SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the Quarterly Period Ended June 30, 1999
Commission File Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact Name of Registrant as specified in its charter)
Texas 74-2126975
(State of Incorporation) (I.R.S. Employer Identification Number)
The Austin Centre, 701 Brazos, 12th Floor
Austin, Texas 78701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 404-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Number of common shares outstanding ($.20 par value) at end of period: 5,054,661
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
June 30, 1999 and December 31, 1998................................. 3
Consolidated Statements of Income
For the three and six month periods ended
June 30, 1999 and 1998.............................................. 5
Consolidated Statements of Cash Flows
For the three and six month periods ended
June 30, 1999 and 1998.............................................. 9
Notes to Consolidated Financial Statements...................................13
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations......................15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ...............................................23
Part II
Other Information...........................................................25
Signature Page..............................................................27
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
(unaudited)
<S> <C> <C>
ASSETS
Investments other than investments in
affiliate: Fixed maturities available
for sale at market value (amortized cost
of $74,453 and $76,727 at June 30,
1999 and December 31, 1998, respectively ) $ 75,244 $ 79,402
Equity securities at market (cost approximates
$11 at June 30, 1999 and December 31, 1998) 4 4
Policy loans 3,277 3,155
Short-term investments 28,315 27,589
---------------- --------------
Total investments 106,840 110,150
Cash 1,002 2,601
Investment in affiliate 69,779 70,950
Accrued investment income 1,167 1,209
Agency advances and other receivables 7,450 7,759
Reinsurance receivables 13,562 12,426
Due and deferred premiums 12,442 12,181
Property and equipment, net 1,758 1,758
Deferred policy acquisition costs 50,635 48,510
Present value of future profits of acquired
businesses 25,682 28,294
Other assets 4,871 5,392
Separate account assets 335 508
---------------- --------------
Total Assets $ 295,523 $ 301,738
================ ==============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Policy liabilities and contract holder
deposit funds:
Future policy benefits $ 59,826 $ 60,069
Contract holder deposit funds 44,681 45,128
Unearned premiums 14 28
Other policy claims and benefits payable 4,441 4,582
-------------- --------------
108,962 109,807
Subordinated notes payable to affiliate 44,571 47,645
Deferred federal income taxes 23,824 23,984
Other liabilities 3,061 4,474
Separate account liabilities 335 508
-------------- --------------
Total Liabilities 180,753 186,418
-------------- --------------
Commitments and Contingencies
Shareholders' equity:
Common stock, $.20 par value, 10,000,000
shares authorized; 5,845,300 shares
issued, 5,054,661 outstanding in 1999 and 1998 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income 1,279 5,898
Retained earnings 112,472 108,403
-------------- -------------
122,145 122,695
Common treasury stock, at cost, 790,639
at 1999 and 1998. (7,375) (7,375)
-------------- --------------
Total Shareholders' Equity 114,770 115,320
-------------- --------------
Total Liabilities and Shareholders' Equity $ 295,523 $ 301,738
============== ==============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
Revenues:
Premiums $ 9,101 $ 9,957
Net investment income 1,701 1,983
Earned insurance charges 1,209 1,738
Other 297 350
------------- ----------------
12,308 14,028
Benefits and expenses:
Policyholder benefits and expenses 4,192 3,796
Interest expense on contract holders
deposit funds 467 566
Amortization of present value of future
profits of acquired businesses 1,402 1,756
Amortization of deferred policy
acquisition costs 1,180 1,070
Operating expenses 2,806 3,500
Interest expense 552 682
------------- ----------------
10,599 11,370
------------- ----------------
Income before federal income tax and
equity in net earnings of affiliates 1,709 2,658
Provision for federal income taxes 434 733
------------- ----------------
Income before equity in net earnings
of affiliates 1,275 1,925
Equity in net earnings of affiliate,
net of tax 526 568
------------- ----------------
Net Income $ 1,801 $ 2,493
============= ================
</TABLE>
The accompanying notes are an integral
part of these consolidated
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,428
=================== ==================
Basic earnings per share $ 0.36 $ 0.46
=================== ==================
Diluted:
Common stock and common stock equivalents 5,194 5,603
=================== ==================
Diluted earnings per share $ 0.35 $ 0.44
=================== ==================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
Revenues:
Premiums $ 17,682 $ 19,721
Net investment income 3,454 3,921
Earned insurance charges 2,585 3,165
Other 702 697
----------------- -----------------
24,423 27,504
Benefits and expenses:
Policyholder benefits and expenses 7,933 7,904
Interest expense on contract holders
deposit funds 972 1,206
Amortization of present value of future
profits of acquired businesses 2,612 3,269
Amortization of deferred policy
acquisition costs 2,383 2,266
Operating expenses 5,722 6,599
Interest expense 1,250 1,401
----------------- -----------------
Total 20,872 22,645
----------------- -----------------
Income before federal income tax and
equity in net earnings of affiliates 3,551 4,859
Provision for federal income taxes 773 1,133
----------------- -----------------
Income before equity in net earnings
of affiliates 2,778 3,726
Equity in net earnings of affiliate,
net of tax 1,291 1,100
----------------- -----------------
Net Income $ 4,069 $ 4,826
================= =================
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,428
================== =================
Basic earnings per share $ 0.81 $ 0.89
================== =================
Diluted:
Common stock and common stock equivalents 5,201 5,603
================== =================
Diluted earnings per share $ 0.78 $ 0.86
================== =================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 1,801 $ 2,493
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 1,402 1,756
Amortization of deferred policy
acquisition costs 1,180 1,070
Equity in undistributed earnings of affiliate (1,164) (1,253)
Changes in assets and liabilities:
Increase in accrued investment income (186) (262)
Decrease (increase) in agent advances and
other receivables 142 (524)
Increase in due and deferred premiums (458) (178)
Increase in deferred policy acquisition costs (2,451) (2,134)
Decrease (increase) in other assets 180 (172)
(Decrease) increase in policy liabilities
and accruals (927) 424
(Decrease) increase in other liabilities (761) 592
(Decrease) increase in deferred federa
income taxes (298) 930
Other, net (2) (207)
---------------- -----------------
Net cash provided by operating activities $ (1,542) $ 2,535
---------------- -----------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (2,996) $ -0-
Proceeds from sales and maturities of
fixed maturities 3,486 1,711
Increase in policy loans ( 44) (139)
Net change in short-term investments 1,877 (2,164)
Purchase & retirement of property
and equipment 0 (34)
------------- -------------
Net cash provided by investing activities 2,323 (626)
------------- -------------
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (1,537) (1,537)
------------- --------------
Net cash used in financing activities (1,537) (1,537)
------------- --------------
Net (decrease) increase in cash (756) 372
Cash, beginning of period 1,758 838
------------- -------------
Cash, end of period $ 1,002 $ 1,210
============= =============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 4,069 $ 4,826
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 2,612 3,269
Amortization of deferred policy
acquisition costs 2,383 2,266
Equity in undistributed earnings of affiliate (2,478) (2,473)
Changes in assets and liabilities:
Decrease (increase) in accrued
investment income 42 (68)
Increase in agent advances and
other receivables (827) (1,266)
Increase in due and deferred premiums (261) (246)
Increase in deferred policy acquisition costs (4,508) (4,070)
Decrease in other assets 521 1,008
(Decrease) increase in policy liabilities
and accruals (845) 121
Decrease in other liabilities (1,413) (1,194)
(Decrease) increase in deferred federal
income taxes (160) 1,258
Other, net (71) (209)
-------------- -----------------
Net cash provided by operating activities $ (936) $ 3,222
-------------- -----------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
(unaudited)
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (9,996) $ (9,082)
Proceeds from sales and maturities of
fixed maturities 13,255 6,372
Increase in policy loans (122) (213)
Net change in short-term investments (726) 3,510
Purchase & retirement of property
and equipment 0 (34)
------------- ------------
Net cash provided by investing activities 2,411 553
------------- ------------
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable (3,074) (3,073)
------------ ------------
Net cash used in financing activities (3,074) (3,073)
------------ ------------
Net (decrease) increase in cash (1,599) 702
Cash, beginning of year 2,601 508
------------- -------------
Cash, end of period $ 1,002 $ 1,210
============= =============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial
statements.
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The financial statements included herein reflect all adjustments which are, in
the opinion of management, necessary to present a fair statement of the interim
results. The statements have been prepared to conform to the requirements of
Form 10-Q and do not necessarily include all disclosures required by generally
accepted accounting principles (GAAP). The reader should refer to Form 10-K for
the year ended December 31, 1998, previously filed with the Commission for
financial statements prepared in accordance with GAAP. Certain prior year
amounts have been reclassified to conform with current year presentation.
The consolidated financial statements include the accounts of Financial
Industries Corporation ("FIC") and its wholly-owned subsidiaries. The investment
of FIC in InterContinental Life Corporation ("ILCO") is presented using the
equity method. All significant intercompany items and transactions have been
eliminated.
Comprehensive Income
Total comprehensive (loss) income for the six months ended June 30, 1999 and
June 30, 1998 is $(.55) million and $4.9 million, respectively.
The following is a reconciliation of accumulated other comprehensive income from
December 31, 1998 to June 30, 1999 (in thousands):
Net Total
Net unrealized appreciation accumulated
gain on investments (depreciation) other
in fixed maturities of equity comprehensive
available for sale securities income
Balance at December 31, 1998 $ 5,900 $ (2) $ 5,898
Current Period Change (4,620) 1 (4,619)
-------- -------- ---------
Balance at June 30, 1999 $ 1,280 $ (1) $ 1,279
======== ========= ========
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
New Accounting Pronouncements
In December 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments," which provides guidance on accounting for
insurance-related assessments. The Company adopted SOP 97-3 effective January 1,
1999. The adoption of SOP 97-3 did not have a material impact on the Company's
results of operations, liquidity or financial position.
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133 is applicable to financial statements for all
fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133." The operations of the
Company are not affected by the provisions of FAS No. 133.
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation:
For the six-month period ended June 30, 1999, Financial Industries Corporation's
("FIC") net income was $4,069,000 (basic earnings of $0.81 per common share, or
diluted earnings of $0.78 per common share) as compared to $4,826,000 (basic
earnings of $0.89 per common share, or diluted earnings of $0.86 per common
share) in the first six months of 1998. Earnings per share are stated in
accordance with the requirements of FAS No. 128, which establishes two measures
of earnings per share: basic earnings per share and diluted earnings per share.
Basic earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflect the potential dilution that would
occur if securities or other contracts to issue common stock were converted or
exercised.
Results of Operations
FIC's income from operations - as determined before federal income tax and
equity in net earnings of its affiliate, InterContinental Life Corporation - for
the six-month period ended June 30, 1999, was $3,551,000 (on revenues of
$24,423,000), as compared to $4,859,000 (on revenues of $27,504,000) in the
first six months of 1998.
Earnings for the six-month period ended June 30, 1999 were affected by an
increase in claims. For the 1999 period claims were $0.9 million higher (net of
tax) than the level during the 1998 period.
Earnings per share (basic and diluted) for the six-month period ended June 30,
1999 include $.03 per share due to the decrease in the number of common shares
outstanding resulting from (i) FIC's purchase on November 17, 1998 of 101,304
shares of FIC's common stock from the Roy F. and Joann Cole Mitte Foundation
(the "Foundation"), a Texas non-profit corporation which is controlled by Mr.
Mitte and his wife, at a price of $18.625 per share (or a total purchase price
of $1,886,787) and (ii) Family Life Insurance Company's purchase on November 17,
1998 of 272,000 shares of FIC's common stock from the Foundation at a price of
$18.625 per share (or a total purchase price of $5,066,000).
Premiums for the first six months of 1999, net of reinsurance ceded, were $17.7
million, as compared to $19.7 million in the first six months of 1998.
Policyholder benefits and expenses were $7.9 million in the 1999 period, as
compared to $7.9 million in the first six months of 1998.
As of June 30, 1999, the market value of the fixed maturities available for sale
segment was $75.2 million as compared to an amortized value of $74.5 million, or
an unrealized gain of $0.7 million. The increase reflects unrealized gains on
such investments related to changes in interest rates subsequent to the purchase
of such investments. There is no assurance that this gain will be realized in
the future. The net of tax effect of this increase ($0.55 million at June 30,
1999) has been recorded as an increase in shareholders' equity. As required
under the provisions of FAS No. 130, the determination of "Accumulated other
comprehensive income" includes separate
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<PAGE>
identification of the change in values which occurred during the current period.
The operating strategy of the Company's management emphasizes several key
objectives: expense management; marketing of competitively priced insurance
products which are designed to generate an acceptable level of profitability;
maintenance of a high quality portfolio of investment grade securities; and the
provision of quality customer service.
Equity in Net Income of InterContinental Life Corporation
General:
For the six-month period ended June 30, 1999, the Company's equity in the net
earnings of InterContinental Life Corporation ("ILCO"), net of federal income
tax, was $1,291,000, as compared to $1,100,000 for the first six months of 1998.
On March 17, 1999, ILCO paid a stock dividend (one share of common stock for
each outstanding share of common stock). FIC currently owns 3,590,292 shares of
ILCO's common stock. In addition, Family Life currently owns 342,400 shares of
ILCO common stock. As a result, FIC currently owns, directly and indirectly
through Family Life, 3,932,692 shares (approximately 45%) of ILCO's common
stock.
Prior to September 30, 1998, FIC held options to acquire (on a pre-dividend
basis) an additional 1,702,155 shares. The options were granted under an option
agreement between FIC and ILCO which was entered into in March, 1986 ("Option
Agreement"). The Option Agreement provided that it continued in effect as long
as FIC guaranteed indebtedness of ILCO. Since the Senior Loan of ILCO was fully
repaid on September 30, 1998, FIC's rights under the Option Agreement expired on
September 30, 1998.
As of June 30, 1999, the market value of ILCO's fixed maturities available for
sale segment was $411.5 million as compared to an amortized cost of $408.7
million, or an unrealized gain of $2.8 million. The increase reflects unrealized
gains on such investments related to changes in interest rates subsequent to the
purchase of such investments. Since FIC owns approximately 45% of the common
stock of ILCO, the net of tax effect of this increase ($1.8 million at June 30,
1999) is included in "Accumulated other comprehensive income" on the
Consolidated Balance Sheets and has been recorded as an increase in
shareholders' equity.
Liquidity and Capital Resources of ILCO:
ILCO is a holding company whose principal assets consist of the common stock of
Investors Life Insurance Company of North America ("Investors-NA") and its
subsidiary, Investors Life Insurance Company of Indiana (formerly
InterContinental Life Insurance Company). ILCO's primary source of funds
consists of payments under the surplus debentures from Investors-NA.
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<PAGE>
Prior to September 30, 1998, the cash requirements of ILCO consisted primarily
of its service of the indebtedness created in connection with the 1988
acquisition of the Investors Life Companies and the 1995 acquisition of Meridian
Life Insurance Company (which company was subsequently merged into another life
insurance subsidiary of ILCO). As of December 31, 1997, the outstanding
principal balance of ILCO's senior loan obligations was $11.0 million, which
reflected the prepayment by ILCO of the payment originally scheduled for January
1, 1998. A regular payment in the amount of $3.7 million was made on April 1,
1998, and a prepayment of the July 1, 1998 installment, in the amount of $3.7
million, was made on June 30, 1998. The outstanding principal balance of ILCO's
senior loan obligations was $3.6 million at June 30, 1998. The final installment
on the senior loan obligation scheduled for October 1, 1998, was prepaid on
September 30, 1998. As a result, the senior loan obligation of ILCO was fully
discharged effective September 30, 1998.
ILCO's principal source of liquidity consists of the periodic payment of
principal and interest to it by Investors-NA, pursuant to the terms of the two
surplus debentures. The surplus debentures were originally issued by Standard
Life Insurance Company and their terms were previously approved by the
Mississippi Insurance Commissioner. In connection with the 1993 merger of
Standard Life into Investors-NA, the obligations of the surplus debentures were
assumed by Investors-NA. As of June 30, 1999, the outstanding principal balances
of the surplus debentures were $4.0 million and $6.9 million, respectively.
Since Investors-NA is domiciled in the State of Washington, the Washington
insurance law applies to the administration of the terms of the surplus
debentures. Under the provisions of the surplus debentures and current law, no
prior approval of the Washington Insurance Commissioner is required for
Investors-NA to pay interest or principal on the surplus debentures; provided
that, after giving effect to such payments, the statutory surplus of
Investors-NA is in excess of $10 million (the "surplus floor"). However,
Investors-NA has voluntarily agreed with the Washington Insurance Commissioner
that it will provide at least five days advance notice of payments which it will
make under the surplus debenture. As of June 30, 1999, the statutory capital and
surplus of Investors-NA was $66.4 million, an amount substantially in excess of
the surplus floor. The funds required by Investors- NA to meet its obligations
to ILCO under the terms of the surplus debentures are generated from operating
income generated from insurance and investment operations.
In addition to the payments under the terms of the Surplus Debentures, ILCO has
received dividends from its subsidiaries. Washington's insurance code includes
the "greater of" standard for payment of dividends to shareholders, but has a
requirement that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash dividends may be paid only from
earned surplus. Under the "greater of" standard, an insurer may pay a dividend
in an amount equal to the greater of (i) 10% of policyholder surplus or (ii) the
insurer's net gain from operations for the previous year. As of June 30, 1999,
Investors-NA had earned surplus of $39.1 million.
Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance
code, a domestic insurer may make dividend distributions upon proper notice to
the Department of Insurance, as long as the distribution is reasonable in
relation to adequate levels of policyholder surplus and
- 17 -
<PAGE>
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 $16.6 million at June 30,
1999. In June, 1999, Investors-IN paid a dividend in the amount of $3 million to
its sole shareholder, Investors-NA. The amount of the dividend was less than the
net gain from operations for the prior fiscal year. Advance notice of the
payment was provided to the Indiana Department of Insurance, in accordance with
the provisions of the Indiana Insurance Code.
The Form 10-Qs of ILCO for the six-month periods ended June 30, 1999 and June
30, 1998, set forth the business operations and financial results of ILCO and
its life insurance subsidiaries. Such 10-Q reports of ILCO, including the
discussion by ILCO's management under the caption "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" are incorporated
herein by reference.
Liquidity and Capital Resources:
FIC is a holding company whose principal assets consist of the common stock of
Family Life and its equity ownership in ILCO. FIC's primary sources of capital
consists of cash flow from operations of its subsidiaries.
The cash requirements of FIC and its subsidiaries consist primarily of its
service of the indebtedness created in connection with its ownership of Family
Life. As of June 30, 1999, the outstanding balance of such indebtedness was
$44.6 million on the Subordinated Notes granted by Investors-NA.
The principal source of liquidity for FIC's subsidiaries consists of the
periodic payment of principal and interest by Family Life pursuant to the terms
of a Surplus Debenture. The terms of the Surplus Debenture were previously
approved by the Washington Insurance Commissioner. Under the provisions of the
Surplus Debenture and current law, no prior approval of the Washington Insurance
Department is required for Family Life to pay interest or principal on the
Surplus Debenture; provided that, after giving effect to such payments, the
statutory surplus of Family Life is in excess of 6% of assets (the "surplus
floor"). However, Family Life has voluntarily agreed with the Washington
Insurance Commissioner that it will provide at least five days advance notice of
payments which it will make under the surplus debenture. As of June 30, 1999,
the statutory capital and surplus of Family Life was $27.9 million, an amount
substantially in excess of the surplus floor. As of June 30, 1999, the principal
balance of the Surplus Debenture was $18.4 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
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<PAGE>
the new law applies only to dividend payments, the ability of Family Life to
make principal and interest payments under the Surplus Debenture is not
affected. The Company does not anticipate that Family Life will have any
difficulty in making principal and interest payments on the Surplus Debenture in
the amounts necessary to enable Family Life Corporation to service its
indebtedness for the foreseeable future.
The sources of funds for Family Life consist of premium payments from
policyholders, investment income and the proceeds from the sale and redemption
of portfolio investments. These funds are applied primarily to provide for the
payment of claims under insurance and annuity policies, operating expenses,
taxes, investments in portfolio securities, shareholder dividends and payments
under the provisions of the Surplus Debenture.
FIC's net cash flow provided by operating activities was $(0.9) million in the
first six months of 1999, as compared to $3.2 million in the first six months of
1998. Net cash flow used in financing activities was $3.1 million in the first
six months of 1999, as compared to $3.1 million in the first six months of 1998.
In connection with the purchase of the Investors Life Companies by ILCO and the
purchase of Family Life by a wholly-owned subsidiary of FIC, FIC guaranteed the
payment of the indebtedness created in connection with such acquisitions. After
giving effect to the refinancing of the ILCO Senior Loan and the repayment of
the ILCO Subordinated Loans, the guaranty commitments of FIC with respect to the
debt obligations of ILCO related to the ILCO Senior Loan. The outstanding
principal balance of ILCO's senior loan obligations was $3.6 million at June 30,
1998. The final installment on the Senior Loan obligation scheduled for October
1, 1998, was prepaid on September 30, 1998. As a result, the Senior Loan
obligation of ILCO was fully discharged effective September 30, 1998, relieving
FIC of the guaranty commitments with respect to the debt obligations of ILCO.
The guaranty commitments of FIC under the loans incurred in connection with the
acquisition of Family Life (after taking into account the repayments and new
loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued
by Family Life Corporation to Investors Life Insurance Company of North America,
and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term investments
are sufficient to meet the needs of its business and to satisfy debt service.
There are no trends, commitments or capital asset requirements that are expected
to have an adverse effect on the liquidity of FIC.
Investments
As of June 30, 1999, the Company's investment assets totaled $106.8 million, as
compared to $118.8 million as of June 30, 1998.
The level of short-term investments at June 30, 1999 was $28.3 million, as
compared to $31.1 million as of June 30, 1998. The fixed maturities available
for sale portion represents $75.2
- 19 -
<PAGE>
million of investment assets as of June 30, 1999, as compared to $84.8 million
at June 30, 1998. The amortized cost of fixed maturities available for sale as
of June 30, 1999 was $74.5 million representing a net unrealized gain of $0.70
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 June 30, 1999, consisted
solely of fixed maturities investments which, in the annual statements of the
companies, as filed with state insurance departments, were designated under the
National Association of Insurance Commissioners ("NAIC") rating system as a "1"
(highest quality).
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $22.4 million and $188.4 million, respectively, and mortgage-backed
pass-through securities of $4.7 million and $27.2 million, respectively, at June
30, 1999. Mortgage-backed pass-through securities, sequential CMO's and support
bonds, which comprised approximately 42.6% of the book value of FIC's
mortgage-backed securities and 51.7% of the book value of ILCO's mortgage-backed
securities at June 30, 1999, are sensitive to prepayment and extension risks.
ILCO and FIC have reduced the risk of prepayment associated with mortgage-backed
securities by investing in planned amortization class ("PAC"), target
amortization class ("TAC") instruments and scheduled bonds. These investments
are designed to amortize in a predictable manner by shifting the risk of
prepayment of the underlying collateral to other investors in other tranches
("support classes") of the CMO. At June 30, 1999, PAC and TAC instruments and
scheduled bonds represented approximately 57.4% of the book value of FIC's
mortgage-backed securities and approximately 48.3% of the book value of ILCO's
mortgage-backed securities. Sequential and support classes represented
approximately 25.2% of the book value of FIC's mortgage-backed securities and
approximately 39.1% of the book value of ILCO's mortgage-backed securities at
June 30, 1999. In addition, FIC and ILCO limit the risk of prepayment of CMOs by
not paying a premium for any CMOs. ILCO and FIC do not invest in mortgage-backed
securities 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 June 30, 1999. The prepayment risk that certain
mortgage-backed securities are subject to is prevalent in periods of declining
interest rates, when mortgages may be repaid more rapidly than scheduled as
individuals refinance higher rate mortgages to take advantage of the lower
current rates. As a result, holders of mortgage-backed securities may receive
large prepayments on their investments which cannot be reinvested at an interest
rate comparable to the rate on the prepaying mortgages. Neither FIC nor ILCO
made additional investments in CMOs during 1998 and the first two quarters of
1999. The current investment objectives of both FIC and ILCO do not contemplate
additions to the portfolio
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<PAGE>
of CMO investments during the remainder of 1999.
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of its life insurance
subsidiary enhances the ability of the Company to service its debt, provide
security to its policyholders and to credit relatively consistent rates of
return to its policyholders.
Y2K Compliance
The Company and its subsidiaries utilize a centralized computer system to
process policyholder records and financial information. In addition, the Company
uses non-centralized computer terminals in connection with its operations. The
software programs used in connection with these systems will be affected by what
is referred to as the "Y2K date problem". This refers to the limitations of the
programming code in certain existing software programs to recognize date
sensitive information as the year 2000 approaches. Unless modified prior to the
year 2000, such systems may not properly recognize such information and could
generate erroneous data or cause a system to fail to operate properly.
The Company has evaluated its centralized computer systems and has developed a
plan to reach Y2K compliance. A central feature of the plan is to convert most
of the centralized systems to a common system which is already in compliance
with Y2K requirements. The Company is in the process of this systems conversion
and anticipates that the project will be completed in advance of the year 2000.
The Company has increased the budget for the implementation and completion of
the Plan from the prior years estimate. As of December 31, 1997, the Company had
budgeted approximately $330,000 for implementing the Plan. Based on its current
analysis, the Company expects that the cost of implementing and completing the
Plan will result in an after-tax expense of approximately $898,000 for the
three-year (1997 - 1999) conversion period. For the three month period ended
June 30, 1999, the Company has incurred an after tax expense of approximately
$46,000 in connection with the completion of the Plan. Between January 1, 1997
and June 30, 1999, the Company has expended approximately 80% 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 103,370 policies for Family Life) was completed in
March, 1998. The conversion of the Cypros AP system (administering approximately
17,990 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
- 21 -
<PAGE>
(administering approximately 42,000 active policies for Investors-NA at the time
of conversion) was converted to CK/4 in January of 1998. The conversion of the
Life 70 system (administering approximately 15,300 active policies for
Investors-IN) was completed in May of 1999. The modification of the Lifecomm-B
system which is responsible for the administration of approximately 17,000
active policies assumed after ILCO's acquisition of State Auto Life was also
completed. The conversion of the Lifecomm-A system (administering approximately
57,140 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.
- 22 -
<PAGE>
Cautionary Statements for Purposes of the "Safe
Harbor" Provisions of the Private Securities Litigation
Reform Act of 1995
Except for historical factual information set forth in this Management's
Discussion and Analysis, certain statements made in this report are forward
looking and contain information about financial results, economic conditions,
Y2K risks and other risks and known uncertainties. The Company cautions the
reader that actual results could differ materially from those anticipated by the
Company, depending upon the eventual outcome of certain factors, including: (1)
heightened competition for new business, (2) significant changes in interest
rates, (3) adverse regulatory changes affecting the business of insurance and
(4) adverse changes in the Y2K readiness of the Company or its significant third
party providers.
Accounting Developments
In December, 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", which provides guidance on accounting for
insurance-related assessments. The Company adopted SOP 97-3, effective January
1, 1999. The adoption of SOP 97-3 did not have a material impact on the
Company's results of operations, liquidity or financial position.
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133 is applicable to financial statements for all
fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133." As the Company does
not have significant investments in derivative financial instruments, the
adoption of FAS No. 133 does not have a material impact on the Company's results
of operations, liquidity or financial position.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General:
FIC's principal assets are financial instruments, which are subject to market
risks. Market risk is the risk of loss arising from adverse changes in market
rates, principally interest rates on fixed rate investments. For a discussion of
the Company's investment portfolio and the management of that portfolio to
reflect the nature of the underlying insurance obligations of the Company's
insurance subsidiaries, please refer to the information set forth in Item 2
"Management's Discussion and Analysis of Financial Conditions and Results of
Operation - Investments" of this report.
The following is a discussion of the Company's primary market risk sensitive
instruments. It
- 23 -
<PAGE>
should be noted that this discussion has been developed using estimates and
assumptions. Actual results may differ materially from those described below.
Further, the following discussion does not take into account actions which could
be taken by management in response to the assumed changes in market rates. In
addition, the discussion does not take into account other types of risks which
may be involved in the business operations of the Company, such as the
reinsurance recoveries on reinsurance treaties with third party insurers.
The primary market risk to the Company's investment portfolio is interest rate
risk. Since the Company own approximately 45% of the common stock of ILCO, the
interest rate risk of ILCO's fixed income portfolio has an effect on the value
of FIC's "investment in affiliate". The Company does not use derivative
financial instruments.
Interest Rate Risk:
(a) FIC's Fixed Income Investments:
Assuming an immediate increase of 100 basis points in interest rates,
the net hypothetical loss in fair market value related to the financial
instruments segment of the Company's balance sheet is estimated to be
$3.3 million at June 30, 1999 and $2.5 million at December 31, 1998.
For purposes of the foregoing estimate, the following categories of the
Company's fixed income investments were taken into account: (i) fixed
maturities, including fixed maturities available for sale, and (ii)
short-term investments. The market value of such assets was $103.6
million at June 30, 1999 and $107.0 million at December 31, 1998.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was
$27.5 million at June 30, 1999 and $33.9 million at December 31, 1998.
Assuming an immediate increase of 100 basis points in interest rates,
the net hypothetical loss in the fair market value related to such
mortgage-backed securities is estimated to be $1.6 million at June 30,
1999 and $1.2 million at December 31, 1998.
(b) FIC's Investment in Affiliate:
The value of FIC's investment in affiliate is affected by the amount of
unrealized gains and losses, net of tax, in the investment portfolio of
its affiliate, ILCO. Assuming an immediate increase of 100 basis points
in interest rates, the net hypothetical loss in value, net of tax,
related to the Company's investment in affiliate is estimated to be
$6.4 million at June 30, 1999 and $4.6 million at December 31, 1998.
The hypothetical effect of the interest rate risk on fair values was estimated
by applying a commonly used model. The model projects the impact of interest
rate changes on a range of factors, including duration and potential prepayment.
- 24 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
Part II.Other Information
Item 1. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact upon the
financial statements.
ILCO and Investors-NA are defendants in a lawsuit which was filed in October,
1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also
a named defendant in the lawsuit. The named plaintiffs in the suit (a husband
and wife), allege that the universal life insurance policies sold to them by INA
Life Insurance Company (a company which was merged into Investors- NA in 1992)
utilized unfair sales practices. The named plaintiffs seek reformation of the
life insurance contracts and an unspecified amount of damages. The named
plaintiffs also seek a class action as to similarly situated individuals. No
certification of a class has been granted as of the date hereof. The Company
believes that the suit is without merit and intends to vigorously defend this
matter.
In August, 1997, another individual filed a similar action in Travis County,
Texas against the corporate entities identified above. The lawsuit involves the
same type of policy and includes allegations which are substantially identical
to the allegations in the first action. The named plaintiff also seeks class
certification. The Company believes that the court would consider class
certification with respect to only one of these actions. The Company also
believes that this action is without merit and intends to vigorously defend this
matter.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of the Shareholders was held on May 18,
1999. The only matter submitted at the meeting to a vote of
the Shareholders was the election of directors. All of the
nominees had previoulsy served as directors of the Company,
and all were reelected as directors.
- 25 -
<PAGE>
The voting tabulation as to each nominee was as follows:
Name In Favor Withheld
Barnett, John D. 2,729,110 464,010
Crowe, Joseph F. 2,729,195 463,925
Demgen, Jeffrey H. 2,728,510 464,610
Fleron, Theodore A. 2,729,245 463,875
Grace, James M. 2,728,435 464,685
Mitte, Dale E. 2,726,475 466,645
Mitte, Roy F. 2,726,040 467,080
Parker, Frank 2,727,335 465,785
Payne, Dr. Eugene E. 2,729,095 464,025
Richmond, Thomas C. 2,729,110 464,010
Supple, Dr. Jerome H. 2,729,145 463,975
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Form 10-K Annual Report of Registrant for the year ended
December 31, 1998 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K:
None
- 26 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FINANCIAL INDUSTRIES CORPORATION
/s/ James M. Grace
James M. Grace, Treasurer
Date: August 13, 1999
- 27 -
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FOR 10-Q FOR
THE SIX MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCES
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 75,244
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 106,840
<CASH> 1,002
<RECOVER-REINSURE> 13,562
<DEFERRED-ACQUISITION> 50,635
<TOTAL-ASSETS> 295,523
<POLICY-LOSSES> 59,826
<UNEARNED-PREMIUMS> 14
<POLICY-OTHER> 44,681
<POLICY-HOLDER-FUNDS> 4,441
<NOTES-PAYABLE> 44,571
0
0
<COMMON> 1,169
<OTHER-SE> 113,601
<TOTAL-LIABILITY-AND-EQUITY> 295,523
17,682
<INVESTMENT-INCOME> 3,454
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 702
<BENEFITS> 7,933
<UNDERWRITING-AMORTIZATION> 2,383
<UNDERWRITING-OTHER> 5,722
<INCOME-PRETAX> 4,842
<INCOME-TAX> 773
<INCOME-CONTINUING> 4,069
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,069
<EPS-BASIC> 0.81
<EPS-DILUTED> 0.78
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
