SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
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)
701 Brazos, Suite 1400, Austin, Texas 78701
(Address of Principal Executive Offices) (Zip Code)
(512) 404-5050 (Registrant's Telephone Number)
Securities Registered pursuant to Section 12(b) of the Act: None
Securities Registered pursuant to Section 12(g) of the Act:
Common Stock, $.20 par value
(Title of Class)
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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 and (2) has been subject to such filing requirements for
the past 90 days. YES X NO
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on March 15, 1999, based on the closing sales price in The Nasdaq
Small-Cap Market ($13.75 per share), was $46,073,431.
The number of shares outstanding of Registrant's common stock on March 15, 1999
was 5,054,661.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
DOCUMENTS INCORPORATED BY REFERENCE:
A. Reports on Form 10-K of InterContinental Life Corporation for
the fiscal years ended December 31, 1998, 1997 and 1996 are
hereby incorporated by reference.
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PART I
Item 1. Business
General
Financial Industries Corporation ("FIC", the "Company" or the "Registrant") is a
holding company primarily engaged in the life insurance business through its
ownership of 100% of Family Life Insurance Company ("Family Life") and its
approximately 45% interest in InterContinental Life Corporation ("ILCO").
The Registrant was organized as an Ohio corporation in 1968 and was
reincorporated in Texas in 1980. Its executive offices are located at 701
Brazos, Suite 1400, Austin, Texas 78701. Through 1984, FIC's principal business
was the sale and underwriting of life and health insurance, mainly in the
midwestern and southwestern United States. In 1985, FIC acquired control of
ILCO.
FIC, ILCO and their insurance subsidiaries have substantially identical
managements. Officers allocate their time between FIC and ILCO in accordance
with the comparative requirements of both companies and their subsidiaries. Roy
F. Mitte, Chairman, President and Chief Executive Officer of FIC, ILCO and their
insurance subsidiaries, is the owner, directly and beneficially, of
approximately 29.54% of the outstanding shares of FIC's common stock.
Acquisitions
Strategy. The Company's strategy has been and continues to be to grow internally
and through acquisitions, while maintaining an emphasis on cost controls.
Management believes that, under appropriate circumstances, it is more
advantageous to acquire companies with books of in-force life insurance than to
produce new business, because initial underwriting costs have already been
incurred and mature business is generally less likely to terminate, making
possible more predictable profit analysis. However, Family Life does continue to
market those products that are profitable, as well as develop new products and
streamline distribution channels. See "Agency Operations". It is also
management's belief that the continuing consolidation in the life insurance
industry presents attractive opportunities for the Company to acquire life
insurance companies that complement or fit within the Company's existing
marketing structure and product lines. The Company's objective is to improve the
profitability of acquired businesses by consolidating and streamlining the
administrative functions of these businesses, eliminating unprofitable products
and distribution channels, applying its marketing expertise to the acquired
company's markets and agents, and benefitting from economies of scale. FIC's
ability to make future acquisitions will be dependent on its being able to
obtain the necessary financing. In addition, since ILCO has the same acquisition
strategy as FIC, a conflict of interest could arise in the future between FIC
and ILCO with respect to acquisition opportunities.
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Acquisition of ILCO. In January 1985, FIC acquired 26.53% of ILCO's Common
Stock. FIC and Family Life subsequently acquired additional shares of ILCO's
Common Stock and as of March 15, 1999, FIC owned, directly and indirectly
through Family Life, approximately 45% of the outstanding shares of ILCO's
Common Stock. Prior to September 30, 1998, FIC held options to acquire up to
1,702,155 additional shares of ILCO's Common Stock. The consideration for the
options, which were granted in 1986, was FIC's granting to ILCO a loan in the
principal amount of $1.2 million, FIC's agreement to guarantee future loan
obligations of ILCO and FIC's agreement to guarantee ILCO's lease obligation on
its headquarters building upon demand. As described under the heading "The ILCO
Senior Loan", the Senior Loan of ILCO was fully repaid on September 30, 1998.
Accordingly, FIC's rights under the 1986 option agreement expired on September
30, 1998.
Acquisition of Family Life. FIC acquired Family Life from Merrill Lynch
Insurance Group, Inc. on June 12, 1991. The consideration for the purchase was
$114 million consisting of a cash payment of $70 million and $44 million of
subordinated promissory notes issued by subsidiaries of FIC to the seller and
its affiliates. Family Life's primary business is the underwriting and sale of
mortgage protection life insurance to customers who are mortgage borrowers from
financial institutions where Family Life has marketing relationships. Family
Life distributes its insurance products primarily through a national career
agency sales force. See "Business of Family Life Insurance Company".
ILCO's Acquisitions
In November 1986, ILCO acquired Standard Life Insurance Company ("Standard
Life"), headquartered in Jackson, Mississippi, for a gross purchase price of
$54.5 million. A portion of the funds used by the new life insurance company
formed by ILCO to make the acquisition ("New Standard") was the proceeds of a
loan extended to the Company by a national bank in the principal amount of $15.0
million (the "Standard Term Loan"). This sum was, in turn, loaned by ILCO to New
Standard, and the loan was evidenced by a surplus debenture. New Standard was
merged into Standard Life in June 1988.
In December 1988, ILCO, through Standard Life, purchased Investors Life
Insurance Company of California ("Investors-CA") and Investors Life Insurance
Company of North America ("Investors- NA") from CIGNA Corporation for a purchase
price of $140 million. ILCO obtained the funds used for the acquisition from:
(a) a Senior Loan in the amount of $125.0 million provided by six financial
institutions, (b) a $10.0 million subordinated loan provided by two insurance
and financial service organizations and (c) the sale of $5.0 million of Class A
Preferred Stock to CIGNA and $15.0 million of Class B Preferred Stock to the
subordinated lenders. Approximately $15.0 million of these funds were used to
discharge the Standard Term Loan. The balance of these funds were loaned by ILCO
to Standard Life. To evidence this indebtedness, Standard Life issued a $140.0
million surplus debenture to ILCO. In connection with the subordinated debt and
preferred stock financing, ILCO issued detachable warrants entitling the holders
to purchase 1,107,480 shares of ILCO's Common Stock at $3.33 per share.
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In May 1990, ILCO effected an exchange agreement with the holders of its Class A
Preferred Stock and its Class B Preferred Stock. Under the provisions of the
exchange agreement, the holders of the Class A Preferred Stock received $5
million principal amount of a 13.25% 1998 Series Subordinate Notes, due November
1, 1998, together with a make whole amount equal to 13.25% of the then
outstanding balance of the Note. The holders of the Class B Preferred Stock
received $15 million principal amount of a 13.25% 1999 Series Subordinated
Notes, due November 1, 1999.
ILCO prepaid the subordinated debt and purchased the warrants in early 1993. See
"The ILCO Senior Loan".
In February, 1995, ILCO, through Investors-NA, purchased from Meridian Mutual
Insurance Company the stock of Meridian Life Insurance Company, an
Indianapolis-based life insurer, for a cash purchase price of $17.1 million.
After the acquisition, Meridian Life changed its name to Investors Life
Insurance Company of Indiana ("Investors-Indiana").
In July, 1997, ILCO and Investors-Indiana acquired State Auto Life Insurance
Company, an Ohio domiciled life insurer, from State Automobile Mutual Insurance
Company, for an adjusted cash purchase price of $11.8 million. In connection
with this transaction, the bank group participating in the ILCO Senior Loan
agreed to defer payment of $4.5 million otherwise payable on April 1, 1997 under
the terms of the ILCO Senior Loan, and to reduce the amount of the payment
otherwise due on July 1, 1997 by $2.5 million. This deferral resulted in
extending the maturity date of the Senior Loan to October 1, 1998. Under the
terms of the transaction, State Auto Life was merged into Investors-Indiana.
In December, 1997, InterContinental Life Insurance Company ("ILIC") transferred
its domicile from New Jersey to Indiana. Following completion of the
redomestication, ILIC merged with Investors-Indiana, with ILIC as the surviving
entity in the merger process. Immediately after the merger, ILIC changed its
name to Investors Life Insurance Company of Indiana. As used hereinafter, the
phrase "Investors-IN" shall be used to refer to the merged entities.
On June 30, 1998, ILCO, through a subsidiary, acquired Grinnell Life Insurance
Company ("Grinnell Life") for an adjusted purchase price of $16.6 million. A
portion of the purchase price ($12.37 million) was paid by way of a dividend to
the seller immediately prior to the closing of the transaction; the balance of
the purchase price was paid by ILCO's subsidiary. As part of the transaction,
Grinnell Life was immediately merged with and into that subsidiary, with that
subsidiary being the surviving entity.
Business of Family Life Insurance Company
Family Life, which was organized in the State of Washington in 1949, specializes
in providing mortgage protection life and accidental death insurance and annuity
products to mortgage borrowers of financial institutions. Family Life has
policies in force with customers of approximately 213
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financial institutions, of which approximately 60 actively provide Family Life
with regular updating of their lists of borrowers.
Family Life's mortgage protection business consists of term and universal life
insurance sold to borrowers of mortgage debt, designed to repay the mortgages of
policyholders in the event of their death. This business is sold to customers of
client financial institutions, usually through a list of borrowers provided by
the financial institution. These policies often list the lending financial
institution as the primary beneficiary of the life insurance policy. An
important feature of the Family Life product is the ability to bill and collect
premiums through the policyholder's monthly mortgage payments.
Family Life has annuity products and a variety of life insurance products,
including decreasing term life insurance, universal life insurance, ten-year
level term products, and a whole life insurance product.
During 1998, 1997 and 1996, Family Life received statutory premium income from
sales of its annuity products and various lines of insurance as follows: $0.1
million , $0.1 million and $0.2 million, respectively, from annuity products;
$42.9 million, $45.6 million and $48.3 million, respectively, from individual
life; $0.0 million, $0.3 million and $1.0 million, respectively, from individual
accident and health; $314,846, $416,870 and $469,327, respectively, from group
life and $158,622, $198,911 and $238,128, respectively, from group accident and
health.
Family Life is licensed to sell mortgage life insurance products in 49 states
and the District of Columbia. In 1998, premium income from these products was
derived from all states in which Family Life is licensed, with significant
amounts derived from Texas (25%), California (24%), and Florida (5%).
Family Life's primary distribution channel is its agency force of approximately
574 career agents (at December 31, 1998), who are organized into 24 regions.
Most of the career agents sell mortgage life insurance products exclusively for
Family Life. The mortgage life insurance business is very fragmented. Family
Life believes that it is among the larger writers of agent sold mortgage life
insurance in the United States and the only nation-wide agent-sold life
insurance company operating through leads from financial institutions. Many of
Family Life's competitors are life insurance companies with more resources than
Family Life and whose mortgage life insurance business represents only a small
portion of their total business.
During 1998, Family Life expanded its distribution system, to recruit agents
whose product portfolio includes a broader range of life and annuity products,
in addition to the traditional mortgage protection life insurance products
offered by Family Life. While Family Life's traditional sales force consists of
agents who are contracted exclusively with the company, agents who participate
in the expanded distribution system may have selling relationships with other
insurers in addition to Family Life. During 1999, Family Life expects to recruit
20 to 30 agents for this marketing effort.
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Consolidation and Administration
Following the 1991 acquisition of Family Life by FIC, management integrated the
sales, marketing, underwriting, accounting, contract and licensing, investments,
personnel, data processing, home office support and other departments of Family
Life and the life insurance subsidiaries of ILCO. Management believes this
integration has resulted in cost savings for Family Life and ILCO's insurance
subsidiaries. During 1992, ILCO's and FIC's insurance operations were
centralized at their headquarters in Austin, Texas, with the exception of
certain services performed in Seattle, Washington. Management believes that
relocating administrative functions to Austin has reduced costs and improved the
efficiency of the insurance companies' operations.
At December 31, 1998, the number of employees within FIC and its subsidiaries,
together with the employees of ILCO's insurance subsidiaries, was approximately
322 .
Business of InterContinental Life Corporation
ILCO was incorporated in 1969 under the laws of New Jersey. In June, 1997, ILCO
transferred its domicile to the State of Texas. Its executive office is located
at 701 Brazos, Suite 1400, Austin, Texas 78701.
Operations. ILCO has developed management techniques to reduce operating
expenses by centralizing, standardizing and more efficiently performing many
functions common to most life insurance companies, such as underwriting and
policy administration, accounting and financial reporting, marketing, regulatory
compliance, actuarial services and asset management. ILCO has selectively
recruited personnel in sales, marketing and various administrative departments.
ILCO's centralized management techniques resulted in significant employee
reductions and expense savings in the life insurance companies acquired by ILCO.
During 1998, the general insurance expenses of ILCO's insurance subsidiaries
were $15,172,682, as compared to $15,574,265 in 1997 and $12,008,163 in 1996.
The level of expenses at the ILCO life companies for the year 1998 was affected
by expenses incurred in connection with Year 2000 compliance, as well as the
expenses incurred in connection with ILCO's acquisition of Grinnell Life
Insurance Company. The increase in 1997, as compared to 1996, resulted primarily
from expenses incurred in connection with ILCO's acquisition of State Auto Life
in July, 1997 and expenses related to the modification of data processing
systems for Year 2000 compliance. Management is committed to maintaining the
general insurance expenses of ILCO's insurance subsidiaries at a level which
will generate an acceptable level of profitability while maintaining the
competitive pricing of their insurance products.
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Principal Products. ILCO's insurance subsidiaries are engaged primarily in
administering existing portfolios of individual life insurance and accident and
health insurance policies and annuity products. Approximately 80.6% of the total
collected premiums for 1998 were derived from renewal premiums on insurance
policies and annuity products sold by ILCO's insurance subsidiaries prior to
their acquisition by ILCO.
ILCO's insurance subsidiaries are also engaged in marketing and underwriting
individual life insurance and annuity products in 49 states and the District of
Columbia. These products are marketed through independent, non-exclusive general
agents.
The products currently being distributed by ILCO's life subsidiaries include
several versions of universal life insurance, which provide permanent life
insurance which credit company-declared current interest rates. The universal
life insurance portfolio of ILCO's insurance subsidiaries consists of flexible
premium universal life insurance policies. Under the flexible premium policies,
policyholders may vary the amounts of their coverage (subject to minimum and
maximum limits) as well as the date of payment and frequency of payments.
Direct statutory premiums received from all types of universal life products
were $38.9 million in 1998, as compared to $40.6 million in 1997 and $40.6
million in 1996. Investors-NA received reinsurance premiums from Family Life of
$2.5 million in 1998, pursuant to the reinsurance agreement for universal life
products written by Family Life. In 1998, premium income from all life insurance
products was derived from all states in which ILCO's insurance subsidiaries are
licensed, with significant amounts derived from Pennsylvania (14%), Ohio (8%)
and New Jersey (8%).
Two of ILCO's insurance subsidiaries receive premium income from health
insurance policies. In 1998, premium income from all health insurance policies
was $1.0 million, as compared to $0.9 million in each of 1997 and 1996. As
described below, the health insurance business of ILCO's subsidiaries is 100%
reinsured with a third party reinsurer.
In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance
treaty under which all of the contractual obligations and risks under accident
and health and disability income insurance policies were assumed by a third
party reinsurer. The transfer is effective as of July 1, 1997. The decision to
dispose of this book of business was based on ILCO's analysis that the business
was not generating targeted profit objectives and that the products were not
part of the core business of ILCO's subsidiaries. The sale permits the companies
to focus on its primary business - life insurance and annuity sales. In
connection with the transaction, the total amount of net reserves transferred by
the ILCO subsidiaries was $6,327,504. In addition to the transfer of reserves,
ILCO's life companies paid the reinsurer $1,037,150 in connection with the
transaction, which amount was accounted for as an expense for the year ended
December 31, 1997. In 1997, the transferred business generated approximately
$791,000 in annualized premiums for ILCO's life subsidiaries.
Investors-NA sponsors a variable annuity separate account, which offers single
premium and flexible premium policies. The policies provide for the contract
owner to allocate premium payments among
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four different portfolios of Putnam Variable Trust (the "Putnam Fund"), a series
fund which is managed by Putnam Investment Management, Inc. Prior to April,
1995, the underlying investment vehicle for the variable annuity contracts was
the CIGNA Annuity Funds Group. A substitution of the Putnam Fund for the CIGNA
Funds was completed in April, 1995. The plan of substitution was approved by the
Securities and Exchange Commission. Following such approval, the plan was
submitted to policyholders for approval, which was obtained. As of December 31,
1998, the assets held in the separate account were $51.3 million. During 1998,
the premium income realized in connection with these variable annuity policies
was $156,419, which was received from existing contract owners.
Investors-NA also maintains a closed variable annuity separate account, with
approximately $21.6 million of assets as of December 31, 1998. The separate
account was closed to new purchases in 1981 as a result of an IRS ruling which
adversely affected the status of variable annuity separate accounts which invest
in publicly-available mutual funds. The ruling did not adversely affect the
status of in-force contracts.
During 1997, ILCO's life company subsidiaries expanded their marketing efforts
in the fixed annuity market. Direct deposits from the sale of fixed annuity
products were $6.14 million in 1998, as compared to $3.5 million in 1997, and
$1.7 million in 1996. Investors-NA also received reinsurance premiums from
Family Life of $1.7 million in 1998, pursuant to a reinsurance agreement for
annuity products between Investors-NA and Family Life Insurance Company.
Merger of Insurance Subsidiaries. Investors-NA redomesticated from Pennsylvania
to Washington in December of 1992. Investors-CA merged into Investors-NA on
December 31, 1992. Standard Life merged into Investors-NA on June 29, 1993. The
mergers have achieved cost savings, such as reduced auditing expenses involved
in auditing one combined company; the savings of expenses and time resulting
from the combined company being examined by one state insurance department
(Washington), rather than three (California, Pennsylvania and Mississippi); the
reduction in the number of tax returns and other annual filings with 45 states;
and smaller annual fees to do business and reduced retaliatory premium taxes in
most states.
In December, 1997, ILIC transferred its domicile from New Jersey to Indiana.
Following completion of the redomestication, ILIC merged with Investors-Indiana,
with ILIC as the surviving entity in the merger process. Immediately after the
merger, ILIC changed its name to Investors Life Insurance Company of Indiana. As
used hereinafter, the phrase "Investors-IN" shall be used to refer to the merged
entities. As a result of the merger, Investors-IN is licensed in 44 states. As
of December 31, 1998, it had assets of $188.1 million and capital and surplus of
$23.1 million.
ILCO's management believes that these acquisitions and consolidations have
caused a reduction in expense and have further strengthened the financial
condition of the combined companies.
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Investment of Assets
The assets held by Family Life and ILCO's life insurance subsidiaries must
comply with applicable state insurance laws and regulations pertaining to life
insurance companies. The investment portfolios of Family Life and ILCO's life
insurance subsidiaries are tailored by their managements to reflect the nature
of the insurance obligations, business needs, regulatory requirements and tax
considerations relating to the underlying insurance business with respect to
such assets. This is particularly the case with respect to interest-sensitive
life insurance products, where the investment emphasis is to obtain a targeted
margin of profit over the rate of interest credited to policyholders, while
endeavoring to minimize the portfolio's exposure to changing interest rates. To
reduce the exposure to such rate changes, portfolio investments are selected so
that diversity, maturity and liquidity factors approximate the duration of
associated policyholder liabilities.
The investment objective of Family Life and ILCO's insurance subsidiaries
emphasizes the selection of short to medium term, high quality fixed income
securities, rated Baa-3 (investment grade) or better by Moody's Investors
Service, Inc. At December 31, 1998, only 1.5 % of ILCO's total assets were
invested in mortgage loans or real estate. Non-affiliated corporate debt
securities that were non-investment grade represented 0.6% of ILCO's total
assets at December 31, 1998. ILCO had investments in debt securities of
affiliated companies aggregating approximately $47.6 million as of December 31,
1998. Family Life does not have investments in mortgage loans, real estate,
non-investment grade debt securities or affiliates' debt securities.
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $28.0 million and $212.1 million, respectively, and mortgage-backed
pass-through securities of $5.1 million and $32.1 million, respectively, at
December 31, 1998. Mortgage-backed pass-through securities, sequential CMO's and
support bonds, which comprised approximately 39.9 % of the book value of FIC's
mortgage-backed securities and 42.6% of the book value of ILCO's mortgage-backed
securities at December 31, 1998, 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, accretion directed bonds 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 December 31,
1998, PAC and TAC instruments and accretion directed and scheduled bonds
represented approximately 60.1% of the book value of FIC's mortgage-backed
securities and approximately 37.8% of the book value of ILCO's mortgage-backed
securities. Sequential and support classes represented approximately 24.5% of
the book value of FIC's mortgage-backed securities and approximately 34.6% of
the book value of ILCO's mortgage-backed securities at December 31, 1998. 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 December 31, 1998. The prepayment risk that certain mortgage-backed
securities are subject to is prevalent in periods of declining interest
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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 current investment objectives of both
FIC and ILCO do not contemplate additions to the portfolio of CMO investments
during 1999.
FIC and ILCO do not invest in non-agency mortgage-backed securities, which have
a greater credit risk than that of agency mortgage-backed securities.
ILCO and FIC do not make new mortgage loans on commercial properties.
Substantially all of ILCO's mortgage loans were made by its subsidiaries prior
to their acquisition by ILCO. At December 31, 1998, 0.8% of the total book value
of mortgage loans held by ILCO had defaulted as to principal or interest for
more than 90 days, and none of ILCO's mortgage loans were in foreclosure. During
1998, none of ILCO's mortgage loans were converted to foreclosed real estate or
were restructured while ILCO owned them. Family Life does not have any mortgage
loans.
Another key element of FIC's and ILCO's investment strategy is to avoid large
exposure in other investment categories which management believes carry higher
credit or liquidity risks, including private placements, partnerships and bank
participations. These categories accounted for approximately 0.4% of ILCO's
invested assets and none of FIC's invested assets at December 31, 1998.
A subsidiary of ILCO, Investors-NA, was the owner and developer of Bridgepoint
Square Offices. Following the completion of the construction, the project
consisted of four office buildings, with a total rentable space of approximately
364,000 square feet, and two parking garages. Investors-NA purchased the 20 acre
tract of land for this complex in January, 1995. At that time, the tract
included one completed and fully leased office building, an adjacent parking
garage, and sites for three more office buildings and another parking garage.
Investors-NA completed construction of the three remaining office buildings and
parking garage in 1997. See Item 2. Properties.
In May 1996, Family Life Insurance Company ("FLIC"), an indirect, 100% owned
subsidiary of FIC, purchased a 7.1 acre tract adjacent to the original
Bridgepoint Square tract. This second tract contained one building site and one
garage site. In January, 1997, FLIC began construction on a four-story office
building, with rentable space of approximately 76,793 square feet, and the
parking garage, with 350 parking spaces. In May, 1997, the entire rentable space
in the building was leased to a major tenant in the technology business.
Construction of the parking garage and the building shell was completed in
October, 1997.
In November, 1997, Investors-NA and Family Life entered into a sale agreement
with an independent third party for the sale of their respective interests in
Bridgepoint Square Offices. The transaction, which closed on December 5,1997,
was for an aggregate price of $78 million. The sale
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resulted in a net pre-tax profit to Investors-NA of approximately $14.0 million,
and a net pre-tax profit to Family Life of approximately $4.5 million. See Item
2. Properties.
In October, 1998, Investors-NA purchased two adjoining tracts of land located in
Austin, Texas totaling 47.995 acres. The aggregate purchase price for these
tracts was $8.1 million. Investors-NA has obtained approval of a site plan
development proposal for these tracts. The development permit provides for the
construction of seven office buildings totaling 600,000 square feet, with
associated parking, drives and related improvements. The initial phase of the
project ("Phase One") will consist of two office buildings, associated parking
and the infrastructure for the entire project. Construction on Phase One began
during the first quarter of 1999.
FIC and ILCO have established and staffed an investment department, which
manages portfolio investments and investment accounting functions for their life
insurance subsidiaries.
Agency Operations
The products of FIC's and ILCO's insurance subsidiaries are marketed and sold
through two divisions:
A. Investors Life Distribution System
The Investors Life Distribution System sells a wide range of life insurance and
annuity products through an independent, non-exclusive general agent sales
distribution system. The products sold are issued by subsidiary companies of
ILCO.
All marketing and sales for the Company are directed by the Executive Vice
President of Marketing and Sales. The Senior Vice President for Investors Sales
directs Regional Vice Presidents who are responsible for the recruitment of
general agents and managing general agents for individual insurance sales in the
Investors Life Distribution System.
B. Family Life Distribution System
This nationwide system sells Family Life's products through an exclusive agent
force. This agent force sells mortgage protection life insurance and annuity
products. The products are sold primarily to middle-income customers of client
financial institutions, usually through a list of borrowers provided by the
financial institution. Family Life works closely with the financial institutions
to maintain and insure that Family Life lead systems, which had been built from
the loan portfolios of each active financial institution, operate at a level
that favors both parties. Family Life agents make courtesy calls to borrowers of
the financial institutions which are active on the Family Life lead system to
offer the borrower the opportunity to purchase mortgage protection insurance
(term or universal life insurance products).
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During 1998, Family Life expanded its distribution system, to recruit agents
whose product portfolio includes a broader range of life and annuity products,
in addition to the traditional mortgage protection life insurance products
offered by Family Life. While Family Life's exclusive sales force consists of
agents who are contracted exclusively with the company, agents who participate
in the expanded distribution system may have selling relationships with other
insurers in addition to Family Life. During 1999, Family Life expects to recruit
20-30 agents for this marketing effort.
Sales and Marketing for Family Life is directed by the Executive Vice President
of Marketing and Sales. Reporting to the Executive Vice President, the Senior
Vice President of Marketing heads the Family Life marketing organization which
is focused on the development and maintenance of contractual agreements with the
financial institutions which provide referrals to, and collect monthly premiums
from, their borrowers for Family Life insurance plans. The Senior Vice President
for Family Life Sales directs 24 Regional Vice Presidents. The Family Life
distribution system consists of 155 District Sales Managers, and 574 active
career agents.
Data Processing
The data processing needs of FIC's and ILCO's insurance subsidiaries are
provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by
FIC Computer Services, Inc., a subsidiary of FIC. See Item 13.- Certain
Relationships and Related Transactions with Management.
As the provider of data processing for the Company and its subsidiaries and
affiliates, FIC Computer Services, Inc. utilizes 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 by these systems will be affected by what
is referred to as the "Year 2000 problem" or "Y2K 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.
In response to the potential operations and policy administration problems
caused by the computer calendar change on January 1, 2000, the management of the
Company instructed FIC Computer Services, Inc. to analyze its system
capabilities and the operational requirements of the Company and its respective
subsidiaries and affiliates with respect to the Y2K problem. In 1996, FIC
Computer Services, Inc. conducted the analysis of all of the Company's systems.
After reviewing that analysis, the Company determined that a plan should be
devised to prevent the data processing errors that may be encountered due to the
Y2K problem. In November, 1996, a three-year plan outlining a proposed solution
(the "Plan") was established and approved by the Company to ensure that all of
the data processing systems would be Y2K compliant or converted onto Y2K
compliant systems. The Company began the major work under this Plan in 1997 and
it is scheduled to be completed by the Fall of 1999.
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The Company established this Plan because FIC Computer Services, Inc.'s analysis
revealed that those systems that are not converted or modified into Y2K
compliant systems, may produce policy administration errors as a result of the
calendar change, requiring that the life insurance subsidiaries manually
administer those policies. This would result in a material increase in
administrative costs incurred by the life insurance subsidiaries of both ILCO
and FIC.
The Company's analysis also indicated that, in addition to potential policy
administration errors in the life insurance subsidiaries, any machine which
contains a microchip is subject to error due to the Y2K problem. Such an
occurrence could not only create errors in the Company's internal systems, but
those of the Company's suppliers and service providers. In order to prepare for
this contingency, the Plan called for the acquisition of new mainframe hardware
and software, and the modification and conversion of our telephones, voice mail
and desk-top personal computers.
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. 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.
Under the Plan, FIC Computer Services, Inc. will utilize its own personnel,
acquire Y2K compliant operating software, and engage the assistance of outside
consultants to facilitate the systems conversions and modifications. 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 twelve month period ended December 31, 1998, the
Company has incurred an after tax expense of approximately $289,000 in
connection with the completion of the Plan. Between January 1, 1997 and December
31, 1998, the Company has expended approximately 60.3 % of the three-year
expected after-tax cost discussed above. In the event that the Plan does not
achieve full compliance by the target dates, or if unforeseen matters involving
Y2K appear at later dates, the Company will utilize the staff of FIC Computer
Services, Inc. to identify and resolve such issues as and if they arise.
In order to continuously evaluate the effectiveness of the modifications and
conversions made to the various systems, FIC Computer Services, Inc. has
acquired testing software to simulate dates on or after January 1, 2000.
Additionally, FIC Computer Services, Inc. runs the systems through model office
cycles and also conducts visual inspections of screen displays to determine
whether the systems are functioning in a Y2K compliant manner.
The system which administers a material number of policies for Family Life will
be modified rather than converted. The modification of the PMS system
(administering approximately 122,000 policies
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for Family Life) was completed in March, 1998. The conversion of the Cypros AP
system (administering approximately 19,550 active policies for Family Life) is
scheduled for completion at the end of September, 1999.
A non-material 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 42,280 policies
for Investors-NA) was converted to CK/4 in February of 1998. The conversion of
the Life 70 system (administering approximately 16,120 active policies for
Investors-IN) is scheduled for completion in May, 1999. The modification of the
Lifecomm-B system which is responsible for the 18,000 policies assumed after the
acquisition of State Auto Life originally scheduled for completion in April,
1999, was completed in February, 1999. The conversion of the Lifecomm-A system
(administering approximately 62,410 active policies for Investors-NA) is now
scheduled for completion in September of 1999.
The various software applications described above are licensed to the Company or
its affiliates under agreements which permit the Company's and ILCO's
subsidiaries to process business on its computer systems utilizing such
software.
In 1997, FIC Computer Services, Inc. purchased new mainframe hardware and
accompanying operating software, which the vendor has represented to be Y2K
compliant. FIC Computer Services, Inc. has completed the installation and
testing of such new mainframe hardware and software for compliance with the
requirements of the Year 2000 conversion. In addition, FIC Computer Services has
purchased certain third-party software which is run on the mainframe. This
software has been represented by the vendor as being in compliance with Year
2000 requirements. Testing is currently being done on such third-party software,
which testing is expected to be completed by September 1, 1999. The telephone
system, which includes both PBX and voice mail systems, 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.
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. Pursuant to the Plan, 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
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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 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.
Competition
There are many life and health insurance companies in the United States. Agents
placing insurance business with Family Life and ILCO's insurance subsidiaries
are compensated on a commission basis. However, some companies pay higher
commissions and charge lower premium rates and many companies have more
substantial resources than Family Life and ILCO's insurance subsidiaries. The
principal cost and competitive factors that affect the ability of Family Life
and ILCO's insurance subsidiaries to sell their insurance products on a
profitable basis are: (1) the general level of premium rates for comparable
products; (2) the extent of individual policyholders services required to
service each product category; (3) general interest rate levels; (4) competitive
commission rates and related marketing costs; (5) legislative and regulatory
requirements and restrictions; (6) the impact of competing insurance and other
financial products; and (7) the condition of the regional and national
economies.
Reinsurance and Reserves
In accordance with general practices in the insurance industry, Family Life and
ILCO's insurance subsidiaries limit the maximum net losses that may arise from
large risks by reinsuring with other carriers. Such reinsurance provides for a
portion of the mortality risk to be retained by Family Life and the ILCO
subsidiaries with the excess being ceded to a reinsurer at a premium set forth
in a schedule based upon the age and risk classification of the insured. The
reinsurance treaties provide for allowances that help Family Life and ILCO's
insurance subsidiaries offset the expense of writing new business. Family Life
generally retains the first $200,000 of risk on the life of any one individual.
Investors-IN generally retains the first $60,000 to $100,000 of risk on the life
of any individual, depending on the type of coverage being written. Investors-NA
generally retains the first $250,000 of risk on the life of any individual.
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Family Life maintains a bulk reinsurance treaty, under which it reinsured all of
its risks under accidental death benefit policies. The treaty was most recently
renegotiated with the current reinsurer in January, 1997.
As discussed above (see "Principal Products"), in December, 1997, FLIC and
ILCO's life insurance subsidiaries entered into a reinsurance treaty under which
all of the contractual obligations and risks under accident and health and
disability income policies were assumed by a third party reinsurer. In
connection with the transaction, the total amount of net reserves transferred by
the FLIC was $852,688. In addition to the transfer of reserves, FLIC paid the
reinsurer $100,000 in connection with the transaction, which amount was
accounted for as an expense for the year ended December 31, 1997. In 1997, the
accident and health business generated approximately $735,000 in annualized
premiums.
In 1995, Family Life (as the ceding company) entered into a reinsurance
agreement with Investors- NA (as the reinsuring company) pertaining to universal
life insurance written by Family Life. The reinsurance agreement is on a
co-insurance basis and applies to all covered business with effective dates on
and after January 1, 1995. The agreement applies to only that portion of the
face amount of the policy which is less than $200,000; face amounts of $200,000
or more are reinsured by Family Life with a third party reinsurer. In 1996,
Family Life (as the ceding company) entered into a reinsurance agreement with
Investors-NA (as the reinsuring company), pertaining to annuity contracts
written by Family Life. The agreement applies to contracts written on or after
January 1, 1996. These reinsurance arrangements reflect management's plan to
develop universal life and annuity business at Investors-NA, with Family Life
concentrating on the writing of term life insurance products.
Although reinsurance does not eliminate the exposure of FIC's and ILCO's
insurance subsidiaries to losses from risks insured, the net liability of such
subsidiaries will be limited to the portion of the risk retained, provided that
the reinsurers meet their contractual obligations.
ILCO's insurance subsidiaries and Family Life carry reserves on their books to
meet future obligations under their outstanding insurance policies. Such
reserves are believed to be sufficient to meet policy obligations as they mature
and are calculated using assumptions for interest, mortality, expenses and
withdrawals in effect at the time the policies were issued.
Acquisition of Family Life
In June, 1991, FIC purchased Family Life, a Washington based life insurance
corporation, from Merrill Lynch Insurance Group, Inc. ("Merrill Lynch"). The
business of Family Life, as reconstituted for sale, consists principally of the
underwriting and sale of life insurance to mortgage borrowers through lending
institutions.
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The consideration for the purchase was $114 million consisting of a cash payment
of $70 million and $44 million of subordinated promissory notes issued by
subsidiaries of FIC to the seller and its affiliates.
To effectuate the transaction, FIC organized two downstream holding companies:
Family Life Corporation ("FLC"), and Family Life Insurance Investment
Corporation ("FLIIC"). FLIIC was organized as a wholly-owned subsidiary of FIC
and, in turn, was issued all of the outstanding shares of FLC. FLC purchased
250,000 shares of common stock, being all of the outstanding shares, of Family
Life from Merrill Lynch for an $84 million cash payment (including $14 million
that had been borrowed by FLIIC from an affiliate of Merrill Lynch) and a $30
million senior subordinated note. Following the purchase of the Family Life
shares by FLC, Family Life issued 250,000 previously unissued shares of its
common stock to FLC for a $2.5 million cash payment and immediately thereafter
redeemed from FLC 250,000 shares of its common stock that had been purchased by
FLC from Merrill Lynch. The consideration paid to FLC by Family Life for said
redeemed shares consisted of $2.5 million cash, a newly issued surplus debenture
(an instrument having certain restrictions on payment for the protection of
policyholders) in the principal amount of $97.5 million and $14 million
principal value of newly issued preferred shares.
As part of the financing arrangement, FLC entered into a Senior Loan agreement
under which $50 million was provided by a group of banks (the "Family Life
Senior Loan"). The balance of the financing consisted of a $30 million
subordinated note issued by FLC to Merrill Lynch and $14 million borrowed by
FLIIC from an affiliate of Merrill Lynch and evidenced by a subordinated note in
the principal amount of $12 million and a subordinated note in the principal
amount of $2 million (collectively, the "Merrill Lynch Subordinated Loans") and
$25 million lent by two insurance company subsidiaries of ILCO (the "Investors
Life Subordinated Loans"). The latter amount was represented by a $22.5 million
loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC
by Investors-CA. In addition to the interest provided under the Investors Life
Subordinated Loans, Investors-NA and Investors-CA were granted by FIC
non-transferable options to purchase, in amounts proportionate to their
respective loans, up to a total of 9.9 percent of shares of FIC common stock at
a price of $10.50 per share, equivalent to the then current market price,
subject to adjustment to prevent dilution. The initial terms of the option
provided for their expiration on June 12, 1998, if not previously exercised. In
connection with the 1996 amendments to the $34.5 million subordinated loans
obtained from Investors-NA, the expiration date of the options was extended to
September 12, 2006. For a discussion of the 1996 amendments, please refer to
Item 13, Certain Relationships and Related Transactions with Management, above.
Of the total $119 million of cash borrowed and notes issued by FIC and its
subsidiaries for purposes of the transaction, $114 million constituted the
purchase price for Family Life and $5 million was used to pay transaction costs,
for working capital and for other related purposes. In connection with the
several loans effected for purposes of the transaction, various creditors
priorities and normal borrower requirements and restrictions were established
and FIC issued its direct guaranty of the respective loans, subject to certain
priorities, to the various lending banks, Merrill Lynch and its affiliates, and
Investors-NA and Investors-CA. The outstanding shares of common stock of Family
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Life were also pledged as collateral to the bank lenders and, upon repayment of
the bank loan, to Merrill Lynch. The transaction was structured to conform to
the requirements of Section 338(h)(10) of the Internal Revenue Code.
On July 30, 1993, the Merrill Lynch Subordinated Loans were prepaid. $38 million
plus accrued interest was paid to retire the indebtedness, which had a principal
balance of approximately $50 million on July 30, 1993. The primary source of the
funds used to prepay the Merrill Lynch Subordinated Loans was new subordinated
loans totaling $34.5 million that were obtained from Investors-NA. See "The
Family Life Refinancing."
Family Life Senior and Subordinated Loans
Senior Loan. The Senior Loan obligations of FLC were completely paid off on
April 17, 1996. During the period that the Senior Loan was in effect, it was a
secured and guaranteed five year term loan in the initial principal amount of
$50 million.
Upon the retirement of the Senior Loan, certain of its provisions were
automatically incorporated into the Investors Life Subordinated Loans which are
described in the following section. Those provisions include specified events of
default, including, but not limited to, failure to pay principal, interest,
commitment fees or other amounts payable when due, failure to maintain certain
financial covenants, violation of covenants (including covenants with respect to
the maintenance of a minimum net worth), material misrepresentations, defaults
under other indebtedness, the loss of any license of an insurance subsidiary of
FLC which would have a material adverse effect on FLC, defaults under the FIC
guaranty agreement, a fine in an amount in excess of $100,000 imposed upon any
insurance subsidiary of FLC by any state insurance regulatory agency, changes in
ownership or control of FIC by its controlling person, Roy F. Mitte, or in ILCO
by FIC and the occurrence of certain events of bankruptcy. In addition, the
security interests furnished to the lenders under the Senior Loan were
transferred to Investors-NA. The security interests include all of the issued
and outstanding shares of preferred stock and common stock of FLC and Family
Life and the $97.5 million surplus debenture of Family Life.
Investors Life Subordinated Loans. The $22.5 million subordinated senior note
issued by FLC to Investors-NA was originally scheduled to mature on June 12,
1998, with principal payments in four equal semi-annual principal installments
of $5,625,000 each on December 12, 1996, June 12, 1997, December 12, 1997 and
June 12, 1998. Interest is payable semi-annually, at the rate of 11% per annum.
Effective as of June 12, 1996, the note was amended to provide for twenty
quarterly principal payments, in the amount of $1,125,000 each, to commence on
December 12, 1996. The final quarterly principal payment is due on September 12,
2001. The interest rate on the note remains at 11%.
The $2.5 million subordinated note issued by FIC to Investors-CA initially
provided for interest, payable semi-annually, at the rate of 12% per annum, and
its principal was due and payable in full at maturity on June 12, 1998 (the "FIC
Note"). As a result of the merger of Investors-CA into
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Investors-NA, the FIC Note is now owned by Investors-NA. Prior to June 12, 1996,
accrued interest on the FIC Note was paid by delivery of additional notes of FIC
having terms identical to such original note, including the payment of interest
(the "PIK Notes"). Interest payable on and after June 12, 1996 on all of the FIC
Note is to be paid in cash. Effective as of June 12, 1996, the FIC Note was
amended to provide that the principal balance of the note is to be repaid in
twenty quarterly installments of $125,000 each, commencing December 12, 1996
with the final payment due on September 12, 2001. With respect to the PIK Notes,
the amendment provided that the principal balance of the notes ($1,977,119) is
to be paid in twenty quarterly principal payments, in the amount of $98,855.95
each, commencing December 12, 1996 with the final payment due on September 12,
2001. The interest rate on both the FIC Note and the PIK Notes remained at 12%.
The obligors are allowed to prepay the Investors Life Subordinated Loans, in
whole or in part, without premium or penalty. During the time that the Senior
Loan was outstanding, the Investors Life Subordinated Loans were subordinated to
the Senior Loan and constitute a second lien on the pledged collateral subject
to the first lien of the Senior Loan. Repayment of FLC's $22.5 million note is
also guaranteed by FIC.
The Investors Life Subordinated Loan documents specify events of default,
including, but not limited to, failure to pay principal, interest or other
amounts payable with respect to the Investors Life Subordinated Loan documents
when due, violation of covenants in the Investors Life Subordinated Loan
documents (including covenants with respect to the maintenance of a minimum net
worth), material misrepresentations, defaults under other indebtedness, and the
occurrence of certain events of bankruptcy.
The Investors Life Subordinated Loan documents also contain various specified
negative, affirmative and financial covenants to be performed or observed by
FLC, FIC and their subsidiaries. During the period the Senior Loan was
outstanding, the covenants in effect under the Investors Life Subordinated Loan
documents were less restrictive than the covenants under the Senior Loan
documents but become generally equivalent to the Senior Loan restrictions upon
the termination of the Senior Loan.
On July 30, 1993, Investors-NA loaned $34.5 million to FLC and FLIIC in the form
of subordinated notes in connection with the prepayment of the Merrill Lynch
Subordinated Loans. See "The Family Life Refinancing."
As of December 31, 1998 the outstanding principal balance of the Investors Life
Subordinated Loans, including the loans made by Investors-NA in 1993 was $47.65
million.
Options. In addition to the interest provided under the Investors Life
Subordinated Loans, Investors- NA and Investors-CA were granted by FIC
non-transferable options to purchase, in amounts proportionate to their
respective loans, up to a total of 9.9 percent of shares of FIC common stock at
a price of $2.10 per share (as adjusted to reflect the five-for-one stock split
in November, 1996), equivalent to the then current market price, subject to
adjustment to prevent dilution. The initial
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terms of the option provided for their expiration on June 12, 1998, if not
previously exercised. In connection with the 1996 amendments to the $34.5
million subordinated loans obtained from Investors-NA, the expiration date of
the options was extended to September 12, 2006.
The Family Life Refinancing. In July, 1993, the Merrill Lynch Subordinated Loans
were prepaid. $38 million plus accrued interest was paid to retire the
indebtedness, which had a principal balance of approximately $50 million on July
30, 1993.
The primary source of the funds used to prepay the Merrill Lynch Subordinated
Loans was new subordinated loans totaling $34.5 million that were obtained from
Investors-NA. Prior to the 1996 amendments described below, the principal amount
of the new subordinated debt was payable in four equal annual installments in
2000, 2001, 2002 and 2003. The interest rate is 9%. The other terms of the 1993
notes are substantially the same as those of the $22.5 million subordinated loan
that Investors-NA had previously made to FLC and that continue to be
outstanding.
The $34.5 million of new subordinated loans consist of a $30 million loan to FLC
and a $4.5 million loan to FLIIC. The debt restructuring reduced the total
indebtedness of FLC and FLIIC by approximately $15 million. The transaction
resulted in a pre-tax gain of approximately $12 million for the Company in the
third quarter of 1993, and the Company estimates that the restructuring of this
subordinated debt will result in aggregate interest savings to FLC and FLIIC of
approximately $40 million over the next ten years. In recognition of this
reduced interest requirement, the interest rate on the surplus debenture of
Family Life held by FLC was reduced from 12.5% to 9%.
As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC
and FLIIC were modified as follows: (a) the $22.5 million note was amended to
provide for twenty quarterly principal payments, in the amount of $1,125,000
each, to commence on December 12, 1996; the final quarterly principal payment is
due on September 12, 2001; the interest rate on the note remains at 11%, (b) the
$30 million note was amended to provide for forty quarterly principal payments,
in the amount of $163,540 each for the period December 12, 1996 to September 12,
2001; beginning with the principal payment due on December 12, 2001, the amount
of the principal payment increases to $1,336,458; the final quarterly principal
payment is due on September 12, 2006; the interest rate on the note remains at
9%, (c) the $4.5 million note was amended to provide for forty quarterly
principal payments, in the amount of $24,531 each for the period December 12,
1996 to September 12, 2001; beginning with the principal payment due on December
12, 2001, the amount of the principal payment increases to $200,469; the final
quarterly principal payment is due on September 12, 2006; the interest rate on
the note remains at 9%, (d) the $2.5 million note was amended to provide that
the principal balance of the note is to be repaid in twenty quarterly
installments of $125,000 each, commencing December 12, 1996 with the final
payment due on September 12, 2001; the rate of interest remains at 12%, (e) the
Master PIK note, which was issued to provide for the payment in kind of interest
due under the terms of the $2.5 million note prior to June 12, 1996, was amended
to provide that the principal balance of the note ($1,977,119) is to be paid in
twenty quarterly principal payments, in the amount of $98,855.95 each, to
commence
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December 12, 1996 with the final payment due on September 12, 2001; the interest
rate on the note remains at 12%.
In December, 1998, FLIIC was dissolved. In connection with the dissolution, all
of the assets and liabilities of FLIIC became the obligations of FLIIC's sole
shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5
million note described above are now the obligations of FIC.
ILCO's Senior Loan
ILCO's Senior Loan was fully repaid as of September 30, 1998. During the period
that the ILCO Senior Loan was outstanding, FIC guaranteed obligations under the
loan documents. The Senior Loan of ILCO was originally arranged in connection
with the 1988 acquisition of Investors-NA and Investors-CA. In January, 1993,
ILCO refinanced its Senior Loan. That transaction was done in connection with
the prepayment of the subordinated indebtedness and the purchase of warrants
which had been issued as part of the financing of the 1988 acquisitions. The
terms of the amended and restated credit facility were substantially the same as
the terms and provisions of the 1988 Senior Loan. The maturity date, which had
been December 31, 1996, was extended to July 1, 1998 for the Senior Loan. The
average interest rate paid by ILCO on its Senior Loan was approximately 7.76%
during 1996, 7.68% during 1997 and 7.63% during 1998.
In February, 1995, ILCO borrowed an additional $15 million under the Senior Loan
to help finance the acquisition of Meridian Life Insurance Company, and the
maturity date of the Senior Loan was further extended to July 1, 1999. As of
December 31, 1995, the outstanding principal balance of ILCO's Senior Loan
obligations was $59.4 million. In January, 1996, ILCO made a scheduled payment
of $4.5 million under its Senior Loan. In March, 1996, ILCO made the scheduled
payments for April 1st and July 1st, totaling $9 million. At that same time,
ILCO made a payment of $941,000, an additional payment under the terms of the
loan applied to the principal balance. On April 1, 1996, an optional principal
payment in the amount of $15 million was made, which resulted in advancing the
scheduled payoff date of the Senior Loan to April 1, 1998. In July, 1996, ILCO
made the principal payment for October 1st ($4.5 million), plus an optional
principal payment of $0.5 million. In connection with ILCO's acquisition of
State Auto Life Insurance Company in July, 1997, ILCO's Senior Loan agreement
was modified to extend the maturity date to October 1, 1998.
As of December 31, 1997, the outstanding principal balance of ILCO's senior loan
obligations was $11.0 million, which reflected the prepayment by the Company 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.
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Regulation
General. ILCO's insurance subsidiaries and Family Life are subject to regulation
and supervision by the states in which they are licensed to do business. Such
regulation is designed primarily to protect policy owners. Although the extent
of regulation varies by state, the respective state insurance departments have
broad administrative powers relating to the granting and revocation of licenses
to transact business, licensing of agents, the regulation of trade practices and
premium rates, the approval of form and content of financial statements and the
type and character of investments.
These laws and regulations require Family Life and ILCO's insurance subsidiaries
to maintain certain minimum surplus levels and to file detailed periodic reports
with the supervisory agencies in each of the states in which they do business,
and their business and accounts are subject to examination by such agencies at
any time. The insurance laws and regulations of the domiciliary states of FIC's
and ILCO's insurance subsidiaries require that such subsidiaries be examined at
specified intervals. Family Life is domiciled in the State of Washington.
Investors-NA and Investors-IN are domiciled in the states of Washington and
Indiana, respectively. In December 1992, Investors-NA redomesticated from
Pennsylvania to Washington, and Investors-CA merged into Investors-NA. In June,
1993, Standard Life merged into Investors-NA. Prior to December, 1997,
Investors-IN was domiciled in the State of New Jersey. In December, 1997,
Investors-IN transferred its domicile to the State of Indiana.
A number of states regulate the manner and extent to which insurance companies
may test for Acquired Immune Deficiency Syndrome (AIDS) antibodies in connection
with the underwriting of life insurance policies. To the extent permitted by
law, Family Life and ILCO's insurance subsidiaries consider AIDS information in
underwriting coverages and establishing premium rates. An evaluation of the
financial impact of future AIDS claims is extremely difficult, due in part to
insufficient and conflicting data regarding the incidence of the disease in the
general population and the prognosis for the probable future course of the
disease.
Risk-Based Capital Requirements. Effective for the 1993 calendar year, the
National Association of Insurance Commissioners ("NAIC") has adopted Risk-Based
Capital ("RBC") requirements to evaluate the adequacy of statutory capital and
surplus in relation to investment and insurance risks associated with: (i) asset
quality; (ii) mortality and morbidity; (iii) asset and liability matching; and
(iv) other business factors. The states will use the RBC formula as an early
warning tool to discover potential weakly capitalized companies for the purpose
of initiating regulatory action. The RBC requirements are not intended to be a
basis for ranking the relative financial strength of insurance companies. In
addition, the formula defines a new minimum capital standard which will
supplement the prevailing system of low fixed minimum capital and surplus
requirements on a state-by-state basis.
The RBC requirements provide for four different levels of regulatory attention
in those states that adopt the NAIC regulations, depending on the ratio of the
company's Total Adjusted Capital (which generally consists of its statutory
capital, surplus and asset valuation reserve) to its Authorized
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Control Level RBC. A "Company Action Level Event" is triggered if a company's
Total Adjusted Capital is less than 200% but greater than or equal to 150% of
its Authorized Control Level RBC, or if a negative trend has occurred (as
defined by the regulations) and Total Adjusted Capital is less than 250% but
more than 200% of its Authorized Control Level RBC. When a Company Action Level
Event occurs, the company must submit a comprehensive plan to the regulatory
authority which discusses proposed corrective actions to improve its capital
position. A "Regulatory Action Level Event" is triggered if a company's Total
Adjusted Capital is less than 150% but greater than or equal to 100% of its
Authorized Control Level RBC. When a Regulatory Action Level Event occurs, the
regulatory authority will perform a special examination of the company and issue
an order specifying corrective actions that must be followed. An "Authorized
Control Level Event" is triggered if a company's Total Adjusted Capital is less
than 100% but greater than or equal to 70% of its Authorized Control Level RBC,
and the regulatory authority may take any action it deems necessary, including
placing the company under regulatory control. A "Mandatory Control Level Event"
is triggered if a company's Total Adjusted Capital is less than 70% of its
Authorized Control Level RBC, and the regulatory authority is mandated to place
the company under its control.
Calculations using the NAIC formula and the statutory financial statements of
Family Life and ILCO's insurance subsidiaries as of December 31, 1998 indicate
that the Total Adjusted Capital of each of FIC's and ILCO's insurance
subsidiaries is above 640% of its respective Authorized Control Level RBC.
Solvency Laws Assessments. The solvency or guaranty laws of most states in which
an insurance company does business may require that company to pay assessments
(up to certain prescribed limits) to fund policyholder losses or liabilities of
insurance companies that become insolvent. Recent insolvencies of insurance
companies increase the possibility that such assessments may be required. These
assessments may be deferred or forgiven under most guaranty laws if they would
threaten an insurer's financial strength and, in certain instances, may be
offset against future premium taxes. The insurance companies record the expense
for guaranty fund assessments in the period assessed. The net amounts of such
assessments for Family Life and ILCO's insurance subsidiaries were approximately
($15,237) and $7,016, respectively, in the year ended December 31, 1998. Those
amounts are net of the amounts that can be offset against future premium taxes
and, in the case of Family Life, the amount is also net of the amount that can
be recovered from Merrill Lynch pursuant to the Stock Purchase Agreement between
FIC and Merrill Lynch. See "Acquisition of Family Life." The likelihood and
amount of any other future assessments cannot be estimated and are beyond the
control of FIC and ILCO.
Surplus Debentures and Dividends. The principal sources of cash for FLC to make
payments of principal and interest on the Family Life Senior Loan are payments
under the surplus debenture of Family Life Insurance Company (a
Washington-domiciled insurer) and dividends paid by Family Life. Under current
Washington law, any proposed payment of a dividend or distribution which,
together with dividends or distributions paid during the preceding twelve
months, exceeds the greater of (i) 10% of statutory surplus as of the preceding
December 31 or (ii) statutory net gain from operations for the preceding
calendar year is an "extraordinary dividend" and may not be paid until
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either it has been approved, or a 60-day waiting period shall have passed during
which it has not been disapproved, by the Washington Insurance Commissioner. In
1993, Washington amended its insurance code to retain the above-described
"greater of" standard for dividends, but enacted 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
presently permitted to pay cash dividends. However, since this law applies only
to dividend payments, the ability of Family Life to make principal and interest
payments under the surplus debenture is not affected.
Principal and interest payments on the surplus debenture have provided
sufficient funds to meet debt service obligations of FLC. Under the provisions
of the surplus debenture and current law, Family Life can pay interest and
principal on the surplus debenture without having to obtain the prior approval
of the Washington Insurance Commissioner; provided that, after giving effect to
the payment of interest or principal on the surplus debenture, the statutory
capital and surplus of Family Life exceeds 6% of its assets. Pursuant to the
surplus debenture, Family Life paid principal and interest in 1996, 1997 and
1998 totaling $13,526,338, $11,903,287 and $11,564,978, respectively. Family
Life does give five-days prior notification to the Washington Insurance
Department of each proposed payment on the surplus debenture in accordance with
an agreement between Family Life and the Department. 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
FLC to service its indebtedness for the foreseeable future.
Valuation Reserves. Commencing in 1992, the Mandatory Securities Valuation
Reserve ("MSVR") required by the NAIC for life insurance companies was replaced
by a mandatory Asset Valuation Reserve ("AVR") which is expanded to cover
mortgage loans, real estate and other investments. During 1997, a change in the
NAIC's AVR procedures resulted in a one-time reduction in the amount of the
reserves held by Family Life, with a corresponding one-time increase in the
amount of surplus, in the amount of $320,000. A new mandatory Interest
Maintenance Reserve ("IMR"), designed to defer realized capital gains and losses
due to interest rate changes on fixed income investments and to amortize those
gains and losses into future income, is also effective for 1992. Previously,
realized capital gains attributable to interest rate changes were credited to
the MSVR and had the effect of reducing Family Life's required MSVR
contributions. Effective in 1992, such realized capital gains are credited to
the IMR. The combination of the AVR and IMR will affect statutory capital and
surplus and may reduce the ability of Family Life to pay dividends and make
payments on the surplus debenture.
Insurance Holding Company Regulation. Family Life is subject to regulation under
the insurance and insurance holding company statutes of Washington. The
insurance holding company laws and regulations vary from jurisdiction to
jurisdiction, but generally require insurance and reinsurance subsidiaries of
insurance holding companies to register with the applicable state regulatory
authorities and to file with those authorities certain reports describing, among
other information, their capital structure, ownership, financial condition,
certain intercompany transactions and general
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business operations. The insurance holding company statutes also require prior
regulatory agency approval or, in certain circumstances, prior notice of certain
material intercompany transfers of assets as well as certain transactions
between insurance companies, their parent companies and affiliates.
Under the Washington Insurance Code, unless (i) certain filings are made with
the Washington Department of Insurance, (ii) certain requirements are met,
including a public hearing and (iii) approval or exemption is granted by the
insurance commissioner, no person may acquire any voting security or security
convertible into a voting security of an insurance holding company, such as the
Company, which controls a Washington insurance company, or merge with such a
holding company, if as a result of such transaction such person would "control"
the insurance holding company. "Control" is presumed to exist if a person
directly or indirectly owns or controls 10% or more or the voting securities of
another person.
Potential Federal Regulation. Although the federal government generally does not
directly regulate the insurance industry, federal initiatives often have an
impact on the business. Congress and certain federal agencies are investigating
the current condition of the insurance industry (encompassing both life and
health and property and casualty insurance) in the United States in order to
decide whether some form of federal role in the regulation of insurance
companies would be appropriate. Congress is currently conducting a variety of
hearings relating in general to the solvency of insurers. It is not possible to
predict the outcome of any such congressional activity nor the potential effects
thereof on Family Life.
Congressional initiatives directed at repeal of the McCarran-Ferguson Act (which
exempts the "business of insurance" from most federal laws, including the
antitrust laws, to the extent it is subject to state regulation) and judicial
decisions narrowing the definition of "business of insurance" for
McCarran-Ferguson Act purposes may limit the ability of insurance companies in
general to share information with respect to rate-setting, underwriting and
claims management practices. Current and proposed federal measures which may
also significantly affect the insurance industry include minimum solvency
requirements and removal of barriers preventing banks from engaging in the
insurance business.
Federal Income Taxation
The Revenue Reconciliation Act of 1990 amended the Internal Revenue Code of 1986
to require a portion of the expenses incurred in selling insurance products to
be deducted over a period of years, as opposed to an immediate deduction in the
year incurred. Since this change only affects the timing of the deductions, it
does not affect tax expense as shown on the Company's financial statements
prepared in accordance with GAAP. However, the change will increase the tax for
statutory accounting purposes in the first few years, which will reduce
statutory surplus and, accordingly, may decrease the amount of cash dividends
that Family Life can pay. For the years ended December 31, 1996, 1997 and 1998,
the increases (decreases) in Family Life's current income tax provisions,
utilizing the effective tax rates, due to this change were $183,358, $136,000
and $89,034,
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respectively. The change has a negative tax effect for statutory accounting
purposes when Family Life's premium income increases, but has a positive tax
effect when its premium income decreases.
Item 2. Properties
The Registrant's headquarters are currently located at Austin Centre, 701
Brazos, Suite 1400, Austin, Texas. A subsidiary of ILCO, Investors-NA, purchased
Austin Centre, an office-hotel property in downtown Austin in August 1991 for a
purchase price of $31,275,000 from an unrelated seller that had previously
acquired the property through foreclosure. Austin Centre covers a full city
block and is a sixteen story mixed use development consisting of 343,664 square
feet of office/retail space (predominately office space), a 314 room hotel and
61 luxury apartments, all united by a 200 foot high glass atrium. The project
was completed in October 1986.
In September 1995, Investors-NA entered into a contract to sell Austin Centre to
an Austin-based real estate investment firm for a purchase price of $62.675
million, less $1 million to be paid to a capital reserve account for the
purchaser. The sale was consummated on March 29, 1996. A portion of the sale
proceeds equal to the amount that Investors-NA presently had invested in Austin
Centre were retained and reinvested by Investors-NA. The balance of the net
proceeds of the sale were used to reduce ILCO's bank indebtedness by
approximately $15 million.
Following the sale of the Austin Centre, the Company and its affiliates
continued to occupy three floors of the office space, under a lease arrangement.
The current lease, which was entered into in May, 1997, is for a five (5) year
term ending in October, 2002, with options to renew for three successive five
(5) year terms thereafter.
In January, 1995, ILCO, through Investors-NA, purchased, as an investment
property, an office building project known as Bridgepoint Office Square in
Austin, Texas for a cash purchase price of $9.75 million. The property consists
of 20 acres of land with four office building sites and two parking structure
sites. The first phase of development of the property was completed in 1986 and
consists of a five-story office building with 83,474 square feet of rentable
space and a 550-car parking garage.
In the fourth quarter of 1995, construction began on the second office building,
containing approximately 109,000 rentable square feet, and the other parking
garage containing approximately 871 spaces. That phase of the project was
completed in September, 1996. In March, 1996, construction commenced on the
third office building, with approximately 79,000 rentable square feet of office
space and was completed in December, 1996. Construction began on the fourth
building in July 1996, and was completed in July, 1997. The fourth building
contains approximately 92,459 rentable square feet.
On May 3, 1996, Family Life purchased a tract of land adjoining the Bridgepoint
Office Square tract for a cash purchase price of $1.3 million. The property
consists of 7.1 acres of land with one office building site and one parking
structure site. Family Life began construction of the fifth building
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(known as "Bridgepoint Five") on the new site in January 1997. In May, 1997, the
entire rentable space (approximately 76,793 rentable square feet) contained in
the building was leased to a major tenant in the technology business.
Construction of the parking garage and the building shell was completed in
October, 1997.
On November 24, 1997, Investors-NA and Family Life entered into a contract with
Health and Retirement Properties Trust, a Maryland real estate investment trust
(the "Purchaser") to sell their respective interests in the Bridgepoint Square
Office complex. The aggregate purchase price for the project was $78,000,000.
The transaction closed on December 5, 1997. The purchase price was allocated
approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale of
Bridgepoint Office Square resulted in a net profit to Investors-NA of
approximately $14.0 million ($9.1 million after tax) that is included in ILCO's
fourth quarter earnings for the year 1997. For Family Life, the sale resulted in
a net profit of approximately $4.5 million ($3.2 million after tax) that is
included in FIC's fourth quarter earnings for the year 1997.
Family Life leases its home offices at the Sedgwick James Building, 2101 Fourth
Avenue, in Seattle, Washington. The lease currently covers approximately 7,776
rentable square feet of office space for a term expiring in October, 2001. The
base rental is approximately $11,200 per month, which includes Family Life's
proportionate share of the building's operating expenses, including utilities,
property taxes, insurance, maintenance and management. Actual increases from
those initial operating expenses during the lease term are passed on to Family
Life on a proportionate basis.
The Company believes that its properties and leased space are adequate to meet
its foreseeable requirements.
Item 3. 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 on 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. ILCO 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
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allegations which are substantially identical to the allegations in the first
action. The named plaintiff also seeks class certification. ILCO believes that
the court would consider class certification with respect to only one of these
actions. ILCO also believes that this action is without merit and intends to
vigorously defend this matter.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year ended
December 31, 1998 to a vote of security holders.
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PART II
Item 5. Market for the Registrant's Common Stock and Related
Security Holder Matters
A. Market Information
The following table sets forth the quarterly high and low sales prices for FIC
Common Stock in The Nasdaq Small-Cap Market for 1998 and 1997. The quotations
set forth in the table have been adjusted to give retroactive effect to the
five-for-one stock split which was effective November 12, 1996. FIC's NASDAQ
trading symbol is FNIN.
Common Stock
Prices
High Low
1998
First Quarter $ 21.25 $ 16.375
Second Quarter 20.50 17.75
Third Quarter 20.25 12.50
Fourth Quarter 19.50 13.625
1997
First Quarter $ 13.25 $ 10.75
Second Quarter 13.25 11.00
Third Quarter 16.25 11.625
Fourth Quarter 20.25 14.75
B. Stockholders
As of March 15, 1999 there were approximately 15,650 record holders of FIC
Common Stock.
C. Dividends
FIC has not paid a dividend since 1976 and does not expect to pay a dividend
during 1999.
The ability of an insurance holding company, such as FIC, to pay dividends to
its shareholders may be limited by the company's ability to obtain revenue, in
the form of dividends and other payments, from its operating insurance
subsidiary or subsidiaries. The right of Family Life to pay dividends is
restricted by the insurance laws of its domiciliary state. See Item 1. Business
- - Regulation Surplus Debenture and Dividends. However, FIC does not directly own
Family Life's stock but, instead, indirectly owns that stock through a
downstream holding company, Family Life Corporation ("FLC"). FLC, which holds
all of the stock of Family Life, is prohibited from paying dividends on its
common stock by the provisions of the notes from Investors-NA. FIC (as the
successor to the obligations of FLIIC under the provisions of the $4.5 million
subordinated note held by Investors- NA) the immediate parent of FLC and the
directly-owned subsidiary of FIC, is prohibited from paying dividends on its
stock by the provisions of the $4.5 million subordinated note. The ability of
ILCO to pay dividends to FIC and the other shareholders of ILCO is affected by
the receipt of dividends and other payments from its insurance subsidiaries.
Item 6. Selected Financial Data: (Registrant and its Consolidated Subsidiaries)
(In thousands, except per share data)
<TABLE>
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
Operating Revenues $53,607 $63,343 $59,928 $61,541 $68,524
Income (loss) before federal
income tax, equity in net
earnings of affiliates 8,973 13,411 9,791 10,394 10,610
Income before equity in net
earnings of affiliates 6,605 9,870 7,145 7,966 8,264
Equity in net earnings of
affiliate, net of tax 2,613 6,458 9,012 2,051 1,690
Net Income $ 9,218 $ 16,328 $ 16,157 $ 10,017 $ 9,954
Common Stock Equivalents 5,557 5,589 5,568 5,540 5,530
Net income per share
Basic $ 1.71 $ 3.01 $ 2.98 $ 1.85 $ 1.83
Diluted $ 1.66 $ 2.92 $ 2.90 $ 1.81 $ 1.80
Total Assets $301,738 $304,324 $287,730 $287,678 $253,100
Long Term Obligations $ 47,645 $ 53,792 $ 59,940 $ 67,989 $ 77,819
</TABLE>
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
For the year ended December 31, 1998, FIC's net income was $9,218,000 (basic
earnings of $1.71 per common share or diluted earnings of $1.66 per common
share), as compared to $16,328,000 (basic earnings of $3.01 per common share or
diluted earnings of $2.92 per common share) for the year ended December 31, 1997
and $16,157,000 (basic earnings of $2.98 per common share or diluted earnings of
$2.90 per common share), for the year ended December 31, 1996. Earnings per
share are stated in accordance with the requirements of Financial Accounting
Standard (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. For the
year 1996, earnings per share have been restated to reflect the effect of FAS
No. 128.
Results of Operations
Net income from continuing operations (excluding the gain resulting from Family
Life's sale of its interest in Bridgepoint Square Offices in 1997, ILCO's sale
of its interest in Bridgepoint Square Offices in 1997, and ILCO's sale of the
Austin Centre in 1996, as described below) was $9,218,000 (basic earnings of
$1.71 per common share or diluted earnings of $1.66 per common share) for the
year ended December 31, 1998, $9,300,000 (basic earnings of $1.71 per common
share or diluted earnings of $1.66 per common share) for the year ended December
31, 1997 and $9,487,000 (basic earnings of $1.75 per common share or diluted
earnings of $1.70 per common share) for the year ended December 31, 1996.
Net income for the year ended December 31, 1997 includes $3.2 million ($0.57 per
common share) resulting from Family Life's sale of its interest in Bridgepoint
Square Offices. Family Life purchased undeveloped land at the Bridgepoint site
in May, 1996, for a cash purchase price of $1.3 million. The property consists
of 7.1 acres of land with one office building site and one parking structure
site. Family Life began construction of the building (known as "Bridgepoint
Five") in January 1997. In May, 1997, the entire rentable space (approximately
76,793 rentable square feet) contained in the building was leased to a major
tenant in the technology business. Construction of the parking garage and the
building shell was completed in October, 1997. In November, 1997, Family Life
entered into a contract to sell its interest in the Bridgepoint Square Office
complex. The sale also included the adjacent properties developed by ILCO's
subsidiary, Investors-NA. The aggregate purchase price for the project was $78
million. The transaction closed on December 5, 1997. The purchase price was
allocated approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale
resulted in a net profit to Family Life of approximately $4.5 million ($3.2
million after tax) that is included in FIC's earnings for the year 1997.
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FIC's net income is affected by its equity interest in InterContinental Life
Corporation ("ILCO") and ILCO's insurance subsidiaries. Net income for the year
ended December 31, 1997 includes $3.8 million ($0.68 per common share on a
diluted basis) resulting from ILCO's sale of its interest in Bridgepoint Square
Offices. Net income for the year ended December 31, 1996 includes $7.1 million
resulting from ILCO's sale of the Austin Centre, a hotel/office complex, located
in Austin, Texas.
The statutory earnings of Family Life as required to be reported to insurance
regulatory authorities before interest expense, capital gains and losses, and
federal income taxes were $12,930,000 at December 31, 1998, as compared to
$13,625,000 at December 31, 1997 and $12,734,000 at December 31, 1996. These
statutory earnings are the source to provide for the repayment of the
indebtedness incurred in connection with the acquisition of Family Life.
The decline in long-term interest rates during 1998, which was related to
general economic conditions, had a positive effect upon the market value of the
fixed maturities available for sale segment of the Company's portfolio. As of
December 31, 1998, the market value of the fixed maturities available for sale
segment was $79.4 million as compared to an amortized value of $76.73 million,
or an unrealized gain $2.67 million. The net of tax effect of this increase has
been recorded as an increase in shareholders' equity. There is no assurance that
this unrealized gain may be realized in the future.
For the year ended December 31, 1998, FIC's income from operations, before
federal income tax and equity in net earnings of affiliate, was $8,973,000 (on
revenues of $53,607,000), as compared to $13,411,000 (on revenues of
$63,343,000) in the year 1997 and $9,791,000 (on revenues of $59,928,000) for
the year 1996.
Premiums for the year 1998, net of reinsurance ceded, were $38.4 million, as
compared to $40.2 million in 1997 and $43.3 million in 1996. Policyholder
benefits and expenses were $16.3 million in 1998, as compared to $19.9 million
in 1997 and $22.1 million in 1996.
Equity in Net Income of InterContinental Life Corporation
General:
Prior to the acquisition of Family Life in June of 1991, FIC's primary
involvement in the life insurance business was through its equity interest in
ILCO. The Company's equity in the net earnings of ILCO, net of federal income
tax, was $2,613,000 , as compared to $6,458,000 for the year 1997 and $9,012,000
for the year 1996. The decrease in 1997, as compared to 1996 is primarily
attributable to the effect, in 1996, of ILCO's net income resulting from the
sale of the Austin Centre property.
FIC currently owns 1,795,146 shares of ILCO's common stock. In addition, Family
Life currently owns 171,200 shares of ILCO common stock. As a result, FIC
currently owns, directly and
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indirectly through Family Life, 1,966,346 shares (approximately 45%) of ILCO's
common stock. Prior to September 30, 1998, FIC held options to acquire 1,702,155
shares of ILCO's common stock. Under the terms of the option agreement, such
options continued in effect only as long as FIC guaranteed certain indebtedness
of ILCO. Since the Senior Loan of ILCO was fully repaid on September 30, 1998,
FIC's rights under the 1986 option agreement expired on September 30, 1998.
The decline in long-term interest rates during 1998, which was related to
general economic conditions, had a positive effect upon the market value of the
fixed maturities available for sale segment of ILCO's investment portfolio. As
of December 31, 1998, the market value of the fixed maturities available for
sale segment was $450.15 million as compared to an amortized cost of $435.13
million, or an unrealized gain of $15.02 million. There is no assurance that
this unrealized gain will be realized by ILCO in the future. Since FIC owns
approximately 45% of the common stock of ILCO, such unrealized gains, net of
tax, are reflected in FIC's equity interest in ILCO, and had the effect of
increasing the reported value of such equity interest by approximately $4.08
million.
ILCO's results for 1998 include, for the period beginning on June 30, 1998, the
operations of Grinnell Life Insurance Company. Grinnell Life was acquired on
June 30, 1998, through a subsidiary of ILCO, for an adjusted purchase price of
$16.6 million. A portion of the purchase price ($12.37 million) was paid by way
of a dividend to the seller immediately prior to the closing of the transaction;
the balance of the purchase price was paid by ILCO's subsidiary. As part of the
transaction, Grinnell Life was immediately merged with and into that subsidiary,
with that subsidiary being the surviving entity.
Liquidity and Capital Resources of ILCO:
ILCO is a holding company whose principal assets consist of the common stock of
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.
As of December 31, 1997, the outstanding principal balance of ILCO's senior loan
obligations was $11.0 million, which reflected the prepayment by the Company 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 by Investors-NA, pursuant to the terms of the Surplus
Debentures. The Surplus Debentures were originally issued by Standard Life
Insurance Company and their terms were previously approved by
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the Mississippi Insurance Commissioner. Upon the merger of Standard Life into
Investors-NA, the obligations of the Surplus Debentures were assumed by
Investors-NA. As of December 31, 1998, the outstanding principal balance of the
Surplus Debentures was $4.5 million and $11.4 million, respectively. Since
Investors-NA is domiciled in the State of Washington, the provisions of
Washington insurance law apply to 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 December 31,
1998, the statutory surplus of Investors-NA was $68.2 million, an amount
substantially in excess of the surplus floor. The funds required by Investors-NA
to meet its obligations to the Company under the terms of the Surplus Debentures
are derived 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 life insurance 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. As of December 31, 1998,
Investors-NA had earned surplus of $39.3 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, formerly known as ILIC, is domiciled in the State of Indiana. The
transfer of domicile from New Jersey to Indiana was effective December 15, 1997.
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 $18.1 million at
December 31, 1998.
The Form 10-Ks of ILCO for the years ended December 31, 1998, 1997 and 1996, set
forth the business operations and financial results of ILCO and its life
insurance subsidiaries. Such 10-K reports of ILCO, including the discussion by
ILCO's management under the caption "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" are incorporated herein by
reference.
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Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the common stock of
Family Life and its equity ownership in ILCO. FIC's primary sources of capital
consists of cash flow from operations of its subsidiaries and the proceeds from
bank and institutional borrowings.
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 December 31,
1998, the statutory capital and surplus of Family Life was $30.3 million, an
amount substantially in excess of the surplus floor. During 1998, Family Life
made principal payments of $9.0 million and interest payments of $2.6 million to
Family Life Corporation under the Surplus Debenture. As of December 31, 1998,
the principal balance of the Surplus Debenture was $22.9 million. The funds
required by Family Life to meet its obligations under the terms of the Surplus
Debenture are generated primarily from premium payments from policyholders,
investment income and the proceeds from the sale and redemption of portfolio
investments.
Washington's insurance code includes the "greater of" standard for dividends but
has requirements that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash dividends may be paid only from
earned surplus. Family Life does not presently have earned surplus as defined by
the regulations adopted by the Washington Insurance Commissioner and, therefore,
is not permitted to pay cash dividends. However, since the new law applies only
to dividend payments, the ability of Family Life to make principal and interest
payments under the Surplus Debenture is not affected. The Company does not
anticipate that 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 $6.0 million in 1998,
as compared to $4.2 million in 1997 and $9.7 million in 1996. Net cash flow used
in financing activities was $13.10 million in 1998, as compared to $6.15 million
in 1997 and $8.05 million in 1996.
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<PAGE>
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.
Investments
As of December 31, 1998, the Company's investment assets totaled $110.2 million,
as compared to $119.1 million as of December 31, 1997.
The level of short-term investments at the end of 1998 was $27.6 million, as
compared to $34.5 million as of December 31, 1997. The fixed maturities
available for sale portion represents $79.4 million of investment assets as of
December 31, 1998, as compared to $81.9 million at the end of 1997. The
amortized cost of fixed maturities available for sale as of December 31, 1998
was $76.73 million representing a net unrealized gain of $2.67 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 December 31, 1998,
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).
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.
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<PAGE>
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 twelve month period ended
December 31, 1998, the Company has incurred an after tax expense of
approximately $289,000 in connection with the completion of the Plan. Between
January 1, 1997 and December 31, 1998, the Company has expended approximately
60.3 % 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 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 122,000 policies for Family Life) was completed in
March, 1998. The conversion of the Cypros AP system (administering approximately
19,600 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 16,120 active policies for Investors-IN) is scheduled for
completion in April, 1999. The modification of the Lifecomm-B system which is
responsible for the 18,000 active policies assumed after ILCO's acquisition of
State Auto Life is also scheduled for completion in April, 1999.
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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
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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 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. Earlier application is not permitted. However, a
company may disclose pro forma earnings per share amounts that would have
resulted if it had applied the Statement in an earlier period. The Company
adopted FAS 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. 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 FAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information", which establishes standards for reporting
information about operating segments. Generally, FAS No. 131 requires that
financial information be reported on the basis that it is used internally for
evaluating performance. The Company adopted FAS No. 131 effective January 1,
1998 and comparative information for earlier years has been restated. This
statement does
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not need to be applied to interim financial statements in the initial year of
application. The adoption of FAS No. 131 did not impact upon the Company's
reporting of financial information.
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
the effect of such adoption to be reflected in year-end financial statements.
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 is required to adopt SOP 97-3,
effective January 1, 1999. Previously issued financial statements should not be
restated unless the SOP is adopted prior to the effective date and during an
interim period. The adoption of SOP 97-3 is not expected to 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 7A. 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 sections entitled "Acquisition of
ILCO" and "Investment of Assets" in Item I of this report and the information
set forth in "Management's Discussion and Analysis of Financial Condition and
Operations - Investments".
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
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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
$2.5 million at December 31, 1998 and $3.5 million at December 31,
1997. 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 $107.0
million at December 31, 1998 and $116.3 million at December 31, 1997.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was
$33.9 million at December 31, 1998 and $40.2 million at December 31,
1997. 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 $1.2 million at
December 31, 1998 and $1.8 million at December 31, 1997.
(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
$4.6 million at December 31, 1998 and $7.0 million at December 31,
1997.
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.
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Item 8. Financial Statements and Supplementary Data
The following Financial Statements of the Registrant have been filed as part of
this report:
1. Report of PricewaterhouseCoopers LLP, Independent Accountants, dated March
26, 1999.
2. Consolidated Balance Sheets, as of December 31, 1998 and December 31, 1997.
3. Consolidated Statements of Income for the years ended December 31, 1998,
1997 and 1996.
4. Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996.
5. Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996.
6. Notes to Consolidated Financial Statements.
7. Consolidated Financial Statement Schedules.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
No independent accountant who audited the Registrant's financial statements has
resigned or been dismissed during the two most recent fiscal years.
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Part III
Item 10. Directors and Executive Officers of the Registrant
(a) Directors of the Registrant
The names and ages of the current directors of the Registrant, their principal
occupations or employment during the past five years and other data regarding
them are set forth below. All of the directors were elected at the 1998 annual
shareholders meeting. The data supplied below is based on information provided
by the directors, except to the extent that such data is known to the
Registrant.
Name Age Since Director and Other Information
John D. 55 1991 Vice President-Investments, Investment
Barnett Professionals, Inc. Since August 1996.
Vice President-Investments of
Prudential Securities from April 1983
to July 1996.
Joseph F. 60 1992 Vice President of FIC from February
Crowe 29, 1992 to January 3, 1997, when he
retired from active service with the
Company. Director of FIC since February
29, 1992. Vice President of ILCO from
May 1991 to January 1997. Director of
ILCO from May 1991 to October 1997.
Executive Vice President of Investors
Life Insurance Company of North America
Family Life Insurance Company and
InterContinental Life Insurance Company
form June 1991 to January 1997.
Director of Investors Life Insurance
Company of North America, Family Life
Insurance Company and InterContinental
Life Insurance Company from June 1991
to January 1997. Executive Vice
President of Investors Life Insurance
Company of Indiana form February 1995
to January 1997. Director of Investors
Life Insurance Company of Indiana from
February 1995 to January 1997. From
December 1986 to March 1991, Executive
Vice President of Personal Financial
Security Division of Aetna Life &
Casualty Company.
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Jeffrey H. 46 1995 Director of FIC since May 1995. Vice
Demgen President of FIC since August 1996.
Vice President and Director of ILCO
since August 1996. Director of Family
Life Insurance Company since October
1992. Executive Vice President of
Family Life Insurance Company since
August 1996. Senior Vice President
of Family Life Insurance Company from
October 1992 to August 1996. Executive
Vice President and Director of
Investors Life Insurance Company of
North America since August 1996.
Senior Vice President and Director of
Investors Life Insurance Company of
North America from October 1992 to
June 1995. Executive Vice President of
Investors-IN (formerly known as
InterContinental Life Insurance
Company) since August 1996. Executive
Vice President and Director of
Investors Life Insurance Company of
Indiana from August 1996 to December
1997. Senior Vice President of United
Insurance Company of America from
September 1984 to July 1992.
Theodore A. 59 1996 Vice President and Director of FIC
Fleron since August 1996. Vice President and
Director of ILCO since May 1991.
Assistant Secretary of ILCO since June
1990. Senior Vice President, General
Counsel, Assistant Secretary and
Director of Investors Life Insurance
Company of North America and Investors
IN, formerly known as InterContinental
Life Insurance Company since July 1992
Vice President, General Counsel,
Assistant Secretary and Director of
Investors Life Insurance Company of
North America and Investors-IN,
formerly known as InterContinental
Life Insurance Company from January
1989 to July 1992. Senior Vice
President, General Counsel, Director
and Assistant Secretary of Investors
Life Insurance Company of Indiana
from June 1995 to December 1997.
Senior Vice President, General Counsel
Director and Assistant Secretary of
Family Life Insurance Company since
August 1996.
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James M. 55 1976 Vice President,Treasurer and Director
Grace of FIC. Vice President and Treasurer
of ILCO since January 1985. Executive
Vice President,Treasurer and Director
of Investors-IN, formerly known as
InterContinental Life Insurance
Company since 1989. Director,
Executive Vice President and
Treasurer of Investors Life Insurance
Company of North America since 1989.
Executive Vice President, Treasurer
and Director of Family Life Insurance
Company since June 1991. Director,
Executive Vice President and
Treasurer of Investors Life Insurance
Company of Indiana from February 1995
to December 1997.
Dale E. Mitte 64 1994 Director since January 1994. Senior
Vice President, Chief Underwriter and
Director from January 1993 to March 5
1999 of Investors Life Insurance
Company of North America and
Investors-IN, formerly known as
InterContinental Life Insurance
Company. Vice President, Chief
Underwriter and Director from
December 1988 to January 1993 of
Investors Life Insurance Company of
North America and Investors- IN,
formerly known as InterContinental
Life Insurance Company. Director from
June 1991 to April 1992 and Vice
President and Chief Underwriter from
June 1991 to March 5, 1999 of Family
Life Insurance Company. Director,
Senior Vice President and Chief
Underwriter of Investors Life
Insurance Company of Indiana from
June 1995 to December 1997.
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<PAGE>
Roy F. Mitte 67 1976 Chairman of the Board, President and
Chief Executive Officer of FIC.
Chairman of the Board, President and
Chief Executive Officer of ILCO and
Investors-IN, formerly known as
InterContinental Life Insurance
Company since January 1985.
President of ILCO since April 1985.
Chairman of the Board, President and
Chief Executive Officer of Investors
Life Insurance Company of North
America since December 1988. Chairman
of the Board, President and Chief
Executive Officer of Family Life
Insurance Company since June 1991.
Chairman of the Board, President
and Chief Executive Officer of
Investors Life Insurance Company of
Indiana from February 1995 to
December 1997. Chairman, ILG
Securities Corporation since December
1988.
Frank Parker 70 1994 President, Gateway Tugs, Inc., which
is located in Brownsville, Texas and
is engaged in operating and
chartering harbor and intracoastal
tug boats, for more than the last
five years.
Eugene E. Payne 56 1992 Vice President, Secretary and
Director of FIC. Vice President of
ILCO since December 1988 and
Secretary and Director of ILCO since
May 1989. Executive Vice President,
Secretary and Director of Investors
Life Insurance Company of North
America since December 1988.
Executive Vice President since
December 1988 and Director since May
1989 of Investors-IN, formerly known
as InterContinental Life Insurance
Company. Executive Vice President,
Secretary and Director of Family Life
Insurance Company since June 1991.
Director, Executive Vice President
and Secretary of Investors Life
Insurance Company of Indiana from
February 1995 to December 1997.
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Thomas C. 56 1996 Director of FIC since August 1996.
Richmond Director of ILCO from March 1994 to
August 1996. Director from March
1989 to February 1990, Senior Vice
President since January 1993 and Vice
President from March 1989 to January
1993 of Investors Life Insurance
Company of North America and
Investors-IN, formerly known as
InterContinental Life Insurance
Company. Senior Vice President of
Family Life Insurance Company since
June 1991. Senior Vice President of
Investors Life Insurance Company of
Indiana from June 1995 to December
1997.
Jerome H. 62 1998 President and Professor of Chemistry,
Supple Southwest Texas State University
since April 1989. Director of FIC
since 1998.
The incumbent directors have been nominated for submission to vote of the
shareholders for reelection at the 1999 annual shareholders' meeting.
(b) Executive Officers of the Registrant
The following table sets forth the names and ages of the persons who served as
the Registrant's Executive Officers during 1998 together with all positions and
offices held by them with the Registrant. Officers are elected to serve at the
will of the Board of Directors or until their successors have been elected and
qualified.
Name Age Positions and Offices
Roy F. Mitte 67 Chairman of the Board,
President and Chief
Executive Officer
James M. Grace 55 Vice President and Treasurer
Eugene E. Payne 56 Vice President and Secretary
Jeffrey H. Demgen 46 Vice President
In May 1991, Roy F. Mitte suffered a stroke, resulting in partial paralysis
affecting his speech and mobility. Mr. Mitte continues to make the requisite
decisions in his capacity as Chief Executive Officer, although his ability to
communicate and his mobility are impaired.
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(c) Identification of certain significant employees
Not applicable.
(d) Family relationships
Dale E. Mitte is Roy F. Mitte's brother.
(e) Business experience
All of the executive officers of the Company are members of the Board of
Directors, and their business experience has been outlined in Item 10 (a).
(f) Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
beneficial ownership on Form 3 and changes in beneficial ownership on Form 4 and
5 with the Securities and Exchange Commission. Officers, directors and greater
than ten-percent shareholders are required by SEC regulation to furnish the
Company with copies of all Section 16(a) forms they file.
Based solely on review of the copies of such forms furnished to the Company, or
written representations that no Form 5's were required, the Company believes
that during the period from January 1, 1998 through December 31, 1998, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than ten-percent beneficial owners were complied with.
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Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information concerning the compensation of the
Company's Chief Executive Officer and each of the three other persons who were
serving as executive officers of the Company at the end of 1998 and received
cash compensation exceeding $100,000 during 1998:
Annual Compensation
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Long Term
Name and Compensation Awards All Other
Principal Stock Options Compensa-
Position Year Salary(1) Bonus(4) Other(2) (Shares) tion
Roy F. Mitte,
Chairman,
President and 1998 $ 503,500 $2,500,000 -0- -0- -0-
Chief Executive 1997 $ 503,500 $1,500,000 -0- -0- -0-
Officer 1996 $ 503,500 -0- -0- -0- $2,446,3973
James M.
Grace, Vice 1998 195,000 25,000 -0- -0- -0-
President and 1997 195,000 40,000 -0- -0- -0-
Treasurer 1996 195,000 15,000 -0- -0- -0-
Eugene E.
Payne, Vice 1998 195,000 20,000 -0- -0- -0-
President and 1997 195,000 40,000 -0- -0- -0-
Secretary 1996 195,000 15,000 -0- -0- -0-
Jeffrey H. 1998 $ 145,384 $ 15,000 -0- -0- -0-
Demgen, Vice 1997 $ 117,884 $ 30,000 -0- -0- -0-
President7 1996 $ 102,500 $ 7,500 -0- -0- -0-
</TABLE>
(1) The salaries and bonuses set forth in the table were paid by ILCO, except
that FIC and/or Family Life authorized payment of a portion of Mr. Mitte's
salary in each of 1996, 1997 and 1998. The executive officers of FIC have also
been executive officers of Family Life, the insurance subsidiary of FIC, and
ILCO and its insurance subsidiaries. FIC and/or Family Life reimbursed ILCO (or,
in the case of Mr. Mitte, authorized payment of) the following amounts as FIC's
or Family Life's share of the executive officers' cash compensation and bonus
for 1996, 1997 and 1998: (i) Mr. Mitte: $216,857, $999,746 and $1,111,821,
respectively;(ii) Mr. Grace: $83,987, $68,150 and $64,152, respectively; (iii)
Dr. Payne: $83,987, $68,150 and $61,447, respectively; and (iv) Mr. Demgen:
$46,125 and $66,548 and $72,173 1996, 1997 and 1998, respectively.
-49-
<PAGE>
Mr. Mitte and FIC are parties to an employment agreement, providing for the
employment of Mr. Mitte as Chairman, President and Chief Executive Officer of
the Company. The agreement, which was initially effective February 25, 1982,
provides for five-year terms and for automatic renewals for successive five-year
periods, unless otherwise terminated in accordance with the terms of the
agreement. The agreement provides that the level of compensation will be fixed
each year by agreement, but not less than $120,000 per year. In addition, the
agreement provides that Mr. Mitte is entitled to reimbursement for reasonable
business expenses and to participate in all fringe benefit plans and
arrangements available generally to employees of the Company.
(2) Does not include the value of perquisites and other personal benefits
because the aggregate amount of any such compensation does not exceed the lesser
of $50,000 or 10 percent of the total amount of annual salary and bonus for any
named individual.
(3) During 1996, ILCO paid Mr. Mitte: (i) $1,862,000 for the cancellation in
1996 of options to purchase 121,500 shares of the Company's common stock, plus
interest at the rate of 8% per year on such amount for a one year period (for a
total of $2,011,737); (ii) $120,700 for the federal income tax reimbursement
relating to the cancellation in 1995 of options to purchase 50,000 shares of the
Company's common stock; and (iii) $313,960 for the federal income tax
reimbursement relating to the 1996 options cancellation described above in this
footnote.
(4) The data in this column represents the amount of annual bonus awarded. The
bonuses for Mr. Grace, Dr. Payne and Mr. Demgen for the year 1997 represent
amounts paid in 1997, but include the bonuses awarded with respect to the years
1996 and 1997. Dr. Payne elected to defer the amounts shown for 1997 and 1998
into the Company's Non-Qualified Deferred Compensation Plan. The Plan was
established in 1997 to permit Mr. Grace and Dr. Payne to defer a portion of
their compensation. Under the provisions of the Plan, contributions are invested
on a money purchase basis and plan benefits are based on the value of the
account at retirement or other distribution. In accordance with applicable tax
law requirements, amounts allocated to the Plan are subject to the claims of
general creditors of the Company.
Compensation of Directors
Directors who are not officers or employees of the Company are paid a $5,000
annual fee, and are compensated $1,000 for each regular or special meeting of
the Board of Directors which they attend in person.
Members of Compensation Committee
The Compensation Committee makes recommendations to the Board of Directors with
respect to the Chief Executive Officer's compensation. The members of the
Compensation Committee are John D. Barnett, Frank Parker, and Jerome H. Supple.
-50-
<PAGE>
Compensation Committee Interlocks and Insider Participation
Roy F. Mitte determines the compensation of all executive officers of FIC, other
than the Chief Executive Officer. Mr. Mitte is the Chairman of the Board,
President and Chief Executive Officer of FIC and ILCO. He also determines the
compensation of all executive officers of ILCO, other than the Chief Executive
Officer.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table presents information as of March 15, 1999 as to all persons
who, to the knowledge of the Registrant, were the beneficial owners of five
percent (5%) or more of the Common Stock of the Registrant.
Amount and Nature
Name and Address of of Beneficial Percent
Beneficial Owner Ownership of Class
Roy F. Mitte,
Chairman of the Board,
President and Chief
Executive Officer,
701 Brazos
Suite 1400,
Austin, Texas 78701 1,493,216 29.54%
Family Life Insurance Company
701 Brazos Street
Suite 1400
Austin, Texas 78701 272,000 5.38%
InterContinental Life
Corporation
701 Brazos
Suite 1400,
Austin, Texas 78701 690,161 (1, 3) 13.65% (2)
Investors Life Insurance
Company of North America
701 Brazos
Suite 1400
Austin, Texas 78701 690,161 (1, 3) 13.65% (2)
-51-
<PAGE>
Heartland Advisors, Inc.
790 North Milwaukee St.
Milwaukee, WI 53202 438,500 8.68% (4)
(1) Of such shares, 145,500 shares are owned by Investors-NA, 44,250 shares are
owned by Investors-IN, and 500,411 shares are issuable upon exercise of an
option held by Investors- NA. Investors-NA is a direct subsidiary of ILCO.
Investors-IN is a direct subsidiary of Investors-NA.
(2) Assumes that outstanding stock options or warrants held by other persons
have not been exercised.
(3) See Item 1. Business-Acquisition of Family Life for a description of the
options granted to Investors-NA.
(4) As reported to the Company on a Schedule 13(G) filed by Heartland Advisors,
Inc. ("Heartland"). According to the Schedule 13(G), the shares are held
for various investment advisory accounts and the interest of one such
account (Heartland Value Fund, a registered investment company) is more
than 5% of the common stock of FIC. A Schedule 13(G) was filed on January
27, 1998, reporting beneficial ownership of 320,400 shares. A Schedule
13(G)/A was filed on January 21, 1999, reporting beneficial ownership of an
additional 118,100 shares.
The following table contains information as of March 15, 1999 as to the Common
Stock of the Registrant beneficially owned by each director, nominee and
executive officer and by all executive officers and directors of the Registrant
as a group. The information contained in the table has been obtained by the
Registrant from each director and executive officer, except for the information
known to the Registrant. Except as indicated in the notes to the table, each
beneficial owner has sole voting power and sole investment power as to the
shares listed opposite his name.
Amount and Nature of Percent of
Name Beneficial Ownership Class
John Barnett 2,000 *
Joseph F. Crowe -0- (2)
Jeffrey H. Demgen -0- (2)
Theodore A. Fleron -0-
James M. Grace 5,600 (2) *
Dale E. Mitte 2,000 *
Roy F. Mitte 1,493,216 (1,2) 29.54%
-52-
<PAGE>
Frank Parker 10,000 *
Eugene E. Payne -0- *
Thomas C. Richmond 1,100 *
Jerome H. Supple 200 *
All Executive Officers,
and Directors as
a group (11 persons) 1,514,116 (1,2) 29.95 %
(1) As of March 15, 1999, Mr. Mitte, jointly with his wife Joann, owns
1,493,216 common shares of Financial Industries Corporation ("FIC"). The
holdings of Mr. Mitte of FIC's common stock constitutes 29.54% of the
outstanding common stock of the Company. In addition, Mr. Mitte holds the
position of Chairman, President and Chief Executive Officer of ILCO.
(2) No executive officer or director holds any options to acquire FIC Common
Stock. Messrs. Roy Mitte, Grace, Payne and Demgen are executive officers
and/or directors of ILCO and beneficially owned approximately 47.12 % of
the outstanding shares of ILCO common stock as of March 15, 1999. Since FIC
beneficially owns 44.74 % of ILCO's Common Stock, Mr. Roy Mitte's personal
holdings are combined with FIC's holdings in determining the percentage of
ILCO Common Stock beneficially owned by Mr. Mitte. ILCO beneficially owned
690,161 shares of FIC Common Stock (13.65% of the outstanding shares) as of
March 15, 1999.
* Less than 1%.
Item 13. Certain Relationships and Related Transactions
(a) Prior to the repayment of the ILCO Senior Loan on September 30, 1998, the
obligations of ILCO under the Senior Loan were guaranteed by FIC. FIC
presently owns 1,966,346 shares of ILCO's Common Stock, constituting 44.74%
of such shares outstanding.
(b) Roy F. Mitte serves as Chairman, President and Chief Executive Officer of
both FIC and ILCO. James M. Grace serves as Vice President, Treasurer and
Director of both companies; Dr. Payne serves as Vice President, Secretary
and Director of both companies; Messrs. Demgen and Fleron serve as Vice
Presidents and Directors of both companies. Mr. Roy Mitte holds beneficial
ownership of 29.54% of the outstanding shares of the Company (see "Security
Ownership of Certain Beneficial Owners").
(c) As part of the financing arrangement for the acquisition of Family Life
Insurance Company, Family Life Corporation ("FLC"), a subsidiary of FIC,
entered into a Senior Loan agreement
-53-
<PAGE>
under which $50 million was provided by a group of banks.The balance of the
financing consisted of a $30 million subordinated note issued by FLC to
Merrill Lynch Insurance Group, Ins. ("Merrill Lynch") and $14 million
borrowed by another subsidiary of FIC from an affiliate of Merrill Lynch
and evidenced by a senior subordinated note in the principal amount of $12
million and a junior subordinated note in the principal amount of $2
million and $25 million lent by two insurance company subsidiaries of ILCO.
The latter amount was represented by a $22.5 million loan from Investors-NA
to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In
addition to the interest provided under those loans, Investors-NA and
Investors-CA were granted by FIC non-transferable options to purchase, in
the amounts proportionate to their respective loans, up to a total of 9.9
percent of shares of FIC's common stock at a price of $10.50 per share
($2.10 per share as adjusted for the five-for-one stock split in November,
1996), equivalent to the then current market price, subject to adjustment
to prevent dilution. The original provisions of the options provided for
their expiration on June 12, 1998 if not previously exercised. In
connection with the 1996 amendments to the subordinated notes, as described
below, the expiration date of the options were extended to September 12,
2006.
On July 30,1993,the subordinated indebtedness owed to Merrill Lynch and its
affiliate was prepaid. The Company paid $38 million plus accrued interest
to retire the indebtedness, which had a principal balance of approximately
$50 million on July 30, 1993. The primary source of the funds used to
prepay the subordinated debt was new subordinated loans totaling $34.5
million that FLC and another subsidiary of FIC obtained from Investors-NA.
The principal amount of the new subordinated debt is payable in four equal
annual installments in 2000, 2001, 2002 and 2003 and bears interest at an
annual rate of 9%. The other terms of the new debt are substantially the
same as those of the $22.5 million subordinated loans that Investors-NA had
previously made to FLC and that continue to be outstanding.
In June, 1996, the provisions of the notes from Investors-NA to FIC, Family
Life Corporation ("FLC") and Family Life Insurance Investment Company
("FLIIC") were modified as follows: (a) the $22.5 million note was amended
to provide for twenty quarterly principal payments, in the amount of
$1,125,000 each, to commence on December 12, 1996; the final quarterly
principal payment is due on September 12, 2001; the interest rate on the
note remains at 11%, (b) the $30 million note was amended to provide for
forty quarterly principal payments, in the amount of $163,540 each for the
period December 12, 1996 to September 12, 2001; beginning with the
principal payment due on December 12, 2001, the amount of the principal
payment increases to $1,336,458; the final quarterly principal payment is
due on September 12, 2006; the interest rate on the note remains at 9%, (c)
the $4.5 million note was amended to provide for forty quarterly principal
payments, in the amount of $24,531 each for the period December 12, 1996 to
September 12, 2001; beginning with the principal payment due on December
12, 2001, the amount of the principal payment increases to $200,469; the
final quarterly principal payment is due on September 12, 2006; the
interest rate on the note remains at 9%, (d) the $2.5 million note was
amended to provide that the principal balance of the note is to be repaid
in twenty quarterly installments of
-54-
<PAGE>
$125,000 each, commencing December 12, 1996 with the final payment due on
September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK
note, which was issued to provide for the payment in kind of interest due
under the terms of the $2.5 million note prior to June 12, 1996, was
amended to provide that the principal balance of the note ($1,977,119) is
to be paid in twenty quarterly principal payments, in the amount of
$98,855.95 each, to commence December 12, 1996 with the final payment due
on September 12, 2001; the interest rate on the note remains at 12%.
In December, 1998, FLIIC was dissolved. In connection with the dissolution,
all of the assets and liabilities of FLIIC became the obligations of
FLIIC's sole shareholder (FIC). Accordingly, the obligations under the
provisions of the $4.5 million note described above are now the obligations
of FIC.
(d) The data processing needs of ILCO's and FIC's insurance subsidiaries are
provided to ILCO's and FIC's insurance subsidiaries by FIC Computer
Services, Inc. ("FIC Computer"), a subsidiary of FIC. Under the provisions
of the data processing agreement FIC Computer provides data processing
services to each subsidiary for fees equal to such subsidiary's
proportionate share of FIC Computer's actual costs of providing those
services to all of the subsidiaries. Family Life paid $1,610,397 and ILCO's
insurance subsidiaries paid $2,818,095 to FIC Computer for data processing
services provided during 1998.
(e) In 1995, Family Life entered into a reinsurance agreement with Investors-NA
pertaining to universal life insurance written by Family Life. The
reinsurance agreement is on a co-insurance basis and applies to all covered
business with effective dates on and after January 1, 1995. The agreement
applies to only that portion of the face amount of the policy which is less
than $200,000; face amounts of $200,000 or more are reinsured by Family
Life with a third party reinsurer.
(f) In 1996, Family Life entered into a reinsurance agreement with
Investors-NA, pertaining to annuity contracts written by Family Life. The
agreement applies to contracts written on or after January 1, 1996.
(g) In November, 1998, FIC purchased 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). At
the same time, Family Life purchased 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). Mr. Mitte and his wife had previously donated the
shares to the Foundation. The Foundation obtained a private letter ruling
from the Internal Revenue Service, in which the IRS ruled that the sale of
the FIC common stock to the Company would not constitute a direct or
indirect act of self-dealing between the Foundation and the Company. The
transaction was reviewed by a Special Committee of the Board of Directors,
-55-
<PAGE>
consisting of two outside directors. In addition, the Company obtained a
favorable fairness opinion from an independent investment banking firm.
(h) Mr. Crowe retired from active service with the Company in January, 1997 and
served on the ILCO Board until October, 1997; he continues to serve on the
Board of Directors of FIC. Following Mr. Crowe's retirement, the Company
entered into a consulting agreement with him. Under the terms of the
agreement, Mr. Crowe is to be available for periodic consultation on
actuarial matters related to the operations of the life insurance
companies. The agreement provide of a payment of $25,000 per year for a
period of five-years.
-56-
<PAGE>
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents have been filed as part of this report:
1. Financial Statements (See Item 8)
ILCO Form 10-K as of December 31, 1996, 1997 and 1998 and the Financial
Statements contained therein are hereby incorporated by reference.
The following consolidated financial statements of Financial Industries
Corporation and Subsidiaries are included in Item 8:
Report of Independent Accountants . . . .. . . . . . . . .. . . . . . . . . F-2
Consolidated Balance Sheets, September 31, 1998 and 1997. .. . . . . . . . F-3
Consolidated Statements of Income, for
years ended December 31, 1998, 1997 and 1996. . . . . . . . . . . . . . . F-5
Consolidated Statements of Changes in
Shareholders' Equity, for the years ended
December 31, 1998, 1997 and 1996. . . . . . . . . . . .. . . . . . . . . . F-7
Consolidated Statement of Cash Flows, for the
years ended December 31, 1998, 1997 and 1996. . . . . . . . . . . . . . . F-10
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . F-12
-57-
<PAGE>
2. The following consolidated financial statement schedules of Financial
Industries Corporation and Subsidiaries are included:
Schedule I-Summary of Investments
Other Than Investments in Related Parties. . . . . . . . . . . . . . . . F-43
Schedule II - Condensed Financial Statements
of Registrant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-44
Schedule IV - Reinsurance . . . . . . . . . . .. . . . . . . . . . . . . . F-48
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable, and therefore, have been omitted.
2. Exhibits filed with this report or incorporated herein by reference are as
listed in the Index to Exhibits on Page Ex-1.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the fiscal year
ended December 31, 1998.
-58-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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
(Registrant)
By:/s/ Roy F. Mitte By:/s/ James M. Grace
Roy F. Mitte, Chairman of James M. Grace, Treasurer,
the Board, President and Principal Accounting and
Chief Executive Officer and Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 29, 1999.
/s/ Roy F. Mitte /s/ James M. Grace
Roy F. Mitte, Director James M. Grace, Director
/s/ Eugene E. Payne /s/ Jeffrey H. Demgen
Eugene E. Payne, Director Jeffrey H. Demgen, Director
/s/ Joseph F. Crowe /s/ Thomas C. Richmond
Joseph F. Crowe, Director Thomas C. Richmond, Director
/s/ Theodore A. Fleron
Theodore A. Fleron, Director
/s/ Dale E. Mitte
Dale E. Mitte, Director
/s/ John D. Barnett
John D. Barnett, Director
/s/ Jerome H. Supple
Jerome H. Supple, Director
/s/ Frank Parker
Frank Parker, Director
-59-
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
FORM 10-K--ITEM 14 (a) (1) and (2)
LIST OF FINANCIAL STATEMENTS
TABLE OF CONTENTS
(1) The following consolidated financial statements of Financial Industries
Corporation and Subsidiaries are included in Item 8:
Report of Independent
Accountants.................................................................F-2
Consolidated Balance Sheets,
December 31, 1998 and 1997..................................................F-3
Consolidated Statements of Income, for the
years ended December 31, 1998, 1997 and 1996................................F-5
Consolidated Statements of Changes in
Shareholders' Equity for the years ended
December 31, 1998, 1997 and 1996............................................F-7
Consolidated Statements of Cash Flows, for
the years ended December 1998, 1997 and 1996................................F-10
Notes to Consolidated Financial Statements..................................F-12
(2) The following consolidated financial statements of Financial Industries
Corporation and Subsidiaries are included:
Schedule I - Summary of Investments Other
Than Investments in Related Parties.........................................F-43
Schedule II - Condensed Financial Statements of
Registrant..................................................................F-44
Schedule IV - Reinsurance...................................................F-47
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable, and therefore, have been omitted.
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Financial Industries Corporation
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a) (1) and (2) on page F-1 present fairly, in all
material respects, the financial position of Financial Industries Corporation
and its subsidiaries (the "Company") at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Dallas, Texas
March 26, 1999
F-2
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
1998 1997
(in thousands)
ASSETS
Investments other than investments in affiliate:
Fixed maturities available for sale
at market value (amortized cost of
$76,727 and $79,054 at December 31,
1998 and 1997) $ 79,402 $ 81,854
Equity securities at market
(cost approximates $11
at December 31, 1998 and 1997) 4 4
Policy loans 3,155 2,748
Short-term investments 27,589 34,475
Total investments 110,150 119,081
Cash 2,601 508
Investment in affiliate 70,950 66,752
Accrued investment income 1,209 1,184
Agency advances and other receivables 7,759 6,474
Reinsurance receivables 12,426 11,134
Due and deferred premiums 12,181 11,086
Property and equipment, net 1,758 1,724
Deferred policy acquisition costs 48,510 45,122
Present value of future profits of
acquired businesses 28,294 34,437
Other assets 5,392 6,346
Separate account assets 508 476
Total Assets $ 301,738 $ 304,324
The accompanying notes are an integral part of these
consolidated financial statements
F-3
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
1998 1997
(in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract
holder deposit funds:
Future policy benefits $ 60,069 $ 59,987
Contract holder deposit funds 45,128 44,304
Unearned premiums 28 90
Other policy claims and benefits
payable 4,582 5,315
109,807 109,696
Subordinated notes payable to
affiliate 47,645 53,792
Deferred federal income taxes 23,984 21,631
Other liabilities 4,474 4,880
Separate account liabilities 508 476
Total Liabilities 186,418 190,475
(See Notes 4, 8, 12, 14)
Shareholders' equity:
Common stock, $.20 par value,
10,000,000 shares authorized;
5,845,300 shares issued,
5,054,661 and 5,427,965
outstanding in 1998 and 1997,
respectively 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive
income 5,898 6,692
Retained earnings 108,403 99,185
122,695 114,271
Common treasury stock, at cost,
790,639 and 417,335 shares in
1998 and 1997, respectively (7,375) (422)
Total Shareholders' Equity 115,320 113,849
Total Liabilities and Shareholders'
Equity $ 301,738 $ 304,324
The accompanying notes are an integral part
of these consolidated financial
statements.
F-4
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
Year Ended December 31,
<S> <C> <C> <C> <C>
1998 1997 1996
(in thousands)
Revenues:
Premiums $ 38,358 $ 40,249 $ 43,336
Net investment income 7,808 8,106 7,363
Net realized gain on sale of real estate -0- 4,548 -0-
Earned insurance charges 5,971 6,989 5,569
Other 1,470 3,451 3,660
53,607 63,343 59,928
Benefits and expenses:
Policyholder benefits and expenses 16,258 19,905 22,096
Interest expense on contract holders
deposit funds 2,374 2,596 2,239
Amortization of present value of future
profits of acquired businesses 6,143 6,167 4,811
Amortization of deferred policy
acquisition costs 5,174 4,826 4,185
Operating expenses 11,822 12,755 12,975
Interest expense 2,863 3,683 3,831
44,634 49,932 50,137
Income before federal income tax and
equity in net earnings of affiliates 8,973 13,411 9,791
Provision for federal income taxes:
Current 119 1,348 (1,165)
Deferred 2,249 2,193 3,811
Income before equity in net earnings
of affiliates 6,605 9,870 7,145
Equity in net earnings of affiliate,
net of tax 2,613 6,458 9,012
Net Income $ 9,218 $ 16,328 $ 16,157
</TABLE>
The accompanying notes are an integral
part of these consolidated
statements.
F-5
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Years Ended December 31,
1998 1997 1996
(in thousands)
Net Income Per Share (Note 15)
Basic:
Average weighted shares outstanding 5,383 5,428 5,428
Basic earnings per share $ 1.71 $ 3.01 $ 2.98
Diluted:
Common stock and common stock
equivalents 5,557 5,589 5,568
Diluted earnings per share $ 1.66 $ 2.92 $ 2.90
The accompanying notes are an integral part
of these consolidated financial
statements.
F-6
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
<TABLE>
Common Stock Additional
Paid-in
Shares Amount Capital
<S> <C> <C> <C>
Balance at December 31, 1995 5,845 $ 1,169 $ 7,225
Comprehensive Income:
Net income
Other Comprehensive Income:
Change in net unrealized loss on
investments in fixed maturities
available for sale, net of tax
Change in net unrealized appreciation
(depreciation) of equity securities,
net of tax
Total Comprehensive Income
Balance at December 31, 1996 5,845 1,169 7,225
Comprehensive Income:
Net Income
Other Comprehensive Income:
Change in net unrealized loss on
investments in fixed maturities
available for sale, net of tax
Change in net unrealized appreciation
(depreciation) of equity securities,
net of tax
Total Comprehensive Income
Balance at December 31, 1997 5,845 1,169 7,225
Comprehensive Income
Net Income
Other Comprehensive Income:
Change in net unrealized loss on
investments in fixed maturities
available for sale, net of tax
Change in net unrealized appreciation
(depreciation) of equity securities,
net of tax
Total Comprehensive Income
Balance at December 31, 1998 $ 5,845 $ 1,169 $ 7,225
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
F-7
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
Accumulated Other Comprehensive Income
<TABLE>
Net Unrealized Gain
Net Unrealized on Invest- ments in Total
Appreciation Fixed Maturities Accumulated
Depreciation) of Available for Sale Other Comprehensive
Equity Securities Income
<S> <C> <C> <C>
Balance at December 31, 1995 $ 11 $ 8,052 $ 8,063
Comprehensive Income:
Net Income
Other Comprehensive Income:
Change in net unrealized gain on
investments in fixed maturities
available for sale, net of tax (6,832) (6,832)
Change in net unrealized
appreciation (depreciation) of
equity securities, net of tax 14 14
Total Comprehensive Income 14 (6,832) (6,818)
Balance at December 31, 1996 25 1,220 1,245
Comprehensive Income:
Net Income
Other Comprehensive Income:
Change in net unrealized gain on
investments in fixed maturities
available for sale, net of tax 5,440 5,440
Change in net unrealized
appreciation (depreciation) of
equity securities, net of tax 7 7
Total Comprehensive Income 7 5,440 5,447
Balance at December 31, 1997 32 6,660 6,692
Comprehensive Income:
Net Income
Other Comprehensive Income:
Change in net unrealized gain on
investments in fixed maturities
available for sale, net of tax (760) (760)
Change in net unrealized
appreciation (depreciation) of
equity securities, net of tax (34) (34)
Total Comprehensive Income (34) (760) (794)
Purchase of treasury stock
Balance at December 31, 1998 $ (2) $ 5,900 $ 5,898
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
<TABLE>
Total
Retained Treasury Shareholders'
Earnings Stock Equity
<S> <C> <C> <C>
Balance at December 31, 1995 $ 66,700 $ (422) $ 82,735
Comprehensive Income:
Net Income 16,157 16,157
Other Comprehensive Income:
Change in net unrealized loss on
investments in fixed maturities
available for sale, net of tax (6,832)
Change in net unrealized appreciation
depreciation) of equity securities,
net of tax 14
Total Comprehensive Income 16,157 -0- 9,339
Balance at December 31, 1996 82,857 (422) 92,074
Comprehensive Income:
Net Income 16,328 16,328
Other Comprehensive Income:
Change in net unrealized gain on
investments in fixed maturities
available for sale, net of tax 5,440
Change in net unrealized appreciation
(depreciation) of equity securities,
net of tax 7
Total Comprehensive Income 16,328 -0- 21,775
Balance at December 31, 1997 99,185 (422) 113,849
Comprehensive Income:
Net Income 9,218 9,218
Other Comprehensive Income:
Change in net unrealized gain on
investments in fixed maturities
available for sale, net of tax (760)
Change in net unrealized appreciation
(depreciation) of equity securities,
net of tax (34)
Total Comprehensive Income 9,218 8,424
Purchase of treasury stock (6,953) (6,953)
Balance at December 31, 1998 $ 108,403 $ (7,375) $ 115,320
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
F-9
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
Year Ended December 31,
1998 1997 1996
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 9,218 $ 16,328 $ 16,157
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 6,143 6,167 4,811
Amortization of deferred policy
acquisition costs 5,174 4,826 4,185
Financing costs amortized -0- -0- 168
Equity in undistributed earnings of
affiliate
(4,965) (9,323) (12,558)
Changes in assets and liabilities:
(Increase) decrease in accrued
investment income (25) 49 (131)
Increase in agent advances and
other receivables (2,577) (3,624) (1,233)
Increase in due premiums (1,095) (435) (925)
Increase in deferred policy acquisition costs (8,562) (8,615) (8,981)
Decrease (increase) in other assets 954 (640) 558
Increase in policy liabilities and accruals 111 3,629 3,734
Decrease in other liabilities (406) (6,368) (67)
Increase in policy loans (407) (462) (512)
Increase in deferred federal income taxes 2,353 3,679 3,169
Other, net 34 (1,020) 1,330
Net cash provided by operating activities $ 5,950 $ 4,191 $ 9,705
The accompanying notes are an integral part
of these consolidated financial
statements.
</TABLE>
F-10
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
<TABLE>
Year Ended December 31,
1998 1997 1996
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING
ACTIVITIES
Fixed maturities purchased $ (14,082) $ (4,056) $ (4,245)
Proceeds from sales and maturities of
fixed maturities 16,473 7,998 1,265
Net decrease in short-term investments 6,886 (8,860) 1,565
Purchase & retirement of property
and equipment (34) 7,075 (1,347)
Net Cash provided by (used in)
investing activities 9,243 2,157 (2,762)
CASH FLOW FROM FINANCING ACTIVITIES
Issuance of subordinated notes payable -0- -0- 253
Repayment of senior loan and
subordinated notes -0- -0- (6,765)
Repayment of subordinated notes payable (6,147) (6,148) (1,537)
Purchase of treasury stock. (6,953)
Net cash used in financing activities (13,100) (6,148) (8,049)
Net increase (decrease) in cash 2,093 200 (1,106)
Cash, beginning of year 508 308 1,414
Cash, end of year $ 2,601 $ 508 $ 308
Supplemental Cash Flow Disclosures:
Income taxes paid $ 1,184 $ 150 $ 125
Interest paid $ 2,935 $ 3,677 $4,300
The accompanying notes are an integral part
of these consolidated financial
statements.
</TABLE>
F-11
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Organization
Financial Industries Corporation (FIC or the "Company") is principally engaged,
through its subsidiaries, in acquiring and administering existing portfolios of
individual and annuity products. The Company's insurance subsidiary is also
engaged in the business of marketing and underwriting individual life insurance,
disability insurance and annuity products in 49 states and the District of
Columbia. Such products are marketed through an exclusive career agency system.
Principles of Consolidation
The consolidated financial statements include the accounts of FIC and its
wholly-owned subsidiaries at December 31, 1998. The more significant
subsidiaries are Family Life Corporation (FLC), Family Life Insurance Company
(Family Life), FIC Realty Services, Inc. (FIC Realty) and FIC Property
Management, Inc. (FIC-Property) . The Company's approximate 45% investment in
InterContinental Life Corporation (ILCO) is presented using the equity method of
accounting.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles which differ from
statutory accounting principles required by regulatory authorities for the
Company's insurance subsidiary. All material intercompany balances and
transactions have been eliminated. The following accounting policies describe
the accounting principles used in the preparation of the consolidated financial
statements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results will differ from those estimates.
F-12
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investments
The Company's general investment philosophy is to hold fixed maturity securities
until maturity. However, fixed maturities may be sold prior to their maturity
dates in response to changing market conditions, duration of liabilities,
liquidity factors, interest rate movements and other investment factors.
Accordingly, fixed maturity investments are classified as available for sale and
are carried at market value. Unrealized gains and losses on securities available
for sale are not recognized in earnings but are reported as a separate component
of equity in other accumulated comprehensive income, net of related income
taxes.
Premiums and discounts on collateralized mortgage obligations (CMOs) are
amortized over the estimated redemption period as opposed to the stated
maturity. An adjustment to the investment and investment income is recorded on a
retrospective basis to reflect the amounts that would have existed had the new
effective yield been applied since the acquisition of the CMO's. The Company
endeavors to minimize the portfolio's exposure to interest rate changes inherent
in interest-sensitive products by selecting and selling investments so that
diversity, maturity and liquidity factors approximate the duration of related
policyholder liabilities.
Equity securities are carried at market value. Unrealized gains and losses on
equity securities, net of deferred income taxes, if applicable, are reflected
directly in shareholders' equity. Policy loans represent unpaid balances and do
not exceed the cash surrender value of the related policies.
Short-term investments are carried at cost, which approximates market value, and
generally consist of those fixed maturities and other investments with
maturities less than one year from the date of purchase. Securities pledged as
collateral for repurchase agreements are held by the Company's investment
custodian until maturity of the repurchase agreement. Provisions of the
agreement and procedures adopted by the Company ensure that the market value of
the collateral, including accrued interest thereon, is sufficient in the event
of default by the counterparty.
The cost of investments sold is determined on the specific identification basis,
except for stocks, for which the first-in, first-out method is employed. When an
impairment of the value of an investment is considered other than temporary, the
decrease in value is reported in net income as a realized investment loss and a
new cost basis is established.
Cash and Cash Equivalents
Generally, cash includes cash on hand and on deposit in non-interest bearing
accounts. Short term investments with maturities of three months or less at the
time of purchase are reported as cash equivalents.
F-13
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Sale of Real Estate
Net income for 1997 includes $4.5 million (before federal income tax) resulting
from the sale during the fourth quarter of 1997 of the Bridgepoint Square office
complex. The aggregate selling price was $78 million which was allocated
approximately 21.5% to Family Life and 78.5% to Investors Life Insurance Company
of North America (Investors-NA), a subsidiary of ILCO, in accordance with their
respective ownership interests in the Bridgepoint Square office complex. The
sale closed on December 5, 1997.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is provided using straight-line and accelerated methods over
estimated useful lives of 5 to 33 years. Maintenance and repairs are charged to
expense when incurred.
Deferred Policy Acquisition Costs
The cost of acquiring new business, principally first year commissions and
certain expenses of the policy issuance and underwriting departments, which vary
with and are primarily related to the production of new business, have been
deferred to the extent recoverable. Acquisition costs related to mortgage term
life insurance business are deferred and amortized over the premium paying
period of the related policies. Acquisition costs related to universal life
products are deferred and amortized in proportion to the ratio of estimated
annual gross profits to total estimated gross profits over the expected lives of
the contracts.
Present Value of Future Profits on Acquired Businesses
The present value of future profits of acquired businesses (See Note 5) is
amortized over the premium paying period of the related policies in proportion
to the ratio of the annual premium revenue to total anticipated premium revenue
applicable to such policies. Interest on the unamortized present value of future
profits is accreted at approximately 8.5% per annum. The fair value of the net
assets acquired exceeded the purchase price and negative goodwill associated
with the purchase has been netted against the calculated amount of present value
of future profits. The negative goodwill is being amortized over seven years
using the straight line method of amortization.
Separate Accounts
Separate account assets, carried at market value, and liabilities represent
policyholder funds maintained in accounts having specific investment objectives.
The net investment income, gains and losses of these accounts, less applicable
contract charges, accrue directly to the policyholders. The separate account
F-14
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
business was fully reinsured to Merrill Lynch at the date of sale through an
assumption reinsurance agreement which is pending regulatory approval.
Solvency Laws Assessments
The solvency or guaranty laws of most states in which the Company's insurance
subsidiary do business may require the Company's insurance subsidiary to pay
assessments (up to certain prescribed limits) to fund policyholder losses or
liabilities of insurance companies that become insolvent. These assessments may
be deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength, and in certain instances, may be offset against
future premium taxes. The Company's insurance subsidiary expense for guaranty
fund assessment, from states, which do not allow premium tax offsets, was not
material.
Policy Liabilities and Contractholder Deposit Funds
Liabilities for future policy benefits for mortgage life and annuity insurance
products are computed using the net level premium method or an actuarially
equivalent method. The assumption for future investment yield is 8.5 %.
Assumptions for mortality and withdrawal are based on company experience with
provision for possible adverse deviation.
Contract holder deposit funds are liabilities for universal life and annuity
products. These liabilities consist of deposits received from customers and
accumulated at actual credited interest rates on their fund balances less
charges for expenses and mortality.
Other Policy Claims and Benefits Payable
The liability for other policy claims and benefits payable represents
management's estimate of ultimate unpaid losses on claims and other
miscellaneous liabilities to policyholders. Estimated unpaid losses on claims
are comprised of losses on claims that have been reported but not yet paid,
including estimates of additional development of initial claims estimates, and
claims that have been incurred but not reported.
The liability for other policy claims and benefits payable is subject to the
impact of changes in claim severity, frequency and other factors. Although there
is considerable variability inherent in such estimates, management believes that
the liability recorded is adequate.
Federal Income Taxes
In February, 1992, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109).
The Company adopted FAS 109 on a prospective basis effective January 1, 1993.
F-15
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
FAS 109 mandates the asset and liability method for computing deferred income
taxes. Under this method, balance sheet amounts for deferred income taxes are
computed based on the tax effect of the differences between the financial
reporting and federal income tax basis of assets and liabilities using the tax
rates which are expected be in effect when these differences are anticipated to
reverse.
Revenue Recognition
Premiums on mortgage life and health products are recognized as revenue over the
premium paying period. Benefits and expenses are associated with earned
premiums, so as to result in recognition of profits over the life of the
contracts.
Revenues for universal life and annuity products consist of contract charges
(earned insurance charges) assessed against the fund values and net investment
income. Related benefit expenses primarily consist of net investment income
credited to the fund values after deductions for investment and risk charges.
Revenues for universal life and annuity products consist of net investment
income and mortality, administration and surrender charges assessed against the
fund values. Related benefit expenses include universal life benefit claims in
excess of fund values and net investment income credited to universal life and
annuity fund values.
Net Income Per Share
Net income per share is calculated based on two methods, 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.
Both methods are presented on the face of the income statement.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
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 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
F-16
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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 SFAS No.
128 for the year ended December 31, 1997 and has restated the earnings per share
computations for 1996 to conform to this pronouncement.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for the reporting and display of comprehensive
income and its components. 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 has adopted SFAS 130 for the year ended December 31, 1998 and has
restated financial statement presentation for 1997 and 1996 as required by this
pronouncement.
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. As described in Note 1, 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, and restated disclosures for 1997 and 1996 as required by this
pronouncement.
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 is required to adopt SOP 97-3
effective January 1, 1999. Previously issued financial statements should not be
restated unless the SOP is adopted prior to the effective date and during an
interim period. The adoption of this SOP is not expected to have a material
impact on the Company's financial statements. In June, 1998, the FASB issued FAS
F-17
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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
Reclassification
Certain prior years' amounts have been reclassified to conform with the 1998
presentation.
F-18
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Investments
Fixed Maturities
Investments in fixed maturities by category at December 31, 1998 and 1997,
respectively, were as follows (in thousands):
<TABLE>
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
oligations of U.S. government
agencies and corporations $ 16,125 $ 1,014 $ 0 $ 17,139
States, municipalities and political
subdivisions 2,990 107 0 3,097
Corporate securities 24,499 783 4 25,278
Mortgage-backed securities 33,113 778 2 33,888
Total fixed maturities available
for sale $ 76,727 $ 2,682 $ 6 $ 79,402
</TABLE>
<TABLE>
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 18,142 $ 975 $ 1 $ 19,116
States, municipalities and political
subdivisions 2,989 103 3,092
Corporate securities 18,996 527 111 19,412
Mortgage-backed securities 38,927 1,331 24 40,234
Total fixed maturities available
for sale $ 79,054 $ 2,936 $ 136 $ 81,854
</TABLE>
F-19
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The amounts of unrealized gains and losses reflected in the balance sheet in
accumulated other comprehensive income have been reduced by estimated deferred
taxes in the amount of $937,000 and $980,000 in 1998 and 1997, respectively.
Additional deferred taxes of $313,000 and $367,000 in 1998 and 1997,
respectively, have been provided with respect to the Company's protion of ILCO's
unrealized appreciation in marketable securities
The amortized value and market value of fixed maturities at December 31, 1998
are shown below by contractual maturity. Actual maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized Market
Value Value
(in thousands)
Due in one year $ 10,142 $ 10,256
Due after on year through five years 16,717 16,880
Due after five years through ten years 3,276 3,522
Due after ten years 13,479 14,856
Mortgage-backed securities 33,113 33,888
Total fixed maturities available for sale $ 76,727 $ 79,402
To reduce the exposure to market rate changes, portfolio investments are
selected so that diversity, maturity, and liquidity factors approximate the
duration of associated policyholder liabilities.
Proceeds from maturities of investments in fixed maturities during 1998, 1997
and 1996 were $16,473,000, $7,998,000 and $1,265,000, respectively. There were
gains of $5,916 and losses of $16,437 in 1998 and gains of $23,000 and losses of
$0 in 1997 and no gains or losses in 1996.
F-20
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The net change in unrealized investment gains (losses) represents the only
component of other comprehensive income for the years ended December 31, 1998,
1997 and 1996. The following is a summary of the change in unrealized investment
gains (losses) net of related deferred income taxes which are reflected in
accumulated other comprehensive income for the periods presented:
Change in Unrealized Gains (Losses
) on Investments 1998 1997 1996
(in thousands)
Fixed maturities $ (1,170) $ 8,369 $ (10,511)
Equity securities (52) 11 22
(1,222) 8,380 (10,489)
Deferred federal income taxes (428) 2,933 (3,671)
Net change in unrealized gains
(losses) on investments $ (794) $ 5,447 $ (6,818)
The following table sets forth the reclassification adjustments required for the
years ended December 31, 1998, 1997 and 1996:
Reclassification Adjustments 1998 1997 1996
(in thousands)
Unrealized holding gains (losses)
on investments arising during
the period $ (790) $ 5,432 $ (6,818)
Reclassification adjustments for
gains included in net income (4) 15 0
Unrealized gains (losses) on
investments, net of reclass-
ification adjustment $ (794) $ 5,447 $ (6,818)
F-21
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Net Investment Income
The components of net investment income are summarized as follows:
Year ended December 31,
1998 1997 1996
(in thousands)
Fixed maturities $ 5,792 $ 5,853 $ 5,891
Other, including short-term
investments and policy loans 2,080 2,336 1,553
7,872 8,189 7,444
Investment expenses (64) (83) (81)
Net investment income $ 7,808 $ 8,106 $ 7,363
There were no impairments in the value of investments in 1998, 1997 or 1996,
which were considered other than temporary.
3. Disclosure about Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments at December 31,
1998 are as follows:
Carrying Fair
Amount Value
(in thousands)
Financial assets:
Fixed maturities $ 79,402 $ 79,402
Policy loans 3,155 3,155
Short-term investments 27,589 27,589
Cash and cash equivalents 2,601 2,601
Financial liabilities:
Subordinated notes payable
to affiliate $ 47,645 $ 47,645
F-22
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Fixed Maturities
Fair values are based on quoted market prices or dealer quotes.
Policy Loans
Policy loans are, generally, issued with coupon rates below market rates and are
considered early payment of the life benefit. As such, the carrying amount of
these financial instruments is a reasonable estimate of their fair value.
Cash and Short-term Investments
The carrying amount of these instruments approximates market value.
Subordinated Notes Payable to Affiliate
The fair value is based on the Company's estimate of current market conditions.
F-23
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. Investment in
InterContinental Life Corporation
The Company carries its investment in ILCO on the equity method of accounting.
At December 31, 1998, excess of cost over net assets acquired of $1,686,000, net
of accumulated amortization of $1,544,000, is included in investment in
affiliate. At December 31, 1997, these amounts were $1,686,000 and $1,444,000,
respectively. Amortization of this excess is reflected in equity in net earnings
of affiliate. ILCO is primarily engaged in the sale and administration of life
insurance products. Summarized financial information for ILCO is set forth
below:
Balance sheet information: 1998 1997
(in thousands)
Investments $ 702,086 $ 693,059
Deferred policy acquisition costs and
present value of future profits 75,619 75,907
Other assets 572,543 552,687
Total Assets $ 1,350,248 $ 1,321,653
Policy liabilities and contract holder
deposit funds $ 694,351 $ 671,634
Other liabilities 501,662 504,257
Total liabilities 1,196,013 1,175,891
Common stock, additional paid-in
capital and retained earnings 142,664 131,359
Accumulated other comprehensive
income 11,571 14,403
Shareholders' equity 154,235 145,762
Total liabilities and shareholders' equity $ 1,350,248 $ 1,321,653
F-24
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Results of Operations: 1998 1997 1996
(in thousands)
Premium income $ 10,890 $ 11,031 $ 9,980
Net investment income 54,619 57,740 59,836
Gain on sale of real estate -0- 14,630 23,520
Earned insurance charges 41,067 40,853 42,238
Benefits and expenses 91,876 96,081 96,801
Net income 11,119 20,540 26,938
Basic earnings per share $ 2.54 $ 4.75 $ 6.36
Diluted earnings per share $ 2.49 $ 4.70 $ 6.07
Total market value basis of the Company's investment in ILCO approximated
$39,326,920 at both December 31, 1998 and 1997. FIC directly or indirectly owns
1,966,346 shares (approximately 45%, 45%, and 46%) of ILCO's outstanding common
stock at December 31, 1998, 1997 and 1996, respectively.
In January 1985, FIC acquired 26.53% of ILCO's common stock. FIC and Family Life
subsequently acquired additional shares of ILCO's common stock and as of March
16, 1998, FIC owned, directly and indirectly through Family Life, approximately
45% of the outstanding shares of ILCO's common stock. Prior to October 1, 1998,
FIC held options to acquire up to 1,702,155 additional shares of ILCO Common
Stock. As a result of the final repayment on ILCO's Senior Loan (see discussion
under the caption "Senior Loan") on September 30, 1998, FIC's options to acquire
shares of ILCO's Common Stock expired.
The amount of net realized gains included in net earnings of ILCO is $642,000,
$9,623,000, and $15,262,000, for the years ended December 31, 1998, 1997 and
1996, respectively.
5. Acquisition of Business
In 1991, the Company acquired Family Life, a Washington domiciled life insurance
company, from Merrill Lynch Insurance Group, Inc. Present value of future
profits of $87,726,000 was recorded as a result of the purchase.
F-25
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
An analysis of the present value of future profits follows:
1998 1997
(in thousands)
Balance at beginning of year $ 34,437 $ 40,604
Accretion of interest 2,667 3,212
Amortization during the period (8,810) (9,379)
Present value of future profits at
December 31 $ 28,294 $ 34,437
Anticipated amortization of the present value of future profits net of interest
accretion for each of the next five years is as follows (in thousands):
1999 $ 5,713
2000 $ 4,613
2001 $ 3,725
2002 $ 3,008
2003 $ 2,430
At purchase, the present value of future profits was calculated using a discount
rate of approximately 15%. Interest is accredited on the unamortized portion at
approximately 8.5%.
F-26
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. Subordinated Notes Payable
Following is a summary of outstanding debt at December 31:
1998 1997
(in thousands)
Subordinated senior notes payable to
Investors-NA beginning with a
$1,125,000 payment on December 12,
1996 and each subsequent quarter
through September 12, 2001. Interest
is payable on a quarterly basis at 11% $ 16,654 $ 16,875
Subordinated notes payable to Investors-
NA beginning with a $223,856 payment on
December 12, 1996 and each subsequent
quarter through September 12, 2001.
Interest is payable on a quarterly basis
at 12% 2,463 3,358
Subordinated notes payable to Investors-
NA beginning with a $188,071 payment on
December 12, 1996 and each subsequent
quarter through September 12, 2001, a
payment of $1,536,927 on December 12,
2001 and each subsequent quarter through
June 12, 2006 with a final payment of
$1,536,967 on September 12, 2006. Interest
is payable on a quarterly basis at 9% 28,528 33,559
Total subordinated notes payable $47,645 $53,792
The obligors are allowed to prepay the Investors-NA Subordinated Loans, in whole
or in part, without premium or penalty. The Investors-NA Subordinated Loans were
subordinated to the Senior Loan and now constitute a lien on the Pledged
Collateral. Repayment of the Investors-NA Subordinated Loans is also guaranteed
by the Company.
Aggregate maturities of the Subordinated Notes Payable are as follows:
(in thousands)
1999 $6,148
2000 6,148
2001 6,148
2002 6,148
2003 6,148
Thereafter 16,905
$47,645
F-27
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. Income Taxes
The Company files a consolidated federal income tax return with its non-life
subsidiaries. The Company's life insurance subsidiary files a separate federal
income tax return.
The U.S. federal income tax provision (benefit) charged to continuing operations
was as follows:
1998 1997 1996
(in thousands)
Current $ 119 $ 1,348 $ (1,165)
Deferred 2,249 2,193 3,811
Total provision for
income tax $2,368 $ 3,541 $ 2,646
The provision for income taxes is less than the amount of income tax determined
by applying the U.S. statutory income tax rate of 35% to pre-tax income from
continuing operations as a result of the following differences:
1998 1997 1996
(in thousands)
Income taxes at the statutory rate $ 3,141 $ 4,694 $ 3,427
Increase (decrease) in taxes
resulting from:
Small life insurance company
deduction (238) (499) -0-
Dividends received deduction (586) (649) (771)
Tax rate differential (90) (135) (98)
Non-deductible compensation 38 -0- -0-
Other items, net 103 130 88
Total provision for income taxes $ 2,368 $ 3,541 $ 2,646
Provision has not been made for state and foreign income tax expense since this
expense is minimal. Premium taxed are paid to various states where premium
revenue is earned. Premium taxes are included in the statement of income as
operating expenses.
F-28
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Deferred taxes are recorded for temporary differences between the financial
reporting bases and the federal income tax bases of the Company's assets and
liabilities. The sources of these differences and the estimated tax effect of
each are as follows:
Deferred tax liability: 1998 1997
(in thousands)
Equity in net earnings of affiliate $ 4,414 $ 4,062
Excess pension benefit 436 436
Deferred policy acquisition costs 13,072 11,742
Present value of future profits 8,221 7,067
Guaranty fund assessments 388 536
Deferred and uncollected premium 4,141 3,769
Unrealized appreciation on marketable
securities 1,250 1,347
Other taxable temporary differences 5,314 4,442
Total deferred tax liability 37,236 33,401
Deferred tax asset:
Policy reserves 12,123 11,146
Net operating loss carry forward 957 159
Alternative minimum tax credit 114 407
Accrued liabilities 58 58
Total deferred tax assets, net 13,252 11,770
Net deferred tax liability $ 23,984 $21,631
Deferred federal income tax (benefit) expense of $(97,000) and $992,000 for 1998
and 1997, respectively, have been provided on the unrealized appreciation
(depreciation) of marketable securities and included in the balance of the
deferred tax liability. This increase or decrease in deferred tax liability has
been recorded as reduction or increase to the equity adjustment due to the net
change in unrealized appreciation or depreciation and has not been reflected in
the deferred income tax expense, included in net income from operations.
F-29
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Family Life is eligible for a special deduction allowed to small life insurance
companies equal to 60 percent of tentative life insurance company taxable
income, subject to certain limitations.
Provision for U.S. income taxes has not been made on a portion of the
undistributed earnings of ILCO from the date of the Company's investment since
the Company expects such earnings to be remitted in the form of dividends. The
Company has provided for the tax on the undistributed earnings of ILCO net of
the dividends received deduction expected to be allowed when such dividends are
paid. The Company expects that additional deferred taxes would be payable on the
undistributed earnings of ILCO if the Company should sell its investment.
At December 31, 1998, FIC's 1995 federal income tax return was under review by
the IRS. The statute of limitations for examinations remains open for all tax
years subsequent to 1992.
8. Reinsurance
Family Life reinsures portions of certain policies it writes, thereby providing
greater diversification of risk and minimizing exposure on larger policies. The
Company's retention on any one individual ranges from $-0- to $200,000 depending
on the risk.
Policy liabilities and contract holder deposit funds are reported in the
consolidated financial statements before considering the effect of reinsurance
ceded. The insurance subsidiary remains liable to the extent the reinsurance
companies are unable to meet their obligation under the reinsurance agreements.
Under the provisions of the purchase agreement between the Company and Merrill
Lynch, certain life insurance companies affiliated with Merrill Lynch agreed to
assume (on an assumption reinsurance basis) certain single premium whole life
and annuity products written by Merrill Lynch's insurance division on Family
Life's paper. The transfer of these reserves, in accordance with the reinsurance
agreement, is subject to certain regulatory approvals.
The amount remaining under this agreement that had not yet been approved for
transfer to Merrill Lynch was $115,524 and $106,221 at December 31, 1998 and
1997, respectively.
F-30
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The amounts in the consolidated financial statements for reinsurance ceded are
as follows:
December 31,
1998 1997 1996
(in thousands)
Future policy benefits $ 11,950 $ 9,765 $5,729
Unearned premiums 28 90 4
Other policy claims and benefits
payable 448 1,279 426
$ 12,426 $ 11,134 $6,159
For the years ended
1998 1997 1996
(in thousands)
Premiums $ 5,600 $6,169 $6,259
Policyholder benefits and expenses $ 2,479 $1,697 $ 670
Estimated amounts recoverable from reinsurers on paid claims were $4,603 and
$64,142 in 1998 and 1997, respectively. These amounts were included in other
receivables in the consolidated financial statements at December 31, 1998 and
1997.
9. Shareholders' Equity
The Company's ability to pay dividends to its shareholders is affected, in part,
by receipt of dividends from Family Life and ILCO.
Family Life is domiciled in the state of Washington. Under current Washington
law any proposed payment of dividends or distribution by the insurance
subsidiary which, together with dividends or distributions paid during the
preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as
of the preceding December 31, or (ii) statutory net gain from operations, is
called an "extraordinary dividend" and may not be paid until either it has been
approved, or a waiting period shall have passed during which it has not been
disapproved, by the insurance commissioner.
Effective July 25, 1993 Washington amended its insurance code to retain the
"greater of" standard but enacted requirements that prior notification of a
proposed dividend be given to the Washington Insurance Commissioner and that
dividends may be paid only from earned surplus.
F-31
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Family Life does not presently have earned surplus as defined by the regulations
adopted by the Washington Insurance Commissioner and, therefore, is not
presently permitted to pay cash dividends.
However, the Company does not directly own its life insurance subsidiary's
stock, but instead indirectly owns that stock through a downstream holding
company, FLC, whose ability to pay dividends to the Company is significantly
limited by some of the subordinated notes referred to in Note 6 during the terms
of those loans. Consolidated net assets FLC aggregated approximately $54,514,000
and $53,158,000 at December 31, 1998 and 1997, respectively.
The ability of ILCO to pay dividends to the Company and the other shareholders
of ILCO is affected by receipt of dividends from its insurance subsidiaries,
which are generally limited by law to the greater of their net income for the
prior year or 10% of capital and surplus.
Capital and surplus of Family Life as reported to insurance regulators and as
determined in accordance with statutory accounting practices prescribed or
permitted by the state of Washington aggregates approximately $30,294,446 and
$30,386,953 at December 31, 1998 and 1997, respectively. Statutory net income
aggregated approximately $10,473,492, $13,302,000 and $9,153,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
The Company employed no permitted statutory accounting practices that
individually or in the aggregate materially affected statutory surplus or
risk-based capital at December 31, 1998 or 1997.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles
guidance, which will replace the current Accounting Practices and Procedures
manual as the NAIC's primary guidance on statutory accounting. The NAIC is now
considering amendments to the Codification guidance that would also be effective
upon implementation. The Codification provides guidance for areas where
statutory accounting has been silent and changes current statutory accounting in
some areas, e.g. deferred income taxes are recorded. It is not known whether
Family Life's state of domicile's Insurance Department will adopt the
Codification, and whether the Department will make any changes to that guidance.
The Company has not estimated the potential effect of the Codification guidance
on statutory net income and statutory capital and surplus if adopted by the
Department. However, the actual effect of adoption could differ as changes are
made to the Codification guidance, prior to its recommended effective date of
January 1, 2001.
The Company's Articles of Incorporation were amended during 1996 to: (i)
increase the number of authorized shares of common stock from 3,304,200 shares
to 10,000,000 shares and (ii) to reduce the par value of the common stock from
$1.00 to $.20. These amendments to the Articles of Incorporation were related to
the implementation of the five-for-one stock split in 1996, authorized by the
Board of Directors.
F-32
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
10. Options
In connection with the subordinated senior notes and subordinated notes payable
to Investors-NA, Investors-NA was granted non-transferrable options to purchase,
in amounts proportionate to their respective loans, up to a total of 9.9 percent
of the common shares of FIC. The option price is $2.10 per share (adjusted to
reflect the five-for-one stock split in 1996), equivalent to the then current
market price, subject to adjustment to prevent the effect of dilution. The
options expire at the time of final repayment of each of the respective loans.
11. Retirement Plans and Employee Stock Plans
Retirement Plan
Family Life has a non-contributory defined benefit pension plan which covers
employees who have completed one year or more of service. Under the plan,
benefits are payable upon retirement based on earnings and years of credited
service.
a. The Normal Retirement Date for all employees is the first day
of the month coinciding with or next following the later of
attainment of age 65 or the completion of five years of
service, but not later than age 70.
b. The Normal Retirement Benefit is the actuarial equivalent of a
life annuity, payable monthly, with the first payment
commencing on the Normal Retirement Date. The life annuity is
equal to the sum of (1) plus (2):
(1) Annual Past Service Benefit: 1.17% of the first
$10,000 of Average Final Earnings plus 1 1/2% of the
excess of Average Final Earnings over $10,000, all
multiplied by the participant's Credited Past Service.
For these purposes, "credited past service" is service
prior to April 1, 1967, with respect to employees who
were plan participants on December 31, 1975.
(2) Annual Future Service Benefit: 1.5578% of the first
$10,000 of Average Final Earnings plus 2% of the
excess of Average Final Earnings over $10,000, all
multiplied by the participant's Credited Future
Service.
c. Effective April 1, 1997, the Family Life pension plan was
amended to provide that the accrual rate for future service is
1.57% of Final Average Earnings multiplied by Credited Service
after March 31, 1997, less .65% of Final Average Earnings up to
Covered Compensation. With respect to service prior to April 1,
1997, the accrual rate described in paragraph (b), above, is
applicable, with Average Final Earnings taking into account a
participant's earnings subsequent to April 1, 1997.
F-33
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Average Final Earnings are the highest average Considered Earnings during any
five consecutive years while an active participant. Total Credited Past Service
plus Credited Future Service is limited to 40 years.
The pension costs for the plan includes the following components:
1998 1997 1996
(in thousands)
Service cost for benefits earned
during the year $ 59 $ 88 $ 81
Interest cost on projected benefit
obligation 452 509 497
Expected return on plan assets (633) (719) (690)
Pension benefit $ (122) $ (122) $ (112)
F-34
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following summarizes the status of the plan at December 31:
1998 1997
(in thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $ 6,683 $ 6,563
Service cost 59 88
Interest cost 452 509
Benefits paid (897) (907)
(Gain)/Loss due to change in assumptions 525 -0-
(Gain)/Loss due to experience 868 430
Benefit obligation at end of year $ 7,690 $ 6,683
Change in plan assets:
Fair value of plan assets at beginning
of year $ 8,361 $ 8,990
Actual return on plan assets 495 278
Benefits paid (898) (907)
Fair value of plan assets at end
of year $ 7,958 $ 8,361
Funded Status:
Funded status at end of year $ 268 $ 1,678
Unrecognized actuarial net (gain) loss 1,564 33
Prepaid pension expense at end of year $ 1,832 $ 1,710
The significant assumptions for the plans are as follows:
The discount rate for projected benefit obligations was 7.25%, 7.75% and 7.75%
for the years ended December 31, 1998, 1997 and 1996, respectively.
The assumed long-term rate of compensation increases was 5.0 %, 6.0% and 6.0%
for the years ended December 31, 1998, 1997 and 1996, respectively.
The assumed long-term rate of return on plan assets was 8.0% for the years ended
December 31, 1998, 1997 and 1996.
F-35
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
During 1995, the ILCO Employee Stock Ownership Plan and the ILCO Savings and
Investment Plan were amended to allow for the addition of Family Life as a
participating employer, thus allowing Family Life employees to participate in
the plans.
In 1997, the ILCO Savings and Investment Plan was amended to provide for a
matching contribution by participating companies. The match, which is in the
form of shares of ILCO common stock, is equal to 100% of an eligible
participant's elective deferral contributions, as defined in the Plan, not to
exceed 1% of the participant's plan compensation. Allocations are made on a
quarterly basis to the account of participants who have at least 250 hours of
service in that quarter.
Stock Option Plans
In 1984, the Company's shareholders adopted a qualified stock option plan for
officers and key employees. The aggregate amount of the common shares on which
options may be granted is limited to 200,000 shares. The option price will not
be less than 100% of the fair market price of the optioned shares on the date
the option is granted. As of December 31, 1998, no options had been granted
under this plan.
12. Leases
Family Life occupies office facilities under lease agreements with unrelated
third parties which expire over the next year. Certain office space leases may
be renewed at the option of the Company.
Rent expense in 1998, 1997 and 1996 was $628,979, $781,104, and $886,189
respectively. Minimum annual rentals are as follows:
(in thousands)
1999 $ 476
2000 476
2001 469
2002 320
2003 19
Thereafter - 0-
Total $ 1,760
F-36
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
13. Related Party Transactions
The obligations of ILCO under the ILCO Senior Loan were guaranteed by FIC. FIC
presently owns 1,966,346 shares of ILCO Common Stock, constituting 44.93% of
such shares outstanding. As described under the heading "ILCO Senior Loan", the
current Senior Loan of ILCO was fully repaid on September 30, 1998. Accordingly
FIC's rights under the 1986 option agreement expired on September 30, 1998.
FIC Property, a subsidiary of FIC, conducted the leasing activities for the
Bridgepoint Square properties previously owned by Investors-NA. In connection
with the December, 1997 sale of Bridgepoint Square Offices by Investors-NA and
Family Life Insurance Company, FIC Realty received a commission in the amount of
$156,000, of which $122,538 was paid by Investors-NA and $33,462 by Family Life.
In connection with the 1996 sale of Austin Centre by Investors-NA, FIC Realty
received a commission in the amount of $123,350 from Investors-NA.
As part of the financing arrangement for the acquisition of Family Life, a $22.5
million loan was made by Investors-NA to FLC, a subsidiary of FIC, and a $2.5
million loan was made by Investors Life Insurance Company of California
(Investors-CA), which was merged into Investors-NA in 1992, to FIC. In addition
to the interest provided under those loans, Investors-NA and Investors-CA were
granted by FIC non-transferable options to purchase, in the amounts
proportionate to their respective loans, up to a total of 9.9 percent of shares
of FIC's common stock at a price of $10.50 per share, equivalent to the then
current market price, subject to adjustment to prevent dilution. As a result of
the FIC's five-for-one stock split, which was effective November 12, 1996, the
option price is currently $2.10 per share. The options originally were to expire
on June 12, 1998 if not previously exercised. In connection with the 1996
amendments to the subordinated notes, as described below, the expiration date of
the options were extended to September 12, 2006.
On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its
affiliate was prepaid. The Company paid $38 million plus accrued interest to
retire the indebtedness, which had a principal balance of approximately $50
million on July 30, 1993. The primary source of the funds used to prepay the
subordinated debt was new subordinated loans totaling $34.5 million that FLC and
Family Life Insurance Investment Company ("FLIIC"), another subsidiary of FIC,
obtained from Investors-NA. The principal amount of the new subordinated debt is
payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears
interest at an annual rate of 9%. The other terms of the new debt are
substantially the same as those of the $22.5 million subordinated loans that
Investors-NA had previously made to FLC and that continue to be outstanding.
As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC
and FLIIC were modified as follows: (a) the $22.5 million note was amended to
provide for twenty quarterly principal payments, in the amount of $1,125,000
F-37
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
each, to commence on December 12, 1996; the final quarterly principal payment is
due on September 12, 2001; the interest rate on the note remains at 11%, (b) the
$30 million note was amended to provide for forty quarterly principal payments,
in the amount of $163,540 each for the period December 12, 1996 to September 12,
2001; beginning with the principal payment due on December 12, 2001, the amount
of the principal payment increases to $1,336,458; the final quarterly principal
payment is due on September 12, 2006; the interest rate on the note remains at
9%, (c) the $4.5 million note was amended to provide for forty quarterly
principal payments, in the amount of $24,531 each for the period December 12,
1996 to September 12, 2001; beginning with the principal payment due on December
12, 2001, the amount of the principal payment increases to $200,469; the final
quarterly principal payment is due on September 12, 2006; the interest rate on
the note remains at 9%, (d) the $2.5 million note was amended to provide that
the principal balance of the note is to be repaid in twenty quarterly
installments of $125,000 each, commencing December 12, 1996 with the final
payment due on September 12, 2001; the rate of interest remains at 12%, (e) the
Master PIK note, which was issued to provide for the payment in kind of interest
due under the terms of the $2.5 million note prior to June 12, 1996, was amended
to provide that the principal balance of the note $1,977,119 is to be paid in
twenty quarterly principal payments, in the amount of $98,855.95 each, to
commence December 12, 1996 with the final payment due on September 12, 2001; the
interest rate on the note remains at 12%.
In December 1998 FLIIC was dissolved. In connection with the dissolution, all of
the assets and liabilities of FLIIC became the obligations of FLIIC's sole
shareholder, FIC. Accordingly, the obligations under the provisions of the $4.5
million note described above are now the obligations of FIC.
FIC was reimbursed by ILCO for rental expense and certain other operating
expenses incurred during 1998, 1997 and 1996 on behalf of ILCO. The amount of
such reimbursement was approximately $ -0- , $822,000 and $305,000,
respectively.
Data processing services are provided to ILCO's and FIC's Austin, Texas and
Seattle, Washington facilities by FIC Computer Services, Inc. ("FIC Computer"),
a subsidiary of FIC. Each of FIC's and ILCO's insurance subsidiaries has entered
into a data processing agreement with FIC Computer whereby FIC Computer provides
data processing services to each subsidiary for fees equal to such subsidiary's
proportionate share of FIC Computer's actual costs of providing those services
to all of the subsidiaries. Family Life paid $ 1,610,397, $824,425 and
$1,055,639 and ILCO's insurance subsidiaries paid $2,818,095, $3,010,110 and
$2,243,234 to FIC Computer for data processing services provided during 1998,
1997 and 1996, respectively.
In 1995, Family Life entered into a reinsurance agreement with Investors-NA
pertaining to universal life insurance written by Family Life. The reinsurance
agreement is on a co-insurance basis and applies to all covered business with
effective dates on and after January 1, 1995. The agreement applies to only that
F-38
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
portion of the face amount of the policy which is less than $200,000; face
amounts of $200,000 or more are reinsured by Family Life with a third party
reinsurer.
In 1996, Family Life entered into a reinsurance agreement with Investors-NA,
pertaining to annuity contracts written by Family Life. The agreement applies to
contracts written on or after January 1, 1996.
Pursuant to a Service Agreement between Family Life and Investors NA, the
Company reimbursed Investors NA for certain operating expenses incurred on
behalf of FLIC totaling approximately $11 million, $14 million, and $14million
in 1998, 1997 and 1996, respectively.
In November, 1998, FIC purchased 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). At the same time, Family
Life purchased 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). Mr. Mitte
and his wife had previously donated the shares to the Foundation. The shares are
included in common treasury stock in the Company's financial statements at cost.
14. Commitments and Contingencies
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 matters will not have a material impact on the financial
statements.
F-39
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
15. Net Income Per Share (in thousands except per share data)
The following table reflects the calculation of basic and diluted earnings per
share:
<TABLE>
December 31,
1998 1997 1996
(Amounts in thousands, except per share amounts)
<S> <C> <C> <C>
Basic:
Net income available to common
shareholders $ 9,218 $ 16,328 $ 16,157
Average weighted common stock
outstanding 5,383 5,428 5,428
Basic earnings per share $ 1.71 $ 3.01 $ 2.98
Diluted:
Net income available to common
shareholders
$ 9,218 $16,328 $ 16,157
Average weighted common stock
outstanding
5,383 5,428 5,428
Common stock options 293 293 288
Effect of shares of ILCO owns of FIC (85) (86) (88)
Repurchase of treasury stock (34) (46) (60)
Common stock and common stock
equivalents
5,557 5,589 5,568
Diluted earnings per share $ 1.66 $ 2.92 $ 2.90
</TABLE>
16. Business Concentration
The Company's insurance subsidiary, Family Life provides mortgage protection
life, disability and accidental death insurance to mortgage borrowers of
financial institutions. For marketing purposes a significant number of these
financial institutions provide Family Life with customer lists. In 1998, premium
income from these products was derived from forty-nine states with
concentrations of approximately 24% and 25% in California and Texas,
respectively. In 1997, these amounts were 23% and 25%, respectively.
F-40
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
17. Quarterly Financial Data (unaudited) (in thousands, except per share
data)
<TABLE>
Three Months Three Months
Ended Ended
March 31, June 30,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
Total revenues $ 13,476 $ 14,076 $ 14,028 $ 14,367
Net income $ 2,333 $ 2,228 $ 2,493 $ 2,221
Basic earnings per share $ 0.43 $ 0.41 $ 0.46 $ 0.41
Diluted earnings per share $ 0.42 $ 0.40 $ 0.44 $ 0.40
</TABLE>
<TABLE>
Three Months Three Months
Ended Ended
September 30, December 31,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
Total revenues $ 13,461 $ 14,542 $ 12,642 $ 19,171
Net income $ 2,153 $ 2,603 $ 2,240 $ 9,276
Basic earnings per share $ 0.40 $ 0.48 $ 0.43 $ 1.71
Diluted earnings per share $ 0.38 $ 0.47 $ 0.41 $ 1.66
</TABLE>
18. Subsequent Events
On March 6, 1999, ILCO's Board of Directors approved a stock dividend in the
amount of one share of ILCO common stock for each share issued and outstanding.
The stock dividend was paid on March 17, 1999, to holders of record on March 8,
1999
F-41
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN
INVESTMENTS IN RELATED PARTIES
<TABLE>
December 31, 1998
(in thousands)
Column A Column B Column C Column D
Amount Shown on
Type of Investment Amortized Cost Fair Value the Balance Sheet
<S> <C> <C> <C>
Fixed Maturities Available for Sale:
Bonds:
United States Government and
government agencies and authorities $ 16,125 $ 17,139 $ 17,139
States, municipalities and political
subdivisions 2,990 3,097 3,097
Corporate securities 24,499 25,278 25,278
Mortgage-backed securities 33,113 33,888 33,888
Total fixed maturities 76,727 79,402 79,402
Equity securities:
Common Stocks
Industrial and miscellaneous other 11 4 4
Total equity securities 11 4 4
Policy loans 3,155 3,155 3,155
Short -term investments 27,589 27,589 27,589
Total investments $ 107,482 $ 110,150 $ 110,150
</TABLE>
F-42
<PAGE>
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT
BALANCE SHEETS
December 31,
1998 1997
ASSETS (in thousands)
Cash $ 55 $ 54
Short-term investments 57 1,103
Long-term bonds 16 16
Investments in subsidiaries* 131,333 117,286
Property, plant and equipment, net 509 474
Other assets 968 1,018
Accounts receivable 126 77
Total assets $ 133,064 $ 120,032
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Subordinated notes payable $ 6,742 $ 3,358
Other liabilities and intercompany payables 5,936 2,825
Total liabilities 12,678 6,183
Shareholders' equity
Common stock, $.20 par value,
10,000,000 shares authorized;
5,845,300 shares issued, 5,326,661
and 5,427,965 shares outstanding
in 1998 and 1997,respectively 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other compensation income 5,898 6,692
Retained earnings (including $106,037
and $95,703 of undistributed earnings
of subsidiaries at December 31, 1998
and 1997) 108,403 99,185
122,695 114,271
Common treasury stock, at cost, 518,639
and 417,335 shares in 1998 and 1997,
respectively (2,309) (422)
Total shareholders' equity 120,386 113,849
Total liabilities and shareholders' equity $133,064 $120,032
* $60,383 and $50,534 are eliminated in consolidation in 1998 and 1997,
respectively.
F-43
<PAGE>
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT,
STATEMENTS OF INCOME
FOR THE YEARS ENDED
December 31,
(in thousands)
1998 1997 1996
Income $ 89 $ 1,375 $ 811
Operating expenses 436 1,136 461
Interest expense* 769 869 977
1,205 2,005 1,438
Loss from operations (1,116) (630) (627)
Equity in undistributed
earnings from subsidiaries 10,334 16,958 16,784
Net income $ 9,218 $ 16,328 $ 16,157
*In consolidation, $179 is reported as a reduction in equity in earnings of
unconsolidated subsidiary.
F-44
<PAGE>
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT
STATEMENTS OF CASH FLOWS
<TABLE>
FOR THE YEARS ENDED
December 31,
(in thousands)
1998 1997 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 9,218 $16,328 $16,157
Adjustments to reconcile net income to net
cash used in operating activities:
Increase in accounts receivables (49) (20) 3
Increase in investment in subsidiaries* (14,837) (21,024) (13,619)
Decrease in other assets 50 68 2
Decrease in other liabilities and
intercompany payables 3,111 (980) (694)
Decrease in property and equipment (35) 5,702 26
Net cash (used in) provided by in operating
activities (2,542) 74 1,875
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in short-term investments 1,046 823 (1,926)
Subordinated notes payable issued to
Investors-NA 3,384 (895) 32
Purchase of treasury stock (1,887) 0 0
Net cash provided by (used in) financing
activities 2,543 (72) (1,894)
Increase in cash 1 2 (19)
Cash, beginning of year 54 52 71
Cash, end of year $ 55 $ 54 $ 52
</TABLE>
*Eliminated in consolidation
F-45
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE IV-REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
(in thousands)
<TABLE>
Ceded to Other Assumed From Percentage of
Direct Amount Companies Other Companies Net Amount Amount Assumed
<S> <C> <C> <C> <C> <C>
1998
Life Insurance in-
force $7,755,545 $440,270 $ 6,159 $7,321,434 0.08%
Life insurance $ 38,908 $ 769 $ 60 $ 38,199 0.16%
Accident-health
insurance 809 650 0 159 0.00%
Total $ 39,717 $ 1,419 $ 60 $ 38,358 0.16%
1997
Life insurance in-
force $7,809,531 $403,600 $ 6,663 $7,412,594 0.09%
Premium:
Life insurance $ 40,333 $ 704 $ 94 $ 39,723 0.24%
Accident-health
insurance 934 408 -0- 526 0.00%
Total $ 41,267 $ 1,112 $ 94 $ 40,249 0.23%
Life insurance in-
force $8,324,406 $365,103 $ 5,772 $7,965,075 0.07%
Life insurance $ 42,881 $ 851 $ 64 $ 42,094 0.15%
Accident-health
insurance 1,243 1 0 1,242 0.00%
Total $ 44,124 $ 852 $ 64 $ 43,336 0.15%
</TABLE>
F-46
<PAGE>
EXHIBIT INDEX
Exhibit Page Description
No. Nos
3 The current Articles of Incorporation and Bylaws of
Registrant. Exhibit 3 to Registrant's Report on Form 10-K
filed for the year 1985 is hereby incorporated by reference.
3(a) Certificate of Amendment to the Articles of Incorporation of
Registrant, dated November 12, 1996, filed as an exhibit
with Registrant's 10-Q for the quarter ended September 30,
1996 and incorporated herein by reference.
10(ah) Guaranty Agreement dated as of December 28, 1988 from
Registrant to a group of banks on Senior Loan to ILCO, filed
as an exhibit with Registrant's Form 10-K for the year ended
December 31, 1989 and incorporated herein by reference.
10(ai) Guaranty Agreement, dated as of December 1, 1988, on loan to
ILCO on the Note Purchase Agreement between ILCO and a
Connecticut based insurance/financial services company; a
guaranty agreement in substantially identical form was
provided by FIC to each of the seven other entities
participating in said loan, filed as an exhibit with
Registrant's Form 10-K for the year ended December 31, 1989
and incorporated herein by reference.
10(aj) Guaranty Agreement, dated as of July 30, 1990, issued by the
Registrant to a holder of ILCO's 1999 Series Subordinated
Notes; a guaranty agreement in substantially identical form
was provided by the Registrant to each of the holders of
said notes.
*10(ak) Stock Purchase Agreement by and among Merrill Lynch
Insurance Group, Inc., Family Life Insurance Company, Family
Life Corporation, Family Life Insurance Investment Company
and Financial Industries Corporation dated as of March 19,
1991, as amended.
Ex-1
<PAGE>
*10(al) Note dated June 12, 1991 in the amount of $30 million made
by a subsidiary of the Registrant in favor of Merrill Lynch
Insurance Group, Inc.
*10(am) Note dated June 12, 1991 in the amount of $12 million made
by a subsidiary of the Registrant to Merrill Lynch & Co.,
Inc.
*10(an) Note dated June 12, 1991 in the amount of $2 million made by
a subsidiary of the Registrant in favor of the Seller under
the Stock Purchase Agreement dated as of March 19, 1991.
*10(ao) Performance and Payment Guaranty Agreement dated June 12,
1991 by Registrant in favor of the Seller under the Stock
Purchase Agreement dated as of March 19, 1991.
*10(ap) Payment Guaranty Agreement dated June 12, 1991 by Registrant
in favor of the Seller under the Stock Purchase Agreement
dated as of March 19, 1991.
*10(aq) InterCreditor Agreement dated June 12, 1991 among Investors
Life Insurance Company of North America, Investors Life
Insurance Company of California, Merrill Lynch Insurance
Group, Inc., and Merrill Lynch & Co., Inc.
*10(ar) Credit Agreement dated as of June 12, 1991 among Family Life
Corporation (a subsidiary of the Registrant), the Lenders
named therein and the Agent.
*10(as) Guaranty Agreement by Registrant of the $50 million loan to
Family Life Corporation in favor of the bank lenders under
the Credit Agreement dated as of June 12, 1991.
*10(at) Guaranty Agreement by a subsidiary of the Registrant on the
$50 million loan to Family Life Corporation in favor of the
bank lenders under the Credit Agreement dated as of June 12,
1991.
Ex-2
<PAGE>
*10(au) Pledge Agreement by Family Life Corporation (a subsidiary of
the Registrant) in favor of the bank lenders under the
Credit Agreement dated as of June 12, 1991.
*10(aw) Pledge Agreement by Family Life Insurance Investment Company
(a subsidiary of the Registrant) in favor of the bank
lenders under the Credit Agreement dated as of June 12,
1991.
*10(ax) Note dated June 12, 1991 in the amount of $22.5 million made
by a subsidiary of the Registrant in favor of Investors Life
Insurance Company of North America.
*10(ay) Note dated June 12, 1991 in the amount of $2.5 million made
by the Registrant in favor of Investors Life Insurance
Company of California.
*10(az) InterCreditor Agreement among Investors Life Insurance
Company of North America, Investors Life Insurance Company
of California, and the Agent under the Credit Agreement
dated as of June 12, 1991.
*10(aaa) Option Agreement by the Registrant in favor of Investors
life Insurance Company of North America and Investors Life
Insurance Company of California.
10(aab) Hotel Lease Agreement dated as of August 22, 1991 between
Investors Life Insurance Company of North America and FIC
Realty Services, Inc. filed as exhibit 10(aab) by Registrant
on Form 10-K for the year ended December 31, 1991 is hereby
incorporated by reference.
10(aac) Management Agreement dated as of September 4, 1991 between
Investors Life Insurance Company of North America and FIC
Property Management, Inc. filed as exhibit 10(aac) by
Registrant on Form 10-K for the year ended December 31, 1991
is hereby incorporated by reference.
10(aad) Stock Option Agreement dated March 8, 1986 between ILCO and
Registrant filed as exhibit 10(aad) by Registrant on Form
10-K for the year ended December 31, 1992 is hereby
incorporated by reference.
Ex-3
<PAGE>
10(aae) Amended and Restated Guaranty of Registrant dated January
29, 1993 filed as exhibit 10(aae) by Registrant on Form 10-K
for the year ended December 31, 1992 is hereby incorporation
by reference.
10(aaf) Surplus Debenture dated as of June 12, 1991 in the amount of
$97.5 million made by Family Life Insurance Company in favor
of Family Life Corporation filed as exhibit 10(aaf) by
Registrant on Form 10-K for the year ended December 31, 1993
is hereby incorporated by reference.
10(aag) Note dated July 30, 1993 in the amount of $30 million made
by Family Life Corporation in favor of Investors Life
Insurance Company of North America filed as exhibit 10(aag)
by Registrant on Form 10-K for the year ended December 31,
1993 is hereby incorporated by reference.
10(aah) Note dated July 30, 1993 in the amount of $4.5 million made
by Family Life Insurance Investment Company in favor of
Investors Life Insurance Company of North America filed as
exhibit 10(aah) by Registrant on Form 10-K for the year
ended December 31, 1993 is hereby incorporated by reference.
10(aai) Amendment No. 1 dated July 30, 1993 between Family Life
Corporation and Investors Life Insurance Company of North
America amending $22.5 million note filed as exhibit 10(aai)
by Registrant on Form 10-K for the year ended December 31,
1993 is hereby incorporated by reference.
10(aaj) Amendment No. 1 dated July 30, 1993 between Family Life
Insurance Company and Family Life Corporation amending $97.5
million Surplus Debenture filed as exhibit 10(aaj) by
Registrant on Form 10-K for the year ended December 31, 1993
is hereby incorporated by reference.
10(aak) Guaranty Agreement dated July 30, 1993 by Registrant of the
$30 million loan to Family Life Corporation in favor of
Investors Life Insurance Company of North America filed as
exhibit 10(aak) by Registrant on Form 10-K for the year
ended December 31, 1993 is hereby incorporated by reference.
Ex-4
<PAGE>
10(aal) Guaranty Agreement dated July 30, 1993 by Registrant of the
$4.5 million loan to Family Life Insurance Investment
Company in favor of Investors Life Insurance Company of
North America filed as exhibit 10(aal) by Registrant on Form
10-K for the year ended December 31, 1993 is hereby
incorporated by reference.
10(aam) Letter agreement dated May 26, 1993 among Family Life
Corporation, Family Life Insurance Investment Company,
Merrill Lynch & Co., Inc. and Merrill Lynch Group, Inc.
filed as exhibit 10(aam) by Registrant on Form 10-K for the
year ended December 31, 1993 is hereby incorporated by
reference.
10(aan) Waiver and Amendment Agreement dated as of July 23, 1993
among Family Life Corporation, the Lenders named therein and
the Agent filed as exhibit 10(aan) by Registrant on Form
10-K for the year ended December 31, 1994 is hereby
incorporate by reference.
10(aao) Waiver and Amendment Agreement dated as of December 14, 1993
among Family Life Corporation, the Lenders named therein and
the Agent filed as exhibit 10(aao) by Registrant on Form
10-K for the year ended December 31, 1994 is hereby
incorporated by reference.
10(aap) Data Processing Agreement dated as of November 30, 1994
between InterContinental Life Insurance Company and FIC
Computer Services, Inc filed as exhibit 10(aap) by
Registrant on Form 10-K for the year ended December 31, 1994
is hereby incorporated by reference.
10(aaq) Data Processing Agreement dated as of November 30, 1994
between Investors Life Insurance Company of North America
and FIC Computer Services, Inc filed as exhibit 10(aaq) by
Registrant on Form 10-K for the year ended December 31, 1994
is hereby incorporated by Reference.
10(aar) Data Processing Agreement dated as of November 30, 1994
between Family Life Insurance Company and FIC Computer
Services, Inc filed as exhibit 10(aar) by Registrant on Form
10-K for the year ended December 31, 1994 is hereby
incorporated by reference.
Ex-5
<PAGE>
10(aas) Lease Agreement dated as of September 30, 1994 between FIC
Realty Services, Inc. and Atrium Beverage Corporation filed
as exhibit 10(aas) by Registrant on Form 10-K for the year
ended December 31, 1994 is hereby incorporated by reference.
10(aat) Management Agreement dated as of September 30, 1994 between
HCD Austin Corporation as agent for FIC Realty Services,
Inc. and Atrium Beverage Corporation filed as exhibit
10(aat) by Registrant on Form 10-K for the year ended
December 31, 1994 is hereby incorporated by reference.
10(aau) Amendment Agreement dated as of July 31, 1995 among Family
Life Corporation, the Lenders named therein and the Agent
filed as exhibit 10(aau) by Registrant on Form 10-K for the
year ended December 31, 1995 is hereby incorporated by
reference.
10(aav) Amendment No. 2 dated December 12, 1996, effective June 12,
1996 to the note dated June 12, 1991 in the amount of $22.5
million made by Family Life Corporation in favor of
Investors Life Insurance Company of North America filed as
exhibit 10(aav) by Registrant on Form 10-K for the year
ended December 31, 1996 is hereby incorporated by reference.
10(aaw) (i) Amendment No. 1 dated December 12, 1996, effective June
12, 1996 to the note dated June 12, 1991 in the amount of
$2.5 million made by Financial Industries Corporation in
favor of Investors Life Insurance Company of California
filed as exhibit 10(aaw)(i) by Registrant on Form 10-K for
the year ended December 31, 1996 is hereby incorporated by
reference.
(ii) Amendment No. 1 dated December 12, 1996, effective June
12, 1996 to the "payment in kind" provisions of the note
dated June 12, 1991 in the amount of $2.5 million made by
Financial Industries Corporation in favor of Investors Life
Insurance Company of North America filed as
Ex-6
<PAGE>
exhibit 10(aaw)(ii) by Registrant on Form 10-K for the year
ended December 31, 1996 is hereby incorporated by reference.
10(aax) Amendment No. 1 dated December 12, 1996, effective June 12,
1996 to the note dated July 30, 1993 in the amount of $30
million made by Family Life Corporation in favor of
Investors Life Insurance Company of North America filed as
exhibit 10(aax) by Registrant on Form 10-K for the year
ended December 31, 1996 is hereby incorporated by reference.
10(aay) Amendment No. 1 dated December 12, 1996, effective June 12,
1996 to the note dated July 30, 1993 in the amount of $4.5
million made by Family Life Insurance Investment Company in
favor of Investors Life Insurance Company of North America
filed as exhibit 10(aay) by Registrant on Form 10-K for the
year ended December 31, 1996 is hereby incorporated by
reference.
10(aaz) Amendment Agreement dated December 12, 1996 amending the
Option Agreement by Financial Industries Corporation in
favor of Investors Life Insurance Company of North America
and Investors Life Insurance Company of California filed as
exhibit 10(aaz) Registrant on Form 10-K for the year ended
December 31, 1996 is hereby incorporated by reference.
10(aaaa) Ex-9 Assignment Agreement dated December 23, 1998, from Family
Life Insurance Investment Company to Financial Industries
Corporation, assigning the 9% Senior Subordinated Note dated
July 30, 1993 in the amount of $4.5 million made by Family
Life Insurance Investment Company in favor of Investors Life
Insurance Company of North America.
21 Ex-11 Subsidiaries of Registrant.
28 Report on Form 10-K filed by ILCO for the year ended
December 31, 1998 is hereby incorporated by reference in its
entirety.
Ex-7
<PAGE>
* Filed as an Exhibit with Registrant's Current Report on Form
8-K dated June 25, 1991, and incorporated herein by
reference.
Ex-8
<PAGE>
Exhibit 10(aaaa)
Assignment of 9% Senior Subordinated Note Dated July 30, 1993
This Assignment Agreement ("Assignment") is entered into effective December 23,
1998 , 1998 by and between Family Life Insurance Investment Corporation
("Assignor"), Financial Industries Corporation ("Assignee") and Investors Life
Insurance Company of North America ("Payee").
WHEREAS, Assignor is the obligor and Payor under that
certain 9% Subordinated Senior Note dated July 30, 1993 in
the principal amount of $4,500,000, as amended by Amendment
No. 1 dated December 12, 1996, with a current principal
balance of $4,279,221 (as amended, the "Note"), and
WHEREAS, Investors Life Insurance Company of North America
is the Payee under the Note, and
WHEREAS, Assignor will dissolve pursuant to a Plan of
Dissolution and Articles of Dissolution dated November 30,
1998 which were prepared by the Board of Directors of
Assignor and approved by the shareholders of Assignor, and
WHEREAS, Assignee has agreed to assume all of the rights,
duties and obligations of Assignor under the Note, and
WHEREAS, Payee has agreed to release Assignor from
Assignor's duties and obligations under the Note once the
Note is assumed by Assignee,
NOW THEREFORE, for good and valuable consideration, the
receipt and sufficiency of which is hereby acknowledged, the
parties hereto agree as follows:
1. Capitalized terms used herein and not otherwise
defined in this Assignment shall have the meanings
attributed to such terms in the Note.
2. Assignor hereby assigns and sets over to Assignee
all of Assignor's rights, duties and obligations
under the Note.
3. Assignee hereby accepts all of Assignor's rights,
duties and obligations under the Note and agrees
to perform all of the duties and obligations
contained in the Note.
4. By consenting to this Assignment, Payee agrees
that Assignee shall assume all of Assignor's
rights, duties and obligations under the Note.
Ex-9
<PAGE>
IN WITNESS WHEREOF, Family Life Insurance Investment
Company, Financial Industries Corporation and Investors Life
Insurance Company of North America have executed this
Assignment as of December 23 , 1998
Assignor:
FAMILY LIFE INSURANCE
INVESTMENT CORPORATION
By: /s/ James M. Grace
Name: James M. Grace
Title: Executive Vice President
Assignee:
FINANCIAL INDUSTRIES
CORPORATION
By: /s/ Roy F. Mitte
Name: Roy F. Mitte
Title: President
Approved and Agreed to by Payee:
INVESTORS LIFE INSURANCE COMPANY
OF NORTH AMERICA
By: /s/ Roy F. Mitte
Name: Roy F. Mitte
Title: President
Ex-10
<PAGE>
EXHIBIT 21
Subsidiaries of Registrant
Family Life Corporation
Family Life Insurance Company
Financial Industries Service Corporation
Financial Industries Securities Corporation
Financial Industries Service Corporation
of Mississippi, Inc.
Financial Industries Sales Corporation
of Southern California, Inc.
FIC Realty Services, Inc.
FIC Property Management, Inc.
FIC Computer Services, Inc.
Atrium Beverage Corporation
Ex-11
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K FOR
THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 79,402
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 110,150
<CASH> 2,601
<RECOVER-REINSURE> 12,426
<DEFERRED-ACQUISITION> 48,510
<TOTAL-ASSETS> 301,738
<POLICY-LOSSES> 60,069
<UNEARNED-PREMIUMS> 28
<POLICY-OTHER> 45,128
<POLICY-HOLDER-FUNDS> 4,582
<NOTES-PAYABLE> 47,645
0
0
<COMMON> 1,169
<OTHER-SE> 114,151
<TOTAL-LIABILITY-AND-EQUITY> 301,738
38,358
<INVESTMENT-INCOME> 7,808
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 1,470
<BENEFITS> 16,258
<UNDERWRITING-AMORTIZATION> 5,174
<UNDERWRITING-OTHER> 11,822
<INCOME-PRETAX> 11,586
<INCOME-TAX> 2,368
<INCOME-CONTINUING> 9,218
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,218
<EPS-PRIMARY> 1.71
<EPS-DILUTED> 1.66
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
