of
those conversions were completed in November, and the Company expects the
conversion of the remaining Lifecomm-A policies to be completed before the end
of November, 1999.
The Company also faces the risk that one or more of its external suppliers of
goods or services ("third party providers") will not be in a position to
properly interact with the Company due to the inability of such third party
provider to resolve its own Y2K issues. The Company has completed an inventory
of its third party provider relationships. In order to assess the Y2K readiness
of such third party providers, the Company has developed and forwarded a
detailed questionnaire to such providers. The Company has received responses and
assurances of Y2K readiness from all of its mission critical external suppliers,
as well as many of its non-mission critical suppliers. The receipt and
evaluation of responses is on-going, and the Company will consider whether to
continue relationships with external suppliers who fail to respond to the
questionnaire.
In 1997, FIC Computer Services - a subsidiary of FIC which provides data
processing services for the Company and its affiliates - purchased new mainframe
hardware and accompanying operating software, which the vendor has represented
to be Y2K compliant. This hardware and software was tested in 1998. The
telephone system has been tested by the maintenance provider for that system and
the Company has received assurances that the telephone system is Y2K compliant.
With respect to non-centralized systems (i.e., desktop computers), the Company
has obtained updated software releases and new hardware designed to be Y2K
compliant according to the representations of the vendors. The Company expects
that the effort needed to correct for Y2K problems on such systems will be less
time intensive than the effort needed to achieve
- 22 -
compliance for its centralized systems. The installation of such new PC hardware
and software was commenced in early 1999, and was completed in mid-November,
1999.
In the event that a major administrative system fails to operate properly due to
the Y2K problem, or the Company does not complete the necessary systems
conversions prior to January 1, 2000, the Company has developed a plan to
respond to such a contingency. FIC Computer Services has assigned certain
personnel to be members of an emergency response team to resolve Y2K operations
problems. Additionally, insurance policies would be administered manually if the
necessary systems conversions were not completed prior to January 1, 2000, or
subsequent Y2K operations problems persist. Manual policy administration would
require additional personnel. If substantial additional personnel become
necessary for manual policy administration, the training and salary expenses of
such personnel could materially affect the Company's business and results of
operations. The Company is not able to estimate the likelihood that manual
administration will be needed or the amount of any expense which it would incur
in connection with such manual administration.
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,
Y2K risks 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, (3) adverse regulatory changes affecting the business of insurance and
(4) adverse changes in the Y2K readiness of the Company or its significant third
party providers.
Accounting Developments
In December, 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", which provides guidance on accounting for
insurance-related assessments. The Company adopted SOP 97-3, effective January
1, 1999. The adoption of SOP 97-3 did not have a material impact on the
Company's results of operations, liquidity or financial position.
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 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 FASB Statement No. 133." As the Company does
not have significant
- 23 -
investments in derivative financial instruments, the adoption of FAS No. 133
does not 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. 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 45% 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
$3.5 million at September 30, 1999 and $2.5 million at December 31,
1998. 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 $103.3
million at September 30, 1999 and $107.0 million at December 31, 1998.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was
$27.9 million at September 30, 1999 and $33.9 million at December 31,
1998. Assuming an immediate increase of 100 basis points in interest
rates, the net hypothetical loss in the fair market value related to
such
- 24 -
mortgage-backed securities is estimated to be $1.5 million at September
30, 1999 and $1.2 million at December 31, 1998.
(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
$6.4 million at September 30, 1999 and $4.6 million at December 31,
1998.
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.
- 25 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
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 involves the
same type of policy and includes allegations which are substantially identical
to the allegations in the first action. The named plaintiff also seeks class
certification. The Company believes that the court would consider class
certification with respect to only one of these actions. The Company also
believes that this action is without merit and intends to vigorously defend this
matter.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
- 26 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Form 10-K Annual Report of Registrant for the year ended
December 31, 1998 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K:
None
- 27 -
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 12, 1999
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