SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the Quarterly Period Ended March 31, 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
March 31, 1999 and December 31, 1998................................ 3
Consolidated Statements of Income
For the three month periods ended
March 31, 1999 and 1998............................................. 5
Consolidated Statements of Cash Flows
For the three month periods ended
March 31, 1999 and 1998............................................. 7
Notes to Consolidated Financial Statements....................................9
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations......................12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk .............................................. 19
Part II
Other Information...........................................................22
Signature Page..............................................................23
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
(unaudited)
<S> <C> <C>
ASSETS
Investments other than investments
in affiliate:
Fixed maturities available for
sale at market value (amortized
cost of $74,194 and $76,727 at
March 31, 1999 and December 31,
1998, respectively ) $ 76,523 $ 79,402
Equity securities at market (cost
approximates $11 at March 31, 1999
and December 31, 1998) 4 4
Policy loans 3,233 3,155
Short-term investments 30,192 27,589
--------- ---------
Total investments 109,952 110,150
Cash 1,758 2,601
Investment in affiliate 71,571 70,950
Accrued investment income 981 1,209
Agency advances and other receivables 7,990 7,759
Reinsurance receivables 13,164 12,426
Due and deferred premiums 11,984 12,181
Property and equipment, net 1,758 1,758
Deferred policy acquisition costs 49,364 48,510
Present value of future profits of
acquired businesses 27,084 28,294
Other assets 5,051 5,392
Separate account assets 424 508
---------- ---------
Total Assets $ 301,081 $ 301,738
========= =========
</TABLE>
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)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Policy liabilities and contract
holder deposit funds:
Future policy benefits $ 60,085 $ 60,069
Contract holder deposit funds 44,759 45,128
Unearned premiums 28 28
Other policy claims and benefits payable 5,017 4,582
---------- ----------
109,889 109,807
Subordinated notes payable to affiliate 46,108 47,645
Deferred federal income taxes 24,122 23,984
Other liabilities 3,822 4,474
Separate account liabilities 424 508
---------- ----------
Total Liabilities 184,365 186,418
---------- ----------
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 5,027 5,898
Retained earnings 110,670 108,403
---------- ----------
124,091 122,695
Common treasury stock, at cost, 790,639
in 1999 and 1998. (7,375) (7,375)
---------- ----------
Total Shareholders' Equity 116,716 115,320
----------- ----------
Total Liabilities and Shareholders' Equity $ 301,081 $ 301,738
========== ==========
</TABLE>
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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
(unaudited)
<S> <C> <C>
Revenues:
Premiums $ 8,581 $ 9,764
Net investment income 1,753 1,938
Earned insurance charges 1,376 1,427
Other 405 347
----------- ---------
12,115 13,476
Benefits and expenses:
Policyholder benefits and expenses 3,741 4,108
Interest expense on contract holders
deposit funds 505 640
Amortization of present value of future
profits of acquired businesses 1,210 1,513
Amortization of deferred policy
acquisition costs 1,203 1,196
Operating expenses 2,916 3,099
Interest expense 698 719
----------- ---------
Income before federal income tax and
equity in net earnings of affiliates 1,842 2,201
Provision for federal income taxes 339 400
----------- ---------
Income before equity in net earnings
of affiliates 1,503 1,801
Equity in net earnings of affiliate,
net of tax 765 532
----------- ----------
Net Income $ 2,268 $ 2,333
=========== ==========
</TABLE>
The accompanying notes are an integral
part of these consolidated
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended
March 31,
1999 1998
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,428
Basic earnings per share $ 0.45 $ 0.43
========== ============
Diluted:
Common stock and common stock equivalents 5,206 5,603
Diluted earnings per share $ 0.44 $ 0.42
========== ============
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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net Income $ 2,268 $ 2,333
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 1,210 1,513
Amortization of deferred policy
acquisition costs 1,203 1,196
Financing costs amortized
Equity in undistributed earnings of
affiliate (1,314) (1,220)
Changes in assets and liabilities:
Decrease in accrued investment income 228 194
Increase in agent advances and
other receivables (969) (742)
Decrease (increase) in due premiums 197 (68)
Increase in deferred policy acquisition costs (2,057) (1,936)
Decrease in other assets 341 1,180
Increase in policy liabilities and accruals 82 (303)
Decrease in other liabilities (652) (1,786)
Increase in deferred federal income taxes 138 328
Other, net (69) (2)
---------- -----------
Net cash provided by operating activities $ 606 $ 687
---------- -----------
</TABLE>
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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
<S> <C> <C>
Fixed maturities purchased $ (7,000) $ (9,082)
Increase in policy loans (78) (74)
Proceeds from sales and maturities of
fixed maturities 9,769 4,661
Net decrease in short-term investments (2,603) 5,674
----------- -----------
Net cash provided by investing activities 88 1,179
----------- -----------
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (1,537) (1,536)
----------- -----------
Net cash used in financing activities (1,537) (1,536)
----------- -----------
Net increase (decrease) in cash (843) 330
Cash, beginning of year 2,601 508
----------- -----------
Cash, end of year $ 1,758 $ 838
========== ===========
</TABLE>
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
In June 1997, the FASB issued Statement of Financial Accounting Standard (FAS)
130, "Reporting Comprehensive Income." The new standard, which is effective for
financial
statements issued for periods ending after December 15, 1997, established
standards for reporting, in addition to net income, comprehensive income and its
components including, as applicable, foreign currency income, minimum pension
liability adjustments and unrealized gains and losses on certain investments in
debt and equity services. The Company adopted this standard in the first quarter
of 1998. Total comprehensive income for the three months ended March 31, 1999
and March 31, 1998 is $1.4 million and $1.5 million, respectively.
The following is a reconciliation of accumulated other comprehensive income from
December 31, 1998 to March 31, 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 (870) (1) (871)
-------- --------- ----------
Balance at March 31, 1999 $ 5,030 $ (3) $ 5,027
======== ========= ========
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
New Accounting Pronouncements, continued
In June 1997, the FASB issued FAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
information about operating segments. Generally, FAS 131 requires that financial
information be reported on the basis that is used internally for evaluating
performance. The Company adopted FAS 131 effective January 1, 1998. The Company
is principally engaged, through its subsidiaries, in administering existing
portfolios of individual life insurance and annuity products. The Company's
insurance subsidiaries are also engaged in the business of marketing and
underwriting individual life insurance and annuity products in 49 states and the
District of Columbia. Such products are marketed through an exclusive career
agency system. Management considers the Company's insurance operations to
constitute one reportable segment. Premium revenues for traditional insurance
products and earned insurance charges on universal life and annuity products are
presented in the accompanying consolidated statements of income. No single
customer accounts for 10 percent or more of the Company's revenue. The Company
has no foreign operations.
In February 1998, the FASB issued SFAS No. 132, "Employers Disclosures about
Pensions and Other Postretirement Benefits," which revises current disclosure
requirements for employers' pension and other retiree benefits. SFAS 132 does
not change the measurement or recognition of pension or other postretirement
benefit plans. The Company adopted SFAS 132 for the year ended December 31,
1998.
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 SOP97-3 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
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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, 1999. The operations of the Company are not affected by the provisions
of FAS No. 133.
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Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation:
For the three-month period ended March 31, 1999, Financial Industries
Corporation's ("FIC") net income was $2,268,000 (basic earnings of $0.45 per
common share, or diluted earnings of $0.44 per common share) as compared to
$2,333,000 (basic earnings of $0.43 per common share, or diluted earnings of
$0.42 per common share) in the first three 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 three-month period ended March 31, 1999, was $1,842,000 (on revenues of
$12,115,000 ), as compared to $2,201,000 (on revenues of $13,476,000) in the
first three months of 1998.
Earnings per share (basic and diluted) for the three-month period ended March
31, 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 three months of 1999, net of reinsurance ceded, were $8.6
million, as compared to $9.8 million in the first three months of 1998.
Policyholder benefits and expenses were $3.7 million in the 1999 period, as
compared to $4.1 million in the first three months of 1998.
As of March 31, 1999, the market value of the fixed maturities available for
sale segment was $76.5 million as compared to an amortized value of $74.2
million, or an unrealized gain of $2.3 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 ($1.5 at March
31, 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 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:
Prior to the acquisition of Family Life Insurance Company ("Family Life") in
June of 1991, FIC's primary involvement in the life insurance business was
through its equity interest in InterContinental Life Corporation ("ILCO"). For
the three-month period ended March 31, 1999, the Company's equity in the net
earnings of ILCO, net of federal income tax, was $765,000, as compared to
$532,000 for the first three months of 1998.
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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 March 31, 1999, the market value of ILCO's fixed maturities available for
sale segment was $428.7 million as compared to an amortized cost of $415.7
million, or an unrealized gain of $13.0 million. The increase reflects
unrealized gains on such investments related to changes in interest rates
subsequent to the purchase of such investments. Since FIC owns approximately 45%
of the common stock of ILCO, the net of tax effect of this increase ($8.5
million at March 31, 1999) is included in "Accumulated other comprehensive
income" on the Consolidated Balance Sheets and has been recorded as an increase
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.
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 March 31, 1999, the outstanding principal
balances of the surplus debentures were $4.2 million and $8.0 million,
respectively. 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 March 31, 1999, the statutory capital
and surplus of Investors-NA was $65.4 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
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<PAGE>
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 March 31, 1999, Investors-NA had
earned surplus of $37.4 million. Since the law applies only to dividend
payments, the ability of Investors-NA to make principal and interest payments
under the Surplus Debentures is not affected. ILCO does not anticipate that
Investors-NA will have any difficulty in making principal and interest payments
on the Surplus Debentures for the foreseeable future.
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 $18.6 million at March 31, 1999.
The Form 10-Qs of ILCO for the three-month periods ended March 31, 1999 and
March 31, 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 March 31, 1999, the outstanding balance of such indebtedness was
$46.1 million on the Subordinated Notes granted by Investors-NA.
The principal source of liquidity for FIC's subsidiaries consists of the
periodic payment of principal and interest by Family Life pursuant to the terms
of a Surplus Debenture. The terms of the Surplus Debenture were previously
approved by the Washington Insurance Commissioner. Under the provisions of the
Surplus Debenture and current law, no prior approval of the Washington Insurance
Department is required for Family Life to pay interest or principal on the
Surplus Debenture; provided that, after giving effect to such payments, the
statutory surplus of Family Life is in excess of 6% of assets (the "surplus
floor"). However, Family Life has voluntarily agreed with the Washington
Insurance Commissioner that it will provide at least five days advance notice of
payments which it will make under the surplus debenture. As of March 31, 1999,
the statutory capital and surplus of Family Life was $28.4 million, an amount
substantially in excess of the surplus floor. As of March 31, 1999, the
principal balance of the Surplus Debenture was $20.6 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.
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<PAGE>
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 $606,000 in the first
three months of 1999, as compared to $687,000 in the first three months of 1998.
Net cash flow used in financing activities was $(1,537,000) in the 1999 period,
as compared to $(1,536,000) in the first three 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.
Investments
As of March 31, 1999, the Company's investment assets totaled $110.0 million, as
compared to $117.8 million as of March 31, 1998.
The level of short-term investments at March 31, 1999 was $30.2 million, as
compared to $28.8 million as of March 31, 1998. The fixed maturities available
for sale portion represents $76.5 million of investment assets as of March 31,
1999, as compared to $86.1 million at March 31, 1998. The amortized cost of
fixed maturities available for sale as of March 31, 1999 was $74.2 million
representing a net unrealized gain of $2.3 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 March 31, 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).
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<PAGE>
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $23.9 million and $200.6 million, respectively, and mortgage-backed
pass-through securities of $4.9 million and $29.6 million, respectively, at
March 31, 1999. Mortgage- backed pass-through securities, sequential CMO's and
support bonds, which comprised approximately 42.5 % of the book value of FIC's
mortgage-backed securities and 49.9% of the book value of ILCO's mortgage-backed
securities at March 31, 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 March 31, 1999, PAC and TAC instruments and
scheduled bonds represented approximately 57.5% of the book value of FIC's
mortgage-backed securities and approximately 51.1% of the book value of ILCO's
mortgage-backed securities. Sequential and support classes represented
approximately 25.5% of the book value of FIC's mortgage-backed securities and
approximately 36.0% of the book value of ILCO's mortgage-backed securities at
March 31, 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 with increased prepayment risk, such as interest-only
stripped pass-through securities and inverse floater bonds. Neither FIC nor ILCO
had any z-accrual bonds as of March 31, 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 quarter 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 is in the process of this systems conversion
and anticipates that the project will be completed in advance of the year 2000.
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
March 31, 1999, the Company has incurred an after tax expense of approximately
$129,500 in connection with the completion of the Plan. Between January 1, 1997
and March 31, 1999, the Company has expended approximately 74.7% of the
three-year expected after-tax cost discussed above.
The Plan calls 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
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<PAGE>
process includes approximately 29 sub-systems which provide data input to the
main systems. The administrative systems which are not modified will be
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 106,630 policies for Family Life) was completed in
March, 1998. The conversion of the Cypros AP system (administering approximately
18,430 active policies for Family Life) is scheduled for completion at the end
of September, 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 49,280 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 15,510 active policies for Investors-IN) is scheduled for
completion in April, 1999. The modification of the Lifecomm-B system which is
responsible for the 17,240 active policies assumed after ILCO's acquisition of
State Auto Life is also scheduled for completion in April, 1999. The conversion
of the Lifecomm-A system (administering approximately 62,400 active policies for
Investors-NA) is now scheduled for completion in September of 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. As the responses to the questionnaires
are received, the Company will evaluate the overall Y2K readiness of its third
party provider relationships. However, the Company does not have sufficient
information at the current time to determine whether the computer systems of its
third party providers will be in compliance with the Y2K requirements as the
year 2000 approaches.
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 compliance for its centralized
systems. The installation of such new PC hardware and software was commenced in
early 1999 and is expected to be completed by September 1, 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
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<PAGE>
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 February 1997, the Financial Accounting Standards Board (FASB) issued
Financial Accounting Standard (FAS) No. 128, "Earnings Per Share," which revises
the standards for computing earnings per share previously prescribed by APB
Opinion No. 15, "Earnings Per Share." The Statement 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 reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
converted or exercised. The Statement requires dual presentation of basic and
diluted earnings per share on the face of the income statement for all entities
with potential dilutive securities outstanding. The Statement also requires a
reconciliation of the numerator and denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation. The Statement is effective for interim and annual periods ending
after December 15, 1997. The Company adopted FAS No. 128 in its annual financial
statements for the year ended December 31, 1997.
In June, 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income",
which establishes standards for reporting and display of comprehensive income
and its components in a financial statement with the same prominence as other
financial statements. Total comprehensive income is required to be reported in
condensed interim financial statements. Comprehensive income is defined as net
income adjusted for changes in stockholders' equity resulting from events other
than net income or transactions related to an entity's capital instruments. The
Company adopted FAS 130 effective January 1, 1998, with reclassification of
financial statements for earlier years.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
information about operating segments. Generally, SFAS 131 requires that
financial information be reported on the basis that is used internally for
evaluating performance. The Company adopted SFAS 131 for the year ended December
31, 1998. The Company is principally engaged, through its subsidiaries, in
administering existing portfolios of individual life insurance and annuity
products. The Company's insurance subsidiaries are also engaged in the business
of marketing and underwriting individual life insurance and annuity products in
49 states and the District of Columbia. Such products are marketed through an
exclusive career agency system. Management considers the Company's insurance
operations to constitute one reportable segment. Premium revenues for
traditional insurance products and earned insurance charges on universal life
and annuity products are presented in the accompanying consolidated statements
of income. No single customer accounts for 10 percent or more of the Company's
revenue. The Company has no foreign operations.
In February, 1998, the FASB issued FAS No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits", which revises current disclosure
requirements for employers' pension and other retiree benefits. FAS No. 132 does
not change the measurement or recognition of pension or other postretirement
benefit plans. The Company adopted FAS No. 132 effective January 1, 1998, with
restatement of disclosures for earlier years. The adoption of FAS No. 132 did
not have a material impact on the Company's results of operations, liquidity or
financial position.
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.
- 18 -
<PAGE>
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, 1999. As the Company
does not have significant investments in derivative financial instruments, the
adoption of FAS 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
$3.4 million at March 31, 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 $106.7
million at March 31, 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
$29.8 million at March 31, 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
mortgage-backed securities is estimated to be $1.6 million at March 31,
1999 and $1.2 million at December 31, 1998.
- 19 -
<PAGE>
(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
$6.3 million at March 31, 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.
- 20 -
<PAGE>
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
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
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<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/ James M. Grace
James M. Grace, Treasurer
Date: May 14, 1999
- 22 -
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q FOR
THE THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 76,523
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 109,952
<CASH> 1,758
<RECOVER-REINSURE> 13,164
<DEFERRED-ACQUISITION> 49,364
<TOTAL-ASSETS> 301,081
<POLICY-LOSSES> 59,716
<UNEARNED-PREMIUMS> 28
<POLICY-OTHER> 45,128
<POLICY-HOLDER-FUNDS> 5,017
<NOTES-PAYABLE> 46,108
0
0
<COMMON> 1,169
<OTHER-SE> 115,547
<TOTAL-LIABILITY-AND-EQUITY> 301,081
8,581
<INVESTMENT-INCOME> 1,753
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 405
<BENEFITS> 3,741
<UNDERWRITING-AMORTIZATION> 1,203
<UNDERWRITING-OTHER> 2,916
<INCOME-PRETAX> 1,503
<INCOME-TAX> 339
<INCOME-CONTINUING> 2,268
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,268
<EPS-PRIMARY> 0.45
<EPS-DILUTED> 0.44
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
